Florida Bonds prone to default proving most-wanted

Bloomberg NewsMay 8, 2013 

Bonds sold to finance Florida housing developments are being issued at the fastest rate in six years as investors seek extra yield from the municipal debt even as 85 percent of such securities have defaulted since 2008.

Known as dirt bonds, the borrowings are sold by districts set up by builders to finance roads and utility lines on raw land for housing. Jurisdictions in Florida have sold $273 million of the debt this year in 25 issues, on pace for the most since 2007 in terms of dollar amount and number of issues, data compiled by Bloomberg show.

The securities are benefiting from home prices in Florida that rose at the end of 2012 to a 21-month high, data from the Federal Housing Finance Agency show. At the same time, investors are hunting for speculative-grade munis, which have earned 3.1 percent this year, compared with 1.5 percent for the broader local market, Barclays Plc data show.

The jump in issuance shows "that many of those housing markets have stabilized," said Peter Hayes, head of munis at New York-based BlackRock. He oversees $114 billion of local debt, including land-development obligations.

"That helps dirt bonds, along with the fact that they offer more income and more yield than some other sectors," he said.

Before the 18-month recession that started in 2007, developers in states such as Florida took advantage of rising home prices to sell tax-exempt securities. They were dubbed dirt bonds because they were secured by levies and special assessments on land. Defaults on the debt soared when home purchases dwindled as the housing bubble burst. New single- family home sales fell six straight years starting in 2005, Census Bureau data show.

The obligations are among the riskiest in the $3.7 trillion municipal market, with much of the debt offered without a rating.

Fiddler's Creek Community Development District 1, a 1,390-acre community near Naples, sold about $6 million of unrated bonds last week to refinance securities even after it defaulted on some debt issued in 2002

and 2005.

About 600 such districts exist in Florida and have issued about $6.5 billion in munis, according to Richard Lehmann, publisher of the Distressed Debt Securities Newsletter in Miami Lakes. Since 2008, 183 have defaulted on about $5.5 billion.

Lehmann's default definition includes bankruptcy, missed payments or breaking bond covenants by using reserves to cover debt service.

For the more than 400 communities that remained solvent, interest rates near generational lows and housing starts at the highest since 2008 will bring them back to the market to refinance debt or restart work, Lehmann said.

"These new issues are for a lot of older, viable projects, and projects in the second and third stage of their development, which are perfectly solid investment opportunities," said Lehmann, who runs a website about the districts.

In the case of Fiddler's Creek, proceeds from last week's deal will refund bonds sold in 1999, according to offering documents. The original developers filed for bankruptcy in February 2010.

The case is the first in Florida where a development district settled debts with a builder under Chapter 11 bankruptcy procedures over bondholders' objections, according to Lehmann.

"There are still credits that are nightmare credits, so you have to be able to parse the good from the bad," said Terry O'Grady, senior vice president of muni trading at FMS Bonds Inc. in North Miami Beach.

The refunding for Fiddler's Creek is an example of a safer credit, O'Grady said. It has sold about two-thirds of its 1,852 units to residents, including all 780 multifamily homes, offering documents show.

That progress made John Miller at Nuveen Asset Management a potential buyer. Miller, who oversees about $95 billion of munis as co-head of fixed income in Chicago, holds some Florida dirt bonds that were issued this year in his Nuveen High Yield Municipal Bond Fund. Last quarter, his fund beat all other open- ended, national muni funds that are at least three years old.

"The name has been tainted by its history in the bond world, but I don't think it's tainted at the ground level in terms of people wanting to live there," Miller said. "This particular phase is heavily developed and that makes it a more secure" community development district.

Fiddler's Creek sold about $6 million of debt maturing in May 2021 that was priced to yield 4.25 percent, according to Bloomberg data. That's about 2.8 percentage points more than benchmark munis.

Some of the communities coming to market are even viewed by rating companies as on par with Illinois in their ability to repay bondholders. The Double Branch district in Florida's Clay County sold bonds this year to refund debt from 2002 and 2005, earning Standard & Poor's seventh-highest grade because of its "largely built-out nature."

Bonds maturing in May 2031 were priced below par to yield 4.23 percent when sold in February. Three weeks later, the debt traded at a premium, yielding 4 percent.

"Investors want tax-free income and they're willing to take on a little bit of credit risk," Miller said. "This structure has an excellent overall track record if you look broadly across the entire country over the last 20 to 30 years."

States and cities are scheduled to sell about $5.5 billion of long-term debt this week, the least since March. Illinois leads issuers with a $300 million offer of sales-tax bonds on May 9.

At 1.74 percent, yields on benchmark 10-year munis are below the 1.76 percent level for similar-maturity Treasuries. Local interest rates exceeded those on federal securities for 35 of the past 38 trading sessions.

The yield ratio of the two securities, a gauge of relative value, is about 99 percent, down from as high as 113 percent last month. A lower value means munis are more expensive compared with Treasuries.

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