A recent default by a New York tobacco bond issuer, followed by the impairment of a second New York tobacco issuer last week, made the tobacco bond sector the worst-performing in the municipal market this month, with market participants warning that bond prices are inflated and more defaults all but inevitable.
The Nassau County Tobacco Settlement Corp.
The bonds traded on June 10 at 56 cents with a 10.32% yield, down from 81 cents with a 6.74% yield in June 2025.
A popular and sizable part of the high-yield municipal bond market, the tobacco sector's first default comes after years of declines in the revenue stream that backs the bonds, securitized payments from the multi-state 1998 Master Settlement Agreement, where cigarette manufacturers compensated the states for the cost of caring for sick smokers.
As cigarette smoking continues to decline, the MSA payments have been smaller than original projections in many of the bond issuances, and, some warn, are becoming too small to service the nearly $80 billion market. The default has soured investor sentiment across the sector, but some say the bonds are still overvalued.
"I'm myopically focused on tobacco bonds right now," said J.R. Rieger, a bond pricing market veteran whose Rieger Report LLC focuses on distressed debt. "In my view, we as a market are still putting our heads in the sand in these particular bonds because they are not performing relative to the original projections," he said. "The valuations should be lower."
A total of 21 states and territories have securitized their MSA payments, with local governments in California and New York also having issued tobacco bonds,
The debt features a variety of structures, but because the payments are made in perpetuity, the maturities are typically pushed out further into the future until it is eventually repaid.
MMA, which estimates the tobacco bond market at $78.4 billion, puts the sector's default rate at 0.56%. The firm's default database has six impaired tobacco issuers that account for 10.6% of the sector's par, mostly for support draws.
The sector turned in the worst performance in the muni market in June, Barclays said in a June 18 note. The "Nassau County Tobacco default [is] weighing on the entire space and pushing year-to-date returns into negative territory," Barclays said.
The Nassau County Tobacco Settlement Corp. bonds fall in the category of "old vintage" bonds. These bonds — most of which are relegated to the high-yield space — have been having challenges for a long time, said Jeff Timlin, managing partner and head of municipal bond investing at Sage Advisory.
"It's finally caught up with them … Over a decade-plus of the declining tobacco bond sales has finally hit these bondholders," Timlin said.
Sage owns the "new vintage" bonds, which are still rated single-A, and their structures are more favorable to bondholders than the "old vintage" bonds, Timlin said.
The supply-demand dynamic that shapes the muni market is still overriding tobacco's red flags, said a distressed debt analyst, adding that most of the sector's default risk remains three to 10 years away.
"Smart money is selling, but most of these funds, the market is technical, they have cash, they need the coupon," the analyst said. "If it defaults in three years, they don't really care, because they're still getting their coupon for another couple years, and they need to deploy cash."
Bondholders that hold longer-term maturities, including the zero-coupon bonds, and subordinate debt are particularly exposed, buysiders said.
Zero-coupon bonds make up a significant part of the market, Rieger said in a
"In my view, if there are not enough funds coming in to project that those heavy weight of zero coupon bonds are going to be paid, why are we as a marketplace still treating them as if they're performing?" Rieger told The Bond Buyer.
Ohio's Buckeye bonds, which total $5.35 billion and are among the most actively traded in the market, were already restructured in 2020 to avoid default amid declining payments. Despite the refinancing, the Buckeye Tobacco Settlement Financing Authority in December 2024 and last December
A senior Series 2020B-2 5% Buckeye bond due in 2055 traded Wednesday at 79 cents on the dollar. That's down from 86 last June and 93 in June 2024.
In a LinkedIn post, former high-yield bond trader Brian Connery said Buckeye bond documents estimated the state would receive $317 million in MSA payments in 2026, while the actual payment was $203 million.
"Those bonds have already drawn on reserve funds to make interest payments the past two years, and this year's reserve draw will be significantly larger (assuming no NPM receipt)," Connery wrote. Assuming no changes, the subordinate 2020B-2 Buckeye bonds could default by 2028-2029, he said.
He noted that the bonds currently trade around 80 compared to the Nassau bonds, which trade in the 50s.
"Buckeyes are significantly worse given that they are subordinate ... and Buckeye may see a much larger coupon reduction," he said.
Birch Creek Capital noted Friday that Buckeye tobacco underperformed for the week, "giving back roughly 10-12 basis points." The firm said, "some of the weakness [was] potentially tied to the market continuing to digest recent NAAG settlement data and lingering fears of impending downgrades across the sector."
Despite the New York issuer impairments, some investors believe the sector remains resilient.
There will likely be no contagion effect across the tobacco sector until there is a catalyst, such as S&P downgrading some high-grade bonds to high-yield and triggering selling pressure, said the distressed debt analyst.
"Different tobacco bond issuers projected different levels of consumption decline at time of issuance," Mark Paris, CIO and head of municipals at Invesco, said in an email. "We believe the recent default/impairments are idiosyncratic, and we do not expect it to trigger contagion across the broader tobacco bond sector."
