MOODY'S ASSIGNS RATINGS OF Aa3 TO NORTHERN TOBACCO SECURITIZATION CORPORATION, TOBACCO SETTLEMENT ASSET-BACKED BONDS, SERIES 2001
Approximately $126.8 Million of Debt Securities Rated
New York, August 15, 2001 -- Moody's Investors Service assigned ratings of Aa3 to the $126,790,000
Northern Tobacco 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 Northern Tobacco Securitization Corporation transaction involves the
pledging of 40% of the payments owed to the state of Alaska pursuant
to the Master Settlement Agreement (or the MSA). In a previous
transaction the State of Alaska had already securitized a separate 40%
of its tobacco settlement receivables through an Aa3 rated transaction.
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
The most significant variable in the analysis of this transaction is the
projected domestic tobacco consumption over the 28-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 75% 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
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.
The biggest potential threat to the tobacco companies is the Engle class-action
lawsuit initiated by a group of Florida smokers seeking damages from the
tobacco manufacturers for smoking- related health problems.
On July 17, 2000, Moody's confirmed the ratings of the four
major tobacco companies despite a jury verdict of a $145 billion
punitive damage award to the entire class of possible plaintiffs.
On May 10, 2001, Moody's also confirmed the ratings and stable
outlooks of the companies, following the announcement by Philip
Morris and Lorillard, US tobacco subsidiary of Loews, of a
court-ratified agreement between them and plaintiffs' attorney
regarding bonding in the case. For these two companies only,
plaintiffs' attorney has agreed not to challenge the constitutionality
of a law passed by the Florida legislature capping bonds at $100
million. 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 companies that have not entered into an agreement with plaintiffs'
attorney on bonding should be protected by caps on bonds in North Carolina
and Kentucky - where substantially all of their assets are --
if the Florida bond cap was successfully challenged, and (iii) the
probability of class-action decertification on appeal of Engle
is high in view of federal and state jurisprudence. 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. 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, this transaction contains liquidity equal initially
to the maximum annual debt service.
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 Alaska 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
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. Every
court, which has rendered a decision concerning challenges to the
Model Statute, has found it to be 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 fixed rated maturities of June
2003 and June 2008 through June 2011 and super sinker term bonds with
rated maturities of June 2015, 2021, and 2029. Moody's
rating addresses timely payments of interest as well as payment of principal
by the final maturity date. The ratings do not address the timely
payments of principal before the final maturity. However Moody's
assesses the amount of tobacco revenues that will be paid over the course
of the years and that will be used to retire principal up to the final
This transaction benefits from a turbo structure that uses all available
cash to retire bond principal in order of maturity. The application
of these funds, if available, will accelerate the repayment
of outstanding principal and decrease the risk of default on the bonds.
In an event of default, payment on the bonds switches from sequential
pay to pro-rata pay based on outstanding bond principal amounts.
Since there is no cash being paid to the residual holder, this transaction
does not require the structural feature 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).
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 Tobacco Settlement
Asset-Backed Bonds, Series 2001 have expected losses consistent
with the assigned ratings of Aa3.
The complete anticipated rating action is described below:
Issuer: Northern Tobacco Securitization Corporation
$8,955,000 Series 2001 Serial Bonds;Rated Maturities
of June 2003; June 2008 to June 2011: Aa3
$33,595,000 Series 2001 Supersinker Term Bonds;
Maturity Date of June 2015: Aa3
$30,035,000 Series 2001 Supersinker Term Bonds;
Maturity Date of June 2021: Aa3
$54,205,000 Series 2001 Supersinker Term Bonds;
Maturity Date of June 2029: Aa3
Structured Finance Group
Moody's Investors Service
JOURNALISTS: (212) 553-0376
SUBSCRIBERS: (212) 553-1653
Nicolas S. Weill
VP - Senior Credit Officer
Structured Finance Group
Moody's Investors Service
JOURNALISTS: (212) 553-0376
SUBSCRIBERS: (212) 553-1653