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 primarymarket for unenhanced tobacco bonds, which states and localities have sold to securitizetobacco company payments made under the historic 1998 Master Settlement Agreement.
The underwriting team and market participants said that while it has been in the worksfor a while, the deal's timing reflects an ongoing rally in the secondary market forunenhanced tobacco, which was pummeled by skittish investors after an adverse courtruling in the spring.
"This is the right size deal and the right structure for the marketplace," said EdwardK. Flynn, managing director at First Albany Capital Inc., the senior manager and soleunderwriter. "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 aclass-action case while the tobacco manufacturer appealed a $7 billion compensatorydamage ruling.
Since then, the only unenhanced tobacco debt deal was in June and early July whenCalifornia's Golden State Tobacco Securitization Corp. converted around $400 million inoutstanding auction-rate securities to fixed-rate. Instead of unenhanced debt, issuerssuch as California and New York have added state general fund pledges in order toassuage investor concern and float new deals.
The New York Counties Tobacco Trust III is doing the third pooled county deal in NewYork and the first since the April ruling. According to the preliminary officialstatement, the deal is expected to consist of a $21.8 million 2027 term bond, a $15.4million 2033 term bond, and a $41.4 million 2043 term bond.
Departing from the past two county pool deals, where trapping-account pledges were usedfor additional security, the new deal is using the now-standard turbo structure, inwhich tobacco company payments not pledged for debt service are used to retire theoutstanding debt. Based on a forecast of settlement payments, the 2027 term bond has anexpected average life of 3.8 years, the 2033 bond 8.7 years, and the 2043 bond 13.4years.
Oswego and Dutchess counties are securitizing 100% of their expected tobacco settlementpayments, while Rockland County is securitizing the remaining 20% of its payments. Thethree counties have established separate tobacco asset securitization companies as theseller of the bonds. Hiscock & Barclay is the transaction counsel, which is equivalentto 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 generalobligation debt with the money.
In 2001, Rockland County securitized 80% of its tobacco settlement in a stand-alonedeal. In all, according to the New York State Association for Counties, the deal bringsto 35, including New York City, the number of counties that have securitized tobaccosettlement payments in New York. Three years ago, 17 counties did a $240 million pooleddeal, 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 dealdone in the market - and on the second New York deal.
Ken Crannell, director of intergovernmental services at the county association, saidthat on a percentage basis most of the local share of the tobacco settlement in New Yorkhas been securitized. However, the underwriter, First Albany, said other counties thathave either securitized only part of their share or none at all could be interested innew 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 toTriet Nguyen, president of Axios Advisors LLC, an independent high-yield credit researchfirm, 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 isaround the same time the municipal market in general began to rally after a sell-off. Hesaid that his benchmark for tobacco is an unenhanced New Jersey deal done just beforethe Illinois Court ruling. He also said the spread on the 2039 maturity in that deal was225 basis points when it was sold, which fell to 290 basis points by August and hasrecovered 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 helpeddrive 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 anexpedited appeal in the Price v. Philip Morris USA lawsuit.
Moody's Investors Service and Standard & Poor's had not released ratings on the New YorkCounties Tobacco Trust III deal by press time. Following the April ruling both agencies,along with Fitch Ratings, downgraded outstanding unenhanced tobacco deals, which amountsto around $20 billion in principal. Moody's rates most of the debt Baa2, and Standard &Poor's rates it BBB.
