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June 23, 2014

E-cigarettes could stub out tobacco bonds sooner than thought | Reuters

4.9 percent, the biggest decline since the government passed a federal excise tax in 2009, a drop some blame on the rising popularity of the industry’s new tobacco-free alternatives, such as e-cigarettes.”The only cause I can attribute it to is e-cigarettes,” said Alan Schankel, managing director of Janney Capital Market’s Fixed Income Strategy team. “I think they are having an impact.”In 2013, Americans purchased 13.3 billion packs of cigarettes and 400,000 equivalent packs of e-cigarettes, versus 14.1 billion packs of cigarettes and 200,000 equivalent e-cigarettes in 2012.Wells Fargo Securities predicts the pace at which consumers switch from traditional cigarettes to e-vapor alternatives will surge in the coming years. It estimates that sales volumes for traditional cigarettes in the U.S. will decline by 68 percent over the next 10 years, while vapor cigarette sales will soar by more than 13-fold in the same period.The shift in consumer preference and the non-inclusion of e-cigarettes in the MSA “creates an incentive for tobacco manufacturers to encourage their consumers to switch to vapor products,” wrote Wells’ Herzog.For Eaton Vance’s Metzold, the recent takeover buzz in the industry confirms to him that e-cigarettes are where the companies see their future, at least in the U.S market.”Here’s your catalyst,” said Metzold, who sold all of his tobacco bonds more than a year ago. “Tobacco companies are buying the e-cigarette companies.”Lorillard acquired blu for $135 million in 2012, and also bought the UK e-cigarette brand SKYCIG for $49 million. Reynolds began distributing Vuse e-cigarettes in June and the No.1 U.S. tobacco company, Altria Group Inc, is soon due to roll out its e-cig brand MarkTen nationally.NOT EVERYONE’S A BELIEVERStill, not everyone is convinced about the e-cigarettes boom and the likelihood of early default on the bonds.”E-cigarettes are not a real replacement. They are another tool for people to quit smoking, but they are not a substitute. To me, it’s a fad,” said Dick Larkin, senior vice president and director of Credit Analysis, himself a smoker. “E-cigarettes are a threat to the MSA, but I don’t think they are a material threat.”And the bonds are enticing for some, largely because they’re so cheap and offer juicy yields at a time when high rates of return in the fixed income market are relatively scarce.Boston-based investment firm Loomis Sayles bought tobacco bonds several years ago when they were trading at deep discounts.”I don’t think you can say with 100 percent certainty that e-cigarettes will supplant normal cigarettes. How does anyone even know that?” said Steven Bocamazo, credit research manager and senior research analyst at Loomis Sayles. “They have a small market share and, while growing, it isn’t the big threat that everyone is making it out to be.”Tobacco-settlement debt currently counts among the highest-yielding in the municipal bond market.The Standard & Poor’s Municipal Bond Tobacco Index sports an average yield to maturity of 6.24 percent for the $23.9 billion of bonds it tracks. By comparison, S&P’s index for general obligation muni bonds has a yield of just 2.9 percent.But, even with a rally underway this year – the S&P tobacco bond index is up more than 13 percent – most continue to trade at distressed levels, reflecting their perceived default risk. Moody’s rates around 80 percent of all tobacco bonds at “B1″ – which is four notches below investment grade – or lower.”There are fund groups like ourselves, that said, ‘We don’t like what is going on here, we’re getting out,'” said Metzold.SOME STATES SOFTEN THE BLOWThe softening revenue flowing to the bonds from weakening consumption trends has prompted some states to step in to support the bonds.Earlier this month, New Jersey announced it would draw $12.5 million from reserves as a result of “insufficient tobacco settlement revenues” in April. Ohio and Virginia made similar announcements in May.To further bolster payments, some Democrats in Congress want to fold e-cigarettes into the MSA, arguing the payments gives states “a powerful tool to stop e-cigarette makers from targeting youth.” Link: 1.usa.gov/1lDdv2kBut many states haven’t spent the $100 billion received so far in tobac

via E-cigarettes could stub out tobacco bonds sooner than thought | Reuters.

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