Bloomberg News

Schilling-Bond Refunding Hastened by Lowest Yields: Muni Credit

July 23, 2012

The lowest municipal yields in a generation may help Rhode Island cut the cost of repaying $75 million it borrowed to lure former Boston Red Sox pitcher Curt Schilling’s now-bankrupt video-game company from Massachusetts.

While a federal bankruptcy court prepares for the liquidation of 38 Studios LLC, state officials are discussing refinancing the taxable securities to cut interest rates, now as high as 7.75 percent, said Rosemary Booth Gallogly, director of Rhode Island’s revenue department. Rhode Island has the second- highest jobless rate among U.S. states at 10.9 percent and an economy that may slip back into recession.

“We’ll only do this if it ends up costing less money,” Gallogly, 53, who was retained by Governor Lincoln Chafee, said in an interview. “I’m not going to say it’s going to be easy. There’s a lot of controversy surrounding this one.”

Even the worst-rated states and cities are refinancing debt, putting municipal-bond issuance on a pace for a record annual increase with $195 billion of long-term, fixed-rate securities sold this year through July 13. That’s 73 percent more than for the same period in 2011, data compiled by Bloomberg show. About 64 percent of the sales have been for refunding, the most since 1993, according to Bank of America Merrill Lynch.

A2 Rating

The 38 Studios debt is rated A2 by Moody’s Investors Service, its sixth-highest grade. The ranking reflects the state’s pledge to back the bonds, and not the bankrupt enterprise, according to a report from Moody’s in May, after the company missed a loan payment and fired its workforce. The state is expected to make good on its “moral obligation commitment” to cover the debt service if the company can’t, Moody’s said.

“As far as bondholders are concerned, it’s a pretty clean story,” said Triet Nguyen, managing partner at Axios Advisors LLC, an independent municipal-research company. “The EDC and the state are on the hook,” he said, referring to the state Economic Development Corp., which sold the securities.

“There are not a lot of ways to get out of it,” Nguyen said.

The demise of 38 Studios, which produced the game Kingdoms of Amalur: Reckoning before collapsing, shows the peril states and cities take on by borrowing to aid business ventures. Schilling, 45, promised in 2010 to bring hundreds of jobs to Providence when he moved his company there from Maynard, Massachusetts. The bankruptcy left Rhode Island on the hook for $75 million in debt that the company was supposed to repay.

Collapse Fallout

The fallout has been widespread. Schilling, who collected three World Series championship rings during his 23-year career, and Chafee, who opposed the 38 Studios deal as an independent candidate for governor in 2010, engaged in a war of words over whether the governor contributed to the company’s collapse.

The sudden shutdown and liquidation of the game maker prompted federal and state probes and led to disarray in the economic-development agency. Schilling last month said in a radio interview that he put more than $50 million into the venture and that he had to tell his family the fortune he made from baseball is gone.

Schilling didn’t respond to an e-mailed request for comment on the situation forwarded to him by Katie Leighton, his publicist.

Robert Flanders, a former state Supreme Court judge who oversaw the bankruptcy of Central Falls, Rhode Island, has joined calls in the state for Chafee to explore defaulting on the bonds and forcing investors to take a loss.

Other Needs

“Every dollar that’s paid for these moral-obligation bonds is a dollar down the rat hole that could have been paid for education and social services and relief for retirees,” Flanders said in an interview. “We’ve got to fight for every dollar in this state.”

Gallogly has been joined by other state officials, including Treasurer Gina Raimondo, a Democrat, in dismissing a default, saying it would hurt the state’s credit standing.

38 Studios entered Chapter 7 liquidation last month in U.S. Bankruptcy Court in Wilmington, Delaware, listing debts of $150.7 million. Of that amount, $115.9 million is owed to Rhode Island, including fees and interest from the financing.

The company listed assets of $21.7 million. Proceeds from the liquidation, overseen by a court trustee, will be distributed to creditors.

Bond Yields

Rhode Island’s development agency borrowed the money in October 2010. Bondholders receive 7.75 percent interest on $42.5 million of the debt maturing in 2020, 6.75 percent for $8.9 million maturing in 2016, and 6 percent for $23.7 million in 2015, according to bond documents. The yield is federally taxable and exempt from state levies.

The longest-dated debt traded at an average yield of 4.654 percent on May 23, and hasn’t changed hands since, according to data compiled by Bloomberg.

The state loaned $49.5 million of the proceeds to 38 Studios, deposited $23.4 million into accounts to cover initial interest payments, and paid underwriting fees of $1.85 million, according to bond documents. That included almost $563,000 to Assured Guaranty Ltd. (AGO:US) to back the debt.

The agency will exhaust the money set aside for interest payments next year, forcing the governor to ask Democrats who lead the Legislature to set aside money every year for debt service, Gallogly said.

Legislature’s Role

Rhode Island lawmakers, who voted to approve the bond sale, are facing their sixth consecutive year of state budget gaps, according to Moody’s. So instead of seeking money every year for interest payments, the Chafee administration is considering asking the Legislature to replace the moral-obligation bonds with more highly rated appropriation-backed debt, Gallogly said.

Taxable muni bonds are trading at near-record low yields, with A rated debt maturing in 2021 yielding 3.35 percent, the lowest since a Bloomberg Fair Value index began in 1994. Still, the savings Rhode Island could reap from a refinancing might be limited by provisions in the bond contract that require it to pay a penalty if it calls the bonds early, Gallogly said.

“We’ve looked at it preliminarily just to see if that’s an option and probably will pursue it,” she said. “If it were beneficial we would probably be able to sell that to the General Assembly.”

Following are pending sales:

REGENTS OF THE UNIVERSITY OF CALIFORNIA plan to sell $900 million of revenue bonds, including $100 million of taxable debt, as soon as July 26, according to data compiled by Bloomberg. Proceeds will help finance student housing and parking and refinance debt, according to bond documents. Moody’s rates the bonds Aa2, its third-highest grade. (Added July 23)

MARYLAND, with a top credit rating, plans to sell about $728 million of general-obligation debt as soon as next week. Proceeds will help finance state facilities, public schools, community colleges and jails, according to bond documents. (Added July 23)

To contact the reporter on this story: Michael McDonald in Boston at mmcdonald10@bloomberg.net.

To contact the editor responsible for this story: Stephen Merelman at smerelman@bloomberg.net


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