KBRA Assigns Ratings to Northern Tobacco Securitization Corporation Tobacco Settlement Asset-Backed Bonds, Series 2006

NEW YORK–(BUSINESS WIRE)–Kroll Bond Rating Agency (KBRA) assigns ratings to five classes of Tobacco Settlement Asset-Backed Bonds, Series 2006 issued by Northern Tobacco Securitization Corporation.

Transaction Summary

The bonds were issued in 2006 and consist of five classes. The three classes of 2006A Bonds are current pay interest bonds which are entitled to interest payments on each payment date while the 2006B and 2006C Bonds are capital appreciation bonds that capitalize interest through the final maturity date in 2046. The bonds are collateralized by an 80% portion of the tobacco settlement payments that are required to be made by tobacco manufacturers to the State of Alaska under the 1998 Tobacco Master Settlement Agreement (MSA). The collateral also includes a liquidity reserve account.

MSA Overview

In November 1998, the MSA was entered into between 46 U.S. states, the District of Columbia, several U.S. territories and the then four largest U.S. 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 (collectively, PMs), 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.

MSA payments 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 U.S. 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 U.S. states, and territories, the OPMs and certain SPMs regarding claims related to the 2003 – 2012 NPM adjustments and determination of subsequent NPM adjustment. In October 2017, a final settlement agreement (NPM Adjustment Settlement Agreement) became effective. Under the NPM Adjustment Settlement Agreement, PMs have received certain reductions and credits to reflect a percentage of the 2003 through 2012 NPM Adjustment claims that were settled and NPM Adjustment claims for transition years 2013-2015. The NPM Adjustment Settlement also details the determination of NPM Adjustments for sales year 2013 onward. The State of Alaska became a signatory by joinder to the NPM Adjustment Settlement Agreement in March 2018.

KBRA has analyzed this transaction using the Global General Rating Methodology for Asset-Backed Securities and the Global Structured Finance Counterparty Methodology.

Key Credit Considerations

• Senior Liquidity Reserve Account: Funds in the Senior Liquidity Reserve Account are available to pay semi-annual interest payments as well as principal payments at maturity on the senior bonds. The current balance in the account is sufficient to cover all interest payments on senior bonds through the June 1, 2023 distribution date as well as the remaining principal balance of the Class 2006A Bonds that mature on that date. The rating on the Class 2006A Bonds that mature on June 1, 2023 is based solely on the available cash collateral in the account and the ratings requirements for permitted investments.
• MSA Payments Owing By OPMs in perpetuity: The majority of the MSA payments are owing from the two remaining OPMs Philip Morris and British American Tobacco p.l.c.
• Declines in Tobacco Consumption and Risk of Further Declines: While tobacco consumption increased by about 2% in 2020, it had declined by 4%-5% in 2016-2019. Declines in consumption result in less cashflow available to the bondholders because the MSA includes provisions for decreasing payments owed by manufacturers based on decreased cigarette consumption. More recent cigarette consumption declines are partially attributable to increased e-cigarette usage. Other factors can also contribute to decreased tobacco consumption including increased taxation or regulation and decreased discretionary income.
• Cash Flow Analysis: The table below shows the base case assumptions for the key inputs into KBRA’s cash flow analysis. Under the base case scenario, timely interest is paid on the 2006A Bonds through June 1, 2023 and the 2006A Bonds maturing on this date are repaid principal in full. The MSA payments and liquidity reserve are not sufficient to fully repay principal owing on the 2006A Bonds maturing on June 1, 2032. This results in the payment priority switching to prorata among the outstanding 2006A Bonds. The MSA payments are insufficient to repay principal on the 2006A Bonds and are also insufficient to repay accreted principal on the subordinated capital appreciation bonds by the maturity date in 2046.

Rating Sensitivities

The senior liquidity reserve account is sufficient to cover semi-annual interest on all of Class 2006A Bonds and principal on the Class 2006A Bonds maturing on June 1, 2023. The cashflow results show that the Class 2006A Bond maturing after this date and the Class 2006B and Class 2006B Bonds will not repay by maturity under the base case assumptions. The primary factor that could lead to changes in the ratings is cigarette consumption rates. If cigarette consumption increases, MSA payments would be higher which could lead to ratings upgrades. Alternatively, if cigarette consumption declines more than the base case assumptions, MSA payments would be lower, and this could lead to downgrades. KBRA will monitor consumption rate changes as well as the remaining time to legal final maturity of each class of notes.

ESG Considerations

KBRA ratings incorporate relevant credit factors, including those that relate to Environmental Social Governance (ESG). Credit-relevant social and environmental factors related to transactions of this type include consumer smoking habits that are influenced by social factors such as increased healthy living trends and regulations regarding smoking in public places. Governance factors consider the transaction’s structural features such as adherence to representations and warranties, compliance with transfer standards, segregation and application of cashflows, and bankruptcy remoteness.

To access ratings and relevant documents, click here.

Related Publications

• Global General Rating Methodology for Asset‑Backed Securities
• Global Structured Finance Counterparty Methodology

Disclosures

A description of all substantially material sources that were used to prepare the credit rating and information on the methodology(ies) (inclusive of any material models and sensitivity analyses of the relevant key rating assumptions, as applicable) used in determining the credit rating is available in the Information Disclosure Form(s) located here.

Information on the meaning of each rating category can be located here.

Further disclosures relating to this rating action are available in the Information Disclosure Form(s) referenced above. Additional information regarding KBRA policies, methodologies, rating scales and disclosures are available at www.kbra.com.

About KBRA

Kroll Bond Rating Agency, LLC (KBRA) is a full-service credit rating agency registered with the U.S. Securities and Exchange Commission as an NRSRO. Kroll Bond Rating Agency Europe Limited is registered as a CRA with the European Securities and Markets Authority. Kroll Bond Rating Agency UK Limited is registered as a CRA with the UK Financial Conduct Authority pursuant to the Temporary Registration Regime. In addition, KBRA is designated as a designated rating organization by the Ontario Securities Commission for issuers of asset-backed securities to file a short form prospectus or shelf prospectus. KBRA is also recognized by the National Association of Insurance Commissioners as a Credit Rating Provider.

Contacts

Analytical Contacts
Joanne DeSimone, Senior Director (Lead Analyst)

+1 (646) 731-2306

joanne.desimone@kbra.com

John Hogan, Managing Director
+44 208 148 1040
john.hogan@kbra.com

Rosemary Kelley, Senior Managing Director (Rating Committee Chair)

+1 (646) 731-2337

rosemary.kelley@kbra.com

Business Development Contact
Arielle Smelkinson, Senior Director

+1 (646) 731-2369

ariielle.smelkinson@kbra.com