Report: Non-Payment of 38 Studios moral obligation would likely reduce R.I. bond rating to ‘Junk’ status
PROVIDENCE — The Rhode Island Department of Administration announced today the release of a report by SJ Advisors that analyzed the potential financial and reputational impacts on the state of either payment or nonpayment of the moral obligation bond debt service associated with the 38 Studios bankruptcy.
Based on its analysis, the independent financial consulting firm of SJ Advisors concluded that 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 noted in its conclusions that “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.”
When SJ Advisors developed its assessment model, it created it to show the best, middle and worst case scenarios. In its detailed report, 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 – with a net present value cost of about $13.6 million. Should the worst case scenario come to pass, the net cost would be $361.8 million – with the net present value cost at $218.9 million. SJ Advisors believes that the middle case it developed in its analysis is the more likely scenario, where the net cost is estimated to be $125.6 million more than paying the debt service - with a net present value of $71.9 million.
“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,” Governor Lincoln D. 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.”
SJ Advisors concluded after its in-depth analysis that “non-appropriation would result in a series of cascading events that would lead to increased costs associated with the state’s debt. It could also lead to a contagion effect impacting other Rhode Island issuers and even taint the business environment. Additionally, holders of Rhode Island debt would experience a decrease in the value of their bonds.” The report further indicated that the state’s ability to achieve savings through refinancing existing debt would likely be eliminated by the higher yields associated with the downgrade.
SJ Advisors’ analysis examined potential reactions by the bond rating agencies, developed analytical tools to calculate various scenarios the state could face should the state be unwilling to pay the debt service on the moral obligation bonds, analyzed the length of time and the extent of the reactions from the bond rating agencies, as well as explored other potential implications of non-appropriation.
Richard Licht, Director of the Department of Administration noted, “Rhode Island has enhanced its financial management practices and has made great strides in developing a strong reputation in the market. All that work will disappear in an instant should the state fail to meet its fundamental obligations. The state’s excellent credit is fundamental to ensuring we are attractive for businesses to grow and locate here, and it is essential to ensure we can make the necessary investments in our economy. Failure to make this payment would be a grave error for the future of the state.”
“One of the most compelling findings in this report is the increasing clarity of the swift actions we might expect from the rating agencies should the state fail to meet its obligation,” added Peter Marino, Director of the Office of Management and Budget. “This translates to projected financial and reputational costs that would have long term negative consequences to the state.”
Per the direction of the General Assembly in the FY 2014 Budget As Enacted to conduct a study of the implications of payment/non-payment of the moral obligation bond debt service, the Department of Administration engaged SJ Advisors early in the year to complete this analysis for legislative consideration during the 2014 Legislative Session. SJ Advisors brings excellent credentials to this analysis and is registered with the Municipal Securities Rulemaking Board (MSRB) and the U.S. Securities and Exchange Commission (SEC). SJ Advisors will be presenting its report and its findings to the General Assembly on May 13 and May 14, 2014.