No interest tax shield

No interest tax shield Another key offset to the lower corporate tax rate is the proposed ending of the deduction of net interest expense. We assume that this rule would apply to new debt and that existing debt would be grandfathered. This tax shield removal would increase the cost of debt by an incremental 25% (not to mention the 100bp+ rise in long-term interest rates seen since the summer of 2016). In the table below, we illustrate the impact on S&P 500 corporate profits. We estimate that over time, the removal of the interest rate deduction would detract about 4%, or $4-5 from S&P 500 2018 EPS, although the initial impact would be less significant given 70-90% of the debt is long term. Table 17: Estimated EPS impact from the removal of interest tax shield S&P 500 Non-Financials Net Debt ($mn) 2,899 Net DebtEBITDA 1.74 New tax rate 20% After-tax interest rate [interest rate w/ no tax shield * (1 - new tax rate)] 42% Interest rate w/ no tax shield [interest expense / net debt] 5.2% Change in cost of debt [(interest rate w/ no tax shield / after-tax interest rate) -1] 25% Potential profit impact (%) [(interest rate w/) no tax shield - after-tax interest rate) * (net debt / net income}] 4% Potential impact on 2018 EPS $4-5 Source: BofAML US Equity & US Quant Strategy, S&P, FactSet Many investors assume that interest deductions would likely apply only to new debt, and if this were the case, the drag would be gradual for the overall S&P 500 as debt matures and is refinanced. Companies have shifted the composition of their debt toward longer maturities and fixed rates. We estimate an average S&P 500 debt maturity of over eight years, with just one-third maturing within the next three years. The grandfathering of existing debt is a reasonable assumption, but not a sure thing, in our view. There is a possibility that legislators apply it to all debt on the grounds that most companies are expected to be net beneficiaries of comprehensive tax reform. There is also a possibility that this policy is phased in over a number of years, with certain portions of the existing debt losing their interest deductibility over time. Chart 17: Russell 1000 debt by type and Chart 18: Russell 1000 debt by type and Table 18: Russell 1000 estimated weighted maturity - 2007 maturity - October 2016 average debt maturity (ex-Financials & REITs) LT Sector Estimated Wtd Avg Maturity (years) ST Fixed ST UT Cons. Disc. 70 Floating, 5A 2% ikea, Cons. Staples 8.1 23.3% ; 66.6% Energy BA Health Care 8.0 Industrials 8.0 Materials 14 LT Technology 14 Floating, Telecom 108 19.7% ST aes 12.0 Fixed, otal 8.3 2 8% Source: FactSet, BofAML US Equity & US Quant Strategy Source: FactSet, BofAML US Equity & US Quant Strategy Source: FactSet, BofAML US Equity & US Quant Strategy The most negatively impacted companies would clearly be the ones with the most leverage, in addition to those with depressed earnings (Metals & Mining, Energy, etc.). While the Utilities sector has a lot of leverage, there would likely be a pass through to customers in determining their allowed rate increase. Bankof America Merrill Lynch Equity Strategy Focus Point | 29 January 2017. 17 HOUSE_OVERSIGHT_023085