• Minnesota Tobacco Bond May Defy Underperformers
  • Minnesota’s first sale of buy cigarettes bonds may escape concerns about declining industry shipments and legal disputes that have caused the securities to underperform municipal and U.S. Treasury debt this year.

    Democratic Governor Mark Dayton plans to use $640 million of the proceeds to help balance his two-year budget. Legislators authorized the sale in a deal to end a 20-day government shutdown, the longest in a U.S. state since at least 2002, according to the National Conference of State Legislatures.

    Tobacco bonds are backed by payments from producers based on cigarette shipments. The companies and 46 states have been squabbling over the size of the remittances agreed to in a 1998 settlement that excluded Minnesota. Moody’s Investors Service last week downgraded $3.5 billion of the debt to junk and revised its estimated annual cigarette consumption decline to 4 percent from 3 percent because fewer people are smoking cigarettes.

    “The Minnesota deal could come to the market at yields comparable to better-rated cigarettes bonds,” according to a report yesterday by municipal strategists at Citigroup Inc. in New York led by George Friedlander.

    Minnesota isn’t part of the 1998 settlement, according to Joel Michael, a state legislative analyst. Four states including Minnesota, Florida, Mississippi and Texas entered into their own health-care related agreements with the tobacco companies.

    Minnesota may not have to offer the kind of premium those in the settlement pay because its bonds would be outside the legal dispute over payments with producers and because its own agreement with them has claim on their overall profitability, Richard Larkin, director of credit analysis at Herbert J. Sims & Co. in Iselin, New Jersey, said in a telephone interview.
    Lower Premium

    Illinois in late November sold $1.5 billion of tobacco bonds including a portion due June 2028, the longest maturity, with a 6.1 percent yield, or 93 basis points above an A- index of general-obligation debt, according to data compiled by Bloomberg. A basis point is 0.01 percentage point.

    In contrast, Minnesota may price at about 5.25 percent to 5.5 percent for debt maturing between 10 to 15 years, if it follows a similar structure to Illinois’s tobacco deal, said Lyle Fitterer, who helps oversee $26 billion of municipal bonds for Wells Capital Management in Menomonee Falls, Wisconsin.

    “I think it’ll be met with pretty good investor acceptance,” Fitterer said in a telephone interview.

    A dispute dating to 2003 hinges on whether tobacco companies that signed the 1998 agreement -- such as Philip Morris, part of Richmond, Virginia-based Altria Group Inc. (MO) -- have lost market share to producers that didn’t join the deal, such as Cheyenne International and National Tobacco Company LP.
    Profit Clause

    While the payments Minnesota receives are also based on declining cigarette shipments, unlike the 1998 settlement, company profits are included in the payment calculation and will soften any reduction, Larkin said.

    “From a tobacco-bond-investor point of view, that’s another factor that helps reduce investors’ concerns that payments are going to drop because of shipment declines,” Larkin said.

    Tobacco bonds have produced a total return of 4.9 percent this year, which is 355 basis points below that for top-rated tax-exempt municipal debt and 346 basis points under Treasuries, according to Bank of America’s Merrill Lynch Municipal Master Index, which includes price changes and interest income.