Moody’s downgrades River Rock Entertainment Authority bonds: Too soon to be Concerned

March 18, 2011

Several of my readers have written me requesting my opinion on the recent downgrade of the River Rock Entertainment Authority casino bonds that fall due November of this year. The effect of this downgrade has pushed the price of the bonds from the 94 range to the 88 range based on recent prices.

I found the text of Moody’s downgrade announcement, and it stated that the grounds for the downgrade were the lack of significant progress on refinancing and the casino’s other financial obligations such as the emergency access road they are required by their agreement with Sonoma County to construct. Taking the second one first, it is true that River Rock agreed to build the road in 2008 (and to complete construction by 2009, but you know how things are with construction), and that they have escrowed $4.3 million in cash out of their total cash holdings of $43.6 million for the purpose of completing it. I hope that the delay in construction has not imperiled the casino’s relations with Sonoma County, but if the estimate of remaining construction costs is close to accurate, the casino should be able to absorb the cost without difficulty, as according to my previous estimates the casino generates roughly $30 million per year of free cash flow, of which only $11 million is officially distributed to the Tribe.

The refinancing issue is perhaps more troublesome, and Moody’s announcement that there has been a lack of progress is frightening for the markets in that it is ambiguous. A “lack of progress” could mean simply that the River Rock Entertainment Authority has not been active in contacting investment banks to get the refinancing done, in which case they may want to get moving. I don’t know how long it takes to analyze, issue, and sell a bond issue of this size, but I suppose that as the deadline is known and the refinancing is important to River Rock, that it is not too early to expect forward movement.

The more sinister interpretation is that River Rock has been shopping the deal around and had difficulty drawing the interest of investment banks, which could mean that the casino might be forced into higher interest rates or more restrictive covenants. If this is the case, I would attribute it more to the perception of the weakness of the gaming industry as a whole than anything specific to River Rock; as I calculated in my initial recommendation of the bonds, free cash flow covers current interest expenses by roughly three times, which I consider reasonably safe.

Although it is true that there is a competing casino proposed 30 miles south of the casino along the same route that gamblers from the Bay Area would take to get to the River Rock casino, that new competitor is is still in the planning and permitting stage and there are months or years of legal wrangling involved (including the fact that the proposed new site encroaches on the habitat of an endangered newt) before construction can even begin, and at any rate the new casino might not siphon off as many customers as investors fear. Furthermore, River Rock generates significant cash flow in excess of tribal distributions, one solution might be that the new bonds could be given an amortization provision so that the load of interest and principal requirements are cut to what the market would perceive as a more manageable level by the time the new casino is expected to begin operation.

Another issue I have with the Moody’s report is that it apparently assumes that the loss from default will be 50%. I consider this estimate to be completely baseless: not only do the casino’s current cash flows appear adequate to its current interest requirements forever, but they also have no basis from which to calculate the extent of the loss. No Indian casino has ever tested the bankruptcy process, and because only an Indian tribe can hold an interest in a casino, the usual result of a bankruptcy where a class of creditors becomes the new equity holders is unavailable, thus injecting an unwanted level of uncertainty into the situation. As a result, I think a default would be somewhat less painful for the bondholders, particularly as River Rock has recently been building up cash on its balance sheet perhaps in anticipation of being able to float a smaller bond issue.

I should also point out that Moody’s may be drawing upon information has not been made public yet; River Rock’s last 10-Q appeared in the middle of November 2010, and they did not release their annual report until March 31 last year, so it could be that the market is simply overreacting in the absence of updated information. When the annual report is finally released this year, I will read it with interest and it might move me to be more concerned. But as things stand, the downgrade itself does not strike me as particularly significant.

21 Responses to “Moody’s downgrades River Rock Entertainment Authority bonds: Too soon to be Concerned”

  1. the whole thing about non-tribal members not being able to have an equity stake sort of spooks me.

    do you really think that it makes the bonds somehow safer, and therefore worth more?

    my intuition is the exact opposite, but I’m not totally sure. This seems to take away flexibility in restructuring (for bond holders), and seems to tilt the bargaining power in favor of the tribe in case of default. Without equity as collateral, what is the tribe using to secure the debt?

  2. I have e-mailed investor relations a couple of times to ask about the refinancing and the timing of the next announcement. They responded quickly and said that the information will be coming soon, and with the financial release will be an update on the progress of the bond refinancing.

  3. The bonds are not necessarily safer because of the equity rule; the issue with the fact that only an Indian casino can operate the property is that effectively bankruptcy is not an option because all stakeholders have no interest in formally declaring a default and throwing the situation into the lap of a bankruptcy court. This gives all parties an incentive to find a fair deal that results in the casino’s continued operation if there is trouble, which I doubt there will be anyway.

  4. So, now that they’ve had their latest report and conference call, are you still confident in the value of the bonds? It seems to me the road costs are significantly higher than previously discussed, though I may have missed something.

  5. I have to admit there were a few matters of concern in the conference call. In terms of the road, they are in negotiations with Sonoma County to allow the road to take a different route that would save them up to $15 million. This in turn would influence the size of the bond offering, and we shall know in a few weeks, apparently, what is the county’s decision and they will be able to proceed from there.

    More significant, though, is the Tribe’s agreement to pay the County $75 million over 12 years in exchange for the additional load on County resources occasioned by their expanded casino. This obligation does not technically belong to the casino, but the Entertainment Authority announced that it would take over the obligations (rather than making distributions to the Tribe so the Tribe can do it). The conference call did state that the amounts due under the contract are keyed to certain developments in the new casino construction, and that the payment this year will be $3.5 million.

    Now, it seems to me that since the expansion project of the casino has been put on hold, there should be grounds to renegotiate the agreement with Sonoma County, as County resources are no longer required. In fact, under the terms of the memorandum of agreement itself, the agreement is subject to renegotiation if “Phase 1 is not opened within three years from the Effective Date” (17.1.2). The effective date was around March 19, 2008, and in the latest 10-K, it would appear that the first phase is not in fact complete (Page 16). It would therefore not surprise me to hear that there is some renegotiation that at least defers the $75 million obligation (of which $10.3 million has been paid already) until it is feasible to build the revenue-generating expanded casino that would fund it.

    If the obligation is taken on by the Entertainment Authority without amendments, the current level of fixed charges coverage would decline to around 2.3x, which I would consider risky. However, although the term of any refinancing would perhaps be difficult for the casino, in terms of interest rates and covenants, I do not believe that the firm is in an “unfinanceable” situation, as it still has upwards of $50 million in available cash flow per year set against a $200 million bond issue plus, theoretically, a $65 million non-interest-bearing obligation. The River Rock Entertainment Authority may get a rough deal, but I remain confident that they will get a deal.

    Thank you for your interest.

  6. Three extra comments to the above:

    a) there are rumors that the tribe has a private loan on which they may default or have defaulted, something on the order “well south of 50M” as described in the call. The casino people confirmed the existence of the loan, but refused any comments on the presumable default.

    b) modifying their compact with the county on the grounds that the hotel has not been constructed yet may provide some relief from that $3.5M this year, $5M every year after but not much, most of that money is for sheriff “services”, fire, etc.

    c) it’s hard to believe they need to wait for the resolution of that $10M extra cost for the emergency road with the county. What’s $10M compared to $200M they need to refinance now. The longer they wait the worse terms they will get.

    Market wasn’t much impressed with their 10-Q or the call. Bond prices continue to drop.

  7. Read your insights with interest.

    When would you become concerned and what would cause you to become concerned that RR would default on their bonds?

  8. According to what I’ve read, a new bond issue takes 4-6 months to roll out, although I imagine a refinancing might go a little faster. So if there has been no progress on refinancing by June, I would probably start to feel concerned.

  9. Looks like revenue for the first quarter was down 4%.

  10. Then why is the ASK price up $10.00 to $96 ?

  11. I only have 100K of the bonds. Sure wish I were a Bill Gates
    as I would loan them the full 200M. Called them last month and
    the CFO answered the phione. Knew what needed to be done, had some obligations to fulfill and was working on the refinance. As a CPA, I was impressed. Bob Knapp, CPA

  12. Thanks!

  13. Anyone know what is happening now? Sure is tanking.

  14. I also agree, pricing is steadily declining with no negative news surrounding the issue. Aside from monies leaving the high yield bond market the RREA bonds are now pricing below the march downgrade level. Any news us investors are not hearing about?

  15. Okay, so what happens if these guys default? From what I am told by some friends in the institutional bond management business, the little retail investor generally gets made whole. I am not sure how the process plays out though. Any insights out there?

  16. The thought of earning 35% in 2 months and 2 weeks is very tempting.Im thinking of adding more bonds to my holdings.Am I possibly doing the wrong thing? Is there any additional news about the refinancing?

  17. I have not heard that, and I think being made whole would be from the generosity of your broker, not anything automatic. Before default, if there is one, there will probably be an exchange offer to trade your existing bonds for new ones with roughly the same terms but a longer maturity date.

  18. With the amount of Net $’s they generate, it doesn’t seem likely a default would occur. It appears the overly concerned my be a little to anxious. But in case I am wrong,doesn’t the company have to give advanced warning or communicate its position 30,60,90 days etc. before filling for bankruptcy??? Or Not???

  19. If you knew the powers that run the tribe and the casino you would be very concerned about default. A Tribal chief that was recalled and then reinstated and six GM’s in eight years paints a pretty dark picture.

  20. ??

  21. It appears that River Rock has missed paying it’s $200M debt today — any news as to what their plan is? Other then trying to Refi!

Leave a Reply