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Home›Investment›How tobacco bonds work and what can go wrong – ProPublica

How tobacco bonds work and what can go wrong – ProPublica

By Eric Gutierrez
March 19, 2021
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It all started when the states settled their lawsuits against Big Tobacco.

After a long fight, states would finally get billions to cover the health costs of smoking, in perpetuity.

But some government officials wanted the money up front, to cover all kinds of budgetary needs. They said it would be better to get the money now in case the tobacco companies can’t pay later or if cigarette sales collapse.

The answer: bonds. A bond is like a loan. Investors buy the bonds, providing states with liquidity. States reimburse bondholders using tobacco money. The typical bond lasts 30 years or less and pays interest every year.

If payments for tobacco are insufficient, investors have no right – “no recourse” – to be reimbursed with taxpayer money. But they retain the rights to future tobacco payments. Because of the high payouts promised to some bondholders, it could take years or decades for taxpayers to lose tobacco money.

In total, states, counties, cities and territories have sold some $ 36 billion in tobacco bonds that are still outstanding. Most had standard repayment terms. But to get additional cash up front, some sold Capital Appreciation Bonds, or CABs, with steeper repayment terms.

With CABs, no payment is required until maturity, often 40 years or more. Meanwhile, interest is made up of a huge balance owed. In total, governments have sold around $ 3 billion worth of CAB – for which they have pledged to repay $ 64 billion.

The agreements assumed that there would be enough settlement money available to reimburse CABs sooner. But people smoke less. So tobacco payments to states are also falling – and that means they can’t pay back CABs sooner, if at all.

States can avoid defaulting on CABs – for a price. New Jersey recently pledged more of its tobacco money to avoid defaulting on $ 186 million in CAB it owed $ 1.3 billion in 2041.

By promising investors an additional $ 406 million – all of its remaining tobacco money from 2017 to 2023 – New Jersey will be able to prepay its CABs. The alternative – paying investors with tobacco money until the debt is fully paid off – would have meant pay around $ 1.6 billion to bondholders for many years. By putting more money in the pot now, the state has also prompted investors to shell out an additional $ 92 million for this year’s budget.

Related Articles: Read our coverage on Why Certain Tobacco Bonds can return to haunted states and see which states have sold the debt.







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