DALLAS — Texas municipal utility districts — once seen as somewhat risky investments — are quietly expanding the state's suburban frontiers while offering higher bond yields than the cities they surround, experts say.
Since more restrictive laws were passed in the late 1980s, the districts have been generally viewed as a safe bet for investors, even after the housing market collapse of 2008.
"I don't think it's fair anymore to refer to MUD bonds as dirt bonds," said Paul Steets, executive vice president of broker and financial advisory firm GMS Group in Houston. "The kind of issue that you saw before the late 1980s doesn't occur in Texas anymore."
Even as mortgage lenders went belly-up in the Great Recession, Texas MUDs continued pricing bonds with little fanfare.
"As a result of the changes we made in 1989, we had the rules to kind of make this crash-proof on this last recession," said Joe B. Allen, retired founder of the Houston law firm Allen Boone Humphries Robinson in Houston, and expert on MUDs. "There was very little negative that happened to any of the MUDs during the 08-09 crash. In fact, Standard & Poor's actually upgraded 250 MUDs at the bottom of the housing bust."
Part of the reason was that Texas had much less of a housing bubble than other states, allowing it to avoid the subsequent bust. Far fewer homes were underwater on their mortgages. Also, the energy industry kept the Texas economy simmering.
However the lost triple-A ratings of the major bond insurance firms, particularly Ambac and MBIA, dimmed the MUDs' appeal to risk-averse investors alarmed by the mortgage-backed securities debacle. With ratings typically in the mid-to-lower range of investment grade, MUD bonds gained significant allure with insurance.
By the year 2000, about 58% of the MUD bonds issued after 1988 were insured by one of the major bond insurers, according to research by GMS. Between January 2000 and January 2006 more than 85% of all MUD bonds were insured.
No municipal bond insurer has ever had to make a principal or interest payment for any Houston-area MUD bond, according to GMS.
And municipal bond insurers and the Texas MUDs have found each other again.
In 2013, Texas MUD issuance was about $3.54 billion, according to the Texas Municipal Advisory Council. Of that, about $884 million, or 25%, was insured, according to Ipreo.
That compares to only 3.9% of the entire municipal bond market that came insured in 2013, according to Thomson Reuters data.
The newest entrant in the bond insurance business, Build America Mutual, saw an opportunity in Texas after Ambac and MBIA retreated, said Don Farrell, BAM's vice president for the east region.
"Generally speaking, we're probably saving the MUD issuer about 25 basis points," he said. "The range could be from 25 to 40 basis points."
This year about 71% of MUD deals are insured, according to Texas MAC, and BAM, rated AA by Standard and Poor's, has wrapped about 60% of that total after wrapping 65% of insured Texas MUDs in 2013, its first year of doing so.
Assured Guaranty Municipal Corp., has seen its share fall to 26% while its affiliate Municipal Assurance Corp. has the other 14%, according to records from Ipreo.
"BAM pursued the MUD sector because it is a credit sector that has proven to be very stable," Farrell said. "Especially the ones that fit our criteria: residential in nature, no taxpayer concentration, affordable residential tax bills, critical mass in tax base and number of homes, located within or near a thriving MSA.
"When you compare them to other land deals, they are very safe," Farrell said. "There really are no true dirt deals these days."
Despite the relative comfort of the investments, some prospectors go the extra mile to verify information about the districts.
"One key risk of any municipality with a small geographic footprint like a Texas MUD is the economic activity within the borders of that municipality," said Douglas Benton, vice president and senior municipal credit manager for Cavanal Hill Investment Management. "We put over 400 miles on a rental car recently making sure we see firsthand how this broader Houston economic engine impacts the places where we have invested our clients' money."
David M. Oliver Jr., an attorney with Allen Boone Humphries Robinson who co-authored a report on MUDs with Allen in 2005, said that MUD debt should be evaluated with the same discretion a home buyer might exercise.
"Every issue is different and every issuer is different," Oliver said.
With a combined population of more than 2 million, Texas' 1,212 MUDs account for more than $6 billion of outstanding debt, according to Oliver's estimates.
More than 70% of the state's MUDs are in the Houston area, where most were developed in anticipation of annexation by Houston or a suburb.
However, some have resisted annexation. In The Woodlands, a prosperous Montgomery County suburb north of Houston, utility services are provided by 11 MUDs operated by The Woodlands Joint Powers Agency.
"We were created by legislation by the Texas Legislature about 25 years ago," said James Stinson, general manager of the agency. "It's a little unique. I don't think there's another arrangement like it in the region."
As special-purpose governmental units of the state, MUDs may sell bonds, levy and collect taxes, provide and charge for water and sewer services, build infrastructure, condemn property, enforce restrictive covenants, and issue regulations.
MUDs are managed by an elected board of directors, and each director is a resident or a property owner in the district. At The Woodlands JPA, a board is made up of representatives of the 11 MUDs operating under its jurisdiction.
Stinson described his job as "like meeting with 11 small city councils. It's a very interesting process, but we think the business model works pretty well."
Today, The Woodlands is about 90% built out and stands in the fast lane of suburban development as Exxon Mobil builds its new corporate campus nearby and the massive Grand Parkway toll road expands into what will someday be an outer loop around the Houston metro area.
"Homebuilding is still occurring but not at the pace it was 15 years ago," Stinson said. "For many years, we were producing 900 to 1,400 new homes a year."
On the west side of Houston, the affluent city of Sugar Land, population 83,860, was formed almost entirely from the annexation of utility districts.
In Fort Bend County, which includes Sugar Land, Allen — known to associates as "Joe B." — was saluted as a "legend" for his role in the county's development upon his retirement last year.
"Joe B. Allen has provided advocacy and leadership in municipal utility district and special district powers, allowing master-planned communities to thrive in the Gulf Coast region and in Fort Bend County specifically, which has five of the top 20 master-planned communities in the country," said Jeff Wiley, president of the Greater Fort Bend Economic Development Council, in promoting the event called "An Evening With a Texas Legend."
Before the savings and loan collapse of the 1980s, some developers exploited the MUD process by issuing bonds before any work had begun. Thus, the bonds were known as "dirt bonds" because dirt was the district's only asset.
That speculative process, combined with the energy recession of the mid 1980s, resulted in about 5% of the 310 active MUDs defaulting on debt service, according to a report from GMS.
To restore confidence, the Texas Legislature gave the Texas Commission on Environmental Quality more authority to regulate MUD bond sales. Allen served as principal author and key lobbyist for the legislation. The TCEQ then required that utilities be built before issuance of the bonds, requiring an upfront investment from the developer.
The developer is also required, in most cases, to pay 30% of the underground utilities and to finance and construct all of the roads in the subdivisions before bonds can be sold.
Since then, more than 2,400 MUD bond issues totaling over $10 billion in debt have been issued by MUD districts located in the five-county area surrounding Houston, Steets said. None of those issues has ever defaulted on a principal or interest payment, he said.
To obtain BAM insurance, a MUD bond must first carry a rating from one of the major ratings agencies. At Moody's Investors Service, analyst James Hobbs sees a fairly stable scene.
"Over the last five years, MUDs' financial operations on the whole have performed well," Hobbs wrote in a report on MUD medians issued June 18. "Fiscal 2013 median operating data indicate that the majority of MUDs have done a good job at budgeting for revenues while keeping expenditures under control."
Moody's rates $1.93 billion of Texas MUD debt, up from $1.11 billion in 2012. Most of the MUD ratings are in the single-A category, according to Hobbs.
"On the credit positive side, MUDs generally continue to post positive financial performance and healthy cash reserve levels," Hobbs wrote. "They also have no pension obligations. On the credit negative side, MUDs typically have high debt burdens and taxable values that can be concentrated by industry and/or largest taxpayers."
