First draft, subject to revision.
As part of the attempt to balance the Minnesota state budget Governor Palenty is proposing selling future Minnesota proceeds from the the tobacco settlement for "cash now". I personally think that this is a bad idea. It can potentially illuminate the true value of these assets by potentially putting them up for sale.
I have been following this since the Minneapolis smoking ban went into effect three years ago. Those following my
http://freedomtoact.com, started a year ago know that the "smoking ban" campaigns have gone "global".
First the disclaimer: I am not a lawyer and only claim to know this as a "citzen". This is still a better comprehension of tobacco settlement law than 99% of lawyers. I won't attempt the "legal lingo". This is where the "deep legal research" is needed. Also, if I can't understand it, casually following the tobacco settlement since 1998, few others will be able to. Use this "redrant" as a guide to what to look for and what questions to ask.
A "securitization" is basically a sale for "cash now" of a "structured settlement". On the most basic level think of the lottery. If you win (fat chance!) $100 million it is $4 million per year for 25 years (or something like that). If you want to "take the money and run" and get "cash now" you might get a "lump sum" of around $50 million or 50%. On
http://powerball.com/ the current jackpot is $52 million and the lump sum is $ 28.3 Million Cash Value. Around 55% of a 25 year payoff.
This is the "gold standard" of securitization since the 25 year payout is a long haul. The Minnesota tobacco settlement is paid into perpetuity so that might add, at most 5% over a 25 year schedule. If so we give 60% of future payments as a "bullseye". Anything lower spells "issues".
The first "issue" is the time value of money. Sort of the opposite of a mortgage. In my first house mortgage for $57K the 30 year 8% principle and interest payments were $422 per month.
Over 30 years $422 times 360 months would equal $152K. This was FHA insured and market rate interest is lower now but you get the idea. 30 year is roughly equal to "perpetuity".
The other factor is risk. I'm sure we all know how this goes when you borrow someone money. Will it ever get paid back? This is the "800 pound gorilla" in any proposed tobacco secuitization. Currently the Minnesota tobacco settlement has payments at least 10% less then scheduled. This has put the settlement into "perpetuity" to make up for the lower than promised payments.
To be continued: Minnpost.com on Wednesday had this basically accurate, with some "liberal biase" article on the proposed Minnesota securitisation. I assume that this years expected $200 million is already factored in so anticipated one-billion dollars is in lue of payments in future years which are now $200 million per year. I can't make sense of the $1.6 billion expected payments over the next twenty years. It would seem to anticipate lower future payments and taxed cigarette consumption is expected to decrease in the future.
To make a "mock securitisation" let's go back to my original FHA 30 year 8% fixed loan. Let's say that we had six years, the current years and five years ahead for a "cash now". Five years time 12 months is 60 months times $422 per month or $25,320. Two ways to look at this. The original loan was $57K so this is around 60% using "lottery math". Looked at it the other way, $422 per month over 360 months/30 years would be total payouts of $152K. The $25,320 would be around 17% to 18%.
It is a crude comparison but if we assume that the tobacco settlement payments will continue to be the current $200 million per year we have a securitisation yeild of under $20%. I'm sure that there is some formula for "perpetual" but it can't be much more than 30 years. Using a loan calculator I checked my $57K for 100 years and payments are $380.17 per month rather than the $422 at a 30 year term. That's 10% to 12% lower payments. The annuity or cashout would be the mirror of this. This should not be deemed accurate but instead a "ballpark" of 30 year versus perpetual. Figure at best 10% to 15% lees/more for perpetual.
With money there is the "time value" of money and the A"risk value" of money. To take the lottery lets say you won $100 million and you were asked if you wanted the $100 million now or $4 million for the next 25 years. Ignoring taxes here, if you took the $100 million now and invested it at 4% you would basically have a $100 million "endowment" with four million annual income. The lottery winnings are heavily insured so we can ignore risk. Due to the "time value" of money if you won $100 million in the lottery you would get $53 million now. This is dependent on the current interest rate market. Basically, if the interest rate market goes down the lottery "lump sum" percentage goes up. If interest rates go up the percentage goes down. For a reference, if you get an 8% fixed rate 25 year loan, the total of the monthly payments will be basically double the loan principle. If this does not seem logical, remember that as you make the payments the principle is reduced so you are paying more interest. I recall my first mortgage payment had well under 10% to principle.
Next there is "risk value" of money. Here is where it get's "interesting", in term of the proposed MN tobacco securitisation. My home mortgage was backed by the FHA and my home value has more than tripled (even after a recent $15% decline) but let's assume the value was static. If the morgage was held for the full 30 years it might have been one-third paid off in fifteen years and half paid off in 20 years. This is a "first lien" so like wine, the risk improves with age. The opposite will tend to be true with the tobacco settlement money. Will the tobacco companies be structurally and financially viable to pay the money to MN in the future? This is known as the "risk value" of money.
From the peak, the payments, based on cigarettes sold are down some. I heard 10% decline maybe five years ago. The anti-smoking efforts have gone "viral" since I started seriously watching this when Minneapolis started it's smoking ban in the Spring of 2005. This has reduced smoking some and along with it the annual payments to Minnesota. If the "war on smoking" continues this amount could be reduced even more. If the federal government raises the cig tax this could further reduce the taxed cig useage and reduce the payments to MN.
Another factor is so called "pirate" or illegal cigareetes. In Canada, they raised the cig tax and now an estimated half of cigarettes are not taxes. On Canadian Indian reservations cigarettes can be had for a six dollars a carton. Even the Star Tribune coupon section had an ad for a cig rolling machine for cigs for "sixty cents a pack". Off brand cigs sell for under three dollars a pack here and the "little cigars" sell for a dollar a pack. I've been told by smokers that the "little cigars" are quite different and hard to adjust to but when I smoked "generics" worked for me. The big secret is that the tobacco is an extremely small part of the ultimate price of cigarettes so it's not like chuck roast versus tenderlion in beef.
There is also the factor of "small tobacco" versus "the settlement" In the Master National Tobacco Settlement (which I read in the late 1990's) new entries, the so called "small tabacco" would need to escrow 150% of the settlement amount in case claims are brought against them. "Deep pockets" encourage claims. An example is the "issue" that can delay the closure and distribution of an estate. The original stated premise of the tobacco litigation was that the tobacco companies decieved the smokers and the public of the dangers of smoking. A saavy "small tobacco" company doesn't do this so they are being punished for the alledged "sins of the father". I could produce a Certoria arguing convincingly that this is illegal and the small tobacco producers, especially those who don't are due triple punitive damages. It's a tought fight but possible. Right now tobacco matters are "political" and the US Supreme Court hates to be thought of as "political". Hey, I am not even a lawyer!
I recall something about the Minnesota Tobacco Settlement stating that Minnesota cannot raise cigarette taxes. I don't know the details but it seems behind the nonsense of Governor Palenty's past "tobaccos health assessment fee surcharge" proposal nonsense. This leads to potenial liabilities to the state of MN from a securitisation. Let's say this is still in effect (I do not know) and MN securitses it's future payments and raises cig taxes (actually it might make more by not raising cig taxes due to cross border buying). If payments are less than anticipated
