News Column

Chafee consultant urges payment of 38 Studios bonds

May 9, 2014

By Katherine Gregg, The Providence Journal, R.I.

May 09--PROVIDENCE, R.I. -- A consultant hired by the Chafee administration is warning of "swift and severe" consequences if the state defaults on the $75 million state-backed loan to retired Red Sox pitcher Curt Schilling's now-bankrupt 38 Studios.

In a report made public on Friday, SJ Advisors said: "Notwithstanding the fact that the legislature's pledge is non-binding in the legal sense, the bond market sees all of these types of commitments as real, bona fide obligations of the state."

"If they are truly optional, why would the legislature ever honor them?" the consultant asks rhetorically. "A decision to walk away will be seen as reneging on the state's commitments, and therefore will affect the market's view of the state's willingness to pay all of its obligations.."

"We expect that the rating agency reaction will be swift and severe, and that there will be a material and adverse effect on both the interest rates that the state pays when it issues debt and the market value of outstanding Rhode Island bonds," the consultant wrote.

Though Governor Chafee was a staunch opponent of the 38 Studios loan deal, as a candidate in 2010, he has been just as vehement about the need to pay the debt to avert more problems for the state down the road when it needs to borrow.

"We must protect the state's credit rating, its positive reputation and our access to the capital markets. That's why I included $12.5 million in my FY 2015 budget to meet its obligation," Chafee said.

"While this cost to taxpayers is distasteful, we are doing everything we can to reduce the size of the burden on our citizens through litigation. Repayment of these bonds is in the best interest to the state's financial status and its reputation in the marketplace."

Based on the administration's reading of the SJ ADvisors report: "Rhode Island debt would be downgraded from AA to the single B category by Standard & Poor's Rating Services, which is below investment grade (speculative status) and from Aa2 to the Ba category (double B equivalent) by Moody's Investment Service.

"This would put Rhode Island as the lowest state bond rating in the nation and would be considered "Junk Bond" status by the industry."

"SJ Advisors found that even under its best case scenario, the state is financially better off fulfilling its obligations and making the payments for the moral obligation bonds. Under its best case scenario, the decision not to appropriate would cost approximately $36.0 million more than paying the debt service...Should the worst case scenario come to pass, the net cost would be $361.8 million."

Under the most likely scenario, the net cost is estimated to be $125.6 million more than paying the debt service, according to the consultant.

But not everyone agrees the state is obligated to pay the debt.

Former state treasurer Frank Caprio, seeking to regain the office this year, said: "Rhode Island has no legal obligation to make payments on 38 Studio bonds and any effect on bond rating will be temporary in my opinion and experience. The 38 Studio bonds were not approved by RI voters. The sophisticated investors who made the loan are multi-billion dollar companies who understood the risks and have bought insurance to protect their investment. I would also recommend the State begin discussions with the rating agencies and the others who hold and insure the bonds to open a line of communication."

In late March, the Chafee administration gave Minnesota financial analyst Steven J. Johnson a $75,000 contract to perform the analysis, after an earlier request for proposals drew no bids to do the work for $50,000.

The report centers on the $75 million in high-risk, high-yield bonds that financed Schilling's now-bankrupt video-game company. Then-Gov. Carcieri's administration offered the loan to Schilling and his team as an inducement to move his company from Maynard, Mass., to Rhode Island, and bring 450 jobs to the state by the end of 2012.

The taxpayer debt, over and above amounts set aside in reserve at the outset of this doomed venture, was approximately $89 million.

On Nov. 1, 2013, the state paid the investors $7.4 million in principal payments, and $2.7 million in interest, according to the state budget office.

On May 1, the state paid $2.4 million in interest out of state funds. The General Assembly approved this first taxpayer payment last June, after an angry House debate in which one lawmaker after another alleged they had been duped by misinformation and lies into approving the $75 million loan-guarantee in 2010, before any mention that all of this money was earmarked for Schilling's ill-considered venture.

And now the debate at the State House has begun anew over what the state is -- or is not -- obligated to do when the next $12.3 million payment comes due in the 2014-15 budget year, a tax and spending plan lawmakers will soon be debating.

At a House Oversight Committee hearing Thursday night, the head of the business-backed Rhode Island Public Expenditure Council cited an April 17 warning from the Standard & Poor's credit rating service about the dangers of default.

While maintaining the state's ''AA" rating for now, in connection with a recent refunding bond, S & P said: "If we believe that Rhode Island ... [wavers] in its commitment to supporting its debt, we could take negative rating action, potentially lowering [general obligation], appropriation and moral obligation debt by multiple notches."

New House Speaker Nicholas Mattiello, who has not taken a public position on repayment of the bonds, said: "This report provides House members with some good information that will help us to formulate a fact-based decision on the bond repayment. The report will be considered, along with the examination of various aspects of this issue by the House Finance and Oversight committees, that will be reviewed and analyzed by all members of the House before a decision is made."

Senate President Terese Paiva Weed issued this statement: "It was important that as we make decisions on bond repayment in the upcoming budget we receive the independent report on the potential costs and implications of not appropriating funds. Repayment of the bonds protects Rhode Island taxpayers from extremely high borrowing costs and protects the state's reputation. The responsible course of action is to repay the state's obligation while pursuing litigation and every means to recoup costs on behalf of the taxpayers."

It remains unclear exactly how the administration chose SJ Advisors.

But in a Feb. 20 letter, Johnson assured Peter Marino, director of the state's Office of Management and Budget, that "SJ Advisors has the ability to provide a robust market study and analysis of the potential impact on the State of Rhode Island's cost of borrowing and access to the market as a result of not meeting its moral obligation debt payments."

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(c)2014 The Providence Journal (Providence, R.I.)

Visit The Providence Journal (Providence, R.I.) at www.projo.com

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Source: Providence Journal (RI)


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