ORANGE COUNTY IN BANKRUPTCY : Bond Roadblock Sends Recovery on New Route : Finance: County officials turn to certificates of participation to raise cash to repay investors. The interest rate will be higher and they may be hard to sell.

With legal challenges delaying plans to get insurance for $275 million in recovery bonds, Orange County officials are now hoping to repay schools, cities and other agencies by selling certificates of participation, a more controversial and expensive route.

MBIA Insurance Corp., which previously had agreed to back $275 million in 30-year recovery bonds for a fee of about $10 million, has refused to provide insurance for the certificates, called COPs. The insurance would have given the bonds a triple-A rating; without it, the county probably will pay a significantly higher interest rate and could face trouble selling the notes on the market.

COPs are tax-exempt leases on public property, in which an issuer--in this case, the county--essentially gives an asset to investors and then makes rental payments for continued use of the property.

“I think it’s too risky a structure for a bankrupt county,” said a source familiar with the deal, insisting on anonymity. “I think the savings are going to be diminished significantly. . . . This is going to cost the taxpayers more money.”

County bankruptcy attorney Bruce Bennett and financial adviser Christopher Varelas admitted Monday that the COPs were a less attractive option, but said scheduling hang-ups left them little choice. They said they had always pursued a “multiple-track strategy” in case one plan fell through.

“There’s a reason this is Plan 2,” Varelas said.

Paul S. Nussbaum, a top aide to the county chief executive, said, “This is a viable option. It’s not the optimal option. The optimal option is the one we’d chosen previously.”

Local governments that had money in the county’s failed investment pool and will receive the proceeds from the notes as part of a court-approved settlement will see little difference between the insured bonds and the COPs, officials from both sides agreed.

“I don’t care how they get there, as long as they get there,” Jon Schotz, a financial adviser to participants in the sunken pool, said Monday. “You can make it into the worst thing in the world, but the fact of the matter is, they have Plan B. They will get there.”

The notes are the linchpin of the settlement agreement between Orange County and some 200 schools, cities and special districts that invested in the county-run pool before it filed for bankruptcy protection Dec. 6.

According to the deal, schools received about 13% of their Dec. 6 deposit in recovery warrants. Others got about 3%. The county vowed to make the warrants “good as gold,” or equivalent to cash, by mid-June.

Investors each received about 77% of their money back in cash last week, and will get IOUs for the rest.

The recovery warrants are perhaps most important to four local education agencies that have $200 million of debt coming due June 13. Without money from the warrants, those agencies--the Newport-Mesa and Irvine unified school districts, the North Orange County Community College District and the Orange County Department of Education--could default on that debt.

Other school districts might be forced to file for bankruptcy themselves if the recovery warrants are not made good in June.

The county’s original plan to issue insured bonds was derailed last week when creditors filed five objections to the debt issuance. While attorneys on both sides of the case agree that the objections are probably too weak to stop the county from issuing the bonds, the filings have slowed the required legal process to validate the debt.

Hearings on the validation have been scheduled for Friday and Monday. Even if all issues were resolved by Monday, the 30-day appeal period would stretch past the mid-June deadline.

“As far as we’re concerned, there is no doubt the county will prevail on the validation action,” Bennett said. “The risk is the process will take longer than the timetable.” County officials still plan to pursue the validation proceedings, and MBIA representatives said Monday their offer of insurance stands if the bonds are approved in court.

Like the planned bonds, the COPs would be partially backed by motor vehicle fees under a program approved by the state Legislature earlier this month, county officials said. The COPs also would benefit from a “super priority” repayment status granted by the bankruptcy court as part of the settlement agreement, they added.

Market observers said the COPs could cost as much as 2 percentage points, or about $5 million a year, more than the insured bonds would have. But Varelas and Bennett said the county would probably issue new, cheaper debt to buy out the 30-year COPs after a few years, so the added cost would not extend for the full life of the deal.

Varelas said the county has not yet decided which assets it will use to back the COPs, but buildings on the Civic Center Plaza, including the main Hall of Administration where the supervisors sit, are likely to be included. Assets that could be sold or otherwise used to raise revenue will not be used for the COPs, he added.

“It’s a way for us to get value from buildings that would have no other way to get value for the county,” Varelas said.

But with the county’s bruised Wall Street reputation, some said the COPs face an uncertain fate.

“Unless they’ve got somebody backing it, they may have trouble selling it,” said Peter Schaafsma, executive director of the California Debt Advisory Commission. “That was why the deal looked so nice with MBIA is it took away the question of whether or not it was marketable.”

Another observer noted that because COPs are not a court-validation obligation of the issuer, some investors already view them with skepticism, worrying that the issuer will stop paying the “lease” and leave them holding assets they don’t want.

“Everyone pretty much has an eyebrow raised at COPs anyway,” he said. “This willingness-to-pay issue is always an issue in any [COPs] and people who file bankruptcy are not that willing to pay.”