Archive for October, 2009

This is a follow-up to the earlier post on October 14 about Prichard, Alabama when the city failed to make the October payment to their retirees.  According to the Press-Register city leaders do not expect to pay November either.  To protect themselves from the lawsuit that ensued they filed Chapter 9 (municipal) bankruptcy yesterday.  (Note to the municipal bond analysts reading this, Prichard does not have general obligation bonds outstanding at this time, although they do have water and sewer bonds, guaranteed by Assured Guaranty, which should not be affected by the bankruptcy filing).  See link to al.com below:

http://www.al.com/news/press-register/metro.ssf?/base/news/1256721412135050.xml&coll=3

It’s not news that consumer spending is off, but in municipal bond country this also means sales taxes are coming in lower.  Some communities, such as those that depend on major shopping malls may see a double whammy from their major taxpayer, who will be looking to lower their assessed valuation (or worst case, miss their tax payments and face foreclosure – dead mall anyone?)  Take Richmond Heights, Missouri, for example.  A tony suburb of St. Louis, blessed by heavily trafficked intersections, Richmond is home to the St. Louis Galleria.  Sales taxes made up 43% of the city’s 2008 revenues while 12% came from property taxes.  From 2007 to 2008 sales taxes fell from $10.4 million to about $9.5 million.  The St. Louis Business Journal reports that sales tax revenue was $6.6 million through March, 2009.  The Galleria represents 14% of the property tax base and is the top taxpayer in the city. 

Consumer spending, despite what people are saying, is not likely to return to previous levels.  The reason?  Much of consumer spending was driven by home equity extractions during the boom years of property value appreciation.  The attached chart shows equity extractions through second quarter, 2008.  If you look at the chart for a moment, you will see the clear pattern.  Between 2002-2007 alone, more than $3.4 trillion was extracted from home values and spent somewhere. 

Click image TWICE to enlarge

Click image TWICE to enlarge

 

A second reason for reduced spending is retirees who are in the consumption phase of living but have lost a bundle on their retirement assets.  Many may also worry that their on-going pension payments could thin out (see post on Prichard, Alabama). 

We don’t need to remind the reader that the home equity ATM is out of order.  Households are saving (what’s wrong with that?) and it is unclear why some are calling for looser credit so that consumers can borrow more.  (Why encourage more borrowing for already bloated balance sheets?)  The result is that all of the businesses that grew to support the spending frenzy and all those that were built in anticipation of continued spending will have to go out of business or contract.  According to Howard Davidowitz who covers retail, there is 19.5 square feet of stores for every man, woman and child in the United States.  We only need 12 square feet, according to his analysis.

General Growth Properties (GGP) which is owner of the Galleria filed Chapter 11 in April 2009. They have more than 200 malls in 44 states.  Aside from less shopping revenue to fill their basket, the REIT took on significant leverage when they bought the Rouse Company a few years ago.  Among other malls, Rouse owns the South Street Seaport in New York and Faneuil Hall in Boston.  Competitors still above water include Simon Properties (SPG), Pennsylvania REIT (PEI) and Vornado Realty Trust (VNO).  Despite the bankruptcy many GGP malls continue to operate, although we expect that the REIT is likely to challenge property assessments where possible.   

According to the St. Louis Business Journal, the Galleria lost Lord & Taylor three years ago, a key anchor.  Nordstrom was supposed to fill that space but has delayed at least a year. Mark Shale, another key anchor tenant closed last spring.  Linens n’ Things filed bankruptcy recently and shuttered its store on the opposite side of the intersection (Loans n’ Such?).  Nearby, University Village, a mixed-use development is stalled.  A Homewood Suites is on target for opening but construction of a Westin was scuttled.  Retail development at University Village is on ice as well.  Happily, the city has not provided funds for this project.

The city did help fund projects for other commercial projects.  Missouri, like California and Florida is one of those states that uses special districts to spur real estate development. District projects can be funded with tax increment, special assessments or sales taxes and the districts are defined so that beneficiaries of capital improvements secure the bonds or certificates.  In Missouri, transit development districts are supported by sales taxes and in some cases tax increment taxes from the district receiving the benefit of investment.  These securities are not typically rated and are riskier than general obligation bonds. Some cities, like Richmond Heights may be covering debt service payments. 

The Francis Place Redevelopment Project RPA1 Tax Increment and Sales Tax Bonds for Series 2005 (also known as The Boulevard — Saint Louis) is one such example.  The city approved $39.5 million tax increment financing and issued $19 million in 2005.  This was intended to be a mixed use project, a combination of residential, retail, hotel and office.  Based on the city’s 2009-2010 budget it looks like the city is covering about half of debt service from general funds. 

Manhasset Village’s $3.555 million 2006 bonds are to be paid from special assessments but also have a claim against surplus revenues of the city of Richmond Heights (with no obligation on their part to raise taxes).  Manhasset is a 353 unit multi-family project originally built in 1930 and subject to redevelopment into luxury apartments and condominiums.  The project is being delayed because of the economy. There is a debt service reserve fund and it does not appear the city is covering debt at this time. 

Francis Place Redevelopment Project RPA 2 is still on the drawing board but the city’s budget shows debt issuance for 2010-2011.  The city has pledged $19.2 million tax increment to this project.  The city has pledged another $38.25 million tax increment financing for Hadley Township Redevelopment, which has also stalled.  The city has about $16.8 million certificates outstanding, payable from city general funds but they are expecting to pay from sales taxes.  We hope the city keeps its hand on its pocket as it tackles some difficult decisions over the next year.

The check is not in the mail.  Prichard, Alabama, came out of Chapter 9 bankruptcy in 2002 and promised to make deposits into its public pension fund.  They didn’t and now they are simply out of money.  Retirees did not get their October 1 payment.    What’s next?  The retirees are suing.  The city is looking for investors in a bingo operation as a last ditch effort to raise cash.  The bankruptcy word is being raised again.  (see our post from June 20)

The city does not have general obligation bonds outstanding at this time but some are eyeing the cash in the water and sewer system. That system, which refinanced its bonds in May (insured by AGO) has had its disputes as well.  They were under a consent decree to clean up their system.  The Mobile Area Water and Sewer System (MAWSS) was willing to take them over, but the city refused.  The city purchases water from MAWSS and handles its own treatment, distribution, billing and collection services.  Standard and Poor’s rated the system BBB- in 2005 but rates the 2009 bonds A-.  Coverage has improved, disclosure of the multiple lawsuits that were in the 2005 official statement have been dropped from the current disclosure and the refunding will save the water and sewer Board a significant amount of money.    After the May 2009 issue, the Board signed a 10 year public-private-partnership contract for $78 million with Severn Trent to operate the system (the amount is according to WKRG).  The amount seems high for a 2008 budget of about $7.4 million (excluding depreciation and amortization) that also includes about $1.0 million fixed cost for water purchase from MAWSS. 

Is the city’s dilemma symbolic of a pattern across the U.S.?  We think so.  Small municipalities that manage their own pension and retiree benefit programs, poor fiscal management and maybe an external shock such as loss of a major employer or reduced tax revenues are symptoms of trouble.  Vallejo, California fits this pattern as does the Sierra Kings Health Care District, California that just filed Chapter 9 last week.  While the common belief in the market is that municipalities don’t default, we see trouble among these smaller, vulnerable communities.  Watch the balance sheet for these factors before you pass “go”.

At this point in the meltdown timeline, municipal bond defaults have not yet occurred in the traditional sectors we think about such as cities, towns, states, utility systems and school districts.  The few notable exceptions include Vallejo, California, currently working through a Chapter 9 bankruptcy and Jefferson County, Alabama sewer system, which is a heavily leveraged enterprise working through its reserves and under its sixth? tenth? forebearance agreement with a number of swap providers, so according to some balance sheets not yet really in default.  Which brings me to this blog topic: what, after all, is a default?

The SEC currently requires disclosure of a list of material events, so some default reports include a draw on cash reserves along with payment defaults in the same statistics.  The typical understanding of default is a non-payment to the investor or bondholder.  When a security is spiraling downhill fast, a cash draw frequently ripens into a payment default.  Both will be noted in the material event filings.  The numbers will also include multiple filings for different series of bonds for the same issuer, or for two missed payments in the same year, or for multiple missed payments on a monthly basis.

When an investor or portfolio manager, or bond insurer or rating agency makes a decision about the quality of a security, they are usually thinking about the credit, meaning the borrower, or in some cases the obligor if it’s different than the borrower – that is, which entity has to pay back the obligation.  So if you don’t like an obligor, you are not going to like Series 2006A from that obligor as well as not liking Series 2007B.

To clear this up, we parsed the default filings for 2008 and the first half of 2009 for reserve draws, payment defaults and unique obligors vs. actual filings.  If you click on the attached chart, you can enlarge it.  We will be updating this information for third quarter in the near future, so stay tuned….

default table

Click twice to enlarge

Municipal bond defaults over the last two years occur in sectors that tie into the financial crisis: real estate.  Multi-family housing and land development projects that never took off are at the front line.  Special entities – usually a district of some kind, depending on the state – sell tax-exempt bonds to finance infrastructure for real estate development projects.  These are mostly non-rated securities.  Many of the securities were sold during the go-go development years of 2001-2007. 

A stark increase in defaults among Florida “community development districts” took place in 2008-2009.  These are primarily single family subdivisions across the state and many remain in their dirt stage of development.  “CDD’s” as they are called, rely on special assessments paid by the land-owners.  (The owner is assessed based on the “benefit” received from the infrastructure – rather than a property tax based on the value of the property.)  The land-owners in early stage districts are essentially the developers.  Some of them today are bankrupt and unable to pay the assessments. 

In Florida, defaulted properties become part of the tax lien market where individual investors who believed in the prospects of a project could pay off the tax liens and reap high returns on the investment.  With the bursting of the housing bubble, these markets have softened and a traditional source of liquidity that kept this market going has dried up. 

The other state where land development defaults are showing up is California.  There the defaults are in “Mello-Roos” districts, which may be part of a school district or city.  A special tax is charged to land owners located within a Community Facilities District.

Elsewhere, commercial real estate troubles are beginning to show up in debt service reserve withdrawals in sectors such as transportation development districts in Missouri and Arkansas.  These are sales taxes or tax increment bonds that funded infrastructure for a small retail, or commercial real estate development.  Some of these retail establishments never got off the ground.  Again, the common pattern is issuance of bonds during the last five years. 

For some reason, Texas, which has many special districts for land development (known as “MUDS”), are not appearing on the default screen at this time.  Rather, multi-family housing –defaults are clustered in Texas, while the special district (single family developments) are mostly clustered in Florida and in California.  (your thoughts?)

Notable other defaults include repeat headline grabbers: the Las Vegas Monorail, the Connector 2000 toll road in South Carolina and Jefferson County, Alabama sewer system. 

We break down the default data into the following general sectors.  (Note that debt service reserve draws are not included here.)

default sectors

Click twice to enlarge

In the aftermath of the bond insurance meltdown investors found that many of their holdings did not have an underlying rating.  Most are small borrowings and in smaller, lower profile communities across the U.S. landscape.  Among them are some gems that are navigating the difficult waters of the great recession.  However, there are also some clunkers that have less flexibility or ability to manage their finances in these difficult times.  We pulled the lists of non-rated insured securities from CIFG, XLCA, AMBAC, MBIA and FGIC and have a few observations.  CIFG’s and XLCA’s non-rated portfolio were insured mainly in the primary market reflecting their market position at the time of insurance and many are “story” bonds.  MBIA’s non-rated bonds were insured in the secondary market, reflecting the company’s approach in the late 1990’s.  We provide a few sample publications for your download here.

Insured 2007 bonds were sold to finance road construction for the Avery Ranch master planned community north of Austin, Texas.  Download the report.

A sample report on this district’s fiscal condition, 2005 bonds insured by AMBAC, no underlying rating, is available for your review.