How long will the tobacco industry be the goose that lays the golden egg?

Santa Claus, the Easter Bunny, and full settlement payments from the tobacco industry 10 years from now — are they all myths?

Perhaps that’s the view of officials in New York’s Westchester County, who worry that the promise of regular and full payments under the tobacco settlement 10 years from now might turn out to be nothing more than a fairy tale. The county just outside New York City is among a small but significant number of governments successfully creating a separate entity to issue bonds backed by anticipated tobacco settlement payments.

The chief reason for those fears is an adjustment in the payout formula — one of many — that lowers payments from the tobacco companies in proportion to every percentage drop in domestic tobacco consumption, as measured by the amount manufacturers ship to retailers.

"Westchester County firmly believes that the tobacco companies will not have the funds to meet their obligations in the later years of the settlement schedule," says a Web letter to voters from Andrew Spano, Westchester County executive.

Maybe not, but bond raters seem more optimistic that the bonds will be repaid. Moody’s Investors Service in late December assigned ratings of A1 and A2 to bonds with maturity dates of July 2029 and July 2039, respectively. Amortization of the bonds is weighted toward the later years of the anticipated payout.

"We’re taking the future revenue stream and turning it into an asset today," says county attorney Alan Scheinkman. "On a net present value basis, we think we actually came out ahead on the deal."

Westchester County used about $65 million of the bond proceeds to pay off a recurring obligation to the Westchester County Health Care Corp. for future health care services. The hospital corporation, in turn, is using the infusion to restructure the debt of Westchester Medical Center and attract investors to its own bond issue for a new children’s hospital.

"By having this infusion, they will be able to more successfully market their bonds for that long-term capital project and we will be guaranteeing a good number of those bonds," says Mr. Scheinkman.

California is the only state other than New York in which local governments explicitly share in the tobacco settlement payments. In December, Tulare County, an agricultural community of about 355,000 residents in the geographic center of the state, became California’s first government to borrow against anticipated tobacco payments. With the proceeds from the sale of about $45 million in bonds, the county has established an indentured endowment called the "Millennium Fund" to bankroll capital improvement projects.

Tulare’s bonds are rated A+ by Fitch IBCA, a rating agency with U.S. headquarters in New York City. In addition to using conservative assumptions in its structuring of the bond issue, Tulare County has pleased bond analysts by promising to dip into general revenues if tobacco revenues are insufficient to meet its debt service obligations. Because California law prohibits municipalities from securitizing tobacco proceeds, a public finance authority is transferring the funds to the county through an asset lease arrangement.

Good economic times

New York City and New York’s Nassau County have securitized their tobacco settlement payments, and several other California communities are looking at borrowing against their anticipated revenue. State governments seem less interested, though Oregon and several other states have analyzed the idea.

"States have been slow to act on securitization because their economies are so good," suggests Don DeSimone, a policy analyst with the National Association of State Treasurers in Washington, DC. "Now that the funds are being disbursed, they’re going to be looking at it again when their legislatures are back in session."

On Dec. 14, states that had reached so-call "state-specific finality" on their tobacco settlements (i.e., resolution of all pending legal complications) began receiving their first regular payments under the Master Settlement Agreement, with additional payments scheduled for January and April 2000.

Payments are due each succeeding April with an anticipated $206 billion payout through the year 2025.

Contact Mr. Scheinkman at (914) 285-2660 and Mr. DeSimone at (202) 624-8595. An analysis of securitization prepared by the National Governors Association is available at www.nga.org/Pubs/IssueBriefs/1999/ Sum990908Tobacco.asp.