S&P threatens RI with downgrade over 38 Studios bonds

PROVIDENCE, R.I. (WPRI) – One of the three major Wall Street rating agencies has put a negative watch on Rhode Island’s state bond ratings due to uncertainty about whether the state will pay off the bonds sold in 2010 to benefit Curt Schilling’s failed video-game company, 38 Studios.

Standard & Poor’s Ratings Services put its overall AA bond rating for Rhode Island’s general-obligation debt on negative watch, and did the same for its AA- bond rating on the state’s appropriation debt and its A rating on the state’s other moral-obligation debt, the agency said in a statement Monday.

S&P also downgraded its rating on the $75 million in 38 Studios bonds themselves from A to BBB – one notch above junk status – and put the debt from that transaction on negative watch.

The moves are in sharp contrast with what S&P did last June during a similarly heated debate over paying the 38 Studios bonds. At that time S&P kept the bonds’ rating at A with a stable outlook, saying that “default on this moral obligation debt is unlikely due to the support of state leadership.”

On Monday, however, S&P said: “The downgrade on the series of moral obligation bonds issued for the 38 Studios project reflects our view that continued debate about funding appropriations sufficient to repay principal and interest on the bonds indicates diminished support for this appropriation and a higher degree of risk relating to the repayment of these bonds.”

“The negative CreditWatch action reflects our view that broad-based support for repayment of this debt is not clear,” Henry Henderson, a credit analyst at S&P, said in the statement.

The statement went on to say that S&P “would likely take negative rating action, lowering [general obligation], appropriation, and moral obligation debt by multiple notches” if Rhode Island lawmakers refuse to put roughly $12.5 million into the next state budget to make the next two payments to the 38 Studios bondholders.

The agency then known as the R.I. Economic Development Corporation sold $75 million in bonds to investors in 2010 to entice 38 Studios to Rhode Island. The company’s subsequent failure in 2012 left taxpayers on the hook for roughly $90 million in principal and interest payments through the end of this decade.

The types of bonds sold by the EDC are known as “moral-obligation bonds,” which means the state only promised to consider repaying investors if 38 Studios was unable to do so; that’s different from traditional general-obligation bonds, which the state pledges to repay no matter what. Some lawmakers have suggested the state should refuse to pay.

Gov. Lincoln Chafee, who was a staunch opponent of the original 38 Studios deal, has been adamant that the state should repay the bonds to protect its reputation in the financial markets. “It would be a grave error not to make this payment,” Richard Licht, Chafee’s director of administration, told WPRI.com on Monday, adding that he’s “very hopeful” lawmakers will do so.

“Today’s action by Standard & Poor’s underscores the serious consequences to Rhode Island’s credit ratings if the state defaults on the 38 Studios bonds,” Joy Fox, a spokeswoman for Treasurer Gina Raimondo, told WPRI.com.

The first payment made out of state funds, for $2.4 million in interest, was made May 1 using money lawmakers appropriated in last year’s budget after a heated debate. The next payment, for $10.3 million in principal and interest, is due Nov. 1.

An independent study commissioned by the Chafee administration and released last Friday suggested Rhode Island’s state bond rating would likely be dropped to “junk” status if lawmakers refuse to repay the 38 Studios bonds, at a long-term cost of anywhere from $36 million to $362 million.

The 38 Studios bonds were insured by Assured Guaranty Ltd., which would be expected to pay the bonds instead if Rhode Island refuses to do so but could potentially sue the state for the decision.

S&P also warned that $38.4 million in bonds that the EDC sold on behalf of the I-195 Redevelopment District Commission last year to buy the old highway land “contains an acceleration provision if the rating drops below ‘A-‘ or the equivalent from another rating agency,” and said such a move “could be an additional source of credit pressure if acceleration of these bonds is triggered.”

S&P said its analysts “could revise the [state's bond] outlook back to stable if, in our view, there is consistent support for all of the state’s debt.”

Analysts from SJ Advisors, the firm commissioned by the Chafee administration to do the 38 Studios study, are scheduled to brief lawmakers on their findings Tuesday and Wednesday.

Then, at a hearing Thursday, the House Oversight Committee will hear views on whether to repay from three experts – URI economics professor Leonard Lardaro, former R.I. Department of Administration director Gary Sasse, and WhaleRock Point partners portfolio manager Robert Cusack. Sasse and Cusack have both expressed skepticism about repayment.

Barrington businessman Ken Block, who is running against Cranston Mayor Allan Fung in the Republican primary for governor, called on lawmakers Monday to refuse to pay when they take up the state budget sometime in the next two months.

“The threats coming from Wall Street insiders of dire consequences for the state if they fail to make good on the 38 Studios bond is an attempt to shift the risk of that investment onto the state’s taxpayers instead of where it belongs – with the people who bought the bonds,” Block said in a statement.

“The state has the opportunity to send a strong message that these particular bonds are not the same as other bonds issued by the state due to the irregularities of the deal,” he said.

Clay Pell, a Democratic candidate for governor, on Monday joined his two primary opponents in saying the state should pay back the bonds. “Clay does not believe Rhode Island should default on its moral obligation bonds when they come due,” his campaign manager Devin Driscoll told WPRI.com.

Ted Nesi ( tnesi@wpri.com ) covers politics and the economy for WPRI.com and writes the Nesi’s Notes blog. Follow him on Twitter: @tednesi

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