Tobacco Money Could Harm Credit Rating of Some States

State and local governments across the country are turning to tobacco to plug their deficit gaps at a time when states are under the worst fiscal pressure in decades.

But using the billions of dollars from the industrywide tobacco settlement in 1998 could cause more harm than the politicians have been willing to acknowledge.

Eight states are using proceeds from the tobacco settlement to reduce state budget deficits, and six more are considering it, according to the National Conference of State Legislatures.

Five of these states have already had their credit ratings lowered by the three main credit agencies or have been placed on alert about the possibility. New Jersey and Wisconsin have been downgraded, while California, Oregon and Washington are on the alert lists. When ratings are lowered, states have to pay more when selling bonds to compensate investors for the additional risk, raising their costs of capital by millions of dollars for projects from roads to schools.

To generate revenue now, these states are selling municipal bonds tied to some or all of the first 25 years of expected payments from the tobacco companies, under a pact signed with 46 states that has been valued at $206 billion. The rating agencies are concerned that states may be opting for a one-time infusion to help reduce a deficit and that such borrowing is a sure sign of fiscal distress.

"We are not downgrading because they are using tobacco," said Alex Fraser, a director of the state and local government ratings group at Standard & Poor's. "We are downgrading because this state or that state is running out of options. Tobacco securitization is one of the last nonrecurring options that are out there."

The credit rating agencies are likely to lower a state's credit rating if the state fails to convince them that a longer-term solution for its deficit is in the offing.

The use of the tobacco revenue this way "is a good indicator of who is under stress," Mr. Fraser said. The use of the tobacco money "indicates something that may form the basis for a downgrade."

Claire Cohen, a public finance analyst at Fitch Ratings, said, "Yes, indeed, it can lead to a lower general obligation bond rating." Robert A. Kurtter, senior vice president for state ratings at Moody's Investors Service, agreed. "Yes, it can be a factor, and yes, it has been a factor."

What a lower bond rating could cost a state is hard to calculate because states have different needs for financing and the use of tobacco revenue was not the sole cause of any of the downgrades. Still, rating agency officials and underwriters of municipal bonds said that a cut of one notch could raise the interest rates on a new bond by as much as 10 basis points, or hundredths of a percentage point. For a big state issuing a lot of debt, it could amount to millions of dollars of extra interest payments.

When New Jersey announced last spring that it was going to compress about half of 25 years of annual payments of $250 million to $270 million from the tobacco settlement into $1.1 billion for fiscal year 2003, the governor's budget said that this fiscal maneuver would not put the state's "credit rating at risk." Even before the tobacco deal was completed, though, Fitch, Moody's and S.& P. had lowered the state's credit rating a notch.

"The magnitude of the state's budget funding challenge will only be solved over multiple years as indicated by the proposed inclusion of temporizing measures in fiscal 2003, including over $1 billion in a proposed securitization of tobacco settlement revenues," Fitch said in a statement announcing the downgrade, to AA from AA+.

Tom Vince, spokesman for the New Jersey treasurer, John E. McCormac, said the connection of the tobacco revenue and the lower rating "has to do with the use of these funds as a temporary infusion."

"Credit agencies like recurring revenue," he added. New Jersey will sell additional bonds to use the other half of the state's tobacco revenue in fiscal 2004, which begins in July, and 2005, he said.

New York State lawmakers are considering use of tobacco money to cover its budget gap. When asked about such a possibility last week, Gov. George E. Pataki said, "I don't want to rule anything in or out at this point."

Such a maneuver, said Mr. Kurtter of Moody's, would show "that they are pursuing a risky strategy with the hope of growing out of the problem in the future. This is the sign of a relatively weaker credit."

New York, however, might not suffer a further credit downgrade by Moody's because it already has the agency's lowest rating for a state, A2, as does Louisiana.

But New York's rating could fall at the hands of S.& P. and Fitch, which put it three notches higher, at AA, the equivalent of an Aa2 rating from Moody's. "Anytime a state looks at borrowing from future revenue to solve their deficit problem it definitely raises an eyebrow," said Richard Raphael, a public finance analyst at Fitch.

California is expected to do the biggest tobacco securitization by far in the first half of next year, raising about $4.5 billion from a bond issue by committing about 85 percent of its future tobacco revenue to pay the principal and interest.

Tobacco has always helped balance state budgets, with cigarette taxes accounting for $8.6 billion, or 1.5 percent, of total state revenue in fiscal 2002.

What the states are doing now with tobacco is called securitization. They are selling bonds to get cash now and using the years of revenue that they are expecting from the tobacco settlement to pay the principal and interest on the bonds. So they are forgoing a steady stream of revenue well into the future for the use of that money today.

According to the National Council of State Legislatures, 15 states have securitized or are in the process of securitizing their tobacco revenue, with seven of them dedicating the money for purposes like health care and anti-tobacco programs. Some counties and cities in California and New York have also converted their future tobacco revenues to current cash, including New York City. The city was the first to sell tobacco bonds back in 1999 and is scheduled to sell more. But the money has been used and will be used, according to the city, to finance the city's capital budget, not to cover everyday spending.

The use of the tobacco settlement revenue for capital projects is not frowned on by the credit agencies because borrowing is usually done to pay for these projects. Even using tobacco revenue to cover an operating budget would not necessarily be a cause for a downgrade if it were part of a broad plan to restore financial stability. It is the fact that in most cases so far the tobacco money is a one-time nonrecurring revenue that worries the credit rating agencies. The use of a so-called state rainy day fund, if there is no plan to replenish the fund, would raise the same red flag for credit analysts.

Credit agencies are also worried that the money is being borrowed over a long period, like 20 years. In the past, bonds sold to cover operating costs have usually been paid off more quickly. Borrowing over a longer period just raises the possibility that the state or local government will be under fiscal stress much longer.

The eight states that plan to use tobacco money to help cover deficits are California, Iowa, Missouri, New Jersey, Oregon, Rhode Island, Washington and Wisconsin. States considering such action are Colorado, Illinois, Indiana, Minnesota, New York and Texas.

But no! This can't be! The liberal Democrats who plundered this money out of the tobacco companies PROMISED! It was for the children! All of this money would be spent on programs to discourage teen smoking!

I'm CRUSHED!

I'm Shocked!

I can't believe that they'd actually LIE to us!!!

< /sarcasm >

What a bunch of jerks!

Washington State has already sold off their "windfall" for $0.25 on the dollar to plug a 2 billion defict in the budget. When the legislature goes back next month they have to find another 3 billion to get the state checkbook out of the red column. If you remember, our Attorney General Christine Gregoire, (RAT), was the lead plaintiff in this theft. Word has it she'll run for governor in 2004. Sad fact, she'll have a good chance.

New York, however, might not suffer a further credit downgrade by Moody's because it already has the agency's lowest rating for a state, A2

The Empire State's bonds with Wall Street the world's financial capital in its' bounds, are about to become junk.

What burns ME up is that "they" make it sound like Big Tobacco is flipping this money! NOT!

The smokers who pay cigarette taxes are paying 100% percent for the Tobacco Money. The general public believes that it is either the Government or Big T that is paying this money. NOT! /SCREAM!!!!!!

I am amazed [ don't know why ] that states doesn't seem to have any kind of financial expert on staff, someone should have seen this coming, imagine relying on something so unreliable as a consumer product to save their backside, however, I don't agree that tobacco is a last resort........ there is always that $15 hamburger. :-}

What steady stream of revenue? What these financial wizards (mental midgets) in state government are failing to remember is those funds from the tobacco settlement are based 100% upon the sale of cigarettes.

Many of the states which increased their cigarette taxes to balance their budgets, while seeing an increase in tax revenue in the short term, have already seen a drastic decrease in perpack sales. As more smokers find other means of obtaining their cigarettes, or quit altogether, the amount of tobacco settlement money will decrease proportionally.

It's no wonder these jerks are in government, they would never make in the real world (the private sector)

It's no wonder these jerks are in government, they would never make in the real world (the private sector)

With apologies to any teachers out there -
Those who can't do - teach
Those who can't do OR teach - go into government service.

There are exceptions that prove the rule but can anyone name them?

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