October 25, 2019 – S&P Global Ratings downgraded 67 tobacco bond CUSIPs yesterday, citing weak cigarette sales and declining credit quality of Atria, the largest payer of “tobacco settlement revenues” mandated under the Master Settlement Agreement reached between Big Tobacco and 46 states in 1998.

Entities with downgraded bonds (to as low as CCC-) include Buckeye Tobacco Settlement Financing Authority, Golden State Tobacco Securitization Corp and Michigan Tobacco Settlement Finance Authority.

Tobacco Bonds are typically structured as “asset backed securitizations”, where annual settlement receipts used to repay bonds, often on a “turbo redemption” basis where maximum principal is repaid.

As High Yield municipal funds received record inflows in recent years, investment banks – notably Jefferies, the dominant underwriter for tobacco securitizations – have aggressively pitched refinancings to tobacco bond issuers in California, Ohio and New York, many of whom took the investment banks’ advice and refinanced their original tobacco issues.

That strategy may have backfired, with the advent of electronic cigarettes and tougher regulatory restrictions all contributing to larger-than-expected declines in combustible tobacco sales.

In December 2018, Altria was downgraded to “BBB” from “A”, which theoretically increased the credit risk on tobacco bonds, which are repaid with settlement revenues from entities like Altria.

Traders who spoke with BuyMuni indicated that a holder of single-A rated tobacco bonds over 2017-2019 would have generated all-in return of close to 25% (capital and coupon) over a two-year period, attesting to many municipal traders’ reluctance to underweight the sector.

Contact Karen Bigelow at KBigelow@buymuni.com.