With the debt markets recovered from the extreme dislocation of the past few years and in fairly robust shape, tribal governments and their gaming operators are happily dusting off new construction plans, expansion schematics and/or refinancing needs that have sat on their symbolic shelves for too long. However, just as the architectural renderings may need some refreshing, a review of preparation strategies, post-recovery market considerations, lender profiles and due diligence related to sovereign finance is a wise exercise.
Many tribal gaming operators and their respective government leaders are understandably dismayed when their own process to identify and access funding remains challenging in a healthy market environment. Although the debt markets are lending, the tribal gaming sector took some definite hits during the recent crises. Post-recession, the results are heightened scrutiny and greater due diligence requirements, necessitating extreme care and thoughtfulness when preparing for new financing or refinancing by a tribal gaming facility.
As gaming entities prepare to seek funding, it is helpful to understand what lenders (at all levels of the capital stack) consider and require.
Feasibility study: Also known as a market study, this item will be required by lenders for any new construction or an expansion project. This is a “must have” tool for many reasons and should be produced early on in a tribe’s planning process. Updates can be made fairly inexpensively as plans shift, but the importance of a market study cannot be stressed enough. Also, experienced and nationally recognized firms specializing in the sector specific to the new build or expansion (gaming, hospitality, etc.) should be retained, or lenders might not accept the study as credible. Any market study utilized for due diligence in financing must contain not only demographics and data, but also pro forma financial projections typically showing a five-year forecast of the anticipated revenue. (Pro forma projections: The literal definition of “pro forma” is a financial statement that has one or more assumptions or hypothetical conditions built into the data. Projections are forward-looking statements: quantitative estimates of future economic or financial performance often assuming certain conditions such as expansions, improvements, new demographics, etc.)
Formulaic logic: Whether to fund or not and how much is possible to fund are typically factors of fairly simple math. The market utilizes formulas often set by both the external market at large and lenders’ internal criteria. For example, a commercial bank will usually only lend 1.5 or 2 times earnings or EBITDA (see below). Institutional investors in today’s market will go up to 3 times or maybe slightly more depending on the project. Regardless of how nice or attractive the project may be, the formulas are adhered to fairly strictly.
EBITDA: The technical definition is taken straight from the acronym: Earnings Before Interest Taxes Depreciation and Amortization. It is a calculation of net revenue and will be utilized in the marketplace to assess the health of a facility, the debt leverage and coverage ratios. For example, if a gaming facility has EBITDA of $25 million and the expansion plans require a capital raise of $75 million, that equates to a 3 times leverage deal. If one divides EBITDA by interest for any specified period of time, that will usually compute as coverage (depending on how defined within lending agreements). The significance of EBITDA is high. This figure determines quite a bit in the financing process (both the actual EBITDA figure a facility is realizing at the moment and the projected EBITDA expected in the future).
Management: In a financing transaction process, both the management of the tribe and the proposed project must be involved as they run the day-to-day operations and be available to provide up-to-date financials and explain any items of note or question within the documents. Since most projects will use the cash flow from the tribe’s casino/resort as the security/proceeds for debt service, lenders will assess the skill and competency of the operations management. Solid, professional management is essential for the lenders’ comfort, and they will expect to review credentials, resumes and contractual obligations of the senior management, which will typically include the general manager, chief financial officer, chief executive officer and/or an outside management company. Besides cash flow, this is the single most essential factor for investors to review, and the management area is often the most misunderstood by facility owners. Many gaming-property defaults during the recession were blamed on market conditions, but lenders realized that often the management’s lack of experience and improper responsiveness to declining revenues were more truly at fault. It is sufficient to say that competent, experienced management is highly essential and will be reviewed with added scrutiny now.
Tribal government stability: Although competent management is essential, the tribal government is considered the governing body and decision-making faction as representatives of the ownership of the casino/resort. Stability is a key factor that lenders will assess within the elected officials, the tribal constitution, governing process and the history of the tribal government.
Tribal compacts/gaming regulatory: When cash flow from a tribe’s casino operations is utilized as a guarantee for debt service, lenders must review and be comfortable with the regulatory authority of the tribe to operate that casino in the future. Therefore, a review of the tribe’s current compact and licensing documents, as well as the future renewal planning, will always be required. The compact/licensing status must ensure operations throughout the life of the term of the loan period, and renewal patterns and plans will be reviewed.
Historical problems/issues: No government, tribal or otherwise, is without some problematic history that needs to be disclosed to potential lenders. Lawsuits (settled or pending), previous rogue government officials/employees, investigations, accusations, etc., all may be of concern to potential lenders. The worst mistake a tribe can make is to attempt to hide something from the lender. Disclosure is always the best policy, and then the lender and tribe together can discuss a strategy, if need be, to handle further disclosure or mitigation remedies.
Unique sovereign considerations: Because of unique federal laws related to sovereign immunity, combined with recent legal decisions affecting tribal gaming financial transactions, such as Carcieri, Lac du Flambeau and Patchak, lenders are now scrutinizing legal and regulatory items that previously were not included in due diligence. These include items such as land-into-trust documents and declination letters from the National Indian Gaming Commission. A tribal government’s gut reaction may be to question how specific documents may relate to their current financing, but my advice is to comply and provide the paperwork to the potential lenders. In today’s market, nothing should be viewed as unrelated or unnecessary.
Market conditions (unrelated to project): Subprime loans, bankruptcies by European countries and deflation of international monetary values are all examples of events that have recently affected the capital markets. Obviously, external factors such as these are outside the control of any tribal project, but it is important to consider that these types of events may affect the pricing of a facility’s cost of capital. Financing terms and rates are determined based on an individual project’s assets and liabilities, as well as the benchmark rates of the current market. Sometimes, if markets are in flux, it may be wise to wait to close a funding transaction until there is stability that may translate to lower costs of capital.
Structure of existing issues and other debt already in place: A tribe can never issue debt in a vacuum, and it is essential that other debt issuances are scrutinized for debt-ratio tests and subordination issues. A tribal government may have many departments and divisions that seem separate (for example, a gaming authority may be a separate legal entity), but lenders must assess, based on the security utilized, what will affect the debt requirements of any other prior issue. These separate entities might be using the same cash flow for collateral of debt, so they must work together in the placement of such debt. Furthermore, there may be “debt tests” that allow only so much additional debt to be issued. This can limit the amount of new capital that can be raised, regardless of market study numbers. The tribe should be prepared to show their bankers, lenders and attorneys all other debt and loan documentation to ensure proper structuring and synergy.
Strength of construction team (general contractor, architect, developer): For any expansion or new construction project, lenders will want assurance that whatever they are financing will be built by a reputable contractor/architect in a timely fashion. In fact, lenders often appoint their own construction monitors. In the due diligence stage of assessment, lenders will want to review the credentials of the firms selected, and, prior to funding, lenders most often will require a GMP (guaranteed maximum price) from the contractor to ensure the amount of financing raised will be sufficient to complete the project. Tribal gaming owners and operators may want to verify with lenders prior to entering into contracts with these vendors that their selected team meets the lenders’ criteria of being well-established, trusted firms with sufficient experience in the gaming and hospitality sectors.
Updated financials: A lack of updated financials will stall a lending process. It should be essential policy to have regular audited financials for the tribe’s operations, so having accurate and timely financials available should not be an issue. Lenders typically want to review several years of audited statements and the most recent unaudited statement needs to be completely thorough. There should be actual financials from the tribe’s current operations, as well as pro forma projections (as previously mentioned, provided within the market study) for the proposed new or expansion project.
During the Financing Process
The tribal government should stay involved in this important decision and be an ongoing part of the financing transaction through completion. Delegating to others will appear as if the tribe is uniformed and disinterested, which will be a red flag to potential lenders. However, gathering a strong team of professionals around the tribal council and collaborating throughout the process is the best strategy. The tribe must have legal representation when raising capital, but it should be understood that financing is a very specific form of law and a securities attorney will be required. Many a financial transaction has become problematic because a tribe is using an attorney with whom they have a history but who has very little financial expertise. Just like one would not visit a foot specialist for a heart problem, a tribe should avoid using their water rights attorney for securities work.
Tribes typically will use a third-party intermediary to assist in the structuring, placement and overall transaction in raising their capital. These entities can be underwriters, financial advisors, placement agents and/or investment bankers. The role they play is extremely important in securing the best deal for the tribe. They leverage their industry background, market knowledge and experience with comparable financings to bring appropriate lenders to the table, assess term sheets, negotiate final terms and covenants of the lending package for the tribal entity, and assist with reviewing the final legal and financial disclosure documents.
While the good news is that the markets have recovered, tribal financings are always unique and complex. Being fully prepared can only help to streamline the financing process.