O.C. is again an uneasy investor

Times Staff Writer

Merrill Lynch & Co., the brokerage giant blamed for triggering Orange County’s $1.6-billion bankruptcy in 1994, was the single largest dealer of complex debt securities to the county within the last two years that are now at risk of a credit rating downgrade, a Times review of county investment holdings has found.

Merrill’s role in selling the debt instruments to Orange County is emerging just one year after the Board of Supervisors voted to reestablish full business ties with the firm, over the objections of politicians who served during the bankruptcy.

Merrill paid $437 million to settle litigation with Orange County and other investors stemming from the bankruptcy and an additional $30 million to dispense with a criminal inquiry.


The Nov. 30 warning by Moody’s Investors Service that it might downgrade $460 million in securities held by Orange County forced the treasurer’s office to write down their value by nearly $13.8 million. The write-down led to a $12.4-million paper loss for the month of November.

The warning caused jitters among Orange County leaders, still nervous about finances more than a decade after the bankruptcy.

It is also focusing attention on the complex debt instruments tied to so-called structured investment vehicles, which have lost favor on Wall Street because of the sector’s ties to the sub-prime mortgage mess.

Though the securities held by Orange County have almost no underlying sub-prime assets, they are suffering amid the broader loss of confidence in SIV securities.

Concerns over the investments have added to Treasurer Chriss Street’s political woes.

Street faces a previously scheduled vote by the Board of Supervisors next week on whether to strip him of his authority over the county investment pool. Supervisors have cited Street’s business dealings before entering public office a year ago, a $750,000 office remodel and his handling of contracts to redesign the exterior of his building.

The notes under scrutiny constitute less than 8% of the county’s $5.9-billion portfolio, and ultimately the county may recover all of its investment with interest when they mature.


The securities had the highest possible credit rating when they were purchased and have not been downgraded, and the other ratings houses have yet to issue the same warning as Moody’s.

The treasurer’s office said Merrill remained a relatively small trading partner, handling fewer than 5% of the county’s transactions. In a prepared statement, the office defended the investments, saying: “Before making any investment decisions, the treasurer’s office conducts its own fundamental analysis and due diligence. Each investment is judged on its individual merit.”

County fund managers insisted that they developed the investment strategy on their own without input from Merrill and that the brokerage acted as a passive supplier -- much as a supermarket puts food on its shelves for sale. They said the county’s relationship with Merrill was drastically different from the pre-bankruptcy days.

“We know what we want to buy,” said John Byerly, a financial analyst in the treasurer’s office. “They’ve just got really big shelves. If they’ve got 30% of what’s being offered that day, why shouldn’t we buy from them?”

Officials said Merrill’s role in the transactions was largely limited to facilitating contact between the county and the managers of the SIVs. They believed the SIVs were high-quality diversified securities that would give them an opportunity to move away from securities tied to the U.S. mortgage market, which have been hit hard by interest rate and repayment concerns.

Still, Merrill’s role in selling the securities to the county has old hands seeing red.

“Surprise, surprise,” said Assemblyman Jim Silva, a former supervisor who repeatedly objected to doing business with Merrill again. “Merrill Lynch has never really been a friend to the county, if you look at their history.”


Merrill spokesman Bill Halden declined to comment, citing a company policy prohibiting discussion of client matters.

In the early 1990s, Merrill helped the county broker transactions in which the treasurer at the time, Robert L. Citron, borrowed about $13 billion and placed it in risky derivative investments tied to low interest rates. When rates rose, the county lost $1.6 billion and declared bankruptcy. The county still has nearly $450 million in bankruptcy debt to pay off.

The county refused to do business with Merrill for nearly a decade, but slowly began working with the firm again in 2003. Supervisor John Moorlach, who was one of the few to raise concerns about Orange County’s investments before the bankruptcy and became the county’s treasurer in its wake, led the effort to restore dealings with Merrill.

As treasurer and in his current office, Moorlach and others argued that Orange County subsequently established some of the most conservative investment rules in the country, with numerous checks and balances designed to prevent the purchase of risky investments.

Merrill’s sheer size and strength in the markets, the firm’s supporters said, made it a valuable asset to the county.

In an interview Thursday, Moorlach defended his decision to rebuild the county’s ties with Merrill. He said any fault with the current investments lies with the treasurer’s decision to approve them.


“They provide an inventory and you select what you want for your portfolio,” he said of Merrill. “I would have difficulty blaming the broker-dealer. This was a credit that was approved by the treasurer’s office.”

Bill Popejoy, a former county executive who helped clean up the mess after the bankruptcy, said he was reluctant to comment because he did not have firsthand knowledge of the facts. But as to Merrill’s role handling the transactions, he said: “Any broker dealing with the county treasurer’s office has a responsibility to highlight the risks involved, and not to assume the buyers are fully cognizant of the risks they may be taking. It really isn’t just ‘Buyer beware.’ ”

Of the securities at risk of a possible downgrade, Merrill sold $160 million to the county, followed by $150 million sold by Credit Suisse First Boston, $100 million by Bank of America and $50 million by Lehman Bros., records show.

The amount of the write-downs was distributed along the same proportional lines, with Merrill’s representing the largest share at $4.8 million.

Roughly $115 million of the investments now on credit watch purchased from Merrill were in a vehicle named Tango Financial Corp., managed by Rabobank of the Netherlands. County investment officials refused to specify the precise nature of the vehicle’s holdings, citing a confidentiality agreement, but said they had access to detailed information on which the investment decision was based. Generally, they said, the SIVs included commercial bank debt, residential and commercial mortgages, credit cards, student loans and insurance.

Last week, Rabobank announced it would take direct control of Tango’s assets, increasing the likelihood that the county would ultimately recover its investment with interest.