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Bloomberg | June 17, 2026 | Author: Martin Z. Braun |

More than two decades after Wall Street started pumping out a new type of bonds — those backed by the legal-settlement payments governments receive from cigarette companies — one batch has finally been driven into a default. It almost certainly won’t be the last.

The securities allowed state and local governments to get the cash upfront by selling debt that’s repaid, gradually, when the proceeds roll in. That offloaded all the risk to investors, who were compensated with high yields in return.

But the warning signs in what swelled into an $80 billion corner of the municipal-bond market have been building up for years because the size of the annual payments under the 1998 agreement are based on cigarette shipments. And those have been plunging, year after year, at a far faster pace than was expected when the bonds were sold, as Americans shun the habit or take up vaping instead.

New York’s Nassau County Tobacco Settlement Corp., the shell set up to issue so-called tobacco bonds for the Long Island county, was the first to snap. At the start of this month, it was forced to skip a $36 million payment on debt that was coming due because it didn’t have enough money, triggering a default.

The step accelerated what had already been a sharp selloff in the county’s tobacco bonds and dragged down the price of similar securities by signaling increasing distress.

“If the cigarette market continues as it is with these last four years of near double-digit declines from the major tobacco companies, then we’ll eventually see more of these structures hit events of default,” said Matt Wackerman, an analyst at AllianceBernstein.

The rout has driven lower-rated tobacco-settlement securities to a 1.6% loss so far this month, a standout in fixed-income markets that have gained as movement toward ending the US-Iran war eases worries about inflation. Some of Nassau County’s bonds that don’t come due until 2046 have slid to less than 50 cents on the dollar, a drop of about 35% since the end of last year and down from more than 100 cents as recently as 2022.

Analysts say Nassau’s skipped payment wasn’t entirely a surprise, given that it had already been cut deeply into junk status and credit-rating companies have been flagging the broader risk by steadily ratcheting down their grades on other securities. When the bonds default, moreover, investors aren’t wiped out because the deals are structured so they will eventually be paid back as the settlement payments come in, albeit with a delay.

Some of the more recently issued tobacco bonds were also better at taking account of the industry’s decline, and adjustments to the settlement payments based on inflation have softened some of the hit recently.

But it’s widely expected that many tobacco-bond issuers, particularly those who were part of the the early wave of securities sold in the 2000s, will be unable to keep up with their payments as smoking continues to decline.

Between 2021 and 2024, annual cigarette shipments by tobacco companies participating in the accord dropped an average of 7.25% year, cutting into the payments backing the bonds.

S&P downgraded 40 tobacco-bond issues last year, including Nassau County’s. The bulk of the $20.5 billion of tobacco bonds that it tracks, about $12.5 billion of them, are now rated junk. Some $9.7 billion are the CCC category, deeply below investment grade, indicating they’re likely to default.

The tobacco industry continued to contract in 2025, even before the sharp jump in gas prices caused by the Iran war started squeezing American consumers. Altria Group Inc. reported a 10% decline in US domestic cigarette shipment volume in 2025, while British American Tobacco reported a 7.7% decline. The two account for about 80% of US cigarette sales.

“The big picture is consumption is going down,” said S&P analyst Jie Liang. “You’re going to see a lot more downgrades than upgrades.”