O.C. Quickly Feels Wrath of Wall Street

By DEBORA VRANA

June 29, 1995 12 AM PT

TIMES STAFF WRITER

Wall Street moved swiftly Wednesday to punish Orange County for its overwhelming rejection of a sales tax hike, raising serious doubts about the county’s ability to borrow money in the future.

The sales tax defeat pushes the county closer to defaulting on $800 million of bonds due in July and August and is a signal to the municipal bond community that Orange County is willing to walk away from its debt, analysts said.

Market reaction Wednesday included the following events:

* Major rating agencies bitterly criticized the county for its “outrageous and unprecedented” conduct, with one promising to downgrade the county’s bonds to “default,” the lowest status.

* Major mutual funds that own hundreds of millions of dollars in Orange County notes met in New York and discussed rejecting a one-year rollover of their debt approved by U.S. Bankruptcy Court this week. They fear the county won’t have the money to pay them back.

* Insurers and firms that have marketed Orange County bonds since the bankruptcy said it is getting increasingly risky to continue working with the county.

“With this sales tax defeat, Orange County is going to be shut out of the municipal bond market,” said Richard Larkin, a managing director with Standard & Poor’s Corp., a credit rating agency in New York. “It’s not going to be able to pay its notes this year and there is no visible way for them to pay them in 1996. It’s in default.”

Standard & Poor’s said it would give $600 million of county notes due July 10 a default rating regardless of any plan to extend the debt for another year. Other notes due in July and August will also be given a default rating, making it virtually impossible for the county to borrow money to pay expenses.

The sales tax failure “clearly signals the unwillingness of the county supervisors, some of whom opposed the tax increase . . . and the majority of voters to repay lenders,” the rating agency said.

Moody’s Investors Service, which already has given county notes its lowest possible rating, was equally scathing in its comments about the rejection of the half-cent sales tax increase.

It is “outrageous and unprecedented that in the six months since the bankruptcy filing, Orange County has utterly failed to take responsibility for its own actions,” Moody’s said. “The county is demonstrating near-total disregard to the damage this will also inflict on the hard-won trust generally awarded to other municipal borrowers.”

Noteholders, concerned that the county now won’t be able pay them back next year because the tax measure was rejected, are considering rejecting a one-year delay of their debt. They may ask the court to release the millions of dollars of their bond funds still held in reserve accounts by the county. If released by the court, it would give noteholders about 77 cents on the dollar.

“If we don’t accept the rollover and there is a default, it might be cleaner,” said Stephen Ward, investment manager at Charles Schwab Corp. “We might get less money but we’d get it now. There is currently a wide-ranging discussion about this issue.”

Firms that have helped Orange County with its bond sales said they might begin to boycott the county, just as major investors did during the county’s $155-million bond sale Tuesday.

“We would have to look very, very, very hard at any bonds from Orange County in the future,” said Neil Budnick, a senior vice president with MBIA, which insured $280 million of recovery notes just months ago. “The county will not have access to the market anymore.”

On Wednesday, Standard & Poor’s questioned whether the county would be able to pay off the recovery notes insured by MBIA, leaving the firm responsible for paying investors. But Budnick said his firm had expected the sales tax to fail and the county assured him it would make good on the notes.

A.G. Edwards & Sons and Goldman, Sachs & Co., the two underwriting firms that sold $155 million of Orange County bonds on Tuesday, were still stinging from the lack of buyers for county bonds. Both agreed that future borrowings by the county will be tough.

“I think market access for this county will be very hard going forward,” said Charlie Forrest, investment banker with A.G. Edwards who lives in Newport Beach. “We knew this wouldn’t be easy and, in fact, it’s been hard. But we feel a long-term commitment to the county.”

“It’s risky” to underwrite Orange County’s bonds now, said Rich Meister, a managing director with Goldman Sachs & Co. in San Francisco. “But we feel Orange County residents were not voting to default on debt, they were sending a signal that county government needs to operate with less revenue.”

While Goldman and A.G. Edwards say they are committed to working for the county’s recovery, other firms might not be financially able to take on the risks.

“Goldman Sachs can afford to make that kind of commitment to the county, but a lot of firms can’t,” said Steve Kelleher, a bond trader with Sutro & Co. in San Francisco. “Orange County is going to have more trouble in the future.”

While the sales tax rejection did not affect the national bond market or most California bonds, Alameda County was unable to sell $85 million of notes Wednesday, traders said.

“We did have some difficulty selling the bonds because of the sales tax vote in Orange County,” said John Orellana, an analyst for Alameda County. The county plans to return to the market today.

There was little trading of Orange County bonds on Wednesday and those that sold were priced lower to attract wary investors, traders said. Although the lower prices will not affect the county since it already borrowed the money, they reflect the market’s negative perception of Orange County.

“We don’t think it’s fair for the market to do this to us--we aren’t the county,” said Patricia Jakubiak of the Orange County Transportation Corridor Agencies, which recently sold $1.26 billion in bonds to finance South County toll roads. “We’re concerned, because what happens to us when we want to sell bonds again?”

The Public Securities Assn., a trade group created by major securities firms, expressed concern that an Orange County default will raise bond prices for everyone.

“Uncertainty about the county’s willingness to pay is already raising the costs of general obligation debt across the county,” said Heather Ruth, president of the PSA.

County officials said they weren’t surprised the bond market vented its wrath on Wednesday, but were hopeful things would approve once the dust settled.

“The market’s reaction is understandable; the county has an obligation now to restore confidence. We’ve got to find some revenue to pay our debts,” Orange County Supervisor Marian Bergeson said.

“Repudiation of debt is not acceptable. I don’t think the voters want to see us default and stop building roads, schools or stop growing economically.”

(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

Facing Downgrade

As a result of Measure R’s rejection, $800 million in Orange County bonds will be assigned a D rating by Standard & Poor’s Corp. Bond ratings reflect credit-worthiness and rate a bond’s investment quality. The ratings, issued by Standard & Poor’s and Moody’s Investors Service Inc., are assigned to local governments and to individual bond issues. What the long-term ratings mean:

Moody’s: AAA

Standard & Poor’s: AAA

What it means: Best quality with least degree of investment risk. Interest payments protected by exceptional and stable resources; principal is secure. Rarely assigned.

****

Moody’s: AA

Standard & Poor’s: AA

What it means: High grade with slightly lower resources or greater long-term risks than those with AAA rating.

****

Moody’s: A

Standard & Poor’s: A

What it means: Upper-medium grade with adequate security of principal and interest.

****

Moody’s: Baa

Standard & Poor’s: BBB

What it means: Medium grade; lacking in outstanding investment characteristics with some speculative characteristics.