A tobacco bond issued by a local government in the United States has declared default for the first time in history, as falling smoking rates eroded tobacco sales.
According to Bloomberg on Wednesday, the Nassau County Tobacco Settlement Corporation (Nassau CTSC), an entity under Nassau County, New York, disclosed its failure to repay principal on Monday. The corporation received 14.7 million dollars in settlement payments from tobacco companies in April but failed to pay 36 million dollars in senior bond principal on Monday, according to the disclosure. Principal repayment was entirely prohibited because the corporation could not meet the minimum reserve requirement stipulated in its trust agreement.
The issuance of municipal bonds backed by tobacco settlements stems from a unique chapter in US history. In 1998, the attorneys general of 46 US states reached the Tobacco Master Settlement Agreement (MSA) with the four largest US tobacco companies, including Philip Morris. At the time, the state governments had sued tobacco companies, blaming them for rising public health care costs caused by the toxicity of tobacco. As the case, considered the largest civil lawsuit in US history, dragged on, the tobacco companies, fearing bankruptcy, proposed "permanent settlement payments" to the state governments, and an agreement was dramatically reached. The amount the tobacco companies pledged to pay state governments over the first 25 years alone reached 206 billion dollars (318 trillion won).
The problem was that cash-strapped local governments issued bonds backed by the tobacco settlements. According to the US Centers for Disease Control and Prevention (CDC), the adult smoking rate in the United States reached 24.1% in 1998. For this reason, local governments regarded the settlement payments, which were tied to tobacco company sales, as a goose that laid golden eggs. Nassau County also issued bonds worth 431 million dollars in 2006.
However, as a combination of factors including anti-smoking campaigns and cigarette price increases pushed the US adult smoking rate down to single digits at 9.9% last year (as of 2024), the bonds reached a point where they could not repay their principal. According to the National Association of Attorneys General, payments to states that participated in the 1998 master settlement fell 19% last year. According to Municipal Market Analytics, an independent market research firm, this is the first default ever to occur in the tobacco bond sector.
However, because tobacco bond investors hold permanent rights to the 1998 settlement revenue, the bond itself will not disappear. Instead, the bond's maturity is automatically extended, and investors can receive settlement revenue as funds accumulate. The Nassau County tobacco settlement bonds are scheduled to mature in 2046 and were trading at 58.5% of face value as of Tuesday, Bloomberg reported.
