The municipal bond market is still coming to terms with the full implications of the tax law changes enacted late last year, according to participants at a panel on tax reform at the Bond Buyer’s National Outlook Conference.

John Puig, managing director of RBC Capital Markets moderated the panel at the Metropolitan Club in Manhattan on Wednesday.

John Puig, managing director at RBC Capital Markets, moderates a panel on tax reform at the Bond Buyer's National Outlook Conference on Wednesday
John Puig, managing director at RBC Capital Markets, moderates a panel on tax reform at the Bond Buyer's National Outlook Conference on Wednesday Chip Barnett

Some of the panel members had different views about whether advance refundings could be revived in the future, possibly in infrastructure legislation. The new tax law prohibited tax-exempt advance refundings from being done after Dec. 31.

“I don’t think that’s going to happen any time soon,” said Michael Decker, managing director and co-head of municipal securities at the Securities Industry and Financial Markets Association. “I think advance refundings are largely lost and there’s really not a high likelihood that there will be any kind of change to that provision in the near term.”

But Emily Swenson Brock, director of the Government Finance Officers Association's federal liaison center, said GFOA is still fighting to bring advance refundings back.

She said the GFOA, which has about 19,300 members, continues to talk with federal lawmakers about the benefits of advance refundings.

“The advance refunding conversation is still alive,” she said. “We’re keeping it alive and we’re continuing to keep it alive because you can’t talk about infrastructure without talking about essential elements of the tax code.”

Brock said that “the biggest challenge right now in Washington is that they have moved on,” she said. “Moved on from tax reform and are saying that infrastructure is next. ‘We did it. Hurrah! Now we’re moving on.’ We haven’t moved on. And the issuer community hasn’t moved on.”

Brock has been encouraged that a six-page draft outline of the administration's infrastructure plan that was recently leaked proposed expanding private activity bonds used for infrastructure and allowing them to be advance refunded.

But Decker said he thinks that was an old draft that pre-dated enactment of the new tax law, which terminated advance refundings.

Decker said that SIFMA members are now focusing how to address the loss of advance refundings in the context of helping issuers manage their debt portfolios.

“I think that bankers and bond lawyers and issuers are looking at transactions like synthetic-type refundings using some type of derivative product for current refundings,” he said.

He said that advance refundings made up 25% of the market in 2016 – and that while some of that volume will be lost, some will not as issuers turn to current refundings and other alternatives.

Jessica Giroux, the National Association of Bond Lawyers’ director of governmental affairs, said her 2,700 member organization is working on a paper on alternatives to advance refundings.

“It’s going to briefly identify considerations for structuring new financings … and will describe known alternatives to tax-exempt advance refunding bonds and identify issues for consideration in structuring new transactions in light of the advance refunding ban,” said Giroux.

Howard Cure, director of municipal bond research at Evercore Wealth Management, said the market will be looking at several possible alternatives after the end of advance refundings.

“What could we be expecting to see that we haven’t seen yet because of the lack of advance refundings," he asked. "Will you see shorter call dates -- shorter than 10-years, maybe in five-years? Will you see lower coupons or par bonds?”

Cure cautioned issuers about the use of synthetic products because there were “a lot of issuers in the past, small issuers, that frankly got in way over their heads and didn't really understood the mechanics" of them.

Decker suggested these concerns may be unwarranted in the current environment.

“The regulatory scheme for over-the-counter derivatives in general was changed significantly under the Dodd-Frank Act,” Decker said. “During the heyday on the municipal interest-rate swap business, over-the-counter derivatives like swaps and forwards were almost entirely unregulated. Under Dodd-Frank, there’s a very rigorous regulatory scheme in place regulating swap dealers, swap products and other kinds of derivatives. And special rules apply to state and local governments … it’s a very different environment now with many more protections for issuers now than there were in the old days.”

From a credit perspective, rating agencies are looking at how the tax changes are “flowing through and how it’s going to impact credit quality,” said Jane Hudson Ridley senior director at S&P Global Ratings, especially in the local government sector. “There are more risks and unknowns than opportunities and that is in large part due to the tax reform and how that will flow through.”

She added that given the historic strength in the local government sector, S&P doesn’t expected there to be widespread credit changes, but that it will take some time to assess what the impact will be to credit quality.

She added at the state level there were two stories – the higher-taxed blue States that may get pinched by the new law with the loss of deductions and the lower-taxed red States which may see a benefit from having residents with more cash in their pockets to spend.

Decker also noted the loss of tax credit bonds.

“It was a handful of small programs, so it doesn’t have widespread implications,” Decker said, “but for some issuers that product was very popular and it’s unfortunate that we won’t have those anymore.” The tax law prohibited those after the end of 2017 as well.

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