Monday, December 8, 2003

Print Email Reprints

Tobacco is back.

On Thursday the New York County Tobacco Trust III - representing the counties of Oswego, Rockland, and Dutchess - will price $78.6 million in unenhanced tobacco settlement pass- through bonds. The deal is significant, as it could represent a reopening of the primary market for unenhanced tobacco bonds, which states and localities have sold to securitize tobacco company payments made under the historic 1998 Master Settlement Agreement.

The underwriting team and market participants said that while it has been in the works for a while, the deal's timing reflects an ongoing rally in the secondary market for unenhanced tobacco, which was pummeled by skittish investors after an adverse court ruling in the spring.

"This is the right size deal and the right structure for the marketplace," said Edward K. Flynn, managing director at First Albany Capital Inc., the senior manager and sole underwriter. "There is some resiliency to the structure of 100% turbo term bonds."

The market for unenhanced tobacco bonds fell apart in April after a Madison County, Ill., Circuit court judge ordered Philip Morris USA to put up a $12 billion bond in a class-action case while the tobacco manufacturer appealed a $7 billion compensatory damage ruling.

Since then, the only unenhanced tobacco debt deal was in June and early July when California's Golden State Tobacco Securitization Corp. converted around $400 million in outstanding auction-rate securities to fixed-rate. Instead of unenhanced debt, issuers such as California and New York have added state general fund pledges in order to assuage investor concern and float new deals.

The New York Counties Tobacco Trust III is doing the third pooled county deal in New York and the first since the April ruling. According to the preliminary official statement, the deal is expected to consist of a $21.8 million 2027 term bond, a $15.4 million 2033 term bond, and a $41.4 million 2043 term bond.

Departing from the past two county pool deals, where trapping-account pledges were used for additional security, the new deal is using the now-standard turbo structure, in which tobacco company payments not pledged for debt service are used to retire the outstanding debt. Based on a forecast of settlement payments, the 2027 term bond has an expected average life of 3.8 years, the 2033 bond 8.7 years, and the 2043 bond 13.4 years.

Oswego and Dutchess counties are securitizing 100% of their expected tobacco settlement payments, while Rockland County is securitizing the remaining 20% of its payments. The three counties have established separate tobacco asset securitization companies as the seller of the bonds. Hiscock & Barclay is the transaction counsel, which is equivalent to bond counsel.

Of the $78.6 million in principal, Dutchess is expecting $46 million in proceeds, Oswego $21 million, and Rockland $9.5 million. The counties are defeasing outstanding general obligation debt with the money.

In 2001, Rockland County securitized 80% of its tobacco settlement in a stand-alone deal. In all, according to the New York State Association for Counties, the deal brings to 35, including New York City, the number of counties that have securitized tobacco settlement payments in New York. Three years ago, 17 counties did a $240 million pooled deal, and in July 2001 six counties sold $209 million in the second deal.

First Albany was co-book-runner on the first pooled deal - the first pooled tobacco deal done in the market - and on the second New York deal.

Ken Crannell, director of intergovernmental services at the county association, said that on a percentage basis most of the local share of the tobacco settlement in New York has been securitized. However, the underwriter, First Albany, said other counties that have either securitized only part of their share or none at all could be interested in new deals, depending on the results of this week's deal.

If the market holds, the bonds could fetch an overall yield of around 7%, according to Triet Nguyen, president of Axios Advisors LLC, an independent high-yield credit research firm, which would be around 225 basis points over the triple-A market scale.

Nguyen said that the tobacco bond market has been on the upswing since August, which is around the same time the municipal market in general began to rally after a sell-off. He said that his benchmark for tobacco is an unenhanced New Jersey deal done just before the Illinois Court ruling. He also said the spread on the 2039 maturity in that deal was 225 basis points when it was sold, which fell to 290 basis points by August and has recovered to 225 basis points since.

"There has been a pretty big rally in the tobacco bond market," Nguyen said.

Nguyen and others have said that recent legal victories by tobacco companies have helped drive the rally, as has the proposed merger of R.J. Reynolds Tobacco Co. and Brown & Williamson Tobacco Corp. In September, the Illinois Supreme Court decided to hear an expedited appeal in the Price v. Philip Morris USA lawsuit.

Moody's Investors Service and Standard & Poor's had not released ratings on the New York Counties Tobacco Trust III deal by press time. Following the April ruling both agencies, along with Fitch Ratings, downgraded outstanding unenhanced tobacco deals, which amounts to around $20 billion in principal. Moody's rates most of the debt Baa2, and Standard & Poor's rates it BBB.

More articles in News