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UPDATE 1-U.S. municipal tobacco bonds face Fitch downgrades
July 16, 2012 / 10:04 PM / 5 years ago

UPDATE 1-U.S. municipal tobacco bonds face Fitch downgrades

July 16 (Reuters) - Some 150 tranches of U.S. municipal tobacco bonds could be downgraded one to two notches within the next two to four weeks, Fitch Ratings said on Monday, as it now assumes the payments states get will remain flat.

States, counties, cities and towns sold billions of dollars of tobacco bonds backed by the more than $200 billion of payments cigarette-makers agreed to make in 1998 to help pay for the costs of treating ailing smokers.

The accord is called the Master Settlement Agreement and the payments Big Tobacco owes are calculated according to their cigarette sales, their market share, and inflation.

“Fitch believes that zero percent is a reasonable base case expectation based on historical MSA payment trends, its long-term outlook for inflation, tobacco consumption and shipments, and the long tenure of the liabilities,” the Wall Street credit agency said in a report.

Payments due under the MSA have slipped in the past several years, Fitch said, as cigarette sales have fallen and low inflation has persisted. Additionally, cigarette-makers have disputed an estimated $7 billion of payments, it said.

The report from Fitch follows one issued on July 12 by Moody’s Investors Service, which predicted the majority of tobacco bonds would default if cigarette consumption keeps falling at a 3 percent to 4 percent annual pace. .

Both credit agencies have developed so-called break-even models to predict potential defaults. Moody’s based its model primarily on declines in cigarette sales. Fitch, which assumed tobacco shipments will fall 4 percent a year, focused on payments that are made under the MSA.

As a result, Fitch’s analysis delved into the fights between Big Tobacco and the states over whether the cigarette makers that signed the MSA lost market share to companies that did not sign it.

This clash - which prompted Big Tobacco to argue that it owes less under the MSA than the states say - is being arbitrated. The outcome could have a significant impact on how tobacco bonds perform, Fitch said.

“Fitch estimates the maximum upside potential for the states is in the range of $3.5 billion, where most of the funds will be made available through the release of funds in the escrow account,” the credit agency said.

“On the other hand, the maximum downside for states is estimated by Fitch to be about $1.3 billion, which can potentially be claimed by manufacturers by netting the figure from the MSA payment,” it added.

Once the dispute is resolved, states could collect as much as an extra 15 percent a year, Fitch said.

The credit agency added: “Fitch does not expect tobacco consumption to increase but does expect the rate of decrease to stabilize, barring more increases in excise taxes.”

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