Standard & Poor’s stated that cigarette consumption is the most significant factor in determining the credit strength of tobacco securitizations.
Moreover, as part of its updated methodology as of October 2011, the rating agency is now applying a higher rate of consumption decline for each additional year. The rating agency’s assumed rate of tobacco use decline increases at each rating level above ‘B.’
Analysts cited the Children’s Health Insurance Program Reauthorization Act, which increased the Federal excise taxes on tobacco products as a major influence for consumption decline in 2009.
As a result, tobacco payment securitizations, which were issued only a few years prior to the 2009 federal excise tax increase, are at a higher risk of nonpayment than securitizations that were issued many years before or after the tax increase.
S&P looked closely at that the tobacco securitizations issued closer to the implementation of the inconvenient federal excise tax in 2009 have lower ratings than those issued many years prior to or following. For instance, the deals issued before 2004 underwent a fewer number of downgrades versus those issued after and up to 2009.
The latest tobacco securitizations have assumed year-over-year consumption declines between 8% and 12%. Analysts noted that this range is greater than earlier deals, which is roughly a 4% annual decline, according to the offering memorandums.
The report said that S&P’s base-case 'B' rating scenario reflects its assumption that consumption declines will be between 3.25% and 3.75% for 2012 and 2013, while it will be roughly 3% after 2013.
In its analysis, S&P also considered the market share of participating manufacturers (PMs) versus nonparticipating manufacturers (NPMs), inflation, and NPM adjustment assumptions that include withholding amounts and the timing of recovery of withholdings.
In terms of the agency’s, base-case assumptions for these factors, analysts assumed that the PMs will dispute 15% of the total MSA payment and the recovery will occur ten years after with 75% received, inflation is modeled at 3%, and market share percentages remain roughly at their current state. Analysts said that the 3% inflation rate is the minimum inflation rate set in the MSA for payment calculation.
Notably, all classes that S&P rates 'B' or higher are assumed to have the ability to withstand these base-case assumptions. At each higher rating level, the rating agency assumes a higher rate of consumption decline. They explained that although they assume a 3% consumption decline to support a 'B' tranche, this assumption jumps to a 4.0% year-over-year decline rate for a 'BBB' rating.
After the October 2011 revisions, S&P ultimately lowered the ratings on 81 classes of notes from 20 tobacco securitizations as well as affirming the ratings on the remaining 173 classes, including 51 fully defeased classes, of notes from 37 tobacco securitizations.