NEW ISSUE BOOK-ENTRY ONLY In the opinion of Transaction Counsel, under existing law and assuming compliance with the tax covenants described herein, interest on the Series 2001 Bonds is excluded from gross income Jor Federal income tax Purposes under Section 103 of the Internal Revenue Code of 1986, as amended (the “Code”). Transaction Counsel is also of the opinion that such interest is not treated as a preference item in calculating the alternative minimum tax imposed under the Code with respect to individuals and corporations. Interest on the Series 2001] Bonds is, however, included in the adjusted current earnings of certain corporations for purposes of computing the alternative minimum tax imposed on such corporations. Transaction Counsel is further of the opinion that the Series 2001 Bonds and the Interest thereon are exempt from personal income tax imposed by the United States Virgin Islands, any state, other territory or possession of the United States or any political subdivision thereof, or by the District of Columbia. See “TAX MATTERS” herein regarding certain other tax considerations. $21,709,861.90' Tobacco Settlement Financing Corporation Tobacco Settlement Asset-Backed Bonds, Series 2001 The Tobacco Settlement Asset-Backed Bonds, Series 2001 (the “Series 2001 Bonds”) are being issued by the Tobacco Settlement Financing Corporation (the “Corporation”), a special purpose, independent instrumentality of the United States Virgin Islands (the “Virgin Islands”), created by Bill No. 24-0078 of the Twenty-Fourth Legislature of the United States Virgin Islands, Tobacco Settlement Financing Act of 2001 (the “Act”). Pursuant to the Act, and a Purchase and Sale Agreement, dated as of November 1, 2001 (the “Purchase Agreement”), between the Virgin Islands and the Corporation, the Virgin Islands will sell to the Corporation, on the Closing Date, all of its right, title and interest in certain amounts payable after February 1, 2001 to the Virgin Islands under the Master Settlement Agreement (the “MSA”) entered into by participating cigarette manufacturers (the “PMs”), the Virgin Islands, 46 states and five other U.S. jurisdictions in November 1998 in the settlement of certain smoking-related litigation, including, the Virgin Islands’ right to receive future initial, annual and strategic contribution fund payments (such Payments as more fully defined herein, the “TSRs”) to be made by the PMs under the MSA. The Series 2001 Bonds and any series of refunding Bonds are being issued pursuant to an Indenture, dated as of November 1, 2001, as supplemented (the “Indenture”), between the Corporation and The Bank of New York, as indenture trustee (the “Indenture Trustee”). The Indenture prohibits the Corporation from issuing additional bonds, provided however that refunding bonds may be issued by the Corporation Subject to the satisfaction of certain conditions described herein. See “THE SERIES 2001 BONDS — Refunding Bonds.” The Series 2001 Bonds will be secured by and are payable solely from (i) the TSRs (ii) investment earnings on certain accounts pledged under the Indenture (which earnings, together with the TSRs, are referred to herein as the “Collections”), (iii) amounts held in the debt service reserve account (the “Debt Service Reserve Account”) and the NPM adjustment reserve account (the “NPM Adjustment Reserve Account”) established under the Indenture (as more fully described herein, the “Reserves”), (iv) amounts held in the other accounts established under the Indenture (except the Rebate Account) and (v) the rights of the Corporation under the Purchase Agreement. The proceeds of the Series 2001 Bonds, except as deposited in the Debt Service Reserve Account, and other assets of the Corporation (other than the Collections) are not pledged to the payment of, and are therefore not available to the holders of, the Series 2001 Bonds. Pursuant to the Act, the Purchase Agreement and the Indenture, the Corporation has, in the opinion of Transaction Counsel, validly included the pledge and agreement of the Virgin Islands not to limit or alter the rights of the Corporation to fulfill the terms of the Purchase Agreement and the Indenture or impair the rights and remedies of the Bondholders. PAYMENT OF THE SERIES 2001 BONDS IS DEPENDENT ON RECEIPT OF TSRs. THE AMOUNT OF TSRs ACTUALLY COLLECTED IS DEPENDENT ON MANY FACTORS INCLUDING CIGARETTE CONSUMPTION AND THE FINANCIAL CAPABILITY OF THE PMs. SEE “RISK FACTORS” FOR A DISCUSSION OF CERTAIN FACTORS THAT SHOULD BE CONSIDERED IN CONNECTION WITH AN INVESTMENT IN THE SERIES 2001 BONDS. The Series 2001 Bonds maturing on or before May 15, 2014 shall be serial convertible capital appreciation bonds (each a “Convertible CAB”). The Series 2001 Bonds, other than the Convertible CABS, shall be term bonds (each a “Term Bond”). The Series 2001 Term Bonds mature on May 15, 2021 and May 15, 2031. The amount payable on the Series 2001 Bonds on their respective maturity dates is referred to herein as “Principal.” Failure to pay interest on or Principal of the Series 2001 Bonds when due will constitute an Event of Default as described herein. The rating of the Series 2001 Bonds only addresses the Rating Agency’s assessment of the ability of the Corporation to pay interest and Principal when due. Interest and Principal payments will be made from Collections, and, if necessary, Reserves, The Corporation has also covenanted to apply 100% of all Surplus Collections (as defined herein) pursuant to the Indenture to the special mandatory par redemption (“Turbo Redemptions”) of the Term Bonds in order of maturity, and in each case, to the extent made, will be Interest on the Series 2001 Bonds (except the Convertible CABs prior to May 15, 2008) will be payable on each May 15 and November 15, commencing May 15, 2002. The Series 2001 Bonds are subject to redemption and prepayment as described herein. See Inside Cover for Dated Date, Maturity Schedule, Interest Rates, and Prices or Yields Salomon Smith Barney The Series 2001 Bonds are offered when, as and ifissued and accepted by the Underwriter, subject to the approval of legality by Buchanan Ingersoll Professional Corporation, New York, New York, as Transaction Counsel. C. ertain legal matters will be passed upon for the Underwriter by Hawkins, Delafield & Wood, New York, New York, as Underwriter ‘s Counsel. It is expected that the Series 2001 Bonds will be available for delivery in book-entry form only through The Depository Trust Company in New York, New York on or about November 20, 200]. November 8, 2001 t Initial Aggregate Principal Amount. $21,709,861.90 , Series 2001 Bonds Dated: Date of Delivery $6,234,861.907 Series 2001 Serial Maturities (Accretion Period ends on November 15, 2007) Initial Amount per $5,000 Accreted Value Principal Amount at End of Initial Principal Serial Maturity at End of Accretion Amount Date (May 15) _ Accretion Period Yield Period $705,395.60 2008 $ 910,000 4.300% $3,875.80 793,759.20 2009 1,030,000 4.400% 3,853.20 842,754.00 2010 1,100,000 4.500% 3,830.70 887,333.90 2011 1,165,000 4.600% 3,808.30 955,087.65 2012 1,265,000 4.750% 3,775.05 1.002,064.35 2013 1,335,000 4.850% 3,753.05 1.048.467.20 2014 1,405,000 4.950% 3,731.20 $15,475,000 Series 2001 Term Bonds $7,430,000 5.000% Term Bonds Rated Maturity Date May 15, 2021; Yield of 4.950% Projected Final Turbo Redemption Date: May 15, 2013 (Expected Average Life: 7.1 years) " $8,045,000 5.000% Term Bonds Rated Maturity Date May 15, 2031; Yield of 5.125% Projected Final Turbo Redemption Date: May 15, 2016 (Expected Average Life: 13.8 years) i Initial aggregate principal amount. "Assumes Turbo Redemptions are made based on the receipt of Surplus Collections (as defined herein) in accordance with the DRIeWEFA Base Case Forecast and other structuring assumptions. Projections of expected average lives and final Turbo Redemption Dates have not been rated by the Rating Agency. See “SUMMARY OF BOND STRUCTURING ASSUMPTIONS— Effect of Changes in Cigarette Consumption Levels on Turbo Redemptions.” No assurance can be given that these structuring assumptions will be realized. CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS THAT STABILIZE OR MAINTAIN THE PRICE OF THE SECURITIES AT A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN MARKET, OR OTHERWISE AFFECT THE PRICE OF THE SECURITIES OFFERED HEREBY, INCLUDING OVER-ALLOTMENT AND STABILIZING TRANSACTIONS. SUCH STABILIZING, IF COMMENCED, MAY BE DISCONTINUED AT ANY TIME. NO DEALER, BROKER, SALESPERSON OR OTHER PERSON IS AUTHORIZED IN CONNECTION WITH ANY OFFERING MADE HEREBY TO GIVE ANY INFORMATION OR MAKE ANY REPRESENTATION OTHER THAN AS CONTAINED HEREIN, AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATION MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE CORPORATION, THE VIRGIN ISLANDS OR THE UNDERWRITER. THIS OFFERING CIRCULAR DOES NOT CONSTITUTE AN OFFER TO SELL, OR A SOLICITATION OF AN OFFER TO BUY, ANY OF THE SECURITIES OFFERED HEREBY BY ANY PERSON IN ANY JURISDICTION IN WHICH IT IS UNLAWFUL FOR SUCH PERSON TO MAKE SUCH AN OFFER OR SOLICITATION. THERE IS CURRENTLY A LIMITED SECONDARY MARKET FOR SECURITIES SUCH AS THE SERIES 2001 BONDS. THERE CAN BE NO ASSURANCE THAT A SECONDARY MARKET FOR THE SERIES 2001 BONDS WILL DEVELOP, OR IF ONE DEVELOPS, THAT IT WILL PROVIDE BONDHOLDERS WITH LIQUIDITY OR THAT IT WILL CONTINUE FOR THE LIFE OF THE SERIES 2001 BONDS. This Offering Circular contains information furnished by the Corporation, DRI¢WEFA and other sources, all of which are believed ‘o be reliable. Information concerning the tobacco industry and participants therein has been obtained from certain publicly available information provided by certain participants and certain other sources (see “TOBACCO INDUSTRY”). The participants in such industry have not provided any information to the Corporation for use in connection with this offering. In certain cases, tobacco industry information provided herein (such as market share data) may be derived from sources which are inconsistent or in conflict with each other. The Corporation has no independent knowledge of any facts indicating that the information under the caption “TOBACCO INDUSTRY” herein is inaccurate in any material respect, but has not independently verified this information and cannot and does not warrant the accuracy or completeness of this information. The information contained under the caption “DRI*WEFA Report” attached as Appendix A hereto has been included in reliance upon DRI*WEFA as an expert in econometric forecasting. The information and expressions of opinion contained herein are subject to change without notice and neither the delivery of this Offering Circular nor any sale made hereunder shall, under any circumstances, create any implication that there has been no change in the affairs of the Corporation or the matters covered by the report of DRI*WEFA included as Appendix A to, or under the caption “TOBACCO INDUSTRY” in, this Offering Circular since the date hereof or that the information contained herein is correct as of any date subsequent to the date hereof. Such information and expressions of opinion are made for the purpose of providing information to prospective investors and are not to be used for any other purpose or relied on by any other party. See “CONTINUING DISCLOSURE UNDERTAKING.” This Offering Circular contains forecasts, projections and estimates that are based on current expectations or assumptions. In light of the important factors that may materially affect the amount of Collections (see “RISK FACTORS” and “SUMMARY OF THE MASTER SETTLEMENT AGREEMENT” herein), the inclusion in this Offering Circular of such forecasts, projections and estimates should not be regarded as a representation by the Corporation, the Virgin Islands, DRIeWEFA or the Underwriter that the results of such forecasts, projections and estimates will occur. Such forecasts, projections and estimates are not intended as representations of fact or guarantees of results. If and when included in this Offering Circular, the words “expects,” “forecasts.” “projects,” “intends,” “anticipates,” “estimates,” “assumes” and analogous expressions are intended to identify forward-looking statements and any such statements inherently are subject to a variety of risks and uncertainties that could cause actual results to ili ditfer materially from those that have been projected. Such risks and uncertainties include, among others, general economic and business conditions. changes in political, social and economic conditions, regulatory initiatives and compliance with governmental regulations. litigation and various other events, conditions and circumstances, many of which are beyond the control of the Corporation. These forward-looking statements speak only as of the date of this Offering Circular. The Corporation disclaims any obligation or undertaking to release publicly any updates or revisions to any forward-looking statement contained herein to reflect any changes in the Corporation’s expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based. THE SERIES 2001 BONDS HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE UNITED STATES SECURITIES AND EXCHANGE COMMISSION, ANY STATE SECURITIES COMMISSION OR ANY OTHER REGULATORY AUTHORITY, NOR HAS ANY OF THE FOREGOING PASSED UPON THE ACCURACY OR ADEQUACY OF THIS OFFERING CIRCULAR. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. TABLE OF CONTENTS Page SUMMARY STATEMENT .........cccccceeeeseereeteeneenee S-1 INTRODUCTORY STATEMENT ..........:cccessereeteees 1 RISK FACTORS .....cccececceceeseeeeeesesseesessessesseenesseseaenes 2 Decline in Cigarette Consumption Materially Beyond Forecasted Levels May Adversely Affect PayMent 0.0.0... cccccccce esc ceeeteeeneeeneeeeens 2 Tobacco Industry Litigation ...........: scenes 3 Uncertain Business Environment for Domestic Tobacco INdustry.......ccccecesesecsseessesseseessessenseens 5 Insolvency of PMs May Delay or Reduce PAyMEeMts 0... eeccceccecceeeeeeteesetectentetsetecneeaenenaes 5 Other Potential Payment Decreases under the Terms of the Master Settlement Agreement ...... 6 Uncertainty as to Timing of Amortization of Term Bods .o...ccceccceeccceseeenecetecessceseeesseeseesseesaeenseeneeenaas 7 Risks Related to Enforceability or Modification of the Master Settlement Agreement and Constitutionality of the Model Statute ............... 7 Limited Resources of the Corporation ............:006 9 Limited Remedies 200.0... ceeccccseeeeeneenseneeteeeeeaes 9 Limited Liquidity of the Bonds ............: esses 9 Limited Nature of Ratings; Reduction, Suspension or Withdrawal of a Rating........ccccecceseeereeseeeeees 9 IRS Tobacco Audits ........cccccecceeseeeseeeteenteeeeeeeee 10 LEGAL CONSIDERATIONS .......cccccccccccssceeeeteeseneens 11 Bankruptcy Of & PM oo... ceccecseseseeteteeeeeeeeeneens 11 MSA Enforceability ....0.... ccc cceecseeseeeseeteeteeee 12 Model Statute Constitutionality ..........:ccceeeeee 13 Limitations on Certain Opinions of Transaction COUMSE] .....cccecceeeceeteeeeeeenee teasers eeeeseeeeeeeeneeeneees 13 No Assurance as to the Outcome of Litigation... 14 Corporation and Virgin Islands Not Eligible to Declare Bankruptcy........cccceececeeteeteeneeteenaes 14 THE CORPORATION 0.0... ccceceeeeteteceseensetesneenaeees 14 SOURCES AND USES OF FUNDSG........cccceeeeeees 15 Capital Project ......ccccccccceseeseereteeneteteeneteenenes 15 THE SERIES 2001 BONDS .Q.......cccccceseteeseeeteeteneees 16 Payments of Interest ..........ccccccccseeeeneeteeeeeeeneneees 16 Accreted Value of Convertible CABS.............06 16 Payments of Principal and Turbo Redemptions .. 17 Extraordinary PrepayMent..........ccccceeeeseeseeeeees 17 Lump Sum Prepayment ..........cc:ececeseeeeeeeenees 17 Optional Redemption .........ccceccceeeeeeteteeeeeseees 17 Refunding Bonds.........ccccccescseseseeeteeerteetereens 18 Book-Entry Only System .......ccccccceseeeeeeeeeereeees 18 SECURITY oo... cccccccceceececeeccesseeeeecsesseesesesessenseessenesees 20 General ......ccccccccececceeeseeceeeeeneeeeeseeeeeessseesensnneeeee 20 Payment by MSA Escrow Agent to Indenture TYUSLCC oo..cceccccecceeeceeeceneeeeeeeeseessecsseseeeseeeeeaeens 21 ACCOUMS.....ccccccceceeeececeteceeseesesseseseseeeeneeeneesseenseens 21 Flow of Funds ......ccccccceceseeseesesseseesecseessenaseneees 22 Page Events of Default .........0 cece eset ceteessesseeneeeees 25 Non-Impairment Pledge of the Virgin Islands.....25 SUMMARY OF THE MASTER SETTLEMENT AGREEMENT. .........::cccceeceesessceeeeeseesesseeseenesenensesnaey 26 Gerneral........cccccesseeceececcseeesensceeesseceeeeenseeessseeenaes 26 Parties to the MSA... icc ceeeceeceeeeteeeteeeeeneeenee 26 Scope Of Release ........ccccecceceeseeseeseeeeeneteeceereees 27 Overview of Payments by the Participating Manufacturers ........c:ccccceeceesesserseseeeeeseesseeeneeees 27 Initial Payment .0..... cece eee eee eeeceeeeeteeteeeeee 28 Annual Payment ........... cc ecccecceseteeseeeeneeeeseeees 29 Strategic Contribution Fund Payments................ 30 Adjustments to PayMents.........cccccccceseereeteeeteens 30 Subsequent Participating Manufacturers .............33 Payments Made to Date ...........ccceeseeeseeseeeeeeeeeens 33 “Most Favored Nation” Provisions............:c 35 State-Specific Finality and Final Approval.......... 35 Disbursement of Funds from Escrow ...........000 35 Advertising and Marketing Restrictions; Educational Programs ............:ccccesesesseeeteeees 36 Termination of Agreement.............cccceceeeseeeeeees 36 Severability 0... cece cee eeecsseeseceseesteeeeeeeeerenees 37 Amendments and Waivers ...........::cccsesseeseerseenees 37 MSA Provisions Relating to Model/Qualifying Statutes .....cccccccseceseccsteessssesseeeessesssseeesseeeeseees 37 TOBACCO INDUSTRY ......c cece cece eteeteeneeees 39 Industry Overview .0........ccccceeseeeeeteeeeeteeeneeeaeene 39 Shipment Trends ..........cccccceseesessesseeseeeeeeeeeneeenees 4] Consumption Trends...........ccccceeeesseeseeeteeeeeeeees 4) Tax Collections and Retail Expenditures............. 41 Distribution, Competition and Raw Materials .....42 Grey Market.....cccccccccceccsecseerenseteeneeeneenereeeeens 42 Regulatory ISSues.........cccccsseeseeeeeeteeteeeneeneeneens 42 Civil Litigation... eee cece ecneeeneeeesteeeneees 45 DRI*WEFA REPORT 1.0.0.0... ccecceccseseenestseneeeeensenseenes 55 General .......cccccecceecceeceseeeeseeeseeeseeseeeeeeeseeseenseeens 55 Comparison With Prior Forecasts ........:ceeree 57 Historical Cigarette Consumption.............ce 57 Factors Affecting Cigarette Consumption ........... 59 SUMMARY OF BOND STRUCTURING ASSUMPTIONS. .....cccceccccesceessescesceseneeseesesseseeneenes 61 Introduction ........c cee eee eects ceeeceseeseeeneeeseeeeneeeees 61 Collection Methodology and Assumptions.......... 61 Interest Earnings ..........ccceeceeeeesseesseeeeeesseeeseeenees 70 Structuring ASSUMPTIONS...........:ccececeeeeteeteeteees 70 Effect of Changes in Consumption Level on Turbo Redemptions 00... cece cece eeseeereeeeeeseeeneeeeeens 73 SUMMARIES OF CERTAIN PROVISIONS OF THE TRANSACTION DOCUMENTS ..........c cece 78 Certain Defimitions.........0....ecccceeseeeeeteeeteeeteenee 78 The Indenture ........0.ccccccccccccssssceeeeceeeseeeeeeesaeeeees 83 —_ . oN Page Page The Purchase Agreement... cree DS Financial Advisor ccc cee LOS CONTINUING DISCLOSURE UNDERTAKING... (00 DRTOWEE A cee cc ce tennrenee 105 LITIGATION oo. , woe LOL TAN MATTERS oo. eee $02 INDIEX OF DEFINED TERMS occa. 106 General ce coe tetettee 102 Original Issue Discount... bee vee LO2 APPENDIX A - DRIEeWEFA REPORT oo. A-1 Original Issue Premium... ee $02 APPENDIX B - MASTER SETTLEMENT Certain Federal Tax Intormation. 00000000000... 103 AGREEMENT 000. B-] IRS Tobaceo Audits 0 eee 104 APPENDIX C - PROPOSED FORM OF RATING woe Otte [O04 OPINION OF TRANSACTION UNDERWRITING woo ee LOM COUNSEL... C-1 LEGAL MATTERS weenie 105 APPENDIX D - ACCRETED VALUE TABLE.......D-1 OTHER PARTIES woe ce cee 10s Vi SUMMARY STATEMENT This Summary Statement is subject in all respects to more complete information contained in this Offering Circular and should not be considered a complete statement of the facts material to making an investment decision. The offering of the Series 2001 Bonds to potential investors is made only by means of the entire Offering Circular. For locations of definitions of certain terms used herein, see the “Index of Defined Terms.” OVELVIEW oo eecccccscceeeeccesesctececeesseeeenss Security The $21,709,861.90 initial aggregate principal amount of Tobacco Settlement Asset-Backed Bonds, Series 2001 (the “Series 2001 Bonds”) are being issued by the Tobacco Settlement Financing Corporation (the “Corporation”), a special purpose, independent instrumentality of the United States Virgin Islands (the “Virgin Islands”) created by Bill No. 24- 0078 of the Twenty-Fourth Legislature of the United States Virgin Islands, Tobacco Settlement Financing Act of 2001 (the “Act”). Pursuant to the Act, and a Purchase and Sale Agreement, dated as of November 1, 2001 (the “Purchase Agreement”), the Virgin Islands will sell to the Corporation, on the Closing Date, all of its right, title and interest in certain amounts payable to the Virgin Islands under the Master Settlement Agreement (the “MSA”) entered into by participating cigarette manufacturers (the “PMs”), the Virgin Islands, 46 states and five other U.S. jurisdictions in November 1998 in the settlement of certain smoking-related litigation, including the Virgin Islands’ right to receive future initial, annual and strategic contribution fund payments (such payments as more fully defined herein, the “TSRs”) to be made by the PMs under the MSA. No additional bonds may be issued under the Indenture which are secured by a pledge of the TSRs, other than refunding bonds. The Corporation is a special purpose, independent instrumentality of the Virgin Islands created by the Act. The Series 2001 Bonds are being issued pursuant to an Indenture, dated as of November 1, 2001, as supplemented by the Series 2001 Supplement (the “Indenture”), between the Corporation and The Bank of New York, as indenture trustee (the “Indenture Trustee”). The Series 2001 Bonds, together with any additional refunding bonds issued on a parity therewith, are collectively referred to herein as the “Bonds.” See “THE SERIES 2001 BONDS — Refunding Bonds.” It is expected that the Series 2001 Bonds will be delivered in book-entry form through the facilities of The Depository Trust Company, New York, New York (“DTC”), on or about November 20, 2001 (the “Closing Date”). Individual purchases of beneficial ownership interests may be made in the principal amount of $5,000 or any integral multiple thereof other than the Convertible CABs and (ii) in the case of the Convertible CABs in an amount such that the amount (the “Accreted Value”) of each Convertible CAB at the expiration of the accretion period therefor will equal $5,000 or any integral multiple thereof. The initial principal amount of each Convertible CAB per $5,000 Accreted Value and the yield on each such Convertible CAB is set forth on the inside cover hereof. Beneficial owners of the Series 2001 Bonds will not receive physical delivery of bond certificates. The Series 2001 Bonds and any additional series of refunding Bonds will be secured by and are payable solely from (i) the TSRs, (ii) investment earnings on certain accounts pledged under the Indenture (which earnings, together with the TSRs, are referred to herein as the “Collections”), (iii) amounts held in the Debt Service Reserve Account (the “Debt Service Reserve Account”) and the NPM Adjustment Reserve Account (the “NPM Use of Proceeds ..........ceee Master Settlement Agreement Adjustment Reserve Account”) established under the Indenture (as more fully defined herein, the “Reserves”), (iv) amounts held in the other accounts established under the Indenture (except the Rebate Account) and (v) the Corporation’s rights under the Purchase Agreement. The proceeds of the Series 2001 Bonds, except the amounts deposited in the Debt Service Reserve Account, the Operating Account and the Costs of Issuance Account and the assets of the Corporation, other than the Collections, are not pledged to the payment of, and are therefore not available to, the holders of the Series 2001 Bonds. Pursuant to the Purchase Agreement, the Corporation will make $18,453,870 of the proceeds of the Series 2001 Bonds available to the Government of the Virgin Islands for the financing of several capital hospital and health department projects, including: (a) the costs of construction in replacing a destroyed building and in renovating the existing facilities of the United States Virgin Islands Department of Health; (b) the costs of renovating the emergency room and clinics, improvements to the cardiac care unit, constructing a warehouse, replacing the water line, and upgrading the air- conditioning system at the Juan F, Luis Hospital on the island of St. Croix; and (c)the costs of developing new facilities and purchasing new radiotherapy/cancer center equipment for the Roy Lester Schneider Hospital on the island of St. Thomas (collectively, the “Capital Projects”). The balance of the proceeds of the Series 2001 Bonds will be applied: (i) to fund the Debt Service Reserve Account at its required amount, (ii) to pay certain costs of issuance relating to the Series 2001 Bonds, and (ili) to fund initial operating costs, The MSA was entered into on November 23, 1998 among the attorneys general of the 46 states, Virgin Islands, Puerto Rico, Guam, the District of Columbia, American Samoa and the Commonwealth of the Northern Mariana Islands (collectively, the “Settling States”) and the four largest United States tobacco manufacturers: Philip Morris Incorporated (“Philip Morris”). R.J. Reynolds Tobacco Company (“Reynolds Tobacco”), Brown & Williamson Tobacco Corporation (“B&W”) and Lorillard Tobacco Company (“Lorillard”) (collectively, the “Original Participating Manufacturers” or “OPMs”). According to Philip Morris, the OPMs accounted for approximately 94.8%" of the United States domestic cigarette market in 2000 based upon shipments. The MSA resolved cigarette smoking-related litigation between the Settling States and the OPMs and released the OPMs from past and present smoking-related claims by the Settling States, and provides for a continuing release of future smoking-related claims, in exchange for certain payments to be made to the Settling States (including Initial Payments, Annual Payments and Strategic Contribution Fund Payments, each as defined herein), and the imposition of certain tobacco advertising and marketing restrictions, among other things. The Corporation is not a party to the MSA. The manufacturers’ market share information based upon shipments as reported by Philip Morris may be different from Relative Market Share for purposes of the MSA and the respective obligations of the OPMs to contribute to Initial Payments, Annual Payments and Strategic Contribution Fund Payments and is different from that utilized in the bond structuring assumptions. See “SUMMARY OF THE MASTER SETTLEMENT AGREEMENT “—Initial Payments,” °“—Annual Payments” and “—Strategic Contribution Fund Payments” and “SUMMARY OF BOND STRUCTURING ASSUMPTIONS.” Payments Pursuant to the MSA The MSA is an industry-wide settlement of litigation between the Settling States and the Participating Manufacturers (as such term is defined below). The MSA permits tobacco companies other than the OPMs to become parties to the MSA. Tobacco companies other than OPMs that become parties to the MSA are referred to herein as “Subsequent Participating Manufacturers” or “SPMs,” and the SPMs, together with the OPMs, are referred to herein as the “Participating Manufacturers” or “PMs.” Tobacco companies that do not become parties to the MSA are referred to herein as “Non-Participating Manufacturers’ or ‘“NPMs.” See “SUMMARY OF THE MASTER SETTLEMENT AGREEMENT.” Under the MSA, the Virgin Islands is entitled to 0.0173593% of the Initial Payments and Annual Payments and 0.1800232% of the Strategic Contribution Fund Payments made by PMs under the MSA. Under the MSA, the OPMs are required to pay to the Settling States (i) five initial payments (the “Initial Payments”), three of which have already been made, and the last two of which are due on January 10 of 2002 and 2003, (ii) annual payments (the “Annual Payments”) which are required to be made annually on each April 15, having commenced April 15, 2000, and continuing in perpetuity and (ili) ten strategic contribution fund payments (the “Strategic Contribution Fund Payments”), which are required to be made annually on each April 15, commencing April 15, 2008 through April 15, 2017. The Initial Payments, Annual Payments and Strategic Contribution Fund Payments due under the MSA are subject to numerous adjustments, some of which are material. Such adjustments include, among others, reductions for decreased domestic cigarette shipments, reductions for amounts paid by OPMs to four states which had previously settled their claims against the PMs independently of the MSA, and increases related to inflation in an amount of not less than 3% per year in the case of the Annual Payments and the Strategic Contribution Fund Payments. Final Approval of the MSA occurred on November 12, 1999. Upon Final Approval, Citibank N.A., as the escrow agent appointed pursuant to the MSA (the “MSA Escrow Agent’), distributed the up-front Initial Payment, and since then has distributed the subsequent Initial Payments due January 10, 2000, January 10, 2001 and the Annual Payment due April 15, 2000 and April 15, 2001 to the Settling States that achieved State-Specific Finality. The Virgin Islands has already received its share of these payments, none of which, other than the April 15, 2001 Annual Payment, which shall be deposited in the NPM Adjustment Reserve Account, are pledged to the holders of the Series 2001 Bonds. (See “SECURITY—Accounts—NPM Adjustment Reserve Account.’’) Under the MSA, each OPM is required to pay an allocable portion of each remaining Initial Payment and each Annual Payment and Strategic Contribution Fund Payment based on its relative market share of the United States cigarette market during the preceding calendar year, subject to certain adjustments as described herein. Each SPM has Annual Payment and Strategic Contribution Fund Payment obligations under the MSA (separate from the payment obligations of the OPMs) according to its market share only if its market share exceeds the higher of its 1998 market share or 125% of its 1997 market share. The SPMs have no payment obligation with 8-3 Sale of Tobacco Settlement ReVENUES 00... ccceeee ccc ccccc eee eeeecceeeeeeeeeeees Flow of TSRS ........ccccccccccceeceeeeeeenenene respect to the Initial Payments. The payment obligations follow tobacco product brands if they are transferred by any of the PMs. Payments by the PMs are required to be made to the MSA Escrow Agent, which is required, in turn, to remit an allocable share of such payments to the parties entitled thereto. See “SUMMARY OF THE MASTER SETTLEMENT AGREEMENT.” Pursuant to the Act and the Purchase Agreement, the Virgin Islands will sell to the Corporation on the Closing Date all of its right, title and interest after February |, 2001 in certain amounts payable to the Virgin Islands under the MSA, including the Virgin Islands’ right to receive the TSRs. Under the Indenture, the Corporation will assign and pledge the TSRs to the Indenture Trustee. Accordingly, such TSRs will be paid directly by the MSA Escrow Agent to the Indenture Trustee. Payment of TSRs will not be subject to appropriation by the Virgin Islands. The purchase consideration to be paid by the Corporation to the Virgin Islands under the Purchase Agreement will consist of the agreement of the Corporation to transfer the net proceeds of the Series 2001 Bonds and the investment income thereon to the Indenture Trustee. to be held in the Construction Account created by the Series 2001 Supplement for the benefit of the Government to finance the Capital Projects. The MSA Escrow Agent will disburse the TSRs from the Virgin Islands State-Specific Account directly to the Indenture Trustee. The following diagram depicts the flow of TSRs. Industry Overview . Participating Manufacturers |! MSA Escrow Agent | Other State-Specific Accounts under the MSA United States Virgin Islands State-Specific Account ' Indenture Trustee Cigarette Consumption and DRIeWEFA Report Bondholders The four OPMs, Philip Morris, Reynolds Tobacco, B&W and Lorillard, are the largest manufacturers of cigarettes in the United States (based on 2000 market share). The market for cigarettes is highly competitive, and is characterized by brand recognition and loyalty. See “TOBACCO INDUSTRY.” DRI*eWEFA, Inc. (“DRI*WEFA”), an international econometric and consulting firm of over 400 economists in 22 offices worldwide, has been retained on behalf of the Corporation to forecast cigarette consumption in the United States from 2000 through 2030. DRI*WEFA is a wholly-owned subsidiary of Global Insight Inc., a privately held company which is a provider of financial, economic and market research information. DRI*WEFA considered the impact of demographics, cigarette prices, disposable income, employment and unemployment, industry advertising expenditures, the future effect of the incidence of smoking among underage youth, and qualitative variables that captured the impact of anti-smoking regulations, legislation and health warnings. After extensive analysis, DRI*WEFA found the following variables to be effective in building an empirical model of adult per capita cigarette consumption: real cigarette prices, real per capita disposable personal income, the impact of restrictions S-5 Interest ccs Accreted Value on Convertible CABS oo... ccceecceeeeeeees Payment of Principal on smoking in public places and the trend over time in individual behavior and preferences. Using data trom 1965 to 1999 and an analysis of the variables. DRI¢eWEFA constructed an empirical model of adult per capita cigarette consumption (“CPC”) for the United States. Using standard niultivariate regression analysis to determine the relationship between such variables and CPC along with DRIeWEFA’s standard adult) population growth statistics and adjustments for non-adult) smoking, DRI*WEFA projected adult cigarette consumption out to 2030. DRI*WEFA’s report. entitled A Forecast of Total U.S. Cigarette Consumption (2000-2030) for the Tobacco Settlement Financing Corporation (the “DRI*eWEFA Report’). is attached hereto as Appendix A and should be read in its entirety for an understanding of the assumptions on which it is based and the conclusions it reaches. While the DRIeWEFA Report is based on United States cigarette consumption, MSA payments are based in part on cigarette shipments in or to the 50 United States, the District of Columbia and Puerto Rico. The DRI*WEFA Report states that the quantities of cigarettes shipped and cigarettes consumed within the United States may not match at any given point in time as a result of various factors, such as inventory adjustments, but are substantially the same when compared over a period of time. See “DRIeWEFA REPORT.” Interest on the outstanding principal amount of the Series 2001 Bonds (except the Convertible CABs prior to May 15, 2008) from their date of issue will be payable on each May 15 and November 15 (each, a “Distribution Date”). commencing May 15. 2002. Interest will be computed on the basis of a 360-day year consisting of twelve 30-day months. Failure to pay the full amount of interest when due is an Event of Default (as hereinafter defined). If on any Distribution Date there are insufficient funds to pay all interest then due on the Bonds. available amounts will be allocated pro rata among all Bonds based on the respective amounts of interest due thereon. The Convertible CABs will not begin accruing current interest until from and after November 15, 2007. Prior to such date. interest on the Convertible CABs will accrete so that the value of each such Convertible CAB will be an amount equal to the initial principal amount thereof, plus interest accrued thereon from the date of original issuance of such Convertible CAB compounded on May 15 and November 15 of each year, commencing on the Closing Date, at the respective original issue yield to November 15, 2007. The Accreted Value as of each May IS and November [5 from the Closing Date through and including November 15, 2007 is set forth herein. The Accreted Value on other than May 15 and November [5 shall be calculated by straight-line interpolation of the Accreted Value. See “THE SERIES 2001 BONDS —Accreted Value of Convertible CABs”) The Principal of a Series 2001 Bond must be paid on the stated maturity date thereof (each, a “Maturity Date”) in order to avoid an Event of Default as described herein. The ratings of the Series 2001 Bonds only address the Rating Agency's assessment of the ability of the Corporation to pay interest when due and to pay Principal of the Series 2001 Bonds on their respective Maturity Dates and do not address the making of Turbo Redemptions. See S-6 Turbo Redemptions ................. Actual Payments of Principal .. Optional Redemption............... Debt Service Reserve Account “RATING.” Principal will be paid from Collections and, if necessary, Reserves. A failure by the Corporation to pay the Principal of a Series 2001 Bond on its applicable Maturity Date will constitute an Event of Default under the Indenture. “Turbo Redemptions” for the Term Bonds represent the requirement contained in the Indenture to apply /00% of all Collections which are in excess of Indenture requirements for the funding of Operating Expenses, deposits in the Debt Service Account maintained under the Indenture for the funding of interest and Principal, and maintenance of the Debt Service Reserve Account (such excess, the “Surplus Collections”), to the special mandatory par redemption of the Term Bonds on each Distribution Date (each, a “Turbo Redemption Date’), in ascending order of maturity. Turbo Redemptions are not scheduled amortization payments and are to be made only from Surplus Collections, if any. The Debt Service Reserve Account will not be available to make Turbo Redemptions. The rating of the Term Bonds does not address the Rating Agency’s assessment of the Corporation’s ability to make Turbo Redemptions. Due to a number of factors, including actual shipments of cigarettes in the United States, the amount of available Collections may fluctuate from year to year. As a result, Collections received by the Corporation may be insufficient to pay Principal or sufficient to pay Principal but insufficient to make Turbo Redemptions. A failure by the Corporation to pay the Principal of a Series 2001 Bond on its applicable Maturity Date will constitute an Event of Default under the Indenture. Failure to pay Turbo Redemptions is not an Event of Default. The Series 2001 Bonds having a Maturity Date on or after May 15, 2012 are subject to redemption at the Corporation’s option at any time on or after May 15, 2011 in whole or in part, at a redemption price of 100% of the principal amount thereof, plus accrued interest to the date of redemption. At its sole discretion the Corporation may select dates, amounts, interest rates and maturities of those Series 2001 Bonds subject to optional redemption. A reserve account (the “Debt Service Reserve Account’) will be established and held by the Indenture Trustee and will be funded from proceeds of the Series 2001 Bonds in the amount of $1,745,506. Except after an Event of Default, the balance in the Debt Service Reserve Account must be maintained, to the extent of available funds, at the least of (i) the initial deposit therein, plus retained earnings therein, (ii) the amount of $2,352,750 and (iii) the principal amount of Bonds Outstanding on the date of the calculation (the “Debt Service Reserve Requirement”) . Amounts on deposit in the Debt Service Reserve Account will be available to pay (i) the Principal of and interest on the Series 2001 Bonds to the extent Collections are insufficient for such purpose and (ii) after an Event of Default, Extraordinary Prepayments (as defined herein). Amounts in the Debt Service Reserve Account will not be available to make Turbo S-7 NPM Adjustment Reserve Account.. Events of Default: Extraordinary Prepayment Redemptions. Unless an Event of Default has occurred, amounts withdrawn from the Debt Service Reserve Account will be replenished from Collections as deseribed herein. A reserve account (the "NPM Adjustment Reserve Account”) will be established and held by the Indenture Trustee and will be funded in an amount equal to the April 15. 200] Annual Payment in the amount of $696,377.55 received by the Virgin Islands (together with all interest earnings thereon) (the “2001 Annual Payment’). The Virgin Islands has advised the Corporation that the MSA Auditor expects to receive information which will result in a recalculation of the aggregate national 2001 Annual Payment. Such recalculation could give rise to an NPM Adjustment which, as a result of the timing of the Virgin Islands’ enactment of its Model Statute, could in turn reduce or eliminate the Virgin Islands’ 2001 Annual Payment. Any such reduction or elimination would be effected through an offset against future payments of TSRs. If the Indenture Trustee shall receive written notice from the Corporation that the Virgin Islands 2001 Annual Payment is subject to an NPM Adjustment, then the Indenture Trustee shall transfer the amount of such NPM Adjustment (including any payment of accrued interest on such amounts pursuant to the MSA) from the NPM Adjustment Reserve Account to the Collection Account for application pursuant to the Indenture; provided that all amounts on deposit in the NPM Adjustment Reserve Account shall be released to the Corporation for transfer to the Virgin Islands upon receipt by the Indenture Trustee of written evidence from the Rating Agency then rating the Outstanding Bonds that no Bond rating will be withdrawn, reduced or suspended solely as a result of such action (a “Rating Confirmation”). In the event the Indenture Trustee has not received a Rating Confirmation or written notification of an NPM Adjustment by April 15, 2005. the Indenture Trustee shall commence proceedings to seek a Rating Confirmation to secure release of such funds on deposit in the NPM Adjustment Reserve Account. The occurrence of any of the following events will constitute an “Event of Default” under the Indenture: (i) failure to pay Principal of or interest on the Bonds when due: (11) the Corporation fails to observe or perform any other provision of the Indenture which is not remedied within 60 days after notice thereof has been given to the Corporation by the Indenture Trustee or to the Corporation and the Indenture Trustee by holders of not less than 25% in principal amount or Accreted Value of the Outstanding Bonds; (iii) the institution of bankruptcy. reorganization, arrangement. or insolvency proceedings or other proceedings for relief under any bankruptcy or similar law or laws for the relief of debtors by the Corporation which are not dismissed within 60 days after such institution: (iv) the Virgin Islands fails to observe or perform ifs covenant not to limit or alter the rights of the Corporation necessary to fulfill the terms of the Corporation’s agreements with the holders of the Outstanding Bonds, or in any way impairs the rights and remedies of such holders or the security for the Bonds and which failure is not remedied within 60 days after notice thereof has been given to the Corporation by the Indenture Trustee or to the Corporation and the Indenture Trustee by holders of not less than 25% in principal amount or Accreted S-8 Extraordinary Prepayment ACCOUMNL....ceccccereceeeeeeee Lump Sum Prepayment ..... Distributions and Priorities Value of the Outstanding Bonds; (v) the Virgin Islands fails to pay promptly to the Corporation or to the Indenture Trustee any TSRs received by it; and (vi) the Virgin Islands consents to or acquiesces in an amendment or modification of the MSA so as to materially reduce the amount of TSRs payable to the Virgin Islands under the MSA or to materially delay any date of payment of a material amount thereof. Upon the occurrence of an Event of Default, the Outstanding Bonds will be prepaid pro rata, from available funds on deposit in the Extraordinary Prepayment Account (as described below) and the Debt Service Reserve Account without premium (any resulting prepayment of a Bond prior to its respective Maturity Date due to the occurrence of an Event of Default is referred to herein as an “Extraordinary Prepayment’). If an Event of Default has occurred, on each Deposit Date, after the payment of certain expenses, and all current and past due interest on Bonds, Collections will be deposited in the Extraordinary Prepayment Account and will be applied, together with amounts in the Debt Service Reserve Account, to Extraordinary Prepayments of the Bonds on each succeeding Distribution Date. The Series 2001 Bonds are subject to prepayment at any time (each a “Lump Sum Prepayment”) upon receipt by the Indenture Trustee of a lump sum payment received from a PM which results in, or is due to, a release of that PM from all or a portion of its future obligations under the MSA (a “Lump Sum Payment”). Each Lump Sum Payment shall be allocated, after payment of certain expenses and all current and past due interest on the Bonds, to prepay the Bonds pro rata among Bonds at the principal amount thereof, or, in the case of Convertible CABs, at the accreted value of such Convertible CAB. The Indenture Trustee will deposit all Collections in the Collection Account. Amounts deposited during the period January 1 through September 30 in any Fiscal Year (each period from October 1 through the following September 30, a “Fiscal Year”) will be applied to. as described below, expenses and debt service requirements on the Bonds for the current and the first half of the next Fiscal Year. Amounts, if any, deposited during the period October 1 through December 31 in any Fiscal Year will be applied, as described below, to expenses and debt service requirements on the Bonds for the current Fiscal Year. As used herein, the term “Deposit Date” means the date of actual receipt by the Indenture Trustee of any TSRs, provided that any payment received prior to January 1 of the year in which due, will be deemed to have been received on January 1. No later than five Business Days following each deposit of Collections to the Collection Account, the Indenture Trustee will withdraw Collections on deposit in the Collection Account and transfer such amounts as follows, provided, however, that Lump Sum Payments and investment earnings in the Accounts (other than (i) the NPM Adjustment Reserve Account, investment earnings on which shall be retained in such Account, and (ii) the Debt 8-9 Service Reserve Account. investment earnings on which shall be retained in such Account until the amounts on deposit therein are at least equal to $2.352.750 and thereafter amounts on deposit in the Debt Service Reserve Account in excess of $2.352.750 shall be deposited directly in the Debt Service Account) will be deposited directly to the Debt Service Account. All earnings on amounts in the Debt Service Reserve Account will be retained until the amount therein is equal to $2.352.750. () (i) (il) (iv) (Vv) (a) to the Indenture Trustee an amount required to pay the Indenture Trustee fees and expenses due during the current Fiscal Year and, if the Deposit Date is during the period from January | through September 30 of any year, during the first half of the next Fiscal Year, and (b) to the Operating Account, the amount specified by an officer's certificate (provided that such amounts paid pursuant to clauses (a) and (b) shall not exceed $50,000, adjusted for inflation, plus any arbitrage and rebate penalties, the “Operating Cap”) to pay Operating Expenses and the amount necessary to provide for payment of certain credit enhancement and liquidity providers fees, if any, in each case for the current Fiscal Year and, if the Deposit Date is between January | and September 30. for the first half of the following Fiscal Year; to the Debt Service Account an amount sufficient to cause the amount on deposit therein to equal interest (including interest at the stated rate on the principal of Outstanding Bonds and on overdue interest, if any) due on the next succeeding Distribution Date. plus swap payments and interest on variable-rate Bonds due during the Semiannual Period including such Distribution Date. if any, together with any such interest and payments unpaid from prior Distribution Dates: unless an Event of Default has occurred and is continuing, to the Debt Service Account an amount sufficient to cause the amount therein (exclusive of the amount on deposit therein pursuant to clause (ii) above) to equal the Principal due during the current Fiscal Year: unless an Event of Default has occurred and is continuing, to replenish the Debt Service Reserve Account until the amount on deposit therein equals the Debt Service Reserve Requirement; unless an Event of Default has occurred and is continuing, to the Debt Service Account an amount which, together with the amount on deposit therein pursuant to clause (ii) above but exclusive of the amount on deposit therein pursuant to clause (111) above, will be sufficient to cause the amount on deposit therein to equal interest (including interest at the stated rate on the Principal of Outstanding Bonds and on overdue interest, if any) and swap payments. in each case, due (a) during the current Fiscal Year and (b) if the Deposit Date is during the period from January | through September 30 of any year, during the first half of the next Fiscal Year (or, in the case of interest on variable-rate Bonds and swap payments, during the first complete Semiannual Period in such next Fiscal Year), assuming that Principal of the Bonds will be paid in the amounts deposited pursuant S-10 (vi) (vii) (viii) (ix) (x) to clause (iii) above and Turbo Redemptions will be paid pursuant to clause (ix) below; unless an Event of Default has occurred and is continuing, if a Lump Sum Payment has been received, to the Debt Service Account, the amount of such payment; if an Event of Default has occurred and is continuing, to the Extraordinary Prepayment Account, all amounts remaining in the Collection Account; in the amounts and to the accounts specified by Series Supplement for termination payments thereon in excess of the applicable maximum rate, principal payable under term-out of Ancillary Contracts (as defined in the Indenture, including, without limitation, credit enhancement), other amounts under Ancillary Contracts and not payable as Priority Payments (as defined under the Indenture) or debt service and any other junior payments specified as such by the Indenture (collectively, the “Junior Payments’): to the Operating Account an amount specified in an officer’s certificate to pay Operating Expenses other than those paid under (i) above, if any, specified by an officer’s certificate; and unless an Event of Default has occurred and is continuing, all amounts remaining (the “Surplus Collections”) to the Turbo Redemption Account for application to Turbo Redemptions and, at the option of the Corporation at such time as no Term Bonds are Outstanding, the optional redemption of any Convertible CABs then Outstanding. After making the deposits set forth above, the Indenture Trustee shall compare (i) the amount on deposit in the Debt Service Reserve Account to (ii) the principal amount of Bonds which will remain Outstanding after the application of amounts described below on the related Distribution Date, and if the amount in clause (i) is greater than the amount in clause (ii), then the Indenture Trustee shall withdraw from the Debt Service Reserve Account an amount sufficient to, and shall, retire the Bonds in full on such Distribution Date. On each Distribution Date, the Indenture Trustee will apply amounts in the various accounts in the following order of priority: (1) (ii) from the Operating Account, to the parties entitled thereto, to pay Operating Expenses; from the Debt Service Account and the Debt Service Reserve Account, in that order, to pay interest on Bonds (including interest on overdue interest, if any) and Parity Payments due on such Distribution Date, plus any such unpaid interest and Parity Payments due on prior Distribution Dates; Refunding Bonds ..........c ees COVENANIS coc ccccccccccccccccceeceeceeeeeeeeeeees Continuing Disclosure Undertaking . (iit) unless an Event of Default has occurred and is continuing, from the Debt Service Account and the Debt Service Reserve Account, in that order, to pay, in order of Maturity Dates, Principal due on such Distribution Date; (iv) unless an Event of Default has occurred and is continuing, from the Debt Service Reserve Account, any amount remaining in excess of the Debt Service Reserve Requirement. to the Collection Account and from there immediately to the Debt Service Account; (v) from the Debt Service Reserve Account and the Extraordinary Prepayment Account, if an Event of Default has occurred and is continuing, to pay Extraordinary Prepayments: (vi) unless an Event of Default has occurred and is continuing, if a Lump Sum Payment has been received, from the Debt Service Account (exclusive of the amount on deposit therein pursuant to clause (v) under “Distributions and Priorities” above, to pay Lump Sum Prepayments; (vil) from the Funds and Accounts therefor, to make Junior Payments; and (vill) from the Turbo Redemption Account, any amounts remaining therein to make Turbo Redemptions. The Indenture provides that additional series of refunding bonds may be issued by the Corporation (each, a “Series”) subject to the satisfaction of certain conditions described herein. Additional refunding Bonds would be issued on a parity with the Series 2001 Bonds. See “THE SERIES 2001 BONDS — Refunding Bonds.” No other additional bonds may be issued under the Indenture with a claim against the TSRs. Pursuant to the Act and the Indenture, the Corporation has, in the opinion of Transaction Counsel, validly included the pledge and agreement of the Virgin Islands not to limit or alter the rights of the Corporation to fulfill the terms of the Purchase Agreement and the Indenture, or impair the rights and remedies of the Bondholders. The Corporation has covenanted not to impair the exclusion of interest on the Series 2001 Bonds from gross income for federal income tax purposes. See “SUMMARIES OF CERTAIN PROVISIONS OF THE TRANSACTION DOCUMENTS—The Indenture” for a summary of the covenants made by the Corporation and “SUMMARIES OF CERTAIN PROVISIONS OF THE TRANSACTION DOCUMENTS—The Purchase Agreement” for a summary of the covenants made by the Virgin Islands. The Corporation has agreed to provide. or cause to be provided, to each nationally recognized municipal securities information repository and any public or private repository or entity designated by the Virgin Islands as a repository for purposes of Rule 15c2-12(b)(5) adopted by the Securities and Exchange Commission certain annual financial information and operating data and. in a timely manner, notices of certain material events. See S-12 “CONTINUING DISCLOSURE UNDERTAKING” herein. Rating... ececseceseecsecenereeeteeeeeeeeneeaes The rating of the Series 2001 Bonds only addresses the Rating Agency's assessment of the ability of the Corporation to pay interest when due and to pay Principal of the Series 2001 Bonds on their respective Maturity Dates and does not address the ability of the Corporation to make Turbo Redemptions. A rating is not a recommendation to buy, sell or hold securities, and such ratings are subject to revision or withdrawal at any time. See “RATING” herein. Legal Considerations ......... eee Reference is made to “LEGAL CONSIDERATIONS” for a description of certain legal issues relevant to an investment in the Series 2001 Bonds. Neither the Virgin Islands nor the Corporation can be a debtor under any chapter of the United States Bankruptcy Code, nor could the Virgin Islands or the Corporation become a debtor under any chapter of such Bankruptcy Code without an amendment thereto. Risk Factors .......cccccceeseecesececeeeeeenees Reference is made to “RISK FACTORS” for a description of certain considerations relevant to an investment in the Series 2001 Bonds. S-13 (THIS PAGE WAS INTENTIONALLY LEFT BLANK) INTRODUCTORY STATEMENT This Offering Circular sets forth information concerning the issuance by the Corporation of the Series 2001 Bonds in the aggregate initial principal amount of $21,709,861.90._ The Series 2001 Bonds are being issued pursuant to the Indenture. The Corporation is a special purpose, independent instrumentality of the Virgin Islands intended, created and empowered to effectuate the purposes of the Act, with a legal existence separate and apart from the Virgin Islands. The board of directors of the Corporation has three members, consisting of the Governor, and two private sector representatives. For additional information regarding the organization and management of the Corporation, see “THE CORPORATION.” Pursuant to the Act and the Purchase Agreement, the Virgin Islands will sell to the Corporation, on the Closing Date, all of its right. title and interest in certain amounts payable to the Virgin Islands under the MSA, including the Virgin Islands’ right to receive future Initial Payments, Annual Payments and Strategic Contribution Fund Payments to be made by the PMs under the MSA. The MSA, which was entered into on November 23, 1998, resolved cigarette smoking-related litigation between the Settling States and the OPMs and released the PMs from past and present smoking-related claims, and provides for a continuing release of future smoking-related claims in exchange for payments to be made to the Settling States, as well as, among other things, the agreement of the PMs to abide by certain tobacco advertising and marketing restrictions. Under the MSA, the Virgin Islands is entitled to 0.0173593% of the Initial Payments and Annual Payments, and 0.1800232% of the Strategic Contribution Fund Payments to be made by the PMs under the MSA. Under the Indenture, the Series 2001 Bonds are, and any other Series of refunding Bonds will be, payable solely from and secured solely by a statutory pledge of certain of the Corporation’s tangible and intangible assets, including its right to receive the Virgin Islands’ portion of the future Initial Payments, Annual Payments and Strategic Contribution Fund Payments under the MSA (the “TSRs”). See “SECURITY.” Interest on the Series 2001 Bonds is payable on each Distribution Date. Principal of the Series 2001 Bonds will be paid as described under “THE SERIES 2001 BONDS.” The Series 2001 Bonds are subject to redemption prior to maturity, including Turbo Redemptions of the Term Bonds. Certain methodologies and assumptions were utilized to establish the Term Bond Maturities and the Turbo Redemptions as described under “SUMMARY OF BOND STRUCTURING ASSUMPTIONS.” The amount and timing of payments on the Series 2001 Bonds may be affected by various factors. See “RISK FACTORS.” Initial aggregate principal amount. RISK FACTORS Prospective investors Should carcfully consider the factors set forth below regarding an investment tn the Series 2001 Bonds as well as other information contained inthis Offering Circular. Decline in Cigarette Consumption Materially Beyond Forecasted Levels May Adversely Affect Payments Smoking Trends. As discussed tn the DRIeWEFA Report, cigarette consumption in the United States has declined since its peak in 1981 of 640 billion cigarettes to an estimated 423 billion cigarettes in 2000. Adult per capita cigarette consumption (total consumption divided by the number of people 18 years and older) has been declining since 1964. The DRISeWEFA Report forecasts a continued decline in total consumption at an annual rate of 1.79 to 248 billion cigarettes in 2030 under its Base Case Forecast (as defined herein). which represents a decline in adult per capita consumption at an average rate of 2.63% per year. These consumption declines are based on historical trends which may not be indicative of future trends, as well as other factors which may vary significantly from those assumed or forecasted by DRIeWEFA. A decline in the overall consumption of cigarettes below the levels forecasted in the DRIeWEFA Report could have a material adverse effect on the payments by PMs under the MSA and the amounts available to the Corporation to make payments on the Series 2001 Bonds. See “DRI*WEFA REPORT.” Regulatory Restrictions and Legislative Inttidtives. The tobacco manufacturers and tobacco products are the subject of numerous regulations and legislative proposals seeking. among other things, to impose liability upon the industry. further regulate the industry. prohibit public smoking and regulate labeling or advertising of cigarettes. No assurance can be given that future federal. state or Virgin Islands legislation or administrative regulauions will not seek to further regulate. restrict or discourage the manufacture, sale and use of cigarettes. Such legislative or regulatory measures could severely increase the cost of cigarettes. limit or prohibit the sale of cigarettes. make cigarettes less appealing to smokers or reduce the addictive qualities of cigarettes. Without limiting the generality of the foregoing, on August 9, 2000, the United States Surgeon General issued a report entitled “Reducing Tobacco Use: A Report of the Surgeon General” which advocates that significant increases in excise taxes on cigarettes would have a considerable tmpact on the prevalence of smoking and, in the long term. reduce the adverse health effects caused by tobuceo. The Commonwealth of Massachusetts. for example, has enacted legislauion to require cigarette Manufacturers to report the flavorings and cther ingredients used in each brand of cigarettes sold in the Commonwealth, and on a qualified, by-brand basis to provide “nicotine-yield ratings” for their products based on standards established by the Commonwealth. Cigarette manufacturers sued to have the statute declared unconstitutional, arguing that it could result in the public disclosure of valuable proprietary information. In September 2000, the district court granted the phanutfs motion for summary judgment and permanently enjoined the defendants from requiring cigarette manufacturers to disclose brand specific information on ingredients in their products. In October 2001. the First Circuit renistated the statute. declaring ita “valid exercise of the police power” of the State. Defendants have appealed the district courts ruling. New York State law now requires cigarettes to be “self-extinguishing” beginning in 2003. Similar legislation has been proposed (but not adopted) from time to time in other states and localities and at the federal level. Another statute, N-Y. Pub. Health Law Section 1399-11, which became effective in New York State in November 2000, prohibits the shipment or delivery of cigarettes to any person in the state who is not a licensed cigarette tax agent, wholesale or retail dealer or export warehouse proprietor, or a U.S. or New York state government official. The statute would ban mail order, Internet and telephone cigarette sales directly to consumers in the state. One OPM and one SPM thereafter fled suit in a federal district court in New York to overturn the statute. alleging that it was an unconstitutional interference with commerce. In June 2001. a federal district court judge declared the statute unconstituuonal and permanently enjoined enforcement of the statute. As a result of these types of imtiatives and other measures. the overall consumption of cigarettes nationwide may decrease materially more than forecusted in the DRIeWEFA Report and thereby have a material adverse effect on the amounts available te the Corporation to make payments on the Series 2001 Bonds. See "TOBACCO INDUS ERY. -Regulatory Tssues.” Tobacco Industry Litigation The tobacco industry has been the target of litigation for many years. Both individual and class action lawsuits have been brought by or on behalf of smokers alleging that smoking has been injurious to their health, and by non-smokers alleging harm from environmental tobacco smoke (“ETS”), also known as “secondhand smoke.” Plaintiffs in these actions seek compensatory and punitive damages aggregating in the billions of dollars. The MSA does not release PMs from liability in either individual or class action cases. Health care cost recovery cases have also been brought by governmental and non-governmental health care providers seeking, among other things, reimbursement for health care expenditures incurred in connection with the treatment of medical conditions allegedly caused by smoking. The PMs are also exposed to liability in these cases, because the MSA only settled health care cost recovery claims for the Settling States. Litigation has also been brought against certain PMs and/or their affiliates in foreign countries. Individual Lawsuits. One OPM reported that as of August 1, 2001, there are approximately 1500 active individual smoking and health lawsuits (not including the Broin II cases discussed in “TOBACCO INDUSTRY — Civil Litigation”) pending against it and other tobacco industry defendants, approximately 1,250 of which are pending before a single West Virginia state court in a consolidated proceeding that is to begin in March 2002. See “TOBACCO INDUSTRY — Civil Litigation — Individual Plaintiffs’ Lawsuits.” In the last three years, there have been seven reported verdicts, and a 1996 jury verdict that was reinstated upon appeal, in individual smoking and health cases against the tobacco industry, including one or more of the PMs. On June 6, 2001, a California jury found against Philip Morris in Boeken v. Philip Morris Incorporated et al. on all six claims of fraud, negligence and making a defective product. The jury awarded the plaintiff $5.5 million in compensatory damages and $3 billion in punitive damages. In August 2001, the trial court reduced the punitive damages award to $100 million, which was thereafter accepted by the plaintiff. Philip Morris has expressed an intent to appeal. In November 2000, the Florida Supreme Court reinstated a $750,000 award in Carter et al. v. Brown & Williamson Tobacco Corp. for a former smoker that developed lung cancer after smoking for 44 years. In 1996, the jury had found that cigarettes were a defective product and that B&W was negligent for not warning people of the danger but an appeals court reversed this decision. In March 2001, the plaintiff received slightly over $1.0 million from a trust account that held the $750,000 jury award plus interest and became the first smoker to be paid by a tobacco company in an individual smoking and health case. The United States Supreme Court denied B&W’s petition for a writ of certiorari on June 29, 2001. In October 2000, a Tampa, Florida, jury in Jones v. R.J. Reynolds Tobacco Co., a wrongful death case, found Reynolds Tobacco liable for negligence and strict liability and returned a verdict in favor of the widower of a deceased smoker, awarding approximately $200,000 in compensatory damages. The jury rejected the plaintiff's conspiracy claim and did not award punitive damages. According to Reynolds Tobacco, on December 28, 2000, the court granted its motion for a new trial. The Plaintiff appealed the new trial ruling. In March 2000, a California jury in Whiteley v. Raybestos-Manhattan, Inc. et al. returned a verdict in favor of the plaintiffs and found the defendants, including Philip Morris and Reynolds Tobacco, liable for negligent product design and fraud, and awarded $1.72 million in compensatory damages and $20 million in punitive damages. Both damage awards were upheld by the trial judge, who denied the defendants’ post-verdict challenge. The defendants have appealed the verdict. In April 1999, a Maryland jury in Connor v. Lorillard et al. awarded $225,000 in compensatory damages and $2.0 million in punitive damages. An appellate court has remanded the case for a determination of the date of injury to determine whether a statutory cap on non-economic damages applies. In March 1999, an Oregon jury in Williams-Branch v. Philip Morris, et al. awarded $821,485 in compensatory damages and $79.5 million in punitive damages (subsequently reduced by the trial judge to $32 million). In February 1999, a California jury in Henley v. Philip Morris, et al. awarded $1.5 million in compensatory damages and $50 million in punitive damages (subsequently reduced by the trial judge to $25 million). The judgment was affirmed by a state appellate court in November, 2001. The case is being appealed to the California Supreme Court. William s. Ohlemeyer, vice president and associate general counsel for Philip Morris has said that the company is “fairly optimistic” about winning the appeal. The Connor and Williams-Branch cases are also on appeal. Class Action Lawsuits. In addition to suits brought by individuals, plaintiffs have brought smoking and health lawsuits against the tobacco industry. including the PMs, as class actions. The majority of state and Federal courts that have heard such class action lawsuits have denied class certification due to the individual circumstances related to each smoker's election to smoke and the individual nature of the alleged harm. Nevertheless, a few classes have been certified and have withstood preliminary challenges in eight cases — two brought in the state of Florida, three in California, one in Illinois. one in Louisiana and one in West Virginia. The most noteworthy of these cases is Engle v. Reynolds Tobacco, et al. In Engle, a Florida state trial court certified a class consisting of Florida smokers alleging injury due to tobacco use. The court determined that the lawsuit could proceed as a class action because, even though certain factual issues are unique to individual plaintiffs and must be tried separately, certain other factual issues were common to all class members and could be tried in one proceeding for the whole class. In July 1999. in phase I of the three-phase trial, the jury found against the defendants regarding issues common to the class. On April 7, 2000. the jury awarded a total of $12.7 million in compensatory damages to three named plaintiffs. One OPM has requested that the court dismiss the award to one of the plaintiffs because of the jury’s findings on a statute of limitations question. In July 2000, the same jury awarded punitive damages of approximately $145 billion with respect to the entire class of possible plaintiffs. A later phase of the proceedings will determine compensatory damages for the remaining class, which is estimated to range in size from 300.000 to 700,000 members. By order dated November 3, 2000, the United States District Court for the Southern District of Florida granted motions to remand the case to the Eleventh Judicial Circuit of Dade County, Florida (the “State Trial Court”). On November 6, 2000, the State Trial Court issued its final judgment and order in which it (a) denied substantially all of the tobacco company defendants’ pending and post-trial motions, including the motion for reduction of the $145 billion punitive damages award or, in the alternative, a new trial, and (b) entered the punitive damage award as a final judgment. On November 7, 2000, the defendants filed an appeal with respect to the entry of judgment. class certification and numerous other reversible errors that they allege occurred during the trial. In addition, the defendants have each posted a bond to stay collection of the punitive damages and statutory interest thereon pending the exhaustion of all appeals. In May 2000, legislation was enacted in Florida limiting the amount of the appeal bond required to be posted by defendants in class action cases such as Engle to an amount not exceeding $100 million per defendant. The state legislatures of Georgia, Kentucky. Louisiana, Nevada, North Carolina, Oklahoma, South Carolina, Virginia and West Virginia have enacted similar legislation. Posting an appeal bond prevents plaintiffs from executing on any compensatory or punitive damage judgment until final appeals are heard and decided. On May 7. 2001, Philip Morris, Lorillard and Liggett reached a settlement agreement with the Engle plaintiffs whereby the three OPMs will post a $2 billion bond and approximately $1.3 billion will be refunded if the defendants’ appeal is successful. The agreement provides that the three companies will forfeit a total of approximately $709 million even if they are successful on appeal. Reynolds Tobacco and B&W are considering joining the agreement. The Engle plaintiffs have agreed not to challenge Florida's legislation which caps the appeal bond. See “—Risks Inherent in Litigation” below and “TOBACCO INDUSTRY — Civil Litigation — Class Action Lawsuits.” Health Care Cost Recovery Litigation. Plaintiffs in these cases also seek compensatory and punitive damages in the billions of dollars. One lawsuit. filed by the United States Department of Justice against the OPMs and other defendants, seeks to recoup unspecified damages pursuant to the Medical Care Recovery Act and the Medicare Secondary Payer Act for Medicare and other medical expenses allegedly incurred as a result of smoking-related illnesses, and to require defendants to disgorge profits pursuant to the federal Racketeer Influenced Corrupt Organizations (“RICO”) statute. On September 28, 2000, the district court granted the defendants’ motion to dismiss the Medical Care Recovery Act and the Medicare Secondary Payer Act claims and rejected the defendants’ motion to dismiss the RICO claims. In October 2000, the federal government moved for reconsideration of the district court's order to the extent that it dismissed the Medical Care Recovery Act claims for health care costs paid pursuant to government health benefit programs other than Medicare and the Federal Employees Health Benefits Act. The court denied that motion on January 31, 2001. The Department of Justice filed an amended complaint attempting to replead the Medicare Secondary Payer claim. A motion to dismiss the amended complaint was granted in July 2001. In June 2001, a federal jury in the Eastern District of New York -4- awarded Empire Blue Cross Blue Shield $17.8 million in compensatory damages for violations of consumer protection statutes and $11.8 million in separate but overlapping claims. In October 2001, a New Jersey court found tobacco manufacturers liable for healthcare costs borne by Horizon Blue Cross Blue Shield of New Jersey, a health insurance company. The decision was based on state consumer protection laws. A lawyer for Philip Morris, Inc., one of the defendants, has said that the companies intend to appeal the decision to the United States Court of Appeals for the Second Circuit. See “TOBACCO INDUSTRY — Civil Litigation — Health Care Cost Recovery Lawsuits.” In addition, other entities, such as foreign governments, unions, health and welfare funds, hospitals and insurers are seeking reimbursement of health care expenditures allegedly caused by tobacco products. Other Litigation. One or more PMs are also defendants in other litigation stemming from the production, sale or use of tobacco products, including antitrust lawsuits. These cases also include lawsuits brought by former asbestos manufacturers now seeking contribution or reimbursement for amounts they expended in connection with the defense of claims and payment of damages for asbestos injury allegedly caused, in whole or in part, by cigarette smoking. In one such case, Falise, et al. v. American Tobacco Company, Inc., the plaintiff, a personal injury settlement trust established by Johns-Manville Corporation, seeks $4.1 billion in compensatory damages, as well as punitive damages. The case was dismissed in June 2001. See “TOBACCO INDUSTRY — Civil Litigation — Other Tobacco-Related Litigation.” The European Commission (“EC”) brought suit against Reynolds Tobacco and Philip Morris alleging that the defendants engaged in a conspiracy to smuggle cigarettes into EC member states in an effort to evade taxes. On July 18, 2001, the U.S. District Court for the Eastern District of New York found that the EC claims were without merit and dismissed the case. On August 6, 2001, the EC and 10 member states filed a complaint against Reynolds Tobacco, Philip Morris and related companies. The EC complaint is essentially a resubmission of the first complaint filed on November 3, 2000. The complaint seeks unspecified damages including compensatory damages, injunctive relief, and treble damages under RICO. See “TOBACCO INDUSTRY — Civil Litigation — Other Tobacco-Related Litigation.” Risks Inherent in Litigation. Ultimately, the outcome of these and any other pending or future smoking and health or other lawsuits is uncertain. No assurance can be given that the tobacco industry defendants will not at some point incur liability for substantial judgments. One or more adverse judgments could result in a decision by affected PMs to substantially increase cigarette prices, thereby reducing cigarette consumption beyond what is forecast in the DRIeWEFA Report. See “DRI*WEFA REPORT.” Substantial compensatory or punitive damages, if awarded, whether singly or in the aggregate, could, as to any or all of the PM defendants. materially adversely affect their financial condition and thus impair their continued ability to make payments under the MSA. Any one or more of these possibilities could materially adversely affect the payment of TSRs to the Corporation and impair the payments required to be made to Bondholders on the Series 2001 Bonds. For a further discussion of these matters, see “TOBACCO INDUSTRY — Civil Litigation” and “LEGAL CONSIDERATIONS.” Uncertain Business Environment for Domestic Tobacco Industry The domestic tobacco industry operates in a substantially uncertain business environment due to, among others, the following factors: declining consumption trends; price increases associated with the MSA, other settlements and excise and other tax increases; the Engle case and an array of other civil litigation; legislative and regulatory restrictions; and advertising and marketing restrictions, including those imposed by the MSA. These factors may adversely affect the industry’s sales volumes, profitability, financial condition and results of operation for the foreseeable future. Deterioration in the financial condition of the PMs, if sufficiently significant, could have a material adverse effect on their payments under the MSA, which in turn could have a material adverse effect on the amounts available to the Corporation to make payments on the Series 2001 Bonds. Insolvency of PMs May Delay or Reduce Payments Title 11 of the United States Code (the “Bankruptcy Code”) may affect the ability of the Virgin Islands to enforce its rights under the MSA if a PM were to become a debtor under the Bankruptcy Code. For example, under -5- the Bankruptcy Code. virtually all actions to collect money from the bankrupt are automatically stayed upon the commencement of the bankruptcy case and the bankrupt is prohibited during the pendency of the bankruptcy case from making most payments owed under a contract entered into by the bankrupt prior to the commencement of the bankruptcy case, unless payment is permitted by the bankruptcy court. Thus, delays in payments under the MSA by the bankrupt PM would be likely. which could result in delays in, or reductions of amounts available for, payments of the Series 2001 Bonds. Bondholders could also incur a loss of the market value of their investment. Other risks associated with a bankruptcy of a PM include the risk that (i) certain payments previously made to the Bondholders of the Series 2001 Bonds could be avoided as preferential payments, so that Bondholders would be required to return such payments to the bankrupt PM: (ii) the Virgin Islands may not be able to terminate or cause the termination of the MSA; (ii) the Virgin Islands may be unable to exercise remedies under the MSA and (iv) the obligations of the bankrupt PM under the MSA may be modified. For example, if the PM rejects the MSA in bankruptcy. resulting in a claim in favor of the Virgin Islands (and, thus, the Indenture Trustee and Bondholders through the Corporation) for damages, the bankruptcy court may approve a plan of reorganization or liquidation of the bankrupt PM which alters the timing (for a longer or shorter period than the payments on the Bonds) or the amount of payments to be made by the bankrupt PM in respect of the MSA. Additionally, the bankruptcy court may approve a reorganization or liquidation plan which provides for the Virgin Islands (and thus the Indenture Trustee and the Bondholders through the Virgin Islands and the Corporation) to receive a payment on account of its claim for damages resulting from rejection of the MSA in the form of property other than cash (such as securities). The absence of an enforceable Model Statute could have an effect on the decision of a bankrupt PM to accept or reject the MSA. For a further discussion of certain bankruptcy issues and a description of certain legal opinions to be delivered to the Corporation by Transaction Counsel with respect to PM bankruptcy matters, see “LEGAL CONSIDERATIONS.” Other Potential Payment Decreases under the Terms of the Master Settlement Agreement Adjustments to MSA Payments. The MSA provides that the amounts payable by the PMs are subject to numerous adjustments, some of which may be material. Such adjustments could reduce the aggregate amount of TSRs distributable to the Corporation to a level below the amount required to make payments on the Series 2001 Bonds. For additional information regarding the MSA and the payment adjustments, see “SUMMARY OF THE MASTER SETTLEMENT AGREEMENT.” The assumptions used to project Collections are based on the premise that certain adjustments will occur as set forth under the heading "SUMMARY OF BOND STRUCTURING ASSUMPTIONS.” Actual adjustments could be materially different from what has been assumed. Growth of NPM Market Share. The assumptions used to project Collections and structure the Series 2001 Bonds contemplate declining consumption of cigarettes in the United States combined with a static relative market share of 1.5% for the NPMs. See "SUMMARY OF BOND STRUCTURING ASSUMPTIONS.” Should the forecast consumption decline occur, but be accompanied by a material increase in the relative aggregate market share of the NPMs, shipments by PMs would decline at a rate greater than the decline in consumption. This would result in reductions of Annual Payments and Strategic Contribution Fund Payments by the PMs due to application of the Volume Adjustment. One NPM has announced that it has developed a cigarette with virtually no nicotine. This NPM could use the product to capture market share causing a reduction in Annual Payments and Strategic Contribution Fund Payments. In addition, if people used such a product to quit smoking, it could reduce the size of the market. See “SUMMARY OF THE MASTER SETTLEMENT AGREEMENT — Adjustments to Payments” and “DRI*WEFA REPORT.” The aggregate market share of the NPMs utilized in the bond structuring assumptions may differ materially from the market share information utilized by the MSA Auditor in calculating the NPM Adjustment. See "SUMMARY OF THE MASTER SETTLEMENT AGREEMENT —Adjustments to Puyments~ Non-Participating Manufacturers Adjustment.” -6- Disputed Payments. Miscalculations by PricewaterhouseCoopers LLP, the independent auditor appointed under the MSA (the “MSA Auditor’) or disputed calculations by any of the parties to the MSA could result in offsets to, or delays in disbursements of, payments to the Settling States pending resolution of the disputed item in accordance with the provisions of the MSA. The structuring assumptions for the Series 2001 Bonds do not factor in an offset for miscalculated or disputed payments. [The Virgin Islands, however, has advised the Corporation that in accordance with the terms of the MSA, certain of the Settling States and certain of the PMs are disputing the calculations of the January 2000 and 2001 Initial Payments and the April 2000 and 2001 Annual Payments.] Should portions of subsequent Initial Payments, Annual Payments or Strategic Contribution Fund Payments be required under the MSA to be deducted from the Settling States’ shares thereof and diverted to the Disputed Payments Account (as defined in the escrow agreement established pursuant to the MSA) pending resolution of, or in response to, a dispute, such deduction and diversion, if sufficiently large (whether individually or in the aggregate over time), could impair the flow of TSRs to the Corporation. See “SUMMARY OF THE MASTER SETTLEMENT AGREEMENT—Adjustments to Payments— Offset for Miscalculated or Disputed Payments.” Recalculated Payments. In addition, subsequent revisions in the information delivered to the MSA Auditor, and on which the MSA Auditor’s calculations of Initial Payments, Annual Payments and Strategic Contribution Fund Payments are based, may result in a recalculation of such payments resulting in future offsets. No assurance can be given as to the magnitude of any such recalculation. Uncertainty as to Timing of Amortization of Term Bonds No assurance can be given as to the timing of amortization of the Term Bonds. The timing of amortization payments will be based in large part on the Corporation’s receipt of TSRs. A certain level of TSRs has been forecast based on various assumptions including, among others, domestic cigarette consumption levels as set forth in the DRI*WEFA Base Case Forecast and adjustments to the payments by the PMs as required by the terms of the MSA. These assumptions are discussed in “SUMMARY OF BOND STRUCTURING ASSUMPTIONS.” Actual results will vary from the assumptions. Such variance could be material and could affect the level of TSRs. As a result, actual amortization may not conform to the projected Turbo Redemptions. Any material reduction would impair the generation of Surplus Collections available for Turbo Redemptions of Term Bonds and extend the expectations as to average life of the Term Bonds. On the other hand. material increases would generate more Surplus Collections available for Turbo Redemptions and shorten the expectations as to average life of the Term Bonds. No assurance can be given that these assumptions will be realized. Although the Corporation has covenanted to amortize the Term Bonds to the extent of available Collections, pursuant to the schedule of Turbo Redemptions, the Rating Agencies have not been asked to evaluate whether the Corporation will receive Collections sufficient to enable it to make such payments. The ratings only address each Rating Agency’s assessment of the ability of the Corporation to pay interest when due and payment of Principal of the Series 2001 Bonds on their respective Maturity Dates. If the Corporation is able to make payments on the Term Bonds in accordance with the schedule of Turbo Redemptions, the average life of the Term Bonds will be significantly shorter than if paid on their respective Maturity Dates. If the Corporation is unable to make payments on the Term Bonds in accordance with the schedule of Turbo Redemptions, the Term Bonds may remain Outstanding until their respective Maturity Dates without triggering an Event of Default. Bondholders bear the reinvestment risk from faster than expected amortization as well as the extension risk from slower than expected amortization of the Term Bonds. Risks Related to Enforceability or Modification of the Master Settlement Agreement and Constitutionality of the Model Statute MSA Litigation. Certain smokers, consumer groups, cigarette manufacturers, cigarette importers, cigarette distributors, native American tribes, taxpayers, taxpayers’ groups and other parties have instituted lawsuits against various tobacco manufacturers, including the PMs, as well as certain of the Settling States and other public entities. The lawsuits allege, among other things, that the MSA violates certain provisions of the United States Constitution, state constitutions, the federal antitrust laws, federal civil rights laws, state consumer protection laws and unfair competition laws, certain of which actions, if ultimately successful, could result in a determination that the MSA is -7- void or unenforceable. The lawsuits seek, among other things, an injunction against one or more of the Settling States from collecting any monies under the MSA and barring the PMs from collecting cigarette price increases related to the MSA and/or a determination that the MSA is void or unenforceable. In addition, class action lawsuits have been filed in several federal and state courts alleging that under the federal and state Medicaid law. any amount of tobacco settlement funds that the Settling States receive in excess of what they paid through the Medicaid program to treat tobacco-related diseases should be paid directly to Medicaid recipients. To date. no such lawsuits have been successful. An action filed in Pennsylvania in October, 2001 is currently pending. which action challenges the enforcement of the MSA. See TOBACCO INDUSTRY — Civil Litigation. Other such challenges may continue to be brought. In the event of an adverse court ruling, Bondholders could incur a complete loss of their investment. See also * — Tobacco Industry Litigation — Risks Inherent in Litigation” above and * — Limited Remedies” below. For a description of certain opinions to be delivered to the Corporation by Transaction Counsel with respect to the MSA. see “LEGAL CONSIDERATIONS — MSA Enforceability.” Model Statute. Under the MSA, a downward adjustment is made to the Annual Payments and Strategic Contribution Fund Payments payable by a PM if the PM experiences a loss of market share in the United States to NPMs as a result of the PM's participation in the MSA. A Settling State may mitigate the effect of this adjustment by adopting and enforcing a Qualifying Statute or Model Statute, each as hereinafter described. The Virgin Islands has adopted a Model Statute. Two of the cases challenging the enforceability of the MSA, brought by importers and distributors in one case and by a manufacturer in the other, also challenged the enforceability and constitutionality of the Model Statute. The case brought by the importers and distributors has been dismissed with prejudice. Where decisions have been rendered. all such cases to date have upheld the constitutionality of the Model Statute. A recent case, North American Trading Company and International Tobacco Partners, LLC vy. “NAAG" et al. (“North American”), was filed in the United States District Court for the District of Columbia in July, 2001 against NAAG, 13 states and their respective Attorneys General. alleging a number of federal antitrust and constitutional violations. The plaintiffs, as a class of importers of foreign-made cigarettes. had alleged that importers or wholesalers of foreign-made cigarettes intended for resale in the United States are not Tobacco Product Manufacturers (“TPMs”) as defined in the Model Statute and that, consequently, certain provisions of the Model Statute requiring NPMs or TPMs to pay into escrow funds were unenforceable as to such importers or wholesalers of foreign-made cigarettes in any particular state that has enacted a Model Statute. Plaintiffs had also alleged that the MSA and the Model Statute violated certain federal antitrust laws and constitutional provisions. In particular. the plaintiffs asserted that the MSA and the Model Statute violated the Commerce Clause of the United States Constitution by imposing a discriminatory burden on interstate commerce. The action was dismissed on September 18. 2001. Although any future determination that a Model Statute is unconstitutional would have no effect on the enforceability of the MSA itself, such a determination could have an adverse effect on payments to be made under the MSA if an NPM were to gain market share in the future. For a description of certain opinions to be delivered to the Corporation by Transaction Counsel with respect to the Virgin Islands Model Statute, and a more detailed discussion of the constitutional challenges to the Model Statute. see “LEGAL CONSIDERATIONS — Model Statute Constitutionality.” Severability. Most of the major provisions of the MSA are not severable. If a court materially modifies. renders unenforceable or finds unlawful any nonseverable provision, the attorneys general of the Settling States and the OPMs are required by the MSA to attempt to negotiate substitute terms. However. if any OPM does not agree to the substitute terms, the MSA terminates in all Settling States affected by the court's ruling. See “SUMMARY OF THE MASTER SETTLEMENT AGREEMENT -— Severability.” Amendments, Waivers and Termination. As a settlement agreement between the PMs and the Settling States, the MSA is subject to amendment in accordance with its terms. and may be terminated upon consent of the parties thereto. Parties to the MSA, including the Virgin Islands, may waive the performance provisions of the MSA. The Corporation is not a party to the MSA and has no rights under the MSA to challenge any such amendment, waiver or termination. No assurance can be given that such an amendment, waiver or termination would not have a material adverse effect on the Bondholders. Pursuant to the Act. the Purchase Agreement and the Indenture, the Corporation has, in the opinion of Transaction Counsel, validly included the pledge and agreement of the Virgin Islands not to limit or alter the rights of the Corporation to fulfill the terms of the Purchase Agreement -8- and the Indenture or impair the rights and remedies of the Bondholders. See “SUMMARY OF THE MASTER SETTLEMENT AGREEMENT — Amendments and Waivers.” Reliance on Virgin Islands Enforcement. The Virgin Islands may not convey and has not conveyed to the Corporation or the Bondholders any right to enforce the terms of the MSA. Pursuant to its terms, the MSA, as it relates to the Virgin Islands, can only be enforced by the Virgin Islands. Pursuant to the Purchase Agreement, the Virgin Islands has covenanted to enforce the MSA; however, no assurance can be given that the Virgin Islands will enforce any particular provision of the MSA. Failure to do so may have a material adverse effect on the Bondholders. Pursuant to the Act, the Purchase Agreement and the Indenture, the Corporation has, in the opinion of Transaction Counsel, validly included the pledge and agreement of the Virgin Islands not to limit or alter the rights of the Corporation to fulfill the terms of the Purchase Agreement and the Indenture or impair the rights and remedies of the Bondholders. See “SECURITY — Non-Impairment Pledge of the Virgin Islands.” Limited Resources of the Corporation The Series 2001 Bonds are neither general nor moral obligations of the Virgin Islands and are not secured by a pledge of the full faith and credit of the Virgin Islands and holders of the Series 2001 Bonds may not require the levy or imposition of taxes. The assets of the Corporation (other than the TSRs) are not pledged to the payment of, nor are they security for, the Series 2001 Bonds. The Corporation’s only source of funds for payments on the Series 2001 Bonds are the Collections, the Reserves and amounts on deposit in pledged funds and accounts pursuant to the Indenture. Except to the extent that the proceeds of the Series 2001 Bonds are deposited in the Debt Service Reserve Account, the proceeds of the Series 2001 Bonds will not be available to pay debt service on the Series 2001 Bonds. The Corporation has no taxing power and no assets other than the assets acquired pursuant to the Purchase Agreement. Limited Remedies The Indenture Trustee is limited under the terms of the Purchase Agreement and the Indenture to enforcing the terms of such agreements and to receiving the TSRs and applying them in accordance with the Indenture. If an Event of Default occurs, the Indenture Trustee cannot sell its rights under the Purchase Agreement or the Indenture. The Corporation is not a party to the MSA, and neither the Virgin Islands nor the Corporation has made any representation or warranty that the MSA is enforceable. Remedies under the Purchase Agreement do not include the repurchase of the TSRs under any circumstances, including unenforceability of the MSA or breach of any representation of warranty. Limited Liquidity of the Bonds There is currently a limited secondary market for securities such as the Series 2001 Bonds. There can be no assurance that a secondary market for the Series 2001 Bonds will develop, or if a secondary market does develop, that it will provide Bondholders with liquidity or that it will continue for the life of the Series 2001 Bonds. Consequently, any purchaser of the Series 2001 Bonds must be prepared to hold such securities for an indefinite period of time or until final redemption of such securities. Limited Nature of Ratings; Reduction, Suspension or Withdrawal of a Rating Any rating assigned to the Series 2001 Bonds by a Rating Agency will reflect only such Rating Agency’s assessment of the likelihood that such Series 2001 Bonds will receive payments of interest when due and Principal of the Series 2001 Bonds on their respective Maturity Dates. Any such rating will not address the likelihood that the Turbo Redemptions will be made according to the projected Turbo Redemption schedule. The rating of the Series 2001 Bonds will not be a recommendation to purchase, hold or sell such Series 2001 Bonds and such rating will not address the marketability of such Series 2001 Bonds, any market price or suitability for a particular investor. There is no assurance that any rating will remain for any given period of time or that any rating will not be lowered, suspended or withdrawn entirely by a Rating Agency if, in such Rating Agency’s judgment, circumstances so warrant based on factors prevailing at the time, including, but not limited to, the evaluation by such Rating Agency -9- of the financial outlook for the tobacco industry. Any such reduction, suspension or withdrawal of a rating, if it were to occur, could adversely affect the availability of a market or the market price of the Series 2001 Bonds. IRS Tobacco Audits The Internal Revenue Service (the “IRS") is currently examining several tobacco settlement revenue bond and securitization transactions completed to date. New York City has publicly announced that the IRS has terminated its examinetion of New York City’s tobacco securitization transaction without taking any action. Pending IRS audits could adversely affect the availability of a market or the market price of the Series 2001 Bonds. See "TAX MATTERS —— IRS Tobacco Audits.” - 10- LEGAL CONSIDERATIONS Bankruptcy of a PM General. The enforceability of the rights and remedies of the Corporation (and thus the Bondholders) and of the obligations of a PM under the MSA are subject to the Bankruptcy Code and to other applicable insolvency, moratorium or similar laws relating to or affecting the enforcement of creditors’ rights generally. Some of the risks associated with a bankruptcy of a PM are described below and include the risks of delay in or reduction in amount of payment or of nonpayment under the MSA and the risk that the Virgin Islands (and, thus, the Corporation and the Indenture Trustee) may be stayed for an extended time from enforcing any rights under the MSA or with respect to the payments owed by the bankrupt PM or from commencing legal proceedings against the bankrupt PM. Asa result, if a PM becomes a debtor in a bankruptcy case and defaults in making payments of the TSRs, funds available to the Corporation to pay Bondholders may be reduced or eliminated. Furthermore, certain payments previously made to Bondholders could be avoided as preferential payments, so that Bondholders would be required to return such payments to the bankrupt PM. Chapter 7 Bankruptcy. If a PM becomes bankrupt and does not reorganize under Chapter 11, it would be liquidated under Chapter 7 of the United States Bankruptcy Code, in which event its operations would cease and its assets would be sold. In such an event, there would likely be a significant reduction, or even elimination, of payments received from the PM that is in the Chapter 7 case. To the extent that the volume of cigarettes sold by other PMs increased as a result of cessation of operations by the PM being liquidated under Chapter 7 of the Bankruptcy Code, the market share of such other PMs would increase. Chapter 11 Reorganization. Should a PM become a debtor in a Chapter 11 reorganization bankruptcy case, the PM may be required to obtain bankruptcy court approval before making payments owed by it under the MSA. Legal proceedings necessary to determine whether the PM’s obligations under the MSA are operating expenses under the Bankruptcy Code, or are otherwise authorized to be paid during the pendency of the bankruptcy proceedings, could be time consuming and could result in delays in payments by the bankrupt PM. Examples of other bankruptcy-related risks include: (a) MSA as Executory Contract. The treatment of the MSA under the Bankruptcy Code may be dependent upon whether the MSA is construed to be an executory contract (which is not defined by the Bankruptcy Code but generally is considered to be a contract in which material performance remains due from both parties). Under the Bankruptcy Code, if the MSA is treated as an executory contract, a PM acting as a debtor-in-possession would have the right to assume or reject the MSA. However, there is no time period within which a trustee or PM in bankruptcy would be required to assume or reject the MSA. Legal proceedings necessary to resolve the issue regarding whether the MSA is an executory contract under the Bankruptcy Code could be time consuming and could result in delays in payments by the bankrupt PM. Transaction Counsel will render an opinion to the Corporation, subject to all the facts, assumptions and qualifications stated therein, that in a properly presented and argued case, there being no precedent directly on point, a court of competent jurisdiction would hold that the MSA constitutes an executory contract under the Bankruptcy Code. (b) Assumption or Rejection of MSA. Should a bankrupt PM determine to assume the MSA, it would have to cure all outstanding MSA payment defaults or provide “adequate assurance” that such defaults would be cured promptly. “Adequate assurance” is not defined in the Bankruptcy Code and is determined by the bankruptcy court. Thus, the assurance provided by the bankrupt PM may be less than the assurance parties to a contract would require outside of bankruptcy and could result in delays in payments by the bankrupt PM. In the event a bankrupt PM determines to reject the MSA, the Virgin Islands (and thus the Corporation, the Indenture Trustee and the Bondholders, as collateral assignees) may then have an unsecured, nonpriority claim for damages. Rejection of an executory contract should be treated as a breach of the contract by the PM. However, under the Bankruptcy Code, the Virgin Islands (and thus the Corporation, the Indenture Trustee and the Bondholders) nevertheless may be enjoined from commencing or continuing any action against the PM to enforce remedies under the MSA (including an action to collect -ll- payments due under the MSA). In addition, because amounts owed by the PM under the MSA are not fixed, legal proceedings may be necessary to quantify the claims of the Virgin Islands (and thus the Corporation, the Indenture Trustee and the Bondholders) for damages as a result of the PM’s rejection of the MSA. Such legal proceedings could be time consuming and could result in delays, or reductions, in payments by the bankrupt PM. (c) Modification of MSA Obligations. If the MSA is not determined to be an “executory contract,” the PM determines to reject the MSA or the PM is otherwise not authorized to make payments under the MSA. then a bankruptcy of the PM could result in long delays and possibly in large reductions in the amount of TSRs available to pay the Bondholders because under the Bankruptcy Code, the obligations of the PM under the MSA could be modified. For example, the bankruptcy court may approve a plan of reorganization or liquidation of the PM which alters the timing or the amount of payments to be made by the PM under the MSA to the Virgin Islands (and, thus, to the Corporation, the Indenture Trustee and Bondholders). MSA Enforceability Most of the major provisions of the MSA are not severable. If a court materially modifies, renders unenforceable or finds unlawful any nonseverable provision, the attorneys general of the Settling States and the OPMs are required by the MSA to attempt to negotiate substitute terms. However, if any OPM does not agree to the substitute terms. the MSA would terminate in all Settling States affected by the court’s ruling. Certain cigarette importers. cigarette distributors, native American tribes and smokers’ rights organizations have filed actions against some. and in certain cases all, of the signatories to the MSA alleging, among other things, that the MSA violates provisions of the federal constitution, federal antitrust laws, federal civil rights laws, state consumer protection laws and unfair competition laws, which actions, if ultimately successful, could result in a determination that the MSA is void or voidable. A determination by a court that a nonseverable provision of the MSA is void or voidable would. in the absence of an agreement to a substitute term as described above. result in the termination of the MSA in any Settling States affected by the court’s ruling. Accordingly, in the event of an adverse court ruling, the Bondholders could incur a complete loss of their investment. See “RISK FACTORS — Risks Related to Enforceability or Modification of the Master Settlement Agreement and Constitutionality of the Model Statute — MSA Litigation.” In rendering the opinions described below, Transaction Counsel considered the claims asserted in the above-referenced federal and state actions. which it believes are representative of the legal theories that an opponent of the MSA would advance in an attempt to invalidate the MSA. Subject to the assumptions and qualifications set forth below, Transaction Counsel will render an opinion to the Corporation that under federal and Virgin Islands law, the MSA is a valid, binding and enforceable obligation of the signatories thereto and that the MSA has been duly authorized. executed and delivered by the Virgin Islands. acting through its Attorney General. The opinion of Transaction Counsel as to the enforceability of the MSA and the obligations of the aforementioned signatories is also subject to the effect of bankruptcy, insolvency, and other laws affecting creditors’ rights or remedies and general principles of equity. regardless of whether such enforceability is considered in a proceeding in equity or at law. In rendering its enforceability opinion with respect to the MSA, Transaction Counsel has assumed (i) the due organization and valid existence of each signatory to the MSA, (ii) the due authorization, execution and delivery of the MSA by each such signatory, other than the Attorney General of the United States Virgin Islands (the “Attorney General”), and each signatory’s full power, authority and legal right to execute and to deliver, and to perform and observe the provisions of, the MSA, (iii) that the execution, delivery and performance by each such signatory of the MSA does not (1) violate the provisions of the organizational documents of such signatory (other than the Attorney General), (2) violate any judgment, decree, writ, injunction, award, determination or order applicable to any such signatory, or (3) conflict with, or result in a breach of, or constitute a default under, any of the provisions of any indenture. mortgage. deed of trust, contract or other instrument to which such signatory is a party, _|2- a and (iv) the absence of the need for any consent, approval, order or authorization of, or filing with or notice to, any court or other governmental authority in respect of each such signatory that was not obtained. Model Statute Constitutionality Two cases which challenged the enforceability of the MSA also challenged the Model Statute, although, as described herein, one of such cases has been dismissed with prejudice. On August 13, 1999, in PTI, Inc. et al. v. Philip Morris Inc., et al. certain cigarette importers and cigarette distributors filed an action in the United States District Court for the Central District of California against the PMs and all of the state officials involved in the negotiation of the MSA and those charged with the enforcement of the Qualifying Statute as enacted by the respective states (collectively, the “State Defendants”). The plaintiffs therein sought to enjoin the passage or enforcement, as the case may be, of the Model Statute. The complaint alleged, among other things, that the passage, implementation and/or enforcement of the Model Statute would violate federal antitrust laws and certain provisions of the United States Constitution, including the Interstate Compact Clause, the prohibition on Bills of Attainder, the Commerce Clause, the Import-Export Clause, the Supremacy Clause, the First Amendment, the Equal Protection Clause, and the Due Process Clause. The district court found that jurisdiction did not exist over the non-California State Defendants, but dismissed with prejudice all federal antitrust and constitutional claims against the PMs and the California State Defendants based on the merits. On December 15, 2000, in Star Scientific, Inc. v. Mark L. Earley, in his official capacity as the Attorney General of the Commonwealth of Virginia, a cigarette manufacturer filed an action in the United States District Court for the Eastern District of Virginia. The plaintiff manufacturer, making many of the same constitutionality arguments made in the PTI case by the plaintiff importers and distributors there, sought, among other things, to enjoin the enforcement of the Virginia Model Statute. The Star case has been dismissed by the trial court and plaintiffs have appealed to the Fourth Circuit Court of Appeals. In July 2001, the plaintiffs in North American, had filed an action in the United States District Court for the District of Columbia against certain states alleging certain constitutional and antitrust claims and that the Model Statute is unenforceable as to importers of foreign-made cigarettes intended for resale in the United States. Plaintiffs sought to enjoin the enforcement of the Model Statute as it applies to such. The action was dismissed on September 18, 2001. Although any future determination that the Model Statute is unconstitutional would have no effect on the enforceability of the MSA, such a determination could have an adverse effect on payments to be made under the MSA if an NPM were to gain market share in the future. The Virgin Islands has enacted a Model Statute. See “RISK FACTORS — Risks Related to Enforceability or Modification of the Master Settlement Agreement and Constitutionality of the Model Statute — Model Statute.” In rendering the opinion described below, Transaction Counsel considered the claims asserted in the above- referenced federal actions as well as other legal claims which it believes are representative of the legal theories that an opponent of a Model Statute would advance in an attempt to invalidate a Model Statute. Subject to the assumptions and qualifications set forth below, Transaction Counsel will render an opinion to the Corporation that the Virgin Islands’ Model Statute is constitutional and lawful in all material respects under both federal and Virgin Islands law. The opinion of Transaction Counsel as to the enforceability of the Virgin Islands’ Model Statute is limited to the extent that enforceability may be affected by bankruptcy, insolvency and other laws affecting creditors’ rights or remedies heretofore or hereafter enacted, and is subject to general principles of equity (regardless of whether such enforceability is considered in a proceeding in equity or at law). In rendering its enforceability opinion with respect to the Virgin Islands’ Model Statute, Transaction Counsel will rely upon a letter from counsel to the OPMs confirming that the OPMs would not dispute that the Virgin Islands’ Model Statute, if maintained in its current form without modification or addition, is a Model Statute within the meaning of the MSA. Limitations on Certain Opinions of Transaction Counsel The opinions of Transaction Counsel described above expressly note that a court’s decision regarding the matters upon which Transaction Counsel is opining would be based on such court’s own analysis and interpretation of the factual evidence before it and of applicable legal principles. Thus, if a court reached a different result than that expressed in such opinions, such as that the MSA is void or voidable or that the Model Statute is -13- unconstitutional, it would not necessarily constitute reversible error. Consequently, the opinion of Transaction Counsel is not a prediction of what a particular court (including any appellate court) that reached the issue on the merits would hold. but. instead. is the opinion of Transaction Counsel as to the proper result to be reached by a court applying existing legal rules to the facts as properly found after appropriate briefing and argument and, in addition, Is Nola guarantee. Warranty or representation, but rather reflects the informed professional judgment of Transaction Counsel as to specific questions of law. No Assurance as to the Outcome of Litigation With respect to all matters of litigation, mentioned above, that have been brought and may in the future be brought against the PMs, or involving the enforceability of the MSA or constitutionality of the Model Statute or the enforcement of the right to the TSRs or otherwise filed in connection with the tobacco industry, the outcome of such litigation, in general, cannot be determined with certainty and depends, among other things, on (i) the issues being appropriately presented and argued before the courts (including the applicable appellate courts) and (ii) on the courts, having been presented with such issues, correctly applying applicable legal principles in reaching appropriate decisions regarding the merits. In addition, the courts may, in their exercise of equitable jurisdiction, reach judgments based not upon the legal merits but upon a balancing of the equities among the parties. Accordingly, no assurance can be given as to the outcome of any such litigation and any such adverse outcome could have a material adverse impact on the amounts available to the Corporation to make payments on the Series 2001 Bonds. Corporation and Virgin Islands Not Eligible to Declare Bankruptcy Transaction Counsel will render an opinion to the Corporation that neither the Virgin Islands nor the Corporation can be a debtor under any chapter of the United States Bankruptcy Code, nor could the Virgin Islands or the Corporation become a debtor under anv chapter of such Bankruptcy Code without an amendment thereto. THE CORPORATION The Corporation is a special purpose. independent instrumentality of the Virgin Islands created by the Act. The Corporation is governed by a three-person board of directors consisting of the Governor and two independent members, one appointed by the Governor and the other by the President of the Senate of the Virgin Islands. The directors of the Corporation are: Name Principal Occupation The Honorable Charles W. Turnbull Governor Rosalie Simmonds Ballentine Attorney/Private Practice José A. Penn Chief Financial Officer Penn’s Corporation The officers of the Corporation are: Name Title The Honorable Charles W. Turnbull President Amadeo I.D. Francis Vice President and Treasurer Rosahe Simmonds Ballentine Vice President and Secretary José A. Penn Vice President and Assistant Secretary/ Assistant Treasurer SOURCES AND USES OF FUNDS The Corporation will make available to the Government $18,453,870 of the proceeds of the Series 2001 Bonds for deposit to the Construction Account on behalf of the Government for the account of the Tobacco Settlement Health Care and Capital Improvement Fund to finance several capital hospital and health department projects. The Corporation will apply the balance of the proceeds to (i) to make a deposit to the Debt Service Reserve Account at its requirement, (ii) to pay certain costs of issuance of the Series 2001 Bonds, and (ili) to make a deposit to the Operating Account as required by the Indenture. The expected application of such amounts is set forth below: Construction Account $18,453,870 Debt Service Reserve Account 1,745,506 Costs of Issuance 704,594 Underwriter’s Discount 631,469 Operating Account 50,000 Net Original Issue Discount 124,423 Total $21,709,862 Capital Projects The Government intends to apply the net proceeds of the Series 2001 Bonds to the financing of various health related capital improvement projects. Approximately 32% of the net proceeds of the Series 2001 Bonds shall be applied to the construction and equipping of a cancer center for treatment at the Roy Lester Schneider Hospital and Community Health Center on the Island of St. Thomas. The cancer center is the first such center in the Eastern Caribbean and will provide critically needed cancer treatment for residents of the Virgin Islands. Approximately 32% of the net proceeds of the Series 2001 Bonds will finance the renovation and improvement of the cardiac care center at the Governor Juan F. Luis Hospital and Medical Center on the Island of St. Croix. The Government intends to finance the infrastructure improvements at the Governor Juan F. Luis Hospital which are necessary to accommodate the sophisticated cardiac care services to be provided at the cardiac care center. In addition, a portion of the proceeds shall be applied to the renovation of the emergency room and clinics, improvements to the hospital plumbing system and upgrading of the air conditioning system necessary to support the use of new cardiac care equipment. In addition to the hospital capital projects, approximately 36% of the net proceeds of the Series 2001 Bonds will be applied by the Government for the financing of certain Department of Health capital projects. On the Island of St. Thomas, a portion of the net proceeds allocated to the Department of Health will be applied to the renovation and rehabilitation of the North Wing at the Knud Hansen Complex. which was damaged by Hurricane Hugo, for use as clinics, restoration of certain historic sites at Knud Hansen (Old Municipal Hospital Ground), and the construction of a storage facility for the Environmental Health Division for Health Department vector control purposes. On the Island of St. Croix, a portion of the proceeds allocated to the Department of Health will be applied to the renovation of the Charles Harwood Medical Complex which was damaged during Hurricanes Hugo and Marilyn, and for the construction of a storage facility for the Environmental Health Division for Health Department vector control purposes. On the Island of St. John, a portion of the proceeds allocated to the Department of Health will be applied for the renovation and rehabilitation of the Morris De Castro Clinic, which also suffered damage during Hurricane Hugo. -15- THE SERIES 2001 BONDS The following summary describes certain terms of the Series 2001 Bonds. This summary does not purport to be complete and is subject to, and qualified in its entirety by reference to, the provisions of the Indenture and the Series 2001 Bonds. Terms used herein and not previously defined have the meanings ascribed to them in “SUMMARIES OF CERTAIN PROVISIONS OF THE TRANSACTION DOCUMENTS —Certain Definitions.” Copies of the Indenture and the Purchase Agreement may be obtained upon written request to the Indenture Trustee. The Series 2001 Bonds will initially be represented by one or more bond certificates registered in the name of The Depository Trust Company or its nominee (“DTC™), New York, New York. DTC will act as securities depository for the Series 2001 Bonds. Individual purchases of beneficial ownership interests may be made (i) in the principal amount of $5,000 or any integral multiple thereof in the case of the Series 2001 Bonds other than the Convertible CABs and (ii) in the case of the Convertible CABs, in an amount such that the Accreted Value of each Convertible CAB at the expiration of the accretion period therefor will equal $5,000 or any integral multiple thereof. Except under the limited circumstances described herein, no Beneficial Owner of the Series 2001 Bonds will be entitled to receive a physical certificate representing its ownership interest in such Series 2001 Bonds. See “THE SERIES 2001 BONDS — Book-Entry Only System” below. Payments of Interest Interest on the Principal of the Series 2001 Bonds (except the Convertible CABs prior to May 15, 2008) will be payable on each May 15 and November 15. commencing May 15. 2002. Interest will accrue from and including the Closing Date, or from and including the most recent Distribution Date on which interest has been paid to, but excluding, the subsequent Distribution Date. Interest on th: Series 2001 Bonds will be computed on the basis of a 360-day year consisting of twelve 30-day months. Failure t) pay the full amount of interest payable on any Distribution Date is an Event of Default. If on any Distribution Date there are insufficient funds to pay all interest then due on the Bonds, available amounts will be allocated pro rata among all Bonds based on the respective amounts of interest due thereon. For each Distribution Date. payments that are to be made on the Series 2001 Bonds will be made to holders of the Series 2001 Bonds of record (the “Bondholders”) as of the applicable Record Date. “Record Date” means the last Business Day of the calendar month preceding a Distribution Date, or such other date as may be specified by the Indenture or an Officer's Certificate of the Corporation; and the Corporation or the Indenture Trustee may in its discretion establish special record dates for the determination of the Holders of Bonds for various purposes thereof, including giving consent or direction to the Indenture Trustee. “Business Day” means any day other than (i) a Saturday or a Sunday or (ii) a day on which banking institutions in New York, New York. Accreted Value of Convertible CABs The Convertible CABs will not begin accruing current interest until from and after November 15, 2007. Prior to such date. interest on the Convertible CABs will accrete so that the value of each such Convertible CAB will be an amount equal to the initial principal amount thereof, plus interest accrued thereon from the date of original issuance of such Convertible CAB. compounded on May 15 and November 15 of each year, commencing on the Closing Date. at the respective original issue yield to November 15, 2007. The Accreted Value as of each May 15 and November 15 from the Closing Date through and including November 15, 2007 is set forth in Appendix D hereto. The Accreted Value on other than a May 15 and November 15 shall be calculated by straight-line interpolation of the Accreted Value. For the purpose of determining the redemption price and outstanding principal amount of CABs, the value of each such CAB shall be its Accreted Value. -16- Payments of Principal and Turbo Redemptions The Principal of a Series 200! Bond must be paid on the Maturity Date thereof in order to avoid an Event of Default as described herein. The Principal amounts of the Series 2001 Bonds are set forth on the inside cover hereof. Payments of Principal will be made from Collections and, if necessary, Reserves. A failure by the Corporation to pay the Principal of a Series 2001 Bond on its respective Maturity Date will constitute an Event of Default under the Indenture and, to the extent of available Collections and Reserves, will result in the Extraordinary Prepayment of the Bonds on each subsequent Distribution Date as described herein. See “Extraordinary Prepayment” below. The ratings of the Series 2001 Bonds address only the Rating Agency’s assessment of the ability of the Corporation to pay interest when due and to pay Principal of the Series 2001 Bonds on their respective Maturity Dates and do not address the ability of the Corporation to make Turbo Redemptions, as described below. In addition, 100% of all Surplus Collections, if any, shall be applied to the special mandatory par redemption (“Turbo Redemptions”) of the Series 2001 Term Bonds in order of maturity on each Distribution Date. The Debt Service Reserve Account will not be available to make Turbo Redemptions. Failure to make Turbo Redemptions will not constitute an Event of Default. The ratings of the Series 2001 Bonds do not address the Rating Agency’s assessment of the ability of the Corporation to make Turbo Redemptions. Extraordinary Prepayment If an Event of Default has occurred, on each semiannual Distribution Date and such other Distribution Date selected by the Indenture Trustee or the Corporation, Outstanding Bonds will be prepaid pro rata from available funds on deposit in the Debt Service Reserve Account and the Extraordinary Prepayment Account, without premium (any such prepayment, an “Extraordinary Prepayment’). Collections are only deposited in the Extraordinary Prepayment Account to the extent all current and past due interest (not included in Accreted Value) on the Bonds has been paid. Lump Sum Prepayment The Series 2001 Bonds are subject to prepayment at any time at par plus accrued interest to the prepayment date, upon receipt by the Indenture Trustee of a lump sum payment received as a payment from a PM which results in, or is due to, a release of that PM from all or a portion of its future obligations under the MSA (a “Lump Sum Payment”) existing and available on any date chosen by the Corporation for such mandatory prepayment. Each Lump Sum Payment shall be allocated to prepay Principal pro rata among Bonds with accrued interest thereon to, but not including the date of redemption (except when a Convertible CAB is being redeemed on or before the end of its Accretion Period, in which case no accrued interest shall be due and payable), pro rata. Optional Redemption The Bonds having Maturity Dates on or after May 15, 2012 are subject to redemption at the Corporation’s option at any time on or after May 15, 2011, in whole or in part, at a redemption price of 100% of the principal amount thereof, plus accrued interest to the date of redemption. Thirty days’ notice shall be given to holders of the Series 2001 Bonds to be redeemed prior to maturity. The Corporation may select the dates, amounts, rates and maturities of Series 2001 Bonds for optional redemption at its sole discretion. On and after any date of redemption, interest will cease to accrue on any Series 2001 Bonds called for redemption. -17- Refunding Bonds The Corporation may authorize. issue. sell and deliver Bonds from time to time in such principal amounts as the Corporation may determine but only to renew or refund Bonds. by exchange. purchase. redemption or payment, and establish such escrows therefor as i may determine. Subsequent to the issuance of the Series 2001 Bonds, refunding Bonds may be tssued provided that the Corporation or the Indenture Trustee has received written confirmation from each Rating Agenes then rating the Sees 2001 Bonds that such issuance will not cause such Rating Agency to lower, suspend or withdraw the raung then assigned by such Raung Ageney to any Bonds (a “Rating Confirmation’). Book-Entry Only System General. DTC is a linited-purpose trust company organized under the New York Banking Law, a “banking organization” within the meaning of the New York Banking Law. a member of the federal Reserve System, a “clearing corporation” within the meaning of the New York Uniform Commercial Code. and a “clearing ageney” registered pursuant to the provisions of Secuon 17A of the Securities Exchange Act of 1934. DTC holds securities that its participants (each. a “Direct Participant”) deposit with DTC. DTC also facilitates the settlement among Direct Participants of securities transactions, such as transters and pledges. in deposited securities through electronic computerized book-entry changes in) Direct Participants’ accounts, thereby eliminating the need for physical movement of securifes certificates. Direct Participants include securities brokers and dealers. banks, trust companies. clearing corporations, and certain other organizations. DTC is owned by a number of its Direct Participants and by the New York Steck Exchange. Ine. the American Stock Exchange. Inc.. and the National Association of Securities Dealers. Ine Access to fie DTC system is also available to others such as securities brokers and dealers. banks, and trust companies that clear through or maintain a custodial relationship with a Direct Participant, either directly or indirecth (each, an “Indirect Participant” and. together with Direct Participants, “DTC Participants’). The rules applicable te DTC and DTC Participants are on file with the Securities and Exchange Commission. Purchases of benetigial interests in the Seres 200) Bonds under the DTC system: must be made by or through Direct Participants. who will receive a credit for the Series 2001 Bonds on DTC's records. The ownership Interest of each actual purchaser of the Series 2061 Bonds eeach, a “Beneficial Owner’) is in turn to be recorded on the Direct and Indirect Participants’ records. Beneficial Owners will not receive written confirmation from DTC of their purchase. but each Benetictal Owner is expected to receive written confirmations providing details of the transaction, as Well as periodic statements of its boldings. trom the Direct or Indirect Participant through which such Beneticial Owner entered into the transaction. “Transfers of ownership interests in the Series 2001 Bonds are to be accomplished by entries made on the books of DTC Participants acting on behalf of Beneficial Owners. Beneficial Owners will not receive physical certificates representing their ownership interests in the Series 2001 Bonds, except in the event that use of the book-entry system for the Series 2601 Bonds ts discontinued. To facilitate subsequent transfers. all the Sciies 2001 Bonds will be registered in the name of DTC. The deposit of the Series 2001 Bonds with DTC and their registration in the name of Cede & Co. will effect no change in beneficial ownership. DTC will have no Knowledge of the actual Beneticial Owners of the Series 2001 Bonds: DTC's records will reflect only the identity of the Direct Participants to whose accounts the Series 2001 Bonds are credited, which may or may not be the Beneficial Owners. DTC Participants will remain responsible for keeping account of their holdings on behalf of Benefieral Owners. Neither DTC nor Cede & Co. will consent or vote with respect to the Series 2001 Bonds. Under its usual procedures, DTC mails an Omnibus Proxy to the Corporation as soon as possible after the record date. The Omnibus Proxy assigns Cede & Cows consenting or voting rights to those Direct Participants to whose accounts Series 2001 Bonds are credited on the record date Gdentified ina listing attached to the Omnibus Proxy). Except as described below. nether DTC nor Cede & Co. will take any action to enforce covenants with respect to any security registered in the name of Cede & Co. Under its current procedures. on the written instructions of a Direct Participant. DTC will cause Cede & Co. to sign a demand to exercise bondholder rights as -I8- record holder of the quantity of securities specified in the Direct Participant’s instructions, and not as record holder of all the securities of that issue registered in the name of Cede & Co. Also, in accordance with DTC’s current procedures, all factual representations to be made by Cede & Co. to the issuer, the Indenture Trustee or any other party must be made to DTC and Cede & Co. by the Direct Participant in its instructions to DTC. For so long as the Series 2001 Bonds are issued in book-entry form through the facilities of DTC, any Beneficial Owner desiring to cause the Corporation or the Indenture Trustee to comply with any of its obligations with respect to the Series 2001 Bonds must make arrangements with the Direct Participant or Indirect Participant through whom such Beneficial Owner’s ownership interest in the Series 2001 Bonds is recorded in order for the Direct Participant in whose DTC account such ownership interest is recorded to make the instructions to DTC described above. NEITHER THE CORPORATION, THE INDENTURE TRUSTEE NOR ANY UNDERWRITER (OTHER THAN IN ITS CAPACITY, IF ANY, AS A DIRECT PARTICIPANT OR INDIRECT PARTICIPANT) WILL HAVE ANY OBLIGATION TO DIRECT PARTICIPANTS OR INDIRECT PARTICIPANTS OR THE PERSONS FOR WHOM THEY ACT AS NOMINEES WITH RESPECT TO DTC’S PROCEDURES OR ANY PROCEDURES OR ARRANGEMENTS BETWEEN DIRECT PARTICIPANTS, INDIRECT PARTICIPANTS AND THE PERSONS FOR WHOM THEY ACT RELATING TO THE MAKING OF ANY DEMAND BY CEDE & CO. AS THE REGISTERED OWNER OF THE SERIES 2001 BONDS, THE ADHERENCE TO SUCH PROCEDURES OR ARRANGEMENTS OR THE EFFECTIVENESS OF ANY ACTION TAKEN PURSUANT TO SUCH PROCEDURES OR ARRANGEMENTS. Principal of and interest on the Series 2001 Bonds registered in the name of Cede & Co. will be made to DTC. DTC’s practice is to credit Direct Participants’ accounts on a Distribution Date in accordance with their respective holdings shown on DTC’s records unless DTC has reason to believe that it will not receive payment on such date. Payments by DTC Participants to Beneficial Owners will be governed by standing instructions and customary practices, as is the case with securities held for the accounts of customers in bearer form or registered in “street name”, and will be the responsibility of such DTC Participant and not of DTC, the Indenture Trustee, or the Corporation, subject to any statutory or regulatory requirements as may be in effect from time to time. Payment of principal and interest to DTC is the responsibility of the Corporation or the Indenture Trustee, disbursement of such payments to Direct Participants shall be the responsibility of DTC, and disbursement of such payments to the Beneficial Owners shall be the responsibility of Direct and Indirect Participants. So long as Cede & Co. is the registered owner of the Series 2001 Bonds, as nominee for DTC, references in this Offering Circular to Bondholders or registered owners of the Series 2001 Bonds (other than under the caption “TAX MATTERS” herein) shall mean Cede & Co., as aforesaid, and shall not mean the Beneficial Owners of the Series 2001 Bonds. As long as the book-entry system is used for the Series 2001 Bonds, the Indenture Trustee and the Corporation will give any notice of redemption or any other notices required to be given to Bondholders only to DTC or its nominee. Any failure of DTC to advise any Direct Participant, or of any Direct Participant to notify any Indirect Participant, or of any Direct Participant or Indirect Participant to notify any Beneficial Owner, of any such notice and its content or effect will not affect the validity of the redemption of the Series 2001 Bonds called for redemption or of any other action premised on such notice. Conveyance of notices and other communications by DTC to Direct Participants, by Direct Participants to Indirect Participants and by Direct Participants and Indirect Participants to Beneficial Owners will be governed by arrangements among them, subject to any statutory or regulatory requirements as may be in effect from time to time. BENEFICIAL OWNERS SHOULD MAKE APPROPRIATE ARRANGEMENTS WITH THEIR BROKER OR DEALER TO RECEIVE NOTICES (INCLUDING NOTICES OF REDEMPTION) AND OTHER INFORMATION REGARDING THE SERIES 2001 BONDS THAT MAY BE SO CONVEYED TO DIRECT PARTICIPANTS AND INDIRECT PARTICIPANTS. -19- If less than all of the Series 2001 Bonds are being redeemed, DTC’s practice is to determine by lot the amount of the interest of each Direct Participant to be redeemed. For every transfer and exchange of a beneficial ownership interest in the Series 2001 Bonds, the Beneficial Owner may be charged a sum sufficient to cover any tax, fee or other governmental charge, that may be imposed in relation thereto. DTC may discontinue providing its services as securities depository with respect to the Series 2001 Bonds at any time by giving reasonable notice to the Corporation or Indenture Trustee, or the Corporation may decide to discontinue use of the system of book-entry transfers through DTC (or a successor securities depository). Under such circumstances. in the event that a successor securities depository is not obtained, the Series 2001 Bonds are required to be printed and delivered to Beneficial Owners. THE ABOVE INFORMATION CONCERNING DTC AND DTC’S BOOK-ENTRY SYSTEM HAS BEEN OBTAINED FROM SOURCES THAT THE CORPORATION BELIEVES TO BE RELIABLE, BUT THE ISSUER TAKES NO RESPONSIBILITY FOR THE ACCURACY THEREOF. NEITHER THE CORPORATION, THE VIRGIN ISLANDS NOR THE INDENTURE TRUSTEE WILL HAVE ANY RESPONSIBILITY OR OBLIGATION TO DTC PARTICIPANTS, BENEFICIAL OWNERS OR OTHER NOMINEES OF SUCH BENEFICIAL OWNERS FOR (1) SENDING TRANSACTION STATEMENTS: (2) MAINTAINING, SUPERVISING OR REVIEWING. OR THE ACCURACY OF, ANY RECORDS MAINTAINED BY DTC OR ANY DTC PARTICIPANT OR OTHER NOMINEES OF SUCH BENEFICIAL OWNERS: (3) PAYMENT OR THE TIMELINESS OF PAYMENT BY DTC TO ANY DTC PARTICIPANT. OR BY ANY DTC PARTICIPANT OR OTHER NOMINEES OF BENEFICIAL OWNERS TO ANY BENEFICIAL OWNER, OF ANY AMOUNT DUE IN RESPECT OF THE PRINCIPAL OF OR REDEMPTION PREMIUM, IF ANY, OR INTEREST ON THE SERIES 2001 BONDS: (4) DELIVERY OR TIMELY DELIVERY BY DTC TO ANY DTC PARTICIPANT, OR BY ANY DTC PARTICIPANT OR OTHER NOMINEES OF BENEFICIAL OWNERS TO ANY BENEFICIAL OWNERS. OF ANY NOTICE (INCLUDING NOTICE OF REDEMPTION) OR OTHER COMMUNICATION WHICH 1S REQUIRED OR PERMITTED UNDER THE TERMS OF THE INDENTURE OR THE SERIES 2001 SUPPLEMENT TO BE GIVEN TO HOLDERS OR OWNERS OF THE SERIES 2001 BONDS, (5) THE SELECTION OF THE BENEFICIAL OWNERS TO RECEIVE PAYMENT IN THE EVENT OF ANY PARTIAL REDEMPTION OF THE SERIES 2001 BONDS: OR (6) ANY ACTION TAKEN BY DTC OR ITS NOMINEE AS THE REGISTERED OWNER OF THE SERIES 2001 BONDS. None of the Corporation, the Virgin Islands, the Indenture Trustee or the Underwriter can give any assurance that DTC or DTC Participants will distribute payments of principal or premium of or interest on the Series 2001 Bonds paid to DTC or its nominee, or send any redemption or other notices, to the Beneficial Owners, or that they will do so ina timely manner or that DTC will act in the manner described in this Offering Circular. SECURITY General Pursuant to the Act and the Purchase Agreement, the Virgin Islands will sell to the Corporation, on the Closing Date, all of the Virgin Islands’ right, title and interest in certain amounts payable to the Virgin Islands under the MSA, including the Virgin Islands’ right to receive its allocable share of (i) future Initial Payments made by the OPMs under the MSA which are required to be made on January 10, 2002 and January 10, 2003, (ii) future Annual Payments made by the PMs under the MSA, which are required to be made annually on each April 15 in perpetuity, (iii) Strategic Contribution Fund Payments made by the PMs under the MSA, which are required to be made annually on each April 15, commencing April. 15. 2008 through April 15, 2017 (collectively, the “Tobacco Settlement Revenues” or “TSRs™). To date all Initial Payments and Annual Payments required to be paid under the MSA have been made on a timely basis and the Virgin Islands’ share thereof has been received by the Virgin Islands. -20 - The Bonds will be secured by and are payable solely from (i) Collections, including all TSRs to be received by the Corporation, (ii) the Reserves, (iii) amounts held in the other accounts established under the Indenture, and (iv) the Corporation’s rights under the Purchase Agreement. The Series 2001 Bonds shall not constitute an indebtedness of the Virgin Islands. The Series 2001 Bonds are neither general nor moral obligations of the Virgin Islands and are not secured by a pledge of the full faith and credit of the Virgin Islands and the holders of the Series 2001 Bonds may not require the levy or imposition of taxes. The Corporation has no taxing power. Payment by MSA Escrow Agent to Indenture Trustee The MSA Escrow Agent will disburse the TSRs directly to the Indenture Trustee. The disbursement of TSRs is required to be made to the Indenture Trustee by the MSA Escrow Agent 10 business days after the MSA Escrow Agent receives the related Initial Payments, the Annual Payments and Strategic Contribution Fund Payments from the PMs. Accounts All of the following funds and accounts will be established and held by the Indenture Trustee for the benefit of the holders of the Bonds. All money on deposit in the following accounts will be invested in Eligible Investments as defined in the Indenture. Collection Account. Under the Indenture, the Indenture Trustee will establish and hold a segregated trust account (the “Collection Account’) into which the Indenture Trustee will deposit all Collections. Funds on deposit in the Collection Account will be transferred to various other accounts under the Indenture and applied to certain other purposes as described below. Construction Account. Under the Indenture, the Indenture Trustee will establish and hold a segregated trust account for the benefit of the Government of the Virgin Islands (the “Construction Account” ) to be funded on the Closing Date from proceeds of the Series 2001 Bonds in the amount of $18,453,870 as required for deposit into the Tobacco Settlement Health Care Improvement Fund for the financing of the Capital Projects as described in the First Supplemental Indenture of Trust. No amounts in the Construction Account shall be pledged as security for the Series 2001 Bonds. Debt Service Account. Under the Indenture, the Indenture Trustee will establish and hold a segregated trust account (the “Debt Service Account”) into which the Indenture Trustee will deposit amounts transferred from the Collection Account in respect of interest and Principal payments on the Series 2001 Bonds and from which the Indenture Trustee will make payments on the Series 2001 Bonds in accordance with the priority of payments as described below under “Flow of Funds.” Debt Service Reserve Account. Under the Indenture, the Indenture Trustee will establish and hold within a segregated trust account (the “Debt Service Reserve Account”) to be funded on the Closing Date from Series 2001 Bond proceeds in the amount of $1,745,506. Except after the occurrence and continuance of an Event of Default, the balance in the Debt Service Reserve Account must be maintained, to the extent of available funds, at the least of (i) the initial deposit therein plus any retained earnings thereon, (ii) the amount of $2,352,750 and (iii) the principal amount of Bonds Outstanding on the date of calculation (the “Debt Service Reserve Requirement”). Ail earnings on amounts in the Debt Service Reserve Account will be retained until the amount therein is equal to $2,352,750. Amounts in the Debt Service Reserve Account will be available to pay Principal of and interest on the Series 2001 Bonds to the extent Collections are insufficient for such purpose and, after an Event of Default, Extraordinary Prepayments. Amounts in the Debt Service Reserve Account are not available to make Turbo Redemptions. Amounts withdrawn from the Debt Service Reserve Account will be replenished from Collections as described in “Flow of Funds” below. On each Distribution Date, amounts on deposit in the Debt Service Reserve Account in excess of the Debt Service Reserve Requirement will be transferred to the Collection Account and from -21- there, immediately to the Debt Service Account. All funds on deposit in the Debt Service Reserve Account will be invested in Eligible Investments as defined in the Indenture. Extraordinary Prepayment Account. Under the Indenture. the Indenture Trustee will establish and hold a segregated trust account (the “Extraordinary Prepayment Account”) into which the Indenture Trustee will deposit. following the occurrence of any Event of Default and while such Event of Default is continuing, all future Collections. after the payment of certain expenses and all current and preceding due interest on the Bonds. The Indenture Trustee will make Extraordinary Prepayments on the Series 200] Bonds from the Extraordinary Prepayment Account. NPM Adjustment Reserve Account. Under the Indenture, the Indenture Trustee will establish and hold a segregated trust account (the "NPM Adjustment Reserve Account”) into which the Indenture Trustee will deposit the 2001 Annual Payment in the amount of $696,377.55 (together with all interest earnings thereon). The Virgin Islands has advised the Corporation that the MSA Auditor expects to receive information which will result in a recalculation of the aggregate national 2001 Annual Payment. Such recalculation could give rise to an NPM Adjustment which, as a result of the timing of the Virgin Islands’ enactment of its Model Statute. could in turn reduce or eliminate the 2001 Annual Payment. Any such reduction or elimination would be effected through an offset against a future payment of TSRs. It the Indenture Trustee shall receive written notice from the Corporation that the 2001 Annual Payment is subject to an NPM Adjustment, then the Indenture Trustee shall transter the amount of such NPM Adjustment (including any payment of accrued interest on such amounts pursuant to the MSA) from the NPM Adjustment Reserve Account to the Collection Account for application pursuant to the Indenture: provided that all amounts on deposit in the NPM Adjustment Reserve Account shall be released to the Corporation for transfer to the Government upon receipt by the Indenture Trustee of a Rating Confirmation. In the event the Indenture Trustee has not received a Rating Confirmation or written notification of an NPM Adjustment by April 15, 2005, the Indenture Trustee shall commence proceedings to seek a Rating Confirmation to secure release of such funds on deposit in the NPM Adjustment Reserve Account. Operating Account. Under the Indenture. the Indenture Trustee will establish and hold a segregated trust account (the “Operating Account’) into which the Indenture Trustee will deposit amounts transferred from the Collection Account as set forth in the Officers’ Certificate as Operating Expenses and from which the Indenture Trustee will pay Operating Expenses in accordance with the priority of payments as described below under “Flow of Funds.” Turbo Redemption Account. Under the Indenture. the Indenture Trustee will establish and hold a segregated trust account (the “Turbo Redemption Account”) into which the Indenture Trustee will deposit all Surplus Collections. The Indenture Trustee will make Turbo Redemptions of the Series 2001 Bonds from the Turbo Redemption Account. Flow of Funds The Indenture Trustee will deposit all Collections in the Collection Account. Amounts deposited during the period January | through September 30 in any Fiscal Year (each period from October | through the following September 30, a “Fiscal Year”) will be applied to expenses and debt service requirements on the Bonds for the current and the first half of the next Fiscal Year. Amounts, if any. deposited during the period October | through December 31 in any Fiscal Year will be applied to expenses and debt service requirements on the Bonds for the current Fiscal Year. As used herein, the term “Deposit Date” means the date of actual receipt by the Indenture Trustee of any TSRs, provided that any payment received prior to January | of the year in which due, will be deemed to have been received on January 1. No later than five Business Days following each deposit of Collections to the Collection Account, the Indenture Trustee will withdraw Collections on deposit in the Collection Account, and transfer such amounts as follows: provided, however. that Lump Sum Payments and investment earnings in the Accounts (other than (1) the -_2?? NPM Adjustment Reserve Account, investment earnings on which shall be retained in such account, and (11) the Debt Service Reserve Account, investment earnings on which shall be retained in such Account until the amounts on deposit therein ure at least equal to $2.352.750 and thereafter. amounts on deposit in the Debt Service Reserve Account in excess of $2,352,750 shall be deposited directly in the Debt Service Account) will be deposited directly to the Debt Service Account, All earnings on amounts in the Debt Service Reserve Account will be retained until the amount therein is equal to $2,352,750. (i) (ii) (ili) (iv) (v) (vi) (vil) (viii) (a) to the Indenture Trustee an amount required to pay the Indenture Trustee fees and expenses due during the current Fiscal Year and, if the Deposit Date is during the period from January | through September 30 of any year, during the first half of the next Fiscal Year and (b) to the Operating Account the amount specified by an officer’s certificate (provided that such amounts paid pursuant to clauses (a) and (b) shall not exceed $50,000, adjusted for inflation. plus any arbitrage and rebate penalties, the “Operating Cap’) to pay Operating Expenses and the amount necessary to provide for payment of certain credit enhancement and liquidity provider fees. if any. in each case for the current Fiscal Year and, if the Deposit Date is between January | and September 30, for the first half of the following Fiscal Year; to the Debt Service Account an amount sufficient to cause the amount on deposit therein to equal interest (including interest at the stated rate on the Principal of Outstanding Bonds and on overdue interest, if any) due on the next succeeding Distribution Date, plus swap payments and interest on variable-rate Bonds due during the Semiannual Period including such Distribution Date, if any, together with any such interest and payments unpaid from prior Distribution Dates; unless an Event of Default has occurred and is continuing, to the Debt Service Account an amount sufficient to cause the amount on deposit therein, (exclusive of the amount on deposit therein pursuant to clause (ii) above) to equal the Principal due during the current Fiscal Year: unless an Event of Default has occurred and is continuing, to replenish the Debt Service Reserve Account until the amount on deposit therein equals the Debt Service Reserve Requirement: unless an Event of Default has occurred and is continuing. to the Debt Service Account an amount which, together with the amount on deposit therein pursuant to clause (ii) above but exclusive of the amounts on deposit therein pursuant to clause (iii) above, will be sufficient to cause the amount on deposit therein to equal interest (including interest at the stated rate on the principal of Outstanding Bonds and on overdue interest, if any) and Parity Payments, in cach case, due (a) during the current Fiscal Year and (b) if the Deposit Date is during the period from January | through September 30 of any year, during the first half of the next Fiscal Year (or, in the case of interest variable-rate Bonds and Parity Payments, during the last complete Semiannual Period in such next Fiscal Year), assuming that Principal of the Bonds will be paid in the amounts deposited pursuant to clause (iii) above and Turbo Redemptions will be paid pursuant to clause (vi) below: unless an Event of Default has occurred and is continuing, if a Lump Sum Payment has been received, to the Debt Service Account, the amount of such payment; if an Event of Default has occurred and is continuing, to the Extraordinary Prepayment Account, all amounts remaining in the Collection Account; in the amounts and to the accounts established by the Series Supplement for payments thereon in excess of the applicable maximum rate, principal payable under term-out of Ancillary Contracts (as defined in the Indenture, including, without limitation, credit enhancement), other amounts under Ancillary Contracts and not payable as Priority Payments (as defined under the Indenture) or debt service and any other junior payments specified as such by the Indenture (collectively, the “Junior Payments”); -23- (1X) to the Operating Account to pay Operating Expenses other than those paid under (1) above. if any, specified by an officer's certificate: and (x) unless an Event of Default has occurred and is continuing. all amounts remaining (the “Surplus Collections’) to the Turbo Redemption Account for application to Turbo Redemptions and, at the option of the Corperation at such time as no Term Bonds are Outstanding, the optional redemption of any Convertible CABs then Outstanding. After making the deposits set forth above, the Indenture Trustee shall compare (1) the amount on deposit in the Debt Service Reserve Account to (i) the principal amount of Bonds which will remain Outstanding after the application of amounts described below on the related Distribution Date. and if the amount in clause (1) is greater than the amount in clause (ii), the Indenture Trustee shall withdraw from the Debt Service Reserve Account an amount sufficient to, and shall, retire the Bonds in full on such Distribution Date. On each Distribution Date. the Indenture Trustee will apply amounts in the various accounts in the following order of priority: (1) from the Operating Account. to the parties entitled thereto, to pay Operating Expenses: (il) from the Debt Service Account and the Debt Service Reserve Account. in that order, to pay interest on the Bonds (including interest on overdue interest. if any) and Parity Payments due on such Distribution Date. plus any such unpaid interest and Purity Payments due on prior Distribution Dates. (ili) unless an Event of Default has occurred and is continuing. from the Debt Service Account and the Debt Service Reserve Account. in that order. to pay. in order of Maturity Dates, Principal due on such Distribution Date: (iv) unless an Event of Default has occurred and is continuing from the Debt Service Reserve Account. any amount remaining in excess of the Debt Service Reserve Requirement, to the Collection Account and from there immediately to the Debt Service Account: (v) trom the Debt Service Reserve Account and the Extraordinary Prepayment Account, if an Event of Default has occurred and is continuing. to pay Extraordinary Prepayments; (vi) unless an Event of Default has occurred and is continuing. if a Lump Sum Payment has been received, from the Debt Service Account (exclusive of the amount on deposit therein pursuant to clause (v) on the preceding page) to pay Lump Sum Prepayments: (Vil) from the Funds and Accounts therefor, to make Junior Payments: and (viii) from the Turbo Redemption Account. any amounts remaining thereon to make Turbo Redemptions. On the date of issuance of the Series 2001 Bonds. the Corporation shall transfer $696.377.55, constituting the amount of the 2001 Annual Payment. (together with all interest earnings thereon) to the Indenture Trustee for deposit in the NPM Adjustment Reserve Account. All investment earnings on amounts on deposit in the NPM Adjustment Reserve Account shall be retained in such account. If the Indenture Trustee shall receive written notice from the Corporation that the 2001 Annual Payment is subject to an NPM Adjustment, as required by the Indenture. then the Indenture Trustee shall transfer the amount of the NPM Adjustment (including any payment on accrued interest on such amounts pursuant to the MSA) to the Collection Account for application pursuant to the Indenture: provided that all amounts on deposit in the NPM Adjustment Reserve Account shall be released to the Corporation on any date upon receipt by the Indenture Trustee of a Rating Agency Confirmation. -24- Events of Default “Event of Default” means any one of the events set forth below: (i) (ii) (iii) (iv) (v) (vi) the failure to pay Principal of or interest on the Bonds when due; the Corporation fails to observe or perform any other provision of the Indenture which failure is not remedied within 60 days after written notice thereof is given to the Corporation by the Indenture Trustee or to the Corporation and the Indenture Trustee by the holders of at least 25% of the principal amount or Accreted Value of the Bonds then Outstanding, provided that, except for Principal and interest payments specified in clause (i) above, failure to make a Turbo Redemption because of insufficiency of available Collections will not constitute an Event of Default. In the case of a default specified in this subsection, if the default cannot be corrected within the said 60- day period, it shall not constitute an Event of Default if corrective action is instituted by the Corporation within said 60-day period and diligently pursued until the default is corrected; bankruptcy, reorganization, arrangement or insolvency proceedings, or other proceedings for relief under any bankruptcy or similar law or laws for the relief of debtors, are instituted by or against the Corporation and, if instituted against the Corporation, are not dismissed within 60 days after such institution; the Virgin Islands fails to observe or perform its covenant to not limit or alter the rights of the Corporation necessary to fulfill the terms of the Corporation’s agreements with the holders of the outstanding Bonds under the Indenture, or in any way impairs the rights and remedies of such holders or the security for the Bonds until the Bonds are fully paid and discharged, which failure is not remedied within 60 days after written notice thereof is given to the Corporation and the Virgin Islands by the Indenture Trustee or to the Corporation and the Indenture Trustee by holders of not less than 25% of the principal or Accreted Value of the Outstanding Bonds then Outstanding; the Virgin Islands fails to pay promptly to the Corporation or the Indenture Trustee any TSRs received by it in accordance with the Purchase Agreement; or the Virgin Islands consents to or acquiesces in an amendment or modification of the MSA or the Consent Decree, so as to materially reduce the ability of the Corporation to pay the principal of or interest on Bonds when due. Non-Impairment Pledge of the Virgin Islands Pursuant to the Act, the Purchase Agreement and the Indenture, the Corporation has, in the opinion of Transaction Counsel, validly included the pledge and agreement of the Virgin Islands not to limit or alter the rights of the Corporation to fulfill the terms of the Purchase Agreement and the Indenture, or to impair the rights and remedies of the Bondholders. -25 - SUMMARY OF THE MASTER SETTLEMENT AGREEMENT The following ty a brief summary of certain provisions of the MSA, This summary is not complete and is subject to, and qualified in its entirety by reference to, the copy of the MSA which is attached hereto as Appendix B. Several amendments have been made te tie MSA which are not included in Appendix B. Except for those amendments pursuant to which certain tobacco companies became SPMs tas defined below), such amendments invelve technical and administrative provisions not material to the summary below. General The MSA is an industry-wide settlement of litigation between the Settling States and the OPMs and was entered into between the attorneys general of the Settling States and the OPMs on November 23. 1998. The MSA provides for other tobacco companies (the “SPMs”) to become parties to the MSA. The four OPMs together with the 24+ SPMs are referred to as the “PMs.” The settlement represents the resolution of a large potential financial liability of the PMs for smoking-related claims, the costs of which have been borne and will likely continue to be borne by cigarette consumers. Pursuant to the MSA. the Settling States agreed to settle all their past. present and future smoking-related claims against the PMs in exchange for agreements and undertakings by the PMs concerning a number of issues. These issues include. among others, making payments to the Settling States, abiding by more stringent advertising restrictions, and funding educational programs, all in accordance with the terms and conditions set forth in the MSA. Distributors of PMs” products are also covered by the settlement of such claims to the same extent as the PMs. Parties to the MSA The Settling States are the Virgin [Slands. Puerto Rico. Guam, the District of Columbia. American Samoa and the Commonwealth of the Northern Mariana Islands. and all of the states except for the states of Florida, Minnesota. Mississippi and Texas that separately settled with the OPMs prior to the adoption of the MSA (the ~Previously-Settled States”). According to the National Association of Attorneys General (*"NAAG"), as of August 23. 2001. 30 SPMs have signed the MSA. The chart below identifies each of the PMs currently a party to the MSA: OPMs SPMs Brown & Williamson Tobacco Corporation Lorillard Tobacco Company Philip Morris Incorporated R.J. Reynolds Tobacco Company Alliance Tobaceo Corp. Caribbean- American Tobacco Corp. Commonwealth Brands. Inc. Cutting Edge Enterprises. Ine. Daughters & Ryan. Ine. Dhanraj International, Ine. Eastern Company S.A.E. House of Prince A/S Imperial Pobaceo Limited/ITL (USA) Limited Japan Tobaceo International U.S.A. Inc. King Maker Marketing Konet G&D Management Group Ine. Kretek International Landmark Corporation Lane Limited Liggett Group. Inc. Lignum-2. Ine. Mac Baren Pobaceo Company A/S 26 - Medallion Company, Inc., The Monte Paz (Compania Industrial de Tabacos Monte Paz S.A.) P.T. Djarum Peter Stokkebye International A/S Planta Tabak-manufaktur Gmbh & Co. Poschl Tabak GmbH & Co. KG Premier Manufacturing Incorporated Santa Fe Natural Tobacco Company, Inc. Sherman 1400 Broadway, N.Y.C. Inc Societe Nationale d Exploitation Industrielle des Tabacs et Allumettes (Seita) Tobacco & Candy International, Inc. Top Tobacco, LP The MSA restricts PMs from transferring their tobacco product brands, cigarette product formulas and cigarette businesses (unless they are being transferred exclusively for use outside the United States) to any entity that is not a PM under the MSA, unless the transferee agrees to assume the obligations of the transferring PM under the MSA related to such brands, formulas or businesses. The MSA expressly provides that the payment obligations ot each PM are not the obligation or responsibility of any affiliate of such PM and, further, that the remedies, penalties or sanctions that may be imposed or assessed in connection with a breach or violation of the MSA will only apply to the PMs and not against any other person or entity. Scope of Release Under the MSA, the PMs and the other “Released Parties” (defined below) are released from: claims based on past conduct, acts or omissions (including any future damages arising therefrom) in any way relating to the use, sale, distribution, manufacture, development, advertising, marketing or health effects of. or exposure to, or research statements or warnings regarding, tobacco products; and monetary claims based on future conduct, acts or omissions in any way relating to the use of or exposure to tobacco products manufactured in the ordinary course of business, including future claims for reimbursement of health care costs. This release is binding upon each Settling State and any of its past, present and future agents, officials acting in their official capacities, legal representatives, agencies, departments, commissions and divisions. The MSA is further stated to be binding on the following persons, to the full extent of the power of the signatories to the MSA to release past, present and future claims on their behalf: (1) any Settling State’s subdivisions (political or otherwise, including, but not limited to, municipalities, counties, parishes, villages, unincorporated districts and hospital districts), public entities, public instrumentalities and public educational institutions: and (11) persons or entities acting in a parens patriae, sovereign, quasi-sovereign, private attorney general, qui tam, taxpayer, or any other capacity, whether or not any of them participate in the MSA (a) to the extent that any such person or entity is seeking relief on behalf of or generally applicable to the general public in such Settling State or the people of such Settling State, as opposed solely to private or individual relief for separate and distinct injuries, or (b) to the extent that any such entity (as opposed to an individual) is seeking recovery of health-care expenses (other than premium or capitation payments for the benefit of present or retired state employees) paid or reimbursed. directly or indirectly, by a Settling State. All such persons or entities are referred to collectively in the MSA as “Releasing Parties.” The release inures to the benefit of all PMs and their past, present and future affiliates, divisions, officers, directors, employees, representatives, insurers, lenders, underwriters, tobacco-related organizations, trade associations, suppliers, agents, auditors, advertising agencies, public relations entities, attorneys, retailers and distributors (and the predecessors, heirs, executors, administrators, successors and assigns of cach of the foregoing). They are referred to in the MSA individually as a “Released Party” and collectively as the “Released Parties.” However, the term “Released Parties” does not include any person or entity (including. but not limited to, an affiliate) that is an NPM at any time after the MSA execution date, unless such person or entity becomes a PM. It is not clear if the Attorney General of the Virgin Islands bound the Releasing Parties other than the Virgin Islands. To the extent the Attorney General did not bind any of the Releasing Parties in the Virgin Islands, such entity would not be bound by the terms of the MSA. Entities with claims not released could still assert rights against the Released Parties, and any payments which might have to be made by Released Parties could reduce the amount of TSRs. Overview of Payments by the Participating Manufacturers The MSA requires that the PMs make several types of payments, including Initial Payments. Annual Payments and Strategic Contribution Fund Payments. See “Initial Payments,” “Annual Payments” and “Strategic Contribution Fund Payments” below. These payments (with the exception of the up-front Initial Payment) are -27- subject to various adjustments and offsets, some of which are material. See “Adjustment to Payments” below. SPMs are not required to make Initial Payments. Payments required to be made by the OPMs are calculated by reference to the OPM’s domestic shipments of cigarettes. with the amount of the payments adjusted annually roughly in proportion to the changes in total volume of cigarettes shipped by the OPMs in the United States in the preceding year. Payments to be made by the PMs are recalculated each year, based on the United States market share of each individual PM for the prior year, with consideration under certain circumstances, for the profitability of each OPM. The Annual Payments and Strategic Contribution Fund Payments required to be made by the SPMs are based on increases in their shipment market share. Pursuant to an escrow agreement (the “MSA Escrow Agreement’) established in conjunction with the MSA, the Initial Payments, Annual Payments and Strategic Contribution Fund Payments are to be made to Citibank N.A.’, as escrow agent (the “MSA Escrow Agent”), which in turn will disburse the funds to the Settling States. Initial Payments Initial Payments are made only by the OPMs. In December 1998, the OPMs collectively made an up-front Initial Payment of $2.4 billion. The 2000 Initial Payment, which had a scheduled base amount of $2.472 billion, was paid in December 1999 in the approximate amount of $2.15 billion and the 2001 Initial Payment, which had a scheduled base amount of $2.546 billion, was paid in December 2000 in the approximate amount of $2.180 billion (which amounts represent the scheduled base amounts as adjusted by the application of the adjustments discussed below). The remaining two Initial Payments are due on or before January 10 of each of 2002 and 2003. The scheduled base amount (before adjustments discussed below) of each remaining Initial Payment is shown below: Initial Payments Year Base Amount Up-Front $2,400,000,000 2000 2.472.000.000 2001 2,546.160,000 2002 2,622.544,800 2003 2.701,.221.144 In the case of the up-front Initial Payment in 1998, the relative payment responsibilities of the OPMs were calculated using their respective market capitalization percentages, as specified in the MSA. Thereafter, the respective payment responsibilities are to be recalculated each year based on the OPM’s Relative Market Share during the preceding calendar year. “Relative Market Share” is defined as an OPM’s percentage share of the number of cigarettes shipped by all OPMs in or to the 50 states, the District of Columbia and Puerto Rico (defined hereafter as the “United States”). as measured by the OPM’s reports of shipments to Management Science Associates, Inc. (or any successor acceptable to all the OPMs and a majority of the attorneys general of the Settling States who are also members of the NAAG executive committee). The term “cigarette” is defined in the MSA to mean any product that contains tobacco and nicotine, is intended to be burned and is likely to be offered to, or purchased by, consumers as a cigarette and includes “roll-your-own™ tobacco. The base amounts of the remaining Initial Payments shown in the table above are subject to modification according to the following adjustments in the following order: . the Volume Adjustment. ° the Non-Settling States Reduction, and ° the Offset for Miscalculated or Disputed Payments. 4 * Salomon Smith Bamey, an Underwriter, is an atfihate of Citibank, N.A.. which is acting as MSA Escrow Agent under the MSA. - 28 - Annual Payments In addition to Initial Payments, the OPMs are required to make Annual Payments on each April 15, having commenced on April 15, 2000 to continue in perpetuity. The PMs made the first Annual Payment due April 15, 2000, the scheduled base amount of which (before adjustments discussed below) was $4.5 billion. After application of the adjustments, the Annual Payment for 2000 was approximately $3.5 billion. The PMs made the second Annual Payment due April 15, 2001, the scheduled base amount of which (before adjustments discussed below) was $5.0 billion. After application of the adjustments, the Annual Payment for 2001 was approximately $4.06 billion. The scheduled base amount (before adjustments discussed below) of each remaining Annual Payment is set forth below: Remaining Annual Payments Year Base Amount Year Base Amount 2002 $6,500,000,000 2010 $8, 139,000,000 2003 6,500,000,000 2011 8,139,000,000 2004 8,000,000,000 2012 8,139,000,000 2005 8,000,000,000 2013 8,139,000,000 2006 8,000,000,000 2014 8,139,000,000 2007 8,000,000,000 2015 8,139,000,000 2008 8,139,000,000 2016 8,139,000,000 2009 8,139,000,000 2017 8,139,000,000 2018 and 9,000,000,000 thereafter The respective portion of each base amount applicable to each OPM is calculated by multiplying the base amount by the OPM’s Relative Market Share during the preceding calendar year. The base annual payments in the above table will be increased by at least the minimum 3% Inflation Adjustment, adjusted by the Volume Adjustment, reduced by the Previously-Settled States Reduction, and further adjusted by the other adjustments described below. The SPMs are required to make Annual Payments if their market share increases above the higher of their 1998 Market Share or 125% of their 1997 Market Share. The base amounts shown in the table above are subject to the following adjustments applied in the following order: the Inflation Adjustment, the Volume Adjustment, the Previously Settled States Reduction, the Non-Settling States Reduction, the NPM Adjustment, the Offset for Miscalculated or Disputed Payments, the Federal Tobacco Legislation Offset, the Litigating Releasing Parties Offset, and the Offset for Claims-Over. -29- Application of these adjustments resulted in a material reduction of TSRs from the scheduled base amounts of the Annual Payments made by the PMs in April 2000 and April 2001, as discussed below under the caption “Payments Made to Date.” Strategic Contribution Fund Payments In addition, the OPMs are required to make Strategic Contribution Fund Payments on April 15, 2008 and on April 15 of each year thereafter through 2017. The base amount of each Strategic Contribution Fund Payment is $861 million. The respective portion of each base amount applicable to each OPM is calculated by multiplying the base amount by the OPM’s Relative Market Share during the preceding calendar year. The SPMs will be required to make Strategic Contribution Fund Payments if their market share increases above the higher of their 1998 Market Share or 125% of their 1997 Market Share. The base amounts of the Strategic Contribution Fund Payments are subject to the following adjustments: the Inflation Adjustment the Volume Adjustment the Non-Settling States Reduction the NPM Adjustment the Offset for Miscalculated or Disputed Payments the Federal Tobacco Legislation Offset the Litigating Releasing Parties Offset the Offset for Claims-Over Adjustments to Payments The base amounts of the Initial Payments, Annual Payments and Strategic Contribution Fund Payments shown in the tables and discussed above are subject to certain adjustments to be applied in accordance with formulas contained in the MSA. Inflation Adjustment. The base amount of the Annual Payments and Strategic Contribution Fund Payments is increased each year to account for inflation. The increase in each year will be 3% or a percentage equal to the percentage increase in the Consumer Price Index (the “CPI’’) (or such other similar measures as may be agreed to by the Settling States and the PMs) for the preceding year. whichever is greater (the “Inflation Adjustment”). The Inflation Adjustments are compounded annually on a cumulative basis beginning in 1999 and were first applied in 2000. Initial Payments are not subject to the Inflation Adjustment. Volume Adjustment. Initial Payments, Annual Payments and Strategic Contribution Fund Payments are increased or decreased by an adjustment which accounts for fluctuations in the number of cigarettes shipped by the OPMs in or to the United States (the “Volume Adjustment’). If the aggregate number of cigarettes shipped in or to the United States by the OPMs in any given year (the “Actual Volume’) is greater than 475,656,000,000 cigarettes (the “Base Volume’”’), the base amount allocable to the OPMs is adjusted to equal the base amount (in the case of Annual Payments and Strategic Contribution Fund Payments after application of the Inflation Adjustment) multiplied by a fraction, the numerator of which is the Actual Volume and the denominator of which is the Base Volume. - 30 - If the Actual Volume in a given year is less than the Base Volume, the base amount due from the OPMs (in the case of Annual Payments and Strategic Contribution Fund Payments after application of the Inflation Adjustment) is decreased by 98% of the percentage by which the Actual Volume is less than the Base Volume, multiplied by such base amount. If, however, the aggregate operating income of the OPMs from sales of cigarettes in the United States during the year (the “Actual Operating Income’’) is greater than $7,195,340,000, as adjusted for inflation in accordance with the Inflation Adjustment (the “Base Operating Income’), all or a portion of the volume reduction is added back (the “Income Adjustment”). The amount by which the Actual Operating Income of the OPMs exceeds the Base Operating Income is multiplied by the percentage of the allocable shares under the MSA represented by Settling States in which State-Specific Finality has been reached and divided by four, then added to the payment due. However, in no case will the amount added back due to the increase in operating income exceed the amount deducted due to the decrease in domestic volume. Any add-back due to an increase in Actual Operating Income will be allocated among the OPMs on a pro rata basis in accordance with their respective increases in Actual Operating Income over 1997 Base Operating Income. Previously Settled States Reduction. The base amounts of the Annual Payments (as adjusted by the Inflation Adjustment and the Volume Adjustment, if any) are subject to a reduction reflecting the four states that had settled with the OPMs prior to the adoption of the MSA (Mississippi, Florida, Texas and Minnesota) (the “Previously Settled States Reduction”). The Previously Settled States Reduction reduces by 12.4500000% each applicable payment on or before December 31, 2007, by 12.2373756% each applicable payment between January 1, 2008 and December 31, 2017, and by 11.0666667% each applicable payment on or after January 1, 2018. The SPMs are not entitled to any reduction pursuant to the Previously Settled States Reduction. Initial Payments and Strategic Contribution Fund Payments are not subject to the Previously Settled States Reduction. Non-Settling States Reduction. In the event that the MSA terminates as to any Settling State, the Initial Payments, Annual Payments and Strategic Contribution Fund Payments due from the PMs shall be reduced to account for the absence of such state. This adjustment (““Non-Settling States Reduction”) has no effect on the amounts to be collected by states which remain a party to the MSA, and the reduction is therefore not detailed. Non-Participating Manufacturers Adjustment. If the aggregate market share of the PMs in any year falls more than 2% below the aggregate market share held by those same PMs in 1997, and if a nationally-recognized team of economic consultants determines that the decrease is due to the effects of the MSA, an adjustment (the “NPM Adjustment”) is applied to the Annual Payment and Strategic Contribution Fund Payment due in the following year. The 1997 market share percentage for the PMs, less 2%, is defined as the “Base Aggregate Participating Manufacturer Market Share.” If the PMs’ actual aggregate market share is between 0% and 161% less than the Base Aggregate Participating Manufacturer Market Share, the amounts paid by the PMs will be decreased by three times the percentage decrease in the PM’s actual aggregate market share. If, however, the aggregate market share loss from the Base Aggregate Participating Manufacturer Market Share is greater than 16/:%, the NPM Adjustment will be calculated as follows: NPM Adjustment = 50% + [50% / (Base Aggregate Participating Manufacturer Market Share - 16 /%)|{market share loss -167/:%] Regardless of how the NPM Adjustment is calculated, it is always subtracted from the total Annual Payments and Strategic Contribution Fund Payments due from the PMs. The NPM Adjustment applies only to the Annual Payments and Strategic Contribution Fund Payments and does not apply at all if the number of cigarettes shipped in or to the United States in the year prior to the year in which the payment is due by all manufacturers that were PMs prior to December 7, 1998 exceeds the number of cigarettes shipped in or to the United States by all such PMs in 1997. The NPM Adjustment is also state-specific, in that a Settling State may avoid or mitigate the effects of an NPM Adjustment by enacting and enforcing a Model Statute or Qualifying Statute. Any Settling State that adopts and enforces a Model Statute or a Qualifying Statute is exempt from the NPM Adjustment. The decrease in total funds available due to the NPM Adjustment is allocated on a pro-rata basis among those Settling States that either (a) did not enact and enforce a Model Statute or Qualifying Statute or (b) enacted a Model Statute or Qualifying -31- Statute that is declared invalid or unenforceable by a court of competent jurisdiction. If a Settling State enacts and enforces a Model Statute but it is declared invalid or unenforceable by a court of competent jurisdiction, the NPM Adjustment will not exceed 65% of the amount of such state’s allocated payment. If a Qualifying Statute is held invalid or unenforceable. however. such state is not entitled to any protection from the NPM Adjustment. See “— MSA Provisions Relating to Model Statute/Qualifying Statutes — Virgin Islands Model Statute.” The MSA provides that if any Settling State resolves claims against any NPM that are comparable to any of the claims released in the MSA on overall terms more favorable to such NPM, the same terms will be extended to all PHs. Offset for Miscalculated or Disputed Payments. If the MSA Auditor receives notice of a miscalculation of an Initial Payment made by an OPM or an Annual Payment or a Strategic Contribution Fund Payment made by a PM within four years, the auditor will recalculate the payment and make provisions for rectifying the error (the “Offset for Miscalculated or Disputed Payments”). There are no time limits specified for recalculations although the MSA Auditor is required to determine amounts promptly. Disputes as to determinations by the MSA Auditor may be submitted to binding arbitration governed by the United States Federal Arbitration Act. In the event that mispayments have been made. they will be corrected through pa,ments with interest (in the event of underpayments) or withholdings with interest (in the event of overpayments). Interest will be at the prime rate, except where a party fails to pay undisputed amounts or fails to provide necessary information readily available to it, in which case a penalty rate of prime plus 3% applies. If a PM disputes any required payment. it must determine whether any portion of the payment is undisputed and pay that amount for disbursement to the Settling States. The disputed portion ts required to be paid into a Disputed Payments Account pending resolution of the dispute. Failure to pay such disputed amounts into the Disputed Payments Account can result in liability for interest at the penalty rate if the disputed amount was in fact properly due and owing. Federal Tobacco Legislation Offset. If federal tobacco-related legislation is enacted on or before November 30, 2002 and if such legislation provides for payments by any PM to the federal government all or part of which are actually made available to any Settling State, the MSA provides that each PM will receive a continuing dollar-for-dollar offset for such amounts paid to and received by such Settling State (the “Federal Tobacco Legislation Offset”). The Federal Tobacco Legislation Offset applies only to that portion of the federal funds directed to a Settling State that is either unrestricted as to its use or restricted to any form of health care or to any use related to tobacco. The Federal Tobacco Legislation Offset does not generally apply to federal funds conditioned, or appropriately allocable, either to the relinquishment of rights or benefits under the MSA or to a consent decree or actions or expenditures by the Settling State. However, if the Settling State chooses to undertake such action or expenditure, and if such actions or expenditures either (a) do not impose significant constraints on public policy choices, or (b) are both related to health or tobacco and do not require the Settling State to expend state matching funds in an amount that is significant in relation to the amount of federal funds made available to the applicable Settling State, the Federal Tobacco Legislation Offset applies. The Federal Tobacco Legislation Offset does not reduce the total amounts payable by the PM to the Settling States under the MSA by an amount greater than the amount of federal funds that the Settling States could elect to receive. Litigating Releasing Parties Offset. If any Releasing Party initiates litigation against a PM for any of the claims released in the MSA. the PM may be entitled to an offset against such PM's payment obligation under the MSA (the “Litigating Releasing Parties Offset”). A defendant PM may offset dollar-for-dollar any amount paid in settlement. stipulated judgment or litigated judgment against the amount to be collected by the applicable Settling State under the MSA only if the PM has taken all ordinary and reasonable measures to defend that action fully and only if any settlement or stipulated judgment was consented to by the state attorney general. The Litigating Releasing Parties Offset is state-specific. Any reduction in MSA payments as a result of the Litigating Releasing Parties Offset would apply only to the Settling State of the Releasing Party. Offset for Claims-Over. If a Releasing Party pursues and collects on a released claim against an NPM ora retailer, supplier or distributor arising from the sale or distribution of tobacco products of any NPM or the supply of -32- component parts of tobacco products to any NPM (collectively. the “Non-Released Parties”), and the Non- Released Party in turn successfully pursues a claim for contribution or indemnification against a Released Party (as defined herein), the Releasing Party must (a) reduce or credit against any judgment or settlement such Releasing Party obtains against the Non-Released Party the full amount of any judgment or settlement such Non-Released Party may obtain against the Released Party and (b) obtain from such Non-Released Party for the benefit of such Released Party a satisfaction in full of such Non-Released Party’s judgment or settlement against the Released Party. In the event that such reduction or satisfaction in full does not fully relieve the Released Party of its duty to pay to the Non-Released Party, the PM is entitled to a dollar-for-dollar offset from its payment to the applicable Settling State (the “Offset for Claims-Over”). For purposes of the Offset for Claims-Over, any person or entity that is enumerated in the definition of Releasing Party set forth above is treated as a Releasing Party without regard to whether the applicable attorney general had the power to release claims of such person or entity. The Offset for Claims-Over is state-specific and would apply only to MSA payments owed to the Settling State of the Releasing Party. Subsequent Participating Manufacturers SPMs are only obligated to make Annual Payments and Strategic Contribution Fund Payments which are made at the same time as the Annual Payments and Strategic Contribution Fund Payments to be made by OPMs. Annual Payments and Strategic Contribution Fund Payments for SPMs are calculated differently, however, from Annual Payments and Strategic Contribution Fund Payments for OPMs. Each SPM’s payment obligation is determined according to its market share if, and only if, its “Market Share” (defined in the MSA to mean a manufacturer’s share, expressed as a percentage, of the total number of cigarettes sold in the United States in a given year, as measured by excise taxes (or similar taxes, in the case of Puerto Rico) for the year preceding the payment exceeds its “Base Share,” defined as the higher of its 1998 Market Share or 125% of its 1997 Market Share. If an SPM executes the MSA after February 22, 1999, its 1997 or 1998 Market Share, as applicable, is deemed to be zero. Seventeen of the current 24 SPMs signed the MSA on or before the February 22 deadline. For each Annual Payment and Strategic Contribution Fund Payment, each SPM is required to pay an amount equal to the base amount of the Annual Payment and Strategic Contribution Fund Payment owed by the OPMs, collectively, adjusted for the Volume Adjustment described above but prior to any other adjustments, reductions or offsets, multiplied by (i) the difference between that SPM’s Market Share for the preceding year and its Base Share, divided by (ii) the aggregate Market Share of the OPMs for the preceding year. Other than the application of the Volume Adjustment, payments by the SPMs are subject to the same adjustments (including the Inflation Adjustment), reductions and offsets as are the payments made by the OPMs,. except for the Previously-Settled States Reduction. Because the Annual Payments and Strategic Contribution Fund Payments to be made by the SPMs are calculated in a manner different from the calculations for Annual Payments and Strategic Contribution Fund Payments to be made by the OPMs, a change in market share between the OPMs and the SPMs could cause the amount of Annual Payments and Strategic Contribution Fund Payments required to be made by the PMs in the aggregate to be greater or less than the amount that would be payable if their market share remained the same. In certain circumstances, an increase in the market share of the SPMs could increase the aggregate amount of Annual Payments and Strategic Contribution Fund Payments because the Annual Payments and Strategic Contribution Fund Payments to be made by the SPMs are not adjusted for the Previously-Settled States Reduction. However, in other circumstances, an increase in the market share of the SPMs could decrease the aggregate amount of Annual Payments and Strategic Contribution Fund Payments because the SPMs are not required to make any Annual Payments and Strategic Contribution Fund Payments unless their market share increases above their Base Share, or because of the manner in which the Inflation Adjustment is applied to each SPM’s payments. Payments Made to Date The MSA Escrow Agent has disbursed to the Virgin Islands its allocable portions of the first three Initial Payments and the first two Annual Payments. None of these payments are pledged to payment of the Series 2001 Bonds. The MSA states that the information on which the computation of Initial Payments, Annual Payments and -33- Strategic Contribution Fund Payments by the MSA Auditor is based is confidential and may not be used for purposes other than those stated in the MSA. Since no Strategic Contribution Fund Payments are required to be paid until April 15, 2008, Strategic Contribution Fund Payments are not discussed in this section. MSA Payments Made to Date to the Virgin Islands Unadjusted Actual Payment Payment’ Up-Front Initial Payment $ 416,623.20 $ 428,599.38 January 10, 2000 Initial Payment 429,121.90 373,336.05 January 10, 2001 Initial Payment 441,995.55 336,186.29 April 15, 2000 Annual Payment 781,168.50 592,395.62 April 15, 2001 Annual Payment 867,965.00 696,377.55 As shown above, the Virgin Islands” share of the $4.5 billion unadjusted Annual Payment due April 15, 2000 was $781,168.50 which, after application of the adjustments, was reduced to approximately $592,395.62. The Virgin Islands has advised the Corporation that the adjustments principally responsible for such reduction were the Inflation Adjustment (which increased the unadjusted payment by 3%), the Volume Adjustment (which in the case of the OPMs decreased the unadjusted payment by approximately 13.00% and also reflected therein an upward Income Adjustment of what the OPM Volume Adjustment otherwise would have been) and the Previously-Settled States Reduction (a constant 12.45% reduction applied to the 2000 Annual Payment after giving effect to the Inflation Adjustment and the Volume Adjustment). The Virgin Islands has also advised the Corporation that both the Settling States and the PMs are disputing the calculations of the Initial Payment and Annual Payment for 2001 in accordance with the procedures set forth in the MSA. The terms of the MSA relating to such payments and various adjustments thereto are described above under the captions “Initial Payments.” “Annual Payments” and “Adjustments to Payments.” As shown above, the Virgin Islands’ share of the $5 billion unadjusted Annual Payment due April 15, 2001 was $867,965.00 which, after application of the adjustments, was reduced to approximately $696,377.55. The Virgin Islands has advised the Corporation that the adjustments principally responsible for such reduction were the Inflation Adjustment (which increased the unadjusted payment by 6.49%), the Volume Adjustment (which in the case of the OPMs decreased the unadjusted payment by approximately 15% and also reflected therein an upward Income Adjustment of what the OPM Volume Adjustment otherwise would have been) and the Previously-Settled States Reduction (a constant 12.45% reduction applied to the 2000 Annual Payment after giving effect to the Inflation Adjustment and the Volume Adjustment). The terms of the MSA relating to such payments and various adjustments thereto are described above under the captions “Initial Payments,” “Annual Payments” and “Adjustments to Payments.” In addition, subsequent revisions in the information delivered to the MSA Auditor, and on which the MSA Auditor's calculations of the Initial and Annual Payments are based, may result in a recalculation of such payments as well as routine recalculation of future payments. By way of example. the Virgin Islands has advised the Corporation that the MSA Auditor expects to receive information which will result in a recalculation of the aggregate national 2001 Annual Payment. Such recalculation could give rise to an NPM Adjustment which, as a result of the timing of the Virgin Islands’ enactment of its Model Statute, could in turn reduce or eliminate the Virgin Islands’ 2001 Annual Payment. Any such reduction or elimination would be effected through an offset against a future payment of TSRs. Upon delivery of the Series 2001 Bonds, the Corporation shall deposit the Virgin Islands’ 2001 Annual Payment (together with all investment earnings thereon) into the NPM Adjustment Reserve Account where it will be available to the Indenture Trustee should a future MSA Payment be reduced as a result of ha roe ' . : F Source: United States Virgin Islands Department of Finance The 2001 Annual Payment will be deposited in the NPM Adjustment Reserve Account (See “SECURITY — Accounts——NPM Adjustment Reserve Account” herein). -34- the offset described above. The offset, if any, against a future payment of TSRs described above would also include interest on the recalculated payment at the prime rate from the date of the original payment. Surplus Collections available to make Turbo Redemptions would be reduced to the extent such interest exceeds the corresponding interest earned on the amounts on deposit in the NPM Adjustment Reserve Account. In such a situation the average life of the Term Bonds would increase. See “SECURITY — Accounts — NPM Adjustment Reserve Account.” The Virgin Islands has also advised the Corporation that in calculating the Volume Adjustment to an Initial Payment the MSA Auditor intends to estimate consumption for the prior year, and then recalculate the Initial Payment and make adjustments to subsequent payments when final consumption numbers for such prior year are provided to it. No assurance can be given as to the magnitude of any such recalculation. Any such recalculation could trigger the Offset for Miscalculated or Disputed Payments. The amounts shown in the table above under the column heading “Actual Payment” are the approximate amounts of the payments actually received by the Virgin Islands adjusted to indicate the recalculations made to date. “Most Favored Nation” Provisions In the event that any non-foreign governmental entity other than the federal government should reach a settlement of released claims with PMs that provides more favorable terms to the governmental entity than does the MSA to the Settling States, the non-economic terms of the MSA, and only such non-economic terms, will be modified to match those of the more favorable settlement. In the event that any Settling State should reach a settlement of released claims with NPMs that provides more favorable terms to the NPM than the MSA does to the PMs, the terms of the MSA will be deemed modified to match the NPM settlement, but only with respect to the particular Settling State. In the event that any Settling State agrees to reduce the burden placed upon any PM by the terms of the MSA, the MSA will be deemed modified so that each PM enjoys the same reduction in burden, but only with respect to the particular Settling State. In no event will the adjustments discussed in this paragraph modify the MSA with regard to other Settling States. State-Specific Finality and Final Approval The MSA provides that payments could not be disbursed to the individual Settling States until the occurrence of each of two events: State-Specific Finality and Final Approval. “State-Specific Finality“ means, with respect to an individual Settling State, that (i) such state has settled its pending or potential litigation against the tobacco companies with a consent decree, which decree has been approved and entered by a court within the Settling State and (ii) the time for all appeals against the consent decree has expired. If any Settling State fails to achieve State Specific Finality on or before December 31, 2001, its participation in the MSA is automatically terminated. All Settling States have achieved State Specific Finality. “Final Approval“ marks the approval of the MSA by the Settling States and means the earlier of (i) the date on which at least 80% of the Settling States, both in terms of number and dollar volume entitlement to the proceeds of the MSA, have reached State-Specific Finality, or (ii) June 30, 2000. Final Approval was achieved on November 12, 1999. Disbursement of Funds from Escrow The MSA Auditor makes all calculations necessary to determine the amounts to be paid by each PM, as well as the amounts to be disbursed to each of the Settling States. Upon completing any particular set of disbursement calculations, the MSA Auditor must provide copies of the calculations to all parties to the MSA, who shall each have 10 days within which to question or challenge the calculations. The final calculation is due from the MSA Auditor not less than 15 days prior to the payment due date. The calculation is subject to further adjustments if previously missing information is received. In the event of a challenge to the calculations, the non-challenged part of a payment shall be processed in the normal course. Challenges will be submitted to binding arbitration. -35- Disbursement of the funds by the MSA Escrow Agent from the escrow accounts shall occur within 10 business days of receipt of the particular funds. The MSA Escrow Agent will disburse the funds due to, or as directed by. each Settling State in accordance with instructions received from that state. On or prior to the date of delivery of the Series 2001 Bonds. the Virgin Islands will direct the MSA Escrow Agent to disburse the TSRs to the Indenture Trustee. Advertising and Marketing Restrictions; Educational Programs The MSA prohibits the PMs trom certain advertising, marketing and other activities that may promote the sale of cigarettes and smokeless tobacco products (“Tobacco Products”). Under the MSA, the PMs are generally prohibited from targeting persons under 18 years of age within the Settling States in the advertising, promotion or marketing of Tobacco Products and from taking any action to initiate, maintain or increase smoking by underage persons within the Settling States. Specifically. the PMs may not (i) use any cartoon characters in advertising, promoting, packaging or labeling Tobacco Products: (ii) distribute any free samples of Tobacco Products except in a restricted facility where the operator thereof is able to ensure that no underage persons are present; or (iii) provide to any underage person any item in exchange for the purchase of Tobacco Products or for the furnishing of proofs-of- purchase coupons. The PMs are also prohibited from placing any new outdoor and transit advertising, and are committed to remove any existing outdoor and transit advertising for Tobacco Products in the Settling States. Other examples of prohibited activities include, subject to limited exceptions, the sponsorship of any athletic, musical, artistic or other social or cultural event in exchange for the use of tobacco brand names as part of the event; the making of payments to anyone to use. display, make reference to or use as a prop any Tobacco Product or item bearing a tobacco brand name in any motion picture. television show, theatrical production, music performance, commercial film or video game; the sale or distribution in the Settling States of any non-tobacco items containing tobacco brand names or selling messages: and the sale of packs of cigarettes containing fewer than 20 cigarettes unul at least December 31. 2001. In addition, the PMs have agreed under the MSA to provide funding for the organization and operation of a charitable foundation (the “Foundation™) and educational programs to be operated within the Foundation. The main purpose of the Foundation will be to support programs to reduce the use of Tobacco Products by underage persons and to prevent diseases associated with the use of Tobacco Products. On March 31, 1999, and on March 31 of each subsequent year for a period of nine years thereafter. cach OPM is required to pay its Relative Market Share of $25,000,000 (which is not subject to any adjustments, offsets or reductions pursuant to the MSA) to fund the Foundation. In addition, each OPM was and is required to pay its Relative Market Share of $250,000,000 on March 31, 1999, and $300,000,000 on March 31 of each of the subsequent four years to fund the Foundation. Furthermore, each PM may be required to pay its Relative Market Share of $300,000,000 on April 15, 2004, and on April 15 of each year thereafter in perpetuity if, during the year preceding the year when payment is due, the sum of the Market Shares of the PMs equals or exceeds 99.05%. The Foundation may also be funded by contributions made by other entities. Termination of Agreement Any jurisdiction's participation in the MSA is automatically terminated if such jurisdiction does not reach State-Specific Finality on or before December 31. 2001. The MSA is also terminated as to a Settling State (a) if the MSA or consent decree in that jurisdiction is disapproved by a court and the time for an appeal has expired, the appeal is dismissed or the disapproval is affirmed or (b) if the representations and warranties of the attorney general of that jurisdiction relating to the ability to release claims are breached or not effectively given. In addition, in the event that a PM enters bankruptcy and fails to perform its financial obligations under the MSA, the Settling States, by vote of at least 75% of the Settling States. both in terms of number and of entitlement to the proceeds of the MSA, may terminate certain financial obligations of that particular manufacturer under the MSA. The MSA provides that if it is terminated. then the statute of limitations with respect to released claims will be tolled from the date the Settling State signed the MSA until the later of the time permitted by applicable law or one year from the date of termination and the parties will jointly move for the reinstatement of the claims and - 36 - actions dismissed pursuant to the MSA. The parties will return to the positions they were in prior to the execution of the MSA. Severability By its terms, most of the major provisions of the MSA are not severable from its other terms. If a court materially modifies, renders unenforceable or finds unlawful any nonseverable provision. the attorneys general of the Settling States and the OPMs are to attempt to negotiate substitute terms. If any OPM does not agree to the substitute terms, the MSA terminates in all Settling States affected by the court’s ruling. Amendments and Waivers The MSA may be amended by all PMs and Settling States affected by the amendment. The terms of any amendment will not be enforceable against any Settling State which is not a party to the amendment. Any waiver will be effective only against the parties to such waiver and only with respect to the breach specifically waived. MSA Provisions Relating to Model/Qualifying Statutes General. The MSA sets forth the schedule and calculation of payments to be made by OPMs to the Settling States. As described above, the Annual Payments and Strategic Contribution Fund Payments are subject to, among other adjustments and reductions, the NPM Adjustment, which may reduce the amount of money that a Settling State receives pursuant to the MSA. The NPM Adjustment will reduce payments of a PM if such PM experiences certain losses of market share in the United States as a result of participation in the MSA. Settling States may mitigate the effect of the NPM Adjustment by taking certain actions, including the adoption of a statute, law, regulation or rule (a “Qualifying Statute”) which eliminates the cost disadvantages that PMs experience in relation to NPMs as a result of the provisions of the MSA. “Qualifying Statute,” as defined in Section IX(d)(2)(E) of the MSA, means a statute, regulation, law. and/or rule adopted by a Settling State that “effectively and fully neutralizes the cost disadvantages that PMs experience vis-a-vis NPMs within such Settling State as a result of the provisions of the MSA.” Exhibit T to the MSA sets forth a model form of Qualifying Statute (a “Model Statute’) that will qualify as a Qualifying Statute so long as the statute is enacted without modification or addition (except for particularized state procedural or technical requirements) and is not enacted in conjunction with any other legislative or regulatory proposal. The MSA also provides a procedure by which a Settling State may enact a statute that is not the Model Statute and receive a determination from a nationally recognized firm of economic consultants that such statute is a Qualifying Statute. If a Settling State continuously has a Qualifying Statute in full force and effect and diligently enforces the provisions of such statute, the MSA states that the payments allocated to such Settling State will not be subject to a reduction due to the NPM Adjustment. Furthermore, the MSA dictates that the aggregate amount of the NPM Adjustment is to be allocated, in a pro rata manner, among all Settling States that do not adopt and enforce a Qualifying Statute. In addition, if the NPM Adjustment allocated to a particular Settling State exceeds its allocated payment, that excess is to be reallocated equally among the remaining Settling States that have not adopted and enforced a Qualifying Statute. Thus, Settling States that do not adopt and enforce a Qualifying Statute will receive reduced allocated payments if an NPM Adjustment is in effect. The MSA provides an economic incentive for most states to adopt and diligently enforce a Qualifying Statute. The MSA provides that if a Settling State enacts a Qualifying Statute that is a Model Statute and uses its best efforts to keep the Model Statute in effect, but a court invalidates the statute, then, although that state remains subject to the NPM Adjustment, the NPM Adjustment is limited to no more, on a yearly basis, than 65% of the amount of such state’s allocated payment (including reallocations described above). The determination from a nationally recognized firm of economic consultants that a statute constitutes a Qualifying Statute is subject to reconsideration in certain circumstances and such statute may later be deemed not to constitute a Qualifying Statute. In the event that a Qualifying Statute that is not a Model Statute is invalidated or declared unenforceable by a court, -37- or, upon reconsideration by a nationally recognized firm of economic consultants. is determined not to be a Qualifying Statute, the Settling State that adopted such statute will become fully subject to the NPM Adjustment. Summary of the Model Stanie, One of the objectives of the MSA (as set forth in the Findings and Purpose section of the Model Statute) is to shift the financial burdens of cigarette smoking from the Settling States to the tobacco product manufacturers. The Model Statute provides that any tobacco manufacturer who does not join the MSA would be subject to the provisions of the Model Statute because {i]t would be contrary to the policy of the state if tobacco product manufacturers who determine not to enter into such a settlement could use a resulting cost advantage to derive large. short-term profits in the years before liability may arise without ensuring that the state will have an eventual source of recovery from them if they are proven to have acted culpably. It is thus in the interest of the state to require that such manufacturers establish a reserve fund to guarantee a source of compensation and to prevent such manufacturers from deriving large. short-term profits and then becoming judgment-proof before liability may arise. Accordingly, pursuant to the Model Statute. a tobacco manufacturer that is an NPM under the MSA must deposit an amount for each cigarette it sells into an escrow account (which amount increases on a yearly basis, as set forth in the Model Statute). The amounts deposited into the escrow accounts by the NPMs may only be used in limited circumstances. Although the NPM receives the interest or other appreciation on such funds, the principal may only be released (i) to pay a judgment or settlement on any claim of the type that would have been released by the MSA brought against such NPM by the applicable Settling State or any Releasing Party located within such state; (ii) to the extent that the NPM establishes that the amount it was required to deposit into the escrow account was greater than such state’s allocable share of the total payments that such NPM would have been required to make if it had been a Participating Manufacturer under the MSA (as determined betore certain adjustments or offsets); or (iii) 25 years after the date that the funds were placed into escrow (less any amounts paid out pursuant to (i) or (ii). If the NPM fails to place funds into escrow as required, the attorney general of the applicable Settling State may bring a civil action on behalf of the state against the NPM. If a court finds that an NPM violated the statute, it may impose civil penalties in the following amounts: (i) an amount not to exceed 5% of the amount improperly withheld from escrow per day of the violation and in an amount not to exceed 100% of the original amount improperly withheld from escrow: (ii) in the event of a knowing violation. an amount not to exceed 15% of the amount improperly withheld from escrow per day of the violation and in an amount not to exceed 300% of the original amount improperly withheld from escrow: and (iii) in the event of a second knowing violation, the court may prohibit the NPM from selling cigarettes to consumers within such state (whether directly or through a distributor, retailer or similar intermediary) for a period not to exceed two years. NPMs include foreign tobacco manufacturers that intend to sell cigarettes in the United States that do not themselves engage in an activity in the United States. However, enforcement of the Model Statute against such foreign manufacturers that do not do business in the United States may be difficult. See “RISK FACTORS—Risks Related to Enforceability or Modification of the Master Setthement Agreement and Constitutionality of the Model Statute—Model Statute” herein. Virgin Islands Model Statute. The Virgin Islands Model Statute. Section 20 of Bill No. 23-0306 enacted as Act 6391. became effective on June 29, 2001. By letter dated August 8, 2001, counsel to the OPMs confirmed that the OPMs will not dispute that the Virgin Islands Model Statute constitutes a Model Statute under the MSA. The Virgin Islands, as a result of the Uming of enactment of its Model Statute in 2001, will be subject to an NPM Adjustment, if any, for any Annual Payment received prior to April 15, 2002. No assurance can be given as to the size, if any, of any NPM Adjustment, See “SECURITY—Accounts—NPM Adjustment Reserve Account.” Starting April 15, 2002. Annual Payments made to the Virgin Islands will not be subject to the NPM Adjustment. - 38 - TOBACCO INDUSTRY The following description of the domestic tobacco industry has been compiled from certain publicly available documents of the tobacco companies and their parent companies, certain publicly available analyses of the tobacco industry and other public sources. Certain of those companies file annual, quarterly and certain other reports with the Securities and Exchange Commission (the “SEC”). Such reports are available on the SEC's website (www.sec.gov) and upon request from the Office of Public Reference of the SEC, 450 5” Street, NW, Room 1300, Washington, D.C. 20549-0102 (phone: (202) 942-8090, fax: (202) 628-9001 ;e-mail: publicinfo @ sec. gov). The following information does not, nor is it intended to, provide a comprehensive description of the domestic tobacco industry, the business, legal and regulatory environment of the participants therein, or the financial performance or capability of such participants. Although the Corporation has no independent knowledge of any facts indicating that the following information is inaccurate in any material respect, the Corporation has not independently verified this information and cannot and does not warrant the accuracy or completeness of this information. Prospective investors in the Series 2001 Bonds should conduct their own independent investigations of the domestic tobacco industry to determine if an investment in the Series 200] Bonds is consistent with their investment objectives. Retail market share information, based upon sales as reported by the OPMs for purposes of their filings with the SEC, may be different from Relative Market Share for purposes of the MSA and the respective obligations of the OPMs to contribute to Initial Payments, Annual Payments and Strategic Contribution Fund Payments. The Relative Market Share information reported is confidential under the MSA. See “SUMMARY OF THE MASTER SETTLEMENT AGREEMENT — Overview of Payments by the Participating Manufacturers.” Additionally, aggregate market share information, based upon shipments as reported by Philip Morris and Reynolds Tobacco and reflected in the chart below entitled “Manufacturers’ Domestic Retail Market Share,” is different from that utilized in the bond structuring assumptions. See also “SUMMARY OF BOND STRUCTURING ASSUMPTIONS.” MSA payments are computed based in part on cigarette shipments in or to the 50 states of the United States, the District of Columbia and Puerto Rico. The DRI*eWEFA Report states that the quantities of cigarettes shipped and cigarettes consumed within the United States, the District of Columbia and Puerto Rico may not match at any given point in time as a result of various factors, such as inventory adjustments, but are substantially the same when compared over a period of time. Industry Overview According to their own publicly-available documents, the four leading manufacturers of tobacco products in the United States in 2000 collectively accounted for approximately 96% of the domestic cigarette industry retail market share. The market for cigarettes in the United States divides generally into premium and discount sales, roughly 73.5% and 26.5%, respectively, measured by volume of all domestic cigarette sales in 2000. Philip Morris Incorporated (“Philip Morris’), a subsidiary of Philip Morris Companies Inc.. is the largest tobacco company in the United States. In its 2000 Annual Report to Shareholders, Philip Morris reported that its domestic retail market share in 2000 was 50.5% which represents a 1.8% increase over its self-reported 1999 domestic retail] market share. Philip Morris’s major premium brands are Marlboro, Virginia Slims, Benson & Hedges. Merit and Parliament. Its principal discount brands are Basic and Cambridge. Marlboro is the largest selling cigarette brand in the United States, with approximately 37.7% of the United States domestic shipment share in 2000, and has been the world’s largest-selling cigarette brand since 1972. R.J. Reynolds Tobacco Company (“Reynolds Tobacco”) is the second largest tobacco company in the United States. In its Form 10-K filed with the SEC for the period ended December 31, 2000, Reynolds Tobacco reported that its domestic retail market share in 2000 was 23.6% which represents a 1.4% decrease from its self- reported 1999 domestic retail market share. For the second quarter of 2001, Reynolds Tobacco reported in its 10-Q Report filed for the quarterly period ended June 30, 2001 that its domestic retail market share was 23.5% (measured - 39 - by sales volume}. an increase of L8G from the comparable period of 2000. Reynolds Tobacco’s major premium brands are Winston, Camel. Salem and Vantage. [ts discount brands include Doral. Monarch and Best Value. Brown & Williamson Tobacco Corporation B&W"), with headquarters in Louisville. Kentucky. is a wholly-owned subsidiary of British American Tobacco, p.le.. a holding company based in London, England. and is the third largest tobacco company in the United States. According to publicly available documents on its website, B&W reported that its domestic retail market share in 2000 was 11.76 which represents a decrease of 12.5 from its self-reported 1999 domestic retail market share. B& W's largest selling brand is GPC, a discount brand. [ts other major brands are Kool, Carlton and Lucky Strike. Lorillard, Inc. (“Lorillard”). a wholly-owned subsidiary of Loews Corporation. is the fourth largest tobacco company in the United States. In its Form 10-K filed with the SEC for the period ended December 31, 2000, Lorilard’s parent reported that its domestic retail market share in 2000 was 10% which represents a decrease of 6.5° over its self-reported 1999 domestic retail market share. Lorillard’s parent reported in its 10-Q Report filed for the quarterly period ended June 30, 2001 that its domestic market share for the first six months of 2001 (measured by shipment volume) was 9.5. a decrease of 4.0% from the comparable period of 2000. Lorillard’s major brands are Newport, Kent. True. Maverick and Old Gold. Its largest selling brand is Newport, which accounted tor approximately 80% of Lorillard’s sales in 2000, Based on the domestic retail market shares discussed above. the remaining 4% share of the United States retail cigarette market in 2000 was held by a number of other domestic and foreign cigarette manufacturers. including Liggett Group, Inc. (“Liggett™). a wholly-owned subsidiary of Brooke Group. Ltd.. the predecessor of Vector Group, Ltd. Liggett, the operating successor to the Liggett & Meyers Tobacco Company. is the fifth largest tobacco company in the United States. In its Form 10-K filed with the SEC for the period ended December 31. 2000, Liggett reported that its domestic retail market share in 2000 was 1.5% (measured by shipment volume) which represents a 25 increase from its self-reported 1999 domestic retail market share. Until May 1999, Liggett produced four premium brands: L&M. Chesterfield. Lark and Eve. in addition to certain discount brands including Pyramid. On May 24. 1999. Liggett sold the L&M. Chesterfield and Lark cigarette brands to Philip Mortis. Liggett is an SPM under the MSA. The following table depicts the approximate comparative positions of the leading producers in the United States domestic tobacco industry, each of which is an OPM under the MSA, based upon cigarette shipments: Manufacturers’ Domestic Retail Market Share’ Manufacturer 1996 1997 1998 1999 2000 Philip Morris 47.8 48.9% 49.4% 49.6% 50.5% Reynolds Tobacco 26.0 25.4 25.2 24.1 23.6 B&W/American Brands 17.2 16.1 15.0 13.4 11.7 Lorillard S.4 8.7 QA 10.7 10.0 Other’ 0.6 0.9 1 2.2 4.2 The shipment or sales market shares of each of the OPMs has been obtained from publicly available documents of Philip Morris. Reynolds Tobacco. BR W. and Lorillard. The retail market share of the tobacco manufacturers, other than the OPMs. has been determined by subtracting the total retail market share percentages of the OPMs as reported in their own publicly available documents from 100%. In 1996 and 1997 the total retail market share of each of the OPMs as reported in their own publicly available document when aggregated were in excess of 100% -40- Shipment Trends The following table sets forth the industry’s cigarette shipments in the United States for the five years ended Decernber 31, 2000. The MSA payments are calculated in part on industry shipments rather than consumption. Year Ended Domestic Shipments December 31, (Billions of Cigarettes)’ 1996 Le ecceeccescesseceneesneeetecensesseeeeeenaeeneeens 483.2 L997 oe eccceecccceteeeeeneeeeeeeeeeeensesaeeneeeeees 482.9 1998 occ cececeeeeeeeeseeeeeeeeeeeeeeeneeeeneees 460.8 1999 Lecce eteeeeeneeeeeeseeeeseseeeesetseseeees 419.3 2000... eee ecececeeeeeeeeeeceeeeetseteeeseeseeneeeas 419.8 * As reported in SEC filings of the OPMs; however, such amounts may differ materially from the amounts used by the MSA Auditor in calculating Initial Payments and Annual Payments under the MSA. The information in the foregoing two tables, which has been obtained from publicly available sources but has not been independently verified, may differ materially from the amounts used by the MSA Auditor in calculating Initial Payments, Annual Payments and Strategic Contribution Payments under the MSA. Consumption Trends According to the United States Department of Agriculture (the “USDA”) Economic Research Service (“USDA-ERS’”), smokers in the United States will consume an estimated 425 billion cigarettes in 2001, 1.16% less than a year earlier. Price increases, higher state taxes, and expanding regulations have been the main factors cited for declining cigarette use. Consumption per person based on a population 16 years and older slipped to 2.025 cigarettes per annum. The following chart sets forth domestic cigarette consumption from 1996 through 2001. Year Ended US Domestic Consumption December 31, (Billions of Cigarettes)’ 1996 487 1997 480 1998 465 1999 435, 2000 430° 2001 420 - 425" USDA-ERS. The MSA payments are calculated in part on domestic industry shipments rather than consumption. The DRI*WEFA Report states that the quantities of cigarettes shipped and cigarettes consumed within the United States, the District of Columbia and Puerto Rico may not match at any given time as a result of various factors such as inventory adjustments but are substantially the same when compared over a period of time. Estimated by USDA-ERS. ** Tax Collections and Retail Expenditures According to the USDA-ERS, for the twelve months ended December 31, 2000, governmental revenues from tobacco products (the vast majority of which are from cigarettes) totaled approximately $14.5 billion. Of this amount, approximately $5.97 billion was paid in federal excise taxes, and $8.36 billion in state excise taxes. Additional state sales taxes for the comparable period were $2.37 billion. State excise taxes have risen dramatically -4] - inthe past five years due to the number of states that imereased taxes. Twenty states currently impose taxes of $0.50 or more per pack, The average state tis Gveighted by salesi as SO.A4T. On January F200] tne federal excise tax was $0.3-4 per pack and it is scheduled to increase by $0.05 per pack on January b, 2002. Distribution, Competition and Raw Materials Cigarette manufacturers sell tobacco products to wholesalers Gineluding distributors), large retail organizations, including chain stores. and the armed services. They and their affiliates and licensees also market cigarettes and other tobacco products worldwide. directly or through export sales organizations and other entities with which thes have contractual arrangements. The market for tobacco products is highly competitive and is characterized by brand recognition and loyalty. with product quality. price. marketing and packaging constituting the significant methods of competition. Promotional activities include. in certain instances and where permitted by law. allowances. the distribution of incentive items, price reductions and other discounts. Substantial marketing support. merchandising display and competitive pricing generally are required to maintun or improve a brand’s market position. Increased selling prices and taxes on cigarettes have resulted in increased competitive discounting and the proliferation of deep- discount brands from manufacturers not yet impacted to a significant degree by the MSA and other state settlement agreements. Generally. sales of cigarettes in the discount segment are not as profitable as those in the premium segment. The tobacco products of the cigarette manufacturers and their affiliates and licensees are advertised and promoted through various media. although television and radio advertising of cigarettes has been prohibited in the United States. The domestic tobacco manufacturers have agreed to marketing restrictions in the United States as part of the MSA.) They are sul permitted. however. to conduct advertising campaigns in magazines, at retail cigarette locadons, in direct mail campaigns targeted at adult smokers. and in other adult media. Grey Market According to the USDA-ERS. during 1998/99 the differential between the manufacturer’s wholesale price and the export price of United States cigarettes created an opportunity for arbitrage. Independent traders exported United States manufactured cigarettes and then re-imported them into the United States. paying import duties and excise taxes. Because cigarettes sold for export are priced so low. it was possible to import cigarettes into the United States in this fashion and make a profit. while selling them ata lower price than cigarettes produced for the domestic market. In 1999) grey market imports were estimated at 3 to 4.5 billion pieces. less than | percent of total consumption. Legislation prohibiting grey market sales became effective in January 2000, and according to USDA- ERS. grey market sales are expected to cease. Regulatory Issues General. The manutacture. sale and use of tobacco continue to be the focus of numerous regulatory Initiatives, both domestically and abroad. Among other things. these initiatives seek to ameliorate the adverse health effects associated with smoking and exposure to environmental tobacco smoke (“ETS”). Reports concerning the harmful physical effects of cigarette smoking and other forms of tobacco use have been publicized for many years, and the sale. promotion and use of cigarettes and other tobacco products continue to be the subject of increasing governmental and private sector regulation, Federal Regulation. Since W964. the Surgeon General of the United States and the Secretary of Health and Human Services have released a number of reports linking cigarette smoking to a broad range of health hazards. including various types of cancer. heart disease and chronic lung disease. and have recommended various governmental measures to reduce the incidence of smoking. Since 1965. federal law has required that health warnings be printed on each puck of cigarettes _42- On August 9, 2000, the United States Surgeon General issued a report, “Reducing Tobacco Use: A Report of the Surgeon General,” which assesses the value and efficacy of the approaches (educational, clinical, regulatory, economic and comprehensive) that have been used to reduce tobacco use, and evaluates the scientific evidence for each approach. The report states that widespread dissemination of approaches and methods which have been shown to be effective, especially in combination, would, among other things, substantially reduce the number of young people who will become addicted to tobacco, increase the success rate of young people and adults trying to quit using tobacco, and reduce the level of exposure of non-smokers to environmental tobacco smoke. The report concludes that substantial increases in the excise taxes on cigarettes would have a considerable impact on the prevalence of smoking and, in the long term, reduce the adverse health effects caused by tobacco. The report cites as examples the 75 cents per pack proposal contained in the Clinton administration’s Health Security Act of 1993 (which did not pass) and the proposal contained in Healthy People 2010, the national action plan prepared by the United States Department of Health and Human Services to improve the health of all people living in the United States in the first decade of the 21“ century, which set as a goal an average state and federal excise tax of $2.00. The report’s conclusions are not formal policy recommendations, but are intended as a summary of the scientific literature concerning successful methods of reducing tobacco consumption. In recent years. various members of the United States Congress have introduced legislation, some of which has been the subject of hearings or floor debate, that would subject cigarettes to various regulations under the Department of Health and Human Services or regulation under the Consumer Products Safety Act, establish educational campaigns relating to tobacco consumption or tobacco control programs, or provide additional funding for governmental tobacco control activities, further restrict the advertising of cigarettes, require additional warnings, including graphic warnings, on packages and in advertising, eliminate or reduce the tax deductibility of tobacco advertising, provide that the Federal Cigarette Labeling and Advertising Act and the Smoking Education Act not be used as a defense against liability under state statutory or common law, and allow state and local governments to restrict the sale and distribution of cigarettes. The Federal Trade Commission, which has regulated the manner in which cigarette manufacturers test and disclose the tar, nicotine, and carbon monoxide levels of cigarettes, has proposed revisions to the test methodology and reporting procedures established by a 1970 voluntary agreement among domestic cigarette manufacturers. In 1992, the adoption of the Federal Alcohol, Drug Abuse and Mental Health Act required states to adopt a minimum age of 18 for purchases of tobacco products and establish a monitoring system to prevent under-age purchases. In 1992, the United States Environmental Protection Agency (the “EPA”) issued a report that included a risk assessment of the relationship between ETS and lung cancer in nonsmokers and a determination by the EPA designating ETS as a “Group A” carcinogen, a designation which asserts that there is sufficient evidence to conclude that ETS causes cancer in humans. Certain parties, including Reynolds Tobacco, filed suit to challenge the validity of the EPA report and the methodology and procedures used by the EPA to reach its conclusions. The United States District Court for the Middle District of North Carolina ruled in 1998 that the EPA’s classification of ETS was invalid and vacated those portions of the report dealing with lung cancer. The EPA submitted an appeal and an oral argument was held before the United States Fourth Circuit Court of Appeals in June 1999. The court’s decision is still pending. In 1994, the United States Occupational Safety and Health Administration announced proposed regulations to restrict smoking in the workplace, but to date no regulations have been adopted. In August 1996, the federal Food and Drug Administration (the “FDA’’) adopted regulations on the advertising, promotion and sale of cigarettes and smokeless tobacco. The FDA regulations included severe restrictions on the distribution, marketing and advertising of cigarettes, and required the tobacco industry to comply with a wide range of labeling, reporting, record keeping, manufacturing and other requirements. The FDA’s action was based on its determination that nicotine was a drug and that cigarettes and smokeless tobacco were medical devices which delivered nicotine to the body within the purview of the Food, Drug and Cosmetic Act. On March 21, 2000, the United States Supreme Court affirmed a 1998 decision of the Fourth Circuit Court of Appeals invalidating the FDA’s regulations. The Supreme Court held that the Food, Drug and Cosmetic Act as a whole, along with subsequent tobacco-specific legislation enacted by Congress, made it clear that Congress had precluded the FDA from regulating tobacco products as customarily marketed. Although the FDA has withdrawn its regulations, there are currently several bills pending in Congress - 43 - that would give the FDA authority to regulate tobacco products. AL of the pending legislation could result in Substantial federal regulation of the design. performance, manufacture and marketing of cigarettes. Since the Supreme Court decision on the FDA regulations, legislation has been introduced in Congress that would establish various regulations under the Department of Health and Human Services or regulation under the Consumer Products Safety Act. establish educational campaigns relating to tobacco consumption or tobacco control programs. or provide additional funding for governmental tobacco control activities, further restrict the advertising of cigarettes, require additional warnings. including graphic warnings, on packages and in advertising, eliminate or reduce the tax deductibility of tobacco advertising. provide that the Federal Cigarette Labeling and Advertising Act and the Smoking Education Act not be used as a defense against liability under state statutory or common law. and allow state and local governments to restrict the sale and distribution of cigarettes. Rules of the United States Department of Transportation. issued through the Federal Aviation Administration, ban smoking on all domestic flights, as well as on all scheduled international flights by United States or foreign air carriers into or out of the United States. In addition. the United States Interstate Commerce Commission has banned smoking on buses transporting passengers interstate. On August 9, 2000, the United States Surgeon General issued a report, “Reducing Tobacco Use: A Report of the Surgeon General.” that comprehensively assesses the value and efficacy of the major approaches that have been used to reduce tobacco use. The report concludes that a comprehensive program of educational strategies, treatment of nicotine addiction, regulation of advertising. clean air regulations. restriction of minors’ access to tobacco, and increased excise taxation can significantly reduce the prevalence of smoking. The Surgeon General called for increased spending on anti-smoking initiatives by states. up to 25% of their annual settlement proceeds. which is far higher than the approximately 9% allocated from the first year's settlement payments. The Surgeon General's Report documents evidence of the effectiveness of five major modalities for reducing tobacco use. Educational strategies are shown to be effective in postponing or preventing adolescent smoking. — Pharmacologic treatment of nicotine addiction, combined with behavioral support, can enhance abstinence efforts. Regulation of advertising and promotional activities of manufacturers can reduce smoking, particularly among youth. Clean air regulations and restricted minors’ access contribute to lessening smoking prevalence. Lastly. according to the Surgeon General's Report. excise tax increases will reduce cigarette consumption. In May 2001. a commission, established by President Clinton in September 2000, released its final report on how to improve economic conditions in tobacco dependent economies while making sure that public health does not suffer in the process. The Commission recommended moving from the current quota system to what would be called a Tobacco Equity Reduction Program (“TERP™). TERP would allow compensation to be rendered to quota growers for the loss in value of their quota assets as a result of a restructuring to a production permit system where permits would be issued annually to tobacco growers. Also created would be a Center for Tobacco-Dependent Communities, which would address any challenges faced during this period. Three public health proposals that Were suggested by the Commission were: that states increase funding on tobacco cessation and prevention programs: that the FDA be allowed to regulate tobacco products in a “fair and equitable” manner: and that funding be included in Medicaid and Medicare coverage tor smoking cessation. To be able to fund these recommendations. the Commission calls for a 17-cent increase in the excise tax on all packs of cigarettes sold in the United States. The increased revenues would then be deposited into a fund and earmarked for the recommended programs. State and Local Regulation. In addition to federal regulation, most of the states and many local jurisdictions have enacted legislation and regulations restricting displays and advertising of tobacco products, establishing fire safety standards for cigarettes, raising the minimum age to possess or purchase tobacco products, requiring the disclosure of ingredients used in the manufacture of tobacco products. imposing restrictions on public smoking and restricting the sale of tobacco products directly to consumers or other unlicensed recipients or over the Internet. Several state governments are also considering increasing their excise tax on cigarettes. A number of states have enacted legislation designating a portion of increased cigarette excise taxes to fund anti-smoking programs, healthcare programs and/or cancer research. Several states require disclosure of ingredients used in the 44 - manufacture of cigarette products. The Commonwealth of Massachusetts, for example. has enacted legislation to require cigarette manufacturers to report the flavorings and other ingredients used in each brand of cigarettes sold in the Commonwealth, and on a qualified, by-brand basis to provide “nicotine-yield ratings” for their products based on standards established by the Commonwealth. Cigarette manufacturers sued to have the statute declared unconstitutional, arguing that it could result in the public disclosure of valuable proprietary information. In September 2000, the district court granted the plaintiff's motion for summary judgment and permanently enjoined the defendants from requiring cigarette manufacturers to disclose brand specific information on ingredients in their products. In October 2001, the First Circuit reinstated the statute, declaring it a “valid exercise of the police power” of the state. In August 2000, legislation was adopted in the State of New York which requires cigarettes sold in the state to be “self-extinguishing” beginning in 2003. Similar legislation has been proposed (but not adopted) in other states and localities and at the federal level. Another statute, which was intended to become effective in New York State in November 2000, prohibited the shipment or delivery of cigarettes to any person in the state who is not a licensed cigarette tax agent, wholesale or retail dealer or export warehouse proprietor. The statute would have banned mail order, Internet and telephone cigarette sales directly to consumers in the state. One OPM and one SPM filed suit in a federal district court in New York seeking to overturn the statute, alleging that it was an unconstitutional interference with commerce. In June 2001, a federal district court judge declared the statute unconstitutional and permanently enjoined enforcement of the statute. Voluntary Private Sector Regulation. In recent years, many employers have initiated programs restricting or eliminating smoking in the workplace, and many common carriers have imposed restrictions on passenger smoking more stringent than those required by governmental regulations. Similarly, many restaurants, hotels and other public facilities have imposed smoking restrictions or prohibitions more stringent than those required by governmental regulations. Civil Litigation Pending claims related to tobacco products generally fall within four categories: (1) smoking and health cases alleging personal injury brought on behalf of individual plaintiffs, (ii) smoking and health cases alleging personal injury and purporting to be brought on behalf of a class of individual plaintiffs. including cases brought pursuant to a 1997 settlement agreement involving claims by flight attendants alleging injury from exposure to ETS in aircraft cabins, (iii) health care cost recovery cases brought by governmental and non-governmental plaintiffs seeking reimbursement for health care expenditures allegedly caused by cigarette smoking and/or disgorgement of profits, and (iv) other tobacco-related litigation, including suits by former asbestos manufacturers seeking contribution or reimbursement for amounts expended in connection with the defense and payment of asbestos claims that were allegedly caused in whole or in part by cigarette smoking, class action suits alleging that the use of the terms “Lights” and “Ultra Lights” constitute deceptive and unfair trade practices, and various antitrust suits and suits by foreign governments seeking to recover damages for taxes lost as a result of the allegedly illegal importation of cigarettes into their jurisdictions. Plaintiffs seek various forms of relief, including compensatory and punitive damages, treble/multiple damages and other statutory damages and penalties, creation of medical monitoring and smoking cessation funds, disgorgement of profits, legal fees, and injunctive and equitable relief. Individual Plaintiffs’ Lawsuits. The MSA does not release PMs from liability in individual plaintiffs’ cases. Numerous cases have been brought by individual plaintiffs who allege that cancer and/or other health effects have resulted from an individual’s use of cigarettes, addiction to smoking, or exposure to environmental tobacco smoke. Individual plaintiffs’ allegations of liability are based on various theories of recovery, including but not limited to, negligence, gross negligence, strict liability, fraud, misrepresentation, design defect, failure to warn, breach of express and implied warranties, breach of special duty, conspiracy, concert of action, restitution, indemnification, violations of deceptive trade practice laws and consumer protection statutes. and claims under federal and state RICO statutes. One OPM has reported that as of August 1, 2001, there were 1,500 smoking and health cases filed and served on behalf of individual plaintiffs in the United States against it and other tobacco industry defendants, (not including the Broin IT cases described below) approximately 1,250 of which are pending before a single West Virginia state court in a consolidated proceeding that is to begin in March 2002. -45- In addition, one OPM reports that as of August 1, 2001 there were approximately 3,000 additional individual cases (referred to herein as the Broin // cases) filed primarily in Florida by individual current and former flight attendants claiming personal injury as the result of exposure to ETS in airline cabins. The individuals in the Broin II cases are limited by the settlement of a previous class action lawsuit, Broin y. Philip Morris (known as Broin 1), to the recovery of compensatory damages only, and are precluded from seeking or recovering punitive damages. As a result of the settlement, however. the burden of proof as to whether ETS causes certain illnesses such as lung cancer and emphysema was shifted to the tobacco industry defendants. See also “—Class Action Lawsuits” below. The tobacco industry has traditionally defended individual health and smoking lawsuits by asserting, among other defenses, assumption of risk and/or comparative fault on the part of the plaintiff, as well as lack of proximate causation. Thus far. those cases which have resulted in a verdict against the defendants are either on appeal or have been overturned. In the last three years there have been seven reported jury verdicts, and a 1996 jury verdict that was reinstated upon appeal, in individual smoking and health cases against the tobacco industry, including one or more of the PMs. On June 6, 2001, a California jury found against Philip Morris on all six claims of fraud, negligence and making a defective product. The jury awarded the plaintiff $3 billion in punitive damages and $5.5 million in compensatory damages. The $3 billion punitive damages award has been reduced to $100 million post-trial. Philip Morris plans to appeal the verdict. In November 2000. the Florida Supreme Court reinstated a $750,000 award in Carter etal. v. Brown & Williamson Tobacco Corp. for a former smoker that developed lung cancer after smoking for 44 years. In 1996, the jury had found that cigarettes were a defective product and that B&W was negligent for not warning people of the danger. but an appeals court reversed this decision. In March 2001. the plaintiff received slightly over $1.0 million dollars from a trust account that contained the $750,000 jury award plus interest and became the first smoker to be paid by a tobacco company for a tobacco-related illness. On June 29, 2001, the United States Supreme Court denied B& W's petition for a writ of certiorari, thus leaving the jury verdict intact. In October 2000, a Tampa, Florida jury in Jones v. R. J. Reynolds Tobacco Co.. a wrongful death case, found Reynolds Tobacco liable for negligence and strict liability and returned a verdict in favor of the widower of a deceased smoker, awarding approximately $200,000 in compensatory damages. The jury rejected the plaintiff's conspiracy claim and did not award punitive damages. Reynolds Tobacco filed a motion for judgment notwithstanding the verdict. or, in the alternative, for a new trial. On December 28, 2000, the court granted the motion for a new trial. The plaintiff has appealed the new trial ruling. In March 2000, a California jury in Whiteley v. Ravbestos- Manhattan, Inc. et al. returned a verdict in favor of the plaintiffs and found the defendants. including Philip Morris and Reynolds Tobacco, liable for negligent product design and fraud, and awarded $1.72 million in compensatory damages and $20 million in punitive damages. Both damage awards were upheld by the trial judge, who denied the defendants’ post-verdict challenge. The defendants have appealed the verdict. In April 1999, a Maryland jury in Connor v. Lorillard, et al. awarded $225,000 in compensatory damages and $2.0 million in punitive damages. An appellate court has remanded the case for a determination of the date of the injury to determine whether a statutory cap on non-economic damages applies. In March 1999, an Oregon jury in Williams-Branch y. Philip Morris, et al. awarded $821,485 in compensatory damages and $79.5 million in punitive damages (subsequently reduced by the trial judge to $32 million). In February 1999, a California jury in Henley v. Philip Morris et al. awarded $1.5 million in compensatory damages and $50 million in punitive damages (subsequently reduced by the trial judge to $25 million). The judgment was affirmed by a state appellate court in November. 2001. The case is being appealed to the California Supreme Court. William S. Ohlemeyer, vice president and associate general counsel for Philip Morris has said that the company is “fairly optimistic” about winning the appeal. The Connor and Williams-Branch cases are also on appeal. Class Action Lawsuits. The MSA does not release the PMs from liability in class action lawsuits. Plaintiffs have also brought claims as class actions on behalf of large numbers of individuals for damages allegedly caused by smoking. Plaintiffs in class action smoking and health lawsuits allege essentially the same theories of liability against the tobacco industry as those in the individual lawsuits. As of June 30, 2001, in the United States there were approximately 45 purported class action cases pending against cigarette manufacturers and other defendants. Plaintiffs historically have had little success in obtaining class - 46 - certification, a prerequisite to proceeding as a class action lawsuit, because of the individual circumstances related to each smoker's election to smoke and the individual nature of the alleged harm. Plaintiffs have historically had little success in obtaining class certification, a prerequisite to proceeding as a class action lawsuit, because of the individual circumstances related to each smoker’s election to smoke and the individual nature of the alleged harm. All 13 federal courts which have considered the issue to date (including two federal courts of appeals) consistently have denied class certification in smoking and health cases. In May 1996, the Fifth Circuit Court of Appeals overturned the certification of a nationwide class of smokers in Castano v. American Tobacco Company Inc. In May 1999, the United States Supreme Court declined to review the class decertification by the Third Circuit in Barnes v. American Tobacco Company, Inc. (formerly cited as Arch v. American Tobacco Company, Inc.). Most recently on March 19, 2001, in Guillory v. American Tobacco Co., Inc., the United States District Court for the Northern District of Illinois refused to certify a class defined as “all Illinois residents who smoke or smoked cigarettes manufactured by the defendants, who started smoking while a minor, who purchase or purchased cigarettes in Illinois and who desire to participate in a program designed to assist them in the cessation of smoking and/or monitor their medical condition to promote early detection of disease caused by, contributed to by, or exacerbated by cigarette smoking”. In May 2001, in Brown v. Philip Morris, Inc.. the United States Court of Appeals for the Third Circuit affirmed the trial court’s dismissal of a proposed class action alleging the violation of civil rights by the targeting of “African-American smokers.” Most recently, on June 29, 2001 the United States District Court for the District of Nevada denied plaintiffs’ motions for class certification in three cases involving casino workers exposed to environmental tobacco smoke and one case involving smokers with injuries allegedly caused by smoking. On September 6, 2000, in In re Simon (II) Litigation lawyers for plaintiffs in 10 tobacco related cases pending in United States District Court for the Eastern District of New York filed suit in the same court (before Judge Weinstein) to consolidate the pending cases and seek certification of a class and subclasses to obtain compensatory and punitive damages from the tobacco industry defendants. The pending cases include individual and purported nationwide class action lawsuits alleging tobacco related personal injuries, as well as health care cost recovery cases brought by union trust funds, an insurance plan and an asbestos fund. The suit seeks to certify a nationwide class action to consolidate all punitive damage aspects of the pending cases for a single trial and to try the compensatory damage aspects of the pending claims separately. On February 8. 2001, Judge Weinstein issued an opinion stating that severing the issues of liability and punitive damages would help ensure an expeditious resolution due to the unusual complexity of the issues. Two of the ten cases, Falise v. American Tobacco Co. and HK. Porter Company Inc. v. The American Tobacco Company, et al.,were dismissed in June 2001 and July 2001, respectively. The majority of state courts have also rejected class certification. In May 2000, Maryland’s highest court ordered the trial court to vacate its certification of a class in Richardson v. Philip Morris, et al. In September 2000, in Walls v. American Tobacco Co., an Oklahoma state court answered a series of state law questions, certified to the state court by the federal court where the purported class was filed, in such a way that led the parties to stipulate that the case should not be certified as a class action in federal court and that the individual plaintiffs would dismiss their federal court cases without prejudice. In October 2000, the federal court issued its order refusing to certify the case as a class action, and dismissed the individual plaintiffs’ cases. In December 2000, in Geiger v. American Tobacco Co., the Appellate Division of the Supreme Court of New York affirmed the trial court's denial of class action status to a purported class defined as all New York residents, including their heirs, representatives and estates, who contracted lung and/or throat cancer as a result of smoking cigarettes. Plaintiffs filed a motion for leave to appeal the order denying certification to the New York Court of Appeals, the highest court in the state. The New York Court of Appeals dismissed plaintiff's appeal in February 2001. To date plaintiffs have successfully maintained class certification in only eight state court class action cases, two of which were brought in the State of Florida, three in California, one in Illinois, one in Louisiana and one in West Virginia. In Engle v. Reynolds Tobacco, et al., a Florida state trial court certified a class of Florida smokers alleging injury due to their tobacco use. The estimated size of the class ranges from 300,000 to 700.000 members. The court determined that the lawsuit could be tried as a class action because, even though certain factual issues are unique to individual plaintiffs and must be tried separately, certain other factual issues were common to all class members and could be tried in one proceeding for the whole class. In July 1999, in phase I of a three-phase trial, the jury found -AT- against the defendants regarding the issues common to the class. such as whether smoking caused certain diseases, Whether tobacco was addictive. and whether the tobacco companies withheld information from the public. In phase HWA. in April 2000, the same jury which heard phase | awarded a total of $12.7 million in compensatory damages to the three named representative plaintiffs. finding that the defendant tobacco companies bore major responsibility for the plaintiffs” injuries. One OPM has requested that the court dismiss the award to one of the plaintiffs because of the jury's findings on a statute of limitations question. In July 2000. in phase ITB. the same jury also assessed punitive damages of approximately S145 billion with respect to the entire class of possible plaintiffs. The punitive damages awarded against the OPM detendants are: Philip Morris, $73.96 billion: Reynolds Tobacco, $36.28 billion; B&W, $17.59 billion: Lorillard, $16.25 billion: and Liggett. $790 million. Phase HH] will determine compensatory damages for the remaining class members. On July 24, 2000. the defendants filed a motion with the trial court to. among other things, set aside the verdict. direct judgment in favor of the defendants or decertify the class. and order a new trial. On July 14, 2000, the Southeastern Iron Workers Union filed a motion to intervene in Engle seeking to protect its members” subrogation rights under the federal Employment Retirement Income and Security Act. Based on the federal question raised in that motion. defendants removed the case to federal district court in Miami on July 24, 2000. By order dated November 3. 2000, the United States District Court for the Southern District of Florida granted motions to remand the case to the Eleventh Judicial Circuit of Dade County, Florida (the “State Trial Court”). On November 6, 2000, the State Trial Court issued its final judgment and order in which it (a) denied substantially all of the tobacco company defendants” pending and post-trial motions, including the motion for reduction of the $145 billion punitive damages award or, in the alternative. a new trial. and (b) entered the punitive damage award as a final judgment. On November 7. 2000, the defendants in Arg/e filed an appeal with respect to the entry of judgment, class certification and numerous other reversible errors that they allege have occurred during the trial. In addition, the defendants have each posted a bond to stay collection of the punitive damages and statutory interest thereon pending the exhaustion of all appeals. Florida has enacted legislation capping the amount of the appeal bond necessary to stay execution of the punitive judgment pending appeal to the lesser of: the amount of punitive damages. plus twice the statutory rate of interest: or 10% of a defendant's net worth, but in no case more than $100 million. Georgia, Kentucky, Louisiana. Nevada. North Carolina, Oklahoma, South Carolina, Virginia and West Virginia have enacted similar legislation. SEC filings from certain OPMs include the statement that Angle plainufts believe the Florida appeal bond legislation is unconstitutional, In the event that a court of final jurisdiction were to declare the legislation unconstitudonal. certain OPMs have stated that in a worst case scenario, it is possible that a judgment for punitive damages could be entered in an amount not capable of being bonded, resulting in an execution of the judgment before it could be set aside on appeal. On May 7. 2001. the trial court approved a stipulation (the Stipulation”) among Philip Morris. Lorillard. Liggett the “Stipulating Defendants”). the plaintiffs. and the plaintiff class that provides that execution or enforcement of the punitive damages component of the Eng/e judgment will remain stayed against the Stipulating Defendants through the completion of all judicial review. Under the Stipulation, Philip Morris will place $1.2 billion into an interest-bearing escrow account. Should Philip Morris prevail in its appeal of the cuse, this escrow amount is to be returned to Philip Morris. together with its $100 million appeal bond previously posted. [In addition, Philip Morris. Lorillard and Liggett will also place $500 million, $200 million (including Lorillard’s appeal bond). and $9.72 million (including Liggett’s appeal bond). respectively, into a separate interest-bearing escrow account for the benefit of the £yg/e class (the “Guaranteed Amount’). Even if the Stipulating Defendants prevail on appeal. the Guaranteed Amount will be paid to the court, and the court will determine how to allocate or distribute it consistent with the Florida Rules of Civil Procedure. In October 1997, the tohacee industry defendants settled another class action case, Broin 1. Broin T was brought in Florida state court by flight attendants alleging injuries related to ETS. See “Individual Plaintiffs’ Lawsuits” above. In addition to shifting the burden of proof to defendants as to whether ETS causes certain ilinesses such as lung cancer and emphysema, the Brofa 7 sctement required defendants to pay $300 million to be used to establish a foundation to sponsor research with respect to the early detection and cure of tobacco related diseases. Individual members of the Broin / class also retained the right to bring individual claims, although they are limited to non-fraud type claims and may not seck punitive damages. One OPM reports that as of August I, 2001. approximately 3.000 of these individual cases (Known as Broin H cases) have been filed and are still pending. - 4g - In October 2000, the court held that the flight attendants will not be required to prove the substantive liability elements of their claims for negligence, strict liability and breach of implied warranty in order to recover damages, if any. The court also ruled that the trials of these suits will address whether the plaintiffs’ alleged injuries were caused by their exposure to ETS and. if so, the amount of damages. Defendants have appealed these rulings. On April 5, 2001 a jury returned a verdict for the defendants in the case of Fontana v. Philip Morris Incorporated, et al., the first of the Broin IH cases to go to trial. The plaintiff has filed motions for a mistrial. a new trial and a judgment notwithstanding the verdict. As of August 1, 2001, one OPM reports that approximately 15 additional Broin II cases are scheduled for trial between October 2001 and January 2002. In Scott v. American Tobacco Company, Inc., a Louisiana medical monitoring and/or smoking cessation case, the court certified a class consisting of smokers desiring to participate in a program designed to assist them in the cessation of smoking and/ or monitor the medical condition of class members to ascertain whether they might be suffering from diseases caused by cigarette smoking. The class members may also bring individual smoking and health lawsuits, if they desire. The trial court’s certification of the class has survived initial appeal. Trial began in June 2001. In August 2000, a West Virginia state court conditionally certified, only to the extent of medical monitoring, in In re Tobacco Litigation (formerly known as Blankenship), a class of West Virginia residents. The plaintiffs have proposed that the class include all West Virginia residents who (1) on or after January 1, 1995, smoked cigarettes supplied by defendants: (2) smoked at least a pack a day for five years without having developed any tobacco-related illness: and (3) do not receive health care paid or reimbursed by the state of West Virginia. Trial began in January 2001. On January 25, 2001, the trial court granted a motion for a mistrial, ruling that the plaintiffs had improperly introduced testimony about addiction to smoking as a basis for claiming damages. In March 2001, the court denied the defendants’ motion to decertify the class. The retrial began in September 2001. In November 2000, a New York state appellate court reversed a trial court ruling that would have permitted eight separate individual personal injury suits against tobacco companies to be brought in a joint trial. In Glussi v. Fortune Brands, Inc., 714 N.Y.S.2d 516 (N.Y. App. 2000) (also known as the Apostolou case), the state’s appellate division for the Second Department held that combining the various plaintiffs’ claims into a single suit would be too unwieldy and awkward to permit the claims to be fairly heard. Although not technically a class action, the appellate holding confirms the general reasoning behind most decertifications of anti-tobacco class actions. In January 2001, the jury in the Apostolou case ruled in favor of the defendants and no punitive damages were awarded. In Daniels v. Philip Morris, et al., a California state court case, the court certified a class comprised of individuals who were minors residing in California, who were exposed to defendants’ marketing and advertising activities, and who smoked one or more cigarettes within the applicable time period. Defendants appealed the trial court’s certification ruling but their writ was denied. Trial is scheduled for May 2002. In addition, in Miles v. Philip Morris Cos., Inc., an Mlinois state court judge certified a class comprised of all residents of Illinois who purchased and consumed Cambridge Lights and Marlboro Lights within a specified time period but who do not have a claim for personal injury resulting from the purchase or consumption of the cigarettes. The plaintiffs in that case allege consumer fraud claims and seek economic damages in the form of a refund of purchase costs of the cigarettes. Trial is scheduled for May 2002. In October 2001, a Massachusetts Superior Court judge certified a similar class action, Aspinall, et. al v. Philip Morris. Trial is scheduled to take place in the spring of 2002. During April 2001, a California state court issued an oral ruling in the case of Brown v. The American Tobacco Company, Inc., et al., in which it granted in part plaintiff's motion for class certification and certified a class comprised of residents of California who smoked at least one of defendants’ cigarettes during the period from June 10, 1993 through April 23, 2001 and who were exposed to defendants’ marketing and advertising activities in California. Certification was granted as to plaintiff's claims that defendant violated California Business and Professions Code Sections 17200 and 17500. The court denied the motion for class certification as to plaintiff's claims under the California Legal Remedies Act. Defendants have filed a writ with the court of appeals challenging the trial court’s class certification ruling. - 49 - On May 23. 2001, a lawsuit was tiled in the United States District Court for the District of Columbia which seeks class action status for millions of youths who began smoking cigarettes before their eighteenth birthday. Plaintiffs seek to recover moneys that underage smokers spent on cigarettes before their eighteenth birthday, whether or not they have suffered health problems, and/or profits the tobacco manufacturers have earned from sales to children. The lawsuit alleges that tobacco manufacturers concealed the addictive nature of cigarettes and concealed the health risks of smoking in their advertising. Health Care Cost Recovery Lawsuits. Plaintiffs in the health care cost recovery cases include the United States and foreign governmental entities or others, such as labor unions, private companies, HMOs, hospitals, other third-party payors, naive American tribes or private citizens suing on behalf of taxpayers who seek reimbursement of health care costs allegedly incurred as a result of smoking. as well as other alleged damages. The PMs are exposed to liability in these cases, because the MSA only settled health care cost recovery claims for the Settling States. As of June 30, 2001, there were approximately 60 health care cost recovery cases pending in courts in the United States against manufacturers of tobacco products, of which approximately 10 were filed by union trust funds. On May 22. 2001. three of such union trust fund lawsuits were dismissed by the United States Court of Appeals for the District of Columbia. The Court held that plaintiffs” claims were too remote because the alleged injuries were to union members, not union health care trust funds. Eight federal courts of appeals have issued rulings in health care cost recovery actions favorable to the tobacco industry. The United States Courts of Appeals for the Second, Third, Fifth. Seventh, Eighth, Ninth, Eleventh and D.C. Circuits, relying primarily on grounds that the plaintiffs’ claims were too remote. have affirmed dismissals of, or reversed trial courts that had refused to dismiss. such actions. In January 2000, the United States Supreme Court denied plaintiffs” petitions for writs of certiorari in the cases decided by the Court of Appeals for the Second, Third and Ninth Circuits. effectively refusing to consider plaintiffs’ appeals. Although there have been decisions to the contrary, most lower courts which have decided motions in these cases have dismissed all or substantially all of the claims against the tobacco industry. On June 4. 2001. in a U.S. District Court in Brooklyn, NY. a federal jury found that Philip Morris, RJ. Reynolds and Brown & Williamson engaged in deceptive business practices in a case brought by Empire Blue Cross Blue Shield. The jury ruled that the companies must pay up to $17.8 million in a case in which Empire sought to be reimbursed for billions of dollars it allegedly spent on smoking-related costs. Philip Morris, RJ. Reynolds and Brown & Williamson have expressed an intent to uppeal the verdict. In October 2001, a New Jersey court found tobacco manufacturers liable for healthcare costs borne by Horizon Blue Cross Blue Shield of New Jersey, a health insurance company. The decision was based on state consumer protection laws. A lawyer for Philip Morris, Inc.. one of the defendants, has said that the companies intend to appeal the decision to the United States Court of Appeals for the Second Circuit. In September 1999. the Department of Justice filed a lawsuit against the OPMs. certain related parent companies, and two tobacco industry research and lobbying organizations. Among other things, the federal lawsuit seeks to recoup Medicare and other medical expenses of the federal government pursuant to the Medical Care Recovery Act and the Medicare Secondary Payer Act relating to smoking-related illnesses, and alleges violations of the federal RICO statute. The lawsuit seeks unspecified damages, disgorgement of profits by the OPMs under the RICO statute and certain other relief. including an injunction requiring the defendants to make certain public statements in the marketing and promotion of their products regarding the health risks of tobacco and to fund anti- smoking education campaigns and smoking cessation programs. In December 1999, defendants filed a motion to dismiss this lawsuit on several grounds. including that the statutes invoked by the government do not provide a basis for the relief sought. On September 28, 2000, the district court ruled that the government could not use the Medical Care Recovery Act or the Medicare Secondary Payer Act to recover Medicaid expenses related to ill smokers and granted the defendants’ motions to dismiss these claims. The district court also ruled that the government could proceed with its other claims under the RICO statute. In October 2000, the federal government moved for reconsideration of the district courts order to the extent that it dismissed the Medical Care Recovery Act claims for health care costs paid pursuant to government health benefit: programs other than Medicare and the Federal Employees Health Benefits Act. The court denied the motion in July 2001. In February 2001, the government filed an amended complaint attempting to replead the Medicare Secondary Paver Act claim. In July 2001, the court - 50 - dismissed the amended complaint. In February 2001, two Native American tribes moved to intervene and file a class action complaint on behalf of federally recognized Native American tribes seeking to recover costs spent on providing health care to tribal members. The court denied that intervention motion in May 2001. Trial is scheduled for July 2003, although trial dates are subject to change. Philip Morris believes that it has a number of valid defenses to the lawsuit and will continue to vigorously defend it. In A.O. Fox Memorial Hospital, et al. v. American Tobacco Company, Inc., et al., a group of 175 New York State hospitals filed suit in May 2000 in New York Supreme Court, Nassau County, against various defendants, including PMs, seeking to recover unreimbursed and under-reimbursed costs in connection with past, present and future health care provided to patients suffering from tobacco-related illnesses. The lawsuit seeks a minimum of $3.6 billion in damages. Defendants’ motion to dismiss the complaint is pending. The Ninth Circuit has affirmed the dismissal of similar claims brought by a group of Washington hospitals in Association of Wash. Pub. Hosp. Dists. et al. v. Philip Morris, Inc., et al. On October 1, 2001, the U.S. Supreme Court denied the motion for a writ of certiorari. A number of foreign countries have filed suit in state and federal courts in the United States against tobacco industry defendants to recover funds for health care and medical and other assistance paid by those foreign governments to their citizens. Of the 33 cases pending as of June 30, 2001, 6 are pending in state court and 27 are pending in federal court. Eleven of these cases have been transferred to, and are still pending before, the Judicial Panel on Multi-District Litigation in the federal court for the District of Columbia. Other foreign governments and entities have stated that they are considering filing such actions in the United States. Other Tobacco-Related Litigation. The tobacco industry is also the target of other litigation, including: ° Asbestos contribution cases whereby former asbestos manufacturers, their personal injury settlement trusts and insurers seek contribution or reimbursement for amounts expended in connection with the defense and payment of asbestos claims that were allegedly caused in whole or in part by cigarette smoking. As of August 1, 2001, an estimated 20 suits were pending on behalf of former asbestos manufacturers, asbestos manufacturers’ personal injury settlement trusts and an insurance company against tobacco manufacturers. On May 24, 2001, a Mississippi state court rejected claims by asbestos manufacturer Owens Corning that the tobacco companies should reimburse it for payment of asbestos related injury claims that were allegedly caused by cigarette smoking. The Court held that Owens Corning’s alleged injuries were too remote to recover damages for the asbestos injury claims. Owens Corning has indicated that it will appeal. Similar cases are pending in New York, Mississippi and California. e California “Proposition 65” cases, whereby two California cities seek damages for failure to warn that exposure to ETS may cause illness under a law requiring that California residents be informed if they are exposed to substances that are alleged to cause cancer or birth defects. Both cases settled. The two settlement agreements collectively resolve all claims that were, or could have been, brought in these two actions. In November 2000, the court granted defendants’ motion seeking approval of both settlements and entry of a final judgment in both cases. ° As of June 30, 2001, approximately 41 lawsuits have been filed by tobacco wholesalers, or indirect purchasers, against domestic cigarette manufacturers alleging that cigarette manufacturers combined and conspired to set the price of cigarettes, in violation of antitrust statutes and various state unfair business practices statutes. Thirty-eight of these cases remain pending — 7 in federal court and 31 in state courts. In all cases, plaintiffs are asking the court to certify the lawsuits as class actions, and to allow the respective plaintiffs to pursue the lawsuits as representatives of other persons in the United States, and throughout the world, that purchased cigarettes directly from one or more of the defendants. The federal cases have been and sent by the Judicial Panel on Multidistrict -51- Litigation for pretrial in the United States District Court for the Northern District of Georgia. On November 30, 2000, that court dismissed plaintiffs’ claims of fraudulent concealment. claims concerning conduct outside the United States, and allegations relaung to non-price conduct. The court again dismissed the fraudulent concealment claims on June 19, 2001. after plaintiffs attempted to replead them. On January 23, 2001, the federal court certified a class of direct-purchaser plaintiffs. At the state level. the Arizona case Was dismissed on February 28, 2001. and plaintiffs filed a notice of appeal on May 30, 2001. Discovery in all remaining state cases, except Kansas, is being coordinated with the federal cases. Discovery in the federal cases ends July 31, 2001. Parties in the Kansas and Minnesota cases are awaiting rulings on class certification. Suits by tobacco users. manufacturers. consumer advocates and numerous other groups alleging that the defendants conspired to fix cigarette prices. In Bedell Wholesale Co. v. Philip Morris, certain SPMs and NPMs brought an action against the OPMs alleging that certain sections of the MSA violated the Sherman Antitrust Act. The District Court dismissed the cuse holding that the OPMs were immune trom antitrust liability under both the Noerr-Pennington (°NP™) and Parker immunity doctrines. The Court of Appeals on June 19. 2001, affirmed the District Court's dismissal of the case. The Court of Appeals held that detendants were immune from antitrust liability under the NP doctrine but not under the Parker immunity doctrine. The Court of Appeals had earlier explained that in reviewing the District Court’s decision, it would have to affirm the dismissal if the OPMs were immune under either the NP doctrine or the Parker immunity doctrine. In July 2001. the SPMs and NPMs filed a request for an ea banc hearing before the Third Circuit. which request was denied. Attorneys for Bedell filed a petition for a writ of certiorari in the U.S. Supreme Court in October. 2001. Later that month. a group of Pennsylvania plaintiffs brought an action, Mariana vy. Fisher, against the Pennsylvania Attorney General and Secretary of Revenue. based on claims that essentially challenge the Bedell holding. Plaintiffs allege federal antitrust violations and argue that, contrary to the Bedell holding. the MSA. as enforced. fails some of the legal tests required for immunity from federal antitrust liability. Particularly, the plaintiffs argue that the States have not exercised sufficient: control over the anti-competitive aspects of the Manufacturers’ MS A-related activities (Such as raising cigarette prices to fund their MSA payments). Lawsuits have been tiled in Florida by the Republic of Ecuador, the Republic of Belize and the Republic of Honduras. alleging that various OPMs engaged in sophisticated conspiracies to smuggle cigarettes into those respective countries in an effort to evade duties and/or taxes. Plaintiffs seek unspecified amounts in actual damages, treble damages. punitive damages and equitable relief in each of the three suits. A similar lawsuit brought by several Canadian provinces was dismissed in July 2000 and the United States Court of Appeals for the Second Circuit upheld that dismissal in October 2001: no ruling has been issued. The defendants have denied the allegations in each of such cuses. An action in the United States District Court for the Eastern District of New York commenced by the European Commission (“EC”) on November 3, 2000 against Reynolds Tobacco. Philip Morris. and related companies. The EC complaint alleges several claims. including RICO. common Jaw fraud. public nuisance, and unjust enrichment. The EC also alleges that Philip Morris. Reynolds Tobacco, and related companies engaged In a conspiracy to smuggle cigarettes into EC member states in an effort to evade taxes. thereby depriving the EC and its member states of custom duties and value added taxes. = The complaint seeks unspecified damages including compensatory damages. injunctive relief, und treble damages under RICO. On July 18. 2001, the court dismissed the case, stating that the EC had been unable to prove “that it -§2- has suffered any injury as a result of the defendants’ illegal acts.” On August 6, 2001, the EC and 10 member states filed a complaint against Reynolds Tobacco, Philip Morris, and related companies. The EC complaint is essentially a resubmission of the first complaint filed on November 3, 2000. The EC complaint alleges that Philip Morris, Reynolds Tobacco, and related companies engaged in a conspiracy to smuggle cigarettes into EC member states in an effort to evade taxes, thereby depriving the EC and its member states of custom duties and value added taxes. The complaint seeks unspecified damages including compensatory damages, injunctive relief, and treble damages under RICO. Litigation spawned by the MSA and settlements with the Previously-Settled States alleging. among other things, that the MSA or the Model Statute violates certain provisions of the United States Constitution, state constitutions, the federal antitrust laws, federal civil rights laws, state consumer protection laws and unfair competition laws, some of which, if ultimately successful, could result in a determination that the MSA or the Model Statute is void or unenforceable. The lawsuits seek, among other things, an injunction against one or more of the Settling States from collecting any monies under the MSA and barring the PMs from collecting cigarette price increases related to the MSA, and/or a determination that the MSA is void or unenforceable. To date none of the challenges to the MSA or the Model Statute have been successful. although several of the cases brought in federal district courts are on appeal. See “RISK FACTORS” and “LEGAL CONSIDERATIONS” herein. A suit by tobacco manufacturer Star Scientific, Inc., which is not a party to the MSA, is challenging the constitutionality of the MSA, the effect of state statutes adopted under the MSA and any subsequent modifications of the MSA. The Star case has been dismissed by the trial court and plaintiffs have appealed to the Fourth Circuit Court of Appeals. There are six actions pending against RJR Tobacco alleging various violations of the MSA. Four states allege that the posting of signage advertising RJR Tobacco’s brand name sponsorships violates a provision of the MSA governing the times during which such signs may be posted; one state alleges that RJR Tobacco’s purchase of advertising space on matchbooks distributed by an independent third party violates a provision of the MSA governing brand name merchandise: and one state has alleged that the publications in which RJR Tobacco places advertising evidences the direct or indirect targeting of youth, which is prohibited by the MSA. RJR Tobacco has stated that it believes it has meritorious defenses to each of these actions. On June 28, 2001, in Lorillard Tobacco Company v. Reilly, the U.S. Supreme Court ruled that the State of Massachusetts could not impose its own advertising restrictions on tobacco beyond the federal law that bans cigarette advertising and requires warning labels on packages. Based on the First Amendment, the Court found that the attorney general failed to show that Massachusetts’ outdoor advertising regulations for smokeless tobacco and cigars were not more extensive than necessary to advance the state’s interest in preventing underage tobacco use. On July 24, 2001, in North American Trading Company and International Tobacco Partners, LLC v. “NAAG” et al., plaintiffs filed an action in the United States District Court for the District of Columbia alleging certain constitutional and antitrust claims and that the Model Statute is unenforceable as to importers of foreign-made cigarettes intended for resale in the United States. Plaintiffs have requested an injunction to enjoin the enforcement of the application of the Model Statute against them. On September 18, 2001, the District Court dismissed the case. . Lawsuits brought by California, Washington. Arizona, New York and Ohio against Reynolds Tobacco which allege that the OPMs violated MSA advertising restrictions by advertising in publications with greater than 15% youth readership. on car race track billboards for longer than the allowed time limits and on match book covers. The foregoing discussion of civil litigation against the tobacco industry is not exhaustive and is not based upon the Corporation’s examination or analysis of the court records of the cases mentioned or of any other court records. It is based on SEC filings by OPMs and other publicly available information published by the OPMs and others, including recent news reports. Prospective purchasers of the Series 2001 Bonds are referred to the reports filed with the SEC by certain of the OPMs for additional descriptions thereof. Litigation is subject to many uncertainties. In its SEC filing. one OPM states that it is not possible to predict the outcome of litigation pending against it. and that it is unable to make a meaningful estimate of the amount or range of loss that could result from an unfavorable outcome of pending litigation, and that it is possible that its business. volume. results of operations. cash flows or financial position could be materially affected by an unfavorable outcome or settlement of certain pending litigation or by the enactment of federal or state tobacco legislation. 'n ff 1 DRIeWEFA REPORT The following information has been extracted from the DRI¢eWEFA Report, a copy of which is attached hereto as Appendix A. This summary does not purport to be complete and the DRIeWEFA Report should be read in its entirety for an understanding of the assumptions on which it is based and the conclusions it reaches. The DRI*WEFA Report forecasts future United States domestic cigarette consumption. The MSA payments are based in part on cigarettes shipped in and to the United States. Cigarette shipments and cigarette consumption may not match as a result of various factors such as inventory adjustments. General DRIeWEFA, formerly known as Wharton Econometrics, has prepared a report, dated October 19, 2001 (the “DRI*WEFA Report”), for the Corporation on the consumption of cigarettes in the United States from 2001 through 2030 entitled, “A Forecast of U.S. Cigarette Consumption (2000-2030) for the Tobacco Settlement Financing Corporation.” DRI*WEFA is an internationally recognized econometric and consulting firm of over 200 economists in 16 offices worldwide. DRI*WEFA is a wholly-owned subsidiary of Primark Corporation, a publicly traded company which is a provider of financial, economic and market research information. DRI*WEFA has developed a cigarette consumption model based on historical United States data between 1965 and 1999. This econometric model, coupled with DRI*eWEFA’s long term forecast of the U.S. economy, has been used to project total U.S. cigarette consumption from 2001 to 2030. This forecast, in the short-term, differs slightly from the one presented by DRI¢eWEFA in 2000 (“DRI*WEFA’s 2000 Forecast”). In the year 2000, lower than expected prices increased consumption and, after examining manufacturers’ shipment data for the year, DRI*WEFA now estimates a consumption level for year 2000 of 423 billion, 12 billion more than DRI*eWEFA’s 2000 forecast. DRI*WEFA has also revised its year 2001 consumption projection upwards. to 408 billion from 401 billion. The long term forecast is identical to DRI*¢WEFA’s 2000 forecast. After considering the impact of demographics, cigarette prices, disposable income, employment and unemployment, industry advertising expenditures, the future effect of the incidence of smoking among underage youth and qualitative variables that captured the impact of anti-smoking regulations, legislation, and health warnings, DRI*eWEFA determined which variables to use (real cigarette prices, real per capita disposable personal income, the impact of restrictions on smoking in public places, and the trend over time in individual behavior and preferences) and, using these variables, developed a cigarette consumption model based on historical United States data between 1965 and 1999. DRIeWEFA applied a standard multivariate regression analysis to determine the nature of the economic relationship between these variables and adult per capita cigarette consumption in the United States. The regression analysis for the period 1965 to 1999 showed: (i) long run price elasticity of demand of -0.31; and (ii) income elasticity of demand of 0.27. DRI*WEFA estimates that the total consumption for the year 2000 declined by 2.76%. After 2001, DRIeWEFA projects that the rate of decline in total cigarette consumption will moderate and average less than 2% per year. From 1999 through 2030 the average annual rate of decline is projected to be 1.79%. On a per capita basis consumption is projected to fall at an average annual rate of 2.63%. Total consumption of cigarettes in the United States is projected to fall from an estimated 435 in 1999 to under 400 billion by 2002, to under 300 billion by 2019, and to reach 248 billion in 2030. DRI*WEFA’s analysis indicates that total consumption in 2030 will be 248 billion cigarettes (the “Base Case Forecast”), representing a 51% decline from the 1999 level. The DRI*WEFA Report states that DRIeWEFA believes that the assumptions on which the Base Case Forecast is based are reasonable. The results of the Base Case Forecast are shown in the following table. -55- DRI¢WEFA Base Case Forecast of Cigarette Consumption Cigarettes Cigarettes Year (billions) Year (billions) 2000 423.00 2016 310.96 2001 408.00 2017 305.75 2002 394.13 2018 300.62 2003 386.89 2019 295.4] 2004 379.60 2020 290.58 2005 373.24 2021 285.75 2006 366.94 2022 281.13 2007 360.98 2023 276.53 2008 355.27 2024 272.28 2009 349.32 2025 268.07 2010 343.83 2026 263.94 2011 338.37 2027 259.89 2012 332.69 2028 255.93 2013 326.93 2029 252.05 2014 321.15 2030 248.20 2015 316.05 The following graph displays the projected time trend of cigarette consumption in the United States. Annual U.S. Cigarette Consumption: Base Cause Forecast 700 600 wn S -) 300 Billions of Cigarettes & S 200 100 1970 1980 1990 2000 2010 2020 2030 Actual veces Base Case Forecast The DRIeWEFA Report also presents alternative forecasts that project higher and lower paths of cigarette consumption, predicting that by 2030 total United States consumption could be as low as 228 billion or as high as 261 billion cigarettes. - 56 - Comparison With Prior Forecasts On October 25, 1999, DRI*WEFA presented a similar study, “A Forecast of US Cigarette Consumption (1999-2042). Its long run conclusions were quite similar to this study. The current forecast of 248 billion cigarettes in 2030. is 0.8% greater than the 1999 forecast of 246 billion in 2030. In the 1999 study the DRISWEFA projected level of 1999 consumption was 432 billion; the estimated number from the USDA was slightly higher, 435 billion. DRIe*WEFA incorporated this and other new data in 2000. Price increases had been greater than anticipated in the DRIeWEFA 1999 study. DRI*WEFA increased our retail price assumption for 2000 from $3.03 to $3.39, and corresponding decreased its consumption forecast for the year to 411 billion. However, aggressive discounting at the retail level resulted in a lower average price for the year, $3.20 per pack. Increased 2000 consumption forecast DRI*WEFA now estimates a consumption level of 423 billion for 2000, 12 billion more than DRI*WEFA projected in its 2000 forecast, though 8 billion fewer than DRI*eWEFA projected for that year in its 1999 forecast. Historical Cigarette Consumption People have used tobacco products for centuries. Tobacco was first brought to Europe from America in the late 15" century and became America’s major cash crop in the 17" and 18" centuries. Prior to 1900, tobacco was most frequently used in pipes, cigars and snuff. With widespread production of manufactured cigarettes (as opposed to hand-rolled cigarettes) in the United States in the early 20" century, cigarette consumption expanded dramatically. The United States Department of Agriculture (the “USDA”), which has compiled data on cigarette consumption since 1900, reports that consumption (which is defined as taxable United States consumer sales, plus shipments to overseas armed forces, ship stores, Puerto Rico and other United States possessions, and small tax-exempt categories, as reported by the Bureau of Alcohol, Tobacco and Firearms) grew from 2.5 billion in 1900 to a peak of 640 billion in 1981. Consumption declined in the 1980’s and 1990’s, reaching a level of 435 billion cigarettes in 1999. The USDA currently projects that 430 billion cigarettes in 2000. The cigarette market is an oligopoly in which, according to Philip Morris, the four leading manufacturers accounted for over 94% of the market share based on shipments in 2000. The top four companies in shipments were Philip Morris, Reynolds Tobacco, B&W and Lorillard, each of which occupied 50.5%, 23.0%, 11.7%, and 9.6% of the industry market, respectively, as reported by Philip Morris. While the historical trend in cigarette consumption prior to 1981 was increasing, between 1931 and 1932 there was a decline of 9.82% in consumption during the Great Depression. Notwithstanding this steep decline, consumption rapidly increased after 1932, exceeding previous levels by 1934. Following the release of the United States Surgeon General’s Report in 1964, cigarette consumption continued to increase at an average annual rate of 1.20% between 1965 and 1981. Between 1981 and 1990, however, cigarette consumption declined at an average annual rate of 2.18%. From 1990 to 1998, the average annual rate of decline in cigarette consumption was 1.51%: but for 1998 the decline increased to 3.13% and then the decline for 1999 accelerated to 6.45%. These sharp recent declines are correlated with large price increases in 1998 and 1999. Following the 1964 Surgeon General’s Report, adult per capita cigarette consumption (total consumption divided by the number of people 18 years and older) began to decline. Population growth offset this decline until 1981. The adult population (people 18 years and older) grew at an average annual rate of 1.86% for the period 1965 through 1981, 1.17% from 1981 to 1990, and 1.02% from 1990 to 1999. Adult per capita cigarette consumption declined at an average annual rate of 0.65% for the period 1965 to 1981, 3.31% for the period 1981 to 1990 and 2.47% for the period 1990 to 1998. In 1998 the per capita decline in cigarette consumption was 4.21%, and in 1999 the decline accelerated to 7.50%. These sharp recent declines are correlated with large price increases in 1998 and 1999. All percentages are based upon compound annual growth rates. The following table sets forth United States domestic cigarette consumption for the five years ended December 31, 1999. The data in this table vary from statistics on cigarette shipments in the United States. While the DRI*WEFA Report is based on consumption, payments under the MSA are computed, based in part, on -57- shipments in or to the 50 United States. the District of Columbia and Puerto Rico. The quantities of cigarettes shipped and cigarettes consumed may not match at any given point in time as a result of various factors such as inventory adjustments. but are substantially the same when compared over a period of time. Consumption Year Ended December 31 (Billions of Cigarettes) Percentage Change 1999 435 6.45% 1998 465 -3.13% 1997 480 -1.44% 1996 487 0.00% 1995 487 0.21% Survev of the Economic Literature on Smoking. A number of organizations have conducted studies on United States cigarette consumption. These studies have utilized a variety of methods to estimate levels of smoking, including interviews and/or written questionnaires. Although these studies have tended to produce varying estimates of consumption levels due to a number of factors, including different survey methods and different definitions of smoking. taken together such studies provide a general approximation of consumption levels and trends. Set forth below is a brief summary of some of the more recent studies on cigarette consumption levels. Incidence of Smoking. According to a Centers for Disease Control and Prevention (“CDC”) survey released in October 2001, approximately 46.5 million American adults were current smokers in 1999, representing approximately 23.5 of the population age 18 and older. This survey defines “current smokers” as those persons who have smoked at least 100 cigarettes in their lifetime and who have smoked every day or some days at the time of the survey. Although the percentage of adults who smoke (“incidence”) declined from 42.4% in 1965 to 25.5% in 1990, the incidence rate declined relatively slowly through the next decade. The National Center for Health Statistics presents a preliminary estimate of adult incidence for 2000 of 23.3%. Certain studies have focused in whole or in part on youth cigarette consumption. Surveys of youth typically define a “current smoker” as a person who has smoked a cigarette on one or more of the 30 days preceding the survey. The CDC's Youth Risk Behavior Survey estimated that from 1991 to 1999 incidence among high school students (grades 9 through 12) rose from 27.5 to 34.8%, representing an increase of 26.5%. According to the Monitoring the Future Study (a school-based study of cigarette consumption and drug use conducted by the Institute for Social Research at the University of Michigan), smoking incidence among eighth, tenth and twelfth graders was lower in June 2000 than in June 1999. However. incidence levels for 10" and 12" graders remain significantly higher than in June 1991. Smoking incidence for 8" graders has fallen to near its level in 1991. The 2000 Household Survey on Drug Abuse conducted by the Substance Abuse and Mental Health Services Administration of the United States Department of Health and Human Services estimated that approximately 55.7 million Americans age 12 and older were current cigarette smokers (defined by this survey to mean they had smoked cigarettes at least once during the 30 days prior to the interview). This estimate represents an incidence rate of 24.96, which is a decrease from 25.8% in 1999. The same survey found that an estimated 13.4% of youths age 12 to 17 were current cigarette smokers in 2000. a decrease from 14.9% in 1999. Price Elasticity of Cigarette Demand. The price elasticity of demand reflects the impact of changes in price on the demand for the product. Cigarette price elasticities from recent conventional research studies have generally fallen between an interval of -0.3 to -0.5. In other words, as the price of cigarettes increases by 1.0%, the quantity demanded decreases by 0.3% to 0.5%. A few researchers have estimated price elasticity to be as high as -1.23. Research focused on youth smoking has found price elasticity levels of up to -1.41. Two studies recently published by the National Bureau of Economic Research examine the price elasticity of youth smoking. In their study on youth smoking in the United States. Gruber and Zinman estimate an elasticity of smoking participation (defined as smoking any cigarettes in the past 30 days) of -0.67 for high school seniors in the period 1991 to 1997. That is, a 1% increase in cigarette prices would result in a decrease of 0.67% in the number of those seniors who smoked. The study’s findings state that the drop in cigarette prices in the early 1990’s can explain 26% of the upward trend in youth smoking during the same period. The study also found that price has little effect on the smoking habits of younger teens (8" grade through 11" grade), but that youth access restrictions have a significant impact on limiting the extent to which younger teens smoke. A study by Tauras and Chaloupka also found an inverse relationship between price and cigarette consumption among high school seniors, and that the price elasticity of cessation for males averaged 1.12 and for females averaged 1.19. According to the DRISWEFA Report, these estimates imply that a 1% increase in the real price of cigarettes will result in an increase in the probability of smoking cessation for high school senior males and females of 1.12% and 1.19%, respectively. Workplace Restrictions. In their 1996 study on the effect of workplace smoking bans on cigarette consumption, Evans, Farrelly, and Montgomery found that between 1986 and 1993 smoking participation rates among workers fell 2.6% more than non-workers. Their results suggest that workplace smoking bans reduce smoking prevalence by 5 percentage points and reduce consumption by smokers nearly 10%. The authors also found a positive correlation between hours worked and the impact on smokers in workplaces that have smoking bans: the more hours per day that a smoker spends working in an environment where there are smoking restrictions, the greater the decline in the quantity of cigarettes consumed by that smoker. Factors Affecting Cigarette Consumption Most empirical studies have found a common set of variables that are relevant in building a model of cigarette demand. These conventional analyses usually evaluate one or more of the following factors: (i) general population growth, (ii) price increases, (iii) changes in disposable income, (iv) youth consumption, (v) trend over time, (vi) smoking bans in public places, (vii) nicotine dependence and (viii) health warnings. While some of these factors were not found to have a measurable impact on changes in demand for cigarettes, all of these factors are thought to affect smoking in some manner and to be incorporated into current levels of consumption. General Population Growth. DRI*WEFA forecasts that the United States population will increase from approximately 272 million in 1999 to approximately 351 million in 2030. This forecast is consistent with the Bureau of the Census forecast. Price Elasticity of Demand and Price Increases. Cigarette price elasticities from recent conventional research studies have generally fallen between an interval of -0.3 to -0.5. Based on DRI*WEFA’s multivariate regression analysis using data from 1965 to 1999, the long run price elasticity of consumption for the entire population is -0.31, that is, a 1.0% increase in the price of cigarettes decreases consumption by 0.31%. In 1998, the average price of a pack of cigarettes in nominal terms was $2.20. This increased to $2.88 per pack in 1999, representing a nominal growth in the price of cigarettes of 30.9% from 1998. During 1999, consumption declined by 6.45%. This was primarily due to a $0.45 per pack increase in November 1998 which was intended to offset the costs of the MSA and the agreements with the Previously -Settled States. The cigarette manufacturers have since increased wholesale prices on five occasions: in August 1999 by $0.18 per pack, in January 2000 by $0.13 per pack, in July 2000 by $0.06 per pack, in December 2000 by $0.14 per pack and most recently on April 25, 2001 by $0.14 per pack. In addition to the wholesale increases, New York increased its state excise tax by $0.50 per pack to $1.11, following a similar 1999 increase of $0.50 per pack in California. In 2001, Maine, Rhode Island, West Virginia, and Wisconsin have all increased their tax on cigarettes. The average state excise tax is now $0.40 per pack. As a result of these increases DRI*WEFA estimates that average retail prices across the U.S. have risen, in September 2001, to approximately $3.60 per pack. For the year 2000, DRI*WEFA estimates that the average price per pack was $3.20, representing a nominal growth in the price of cigarettes of 11.0% from 1999. Prices are expected to continue to increase 2000due to costs related to the MSA and an increase in the federal excise tax of $0.05 per pack scheduled for 2002, among other reasons. Premium brands are typically $0.50 to $1.00 more expensive per pack than discount brands, allowing a margin for consumers to switch to less costly discount brands in the event of price increases. Under the MSA, volume adjustments to payments are based on the quantity (and not the price or type) of cigarettes shipped. -59- Changes in Disposable Income. Analyses from many conventional models also include the effect of real personal disposable income. Most studies have found that cigarette consumption in the United States increases as disposable income increases. However. a few studies have found that cigarette consumption decreases as disposable income increases. Based on its multivariate regression analysis using data from 1965 to 1999, DRIeWEFA found that the income elasticity of consumption is 0.27; in other words. a 1.0% increase in real disposable income per capita increases per capita cigarette consumption by 0.27%. Youth Consumption. The number of teenagers who smoke is another likely determinant of future adult consumption. While this variable has been largely ignored in empirical studies of cigarette consumption. almost all adult smokers first used cigarettes by high school and very little first use occurs after age 20. One study examines cohort effects (intertemporal correlation) of youth smoking on future adult smoking. The study found that between 25% and 50% of an increase or decrease in youth smoking would persist into adulthood. According to the study, several factors may alter future correlation between youth and adult smoking: there are better means for quitting smoking than in the past. and there are more workplace bans in place that will affect those who are currently in their teen years. DRIeWEFA compiled data from the CDC which measures the incidence of smoking in the 12-17 age group as the percentage of the population in this category that first become daily smokers. The percentage, after falling since the early 1970°s began to increase in 1990 and increased through the decade. DRI*¢WEFA assumes that this recent trend has reached its peak and that youth smoking will resume its longer term decline. Trend Over Time. Since 1964 there has been a significant decline in United States adult per capita cigarette consumption. The 1964 Surgeon General's health warning and numerous subsequent health warnings, together with the increased health awareness of the population over the past 30 years, may have contributed to decreases in cigarette consumption leveis. If. as assumed by DRIeWEFA, the awareness of the adult population continues to change in this way. overall consumption of cigarettes will decline gradually over time. DRI*WEFA’s analysis includes a time trend variable in order to capture the impact of these changing health trends and the effects of other such variables which are difficult to quantity. Health Warnings. Categorical variables also have been used to capture the effect of different time periods on cigarette consumption. For example. some researchers have identified the 1964 United States Surgeon General's Report and subsequent mandatory health warnings on cigarette packages as turning points in public attitudes and knowledge of the health effects of smoking. The Cigarette Labeling and Advertising Act of 1965 required a health warning to be placed on all cigarette packages sold in the United States. beginning January |, 1966. The Public Health Smoking Act of 1969, beginning November |, 1970, required all cigarette packages sold in the United States to carry an updated version of the warning. stating that it was a Surgeon General's warning. The Comprehensive Smoking Education Act of 1984 led to even more specific health warnings on cigarette packages. The dangers of cigarette smoking have been generally known to the public for years. Part of the negative trend in smoking identified in DRIeWEFA’s model may represent the cumulative impact of various health warnings since 1966. Smoking Bans in Public Places. Beginning in the 1970s, numerous states have passed laws banning smoking in public places as well as in private workplaces. As of 1999, 48 states and the District of Columbia required smoke-free indoor air to some degree. or in some public places. Based on its regression analysis using data trom 1965 to 1999, DRI*¢WEFA found that the restrictions on public smoking appear to have an independent effect on per capita cigarette consumption. DRI*WEFA estimates that the restrictions instituted beginning in the late 1970s have reduced smoking by about 2%. However, the timing of the restrictions within and across states makes such statistical identification difficult. The trend variable included in DRI*eWEFA’s econometric analysis is likely to incorporate some part of the cumulative impact of the various smoking bans and restrictions. Nicotine Dependence. Nicotine is widely believed to be an addictive substance. The Surgeon General and the American Medical Association both conclude that nicotine is an addictive drug which produces dependence. The American Psychiatric Association has determined that cigarette smoking causes nicotine dependence in smokers and nicotine withdrawal in those who stop smoking. The American Medical Association Council on Scientific Affairs tound that one third to one half of all people who experiment with smoking become smokers. - 60 - Other Considerations. In August 1999, the CDC published “Best Practices for Comprehensive Tobacco Control Programs.” Citing the success of programs in California and Massachusetts, the CDC recommends comprehensive tobacco control programs to the states. On August 9, 2000, the Surgeon General issued a report, “Reducing Tobacco Use”, that comprehensively assesses the value and efficacy of the major approaches that have been used to reduce tobacco use. The report concludes that a comprehensive program of educational strategies, treatment of nicotine addition, regulation of advertising, clean air regulations, restrictions of minors’ access to tobacco, and increased excise taxation can significantly reduce the prevalence of smoking. The Surgeon General called for increased spending on anti-smoking initiatives by states of up to 25% of their annual settlement proceeds, which is far higher than the approximately 9% allocated from the first year’s MSA settlement payments. The report documents evidence of the effectiveness of five major modalities for reducing tobacco use, namely, educational strategies, pharmacological treatment of nicotine addiction combined with behavioral support, regulation of advertising and promotional activities of manufacturers, clean air regulations, restricted access of minors, and excise tax increases. DRI*WEFA’s research has indicated (and its model incorporates), a negative impact on cigarette consumption due to tobacco tax increases and a negative trend decline in levels of smoking since the Surgeon General's 1964 warning, subsequent anti-smoking initiatives, and regulations which restrict smoking. DRIeWEFA’s model and forecast acknowledges the efficacy of these activities in reducing smoking and assumes that the effectiveness of such anti-smoking efforts will continue. DRI*eWEFA goes on to state that, as the prevalence of smoking declines, it is likely that the achievement of further declines requires either greater levels of spending, or more effective programs, which DRI*WEFA views as the common principle of diminishing returns. In 2000, New York State mandated that by the year 2003 manufacturers provide only cigarettes that self- extinguish. DRI*WEFA expects that by that year an agreement will have been reached on a nationwide standard. DRI*WEFA does not believe that either the New York statute or a nationwide agreement will impact consumption noticeably. DRI*WEFA believes that this will probably raise the cost of manufacture slightly, but is viewed by DRI*WEFA as the continuation of a long series of government actions that contribute to the trend decline in consumption and thus have been incorporated into DRI¢SWEFA’s model. Similarly, on January 16, 2001, Vector Group Ltd. announced plans to introduce a virtually nicotine-free cigarette. This non-addictive product might be used as a tool to quit or reduce smoking. DRI*WEFA views this as a continuation of efforts to provide products, such as the nicotine patch, that are supposed to reduce smoking addiction. These products have likely contributed to the trend decline in consumption incorporated into DRI*WEFA’s model. DRI*WEFA’s forecast expects such efforts to continue to reduce per capita cigarette consumption. SUMMARY OF BOND STRUCTURING ASSUMPTIONS Introduction The following discussion describes the methodology and assumptions used to calculate a forecast of Collections to be received by the Corporation (the “Collection Methodology and Assumptions”), as well as the methodology and assumptions used to structure the schedules of Principal and to calculate the projected Turbo Redemptions for the Series 2001 Bonds (the “Structuring Assumptions”). For sensitivity analyses which evaluate the impact of different consumption levels on Turbo Redemptions, see “Effect of Changes in Cigarette Consumption Levels on Turbo Redemptions” below. Collection Methodology and Assumptions In calculating a forecast of Collections to be received by the Corporation, the forecast of cigarette consumption in the United States developed by DRI*WEFA and described as the Base Case Forecast was applied to calculate Initial Payments to be made by the OPMs and Annual Payments and Strategic Contribution Fund Payments to be made by the PMs pursuant to the MSA. The calculation of payments required to be made was performed in accordance with the terms of the MSA; however, as described below, certain assumptions were made -61- with respect to consumption of cigarettes in the United States and the applicability of certain adjustments and offsets to such payments set forth in the MSA. In addition, it was assumed that the PMs make all payments required to be made by them pursuant to the MSA, and that the relative market share for each of the PMs remains constant throughout the Collection forecast period at 94.0% for the OPMs, 4.5% for the SPMs and 1.5% for the NPMs.” It was further assumed that each company that is currently a PM remains such throughout the term of the Series 2001 Bonds. In applying the consumption forecast from the DRI*¢WEFA Report, it was assumed that United States consumption, which was forecasted by DRI*eWEFA, was equal to the number of cigarettes shipped in and to the United States, the District of Columbia and Puerto Rico, which is the number that is applied to determine the Volume Adjustment. The DRI*WEFA Report states that the quantities of cigarettes shipped and cigarettes consumed may not match at any given point in time as a result of various factors such as inventory adjustments, but are substantially the same when compared over a period of time. DRI*WEFA’s Base Case Forecast for United States cigarette consumption is set forth herein under “DRI*WEFA REPORT.” See Appendix A for a discussion of the assumptions underlying the projections of cigarette consumption contained in the DRIeWEFA Report. Initial Payments In accordance with the Collection Methodology and Assumptions, the amount of Initial Payments to be made by the OPMs was calculated by applying the adjustments applicable to the Initial Payments in accordance with the MSA as follows: Volume Adjustment. First, the Volume Adjustment was applied to the schedule of base amounts for the Initial Payments set forth in the MSA. The Volume Adjustment was calculated for each year by applying the DRI*WEFA Base Case Forecast for United States cigarette consumption to the market share of the OPMs for the prior year. No add back or benefit was assumed for the Income Adjustment. See “SUMMARY OF THE MASTER SETTLEMENT AGREEMENT—Adjustments to Payments—Volume Adjustment” for a description of the formula used to calculate the Volume Adjustment. Non-Settling States Reduction. The Non-Settling States Reduction was not applied to the Initial Payments because such reduction has no effect on the amount of payments to be received by states that remain parties to the MSA. Thus, the Collection Methodology and Assumptions include an assumption that the Virgin Islands will remain a party to the MSA. Offset for Miscalculated or Disputed Payments. The Collection Methodology and Assumptions include an assumption that there will be no adjustments to the Initial Payments due to miscalculated or disputed payments. State Allocation Percentage for the Virgin Islands. The amount of Initial Payments, after application of the Volume Adjustment, was multiplied by the State Allocation Percentage for the Virgin Islands pursuant to the MSA (equal to 0.0173593%) in order to determine the portion of the Initial Payments to be made by the OPMs in each year that are to be allocated to the United States Virgin Islands State-Specific Account. The following table shows the projection of Initial Payments to be received by the Indenture Trustee, calculated in accordance with the Collection Methodology and Assumptions. =F The aggregate market share information utilized in the bond structuring assumptions may differ materially from the market share information utilized by the MSA Auditor in calculating adjustments to Initial Payments, Annual Payments and Strategic Contribution Fund Payments. See “SUMMARY OF THE MASTER SETTLEMENT AGREEMENT — Adjustments to Payments.” -¢9- HeoSc Ll) DHroSeLiO0 (00°000' 80 CET 000'000'007 SPT [e0c/0c/10 O¢OC/0C/10 %HeCOSeLlOO 000°000°L76'9¢7 000°000°0S0°TST 6cOC/NT/0 HeoSeLloo 000°00T PLS OFT 000°000°0£6'°SST 8c0C/0C/L0 DOSELIO'O 000°009°96Z'rrhz 000°000°068'6S7 L707/0/10 _ *BHCOSCLLO'O _ 000°009" COI '8 hz 000°000'0P6'¢9T 9e07/07/ 10 HeoseL10'0 000°008°S86' 1S 000°000°0L0°897 S7OC/0Z/10 Hose Loo 0000S EP6'SST 000°000'082'°CL7Z pc0c/0C/ 10 HeOSeLlo0 000°007'8E6' 6ST 000°000°0¢S°9L7 tcOT/07/10 HeoseLloo 000°007° 297 P9T 000°000'0¢ 1187 CCOC/OC/10 _ HeoSeLl0'0. ; 000°000°S09°897 000°000°0S2'S87 1c0c/02/10 HLOSeLlo0 000‘007'SFI'ELZ 000°000°08S°067 O0c0c/0C/10 *HLOSELLO'O 000'00F'S89°LLZ 000°000°01P'S6z 6107/07/10 *HcoSeLlOO 000°008°78S°T87 000°000°0Z9°00€ 8102/02/10 DHeOSeLio'O 000°000'S0b'L82 000°000'0S2'S0E L10/0Z/10 *®COSELIO'O 000°00r'Z0E'767 000'000‘096'01€ 9102/02/10 PCOSELIO'O 000°000°L80°L6z 000°000‘0S0'91¢ $107/02/10 %eOSELIOO 000°000°I 88° T0¢ 000‘000‘0S I IZ€ vl0Z/07/10 %COSELIOO 000‘007'r 1E°LOE 000°000‘0E6'9ZE £ 10/02/10 *HCOSELLO'O 000°009'°8ZL'ZI¢ 000°000°069°ZEE TIO7/OZ/T0 ee *BeOSeL1o0 oe _ 000°008°L90'8I¢ 000°000'0LE'8Ee 110¢/0¢/10 *HCOSELIOO 000°007' 007 EZE 000°000'0¢8" Ere 0102/07/10 *%HLOSCL1O0 000°008'09€"87E 000°000°0Z¢" ere 600C/02/10 DLCOSELIO'V 000008" ESe'cee 000°000'0L7'SS¢ 8007/0C/10 HeOSeLlo'O 000007 I Ze"6EE 000°000'086'09¢ LO00C/0/10 7 BHEOSELIO'VO 000°009"€Z6 pre 000°000‘'0r6'99¢ 900Z/0T/10 BeOSeL1oo 000°009'SP8'0S¢ 00000007’ ELE $007/0/10 DHEOSELIO'O) 000°000'PZ8'9S¢ 000°000‘°009‘6LE PONT/OC/T0 TITOLE 806% pOe'L9e *%eOSEL1O'O OIL T68SIEC (STOOL S8S) FRE ICC LOLS 000°009°9L9'¢9¢ 000°000'068'98¢ £00C/0C/10 SsLide $ OC67 $ Ges'B9E ¢ HCOSELIO'O 698 60L' PCE C$ (LE6'PES'LOP$) — OOS PPS*7ZI'ZF 000007 Z8r'OLE 000°000'0E T'F6E 7OOT/0C/10 000°000'07S"E8¢ 000°000'000'80r 100¢/0¢/10 DIIAIIS 149q] udy 07 ‘ues doqsn | uonRoo[[y [eio1qns quounsnipy syuawceg uonduinsuod SBIIIO} aed puog Joy wold pawey aunjuapu] do}sny JUNJOA yentuy paisnipy-dWwo uondwinsuod squawikeg yso19qu] 0} sjuawkeg aunquapuy aseg aseg aseg Tentuy jBIOL fenruy Vdd Tad d9jSNIT sINjUIpUT Aq PIAlIday oq 0} SyudUTAeY JeIIU] Jo UONIefo1g Annual Payments In accordance with the Collection Methodology and Assumptions. the amount of Annual Payments to be made by the PMs was calculated by applying the adjustments applicable to the Annual Payments in the order, and in the amounts. set out in the MSA, as follows: Inflation Adjustment. First. the Inflation Adjustment was applied to the schedule of base amounts for the Annual Payments set forth in the MSA. Inflation was assumed to be at a rate of 3.4% for 2000. Thereafter, the inflation adjustment was assumed to be the minimum provided in the MSA, at a rate of 3% per year, compounded annually. for the rest of the Collection forecast period. Volume Adjustment. Next. the annual amounts calculated tor each year after application of the Inflation Adjustment were adjusted for the Volume Adjustment by applying the DRI*WEFA Base Case Forecast for United States cigarette consumption to the market share of the OPMs for the prior year. No add back or benefit was assumed trom any Income Adjustment. See “SUMMARY OF THE MASTER SETTLEMENT AGREEMENT — Adjustments to Payments — Volume Adjustment” tor a description of the formula used to calculate the Volume Adjustment. Previously-Settled States Reduction. Next, the annual amounts calculated for each year after application of the Inflation Adjustment and the Volume Adjustment were reduced by the Previously-Settled States Reduction which applies only to the payments owed by the OPMs. The Previously-Settled States Reduction is as follows for each year of the following period: 2000 through 2007 12.4500000% 2008 through 2017 '2.2373756% 2018 and after 11 .0666667 Non-Sertling States Reduction. For the reasons described above under “Initial Payments,” the Non-Settling States Reduction was not applied to the Annual Payments. NPM Adjustment. The NPM Adjustment will not apply to the Annual Payments payable to any state that enacts and enforces a Model Statute so long us such statute is not held to be unenforceable. The Collection Methodology and Assumptions include an assumpuon that the Virgin Islands will enforce a Model Statute that is not held to be unenforceable. For a discussion of the Virgin Islands Model Statute. see “SUMMARY OF THE MASTER SETTLEMENT AGREEMENT MSA Provisions Relating to Model Statute/Qualifying Statute — Virgin Isiands Model Statute.” Offset for Miscalculated or Disputed Payments. The Collection Methodology and Assumptions include an assumption that there will be no adjusuments to the Annual Payments due to miscalculated or disputed payments. Federal Tobacco Legislation Offset. The Collection Methodology and Assumptions include an assumption that the Federal Tobacco Legislation Offset will have no effect on payments under the MSA. As of the date hereof, no legislation has been introduced in the United States Congress that would cause this offset to apply. Unless federal legislation is enacted on or prior to November 30, 2002, this offset will not apply. Litigating Releasing Parties Offset. The Collecuon Methodology and Assumptions include an assumption that the Litigating Releasing Parties Offset will have no effect on payments. Offset for Claims-Over. The Collection Methodology and Assumptions include an assumption that the Oftset for Claims-Over will not apply. Subsequent Participating Manufacturers. The Collection Methodology and Assumptions assume that the relative market share of the SPMs remains constant at 4.5%. Because the 4.5% market share is greater than 3.125% -64- (125% of 2.5%, the SPMs’ estimated 1997 market share), Collection Methodology and Assumptions assume that the SPMs will be required to make Annual Payments in each year. State Allocation Percentage for the Virgin Islands. The amount of Annual Payments, after application of the Inflation Adjustment, the Volume Adjustment and the Previously-Settled States Reduction for each year was multiplied by the State Allocation Percentage for the Virgin Islands (0.1800232%) in order to determine the amount of Annual Payments to be made by the PMs in each year to be allocated to the United States Virgin Islands State- Specific Account. The following table shows the projection of Annual Payments to be received by the Indenture Trustee through the year 2031, calculated in accordance with the Collection Methodology and Assumptions. - 65 - -99- SS6 £08" 1 625°6C 92862’ 1 4eoseZ1LO0 OO SCLOSE'OL (CCC UPL O8C'D) (C97 IS8’9I9 TL) FOO’ ZEZ’S9C'EL 0000000006 1e0c/St/F0 CFL LOSI OF L‘6C Lo6'12Z'1 ueoseZLod TER'O9LLOT' OL (See'TEC'OZT' DT) (OZF'TOVOLTTL) ZSSrOT'R8eEL 000000000’ O00'000’80E'CET 000000007’ 8FTZ OLOe/ST/F0 CRS PLL SIZL'8C LEX'StL'1 HLOSEZLO'O L88OLO'LS0°OL CET UTZE TST) (88S°S I ZEC9OL) 66S'ROTUE6’TL — 000000'000'6 ~— QU0'000'ZT6’9ET 00000008 0TST 620 /ST/ FO OSPF RELI L6C'8T Z81'0¢2'1 wLOSeZ100 LILV80¢606'6 (8 1e’Co0'eT (CTS PSO’6E TOD) Ob6'FEE' 16c’T1 — 000'000'000'6 000007’ FZS’ OFZ 00000006687 8TUZ/SC/t0 966 CCL I 18e’Ze SI1S69'1 oeoSeZL00 FLO'IS8'F9Z'6 = (OST'UCTSIZ 1) (Z9T'ET E1696) ORFS LE’ EZ9LT. 0000000006 = 000009967 FFT ON0000068’6Se = ZZUT/STZ/F0 700869" I LLY LTE SéS‘029'1 H€OSEZL0°0 LL6'2Zec'€0%' (EEN LOE ZOLL) (koe Z1S’RFC’6) 8 e’RECH9O'LT 000000006 O00D09’EOL’8 FT 000000066’ £9T 900C/St/ FU CLP ELL O80'LZT Soe’OFO' | BLOSeZ LO OLP'9TC' PRES (G6096T‘ORT'D (668'RZ70CR'R) CLF ZO’ FRE'OL 0000000006 — GO0’008’SR6' TET 000000020897 S@0C/ST/ FO LOVOFY'T 989'9C O8t'TC9'I £€OSeZ 00 199 19F OFS (FSO'TSOR OTD) (6€e"Z99°Z0F'8) — SS6’TSTZL6’6 0000000006 = 00000¢’e FH’ Se OOOU00'08C'CZC P02 /ST/F0 RO8'9C9' | Ste’9C PSP‘009' | TRY LEZ OIC (ELE PRT LEI) (81 C9 666'2) 820961 99¢"6 — QOO000000'6 ~— QOOU0Z'8E6"6ET _ OOO'D000E5'97 PCO /ST/ FO COR FOOT ¢96'EC bof 8261 P8200 60. — (O8?STS TEL) (Ose’ce 99092) ETE’ RECTES’R OO'000'000°6 = 000007797 F9T VOODOO 0E 1’ L&T CCOC/&T/ FO IPl‘ese'l SLOSS ivareacn| LOM IZC'CL6'8 — (SFSORFOLL TD) (GeeOR EP ecc'2) FST 106’ TLE’S 0000000006 — 000’000’609’89T_ 0000000ES2Z’E8TZ 1COC/SC/F0 TOL 1961 WZe'Se LeP’9ee’] mLOseZ LOU Q1999Z'0G88 — (COL'OOL LOD) (CLL FES GRO) ETT Z9°Z08"£ 0000000006 O0000T'SFIEZE 000000088067 OC0C/ST/ FO CS'TES' I LSo'bC OOU LISI SLOSEZ10'O LLE'ROF ELS (COOTIS’Z8O'D) CISC’90C' TOP 9) ORE ZEUST EZ 000°000'000'6 — O00O0F’E89‘ZZT 0000000 LF’ S67 6L07/ST/F0 6¢s' Ics" t 9E9'FT ¢ic’Zor | beoseZ lOO SINSERECI'R — (OBVVSTEZOTD) (OLS OL FET'9) — 890'TER'TER'O 00000070006 OO0'00R’TRE’ERT OOO’ OONUTINL BLOT /ET/F0 666 OE I 826‘ 1T CEH'RIC'L HeoseZ lod LIC TSOVOG ZL (TEETZV OCOD) (SCURSO'EECS) — COLZTIO'ULZZE = QUO'0006E TR GOO‘O00’S0F'Z8e OOO'O00'0SZ'S08 — ZLO0T/ST/ FO eZ cce’l YZ9'1C Lor‘oue’ | SeOSeZLU'U LOZ’eeO' Lob’ £ CP LOELOEEOTD) (ZC0'TL ES 896'F)— TOLZ69Z'G 9G OO000E LR OOO O0F’ TOE’ Z6~__ OU0'000'096'01E 9LOC/&T/ FO rane aa eLETC REOTRCE | yeoceZ 100 COT9ON REL COSN'9EN'OENTD) COLL Fe rO9'D) — CeS9CECLO'F — OOO000’6E T'S GOD'Q00'Z80'26T OOOOO0OE0’9 Te SLOC/Sc/F0 Ocd' Z8T'l CLIT LOL99T'T BeoceZLod CO8’COH'96T' LZ SLT ZIOD) (ZS0'TLUS TD) S200 S06 OOOU00'HE LR O00'000 188" 108 OOOOO0UE LEZ FLUC /&c/ 0 SOU TLC NERUC LESOSC | HeoseZlLoo GER Ler Sue Z SOZROUT (SUL TIO SEE Pb) pee 222 61Cb — O00'U00’6E LS O00DDE FLL 20% OOUU000L 69k LLOC/Se/ FU OLU'EST I 9680 Por bec’ | LOSeZLOU O6C OCH ILL (FOR L6E'166) (CERER GONE) S96'TISORS’E — OO0O00'6E VS OO0'OO9'RTZ'TIE 000°000'069’ZEE TIO /ET/ FO poe ZeC' | ORC UT SO LIC | meoeeZ lOO OSR'60OPCLO'Z L806 L'L26) (SCTE VOLO 9ZOCREUESE — OOUTOON' HLTH ODDO08Z90'REE OOOOO00ZE Ret L10C/ Ses FO FLU UCT I FOO'UT OLV'00C' I MLOSEZLOO GRE TUL EIT O'9 — (O8E’ZTO'FVG) — (VETTORTEF’E) — GLOTEONTIZE O00000SE US QO0OOT’00T ETE OOOO000ER’ CFE OLOT/ST/ FO Cec’ HUC | CrZ‘6l Lot’ Pst’ 4 eOSeZ10'0 RLC ERE ECHO (LSE TS) (CL0'662'60C'C) LODE TOT PST OOUO00’6E T'S O00'00809E RTE OOO O00'0TL OF L 600C/ST/ FO olf 2811 LIF 6] ceo ZO] HroeeZ LOU teOZOTRCLZ9O — (GUC"SET'RE6) CLI eee beod) — OLb6RZECEC — OOOO00'@E LS OUOD08’Eb6’SEE QUO OO00ZC' ESE 8OUT/SC/ FO Loe’ SP LL tZy’S I SlZocl'l oeOSeZlO'0 CSVORR LOGO (DO8EFE'SCH) — (CONTETORZ'C) — ST9OTE’EZES— BOO'DOO'000'S — OD0‘00T' ETE OEE OO0'000'086 09 LO0T/&e/ FO seZ’eu TT 1f9’S I ZEVSLU A HOseZloo LO6O08'etr’9 (FOL Loft LO) (L6S'906'6EE'T) — ZOS“00C'ZZ8T 0000000008 000‘009’e TOFFEE 000'0000F 699 900T/ST/ FO RRA‘R ETT ORE'RT 666001 T 4C6seZ10'0 ORV ETTORE TOST06) (LOTT IS'ZERO) ERIS TSORE'T — 000NN0'000'8 — QO0009’GFROSE O00'000'0FT’EZE COT /SC/F0 LOLZ'9011 ZR181 OCE’BR0' I HEosez loo OFS'OCS'0ZT'9 —(FET’Z69' 168) (960/TRO'ZELC) 9 ZR’RO'OTE LE 0000000008 O00’000'FZ8’9SE 00000000962 FOUT/&T/ FO 1C6'R8R 809°F L Cle Pde HLoceZ lov [PCOLS OOS (PELTZT9LL) (TUT LOSE) LOR 17' FPR 000'0000069- Q00009°9Z9’E9E_ GO0’000/068 98 LO0T/ET/ FO O29 THR 690FL LS6'LL8. & SEOECZLO OHH LYEZEN'SS — (FER’ZOZ’OIZS) — (990'ES’ESE’TS) 006’8080E9 -$ — QaO‘ONNONE’9S OOO'VOT'ZRF'OZE OOOUOO'UEL FOE ZO0Z/SZ/F0 000‘0000ZS"E8e 000000000’ 80F 100¢/S¢/t0 IITATOS YQOC] OSM | HOt | UOHRIOLLY [eyOIGNS uoL Npoy ~ uounsnipy yuougsnalpy syuouArgy uoydiuunsuo, ) YSLIOIOL| O7VeC] ~ puog osnyuopuy wn yuopuy oy dO PSL | SOPPYG Papyas OUINOA uoHRyU] jenuuy poysnalpy uoydunsuoy JO} SJUDWAV, | O} SJUDLUA RE SJUDWAR, | oinyUuopuy AJSNOLAOA J aseg WdO ase) oseg penuuy [eyo LT WalS WadlO [ROL VAAMe RIC aa}sni yp ainjuapuy Aq paataday aq 0} sjuauAeg [enuUY Jo UOTIIfO1g Strategic Contribution Fund Payments In accordance with the Collection Methodology and Assumptions, the amount of Strategic Contribution Fund Payments to be made by the PMs was calculated by applying the adjustments applicable to the Strategic Contribution Fund Payments in the amounts, set out in the MSA, as follows: Inflation Adjustment. First, the Inflation Adjustment was applied to the schedule of base amounts for the Strategic Contribution Fund Payments set forth in the MSA. Inflation was assumed to be at a rate of 3.4% for 2000. Therefor, the Inflation Adjustment was assumed to be the minimum provided in the MSA, 3% per year, compounded annually, for the entire Collection forecast period. Volume Adjustment. Next, the Strategic Contribution Fund Payments calculated for each year after application of the Inflation Adjustment were adjusted for the Volume Adjustment by applying the DRIeWEFA Base Case Forecast for United States cigarette consumption to the market share of the OPMs for the prior year. No add back or benefit was assumed from any Income Adjustment. See “SUMMARY OF THE MASTER SETTLEMENT AGREEMENT — Adjustments to Payments — Volume Adjustment’ for a description of the formula used to calculate the Volume Adjustment. NPM Adjustment. The NPM Adjustment will not apply to the Strategic Contribution Fund Payments payable to any state that enacts and enforces a Model Statute so long as such statute is not held to be unenforceable. The Collection Methodology and Assumptions include an assumption that the Virgin Islands will enforce a Model Statute that it is not held to be unenforceable. For a discussion of the Virgin Islands Model Statute, see “SUMMARY OF THE MASTER SETTLEMENT AGREEMENT — MSA Provisions Relating to Model Statute/Qualifying Statute —Virgin Islands Model Statute.” Offset for Miscalculated or Disputed Payments. The Collection Methodology and Assumptions include an assumption that there will be no adjustments to the Strategic Contribution Fund Payments due to miscalculated or disputed payments. Federal Tobacco Legislation Offset. The Collection Methodology and Assumptions include an assumption that the Federal Tobacco Legislation Offset will have no effect on payments under the MSA. As of the date hereof, no legislation has been introduced in the United States Congress that would cause this offset to apply. Unless federal legislation is enacted on or prior to November 30, 2002, this offset will not apply. Litigating Releasing Parties Offset. The Collection Methodology and Assumptions include an assumption that the Litigating Releasing Parties Offset will have no effect on payments. Offset for Claims-Over. The Collection Methodology and Assumptions include an assumption that the Offset for Claims-Over will not apply. Non-Settling States Reduction. For the reasons described above under “— Initial Payments,” the Non-Settling States Reduction was not applied to the Strategic Contribution Fund Payments. Subsequent Participating Manufacturers. The Collection Methodology and Assumptions assume that the relative market share of the SPMs remains constant at 4.5%. Because the 4.5% market share is greater than 3.125% (125% of 2.5%, the SPM’s estimated 1997 market share), Collection Methodology and Assumptions assume that the SPMs will be required to make Strategic Contribution Fund Payments in each year. Allocation Percentage for the Virgin Islands. The amount of Strategic Contribution Fund Payments, after application of the Inflation Adjustment, the Volume Adjustment and the Previously-Settled States Reduction for each year was multiplied by the Allocation Percentage for the Virgin Islands (0.1800232%) in order to determine he amount of Strategic Contribution Fund Payments to be made by the PMs in each year to be allocated to the United States Virgin Islands State-Specific Account. -67- The following table shows the projection of Strategic Contribution Fund Payments and total payments (including Annual Payments and Initial Payments) to be received by the Indenture Trustee through the year 2031, calculated in accordance with the Collection Methodology and Assumptions. - 68 - - 69 - SSOLER | — SSOLTH I HCeCOORTO oe - 7 — ee _ 80 Sc/F0- tPE LOR | ttl Los | Yer COORTO OOO OOO BOE EEC OOO OOO ONT RFC OLOC/Sc/FO crs dll ces TLi | yc cOORTO OOO'O0O' LEO 9ET OODO'OQOOSO'CST OcOC/Sc/P0 Os Stl t OSFSEL'I Yer cOOs LO OOO ODOT FLY OFT OOO DOOOL E'S ST ScOC/Sc/t0 960 cCL I 966° TCL I Yer cVOk TO OOO'O0996C FECT 000°000°068'68T LeOc/sc/t0 Z00°869' | TOO'869' | ; 8 eETOOBTO a OOOOOI EOL RET —_ OOM OOO OFO"EIT, _9OT/ST/PO SLPeLol Slrelo'l HEXCOOBUO 000°008'S86°1SC 000°000°0L0°89C ScOc/Sc/P0 LOV6r9'| LO 6P9'| YHECCOOR UO OOOOOCT CFO SST 000000 O8T'CLE FCOC/S C/O 8O8°9T9 | 80899" | HTETOORTO QOOOOT REO 6ST OOOO OES 9LT ecOC/Sc/FO cor F09 | COP FO9'T HWELTOORLO OOOO CIC F9T OOD O00'OE FEST ccOc/sc/FO IPE eRe [PE ess HELTOOR UO oe OOO'OOO'SO9'89T ——--_ OOD'OON'OSL's8ccOC/Sc/F0. COLLIS | COL TIS | *HEECOUSTO NOOOOC SFE ELE O00 O0O'O8S°06T OCOC/SC/FO rSO'CES | rSOTHS I BHEECOORL'O OOO OOP S89°LLT 0000000 LF S67 OL0C/Sc/F0 OLS ICS | ors 1cs | ATECTOOSLO OOO'OO8' TRS CRT OO0000'0C9' 00K 8LOC/Sc/tO ICOELO'’ lercLo' | 66S Ott | ae ze OLE BPO I HTETOOSTO = PES GODSIO = (HYP LLBSSS) = ELOLEP OID 000°000° 198 000000 SOF L8T OOO OOO'OSL SOE LIOC/Sc/F0 909 1 LOC __ ter oro) tL cee | _ O8L tc rS9°ST9'I HCETOOSTO LO FCO'KOG (TPL EON'STS) —OTESTILIS —_— OVO'OOD'198_ OOOO COE THE 000°000'096'01¢ 910C/Sc/b0 LEVOLET SIF YTD TE [cLeoe I 8Erec 896°CO9'I HEETOOKREO — ISL TT F068 (STI S6S' 96h) FRE LIV VTS 000°000' 198 000°000°L80°L6c OOO OOO'OSO'9T EY S1OC/ST/P0 ROL P68 825°909'| OCR'LET I COVE OIF ess | BEECWRIO O6T7TIS'OLE = (SIO'LSO'LOP) —- SOL'OIO' SRE 000°000° 198 000°000' 188° 10¢ O00 OOO'OS PITY FIOC/S C/O 680°8S8°T PCr 98s’ | SOD TLT I EL8°CC eseC9s | BEETOORL'O —-PSPRZS'89R_ (6TH'ROB'SEH) «= ERE LOL OPE 000°000° 198 000°007' FI LOe 000°000°0¢6°97E ELOC/ST/PO COL'078'T CZL'SOG'T OLO'SSTT ELE77 orl ers | BHTECOOBTO =6ESPEI'LSS = (GOK ETL Tb) BER LIC ROP 000°000°198 0ND'OO9'87L'TIE 000°000°069°TEE T1OT/ST/FO SIS 18L'T Ic@ers | POS LETT 8STCC £99 17S I BHTETOOBI'O —-BLO'BSTSPS —(LpP'BBO'LBE) = STRLPE ILE «00000198 OOO'OOS'L9O'SIE OOD OOD OLE'REE —_ L10@/Sz/P0 COL THLT RBETTS I PLE OCT | SPE Ic ercO0s T ATCTMRUO —- BIOTIN EER (TLTHO'EDE) — LR ESP SEE 000°000° 198 OOO ONT OOC ETE OOO OOO OES CFE O10c/Sc/r0 9S 9OL'T TORTOS I CET POT | 8S9 IT Pry ORF I YECHBUO — OLOLLE'CTR (ZILIe ore) If9°s0900¢ 000°000' 198 OOO'OOS'O9E BTL OOO OOO OTE 6FE 600C/Sc/P0 SPL 399°C QE IRE TS OI LEV FIT $ OLOOSE'1 $ HCETOOSTO = FLEGRG'OIS $ (LOS TRLITE $) LIF TLLIVT S OOOD'OOO 198 $ OOOOOS CS6'EEL OOO OOO OLT SSE 800C/ST/F0 los 8rll LOS BFE HTCCOOREO OOO ONT TEE OEE 000700008609" LOOC/SC/FO. RSLEET RSLEER — HTETOOT'O OOOO ETO THE = CODOOO'UPG'99E_—__ 900E/ST/FO R86 RLET S8O'81 TI HCECOOR UO OONOOT' SFOS OOO OOO ORT ELE SOOC/SC/FO LOLYOT I LOL9OV I DHTETOWREO OOO OOO FTR'9SE 000°000°009' 62L¢ POOT/STC/FO ee OST | [CORRS CICOLE HTELTOOR LO 000°009°9L9'¢9e OOO 000068 98E LOOT/ST/FO [BY POT IS 9C9' TORS SSLide $ HEC COOREO OOO VOT TREOLE O00 000 OL FFEE COOC/SC/FO. OOO OOO OTS ERE 000°000°000' 80F LOO0C/Sc/t0 aaysni yp, aaqsna yp, aajysniy, aaqjsniy aaysniy, aajsn yp, uORHRI0I1V Teqoyqns juawysn{py juawysalpy sjusuideg uoydumsuo) 38899104 aed aunjuapu] aanjuspuy aanjuapuy aanquapuy aanjuapuy aanjuapuy 9ajsnay aWINIOA uoneyuy wdaeS paisn{py-WdO uondumsuod 0} 0} 0} 0} 0} 0) aimjuapu] aseg ase.) aseg syuawkeg squaukeg syuauded syusuAeg syuawmdedg squawkeg VAaIM-RG [RIO] d189j38.1S jenuuy feniuy WdS IBIVS (RI0L, [ROL 1230, sjuautAeg [BJO], syuawAeg 9183}8.S aajsniy ainjuapuy Aq paaiaday aq 0) syuauAeY [BJO], puke puny UoNNqiyUO, 313a}e.1)5 Jo uoTpaloig Interest Earnings The Collection Methodology and Assumptions assume that the Indenture Trustee will receive ten days after January 10 in the years 2002 and 2003 the Corporation’s share of the Initial Payments owed by the OPMs. It is also assumed that the Indenture Trustee will receive ten days after April 15 the Corporation’s share of the Annual Payments owed by the PMs in 2002. and cach year thereafter. Tt is further assumed the Indenture Trustee will receive ten days after April 15 the Corporation’s share of the Strategic Contribution Fund Payments owed by the PMs in the years 2008 through 2017. Interest is assumed to be earned on the Initial Payments, Annual Payments and Strategic Contribution Fund Payments received by the Indenture Trustee at the rate of 3% per annum until the next Distribution Date. No interest earnings have been assumed on the Initial Payments, the Annual Payments and Strategic Contribution Fund Payments prior to the time they are received by the Indenture Trustee. Interest Is assumed to be earned on amounts on deposit in the Debt Service Reserve Account at the rate of 4.25% per annum. Moneys deposited in the Debt Service Reserve Account are expected to be invested in a guaranteed investment contract with Bayerische Hypo- und Vereinsbank AG. New York Branch. Amounts held under the Indenture. other than the Debt Service Reserve Account. are assumed to be invested at a rate of 3% per annum. Structuring Assumptions General The Structuring Assumptions tor the Series 2001 Bonds were applied to the forecast of Collections described above. Based on the Virgin Islands’ objectives to receive approximately $18,453.870 million in net proceeds, Principal payments were structured to produce coverage ratios consistent with the credit ratings on the Series 2001 Bonds. Each of the Term Bond Maturities is sized by developing a hypothetical schedule. “Sizing Amounts for Term Bond Maturities.” The Principal of the Term Bonds due in May 15, 2021 is equal to the sum of all Sizing Amounts for Term Bond Maturities on or before May 15, 2021 and the Principal of the Term Bonds due in May 15, 2031 is equal to the sum of all Sizing Amounts for Term Bond Maturities from May 15, 2022 through May 15, 2031. The ratings on the Term Bonds are not based upon the Corporation’s ability to make payments in accordance with the Sizing Amounts for Term Bond Maturities, rather they are based on payment of each of the Term Bond Maturities. due May 15. 2021. and May 15, 2031. respectively. As used herein, “Serial Maturity/Sizing Amounts for Term Bond Maturities debt service coverage ratio” means, for any period. a fraction, expressed as a multiple. the numerator of which is the amount of Collections received in such period less (-) Operating Expenses, and the denominator of which is the sum of interest. Serial Maturities and the Sizing Amounts for Term Bond Maturities in such period. The Structuring Assumptions are described below: Sizing. The Corporation’s objective in issuing the Series 2001 Bonds is to receive net proceeds in an amount of $18,453,870 to enable the Corporation to, among other things. make funds available to the Government for the financing of the Capital Projects. Debt Service Reserve Account. The Debt Service Reserve Account was established for the Series 2001 Bonds with an initial deposit of $1,745,506. The Debt Service Reserve Account must be maintained, to the extent of available funds, at the least of (1) the initial deposit therein, plus any retained earnings therein, (ii) the amount of $2,352,750 and (ii) the principal amount of Bonds Outstanding on the date of calculation. All earnings on amounts in the Debt Service Reserve Account will be retained therein until the amount therein is equal to $2,352,750. Debt Service Coverage Ratios. The debt service coverage ratios were targeted differently for each Serial Bond Maturity and each Term Bond Maturity, with average and minimum debt service coverage ratios as described under * Principal of the Series 2001 Bonds” below. Operating Expense Assumptions. Operating expenses of the Corporation have been assumed at the Operating Cap of $50,000 upon delivery of the Series 2001 Bonds and inflated at 3.00% per year. No arbitrage -70- rebate expense was assumed since it has been assumed that the yield on the Corporation investments will not exceed the yield on the Series 2001 Bonds. No Parity Payments, Priority Payments or Junior Payments have been assumed. Issuance Date. The Series 2001 Bonds were assumed to be issued on November 20, 2001. Interest Rates. The Series 2001 Bonds were assumed to bear interest at the rates set forth on the inside cover hereof. Principal Amortization. Principal amortization for the Series 2001 Bonds was structured differently for the Series 2001 Serial Bonds and the Series 2001 Term Bonds, as described below. Principal of the Series 2001 Bonds. The Principal payments for the 2001 Bonds were structured to repay the Series 2001 Bonds in the aggregate within 15 years from the date of issuance of such Series 2001 Bonds and to achieve Serial Maturity/Sizing Amounts for Term Bond Maturities debt service coverage ratios consistent with the credit ratings of the Series 2001 Bonds, taking into account the amount of Collections projected (based on the DRI*WEFA Base Case Forecast) and the Structuring Assumptions. The Serial Maturities and the Sizing Amounts for Term Bond Maturities were determined by targeting an average Serial Maturity/Sizing Amounts for Term Bond Maturities debt service coverage ratio of 1.43x, with a minimum Serial Maturity/Sizing Amounts for Term Bond Maturities debt service coverage ratio in any full year of 1.27x. Failure to pay Principal of the Series 2001 Bonds due as of any applicable Maturity Date will constitute an Event of Default. Sizing Amounts for Term Bond Maturities are used solely for sizing Term Bond Maturities and are not terms of the Bonds and thus failure to make payments in such amounts and on such dates as set forth in Schedule below in such amounts will not constitute an Event of Default. The rating assigned to the Series 2001 Bonds by the Rating Agency addresses only such Rating Agency’s assessment of the ability of the Corporation to pay interest when due and to pay Principal on the Series 2001 Bonds. Money on deposit in the Debt Service Reserve Account will be available to pay interest and Principal on the Series 2001 Bonds if money in the Debt Service Account is insufficient for such purpose. The denominator does not include Turbo Redemptions from Surplus Collections and Principal payments are based on the assumption that no such Turbo Redemptions will occur. Set forth below is a schedule showing estimated Serial Maturities, the Sizing Amounts for Term Bond Maturities for the Series 2001 Bonds and the resulting estimated Serial Maturity/Sizing Amounts for Term Bond Maturities debt service coverage ratios, assuming that Collections are received in accordance with the Collection Methodology and Assumptions, and that no Principal is paid in advance of the schedule of Serial Maturities and the Sizing Amounts for Term Bond Maturities, as described above under “Structuring Assumptions.” -71- Schedule of Serial Maturities and Sizing Amounts for Term Bond Maturities Serial Maturities/Sizing Sizing Amounts for Total Amounts Term Bond Date Average Serial for Related Total Debt Maturities DS Nov. 15 Funds (a) Balance Maturities © Maturities (b) Interest Service (c) Coverage Ratio 2001 $23.685.000 2002 S1214.988 23,685,000 $763.003 $763.003 1.59x 2003 1.208.186 23,685,000 773,750 773.750 1.56x 2004 1.053.915 23,685,000 773.750 773,750 1.36x 2005 1.064.577 23.685 000 773.750 773.750 1.38x 2006 1.077.684 23.685.000 773,750 773.750 1.39x 2007 1.090.802 23.685.000 773.750 773.750 1.41x 2008 2.611.699 22.775.000 S 910.000 1.136.108 2.046.108 1.28x 2009 2.736.350 21.745.000 1.030.000 1.093.883 2.123.883 1.29x 2010 2.781.686 20,645,000 1.100.000 1.046.473 2.146.473 1.30x 2011 2.818947 19,480,000 1.168.000 994,928 2.159.928 1.31x 2012 2.856.273 18,215,000 1.265.000 938.089 2.203 089 1.30x 2013 2.891.556 16,880,000 1.335.000 875,671 2.210.671 1.31x 2014 2.925.787 15.475,000 1.405.000 808.524 2,213,524 1.32x 2015 2,959 383 13,905,000 S$ 1.570.000 734.500 2.304.500 1.28x 2016 2.998.653 12.205.000 1.700.000 652.750 2.352.750 1.27x 2017 3.037.799 10,515,000 1.690.000 568.000 2.258.000 1.35x 2018 1.541.725 9.885.000 630.000 $10,000 1.140.000 1.35x 2019 1.559.494 9.255.000 630.000 478.500 1.108.500 1.41x 2020 1.576.622 $8,660,000 $95.00 447.875 1.042.875 1.S1x 2021 1.595 466 8.045.000 615.000 417.625 1.032.625 1.55x 2022 1.614.113 7.385.000 660.000 385.750 1.045.750 1.54x 2023 1.633.706 6.7 10.000 675.000 352.375 1.027.375 1.59x 2024 1.653.228 6,005,000 705.000 317.875 1.022.875 1.62x 2025 1.674.616 5.245.000 760.000 281.250 1.043250 L.61x 2026 1.696.135 4.455.000 T9).000 242.500 1.032.500 1.64x_ 2027 1.718.030 3.630.000 825.000 202,125 1.027,125 1.67x 2028 1.740.322 2,790,000 840.000 160.500 1.000.500 1.74x 2029 1.763.095 1,900,000 §90.000 117,250 1.007.250 1.75x 2030 1.786.309 955.000 945,000 71.375 1.016.375 1.76x 2031 1.809.631 955.000 23.875 978.875 1.85x Total S82 10.000 $15,475,000 S17.489.552 S44.174,552 (a) Includes total payments to the Trustee plus (+) carnings on Debt Service Reserve Account (after the Debt Service Reserve Account Requirement has been satisfied) and earnings on Revenues until distributed less (-) Operating Expenses inflated at 3.00 per annum, (b) Ratings for the Series 2001 Bonds are bused on the timely payment of interest on and ultimate payments of each of the Series 2001 Bonds on their respective Maturity Dates. The amounts in the column entitled “Sizing Amounts for Term Bond Maturities” were used to determine the size of each Term Bond Maturity but are not actual terms of the Series 2001 Bonds. (c) Includes interest. Serial Maturities and Sizing Amounts tor Perm Bond Maturities. The estimated Serial Maturity/Sizing Amounts for Term Bond Maturities debt service coverage ratios shown in the table above assume that Collections are received in accordance with the Collection Methodology and Assumptions and applied, subject to the payment priorities set forth in the Indenture. to pay expenses and interest and Principal when due. The actual Serial Maturity/Sizing Amounts for Term Bond Maturities debt service coverage ratios will be higher than those shown in the above table if Collections are sufficient to pay Turbo Redemptions on each Turbo Redemption Date, as required pursuant to the Indenture. No assurance can be given, however, that sufficient Collections will be received to make Turbo Redemptions on each Distribution Date. Effect of Changes in Consumption Level on Turbo Redemptions Weighed Average Lives and Final Principal Payments. The tables below have been prepared to show the effect of changes in consumption on the weighted average lives and final principal payments on the Term Bonds. For the purpose of measuring the effect of changes in consumption level, the Series 2001 Bonds were assumed to have a weighted average coupon of 4.879% per annum. The tables are based on the Collection Methodology and Assumptions and the Structuring Assumptions, except that the annual cigarette consumption varies in each case. In addition to the DRISWEFA Base Case Forecast, several alternative cigarette consumption scenarios are presented below, including four alternative forecasts of DRI*eWEFA (the DRI*WEFA High Forecast, the DRISWEFA Low Case 1, the DRIeWEFA Low Case 2 and the DRIeWEFA Low Case 3, each as hereinafter defined) and two other consumption scenarios prepared by DRI*WEFA (assuming a 3.5% and a 4.0% annual consumption decline). In each case, if actual cigarette consumption in the United States is as forecast and assumed. and events occur as assumed by the Collection Methodology and Assumptions and the Structuring Assumptions, the final principal payments and weighted average lives (in years) of each of the Term Bonds will be as set forth in such tables. The tables presented below are for illustrative purposes only. Actual cigarette consumption in the United States cannot be definitely forecast. To the degree actual consumption varies from the alternative scenarios presented below, the weighted average lives (and final principal payment dates) for the Term Bonds will be either shorter (sooner) or longer (later) than projected below. Series 2001 Bonds Serial Maturities and Term Bonds Due 2021 and 2031 Weighted Final Average Principal Consumption Life Payment Forecast (in years) (in years) DRI*WEFA Base Case Forecast 10.3 14.5 DRI*WEFA High Forecast 10.2 14.5 DRI*WEFA Low Case 1 10.7 15.5 DRI*WEFA Low Case 2 11.1 15.5 DRI*WEFA Low Case 3 12.2 18.5 3.5% Annual Consumption Decline 11.6 17.5 4.0% Annual Consumption Decline 12.7 20.5 Term Bond with a Maturity of May 15, 2021 Weighted Final Average Principal Consumption Life Payment Forecast (in years) (in years) DRI*eWEFA Base Case Forecast 7.1 11.5 DRI*WEFA High Forecast 6.9 11.5 DRI*WEFA Low Case | 7.7 12.5 DRI*WEFA Low Case 2 8.5 13.5 DRIeWEFA Low Case 3 99 14.5 3.5 Annual Consumption Decline 8.7 14.5 4.0% Annual Consumption Decline 9.7 15.5 Term Bond With a Maturity of May 15, 2031 Weighted Final Average Principal Consumption Life Payment Forecast (in years) (in vears) DRI*¢WEFA Base Case Forecast 13.8 14.5 DRISWEFA High Forecast 13.6 14.5 DRISWEFA Low Case | 14.5 15.5 DRIeWEFA Low Case 2 14.9 15.5 DRIeWEFA Low Case 3 16.8 18.5 3.5% Annual Consumption Decline 16.2 17.5 4.0% Annual Consumption Decline 18.4 20.5 Turbo Redemptions. The tables below have been prepared to show the effect of changes in cigarette consumpuon on the estimated Turbo Redemptions with respect to the Term Bonds. The tables are based upon the same assumptions and utilize the sume alternauve DRISWERA forecasts as shown in the preceding paragraph and tables. 74 Projected Outstanding Amounts for Term Bonds with a Maturity Date of 15, 2021+ 3.5% 4.0% DRI-WEFA DRI-WEFA DRI-WEFA DRI-WEFA DRI-WEFA Annual Annual Base Case High Low Case 1 Low Case 2 Low Case 3 Consumption Consumption Date Forecast Forecast Forecast Forecast Forecast Decline Decline Settlement $7,430,000 $7,430,000 $7,430,000 $7,430,000 $7,430,000 $7,430,000 $7,430,000 $/15/2002 6,980,000 6,980,000 7,025,000 7,050,000 7,000,000 6,990,000 7,000,000 5/15/2003 6,515,000 6,510,000 6,590,000 6,645,000 6,535,000 6,535,000 6,565,000 5/15/2004 6,175,000 6,165,000 6,285,000 6,370,000 6,320,000 6,225,000 6,280,000 5/15/2005 5,815,000 5,790,000 5,960,000 6,085,000 6,145,000 5,910,000 5,995,000 5/15/2006 5,420,000 5,385,000 5,605,000 5,775,000 5,945,000 5,590,000 5,710,000 5/15/2007 4,995,000 4,945,000 5,225,000 5,445,000 5,730,000 5,255,000 5,420,000 5/15/2008 4,325,000 4,240,000 4,660,000 4,990,000 5,510,000 4,840,000 5,105,000 5/15/2009 3,585,000 3,460,000 4,040,000 4,500,000 5,260,000 4,425,000 4,810,000 5/15/2010 2,685,000 2,505,000 3,275,000 3,875,000 4,880,000 3,910,000 4,430,000 5/15/2011 1,765,000 1,530,000 2,505,000 3,265,000 4,520,000 3,445,000 4,130,000 §/15/2012 805,000 505,000 1,710,000 2,640,000 4,155,000 3,015,000 3,890,000 5/15/2013 0 0 855,000 1,975,000 3,745,000 2,595,000 3,665,000 §/15/2014 0 0 0 1,265,000 3,290,000 2,170,000 3,460,000 5/15/2015 0 0 0 0 1,305,000 260.000 1,790,000 5/15/2016 0 0 0 0 0 0 55,000 5/15/2017 0 0 0 0 0 0 0 5/15/2018 0 0 0 0 0 0 0 5/15/2019 0 0 0 0 0 0 0 5/15/2020 0 0 0 0 0 0 0 5/15/2021 0 0 0 0 0 0 0 5/15/2022 0 0 0 0 0 0 0 §/15/2023 0 0 0 0 0 0 0 5/15/2024 0 0 0 0 0 0 0 5/15/2025 0 0 0 0 0 0 0 5/15/2026 0 0 0 0 0 0 0 5/15/2027 0 0 0 0 0 0 0 5/15/2028 0 0 0 0 0 0 0 5/15/2029 0 0 0 0 0 0 0 5/15/2030 0 0 0 0 0 0 0 5/15/2031 0 0 0 0 0 0 0 5/15/2032 0 0 0 0 0 0 0 5/15/2033 0 0 0 0 0 0 0 §/15/2034 0 0 0 0 0 0 0 5/15/2035 0 0 0 0 0 0 0 * — Outstanding amounts represent principal balances after the application of Collections to Principal and Turbo Redemptions on the referenced date. 75 Projected Outstanding Amounts for Term Bonds with a Maturity Date of May 15, 2031+ 3.5% 4.0% DRI-WEFA DRIEWEFA DRIEWEFA DRI-WEFA DRI-WEFA Annual Annual Base Case Low Case 1 Low Case 2 Low Case 3 High Consumption Consumption Date Forecast Forecast Forecast Forecast Forecast Decline Decline Settlement $8,045,000 S#,045,000 Ss8.045,000 $8,045,000 $8,045,000 $8,045,000 $8,045,000 O5 4/15/2002 8,045,000 8,045,000 \ 45,000 SAM45,000 8,045,000 8,045,000 8,045,000 Ny O8/ 15/2003 8,045,000 S045, 000 45,000 8,045,000 8,045,000 8,045,000 8,045,000 05/15/2004 8,045,000 8,045,000 hy 45,000 8,045,000 8,045,000 8,045,000 8,045,000 05/15; 2005 8,045,000 8,045,000 \ 145,000 8,045,000 & 045,000 8,045,000 8,045,000 05/15, 2006 8,045,000 8,045,000 ny 45,000 S045 ,000 $045,000 8,045,000 8,045,000 2007 8,045,000 S.045,000 8,045,000 8 045,000 8,045,000 8,045,000 8,045,000 OS/15/ 2008 8,045,000 &,045,000 8,045,000 §.045,000 8,045,000 8,045,000 8,045,000 O5/13/ 2009 8,045,000 & 045,000 S045 ,000 8,045,000 8,045,000 8,045,000 8,045,000 2010 O5/15, 8,045,000 § 045,000 8,045,000 8,045,000 $045,000 8,045,000 8,045,000 05/15/2011 8,045,000 8,045,000 8,045,000 $8,045,000 $8,045,000 8,045,000 8,045,000 05/15/2012 8,045,000 8,045,000 S,045,000 $045,000 §,045,000 8,045,000 8,045,000 05/15/2013 7,815,000 7 433,000 8,045,000 S.045,000 8,045,000 8,045,000 8,045,000 05/15/2014 6,690,000 6,230,000 7,975,000 8,045,000 $8,045,000 8,045,000 8,045,000 05/15/2015 3,980,000 3 440,000 5,475,000 7 070,000 8,045,000 $045,000 8,045,000 05/15/2016 is) 0 2,845,000 4.690000 7,235,000 6,310,000 &,045,000 05/15/2017 0 } 0 a) 4,970,000 4,230,000 6,300,000 05/15/2018 0 ) 0 a) 3,915,000 3,263,000 5,545,000 05/15/2019 Q ) ( {} 2 765,000 Q 4,740,000 QS 15/2020 QO 0] (i i) 0 Q 3,905,000 Q5 QO Q ( () ie) 0 15/2021 3,045,000 O5 15/2022 a QO (i () 0 QO e) () } (1 () O Oa 15/2023 0 0 05 15/2024 Q iy {1 i] 0 0 0 th a5 15/2025 0 ( i 0 0 ) O05 15/2026 {) t} ( () ) 0 Q 05 thy 2027 () ( ( i 0 0 Q Q5 15/2028 i) a (1 0 0 0 0 a5 15/2029 () () (1 ) is) 0 0 Q5 15/2030 () t) {i 1) 0 Q 0 05 15/203] Q (t (1 0 0 0 G ) (} (i is] 0 O5 15/2032 0 Q 05 15/2033 ) (I (1 ) 0 QO 0 th QS 15/2034 {) () 1) 0 0 0 O05 15/2038 i th {) {) 0 i) ie) * Outstanding amounts represent pripcipal balances after the application of Collections to Principal and Turbo Redemptions on the referenced date 76 Explanation of Alternative DRI*WEFA Forecast. The alternative DRI*eWEFA forecast of cigarette consumption decline are based upon the methodology described below. See also “DRI*\WEFA REPORT” and Appendix A. DRIeWEFA’s high forecast of consumption (the “DRI*eWEFA High Forecast”) deviates from the Base Case Forecast by assuming a lower price forecast, under which prices are increasing at an annual rate 0.5% more slowly than the Base Case Forecast. Under the DRI*WEFA High Forecast, the average annual rate of decline in cigarette consumption is moderated slightly, from an average annual rate in the Base Case Forecast of 1.74%, to 1.58%. DRI*WEFA’s low forecast of consumption (the “DRI*eWEFA Low Case 1”) deviates from the Base Case Forecast by assuming a sharper price elasticity of demand. The DRI*eWEFA Base Case Forecast applied a price elasticity of demand of -0.31. However, in order to develop the lowest consumption forecast that DRIeWEFA believed may be reasonably anticipated, a price elasticity of -0.40 was applied. Under the DRIeWEFA Low Case 1. the average rate of decline in cigarette consumption increased to 1.97%. Under the Base Case Forecast, the rate of decline was 1.74%, Although beyond the range of DRI*WEFA’s reasonably anticipated decline in consumption, DRIeWEFA also prepared an alternative low case (the “DRI*WEFA Low Case 2”) that deviated trom the Base Case Forecast by assuming a price elasticity of demand of -0.50. This produces a decline in consumption of an average annual rate of 2.23%. DRI*WEFA prepared another alternative low case (the “DRI*WEFA Low Case 3”) that deviated from the Base Case Forecast by assuming an adverse federal government settlement and tort claims of three times the size of the MSA, resulting in an immediate real price increase of 57% and a decline in consumption of 17.7% over two years. Despite the higher prices, this scenario would result in higher consumption than in the DRI*WEFA Low Case 2, using the estimated price elasticity of -0.31. Under the DRIeWEFA Low Case 3, the average annual rate of decline in cigarette consumption would be 2.13%, compared to the Base Case Forecast of 1.74%. Finally, for comparative purposes DRI*eWEFA calculated the value of total cigarette consumption under two alternative annual rates of decline, 3.5% and 4.0%. DRI*WEFA states that at 3.5% per year consumption falls to 144 billion by 2031 and at 4.0% it falls to 123 billion by 2031. Average Annual Rate of Consumption Decline DRI*WEFA DRIeWEFA DRIeWEFA DRIeWEFA DRIeWEFA Base Case Forecast High Forecast Low Case 1 Low Case 2 Low Case 3 1.79% 1.64% 2.06% 2.35% 2.35% No assurance can be given that actual cigarette consumption in the United States during the term of the Series 2001 Bonds will be as assumed, or that the other assumptions underlying the Collection Methodology and Assumptions and Structuring Assumptions, including that certain adjustments and offsets will not apply to payments due under the MSA, will be consistent with future events. If actual events deviate from one or more of the assumptions underlying the Collection Methodology and Assumptions or Structuring Assumptions, the amount of Collections available to pay the Principal of and interest on the Series 2001 Bonds (and, accordingly, of Surplus Collections to make Turbo Redemptions of the Term Bonds) could be adversely affected. See “RISK FACTORS” herein. 77 SUMMARIES OF CERTAIN PROVISIONS OF THE TRANSACTION DOCUMENTS Certain Definitions In addition to the other terms defined in this Offering Circular, when used in the summaries of certain provisions of the Indenture and the Purchase Agreement, the following terms have the meanings ascribed to them below: “Accounts” means the accounts in the Collection Account, the Operating Account, the Debt Service Account, the Debt Service Reserve Account, the Extraordinary Payment Account, the Turbo Redemption Account, the Costs of Issuance Account. the NPM Adjustment Reserve Account, the Rebate Account and any accounts established by Series Supplement, all of which shall be segregated trust accounts established and held by the Indenture Trustee. ‘“Accreted Value” means with respect to any Bond and as of any particular date of computation the Accreted Value of such Bond for such date as specified by the Series Supplement relating to such Bond. “Ancillary Contracts” means contracts entered into by the Corporation or for its benefit or for the benefit of any of the Beneficiaries to facilitate the issuance, sale, resale, purchase, repurchase or payment of Bonds, including bond insurance, letters of credit and liquidity facilities and forward delivery agreements with respect to Eligible Investments, but excluding Swap Contracts. “Authorized Officer” or “Responsible Officer” means, (i) in the case of the Corporation, the President, any Vice President or the Treasurer, their successors in office, and any other person authorized to act hereunder by appropriate Written Notice to the Trustee, (ii) in the case of the Trustee, any officer assigned to the Corporate Trust Office, including any managing director, director, vice president, assistant vice president, associate, assistant secretary or any other officer of the Trustee customarily performing functions similar to those performed by any of the above designated officers and having direct responsibility for the administration of this Indenture. and also, with respect to a particular matter, any other officer, to whom such matter is referred because of such officer's knowledge of and familiarity with the particular subject. and (iii) in the case of the U.S. Virgin Islands Public Finance Authority, any officer thereof and any other person authorized to act by appropriate Written Notice to the Trustee. “Beneficiaries” means Bondholders, and, to the extent specified, the parties to Swap Contracts and Ancillary Contracts. “Bondholders” or “Holders” and similar terms mean the registered owners of the Bonds registered as to principal and interest or as to principal only, as shown on the books of the Trustee. “Bonds” means all obligations issued as Bonds pursuant to the Indenture. “Business Day” means any day other than (1) a Saturday or a Sunday or (ii) a day on which banking institutions in New York, New York are required or authorized by law to be closed. “Code” means the Internal Revenue Code of 1986, as amended. and the regulations promulgated thereunder. “Collections” means the TSRs and all fees, charges, payments, investment earnings and other income and receipts (including Bond proceeds but only to the extent deposited in an Account) paid or payable to the Corporation or the Trustee for the account of the Corporation or the Beneficiaries. “Counsel” means nationally recognized bond counsel or such other counsel as may be selected by the Corporation for a specific purpose. “Default” means an Event of Default without regard to any declaration. notice or lapse of time. 78 “Defeasance Collateral” means money and any of the following: (a) (b) (c) (d) non-callable direct obligations of the United States of America, non-callable and non-prepayable direct federal agency obligations the timely payment of principal of and interest on which are fully and unconditionally guaranteed by the United States of America, non-callable direct obligations of the United States of America which have been stripped by the United States Treasury itself or by any Federal Reserve Bank (not including “CATS,” “TIGRS” and “TRS” unless the Corporation obtains Rating Confirmation with respect thereto) and the interest components of REFCORP bonds for which the underlying bond is non-callable (or non-callable before the due date of such interest component) for which separation of principal and interest is made by request to the Federal Reserve Bank of New York in book-entry form, and shall exclude investments in mutual funds and unit investment trusts; non-callable obligations timely maturing and bearing interest (but only to the extent that the full faith and credit of the United States of America are pledged to the timely payment thereof); certificates rated in one of the two highest long-term rating categories by S&P, Moody’s and Fitch (if rated by Fitch) evidencing ownership of the right to the payment of the principal of and interest on obligations described in clause (b), provided that such obligations are held in the custody of a bank or trust company satisfactory to the Indenture Trustee in a segregated trust account in the trust department separate from the general assets of such custodian; and bonds or other obligations of any state of the United States of America or of any agency, instrumentality or local governmental unit of any such state (i) which are not callable at the option of the obligor or otherwise prior to maturity or as to which irrevocable notice has been given by the obligor to call such bonds or obligations on the date specified in the notice, (ii) timely payment of which is fully secured by a fund consisting only of cash or obligations of the character described in clause (a), (b) or (c) which fund may be applied only to the payment when due of such bonds or other obligations and (iii) rated “AAA” by S&P and in one of the two highest long- term rating categories by Moody’s and Fitch (if rated by Fitch). “Defeased Bonds” means Bonds that remain in the hands of their Holders. but are deemed no longer Outstanding. “Distribution Date” means (i) each May 15 and November 15, or if such date is not a Business Day, the following Business Day; (ii) each additional Distribution Date selected by the Corporation or the Indenture Trustee following an Event of Default; and (iii) each Distribution Date to the extent so identified in a Series Supplement. “Eligible Investments” means any of the following: (a) (b) (c) (d) Defeasance Collateral; direct obligations of, or obligations guaranteed as to timely payment of principal and interest by FHLMC or the Federal Farm Credit System; demand and time deposits in or certificates of deposit of, or bankers” acceptances issued by, any bank or trust company, savings and loan association or savings bank. payable on demand or on a specified date no more than three months after the date of issuance thereof, if such deposits or instruments are rated “F-1” by Fitch (if rated by Fitch), “A-1+” by S&P and “P—1” by Moody’s; general obligations of, or obligations guaranteed by, any state of the United States, territory or possession thereof, the District of Columbia or any political subdivision of any of the foregoing rated at least “Aal” by Moody’s and receiving one of the two highest long-term unsecured debt ratings available for such securities from S&P and Fitch (if rated by Fitch): 79 (g) (h) (i) commercial or finance company paper (including both non-interest-bearing discount obligations and interest bearing obligations payable on demand or on a specified date not more than 270 days after the date of issuance thereof) that is rated “F-1" by Fitch (if rated by Fitch), “A-1+" by S&P and “P-1" by Moody's: repurchase obligations with respect to any security described in clause (a), (b), (d) or (e) above entered into with a primary dealer. depository institution or trust company (acting as principal) rated “F-1" by Fitch (if rated by Fitch), “A—1+" by S&P and “P—1” by Moody’s (if payable on demand or on a specified date no more than three months after the date of issuance thereof) or rated at least "Aal” by Moody's and in one of the two highest long-term rating categories by S&P and Fitch (if rated by Fitch) or collateralized by securities described in clause (a), (b), (d) or (e) above with any registered broker/dealer or with any domestic commercial bank whose long-term debt obligations are rated “investment grade” by each Rating Agency. provided that (1) a specific written agreement governs the transaction, (2) the securities are held, free and clear of any lien, by the Indenture Trustee or an independent third party acting solely as agent for the Indenture Trustee. and such third party is (a) a Federal Reserve Bank, or (b) a member of the Federal Deposit Insurance Corporation that has combined surplus and undivided profits of not less than $25 million, and the Indenture Trustee shall have received written confirmation from such third party that it holds such securities, free and clear of any lien, as agent for the Indenture Trustee, (3) the agreement has a term of thirty days or less, or the Trustee will value the collateral securities no less frequently than monthly and will liquidate the collateral securities if any deficiency in the required collateral percentage is not restored within five Business Days of such valuation and (4) the fair market value of the collateral securities in relation to the amount of the obligation, including principal and interest. is equal to at least 102%; securities bearing interest or sold at a discount (payable on demand or on a specified date no more than 270 days after the date of issuance thereof) that are issued by any corporation incorporated under the laws of the United States of America or any state thereof and rated “F-1” by Fitch (if rated by Fitch), “P-1~ by Moody’s and “A-1+" by S&P at the time of such investment or contractual commitment providing for such investment: units of taxable money market funds which funds are regulated investment companies and seek to maintain a constant net asset value per share and have been rated at least “Aal” by Moody’s, in one of the two highest categories by Fitch (if rated by Fitch) and at least *Aam” or “AAm-G” by S&P. including if so rated any such fund which the Indenture Trustee or an affiliate of the Indenture Trustee serves as an investment advisor, administrator, shareholder, servicing agent and/or custodian or sub-custodian. notwithstanding that (1) the Indenture Trustee or an affiliate of the Indenture Trustee charges and collects fees and expenses (not exceeding current income) from such funds for services rendered, (2) the Indenture Trustee charges and collects fees and expenses for services rendered pursuant to the Indenture, and (3) services performed for such funds and pursuant to the Indenture may converge at any time (the Corporation specifically authorizes the Indenture Trustee or an affiliate of the Indenture Trustee to charge and collect all fees and expenses from such funds for services rendered to such funds, in addition to any fees and expenses the Indenture Trustee may charge and collect for services rendered pursuant to the Indenture), investment agreements or guaranteed investment contracts rated, or with any financial institution or corporation whose senior long-term debt obligations are rated, or guaranteed by a financial institution whose senior long-term debt obligations are rated. at the time such agreement or contract is entered into, at least “F-1" by Fitch (if then rated by Fitch), “Aal” by Moody’s and in one of the two highest long-term rating categories by S&P if the Corporation has an option to terminate such agreement in the event that any such rating is either withdrawn or downgraded below the rating on the Bonds, or if not so rated, then collateralized by securities described in clause (a), (b), (d) or (e) above with any registered broker/dealer or with any domestic commercial bank whose long-term debt obligations are rated “investment grade” by each Rating Agency, provided that (1) a specific written agreement governs the transaction, (2) the securities are held, 80 free and clear of any lien, by the Indenture Trustee or an independent third party acting solely as agent for the Indenture Trustee, and such third party is (A) a Federal Reserve Bank, or (B) a member of the Federal Deposit Insurance Corporation that has combined surplus and undivided profits of not less than $25 million, and the Indenture Trustee shall have received written confirmation from such third party that it holds such securities, free and clear of any lien, as agent for the Indenture Trustee, (3) the agreement has a term of thirty days or less, or the Trustee will value the collateral securities no less frequently than monthly and will liquidate the collateral securities if any deficiency in the required collateral percentage is not restored within seven Business Days of such valuation and (4) the fair market value of the collateral securities in relation to the amount of the obligation, including principal and interest, is equal to at least 102%; and (j) other obligations, securities agreements or contracts that are non-callable and that are acceptable to each Rating Agency; provided, however, that no Eligible Investment may (i) except for Defeasance Collateral, evidence the right to receive only interest with respect to the obligations underlying such instrument or (ii) be purchased at a price greater than par if such instrument may be prepaid or called at a price less than its purchase price prior to its stated maturity. “FHLMC” means the Federal Home Loan Mortgage Corporation. “Fiduciary” means the Indenture Trustee, any representative of the Holders of Bonds appointed by Series Supplement, and each Paying Agent, if any. “Financing Costs” means (i) all costs, fees, credit and liquidity enhancements, legal fees, financial advisory fees, transaction structuring and underwriting fees, costs of issuance and other expenses of any kind whatsoever of the Corporation, or, to the extent agreed by the Corporation in the Purchase Agreement, of the Virgin Islands and the Financing Authority, and (ii) the funding of reserve funds and other funds pledged to the Indenture Trustee from the proceeds of the Series 2001 Bonds (other than capitalized interest, if any) and (iii) the funding of initial operating expenses of the Corporation. “Junior Payments” means (i) termination payments on Swap Contracts and any other payments thereon in excess of the applicable Maximum Rate, (ii) Bond principal payable under term-out provisions of Ancillary Contracts, (iii) other amounts due under Ancillary Contracts and not payable as Priority Payments or Debt Service, (iv) purchase price of Bonds, and (v) Junior Payments so identified in or by reference to the Indenture. “Lien” means a security interest, lien, charge, pledge, equity or encumbrance of any kind, attaching to the interests of the Virgin Islands in and to the Tobacco Assets. “Majority in Interest” means as of any particular date of calculation, the Holders of a majority of the Outstanding Bonds eligible to act on a matter, measured by the then Accreted Value of Outstanding Bonds for which an Accreted Value for such date has been specified in a Series Supplement relating to such Bond and by the amount of Principal payable at maturity of all other Outstanding Bonds. “Maximum Rate” means (i) the highest rate payable on a Bond to Holders other than parties to Ancillary Contracts, as specified by Series Supplement or (ii) the rate specified by Series Supplement as the Maximum Rate on a Swap. “Operating Cap” means $50,000 in the Fiscal Year ending September 30, 2002, inflated in each following Fiscal Year by the Inflation Adjustment (as defined in the MSA) applicable pursuant to the MSA to the calendar year ending in such Fiscal Year, plus arbitrage rebate and penalties specified by Officer’s Certificate. “Operating Expenses” means all expenses incurred by the Corporation in connection with the Bonds, including but not limited to, the cost of preparation of accounting and other reports, costs of maintenance of ratings on the Bonds, arbitrage rebate and penalties, salaries, administrative expenses, insurance premiums, auditing and legal expenses, fees and expenses incurred for the Trustee, any Paying Agents, professional consultants and 81 fiduciaries, costs incurred to preserve the tax-exempt status of any Tax-Exempt Bonds. costs related to. the Corporation’s or the Trustee’s enforcement rights with respect to the Indenture or the Bonds and all Operating Expenses so identified in the Indenture. “Opinion of Counsel” means one or more written opinions of counsel who may be an employee of or counsel to the Virgin Islands. which counsel shall be acceptable to the Indenture Trustee. “Outstanding Bonds” means Bonds issued under the Indenture, excluding: (i) Bonds that have been exchanged or replaced. or delivered to the Indenture Trustee for credit against a principal payment: (ii) Bonds that have been paid: (ii) Bonds that have become due and for the payment of which money has been duly provided: (iv) Bonds tor which (A) there has been irrevocably set aside sufficient Defeasance Collateral timely maturing and bearing interest, to pay or redeem them and (B) any required notice of redemption shall have been duly given in accordance with the Indenture or irrevocable instructions to give notice shall have been given to the Indenture Trustee; (v) Bonds the payment of which will have been provided for pursuant to Section 2.02 of the Indenture: and (vi) for purposes of any consent or other action to be taken by the Holders of a Majority in Interest or specified percentage of Bonds under the Indenture. Bonds held by or for the account of the Corporation, the Virgin Islands or any person controlling, controled by or under common control with either of them. For the purposes of this detinition, “control.” when used with respect to any specified person, means the power to direct the management and policies of such person. directly or indirectly, whether through the ownership of voting securities, by contract or otherwise, and the terms “controlling” and “controlled” have meanings correlative to the foregoing. “Parity Payments” means payments under Swaps not to exceed the applicable Maximum Rate, but does not include any payments under Ancillary Contracts. “Permitted Indebtedness” means Bonds and borrowings to pay Operating Expenses as described in Section 5.01 of the Indenture and bonds or other obligations payable solely from specified assets of the Corporation not subject to the lien of the Indenture and the holders of which expressly have no recourse to any other assets of the Corporation in the event of non-payment. “Priority Payments” means tees payable pursuant to Ancillary Contracts that are identified by a Series Supplement as Priority Payments, which shall not include payments of or in lieu of interest, Principal, redemption price or purchase price of Bonds. “Purchase Consideration” means the consideration required to be given to the Virgin Islands as set forth in accordance with the provisions of the Purchase Agreement summarized herein under the caption “Purchase Consideration.” “Rated Swap” means a Swap Contract if the counterparty is limited to entities (1) the debt securities of which are rated at least “Aal” by Moody's and in one of the two highest long-term debt rating categories by S&P and Fitch af rated by Fitch) or (2) the obligations of which under the Swap Contract are either so rated or guaranteed or insured by an entity the debt securities or insurance policies of which are so rated or (3) the debt securities of which are rated in the third highest long-term debt rating category by Moody's, S&P and Fitch (if rated by Fitch) or whose obligations are guaranteed or insured by an entity so rated. in either case the obligations of which under the contract are continuously and fully secured by Eligible Investments meeting criteria provided by the Rating Agencies to the Corporation and then in effect. “Record Date” means the last Business Day of the month preceding a Distribution Date. or such other date as may be specified by the Indenture or an Officer's Certificate: and the Corporation or the Indenture Trustee may in its discretion establish special record dates for the determination of the Holders of Bonds for various purposes thereof, including giving consent or direction to the Indenture Trustee. “Semiannual Period” means (i) with respect to Initial Payments (as defined in the MSA) and other Collections received in January, February and March, each six-month period beginning February | or August 1, and (ii) with respect to all other Collections, cach six-month period beginning May 15 or November 15. 82 “Series 2001 Bonds” means the Corporation’s $21,709,862 aggregate initial principal amount Tobacco Settlement Asset-Backed Bonds, Series 2001, initially dated November 1, 2001, including any Bonds issued in exchange or replacement therefor. “Swap” or “Swap Contract” means an interest rate exchange, currency exchange, cap, collar, hedge or similar agreement entered into by the Corporation. “TSRs” means the Initial Payments, Annual Payments and Strategic Contribution Fund Payments (each as defined in the MSA) that are owned by and payable to the Corporation or received by the Corporation or the Trustee on behalf of the Corporation pursuant to the MSA, the Consent Decree, the Purchase Agreement and the Act and the right to receive the same. “Tobacco Assets” means all right, title and interest of the Virgin Islands in all amounts paid or payable to the Virgin Islands under the MSA, other than the amounts paid to the Virgin Islands thereunder prior to February 1, 2001, including, without limitation, the rights of the Virgin Islands to receive the money due to it in the future under the MSA and any investment income on moneys paid to the Virgin Islands under the MSA since February 1, 2001. “Tobacco Bonds” means bonds, notes and other obligations at any time issued by the Corporation under the Indenture or otherwise. “Transaction Counsel” means Buchanan Ingersoll or another nationally recognized bond counsel firm of attorneys acceptable to the Indenture Trustee. “Transaction Documents” means the Purchase Agreement, the Indenture and the Underwriting Agreement. “Underwriting Agreement” means the Purchase Contract by and between the Corporation and Salomon Smith Barney Inc., as representative, in such form as the parties thereto shall agree. The Indenture The following summary describes certain terms of the Indenture pursuant to which the Series 2001 Bonds will be issued. This summary does not purport to be complete and is subject to, and qualified in its entirety by reference to, the provisions of the Indenture and the Series 2001 Bonds. Copies of the Indenture and the Series 2001 Supplement may be obtained upon written request to the Indenture Trustee. See “SECURITY” and “THE SERIES 2001 BONDS” for further descriptions of certain terms and provisions of the Series 2001 Bonds. Directors and Virgin Islands Not Liable on Bonds. Neither the members, directors or officers of the Corporation nor any person executing Bonds or other obligations of the Corporation nor any official, employee or agent of the Corporation shall be liable personally thereon or be subject to any personal liability or accountability solely by reason of the issuance thereof. The Series 2001 Bonds and other obligations of the Corporation shall not constitute indebtedness of the Virgin Islands. The Series 2001 Bonds are neither general nor moral obligations of the Virgin Islands and are not secured by a pledge of the full faith and credit of the Corporation and holders of the Series 2001 Bonds may not require the levy or imposition of taxes. (Section 1.03) Separate Accounts and Records. The parties represent and covenant, each for itself, that: (a) the Corporation and the Indenture Trustee each will maintain its respective books, financial records and accounts (including, without limitation, inter-entity transaction accounts) in a manner so as to identify separately the assets and liabilities of each such entity; each has observed and will observe all applicable corporate or trust procedures and formalities, including, where applicable, the holding of regular periodic and special meetings of governing bodies, the recording and maintenance of minutes of such meetings and the recording and maintenance of resolutions, if any, adopted at such meetings; and all transactions and agreements between the Corporation and the Indenture Trustee have reflected and will reflect the separate legal existence of each entity and have been and will be 83 formally documented in writing: and (b) the Corporation has paid and will pay their respective liabilities and losses from their own respective separate assets. In furtherance of the foregoing. the Corporation has compensated and will compensate all consultants, independent contractors und agents from its own funds for services provided to it by such consultants, independent contractors and agents.(Section 1.04) Security and Pledge. Pursuant to the Indenture, the Corporation will assign and pledge to the Indenture Trustee in trust upon the terms of the Indenture (a) the Collections, (b) all rights to receive the Collections and the proceeds of such rights. (c) the TSRs. (d) except for the Rebate Account and the Construction Account, all Funds and Accounts and assets thereof. including money. contract rights, general intangibles or other personal property, held by the Indenture Trustee under the Indenture. (e) subject to the following sentence, all rights and interest of the Corporation under the Purchase Agreement. including the representations, warranties and covenants of the Virgin Islands in the Purchase Agreement, and (f) any and all other property of every kind and nature from time to time, by delivery or by writing of any kind, conveyed. pledged. assigned or transferred as and for additional security under the Indenture. Except as specifically provided in the Indenture, such assignment and pledge does not include: (i) the rights of the Corporation pursuant to provisions for consent or other action by the Corporation, notice to the Corporation, indemnity or the filing of documents with the Corporation, or otherwise for its benefit and not for that of the Beneficiaries, or (i) any right or power reserved to the Corporation pursuant to the Act or other law: nor does Section 2.01 of the Indenture preclude the Corporation's enforcement of its rights under and pursuant to the Purchase Agreement for the benetit of the Beneficiaries as provided in the Indenture. The proceeds of the Series 2001 Bonds, other than the $1,772,034 deposited in the Debt Service Reserve Account, the Debt Service Account. and the amounts deposited in the Operating Account. do not constitute any portion of the Tobacco Assets, are not pledged to the holders of the Series 2001 Bonds and are not subject to the lien of the Indenture. The Corporation will implement. protect and defend this assignment and pledge by all appropriate legal action, the cost thereof to be an Operating Expense. The collateral is to be pledged to secure the payment of Bonds and payments in respect of Swap Contracts and Ancillary Contracts. all with the respective priorities specified in the Indenture. The pledge and assignment made by the Indenture and the covenants and agreements to be performed by or on behalf of the Corporation shall be for the equal and ratable benefit. protection and security of the Holders of any and all of the Outstanding Bonds, all of which, regardless of the time or times of their issue or maturity, shall be of equal rank without preference. priority or distinction of such Bonds over any other Bonds except as expressly provided in the Indenture or permitted thereby. The lien of such pledge and the obligation to perform the contractual provisions in the Indenture shall have priority over any or all other obligations and liabilities of the Corporation secured by the Collections. The Corporation shall not incur any obligations, except as authorized by the Indenture, secured by a lien on the Collections, Funds or Accounts equal or prior to the Hen in the Indenture. (Section 2.01) Defeasance. When (a) there is held by or for the account of the Indenture Trustee Defeasance Collateral in such principal amounts, bearing fixed interest at such rates and with such maturities as will provide sufficient funds to pay or redeem all Outstanding Bonds in accordance with their terms and all obligations to Beneficiaries (including parties to Swap Contracts and Ancillary Contracts) in full to be verified by a nationally recognized firm of independent certified public accountants). (b) any required notice of redemption shall have been duly given in accordance with the Indenture or irrevocable instructions to give notice will have been given to the Indenture Trustee. and (c) all the rights under the Indenture of the Fiduciary have been provided for, then upon written notice from the Corporation to the Indenture Trustee. such Beneficiaries shall cease to be entitled to any benefit or security under the Indenture except the right to receive payment of the funds so held and other rights which by their nature cannot be satisfied prior to or simultaneously with termination of the lien, the security interests created by the Indenture (except in such funds and investments) shall terminate, and the Corporation and the Indenture Trustee shall execute and deliver such instruments as may be necessary to discharge the Indenture Trustee’s lien and security interests created under the Indenture and to make the TSRs payable to the Corporation. Upon such defeasance, the funds and investments required to pay or redeem the Bonds and other obligations to such Beneficiaries shall be irrevocably set aside for that purpose. subject. however, to the provisions of the Indenture, and money held for defeasance shall be invested only as provided in the provisions of the Indenture summarized above under the caption “Security and Pledge” and applied by the Indenture Trustee and other Paying Agents, if any, to the retirement of the Bonds and such other obligations. Any funds or property held by the Indenture Trustee and not required for payment in full or redemption of the Bonds and such other obligations to Beneficiaries and Fiduciaries shall be distributed to the order of the Corporation upon such indemnification, if any, as the Indenture Trustee may reasonably require. (Section 2.02) &4 Bonds of the Corporation. By Series Supplement complying procedurally and in substance with the Indenture, the Corporation may authorize, issue, sell and deliver (1) the Series 2001 Bonds and (2) other Series of Refunding Bonds from time to time in such principal amount as the Corporation shall determine but only to renew or retund Bonds by exchange. purchase, redemption or payment, and establish such escrows therefor as it may determine. See “THE SERIES 2001 BONDS.” (Section 3.01) Subsequent to the issuance of the Series 2001 Bonds, Refunding Bonds may be issued provided that the Corporation or the Trustee has received a Rating Confirmation from each Rating Agency then rating the Series 2001 Bonds or any other Series of Bonds. Accounts. There is established within the Indenture the Collection Account, Operating Account, the Debt Service Account, the Debt Service Reserve Account, the Extraordinary Prepayment Account, the Rebate Account, the Turbo Redemption Account, the Costs of Issuance Account and the NPM Adjustment Reserve Account and such other Accounts as may be established in the Bond Fund by Series Supplement or Supplemental Indenture. (Section 4.01) Swap Contracts and Ancillary Contracts. The Corporation may enter into, amend or terminate, as it determines to be necessary or appropriate, Swap Contracts or Ancillary Contracts, and may by Series Supplement provide for the payment of amounts due thereunder as Junior Payments or, to the extent permitted under the Indenture, as Parity Payments or Priority Payments. (Section 4.05) Redemption of the Bonds. The Corporation may redeem Bonds at its option in accordance with their terms and, subject to provisions in the Indenture summarized herein under the caption “SECURITY — Flow of Funds” will redeem Bonds in accordance with their terms pursuant to any mandatory redemption (“sinking fund”) requirements established by the Series Supplement. When Bonds are called for redemption, the accrued interest thereon shall become due on the redemption date. To the extent not otherwise provided, the Corporation shall deposit with the Indenture Trustee on or prior to the redemption date a sufficient sum to pay principal. redemption premium, if any, and accrued interest. Unless otherwise specified by Series Supplement. there shall, at the option of the Corporation, be applied to or credited against any sinking fund requirement the principal amount of any Bonds subject to redemption therefrom that have been defeased, purchased, or redeemed and not previously so applied or credited. When a Bond is to be redeemed prior to its Maturity Date, the Trustee shall give notice in the name of the Corporation, which notice shall identify the Bonds to be redeemed, state the date fixed for redemption and state that such Bonds will be redeemed at the corporate trust office of the Trustee or a Paying Agent. The notice shall further state that on such date there shall become due and payable upon each Bond to be redeemed the redemption price thereof, together with interest accrued to the redemption date, and that money therefor having been deposited with the Trustee or the Paying Agent on or prior to the redemption date, from and after such date, interest thereon shall cease to accrue. The Trustee shall give 30 days’ notice by mail, or otherwise transmit the redemption notice in accordance with any appropriate provisions hereof, to the registered owners of any Bonds which are to be redeemed, at their address shown on the registration books of the Corporation. Such notice may be waived by any Holder of Bonds to be redeemed. Failure by a particular Holder to receive notice, or any defect in the notice to such Holder, shall not affect the redemption of any other Bond. Any notice of redemption given pursuant to this Indenture may be rescinded by Written Notice by the Corporation to the Trustee no later than 5 days prior to the date specified for redemption. Any notice of redemption given pursuant to this Indenture may be rescinded by Written Notice by the Corporation to the Trustee no later than 5 days prior to the date specified for redemption. The Trustee shall give notice of such recission as soon thereafter as practicable in the same manner and to the same persons, as notice of such redemption was given as described above. Unless otherwise specified by Series Supplement: (i) if less than all the Outstanding Bonds of like Series, and Maturity Date are to be redeemed, the particular Bonds to be redeemed will be selected by the Indenture Trustee by such method as it will deem fair and appropriate and which may provide for the selection for redemption of portions (equal to any authorized denominations) of the principal of Bonds of a denomination larger than the 85 minimum authorized denomination, and (ii) the Indenture Trustee will redeem any and all Bonds held by the provider of an Ancillary Contract prior to any other Bonds redeemed under the Indenture unless otherwise directed by an officer’s certificate of the Corporation. (Section 4.06) The Bonds are subject to mandatory redemption (each a “Lump Sum Prepayment”) at par plus accrued interest to the date of redemption at any time upon receipt by the Trustee of a Lump Sum Payment. Each Lump Sum Prepayment shall be allocated after the payment of certain expenses and all current and past due interest on the Bonds to the pro-rata redemption of Outstanding Bonds. The Bonds are subject to mandatory redemption in full at par from moneys withdrawn from the Debt Service Reserve Account pursuant to the final paragraph of Section 4.03(a) of the Indenture on the Distribution Date specified therein. The Term Bonds are subject to special mandatory redemption on each Distribution Date at a redemption price equal to 100% of the principal amount of the Term Bonds to be redeemed plus accrued interest thereon to the date fixed for redemption, without premium, from Surplus Collections on deposit in the Turbo Redemption Account. Any redemptions of Term Bonds pursuant to Section 4.06(g) of the Indenture shall redeem the Term Bonds in order of Maturity Dates and pro rata among Bonds within a maturity. Any redemptions of Bonds (other than the Series 2001 Bonds) pursuant to this subsection shall be as specified by the applicable Series Supplement. Investments. Pending its use under the Indenture, money in the Funds and Accounts may be invested by the Indenture Trustee in Eligible Investments maturing or redeemable at the option of the holder at or before the time when such money is expected to be needed and shall be so invested pursuant to written direction of the Corporation if there is not then an Event of Default actually known to an Authorized Officer of the Indenture Trustee. The Trustee may, at the direction of the Corporation, invest money in the Funds and Accounts, established under the Indenture in Defeasance Collateral. Specifically, Eligible Investments shall mature or be redeemable at the option of the Corporation on or before the Business Day preceding each next succeeding Distribution Date, except to the extent that other Eligible Investments timely mature or are so redeemable in an amount sufficient to make payments under clauses (1) through (5) of Section 4.03(b) of the Indenture on the next succeeding Distribution Date. Investments shall be held by the Indenture Trustee in the respective Funds and Accounts and shall be sold or redeemed to the extent necessary to make payments or transfers from each Fund or Account. The Indenture Trustee shall not be liable for any losses on investments made at the direction of the Corporation. On the Business Day immediately preceding each Distribution Date, the Trustee shall value the money and investments in the Debt Service Reserve Account according to the methods set forth in Section 4.07 of the Indenture. Any amounts in the Debt Service Reserve Account in excess of the Debt Service Reserve Requirement shall be applied as provided in Section 4.03 of the Indenture. In computing the amount in any Fund or Account. the value of Eligible Investments shall be determined by the Indenture Trustee at least us frequently as the Business Day preceding each Distribution Date and shall be calculated as follows: (1) As to investments the bid and asked prices of which are published on a regular basis in The Wall Street Journal (or, if not there, then in The New York Times): the average of the bid and asked prices for such investments so published on or most recently prior to such time of determination; (ii) As to investments the bid and asked prices of which are not published on a regular basis in The Wall Street Journal or The New York Times: the average bid price at such time of determination for such investments by any two nationally recognized government securities dealers (selected by the Indenture Trustee in its absolute discretion) at the time making a market in such investments or the bid price published by a nationally recognized pricing service: (iii) As to certificates of deposit and bankers acceptances: the face amount thereof, plus accrued interest; and 86 (iv) As to any investment not specified above: the value thereof estublished by prior agreement between the Corporation and the Indenture Trustee. The Indenture Trustee may hold undivided interests in Eligible Investments for more than one Fund or Account (for which they are eligible) and may make interfund transfers in kind. In respect of Defeasance Collateral held for Defeased Bonds, the provisions of the Indenture summarized under the caption “/nvestments” shall be effective only to the extent it is consistent with other applicable provisions of the Indenture or any separate escrow agreement. (Section 4.07) Rebate. (a) (b) (c) (d) (e) The Trustee shall establish and maintain when required an account separate from any other account established and maintained hereunder designated as the Rebate Account. Subject to the transfer provisions provided in paragraph (e) below, all money at any time deposited in the Rebate Account shall be held by the Trustee in trust, to the extent required to satisfy the Rebate Requirement (as defined, computed and provided to The Trustee in accordance with the Tax Certificate), for payment to the federal government of the United States of America. Neither the Corporation nor any Bondholder shall have any rights in or claim to such money. All amounts deposited into or on deposit in the Rebate Account shall be governed by Sections 4.09 and 5.03 of the Indenture and by the Tax Certificate. The Trustee shall be deemed conclusively to have complied with such provisions if it follows to such directions of the Corporation, including supplying all necessary information specified in the Tax Certificate to the extent the Trustee possesses such information in the manner provided in the Tax Certificate, and shall have no liability or responsibility to enforce compliance by the Corporation with the terms of the Tax Certificate. Upon the Corporation’s written direction, an amount shall be deposited to the Rebate Account by the Trustee from amounts on deposit in the Operating Account so that the balance in the Rebate Account shall be equal to the Rebate Requirement. Computations of the Rebate Requirement shall be furnished by or on behalf of the Corporation in accordance with the Tax Certificate. The Trustee shall supply to the Corporation all information required to be provided in the Tax Certificate to the extent such information is reasonably available to the Trustee. The Trustee shall have no obligation to rebate any amounts required to be rebated pursuant to this Section, other than from moneys held in the Operating Account or the Rebate Account created under this Indenture. At the written direction of the Corporation, the Trustee shall invest all amounts held in the Rebate Account in Eligible Investments, subject to the restrictions set forth in the Tax Certificate. Moneys shall not be transferred from the Rebate Account except as provided in paragraph (e) below. The Trustee shall not be liable for any consequences arising from such investment. Upon receipt of the Corporation’s written directions, the Trustee shall remit part or all of the balances in the Rebate Account to the United States, as directed in writing by the Corporation. In addition, if the Corporation so directs, the Trustee will deposit money into or transfer money out of the Rebate Account from or into such accounts or funds as directed by the Corporation’s written directions; provided, that only moneys in excess of the Rebate Requirement may, at the written direction of the Corporation, be transferred out of the Rebate Account to such other accounts or funds or to anyone other than the United States in satisfaction of the arbitrage rebate obligation. Any funds remaining in the Rebate Account after each five year remittance to the United States, redemption and payment of all of the bonds and payment and satisfaction of any Rebate Requirement, or provision made therefor satisfactory to the Trustee, shall be withdrawn and deposited in the Collection Account. 87 (f) Notwithstanding any other provision of this Indenture, the obligation to remit the Rebate Requirement to the United States and to comply with all other requirements of the Tax Covenants provisions of the Indenture and the Tax Certificate shall survive the defeasance or payment in full of the Bonds. Contract; Obligations to Beneficiaries. In consideration of the purchase und acceptance of any or all of the Bonds and Swap Contracts and Ancillary Contracts by those who shall hold the same from time to time, the provisions of the Indenture shall be a part of the contract of the Corporation with the Beneficiaries. The pledge made in the Indenture and the covenants set forth in the Indenture to be performed by the Corporation shall be for the equal benefit. protection and security of the Beneficiaries of the same priority. All of the Bonds or payments on Swap Contracts or Ancillary Contracts of the same priority, regardless of the time or times of their issuance or maturity, shall be of equal rank without preference. priority or distinction of any thereot over any other except as expressly provided in the Indenture. Under the Indenture. the Corporation covenants to pay when due all sums payable on the Bonds, but only from the Collections and money designated in the Indeniure, subject only to (1) the Indenture, and (i!) to the extent permitted by the Indenture, (x) agretinents with Holders of Bonds picgrty ‘particular collateral for the payment thereot and (y) the rights of Beneficiaries under Swap Contracts and Ancillary Contracts. The obligation of the Corporation to pay Principal, interest and redemption premium, if any, to the Holders of Bonds shal! be absolute and unconditional, shall be binding and enforceable in all circumstances whatsoever, and shall not be subject to setoff. recoupment or counterclaim. The Corporation shall pay its Operating Expenses and make Priority Payments to the parties entitled thereto. The Corporation may borrow money to pay, and repay such borrowings as, Operating Expenses. The aggregate amount of such outstanding borrowings shall never exceed the Operating Cap and shall be zero for at least 30 days of each Fiscal Year. In addition, the Corporation represents under the Indenture that it is duly authorized pursuant to law, including the Act, to create and issue the Bonds, to enter into the Indenture and to pledge the Collections and other collateral purported to be pledged in the manner and to the extent provided in the Indenture. The Collections and other collateral so pledged are and will be free and clear of any pledge. lien, charge or encumbrance thereon or with respect thereto prior to, or of equal rank with, the pledge created by the Indenture. and all corporate action on the part of the Corporation to that end has been duly and validly taken. The Bonds and the provisions of the Indenture are and will be the valid and binding obligations of the Corporation in accordance with their terms. (Section 5.01) Enforcement. Under the Indenture, the Corporation covenants to enforce or cause the Trustee to enforce, by appropriate legal proceedings, each covenant, pledge or agreement made by the Virgin Islands in the Purchase Agreement for the benefit of any of the Beneficiaries. Tax Covenants. The Corporation will covenant under the Indenture that: (a) the Corporation shall at all times do and perform all acts and things permitted by law and necessary or desirable to assure that interest paid by the Corporation on Tax-Exempt Bonds will be excludable from gross income for federal income tax purposes pursuant to Section 103(a) of the Code: and (b) no funds of the Corporation shall at any time be used directly or indirectly to acquire securities, obligations or other investment property the acquisition or holding of which would cause any Tax- Exempt Bond to be an arbitrage bond as defined in the Code. If and to the extent required by the Code, the Corporation shall periodically, at such times as may be required to comply with the Code, pay as an Operating Expense the amount, if any, required by the Code to be rebated or paid as a related penalty. The Corporation's tax covenants shall, notwithstanding any other provisions of the Indenture. survive the defeasance or other payment of the Tax-Exempt Bonds. (Section 5.03) Accounts and Reports, The Corporation will make the following covenants under the Indenture (Section 5.04): 88 (a) (b) (c) (d) (e) cause to be kept books of account in which complete and accurate entries shall be made of its transactions relating to all funds and accounts under the Indenture, which books shall at all reasonable times and at the expense of the Corporation be subject to the inspection of the Indenture Trustee and the Holders of an aggregate of not less than 25% in Principal amount or Accreted Value of Bonds then Outstanding or their representatives duly authorized in writing; annually, within 305 days after the close of each Fiscal Year, deliver to the Indenture Trustee and each Rating Agency, a copy of its financial statements for such Fiscal Year, as audited by an independent certified public accountant or accountants; keep in effect at all times by Officer’s Certificate an accurate and current schedule of all Debt Service to be payable during the life of then Outstanding Bonds, Swap Contracts and Ancillary Contracts; certifying for the purpose such estimates as may be necessary: for each Distribution Date, cause the Indenture Trustee to provide to the Corporation and each Rating Agency a written statement indicating: () the Outstanding Bonds of each Series; (2) the amount of Principal to be paid to the Holders of the Bonds of each Series on such Distribution Date; (3) the amount of interest to be paid to the Holders of the Bonds of each Series on such Distribution Date; (4) the Principal Due and Turbo Redemptions for the Bonds as of that Distribution Date; (5) the amount on deposit in each Fund and Account as of that Distribution Date: (6) the Debt Service Reserve Requirement as of that Distribution Date; (7) whether or not a Lump Sum Payment has been received; and (8) the amount of Priority Payments, Parity Payments and Junior Payments paid or to be paid to Beneficiaries under each Swap and Ancillary Contract on such Distribution Date; and as soon as possible after notice of an NPM Adjustment to the 2001 Annual Payment, provide to the Trustee and each Rating Agency a copy of such notice, including the amount of NPM Adjustment to the 2001 Annual Payment. Ratings. Unless otherwise specified by Series Supplement, the Corporation shall pay such reasonable fees and provide such available information as may be necessary to obtain and keep in effect ratings on all the Senior Bonds from at least one nationally recognized statistical rating organizations. (Section 5.06) Affirmative Covenants. The Corporation will make the following affirmative covenants under the Indenture: Punctual Payment. The Corporation shall duly and punctually pay the Principal of and premium, if any, and interest on the Bonds in accordance with the terms of the Bonds and the Indenture. Maintenance of Existence. The Corporation shall keep in full effect its existence, rights and franchises as a special purpose independent instrumentality of the Virgin Islands. 89 Protection of Collateral. The Corporation shall from time to time execute and deliver all documents and instruments, and will take such other action. as is necessary or advisable to: (i) maintain or preserve the lien and security interest (and the priority thereof) of the Indenture: (i) perfect. publish notice of or protect the validity of any grant made or to be made by the Indenture: (il) preserve and defend title to the Collections and other collateral pledged under the Indenture and the rghts of the Indenture Trustee and the Bondholders in such collateral against the claims of all persons and parties. including the challenge by any party to the validity or enforceability of the Consent Decree. the Indenture, the Purchase Agreement, the Trust Act or the Act or the performance by any party thereunder; (iv) enforce the Purchase Agreement: (¥) pay any and all taxes levied or assessed upon all or any part of the collateral: or (vi) carry out more effectively the purposes of the Indenture. Performance of Obligations. The Corporation (1) shall diligently pursue any and all actions to enforce its rights under each instrument or agreement included in the collateral and (ii) shall not take any action and will use its best efforts not to permit any action to be taken by others that would release any person from any of such person’s covenants or obligauions under any such instrument or agreement or that would result in the amendment, hypothecation, subordination, termination or discharge of, or impair the validity or effectiveness of, any such instrument or agreement, except. in each case. as expressly provided in the Indenture, the Purchase Agreement or the Consent Decree. Notice of Events of Detault. The Corporation will give the Indenture Trustee and Rating Agencies prompt written notice of each Event of Default under the Indenture. Negative Covenants. Vhe Corporation will make the following negative covenants under the Indenture: exchange or otherwise dispose of any of its properties or assets that are pledged under the Indenture. Sale of Assets. Except as expressly pernutted by the Indenture, the Corporation shall not sell, transfer, premium, if any. or interest due in respect of, the Bonds or assert any claim against any present or former Bondholder by reason of the payment of taxes levied or assessed upon any part of the collateral. Liquidation. The Corporation shall not terminate its existence or dissolve or liquidate in whole or in part. impaired. or permit the Hien of the Indenture or the Purchase Agreement to be amended. hypothecated, subordinated, terminated or discharged, or permit any person to be released from any covenants or obligations with respect to the Bonds under the Indenture except as may be expressly permitted thereby, (ii) permit any lien, charge, excise, claim, security interest, mortgage or other encumbrance (other than the lien of the Indenture) to be created on or extend to or otherwise arise upon or burden the collateral or any part thereof or any interest therein or the proceeds thereof or (111) permit the lien of the Indenture not to constitute a valid first priority security interest in the collateral. Limitations on Consolidation, Merger, Sale of Assets, ete. Except as otherwise provided in the Indenture, the Corporation shall not consolidate or merge with or into any other person. or convey or transfer all or substantially all of its properties or assets. unless: (a) the person surviving such consolidation or merger (if other than the Corporation or the transferee) is organized and existing under the laws of the United States, the Virgin Islands or any state and expressly assumes the due and punctual payment of the Principal of and premium, if any, and interest on all Bonds and the performance or observance of every agreement and covenant of the Corporation in the Indenture: (b) immediately after giving effect to such transaction, no Default has occurred and is continuing under the Indenture: (c) the Corporation has received a Rating Confirmation: 90 (d) the Corporation has received an opinion of Counsel to the effect that such transaction will not have material adverse tax consequence to the Corporation and will not adversely affect the exclusion of interest on any Tax Exempt Bond from gross income for federal income tax purposes; (e) any action as is necessary to maintain the lien and security interest created by the Indenture has been taken; and (f) the Corporation has delivered to the Indenture Trustee an Officer’s Certificate and an opinion of Counsel to the effect that such transaction complies with the Indenture and that all conditions precedent to such transaction have been complied with. No Other Business. The Corporation will not engage in any business other than financing, purchasing, owning and managing the collateral in the manner contemplated by the Indenture and activities incidental thereto. No Borrowing. The Corporation will not issue, incur, assume, guarantee or otherwise become liable, directly or indirectly, for any indebtedness except Permitted Indebtedness. Swap Contracts and Ancillary Contracts are not indebtedness within the meaning of this covenant. Guarantees, Loan, Advances and Other Liabilities. Except as otherwise contemplated by the Indenture and the Purchase Agreement, the Corporation will not make any loan or advance of credit to, or guarantee (directly or indirectly or by an instrument having the effect or assuring another’s payment or performance on any obligation or capability of so doing or otherwise), endorse or otherwise become contingently liable, directly or indirectly, in connection with the obligations, stock or dividends of, or own, purchase, repurchase or acquire (or agree contingently to do so) any stock, obligations, assets or securities of, or any other interest in, or make any capital contribution to, any other person. Restricted Payments. The Corporation shall not, directly or indirectly, make payments to or distributions from the Collection Account except in accordance with the Indenture. (Section 5.08) Prior Notice. The Corporation shall give each Rating Agency thirty days’ prior written notice of each issue of Bonds, with a copy of the proposed Series Supplement, and of each Supplemental Indenture, amendment to the Purchase Agreement, Swap Contract, Ancillary Contract or defeasance or redemption of Bonds. Certain Corporation and Virgin Islands Covenants. Under the Indenture, the Corporation acknowledges that the MSA, the Consent Decree and the Purchase Agreement constitute important security provisions of the Bonds and waives any right to assert any claim to the contrary and agrees that it will neither in any manner directly or indirectly assert, nor in any manner directly or indirectly support the assertion by the Virgin Islands or any other person of, any such claim to the contrary. By acknowledging that the MSA, the Consent Decree and the Purchase Agreement constitute important security provisions of the Bonds, the Corporation also acknowledges under the Indenture that, in the event of any failure or refusal by the Virgin Islands to comply with its agreements included in the MSA, the Consent Decree and the Purchase Agreement, the Holders of the Bonds may have suffered monetary damages, the extent of the remedy for which may be, to the fullest extent permitted by applicable federal and Virgin Islands law, determined, in addition to any other remedy available at law or in equity, in the course of any action taken pursuant to the Indenture; and the Corporation will waive any right to assert any claim to the contrary and agrees that it shall neither in any manner directly or indirectly assert, nor in any manner directly or indirectly support the assertion by the Virgin Islands or any other person of, any claim to the effect that no such monetary damages have been suffered. Pursuant to the Act, the Corporation has included in the Indenture the Virgin Islands’ pledge and agreement with the Holders of the Outstanding Bonds that the Virgin Islands will not limit or alter the rights of the Corporation to fulfill the terms of its agreements with such Holders, or in any way impair the rights and remedies of such Holders or the security for such Bonds until such Bonds, together with the interest thereon and all costs and expenses in connection with any action or proceeding by or on behalf of such Holders, are fully paid and discharged. (Section 6.01) 91 No Indebtedness or Funds of the Virgin Islands. The Indenture doves not constitute indebtedness of the Virgin Islands for purpose of any constitutional or statutory limitations. The Corporation’s revenues are not funds of the Virgin Islands. (Section 6.02) Resignation or Removal of the Indenture Trustee. Under the Indenture, the Indenture Trustee may resign on not less than 30 days’ written notice to the Corporation. the Holders and the Rating Agencies. The Trustee will promptly certify to the Corporation that it has sent written notice to all Holders and such certificate will be conclusive evidence that such notice was mailed as required hereby. Upon receiving such notice of resignation, the Corporation shall promptly appoint a successor and, upon the acceptance by the successor of such appointment. release the resigning Trustee from its obligations hereunder by written instrument, a copy of which instrument shall be delivered to each of the Holders. the resigning Trustee and the successor Trustee. The Indenture Trustee may be removed by the Corporation or by a Majority in Interest of Outstanding Bonds, upon written notice to the Trustee, if rated below investment grade by Moody's and each successor Indenture Trustee will have an investment grade rating from Moody's. The Indenture Trustee may also be removed by written notice from the Corporation if no Default is then continuing or from a Majority in Interest of the Holders of the Outstanding Bonds to the Indenture Trustee and the Corporation. Such resignation or removal will not take effect until a successor has been appointed and has accepted the duties of the Indenture Trustee. (Section 7.04) Successor Fiduciaries. Any corporation or association which succeeds to the municipal corporate trust business of a Fiduciary as a whole or substantially as a whole, whether by sale, merger, consolidation or otherwise, will become vested under the Indenture. with all the property, rights, powers and duties under the Indenture, with out any further act or conveyance or without the execution or filing of any paper with any party hereto except where an instrument of transfer or assignment is required by law to effect such succession, anything in the Indenture to the contrary notwithstanding. In case a Fiduciary resigns or is removed or becomes incapable of acting, or becomes bankrupt or insolvent, or if a receiver, liquidator or conservator of a Fiduciary or of its property is appointed, or if a public officer takes charge or control of a Fiduciary. or of its property or affairs, then such Fiduciary shall with due care terminate its activities under the Indenture and a successor may. or in the case of the Indenture Trustee will, be appointed by the Corporation. The Corporation shall notify the Holders and the Rating Agencies of the appointment of a successor Indenture Trustee in writing within 20 days from the appointment. The Corporation will promptly certify to the successor Indenture Trustee that it has given such notice to all Holders and such certificate will be conclusive evidence that such notice was given as required by the Indenture. If no appointment of a successor Indenture Trustee is made within 45 days after the giving of written notice in accordance with the provisions of the Indenture summarized above under the caption “Resignation or Removal of the Trustee” or after the occurrence of any other event requiring or authorizing such appointment, the outgoing Indenture Trustee or any Holder may apply to any court of competent jurisdiction for the appointment of such a successor. and such court may thereupon, after such notice, if any. as such court may deem proper. appoint such successor. Any successor Indenture Trustee appointed in accordance with the provisions of the [Indenture shall be a trust company or a bank having the powers of a trust company, having a capital and surplus of not less than $50,000,000. Any such successor Indenture Trustee shall notify the Corporation of its acceptance of the appointment and, upon giving such notice, shall become Indenture Trustee, vested with all the property. rights, powers and duties of the Indenture Trustee under the Indenture, without any further act or conveyance. Such successor Indenture Trustee shall execute, deliver, record and file such instruments as are required to confirm or perfect its succession under the Indenture and any predecessor Indenture Trustee will from time to time execute, deliver, record and file such instruments as the incumbent Indenture Trustee may reasonably require to confirm or perfect any succession under the Indenture. (Section 7.05) Reports by Trustee to Holders. The Trustee, on or prior to each Distribution Date for a Series of Bonds. shall deliver to the Holders of such Bonds and each Rating Agency, a written statement indicating those items described in subsection (d) under the heading of “Accounts and Reports” herein. The Trustee’s responsibility for delivering such information is limited to availability, timeliness and accuracy of the information provided to the Trustee by the Corporation in accordance with the Indenture. (Section 7.06) Nonpetition Covenant. Notwithstanding any prior termination of the Indenture, no Fiduciary shall, prior to the date which is one year and one day after the termination of the Indenture, acquiesce, petition or otherwise invoke or cause the Corporation to invoke the process of any court of government authority for the purpose of commencing or sustaining a case against the Corporation under any Federal or state bankruptcy, insolvency or similar law or appointing a receiver, liquidator, assignee, trustee, custodian, sequestrator or other similar official of the Corporation or any substantial part of its property, or ordering the winding up or liquidation of the affairs of the Corporation. (Section 7.07) Action by Holders. Any request, authorization, direction, notice, consent, waiver or other action provided by the Indenture to be given or taken by Holders of Bonds may be contained in and evidenced by one or more writings of substantially the same tenor signed by the requisite number of Holders or their attorneys duly appointed in writing. Proof of the execution of any such instrument, or of an instrument appointing any such attorney, will be sufficient for any purpose of the Indenture (except as otherwise expressly provided in the Indenture) if made in the following manner, but the Corporation or the Indenture Trustee may nevertheless in its discretion require further or other proof in cases where it deems the same desirable. The fact and date of the execution by any Bondholder or his attorney of such instrument may be proved by the certificate or signature guarantee, which need not be acknowledged or verified, of an officer of a bank, trust company or securities dealer satisfactory to the Corporation or to the Indenture Trustee; or of any notary public or other officer authorized to take acknowledgments of deeds to be recorded in the state in which he purports to act, that the person signing such request or other instrument acknowledged to him the execution thereof; or by an affidavit of a witness of such execution, duly sworn to before such notary public or other officer. The authority of the person or persons executing any such instrument on behalf of a corporate Holder may be established without further proof if such instrument is signed by a person purporting to be the president or a vice president of such corporation with a corporate seal affixed and attested by a person purporting to be its clerk or secretary or an assistant clerk or secretary. Any action of the owner of any Bond will be irrevocable and bind all future record and beneficial owners thereof. (Section 8.01) Registered Owners. Certain provisions of the Indenture applicable to DTC as Holder of immobilized Bonds shall not be construed in limitation of the rights of the Corporation and each Fiduciary to rely upon the registration books in all circumstances and to treat the registered owners of Bonds as the owners thereof for all purposes not otherwise specifically provided for by law or in the Indenture. Notwithstanding any other provisions in the Indenture, any payment to the registered owner of a Bond will satisfy the Corporation’s obligations thereon to the extent of such payment. (Section 8.02) Remedies. If an Event of Default occurs and is continuing the Indenture Trustee may, and upon written request of the Holders of 25% in Principal amount or Accreted Value of the Bonds Oustanding shall, in its own name by action or proceeding in accordance with the law: (1) enforce all rights of the Holders and require the Corporation or, to the extent permitted by law. the Virgin Islands to carry out their respective agreements with the Holders and to perform its duties under the Purchase Agreement; (ii) sue upon such Bonds; (iii) require the Corporation to account as if it were the trustee of an express trust for the Holders of such Bonds; and (iv) enjoin any acts or things which may be unlawful or in violation of the rights of the Holders of such Bonds. The Indenture Trustee shall, in addition to the other provisions of this section, have and possess all of the powers necessary or appropriate for the exercise of any functions incident to the general representation of Holders in the enforcement and protection of their rights. Upon a failure of the Corporation to pay when due, Principal of or interest on any Bond or a failure actually known to an Authorized Officer of the Indenture Trustee to make any other payment required thereby within seven 93 days after the same becomes due and payable, the Indenture Trustee shall give written notice thereof to the Corporation. The Indenture Trustee shall give Default notices under certain provisions of the Indenture when instructed to do so by the written direction of another Fiduciary or the owners of at least 25% in Principal amount or Accreted Value of the Outstanding Bonds. The Indenture Trustee shall proceed for the benefit of the Holders in accordance with the written direction of a Majority in Interest of the Holders of the Outstanding Bonds. The Indenture Trustee shall not be required to take any remedial action (other than the giving of notice) unless indemnity satisfactory to the Indenture Trustee is furnished for any expense or liability to be incurred therein. Upon receipt of written notice, direction and indemnity. and after making such investigation, if any, as it deems appropriate to verify the occurrence of any event of which it is notified as aforesaid, the Indenture Trustee will promptly pursue the remedies provided by the Indenture or any such remedies (not contrary to any such direction) as it deems appropriate for the protection of the Holders, and will act for the protection of the Holders with the same promptness and prudence as would be expected of a prudent person in the conduct of such person’s own affairs. (Section 9.02) Extraordinary Prepayment. If an Event of Default occurs, the Outstanding Bonds shall be redeemed after payment of certain expenses and all current and past due interest on the Outstanding Bonds, pro rata in authorized denominations from all available funds in the Debt Service Reserve Account and the Extraordinary Payment Account, at the Principal amount or Accreted Value thereof, plus accrued interest, if any, to the date of redemption. (Section 9.03) Individual Remedies. No one or more Holders will by his or their action affect, disturb or prejudice the pledge created by the Indenture, or enforce any right under the Indenture, except in the manner therein provided; and all proceedings at law or in equity to enforce any provision of the Indenture will be instituted, had and maintained in the manner provided therein and for the equal benefit of all Holders of the same class; but nothing in the Indenture will affect or impair the right of any Holder of any Bond to enforce payment of the principal of, premium, if any, or interest thereon at and after the same comes due pursuant to the Indenture, or the obligation of the Corporation to pay such principal, premium, if any, and interest on each of the Bonds to the respective Holders thereof at the time, place, from the source and in the manner expressed in the Indenture and in the Bonds. (Section 9.04) Venue. The venue of every action, suit or special proceeding against the Corporation shall be laid in the Virgin Islands. (Section 9.05) Waiver. If the Indenture Trustee determines that a Default has been cured before becoming an Event of Default and before the entry of any final judgment or decree with respect to it, the Indenture Trustee may waive the Default and its consequences, by written notice to the Corporation, and shall do so upon written instruction of the Holders of at least 25% Principal amount or Accreted Value of the Outstanding Bonds. (Section 9.06) Supplements and Amendments to the Indenture. The Indenture may be: (i) supplemented by delivery to the Indenture Trustee of an instrument certified by an Authorized Officer of the Corporation to (1) provide for earlier or greater deposits into the Bond Fund, (2) subject any property to the lien of the Indenture, (3) add to the covenants and agreements of the Corporation or surrender or limit any right or power of the Corporation, (4) identify particular Bonds for purposes not inconsistent with the provisions of the Indenture, including credit or liquidity support, remarketing, serialization and defeasance, (5) cure any ambiguity or defect, (6) protect the exclusion of interest on the Tax-Exempt Bonds from gross income for federal income tax purposes, or the exemption from registration of the Bonds under the Securities Act of 1933, as amended, or of the Indenture under the Trust Indenture Act of 1939, as amended, or (7) authorize Bonds of a Series and in connection therewith determine the matters referred to in the Indenture, and any other things relative to such Bonds that are not materially adverse to the Holders of Outstanding Bonds, or to modify or rescind any such authorization or determination at any time prior to the first authentication and delivery of such Series of Bonds; or (ii) amended in any other respect by the Corporation and the Indenture Trustee, (1) to add provisions that are not materially adverse to the Holders, or (2) to adopt amendments that do not take effect unless and until (a) no Bonds Outstanding prior to the adoption of such amendment remain 94 Outstanding or (b) such amendment is consented to by the Holders of such Bonds in accordance with the provisions of subparagraph (iii) below: or (ill) amended only with written notice to the Rating Agencies and the written consent of a Majority in Interest of the Bonds to be Outstanding and affected thereby. However, the Indenture may not be amended so as to (1) extend the maturity of any Bond, (2) reduce the Principal amount, applicable premium or interest rate of any Bond, (3) make any Bond redeemable other than in accordance with its terms, (4) create a preference or priority of any Bond over any other Bond of the same class, or (5) reduce the percentage of: the Bonds required to be represented by the Holders giving their consent to any amendment, unless the Holders of the Bonds affected by such amendment have consented to it in writing. Any amendment of the Indenture shall be accompanied by an opinion of Transaction Counsel or other nationally recognized bond counsel to the effect that the amendment is permitted by law and does not adversely affect the exclusion of interest on the Tax-Exempt Bonds from gross income for federal income tax purposes. When the Corporation determines that the requisite number of consents have been obtained for an amendment to the Indenture or to the Purchase Agreement which requires consents, it shall file a certificate to that effect in its records and give written notice to the Indenture Trustee and the Holders. The Indenture Trustee will promptly certify to the Corporation that it has given such notice to all Holders and such certificate will be conclusive evidence that such notice was given in the manner required by the Indenture. (Section 10.01) Supplements and Amendments to the Agreement. In the event that the Indenture Trustee receives a request for a consent or other action under the Purchase Agreement the Indenture Trustee may, and if consent or other action by Holders is required will transmit a notice of such request to each Holder and request directions with respect thereto; and the Indenture Trustee (and the Corporation, if applicable) shall proceed in accordance with such directions (if any), the Indenture and the Purchase Agreement. (Section 10.02) The Purchase Agreement The following summary describes certain terms of the Purchase Agreement. This summary does not purport to be complete and is subject to, and qualified in its entirety by reference to the provisions of the Purchase Agreement. Copies of the Purchase Agreement may be obtained upon written request to the Indenture Trustee. Conveyance of Tobacco Assets. On the Closing Date, and simultaneously with the Corporation’s delivery of the Purchase Consideration in accordance with the provisions of the Purchase Agreement summarized below under the caption “Purchase Consideration” the Virgin Islands shall by appropriate instrument or instruments sell, transfer, assign, set over and otherwise convey to the Corporation, without recourse (but subject to continuing obligations set forth in the Purchase Agreement) the Tobacco Assets. The Virgin Islands has acknowledged and consented to any pledge, assignment and grant of a security interest by the Corporation to the Indenture Trustee pursuant to the Indenture for the benefit of the Bondholders of any or all right, title and interest of the Corporation in, to and under the Tobacco Assets or the assignment of any or all of the Corporation’s rights and obligations under the Purchase Agreement to the Indenture Trustee for the benefit of the Bondholders. From and after the Closing Date all payments required by the MSA to be made to the Virgin Islands shall be made to the Corporation, or to the extent provided in the Indenture, to the Indenture Trustee. In the event the Virgin Islands shall receive any payments or other funds constituting Tobacco Assets after the Closing Date the Virgin Islands will promptly disburse the same to the Corporation or the Indenture Trustee, as directed. The Virgin Islands agrees to execute and deliver to the Escrow Agent under the MSA irrevocable instructions to make the payments constituting Tobacco Assets directly to the Corporation or the Indenture Trustee as required by the Transaction Documents, and further authorizes the Corporation to make or amend such instructions on its behalf. Purchase Consideration. On the Closing Date, and simultaneously with the Virgin Islands’ conveyance of the Tobacco Assets: 95 (a) The proceeds of the sale of the Series 2001 Bonds remaining after deducting therefrom all Financing Costs paid or to be paid therefrom (including costs and expenses of the Virgin Islands or of the Corporation which under the terms of the Purchase Agreement or of the Indenture are permitted to be paid or reimbursed from the proceeds of the Series 2001 Bonds) (“Net Proceeds’) shall be transferred to the Escrow Trustee. The Net Proceeds are held in the Construction Account created by the 2001 Supplement for the account of the Tobacco Settlement Health Care and Capital Improvement of the Virgin Islands Fund to pay for health care projects set forth in the Purchase Agreement. (b) The Virgin Islands shall transfer the April 15, 2001 Annual Payment in the amount of $696,377.55, representing Tobacco Assets received since February 1, 2001, plus all investment income therefrom, to the Corporation for deposit in the NPM Adjustment Reserve Account established under the Indenture. (Section 2.02) No Payments to the Corporation. The Virgin Islands shall not make payments of any money to the Corporation except pursuant to appropriation. (Section 2.03) Reimbursement of Virgin Islands Expenses at Closing. On or prior to the Closing Date the Corporation shall reimburse the Virgin Islands for or pay directly any costs and expenses incurred by the Virgin Islands on or prior to the Closing Date in connection with the sale of the Tobacco Assets, the establishment and organization of the Corporation and the Trust Fund, the Purchase Agreement, the Indenture and the transactions contemplated thereby. The Virgin Islands agrees to itemize such costs for which it seeks reimbursement in a certificate of a Responsible Officer delivered to the Corporation on or prior to the Closing Date. The Corporation shall reimburse the Virgin Islands for or pay such costs and expenses from the proceeds of the Series 2001 Bonds and the same shall be deemed to be Financing Costs. (Section 2.04) Representations of Virgin Islands. The Virgin Islands makes the following representations on which the Corporation is deemed to have relied in acquiring the Tobacco Assets. The representations speak as of the Closing Date. and shall survive the sale of the Tobacco Assets to the Corporation and the pledge thereof to the Indenture Trustee pursuant to the Indenture. Power and Authority. The Virgin Islands has the full power and authority to execute and deliver the Purchase Agreement and to carry out its terms; the Virgin Islands has full power, authority and legal right to sell and assign the Tobacco Assets to the Corporation and has authorized such sale and assignment to the Corporation by all necessary action; and the execution, delivery and performance of the Purchase Agreement have been duly authorized by the Virgin Islands by all necessary action. Pursuant to the Act, the Governor of the Virgin Islands has full power and authority to determine the terms and conditions of the Purchase Agreement and the related documents and agreements and to execute and deliver the same. Binding Obligation. The Purchase Agreement has been duly executed and delivered by the Mayor on behalf of and in the name of the Virgin Islands and, assuming the due authorization, execution and delivery of the Purchase Agreement by the Corporation, constitutes a legal, valid and binding obligation of the Virgin Islands entorceable in accordance with its terms. Amounts Paid to Date. As of the date of the Purchase Agreement, the Virgin Islands has received Tobacco Assets since February 1, 2001 in the amount of $696,377.55. No Consents. No consent. approval, authorization, order, registration or qualification of or with any court or governmental agency or body is required for the consummation of the transactions contemplated by the Purchase Agreement, except for those which have been obtained and are in full force and effect. No Violation. The consummation of the transactions contemplated by the Transaction Documents and the fulfillment of the terms thereof do not. to the Virgin Islands’ knowledge, in any material way conflict with, result in any material breach by the Virgin Islands of any of the material terms and provisions of, nor constitute (with or without notice or lapse of time) a material default by the Virgin Islands under any indenture, agreement or other instrument to which the Virgin Islands is a party or by which it shall be bound; nor violate any law or, to the Virgin Islands’ knowledge, any order. rule or regulation applicable to the Virgin Islands of any court or of any federal or 96 state regulatory body, administrative agency or other governmental instrumentality having jurisdiction over the Virgin Islands. No Proceedings. To the Virgin Islands’ knowledge, except as disclosed in this Offering Circular or in a schedule delivered to the Corporation, there are no material proceedings or investigations pending against the Virgin Islands, before any court, regulatory body, administrative agency or other governmental instrumentality having jurisdiction over the Virgin Islands: (i) asserting the invalidity of any of the Transaction Documents or the Series 2001 Bonds, (ii) seeking to prevent the issuance of the Series 2001 Bonds or the consummation of any of the transactions contemplated by any of the Transaction Documents, or (iii) seeking any determination or ruling that would materially and adversely affect the validity or enforceability of any of the Transaction Documents or the Series 2001 Bonds. Title to Tobacco Assets. From and after the conveyance of the Tobacco Assets by the Virgin Islands to the Corporation on the Closing Date the Virgin Islands shall have no interest in the Tobacco Assets. The Virgin Islands has such right, title and interest to the Tobacco Assets as provided by the Consent Decree and the MSA. Absence of Liens on Tobacco Assets. The Virgin Islands has not sold, transferred, assigned, set over or otherwise conveyed any right, title or interest of any kind whatsoever in all or any portion of the Tobacco Assets, nor has the Virgin Islands created, or to its knowledge permitted the creation of, any Lien therein. The Virgin Islands acknowledges that the Corporation will assign to the Indenture Trustee for the benefit of the Bondholders all of its rights and remedies with respect to the breach of any representations and warranties of the Virgin Islands under the Purchase Agreement. Upon discovery by the Virgin Islands or the Corporation of a breach of any of the foregoing representations and warranties that materially and adversely affects the value of the Tobacco Assets, the party discovering such breach shall give prompt written notice to the other party, to the Indenture Trustee and to the Rating Agencies. The Virgin Islands shall not be liable to the Indenture Trustee or the Bondholders for any loss, cost or expense resulting solely from the failure of the Indenture Trustee to promptly notify the Virgin Islands upon the discovery by a Responsible Officer of the Indenture Trustee of a breach of any representation or warranty contained in the Purchase Agreement. (Section 3.01) Liability of Seller; Indemnities. To the extent permitted by law, the Virgin Islands shall indemnity, defend and hold harmless the Corporation and the Indenture Trustee and its respective officers, directors, employees and agents from and against any and all costs, expenses, losses, claims, damages and liabilities to the extent that such cost, expense, loss, claim, damage or liability arose out of, or was imposed upon any such person through, the negligence, willful misfeasance or bad faith of the Virgin Islands, in its capacity as seller hereunder, in the performance of its duties under the Purchase Agreement or by reason of reckless disregard of its obligations and duties under the Purchase Agreement. To the extent permitted by law, the Virgin Islands shall indemnity, defend and hold harmless the Indenture Trustee and its officers, directors, employees and agents from and against all costs, expenses, losses, claims, damages and liabilities arising out of or incurred in connection with the acceptance or performance of the trusts and duties herein and in the Indenture contained, except to the extent that such cost, expense, loss, claim, damage or liability shall be due to the willful misfeasance, bad faith or negligence of the Indenture Trustee. At the option of the Virgin Islands and absent any conflict of interest, any indemnified party shall be represented by the counsel retained by the Virgin Islands with respect to any litigation brought by or against such indemnified party or its officers, directors or employees with respect to any claims, damages, judgments, liabilities or causes of action to which such persons may be subject and to which they are entitled to the indemnified under the Purchase Agreement. Indemnification under the Purchase Agreement as described above shall survive the resignation or removal of the Indenture Trustee and the termination of the Purchase Agreement and the Indenture, and shall include reasonable fees and expenses of counsel and expenses of litigation. If the Virgin Islands shall have made any indemnity payments pursuant to the Purchase Agreement and the person to or on behalf of whom such payments are made thereafter shall collect any of such amounts from others, such person shall promptly repay such amounts to the Virgin Islands, without interest. (Section 3.02) 97 Limitation on Liability. The Virgin Islands and any officer or employee or agent of the Virgin Islands may rely in good faith on the advice of counsel or on any document of any kind. prima facie properly executed and submitted by any person respecting any matters arising under the Purchase Agreement. The Virgin Islands shall not be under any obligation to appear in. prosecute or defend any legal action that shall not be related to its obligations under the Purchase Agreement, and that in its opinion may involve it in any expense or lability. The Virgin Islands shall not be required to indemnity any person for a claim settled without the prior consent of the Governor and the Legislature of the Government of the Virgin Islands. Neither the Virgin Islands nor any of the officers or employees or agents of the Virgin Islands shall be under any liability to the Corporation, except as provided under the Purchase Agreement. for any action taken or for refraining from the taking of any action pursuant to the Purchase Agreement or for errors in judgment; but this sentence shall not protect the Virgin Islands or any such person against any liability that would otherwise be imposed by reason of willful misfeasance. bad faith or negligence in the performance of duties or by reason of reckless disregard of obligations and duties under the Purchase Agreement. (Section 3.03) Protection of Title: Non-Impairment Covenant. The Virgin Islands shall take all actions as may be required by law fully to preserve, maintain, defend. protect and confirm the interests of the Corporation and the interests of the Indenture Trustee on behalf of the Bondholders in the Tobacco Assets and in the proceeds thereof. The Virgin Islands will not take any action that will adversely affect the Corporation's or the Indenture Trustee's ability to receive payments made under the MSA. The Virgin Islands has pledged and agreed with the Corporation, and the Holders of the Bonds, that the Virgin Islands will not limit or alter the rights of the Corporation to fulfill the terms of its agreements with such Holders, or in any way impair the rights and remedies of such Holders or the security for the Bonds until the Bonds, together with the interest thereon and all costs and expenses in connection with any action or proceeding by or on behalf of such Holders. are fully paid and discharged. (Section 4.01) Protection of MSA. The Virgin Islands will not take any action and will use its best reasonable efforts not to permit any action to be taken by others that would release any person from any of such person’s covenants or obligations under the MSA or that would result in the amendment. hypothecation, subordination, termination or discharge of, or impair the validity or effectiveness of, the MSA, nor, without the prior written consent of the Corporation and the Indenture Trustee on behalf of the Bondholders, amend, modify, terminate, waive or surrender, or agree to any amendment, modification, termination, waiver or surrender of. the payment terms of the MSA or the Purchase Agreement, or waive timely performance or observance under such documents, in each case if the effect thereof would be materially adverse to the Bondholders. The Virgin Islands has covenanted that it will remain subject to personal jurisdiction in the MSA and accordingly is bound to the provisions thereof which purport to bind the Virgin Islands; that it will not seek to avoid personal jurisdiction with respect to the MSA or exclude itself from the Class (as defined therein), that it will take all reasonably necessary action permitted by law to enforce its payment rights thereunder for the benetit of the Corporation at the expense of the Corporation; to the extent it has not otherwise done so, that it shall absolutely and unconditionally release and forever discharge all Released Parties from all Released Claims (as such terms are defined in the MSA) that the Virgin Islands directly, indirectly, derivatively or in any other capacity ever had. now has or hereafter can, shall, or may have, to the same extent that the Settling States (as defined in the MSA) are releasing Released Claims against Released Parties under the MSA: and that it shall not sue or seek to establish civil liability against any Released Party based, in whole or in part, upon any of the Released Claims. (Section 4.02) Further Actions. Upon request of the Corporation or the Indenture Trustee. the Virgin Islands will execute and deliver such further instruments and do such further acts as may be reasonably necessary or proper to carry out more effectively the purposes of the Purchase Agreement. (Section 4.03) Tax Covenant. The Virgin Islands shall at all times do and perform all acts and things permitted by law and necessary or desirable to assure that interest paid by the Corporation on Series 2001 Bonds shall be excludable trom gross income for federal income tax purposes pursuant to Section 103(a) of the Code; and no funds of the Virgin Islands shall at any time be used directly or indirectly to acquire securities, obligations or investment property the acquisition or holding of which would cause the Series 2001 Bond to be an arbitrage bond as defined in the Code and any applicable regulations issued thereunder and in furtherance of such covenant shall execute and comply with a tax certificate provided by Transaction Counsel. (Section 4.04) 98 Amendment. No agreement or other instrument purporting to amend, modify. supersede or retract or otherwise alter the Purchase Agreement or any provision thereof shall have any force or effect unless approved by the Governor, in the case of the Virgin Islands, and the Board of Directors of the Corporation, in the case of the Corporation and executed and delivered by a Responsible Officer of the Party against whom asserted; nor, so long as any Tobacco Bonds remain outstanding, except as provided hereinafter. The Purchase Agreement may be amended by the Virgin Islands and the Corporation to modify the provision regarding no payments by the Virgin Islands to the Corporation or, with the consent of the Indenture Trustee, but without the consent of any of the Bondholders: (a) to cure any ambiguity; (b) to correct or supplement any provisions in the Purchase Agreement; (c) to correct or amplify the description of the Tobacco Assets; (d) to add additional covenants for the benefit of the Corporation; or (e) for the purpose of adding any provisions to or changing in any manner or eliminating any of the provisions in the Purchase Agreement that shall not, as evidenced by Rating Confirmation (as such term is defined in the Indenture) or an Opinion of Counsel delivered to the Indenture Trustee, adversely affect in any material respect the Tobacco Bonds. Except as otherwise provided in the preceding paragraph, the Purchase Agreement may also be amended from time to time by the Virgin Islands and the Corporation with the consent of the Indenture Trustee and Rating Confirmation or the consent of a Majority in Interest of the Tobacco Bonds for the purpose of adding any provisions to or changing in any manner or eliminating any of the provisions of the Purchase Agreement or of modifying in any manner the rights of the Bondholders; but no such amendment shall reduce the aforesaid portion of the outstanding amount of the Tobacco Bonds, the Holders of which are required to consent to any such amendment, without the consent of the Holders of all the outstanding Tobacco Bonds. Promptly after the execution of any such amendment or consent, the Corporation shall furnish written notification of the substance of such amendment or consent to the Indenture Trustee. It shall not be necessary for the consent of Bondholders pursuant to the foregoing paragraphs to approve the particular form of any proposed amendment or consent, but it shall be sufficient if such consent shall approve the substance thereof. Prior to the execution of any amendment to the Purchase Agreement, the Indenture Trustee shall be entitled to receive and conclusively rely upon an Opinion of Counsel stating that the execution of such amendment is authorized, or permitted by the Purchase Agreement. Without the prior written consent of the Indenture Trustee, which consent may be granted or withheld in such Person’s sole discretion, no amendment, supplement or other modification of the Purchase Agreement shall be entered into or be effective if such amendment, supplement or modification affects the Indenture Trustee’s own rights, duties or immunities under the Purchase Agreement or otherwise. (Section 5.01) Assignment. Except pursuant to the Indenture, the Purchase Agreement may not be assigned by the Virgin Islands and any purported assignment shall be of no effect. The Purchase Agreement may not be assigned by the Corporation except as explicitly set forth therein. (Section 5.03) Nonpetition Covenants. The Virgin Islands shall not, prior to the date which is one year and one day after the date on which the principal of and interest on all Bonds issued under the Indenture have been paid in full, acquiesce, petition or otherwise invoke or cause the Corporation to invoke the process of any court or government authority for the purpose of commencing or sustaining a case against the Corporation under any Federal or state bankruptcy, insolvency or similar law or appointing a receiver, liquidator, assignee, trustee, custodian, sequestrator or other similar official of the Corporation or any substantial part of its property, or ordering the winding up or liquidation of the affairs of the Corporation. (Section 5.08) Limitation of Liability of the Virgin Islands. Notwithstanding anything contained in the Purchase Agreement to the contrary, no officer, employee or agent of the Virgin Islands shall have any liability for the representations, warranties, covenants, agreements or other obligations of the Virgin Islands under the provisions of the agreement or in any of the certificates, notices or agreements delivered pursuant to the Purchase Agreement, as to all of which recourse shall be had solely to the Virgin Islands. (Section 5.09) 99 CONTINUING DISCLOSURE UNDERTAKING To the extent that Rule 15c2-12 (the “Rule”) of the Securities and Exchange Commission (“SEC”) promulgated under the Securities Exchange Act of 1934, as amended (the “1934 Act”), requires the Underwriter to determine, as a condition to purchasing the Series 2001 Bonds, that the Corporation will make such covenants, the Corporation will covenant for the sole benefit of the Bondholders as follows: The Corporation shall provide: (a) (b) within 305 days after the end of each Fiscal Year, to each nationally recognized municipal securities information repository and to any state information depository, core financial information and operating data for the prior Fiscal Year, including (i) the Corporation’s audited financial statements. prepared in accordance with generally accepted accounting principles in effect from time to time, and (ii) material historical quantitative data on the Corporation's revenues, expenditures, financial operations, indebtedness, the debt service coverage for the most recent full Fiscal Year for each Series of Senior Bonds based on Serial Maturities, Rated Maturities and Super Sinker Redemptions; and in a timely manner, to each nationally recognized municipal securities information repository or to the Municipal Securities Rulemaking Board, and to any United States Virgin Islands information depository, notice of any of the following events with respect to the Series 2001 Bonds, if material: (1) principal and interest payment delinquencies: (2) non-payment related defaults: (3) unscheduled draws on debt service reserves reflecting financial difficulties: (4) unscheduled draws on credit enhancements reflecting financial difficulties: (5) substitution of credit or liquidity providers, or their failure to perform: (6) adverse tax opinions or events affecting the tax-exempt status of the Series 2001 Bonds; (7) modifications to rights of Bondholders; (8) bond calls; (9) defeasances; (10) release, substitution, or sale of property securing repayment of the Series 2001 Bonds; (11) rating changes; and (12) failure of the Corporation to comply with clause (a) above. The Corporation will not undertake to provide any notice with respect to (i) credit enhancement if the credit enhancement is added after the primary offering of the Series 200] Bonds, the Corporation does not apply for or participate in obtaining the enhancement and the enhancement is not described in this Offering Circular or (ii) tax exemption other than pursuant to Section 103 of the Code. The Corporation will not undertake to provide the above-described event notice of a mandatory scheduled redemption, not otherwise contingent upon the occurrence of an event, if (1) the terms, dates and amounts of redemption are set forth in detail herein, (ii) the only open issue is which Bonds will be redeemed in the case of a 100 partial redemption, (iii) notice of redemption is given to the Bondholders as required under the terms of the Bonds and (iv) public notice of the redemption is given pursuant to 1934 Act Release No. 23856 of the SEC, even if the originally scheduled amounts are reduced by prior optional redemptions or Series 2001 Bond purchases. The Corporation will not undertake to provide updates or revisions to any forward-looking statements contained in this Offering Circular, including but not limited to those that include the words “expects,” “forecasts,” “projects”, “intends,” “anticipates, ” “assumes” or analogous expressions. 29 66 estimates, No Bondholder may institute any suit, action or proceeding at law or in equity (“Proceeding”) for the enforcement of the continuing disclosure undertaking (the “Undertaking”) or for any remedy for breach thereof, unless such Bondholder shall have filed with the Corporation evidence of ownership and a written notice of and request to cure such breach, and the Corporation shall have refused to comply within a reasonable time. All Proceedings shall be instituted only as specified herein, in the federal or state courts located in the Virgin Islands, and for the equal benefit of all holders of the outstanding bonds benefited by the same or a substantially similar covenant, and no remedy shall be sought or granted other than specific performance of the covenant at issue. An amendment to the Undertaking may only take effect if: (a) the amendment is made in connection with a change in circumstances that arises from a change in legal requirements, change in law, or change in the identity, nature, or status of the Corporation, or type of business conducted; the Undertaking, as amended, would have complied with the requirements of the Rule at the time of sale of a series of Bonds, after taking into account any amendments or interpretations of the Rule, as well as any change in circumstances; and the amendment does not materially impair the interests of Bondholders, as determined by parties unaffiliated with the Corporation (such as, but without limitation, the Corporation’s financial advisor or bond counsel) and the annual financial information containing (if applicable) the amended operating data or financial information will explain, in narrative form, the reasons for the amendment and the “impact” (as that word is used in the letter from the SEC staff to the National Association of Bond Lawyers dated June 23, 1995) of the change in the type of operating data or financial information being provided; or (b) all or any part of the Rule, as interpreted by the staff of the SEC at the date of issuance of the Series 2001 Bonds, ceases to be in effect for any reason, and the Corporation elects that the Undertaking shall be deemed terminated or amended (as the case may be) accordingly. For purposes of the Undertaking, a beneficial owner of a security includes any person who, directly or indirectly, through any contract, arrangement, understanding, relationship, or otherwise has or shares investment power which includes the power to dispose, or to direct the disposition of, such security, subject to certain exceptions as set forth in the Undertaking. Any assertion of beneficial ownership must be filed, with full documentary support, as part of the written request described above. LITIGATION There is no litigation pending in any court (either in Virgin Islands or federal court) to restrain or enjoin the issuance or delivery of the Series 2001 Bonds or questioning the creation, organization or existence of the Corporation, the validity or enforceability of the Act, the Purchase Agreement, the Indenture, the transfer of the TSRs by the Virgin Islands to the Corporation, the proceedings for the authorization, execution, authentication and delivery of the Series 2001 Bonds or the validity of the Series 2001 Bonds. For a discussion of other legal matters, including certain pending litigation involving the MSA and the PMs, see “RISK FACTORS,” “TOBACCO INDUSTRY” and “LEGAL CONSIDERATIONS.” 101 TAX MATTERS General The Internal Revenue Code of 1986, as amended (the “Code™). imposes certain requirements that must be met subsequent to the issuance and delivery of the Series 2001 Bonds for interest thereon to be and remain excluded trom gross income for federal income tax purposes. Noncompliance with such requirements could cause the interest on the Series 2001 Bonds to be included in gross income for federal income tax purposes retroactive to the date of issue of the Series 2001 Bonds. The Corporation has covenanted in the Indenture to comply with the applicable requirements of the Code in order to maintain the exclusion of the interest on the Series 2001 Bonds from gross income for federal income tax purposes pursuant to Section 103 of the Code. In the opinion of Buchanan Ingersoll Professional Corporation, Transaction Counsel, under existing law and assuming compliance with the aforementioned covenants, interest on the Series 2001 Bonds is excluded from gross income for federal income tax purposes under Section 103 of the Code. Transaction Counsel is also of the opinion that such interest is not treated as a preference item in calculating the alternative minimum tax imposed under the Code with respect to individuals and corporations. Interest (and original issue discount treated as interest) on the Series 2001 Bonds is. however. included in the adjusted current earnings of certain corporations for purposes of computing the alternative minimum tax imposed on such corporations. Under existing law, in the opinion of Transaction Counsel. interest on the Series 2001 Bonds will be exempt from personal income taxes imposed by the Virgin Islands, any state, other territory or possession of the United States or any political subdivision thereof, or by the District of Columbia. Original Issue Discount Transaction Counsel is further of the opinion that the difference between the principal amount of the Series 2001 Bonds with the Maturity Date. May 15. 2031 (the “Discount Bonds”) and the initial offering price to the public (excluding bond houses, brokers or similar persons or organizations acting in the capacity of underwriters or wholesalers) at which price a substantial amount of such Discount Bonds of the same maturity was sold constitutes original issue discount which is excluded from gross income for federal income tax purposes to the same extent as interest on the Series 2001 Bonds. Further, such original issue discount accrues actuarially on a constant interest rate basis over the term of each Discount Bond and the basis of each Discount Bond acquired at such initial offering price by an initial purchaser thereof will be increased by the amount of such accrued original issue discount. The accrual of original issue discount may be taken into account as an increase in the amount of tax-exempt income for purposes of determining various other tax consequences of owning the Discount Bonds, even though there will not be a corresponding cash payment. Owners of the Discount Bonds are advised that they should consult with their own advisors with respect to state and local tax consequences (including, among others, the Virgin Islands) of owning such Discount Bonds. Original Issue Premium The Series 2001 Bonds with the Maturity Date May 15, 2021 (the “Premium Bonds”) are being offered at prices in excess of their principal amounts. Transaction Counsel is of the opinion that an initial purchaser with an initial adjusted basis in a Premium Bond in excess of its principal amount will have amortizable bond premium which is not deductible from gross income for federal income tax purposes. The amount of amortizable bond premium for a taxable year is determined actuarially on a constant interest rate basis over the term of each Premium Bond. For purposes of determining gain or loss on the sale or other disposition of a Premium Bond, an initial purchaser who acquires such obligation with an amortizable bond premium is required to decrease such purchaser's adjusted basis in such Premium Bond annually by the amount of amortizable bond premium for the taxable year. The amortization of bond premium may be taken into account as a reduction in the amount of tax-exempt income for purposes of determining various other tax consequences of owning such Bonds. Owners of the Premium Bonds are advised that they should consult with their own advisors with respect to state and local tax consequences (including, among others, the Virgin Islands) of owning such Premium Bonds. 102 Certain Federal Tax Information General. The following is a discussion of certain additional tax matters under existing statutes. It does not purport to deal with all aspects of federal taxation that may be relevant to particular investors. Prospective investors, particularly those who may be subject to special rules, are advised to consult their own tax advisors regarding the Federal tax consequences of owning and disposing of the Series 2001 Bonds, as well as any tax consequences arising under the laws of any state or other taxing jurisdiction. Transaction Counsel will not be opining on the following matters. Social Security and Railroad Retirement Payments. The Code provides that interest on tax-exempt obligations is included in the calculation of modified adjusted gross income in determining whether a portion of Social Security or railroad retirement benefits received are to be included in taxable income. Branch Profits Tax. The Code provides that interest on tax-exempt obligations is included in effectively connected earnings and profits for purposes of computing the branch profits tax on certain foreign corporations doing business in the United States. Borrowed Funds. The Code provides that interest paid (or deemed paid) on borrowed funds used during a tax year to purchase or carry tax-exempt obligations is not deductible. In addition, under rules promulgated by the Internal Revenue Service for determining when borrowed funds are considered used for the purpose of purchasing or carrying particular assets, the purchase of obligations may be considered to have been made with borrowed funds even though the borrowed funds are not directly traceable to the purchase of such obligations. Property and Casualty Insurance Companies. The Code contains provisions relating to property and casualty insurance companies whereunder the amount of certain loss deductions otherwise allowed is reduced (in certain cases below zero) by a specified percentage of, among other things, interest on tax-exempt obligations acquired after August 7, 1986. Financial Institutions. The Code provides that commercial banks, thrift institutions and other financial institutions may not deduct the portion of their interest expense allocable to tax-exempt obligations acquired after August 7, 1986, other than certain “qualified” obligations. The Series 2001 Bonds are not “qualified” obligations for this purpose. S Corporations. The Code imposes a tax on excess net passive income of certain S corporations that have subchapter C earnings and profits. Interest on tax-exempt obligations must be included in passive investment income for purposes of this tax. Earned Income Credit. For any taxable year beginning after December 31, 1995, the Code denies the earned income credit to persons otherwise eligible for it if the aggregate amount of disqualified income of the taxpayer for the taxable year exceeds $2,200, subject to adjustment for inflation for taxable years beginning after December 31, 1996. Interest on the Series 2001 Bonds will constitute disqualified income for this purpose. Changes in Federal Tax Law and Post Issuance Events. From time to time proposals are introduced in Congress that, if enacted into law, could have an adverse impact on the potential benefits of the exclusion from gross income for federal income tax purposes of the interest on the Series 2001 Bonds, and thus on the economic value of the Series 2001 Bonds. This could result from reductions in federal income tax rates, changes in the structure of the federal income tax rates, changes in the structure of the federal income tax or its replacement with another type of tax, repeal of the exclusion of the interest on the Series 2001 Bonds from gross income for such purposes, or otherwise. It is not possible to predict whether any legislation having an adverse impact on the tax treatment of holders of the Series 2001 Bonds may be proposed or enacted. Transaction Counsel has not undertaken to advise in the future whether any events after the date of issuance and delivery of the Series 2001 Bonds may affect the tax status of interest on the Series 2001 Bonds. Transaction Counsel expresses no opinion as to any federal, Virgin Islands or local tax law consequences with respect to the 103 Series 200] Bonds, or the interest thereon, if any action is taken with respect to the Series 2001 Bonds or the proceeds thereof upon the advice or approval of other counsel. IRS Tobacco Audits The Internal Revenue Service (the “IRS”) is currently examining bonds of other issuers that have been issued to date and are secured by tobacco settlement revenues. The IRS. by letter dated November 1, 2000, has notified one of those other issuers that the IRS had closed its examination of that issuer's tobacco settlement revenue bonds with no change to the position that interest on such bonds is excludable from gross income under the Code. If the IRS determines in any of those transactions that interest on such bonds is includable in gross income for federal income tax purposes. it could make a similar determination with respect to the interest on the Series 2001 Bonds if the basis for the IRS determination for the other bond issue were also applicable to the Series 2001 Bonds. The IRS audits may also have an adverse effect on the market for or market price of the Series 2001 Bonds. Transaction Counsel will deliver the opinions described under "TAX MATTERS” under the captions “General”, “Original Issue Discount” and “Original Issue Premium” above upon issuance of the Series 2001 Bonds. RATING It is a condition to the obligation of the Underwriter to purchase the Series 2001 Bonds that, at the date of delivery thereof to the Underwriter, the Series 2001 Bonds shall have been assigned a rating no less than A3 by Moody's Investors Service (“"Moody’s’). The rating addresses the Rating Agency’s assessment only of the ability of the Corporation to pay interest when due and to pay Principal of the Series 2001 Bonds in accordance with the Maturities. The rating will not address the likelihood of payment in accordance with the projected Turbo Redemption schedule or the ability of the Corporation to make Extraordinary Prepayments, if any. The rating by Moody’s of the Series 2001 Bonds reflects only the view of such organization and any desired explanation of the significance of such rating and any outlooks or other statements given by the Rating Agency with respect thereto should be obtained from the Rating Agency at the following address: Moody's Investors Services, Inc.. 99 Church Street. New York. New York 10007. There is no assurance that the initial rating assigned to the Series 2001 Bonds will continue for any given period of time or that such rating will not be revised downward, suspended or withdrawn entirely by the Rating Agency. Any such downward revision, suspension or withdrawal of the rating may have an adverse effect on the availability of a market for or the market price of the Series 2001 Bonds. UNDERWRITING The Underwriter, Salomon Smith Barney, Inc., has agreed. subject to certain conditions, to purchase the Series 2001 Bonds from the Corporation for an underwriting purchase price of $20,953,969.88 (representing the principal amount of the Series 2001 Bonds less original issue discount of $124,323.20 and an underwriting discount of $631.468.82). Salomon Smith Barney. Inc. will be obligated to purchase all Series 2001 Bonds if any such Series 2001 Bonds are purchased. The Series 200! Bonds may be offered and sold to certain dealers (including dealers depositing the Series 2001 Bonds into investment trusts) and institutional purchasers at prices lower than such public offering prices. and such public offering prices may be changed, from time to time, by Salomon Smith Barney, Inc. The Corporation has agreed to indemnify, to the extent permitted by law, Salomon Smith Barney, Inc. against certain Habilities. including liabilities under federal securities laws. Salomon Smith Barney. Inc. is an affiliate of Citibank, N.A. which is acting as MSA Escrow Agent under the MSA. 104 LEGAL MATTERS Buchanan Ingersoll Professional Corporation, New York, New York, Transaction Counsel, will render an opinion with respect to the validity of the Series 2001 Bonds in substantially the form set forth in Appendix C hereto. Certain legal matters will be passed upon for the Virgin Islands by its Attorney General, and for the Underwriter by Hawkins, Delafield & Wood, New York, New York, as Underwriter’s Counsel. OTHER PARTIES Financial Advisor First Union Securities, Inc., New York, New York, operating under the trade name Wachovia Securities (“Wachovia Securities’), has been retained to act as financial advisor for the Virgin Islands in connection with the issuance of the Series 2001 Bonds. Although Wachovia Securities has assisted in the preparation of this Offering Circular, Wachovia Securities is not obligated to undertake, and has not undertaken to make, an independent verification or to assume responsibility for the accuracy, completeness or fairness of the information contained in this Offering Circular. DRI¢WEFA DRI*WEFA has been retained by the Corporation as an independent economic expert. The DRI*WEFA Report attached as Appendix A hereto is included herein in reliance on DRI*WEFA as experts in such matters. DRI*WEFA’s fees for acting as the Corporation’s independent economic consultant are not contingent upon the issuance of the Bonds. The DRI*WEFA Report should be read in its entirety. TOBACCO SETTLEMENT FINANCING CORPORATION By: /s/ Amadeo I.D. Francis Name: Amadeo I.D. Francis Title: Vice President & Treasurer November 8, 2001 105 INDEX OF DEFINED TERMS ACCOUMS 00... eeccceceeeeeseeeseeeeeeteeeteeenseceessesseseaeenaeneaes 78 DRI*WEFA Low Case 2...0.....ccccecceeeee cree ene eeeee 77 Accreted Value ........ccccccecceecceeeesetesteeerenenenes S-1, 78 DRI*WEFA Low Case 3.0.0... eeeceeeeeeeeeceeenees 77 ACU oeeececccecceeeeeeeeeeeeenteeteenenneeneeneteseneeseensesereeseasentes i, S-1 DRI*WEFA Repott.......cc cece eceeeeenenecneeneenes S-6, 55 Actual Operating Income .........ccccceeseeseeeetteeenes 31 DRI*WEFA’s 2000 Forecast «0.0.0... ccccceseeseeseeeees 55 Actual VOLUME .........:cecceceecceeereeeseeeecneeeeceeeaeeeeneeneens 30 DTC oon ieeceecceccecceceeneeneeeecnecneeeesesesaesnessecseeseeneens S-1, 16 Ancillary Contracts 00... cceceeceeeeeees eee enensessseeees 78 DTC Participants .......0..:ccceceeeeee teers eeneeeeeneeeneees 18 Annual Payment ...........eceeeseeeeeceecseenseenseeseenaes S-3 EC oo eeeeceeeecenecteeensceeeectecneceesetesneeteesneesseenseesaes 5,52 Attorney General ........ cece cece ceeceeeseerenertaeenees 12 Eligible Investment «0.0.0.0... cece cee eee eneeees 79 Authorized Officer... eee ce eee reernereeenees 78 EPA... eecceeceeeeeeeeeeeerneecneesaeceeetnetesecnsesseeseseaeseaeseaes 43 BSW occ eee eeenreteeenesnenenseesseenteesneceey S-2, 40 ETS oo ecceececceccceeeneeeeeneeeeeteetaeressseesessesseeneceeeseeseens 3, 42 Bankruptcy Code 0.0... ccceeeeececesceecesceseseneeeateeenee 5 Event of Default... cence eee S-8, 25 Base Aggregate Participating Manufacturer Extraordinary Prepayment ...............: cece S-9, 17 Market Share .........ce cece ee ec eeeesecsseenseeeeeaes 31 Extraordinary Prepayment Accoumt...............0000 22 Base Case Forecast ........0ccecccceeseeeeeeenecsseeseteseenaes 55 FDA oocceecceesceecececeeceeeeneceesceeeseeeerceeeeeeeseensenssessees 43 Base Operating INCOME... cece cee cereeeeeeeee 31 Federal Tobacco Legislation Offset.......0..... 32 Base Share .......cccceccceeccseeseeeeeeeseessceseseesneesnessaeenaes 33 FHLMC 000... eeceeceeceeeceeeeeeeeeeeeeeeneeeeseesseseessesnsenses 81 Base Volume........cccccccceecceeneesseeceseeeessecenssesseeessees 30 FICUciary .0..... eee cecceeeeeeeeeeeeeecneteeececeseeeeeeneeeeeeseeel 81 Beneficial Owner 0.0... cece eee eeseeteceeessereeeaes 18 Final Approval 00.00... cceceeceseececssesseseeeeesseeseeneens 35 Beneficiaries 0.0.0.0... eee eee e reece ecreetneeeneees 78 Financing Costs ......cceccseeceeseeeneetsseesrseeeeennseee 81 1310) 116000) (6 Co) pe 16, 78 Fiscal Year ........cccceccceecesseeeeseeeereeeneeseneeeees S-9, 22 |B 0) 16 (EEE S-1, 78 Foundation ..0...0ccecccccceeeceeeteeeesseseeesseeseetneseaeseaes 36 Business Day ........ccccccceecescecseeeeeesesseeeneenenees 16, 78 Guaranteed AMOUNM........... cece ceeecesseeeteeeseeseens 48 Capital Projects 0.00... ccc cece eer een ee erteeeeenaeees S-2 HOINde rs... ceccceccecececeeeeeeeceeeeeeneeenteeseneeesieeseneeseeen 78 CDC occ ccceeteceenereeeeeeeneeenecnscneseecsseeeeseteneeaee 58 INCIDENCE 00... eee eeeeeceeeteeeeceseeeceseseesaeeaeesessesscsseseeees 58 CIZALEUC ee ee eet eetereecteceeteeeeneceretsseseeesaseaeenaes 28 Income Adjustment..........0...0c cece erect eeeens 3] Closing Date ..........ccccceeceee sete erste eteseseseseeaeens S-1 Indenture .....0. ccc cccceeeeeseceeeeeeneeeeeesenteeceneesenneesae i, S-1 Ode... ce eceeeeeeceeceeeeeeteeeeeeneeeseessenseenueseseesenaes i, 78, 102 Indenture Trustee 0.0... cece cece eeetreeeeeneeees i, S-1 Collection ACCOUME ......cceeeceeeeee tee teeeeeetnseseessenaes 21 Indirect Participant... eee eeeecereeeeeteeeees 18 Collection Methodology and Assumptions............. 61 Inflation Adjustment ........00. ccc eee eee eeneee 30 Collections 0.0... ccc ecceceeteeceeneeeeseeteeeeeneeeeees i, S-1, 78 Initial Payment .20.0 ee eece eet eeeeeeeereeeeneeees S-3 Construction ACCOUNL oo... icc cc ees eee eeeeeneeeseenees 21 IRS occcccceccceeceeeeeeeeeneeeeseeeeneeesesneesieeesteeeeneeens 10, 104 Convertible CAB .0.....cececceececc cee cseereesteeeneereeenes i Junior Payments... cece ees eeee eee eee S-11, 23, 81 Convertible Capital Appreciation Serial LIC oo. cc ecceeeeeeeeeeeeeeeeteeeeeneeetsettetaeensessesseseeeed 81 1310) 0 (0 EEE 7] Liggett... eee cece cere ceeeneeeneeeeeneenteetseeeee 40 COrporatiOn oo. c cece ee ence ee erence ener etereeees i, S-1 Litigating Releasing Parties Offset ...........0..00 32 Counsel 0.0.0... cceccesssssssssssssssssssssssseeseeeeeeeeseeeseesseeeeess 78 Lorillard ooo... cccccccceeeecesssssssssssssssssseeeseeeseeeeeeees S-2, 40 CPC... eeccccecccec cece eeetceeeeeneecesneeeseneeeeenneeeennsiecenegs S-6 Lump Sum Payment 00.00... erreee S-9, 17 CPI oer ee eee enee sree ceceecssesseeeseeeseseeseeeenes 30 Lump Sum Prepayment ............ccccseseeeeeseees S-9, 86 Debt Service ACCOUNE oo... ec cer rete eeeeeeee 21 Majority in Interest .......0.. cece cesesseeteeeeeeneeeeeees 81 Debt Service Reserve Account ............. i, S-1, S-7, 21 Market Share.........ccccceecseceeeeceeeenseeeeseseteseeseesseenneees 33 Debt Service Reserve Requirement ................ S-7, 21 Maturity Date... eee ee eee cere eeeceeeeeeeeeeeeeeeee S-6 Default 0.00 ecnee cee crneeereenesneeeresnesresterenee 78 Maximum Rate .0....0... cece ec eee eee reereeeenseseeseeens 81 Defeasance Collateral .....0..0 ccc eect ereeeey 79 Model Statute 0.2... eee eeeeeesetseeeseeeeeseesseeseeens 37 Defeased Bonds ..........ccccceececeeeseeeeeteserneesneetneeiaes 79 MOOY’S oo. .eeeceeceseeeeeseeseesceseeseesseasesesaserersteareseesecas 104 Deposit Date 00... eee cece eeereeeee S-9, 22 MSA ooo eccccccceecceeceeceeeeecesceeceseesetseseaeesseseesseeseeenes i, S-1 Direct Participant ........ cece cece ce cree ereeneeneens 18 MSA Auditor oo... eee eee ceeeeseseeeeeeeseeseeeeneenes 7 Discount Bonds... cece eee er ren eee sesereseens 102 MSA Escrow Agent... cece eceeccceeseseeeneeeneeees S-3, 28 Distribution Date 20.00... eee ener erie S-6, 79 MSA Escrow Agreement ...........ccccecceseeeeeeeeneees 28 DRICWEFA........cecececeeceecereeeretee terre cesseteeesenaseneens S-5 NAAG Le ceceececeete cee eneererecneceeesaceecnsensseecseceesseesesates 26 DRIeWEFA High Forecast ............ cece eee 77 1934 ACE oe eeceeeeeecneeeeeteecseenseesuessesssesaeenees 100 DRI*WEFA Low Case 1 oo... ec eeeeeeeer renee eeeees 77 Non-Participating Manufacturers.....00...0. ce S-3 Non-Released Parties ......0....0.cccccecsccessecesseeesseesseess 33 Non-Settling States Reduction.......0cccccccceeeeees 31 North American oo... cecccsesescsesscessessesesesssscseeseaees 8 NP oececcccccessesesessesessnessesecseeenesseseeseseseesssesecasstereasess 52 NPM Adjustment .0..0...ccccccccccccsccscesecsesseesensevaeeaee 31 NPM Adjustment Reserve Account...... i, S-2, S-8, 22 NPMS 200. ccccsceceececeseescesessesesseescsssssssessessssceaseasacens S-3 Offset for Claims-Over .......ccccccceccceseescesvseeeees 33 Offset for Miscalculated or Disputed PAyMeMt oo. .eeeceeeeeeeseseeseeeeseeeteecsecssesssscsescatens 32 Operating ACCOUNL........ ccc cscesesscsceseeesseeacens 22 Operating Cap....cccccccceccsscssccsseesseeees S-10, 23, 81 Operating Expenses ......c.ccccccccceesscscsesessesessenseaees 81 Opinion of Counsel 0.0... ccceccsscceccsscsesssecescnseseeaees 82 OPMS 0... cece eceeeeseseeetetetseseseseseseetssesstssecsesenes S-2 Original Participating Manufacturers ...............0.0. S-2 Outstanding Bonds..........ceecceeesessesescesessseseeseseeees 82 Parity Payment .....0...cecccccccscseseescscssescscscescsssussenens 82 Participating Manufacturers...........ccccccceeseseeeees 8-3 Permitted Indebtedness ..........ccccccccesscsscsecsseeeesees 82 Philip MOPvis........cccccccccccsccscsscsscsscscesesssseceeeeees $-2, 39 PMS ooo cecceeseeeeseeseeseteceesessesecseeseeeees i, S-1, S-3, 26 Premium Bonds .........ccccccccsseseesesecscseeessescescseseseeas 102 Previously Settled States Reduction ..........c0cccc0 31 Previously-Settled States ......cccccccceccsssseeseees 26 PHINCipal oo. eeeeeeeeeeeseseesesessecsessecsessesesecsscsscaceseneeas i Priority PayMent...........ceecsesesesessescseeecsesceecscssesens 82 PLOCEECING oo. ec ccceceeseeseeeesesseesesecsecscescsscsecsensens 101 Purchase Agreement ..0.......cccccccssssescssssessssessseees i, S-1 Purchase Consideration........0...cccccccccccscssssseseecseeseee 82 Qualifying Statute 0... cc ccecececcecseescseseeetensens 37 Rated Swap o...cccccccceccesesecsesetseseescscsesscsesscsssesesaes 82 Rating Confirmation .........000.0ccccccecsseecesseeeees S-8, 18 Record Date .......cccec ccc ccecccesesseeessecesseeecsasesseece 16, 82 Relative Market Share .....0..cccccccssceseeessesereeees 28 Released Parties 0.00... cccccccssescsscsessesesssessssessesesens 27 Released Party .........c cc eccceeeeceseesseseessesseesseseeseens 27 Releasing Parties .......0.ccececccccssssesesessceeessesesssecsens 27 RESELVES ...occee ce eecccccseeseeseeeeeeeseeseesesesseeassecensseseees i, S-2 Responsible Officer ........ccccecseeseeeeseeeeseseeseseeees 78 Reynolds Tobacco 0.0... ceceseeeesessssceeeesssesees S-2, 39 RICO. cece cccceceneneesenetsesenecssseecsesecsesesscseessecsens 4 Serial Maturity/Sizing Amounts for Term Bond Maturities debt service coverage TAUIO cece cece eeeeeeeeeeseeeseessseeseesscsecstcseessvsessveceess 70 N18 (he S-12 Series 2001 Bonds ......ccccccccccsescseseseneeees i, S-1, 83 Settling States 0... ccccccccsecscsccscsscstscestavseeees S-2 OA ee S-3, 26 State Defendant ....0... ccc ccccccescsscescesesseesesceeeeeeas 13 State Trial Court .0....ccccccccccscccessceseessessnsceeeees 4, 48 State-Specific Finality 000.0. ccccccceseeeeeeee ese 35 Stipulating Defendants... ccceccescesteee sees 48 Stipulation... cc ccecesesccscseesesessessscesescsssssssvesees 48 Strategic Contribution Fund Payments .................. S-3 Structuring ASSuMptiONS............:ccccecesssseseeseseeeees 61 Subsequent Participating Manufacturers ............... S-3 Surplus Collections .........000ccceceee eee S-7, S-11, 24 SWAP ooeccscccectececeecnecneeeeescsecsecsessecstssssscseeecseseasens 83 Swap Contract... ccccceeeeteeseeeseeeessetecssseeseees 83 Term Bond oo... ccccceseeeessssessssesesecacseescscsesscseeevsenavaes i TERP ooo cccenecneeeeseeeeeseesecseassessecsessssscseeneeas 44 Tobacco ASSCts oo... cccccecceecseseescesesecscssesessesccsevseeees 83 Tobacco Bonds ..0....eecececcessesesccseeseessesesecsecsceseeens 83 Tobacco Product... cccceccesecscsecsesssesssecsessceseasenees 36 Tobacco Settlement Revenues ...........c.ccccceeeeseeeeees 20 TPMS 00. ee ceeccesesseseeseeecsscsscsecssesesscsecsevecsscsevaesarvaseaes 8 Transaction Counsel ........ccccccccsccsssssesessesecseeseneens 83 Transaction Documents ..........ccccccccccceeesessesseeeeeees 83 TSRS occ eeeceeteceeeeseeseeteeeseessessesseeaee i, S-1, 1, 20, 83 Turbo Redemption Account........ccccccccceceeeseeee 22 Turbo Redemption Date........0..cccccccecsceeeeeeeeees S-7 Turbo Redemptions ............ccccccceceeeseseeeees i, S-7, 17 2001 Annual Payment... cccccceccccseescesenecees S-8 Undertaking oo... ccc cceeeeenscseeetssestsssssnsceees 101 Underwriting Agreement ........0.0..cccccececceeseeeeeees 83 United States oo... ccccccccsseesseesseesseesscesenseenees 28 USDA wee cceseesesecseeseseseeesscssessescsesevassaseasees 41,57 USDA-CERS 0c cectecscsececsesscssscssescesesenseees 4] Virgin Islands... eececcccsscsecsecsccssesesesscesesseaseas i, S-1 Volume Adjustment........cccccccceceesseseseessensenes 30 Wachovia Securities .......cccccccccscceccceesscesesceseesens 105 (THIS PAGE WAS INTENTIONALLY LEFT BLANK) APPENDIX A DRI*¢WEFA REPORT (THIS PAGE WAS INTENTIONALLY LEFT BLANK) A Forecast of U.S. Cigarette Consumption (2000-2030) for the Tobacco Settlement Financing Corporation Submitted to: Tobacco Settlement Financing Corporation Prepared by: DRIeWEFA, Inc. October 19, 2001 Jim Diffley Group Managing Director Jeannine Gill o ¢@ Sete e %e Economist 2 oe + 6 Pea A Global Insight Company DRIeWEFA, Inc. 800 Baldwin Tower Eddystone, PA 19022 (610) 490-2642 FAX: (610) 490-2770 Copyright © 2001 DRI@WEFA, Inc. Executive Summary DRIeWEFA has developed a cigarette consumption model based on historical U.S. data between 1965 and 1999. This econometric model, coupled with our long term forecast of the U.S. economy, has been used to project total U.S. cigarette consumption from 2000 through 2030. Our Base Case Forecast indicates that total consumption in 2030 will be 248 billion cigarettes (approximately 12 billion packs), a 43% decline from the 1999 level. We also present alternative forecasts that project higher and lower paths of cigarette consumption. Under these. less likely scenarios, we forecast that by 2030 US cigarette consumption could be as low as 228 billion and as high as 261 billion cigarettes. In addition, we also present scenarios with more extreme variations in assumptions for the purposes of illustrating alternative paths of consumption. Our model was constructed from widely accepted economic principles and DRIeWEFA’s long experience in building econometric forecasting models. A review of the economic research literature indicates that our model is consistent with the prevalent consensus among economists concerning cigarette demand. We considered the impact ot demographics, cigarette prices, disposable income, employment and unemployment, industry advertising expenditures, the future effect of the incidence of smoking amongst underage youth, and qualitative variables that captured the impact of anti-smoking regulations, legislation, and health warnings. After extensive analysis, we found the following variables to be effective in building an empirical model of adult per capita cigarette consumption: real cigarette prices. real per capita disposable personal income, the impact of restrictions on smoking in public places, and the trend over time in individual behavior and preferences. The projections and forecasts are based on reasonable assumptions regarding the future paths of these factors. This forecast, in the short-term, differs slightly from the one presented by DRIeWEFA in 2000 (*DRIeWEFA’s 2000 Forecast’). In the year 2000, lower than expected prices, resulted in higher than expected consumption. After examining manufacturers’ shipment data for the year, DRIleWEFA now estimates a consumption level for year 2000 of 423 billion, 12 billion more than DRIeWEFA’s 2000 forecast. DRIeWEFA has also revised its year 2001 consumption projection upwards, to 408 billion from 401 billion. The long term forecast is identical to DRleWEFA’s 2000 forecast. Disclaimer The projections and forecasts regarding future cigarette consumption included in this Report are estimates which have been prepared on the basis of certain assumptions and hypotheses. No representation or warranty of any kind is or can be made with respect to the accuracy or completeness of, and no representation or warranty should be inferred from, these projections and forecasts. The projections and forecasts contained in this Report are based upon assumptions as to future events and, accordingly, are subject to varying degrees of uncertainty. Some assumptions inevitably will not materialize and, additionally, unanticipated events and circumstances may occur. Therefore, actual A-2 cigarette consumption inevitably will vary from the projections and forecasts included in this Report and the variations may be material and adverse. Historical Cigarette Consumption People have used tobacco products for centuries. Tobacco was first brought to Europe from America in the late 15"" century and became America's major cash crop in the 17" and 18" centuries’. Prior to 1900, tobacco was most frequently used in pipes, cigars and snuff. With the widespread production of manufactured cigarettes (as opposed to hand- rolled cigarettes) in the United States in the early 20" century, cigarette consumption expanded dramatically. Consumption is defined as taxable United States consumer sales, plus shipments to overseas armed forces, ship stores, Puerto Rico and other United States possessions, and small tax-exempt categories’ as reported by the Bureau of Alcohol Tobacco and Firearms. The United States Department of Agriculture (“USDA”), which has compiled data on cigarette consumption since 1900, reports that consumption grew from 2.5 billion in 1900 to a peak of 640 billion in 1981°. Consumption declined in the 1980's and 1990's, reaching a level of 465 billion cigarettes in 1998 and 435 billion cigarettes in 1999*. 1999 is the latest year for which the USDA has estimated cigarette consumption. The USDA currently projects that 430 billion cigarettes were consumed in 2000, based on tax data for the first three quarters of the year. ' Source: “Tobacco Timeline,” Gene Borio (1998). * Bureau of Alcohol, Tobacco and Firearms reports as categories such as transfer to export warehouses, use of the U.S., and personal consumption/experimental. * Source: “Tobacco Situation and Outlook”, U.S. Department of Agriculture-Economic Research Service, September 1999 (USDA-ERS). * Source: USDA-ERS A-3 Historical U.S. Cigarette Consumption: 1945-1999 700 600 7 G 3 § 500- nd g 400° 300 5 200 TUTTTTTTTTTTTrrrrrrsrsrrsr rr rT rer rrr rT rv Trev ver FPF rT vr PT TT rT 1945 1955 1965 1975 1985 1995 —— Total Consumption While the historical trend in consumption prior to 1981 was increasing, there was a decline in cigarette consumption of 9.82% during the Great Depression between 1931 and 1932. Notwithstanding this steep decline, consumption rapidly increased after 1932, exceeding previous levels by 1934. Following the release of the Surgeon General's Report in 1964, cigarette consumption continued to increase at an average annual rate of 1.20% between 1965 and 1981. Between 1981 and 1990, however, cigarette consumption declined at an average annual rate of 2.18%. From 1990 to 1998, the average annual rate of decline in cigarette consumption was 1.51%; but for 1998 the decline increased to 3.13% and then the decline for 1999 accelerated to 6.45%. These sharp recent declines are correlated with large price increases in 1998 and 1999. Adult per capita cigarette consumption (total consumption divided by the number of people 18 years and older) began to decline following the Surgeon General’s Report in 1964. Population growth offset this decline until 1981. The adult population grew at an average annual rate of 1.86% for the period 1965 through 1981, 1.17% from 1981 to 1990 and 1.02% from 1990 to 1999. Adult per capita cigarette consumption declined at an average annual rate of 0.65% for the period 1965 to 1981, 3.31% for the period 1981 to 1990 and 2.47% for the period 1990 to 1998. In 1998 the per capita decline in cigarette consumption was 4.21% and in 1999 the decline accelerated to 7.50%. These sharp recent declines are correlated with large price increases in 1998 and 1999. All percentages are based upon compound annual growth rates. The following table sets forth United States domestic cigarette consumption for the five years ended December 31, 1999°. The data in this table varies from statistics on cigarette shipments in the United States. While our Report is based on consumption, payments made under the Master Settlement Agreement dated November 23, 1998 (MSA) between certain cigarette manufacturers and certain settling states are computed based in part on shipments in or to the fifty United States, the District of Columbia and Puerto Rico. The quantities of cigarettes shipped and cigarettes consumed may not match at any given point in time as a result of various factors such as inventory adjustments, but are substantially the same when compared over a period of time. U.S. Cigarette Consumption Year Ended December 31, Consumption Percentage Change (Billions of Cigarettes) 1999 435 -6.45 1998 465 -3.13 1997 480 -1.44 1996 487 0.00 1995 487 0.21 The US Cigarette Industry The cigarette market is an oligopoly in which, according to Philip Morris, the four leading manufacturers accounted for over 94% of the market in 2000. These top four companies in shipments were Philip Morris, RJ Reynolds, Brown & Williamson, and Lorillard, who occupied 50.5 percent, 23.0 percent, 11.7 percent, and 9.6 percent of the market respectively, as reported by Philip Morris. The United States government has raised revenue through tobacco taxes since the Civil War. Although the federal excise taxes have risen through the years, excise taxes as a percentage of total federal revenue have fallen from 3.4 percent in 1950 to approximately 0.5 percent today. In 2000, the federal government received $7.5 billion in excise tax revenue from tobacco sales. In addition, state and local governments also raise significant revenues, $8.7 billion in 2000, from excise and sales taxes. Cigarettes constitute the majority of these sales, which include cigars and other tobacco products. ° Source: USDA-ERS. Survey of the Economic Literature on Smoking A number of organizations have conducted studies on United States cigarette consumption. These studies have utilized a variety of methods to estimate levels of smoking, including interviews and/or written questionnaires. Although these studies have tended to produce varying estimates of consumption levels due to a number of factors, including different survey methods and different definitions of smoking, taken together such studies provide a general approximation of consumption levels and trends. Set forth below is a brief summary of some of the more recent studies on cigarette consumption levels. Incidence of Smoking Approximately 46.5 million American adults were current smokers in 1999, representing approximately 23.5% of the population age 18 and older, according to a Centers for Disease (ontrol and Prevention (“CDC”) study° released in October 2001. This survey defines "current smokers" as those persons who have smoked at least 100 cigarettes in their lifetime and who smoked every day or some days at the time of the survey. Although the percentage of adults who smoke (incidence) declined from 42.4% in 1965 to 25.5% in 1990,’ the incidence rate declined relatively slowly through the next decade. The National Center for Health Statistics presents a preliminary estimate of adult incidence for 2000 of 23.3%." Certain studies have focused in whole or in part on youth cigarette consumption. Surveys of youth typically define a "current smoker" as a person who has smoked a cigarette on one or more of the 30 days preceding the survey. The CDC's Youth Risk Behavior Survey estimated that from 1991 to 1999 incidence among high school students (grades 9 through 12) rose from 27.5% to 34.8%, representing an increase of 26.5%.’ According to the Monitoring the Future Study, a school-based study of cigarette consumption and drug use conducted by the Institute for Social Research at the University of Michigan, smoking incidence among eighth, tenth and twelfth graders was lower in June 2000 than in June 1999. However, incidence levels for 10" and 12" graders continue to remain higher than in June 1991 '° Smoking incidence for 8" graders has fallen to near its level in 1991. ® Source: CDC. Morbidity and Mortality Weekly Report, “Cigarette Smoking Among Adults — United States. 1999,” October 12, 2001. ” Source: CDC, Office on Smoking and Health. ’ Source: National Center for Health Statistics, National Health Interview Survey. September 20, 2001 * Source: CDC. Morbidity and Mortality Weekly Report, “Youth Risk Behavior Surveillance — United States, 1999,” June 9, 2000. '” Source: Monitoring the Future Study. A-6 Prevalence of Cigarette Use Among 8", 10", and 12" Graders Grade June 1991 June 1999 June 2000 “99-00 ‘91-00 Change (%) | Change (%) gn 14.3 17.5 14.6 -16.6 2.10 10" 20.8 25.7 23.9 -7.0 14.90 12" 28.3 34.6 31.4 -9,3 10.95 The 2000 Household Survey on Drug Abuse conducted by the Substance Abuse and Mental Health Services Administration of the United States Department of Health and Human Services estimated that approximately 55.7 million Americans age 12 and older were current cigarette smokers (defined by this survey to mean they had smoked cigarettes at least once during the 30 days prior to the interview). This estimate represents an incidence rate of 24.9%, which is a decrease from 25.8% in 1999. The same survey found that an estimated 13.4% of youths age 12 to 17 were current cigarette smokers in 2000, a decrease from 14.9% in 1999. Price Elasticity of Cigarette Demand The price elasticity of demand reflects the impact of changes in price on the demand for the product. Cigarette price elasticities from recent conventional research studies have generally fallen between an interval of -0.3 to -0.5.'' (In other words, as the price of cigarettes increases by 1.0% the quantity demanded decreases by 0.3% to 0.5%.) A few researchers have estimated price elasticity as high as -1.23. Research focused on youth smoking has found price elasticity levels of up to -1.41. Two studies recently published by the National Bureau of Economic Research examine the price elasticity of youth smoking. In their study on youth smoking in the United States, Gruber and Zinman estimate an elasticity of smoking participation (defined as smoking any cigarettes in the past 30 days) of -0.67 for high school seniors in the period 1991 to 1997.'* That is, a 1% increase in cigarette prices would result in a decrease of 0.67% in the number of those seniors who smoked. The study’s findings state that the drop in cigarette prices in the early 1990’s can explain 26% of the upward trend in youth smoking during the same period. The study also found that price has little effect on the smoking habits of younger teens (8" grade through 11" grade), but that youth access restrictions have a significant impact on limiting the extent to which younger teens smoke. Tauras and Chaloupka also found an inverse relationship between price and "' Chalpouka FJ,Warner KE:P.5. 2 Source: Gruber, Jonathon and Zinman, Jonathon. “Youth Smoking in the U.S.:Evidence and Implications”. Working Paper No. W7780, National Bureau of Economic Research, 2000. A-7 cigarette consumption among high school seniors.'* The price elasticity of cessation for males averaged 1.12 and for females averaged |.19 in this study. These estimates imply that a 1% increase in the real price of cigarettes will result in an increase in the probability of smoking cessation for high school senior males and females of 1.12% and 1.19%, respectively. In another study, Czart et al (2001) looked at several factors which they felt could influence smoking among college students. These factors included price, school policies regarding tobacco use on campus, parental education levels, student income, student marital status, sorority/fraternity membership, and state policies regarding smoking. The authors considered two ways in which smoking behavior could be affected: (1) smoking participation; and (2) the amount of cigarettes consumed per smoker. The results of the study suggest that, (1) the average estimated price elasticity of the smoking participation is —0.26, and (2), the average conditional demand elasticity 1s —0.62. These results indicate that a 10% increase in cigarette prices, will reduce smoking participation among college students by 2.6% and will reduce the level of smoking among current college students by 6.2%." Tauras et al (2001) conducted a study that looked at the effects of price on teenage smoking initiation.'* The authors used data from the Monitoring the Future study which examines smoking habits. among other things, of 8", 10". and 12" graders. They defined smoking initiation in three different ways: smoking any cigarettes in the last 30 days, smoking at least 1-5 cigarettes per day on average, or smoking at least 2 pack per day on average. The results suggest that the estimated price elasticites of initiation are -0.27 for any smoking, -0.81 for smoking at least 1-5 cigarettes, and —0.96 for smoking at least one-half pack of cigarettes. These results above indicate that a 10% increase in the price of cigarettes will decrease the probability of smoking initiation between approximately 3% and 10% depending on how initiation is defined. Nicotine Replacement Products Nicotine replacement products, such as Nicorette Gum and Nicoderm patches, are used to aid those who are attempting to quit smoking. Before 1996, these products were only available with a doctor’s prescription. Currently, they are available as over-the-counter products. One study, by Hu et al., examines the effects of nicotine replacement products on cigarette consumption in the United States.'° One of the results of the study found '* Source: Tauras, John A. and Chaloupka, Frank, J.. “Determinants of Smoking Cessation: An Analysis of Young Adult Men and Women.” Working Paper No. W7262. National Bureau of Economic Research, 1999, '* Czart et al. “The impact of prices and control policies on cigarette smoking among college students”. Contemporary Economic Policy, Western Economic Association. Copyright April 2001. 'S Tauras et al. “Effects of Price and Access Laws on Teenage Smoking Initiation: A National Longitudinal Analysis”. University of Chicago Press. Copyright 2001. '© Hu et al. “Cigarette consumption and sales of nicotine replacement products”. TC Online, Tobacco Control. http:\\tc.bmjjournals.com. A-8 that, “a 0.076% reduction in cigarette consumption is associated with the availability of nicotine patches after 1992.” Workplace Restrictions In their 1996 study on the effect of workplace smoking bans on cigarette consumption, Evans, Farrelly, and Montgomery found that between 1986 and 1993 smoking participation rates among workers fell 2.6% more than non-workers.’’ Their results suggest that workplace smoking bans reduce smoking prevalence by 5 percentage points and reduce consumption by smokers nearly 10 percent. The authors also found a positive correlation between hours worked and the impact on smokers in workplaces that have smoking bans. The more hours per day that a smoker spends working in an environment where there are smoking restrictions, the greater is the decline in the quantity of cigarettes consumed by that smoker. Factors Affecting Cigarette Consumption Most empirical studies have found a common set of variables that are relevant in building a model of cigarette demand. These conventional analyses usually evaluate one or more of the following factors: (i) general population growth, (ii) price increases, (111) changes in disposable income, (iv) youth consumption, (v) trend over time, (vi) smoking bans in public places, (vii) nicotine dependence and (viii) health warnings. While some of these factors were not found to have a measurable impact on changes in demand for cigarettes, all of these factors are thought to affect smoking in some manner and to be incorporated into current levels of consumption. General Population Growth. DRIeWEFA forecasts that the United States population will increase from approximately 272 million in 1999 to approximately 351 million in 2030. This forecast is consistent with the Bureau of the Census forecast based on the 1990 Census. On December 28, 2000 the Bureau reported results from the 2000 Census that estimate the US population on April 1, 2000 to be 281 million. We have not yet incorporated this data into our analysis because it has yet to be reconciled, by the Bureau, to its 1990 estimate. That 1990 Census estimate likely suffered from a significant undercount of population. As the USDA, in its estimate of per capita consumption, also uses estimates based on the 1990 Census, our forecast is consistent with the USDA history. When the final population data from 1990 to 2000 is released it is expected to show that per capita consumption of cigarettes was slightly lower than originally thought, '? Source: Evans, William N.; Farrelly, Matthew C.; and Montgomery, Edward. “Do Workplace Smoking Bans Reduce Smoking?”. Working Paper No. W5567, National Bureau of Economic Research, 1996. but that its growth trend is the same. We do not expect the revised population and per capita consumption levels to affect our forecast of total cigarette consumption. Price Elasticity of Demand and Price Increases. Cigarette price elasticities from recent conventional research studies have generally fallen between an interval of -0.3 to -0.5. Based on DRIeWEFA’s multivariate regression analysis using data from 1965 to 1999, the long run price elasticity of consumption for the entire population is -0.31; a 1.0% increase in the price of cigarettes decreases consumption by 0.31%. In 1998, the average price of a pack of cigarettes in nominal terms was $2.20. This increased to $2.88 per pack in 1999, representing a nominal growth in the price of cigarettes of 30.9% from 1998. During 1999, consumption declined by 6.45%. This was primarily due to a $0.45 per pack increase in November 1998 intended to offset the costs of the MSA and agreements with previously settled states. The cigarette manufacturers have since increased wholesale prices on five occasions: in August 1999 by $0.18 per pack, in January 2000 by $0.13 per pack, in July 2000 by $0.06 per pack, in December 2000 by $0.14 per pack, and most recently on April 25, 2001 by $0.14 per pack. In addition to the wholesale increases, New York increased its state excise tax by $0.50 per pack, to $1.11; this followed a similar 1999 increase in California of $0.50. In 2001, Maine, Rhode Island, West Virginia, and Wisconsin have all increased their tax on cigarettes. The average state excise tax 1s now over $0.40 per pack. As a result of these increases we estimate that average retail prices across the U.S. have risen, in September 2001, to approximately $3.60 per pack. For the year 2000, we estimate that the average price per pack was $3.20, representing a nominal growth in the price of cigarettes of 11.0% from 1999. Prices are expected to continue to increase due to costs related to the MSA and an increase in the federal excise tax of $0.05 per pack scheduled for 2002, among other reasons. Premium brands are typically $0.50 to $1.00 more expensive per pack than discount brands, allowing a margin for consumers to switch to less costly discount brands in the event of price increases. Under the MSA, volume adjustments to payments are based on the quantity (and not the price or type) of cigarettes shipped. Changes in Disposable Income. Analyses from many conventional models also include the effect of real personal disposable income. Most studies have found cigarette consumption in the United States increases as disposable income increases.'* However, a few studies found cigarette consumption decreases as disposable income increases.'” Based on our multivariate regression analysis using data from 1965 to 1999, the income elasticity of consumption is 0.27; a 1.0% increase in real disposable income per capita increases per capita cigarette consumption by 0.27%. Youth Consumption. The number of teenagers who smoke is another likely determinant of future adult consumption. While this variable has been largely ignored in empirical studies of cigarette consumption ~’ almost all adult smokers first use cigarettes by high * Ippolito, et al.; Fuji. 'Y Wasserman, et al.; Townsend et al. ““ Except for those, such as Wasserman. et al. that studied the price elasticity for different age groups. A- 10 school and very little first use occurs after age 20.” One study examines the effects of youth smoking on future adult smoking.” The study found that between 25% and 50% of an increase or decrease in youth smoking would persist into adulthood. According to the study, several factors may alter future correlation between youth and adult smoking: there are better means for quitting smoking than in the past, and there are more workplace bans in place that will affect those who are currently in their teen years. We have compiled data from the CDC which measures the incidence of smoking in the 12-17 age group as the percentage of the population in this category that first become daily smokers. This percentage, after falling since the early 1970s, began to increase in 1990 and increased through the decade. We assume that this recent trend has reached its peak, and that youth smoking will resume its longer-term decline. Trend Over Time. Since 1964 there has been a significant decline in U.S. adult per capita cigarette consumption. The Surgeon General’s health warning (1964) and numerous subsequent health warnings, together with the increased health awareness of the population over the past thirty years, may have contributed to decreases in cigarette consumption levels. If, as we assume, the awareness of the adult population continues to change in this way, overall consumption of cigarettes will decline gradually over time. Our analysis includes a time trend variable in order to capture the impact of these changing health trends and the effects of other such variables which are difficult to quantify. Health Warnings. Categorical variables also have been used to capture the effect of different time periods on cigarette consumption. For example, some researchers have identified the United States Surgeon General's Report in 1964 and subsequent mandatory health warnings on cigarette packages as turning points in public attitudes and knowledge of the health effects of smoking. The Cigarette Labeling and Advertising Act of 1965 required a health warning to be placed on all cigarette packages sold in the United States beginning January 1, 1966. The Public Health Smoking Act of 1969 required all cigarette packages sold in the United States to carry an updated version of the warning, stating that it was a Surgeon General’s warning, beginning November 1, 1970. The Comprehensive Smoking Education Act of 1984 led to even more specific health warnings on cigarette packages. The dangers of cigarette smoking have been generally known to the public for years. Part of the negative trend in smoking identified in our model may represent the cumulative impact of various health warnings since 1966. Smoking Bans in Public Places. Beginning in the 1970s numerous states have passed laws banning smoking in public places as well as private workplaces. As of 1999, 48 states and the District of Columbia required smoke-free indoor air to some degree or in some public places.’ Based on the regression analysis using data from 1965 to 1999, the restrictions on public smoking appear to have an independent effect on per capita *! Source: Surgeon General’s 1994 Report, “Preventing Tobacco Use Among Young People.” *2 Source: Gruber, Jonathon and Zinman, Jonathon. “Youth Smoking in the U.S.:Evidence and Implications”. Working Paper No. W7780, National Bureau of Economic Research, 2000. 3 Source: American Lung Association, “State Legislated Actions on Tobacco Issues”, 1999. A- 11 cigarette consumption. We estimate that the restriction instituted beginning in the late 1970’s has reduced smoking by about 2%. However, the timing of the restrictions within and across states makes such statistical identification difficult. The trend variable included in our econometric analysis is likely to incorporate some part of the cumulative impact of the various smoking bans and restrictions. Nicotine Dependence. Nicotine is widely believed to be an addictive substance. The Surgeon General”* and the American Medical Association” (AMA) both conclude that nicotine is an addictive drug which produces dependence. The American Psychiatric Association has determined that cigarette smoking causes nicotine dependence in smokers and nicotine withdrawal in those who stop smoking. The American Medical Association Council on Scientific Affairs found that one third to one half of all people who experiment with smoking become smokers. Other Considerations In August, 1999 the CDC published Best Practices for Comprehensive Tobacco Control Programs. Citing the success of programs in California and Massachusetts, the CDC recommends comprehensive tobacco control programs to the states. On August 9, 2000 the Surgeon General issued a report, Reducing Tobacco Use (“Surgeon General’s Report”), that comprehensively assesses the value and efficacy of the major approaches that have been used to reduce tobacco use. The report concludes that a comprehensive program of educational strategies, treatment of nicotine addiction, regulation of advertising, clean air regulations, restriction of minors’ access to tobacco, and increased excise taxation can significantly reduce the prevalence of smoking. The Surgeon General called for increased spending on anti-smoking initiatives by states, up to 25% of their annual settlement proceeds, which is far higher than the approximately 9% allocated from the first year’s settlement payments. The Surgeon General’s Report documents evidence of the effectiveness of five major modalities for reducing tobacco use. Educational strategies are shown to be effective in postponing or preventing adolescent smoking. Pharmacologic treatment of nicotine addiction, combined with behavioral support, can enhance abstinence efforts. Regulation of advertising and promotional activities of manufacturers can reduce smoking, particularly among youth. Clean air regulations and restricted minor’s access contribute to lessening smoking prevalence. And excise tax increases will reduce cigarette consumption. In May 2001, a Commission, established by President Clinton in September 2000, released its final report on how to improve economic conditions in tobacco dependent ** Source: Surgeon General’s 1988 Report, “The Health Consequences of Smoking — Nicotine Addiction”. ** Source: Council on Scientific Affairs, “Reducing the Addictiveness of Cigarettes, “Report to the AMA House of Delegates, June 1998. economies while making sure that public health does not suffer in the process.*° The Commission recommended moving from the current quota system to what would be called a Tobacco Equity Reduction Program (TERP). TERP would allow compensation to be rendered to quota growers for the loss in value of their quota assets as a result of a restructuring to a production permit system where permits would be issued annually to tobacco growers. Also created would be a Center for Tobacco-Dependent Communities, which would address any challenges faced during this period. Three public health proposals that were suggested by the Commission were: that states increase funding on tobacco cessation and prevention programs; that the FDA be allowed to regulate tobacco products in a “fair and equitable” manner; and that funding be included in Medicaid and Medicare coverage for smoking cessation. To be able to fund these recommendations, the Commission calls for a 17-cent increase in the excise tax on all packs of cigarettes sold in the United States. The increased revenues would then be deposited into a fund and earmarked for the recommended programs. Our research has indicated, and our model incorporates, a negative impact on cigarette consumption of tobacco tax increases, and a negative trend decline in levels of smoking since the Surgeon General’s 1964 warning, subsequent anti-smoking initiatives, and regulations which restrict smoking. Our model and forecast acknowledges the efficacy of these activities in reducing smoking and assumes that the effectiveness of such anti- smoking efforts will continue. As the prevalence of smoking declines, it is likely that the achievement of further declines requires either greater levels of spending, or more effective programs. This is the common economic principle of diminishing returns. New York State, in 2000, mandated that manufacturers provide, by 2003, only cigarettes that self-extinguish. We expect that an agreement will be reached by then on a nationwide standard. We do not believe that either the New York statute or a nationwide agreement will impact consumption noticeably. It will probably raise the cost of manufacture slightly, but we view it as a continuation of a long series of government actions that contribute to the trend decline in consumption which has been incorporated into our model. Similarly, on January 16, 2001, Vector Group Ltd. announced plans to introduce a virtually nicotine-free cigarette. This non-addictive product might be used as a tool to quit or reduce smoking. We view this as a continuation of efforts to provide products, such as the nicotine patch, that are supposed to reduce smoking addiction. These products have likely contributed to the trend decline in consumption incorporated into our model. In our forecast we expect such efforts to continue to reduce per capita cigarette consumption. 6 “Tobacco at a Crossroad: A Call for Action”. President’s Commission on Improving Economic Opportunity in Communities Dependent on Tobacco Production While Protecting Public Health, May 14, 2001. A-13 An Empirical Model of Cigarette Consumption An econometric model is a set of mathematical equations which statistically best describes the available historical data. It can be applied, with assumptions on the projected path of independent explanatory variables, to predict the future path of the dependent variable being studied, in this case adult per capita cigarette consumption (CPC). After extensive analysis of available data measuring all of the above-mentioned factors which influence smoking, we found the following variables to be effective in building an empirical model of adult per capita cigarette consumption for the United States: 1) the real price of cigarettes (cigprice) 2) the level of real disposable income per capita (ydp96pc) 3) the impact of restrictions on smoking in public places (smokeban) 4) the trend over time in individual behavior and preferences (trend) We used the tools of standard multivariate regression analysis to determine the nature of the economic relationship between these variables and adult per capita cigarette consumption in the U.S. Then, using that relationship, along with DRIeWEFA’s standard adult population growth, and adjustment for non-adult smoking, we projected actual cigarette consumption (in billions of cigarettes) out to 2030. It should also be noted that since our entire dataset incorporates the effect of the Surgeon General’s health warning (1964), the impact of that variable too is accounted for in the forecast. Similarly the effect of nicotine dependence is incorporated into our entire dataset and influences the trend decline. Using U.S. data from 1965 through 1999 on the variables described above, we developed the following regression equation. All of the data sources are detailed in Appendix 1 of this Report. log (epc) = 53.3410 - 0.02316 * trend - 0.21193 * log (cigprice) - 0.09367 * log (cigprice)(-1) + 0.26979 * log (ydp96pc) - 0.01901 * smokeban The model is estimated in logarithmic form, since that allows the easy computation of the responsiveness (or elasticity) of the dependent variable (adult per capita cigarette consumption) to changes in the various explanatory (or the right hand side) variables. This model has an R-square in excess of 0.99, meaning that it explains more than 99 per cent of the variation in US adult per capita cigarette consumption over the 1965 to 1999 period. In terms of explanatory power this indicates a very strong model with a high level of statistical significance. A- 14 Our model is completed with two other equations: (1) Total adult cigarette consumption = cpe * U.S. adult population. (2) Total cigarette consumption = total adult cigarette consumption + total youth cigarette consumption. We have measured the consumption level of cigarettes in the 12-17 age group by examining the difference between total consumption and total adult consumption. We then use the expected trend of youth smoking incidence to adjust for the volume of cigarette consumption in this age group. We estimate youth consumption in 1999 of 5.92 billion cigarettes. Youth incidence is expected to gradually decline after 2002, and our estimated consumption levels will gradually fall to 3.70 billion in 2030. Dependent Variable Adult Per Capita Cigarette Consumption (CPC) CPC measures the average annual cigarette consumption of the American adult. It is calculated by dividing total adult cigarette consumption by the size of the population 18 and above. Of the different measures of cigarette consumption available, this is considered to be the most reliable. It also directly reflects the changing behavior of individual smokers over the historical period. Data were obtained from the U.S. Department of Agriculture’s (USDA) Economic Research Service. Explanatory Variables The Real Price of Cigarettes (CIGPRICE) Reliable data on retail cigarette prices from the consumer price index (CPI) are only available since 1997, an inadequate time frame to build our model. However, tobacco CPI, which is available for the entire period of analysis, closely follows cigarette prices, since cigarettes constitute over 95 per cent of tobacco products. We have, therefore, used A-15 the tobacco CPI in our model, as is standard. Further, we have deflated this price of cigarettes (tobacco) by the overall price level to ensure that any change in cigarette consumption is correctly attributed to a change in the price of cigarettes relative to other goods, rather than an overall change in the price level. The overall, as well as tobacco CPI. were obtained from the Bureau of Labor Statistics (BLS). The coefficient on CIGPRICE, in the regression equation measures the elasticity of cigarette consumption with respect to price. In our model this effect consists of two parts. The coefficient of -0.21 measures the short-run elasticity of cigarette demand. That is, a 1°» increase in price reduces consumption by 0.21% in the current year. The second coefficient, -0.09 relates to prices in the previous year. It indicates that, following a 1% increase, an additional decrease in cigarette consumption of 0.09% will occur. Thus, according to the data, a one per cent increase in price decreases cigarette consumption by 0.31 (.3055) per cent in the long term. The low value of the elasticity indicates that cigarette consumption is price inelastic, or relatively unresponsive to changes in price. This coefficient is estimated such that a statistical confidence interval of 95% places its value between -0.24 and -0.38. This implies that there is a probability of 5% that the price elasticity is outside this range. Real Disposable Income Per Capita (YDP96PC) Real disposable income per capita measures the average income per person after tax in constant 1996 dollars. Data used were collected by the Bureau of Economic Analysis (BEA). For goods considered “normal”, consumption increases as incomes rise. Hence the coefficient is positive. On the other hand if the coefficient is negative, it indicates that the good is “inferior” and less is purchased as incomes rise. Our analysis indicates that the income elasticity of cigarettes, given by the regression coefficient on YDP96PC, is 0.27. The positive sign on the coefficient indicates that cigarettes are a normal good. Specifically, every percent increase in real disposable income per capita has raised adult per capita cigarette consumption by 0.27 percent. However, the low value of the elasticity indicates that the demand for cigarettes is income inelastic, or relatively unresponsive to changes in income. This coefficient (0.27) is estimated such that a statistical confidence interval of 95% places its value between 0.03 and 0.52. This implies that there is a probability of 5% that the income elasticity is outside this range. Qualitative variable The qualitative variable that we have explicitly included in our model relates to the restrictions on public smoking since the 1980s (SMOKEBAN). The negative coefficient on the variable implies that smoking decreases as a result of smoking bans. The coefficient on SMOKEBAN is estimated such that a statistical confidence interval of A- 16 95% for its value is from 0 to -0.53. This implies that there is a probability of 5% that the coefficient is outside this range. Trend and constant term According to the regression equation specified above, adult cigarette consumption per capita (CPC) displays a trend decline of 2.32 per cent per year. The trend reflects the impact of a systematic change in the underlying data that is not explained by the included explanatory variables. In the case of cigarette consumption, the systematic change is in public attitudes toward smoking. The trend may also reflect the cumulative impact of health warnings, advertising restrictions, and other variables which are statistically insignificant when viewed in isolation. This trend, primarily due to an increase in the health-conscious proportion of the population averse to smoking, would by itself account for 90.3% of the variation in consumption. This coefficient is estimated such that a statistical confidence interval of 95% for its value is from 0.0195 to 0.0269 (1.95% to 2.69%). This implies that there is a probability of 5% that the trend rate of decline is outside this range. The constant term (53.34) also reflects the impact of excluded variables, those that stay fixed over time (e.g., the health warnings on cigarette packs). It should be noted that the actual decline in CPC in any given year could be above or below the trend, depending on the values of the other explanatory variables. Forecast Assumptions Our forecast is based on assumptions regarding the future path of the explanatory variables in the regression equation. Projections of U.S. population and real per capita personal disposable income are standard DRIeWEFA forecasts. Annual population growth is projected to average 0.8%, and real per capita personal disposable income is projected to increase over the long term at just over 2.1% per year. The projection of the real price of cigarettes is based upon its past behavior with an adjustment for the shock to prices due to the tobacco settlement. Cigarette prices increased dramatically in November 1998, as manufacturers raised prices by $0.45 per pack. Subsequent increases brought prices to an average of $2.88 per pack in 1999 and $3.20 in 2000. The most recent increase, of $0.14 on April 25, 2001 brings the current price to approximately $3.60. Our consumption model anticipates that for the year 2001 the average price per pack will be $3.60. Our model, intended for long-term forecasting, uses annual data to describe changes in prices and other variables. When viewed over long intervals of time, the changes will appear to be gradual. The purpose of the model is to capture these broad changes and their influence on consumption. Because cigarette manufacture is dominated by a few firms, price changes will typically be discrete events, with jumps such as occurred on August 31, 1999 and December 18, 2000, followed by plateaus, rather than small and A-17 continuous changes. The exact timing during the year of price changes influences only the short-term path of consumption. Our forecast assumptions have incorporated price increases in excess of general inflation in order to meet the requirements of the MSA and offset excise and other taxes. Based upon our general inflation and cost assumptions, we anticipate that the nominal price per pack of cigarettes will rise to $14.82 by 2030, which is $6.68 in 2000 dollars. Relative to other goods, cigarette prices will rise by an average of 2.49% per year over the long term. The average real increase over the 30 years ending 1998 was 1.48% per year. Prior to the MSA, only once, in 1983, have real cigarette prices appreciated at a double digit, or greater than 10%, rate. If a 10% rate of price increase were to continue, the annual rate of decline in cigarette consumption predicted by our model would increase to approximately 4%. Our Base Case Forecast assumes that the incidence of youth smoking will not taper off until 2003, despite recent administrative initiatives to curb underage smoking. This is due to the momentum provided by current youth smokers. We then assume that youth smoking declines following the longer term trend of the 1970’s and 1980’s. By 2030 we assume that youth smoking will have declined at an average annual rate of 1.50% since 1999, or by 37.5% overall. We believe the assumptions on which the Base Case Forecast are based to be reasonable. Forecast of Cigarette Consumption After developing the regression equation specified above, we used it to project CPC for the period 2000 through 2030. Then using the standard adult population projections of DRIeWEFA’s macroeconomic model, we converted per capita consumption to aggregate adult consumption. We then added our estimate of teenage smoking volume going forward. In using regression equations developed on the basis of historical data to project future values of the dependent variable, we must also assume that the underlying economic structure captured in the equation will remain essentially the same. While past performance is no guarantee of future patterns, it is still the best tool we have to make such projections. The graphs below display the projected time trend of U.S. cigarette consumption. The first graph illustrates total actual and projected cigarette consumption in the United States. The second graph illustrates actual and projected CPC in the United States. For the period 1965 through 1999 the forecast line on the second graph indicates the value of CPC our model would have projected for those years. A-18 Annual U.S. Cigarette Consumption: Base Case Forecast 700 600 a vy N at Nn cm) cm) aN ) —) f / Billions of Cigarettes 300 “Se 200 terete ee a 9965 1975 1985 1995 2005 2015 2025 —— Actual -—-— Base Case Forecast Annual U.S. Adult Per Capita Cigarette Consumption Base Case Forecast 300 965 19751985. *21998.-2005—C«O1S ODS Actual ~ ~- Base Case Forecast | In addition to the expected trend decline in cigarette consumption the sharp upward shock to cigarette prices in late 1998 and 1999 contributed to an estimated 6.45% reduction in consumption in 1999. While consumption declined by an estimated 6.45% in 1999, industry shipments declined by almost 9%. The relative performance of shipments was expected to be better in 2000. Considerable inventory building occurred in late 1998 as wholesalers ordered ahead of the November 1998 price increase. This increase in inventories was followed by a fall in shipments in early 1999 as the stockpiled cigarettes were distributed to retail outlets. Thus total 1999 shipments showed a particularly sharp fall from 1998 levels. Also the shipments of the four “Original Participating Manufacturers” declined relative to the overall market as their market share declined. On January 25, 2001, RJ Reynolds reported that domestic industry shipments in 2000 increased by 0.1% over 1999. For the reasons given above, shipment volumes in the first half of the year exceeded the depressed 1999 levels, while volume decreased in the second half by 2.58% from the second half of 1999. From this data we estimate that consumption for the year 2000 declined by 2.76%. Industry shipments for the first three quarters of 2001 were, at 308.8 billion, 2.6% below the first three quarters of 2000. After 2001, the rate of decline in total cigarette consumption is projected to moderate and average less than 2% per year. From 1999 through 2030 the average annual rate of decline is projected to be 1.79%. On a per capita basis consumption is projected to fall at an average rate of 2.63% per year. Total consumption of cigarettes in the U.S. is projected to fall from an estimated 435 billion in 1999 to under 400 billion by 2002, under 300 billion by 2019, and to reach 248 billion in 2030. Statistical Confidence and Forecast Error In addition to potential forecast errors due to incorrect forecast assumptions, there also exists possible error in the statistical estimation. The estimation and development of an econometric model is a statistical exercise. Thus, our parameters are estimated with some degree of error. We have provided confidence intervals for the coefficient (elasticity) estimates. For instance, there is a 2.5% probability (5%/2) that the price elasticity exceeds 0.38. There is similarly a 2.5% chance that the income elasticity is less than 0.03. But if these events were independent, the probability of both would be .025 x .025 = .000625, or .0625%, less than one tenth of one percent. Comparison With Prior Forecasts On October 25, 1999 DRIeWEFA presented a similar study, “A Forecast of US Cigarette Consumption (1999-2042)”. Its long run conclusions were quite similar to this study. The current forecast of 248 billion cigarettes in 2030, is 0.8% greater than the 1999 forecast of 246 billion in 2030. In the 1999 study our projected level of 1999 consumption was 432 billion; the estimated number from the USDA was slightly higher, 435 billion. We incorporated this and other new data in 2000. At that time we realized that price increases had been greater than anticipated in our 1999 study. We increased our retail price assumption for 2000 from $3.03 to $3.39, and correspondingly decreased our consumption forecast for the year to 411 billion. However, aggressive discounting at the retail level resulted in a lower average price for the year, $3.20 per pack. Increased consumption due to lower than anticipated prices explains most of the revision to our 2000 consumption forecast. We now estimate a consumption level of 423 billion for 2000, 12 billion more than we projected in our 2000 forecast, though 8 billion fewer than we projected for that year in our 1999 forecast. Alternative Forecasts Two sources of variance may appear in the forecast derived by our model. First, as detailed in the Explanatory Variables section, there is some degree of forecast error in the parameters of the model. Second, the time paths of the explanatory variables may differ from our Base Case Forecast assumptions. Alternative forecasts are included in order to provide an interval forecast that, in our opinion, encompasses all of the likely potential realizations over time. The high and low alternative forecasts are derived as follows. In the high scenario, we use a lower price forecast, under which prices are increasing at an annual rate 0.5% more slowly than our current base case forecast. Under this scenario, the rate of decline is moderated slightly, from an average rate of 1.79 to 1.64%, resulting in consumption of 261 billion in 2030. In the low forecast, Low Case 1, we posit a sharper price elasticity of demand. Our estimate of the price elasticity, -0.31, is on the low end of the range when compared to that of certain other economic researchers. Recent economic research has forged a consensus that the elasticity lies between —0.3 and —0.5. We have, therefore, used a higher elasticity of -0.4, to generate the lowest consumption forecast which might be reasonably anticipated by our model. This increases the average rate of decline to 2.06% and results in cigarette consumption of 228 billion in 2030. Annual U.S. Cigarette Consumption 2 TrT?rt+rf?fstfrtrs?ryshSThmPhd)yU rT TU PUP dT dT TT TT FT TY FY tT Fr Tt fF tT tT F tt fF tt 00 1990 2000 2010 2020 2030 — Actual —— Buse Case Forecast —— tow Forecast. with -O.4 Price Plastieny of Demand ---- High Forecast,with 0.5% Lower Price Forecast Hypothetical Stress Scenarios The model was also tested under more extreme, and concurrently less likely, conditions. These exercises do not represent informed anticipation of possible future conditions. Rather, they are meant only to test the model under extreme conditions. First, we increased the negative response of consumer demand to recent price increases by assuming a much larger, -0.5, elasticity. This sharpens the fall in total consumption to an average annual rate of 2.35%, and results in demand of 208 billion cigarettes in 2030 (DRIeWEFA Low Case 2). This scenario would also be the result if, instead of a greater price sensitivity of smokers, we postulated an increased rate of cigarette price increase. Indeed, if cigarette prices, instead of averaging increases in real terms of 2.49% per year, accelerated to a pace of 4.11% annually, demand would also fall to 208 billion in 2030. A second large negative stress is placed by postulating, in 2003, either an adverse federal government settlement or tort claims of three times the size of this MSA. This would result in a real price increase of 57%, and a large decline, -17.7% over two years, in consumption. By 2030, consumption will have fallen to 208 billion cigarettes, an average annual rate of decline of 2.35% (DRIeWEFA Low Case 3). The estimated price elasticity of —0.31 is used in this case. This results in the same level of consumption by 2030 as in DRIeWEFA Low Case 2, despite the higher prices. Alternative Forecasts 2030 Consumption Level (Bil.) Average Annual Decline (%) Base Case Forecast 248 1.79 Low Case 1 228 2.06 High Alternative 261 1.64 Low Case 2 208 2.35 Low Case 3 208 2.35 Annual U.S. Cigarette Consumption 550 500 7 5 4507 SS g 400 an a“ “> = 3507 ~~ = 300 tee i =e ~~ . ~~ —_, — ® 950- “Slay = - we 200 - T T TT TTT TT FT ISO TrrrrrrrrriTrTrTrrrt Tr tT ft 20 2030 Actual Base Case Forecast ——- Low Forecast —=— WEFA Low Case 2 ---= WEFA Low Case 3 Finally, for comparative purposes we have calculated the volume of total cigarette consumption under two alternative annual rates of decline, 3.5% and 4%. At 3.5% per year consumption falls to 144 billion by 2030 and at 4% it falls to 123 billion. A- 23 Base Case Forecast: Assumptions for Explanatory Variables Incidence of | Average Year Real Per Capita Real Price of U.S. Adult Smoking in Youth Nominal Personal Income Cigarettes Population 12-17 Age Consumption Price Per | Group Pack Growth Rate Growth Rate Growth Rate Fraction Billions $ (Current) — ("o) (Po) (%%) 1965 4.84 4.13 1.95 0.04 1966 4.11 0.92 1.28 0.04 1967 3.13 0.72 1.39 0.05 1968 3.55 1.89 1.56 0.05 1969 2.21 0.00 1.69 0.06 1970 2.97 2.24 2.00 0.05 1971 2.81 O12 2.27 0.06 1972 3.43 2.08 2.85 0.06 1973 5.76 -3.29 2.03 0.07 1974 -1.19 -5.49 2.05 0.07 1975 0.97 -1.87 2.12 0.05 1976 2.93 -1.40 2.07 0.05 1977 2.44 -1.60 1.9] 0.07 1978 4.10 -2.05 1.9] 0.06 1979 2.02 -4.73 2.00 0.05 1980 0.01 -5.03 1.96 0.05 1981 1.56 -2.11 1.73 0.06 1982 0.59 4.80 1.64 0.05 1983 1.93 15.84 1.46 0.04 ' 1984 6.79 2.10 1.48 0.05 | 1985 2.45 2.31 1.16 0.05 1986 2.28 4.84 1.38 0.06 1987 1.37 3.36 1.23 0.05 1988 3.50 4.83 1.26 0.05 1989 1.53 7.64 1.35 0.05 1990 1.10 4.71 0.89 0.06 7.96 1991 -0.38 7.16 0.96 0.06 7.72 1992 2.29 5.24 0.99 0.06 7.62 1993 -0.04 0.9) 1.02 0.06 7.12 1994 1.56 -6.11 0.95 0.07 | 7.21 1995 1.72 -0.21 0.85 0.07 | 7.76 | 1996 1.57 0.18 0.89 0.08 | 7.54 1997 2.20 2.31 1.27 0.08 | 6.58 1998 3.87 11.03 1.18 0.08 6.30 2.20 1999 2.33 26.72 _ 1.13 0.08 5.92 2.88 2000 2.05 TAT 1.14 0.09 5.92 3.20 2001 2.13 9.90 1.10 0.09 6.14 3.60 2002 2.44 3.64 | 1.02 0.09 6.36 3.82 2003 2.10 3.55 0.96 0.08 6.36 4.05 2004 2.14 3.46 : 0.87 ! 0.08 6.36 4.30 2005 2.23 2.89 0.98 | 0.08 6.21 4.54 2006 2.66 3.30 0.89 0.08 6.06 4.80 2007 2.56 3.23 1.00 0.08 5.92 5.08 2008 2.15 271 1.00 | 0.08 5.92 5.35 2009 2.00 3.10 1.02 0.07 5.77 5.65 A - 24 Incidence of Real Price of U.S. Adult Youth Average Price Year Real Per Capita Smoking in Per Pack of Personal Income Cigarettes Population 12-17 Age Consumption Group Cigarettes Growth Rate Growth Rate Growth Rate % Billions $ (Current) (%) (%) (%) 2010 2.21 2.61 1.00 0.07 5.62 5.95 2011 2.23 2.57 0.93 0.07 5.47 6.25 2012 2.02 2.52 0.88 0.07 5.32 6.57 2013 2.02 2.48 0.81 0.07 5.18 6.90 2014 2.02 2.84 0.80 0.07 5.18 7.27 2015 2.04 2.02 0.84 0.07 5.18 7.60 2016 2.04 2.37 0.82 0.07 5.18 7.98 2017 2.05 2.34 0.77 0.07 5.18 8.36 2018 2.05 2.31 0.76 0.07 5.18 8.77 2019 2.06 2.27 0.74 0.06 5.03 9.19 2020 2.08 1.89 0.76 0.06 4.88 9.60 2021 2.09 2.22 0.77 0.06 4.73 10.06 2022 2.10 1.85 0.77 0.06 4.59 10.50 2023 2.11 2.17 0.78 0.06 4.44 11.00 2024 2.11 1.81 0.78 0.06 4.44 11.48 2025 2.11 1.79 0.79 0.05 4.29 11.98 2026 2.11 1.78 0.79 0.05 4.14 12.49 2027 2.1] 1.76 0.79 0.05 3.99 13.03 2028 2.11 1.75 0.80 0.05 3.85 13.59 2029 2.11 1.73 0.80 0.05 3.70 14.17 2030 2.11 2.02 0.80 0.05 3.70 14.82 A-25 Historical / Base Case Forecast U.S. Adult Per Capita and Total Consumption of Cigarettes (1965 — 2030) Total Total Per Capita Growth Rate Consumption Growth Rate Consumption (%) Consumption (billions of (%) (billions) packs) 1965 4259 1.53 528.70 26.44 3.42 27.06 2.36 1966 4287 0.66 541.20 1967 4280 -0.16 549.20 27.46 1.48 1968 4186 -2.20 545.70 27.29 -0.64 1969 3993 -4.61 528.90 26.45 -3.08 1970 3985 -0.20 536.40 26.82 1.42 1971 4037 1.30 555.10 27.76 3.49 1972 4043 0.15 566.80 28.34 2.11 29.49 4.04 1973 4148 2.60 589.70 1974 4141 -0.17 599.00 29.95 1.58 1975 4123 -0.43 607.20 30.36 1.37 1976 4092 -0.75 613.50 30.68 1.04 1977 4051 -1.00 617.00 30.85 0.57 1978 3967 -2.07 616.00 30.80 -0.16 1979 3861 -2.67 621.50 31.08 0.89 3849 -0.31 631.50 31.58 1.61 1980 1981 3836 -0.34 640.00 32.00 1.35 -0.94 1982 3739 -2.53 634.00 31.70 1983 3488 -6.71 600.00 30.00 -5.36 1984 3446 -1.20 600.40 30.02 0.07 1985 3370 -2.21 594.00 29.70 -1.07 1986 3274 -2.85 583.80 29.19 -1.72 1987 3197 -2.35 575.00 28.75 -1.51 1988 3096 -3.16 562.50 28.13 -2.17 540.00 27.00 -4.00 1989 2926 -5.49 1990 2826 -3.14 525.00 26.25 -2.78 1991 2727 -3.50 510.00 25.50 -2.86 1992 2647 -2.93 500.00 25.00 -1.96 1993 2542 -3.97 485.00 24.25 -3.00 1994 ete 24824 -0.71 486.00 24.30 0.21 1995 2505 -0.75 487.00 24.35 0.21 2482 -0.84 487.00 24.35 0.00 1996 1997 2423 -2.50 480.00 24.00 -1.44 1998 2326 -4.00 465.00 23.25 -3.13 1999 2136 -8.17 435.00 21.75 -6.45 FORECAST 2000 2061 -3.49 423.00 21.15 -2.76 2001 1964 4.71 408.00 20.40 -3.55 1878 -4.38 394.13 19.71 -3.40 2002 2003 1825 -2.80 386.89 19.35 -1.84 18.98 -1.88 2004 1775 -2.76 379.60 A- 26 Total Total Per Capita Growth Rate Consumption Consumption Growth Rate Consumption (%) ene (billions of (%) (billions) packs) 2005 1728 -2.62 373.24 18.66 -1.68 2006 1684 -2.54 366.94 18.35 -1.69 2007 1641 -2.59 360.98 18.05 -1.62 2008 1598 -2.58 355.27 17.76 -1.58 2009 1556 -2.65 349.32 17.47 -1.67 2010 1516 -2.54 343.83 17.19 -1.57 2011 1479 -2.48 338.37 16.92 -1.59 2012 1442 -2.52 332.69 16.64 -1.68 2013 1405 -2.51 326.93 16.35 -1.73 2014 1369 -2.58 321.15 16.06 -1.77 2015 1336 -2.44 316.05 15.80 -1.59 2016 1303 -2.44 310.96 15.55 -1.61 2017 1271 -2.46 305.75 15.29 -1.68 2018 1240 -2.45 300.62 15.03 -1.68 2019 1210 -2.44 295.41 14.77 -1.73 2020 118] -2.36 290.58 14.53 -1.63 2021 1153 -2.39 285.75 14.29 -1.66 2022 1126 -2.34 281.13 14.06 -1.62 2023 1099 -2.37 276.53 13.83 -1.64 2024 1074 -2.32 272.28 13.61 -1.54 2025 1049 -2.29 268.07 13.40 -1.55 2026 1025 -2.28 263.94 13.20 -1.54 2027 1002 -2.28 259.89 13.00 -1.53 2028 979 -2.27 255.93 12.80 -1.52 2029 957 -2.27 252.05 12.60 -1.52 2030 935 -2.33 248.20 12.41 -1.52 Base Case and Alternative Forecasts of Total U.S. Cigarette Consumption Low Case 1: High Forecast: Year Base Case Forecast -0.4 Price Elasticity of Demand Lower Price Assumption Cigarettes Packs _|\Growth Rate| Cigarettes Packs |Growth Rate| Cigarettes Packs — |Growth Rate (billions) (billions) (%) (billions) (billions) (%) (billions) (billions) (%) 1999 435.00 21.75 -6.45 435.00 21.75 -6.45 435.00 21.75 -6.45 2000 423.00 21.15 -2.76 404.97 20.25 -6.90 423.00 21.15 -2.76 2001 408.00 20.40 -3.55 | 393.36 19.67 -2.87 408.00 20.40 -3.55 2002 394.13 19.71 3.40 | 385.51 19.28 -2.00 396.03 19.80 -2.93 2003 386.89 19.35 -1.84 | 377.19 18.86 -2.16 389.37 19.47 -1.68 2004 379.60 18.98 -1.88 368.92 18.45 -2.20 382.64 19.13 -1.73 2005 373.24 18.66 -1.68 361.77 18.09 -1.94 376.82 18.84 -1.52 2006 366.94 18.35 -1.69 354.58 17.73 -1.99 371.04 18.55 -1.53 2007 360.98 18.05 -1.62 347.79 17.39 -1.92 365.58 18.28 -1.47 2008 355.27 17.76 -1.58 341.44 17.07 -1.83 360.37 18.02 -1.43 2009 349.32 17.47 -1.67 334.78 16.74 -1.95 354.90 17.74 -1.52 2010 343.83 17.19 -1.57 328.73 16.44 -1.81 349.87 17.49 -1.42 2011 338.37 16.92 -1.59 322.75 16.14 -1.82 344.86 17.24 -1.43 2012 332.69 16.64 -1.68 316.60 15.83 -1.91 339.60 16.98 -1.52 2013 326.93 16.35 -1.73 310.41 15.52 -1.96 334.25 16.71 -1.58 2014 321.15 16.06 -1.77 304.13 15.21 -2.02 328.86 16.44 -1.61 2015 316.05 15.80 -1.59 298.74 14.94 -1.77 324.14 16.21 -1.44 2016 310.96 15.55 -1.61 293.30 14.66 -1.82 319.42 15.97 -1.45 2017 305.75 15.29 -1.68 287.76 14.39 -1.89 314.56 15.73 -1.52 2018 300.62 15.03 -1.68 282.35 14.12 -1.88 309.78 15.49 -1.52 2019 295.41 14.77 -1.73 276.87 13.84 -1.94 304.89 15.24 -1.58 2020 290.58 14.53 -1.63 271.88 13.59 -1.81 300.38 15.02 -1.48 2021 285.75 14.29 -1.66 266.81 13.34 -1.86 295.85 14.79 -1.5] 2022 281.13 14.06 -1.62 262.06 13.10 -1.78 291.53 14.58 -1.46 2023 276.53 13.83 -1.64 257.25 12.86 -1.83 287.21 14.36 -1.48 2024 272.28 13.61 -1.54 | 252.88 12.64 -1.70 283.24 14.16 -1,38 2025 268.07 13.40 -1.55 | 248.56 12.43 -1.71 279.29 13.96 -1.39 2026 263.94 13.20 -1.54 244 33 12.22 -1.70 275.43 13.77 -1.39 2027 259.89 13.00 -1.53 240.20 12.01 -1.69 271.63 13.58 -1.38 2028 255.93 12.80 -1.52 236.16 11.8] -1.68 267.91 13.40 -1.37 2029 252.05 12.60 -1.52 232.21 11.61 -1.67 264.26 13.2] -1.36 2030 248.20 12.41 -1.52 228.25 11.41 -1.71 260.64 13.03 -1.37 Base Case Forecast and Low Case Extreme Projections Year Base Case Forecast Low Case 2: Low Case 3: -0.5 Price Elasticity of Demand Large MSA in 2003 Cigarettes Packs Growth Rate| Cigarettes Packs Growth Rate| Cigarettes Packs Growth Rate (billions) (billions) (%) (billions) (billions) (%) (billions) (billions) (°o) 1999 435.00 21.75 -6.45 435.00 21.75 -6.45 435.00 21.75 -6.45 2000 423.00 21.15 -2.76 398.01 19.90 -8.50 411.22 20.56 -5.47 2001 408.00 20.40 -3.55 385.12 19.26 -3.24 400.82 20 04 -2.53 2002 394.13 19.71 -3.40 376.03 18.80 -2.36 394.13 19.71 -1.67 2003 386.89 19.35 -1.84 366.58 18.33 -2.51 343.73 17.19 -12.79 2004 379.60 18.98 -1.88 357.27 17.86 -2.54 318.38 15.92 -7.37 2005 373.24 18.66 -1.68 349.32 17.47 -2.23 313.04 15.65 -1.68 2006 366.94 18.35 -1.69 341.23 17.06 -2.32 307.75 15.39 -1.69 2007 360.98 18.05 -1.62 333.59 16.68 -2.24 302.75 15.14 -1.62 2008 355.27 17.76 -1.58 326.60 16.33 -2.10 297.96 14.90 -1.58 2009 349.32 17.47 -1.67 319.21 15.96 -2.26 292.98 14.65 -1.67 2010 343.83 17.19 -1.57 312.61 15.63 -2.07 288.38 14.42 -1.57 2011 338.37 16.92 -1.59 306.12 15.31 -2.08 283.80 14.19 -1.59 2012 332.69 16.64 -1.68 299.51 14.98 -2.16 279.03 13.95 -1.68 2013 326.93 16.35 -1.73 292.91 14.65 -2.20 274.20 13.71 -1.73 2014 321.15 16.06 -1.77 286.16 14.31 -2.31 269.35 13.47 -1.77 2015 316.05 15.80 -1.59 280.51 14.03 -1.97 265.07 13.25 -1.59 2016 310.96 15.55 -1.61 274.73 13.74 -2.06 260.80 13.04 -1.61] 2017 305.75 15.29 -1.68 268.90 13.45 -2.12 256.43 12.82 -1.68 2018 300.62 15.03 -1.68 263.22 13.16 -2.11 252.14 12.61 -1.67 2019 295.41 14.77 -1.73 257.52 12.88 -2.17 247.76 12.39 -1.73 2020 290.58 14.53 -1.63 252.39 12.62 -1.99 243.71 12.19 -1.63 2021 285.75 14.29 -1.66 247.13 12.36 -2.08 239.66 11.98 -1.66 2022 281.13 14.06 -1.62 242.26 12.11 -1.97 235.79 11.79 -1.62 2023 276.53 13.83 -1.64 237.30 11.87 -2.05 231.93 11.60 -1.64 2024 272.28 13.61 -1.54 232.84 11.64 -1.88 228.36 11.42 -1.54 2025 268.07 13.40 -1.55 228.44 11.42 -1.89 224.83 11.24 -1.55 2026 263.94 13.20 -1.54 224.15 11.21 -1.88 221.37 11.07 -1.54 2027 259.89 13.00 -1.53 219.96 11.00 -1.87 217.97 10.90 -1.53 2028 255.93 12.80 -1.52 215.88 10.79 -1.85 214.65 10.73 -1.52 2029 252.05 12.60 -1.52 211.89 10.59 -1.85 211.39 10.57 -1.52 2030 248.20 12.41 -1.52 207.85 10.39 -1.91 208.17 10.41 -1.52 Alternative Constant Rate Decline Projections of Total U.S. Cigarette Consumption | Year 3.5% 4.0% | Decline Per Year Decline Per Year | Cigarettes Packs |Growth Rate| Cigarettes Packs _|Growth Rate (billions) (billions) | (%) (billions) (billions) (%) 1999 435.00 21.75 435.00 21.75 2000 419.78 20.99 -3.50 417.60 20.88 -4.00 2001 405.08 20.25 -3.50 400.90 20.04 -4.00 2002 390.90 19.55 -3.50 384.86 19.24 -4.00 2003 377.22 18.86 -3.50 369.47 18.47 -4.00 2004 364.02 18.20 -3.50 354.69 17.73 -4.00 2005 351.28 17.56 -3.50 340.50 17.02 -4.00 2006 338.98 16.95 -3.50 326.88 16.34 -4.00 2007 327.12 16.36 -3.50 313.80 15.69 -4.00 2008 315.67 15.78 -3.50 301.25 15.06 -4.00 2009 304.62 15.23; -3.50 289.20 14.46 -4.00 2010 293.96 14.70 -3.50 277.63 13.88 -4.00 2011 283.67 14.18 -3.50 266.53 13.33 -4.00 2012 273.74 13.69 -3.50 255.87 12.79 -4.00 2013 264.16 13.21 -3.50 245.63 12.28 -4.00 2014 254.92 12.75 -3.50 235.81 11.79 -4.00 2015 245.99 12.30 -3.50 226.38 11.32 -4.00 2016 237.39 11.87 -3.50 217.32 10.87 -4.00 2017 229.08 11.45 -3.50 208.63 10.43 -4.00 2018 221.06 11.05 -3.50 200.28 10.01 -4.00 2019 213.32 10.67 -3.50 192.27 9.61 -4.00 2020 205.86 10.29 -3.50 184.58 9.23 -4.00 2021 198.65 9.93 -3,50 177.20 8.86 -4.00 2022 191.70 9.58 -3.50 170.11 8.51 -4.00 2023 184.99 9.25 -3.50 163.30 8.17 -4.00 2024 178.51 8.93 -3.50 156.77 7.84 -4.00 2025 172.27 8.61 -3.50 150.50 7.53 -4.00 2026 166.24 8.31 -3.50 144.48 7.22 -4.00 2027 160.42 8.02 -3.50 138.70 6.94 -4.00 2028 154.80 7.74 -3.50 133.15 6.66 -4.00 2029 149.39 7.47 -3.50 127.83 6.39 -4.00 2030 144.16 7.21 -3.50 122.71 6.14 -4.00 Appendix 1: Raw Data Reference Mnemonic Label Time Frame Source ADV Advertising and Promotional Expenditures, | 1963-1999 Federal Trade Commission Millions of Dollars Report to Congress for ‘90, ‘91, “92, °93, °96, 97, °98, ‘99 CIGPRICE Real Tobacco Consumer Price Index 1947-1999 DRIeWEFA Calculation: CPITOB/CPIU = CIGPRICE CPC Adult Per Capita Consumption, Cigarettes 1945-1999 Tobacco Situation and Outlook Report, USDA’s Economic Research Service, various issues CPITOB Consumer Price Index, Tobacco 1947-1999 Bureau of Labor Statistics 1982/1984 = 100 CPIU Consumer Price Index, All Items 1947-1999 Bureau of Labor Statistics NP Total Population, Millions 1946-1999 BEA, NIPA NP16A Total Population, Above 16, Millions 1946-1999 BUREAU OF THE CENSUS NPTF1617 Total Population, Female 16-17, Millions 1946-1999 BUREAU OF THE CENSUS NPTM1617 Total Population, Male 16-17, Millions 1946-1999 BUREAU OF THE CENSUS NPI8A Total Population, Above 18, Millions 1946-1999 DRIeWEFA Calculation: NP16A - (NPTF1617 + NPTMI1617) SMOKEBAN Dummy Variable that Captures the Effect of | 1965-1998 DRIeWEFA the Bans on Smoking in Public Places from the 1980’s to the 1990’s RADVPC Real Per Capita Advertising Expenditures 1960-1997 DRIeWEFA Calculation: [(YDP96 x 100) / CPIU] / NP = RADVPC TEENPER Incidence of First Daily Use of Cigarettes, 1965-1997 Center for Disease Control and Ages 12-17, Percentage Prevention, 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UK Department of Health. Effect of Tobacco Advertising on Tobacco Consumption : A Discussion Document Reviewing the Evidence. London: U.K. Department of Health, Economics and Operational Research Division, 1992. Wasserman J, Manning WG, Newhouse JP, Winkler JD. “The Effects of Excise Taxes and Regulations on Cigarette Smoking.” Journal of Health Economics 1991, 10 (1): 43-64. A- 34 Winston GC. “Addiction and Backsliding: a Theory of Compulsive Consumption.” Journal of Economic Behavior and Organization 1980; 1 (4): 295-324. (THIS PAGE WAS INTENTIONALLY LEFT BLANK) APPENDIX B MASTER SETTLEMENT AGREEMENT (THIS PAGE WAS INTENTIONALLY LEFT BLANK) sects TWOApY WUT, (xx) seeseee .SUONEZIUETIC parejay-coseqo |, (mm) .SIONPaug Oooego]., (AA) _dasusesnue yy Tnpaig o20eqoL., (nn) snUEW leg basqns.. (11) Aneuty sytoadg-2181$., (ss) 2eIg., (4) teens cemeemennnne | Sree Sumag., (bb) yaueg Suiscajoy,, (dd) “,vaMse paseaiay,, (00) SWC Paserjay,, (uu) boost “.G2EYS TE BAUTE|ayY,,. 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IPINING FLYLS JO Wj2VIq IYI soy WauNIDE;nUT Bupedsayeg (pu ay) Woy viuaued Sujajaoas us jua8e spay) ve 198 VO) ‘[UOIsIAIPgnS [CIO Sune8pry ag jo Ajuoyine Bunnaavoid pouamwaa08 ayr Aq Bunum ut payswao sme, ve Jo FLVLS JO aeig ay) jo [essuad Aawony ayy fq) wawau8y aq oO § NQYyxy ul paynuap: Anus so uossad yoea Xq “Bunum uy paroudissp uosuad ay) suv aayionenamay parnuxiwag, (y) ———— ee oe aes (THIS PAGE WAS INTENTIONALLY LEFT BLANK) APPENDIX D ACCRETED VALUES TABLE Series 2001 Serial Maturities 05/15/2008 05/15/2009 05/15/2010 05/15/2011 05/15/2012 05/15/2013 05/15/2014 11/20/2001 $705,395.60 $793,759.20 $842,754.00 $887,333.90 $955,087.65 $1,002,064.35 $1,048,467.20 5/15/2002 720,137.60 810,723.30 861,179.00 907,173.85 977,136.60 1,025,680.50 1,073,686.95 11/15/2002 735,625.80 828,562.90 880,561.00 928,039.00 1,000,336.70 1,050,551.55 1,100,255.50 5/15/2003 751,441.60 846,793.90 900,372.00 949,381.80 1,024,106.05 1.076.036.70 1,127,484.40 11/15/2003 767,594.10 865,416.30 920,623.00 971,225.55 1,048,419.35 1,102,122.60 1,155,387.70 $/15/2004 784,101.50 884,461.00 941,336.00 993,558.60 1,073,327.20 1.128.849.30 1,183,993.50 11/15/2004 800.954.70 903,917.70 962,522.00 1,016,415.90 1,098,816.95 1,156.230.15 1,213,287.75 5/15/2005 818,181.00 923,807.00 984,181.00 1,039,785.80 1,124,913.90 1,184,265.15 1,243,326.65 11/15/2005 835,771.30 944,128.90 1,006,324.00 1,063,703.25 1,151,630.70 1,212,981.00 1,274,096.15 5/15/2006 853,734.70 964,904.00 1,028,962.00 1,088,168.25 1,178,980.00 1,242,404.40 1,305,624.35 11/15/2006 872,089.40 986,132.30 1,052,117.00 1,113,192.45 1,206,987.10 1,272,522.00 1,337,939.35 5/15/2007 890,844.50 1,007,824.10 1,075,789.00 1,138,799.15 1,235,652.00 1,303.387.20 1,371,055.20 11/15/2007 910,000.00 1,030,000.00 1,100,000.00 1,165,000.00 1,265,000.00 1,335,000.00 1,405,000.00 DO NOT STAPLE THIS FORM 12)995 MSRB FORM G-36 (OS) - FOR OFFICIAL STATEMENTS SECTIONI - MATERIALS SUBMITTED A. THIS FORM IS SUBMITTED IN CONNECTION WITH (check one) "T35) A FINAL OFFICIAL STATEMENT RELATING TO A PRIMARY OFFERING OF MUNCIPAL SECURITIES (enclose two (2) copies): (a) DATE RECEIVED FROM ISSUER: 11/15/2001 (b) DATE SENT TO MSRB: 11/15/2001 2. (1 AN AMENDED OFFICIAL STATEMENT WITHIN THE MEANING OF RULE G-36(d) (enclose two (2) copies): (a) DATE RECEIVED FROM ISSUER: (b) DATE SENT TO MSRB: B. IF MATERIALS SUBMITTED WITH THIS FORM CONSIST OF MORE THAN C. IF THIS FORM AMENDS PREVIOUSLY SUBMITTED FORM WITHOUT ONE DOCUMENT (€.g., preliminary official statement and wrap, even if CHANGING MATERIALS SUBMITTED, CHECK HERE (include copy of physically attached), PLEASE CHECK HERE: 1 original Form G-36(ARD): 0 SECTION II — IDENTIFICATION OF ISSUE(S) Each must be listed separately. If more space is needed to list additional issues, please include on separate sheet and check here: C1 A. NAME OF ISSUER: TOBACCO SETTLEMENT FINANCING CORPORATION STATE: VI DESCRIPTION DATED OF ISSUE: TOBACCO SETTLEMENT ASSET-BACKED BONDS, SERIES 2001 DATE: 11/20/2001 B. NAMEOF ISSUER: : STATE: DESCRIPTION DATED OF ISSUE: DATE: C. NAMEOF ISSUER: STATE: DESCRIPTION DATED OF ISSUE: DATE: er SECTION ITI - TRANSACTION INFORMATION A. LATEST FINAL MATURITITY DATE OF ALL SECURITIES IN OFFERING: 05/15/2031 B. DATE OF FINAL AGREEMENT TO PURCHASE, OFFER OR SELL SECURITIES (ate of Sale): 11/08/2001 C. ACTUAL OR EXPECTED DATE OF DELIVERY OF SECURIES TO UNDERWRITER(S) (Bond Closing): 11/20/2001 D. IF THESE SECURITIES ADVANCE REFUND ALL OR A PORTION OF ANOTHER ISSUE, PLEASE CHECK HERE: 0) A separate Form G-36 (ARD) and copies of the advance refunding document must be submitted for each issue advance refunded. a SECTION IV —- UNDERWRITING ASSESSMENT INFORMATION This information will be used by the MSRB to compute any rule A-13 underwriting assessment that may be due on this offering. The managing underwriter will be sent an invoice if a rule A-13 assessment is due on the offering. A. MANAGING SEC REG. UNDERWRITER SALOMONSMITHBARNEY NUMBER: 8-08177 B. TOTAL PAR VALUE OF ALL SECURITIES IN OFFERING $ 21,709,861.90 C. PAR AMOUNT OF SECURITIES UNDERWRITTEN (if different from amount shown in item B above): $ D. CHECK ALL THAT APPLY: Os 1. At the option of the holder thereof, all securities in this offering may be tendered to the issuer of such securities or its designated agent for redemption or purchase at par value or more at least as frequently as every nine months until maturity, earlier redemption, or purchase by the issuer or its designated agent. O 2. At the option of the holder thereof, all securities in this offering may be tendered to the issuer of such securities or its designated agent for redemption or purchase at par value or more at least as frequently as every two years until matunity, earlier redemption, or purchase by the issuer or its designated agent. 0 3. This offering is exempt from SEC Rule 15c2-12 under section (d)(1)(i) of that rule. Section (d)(1)(i) of SEC rule 15c2-12 states that an offering is exempt from the requirements of the mule if the securities offered have authorized denominations of $100,000 or more and are sold to no more than 35 persons each of whom the participating underwriter believes: (1) has the knowledge and expertise necessary to evaluate the merits and risks of the investment, and (21) is not purchasing for more than one account, or with a view toward distributing the securities. CONTINUED ON OTHER SIDE Page 1 of 2 SECTION V — CUSIP INFORMATION MSRB rule G-34 requires that CUSIP numbers be assigned to each issue of municipal securities unless the issue is ineligible for CUSIP number assignment under the eligibility criteria of the CUSIP Service Bureau. A. CUSIP-9 NUMBERS OF ISSUE(S) Maturity Date CUSIP Number Maturity Date CUSIP Number Maturity Date CUSIP Number 05/15/08 88880R AA8 05/15/09 AB6 05/15/10 AC4 OS/15/11 AD2 05/15/12 AEO 05/15/13 AF? 05/15/14 AGS 05/15/21 AH3 05/15/31 AJ9 B. IF ANY OF THE ABOVE SECURITIES HAS A CUSIP-6 BUT NO CUSIP-9, CHECK HERE AND LIST THEM BELOW 1 (Please see instructions in Form G-36 Manual) List ALL Cusip-6 NUMBERS ASSIGNED State the reason why securities have not be assigned a ‘‘Cusip-9” C.__IFANY OF THESE SECURITIES IS INELIGIBLE FOR CUSIP NUMBER ASSIGNMENT, PLEASE CHECK HERE oO State the reason why securities have not be assigned a “Cusip-9” SECTION VI —- MANAGING UNDERWRITER’S CERTIFICATION © *™* S'CN4 TURE THE UNDERSIGNED CERTIFIES THAT THE MATERIALS ACCOMPANYING THIS — r+ att OTHER INFORMATION CONTAINED HEREIN IS TRUE AND CORRECT. THE UNDERSIG DISSEMINATED. ee re ON BEHALF (€ [ SIGNED: Fey | NOV 16 2001 ae ; wos! nd PHONE: ost likely to be materials) ———XVKX—SSX— 1 for detailed npleted or m ‘NED FOR this form and two copies of the advance refunding documemt mun uw ....-ded to be n the meaning of rule G-36. 1g materials to MSRB, MSIL System, 1900 Duke Street, Suite 600, Alexandria, Virginia