S&P; Lowers Ratings on Tobacco Muni Bonds

Municipal tobacco-settlement bonds worth $17 billion had their credit ratings cut by as many as two levels by Standard & Poor’s on Thursday because of smokers’ lawsuits and declines in U.S. cigarette consumption.

The downgrade could make it more expensive for states including California to issue more of the bonds, which are backed by future payments tobacco companies will make to the states under a landmark 1998 settlement of health-liability suits.

S&P;, which said the ratings may be cut further, lowered most of the bonds two levels, to BBB, the second-lowest investment-grade rating.

The reduction brings S&P;’s ratings in line with those of rivals Fitch Ratings and Moody’s Investors Service.

“This security is not what it was in 1999,” S&P; analyst Steven Murphy said. “A lot of things have changed in this industry and the strength underlying these bonds is weaker.”

The ratings cut reflects the risk that tobacco companies backing the bonds could get hit by more health-related private lawsuits, and the potential for cigarette consumption to continue to fall because of restrictions on public smoking, health concerns and the rising cost of cigarette taxes, S&P; said.

Cigarette shipments fell 7.8% in the first six months of this year, S&P; said.

The lower ratings may keep more individual investors from buying the bonds, said John Hallacy, head of municipal bond research at Merrill Lynch & Co. The lower rating also could force some mutual funds to sell because of requirements that they maintain debt ratings in the A-rated category or better.

“It just further diminishes the market for the bonds,” Hallacy said.

Others said the prices, and tax-free yields, on the bonds may already reflect the potential for more bad news.

Rising yields on the bonds have prompted states such as New York and California to abandon plans to sell bonds backed only by the tobacco settlement.

California plans in October to sell $2.3 billion in bonds backed by the tobacco settlement and by a state budget appropriation, to make the securities more palatable.