COUNTY ON THE EDGE : Sale of Short-Term Notes a Bright Spot Amid Fiscal Gloom : Finance: County’s purchase of bank letter guaranteeing repayment helps attract investors. Lower-than-expected 3.75% interest rate on $1.3-billion borrowing is good news.

Heavy bidding from investors allowed Los Angeles County to pay a lower-than-expected yield on its huge short-term debt offering on Wednesday, providing one bit of good news in an otherwise bleak fiscal outlook.

The county sold $1.3 billion in one-year notes at a yield of 3.75%, significantly less than the 4% yield some municipal security traders thought might be required to attract investors.

The note sale, a normally routine June borrowing that provides the county with cash in advance of next year’s tax payments, became a referendum on Wall Street’s faith in the county’s ability to close its massive budget gap.

County Treasurer Larry J. Monteilh, in a letter to the Board of Supervisors, said the note sale’s success partly reflected “the strong support of your board in addressing investor concerns.”

But Monteilh also conceded that the lower yield was directly tied to the county’s purchase of a bank letter of credit to guarantee the notes’ repayment. The county has rarely been compelled to buy such insurance in order to attract investors to its short-term notes.

Maureen Sicotte, the county’s director of public finance, estimated that the insurance will cost the county as much as $1.6 million in fees to the banks. But without the insurance, she said, the county might have incurred $5.1 million or more in extra interest costs because investors would have demanded a higher yield, probably well over 4%.

Indeed, some tax-exempt money market mutual funds, which usually are big investors in municipal notes, have been unwilling to buy any such notes from California issuers this spring without third-party guarantees--a backlash in the wake of Orange County’s surprise bankruptcy filing last December.

David MacEwen, senior municipal manager at the Benham Group of mutual funds in Mountain View, Calif., said “we would not have bought L.A. County’s notes without enhancement,” an industry term for insurance.

With a consortium of six large banks guaranteeing the notes, however, Benham joined a host of other institutional investors and individual investors in bidding for the securities. A total of $1.9 billion in bids was received, far oversubscribing the $1.3 billion offering.

The aggressive bidding allowed Bank of America’s securities unit, which managed the sale of the notes, to reduce the yield from the 3.9% it had estimated Tuesday to 3.75%, said Anthony Taddey, BofA’s municipal securities director.

The drop in yield wasn’t as steep as it appeared, though. The 3.75% rate is what smaller bidders received. Major institutional buyers such as mutual funds received a yield of 3.8% after factoring in price concessions that are common in such note sales.

Nonetheless, “we think it was a good day for the county,” Taddey said.

A strategy of marketing the notes heavily to individual investors--an effort to blunt the bargaining power of institutional buyers--helped the county, Taddey said. He said orders from individuals totaled more than $300 million.

Because the interest is exempt from federal and California state income taxes, the true yield to high-tax-bracket investors is substantially higher than 3.75%.

Even so, Taddey said he had originally expected $400 million in individual-investor orders. “I think we got less because people have been reading the newspapers [regarding the county’s budget predicament] and some of them are nervous” despite the notes’ insurance, he said.

Among institutional investors, bidding was influenced partly by the need to replace maturing California notes purchased a year ago. Because municipal note and bond issuance is down this year in general, fund managers who passed up the Los Angeles County offering faced the prospect of a shortage of securities for their portfolios.

Despite its financial problems, “L.A. County is still a big and very liquid name” among municipal securities issuers, said Pam Tynan, manager of the Vanguard Group’s California tax-free money fund in Valley Forge, Pa.

But she also said that while the 3.8% institutional yield on the notes was lower than expected, it still is well above what some high-quality issuers outside California have paid to sell notes this month.

The state of Wisconsin, for example, paid 3.63% on one-year notes it recently sold. The city of Houston paid 3.65%.

Analysts say the higher yield demanded on Los Angeles County’s notes, and those of other California municipalities in recent weeks, reflects investors’ genuine concern over the issuers’ financial health as California’s economy struggles out of recession.

Even as Los Angeles County sold the $1.3 billion in short-term notes on Wednesday, a major credit-rating agency downgraded $215 million in longer-term bonds outstanding from the county, including those for the Disney Concert Hall parking facility.

Fitch Investors Service, in downgrading the bonds from A+ to A-, said it was concerned about the county’s “severe financial strain.” Earlier this week, two other major credit-rating services warned that they may downgrade all of the county’s long-term bonds if structural budget problems aren’t adequately addressed.

Investors’ fears have been compounded by Orange County’s bankruptcy. Some big investors, angry over the bankruptcy, have publicly admitted they are bidding California municipal yields up to send a message that Orange County’s bankruptcy has a statewide cost.

“There is a difference in what the market is making California pay” to issue debt, Sicotte said. “It’s like we’re being held hostage.”