LOCKPORT – Niagara County refinanced its tobacco bonds last month, netting $2 million in spendable cash, but it had to pay a mutual fund firm nearly $7 million to make the deal.
Oppenheimer Funds held out for a buyback of some of the county’s 2005 set of tobacco bonds, which the firm owned and which might have defaulted decades from now.
If the county’s tobacco bond agency hadn’t paid Oppenheimer, the county wouldn’t have been able to grab the $2 million, officials explained Friday.
The Raymond James bond underwriting firm and the Harris Beach law firm were among the others who cashed in from last month’s $44.3 million bond sale.
Besides the money paid to Oppenheimer, almost all of the proceeds were used to pay off the county’s original tobacco bonds, issued 14 years ago.
The county’s leftover $2 million is likely to be used to pay for roof repairs at the County Jail, County Treasurer Kyle R. Andrews said Friday.
He should know, because under the terms of the bond sale, the treasurer and the County Legislature chairman together have the sole power to decide where the money goes from the “residuals,” or tobacco-related income not needed to pay interest to the bondholders. Andrews said the county hasn’t had any residuals since 2005, when it did its second tobacco-related bond issue.
The bondholders earn “triple tax-exempt” interest on the bonds: no federal, state or local taxes. But if there isn’t enough profit in the tobacco business to pay them, default looms.
The day of reckoning might be decades off. Some of Niagara County’s new bond issue doesn’t come due until 2040. Some of the bonds it issued in the 2005 deal will last until 2060.
If some day the bonds turn into worthless pieces of paper because of a lack of tobacco revenue, bondholders won’t be able to go to the county to be paid off, said John J. Ottaviano, the Lockport attorney who serves as counsel to the county’s tobacco bond agency.
“Niagara County only pledged the revenue from the tobacco companies as repayment,” he said. “These are sophisticated buyers and investors. They knew what they were getting into, and they got tax-exempt money.”
Ottaviano said the county’s tobacco bond selling entity is structured as a “remote bankruptcy corporation,” meaning that if it defaults some day, there would be no impact on the regular county finances or credit rating.
The history of the September deal begins with the 1998 legal settlement between most of the states and the major tobacco companies over the public health and Medicaid costs of smoking. In New York, a share of the payments was given to the counties, since New York is one of the few states where Medicaid is a county expense.
Niagara County was entitled to about $4 million a year from the tobacco companies for decades to come, but in 2000, the county opted to sell its share in the form of bonds in order to obtain a large lump sum instead of taking the annual payments.
The county created the Niagara Tobacco Asset Securitization Corp. to sell the bonds. In 2000, the county received about $48 million. It used $23 million to pay off existing debt, including the cost of the expansion of the jail. The Legislature spent $19 million over the next few years on a wide assortment of projects and purchases, and the rest was set aside as security for bondholders or to pay fees and expenses connected with the deal.
In 2005, Niagara joined several other New York counties in a pool to sell more bonds, backed by the residuals it had received during the first few years of the bond deal. This second sale, organized by the New York State Association of Counties, brought Niagara County nearly $18 million. All four sets of tobacco bonds Niagara County issued in 2005 were purchased by Oppenheimer.
But cigarette sales continued to decline. An annual drop of 2.5 percent was assumed as a possibility when the deal was arranged, and bond investors were warned if the decline in sales was more than that, they might be buying bonds the issuers could never pay off.
Figures on the U.S. Centers for Disease Control website show that the decrease was substantially more than 2.5 percent every year but one from 2005 to 2010, with the biggest drop being 8.3 percent in 2009.
In all, cigarette consumption in the U.S. fell 32.8 percent from 2000 through 2011. The threat loomed that the tobacco companies eventually wouldn’t be able to supply counties with enough revenue to pay off the bondholders. “The people who bought the bonds were betting it wasn’t going to go down that rapidly,” said Todd Miles, a partner in the Harris Beach law firm.
Miles said the Association of Counties suggested this year’s refinancing because of the current historically low interest rate environment. Miles said Harris Beach suggested that Niagara County go it alone, because it was the largest player in the state tobacco bond pool.
Oppenheimer was in second position to be paid off, behind the buyers of the 2000 bonds, who will receive $39.8 million.
For the county to obtain any net revenue from last month’s sale, it in effect had to cut in line ahead of Oppenheimer, Miles said. That meant the mutual fund company could stop the county from obtaining any money in the latest refinancing, unless the county paid off Oppenheimer’s riskiest bonds: the ones maturing farthest in the future and those most likely to never be paid off in the normal course of the tobacco business.
Ottaviano said Oppenheimer took 52 percent of the face value of the bonds it bought nine years ago.
“Oppenheimer was negotiating from a position of leverage,” Andrews said. “It was a year and a half of work, but it was worth it.”
The county could have simply sat tight, paid interest to the tobacco bondholders as long as possible, and let Oppenheimer take a red ink bath if it came to that. But Legislator Clyde L. Burmaster, president of the tobacco corporation, wouldn’t hear of it.
“We’re going to do everything we can to pay off those people as long as I’m president of this corporation,” Burmaster said. He said he didn’t want Niagara County’s name to be connected with a default, even if it would be isolated from the county’s regular budget.
Raymond James, which underwrote the bonds, in effect buying them in order to resell them, was assured a profit of $604,000, according to figures provided by Ottaviano. Miles said Harris Beach received $250,000 in legal fees.