New York Tobacco Refinancing Might Yield $500 Million
Oct. 30 (Bloomberg) — Tobacco bonds that helped New York close a budget deficit in 2003 could be refinanced and provide $500 million to help eliminate this year’s $3.2 billion spending gap, according to a plan bankers presented to state officials.
The proposal by Morgan Stanley and Bank of America Corp.’s Merrill Lynch & Co. would have the state sell new bonds with the double-barreled backing of annual payments from cigarette makers, and state appropriations if needed, said Travis Proulx, a spokesman for Democratic Senate leader John Sampson of Brooklyn. The existing bonds have such a dual guarantee.
“Refinancing of tobacco bonds could provide for immediate revenue to the state — upwards of $500 million,” Sampson said in a statement yesterday. “We must explore that option” to help avoid Governor David Paterson’s proposed cuts in education and health care, he said.
States and municipalities sold $37 billion in tobacco bonds to cash in on their shares of a 1998 settlement with cigarette makers. The bonds have been one of the strongest sectors of the municipal bond market this year. Investors’ total return from interest payments and price gains on tobacco bonds was 31.9 percent in the first nine months, according to a Merrill Lynch index.
The new bonds would have a thinner cushion of cigarette company payments than the existing $3.59 billion of bonds, allowing additional debt to be issued with proceeds to help close the budget gap, Proulx said.
Paterson called the idea “dead” at a public meeting in New York City yesterday. Jennifer Sala, a spokeswoman for Morgan Stanley, and Kerrie McHugh, a spokeswoman for Merrill Lynch, declined to comment.
At an Oct. 21 meeting with Sampson and other legislative leaders, Paterson said the savings might be only $25 million. The governor said that wouldn’t provide the immediate cash needed by mid-December, when the state faces payments of $5.1 billion to schools and local governments and expects to have only $2 billion in cash on hand.
Questions to Paterson about the discrepancy between his description of savings and Sampson’s were referred to the Division of Budget.
“We are not currently exploring the proposal as a viable option at this time given Governor Paterson’s stated position that we need to focus on recurring spending reductions,” said Matt Anderson, a spokesman for the Division of the Budget. The state’s 2003 tobacco bond sale helped lead to a reduction in its general obligation bond rating to AA- by Fitch Ratings, Anderson said.
‘Appetite in the Market’
“Given the appetite in the market, we could go down in coverage a little bit and still attract investors at rates that would be lower than for existing bonds,” said Larry Soule, deputy secretary of the Senate Finance Committee and a former public finance banker and municipal bond analyst at Moody’s Investors Services. The state’s potential gain declines as interest rates rise, he said.
Payments from tobacco companies would equal about 1.2 times the interest and principal payments on new bonds, compared with 1.5 times for those sold in 2003. The bonds would be backed by fewer cigarette company payments, meaning the state would face an increased risk that in future years it would have to provide money if tobacco payments aren’t enough to pay bondholders, Soule said. That risk isn’t “significant,” he said.
Declining numbers of smokers, partly the result of higher cigarette taxes, have led tobacco companies to reduce their payments and to dispute the amounts they owe, according to the state’s July 29 updated annual information statement. Bankers say there is still enough projected revenue to support a new, larger bond sale, according to Soule.
Projections of cigarette sales used in bond documents are too high, and don’t adequately reflect the impact of higher federal and state taxes, said Richard Larkin, director of municipal bond research at Herbert J. Sims, an Iselin, New Jersey-based municipal bond firm.
“Cigarette consumption this year is down 10 percent,” Larkin said, based on federal and tobacco company data.
Larkin said buyers of any new bonds would have to assess the risk of lower-than-projected payments by tobacco companies and the risk that the state’s bond rating may be put under review for a downgrade because of declining revenue.
Paterson said yesterday his focus on spending cuts will help avoid a lower bond rating.
New York’s existing tobacco bonds are rated AA- by Standard & Poor’s, the fourth highest rating and one level lower than bonds backed by the state’s full faith and credit, according to the budget office.
Spending cuts of $480 million for aid to schools and $287 million for Medicaid are part of Paterson’s two-year, $5 billion plan. Since he became governor in 2008, Paterson has often criticized previous bond sales that are now part of the state’s $54 billion of debt, and said New York “can’t afford” to sell more bonds to pay for budget gaps.
Other states and local governments have squeezed cash from old tobacco bonds to help balance their budgets. Wisconsin collected $309 million in March when it sold $1.54 billion of bonds backed by state appropriations to refinance debt issued by Badger Tobacco Asset Securitization Corp. New Jersey, Virginia, California, and Westchester County in New York are among other governments that have sold new tobacco-backed bonds to take advantage of lower interest rates and raise cash.
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