PROVIDENCE, R.I. (WPRI) – An advisory firm is doubling down on its recommendation that investors sell Rhode Island government bonds, citing the lingering controversy over the 38 Studios debt and the state’s broader economic troubles.
Gurtin Fixed Income Management, a California-based firm that manages $9 billion in assets, stopped buying Rhode Island state debt last May when its research team put a “sell” rating on the state’s liabilities.
Gurtin said it was alarmed that the General Assembly seriously considered refusing to use taxpayer money to pay $75 million in bonds sold in 2010 by the R.I. Economic Development Corporation, a quasi-state agency, to lure Curt Schilling’s 38 Studios to Rhode Island. The company went bankrupt in 2012, leaving taxpayers to foot the bill.
In two new reports issued this spring, Gurtin expanded on its concerns about not only the 38 Studios debt but “an array of economic and fiscal challenges” facing Rhode Island’s government.
“While the [38 Studios] saga may have been the inflection point that drove our initial decision to move the state to a Sell, we now believe the state’s other more chronic problems pose a heightened level of credit risk,” Gurtin argued in an analysis released last month.
Among other challenges, Gurtin cited Rhode Island’s reliance on revenue from gambling, which accounts for about 11% of general revenue, second only to Nevada among the states. A state-commissioned study issued last fall suggested Rhode Island gambling revenue could drop almost 40% once new casinos get up and running in Massachusetts.
A second challenge cited by Gurtin is the state’s annual budget deficit. In March, the Raimondo administration projected the shortfall will grow from $75 million in 2016-17 to $377 million in 2019-20 if current trends continue.
“The catalysts of the state’s expenditure growth are expected to be concentrated into two main categories: Medicaid and pensions, both of which are notoriously challenging for states to reduce,” Gurtin said, while adding that the proposed settlement to end a lawsuit against the 2011 state pension overhaul “represents a key step in Rhode Island’s plan to shore up its pension troubles.”
A third challenge for Rhode Island cited by Gurtin: “economic and demographic trends continue to be poor.” The analysis noted that the state was hit particularly hard by the Great Recession after losing 42% of its manufacturing jobs since 2000, and also that it has a stagnant population, with one of the lowest birth rates in the country and the ninth-oldest average age for residents.
“The state’s aforementioned pension and Medicaid issues are at least in part a consequence of the state’s weak demographic trajectory which shows few signs of abating,” Gurtin said.
Yet another challenge cited by Gurtin is Rhode Island’s small size, which makes it easier for residents and businesses to move across the border if they’re dissatisfied with the state’s economic environment.
“We have long opined that the key strengths shared by all states are their sovereign ability to generate revenue through taxation, to reduce expenditures, and to push problems onto local governments,” Gurtin said. “While Rhode Island does possess these powers, its size poses unique challenges.”
A separate Gurtin report, issued in March, laid out its research team’s agitation over state leaders’ flirtation with refusing to pay the 38 Studios bonds. Taxpayers made a $2.2 million payment to bondholders just last week; they’re still on the hook for $73 million to pay in full.
While the debate over repaying the debt has been much quieter this year – Governor Raimondo has included $12.5 million in her proposed budget to make the next round of payments to bondholders, and House Speaker Nicholas Mattiello has declared the issue settled – it left an impression on Gurtin.
“The case of Rhode Island is noteworthy since the repayment of a state obligation, regardless of security, had rarely been so tenuous,” Gurtin’s report said. “It is without precedent for a state government in the modern municipal bond era to force bondholders to wait until the final hour to find out if they will be paid.”
Much of the Gurtin report revisited arguments made in the past, suggesting that the market views the so-called “moral-obligation bonds” floated in the 38 Studios deal “as an implicit obligation of the state” and “debt repayment is not viewed as optional.”
“If the state had chosen to default it would have been an unprecedented event,” Gurtin said, adding that the state “deliberately made representations it would stand behind the debt to help facilitate the bonds’ marketability.”
The report acknowledged there is widespread uncertainty about how Rhode Island would be impacted if it refuses to pay the 38 Studios bonds, both in terms of its ability to borrow at reasonable interest rates and its future credit ratings from Moody’s, Standard & Poor’s and Fitch, the “big three” rating agencies.
“The ripple effect throughout the market is very difficult to quantify, but we believe it could have been more far-reaching than many may appreciate,” Gurtin argued.
Gurtin previously issued a broader examination of moral-obligation bonds back in January, citing the 38 Studios dispute in detail.
“The level of surprise in the market following the state’s reluctance to pay 38 Studios bondholders is clear evidence that there is broad misunderstanding of moral obligation pledges, which frighteningly extends beyond investors and into the very governments that issue debt backed by this security,” the report said.
That report also criticized Moody’s and S&P for giving the 38 Studios bonds relatively high credit ratings based primarily on the state’s underlying credit rating, rather than looking more closely at the specifics of the 38 Studios transaction.Ted Nesi (firstname.lastname@example.org) covers politics and the economy for WPRI.com. He hosts Executive Suite and writes the Nesi’s Notes blog. Follow him on Twitter: @tednesi