‘Hemorrhaging Has Stopped,’ O.C. Leaders Say

Six weeks after declaring bankruptcy, relieved Orange County leaders said Wednesday they have stabilized the county’s beleaguered investment pool by selling nearly all of its riskiest securities and concluded that its losses are less than previously believed.

Former state treasurer Thomas W. Hayes pegged the county’s revised losses at $1.69 billion and said its cash flow has improved. Previously, the county’s financial advisers estimated the portfolio’s value had dropped $2.02 billion.

“‘The hemorrhaging in the pool has stopped,” said Hayes, who was hired to restructure the county portfolio that also includes the investments of 186 cities, school districts and other agencies. “The pool is now safe, very short-term and very liquid, with the ability of the county to pay its bills and to reach an early settlement with the investors.”

The revised figures mean the loss to the county pool was 22.3% on its participants’ $7.57 billion in deposits, down from an earlier estimate of 27%.

The improved outlook, however, is unlikely to help shrink the predicted shortfall of $172 million in the county’s general fund over the next six months; expected interest revenue still will not materialize in the wake of the county’s Dec. 6 bankruptcy, officials said.

“It means that there is more in the investment pool, but the yield on the investment pool is gone,” county spokesman Mike Kolbenschlag said. “That whole investment pool is tied up.”

The county’s advisers blamed poor bookkeeping by resigned Treasurer-Tax Collector Robert L. Citron and his staff for the shifting numbers.

“I think the Orange County accounting system needs to be brought into the 21st Century,” Hayes said. “We live in a state where we have access to computers. Any business out there uses computers. And while some of the records here were computerized, some were not.”

As Hayes made his announcement Wednesday:

* County Administrative Officer Ernie Schneider released his completed plan to fill the $172-million gap the county faces by June 30, the end of the budget year. Besides the $47.9 million the county already expects to save through layoffs and canceled projects, Schneider wants to reap about $17.4 million by charging impound fees on the cars of unlicensed drivers and withholding some extra payments into the county’s risk management and retirement funds.

*

Another $107 million would be covered by postponing some short-term debt payments, making additional budget cuts and seeking new loans. Several supervisors, however, said they would be reluctant to take on new debt while the county’s financial state remained so precarious.

* In the aftermath of a Sacramento hearing on the bankruptcy, members of a special Senate committee buckled down Wednesday to begin finalizing what new laws are needed to prevent any future problems--and help yank Orange County out of its predicament.

Some lawmakers, such as Sen. Quentin L. Kopp (I-San Francisco), talked about pushing for wholesale reform of the state’s legal checks and balances on municipal finance, which are among the most lax in the nation. Others want to work with a finer blade to carve careful regulations that will eliminate the pitfalls that plagued Orange County, but without completely hamstringing city and county treasurers.

The committee also began weighing a proposal to establish the sort of state-sanctioned independent corporation that was used to lift New York City out of its financial crisis in the 1970s.

* Board of Supervisors Chairman Gaddi H. Vasquez and Supervisor Marian Bergeson drafted a letter to Gov. Pete Wilson requesting a special session of the Legislature next month to review bills that could help Orange County emerge from the crisis. The legislative remedies include allowing the county to privatize some services and temporarily waiving state mandates for some health and welfare programs.

* Anaheim city officials were happy to learn that their short-term bond issues had been taken off of credit watch by Standard & Poor’s, a major credit rating agency--although the city’s long-term debt remains on credit watch.

Among the short-term bond issues that had been on credit watch was the $95 million the city borrowed last year to invest in the county pool. The city has $169 million invested in the fund.

“Anaheim is the first city to be taken off of credit watch, which is a tribute to our financial stability,” said city spokesman Brett Colson. “We are sure that Wall Street will react positively to this news.”

* Saddleback College President Ned Doffoney proposed $1.2 million in cuts in response to the county financial crisis. Officials want to hold off buying classroom chairs, office equipment and new computers for student labs. He said there is no money to repair leaks that sprung after last week’s rains. “We can’t make those important . . . repairs right now,” he said. The cuts must still must be approved by college district trustees.

* The Board of Supervisors hired underwriters Goldman Sachs & Co. and A.G. Edwards & Sons to help restructure the county’s debt and--possibly--underwrite new bonds. Schneider’s plan indicated that restructuring more than $107 million in debt is a critical step for the county.

*

While supervisors expressed great relief at word that estimates of the investment pool’s losses had narrowed, Board Chairman Vasquez warned that the crisis was still severe.

“We still have a long way to go,” he said. “We have some difficult decisions to make, not only relative to the portfolio but to the restructuring of government.”

Hayes said Wednesday the county’s investment fund is in much better shape, is beginning to earn moderate interest from its safer, short-term investments and is much less susceptible to any future interest rate hikes. With the restructuring nearly complete, the pool now holds mostly short-term government securities, such as U.S. Treasury bills. Hayes said the average maturity of the securities owned by the county were reduced from four years to about 10 days, meaning the fund has a better cash flow.

“This is the best news that I’ve had in six weeks,” Supervisor William G. Steiner said. “While it is still a terrible loss for Orange County and all pool participants, this is far, far, far better than we have expected and it makes the solution a little easier.”

As part of the restructuring effort, the county sold $58 million of high-risk securities Wednesday. County officials expect to sell or restructure the final batch of complex securities, about $380 million of so-called structured notes issued by U.S. government agencies, such as the Student Loan Marketing Assn., by the end of the week, said William D. Rifkin, managing director of Salomon Bros., the county’s financial adviser.

These notes were set up to pay fluctuating interest returns linked to changes in market rates.

Hayes revised the estimate on the county’s losses after auditors from the state and from Arthur Andersen & Co. spent “hundreds of hours” combing through the county’s antiquated bookkeeping records.

The auditors found $310 million in cash and $92 million in securities they had not known the county possessed, collected $40 million in bonds that had been held as excess collateral by county lenders and earned $36 million more than expected from selling county holdings.

“There were assets of the pool that were scattered all over the county,” Hayes said.

Earnings from securities sales exceeded earlier expectations by $36 million, Hayes said. The auditors also discovered that investors had $150 million more in the fund initially than was previously thought.

That was “unaccounted-for money,” said Hayes, adding that “there was no evil intent” or sense that the money was socked away by county officials for other purposes.

The net result of the auditors’ review? The fund’s losses were $330 million less than previously feared.

“There will be more money to distribute to investors,” Hayes sad. “How that is allocated will depend on the bankruptcy court.”

According to Hayes, the investment fund is in much better shape than at the time of the bankruptcy filing, is beginning to earn moderate interest from its safer, short-term investments and is much less susceptible to any future interest rate hikes.

*

The pool now holds mostly short-term government securities, such as U.S. Treasury bills. Hayes said that with average maturity of the securities now just 10 days, the fund is much more liquid.

As part of the effort, the county sold $58 million of high-risk securities Wednesday. County officials expect to sell or restructure the final batch of complex securities--about $380 million of so-called structured notes issued by U.S. government agencies--by the end of the week, Rifkin said.

These notes, from agencies such as the Student Loan Marketing Assn., or Sallie Mae, were set up to pay fluctuating interest returns linked to changes in market rates.

The pool is now earning about 5.4% interest, said Hayes, although how those interest earnings will be distributed among investors in the pool depends on how the 22.3% overall loss is shared.

“I would say that anybody who had money in the pool is in fact earning interest. It’s just not at the high market rates they were accustomed to,” Hayes said.

Hayes stressed that weaknesses in the county’s accounting system were so extreme that hundreds of millions of dollars in assets were “lost” and took a month to discover.

“A lot of adjustments had to be made,” Hayes said. “You need to fix that financial control system. You need to fix that accounting system. It’s industry standard that that information should be available instantaneously, not after a month and hundreds of audit hours.”

His job nearly over, Hayes said, he would be returning Feb. 3 to Sacramento, where he is president of Metropolitan West Securities.

Also on Wednesday, Schneider released a more comprehensive proposal for how the county should dig its way out a $172-million budget shortfall over the next six months. The proposal will be considered by the Board of Supervisors today.

A key element in Schneider’s recovery plan has the county restructuring or postponing payments on about $107 million of its short-term debt obligations. Essentially, Schneider is counting on the county’s ability to get new loans and stretch out existing ones to fill the budget gap. Those loans would be paid back over time as the county regains its financial footing.

“It must be stressed that even with restructuring of the short-term debt, long-term cost-cutting and revenue-enhancement measures are absolutely critical to the recovery effort,” Schneider wrote in his 29-page report.

Schneider addressed the remainder of the shortfall with a variety of cuts and revenue enhancement. One of the most workable options, Schneider said, would be for the county to reduce the gap by about $17 million by hiking filing fees at the county clerk’s office, halting payments to the retirement fund and charging fees for impounding cars.

A less likely scenario, Schneider said, has the county saving $4.5 million by cutting employee salaries 5% across-the-board, recouping about $124 million through legislative actions to accelerate funds due the county and seeking relief from paying state and federal mandates, including a host of welfare programs.

Included in Schneider’s proposal is a list of 20 county assets the county might be able to sell or lease to generate $27 million to $36 million. The properties include: John Wayne Airport, eight county libraries and the Santa Ana Civic Center.

Supervisor Jim Silva, however, said restructuring the debt is not realistic and that the county should meet its debt obligations and look to cuts instead.

(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

Portfolio Revision

Orange County’s investment losses are less than originally believed. Here’s the original estimate, done by Salomon Bros., and the revised estimate, produced by Arthur Andersen & Co. and the state auditor:

(Dollar amounts in billions)

Original estimate Revised estimate (12/12/94) (1/17/95) Amount contributed by investors $7.42 $7.57 Remaining in fund Market value of securities held $5.03 $5.16 Cash and equivalents 0.23 0.54 Excess collateral held by dealers 0.04 0.00 Excess collateral collected or 0.10 0.18 or due from dealer liquidations Loss $2.02 $1.69

Source: California state auditor