State Panel Seeking Tougher Rules for Mello-Roos Districts : Legislation: The commission is recommending changes aimed at giving home buyers more protection.

Reacting to public outcry over Mello-Roos taxes, which are paid by homeowners in many emerging communities to finance roads and other public facilities, a state commission is recommending changes to give home buyers more protection against abuse.

The California Debt Advisory Commission has proposed limiting future Mello-Roos tax increases to 2% per year compared to 4% now. And detailed disclosures would be given to home buyers at the same time an offer is submitted for a house rather than after the property is in escrow.

To minimize the chance of a developer defaulting on its share of the tax burden, the commission has suggested tougher standards for collateral used to secure Mello-Roos bonds. Land used as collateral for Mello-Roos bonds would have to be worth at least three times more than the bond debt.

Also, people who are paying Mello-Roos taxes to finance schools would be first on the list to send their children there. Currently, some school boards are under attack for allowing parents who are not paying Mello-Roos taxes to send their children to new campuses. This while some parents who are paying the special tax are required to send their children to older schools that are sometimes farther from home.

The recommendations were the result of a public hearing conducted by State Treasurer Kathleen Brown and the debt advisory commission last January in Santa Ana. The hearing was prompted in part by a series of articles published by The Times Orange County Edition in December.

The series showed how so-called Mello-Roos bonds are sold by local governments to pay for streets, schools and libraries in some new communities.

Mello-Roos districts, also called community facilities districts, usually are created when a large chunk of vacant land is owned by only one or two developers.

The districts then sell bonds to finance public facilities that enable development of the land. Until homes and businesses are built and occupied, the landowners pay the Mello-Roos taxes used to pay off the bonds. But as new homeowners and businesses move in, they assume the cost of repaying the bond debt, which can amount to more than $1,000 a year on top of their regular property taxes.

The Times articles detailed several weaknesses and failings of the system. Among them:

* Home buyers often are not aware of the amount of debt their local Mello-Roos district is authorized to accumulate or the projects that can be funded with bond proceeds.

* In some instances, local government officials have quietly imposed Mello-Roos taxes that favor developers at the expense of home buyers.

* Governments in Orange and Riverside counties have entered into deals with developers that were in trouble financially, imperiling the security of the bonds.

* Developers have been allowed to select the appraisers who value the land that is collateral for the bonds.

For example, Lake Elsinore, a city of 19,200 residents in Riverside County, has authorized the issuance of $500 million in bonds, to the surprise and concern of both residents and state officials.

Trouble is brewing in one of the city’s housing developments called Tuscany Hills. Fewer than 200 of the planned 2,000 homes have been built, leaving Tuscany Hills with a $14.1-million bond debt that can’t be retired because there are not yet enough residents.

Also, the ailing savings and loan that owns the remaining acreage has ceased its development operations on orders from federal regulators. So Lake Elsinore is counting on reserves and a hoped-for economic upturn to resolve the situation before there’s a need to foreclose on the land and resell it for taxes.

In Orange County, the risk associated with Mello-Roos bonds was demonstrated last year when two major firms failed to pay their tax bills for a site in Portola Hills, just northwest of Mission Viejo.

Eventually they got caught up in their payments, but at a price to taxpayers: A higher interest rate paid to investors willing to purchase the bonds, which leaves less money to build public facilities.

Orange County already has in place many of the changes recommended by the debt advisory commission. “It sounds like they used Orange County as the model for others to follow,” said Eileen T. Walsh, Orange County’s public finance officer.

Sen. Henry J. Mello (D-Watsonville), who co-authored legislation that created Mello-Roos financing, has proposed legislation that already contains much of what the debt advisory commission is recommending. The bill passed the state Senate last week , 36-0. It now goes to the Assembly.

But partly as the result of lobbying by developers and financial consultants, he has balked at two key commission proposals:

The first would require a public hearing before any major “redirection” of Mello-Roos bond proceeds between competing public works projects. This proposal is a response to Aliso Viejo residents who complain that the San Joaquin Hills tollway--a regional facility--will consume a disproportionate share of Mello-Roos bond proceeds at the expense of other, more local public facilities promised to them when they bought their houses.

The second proposal would restrict the much-criticized practice of diverting some Mello-Roos funds from the public works projects promised to new residents. Currently, some money from bond sales is immediately set aside to pay interest to bond buyers instead of waiting for Mello-Roos tax receipts from homeowners and businesses to accumulate and then cover the interest cost.

This works to the disadvantage of taxpayers because money put into reserves to pay interest costs is not available to be spent on public works projects and may, in some cases, delay such projects. And because one to two years’ worth of interest outlays--to be paid twice annually to bond investors--is extracted from the original proceeds of the bond, developers often finish their projects before they have to pay any Mello-Roos taxes.

The debt advisory commission wants to reduce the amount of money that can be diverted from two years’ worth of interest payments to only one.

No government agency currently imposes such restrictions on the bonds.

Dean Mysczinski, an aide to Mello, said the senator opposes the public consent requirement because existing law already requires voter approval of changes to the list of Mello-Roos projects given to home buyers at the time of purchase.

“If that’s not being enforced, we need to find out why,” he said.

In Aliso Viejo, the tollway was listed as a project that would be funded in part with Mello-Roos bond proceeds. But there was no indication which of the many public works projects listed would be built first or how much of the projected annual cash flow from Mello-Roos taxes collected there would be consumed by that one, enormous project.

The amount of money originally estimated for each project in the list distributed to home buyers before escrow must not be frozen at a specific price or built in a specific order, Mysczinski said, because “projects and costs change over time. . . . City and county officials have to be trusted to make good decisions.”

Except for the areas where Mello is resistant, the debt advisory panel is pleased with Mello’s bill, said Steve Juarez, the commission’s executive director.

The panel will not try to find another legislator to carry its proposals, Juarez said, because it is unlikely that any Mello-Roos reform bill could pass without Mello’s blessing. But Juarez said staffers have lobbied Mello in hopes of persuading the senator to amend his bill.

Aliso Viejo attorney John Beckley, one of the residents who criticized Mello-Roos taxes at the January hearing in Santa Ana, is also happy about most of the legislative proposals.

“When I moved in, the disclosure was awful,” Beckley said. “The builder never told me that I was paying for the San Joaquin Hills tollway. . . . I had to go out and get the information about what I was paying for through other means. Even now, a lot of people don’t even know what a (Mello-Roos) district is.”

Since The Times published its Mello-Roos series in December, Mello and other lawmakers have been deluged with material from financial consultants that argues the value and safety of Mello-Roos bonds.

Part of the paper blizzard included a study by the KPMG Peat Marwick financial consulting firm, which concluded that Mello-Roos bonds are “safe investments.”

The report said there are “several troubled Mello-Roos financings, including Temecula Valley Unified School District, Oceanside, Oxnard and Portola Hills in Orange County.”

But the report added: “These instances are the exception, not the rule.”