Originally published on May 30, 2017

Keith Fitz-Gerald is out with a new ad for his Money Map Report that promises you can “claim” payments from big tobacco — and, naturally, Gumshoe readers are curious… is there really some way that normal folks like you and I can “collect thousands of dollars a month, tax-free, from Master Settlement Payments?”

Well, sort of. But probably not the way you’re thinking. Let’s look at the details and get you some answers…

As with most ads of this sort, the pitch is that this money is sitting there just waiting to be claimed… all you have to do is get your name on the list!

The money comes from the Master Settlement Agreement that the big tobacco companies signed with all the state Attorneys General about 20 years ago, settling all the lawsuits states had filed to both restrict tobacco advertising and to recoup tobacco-related health care costs.

Here’s a little taste of the ad:

“This Master Settlement Agreement has no end date. Big Tobacco is legally obligated to pay out this cash forever.

“In fact, we estimate they’ve been paying out about $686 million a month…

“And it may surprise you to learn that you could personally claim a tax-free portion of this settlement!

“Every month a check made out for $2,300 could arrive in your mailbox…

“Even if you’ve never smoked…”

There’s a lot of stuff in the ad to fire up anger about the big tobacco companies and their practices, from ridiculous advertising about the health benefits of smoking to suppressed research and aggressive lobbying… all of which sets up a straw man that makes you angry, and makes it easier to believe that there’s some way that makes sense for you to deserve and receive some kind of “free money.” More from the ad:

“Big Tobacco destroyed countless lives.

“Their actions placed an undue burden on our healthcare system…

“And they got away with it for too long….

“The Master Settlement Agreement dictates Big Tobacco distribute cash to 46 states and five U.S. territories forever.

“And thanks to a special clause in this deal, Americans have the chance to claim 100% tax-free income from it….

“This money is even guaranteed and backed by the government.”

And more language about how this is something you “claim” and “receive” … nothing about you ever having to do anything other than make a phone call or fill out a form online in order to “begin receiving” the payments.

“At this very moment, government offices in cities and towns across the country are receiving this cash.

“It’s being held in escrow accounts, waiting to be claimed.

“But what most people don’t realize is that even if you weren’t a direct victim of Big Tobacco’s misdeeds…. you can still get a portion of this settlement cash…

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And I want to help you do just that.”

And now big are these payments? Fitz-Gerald cites several different examples of indiiduals who have been collecting big from tobacco at $3,300, $5,000 or $6,000 a month, but the number most frequently repeated in the ad is “an average of $2,300 or more.”

So what the heck is he talking about? Is there some “settlement fund” that’s going to give you money?

No.

But there is a settlement fund in most states, and most states have borrowed against that future revenue, so there are a lot of municipal tobacco settlement bonds — and you could buy those bonds to lend money to the state, and receive tax-free municipal bond interest in return that is backed by the perpetual cash flow from the tobacco settlement.

So, tragically, this is an investment — not a magical pool of money that you can just ask for by using a secret codeword because you had a hard time quitting smoking, or lost a family member to lung cancer, or are just angry at tobacco companies in general.

To be fair, Keith Fitz-Gerald does very briefly note that you would have to make a one-time investment — though, as one might expect, he minimizes it and hides it in a section where he’s already got you thinking about lottery-like winnings:

“You’ve heard of a similar deal with lottery winners.

“The person who hits the Powerball will sometimes take a lump-sum payment from the government now instead of receiving annual installments.

“Only this time, it’s the government looking for the lump-sum capital.

“And because your money is being pooled with that of other Americans, you don’t have to put up a great deal to get started.

“Your one-time investment can be as little as $250.

“And in return, you will be transferred a share of the settlement money Big Tobacco is legally obligated to pay that city or small town forever.

“The checks will arrive every month. This income is tax-free.”

There are some unique characteristics to these tobacco-fueled municipal bonds… they are typically tied specifically to the tobacco company payments, so they may in some ways be protected from bankruptcies (ie, if Illinois declares bankruptcy, it might be that the Illinois tobacco bonds continue to receive their payments even if general obligation bonds do not — I can’t promise that this is true, and I’m no tax law expert).

And the tobacco settlement payments themselves are inflation-protected in at least some cases, though each bond is structured differently so I don’t know if they include rising payments (for what it’s worth, lots of people find the sector challenging — the complexity and lack of predictability of the tobacco revenue stream even drove Fitch to stop rating some of these bonds).

That specific connection to one defined string of revenue is somewhat similar to special project bonds, like those that might support the renovation of an airport or of a sewer system and that are paid back by revenue generated by that project (sewer fees, airport fees, etc.). Which can be good or bad, but it does at least make the particular bond more analyze-able because you’re not simply betting on whether or not the state will go bankrupt during the 30 years before the bond matures. And in many cases, the yields will also be higher on those “special projects” because they’re not backed by general taxing authority but by a specific business or activity.

Fitz-Gerald says that this tobacco settlement has generated “156 lucrative deals” …

“The government has worked out a series of very special deals on behalf of ALL AMERICANS.

“Currently, there are 156 lucrative deals to choose from.

“But we don’t anticipate that remaining the case for very long.

“Because Americans who have become privy to what I call ‘Master Settlement Payments’ are beating down doors to lock up their spots.”

I don’t know if the 156 number is accurate or not, there are a bewildering array of municipal tobacco bonds, but the “on behalf of ALL AMERICANS” bit does not mean that everyone gets some of the cash… it means that the state (or city, in a few cases) gets the cash from these ongoing tobacco settlement payments, and they use it how they want to.

So how do these tobacco bonds actually work?

Well, the states settled with the tobacco companies in 1998, dropping their suits and claims for health-related tobacco costs in exchange for an ongoing stream of cash that is based on the number of cigarettes sold.

In most cases, the states initially determined that this cash would go to help cover the health care costs of tobacco that are borne by the state, and to help fund anti-smoking programs… but, of course, when a state budget hits a tough patch (as they all do, from time to time), the temptation was immediately to use this tobacco money to plug other holes in the budget.

And in order to use more of that future tobacco money today to solve the current problems with their budgets, a lot of states decided to essentially sell off this future revenue stream to investors by issuing municipal bonds. The state gets cash up front, the investors get either a fixed or a revenue-dependent coupon payment for 20 or 30 or 40 years or until some preset revenue target is reached.

There are now a large number of these bonds — according to VanEck, Tobacco Settlement Securitization Bonds (they call them TSSB’s) make up a large chunk of the high-yield municipal bond market — and they are probably the most prominent and liquid chunk of the high-yield muni market right now because of Puerto Rico’s bankruptcy (according to that same VanEck article, Puerto Rico munis were about a third of high-yield muni market with about $70 billion in outstanding principal, while tobacco bonds were about $32 billion of the $210 billion total).

So most municipal bond funds, particularly those that offer higher yields, are going to have at least some exposure to this tobacco bond sub-sector. The VanEck Vectors High-Yield Municipal ETF (HYD), for example, has a yield of about 4.5% and six of its top ten holdings are tobacco securitization bonds.

That kind of yield sounds pretty good for any kind of income investment right now, but it’s particularly a high yield for a muni bond, since the primary attraction of munis is that they are free from federal taxes — so if you’re someone in the highest federal tax bracket, and you can get a tax-free yield of 5%, that’s going to give you the same income as a 7.5% yield on a taxable bond. So you can see that someone’s pricing in some risk there — what is it?

Well, partly there’s the risk that the tobacco settlements may bring in less money than expected. The tobacco companies are doing just fine and their cash flow is still very high, but the settlement payments are generally based on the volume of cigarettes sold, NOT on the revenue. Tobacco companies are doing better because they’re raising prices, not because they’re selling more cigarettes… and as states and the federal government also come at tobacco from the other direction, increasing cigarette taxes, they’re further depressing the sales of cigarettes. Cigarette sales have been in persistent decline for decades, and that was calculated into the initial formulation of these bonds, but the decline has often been substantially faster than was predicted.

And there’s also the risk that tax laws might change, and that interest rates might change — that’s arguably why municipal bonds collapsed late last year at the time of the election (though they’ve made up about half of that fall already)… not only did interest rates bump up quickly as investors started to worry about a new wave of deficit spending and inflation, hurting all kinds of bonds, but risks of a meaningful change to tax law suddenly appeared. The two big tax law things that could impact municipal bonds are the tax benefit, meaning that the Feds could either take away or limit the tax-free nature of municipal bond income, and the tax rate itself, since if tax rates are cut then being tax-free is less of a benefit.

So there’s clearly risk, though I think fears of major tax law changes to muni bonds are probably overstated — even if you premise that Congress and the President will agree on something in the near future, which itself is quite a leap right now, they’re unlikely to take away a tax break primarily used by financially comfortable retirees… if only because those folks are probably the most reliable voters in the country (the general finding of most surveys is that, as the NY Times noted in an article last Fall, “The richer, older and more educated you are, the more likely you are to vote.”)

Are there hidden opportunities in this little world? Probably so… I’m not at all an expert at analyzing municipal bonds, and analyzing and buying individual municipal bonds, particularly those that are complex and non-standard like tobacco bonds, is certainly outside my wheelhouse.

There are some great articles looking at this segment if you’d like to start to build your own understanding of how it all works — I’d start with ProPublica’s piece about the big-picture problems with state tobacco bond financing to provide some perspective, though things have changed a little since then (that was in 2014), then move on to an article from PIMCO’s David Hammer about “seeking value in the ashes” in this sector, from about two years ago, and a Nuveen article about “careful credit analysis” in tobacco bonds. That should give at least some basic level of understanding of how the bonds work and what’s been impacting their prices.

An individual investor looking to build a municipal bond portfolio would probably want to work with a broker who has some expertise in this sector — trading and analyzing individual bonds is not for everyone, and you will probably want to hold at least a dozen bonds in order to get some diversification, which would mean committing at least $50-100,000 to a municipal bond portfolio (most bonds transact in groups of at least five or ten, which would be $5,000-$10,000 of principal for each issuer). And unless you’re able to analyze and trade those bonds at pretty low cost, brokerage fees, either in management fees from the firm who helps you or in the commissions built into the spread offered to you on those bonds, might be prohibitively expensive with a portfolio of that size.

Discount brokers like Fidelity or Vanguard will trade individual muni bonds (or corporate bonds) for you, at generally quite low cost, but they probably won’t hold your hand and tell you which tobacco funds are riskier than others or explain any other esoteric aspects of specific offerings.

I’d personally be much more interested in a diversified portfolio through a mutual fund, ETF or closed-end fund if I were considering municipal bonds — and if you’re looking for a higher-yielding muni bond offering from any of those kinds of mutual funds, it’s almost certainly going to include a healthy slug of tobacco bonds.

I skimmed through the portfolios of a half-dozen municipal bond ETFs and closed-end funds with yields of over 4%, and didn’t find any that didn’t have at least 5-10% of their portfolio allocated to tobacco bonds, but Morningstar says there are some municipal bond managers who eschew the sector. That VanEck index fund I noted above, the VanEck Vectors High-Yield Municipal Index ETF (HYD), has 18.5% of its portfolio in tobacco bonds right now, so to some degree that offers a meaningful amount of diversification for those looking for high yield municipal bonds and a possible kicker if tobacco bonds turn out to be the best part of that market (that’s not a recommendation, I haven’t looked at all the high-yield muni ETFs and don’t know how their strategies or portfolios differ, but I think HYD is the largest and lowest cost ETF in that segment).

What would it take to get that $2,300 a month that Fitz-Gerald promotes, then, from this “master settlement?” Well, there are a wide variety of tobacco bonds that are currently priced very differently, but in skimming through some lists it looks like 5% is a decent guess for the average yield for these bonds, many of which have maturities out 20-30 years. $2,300 a month would be (math alert!) $27,600 a year. If you’re earning a 5% yield on your investment, and it totals $27,600 a year, then that means your initial investment is $540,000.

So one thing is certain, if you start with a one-time investment of “as little as $250,” as the ad notes, you’re not getting anything near that $2,300 a month in income. A $250 portfolio of tobacco bonds would provide you with income of about $1 a month (that’s just to illustrate, of course, you can’t typically buy individual bonds in sub-$1,000 increments — though you could buy a few shares of a broader high-yield municipal bond ETF for that price and get roughly that kind of income).

And, of course, though municipal bonds are historically much less risky than corporate bonds, with very low default risk, you are taking some risk in lending money to these tobacco settlement funds, or to states and municipalities in general, and that risk is substantially higher if you buy a few individual muni bonds than if you buy a portfolio of muni bonds in a mutual fund or ETF of some sort. Even if the tobacco cash flow stays steady enough to provide you with the expected return on your bond or your portfolio of bonds, you could easily lose money if interest rates rise dramatically and you have to sell bonds before they mature… and if tax law changes, the income could suddenly become less attractive to you if you have to pay taxes on it.

So, yes, you can (sort of) “stake your claim” to the “Master Settlement Agreement,” and you probably can generate income of $2,300 a month from that “claim”… but it’s not really a claim, it’s an investment return — the first step, before pocketing that $2,300 a month, is taking a half million dollars of your money and investing it in municipal bonds backed by tobacco settlement cash flows (and taking some level of risk in the process). Somehow, Fitz-Gerald’s ad didn’t really focus on that part where you put up the money… funny, that.