How Bad Credit Payday Loans Impact The Big Tobacco
Politicians demanded cash upfront for a judicial win against Big Tobacco, which bankers gladly provided. What is the cost? On a $3 billion advance, a few states committed to repaying $64 billion. If you need a payday loans for bad credit try citrus north for free.
Attorneys general from around the nation reached an unprecedented agreement with the tobacco industry in November 1998 to pay for the health care expenses associated with smoking. Almost every cigarette sold in the future would pay money to the states, territories, and other governments concerned, totaling more than $200 billion in the first 25 years of a court settlement that required payments to be paid in perpetuity.
Then Wall Street came knocking with an offer that many state and local officials couldn’t refuse: cash upfront in exchange for the right to some or all of their tobacco revenues from investors. After the state reached agreements that opponents characterized as “payday loans,” others saw as wise. If people smoked less and tobacco money ran out, private investors, not taxpayers, would bear the brunt of the loss.
Things haven’t gone reasonably as expected.
According to a ProPublica study of more than 100 tobacco agreements made after the settlement, they are causing new budgetary problems for governments, forcing some to seek bailouts or threatening to raise borrowing costs in the future.
One source of suffering is a little-known component included in many deals: high-risk financing that squeezed out a few more bucks for governments but guaranteed large balloon payments down the future, some in the billions.
These instruments, known as CABs (capital appreciation bonds), have become poisonous. According to an analysis of bond documentation and Thomson Reuters statistics, they account for barely a $3 billion slice of the roughly $36 billion in tobacco bonds outstanding. However, the nine states, three territories, the District of Columbia, and many counties that issued them have pledged to repay them in $64 billion.
The debts must be repaid using settlement money rather than tax dollars under the agreements. On the other hand, taxpayers lose out when tobacco revenue that might be used for other government programs is diverted to pay off CABs. Bondholders have a right to continue tobacco payments even after a default, so governments can’t just walk away from the obligation.
So far, the clear winners have been investment bankers from Citigroup, the now-defunct Bear Stearns, and others. According to ProPublica estimates, they have earned more than $500 million in fees for their financial engineering. They stand to profit even more now that governments are looking to modify past arrangements to obtain more tobacco money upfront.
Part of the problem with tobacco bonds stems from the same type of blunder that caused the housing boom.
Tobacco transactions depended on optimistic forecasts of how many Americans would smoke, much as mortgage lenders anticipated that property values would continue to rise. Forecasters were correct in predicting further declines in cigarette sales, but the current annual reduction — roughly 3 to 3.5 percent — is about twice what was included in the accords.
The outdated calculations entail an ever-widening disparity between what governments planned to recover under the settlement and the payments they promised investors since the bonds offered to investors may last for 40 years or more.
Since they aren’t due for decades, the CABs offer huge returns — up to 76 times borrowed. Interest accrues on both the principal and the growing amount in the meanwhile.
State and local government defaults are uncommon, but rating agencies have warned that tobacco bonds, in general, might default en masse. In May, Moody’s predicted that up to 80% of the tobacco concerns it monitors would fail.
CAB defaults seem to be set in stone.
Firms on Wall Street are already offering their services to assist in unraveling agreements that they helped build.
New Jersey received $4.5 million from Barclays, which handled the deal. The state also received $92 million in cash upfront to assist Gov. Chris Christie and legislators in closing a budget shortfall. Even yet, rating agencies weren’t thrilled, and the state was downgraded, making borrowing more expensive for New Jersey.
In late July, Rhode Island revealed a proposal to buy some of the holders of $197 million in CABs it issued in 2007. The agreement would save the state $700 million on a $2.8 billion bond payment due in 2052 and allow it to refinance some of its earlier tobacco obligations at lower interest rates. Some bondholders are now seeking to prevent the sale from going forward.
The tobacco transaction in Ohio was the biggest in history. CABs raked $319 million in exchange for a $6.6 billion balloon payment – a fraction of a penny on the dollar. According to the bond selling document, Bear Stearns, Citigroup, and other Wall Street companies collected nearly $23 million in fees on the deal.
Then there’s Puerto Rico, a lengthy history of financial difficulties.
Bear Stearns failed in April 2008. According to the bond offering document, it completed a $196 million tobacco bond, which burdened the Puerto Rico Children’s Trust, a fund set up to help island families, with t. Fees from Bear Stearns and Citigroup totaled $1.4 million.
This year, Puerto Rico’s tobacco settlement revenues were 13% lower than expected when the agreement was reached. In addition, the Commonwealth is battling to avoid default on a pile of additional debt. Officials did not reply to written queries, phone calls, or interview requests.
Critics have often accused states and other jurisdictions of breaching the tobacco settlement’s objectives by diverting funds from anti-smoking and healthcare initiatives.
“The securitization scheme not only accelerated the use of that money’s expiration, but it also basically guaranteed that it would never be used for its conceived purpose,” said Dave Dobbins, executive director of the American Legacy Foundation, a nonprofit established under the settlement to fun is gone, the securitization plan is for some individuals coming ho whenever governments get access to a stream of money to roost… And the tobacco issue persists: 480,000 people are estimated to die this year from cigarette-related diseases.
“It’s a bleak tale.”
Tobacco Cash “Turbo”
Wall Street bankers offer arrangements to change a steady supply of money into a one-time payment whenever governments have access to it. Bonds are offered to investors who lend the government money in return for an income stream similar to a loan. Bankers are paid depending on the transaction amount, so they have every motive to enhance the value.
The tobacco settlement of 1998 was no ordinary income stream: it was the most significant financial settlement in legal history, with a predicted net worth of $206 billion for states and other governments through 2025. At the time, Iowa Attorney General Tom Miller noted, “The money is substantial.”
On Wall Street, a tiny industry sprung up almost quickly. The idea is to persuade nations to pawn earnings.
According to pitch materials, Citigroup, JPMorgan, UBS, Goldman Sachs, Morgan Stanley, and now-defunct businesses such as Bear Stearns, Lehman Brothers, and Merrill Lynch all devoted bankers to the cause. Bear Stearns even had its own “Tobacco Securitization Group,” which consisted of 21 people dedicated to monetizing the settlement.
“The ink on the deal had hardly dried when these guys began coming at us, promoting the concept of securitization,” said Christine Gregoire. She helped lead the tobacco settlement discussions as Washington’s attorney general and subsequently rejected securitization as governor.
“I was simply like, ‘Wow, I can’t believe they figured of a way to earn one-time money and be in debt to the income stream right now.’ And I recall being insulted by the concept from the start,” she said.
Gregoire’s complaint is similar to why it’s not a brilliant idea to purchase food on credit: paying interest overtime on products you’ll rapidly consume results in you spending more — and receiving less.
When her state contemplated generating $450 million to repair a budget shortfall by cashing out tobacco profits in 2002, she cautioned, “It’s not smart fiscal management of public money to give away 75 cents on a dollar of income.”
Regardless, Washington legislators forged forward. The strategy secured 29.2 percent of the state’s anticipated tobacco income, or $40 million to $50 million each year. That money would be pledged to investors until the loan was repaid entirely, which would be approximately 2025.
Bear Stearns tobacco banker Kym Arnone recommended the state against utilizing CABs.
“At this time, no market for tobacco CABs has arisen since investors are hesitant to postpone all of their income until the bond’s ultimate maturity when there is a high risk of payment interruption or delay,” according to a 2002 pitch document signed by Arnone.
The state took that recommendation. By regularly issuing ordinary bonds that pay interest and principal, Washington could sell one of Bear Stearns’ less expensive transactions. Until last year, investors were awarded $848 million from tobacco settlement money, a bit less than double the $450 million the state received.
However, one of the first agreements was with Washington. As the securitization trend proceeded — according to Thomson Reuters statistics, Bear Stearns alone led $23 billion in transactions from 2000 to 2007 — bankers looked for methods to fatten the deals and profits.
The CAB was the most prominent of them. By 2005, investment bankers had found ready purchasers for this form of a bond, partly due to the “turbo” bond, a repayment arrangement initially proposed by Goldman Sachs.
Governments agreed to make early payments if they had excess funds from the tobacco settlement, provided they used a turbo bond. They appealed to CAB investors who may need cash before the ultimate payout.
“That’s why they’re called turbos – they pay off quicker,” said John Lampasona, a tobacco bond analyst at Standard & Poors.
Cigarette sales estimates that were reassuring also helped the CAB market.
A consultancy business, IHS Global Insight, made millions of dollars by forecasting practically every sale in the industry. The forecasts convinced investors that additional cash would be available to prepay CABs. Since then, smoking bans and significant price rises have been almost twice the pace of fall in cigarette sales predicted by IHS.
James Diffley, IHS’s chief forecaster for cigarette sales, told ProPublica, “I take all the credit and all the guilt.” “It’s a forecasting exercise,” says the narrator. Nobody expected the world to turn out the way it did.”
According to the bank that negotiated the transaction, a 2005 deal involving Puerto Rico was the first CAB sale. Merrill Lynch persuaded the Puerto Rico Children’s Trust to issue $108 million in CABs with maturities between 2045 and 2050. Many authorities who decided to sell the debt would be deceased, and a $2.5 billion payment would be due.
According to Merrill Lynch, Puerto Rico could pay off the debt early by paying $372 million in accelerated repayments from 2024 through 2028. That forecast, secreted away in the 2005 bond offering, was predicated on industry payments matching IHS’s fundamental cigarette sales forecast.
According to a Merrill Lynch pitch document, mutual fund managers Oppenheimer Funds, BlackRock, Eaton Vance, Dreyfus, Nuveen, and Goldman Sachs Asset Management acquired Puerto Rico’s turbo CABs. Merrill Lynch, now owned by Bank of America, refused to comment for this piece.
Following that transaction, bankers began adding CABs into various tobacco securities. Between 2005 and 2008, ProPublica uncovered 92 CABs that included accelerated repayments, generating roughly $3 billion.
These bonds have a $64 billion payback, almost 21 times borrowed. ProPublica calculates that the payment would be roughly five times in the rare event that they were all reimbursed early. According to Estes, the finance expert, traditional bonds, such as those issued by Washington generally, repay around three times the amount borrowed.
CABs have caused controversy in various areas due to their strict payback requirements. Michigan, for example, local school districts’ ability to issue CABs in the mid-1990s since they might result in massive debt loads in the future.
Despite this, Michigan sold a $55 million CAB in 2006, bundled inside a bigger $490 million tobacco issuance by Bear Stearns. In 40 years, the CAB committed to returning $1.5 billion, or 27 times the amount borrowed.
Oppenheimer Funds did not respond to a request for comment for this article. However, Michael Camarilla, senior portfolio manager for the firm’s municipal team, told Bloomberg News in May that the tobacco industry offered a purchasing opportunity for investors who were ready to hang on to the debt. He remarked, “Right present, tobacco and Puerto Rico are the cheapest industries.”
According to Lipper statistics, the company was the most prominent turbo CABs in May. Oppenheimer Funds would receive around $40 billion if all securities were paid off in full at maturity. However, given the diminishing settlement revenues from 1998, this looks to be exceedingly improbable. According to Lipper, the business evaluated these CABs at just around $700 million in May or approximately 1.8 cents on the dollar.
“I have yet to see a capital appreciation bond that I believe will be paid,” said Dick Larkin, a credit analyst with the Florida brokerage company Herbert J. Sims & Co., who has been warning about tobacco bonds for a decade.
A similar conclusion has been reached by several of the early investors.
“We don’t want any bonds in this industry overall,” said Tom Petzold, senior portfolio manager at Eaton Vance, one of the mutual funds that purchased Merrill Lynch’s Puerto Rico CABs. According to Lipper, a $6.6 million portion of the 2005 purchase was the last CAB in one of the firm’s funds as of May.
Hedge funds are stepping in to help investors like Metzold limit their losses. They may earn money by buying the debt at distressed prices. According to S&P Dow Jones Indices, tobacco bonds of all kinds have been a favorite playground for speculators this year, yielding 10.83 percent and making it one of the best performing sectors of the municipal bond market.
The “Max Out” Approach
According to analysts, states agreed to the CABs’ stringent repayment conditions to extract as much money as possible from the tobacco settlement funds. Dean Lewallen, a senior research analyst at investment firm AllianceBernstein in New York, said, “They were intended to milk every last penny.”
States received more upfront funding through layering in CABs than they would have gotten otherwise. It would free up tobacco money to pay any CABs included in the package after ordinary 30-year bonds were paid off. They may then be paid off before the substantial balloon payments were due at the end of the term.
The scenario presumptively anticipated that settlement revenues would arrive on time. When many of the securitizations were sold in 2007, bankers and politicians were more worried about another element of the transactions: the magnitude of the transactions.
According to press accounts at the time, Ohio’s newly elected treasurer, Richard Cordray, started touting the concept of securitizing the state’s tobacco money in February of that year, just after taking office.
Ted Strickland, Ohio’s then-governor, approved the concept, and it swept through the legislature in June. The aim was to sell all of Ohio’s tobacco money to fund new school buildings and elderly tax relief.
The sale was in full motion by July, according to Cordray and then-Budget Director Pari Sabety. Cordray stated in public speeches pushing the agreement that it made sense since tobacco payments may be reduced in the future.
The CABs were expensive. They have higher interest rates, 7.25 and 7.5 percent, than the 6.5 percent “sticker shock” figure that forced Puerto Rico to cancel its CAB auction. $6.6 billion will be owed on them when they reach maturity in 2047 and 2052, respectively. That’s a total repayment ratio of nearly 21 times the amount borrowed, assuming no turbo payments that may pay off the loan early.
The interest rates on Ohio tobacco debt, on the other hand, varied from 4% to 6.5 percent.
Bear Stearns fell bankrupt only a few months after the acquisition, anticipating the impending financial crisis. Arnone then joined Lehman Brothers, which went bankrupt in September 2008 and had North American businesses taken out by Barclays Capital.
Two weeks later, Arnone was hawking another tobacco contract to Iowa authorities, writing on Barclays’ letterhead, “Individuals make the difference — not corporations, which have sadly shown to be ephemeral in this climate.”
The race had finally come to a halt at that point. Following the fall of Lehman Brothers, Oppenheimer Funds, which had been the “only source” of liquidity in the CAB market, stopped purchasing. Arnone advised the state to avoid using CABs. Iowa backed out of the arrangement after failing to meet its goal amount.
Citigroup, Morgan Stanley, and JPMorgan refused to comment on this report. Arnone and Barclays did not reply to a list of specific questions or requests for a response.
“The decision to go through with the acquisition was taken by Ohio’s leadership in 2007,” the state’s Office of Management and Budget stated in a statement when asked about the deal’s wisdom. We are unable to comment on their thoughts at this time.”
Although Strickland did not reply to a request for comment, Cordray told ProPublica that the state made the correct choice. According to him, the drop in tobacco payments indicates that they were riskier than previously thought, and CABs assisted the state in maximizing its profits. He added that investors, not Ohio, should bear the brunt of any subsequent payment reductions.
“Obviously, they’ll want to come back with a cup in their hand and tell the state, ‘Put some money in it,'” Cordray said. “However, it isn’t needed; it isn’t legally required, and that was the entire point of this transaction.”
“We essentially burned it all down.”
Ohio avoided issuing general obligation bonds, which are repaid with taxes, to finance construction expenses by utilizing tobacco bond money. However, all governments did not employ tobacco debt for such long-term investments.
The state of New Jersey serves as an excellent example. In 2002 and 2003, the state issued tobacco bonds for the first time, raising $3.5 billion to plug budget gaps. “We practically burnt it all in two years,” said David Rousseau, state treasurer from 2008 to 2010. “It wasn’t one of New Jersey’s better business decisions.”
To repay the debts, the state raised an additional $3.6 billion in 2007. The contract, arranged by Arnone’s Bear Stearns team, had one bright spot: it allowed New Jersey to retain around 24% of its tobacco payments rather than the 100% it had given up in the previous agreement. This freed approximately $50 million to $60 million in revenues for the state rather than investors each year.
But only for a short time.
When faced with another $800 million budget shortfall this year, state authorities went to Arnone again. The two CABs issued in 2007 and the $1.3 billion payouts were also a source of worry. The solution was to sign over the untapped tobacco money expected from 2017 to 2023 — an estimated $406 million — to pay off the debt early in exchange for new cash from investors.
The state said it came out ahead in the transaction, partly owing to the $92 million in revenue it received for the budget. Nonetheless, Standard & Poor’s downgraded New Jersey’s taxpayer-backed debt by one notch, noting the state’s “dependence on one-time measures that are adding to increased fiscal strain in the future.” The rating agencies Moody’s and Fitch followed suit, citing the same issue.
The downgrading demonstrates how CABs may cause harm despite laws intended to protect the state and taxpayers.
Like other states that marketed tobacco bonds, New Jersey did so via a shell company. The New Jersey Tobacco Settlement Financing Corp. is authorized to operate “in, but not of” the state’s treasury. The tobacco proceeds that the state agreed to hand over to pay off the corporation’s obligations are its sole assets.
“The bondholders have a lien on just those sums, and no other monies,” said David Narefsky, a municipal bond lawyer at Chicago legal firm Mayer Brown.
The CABs, on the other hand, do not go away if they are not paid back on time. Barclays warned the state that bondholders would still be first in line for any future tobacco revenue in the event of a default. The bonds would continue to collect interest and be repaid at a higher rate – $1.6 billion per year from 2041 to 2049.
In a statement explaining the March arrangement, New Jersey made it clear that the CAB bondholders could not be disregarded.
While New Jersey is “not legally obligated” to avoid a default, it did not want the corporation’s financial woes to show up on its records — or irritate its creditors, according to the statement: “The State sees a benefit in keeping good ties with tobacco bond investors since they are more inclined to invest in other State bonds.”
Rhode Island similarly concluded that it couldn’t disregard its CABs any longer. To take advantage of decreasing interest rates, the state intends to refinance its tobacco settlement bonds from 2002. However, the deal, which involves selling $594 million in new tobacco bonds to pay off the old ones, can’t move forward unless the owners of the company’s 2007 CABs agree.
As a result, Rhode Island plans to spend more than $60 million to purchase them and obtain their permission. According to a source acquainted with the matter, “all of the CAB bondholders are receiving something.”
The state of Rhode Island had intended to gain at least $20 million from the deal to help fund its budget. However, the agreement was put on hold when Oppenheimer Funds, which owns part of the tobacco debt, filed a lawsuit this week arguing that it will “siphon off” money from bondholders and give it to the state.
‘Money from Heaven’
As CAB debt accumulates on state financial sheets, optimism for payback — rapid or otherwise — is dwindling.
Only one of the four areas that had planned CAB turbo prepayments had done so yet, according to ProPublica: Placer County, California, which has a relatively tiny $14.3 million problem with a $68 million payout. The other three, tobacco CABs pooled and sold by New York counties, have not.
Making those turbo prepayments on traditional bonds has proven difficult. Prepayments on Ohio’s regular tobacco bonds, which must be paid off before any money goes to the CABs, have fallen behind by about $70 million. The state’s debt manager, Kurt Kauffman, said it’s too early to tell how Ohio’s CABs would be returned.
“We simply don’t know,” he explained. “It’ll be up to the future leaders to decide.”
Others are looking to see how their colleagues handle the situation.
California’s debts are a concern, as the state has promised to repay nearly $3.7 billion on $350.5 million in CABs sold by its Golden State Tobacco Securitization Corp. in 2007. Early turbo repayments for the corporation’s 2007 bonds are behind schedule.
“Hopefully it doesn’t come to that,” Tom Dresslar, a spokesperson for Treasurer Bill Lockyer, said, “because this office would be worried about a negative repercussion in the market.”
Because they tended to rack up future payments, Lockyer has previously referred to CABs used by school districts as “payday loans.” Dresslar claimed Lockyer had just taken office in 2007, and the bond transaction was already in the works when asked why California sold tobacco CABs during his term.
In states that have avoided CABs, debt management is more straightforward. Washington refinanced the tobacco bonds in 2002, selling $334.7 million in new lower-cost debt. Arnone was in charge of that deal. The state dodged CABs once again.
By 2023, Washington expects to have paid off its tobacco debt two years earlier. At that point, all tobacco dollars will be directed to taxpayers rather than investors.
“The tobacco settlement money was intended to go towards research and education to prevent individuals from starting to smoke, and of course, we want that to happen,” said Kim Herman, the state’s tobacco securitization authority’s executive director.
After all, the cost of smoking prompted states to fight Big Tobacco for money in the first place. However, the final legal settlement did not require states to spend at least some money on smoking prevention when it was signed in 1998.
“That was a mistake,” said Iowa Attorney General Tom Miller, who was a crucial figure in the settlement talks and is still in office. Miller said he didn’t mind if a substantial amount of Iowa’s earnings, 78 percent, was securitized as long as a portion of the proceeds went to tobacco prevention initiatives.
However, Michael Moore, who brought the first lawsuit that resulted in the settlement as Mississippi’s attorney general, claims that the securitized states made a “sucker bet” that diverted the fight’s profits away from their intended purpose.
“The decision-makers believe this money came from the sky,” Moore said. “No. This money was allocated to a public health battle, arguably the largest in our country’s history, aimed at combating the leading cause of death and disease.”
According to the Centers for Disease Control and Prevention, states need to spend $3.3 billion a year on anti-tobacco programs to make a significant dent in smoking.
Tobacco companies spend $8.8 billion a year on marketing, according to the Campaign for Tobacco-Free Kids, a smoking-prevention organization. According to the campaign’s most recent report, states spent $481 million on prevention in their most recent fiscal years.