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Mello-Roos in Freefall

AUG 19, 2008 1:00am ET
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SAN FRANCISCO - California communities have dramatically reduced sales of Mello-Roos community facilities district bonds over the past two years, as the U.S. housing market collapsed and greenfield development ground to a halt, new government data shows.

New-money Mello-Roos issuance dropped 59% in fiscal 2008 to $925 million from $2.3 billion a year earlier, according to the California Debt and Investment Advisory Commission. That's down from $3 billion at the peak of the housing boom in fiscal 2006 and the lowest annual total since fiscal 2001.

Mello-Roos bonds, typically sold without a credit rating, are often used to fund infrastructure in new real estate developments.

"Issuance is down in the past year because of the real-estate situation," said Daniel C. Bort, an attorney with Orrick, Herrington & Sutcliffe in San Francisco, who advises Mello-Roos issuers. He's seen both a decrease in supply of such bonds coming to market and a decrease in investor appetite for the riskiest so-called dirt bonds - bonds that fund infrastructure on tracts of newly developed land.

California single-family housing starts fell 55% in the first six months of 2008, according to the California Building Industry Association and the Construction Industry Research Board.

The CDIAC report also showed that Mello-Roos districts have been forced to increase their draws on debt service reserve funds, but defaults remain at record lows. Nineteen districts drew on reserves over the past two fiscal years, twice the number of draws in the previous five years combined. Only two districts defaulted over the past two years, making them the two best years on record.

"Despite the potential impacts of evolving residential mortgage conditions, local governments are not reporting higher default rates," the report said.

It's too early to know if the increase in reserve draws is a leading indicator of defaults to come. That was the case during the last major period of market stress. Defaults and reserve draws surged in the early- and mid-1990s. Draws on reserves peaked at 44 in 1995-96, followed by a peak in defaults at 29 in 1997-98.

The data reflect information reported to CDIAC through July 29, 2008, and the historical data go back to 1993. Graduate students at the Goldman School of Public Policy at the University of California, Berkeley, performed the analysis for the commission.

California created Mello-Roos districts - named after the two lawmakers who sponsored the enabling legislation - in 1982 to finance infrastructure in the wake of the passage of Proposition 13 tax limits. California community facilities districts have issued $18.4 billion of the bonds since 1992 and about $12 billion of the debt is currently outstanding, CDIAC said.

Mello-Roos districts can issue tax-backed bonds for infrastructure with the approval of either two-thirds of the residents of a district or two-thirds of property owners in districts with fewer than 12 residents.

To increase security of the bonds, state lawmakers gave districts enhanced tax foreclosure powers. Delinquent taxpayers can lose their homes in as little as a year in a Mello-Roos district, much less than the amount of time it takes authorities to complete a tax foreclosure elsewhere.

The study's authors interviewed local government officials, as they tried to explain the low default rates of recent years. While they didn't reach any definitive conclusions, they said governments may have learned to manage the liabilities better in periods of stress.

They found that some counties try to prevent defaults by advancing unpaid taxes to districts in anticipation of such tax foreclosures. Local governments also intervene to refinance debt and lower payments before districts end up in default.

"The city of Sacramento, for example, responded to its tax delinquencies by refunding many of its existing Mello-Roos bonds," CDIAC said.

The "single most important" reason for lower defaults in recent years is that governments forced developers to take a more "conservative" approach to Mello-Roos financing, the report said. Many municipalities cap issuance to keep property taxes and tax delinquencies lower, CDIAC said.

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