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Tobacco Deal Goes To Barclays

CHICAGO — Minnesota has selected Barclays Capital to lead a team of eight underwriting firms that will bring the state’s first ever tobacco bond sale to market this fall.

Bank of America Merrill Lynch and Jefferies & Co. will serve as co-senior managers while Citi, RBC Capital Markets, Wells Fargo Securities, Samuel A. Ramirez & Co., and U.S. Bank will round out the team, according to Minnesota Management and Budget assistant commissioner for treasury Kristin Hanson.

Public Financial Management Inc. is financial advisor to the state and Kutak Rock LLP is transaction and bond counsel.

Barclays served as lead manager on the New York State Tobacco Settlement Financing Corp.’s refunding of $975.5 million of bonds earlier this summer.

In the Midwest, Barclays served as co-book-runner with Citi, which was in the lead spot, on Illinois’ $1.75 billion sale late last year and led the team on Wisconsin’s issue that refunded $1.4 billion of tobacco bonds in 2009.

Barclays became a top player in the tobacco sector after it acquired Lehman Brothers’ broker-dealer after Lehman’s 2008 bankruptcy. Tobacco banker Kym Arnone left the now-defunct Bear Stearns & Co. — which was a top tobacco bond manager — in 2008 to join Lehman.

The tobacco deal will follow Minnesota’s sale in late September of $769 million of new-money general obligation bonds to fund projects approved in its recent capital budgets.

The state is also sorting through refunding opportunities to include in that transaction, MMB officials said Tuesday.

Minnesota recently completed a request for proposals process to establish an updated pool of firms for use on negotiated GO issues permitted through June 30, 2013, but is still reviewing the submissions and expects to offer the upcoming GO deal competitively.

The state’s GOs are rated AA-plus with a stable outlook by Fitch Ratings and Aa1 with a negative outlook by Moody’s Investors Service. It retains its AAA rating from Standard & Poor’s.

Minnesota launched a request for proposals process in August for its tobacco securitization soon after Gov. Mark Dayton and lawmakers agreed to issue between $800 million and $900 million of tobacco bonds, with the aim of raising $640 million in cash to help clear out a deficit in the $35 billion biennial budget. The agreement ended a state government shutdown that began July 1.

Officials anticipate selling the tobacco bonds in two tranches, with the tentative goal of raising $400 million in tax-exempt proceeds by Nov. 4. The state would use the proceeds to cover required December debt service deposits. The second tranche would raise the remaining balance by November 2012.

The legislation gives finance officials some flexibility in structuring the transaction as either tobacco securitization bonds or tobacco appropriation bonds. The state anticipates selling the first as a securitization and has not decided on the second.

Under the legislation, tobacco securitization bonds would be structured as special revenue bonds, secured by a pledge of tobacco settlement revenues that can be issued in a public or private sale.

Minnesota has not previously leveraged its tobacco settlement payments. It was one of four states — along with Florida, Mississippi and Texas — that did not participate in the 1998 Master Settlement Agreement with tobacco companies to settle health care claims.

Minnesota entered into its own agreement with the four major cigarette manufacturers.

The state received $105 million in 2000 under its agreement. Its highest payment, $184 million, came in 2008. It expects $165 million this year. It saw a 6.4% drop in its 2010 payment and anticipates a 4.4% decline next year, a 2.6% decline in 2013, and a 3% decline in 2014.

Tobacco companies made $6 billion in payments to states in 2011 under the MSA, down 5.6% from a year earlier, according to a report from Herbert J. Sims & Co. Annual payments are based on a complex formula that adjusts for the size of the cigarette market, inflation, consumption and other factors.

Interest in traditional tobacco bond structures languished in recent years as the number of smokers dwindled while the industry faced ongoing lawsuits and bond ratings tumbled amid warnings that issuers will soon need to dip into reserves to cover debt service on some turbo bonds. Interest has been renewed in secondary market trading among yield-hungry investors.

Dick Larkin, director of credit analysis at Herbert Sims, said Minnesota will need to build in a minimum 4% decline in smokers’ consumption to its repayment structure, incorporate the continued withholding of some disputed payments by manufacturers, and limit maturities to attract buyers, as Illinois did.

“The key thing is to keep the bonds shorter for a better reception,” he  said.

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