The House overwhelmingly approved legislation on children's health insurance yesterday that could result in major cuts to expected tobacco settlement payments that states use to repay tobacco bonds.
Municipal market participants said the Children's Health Insurance Program Reauthorization Act of 2009 - which would reauthorize a state-administered, federally funded program and help pay for it with a cigarette tax increase of 61 cents per pack - could be troublesome for tobacco bonds.
"If this passes [into law], it's significant enough of an event that it not only has ratings implications, it also has pricing implications for bonds that have already been battered," said Richard P. Larkin, senior vice president and director of research at Herbert J. Sims & Co.
For 20 different maturities that already have been put on negative watch by Standard & Poor's - from issuers in Ohio, Michigan, New Jersey, Rhode Island, Virginia, and California - and this legislation could be the straw that breaks the camel's back, Larkin said, possibly sending them down to non-investment grade and causing other bonds to be put on watch.
The House bill would raise the total cigarette tax to $1 per pack and increase the per-unit tax for other tobacco products as well.
The House bill, sponsored by Rep. Frank Pallone Jr., D-N.J., passed by a vote of 289 to 139 with six no-votes. The Senate Finance Committee holds a markup session today for- legislation with identical tax increases for cigarettes.
Congress passed similar legislation to expand S-CHIP eligibility twice in 2007, but President Bush vetoed those bills and Congress was unable to override the vetoes. Lawmakers instead extended the existing program through March 2009.
Yesterday's vote to reauthorize S-CHIP would result in big losses to state tobacco settlement receipts, Larkin said.
"You're going to see a significant decline in the settlement revenues used to pay tobacco bonds," he warned.
Larkin said that if the tobacco tax provisions are enacted into law, tobacco settlement payments to states scheduled for April 2010 could be as much as 10% lower than Global Insight Inc., an economic and forecasting company, projected for a tobacco bond issue last June. That's about $800 million less than the $7.7 billion that most states are expecting based on that projection.
The 61-cent tax hike would bump up prices on cigarette packs by an average of about 15% across the country, he said.
"Historically, the demand for cigarettes has been dropping on average a little less than 4% a year," Larkin said. "This would add another 4.5% decrease onto that."
His projections are based on a 0.3% decrease in tobacco demand for every 1% increase in tobacco taxes, for at least the first year of the new tax. But the demand would probably continue to be depressed beyond that first year, he said.
The drop in tobacco revenues would be the largest since the 1998 Master Settlement Agreement was entered into between tobacco manufacturers and 46 states and six territories, Larkin said, adding that all of the participating states would be affected proportionately by the possible decline in revenues.
Under the settlement agreement, tobacco companies agreed to pay billions of dollars to the states over a 25-year period, and muni issuers have sold tobacco bonds securitized by those annual payments since 1999.
The legislation comes as tobacco bonds have been trading at a discount. About $800,000 of one-year bonds issued by the Buckeye Ohio Tobacco Settlement Financing Authority were sold to a customer yesterday around noon at a price of 99.6 and a yield of 5.02.
The potential for lost tobacco revenues and resulting declines in settlement payments would add to stresses that have plagued tobacco bonds for years. Lawsuits slowed issuances to a halt in 2004. Disputes over prior-year adjustments prompted companies to withhold more than $1.45 billion total of annual settlement payments in 2006 and 2004. The bonds bounced back in the market by the first quarter of 2007, representing 7.7% of all munis sold that quarter.