New York City Tobacco Bonds Face New Hurdle

The Wall Street Journal - 10/25/1999

By Dena Aubin

(Copyright (c) 1999, Dow Jones & Company, Inc.)

NEW YORK -- The prospect of another massive judgment against the tobacco industry has thrown a new hurdle across New York City's path as it gears up for its inaugural issue of tobacco settlement bonds.

In what is likely to be the nation's first such deal, the city expects to sell about $680 million in bonds in early November through the Tobacco Settlement Asset Securitization Corp., or TSASC, a local development corporation.

City officials Thursday downplayed the impact of Wednesday's ruling in a Florida class-action lawsuit, but some people think it will make the bonds a tougher sell.

"There's just so many clouds hanging over the tobacco industry now, mostly in terms of litigation or potential litigation," said Mike Pietronico, head of municipal trading for Offitbank, a New York money management firm. "It seems to be evolving on a weekly basis."

A Florida appeals court ruled last week that a lump-sum payment may be awarded to 500,000 plaintiffs in a lawsuit against the tobacco industry. A jury will meet Nov. 1 to determine damages, which some say could total as much as $300 billion.

The tobacco companies were hoping for individual awards, which would have been easier to defend against, rather than for a single lump sum.

"These things have typically resolved themselves favorably in the appeals process, but these things take time," said Alan Anders, a director of TSASC. "It's another thing we will have to explain, but that's another reason we are meeting with investors."

For New York City, the stakes are high.

Approaching its debt limit for other types of borrowing, the city is counting on issuing about $2.5 billion in tobacco bonds over the next four years to keep its capital program moving.

Some analysts studying the city's tobacco bonds say they have financial cushions built in to pay bondholders, despite another costly settlement.

"I think the transactions we're looking at have built in pretty broad safety margins that would be able to accommodate the risk of a settlement; in fact, even more than one settlement of the magnitude that might be out there for Florida," said Brad Gewehr, director of municipal research for PaineWebber Inc.

Anne Ross, senior vice president and analyst at Roosevelt&Cross, Inc., New York, said the deal carries some risks, but "on balance, it is well-structured."

Especially in the early years, revenues will be ample to pay bondholders, she said.

"When you go through an analysis of [cigarette] consumption . . . you can drive consumption virtually into the ground, and you're still going to have sufficient revenues to pass on to the bondholders," said Ms. Ross.

Although the Florida ruling raises questions, the tobacco companies "have tremendous cash flow," said John Hallacy, municipal credit analyst at Merrill Lynch&Co., New York. "It really takes a lot to put a big dent in that."

Even so, some traders are calling into question how marketable the bonds will be.

"The question is, 'Can you sell them into a market that's kind of foggy?' " said one New York trader.

Although insurance would limit the downside risks on the city's bonds, no decision has been announced on whether or not the bonds will carry insurance.

Offitbank's Mr. Pietronico said that even if the deal is insured it may have to offer significant price concessions over insured New York City general obligation bonds.

"I think there's going to have to be a lot of yield, and I think the biggest buyers will be more speculative-type buyers," said Mr. Pietronico.

Ratings haven't been released for the offering.

Standard&Poor's Corp. said early last week that it would rate the bonds no higher than single-A, while Moody's Investors Service said a rating higher than that was possible.


  1. What sorts of investors (non-speculative), do you think, would buy these tobacco bonds?
  2. Can you think of a hedging use for these bonds?
  3. How would you compute the duration of these bonds?
  4. Once these bonds are issued, the holders of the bonds would want to increase the profitability of the tobacco companies.  Would this be a significant political problem, in your opinion?