SAN FRANCISCO - Issuers are currently being bombarded with proposals from underwriting firms to do tobacco settlement-backed deals on either a taxable or tax-exempt basis, and are fielding suggestions that they use the money to do anything from funding various kinds of trust funds to completing needed infrastructure projects.
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But if an issuer chooses to bond against expected future payments from the tobacco companies, the question of for what the proceeds will be used will play a determining role in how that deal is structured, according to panelists speaking here Thursday at The Bond Buyer Tobacco Settlement Symposium.
For New York City, the decision to securitize came from an obvious need to continue funding its capital program in the face of a looming debt cap and in the face of a state Legislature none-too-ready to authorize additional debt for the city, said Mark Page, general counsel for the city's office of management and budget.
The city turned to securitization because it needed the money up front, the proceeds were new and not committed to any particular budget line, a non-recourse loan would not count against its debt cap, and other ways of monetizing the settlement had a higher long-term cost, Page said.
New York, or any other issuer, might have been able to auction off the rights to receive payments under the Master Settlement Agreement between the tobacco companies and 46 states, he suggested. The drawback of that kind of deal would have been the loss of payments that have no quantifiable present value, such as settlement payments due after 2040, but which will be a valuable source of revenue in the future, Page explained.
For the city, making the decision to issue the bonds on a tax-exempt basis was not difficult because funding the city's capital program complies with the provisions of the federal requirements for tax-exempt bonds. But, as underwriting firms are pitching the idea of securitization to issuers with different needs and for different purposes, the question of what tax structure to use becomes a bigger issue, panelists said.
James F. Haddon, a managing director with Salomon Smith Barney Inc., which ran the books on the three tobacco bond deals issued to date, suggested that issuers that want to divest themselves of tobacco industry risk or set up a trust fund with their settlement proceeds should securitize their settlement payments on a taxable basis.
A trust funded by securitization proceeds will be larger than one funded on a receive-as-you-go basis, he said, while issuing on a taxable basis would give issuers a broader range of options on how to invest the proceeds than a tax-exempt borrowing would. Taxable deals, moreover, may offer the potential to sell bonds to audiences usually not available to municipal issuers, such as European investors, he added.
Issuers could also consider securitizing in separate taxable and tax-exempt tranches, Haddon said. Marketing the different tranches would not necessarily pose greater difficulties because of the varied audience of buyers that participated in the first three deals, which included insurance companies, crossover buyers, and other nontraditional municipal investors, he said.
But Marvin Markus, a managing director with Goldman, Sachs & Co., said attracting European investors would be difficult because they have remained cool to asset-backed offerings, even when presented with a traditional ABS structure, such as credit card receivables. Investors in taxable debt are also pickier than their tax-exempt counterparts because they have access to a broader range of debt, and so can more easily skip a deal they are not entirely comfortable with, he added.
On the tax-exempt side, Eric Altman, a managing director with J.P. Morgan Securities Inc., showed off a tax-exempt structure where issuers could borrow at a lower cost and invest the proceeds in a trust fund invested in tax-exempt securities. The plan, he said, would give borrowers a good deal of flexibility in the use of the fund's earnings, as well as potentially freeing up future funds that might have gone for pay-as-you-go financing that could be used for other purposes, including establishing an unrestricted trust fund.
Officials in Erie County, N.Y., have decided that the county should securitize its expected payments under the MSA, but have not yet concluded whether the offering should be on a tax-exempt basis, said Joseph Passafiume, director of the county's division of management, budget, and finance.
Even with an aggressive issuer and a well-considered plan, other hurdles remain.
Virginia was close to issuing tax-exempt tobacco settlement bonds, but opposition from the General Assembly blocked the deal's progress, said Mary Morris, the state's treasurer.
The state had many reasons for wanting to pursue a securitization, including the need to fund Gov. Jim Gilmore's ambitious road program and a desire to minimize the state's exposure to risk of tobacco company nonpayment, she said.
But with a part-time citizen-legislature that had a hard time mastering the intricacies of the complex transaction and a tobacco-state population "inclined to discount industry risk," Virginia officials could not get the legislature to sign off on the proposal this year, Morris said. That is one possibility it may be impossible to structure around.
