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Excerpts from Sector Spotlight: Federal Lawsuit Could Leave Tobacco Bonds Up in the Air

By Jennifer Karchmer, The Bond Buyer, http://www.bondbuyer.com [09/30/99]

The already complicated issue of tobacco securitization just got even more complex in the wake of the federal government's lawsuit against the nation's major cigarette companies.

Investors say they want a deal structure in their hands before they speculate on how tobacco bonds will be priced in light of the litigation. However, they agree that a pending lawsuit can't be good for bonds.

On Sept. 22, the U.S. government filed a civil case against the tobacco companies in federal district court, seeking to recover billions in smoking-related health care costs.

Buy-side players say this latest plot twist adds another layer of uncertainty to the already voluble discussion surrounding tobacco bonds.

The asset-backed securities were already expected to be heavily influenced by underlying risks that could undercut the bonds' trading value. But now, analysts point out, the federal lawsuit exacerbates the situation, potentially weakening the companies' ability to pay the states as a result of the massive settlement.

Analysts say the complicated credit structure may involve a combination of municipal, asset-backed, and corporate analysis.

Meanwhile, investors say they feel left behind a smoke screen, still wondering if insurance will be available to wrap around the bonds and what rating the credit agencies plan on assigning the debt. Without looking at a specific operating statement, market players say it's unclear what role the latest litigation will play in the municipal securitization.

The number of smokers in the nation is likely to play a major role in the credit analysis of future tobacco-backed bonds, observers note.

According to underwriter Salomon Smith Barney Inc., the number of Americans who continue to smoke will provide a consistent cash flow to states receiving a share of the settlement.

One analyst points out that the outcome of the lawsuit is just as important as the litigation itself.

"The question is how realistic is the lawsuit and its claims against the tobacco companies," said Kevin Taylor, an analyst at Prudential Securities Inc., who published one of the first reports on the municipal securitization in March.

If the government were to lose the case, Nuveen's Hicks pointed out, it would be beneficial for tobacco-backed bonds "because it's one less finger in the pot to get the tobacco companies' revenues."

On the other hand, if the cigarette companies were on the losing end, "it would mean that additional payments would need to be made beyond what they need to make to the states, so that would further undermine their own financial strength," Hicks said.

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