Some Rhode Island Schilling bonds weaken with default risk

Fri May 16, 2014 5:40pm EDT

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May 16 (Reuters) - Against the risk of default, some bonds issued by Rhode Island on behalf of former Boston Red Sox pitcher Curt Schilling's failed video game company traded for the first time in 19 months late this week at weaker prices.

The trades come as lawmakers debate whether Rhode Island should pay debt service on the bonds, issued in 2010 to lure Schilling's company, 38 Studios, to Rhode Island from Massachusetts. The company filed for bankruptcy in 2012.

Some say the state should not have to bear the brunt of a soured deal that taxpayers never had the opportunity to approve. The state backed the bonds with its "moral obligation," but not a more binding legal commitment to pay. The bonds are insured.

Standard & Poor's Ratings Services cut the bonds three notches to 'BBB' on Monday, simultaneously warning it could also slash Rhode Island's 'AA' general obligation credit rating by several notches if lawmakers decide not to allocate funds to pay.

If Rhode Island fell below investment grade, taxpayers could wind up paying even more because of higher future government borrowing costs than they would if the state just finished repaying the original $75 million loan, a recent state-commissioned report by SJ Advisors found.

After the S&P warning this week, some other Rhode Island debt saw liquidity for the first time in months. General obligation bonds maturing in 2020 that had not changed hands since late January were sold at a higher price on Tuesday.

In three very small trades on Thursday and Friday, 38 Studios bonds maturing in November 2015 were priced between 101.6 and 102.3 cents on the dollar, with a high yield of 4.84 percent. That is cheaper than when they last traded in October 2012, when a large block sold at 104.8 cents with a yield of about 4.3 percent.

A longer maturity of 38 Studios bonds, which comes due in 2020 and carries a 7.75 percent coupon, traded in early May for the first time in about 10 months at higher prices.

States historically pay their debt obligations, regardless of what they are called, said Van Eck Global chief municipal strategist James Colby.

If Rhode Island fails to pay the 38 Studios moral obligation bonds, it would "send a resounding message to municipal bond investors that a cornerstone element of the municipal capital markets is being tested," he said.

The broader muni market has about $21 billion of state-issued moral obligation debt outstanding, according to Moody's Investors Service, which rates about $5.4 billion of that. Local governments also issue such debt, but totals were not available.

"This might be the first case where the state had the ability to pay, but just did not for whatever reason, step up and pay," said Chad Farrington, head of municipal bond research at Columbia Management Investment Advisers. "That it's even being talked about is a good reminder to everybody that you need to know what you're buying." (Reporting by Hilary Russ. Editing by Andre Grenon)

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