ORANGE COUNTY IN BANKRUPTCY : A Bit of Good News : Drop in Rates Helps Get Bond Liquidation Off to Strong Start
The liquidation of $7.96 billion in bonds owned by Orange County’s bankrupt investment fund got off to a strong start Thursday, helped by rising expectations that the Federal Reserve Board will defer further credit-tightening moves until next year.
Salomon Bros., the brokerage managing the liquidation, said it sold county-owned U.S. government bonds with a face value of $483 million in a wide-open auction that attracted $7.5 billion in bids.
A sharp decline in shorter-term market interest rates Thursday gave Salomon a tail wind in unloading the bonds, which were conventional issues maturing in 2 1/2 to four years.
Analysts said the bond market was cheered by two economic reports suggesting that the pace of growth is slowing. That may allow the Fed to delay another hike in short-term interest rates, which many analysts had expected would come when central bank policy-makers meet next week.
As shorter-term market interest rates eased Thursday, bidders for the county’s bonds were willing to accept lower yields than they would have demanded a few days ago, traders said. Lower yields translated into higher prices paid for the bonds, which puts more cash back into the devastated investment fund.
Salomon said the bonds fetched between 89.5 cents and 94.5 cents per dollar of face value. “We were very pleased with demand,” one Salomon trader said.
However, those prices were below the average value of 95.5 cents on the dollar that Salomon ascribed to the “conventional” part of the bond portfolio on Monday. At the time, many Wall Street analysts said Salomon’s valuation of the portfolio seemed optimistic.
Nonetheless, Wall Street traders at rival brokerages said the prices paid in Thursday’s auction were far better than the market had expected.
“These prices are on the moon,” a trader at a Salomon competitor said.
The bonds’ prices were at a discount to their face value of 100 cents on the dollar because the securities had been issued at significantly lower interest rates over the last two years. When purchased by the county fund, the annualized fixed-rate yields on the bonds were in the 4%-to-5.7% range.
On Thursday, the discounted prices paid by the buyers translated into annualized yields of 7.90% to 8.02%, returns that take into account the interest coupon and the capital gain when the bond matures at full face value.
Wall Street’s measure of the success of such an auction is the extent to which yields on these U.S. government agency securities top the yields available on bonds issued directly by the U.S. Treasury.
Because U.S. government agency securities, such as bonds issued by the Federal Home Loan Bank System, are considered slightly riskier than direct obligations of the Treasury, the former pay yields above those on comparable-maturity Treasury bonds. But that yield spread can vary.
In Thursday’s auction, the average yields demanded by buyers ranged from 0.24 point to 0.365 point above the market yield on the three-year Treasury note, which Salomon set at 7.657% at midafternoon.
Traders said investors’ willingness to buy the bonds at those spreads represented a significant improvement in the market from last week--when the county fund’s creditor brokerages were liquidating $11.5 billion in similar government agency bonds they held as collateral for loans to the fund.
Yields on U.S. agency bonds shot up to as much as 0.65 point above comparable Treasury yields last week, at the height of the collateral selloff, traders said.
“Anyone who bought last week now is looking like a genius,” one bond trader said.
The implication is that the brokerages that dumped the collateral bonds last week were doing so at “fire sale” prices, some traders said. That could boost the county’s legal case against the brokerages: The county has sued one brokerage, Nomura Securities, and has pledged to sue the others on the grounds that they illegally seized and sold the collateral bonds.
The brokerages argue that they were within their rights to sell the collateral after the county defaulted on loan payments.
Traders said a big reason Thursday’s sale went well is that the market trusts that Salomon’s auction of the Orange County portfolio will be orderly, as has been pledged by former state Treasurer Thomas W. Hayes, who is overseeing county finances.
In contrast, the bond market was fraught with uncertainty last week as the collateral bonds were liquidated and as traders guessed about the future of the rest of the portfolio.
Salomon officials said Thursday that they plan to sell another $566 million of county-owned bonds today. Like the securities sold Thursday, those auctioned today will be conventional fixed-rate bonds, though they mature further in the future: 1999, 2001 and 2004.
Salomon’s biggest challenge lies ahead: unloading the $4.7 billion in complicated derivative bonds that make up the bulk of the remaining portfolio.
Sources say those securities could be sold via auctions--with the most likely buyers major brokerages such as J.P. Morgan Securities--but are more likely to be unloaded through restructurings negotiated with the government agencies that issued them.
Analysts say that by renegotiating or liquidating the bonds with those agencies, such as the Federal Home Loan Bank System and the Student Loan Marketing Assn., Salomon should be able to wring more value out of the bonds than it could by selling on Wall Street.
The agencies themselves, all of which say they have already been contacted by Salomon, are expected to cooperate in renegotiations, though they have indicated they will not offer the county fund any type of deal that could be construed as a bailout.
* BROAD INVESTIGATION
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(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)
The Liquidation Begins
Here are details on Orange County investment fund bonds auctioned Thursday. The coupon yield shows what the fund earned on the bonds (assuming the fund paid par value). The yield as sold shows what the new owners will earn, because they paid a discounted price for the bonds.
Amount Coupon Avg. yield Issuer (millions) Maturity yield as sold FHLB $45 6/97 4.00% 7.91% FHLB 10 6/97 4.30% 7.90% FNMA 15 9/97 5.70% 8.00% FNMA 200 6/98 5.41% 7.99% FHLB 23 7/98 5.22% 8.02% FNMA 25 8/98 5.35% 8.02% FNMA 60 9/98 4.70% 8.01% FHLMC 100 9/98 4.75% 8.02% FNMA 5 12/98 5.30% 8.00%
Issuers: FHLB: Federal Home Loan Banks; FNMA: Federal National Mortgage Assn.; FHLMC: FederalHome Loan Mortgage Corp.
Source: Salomon Bros.
