Even before we knew what kind of tax reform we would end up with, it was obvious that the municipal bond market was a target of the president and Congress. The list of restrictions on and outright bans on certain types of municipal bonds was downright dizzying. While the new law does bring some changes, municipal bond investors should consider themselves fortunate that the legislation wasn’t any worse.
As any veteran of the municipal market will tell you, there have been countless threats to the tax status of muni bonds and the way they are issued, but these threats typically turn out to be smoke and mirrors. We will remember 2018 as the year that Congress really set the municipal market in its cross-hairs, though.
Two changes make a bullish case
Under the new tax law, municipal issuers cannot conduct advanced refunding. This practice, whereby issuers of muni bonds have the option to call bonds with longer maturities and reissue them with lower coupon rates, provides relief to issuers in decreasing interest rate environments. In the new environment, all existing municipal bonds will mature. As a result, the municipal market will shrink, given estimates that advance refunding currently account for up to 17 percent of municipal bond issuance.
The limits for deducting state tax against a federal tax bill is now $10,000, so munis will now be more attractive to affluent investors in high-tax states such as California, Connecticut, Maryland, New York, and New Jersey.
These factors make for a bullish case for the municipal market. Increased demand for a shrinking market will mean an increase in prices, regardless of what interest rates do.
Now that corporations and insurance companies find themselves with the good fortunate of lower tax rates, they will not be chasing after municipal bonds as much as in the past.
Leveraged corporations will have less of an incentive to borrow under the new law, and in fact, may start aggressively paying down debt in light of lower tax rates and new depreciation rules.
Clearly, there is a lot of uncertainty. Only time will tell how corporate and individual investors will react to the new tax law.
What options are out there for individuals?
With over 50,000 municipal issuers and over 1.5 million CUSIPs, where do investors even begin? Let’s look at just a few of the most solid municipal investment out there.
Large seaports and airport are perennial favorites, and good choices are easy to find just by surveying lists of the top ten seaports and airports in the U.S. You’ll recognize most of these names.
Top Ten U.S. Seaports:
- Los Angeles
- Long Beach
- New York/New Jersey
- South Carolina
Top Ten U.S. Airports
- Los Angeles International
- Hartsfield – Atlanta
- JFK International – New York
- O’Hare International – Chicago
- Phoenix Sky Harbor
- Dallas/Ft. Worth
- San Francisco International
- Denver International
- McCarran International – Las Vegas
- George Bush International – Houston
Stick with highly-rated seniors
Reduce your credit risk exposure by sticking to senior liens. Compared to junior debt, the difference in yield just isn’t worth the risk. Buy new issues only if possible so you’ll be getting the same price as the big mutual fund companies. Check the issuer’s credit rating and only go with the highest tiers, ensuring that tax-free income keeps rolling in.
We believe municipal bond yields will improve in 2018 unless an unexpected market event takes place. With careful selection of the issues you decide to invest in, success will be yours no matter what comes out of Congress next.
Yorkville Advisors are a global investment partner