Ohio Poised for Worst Return Since 2008 on Tobacco: Muni Credit
Ohio’s debt is headed for its worst annual return since 2008 because of a slump in the value of the state’s tobacco bonds.
Municipal bonds issued in Ohio have lost 5.7 percent since Dec. 31, compared with a 10 percent gain in 2012, a Standard & Poor’s Municipal Bond Index shows. The Buckeye State’s debt is on track to lose the most value in five years even though an improving economy boosted state cash reserves to a record.
Tobacco bonds are burdening the second-biggest economy among Midwestern states after Illinois. Debt backed by payments from cigarette makers is the worst-performing segment of the $3.7 trillion muni market with a 9.3 percent loss this year, after gaining 25 percent in 2012, S&P data show. A decline in smoking has reduced revenue from the companies. Ohio’s Buckeye Tobacco Settlement Financing Authority’s bonds, sold in 2007 and rated B- by S&P, make up almost 12 percent of S&P’s Ohio index.
“I don’t think there’s anything necessarily inherent in the state of Ohio or its issuing entities that’s a drag on the index -- it’s all really about the Buckeye tobacco performance,” said Peter Hayes, head of munis at New York-based BlackRock Inc., which manages $114 billion of local debt.
Buyers are seeking higher-rated securities as investors have pulled cash from muni-focused mutual funds on concern that the Federal Reserve may curb bond purchases. The Fed has been buying debt to keep short-term interest rates near zero to spur the economy.
Withdrawals have totaled $13.8 billion in the eight weeks through Aug. 14, the most since February 2011, Lipper US Fund Flows data show. That pushed yields on benchmark 30-year munis to about 4.7 percent last week, the highest since April 2011, data compiled by Bloomberg show.
About $94 billion of municipal securities are backed by tobacco-company payments as part of a 1998 settlement with states, generating revenue based partly on annual cigarette shipments. The bonds have lost more than twice as much this year as the broader S&P muni index, which declined about 4.4 percent through Aug. 15. Tobacco bonds are the worst performer compared with debt tied to segments such as hospitals, water and sewer systems and transportation networks.
A recovery that began after March 2010 in Ohio has continued, with just two quarterly declines through March, ranking it fifth in improvement, according to the Bloomberg Economic Evaluation of States. Ohio’s jobless rate fell to a post-recession low of 6.7 percent in December, and crept up to 7.2 percent in July, compared with a national average of 7.4 percent that month.
State tax revenue has exceeded the forecasts of Republican Governor John Kasich’s administration, and last month, Ohio increased its reserve fund to $1.5 billion. During fiscal 2009 and 2010, budget office figures show the balance was 89 cents.
“Ohio’s in reasonably good shape, but the tobacco-bond arena, not so much,” said Alan Schankel, head of fixed-income research at Janney Montgomery Scott LLC in Philadelphia.
Smokers quitting or cutting back have led to lower cigarette shipments by tobacco companies, reducing payments to some states. Consumption in 2013 may drop at least 4 percent, following six straight years of declines, according to Schankel.
President Barack Obama proposed raising the federal tax on cigarettes by 94 cents, to $1.95 for a pack of 20, to finance a pre-kindergarten program. His plan was included in his 2014 budget recommendation in April. A price jump of that size would cut consumption by about 10 percent, according to Kenneth Shea, a Bloomberg Industries senior tobacco analyst.
Investors holding tobacco bonds with longer maturities, “better start smoking and get all your friends to start smoking again too, because there ain’t going to be enough money,” said Richard Larkin, director of credit analysis at Fairfield, Connecticut-based Herbert J. Sims & Co.
Buckeye tobacco bonds maturing in June 2034, rated B3 by Moody’s Investors Service, or six steps below investment grade, had a yield of about 8.5 percent Aug. 15, according to Bloomberg Valuation data. That’s about 4.5 percentage points above top-rated munis and compares with a yield of 6.6 percent and a 4.1 percentage-point spread to the benchmark index in January.
Two Buckeye bonds in the Ohio S&P index are zero-coupon securities that push all principal and interest payments out to future years, with maturity values totaling more than $6.6 billion, said J.R. Rieger, vice president of fixed-income indexes at S&P in New York. Ohio has zero-coupon tobacco bonds maturing in 2047 and 2052, data compiled by Bloomberg show.
Their long maturities extend the duration of the Ohio index, producing greater volatility during the past 12 months as interest rates changed and tobacco bonds fluctuated, Rieger said by e-mail.
The S&P tobacco-bond index drop has been driven partly by investors seeking higher-rated securities and Obama’s proposed tax increase. The index gained last year as investors sought higher yields and because of a payment-related side agreement to the 1998 settlement among 17 states, the District of Columbia and Puerto Rico also pushed values higher, said Larkin, of Sims.
It was “a fool’s rally,” he said. Investors are now realizing that the debt remains at risk, partly because of the effects of the decline in smoking on future payments -- especially those for high-yield securities maturing after 2040, he said.
The ratio of 30-year top-rated muni yields to those for comparable U.S. Treasuries is near the highest in more than a year. The proportion fell to 121 percent Aug. 16 after reaching 125 percent Aug 9, the most since June 1, 2012. The higher the percentage, the greater the relative value of municipal securities compared with Treasuries.
In the municipal market this week, issuers plan to offer $4.5 billion of long-term debt after selling about $4 billion last week, according to data compiled by Bloomberg. The biggest sale this week is the New Jersey Transportation Trust Fund Authority’s $850 million of tax-exempt bonds. It’s the slowest two weeks of issuance since early January.
Following is a pending sale:
Columbus, the largest city in Ohio with a population of 809,800, plans to sell almost $321.5 million of general-obligation bonds this week. Uses of the funds raised with the tax-exempt debt will include financing new equipment and improvements to municipal facilities, roads and sewers. Moody’s Investors Service rates the securities Aaa and the bonds mature as late as August 2034. The offering is being managed by Bank of America Corp.’s Merrill Lynch unit and will leave the city with about $2.4 billion in general-obligation debt outstanding.
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