DALLAS In 1997, residents of a proposed municipal utility district in Denton County, Tex., agreed to issue $20 million of tax-exempt water and sewer bonds by a vote of 1-0.
Actually, there was only one resident, and he was just passing through, according to news reports.
From that single-vote authorization and the bond issues that ensued, however, one of the Dallas areas most affluent subdivisions arose, complete with a championship golf course and attractive homeowner amenities.
Such is the pattern with MUDs, special taxing districts that rise on the fringes of large urban areas, especially in Texas, where more are in operation than any other state. Controversy and confusion sometimes follows in their wake as local reporters or residents of neighboring cities try to sort through the peculiar legalities of their creation.
Authorized by the Texas constitution to raise taxes and charge for services, MUDs played a major role in Houstons suburban boom in the 1970s and 1980s as developers sought ways to provide streets and utilities in undeveloped tracts beyond the citys borders.
When MUDs began to multiply in unincorporated areas of Dallas and Fort Worth in the 1990s, controversies arose over the chummy relationships between partners in the ventures and the crude electioneering required to get the dirt flying. A 2001 series in the Dallas Morning News reported instances of single voters authorizing bond issues or promoters moving two or three trailers onto vacant land so that residents could vote to authorize debt and the taxes to pay it off.
The MUD boom resulted in several bond defaults in the 1990s.
Experts in the bond industry regard the districts as among the least understood credits in the tax-exempt universe. But the sector is maturing and a recent conference held by Standard & Poors in Dallas focusing on MUDs attracted more attendees than expected.
These are the districts that scared people, Standard & Poors director Alexander Fraser said. These are the kinds of things that might default. But in going through the state and researching these districts, we found a lot of comfort.
Indeed, Standard & Poors now rates 140 Texas MUDs, compared to fewer than 20 five years ago. While the majority of ratings remain at the bottom of investment grade or BBB, Standard & Poors analysts rate 17 districts at A-minus or better.
For the most part, once you get to investment grade, the default rate is very, very low, which is what you would hope for with an investment grade, said Theodore Chapman, associate director for Standard & Poors in Dallas. Of the 1,400 or so special districts in Texas, I think it was less than two dozen that ever defaulted. For the most part the default rate is very low.
The perception that MUDs just pop up because a developer wants to make a buck is misplaced, according to Chapman. There is a lot regulation, he said, displaying an inch-thick booklet of forms that must be filled out to gain a permit. Developers have to jump through a lot of hoops as well.
Amid widespread reports of financial and credit problems with special districts, the Texas Legislature tightened regulations in 1989, requiring approval from both the Texas Commission on Environmental Quality and county commissioners to create a MUD. Before a district can sell bonds, it must reach feasibility benchmarks set by the TCEQ unless the debt-to-assessed valuation ratio is less than 10% or the district has investment-grade ratings or bond insurance.
While investment grade ratings enlarge the market, boost the supply of bank-qualified debt, and raise the comfort level for investors buying MUD bonds, traders say that does not necessarily increase demand. The fact that the perceived risk is higher than the probability of default gives savvy investors a leg-up on the market, one trader said.
Once you get to investment grade, they have to compete with everything out there, the trader said.
While MUD bonds are clearly moving up the food chain, that does not mean the supply of unrated MUD debt is likely to disappear anytime soon.
Most districts first issues are sold nonrated, said Drew Masterson, senior vice president of First Southwest Co. Often the second issue will qualify for double-A rated bond insurance. By the third issue, districts frequently garner an investment grade underlying rating and qualify for triple-A bond insurance.
With Texas officials projecting total spending of $108 billion on water, sewer, and flood control projects by 2050, a good percentage of that debt is likely to come from MUDs, experts say.
MUDs account for about $1.1 billion of outstanding debt in Texas, according to Nora Wittstruck, an associate analyst at Moodys Investors Service, which rates 115 of the 700 active MUDs in Texas.
The Houston area has more than half the states MUDs 584 to second-place Dallas-Fort Worths 76. Austin has 68 MUDs, compared to 21 for San Antonio and eight for El Paso. Not all of these 757 MUDs are active.
For investors interested in the MUD market, the key to success on the speculative first issues is researching the developers and understanding the local dynamics, says Stephen D. Lipkin, who got his start dealing in MUD bonds in the Houston area in the pioneering days when due diligence sometimes meant standing in an open field.
You looked for who the developer was because you had to make certain the developer had deep enough pockets to wait out a bad period, said Lipkin, who is now managing director of National Alliance Securities Corp. in Dallas.
The other major indicator of a MUD developers success is the tax burdens on the homeowners or businesses that settle in the area.
You cannot have a district that has a tax rate so out of whack that people will leave for a nearby city, Lipkin said.
Overlapping taxes are big issues for MUD residents as other jurisdictions such as counties, school districts, or other special districts impose levies for services. Because neighborhood schools are the key attraction for young, first-time homebuyers, developers will often donate land for a new school, Standard & Poors associate director James Breeding said.
Often theyll donate land for an elementary school, sometimes a middle school, but never a high school, Breeding said.
