Fitch Affirms Quechan's Issuer Rating at 'CCC'; Outlook Negative
Fitch Ratings has affirmed its ratings for the Quechan Tribe of the Fort Yuma Indian Reservation (Quechan) as follows:
--Issuer rating at 'CCC';
--$30 million governmental project bonds series 2007 (tax-exempt) at 'CCC';
--$110 million gaming enterprise revenue bonds series 2008 at 'B-'.
The ratings have been removed from Rating Watch Negative and subsequently assigned a Negative Rating Outlook.
The 'CCC' issuer rating and the Negative Outlook reflect the deteriorating reserves of Quechan's tribal government, precipitated by the lackluster performance of the new casino resort and the tribe's reluctance to make meaningful cuts in governmental spending, including the per capita distributions. The tribe exhausted much of its reserves while building a replacement casino resort and has continued to deplete cash since the project opened in February 2009. At the current rate, Fitch estimates that without significant corrective measures, the entire cash balance will be nearly or entirely depleted by the end of fiscal 2011.
MEANINGFUL SPENDING CUTS NEEDED:
Despite the project opening up below original expectations and the increased debt burden related to the project lowering the cash available for tribal transfers, the tribe has not made meaningful spending adjustments as of yet. Tribal management did state that the tribal council is aware of the liquidity situation and will revisit the per capita policy prior to the May semi-annual payment, near the end of the high-season for the casino operations. Fitch estimates that substantial cuts in per capita payments would be required to preserve cash balances over the next 12-24 months potentially followed by further cuts longer-term, absent considerable improvement at the casino enterprise or cuts elsewhere.
Also, without an amendment, the tribe is likely to violate the Dec. 31, 2010 net liquidity test covenant on the governmental project bonds. The net liquidity test compares Quechan's liquid assets net of short-term liabilities to the $30 million of the governmental project bonds outstanding and would require the tribe to fund a $30 million reserve fund if the ratio falls below 0.75 to 1. The tribe is in the process of negotiating an amendment to the covenant, which would provide additional time for spending cuts to be made and casino operations to improve.
ECONOMIC CONDITIONS CONTINUE TO PRESSURE CASINO OPERATIONS; SOME UPSIDE REMAINS:
In the second quarter of 2010 (2Q'10), after four full quarters of operations, Quechan's new casino resort experienced a 4% year-over-year decline in net revenues, while the older Arizona facility had a decline of 9%. EBITDA declines were significantly more severe but were impacted by one-time items and a larger number of slot machines in California, where the state fee schedule is less favorable. On an LTM basis, the casino enterprise revenues are up 23% and EBITDA is down 4% through June 30, 2010. Preliminary results for 3Q'10 show that EBITDA grew slightly in the most recent quarter. Casino management has implemented a number of cost saving initiatives that are expected to be significantly accretive to earnings. While Fitch recognizes the upside in the initiatives, Fitch's base case reflects mostly flat near-term performance given the prevailing economic conditions in the Yuma market. In August 2010, unemployment in Yuma MSA reached 30.2%, which is about 10% above the pre-recession levels, and Fitch sees no clear catalysts for a sharp turnaround. Much will depend on the late fall and the winter months of 2010/2011, when seasonal hiring will begin and the population will swell with seasonal residents. Management projects a 20% increase for fiscal 2011 EBITDA from the June 30, 2010 LTM levels, which Fitch thinks is aggressive.
SOLID COVERAGE OF GAMING ENTERPRISE BONDS:
Although the project has performed worse than expected, the casino enterprise EBITDA on an LTM basis still covers the current revenue recourse debt service by 1.8 times (x) and by 1.6x once the principal starts to amortize on the 2008 revenue bonds about three years from now. The revenue recourse debt holders also benefit from the coverage test covenants, with the test coverage ratio stepping up to 2.0x from the current level of 1.75x for the March 31, 2010 test. Fitch believes that Quechan could trip the covenant at the 1Q'11 test date, which would trigger a consultant call-in, a lock-box flow-of-funds, and a funding requirement for a springing debt service reserve fund. The reserve fund would require the casinos to divert about $13 million (10% of recourse debt outstanding) over a 12-month period into the fund, which would place greater pressure on the tribe's liquidity. The tribe is working to get a waiver or an amendment for the revenue debt reserve funding requirement, which Fitch believes may be achievable in some form.
RATING DRIVERS CENTER ON TRIBE'S ABILITY TO PRESERVE LIQUIDITY:
Fitch believes that substantial cuts in the per cap payments are required to preserve liquidity in the short-term. In the long-term further cuts might be necessary if the operating results fail to markedly improve, bondholders do not agree to amend/waive the requirement to fund the revenue bond springing debt service reserve fund, or the governmental services spending is not significantly reduced. A failure of this confluence of factors to achieve a more stabilized balance between the available recurring resources and tribal spending could result in a downgrade within the next six to 12 months. Specifically, Fitch will be monitoring the tribe's decision making process related to the May 2011 per cap payment, the casino operating results for the seasonally strong March 31 ending quarter in 2011, and the revenue bondholders' decision regarding the waiver/amendment to the reserve funding requirement. Fitch will also look for the amendment to the net liquidity test in the near term.
A downgrade of the issuer rating and the government bond rating to 'CC' or 'C', implying that Fitch considers the probability of default to be probable or imminent, respectively, could occur if the stated conditions are not met. The removal of the Negative Outlook and the affirmation of the ratings would hinge on the tribe's ability to demonstrate over the next 12-24 months their commitment to preserving adequate liquidity measures and a meaningful improvement in the casino operations. In the event of a downgrade, the revenue bonds would likely be differentiated from the issuer and government debt ratings by two notches, up from the current one notch distinction. The change in notching would reflect the revenue bonds' seniority in the flow of funds and the cash-trapping mechanism that could be activated after the March 31, 2011 coverage test.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Native American Gaming: Rating Methodology (Corporates)', dated Sept. 4, 2007;
--'When Will the Tables Turn? Fitch's 2010 Gaming Outlook' dated Dec 17, 2009;
--'Fitch: Quechan Tribe's Ratings Placed on Watch Negative on Weak Third Quarter Results', dated Oct. 15, 2009;
--'Native American Gaming Insights: Growing Pains for California's Gaming Industry' dated Aug. 24, 2009;
--'Managing Through Distress: Considerations for Investors in Distressed Native American Gaming Credits' dated May 11, 2009;
--'Fitch Affirms and Removes Quechan Tribe from Watch Negative Following Opening of Casino Project, dated April 21, 2009;
--'Coercive Debt Exchange Criteria' dated March 3, 2009;
--'Fitch Quechan Tribe's Ratings Remain on Watch Negative Following Receipt of Loan Proceeds, dated Jan. 8, 2009;
--'Fitch Downgrades & Places Quechan Tribe (CA) Rtg on Watch Negative', dated Oct. 3, 2008;
--'Credit Analysis: The Quechan Tribe of the Fort Yuma Indian Reservation', dated May 15, 2008;
--'Fitch Downgrades Quechan Tribe's Issuer Rating to 'B+'', dated April 22, 2008.
Applicable Criteria and Related Research:
Native American Gaming: Rating Methodology (Corporates)
Coercive Debt Exchange Criteria
When Will the Tables Turn? Fitch￢ﾀﾙs 2010 Gaming Outlook
Credit Analysis: Quechan Tribe of the Fort Yuma Indian Reservation
Native American Gaming Insights: Rules, Regualtions and the Outlook for Off-Reservation Gaming Approvals
Managing Through Distress (Considerations for Investors in Distressed Native American Gaming Credits)
Native American Gaming Insights: Growing Pains for California's Gaming Industry
Alex Bumazhny, CFA
One State Street Plaza
New York, NY 10004
Michael Paladino, CFA
Michael Simonton, CFA
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