ORANGE COUNTY IN BANKRUPTCY : Selling Off Another Chunk : Salomon Bros. Unloads $1 Billion From Bankrupt Fund

Salomon Bros. unloaded $1 billion in securities from Orange County’s bankrupt investment fund on Friday--double Thursday’s pace--while cautioning that the hardest sales lie ahead.

In the second day of the court-approved liquidation process, Salomon auctioned longer-term conventional bonds with a principal value of $566 million, and also sold the first of the portfolio’s complex “derivative” securities: $440 million in foreign bank-issued “structured” certificates of deposit.

The bond auction fetched $4.8 billion in bids and what bond dealers said were good prices. The U.S. government agency bonds, maturing in 4 1/2 to 10 years, were sold for 96 cents to 98.75 cents per dollar of face value.

Those were higher prices than what Salomon received on the $483 million of shorter-term bonds sold Thursday. Salomon said the bonds sold Friday were issued more recently and thus paid interest rates closer to market yields--reducing the need to discount their prices.

Buyers of Friday’s batch of bonds garnered yields between 7.7% and 8.7%.

With Friday’s auction, the bulk of the county fund’s conventional bonds are gone, leaving mostly derivative bonds. The latter will be much tougher to sell.

The fund began the week with a market value estimated by Salomon at $7.96 billion. But that included $2.56 billion in bonds held as collateral for loans still outstanding to the fund, which had borrowed massively in a wrong-way bet on interest rates this year.

Excluding the collateral bonds--most of which are held by Merrill Lynch & Co., which has not said when it might sell--the remaining portfolio was worth $5.4 billion at the start of the week. The sales Thursday and Friday have reduced that to less than $3.9 billion.

Most of what remains are so-called structured notes issued by U.S. government agencies. Such notes are set up to pay fluctuating interest returns depending on changes in market rates.

Because former county treasurer Robert L. Citron believed that market interest rates would fall this year, he invested heavily in notes that would pay more interest if rates declined--but less if rates rose. The surge in rates since February has slashed the interest earnings on many of the notes and sharply devalued them.

While Salomon officials were encouraged that they were able to sell $440 million in structured CDs on Friday, they cautioned that Wall Street’s expectations that the rest of the notes will be unloaded next week may be too optimistic.

With the holidays thinning investors’ ranks, “The county is going to have to decide whether the market environment is appropriate to proceed” with the liquidation, a Salomon executive said.

Moreover, he noted that there are “perhaps as few as 25” major financial firms that have the sophistication needed to evaluate and bid for the fund’s derivative notes.

The risk to the county in delaying sale of the notes is that any new rise in market interest rates would further devalue them, deepening fund losses. Salomon early this week estimated that fund participants would get back 73 cents on the dollar, overall, if the investments were sold at current market prices.

Many analysts believe that, rather than sell the notes in the market, Salomon will restructure them with the U.S. government agencies that issued them--a solution that could be slightly less costly to the county.

Negotiations with all of the agencies involved, including the Student Loan Marketing Assn. and the Federal Home Loan Bank System, are continuing, but it isn’t clear that deals can be struck before Christmas, sources say.

* UNDER FIRE

KPMG Peat Marwick failed to warn of O.C. problems. A1

Merrill Lynch yanked from MTA’s underwriter list. D2

More coverage: A1, A24-25, D2

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There’s Bad--and Then There’s Really Bad

Granted, 1994 hasn’t been a great year for investors. But the performance of Orange County’s investment pool, which bet big--and wrong--on lower interest rates, nonetheless looks devastatingly bad in comparison with other investment programs. The Orange County fund has lost 27% of its value since Jan. 1. Here’s how other investments and indexes have fared since Jan. 1:

Five-year bank CD*: +4.6%

Money market mutual funds: +3.5%

One-year bank CD*: +3.0%

Passbook savings: +2.0%

Dow Jones industrial average: +1.4%

Under your mattress: 0.0%

Gold: -3.1%

Blue-chip stock mutual funds: -3.1%

30-year Treasury bonds: -7.7%

Orange County investment pool: -27.0%

* Opened at beginning of year.

Sources: Bloomberg Business News, Bradshaw Financial Network, Lipper Analytical Services, Merrill Lynch, Bank of America. Calculations are total returns, including principal value and yield.