For all involved, it would have been much better back in 2010 if former Red Sox pitcher Curt Schilling had taken his ball and bat and just gone home.
Despite the fact that no private equity firms in Boston, the hometown of the Sox, would turn over a dime to Schilling for his dicey investment idea, neighboring Rhode Island cheerfully stepped up to the plate. Now, a year after Schilling's doomed gaming business, 38 Studios, famously deflated, the state of Rhode Island, after much debate, has decided to pay the first of many payments on the $75 million in loan guarantees it provided.
That decision affects the finances not only of the tiny New England state, but also those of Assured Guaranty (NYSE:AGO), the monoline insurer that backed the bonds behind that imprudent investment.
A pandemic of possible defaults
This is not the first time Assured has had to deal with a possible default on bonds it has insured. As Detroit teeters on the brink of bankruptcy, city managers have tried to prod investors into settling for $0.10 on the dollar. Both Assured and MBIA (NYSE:MBI) have backed municipal bonds for the city, although as analyst Mark Palmer has pointed out, the risk of default is minimal. That's because the revenue generated by Assured's utility bonds and MBIA's sewer bonds will likely continue to be paid by the income generated by the continued operation of the electric and sewer systems.
Similarly, Assured's involvement in the backing of Schilling's 38 Studios bonds wouldn't have dinged the insurer too badly, even if the vote had gone south. There was, however, strong support for a vote to pay the bonds, and harbingers of trouble to come if that scenario didn't come to pass. Moody's stood at the ready to downgrade the state's credit rating the moment the legislature voted to deny payment, and it has already downgraded the entity that provided the funds in the first place.
Considering the state's fiscal situation, the vote was gutsy. Rhode Island is in the economic doldrums, and a study by the Rhode Island Public Expenditure Council said that refusing to fund the payment would save the state more than $89 million. At the same time, it noted the dire consequences the state would face if they did renege. Rhode Island's governor wanted the debt payment made, as well.
A win for bond insurers
The vote to pay the first bond payment is a win for Assured and all bond insurers, since other government entities will presumably think twice before defaulting themselves if the cost appears to be too high.
Even if the vote had gone the other way, Assured's improving health would have kept the suffering to a minimum. The insurer has had a run of good luck recently, wringing a $105 million settlement from Flagstar Bancorp (NYSE:FBC) regarding mortgage-backed securities it backed during the go-go days of 2005 and 2006. Flagstar also came to terms with MBIA a few weeks ago, paying that insurer $110 million.
Add to that the fact that rising interest rates can only pique interest in the services that bond insurers have to offer, and Assured's future looks, well, assured. Unfortunately, the same can't be said for the state of Rhode Island.
Fool contributor Amanda Alix has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.