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Q

We are holding some Buckeye tobacco bonds and I would like to know what would happen if contributions to the Master Settlement Agreement seriously decline. I have read that the likeliest scenario would be the extension of maturity, which would be fine. But what are the other possibilities? I assume that defaults do not just happen overnight, or do they? My wife and I have been working with Saul Rosen for a couple of years now and we think he and your firm is top of the ladder. We appreciate the straightforward business practices and no-nonsense advice.

A

James A. Klotz responds:

Basically, the stronger the decline in cigarette shipments, the lower the payments to the states. If declines in payments backing the settlement are greater than expected, there would be less money to retire bonds through turbo redemptions. This would lead to bonds being retired on their maturity dates, rather than earlier from turbo redemptions. If the declines were greater yet, at some point the issue would dip into its liquidity reserve to make up any shortfall in debt service due to bondholders. If this scenario continued, you could eventually have a partial default. While possible, no one foresees such an event occurring any time soon.

All of these scenarios depend on the longer-term rate of cigarette shipment declines. Historically, the rate of decline has been fairly predictable, with ups and downs to the rate occurring depending on either federal or state excise tax increases on tobacco. After a tax increase, rates of decline tend to be greater, with a return to more normal declines a year or two later.

In summary, tobacco bonds ultimately perform like other bonds. They are structured around certain assumptions regarding revenue performance over time. Ohio’s tobacco bonds were changed to a “Stable” outlook by Standard & Poor’s on December 30, 2010. Previously, their outlook was “Negative.”