With several tribal gaming borrower defaults recently gaining national media attention, there has been much speculation with regard to the viability, enforceability and overall strength of tribal casino/resort investments. As with most media-saturated topics, the cases gaining the most attention are fairly atypical, yet still rise to the forefront of discussions. Atypical or not, these defaults have caused even seasoned tribal investors to pause and cautiously review lending decisions with even more diligence than before. The tribal gaming sector has always been ascribed its own set of unique risk factors, but are these new concerns warranted sector-wide? Either way, a discussion of key critical lending and investment considerations is certainly warranted.
Investors typically look to the rating agencies to provide insight into credit worthiness and risk factors of gaming issuers. Moody’s, a leading rating agency, has historically published a general Native American and Gaming Rating Methodology Report that notes its perceived risk factors unique to tribal gaming facilities. However, in reviewing several of these factors, it appears that in the current market climate, certain characteristics that have been perceived as negative may actually bring added benefit and even downside protection. The following are a few of the cited risk factors attributed to tribal gaming issuers as noted by Moody’s, other rating agencies and investors in general.
Single Asset Risk
The “Single Asset” risk is one that is characteristic to nearly all of Indian country. Legal and regulatory requirements (federal regulations require that the operation of tribal gaming facilities take place only on trust land and be owned by federally recognized tribal governments) cause most tribes to be limited to a single gaming facility. Even if a tribe is allowed to operate multiple casinos on its trust land, in most cases the risk factors are still attributed because these casinos typically share management and similar geography. Investors therefore deem that commercial gaming issuers who have multiple gaming assets under ownership separated by geographic diversity are considered to have “de-risked” their asset base, and lenders historically have perceived multiple locations as a hedge against declining revenues in any one region. In reviewing the single asset versus multiple asset risk factors in the recent climate of market and economic volatility, several multiple asset commercial gaming enterprises have suffered greatly due to the parent company being overextended, realizing multiple declines and having complex financial structures when attempting to reorganize debt, dispose of assets or rework corporate formations. For example, in a very visible bankruptcy proceeding, Las Vegas-based Station Casinos, a historically strong locals market owner-operator of multiple commercial and tribal casinos (as managers), suffered from declining revenues and over-leveraged debt ratios. When seeking a resolution with its lenders, the complexity of its 15-plus properties caused concerns and delays.
Station Casinos is not alone; Harrah’s and MGM have experienced similar over-leveraging of their multiple property platforms. Most industry experts agree that the multi-asset structure is not a problem in and of itself, but that the credit markets allowed more leveraging due to the perception that there was a greater probability of revenue, and that lenders permitted debt leverage ratios that would never be allowed with single asset credits. Regardless of the rationale, the reality is that many single asset gaming properties have proven to be the safer investment.
Since tribal gaming facilities can only operate on trust land, location shopping to find a site with attractive demographics is not allowed. Consequently, a large portion of tribal casinos are regional facilities sometimes located in fairly remote locations. The Moody’s report notes that most Native American gaming markets appear to be “drive-to destinations where slot play, as opposed to table play, makes up a greater portion of gaming revenue.” The perceived risk factor therefore is that these locals markets will not benefit from the deep and healthy client base of destination resort locations such as Las Vegas or Atlantic City. However, in an ironic twist, during the recent economic crises, since destination locales require air travel and derive their revenue from retail shopping, expensive entertainment, lodging and dining as well as gaming, Las Vegas and Atlantic City properties suffered in greater numbers than the stalwart locals tribal markets. During one month in early 2010, Bloomberg News reported that “Casino gambling revenue dropped 15 percent on the Las Vegas Strip … and tumbled 19 percent in Atlantic City … as the U.S. recession curbed spending on travel and betting.”
Most tribal casinos are not public filers, so an aggregate revenue database is non-existent; however, the majority of tribal issuers have individually reported declines in the single digits during the same economic period. Many tribal gaming facilities have hired new management or management consultants to respond proactively. It appears that with a single asset and a locals market clientele, management has to be much more aggressive and responsive to retain their loyal customer base. Additionally, when families stay close to home, the locals facilities benefit.
Tribal sovereignty, related limited waivers of immunity for contractual obligations, and security recourse are probably the most misunderstood concepts related to risk factors of tribal issuers. The fundamental concept of how to best secure a tribal asset is a valid discussion. One answer is in the underlying documents of the transaction—utilizing federal Indian law experts and notating exact jurisdictional recourse provisions can create nearly the same level of security (or greater) as is available in commercial assets.
However, despite negative perceptions that the sovereign veil creates difficulty and inaccessibility, statistics indicate that there is actually more opportunity for resolution with a tribal government than with a commercial borrower. Moody’s reports that both commercial and tribal debt issuers currently have approximately 50 percent of their properties assessed a negative credit rating. Of the negative credit rated tribal facilities, 100 percent of those that have actually defaulted have entered into negotiations with their lenders to work out mutually beneficial solutions. However, several of the commercial borrowers in default have filed for protection under bankruptcy laws and the lenders must endure lengthy, expensive, litigious proceedings to seek resolution. The topic of whether any bankruptcy laws are available to tribes is a hotly debated topic among legal experts. However, no tribes have filed for this type of protection and instead have chosen to discuss and work out solutions with lenders. One tribal leader whose gaming facility is in debt restructuring negotiations stated that since the location is their homeland and will be for generations to come, they are committed to work this out, as “there is no possibility of packing up, closing down or relocating somewhere else.”
Wayne Shammel, presently general counsel for the Cow Creek Band of Umpqua Tribe of Indians, has been an associate or principal on over a billion dollars of capital financing in Indian country. Shammel cites full disclosure and candor between tribal clients and their financial partners, even when the going gets tough, as the basis for solid long-term investor-lender relationships: “By working overtime on disclosure and communications … we illustrate to our partners that we understand the processes that we’ve subscribed to in a capital financing.”
Perhaps the most feared risk factor—for which lending premiums are assessed to tribal borrowers and issuers—is the uniqueness of the security provisions. Tribal lenders and investors typically understand that due to trust land restrictions, unlike commercial facilities, the underlying land is not available for standard mortgage lien structures. Therefore, the collateral in Indian gaming is primarily the cash flow of the operations. So then, how best to perfect the security provisions, especially in situations of default? Surprisingly enough, recent tribal transactions have been structured with broad security provisions designed to give lenders and investors added comfort. These provisions provide for stronger security than typically seen previously and are indicative of many tribes’ willingness to work with the lending community and honor their commitments. Several recent tribal issuances (both loans and bonds) have included some form of the following broad security covenants:
1. Debt is most often secured by a pledge of gross revenues of the tribe’s gaming operations pursuant to security agreements.
2. Under the terms of a depository agreement or escrow agreement, the tribe may be required to deposit gross gaming revenues into an account controlled by the lender and permitted to withdraw amounts so deposited to pay costs of gaming operations upon request.
3. The debt is secured by a pledge of substantially all personal property, including accounts of the tribe’s casinos/gaming resorts.
4. The debt/loans are full recourse loans, permitting enforcement against all assets of the tribe other than certain “protected assets.”
5. In some cases, tribes will grant a leasehold mortgage.
Providing such broad security is not an easy pill to swallow, yet tribal councils realize the good of their future generations are at stake and they must find the necessary resolutions in order to move forward and grow their operations appropriately.
Tribal gaming sector risk factors, when scrutinized, certainly appear to potentially have, at minimum, mitigating considerations and definitely some added comfort and protection at best. Unbelievably, amidst the worst economic crisis in the U.S. since the Great Depression, Indian gaming posted positive aggregate year over year growth in 2008, according to Casino City’s 2009-2010 Indian Gaming Report. This revenue growth, taken in consideration with tribal governments’ commitment to economic development and sustainability, should provide comfort for investors and lenders. Gaming tribes maintain a long-term view of their future, taking commitments to investors and lenders extremely seriously. This enduring philosophy, together with the additional “belts and suspenders” provided within current security and legal documents, should give capital markets’ investors and lenders comfort to move beyond the risk factors and appreciate the opportunity that remains in the tribal gaming sector.
Author’s Note: Information herein is obtained from sources that The PrinceRidge Group LLC believes to be reliable and accurate, but is not guaranteed as such. This is not a research report, nor a product of any research department. The above article should not be, and is not intended to be, investment advice by The PrinceRidge Group LLC or any of its employees. The above article is not an offer, recommendation or solicitation to buy or sell any financial products related to tribal gaming. The PrinceRidge Group LLC is not responsible for any investment that any investor may make in any financial products related to tribal gaming and each proposed trade or transaction should be analyzed by any investor in the context of its own objectives, overall portfolio, liquidity and risk tolerance. The PrinceRidge Group and its employees may execute trades, recommend trades, or have positions relating to the subject issuers that are inconsistent with the positions, if any, taken herein. Additional information is available upon request.