Apertor california and-lv_strip

Apertor Research www.apertorhospitality.com

May 19, 2010 Gregg Carlson
Advisor
702.506.0475 x540

California’s Impact on the Las Vegas Strip gcarlson@apertorhospitality.com

“ Slow recovery ahead based on conditions 300 miles away”

In our ongoing effort to judge prospective demand levels on the Las Vegas
Strip (LV Strip), we have updated our surveyed “top down” economic view of
the Southern California/California (Sou CA/CA) economy. Sou CA/CA has been
and remains the largest feeder market for the LV Strip, supplying approximately
26%/31% of LV Strip visitors during 2009.

Sou CA/CA is also home to a diverse economy that is tied to the balance of the
U.S., Mexico/Central/South America, Japan/China/Asia and other regions of the
world due to its manufacturing base, geographic location, variety of major industry
segments and significant shipping-transportation lane (one of the busiest ports in
the world and the largest in the U.S.). On a GDP equivalent basis, Sou CA/CA also
continues to rank as one of the largest economies in the world as of 2008 as follows:

California[1] 8th

Los Angeles Five-County Area[2] 17th

Los Angeles County 19th

CA has recently suffered through one of its worst economic downturns in history.
While signs of healing have emerged, economic pain remains for the economy as
a whole and for Sou CA consumers impacted by continuing high unemployment
and housing market stress, among other factors. Our research suggests that LV Strip
volume performance (visitation and spend) is tied to economic conditions in Sou
CA/CA. As a result, we continue to believe that industry “top-line” fundamentals and
timing of a recovery on the LV Strip will be significantly influenced by the shape
and breadth of the overall economic recovery in Sou CA/CA and more specifically,
improvement in economic factors that impact Sou CA/CA consumers.

1 California ranks 8th behind the U.S., Japan, China, Germany, France, the U.K. and Italy.
2 The Los Angeles Five-County Area includes Los Angeles, Orange,
Riverside, San Bernardino and Ventura Counties.

©2010 Apertor Hospitality, LLC.
All Rights Reserved.

California’s Impact on the Las Vegas Strip
May 19, 2010

While recent (fall 2009 to February 2010) LV Strip volume-related data points
remain well below 2006 to 2007 peak industry levels, several metrics (visitation,
auto traffic and gaming revenue) have shown sequential signs of improvement
from the late 2008 to early 2009 trough levels as they appear to be “less bad” on a
y/y basis. Current consensus thinking is that convention group business volume
levels will remain challenged into the first half of 2010 before commencing
recovery during late 2010 to 2011. For LV Strip operators, the open question is,
where will the numbers go from here?

We previously studied Sou CA/CA LV Strip economic trends during July 2009. At
the time, conditions remained challenged, with many surveyed CA economic data
points trending flat or downward in direction. The forecasts we viewed at the time
predicted continued difficult economic conditions through 2009 and into 2010 for
Sou CA. Specifically, unemployment was expected to rise and significant challenges
were expected to remain in the housing market, while overall economic growth
was expected to remain weak. Based on the available data points and forecasts at
the time, we hypothesized that macroeconomic conditions would outweigh the
“new supply drives visitation” factor, despite the fact that City Center would attract
attention and visitation. Late summer–fall 2009 and early 2010 data points have
generally supported this thesis.

Current forecasts of economic metrics tied to LV Strip performance in the U.S., Sou
CA/CA and AZ suggest that while the worst may be over, recovery prospects will
be mixed during 2010 with a modest to less than robust recovery in 2011 to 2012.
Our research suggests that the level of forecasted macroeconomic recovery will
not be sufficient to drive performance on the LV Strip between 2010 and 2012 to
previous peak levels (2006 to 2007). This implies that if recovery to historic peak
volume levels occurs, it will likely occur after 2012. Economic measures we surveyed
were generally not forecasted this far into the future, as credible forecasts for 2013
or later are difficult to make at this juncture. Forecasts of select economic metrics
that do exist generally fall below levels achieved from 2006 to 2007, the peak
performance period for the LV Strip in the previous decade. As a result, we remain
skeptical of near-historic peak level LV Strip forecasts in the foreseeable future.

In addition to ongoing issues that could put the economic recovery forecast at
risk (national and regional housing concerns, unemployment and household
deleveraging issues, among others noted in this report), we expect Sou CA/CA
tribal gaming to remain a competitive threat to the LV Strip. Also, given the slow
growth and ongoing relatively weak demand environment we forecast for the
LV Strip for the foreseeable future, we believe incremental supply (Cosmopolitan,
Fontainebleau, etc.) would pose a further threat (cannibalization) to the existing
LV Strip property base.

©2010 Apertor Hospitality, LLC.
All Rights Reserved.

1
May 19, 2010

Table of Contents
2 Executive Summary 30 Southern California Industry Trend Survey
2 Overview 30 Retail Industry
3 Key Takeaways 31 Summary of Southern California Industry Trends

33 Economic Forecast Survey
6 Recent National Macroeconomic
Trends and the LV Strip 37 Tying It All Together
7 Consumer Confidence
8 Employment & Unemployment 40 Risks in the Analysis
10 Housing Market Data
12 Household Deleveraging Trends

13 Customer Origin for the Las Vegas Strip 41 Appendix A — California Alt–A & Subprime
13 Recent LV Strip Visitation & Spending Patterns Mortgage Distress–Reset Analysis

42 Appendix B — U.S. Mortgage Originations by Product
16 Specific Southern California/
California Economic Metrics 43 Appendix C — Southern California–Western
Region Tribal Gaming Revenue and the LV Strip
16 Employment and Unemployment
18 Housing Market Data 47 Appendix D — Arizona Economic Forecast
18 Existing Home Sales and Prices
20 Mortgage Defaults and Delinquencies 49 Appendix E — 90+ Day Mortgage
Delinquencies per TransUnion Database
22 Mortgage Resets: The Mortgage Reset Wave Is Here
24 Housing Starts 50 Bibliography
26 Linking Southern California Housing
Prices to the LV Strip 52 Disclosures and Terms of Use
27 Population Trends
28 Southern California Port Activity
29 Personal Income and GSP Measures

©2010 Apertor Hospitality, LLC. All Rights Reserved.

Executive Summary 2
May 19, 2010

Executive Summary

Overview

We have long held the view that the current industry downturn on the LV Strip is as much
a function of deteriorating household budgets/wealth as it is an issue of over-supply from
operators building inventory. In early 2008, Palazzo opened and did not grow the market
on a fair-share basis during a time when the severity of the oncoming recession was not
completely recognized. At the time of its opening, the national and California unemployment
rate was ticking up from 4.78%/5.78% U.S./CA in 4Q07 to 5.37%/6.84% U.S./CA in 2Q08, while
consumer confidence was ticking down as the front edge of the recession began to emerge.
When Palazzo opened during 1Q08, our channel checks of casinos, restaurants and retail
stores delivered a strong message that consumer behavior had changed, as traffic was starkly
absent after many years of growth. At the time of these observations, neither the industry,
Wall Street or the financial markets had yet to completely comprehend the magnitude of the
downturn that was about to come, which would significantly impact the U.S./CA consumer
and the gaming industry on the LV Strip.

In the meantime, what may have not been completely recognized by the industry was that
U.S. and California households were in the midst of taking an enormous hit to household
net-worth (U.S. -20%) during 2008, tied to the ongoing U.S. and CA housing crash. Not long
after Encore opened during late 2008, it became apparent that operating performance
was going to be an issue as unemployment reached 6.86%/8.33% in the U.S./CA, consumer
confidence plummeted and mortgage delinquencies continued to unabatedly increase. As
unemployment continued to rise during 2008 and into 2009, it became a headline issue,
although its use as a leading or lagging economic indicator remained a point of contention.
At current high national and regional levels (10%–20%ish unemployed–discouraged-
underemployed), we believe it is a factor influencing overall consumer sentiment, and
along with other personal income/household wealth issues, affects consumer spending and
behavior.

While our research is focused on California, we begin by summarizing national consumer-
related headline macroeconomic data points to provide some overall context, as the LV Strip
is a regional, national and international destination market. We then illustrate the significant
link between California and the LV Strip. We present data on recent visitation and spending
patterns that appear to support our thesis that household balance sheet and income drives
current industry demand (as opposed to the latest and greatest gaming facility).

We then drill down into California’s economic conditions in general, and the Sou CA/CA
consumer more specifically. Although there is some grey area as to the importance and
interplay of the specific economic metrics we analyze, we summarize the metrics in Sou
CA/CA that we believe most impact California consumers and their discretionary spending
ability. Beyond the Sou CA/CA consumer, we also examine broader measures of specific
economic activity in Sou CA (port traffic, population trends, etc.) and income-GDP measures.


Executive Summary 3
May 19, 2010

Where applicable, we link Sou CA consumer related and applicable general economic data
points to LV Strip volume and spend metrics.

Beyond economic measures, as a proxy for consumer spending patterns, we provide color
on recent Sou CA retail industry trends as well as a recent summary and outlook of Sou CA
based major industry segments.

We summarize Sou CA economic forecasts by providing survey history and the latest
forecasts to make forward-looking inferences regarding the future of the LV Strip over the
next couple of years. We also illustrate Sou CA tribal gaming and LV Strip market share and
present economic data for Arizona, the second largest LV Strip feeder market in the U.S.

Key Takeaways

„ Although recent surveyed U.S. economic data points have improved from trough
levels, they remain far below peak 2006 to 2007 levels. Consumer confidence
remains weak and well under non-recession period levels while unemployment
remains high and is expected to remain at elevated levels for the foreseeable
future. While the housing market may be showing signs of bottoming out at
well below recent peak levels, mortgage distress continues to increase.

„ California/Southern California remains the most significant point of
origin for the LV Strip. Between 2004 and 2009, 28%–33%/24%–29% of
LV Strip visitors originated from California/Southern California.

„ LV Strip volume data (e.g., gaming revenue and visitation) have
tracked annual declines in recent years for key Sou CA macroeconomic
indicators such as employment/unemployment, housing prices/
starts and mortgage delinquencies/foreclosures.

„ While recent select LV Strip traffic and volume metrics (e.g., gaming revenue and
visitation) have improved on a y/y basis owing to easy comps, they remain far
below peak levels. Recent Sou CA data points remain a mixed bag, as some have
shown improvement (e.g., port activity and existing home prices) while others
remain weak (e.g., employment and mortgage delinquencies/foreclosures).

„ Recent Sou CA/CA economic survey forecasts predict a relatively weak and
protracted recovery with overall conditions remaining challenged in 2010
and recovery taking hold in 2011. Employment growth is expected to remain
weak during 2010 with muted gains in 2011. Unemployment levels are
forecasted to remain at double-digit levels well into 2012 and 2013. While
the housing market may grow from trough levels, significant risks remain in
Sou CA/CA tied to mortgage distress, continued high unemployment, large
numbers of negative loan-to-value mortgages and mortgage reset risk.


Executive Summary 4
May 19, 2010

„ While population growth slowed during the recession,
growth is expected to continue for the foreseeable future and
remain a driver of overall Sou CA economic growth.

„ Sou CA port volume historically has been correlated to LV Strip volume. After a
significant decline in 2008 and in the first half of 2009, volumes improved during
the second half of 2009. Port volumes are expected to grow modestly during 2010
at 5% and then continue to grow at a modest pace thereafter. Volume levels similar
to 2006 through 2007 peak levels are not expected over the next couple of years.

„ Historically, LV Strip volume has been correlated with Sou/CA personal
income and GDP growth. Personal income is expected to remain
flat in 2010 and grow moderately (below recent peak levels) during
2011, implying that growth on the LV Strip will be moderate.

„ Sou CA retail sales are expected to experience slow growth in 2010 with
some modest sequential improvement in 2011. Growth in the retail sector
has typically been correlated to volume growth on the LV Strip, implying that
growth will be weak in 2010 on the LV Strip with modest recovery to follow.

„ In the aggregate, Sou CA industry segments are expected to face a slow
growth environment during 2010. Some sectors will face continued distress
(building, commercial real estate and financial services) while some sectors
will experience a level of recovery (business services, health care and
technology). Employment growth in most sectors will remain muted.

„ Sou CA economic forecasts predict little recovery in 2010 and modest
recovery in 2011. While a double-dip recession is not expected, the forecasters
point out that remaining risks may bring bumps along the way.

„ While data is not yet available for 2009, data for 2008 and prior years
suggest that Sou CA tribal gaming operations have taken some regional
market share from the LV Strip. Note: Data for 2009 should become available
in summer 2010, and will then be used to update our analysis.

„ Arizona remains the second largest state in terms of LV Strip visitor point
of origin, contributing 10% of 2009 visitor volume. Arizona was one of the
hardest-hit states in the U.S. recession. While some economic metrics in
Arizona have improved recently, key metrics like unemployment are not
expected to reach bottom until the second half of 2010. Forecasts call for
a weak protracted recovery that stretches beyond 2010 and 2011.


Executive Summary 5
May 19, 2010

In summary, recent Sou CA economic data points remain well below levels that existed
during the peak performance years on the LV Strip (2006 to 2007). Sou CA economic
forecasts we surveyed call for a choppy 2010 followed by moderate recovery in 2011 and
2012. Forecasted U.S. and Sou CA economic data points for 2010, 2011 and 2012 remain
well below 2006 to 2007 levels implying that LV Strip performance will also remain well
below peak year levels at least through 2012. Therefore we presently see limited possibility
of a repeat of LV Strip peak performance levels in the foreseeable future based on these
data points. Additionally, the lack of household-debt-supported consumer spending and
the threat of Sou CA regional tribal gaming market share gains also reduce the near-term
probability of a recovery scenario. Finally, given the slow growth and ongoing relatively
weak demand environment we forecast for the LV Strip for the foreseeable future, we
believe incremental supply (Cosmopolitan, Fontainebleau, etc.), would pose a further threat
(cannibalization) to the existing LV Strip property base.


Recent National Macroeconomic Trends and the LV Strip 6
May 19, 2010

Recent National Macroeconomic Trends and the LV Strip

The economic forecasts and headlines we surveyed suggest that the recession, which
officially began in late 2007 to early 2008, ended in mid-2009. It is now well documented
that the recession resulted in a huge hit to consumers in the form of job losses (8.4 million
jobs disappeared), ongoing unemployment, income losses, and a massive negative wealth
hit due to the housing crisis. While household asset values have significantly declined,
household debt remains high and remains to be de-leveraged through restructuring and
pay-down. There was evidence during the second half of 2009 that the national economy
began to grow again due to inventory restocking, consumer spending tied to “cash for
clunkers” and housing-related incentive programs, among other factors. Despite the recovery
headlines, the consensus view is that challenges remain for consumers, as unemployment is
expected to remain at elevated levels, employment growth is expected to remain at muted
levels, and total employment is expected to remain well below peak 2007 levels into 2013
(2 million jobs below 2007 levels at the end of 2012, per UCLA’s latest Anderson forecast).[3]

As we write, signs of economic recovery are spreading (e.g., increases in retail sales from
historically low levels, recent existing home sales increases, export activity increases and
growth in business equipment and software). For 2010 and 2011, the key forecasting issue is
the shape, breadth and speed of recovery. U.S. GDP growth rate forecasts we have surveyed
range from 2% to 3% for 2010 to 2012, which are not viewed as strong on a typical post-
recession basis. Economic forecasters we surveyed during the summer of 2009 have recently
become more positive, hinting that 2010 may continue to improve to some degree.

As the most significant national destination market in the U.S. gaming industry, the LV
Strip has suffered during the recession, demonstrating that it is not immune to national
and regional economic trends. Post-recession, during the second half of 2009, the market
appeared to recover in some metrics on a y/y basis owing to easy comps. On an absolute
basis, however, gaming revenue remains well below the peak market levels achieved
during 2006 and 2007. Like the U.S. economy, the question for the LV Strip is focused on the
strength, shape and breadth of recovery between 2010 and 2012. Our research suggests that
LV Strip gaming revenue trends are correlated to overall consumer spending and changes to
household net worth.

In recent years, U.S. GDP growth has been driven by consumer spending, which in turn
was fueled by increased debt and decreased savings. Between 3Q08 and 2Q09, consumer
spending and personal income dropped, while the savings rate increased (partially fueled
by an overall decline in U.S. tax rates). Forecasts we have surveyed predict muted personal
income growth during 2010 (2% to 3%), with sequentially better income growth during
2011 (4% to 5%). In 2007, prior to the recession, personal income grew at a 4% to 5%
rate. Consumer spending is expected to be flat over the next year followed by 2% growth
between 2Q11 and 1Q12 (note–the real increase in consumer spending between 1987 and
2007 was 2.2%). While GDP grew nearly 6% during 4Q09, consumer spending increased

3 The UCLA Anderson forecast is a quarterly forecast of U.S. and California economic trends.


May 19, 2010

by 1%, essentially decoupling from GDP growth. The forecasts we have reviewed assume
continued decoupling between GDP growth and consumer spending. In summary, our
national forecast survey suggests that consumer spending will remain weak in the near term,
implying that growth will not come back to the LV Strip until sometime after 1Q11. There are
unknown factors that may influence this forecast positively or negatively, including better-
than-expected spending patterns, additional unexpected weakness in the labor market, an
increase in interest rates that would do further damage to the housing market, and the high
level of consumer debt that will need to be deleveraged via repayment (thus dampening
consumption) and/or write-offs by the banks. Outlined below is a discussion of a select few
consumer-related economic metrics.

Consumer Confidence

Figure 1 shows that LV Strip gaming revenue has been correlated to overall consumer
confidence. The index has recently bounced off recession lows of 30 during 4Q08 through
1Q09. The current index is in the 50s range, while a 100 index range is considered to be
normal. The “look-ahead” expectations index is also weak. We believe consumer confidence
would rise in conjunction with higher income and/or employment growth. As employment
is expected to remain weak, we expect confidence to remain weak in the near term. History
suggests that the LV Strip will recover when confidence recovers.

Figure 1 — Consumer Confidence Index & LV Strip Gaming Revenue ($’s in millions)†

$900 140 LV Strip gaming
$800 revenue ($1m+)†
120
$700
100
$600 Consumer
80 confidence index
$500
$400 60
$300
40
$200
20
$100
$0 0
Jun 01

Dec 01

Jun 02

Dec 02

Jun 03

Dec 03

Jun 04

Dec 04

Jun 05

Dec 05

Jun 06

Dec 06

Jun 07

Dec 07

Jun 08

Dec 08

Jun 09

Dec 09

Source: Conference Board, Nevada Gaming Commission, Apertor Hospitality
† Nevada Gaming Commission, Monthly Gaming Revenue Report, Las Vegas Strip, $1 million and over gaming revenue category


May 19, 2010

Employment & Unemployment

Since December 2007, 8.4 million jobs have been lost. Unemployment increased throughout
2008 and well into 2009 before it was acknowledged as a serious issue for the gaming
industry. Throughout 2009 we continued to read industry analysis making the case that there
was little relationship between gaming revenues and changes in the unemployment metric.
Unemployment is also viewed as a lagging economic indicator and an economic factor that
is reaching or has reached a bottom. The current consensus view is that the U.S. is in a jobless
recovery, with unemployment likely to remain at elevated levels for an extended period of
time. Forecasts we have surveyed suggest that at the end of 2012, even in an economic-jobs
recovery, total employment will remain two million jobs below the 2007 peak.

When underemployment is included, actual rates are higher than headline numbers. Beyond
the direct hit to individual and aggregate personal income levels, we believe continued weak
employment growth/high unemployment figures have a dampening effect on consumer
sentiment, which historically impacts gaming spending (see Figures 2 & 3). Looking ahead,
the ongoing issue will be, are current high unemployment levels cyclical or structural in
nature? The gaming industry will keep its fingers crossed and hope that the issue is cyclical.
Current economic forecast consensus suggests that it may be structural, and economic
research suggests that the housing crises drove unemployment in many regions of the U.S.[4]
Our sense is that a housing market recovery reversion to recent peak year levels is not in the
cards implying that housing-driven employment gains will not reach the magnitude of the
previous up cycle.

As we write, March 2010 employment numbers were released showing the first gain in
three years. The gain predominantly came from the hiring of temporary census workers and
positive hiring in the manufacturing sector. The challenge is that despite this gain, long-term
unemployment will remain high and is expected to stay elevated for an extended period
of time. While the published unemployment rate remained at 9.7%, the broader measure
of unemployment (which includes discouraged workers) increased by .1%, to 16.9%. While
lower than the October 2009 high of 17.4%, the number remains discouragingly high. In
summary, while job growth was positive in March, the consensus economic view is that the
recovery in jobs is expected to be slow. And because history suggests a negative correlation
between U.S. unemployment numbers and LV Strip gaming revenue, we believe forecasted
ongoing elevated unemployment levels are not helpful for LV gaming’s revenue growth
prospects, for the market as a whole and particularly the middle market.

4 For an analysis of the U.S. housing crises and unemployment see Atif Mian and Amir Sufi, Household Leverage
and the Recession of 2007 to 2009, University of Chicago and NBER, November 6, 2009.


May 19, 2010

Figure 2 — Consumer Confidence and Unemployment

140 12%

120 10%
100
8%
80
6%
60
4%
40

20 2%

0 0%
Dec 00
Mar 01
Jun 01
Sep 01
Dec 01
Mar 02
Jun 02
Sep 02
Dec 02
Mar 03
Jun 03
Sep 03
Dec 03
Mar 04
Jun 04
Sep 04
Dec 04
Mar 05
Jun 05
Sep 05
Dec 05
Mar 06
Jun 06
Sep 06
Dec 06
Mar 07
Jun 07
Sep 07
Dec 07
Mar 08
Jun 08
Sep 08
Dec 08
Mar 09
Jun 09
Sep 09
Dec 09
Mar 10
Consumer confidence index U.S. unemployment rate

Source: Conference Board, U.S. Department of Labor

Figure 3 — U.S. Nonfarm Employment and LV Strip Gaming Revenue (amounts in millions)

140 $700

138
$600
136

134 $500

132
$400
130
$300
128

126 $200
124
$100
122

120 $0
Dec 99

Mar 01
Jun 01
Sep 01
Dec 01

Mar 05
Jun 05

Dec 05
Mar 06
Jun 06

Dec 06

Mar 09
Jun 09

Dec 09
Sep 05

Sep 06

Sep 09
Dec 00

Dec 02

Dec 03

Dec 04

Dec 07

Dec 08
Jun 00

Jun 02

Jun 03

Jun 04

Jun 07

Jun 08
Mar 00

Mar 02

Mar 03

Mar 04

Mar 07

Mar 08

Mar 10
Sep 00

Sep 02

Sep 03

Sep 04

Sep 07

Sep 08

Nonfarm employment Monthly LV Strip gaming revenue†

Source: Bureau of Labor Statistics, Nonfarm Employment, Apertor Hospitality


May 19, 2010

Housing Market Data

Although housing prices seem to have bottomed out and improved somewhat in select
regions during 2009, the consensus view is that prices are not expected to reach 2006 peak
year levels for the foreseeable future. While national numbers are modest, some markets
(e.g., Cleveland, Memphis, San Francisco and Denver) are hot, posting double-digit increases
in prices during 2009. Policy (low interest rates, quantitative easing, FHA loan guarantees
and the homebuyer tax credit) more than fundamentals is driving the market. The challenge
is that such policies have a limited lifespan due to the risk of inflationary pressures, among
other factors.[5]

In spite of the price increase during 2009, the larger issue of foreclosures remains, as
homeowner rescue plans so far have had little to no impact on the pace of foreclosures. At
December 31, 2009, the Mortgage Bankers Association reported that approximately 14%
of all mortgages where non-performing (see Figure 4). In terms of raw data, the number of
mortgages that are 60 days delinquent or foreclosed has grown from 1.3 million mortgages
to 5.0 million mortgages between 4Q06 and 4Q09, with almost all regions in the U.S. being
negatively, though unevenly, affected. Areas like CA and NV have fared worse than the
remainder of the U.S. and now lead the nation in terms of share of delinquent loans at 4Q09.

The combination of past overbuilding, a high number of distressed mortgages potentially
creating future supply, high vacancy rates and job-loss-related personal income challenges
imply that a significant uptick toward 2006 peak pricing levels in the housing market is
unlikely to occur for several years.

An overall positive is that the dramatic decrease in housing prices has made housing more
affordable. An overall negative is that at the end of 2009, approximately 29% of all U.S.
mortgages sat at a negative loan-to-value ratio. An additional housing market overhang is
the large number of remaining variable-rate mortgages that may be reset at higher interest
rates (if rates increase) between now and 2012.

Prior to the bust, debt-fueled housing appreciation drove consumer spending and gaming
industry revenues (see Figure 5). Between 2010 and 2012, we do not expect housing to
be a significant driver of gaming industry spend, as we do not believe the “house as an
ATM” phenomenon will be repeated. We also believe that the probability of housing prices
reaching past peak levels is low.

5 For additional information, see Beacon Economics winter 2010 forecast.
Beacon Economics is an independent economic forecasting firm based in California.


May 19, 2010

Figure 4 — U.S. Mortgage Delinquencies and Foreclosures (% of outstanding mortgages)

16% Delinquencies
14% Foreclosures
12% Total delinquencies
10% and foreclosures

8%
6%
4%
2%
0%
1Q05

2Q05

3Q05

4Q05

1Q06

2Q06

3Q06

4Q06

1Q07

2Q07

3Q07

4Q07

1Q08

2Q08

3Q08

4Q08

1Q09

2Q09

3Q09

4Q09
Source: Mortgage Bankers Association

Figure 5 — Case Shiller Index & LV Strip Gaming Revenue ($’s in billions)

220 $7 Case Shiller index
200
$6 LV Strip gaming
180
revenue ($72m+)†
160 $5
140
$4
120
100
$3
80
60 $2

40
$1
20
0 $0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Source: S&P Case Shiller Index, Nevada Gaming Commission, Apertor Hospitality


May 19, 2010

Household Deleveraging Trends

Until recently, the gaming industry mantra has been that supply and development creates
demand. However, since the peak performance years of 2006 to 2007, demand has clearly
slackened. The current bull case is that recent data points suggest a recovery is ahead as
demand is coming back. The reality is that the consumer appears to be in a vastly different
place today compared to the 2006 to 2007 peak industry period. As a result, we are reluctant
to forecast recent positive data points in a linear manner into the indefinite future due to
current high levels of consumer debt that may very well be paid down over several years
(e.g., by deleveraging), thus dampening consumer spending in the gaming industry (see
Figure 6).

The bull case is that household deleveraging either will not occur or will occur in a manner
whereby consumer spending is not significantly impacted looking forward. The bear case is
that household deleveraging occurs in a manner that reduces overall consumer spending.
As we are in an unprecedented situation, only time will tell which scenario proves correct.
Our view is that, in either case, the gaming industry will be significantly impacted.

Figure 6 — U.S. Aggregate Household Liabilities as Share of Disposable Income (100 = 100%)

150
140
130
120
110
100
90
80
70
60

Q309
1971

1981

1991

2001
1967
1968
1969
1970

1972
1973
1974
1975
1976
1977
1978
1979
1980

1982
1983
1984
1985
1986
1987
1988
1989
1990

1992
1993
1994
1995
1996
1997
1998
1999
2000

2002
2003
2004
2005
2006
2007
2008

Source: McKinsey & Company, Federal Reserve


Customer Origin for the Las Vegas Strip 13
May 19, 2010

Customer Origin for the Las Vegas Strip

The Las Vegas Convention and Visitors Authority (LVCVA) conducts an annual visitor survey
that, among other things, documents the place of residence/point of origin for LV Strip
visitors. California has been the largest individual category of visitors included in the survey,
accounting for 26%–33% of all LV Strip visitors from 2004 to 2009 (the survey period we
reviewed). Southern California contributed 24%–29% of total LV Strip visitors between 2004
and 2009, and it remains the largest single geographic submarket for the LV Strip (Arizona
is ranked #2 as an individual state, with the remaining rankings defined as regions). In
summary, Southern California is the nearest and largest single market (by a factor of 2x–3x or
more) for the LV Strip (see Figure 7). Therefore LV Strip volume performance is directly and
significantly impacted by conditions in Sou CA/CA.

Figure 7 — LV Strip Visitor Origin (% of total visitors)

100%
14% Foreign
90%
Other western states
80% 15%
6% 6% Arizona
70% 7% 9%
4% 4% 6% 6% 9% 10%
60% Northern CA
4% 5%
27%
50% 29% 27% 25%
Southern CA
24% 26%
40% Midwest US
30% Southern US
12%
20%
Eastern US
11%
10%
7%
0%
2004 2005 2006 2007 2008 2009

Source: LVCVA Annual Visitor Survey

Recent LV Strip Visitation & Spending Patterns

In Figures 8 & 9 we show that headline LV Strip visitor volume and spend metrics grew post-
9/11 and peaked during 2006 and 2007 due to the opening of Wynn in 2005 (which grew the
market) and also due to a demand environment (driven by macro conditions) that supported
industry pricing power. The majority of new LV Strip development projects were announced
during this period of peak demand. In 2007, growth leveled off before dropping significantly
as the recession intensified in the latter half of 2008. Y/Y results remained negative until
the second half of 2009, when y/y numbers largely turned positive due to easy comps (see
Figure 10). As City Center recently opened, the jury is still out regarding the magnitude of
volume growth driven by this project.


May 19, 2010

U.S. and CA economic metrics were positive between 2003 and 2006 and then began to
flatten during 2007. From 2008 to early 2009, U.S. and CA economic metrics rolled over
during the economic crises, and remained weak throughout 2009.

Looking forward, the breadth and depth of recovery are uncertain. Our view is that the shape
and magnitude of overall economic recovery in Sou CA will influence the shape and depth of
recovery for Sou CA/CA consumers and therefore the LV Strip.

Figure 8 — Las Vegas Strip Gaming Revenue ($’s in millions)†

$700
$650
$600
$550
$500
$450
$400
$350
$300
Dec 01

Jun 02

Dec 02

Jun 03

Dec 03

Jun 04

Dec 04

Jun 05

Dec 05

Jun 06

Dec 06

Jun 07

Dec 07

Jun 08

Dec 08

Jun 09

Dec 09
Source: Nevada Gaming Commission

Figure 9 — Y/Y Change in LV Strip Visitation and Gaming Revenue

15% LV Visitor volume

10% Air traffic

5% 2009 I 15 traffic
2001 2008
0% LV Strip gaming
2002 2003 2004 2005 2006 2007 revenue ($72m+)†
-5%

-10%

-15%
Source: LVCVA, Nevada Gaming Commission, Apertor Hospitality


May 19, 2010

Figure 10 — Monthly Changes in LV Strip Visitation and Gaming Revenue

15% Visitor volume
10%
Air traffic
5%
I 15 traffic
0%
LV Strip gaming
-5% revenue ($72m+)†
-10%

-15%

-20%

-25%

-30%
Oct 08
Jan 08
Feb 08
Mar 08
Apr 08
May 08
Jun 08
Jul 08
Aug 08
Sep 08

Nov 08
Dec 08
Jan 09
Feb 09
Mar 09
Apr 09
May 09
Jun 09
Jul 09
Aug 09
Sep 09
Oct 09
Nov 09
Dec 09
Jan 10
Source: LVCVA, Nevada Gaming Commission, Apertor Hospitality


Specific Southern California/California Economic Metrics 16
May 19, 2010

Specific Southern California/California Economic Metrics

We examined trends in specific consumer-related economic metrics such as employment
and housing as well as broader economic measures of population trends, port activity and
income/GDP equivalent measures. We also examined the movement in these measures
during the past decade as Sou CA/CA moved from economic growth to recession. Our
analysis provides forecasts of these measures and makes comparisons to LV Strip volume
metrics to make inferences of performance levels of the LV Strip from 2010 to 2012.

Although the worst may be nearly over in Sou CA/CA for the consumer, forecasts of the
examined metrics suggest a moderate sequential recovery (from current low levels) for the
consumer in 2011 and 2012 after a sluggish 2010.

History suggests a strong relationship between the examined metrics and LV Strip
performance. The Sou CA economic forecast implies a flattish year in 2010 for the LV Strip
with some recovery in 2011. At the same time, we have not seen any data suggesting that a
LV Strip recovery to peak 2006 to 2007 levels is likely in the foreseeable future.

Employment and Unemployment

Nonfarm employment in Sou CA/CA grew sequentially from 2003 and reached a peak
during 2007 (see Figure 11). Sou CA/CA employment has been hit hard during the recession
as total employment declined by approximately 500k/850k between 2007 and 2009.
Employment losses are forecasted to bottom out during 2010 before employment rises in
2011. The challenge is that 2011 total employment growth (at +1%) is expected to be muted,
as unemployment is forecast to remain high. Though the state’s economy will be growing,
it will not be growing fast enough to push unemployment rates below double digits before
2012. In 2010, most industries in Sou CA are not expected to be growing enough to stimulate
hiring. Businesses are also expected to remain reluctant to hire workers until confidence
develops that industry recovery is established and sustainable. Sou CA is expected to shed
jobs in 2010 (-.5% to -1%) with employment growth (+1%) beginning slowly in 2011. In
summary, the forecasts for continued double-digit unemployment and slow employment
growth through late 2010 to 2011 imply that 2006 to 2007 peak year employment levels are
unlikely to return in the foreseeable future. As a result, we do not expect employment trends,
a major driver of LV Strip volume, to return to previous peak levels (see Figure 12).


May 19, 2010

Figure 11 — Sou CA Nonfarm Employment & LV Strip Gaming Revenue (employment in millions, $’s in billions)

8.8 $7 Sou CA employment
8.6
$6 LV Strip gaming
8.4 revenue ($72m+)†
$5
8.2

8.0 $4

7.8 $3

7.6
$2
7.4
$1
7.2

7.0 $0
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 F 2011F

Source: LAEDC, Nevada Gaming Commission, Apertor Hospitality

Figure 12 — Y/Y Change in LV Strip Volume Metrics & Sou CA Unemployment Rate

15%
LV Visitor volume

10% Air traffic

I 15 traffic
5% 2009
LV Strip gaming
revenue ($72m+)†
2008
0%
Sou CA
2002 2003 2004 2005 2006 2007 2010 F 2011F unemployment rate
-5% 2001

-10%

-15%

Source: LAEDC, LVCVA, Nevada Gaming Commission, Apertor Hospitality


May 19, 2010

Housing Market Data

Since the onset of the recession, CA has faced significant challenges in its housing market.
After years of leading the U.S. in home price appreciation, prices began to fall significantly
during 2007 and 2008, which triggered a significant wave of foreclosures and defaults.
Property values that fell well below mortgage levels put many people into significant
negative equity situations that, along with job losses, caused people to walk away from their
homes. Fueled by easy credit, California home values grew to levels that were out of line with
income growth. California also had a disproportionate share of adjustable rate mortgages
(option ARMs) relative to other areas of the U.S. that, combined with speculation and loose
underwriting standards, made California more vulnerable to the housing collapse than other
states in the U.S. Like California, the states of Florida, Nevada and Arizona experienced similar
housing market conditions during the boom, which has led to the current highest levels
of distress in the U.S. in terms of post-peak depreciation, delinquencies, foreclosures and
negative loan-to-value mortgages.

Far below peak prices, Sou CA home prices have bounced off a bottom during 2009.
While the lack of housing starts will help supply and demand rebalance, a significant supply
overhang remains due to the large number of delinquencies and foreclosures that have
continued to increase through the end of 2009.

By the end of 2009, Sou CA was home to a significant number of negative loan-to-value
mortgages (which is closely tied to pre-foreclosure activity) and a disproportionate share
of option ARMs that could reset at higher rates, thus triggering another wave of defaults
between 2010 and 2012. So while Sou CA unsold new housing and building permits are
low (a positive for the housing market), foreclosures remain a major strain on the market,
accounting for 40% of resales in December, compared with February’s 2009 high of 57%.

Although credit conditions remain tight, mortgage rates are low and existing home
inventories are falling. Government incentives have also helped. It is too early to tell if
stability is an illusion, as substantial improvement in the job market is yet to take hold.
With the large number of distressed households, a large amount of uncertainty remains in
the Sou CA housing market.

Forecasts we have surveyed point to the large degree of uncertainty and to a dip in existing
home prices in 2010 before a very modest (muted) recovery in pricing and sales between
2011 and 2013.

Existing Home Sales and Prices

Figure 13 depicts activity in six counties of Sou CA, including Los Angeles, Orange, Riverside,
San Bernardino, Ventura and San Diego Counties. Los Angeles County alone accounts for
approximately half the activity. Aggregate pricing dropped approximately 50% from peak-to-
trough in 2008, triggering an economic crisis in CA and the U.S.


May 19, 2010

Figure 13 — New/Existing Median Home Sales & Prices in Sou CA

450,000 $600,000 New/existing home sales

400,000 New/existing home prices
$500,000
350,000

300,000 $400,000

250,000
$300,000
200,000

150,000 $200,000

100,000
$100,000
50,000

- $0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Source: Dataquick

On an individual county basis, existing home prices fell in Sou CA after reaching a peak
during 2007. LA prices dropped 43% peak-to-trough while Riverside-San Bernardino prices
dropped 58% (see Figure 14).

Figure 14 — Sou CA Median Existing Home Prices by County

$800,000

$700,000 Los Angeles
$600,000
Orange County
$500,000
Riverside
$400,000

$300,000 Ventura

$200,000

$100,000

$0
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Source: LAEDC

Existing home prices have shown stability during 2009, as they have increased slightly since
bottoming out in early 2009 (see Figure 15).


May 19, 2010

Figure 15 — Monthly Sou CA Existing Home Sales & Prices

25,000
$400,000 New/existing home sales

20,000 $350,000 New/existing home prices
$300,000

15,000 $250,000

$200,000
10,000
$150,000

$100,000
5,000
$50,000

- $0
Jul 08

Jul 09
Jan 08
Feb 08
Mar 08
Apr 08
May 08
Jun 08

Aug 08
Sep 08
Oct 08
Nov 08
Dec 08
Jan 09
Feb 09
Mar 09
Apr 09
May 09
Jun 09

Aug 09
Sep 09
Oct 09
Nov 09
Dec 09
Jan 10
Feb 10
Source: Dataquick

Mortgage Defaults and Delinquencies

Mortgage defaults and foreclosures rose substantially between 2007 and 2009 (see Figure
16). The timing of the activity represented in the chart was particularly influenced by the
processing backlog in banks and loan servicers, which were hit with a massive wave of
default activity and, to a lesser degree, government loan modification program efforts. The
levels of activity are far above low points prior to the recession and are significantly higher
than previous recessions.

Figure 16 — Sou CA Housing Notices of Defaults & Foreclosures

90,000
Notices of Default
80,000
Foreclosures
70,000

60,000

50,000

40,000

30,000

20,000

10,000

-
Q107 Q207 Q307 Q407 1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 4Q09

Source: Dataquick


May 19, 2010

As they precede notices of default, notices of delinquency are precursors to foreclosures.
Ninety-day notices of delinquency remained on the rise at the end of 2009 on a year-to-year
basis (see Figure 17). Sixty-day delinquency notices are also substantially higher at 4Q09
compared to 4Q08 and 4Q06 (a pre-crises period) as follows: 1.59% in 4Q06, 8.56% in 4Q08
and 12.34% in 4Q09. The continued increase in delinquencies suggests that the Sou CA
housing market is not yet out of the woods.

Figure 17 — Sou CA 90 Day Mortgage Delinquencies (% of delinquent mortgages)[6]
18%
16%
4Q08
14%
12%
4Q09
10%
8%
6%
4%
2%
0%
Los Angeles Orange County San Diego Riverside Santa Barbara Ventura

Source: Dataquick

Sou CA ranks high in the share of negative loan-to-value mortgages. Of the top 50 ranked
regions in the U.S., Sou CA’s major counties each rank in the top half of overall U.S. rankings
in 4Q09. Negative loan-to-value mortgages are considered an indicator of possible future
foreclosures. As a result, Sou CA negative loan-to-value mortgages could pose a risk to
housing values and remain a risk to recovery if foreclosures increase, thus increasing future
supply. In Table 1, we present Southern California and other western region negative
loan-to-value estimates developed by First American CoreLogic (a national real estate
research firm). Deutsche Bank has also released national and regional negative loan-to-value
estimates that are generally more negative than the data presented in Table 1, which we
discuss below.

In August 2009, Deutsche Bank (DB) published a forward-looking analysis of current and
projected negative equity mortgages by mortgage type and location.[7] DB estimated that
as of 12/31/08, the percentage of borrowers in Los Angeles and Riverside/San Bernardino
Counties with negative equity was 51%/81% respectively. DB estimates that the percentage
of borrowers in 1Q11 in Los Angeles and Riverside/San Bernardino with negative loan-to-
value will be 62%/87%. DB’s model is based on projections of absolute unemployment,
changes in unemployment, excess distressed inventory and recent price changes. DB
indicates that affordability is currently not a reliable metric for predicting price changes.[8] At

6 See Appendix E–90+ Day Mortgage Delinquencies per the TransUnion Database for a visual depiction of U.S. mortgage
delinquencies. The map was provided by the Federal Reserve of New York and is based on late 2009 data. The map is based on a
10% sample (that is statistically significant) of TransUnion’s national trend database. TransUnion is a national credit bureau.
7 Shen Ying, Karen Weaver, “Drowning in Debt – A look at Underwater Homeowners”, Deutsche Bank, August 2009
8 Shen Ying, Karen Weaver, “The Outlook For U.S. Home Prices – Beyond the Bubble”, Deutsche Bank, March 2009


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