Market for Orange County Bonds Dries Up : Finances: Investors express concern that $1.5 billion in potential losses could grow. Rising interest rates compound the disaster.

The market for bonds issued by Orange County and its agencies continued to evaporate Monday as bond traders and investors expressed mounting concern that the $1.5 billion in potential losses suffered by the county’s investment fund could grow substantially.

Widespread suspicion that more losses could be uncovered effectively froze most trading.

“People are a lot more concerned than they were last week,” said Robert Gore, a bond trader with the Crowell Weedon & Co. investment banking firm in Los Angeles. “Nobody really knows what’s in the fund.”

The reluctance of new buyers to step forward means most current holders of Orange County and related bonds--including mutual funds and individuals--may be stuck holding the paper at least until the county fund’s financial situation becomes clearer.

Independent auditors for Orange County expressed uncertainty about the county’s finances on Monday. Peggy McBride, a partner with KPMG Peat Marwick in Costa Mesa, the county’s auditor for the past three years, said her firm had not yet decided whether it will complete a regularly scheduled review of county finances slated to be finished by the end of December. The report includes an audit of the county investment pool, which was valued at $18.5 billion as of Dec. 1.

“It has not yet been decided, now that all this has happened,” she said. “We don’t know if it will be released on time.”

Because of apprehension about the county’s financial strength, those few investors offering to buy Orange County bonds or those of the county’s municipalities were demanding price discounts of at least 10% below similar, untainted bonds.

News late last week that credit rating agency Standard & Poor’s Corp. had put Orange County debt issues on watch for possible downgrading helped cause further deterioration in the market for the bonds.

A Los Angeles broker, who asked not to be identified, attempted unsuccessfully to sell about $2 million worth of Orange County school district notes from an issue in June, which has become controversial because of rare guarantees that the invested proceeds would not lose money. Reportedly, at least one large mutual fund was also unable to find a buyer for similar bonds.

“Orange County bonds are getting hammered,” said Sandra Allworth, a partner at Artemis Capital Group in New York. “They (investors) are getting some bids on Orange County bonds but they are nothing like they would normally get.”

Traders noted, however, that the municipal bond market is generally an illiquid market, where many small bond issues trade infrequently. So gauging true supply and demand at any moment can be difficult.

Orange County’s situation did not seem to have an impact on the overall municipal bond market, which held firm Monday. The San Francisco Redevelopment Agency, for example, succeeded in selling $116 million worth of bonds without paying a penalty in the form of higher interest rates. The 30-year bonds were priced to yield 6.94%.

In more bad news for Orange County, short-term interest rates surged again on Monday, responding to new signs of economic strength. Each increase in short rates boosts the cost of the loans the county has used to buy long-term bonds. That could force further collateral calls on the county fund, draining available cash resources.

David Herships, an analyst with investment banking firm Kemper Securities in Chicago, put out a report Monday echoing most market participants’ fears about increased losses to the Orange County portfolio, which represent about 20% of the amount actually invested. Of most concern, he said, is a $110-million pension bond issue sold by the county in September, which allow buyers to demand their money back from the county on seven days’ notice.

“It’s like walking into the bank and asking for your money back. Their county treasurer promised a lot of people a lot of things,” said Herships. “‘They’ve got a lot of problems. Who knows what the real losses are?”

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Times staff writers John O’Dell and Tom Petruno contributed to this report.