Fitch Affirms New Jersey EDA's $1.1B Cigarette Tax Revs at 'BBB+'; Outlook Revised to Stable

NEW YORK--(BUSINESS WIRE)--Fitch Ratings takes the following action on the New Jersey Economic Development Authority's cigarette tax revenue bonds as part of its continuous surveillance effort:

--$1.1 billion outstanding cigarette tax revenue bonds series 2004 affirmed at 'BBB+' (underlying rating).

The Rating Outlook is revised to Stable from Negative.

RATING RATIONALE:
--Cigarette tax collections, the source of bond repayment, have been declining modestly, and the degree of future declines is uncertain, particularly given the heightened exposure of a single-state revenue source.
--Cigarette sales have been negatively affected by repeated tax rate increases on the state and federal level as well as initiatives to curtail smoking. The Stable Outlook is reflective of the rebound in cigarette sales in New Jersey for the current fiscal year despite the effects of these tax increases.
--Debt service coverage is slim, and the bonds' final maturity is long (2034, notwithstanding the intention to accelerate payments), exacerbating concerns about the uncertainty of future revenue performance.
--Potential legislative and regulatory changes in the future could negatively impact collections.

KEY RATING DRIVERS:
--Maintenance of adequate debt service coverage and continued acceleration of principal repayment.
--Cigarette sales declines in excess of the recent historical trend.

SECURITY:
The bonds are special, limited obligations of the authority, payable under a state contract between the treasurer and the authority solely from a dedicated 78.598% of revenues from a $0.65/pack cigarette tax deposited in the cigarette tax revenue fund held in the state treasury, subject to appropriation. Neither the cigarette tax revenues nor the fund are pledged.

CREDIT SUMMARY:
The authority issued $1.461 billion in cigarette tax bonds in October 2004 for deficit financing purposes, to fund appropriations in the state's fiscal 2005 budget. Interest was capitalized through June 2006, with Dec. 15, 2006 the initial payment of interest from dedicated revenues and June 15, 2007 the first principal maturity.

On a monthly basis, the dedicated cigarette tax fund, a separate fund in the state treasury, receives an amount equivalent to cigarette tax revenues generated from a $0.65 per pack tax. Of this amount, 78.598% is transferred to the trustee under the contract for debt service, subject to legislative appropriation, and used to pay scheduled debt service and for debt acceleration. The remainder is appropriated by the state legislature for other purposes. Before any cigarette tax revenues can flow to the fund, a prior $151 million annual statutory allocation to two state health-related funds must be met. Upon satisfaction of the prior dedication, all state-collected cigarette tax revenues are applied to the fund to bring it to the level it would have been if the prior transfer had not been made. At that point, the allocation to the fund reverts to the $0.65/pack.

The indenture is closed and there is no authorization for additional bonds. As such, there is no additional bonds test and no annual coverage requirement. A fully funded debt service reserve fund is invested in GICs with CDC Funding Corp. and Societe Generale, with annual interest earnings available for debt service and debt acceleration. Acceleration of debt through prepayments and open market purchases was intended at the time of sale and such accelerations have been implemented, reducing remaining scheduled debt service by more than $192 million compared to the original schedule. The bonds' final maturity is still scheduled for 2034.

The legislature may alter or amend the cigarette tax act or the application of cigarette tax revenues. The state has not pledged or covenanted that it will not take any action that will adversely affect the collection of sufficient cigarette tax revenues to fund the appropriations. The cigarette tax is collected primarily from licensed distributors who receive cigarettes directly from out-of-state manufacturers and is thus dependent upon in-state cigarette sales. Unless otherwise provided by law, every package of cigarettes must be stamped before being transferred from the original acquirer in New Jersey. This tax is not imposed on other tobacco products.

As expected at the time of sale, coverage by the dedicated 78.598% of the $0.65 portion of the state's cigarette tax is slim. Cigarette consumption has been declining and continues to drop. Although this was anticipated at the time of the 2004 bond sale, actual performance has been worse than projected. The consultant's report at the time of sale projected annual declines in New Jersey taxable cigarette sales of 2.0%-2.4% annually through 2034, with annual scheduled debt service dropping at a greater rate in most years. In fact, sales since fiscal 2004 have been down an average of about 5%. The larger than expected declines partially reflect the fact that the state has raised its cigarette tax rate twice since the bond sale, from $2.40 per pack to the current $2.70 per pack, while the federal government increased its tax rate from $0.39 to $1.01 per pack effective April 1, 2009. In addition, the state imposed a statewide indoor smoking ban, with the exception of casino gaming floors, in 2006. At the time of the 2004 bond sale, New Jersey's cigarette tax was the highest in the nation; now the rate is below that of New York and several other states but well above that of Pennsylvania and Delaware.

For fiscal 2010, the most recently completed year, sales were down 3.1%, and fiscal 2011 results through March 2011 show sales have increased by 4% despite the recent tax increases noted earlier. Fiscal 2010 revenues for debt repayment, inclusive of debt service reserve fund earnings, of $150.7 million covered scheduled fiscal 2010 debt service by 1.23 times (x). Originally forecast revenues of $159.5 million covered scheduled fiscal 2011 debt service of $127 million by 1.24x. The relative stability in debt service coverage reflects the accelerated principal repayment noted above.

There are no bondholder remedies in the event of non-appropriation. Fitch recognizes that the authority provides broad capital support of state programs and accounts for a significant amount of the state's tax-supported debt.

Additional information is available at www.fitchratings.com.

In addition to the sources of information identified in Fitch's Tax-Supported Rating Criteria, this action was additionally informed by information from the Underwriter.

Applicable Criteria and Related Research:
--'Tax-Supported Rating Criteria', Aug. 16, 2010;
--'U.S. State Government Tax-Supported Rating Criteria', Oct. 8, 2010.

For information on Build America Bonds, visit www.fitchratings.com/BABs.

Applicable Criteria and Related Research:
Tax-Supported Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=548605
U.S. State Government Tax-Supported Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=564546

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE WWW.FITCHRATINGS.COM. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE.