Moody's: Tobacco Arbitration Rulings a Credit Positive for Securitizations

CHICAGO — The recent arbitration rulings over disputed tobacco industry settlement payments to the states offer good news for tobacco securitization ratings, but future arbitration proceedings still pose a risk, Moody's Investors Service said in a new report.

The report is the rating agency's first formal comment on arbitration results announced Sept. 11 over disputed payments tobacco manufacturers owed to the states participating in the 1998 Master Settlement Agreement in 2003.

The rulings — tied to whether the states sufficiently enforced rules aimed at preventing those tobacco companies that did not participate in the settlement from gaining a competitive edge over the participating companies — found in favor of 11 states and against six states. Separately, 22 states had previously settled the disputes in agreements struck in 2012 and this year.

Moody's rates tobacco settlement-backed securitization bonds issued by four of the states that won the arbitration, including Iowa, New York, Ohio, and Washington. All face arbitration over payments between 2004 and 2012.

"The decisions are credit positive for the securitizations we rate and could be indicative of future decisions," Moody's wrote. "There are nevertheless several factors that could add risk to this scenario, and arbitration panels that are convened in the future to examine diligent enforcement of the statutes for subsequent years could reach a different conclusion."

"A finding that a state did not diligently enforce the statute could significantly weaken the securitizations' credit quality," analysts warned.

As a result of the positive arbitration news, the 2014 MSA payments to the states sponsoring those rated securitizations will increase between 9% and 12% as they recover withheld payments that had been kept in escrow.

Iowa expects to collect an additional $6 million, New York $92 million, Ohio $35 million, and Washington $15 million. Those who saw negative arbitration rulings will collectively lose about $500 million next year.

The decisions over 2003 enforcement could "point to similar" decisions in the dispute over subsequent years but Moody's warned that's not certain as past rulings do not set precedent and panel members could change.

Under the rule that is the subject of arbitration, states must require that each non-participating tobacco manufacturer annually fund an escrow account in an amount approximately equal to the MSA payment they would have been required to make if they had participated. The participating companies have argued that some states have failed to enforce the rules and that's resulted in market share loss.

Moody's warned in a report last year that nearly 75% of the tobacco settlement-backed bonds it rates will default if consumption continues to decline at a rate of 3% to 4% annually. Moody's rates a total of 32 tobacco settlement securitizations with a balance of $20.4 billion outstanding.

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