The Tax Act has impacted the municipal bond market in a number of ways.
First, and probably most importantly, advance refunding bonds may no longer be issued on a tax-exempt basis. Under the Internal Revenue Code, an advance refunding is any refunding issue where the redemption of the refunded bonds occurs more than 90 days after the new issue. If the redemption occurs within the 90 day window, the refunding is considered a current refunding.
Under the previous law, issuers could issue current refunding bonds without limit, but only one tax-exempt advance refunding of an issue was permitted. Under the Tax Act, current refunding bonds are still eligible for tax-exempt treatment, but advance refunding bonds may only be issued on a taxable basis. It is expected that taxable advance refunding bonds will be issued, where the economics make sense or if the refunding is still required for non-savings purposes.
Second, the Tax Act did not reauthorize most tax-credit bonds, including QZABs, QSCBs, QECBs and CREBs. No new tax credit bonds may be issued in the future, although new market tax credits and federal historic tax credits were not affected, so those options may still be available for eligible projects.
Additionally, Congress did not include any transition rules in the adopted Tax Act which might preserve the credit for refunding issues, so any existing tax credit bonds that need to be refunded for any reason will lose the tax credit subsidy. This means that there will be no federal subsidy paid for refunding existing tax credit bonds. So, in all likelihood, any refunding would be made from traditional tax exempt bonds.
Third, the elimination of the alternative minimum tax on corporations means that tax-exempt bonds subject to AMT (certain exempt facility and other private activity bonds) are now more attractive to corporate investors. It’s unclear how much this will move the needle on pricing for AMT bonds.
On a separate, but related issue, many existing privately placed tax-exempt bonds included rate adjustment language preserving the after-tax yield for investors if there was a change in the marginal corporate tax rate. The drop in the corporate rate from 35% to 21% may trigger those provisions, so existing issuers should consult their bond counsel and/or financial advisor to review their existing obligations to see if they might be notified of a rate increase and consider if any refunding may be appropriate.