The Coming Bond Bust

From Bloomberg:

Eaton Vance Dumps Dirt Bonds as Florida Land Districts Default

March 9 (Bloomberg) -- Thomas Metzold, Eaton Vance Corp.’s co-head of municipals, sold all his defaulted bonds of Tison’s Landing, an unfinished housing development in Jacksonville, Florida, as the debt fell to a third of face value last year.

Dumping the so-called dirt bonds at a discount was a better bet, the Boston-based Metzold said, than taking over 218 empty acres (88 hectares) from the project’s builder and waiting for a real-estate rebound that may not come until the early 2030s, according to a Moody’s forecast.

Lord Abbett & Co., the 81-year-old mutual-fund manager in Jersey City, New Jersey, faces the same choice as Eaton Vance, with Florida community development district bonds defaulting faster than any U.S. tax-exempt debt. The two-year-old recession and the first population decline since World War II have virtually erased demand for new houses in the fourth-most- populous state, stripping value from a security dependent on incoming residents to pay investors.

“We’re managers of municipal bonds, not real estate people,” said Metzold, 51, whose company manages $161.6 billion, of which 16 percent are tax-exempt assets. “We thought about foreclosing but decided the risks were too great.”

Florida home-building permits in 2008 fell 45 percent from 2007 to the lowest since at least 1980, U.S. Census Bureau data show. That’s pushed a record $3 billion of debt sold by 122 community development districts into default, according to Distressed Debt Securities, a Miami Lakes, Florida, newsletter. The bonds total almost half the $6.3 billion of tax-exempt debt from 183 issuers that failed last year, the publication said.

‘Default Wave’

It’s the single biggest default wave in the history of municipal bonds,” said Richard Lehmann, the newsletter’s publisher, who defines default as failing to pay debt service or tapping reserves to do so. “There are about 78 more districts with $2.7 billion of bonds on our watch list that are likely to go into default this year.”

Fast-growing states such as Florida, California, Colorado and Texas use tax-exempt community development district bonds to install roads, sewers and utility lines on raw land, making it suitable for building. By creating special taxing districts to pay for the work instead of having municipalities do so, only residents who benefit bear the cost. From 2003 through 2008, 438 Florida districts sold $6.5 billion of dirt debt, Lehmann said, fueling a housing boom that permitted 1.2 million new homes since 2000, the Census Bureau data show.

Private companies that build on development-district land must pay interest and principal on dirt bonds until residents buy homes, move in and take over the fees. If they don’t, investors are paid from reserves, putting bonds into technical default.

Missed Payments

About $2.4 billion in face value of Florida dirt bonds used reserves or failed to make interest payments in November
, said a report last month by Interactive Data Corp., a market- information provider in Bedford, Massachusetts. The missed payments, up 41 percent from May, were mostly on bonds sold from 2004 to 2007, the height of Florida’s real estate boom, the report said.

That’s what happened to $36.8 million of bonds sold in December 2005 for Tison’s Landing, 15 miles (24 kilometers) north of downtown Jacksonville, where none of 680 planned homes has been built.