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S&P places tobacco revenue ABS bonds under downgrade review

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What’s good for smokers’ lungs is causing more stress for investors in legacy tobacco settlement revenue bonds.

S&P Global Ratings announced it has placed a ratings downgrade watch on 240 classes of outstanding revenue bond securitizations, following the release of a report from the National Association of Attorneys General (NAAG) indicating an accelerating decline in domestic cigarette sales volume.

The bonds under review are worth billions of dollars in notional value, and are spread out from among 24 state tobacco settlement authorities, according to an S&P report. Some of the bonds include those which already carry extremely risky triple-C ratings that have them within a few notches of default status.

The bonds are secured by cigarette industry payments that 46 states as well as Washington, D.C., and five U.S. territories receive annually via a landmark 1998 master settlement agreement (MSA) that tobacco companies reached with attorneys general nationwide. The payments are as compensation for local government expenses stemming from health problems related to tobacco use.

The ABS bonds under review include both pre-crisis issues and post-crisis refinancings and new offerings of tobacco revenue-backed notes.

The downgrade watch was enacted on Friday following a May 3 report from the NAAG showing an accelerated 4.75% decline in domestic cigarette shipping volume (approximately 236 billion cigarettes) in 2018 – which S&P had anticipated in a cigarette industry report published in April.

A decline in shipping volume reduces the amounts that cigarette companies must pay to states to meet their MSA requirements. Payments of $132 billion to date have ranged annually from $3.9 billion in 1999 to a peak of $7.6 billion in 2013. For 2018, cigarette manufacturers paid up $6.9 billion, according to NAAG statistics.

“It is uncertain if declines in shipping volumes will be a permanent trend,” S&P’s report stated. “We will analyze the impact of this stress on all of our outstanding rated tobacco settlement revenue transactions as a way of capturing the effect on cash flow results if shipment volumes continue to decline at an accelerated rate in the future.”

The 240 classes placed on negative credit watch include bonds issued by tobacco settlement authorities in Ohio, New York, California, Illinois, Iowa, Louisiana, Michigan, South Dakota, Washington, West Virginia and the District of Columbia. The maturities range from 2019 to 2052.

Among the bonds under watch are all eight classes from the approximate $5.5 billion in Series 2007 A-2 and A-3 notes issued by the Buckeye Tobacco Settlement Financing Authority in Ohio. The S&P ‘B-‘ ratings for all the Buckeye bonds had recently been affirmed in January following a stressed cash-flow performance review by the agency.

Moody's Investors Service has four of the Buckeye A-2 bonds series rated Caa3 from an October 2018 downgrade from Caa1, with three others confirmed last year at B3. The Class A-3 notes are rated Caa1 by Moody's.

Other securitization bonds already with CCC or CCC+ ratings include those issued by the California County Tobacco Securitization Agency, Golden State Tobacco Securitization Corp., Michigan Tobacco Settlement Finance Authority, Northern California Tobacco Securitization Authority, San Diego County Tobacco Asset Securitization Corp., and the Tobacco Settlement Financing Corp. in Louisiana and the Tobacco Settlement Finance Authority in West Virginia.

Most of those deals were among 87 note classes previously downgraded by S&P in 2012 after it had revised its stress-case and cash-flow modeling for tobacco revenue bond securitizations.

The triple-C ratings are three to four notches above a default ‘D’ rating on either agency's ratings scale.

The downgrade watch on the 240 note classes are in addition to the review S&P placed on 32 other tobacco revenue bonds from New York and California earlier this year. That review announcement followed a Dec. 20, 2018, corporate downgrade of tobacco giant Altria by both S&P and Fitch Ratings. Both agencies had downgraded Altria two notches after the conglomerate purchased a minority $12.8 billion stake in vapor products firm Juul Labs that boosted its leverage to three times earnings.

The decline in cigarette volume is only one factor in S&P’s latest downgrade review. The growth in electronic cigarettes, state proposals to raise the minimum purchase age of cigarettes, as well as an expected ban on menthol cigarettes (within five years, S&P says), “would probably lead to [more] incremental volume declines” in future years, the agency reported.

Prices for combustible cigarettes also continue to climb because of higher taxes and manufacturer price hikes, S&P added.

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