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NEW YORK (Dow Jones) -- States are estimated to receive about 1% more in annual payments from tobacco companies this year than in 2011, suggesting more money will be available to repay billions of dollars of municipal bonds backed by the tobacco payments.
States are expected to receive about $6.1 billion from the tobacco companies this year, according to figures released by the National Association of Attorneys General. Last year, they collected about $6.03 billion. The payments are being made under a 1998 settlement that resolved the states' health-related claims against tobacco manufacturers.
The tobacco companies are supposed to make their annual payments on April 15, but will make them on April 16 this year because this year's April 15 falls on a Sunday. The amount actually collected could be slightly different if some companies fail to make their payments; last year, defaults were about $20 million. Payments are based on U.S. cigarette consumption in the previous calendar year.
Cigarette consumption has declined faster than expected over the last few years, forcing Virginia, Ohio and California to draw on reserves last year to pay investors who own tobacco bonds. It was not immediately clear whether the slight uptick in payments would be enough to keep states from tapping their reserves again.
Cigarette consumption declined 3.5% in 2011, following a decrease of 3.8% in 2010 and 8.6% in 2009, according to industry research group Management Science Associates.
The companies that signed the 1998 agreement can withhold some payments if they lose market share to other manufacturers that have not signed on. The companies are not required to withhold this so-called "non-participating manufacturer adjustment," but last year the three original signatories -- Reynolds American Inc. (RAI), Lorillard Inc. (LO) and Altria Group Inc. (MO) -- kept that money from the states.
Although this year's payment is based on 2011 cigarette consumption, the non-participating manufacturer adjustment for the three original signatories is based on the 2009 sales year. The adjustment that year is around $780 million, less than the approximately $825 million the previous year, according to the attorneys general.
Even though cigarette consumption continues to decline, the smaller adjustment this year helps the states with a slight uptick in tobacco payments. The approximately $6.1 billion in tobacco payments estimated for this year incorporates the adjustment.
The market share of the original signatories continues to rise. Their combined share was 84.71% in 2011, the most since 2007, when the figure was 84.77%, according to the attorneys general. Market share for companies that did not sign the 1998 agreement was 5.65%, the lowest since at least 2003, according to the attorneys general.
Vikram Rai, a credit strategist at Citi, said that a slight uptick in actual payments this year would be a plus for tobacco bonds, though the shorter-dated bonds could rally more. Additionally, if the original signatories continue to regain market share from companies that did not sign the agreement, their future adjustments should be lower.
Cautious investors have traditionally shunned tobacco bonds due to their risk, but others have been drawn to their high yields. Tobacco bonds tend to be more volatile than other municipal bonds and can still offer juicy returns, although they also have the potential to underperform.
More recent tobacco bond sales have taken into account the larger consumption declines of recent years to appeal to more risk-averse investors. For example, Ohio cited a study in its 2007 bond prospectus that estimated a 1.8% annual decline in cigarette consumption. Earlier this year, though, Alabama sold tobacco bonds that wouldn't default unless consumption declines 25% each year.
Forty-six states signed the 1998 agreement, and there are about $30 billion worth of tobacco bonds outstanding.
-By Mike Cherney, Dow Jones Newswires; 212-416-3163; email@example.com