S&P to Rate Tobacco Bonds as High as 'A'
After conducting an extensive analysis of all known rating risks, Standard & Poor's today announced that bonds secured by tobacco settlement revenues can achieve ratings as high as 'A.'
``While we do see a number of risks associated with securitizing the tobacco settlement revenues, including risks related to the price of cigarettes and litigation against the industry, we see enough strengths in the transactions we are seeing to rate at the 'A' level,'' said Richard Gugliada, managing director in Standard & Poor's Structured Finance Department.
Standard & Poor's expects to announce ratings to individual municipal debt issues of tobacco bonds in the coming weeks. Debt rated 'A' reflects Standard & Poor's opinion of a strong ability to repay debt on time and in full but that the issuer is more susceptible to the adverse effects of changes in circumstances and economic conditions than more highly-rated debt. The highest rating assigned by Standard & Poor's is triple-A.
Standard & Poor's has been working on the criteria needed to rate tobacco bonds since 46 states and a number of local governments negotiated a multi-billion-dollar Master Settlement Agreement (MSA) with the major U.S. tobacco manufacturers in November 1998. This agreement has led several local governments to pursue the unique opportunity to accelerate the funds due and payable under the agreement by securitizing the agreement's payment flow, a trend that will likely continue.
``To date, municipal governments' utilization of securitization techniques has been limited and generally restricted to delinquent tax lien sales, stranded cost financings and a few future flow transactions,'' said Steven Murphy, managing director in Standard & Poor's Public Finance Department. ``However, the existence of the MSA may serve to change this trend.''
Standard & Poor's ratings on tobacco bonds will be based upon the following factors:
The price elasticity of demand for cigarettes and the uniqueness of the product. Although domestic shipments of cigarettes have declined over the last several years, the low price elasticity of the product nevertheless reveals a consistent underlying demand for the product despite the recent price increases, a significant portion of which have been driven by the MSA. Demand for the product should continue despite the potential for continued price increases, which could result from, among other things, future litigation payments.
The limited joint and several obligation characteristics of the Master Settlement Agreement. The MSA provides for payments to the Settling States, levied on a per unit basis, based on a market share allocation among participating manufacturers. To the extent that a company ceases to manufacture cigarettes, the market share of such company would be reallocated among remaining manufacturers. As long as the remaining companies continue to participate in the MSA, there should only be a temporary loss of settlement revenues, which would eventually be recaptured to the extent the remaining participating companies absorb the market share of the lost company. A properly structured securitization could absorb the temporary loss settlement revenues caused by the unwinding of a manufacturer. The features of the MSA facilitate an approach which accounts for the overall strength of the industry as opposed to a purely company-specific approach.
The strong incentives to participate in the MSA as provided by the Model Statute. The Model Statute, Exhibit T to the MSA, provides a strong incentive for manufacturers to participate in the MSA, in the states that choose to adopt it. The Model Statute requires a non-participating manufacturer to establish a qualified escrow account, which is funded through an annual deposit based upon the company's cigarette sales in a given year. This reserve fund is intended to prevent a non-participating manufacturer from achieving an unfair cost advantage in relation to participating manufacturers, as well as provide the state with a source of recovery to the extent that a non-participating manufacturer is proven to be liable for damages.
The limited predictability of domestic shipments of cigarettes over the long term. As the relative predictability of cigarette sales decreases over time, a securitization that is secured by cigarette shipments over an extended period of time, e.g., 40 years, would be prevented from achieving a rating higher than 'A.' The limited predictability is a result of uncertainties, including the potential for price increases resulting from any future litigation, imposition of future taxes by federal, state and local governments, and the effect of smoking prevention programs and education initiatives.
The potential impact of present and future litigation facing the cigarette industry. Currently, the industry faces a number of large lawsuits, including the Engle class-action suit in Florida, and a suit filed by the Justice Department on September 22, 1999. Although the industry has historically been successful in defending itself against individual lawsuits, it is difficult to reasonably predict the outcome of all present and future litigation.
Transaction-specific enhancement. The rating received by a particular transaction will also be dependent upon the levels of debt service coverage provided by the transaction's structure. For example, a transaction should have a reserve mechanism in place that is sufficient to cover a number of contingencies, including unanticipated shipment declines, potential litigation, etc.
Bond Maturity. As stated above, the level of predictability of certain events decreases over time. Therefore, a transaction with a shorter maturity has a higher potential for achieving an 'A' rating than a transaction with a longer maturity, due in part to the ability to more accurately forecast outcomes over the short term.
For additional information, media may contact Christina Pretto, New York, 212-438-2757 or Trevor Curwin, New York, 212-438-6679.