Less than five years after Ohio restructured the credit to avoid a default, the Buckeye Tobacco Settlement Financing Authority needed a debt service reserve draw to pay holders of its tobacco settlement securitization bonds.
The Buckeye authority required a reserve draw to make an $81.6 million interest payment due Dec. 1, according to a
The authority was issued the country's biggest securitization of tobacco settlement revenues in 2007, part of
In 2020, with the Buckeye tobacco bonds facing downgrades and the prospect of default, Ohio undertook a $5.35 billion refinancing that re-established some of the bonds — which had tumbled into junk territory — as investment grade. The refinancing won The Bond Buyer's 2020
In November, the Buckeye authority initiated a draw of $10.581 million on the Class 2 Senior Liquidity Reserve Subaccount, which secures only the Series 2020B-1 senior bonds and the Series 2020B-2 senior bonds, according to
The remaining balance in the Class 2 reserve account is now $160.268 million; the amount required to be held in the reserve account is $170.85 million.
At the authority's Sept. 24 meeting, Assistant Secretary Diane Chime said Ohio received $231.8 million for its 2023 tobacco settlement revenues payment, but an additional $92.2 million was held aside by tobacco manufacturers in the disputed payment account, according to the
For the first time since 2020, tobacco settlement revenues and interest earnings on the reserve fund and other pledged accounts fell short of the amount needed for debt service.
"That level of withholdings [by the tobacco manufacturers] was higher than in recent years," Laura Martine, director of communications for Ohio Treasurer Robert Sprague, told The Bond Buyer.
Martine noted that all bondholders were paid in full and no event of default occurred as defined in the bond indenture, which excludes reserve draws from its definition of "event of default."
In its Jan. 8 default trends report, Municipal Market Analytics flagged the performance issues of Ohio's tobacco bonds, noting that the reserve draw had driven a jump in the state's impairment rate to 8%.
MMA Partner Matt Fabian said that currently, the tobacco bonds account for about three-quarters of impaired Ohio debt.
"Over the long term, things shift," he said. "This is exactly the risk states like Ohio transferred to bondholders when they did the securitizations in the first place; it's why tobacco bonds exist. Bondholders accepted the long-term timing risk of settlement payments in exchange for receiving a relatively high interest rate. State taxpayers received money up front and so didn't have to worry about future cigarette deliveries."
It's been a bumpy road for the Buckeye authority, and the tobacco bond landscape has changed considerably since its tobacco bonds were first issued.
The MSA required participating manufacturers to pay their relative market share of billions in annual payments to states.
It established a formula that was designed to offset the competitive disadvantage to participating manufacturers in the settlement of having to make annual payments to every state.
And it created a disputed payments account, into which contested payments would be set aside pending the resolution of an investigation by an independent auditor.
Not all states are happy with the results of the MSA. New Mexico has since
Between 2000 and 2017, many states chose to securitize their payments under the MSA, with 20 states and territories issuing tobacco bonds during that period.
The state's General Assembly created the Buckeye authority in June 2007, and that October, the state, as was standard for tobacco securitizations, gave the authority all its rights and interests under the MSA, including Ohio's share of tobacco settlement revenues until all bonds have been repaid. The authority consists of the governor, the Ohio treasurer and the Office of Budget and Management director.
It was a fertile time for tobacco securitizations. A 2007 response from JP Morgan to the state's request for proposals that was
The Buckeye authority picked Bear Stearns and Citi
Fitch
Ohio's 2017 $5.5 billion securitization was the largest ever completed, Joshua Cain wrote in
And like California's Golden State Tobacco Securitization Corp., whose securitization approach it matched, Ohio's authority opted for an aggressive structure with a high sensitivity to drops in available revenue. Ohio's 2007 A-2 tranche was paid down slower than expected, and the authority had to draw on its reserve fund to make principal and interest payments, Cain noted.
"Since all tobacco settlement securitizations are backed by the same underlying cash flow, differences in structure, mainly those that affect coverage and seniority/payment priority, are the primary source of [the] variance in credit quality," Cain wrote. "Clearly, the relative aggressiveness and complexity of different tobacco bonds has had a real effect on their economics."
The Ohio authority's taxable Series 2020A-1 senior bonds and Series 2020B-1 senior bonds — and the tax-exempt Series 2020A-2 senior bonds, Series 2020B-2 senior bonds and Series 2020B-3 senior bonds — are a mix of current interest and capital appreciation bonds.
The official statement for the Series 2020 bonds features a section on bond structuring assumptions. They include "that there will be no adjustments to the annual payments due to miscalculated or disputed payments."
Other assumptions were that participating tobacco manufacturers would make all payments required of them by the MSA; that the aggregate market share of the original four tobacco giants would remain constant throughout the forecast period at its 2018 level; and that the aggregate market share of newer participating manufacturers would also remain constant at its 2018 level.
Martine, the treasurer's spokesperson, said the Series 2020 bonds "are structured to withstand year-over-year [tobacco] consumption decline," and the senior liquidity reserve accounts offer additional bondholder security in the event that pledged tobacco receipts underperform estimates.
Jie Liang, sector lead for S&P Global Ratings structured finance ratings, noted that S&P's criteria include a set of stress runs, such as the cigarette volume decline test, the NPM adjustment stress test and the PM bankruptcy test.
S&P's base case assumption for 2023 consumption decline was 4.00% to 4.50%. The actual consumption decline for 2023 was around 8.7%, according to National Association of Attorneys General data.
"We revised our assumptions last week based on longer term trends," Liang said. "We also run additional sensitivity scenarios such as a one-time steep decline in cigarette consumption to address potential shocks to the industry or significant regulatory changes."
Over the long term, MMA's Fabian said, "the whole asset class has a payment sufficiency challenge." As cigarette smoking declines and is eclipsed by vaping, tobacco settlement revenues haven't kept up with projections.
"And projects that aren't restructured to fit into the latest version of the cash flows may wind up drawing on reserves earlier than the others," Fabian added.
For the 2020 refunding, S&P assigned ratings between BBB-plus and A to different tranches, leaving the largest $3.78 billion chunk of the deal unrated.
That rating range still holds.
The
"Our rating rationale is mainly based on tobacco consumption, the [participating manufacturer] market share, and the potential impact of industry litigation," Liang said. "Asset isolation from the municipalities' general obligations and bankruptcy remoteness of the legal structure typically allow the senior bonds to receive investment-grade ratings, depending on our cash flow analysis of the payment structure."
