By Lisa Lambert
WASHINGTON, Dec 20 (Reuters) - A deal announced this week
with tobacco companies will distribute money that has been tied
up for years to 17 states, but the funds may provide only
short-term relief to underfunded tobacco bonds.
Cigarette makers, including Philip Morris USA and R.J.
Reynolds Tobacco Co, on Tuesday announced a settlement with the
states in a long-running dispute over the amount of payments
they are required to make under the 1998 landmark anti-smoking
The settlement gives states a share of $4 billion in
disputed payments currently held in escrow. The manufacturers
will receive credits against future payments.
Rating agencies have recently raised red flags that
declining tobacco consumption could affect the future of those
bonds. The settlement will provide certainty and will free up
some cash, but it will likely not wipe out the risk of defaults
on the debt, said Richard Larkin, senior vice president of
Herbert J. Sims & Co, Inc and a longtime tobacco bond analyst.
The deal will be "a one-time windfall that will improve debt
coverage in 2013, but that windfall will be reduced by the 50
percent refund requirements," said Larkin.
He said a total of $1.68 billion will be paid to the states
in April 2013, but cigarette companies will receive $1.6 billion
in refunds over the next five years as credits.
The 1998 agreement, which involved almost all 50 states,
included a section designed to level the playing field between
companies that signed it and those that did not. It cut the
signing companies' payments to the states by an amount
equivalent to the market share the companies lost to the firms
that did not sign the agreement.
Those reductions created a long-standing fight, with the
participating companies arguing that their sales are not big
enough to justify payments. They put the sums they dispute into
escrow, keeping states, the District of Columbia and Puerto Rico
from collecting the money.
"The settlement, if approved, will increase the amount of
money that the District receives," said David Umansky, spokesman
for Washington D.C.'s chief financial officer. "In particular,
the settlement will limit the ability of tobacco companies to
withhold amounts from future payments to the District."
Georgia will get $56 million in 2013 from the settlement,
said state Attorney General Sam Olens. He added that the
agreement saved the state legal costs and ensures continued cash
flows in the future that are now mostly used for health
"We did not securitize any of our tobacco funds. It will not
impact any of our outstanding debts," said Susan Ridley,
director of Georgia's Financing and Investment Division.
Arkansas sold only about $5 million in bonds, and the $24.2
million it receives in 2013 from the settlement will mostly go
to the state's public health programs dealing with cigarette
addiction, according to Brad Phelps, the state's deputy
attorney-general, who helped craft the settlement.
States, counties and cities have sold nearly $40 billion of
bonds backed by the more than $200 billion in payments that U.S.
cigarette makers agreed to make to them over time.
"I know this is good for tobacco bonds but it's not like it
completely solved the shortfall problems," Larkin said, noting
the companies' credits will mean states do not receive the total
sum they anticipated. "They're not going to get as much money as
they originally thought, but they're going to get more money
than they were getting.
"It's just going to delay the year when they run out of
money and they don't have enough to cover all their bonds. It's
a major development, but it's very complicated," he said.
California, one of the largest issuers of tobacco bonds,
said the settlement would provide no new net benefit to its
bottom line. The bonds were sold by the Golden State Tobacco
Corporation, which in turn paid the state, according to the
state treasury department, and that corporation is entitled to
Attorneys general for New Jersey and Virginia, also major
tobacco bond issuers, did not respond to requests for comment.
According to Standard & Poor's, Virginia has sold more than $1
billion in tobacco bonds, and New Jersey more than $3.5 billion.
Larkin analyzed how the terms of the settlement would affect
Virginia. In 2013, the state would receive $82 million "freed
escrow funds, but would simultaneously also see about $38
million held back for the refund," he wrote in a note on the
settlement. The net new funds to the state over the next five
years would be only about $7 million.
Virginia and California have had to tap reserves to repay
bondholders and "the 2013 windfall would allow them to actually
add back to reserve funds," Larkin wrote. "In 2014, however,
renewed refunds will weaken cash flow and perhaps put these
states into a situation where reserves will again be needed."
The other states in the settlement - Alabama, Arizona,
Kansas, Louisiana, Michigan, Nebraska, Nevada, New Hampshire,
North Carolina, Tennessee, West Virginia and Wyoming - also
could not be reached for comment. Puerto Rico is part of the
settlement, as well.
If more states join the settlement, the percentage of
refunds to the companies could be reduced, Larkin said.
"If nothing changes and no new states sign the agreement,
cash flow shortages and slower than expected turbo redemptions
will continue to leave states like California and New Jersey
with projected bond defaults in about 17-22 years unless
consumption declines improve," Larking concluded.
In July, Moody's Investors Service warned that the majority
of tobacco bonds will default if cigarette consumption keeps
falling at a 3 percent to 4 percent pace.
The debt often outperforms the rest of the $3.7 trillion
U.S. municipal bond market.
(Additional reporting by Michael Connor)
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