MOODY'S ASSIGNS Aa1 RATINGS TO ALABAMA 21ST CENTURY AUTHORITY, SERIES 2000
$50.0 Million of Asset-Backed Securities Rated.
New York, September 21, 2000 -- Moody's Investors Service assigned ratings of Aa1 to the $50,000,000
Alabama 21st Century Authority Tobacco Settlement Revenue Bonds,
Series 2000. Michael Kanef, vice president in the Structured
Finance Group, said that the ratings are based on Moody's (a) projections
of domestic tobacco consumption over the life of the transaction,
(b) analysis of the material risks and (c) evaluation of the structural
and legal protections.
SOURCE OF PAYMENT
The Alabama 21st Century Authority transaction involves the pledging of
payments owed to the State of Alabama under the Master Settlement Agreement
(or the MSA), which settled litigation between states and territories
and the major US domestic tobacco manufacturers. Under the MSA,
the states agreed to suspend their litigation against the "Big Four" domestic
tobacco companies -- Philip Morris, BAT, RJR
and Loews -- in exchange for current and future payments
to be made to the states based primarily upon the amount of tobacco sold
in the US domestic market.
The negotiations originally involved the Big Four US tobacco companies.
Additional tobacco manufacturers can join in the settlement and thereby
limit their litigation exposure to the states. To date, manufacturers
with over 98% of the domestic market have signed onto the MSA.
Under the MSA, the manufacturers have agreed to make payments to
the states based on their market share. In each case, the
annual payment obligations are the individual obligations of the manufacturers
and therefore no manufacturer is liable for the payment obligations of
Debt service payments are based upon a state statute which makes an "irrevocable
and continuing" appropriation of the MSA payments deposited in the Alabama
21st Century Fund. MSA payments coming to the state and pledged
to the bonds are required by the statute to be deposited into the Fund
and used first for debt service before being available for transfer to
the state general fund for other designated purposes.
The most significant variable in the analysis of this transaction is the
projected domestic tobacco consumption over the 20-year term of
the transaction. Each annual payment due under the MSA is based
on the volume of tobacco sold in the domestic market. Moody's analyzed
the potential declines in consumption including those that could result
from litigation, tax increases and regulatory changes. Moody's
simulated several different scenarios that resulted in cumulative declines
averaging in excess of 85% over the life of the transaction.
Based on this modeling and the structure of the transaction, Moody's
believes that the bonds have a low risk of default consistent with the
Moody's also considered the extent to which the structure of the tobacco
industry and the MSA limit the likelihood that manufacturers who do not
participate in the MSA would be able to capture a significant share of
tobacco sales volume, reducing the payments to the states under
the MSA. There are two primary ways in which manufacturers might
not participate in the MSA: (a) the bankruptcy of a participating
manufacturer and (b) the entry into the market of new manufacturers that
do not join in the MSA.
Moody's long term unsecured ratings on the big four tobacco companies
(Phillip Morris Companies, Inc.: A2; R.J.
Reynolds Tobacco Holdings, Inc.: Baa2, backed
by a guarantee from R.J. Reynolds Tobacco Company;
British American Tobacco plc: A2; and Loews Corporation:
A1) reflect the bankruptcy risk facing each company for the next three
to five years. These ratings reflect concerns regarding potential
litigation risk and the likelihood that credit issues could result in
the bankruptcy of one or more of these companies. Because the big
four tobacco companies are the largest obligors under the MSA (manufacturing
over 90% of the tobacco consumed domestically) changes in the ratings
of these companies may have an impact on the ratings of bonds backed by
payments under the MSA.
On July 17, 2000, Moody's confirmed the ratings of the four
major tobacco companies following the recent verdict in the Engle case.
Moody's also confirmed the stable outlooks of these companies.
The confirmations and stable rating outlooks reflect the facts that (i)
based on the trial structure defined by the trial court judge, the
companies would not have to pay these damages before the end of a possibly
decades-long process of individual trials, (ii) the trial
court judge could reduce the awards before entering the verdict,
(iii) the probability of class-action decertification on appeal
of Engle is high, and (iv) the companies have significant protection
against the risk of an overwhelming bond requirement. However,
the unusual structure of Engle remains a source of significant uncertainty
in future proceedings of this case. Moody's will continue to closely
monitor developments in Engle, including whether a judgment is soon
entered and posting of a bond is required by the trial court judge.
Moody's will also monitor whether the well-publicized Engle decision
induces a shift in court sentiments in other cases that would be adverse
to the companies.
The bankruptcy of one or more of the participating manufacturers (PMs)
could result in the disruption of cash flows for a transaction backed
by MSA payments because of a bankruptcy stay pursuant to either a Chapter
7 or Chapter 11 bankruptcy filing. In the event of a bankruptcy
filing by one or more PMs, the bankruptcy court could stay (temporarily
suspend), all payment obligations of the bankrupt. Thus,
the ability of the bankrupt to make any payments pursuant to the MSA for
the duration of the stay could be limited. In order to protect
against this risk, the Alabama 21st Century Authority transaction
contains liquidity sufficient to meet the one-year of maximum annual
debt service for the bonds.
In the event of a Chapter 11 bankruptcy proceeding, Moody's believes
that the MSA will likely be considered an executory contract (an executory
contract is a contract pursuant to which both parties have unfulfilled
obligations). As an executory contract, a bankrupt PM must
either accept the MSA and pay amounts due or reject it and lose the benefits
provided by the MSA. If the MSA is rejected by a PM, payments
to bondholders could be reduced because the market share of the bankrupt
entity would no longer be included in the measure of tobacco sales used
to compute the payment obligations under the MSA and would reduce the
required payments by the remaining PMs.
The impact of the reduction in payments caused by a rejection of the MSA
by a bankrupt PM may be limited by the reduction in market share that
a PM would likely experience as it approaches bankruptcy. As a
PM approaches and seeks to avoid bankruptcy, it may attempt to raise
capital though the sale of one or more significant brands. It is
also likely that due to liquidity constraints, a stressed PM will
reduce advertising and promotional activities in support of its brands.
These actions are likely to result in a reduction in the market share
of the affected PM. Because the payment obligations of a PM under
the MSA are based upon each PM's market share, to the extent that
a manufacturer's market share declines as it approaches and enters bankruptcy,
any impact on the issued bonds will be decreased.
In connection with the MSA, Alabama has passed a Model Statute that
reduces the economic incentive for a tobacco manufacturer to sell products
without acceptance of the MSA. The Model Statute requires nonparticipating
manufacturers to make payments into an escrow account roughly equal to
the required payments under the MSA. These funds are held by the
state and will be used to make payments to potential plaintiffs in connection
with future suits against such nonparticipating manufacturers.
Although there are questions as to the constitutionality of the Model
Statute, at present it acts as an economic equalizer that reduces
the incentive for a nonparticipating manufacturer to reject the MSA in
bankruptcy. In addition, it is likely that in the context
of a Chapter 11 bankruptcy proceeding, the states will use all means
at their disposal to convince the bankrupt to accept the MSA.
Moody's analysis concluded that in order for the bankruptcy of a participating
manufacturer to affect this transaction a series of joint events must
occur: bankruptcy, retention of market share by the bankrupt,
Model Statute failure, and failure of the state to take action to
cause the bankrupt to affirm the MSA. In Moody's opinion,
the probability of these events happening is extremely low.
In addition to the bankruptcy of a manufacturer, volume can escape
from the MSA if a new manufacturer gains market share and chooses not
to become a participating manufacturer under the MSA. Moody's believes
that the MSA is a positive settlement for the tobacco industry which removed
the single largest litigation risk facing the industry at a reasonable
cost which was passed on to the consumer. In fact, well over
98% of the tobacco sold in the domestic market is produced by PMs.
It is likely that given the benefits of the MSA and its low cost,
most new market entrants will choose to become PMs. In addition,
the Model Statutes remove the economic advantage for a potential non-participating
manufacturer. Furthermore, even if the Model Statute is no
longer in place, new entrants will have significant incentive to
join the MSA and avoid potential state action against them.
The structure includes serial bonds with maturities from 2001 through
2013 and term bonds maturing in 2016 and 2020. Alabama retains
the power to issue additional senior debt with debt service of up to statutorily
specified amounts (maximum debt service of up to $16 million per
annum). Moody's ratings reflect the likelihood of default and severity
of loss commensurate with the total amount of statutorily permitted issuance.
Additional bonds may be issued with a Moody's rating confirmation.
Unlike each of the previously issued MSA payment backed bonds, this
transaction does not include either a flexible amortization schedule or
"super sinker" bonds. In addition, this transaction does
not include the structural benefits provided by triggers (which result
in the trapping of payments otherwise released to the holder of the residual
certificate upon the occurrence of certain events). Triggers present
in previously rated transactions (but not present in this transaction)
include those based on (a) declines in volume of domestic tobacco consumption
below a specified schedule; (b) successful challenges to the model
statutes; (c) the reduction in the rating, to below investment
grade, of an original participating manufacturer with significant
market share; and (d) a material increase in the level of nonparticipating
manufacturer market share.
COMPARISON TO PRIOR TRANSACTIONS
The coverage in the Alabama 21st Century Authority transaction is higher
than the coverage in any of the previously rated MSA payment backed bonds
based upon Moody's projected volume declines. The Alabama 21st
Century Authority transaction is therefore less susceptible to decreases
in the level of tobacco consumption in the domestic United States over
the life of the transaction. This increased coverage compensates
investors for the absence of the flexible amortization schedule and the
trapping events included in the previously issued MSA payment backed bonds.
Based on the statistical modeling, the structural integrity of the
transaction, and the credit analysis of the tobacco manufacturers
and the US tobacco industry, Moody's believes that this transaction
has an expected loss consistent with the anticipated ratings of Aa1.
The complete rating action is described below:
Issuer: Alabama 21st Century Authority, a public corporation
and instrumentality of the State of Alabama.
$26,150,000 Fixed Rate Serial Bonds; Rated Maturities
of 2001 to 2013: Aa1
$9,050,000 Fixed Sinking Fund Term Bonds; Rated
Maturity Date of December 1, 2016: Aa1
$14,800,000 Fixed Sinking Fund Term Bonds; Rated
Maturity Date of December 1, 2020: Aa1
Structured Finance Group
Moody's Investors Service
JOURNALISTS: (212) 553-0376
SUBSCRIBERS: (212) 553-1653
Vice President - Senior Analyst
Structured Finance Group
Moody's Investors Service
JOURNALISTS: (212) 553-0376
SUBSCRIBERS: (212) 553-1653