California Tax Imperils Best Tobacco Gain Since ’09: Muni Credit

California Tax Imperils Best Tobacco Gain Since ’09
Voters in Missouri, with the lowest state cigarette tax in the U.S. at 17 cents a pack, go to the polls in November on a $1 increase. Photographer: Chris Goodney/Bloomberg

More than 300,000 uncounted ballots in a California tax referendum may dictate the future of the biggest rally since 2009 for bonds backed by payments from tobacco companies.

Proposition 29, seeking to more than double taxes on a pack of cigarettes in the most-populous U.S. state, was initially behind by about 63,000 votes of 3.9 million cast June 5. Counting of absentee ballots has narrowed the margin to 17,571 as of yesterday, with about 371,000 untallied, according to the Secretary of State’s office.

Investors such as Bill Black at Invesco Ltd. said they’re checking the California vote results daily. Black, whose company manages $20 billion in municipal debt, said that a higher tax may lower sales underpinning the payments that states receive from tobacco companies under a 1998 settlement of smoking-related litigation.

“If the measure succeeds, that would probably encourage other states to raise their taxes as well,” said Black, who holds California tobacco bonds. “That would have a significant impact” on tobacco bond yields, he said from Oakbrook Terrace, Illinois.

California accounts for $28 billion of tobacco securities, the biggest portion of the $102 billion of such debt outstanding, data compiled by Bloomberg show. Tobacco bonds have earned 4.09 percent this year through June 18, compared with 3.97 percent across the $3.7 trillion muni market, Bank of America Merrill Lynch indexes show. The segment hasn’t beaten the market since 2009.


California’s proposed $1-a-pack increase would boost the tax to $1.87, with the additional revenue slated for cancer research and anti-smoking programs. The tobacco industry led a campaign that spent $46.8 million to kill it.

A victory for the tax’s proponents may inspire other states to follow suit, said Jack Pitney, a political science professor at Claremont McKenna College in Claremont, California.

Voters in Missouri, with the lowest state cigarette tax in the U.S. at 17 cents a pack, go to the polls in November on a $1 increase. Illinois Governor Pat Quinn, a Democrat, signed a law June 14 that raised the levy there by $1 a pack, to $1.98.

A California tobacco bond maturing in June 2027 traded yesterday at an average yield of 6.3 percent, according to data compiled by Bloomberg. The security, which Standard & Poor’s rates B, five levels below investment grade, yielded 2.45 percentage points more than top-rated munis, the least since January, Bloomberg Valuation data show.

Smoking Rates

Each 10 percent increase in tobacco prices reduces smoking rates by 4 percent, Christopher Hansen, president of the Cancer Action Network, the national advocacy affiliate of the American Cancer Society, said in an interview.

Two-thirds of campaign contributions to defeat Proposition 29 came from Richmond, Virginia-based Altria Group Inc., maker of Marlboro, which put in $31.3 million, according to data compiled by MapLight, a nonpartisan research organization based in Berkeley. Reynolds American Inc., the maker of Camel and Winston, based in Winston-Salem, North Carolina, gave $14.1 million, according to MapLight data.

Bill Phelps, a spokesman for Altria Group, said the company opposes “additional, targeted taxes on tobacco.” Jane Seccombe, a spokeswoman for Reynolds American, referred questions to Beth Miller, a hired spokeswoman for the campaign to defeat the measure.

“We are cautiously optimistic that Prop. 29 will be defeated when all is said and done,” Miller said by e-mail.

Lead Dwindles

Opponents of the tax led 50.2 percent to 49.8 percent as of 12:47 p.m. California time yesterday, the latest tally available on the secretary of state’s website. The day after the election, the lead was 50.8 percent to 49.2 percent. County officials have until July 6 to report totals to the state.

Richard Larkin, director of credit analysis for Herbert J. Sims & Co. in Iselin, New Jersey, said the measure could decrease smoking by 10 percent in the state and 2 percent nationally.

Payments from the settlement agreement with cigarette manufacturers rose in 2012 for the first time in three years, according to a report by Janney Montgomery Scott LLC in Philadelphia. About $6.2 billion was distributed to 46 states, the District of Columbia and five U.S. territories, up from $6 billion in 2011.

Cigarette consumption fell about 3 percent in 2011, the smallest drop since 2006, according to Janney. It has dropped from a 1981 peak of 640 billion cigarettes to less than 300 billion in 2011, according to the report.

Tax Impact

The decline “has been at a steeper pace than most people would have thought, and taxes have to be a big part of it,” said Matt Dalton, who manages about $1 billion of munis, including California tobacco bonds, at Belle Haven Investments Inc. in White Plains, New York. The California measure “is just another wind blowing negatively towards tobacco bonds.”

Rejection of the California measure might discourage anti-smoking advocates, Pitney said. California has the second-lowest proportion of smokers of any state, 12.8 percent, compared with 20.6 percent of adults nationwide, he said.

“A failure in California would make it harder to pass such measures in other states,” he said by e-mail. “If the tobacco companies can beat it here, then they can beat it anywhere.”

Following are pending sales:

NEW YORK STATE THRUWAY AUTHORITY plans to issue $1.1 billion in revenue bonds as soon as next week, according to an offering statement. Proceeds from the sale will be used to fund capital projects. On June 12, S&P lowered its outlook on the bonds to negative from stable and assigned the securities an A+ rating, fifth-highest. (Added June 20)

THE CITY OF OAKLAND, California, plans to issue $211 million in taxable pension-obligation bonds as soon as today, according to Moody’s Investors Service. Moody’s rates the bonds Aa3, fourth-highest. (Added June 20)

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