That would change the nature of the market. Can the banking system provide them with financing? Could muni bond banks expand because of the cost pressure on small municipalities?
Also, at some point, the level of spending will be lower and not grow as much and there will be pressure to have more balance at the government level. That will put increased pressure on credit quality — particularly any project or financing needs that have federal money involved.
You have to have some concerns about the credit worthiness of the bonds in your portfolio. You want strong claims on the money – that matters a lot to us.
If there’s less federal money flowing through the state and local government — specific programs or block grants of one kind or another — for mass transit, highways, education, then there would be pressure on all of those intergovernmental transfers.
All you have to do is put in a 10% or 15% cut — depending on how vulnerable the entity is — and that can be material. You don’t even have to go to the hard scenarios or be as severe as the fiscal cliff. It’s hard to see how any resolution of budget issues doesn’t involve some reduction in payments.
James Colby, senior municipal strategist and portfolio manager at Van Eck Securities, who helps manage $1.85 billion of municipal bond ETFs:
Regardless of which candidate emerges victorious, the Congressional outcomes will dictate policy for the next four years, since it does appear that there will be no change in the balance of power that could lead to a painfully-slow approach to implementation of new ideas.
Pronouncements from both parties have included some serious elements which, if pursued, would undermine the current utility of the tax-exemption provided in municipal finance. Strong efforts need to be made to present a balanced view, to ensure that any outcome does not seriously impact small issuers’ access to the capital markets or inadvertently increase taxpayer’s burden during the nation’s struggle to regain its financial footing.
Even after the election decides the next leadership team, as well as the framework, or “platform,” out of which political initiatives will likely drive expectations, market fundamentals will continue to frame current opportunities in the municipal market.
Anthony Valeri, senior vice president and market strategist at LPL Financial, which managesover $350 billion in total assets:
The biggest concern is a Republican sweep where Gov. Romney’s proposed tax plans stand the greatest chance of coming to fruition. These include lowering tax rates — 28% would be the top — and also excluding all investment income for those earning less than $200,000 per year.
The tax treatment of municipal bond interest income may come under scrutiny regardless of who wins the White House because the exemption of municipal bond interest income is one of the largest tax expenditures of the U.S. government.
Of the two, the latter is more dangerous to municipal bonds, but both would reduce demand for municipal bonds. Roughly 50% of municipal bonds are owned by individuals making less than $200,000 per year. The exclusion would make all other investments — including stocks — more attractive relative to municipal bonds.
Capping the municipal exemption at 28% would make municipal bonds less attractive, but not by a lot since they’re cheap already, but it could be the final catalyst needed to sell given strong year-to-date performance and record low yields.
The biggest expectation is that more than likely nothing substantive will happen to municipal bonds. A split Congress — a likely outcome — would mean that the Senate will likely stop any tax cuts from passing and vice versa; and the House will likely kibosh any tax hikes. The status quo is likely to be maintained. Furthermore, municipal tax exemption has been challenged numerous times over the years with legislation often dying in Congress. The fact of the matter is that there is no viable alternative to tax-exempt financing. Raising borrowing costs, by doing away with the tax exemption, would likely leave states and municipalities going back to Washington for direct aid.
So eliminating, or reducing, the tax-exemption doesn’t necessarily mean it will lessen Washington’s need to provide some assistance to states and municipalities.
I expect the impact from the election to be modest. Should Obama win, we are not expecting rates to fall much lower than current levels.
