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Illinois in $1.5 Billion Bond Sale to Pay Bills

Illinois on Monday begins a $1.46 billion bond sale that will allow the cash-strapped state to use future payments from a legal settlement with tobacco companies to pay its bills.

The sale comes at a nervous time for municipal debt markets. In the past two weeks, investors have withdrawn more than $5 billion from mutual and exchange-traded funds that buy “munis”, according to Lipper, the fund tracker, as a rise in yields on benchmark Treasury bonds compounded fears of rising defaults by muni issuers.

Illinois, along with California, is among the most troubled of the 50 US states, which are struggling with budget deficits and underfunded pension plans. Most of the proceeds from this week’s bond sale will pay $1.2 billion to $1.3 billion of overdue bills to vendors, who, under state law, would have to file claims in court if they are not paid by December 31, said John Sinsheimer, Illinois’ director of capital markets.

Tobacco
Photo by: Ellie Van Houtte
Tobacco

A successful deal could pave the way for other states to securitise tobacco settlement money at a time when they are cutting services and raising taxes to balance their budgets.

“States are eager to shift the risk of the [tobacco settlement] payments to bondholders and get the money upfront,” said Matt Fabian, managing director at Municipal Market Advisors.

The Illinois bonds, which are being sold through a special purpose vehicle called the Railsplitter Tobacco Settlement Authority, would be the first significant sale of tobacco bonds in several years. The market totals an estimated $30 billion. Mr Sinsheimer said the Railsplitter bonds were more conservative than other bonds backed by tobacco settlement pay-outs, securitising less than 50 per cent of the anticipated settlement cash.

Tobacco bonds are backed by payments from a 1998 legal settlement that 46 states signed with tobacco producers for medical costs associated with diseases caused by tobacco use. The annual settlement payments are based on the number of cigarettes shipped in the US, a figure which has declined in the last few years, driving down bond prices.

Pending litigation related to the sales of companies not participating in the settlement could also threaten payments. If the signatory companies can prove that the settlement gives competitors an advantage, they can get refunds on past payments.

“The problem with most tobacco bonds is that states tried to sell as many bonds as possible against the settlement money,” said Dick Larkin, director of credit analysis at Herbert J Sims, the financial services company.

Standard & Poor’s this month downgraded about $17 billion of tobacco bonds. Cigarette shipments could drop 10 per cent a year before threatening debt payments for Railsplitter, according to Mr Sinsheimer. Shipments have declined by an average of 3 per cent annually over the last decade, he said, but they fell 9.3 per cent last year.

Pricing is expected on Wednesday, with Railsplitter offering yields as high as 6.25 per cent on bonds due in 2027.