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A Federal Bankruptcy Court case in the Middle District of Florida is setting some precedents for Florida CDD municipal bondholders, and perhaps for holders of similar bonds nationwide. The case involves a Community Development District called Fiddlers Creek, which is located southeast of Naples Florida and near Marco Island. The district was begun in 1999 and has progressed in stages with 1782 homes built and occupied and plans for an additional 3329 units. Over the years it has incurred $312 million in bank debt and $131 million in CDD bond debt. When the housing collapse came, the developer began defaulting on interest payments and then filed for bankruptcy on February 23, 2010.

The case has now reached the stage where creditors are being asked to approve a plan of reorganization which promises to make all parties whole. The problem is, CDD bondholders have no vote in the plan since the court has decided they are not creditors of the developer, but rather creditors of the CDD. The problem with this is that the CDD board of directors is controlled by the developer since he is the largest landholder. The CDD can thus be expected to approve the plan. This would not seem to be all that bad if everyone could believe in the forecast that there will be enough value in the project to settle all claims. This is viewed with skepticism by certain bondholders given that all land prices in Florida have fallen since 2007. If so, the developer will have a hard time selling lots with the current assessed tax burden. If, on the other hand, the developer drops the price to compensate, the banks will suffer the shortfall to the extent that the sales price doesn’t cover the pro-rata mortgage amount. A further problem is that the plan modifies the terms of the bonds without bondholder consent and provides for additional assessments against landowners which may not hold up if challenged in court.

Without the bankruptcy court intervention, the CDD would have foreclosed on the developer, thereby forcing the banks to either take title and make tax payments (unlikely) or be squeezed out. Under the proposed plan, the banks will all be cashed out before the long CDD bonds come due. Thus, over time, the obligation to the CDD bondholders moves from the weak hands of the developer to the stronger hands of individual homeowners. Not a bad outcome except that an untold amount of interest payments may be missed and never be made up.

While such a plan may work for a development that has such a high degree of completion, it is unlikely to work with a district that has few homeowners and no sales momentum since working capital loans for a developer will be hard to obtain. Also, home mortgages will look extra risky to a mortgage lenders who faces the added risk that the project will eventually fail.

We have always been of the opinion that the vast majority of the CDDs will not be brought to completion without a significant reduction of the CDD assessments that each lot carries to make them price competitive. This solution, however, brings up the issue of how do you reduce assessments for new buyers while holding old buyers to their now no longer pro-rata assessments. There are no easy answers here and it is unlikely that the solution will come out of a bankruptcy court.