Moody’s Investors Service on Tuesday took rating actions on 35 tobacco securitizations affecting about $22 billion of debt due to implications from a recent court ruling and a drop in tobacco consumption.
The rating agency said an October federal appellate court ruling in New York upheld a master settlement agreement reached in 1998 between 46 states and U.S. tobacco companies and that allowed Moody’s to take all outstanding tobacco bonds it rates off a review “with direction uncertain.”
“As a result of these positive developments, we believe that other legal challenges to the MSA regime are equally likely to fail and that such legal risk to the transactions has been materially reduced,” Moody’s said in a statement.
The lawsuit, brought by cigarette importers and distributors, charged that the deal violated federal antitrust law and the U.S. Constitution’s commerce clause.
States and local governments have issued billions of dollars of bonds backed by the settlement payments, using the proceeds in some cases to ease their budget problems, as was the case with a $1.5 billion Illinois tobacco bond sale in November.
Moody’s placed parts of several bond issues backed by settlement money on review for potential downgrades or upgrades, while confirming the Baa3 ratings on 12 tranches in eight deals, according to Irina Faynzilberg, a Moody’s analyst. Last month, Standard & Poor’s Ratings Services cut 51 tobacco settlement-backed ratings and affirmed 71 others.
The drop in consumption led Moody’s to place the ratings on 67 tranches from 19 tobacco bond issues on review for a possible rating downgrade. The rating agency cited a 16 percent, or $6.4 billion, drop in payments tobacco companies made to states under the agreement in 2010 compared with 2009, due in part to a hike in the federal excise tax on cigarettes.
Moody’s said while no tobacco issues had to draw down cash reserve funds to make debt service payments, coverage ratios in many deals “declined substantially.”
“Moody’s expects that the projected cigarette consumption declines will subject some transactions to a significant stress,” the rating agency said.
The meat of the Moody’s release is the section on patterns of declining consumption that may lead to downgrades to below investment grade for some long-term tobacco bonds, according to Dick Larkin, a senior vice president at Herbert J Sims & Co.
“They are finally catching up. I have been writing about consumption declines for years,” he said. “They seem to be saying that the declines won’t affect short-term bonds since the money will be there to pay them. The shorter bonds may be upgraded. But the longer credits, say after 2030, they may be put on negative watch for possible downgrade.”
Scott Cottier, senior portfolio manager at Oppenheimer Funds Inc, called Moody’s action neutral to positive for tobacco bonds.
Many of the securities could be upgraded by Moody’s, he said. Oppenheimer holds $3 billion to $4 billion of tobacco securities in its open-ended mutual funds.
Cottier said Moody’s concern about declining consumption was overblown. The agency was overestimating the rate of future declines in cigarette consumption and was mistakenly extrapolating from a few recent years of unusually steep drop-offs in cigarette smoking, he said.
Moody’s, he said, was projecting continued declines in cigarette use of 3 to 4 percent a year, while the average since 1981 was only 2.25 percent.
“Moody’s is taking an extremely conservative approach going forward,” Cottier said.
Moody’s placed the ratings on 140 tranches from 25 deals on review for possible upgrades due to their strong cash position and low leverage, Moody’s said.
“Many of them mature in the near future and will not be materially affected by the future MSA payment declines,” the rating agency said.
Faynzilberg said Moody’s is targeting 90 days to complete the ratings reviews.
By Karen Pierog