by James A. Bacon
Alarming news about Virginia bonds. The NYT reported last week that Virginia is one of three states that have tapped special tobacco-bond reserves to pay their bond holders — “something analysts consider a technical default because it effectively means the bondholders are being paid with their own money.”
The underlying problem is that the bonds are backed by payments from tobacco companies under the 1998 settlement agreement, and those payments are not coming in as projected. The bonds were issued on the assumption that tobacco payments would decline about 1.8% a year as cigarette consumption slowed. But in fact payments have been declining about 4.1% per year, the Times quotes Richard Larkin, director of credit analysis at Herbert J. Sims & Company, as saying. Writes the Times:
Many of the tobacco bonds have maturities of decades, and if smoking keeps declining at the current pace, some of the reserves set up as backstops will run dry, Mr. Larkin said. At that point, investors — including individuals, insurance companies and mutual funds — will be at a loss. …
In Mr. Larkin’s analysis of tobacco bonds issued by seven states and New York City, he found that if tobacco payments continued to decline by 4 percent per year, full-blown defaults would begin in 2024, when Ohio would be about $350 million short on $1.1 billion of tobacco bonds maturing that year.
New Jersey, California, New York City and Virginia would be several billion dollars short on tobacco bonds maturing in the years after that.
This can’t be good news, but it’s not clear to me exactly how bad it is. Documents published by the Virginia Tobacco and Indemnification Commission shed no light. The 2012 Annual Report has yet to be published online, and even when it is, it probably will be worthless. The 2011 report contains only a bare-bones statement of assets, liabilities, revenues and expenditures, and it provides no narrative explanation of the commission’s finances. Further, the commission website contains no press releases. There is no record that the commission took any public note of the necessity to dip into the bond reserve fund.
The Strategic Plan does not discuss commission finances. A 2007 Blue Ribbon Panel provides only a cursory overview of commission finances, mainly touching upon issues relating to the investment of the commission’s endowment fund. The minutes of the January 10, 2012, commission meeting make no mention of invading the bond reserve fund. Minutes of the January 2012 executive committee meeting contain a discussion of the endowment’s financial performance but make no allusion to the bond fund. There’s no mention either in the December 2011 minutes.
The problem may be less alarming for bond holders than portrayed by the Larkin report. Virginia did not spend the billions of dollars it raised through bond sales right away. It deposited the money into an endowment, which draws a modest interest income, and it has been drawing down the endowment steadily but slowly. As of June 30, 2010, the endowment stood at $923 million. In June 30, 2011, it stood at $830 million. Presumably, the Tobacco Commission could cover any shortfalls from tobacco company payments with its own assets. That would short-change economic-development funding programs in Southside and Southwest Virginia but it would preserve the credit rating of the state bonds.
Still, any time people in the financial community bandy around the phase “technical default” in conjunction with Virginia bonds, even if those bonds are not backed by the full faith and credit of the commonwealth, it should be a cause for concern. It’s also scary that the “best run state in the country” should be keeping company with the likes of California, New Jersey and New York City.
Perhaps most disturbing of all is the apparent lack of any discussion of the funding gap in any of the Tobacco Commission documents or anywhere else in the public record accessible by Google. (Perhaps I have missed something. If so, please let me know.) This is a long-brewing problem. It did not pop up overnight. Is the Tobacco Commission board even aware there’s an issue? Is anyone in the McDonnell administration paying attention?
Hat tip to FreeDem.