The cost of defaulting on the 38 Studios bonds

June 10, 2013

The Rhode Island General Assembly’s House Finance Committee heard testimony last Thursday from Matt Fabian of Municipal Market Advisors – an independent research service with about 300 subscribers – about the cost and implications of the state defaulting on the 38 Studios moral obligation bonds. Committee Chair Helio Melo’s main line of inquiry was “Does it cost us more money in the long run” if the state were to default on those bonds?

At 29 minutes into the hearing Fabian says that it is unlikely that the state’s general obligation rating would be lowered below investment grade, but it could be knocked down one, two or three notches. He says “It could go down to a BBB, the lowest investment grade rating …  it is a scenario but not most likely.” This is the closest Fabian gets to predicting the cost.

Most members of the House Finance Committee wanted hard numbers to make a decision. Understandably, it seemed difficult for them to convert Fabian’s commentary into decisions for the state. reported:

The committee members listened to Fabian’s comments closely, but more than one expressed skepticism about the lack of hard data about the impact of a default.

“I say we get out of this now, have these insurance companies pay this bill, and then we negotiate with the insurance companies if they want to ‘morally’ come after us,” said Rep. Ray Hull, D-Providence.

Melo replied that the 38 Studios insurance policy was paid for out of the bond proceeds, not by the state.

House Minority Leader Brian Newberry, R-North Smithfield, called the hearing ‘a dog-and-pony show’ designed by top leaders to push rank-and-file members to support repayment. He also noted that Fabian said he could have done a more thorough analysis of the state’s options had they approached him sooner.

In light of Newberry’s comment, I did some back-of-the envelope calculations that may or may not be useful to RI legislators. Here is a chart that shows the interest on municipal debt for various levels of credit ratings for the month of June, 2008 through June 2013. The yields are from Thomson Reuters Municipal Market Data’s database. Rhode Island general obligation bonds are currently rated  Aa2/AA/AA.

To make the data a little more useful, I calculated what the annual interest would be for the approximately $2 billion in state tax-supported and state supported revenue debt (pages 8 and 9) at various credit rating levels:

Here is the spreadsheet of the underlying data.

There are many market and legal considerations that go into the treatment of the moral obligation bonds in Rhode Island, but if the primary concern is the cost of defaulting on the 38 Studios bonds, this data might help. Also Thomson Reuters Municipal Market Data’s Daniel Berger is happy to appear in front of the Finance Committee to walk them through the numbers.


Rhode Island General Assembly:  Video of House Finance Committee hearing of June 6, 2013 (2nd row, 2nd from right)

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