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Rating Action:

MOODY'S CONFIRMS RATING OF TOBACCO COMPANIES BUT RETAINS NEGATIVE OUTLOOK IN RESPONSE TO MCCAIN DRAFT LEGISLATION

31 Mar 1998
New York, 03-31-98 -- Moody's Investors Service confirmed the ratings of five tobacco companies competing in the U.S. market, but expressed a very negative outlook for the ratings following the release of the Senate Commerce Committee's summary of the draft legislation entitled "National Tobacco Policy and Youth Smoking Reduction Act." Moody's believes that certain central features of the draft legislation would, to varying degrees, seriously weaken the ability of these companies to retain their current ratings. These features include: the size of the annual payment required of the industry, the de-linking of the payment requirements and future declines in cigarette consumption, and the size and non-tax-deductible status of penalties relating to a failure to reach targets for reducing under-age usage.
The current draft legislation does not yet address the critical issue of relief from civil litigation. However, even if the draft legislation were to eventually incorporate such relief, the financial payments incorporated in the draft are so burdensome that it is uncertain whether any company would retain its current rating, and some companies could experience material downgrades. In the absence of meaningful protection from future litigation, the negative impact of the current proposal on the credit quality of rated companies would be further exacerbated.
Moody's noted that in June of 1997, it confirmed the rating of the U.S. tobacco industry following the announcement of settlement proposal agreed on by the industry and certain state attorneys general. That confirmation reflected our expectation that each company in the industry would have a variety of options available to help moderate the erosion in debt protections that would result from the proposal, and that any erosion which did occur could be adequately offset by a significant degree of insulation from future litigation risk.
The following companies ratings are confirmed and negative outlooks maintained following the announcement of the recent draft legislation:
Philip Morris Companies, Inc. and its guaranteed subsidiaries: long-term debt rated A2 and Prime-1 rating for commercial paper.
RJR Nabisco, Inc. and its guaranteed subsidiaries: long-term debt rated Baa3 and Prime-3 rating for commercial paper.
B.A.T Industries plc and its guaranteed subsidiaries: long-term debt rated A2 and Prime-1 rating for commercial paper.
Loews Corporation: long-term debt rated A1.
UST: Prime-1 rating for commercial paper.
Following is a summary comparison between the draft legislation and the June 1997 proposal:
Total Industry Payments: Under the terms of the draft legislation total industry payments will approximate $575 billion over 25 years compared with $368 billion under the June 1997 proposal. This represents a substantial 56% increase.
Lack of Adjustment for Lower Consumption Levels: The draft legislation requires specific, non adjustable payment levels during the first five year after enactment: $14.4 billion in 1999, $15.4 billion in 2000; 17.6 billion in 2001, $21.2 billion in 2002, and $23.6 billion in 2003. These payment levels are required irrespective of any future declines in cigarette consumption. However, it is likely that the base historic rate of about 2.0% per year declines in consumption will continue. In addition, the payment levels required by the draft legislation will result in significant price increases, which will in turn precipitate sharp declines in consumption. Under the draft legislation, payment levels are not adjusted for declines in consumption until 2004.
In contrast, under the June 1997 proposal, annual payment levels would be adjusted downward by the annual percentage decline in consumption. This adjustment mechanism would be operative during the second year after enactment. As a result of this volume adjustment process, payments due under the June 1997 agreement are similar in nature to an excise tax which also varies directly with volume.
The impact of the draft legislation is that during the first five years after enactment, the dollar amount paid by the industry is likely to be about 80% higher than under the June 1997 proposal. In addition, because the draft legislation sets an absolute and unadjusted payment level for the industry, Moody's would view these payments much like a regulatory or legislated fixed charge. Consequently the industry's debt protection measures and ability to service its major financial fixed charge – interest expense – would be severely eroded.
Underage Tobacco Usage Targets: The draft legislation proposes an annual yearly cap of $3.6 billion on penalties to be paid by the industry for not reaching targets for reducing underage smoking. In addition, these penalties would not be tax deductible. The June 1997 proposal set a cap of $2.0 billion for not reaching the same target levels, and treated these payments as tax deductible expenses.
Litigation: The draft legislation does not address the issue of any type of protection from litigation for the industry. In contrast, the June 1997 proposal would: settle present federal, state medical cost recoupment, and class actions litigation; bar similar actions in the future; preserve the rights of individuals to sue but set caps on total annual payments by the industry; and, allow claims for punitive damages only to the extent that such claims were based on industry conduct taking place after enactment of the proposal.
Moody's believes that meaningful legislative protection from litigation will be a critical element of industry participants to retain current rating levels. In the absence of such protection, state and federal authorities will have considerable latitude to extract very high payment streams from the industry, without providing the industry with relief from the oppressive cloud of litigation risk.

No Related Data.
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