NEW YORK — As Wall Street opens more and more to tribal financing, one of
the last barriers is the arcane process of bond rating.

Three main rating agencies hold the keys to a public sale of tribal bonds,
most likely the cheapest way of raising money for either commercial
projects or tribal facilities like government buildings, clinics or
schools. Their verdict is so prized by investors that bond issuers have no
choice but to pay the rating fee, even when the result is less than
complimentary.

But these agencies are just beginning to understand Indian country. Some
tribal leaders say they still have a lot to learn. Deron Marquez, chairman
of the San Manuel Band of Mission Indians, told the Native American Finance
conference earlier this summer that the bond raters were the slowest part
of the financial world to “get it.”

Bond raters, in their turn, were out in force to explain their business.
Two of the big three agencies sent speakers to the conference, held at the
Mohegan Sun the end of June. Standard and Poor’s deployed its biggest gun,
general counsel and managing partner James Penrose, to discuss “the
perceived risks of tribal finance deals.” S&P Director Michael Scerbo, its
specialist on tribal bonds, shared the stage with H. Fabian Ramirez from
Fitch Ratings at another panel on “The Ratings Process: for Better or
Worse.”

The panels gave a quick course on the system that assigns grades from “AAA”
to “D” to almost all bond issues. Triple A is the best. It drops by
degrees, such as “AA,” “A” and “BBB.” The lowest “investment-grade” rating
is triple B, an important cut-off since many large investors, such as
pension funds and banks, are forbidden by law from buying bonds with lower
than investment-grade rating.

Standard and Poor’s gave an investment-grade rating to only one, the
Mashantucket Pequot issue for Foxwoods Resort Casino, of the 10 tribal
gaming bonds it has rated. (Scerbo also noted that only one of 35
commercial gaming companies was rated investment grade.) Only one Indian
tribe, the Southern Utes of Colorado, has the highest AAA rating. According
to the Fitch analysis, its financial strength comes from both good
management and rich energy resources.

Bonds below triple B are sometimes called “junk bonds,” or more politely
“high-yield bonds.” Because they are seen as higher risk and sell to a
smaller market, they have to offer higher interest rates. The cost adds up,
but it has also attracted smart investors to tribal bonds. High-yield
casino issues are regularly oversubscribed by bargain hunters who
implicitly think the bond raters have overstated their risk.

Yet issues with investment grade ratings still produce more funding for
tribal use. A higher letter grade could mean money left over to add a day
care center or senior center to a tribal government building.

A higher grade, Ramirez wrote in a pamphlet distributed at the conference,
“ordinarily requires a history of balanced or improving fiscal operations,
conservative fund management, stable government and leadership, legal
enforceability of the debt obligations, and a borrowing structure that
emphasizes timely repayment.”

The analysts pore over a long list of factors, ranging from per capita
distribution policies to transparency of the accounting.

Along with the technical analysis, the raters confronted the major issue in
tribal credit: sovereignty. Penrose explained that agencies were leery of
grading bonds from tribal governments which could assert sovereign immunity
against suits. Ratings would be low without some sort of compromise on
sovereignty that provided for “accountability.” Investors, he said, needed
a mechanism “that will translate into a meaningful chance for recovery.”

But some tribes had come with a solution, he said. Some casino bonds were
issued by tribal gaming authorities. These intermediate bodies could agree
to subject themselves to lawsuits or binding arbitration without
compromising the sovereignty of the tribal government itself. Since they
could limit the financial backing of the bonds to casino revenues, they
also did not endanger other tribal revenues if they ran into trouble.

Tribal bonds face another problem — the Internal Revenue Service. Because
states have sovereignty, too, the interest on bonds issued by state
governments and their municipalities are usually not subject to federal
income tax. Since they pay untaxed dividends, their interest rates are the
lowest of all.

But tribes face a disadvantage. A glitch in federal law subjects their
issues to sharper scrutiny than any state undergoes. The IRS has threatened
the tax-exempt status of tribal bonds that it thinks don’t serve strict
government purposes, a threat that makes the bond market and bond raters
very nervous.

Bond raters watch tribal governments closely as well. In a report
circulated after the conference, Scerbo listed a number of positive factors
he looked for: “reasonable terms for elected officials, a sufficient number
of tribal council members to effectively represent the tribe, an
established decision-making process which empowers decision makers while at
the same time remains flexible, and an alignment of interests between the
tribal council and tribal members.” He said that his agency would interview
at least one tribal council member on these points while making its rating.

At the same time, weaknesses in government could lower a bond rating.
Scerbo cited the Seminole Tribe of Florida. Up until 2003, he said, the
Seminoles’ “limited internal controls … led to alleged impropriety by
both the then Tribal Council Chairman and Tribal Council.” Even though the
Seminoles had improved controls since then and had a strong financial
position and good market for their six casinos, they received only a “BB”
bond rating.

Penrose told the conference that tribes had only just begun to test the
public bond market. Rated bond issues, he said, made up only three percent
of total tribal borrowing. But Marquez recalled a time when “tribes never
had the ability to access the capital markets.” It was only when tribes
began to run successful enterprises and show strong profits on their
balance sheets that financial institutions took an interest.

Now that Wall Street is well aware of the cash flow from tribal gaming and
an increasing number of non-gaming business successes, the doors to this
market are opening. And tribes and financial gatekeepers like the rating
agencies are beginning to learn each other’s mysterious ways.