May 3rd, 2015
by Cezary Podkul, ProPublica
The allure of tobacco bonds appears to have won over another customer – cash-strapped Louisiana.
Gov. Bobby Jindal, a potential GOP presidential candidate, is scrambling to deal with a $1.6 billion hole in his next budget. Now, over the opposition of the state's treasurer, Jindal has lined up a $750 million deal to borrow against future income from the state's share of a 1998 legal settlement with cigarette makers.
New Jersey, Rhode Island and two New York counties have rescued failing bonds in the past year. In New Jersey's case, a tobacco bond bailout turned a profit of more than $100 million for a hedge fund in middle of the deal. Six more New York counties have OK'd similar transactions.
As we've reported, these bailouts are the legacy of a borrowing binge by politicians who wanted to turn annual payments from the landmark settlement into upfront cash. Many got just pennies for every dollar they promised to repay.
Louisiana's budget problems, brought on by spending down state savings accounts and a decline in revenues from falling oil and gas prices, quickly caught the attention of Wall Street firms.
In February, Citigroup brought state officials a flashy 62-slide presentation titled "Financing Tools for Managing Budgetary Stress." It featured a list of 36 revenue sources that governments have borrowed against to tide over budgets – everything from taxi surcharges to income from the 1998 tobacco settlement.
Borrowing against future revenues could "buy more runway" for Louisiana, the presentation said, highlighting tobacco bonds as one major option.
Rival Goldman Sachs approached the state in March and also suggested borrowing against the tobacco settlement money or lottery revenues.
At 5 p.m. on Friday, March 13, Jindal's office announced the appointment of four members to a state-run corporation that oversees Louisiana's tobacco borrowing. Four days later, the corporation's 13-member board held a hastily called meeting to approve a $750 million deal with the help of Citigroup.
That didn't sit well with Treasurer John Neely Kennedy, also a Republican, who sits on the board along with Jindal's appointees and other statewide elected officials. "This is about the last savings account left that we haven't taken money from," Kennedy complained at the March session.
The deal would pledge 40 percent of Louisiana's annual tobacco settlement revenues in bond repayment that would stretch out nearly 30 years. In 2001 and 2013, the state borrowed against the other 60 percent of its tobacco settlement money, netting about $1.2 billion. Citigroup served as an underwriter in 2013.
Turning recurring revenues like the tobacco money into upfront payouts is widely considered poor fiscal management.
"You're borrowing money from the future to pay today's expenses. That's how we got into this problem, and this is only kicking the can down the road and paying interest on top of it."
Firms like Citigroup get paid based on the size of the bond issue, creating an incentive for big deals. A Citigroup spokesman declined to comment.
Given the size of the new Citigroup deal – it would be Louisiana's second-biggest bond issue after the original 2001 tobacco bond sale – Kennedy wanted to bid out the underwriting and related services contracts to ensure the best price. A spokeswoman for the Louisiana Treasury said it would have been "best practice" to do so.
Competitive bids aren't mandatory under Louisiana law, state budget officials said, but the deal requires approval by the legislature, which adjourns on June 11.
With pressure to meet that deadline, the state decided to hire Citigroup without a competitive bidding process. A sale agreement dated June 1 has already been drafted, documents obtained through a public records request show.
Citigroup Presentation February 2015 Draft Trust Indenture Dated June 1, 2015 Goldman Sachs Presentation March 2015 Draft Purchase and Sale Agreement Dated June 1, 2015 Louisiana Tobacco Settlement Financing Corporation Presentation March 2015 Citigroup Preliminary Bond Proceeds Estimate
Kennedy told ProPublica:
"This whole thing has been ass-backwards. It's all about getting their hands on the money, and it is not in the best interest of the taxpayers."
Kristy Nichols, top budget officer for Jindal and chairwoman of the tobacco board, said money from the bond sale won't be spent all at once. The bonds will be sold in three stages. Proceeds will pay for two constitutionally dedicated funds – one for state college scholarships and another for coastal restoration – over the next eight years.
If the legislature decides to spend the money more quickly, Jindal's administration won't support the transaction, Nichols said. "It needs to be protected and it needs to be paid out incrementally over the next eight years," she said.
The downside is that the state will have to pay fees three times, once for each transaction. But Nichols said the state has locked in a good price based on an earlier transaction Citigroup and other advisors did for the state. Officials estimate about $2 million in fees for the first $300 million bond sale, which implies about $5 million in total fees for whole eight-year plan.
By the ninth year, the hope is that the Louisiana's 2001 tobacco bonds will be paid back, returning that income stream to the state budget.
Kennedy – who's served as treasurer since 2000 – isn't so sure it'll play out that way. He said at the March meeting:
"This is my worry. You dangle $700 million dollars in front of the Louisiana legislature right now, and it's going to be spent as fast as green grass through a goose."
Editor's note: Citigroup and Goldman Sachs presentations, Louisiana Tobacco Settlement Financing Corporation presentation as well as draft bond documents can be accessed from the original article at ProPublica.
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