Bond Market Skeptical of County Plan to Borrow Anew

Duncan Smith has a message for Orange County officials hoping to solve their financial crisis by selling more bonds: “I won’t buy any of them.”

Smith’s reaction is not to be taken lightly. As chief trader for Lebenthal & Co., perhaps the leading retailer of municipal bonds to small investors, he is one of the market professionals the county may have to please if it is to rebuild its shattered finances, in part through billions of dollars in new borrowings on Wall Street.

Orange County’s recovery plan, which also includes wielding the budget ax and crusading for damages in court, is highly dependent on a bond market that is deeply skeptical of the county’s financial condition and determined to exact a high price for cooperation.

Market professionals said Thursday that the county can expect to pay as much as 10% interest annually on any new short-term debt--nearly twice its pre-bankruptcy rate--and will have to provide potential buyers with financial data and assurances of repayment far beyond those it has offered before.

Moreover, some key questions about the county’s fiscal condition will have to be resolved before any new bond issues can be floated--chief among them how the $2.02-billion loss incurred by the now-bankrupt investment pool will be apportioned among the county and the 186 other public entities whose money was managed by former Treasurer Robert L. Citron.

School districts contend that because they were required by law to place their money in the pool, they should be repaid in full. And as long as such issues are unresolved, the county’s exposure to the pool’s 27% investment loss cannot be measured.

“They need a credible plan for how they’re going to deal with the losses,” said Amy Doppelt, a public finance analyst at Fitch Investors Service in New York. “There seem to be a lot of uncertainties at this point.”

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Not only will bond buyers have to be convinced, but so will the bond insurers and banks to which the county is likely to turn for backup guarantees--known to the market as “credit enhancements”--assuring investors that principal and interest will be repaid.

Even so, many traders and analysts are far from sure that a return to the market is possible anytime soon.

“I’d be very surprised if anyone would give them a credit enhancement right now, and the cost would be exorbitant,” said Robert Gore, a municipal bond trader at Crowell Weedon & Co. in Los Angeles. “It seems really premature for the county to be talking about new debt.”

But that is exactly what the county’s financial advisers are doing.

The team of lawyers, accountants and financiers said Wednesday that one option they are considering is floating a $2-billion bond issue to cover the investment losses and repay the participants in full. The county also may need to float the kind of short-term notes that routinely finance day-to-day cash needs for the nation’s municipalities.

Further, the advisers said the county does not have enough money to pay principal and interest on about $1 billion in short-term debt due between now and midyear. That means the county almost certainly will have to ask holders of those bonds to accept a stretched-out payment schedule to avert a default.

Thus far, some bond experts complain, county officials have not shown that they are willing to take politically unpopular steps to improve the county’s fiscal standing. The Board of Supervisors has pledged not to propose new taxes to cover a budget gap now estimated at more than $330 million over the next 18 months.

“My feeling is you’ve got one of the wealthiest counties in the country here,” Gore said. “If you’re talking about restructuring the debt without even talking about a one-time rise in taxes, I don’t think the market will be very receptive.”

Also unnerving traders are suggestions from county supervisors that debt service on existing bonds and notes may not be given a higher priority for payment than other county obligations.

“Before they float a deal, I’ll have to hear them say that debt service is sacrosanct,” said Lebenthal & Co.’s Smith.

Thus far, the county has formally defaulted only on one $110-million note on which it continues to pay interest but not principal. It went into technical default on other notes by not setting aside cash to pay interest due in July. County officials say they hope to avert default on other short-term issues by rolling them over when they come due this summer--that is, extending their terms without repaying them upon maturity.

If not everyone in the market believes a new debt issue is impossible, the feeling is overwhelming that its cost and terms will be exceptionally stringent. The closest analogy may be to the state of California, which in July was able to float $4 billion in short-term debt only by paying a consortium of 14 banks for a costly repayment guarantee. The state also had to provide investors with a detailed budget plan for 1995 and 1996.

Similar terms may await Orange County.

“This county is going to have to achieve a very high level of disclosure of its financial condition and present a bulletproof security for any debt,” said Tim Schaeffer, a public finance specialist and senior vice president at Evensen Dodge, a Costa Mesa-based investment firm. “It’s very bitter medicine for a big entity like Orange County to swallow, but they may have to.”

Among other things, the county may have to find a reliable source of revenue that can be pledged to cover the new issue’s principal and interest. In the 1970s, New York City pledged its stock-transfer tax and much of its guaranteed state aid to back a series of bond issues that eventually extricated it from near-bankruptcy.