Cigarette consumption in the U.S. is declining, according to industry statistics, which suggests a shortfall in available revenue to secure tobacco ABS deals. As Louisiana and Virginia prepare to issue their own tobacco settlement bonds, however, securitization professionals say there is still plenty of room for growth in the unique asset class.
Only about 19 out of 46 states that participated in the $200 billion Master Settlement Agreement from 1998 have securitized their share of payments, leaving more room for growth in the asset class, said industry observers. In the meantime, a couple of seasoned users of ABS are tapping the securitization market for more of their share of the settlement.
Earlier this month, the Louisiana State Bond Commission voted to securitize the remaining 40% of its share of the Master Settlement Agreement (MSA). The state's transaction, which will likely be called the Louisiana Tobacco Finance Corp., is slated to reap about $1 billion for the state and was approved over the objections of the state Treasurer and public health groups. Opponents of Louisiana's deal say that the commission is simply giving away about $2.1 billion that it would be entitled to over 25 years for the upfront payment. Health advocates also say that the deal would effectively shut down funding to programs dedicated to helping Louisiana residents to quit smoking, according to press reports.
Also, the Virginia Tobacco Settlement Financing Corp. sold more than $1 billion of securities backed by tobacco settlement payments earlier this month. The deal, on which Bear Stearns acted as lead underwriter, is the second one for Virginia, and will refinance outstanding bonds from the 2005 series, according to Moody's Investors Service. The deal essentially allows Virginia to securitize half of the amount of payments that the state will receive under the MSA.
In terms of the structure, the three-tranche transaction includes taxable current interest bonds that will mature in 2046, tax-exempt current interest bonds slated to mature in 2047 and a tax-exempt convertible bonds that will mature in 2046.
Moody's gave the Virginia deal a preliminary rating of Baa3', although the rating agency has the bonds under review because of uncertainty around the outcomes of a couple of ongoing antitrust lawsuits in connection with the MSA. The MSA attempted to restrict tobacco marketing activities, support public health initiatives and reimburse participating states and territories for public money spent on treating tobacco-related health issues. Two lawsuits, commonly known as Freedom Holdings versus Spitzer and Troy King versus Grand River, are essentially antitrust lawsuits that challenge smaller tobacco companies' obligations to pay into escrow accounts set up to help cover future damage awards in tobacco-related lawsuits. The cases are far from resolved, but their eventual outcomes could change cashflow to the bonds, the according to industry observers. Grand River, for instance, is a complex case. It is currently in a fact-finding phase that involves about 31 states, said one industry observer at a recent Bear Stearns conference.
"The (Virginia) bonds are under review with direction uncertain because of the risks associated with legal challenges to enforceability of the MSA," according to Moody's, referring to the Virginia deal.
As with all of its ratings of tobacco settlement securitizations, Moody's ratings also partially reflect a general trend of declining cigarette consumption in the U.S. due to litigation, tax increases or regulatory changes. Industry observers, as well as Moody's also considered smoke cessation programs and drugs might impact cigarette consumption over the long term.
Various estimates form industry observers estimate that cigarette consumption is slated to fall off by about 1.9% in 2007. A Texas cigarette tax increase, which went into effect last January and raise the cost of a pack of cigarettes by $1, caused cigarette consumption to drop by about 1.3 billion units, according to one industry observer at the conference.
Some litigation risk is moderating, Moody's acknowledged. Last year, the tobacco industry prevailed decisively in the Engle case, when the Florida Supreme Court decertified the case and reversed a state jury's award of $145 billion, calling it excessive. The decision made headlines for several reasons, including the fact that the Engle case was the first smokers' class action lawsuit in U.S. history to reach the trial phase. Among other statements in its decision, the court criticized the plaintiffs' lawyer for misconduct and said it inflamed the jury into awarding the $145 billion, according to press reports.
Also, in the Price case, the Illinois Supreme Court reversed a $10 billion judgement against Phillip Morris, saying the company was allowed by the Federal Trade Commission under the Consumer Fraud and Deceptive Business Practices Act to market certain cigarettes as "light" and "low tar."
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