Tobacco Bonds and the Land of Lincoln

MUNI WATCH: State Tobacco Funds' Fate In Land Of Lincoln


DOW JONES NEWSWIRES

(This article was originally published Thursday)

By Stan Rosenberg

Of DOW JONES NEWSWIRES
NEW YORK -- Trading in the tobacco bonds issued by state and local governments ground to a standstill Thursday after an Illinois Senate Executive Committee rejected an amendment that would have capped the size of an appeal bond for Philip Morris USA.

Traders and analysts are pondering the impact on the $19 billion market for this debt, much of which has been used as "one-shot" financing to help troubled states meet ballooning budget deficits.

The bonds, which had stabilized slightly Thursday morning on reports that a bond cap might be worked out, continued to be quoted around a record 8.00% yield level after having plummeted earlier this week.

Long-term 6.75% bonds of New Jersey's Tobacco Settlement Financing Corp. were quoted unchanged from the morning around 7.95% after having been around 8.15% on Tuesday.

Meanwhile, "The worst may be over until April 15," said Gary Pollack, a managing director at Deutsche Bank Private Wealth Management, New York

April 15 isn't only time to file taxes. It's the date that Altria Group Inc. (MO) unit Philip Morris USA will or won't make a $2.5 billion payment under a 1998 pact between major cigarette makers and 46 states. Philip Morris accounts for 50% of the payments.

Altria Group's (MO) Philip Morris unit has said it wants to appeal a $10.1 billion verdict handed down last month in the Miles class-action case by a Madison County, Ill., circuit court judge, but claims it cannot afford to post the $12 billion appeal bond ordered by the judge, which is due April 21.

Philip Morris has said that it might have to file for bankruptcy protection if the bond isn't reduced.

Late Thursday, Fitch Ratings downgraded all tobacco settlement securitizations to triple-B-plus from single-A after having placed them on a negative rating watch on March 26. The unsecured debt ratings of Altria and its consolidated subsidiaries also were cut to triple-B-plus from single-A.

Fitch's action Thursday followed a Moody's Investors Service downgrading of the tobacco bonds Monday by as much as three notches. Meanwhile, Standard & Poor's also has the entire municipal tobacco sector on watch for possible downgrades, should Philip Morris miss the April 15 payment.

Philip Morris' statements, as well as the rating agency actions, threw the market for already-outstanding municipal tobacco bonds into disarray. Virginia on Tuesday canceled a $767 million tobacco bond offering that already had been priced but which hadn't yet closed, and California Thursday said it was putting a $2.3 billion tobacco bond sale planned for mid-April on hold.

Meanwhile, the municipal market continued to watch and wait, hoping some kind of settlement on the bonds might still be worked out in Illinois.

"I think they're still going to negotiate further," said an executive at one firm that underwrites municipal tobacco debt. "There's a lot of room between $1 billion and $12 billion," he said, alluding to the $1.2 billion represented by the rejected 10% appeal bond.

In yet another development Thursday, Moody's, which Monday downgraded Altria's ratings two notches to just three levels above junk status, placed the ratings of R.J. Reynolds Tobacco Holdings under review for possible downgrade, "reflecting weakness in the company's fundamentals exacerbated by increased litigation risk."

The company's unsecured debt guaranteed by parent R.J. Reynolds Tobacco Co. (RJR) is rated Baa2, while its senior unsecured debt not guaranteed by the parent firm is rated Baa3.

Taking note of the Illinois court verdict against Philip Morris, Moody's said that case "illustrated the difficulties faced by a company involved in numerous legal claims, such as R.J. Reynolds. The significant share and the long-standing presence of R.J. Reynolds' brands in the U.S. cigarette market make the company an attractive target for litigation. This could increase the risk that R.J. Reynolds could be faced with significant bonding requirements in the future, especially in difficult legal jurisdictions, in spite of sometimes strong bases for appeal."

-By Stan Rosenberg, Dow Jones Newswires, 201 938-2143;

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