Underwriters and issuers planning the next wave of tobacco issuance want to simplify the deals' structures to attract more investors and achieve better yields.
Officials at Bear, Stearns & Co., which will serve as senior manager to two of the upcoming offerings, said they believe eliminating the "flexible amortization" structure that created separate "planned" and "rated" maturities in the first deals will make the new transactions more understandable to municipal investors.
While the first three deals last fall, by New York City, Nassau County, and Westchester County were all successfully placed with investors, the yields they carried were above those on comparable maturities of other, similarly-rated municipals.
Now, as Monroe County, N.Y. prepares to sell a $160 million issue this week with First Albany Corp., N.Y. as senior manager, and Bear Stearns works on structuring and marketing deals for Erie County, N.Y. and the Alaska Housing Finance Corp., expected to price in September, many market participants are watching closely to see if new structures can shrink those spreads.
The Bear Stearns bankers say that a simpler structure and the market's increasing familiarity with the underlying credit can lead to better rates this time around.
In the most notable departure from the earlier deals, the Bear Stearns bankers say they do not expect to draw a distinction between planned maturities and rated maturities.
Under the rated maturity-planned maturity structure used in the earlier deals, bonds were marketed based on the year in which the issuer expected to have the money available to repay them. However, they also carried longer, rated maturities, which represented when the bonds would be repaid if settlement payments fell below expectations, or go into default if the payments were not made.
Although such flexible amortization cushions are common in the ABS market, they were a new concept for the municipal market. And while the structure for the earlier deals resulted in relatively high ratings, several market participants said they believed any gain the issuers received from the higher ratings was outweighed by the penalty they suffered from lack of investor confidence.
Nonetheless, not everyone is abandoning the structure altogether. Edward Flynn, senior vice president at First Albany working on the Monroe County issue, said that deal would include both fixed- and flexible-amortization components.
And while the planned-rated maturities structure may be discarded, other signature facets of the tobacco bond structures that were drawn from the asset-backed market are likely to be retained, although Kym Arnone, senior managing director at Bears Stearns, said it was too soon to say exactly how.
For instance, the legal covenants on the first deals all included "trapping events," in which the issuers agreed to fund additional reserve funds if there are suggestions that the settlement payments will fall below expectations. Arnone said her firm and issuer officials are reviewing all of the covenants from the first deals to see if they can be "refined," although she said most will be retained.
Acceptance Questions Remain
Despite the deal sponsors' confidence in their ability to improve on the initial tobacco deals, it remains to be seen whether investors' other concerns can be answered. One of these is the disclosure last spring that the Internal Revenue Service has begun auditing all three of the outstanding tobacco ABS deals.
The underwriters said they do not believe the audits will be an issue, since the initial underwriters and their bond teams have passed along indications from IRS agents that the audits are merely for the agency to learn about the new structure.
They also point to the strong legal opinions regarding the deals' tax-exempt status, and the fact that the bond proceeds will be devoted to recognized public purposes.
Finally, the issuers marketing the new deals will have to respond to the intense media attention stemming from the massive punitive damage award in the Engle case in Florida.
Arnone said she is confident that most investors will agree with legal analysts who predict that the award will be overturned on appeal, and that the underwriters' efforts to publicize a spate of recent legal wins by the tobacco industry in other liability cases will overcome any lingering concerns.
Overall, the Bear Stearns bankers said the performance of the new issues will owe a debt to the pioneering work the industry accomplished on the initial round of issues.
"This is an evolutionary process, and at this point, everybody is further up the learning curve," said Daniel Keating, a senior managing director at Bear Stearns.