President Barrack Obama yesterday signed into law an extension and expansion of the State Children's Health Insurance Program that increases the tax on cigarettes by 62 cents to $1.01 per pack. The action puts into question new tobacco bond deals that states want to back with consumption-based settlement payments from tobacco companies.

The House signed off by a vote of 290 to 135 on S-CHIP legislation providing the federally funded, state-run program about $33 billion of additional funding through 2013. The Senate voted Friday to approve the bill that originated in the House, and the president was expected to receive the bill this week after a final stamp of approval from the House on amendments added by the Senate. One Senate change raised the cigarette tax increase to 62 cents from 61 cents.

Under the 1998 Master Settlement Agreement, tobacco manufacturers make annual payments to 46 states and six territories, based on tobacco consumption. Municipal issuers have sold tobacco bonds securitized by those annual settlement payments since 1999.

During the run-up to passage of the bill, municipal market participants worried that the tobacco tax increase — a boost of more than 150% — would have negative consequences on tobacco bonds. But the concern was not universal.

"Certainly an increase in price is going to decrease the number of cigarettes sold," said Troy Willis, senior portfolio manager for Oppenheimer Funds in Rochester, Minn. "Instead of Marlboro, [smokers] might buy generics, but that has no impact on tobacco bonds."

Willis said tobacco bond deals are accompanied by analysis forecasting tobacco bond health that considers some tax increases on tobacco products, among other factors. While the tobacco tax hike may be "a little higher and earlier" than expected, he said it will not have as drastic an effect as some market participants have worried. "We don't expect it to be a major change in credit," he added.

Two Midwestern states —Wisconsin and Minnesota — have tobacco deals in the works, but both would tack on a state appropriation pledge to the bonds, reducing the potential market impact of a cigarette tax increase.

With its restructuring of $1.4 billion of tobacco bonds on hold since last year due to market conditions, Wisconsin decided to tack on the appropriation pledge to help bring down interest rate costs and kick-start the deal.

The Minnesota transaction still is in the early stages. Gov. Tim Pawlenty proposed issuing $973 million of bond appropriation-backed bonds that would be repaid with tobacco settlement funds in his budget unveiled last week. The proposal received a cool reception during a legislative hearing Tuesday.

Willis said he believed the tobacco tax increase would have "no effect" on bonds sold with state appropriation pledges.

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