O.C. Left Scorched as Bond Fire Sale Fizzles : Bankruptcy: Hostile investors turn their backs as cash-strapped county seeks to borrow $155 million.

As Orange County sought to borrow $155 million Tuesday, a hostile investment community turned its back and hesitated to buy the county’s bonds even at fire-sale prices.

Buyers were scared away by fears that county voters Tuesday would reject a proposed sales tax increase and push the county closer to default on about $1 billion of debt coming due in the next six weeks.

Despite a widespread boycott by the major mutual funds that traditionally gobble up such bonds, the county was able to sell some bonds to retail investors, mostly wealthy individuals who demanded higher interest rates that will cost the county an extra $1.5 million in interest each year over the next two decades.

Due to special features to provide investors a greater sense of security, higher interest rates and the fees for selling the bonds, the county paid about $17 million to borrow $155 million. Traders said some of those costs could be decreased in upcoming years if the bonds are restructured.

Although the county offered higher rates in an attempt to entice investors, a majority of the bonds remained unsold Tuesday, Wall Street sources said. The county’s underwriters, responsible for making sure the bonds were sold, had to buy what was left over and will seek to peddle them later.

“I’ve never seen anything like this. There just wasn’t any institutional interest,” said one bond trader at a large firm. “Most of these funds already own Orange County bonds and are still very angry and nervous. They retaliated today.”

Michael McCarthy, managing director with Goldman Sachs & Co., the county’s underwriter, called the lack of interest in the once double-A rated county “unprecedented.”

County officials also marveled at the lack of response by investors in calls to potential buyers Tuesday.

“It’s like you’re talking to an echo. It’s like the phone’s been disconnected,” said County Chief Executive Officer William J. Popejoy. “There’s just nothing out there.”

The so-called Teeter bonds, a key part of the county’s recovery plan, were finally priced to yield 6.35% in average interest, about 1.25 percentage points higher than what the county was hoping.

When the county sold $280 million of recovery notes two weeks ago it suffered a penalty of only 0.25%.

Christopher Varelas, a banker with Salomon Bros., the county’s financial adviser, said the municipal bond market was punishing the county and its residents.

“These buyers were making a statement. They were passing up short-term profits to send a signal that they wanted to preserve the basis of the municipal bond market,” Varelas said.

The rejection of the sales tax is seen by some as a watershed for the municipal bond market. Analysts say it sends a signal that voters here are not responsible for, or committed to, paying back bond debt.

This will translate into higher borrowing costs, not only for Orange County, but for other California governments that try to raise money, analysts said. Market participants and traders predicted that Tuesday’s market hostility was nothing--things will only get worse for Orange County. Joe Piraro, who manages $2.5 billion for Van Kampen Merritt Inc. in Chicago, said he decided to avoid the bonds because the people in Orange County were not committed to paying their debts.

“The people in Orange County feel it’s not their problem,” he said. “This will have a negative reflection not only in Orange County but the entire municipal market. They will all pay.”

With the Teeter bonds, the county borrows so that it can fund various operations immediately rather than waiting until delinquent taxes are ultimately remitted years down the road. As the overdue taxes are paid, they are used to pay off the bonds.

Bonds previously issued were coming due Friday. But without the cash to pay off the $175 million in old bonds, the county was in danger of defaulting. By raising new money, the county pays off a portion of the $175 million in old Teeter bonds, with the rest paid from cash reserves that had been set aside.

Not only does the county pay off the old debt with the new bonds, it gets $10 million in extra cash over the next several years to refill coffers depleted by massive losses in its investment fund.

Popejoy said that, in retrospect, if it had a choice, the county should have avoided the municipal bond market.

“The deal, if we had any alternatives, should have been pulled. We just got crunched,” Popejoy said.

While the bonds were sold by a newly created agency called the Orange County Special Financing Authority and were guaranteed by a letter of credit from Industrial Bank of Japan, investors were not placated.

“It’s tough as nails to try and sell Orange County bonds, even insured ones,” said Art Rock, a bond trader with Stone & Youngberg in Sherman Oaks. “My retail customers are older, they’ve been through the risk-taking part of their lives and now they are in a preservation mode.”

Times staff writer Jodi Wilgoren contributed to this report.

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Money’s Expensive

Orange County battled a hostile municipal bond market Tuesday as it tried to sell $155 million of Teeter bonds. The cost of the attempt: $17 million. Here’s how it breaks down, in millions: Letter of credit guarantees investors will get money, $8.6 million: 51% Interest premium, $6.5 million: 38% Service fee to bond sellers, $1.9 million: 11% Sources: Salomon Bros., market traders

Researched by DEBORA VRANA / Los Angeles Times