ORANGE COUNTY IN BANKRUPTCY : $11.4 Billion in Collateral Sold by Brokerages

Orange County officials disclosed Friday that investment firms have sold $11.4 billion in bonds they held as collateral on loans to the county, deepening the county’s financial crisis as a swarm of investigators stepped up inquiries into the debacle.

Those sales--made in spite of the county’s bankruptcy filing--mean its investment fund has lost hundreds of millions of dollars it may never recover, financial analysts said.

“The worst of all possible things has happened,” said Zane B. Mann, publisher of the California Municipal Bond Advisor newsletter. “The money is frozen in the pool, and the assets that secure the pool have been cut in half.”

Ernie Schneider, the county’s administrative officer, said even the county does not know how severe a blow Wall Street firms have dealt the investment pool, which includes investments from 185 cities, school districts and other agencies.

One bright spot--however meager--is that even though the fund is frozen, its cash holdings have improved as some county-held securities matured this week, he said. The pool, which had $350 million in cash when bankruptcy was declared, has $500 million or more in cash now.

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“We’re expecting to deal with this situation by ourselves,” Schneider said. “Orange County has always lived within its means. Always.”

In other developments Friday:

* County officials acknowledged that the Board of Supervisors had authorized former Treasurer Robert L. Citron to invest in so-called reverse repurchase agreements, loans that allowed him to balloon the fund’s size almost threefold. Supervisors approved the practice in 1985 and have not revisited the issue since.

* Citron, 69, who resigned Sunday, hired an attorney, former federal prosecutor David Weichert, a criminal and civil litigator who represented one of the executives in Charles H. Keating Jr.’s financial empire.

* The county district attorney’s office said it would expand its inquiry into the crisis to include allegations that Citron may have accepted improper gifts from financial investors.

* Willie Brown, the Assembly’s Democratic leader, said he was seriously considering calling a special session of the lower house Dec. 20 to deal with the Orange County fiscal disaster. Brown, the Assembly’s presiding officer in the wake of a deadlock over the speakership, said other lawmakers are urging him to send a reassuring signal to Wall Street.

“I don’t have a solution, but I think the banking world would love to see some action by respected elected types in Sacramento that they are at least trying to solve the problem,” he said.

* Gov. Pete Wilson said he will send a team from the state Department of Finance to Orange County to help former state Treasurer Thomas Hayes, the county’s new financial adviser. Wilson said he believes Orange County’s crisis stems from problems with an individual--Citron--not the system.

Wilson said the state might advance money to Orange County to assist with cash flow, but has no authority to guarantee future loans to help it build back its finances.

* County officials filed a lawsuit against Nomura Securities Co., a brokerage that seized and sold $900 million worth of the county’s bond holdings this week. Officials promised further action against the Wall Street firms that sold a total of $11.4 billion in bonds they held as collateral on loans the county took to boost what has proved an ill-considered bet on falling interest rates.

* Merrill Lynch, a key county financier, is under investigation by both the Securities and Exchange Commission and the National Assn. of Securities Dealers for its financial dealings with the county, which Tuesday became the largest municipality in U.S. history to file for bankruptcy protection. Both Merrill Lynch and another brokerage, Rauscher Pierce Refsnes, were subpoenaed by the SEC.

* Paychecks went out on time to 28,000 school bus drivers, cafeteria workers and secretaries throughout the county, as promised. The local teachers credit union offered emergency loans to members if paychecks are delayed because of the crisis.

* The financial catastrophe prompted Laguna Beach school officials to halt plans to renovate classrooms at Thurston Middle School that were destroyed by last fall’s firestorm.

Most city officials in the county said they expect to be able to make payrolls, pay vendors and cover routine expenses for the immediate future.

“But it’s going to be tight as hell,” La Habra City Manager Lee Risner said. “If anything serious goes wrong or a disaster occurs during the year, then God have mercy on our soul.”

An advisory committee of six city managers announced two priorities: gaining control of their share of tax money as it is paid to the county and trying to separate city money in the investment fund from what is being considered “county assets.”

Raising the stakes in their battle with the county, Wall Street brokerages confirmed Friday that they collectively are hanging onto $100 million to $200 million due the county on their sales this week of the $11.4 billion in county-owned securities. The $100 million to $200 million represents excess collateral the firms held on the county’s loans.

The brokerages apparently are refusing to forward the cash to the county because of the lawsuit filed Friday in federal bankruptcy court in Santa Ana against Nomura Securities, alleging that the seizure and sale of the securities was illegal.

The suit alleges that the brokerage violated an “automatic stay” imposed by the bankruptcy filing when it sold the county’s securities on Wall Street this week. Bruce Bennett, the county’s bankruptcy lawyer, asks that Nomura be held in contempt of court and forced to replace the $900 million in securities plus compensatory and punitive damages and legal fees.

Bennett and Schneider said other suits are likely to follow next week. “We will go after every single one of (the investment bankers selling collateral),” Schneider said.

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In a statement, Nomura declared that the suit was “baseless and without merit,” and said it would defend itself “vigorously.” Lawyers for Nomura and the other brokerages say the collateral sales were proper under a legal exemption from the stay.

The securities sold were held as collateral for loans the brokerages had made to the county, as part of its strategy of leveraging its bet on bonds. When the county missed payments on some of the loans, the brokerages said they began exercising their right to sell the collateral and close out the loans--a process that triggered the county’s bankruptcy filing Tuesday and that continued in the days after.

Bennett said he believes the county will ultimately get that money back.

One of the most important questions--exactly what is left in the county fund, after this week’s forced sale of the $11.4 billion in collateral--remains the subject of speculation because the county will not provide figures.

Bennett said newly appointed financial consultants from the New York investment bank Salomon Bros. were trying to determine the current value of the portfolio. They have “been instructed to prepare comprehensive reports as soon as is humanly possible,” he said.

Assuming the county was on target last week in estimating that the fund had a current market value of $18.5 billion, the $11.4 billion in securities sales this week by brokerages would have reduced the fund to about $7.1 billion.

That total could be further reduced by $2.1 billion in loans still outstanding to Merrill Lynch and Donaldson Lufkin & Jenrette Securities--meaning the fund could contain bonds worth just $5 billion, or 36% less than the $7.8 billion the county has said its investors put in.

Last week, the county said the net loss on the portfolio was about $1.5 billion, or about 20% of investors’ capital. And some Wall Street executives said Friday that the value of the remaining securities could be significantly greater than $5 billion, meaning that the county’s $1.5-billion loss estimate may still be in the ballpark.

Until the county details the portfolio, however, the extent of the fund’s losses won’t be known.

Others saw more losses coming.

Peer Swan, chairman of the Irvine Ranch Water District, an investor in the portfolio, predicted that the fund’s losses could total $2 billion to $3 billion.

Making the situation even worse, some say, is the fact that the $11.4 billion that has been sold included the county’s most solid securities, while the holdings that are left are shakier.

Mann of the California Municipal Bond Advisor said it was impossible for outsiders to speculate on the exact value of what remains in the pool because the county has not released the exact design of the portfolio.

“Until this winds down, and I’m thinking several days or weeks, the local communities are not going to have any idea what they’re going to salvage from this,” Mann said. “Some day the whole thing is going to be unwrapped and people are going to be paid. What’s completely obscure right now is: Is that going to be 50 cents on the dollar? Or 5 cents?”

Mann also pointed out that legal fees and administrative costs often eat up large chunks of the resources in bankruptcy cases. County officials have refused to provide estimates of how much is currently being spent on extra personnel to solve the crisis, except to say that their lead bankruptcy attorney is paid $375 an hour.

Earlier this week, two class-action lawsuits were filed on behalf of investors holding Orange County bonds. Lawyers indicated more are on the way.

One was filed on behalf of Leetate Smith, a retired insurance executive in Rancho Santa Fe, and another on behalf of a woman named Janice Morgenstern.

They both name former county treasurer Citron, his then-assistant Matthew R. Raabe, county Auditor Steven E. Lewis and Merrill Lynch, which underwrote much of Citron’s bond trading, as defendants. The county itself is not named as a defendant, attorney Edward M. Gergosian said, because it has the shelter of bankruptcy protection.

The SEC’s inquiry into the county’s dealings escalated with the delivery of subpoenas to Merrill Lynch and Rauscher Pierce Refsnes. Both investment houses were involved in a multimillion-dollar Orange County bond deal that has spurred questions about whether disclosure laws were followed. The firms denied any wrongdoing.

SEC officials, in a statement Friday, said that they cannot set investment policy for municipalities, but that the commission does have “authority and responsibility” to regulate dealers and “eliminate corrupt practices.”

In Washington, sources said the National Assn. of Securities Dealers has opened an investigation into $3,000 in contributions from three Merrill Lynch employees to Citron during the treasurer’s hotly contested reelection campaign earlier this year.

The district attorney’s office said Friday that it was expanding its review of the imbroglio to include an inquiry into whether Citron violated restrictions on such gifts that went into effect last year. Citron received more than $400 in gifts from 14 investment firms active in the county’s retirement fund.

“Bob has had an exemplary record of public service for over 20 years,” Citron’s new attorney, Weichert, said late Friday. “There is no fathomable reason why such a distinguished public servant would knowingly jeopardize the financial soundness of the county.”

Investigators asked to talk Friday with Raabe, now the county’s acting treasurer, but he declined to speak with them until he had consulted an attorney.

Friday was a low-profile day for top county officials, including newly appointed financial adviser Hayes, who declined requests for interviews and spent hours behind the closed door of a fifth-floor Hall of Administration conference room being guarded by a sheriff’s deputy.

County officials shuttled in and out of the so-called “war room” that was set up at the county’s administrative headquarters.

Sandra Sternberg, who is acting as spokeswoman for the county during the crisis, said the Board of Supervisors canceled its scheduled Friday meeting and a press conference because the supervisors are too busy in marathon briefings behind closed doors with their financial advisers and lawyers.

“They’re trying to get the team together,” Sternberg said. “They’re working the weekend, to take a look at this thing, come back fresh on Monday and answer some questions. It’s just disruptive,” she said of media inquiries. “These people are working.

Citron’s absence from the building was being felt in many ways.

“The one person who knew everything (about the investment fund) is not here anymore,” Sternberg said. “We need to have all the pieces of the problem before we can put this thing together. This is probably the first long, hard look at the county’s financial situation that’s been done in 20 years.”

At 6:50 a.m., Hayes was behind a desk with the receiver to his ear and a cup of coffee in his hand, trying to calm the financial markets in New York and help restructure the county’s ever-growing debt.

“He’s raised my comfort level a great deal,” Board of Supervisors Chairman Thomas F. Riley said.

Throughout the day, Hayes met with bankruptcy attorneys, county supervisors and other high-level county officials, including the county’s chief administrator, auditor and district attorney.

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One floor under Hayes’ war room, a team of lawyers discussed legal strategies. At noon, half a dozen attorneys, who had flown into the county, went directly to the Hall of Administration with briefcases and luggage in hand.

Meanwhile, problems similar to those sinking Orange County’s finances were emerging for risk-taking municipalities around the country.

Reports of investment losses have appeared around the country since Orange County’s debacle became known, affecting communities in Texas, Florida, Kentucky, Maine, Maryland, Illinois, Wyoming, West Virginia and elsewhere.

On Friday, Moody’s Investors Service put the bond rating of Walworth County, Wis., under review for possible downgrade after the value of its investments plunged.

Even where there has been no significant drop in value, nervous Wall Street brokers are keeping a close eye on some funds--such as that of San Bernardino County.

Salomon Bros. on Friday issued a $300,000 call for additional collateral to that county after the value of securities in its $2.4-billion investment pool dipped by $150,000, said Assistant Treasurer-Tax Collector Dick Larsen. About a third of that fund is borrowed money, using reverse repurchase agreements, a type of loan.

And investors appear to be edgy about their money as well. A story in Friday’s Wall Street Journal, drawing analogies between Orange County and the investment pool for the state of Texas, spurred a mini-run on the pool, with investors pulling $326 million out in one day, leaving about $3.3 billion. The fund, called TexPool, invests money on behalf of more than 1,350 school districts, municipalities and others.

Times staff writers Matt Lait, Greg Hernandez, Greg Johnson, Rebecca Trounson, Nancy Wride and Chris Woodyard in Orange County, Henry Weinstein in Los Angeles, Eric Bailey in Sacramento and Scot J. Paltrow in New York contributed to this story. Correspondents Mimi Ko and Russ Loar also contributed.

(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

BUDGET PROFILE, 1994-95

General Fund Appropriations by Program

Environmental Resources: 20%

Public Protection: 16%

Community & Social Services: 16%

Debt Services: 14%

Insurance, Reserves & Misc.: 14%

General & Government Services: 8%

Health Services: 6%

Capital Improvements: 6%

(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

General Purpose Revenue by Source

Interest: 35%

Property Taxes: 25%

DMV Fees: 21%

Fund Balance Available: 12%

Sales & Other Tax: 4%

Other: 3%

(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

Authorized Positions by Program

Public Protection: 42%

Community & Social Services: 21%

General Government & Services: 14%

Health Services: 13%

Environmental Management: 9%

Insurance, Reserves & Misc.: 1%

Source: Orange County Administrative Office

(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

Collateral Damage

As Orange County ended its first week in bankruptcy:

* Attorneys for the county sued Nomura Securities, the first of several expected challenges aimed at recouping $11.4 billion in bond holdings sold off by Wall Street firms.

* The Securities and Exchange Commission issued subpoenas to two brokerage houses as part of an investigation of Wall Street’s role.

* County officials acknowledged that they failed to heed warnings that the treasurer’s office was out of control.

* The county district attorney’s office said it was reviewing allegations that ex-treasurer Robert L. Citron accepted improper gifts from Wall Street advisers.

How Much Is Left?

Officials won’t answer questions about the condition of the county’s investment pool.

* However, after Wall Street’s seizures of collateral--and with the continuing fall in the value of the county’s holdings--the fund is worth between $5 billion and $6.3 billion, a 20% to 36% loss, some analysts estimate.

Living on Borrowed Funds

The collapse of the investment pool was accelerated by Citron’s massive borrowing. At first, investing borrowed money helped raise returns. But when interest rates started climbing, the loans grew too costly.

(In billions of dollars:)

*6/92

Holdings: $4.7 billion

Borrowings: $3.9 11/94

Holdings: $7.8

Borrowings: $12.9

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Sources: County annual audits, county investment portfolio statements, Times reports * BANKRUPTCY COVERAGE

Related Orange County stories inside. A20-A23, D1