UPDATE 1-Rhode Island will be downgraded if Schilling debt defaults -S&P

Mon May 12, 2014 4:56pm EDT

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(Adds background on Schilling's company and Rhode Island's involvement in bonds)

May 12 (Reuters) - Rhode Island will suffer a dramatic downgrade to its "AA" credit rating if lawmakers allow a default on bonds the state backed for ex-Red Sox pitcher Curt Schilling's now-defunct videogame company, Standard & Poor's Ratings Services warned on Monday.

The state has no legal obligation to pay debt service on the $75 million of bonds it issued in 2010 on behalf of 38 Studios, Schilling's company, and the bonds are insured. But the state pledged its "moral obligation" to pay, and now legislators are questioning whether to do so.

S&P also cut the 38 Studios' bonds themselves to "BBB" from "A" on Monday. And it placed those bonds, Rhode Island's general obligation bonds, appropriation debt and moral-obligation backed bonds on Creditwatch negative.

Schilling's company filed for bankruptcy in 2012.

The Wall Street credit rating agency said it would make a decision whether to downgrade Rhode Island debt when the state budget for fiscal 2015, which begins July 1, is finalized.

A state-commissioned analysis on Friday found that the state's rating would be cut to "junk" if it chose not to pay debt service costs for Schilling's bonds.

That report, by SJ Advisors, found that defaulting on the debt would cost more than paying it: between $36 million and nearly $362 million more, because the downgrade that follows would prompt higher borrowing costs for Rhode Island. A multi-notch downgrade could also cause the state's outstanding bonds to lose between $212 million and $255 million in value altogether, the report said.

Governor Lincoln Chafee included about $12.4 million in his proposed budget to cover debt service on the bonds.

Former Governor Donald Carcieri, who left office in January 2011, supported the deal with Schilling as a way to lure 38 Studios to relocate to Rhode Island from Maynard, Massachusetts. (Reporting by Hilary Russ in New York; editing by G Crosse and Matthew Lewis)

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