The Rhode Island Tobacco Settlement Financing Corp. deal has been put on hold by Citigroup after OppenheimerFunds Inc. challenged the deal in court.
Citigroup, the lead manager for the $593 million negotiated deal, intended to issue the debt on Tuesday morning but placed the revenue refunding deal on "day to day" status on Monday afternoon, according a New York based tobacco analyst and a Kansas City based analyst. Citigroup declined to comment on the situation. Typically, an underwriter may put a deal on day to day in a volatile yield environment.
The change of timing probably had to do with a lawsuit filed by two Oppenheimer Rochester municipal funds, which challenged the deal in a state court in Rhode Island, according to the two analysts, who spoke on condition of anonymity because they were still contemplating whether to buy the bonds.
Oppenheimer claimed the transaction "violated State law and the Corporation's obligation to current bondholders, including our funds, whose investments allowed the State to collect much needed cash by monetizing its anticipated future payments from the tobacco companies," according to a statement from the firm's corporate communications department. Oppenheimer declined to elaborate, a spokesperson said.
The deal will probably come to market by the end of the week or early next week, the analysts said.
Oppenheimer's objection to the deal probably stems from the deal's use of proceeds and revised seniority status of bondholders, said the analysts. The deal comes in two parts, the $336 million Series 2014A tranche, which includes serial bonds and term bonds, and the $257 million Series 2014B current interest turbo bonds, according to the preliminary official statement provided by MuniOS.
Proceeds would go to entirely refund the state's Series 2002 tobacco bonds and partially refund its Series 2007 tobacco bonds, which are subordinate to the 2002 bonds, according to the analysts. After the Series 2014 bonds are placed, they will effectively be senior to the 2007 bonds, said the analysts.
The bonds also include a $20 million payment to the state, another possible subject of Oppenheimer's concern.
"The state is collecting a chunk of money on the back of this deal and the 2007 holders, or Oppenheimer, are saying that 'yes, we're subordinate, but those state allocated funds should have been allocated towards our repayment first,'" the New York based analyst said.
Citigroup may also be hitting the brakes because of low subscription rates, the New York based analyst said.
The longest dated Series 2014A bonds were initially priced to yield 5%, which the market has pushed back on, asking for 5.2% and 5.25%, he said. The sector is notorious for distress, as seen in its predecessors Buckeye and Golden State tobacco, making the deal too expensive for investors familiar with its history.
"It says a lot about the rate environment right now that [Citigroup] thinks that it can get the deal in at a five handle," said the Kansas City based analyst, noting the scarcity of high yield paper in the primary market so far in 2014.
While similarly structured to some of the sector's more infamous names, the Rhode Island deal is considered much safer given its larger buffer for tobacco consumption declines. Golden State and Buckeye tobacco bonds had built in a 3.5% decline in usage, which became problematic in years like 2009 or 2010 when consumption declined 9.1% and 6.4%, respectively, according to data provided by the Center for Disease Control and Prevention.
The Series 2014A bonds can withstand up to 8.5% declines in tobacco use and the Series 2014B up to 6%, making them inherently much safer than other tobacco bonds considered the average rate of decline between 2000 and 2014 has been 3.5%, according to the New York based analyst.
As the maturities get longer, the risk becomes higher, the New York analyst said, noting the duration risk was even higher with tobacco bonds than with other municipal debt. Consecutive years of compounding consumption declines would have the potential to cause significant distress in the long dated bonds, while the shorter dated serials would be able to weather the storm, according to the New York based analyst.
That risk has been reflected in separate ratings for different durations; Standard & Poor's gave the Series 2014A bonds up to 10 years an A, between 11 and 20 years an A-minus, and maturities longer than 21 years a BBB+. S&P did not rate the Series 2014B turbo bonds. Fitch Ratings gave them a BBB-plus. In its report, Fitch noted that this was the lower rating for the turbo bonds and that the shorter dated maturities would be rated higher if they were to split their ratings.
