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Tobacco Bonds Rally After Cigarette Makers Release $4 Billion

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Dec. 19 (Bloomberg) -- Tobacco bonds issued by U.S. states are gaining after Philip Morris USA and other cigarette makers said they would distribute to 17 states $4 billion in payments previously withheld from a 1998 settlement.

The extra yield that investors demand to buy a California tobacco bond fell by more than 0.2 percentage point today, and is down 10 percent this month, data compiled by Bloomberg show. Philip Morris, Lorillard Inc. and Reynolds American Inc. said yesterday they would release the funds in exchange for credit against future payments toward the settlement.

“There’s more certainty, and that’s good for the states and ultimately good for the tobacco bonds,” said Alan Schankel, managing director of fixed-income research at Janney Montgomery Scott LLC in Philadelphia.

A tax-exempt Golden State Tobacco Securitization Corp. bond rated B3 by Moody’s Investors Service, six steps below investment grade, and due in 15 years, traded today with an average yield of 5.32 percent, data compiled by Bloomberg show. That’s 3.2 percentage points above a benchmark index, down from 3.56 percentage points Nov. 30.

Tobacco bonds rated junk have earned about 28 percent this year, compared with 7 percent for the broader $3.7 trillion municipal market, Barclays Plc data show.

In the 14-year-old agreement, the producers make annual payments to 46 jurisdictions based on cigarette shipments to cover the companies’ liability in health-care cost litigation.

The makers and the states were in disagreement over claims that market-share erosion should reduce the companies’ payments.

To contact the reporter on this story: Michelle Kaske in New York at mkaske@bloomberg.net

To contact the editor responsible for this story: Stephen Merelman at smerelman@bloomberg.net

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