Moody's Investors Service today took actions on 35 transactions of payments owed to the issuers pursuant to the Master Settlement Agreement (MSA) between the domestic tobacco manufacturers and the 46 states and certain territories party thereto.
The actions are being taken because of the adjudication of the Freedom Holdings case, the result of which materially lessens the uncertainty around some important legal risks to these deals' cash flows.
The agency's specific actions address its views on the reduced legal uncertainty to the MSA cash flows as a result of the Freedom Holdings decision as well as the impact of continued drops and outlook for the future dips in the consumption of cigarettes.
Moody's is removing the review with direction uncertain and confirming the ratings on 12 classes in eight offerings. Because of certain litigation challenges to MSA-related legislation, all deals were placed under review with direction uncertain back in April 2004.
In November 2008, the district court judge in the Southern District of New York in the 2nd Circuit issued his preliminary bench ruling on the merits of Freedom Holdings, et al. v. Cuomo, et al.
The judge for the case dismissed the plaintiffs' claims on all counts. The plaintiffs, which were importers and distributors of cigarettes, had alleged that the MSA and the New York implementing legislation violated federal antitrust law and the U.S. Constitution's Commerce Clause. This favorable decision was upheld by the 2nd Circuit Appellate Court in October 2010.
Citing these positive developments, Moodys' thinks that other legal challenges to the MSA regime are equally likely to fail, and that such legal risk to the transactions has been notably reduced. Based on this, the rating agency is taking all outstanding rated bonds off review with direction uncertain.
The rating firm is placing 67 classes in 19 deals under review for possible downgrade. The 2010 MSA payment was roughly $6.4 billion or 16%, which is lower compared with the 2009 payment.
The payment reduction was because of two main factors. These are the 9.3% drop in the 2009 cigarette shipments in response to the rise in federal excise tax to $1.01 from 39 cents per pack that came on top of the "normal" cigarette consumption drop as well as the roughly 8% non-participating manufacturer (NPM) adjustment. The NPM adjustments are subject to a dispute between the states and the participating manufacturers. Most of these adjustments will not be available to service the securitization debt until the dispute is resolved, Moody's said.
The the 2010 MSA payment drop negatively affected the securitizations' Debt Service Coverage Ratios (DSCR). Although no deals that Moody's rates had to draw on the available cash reserve accounts to make the required interest and/or principal payments, DSCRs in many
transactions dipped substantially.
Moody's expects that the projected cigarette consumption declines will subject some deals to significant stress. Historically, cigarette consumption has seen annual drops of between 2% and 4%. The rating agency expects annual dips to continue in the upper end of the 3% to 4% range and beyond this, if any decline shock events happen. Declines result from increasing consumer awareness of the health risks from tobacco products, the restrictive regulations, and the wide availability of the smoking cessation products.
Any added taxation and the expected limitations on menthol cigarettes could also cause more one-time decline shocks (i.e., accelerated decline rates) to the annual cigarette shipment volumes.
Moody's is also placing 140 classes in 25 deals under review for possible upgrade. Most of these classes are serial bonds that are positioned very strongly, the rating agency said. Many of them mature in the near future, and will not be substantially affected by the future MSA payment drops.
In addition, many deal structures include liquidity and debt service reserve accounts in amounts enough to cover most, if not all, serial bond maturity payments, Moody's concluded.