California Refinancing Tobacco-Bond Issue

California today expects to complete a sale of $3.2 billion of tax-free bonds backed by payments owed the state by the tobacco industry under a 1998 health liability settlement.

The deal is a refinancing of the state’s initial tobacco-bond sale in 2003. Because interest rates on newly issued bonds of this type have declined sharply since 2003, the state can save money by refinancing the debt.

Small investors were permitted to put in bids for the bonds Tuesday. The annualized yields offered included 4.38% on an insured series maturing in 33 years and 4.7% on an uninsured series maturing in 40 years.

Because the bond interest is exempt from federal and state income tax, the true returns to investors can be much higher.

Institutional investors, such as mutual funds, will put in their bids today.

The IOUs, issued by the Golden State Tobacco Securitization Corp., are backed by 43.3% of the state’s share of the 1998 tobacco settlement as well as supplemental reserve accounts, and if necessary the state general fund. The pledge of state appropriations is subject, however, to legislative approval.

The extra security pledges on the bonds allowed the state to obtain private insurance on some issues and may attract potential buyers who are more risk-averse, analysts said.

For California, the refinancing will generate about $525 million in additional proceeds for the state to plow into its general fund, according to the state treasurer’s office.