Trend in the Region

Some Omaha-Area Improvement Districts Don’t Recoil From Chap. 9

CHICAGO — Some struggling development districts around Omaha have turned to Chapter 9 bankruptcy as a way to restructure debt as they wait out an ailing housing market.

Like other so-called dirt-bond districts around the country, many sanitary and improvement districts, or SIDs, in the Omaha region have strained to meet debt payments since the collapse of housing values in 2008.

The SIDs are initially financed with five-year warrants; that debt is later refinanced into 20-year bonds if the development has value. Most deals are under $10 million in size, unrated, and seldom trade until they are later refinanced as long-term debt backed by property taxes in the district.

The original warrant issuance finances infrastructure improvements for new subdivisions, and is paid off with special assessments and property taxes levied against the new homes.

In Nebraska, the districts have proved a popular method to finance suburban development outside triple-A rated Omaha, and there are currently around 300 in Douglas and Sarpy counties that have yet to be annexed by the city.

“It’s a great growth tool,” Douglas County Treasurer John Ewing said. “From my perspective, the benefits of the SIDs outweigh the potential risks, but you do have to look at them to see if you’re making sure if there are any changes in policy or procedure that need to be done,”

The downturn in the housing market left many SIDs struggling to make debt-service payments. The fewer houses there are in a district, the more each homeowner owes, a cycle that discourages new home owners from buying into a development.

Three Chapter 9 bankruptcy filings in 2009 and two in 2010 were made by Douglas County SIDs, according to a recent Bank of America Merrill Lynch report.

The Municipal Securities Rulemaking Board’s website reports at least four Douglas County SID bankruptcies since last summer. Chapter 9 in the federal bankruptcy code provides for reorganization plans available only to municipalities.

Holders of long-term SID debt face less risk because such bonds are not issued until a development has an established value.

Bondholders are repaid from the property taxes of existing homeowners and have priority of payment under state law. It is the holders of the five-year warrants used to initially fund a district’s infrastructure that are considered the most vulnerable.

Under Nebraska law, warrant holders are paid back in order of registration, meaning that the first warrant holder is paid first and the last one last.

That structure makes a workout plan outside of bankruptcy less likely, as it is difficult to get first warrant holders to agree to a haircut, according to one local market participant who is familiar with SID transactions.

In lieu of a creditor-wide agreement, bankruptcy presents the most efficient way to resolve the problem, the market player said.

“It’s an effective tool to help adjust the debt of these districts, and to put not only the district, but also the warrant holders, in the best possible position to insure for the district that it is possible to see future development,” the source said. “The districts are lowering their debt-service load, so they can hopefully develop and sell more lots. The people who are creditors understand that bankruptcy might be the best alternative under the circumstances.”

Douglas County Sanitary and Improvement District #517, “The Hamptons,” declared Chapter 9 bankruptcy in April 2011.

The district’s finance team two weeks ago priced $6.3 million of certificates of indebtedness, and will use the proceeds to pay off warrant holders on a pro-rata basis as opposed to “first come-first serve.”

Like most SID bankruptcy plans, the #517 plan will stretch out repayment terms on the warrants, in this case to 15 years from five years. It will lower the interest rate to 5% from 7%, and modify interest terms to simple from compounded interest.

Overall the bankruptcy plan will lower the development’s debt load by 20%, according to the local broker-dealer involved in the transaction.

Bondholders are considered creditors but are not impaired, he said.

“We’re not going to build 60 homes over the next two years, so why not solve it long-term?” said John Kuehl, senior vice president and SID manager at D.A. Davidson & Co. “The district can still make it without full development — we can build 50 or 60 homes over the next 15 years. That’s a realistic plan. We just took the tack that we want to solve it over the longer term.”

D.A. Davidson is one of three underwriting firms in the region that specializes in SID transactions. The other two are Kuehl Capital Corp. and Ameritas Investment Corp.

Baird Holm LLP acts as bond counsel on nearly all the bankruptcy deals.

The bankruptcy process, if kept simple, could be a good route for the troubled districts, said Richard Lehmann, publisher of the Distressed Debt Securities Newsletter.

“If there isn’t a lot to argue over — the process is pretty cut and dried,” he said. “You look at places like Harrisburg and Jefferson County, they’ve gone through these long drawn-out agonies and gnashing of teeth. The bankruptcy process is there to resolve these kinds of things.

“The underwriters and financial community tends to throw out the idea that you’ll never be able to sell a bond again,” Lehmann added. “That’s total nonsense. People forget very quickly and only ask for a few more points.”

Douglas County SIDs have been around since the 1950s, and it is not the first time the districts have faced widespread failure. There was a wave of such bankruptcies in the area in the 1980s.

“There’s a history there of these districts not doing as well,” said John Hallacy, head of municipal research at Bank of America Merrill Lynch. “This is somewhat of a long-standing challenge. These places are small, and that doesn’t mean that investors aren’t affected, but we don’t traffic in those kinds of bonds.”

Of the 843 districts that have been created, more than 550 have been successful enough to have been annexed by Omaha or a surrounding city.

There are currently 300 unannexed SIDs in Douglas and Sarpy counties.

Part of the problem could be the sheer volume of the districts, said Ewing, the Douglas County treasurer.

Ewing stressed that given enough time, many of the failing districts could still recover.

“If they can restructure their debt, a lot of them will be okay,” he said. “If we can get the housing market to rebound in the near future, some of them will be in a good position to get things moving again.”



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