Public Finance Update - November 2009

REO portfolios continue to grow, and many new REO properties are located within a Mello-Roos community facilities district (a “CFD”). In this period of falling property values, tight credit, and loan and tax delinquencies, evaluating CFD property can pose a significant challenge. The following are a few tips that should be considered when evaluating CFD property. For a detailed discussion of how to understand and maximize the value of CFD property, please see Goodwin Procter’s publication “Mello-Roos Community Facilities Districts: Top 10 Tips Every Lender and Property Owner Must Know.”

Look at Special Tax Delinquencies.   Special taxes are typically collected on the secured tax rolls of the local county in the same manner, and with the same delinquency penalties, as general property taxes. If the special taxes are not paid for a year after foreclosure, the penalty can grow to 28%. If the CFD property is delinquent, the owner can and should negotiate with the local agency regarding the payment of all delinquencies. The local agency has the authority, and is often willing, to reduce or waive penalties and interest.

Beware Deficient Title Reports and Tax Bills.   Due diligence for any REO property includes a review of the preliminary title report and the most recent tax bill. Unfortunately, those documents don’t always tell the full story. For instance, neither the title report nor the tax bill will show (a) maximum special taxes, (b) the amount of delinquencies, penalties, and interest due, (c) special tax buy-down provisions, (d) the amount of any annual escalator in the special taxes, or (e) the amount of special taxes applicable upon reclassification of property. Any evaluation of CFD property should, therefore, include a careful review of the special tax formula to clarify those and other issues that are not always revealed in a typical due diligence review.

Taxation Can Occur Without Bonds.   If special tax bonds have not been issued, a CFD can be restructured, which can alleviate or eliminate the potential problem of premature special tax levies. In addition, to the extent special taxes have already been paid, a refund may be obtained for the property owner. Such restructuring can also match the special tax rates with the current home prices so that the total tax rate is within acceptable levels without requiring a special tax prepayment.

Beware the Buy-Down.   In many special tax formulas, local agencies provide for a mandatory buy-down of special taxes in the event home prices drop below a certain threshold. Most local agencies limit the overall tax rate to an established threshold, commonly 2% of the expected home prices. Owners of CFD property should always review the mandatory buy-down and prepayment provisions of the special tax formula to determine if there is an ability to minimize the impact of such buy-down provisions.

Under the Build America Bonds program, state and local governments may issue subsidized bonds in 2009 and 2010. Build America Bonds, or “BABs,” are municipal bonds that could otherwise be issued as tax-exempt bonds, but which the issuer elects to treat as taxable under Section 54AA of the Internal Revenue Code. There is no volume limitation on BABs during the two designated issuance years, and BABs can be used to finance virtually any governmental purpose for which state and local governments can otherwise issue tax-exempt municipal bonds, subject to the same limits on private business use, private business payment, and security that apply to tax-exempt municipal bonds. For example, proceeds from an issuance of BABs can be used to finance public buildings, schools, roads, transportation infrastructure, government hospitals, public safety facilities and equipment, water and sewer projects and other public utilities, environmental projects, energy projects, and governmental housing projects, to name just a few.

Since the inception of the Build America Bonds program, the most common BABs issued have been general obligation bonds, and the majority of BABs issued have received a rating of “AA” or better.  The proceeds from the issuance of BABs have been used to finance public facilities for a variety of purposes, including transportation, utilities, education, and health care.

As of October 2009, issuers had closed 466 issuances of BABs totaling approximately $43 billion in principal amount, with a median principal amount of $20 million.  The following table shows the total principal amount of BABs issued each month since the inception of the program:

On September 30, 2009, Goodwin Procter hosted leaders from the public and private sectors for “Dollars + Dirt: A Symposium on Infrastructure Development and Financing Opportunities” in Century City, California.

The yield on AAA-rated municipal bonds increased slightly in November 2009 to 4.49% for 30-year bonds and 3.33% for 10-year bonds. During the same period, the yield on Treasuries dropped slightly to 4.27% on 30-year bonds and 3.33% on 10-year notes, bringing the 10-year muni-treasury yield ratio back to 100%.

 

Source: Bloomberg (www.bloomberg.com)

Some indicators relevant to the bond market improved slightly in September 2009. Existing home sales increased by 9.4% over August figures and are 9.2% higher than in September 2008. New home sales fell slightly, but housing starts increased by 0.5% in September as compared to a month earlier. Here are the official numbers:

 

Sources: Unemployment Rate and Consumer Price Index: U.S. Bureau of Labor Statistics (www.bls.gov)
Existing Home Sales, New Homes Sales, and Housing Starts: National Association of Realtors (www.realtor.org)