Tobacco Settlement Maneuver: Who Wins and Loses from Another Imprudent and Confusing Transaction?
Last week the Christie administration approved a transaction that will provide over $90 million in additional tobacco settlement proceeds this year to help plug a shortfall of nearly $800 million, but the move will drain hundreds of millions of dollars in revenue from the state’s coffers later in the decade.
According to the offering statement and press reports, New Jersey will gross $96 million from bond holders as a premium for the increased value in the bonds that occurs from the state pledging the tobacco settlement proceeds from 2017 to 2023 to the bondholders. After expenses, this year’s budget will receive approximately $92 million.
But as a result New Jersey will give up over $400 million in revenue during that seven-year span just to generate the $92 million in the current budget.
The pledge of the additional proceeds will, however, result in New Jersey paying off the $1.4 billion debt 26 years earlier than expected, in 2023 rather than 2049. For the state to gain revenues for budgets after 2023, it would have to refinance the remaining bonds to reduce the current 75 percent pledge of interest to bondholders to a lower percentage. A lower pledge of settlement payments would result in more money for the 2024 budget and beyond. It is not clear if a refinancing would be viable in 2024.
Under the 1998 tobacco settlement, the tobacco companies agreed to pay participating states in perpetuity for health care costs associated with smoking. New Jersey is currently expected to receive $200 million to $250 million per year if current smoking levels are maintained.
In 2002, New Jersey sold the expected future payments to bond holders, using the over $3 billion in proceeds to balance two budgets but costing the state between $200 and $250 million a year of lost revenue thereafter. A recent refinancing of the bonds reduced the state’s pledge from 100 to 76 percent, leaving the state budget with annual revenue of about $55 million. It is this revenue that will now be handed over to bondholders between 2017 and 2023.
So who wins and loses from this latest change?
This year’s budget : The current year (FY 2014) budget shortfall gets partially addressed by the $92 million infusion. Although not technically a “winner,” the next two budgets will not be impacted since the administration chose not to pledge the higher bondholder payments until the FY 2017 budget. This transaction will only reduce revenues for two of the remaining four Christie budgets because of the delayed payments.
Barclays: The global banking giant will receive between $4 and $5 million in fees for the transaction.
Current bond holders: According to press reports the price of the zero-coupon bonds tripled in the four days after the deal was announced, rising to 10.7 cents on the dollar on March 7 from about 3 cents on March 3. Ratings on the bonds increased 10 steps from CCC+ (seven steps below investment grade) to A- (investment grade). OppenheimerFunds Inc., Goldman Sachs and Columbia Management Investment Advisors are among the largest owners of these bonds, according to press reports. These bondholders are, however, paying the state $96 million up front which will offset some of the gain in the value of the bonds.
FY 2024 budgets and beyond: Assuming that the $1.4 billion in bonds are paid off by 2023 or shortly thereafter, it is possible that the state could refinance the remaining bonds and thus reduce the underlying 75 percent pledge of settlement proceeds established in 2007. This would free up more residual settlement payments for budgets after 2023. Even if there is no refinancing, maintenance of the 75 percent pledge would likely result in the remaining bonds being paid off prior to 2049 thus freeing up money in whatever year the bonds are paid off.
Seven years of future budgets: New Jersey will lose between $56 million and $67 million a year between fiscal years 2017 and 2022, and approximately $20 million in fiscal year 2023. This is money that will not be able to pay for any of the state’s needs.
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