Market Watch : Study Says Mello-Roos Risk Is Low : Bonds: But researchers warn that some information is missing and that some hints at more defaults in the future.
A new study of Mello-Roos municipal bonds--a common financing tool for real estate development in California--suggests that the overall investment safety of the bonds remains high, despite the ongoing housing slump.
The report’s authors concede, however, that they couldn’t collect information on all issuers, and warned that some data “may prompt some (investors) to believe that more Mello-Roos bond defaults may occur in the future.”
Among the report’s findings, compiled by FRA Services Inc. in Costa Mesa at the request of the California Public Securities Assn.:
* A total of 290 Mello-Roos bond issues worth $3.6 billion are outstanding, with only one default recorded as of June 30, 1992.
* The average delinquency rate by taxpayers whose payments back Mello-Roos bonds was 8.52% in the tax year ended last June, which appears to be in a normal range for tax delinquencies generally. However, the delinquency data covers only two-thirds of all tax-supported Mello-Roos issues.
* Despite a low overall delinquency rate, five jurisdictions had delinquency rates on Mello-Roos taxes of more than 50%, implying potential inability to repay bondholders. Coincidentally, five jurisdictions were already tapping special, finite reserve funds to cover delinquencies.
Mello-Roos bonds have been used since 1982 to skirt tax limitations of Proposition 13. Typically, the bonds are issued to fund roads, sewers and other infrastructure needed before a housing development is built.
The developer is usually responsible for making payments on the bonds until the homes are sold. The homeowners then become responsible for payments via a special tax.
Because the peak of Mello-Roos bond issuance coincided with the real estate market’s peak in 1990, a major concern has been that some builders have used bond proceeds to develop infrastructure, but then haven’t built houses on the land. In such cases, if a developer encountered money trouble, the municipality issuing the bond might have to foreclose on the developer, because no taxpayers would be available to fund the bond.
However, FRA said that through last June it found no cases of municipalities collecting bond payments via foreclosure sales. But it also said it couldn’t determine whether some municipalities had been forced to threaten foreclosure to prompt developers to pay up.
Another favorable sign is that developers aren’t abusing their ability to “capitalize” initial interest payments of Mello-Roos bonds.
By law, Mello-Roos issuers may set aside some proceeds from the bond sales to pay bondholders’ interest for 24 months, essentially repaying the owners with their money rather than with taxes.
The delay gives developers time to sell houses or begin making tax payments themselves.
But while the law allows 24 months of capitalized interest, FRA said that, on average, only 11.6 months passed before tax payments began.
