How to Analyze Tobacco Bonds
Gerry Lian Executive Director Morgan Stanley Investment Management
On November 23, 1998 a total of 46 U.S. states, the District of Columbia, the Commonwealth of Puerto Rico, and four U.S. territories entered into the Master Settlement Agreement (MSA) with four major U.S. tobacco companies: Philip Morris Inc., R.J. Reynolds Tobacco Co., Lorillard Tobacco Co., and Brown & Williamson Tobacco Corp. This agreement represents the largest civil settlement in U.S. history. Following its execution and approval by these participants, the “settling states,” have issued over $36.5 billion of tax-exempt revenue bonds secured by a pledge of tobacco settlement revenues provided under the MSA.
The purpose of this chapter is to set forth an analytical framework to evaluate the credit risk of bonds secured by tobacco settlement revenues (“Tobacco Settlement Revenue bonds” or “TSR bonds”). Due to an unusual bundle of risks, TSR bonds) constitute a highly unique and challenging type of municipal bond that is subject to a wide risk spectrum. This spectrum includes structural risk, corporate credit risk, cash flow risk, and litigation risk. The following discussion shall proceed to define and evaluate the specific elements comprising each risk category.
Before proceeding to the analysis, it is important to provide an overview and summary of the MSA and to illuminate the structural characteristics of TSR bonds.
The Master Settlement Agreement ...