NEW YORK - The outlook for new and existing tobacco settlement revenue bonds is stable, says Moody's Investors Service in a report.
The stable outlook reflects Moody's evaluation of the bonds' key performance drivers, including analysis of recently released 2011 data from the National Association of Attorneys General; these data underlie the calculation of the April 2012 Master Settlement Agreement (MSA) payment.
"Our outlook is based on the evaluation of the drivers of credit quality," says Sally Acevedo, a Moody's Vice President - Senior Analyst. "Among the positive drivers are cigarette market share, the credit profile of the participating manufacturers, and the unlikely success of any litigation, such as anti-trust suits, that challenges the MSA-regime. Negative drivers include consumption declines and non-participating manufacturers' adjustment disputes."
"But we don't expect resolution this year of any of the disputes regarding adjustments for market share losses from participating manufacturers to other manufacturers. The disputes, called NPM adjustment disputes, tie up funds that the transactions would otherwise use to make bond payments. We expect the states, whose interests align with those of bondholders, to aggressively defend their positions," adds Acevedo.
An additional credit driver only applies to California county-sponsored bonds: such counties' respective share of the state's total population. "Population shifts in certain California counties have materially changed our MSA payment projections for such counties' sponsored bonds," says Acevedo. "For some counties this is a credit positive and in other cases it results in a credit negative."
National cigarette consumption will continue to decline, at a rate of 3%-4% throughout 2012, with steeper yearly declines if shock events occur. Potential shocks include 1) the successful introduction of alternative smoking products the MSA does not capture or of smoking cessation products or pharmaceuticals; 2) material increases in cigarette prices because of rising excise taxes nationwide; and 3) an increase in regulations restricting cigarette sales.
"However, our ratings already incorporate a 4% mean annual decline, as well as periodic volatility shocks to address event risk," says Acevedo. "Still, we anticipate that new transactions in 2012 will include more credit enhancement than past transactions."
To offset the steeper projected consumption declines, future transactions are likely to have lower leverage and consequently higher debt service coverage ratios (DSCR) than transactions in the past. The DSCR is a ratio that measures the MSA cash flow available to service the rated scheduled ABS payments and pay other transaction costs.
Consumption decline is a key risk against which credit enhancement provides protection. The primary asset that backs all tobacco settlement bonds, whether existing or new, is the issuing state's proportionate share of payments under the MSA. Under the MSA, participating manufacturers make perpetual annual payments to 46 states, the District of Columbia and five US territories, based primarily on the annual volume of cigarettes shipped in the US, a measure that closely tracks cigarette consumption. The calculation of annual MSA payments uses the previous year's cigarette shipment data.
In addition to consumption declines, the credit effect of other key factors affecting transaction performance in 2012 will vary, but, when considered in the context of Moody's projections for consumption declines, result in a stable ratings outlook for tobacco settlement bonds, given Moody's modeling assumptions and qualitative analysis.
