The New Tax Law Brings Securitized Bonds to the Forefront
President Trump’s tax plan could cause issuers to launch five-, 10-, or 30-year bonds with five-year calls. This is good news for millennials who want to protect themselves from a rising interest rate environment and who desire to diversify an all-stock portfolio.
Millennials can benefit from investing in some floating-rate securitized bonds for their higher-inflation and property prices and to earn spread above risk-free investments, such as treasury bonds and T-bills.
Why Securitized Bonds?
Among the shorter fixed-income investments currently available, securitized bonds are attractive because of durations as low as 30 days. Unlike private activity bonds, securitized bonds can be backed by pools of mortgages, leases, auto loans, student loans, or commercial mortgage loans, for example, and their issuance is typically a mix of fixed and floating rate bonds, while T-bills and treasury bonds are issued by the federal government to fund its operations.
Experts expect securitized bonds to do well because of the environment created by the new tax law.
For example, the coupon on a floating-rate securitized bond is indexed to one- or three-month LIBOR benchmark rates for short-term loans, which are expected to increase as the Federal Reserve Bank shortens term rates.
No More Advance Refunding
At the core of the shorter-duration trend overall is the disallowance of advance refunding issuance under Trump’s tax plan.
“It’s a direct contributor to decreased supply, accounting for about 20 percent of the market,” said Adam Weigold, vice president of Eaton Vance Management and senior portfolio manager on Eaton Vance’s municipal bond team.
Homeownership and the New Tax Law
The new tax law is at best neutral and at worst negative for homeowners, who could bear the brunt in expensive coastal areas of states such as New York, Connecticut, New Jersey, and California, where home values and state, local, and property tax rates are higher.
That’s because, under this tax reform, interest deductibility is limited to the first $750,000 of mortgage debt — instead of the first $1 million — for loans leveraged after December 14, 2017. Plus, the total deduction for state, local, and property taxes is $10,000, where it used to be uncapped.
Final Thoughts on Securitized Bonds and the New Tax Law
According to experts, the interest and capital gains on low-duration securitized investments are fully taxable under both the old and the new tax frameworks. It is at the asset level where the rules have changed — such as that of a homebuyer or a commercial real-estate investor.
This is particularly relevant to millennials because they are the largest group of homebuyers, according to Ellie Mae, a software company that analyzes mortgage data.
What makes floating rate securitized bonds interesting now is that they hold their value in rising-rate environments better than fixed-rate bonds. As a result, low-duration securitized assets that are not as interest-rate sensitive — such as non-agency mortgages, commercial mortgages, mortgaged back securities, and collateralized loan obligations — could emerge as leading investments under the revised tax code.