Bondholders not notified of potential for flooding
In 74 sales, special purpose districts in Cinco Ranch only once disclosed risk
The special purpose districts that have powered development in the Cinco Ranch area west of Houston repeatedly failed to disclose to bond investors the risk of severe flooding from the adjacent Barker Reservoir, a Houston Chronicle investigation found.
Hundreds of homes near the reservoir were flooded when Hurricane Harvey battered southeast Texas in late August. Many homeowners complained bitterly that they were never warned the reservoir could pour into their neighborhoods during an extreme storm.
Bond investors who placed bets on the long-term economic health of the Cinco Ranch area were not told about the danger, either — although it had been documented for years in Fort Bend County planning records and in reports by the U.S. Army Corps of Engineers, which operates the reservoir.
A patchwork of municipal utility districts, known as MUDs, and similar agencies oversee basic services in Cinco Ranch, a master-planned community 25 miles west of downtown Houston. They regularly sell bonds to install and improve water, sewer, drainage systems and other infrastructure.
The Chronicle looked at 10 districts that serve subdivisions along the southwestern fringe of Barker Reservoir. All were flooded or evacuated during Harvey.
Those districts have sold bonds 74 times since 1991, borrowing a total of $297 million. For each sale, an offering statement was distributed to investors, with a detailed description of risk factors that could affect property values, the quality of life and the district’s ability to make timely payments of interest and principal on the bonds.
Only one of those 74 statements disclosed the risk that the reservoir could inundate nearby subdivisions, the Chronicle found.
The sole exception was a 1992 bond sale by the Willow Fork Drainage District, which acknowledged the problem. In 17 subsequent bond sales, including one this year, the same district’s bond statements made no reference to the potential for flooding from the reservoir.
The absence of disclosure cut off a potential avenue for investors, homebuyers
and the wider public to become aware that neighborhoods near Barker could be under water after an intense storm. Bond statements are one way such information enters the public domain.
Federal securities law requires government agencies to disclose any “material” information that would bear on a reasonable investor’s decision whether to buy their bonds. Whether the risk of flooding from Barker Reservoir is “material” within the meaning of the law has never been tested.
But Jim Blackburn thinks investors deserved to know.
He’s an environmental lawyer and planner who has studied the Houston area’s vulnerability to flooding for years.
The lack of disclosure reflects the tendency of developers, businesspeople and elected officials to downplay the threat of flooding, for fear that talking about it could inhibit economic growth, he said.
“We don’t reveal the weaknesses in our system, and it is our obligation to the people who live here and invest in Houston,” said Blackburn, who is co-director of Rice University’s Severe Storm Prediction, Education and Evacuation from Disaster Center.
Larry Dunbar, a lawyer and engineer who advised Fort Bend County officials on the risk of reservoir flooding back in the 1980s, said the problem has been hiding in plain sight for decades.
“It’s obviously something that not only should the homeowners have been made aware of, but obviously any bond investors likewise would probably want to know about it,” he said.
Disclosure is crucial to bond investors because they put their money at risk for 10, 20 or even 30 years, depending on a bond issue’s repayment schedule. Special purpose districts repay bonds with property taxes. A decline in property values could reduce tax revenue and, potentially, jeopardize repayment of the bonds.
Bonds like those sold by the Cinco Ranch-area districts are held mainly by wealthy individuals, said David Loesch, owner of DRL Group, a Katy-based firm that sells municipal securities.
The devastation caused by Harvey has not affected the districts’ ability to keep up with interest and principal payments. Experts said the potential threat to bondholders is longer-term: Repeated flooding, especially if it damages sewage plants or other infrastructure, could make neighborhoods less desirable, depressing property values.
Subdivisions in the eastern part of Cinco Ranch are imperiled by the reservoir’s “flood pool” — the technical term for the water that builds up behind Barker Dam during storms.
Because the reservoir is open terrain, without banks or walls, the size of the flood pool varies depending on how much rain falls and how much water is released through the dam’s gates, to flow downstream toward Houston. The reservoir is dry much of the year and is filled with parks and trails, so many people don’t recognize its true purpose.
Barker and Addicks Dams were built by the Army Corps in the 1940s to protect downtown Houston from flooding. They were originally designed to hold back storm runoff for short periods.
But as development filled more of the flood plain downstream of the dams, releases of water had to be carefully restricted. Development in the prairie west of the dams further complicated the situation, increasing storm runoff into the reservoirs. The flood pools grew steadily larger.
In an extreme storm, more water can accumulate in the reservoirs than the Army Corps has land to contain it. The government-owned area behind Barker Dam covers about 12,000 acres. But the dam can hold back enough water to submerge more than 16,000 acres. That’s called the “maximum flood pool,” and it now includes thousands of homes and businesses.
Concerns about the potential for devastating flooding prompted Fort Bend County, beginning as early as 1991, to include a fineprint notation on subdivision maps for areas near the reservoir. It states that the land is “subject to extended controlled inundation under the management of the U.S. Army Corps of Engineers.”
Developers submit the maps when they seek approval to subdivide land for homes. County officials intended the notation as a way to alert homebuyers. They now acknowledge it was ineffective, because few buyers know to consult the maps.
The flood risk surfaced anew in a 2009 Army Corps master plan for Barker and Addicks Reservoirs. The report said the reservoirs — as of then — had not overflowed into adjacent neighborhoods, but indicated that it could be only a matter of time.
If some severe storms of the preceding decade had “been centered over Addicks and Barker Reservoirs or the Upper Buffalo Bayou Watershed, the combined rainfall and runoff could have resulted in flood pools exceeding the limits of government owned land,” according to an appendix in the report.
An aerial view of Barker Reservoir, on page 7 of the document, showed that there was no margin for error: Subdivisions had been built right up to the edge of government-owned land — and well within the maximum flood pool.
In internal emails that came out in 2011 in an environmental lawsuit over the Grand Parkway, Army Corps officials discussed how the reservoir flood pools were getting larger and larger, heightening the risk that they could spill into surrounding communities.
“Should this occur, a large number of residents, businesses and infrastructure located within the maximum possible pools could be severely impacted for an extended period of time,” one email said.
Why the drafters of the Cinco Ranch-area bond statements almost always omitted that danger is unclear. By phone and email, the Chronicle contacted two dozen lawyers, financial advisers and others involved in the bond sales. Only two would comment on whether the reservoir flood risk should have been disclosed.
W. Dickinson Yale Jr., a lawyer for Cinco MUD 8, said the district “gives all the notification required by state law.” He said that if a threat of flooding existed, it was a matter for buyers and sellers of property and their title insurance companies.
Jim Boone, managing partner of Allen Boone Humphries Robinson, which serves as both bond counsel and general counsel for several Cinco Ranch-area MUDs, said the firm’s lawyers did not know about the flood warning on the Fort Bend County subdivision maps.
Boone said his firm’s involvement in preparing bond statements focused on “legal and federal tax matters,” and that other MUD advisers were responsible for disclosing risk factors.
Referring to Harvey-related flooding in Cinco Ranch, he added: “We were shocked and surprised that the United States Army Corps of Engineers would flood private property … through their operation and management of the Barker Reservoir, without any legal right to do so.”
Cinco Ranch was a vast stretch of cattle ranches, dairy farms and rice fields when developers began turning it into masterplanned suburbia in the 1980s.
MUDs played a central role in the transformation, as they have in unincorporated areas across the Houston region.
MUDS are created by the Legislature or the Texas Commission on Environmental Quality, typically at the initiative of developers. A handful of “electors” can vote to ratify a district’s existence and authorize it to sell hundreds of millions of dollars in bonds. The electors are handpicked and sometimes live in trailers on the site of the future subdivision, to satisfy a legal requirement that they be residents of the district.
The initial bond sale goes to reimburse the developer for putting in roads, water mains and other infrastructure. That way, the developer doesn’t have to add infrastructure costs to the price of homes. More bonds are sold as new stages of the community are developed.
As residents move in, the MUD becomes the de facto local government, contracting with outside firms to provide basic services. The MUD taxes property owners to repay the bonds, with interest.
Other special purpose districts build, improve and maintain water, sewer or drainage systems. Serving individual MUDs or groups of MUDs, they also sell bonds, and pay them off by collecting property taxes — on top of those collected by the MUDs.
The system has been criticized for cronyism and lack of transparency, although its defenders say it helps keep housing affordable and is less costly and intrusive than traditional local governments.
The districts’ bond sales are handled by professional advisers with varying responsibilities.
The bond counsel issues an opinion on whether the bonds are being sold for a lawful purpose and qualify for tax-exempt status. The financial adviser helps a district decide how to structure the bond sale, when to issue the bonds and how to market them. The adviser typically oversees preparation of the bond statement as well.
In some cases, a “disclosure counsel” weighs in on what should be in the bond statement. The underwriter, which buys the bonds in bulk and then sells them to investors, often hires its own counsel to check the bond statement for accuracy and make sure disclosure is sufficient.
Before a bond sale can go forward, the district’s board of directors must approve the statement.
Typical of the bond sales examined by the Chronicle was a $4.7 million issue put on the market in 2014 by Grand Lakes MUD 1. The purpose was to refinance existing debt.
The offering statement went into detail about esoteric matters, including the potential impact of stiffer state standards for issuing permits for “Phase II (Small) Municipal Separate Storm Sewer Systems.”
It said nothing about the threat of flooding from the reservoir.
First Southwest Co., now part of Hilltop Securities, was listed as financial adviser for the sale. The law firm Fulbright & Jaworski, now Norton Rose Fulbright, was underwriter’s counsel. Neither responded to requests for comment. No disclosure counsel was listed.
The law firm Schwartz, Page & Harding is general counsel and bond counsel for Grand Lakes MUD 1 and two other special purpose districts near the reservoir.
Asked for comment on the bond statement, a lawyer with the firm Christopher Skinner, said he would consult with the MUD 1 board of directors.
“Following due consideration of your request, the Board determined not to expend District resources in responding to your inquiry,” Skinner said by email.
Asked why resources would have to be expended, he replied: “As attorneys, our time is chargeable to our clients.”
Mention of reservoir flooding was also missing when Cinco MUD 2 sold $4.3 million in bonds in 1992. The district serves Cinco Ranch South Lake Village, Bayou Park Estates and other neighborhoods.
The 94-page bond statement listed various “risk factors,” including uncertainty about whether the resale values of homes will support “the growth and maintenance of taxable value in the district and tax revenues.”
Under the heading “Matters Related to the Developer,” the document stated: “The District can make no prediction as to the effects that inflation, interest rates, a depressed economy, falling energy prices, potential transportation problems, flooding or other factors, whether economic, governmental or otherwise, may have on the plans of the Developer.”
The statement also noted that the Willow Fork Drainage District, which encompasses Cinco MUD 2 and several other MUDs, had financed construction of drainage improvements within Barker Reservoir.
But the document said nothing about the possibility that the reservoir could flood adjoining neighborhoods, including those in MUD 2.
The bond counsel for the sale was the law firm Vinson & Elkins. The financial adviser was Legg Mason Wood Walker. The bond statement does not list a disclosure counsel or an underwriter’s counsel.
In the lone exception to the pattern of nondisclosure, the Willow Fork Drainage District, in its offering statement for a $9 million bond sale in 1992, acknowledged that the Fort Bend County Engineering Department had expressed concern about “potential flooding of non-government owned land upstream of the Barker Reservoir, including portions of the District.”
In 17 subsequent bond sales, the district did not mention that risk.
Fulbright & Jaworski (later Norton Rose Fulbright) was disclosure counsel or underwriter’s counsel on eight of the district’s post-1992 bond sales.
Counting its work for other Cinco Ranch-area districts, the law firm was disclosure counsel or underwriter’s counsel on 40 bond sales in all — none of which acknowledged the risk of reservoir flooding.
Many of the bond statements reviewed by the Chronicle mention the 100year flood plain, an area with a 1 percent chance of being flooded in a given year. The statements typically say that no areas within the district are in the 100-year flood plain, or they describe drainage improvements made to remove areas from the 100year flood plain.
The flood pool is different from the flood plain. Measures taken to safeguard property against a 100-year flood won’t necessarily offer protection from the flood pool. Parts of Cinco Ranch that are not within the 100-year flood plain were nevertheless inundated by Barker Reservoir during Harvey.
The risk of reservoir flooding was mentioned in only one of the 38 bond sales for which RBC Capital Markets and its predecessor firms served as financial adviser or underwriter. (The exception was the 1992 bond sale by the Willow Fork Drainage District.)
Matt Dustin, vice president of municipal finance in RBC’s Houston office, declined to comment on whether all of the bond statements should have cited the danger. But he said the issue is now top of mind for bond professionals.
“There has been lots of discussion about the need for more disclosure post-Harvey, for sure,” Dustin said. “And I think going forward, every underwriter and financial adviser and bond counsel is going to be more diligent about the types of disclosures.” BBB
If a bond statement misrepresents or leaves out material facts, investors can sue those involved in preparing the document, and the federal government can pursue fines and other penalties under antifraud laws.
Determining whether information is material “can be a very complex analysis,” said Robert Doty, a municipal bond expert based in Annapolis, Md. “It would take into account how realistic people would have viewed the threat.”
Doty has been a bond counsel, underwriter and investment banker and is now a consultant and expert witness in municipal bond cases. He helped write the disclosure guidelines used by the Government Finance Officers Association.
He said those who prepared the Cinco Ranch-area bond statements should, at a minimum, have seriously considered disclosing the risk of reservoir flooding.
Doty said it was signifi- cant that Fort Bend County saw fit to require the notation on subdivision maps warning of the danger of “extended controlled inundation.”
“It shows that somebody thought of it,” he said. “That would be part of the information that would be considered in an analysis of whether this was material information.”