WICHITA EAGLE: ‘Tobacco securitization’ and what it would mean for Kansas

By Bryan Lowry
April 22, 2016

The Capitol is buzzing with the phrase “tobacco securitization” in the wake of the news that the state faces a $290 million budget hole.

It’s one of Gov. Sam Brownback’s preferred ways to address the shortfall.

But what the heck is that? And how would it affect the state?

Here are some answers.

What is the tobacco settlement?

Kansas was one of 46 states that won a lawsuit against the nation’s four largest tobacco companies in 1998. The states sought money to cover the health care costs of smoking. Kansas receives annual payments based on cigarette sales as a result.

Under current law, the Kansas money goes into the Children’s Initiatives Fund, used to pay for early childhood programs, such as Early Head Start and Parents as Teachers. Any leftover money is supposed to be saved for future funding of children’s programs.

The amount of money Kansas receives fluctuates based on tobacco sales and other factors. It expects to receive about $58 million in the fiscal year that begins in July. Annual revenue from the settlement is expected to decline over time as fewer people smoke.

What is tobacco securitization?

Simply put, this would allow the state to sell off the rights to part of its tobacco money for the next 20 to 30 years in exchange for about $160 million now.

Simply put, this would allow the state to sell off the rights to part of its tobacco money for the next 20 to 30 years in exchange for about $160 million now.

It would work like this:

The Legislature would have to authorize the governor to proceed. If that happened, the state would form a corporation to “sell the annual revenue stream to a banking-type entity,” according to budget director Shawn Sullivan.

The bank would sell the revenue stream on the bond market as a security and the state would receive a lump sum in return. CitiGroup presented the idea to Sullivan and other officials in October.

Under the governor’s proposal, the state would still keep $42 million from the settlement for early childhood programs each year. The rest of the annual payment would go to the bank to pay off the bonds, instead of being saved for future programs for children.

The state would have to pay interest on the bonds, which would cut into its overall gain from the settlement.

Sen. Ty Masterson, R-Andover, compared it to cashing out your pension early as a lump sum or taking lottery winnings up front. You’ll receive more money in the short term, but less money overall.

Sen. Ty Masterson, R-Andover, the Senate’s budget chairman, compared it to cashing out your pension early as a lump sum or taking lottery winnings up front. You’ll receive more money in the short term, but less money overall.

“It’s a personal choice,” he said.

Have other states done this?

Yes, 19 states, three U.S. territories and the District of Columbia have made similar transactions for a total of $64 billion since 1999, according to the October CitiGroup presentation.

Some states used the money to fill in budget holes. Others used it for building projects, such as the construction of new schools.

Some states who relied on these deals for short-term cash are now suffering consequences. “Michigan. They’re going to pay back 1,700 times what they borrowed,” said Jim Estes, a professor of public finance at California State University, San Bernardino, who has studied tobacco bonds.

New Jersey, for example, experienced a credit downgrade after refinancing its tobacco bonds in October of 2014.

What’s the risk to the state?

The risk would depend on how the deal was structured. Certain bonds would entail greater short-term gain for the state, but higher risk in the long-term. No prospective deal is available for review.

Sullivan says that the investors, rather than the state, would take a risk in future years as revenue from the settlement declines.

However, a 2014 investigation by ProPublica said that other states saw a greater percentage of their tobacco settlement money going to pay back investors than initially expected. It compared the deals to the type of investments that led to the 2007 housing crisis.

“Just as mortgage lenders bet that home prices would keep rising, the tobacco deals relied on optimistic predictions of how much Americans would smoke…Because the bonds sold to investors can stretch 40 years or more, the outdated estimates mean an ever-widening gap between what states expected to collect under the settlement and the payments they promised investors,” the investigation stated.

Estes, the professor, said the declines in annual payments should give Kansas pause.

“The revenue has fallen to the point that if they’re only going to use revenue from the tobacco settlement there won’t be enough,” he said. “They’re going to have to take it out of the general budget.”

He noted that the settlement is falling at a rate of 4 percent a year and that number is accelerating as more people switch to e-cigarettes. “Take into account that vaping is now going to be eating that,” he said. “Is that really something that you want to do?

What do supporters say?

Use of future tobacco money – along with a sweep of highway funding and a cut to higher education – leaves the state with a larger cash balance than the other options being considered by Brownback.

It also allows the state to avoid any program cuts in the short term. Sullivan has called the plan a bridge to the next legislative session.

The other options put forward by the governor include delaying payments to the state’s pension fund or making significant cuts to state services.

Brownback said Friday that he has no preference between using the tobacco money or delaying the pension payment. “Either of them, I think, are reasonable ways to handle the revenue situation that we’re in,” he said. He prefers both of these options to making across-the-board budget cuts.

That slightly contradicts what Sullivan said when he rolled out the plans Wednesday. He said then that the tobacco settlement was Brownback’s preferred option.

What do critics say?

It’s one-time money, and it locks the state into a long-term commitment for a short-term fix.

Sullivan says the deal would not go on state books as a debt because it is selling future revenue. But Rep. Mark Hutton, R-Wichita, said it would be a form of debt. He pointed out that it would mean a loss of revenue for the state for several years to come, calling that a cut to future budgets.

Ken Kriz, an economist at Wichita State University who studies public finance, said that the state was putting short-term needs ahead of long-term priorities.

“It’s obvious that nobody really is thinking about long-term consequences. The entire goal is to plug the short-term hole in the budget,” he said.

Estes echoed this point. “All we’re doing is throwing the ball down the road…No matter what happens, you’re at least three to four governors away who can then claim, ‘it’s not my fault, I didn’t do it.’”

How would children’s programs be affected?

That’s a matter of opinion.

Rep. Kathy Wolfe Moore, D-Kansas City, said keeping the amount for children’s programs flat at $42 million each year could lead to program cuts in the future, because that amount won’t have the same buying power that it does now.

Sullivan said the Legislature would have the power to authorize additional funding for childhood programs from the state’s general fund as time went on.

Shannon Cotsoradis, president of Kansas Action for Children, the children’s advocacy group that first disclosed the Brownback administration was weighing tobacco bonds as a budget fix last month, said the impact to childhood programs could be worse than flat funding.

“There’s no way to lock in that $42 million,” she said. In order to sell the tobacco bonds, the Legislature will have to change the law that protects the money for children’s programs. That would make the dollars vulnerable to fund sweeps similar to the state’s highway fund, she said.

“Once you remove those statutory protections, those dollars are all floating now,” she said.

How long has this been in the works?

CitiGroup presented the idea to state officials in October, according to documents disclosed by Kansas Action for Children. Brownback presented the idea to legislative leaders in March.

When Kansas Action for Children first raised concerns that the administration was looking to sell off the tobacco funds in March, Brownback administration officials dismissed the claim as a rumor.

“Despite rumors, there is no deal or pending legislation to sell tobacco settlement money,” Eileen Hawley, the governor’s spokeswoman said on Twitter.

Sullivan mocked the idea as a conspiracy theory, asking on Twitter, “Why are there black helicopters circling my office? Are they here to drop off this secret deal?”

Cotsoradis questioned how over a period of six weeks tobacco bonds went from a “black helicopters” conspiracy theory to the governor’s No. 1 budget choice.

“It clearly has been an option on the table and is a serious contender from the governor’s perspective,” she said.

What happens next?

Lawmakers return to Topeka Wednesday. The Legislature would need to pass a bill authorizing the governor to move forward with the deal. That would require 21 votes in the Senate and 63 in the House.

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