Foxwoods' implosion

BUSINESS SEPTEMBER 17, 2010
Tribe's Roll of Dice Rattles Lenders

By MIKE SPECTOR And ALEXANDRA BERZON

Financial troubles at Foxwoods Resort Casino in Connecticut, above, have led to debt-restructuring talks between the Pequots and their lenders.

LEDYARD, Conn.—Michael Thomas, a Pequot Indian with a brash leadership style and a checkered past, was a driving force behind turning Foxwoods Resort Casino into one of the world's largest casinos, and for making tribal members rich in the process. These days, he's being cast as the man who triggered a financial crisis.

With gambling revenues sinking and a showdown with lenders looming, Mr. Thomas vowed last summer to protect dividend payments to tribal members—as high as $120,000 a year for some—before reimbursing creditors owed more than $2 billion.

That audacious move spooked banks and bondholders. Other Pequot leaders, fearing a backlash, disavowed Mr. Thomas's comments and ousted him as chairman of the tribal council. As the crisis worsened, the tribe stopped making debt payments. In July, tribal leaders did exactly what Mr. Thomas said he wouldn't: They said they will halt the payouts that have put two or more BMWs in the driveways of some tribal members, and have made the Mashantucket Pequots the envy of the Indian gambling world. Lenders are now trying to hammer out a debt-restructuring deal with the tribe.

The financial mess on this tiny reservation in rural eastern Connecticut has rattled the once-booming business of casinos run by American Indians, drawing attention to the ramifications of their unique legal status. Tribal-owned casinos can't be forced into bankruptcy, many experts say, because tribes are sovereign nations. And federal law allows no one but Indians themselves to operate casinos on reservations, which effectively prevents creditors from seizing them and selling them off.

The showdown between the Pequots and their lenders, which include Bank of America Corp. and Wells Fargo & Co., has raised what was once an unthinkable question: What happens if a sovereign tribe defaults?

"The usual route through which these problems are resolved is that equity disappears," meaning that owners are wiped out, said Mr. Thomas, 42 years old, during an interview at his reservation home. "My people are not equity."

Mr. Thomas's vow has stoked fears among other Indian leaders that it will become more difficult for tribes nationwide to borrow money. His letter to fellow Pequots "was a statement that investments in tribes are not safe and that tribes will try to figure out some way to get out of them, and that is not the case," says Bob Garcia, chairman of the Confederated Tribes of the Coos, Lower Umpqua and Siuslaw Indians in Oregon.

Wall Street used to shy away from lending to tribes. But in the late 1990s, after lawyers crafted language in loan documents waiving tribes' sovereign protections from being sued in state or federal courts, the Indian-gambling debt market took off. Loans were secured by cash flow from the casinos.

Over time, the Indian lending market grew to an estimated $20 billion in outstanding debt. The easy money encouraged the Pequots and other tribes to keep building.

Then the national economy hit the skids and gamblers pulled back, putting pressure on casinos nationwide. Now lenders are tightening credit for tribes, asking more questions and charging higher interest rates.

The Mohegan tribe, which operates the Mohegan Sun near Foxwoods in Uncasville, Conn., had to pay a higher interest rate than originally expected on $200 million in bonds issued last fall, casino executives say. During meetings with potential investors, Mohegan tribe and casino officials tried to distance themselves from the Pequots, in part by saying Mohegan tribal members receive smaller dividends, the executives say.

Michael Thomas was ousted as tribal council chairman after irking lenders.

Another development that alarmed investors occurred in April, when a federal judge in Wisconsin ruled that a $50 million bond deal was invalid because it violated federal Indian casino law.

The decision, which is under appeal, could mean that the 3,500-member Lac du Flambeau Band of Lake Superior Chippewa Indians won't have to pay back its lenders. That worried investors, even though the bond terms that the judge found problematic are unique to that deal, Indian-gambling lawyers say.

Many tribes haven't amassed debt burdens as large as the Pequots did for Foxwoods. Only a handful have defaulted on debt.

Still, lenders and other tribes are following the Foxwoods restructuring closely. If creditors are forced to take big losses, investors could pull back from lending to the roughly 240 tribes that run casinos, bingo halls, lotteries and poker rooms, according to both lenders and other tribes.

That, in turn, could hurt the tens of thousands of Indians across the country who rely on casino revenue to fund local governments and economies, says Mr. Garcia of Oregon's Confederated Tribes of the Coos, Lower Umpqua and Siuslaw Indians.

"We use the money from casinos to fund scholarships for students and health-care benefits, pay for things for elders," he says. "Once we're done with that, there isn't anything left" for tribal-member dividends. "That's the way for most tribes."

Members of the Pequot tribal council declined interview requests, and the tribe divulges only minimal information about its finances. Moody's Investors Service recently stopped rating the Pequot tribe amid a dearth of financial information.

The Pequots were among the first tribes to encounter European settlers, and were all but killed off in various battles centuries ago. In the 1970s, their descendants began trying to revitalize the tribe's sparsely populated reservation. By 1983, the Pequots had federal recognition and a $900,000 trust fund for land acquisition and economic development. Several early stabs at businesses—a pig farm, maple-syrup production and firewood sales—failed.

Mr. Thomas was connected to a group of outsiders initially denied entry into the tribe. The group, black descendants of the Narragansett tribe in Rhode Island, eventually gained admittance to the Pequots by claiming a distant family connection to a prominent Pequot.

Mr. Thomas's own link was convoluted: His cousin was a distant relative of a woman named Elizabeth George. Ms. George was the grandmother of Richard "Skip" Hayward, the man who revitalized the Pequot reservation and helped start Foxwoods.

Mr. Thomas moved to the Pequot reservation as a teen. The wooded reservation was "the most boring a place a 15-year-old could be," he recalls. He moved back to live with his family in Rhode Island.

By 1986, the Pequots had opened a high-stakes bingo hall, getting their first taste of gambling profits. Mr. Thomas, meanwhile, was living in a tough neighborhood outside Providence, R.I., where he embraced "the fast life" and "fell in with all the wrong folks," he says.

In 1987, when Mr. Thomas was 18, Rhode Island police pulled him over and found several bags of cocaine in his car. Mr. Thomas says he was in the "grip" of drugs and spent nearly a year in state prison. When he got out, he returned to the Pequot reservation, eventually landing a job in the bingo hall.

In the early 1990s, the Pequots won a battle against Connecticut politicians to build the casino. With banks skittish about tribes, the Pequots got initial financing from Lim Goh Tong, a Malaysian gambling mogul.

The business was structured so that revenue from the casino was distributed to creditors on a tiered basis—an arrangement the tribe refers to as a "waterfall." Revenue not used to pay debts or plowed back into the business went to tribal government and to members via dividends.

Banks and potential bond investors at first were wary of the business. "There wasn't a sense for what these things are, for the power of the cash-flow generating machine," says William Newby, a recent managing director at UBS who once directed casino investments for Bank of America, which worked on the first Foxwoods bank loan. When Foxwoods began to boom, those concerns melted away.

In 1994, when Mr. Thomas was in his mid-20s, he won a seat on the tribal council, following in the footsteps of his mother and grandmother. Mr. Thomas and his allies wanted a greater say in Foxwoods' operations. Among the ideas Mr. Thomas pushed: putting more of the casino's profits into the pockets of tribal members.

After serving as the tribe's treasurer, Mr. Thomas was elected tribal-council chairman in 2002. He pushed relentlessly to expand Foxwoods, believing competition from the Mohegan Sun necessitated growth.

Investors were happy to finance it. The Pequots' investment-grade debt was a rarity among Indian tribes.

Life was good for tribal members. In addition to their dividend checks, they received free health care and college educations.

Mr. Thomas believed he could deliver lasting prosperity to the tribe through major expansions—just as Las Vegas for years staved off competition from nearby California casinos by building increasingly glitzy casinos.

The result was a three-year, $700 million expansion. The tribe licensed the MGM brand name and built "MGM Grand at Foxwoods," a casino hotel. In 2007, it spent another $55 million to add restaurants and shops to MGM. It built two new golf courses.

Indian-Gambling Nation

Its total debt soared above $2 billion, with each new bond issue falling further down the repayment waterfall.

In spite of the expansion, business at Foxwoods began tumbling in 2007. Total revenues dropped to $1.36 billion in 2009, down 14% from their 2006 peak.

"Look, at that time I was looking at it offensively, rather than defensively," Mr. Thomas says of the expansion. "Certainly, given what we've been through in the meantime, I'd look at it defensively in retrospect."

Mr. Thomas faced his own financial problems. In 2008, Sovereign Bank of West Hartford, Conn., sued him in state court for failing to repay $5.2 million in personal loans.

His lawyers argued the loans were an illegal attempt at a bribe to "influence or reward an agent of an Indian tribal government," according to court records. The lawsuit remains unresolved. Sovereign Bank declined to comment.

By August 2009, with the tribe's finances fraying, Mr. Thomas sent a letter to tribal members. In it, he blamed the tribal council for failing to expand faster to attract more customers. Instead, he wrote, "our development has stagnated, our earnings have fallen and the living standards of our tribe have been cut and put in jeopardy."

He promised in the letter to put tribal members' dividends in a "lock-box" that creditors couldn't touch. He said he wouldn't accept dividend cuts or reductions in the tribe's budget. "There are those who would eliminate or almost eliminate both items to curry favor with bankers and bondholders," he wrote. "I will not allow them to succeed."

The letter worried Wall Street lenders, who already harbored concerns that tribes might favor tribal members over lenders in times of financial distress.

The tribal council responded to Mr. Thomas in writing that it was "appalled" by his letter, and it orchestrated his ouster.

At the end of last year, the Pequots failed to pay about $7 million of interest on $500 million in bonds, putting the tribe in default. They also missed a July 13 deadline to repay a $700 million credit line from banks. The banks have agreed to forbear to give the tribe time to cut a deal with bondholders, who rank below the banks in the pecking order of creditors.

In most debt restructurings, lenders agree to forgo some or all of the money they are owed, often getting new stock in return. But because federal Indian gambling law bars anyone but tribes from having ownership stakes in casinos, Foxwoods' lenders can't take equity. That removes a big enticement for them to forgive debt. Federal law also bars Foxwoods' lenders from operating a casino on Indian land, making foreclosure an unattractive option.

Those restrictions have given the tribe leverage in negotiations. The Pequots have asked bondholders to slash the total they are owed.

Bondholders don't want to do that, but some of them have offered to stop receiving interest for a time and to push back repayment deadlines. Last week, a committee of bank lenders proposed a middle ground, according to people familiar with the talks.

Mr. Thomas is no longer involved in the negotiations. He says his controversial letter was misinterpreted. It represented, he says, the kind of opening salvo typical in restructuring negotiations. "My friends on Wall Street understood that what I was doing was…making sure that my people understood they were being defended through that long process," he says.

At the same time, Mr. Thomas says he meant what he wrote. "For us, community comes first, period. Period. Ahead of everything—lenders, everything."

—James Oberman contributed to this article.