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Kroll Bond Rating Agency Assigns Ratings to Golden State Tobacco Securitization Corporation, Series 2007A


Kroll Bond Rating Agency (“KBRA”) assigns ratings to five classes of Tobacco Settlement Asset-Backed Bonds, Series 2007 (“the Bonds”) issued by Golden State Tobacco Securitization Corporation (“the Corporation”).

The Bonds were issued in 2007 and originally refunded the Series 2003A transaction issued by the Corporation. The collateral for the securitization is a pledged percentage of annual payments made by the tobacco participating manufacturers (PMs) under the 1998 Tobacco Master Settlement Agreement (MSA).

While California (“the State”) is entitled to 12.76% of the annual MSA payments (and 5.17% of the Strategic Contribution Payments), half of these tobacco settlement revenues (TSR), are allocated to multiple cities and counties (participating jurisdictions) in the state, the remaining 50% is allocated to the state (“the State’s Share”). The Corporation has purchased from the State all of its right, title and interest in the State’s Share. The 2007 bonds are entitled to 56.57% of the Corporation’s TSRs. Therefore the Corporation receives approximately 3.61% of the TSRs (not including the Strategic Contribution Payments, of which 2017 is the last payment year). The remaining 43.43% of the Corporation’s TSRs were purchased by the Corporation under a separate indenture and are not available for this transaction. The original 2007 structure consisted of $3.7Bn senior current interest bonds, $289MM were serial bonds with maturities from 2008 through 2017, the remaining $3.4Bn are turbo term bonds maturing in 2027, 2033, and 2047 (two series mature in 2047). In addition there are $524.8MM of senior convertible bonds (converted in 2012) maturing in 2037, $271.9MM of first subordinate capital appreciation bonds, and $78.5MM of second subordinate capital appreciation bonds. The Corporation is currently partially refinancing the senior current interest bonds maturing in 2017, the senior current interest turbo term bonds maturing in 2047 and the capital appreciation bonds maturing in 2047. The Corporation is also fully refunding the current interest turbo term bonds maturing in 2027.

In November 1998, the MSA was entered into between 46 US states, the District of Columbia, several US territories and the then four largest US tobacco manufacturers, known as the original participating manufacturers (OPMs). Numerous smaller tobacco manufacturers joined the MSA after the OPMs, and are referred to as subsequent participating manufacturers (SPMs). There are tobacco manufacturers that did not become parties to the MSA, and such firms are known as the Non-Participating Manufacturers (NPMs). The MSA resolved cigarette smoking-related litigation among the settlement states and the participating manufacturers, consisting of both the OPMs and the SPMs, and provides those states with annual tobacco settlement payments from the PMs in perpetuity. After the MSA was signed, many states and local governments securitized some or all of their rights to receive future settlement payments.

Under the MSA, payments to the states are subject to various adjustments, including the inflation adjustment, volume adjustment, and NPM adjustment. The inflation adjustment increases the base amounts of the MSA payments, based on the higher of the percentage increase in the consumer price index for all urban consumers and 3%. The volume adjustment increases or decreases the MSA payments by an amount that accounts for fluctuations in the number of cigarettes shipped by the OPMs in or to the United States. The NPM adjustment may reduce the payments of the PMs under the MSA in the event of losses in market share by the PMs to NPMs as a result of such PMs’ participation in the MSA.

Under the MSA, three conditions must be met in order to trigger an NPM adjustment: 1) a market share loss was experienced for the applicable year; 2) a nationally recognized firm of economic consultants determines that the disadvantages experienced as a result of provisions of the MSA were a significant factor contributing to the market share loss for the applicable year; and 3) the settling state in question are found to not have diligently enforced their qualifying statutes. The PMs have disputed MSA payments related to sales years dating back to 2003.

In December 2012, terms of a settlement agreement were agreed to by a number of US states and territories, the OPMs and certain SPMs regarding claims related to the 2003 – 2012 NPM adjustments and determination of subsequent NPM adjustment. Under this settlement term sheet, OPMs and certain SPMs had received certain reductions in 2013 and 2014 and will receive reductions to subsequent MSA payments in the form of credits and transition year reductions. Each of the signatories to the settlement term sheet has received its allocable share from the disputed payments account under the MSA in connection with its 2013 MSA payment. The settlement term sheet also details the determination of NPM adjustments for 2013 onward for the signatory states. Further, the settlement term sheet provides that the signatory states and the signatory PMs will split the amounts at issue under the provisions relating to NPM sales for which state cigarette excise tax was not paid (Non-SET-Paid), for 2015 and each subsequent year on a 50-50 basis.

KBRA considered several key factors in its analysis of this transaction, including:

  • Recent normalization of tobacco consumption decline following several years of above-average declines.
  • The credit quality of the large tobacco participating manufacturers, which has strengthened in recent years.
  • The December 2012 settlement term sheet as it relates to the signatory jurisdictions, including the State.
  • The popularity of current and future tobacco alternatives, including E-cigarettes, and their market acceptance and penetration.
  • The potential for litigation that may have a material impact on the PMs or the MSA.
  • Other potential risks to demand, including reduction in discretionary income and other recessionary patterns that may have a meaningful impact on tobacco consumption.

KBRA analyzed the transaction using KBRA’s General Rating Methodology for Asset-Backed Securities published on July 30, 2012. Under some of the base case scenario assumptions (described below), the Series 2007 classes pay prior to or on their legal final maturity. However, as the stress assumptions move to the more conservative end of the range, none of the classes pay in full by legal final maturity except for the class that matures 6/1/2017.

The rating on the serial bond maturing in June 2017 is not reliant on any cash flow stresses as it is fully collateralized by the funds in the senior liquidity reserve account. As the transaction documents state eligible investments allows financial instruments at financial institutions rated in the A category, the Series 2007A-1 2017 class is rated A(sf).

Series and Class       Par Amount       Maturity       Rating
Series 2007A-1       $ 17,065,000       6/1/2017       A (sf)
Series 2007A-1       $ 610,525,000       6/1/2033       B- (sf)
Series 2007A-2       $ 524,780,000       6/1/2037       B- (sf)
Series 2007A-1       $ 1,176,765,000       6/1/2047       CCC+ (sf)
Series 2007A-1       $ 693,575,000       6/1/2047       CCC+ (sf)

Related Publications: (available at www.kbra.com)

About Kroll Bond Rating Agency

KBRA is registered with the U.S. Securities and Exchange Commission as a Nationally Recognized Statistical Rating Organization (NRSRO). In addition, KBRA is recognized by the National Association of Insurance Commissioners (NAIC) as a Credit Rating Provider (CRP).

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