Moody's assigns A2 rating to JobsOhio Beverage System's $1.5 billion of Statewide Senior Lien Liquor Profits Revenue Bonds, Series 2013A and Series 2013B

Developing outlook is linked to pending litigation

JOBS OHIO BEVERAGE SYSTEM, OH
State Governments (including Puerto Rico and US Territories)
OH

Moody's Outlook  
 

NEW YORK, January 07, 2013 --Moody's Investors Service has assigned an initial rating of A2, with a developing outlook, to the JobsOhio Beverage System's planned issuance of $1.5 billion of Statewide Senior Lien Liquor Profits Revenue Bonds, Series 2013A and Series 2013B. The bonds are secured by a first-lien pledge of net profits from the state's Liquor Enterprise. Proceeds will defease prior debt secured by the same revenue stream, while also providing a $500 million infusion for state general operating expenses and approximately $225 million for economic development programs and working capital. Interest payments on the Series 2013A bonds will not be subject to federal income taxes, and the Series 2013B bonds will be subject to federal income taxes.

SUMMARY RATING RATIONALE

The rating is based on a revenue stream that is narrow, consisting of net profits from liquor sales, yet that is also derived from a statewide base. The consumer spending behind these pledged revenues is discretionary, but a history of steady growth through recessions indicates only limited economic risk. Revenues, pledged on a net basis, are vulnerable to state Liquor Enterprise expense growth. Expected maximum annual debt service (MADS) coverage, as well as a test mandating two times MADS coverage for additional bonds and a requirement for monthly set-asides of pledged revenue, should afford a sufficient buffer against potential revenue underperformance. The rating also factors in a pending threat from unresolved litigation against the creation of the entity that will issue the debt, a 501(c)(3) called the JobsOhio Beverage System. The developing outlook indicates that near-term developments in that litigation may affect the credit rating.

STRENGTHS

--Leverage constraint requiring two times MADS coverage

--Requirement that revenues be set aside monthly in advance of principal and interest payment dates

--History of persistent growth in pledged Liquor Enterprise net profits

CHALLENGES

--Narrow nature of pledged revenue stream

--Pledged revenues' vulnerability to Liquor Enterprise expenditure growth, and to increases in state tax deducted from gross revenues

--Lack of debt-service reserve fund

DETAILED CREDIT DISCUSSION

FINANCING WILL TRANSFER STATE LIQUOR ENTERPRISE TO NON-PROFIT CORPORATION

The current transaction lets the state defease the $642 million of outstanding senior- and junior-lien long-term debt and almost $200 million of bond anticipation notes backed by Liquor Enterprise net profits. Those bonds are secured by net profits of the Ohio State Liquor Enterprise and are rated Aa2 for the senior lien (known as Chapter 166) and Aa3 for the junior lien (Chapter 151), respectively. The BANs are rated MIG 1. JobsOhio Beverage System, the non-profit corporation, will use the proceeds of the current offering to obtain the franchise on the state's liquor enterprise, pursuant to a franchise and transfer agreement. It will pledge profits of that enterprise to bondholders in a fashion similar to the pledge that currently exists for the Chapter 166 and Chapter 151 credits. The consideration that JobsOhio Beverage System will pay to obtain an exclusive, 25-year franchise on the liquor enterprise will include the approximately $500 million transferred to the state for general operating purposes and funds used for the defeasance of prior debt. JobsOhio also anticipates retaining approximately $225 million of bond proceeds to use as working capital and for certain economic development programs to be overseen by its affiliate, JobsOhio, a 501(c)(4) created in July 2011 by Governor John Kasich. The liquor enterprise will operate the same way as before; under an operations services agreement, the state Commerce Department's Division of Liquor Control will retain its management role. The enterprise has been run by the state since 1934, the year after the repeal of Prohibition. JobsOhio Beverage System covenants that it will not modify the liquor enterprise such that it would be unable to meet obligations to bondholders.

BONDHOLDER PROTECTIONS INCLUDE ADDITIONAL BONDS TEST, MONTHLY SET-ASIDE REQUIREMENT

Under the bonds' master trust indenture, bondholders benefit from a first-lien pledge of net liquor profits. Additional parity debt can be issued, but only if pledged revenues cover the resulting projected MADS by at least 2.0 times. This additional bonds test must be satisfied using actual revenues in 12 consecutive months of the 18 months prior to any new borrowing. Debt service coverage is supported by a rate covenant intended to ensure that the liquor enterprise is managed so that its revenues will remain sufficient. If annual coverage falls below 1.35 times debt service, the enterprise must retain a consultant to determine the price increases or other actions needed to maintain coverage. Another safeguard is a requirement for monthly set-asides of pledged revenues in trustee-held accounts. Each month, one-fifth of the next semiannual interest payment and one 10th of the next annual principal payment must be provided. This requirement mitigates the potential weakness resulting from the lack of a debt-service reserve. JobsOhio Beverage System under the indenture covenants not to file for bankruptcy protection or to institute any other reorganization or liquidation proceedings.

REVENUES HAVE CONSISTENTLY INCREASED IN RECENT YEARS

Pledged revenue growth trends have been solid, with a 10-year compound annual growth rate of 6.2%. The weakest annual increase was 2% in fiscal 2010, in the midst of a severe US recession. That growth persisted even then indicates the liquor enterprise's resistance to economic downturns. At the same time, the rating assigned takes into account the fact that the revenues are derived from a comparatively narrow portion of the state's total economic base, one that relies on consumers' continuing desire and ability to spend on alcoholic beverages. The pledged revenues are also vulnerable to factors such as increasing liquor enterprise operating costs. Another potential risk is the legislature's ability to change a per-gallon tax that comes off the top of liquor enterprise revenues.

LITIGATION OPPOSING CREATION OF JOBSOHIO REMAINS UNRESOLVED

We further believe that legal challenges to the structure supporting the bonds will not disrupt or alter the arrangement, given rulings by courts at various levels on the objections raised by plaintiffs. But JobsOhio opponents have filed lawsuits asserting that the non-profit entity's creation ran afoul of certain state constitution provisions. The litigation pending before the state's Supreme Court now consists of an appeal by ProgressOhio, which opposes JobsOhio. ProgressOhio's appeal relates to an appellate-court ruling that dismissed the ProgressOhio suit for lack of standing. To date, the state Supreme Court has not indicated whether it will hear this appeal. The state's Attorney General will issue a no-merit opinion stating that these plaintiffs lack standing. While we acknowledge the Attorney General's opinion as well as a history of rulings dismissing the suit for lack of standing or lack of jurisdiction, we note that the substance of the plaintiffs' assertions has not yet been resolved. Moreover, the issuer has not made any significant contingency plans that would protect bondholders from adverse rulings. Given that we view the new JobsOhio Beverage System credit as comparable the state's existing Chapter 166 and 151 bonds, resolution of the pending litigation would, all other factors remaining equal, lead to a higher rating.

OUTLOOK

The developing outlook assigned to this credit indicates that we expect the rating to be influenced near-term by developments in the pending appeal of the lower court rulings that the plaintiffs lack standing. A conclusive ruling by the state Supreme Court that ends any currently pending litigation could be expected to have a positive effect on the rating.

WHAT COULD MOVE THE RATING UP

--Resolution of pending litigation against JobsOhio

--Provision of contingency measures that shield bondholders from impact of litigation

WHAT COULD MOVE THE RATING DOWN

--Advances in legal challenges to JobsOhio, such as through a Supreme Court action that allows case to proceed

--Deterioration of net liquor profits revenues pledged to bondholders

The principal methodology used in this rating was US Public Finance Special Tax Methodology published in March 2012. Please see the Credit Policy page on www.moodys.com for a copy of this methodology.

REGULATORY DISCLOSURES

For ratings issued on a program, series or category/class of debt, this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the rating action on the support provider and in relation to each particular rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

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Edward Hampton
Lead Analyst
Public Finance Group
Moody's Investors Service

Baye Larsen
Backup Analyst
Public Finance Group
Moody's Investors Service

Emily Raimes
Additional Contact
Public Finance Group
Moody's Investors Service

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