Fitch Ratings said it would withdraw of all its ratings on U.S. tobacco asset-backed securities by next month because of changes it perceives in the bonds' risk factors.
"The primary reason for the intended withdrawal is that individual, custom modifications (by several participants) to material calculations originally part of the base Master Settlement Agreement (the MSA) have eroded Fitch's confidence that ratings can be consistently maintained, as insufficient information exists to predict the likelihood and effect of future modifications or that insufficient information will exist to support new, material variables included in them," Fitch wrote in a press release dated May 16.
The rating agency said the withdrawal – which affects over 40 tobacco issues from New York to California and Michigan to the U.S. Virgin Island – will take place 30 days from the date of the release.
"I didn't expect it, but by the same token it's not having an impact on the market," John Miller, managing director and co-head of fixed income at Nuveen Asset Management, said in an interview with The Bond Buyer on Wednesday.
Miller said Nuveen owns tobacco bonds from the Buckeye State and Golden State tobacco securitization corporations that will lose their Fitch rating come June 16, but said the market should be content with the fact that the bonds are still rated by Moody's Investors Service and Standard & Poor's.
The market took the news in stride, and price quotes remained steady on tobacco bonds this week as reported by municipal valuation services, while yields were hovering around 6% on Tuesday on Ohio tobacco debt maturing in 2047.
Fitch said the risks far outweighed the benefits of continuing to rate the tobacco securitization bonds.
"Historically, the method for calculating the amount of the annual and strategic contribution fund payments was solely prescribed by the terms of the MSA," Fitch wrote.
The calculation determines the total payment amount due from the participating tobacco manufacturers, and is later distributed among the jurisdictions that are party to the MSA, and a portion of the funds are ultimately transferred to the issuers of the securities through a single, consistent application of the calculation adjustments "that affected all participating jurisdictions in the same way."
"However, more recent settlement agreements related to disputed payments connected to the non-participating manufacturer (NPM) adjustment have eroded Fitch's confidence in the predictability of the calculation of MSA payments going forward," the release continued.
Miller said although he was "surprised" by the Fitch decision, he recognized how the agency "became uncomfortable" with the risks.
"There's inherent uncertainty with regard to things like sales, litigation risk, and the non-participating manufacturers' market share affecting cash flow," Miller said.
In addition, he said that many of the Fitch ratings were rated at triple-C, among the lowest credit ratings.
"Nonrated is not necessarily worse than that," he said.
Additionally, Miller said many of the large buyers and owners of tobacco bonds tend to do their own research and modeling for cash flow on the bonds anyway.
"Different maturities might have different ratings internally," he said.
Fitch said the positive features of the settlement agreements aside, "the longer-term ramifications of the modifications to the NPM Adjustment calculation for both settling and non-settling jurisdictions is less clear and more problematic."
"The foregoing risks – the significant trend toward material, and different settlements, the introduction of new variables with little analyzable history, and the incentives in place for additional settlements – erode our confidence that a consistently reliable structured finance rating methodology can be applied going forward," the Fitch release stated.
Billions of dollars of bonds are backed by money from U.S. tobacco companies under a 1998 master settlement agreement (MSA) to compensate 46 states, Washington D.C., and Puerto Rico for the cost of caring for sick smokers.
States have received more than $50 billion so far under the MSA, according to the National Association of State Attorneys General, which manages the agreement.
