Last week New York City tossed the first batch of tobacco-backed bonds into the asset-backed securities market, receiving a warm reception from investors who will be seeing several tobacco-backed deals coming down the pike.

"We had a real strong deal," said Allen Anders, director of public finance for the city. "We had $600 million in bonds to offer today, and we had $1 billion of priority orders from institutions. So we were oversubscribed on all our securities."

Of the $710 million in bonds the city had to sell, $110 million were pre-sold, and not offered in the market when the $600 million priced.

Yields ranged from 402 basis points to 644 basis points on the 40-year bond, which should mature by 2029.

According to Anders, these bonds are the first of a four-part issuance program, with a combined volume of $2.8 billion in bond sales. Proceeds will go to the Capital Program for the City of New York. "We've created this because we've had a temporary debt limit problem," Anders said.

Nearby Nassau County, is expected to launch a $300 million to $350 million deal sometime this week, pending their review of New York City bonds, said Herman Charbonneau of Roosevelt & Cross Inc., the firm advising the county.

"There's about an 80% chance it goes [this] week," said Charbonneau. "There have been some changes made, with regard to things like trapping events, and those changes have been made to make the ratings agencies happy."

Trapping Events

In accordance with demands by the ratings agencies, the tobacco bonds, from both New York City and Nassau County, have been tacked with triggers that can trap cash found in residual certificates, which would normally flow back to the issuer.

The cash moves down a typical waterfall structure, said Michael Kanef of Moody's Investors Service, where there is a priority of payment. The fees and expenses of the deal are covered first, followed by interest and principal and so on.

"Assume for a moment you have enough to pay all those things, there's extra amount at the bottom that is paid to the owner of the residual certificate, which in this case is the city," said Kanef.

There are a few events that allow money to be removed from the residual certificates.

For example, a significant decrease in overall market participation by any of the tobacco companies involved in the master settlement agreement would cause a trapping period. This could result from the bankruptcy of an MSA tobacco company, or the entrance of a new company into the market, significant enough to draw market share from the MSA tobacco companies.

"In the event that one of the Big Four tobacco company's ratings fall below the investment grade, you would begin to capture residuals as well," said Kanef.

Kanef feels that the likelihood of these events is slim, and would require a "a series of linked improbabilities."

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