More than 100 callers participated in Fitch's 11:00 a.m. conference call today on the state of the tobacco industry and the drivers of the recent downgrades. In all, the entire tobacco settlement ABS sector was downgraded, affecting approximately $18 billion in bonds.

Currently, Fitch’s settlement backed bonds – with top classes at ‘BBB’ — enjoy a one-notch separation from the agency’s industry rating, which is now at ‘BBB-’. While these are closely aligned, as the payments to the master settlement are essentially payments by the industry to the states, Fitch believes that the participating tobacco companies are slightly more likely to honor their master settlement payments in bankruptcy than their unsecured debt, mostly because the contract to pay is executory, which means that if the tobacco company continues making payments, the States will not sue them again.

On Fitch’s Kevin Duignan of the ABS group indicated that it’s possible the notching differential could change if the industry were to experience another major downgrade, though it would depend on the nature of the event triggering the downgrade.

One theoretical example would be a bankruptcy of one of the major tobacco companies, where the company immediately affirmed its intention to keep paying into the MSA. In this case, while the corporate rating would drop to ‘D’, possibly impacting the industry rating, there would be grounds to further separate the MSA-backed deals from the corporate credit of the industry.

“If that were to happen, we’d have a big uncertainty lifted,” said Michael Dean, a managing director at Fitch.

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