It’s tax season and also the time of year when tobacco manifactures write checks to state governments for their annual share of an estimated $200 billion settlement (due to be paid out over 25 years) that Philip Morris USA, R.J. Reynolds, Brown & Williamson and Lorillard struck with attorneys general in 46 states.
For investors in nearly $54 billion in municipal bonds backed by checks from these tobacco companies, the payments offered both good and bad news for their anticipated return on investment. Their bonds are safer because fewer Americans quit smoking this year than in 2009.
In 2010, that number dropped about 4%, translating into about $7 billion in payments compared to a nearly 10% drop in cigarette shipment volumes between 2008 and 2009.
The dark surprise in this year’s payout: Philip Morris USA opted to put about $267 million of its $3.5 billion payment in a disputed accounts fund that prior to this year’s payout contained about $3.2 billion. The 1998 settlement set up a government-mandated oligopoly for the major cigarette manufacturers, as state governments agreed to protect the major manufacturers’ market share. The cigarette manufacturers are disputing whether states have protected their stake effectively.
Philip Morris is the only tobacco manufacturer backed by this settlement that had not withheld funds subject to arbitration. R.J. Reynolds Tobacco and Lorillard have previously been withholding payments. Arbitration hearings on this issue are ongoing in Chicago, but analysts say the deliberations could drag out for several years.
As I outline in an article in a recent issue of Forbes Magazine, holders of many states tobacco-backed bonds are worried about whether there will be enough cash on hand from the settlement to pay them out in full.
On this week’s payment news, one trader said that bonds were down about 20 basis points, but the reaction has “been pretty muted.”
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