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Figure 2: Bloomberg’s 10-year AAA Bank Qualified Municipal Bond Index
                                                                                      As I noted last November,
                                                                                      banks  represent  a relatively
                                                                                      small      percentage       of
                                                                                      municipal     bond    holders
                                                                                      (Figure  3  below).  Through
                                                                                      the end of 2016, banks held
                                                                                      15.7%  of  municipal  bonds
                                                                                      outstanding.  In  the  retail
                                                                                      sector, individuals and mutual
                                                                                      funds held 70.2% through the
                                                                                      end of last year. However,
                                                                                      the increase in bank holdings
                                                                                      over the  past  decade  has
                                                                                      nearly doubled.  Given  that
                                                                                      banks would see the largest
                                                                                      tax rate reductions, there’s a
         possibility that at least some banks will reduce their municipal holdings.

         Figure 3: Municipal Holders 1996 – 2016

                                                                                       Passage of tax reform faces
                                                                                       many    hurdles.   President
                                                                                       Trump has  already said
                                                                                       he’d leave it up to Congress
                                                                                       to  determine  what  the  top
                                                                                       tax  rate  should  be.  Some
                                                                                       have speculated  that would
                                                                                       include  adding  a  fourth
                                                                                       bracket for the  highest
                                                                                       wage earners. Moreover,
                                                                                       the  elimination  of  state and
                                                                                       local tax deductions  would
                                                                                       be  a negative for municipal
                                                                                       issuers, so we’d expect push
                                                                                       back  from  both  sides  of
                                                                                       the isle on that front. One
         positive for municipal holders would be the removal of the AMT. This would bring back many buyers of
         munis that we’re previously out of the market for munis subject to the AMT. These bonds, largely issued
         by airports and housing developers, generally trade at a discount to traditional tax exempt municipals but
         would rally if the AMT is eliminated.
         At this point, there is a great deal of uncertainty surrounding the impact to the municipal market under the
         current tax reform framework. If tax reform gets through the House and Senate, there’s a high probability
         that  we’ll  see  changes  to  the  plan  under  its  current  form. Municipal  investments  have  long  provided
         attractive yields for banks relative to alternative sectors of the same credit quality, and should remain so
         under lower tax rates. However, municipal investors should continue to monitor potential changes to the
         tax code that might impact their appetite for tax-exempt income. n

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