President Barrack Obama is expected to soon sign into law a bill approved by the Senate late Thursday that would expand the State Children’s Health Insurance Program  (S-CHIP) and raise tobacco taxes, prompting concern in the muni market about debt service payments on tobacco bonds nationwide.

When enacted, the S-CHIP legislation will raise the tax on cigarettes by 61 cents, to a total of $1 per pack, and increase the per-unit tax on other tobacco products.

This may bring about a precipitous decline in the cigarette revenue that tobacco manufacturers collect, in turn reducing the amount of settlement payments that companies make to 46 states and six territories under the 1998 Master Settlement Agreement.

Municipal issuers have sold tobacco bonds securitized by those annual settlement payments since 1999.

Between the historical rate of decline in consumption and a drop in demand caused by the tax, tobacco revenues could be down almost 10% next year, said Richard P. Larkin, senior vice president and director of research at Herbert J. Sims & Co.

Larkin estimated that the 61-cent increase in cigarette taxes is likely to add another 4.5% decline to the 4% annual decline in cigarette demand, based on a projected 0.3% decrease in demand for every 1% increase in tax on tobacco products.

As a result, settlement payments to states scheduled for April 2010 may be markedly lower than expected, as much as 10% lower than recent projections, he said.

Most states are expecting a total of about $7.7 billion that would then be used to repay tobacco bonds. The revenue drop would add to challenges facing states that have been considering new tobacco bond issues, since long-term yields on the bonds are already pushing 10%, Larkin said.

Minnesota Gov. Tim Pawlenty last week announced a $57 billion budget relying in part on the issuance of $980 million of tobacco bonds. The issue would be the state’s first such deal and would comprise about half of Minnesota’s settlement share.

Larkin said the state would probably be hit with high interest rates on the bonds. A spokesperson for Pawlenty could not be reached for comment by press time.

Additionally, at least 20 different ­tobacco issues that have been put on negative watch by Standard & Poor’s could be moved to non-investment grade if the new tax prompts tobacco consumers to stop buying cigarettes and other products, Larkin has said.

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