MUNIS GONE WILD

"By David Schawel, CFA

Introduction: Lost in the implosion of the securitized markets sits an overlooked yet just as opaque remnant of the housing crisis – CDD or “Dirt Bonds”. Save for the rare fixed income aficionado, this segment is still to this day unknown. In general, a CDD is a local, special purpose government authorized by the state as an alternative method for managing and financing infrastructure required to support community development. In most cases, the community development is water, sewer, and drainage infrastructure to raw undeveloped lots. The CDD then levies assessments on the property.

These taxes and assessments pay the construction, operation and maintenance costs of the district and are set annually by the governing board of the district. The taxes and assessments are in addition to county and other local governmental taxes and assessments and all other taxes and assessment provided for by law.

Like the developments in the well-known mortgage backed securities markets, the progression of the CDD market combined two common elements: 1. An insatiable institutional demand for yield and 2. the housing boom. According to the Florida CDD report, there are over 600 CDD districts in Florida that have issued more than $6.5 billion in municipal bonds to finance their infrastructure. It’s estimated that over $3billion in bonds are now in default. The lion’s share of these bonds is held in high yield municipal bond funds...

Conclusion:

After spending a fair amount of time researching this bond and the probability of future cash flows, I was surprised at the distressed nature of the security. I could be off-base, but it seems highly unlikely that Lennar would continue to make principal, interest, and tax payments on lots with no apparent demand and overhang & headwinds from existing homes in foreclosure.

Furthermore, given the supply glut of existing lots and inventory, the local land experts relayed extreme bearishness at the prospect of selling the lots. A very large mutual fund family is holding the bond at ~43 cents on the dollar. Is this valuation possible? Yes, but based on what I have uncovered it could be argued that the likelihood of principal repayment could be substantially less than that.

While this bond may or may not be representative of the whole mutual fund universe, it raises questions about how accurately funds are valuing the bonds. The conclusion of this analysis leaves far more questions than answers."

at http://pragcap.com/munis-gone-wild