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Best of Liz Benston

Gaming Guru

Liz Benston

Gaming's bond ratings reflect past, not future

28 July 2008

LAS VEGAS, Nevada -- A couple of weeks ago, major bond rating agencies downgraded credit issued by the major gaming companies, warning that the gambling business in Las Vegas is in trouble.

Though it made for dramatic headlines, experts say the actual effect of the ratings downgrades — which were based on old information rather than new developments — will likely be muted.

Gaming stocks and bonds had been badly pummeled by early evidence of the tourism slowdown and decisions by airlines to cut back on flights to Las Vegas.

When tourism was booming, casino companies were flying high on Wall Street. The bad news had a whipsaw effect and the stocks had further to fall than those of companies in less volatile industries.

The bond raters were being reactive. Their reports explained that the downgrades indicate much of the bad news had happened but that lower-than-expected May gaming revenue, released the week before by the state, triggered the lower ratings.

"I think they were waiting for more concrete data" to emerge before a downgrade, said Dennis Farrell, a bond analyst with Wachovia Capital Markets.

For investors who had reacted to the tourism slowdown, the moves by the ratings agencies were an expected, though delayed, reaction.

"It's kind of pointless, like driving a car by mostly looking in the rear-view mirror," said another Wall Street analyst, who asked not to be named. Analysts who work for investment banks have a different, and, they think, more sensible role in making predictions that investors can profit from.

Bond rating agencies have good reason to be conservative.

Lower bond ratings make it more expensive for companies to borrow money — a big deal for companies seeking to refinance or raise money for new projects.

The big rating groups — Standard & Poor's, Moody's and Fitch — have lately come under scrutiny by the Securities Exchange Commission for their role in the mortgage mess. Regulators think they didn't cut their ratings for subprime mortgage investments fast enough and failed to warn that the real estate bubble was about to burst. In a report issued this month, the SEC said it found conflicts of interest in the process of rating the debt of companies. Bond rating agencies, which are paid by credit issuers, such as the gaming companies, for their ratings, gave the mortgages higher ratings than they deserved to not lose their business, the report found.

Lenders are leery of the gaming industry, though companies in many industries are finding it equally difficult to get financing.

The takeover of Harrah's Entertainment Inc. by private equity firms in late January was the last of the major leveraged buyouts to close on Wall Street after lending dried up.

Though Harrah's had locked in interest rates for its bonds, the banks that owned them had trouble finding buyers and sold the bonds at a discount to get them off their books. The fire sale cost the banks hundreds of millions of dollars and Harrah's bonds are now trading at 75 cents to 85 cents on the dollar.

Gaming companies haven't been doing much financing lately, anyway. Money had grown cost-prohibitive several months ago, as banks tightened lending amid the nation's deepening mortgage crisis.

Gaming companies with projects under way had raised a lot of cheap money in the bull market. Those that didn't secure their financing last year are probably frozen out, which means there might not be much development on the Strip for a few years after Boyd's Echelon opens in 2011, Farrell said.

Investors, who react to future events rather than past ones, are focused on upcoming second quarter earnings reports and daily movements in fuel prices.