Colorado residential development districts targeted for reform

Colorado legislation to regulate debt issued by special districts that fund new residential development provoked lengthy hearings in this year’s General Assembly, which approved a “transparency” measure that fell short of addressing a key conflict of interest cited by critics.  

That conflict was directly addressed by House Bill 1090, which would have prevented developers from purchasing debt issued by the metropolitan districts they create. It passed the House in a 38-24 vote in February, but failed to advance in the Senate.

“We had a good debate about it and I think we’re educating more legislators than we ever had before,” said John Henderson, a founding member of Coloradans for Metro District Reform. “We still came out a little bit short.”

The greater scrutiny comes as rising interest rates and a slowdown in the housing market are pressuring the districts, which are approved by local Colorado governments as a way to have taxpayers in new residential developments fund infrastructure such as roads and sewers, particularly in the wake of a 1992 constitutional amendment requiring voter approval for tax increases.

District property owners, who in the early stages of a project typically include only the developer, vote to authorize the issuance of tax-exempt bonds backed by property taxes.

What lawmakers did pass this session was Senate Bill 110, which was signed by Democratic Gov. Jared Polis April 3.

Starting in 2024, service plans filed by districts must list maximum property tax levies and debt issuance — something most existing districts already do. The law also limits the interest rate on bond issues that are purchased by developers beginning next year. A registered municipal advisor must certify the rate is the lesser of current market rates based on the issue’s structure and the district’s “financial circumstances,” or an interest rate cap based on the 30-year yield on Municipal Market Data’s triple-A scale plus 400 basis points as of seven business days prior to issuance.

Henderson said the new law essentially sanctions bond-buying by a developer who has “a 180-degree direct conflict of interest” with the residents.

“The proceeds all go to the developer and the people paying the interest and the principal never have anything to say whether these things should be issued and what the amount should be, what the interest should be, what the payment schedule should be,” he said. 

At a House committee hearing earlier this year on the now-dead HB 1090, its sponsor, Democratic State Rep. Mike Weissman, said the measure was aimed at restoring some restraint to districts’ creation and issuance of debt, particularly when it comes to the buyers of that debt.

“In just about every other case, those purchasing government debt are at an arm’s length from the issuance of the debt,” he said.

He pointed to a 2019 investigation by The Denver Post that raised concerns over conflicts of interest and a lack of checks and balances as some homeowners were being hit with rising property tax bills to pay off district-issued debt.

Under HB 1090, a member of the board of a metropolitan district that approved the issuance of any debt while the member was serving on the board would have been prevented from acquiring any interest in the debt individually or on behalf of any organization or entity for which the board member is engaged as an employee, counsel, consultant, representative, or agent unless the debt was acquired indirectly through an investment fund and the member has no input into or control over the individual securities that the fund purchases, according to a bill summary. 

A similar bill sponsored by Weissman also stalled in the Senate last year after passing the House in a 34-31 vote.

Supporters of Colorado’s more than 2,200 metro districts argued this session’s version would stymie developments at a time the state faces a more than 500,000-housing-unit gap.

“There are instances when homebuilders or land developers cannot sell metro district debt to investors just because of the status of the project or the status of the credit markets and in those times, (they) need to retain a binding right to reimbursement for the public infrastructure that they built in accordance with the agreements with the city, ” said Zach Bishop, a managing director in Piper Sandler’s special district group and board chairman of the Metro District Education Coalition. 

While developer-bought bonds are a small fraction of the debt sold by metro districts, the practice has become more prevalent because early-stage debt is difficult to sell in the current market, he added. 

The official statement for bonds publicly sold by a Colorado district last year pointed to other potential conflicts of interest, a way to work around them, as well as an enormous amount of originally authorized debt.

The unrated $25.6 million special revenue improvement bond issue for the Centerra Metropolitan District No. 1 in Loveland, Colorado, disclosed that all the members of the district’s board of directors are employees of McWhinney Real Estate Services, Inc. The board of that company is composed of Chad and Troy McWhinney, whose Centerra Properties West, LLC, originally assembled much of the land and is the primary owner of remaining undeveloped property. 

In lieu of abstaining from voting on a matter involving a conflict of interest, a director can disclose the conflict in writing to the Colorado Secretary of State and to the district’s board ahead of a meeting where the director’s presence is needed to establish a quorum of board members, according to the OS.

Authorization for the bond sale dates back to 2004 when the district’s creation was approved by the Loveland City Council, as well as “eligible” district voters, who also voted in favor of issuing up to $3.15 billion of general obligation bonds for public infrastructure, the OS noted. Nearly $2.89 billion of unused authority remained after the new debt’s issuance.

Bonds for initial district developments are usually unrated, according to Bishop. 

“As those districts build out and homes are completely built, it’s very frequent for districts to go back and refinance nonrated debt with investment-grade-rated debt,” he said.

Moody’s Investors Service has ratings from A1 to a non-investment grade Ba2 for 68 Colorado metro districts. In a March report, the rating agency said higher interest rates and a slowdown in homebuilding pose challenges over the next three to five years for the districts. 

“Slowing construction and reduced demand among homebuyers will increase risks, particularly where additional growth is required to meet debt service requirements,” Moody’s said. “Debt burdens for most rated metropolitan districts, however, will continue to decline due to anticipated tax base growth in fiscal 2024 as well as ongoing principal amortization.”

The preponderance of district bonds rated by S&P Global Ratings are in the A-minus and BBB categories.

“Although weakening macroeconomic conditions could result in a slower pace of growth in 2023, we do not anticipate significant deterioration across rated districts, as we believe that the property tax revenue structure coupled with strong statewide demand for property will continue to support stable credit fundamentals in the near term,” the rating agency said in an October report.

Colorado’s governor also signed into law a bill allowing certain districts to levy sales taxes to fund parks or recreational facilities or programs if approved by voters within the district.

Currently, 13 districts have a sales tax that can support fire and safety protection, street improvements, and transportations services, according to a legislative council fiscal note on the bill.