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Rating Action:

MOODY'S ASSIGNS RATINGS OF A1 TO MONROE TOBACCO ASSET SECURITIZATION CORPORATION, TOBACCO SETTLEMENT ASSET-BACKED BONDS, SERIES 2000

17 Aug 2000
MOODY'S ASSIGNS RATINGS OF A1 TO MONROE TOBACCO ASSET SECURITIZATION CORPORATION, TOBACCO SETTLEMENT ASSET-BACKED BONDS, SERIES 2000

Approximately $163.4 Million of Debt Securities Rated.

New York, August 17, 2000 -- Moody's Investors Service assigned ratings of A1 to the Monroe Tobacco Asset Securitization Corporation ("MTASC") Tobacco Settlement Asset-Backed 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 to the transaction and (c) evaluation of the structural and legal protections in the transaction.

SOURCE OF PAYMENT

The Monroe Tobacco Asset Securitization transaction involves the securitization of a portion of the payments owed to New York State 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 -- and the domestic tobacco companies agreed to make current and future payments to the states based primarily upon the amount of tobacco sold in the US domestic market. Although amounts owed under the MSA are payable to the settling states, pursuant to a final consent decree, New York State has agreed to provide each of its counties with a specified share of the MSA payments. This transaction is backed by those amounts allocated to Monroe County and is the fourth transaction backed by payments allocable to New York State.

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 another manufacturer.

VOLUME PROJECTIONS

The most significant variable in the analysis of this transaction is the projected domestic tobacco consumption over the 40-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 potential litigation, tax increases and potential regulatory changes. Moody's used a Monte Carlo analysis to simulate several different scenarios that resulted in cumulative declines averaging over 80% 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 assigned ratings.

NONPARTICIPATING MANUFACTURERS

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.

Bankruptcy Risk

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 MTASC 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 may 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 offset and reduce the payment requirements of 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, New York State 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. The probability of these events happening is extremely low.

New Entrants

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 participating manufacturers. It is likely that given the benefits of the MSA and its low cost, most new market entrants will choose to become participating manufacturers. 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.

STRUCTURE

Although the structure includes both fixed and flexible amortization bonds, Moody's ratings are based upon the required amortization schedule for each bond. The dual amortization schedule utilized for the flexible term bonds is beneficial to investors only to the extent that there are cash flows available to the bonds in amounts above those required to meet the rated amortization schedule. These excess amounts, which would otherwise be paid to the holder of the residual certificate, are instead used to retire bond principal up to the flexible amortization schedule. The application of these funds, if available, will accelerate the repayment of outstanding principal and decrease the risk of default on the bonds.

Moody's also considered the additional benefit of structural triggers (which result in the trapping of payments otherwise released to the holder of the residual certificate upon the occurrence of certain events) in assigning the ratings to the bonds. The triggers are 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; (d) a material increase in the level of nonparticipating manufacturer market share; and (e) the receipt of a lump sum payment.

COMPARISON TO PRIOR TRANSACTIONS

The coverage in the MTASC transaction is lower than the coverage in the NYC TSASC transaction (previously issued and rated by Moody's) based upon projected volume declines. The MTASC transaction is therefore more susceptible to decreases in the level of tobacco consumption in the domestic United States over the life of the transaction. In addition, there is a correspondingly lower level of residual cash flow that limits the value of the transaction's triggers.

However, several structural enhancements resulted in better anticipated performance for the MTASC transaction as compared to that of the Nassau CTSC transaction (previously issued and rated by Moody's). Structural enhancements include (i) the pro-rata allocation of available cash upon an event of default; (ii) the application of flexible amortization payments to retire higher interest rate debt; and (iii) slightly better coverage under Moody's stressed consumption declines.

Based on the statistical modeling, the structural integrity of the transaction including the benefits discussed above, and the qualitative analysis of the tobacco manufacturers and the US tobacco industry, Moody's believes that this transaction has an expected loss consistent with the assigned ratings of A1.

The complete rating action is described below:

Issuer: MTASC, a local development corporation organized under the Not-For-Profit Corporation Law of the State of New York.

$11,430,000 Fixed Rate Serial Bonds; Rated Maturities of 2002 to 2015: A1

$11,165,000 6.375% Fixed Sinking Fund Term Bond; Rated Maturity Date of June 1, 2019: A1

$28,935,000 6.150% Flexible Sinking Fund Term Bonds; Rated Maturity Date of June 1, 2025: A1

$64,630,0006.375% Flexible Sinking Fund Term Bonds; Rated Maturity Date of June 1, 2025: A1

$47,240,0006.625% Flexible Sinking Fund Term Bonds; Rated Maturity Date of June 1, 2025: A1

New York
Maureen Coen
Managing Director
Structured Finance Group
Moody's Investors Service
JOURNALISTS: (212) 553-0376
SUBSCRIBERS: (212) 553-1653

New York
Michael Kanef
Vice President - Senior Analyst
Structured Finance Group
Moody's Investors Service
JOURNALISTS: (212) 553-0376
SUBSCRIBERS: (212) 553-1653

No Related Data.
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