Tobacco Bonds Could Go Up in Smoke, Moody’s Says

Three-quarters of the $20 billion tobacco bonds rated by Moody’s Investors Service could go into default if cigarette consumption continues to decline at the current rate, the ratings firm said in a report today. The bonds are sold by states and backed by payments from cigarette manufacturers that flow from a legal settlement in the late 1990s.

The size of those payments will depend on how many cigarettes Big Tobacco actually sells in the future and estimates of that figure are rapidly shrinking because less people are smoking. Declines in cigarette purchases are running between 3% and 4% a year, and unless that rate tapers off, 74% of the bonds Moody’s rates will miss payments, the firm said. Even the drop in consumption slows to between 2% and 3%, one-third of the bonds could default.

Bonds most at risk are those with longer maturities, and those that rank subordinate to other bonds, meaning that they will be paid out later, when declining cigarette sales will have higher cumulative impacts. New Jersey’s benchmark $1.26 billion 5% tobacco bond due 2041 is trading between 77 and 80 cents on the dollar this month, up from about 72 cents at the start of the year, according to the Municipal Securities Rulemaking Board.