An arbiter's ruling last week might prompt several tobacco companies to reduce pending April payments to states under the 1998 Master Settlement Agreement (MSA). Although these cash flows are used to securitize billions of dollars in ABS deals, market sources only expect the potential shortfall to adversely affect the scheduled turbo payments on those deals.
Last Monday, the group of tobacco companies obligated to make payments under the settlement agreement, known as Participating Manufacturers, won an arbiter's ruling which said that advertising restrictions imposed by the 1998 MSA were a significant contributing factor to their loss of market share in U.S. cigarette sales. The provision says that if this settlement's restrictions cause the PMs to lose market share collectively by two percentage points, they might be entitled to reduce the amount that they are scheduled to pay the 46 participating states on April 17.
Market participants expect the tobacco companies to use the arbiter's ruling as justification to reduce those payments. If that happens, Jerry Solomon, a municipal bonds analyst at Bear Stearns, said that tobacco companies could lower their obligations by as much as 18%, or $1.2 billion. Even if the payments fall short, all of the trusts should be able to meet their expected interest and principal payments for this year, Solomon wrote in a research note.
"However, none of these deals, with the exception of the 2001 DC [Washington, D.C. bond trust] deal, will be able to make the projected 2006 turbo payments," Solomon added. Two transactions in particular - the Rhode Island 2002 and the California County-Sonoma 2005 - will have to dip into liquidity reserve accounts in order to make scheduled principal and interest payments.
If this is a one-time event, and not a liquidity event wherein states get back any withheld funds, Bear Stearns expects all tobacco securitization deals to be paid off prior to their final maturity dates.
The current skirmish is far from over, because the cigarette manufacturers have several hurdles to clear before being allowed to reduce their April payments. The National Association of Attorneys General insists that tobacco companies affected by the 1998 MSA should pay up on time. The group says the tobacco companies have not met the requirements of another mechanism - known as the non-participating manufacturer (NPM) Adjustment - that might allow them to reduce their obligations. In that, the cigarette companies have to prove that the states did not diligently enforce their statues providing for nonparticipating manufacturer escrow payments, according to the NAAG.
Further, any payment reduction would have to be decided on a state-by-state basis, because each state has different ways of enforcing the rules under the trust and resolving conflicts that arise from the MSA.
As for future tobacco settlement ABS bonds, Moody's Investors Service did not weigh in on the matter. Fitch Ratings, however, did say that the current payment dispute might affect future bonds. It also acknowledged that some deals had enough liquidity in reserve to meet near-term payments, but that an unfavorable resolution could reduce the amount of cash available to support the bonds, which might eventually lower ratings.
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