By Joan Gralla
July 12 The majority of tobacco bonds sold by U.S. states, counties and cities will default if cigarette consumption keeps falling at a 3 percent to 4 percent annual pace, Moody's Investors Service said on Thursday.
Municipal tobacco bonds are backed by the more than $200 billion in payments cigarette-makers agreed to make over time to states to help pay for the costs of treating ailing smokers.
Under the scenario of declining smoking that Moody's projected, "Bonds constituting 74 percent of the aggregate outstanding balance of all the tobacco settlement bonds will default," the Wall Street credit agency said in a statement.
Some 15 tranches that make up 33 percent of the rated bonds would default if cigarette consumption declines 3 percent a year, Moody's said. Another 25 tranches, equal to 41 percent of the outstanding debt, would default if consumption declines 4 percent a year.
A Moody's spokesman said the credit agency has never predicted any possible date of any defaults.
James Colby, chief municipal strategist for Van Eck Global, said he had not seen the Moody's report, but "Prior analyses have suggested that the earliest that some of these will exhibit stress is four to five years off."
Moody's rates a total of $20.4 billion in 32 tobacco bond securitizations. Some 79 percent of them are rated B1 or lower. That speculative grade rating is three notches above the "substantial risk" ranking.
Moody's, in a chart, ranked the bonds it rates by their break-even point in consumption. The break-even estimates the rate of decline in cigarette consumption that would lead to a default for each bond. For example, debt with an average consumption break-even rate of more than 24 percent is rated A1. Debt with a break-even point of just above 2 percent is rated B3 or Caa1.
Arkansas Development Finance Authority Tobacco Settlement Revenue Bonds, Series 2001, have a break-even point of more than 25 percent.
In contrast, California County Tobacco Securitization Agency (Los Angeles County Securitization Corporation) Series 2006A Convertible Turbo Bonds have a break-even point of 3.5 percent to 4 percent.
After the Moody's release, yields for a few tobacco bonds eased.
The 2047 Buckeye Ohio tobacco bonds traded at yields ranging from 7.3 percent to 7.5 percent just a few minutes after the Moody's report, according to pricing data compiled by Municipal Market Data, a Thomson Reuters company. Earlier that morning, issues changed hands at 7.6 percent to 7.7 percent.
"Because we are in this low interest rate environment, and will continue to be for some time, tobacco (debt) because of its liquidity ... is actively sought after," said Colby.