Fitch: Quechan Tribe's Ratings Placed on Watch Negative on Weak Third Quarter Results.

NEW YORK -- The ratings assigned to the Quechan Tribe of the Fort Yuma Indian Reservation (Quechan) have been placed on Rating Watch Negative following Fitch's assessment of the credit implications of recent developments. Fitch rates Quechan as follows:

--Issuer rating 'CCC';

--$30 million governmental project bonds series 2007 (tax-exempt) 'CCC';

--$110 million gaming enterprise revenue bonds series 2008 'B-'.

The 'CCC' issuer rating incorporates Fitch's view that significant challenges remain in successfully ramping up operation of the recently opened Quechan Casino Resort (QCR) against the back drop of strained regional economic conditions in the Yuma gaming market.

The ratings were placed on Watch Negative as a result of the following developments:

--Weak third quarter (3Q'09) operating results at QCR raise concern about the outlook for the property's performance during the upcoming winter 2010 season;

--Fitch believes that the credit could be in violation of the debt service coverage financial maintenance covenant in the gaming revenue bond indenture as of the Sept. 30, 2009 test date, depending upon the interpretation of the language in the indenture.

Potential For Violation Of Bond Financial Maintenance Covenants:

Fitch believes there is ambiguity in the gaming enterprise revenue bond indenture with respect to the definition of annual debt service that is used in the calculation of the debt service coverage ratio (DSCR) for the purposes of compliance with a financial maintenance covenant. Bondholder approval of a technical amendment would be required to cure the ambiguity in the indenture language. Specifically, it is unclear whether the calculation must include principal amortization of balloon debt. Based on the current level of cash flow, the inclusion of balloon debt principal could cause the credit to be in violation of the highest DSCR trigger, which occurs at 1.75 times (x), depending upon the interpretation of the language in the indenture. The tribe is required to certify to bondholders the DSCR for the Sept. 30, 2009 test date by Nov. 15, 2009.

Whenever coverage falls below 1.75x based upon the calculation on a quarterly test date, the tribe must:

--Retain an independent management consultant;

--Adhere to a third party trustee controlled flow of funds with respect to the casino cash flow;

--Begin funding a debt service reserve from the casino cash flows, through the flow of funds, for the benefit of the gaming enterprise revenue bondholders. The requirement for the reserve is equal to 10% of the amount of recourse debt outstanding (currently the requirement is $12.85 million), to be funded in 12 monthly installments through the trustee controlled flow of funds waterfall.

The last requirement is of the most significant concern. Based on current cash flow, if the tribe is required to fund the reserve, Fitch believes it will have difficulty meeting all of its fixed payment obligations, including debt service, while maintaining current levels of funding for government services and per capita distributions to members.

Tribal Government Liquidity Position Eroded By QCR Project Funding Contribution:

The tribal government was required to contribute a significant amount of equity in order to complete funding of construction of the QCR project, resulting in an erosion of the tribal government balance sheet. While a portion of this equity contribution has been reimbursed by external debt financing arranged after completion of the project, liquidity at the tribal government remains strained relative to the level of resources on hand at the beginning of construction. The terms of the debt agreements limit the tribe's ability to secure additional external financing to reimburse the tribal government balance sheet. Specifically, Fitch believes that the tribe has exhausted its capacity to issue debt under the completion financing bucket of the gaming enterprise revenue bond indenture, which permitted the incurrence of up to $25 million in debt without demonstrating compliance with the additional bond test (ABT).

The tribe was permitted to incur completion financing debt for the purposes of funding the construction budget, and to reimburse the tribal government for $8.3 million in cash contributed to the QCR project fund to cure a deficiency during construction. The tribe was able to borrow $18.5 million in the form of loans from other tribal governments (the loans) for these purposes. The loans rank on parity with the gaming enterprise bonds with respect to the lenders' security interest in the casino cash flow. Issuance of the remaining $6.5 million in completion financing capacity would require approval of the gaming enterprise bondholders and the lenders of the loans, which Fitch believes they are unlikely to grant. Therefore, issuance of additional recourse debt (defined as debt secured by the casino assets, including cash flow), will require compliance with the ABT (pro forma debt service coverage of at least 2.25x and pro forma leverage of no greater than 3.75x), which the tribe cannot demonstrate on the basis of current cash flows.

Since Quechan's ability to issue additional debt to reimburse tribal government equity is limited by its debt agreements, casino free cash flow after meeting fixed expense at the gaming operation, including debt service charges, is the primary means of supporting governmental services and restoring liquidity to the tribal government balance sheet. Although reliance on casino cash flow for economic support of the government is not atypical for a tribe with a gaming operation, there is concern when the liquidity cushion at the tribal government is eroded. With limited alternative means to support governmental expenses, generation of sufficient positive free cash flow of the casino operation is critical to avoid potential cuts to government service levels and per capita distributions to members.

Casino Cash Flow Outlook; Significant Operational Ramp Up Risk Of QCR Project Remains:

The primary risk in Quechan's casino cash flow outlook is the ability to successfully ramp up operation of the QCR project in a very challenging economic environment. The project is located in the Yuma regional gaming market, and operating trends at Quechan's casinos began to show the impact of the economic recession in mid-2007, during the construction of QCR. In 2008, Quechan's two casino properties posted full year revenue and EBITDA declines of 7.4% and 17.5%. QCR opened on Feb. 14, 2009; upon opening, Quechan's former California casino property was closed, while the Arizona casino property remains in operation. In a regional gaming market that exhibits a great degree of operational seasonality, initial results at QCR benefited from opening during the winter season, but based on LTM Sept. 30, 2009 results, the property is performing significantly below Fitch's base case EBITDA expectations and in-line with its stress case expectations. For the first nine months of 2009, representing seven and a half months of operation of QCR, EBITDA was flat versus the prior year period on the basis of a 17% increase in revenue offset by compression in the EBITDA operating margin to 41% from 48%.

The Yuma regional economy has performed worse than the broader U.S. economy during this economic recession on the basis of employment and income trends. A great degree of seasonality in Quechan's casino operating trends is the result of a large influx of retirees during the winter months, when the local population swells. In past years EBITDA during the March quarter typically contributed over 40% of full year EBITDA. Soft operating results during the high season in 2008 and 2009 were reportedly the result of the snowbird population arriving in the region later than in past years. On the basis of its operating outlook for California's regional gaming markets, Fitch expects poor economic conditions to again impact results at Quechan's casinos during the upcoming winter 2010 season.

Despite the initial performance of QCR tracking below expectations, Fitch believes that over the longer term and assuming recovery of regional economic conditions, the Yuma gaming market holds good depth and potential. However, there is significant execution risk, as Fitch believes that success of the QCR property depends upon management's ability to grow the market by attracting a new player population to the QCR property while maintaining the attractiveness of the Arizona facility to the local player population. This will require successful execution of a well designed marketing and branding plan, as well as strategic use of the hotel property at QCR. Since the opening of the property in February, there have been senior level management changes, including replacement of the general manager at the property. Several senior level management positions are currently unfilled, and the tribe is interviewing candidates.

On the positive side, the credit's liquidity profile benefits from lack of near term debt refinancing risk and, since the completion of QCR, no project development financing risk. Coverage of all interest expense (including the government project bonds and tribal loan), from casino EBITDA equaled about 1.5x based on LTM Sept. 30, 2009 results. Quechan is required to make monthly sinking fund payments of principal and interest on the gaming enterprise bonds, governmental project bonds and the loans. Principal payment on the loans begins in 2010, but is nominal through final maturity in 2015, when both have a sizeable bullet maturity. Principal payments on both series of bonds begins in 2012 and is level through final maturity. The first significant debt maturity occurs in 2013, when the casino is required to re-pay the Quechan government $25 million of contributed equity that was structured as a loan to the casino operation. This piece of debt is subordinate in right of payment to the bonds and the loans. Fitch expects that the Quechan government will extend the maturity if the casino cannot refinance or cash fund the principal payment.

Recent Changes To Capital Structure, Governmental Project Bond Indenture Covenant Amendment Are Credit Neutral Events:

Prior to recent changes, Quechan's capital structure included the following pieces of debt:

--Gaming enterprise revenue bonds ($110 million);

--A loan from another tribal government ($13.5 million);

--Governmental project bonds ($45 million);

--An interfund loan from the Quechan tribal government ($30 million).

Recent Changes Include:

--An additional loan from another tribal government ($5 million), the proceeds will reduce the outstanding balance on the interfund loan to $25 million from $30 million;

--Repurchase of $15 million of the governmental project bonds at a discount of 15%, for $12.8 million in cash. Of the $45 million initially issued, $30 million in governmental project bonds remain outstanding.

On a cash flow basis, the impact of these changes is mildly positive; Fitch estimates that annual interest expense is reduced by about $675,000, representing approximately a 2.8% reduction. Fitch has determined that the repurchase of a portion of the governmental project bonds at a discount to par does not constitute a coercive debt exchange, as the transaction was not coercive or de facto involuntary on the part of bondholders, since it was not precipitated by an impending liquidity crisis. Fitch does not believe there was explicit threat of bond payment default or covenant violation in the absence of the transaction (for additional information see Fitch research 'Coercive Debt Exchange Criteria' dated March 3, 2009).

The tribe used unspent governmental project bond proceeds to repurchase the debt; the proceeds had been intended to be used to construct a traffic mitigation project at the QCR property as a condition of the tribe's gaming compact with the state of California. According to Quechan management, the state has determined that the tribe does not need to complete the project at this time in order to comply with the terms of the compact. However, the state will continue to conduct traffic studies and there is no guarantee that the tribe will not be required to construct the project at some point in the future should it be determined that traffic mitigation is necessary at the site.

In conjunction with the repurchase of the governmental project bonds, the tribe and bondholders agreed to an amendment of the governmental project bond indenture's liquidity maintenance covenant. The covenant previously allowed the tribal government to include receivables from the casino as part of the unrestricted net asset balance, which was required to equal 125% of the outstanding par amount of the governmental project bonds, tested on a quarterly basis. Since the beginning of construction of the QCR project, the quality of the unrestricted assets used to demonstrate compliance with the test deteriorated as the amount of casino receivables increased due to the contribution of equity to the project. At its highest point 58% of the unrestricted asset balance was comprised of receivables from the casino, up from only 6.6% at the time of the bond issuance.

The revised covenant requires the tribe to maintain a certain ratio of adjusted liquid net assets to tribal long-term debt. Liquid assets can include only unrestricted cash, cash equivalents and marketable securities of the tribal government and therefore cannot include any portion of the receivables balance. Tribal long-term debt excludes debt secured by the casino cash flow and includes only the governmental project bonds at this time. The ratio is tested quarterly; beginning with the quarter ended Sept. 30, 2009 the ratio cannot be less than 0.6 to 1.0. The required ratio to demonstrate compliance with the test steps up quarterly by 0.05 thereafter, through the quarter ended June 30, 2010, when it cannot be less than 0.75 to 1.0. Based on the June 30, 2009 tribal government balance sheet, the ratio was 0.73 to 1.0.

Potential Rating And Outlook Drivers:

Operating performance during the upcoming winter 2010 season will be critical in determining the direction of the rating due to the high degree of seasonality in the Yuma gaming market. Fitch expects top line revenue trends will continue to be negatively impacted by the poor condition of the regional economy, posing a significant challenge for the new senior management team. However, Fitch believes there is significant operational upside potential related to the improvements that are planned by new senior management. Resolution of the Negative Watch will depend upon the casino operation generating sufficiently positive free cash flow to continue funding all of its fixed obligations, while also avoiding significant cuts to government service levels and per capita distributions.

Conversely, a downgrade to 'CC' could be precipitated by a liquidity crisis if cash flows deteriorate to a level where it is probable that tribe will not be able to continue to meet its fixed payment obligations. This may occur in the near term if the tribe is required to begin funding the gaming enterprise revenue bond debt service reserve if it is determined that based upon the interpretation of the indenture language the coverage ratio is below 1.75x as of the Sept. 30, 2009 or Dec. 31, 2009 test date, and the tribe is unable to obtain approval for a technical amendment of the indenture from bondholders. If that event does not occur, the next significant inflection point for the credit will be operating performance during 1Q'10.

The gaming enterprise bonds are rated one notch above the issuer rating due to security provisions included in the bond indenture, in accordance with Fitch's published criteria for Native American gaming issuers. The governmental project bonds are rated on par with the issuer rating, because they are unsecured relative to the gaming bonds. The gaming enterprise bondholders have a security interest in the casino cash flows, while the governmental project bonds are non-recourse to the casino assets, including the cash flows.

For additional information on Quechan's credit profile and the Native American gaming sector refer to the following reports available at www.fitchratings.com:

--'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.

--'Tough Odds to Continue for Gaming', dated Jan. 30, 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 of 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.

Additional information is available at www.fitchratings.com.

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