Despite Anti-Smoking Campaign, California Selling More Tobacco Bonds

Last year, California legislators increased the legal smoking age by three years, to 21, and increased taxes on cigarettes by $2 a pack.

Because the state is so populous, these moves are expected to impact national consumption levels.

Yet California is still hoping investors will pony up for new bonds backed by the payments it receives under the 1998 Master Settlement with tobacco manufacturers.

Golden State Tobacco Securitization 2017-1 will issue $618.8 million of bonds, according to a prospectus filed Monday on Munios. There will be 12 tranches of notes with maturities ranging from 2018 through 2029.

Jefferies and Citigroup are joint senior managers.

Proceeds will be used to retire bonds issued a decade ago, in 2007.

Despite California’s moves to combat consumption, tobacco bonds have rallied smartly over the past year. The S&P Municipal Bond Tobacco Index, which includes both investment-grade and high-yield bonds, is up 8.44% year to date, and has returned an average of 11.31% over the last three years. 

The reasons range from declining energy prices, which left consumers with more disposable income, to Puerto Rico’s financial woes, which left money managers looking for other high yielding investments to help juice returns.

So refinancing allows California to take advantage of both lower interest rates and strong demand.

Potential investors may also welcome the opportunity to invest in tobacco bonds underwritten with more recent projections for consumption trends.

Under the Master Settlement Agreement, California receives 12.76% of annual payments and 5.17% of strategic contribution payments; however 45% of state’s entitlement goes to participating counties and 5% to participating cities.

Cigarette consumption rose by 1.9% in 2015, for the first time in years, to 269 million, but is believed to have resumed the decline in 2016 and expected to continue to decline thereafter. The offering prospectus cites an estimate from IHS Global that consumption will falling by 3.1% a  year over the next 12  years, resulting in 36% decline from the 2015 level by 2029.

Here’s a breakdown of how proceeds will be used: $587.74 million of “senior current interest” 2007 bonds will be redeemed or defeased (the collateral replaced with Treasury bonds) and $450 million “second subordinate capital appreciation” 2007 bonds will be repurchased.

After that, $3.038 billion subordinate capital appreciation bonds issued in 2007 will remain outstanding.