Editor’s Note: This is the first in a new series of articles brought to you by the International Association of Gaming Advisors. In this spot each month, you’ll find a column from a different member of IAGA discussing pressing issues the industry must be aware of.
We have all read about the dark side of casino debt: bankruptcies, defaults, debtors in possession and restructurings. This article is not about the darkness, but about the bright light that has been shining on the casino industry—the bright green financial light, that is. Casino operators and proposed casino operators have closed numerous financings over the past 12 to 15 months. While some of these transactions have been re-financings of existing debt, billions of dollars of new money have poured into the casino industry to finance construction of new casino projects, such as the Horseshoe Casino Cleveland to be opened in the spring of 2012 and Revel, to be opened in May 2012 in Atlantic City.
Whether it‘s a refinancing or new funds, once a financing source has been identified and negotiations begin, the question is always “What regulatory hurdles must be climbed before we can close?” Fulfilling regulatory requirements so a debt transaction can be immediately launched when the timing is right is crucial in this volatile financial market, where a small window of opportunity can open after days, weeks or months of closure. As such, the regulatory process plays a critical role in the consummation of a debt transaction.
While each jurisdiction has its own approach to regulating the incurrence of debt, jurisdictions can be grouped into two major categories: those that only require a casino licensee to notify the regulators of a major debt transaction and those that require prior approval of a major debt transaction. This article will summarize the requirements of both.
Hear Ye, Hear Ye!
Jurisdictions that only require notice are by far the favorites of lenders and casino operators. In notice-only states, a debt transaction can be closed when the business aspect of the deal is complete without worrying about when the next gaming board meeting is or how quickly the busy gaming board staff can navigate through the thousands of pages of debt transaction documents. The underlying principles of integrity and public confidence in gaming remain paramount in notice-only states, as debt transactions and lenders are subject to the continuing requirements and safeguards of the gaming laws. These safeguards range from the ability of a jurisdiction to reopen a license hearing to consider the effect of the transaction on the casino licensee to requiring licensure, suitability or a waiver from licensure or suitability of certain lenders.
Additionally, even in a state where the gaming laws do not require lender licensing, suitability or a waiver, the gaming regulatory body can require a casino licensee to sever ties with a lender if the gaming regulatory body believes that the lender is an unsuitable association. If the casino licensee does not disassociate with the lender, it can be subject to serious penalties up to and including suspension or revocation of its license. To that point, some states have a requirement that a notice-only transaction may only be conducted with a lender in the business of providing debt or equity capital to individuals or entities who are making a passive ordinary course of business loan. If other facts exist, prior approvals are required.
May I, Please?
The statutes of many states require pre-approval of material debt transactions. Voluminous materials, such as drafts of debt transaction documents, lender lists, projections and summaries of terms must be submitted. Although there is no uniformity, pre-approval jurisdictions generally examine at least one, if not all, of the following three major areas: financial stability, lender suitability and terms of the transaction.
One purpose of pre-approval of debt transactions is to review a casino’s financial viability after incurrence of the debt transaction. Therefore, gaming regulators request the casino licensee to prepare and submit projections assuming the incurrence of the new debt. The casino operator will generally need to demonstrate that after the consummation of the debt transaction it will have the ability to pay all wagers when due, pay its taxes, make certain capital and maintenance expenditures, and pay its debts.
Another area of inquiry for gaming regulators in pre-approval states is lender suitability. Lender suitability requirements vary from jurisdiction to jurisdiction and also vary based on the type of transaction, whether it is public or private. In some pre-approval states, no suitability or waiver from suitability is required, but instead a due diligence burden is placed on the casino licensee. If a gaming regulator finds a lender to be an “unsuitable association,” the casino licensee must force that lender to dispose of its holdings or the casino operator can risk licensing consequences. In other states, suitability or a waiver is required at least for a lead lender.
Fortunately, lender suitability requirements have been reformed in recent years. Not too long ago a waiver was generally only available for traditional institutional investors. However, state legislatures and gaming regulatory bodies have recognized that the lending world has changed and that there are established reputable lenders who do not meet the strict traditional definition of institutional investors, but who are passive and loan money in the ordinary course of their business. These lenders can now obtain a waiver. Furthermore, fewer states now require certifications or other documents from lenders. Still, the lender suitability process can impact the timing of a transaction.
Many jurisdictions also look at certain terms of the transaction documents for compliance with the gaming laws. For example, they look for language regarding mandatory redemption or disposition if a lender is found unsuitable or deemed to be an unsuitable association. They may review language regarding foreclosure on gaming assets as well. Some jurisdictions also look to see if the terms of the transaction are reasonable compared to other similar transactions.
In addition to the timing problem, another complication of the debt approval requirement is a product of the unpredictable markets of today. These unpredictable markets can require modification to the transaction, such as changes in covenants, varied allocation between two simultaneous issues of debt, increases in the total amount of debt, and unexpected interest rates. Most debt approvals contain caveats that if the transaction materially changes, a new approval must be obtained. This requirement can cause a casino operator to miss a window of opportunity. Casino operators try to avoid this scenario by providing “worst case scenario” models in their projections, but the impact of world events on the financial markets cannot always be predicted.
A final concern in debt-approval states is the confidentiality of the terms of the transaction. Most states that require pre-approval issue the approval at a hearing. As interest rates, covenants and exact funding amounts are not usually finalized at the time of the hearing, any disclosure of this information could impact the final terms of the transaction. Add to that a concern that in a high-yield offering, matters discussed at a hearing could trigger SEC non-solicitation rules. As such, balancing the confidentiality concerns with the need to inform the public at an open hearing can be difficult to navigate.
As you can see, the gaming regulatory process plays an integral role in the success of a casino debt transaction. Regulators, lenders and casino operators have been working cooperatively throughout the debt approval process to avoid unnecessary delays, and gaming regulatory authorities have uniformly strived to have debt transaction approvals placed on a meeting agenda and voted on as expeditiously as possible without compromising the goals of the gaming laws. Still, if I had a vote, I would vote for the timing certainty of a notice state.