EASY TRIBAL CASINO FINANCING: RIP?

GAMINGLEGALNEWS EDITORIAL BOARD
Dennis J. Whittlesey, Gaming Law/Indian Law



EASY TRIBAL CASINO FINANCING: RIP?
by Dennis J. Whittlesey

The federal Indian Gaming Regulatory Act became law in October 1988, and
a movie entitled “Field of Dreams” was released six months later. The
former established the foundation for what has become a monster gaming
industry. The latter was a fantasy about a man living in Iowa who built a
baseball field in the middle of his farm.

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While these two events ostensibly had nothing to do with each other, they
ultimately became synonymous in the minds of many, for Indian gaming soon
adopted as an unofficial motto the signature idea from the movie: “Build
it and they will come.”

So tribes built casinos wherever they could, and the people came. Some of
the tribes built mega-casinos with attendant major hotels and shopping
malls, and the people came. The surge was onward and upward without
regard to when and where it might stop. Indeed, two of the largest
casinos in the world – Foxwoods and Mohegan Sun – were constructed in
Southern Connecticut, and both prospered.

And the financial community quickly caught on that business with tribes
was prosperous, profitable and ostensibly safe. Money was available for
tribal casino projects, even though conventional securitization was not,
since tribal lands and buildings are in trust status and cannot be
mortgaged. Security interests had to be protected through carefully
constructed loan documents but ultimately depended on debt service coming
primarily from casino revenues. However, this was not seen as risky since
it was widely assumed as a matter of “conventional wisdom” – as well as
the history of the gaming industry’s financial performance – that casinos
were immune from financial downturns. The terms Indian gaming and
expansion became synonymous. New and larger tribal casinos were developed
and other still larger casinos planned; meanwhile, many existing tribal
casinos were significantly expanded to offer much broader gaming
opportunities, as well as hotels, vast dining and entertainment venues,
and casino-connected shopping malls previously seen only in Las Vegas.
“Build it and they will come” went from motto to mantra for the entire
Indian gaming industry and its business partners in the financial
community. Conventional wisdom served everyone quite well, at least as
long as financial times were good.

Conventional wisdom is no longer “conventional” or “wisdom.” Over the
past 18 months, the gaming industry throughout the country – both Indian
and non-Indian – has seen a downturn due to the ongoing national and
global financial crisis. The “rosy scenario” for gaming expansion has
faded.

The two largest tribal casinos in the world – Foxwoods (owned by the
Mashantucket Pequot Tribe) and Mohegan Sun (owned by the Mohegan Tribe) –
have served as examples for others to follow. Located only seven miles
apart, each is a billion dollar operation which has aggressively expanded
in anticipation of increasing its market and building brand loyalty which
would deflect any impact from the expansion of gaming into New England.
Each now faces fiscal problems.

Other tribal casinos are also in financial distress due to both over
expansion and tribal memberships demanding periodic stipend payments from
casino revenues. For example, Foxwoods owed its creditors more than $2
billion and was unable to service its debt, yet was paying up to $120,000
annually to each tribal member. When the creditors raised objections to
the stipend payments, former Tribal Chairman Michael Thomas announced
that he would continue the members’ payments even though doing so meant
that debt service could not be satisfied. Thomas was removed as Chairman
by the Tribal Council, and the individual stipends were suspended when
the tribe was unable to make its debt payments. The tribe and its
creditors reportedly have been engaged in serious negotiations to
restructure the debt, negotiations necessitated by the fact the Indian
tribes are not subject to federal bankruptcy laws.

The Foxwoods financial situation was highlighted in a recent article in
The Wall Street Journal reporting on, and analyzing, the current fiscal
woes within Indian Country. Coincidentally, the article appeared just
after the Native American Finance Officers Association sponsored the
“Wall Street Summit II & Tribal Bond Investors Summit” in Jersey City,
New Jersey, on September 14-16. (Significantly, one of the major panels
at NAFOA concerned “At Debt’s Door: Surviving a Distressed Credit
Scenario.”) While the WSJ article portrayed an overly dismal picture of
the situation at Foxwoods, the fact remains that there are problems at a
number of tribal casinos. Mohegan Sun is one.

Mohegan – like Foxwoods – has experienced declining gaming revenues over
the past several years while at the same time incurring new debt. Both
have pursued gaming in Pennsylvania at great expense (Mohegan was
successful in winning a license and commencing operations), pursued
non-Indian gaming in other states at great expense, worked with other
tribes across the country to help them develop gaming at great expense,
and expanded their signature properties at great expense. (The WSJ
article reported that Foxwoods has just completed a three-year expansion
project at a cost of $700 million, an expansion which has not generated
revenues sufficient to service the additional debt.) Adding to the
picture was the news a week ago that Mohegan Sun was laying off between
350-400 employees due to reduced earnings, the first layoffs in that
casino’s history.

NAFOA’s widely respected President Bill Lomax has written that the WSJ
article demonstrated a fundamental lack of understanding of tribal
governments and their business management abilities, expressing concern
that these misunderstandings could negatively impact tribal attempts to
conduct business with tribes. Lomax’s point is well-taken, but the
financial community concerns go much deeper than the debt service at the
two casino giants in Connecticut. And that brings us to the Lac du
Flambeau Tribe of Wisconsin and the astonishing turn of events associated
with its Lake of the Torches Resort/Casino.

When Lac du Flambeau was unable to meet its debt service on a $50 million
bond indenture in late 2009, the bondholder requested its trustee to
invoke certain provisions of the indenture documents including judicial
relief for the appointment of a receiver to operate the casino. The bond
indenture was placed in 2008, and some $46.6 million was outstanding at
the time of default and protective relief seemed certain. However, in
January 2010, a federal judge in Wisconsin denied the requested relief
with a finding that the entire financial transaction was void under the
federal Indian Gaming Regulatory Act because the receivership provision
constituted a management contract as a matter of law. It is
well-established that management contracts and all collateral documents
are void unless approved by the Chairman of the National Indian Gaming
Commission. The Lake of the Torches agreements had not received NIGC
approval, so all of the transaction documents were void. The Lac du
Flambeau tribal leaders originally pledged to honor the financial
obligations, but have since advised the federal court that the tribe no
longer intends to do so. Unless the January decision is reversed on
appeal, the bondholders have no means to recover the outstanding debt.
The problem is not in Indian gaming per se, a point made by NAFOA’s
Lomax. As with any other segment of business, the problem is in the
conduct of business in individual cases, and Indian gaming has a very
good track record overall in responsible planning and management. But,
bad situations receive wide attention because tribal financing uniquely
requires creative ways of protecting the investment community since there
can be no foreclosure and asset seizure. While it always is unfair to
paint a picture of an entire industry based on actions of a few, the fact
is that there is still a great deal of uncertainty among those wishing to
contract with tribes. The end result must be – and, indeed, already is –
increased scrutiny of transactions, transaction documents, and the tribes
with which one is dealing.

However, even increased knowledge and vigilance may not be enough to
insure that responsible tribal projects can be funded. The investment
community will look at the outstanding debt in Indian Country, as well
as the overall downturn in casino revenues. New England tribes are on the
front line of this.

This subject was directly addressed a week ago by Rochanne Hackett,
Senior Vice President and Director of Gaming Development for Wells Fargo
Bank, at the New England Gaming Summit held at Mohegan Sun. Hackett
reported that the lending pool for Indian casinos shrunk some 70 percent
this year, and directly affecting this development was the debt and
business downturn from Foxwoods and Mohegan Sun. She stated that
commercial banks are willing to lend $300 million for new tribal casino
projects, a sharp reduction from the $1 billion which was available only
a couple of years ago.

There still is money available, but securing it likely will be more
complicated from this point forward. Citing the Mohegan Tribe’s interest
in developing a non-tribal casino in Western Massachusetts if the state
enacts enabling legislation, Hackett noted that the state licensure
probably will require licensees to invest at least $600 million in
addition to the costs of land acquisition, which would require creative
financing, including multiple lenders and subordinated debt loans.
However, she was describing financing for a non-tribal project which
would not enjoy the sovereign immunity of tribal casinos, and it is not
clear that a tribal project can ever be financed at the $600 million
level.

In light of the potential default at Foxwoods, the invalidation of loan
obligations at Lac du Flambeau, the huge debt of Mohegan, and other
troubled tribal projects in such places as Arizona, California, and
Washington, there are concerns about funding future tribal projects or
even continuing fiscal stability of existing tribal casinos. All of these
developments dramatically expose the fragile foundation of the “build it
and they will come” philosophy. It is true that tribal gaming had a very
good run for the past decade, but there was overexpansion, too much debt,
and a shrinking clientele due to increased competition and the economic
downturn. The adjudicated invalidity of the financing documents at Lac du
Flambeau only adds to the concern, since at least one well-known casino
financing expert has suggested that dozens of tribal casinos utilized
financing documents identical to those at Lake of the Torches.

Nobody is predicting the collapse of any tribal casino yet, although
Foxwoods continues to be carefully watched. There is something of a “too
big to fail” philosophy at play in the American financial markets.

Whether it proves true is still unknown.

The sky is not yet falling on tribal gaming in general, but it definitely
has fallen on rapid growth and debt accumulation. The notion of “build it
and they will come” will retreat to motion pictures where it belongs.

As for easy tribal financing, it soon may be time to proclaim: requiescat
in pace.