MOODY'S ASSIGNS RATINGS OF Aa3, A1, AND Baa2 TO ERIE TOBACCO ASSET SECURITIZATION CORPORATION, TOBACCO SETTLEMENT ASSET-BACKED BONDS, SERIES 2000A AND SERIES 2000B
Approximately $246.3 Million of Debt Securities Rated
New York, October 06, 2000 -- Moody's Investors Service assigned ratings of Aa3 to the $20,090,000
Erie Tobacco Asset Securitization Corporation, Serial Maturities
Tobacco Settlement Asset-Backed Bonds, Series 2000A ;
A1 to the $176,895,000 Erie Tobacco Asset Securitization
Corporation, Senior Term Tobacco Settlement Asset-Backed
Bonds, Series 2000A; and ratings of Baa2 to the $49,340,000
Erie Tobacco Asset Securitization Corporation, Tobacco Settlement
Asset-Backed Bonds, Series 2000B. 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 Erie Tobacco Asset Securitization Corporation (ETASC) transaction
involves the pledging of 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 -- 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. 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 MSA payments. This transaction
is backed by those amounts allocated to Erie County and is the fifth transaction
backed by payments allocable to New York State rated by Moody's.
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
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
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
(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 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 ETASC 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, 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.
In a recent court decision, the first court to consider a challenge
to the Model Statutes found the California Model Statute to be constitutional
and enforceable. In addition, in connection with this transaction
Moody's has received reasoned legal opinions that the New York Model Statute
is constitutional and enforceable.
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 2005 through
2015 and term bonds maturing in 2020, 2024, 2030, 2032,
and 2040. In addition, this issuance includes two series
of bonds with different priorities of payment: the Series 2000A
and Series 2000B bonds.
Although the structure includes both fixed bonds and term bonds subject
to super-sinker redemption, Moody's ratings are based upon
the required amortization schedule for each bond. The super-sinker
redemption schedule utilized for the 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 principal installment 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 super-sinker redemption 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. Triggers include those based
on (a) declines in volume of domestic tobacco consumption below a specified
schedule; (b) the reduction in the rating, to below investment
grade, of an original participating manufacturer with significant
market share; and (c) a material increase in the level of nonparticipating
manufacturer market share.
The Model Statute trapping event, which resulted in the capture
of residual if the Model Statute was declared unenforceable, is
not included in this transaction. The risk that the New York Model
Statute is declared unenforceable is mitigated by the opinions of counsel
with respect to the constitutionality of the New York Model Statute and
the overall strength of the transaction.
COMPARISON TO PRIOR TRANSACTIONS
The coverage for the ETASC 2000A senior bonds is somewhat higher than
that of the previously issued Monroe County and Nassau County transactions
based upon Moody's projected volume declines. The performance of
the ETASC 2000B junior bonds in Moody's statistical models is commensurate
with the expected ratings.
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 Serial Maturities
and Senior Term Bonds of Series 2000A bonds and the Series 2000B bonds
have expected losses consistent with the assigned ratings of Aa3,
A1 and Baa2 respectively.
The complete rating action is described below:
Issuer: Erie Tobacco Asset Securitization Corporation
$20,090,000 Series 2000A Senior Serial Bonds;
Rated Maturities of 2005 to 2015: Aa3
$17,380,000 Series 2000A Senior Term Bonds; Rated
Maturity Date of July 15, 2020: A1
$16,825,000Series 2000A Senior Term Bonds; Rated
Maturity Date of July 15, 2024: A1
$36,060,000 Series 2000A Senior Term Bonds; Rated
Maturity Date of July 15, 2030: A1
$17,500,000Series 2000A Senior Term Bonds; Rated
Maturity Date of July 15, 2032: A1
$89,130,000 Series 2000A Senior Term Bonds; Rated
Maturity Date of July 15, 2040: A1
$49,340,000 Series 2000B Subordinated Term Bonds;
Rated Maturity Date of July 15, 2040: Baa2
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