Monday, April 25, 2016

Back to Blogging? The Kansas Tobacco Fund Securitization

I've been absent for a while, not writing on the blog much. A few explanations for that (take your pick):

  • I have a consulting gig in addition to my normal job that's taking up quite a bit of time and limiting my ability to blog.
  • I've been busy around the house with spring and having to mow and the like.
  • I spent the first half of last week at a conference in South Florida.
  • I've been a bit uninspired lately.
And a picture of .. my feet.. in Florida:

Point being, I haven't posted much lately, and I feel somewhat bad about that.  In my day job I've been doing some cool stuff that's keeping me entertained though, largely involving large-scale text data.

This week I'll try to make up for it on this blog by posting a few short pieces, mostly in relation to things I see on my twitter feed.  Here's the first one on: Securitizing the Kansas Tobacco Trust Fund.


This is something that's all over the news and Twitter in my home state, and it basically comes down to this:

  • Kansas has some, how shall we say it, budgetary issues going forward.  The big debate between parties comes down to whether it's a "revenue problem" or a "spending problem," but alas that's not the point of this blog.
  • The question is: can we sell the Kansas Tobacco settlement money (somewhat like a medical structured settlement for accident victims, like you see on daytime TV) NOW for money?  

If you don't watch daytime TV, here's a video that gives you an idea:

Selling a structured settlement or "future receivables" in accounting terms is not uncommon and many people and businesses do this when in desperate situations.  It's in a general class of financial products called "factoring," (or securitization) where an entity will purchase a future stream of payments (like an annuity, structured settlement, tobacco money) from you at a discount (% less than the total stream of payments) so you can "use your money now."  When I was in the field of risk analytics, I consulted on quite a few factoring decisions, so I have a reasonable understanding of the process and risks.

The information has been limited about the Kansas situation, but here's the information I have pieced together (see note in italics below, these numbers not out of line with historical standards):

  • Kansas would receive a one-time payment of $160 Million from a banking entity.
  • Kansas would turn over $16 Million of the tobacco fund payments each year for 20 years.
  • This would correspond to $320 Million in total payments, or a discount of 50%.

This may seem like a steep price, but when you need cash like Kansas does right now, capital often doesn't come cheap.  Is there an easy way to think about this?

Factoring can be a bit abstract, but we can think of it as a mortgage:

The bank is giving us some money now, for a current need (buying a house, for instance), and we'll make payments for 20 years on that initial infusion of cash.

I can create more detailed numbers on the backend finances to extend the mortgage metaphor.  This is actually a simple finance question that we can solve for an interest rate with an amortization calculator, and the estimates from media.  So if the numbers above are accurate ($160Mil, $16Mil, 20 years) we can back into the effective interest rate of the loan made, which is: between 7.8% and 8.9%, depending on the amortization strategy (how often payments, when interest accrues, etc).

Once again, these numbers are going off of news reports, so if anyone has numbers that are more in line with what is being discussed let me know and I'll re-run.  It needs to be noted, however, that a 50% discount is in line with securitization of tobacco funds in other states, as demonstrated by this federal reserve paper. (data is old, there's a potential it's somewhat better now, but the underlying theme is the same: securitization of tobacco funds is a finance-costly endeavor)


This information may seem a bit abstract, but this gives us an idea of what the State of Kansas is doing, essentially taking a loan out against future secured payments.  Is it worth it?  That's largely a political question: Should budgets be cut?  Should taxes be raised?  In this case, factoring the tobacco fund allows political avoidance (fewer cuts, no raised taxes) at the cost of somewhat high 8% financing charge.

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