CHICAGO — The Illinois Railsplitter Tobacco Settlement Authority yesterday received A-level ratings from Standard & Poor’s on its $1.46 billion issue of tax-exempt tobacco bonds set for next week.
Most tobacco bonds rated by Standard & Poor’s had carried BBB ratings. The agency downgraded many earlier this month based on a change in its modeling assumptions on tobacco usage.
The rating agency assigned an A to the deal’s serial maturities and an A-minus to its term bonds, according to state debt manager John Sinsheimer. A pre-sale rating report was not yet available.
Fitch Ratings recently rated the bonds BBB-plus, its highest tobacco rating and one notch higher than its view of the overall sector.
The authority will take retail orders on Monday and Tuesday and open the sale to institutional buyers on Wednesday. It offers bonds with serial maturities between 2012 and 2015 of $51.76 million each and of $104.42 million from 2016 through 2021. There are term bonds of $313.2 million in 2024 and 2027, with three-year sinking fund installments on each of the term bonds.
The finance team held a series of investor meetings across the country in hopes of generating strong interest in the sale that will compete with a bounty of supply. It is the first tobacco bond sale in more than two years as the sector has been battered by cigarette consumption declines, lawsuits, rising taxes, rating downgrades, and default warnings.
The state aims to attract investors with a shorter 17-year final maturity than on many past tobacco issues along with a more traditional structure and strong debt-service coverage ratios that ensure bondholders are repaid even amid a 10% annual decline in tobacco consumption. Consumption fell by 9.3% last year for a five-year average decline of 4.3 %. Such declines affect the payments under the Master Settlement Agreement between most major tobacco companies and 46 states. A reserve will be funded at $146 million.
“The rating reflects the underlying credit strength that we’ve shared with investors,” Sinsheimer said. “Investors are doing more and more of their own credit work and they understand the credit strengths this bond offers.”
The bonds are backed solely by the state’s share of its MSA payments. Illinois received $284 million this year and expects to receive $305 million next year. The tobacco companies paid states $6.39 billion this year, down from the $8.14 billion original base estimate in the agreement.
Citi is the book-runner and Barclays Capital is co-book-runner. Public Financial Management Inc. is financial adviser. Nixon Peabody LLP is bond counsel. Jefferies & Co., JPMorgan, and Morgan Stanley are co-senior managers. Another six firms round out the underwriting team as co-managers.
Investors shed their tobacco bonds in droves last week after Standard & Poor’s recent downgrades of 51 ratings for 16 tobacco settlement securitizations, according to Bank of America Merrill Lynch’s weekly municipal commentary. The bonds carry a face value of $22 billion.
All but six were knocked down into junk territory. Standard & Poor’s affirmed the ratings on about $13.8 billion of tobacco bonds. The agency announced its review of 122 ratings in August following a revision of its modeling assumptions that project a consumption decline of 1.5% to 2.5% this year in addition to a base-case assumption of 3.5%.
Bank of America Merrill Lynch analysts wrote: “The descent into the speculative-grade ranges for many of the tranches will create a ceiling on prices that is likely to hold, at least until the participating manufacturer dispute regarding state enforcement over the non-participating manufacturers is eventually resolved.”
The participating members in the settlement dispute about 10% of the MSA payments, alleging lax enforcement of non-participating members has hurt their market share. The issue is the subject of arbitration, which is expected to take two to four years.
The 9.3% consumption decline last year is primarily attributed to a federal excise tax increase and the recession. Recent data suggests that the annual decline rate may be leveling off to roughly 2% to 3% as the economy recovers from the recession, according to the Bank of America report.
The deal — which will raise about $1.3 billion to pay off a state backlog of fiscal 2010 bills — is Illinois’ first to securitize its share of MSA payments.
