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Tobacco bonds to see reduced payments next year

SAN FRANCISCO, Sept 19 | Thursday, 19 Sep 2013
(Reuters) – With smoking on the decline and no resolution yet to a refund dispute under the 1998 Tobacco Master Settlement Agreement for 11 states, payments that provide revenue for tobacco bonds are likely to fall next year, according to a report by an underwriter released on Thursday.

“The implications of higher-than-average smoking declines for this year do not bode well for 2014 payments,” HJ Sims director of credit analysis Richard Larkin said in the report.

Six states, which lost an arbitration last week, will have to share a repayment for $642 million, and total payments from the settlement are projected to be $6.78 billion next year, according to the report by one of the oldest underwriters of tax-exempt bonds in the United States.

Payments totaled $7.3 billion last year, according to the Campaign for Tobacco-Free Kids.

An arbitration panel last week ruled in favor of nine states and against six others in a bid to reduce payments by U.S. cigarette makers for 2003. Payments made in 2004 through 2012 are still in dispute before the panel.

Among 22 states which settled their dispute with cigarette makers, some are likely to see a drop in future payments.

“California, New Jersey & Virginia are now in a position where debt retirement will drop dramatically, debt reserves will be invaded, and the prospect for bond defaults accelerated, starting next year,” Larkin added.

States, counties and cities issued $40 billion of tobacco bonds backed by the more than $200 billion in payments that U.S. cigarette makers agreed to make to them over time to compensate for the cost of caring for sick smokers.

Larkin expects cigarette makers to continue disputing payments “thereby withholding portions of settlement payments or placing them in a disputed escrow account, preventing their use by states.”

Larkin said he now feels more confident about his forecast for tobacco bond defaults through 2047 than at any time since 2010.

“Of the projections I’ve done so far, the states that have tobacco bonds out and who settled in 2012-13, are still going to eventually default on tobacco bonds,” Larkin said.

Cash flow for Ohio’s “Buckeye” tobacco bonds will get a boost from the arbitration but that will only push out the date the debt defaults to later years because tobacco use is declining more than expected, Larkin said.

The arbitration panel last week found Ohio had complied with its part of the 1998 settlement between tobacco companies and 46 states. Ohio will gain $35 million from the decision for 2003.

The report concluded that arbitrations for following years could produce a different outcome for Ohio. “In my opinion Ohio could see a reversal of their ruling in the next round of arbitrations,” Larkin said. (Reporting by Jim Christie; Editing by Leslie Gevirtz)