As the number of smaller tobacco manufacturers increases - reportedly stealing away market share from the beleaguered tobacco giants and reducing payments that member states receive from the Master Settlement Agreement - investors are becoming concerned about the effect of these companies on existing tobacco securitizations.

But rating agency analysts claim that they have factored the effects of smaller tobacco companies into their rating approach, and near-term changes in the ratings of the bonds are not likely.

"We had taken into account a major drop in market share by the participating manufacturers," said Nicolas Weill, a vice president at Moody's Investors Service. "So this is not outside the stress test that we apply to the various structures."

Further, judging from 2000 statistics, the four giants are still reigning among tobacco manufacturers, representing 95% of the market share.

Moreover, it would be difficult for smaller companies to gain extensive market penetration; though many of them opted not to join the MSA, state laws still require them to make payments to escrow accounts, which is a significant burden to some of these companies. They are forced to charge smokers a higher price in order to keep up with the payments, sources said, and in return they are released from any future smoking-related claims.

"The escrow payments are meant to level the playing field between non-participating manufacturers and participating manufacturers," said Bernhard Fischer, a director at Standard & Poor's.

Advertising and marketing restrictions would also hinder the growth of these companies, Fischer added.

"There are now severe restrictions on cigarette advertising and marketing, so the major brands that have strong market share are likely to maintain market share," he said. "But it will be difficult to market a new brand given the advertising restrictions put in place by the agreement. And also, currently it appears that the non-participating company brands are competing with the major manufacturers' discount brands, and not the premium brands."

Unpaid escrows

However, many of these companies, according to an article in last week's Wall Street Journal, have not been making their monthly payments, prompting at least six states to go to court.

Despite these snags, however, analysts believe that states would still be able to compel these smaller tobacco companies to pay up.

A case in point is Star Scientific Inc., which challenged the escrow payments it has to make in front of a Richmond, Va. court. The Journal reported that the company said the $13.1 million it had to shell out for 2000 was an "unlawful taking of private property," violating the Fifth Amendment. The Federal Judge dismissed the claims in March, but Star Scientific has since appealed the case.

Healthier alternatives

Another perceived threat to consumption levels is the appearance of so-called less-hazardous cigarettes, which some believe are not covered under the MSA.

Analysts say that as long as the cigarette contains nicotine, tar or tobacco - even in reduced amounts - it is still classified as a cigarette under the MSA. The real threat, sources say, is the development of alternatives such as a new patch that would cure the smoking urge or addiction altogether, therefore reducing consumption significantly.

However, even substantial decreases in cigarette consumption have been factored into the rating analysis.

"We make very severe assumptions about cigarette consumption," said Moody's Weill. "We assume that over the life of these transactions, consumption will have declined by about 75% to 80%."

Meanwhile, Moody's will release its methodology for rating tobacco deals this week.

Since the first deal in 1999, Moody's has slightly changed its criteria to reflect the fact that tobacco consumption in the past two years has not declined as much as originally anticipated.

"We have adjusted slightly the short-term decline numbers, but we have kept the long-term decline curve identical," Weill said.

Subscribe Now

Access to a full range of industry content, analysis and expert commentary.

30-Day Free Trial

No credit card required. Access coverage of the securitization marketplace, including breaking news updated throughout the day.