ORANGE COUNTY IN BANKRUPTCY : Fund’s Liquidation Strategists Lay Out 6-Month Plan to Sell : Q & A
Former state Treasurer Thomas W. Hayes, now a consultant to Orange County, and William D. Rifkin, a managing director of mergers and acquisitions with Salomon Bros. in New York, laid out their strategy Tuesday for liquidating the county’s investment pool.
When they are done, Rifkin promised, “it’s all going to go.” While some experts question that strategy, county officials and their advisers say it may be the only politically palatable option, ridding the county of its holdings of controversial derivatives.
Government agencies invested about $7.4 billion in the pool; Salomon estimates the holdings would fetch $5.4 billion if they were sold today.
Working around the clock since Friday, a 30-member Salomon team developed the preliminary strategy that may include some type of hedge against rising interest rates for the more volatile, hard-to-sell securities left in the portfolio.
Though it won’t conduct a fire sale, the county intends to sell its remaining securities within 180 days, Hayes and Rifkin said in an interview.
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Q. How will the county restructure its portfolio? Can you hedge against the risk?
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A. Hayes: I’m not saying we are going to hedge or not. That’s certainly an option. Our goal is to, as orderly as possible, execute trades that will reduce the risk and volatility in the portfolio. And that will shorten the time frames and make the fund more consistent with what I believe should be in a short-term money fund for a government.
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Q. So you want to start liquidating the fund immediately?
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A. Hayes: Correct. We are going to do it prudently. If there is something to do (today) that makes sense, we are going to do it. If it doesn’t, we won’t. I want to be upfront with the people in the financial community that this is not a fire sale. And I don’t want to create the atmosphere of a fire sale. Orange County is still a very economically viable county, and we are going to take full advantage of that in how we deal with the portfolio.
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Q. What particular assets would you attempt to sell first?
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A. Hayes: I think we’re working on everything simultaneously, and we will make our decisions on what is in the best interest for the fund and the people in Orange County. Relative to what we will do first, it will depend on what the market is. If we see something that comes along very quickly that will shorten the average maturity of the (bonds of) government agencies in the portfolio, it might be first.
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A. Rifkin: There is very little in the portfolio now that will be there when the process is completed. It’s all going to go. So it really doesn’t matter what we sell first.
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Q. Why not hold on to the government and Treasury bonds in the portfolio until maturity? Won’t that reduce losses?
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A. Rifkin: It’s too long-term. It has got an average maturity of four years, and that’s just too long.
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Q. Won’t selling this huge portfolio in 180 days or less be extremely difficult?
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A. Hayes: It will be complex, it will be difficult, but I think we’re up to it.
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A. Rifkin: The value we put on the (remaining) portfolio, the ($5.4) billion, is the value at which we think it can be sold. We factored into the price that it is a very large portfolio and that a number of these instruments are not conventional instruments. We are confident we can sell the securities at this price if interest rates do not change. If interest rates change, it may be worth more, it may be worth less.
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Q. One of your options is selling the entire portfolio at once. How likely is that?
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A. Hayes: It depends on the price. It certainly is not an option we are going to discount.
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Q. Who do you see as likely buyers? Insurance institutions, mutual funds?
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A. Rifkin: All of the above, and other dealers.
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Q. How short should the Treasury maturities be in the restructured portfolio?
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A. Hayes: I can go back to when I was state treasurer. I had a portfolio that was about 180 days in length. I thought that was appropriate for a state money fund. I think for this fund, we will bring the maturity down even lower than that. You need shorter maturity.
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Q. Let’s talk about portfolio value. Last week it was valued at $7.8 billion in actual contributions by the pool participants. Now you are saying they contributed $7.4 billion.
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A. Hayes: I don’t know where that (higher) figure came from. We are confident in these numbers, but they are unaudited numbers.
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A. Rifkin: We have a portfolio list from Bank of America, the trustee, and we are reasonably confident of what is in the portfolio. But it has not been audited. So we hope it’s right.
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Q. How damaging was the $11.4-billion sale of collateral by brokerage firms last week? (Brokerages that lent the county money to buy more bonds redeemed their collateral when the county began failing to make loan payments.)
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A. Rifkin: I don’t think it was all that material. It reduced flexibility. But from a value standpoint, it really was a small factor. The real culprits are increased interest rates and leverage.
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Q. Wouldn’t it be tough to sell this security by security?
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A. Rifkin: Well, there are only on the order of 85 to 90 securities in this portfolio. The principal amounts are large. We aren’t talking about $1,000-denomination bonds.
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Q. What are your other options?
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A. Rifkin: We could approach Sallie Mae (the Student Loan Marketing Assn., which provides a secondary market for student loans), and I am using them as an example. We would approach a federal agency and see if there is a way--at no economic cost--whereby we can turn their structured note into a more conventional security.
As an example, when an agency issues an inverse security, it isn’t interested in selling inverse floaters; it’s trying to raise money at the lowest possible cost. So it would combine that issuance with some sort of other instrument, like an interest rate swap, and turn it into a more conventional borrowing with a fixed or floating rate. It’s possible for us to put the two pieces back together and then have the agency issue a more traditional, more conventional security. Then we would sell that. Now, that’s not to say we can’t sell the inverse floater; we can. But we may be able to get a better deal this way.
We’ve approached some of the agencies and they seem receptive. I don’t want to say which ones. I’m not trying to say we’re dependent on the agencies--we’re not--but it would be nice if they would assist.
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Q. But wouldn’t that involve more derivatives?
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A. Rifkin: No, we would not do a derivative. The agency has already done a swap, so if we could convince them to combine the swap with the (underlying) instrument and reissue a more conventional security, that would be helpful.
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Q. And who would pay the costs for these new issues?
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A. Rifkin: There wouldn’t necessarily be any issuance costs, because you would be dealing directly with the agency. Now, these are just ideas, ideas we’re kicking around.
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Q. Initially, there appeared to be discrepancies in the portfolio, securities that didn’t exist. Has that been cleared up?
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A. Rifkin: When we first went through it, we found discrepancies, but we found explanations. So that seems to be accurate.
