Selloff Leaves County With Riskiest Items
Last week’s mass sale of Orange County’s portfolio holdings by its lenders consumed many of its most conservative and marketable securities, leaving it with the riskiest and most exotic investments, financial experts close to the county’s rescue effort said Sunday.
The residual holdings, which the bankers valued at $5.5 billion to $6 billion, are also “enormously” vulnerable to changes in interest rates, said one source familiar with the portfolio--an exposure the financial team is laboring to curtail as it attempts to unwind the county’s ill-starred bet on an interest rate decline.
“We’re trying to create a transaction here that stops the bleeding, stops the losses,” one source said.
The bankers’ latest estimate of the portfolio value is equivalent to a loss of $1.5 billion to $2 billion, about in line with most recent estimates. But they cautioned that the figure is a “snapshot” of the portfolio’s value and could fluctuate sharply with changes in interest rates or with the pace or manner in which the holdings are placed on the market.
“If I were to say the value is $5.5 billion, I might be dead right at this moment,” said one source close to the county, “but when you throw $11 billion on the market you’ll have gaps in the market price.” The $11 billion is the estimate of how much of the county’s collateral its Wall Street lenders sold last week.
Consequently, sources say, the county’s advisory team from the Salomon Bros. investment firm is trying to develop strategies aimed at unwinding the county’s investments as cautiously as possible while protecting against its tremendous interest rate risk. Such strategies might include using interest rate futures and options that become more valuable as rates rise, thus offsetting further losses in the portfolio.
“You’ve got to go in and price and value every security, then hedge against the risk,” said one source familiar with the effort.
Complicating the situation is the condition of record-keeping at the county. Sources close to Salomon said that among the obstacles it faces is that crucial documentation establishing the fund apparently does not exist.
That means there are few papers spelling out who controls or legally owns the investment fund, as well as how it is governed and what to do in the event of default.
“It appears that everything was very informal for handling huge amounts of money,” said a person familiar with the Salomon group’s work.
Such documentation would help to decide how to apportion losses or income from the sale of securities among the funds’ investors; its absence could substantially delay efforts to quickly stanch the funds’ losses and sell off its riskier holdings, the sources said.
Although the advisory team has apparently found many of the same kinds of record-keeping discrepancies identified by The Times on Saturday, including securities that could not be immediately identified and others that remained listed on inventory records even after they matured or were sold, these gaps are not considered serious.
The sources ascribed the discrepancies largely to “clerical” errors and said they are not expected to affect bottom-line calculations of the portfolio’s value. Such bookkeeping errors are not unusual in comprehensive audits of the kind being undertaken with the county investment fund, one source said, and do not now point to any fraud on the part of the county’s investment guardians.
“There’s nothing that doesn’t look ultimately documentable,” said one source. The Salomon team is working largely with records held by the county’s investment trustee, Bank of America, which are considered to be the most authoritative.
Once the nature of the portfolio is established, the financial team will turn its attention to how best to extricate the county from its perilous bet on interest rates. This involves selling the riskiest or most volatile and complex securities.
But the bankers are particularly determined to avoid a “fire sale” in which large blocks are dumped on the market, where they might become subject to opportunistic bidding.
Among former county Treasurer-Tax Collector Robert L. Citron’s purchases were securities whose interest payouts were pegged to several different benchmarks. Pricing such paper for sale involves assessing the future course of each benchmark and their possible interrelationships, a task requiring banks of high-powered computers.
After the selloff of the county’s more conventional holdings by its Wall Street lenders, such securities are now overrepresented in the portfolio, sources said. The residual holdings tend also to be longer-term securities, which are more sensitive to interest-rate changes than those that would mature--that is, be paid off by their issuers--in the nearer term.
For all that, sources familiar with the workout team’s deliberations became increasingly critical of Citron’s investment strategy as the scale of his bet on interest rates became clearer over the weekend.
Particularly dangerous, some say, was his insistence that the portfolio’s dizzying plunge in value this year represented only “paper” losses of principal that did not need to be recorded. As he described it to county supervisors in an interim report in September, Citron’s policy was to hold all securities to their maturity dates, when they would be paid in full and the principal losses would disappear.
That policy, however, allowed him to blind himself to the reality that the market was moving sharply against him. In fact, one analyst said, had Citron not locked the portfolio so deeply into an expectation of falling rates, he would have been able to sell some of his holdings to take better advantage of the higher interest being paid on bonds and notes across the investment spectrum.
Instead, the portfolio was saddled with securities that were designed to pay out less interest as rates rose--and those are the securities for which the advisory team must now find buyers.
Hiltzik and Vrana reported from Los Angeles, Paltrow from New York. Times correspondent Hope Hamashige also contributed to this story.
