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Chart 19: Sector EPS impact from ending Chart 20: Sector EPS impact from ending Chart 21: Sector EPS impact from ending interest deductibility (15% rate; ex- fin, utes) interest deductibility (20% rate; ex- fin, utes) interest deductibility (25% rate; ex- fin, utes) 8% 6% 4% 2% 0% -12%10%-8% -6% -4% -2% 0% 15% — -10% -5% 0% Energy -6.2% Telecom -5.9% Materials Energy -10.2% Telecom -96% Materials Energy Telecom Materials Discretionary Industrials Real Estate Staples Health Care Info Tech Discretionary Discretionary Industrials Real Estate Staples Health Care Info Tech Industrials Real Estate Staples Health Care Info Tech m 15% tax rate mw 20% tax rate mw 25% tax rate Source: BofAML US Equity & Quant Strategy, FactSet, S&P Source: BofAML US Equity & Quant Strategy, FactSet, S&P Source: BofAML US Equity & Quant Strategy, FactSet, S&P How will levered companies react? Companies will likely grow comfortable with a smaller amount of debt, retain more earnings, use less cash for dividends and share buybacks, and potentially draw down cash if they have it. If a tax holiday is also granted, that might offset the loss of benefit. Companies that regularly issue long-term debt may choose to reduce that burden to offset the tax change, and find those funds elsewhere. We find it unlikely that the change would result in a surge in equity issuance, unless the change applies to existing debt, which is unlikely in our view. While this change should be taken as a line item ina wholistic bill, there are victims and beneficiaries here. Corporations that have high leverage ratios, low retained earnings, high interest expense to earnings ratios, no cash overseas offset from repatriation, and those that have recurring long-term debt needs may be most at risk. Other implications While some argue that companies will try to raise outsized amounts of investment grade capital ahead of the deadline to lock in funding with the tax benefit before the loophole is closed, there is a reasonable chance that a provision is included in the legislation that would treat such debt as new debt. In our Investment Grade Strategist Hans Mikkelsen’s view, demand for IG credit could be materially reduced over time. The tax change could also dampen Leverage Buyout (LBQ) activity, according to our High Yield strategist Michael Contopoulos, where these funds are already struggling to generate high returns —note that LBO funds are currently sitting on close to $1tn in cash looking for a home, according to Preqin’s third quarter update. Who could be hurt: See Table 21 for a screen of stocks with high net interest expense as a percentage of net income which could potentially be hurt most by an end to the deductibility of interest expense. : , Bankof America 18 Equity Strategy Focus Point | 29 January 2017 Merrill Lynch HOUSE_OVERSIGHT_023086