ORANGE COUNTY IN BANKRUPTCY : Other Public Funds Use Risky Strategies : Finances: But few invest as aggressively as Orange County. Cash needs may force San Diego County to sell some holdings.
Many California municipalities use some of the same financing techniques that brought down Orange County’s investment pool, according to interviews with local treasurers, investment officers and market observers.
But no other California municipality appears to face losses as drastic as Orange County’s, in part because few, if any, use these techniques for speculative purposes to the same degree as Orange County.
Virtually every city and county in California that keeps an investment fund--and that’s most of them--would show a loss of between 1% and 5% of face value if forced to sell their holdings today. San Diego County, perhaps the most aggressively invested large county in the state after Orange County, would show a 10.7% loss if forced to sell its $3.3-billion portfolio at today’s market prices, said county Treasurer Paul Boland.
The market losses by San Diego County and other municipalities would occur because the value of fixed-income securities such as bonds--which provide the bulk of the localities’ investments--have dropped in market value as interest rates have risen. And rates have been rising inexorably all year.
“Everybody is under water when interest rates rise,” said George Jeffries, chief investment officer for Los Angeles County.
But because most local investment officers adhere to a policy of holding their securities to maturity--the date when the issuers pay them back in full--it is rare for municipalities to show a real loss. Most municipalities polled Wednesday by The Times said they do not anticipate having to realize those losses because their cash flow is more than enough to cover any possible needs.
San Diego, again, is among the exceptions. To avoid a cash crunch similar to Orange County’s, Boland said that he plans to raise as much as $500 million--bringing the county fund’s total available cash to $1.2 billion--by selling some losing securities, taking profits on others and retaining some investment gains that would otherwise be distributed to investors.
Those steps will cut the fund’s investment return from 5.8% so far this year to 4.6%, Boland said.
Among the risk factors in the portfolio is that as much as 25% is invested in structured securities similar to those that comprised as much as $8 billion of Orange County’s $20-billion portfolio; many of them are securities whose payouts and values drop as interest rates rise.
The San Diego holdings’ average maturity is about three years, also at the high end of the range for California localities. Moreover, as much as 10% of the fund’s capital comes from voluntary investors--municipalities and special districts that could withdraw all or part of their money on short notice.
“Their pulling out could be a problem,” Boland said, although there is no indication that anyone has done so. One reason Orange County sought bankruptcy protection was to prevent such withdrawals from its voluntary investors.
Market experts say fears that other municipalities played the investment markets as wildly as Orange County--and thus may be subject to similarly catastrophic losses--may hurt the market for all California municipal borrowers.
“I suspect there may well be other municipalities in California that have indulged in similar activities,” said DeWitt Bowman, former chief investment officer for the California Public Employees Retirement System. “I hope we’re not looking at the tip of the iceberg.”
Many municipalities say they are occasional users of such devices as reverse repurchase agreements, in which an investor pledges a bond as collateral to borrow money; in certain cases the deals can grind out a slight additional investment return.
Orange County used these “reverse repos” as cash generators to make further investments, building its portfolio into a massive--and losing--bet on interest rates. County and city treasurers interviewed Wednesday said for the most part they entered these deals sparingly and almost always backed them up with opposing deals that would cover any potential losses.
Market participants around the state say localities fall into two groups: Small cities and counties with scant resources for investment, and large ones with plenty of spare cash to place in the market. In each category some are known as more conservative than others.
Both Los Angeles city and county are known as particularly conservative investors, market participants say.
Of the city of Los Angeles’ general pool of about $3 billion, about 25% is in securities that mature over the next five weeks, said Henry Davis, chief investment officer, including at least $200 million that will mature over the next 30 days. The city also sedulously avoids reverse repurchase agreements and other complex strategies aimed at improving investment return by assuming greater risk.
As for the county, Jeffries says his portfolio of about $6 billion has an average maturity of slightly over one year and that 41% of his holdings mature within 60 days.
