Posts Tagged ‘special district’

Add Xenia Rural Water District’s to the short but growing list of over-leveraged municipal borrowers.  With $143 million in debt and about 9,000 customers, the unfolding socio-gram includes bondholders, bond insurers CIFG and Assured Guaranty, the US Department of Agriculture, Bank of America, and last, but not least, the ratepayers.  A $5.2 million note to Bank of America comes due June 1 and the district is already in arrears to the USDA.  The BofA notes were sold on the assumption they would be taken out with permanent financing from the USDA.  Will that happen?  USDA has called in its auditors and expects to complete a financial review during May.  Having the federal lender as a creditor on this workout should make things interesting. The State of Iowa is also auditing, with results for 2009 to come out in a month.   As of the district’s 2008 audit there was 64% coverage of debt service from available revenues. 

The district had great dreams of expansion, aggressive you might say.  One of the problem projects was a 16 mile pipeline designed to reach about 20-30 homes, according to the Ames Tribune.  The former Executive Director Dan Miller (separated at birth from Harrisburg, PA’s comptroller, Dan Miller?) had a penchant for expansions, even when they no longer made sense.  The district expected to double the number of connections and revenues by 2011 when maximum debt payments kick in according to a read of the official statement.  For a rural, agricultural region, even in the best of times, this is ambitious.

Then there were the line extensions to several ethanol projects within the district.  According to the Guthrie Center Times, at least one of these projects

may have contributed to Xenia’s dire situation.. The company extended a pipeline from Clive to the western edge of Waukee and from DeSoto to Menlo at a cost of $15 million to provide water to the Hawkeye Renewables ethanol plant at Menlo.  The work was done by Xenia’s construction crew and the cost overrun of $3.5 million had to be born by the company.  Xenia charged Hawkeye Renewables $1 million for the connection fee to the pipeline.

The district has been in discussions to have Des Moines Water Works acquire Xenia.  They’ve raised rates by 22% and are asking forgiveness of $45 million of debt. 

The plot thickens.  CIFG, the now defunct bond insurer, guaranteed the $83.6 million 2006 bonds when they were issued (and when they were rated “AAA”).  The underlying rating on the bonds was then “BBB” by Standard and Poor’s, lowered to “BB” in August, 2009 following disclosure of the district’s difficulties.  CIFG is now in runoff and as part of the bond insurer’s workout, Assured Guaranty entered into a reinsurance agreement for the troubled company’s $13 billion municipal portfolio.  Assured Guaranty, as agent for CIFG said “no” to the district’s workout plan.  They would like to see rates go up enough to cover their obligations, without debt forgiveness.

BTW, Iowa is one of those states that do not permit municipalities to file bankruptcy.  So what happens now? 

For bondholders to claim an Assured Guaranty payment on default, the reinsured CIFG bonds have to be “novated” which is an insurance term for extinguishing the original CIFG policy and issuing a new Assured Guaranty policy. 

The process began on an optimistic note.  Assured Ltd’s president and CEO, Dominic Federico said in October 2008, announcing the deal:

Public finance investors will benefit from an upgrade of the rating on their investment if they agree to the novation of their current policy with CIFG NA, and we look forward to helping them make the novation process as quick and efficient as possible. 

Three months later, Assured sounded a far less confident and far more measured:

The novation process for each covered policy will be determined in conjunction with representatives for each underlying insured credit based on the applicable legal requirements and the particular facts and circumstances of each such insured credit.  There can be no assurance as to the timing of the novation process or whether an insured credit will be successfully novated. 

Then New York State Insurance Commissioner Eric Dinallo was more upbeat.  He stated in January 2009:

We expect that the municipal bonds currently insured by CIFG will go from junk to the highest investment grade.  This will result because the bonds will be reinsured by and are intended to be novated to Assured Guaranty Corp, meaning that Assured will replace CIFG as the insurer…

But the novation process is taking far longer than expected.  According to last week’s Bond Buyer the “vast majority” of bonds have yet to be novated.   One has to assume the bondholders have every reason to be cooperative in this process.  As of this morning the Xenia bonds were still rated “BB” by Standard and Poor’s. S&P rates Assured “AAA” so these bonds have not been re-branded.  Maybe Assured has an out on the novation, given Xenia’s now non-investment grade rating. 

If the bonds are just reinsured and not novated, any payment that CIFG recoups from Assured via the reinsurance agreement could just go into the big, black CIFG pot and not to bondholders. 

Meanwhile, back on the farm, customers are none too happy with the prospect of 63% higher water rates.  Ratepayers, who include rural residents as well as numerous franchise communities, are busily looking into ways to get off the system. Heavy attrition would make achieving revenue targets only that much more difficult.

In a recent report about Mello-Roos Community Facility Districts (CFD’s) the California Debt and Investment Advisory Commission (CDIAC) stated:

Despite the potential impacts of evolving mortgage conditions, CFD’s have not reported higher default rates, at least through 2007-2008, but have reported a recent rise in the number of their draws on reserves.

(Mello-Roos bonds are post-proposition 13 financings that are secured by “special taxes” rather than more typical ad valorem taxes.  They are mostly issued by school districts, cities and towns and are a popular version of California’s land secured tax exempt finance.) 

To date CFD’s have held their own on the default scene, certainly doing better relative to Florida community development districts which are defaulting in droves.  We believe the lag in defaults is too lightly appreciated and there will be an elevated default pattern in the next two years. 

Like other corners of the real estate markets, Mello-Roos borrowings soared in the 2000-2007 time period.  We show CDIAC’s summary for Mello-Roos activity.   Nearly 60% of all issuance from 1992-93 was sold during this time period.

CLICK TWICE TO OPEN LARGER

CLICK TWICE TO OPEN LARGER

A look at the 1990’s downturn in the California real estate market compared with Mello-Roos defaults is instructive.  The Calculated Risk blog posted the following chart in 2005:

CLICK TWICE TO OPEN LARGER

CLICK TWICE TO OPEN LARGER

Calculated Risk shows the early 1990’s real estate boom had positive growth until 1991 then went negative until finally turning positive 1996. 

Now look at the default chart from the CDIAC report.

CLICK TWICE TO MAKE LARGER

CLICK TWICE TO MAKE LARGER

Two observations: first, as expected, draws on reserves peaked ahead of defaults.  Draws hit their high in 1995-96, just when real estate was beginning to climb out of the trough.  Second, defaults didn’t peak until 1997-1998 and remained elevated until the 2001-2002 year.

 

Bill Huck, CEO of S&Y Capital Group points out that building permits are a better indicator of trouble.  Building permits began their steady and steep decline in 1985-86 and didn’t trough until 1993. 

CLICK TWICE TO MAKE LARGER

CLICK TWICE TO MAKE LARGER

Baked into this relationship is the assumption that land development must continue for the districts to remain solvent – underscoring the “speculative” nature of this type of finance.  So a drop off in building permits correlates with a prediction of future defaults – with a longer lag period than the asset value decline that is grabbing so many headlines today.  Once a home is sold, even if it has lost value or is in foreclosure you are most likely to get the Mello-Roos tax payments, Huck commented. 

 

A few factors slow down the default timeline.  First, some counties where Mello Roos predominates, such as Orange (but not Riverside) includes districts in the “Teeter” program.  Under Teeter the counties pay 100% of the property taxes to the local agencies and then receive penalty and interest payments.  The counties have the right to kick out an agency from the program in the next year, so this source of cash flow is not ironclad.   Most counties would rationally kick out delinquent payers rather than lose money on their Teeter programs.   Second, many CFD’s have debt service reserve funds, so reserve draws are an important early indicator of trouble.  Finally, many CFD’s are less leveraged than special districts in other states.  The awareness of payment problems has led financial managers to be pro-active, whether through bond refinancing or more aggressive foreclosure resolution.  Given that reserve draws are elevated again we expect to see defaults climb in the next few years – or sooner if covering counties exit the Teeter plan.

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.

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

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.