OREANDA-NEWS. Fitch Ratings has affirmed the 'BBB+' rating on the New Jersey Economic Development Authority's cigarette tax revenue refunding bonds, series 2012, outstanding in the amount of approximately \$892.5 million. The Rating Outlook is Stable.

SECURITY
The bonds are special and limited obligations of the authority, payable under a state contract between the treasurer and the authority solely from 100% of revenues from a \$0.65/pack statewide cigarette tax deposited in the dedicated cigarette tax revenue fund held in the state treasury, subject to appropriation.

KEY RATING DRIVERS

CIGARETTE TAX REVENUES EXPECTED TO DECLINE: Cigarette tax collections, the sole source of bond repayment, have been declining modestly and are expected to continue to decline through the life of the bonds. Cigarette sales have been negatively affected by repeated tax rate increases on the state and federal level as well as initiatives to curtail smoking. Future legislative and regulatory changes could negatively affect collections.

SATISFACTORY DEBT SERVICE COVERAGE LEVELS: Debt service coverage is satisfactory and is expected to be maintained at adequate levels. The authority has structured a declining debt service profile to maintain solid coverage even with the expected deterioration in the pledged revenue source.

DEBT SERVICE SUBJECT TO APPROPRIATION: The rating reflects the credit quality of pledged revenues as well as the requirement for annual legislative appropriation. The appropriation requirement limits the bonds' rating to a level one notch below the state's general obligation (GO) credit quality.

NO ADDITIONAL BORROWING PERMITTED: The indenture is closed and there is no authorization for additional bonds, protecting against further leveraging of the revenue stream.

RATING SENSITIVITIES

SHIFTING CONSUMPTION PATTERNS: The rating is sensitive to shifts in consumer use of tobacco products, should such shifts result in debt service coverage that is materially below current expectations. Use of tobacco products is affected by numerous factors including federal and state tobacco regulatory and tax policies, population growth, price increases, disposable income, smoking bans, nicotine dependence, and health warnings.

CHANGE IN STATE CREDIT QUALITY: Because the requirement for appropriation caps the rating at a level no higher than one notch below the state's GO rating, the current rating is sensitive to a change in the state's GO credit quality.

CREDIT PROFILE
The bonds are secured by deposits to the state's dedicated cigarette tax revenue fund, a separate fund in the state treasury, subject to legislative appropriation, in an amount equivalent to cigarette tax revenues generated from a statewide \$0.65 per pack tax (the dedicated tax; from a total \$2.70/pack tax). 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 requirement for annual legislative appropriation caps the current rating at a level no higher than one notch below the state's GO rating (currently at 'A' with a Negative Rating Outlook). 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 could adversely affect the collection of sufficient cigarette tax revenues to fund the appropriations, and there are no bondholder remedies in the event of non-appropriation. However, Fitch recognizes that the authority provides broad capital support of state programs and accounts for a significant portion of the state's tax-supported debt.

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. The indenture is closed, and there is no authorization for additional bonds. Accordingly, there is no additional bonds test and no annual coverage requirement.

A declining trend in cigarette consumption in New Jersey has been the result of changes in state and federal tax structures, health care trends, levels of disposable income, and the imposition of a statewide indoor smoking ban, except on casino gaming floors, in 2006. New Jersey's cigarette tax rate is currently \$2.70 per pack, while the federal government's tax rate is \$1.01 per pack. New Jersey's cigarette tax ranks eighth highest nationally, with New York first, although New Jersey's rate is well above that of neighboring Pennsylvania and Delaware.

A consultant's report at the time of the 2012 bond sale projected declines in New Jersey taxable cigarette sales of just over 3% annually through final maturity in fiscal 2029. Actual revenue has been modestly below that forecast, although annual declines are still projected in that range.

The state reports that it under-deposited dedicated tax revenues in fiscal 2013 due to \$15.7 million in June 2013 collections being credited to dedicated revenue collections in fiscal 2014; that fiscal year had a corresponding over-deposit. Deposited dedicated tax revenue collections in fiscal 2013 were \$160.4 million rather than the \$176.1 million by calculation. For fiscal 2014, \$191.4 million was deposited, including \$4.3 million in debt service reserve fund interest earnings, rather than \$171.5 million in applicable dedicated tax revenue. Fitch's concern regarding the incorrect deposits is eased by the receipt of revenue in each fiscal year that was well in excess of debt service requirements as well as the sufficiency of revenue at the required debt service payment dates.

Based on the dedicated tax rate, fiscal 2014 dedicated revenues fell 3% year-over-year, and the state forecasts a 3% decline in fiscal 2015 and a larger 4% decline in fiscal 2016, generally in line with the expectations noted above. Debt service coverage based on fiscal 2014 dedicated revenue (adjusted for the incorrect deposits noted above) was 1.86x, essentially meeting the state's expectation of 1.85x coverage that year. The state forecasts coverage dropping to 1.49x in fiscal 2015 with an increase in debt service in that year. Thereafter, debt service requirements decline every year and coverage remains around 1.5x, assuming declines of about 3% annually.