Legislature considers tobacco fund bonds
TOPEKA -- In November 1998, government officials nationwide gushed over the unprecedented legal settlement in which major cigarettemakers agreed to pay $206 billion to 46 states for costs related to smoking illnesses.
But now officials from many states, including Kansas, are worried they won't see their share of the money because the cigarette companies face an uncertain financial future.
So Kansas and other states are looking to "securitize" their portions of the settlement. Kansas' share is $1.6 billion over 25 years.
The proposal in Kansas, backed by Gov. Bill Graves, calls for selling $500 million worth of "tobacco bonds."
Supporters of the plan say it will protect the state from potential losses suffered by cigarette companies and will make money at the same time.
"We have a win-win combination with virtually no downside," said Sen. Dave Kerr, R-Hutchinson, chairman of the Senate budget-writing committee.
Others say that legal and financial threats to cigarettemakers may be overstated, that the bond deal is risky and that they don't want to jeopardize a generation of funding for children's programs.
"It has hit on our Midwestern sensibility; if it seems too good to be true, it might be," said Rep. David Adkins, R-Leawood, chairman of the House budget-writing committee, who wants to study the issue further.
Fueling that suspicion is the way the proposal came about. The House never saw the plan until the day the Legislature adjourned its regular session.
"Clearly it has been done in the smoke-filled corridors, pardon the pun, of some legislative offices,'' said Rep. Henry Helgerson, D-Wichita. "If it is a good idea -- and some states have moved in this direction -- then it should have a full public airing."
How the plan works
By selling bonds, the state would be borrowing money from investors and paying it back with interest. The bonds would be secured by the annual payments that Kansas is scheduled to receive from the cigarette companies.
Supporters say the bonds would pay a high interest rate, but there would be a risk for the investor. If cigarettemakers went bankrupt or suffered other financial problems that left them unable to make their payments, as some state officials say might happen, it would be tough luck for the bondholders instead of the state, according to the Graves' administration.
"The most important aspect of the deal would be to transfer the risk of the settlement proceeds to investors," said Rebecca Floyd, general counsel for the Kansas Development Finance Authority, which developed the plan. The finance authority is the state agency that issues bonds and other securities to finance big projects and other programs.
"This is a unique opportunity for the state of Kansas to have a sure thing in hand," Floyd said. "We also know that the tobacco companies are likely to be involved in continued litigation and reduced sales. It is foreseeable that at some point these revenue streams will dry up."
The state could also make more than the $1.6 billion settlement by sinking the money it makes from the bond sale into higher interest investments, proponents say.
Where it stands
The plan cleared the Senate the day before the Legislature recessed for 2 1/2 weeks. The House did not act on it, choosing instead to request a joint House-Senate conference committee to examine the plan in more detail.
Adkins has scheduled a hearing on the plan for 1 p.m. Wednesday, a week before the Legislature returns for a wrap-up session.
He questions whether the proposal is being pushed for reasons of good public policy or to enrich those who would be hired to conduct the transaction.
"It sounds like a good idea, but one that I have a whole lot of questions about," he said.
Opposition and questions about the plan have come from moderate and conservative Republicans and from Democrats.
The finance authority has been studying the issue for nine months, but Helgerson, who has been a key lawmaker on legislation related to the tobacco settlement, said he first heard about the proposal six weeks ago.
"There is the opportunity here for some shenanigans to be played," Helgerson said.
He noted that because the plan is already in a conference committee, House members will have no opportunity to alter the bill. Their only choice will be to vote yes or no.
"How are legislators or members of the general public supposed to amend the bill when they've already clamped down the opportunity for public discussion?" Helgerson asked.
Kerr said the idea had a full public airing through debate in the Senate, where it was approved 30-9. "The vote in the Senate was a strong one and indicative of people being able to understand what appears to be a pretty overwhelming case in favor of securitization," Kerr said.
No-bid contract questions
Helgerson and others also question a provision that would allow the Graves administration to pick the investment bankers and bond counsel to handle the transaction without seeking bids.
During the session, lawmakers passed legislation tightening requirements for competitive bidding on state contracts in light of alleged favoritism shown on some no-bid contracts. Attorney General Carla Stovall's decision to grant a no-bid contract to her former law firm to handle tobacco litigation, for which the firm stands to receive $27 million, played a big role in passage of the legislation.
Kerr said the state will seek requests for proposals nationwide. But, he said, the state must be able to hire experts and not have to go with a low bidder in a competitive bidding arrangement.
Some critics argue that the sale of $500 million in bonds will result in more state spending.
"My no vote is a vote against creating a pool of money which will possibly be used to continue the spending frenzy which this Legislature has practiced for the past few years," said Sen. Karin Brownlee, R-Olathe, when the Senate debated the plan.
Kerr said he understands Brownlee's argument but doesn't believe the state will act irresponsibly because the funds will be dedicated to a trust fund that will help children's programs.
If Kansas wants to take advantage of this proposal, he said, it needs to strike now. The finance authority says investment bankers believe there is an ''appetite'' in the market for $10 billion to $12 billion of these kinds of bonds.
But why would an investor buy a bond backed by settlement funds that state officials fear may not be there some time in the future?
"The financial market is willing to accept those risks. They take greater risks than the states," said Floyd, the general counsel for the finance authority.
Kerr, who makes his living in the investment business, agreed.
"It appears to be that the buyers would be huge bond funds that like the idea of having a slightly increased yield based on additional risk as part of an overall mix of portfolios."
The future of Big Tobacco
Still, some say the whole premise for trying this deal -- that cigarette companies are in trouble -- may be false.
On one hand, the companies have found themselves on the defensive. The FDA is seeking to regulate cigarettes, the Department of Justice has filed a civil lawsuit against the industry, and in Florida, cigarettemakers could face billions of dollars in damages from individual smoker cases. Last week, smokers in Kansas filed a lawsuit seeking a share of the state's settlement.
On the other hand, tobacco companies have low debt and significant cash flow. And unlike other companies hit with major product liability cases, tobacco companies are going to continue selling their product, according to an analysis by officials in Indiana, one of the many states studying the issue.
To date, only New York City and two counties in New York have "securitized" their settlements by issuing tobacco bonds, according to Lee Dixon, with the National Conference of State Legislatures. New York's settlement was fashioned differently than most states' in that the money was divided between the state, New York City and the state's remaining counties.
Adkins said important questions remain to be answered. He doesn't believe Kansas could escape liability if the bonds defaulted. Perhaps, he said, that would affect the state's bond rating.
"Obviously, if our credit is downgraded, that produces a cost of financing debt that would be significant," he said.