Fitch Affirms Quechan Tribe's IDR at 'B-'; Outlook Stable
The tribe also has a credit facility that ranks pari passu to the TED bonds, which Fitch does not rate, and which is comprised of a \$102 million term loan and \$5 million revolver.
The credit facility has additional financial covenants including: a 1.05x fixed-charge coverage test (which includes tribal distributions), a minimum EBITDA test, maximum capital expenditure test, and a leverage maintenance test. Additional pari passu borrowings are not permitted under the credit facility. Amortization on the term loan is aggressive at roughly \$11 million-\$14 million per year.
KEY RATING DRIVERS
The affirmation of Quechan's 'B-' IDR reflects the tribe's stable credit profile and more prudent fiscal management since the current council took office in 2011. These factors are offset by limited financial flexibility and continued weakness in the operating environment. Quechan's casino enterprise's debt/EBITDA and EBITDA/debt service ratios for the latest 12-month (LTM) period ending March 31, 2015 are 3.1x and 1.8x, respectively, or 3.9x and 1.7x when including the tribe's GO bonds. The debt/EBITDA ratios have improved somewhat over the past year with term loan amortization offsetting slight EBITDA declines. The amortization did weaken debt service coverage ratios, which were in the 2.5x-3.0x range prior to the term loan issuance.
Liquidity is solid with the unrestricted cash at the tribal level providing for roughly 12 months of operations without any further distributions from the casino operations. Available liquidity on the casino side is minimal but adequate for operating needs when taking into account the healthy free cash flow (FCF) at the casino enterprise before distributions to the tribe and the credit facility covenants that limit tribal distributions based on cash flow. There are no near-term maturities with the exception of the sizable term loan amortization payments of \$11 million - \$14 million per year. The TED bond and GO bond principal repayments are relatively immaterial until 2017 and 2018, respectively, when amortization payments begin to kick in at \$2 million - \$2.5 million each per year. This provides the tribe more financial flexibility in the near term as it pays down the term loan.
Fitch expects unrestricted cash levels for the tribe to remain stable even in light of the accelerated amortization of the term loan and future mandatory sinking payments of the TED/GO bonds. This assumes stable casino profitability, relatively low amount of casino capital expenditures, and tribal expenditures slightly less than experienced in 2013 to reflect recent cost saving initiatives. This also assumes no investment income, although this has been a significant source of income for the tribe in prior years.
While Fitch forecasts Quechan's reserves to remain stable, there is little headroom for deterioration in casino operating performance in terms of the casino transfers being able to cover the tribe's governmental budget. Quechan's current leadership is committed to maintaining or growing its reserves, which is in contrast to four to five years ago when the risk of the tribe depleting its reserves was a more serious risk.
A reduction in governmental spending was spearheaded by a largely new tribal council that took office in 2011. A majority of the council members were re-elected in 2014, however the election was contested and a re-vote was called for in June 2015, resulting in some turnover including a new President. Fitch will continue to monitor the tribal council elections and the potential for political turnover is reflected in the current IDR.
Positive rating pressure is limited at this time given the near-term headwinds despite the credit metrics being strong relative to the 'B-' IDR. The headwinds include the weak Yuma, AZ operating environment. Negative trends have not yet stabilized at Quechan's casinos, with revenues and EBITDA declining 3% and 14% in 2014, respectively. In 1Q'15 the revenue decline slowed to 1% and EBITDA rose 9%, thanks in part to the more efficient market strategy of a new casino management team that was put in place earlier this year. Fitch remains cautious on revenue trends in the Yuma region given the consistently high unemployment rates.
Fitch forecasts Quechan to remain in compliance with the amended covenants through Fitch's forecasted period as EBITDA stabilizes and the term loan continues to amortize at an accelerated pace, helping to decrease leverage. The tribe amended its credit agreement as it was above the leverage covenant threshold for the period ending June 30, 2014. The minimum EBITDA covenant was also at risk of being violated.
TRANSACTION RATINGS
The one-notch upgrade of the TED bonds reflects Fitch's adjustment of the soft cap from a RR3 (+1 notch from the IDR) on Native American gaming issue ratings to a RR2 (+2 notches). The sample size of Native American restructuring workouts is growing. The recoveries have generally been consistent with those seen in the broader corporates universe, although the workout mechanism for tribal credits is largely limited to debt-for-debt exchanges. The soft cap is intended to reflect the limited sample size of workout situations in this subsector and the risks unique to Native American finance (mainly sovereign risk and the lack of bankruptcy option).
Fitch views prospects for the TED bonds in terms of probability of default and recovery in case of default as distinctly better relative to the GO bonds. This is because the TED bonds are backed by casino revenues, whereas the GO bonds are not. The revenue pledge is strengthened by a trustee-controlled flow of funds that ensures the bond debt service is paid prior to any tribal distribution. The flow of funds is sprung if coverage falls below 1.65x. As of March 31, 2015, coverage of debt service was at 1.84x. This mechanism allows Fitch to partially segregate the credit risk of the casino operations from the tribe, which has a weaker credit profile. (There are no cross default provisions between casino revenue backed debt and the GO bonds).
However, the tribal credit profile is still heavily factored into the TED bond ratings, since significant distress on the tribal side may potentially force the TED bondholders or lenders to make concessions to allow the tribe to maintain adequate liquidity and critical governmental services. The tribe does maintain a debt service reserve fund for the benefit of the GO bonds.
RATING SENSITIVITIES
Positive: Future developments that in some combination could lead to positive rating actions include:
--Casino level debt/EBITDA declining and remaining below 3x and 3.5x including the GO bonds;
--Tribe maintaining prudent fiscal management practices (i.e. adjusting governmental spending to match casino distributions and other revenue sources);
--Quechan maintaining or increasing tribal cash reserves. Reserves can currently sustain roughly twelve months of operations without additional casino distributions.
--Comply with the credit agreement's financial covenants.
Negative: Future developments that in some combination could lead to negative rating action include:
--Casino level debt/EBITDA ratio exceeding 4.0x (4.5x with GO bonds) for an extended period of time;
--Tribe deviating from prudent fiscal management (e.g. increases per cap payments at expense of depleting tribal reserves, aggressive capital expenditure policy);
--Tribal reserves declining to a point that the tribe can only cover about six months of operations without casino distributions. The tribe's cash position fluctuates seasonally (first quarter being the highest point); therefore, there is some room for dips in cash levels during the low months (summer);
--Tribe having difficulty obtaining waiver(s) in case of breaching financial covenants.
KEY ASSUMPTIONS
--Fitch projects low single-digit revenue declines reflecting continued weakness in the Yuma, AZ operating environment.
--EBITDA margin expands in the near-term through more efficient cost strategy put in place by the new casino management team.
--No additional debt raised through the forecast period and continued pay down of the term loan through the scheduled amortization payments.
--Tribal distribution levels consistent with the past few years and relatively low amounts of casino capital expenditures.
FULL LIST OF RATING ACTIONS
Fitch takes the following rating actions:
Quechan Indian Tribe
--Long-term IDR affirmed at 'B-';
--Tribal economic development bonds upgraded to 'B+/RR2' from from 'B/RR3';
--Governmental Project Bonds affirmed at 'B-/RR4'.
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