Advice for Orange County Bond Investors: Don’t Panic
The potential debacle brewing with Orange County’s public investment fund will probably slam the California municipal bond market in coming days, but the damage isn’t likely to be permanent, many analysts say.
That means most investors who directly or through mutual funds own tax-exempt muni bonds issued by or tied to Orange County--or bonds from the other issuers that have money invested in the O.C. fund--should avoid panicking and selling. You’d just be playing into the hands of professional investors eager to snap up bargains.
Fear that Orange County could suffer financial distress from what are so far unrealized losses in its now $18.5-billion investment portfolio caused potential buyers to pull back from O.C.-related bonds in trading late Thursday, some muni bond analysts said.
“We had trouble getting any bids” on O.C. issues after the news broke, one Los Angeles trader said. But the market wasn’t active anyway, he said, so the day offered little insight as to what may happen with bond values today.
The market’s concern, of course, is that O.C. and the other 180 government entities that have invested public money with Orange County Treasurer Robert Citron will incur losses that could impair their ability to pay interest on their debts, or to repay the debts when due.
If Orange County “starts to default on any payments, then as big as Orange County is, it will probably chill the rest of the California market as well,” said Harold S. Pittman, Ventura County’s treasurer.
But Napoleon Brandford III, vice chairman of San Francisco-based bond underwriter Grigsby Brandford & Co., called the O.C. fund’s trouble “really an isolated incident as we can tell so far,” adding that, long-term, Orange County “is in great shape.”
Veteran bond analysts noted that, in general, Citron’s fund doesn’t single-handedly back up bonds issued by the fund’s investors. In fact, most of the bonds outstanding from these issuers, including Orange County, would normally be backed by taxes or other revenue collected on an ongoing basis on behalf of projects funded by the bonds--such as roads, water and sewer systems.
“Whatever stood behind the bonds yesterday still stands behind them today,” said Zane Mann, publisher of the California Municipal Bond Advisor newsletter in Palm Springs.
What’s more, many of the issuers’ bonds may carry private insurance that would assure timely payment of interest in the event of trouble.
Even so, Mann and other experts say prices of any bond whose issuer is an investor with Citron may well tumble in the days ahead--sending yields up sharply--as the market reacts to the possibility of problems. “You will get that panic effect,” said Walt Beveridge, who manages short-term muni funds for Charles Schwab & Co. in San Francisco. “It’s just inherent in these situations.”
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Moody’s Investors Service estimates that investors own about $780 million in bonds issued directly by Orange County, including pension bonds and certificates of participation used to fund county infrastructure projects. Other tax-supported debt issued by O.C. government entities, such as transportation authorities, totals about $3.7 billion.
Mann noted that much of the money in Citron’s fund may represent “reserve account” dollars set aside for individual bond issues. Generally, bond issuers always have one year’s worth of interest payments put aside to give investors comfort that they will receive their interest on time.
Any threat to those reserve accounts, Mann said, will cause potential buyers of the bonds in question to demand a higher yield from sellers, to compensate for the risk that interest might be late--even if the possibility of that happening is remote, given that taxes and other revenues are regularly flowing in.
What’s important for investors to remember, Mann and others say, is that there has historically been very little risk of loss in individual municipal bonds if you can hold them to maturity. What happens to their underlying prices in the interim doesn’t affect the interest you receive or the principal amount you’ll eventually be repaid. And defaults in recent years have been extremely rare, despite the fiscal distress the state of California and its local entities have endured.
For owners of muni bond mutual funds, however, the situation is different: Because the funds have no set maturity, any losses incurred as fund managers trade out of temporarily devalued bonds may never be recovered. Thus, new problems for California muni issues, even if short-term in nature, could cause anguish for fund owners.
Ironically, the mammoth California muni bond market--estimated to be worth more than $120 billion--had been attracting new buyers in recent days, as many investors began to view tax-free yields of 6% to 7% on long-term muni issues as particularly lucrative. Muni yields had surged anew over the past month or so as interest rates in general rose on concerns about the economy’s strength and the potential for higher inflation in 1995.
Now even those muni bond issuers who aren’t invested in Citron’s fund fear that investors will paint all California bonds with the same brush, forcing issuers of all kinds to pay higher interest rates if they issue new securities.
The major independent bond-rating services, such as Moody’s and Standard & Poor’s Corp., said Thursday that they had made no decisions on the ratings accorded to Orange County bonds and those of other issuers invested in the O.C. fund. “Moody’s is having ongoing discussions with (county) officials to review the situation,” the rating agency said. “At this time we have taken no ratings actions.”
But if the agencies should eventually brand Orange County bonds as less safe because of the investment fund’s troubles, “it may also influence” the agencies’ views of other California counties, said Ventura County’s Pittman.
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Still, muni bond market veterans note that the California market has suffered a number of blows to its image in recent years, none of which have proved devastating for very long. In the early ‘90s, for example, many investors feared that so-called Mello-Roos bonds issued for real estate projects would see massive defaults as the state’s real estate market tanked. But that didn’t happen.
Likewise, the state’s many natural disasters since 1990 haven’t more than temporarily shaken investors’ faith in California bonds and the ability of the issuers to honor their debts.
Instead, the California muni market’s biggest problem has been the same problem that has affected all types of bonds: the surge in market interest rates this year as the Federal Reserve Board has tightened credit for the first time in five years. Rising market rates devalue older bonds issued at fixed rates and make investors reluctant to invest in new bonds, for fear of seeing rates climb ever higher.
Until long-term interest rates begin to decline again, the market turmoil incited by Orange County’s problems could mean that California muni owners’ patience will be tested that much more severely. But that will also spell opportunity for investors who may view higher California muni yields as quite attractive in the long run.
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Times staff writer James F. Peltz contributed to this report.
