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Q

I found your offering of a “tobacco securitization settlement bond” interesting. Can you tell me what it is? In the past, I’ve purchased AAA, insured tax-free munis. What is the difference in quality (i.e. reliability) between what I’ve owned and the tobacco bonds? Are tobacco bonds insured or insurable?

A

James A. Klotz responds:

In 1998, the nation’s largest tobacco makers agreed to pay 46 states and four territories a total of about $200 billion over 25 years to settle states’ legal claims against the companies. The disbursements are made yearly and are based on the number of cigarettes shipped domestically for that year.

In order to gain access to these funds up front, many states “securitized,” or issued bonds, against these payments. In turn, annual payments by the tobacco companies go to bondholders instead of the states. Currently, about $20 billion in tobacco securitization bonds are outstanding.

Many investors favor tobacco bonds because of their outstanding yields. Additionally, lawsuits challenging both tobacco companies and the agreement with the states have declined, and the legal environment has been viewed as more benign by bond investors.

If you search our Web site for “tobacco bonds,” you will see many articles on developments affecting these bonds.

The tobacco securitization bonds are mostly rated in the “BBB” and “BB” categories by the rating agencies. At this point, none appear to be insured.