Republican U.S. tax plan sets municipal bonds off on shaky ride

NEW YORK, Nov 3 (Reuters) - The U.S. tax restructuring plan unveiled by Republican lawmakers on Thursday proposed changes that would remove tax advantages of some types of municipal bonds at a time of robust market performance and, in the coming week, a hefty issuance calendar.

In weeks ahead, negotiations over the plan will likely leave the $3.8 trillion municipal bond market with a higher level of uncertainty as the proposal contained surprise provisions that would change several popular areas of the market.

"While most of its provisions were expected, and rather benign for the asset class, policymakers surprised muni investors by curtailing the eligibility to issue certain types of tax-exempt bonds," Barclays Capital said in a report on Friday.

For example, the plan would curtail tax advantages enjoyed by private activity bonds (PABs), advanced refundings and debt for professional sports stadiums.

"Near term, we expect a short-lived spike in issuance as some of the 2018 advance refunding and PAB is pulled into 2017. There is ample cash to absorb it, but (benchmark municipal yield to U.S. Treasury yield) ratios might increase as a result, though we would view it a buying opportunity, due to likely slower supply in 2018," Barclays wrote.

Next week, there is an above-average $9.18 billion supply of bonds and notes expected to come to market.

Leading the pack in competitive offerings is Pennsylvania, set to issue $973.99 million in general obligation refunding bonds on Nov. 8. Pennsylvania's debt is rated Aa3 by Moody's Investors Service, A-plus by S&P Global and AA-minus by Fitch.

The biggest negotiated deal comes from Arizona's Salt River Project Agricultural Improvement and Power District, which plans to offer $736,04 million of Salt River Project Electric System Revenue Bonds on Nov. 6.


Under the plan, various tax-free bonds would be eliminated or changed, such as PABs, typically used to fund capital projects for airports, non-profit hospitals and affordable housing entities.

Advanced refunding bonds are also nixed under the tax plan. Tax-credit bonds would be repealed, but federal tax credits for existing bonds would remain. Debt issued for professional sports facilities would no longer receive tax-free benefits.

The bill cuts corporate tax rates to 20 percent, which could lower demand for municipal bonds among corporations seeking to lower their tax bill, some fixed-income advisors say.

However, removal of state and local tax deductions could make tax-exempt municipal bonds more attractive as individuals seek to lower their taxable income. (Additional reporting by Karen Pierog in Chicago; editing by Daniel Bases and David Gregorio)