TEXT - Fitch affirms Oklahoma's Cherokee National Healthcare bonds
Feb 27 - Fitch Ratings takes the following action on Cherokee Nation, OK (the Nation) debt: --$20.3 million Health Care System bonds, series 2006 affirmed at 'BBB-'. The Rating Outlook is Stable. SECURITY The bonds are secured by gross third-party revenues (primarily Medicare and Medicaid) of the health system and a full faith and credit pledge of the Nation. Pledged health system revenues are swept daily, or when first received, to the trustee-held bond fund account with excess of the monthly requirement transferred back to the Nation. The Nation has also granted a limited waiver of sovereign immunity in conjunction with the bonds. KEY RATING DRIVERS GAMING SUPPORTS STRONG GOVERNMENTAL OPERATIONS: The Nation is dependent upon the cash flows of the gaming operation (Cherokee Nation Businesses, LLC, or CNB) to approximately half of general fund operations. CNB has a strong credit profile supported by its competitive position in the Oklahoma market. CNB is unlevered, generates consistent free cash flow (pre-dividend), and has stable EBITDA margins. STRONG COVERAGE AND ESSENTIALITY: Health care services are essential to the Nation as a service to members and pledged third-party health care revenues provide ample debt service coverage. TIGHT LEGAL STRUCTURE: Legal protections are solid and include a daily sweep of pledged revenues to a trustee-held lock box. STABLE GENERAL FUND: Increased gaming income and lower spending has yielded positive general fund margins and an improved fund balance and liquidity position. RELATIVE REVENUE DIVERSITY: The Nation maintains relative revenue diversity compared to other gaming tribes in that although still concentrated, governmental operations receive support from non-gaming sources for about half of governmental spending. RATING SENSITIVITIES MATERIAL CHANGE IN GAMING ENTERPRISE PERFORMANCE: Strong performance at the gaming enterprise has been the key driver of the Nation's overall stable financial profile. Any material deterioration in finances, although not expected by Fitch, would put negative pressure on the rating. CREDIT PROFILE The Nation, headquartered in Tahlequah, Oklahoma, is the second largest federally recognized tribe, with approximately 305,000 enrolled members. The tribal jurisdictional area consists of 9,234 square miles of land located over 14 counties in northeastern Oklahoma near Tulsa. STRONG GAMING PERFORMANCE CONTINUES Gaming revenues are the largest source of general fund income supporting tribal operations. Fitch considers this income stream to be relatively stable despite the discretionary nature of gaming and the competitive market in which the Nation's casinos operate. The Nation's eight casinos are well-dispersed geographically throughout northeast Oklahoma and the Nation continues to reinvest in its facilities. The Nation's flagship property is the Hard Rock Casino & Resort Tulsa, which was recently re-modeled in 2011. The Nation is also adding a third-tower to the property that should be open at the end of February 2013. The new tower adds 98 new suites and was funded through cashflow. CNB has no material debt on its balance sheet as of Sept. 30, 2012. Liquidity is strong at $151 million, comprised of $52.7 million in available borrowings under its revolver and $98.1 million of cash. CNB generates strong positive free cash flow, totaling $78 and $86 million (pre-dividend) in fiscal 2012 and 2011, respectively, and it is expected to increase in the next few years. The positive cashflow is also expected to internally fund capital improvements. Management is actively looking at new opportunities to protect its market share and looks to spend $55 to $65 million annually toward that end. STABLE HEALTHCARE OPERATIONS; ESSENTIAL SERVICE The Nation's health care system serves an eligible patient population of approximately 101,000 within its 14-county jurisdictional area. The health care system includes nine clinics and one hospital, Hastings Hospital, which prior to fiscal 2009 was an Indian Health Services (IHS) managed facility. Primary care visits have steadily increased and climbed to 425,000 in fiscal 2012, up from approximately 345,000 in 2009. Given the growth in demand, the Nation recently opened an additional clinic in Vinita, which was funded by a private placement with the Bank of Oklahoma. Under a joint venture funding agreement with IHS, the construction and operation of the facility should result in enhanced IHS funding beginning in fiscal 2013. IHS funding has been relatively stable at $139 million in fiscal 2010, $137 million in fiscal 2011, and $145 million in fiscal 2012. The fiscal 2013 appropriation is expected to be at least $140 million. However, this funding is subject to a 5% sequestration cut in March if Congress and the administration fail to reach an agreement on the federal deficit. The potential cut to the Nation is approximately $10 million, which the Nation will need to manage through expense reductions. Additional capital needs of the Nation include up to $80 million to build a replacement hospital and expand/replace several outpatient clinics. The Nation is in the early stages of planning but is considering pay-go fund these projects with surplus cashflow from its gaming operations. The series 2006 bonds are secured by the Nation's full faith and credit as well as by third-party revenues, which have experienced strong growth due to enhanced services and efforts to qualify patients for Medicare and Medicaid. Third-party revenue increased to $73 million in fiscal 2012 compared to $70 million in fiscal 2011 and $58.6 million in fiscal 2010. The bonds require annual level sinking fund payments of $2.9 million and the pledged revenues provide ample coverage of debt service of roughly 25x. Coverage is much higher than projected at the time of issuance due to some early debt retirement and significant growth in third-party revenues as noted above. GOVERNMENTAL FINANCIAL OPERATIONS SUPPORTED BY GAMING AND OTHER ENTERPRISES The Nation's primary general fund revenue source is a dividend paid from the net income of CNB. The transfer amount is dictated by tribal policy, which now requires at least 35% of CNB's net income transferred to the tribe annually, up from 30% prior to fiscal 2012. The dividend comprised between 40% - 45% of total general fund revenues from fiscal years 2006 - 2011 and increased significantly in fiscal 2012 (to $54 million from $30 million). The increase was due to the policy shift noted above and strong growth in gaming income; management reports the additional monies will be used to fund one-time capital acquisitions out of the general fund. Diversification of the revenue stream supporting general government services is provided by the collection of motor fuel, tobacco and motor vehicle taxes. General fund balances declined in fiscal 2009 and 2010 due to capital expenditures and increased contributions to certain programs, but fiscal 2011 results were positive. The Nation concluded the year with an unrestricted general fund balance of $23.9 million or 37% of spending. Total fund balance is much higher, close to 100% of spending, with a large portion of reserves set aside for spending on the Nation's major programs: highway, health care and education. The unaudited fiscal 2012 operating margin was large at 28% of spending, due to the increase in the gaming dividend and conservative budgeting. Officials anticipate closing the year with an unrestricted fund balance of $41.5 million or over 50% of spending, with some of these funds to be used for capital outlays in fiscal 2013. NEW LEADERSHIP; SEQUESTRATION PRESENTS BUDGET UNCERTAINTY The Nation has a tripartite government operated pursuant to a tribal constitution. The executive branch of the Nation is led by the Principal Chief, who is elected at large for a four-year term. A controversial election in June 2011 was followed by a special election in September 2011, at which time a new Principal Chief was elected; the new chief replaced people in key financial management roles. The current-year budget is the first under the new administration and is essentially flat from the fiscal 2012 budget. Fitch views positively the consistency in the Nation's conservative financial management approach and considers this management trait a key credit strength. However, federal sequestration (effective March 1) could directly impact housing and other federally-funded government services offered by the Nation. Officials have plans to manage the cuts through spending reductions, and Fitch views successful management of the potential budget reductions a key credit consideration.
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