ORANGE COUNTY IN BANKRUPTCY : Portfolio of ‘Safer’ Bonds Held Some of the Most Risky : Securities: Records show that it borrowed to make further investments. Municipalities that used the fund say they were misled.

The “safe” Orange County bond pool designed to hold short-term money for 13 agencies and cities actually held some of the most volatile and risky securities purchased by county Treasurer Robert L. Citron, portfolio records show.

An inventory of the bond pool’s portfolio dated Dec. 31, 1993, shows that for every dollar invested, the pool had borrowed about $1 to make further investments. Although that level of borrowing did not approach the 3-to-1 leverage in the county’s main investment fund at the time, it was still much higher than many of its investors expected.

Overall, the portfolio inventories, examined Tuesday by The Times, document county investment adviser Thomas W. Hayes’ assertions last week that the two pools resembled each other, both in the nature of their investments and in that they used leverage to boost investment yields.

The character of the two pools--the $1.2-billion “bond pool” and the theoretically riskier $6.6-billion “commingled pool,” which had investments from 187 public entities--has become an issue in Orange County’s bankruptcy.

The reason: The 13 municipalities with money in the bond pool contend that they were assured by Citron that their money would be segregated and managed separately from the larger fund.

The bond pool should have been safer, they say, because it was made up largely of proceeds of tax-exempt borrowings. Under federal law, municipalities may not earn more in interest from the proceeds of tax-exempt bonds than they pay out in interest on those bonds. Any excess must be rebated to the federal government.

Accordingly, the bond pool investors argue that they should be protected from shouldering the loss of as much as 27% projected for the county’s investments as a whole.

Moreover, what Citron did and did not disclose about how he was investing the municipalities’ money are among the issues being investigated by a raft of federal, state and local authorities.

“We obviously thought it would be a lot safer,” said Gary Burton, deputy director of finance and administration for the Orange County Transportation Authority, the bond pool’s largest investor.

Other investors in the bond pool include the county itself; the Transportation Corridor Agencies; the Orange County Sanitation District; Coast Community College; the Irvine Unified School District; the cities of Santa Barbara, Yorba Linda, Newport Beach and Santa Ana; the Moulton Niguel and Santa Margarita water districts and the Midway City Sanitary District.

The portfolio records indicate that as of last Dec. 31, derivatives accounted for almost exactly the same percentage of total holdings in the bond fund and the county’s portfolio as a whole--21%. Because more recent portfolio lists are not available for the two funds, it is unknown to what extent the portfolios changed over the last year.

Still, at year-end 1993, the bond pool contained a substantial volume of securities representing highly volatile bets that interest rates would remain steady or decline.

For example, one $4-million investment purchased in July, 1993, paid interest of 12.7% minus two times the six-month London Interbank Offering Rate, a standard money-market interest benchmark.

As rates declined, the security would pay sharply higher interest. Instead, however, they have risen, and the interest payable on the note has dropped from 5.575% last December to only 0.45% last month. The interest rate is to be recalculated in May, but at current LIBOR rates of 6.5%, the security would pay zero interest. Its market value would deteriorate accordingly.

It could not be determined if the county bond pool still owns the investment.

Bond pool investors say Citron paid them as much as two percentage points less in yearly interest than was paid on the larger commingled fund, presumably because their investment earnings were limited by law. As a result, many officials say, they assumed that their money was invested in conventional short-term securities paying market interest rates.

“I wasn’t aware of any of these structured notes (derivatives),” said Gary Streed, director of finance for the Orange County Sanitation District. “Whether they were there wasn’t a question I thought needed to be asked.”