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Portola Hills Highlights Pitfalls : Real estate: Orange County now looks more carefully at the financial underpinnings of developers.

BONDS OF DEVELOPMENT: The impact and risks of Mello-Roos bonds. First of three parts


Using Mello-Roos bonds to pay for projects in undeveloped areas can be risky even in Orange County, as was shown recently when two major firms failed to pay their tax bills for a site just northwest of Mission Viejo.

Here's what happened at Portola Hills, a project of the Baldwin Co. and J.M. Peters Co.:

In August, 1988, federal regulators ordered a Houston-based thrift called San Jacinto Savings to stop investing in its subsidiaries because of losses suffered on high-risk real estate investments. Those subsidiaries include J.M. Peters, which is 87% owned by San Jacinto.

In November, 1988, county officials sold $15.6 million in bonds for Portola Hills, a debt that Peters and the Baldwin Co. are both responsible for paying until homes are sold to consumers there.

Since then, the federal government has seized San Jacinto. Baldwin and Peters together became delinquent last year for nearly $400,000 in Mello-Roos taxes due on Portola Hills.

"Although (Baldwin) and Peters paid most of (those) first and second installment payments . . . including penalties, on April 10, 1991, they did not make (Mello-Roos) payments in an aggregate amount of $2,214.35 and $2,377.92, respectively, for five parcels of land they own or owned in the district," according to the county's official warning to potential bond investors.

Bert Ely, a nationally recognized banking consultant, said the August, 1988, regulatory order against San Jacinto Savings should have put the county on notice that J.M. Peters might not be able to pay its bills, including taxes.

Eileen Walsh, the county's chief public finance officer, said she does not know whether county government was aware of the August, 1988, federal regulatory actions against San Jacinto Savings.

Regardless, Walsh said, the best safety valve protecting bond investors and homeowners is the value of the land used as collateral for the bonds.

And, she noted, the land value was based in part on the advice of appraisers selected and hired by the county.

"I'm not sure anyone knew that 87% of (Peters') stock was owned by San Jacinto Savings," Walsh said.

On Nov. 30, 1990, the federal Office of Thrift Supervision ordered the government takeover of San Jacinto, saying it was operating in an "unsafe and unsound" manner.

If tax delinquencies for Portola Hills were to mount, and the Mello-Roos district was in danger of defaulting on its bond payments, the county would try to foreclose on the land used as collateral for the bonds, county officials said. The county would then sell the acreage, making the new owner responsible for paying the overdue taxes.

But what if there were no buyers at the right price? Ultimately, homeowners would be responsible for paying the debt.

Because of the county's experience with Peters, Walsh said, "there are now special risks in that district."

Walsh said that before the county sold another $9.2 million in Mello-Roos bonds for Portola Hills in October, the county obtained a surety bond, which is similar to an insurance policy. Also, the experience with Baldwin and Peters is noted in the county's official statement accompanying the bond offer.

More significantly, Walsh said, the county is being forced to pay a higher interest rate on the bonds--9.3%--because of the experience with Baldwin and Peters. Higher interest rates mean higher Mello-Roos taxes for the homeowners who must eventually pay off the bonds.

Both Baldwin and Peters are now current on their tax payments, Walsh said. According to a bond disclosure report issued in October, residential construction is halfway complete at Portola Hills. No commercial structures have been finished.

Because of their lateness and the problems with San Jacinto Savings, Walsh said the county now looks more carefully at the financial underpinnings of developers.

"It's one of those Monday morning quarterback deals," Walsh said. "It wasn't an issue back then."

In at least two other community facilities districts, major landowners have been seriously delinquent in paying their Mello-Roos tax installments: an area of the Trabuco Canyon Water District and a county-run district in Coto de Caza, where the delinquency rate reached a staggering 10.37% during the 1990-91 fiscal year; the county average was just 2.38%.

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