Mem­phis’s les­son in how not to use a muni bond

Af­ter fed­eral sub­si­dies are cut off, in­vestors see a big loss Tax-free bonds for pri­vately run groups are “a peren­nial prob­lem”

Bloomberg Businessweek (Asia) - - CONTENTS - ——Richard Ham­let, Global Min­istries Foun­da­tion −Martin Z. Braun

At the War­ren and Tu­lane apart­ments in Mem­phis, in­spec­tions have found roach in­fes­ta­tions, bro­ken win­dows, buck­ling ceil­ings, and miss­ing or dam­aged ap­pli­ances. “It’s ap­palling,” says Jes­sica John­son-Peter­son, who’s lived at the War­ren apart­ments with her hus­band and chil­dren since 2009. “We have to jump through ex­treme hoops to even get any­one’s at­ten­tion.”

Such con­di­tions led the U.S. Depart­ment of Hous­ing and Ur­ban De­vel­op­ment in Fe­bru­ary to cut off rent sub­si­dies for more than 1,000 res­i­dents. Those fed­eral dol­lars were to be used to re­pay $12 mil­lion of bonds sold by the apart­ments’ owner, Global Min­istries Foun­da­tion. With­out that money, the bonds went into tech­ni­cal de­fault, push­ing their price to as lit­tle as 21¢ per dol­lar of their face value.

The GMF debts were mu­nic­i­pal bonds, govern­ment-spon­sored debt that of­fers in­vestors in­come free from taxes. Mu­nis may call to mind in­vest­ments in toll bridges and sew­ers, but they also in­clude bonds like GMF’s is­sued through “con­duits”—lo­cal agen­cies with few, if any, em­ploy­ees that ex­ist only to sell tax-ex­empt debt for a fee. With lit­tle re­spon­si­bil­ity for the projects they fi­nance—some­times in dif­fer­ent states—the au­thor­i­ties have raised money for pri­vately run nurs­ing homes, char­ter schools, and even amuse­ment parks.

“Con­duits have been a peren­nial prob­lem in the mar­ket,” says Christo­pher Tay­lor, the for­mer ex­ec­u­tive di­rec­tor of the Mu­nic­i­pal Se­cu­ri­ties Rule­mak­ing Board, the in­dus­try’s reg­u­la­tor. About 60 per­cent of muni bonds that de­fault are is­sued by such con­duits, ac­cord­ing to Matt Fabian, a part­ner at Mu­nic­i­pal Mar­ket An­a­lyt­ics.

The mar­ket for con­duit bonds is one of Wall Street’s most opaque niches. Seven days af­ter GMF is­sued a let­ter to the bond trustee about the de­fault, some bonds were sold in lots of $25,000 and $50,000 for as much as 10 per­cent

“Our man­age­ment team, in ad­di­tion to out­side con­trac­tors we en­gaged, worked hard un­der very stress­ful con­di­tions to mit­i­gate phys­i­cal de­fi­cien­cies on the sites.” more than face value. Nei­ther the buy­ers nor sellers are known. The trades sug­gest that small­time in­vestors may not be get­ting im­por­tant in­for­ma­tion when they buy bonds. In 2009 the muni rule-mak­ing board launched a web­site for re­port­ing such in­for­ma­tion, but in­vestors may not know the records are avail­able.

GMF, which says on its web­site that it works “for the glory of God and the eter­nal wel­fare of mankind,” owns 10,500 low-rent apart­ments in eight states. It fi­nanced its pur­chase of the Mem­phis apart­ments through the city’s Health, Ed­u­ca­tional, and Hous­ing Fa­cil­ity Board. The agency’s head says that GMF had a good rep­u­ta­tion with the in­vest­ment com­mu­nity be­fore the de­fault.

Richard Ham­let, GMF’s pres­i­dent, says his or­ga­ni­za­tion has in­vested more than $3 mil­lion in the Mem­phis apart­ments, which were suf­fer­ing from crime and poor main­te­nance be­fore GMF pur­chased them in 2011. “Our man­age­ment team, in ad­di­tion to out­side con­trac­tors we en­gaged, worked hard un­der very stress­ful con­di­tions to mit­i­gate phys­i­cal de­fi­cien­cies on the sites,” Ham­let says.

GMF is a non­profit. Ac­cord­ing to its tax records, Ham­let was paid $535,000 in salary and ben­e­fits in 2014. He says that’s in line with his in­dus­try peers.

Con­di­tions de­te­ri­o­rated af­ter the GMF ac­qui­si­tion, fed­eral re­ports say. An April in­spec­tion of 30 build­ings and 25 units found “life-threat­en­ing” breaches in­clud­ing ex­posed wires and blocked emer­gency ex­its. Al­though GMF hasn’t missed pay­ments on the bonds, it’s likely to do so within two years un­less it can sell the build­ings, Stan­dard & Poor’s Fi­nan­cial Ser­vices said on Feb. 19. The end of HUD sub­si­dies put the bonds in tech­ni­cal de­fault. Ham­let says this “is the first bond de­fault I have had in my ca­reer in this space.”

Fed­eral hous­ing of­fi­cials have be­gun plan­ning to re­lo­cate res­i­dents of the War­ren and Tu­lane apart­ments. “I’m ec­static,” John­son-Peter­son says. “I feel like it’s an op­por­tu­nity to be able to pro­vide bet­ter chances for my chil­dren and a bet­ter en­vi­ron­ment to raise my chil­dren.”

The bot­tom line Mu­nic­i­pal bonds don’t only fund govern­ment and big pub­lic works. Some­times the bor­row­ers are pri­vate groups with shaky projects.

HUD said the War­ren and Tu­laneapart­ments de­te­ri­o­rated un­derits own­ers

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