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Rating Action:

MOODY'S ASSIGNS RATINGS OF A1 TO ULSTER TOBACCO ASSET SECURITIZATION CORPORATION, TOBACCO SETTLEMENT ASSET-BACKED BONDS, SERIES 2001

08 Feb 2001
MOODY'S ASSIGNS RATINGS OF A1 TO ULSTER TOBACCO ASSET SECURITIZATION CORPORATION, TOBACCO SETTLEMENT ASSET-BACKED BONDS, SERIES 2001

Approximately $28.4 Million of Debt Securities Rated.

New York, February 08, 2001 -- Moody's Investors Service assigned ratings of A1 to the $28,352,454.30 Ulster Tobacco Asset Securitization Corporation, Tobacco Settlement Asset-Backed Bonds, Series 2001. Nicolas Weill, 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 Ulster Tobacco Asset Securitization Corporation (UTASC) transaction involves the pledging of payments owed to the State of New York pursuant to the Master Settlement Agreement (or the MSA), and assigned to Ulster County pursuant to the New York Consent Decree. Under the MSA, which settled litigation between states and territories and the major US domestic tobacco manufacturers, 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 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 litigation, tax increases and regulatory changes. Moody's simulated several different scenarios that resulted in cumulative declines averaging in excess of 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. Each of these risks is addressed below.

Bankruptcy Risk of a Participating Manufacturer

Moody's long term unsecured ratings on the big four tobacco companies (Philip 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 about 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 despite the verdict in the Engle case. Moody's also confirmed the stable outlooks of these companies. Moody's will continue to closely monitor developments in the Engle case. In addition, 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 UTASC transaction contains liquidity in the amount of 125% of average 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 (which is defined as a contract in 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, the State of New York 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.

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 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.

STRUCTURE

The structure includes two types of bonds: current interest bonds with final rated maturities of June 2030 and June 2040 and convertible capital appreciation bonds with final rated maturities of June 2025 and June 2040.

Current interest bonds will pay interest on June 1 and December 1 of each year, commencing on June 1, 2001. Convertible Capital Appreciation Bonds will accrete interest up to June 2004 for the bonds maturing in 2025, and up to June 2010, for the bonds maturing in 2040. The Convertible Capital Appreciation Bonds will start paying current interest starting on December 1 of that year. Thereafter, interest will be paid on June 1 and December 1of each year.

No principal payments will be made until 2011. Thereafter planned principal payments will be made to the various bonds, sequentially, in order of their rated maturity dates and by lot among bonds with the same maturity dates. Rated principal payments will become due starting 2014.

This transaction includes the structural benefits provided by trigger events which result in the trapping of payments otherwise released to the holder of the residual certificate upon the occurrence of certain events. Although In Moody's opinion the absence of principal payment up to 2011 is an increased risk to the transaction, it is appropriately covered by the overcollateralization available in the transaction and the amount of cash flow available to trap additional cash, should a trigger event occur.

COMPARISON TO PRIOR TRANSACTIONS

The average coverage for the UTASC 2001 bonds is higher than that of previously A1 rated transactions. However, the higher coverage available in the first 10 years does not benefit the bondholders as much as in other transactions since the delayed amortization in the structure makes bonds issued by UTASC more susceptible to decreases in the level of tobacco consumption over the life of the transaction. It is only in the latter years that the transaction will have the real benefit of a higher coverage ratio.

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 the Series 2001 bonds have expected losses consistent with the anticipated ratings of A1.

The complete anticipated rating action is described below:

Issuer: Ulster Tobacco Asset Securitzation Corporation

$11,765,000 Term Current Interest Bonds; Rated Maturities of June 1, 2030: A1

$10,190,000 Term Current Interest Bonds; Rated Maturities of June 1, 2040: A1

$3,759,455 Term Convertible Capital Appreciation Bonds; Rated Maturity Date of June 1, 2025: A1

$2,637,999.30 Term Convertible Capital Appreciation Bonds; Rated Maturity Date of June 1, 2040: A1

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

New York
Nicolas S. Weill
VP - Senior Credit Officer
Structured Finance Group
Moody's Investors Service
JOURNALISTS: (212) 553-0376
SUBSCRIBERS: (212) 553-1653

No Related Data.
© 2019 Moody’s Corporation, Moody’s Investors Service, Inc., Moody’s Analytics, Inc. and/or their licensors and affiliates (collectively, “MOODY’S”). All rights reserved.

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