New Jersey cigarette bonds downgraded on declining consumption trends

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Shifts in smoking habits and increasing tobacco restrictions drove two downgrades of the New Jersey Cigarette Tax Revenue Bonds.

Moody’s Investors Service and Fitch Ratings both lowered the Garden State’s cigarette tax bonds by one notch, with Monday citing decreased pledged revenues for the securities that were issued in 2012 through New Jersey Economic Development Authority. Fitch dropped the bonds to BBB from BBB-plus with the Moody’s rating falling to Baa2 from Baa1.

New Jersey Cigarette Tax Revenue Bonds are backed by funds subject to legislative appropriation out of the state capital in Trenton (pictured).

The Moody’s and Fitch downgrades affect roughly $563 million of debt. Both assigned stable outlooks.

“The downgrade to Baa2 on New Jersey's Cigarette Tax Revenue Bonds reflects the rapid decline in pledged revenues and debt service coverage over the past three fiscal years,” Moody’s analyst Baye Larsen wrote. “These trends have been driven by a regulatory increase in the legal smoking age and shifting consumer preference towards vaping products that are taxed but not included in pledged revenues.”

The bonds are paid through deposits to New Jersey’s dedicated cigarette tax revenue fund that subject to legislative appropriation. A previously agreed to $151 million annual statutory allocation to two state health-related funds must be met, however, before any cigarette tax revenues can flow to the fund.

Larsen noted that Moody’s originally forecast 5% annual revenue declines as a “best case scenario” with recent trends instead averaging 6.8% dips. She added that the downgrade also factors in a narrow pledged revenue stream that has been steadily eroding from decreased cigarette consumption and sales.

The cigarette bonds saw a “sizable” 6.5% decline in the 2019 fiscal year on the heels of a 6% drop in 2018 tied largely to the legal smoking age being changed to 21 from 19, according to Fitch. A state contract from between the New Jersey Department of Treasury and the NJEDA deposits 0.65 cents a pack from the state’s 2.70 a pack tax into the revenue fund.

“Historical and prospective revenue declines are attributable to the discretionary purchases of cigarettes that are affected by state and national economic conditions, tax policy changes, law changes, consumer tastes and the availability of tobacco-product alternatives, including e-cigarettes,” Fitch analyst Marcy Block wrote. “Annual declines are expected to continue through the life of the bonds as cigarette sales are negatively affected by tax-rate increases on the state and federal level.”

New Jersey's cigarette tax ranks 10th highest nationally with neighboring states Connecticut and New York tied for first, according to Fitch. Gov. Phil Murphy proposed an increase to the cigarette tax in his 2021 fiscal year budget proposal on Feb. 25 that would raise the state’s level to Connecticut and New York.

Larsen said that ongoing COVID-19 pandemic was not a key factor in the rating downgrade and no immediate credit risks are expected from the health crisis.

“The situation surrounding coronavirus is rapidly evolving and the longer term impact will depend on both the severity and duration of the crisis,” she said.

New Jersey’s general obligation bonds are rated A3 by Moody’s, A-minus by S&P and A by Fitch Ratings and Kroll Bond Rating Agency. Moody’s revised the state’s credit outlook to negative from stable citing the COVID-19 impact on revenues.

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Downgrades Revenue bonds New Jersey Economic Development Authority New Jersey
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