California, Ohio Use Reserves for Tobacco Bonds

California, Ohio and Virginia will use reserve funds to pay interest and principal on bonds backed by tobacco company payments under a 1998 health-care settlement, according to a report by Herbert J. Sims & Co.

Payments to the states by Altria Group Inc. (MO)’s Philip Morris unit, Reynolds American Inc. (RAI) and other companies have declined on lower U.S. cigarette sales and as the companies lose market share to tobacco manufacturers that didn’t participate in the settlement, according to Richard Larkin, director of credit analysis at Sims in Iselin, New Jersey.

“Any time you see a municipal bond go to their reserve fund, it’s a significant sign of trouble,” Larkin said in a telephone interview. “It’s not an imminent default, but it’s a sign that cash flow is certainly far weaker than any of us thought.”

U.S. states have more than $107.6 billion in outstanding bonds backed by the 1998 settlement, according to data compiled by Bloomberg. Under the settlement, tobacco companies agreed to reimburse states $246 billion for treating smoking-related illnesses. The companies make annual payments each April.

The amounts paid to the states declined 5.6 percent this year, mostly because Altria’s Philip Morris decided for the first time to withhold disputed payments, Larkin said, citing data from the National Association of Attorneys General. In 2010, the payments fell 16 percent after the federal government raised cigarette excise taxes 61 cents.
Payments in Escrow

Since 2005, Reynolds and Lorillard Inc. (LO) have put a portion of their payments into an escrow fund, arguing that they’re entitled to refunds because they’ve lost market share to other producers such as National Tobacco Co. LP, which didn’t sign the 1998 accord.

Philip Morris made its full payments to the states, even though the tobacco company disputed them, until this year, when it withheld $267 million, Larkin said. Philip Morris disclosed the escrow payment in an April 15 statement.

California’s Golden State Tobacco Securitization Corp. and Ohio’s Buckeye Tobacco Settlement Financing Authority may use debt-service reserves to meet the minimum required interest payments on Dec. 1, according to bond filings.

The Virginia Tobacco Settlement Financing Corp. will need to use debt reserve funds for its Dec. 1 payment, he said.

Issuers such as Golden State are special entities set up to sell debt backed by the tobacco-settlement money. The states don’t guarantee interest and principal payments on the bonds.
California Reserve Plan

California plans to draw $5.35 million from reserves to help make a $68.3 million interest payment on series 2005 bonds and $7.7 million to make a $87.9 million interest payment of series 2007 bonds, both due Dec. 1, said Tom Dresslar, a spokesman for Treasurer Bill Lockyer.

“Like any other issuer, the state doesn’t relish, to say the least, being forced to draw on reserves,” Dresslar said. “Hopefully, we won’t have to be in that position again.”

Kurt Kauffman, Ohio’s debt manager, said his state expects to use $6 million to $8 million in reserves in December, based on current projections.

“We have a $389 million funded reserve so that offers a significant degree of protection to investors,” Kauffman said in a telephone interview.

Virginia’s director of debt management, Evelyn Whitley, said her state will draw $3.6 million from reserves to make a Dec. 1 interest payment.

“I don’t think it should come as any great surprise,” Whitley said. The state filed a notice when it didn’t make sinking-fund payments last year, she said, and investors “realized it was cutting it close then.”
Lower Investment Returns

Besides payment declines, California and Virginia also received lower-than-expected investment returns on their debt- service reserves, Larkin said. Both states put the money in investment contracts with Lehman Brothers Holdings Inc. (LEHMQ), which filed for bankruptcy in 2008, he said.

While it’s unlikely that more Americans will take up smoking, the outlook for tobacco bonds may improve if U.S. states win a legal challenge to the companies that are withholding payments, Larkin said. About $2 billion held in escrow would go to the states, he said.

“That boost in cash flow would be significant,” Larkin said. “If the states lose, it will look a lot worse.”

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Smokers See Some Smoking Brands As Safer

One in five smokers believes some brands of Lucky Strike cigarettes are safer than others, a study has found. Smokers of ”gold”, ”silver” or ”slim” cigarettes were also more likely to think their brands were less harmful. The findings highlight the power that packaging can have on risk perception, and come as the federal government prepares to introduce its plain-packaging legislation.

As part of an international study, published in the journal Addiction, researchers surveyed more than 8000 current and former smokers, including more than 2000 Australians, about their smoking beliefs.

Females were more likely to believe some brands might be less harmful while older individuals considered their cigarettes brand was safer.

More than a third of respondents falsely believed nicotine was linked to cancer, and 41 per cent believed light cigarettes were better for them.

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Danville company proposes new use for tobacco

If a new company at Dan River Business Development Center has its way, that will happen — but the product will be used to create biofuels instead of cigarettes.
Peter Majeranowski, a founder and managing director of Tyton BioSciences, said years of development have gone into the product, which will be genetically modified to produce “both ethanol and biodiesel at yields that far surpass the traditional crops of corn and soy.”
And, because corn and soy are also food crops, using tobacco to create the same products can alleviate the complaints that food prices are rising because of demand for crops as fuel, Majeranowski said.
Smoking-grade tobacco was much more difficult to grow than the crop his company is developing, Majeranowski said.
Farmers will be able to plant between 80,000 to 100,000 plants per acre, rather than the average 6,000 plants per acre of smoking-grade tobacco. It can be mechanically harvested and can be processed “green,” as opposing to going through the drying process that smoking-grade tobacco goes through. Tobacco fields for biofuels also can yield two to three harvests a year, Majeranowski said.
“We can chop it close to the ground, and it grows back,” Majeranowski said. “We don’t have to worry about flavor, just how many green leaves and stems we can get per acre.”
The seeds are still being tested, but the company has successfully processed the genetically altered plants to extract sugars for ethanol and oil for biodiesel fuel; the process has a patent pending on it, Majeranowski said.
During processing, sugar for ethanol and oil for biofuel are extracted, both in larger quantities than comparable amounts of soy or corn, Majeranowski said.
According to Majeranowski, the group was encouraged by Gov. Bob McDonnell’s office to visit Danville, and Secretary of Agriculture and Forestry Todd P. Haymore recommended they talk to the Institute for Advanced Learning and Research about their project.
Majeranowski said he met with Liam Leightley, executive director at the institute, and Barry Flinn, who directs the Institute for Sustainable and Renewable Resource, and was impressed with the facility. The new Sustainable Energy Technology Center at the institute also was one of the reasons that Tyton BioSciences chose Danville for its new home.
“It’s just five minutes from our office,” Majeranowski said. “We will collaborate on certain parts of our research; it’s a great fit for us.”
Next week, the company hopes to learn whether it will get a $2.2 million grant from the Tobacco Commission, which, combined with about $2 million of its own investment, will get the new seeds closer to the production stage.
Majeranowski said: “We have committed to stay in Danville beyond the potential Tobacco Commission grant period because of Danville’s rich tobacco history and growing know-how, as well as its new research facilities.
“We are also excited to help re-ignite the agricultural community with a new tobacco crop that can help the country break its addiction to foreign energy.”

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