One of the primary differences between tribal and commercial gaming is the structure of ownership. By definition under the Indian Gaming Regulatory Act, tribal casinos can only be owned by federally recognized American Indian tribal governments located on reservation land held in trust by the federal government.
However, when financing Indian-owned casinos, tribal gaming facilities are typically viewed by the capital markets and the Internal Revenue Service (IRS) as commercial credits, so therefore, do not always receive the benefits of government/municipal financing that include lower interest rates and longer terms (than taxable debt). When other governmental bodies access municipal financing for economic development projects, they benefit from the lower cost of capital and manageable payment schedules. This seems to be an unfair disadvantage placed on tribal government operated gaming facilities, but regardless of the apparent political inequity, tribal governments can still access municipal financing for non-gaming projects and with recent legislation, may now access this lower cost financing for some resort-related amenities and other commercial projects.
What Does Tax Exempt Mean for a Tribal Issuer?
• The proceeds must be used either for “essential government purposes” or carved out allotments as provided by the IRS.
• In no case can the proceeds be used for the actual gaming building.
• The lender/investor does not pay federal income tax on interest payments received from the tribal issuer.
• Lower interest rates for the tribal issuer (typically 2–3 percent less)
• Typically longer term/tenor of debt (10–30 years versus 5–10 years)
• Different investor pool than taxable debt
• Also called “municipal debt” or “munis”
Tax-exempt debt service can be paid for and/or secured by cash flow from the casino/resort or other “taxable” sources, but the proceeds from tax-exempt financings cannot be utilized for gaming purposes.
Examples of projects that have historically been financed in Indian country with tax-exempt issuances that meet the “essential government services” test include hospitals/clinics, schools, public safety facilities (police/fire), water treatment/sewer systems, certain energy systems, raw land, tribal government services buildings, museums/cultural centers and housing. Under current tax code, no portion of a gaming facility can be financed using municipal tax-exempt debt. As aforementioned, the IRS code defines a much more narrow scope of uses for tribal governments in comparison to states and municipalities.
However, expansion of tax-exempt financing for tribal governments has been in the spotlight recently. On Feb. 17, 2009, President Obama signed HR-1, the American Economic Recovery and Reinvestment Act (AERRA), also known as the “Stimulus Bill.” Part of this act authorized one-time expanded federal tax incentives for the issuance of tax-exempt bonds and is designed to increase the borrowing capability of tribal nations and decrease the cost of such capital. These incentives allow for new financing opportunities and a wider scope of uses for tribal governments as borrowers.
Tribal Economic Development Bonds
Section 1402 of the AERRA authorized the Department of the Treasury to approve up to $2 billion in Tribal Economic Development Bonds (TEDBs) to raise money from third-party lenders at tax exempt rates (i.e., interest is federally tax free to investors) to finance projects on reservations.
Section 1402 states that TEDBs may not be used to finance 1) any portion of a building in which Class II or Class III gaming is conducted; 2) any property used in the conduct of gaming; and 3) any facility located outside the reservation. Where these bonds can greatly benefit a tribal economic master development plan is in the expanded types of projects now authorized. Although TEDBs are not allowed to be utilized for an actual gaming building, many of the ancillary resort amenities that were previously ineligible under the old “essential government services” test now appear eligible (if not attached to the gaming building). Types of projects believed to be allowable under this new provision are hotels/ spas, convention/conference centers, golf courses, travel centers, convenience stores, energy developments, solid waste /water treatment facilities and manufacturing.
Challenges/Misconceptions
There is no question that the AERRA offers unprecedented opportunity for tribal governments related to their financing needs. There was a very celebratory reaction when the TEDB provision was initially announced and even more when the tribes that applied were granted the first round of allotments on Sept. 15, 2009. However, the prevalent misconception was that the allotments provided the actual funding. This couldn’t be further from reality. All the allotment provides for is permission from the IRS to issue the debt (for the specific requested expanded uses) at a tax-exempt rate. The tribal issuer still needs to identify the appropriate lenders (most likely through professional bankers or placement agents) and to do so must ensure that the project is ready, creditworthy and feasible with all of the capital markets’ requirements and criteria in place. This misunderstanding and lack of preparedness caused most tribes to miss the deadline to issue their bonds. However, in November 2010, the IRS issued a six-month extension to June 2011 for bond issuance to these first round allottees, and the tribes may apply for an additional six months extension if needed.
Preparing a project with all the necessary requirements to launch a successful financing transaction is not easy. With the recent dislocation of the capital markets and the resulting recession-like economy of the last several years, even in light of an optimistic recovery possibly in sight, lenders have tightened credit and increased the strictness of lending criteria. Additionally, tax-exempt investors have historically been more conservative lenders, even in the best of times.
Understanding the Investor Base
Tax-exempt/municipal investors are typically large institutional funds such as money markets, insurance companies and mutual funds. Unlike their counterparts on the taxable side, which are active in the gaming/resort sector, municipal credit analysts are much more conservative and their portfolios consist of low-risk, long-term government projects for tribal governments, cities, counties and state developments. For the right-sized project and appropriate tribal credit, tax-exempt bonds will usually provide the most manageable payment schedule and optimum lending for tribal government projects. However, most municipal credit analysts will assign a slight premium (i.e., charge a higher interest rate) to American Indian infrastructure projects compared to similar state/municipal projects and require certain strict criteria be in place before committing capital. Some of the reasons for the added premium on tribal transactions are lack of state exemptions (tribal transactions are federally tax exempt but only state exempt in specific cases), usually private as opposed to public reporting, often unrated credits, issues related to sovereign immunity and, in many cases, lack of private letter rulings (i.e. lack of absolute determinations regarding the eligibility of projects for the tax-exempt financing). Strict criteria will most likely include very conservative leverage ratios, lengthy non-call periods, extensive due diligence with regard to project and management, completion guarantees and construction monitors (if new construction), and scrutiny of political process and stability.
Coordinated Effort
Tax-exempt issuances, and tax-exempt bonds in particular, can provide the lowest cost of capital and the most flexibility for tribes when financing their government infrastructure and non-gaming amenities during construction and/or expansion of their gaming/resort facilities. Tax-exempt debt can be issued side-by-side, or pari passu, with the taxable debt. However, the uses must be very distinctly carved out between infrastructure, non-gaming and commercial gaming uses. The planning needs to be a coordinated effort with the tribe’s team of advisors, bankers, lawyers, developers, architects, contractors and management.
In an economy fraught with declines, defaults, bank closures and market volatility, the special allotment from the federal government provided for within the AERRA appears to be much-needed good news for tribal governments and their ability to access and issue new debt. Although there are still questions and challenges, ultimately, tribes are encouraged and hopeful that their status as governments will benefit their financing strategies in the marketplace. After all, unlike their commercial counterparts, the profits of a tribal casino are dedicated to providing governmental needs and services to the nation the gaming facility serves. With some of the recent concerns from the capital markets about tribal issuances, tribes are looking very seriously and thoroughly at their capital structures and creditworthiness in attempts to maximize efficiency and credibility. With lower cost of capital achieved by utilizing municipal debt, the overall picture only improves for the lenders and the issuers. Whether via the essential government services test which has always been in place or via the special AERRA allotments, tribal gaming facilities should be encouraged to explore the possibility of issuing tax-exempt debt and to properly prepare their projects to do so.
Valerie Red-Horse is an investment banker and financial advisor in her role as President/Owner of Red-Horse Financial Group Inc., offering securities through Western International Securities Inc., a FINRA and SIPC member firm. Red-Horse Financial Group and Western International Securities Inc. are separate and unrelated companies. She can be reached at valerie[at]wisdirect.com or (818) 389-4714.
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