Unfortunately for investors, while many are making positive
health choices by giving up their bad habits, the bonds are
headed for default. The majority is expected to reach that point
within the next decade. Though projections were expecting a two
or even a three percent drop in consumption, the annual decline
has been closer to 3.5 percent on average. Last year, the drop
was 4.9 percent, the highest level of decline since the excise tax
was passed in 2009.
In the past, the analysts blamed the banning of smoking in
public facilities and the excise taxes for declined consumption,
but the rapid decrease suggests that other factors are at play.
Anti-Smoking Ads Certainly part of the decline could be blamed
on government agencies’ efforts to spread the word about the
dangers of smoking. The television ads of recent years are
rather explicit in their attempts to showcase the true
disfigurement that can occur after years of smoking. Among
those is this video, issued by the CDC.
Centers for Disease Control and Prevention
Growing Vaporizer Trend The drop of nearly five percent last
year can be, in part, attributed to the growing popularity of
e-liquids. In 2013, United States citizens bought nearly a
billion fewer cigarettes than the year before, yet sales of
e-cigarettes doubled in that same time. By current estimates,
cigarette sales could decrease by nearly 70 percent by 2024,
while e-cig sales are expected to reach more than five million
units by that date.
States Getting Themselves into a Bind
The states were not truly acting irresponsibly, but at the
same time, many investors will be feeling a bit uneasy about now.
Even more frustrating for millions is the fact that the states
have not done with the money as they had proposed. The entire
purpose for the payments was to help cover some of the expense
attributed to the use of tobacco, such as medical expenses.
However, of the $100 billion paid out thus far, less than 15 percent
has been used for such reasons.
Now states are forced to seek funds from elsewhere as tobacco
payments come up short of what is owed to investors. New Jersey
has already withdrawn $12.5 million and it is expected that Ohio
will pull more than twice that from reserves.
What This Means for Bond Holders
The big attraction to the tobacco bonds was the high rate
of return promised. According to the Standard and Poor’s Index,
they matured at 6.24 percent as compared to the 2.9 percent
earned on general muni bonds.
However, Moody’s now is suggesting that as many as 80 percent
of them are headed for default. Should the decline in tobacco
consumption reach rates of six or seven percent in the coming
years, the defaults could occur much sooner. The first cases
could be as soon as 2019.
There is a downward trend within a portion of the investment market that has some celebrating, while other nervously cling to dreams of proper payout. Outstanding tobacco bonds are looking more than a little volatile as smokers drop their bad habit in record numbers. Many are suggesting that the growth of the e-liquids market is partially at fault.
How Tobacco Bonds Work
In 1998, the tobacco companies and state government agencies finally saw eye-to-eye, creating the Master Settlement Agreement. This is now, informally, referred to as the MSA
and has resulted in 16 years of payments made from tobacco companies to 46 U.S. states. These payments are not fixed,
but vary depending annual tobacco shipments. The states
also receive a cut depending on their respective populations.
In order to get that money faster, many governments arranged the sale of bonds with appealing rates of return. The investors willing to put up sums upfront were rewarded with annual paybacks, as the tobacco funds arrived. Trouble arose when
the tobacco shipments declined and the payments coming in
did as well.
Rapid Growth in E-Cig Market
Though the government did expect a slight decline in tobacco usage over time, the drop has been nearly twice what was predicted. Many people feel that the soaring success of vaporizers and e-liquid flavors are the cause of the more
drastic drop in tobacco usage. The ability to get the nicotine
in a similar fashion, but without the toxins and within public establishments is a definite draw for many smokers.
Though the sales remain miniscule when compared to those of traditional cigarettes, there were 2.2 billion dollars’ worth of
e-cigarettes and paraphernalia last year. Some analysts believe that this niche could claim more than half of the total market within 10 years.
Reuters was among the first to report the possible merger between two tobacco giants, Reynolds American Inc. and
Lorillard Inc. What’s the attraction for Reynolds? Many believe that the deal has much to do with Lorillard’s ownership of
Blu e-cigarettes. Lorillard bought the leading e-cig brand for
$135 million a couple of years ago.