Florida Dirt Bond Holders Put at Line’s End in Bankruptcy Ruling

Holders of a Florida development’s tax-exempt bonds are fighting a judge’s order that may make it harder for owners of at least $2.9 billion of defaulted debt to get paid by excluding them from a bankruptcy settlement.

Owners of more than $100 million of so-called dirt bonds sold by two Fiddler’s Creek Community Development Districts heard in August that most of their debt payments will begin after those to other creditors of Fiddler’s Creek LLC, the bankrupt builder of a 4,000-acre (1,600-hectare) community in Naples, on Florida’s west coast.

Defaults on Florida dirt bonds, repaid with homeowner and landholder fees, have soared to at least 40 percent, or $2.9 billion, of the $7 billion outstanding, according to data compiled by Bloomberg using disclosures made over the past year. Projects went unfinished as home prices in the state plunged 42 percent from their 2006 peak to the second quarter of 2011, according to Federal Housing Finance Agency data.

“This is the single biggest default event in the history of the municipal market,” Richard Lehmann, publisher of Distressed Debt Securities, a newsletter, said in his August issue. He put the defaulted amount, including those that tapped reserves, at $5.1 billion, or 77 percent of those issued since 2003.

Dirt bonds are sold by community development districts set up by builders to finance roads and utility lines on raw land for housing. About 371 in Florida issued the $7 billion outstanding, according to data compiled by Bloomberg.

Share of Defaults

Bonds backed by special assessments like those in development districts account for 22 percent of recent local-bond defaults, John Hallacy, head of municipal research at Bank of America Merrill Lynch in New York, said in a Sept. 23 report.

More than $1.1 billion of bonds in the $2.9 trillion municipal market have defaulted so far this year, compared with $4.25 billion in all of 2010, according to the bank.

The Fiddler’s Creek case is the first in Florida where a development district settled debts with a builder under Chapter 11 bankruptcy procedures over bondholders’ objections, said Lehmann. It may prompt more Chapter 11 filings by builders looking to delay bond payments, he said.

“The bondholders were supposed to be the first people in line, and now they’ve been basically made the last,” Lehmann said by telephone from Miami Lakes, Florida, where he heads Income Securities Advisors Inc.

May Set Precedent

The Fiddler’s Creek bankruptcy decision may set a precedent in other states, including California, Colorado and Nebraska, where similar districts borrow for industrial and residential development, said Richard Levin, a bankruptcy lawyer at Cravath, Swaine & Moore LLP in New York.

More than 20 districts in Florida have developers that filed for or emerged from bankruptcy, according to court records. Builders of two, Cordoba Ranch and Landmark at Doral, with a combined $81.6 million in bonds outstanding, filed for Chapter 11 since the Fiddler’s Creek settlement, the data show.

The two Fiddler’s Creek districts sold more than $150 million of tax-exempt debt beginning in 1996 to build infrastructure for a project that was to include 6,000 homes, golf courses, clubhouses and tennis courts. Fewer than 1,800 houses had been built as of a March 2010 court filing.

The developer lost as much as $42 million in anticipated revenue as prices fell and buyers refused to close purchases, according to a transcript of a July hearing that led to the judge’s ruling. The builder, which expected the project to bring in $397 million, according to a court filing, hasn’t paid assessments toward most of the bonds since 2008.

Bankruptcy Petition

The developer and 27 related entities submitted a Chapter 11 bankruptcy petition in February 2010. The filing is used by companies to reorganize debts under court supervision; municipalities use Chapter 9 bankruptcy in a similar way.

Judge K. Rodney May, of federal bankruptcy court in Tampa, confirmed a debt reorganization agreement on Aug. 29 between the builder and the development district that delays bond payments.

May refused to give bondholders voting rights on the plan, saying they’re not direct creditors. He called them “a creditor of a creditor,” according to a transcript of the July 29 hearing, because they didn’t buy bonds from the developer but from the district, which lent the funds to the builder.

“We were told, ‘Just sit on your hands and you’ll get paid eventually,’” Andrew Sanford, an analyst for ITG Holdings, an investment firm in Naples that holds $15 million of the bonds, said in a telephone interview.

Ruling Appealed

On Sept. 26, U.S. Bank National Association, which represents bondholders, appealed the ruling. Tom Joyce, a spokesman, declined to comment in an e-mail. W. Keith Fendrick, Michael P. Maguire and Douglas Darbut, lawyers at Holland & Knight LLP in Tampa who appealed, didn’t return calls.

The reorganization plan went into effect on Sept. 2, according to court documents. That makes it difficult for bondholders to successfully challenge the ruling, said Levin of Cravath, Swaine.

“The courts are reluctant to unwind a confirmed reorganization plan on appeal if a plan has already been implemented,” he said in a telephone interview. “Those are pretty tough eggs to unscramble.”

The Fiddler’s Creek agreement delays payments to bondholders until April 2012 or 2013, depending on the sale date of their securities. Payments on other obligations will begin first, including on a $6.6 million loan held by Mount Kellett Capital Management LP and toward outstanding real-estate taxes, according to court documents.

Repayment Expected

The developer is “very comfortable” that bondholders will be paid, said Mariaelena Gayo-Guitian, a bankruptcy lawyer at Genovese Joblove & Battista who represented the builder. Bondholders “are maintaining their priority liens,” she said in a telephone interview from Fort Lauderdale.

The judge’s decision will depress prices of Fiddler’s Creek bonds, said Lehmann. A 10-year security sold in 2003 traded at about 36 cents on the dollar on July 26, according to data compiled by Bloomberg.

“It’s a major change in the collateral value that people perceive,” Lehmann said of the ruling’s effect.

The case is Fiddler’s Creek, LLC, 8:10-bk-03846-KRM, U.S. Bankruptcy Court, Middle District of Florida (Tampa).

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