LOS ANGELES -- Investment bankers and others in California are hailing a comeback in the market for Mello-Roos bonds, following months of uncertainty triggered by predictions of potential defaults on the land-secured debt.
"There is definitely a comeback to this market," said Maureen A. McCafferty, a partner at Stone and Youngberg in San Francisco. "Part of the problem was an overreaction to a lot of negative articles last year."
Prices on bonds sold since last fall under the Mello-Roos Community Facilities Act of 1982 have improved significantly, traders noted, with yields dropping an average of 75 to 100 basis points. Mello-Roos deals in November traded at an average of about 8.5%, while average yields now hover closer to 7.5% traders said.
Local entities in California have sold more than $3.6 billion of Mello-Roos bonds, most of which were unrated. The debt provides local governments with a flexible way to finance infrastructure -- such as sewers, schools, and highways -- though creation of special taxing districts.
But California's real estate slow-down over the last years raised concerns over the financial cushion protecting such debt. Related reports and articles with a negative tone from municipal analysts and newspapers fueled the concern and helped force yields higher.
The resulting fears prompted a statewide hearing on the Mello-Roos act, producing new legislation designed to ease concern about the financing tool.
The market for Mello-Roos bonds improved after special taxes collected simultaneously with property taxes on Dec. 10 and April 10 showed that the majority of payments were made, municipal sources said. The lack of defaults helped boost the market, along with an absence of negative articles on the Mello-Roos technique, the sources added.
"The Mello-Roos market is certainly stronger than last fall," said Mark J. Adler, a vice president of PaineWebber Inc. in Los Angeles.
For example, several market participants pointed to a June 2 deal when Orange County sold $11.5 million of Mello-Roos bonds for the Rancho Santa Margarita community facilities district at a net interest cost of 7.5%.
"We're certainly pleased," said Mr. Adler, whose firm co-managed the financing. "If that issue was sold last fall, it would have been in the mid-8s," Lehman Brothers was senior manager on the issue.
Bernie Schroer, senior portfolio manager for the Franklin Group of Funds, which holds nearly $900 million of Mello-Roos bonds, said the market is stronger for the debt. Nevertheless, he said he is still "very selective" in buying Mello-Roos bonds.
"The ones that have good coverage [lien to value ratios] are getting very good bids. The market has come way back," he said.
David Hitchcock, a director of Standard & Poor's Corp. who specializes in evaluations of Mello-Roos debt, said caution is justified despite the healthier market for Mello-Roos debt with strong coverage.
"I think it is premature for the market to come back just a couple months after the publicity dies down," he said. "I think there will still be problems in the future [and] time will tell."
A report by Mr. Hitchcock last year highlighted potential concerns about Mello-Roos financings. But it also raised the ire of certain market participants, who believed the report insinuated a potential analogy between the California market and a rash of special district defaults in Colorado.
Market participants also disagreed with the tone of certain articles in the general press, objecting that the entire Mello-Roos market was tarred with the same brush.
The "articles in certain national newspapers tarnished our market for a while," Mr. Adler noted.
Mr. Hitchcock, who stressed that he never predicted defaults would occur this year, said he remains concerned about unsophisticated investors who hold certain Mello-Roos debt.
He said he fears that "the people who know the least about Mello Roos will be the ones to get burned.
"You have to be in a situation like I am, getting calls from grandmothers and housewives who say, 'I have this bond.' The individual retail investor is not very sophisticated."
In today's CreditWeek Municipal, Standard & Poor's was expected to release a report that more clearly differentiates the agency's rating criteria for investment-grade and non-investment-grade Mello-Roos debt. The agency says that this should help individual investors evaluate the creditworthiness of various districts, the agency says.
Educational meetings held last year by the California Debt Advisory Commission and Stone & Youngberg helped the market by increasing information about Mello-Roos financings, several traders said. A bill pending in the state Assembly to increase ongoing disclosure of Mello-Roos also may have eased concerns about the debt, market participants said.
Although rates in the general municipal market improved in recent months, market participants said the comeback in the Mello-Roos market was too strong to reflect only general market conditions.
"We certainly haven't seen a 100 basis point drop in other sectors of the market," Mr. Adler said.
Kenneth E. Williams, a managing partner of Stone & Youngberg, noted that Riverside County encountered difficulty in December pricing a Mello-Roos deal for the Walsh Medical Center because of a weak market.
The issue eventually closed in February at an interest cost of about 8.5%, according to Tim Davis, special counsel for Riverside County. As an example of the improved market since then, Mr. Davis said the county recently sold a Mello-Roos issue with strong lien-to-value ratios at a 7.55% rate.
"Those Chicken Littles that went around saying, 'The sky is falling,' are starting to look pretty silly now," Mr. Davis said.
But some traders said it still pays to approach certain deals with caution, especially when the financings involve districts where questions arise regarding the feasibility of future development.
At least one New York trader, who asked not to be named, said he refuses to purchase Mello-Roos bonds." Just because they are trading up doesn't mean the credit is improving," he said. "It doesn't mean you won't get burned down the road."