It has only been two months since the new administration has been in the White House. At the time the 2017 Outlook was published, we discussed numerous “Gray Swans” that we anticipated could impact the muni market, but could not quantify the degree of their impact. After 60+ days, we feel it is time to revisit our “concerns” as we now have a little better feel for direction of things and where these Gray Swans may be migrating. It appears to us that the muni market overreacted to these possible Gray swan events, and that the reality of “reforms” has munis in a good place.
Income Tax Reforms – After the inability to replace Obamacare, there is a lot of question as to whether tax reform will be successful. Even if it is, we feel it will not be the poison many originally thought it would be for munis. Instead of lowering the tax rate to 28%, it now seems the plan is a three-bracket system with 33% being the highest, followed by 25% and 12%. If this is the case, the muni market will not be adversely impacted. In fact, it may slightly outperform, as we felt the market priced in a 30% rate.
Corporate Tax Reforms – The original plan was to take the corporate tax rate to 15% from 35%. It appears a more likely change will be to 25%. Once again, this is much more muni friendly than the market’s original valuation in November/December 2016.
A Large Infrastructure Funding Program – All indications point to this not happening until 2018 and still leaning towards tax credits. The additional issuance for local projects that provide tax credits would have been a burden on the municipal market in 2017. The longer this program takes to be enacted, the better it is for the muni market. It also helps the chances that the use of inefficient tax credits will be reevaluated for a more efficient program. Once again, this is a positive development for munis to outperform.
A new Record Issuance? It does not look like this will happen in 2017. The slight increase in rates seems to have had an adverse impact on refunding activity. Add to this the lack of any sort of infrastructure program, and you get a decrease in muni supply. As of March 31, issuance is 10.6% below 2016, and the trend seems to be down. This will help munis perform better, as fewer bonds are being issued.
Credit concerns on the Muni Horizon – Other than Puerto Rico looking like a complete loss (new estimates of a 25% payout), the muni credit horizon remains clear. We still feel things could get ugly this summer if Illinois does not get a budget passed. This remains a Gray Swan without much direction.