HomeMy WebLinkAboutMINUTES - 03141995 - WS P.Leli
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Treasurer's Office Contra Coiuntty TTreasurer-Tax Collector
Costa Clarissa Javier
625 Court Street Chief Investment Officer
Finance Building, Room 102 Janette San Luis
�artinez, California 94553-1281 County Investment Officer
10)646-4115
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March 14, 1995
The Honorable Members of the Board of Supervisors
County of Contra Costa
Administration Building
Martinez, CA 94553
Members of the Board:
Submitted herein is the County Treasurer-Tax Collector's Investment report as requested
by the Board of Supervisors on December 9, 1994 and subsequently approved on
a, December 13, 1994.
The report includes: 1) past investment policies and practices of the County, 2) the
current investment portfolio and, 3) revised interim investment strategies and policies.
Various exhibits, tables, news articles and other pertinent information are provided to
illustrate, analyze and explain the safety and integrity of the portfolio of Contra Costa
County's Investment Pool.
The investment data contained in this report covers the County and all participating
County agencies and Districts as of January 31, 1995. The County Retirement System
is not included in this report, as its investments are not commingled with the general
County Pool.
This report concludes with certain investment program recommendations by the
Treasurer.
Respectfully Submitted,
Alfred P. Lomeli,
• Treasurer-Tax Collector
APL:gm
THE TREASURER'S INTERIM
PERFORMANCE REPORT
OF THE
CONTRA COSTA COUNTY
INVESTMENT POOL
MARCH 14, 1995
Prepared by
Alfred P. Lomeli
Contra Costa County Treasurer-Tax Collector
County of Contra Costa -Treasurer's Report on County Investment Pool Page 1
TABLE OF CONTENTS
Item Page Number
Section 1 Executive Summary . . . . . . . . . . . . . . . . . . . . . . 4
Section 2 Current Investment Policy . . . . . . . . . . . . . . . . . . 6
Section 3 Current Investment Pool Portfolio . . . . . . . . . . . . 24
Section 4 Investment Strategies and
Treasurer's Recommendations . . . . . . . . . . . . . . 40
Appendices A. Selected Reports from
Moody's Investors Service
B. Selected Reports from Standard &
Poor's Ratings Group
C. Selected Reports from
Fitch Investors Service
D. Selected Newspaper Articles
E. Structured Notes
County of Contra Costa - Treasurer's Report on County Investment Pool Page 2
•
SECTION 1
EXECUTIVE SUMMARY
r
County of Contra Costa -Treasurer's Report on County Investment Pool Page 3
•
EXECUTIVE SUMMARY
The County Investment Pool (the "Pool") acts as a depository for over 70 units of local
government which includes the funds of the County, school districts, special districts and other
entities. All participating units of government are located within the County; over the years the
Treasurer's policy has been to not accept funds from individuals or from units of government
located outside of Contra Costa County.
It should be noted that the information presented herein on the Pool pertains solely to funds
held on behalf of the entities described in the preceding paragraph and does not include funds
held on behalf of the Contra Costa County Employers Retirement Association.
The size of the Pool during recent fiscal years has fluctuated on a seasonal basis from a low of
$490 million to a high of almost $1 billion.
The Treasurer has conducted a complete review of.investment activity within the Pool during
the first seven months of the current fiscal year and makes the following observations and
recommendations:
• The Treasurer finds that the existing level of risk in the County Investment Pool is
• minimal.
• The Treasurer notes that the Pool was not cited as "risky" by the national rating
agencies in their recent analysis of county pools and that the County maintains the
highest short-term ratings possible.
• The pool has earned a cumulative total of nearly $120 million during the past 10 1/2
years. This enables the County budget to avoid unanticipated budget cuts such as those
facing Orange County as well as other counties.
• During the past decade, the Treasurer indicates that certain structured notes have been
purchased with maturities of greater than one year for the pool. To date the County has
earned approximately $1.2 million more in interest earnings from these structured notes
than if conventional treasuries would have been exclusively utilized.
• The County's portfolio currently has no reverse repurchase agreements in place.
• The Treasurer has implemented new interim investment policy changes which would
prohibit any utilization of derivatives and reverse repurchase agreements.
• The Treasurer recommends that an Investment Oversight Committee be formed to
review the County Investment Policy and to regularly monitor and report the condition of
the Pool to the Board of Supervisors.
•
County of Contra Costa -Treasurer's Report on County Investment Pool Page 4
SECTION 2
CURRENT INVESTMENT POLICY
County of Contra Costa -Treasurer's Report on County Investment Pool Page 5
Section 2 - Current Investment Policy
Section 2 is comprised of three parts.
Part 1 provides the current applicable code section of the State of California
Government Code covering the investment of funds by local units of government code.
This section of the State of California Government Code is currently the subject of
intense public debate and review as a result of the Orange County bankruptcy. It is
quite probable that recommended changes in the code will be adopted with the effect of
reducing the number of investment choices for local governments, although the
Treasurer is unable to predict the precise nature and timing of such changes.
Part 2 contains the current investment policy of the County. Some County Treasurers
in California have determined that investments permitted under the State of California
Government Code are too general and have adopted more restrictive codes for the
local county operations. Restrictions of this type have been in place in the County's
Investment Policy for a number of years and are set forth on page 17. Changes
recently implemented by the Treasurer are provided later in Section 4 of this report and
have had the effect of making the County's Investment Policy even more restrictive
than the one presented in this section.
Part 3 provides a copy of the Board Authorization dated August 25, 1981 that permitted
the use of reverse repurchase agreements.
County of Contra Costa -Treasurer's Report on County Investment Pool Page 6
PART 1 - STATE GOVERNMENT CODE
FOR PERMITTED INVESTMENTS
i
County of Contra Costa -Treasurer's Report on County Investment Pool Page 7
1994 POCKET SUPPLEMENT
ISSUED IN DECEMBER, 1993
COVERING LEGISLATION THROUGH
THE 1993 SESSION OF THE 1993-94 LEGISLATURE
DEERING' S
GOVERNMENT
CODE
ANNOTATED
OF THE STATE OF CALIFORNIA
§§ 50800-54299
Annotated and Indexed by the Publisher's Editorial Staff
Note-An updated analysis of the Government Code appears at the beginning of
the supplement to the first volume.
Bancroft-Whitney
Law Publishers
3250 Van Ness Avenue
P.O. Box 7005
San Francisco, CA 94102-7005
County of Contra Costa -Treasurer's Report on County Investment Pool Page 8
• GOVERNMENT CODE § 53601
§ 53600 . Definitions
As used in this article, "local agency" means county, city, city and county, including a chartered
city or county, school district, community college district, public district, county board of
education, county superintendent of schools, or any public or municipal corporation.
A m ended Stals 1987 ch 887 § 2.
Amendments:
1987 Amendment:Added"community college district."after"school district,".
§ 53601. Instiuments authorized for investment
The legislative body of a local agency having money in a sinking fund of, or surplus money in,
its treasury not required for the immediate necessities of the local agency may invest any portion
of the money which it deems wise or expedient in the following; provided, however, that where
this section does not specify a limitation on the term or remaining maturity at the time of the
investment, no investment shall be made in any security, other than a security underlying a
repurchase or reverse repurchase agreement authorized by this section, which at the time of the
investment has a term remaining to maturity in excess of five years, unless the legislative body
has granted express authority to make that investment either specifically or as a part of an
investment program approved by the legislative body no less than three months prior to the
investment:
• (a) Bonds issued by the local agency, including bonds payable solely out of the revenues from
a revenue-producing property owned, controlled, or operated by the local agency or by a
department, board, agency, or authority of the local agency.
(b) United States Treasury notes, bonds, bills, or certificates of indebtedness, or those for
which the faith and credit of the United States are pledged for the payment of principal and
interest.
(c) Registered state warrants or treasury notes or bonds of this state, including bonds payable
solely out of the revenues from a revenue-producing property owned, controlled, or
operated by the state or by a department, board, agency, or authority of the state.
(d) Bonds, notes, warrants, or other evidences of indebtedness of any local agency within this
state, including bonds payable solely out of the revenues from a revenue-producing property
owned, controlled, or operated by the local agency, or by a department, board, agency, or
authority of the local agency.
(e) Obligations issued by banks for cooperatives, federal land banks, federal intermediate credit
banks, federal home loan banks, the Federal Home Loan Bank Board, the Tennessee Valley
Authority, or in obligations, participations, or other instruments of, or issued by, or fully
guaranteed as to principal and interest by, the Federal National Mortgage Association; or
in guaranteed portions of Small Business Administration notes; or in obligations, participa-
County of Contra Costa-Treasurer's Report on County Investment Pool Page 9
GOVERNMENT CODE § 53601
tions, or other instruments of, or issued by, a federal agency or a United States government-
sponsored enterprise.
(f) Bills of exchange or time drafts drawn on and accepted by a commercial bank, otherwise
known as bankers acceptances, which are eligible for purchase by the Federal Reserve
System. Purchases of bankers acceptances may not exceed 270 days maturity or 40 percent
of the agency's surplus money which may be invested pursuant to this section. However,
no more than 30 percent of the agency's surplus funds may be invested in the bankers
acceptances of any one commercial bank pursuant to this section.
This subdivision does not preclude a municipal utility district from investing any surplus
money in its treasury in any manner authorized by the Municipal Utility District Act,
Division 6 (commencing with Section 11501) of the Public Utilities Code.
(g) Commercial paper of "prime" quality of the highest ranking or of the highest letter and
numerical rating as provided for by Moody's Investors Service, Inc., or Standard and Poor's
Corporation. Eligible paper is further limited to issuing corporations that are organized and
operating within the United States and having total assets in excess of five hundred million
dollars ($500,000,000) and having an "A" or higher rating for the issuer's debt, other than
commercial paper, if any, as provided for by Moody's Investors Service, Inc., or Standard
and Poor's Corporation. Purchases of eligible commercial paper may not exceed 180 days
• maturity nor represent more than 10 percent of the outstanding paper of an issuing
corporation. Purchases of commercial paper may not exceed 15 percent of the agency's
surplus money which may be invested pursuant to this section. An additional 15 percent,
or a total of 30 percent of the agency's surplus money, may be invested pursuant to this
subdivision. The additional 15 percent may be so invested only if the dollar-weighted
average maturity of the entire amount does not exceed 31 days. "Dollar-weighted average
maturity" means the sum of the amount of each outstanding commercial paper investment
multiplied by the number of days to maturity, divided by the total amount of outstanding
commercial paper.
(h) Negotiable certificates of deposits issued by a nationally or state-chartered bank or a state
or federal association (as defined by Section 5102 of the Financial Code) or by a state-
licensed branch of a foreign bank. Purchases of negotiable certificates of deposit may not
exceed 30 percent of the agency's surplus money which may be invested pursuant to this
section. For purposes of this section, negotiable certificates of deposits do not come within
Article 2 (commencing with Section 53630) of Chapter 4 of Part I of Division 2 of Title
5, except that the amount so invested shall be subject to the limitations of Section 53638.
(i) Investments in repurchase agreements or reverse repurchase agreements of any securities
authorized by this section, so long as the proceeds of the reverse repurchase agreement are
invested solely to supplement the income normally received from these securities.
Investment in a reverse repurchase agreement shall be made only upon prior approval of
the legislative body of the local agency. For purposes of this section, the term "repurchase
agreement" means a purchase of securities by the local agency pursuant to an agreement
County of Contra Costa -Treasurer's Report on County Investment Pool Page 10
GOVERNMENT CODE § 53601
by which the seller will repurchase the securities on or before a specified date and for a
specified amount and will deliver the underlying securities to the local agency by book
entry, physical delivery, or by third-party custodial agreement. The transfer of underlying
securities to the counterparty bank's customer book-entry account may be used for book-
entry delivery. The term "counterparty" for the purposes of this subdivision, means the
other party to the transaction. A counterparty bank's trust department or safekeeping
department may be used for physical delivery of the underlying security. The term of
repurchase agreements shall be for one year or less. The term "securities," for purpose of
repurchase under this subdivision, means securities of the same issuer, description, issue
date, and maturity.
The term "reverse repurchase agreement" means a sale of securities by the local agency
pursuant to an agreement by which the local agency will repurchase such securities on or
before a specified date and for a specified amount.
(j) Medium-term notes of a maximum of five years maturity issued by corporations organized
and operating within the United States or by depository institutions licensed by the United
States or any state and operating within the United States. Notes eligible for investment
under this subdivision shall be rated in a rating category of"A" or its equivalent or better
by a nationally recognized rating service. Purchases of medium-term notes may not exceed
30 percent of the agency's surplus money which may be invested pursuant to this section.
(k) Shares of beneficial interest issued by diversified management companies, as defined in
Section 23701m of the Revenue and Taxation Code, _investing in the securities and
obligations as authorized by subdivisions (a) to (1), inclusive, of this section and which
comply with the investment restrictions of this article and Article 2 (commencing with
Section 53630). To be eligible for investment pursuant to this subdivision, these companies
shall either: (1) attain the highest ranking or the highest letter and numerical rating
provided by not less than two of the three largest nationally recognized rating services, or
(2) have an investment adviser registered with the Securities and Exchange Commission
with not less than five years' experience investing in the securities and obligations as
authorized by subdivisions (a) to (m), inclusive, of this section and with assets under
management in excess of five hundred million dollars ($500,000,000). The purchase price
of shares of beneficial interest purchased pursuant to this subdivision shall not include any
commission that these companies may charge and shall not exceed 15 percent of the
agency's surplus money which may be invested pursuant to this section.
(1) Notwithstanding anything to the contrary contained in this section, Section 53635 or any
other provision of law, moneys held by a trustee or fiscal agent and pledged to the payment
or security of bonds or other indebtedness, or obligations under a lease, installment sale,
or other agreement of a local agency, or certificates of participation in those bonds,
indebtedness, or lease installment sale, or other agreements, may be invested in accordance
with the statutory provisions governing the issuance of those bonds, indebtedness, or lease
installment sale, or other agreement, or to the extent not inconsistent therewith or if there
County of Contra Costa -Treasurer's Report on County Investment Pool Page 11
GOVERNMENT CODE § 53601
are no specific statutory provisions, in accordance with the ordinance, resolution, indenture,
or agreement of the local agency providing for the issuance.
(m) Notes, bonds, or other obligations which are at all times secured by a valid first priority
security interest in securities of the types listed by Section 53651 as eligible securities for
the purpose of securing local agency deposits having a market value at least equal to that
required by Section 53652 for the purpose of securing local agency deposits. The securities
serving as collateral shall be placed by delivery or book entry into the custody of a trust
company or the trust department of a bank which is not affiliated with the issuer of the
secured obligation, and the security interest shall be perfected in accordance with the
requirements of the Uniform Commercial Code or federal regulations applicable to the
types of securities in which the security interest is granted.
(n) Any mortgage pass-through security, collateralized mortgage obligation, mortgage-backed
or other pay-through bond, equipment lease-backed certificate, consumer receivable pass-
through certificate, or consumer receivable-backed bond of a maximum of five years
maturity. Securities eligible for investment under this subdivision shall be issued by an
issuer having an "A" or higher rating for the issuer's debt as provided by a nationally
recognized rating service and rated in a rating category of"AA" or its equivalent or better
by a nationally recognized rating service. Purchase of securities authorized by this
subdivision may not exceed 20 percent of the agency's surplus money that may be invested
pursuant to this section.
Amended Stats 1987 ch 446 § 1, ch 887 § 3.5; Stats 1988 ch 294 § 1,effective July 7, 1988. ch 491 § l; Stats 1992
ch 173 § I (AB 3576).
Amendments:
1987 Amendment: (1) Amended subd (i) by (a) deleting the comma after "specified date" in the third sentence; (b)
substituting "by" for "a" after "delivery,or" in the third sentence; and (c)designating the former last sentence to be
the second paragraph; (2) deleted former subd 0) which read; 0)Mortgage securities purchased under an agreement
to resell pursuant to subdivision (i),provided that the mortgage securities are eligible investments under subdivision
(a) or (b) of Section 13000 of the Financial Code. A local agency's investment in a mortgage security shall not
exceed 95 percent of the mortgage securities'fair market value and shall not exceed 25 percent of the agency's surplus
money which may be invested pursuant to this section."; (3) redesignated former subds (k)-(m) to be subds
(4)amended subd(j)by(a)deleting"corporate" after"Medium-term",and after"medium-term";(b)adding"organized
and" after "corporations"; (c) adding "or by depository institutions licensed by the United States or any state and
operating within the United States",(d)substituting"Notes" for"Securities";(e)substituting"a rating category of"A"
or its equivalent or better by a nationally recognized rating service" for "the top three note rating categories by two
of the three largest nationally recognized rating services"; (f) substituting "Purchases" for "Purchase"; and (g)
substituting "30" for "15% (5) amended subd (k) by (a) substituting "(1)" for "(m)% (b) deleting "and deposit" after
"the investment";and(c)adding the apostrophe after"five years",(6)deleted the comma after"agreement,or" in subd
(1);(7) added subd(m);and(8)deleted the former last paragraph which read: "This section shall remain in effect only
until January 1, 1988,and as of that date is repealed, unless a later enacted statute, which is enacted before January
1, 1989, deletes or extends that date. If that date is not deleted or.extended, then. on and after January 1, 1988,
pursuant to Section 9611 of the Government Code, Section 53601 of the Government Code, as amended by Section
1.5 of Chapter 567 of the Statutes of 1983, shall have the same force and effect as if this temporary provision had
not been enacted." (As amended by Stats 1987,ch 887,compared to the section as it read prior to 1987. This section
was also amended by an earlier chapter, ch 446. See Gov C § 9605.) 1988 Amendment: Added "the following;
County of Contra Costa -Treasurer's Report on County Investment Pool Page 12
• GOVERNMENT CODE § 53601
provided,however,that where this section does not specify a limitation on the term or remaining maturity at the time
of the investment, no investment shall be made in any security, other than a security underlying a repurchase or
reverse repurchase agreement authorized by this section, which at the time of the investment has a term remaining
to maturity in excess of five years, unless the legislative body has granted express authority to make that investment
either specially or as a part of an investment program approved by the legislative body no less than three months prior
to the investment" in the introductory clause. (As amended by Stats 1988, ch 491, compared to the section as it read
prior to 1988. This section was also amended by an earlier chapter, ch 294. See Gov C § 9605.) 1992 Amendment:
Added subd (n).
Collateral References:
Review of Selected 1988 Legislation. 20 Pacific LJ 720.
•
County of Contra Costa -Treasurer's Report on County Investment Pool Page 13
•
PART 2 - CURRENT COUNTY
INVESTMENT POLICY
County of Contra Costa -Treasurer's Report on County Investment Pool Page 14
TREASURY CASH MANAGEMENT POLICY
Public funds are to be invested in the following manner:
1. LEGALITY
The cash management program must conform to the laws set forth
commencing with Section 53600 of the California Government Code.
2. SAFETY OF PRINCIPAL
The duty of the Treasurer is to hold safely all public funds under his control.
3. LIQUIDITY
The Treasury must maintain sufficient funds to redeem warrants and checks
as presented by the banks.
4. YIELD
Prudence must be used in maximizing yield consistent with the first three
priorities.
AUTHORIZED INVESTMENTS
Commencing with Section 53601 of Article 1, Chapter 4 of the Government Code of the
State of California, surplus money may be invested in the following:
A. Bonds issued by local agency.
B. United States Treasury Notes, bonds, bills or certificate of indebtedness or
those for which the faith and credit of the United States are pledged for the
principal and interest.
C. Registered state warrants or treasury notes or bonds of this state.
D. Bonds, notes, warrants or other evidence of indebtedness of any local
agency of the State of California.
E. Obligations of the United States Government issued by the Bank for
Cooperatives, Farm Credits, Federal Home Loan Bank ("FHLB"), Federal
National Mortgage Association, ("FNMA"), Government National Mortgage
• Association ("GNMA"), Small Business Administration Notes ("SBA").
County of Contra Costa -Treasurer's Report on County Investment Pool Page 15
F. Bills of Exchange or time drafts drawn Bankers Acceptance) on and
9 ( P )
accepted by a commercial bank which are eligible for purchase by the
Federal Reserve System.
G. Commercial Paper of "Prime" quality: Al - (Moody) and P1 - (S&P), ratings
limited to corporations with assets over $500,000,000.
H. Negotiable Certificates of Deposit issued by a nationally or state chartered
bank or a state or federal savings and loan association.
I. Investment in repurchase agreements or reverse repurchase agreements.
J. Medium term corporate notes of a maximum of five years maturity issued by
corporations operating within the United States.
K. Shares of beneficial interest issued by diversified management companies
as defined in Section 23701m of the Revenue and Taxation Code, investing
in the securities and obligations as authorized by subdivisions (a) to (k),
inclusive, of this policy and which comply with the investment and deposit
restrictions of this policy.
L. Any mortgage pass-through security, collateralized mortgage obligation,
mortgage-backed or other pay-through bond, equipment lease-backed
certificate, consumer receivable pass-through certificate, or consumer
receivable-backed bond of a maximum of five years maturity.
I. RESTRICTIONS SET BY GOVERNMENT CODE
A. Bankers Acceptance (Bills of Exchange or Time Draft).
1. Required to be eligible for purchase by the Federal Reserve System.
2. Must not exceed 270 day maturity.
3. Must not exceed 40% of the County's surplus funds. No more than
30% of the County's surplus funds can be invested in the Bankers
Acceptance of any one commercial bank.
B. Commercial Paper
1. Must be "Prime" quality of the highest ranking as provided by Moody's
Investment Service, Inc. or Standard and Poor's Corporation - (Al -
P1).
County of Contra Costa -Treasurer's Report on County Investment Pool Page 16
2. Limited to issuing corporations that are organized and operating within
the United States with total assets in excess of five hundred million
dollars ($500,000,000).
3. Must not exceed 180 day maturity.
4. Must not represent more than 10% of the outstanding paper of an
issuing corporation.
5. Must not exceed 15% of the County's surplus funds.
6. May invest an additional 15% if the dollar-weighted average maturity
of the entire amount does not exceed 31 days.
C. Negotiable Certificate of Deposit
1. Must not exceed 30% of the County's surplus funds.
2. Limited to issuing national or state chartered banks or state or federal
savings and loan associations or state-licensed branches of foreign
banks.
D. Reverse Repurchase Agreements
1. Require approval of County's Board of Supervisors.
E. Medium Term Corporate Notes
1. Securities eligible for investments under this subdivision shall be rated
in the top three note rating categories by two of the three largest
nationally recognized rating services. Purchase of medium term
corporate notes may not exceed 30% of the agency's surplus money.
11. RESTRICTIONS SET BY TREASURER'S POLICY
A. Reverse repurchase agreements will be used strictly for the purpose of
supplementing income; limit of three (3) outstanding without prior approval of
the Treasurer.
B. Swaps and Trades will each be approved on a per trade basis by Treasurer
or Chief Investment Officer.
C. SBA loans require prior approval of the Treasurer in every transaction.
County of Contra Costa -Treasurer's Report on County Investment Pool Page 17
iD. Repurchase Agreements will generally be limited to Wells Fargo Bank, Bank
of America, First Interstate Bank or Merrill Lynch. Collateral will be held by a
third party to the transaction which may include the trust department of
particular banks.
E. Securities purchased through brokers will be held in safekeeping at Bank of
America Services clearance office in New York or as designated for
Government Securities.
F. Bank C.D.'s will be collateralized at 100% by Government securities or 150%
by current mortgages. There will be no waiver of the first $100,000.00
collateral except by special arrangement with the Treasurer.
G. Negotiable C.D.'s from S & L's will be limited to 100 thrift institutions in the
United States as listed in order of net income for 1993 or a supplementary
list approved by the Treasurer.
H. Any mortgage pass-through security, collateralized mortgage obligation,
mortgage-backed or other pay-through bond, equipment lease-backed
certificate, consumer receivable pass-through certificate, or consumer
receivable-backed bond will be limited to a maximum of five years maturity.
GLOSSARY
BANKERS ACCEPTANCES
Bankers Acceptance is a time bill of exchange drawn on and accepted by a commercial
bank to finance the exchange of goods. When a bank "accepts" such a bill, the time draft
becomes, in effect, a predated, certified check payable to the bearer at some future
specified date. Little risk is involved for the investor because the commercial bank
assumes primary liability once the draft is accepted.
CERTIFICATES OF DEPOSITC( /D's)
C/D's are certificates issued against funds deposited in a commercial bank for a definite
period of time and earning a specified rate of return. They are issued in two forms -
negotiable and non-negotiable.
A. NEGOTIABLE CERTIFICATES OF DEPOSIT.
May be sold by one holder to another prior to maturity. This is possible because
the issuing bank agrees to pay the amount of the deposit plus interest earned to the
• BEARER of the certificate at maturity.
County of Contra Costa -Treasurer's Report on County Investment Pool Page 18
•
B. NON-NEGOTIABLE CERTIFICATES OF DEPOSIT
These certificates are collateralized and are not money market instruments since
they cannot be traded in the secondary market. They are issued on a fixed maturity
basis and often pay higher interest rates than are permissible on other savings or
time deposit accounts.
FUTURES
Futures contracts are the units of trading at a commodity exchange. They are legally
binding agreements made within the confines of an exchange trading area. All futures
contracts call for the purchase or sale of a physical commodity or financial instrument on
dates from one month to more than two years in the future.
Hedging is the initiation of a position in the futures market that is intended as a temporary
substitute for the sale or purchase of the actual instrument.
Futures may be purchased in anticipation of future cash purchases as a protection against
the possibility of increasing cost.
OPTIONS
The buyer of a call option has the right to buy the underlying security at a fixed price. The
option seller is obligated to sell the security if the buyer chooses to exercise the option.
SURPLUS FUNDS
Since tax collections are twice a year and the County spends the revenue over a period of
twelve months for this policy statement, all funds which are not required to meet the banks'
demands on the treasury to redeem warrants on any given day are considered "surplus
funds" for investments.
REPURCHASE AGREEMENTS
A repurchase agreement is an investment transaction which permits temporary funds to
be invested for a period of time, (usually under 30 days), exactly suited to an investor's
money requirements. It assures him a specific rate of return. This transaction usually
involves the sale of marketable securities and a simultaneous commitment by the seller to
repurchase the securities at the same price on a specified later date at the time the
agreement is negotiated.
County of Contra Costa -Treasurer's Report on County Investment Pool Page 19
. REVERSE REPURCHASE AGREEMENTS
Repurchase agreements allow the banks/dealers to buy temporary idle funds from the
County by selling to the County U.S. Government or other securities.
A reverse repurchase agreement is the opposite. The dealer buys securities with a
contractual agreement to sell them back at a prearranged date. The County pays him
interest for the use of his funds.
The money "borrowed" on a "reverse repo" can then be reinvested in more rewarding
investments.
•
County of Contra Costa -Treasurer's Report on County Investment Pool Page 20
PART 3 - BOARD AUTHORIZATION
PERMITTING THE USE OF REVERSE
REPURCHASE AGREEMENTS
s
County of Contra Costa -Treasurer's Report on County Investment Pool Page 21
In the Board of Supervisors
of.
Contra Costa County, State of California
August .25 19 81
In the Matter of
REVERSE REPURCHASE AGREEMENT
The County Treasurer-Tax, Collector is hereby authorized
to participate in Reverse Repurchase Agreements in accordance with
Government Code Sections 53601 (i) and 53635(1) .
PASSED by the Board on August 25, 1981, by the following
vote:
AYES: Supervisors Fanden, Schroder, McPeak,
Torlakson, Powers
NOES: None
.ABSENT: None
I hereby certify that the foregoing is a true and correct copy of an order entered on the
minutes of sold Board of Supervisors on the date aforesaid.
Orig. Dept. : Treas-Tax Collector Witness my hand and the Seal of the Board of
Supervisors
cc : -treasurer-Tax Collector affixed this 25thday of August 19 81
Auditor-Controller
County Administrator J. R. OLSSON, Clerk
County Counsel /a
gy --�-� l/ �itR.-�sL���-', Deputy Clerk
G/�
Jeanne O. Maglio
County of Contra Costa -Treasurer's Report on County Investment Pool Page 22
•
SECTION 3
CURRENT INVESTMENT POOL
PORTFOLIO
County of Contra Costa -Treasurer's Report on County Investment Pool Page 23
. Section 3 - Current Pool Investment Portfolio
Section 3 is comprised of three parts.
Part 1 provides a brief discussion of the rating agencies' criteria for evaluating the credit
integrity of County investment pools in California. It is shown that Contra Costa
County's pool has not been cited as a "risky" pool by any of the rating agencies. In
addition, the Treasurer notes that the County's short-term ratings remain in the highest
credit categories by both of the major rating agencies.
Part 2 contains two graphs depicting the historical balances in the Pool, tabular data
pertaining to the current composition of the County Pool's investment portfolio, data on
the liquidity profile of the pool, and earnings on the Pool 's portfolio.
• Part 3 provides a listing of responses to commonly asked questions regarding Pool
investment practices.
County of Contra Costa -Treasurer's Report on County Investment Pool Page 24
•
PART 1 - CREDIT INTEGRITY
OF THE COUNTY POOL
County of Contra Costa -Treasurer's Report on County Investment Pool Page 25
PART 1 - CREDIT INTEGRITY OF THE COUNTY POOL
As a consequence of the Orange County bankruptcy, the major rating agencies -
Moody's Investors Service, Standard & Poor's Ratings Group, and Fitch Investors
Service - have each conducted extensive reviews of the credit integrity of the
investment pools that are managed by the counties they rate. Only the two most
prominent rating agencies - Moody's Investors Service and Standard & Poor's Ratings
Group - maintain ratings for the County of Contra Costa. Analysts from each of these
agencies have recently conducted interviews with County officials and have collected
information such as that provided herein in order to assess the credit integrity of the
County's Pool.
The rating agencies utilize three major factors in assessing the risk of a county pool:
1) The extent to which leveraging is utilized, i.e. the extent to which the County
utilizes borrowed funds as collateral to purchase securities. The most well-
known form of leveraging is the use of reverse repurchase agreements.
2) The extent to which derivatives are utilized without offsetting hedges or
matched positions, i.e. the presence of securities whose interest rates are
determined by the performance of a different security without simultaneously
establishing a hedge or offsetting position.
3) The extent to which outside investors utilize the pool for speculative purposes,
i.e. the extent to which the liquidity of the pool is exposed to fickle investors who
invest or withdraw funds for speculative reasons.
Results of Rating Agency Review. After conducting a census of all 58 California
counties, the major rating agencies have cited the following counties as having risky
investment practices:
Monterey
Placer
Orange
San Diego
Sonoma
Solano
SThese counties are on credit watch.
County of Contra Costa -Treasurer's Report on County Investment Pool Page 26
Results for Contra Costa County. The County enjoys the highest credit rating
offered by Moody's (MIG 1) and Standard and Poor (SP-1+) . Only three other counties
in the State are in this same category. They are Sacramento, Ventura and Marin
Counties.
County of Contra Costa -Treasurer's Report on County Investment Pool Page 27
PART 2 - CURRENT INVESTMENT
POOL PORTFOLIO
County of Contra Costa - Treasurer's Report on County Investment Pool Page 28
. Section 2 - Current Composition of the County Pool
Contained in this part of the report are various graphs, tables, and data pertaining to the
current investment portfolio for the Pool.
The first two pages provide graphs depicting the historical balances in the Pool for the
County-only portion of the pool and for the entire Pool.
The third page provides a delineation of the components of the portfolio, their risk
rankings, par amounts, market values, and their compliance with the Government Code
as permitted investments.
The fourth page provides a graphical illustration of the Pool's portfolio's composition
• and a table that addresses the liquidity of the Pool in terms of the average weighted
days to maturity.
The fifth page provides summarial data on budgeted versus actual investment
earnings of the portfolio since fiscal year 1984-85.
County of Contra Costa -Treasurer's Report on County Investment Pool Page 29
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County of Contra Costa -Treasurer's Report on County Investment Pool Page 31
COMPOSITION OF THE PORTFOLIO
POOLED FUND INVESTMENT PORTFOLIO
JANUARY 31, 1995
The following listing provides essential areas involving the Treasurer's management of
the County pool portfolio; namely the composition of the portfolio ranked in accordance
to the safety of the securities within the portfolio, the cost (i.e., book value) vs. the
current market value of the securities in the portfolio and the position of the portfolio as
of the report date. While the table denotes a current market value loss (i.e., a paper
loss) on the portfolio, nonetheless, it is the Treasurer's policy to avoid actual losses in
investment principal by holding securities to their maturity. The liquidity position of the
portfolio is such that there is no contemplation or need to sell securities prior to their
maturity.
MARKET GOVERNMENT CODE
RISK TYPE COST VALUE" % RESTRICT. COMPLY
I U.S*TREASURIES AND CASH $146,430,385 $146,770,566 17.79% NONE YES
2 U.S.AGENCIES-FEDERAL,STATE&LOCAL $216,750,061 $215,474,009 26.34% NONE YES
3 MONEY MARKET INSTRUMENTS $349,946,216 $350,154,018 42.53% NONE YES
4 STRUCTURED NOTES $109,750,000 $95,930,000 13.34% SOME YES
5 SPECIAL INVESTMENTS $0 $0 0.00% SOME YES
6 LONG-TERM SPECIAL INVESTMENTS $0 $0 0.00% SOME YES
SUBTOTAL $822,876,662 $808,328,593 100.00%
MARKET VALUE RATIO(98.23%) $01 $14,548,069
TOTAL $822,876,662 1 $822,876,662 100.00%
*Source of market valuation data=Interactive Data Corporation,Waltham, Massachusetts, except for structured notes which are
from Bank of America and various sources.
The above risk ranking is derived from securities' classifications that are generally used
by banks, bank examiners, insurance examiners, state and federal regulatory agencies.
Category 1 includes cash and U.S. Treasuries which are direct obligations of the, U.S.
Government. Category 2 includes all investment instruments that are guaranteed by
the federal and/or local U.S. governments. Category 3 includes money market
instruments such as bankers' acceptance, commercial paper and certificates of deposit
that are highly liquid and have short term maturities. Category 4 are federal agency
notes and negotiable certificates of deposit. The principal of the agency notes is
government guaranteed. The certificates of deposit are rated "AAA". Both have less
liquidity, relatively greater interest rate risk, and longer-term maturities. Category 5
includes investments such as CMO's that are less liquid, have longer-term maturities
and possess substantial market risk. Category 6 includes long-term commercial,
corporate, or foreign debt that are highly illiquid, have longer-term maturities and
possess substantial market risk.
County of Contra Costa-Treasurer's Report on County Investment Pool Page 32
• A graph is presented that compares the County's market value ratio in 1994 to that of
other Northern California counties.
SELECTED CALIFORNIA COUNTIES
AS OF DECEMBER 1994
TOTAL MARKET
COUNTY PORTFOLIO VALUE RATIO
CONTRA COSTA COUNTY** $822,876,662 98.23%
SAN MATEO $588,700,000 98.28%
SANTA CLARA $1,232,359,000 96.77%
SACRAMENTO $1,093,055,210 96.64%
SOLANO* $427,339,795 95.46%
SONOMA* $762,803,521 93.40%
" On credit watch list of Moody's
** As of January 31, 1995
Source: California Association of County Treasurers and Tax Collectors.
INVESTMENT PORTFOLIO BY INVESTMENT
TYPE AS OF JANUARY 31, 1995
STRUCTURED NOTES 130 18yo
U.S.TREASURIES&CASH
ca
42%
MONEY MARKET INSTRUMENTS U.S.AGENCIES-FEDERAL,STATE&LOCAL
•
County of Contra Costa-Treasurer's Report on County Investment Pool Page 33
PORTFOLIO LIQUIDITY
(AS OF JANUARY 31, 1995)
Over 77% of the portfolio has a maturity of less than a year. This greatly enhances the
safety of the Pool and County's ability to meet its cash flow needs. The average
weighted days to maturity is 314 days.
MATURITIES LESS THAN 1 YEAR $636,529,890 77.35%
MATURITIES 1 TO 2 YEARS $44,566,160 5.42%
MATURITIES 2 TO 3 YEARS $43,493,344 5.29%
MATURITIES 3 TO 4 YEARS $44,115,236 5.36%
MATURITIES 4 TO 5 YEARS $52,404,547 6.37%
MATURITIES GREATER THAN 5 YEARS* $1,767,485 0.21%
TOTAL 1 $822,876,662 1100.00%
*Represents Bond Proceeds of Martinez Unified School District
MEASURES OF PORTFOLIO EARNINGS
BUDGETED VERSUS ACTUAL INVESTMENT EARNINGS*
Cumulatively over the past ten and a half fiscal years, actual interest earnings have
been almost $120 million.
FISCAL YEAR BUDGETED ACTUAL
1984-85 9,825,000 11,854,000
1985-86 10,327,000 11,788,942
1986-87 8,570,000 12,132,846
1987-88 7,063,000 8,754,890
1988-89 9,100,000 11,044,838
1989-90 10,000,000 14,603,659
1990-91 13,210,000 11,937,540
1991-92 12,405,176 10,545,226
1992-93 9,000,176 12,702,357
1993-94 8.350.000 10.398.000
SUBTOTAL 97,850,352 115,762,298
1994-95 7,536,500
TO 12/31/94 3,768,250 ** 4,144,000 ***
TOTAL 101,618,602 119,906,298
* Budgeted and actual data derived from Final Budget books.
**Semi-Annual Year budget assumes 50% of total fiscal year budget.
***Semi-Annual Fiscal year actual data is actual gross booked pool income.
County of Contra Costa -Treasurer's Report on County Investment Pool Page 34
CUMULATIVE EARNINGS OF THE POOL
SINCE FISCAL YEAR 1984-85
FISCAL YEAR INTEREST EARNINGS*
1984-85 29,547,000
1985-86 30,156,000
1986-87 29,596,000
1987-88 28,865,000
1988-89 38,617,000
1989-90 47,974,000
1990-91 42,290,000
1991-92 41,459,000
1992-93 39,915,000
1993-94 33.001.000
TOTAL $361,420,000
* SOURCE-SUNGUARD INVESTMENT FINANCIAL SYSTEM
County of Contra Costa -Treasurer's Report on County Investment Pool Page 35
•
PART 3 - COMMONLY ASKED
QUESTIONS REGARDING THE POOL
INVESTMENT PRACTICES
County of Contra Costa -Treasurer's Report on County Investment Pool Page 36
•
COMMONLY ASKED QUESTIONS REGARDING
THE POOL INVESTMENT PRACTICES
1. Did the Treasurer contract or utilize the services of any outside, private
investment manager for pool purchases? NO
2. Did the Treasurer contract or utilize the services of any investment advisor
for pool purchases? NO
3. Are there any investment agreement contracts outstanding affecting the
portfolio? NO
4. Are any securities held in bank custody subject to a bank "Security Lending
Agreement"? NO
5. Are any securities on loan to a brokerage firm as a result of reverse-
repurchase agreements made by the Treasurer? NO
6. Is the Treasury susceptible to possible margin calls on loaned securities?
NO
7. Did the Treasurer sell any securities prior to maturity in order to meet cash
flow needs? NO
8. Did the Treasurer sell any security at a principal loss? NO
9. Did the Treasury buy or does it hold any securities that carries an inverse
floating interest equation (i.e., a derivative)? YES
10. Does the Treasurer plan to invest in derivatives in future investment
. strategies? NO
County of Contra Costa -Treasurer's Report on County Investment Pool Page 37
11. Did the Treasurer buy any CMO's (i.e., collaterialized mortgage obligation)?
NO
12. Did the Treasurer buy any shares in a mutual bond fund where the
underlying value of the securities in the portfolio are subject to daily market
value adjustments? NO
13. Did the Treasurer enter into any "covered call" or "put option contract"? NO
14. Did the Treasury establish any new account and/or accept deposits from any
governmental entity not now a participant of the Treasury investment pool?
NO
15. Has the County entered into any taxable TRANS for the purpose of further
enhancing portfolio yield? NO
County of Contra Costa -Treasurer's Report on County Investment Pool Page 38
SECTION 4
INVESTMENT STRATEGIES AND
TREASURER'S RECOMMENDATIONS
County of Contra Costa -Treasurer's Report on County Investment Pool Page 39
Section 4 - Investment Strategies and Treasurer's Recommendations
Section 4 is comprised of two parts.
Part 1 presents a summary of actions already implemented by the Treasurer
concerning investment practices for the Pool and a recommendation by the Treasurer
that an Investment Review Committee be formed for oversight and monitoring
purposes.
Part 2 contains a position paper by the California Association of County Treasurers and
Tax Collectors regarding the formation of local investment pool oversight committees.
County of Contra Costa -Treasurer's Report on County Investment Pool Page 40
•
PART 1 - ACTIONS ALREADY TAKEN BY
THE TREASURER AND THE
TREASURER'S RECOMMENDATIONS
County of Contra Costa -Treasurer's Report on County Investment Pool Page 41
. STRATEGIES AND TREASURER'S RECOMMENDATIONS
I. Actions Already Initiated By Treasurer (as of December 1994)
A. No reverse repurchase agreements will be used.
B. Securities purchased through brokers will be held in safekeeping at
Bank of America Services clearance offices or as designated for
Securities.
C. There will be no purchases of derivatives, floating rate notes or
collateralized mortgage obligations.
D. Maximum maturity of newly acquired investments will be no greater
than two (2) years, unless directed by the governing authority of the
district.
•
E. All other elements of the current investment policy remain in effect.
County of Contra Costa - Treasurer's Report on County Investment Pool Page 42
II. Further Recommendations BY The Treasurer
The Treasurer recommends that an Investment Oversight Committee
(IOC) be formed for the purpose of :
• reviewing the County's Investment Policy ; and
• regularly monitoring the County Investment Pool's performance
and reporting the same to the Board of Supervisors.
The Treasurer further recommends that the Investment Oversight
Committee be composed of seven members. The Treasurer, County
Administrator, Auditor-Controller, and County Counsel shall serve as ex-
officio members of the IOC. The fifth member shall be appointed by the
Board of Supervisors. The Treasurer recommends the Board appoint or
hire a Certified Financial Advisor. The sixth and seventh members shall
be representatives of entities that invest their funds in the Pool.
The Treasurer further recommends that the IOC report back to the Board
on a regular basis.
County of Contra Costa -Treasurer's Report on County Investment Pool Page 43
i
PART 2 - CACTTC POSITION PAPER
ON THE FORMATION OF LOCAL
OVERSIGHT INVESTMENT
COMMITTEES
i
County of Contra Costa -Treasurer's Report on County Investment Pool Page 44
OP��A ASSOO14r'0
�
CALIFORNIA ASSOCIATION
0
OF COUNTY TREASURERS AND TAX COLLECTORS
� Ov
U
R�sGgegs A140 Sr+
CACTTC SPECIAL COMMITTEE ON INVESTMENTS
BACKGROUND PAPER ON
LOCAL GOVERNMENT INVESTMENT PRACTICES
The California Association of County Treasurers and Tax Collectors has appointed a special committee to
specifically address the concerns and repercussions of the failure of the Orange County investments. The
committee will include County Treasurers, representatives of CSAC, CMTA, CSMFO, CAO's Association,
Auditor's Association, and the State Treasurer's Office.
COUNTY TREASURIES -HOW THEY WORK
. County Treasurers act as the banker, cash manager, and investment officer for most local governments
within the county. Generally, over a hundred local school districts, special districts, and trustees pool their
funds into a single account. Thus, instead of 100 part time, local officials attempting to invest public
monies in a risky market, county treasurers can function as full time, professional investment managers.
Instead of individual districts, coping with small and varying cash balances,the county treasury has a large
and relatively predictable cash balance available for investment. The same economics of scale and lack of
duplication carry over to the banking operation. Instead of 100 local officials attempting to manage their
check books, one consolidated account allows for reduced transaction charges and simplified accounting
and reporting responsibilities.
The concept of a county treasury is good public policy. Nevertheless, we recognize the existence of
problems and offer the following suggestions for your consideration.
County of Contra Costa -Treasurer's Report on County Investment Pool Page 45
Oversight Committee
General:
County treasuries consolidate the banking, cash management and investment activities of most local gov-
ernments in their jurisdictions into one operation. Over 100 local school districts, special districts, trustees,
as well as the county, pool their funds into one account. The pooling avoids the duplication that would occur
if the individual districts were to pursue their own banking and investment operations. Further, the econo-
mies of scale allow the county to function as professional money managers and investment officers to
protect the public interest in a complex and risk bond market.
The treasury pools, while good public policy, are not governed by a coherent, comprehensive body of law.
Local governments,which are required to deposit their funds in the county treasury, have little involvement
in how their funds are managed and invested. Conversely, while the law is explicit relating to deposits, it is
ambiguous to individual districts' authority to withdraw funds from the pools and invest separately. Fre-
quently, individual districts withdraw large sums from the pools whenever they feel it is in their interests to
do so. These actions hamper the county treasurers' ability to fashion coherent, secure and remunerative
investment policies and ultimately work to the disadvantage of all pool participants.
It is recommended that statutory language be adopted creating in each county oversight committees. These
committees would include representatives from both local non-county governments and the county. The
committees would be responsible for adopting investment policies, conducting audits to ensure compli-
ance, determining appropriate investment broker and dealer relationships, including restrictions regarding
gifts and honoraria, defining how public entities outside the jurisdiction of the county treasury could or could
not participate in the pool, and governing the withdrawal from the county pools of monies by local govern-
ments for investment purposes. Suggested language follows:
SECTION 1. The Legislature finds and declares that local governments, including school districts, who are
required to deposit their monies in county treasuries, should participate in the policy governing the invest-
ment of their funds. The Legislature further finds and declares that county treasuries, by pooling the funds
of many local districts and entities, and consolidating their banking and investment activities, are in the
public interest by acting to reduce duplication, achieve economies of scale and allowing coherent, consoli-
dated investment strategies to be employed. The Legislature further finds and declares that the establish-
ment of oversight committees will promote the public interest by allowing non-county districts and entities
involvement in the management of their funds and enhance the security and investment return on public
monies by providing a more stable and predictable balance available for investment by establishing criteria
for the withdrawal of large amounts of monies from the treasury pools.
County of Contra Costa -Treasurer's Report on County Investment Pool Page 46
SECTION 2. Article 6, beginning with Section 27130 of the Government Code is added to. read:
ARTICLE 6
COUNTY TREASURY OVERSIGHT COMMITTEES
27130. There is hereby established in each County and City and County a County Treasury Oversight
Committee.
27131. The Oversight Committee shall consist of the County Treasurer, the County Auditor Controller or
the County Finance Director, a representative of the County Board of Supervisors, the County Superinten-
dent of Schools, a representative selected by a majority of the school districts within the county, and a
representative selected by a majority of the Special Districts who are required or authorized to deposit their
Monies in the county treasury.
27132. The Oversight Committee shall adopt an annual Investment Policy. The Investment Policy shall
include:
(a) A listing of allowed investment securities, including a maximum allowable percentage of type of
security.
(b) The maximum term of any security purchased by the county treasury.
(c) The criteria for the selection of security brokers and dealers from whom the county treasury pur-
chases securities.
(d) Restrictions on the acceptance of honoraria, gifts and gratuities from brokers, dealers, bankers or
. other professionals with whom the county treasury conducts business by any member of the Over-
sight Committee. These restrictions can be in addition to those promulgated by the Fair Political
Practices Commission.
(e) A requirement that the county treasurer render to the committee a monthly investment report. in
such form as the committee may require.
(f ) The manner of calculating and apportioning the costs of investing, depositing, banking, and han-
dling funds authorized by §27013 of the Government Code.
(g) The terms and conditions under which public entities and public officials not required to deposit
their funds in the county treasury may deposit their surplus monies for investment purposes.
County of Contra Costa - Treasurer's Report on County Investment Pool Page 47
27133. The Oversight Committee shall cause an annual audit to be conducted to determine compliance
with the investment policy. The audit may address questions of investment portfolio structure and risk. The
costs of the audit are county charges and shall be charged against the county treasurer's budget.
27134. Notwithstanding any other provisions of law, any public entity or public official who is required by
law to deposit funds in the county treasury,seeking to withdraw funds for the purpose of investing outside of
the county treasury, must obtain the approval of the Oversight Committee before withdrawing the funds.
The committee shall adopt criteria for considering such requests. The criteria shall include an assessment
of the impact of the withdrawal on the stability and predictability of the pool and a finding by the committee
that the withdrawal will not adversely impact the interests of the pool participants. The county treasurer
may reject any request for withdrawal of funds under this section if he or she concludes that the withdrawal
could create a substantial probability of a run on the investment pool. No such rejection by the county
treasurer shall be done unreasonably.
27135. Nothing in this Article shall be construed to empower the Oversight Committee to direct individual
investment decisions, select individual investment brokers or dealers or impinge on the day to day opera-
tions of the county treasury.
•
County of Contra Costa -Treasurer's Report on County Investment Pool Page 48
APPENDIX A
SELECTED REPORTS FROM MOODY'S
INVESTORS SERVICE
Key to Moody's
Municipal Ratings
Moody's ratings provide investors with a Issues that are subject to a periodic reof- A
simple system of gradation by which the fer and resale in the secondary market in Bonds that are rated A possess many
relative investment qualities of debt a"dutch auction"are assigned a long-
instruments may be noted. term rating based only on Moody's favorable investment attributes and are to
beassessment of the ability and willingness considered as upper medium grade
There are nine basic rating categories for obligations.Factors giving security to
long-term obligations.They range from of the issuer to make timely principal and principal and interest are considered ade-
interest payments.Moody's expresses no
Aaa{highest qualify}to C(lowest qual- quare,but elements may be present That
opinion as to the ability of the holder to
fry).Those bonds in the Aa,A,Baa,Ba suggest a susceptibility to impairment
and B groups that Moody's believes pos- sell the security in a secondary market some time in the future.
sess the strongest investment attributes "dutch auction."Such issues are identi-
are designated by the symbols Aal,Al, bed by the insertion of the words"dutch Baa
Baal,Bal and Bl.Advance refunded auction"into the name of the issue. Bonds that are rated Baa ane considered
issues that are secured by escrowed funds as medium grade obligations,i.e.,they
held in cash,held in trust,reinvested in Definitions of Bond Ratings are neither highly protected nor poorly
direct non-callable United States govern- Aaa secured.Interest payments and principal
ment obligations or non-callable obliga- security appear adequate for the present
tions unconditionally guaranteed by the Bonds that are rated Aaa are judged to but certain protective elements may be
be of the besequatity.They cant'the
U.S.government are identified with a N lacking or may be characteristically unre-
(hatchmark)symbol,e.g.#iAaa, smallest degree of investment risk and liable over any great length of time.Such
are generally referred to as"gilt edge." bonds lack outstanding investment char-
There are four rating categories for short- Interest payments are protected by a large acteristics and in fact have speculative
term obligations that define an invest- or by an exceptionally stable margin and characteristics as well.
ment grade situation.These are desig- principal is secure.While the various
nated Moody's Investment Grade as MIG protective elements are likely to change, Ba
1(best quality)through MIG d(adequate such changes as can be visualized are Bonds that are rated Ba are judged to
quality).Short-term obligations of specu- most unlikely to impair the fundamen- have speculative elements;their future
lative quality are designated SG. tally strong position of such issues, cannot be considered as well assured.
In the cast of variable rate demand obli- Aa Often the protection of interest and prin-
gations(VRDOs),a two-component rat- cipal payments may be very moderate,
ing is assigned.The first element repre- Bonds that are rated Aa are judged to be and thereby not well safeguarded during
sents an evaluation of the degree of risk of high quality by all standards.Together both good and bad times over the future.
associated with scheduled principal and with the Aaa group they comprise what Uncertainty of position characterizes
interest payments,and the other repre- are generally known as high grade bonds. bonds in this class.
sents an evaluation of the degree of risk They are rated lower than the best bonds_
associated with the demand feature.The because margins of protection may not be B
short-term rating assigned to the demand as large as in Aaa securities or fluctua- Bonds that are rated B generally lack
feature of VRDOs is designated as tion of protective elements may be of characteristics of the desirable invest-
VMIG.When either the long-or short- greater amplitude or there may be other merit.Assurance of interest and principal
term aspect of a VRDO is not rated,that elements present that make the long-term payments or maintenance of other terms
piece is designated NR,e.g.,Aoo/NR or risks appear somewhat larger than in of the contract over any long period of
NR/VMIG 1. Aaa securities. time may be small.
o
COO or(d)payments to which some other MIG 2/VMIG 2
limiting condition attaches.Parenthetical
Bonds that are rated Coa are of poor 'Ibis designation denotes high quality.
rating denotes probable credit stature
standing.Such issues may be in default upon completion of construction or eGmi- Margins of protection are ample although
or there may be present elements of dan- nation of basis of condition. not so large as in the preceding group.
ger with respect to principal or interest. MIG 3/VMIG 3
Ca Definitions of
Short-Term Loan Ratings Ibis designation denotes favorable qual-
Bonds that are rated Ca represent obliga- ity.All security elements are accounted
Issues or the features associated with
tions that are speculative in a high for but there is lacking the undeniable
degree.Such issues are often in default or MIG or VMIG ratings are identified by strength of the preceding grades.Liquid"
have other marked shortcomings. date of issue,date of maturity or maturi- ity and cash flow protection may be nar-
ties or rating expiration date and descrip- row and market access for refinancing is
C tion to distinguish each rating from other likely to be less well established.
Bonds that are rated C are the lowest ratings.Each rating designation is unique
rated class of bonds,and issues so rated with no implication as to any other simi- MIG 4/VMIG 4
can be regarded as having extremely poor lar issue of the same obligor.MIG ratings This designation denotes adequate qual-
prospects of ever attaining any real terminate at the retirement of the obliga- ity protection commonly regarded as
investment standing. tion while VMIG rating expiration will be
g required of an investment security is pre-
a function of each issue's specific suuc-
Con.(...) lural or credit features. sent and although not distinctly or
predominantly speculative,there is spe-
Bonds for which the security depends MIG 1/VMIG 1 cific risk.
upon the completion of some act or the
fulfillment of some condition are rated This designation denotes best quality. SG
conditionally.'Iltese are bonds secured There is present strong protection by This designation denotes speculative
by:(a)earnings of projects under con- established cash flows,superior liquidity quality.Debt instruments in this categor)
struction,(b)earnings of projects unsea- support or demonstrated broad-based lack margins of protection.
soned in operating experience,(c)rentals access to the market for refinancing.
that begin when facilities are completed,
Moodys Investors service
Public Finance Department Rating Desk
Moody's Investors Service
99 Church Street
New York.NY 10007
(212)553.0533
STATUS OF ORANGE COUNTY, CALIFORNIA DEBT
New York,New York-January 11, 1995-On January 6, 1995,Moody's
Investors Service reinstated and lowered the ratings on a number of the short-
term and long-term obligations of Orange County,California. These ratings
were suspended on December 6, 1994 pending clarification of the county's
intention and ability to pay debt service under bankruptcy. The rating revisions
reflect the county's reduced ability to meet debt service requirements. It is clear
that absent extraordinary Intervention,there Is no ability to pay notes maturing in
June and July 1995. The following is a brief summary of each of the county's
obligations and our understanding of the status of their debt service payments.
Orange County Debt Issues MoWe Rating Description
General Obligation Bonds Can(revised from General Obligation Improvement
$7115,000 Aa1) Bonds. Interest payment due
January 1,paid January S. Semiannual
debt service payment due July 1 1995.
Pension Obligation Series A Can(revised from Default on Series B moss-defaults
(taxable) At) Serles A under single resolution. FWI
$209,1340,000 years debt service for 1994-95 set
aside with trustee. Semiannual Interest
a ment due March 1.
(Continued)
Orenp County Debt lasts MOOdYS Rath Description
Pension Obligation Series 8 Coe(revised from Bonds In default due to inability of
(Taxable) AINMIG 1) Countyto most bond tender on
$110,000,000 December 8 because of pool
bankruptcy. Full year's debt service for
199495 set aside with trustee.
Interest payment due January 3 paid
Janus 5.
Public Facilities Corporation Con.(Caa)(revised Debt service payment due January 3
Certificates of Participation from Con.(All)) made from reserve fund held by
dated 7/1/86 trustee. Approximately$3.6 million
$13,485,000 remains In reserve fund. Next debt
service payment of$3.6 million is due
JUIV 1.
Public Facilities Corporation Cat(revised from A) Solid Waste Management System
Certificates of Participation Certificates of Participation. Nexd
dated 12/1/88 Interest payment due June 1, 1994.
$81.815,000 Approximately$8.3 million In debt
service reserve fund held by trustee.
California Financial Services Con.(Cas)(revised Certificates Issued under Master Lease
(1990 Equipment Project) from Con.(A)) Program for equipment acquisition.
Certificates of Participation $1.3 million interest payment due
dated 1/1/91 March 1,1996,required to be
$11,975,000 transferred to trustee February 10.
Approximately$1 million In debt
service reserve fund held by trustee,
Redevelopment Agency Caa(revised from Tax increment revenues may be
Santa Ana Heights Project Sul) protected under bankrupt*however.
Area Tax Allocation Bonds redevelopment agency debt Is Included
$57.436,000 In bankruptcy filing as a debt of the
county. We aro trying to clarity legal
status.
1994-95 TRANS Speculative Grade Annual cash flow borrowing. Principal
Series A (revised from MIG 1) and interest due at note maturity on
$169,000,000 July 28,1996. Monthly segregation of
note prirtcipal began as scheduled In
September 1994 but was Invested in
the pool.County did not mast
segregation pledge for December and
does not expect to segregate for
Jan
Orange County Debt Issues Mood 's Rating Description
199495 TRANe Speculative Grade Variable rate portion of annual cash
Series B (revised from MIG 1) flow borrowing. Note matures
$31,000,000 August 10,1995. Segregation pledge
Is for June only. Interest payments
due first business day of each month.
January 3 interest payment paid
January 5.
199495 Taxable Notes Not Prime(revised Principal due July 10, 1995 payable
$6001000,000 from P-1) from funds deposited upon closing,
together with Interest requirements,
in County Investment pool.
Interest payments due first business
day of each month.January 3 Interest
payment paid January 5.
199495 Teeter Plan Tax- Speculative Grade Payable first from delinquent tax
Exempt Notes (revised from MIG 1) receipts then from Standby Bond
$64,000,000 Purchase Agreement with County
Investrnsnt pool.Interest payments
due fust business day of each month.
January 3 interest payment paid
January S.
1994-95 Teeter Plan Taxable Not Prime(revised Payabls first from delinquent tax
Notes from P-1) receipts then from Standby Bond
$111,000,000 Purchase Agreement with County
Investment pool.Interest payments
due first business day of each month.
January 3 Interest payment paid
January S.
Airport Revenue Bonds Suspended Rating remains suspended until legal
$133,040,000 status and sutficlency of pledged
revenues under bankruptcy are
determined. Airport made sernhwwtual
debt service payment on January 3.
Airport had made fire of six monthly
transfers to the trustee prior to
bankruptcy filing. Paid abdh month
from revenues received after the filin
199495 Pooled TRANs Suspended Rating remains suspended until legal
$299001000 statue of pledged revenues under
bankruptcy is determined. Security for
TRANS Is payments from school
districts and Standby(Vote Purchase
Agreement from county pool. Notes
are due Ja 28 1985.
i
Rating Definition* ,
Caa: Bonds which are rated Caa are of poor standing. Such issues may be In
default or there may be present elements of danger with respect to principal or
Interest.
Con. (...): Bonds for which the security depends upon the completion of some
act or the fulfillment of some condition are rated conditionally.
Speculative Grade: This designation denotes speculative quality. Debt
instruments in this category lack margins of protection.
Not Prime: Issuers rated Not Prime do not fall within any of the Prime rating
categories.
Contacts:
Karen Krop
Assistant Vice President
(212) 553-4860
Barbara J. Flickinger
Vice President-Assistant Director
Far West Regional Ratings
(212) 553-7736
David Brodsly
Vice President- Manager
Western Regional Office, San Francisco
(415) 274-1700
•
_ Moodys Investors Service
" Public Annnce Deportmont Rating Desk
M000y's Investors Service
99 Church Sheet
ra New York,NY 10007
Fav 11 it jL A-r-- JL V L-V (212)5534533
MOODY'S LOWERS THE RATINGS ON SHORT-TERM AND
LONG-TERM OBLIGATIONS OF ORANGE COUNTY,CALIFORNIA
New York,New York--January 6, 1995--Effective today,Moody's Investors
Service reinstated and lowered the ratings on a number of the short-term and
. long-term obligations of Orange County,California. These ratings were
suspended on December 6, 1994 pending clarification of the County's intention
and ability to pay debt service undor bankruptcy. While some of the county's
recent actions show attentiveness to meeting its debt obligations,it is now clear
that the county's ability to fully pay debt service on its long-term obligations is
severely strained and,absent extraordinary intervention,there is no ability to pay
notes maturing in June and July 1995. With little assurance of payment of
interest and principal on the County's obligations for the foreseeable future,we
are now reinstating and lowering the long-term ratings on the county's
obligations listed below to QW. The ratings on various short-term obligations
listed below have been reinstated and lowered to 9Q(Speculative Grade)and
Not Prime. The rating on the Pension Obligation Bonds,Series B,which was
also suspended on December 6th,was reinstated and lowered on December 6th
to-Caa because of the investment pool's inability to honor the tender feature of
the bonds.
•
Uncertain Outlook For County Debt
Moody's analysts met recently with county officials and their advisors who
provided new cash flow projections through June 30, 1995, indicating that
receipts received after the bankruptcy filing would not be sufficient to pay the
county's operations and debt service, even if significant budget cuts are
achieved. The new cash flow projections make it clear that in the interim, debt
service payments are very much in jeopardy. County officials have indicated to
Moody's that decisions on future debt service payments will be made on a case-
by-case basis.
Recent actions are indicative.of the continued precarious position of debt
holders. The county has now made provisions for bondholders to receive debt
service payments which were due January 3, curing the default which had
occurred due to the lack of timely payment. The county chose to pay debt .
service on the 1986 Certificates of Participation from its debt service reserve
fund. It has also chosen not to make two segregation payments required for the
1994-95 Tax and Revenue Anticipation Notes. These actions are symptomatic
of the severe cash flow problems the county is experiencing.
There appears to be support among some county representatives and in the
Orange County business community to make the efforts necessary to avoid debt
payment defaults. Some county officials have suggested that solutions to the
county's cash flow problems can be found, possibly by restructuring debt,
seeking agreements with bondholders to extend debt payments, or undertaking
a now financing to consolidate county obligations. However, no specific
proposals have been made, there are legal and political obstacles to such
proposals, and in any case it will be difficult to create financial capacity to
support any significant new debt obligation.
The county's financial situation is very precarious and the$172 million shortfall
between this year's projected revenues and expenditures is substantial. The
county has lost close to$160 million in budgeted interest earnings and the Board
has voiced its opposition to seeking other revenue options. While the Board has
approved$40 million in spending cuts, substantial additional cuts will be difficult
to achieve this late in the fiscal year. Moody's will continue to monitor the
county's efforts to find solutions to its cash flow problems, balance operations,
and endeavor to meet its short and long-term debt obligations.
Ratings remain suspended on two obligations:the Orange County Airport
Revenue Bonds and the 1994-95 Pooled TRANs. The Orange County airport
enterprise system has established a separate fund for revenues received after
the bankruptcy filing to provide for operations and debt service. The status of
the rating will be reviewed once we have assessed the impact on the airport's
operations and capital program of the airport's losses on its funds invested in the
county investment pool. The rating on the pooled TRANs issued on behalf of
various school districts will be reviewed once we have clarified the legal status of
the pool under bankruptcy. In addition, we will need to review updated cash
flows of the participating school districts.
Below are listed the ratings affected by today's actions. We will follow up shortly
with a more detailed description of each of the County's obligations and report
on the status of their debt service payments.
Rating
Prior To Amount
Seriee Rating Suspension ($000)
----•--• -------------------------------------•--•------------------------------
Or.ange County General Obligation Bonds Caa Aa1 S 785
Orange County Taxable Pension Obligation Bonds,
Series A Caa Al 209,840
Orange CounLy-orange County Public Facilities
CurporaLion, Certificates of Participation
Series '86, dtd. 7/1/R6 Can. (Caa) Con. (A1) 13,485
Orange County-orange County Public Facilities
Corporation. Certificates of Participation
Series 186, dtd. 12/1/88 Caa A 81,615
orange County-California Financial Services
(1990 Equipment Project) Certificates of
Participation, dtd. 1/1/91 Con. (Caa) Con. (A) 11,975
orango County Civic Center Authority-Santa Ana
Lease Rental 19'/2 Refunding Can, Al 785
Orange County Development Agency Santa Ana
Heights ProjEecL Area Tax Allocation Bond.. Caa Baal 57,43S •
orange County TRANS 1994-95 Series A 11180 MIO 1 169,000
Orange County TRANS 1994-95 Series B 11380 HIC 1 31,000
Orange County 1994-95 Taxable Notes not Prim P-1 600,000
Orange County 1994-95 Taxable (Teeter-Plan)
Notes not Prima P-1 1111000
orange County 1994-95 Tax-Exempt (Teeter-Plan)
Notes (1)80 MIO 1 64,000
[1]Speculative Grade.
Contacts:
Karen Krop Barbara Flickinger David Brodsly
Assistant V.P. Assistant Director/Manager V.P. & Manager
(212) 553-4860 (212) 553-7736 (415) 274-1739
Moody's unuici i Credit Report
California County Investment Pools:
Sonoma County, California December 29, 1994
Addendum Comment
to the report of In our Comment of December 23,the size of the ther informed us that as of December 29,the size of
December 23, Sonoma County investment Pool as of December 12 the pool had increased to$760 million.This excludes
1994: was stated as$565 million:the correct amount was the amount related to reverse repurchase agreements,
3733 million,which excludes 3143 million related to which had decreased to SI I I million.
reverse repurchase agreements.The County has fur-
analysts:
Dion*R.Gatewood
(212)553-0849
Barbara J.Fllokinger
(212)SW7736 '
194908805 ■
Moody's Public Finance Department Ratlnp Dtc
Moody's Investors service
99 Church street
New York,NY 10007
it (212)553-0533
MOODY'S PROVIDES UPDATE ON SCHEDULED JANUARY 3
DEBT SERVICE PAYMENTS FOR ORANGE COUNTY,
CALIFORNIA AND COUNTY SCHOOL DISTRICTS
New York, New York - December 29, 1994- The Orange County Board of
Supervisors today took several actions to provide for debt service,payments
coming due on January 3. However, it is not clear that these actions, taken just
five days before the required payment date to bondholders, were approved in
time to allow timely payment of debt obligations. The county's actions appear to
represent a first step toward acknowledging that, while operating under the
bankruptcy filing, debt obligations will be a priority. At the same time, the
county's decision to forego segregating funds for the repayment of the 1994-95
Tax and Revenue Anticipation Notes, as well as its decision to utilize the reserve
fund to make payment on the Certificates of Participation, Series 1966,
underscores the fact that the position of debtholders remains very tenuous.The
ratings on the county's obligations were suspended on December 6, when the
county and the investment pool filed for bankruptcy because of large investment
losses by the pool.
County Actions Regarding Debt Repayment
Moody's has been informed by officials of Orange County that today the Board of
Supervisors authorized its bankruptcy counsel to seek permission from the
Bankruptcy Court to withdraw sufficient funds from the county Investment pool to
make county Interest payments coming due on January 3. However, such
payments are subject to approval by the bankruptcy judge, and, according tQ
county officials, It Is not clear that such approval will be obtained In.time to allows
debt service payments to be made when due on January 3. It is not clear what
are the legal repercussions, if any, should. interest payments be late. These
payments are for interest on: 1994.95 Tax and Revenue Anticipation Notes,
Series B; 1994-95 Taxable TRANs; Taxable and Tax-Exempt Teeter Notes;
General Obligation Improvement Bonds; and.Sanitation District No. 12 Sewer
Bonds.
County officials have also Informed us that the county will not follow the
provisions of the resolution for the $169 million 1994-95 Tax and Revenue
Anticipation Notes, which require segregation of funds for note repayment of
$34.7 million in December and $18.7 million In January. While the county's
failure to set aside these monies raises serious concerns, the note resolution
requires that "any deficiency shall be satisfied and made up from any other
moneys of the County lawfully available..". It is too early to tell whether the
county will be able to make up these amounts to make full and timely payment at
note maturity on July 19, 1995.
County officials have also informed us that the$488,175 debt service payment
due on January 3 for the Certificates of Participation, Series 1986, will be made
from debt service reserve funds held separately by the trustee. After this
payment, approximately$3.65 million will remain in the reserve fund.
•
The county also has a monthly interest payment due on its Series B Pension
Obligation Bonds. Although the county Indicated that Interest is scheduled to be
paid from a fully funded escrow account held outside the pool, the county could
not confirm whether the January 3 Interest payment will be made.
Update On School Districts' Debt
Officials from the county and the county board of education have confirmed that
full and timely payment will be made on five school district obligations. While the
districts are not bankrupt, their funds were held by the county Investment pool
and have been largely frozen. The January 3 payments will be made from
district revenues received after the pool's bankruptcy filing; these post-
bankruptcy revenues had been segregated into.a new pool.
Finally, we have been informed that for pool participants other than the county,
funds for respective tax and revenue anticipation notes will be segregated in
accordance with the respective resolutions from post-petition montes of the
participants.
Debt Service Due January 3
Orange County '
Certificates of Participation; Series 1986
General Obllgatlon Improvement Bonds
Pension Obligatlon Bonds Series B
1994-95 Taxable and Tax-Exempt Teeter Notes
1994-95 Taxable Tax and Revenue
Anticipation Notes
1994-95 Tax and Revenue Anticipation
Notes, Series B
Sanitation District No. 12 Sewer Bonds
School Districts*
Centralia School District
Irvine Unified School District
Place ntia-Yo rbia Linda Unified School District,
1994-95 Taxable Notes
Santa Ana Unified School District
Yorba Linda School District (now Placentla-
Yorba Linda Unified School District)
'Interest payments.
General obligation,unllmited tax bonds unless otherwise noted.
Contacts:
Barbara Flickinger
Vice PresldenUAssistant Director
Far West Region
(212) 553-7736
Karen Krop
Assistant Vice President
Far West Region
(212) 553-4860
r
Moody'sMunicipal Credit Report
Califomia County Investment Pools December 23, 1944
Comment
Moocty's Assesses investment Risk of California County investment Pools
Because of the large kivestunent losses incurred by Diego.Solana,and Sonoma.For those counties,we
the Orange County Investment Pool,which resulted have had extensive discussions and obtained some
in the Pool and the County subsequently filing for degree of documentation of their portfolios and list-
banlauptay.Moody's has undertaken a survey of the ings of participants in the pool,yve should note that
other 57 county investment pools in California to most county treasurers consider it a statutory require-
update our assessments of their vulnerability to simi• went that schools deposit IOD%of their funds with
lar events.While various pools have undertaken dif. the county treasurer.However,one county has indi-
ferent strategies relative to their toleramce of cated that a school may invest up to S20 million of its
investment risk.we have not identified any other funds in the State's Load Agency Investment Fund
county pool in California that exhibits the high risk (LA]F);we are following up to clarify the investment
characteristics of Orange County.Asa result,no requirements for school districts.
rating action,including placing any ratings under
pools While the
review.has been taken at this tittle managers of each of chase h report that
they have developed orare begirmi ng to develop
In Orange County,the aggressive use of leveraging to strategies to address the risks posed by the nature of
enhance yield and substantial.unbedged positions in their pooh.we will be having Rather discussions or
derivative instruments which were highly sensitive to meetings with managers of these pools in order to
increases in interest rates resulted in market value verify information which they have provided to us in
losses,collateral calls which forced realization of orda to better assess their strategies.To date,the
those market value losses and finally,demands for officials responsible for the pools have been very
withdrawal of their funds by participants who were forthcoming in their willingness to discuss their
not mandated to be in the pool.Our survey focuses investment strategies and the current status of their
on the extent to which these same risks exist in the 57 portfolio.
other pools. The key aspects of than six coum
ty Pools are high-
For our survey,Moody's analysts contacted and lighted below:
spoke with officials from all 57 countries.Of these, Montemy County
officials from 37 counties reported diet them was no
use of reverse repurchase agreements or derivatives The county's investment strategy of using reverse
in their county pool.Officials from 14 counties Purchase agreements and derivatives for yield
reported some use of either leverage or derivatives, enhancement has exposed the investment pool to a
although the amounts were generally moderate;we level of risk in a rising interest rate environment It is
will be following up at a lata date but see no imme• important to trope that allparticipants are mandatory
diate need for conoem. so them is minimal risk of unplanned liquidation
demands.According to county officials,the reverse
Six counties reported a significantly more aggressive repurchase position is 5237 million and then have
use of either leverage or derivatives,or both.These experienced no margin calls.Officials also report-
counties am:Monterey.Placer,San Bernardino,San
0
these transactions have been segregated into a sepa- documentation of their reported strategies to address
rate pool which could decrease the risk of unplanned risks in the portfolio and verify separation of the two
liquidation demands.The other'core portfolio'is pools to ensure satisfactory liquidity levels.
reported to hive a book value of S338 million and a Contact:
December 5,1994,market value of$322 million.We Dane R.Gatewood
are requesting additional information and are plan- (212) 553-0844
ning to meet with county officials to obtain further
Placer Cot my liquid investments.which officials assert is more than
The county's pool had an unleveraged book value of sufficient to meet current cash flow projections and
$378 million as of December 13,with an additional potential unplanned withdrawals.Because of the
Ebb million in securities financed with reverse repur. complex nature of the county's portfolio,we will
chase agreements.The county has been significantly meet with county officials to better understand the
reducing its use of reverse repurchase agreements as county's investment risk management program.
interest rates have risen over the past year.Approxi- Contacts:
mately 42%of the pool is invested in derivative David Brody
securities.about 314 of which aro in an inverse rate (415) 274.1734
mode.Less than 10%of the deposits represents vol- Kevork Khrimlan
unitary participants.Approximately 2596 of the port- (212) 553.4756
folio,or$140 million,is invested in shout term or
San Bernardino County of$18.4 million through November 30.The low level
The county's investment pool,totaling nearly$2.5 of non-mandatory participants in the pool mitigates
billion,has been managed with a relatively aggres- the risk that the pool will have to liquidate securities
sive use of leverage to enhance yield.The county's and realize paper losses.The largest voluntary depoa-
portfolio includes more than$800 million of reverse nom'Chino IM13,has$66 million in the pool and the
city has reportedly indicated its intent to maintain
repurchase agreements.The county has also issued a these funds in the pool.
$300 million taxable note for arbitrage purposes(not
rated by Moody's).While the degree of leverage is We will be following up wills county officials to
high.the County reports that it has been reducing its monitor their reported changes in strategy regarding
reverse repurchase agreement position in light of reverse repurchase agreements and to gain additional
recent market developments:on December 13, information to evaluate the pool's liquidity position.
$46.75 million of these agreements were not rolled Contact:
over.County officials have stated to Moody's that the Ntkolo! J. Sklaroff
reverse repos are restricted to 90 days and also report (415) 274.1741
that these positions required margin calls during 1994.
Scan Diego County County Employees Retirement F1urd.whose obliga-
The San Diego County Investment pool has invested tion to invest in the pool is not yet clear,accounts for
in a significant amount of interest rate sensitive an additional 14.5%.The county and the major par-
instruments and has sustained paper]oases of about ticipants of the pool are reportedly taking steps to
10.7%.While the pool does not have leveraged regulate demands on the pool to prevent realizing
investments such as reverse repurchase agreements, losses on the sale of investments.Because of the risks
the pool's voluntary participants account for about presented by the use of structured notes and other
2.5%of the portfolio,which makes the pool vulnera- interest rate sensitive securities,as well as a signifl-
ble to early withdrawals by these participants.The carat proportion of discretionary participaab,
Moody's will monitor performance of the pool Contact:
closely,and plans to meet with appropriate officials Kevork Khdrnian
to further assess their strategies. (212) 553-4756
Solano County collateral calls,it is important to note that there ate
Solano County has an aggressive investment strategy, no discretionary participants in the pool which could
with use of about$182 million in reverse repurchase cause unexpected.large withdrawals of funds.We
agreements and significant use of derivatives on a plan to hold further discussions with county officials
pool with market value of$427 million as of Novem- to verify their investment plans,to discuss the degree
ber 30, 1994.Further,the weighted averago maturity of exposum resulting from the derivative positions. .
of the pool's investments is relatively long at 875 and to evaluate the County's strategy to assure neces-
days.Officials responsible for managing the pool
sary future liquidity.
have indicated to Moody's that they have begun to Contact:
shorten the maturity of their investments While the Ron Junker
county's investment strategies have exposed the pool (415) 274-1736
• to rising interest rates and have required cash for
r
Sonoma County county,no participant has requested unusual with-
The
ithThe county utilizes a significant amount of reverse drawals from the.fiuid and each is continuing to make
repurchase agreements and derivatives to enhance the deposits.In light of the exposure to possible addi-
overall portfolio yield.Derivatives including floaters tional margin calls and the Inclusion of voluntary
and inverse floaters represent approximately$322 participants which could request immediate with-
million of the total portfolio value of$561 million. drawal.we will continue to monitor the overall per-
Since December 5.there have been two margin calls formanoe of the portfolio and the county's liquidity
of$1.6 million on the reverse positions which were position'
satisfied with cash and securities on hand Contact:.
The county has approximately eight voluntary city Diane R. Gatewood
participants in the investment pool with a total invest- (212) 553-0849
ment of approximately$75 miflion.According to the
•
Moody's Public Finance Department JtWng Dolt
Molds Investors Seroce
99 Church sheet
111]R - L IL A 1-1 New York,W 10007
(212)6&VMU
Moody's Assesses Investment Risk of California County Pools
New York, New York-December 22, 1994. Because of the large investment
losses Incurred by the Orange County Investment Pool,which resulted in the
Pool and the County subsequently filing for bankruptcy, Moody's has undertaken
a survey of the other 57 county Investment pools in California to update our
assessments of their vulnerability to similar events. While various pools have
undertaken different strategies relative to their tolerance of investment risk, we
have not Identified any other county pool in California that exhibits the high risk
characteristics of Orange County.As a result, no rating action, including placing
any ratings under review,has been taken at this time.
In Orange County,the aggressive use of leveraging to enhance yield and
substantial,unhedged positions in derivative instruments which were highly
sensitive to increases in interest rates resulted in market value losses, collateral
calls which forced realization of those market value losses, and finally,demands
for withdrawal of their funds by participants who were not mandated to be in the
pool.Our survey focuses on the extent to which these same risks exist in the 57
other pools.
For our survey, Moody's analysts contacted and spoke with officials from all 57
counties. Of these, officials from 37 counties reported that there was no use of
reverse repurchase agreements or derivatives In their county pool. Officials
from 14 counties reported some use of either leverage or derivatives, although
the amounts were generally moderate; we will be following up at a later date but
see no immediate need for concern.
Six counties reported a significantly more aggressive use of either leverage or
derivatives, or both. These counties are; Monterey, Placer, San Bernardino, San
Diego, Solano, and Sonoma. For those counties,we have had extensive
discussions and obtained some degree of documentation of their portfolios and
listings of participants in the pool. We should note that most county treasurers
consider it a statutory requirement that schools deposit 100° of their funds with
the county treasurer. However, one county has indicated that a school may
invest up to 20% of its funds In the State's Local Agency Investment Fund
(LAIF); we are following up to clarify the investment requirements for school
districts.
While the managers of each of these pools report that they have developed or
are beginning to develop strategies to address the risks posed by the nature of
their pools, we will be having further discussions or meetings with managers of
these pools in order to verify information which they have provided to us in order
to better assess their strategies. To date, the officials responsible for the pools
have been very forthcoming in their willingness,to discuss their investment
strategies and the current status of their portfolio.
w
The key aspects of these six county pools are highlighted below.
Monterey County
The county's investment strategy of using reverse purchase agreements and
derivatives for yield enhancement has exposed the investment pool to a level of
risk in a rising Interest rate environment. It is important to note that all
participants are mandatory so there is minimal risk of unplanned liquidation
demands. According to county officials, the reverse repurchase position is $237
million and these have experienced no margin calls. Officials also report these
transactions have been segregated into a separate pool which could decrease
the risk of unplanned liquidation demands. The other 'core portfolio' is reported
to have a book value of$338 million and a December 1, 1995 market value of
$322 million. We are requesting additional information and are planning to meet
With county officials to obtain further documentation of their reported strategies
to address risks in the portfolio and verify separation of the two pools to ensure
satisfactory liquidity levels.
Contact: Diane R. Gatewood
(212) 553-0849
Placer County
The county's pool had an unleveraged book value of$378 million as of
December 15, with an additional $68 million in securities financed with reverse
repurchase agreements.
w
The county has been significantly reducing its use of reverse repurchase
agreements as interest rates have risen over the past year. Approximately 42%
of the pool is invested in derivative securities, about 3/4 of which are in an
inverse rate mode. Less than 10% of the deposits represents voluntary
participants.
Approximately 25% of the portfolio, or$140 million, is invested in short term or
liquid investments, which officials assert is more than sufficient to meet current
cash flow projections and potential unplanned withdrawals. Because of the
complex nature of the county's portfolio, we will meet with county officials to
better understand the county's investment risk management program.
Contacts: David Brodsly Kevork Khrimian
(415) 274.1739 (212) 5534756
San Bernardino County
The county's investment pool, totaling nearly$2.5 billion, has been managed
with a relatively aggressive use of leverage to enhance yield. The county's
portfolio includes more than $800 million of reverse repurchase agreements.
The county has also issued a $300 million taxable note for arbitrage purposes
(not rated by Moody's). While the degree of leverage is high, the County reports
that it has been reducing its reverse repurchase agreement position in light of
recent market developments; on December 13, $46.75 million of these
agreements were not rolled over. County officials have stated to Moody's that
the reverse repos are restricted to 90 days and also report that these positions
required margin calls during 1994 of$18.4 million through November 30.
f
The low level of non-mandatory participants in the pool mitigates the risk that the
pool will have to liquidate securities and realize paper losses. The largest
voluntary depositor, Chino Hills, has $66 million in the pool and the city has
reportedly indicated its intent to maintain these funds in the pool.
We will be following up with county officials to monitor their reported changes in
strategy regarding reverse repurchase agreements and to gain additional
information to evaluate the pool's liquidity position.
Contact: Nikolai J. Sklaroff
(415) 274-1741
San Diego County
The San Diego County Investment pool has Invested in a significant amount of
interest rate sensitive instruments and has sustained paper losses of about
10.7%. While the pool does not have leveraged investments such as reverse
repurchase agreements, the pool's voluntary participants account for about 25%
of the portfolio, which makes the pool vulnerable to early withdrawals by these
participants. The County Employees Retirement Fund, whose obligation to
invest in the pool is not yet clear, accounts for an additional 14.5%. The county
and the major participants of the pool are reportedly taking steps to regulate
demands on the pool to prevent realizing losses on the sale of investments.
Because of the risks presented by the use of structured notes and other interest
rate sensitive securities, as well as a significant proportion of discretionary
participants, Moody's will monitor performance of the pool closely, and plans to
meet with appropriate officials to further assess their strategies.
Contact: Kevork Khrimian
(212) 5534756
Solano County
Solano County has an aggressive Investment strategy, with use of about $182
million In reverse repurchase agreements and significant use of derivatives on a
pool with market value of$427 million as of November 38, 1994. Further, the
weighted average maturity of the pool's investments is relatively long at 875
days. Officials responsible for managing the pool have indicated to Moody's that
they have begun to shorten the maturity of their investments.
While the county's investment strategies have exposed the pool to rising interest
rates and have required cash for collateral calls, it is important to note that there
are no discretionary participants in the pool which could cause unexpected,
large withdrawals of funds. We pian to hold further discussions with county
officials to verify their investment plans, to discuss the degree of exposure
resulting from the derivative positions, and to evaluate the County's strategy to
assure necessary future liquidity.
Contact: Ron Junker
(415)274-1736
Sonoma County
The county utilizes a significant amount of reverse repurchase agreements and
derivatives to enhance the overall portfolio yield. Derivatives Including floaters
and inverse floaters represent approximately$322 million of the total portfolio
value of$565 million. Since December 5, there have been two margin calls of
$1.6 million on the reverse positions which were satisfied with cash and
securities on hand.
The county has approximately eight voluntary city participants in the investment
pool with a total investment of approximately$75 million. According to the
county, no participant has requested unusual withdrawals from the fund and
each is continuing to make deposits. In light of the exposure to possible
additional margin calls and the inclusion of voluntary participants which could
request immediate withdrawal, we will continue to monitor the overall
performance of the portfolio and the county's liquidity position.
Contact; Diane R. Gatewood
(212) 553-0849
•
Moody's Public Finance Department Ramp Do*
Mloodys Iriveeors Service
99 Church street
New York,NY 10007
(212)5530533
MOODY'S CONDUCTS NATIONWIDE SURVEILLANCE SURVEY
OF MUNICIPAL INVESTMENT PRACTICES
New York, New York--December 22, 1994--Today,Moody's Investors Service
released the results of its recently conducted surveys on the investment
exposure of California counties and on the investment exposure of significant
issuers of municipal debt elsewhere in the United States. In the wake of the
Orange County bankruptcy,Moody's has undertaken these surveys of selected
issuers around the country to determine whether there are investment practices
similar to Orange County's that could lead to losses severe enough to affect the
credit rating of a rated borrower. The results of these surveys confirmed that,as
a general rule: 1)government issuers follow conservative investment strategies,
and 2)do not leverage to speculate on interest rate fluctuations. In the survey of
California counties,this was generally true but Moody's has identified six
counties which require further review and monitoring. Results of the Califomia
counties survey are detailed in a release being issued simultaneously with this
release.
In the course of the nationwide survey Moody's contacted approximately 1450
issuers throughout the country,which together have over$470 billion in
outstanding rated debt. The survey was designed primarily as a screen to
quickly identify investment practices involving leveraging,derivative instruments
i
and other investment strategies sensitive to recent interest rate changes which
might give rise to potential credit concerns. Given the survey's large scale and
time sensitivity, it was not intended as a general evaluation of the
appropriateness of specific investments or particular investment strategies.
Use of Derivatives and Leveraging Not Seen as a Widespread Concern
In Orange County, the aggressive use of leveraging to enhance yield and the
presence of substantial unhedged positions in highly interest rate sensitive
derivative instruments resulted in market value losses, collateral calls forcing
realization of those market value losses, and, finally, demands for withdrawal by
voluntary participants in the County's investment pool. The survey has not
identified any rated issuer who is engaged in an investment strategy based on
the type and magnitude of leveraging used by Orange County. Most issuers
have represented that either they do not engage in leveraging strategies or are
not authorized to borrow for investment purposes. Many of those issuers who
have indicated they are involved in reverse repurchase agreements or securities
lending have represented to us that these agreements amount to a very small
portion of their investment-portfolios, are valued frequently and are of short
duration.
Our survey found that some municipal investment strategies are not sufficiently
adaptable to the type of market changes that are taking place. Some issuers
have reported that they have"unrealized"losses on investments, from both
traditional long term bonds and derivatives that are sensitive to interest rate
swings, but most have matched the maturities of such investments to cash flow
needs and plan to hold the securities to maturity. Losses resulting from
investments, particularly"unrealized" losses, are evaluated by Moody's in the
context of the credit as a whole. The concern with "unrealizecr losses has
•
traditionally been and continues to be the need of an issuer to liquidate the
securities and experience the actual loss. Losses are realized when there is a
mismatch between the duration of investments in the portfolio and either normal
cash flow requirements or unanticipated withdrawals requiring liquidation of
investments prior to their maturity.
Although many issuers that Moody's surveyed have some portion of their
portfolio invested in derivatives or interest rate sensitive collateralized mortgage
obligations, it is not necessarily the investment itself, but how the product is
managed which determines whether there is cause for credit concern. With
proper understanding and management and a clear sense of priorities for the
entire portfolio based on the general principals of safety of principal first, liquidity
second and yield last, generally no credit issues are raised.
As a result of our survey, only a limited number of credits have been flagged for
further review. While Moody's anticipates few, if any, rating actions as a result
of this survey, a more extensive review is being conducted in those limited
instances to determine if there is any effect on the credit position of the rated
debt obligation. Our survey also found that fund managers, governmental
depositors, and elected officials who are sponsors or overseers of municipal
investments have been prompted by the Orange County situation to assess their
positions and to reevaluate their investment policies.
Going forward Moody's will review and revise, as necessary, our approach to
monitoring the evaluation of investment practices by debt issuers in the public
finance market place. This effort will extend to consideration of the information
required for review, the criteria employed in our analysis and the method of
dissemination of this information to investors.
Now the Survey Was Conducted
Moody's surveyed issuers at all levels of government in all 50 states and Puerto
Rico. The scope of the survey was determined on a state by state basis. In all
instances, issuers with rated short-term notes were contacted. All 50 states and
Puerto Rico were contacted about the investment practices for state-managed
funds. In addition, Moody's questioned state officials in the 29 states that
manage pooled investments on behalf of localities. In certain circumstances,
state officials responsible for oversight of local investment practices were
contacted. All major issuers in each state were included in the survey, including
the largest cities and other issuers with significant amounts of outstanding debt.
Where Moody's identified local investment pooling practices, the official
responsible for the investment of the pooled funds was questioned. In some
instances, financial advisors or major bond counsel were called to generally
confirm the nature of the investment practices within their state. Included in the
survey were 48 state housing agencies, 280 hospitals and 44 universities with
outstanding rated debt. In addition, Canadian provinces, as well as large -
Canadian municipalities and regional municipalities, which together have over
US$ 200 billion of rated debt outstanding were also contacted as part of our
survey. The results of the survey reported in this release do not include any
reviews done for Orange County or participants intheOrange County
Investment Pool. Results of these reviews have been and will continue to be
reported on in separate releases.
The survey was conducted by telephone and, in almost all cases, the official(s)
directly responsible for the investment activity of the entity was questioned. Each
issuer was ask6d a series of questions concerning their level of investment
activity in derivatives and other interest rate sensitive securities, including
collateralized mortgage obligations, inverse floaters, and structured notes.
Issuers were also questioned about the existence and extent of any leveraging
practices. In addition, each issuer was asked if they had realized or anticipate
realizing any losses as a result of selling securities for cash flow needs. Each
issuer was also questioned about the magnitude of any current unrealized
losses.
We are still awaiting responses from a few issuers contacted as part of this
survey. We will continue to follow up in these instances and will report our
findings, as necessary.
Contacts:
Regis Shields, Esq.
Assistant Vice President
(212) 553-4974
Barbara Flickinger
Vice President/Assistant Director
(212) 553-7736
Howard Mischel
Vice President/Managing Director
(212) 553-4467
Daniel Heimowitz
Executive Vice President/Director
(212) 553-0340
Moody's Public Finance Deportment Rwng 06*
Moodo Invertors SaMce
• 99 Church~
Now York,W 10007
1RArKtK 2-2*6r— I I L (212)5531=
MOODY'S ASSESSES ORANGE COUNTY, CALIFORNIA
SITUATION AND IDENTIFIES NO IMMEDIATE CONCERNS FOR
THE RATED BOND INSURERS
Now York, Now York-December 22,1994•Moody's Investors Service Is In the
process of assessing the bond Insurers'potential exposure to Orange County,
California pool participants. In this regard,Moody's analysts have contacted
Issuers of insured debt to determine how much,if any,of their funds are in the
pool and the extent to which lack of access to these funds could,potentially,
impact future debt service payments,The situation In Orange County is yet to be
resolved. As we have stated in previous releases,Moody's has been working
with the pool participants to assess the full impact. In most cases,provisions
have been made to separate future cash flow from cash flow received prior to
the bankruptcy proceedings. Moody's analysts are in the process of assessing
the adequacy of current cash flows to meet future debt service payments. To
date,there have been no issuer defaults on insured debt requiring payment by
the bond insurers. Our analysts have identified the insured issues which could
potentially be Impacted by the situation in Orange County and thus require a
payment by the insurers. The attached list identifies each of these issues and
the associated net par outstanding. (Also attached please find a list of issues for
which we are currently awaiting more information and which could be added to
the list of potentially impacted issues at a later date). It should be noted that the
Aaa ratings of these Issues are not currently u6der review and remain
unchanged.
The following table is a summary of the 1995 debt service payments relating to
the potentially impacted issues. The debt service numbers represent the full
payment each of the insurers would be required to make if the issuers made no
payments. While we are still working to assess each issuers' specific ability to
meet debt service requirements, the debt service numbers do not represent any
expectation of likely payout.
995 Not Debt Service_
AMBAC Indemnity Corporation (AMBAC) $46 million
Capital Guaranty Insurance Company (Capital Guaranty) $5 million
Capital Markets Assurance Corporation (CapMAC) $Q
Financial Guaranty Insurance Company (FDIC) $45 million
Financial Security Assurance incorporated (FSA) $3 million
Municipal Bond Investors Assurance Corporation (MBIA) $65 million
Net debt service for 1995 represents the amount of principal and interest the
insurers may be obligated to pay In 1995 in the event the issuer defaults.
In the event that any of the insured issuers are unable to pay debt service when
due, the bond insurer is obligated to make timely payments of principal and
Interest as regularly scheduled. Under the terms of the insurance policy, there is
no acceleration of principal and interest.
•
We will provide updates as additional information becomes available. At that
time, the cumulative exposure for each of the insurers can be ascertained.
Moody's is confident that the insurers can make any debt service payments
required over the course of the next twelve months. Based on Information
available today, we have no reason to believe that there will be any negative
long-term implications for the Insurers as a result of the situation in Orange
County. We will continue to follow the situation closely as it relates to the
insured issues and report to what extent, if any, there are payouts by the
Insurers.
Potentially Affected Insured Issues
• potentially Affected Insured Issues AM&C
Etat Par
outstanding
------------------------------------------------------------------------------
Anaheim-Anaheim Public Improvement Corp. ctra. of part. (1993
Land Acquis. Refin. Droj.) dtd. 11-1-93 19,250,600
Anaheim-Anaheim Public Improvement Corp. Ctfa. of part. (1993
Police Fee. Refin. Proj.) dtd. 7-15-93 20,038,000
Anaheim-Anaheim Public Irprovement Corp. Ctfs. of part. (1993
Refunding Proj.) dtd. 1-14-93 114,395,590
Anaheim Redevelopment Agoy. Tax allocation Refunding
ser. D, dtd. 10-1-96 44,133,375
Claremont Redevel. Agcy. Tax allot. Bonds dtd. 11-1-99 7,156,000
Huntington Beach-Huntington Beach Civic Imp. Corp. Ctfs. of Dart.
Refunding (Civic Center Aefin. Proj.) dtd. 2-1-93 19,030,000
Huntington Beach-Runtington Beach Civic snip. Corp. Ctfs. of part.
Refunding (Police Admin. Bldg. Refin. Proj.) dtd. 3-1-93 130506,000
Potentially Affected insured Issuest AMBAC (continued)
Net Par
Outstanding
------------------------------------------------------------------------------
La Habra-La Habra Civic Imp. Auth. atfs. of part. (1992 hater
Sys. Ref. Proj.) dtd. 2-1-92 2,233,800
Moulton-Miguel Ntr. Dist. Moulton-Miguel Water Dist. Pub. rac.
Corp. We. of part. dtd. 21-i-93 38,114,001
Orange Co. Local Trans. Auth. 46,000,000
Orange Co. Sanit. Dists.t Dist. 1, 2, 3, 5, 6, 7 a 11 Ctfs. of
part. Refunding dtd. 9-16-93 113,784,000
Orange Co. Sanit. Dimts.t Dist. 1. 2, 3, 5, 6, 7 a 11 Ctfs. of
part. Refunding mar. X92 27,158,000
Orange Co. Wtr. Dist.-O.C.N.D. Pub. Pao. Corp. Ctfs. of part.
dtd. 7-1-89 (Secondary Market) 4,355,332
Orange County Ctfs. of part. (Loma Ridge/Data Center Proj.)
dtd. 4-1-91 26,375,965
Orange County-Orange Co. public Pao. Corp. Ctfe. of part. (Civic
Center Sxp. Proj.) dtd. 11-15-91 71,965,980
orange County-Orange Co. Public tae. Corp. Ctfs, of part. (Civic
Center Pkg. Pao. Pro3.) Dated 8-1-91 28,702,943
orange County-Orange Co. Public Fac. Corp. Ctfs. of part.
Refunding ser. 192 (Juvenile Justice Ctr. Fac.) dtd. 6-1-92 81,285,814
Orange Redevel. Agency flax allot. (0outhV*9t Redevel. Proj.)
Series 193A, dtd. 4-1-93 28,163,000
orange Redavel. Agency Tax allot. (Southwest Redevel. Prej.)
Series 1933, dtd. 6-1-93 9,138,000
Orange Redeval. Agency Tax allot. Bonds dtd. 8-1-86 31665,000
Santa Ana Ctfs. of part. (Mass Comnatiag Fee. Ref. Proj.) sow.
'93C, dtd. 2-1-93 41304,000
Santa Ana Ctfs. of part. (Parking Fee. Refunding Proj.)
dtd. 2-1-93 14,169,000
Santa Margarita Nater Dist. Bonds dtd. ll-1-86 3,397,344
Seal Beach Redevel. Aa0y. 'Pax allot. Bonds dtd. 9-1-96 1,528,313
abandon Jt. Qnif. S.D. Bonds dtd. 12-1-93 1,204,000
Stanton Redevel. Agcy. Stanton Comm. Devel. Proj.
tax allot. dtd. 11-1-93 4,515,000
------------
Total 4742,771,049
Potentially Affected Insured Issues& FGIC
Net Par
Outstanding
---------------------7--------------------------------------------------------
Orange Co. Local Trans. Auth. Sales tax rev. Second senior Bonds
dtd. 2-1-94 124,506,000
Orange Co. Local Trans. Auth. Sales tax rev. Second senior Series
dtd. 9-30-92 136,417,000
Orange Co. Sanit. Dists.: Dist. 1, 2, 3, 3, 6, 7 a 11 Ctfs. of
part. (Capital Imp. Prop.) eer. 190-1928, dtd. 3-1-91 78,683,000
Orange Co. Sanit. Dists.l Diet. 1, 2, 3, 6, 7 a 11 ctfs. of Dart.
(Capital Inv. Pros. 1990-92 ser. C) 56,314,000
Orange Co. Service Auth. for Freeway Zmergencie■ Orange Co. Pub.
Fee. Corp. atfs. of part. Dated 9-15-87 (ins. mat. 10-1-97) 1,944,000
Orange Co. Service Auth. for Freeway Rmergencia■ Orange Co. Pub.
Fac. Corp. atfs. of part. Dated 9-15-87 (ins. mat. 10-1-99)
(Secondary Market) 921,000
Orange County Airport rev. Bonds dtd. 7-1-87 (ins. mat. 7-1-96,
7-1-97, 7-1-98 a 7-1-09) 34,811,989
South Orange Co. Pub. Fin. Auth. Special tax (Foothill Area)
ser. C (Mello Roos) Bonds dtd. 8-24-94 210,432,002
------------
Total $664,228,987
------------------------------------------------------------------------------
•
Potentially Affected Insured Issuesc MBIA
Net Par
Outstanding
---------------------7--------------------------------------------------------
Anaheim Pub. Fin. Auth. Anaheim Radevel. Agency tax alloc.
(Radevel. Proj. Alpha) dtd. 3-15-92 121,153,000
Centralia S.D. Centralia Md. Youndation ctfs. of part. (Centralia
School Proj.) Refunding dtd. 10-1-93 6,640,000
Coast Comm. College Dist. 480,000
auntington Beach Huntington Beach Pub. pin. Auth. otfs. of part.
(Dispatch Sys., Tel. Sys. a Computer Proj.) dtd. 3-1-89 1,876,364
Irvine Ranch Water Dist. Consolidated ref. war. I M, dtd. 8-15-
85 23,880,874
Irvine Ranch water Dist. Inprovement Dist 109
Certif. of Participation 1,701,423
Irvine Ranch Water Dist. Improvement Dist. 103 Bonds dtd. 5-1-83 376,733
Irvine Ranch Water Dist. Improvement Dist. 105 Bonds dtd. 5-1-83 1,149,516
Irvine Ranch water Dist. Improvement Dist. 109 Bonds dtd. 5-1-83 3,844,600
Irvine Ranch Water Dist. Improvement Dist. 121 Bonds dtd. 5-1-83 11091,550
Irvine Ranch Water Dist. loparovement Dist. 141 Bonds dtd. 5-1-83 1,878,831
Irvine Ranch Water Dist. Improvement Dist. 161 Bonds dtd. 5-1-83 584,419
Irvine Ranch Water Dist. Improvement Dist. 203 Bonds dtd. 5-1-83 1,028,769
Irvine Ranch Water 'Dist. Improvement Dist. 221 Bonds dtd. 5-1-83 7,196,551
Irvine Ranch water Dist. Improvement Dist. 250 Bonds dtd. 5-1-83 6,080,844
Irvine Ranch water Dist. Improvement Dist. 261 Bonds dtd. 5-1-83 1,013,939
Irvine Ranch Water Dist. Improvement Dist. 290 Bonds dtd. 5-1-83 724,486
Irvine Unif. B.D. Comm. Bao. Dist. 886-1, Special flax We.,
Series A, dtd. 5-13-88 (Secondary Market) 4.130,000
Local Govt. Fin. it. Dowers Auth.-Local Govt. lin. Corp. Anaheim
Rodevel. Agcy. Proj. Alpha Series 186A tax alloc. (Secondary
Market) 10,069,000
Montebello Comm. Redevel. Agency Tax allot. MOnteballc Hills
Redevel. Proj. Subordinate lien dtd. 9-1-89 14,795,000
Moulton-Niguel Wtr. Dist. Bonds dtd. 6-13-93 89,296,277
Mountain View-Mountain View Cap. Imp. - Lease 13,131,481
Mountain view-Mountain View cap. IM. Pin. Auth. Revenue (City
Hall/Community Theatre Complex) dtd. 4-1-92 Tax Allocation Bond 24,026,03.7
r
Potentially Affected Insured Issues. KBIA (continued)
not Par
Outstanding
------------------------------------------------------------------------------
Orange Co. Revel. Agcy. Orange Co. Fin. Auth, tax alloc. rev.
(Neighborhood Devel. a preservation Proj.)
Series 192A, dtd. 6-1-92 26,413,000
Orange Co. bevel. Agoy. Orange Co. lain. Auth. tax aiioc. rev.
(Neighborhood bevel, a Preservation Proj.)
Series 1923, dtd. 6-1-92 2,540,000
Orange Co. Flood Control Dist. 410,000
Orange Co. Reassessment Dist. 94-1 (Golden Lantern) Limited
oblig. rat. dtd. 7-28-94 15,420,000
Orange Co. Trans. Auth. 38,675,000
Orange CO. Water Dist.-O.C.W.D. Public Fac—Corp. Ctfs. of part.
Boris& 189, dtd. 7-1-89 (Secondary Market) 3001000
Orange Co. Water Dist.-O.C.W.D. Public Fac. Corp. Ctfs, of part.
Series +93A, dtd. 8-1-93 (Secondary Market) 750,000
Orange County Airport rev. Bonds dtd. 6-1-93 74,601,000
Orange Redevel. Agency tease rev. (Orange Polios, Fac.
Headquarters vroj.) ser. 189 13,695,000
Saddleback Comm. Call. Dist. Pao. Corp. Ctfs. of part.
dtd. 7-1-89 13,842,457
Saddlebaok Valley unit. S.D. Bonds dtd. 6-1-75 1,500,000
Santa Ana Comas. Redevel. Agency Tax allot. (South Main at.
Redevel. Proj.) Series 193D, dtd. 8-1-93 64,145,000
Santa Ana Financing Auth. Lease rev. Series 19471, dtd. 3-1-94 100,371,486
Santa Ana Financing Auth. Nater rev. ponds dtd. 8-1-94 21,090,000
Santa Margarita Water Dist. xaprovement Dist. Dist. 1-B Bonds
dtd. 10-1-80 4,741,484
So. Coast Wtr. Dist. (form. So. Coast Co. hater Dist.) G.O.
series 1992 3,383,000
South Orange Co. pub. Fin. Auth. Special tax (Senior lian)
ser. 19", dtd. 6-14-94 118,518,010
------------
Total $827,067,136
Potentially Affected Insured Issues& CLIC
Net Par
Outstanding
Brea-Olinda Unif. S.D. Brea Hope, Ino. otfs. of part. (Brea-Olinda
High School Ref.) ser,. 194A, dtd. 8-1-94 23,470,000
Irvine Unified School District, Community Facilities District no.
86-1, Special Tax Bonds, Aeries A (Secondary Market) 3,000,000
Orange Co. Comas. Fac. Dist. 86-1 Spacial tax (Rancho Santa
Margarita) Bonds dtd. 11-1-89 39,365,000
Total 065,835,000
------------------------------------------------------------------------------
Potentially Affected Insured Issussi SSA
Net Par
Outstanding
Midway City San. Dist. California Spec. Dist. Fin. Prog.
Series 194Y, dtd. 6-1-94 4,139,000
Orange County Airport rev. bonds dtd. 7-1-87 5,553,000
Orange County-Orange CO. Public Faa. Corp. Ctfs. Of part. (Master
Lease Prog.-1993 Proj.) 1993 ear. A, dtd. 2-1-93 10,635,000
Total $30,327,000
•
Insured Issues--Awaiting Further Information
insured issues--Awaiting Further Information: AMBAC
Not. Par
Outstanding
------------------------------------------------------------------------------
mission Viejo Ctfs. of Dart. dtd. 7-15-90 9,775,113
South Coast Wtr. Dist. (form. South Coast Co. dater Dist.) Bonds
dtd. 3-1-91 4,114,200
Yorba Linda Redevel. Agoy. Residential mtge. rev. Series 'BSA,
dtd. 5-1-85 1,528,175
Total $9,417,488
------------------------------------------------------------------------------
Insured 2msues--Awaiting Further Information: POZC
Nat par
Outstanding
------------------------------------------------------------------------------
Newport Beach Nater rev. Bonds dtd. 8-1-94 16,286,106
Orange County Single Family nam Mortgage Rev Bonds 1983 issue II
(Secondary Market) 343,065
Santa Ana Hosie Mtge. Rev. 1985 Ser. A 1,866,846
Santa Barbara (California) Water Revenue Refunding Bonds of 1979
(secondary Market) 431,000
Total $18,927,017
Insured 2ssuaa--Awaiting Further Informations MBIA
Net Par
Outstanding
Milpitas Unit. Dist. sower rev. Division 1 dtd. 12-13-75 280,000
Milpitas Redevel. Agency Redevelopment Proj. area 1 tax allot.
nonda dtd. 2-11-93 19,390,000
Yorba Linda Redevel. Agcy. Tax alloo. (Yorba Linda Redevel.
Proj.) ear. 193A, dtd. 12-28-93 33,659,000
Yorba Linda Redevel. Agcy. Tax alloo. Bonds dtd. 11-1-89 20,248,000
Banta Margarita-Dana point Auth. Revenue oar. a (Santa Margarita
Water Diets. 3, 3A, 4 & 4A G.O. Refinancing) Bonds dtd. 7-15-94 123,179,000
Santa Margarita-Dana point Auth. Revenue ser. A (Santa Margarita •
Water Dista. 1, 2, 2A & 8 O.O. Refinancing) Bonds dtd. 7-15-94 51,373,000
------------
Total $248,119,000
------------------------------------------------------------------------------
Insured xaaua--Awaiting Further Informations CaiC
Not Par
Outstanding
------------------------------------------------------------------------------
California statewide Comm. Dev. Auth
(pool-Leguna Beach and Buena Park) $3,000,000
I
Contacts:
Daniel N. Heimowitz
Executive Vice President & Director
Public Fipance
(212) 553-0340
Laura Levenstein
Vice President&Assistant Director
Bond Insurance
(212) 553-0319
Nicholas Ferreri
Assistant Vice President
Public Finance
(212) 553-3628
Fredric Wessler
Assistant Vice President
Public Finance
(212) 553-1426
John Kriz
Managing Director
Corporate
(FSA &CapMAC)
(212) 553-7134
William Boak
Senior Analyst
Corporate
(FSA &CapMAC)
(212) 553-1407
Moody's Public Finance Depatment aa"DNk
Moodys Invedors SoMce
"WL Ir 99 Church street
Now York,W 10007
RA 1 -1 (212)5530533
MOODY'S ASSESSES IMPACT ON SHORT-TERM DEBT OF
BANKRUPTCY FILINGS BY ORANGE COUNTY,CALIFORNIA
AND THE COUNTY INVESTMENT POOL
New York,New York-December 21, 1994-
FUTURE PAYMENT STATUS OF NOTES DEPENDS ON STATE LAW,CASH
FLOW AND BANKRUPTCY FACTORS
There are four major types of short-term debt affected by the investment losses
of the Orange County,California investment pool and the filing for bankruptcies
of Orange County and the investment pool.These are:tax-exempt Tax and
Revenue Anticipation Notes(TRANS);taxable TRANs;tax-exempt and taxable
Teeter notes of Orange County;and the Orange County tax-exempt pooled
TRANs issued for local school districts. A list of affected issues is attached.
Whether or not any given issue is paid in full and on time may depend on the
interaction of three factors:state laW affecting the notes'pledged security and
priority of payment;cash available or to be received that the Issuer may use for
payment of the notes;and the legal effects on both of the other variables of the
county and investment pool bankruptcy filings.Given the sparse language of
Chapter 9 of the Bankruptcy Code and the lack of relevant precedents for
judicial interpretation of its provisions,there may be a variety of claims and
conflicts among general creditors,investment pool participants,underlying units
of government, and other interested parties that could result in substantial
disputes requiring time to resolve. The uncertainty is heightened at this time by
the fact that the county has not yet expressed its intentions to its creditors
through the filing of its reorganization plan.
(Continued)
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PROJECTED CASH FLOWS WILL DETERMINE CREDIT QUALITY OF
INVESTMENT POOL PARTICIPANTS' (OTHER THAN THE COUNTY) CASH
FLOW TAX-EXEMPT TRANs
There have been notable developments related to the repayment outlook for the
cash flow tax-exempt TRANs issued by pool participants (other than Orange
County). The TRANs are secured by a first lien on certain unrestricted revenue
as described in the authorizing statute and each participant's note resolution. In
addition, each of the notes is a general obligation of the issuer.
While it is possible that cash received post-bankruptcy by Orange County
investment pool participants may continue to be subject to the bankruptcy
proceedings, there so far appears to be broad-based support for efforts to
separate pool participants' (other than the county's) post-bankruptcy cash
receipts and make them available for the Issuers' use, including payment of their
TRANs.
To these ends, the county supervisors have recently created a new investment
fund to receive all property taxes to be collected by the county for all its taxing
jurisdictions. County officials have indicated that the new fund's purpose is to
receive taxes and allow appropriate accounting for those monies separate from •
the bankruptcy filings. Moody's has been informed that all tax receipts in the new
fund will be invested in short-term Treasury obligations.
Since outstanding cash flow TRANs rated by Moody's mature during June 1995
or later, and property tax segregation for the cash flow notes typically occurs in
December or later, there may be time to accumulate cash and take other actions
necessary to protect investors. The pool's bankruptcy filing occurred just prior to
the first major receipt of property taxes on December 10, at a time when most
TRAN proceeds have typically been expended and TRAN issuer cash balances
are at their lowest. Assuming that post-bankruptcy receipts are not made subject
to the bankruptcy and assuming no challenges to their state law lien and priority
of payments, our analysis will focus on funds available for payment at maturity.
While we have requested revised cash flows from the investment pool
participants, most cash flows received to date show only receipts and
disbursements of monies in the new fund for the next 90 days;the cash flows do
not include any funds from the old investment pool. Once we receive, verify, and
analyze more complete participant cash flows, we should be able to complete
the review of the outstanding cash flow TRANs.
1NVESTMENT POOL LOSS ALLOCATION AND STATUTORY CLAIMS WILL
DETERMINE CREDIT QUALITY OF TAXABLE TRANS OF INVESTMENT
POOL PARTICIPANTS (OTHER THAN THE COUNTY)
The situation for taxable TRANs, in which pool participants other than the county
borrowed money In the taxable markets and invested the proceeds in the county
investment pool, is considerably less certain. Unlike the tax-exempt TRANs,
these taxable TRANs had a fully funded payment source, the invested proceeds
plus fully funded interest, that was present from the date of issuance, and a
specific lien on that source. It is also important to note that, unlike the tax-
exempt cash flow TRANs, the 1994-95 taut and revenue receipts of the issuer
were not pledged to the taxable TRANs. Finally, like the non-county tax-exempt
cash flow TRANs, the taxable TRANs are backed by the issuer's general
obligation.
Because these TRAN proceeds were invested in the pool and the pool has
availed itself of the protection of Chapter 9, the likelihood of payment of the
taxable TRANs Is highly dependent upon the bankruptcy proceedings and how
the losses from the investment pool will be allocated. It is clear that the
Investment pool has sustained substantial losses. However, because of
uncertainties as to the survival of state law liens and priority of,payments
subsequent to bankruptcy, it is not at all clear whether Investment pool
participants will be able to obtain the full value of their pledged security from the
pool or, if not paid In full, it is not clear when, how, and the amount of payments
that will be made to them.
SPECIAL CONCERNS FOR THOSE ISSUERS OF TAX-EXEMPT TRANs
WHICH ALSO HAVE TAXABLE TRANs OUTSTANDING
Should investment pool distributions be insufficient to pay the taxable TRANs,
the presence of general obligation backing for the taxable TRANs may put
pressure on the issuer to pay the notes from other lawfully available funds. Any
payment of the taxable TRANs from an issuer's general funds could jeopardize
the overall financial situation for the Issuer. Additionally, while the lien of the
tax-exempt TRANs on 1994-95 taxes and revenues Is clear, should there be a
default on an issuer's taxable TRANs, it is conceivable that the holders of the
defaulted TRANs will seek access to the taxes and revenues pledged to the tax-
exempt TRANs. Resolution of the legal issues may create delays that could
affect timely payment of the tax-exempt TRANs for those Issuers with
outstanding taxable TRANs.
We are following up with the four issuers of rated taxable TRANS other than the
county, as well as with Montebello, which has a rated tax-exempt TRAN as well
as a taxable TRAN not rated by Moody's, in order to determine their plans
should they receive less money from any investment pool distribution than the
amount required to pay the taxable TRANS at maturity.
COUNTY'S BANKRUPTCY FILINGS BRING SIGNIFICANT UNCERTAINTY TO
STATUS OF ORANGE COUNTY'S OWN TAX-EXEMPT TRANS,TAXABLE
TRAN*,AND TEETER NOTES
As direct obligations of the bankrupt party, the legal and financial positions of
the county's own cash flow TRANS, taxable TRANs, and Teeter Notes, both tax-
exempt and taxable, is considerably more uncertain than those of the other pool
participants. Again, the lack of specific language in Chapter 9 to resolve survival
of lien and priority of payment Issues, the lack of precedents for the court's use
in resolving these same Issues, and the current lack of a county reorganization
plan all combine to prevent easy determination of the credit standing of the
various county notes.
Prior to the bankruptcy filings, the legal security for the various notes was
reasonably well-established pursuant to state law. The county's tax-exempt
TRANs are secured by 1994-95 tax and revenue receipts,with general
obligation backing. The county's taxable TRANS are secured by note proceeds,
invested in the investment pool, together with an amount sufficient to pay
estimated interest, again with general obligation backing. The Teeter notes are
primarily secured by delinquent tax payments received In 1994-95. Like the
taxable TRANs, they are granted no claim on 1994-95 taxes and revenues under
the authorizing resolutions but are secured by a pledge of lawfully available
county funds. In addition, they have a standby note purchase agreement with the
investment pool.
The bankruptcy filing has raised a number of issues as to the legal status and
priority of payment of each of those liens. The post-bankruptcy cash flow needed
to pay the tax-exempt TRANs and Teeter notes may be subject to bankruptcy
proceedings which will make it more difficult to establish a post-bankruptcy set-
aside that goes unchallenged. While the taxable TRANs may have a better
legal claim in bankruptcy to the funds In the investment pool, the lien may prove
a hollow one since the investment pool may provide insufficient funds to fully pay
them.
Because of their much more limited initial pledged security, the Teeter notes
effectively have only a claim against lawfully available county funds. While the
Tester notes have a claim against the county's Tax Loss Reserve Fund,this
fund, too, was invested in the county pool and is exposed to some share,of the
• losses. The legal status of the investment pool standby note purchase
agreement is uncertain;the enforceability opinion on the standby note purchase
agreement provided at the time of sale declined to offer an opinion on its
enforceability in the event of bankruptcy. Finally, the taxable Teeter notes may
have a claim over the tax-exempt Teeters under state law prioritization of
payments, should these liens survive.
Since there are many unresolved legal issues relating to the bankruptcy filing
and the resulting uncertainties of interpretation as to the survival of the state
statutory liens and priority of payments, it is not currently possible to determine
how and when these issues will be resolved and what impact their resolution will
have on note repayment.
UNRESOLVED LEGAL ISSUES STILL AFFECT CREDIT QUALITY FOR
COUNTY'S SCHOOL DISTRICT TRANs POOL
The situation for the county's 1994-95 Pooled TRANs is also less than clear.
The mechanism behind the financing was the county's purchase of TRANs from
underlying school districts as an investment and the county's sale of Pooled
TRANs to investors. The pledge to the investors is a lien on the revenues
received by the county from the school district TRANs. To enhance credit for the
pooled financing, the county pool agreed to provide additional funds under a
standby note purchase agreement to cover shortfalls in the event underlying
school district TRANs are not paid.
Like other tax-exempt TRANs, the tax receipts for the school districts may flow
through the newly established fund and may be sufficient to pay each
participating school district's TRAN obligations to the county. We will analyze
each participant's updated cash flows to determine the combined cash adequacy
for the Pooled TRANs. However, because of the nature of the mechanism under
bankruptcy, questions arise as to whether the cash received from the school
district TRANs will flow through to the investors in the Pooled TRANs or whether
the school district payments will be deemed the county's monies. These issues
will also require time to resolve.
Finally, should there be insufficiency of funds available from the districts to pay
the underlying TRANs, the standby note purchase agreement may not be legally
enforceable against the investment pool. Like the similar agreement for the
Teeter notes, counsel to the county declined to opine as to whether the
agreement was enforceable in the event of a bankruptcy. In addition, even if it is
enforceable,the pool may not have sufficient funds available to meet its
obligations under the agreement.
Conclusion
The relative rarity of municipal bankruptcy filings has left many fundamental
questions unanswerable at this time. We expect to be going forward with our
analysis of each participant's cash flows as meaningful Information becomes
available, and to update our analysis as we receive clarification on the many .
outstanding unresolved issues.
PRINCIPAL INTEREST
AMOUNT PAYMENT PAYMENT
ISSUER NAME RATING ($000) DATE DATE
Anaheim(TRANS) 1994 MIG 1 24,500 7/28195 7/28/95
Anaheim Taxable Notes MIG 1 95,000 4/4/95 4/4/95
1994[2]
Atascadero(TRANS) MIG 2 1,300 7/12195 7/12/95
1994-95
Fullerton (TRANS) 1994 MIG 1 4,500 7/31/95 7/31/95
Garden Grove Sanitation MIG 1 5,075 5/1/95 5/1/95
District(TRANS)
1993-94[2]
Huntington Beach- MIG 1 15,000 10/1/95 10/1/95
Huntington Beach Public
Finance Authority
(TRANS) 1994-95
La Habra(TRANS) 1994 MIG 1 2,200 6/30/95 6/30/95
Montebello(TRANS) 1994 MIG 1 6,000 9/29/95 9/29/95
Orange County(TRANS) [1] 299,660 7/28/95 7/28/95
1994-95(Pooled)
Orange County(TRANS) [1] 600,000 7/10/95 1/3/95
1994-95(Taxable
Notes)[2]
Orange County(TRANS) [1] 111,000 6/30/95 1/3/95
1994-95(Taxable
Notes)Teeter Plan
Orange County 1994.1995 [1] 64,000 6/30/95 1/3/95
(Teeter Plan)Tax-
Exempt Notes
Orange County(TRANS) [t] 169,000 7119/95 7/19195
1994-95 Ser.A
Orange County(TRANS) [1] 31,000 8/10/95 1/3195
1994-95 Ser. B
Orange County Flood P-1 100,000 8/1/95 1/3/95
Control District Taxable
1994-95 Notes[2]
Placentla-Yorba Linda P-1 50,000 8/24/95 1/3/95
Unif. S.D. 1994-95
Taxable Notes[2]
Seal Beach(TRANS) MIG 1 2,100 7/5/95 7/5/95
1994
[1]Suspended.
[2]Taxable TRANs.
Contacts:
Jamie Burr
Vice President- Assiitant Director
Legal Analysis
(212) 553-0471
Karen Krop
Assistant Vice President
(212) 553-4860
Barbara Flickinger
Vice President-Assistant Director
Far West Regional Ratings
(212) 553-7736
David Brodsly
Vice President- Manager
Western Regional Office, San Francisco
(415) 274-1700
Howard Mischel
Vice President- Managing Director
Regional Ratings
(212) 553-4467
Dan Heirnowitz
Executive Vice President- Director
Public Finance Department
(212) 553-0340
Moody's Public Finance Department Rating Desk
Moody's Investors Service
99 Church areal
New York,NY 10007
Ila 11 (212)553-0533
Moody's Reviews Participants in the Orange County Investment
Pool With Debt Service Payments Due January 1, 1995
New York, New York. December 21, 1994. On December 6 Moody's placed
under review unenhanced,uninsured ratings of issuers which have funds
invested in the Orange County Investment Pool. On December 12, Moody's
identified the next debt service payment for each of these issuers as the initial
phase of a comprehensive assessment of the impact of the Orange County
Investment Pool bankruptcy.
The following provides a preliminary assessment of the ability of eleven
participants in the Orange County Investment Pool to meet their upcoming
January debt service payments. This review is based on Moody's recent
conversations with the individual issuers. Once the magnitude of investment
losses are determined,we will reassess each participant's credit position. Even
at this preliminary stage of the analysis it seems clear that the impact of
investment fund losses will vary from participant to participant. With the
exception of school districts whose financial positions are more closely tied to
near term decisions or rulings relating to the bankruptcy,the following
participants have been able to identify cash resources outside the Orange
County Investment Pool to make their January debt service payments in full and
on time.
The following pool participants have debt service payments due in January,
1995.
Next
Debt Principal
Issuer Rating Outstanding Payment
------------------------------------------------------------------------------
Aliso water Management Agency
Lease Rental dated 111178 Al $ 2,960,000 $ 145,000
Lease Rental dated*1/1/79 Al 3,100,000 140,000
Centralia School District Al 1,315,000 155,000
Coastal District Financing Authority
South Coast Water District A 4,350,000 75,000
costa Mesa Ila 2,000,000 160,000
Trvine Unified School District A 15,412,230 2,430,000
Irvine Aa 9,660,000 1,410,000
Santa Ana Unified School District Al 4,400,000 800,000
seal Beach slater Revenue Bonds Al 240,000 205,000
Placentia Redevelopment Agency
COPS dated 4!1194 Baal 3,135,000 130,000
Placentia-Yorba Linda Unified School District,
rY 1995 Taxable Notes Due 8/24/95111 B-1 50,000,000 50,000,000
Yorba Linda School District a 40;000 40,000
(111ntere3t due January 3, 1995.
Aliso Water Management Agency
The Aliso Water Management Agency provides regional wastewater treatment,
transmission and disposal services. Proceeds from the Agency's Leasehold
Revenue Bonds dated January 1, 1978 and January 1, 1979 were used to fund
the City of Laguna Beach's proportionate share of regional wastewater facilities.
The City of Laguna Beach has covenanted to budget and appropriate an annual
base rental payment to the Agency equal to debt service and other costs.
The City has, and intends to continue to make base rental payments through
sewer service fees charged on County property tax bills and collected twice a
year. The City remits the annual base rental payment to the Agency on or
before May 31 each year.
Agency interest payments due January 1, 1995 have been deposited with the
trustee. The next principal and interest payment is due in July, 1995. City
officials expect to meet all debt service payments in full and on time from sewer
service fees which are more than sufficient to cover base rental payments. Debt
service reserve funds are held by the trustee.
The$13 million of Agency funds invested in the Orange County Investment Pool
represented excess operating reserves which were not earmarked for
construction projects or for repayment of debt.
Coastal District Financing Authority
South Coast Water District
The district has$8.0 million invested in the Pool representing 50% of its cash
balances. Approximately$2 million of the $8 million invested in the Pool consists
of proceeds from the district's Series 1993 Revenue Bonds which were
earmarked for reimbursements to the district's General Fund for monies already
advanced The remaining $8.0 million is invested in the State Local Agency
Investment Fund (LAIF) ($7.0 million)and with PaineWebber($1.0 million) in
U.S. government treasuries. Of the total, $14 million represents discretionary
funds available for future capital projects.
The district has begun to receive property taxes for December. Property taxes
have always been sent to the district and have never been deposited directly to
the County Investment Pool. Immediate debt service requirements due on
January 1 include general obligation payments of$411,166, a $129,800 interest
payment for the 1993 Revenue Bonds, and a $2.2 million repayment of a
. promissory note. These payments will be made from funds invested in LAIF.
The district does not anticipate any cash flow problems as a result of the Orange
County Investment Pool bankruptcy.
Costa Mesa, Califomia
At the time of the bankruptcy filing the city of Costa Mesa had $2.6 million
invested with the Orange County Investment Pool representing 10% of the city's
unreserved cash balances. The remaining $22.3 million is currently invested
primarily with LAIF. In addition to these amounts, the city has debt service
reserve funds, debt service funds and capital projects funds invested with its
trustee banks in government securities. The city's immediate debt service
requirements within the next four months include $212,000 for the 1974 general
obligation bonds due January 3, and $110,000 for the Costa Mesa Public
Financing Authority 1991 Lease Revenue Bonds due February 1. The city
may have liability for rcpayment of$182,000 of Assessment District 82-2 Bonds
due January 3 and contingent liability for$29,000 due on Assessment District
80-1 Bonds and $266,000 for Costa Mesa Redevelopment Agency debt due
April 1, 1995.
•
The city expects to meet debt service payments in full and on time from its
monies invested outside the County Pool.
Irvine, California
The city of Irvine invested two-thirds of its investment portfolio of$318 million
with the Orange County Investment Pool. The city's $209 million investment in
the Pool includes $64 million of Taxable Notes, $10 million of tax-exempt
TRANS, $106 million in the General Pool Account and other investments. The
$109 million not invested with the Pool includes $82 million invested with LAIF
and $27 million held by various banks.
Capital projects-including various street and road improvements-are funded
from construction funds held by the city and therefore will not be impacted in the
near term by the bankruptcy.
In the immediate term, the city will be able to meet debt service payments on its
general obligation and lease revenue debt from the$82 million reserves
invested with LAIF. The city's $64 million taxable notes and$10 million TRANs
both mature in July, 1995.
Seal Beach Water Revenue Bonds
The Seal Beach water revenue system has$2 million or 28% of its funds
invested with the Orange County Investment Pool. Of the remaining$5.2
million, $4.7 million is invested with LAIF and $0.5 million is on deposit with
Bank of America. The January 1 debt service payment of$44,000 (interest due)
has already been made from the city's general checking account at
Bank of America.
Placentia Redevelopment Agency
At the time of the bankruptcy filing, the City of Placentia had $20 million invested
in the Orange County Investment Pool. Outside of the Pool, the City has$1
million invested with LAIF and a$1 million Farmers Home Loan Bank callable
note held at a local bank. The debt service reserve fund of$297,000 for the
1994 COPs is held by the trustee bank. Debt service of$400,000 including
principal and interest payments on the Agency's 1994 COPS is due on
January 1, 1995. The City expects to make the debt service payment from
monies held outside the Pool. No project or construction funds were invested in
the Pool.
1
•
Placentia-Yorba Linda Unified School District
Yorba Linda School District
As of December 12, 1994, the District (consolidating the Placentia Unified
School District and the Yorba Linda School District) had $1.1 million in funds
held outside the Orange County Investment Pool, at First Interstate bank. The
District expects to make the$271,000 interest payment due on January 2, 1995
on the District's fiscal year 1995 taxable notes from these monies and to make
the Yorba Linda School District general obligation debt service payments from
property taxes collected in December and deposited in the post-bankruptcy
account.
Centralia School District
Irvine Unified School District
Santa Ana Unified School District
Centralia School District has principal and interest due January 1; Irvine Unified
School District has principal and interest due on January 1; Santa Ana Unified
. School District has an interest payment due January 1. Moody's has had
discussions with representations of all three school districts but no definitive
information is available at the present time.
With few exceptions, school districts in California are required by statute to
deposit operating and debt service monies with their respective county
investment pools. The majority of school district participants in the Orange
County Investment Pool relied on the County Treasurer's office for money
management services including revenue collection, payroll distribution and debt
repayment. As such, any short-term and long -term assessment of the impact of
the County and the Pool's bankruptcy on school districts within Orange County
is closely tied to resolution of bankruptcy issues including questions of legal
standing and priority of payments.
Contacts:
Chee Mee Hu Barbara Flickinger
Vice President/Supervisor Vice President/Assistant Director
(212) 553-3665 (212) 553-7736
•
Moody's Public Finance Department Rating Dusk
WOWS Investors Service
99 Church street
New York.NY 10007
1R - IL ILI Z 4" %bz y T IT (212)553-0533
This press release replaces the release sent at 10:07 a.m.this morning
MOODY'S REVIEWS THE ORANGE COUNTY TRANSPORTATION
AUTHORITY 100-DAY STRATEGIC PLAN
New York,New York--December 19, 1994--Moody's Investor's Service has
conducted a number of in-depth discussions with the Orange County
Transportation Authority("OCTA")to assess the Authority's ability to meet its
next debt service payments coming due on February 15, 1995 and to continue
normal operations. According to OCTA,the Authority has$1.15 billion invested
in the Orange County Investment Pool representing almost 100%of its assets,
comprised primarily of capital construction funds and debt service funds. OCTA
holdings comprise 15%of the Orange County Investment Pool making the
Authority one of the largest participants in the pool. The County expects to lose
some portion of,and currently does not have access to,these monies pending
resolution of issues related to the Chapter 9 bankruptcy.
According to the information obtained by Moody's,the OCTA Board has
approved an interim plan to ensure all upcoming debt service payments are
made in full and on time. The Authority has identified cash flow requirements
going forward and is positioned to meet operating needs and debt service
payments including principal and interest payments due February 15, 1995.
Ratings on various OCTA obligations were placed under review on December 6,
when the Investment Pool declared bankruptcy and all funds were frozen.
OCTA's ratings will remain under review until the bankruptcy issues are resolved
and the full extent of OCTA's investment losses are known. At this time,based
on the documentation provided us by OCTA officials, we expect that OCTA has
good short-term capacity to meet upcoming debt service requirements. The
Authority has prepared a credible plan which is indicative of the strong credit
characteristics they have maintained historically. Once the extent of investment
losses are determined, we will reassess the Authority's credit position and
sonsider the impact of the loss of capital funds.
While OCTA's ability to meet its critical needs, including debt service, appears
relatively secure, there may be certain programmatic changes required as a
result of losses incurred by the Orange.County Investment Pool. The greatest
impact will most likely be felt by the Orange County Local Transportation
Authority (OCLTA) which is responsible for implementation of the Measure M
sales tax program for freeway, regional and local streets and transit projects and
by OCTD which is the operating arm of the OCTA providing mass transit service
to the county's 2.6 million residents.
In order to address cash flow needs for the next 100 days, the OCTA Board of
Directors authorized a strategic plan on December 12, 1994 which outlines the
following.
• The$46 million Debt Service Payment Due February 15, 1995 on the
OCLTA Sales Tax Revenue Bonds 1992, First Senior Bonds, 1992,
Second Senior Bonds and 1994, Second Senior Bonds will be paid in
full.
Historically, monthly receipts of Measure M sales taxes have averaged
$10-12 million per month and OCTA expects to provide a large portion of debt
service from Measure M sales taxes collected in December and January. It
necessary the OCTA may also be able to procure early access to February
collections from the State Board of Equalization. All Measure M sales tax
revenues received by OCTA are sent directly to the Trustee Bank and all transit
operating revenues and subsidies are directed to Sanwa Bank. Since the
bankruptcy filing, OCTA has successfully obtained early release of$8.8 million of
Section 9 operating grants from the Federal Transit Administration and$15
million of its State and Local Transportation Partnership Program Funds which
CalTrans forwarded to OCTA on an expedited basis at the Governor's direction
on December 14, 1994. Alternatively. OCTA may access the remaining$26
million from a$200 line of credit with Industrial Bank of Japan ("IBX) which was
authorized in conjunction with the,OCTKs commercial paper program. IBJ has
continued to honor draws on the commercial paper program.
• OCTD will be able to continue to provide mass transit services at least
until June, 1995 based on current cash flows. Debt service payments
due in January on the District's 1990 and 1993 Bus Acquisition
Certificates of Participation will be met from FTA Section 9 grants, state
funding and local property taxes.
Updated cash flows for OCTD operations indicate sufficient resources from
farebox revenues and various subsidies to continue to provide normal services.
Farebox receipts are projected at approximately$1.8 million per month.
Discretionary and contractual expenditures are under review. Based on historic
patterns, OCTD projects receipt of operating subsidies including $17.4 million of
Local Transportation Fund sales tax revenues and at least$1.0 million of State
Transit Assistance gas tax revenues collected by the State, by April, 1995.
OCTD also collects property taxes and estimates$2.8 million in property tax
collections by the end of April, 1995. Cash flows indicate normal non-payroll
operating expenditures of approximately$5.0 million per month and payroll
expenditures of$4.9 million per month.
• OCTA is undertaking other interim measures to control program
expenditures and to ensure operating viability.
While certain construction projects are continuing- particularly those located
along Interstate 5 - OCTA has taken measures to ensure operating viability until
it can access OCTA funds which were invested in the Orange County Investment
Pool.
These measures include suspension of right-of-way acquisition, suspension of
work on design contracts and suspension of discretionary purchases. Based on
these interim measures the Authority expects to meet its debt service
obligations on February 15, 1995 and to continue operations at least until June,
1995. The next OCLTA debt service payment in August will be met primarily
from six months of Measure M sales tax receipts. Monthly sales tax receipts.
have averaged $10-12 million per month over the last four years and the
Authority expects to be able to meet its debt service obligations going forward.
Bond Counsel to the Authority has confirmed to Moody's that the collection of
Measure M sales taxes is independent of project delivery.
This analysis is based on information provided to Moody's by the OCTA which
includes updated cash flows and materials presented to and approved by the
OCTA Board. Moody's will continue to evaluate the financial and operating
condition of the Authority going forward and provide updates as necessary
SB 838 established the Orange County Transportation Authority (OCTA) in 1991
and thereby consolidate numerous transportation agencies under its aegis. The
various Orange County agencies consolidated under the umbrella of the OCTA
include the Orange County Transportation Commission (OCTC), Orange County
Transit District (OCTD), Orange County Consolidated Transportation Services
Agency (OCTSA), Orange County Service Authority for Freeway Emergencies
(SAFE), Orange County Congestion Management Agency, Service Authority for
Abandoned Vehicles (SAAV) and the Orange County Local Transportation
Authority (OCLTA). The OCTA oversees the planning, financing and
management of all transportation and transit projects throughout the Orange
County.
Contacts:
Chee Mee Hu
Vice President/Supervisor
(212) 553-3665
Barbara Flickinger
Vice President/Assistant Director
(212) 553-7736
•
Moody's Public Finance Department mating Desic
Moodyrs Investors Service
99 Church street
New York.NY 10007
(212)5534533
MOODY'S CONDUCTS FOLLOW-UP MEETINGS
IN ORANGE COUNTY,CALIFORNIA
New York,New York--December 15, 1994—Effective today, senior officials of
Moody's Investors Service met with various representatives of Orange County,
Califomia including Tom Hayes and other Senior officials and their advisors.
. The purpose of our trip was to get an updated assessment of the situation and to
continue discussions regarding the status of outstanding debt obligations in light
of the losses incurred by the County Investment Pool and the bankruptcy filings
of the Pool and the County. We expressed concerns about immediate cashfiow
needs for upcoming debt service payments as well as future steps necessary to
protect debtholder security.
Among the topics discussed with County officials were the size of the investment
losses and the strategy to stabilize and liquidate the investment portfolio,the
availability of cash resources and the alternatives for interim disbursements of
cash to meet compelling needs of the participants,including cashflow necessary
to meet upcoming debt service. Issues relating to repayment of debt obligations
remain complicated by the bankruptcy filings and will likely be subject to a great
deal of discussion and legal interpretation before they can be resolved.
•
We also had discussions regarding the longer-term outlook for the County and
the participants relative to the ultimate allocation of losses and some of the
possible alternative means available to address those losses. Moody's officials
emphasized that default avoidance will be a critical element in our credit
evaluation of the County and the other participants as they attempt to deal with
this situation and restore confidence in their creditworthiness.
We expect to comment at greater length shortly about our current analysis of the
status of various debt obligations.
Contacts:
Barbara Flickinger
Vice President-Assistant Director, Far West Region
(212) 553-7735
David Brodsly
Vice President-Manager, Far West Region, San Francisco
(415) 274-1739
George Leung
Vice President-Managing Director, State Ratings
(212) 553-0342
Dan Heimowitz
Executive Vice President-Director, Public Finance
(212) 553-0340
Moody's Public Rnance Department Rating Do*
Mood,/&irwadon source
99 Church am W
x ITO Now York,W 10007
19-f 3 11 13 (212)553-0633
MOODY'S ISSUES REVISED RATINGS LIST FOR ORANGE
COUNTY, CALIFORNIA INVESTMENT POOL PARTICIPANTS
New York,New York—December 14, 1994—On December 6,1994, Moody's
Investors Service placed under review 110 ratings of 58 issuers with funds
invested in the Orange County Investment Pool. Ratings were placed under
review because of uncertainty resulting from the pool's announced losses.
We are now publishing an updated list which takes into account rating actions
subsequent to December 6. These rating actions included the suspension of the
ratings of all Orange County obligations because the County filed for bankruptcy,
and downgrades of two obligations(County Sanitation Districts 1,2,3,5,6,7,
11, 13 and 14 and County Taxable Pension Obligation Bonds,Series B)to
reflect nonpayment on the the former and default on the latter. In addition,a
number of issuers have been added to or deleted from the group of issuers
whose ratings were placed under review December 6th,as we have since
obtained more complete information about which rated debt issuers are,or are
not,participants in the County's investment pool.
The updates to our ratings list are summarized below,followed by a list of all
unenhanced,uninsured Moody's ratings affected by the bankruptcy of Orange
County and the Orange County Investment Pool.We will continue to report any
future rating actions on a case by case basis and publish periodic updates to the
complete list as warranted.
Contacts:
Karen Krop Barbara Flickinger
Assistant Vice President Vice President and Manager
Public Finance Far West Region
(212)553-4860 (212)553-7736
RATINGS FOR ORANGE COUNTY, CALIFORNIA
INVESTMENT POOL PARTICIPANTS
Added To December 5 Llet of
Ratings Under Revlew
Issuer Rating Debt Outstanding
Atascadero (TRANs) 1994 MIO 2 $1,300,000
Anaheim Electric Revenue Serles'91 AsNMIa 1 $3,422.000
Anaheim Electric System Commercial Paper P-1 $28,000,000
Claremont A $145,000
Montebello(TRANs) 1994 MIG 1 $6,000,000
Montebello Pub. Impr. Corp. Ctfs. of Part.
(1990 Cap. Impr. Proj.) Bee $7,290,000
Mountaln View Aa $1,266,000 •
Mountain View Redev.Agcy. (Shoreline
Regional Park Comm.Tax Alloc.) A $24,870,000
Ocean View S.D. A $50,000
Santa Barbara Water Rev. Al (1)
Santa Barbara-Santa Barbara Pub. Fac.
Corp. Ctfs.of Part.dtd.4-1-89 A $17,650,000
Santa Barbara-Santa Barbara Pub. Fac.
Corp. Ctfs. of Part.dtd.8-1-86 Al $6,690.000
Santa Barbara-Santa Barbara Redev,Agcy.
Cifs.of Part. Harbor Imp.Proj. dtd.5-1-86 Al $13,840,000
Santa Barbara-Santa Barbara Redev.Agcy.
Ctfs. of Part. Harbor Imp.Proj.dtd.5-1-92 Al $19,110,000
•
Removed From December 6 List of Comment
Ratings Under Review
Anaheim Stadium Incorporated,CA Certificates of Bonds were called
Participation (1982 Capital Improvement Proj.)
East Orange Co.Water District No funds Invested in
Orange Co. Pool
EI Toro Water District No funds Invested In
Orange Co. Pool
EI Toro Water Dist.-EI Toro Water Dist. Pub. Fac. No funds invested In
Corp., CA. Ctfs.of Part. (Rfdg. Series A)dtd. 6-1- Orange Co. Pool
93
Garden Grove, CA.Library Lease Rental No funds Invested In
Orange Co. Pool
Garden Grove, CA. Municipal Service Center No funds Invested In
Lease Rental Orange Co. Pool
Garden Grove Water Corp.,CA. Lease Rental No funds invested in
Orange Co.Pool
Local Govt. Fin.Auth., CA. (Fullerton Redev. Bonds refunded
Agcy/Fullerton) 1988 Refunding Revenue dtd. 12-
1-88
Montebello-Montebello Pub. Imp.Corp.Ctfs. of Bonds refunded
Part. Montebello Comm. Redevel.Agcy.,Tax
Alloc., (1992 Police Fac. Expansion Proj.)
Moulton-Niguel Water Dist.Cone. Imp. Dist.3, CA. Bonds called
(Formerly Imp. Dist.3&3A)
Moulton Niguel Water Dist. Imp. Dist.2,CA Bonds called
Moulton Niguel Water Dist. Imp. Dist.7,CA Bonds called
Newport-Mesa U.S.D.,CA Bonds matured
Westminster Redev.Agcy,CA. (Westminster No funds invested in
Commercial Redev. Prof. 1)Tax alloc. Orange Co. Pool
Westminster, CA.Water Revenue No funds invested in
Orange Co. Pool
Westminster-Westminster Pub. Fin.Auth.,CA. No funds Invested In
Certificates of Participation (1993 Water System Orange Co. Pool
Imp. Proj.)
LIST OF UNENHANCED, UNINSURED RATINGS FOR PARTICIPANTS IN
ORANGE COUNTY,CALIFORNIA INVESTMENT POOL
Issuer Rating Debt Outstanding
Aliso Water Mgmt. Agency, Lease Rental
dtd. 1-1-78 Al $2,960,000
Allso Water Mgmt.Agency, Lease Rental
d1d.7-1-79 Al $3,100,000
Anaheim Aal $9,978,000
Anaheim (TRANS) 1994 MIO 1 $24,500,000
Anaheim&Anaheim U.H.S.D Comm.Ctr.
Auth. (now Anaheim Comm. Ctr.Auth.)
Lease Rental Al $8,638,000
Anaheim Comm. Ctr.Auth. (formerly
Anaheim &Anaheim U.H.S.D. Comm.
Ctr. Auth.) Lease Rental Con.(A) $81,745,000
Anaheim Electric Revenue Aa $208,179,000
Anaheim Electric Revenue Serles'91 Aa/VMIG1 $3,422.000
Anaheim Electric System Commercial Paper P-1 $28,000,000
Anaheim Pub. Fin.Auth. Revenue,
(Water Utilities Filtration Plant Project) Al $20,000,000
Anaheim Taxable Notes 1994 MIG 1 $95,000,000
Anaheim Water Revenue Aa $25,804,000
Anaheim Wtr. Rev. (RANS) 1994 MIO 1 $2,500,000
Anaheim-Anahelm Pub. Improvement Corp.
Ctfs.of Part. (1989 Land Acquisition Proj.)
dtd. 11-1-69 Con.(Al) $17,970,000
Atascadero(TRANS)19941995 MIG 2 $1,300,000
Brea Olinda U.S.D.-B.O.U.S.D.Fin, Corp.
Ctfs.of Pan. (Brea 011nda H.S. Refln. Prog.)
Ser. '94B did.8-1-94(Junior Lien) Baal $12,785,000
Buena Park Water Revenue A $280,000
California Special Dist,Assoc, Fin. Corp.
1992 Series T Ctfs.of Part. (Tri-Cities
Munic.Water Dist.) A $5,895,000
California Transit Fin.Corp.Orange Co.
Trans.Auth. Ctfs,of Part.Ser.'93C
did.6.1-93 All $21,100,000
Capistrano U.S.D. Al (1)
Centralia S.D. Al $1,315,000
Claremont A $145,000
Coastal Dist. Fin.Auth., (So. Coastal Water
Dist.Cap.Fac.Revenue) A $4,350,000
Costa Mesa AA $2,000,000
Costa Mesa City Hall&Pub. Fac. Corp.,
Lease Revenue did. 10-1-88 Al $15,990,000
Costa Mesa Pub. Fn. Auth. Lease Revenue Al $13,945,000
Cypress E.S.D.-Cypress Ed. Found.,Ctfs.of
Part. (Capital lmpr. Pro!.&Equip)did. 12-1- A $3,900,000
91
Cypress Rec. &Park Dist, Al $715,000
Cypress-Cypress Redev. Agency,Otis.of
Part. (Civic Center Refln. &Impr. Proj.) Al $8,830,000
Fountain Valley S.D., (formerly Elementary) A $1,820,000
Fullerton(TRANS) 1994 MIG 1 $4,500,000
Fullerton Library Bldg.Auth.,Lease Rental
Ser. '72 A $620,000
Fullerton Parking Auth. Lease Rental
Ser. 174 A $75,000
Harden Grove San.Dist.(TRANS) 1993-94 MIG 1 $5,075,000
Huntington Beach City Aa $939,000
Huntington Beach-Huntington Beach Pub.
Fin.Auth, (TRANS) 1994-95 MIG 1 $15,008.000
Huntington Beach Pub.Fac.Corp.Ser.
Did.9-1-72 Al $1,065,000
Huntington Beach Pub.Fin.Auth.,
(Huntington Ott., Main Pier,Oakview Talbert
Beach Proj.Areas)Redev. Projs. Rev.Tax
Alloc. 8a $32,715,000
Huntington Beach U.H.S.D. Fin.Corp.Ctfs.
of Part.School Fac.Fin.Proj.)Set. 1992 A $1,225,000
Huntington Beach-Huntington Beach Redev.
Agency Ctfs.of Part. Rfdg,proj. (Emerald
Cove Sr. Citizens Hsg. Proj Al $5,555,000
Irvine An $9,6601000
Irvine-Irvine Pub. Fac. Corp., Rfdg. Ctfs. of
Part. (Animal Care Center&Operation
Supp. Fac.)did.4-1-80 At $5,060,000
Irvine Ranch Water Imp. Dist.1 A (1)
Irvine U.S.D. A $15,412,230
Laguna Beach City An $20,000,000
La Habra(TRANS) 1994 MIG 1 $2,200,000
La Palma Comm. Dev. Commission
Tax Alice. Baa $11,685,000
Local Govt. Fin.Auth. (Fullerton Redev.
Agcy/Fullerton) 1989 Refunding Revenue
did. 7-1-89 A $3,920,000
Local Govt. Fin.JL Powers Auth.-Local
Govt. Fin.Corp. (Anaheim Redev.Agency
Proj.Alpha 1988 Issue A) A $58,835,000
Los Alamitos U.S.D.Comm. Fac. Dist.
No.90-1, Special Tax Beal $11,920,000
Montebello(TRANS) 1994 MIG 1 $6,000,000
Montebello Pub. Impr. Corp. Ctfs. of Part.
(1990 Cap. Impr. Proj.) Bay $7,290,000
Mountain View As $1,265,000
Mountain View(Shoreline Reg.Park Comm.
Tax Alloc.) A $24,870,000
Ocean View E.S.D. A _ _$501000
.
Orange County (4) $785,000
Orange Co. (TRANS) 1994-85(Pooled) (4) $299,660,000
Orange Co. (TRANS) 1994-95
(Taxable Notes) (4) $600,000,000
Orange Co. (TRANS)1994-95
(Taxable Notes)Teeter Plan (4) $111,000,000
Orange Co. (TRANS) 199495 Ser.A) (4) $169,000,000
Orange Co. (TRANS)1994-95 Ser. B) (4) $31,000,000
Orange Co.,-Califomia Financial Svcs.
(1990 Equip. Proj.)Ctfs.of Part.did. 1-1-91 (4) $11,975,000
Orange Co.,Airport Rev.Bds. (4) (3)$133,040,000
Orange Co., CIVIC Center Auth.,Santa Ana
Lease Rental 1972 Rfdg. (4) $785,000
Orange Co.,Comm. Fac.Dist.
No. 87-3(Mission Viejo)Spec.Tax Bds. A $51,070,000
Orange Co., Devel.Agcy.
Santa Ana Heights Proj.Tax Alloc. Bds. Bast $57,435,000
Orange Co., Flood Control Dist. An $2,190,000
Orange Co., Fid.Cont. Dist.
Taxable 1994-95 Notes P-1 $100,000,000
Orange Co., Loc.Trans.Auth.
Commercial Paper Notes P-1 (2)$200,000.000
. Orange Co., Loc.Trans.Authority Sales Tax
Rev. First Senior An $262,930,000
Orange Co., Pension Oblig. (Taxable Ser.A) (4) $209,840,000
Orange Co., Pension Obllg. (Taxable Ser. B) Caa $110,000,000
Orange Co., Pub. Fac.Corp. Ctfs.of Part.
Ser. '88 did. 7-1-88 (4) $13,486,000
Orange Co., Pub. Fac.Corp. Ctfs, of Part.
Ser.'88 did. 12-1-88 (4) $81,615,000
Orange Co., 1994-95(Teeter Plan)
Tax-Exempt Notes (4) $64,000,000
Orange Co.,Sanit. Dist.No. 12 A $320,000
Orange Co.,Sanit. Dist. No. 1,2,2A, 3, 11 A $75,000
Orange Co.,Sanit. Dist. No. 1,2,3,4,5, 6,
7, 11, 13 and 14 Commercial Paper Not Prima $48,000,000
Orange Co.,Transit Dist.Ctfs.of Part.
('90 Bus Acquisition Pro].) Al $11,120,000
Orange Co.,Water Dist.Callfomla-
O.C.W.D. Pub. Fac.Corp. Ctfs. of Part.did. Aa $26,7e0,000
7-1-89
Orange Co.,Water Dist.
Commercial Paper Program P-1 $25,000,000
Orange Co.,Water Dlet.-O.C.W.D.Pub.
Fac. Corp.Ctfs. of Part. did. 12-1-93.Ser. Aa (1)
'93B
Orange Co.,Water Dist.-O.C.W.D. Pub.
Fac. Corp. Ctfs. of Part.did. 6-1-93.Ser. As $141,545,000
'93A
Orange U.S.D.-Orange Sch. Fin.Corp. Ctfs.
of Part. did. 1-1-91 Con.(A) $10,950,000
Orange U.S.D.-Orange Sch. Fin.Corp. Ctfs.
of Part. did.2-1-94 A $2,435,000
Placentia A $310,000
Placentia-Placentia Redev.Agcy.Ctfs.of
Part. dtd.4-1-94 Baal $3,135,000
Placentia Unif. S.D. (now Placentia Yorba
Linda U.S.D.) Al $470,000
Placentia-Yorba Linda Unif.S.D. 199495
Taxable Notes P-1 $50,000,000
Placenta-Yorba Unda Unif.S.D. 1994
Taxable Notes,Series B P-1 $50,000,000
Saddleback Comm.Coll. Dist. Fac. Corp.
Ctfs. of Part. (1991 Athletic Fac, Refin. Baal $4,930,000
Proj.)
Santa Ana U.S.D. Al $4,400,000
Santa Ana Water Rev. Al $13,100,000
Santa Barbara Water Rev. Al (1)
Santa Barbara-Santa Barbara Pub.Fac.
Corp.Ctis. of Part.did.4.1.89 A $17,650,000
Santa Barbara-Santa Barbara Pub.Fac.
Corp.Ctfs.of Part. did.8-1-86 Al $6,690,000
Santa Barbara-Santa Barbara Redev,Agcy.
Ctfs.of Part. Harbor Imp. Prof.dtd.5.1-88 Al $13,640,000
Santa Barbara-Santa Barbara Redev,Agcy.
Ctfs.of Part. Harbor Imp. Pro].did.5-1-92 Al $19,110,000
Seal Beach (TRANS) 1994 MIG 1 $2,100,000
Seal Beach Water Rev. Baa $205,000
So. Coast Mr. Dist. Imp. Dist. 1 (Form.So.
Laguna San. Dist) Al (3)$4,990,000
Yorba Unda Co.Water Dist. (W.Svc.Area). Al (1)
Yorba Linda S.D. A $40,000
Yorba Linda Water Dist, Imp. Dist. 1 At $5,840,000
Yorba Linda-Yorba Linda Pub. Fin.Auth.
Ctfs,of Part. (Recycling Equip. Pro].)dtd.5- A $3,050,000
1-91
(1) Not available.
(2)Authorized amount.
(3) Uninsured portion.
(4)Suspended.
Moody's Public Rnance Department Rana Dusk
Moodys Investors Service
Ra
ruW
99 Church street
MAI
New York,NY 10007
(212)553-0533
MOODY'S IDENTIFIES NEXT DEBT SERVICE
PAYMENTS FOR PARTICIPANTS IN
ORANGE COUNTY, CALIFORNIA INVESTMENT POOL
New York,New York--December 12,1994—Effective today,Moody's Investors Service
announced today that R has completed a survey of upcoming debt service requirements as an
initial phase of a comprehensive review of the participants of the Orange County,Caufomia
Investment Pool. The survey covers only participants which have unenhanced,uninsured
ratings.
Moody's suspended the ratings on the County's debt as of December 6,when the County and
the pool filed for bankruptcy. We have also placed under review the ratings on the debt of all
other pool participants.In addition,the rating for the taxa Is commercial paper for the County
Sanitation Districts 1,2,3,5.6,7,11,13 and 14 of Orange County has been lowered to Not Prime
because of the districts'inability to access funds in the pool. The rating on the Orange County
Taxable Pension Obligation Bonds,Series B has been lowered to tom; the County defaulted on
these bonds because it was unable to access its unrestricted funds in an amount sufficient to
redeem tendered bonds.
The purpose of this initial survey was to identify the next debt service payments coming due for
each obligation. According to our survey.Anaheim has$2.5 million in revenue anlicipation notes
coming due December 15. City officials have informed us that this payment will be made from
funds not invested in the County pool. We have identified seven issuers with interest and
principal payments and nineteen issuers with only interest payments due in January 1995.
The debt service information provided was compiled from various sources including Moody's
records,official statements,Munistat,CUSIP,and Bloomberg. The information has not been
verified with the issuers and we are in the process of contacting them to confirm these schedules
and to obtain information about the issuers'plans to meet upcoming obligations,most particularly
focusing on debt service.
Contacts:
Karen Krop Barbara J.Flickinger
Assistant Vice President Vice President and Assistant Director
(212)553.4860 (212)553-7736
i
ORANGE COUNTY, CALIFORNIA INVESTMENT POOL PARTICIPANTS
Upcoming Debt Service Payments
Next Next
Principal Int
Debt Payment Principal Paymt Interest
Issuer Rating Outstanding Date Amount Date Amount
Aliso Water Mgmt.Agency,
Lease Rental did.1-1.78 Al $2,960,000 711/95 $90,000 1/1/95 $55,500
Aliso Water Mgmt.Agency,
Lease Rental did.7-1-79 Al $3,100,000 711/95 $140,000 1/1/95 $55,500
Anaheim Aal $9,976,000 10/1/95 $400,000 4/1/95 $535.635
Anaheim(TRANS) 1994 MIG 1 $24,500.000 7/28M $24,500,000 7/28/95 (1)
Anaheim&Anaheim U.H.S.D
Comm. Ctr. Auth. (now
Anaheim Comm.Ctr.Auth.)
Lease Rental . Al $8,638,000 8/1/95 $1,480,000 211/95 (1)
Anaheim Comm.Cir.Auth.
(formerly Anaheim&Anaheim
U.H.S.D.Comm.
Ctr.Auth.)Lease Rental Con.(A) $61,745,000 8/1/95 $840,000 211/95 $4,7418
Anaheim Electric Revenue An $206,179,000 10/1/95 $11.995,000 411/95 $12,854,340
Anaheim Electric Revenue
Sedes'91 AaIVMIGI $3.422,000 10/1/03 (1) 4/1/95 (1)
Anaheim Electric System
Commercial Paper P-1 $28,000,000 (1) (1) (1) (1)
Anaheim Pub. Fin. Auth.
Revenue, (Water Utilities
Filtration Plant Project) Al $20,000,000 10/1/06 $640,000 4/1/95 (1)
Anaheim Taxable Notes 1994 MIG 1 $95,000,000 4/4/95 $95,000,000 4/4/95 (1)
Anaheim Water Revenue Aa $25,804,000 4/1/95 $100,000 44//95 $199,661
Anaheim Mr. Rev.
(RANS) 1994 MIG 1 $2,500,000 12115/94 $2,500.000 12/15/95 (1)
Anaheim-Anaheim Pub.
improvement Corp.COPS
(1989 Land Acquisition
Proj.)did.11.1.89 Con.(Al) $17,970,000 11/1/95 $195,000 5/1/95 (1)
Atascadero(TRANS)
19941995 MIG 2 $1,300,000 7/12195 $1,300,000 7/12/95 (1)
Brea Olinda U.S.D.-B.O.
U.S.D.Fin.Corp.Ctfs.of
Part.(Brea Olinda H.S. Refin.
Prog.)Ser.'94B did.
8-1-94(Junior Lien) Baal $12,785,000 8/1/09 $1,865,000 2/1/95 (1)
Buena Park Water Revenue A $260,000 3/1/95 $145,000 3/1/95 $2,900
0
•
California Special Dist.Assoc.
Fin.Corp. 1992 Series T COPS
(Tri-Cities Munic.Water Dist) A $5,895,000 12/1/95 $120,000 611/95 (1)
California Transit Fin.Corp.
Orange Co. Trans. Auth.Ctfs.
of Part. Ser. '93C dtd.6-1-93) Al $21,100,000 7/1/96 $2.205.000 1/1/95 (1)
Capistrano U.S.D. Al (1) 2/2/95 $595,000 2/1/95 $19.250
Centralia S.D. Al 51,315,000 1/1/95 $155,000 1/1/95 (1)
Claremont A $145,000 6/15/95 $45,000 6/15/95 (1)
Coastal Dist. Fin.Auth..(So.
Coastal Water Dist. Cap. Fac.
Revenue) A $4,350,000 7/1/95 $75.000 1/1/95 $129.779
Costa Mesa Aa 52,000,000 1/1/95 $160.000 1/1/95 $52,500
Costa Mesa City Hall&Pub.
Fac. Corp.. Lease Revenue
dtd. 10-1-88 Al $15,990,000 10/1/95 $240,000 4/1/95 (1)
Costa Mesa Pub. Fin.Auth.
Lease Revenue Al $13,945,000 10/1/95 $400,000 4/1/95 (1)
Cypress E.S.D.-Cypress Ed.
Found..COPs(Capital Impr.
Proj.&Equip)dtd. 12-1.91 A S3,900,000 12/1/95 $470,000 6/1/95 $115,383
Cypress Rec.&Park Dist. Al $775,000 11/1/95 $175,000 5/1/95 (1)
Cypress-Cypress Redev.
Agency. Ctfs.of Part. (Civic
. Center Refin. & Impr. Proj.) Al 55,830,000 8/1/95 $95,000 2/1/96 $193,966
Fountain Valley S.D.,
(formerly Elementary) A $1,820,000 10/1/95 $5051000 4/1/95 $336,313
Fullerton (TRANS) 1994 MIO 1 $4,500,000 7/31/95 $4,500.000 7/31/95 (1)
Fullerton Library Bldg.Auth.,
Lease Rental Ser.'72 A $620,000 3/1/95 $60,000 311/95 $17,106
Fullerton Parking Auth.Lease
Rental Ser. '74 A $75,000 8/15/95 $75,000 2/1195 (1)
Garden Grove San. Dist.
(TRANS) 1993-94 MIG 1 $5,075.000 5/1/95 $5,075,000 5/1/95 (1)
Huntingtnn Beach-Huntington
Beach Pub. Fn.Auth.
(TRANS) 1994-95 MIG 1 $15,000,000 10/1/95 $15,000,000 10/1/95 (1)
Huntington Beach City Aa $939,000 3/1/95 $445,000 311/95 (1)
Huntington Beach Pub. Fac.
Corp.Ser. Dtd.9-1-72 Al $1,085,000 9/1195 $340,000 3/1/95 $32.550
Huntington Beach Pub. Fin.
Auth., (Huntington Ctr.,
Main Pier,Oakview Talbert
Beach Proj.Areas)Redev.
Projs. Rev.Tax Alloc. Ba $32,715,000 8/1/95 $410,000 211195 (1)
Huntington Beach U.H.S.D.
Fin.Corp.Ctfs.of Part. School
Fac. Fin. Proj.)Ser. 1992 A $1,225,000 211196 $120,000 2/1/95 $34,355
Huntington Reach-Huntington
Beach Redev.Agency COPs
Rfdg. proj.(Emerald Cove
Sr.Citizens Hsg. Proi Al $5,555,000 9/1/95 580,000 3/1/95 $188,529
Irvine A $9,660,000 1/1/95 $1,410,000 1/1/95 (1)
Irvine Ranch Water Imp.
Dist.1 A (1) 8/1/95 (1) 2/1/95 (1)
Irvine U.S.D. A $15,412,230 1/1/95 $2,430.000 1/1/95 (1)
Irvine-Irvine Pub. Fac. Corp.,
Rfdg.Ctfs.of Part.
(Animal Care Center&
Operation Supp. Fac.)
dtd.4-1-90 Al $5,060,000 5/1/95 $215,000 5/1/95 $174,140
Laguna Beach City Aa $20,000,000 8/15/95 $595,000 2/15/95 $627,963
La Habra(TRANS) 1994 MIG 1 $2,200,000 6/30/95 $2,200,000 6/30/95 (1)
La Palma Comm. Dev.
Commission Tax Alloc. Baa $11,685,000 6/1/95 $170,000 12/1/95 $735,203
Local Govt.Fn.Auth.
(Fullerton Redev.
Agcy/Fullerton) 1989
Refunding Revenue
did.7.1-89 A $3,920,000 2/1/95 $100,000 2/1/95 (1)
Local Govt.Fin. A. Powers
Auth.-Local Govt. Fin.Corp.
(Anaheim Redev.Agency
Proj.Alpha 1986 Issue A) A $58,835,000 9/1/15 $58,835,000 9/15/15 (1)
Los Alamitos U.S.D.
Comm.Fac. Dist.
No.90-1,Special Tax Baal $11,920,000 8115/99 $160,000 2/15/95 $32-0
Montebello(TRANS) 1994 MIG 1 $6,000,000 9/29/95 $6,000,000 9/29/95 (1)
Montebello Pub. Impr.Corp.
Ctfs.of Part. (1990 Cap. Impr.
Proj.) Baa $7,290,000 6/1/95 $605,000 6/1/95 (1)
Montebello-Montebello Pub.
Imp. Corp. Ctfs.of Part.
Montebello Comm, Redevel.
Agcy., Tax Alloc., (1992 Police
Fac. Expansion Proj.) Can.(Baal) $12.345.000 11/1/96 $140,000 5/1/96 (1)
Mountain View Aa $1,265,000 4/1/95 $85,000 4/1/95 (1)
Ocean View E.S.D. A $50,000 4/1/95 $50.000 4/1/95 (1)
Orange County (8) $7.85,000 7/1/95 $195,000 1/1/95 (1)
Orange Co. (TRANS) 1994-95
(Pooled) (8) $299,660,000 8/1/95 $299,660,000 8/1/95 (1)
Orange Co.(TRANS)1994-95
(Taxable Notes) (8) $600,000,000 7/10/95 $600,000,000 1/2/95 (1)
Orange Co. (TRANS) 1994-95
(Taxable Notes) Teeter Plan (8) $111,000,000 6/30/95 $111,000,000 1/2/95 (1)
Orange Co.(TRANS) 1994-95
Ser.A) (8) $169,000,000 7/19/95 $169,000,000 7/19/95 (1)
Orange Co. (TRANS) 1994-95
Spr.B) (8) $31,000,000 8/10/95 $31,000,000 VMS (1)
Orange Co.,Airport Rev.Bds. (8) (4)$117,015,000 7/1/95 $2.000,000 1/1/95 $9.248.343
Orange Co.. Civic Center
Auth.,Santa Ana Lease Rental
1972 Rfdg. (8) $785,000 11/1/95 $785.000 5/1/96 $50.000
Orange Co..Comm. Fac. Disl.
No.87-3(Mission Viejo)Spec.
Tax Bds. A $51,070,000 8/15/95 $480,000 2115195 $1,981,404
Orange Co., Devel. Agcy.
Santa Ana Heights Proj.Tax
Alloc. tads. seal $57,435,000 9/1/95 $835,000 3/1/95 $1,705,154
I
Orange Co..Flood Control Dist. Aa $2,190,000 2/11/95 $1.095,000 21I/95 (1)
Orange Co.,Md. Cord. Dist.
Taxable 1994-95 Notes P-1 $100,000,000 8/2/95 $100,000,000 1/2195
Orange Co.,Loc.Trans.Auth.
Commorcial Paper Notes P-1 (2)$200,000,000 (3) (2)$200,000,000 (1)
Orange Co.,Loc. Trans.
Authority Sales Tax Rev.
First Senior Aa $262,930.000 2/15195 $12,790,000 2/15/95 $8,896,366
Orange Co., Pension Oblig.
(Taxable Ser.A) (8) $209,840,000 9/1/95 $8.335.000 3/1195 $8.207,160
Orange Co.,Pension Oblig.
(Taxable Ser.8) Caa $110,000,000 9/1/08 $24.700.000 1/2/95
Orange Co..Pub. Fac.
Corp.Ctfs.of Pall.
Set.'66 did.7-1-06 $13,485,000 7/1/93 $3,070,000 1/1/95 $488,175
Orange Co., Pub.Fac.
Corp.Ctfs.of Part
Ser.'88 dtd. 12-1-88 $81,615,000 12/1/96 $2.010,000 611/95 $3,148.916
Orange Co.. Sanit. Dist.No. 12 A $320,000 7/1/95 $110,000 1/1/95 (1)
Orange Co.,Sanit. Dist.No. 1,
2,2A,3.11 A $75,000 1/11/95 $15,000 1/1/515 (1)
Orange Co..Sanit.Dist
No.1,2.3,4,5,6.7.11.13.14 Not Prime $46,000.000 (6) 1/10/95 $20,000,000 (6) 1/10195 (1)
Orange Co.,Transit Dist COPs 6/1/95 (1)
('90 Bus Acquisition Proj.) Al $11,120.000 1211/95 $725,000
Orange Co.,Water Dist.
Calif ornia-O.C.W.D. Pub.Fac.
Corp.COPs dtd.7-1-89 Aa $26,760,000 8/15M $1.995.000 .2/15/95 $1.718,161
Orange Co.,Water Dist.
Commercial Paper Program P-1 $25,000,000 (1) (5)$25,000,000 (1)
Orange Co.,Water Dist.-
O.C.W.D. Pub. Fac.Corp.
COPs dtd. 12-1-93.Ser.'93B Aa (1) 8/15195 (1) 21,1/96 (1)
Orange Co.,Water Dist.
O.C.W.D. Pub.Fac.Corp.
COPs dtd. 8-1-93. Ser.'93A An $141,545,000 8115/95 $1,215,000 2115/95 $7,481.258
Orange Co., 1994-95(Tester
Plan)Tax-Exempt Notes (8) $64,000.000 6/30195 $64.000.000 1/2/95 (1)
Orange Co.,-Calitomia
Financial Svcs.(1990 Equip.
Proj.)COPs did. 1-1-91 (0) $11.975,000 9/1/95 $2,500,000 311/9!5 (1)
Orange U.S.D.-Orange Sch.
Fin.Corp. COPS did. 1-1-91 Can.(A) $10,950,000 6/1/95 $65.000 611195 (1)
Orange U.S.D.-Orange Sch.
Fin. Corp.COPs dtd.2-1-94 A $2,435,000 6/1/95 $70,000 6/1/95 (1)
Placentia A $310,000 10/1/95 $15,000 4/1/95 (1)
Placentia Civic Center Auth.
Lease Rental Series A Baal $330.000 10/1/95 $150,000 4/1/95 $18.910
Placentia Unif.S.D.(now
Placentia Yorba Linda U.S.D.) Al $470,000 8/15195 $470,000 2115/95 (1)
Placentia-Placentia Redev.
Agcy. Ctfs.of Part,dtd.4.1.94 Baal $3,135,000 1/1/95 $130,000 1/1/95 (1)
Placentia-Yorba Linda Unif,
S.D. 1994-95 Taxable Notes P-1 $50,000.000 8124/95 $50,000.000 1/2195 (1)
Saddleback Comm. Coll. Dist.
Fac.Corp.COPs(1991 Athletic
Fac. Refin. Proj.) Baal $4,930.000 8/1/96 $70,000 2/1/95 (1)
Santa Ana U.S.O. Al $4,400,000 7115/95 $800,000
Santa Ana Water Rev. Al $13,100.000 7/1/99 $1,310,000 1/1/95 (1)
Seal Beach(TRANS) 1994 MIG 1 $2.100,000 6/30/95 $2,100,000 7/5/95 (1)
Seal Beach Water Rev. Al $205,000 1/1/98 $240,000 1/1/95 (1)
So.Coast Mr. Dist. Imp.Dist.
1 (Form. So.Laguna San.Dist) Al (7)$4,990,000 5/1/95 $335,000 11/1/95 (1)
Yorba Linda Co.Water Dist.
(W. Svc.Area). Al (1) 3/1/95 (1) 3/1/95
Yorba Linda S.D. A $40,000 7/1/95 $40,000 1/1195
Yorba Linda Water Dist. imp.
Dist. 1 Al $5,840,000 5/1/95 $485,000 511/95 (1)
Yorba Linda-Yorba Linda Pub.
Fin.Auth.COPS(Recycling
Equip. Proj.)dtd. 5-1-91 A $3,050,000 11/1/95 $355,000 5/1/95 (1)
(1)Not available.
(2)Audhorized amound.
(3)1 iquidity expires June 24, 1495.
(4)U simurW portion.
(S)Liquidity expires Mays, I9Sn).
(6)$26 million of commercial paper matured on Dacember 7. 1994,but were not presented for payment.
(7)Includes all uninsured general obligation debt of the South Cmt Water District.
(U)Suspended.
APPENDIX 6
SELECTED REPORTS FROM
STANDARD & POOR'S
RATINGS GROUP
44 FUNDAMENTALS OF MUNICIPAL BONDS
The rating agencies charge fees for their bond ratings based on the size of the
issue and the amount of analysis needed. Most major issuers communicate regu-
larly with the agencies, and underwriters are often involved in making presenta-
tions to the agencies on behalf of issuers.The rating agencies review their ratings
periodically and request updated information. In addition,they provide a review
process for municipalities seeking to improve their ratings.The municipal securi-i
ties ratings assigned by Moody's,Standard&Poor's,and Fitch are described in
Figure 2-5.
FIGURE 2-5. Guide to the Municipal Bond Ratings of Moody's Inves-
tors Service,Inc.,Standard&Poor's Corporation,and Fitch Investors
Service,Inc.
KEY TO STANDARD&POOR,s DEBT BEATINGS CCRrrERIA
Long-Term Debt
AAA Debt rated "AAA'.' has the highest rating assigned by Standard & Poor's.
Capacity to pay interest and repay principal is extremely strong.
AA Debt rated"AA"has a very strong capacity to pay interest and repay principal
and differs from the highest-rated issues only in small degree.
A Debt rated "A" has a strong capacity to pay interest and repay principal
although it is somewhat more susceptible to the adverse effects of changes in
circumstances and economic conditions than debt in higher-rated categories.
BBB Debt rated"BBB"is regarded as having an adequate capacity to pay interest
and repay principal.Whereas it normally exhibits adequate protection parame-
ters,adverse economic conditions or changing circumstances are more likely to
lead to a weakened capacity to pay interest and repay principal for Oebt in this
category than in higher-rated categories.
BB Debt rated "BB," "B," "CCC," or "CC" is regarded, on balance,..as
B predominantly speculative with respect to capacity to pay interest and repay
CCC principal in accordance with the terms of the obligation. "BB" indicates the
CC lowest degree of speculation and "CC" the highest degree of speculation.
While such debt will likely have some quality and protective characteristics,
these are outweighed by large uncertainties or major risk exposures to adverse
conditions. j
C This rating is reserved for income bonds on which no interest is being paid::
D Debt rated "D" is in default, and payment of interest and/or repayment of l
principal is in arrears. .;
=�r
Plus(+)or Minus(—):The ratings from"AA"to"B"may be modified by
the addition of a plus or minus sign to show relative standing within the major:;
rating categories.
The Municipal Bond Industry 45
Provisional Ratings:The letter"p-indicates that the rating is provisional.A
provisional rating assumes the successful completion of the project being fi-
nanced by the debt being rated and indicates that payment of debt service
requirements is Iargely or entirely dependent upon the successful and timely
completion of the project.This rating,however,while addressing credit quality
subsequent to completion of the project,makes no comment on the likelihood
of,or the risk of default upon failure of,such completion.The investor should
exercise judgment with respect to such Iikelihood and risk.
L The letter"L" indicates that the rating pertains to the principal amount of
those bonds where the underlying deposit collateral is fully insured by the
Federal Savings & Loan Insurance Corp. or the Federal Deposit Insurance
Corp.
*Continuance of the rating is contingent upon S&P's receipt of an executed
copy of the escrow agreement or closing documentation confirming invest-
ments and cash flow.
NR Indicates no rating has been requested,that there is insufficient information on
which to base a rating,or that S&P does not rate a particular type of obligation
as a matter of policy.
Notes
A Standard&Poor's note rating reflects the liquidity concerns and market access risks
unique to notes.Notes due in 3 years or less will likely receive a note rating.Notes maturing
beyond 3 years will most likely receive a long-term debt rating.The following criteria will
be used in making that assessment:
Amortization schedule(the larger the final maturity relative to other maturities,
the more likely it will be treated as a note).
Source of payment (the more dependent the issue is on the market for its
refinancing,the more likely it will be treated as a note).
SP-1 Very strong or strong capacity to pay principal and interest. Those issues
determined to possess overwhelming safety characteristics will be.given a plus
(+)designation.
SP-2 Satisfactory capacity to pay principal and interest.
SP-3 Speculative capacity to pay principal and interest.
Tax-Exempt Commercial Paper
A Issues assigned this highest rating are regarded as having the greatest capacity
for timely payment.Issues in this category are delineated with the numbers 1,2,
and 3 to indicate the relative degree of safety.
A-1 This designation indicates that the degree of safety regarding timely payment is
either overwhelming or very strong.Those issues determined to possess over-
whelming safety characteristics are denoted with a plus(+)sign designation.
46 FUNDAMENTALS OF MUNICIPAL BONDS
A-2 Capacity for timely payment on issues with this designation is strong. How-
ever,the relative degree of safety isnot as high as for issues designated-A- "
A-3 Issues carrying this designation have a satisfactory capacity for timely pay-
ment.They are,however,somewhat more vulnerable to the adverse effects of
changes in circumstances than obligations carrying the higher designations.
B Issues rated"B"are regarded as having only an adequate capacity for timely
payment.However,such capacity may be damaged by changing conditions or
short-term adversities.
C This rating is assigned to short-term debt obligations with a doubtful capacity
for payment.
D This rating indicates that the issue either is in default or is expected to be in
default upon maturity.
Variable-Rate Demand Bonds
Standard&Poor's assigns"dual"ratings to all long-term debt issues that have as part of
their provisions a variable-rate demand or double feature.
The first rating addresses the likelihood of repayment of principal and interest as due,and
the second rating addresses only the demand feature.The long-term debt rating symbols are
used for bonds to denote the long-term maturity and the commercial paper rating symbols
are used to denote the put option(for example,"AAA/A-I+")or if the nominal maturity
is short,a rating of"SP-I+/AAA"is assigned.
KEY TU MooDY's MUNICIPAL RATINGS
There are nine basic rating categories for long-term obligations.They range from Aaa
(highest quality)to C(lowest quality).Bonds in the Aa,A,Baa,Ba and B groups which
Moody's believes possess the strongest investment attributes are designated by the symbols
Aal,Al,Baal,Bal and Bl.
There are four rating categories for short-term obligations,all of which define an invest-
ment-grade situation.These are designated Moody's Investment Grade as MIG 1 through
MIG 4.
In the case of variable-rate demand obligations(VRDOs),two ratings are assigned;one
representing an evaluation of the degree of risk associated with scheduled principal and
interest payments,and the other representing an evaluation c f the degree of risk associated
with the demand feature.The short-term rating assigned to the demand feature of VRDOs is
designated as VMIG(pronounced vee MIG).When no rating is applied to the long-or
short-term aspect of a VRDO,it will be designated NR.
Definitions of Bond Ratings ,
Ana Bonds which are rated Aaa are judged to be of the best quality.They carry the
smallest degree of investment risk and are generally referred to as"gilt edge."
Interest payments are protected by a large or by an exceptionally stable margin
Orange Cnty Pool Part Nts Lowered to Spec Grade by SSP
NY -- S&P CreditWire 1/10/95 -- S&P lowers its ratings to speculative-
grade levels on the debt issues of four municipal issuers that have the
proceeds of their taxable note borrowings in the bankrupt Orange County
Pooled Investment Fund (Pool; see table below).
These governments' inability to access cash from the bankrupt Pool
leaves them with a significantly reduced capacity to meet their debt
repayment obligations in a timely manner. Because of the strain caused by the
size of the taxable note payments, all other general fund obligations of
these issuers also are lowered to speculative-grade rating levels (see table
below).
The ratings of other entities that issued taxable notes and have money
in the Pool, including Anaheim ($95 million taxable notes); Irvine ($62.5
million); and Placentia ($10 million); and Placentia-Yorba Linda Unified
School District ($50 million); and the Orange County Flood Control District
($100 million) remain on CreditWatch with negative implications pending
further review. These issuers may prove to have liquidity to meet their
obligations at a rating level other than 'SP-31. S6P will review and take
rating actions on these remaining taxable note issuers over the next week.
The downgrades of the four issuers' obligations to speculative-grade
rating levels result from uncertainties about their capacity to meet their
payment obligations on the taxable notes, as well as their other obligations,
from currently identifiable and available resources. Although all of the
issuers expressed to S&P a very strong willingness and desire to honor their
contractual obligations, their ability to make taxable note repayments is
dependent upon actions by the county, other Pool investors, and the
bankruptcy court. S&P believes this dependence makes the taxable notes
speculative grade.
The taxable notes are large, relative to the budgets of the four issuers
-- equaling roughly half of annual revenues. Taxable note proceeds were
invested in the Pool at issuance, and would be available to make payments,
were it not for the bankrupt status of the Pool. These issuers cannot make
full payment on the taxable notes without access to a substantial portion of
monies held in the Pool.
Because the taxable notes are general obligations of the issuers payable
from fiscal 1994-1995 revenues, S&P is lowering all other general fund-
secured obligations to speculative-grade levels. This reflects the likelihood
that repayment funds will be tight and the possibility that the taxable
noteholders will make claims against payments on other debt obligations,
should the taxable notes default.
Ratings lowered, now on CreditWatch developing
Rating
Par amt. (mil. $) To From
Irvine USD txbl. nts. $54.575 SP-3 SP-1+
Irvine USD TRANs 20.7 SP-3 SP-1+
Newport-Mesa USD t-cbl. nts. 46.96 SP-3 SP-1+
Newport-Mesa USD COPS ser. 94 5.3 B A
North Orange Cnty. CCD txbl. nts. 56.285 SP-3 SP-1+
Orange Cnty. Board of Ed. txbl. nts. 42.19 sP-3 SP-1+
Newport-Mesa USD's COPs are lowered to single-'B' because of the
following three factors:
-- The COPs were sold in October 1994, and have a debt service reserve
fund that provides immediate liquidity. The DSR is invested in "permitted
investments," which does not include the Pool.
-- Lease payments are general fund obligations, and the investment loss
in the Pool could significantly harm general fund operations. The DSR will
enable the district to fit lease payments into its budget until the Nov. 1,
1995 debt service payment, and the DSR still covers 968 of this $403,000
payment.
-- Failure to pay lease rentals would result in an event of default, and
investors could attempt to repossess the leased assets, providing incentives
for the district to make payments if at all possible.
All of the downgraded 'obligations remain on CreditWatch, now with
"developing" implications, since actions by the issuers, the county, or the
court could lead to either a greater ability to pay or result in defaults.
Should the county and the bankruptcy court choose to release a large
percentage of the issuers' funds held in the Pool, it is possible that they
could make timely payments on their obligations. However, it is likely to be
several months before the full Pool liquidation and distribution plan is
finalized; the potential for various governments to dispute the plan
(possibly in the courts) makes the timing of cash distributions very
difficult to predict. This unpredictibility results in the speculative-grade
ratings. -- CreditWire
Contact: Richard Larkin {212) 208-1767,
Jane Eddy (212) 208-8686,
Steve Nelli (212) 208-8975,
Steve Murphy (212) 208-1806.
SMviaNewsEDGE
:SUBJECT: HYBM MUBR SPRG SRTG CMKT
Copyright (c) 1995 Standard t Poor's Ratings Group
Received by NewsEDGE/LAN: 1/10/95 5:10 PM
APPENDIX C
SELECTED REPORTS FROM
FITCH INVESTORS SERVICE
Press Release DITCH
Fitch Inv000n Swvke,Inc
One S"Street PIC=
New York,NY 10004
)212)908-0500
Fitch Review Finds Three Calif. countT Portfolios W411 Managed
FITCH FINANCIAL WIRE (FFW)--NY--12/15/94: After a review of
investment portfolios and practices, Fitch does not expect to
change its short- or long-term ratings on securities issued by
Riverside, San Bernardino and Napa Counties due to investment-
related concerns.
our review identified three factors that are important in analyzing
a county's potential exposure to illiquidity, market loss, and
problems meeting debt service and other financial obligations.
These factors, outlined in an accompanying release, are: investment
composition, particularly derivatives, leveraging, and the presence
of voluntary participants in the investment pool. (See previous
press release.)
Riverside County's investment pool holds only minimal derivative
investments, is not leveraged,. and includes only a small amount
from voluntary. participants. The pool totals just over $1 billion
and only $15 million is invested in derivative securities which
mature in December 1998. The county intends to hold this investment
until maturity. The pool includes only $111 million belonging to
voluntary depositors. The fund's weighted maturity is 2.8 years and
over one-half of the fund is invested in U.S. Treasury obligations.
The county's recently revised investment policy allows reverse
repos to be used only for immediate cash flow needs, and requires
that assets acquired with the proceeds have maturities matching the
agreement, or other known cash must be available at repo maturity.
Also, reverse repo maturities are limited to 120 days. Recently
revised investment guidelines also shorten the maximum allowable
maturity of any security to three years.
Fitch County and Pool Participant Ratings:
Riverside Co. Tax and Rev. Anticipation Notes (TRANS) F-l+
Riverside Co. Cert. of Partic. (COPs) Ser 1991 A and B A+
Riverside Co. 1993 Master Refunding Project COPs A+
County of Riverside Asset Leasing Corp. COPS Ser 1993A A+
Beaumont Unif. school District COPS (Cap. Imp. Proj.) BBB+
Perris Union High School Dist COPS (1991 Land Acq.) A-
Perris Union High School Dist COPS (1993 Projects) A-
Riverside Unif. Sch. Dist. (CFD No. 1) ser. 1988 BBB
San Bernardino County's investment pool totals $2.4 billion with
$753 million in assets subject to reverse repurchase agreements.
The reverse repos include $253 million in which the assets
purchased with the proceeds are matched to the reverse repos'
termination. Proceeds from the remaining $500 million were used to
acquire variable-rate government agency debt, with the interest
- more -
•
Press Release FITCH
#itch hwestors setvice,1M.
One Skoie Streel No=
New York,NY 10004
(212)908-0500
rate reset date matched to the reverse repos' expiration. If the
firms involved with the county in a reverse repo choose not to
renew the agreement, the purchased assets could be liquidated at or
close to par. Collateral calls have been small and have not placed
liquidity pressure on the fund. While nearly one-third of the pool
currently is in reverse repos, the county recently announced its
intent to reduce this share to 10-15t. Towards this goal, the
county allowed a $47 million reverse repo to end on December 13,
and plans not to renew certain others in the future. The pool's net
investment of $1.6 billion is primarily from the county and school
districts, with only $96 million from voluntary participants. The
fund's assets are invested in high quality government agency
securities, certificates of deposit, and commercial paper with a
five-year maximum maturity. No significant derivative securities
with high price or return volatility are present. A barbell
approach to investing, with significant short-term investments, has
allowed the pool to maintain sufficient liquidity and mitigated
market value depreciation. Current portfolio market to book value
analysis indicates less than 5% depreciation as a result of the
overall increase in interest rates.
Fitch County and Pool Participant Ratings:
San Bernardino Co. 1994-95 TRANS (Tax-exempt) F-1+
San Bernardino Co. 1994-95 TRANS (Taxable) F-i+
San Bernardino Co. Transp Auth Sales Tax Rev. Bonds A+
San Bernardino Co. Transp Auth Commercial Paper F-1+
Apple Valley Unif. Sch. Dist. COPS BBB
Rim of the World Unif. Sch. Dist. 1992 COPS A
Napa County's portfolio is invested conservatively, primarily in
high grade government agency obligations, certificates of deposits,
bankers acceptances and commercial paper. About 25t of the
portfolio is kept in cash or cash equivalents, and longer
securities are bought with the intention of holding then until
maturity. The fund totals about $114 million. Only $7 million is
invested in derivative securities, two step-up inverse floaters.
The inverses mature in 1996 and 1997; the county plans to hold them
until maturity. The .pool has no assets subject to reverse
repurchase agreements or otherwise leveraged. All assets in the
fund represent investments of either the county, county agencies,
or school districts within the county.
Fitch county and Pool Participant Ratings:
Napa Co. COPS (1993 Capital Improvement Proj.) A+
South Napa Waste Mng. Auth. 1994 Rev. Bonds A-
Similar information will be released on other counties as the
information becomes available and our analysis is complete.
For more information, call Amy S. Doppelt (212) 908-0514 or Stephen
,7oynt (212) 908-0530.
Press Release FITCH
Finch Investors Service,Inc.
One Srok Steel Plaza
New York,NY 10004
(212)908-0500
Fitch Outlines Cre41t Factors In asasssiaq Calif. Invostmont pools
PITCH FINANCIAL WIRE (FFW)--NY--12/15/94: Fitch continues to
question California counties regarding investment practices,
potential losses, and liquidity.
Our review identified three factors thsit are imctarta_nt in anaiy2 i na
a county's potential-exposure to illiquidity, market loss, and
pro ems meeting debt service and o er ancial obligations.
These factors are investment composition, particularly derivatives,
leveraging, and the presence of, voluntary participants in the
investment pool.
Investment Composition, Particularly Derivatives: The investment
portfolio's maturity, interest rate sensitive and duration can
create sizeable market losses, either actual or on paper, and
illiquidity in the portfolio. While small and balanced use of
derivative instruments such as inverse floaters and structured
notes may create additional yield opportunities, excessive use can
significantly exacerbate market depreciation and illiquidity.
14!_ aa�ftltities choosing to increase the investment
`15ortfolio's size by using reverse repurchase agreements, taxable•
debt, or other leveraging techniques can be vulnerable to
additional losses and liquidity problems if the transactions are
excessive in size or not matched. However, reverse repurchase
agreements often are used by municipalities to most unanticipated
cash flow needs. Reverse repo risk is minimized if the agreement's
term matches that of the asset purchased with the reverse proceeds.
Also, the shorter the term of the collateral used in the reverse
repo, the less the exposure to value declines if interest rates
increase, thereby lowering the exposure to calls for additional
collateral.
t3. Prese
jLge of voluntary Participants i e nvestnent Pool: While
1 counties in California invest funds for ease ves, other
county entities, and school districts within the county, by law
they may accept funds of other municipalities choosing to invest in
the county pool. These voluntary investors can withdraw their funds
with 30 days notification, thereby subjecting the fund to cash
needs on relatively short notice. These withdrawals could force the
county to liquidate securities and turn paper losses into actual
ones.
Pitch has obtained and analyzed information from Riverside, San
Bernardino, and Napa counties in light of the above factors. As a
result of our analysis, we believe that each of the county's
investment pool's presently are well managed. (see following press
release.)
For more information, call Any S. Doppelt (212) 908-0514 or Stephen
Joynt (212) 908-0530.
FITCH INVESTORS SERVICE
RATING DEFINITIONS
INVESTMENT GRADE Fitch's investment grade bond ratings provide a guide to investors in determining the
BOND RATINGS credit risk associated with a particular security. The ratings represent Fitch's
assessment of the issuer's ability LO meet the obligations of a specific debt issue or class
of debt in a timely manner.
The rating takes into consideration special features of the issue,its relationship to
other obligations of the issuer, the current and prospective financial condition and
operating performance of the issuer and any guarantor,as well as the economic and
political environment that might affect the issuer's future financial strength and credit
quality.
Fitch ratings do not reflect any credit enhancement that may be provided by
insurance policies or financial guaranties unless otherwise indicated.
Bonds that have the same rating are of similar but not necessarily identical credit
quality since the rating categories do not fully reflect small differences in the degrees of
credit risk.
Fitch ratings are not recommendations to buy,sell,or hold any security.Ratings
do not comment on the adequacy of market price,the suitability of any security for a
particular investor,or the tax-exempt nature or taxability of payments made in respect
of any security.
Fitch ratings are based on information obtained from issuers,other obligors,
underwriters,their experts,and other sources Fitch believes to be reliable. Fitch does
not audit or verify the truth or accuracy of such information. Ratings may be changed,
suspended,or withdrawn as a result of changes in,or the unavailability of,information
or for other reasons.
AAA Bonds considered to be investment grade and of the highest credit quality. The obligor
has an exceptionally strong ability to pay interest and repay principal,which is
unlikely to be affected by reasonably foreseeable events.
AA Bonds considered to be investment grade and of very high credit quality.The obligor's
ability to pay interest and repay principal is very strong,although not quite as strong as
bonds rated`AAA'.Because bonds rated in the'AAA'and'AA'categories are not
significantly vulnerable to foreseeable future developments,short-term debt of these
issuers is generally rated'F-I+'.
A Bonds considered to be investment grade and of high credit quality.The obligor's
ability to pay interest and repay principal is considered to be strong,but may be more
vulnerable to adverse changes in economic conditions and circumstances than bonds
with higher ratings.
BBB Bonds considered to be investment grade and of satisfactory credit quality.The
obligor's ability to pay interest and repay principal is considered to be adequate.
Adverse changes in economic conditions and circumstances, however,are more likely
to have adverse impact on these bonds,and therefore impair timely payment. The
Sept.30, 1993
3MKTNG 1
FITCH INVESTORS SERVICE
RATING DEFINITIONS
likelihood that the ratings of these bonds will fall below investment grade is higher •
than for bonds with higher ratings.
Plus (+) Minus H Plus and minus signs are used with a rating symbol to indicate the relative position of a
credit within the rating category. Plus and minus signs, however,are not used in the
'AAA'category.
NR Indicates that Fitch does not rate the specific issue.
Conditional A conditional rating is premised on the successful completion of a project or the
occurrence of a specific event.
Suspended A rating is suspended when Fitch deems the amount of information available from the
issuer to be inadequate for rating purposes.
Withdrawn A rating will be withdrawn when an issue matures or is called or refinanced, and,at
Fitch's discretion,when an issuer fails to furnish proper and timely information.
FitchAlert Ratings are placed on FitchAlert to notify investors of an occurrence that is likely to
result in a rating change and the likely direction of such change. These are designated
as "Positive",indicating a potential upgrade, "Negative",for potential downgrade, or •
"Evolving",where ratings may be raised or lowered. FitchAlert is relatively short-term,
and should be resolved within 12 months.
Credit Trend Credit trend indicators show whether credit fundamentals are improving, stable,
declining, or uncertain, as follows:
Improving t
Stable f--►
Declining 1
Uncertain
Credit trend indicators are not predictions that any rating change will occur, and
have a longer-term time frame than issues placed on FitchAlert.
SPECULATIVE GRADE Fitch speculative grade bond ratings provide a guide to investors in determining
BOND RATINGS the credit risk associated with a particular security. The ratings (`BB' to `C')
represent Fitch's assessment of the likelihood of timely payment of principal and
interest in accordance with the terms of obligation for bond issues not in default.
For defaulted bonds, the rating (`DDD' to 'D') is an assessment of the ultimate •
recovery value through reorganization or liquidation.
Sept. 30, 1993
JMKTNG.2
FITCH INVESTORS SERVICE
RATING DEFINITIONS
The rating takes into consideration special features of the issue, its
relationship to other obligations of the issuer, the current and prospective
financial condition and operating performance of the issuer and any guarantor, as
well as the economic and political environment that might affect the issuer's
future financial strength.
Bonds that have the same rating are of similar but not necessarily identical
credit quality since rating categories cannot fully reflect the differences in degrees
of credit risk.
BB Bonds are considered speculative. The obligor's ability to pay interest and repay
principal may be affected over time by adverse economic changes. However,business
and financial alternatives can be identified which could assist the obligor in satisfying
its debt service requirements.
B Bonds are considered highly speculative.While bonds in this class are currently
meeting debt service requirements, the probability of continued timely payment of
principal and interest reflects the obligor's limited margin of safety and the need for
reasonable business and economic activity throughout the life of the issue.
CCC Bonds have certain identifiable characteristics which,if not remedied,may lead to
default.The ability to meet obligations requires an advantageous business and
economic environment.
CC Bonds are minimally protected. Default in payment of interest and/or principal seems
probable over time.
C Bonds are in imminent default in payment of interest or principal.
DDD, DD,and D Bonds are in default on interest and/or principal payments.Such bonds are extremely
speculative and should be valued on the basis of their ultimate recovery value in
liquidation or reorganization of the obligor. 'DDD'represents the highest potential for
recovery on these bonds,and'D'represents the lowest potential for recovery,
Plus W Minus Plus and minus signs are used with a rating symbol to indicate the relative position of a
credit within the rating category. Plus and minus signs,however,are not used in the
'DDD','DD',or'D'categories.
SHORT-TERM RATINGS Fitch's short-term ratings apply to debt obligations that are payable on demand or have
original maturities of generally up to three years, including commercial paper,
certificates of deposit,medium-term notes,and municipal and investment notes.
The short-term rating places greater emphasis than a long-term rating on the
existence of liquidity necessary to meet the issuer's obligations in a timely manner.
Sept.30, 1993
3MKTNG 7
FITCH INVESTORS SERVICE
RATING DEFINITIONS
F-1+ Exceptionally Strong Credit Quality. Issues assigned this rating are regarded as •
having the strongest degree of assurance for timely payment.
F-1 Very Strong Credit Quality. Issues assigned this rating reflect an assurance of timely
payment only slightly less in degree than issues rated'F-1+'.
F-2 Good Credit Quality. Issues assigned this rating have a satisfactory degree of
assurance for timely payment,but the margin of safety is not as great as for issues
assigned'F-1+'and'F-1'ratings.
F-3 Fair Credit Quality.Issues assigned this rating have characteristics suggesting that the
degree of assurance for timely payment is adequate,however, near-term adverse
changes could cause these securities to be rated below investment grade.
F-S Weak Credit Quality.Issues assigned this rating have characteristics suggesting a
minimal degree of assurance for timely payment and are vulnerable to near-term
adverse changes in financial and economic conditions.
D Default.Issues assigned this rating are in actual or imminent payment default.
LOC The symbol LOC indicates that the rating is based on a letter of credit issued by a •
commercial bank.
PREFERRED STOCK Preferred stock ratings should be viewed in the universe of equity(preferred and
RATINGS preference) and not in relationship to bonds.Although certain preferred stock issues
may carry the same rating as an issuer's bond obligations, preferred stocks by
definition are junior to debt obligations. Preferred capital is basically permanent capital
which in certain instances may be retired via sinking funds or called. The rating of a
preferred stock issue is an indication of the company's ability to pay the preferred
dividends and any sinking fund obligations on a timely basis. Preferred dividends are
payable only when declared;they are not contractually guaranteed.
AAA Preferred stocks assigned this rating are the highest quality.Strong asset protection,
conservative balance sheet ratios,and positive indications of continued protection of
preferred dividend requirements are prerequisites for an'AAA'rating.
AA Preferred or preference issues assigned this rating are very high quality. Maintenance
of asset protection and dividend paying ability appears assured but not quite to the
extent of the'AAA'classification.
A Preferred or preference issues assigned this rating are good quality. Asset protection •
and coverages of preferred dividends are considered adequate and are expected to be
maintained.
Sept. 30, 1993
3MKrNG 4
FITCH INVESTORS SERVICE
RATING DEFINITIONS
F-I+ Exceptionally Strong Credit Quality. Issues assigned this rating are regarded as
having the strongest degree of assurance for timely payment.
F-1 Very Strong Credit Quality. Issues assigned this rating reflect an assurance of timely
payment only slightly less in degree than issues raLed'F-I+'.
F-2 Good Credit Quality. Issues assigned this rating have a satisfactory degree of
assurance for timely payment,but the margin of safety is not as great as for issues
assigned'F-1+'and'F-1'ratings.
F-3 Fair Credit Quality. issues assigned this rating have characteristics suggesting that the
degree of assurance for timely payment is adequate,however,near-term adverse
changes could cause these securities to be rated below investment grade.
F-S Weak Credit Quality.Issues assigned this rating have characteristics suggesting a
minimal degree of assurance for timely payment and are vulnerable to near-term
adverse changes in financial and economic conditions.
D Default.Issues assigned this rating are in actual or imminent payment default.
LOC The symbol LOC indicates that the rating is based on a letter of credit issued by a
commercial bank.
FITCH INVESTORS SERVICE
RATING DEFINITIONS
Preferred or preference issues assigned this rating are reasonably safe but lack the •
BBB protections of the'A' to'AAA'categories. Current results should be watched for
possible signs of deterioration.
Preferred or preference issues assigned this rating are considered speculative. The
BB margin of protection is slim or subject to wide fluctuations.The longer-term financial
capacities of the enterprises cannot be predicted with assurance.
Issues assigned this rating are considered highly speculative.While earnings should
B normally cover dividends,directors may reduce or omit payment due to unfavorable
developments,inability to finance,or wide fluctuations in earnings.
Issues assigned this rating are extremely speculative and should be assessed on their
CCC prospects in a possible reorganization. Dividend payments may be in arrears with the
status of the current dividend uncertain.
Dividends are not currently being paid and may be in arrears. The outlook for future
CC payments cannot be assured.
Dividends are not currently being paid and may be in arrears. Prospects for future
C payments are remote.
•
Issuer is in default on its debt obligations and has filed for reorganization or
D liquidation under the bankruptcy law.
Plus and minus signs are used with a rating symbol to indicate the relative position of a
Plus W Minus H credit within the rating category. Plus and minus signs,however,are not used in the
'AAA','CCC','CC','C',and'D'categories.
These securities have not been and will not be registered under the U.S. Securities Act
EURO ISSUES/ of 1933.Any offer or sale of notes in the U.S. (including its territories and possessions
EURO DOLLARS and all areas subject to its jurisdiction or to nationals or residents thereof,including
any corporation or other entity created or organized therein) may constitute a violation
of U.S. law.
CLAIMS-PAYING Fitch's claims-paying ability ratings provide an assessment of an insurance company's
ABILITYRATINGS financial strength and, therefore,its ability to pay policy and contract claims under the
terms indicated. The rating does not apply to nonpolicy obligations of the insurer,such
as debt obligations (which are addressed under Fitch's bond ratings),nor does it apply
to the suitability or terms of any individual policy or contract.
AAA The ability to pay claims is extremely strong for insurance companies with this highest •
rating. Foreseeable business and economic risk factors should not have any material
Sept. 30, 1993
3MKTNG.5
FITCH INVESTORS SERVICE
RATING DEFINITIONS
. adverse impact on the ability of these insurers to pay claims. Profitability,overall
balance sheet strength, capitalization,and liquidity are all at very secure levels and are
unlikely to be affected by potential adverse underwriting, investment,or cyclical
events.
AA insurance companies with this rating are very strong and only slightly more
susceptible to exhibiting any weakening of financial strength due to adverse business
and economic developments. Any foreseeable deterioration in financial strength would
still leave carriers in this category with a strong claims-paying ability.
A Insurers in this category are strong companies with no immediate expectations for
encountering events significant enough to weaken their claims-paying ability.
However,major business or cyclical pressures are more likely to have an adverse
impact on profitability,liquidity,and capitalization and, therefore, on the ability to pay
claims.
BBB Companies in this category have adequate financial strength and claims-paying
capability. For insurers with this rating,longer-term obligations would be more
susceptible to claims-paying concerns under adverse circumstances than for higher
rated companies.
BB For insurers rated in this category, the ability to pay claims is vulnerable to company-
specific adverse financial events or stressful cyclical downturns. It will be more
difficult for carriers with this rating to maintain adequate claims-paying ability under
severe business and economic circumstances.
B There is significant risk that companies in this category will not be able to pay claims
when due. Liquidity and capital adequacy are likely to be impaired under even
moderately negative business and economic developments.
CCC, CC,and C Insurance companies with one of these ratings are considered very weak with respect
to their ability to pay claims.The carrier may be under the supervision of a state
insurance department and already may not be making all policy claims payments in a
timely fashion.
D Insurance carriers have been placed in liquidation by state insurance departments and
policy claims payments are being controlled,delayed, or reduced.
Plus W Minus H Plus and minus signs are used with a rating symbol to indicate the relative position of a
credit within the rating category. Plus and minus signs, however,are not used in the
'AAA'and'D'categories.
•
Sept. 30, 1993
3MKTNG.6
FITCH INVESTORS SERVICE
RATING DEFINITIONS
SERVICER RATINGS Servicers are key to maintaining the credit quality of a pool of nonperforming •
commercial mortgages and real estate owned assets. In assessing and analyzing a
servicer's capabilities, Fitch reviews several key factors, including the servicer's
management team,organizational structure, track record,and workout and asset
disposition experience and strategies.
Superior Servicer considered to be of the highest quality. A servicer in this category possesses a
strong,seasoned management team,extensive workout and disposition experience,
and,typically,significant financial resources.
Above Average Servicer considered to be of very high quality. A servicer in this category possesses a
strong management team,with good workout and disposition experience,and may
have significant financial resources.
Average Servicer considered to be of high quality. A servicer in this category possesses adequate
workout and disposition experience but may lack significant financial resources.
Below Average Servicer considered to be of acceptable,but sub-par,quality. Senior management is
relatively unseasoned,workout experience is minimal,and typically lacks significant
financial resources.
Unacceptable Servicer unacceptable to Fitch. Use of such a servicer probably would preclude Fitch's •
rating the transaction's debt securities at'BBB'or higher levels.
FUND CREDIT RATINGS Fitch's credit ratings help investors identify the degree of credit risk in the fund's
underlying investments and in its management. Fitch evaluates several factors,
including management's financial condition,risk management procedures,and
operations. Underlying credit ratings are meaningful because mutual funds can
increase their yield by investing in lower-rated investments. However,a lower credit
rating suggests increased risk in the issuer's ability to pay principal and interest. The
potential for loss to a mutual fund investor is mitigated by the fund's diversification,
but credit defaults could still cause a partial loss of an investment. Credit ratings are
valuable in identifying this risk. They provide an investor with an important view of
risk excluding changes in interest rates and help assure investors of a fund's ability to
provide consistent returns under stable market conditions.
References to existing taxable and tax-exempt ratings include those assigned by a
nationally recognized statistical rating organization (NRSRO). Rating symbols referred
to in the definitions are those of Fitch and/or the equivalent symbol by any other
NRSRO.
AAA Bond funds have the highest credit quality. The fund's assets carry the highest credit
ratings from at least two NRSROs. These funds must meet'AAA' credit standards. All •
short-term securities in the fund must carry the highest short-term rating by at least
Sept. 30, 1993
JMK7NG.7
FITCH INVESTORS SERVICE
two NRSROs. Maximum 15%of total assets from one'AAA'issuer, except for
government or agency securities,with no other'AAA' issuer accounting for more than
5%of total assets.
AA Bond funds have very high credit quality.The fund's assets predominantly carry the
top two credit ratings from at least two NRSROs. These funds must meet'AA' credit
standards,which require'AAA'rated securities to offset any security rated W. No
security can be rated below'BBB'. Securities rated below'AA'by at least two NRSROs
must represent less than 20%of the fund and be offset by solid credit diversification.
All short-term securities in the fund must carry the highest short-term rating by at least
two NRSROs.Maximum 15%of total assets from one'AA'or'AAA' issuer, except for
government or agency securities,with no other'AA'issuer accounting for more than
5%of total assets. Each issuer below'AA'should represent the lesser of 2%or$5
million.
A Bond funds have high credit quality.The fund's assets predominantly carry the top
three credit ratings from at least two NRSROs.These funds must meet'A'credit
standards,which require higher rated securities to offset any BBB'rated security.No
security in the fund can be rated below BBB'. Securities rated below'A'by at least two
NRSROs must represent less than 20%of the fund and be offset by solid credit
diversification.No more than 5%of the short-term securities held may carry the
second highest short-term rating from two NRSROs. Maximum 15%of total assets
from one'A'issuer,except for government or agency securities,with no other'A'issuer
accounting for more than 5%of total assets. Each issuer below'A'should represent the
lesser of 2%or$5 million.
BBB Bond funds have adequate credit quality.The fund's assets predominantly carry the top
four credit ratings from at least two NRSROs.These funds must meet'BBB'credit
standards,which require higher rated securities to represent four times the market
value of all BB'rated securities in the fund. No security in the fund can be rated below
'BB'.Securities rated'BB'by two NRSROs must represent less than 200,6 of the fund and
be offset by solid credit diversification.Short-term securities must carry at least the
second highest short-term rating from two NRSROs. Maximum 15%of total assets
from any investment grade issuer, except for government or agency securities. Each
issuer below investment grade should represent the lesser of 2%or$5 million.
BB Bond funds are considered speculative. No security in a'BB'fund may be rated lower
than'B'by two NRSROs. In addition,the market value of any B'rated securities must
be balanced by twice that amount of investment-grade debt.Short-term securities must
predominantly carry at least the second highest short-term rating from two NRSROs.
B Bond funds are considered very speculative. The fund consists of predominantly below
investment grade issues.
Sept. 30, 1993
3MKTNG.e
FITCH INVESTORS SERVICE
Plus W Minus (—) Plus and minus signs are used with a rating symbol to indicate the relative position of a •
credit within the rating category. Plus and minus signs, however,are not used in the
`AAA'category.
FUND STABILITY Fitch's stability ratings quantify the potential volatility of total return,including
RATINGS potential volatility of the market value of fund shares. For each fund, Fitch analyzes
interest rate risk,spread risk,currency risk,and the use of derivative securities. The
stability rating is derived from a quantitative computer model that measures the
prospective market value volatility affecting future returns.
The Fitch stability rating complements the credit rating because it identifies the
degree of a mutual fund's market risk,which sometimes can greatly outweigh its credit
risk.
Fund shares will be assigned a stability rating of`1','2',or 3',with'1'indicating
the most stability and'T indicating the least stability. Stability ratings will be preceded
by an`S','M', or`L'for funds with portfolios consisting of short-, medium-,and
long-term assets,respectively. The first letter designates the average risk-adjusted
duration of the assets held in the fund. Long-term funds inherently have more price
volatility than short-term funds.
Fitch analyzes the total return variations over a time horizon equal to the average
duration of the fund's assets.Time horizons are:short term for durations that range
from one to 3.5 years;medium term for durations from 3.5 to 7.5 years;and long term
for durations from 7.5 to 12.5 years.
If held for its duration,a stable fund will provide stable returns. A volatile fund
provides a wide spectrum of possible total returns over its duration.
Stable Funds assigned market risk ratings of'S-1','M-1',or'L-1'will have relatively stable
total returns over the appropriate time horizon. On average, these funds have
risk-adjusted durations comparable to the duration of a short-,medium-,or long-term
Treasury,respectively.
Variable Funds assigned market risk ratings of'S-2',`M-2',or`L-2'will have variable total
returns over the time horizon.On average,these funds have risk-adjusted durations
less than twice the duration of a short-, medium-,or long-term Treasury, respectively.
Volatile Funds assigned market risk ratings of'S-3','M-3',or`L-3' have total returns that will
vary widely over the time horizon. On average, these funds have risk-adjusted
durations greater than twice the duration of a short-, medium-,or long-term Treasury,
respectively.
•
Sept. 30, 1993
3MKTNG 9
APPENDIX D
SELECTED NEWSPAPER ARTICLES
FRIDAY,JANUARY 27,1495
+ateo Count
s + nMy
Treasurer Y
Doing
`We haven't make up for the loss of projected
revenue from interest and taxes.
Reports of Maltbie's comments
lost one went out over financial news
wires, causing investor concerns
red cent that could boost the county's bor-
rowing
orrowing costs,Buffington said.
"The only thing I can conclude
By John Wildermuth' is that(Maltbie) wanted to get his
Chronicle Peninsula Bureau hands on the trust fund and this
was the way to do it,"the treasurer
Complaints about San Mateo said.
County's budget problems are County supervisors agreed
overblown and could end up hurt- Tuesday to tap the trust fund at
ing the county financially,county the end of the year to make up for
Treasurer Lee Buffington warned. any revenue shortage. Money
In an interview, Buffington from the fund would be funneled
lashed out at County Manager into the probation and sheriff's de-
John Maltbie,who told the Board partment,but only if the county's
of Supervisors this week that the' revenue remains below budget es-
treasurer's office may have cost tIates,Maltbie said.
the county $6 million by mishan- With Orange County's $2 bil-,
dling investment transactions. lion fiscal disaster fresh in people's
"It's very unfortunate that he minds,this is no time to be talking
said what he did,"Buffington said. about San Mateo County losing
"I don't know what his motivation money or running in the red,Buf-
was or what he was trying to ac- fington said, especially when.
complish." that's not the case.'
The treasurer complained that "We haven't lost one red cent;
Maltbie was using worst-case num- we just haven't made as much as
bers when he told the supervisors we expected,"Buffington said."If.
that as much as $10 million may you buy a$1 lottery ticket and you
have to be moved from the coun- don't win,you didn't lose$20 mil-
ty's Public Safety Trust Fund to.. lion,you lost one dollar."
Estimates for this year's $650 good financial shape,"said Super-
million budget were based in part, visor Ted Lempert. "I don't think
on anticipated investment earn- finger-pointing is going to help
ings.Interest earnings since June, _ anything."
however, have been only about Buffington said most of the fin-
1.81 percent, leading county offi-, ger-pointing is coming from Malt-
cials to project a $3.5 million loss bie and other county officials in-
for the year. terested in replacing the county
In addition, the county lost treasurer, who is an elected offi-
about$2.1 million on a$65 million cial,with an appointed finance di-
note it sold, including $550,000 in rector, who would work for the
actual losses and $1.56 million in county manager.
interest the county will not re- "I'm getting tired of being
ceive. blamed for everything," the trea-
County Supervisor Tom Huen surer said. "We've got cash,we've
ing argued that any problems in got liquidity,but we're still getting
the treasurer's office directly af. rocks thrown at us, which isn't
fect county services. much fun."
"Every year at budget time we
struggle over items of $50,000 or
$60,000,trying to squeeze out a few
more services for county resi-
dents," Huening said yesterday.
"To see a shortfall based on lack of
performance (by the treasurer's
office)is disheartening."
Although four of the county's
five supervisors backed Buffing-. .
ton's opponent in last June's elec-
tion, the other board members
were unwilling to blame the trea-
surer for any budget concerns the
county might have.
"Overall,the county is in prei
Orange County had
$85 million stashed
in `m ste ' Minds
By ANNIE SHOOMAN another dimension to this crisis,"
Associated Press said attorney Bruce Bennett, who
also represents Orange County. "As
SANTA ANA -- Up to $85 mil- of now, the records seem to show
lion in interest due to Orange Coun- that the money was misallocated."
ty investment pool participants was Assistant Treasurer-Tax Collec-
actually stashed in "mystery" ac- for Matthew Raabe was immediate-
counts maintained by the Treasur- ly placed on administrative leave.
er's Office,the Board of Supervisors Former Treasurer Robert L. Citron
said Saturday. resigned after the county filed for
The information will be turned federal bankruptcy protection last
aver to the Securities and Exchange month.
Commission and the Orange County Supervisors will meet in closed
District Attorney's Office, which al- session to "consider personnel ac-
ready are probing possible wrong- tion against Mr. Raabe, and other
doing in the county's $1.69 billion individuals who may have been in-
investment loss, Supervisor Gaddi volved as soon as legally permissi-
Vasquez said at a hastily called ble," said a board statement.
news conference. The .county said auditors from
Vasquez said auditors examining the Arthur Andersen accounting
the county's books Friday found$82 firm "discovered evidence showing
million to $85 million had been di- accounting irregularities in the rec-
verted to a fund consisting of two ords of the Orange County Treasur-
accounts: the 9 JJ Account and the er's Office" involving interest reve-
Economic Uncertainty Fund. nues for fiscal 1994 and 1995.
"It appears government records "Based on documents that they
have been falsified," County Coun- have reviewed yesterday and con-
sel James Mercer told reporters at firmed today,some interest revenue
the county Hall of Administration. from investments in the Orange
"We don't know why or who cre- County investments pools appears
ated it," Mercer said of the 9 JJ to have been allocated to a fund
Fund, which was created in July maintained in the Treasurer's Office
1994. instead of to participants in the
"It doesn't please us at all to find pools."
Matter of Security But what were government-sponsored
agencies doing issuing risky derivative
securities in the first place?
"Agencies of the federal government
Risky Derivatives re have been pumping this junk out there for
a tiny saving in interest costs,"says Bert
Huge Source of Funds Ely,a consultant on financial institutions
in Alexandria, Va. "They're trading on
their triple-A, government-sponsored
status in a way that I don't think is
For Federal Agencies desirable from a public-policy standpoint.
That activity is going to come under close
scrutiny this year."
The growing outcry already has
Investors Learn the Hard Way slammed the brakes on new issues of
structured notes, which until last year
were one of Wall Street's most lucrative
That `U.S.-Backed' IS
new products. Unlike conventional fixed-
income securities, structured notes pay
No Guarantee of Safety returns based on changes in some underly-
ing
nderlying index or formula.Those that torpedoed
investors in 1994 typically involved bets on
`A Hungry System to Feed' relationships between various interest
rates, which made the notes'values and
risks hard to figure. A common type of
structured note,for example,has a yield
B RANDALL SMITH and JOHN CONNOR pegged to the difference between short-
y term and long-term interest rates.
Staff Reporters of THE WALL STREET JOURNAL What particularly has raised hackles
Last February,just before the Federal lately is the part played by government
Reserve began jacking up interest rates,a Federal Debt
U.S. Army welfare and recreation fund
invested$15 million in what looked like a nGovernment-agencyatyear-end
eand19 issues of structured
sure thing:A two-year,triple-A-rated,U.S. notes at year end 1994
STRUCTURED TOTAL
government-agency note with a tempting NOTES DEBT our-
OUTSTANDING .STANDING
initial yield of 4.75%,well above the then- AGENCY (billions) :(barons)
prevailing rate. Federal Home Loan ' $44.3 $147.6
But in just three months, the note's Bank System
yield was reset to 0% under a complex Fannie Mae(Federal 30.0 225.0
formula, making it dead money to the Nat'l Mtge.Assn.)*
investor..So far,the Army fund has taken a Freddie Mac(Federal 13.2 48.2
7.9%paper loss on the notes,a hefty hit for Home Loan Mtge.Carp.)
a short-term note in a supposedly low-risk Sallie Mae(Student 7.5 50.7
fund that manages cash balances for Army Loan Mktg.Assn.)*
base golf courses and bowling alleys. Federal Farm credit 5.4 54.0
"This is not wonderful," frets fund Bank Funding Corp.
erJeffre
*wall Street estimates
manager Y Dalbe .Y Source:The agencies.
This security, known as a structured
note,wasn't issued by a penny stockbroker agencies as dominant issuers of such risky
or a widget manufacturer. It was the derivative securities."The Orange County
bankruptcy has intensified"that concern.
Federal Home Loan Bank System,a lightly says Aida Alvarez,director of the Office of
supervised, Depression-era creation, Federal Housing Enterprise Oversight,
which is at the center of the gathering which monitors the Federal National Mort-
storm about the government's role In i$$u' gage Association and the Federal Home
Loan Mortgage Corp.
ing such gimmicky and risky Securities. Although these organizations aren't lit-
Orange County Connection erally government agencies, they issue
securities with implied government back-
The Army wasn't the only investor to be ing that are known on Wall Street as
burned by such safe-looking securities. government-agency securities.
Structured notes issued by the Federal The largest issuer of structured notes is
Home Loan Bank System and other federal the Federal Home Loan Bank System,an
agencies also played a prominent role in fundsyt omortgagerinalllntended lende s durito ngvide the
Orange County's bankruptcy filing last Depression. Nowadays, the system also
month. Similar investments blew up last makes investments to generate a profit in
year in supposedly low-risk funds run by order to pay an annual$300 million interest
BankAmerica nd Mellon Bank tab for the cost of the 1989 savings-and-loan
Corp.rP• bailout.The system—the world's second-
Corp.,among others. largest borrower after the U.S.Treasury
last year, according to Securities Data
Corp.—has S44.3 billion of such derivative
securities outstanding.
Among other things, the controversy
over structured notes has exposed a glar-
ing lack of supervision of the Home Loan
Banks: A majority of seats on the five-
member Federal Housing Finance Board,
which supposedly oversees the system,
have been vacant for more than a year.
Two board members nominated by]?cosi-
Please Turn to Page A4,Column I
Continued From First Page Jay Roy, president of the Pittsburgh
dent Clinton have been held up in Con- Home Loan bank,who shares responsibil-
gress. ity for overseeing the system's financing
Criticizing the Home Loan Banks be- operations, says he has "no indication"
fore the Senate Banking Committee on that structured notes were sold to unsuit-
Jan. 5, Frank Newman, who was then able investors.He and other system offi-
acting Treasury Secretary, sarcastically cials say they take steps to make sure
noted the system's heavy issuance of"in- dealers don't sell them to investors who
verse floaters, range bonds, fairway don't understand the risk.
bonds,a whole range of interesting-sound- But for some time, regulators have
ing things."Mr.Newman then promised a been warning investors about the dangers
proposal later this year for restructuring of structured notes—federal or private—
and oversight of the agency—"hopefully which may offer seductively high yields
before it does turn into a problem." when rates are stable or fall,but rack up
Critics question the aggressive way wicked losses when rates rise. The SEC
that these and other federal borrowers issued warnings in 1993,and last year It
handed over their names and credit rat- told money-market funds to dump them
ings to Wall Street dealers,giving them a outright.
free hand in designing and selling struc- Regulators and Wall Street traders
tured notes to the public.It is the dealers, widely agree that underwriters selling
not the agencies,who attach all the bells structured notes have targeted investors
and whistles to the structured notes and with the lowest risk tolerance, including
actually sell the notes to investors. The money-market funds, bank investment
agencies themselves get a slightly lower funds and investment pools like Orange
interest rate in exchange for allowing Wall County's that weren't supposed to be put-
Street to dress up their debt this way. ting principal at risk.
Because they have relatively short ma- "They've been pawning this stuff off on
turities and interest rates that reset small banks and savings and loans in the
monthly or quarterly, the notes often re- heartland." says Walker Todd, a Cleve-
sembie securities designed for no-risk land lawyer who used to work at the
money-market funds.But they often con- Federal Reserve."How seemly is it for an
tain features that make them lose value instrumentality of the federal government
like riskier,longer-term bonds. to be robbing Peter to pay Paul?"
Fewer Facts Even some top officials of the Home
What's more, government-sponsored Loan Bank System have raised questions.
enterprises don't have to register their George Barclay,president of the Federal
securities with the Securities and Ex- Home Loan Bank of Dallas,says his organ-
change Commission the same way corpo- ization stopped 'issuing structured notes
rations do.And that means investors may last year, partly because he sensed that
get less information about risk. Many they "were finding their ways into the
market experts believe such agency notes portfolios of less-suitable investors."To be
lulled investors into a false sense of secu- sure,that is easier for him to say because
rity by their government sponsorship and the Dallas bank hasn't had to issue debt of
triple-A credit ratings. any kind in that period.
A case in point is a July 13,1993,letter The Home Loan Bank System as a
from Orange County's assistant treasurer, whole has been on a little-noticed borrow-
Matthew Raabe, to an investor in the ing binge in recent years, relying on,
ill-fated municipal investment pool. The structured notes for 3017c of its outstanding
letter stressed: "We kept risk low by debt.Since the end of 1991,its assets have
purchasing United States government se- grown 49%to$230 billion,and its member-
curities which are universally accepted as ship by 77%to 5,248 institutions.
having nearly no risk of default." Most of the growth has come from
The agencies respond that structured commercial banks, which until 1989 fell
nates are simply a way to meet their outside the system's mandate. Commer-
obligation to lower the cost of the funds cial banks have signed up in order to gain
they provide. Although the agencies access to low-cost,longer-term financing
started issuing structured notes in the late in the form of advances from the system,
1980s, they didn't do so in large volume Such advances can be cheaper to obtain
until 1992, when the dramatic falloff in, than retail deposits.In return,the banks
short-term interest rates prompted a must devote 10%of their assets to mort-
search by investors for new forms of gage loans.
higher-yielding securities. Critics wonder whether the housing and
Hungry System banking sectors need such federal subsi-
Nicolas Retsinas,the interim head of dies. They call the system a bloated,
the Federal Housing Finance Board,says self-perpetuating bureaucracy with its 2,-
use of structured notes has saved the Home 109 staffers and annual operating expenses
Loan Bank System the equivalent of about of 5200 million.
590 million annually in interest costs. A 1993 study by the Congressional
"We have a hungry system to feed," Budget Office concluded that the system
said John Darr,the architect of the sys- may have outlived its usefulness. The
tem's structured-note sales, in an inter reason:The growth of the mortgage-secu-
view last summer, After the Orange rities market has slashed the percentage of
County bankruptcy last month,Mr.Darr mortgages held by banks and savings
brushed off questions about the agency's institutions from 74%in 1977 to 34%in 1992.
role: "Is it my responsibility to protect As a result,the budget office said,"policy
people who don't know what they're doing makers may want to determine whether
from themselves?"
•
the Federal Home Loan Banks are needed 1994 base pay of 8239,560,plus an incentive
in today's market." bonus for the previous year of nearly 25%.
Mr. Darr, the architect of the Home Investors in many Federal Home Loan
Loan Bank's aggressive borrowing, him- Bank structured notes, by contrast,
self has a mixed professional track record. haven't been so richly rewarded. The
As executive vice president of finance and Army welfare fund's two-year note, for
administration of the Student Loan Mar- example, offered a juicy yield of 1.25
keting Association, he helped pioneer percentage points over a short-term bank
swaps, a successful but controversial de- index — but only if that index rate fell
rivative market,in the early 1980s.In 1984 inside a narrow,pre-set range.If the index
he joined Financial Corp. of America, the didn't remain in that range, the note
once high-flying savings and loan run by holder would receive zero interest for the
financier Charles Knapp that eventually next quarter.
collapsed. Mr. Darr left after only five When short-term interest rates shot up
months, joining another savings institu- by 1.5 percentage points last spring, this
tion that later failed, and later went to "fairway bond" ended up in the rough.
a mortgage-investment fund that didn't Despite adjustments to its terms at the
meet its growth targets.Mr.Darr concedes Army's request, the yield remains at 0%.
that joining Financial Corp. "was a mis. Although the Army fund may hold the note
• take." to maturity and get its principal back,it is
In July 1992,Mr.Darr became manag- carrying the note at a loss on its books to
ing director of the system's office of fi- reflect its current resale value.
nance.Although Wall Street dealers pitch Ironically, the Army fund was so
structured-note issues directly to individ- safety-conscious that it could invest only in
ual Home Loan Banks, it is Mr. Darr who securities issued by the U.S. Treasury or
acts as the ringmaster for their hundreds other government agencies. The 8400 mil-
of relatively small deals. And it was Mr. lion Army fund has since changed its
Darr who sponsored the shift to smaller, guidelines to prohibit notes whose interest
custom-tailored and individually negoti- rate could fall to zero.While fund manager
ated deals many involving structured Mr. Dalbey says he understood the Home
notes. In all,the system has issued struc- Loan note's risks, he just never dreamed
tured debt tied to more than 175 indexes. that such an outcome was possible. "Our
As federal bureaucrats go,the 50-year- worst case wasn't worst enough," he
old Mr.Darr is highly paid..He received a says.
ORANGE COUNTY,CALIFORNIA WEDNESDAY,JANUARY 18, 1995
Incredibleing
W1tnesses . ,*
BANKRUPTCY HEARING: Key figures blame FULL STORY
each other for Orange County fund collapse.
►SCENE:Hearing a parade of well-
By CHRIS KNAP "I have never heard so,many dressed"victims. News,Page 12
and MARC LIFSHER proud and successful people con-
The Orange County Register verted so rapidly to humility," 10-TESTIMONY:Vasquez,Stanton
SACRAMENTO Former said state Sen.Tom Hayden,D- defend roles.News,Page 12
Treasurer Robert L. Citron Santa Monica. ig have never ►JOBS:Judge halts coup layoffs
blamed Merrill Lynch&Co.Mer- heard so many bright people con pending hearing.News, 13
rill Lynch salesman Michael Sta- verted into Forrest Gumps. I p 9 9 9
menson blamed Citron and other have never seen so many high 111o.LIBRARY:Book self-checkout pro-
county officials. Orange County achievers converted to incredi- gram scrapped.Metra,Page 1
ble shrinking witnesses."
Supervisors Gaddi Vasquez and
Roger Stanton blamed Citron In testimony to the Senate
-and Merrill Lynch. cial Committee on Local Govern-ern-
egy was prudent"until the very,
nteni Investments: very end."
Witness after witness sounded ►Citron described himself as a ►Stamenson and other Merrill
the refrain during a daylong,fin- self-taught investor who relied officials defended themselves
ger-pointing round robin Tues- heavily on Stamenson and Mer- against allegations,contained in
day over the county's $: billion rill economist Charles Clough. a lawsuit filed by Orange County,
investment debacle. Citron said he believed his strat- that they were responsible for
R�+
Citron's strategy and continued
IN THEIR WORDS: WEDNESDAX'S TESTIMONY to sell him risky securities de-
spite knowledge that the pool
ROBERT L.CITRON "I believed at;the time that I.was{an expeit) risked collapse.
Since this situation has.happened;..I must humblystate that i was ►Assistant Treasurer Matt
not as sophisticated as I thought!.Was',- the,former Orange County;; testified that he continued
treasurer said.Page 12 to tell investors that the pool was
MICHAEL STAMENSON."It is unfair and wrong fo'r some to tryto sound through October, despite
make Merrill Lynch or me a scapegoat"said the Merrill Lynch broker his concerns about heavy bor-
who handled huge Orange County investments..Page 12 rowings by Citron.Raabe said he
did not fully understand how the
find worked.
WHAT'S NEXT? ►Supervisors Vasquez and
Stanton testified that they never
►Legislation,including restrictions on investments that local govern- questioned the treasurer about
ments can make,requirements that treasurers make regular disclo how he was investing their mon-
sures of losses in market value,and local oversight committees to ey. Stanton criticized Merrill
review investment decisions. Lynch for not sharing warnings
►Next Tuesday,advocates for poor and sick county residents will ar about risk with the supervisors.
gue against bankruptcy-caused proposed cuts to health care services. Orange County filed the na-
tion's largest municipal bank-
ruptcy Dec.b.
Judge halts' county -la offs
h�earrinpending
Wednesday, Jan. 18, 1995
EMPLOYMENT: Union cy existed.
They noted that the county had
attorneys question agreed to pay legal costs for ex-
whether an emergency Treasurer Robert L. Citron, Street firm of breaking state law
existed t0 allow super-
whose investment policy led to when it bought county securities
the bankruptcy, and that it will and resold the proceeds in a bet
0 N1sor5 to Suspend all pay up to $600,00 for a public- that interest rates would fall.
relations firm to handle the me- "The premium was used to
labor Contracts. dia and has hired new employees speculate on interest rates," at-
even while current workers are torney J.Michael Hennigan said
By being laid off. during a break. "It's illegal un-
PHIL M.GOLLNER "If this is a fiscal emergency, der the Government Code. It's
and CHERYL DOWNEY where things truly were grinding illegal for the county to pay Mer-
The Orange County Register to a halt,I guess they wouldn't be rill Lynch to bet on interest
Nine county labor organiza_ doing this,"said James I.Stang, rates."
tions won at least a brief reprieve a lawyer for the unions. Merrill Lynch has denied any
late Tuesday from layoffs that The unions also say the county wrongdoing,contending that it is
had been set to begin Thursday. has other options,such as raising being made a scapegoat for Cit-
U.S. Bankruptcy Court Judge taxes and fees, that would pre- ron's actions.
John E. Ryan issued a tempo- Fent layoffs.County officials say County supervisors sued the
rary restraining order halting they are not overstating the case company fast week, demanding
the layoffs pending a hearing —and supervisors have rejected that it pay the $2 billion loss
Friday on whether Orange Coun- the notion of tax increases. caused by the collapse of the
ty's bankruptcy filing was an "I think under these circum- county's investment pool. The
emergency that allowed it to sus- stances,the county has an emer- lawsuit alleges that Merrill
pend its labor contracts. gency situation,"deputy counsel Lynch representatives encour-
Supervisors cited the financial Edward Duran said. aged Citron to engage in the
crisis to suspend all labor con- Placing the blame: while Citron risky investments that precipi-
tracts and eliminate about 400 pointed an accusing finger at tated the crisis.
positions through attrition, re- Merrill Lynch during legislative Lawyers sparred in court
tirements, unfilled vacancies hearings in Sacramento, attor- Tuesday over the use of so-called
and layoffs. At least I86 county neys for the county were doing reverse-to-maturity agree-
employees have received tenni- likewise in U.S. Bankruptcy ments, which county officials
nation notices. Court in Santa Ana. said Merrill Lynch had no right
Attorneys for the anions have During a daylong hearing to resell at a profit.
questioned whether an entergcn- Tuesday, they accused the Wall Until last week the county be-
was within the industry Stan- Tuesday to become interim chief
dard. executive officer for cash-.
"We had the right to do what strapped Orange County to re-
lieved the money was being held we wanted with those securi- structure its bureaucracy and
by Merrill Lynch as collateral,. ties," said Gary F. Rupert, a sell county assets.
but officials learned Thursday managing director at Merrill Crean, chief executive officer
that the brokerage had been sell- Lynch and head of risk manage- of Fleetwood Enterprises and a
ing it off.About$13 billion in col- ment for its Global Securities Fi- longtime county philanthropist,
lateral has been sold by various nance Group. said he shares frustration ex-.
securities companies since the Listening in:At the county Hall pressed by the Lincoln Club of
county declared bankruptcy of Administration in Santa Ana Orange County that supervisors
Dec. 6. on Tuesday, the Sacramento aren't responding adequately to
The object of Tuesday's hear- hearing on Orange County's the bankruptcy.
ing was to determine whether bankruptcy was .more popular The Lincoln Club, a Republi-
Merrill Lynch should be re- than a soap opera on a college can fund-raising group,released
strained from selling additional campus. Testimony was trans- a list of actions it wants supervi-
collateral it holds. mitted live over the county's in- sors toapprove promptly,includ-
Boih sides eventually agreed house speaker system typically ing salary cuts, staff reductions
on a pian to preserve proceeds of used to hear Board of Supervi- and appointment of a temporary
about $287 million in remaining sors' meetings. county CEO with broad powers
collateral sales until a judge de- Secretaries and county em- to address the crisis.
cides on Merrill Lynch's request ployees listened to testimony "I don't think the supervisors
to move the case to U.S. District from the stars of the county's cri- know what to think about it.
Court. sis: former Treasurer Citron, They're in a state of shock,"
Attorneys for the county ech. Assistant Treasurer Matt Raabe Crean said.
oed an oft-heard refrain Tuesday and Supervisors Gaddi Vasquez Among his suggestions: Float
that Citron was duped into high- and Roger Stanton. 'Televisions a bond issue to pay off the needi-
risk investments by sophisticat. in some offices—including those est investors who lost money in
ed Nall Street tycoons. of Orange County Administra- the pool, specifically schools,
"Citron was terribly naive," tive Officer Ernie Schneider and and pay off the debt from cuts to
Hennigan said. "Real naive,.be- Supervisor Marian Bergeson — county employees and services.
lieve me." were tuned to the live broadcast
Merrill Lynch officials said on Orange County NewsChannel. Register staff writers lean 0.Pasco
Citron was warned of the risks, Cooking up an offer: Motor-- Kim Christensen,Ronald Campbel!
insisting that their handling of home magnate and cable-televi- and Jonathan Lansner contributt-d to
Orange County's investments Sion chef.fohn Crean volunteered this report.
Fixing f blame
comes full circle
SCENE' At Tuesdays to acknowledge the obvious.
"In retrospect, I found I was
Senate heariner it not the sophisticated treasurer I
seemed eves' ,one NVas said I was," he told the Senate
Special Committee on Local Gov-
a victim. ermnent Investments.
Ambassadors from Nall Street
By JEFF KRAMER scoffed at Citron's effort to cast
The Orange County Register himself as an•aw-shucks yokel,
SACRAMENTO—If losing$2 portraying him as a savvy client
billion shattered most of former who knew the risks.
Treasurer Robert L. Citron's "I learned a lot from him,
mystique, his sworn testimony since he was doing reverse-re-
before a state Senate panel Tues- purchase transactions before I
day took care of the rest. ever knew what the term
The Oz-like figure of local lore, meant," Stamenson testified.
the fiscal wizard with disciples Sen.Quentin Kopp,I-San Fran-
across the nation,never showed. cisco, who spent the day tor-
Instead,the audience of 300— menting major players in the
a buzzing throng of lawyers, re- scandal, was also skeptical of
Porters and Rolex-wearing high- Citron's poor-me defense.
finance types — witnessed a "Mr.Citron came across to me
humbled, . remorseful retiree, as a very gentle, self-effacing
seemingly as baffled by events man,' Kopp remarked to a Bub-
as his panel of inquisitors. sequent witness, Orange County
There was also an appearance Supervisor Gaddi Vasquez. Is
by mystery man Michael Sta- that really his persona?"
menson, the Merrill Lynch bro- Vasquez paused long enough to
ker who until now had never cause the audience to titter.
commented publicly about his `Well,sir,"he replied finally.
role in the spectacular collapse "I would generally say: Yes."
of the fund. Stamenson strode Citron described himself as a
into the hearing room at a brisk third-generation ICalifornian
gait, surrounded by a coterie of whose asthma kept him from
associates and attorneys. serving in the military .and
In Citron's first public appear- whose personal finances kept
once since Ile resigned more than him from graduating from USC.
a month ago,the former treasur- He testified that he had never
er spoke resonantly and confi- owned a share of stock and that
dently at first, blaming the na- his training in municipal finance
tion's largest municipal bank- amounted to a course at Loyola
ruptcy on Merrill Lynch, the University in the mid-1950s.
Nall Street titan that brokered 70
percent of the county's disas- He said he expected to"carry
trous deals. the burden"of the Orange Coun-
But his strategy required him ty disaster for the rest of his life.
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CHARLAINE BROWNlThe Orange County Register
Former Orange County Treasurer Robert Citron is sworn in at the Senate Special Committee on Local Government Investments.
9veryone, it seemed, was a — or at least its aura of slick to prevent similar catastrophes. ston remarked.
victim—a well-dressed victim. affluence—was on triaC At one point, Sen. Patrick
Citron blamed the experts and "The county looks like any oth- Johnston, D-Stockton, played a REPLAY:To hear highlights of
the pressure allegedly put on him er cow county in the state,"said tape of Tom Riley, then chair-
by taxpayers and other officials Michael Semler,a University of man of the Board of Supervisors, the Q&A by members of the com-
to raise extra revenue. Vasquez San Francisco finance instruc- presiding over a consent calen- mittee with Robert Citron,call
and fellow Supervisor Roger tor. der,in which items,are passed in Register InfoLine at(714)550-
Stanton blamed everyone but Some members of the panel bulk without debate. 4636,category 7244.To hear
themselves. Stamenson brought brought a decidely judgmental comments by Merrill Lynch broker
it full circle by blaming Citron. tone to the proceedings,suppos- "Well, there went $700 mil- Michael Stamenson,dial category
In some ways,Orange County edly convened to discover a way lion," a visibly disgusted John- 7243.
Broker says Citron
as fund mastermind
CRISIS: Merrill Lynch
employee denies push- °
ing risky investment
strategy.
g
T
By LIZ PULLIAM M:
The Orange County Register } ' w +�
SACRAMENTO — In his`first
public comments, Merrill Lynch '
g Co. broker Michael Stamenson >Ya
insisted that he did not create the
strategy or push the investments
that led to Orange County's $2
billion Ioss,despite county asser-
tions to the contrary. MICHAEL STAMENSON
.Stamenson told a Senate hear-
ing that former county Treasur- said Merrill Lynch repeatedly
er Robert L.Citron not only mas- suggested that Citron consult
terminded the,county's invest- with the Board of Supervisors
ment pool but taught Stamenson about the risks of his strategy.
a thing or two about moneymak- Citron agreed to use some of
ing.strategies. Merrill Lynch's wording when
"I learned•a lot from him, describing his investments in an-
since he was doing reverse-re- nual reports, but refused to con-
purchase transactions before I suit with supervisors,Stamenson
even knew , what the term said.
meant," Stamenson said. Stamenson faced pointed ques-
Merriil Lynch is fighting the tions from Sena Lucy Killea, I-
county's assertion that the gall San Diego, who questioned why
Street firm illegally sold the Merrill Lynch helped the county
county risky securities and borrow more money—including
helped Citron break state debt- underwriting a$600.million bond
limit laws. Orange County sued issue this summer — when the
Merrill Lynch for $2 billion last Nall Street firm knew the fund
week. was in trouble. Stamenson re-
But Stamenson said Citron was ferred the question to Merrill
a "sophisticated, experienced Lynch lawyers, who have said
and knowledgeable investor" the company broke no laws.
whose strategy was already in Senators also heard from Jef-
place when Stamenson began frey Leifer, president of a finan-
selling the county investments in cial consulting firm that helped
1986. Merrill Lynch eventually the county negotiate fees on sev-
sold the county about 70 percent eral of its bond underwritings,
of the$20 billion in investments it including the $600 million deal.
controlled with its $7.4. billion Leifer said that he earned$1 mil-
fund. lion in fees from seven county
Stamenson, a San Francisco transactions last year but was
broker who earned multimillion- not responsible for making sure
dollar bonuses for his success in official paperwork warned po
selling investments to Orange tential investors about the dan
County and other governments, gers in the fund.
domineering person,than he ap- derivatives and the use of lever-
Citr®n eats humble pee peared to be in his testimony." aged borrowings,and a prohibi-
Citron complained that county tion on government borrowings
f®r skeptical senators administrators had pressured solely to speculate on interest
him to earn ever more interest on rates.
county reserve funds to pay for a Citron's testimony contained a
1993 gang-suppression effort, few brief flashes of the confident
FORMER TREASURER' was (an expert)," Citron told a among other programs. treasurer who convinced 187 in-
,special Senate committee inves- But committee members were vestors that his pool was fail-
`I Nvas not as sophistl- tigating the collapse."Since this openly skeptical, pointing out safe.One came when committee
cated as I thought I situation has happened...I must that Citron had lobbied for liber- members asked about the Wall
humbly state that I was not as alization of state laws to permit Street brokers' decision to sell
Nvas,' he Says. sophisticated as I thought I was. many of the investments he used, the collateral that backed the
"In retrospect it is clear that I that many of his letters and re- county's leveraged borrowings.
By CHRIS KNAP followed the wrong course.I will Ports were laden with highly "If I was still there the dealers
The Orange County Register carry that burden the rest of my technical explanations of compli- would not have sold the securi-
SACRAMENTO — Former -life." cated securities,and that he once ties,"Citron testified.
Orange County Treasurer Rob- But under questioning by scoffed
tSanbrokers Jose's
efforts
o Also testifying Tuesday was
e
ert L. Citron testified Tuesday members of the Senate Specialcity Assistant Treasurer Matt Raabe,
that he was an unsophisticated Committee on Local Govern- treasurer lost$60 million in 19$4. who pointed the finger at his for-
investor who did not understand ment Investments, Citron also "It seems to me that you mer boss,saying Citron charted
the risks of the strategy that testified that he had discounted achieved pretty close to absolute the investment strategy himself,
eventually cost Orange County$2 warnings by other Merrill offi- power in investing this money," ignored warnings, and deviated
billion. cials,overlooked the concerns of said Eli Broad, chairman of the from a risk-reduction strategy
Citron blamed Merrill Lynch& Republican challenger John special committee's private-see- Raabe and Stamenson had
Co. for giving him bad advice, Moorlach and at times broken for advisory panel. "What we helped fashion for the pool.
saying Merrill economist state law by buying below-grade have here is a failure of a basic
Charles Clough assured him that investments. principal of American govern- Raabe also testified that he
interest rates would stay low and "What he did today is adopt the ment — by that I mean checks continued to tell local govern-
salesman Michael Stamenson re- 'I'm too stupid to know' de- and balances." ments that the county invest-
peatedly urged the county to bor- fense," said Sen. Quentin Kopp, ment pool was safe through Octo-
row,or"leverage,"more and to I-San Francisco."He's not at all Citron agreed that a series of ber,despite numerous warnings
purchase volatile "derivative" stupid.The fact of the matter is reforms would be helpful,includ- to the contrary and his own pri-
sccurities. he's a much more knowledgeable ing a local oversight committee, vate concerns that the fund was
"I believed at the time that I person...he's also a much more restrictions on the purchase of over-leveraged.
•
ron for reaping better returns Vasquez said,did not come until
orange County officials than other government funds. late November 1993,just days be-
"Overthe years,we had never fore the county filed for bank-
.11L on bonds received any information from r protection.
testify in cap
staff,advisers or member;.of the Stanton cited recently released
pool that there were trends or Merrill Lynch memorandums as
issues that caused concern about proof that the broker warned Cit-
INVESTMENTS- Vas- ker 1'derrill Lynch&Co.,not its the stability or future of the ron as early as October 1992
elected board of supervisors, Orange County investment about the risky investments in
quez and Stanton say board members Gaddi Vasquez pool," Vasquez testified. his fund.
then had no reason to and Roger Stanton told a Senate, Stanton said he counted on Cit- "At no time to my knowledge
y committee Tuesday. ron's upbeat reports and the'ad- did Merrill Lynch bring its con-
think anything vvas The supervisors conceded that vice of the county's chief admin- cerns directly to the board of su-
\tTOilt; they delegated legal authority to istrative and financial officers pervisors or to any of the more
Citron to purchase complex fi- that the treasurer's highly re- than 180 public agencies which
By MARC LIFSHER nancial instruments and ap- garded pons appeared strong. Merrill knew had investment
The Orange County Register proved without public discussion Outside auditors and national funds in the pool," he said.
the borrowing of more than $1 bond-rating services uniformly The county has sued Merrill,
SACRAMENTO — Blame for billion to swell it risky portfolio. gave Citron's investments clean alleging the company violated
Orange County's$2 billion finan- But Vasquez and Stanton said bills of health and top grades, state law by failing to warn it
cial loss lies with former Trea- they relied on the opinions of fi- Stanton said. vestment-fund participants
surer Robert I._ Citron and bro- nancial experts who praised Cit-- The first indication of trouble, the potentially risky securities.
Interoffice
TO: All Merrill Lynch Employees Memorandum
P.Y.I.,the following memo has been distributed To: Merrill Lynch Employees
to all employees in Southern California. At: Southern California District
From: Daniel P.Tully
At: Chairman and CBO
xeraLywh Tel:
Date: January 10, 1995
Subject: The Merrill Lynch Relationship With()range Co=ly
I enjoyed meeting with you this past weekend to discuss our strategy and objectives for 1995.
Rarely do we have a chance to get all of our Southern California offices together as a group,and I
believe we were able to take maximum advantage of this occasion to share information and plan
for the years ahead.
We covered a wide range of topics,including the Orange County situation. We all regret the
concern and anxiety imposed on the residents of Orange County by the county's financial
difficulties. At the same time,we all recognize that a significant amount of misinformation
continues to circulate in numerous news media accounts --particularly in Orange County--
regarding Merrill Lynch's relationship with the county and the role we played as one of the
broker/dealers with which the county did business over a long period of time. This
misinformation compels us to set out facts and information about our actions that you can use to
respond to questions you receive from your clients and others. Once this information is known,it
will be quite clear why Merrill Lynch has maintained,with confidence from the outset,that we
acted properly and professionally in our relationship with Orange County.
You should be aware that Merrill Lynch repeatedly discussed with the county that it stood to
incur a marked-to-market portfolio loss should interest rates rise,and we offered in 1993 to
repurchase.at a proftt to the county,all derivative securities in the portfolio that had been
purchased from Merrill Lynch. We never served as Orange County's financial advisor,nor did
we create or direct the county's investment strategies. Nonetheless,as with all clients,we offered
the county our investment and economic outlooks,and our views with regard to risk profiles in
light of our interest rate forecasts. These opinions were conveyed both verbally and in writing on
a number of occasions. Among them:
• As early as February 1992,senior Merrill Lynch managers met with the Orange County
Treasurer's Office to ensure that they were aware of and understood the extent of the risks
involved in purchasing derivative securities and doing reverse repurchase agreements. We
were reassured by the Treasurer's Office on both points.
In mid-October 1992,Merrill Lynch sent the Treasurer's Office a cautionary letter analyzing
the county's portfolio volatility,based on our understanding of what the portfolio contained in
mid-July. The letter first set out that the portfolio,while having an average maturity of only
1.4 years,was exposed to the risk of greater volatility because of the various leverage
strategies being used to enhance returns. The letter suggested that"Orange County constantly
review the volatility in the existing portfolio and review incorporating some measure of
duration[i.e.exposure to changing interest rates)as an additional portfolio guideline."
Three weeks later.on November 3, 1992,Merrill Lynch again suggested to the Treasurer's
Office that,given the relative size of Orange County's derivatives holdings and changes in
interest rates and foreign markets,Orange County should re-balance its portfolio.
In late January 1993,senior Merrill Lynch managers again met with the Treasurer's Office to
detail their views on the portfolio's status,risks,and exposure in various interest rate
scenarios. The Treasurer's Office reiterated that they understood the risks inherent in the
portfolio and added that they believed they could foresee an interest rate increase and adjust
their strategy appropriately.
In the Fall of 1993,Merrill Lynch Chief Investment Strategist Charles Clough expressed his
opinion to the Treasurer's Office that bond investors should pull back on duration because
bonds were likely to retreat. Mr.Clough recommended a more defensive posture. (Mr.
Clough's revised, 1993 outlook for higher interest rates was consistent,by the way,with
research subsequently published by Merrill Lynch's Chief Economist,Don Straszheim,and
Chief Fixed Income Strategist,Tom Sowanick.)
On February 23, 1994,Merrill Lynch representatives met with the Treasurer's Office and
provided a written presentation which emphasized the unpredictable nature of interest rates
and stated: "interest rates going forward are more of a question mark than at any point in the
past several years." The presentation added: "Historically the first Fed tightening has led to
numerous others." The presentation also indicated that for each 100 basis point Interest rate
increase,an erosion of approximately$270 million in the market value of the structured
securities(derivatives)in the portfolio would result. Merrill Lynch suggested several
strategies that the county could implement in a rising interest rate environment.
Much attention has been focused on the fact that the Orange County portfolio contained
derivatives. We have stated that securities purchased by the county from Merrill Lynch and
contained in its portfolio at the time of bankruptcy were high-quality--mainly U.S.government
agency obligations and bank certificates of deposit appropriate to the county's publicly stated
"buy-and-hold"investment strategy. While some of these products were structured notes,they
had relatively simple interest rate structures and were not as exotic or high-risk as some accounts
have inaccurately described them.
Moreover,as mentioned above,it is important for you to know that in the Spring of 1993,Merrill
Lynch offered to repurchase the derivatives in the portfolio that Orange County had purchased
from Merrill Lynch. These transactions would have resulted in a profit to the county.
Specifically:.
• On March 31, 1993,Merrill Lynch sent the Treasurer's Office a written offer to repurchase all
of the derivatives which Orange County had purchased through Merrill Lynch and which
remained in the portfolio. The letter noted that these securities owned by the county might be
particularly volatile due to leverage.
On April 26, 1993,the Treasurer's Office declined to accept Merrill Lynch's repurchase offer
and stated: "We have always been aware of the vicissitudenary(sic)nature of the derivative
securities that we have mainly bought from Merrill Lynch and others. Although there may be
an alleged interest rate risk in these type of securities.we believe because of future low
interest rates that the securities that we now own may be even more valuable than they are
today."
Merrill Lynch reiterated its position in a follow-up Ietter to the Treasurer's Office on June 16.
1993. This letter stated in part: "It was our hope to assist you In bringing the O.C.portfolio
in line with a risk profile that is less leveraged and better positioned to perform in the event of
unanticipated movements in interest rates."
In short,Merrill Lynch repeatedly provided the Orange County Treasurer's Office with our views
regarding an evolving investment and interest rate environment,and offered real solutions to
adapt to changing interest rate trends. While our views(and we presume those of others)were
considered,the Treasurer's Office made it clear that they had their own outlook.that it was
contrary to ours,and that they would follow their own analysis in managing the county's
portfolio.
Orange County has been a client for over 20 years. Merrill Lynch chose not to abandon this
client simply because it,as a sophisticated institutional investor,did not share our views on the
investment outlook. We were not the sole provider of investment products and financing for the
county,which would have been able to pursue its investment strategies with or without Merrill
Lynch. We believed that the most responsible role we could play was the one we did pursue--to
keep the client apprised of our evolving views on interest rate trends,and to present options that
Orange County could use,if it so chose,to modify the portfolio in anticipation of a more bearish
interest rate environment.
In early December 1994,after the county disclosed a marked-to-market loss of approximately
seven percent in its total investment portfolio,virtually all of the broker dealers except Merrill
Lynch who had provided financing through reverse repurchase agreements liquidated their
collateral. This was widely reported to have been a primary factor in the county's decision to file
for bankruptcy. Merrill Lynch stood,virtually alone,in its decision not to liquidate our
approximately$2 billion in collateral. Instead,we have cooperated fully with the county and its
financial advisor,Salomon Brothers,in their plan for the orderly sale of portfolio assets to stem
further losses.
It is typical»but nonetheless disingenuous--that some now maintain that they were not aware
of the potential risks involved in the county's investment strategy. Those risks were publicly
aired in a recent political campaign,and the strategy of using leverage to achieve above-average
returns was discussed in the annual reports made by the Treasurer's Office to the County Board of
Supervisors. It is an immutable fact of investing that higher-than-average returns can never be
achieved without incurring an equivalent,higher-than-average risk. As all of the key federal
regulators testified before Congress last week,it was a leveraged investment strategy,not
derivatives,that led to the difficulties encountered by the investment pool.
We hope this information is helpful to you in responding to inquiries. While we regret the
county's current financial plight,the Merrill Lynch story is a good one. And it is one that will
eventually be reported,as we are called upon to assist various regulators and others in piecing
together the true facts surrounding the county's current difficulties. As always,we arc committed
to keeping you,and through you our clients,fully aware of the true nature of Merrill Lynch's
dedication to all of our clients.
In closing,I want to reiterate that all of us in senior management greatly appreciated the
opportunity to get together with all of you. From our point of view—and we hope yours as well
--it was time extremely well spent. We want to again thank you for all of your hard work and
loyalty,and your ongoing dedication to the Merrill Lynch Principles of Client Focus,Respect for
the Individual,Teamwork,Responsible Citizenship and Integrity. These will continue to be our
keys to success as individuals,and as a company.
My best wishes to all of you for a healthy and productive 1995.
Citron Concedes He
Had leo Backup Plan
if Fund Luck Soured
■ Hearing:Former O.C.treasurer makes public apology
before state panel.He and other key figures in county
pool debacle almost all seek to shift blame elsewhere.
By ERIC BAILEY,MARK PLATTE and JODI WILGOREN,TIMES STAFF WRITERS
SACRAMENTO—Portraying himself as an unsophisticated financial
neophyte who relied too heavily on the advice of others,former Orange
County Treasurer Robert L. Citron offered a public apology Tuesday
before a special state Senate committee, declaring that the county's
financial crisis is a burden he will
carry"the rest of my life."
Citron—at times appearing ner-
vous and hesitant but defending his
performance over 24 years in of-
fice—said he had no contingency
plan to handle the sort of invest-
ment meltdown that prompted the
county to file for bankruptcy pro-
::. .... tection last month. Indeed, Citron
asserted that he never had ana-
lyzed what would happen if inter-
est rates rose or investors pulled
their money out of the county's
investment fund.
"I was so sure of what I was
doing based upon the many years
of success," Citron, 69, told the
members of the state Senate Spe-
cial Committee on Local Govern-
CAROLYN COLE/Los Anple T,mes ment Investments."In retrospect,I
. Former Treasurer Robert L.Citron find that I was not the sophisticat-
is sworn in before Senate panel. ed treasurer I thought I was."
Citron joined a parade of elected
Judge Bars O.C. leaders, investors, auditors and
brokers to the witness chair—al-
most all of whom sought to shift
Layoffs blame for the financial debacle to
others, including Citron, county
supervisors and the Merrill Lynch
investment house.
Noting that he never obtained a
Proved Legal
college degree and had little formal
training in government finance,
By LEN HALL,LEE ROMNEY Citron said he learned about some
and SHELBY GRAD of the risky investments he pur-
SPECIAL TO THE TIMES sued while on the job.
SANTA ANA—A federal judge His assistant, Matthew Raabe,
barred Orange County from firing said he likewise did not have a
government workers Tuesday,or- clear understanding of the work-
dering that officials must first show ings of the investment fund that
that the layoffs are legal and the treasurer's office managed for
necessary because of the county's the county and 186 school districts,
financial crisis. cities and other agencies and was
Elated union leaders said the not aware of how swiftly it could
ruling came just one day before 86 collapse.
employees would have lost their 'I did not, for instance, under-
jobs. Please see CITRON,A20
"This is really a great win for
labor," said David L. Hamilton, a
representative of one of 10 labor Bonds Coyerne_
groups who banded together to sue Is THE REAL CITRON—Naive public
the county Tuesday. official tricked by brokers,or
U.S. Bankruptcy Judge John E. shrewd trader who fooled himself?
Ryan issued the temporary re- Citron's contradictions. A18
straining order halting further lay-
offs. The judge ordered county ■ NO-FAULT LINES—Somebody
officials to return to court Friday— made a major mistake,but key
and said they must show that the figures at Senate hearing try to
layoffs were necessary because of deflect the responsibility. A19
the county's Dec. 6 bankruptcy a MORE STORIES,PHOTOS:A 18-22,
filing. D6
Please see LAYOFFS,A22
CITRON: deDuring more than an hour of
questions and answers, Stamenson
scribed Caron as a"sophisticated,
experienced and knowledgeable"
No Plan for investor and said neither he nor his
firlriever acted as a financial adviser
to Orange County.
Countering Citron's argument
thaCStamenson led him into risky
Bad Guess pgremenag such as reverse re-
'
agreements, Stamenson
said he had learned much himself
Continued from Al frdm.Citron, adding that "he was
stand how quickly and to what doing`reverse repos before I even
extent the structuring of individual knew what the term meant."
securities would affect the portfolio .Stamenson flatly denied the sug-
as interest rates continued to in- ge$tion by Citron,and other county
crease,"Raabe said."I have come officials,that Merrill Lynch served
to realize in the past 21A months as an architect of the investment
tharthose of us who are untrained strategy
in the complicated and somewhat But the senators grilled Stamen-
bizarre aspects of derivatives and son on the distinction between
government agency securities can- giving advice and being a financial
not.:egin to suggest how to regu- adviser, insisting the difference
late their use." was semantic,not substantive.
The fund lost more than$2 bil- "What the hell were you talking
lion last year as Citron's highly about with this man every day?"
leveraged investments in interest demanded Sen.William A.Craven
rate sensitive securities tumbled in (R-Oceanside), the co-chairman
value while the Federal Reserve of',ihe committee. "To me, that's
Board was raising rates six times. advice."
Raabe,who became Citron's as- $tamenson said that while he
sistant in March, 1993,bristled at spoke each morning about 8 a.m.
suggestions that he encouraged with Citron,he was not the treasur-
any_"entity to invest in the fund or er s "first call." That spot was
helP,ed direct its investments, reserved for Albert J.De Spirito,a
"I-was not the person who de- senior vice president with responsi-
fined'the investment strategy or bility for government securities at
made, investment decisions," Dean Witter & Co.'s Los Angeles
Raabe said. office.
Wall Street sources said De Spir-
Citron also pointed a finger at ito worked as a salesman in the Los
others—especially Merrill Lynch, Angeles office of Salomon Bros.
the-brokerage that sold the county
about 70% of the securities in its .
portfolio.
46
relied on the expert advice of
j financial professionals," Cit-
ron said. "In retrospect,it is clear
that.1 followed the wrong course."
In particular, he dealt almost
daily with Merrill Lynch broker
Michael G. Stamenson, who also
testified. Both men are under in-
vestigation by the Securities and
Exchange Commission,and the de-
bacle is the subject of numerous
other state and federal probes.
JT ough Citron was describing
Merrill Lynch as the county's de
facfo"financial adviser," officials
of:.}ie firm said Citron made all
decisions related to investments.
Stamenson expressed regret at
tW..'&unty's loss, but said Merrill
was.not at fault.
"Neither I, nor anyone else at.
Merrill Lynch,designed or struc-
tdieC the county's investment
sg8legy or controlled the county's
investments.Mr.Citron did,"Sta-
menson said."One thing should be
clear—, Bob Citron controlled the
OU.We County portfolio. Merrill
Lynch did not.I did not."
.The county sued Merrill Lynch
last week, seeking$2.4 billion in
damages and alleging that the firm
lured-Citron into exotic invest-
menti that broke state law and
pushed the county into collapse.
Vestifying at opposite ends of a
longday, Stamenson and Citron
offered conflicting perspectives on
many key issues.
until about 1981. Subsequently he Later,a member of a private-sec-
until panel that is aiding the Senate
worked for the firms of First Boston committee also challenged Citron's
and Drexel Burnham Lambert be- perception of interest rates.
fore joining Dean Witter. When James Pugash,president
Citron said during Tuesday's of Hearthstone Advisors, a San
hearing that he has known De Fernando Valley consulting firm,
Spirito since 1974 and had consult- asked,"Isn't the real problem that
ed him often. De Spirito declined
comment Tuesday on his dealings people didn't want to face the truth
with Citron. that Orange County was hooked on
Records show that Dean Witter money from the pool. Citron re-
was lead manager or underwriter plied: 'There could be a degree of
validity in that statement,yes."
on some $150 million in Orange
Sen. John R. Lewis (R-Orange)
County bond issues between 1990
and 1994, making it the county's and others pressed Citronnabout
bout why
ehe would make investment decisions
eighth-largest underwriter during
that period. based on criteria other than the
safety of taxpayers'money.
itron said he did not believe "There is great pressure put on
that the fund was "in serious me and others to maximize our
trouble until the very,very end.I returns for budgetary reasons,and
always believed that the fund. . . that is how the situation grew that
would never have a principal loss, required me to try to maximize the
because we would never have to returns,"Citron said.
sell securities until they matured." He said he had no documents
He also suggested that the coun- showing what sort of pressure was
ty's bankruptcy filing was"prema- applied, suggesting instead that it
ture." Noting that Wall Street came verbally. He recalled that
firms dumped$11 billion in collat- County Administrative Officer Ernie
eral after the bankruptcy and his Schneider asked him to come up
resignation,Citron said:"I believe with money to fund a gang suppres-
if I was still there at that time that sion program, adding that similar
dealers would not have sold the pleas were made"several times."
securities." Citron,who held the office for 24
Citron—certain that interest rates years before his resignation last
would stay low and that the county's month, testified that counties
investment pool would prosper— should not borrow money to in-
laid Merrill Lynch officials im- vest—as he did in hopes of multi-
pressed him with graphs and charts plying the returns of the Orange
"that were easily understandable to County portfolio—and should use
derivatives only to reduce risk,not
someone like myself."
for speculation.
That notion drew a sharp re-
sponse from Sen. Rob Hurtt (R-
Garden Grove),who suggested that
even the most casual observer of the
economy understood that interest
rates were likely to rise in 1994.
"Everybody knew . . . that in-
terest rates were artificially low,"
that they would rise and that "it
was only a question of when,"
Hurtt said.
Sen. Tom Hayden (D-Santa Raabe's testimony seemed in con-
Monica)questioned why disclosure flict with much of what Citron said
statements for two investment For instance,the assistant treasurer
deals put together by the county described his former boss as an
within three months of one another experienced,savvy money manager
in 1994 revealed such different and said Citron chose the under-
levels of risk. The first intimated writers and bond counsels for short-
certain problems with the county's term debt issuances—though Citron
financial situation, while the sec- had said the Board of Supervisors
and was"downright upbeat,"Hay- and the county administrative office
den said,adding that he felt there made those selections.
was"a glossing over of the risk." "Mr.Citron had been in office for
Citron responded that the county 20 years. . . . He was a very
"relied on professionals"in invest- experienced treasurer, and I pre-
ment banking to put the prospec- sumed he knew what he was
tuses together. supposed to do," Raabe said. "I
sked what checks and balan- understood him to be an invest-
A ces are needed to head off a ment manager who had an extraor-
dina a national reputation."
similar debacle, Citron—who had uelched an effort, to set up a Raabe testified that the s a -
s
q lure of county government ham-
panel to oversee his investments— pered the county's ability to deal
suggested establishment of a small with the.crisis during the days
group of advisers "qualified by before the bankruptcy filing. He
training and education' to oversee said, too, that the county's losses
investment pools. would have been far smaller if the
Some checks already are in place, filing had been averted.
he added, noting that the Orange "There was a very strong,con-
County portfolio had been reviewed certed effort on [the part of] a
in the spring of 1994 by the SEC. number of people to avoid this
Based on that checkup,Citron said problem,"Raabe said.
he concluded that problems would Raabe told the committee he
not materialize in the pool. grew concerned about the portfolio
Citron,who received more than in September, but later in'the
$14,000 in campaign contributions afternoon Mountain View Finan-
from Wall Street last year,said he cial Director Robert Locke told the
believed that brokerages should panel that Raabe visited his city on
not be allowed to donate money to Oct. 15 to assure him about the
any political campaign. security of the pool. "He gave
Asked if the bankruptcy resulted assurances that the pool was in
in part from the"conflict of inter- good shape,"Locke said.
est" that existed because Merrill Hurtt noted the discrepancy in
Lynch earned more as it did more the two witnesses'testimony,say-
transactions with the county,Cit- ing,"It looks like we have a little
ron replied that "in retrospect, it chronology problem."
appears that way." Even Jeff Leifer, president of
Leifer Capital, who said he has
earned about $1 milli?n from the
a
V I
•
t•4
gg lit
Rer A `I III
mv"
m ALEXANDER GARCIA t LW Angelft nmes
Orange County Supervisors Roger R.Stanton,left,and Gaddi H.Vasquez appear before special committee.
county working as a consultant on 66We received glowing writ-
bond issues, sought to distance �/�/ ten and verbal reports
himself from Citron on Tuesday. about the investment pool's per-
He steadfastly denied he was a formance,and our continued high
financial adviser to the county. bond ratings gave us a sense of
His relationship with Citron has assurance that our actions were on
come under scrutiny because much solid ground,"Vasquez said.
of the work he did for the county But when Ko
Vas-
was never put out to bid and he PP questioned Vas-
was a contributor to the campaigns quez about a treasurer's
auditor's report
of Citron and county supervisors. a real of the treasurer's office and
Sen. Quentin L. Kopp U-San a letter from accountant John
Moorlach predicting the fund's col'
Francisco) pressed Leifer about lapse—documents which had nota
those contributions to Citron and tions indicating that they were sent
other politicians.Leifer said all his to board offices—the supervisor
contribution were legal, but said he had never seen them.
couldn't remember how much or to Sen. Patrick Johnston (D-
whom he's contributed.Kopp grew Stockton)asked Vasquez why the
irritated. county did not more closely moni-
You're a very defensive young for its finances,noting that even a
man on this subject."Kopp said. controversial issue of$600 million
After the hearing, Kopp had iri taxable notes in July was ap-
harsh words for nearly every wit- proved without debate.
ness,calling them"a sorry group of When Vasquez said he could not
human beings—all under the rubric recall details of the transaction,
of greed Almost immorality." Johnson pulled up a tape recorder
Kopp called Citron"disgusting," and played a one-minute segment
saying the,former treasurer put on showing that the item was passed
an act for the hearing. on the supervisors'consent calen-
"He's not the kind of person he dar with no discussion.
presented himself as today—this He stopped the tape and said:
quiet, unsophisticated person," "Well, that took care of [$6001
Kopp said. He was an arrogant million."
fellow who intimidated these su-
pervisors.He was lauded.He was Sacramento and writers Matt
tt La lane
sought after. And they abrogated Debora Vrana In Orange County eon.
their responsibilities." tributed to this report.
Late in the day, state senators
peppered county Supervisors Gad-
di H.Vasquez and Roger R.Stan-
ton with unusual aggressiveness t
about the Board of Supervisors'
role in the collapse of the fund.
The panel members contended
that the supervisors had the ulti-
mate responsibility for oversight of
the treasurer's office,did not heed
warnings about the risks of the fund
and shirked their legislative respon-
sibility to protect taxpayer money.
Vasquez and Stanton said they
were led astray because they relied
on the advice of county staff and
financial experts who indicated
that the pool was in good health.
•
O.C. Public Libraries
Say New Cuts Would
Decimate the System-
■Services:Officials warn crisis,which forced it to declare
bankruptcy Dec.6,Adams said444s.
of further reductions in doubtful the libraries will continue
hours,Increase in fees and to receive the extra county money,,,
Library officials are now ex=-,".
maybe closure of branches. fining where to make a new round
More private funds Sought. of cuts.Adams said he will pr-ob.
. ably present several options far.Ibe'
Board of Supervisors to consider.
By SHELBY GRAD,BERT ELjERA when they take up the issue-in
and ALAN EYERLY March.
SPECIAL TO THE TIMES "There are different ways.this
Orange County's public li- can be accomplished, none;bf
braries,already battered by which are good,"Adams said.. ^•
sharp funding cuts two
years ago,are the likely target of Officials may increase finr4; Library's Books
more budget.reductions in the overdue books and tie'6iri The Orange County Public Library system will spend$3.5 million.,
all fee when borPoit'E, '
wake of the county's bankruptcy,a charging a smof its$23.7-million budget on new books this fiscal year,while it, ,-
closethat could force officials to ers request that a book b4'X'e,-, g y
close branches and increase fees served.The system may also Ins71= accommodates millions of patrons.Library officials expect their_
and fines. tute a fee for ordering books'6G budget will be cut about 24%because of the county's fiscal crisis...,
County Librarian John Adams other libraries,such as UC Irvi"ne''d:' A look at the library system over the past five years:
said Tuesday he expects to trim his Closing branches is anothertlg?
budget by about 24%, from tion,but Adams said it is too 4ar19•', _ �j
$23.7 million for the current fiscal to tell which branches could be- se mnwo.aawior tM mnwur
year to $18 million for fiscal targeted."It's one thing we need'to $30 323.7 7 8:8 '-
1995-96. In-1992-93 the system's look at,"he said. 25 e
budget was$27.1 million. "- s
It
Officials-also will examine 20
"It has been an extraordinarilyy ;- 4
whether libraz hours can be fu, 1s 3
difficult period.It has been a great ther reduced."Our experience,", 10 2
challenge to maintain services when we went to four days a week, s i
while undergoing these reduc- people were confused and didn't o
tions," Adams said. "The bank- know when the library was opeq'- 199091 9192 5293 5394 '9695 199091 '9192 9293 11396
ruptcy is the frosting on the cake." Adams said."I think[being opm)
In an effort to soften the impact, less than four days[a week)would
the 28-branch county system may make it even more confusing."
create an independent foundation Billie Jackson,58,of ui:a $6 8 8.8
r
to raise money for the libraries. retired secretary who s Maheahe:tuiie s
111
Anaheim's four-branch library re the Heritage Park branch,-,iiid 4 $3.8 s
network,which is independent of at
h unfair that we bra havch,, to
the county system,also may form pay the price for the bankrupiay% 3 4
its own fund-raising arm. 2
"This is the worst I've seen in a We are just trying to educate, 2
long time," said William Griffith, ourselves and improveourselvgs. 1 _
n
who has served as director of Ana- Adams also expressed reserya.' 199091 5192 •9293 5394 '9495 199091 '9192 11293 93."
heim'a libraries since 1957. "I'm tions about cutting back on book '•"
worried.Libraries are too valuable and periodical orders. "Without.
to let go,(but)I'm afraid we're going some new kinds of new materials,
to get cut.I hate to see it." there is no public library,"he said.'.'
Finding new revenue sources
I will be crucial to getting through
n 1993,the Orange County pub- '
a the financial crisis, he said:,:An
tic Library system sufferedPu
independent library truncation
serious budget cut when the state
reduced its share of property tax could receive and disburse •
revenue. The funding reduction raid and individual donationnss,. •
he
h
forced officials to cut back the satd.Most branches now receive.a
number of days that libraries are small amount of private suppOrt"
open,from six days a week to the raised by volunteer organizations.
equivalent of four,and reduce the Other cities have found
system's annual budget for new with library foundations.Newpoorrt.'
book purchases from$6 million to Beach's foundation raised Mone:.
$3.5 million. than$2 million to help build,;jl:
city's new$8-million main BbrarX,
"It's been hard getting used to which opened in 1994.
these new hours,"said Jin Lee,an ••The community values the,y;
Irvine computer technical consult- brary,"said David Carmichael,htad-;
ant who scans magazines at the of the Newport Beach foundation.-!.,,,:
Heritage Park library in Irvine at But volunteers at some boat..:
least once a week."I come here at county libraries questioned, 'AW,
noon and it's closed.I can't believe much more the public has to give;:-
they'd cut back even more. The "We're probably doing as mush
libraries need more money, not as we can right now,"said Dorothy
less." Nail,who heads the Friends of the•
Until now,the cuts have been Fountain Valley.Library, which.
softened by a $2-million annual runs a bookstore to benefitvtbe,
county subsidy to the system.Be- library."We're working as hard as-
cause of the county's financial we can."
•
7,
Willmgd,O,Acce pt .Fault
■Hearing:Grilled by state .
senators;key figures try to
deflect the responsibility of
,county fiasco onto others.;:
By REBECCA TROUNSON
-TIMES STAFF WRITER,.'.;
ACRAMENTO 'There they,
all were;'the major players in
Orange County's extraordi-
nary;-plunge',Into bankruptcy,
shoulder to shoulder with a few.of
;,the victims;an army of attorneys,a
.crowd of reporters and a handful of
bystanders, all'jammed`into:`a
wood-paneied'aCapitol _hearing
','•`But--oddly�,enough; iiot",one-sof
Ehose=present•was`responaib1%at.
least;aeaording,to.:witness after'
,witness who;;each;claimed�that
nearly'everyoneelse in.:the.ioom
was at fault in the county's.fiasco;;=
Ai;There,was Robert,F Citron-'the
:benign-lagkirig;69,-year-old
;mer county;treasurer,shittingtm
='
;comfoetably on'thehotseat Tues':
,lay through nearly three hours of.
grilling by a.panel of state_sena=
tors`the=reassuring hand afr his
lawye;,resting occasionally on,his
graY-swted back Far.''.his part
Citron said,he.. an unsaphisti
cated'investor:who relied heavily
on his"'financial`advisers;'notabiy'
Merrill Lynch.
There were�Yhe,two;$veteran
�.Orangef{opYity�supervisors+Gadd,',}
H Vasquez and Roger R°Stanton,'
nervously avraiting their.:turns at">
„'thea witness table. their'a;tarney
sandwiched biiwell.them; their
brows:furrowed'as.the.senators.:_
heaped blame their.way..;::::;;,s
With,an unusualiy;,aggressive
s
mer treasurer, in an occasion
quavering voice, answered qugs
tion after question,fewer.and fewia
er bystanders remained :,
,t One woman,who said she works
on political campaigns,skipped_6>t
well before'noon;confessing t$at
she found the talk oferivatid
reverse repos 'and other finan
.v
terms.. 1. than� v �-"T
its the hottest thing god
the CPpitol but it's ao boring's
said; a bit apolo eti '
made her way toward thesdgor '
k.. h 1..,�'�3 SS) •:.�.9�+ rye.�7+. ,V
', Finally,_yhe vaiiquished;ea, �`
- aurer_himself left,the�hearui�
flanked by his ittorpey da d
Wiechert,and two Capitol
rz S BUazds
Half.a dozen`telgvmon i�ant$rg
is r-� t3 t};v�.'`aE ,� ` } e. _.' s .�!1.'��.q�} AI.QCANDIIt GARQA Loc Ange1eaTimm
operators an �a119tller`'dOLlrl^,
Robert L Caron,ieftt�answers state Senate panel s question With his attorney,bavid ether,at his side^ por�.ers awaited him' he ha(lw y�
btuich of;lawmakers quesUomngties in its ill fated investment pool' •the hallways butside were some 40 ' tossing:?oµl � ons_��° .t
their actions,Vasque¢and Stantoh burns even the bnefest of breaks :reporters and photographers At -..thing from the prospects for fn
sought to deflect blame to financial .:,the Merrill men Aeployed through :'pre,point, se+�eral of the media est rates to the:prospects'fbr, ig
:experts to county staff"to the the room gWetly, msnstently re hovering outside the chamber door P USC footbalf tt"am' n
former treasurer.-^�,�r" aim d,'peating,theu spin on the financial ;Tuesday morning 3aistook the season L,S ts�
r• r + .c t Citron ducked:intd"an eleva
t k, coals 'We did not direct or control graying;bespectacled Sen Welham bo,ra
ee I the while,,the supervisors .'the investment strategy,,we are A,Craven B Oceanside);.for the Once inside fie remamjed i;IA.g}g
l ,utsisted that they were now in :not responsible :+,, . :r<' ` °graying,owLsh star v�ntness dechned to offer a inessa$e to Ehg
control of recovery efforts and will On a raised platform were.dii I(i r 'It's..not him a:television re taxpayers bf Oranggtounty
use'the opportunity to'remake `state'senators,with severol clearly porter grovyled,.tb his"photogra nally "asked_how hemfelt,,
county government.%They told the M relishing the opportunity,to be the t pher Jthen turned backs toward said simply 'Ifeelf�ie"a .�, n
'.senators that they did not"wantCa "'.fust investigators to interrogate ;Craven `You wast to be Citron '' �.ttie_heariiig neared:its.e de-
state bailout saying.,the 'coun>y> ,those'at'the center of the;,biggest today?, he,,foked to the veteran Hayden;offered'a partmgshot,
was`goingto work itself out of its mumci bond debacle in U S*;ik senator,`co chatrman of fhe =.
funannal ess ti hnsto P the witnesses "I have never
ry �, ns.;'.tl4uentm I;' Kopp ?state Senate Cgmmittee ni► Local marl}proud and successful
Near'an aisle=the better for (I San Francisco) and Tom Hay t Government Investments o conve ed so ra ndl
easy access to'members_of the idea(D-Santa Monica)fired short. No '.CrWenrephedrgriimmg P rt P YtAh~
press aligned against,a'chamber .;quick and often pointed questions Almost certainly neithe dad ty Hayden'said, shortly°t+e
wall—was the six-member'pubhc relinquishing the microphone each Citron;.who made his way into the leaving for an earthquake.ni oe
relations team from Merrill Lynch, :time with evident reluctance { ' room through j;a al
side.entrance, n "event in Los-Angeles,"� vg
".the brokerage house that sold the And 'scattered throughout the nearI hnotnced:•. n :_,,; never;seen so many bright` e
county many of the riskiest securi : chamber and jostling each other m Inside,as the:beleaguered for turned into Forrest Gumps.:y c
•
_ ,True,we could've stopped any-
REACT thing that came up on the agenda.
Some Support' But that's a very difficult thing to
Continued from A18 do when you don't know what's
Citron While � pearance was both "difficult and going on,"Riley said.
- - fascinating to watch."- Citron's statement that he ran
Others Scoff�� "I was proud he testified and was the investment pool on financial
willing to say he went down the advice from Merrill Lynch brought
wrong course,"Moorlach said."It's Fries of disbelief from Larry Bales,
By H.G.REZA not an easy thing for someone who an auditor and appraiser in the
and LEE ROMNEY had been so brazen to admit.But I county assessor's office. Citron
TIMES STAFF WRITERS had problems when he said he was blamed Merrill Lynch when in fact
SANTA ANA—Former,' only a lay person who depended on all;top county officials should share
count Treasurer-Tax Co- y the blame,he said.
y �� Merrill Lynch for financial advice. "Tt's the biggest cover-up in the
lector Robert L. Citron's How can someone who invested world," said Bales, who nonethe-
televised testimony before billions in the bond market for 20 less added that he believed Citron's
a state Senate committee= years call himself a lay person?" story that he felt compelled to
Sacramento got mixed re William Mitchell, chairman of continue gambling for high returns
views in Orange County;-- Orange County Common Cause,
g Y because of pressure from county
with critics scoffingat•his:l said that Citron was echoing"the
officials to generate more revenue.
explanation he was only party line. . . [that]big bad Wall
following the advice of Street took us to the cleaners" ongtime employees of the office
Merrill Lynch when the— when he sought to blame every- .Citron ran for more than two
investment pool lost$2 bil thing on Merrill Lynch. decades had a generally sympa-
lion and some former em= '�If you believe Citron, that it tlietic view of their former boss.
ployees expressing sympa'-'' was all Merrill Lynch's fault,then Tliere were whispered exchanges
thy for their ex-boss. we've been electing idiots who are ._4bput what he might have worn to
"Overall, his presents easily fooled by more sophisticated the hearing, and speculation that
tion was very good," said individuals," Mitchell said. "He is he left his trademark turquoise
newly seated Supervisor'" parroting the county's first line of jewelry at home.
Jim Silva."He answered a^ defense:Blame others." ' "Before we were angry because
lot of questions I had aboutA office who asked not u n employee of the treasurer'be s he left," said Belinda Quam, 40,
his role in all this.But I was'; who worked with Citron for seven
surprised when he' years."But now it's more compas-
very
said he didn't understand" identified said she was"heartbro- sion and concern for him. We
ken"by Citron's attempt to defend
what he was doing." su rt him."
= ply
himself. "He's a good man who is uam said she has taken man
Costa Mesa certified" Q y
very.introverted.He's not a crimi- an calls from the public and
• public accountant John' nal,and it was very sad to hear him always comes to Citrons defense.
M.W. Moorlach, who was stutter as he tried to explain that `.'I'm always saying to people,'Did
defeated by Citron in June' he didn't do anything wrong." you forget about the money he
in the race for Orange" Supervisor Marian Bergeson said made for us?'" she said. "He
County treasurer-tax col- Tuesday's hearing taught her
y g g played a lot of smart ball and
lector,said that his onetime
something about Citron's character people forget about that."
opponent's television ap- and pointed out the need to reform Jeff Gray,an associate of Moor-
Please see REACT,A19 cqunty government. She said the
county treasurer should be ap- 'lath, , that watching where Citron and
day's
pointed rather than elected. hearing, assist
-
pointed
thing I did gain was a more int treasurer Matthew Raabe were
,O
personal understanding of Bob Cit- blaming Merrill Lynch and others
raft".:,Bergeson-said. '..He came for Orange County's bankruptcy,
aorms .as very contrite in his was like viewing a rerun of"Ho-
presentation..I think the fact that gan's Heroes."
he;was willing to put himself in "It was like watching Sgt.
that position was admirable." Schultz telling Col.Klink,'I know
,Iaretrospect,Bergeson said,it is t :notliiii:ing,"said Gray.
clear the county failed to properly
oversee Citron's investments.
.'fit's apparent two things could
have prevented this: adequate
oversight and disclosure to inves-
tcrs she said. "There.was un-
questionably too much trust placed
in Citron's policies and not enough
questions were asked."
--Former supervisor Thomas F.
Riley, who retired earlier this
rgonth,agreed that the board failed
to ask the right questions about
Citron's investment policy.But the
problem was that nobody except
Citron knew what his investment
strategy was,Riley said.
•
N6VSAWjiiii_JS
A Wheeler-Dealer-
in
Finances or Just.
a Naive Official?
a Investments:Some key
points of former
treasurer's testimony
seemed to be contradicted
in his responses to later
questions—or were
aggressively disputed by
Merrill Lynch.
By TOM PETRUNO
TIMES STAFF WRITER
SACRAMENTO—Amid the
barrage of conflicting state-
ments and seeming self-con-
tradictions offered Tuesday by the
key players in Orange County's
financial debacle,the central ques-
tion appeared to go unanswered:
Who was the real Bob Citron,and
how much did he really know
about managing money?
Was the longtime Orange Coun-
ty treasurer a mild-mannered,na-
ive public official led to investment
slaughter by savvy Wall Street
brokerages? Or was he a shrewd
financial wheeler-dealer who be-
lieved in his own magic and lis-
tened to no one but himself?
The blame for the $ZO2-billion
loss in the county's investment fund
and the county's subsequent bank-
ruptcy filing cannot be properly
affixed without settling that debate,
but state senators questioning a long
line of witnesses Tuesday may not
have gotten much closer to the
answers they and Orange County
taxpayers want.
Instead, the legislators slogged
through a morass of self-serving
testimony that often did not hold up
well under scrutiny.And while the
questioning revealed numerous in-
stances in which the letter of the
law apparently was not followed in
the transactions within and super-
vision of the county's investment
fund, no "smoking gun" was evi-
dent.
Merrill Lynch acted as a financial
adviser to Orange County,"he said.
Yet Citron also testified that he
called daily for advice from'Albert
J.De Spirito,an executive at rival
brokerage Dean Witter Reynolds
in Los Angeles. Indeed,De Spirito
That is, nothing was said that was Citron's first call each morn-
could be immediately seized upon by ing, said Michael Stamenson, the
prosecutors,who are sure to study Merrill broker who got most of
Tuesday's testimony carefully as Orange County's bond busi,ress.
state and federal investigations of Stamenson,based in San Francis-
the county disaster continue. co,said he was second on Citron's
"I don't know any more than I list of calls.
knew before," said Newport-Mesa Citron did not volunteer;:and
Unified School District trustee Ju- senators did not ask,what kind of
lith A. Franco, who sat in the advice Tie Spirito may have-,pro-
audience of the hearing room listen- vided regarding the portfolio's
ing for more than eight hours."It's management. `
kind of a'he said,you said'type of (Contacted at his San Nix4rino
an explanation." home late Tuesday, De Spirito
Citron set the tone for the hear- declined comment on his dealings
ing,portraying himself as a victim with Citron.)
who"relied on the expert advice of Asked why he took the-ex-
But
professionals." y
But some of the key points of histreme risks that he did with-thetestimony seemed to be contradict- county portfolio, Citron said,there
ed in his responses to later ques- was"great pressure put on me and
tions—or were aggressively dis- others" to help the county earn
puted by Merrill Lynch, the more interest income and thereby
brokerage from which Citron avoid budget cuts.
bought the bulk of his doomed But pressed for examplesvf-that
portfolio's securities: pressure,Citron said he couldre-
• Citron referred to himself as a call only"several times"wlien he
treasurer who never graduated said county officials had"through
from college, was forced to learn verbal contact"asked him t6-earn
on the job and thus"placed a great more money.
deal of reliance on the advice of a Citron painted Stamenson as
market professionals." the architect of the portfolio's
But when asked later in hisstrategy of investing in high-risk
testimony why he had no contin derivative securities."I remember
gency plan to deal with the devas- it as if it was yesterday," Citron
tating effect of rising interest rates said,referring to the first detiva-
on his 520-billion,highly leveraged tive security he bought from.Sta-
investment portfolio, he said: "I menson,in 1991.
was so sure of what I was doing, But later,Orange County Assist-
based on the many years of success ant Treasurer Matthew Raabe tes-
that I had." tified that he and Stamenson had
Senators did not ask Citron about met with Citron jointly in Septem-
a briefing Merrill Lynch gave him in ber or October to discuss Raabe's
February, 1994, detailing that the concerns about the portfolio's
county's high-risk "derivative" heavy use of borrowed money to
bonds would decline in`value by buy derivatives.
$270 million for every one-point rise "Stamenson was helpful in what
in interest rates. That report fol- we were trying to do"in address-
lowed the first of last year's six rate ing the portfolio's risk,Raabesaid.
increases by the Federal Reserve. But Citron, he said, chose not to
•Citron referred only briefly to heed their concerns. . --
the Merrill report,but throughout • Though he had been treasurer
his remarks he sought to tie Merrill for 24 years, Citron said he was
closely to his ill-fated strategy of unaware of state law that required
borrowing short-term to buy long- him to submit specific details of his
term bonds and complex deriva- investments to the County Board of
tives,"At least to this lay person, Please see TREASURER,A19
•
TREASURER: Citron Was Unaware of Law That Required Reports to Board
Continued from Al rowed money to intensify his bet fund's use of"reverse repurchase even knew what the term meant." that could develop from a number
Supervisors monthly. Neither on falling interest rates—a bet agreements ... last a strategy Yet Stamenson failed to expand of ongoing investigations.
could county board Chairman Gad- largely responsible for the county that utilizes leverage, and also on Merrill's reasoning why,despite In that light,securities attorndys
di Vasquez explain why the board fund's collapse as interest rates involved in this strategy is the use its stated concerns about Citron's said Tuesday that Citron's stance—
had not demanded those reports. surged last year. of structured or floating interest growing use of leverage in the that he was following Merrill
For its part,Merrill Lynch reit- The county,in suing Merrill for rate securities." portfolio last year, the firm still Lynch's advice—is aimed not only
erated the position it has stood by damages from the fund's collapse. Stamenson,testifying late in the agreed to underwrite a 5600-mil- at portraying the securities firm as
since the bankruptcy filing,which has argued that the firm earned day, described himself as "one lion county note offering in July, the architect of the county's failed
is that the firm"did not create or many millions of dollars in fees account executive among a number the proceeds from which were used investment strategy but in show
direct the county's investment from the county,and had a respon- of different brokerage firms that to support the fund. ing that in his own actions he relie4
strategy"even though it acknowl- sibility to inform the supervisors provided Mr.Citron with informa- Merrill officials have. insisted in good faith on professional guld-
edges having sold between 60% directly of the high-risk nature of tion and opinions and competed for that they were simply serving ance.
and 70% of the securities the Citron's strategy. Merrill has ar- Mr.Citron's business." their customer.But the deal,origi- "He's saying he was informed:by
county owned in the fund. gued that it had no such responsi- Far from being an inexperienced nally to be underwritten by Paine people with good reputations,"said
Merrill officials,in written mate- bility,and that in any case Citron investor,Citron was"fully versed in Webber,was taken over by Merrill Stanley Arkin,a defense attorney
rial submitted to the Senate Special had kept the board abreast of his the advantages and risks associated after it stepped in and offered with practices in Los Angeles and
Committee on Local Government tactics, with the securities that he pur. Citron a more lucrativedeal. New York,in an interview before
• Investments.described Citron as a But the evidence Merrill cited chased from brokerage firms. in- In part. Tuesday's testimony Citron's testimony.
"sophisticated investor." More- - regarding Citron's disclosures to cluding Merrill Lynch."Stamenson could be viewed as a dress rehears- Times staff writers Michael A.illi-
over,Merrill insisted that county the board was a boilerplate passage said.He added:"I learned a lot from al for the civil trials likely in the tzlk In Orange County and lesui
supervisors were well aware of in his 1992.1993 financial state- him, since he was doing reverse wake of the county's fiscal calami- Sanchez M Los Angeles contributed to
Citron's strategy,which used bor- ment.That report referred to the repurchase transactions before 1 ty—and the criminal prosecutions this story.
•
i
,Who Said What on Key issues
40
MEW
Former county County assistant Chairman,County County supervisor Merrill Lynch
treasurer-tax treasurer Board of broker
collector Supervisors
Blamed Merrill Blamed Citron.Said Blamed lack of Blamed Merrill Blamed Citron.
Who's to Lynch.Called the the fund was information from Lynch.Pointed out Contended he was
Eli1eie: firm his"financial entirely under Citron and bond that from July,1994, just a salesman who
adviser."Said he Citron's control, rating agencies.Said to November,1994, sold the county
relied on and he had only a the Board of the firm sold more securities."Neither I
information from working knowledge Supervisors never than$1 billion of nor anyone else at
Merrill and spoke of it."I was not the received notes for the Merrill Lynch
with salesman person who made information on county,with designed or
Michael Stamenson the investment problems with the proceeds invested in structured the
daily on the status strategy or made pool,only"glowing the same pool that it county's investment
`. of markets.Shifted investment verbal and written was warning Citron strategy or
some blame to bond decisions,"he said, reports."Said high about.Was controlled the
rating agencies and although he bond ratings for troubled that county's
securities regulators, admitted Citron Orange County Merrill Lynch's red investments—Mr.
contending their sent him to explain provided flag warnings to Citron did."
examinations of the the fund to "continued Citron were not Disputed Citron's
fund in early 1994 potential investors. assurances the given to county claim that Merrill
signaled He saw Citron as an investment pool officials or bond Lynch was a
"confidence"in experienced and its strategies buyers, financial adviser:
what he was doing. treasurer and were sound."
/= Also blamed "assumed he knew
himself. what he was doing."
r Said he became Called Citron a Said he and other Did not discuss,but Called Citron"a
Citron's confident in his "very experienced supervisors relied the Board of highly
Expertise: financial ability and treasurer."Said he heavily on the Supervisors' sophisticated"
skills due to past assumed Citron was county's financial position has been investor.Also
success and high making the right experts,such as that members relied contended he
returns.But, investments. Citron,and rating on Citron,an learned from
looking back,found agencies for advice. elected official. Citron,who was
"I was not the Received glowing "doing reverse
sophisticated reports on the repurchase
treasurer I thought fund's status. agreements before I
I was." even knew what the
term meant."
Merrill Contended Merrill Said he had few Did not discuss. Contended Merrill Said he made
Lynch was his dealings with Lynch never gave recommendations
Lynch's Role: "financial adviser" Merrill Lynch.But the board the same to Citron on what
and spoke daily to after the fund began fund warnings it he could purchase
at least one person, to lose value,met was giving Citron. from Merrill Lynch
Stamenson,at the with Stamenson Said Merrill treated but did not direct
firm for advice. twice,in July,1994, Citron as if he were the county's
and September, an individual,and investment strategy
1994,to discuss the county money as if or control the fund.
funds. it were Citron's.
On the Never believed the Said he did not Maintained he Said county officials Said any bond
fund was in serious know details about wasn't given were misled as to portfolio,even one
...Investment trouble"until the the fund. information on the the true status of the holding"plain
Tund• very end."Said he pool that Citron pool. vanilla"securities,
thought the fund was getting, would have lost
was set up so that it including reports value during 1994
- would never have a detailing how the and Change
loss in principal. fund would lose County's portfolio
value if interest was no exception.
rates rose.
SEC Because of questions Said he gave SEC all Said Board of Did not discuss. Did not discuss.
raised about relevant documents Supervisors was
Investigation Citron's investment on the fund.But never informed
-in April, strategy during last after the April about Citron's
1 SSS' years election,the meeting in Los meeting with the
Securities and Angeles said he SEC in April:Said
Exchange "never heard from he was told later
Commission called the SEC again." that it was decided
county officials into that county officials
its Los Angeles didn't need to
office to discuss the know.
fund.Citron said he
gave SEC"about 24
boxes of
documents."
On the Would favor limits Would support any Against state Against state bailout Said Merrill Lynch
on the amount of new state bailout.Said county because it would set is"concerned"
FUtUCe: derivatives that a restrictions that officials have put a precedent for about the events
government agency would prevent the together a team that other fiscally facing Orange
could own.Also Orange County will be able to work troubled County and will not
would back a fiscal debacle from out the county's municipalities. walk away.Merrill
complete ban on happening again. fiscal troubles and Favored new state Lynch remains
campaign restructure the laws banning all committed to
contributions and government.Would contributions from working with the
gifts from firms that support new state bond business firms. county"in any
do bond business restrictions against practical way."
r. with the county. contributions from
bond firms.
Key Excerpts From Testimony
by Citron, Stamenson
Here are excerpts from the open-
ing statements presented Tuesday by
Robert L. Citron and Michael Sta-
menson, key witnesses testifying
before the state Senate Special Com-
mittee on Local Government Invest-'
ments:
(( i st,and foremost,let me
express my deep sorrow
to the people of Orange
County for the financial crisis that
-ias arisen.As treasurer,I followed
�n investment course that I be-
lieved was prudent and suitable to
neet the county's growing finan-
!ial needs.In following that path,I
relied on the expert advice of
financial professionals. In retro-
spj�EL;it is clear that I followed the
wrong course. I will carry that
burden the rest of my life.I am not
here seeking to place blame or
shtfk".responsibility—I am.here
simply to tell the truth."
Education Background
"Yam 69 years old and a third-
generation native Californian. My
wifg;'Terry,and I have been mar-
ried-almost 40 years. My parents
raised-me during the Great Depres-
sion'-J was ineligible for military
service due to an asthmatic condi-
tion—and••and therefore entered the
University of Southern California.
Duiing my first two years at USC,I
studied a pre-med curriculum as I
wanted to follow in my father's
footsteps. I switched in my third
year.,to general business courses
and left during my fourth year due
to financial circumstances.I never
received a college degree.I attend-
ed.Loyola University for a semes-
ter,in the early'50s to learn about
government finance.
'titween 1948 and 1960,I was
empIpyed primarily in the area of
consumer finance.In 1960,a friend
encouraged me to seek employ-
mint.'with Orange County as a
depyty tax collector.I was hired in
that year and held that position
until 1970 when I was elected to
tfie'position of tax collector for
Orange County."
Claims Inexperience
"I was an inexperienced inves-
tor.J had never, nor have I ever,
owned a share of stock.My prima-
ry„t;ajning was on-the-job.Due to
my inexperience, I placed a great-
deal of reliance on the advice of
market professionals.This reliance
increased as the number and types
of 4rivestments permitted by the
Government Code were liberalized,
and"as financial instruments be-
came more complex.This is not to
say that by the time derivatives
were. first sold to the county, f
almost four years ago,that I didn't "
consider myself to be an expert- r
ended and successful treasurer. .
The county achieved many years ry
of extremely high returns during
my tenure.However,in retrospect,
I wish I had more education and .
training in complex government
securities.” 4,
Merrill Broker
"I first met Mr.Stamenson in 1975
and I started doing business with
him on behalf of the county in 1988
when he took over from Mr. Fred
Walker as the county's Merrill
.Lynch representative. Merrill
Lynch,was the primary investment
firm selling securities to the county `
in'the late'80s and'90s. . . .I have
heard the figure that Merrill Lynch ALEXANDER GARCIA/Los Angeles Times
sold the county about 70% of the Former Treasurer Robert L. Cit-
approximately$20 billion of securi- ron: "At least to this lay person,
ties in the county's portfolio at the
time of the bankruptcy.This figure Merrill Lynch acted as a financial
is,consistent with my recollection adviser to Orange County."
that Merrill Lynch was the predom-
inant
to the
inant`seller of securities the to Orange County' of the same
county. . . . At least to this lay date. . . .In this document,Merrill
person, Merrill Lynch acted as a Lynch made a number of invest-
financial adviser to Orange County." ment suggestions that the county
strived to implement.There was no
sense 'of doom or gloom at this
Merrill Lynch Advice meeting.In fact,six days later,on
March 1, 1994, I had a breakfast
"In late 1992 and early 1993, meeting with Mike and Mr.Clough.
Merrill Lynch recommended,after Mr.Clough reiterated that interest
an analysis of Orange County's rate.increases were not sustain-
portfolio,that the county lower its able. . . . During the spring and
risk profile in the area of deriva- summer of 1994,the county's port-
'tives. The county followed this folio was the subject of numerous
advice by purchasing predomi- reviews by Merrill Lynch and
narkUy fixed callable instruments in others.In April, 1994,representa-
mid-1993. Merrill Lynch also of- tives of the Securities and Ex-
fered to buy back certain deriva- change Commission interviewed
tives*:on March 31, 1993. These Matt Raabe and me about the
derivatives represented some of county's investments. . .
the most profitable instruments in "Also in April of 1994,represen-
the.portfolio as they were paying tatives of Moody's and Standard
some of the greatest returns. The and Poor's inquired about the
treasurer's office decided not to county's investments. After the
accept Merrill Lynch's proposal inquiries both services continued
J06 in great part on its reliance on to rate highly the county's debt
the economic analysis of Merrill offerings."
synch chief investment analyst
;hailes Clough.Clough stated that
period of low interest rates would
Lst-.for three to five years, and
erhaps for a decade. This would
chance the value of the county's
:rivatives."
Jhen Rates Rose
.'On Feb. 23, 1994, Assistant
easurer Matt Raabe and I met
h Merrill Lynch represents- .
's, including Mike Stamenson,
tiscuss a lengthy'Presentation
Citron's Philosophy.
"It was my investment strategy
to use the county's large cash
reserves in periods of rising rates to
cover the increased cost of borrow- .
ing. It was also my philosophy to
hold the county's securities to ma-
turity to avoid sustaining any loss in
the principal value of the securities.
Before the bankruptcy,I sincerely•
believed that these philosophies.
were sound.My adherence to these
philosophies is a matter of public
record. In retrospect, they were'
unable to weather the fastest inter-
est rate hikes in history."
S
« ince 1986,I have been Merrill
J Lynch's account executive
for the Orange County treasurer's
office.Let me say first that I,like
everyone here, very much regret
the burdens and anxiety imposed on
the people of Orange County by this
calamity.I cannot lose sight of the
enormous personal pain that this
situation has produced."
On Assigning Blame
"When a financial disaster like
this strikes,it is important both to
minimize the adverse effects on the
citizens, and to consider whether
corrective legislation should be en-
acted to preclude a recurrence:
Sadly,some may also find it tempt-
ing in the emotional aftermath to
point fingers and assign blame—of-
tentimes where it does not belong."
On Investments
"Neither I nor anyone else at
Merrill Lynch designed or struc-
tured the county's investment
strategy or controlled the county's
investments—Mr.Citron did.Nei-
ther I nor Merrill Lynch had any
discretionary authority whatsoev-
er over the Orange County ac-
count. . . .Mr.Citron had a rela-
tionship with most major financial
institutions,and he actively sought
competitive bids."
Merrill Not Alone
"Merrill Lynch has been the No.
1-ranked firm in underwriting debt
and equity securities for the past six
years.Because of our presence and
position in the capital markets,on
many transactions Merrill Lynch
was able to offer the best price,and
therefore was able to execute a
significant portion—perhaps 60%
or 70%—of Orange County's de-
sired securities purchases. Please
keep in mind that the balance of the
purchases—also a significant per-
centage of the county's business—
was purchased by the treasurer's
office from other brokers."
Dealings With Citron
"For my part, I made recom-
mendations to Mr. Citron about
what he might buy, with n eye
invest-
ment
achieving his stated objectives of.holding until
7
maturity and increasing the coun- the range of views held by Merrill
ty's interest income. Often he so- '' Lynch economists about the direr-
licited these recommendations. x' tion of interest rates, not only the
Sometimes he accepted our recom- views of Chuck Clough,whom Mr.
mendations,sometimes he did not. Citron mentioned in his testimony
But one thing should be clear—Bob " this morning.I should also note that
Citron controlled the Orange Coun- I understand Mr. Clough told Mr.
ty portfolio. Merrill Lynch did Citron that he should position him-
not—I did not." self to be more defensive against an
"Bob Citron was highly qualified increase in interest rates."
to make these decisions for Orange
County. I have known him since Repurchase Offer
1975,and there is no doubt that he
was and is a highly sophisticated,. "I want to emphasize that we
experienced and knowledgeable offered to repurchase every deriv-
investor,fully versed in the advan- ative security Mr.Citron had pur-
tages and risks associated with the chased through our firm. We did
securities that he purchased from not select out those that were .
brokerage firms, including Merrill profitable.
Lynch. I learned a lot from him, "Mr. Citron declined the offer,
since he was doing reverse repur-
chase transactions before I even because he believed he could con.
chase time to achieve high yields by
knew what that term meant.' holding his investments to maturi-
CAROLYN COLE/LosAngeies nmes ty. Nonetheless, he was fully
Supervisors Knew Merrill Lynch salesman Mike Sta- aware of the risks associated with
menson: "Bob Citron controlled his strategy.His investment strat-
"He .disclosed this investment the Orange County portfolio. egy was not irrational.In fact,Mr.
strategy fully and frequently to the Merrill Lynch did not—t did not." Citron had enjoyed unprecedented
err
Board of Supervisors. In fact, the y success with his investment strate-
citizens of Orange County reelect- gy. Based upon our relationship,
ed Bob Citron in 1994, after his would happen if interest rates con- and his track record, I respected
investment strategy had become tinue to rise We explained the his judgment,his understanding of
the sole issue in the campaign." risks of each security the county his investment objectives,and his
treasurer's office purchased, understanding of the potential
whether we were first to suggest risks of his investment strategies."
Disclosure by Merrill the investment-or,as was the case
on many occasions, he had dis-
"The types of structured securi- cussed a proposed investment
ties that Merrill Lynch sold to structure with other dealers and
Orange County were not 'exotic requested our input.
derivatives.' They were primarily "Moreover, beginning in 1992, I
U.S. government agency obliga- and others from Merrill Lynch met
tions with relatively simple inter- with, and wrote to, Mr. Citron on
est rate structures. many occasions to inform him of the
"Some have suggested that al- risk exposure that the investment
though Merrill Lynch understood pool would face if—if—interest
the risks associated with the in- rates were to rise. There was no
vestments Orange County made, doubt in anyone's mind that Mr:
we did not disclose them, That is Citron fully understood this risk
not true. In fact,we gave him an exposure. We also provided Mr.
analysis that showed him what Citron with information reflecting
Funds Safeguarded Until Decision
By SUSAN MARQUEZ OWEN Mescon said he was satisfied with Also left undecided by Tuesday's
and GREG)OHNSON the terms of the agreement which hearing is the key issue of whether
TINES STAFF WRITERS calls for the firm to invest the Merrill Lynch sold$800 million in
proceeds of the$250-million sale of securities early last year without
SANTA ANA—Merrill Lynch county collateral in U.S. treasury the county's permission.
and Orange County on Tues- bills. In seeking a temporary re- Merrill Lynch attorneys said the
day hammered out an agree- straining order against the sale,the sales were done "in the normal
ment that will safeguard more than county had asked that the sale course of business."
$250 million in disputed securities proceeds be set aside in a special But county attorneys argued
until a federal judge can determine trust account until its dispute with that the firm never had the right to
which party owns them. Merrill was settled. sell the securities, and failed to
The agreement also ensures that "The county has the protection it notify the county of the sale.The
the county can continue to demand sought,"Mescon said. county maintained that it had list-,
information from Merrill about theed the securities in its portfolio for
fate of another $800 million in ounty attorney J. Michael 18 months in reports sent to Merrill
assets that Merrill Lynch appar- Hennigan said he too was Lynch,yet the firm never indicat-
ently.sold without the county's pleased with the agreement. Be- ed that they had been sold.
permission in early 1994. cause the treasury bills are easily profits from those sales also be-
The compromise ended a day- identifiable,the county will be able long to the county, Hennigan ar-
long'hearing that opened with an to track the investments—a key gued. Furthermore, the original
unexpected bid by Merrill Lynch to element of the county's plan to agreement between the county and
transfer the argument over more eventually retrieve the value of firm over the securities was illegal,
than$1 billion in county securities the securities through its lawsuits. he said, because it resulted in the
and the county's$3-billion damage "I got everything I wanted,"he county's gambling on interest rates.
suit against the firm to U.S.District said."And you can color me confi- "They (Merrill Lynch) have got
Courtin Los Angeles. dent that whatever judge finally major problems,because the agree-
Bankruptcy Judge Judge John E. decides on this will rule in the ment violated (state) government
Ryan approved the agreement that county's favor." - codes,"he said.
will allow Merrill Lynch time to Some attorneys questioned the Hennigan said that the illegality
seek the transfer without hinder- firm's motives for wanting to move of the transactions is the basis for
ing the county's ability to fight for the case out of Ryan's Santa Ana the county's$3-billion suit.
the return of more than$1 billion courtroom. But Merrill Lynch attorneys said
in assets. A federal judge in Los County bankruptcy attorney the county has already received all
Angeles is expected to make a Bruce Bennett said the firm appar- it is owed by the firm except for
ruling about where the legal issues ently wants another judge "who about $23 million" in anticipated
should be decided within the next knows nothing about this issue"to profits from the most recent sale of
two weeks. decide the case. $250 million in securities.
The firm's attorneys argued that Other attorneys in the court- The brokerage cautioned that
the county's damage suit belongs room said they believe the firm is the county's legal challenge to the
in U.S. District Court, rather than concerned that a string of decisions reverse repurchase sales agree-
the Bankruptcy Court, because it by Ryan that have favored the ment between the county and firm
involves civil issues and questions county indicate that Ryan would could put "billions of dollars" in
about interstate commerce. side with the county against Mer- similar municipal investment funds
Merrill Lynch attorney Richard rill Lynch. at risk in California.
San
(Eroutdc JANUARY 13,79S>S
Orange County Sues Merrill Lynch
Broker.accused of unsuitable, illegal investments
A""tared Pisa Merrill Lynch devised an in-
Santa Ana vestment program under which Vasquez said.
The supervisors of bankrupt the county investment pool bor- Merrill Lynch replied that the
Oran a County sued Merrill Lynch rowed more than $18 billion, in- borrowings were disclosed to the
g y cluding $2.4 billion from Merrill
& Co. yesterday for more than$2 Lynch, while knowing the state county Board of Supervisors by
billion in damages, contending Constitution set a$1.6 billion limit former Treasurer Robert L. Cit-
that the unsuitable investments.the county _the amount of the county's gen- strronat gy has been predicatewho also told the d on in-
eral fund budget, the suit main- terest earnig rates to continue to
The lawsuit also accuses the tains. remain lawnn
brokerage of violating a state con-
stitutional provision forbidding Merrill "abused the trust and The supervisors �merely ap-
counties, cities, boards of educa- confidence of the people by per- , plauded the historically high
tion and school districts from bor- mitting and encouraging". invest- yields generated during.Citron's
rowing more money in .any year ments by the county fund that tenure and urged him to continue
than their total annual revenue were "neither authorized by law 'his policies.
without a two-thirds approval or suitable for taxpayers," Board "For the Board of Supervisors
from voters. of Supervisors chairman Gaddi H. _ to now accuse Merrill Lynch is dis-
0 at best, and an abdica-
tion of their own responsibilities in
this matter,"the brokerage said in
a statement.
"For years they reaped high re-
wards.Now they want to deny the
risks.. In effect, they're saying:
`Heads we win,tails you lose."'
The federal lawsuit, filed in
Santa Ana, is the latest of more
than a dozen already filed by the
coi1nty against Merrill Lynch.
0
Citron Shifts Blame for Fund Fiasco
Citron told the Senate Special that brought down Orange Coun- "In retrospect,a fund such as
Orange County's Committee on Local Government ty's fund. ours could have a small board of
ex-treasurer faults Investments."That is how the situ- But Michael Stamenson, Mer- advisers,"Citron said.
ation grew that required me to try rill Lynch's top municipal invest- Year after year,Citron gener-
supervisors, broker to maximize the returns." ment salesman,told the committee ated high returns on the fund,
But Gaddi Vasquez, chairman that neither he"nor anyone else at which invests money for Orange
of the Orange County Board of Su- Merrill Lynch designed or struc- County and 186 other government
By Greg Lucas pervisors, told the committee no tured the county's investment entities, including many school
Chronicle Sacramento Bureau members of the board publicly or strategy or controlled the county's districts.
Sacramento privately pushed Citron to create investments—Mr.Citron did." But to invest more money,Cit-
Orange County's multibillion- higher yields. Citron said that large sales of ron borrowed roughly$2 for every
dollar financial debacle was caus- Citron's assistant, Matthew taxable notes and other invest- dollar in the fund, which at its
ed by pressure from supervisors Raabe,said he felt no pressure to ment actions he took were routine- height contained$8 billion.As in-
eager to maximize investment maximize yields until June 1994 at ly approved by the board with lit- terest rates rose in 1994,interest
profits and bad advice from Mer- a meeting with the county's bud. tle or no debate.He said the board payments for the fund spiked at
rill Lynch,former Treasurer Rob- get adviser. Vasquez said he was requested that he no longer per- the same time brokers sought
ert Citron told a state Senate com- unaware of that meeting. sonally present his annual state- more collateral.
mittee yesterday.. Citron also blamed the fund ment of the fund's condition but
With his lawyer at his side,Cit- losses on his reliance on advice simply submit it to the board. The county declared bankrupt-
ron described a county Board of from Charles Clough, Merrill Citron told the committee he cy in December and since then has
Supervisors that provided scant Lynch's top analyst, that interest never relayed to the supervisors estimated its losses at$2 billion.
scrutiny of his risky investment rates would fall or stay flat. that federal securities regulators Citron has resigned.
strategy, hungry only for high "In retrospect,I find I was not conducted a 1994 inquiry about his
yields on the county's investment the sophisticated treasurer I investment practices. Ninety-five percent of the de-
portfolio to offset shortages in the thought I was," said Citron, who Eli Broad, an adviser to the rivatives in which the county in-
county's budget. added that he favors legislation committee,said that Citron wield. vested were sold by Merrill Lynch.
"There was great pressure put that would limit the ability of local ed"absolute power"over the fund Thanks to low interest rates, the
un me and others to maximize our treasurers to use some of the spec- and asked if that was a prudent derivatives had the highest yields
returns for budgetary reasons," ulative investment approaches strategy. of the portfolio. ^�
•
u
`There was great
pressure put on
me and others to
maximize our
returnsfor
budgetary
reasons'
ROBERT CITRON,
ex-Orange County treasurer
Br ASSOCU r£D PRESS
In March 1993, Merrill Lynch interest rates could savage the i
offered to buy back all the deriva- county's portfolio—Merrill Lynch
tives. continued to pitch interest rate-
sensitive securities and forecasts
"This would have enabled Or- of lower interest rates.
ange County to lower its risk pro-
file at a profit,"said Stamenson in Even after interest rates rose in
his written statement. Citron de- early February 1994—the first of
clined the offer. six increases during the year
Merrill Lynch recommended no
But Citron said that by late 1993 changes in strategy,Citron claim-
-despite its warnings that higher ed.
i
Orange County Lawsuit Seeks $2 Billion
From Merrill Lynch Over Pool Debacle
By Bid Alurruo
LOS ANGELES—Orange Coun- ton"to invest public funds in volatile
ty,Calif..fled a lawsuit late yesterday financial instruments that were not errs
asking for mere fisc$2 billion in dam- thorired by law one suitable for the in•
ages from Mertill Lynch fk C'TU vestment of taxpayers'dollars"
suit,filed in U.S.Bankruptcy Court in MW wit.rumotad m be in the worts
Santa Ana.Calif..said the New York for several weeks.was widely arsfic''
City-based brokerage firm"abused fin ppated by market observers.Earlier
trust and confidence"of county Mai- Lynch
harms V iigsins,a Merrill
LynchLydspolraaosR katal-if the nasty
dents.
The county charged that Merrill sues Merrill Lynch.we will contest
Lynch permitted and rmomaged cots, those allepbOm vigaoudy:'
ty
rix collator Robert L Cit- In aniieip lopd
an of Ison'the bro.
ty kerage firm on Tuesday released a
---�.• number of documents sbowing that it
gave twmeroua warnings over several
yeas to Croon that his highly lever-
aged investment atntegy was rialry.
Nrr as r ofagoL COUiPl'1//ys!1
Fridsy.}scary 13.199! ' Tui i"ioid - (209)If
Oranpa Count/ treasurer;Jeff Leifer,a financial ad- "He'll be under oah.He is testifying tum Orange County's credit prospects
O J visa to the county;Gedale Horowim under subpoena." are gloomy and additional defaults am
C--&WP%—P.arpp a managing director at Salomon However.Job-oa said,Stamenson likely.
In other developments yesterday. Brothers,which is helping the coun- and all other participants would have A report by the tax-exempt fixed in-
Merrill Lynch broker Michael G.Su- ty sell its portfolio's securities;and, the option to plead the Fifth Amend- come research department at Kemper
menson will testify before a Califor. representatives of local governments ment.a constitutional protection Securities.Inc.sad implications for
nia Senate committee investigating the that invested money in the ill-fated against self-incrimination. investors will not be clear until the
Orange County investment pool deba- pool. Johnson said the committee has the county submits a debt reorganization
cle next Tuesday,Wiggins said Yesterday,Scott 8.Johnson,chief power to compel testimony,but"if you plan.
Stamenson,the chief investment counsel for the Senate committee.said compel testimony,then you end up Separately,the municipal bond de,
salesman to Citron,resigned shortly Merrill Lynch officials told him that granting immunity." patment of Sandler O'Neill&Part-
before the county filed for bankruptcy Stamen."will be available for ser- Johnson said the committee was am,L.P.said in a report tum the coun-
protection Dec.ti after a$2.02 billion vice of process on Monday,and will urged by U.S. attorney Nora M. ty's credit outlook"is grim at best"
loss on its investment pool. be here to testify on Tuesday.I have Manella to not gram immunity to any Michael Johnston.director of re.
71ne Merrill Lynch broker's willing- not ever heard from Stamenson or his participants.Manella wrote state Sen. search for Sandler O'Neill,said yes-
ness to testify was called into question attorney personally" William A.Craven,R-Oceanside,on terday tum the firm is concerned that
on Wednesday when the Senate Spe- "He is going to be there:'said Wig- Jan.4 that"a gent of immunity by the Orange County has not shown"any
tial Commium on Local Government gins,the Merrill Lynch spokesman. Senate could creme a serious impedi- willingness to make difficult decu-
Investments—which will hold the "We've told them that he will testify mem to the federal criminal prosecu- sions:'such as rasing taxes or mak-
hearing at the state Capitol—issued voluntarily.If they want to give him a tion of any person who testifies under ing severe budget cuts.
a press release saying that Stamenson subpoena,he will testify under sub- such a grant of immunity"Craven co- "If they don't really have a serious
"continues to evade a subpoena" poena.This is a tempest in a teapot chairs the committee with Sen.Lucy commitment to resolving this problem
Besides Stamenson,scheduled bene." Killea. ...I am not sure why the bond market
hearing participants include Citron; Johnson said Stamenson will not be to other developments: would loan them money again:'he
Matthew Raabe,county assistant given the option to testify voluntarily: •Two new research reports suggest said. �
Orange County to Pay $175 Million
Of Frozen Taxes, Heading off Suit
By Michael Utley
LOS ANGELES—In a move ex- Barnard said yesterday he believes
pected to avert a threatened class-ac- Huntington Beach will receive about
tion lawsuit by other local govern- $2.5 million in property tax revenues
ments,Orange County officials plan that will go into the city's general fund
to pay out$175 million in propertyaccount.The planned lawsuit has been
taxes that have been held in the conn- abandoned,he said.
ty's frozen investment pool. Of the$175 million,Orange Coun-
The withholding of the tax money, ty will pay itself$15.5 million.Cities
collected before the county's Dec.6 will receive$22 million.School dis-
bankruptcy filing,sparked a heated war tricts and other agencies will get the
of words between the county and oth- rest.
er local agencies who were prepared "Today's action puts behind us a
to file suit last Friday if the funds were very difficult and potentially con-
not released. tentious issue,"said Lee Bogdanoff,
"We,as well as the 1$6 other agen- the county's bankruptcy lawyer,in a
cies that receive property tax dollars, statement Friday evening.
are happy we are getting our money," "Even more important,however,is
said Richard D.Barnard,deputy city that it provides additional relief to mu-
administrator of Huntington Beach, nicipalities and schools that have been
Calif.—one of the first cities to threat- deprived of critical operating funds for
en county officials with legal action. the past month;'Bogdanoff said.
County officials decided to release
the funds because they were not part
of the regular deposits that local agen-
cies had put into the pool before the
bankruptcy filing.
Those deposits continue to be from
as the county proceeds with its re-
structuring plan—selling off its se-
curities,buying new ones,and mov-
ing ahead with massive budget cuts.
The property taxes were just an in-
advertent casualty of the unprecedent-
ed financial crisis,Bogdanoff said in
an interview yesterday.
"Many of the beneficiaries of those
taxes—municipalities and districts—
were not otherwise participants in the
pool;'Bogdanoff said."This problem
added so many players that we thought
a very practical solution was just to
distribute the funds in accordance with
non-bankruptcy law,finish the case for
these numerous municipalities,and
move on."
"It's part of our damage control ef-
fort;'he said
County officials will go before a
Pkwe am w ORANGE COUM7 page 4
Orange Count 'The Bo.rd of Supervisors went ThOW3unty has given pink slips to
! into close#session yesterday at 10 77 a ees so far,but union lead-
cww,e.+tjrow�r..r s a.an. Pacidi+c standhtir#time and had orssaty y will fight the layoffs in
federal banknWtcy judge on Jan.29 not emotod with an announcement court.,,,,
to selk final approval for the$175 by mhda*e bwa. before the bankruptcy,for- .
million payout.They d6#sot expect Today,the board is expected to met... ty treasurer-tax collector
the judge to have any objections,be- meet publicly to discuss reports from Rio Citron was not the"finan-
cause the payout was negotiated with county doprtnhent heads who have sial "he was made out to be .
creditors,Bog#anoff said. drafted to cut their budgets dhhrih* 24 years in office,accord-
The payments are expected to be in light of a$40.2 million deficit. Ing tw.i port in Sunday's Los An-
made shortly after the judge's deci- That projected deficit has since in- geltr'lea.
sion, and before the end of the creased to$172 million,but the re- Afii"�peviewing Citron's records,
month. vised figuee,released last week,came the navlpaaper said it found that his
Bogdanoff said the threatened law- out too late to be included in the re- inve ' t successes were modest,
suits did not affect the county's de- ports to be reviewed today.Further and_._C_
hie rate of return fell be-
cision"one iota:'The proposal had cuts are expected. - lowprovided by the state's
been on the table a week before any -County officials announced Fri- less `" investntea t fund.
of the agencies started talking about day that they have begun operating This port said Citron netted$1
legal action,he said. an outplacement assistance center to billion his teaure,or about half
"We're ready to go to court and employees who are laid off as a re- the$ billion that the county lost
fight over a lot of things,"the lawyer sult of the financial crisis. d past year.
said. "But this is something that it Thetacility in Santa Ana will pro- lHer,the article did note that
makes no sense to fight aver.Threats vide job information and counseling f1994,Citron earned the
had absolutely nothing to do with it." services to tete estimated 800 to 1,096 cthan$3.6 billion in in-
In other Orange County develop- workers who are expected to lose te the state fund would
ments: their jobs in the coming months. h .9 billion. O
Orange County Should Not Cause
Tower Repeal, Muni Officials Say
By Lynn Stevens Hume
WASHINGTON—Federal regula. municipal market are more far.reach-
tors and municipal market groups said ing than those for corporate issuers.
yesterday they are opposed to a Tower Municipal disclosure requirements,
Amendment repeal or other legislation they said,are flexible enough to cover
aimed at subjecting most municipal w a wide range of issuers that are each
suers to corporate-like disclosure re- governed by different state and local
quirements in the wake of the Orange laws and also require immediate noti-
County,Calif.,debacle. fication to the market of any material
Securities and Exchange Commis- events that could affect municipal of-
sion chairman Arthur Levitt and oth- ferings.
ers testifying at a House Commerce Putman,Gmcn,and others said mu-
Committee bearing said consideration nicipal disclosure requirements and
Of such legislation would be"pterna- SEC enforcement authorities are prob-
ture"before new SEC rules and in- ably sufficient to address any disclo-
dustry initiatives to improve munici- sure concerns stemming from the Or-
pal disclosure are given a chance to ange County controversy.The county
work. filed for bankruptcy late last year af-
R.Fenn Putman,testifying for the ter suffering major derivatives and in-
Public Securities Association.and Jef- vestment-related losses in its multibil-
frey Green,representing the Govern- tion dollar investment pool.
meat Finance Officers Association. But Rep.Christopher Cox,a Re-
said disclosure requirements for the publican on the Commerce Commit-
tee who tepreseas Orange County,told
reporters after the hearing that he sail
• thinks legislation is needed to increase
municipal disclosure.in pan because
federal laws did not require Orange
County official+to disclose their risky
investment stratepes.
Cox said that he is considering in-
troducing lepslnion calling for the
SEC.the Municipal Securities Rule-
malting Board.and others to develop
new disclosure standards that would
"mese closely conform municipal dis-
cleaxrre an corporate disciosure"The
bill,said Cox,would not repeal the
Tower Amendment but would require
mrmieipsl issuYs to make specific cor-
parale-like disclosures,such as the at-
entities in their investment pordolios.
Hoose Banking Committee chair-
man Rep.Jim Leach.R:Iowa,and
Sen.Barbara Boxer.D.-CatiL,have
each skeedy introduced bills to repeal
the TowerAm w-h—
s
Derivatives House within the first 100 days of the more lawsuits'
congressional session. Most of the witnesses testifying at
C-d-df—f— w Markey suggested the bill,which the hearing said that Orange County's
The Tower Amendment,which was Cox introduced on Jan.4,was specif- financial problems stemmed from
added to the Securities Exchange Act ically written not to be retroactive— risky investment strategies that en-
of 1934 in 1973 by the late Sen.John as an earlier draft bill was—so that tailed too much leveraging and market
Tower,effectively bars the SEC and the reforms would not apply to law- risk.
MSRB from regulating municipal is- suits being brought over the Orange "Were 1 a county treasurer or state
suers.Specifically it prohibits the SEC County debacle by investors and oth- connoner I personally would trot lever-
and MSRB from requiring municipal ers. age.l think it's a bad practice:Levin
issuers to file any documents with them "Mis raises the obvious question of said
before seeing bonds. why the sponsors of this legislation SEC commissioner Richard
All of the witnesses at the hearing don't want to subject Orange County Roberts said that while there"are
said that a repeal of the amendment plaintilhfs to the rules they propose to some insuAM in which leveraging
would be burdensome and costly for put in place for the rest of America." may not be a bad thing,"states might
the SEC as well as for stare and local said Mmlicy. Want to adopt policies restricting its
issuers,which far outnumber eorpo- Mukey askt4 Levitt about several use.Roberts said also that state and
rate issuers. provisions of the bill,including one local officials should consider mark-
"Such action would have pro- that wouldreghme the loser of a lawsuit ing to market the securities in their
found effects on the municipal bond to pay an of irs opponem's court costs, investment pools at least once a
market and,given the 52,000 issuers even if the loser is an investor and the month.
of municipal securities,could re- opponent is a big Wall Street invest- "What really astonishes me:'said
quire significant resources to ad- ment banking firm. Levitt,"was the failure of responsible
minister,"Levitt said in his prepared Levitt said that he has"some ques- government officials to consider the
statement. tions and reservations"about the pro- relationship between yield and risk:'
The Tower Amendment,he said.is visions and is concerned they could af- In Orange County,he said,"no one
one of those"contentious issues"in- fect the SEC's mission to"protect the bothered to equate a higher yield with
volving"jurisdictional disputes"that private right of acts^_ 'under securi- a higher risk."
"1 avoid like the plague." ties fraud laws. Levitt said other Orange County-
Rep.Jack Fields,R-Tex.,the chair- At the same time,bcwever,Levitt like crises could unfold in the com-
man of the committee's telecommuni- said he wants to wo t with the com- ing months and that the SEC is
canons and and finance subcommittee,said mittee to come up with legislation that ing to monitor them.But it would be
the municipal market has made great will"address the abuses while pro- "incorrect"to assume the SEC is ex-
strides in improving municipal disclo- taring investors'rights." amining lou and lots of communi-
sure. Con defended the bile.,telling ties.
At the same time,however,Fields Markey."Our capital markets pteaeat- But Levitt said the hearing will be
asked Levitt and other witnesses at ly are burdened with excessive litip- an important reminder to municipal
the hearing for their help in examin- tion."He tried to refocus the Keating market participants that legislation is
ing the differences between municipal on disclosure.saying."rbe bat way an option if they see am viligam about
and corporate disclosure require- to protect investors and the employees mating disclosure and other require-
ments. of firms...is better disclown...not mems.
Meanwhile.Rep.Edward Markey.
DMus.,the former chairman and cur-
root ranking minority member of the
subcommintic renewed his cad for leg-
islation requiring SEC registration of
conduit bonds.The SEC a worts such
legislation,but municipal market
groups do not.
Green,general counsel for the Port
Authority of New York and New Jer-
sey,said a key problem is defining
conduit bonds.
"We can work on the definition:'
Markey told him.
A Markey aide said after the hear-
ing that he is not sure whether a par-
tial repeal of the Tower Amendment
would be needed,but that Markey
has asked the SEC to draft a bill.
Markey used the hewing as a forum
to blast a securities litigation reform
bill(H.R. 10)proposed by Rep.Cox,
one of several bills the House Repub-
licans have vowed to push through the
Larger Cuts Loom
For Orange County
As New Fund Audit
Shows Big Shortfall
By Michael Utley
SANTA ANA,Calif.—Orange
County officials will have to make even
more drastic budget cuts than first pro.
jected,following an audit report re-
leased late Wednesday showing a gen-
eral fund shortfall of$172 million.
That figure is more than four times
higher than the amount previously dis-
closed by officials in the wake of last
month's S2 billion investment fund loss
and subsequent bankruptcy filing.
"The loss is absolutely real and far
deeper than anyone previously antici-
pated:'said Gaddi H.Vasquez,chair-
man of the Board of Supervisors,in a
packed press conference.
Officials said the heightened fiscal
Plena rum w ORANGE COUNTY page 14
Orane Count players in the Orange County deba- Such an outcome would cost the School Board President Tom
gy cle to appear at a Jan. 17 hearing in county an estimated 74%of its prin- Burnham told Reuters that the dis-
C-1inreeJ—f-1page Sacramento. cipal. trict may also consider issuing new
crisis may cause the county to miss Those subpoenaed include former A newly formed committee repre- debt,laying off employees,and mak-
scheduled principal debt payments county treasurer-tax collector Robert senting investors in the pool has said ing other budget cuts totaling at least
through June 1995.The$172 mil- L.Citron,who has resigned;assis- that at least the school districts $800,000 this year.
lion loss is more than 37%of the tant treasurer Matthew Raabe;and should get all of their money back. The district,with$100 million in
county's$463 million in annual un- Michael Stamenson,a broker with "We can't guarantee that,but the frozen county pool,is consis-
restricted revenues for fiscal 1995. Merrill Lynch who is under investi- that's our goal,"Stan Oftelie,chair- tently recognized as one of the top
wh"ich ends June 30. gation by federal authorities for his man of the committee,told the Or- school districts in the county.
There simply is not enough cash role as a financial adviser to the ange County Register. •Orange County's administrative
flow in the general fund to meet all county. Schools and other special districts and judicial offices have reportedly
of our obligations,"Vasquez said. The committee joins numerous are required by law to invest their been flooded with calls from people
"Yet we are committed to doing other county,state,and federal agen- funds with the county. who put up cash for bail money and
what is right while dealing with the cies investigating the events leading County officials have already said have not been able to get their mon-
deficit'' up to the Dec.6 bankruptcy.Crimi- they are prepared to sell off numer- ey returned.
The supervisors adjourned yester- nal charges are being explored by ous assets to help meet their finan- "The system has come to a
day's meeting without taking any ac- the county district attorney. tial obligations.Suggestions include screeching halt:'Gary Leach,coun-
lion.They are scheduled to recon- Also on Wednesday,the county selling off John Wayne Airport,pri- ty claims manager,told the Los An-
vene today at 1:30 p.m.Eastern stan- General Services Agency said 72 of vatizing county departments,and geles Times."They are all going to
dard time. its 1,100 employees received layoff taking in trash from neighboring get their money.We just don't know
Following the audit report by the notices. communities. when"
accounting firm Arthur Andersen& "They got pink slips today,telling The county is also attempting to •A Los Angeles County supervi-
Co.,officials laid out a tentative pro- them they have 14 days:'Bert Scott, generate much needed cash by sell- sor who is also chairman of the
poral for recovery that includes debt director of the agency,told the ing off portions of the investment county's massive Metropolitan
refinancing,additional cuts in ser- Reuters News Agency.The layoffs portfolio,but Wednesday's sale did Transportation Authority said Thurs-
vices and personnel,convincing and early retirements are expected not go as well as expected,officials day he has asked for a comprehen-
creditors to share in the loss,and ftl- to save the agency$4.5 million, said. sive review of the authority's bond
ing numerous lawsuits against the Scott said. Salomon Brothers Inc.,acting as underwriters and financial advisers.
county's previous financial advisers. The layoffs are among the first in the county's broker,sold$258 mil- "The Orange County fiscal crisis
The proposal was not complete, an estimated elimination of 800 to lion face value of corporate notes on has raised questions about the role
lacking specific numbers and time- 1,000 employees.That estimate,how- the open market Wednesday.But the of bond underwriters and financial
lines.Officials said they would an- ever,was made before Wednesday's firm put off selling an additional institutions at every point in the rise
nounce those details as soon as pos- announcement of greater losses. $200 million because of unfavorable and fall of Orange County's for-
sible. Bruce Bennett,the county's bank- market conditions. tunes;' said supervisor Mike
The grim outlook and the restruc- ruptcy attorney,said the county it- Previous sales last month and ear- Antonovich in a written press state-
turing plan were outlined for a Board self—separate from the 186 other ly this month had gone well,with ment.
of Supervisors that includes two new local governments with funds in the Salomon Brothers getting better- "Because many of the underwrit-
officials—Marian Bergeson and investment pool—has lost at least than-expected prices. crs also do business with the MTA,
Jim Silva—who were sworn in ear- $700 million on its$2.4 billion in In other Orange County develop- the public deserves a complete«=
lier in the day. the pool. ments: view of their actions:'he wrote.
"It's a challenge unlike any other But there have been many calls for •The Irvine Unified School Dis- Antonovich asked the authority's
have faced:'said Bergeson. the county to swallow the entire$2 trict said Wednesday it is considering executive officer to issue a report on
Meanwhile,the California Sen- billion loss on its own,because selling property,including its head- his findings at the next meeting of
ate's Rules Committee issued sub- county officials were the ones mak- quarters building,to offset potential the transportation authority board,
poenas Wednesday requiring several ing the risky investment decisions, investment fund losses. on Jan.25. U
•
Orange County Must Issue Debt
To Cover Expenses, Officials Say
By Michael Utley
LOS ANGELES—Two top offi- amount.
cials said over the holiday weekend Supervisor Marian Bergeson, who
that bankrupt Orange County will have took office Monday,said yesterday that
to issue debt in coming months to meet she heard about their comments,cir-
its operating expenses. culated on the Reuter news service,but
The statements came as the county had not been notified of any official
took additional steps to avoid threat- debt issuance plans.
ened legal action from labor unions "With the intensity and the need for
and local governments with deposits cash flow,there probably will have to
in the now-frozen investment pool. be some line of credit extended,"
Thomas Uram,director of the coun- Bergeson said."How we go about that
ty Heath Care Agency, said Monday I guess is going to be the big question."
that due to the county's projected op- County officials estimate that they
erating deficit by the end of fiscal 1995 will be able to cut about$40 million
on June 30,it will be forced to borrow. from the fiscal 1995 budget over the
Supervisor William Steiner said the next six months. But that is not ex-
same late Friday,adding than Ae coun- pected to be enough to offset the$120
ty will probably issue tax and revenue million in lost interest earnings from
anticipation notes. He did not give an the investment pool.
The county,through its financial ad-
viser Salomon Brothers, is in the
process of selling off portions of its
portfolio to generate much needed cash
following a$2.02 billion loss due to
rising interest rates.
Despite the sale, "we are going to
have to borrow money;' Uram told
Reuter."It appears we are going to be
in a deficit:'
"I think we'll sue our way, borrow
our way, and cut our way out of this
mess,"Uram said.
To head off mounting legal action
from its largest labor union,the board
of supervisors on Friday eased the re-
quirements for early retirement,hop-
ing some employees would leave their
jobs before layoffs are needed.
The supervisors agreed that the
county should pay retiring employees
for all accrued vacation and sick time.
That payment was not being offered
prior to Friday because officials were
worried about coming up with the
money.
"We are offering county employees
who elect the early retirement option
a chance to protect themselves from
the uncertainties of the bankruptcy
Please turn to ORANGE COUNTY page 5
•
Orange County
Continued from front page
process," board chairman Gaddy H.
Vasquez said in a prepared state-
ment. "We believe that the plan is
fair to both employees and the coun-
ty.t
Union leader John Sawyer Jr.,
however, said the 11,000-member
Orange County Employees Associ-
ation is not backing down from its
threatened lawsuit challenging the
county's planned layoffs.
Sawyer said provisions for vaca-
tion and sick pay are already in-
cluded in the labor contracts that
county officials are attempting to ig-
nore.
"The board continues to act uni-
laterally without meeting with
OCEA and without following provi-
sions of the labor agreements,"
Sawyer said. "This can only make
matters worse for employees and for
the public they serve:'
If the county continues to ignore
the contracts,Sawyer said,the union
will file suit.Sawyer estimated that
the county will lay off 800 to 1,000
employees in the next six months.
County officials have said they
plan to institute the layoffs on a mer-
it basis, not according to seniority.
Sawyer said'that is a violation of
union contracts.
The Orange County Operations
Management Council,created in the
days following the county's Dec. 6
bankruptcy filing,recommended the
vacation and sick-time payments.
County sheriff-coroner Brad
Gates, chairman of the three-mem-
ber team, said the council is com-
mitted to helping county employees,
in addition to cutting the budget.
"We continue to explore all po-
tential methods of reducing county
costs and increasing its revenues,"
Gates told the board of supervisors
Friday.
The board has given department
heads until Tuesday to come up with
$40.2 million in cuts,most of which
are expected to be achieved through
layoffs. 0
t
THE PHANTOM
OF ORANGE COUNTY
Little-noticed financial adviser Jeff Leifer is on the hot seat
The great Orange County bankruptcy and administration for the Orange
drama has a cast of thousands. Sur- County Transportation Authority,says
rounding the' protagonist, former Leifer was hired in part to review the
County Treasurer Robert L. Citron,are offering documents: "We were being
municipal officials, Wall Street brokers, advised in terms of what needed to be
and lawyers galore. in there—full disclosure in terms of
But so far,one important player has flow of revenue in our case back to
escaped much notice:Citron's financial 1992."
adviser,Jeffrey Leifer. The head of a Leifer began his career at Erlich-
tiny Santa Monica(Calif.) firm, Leifer Bober & Co., a Los Angeles-based
served as Orange County's most impor- bond house no longer in existence,
tant debt adviser in 1993 and 1994 and before joining First Interstate Bank.
advised on most of the county's largest He worked in its now-defunct pub- .
municipal-securities offerings. He is lic-finance unit and was registered
among those being investigated by the with the SEC as a broker. In 1959,
Securities & Exchange Commission, he launched Leifer Capital.
say sources close to the probe.The SEC ._.,.r .. .
wants to know whether Leifer ~' `'ri"
reviewed offering statements to be
distributed to investors and adequate-
ly disclosed information, particularly ` ' " ` •
about a$600 million note offering last :
July.The proceeds of the offering were
lieile"r �`Fll!#
invested in the Orange County invest-
ment pool,which later reported losses 11=""_W.
of more than$2 billion.A key question:
Did the statement for the notes suffi-
ciently portray the risks of investing in i
the highly leveraged fund?
Leifer,through a spokesman,denies h !
he had any responsibility for public dig- Add •
closure and. due diligence, claiming
that was the responsibility of "other adWdeW
>
professionals."He is probably referring tw
�,.
to Merrill lynch&Co.,the underwrit-
er of the$600 million issue.The SEC is
also investigating Merrill for adequate -
disclosure. A Merrill spokesman says lnMAP- 'I'll ISIVS&IS
the firm fully disclosed all risks and is Wdtwl I&*
cooperating with the SEC. By Qct &*(t, &*-:''
ovE nlawr. Yet some of Leifer's other reeoe� d .4 biRle�e .
municipal clients say one of his main adviser o&73%of .. : -. t
jobs was reviewing offering-disclosure
documents for financial accuracy. In two i
cases, they say, Leifer oversaw official
statements, which are the municipal C'
equivalent of prospectuses, on behalf of bee�of hW basso iit
his clients. Rodney Dole, controller for imeaufted f=&sm
Sonoma County, says that in the five
inveataut info 4etl5ee.
note issues that Leifer advised them on
over theast four ears it was"one of
his main responsibilities to assist us in Lsme by l lmffl and
sus. .
preparing the official statement." DATA:WMM WK SMMWnsowt: �,=
cxSOMKV19 , i
James Kenan, director of finance
Recently,he hired Ronald S.Rubino,an
influential former Orange County bud-
get director.His friendship with Citron
blossomed,and Orange County became
his biggest customer.
By 1994,he was advising the county
on most of its large debt issues. Local
officials say Leifer was known for
negotiating good prices for his clients
and was always available to speak to
their gatherings about issuing debt.
DIsTANCL It won't help Leifer that
Merrill is busy portraying itself as a
mere technician that simply executed a
plan Citron and Leifer had mastermind-
ed. Merrill is trying to distance itself
from Citron and;Leifer, despite the gi-
ant firm's three roles visa-vis Orange
County: as underwriter, lender to the
investment pool that was run by
Citron, and as a
,e.
broker of investment
products to the fund. "We were never
the investment adviser to Citron,,'says
a Merrill spokesman..
What could help Leifer immensely is
that the responsibilities of financial
advisers are so ill-defined.Such advis-
ers arose in the public sector to act as
impartial consultants to bond issuers.
Their duties typically include advising
municipalities on what form of debt to
issue and conducting a search for the
best underwriter at the best price.
The bigger issue is that anyone can
become a financial adviser."No regula-
tory structure 'touches them at all,"
says Christopher Taylor, executive
director of the Municipal Securities
Rule Making Board, a self-regulatory
organization that oversees municipal
offerings. Leifer Capital, like most
independent financial advisers, is not
registered with the National Associa-
tion of Securities Dealers.And courts
provide little legal guidance, since
most bond-related litigation concerns
corporate debt,which doesn't use finan-
cial advisers.
With Washington gearing up to.focus
on Orange County,Leifer's responsibil-
ities—and those of financial advisers in
general—are likely to move into the .
spotlight.
By Nanette Byrnes in Los Angeles,
with Leah Nathan Spiro in New York
Before the Fall Indeed, when Goldman. Sachs & Cu.
officials voiced criticisms of hissnvest-
ment practices in
Hubris and Ambition October 1993, hedashed off a harsh
1 letter to the firm.
In Orange County: i .4 Goldman's bankers
"don't understand
' lty the type of invest-
i Robert Citron's Story ment strategies that
we are using," he
How the Treasurer Rebuffed woe, adding
sugg st
that you not seek
Many Efforts to Question 3 doing business"
His Doomed Strategy County.
with Orange
� gy Rnbert L.Citron Y
lits assertions
that he knew better than other investment
Now He Blames Merrill Lynch professionals were legendary among peo-
ple who dealt with him. Chriss Street, a
Corona Dei Mar investment banker, re-
By SARAH LuHmAN calls asking Mr.Citron in July 1993 what
And JOHN R.EmSHwILLER would happen to his highly leveraged
Staff Reporters of THE WALL STREET JOURNAL portfolio if interest rates rose. The trea-
.SACRAMENTO,Calif.—Robert L.Ci- surer insisted that they wouldn't. Mr.
tron,stuttering and subdued in his muted Street asked Mr.Citron how he knew."I
gray suit and bifocal glasses,looked every am one of the largest investors in
bit the victim yesterday. The deposed America,"Mr.Citron replied,according to
treasurer of Orange County, the man Mr.Street."I know these things."
whose vaunted $7.4 billion investment Although Mr.Citron's world seemed to
portfoliowasravaged by$2billion inlosses crash suddenly last month, it actually
last month,seemed meek and hesitant as began unraveling more than a year ago,
he told state legislators that he had been when rates did in fact begin to rise.As the
led astray by Merritt Lynch&Co. months wore on, he took on ever-riskier
"Due to my inexperience, I placed a investments in an apparent bid to prop up
great deal of reliance on the advice of his portfolio. And he showed even more
Rallying Cry concern about keeping control over his
Wail Street investment strategists are investment strategy and decisions.
Eccentric Behavior
rallying around a Merrill Lynch expert
who is under fire for Orange County, All the while,the occasionally eccentric
Calif.'s financial woes.See Heard on the treasurer—a man given to rambling dis-
Street on page Ci. courses and flashy displays of turquoise
market professionals,"he testified during Indian jewelry — began acting more
a hearing on the debacle,which propelled strangely.By the end,when he was forced
the county into bankruptcy court and now to resign on a December Sunday,county
threatens to prompt massive layoffs of officials were so concerned about his men-
teachers, policemen and social workers. tal state that they made sure a mental-
"At least to this lay person,Merrill Lynch health counselor was on call for him.Mr.
acted as a financial adviser to Orange Citron seemed "isolated" and "kind of
County. ... In retrospect, I wish I had paralyzed"by last fall,says Peer Swan,a
more education and training in complex board member of two local agencies that
government securities." invested in Mr.Citron's investment pool.
Repeatedly during Mr. Citron's testi- To be sure, for every investor and
mony—his first public statement since he broker who expressed concern about Mr.
was forced to resign in December — he Citron's strategy,there were many more
portrayed himself as an unsophisticated who were happy not to question his
local official who was easy prey for Merrill methods as long as he was doing well."It
Lynch.The 69-year-old executive needs to didn't really matter to me"how he got such
show that he isn't responsible for the high returns, says Mark Weiss, former
massive losses; he is under civil and treasurer of the city of Orange."I figured
criminal investigation by at least three they knew what they were doing."
state and federal agencies. Such attitudes helped Mr.Citron build
Yet an examination of his record shows himself a personal fief.Socially awkward,
that, throughout his more than 20-year with an undistinguished early career in the
career, Mr. Citron presented himself as private sector,Mr.Citron landed the trea-
anything but"inexperienced"and a"lay surer's post in 1973 and decided he was
person."Indeed,in interviews with dozens going to be the best county treasurer in the
of people who know him,a picture emerges country,
of a man brought down by hubris and It seemed,at first,an ideal match.Mr.
ambition,a man who lashed out at those Citron,who lives with his wife of 39 years
who questioned his strategies and who in a modest Santa Ana home,toiled long
sought to impose iron-fisted control over hours.He spent most of his time behind his
his investment decisions, desk, which was adorned by a bronzed
Please 9Lrn to Page A8,Column t
Continued From First Page
Discovering Leverage
lump of horse manure from Traveler,the Mr.Citron also discovered the lure of
mascot of the University of Southern Cali- leverage:If he could make money for the
fornia,where he attended classes in the county investing the funds it had,he could
1940x.Uncomfortable in a crowd,the only make even more by borrowing additional
time he seemed to relax at the treasurers' funds and investing those—as long as the
dinners he had to attend was when he investments had higher yields than the
gathered a few people around the piano to interest rates on the money he borrowed.
sing "corny standards" from the 1940s, Mr.Citron thus began to pump out ever-
says Norm Fullerton,treasurer of Merced higher earnings. From fiscal 1984 to the
County. year ended June 30, 1994,county invest-
The Orange County treasurer's job ment-portfolio income rose nearly fourfold
wasn't exactly high finance.Records were to 5666 million.
kept on index cards, ledgers and even a `We have perfected the Reverse Repo
wail calendar,Treasurers were restricted procedure to a new level,"Mr.Citron said
from investing in anything but the most in one annual report."We are exulted that
conservative vehicles. All in all, the job we are continually able to earn high inter-
seemed to be in keeping with Mr.Citron's est earnings way above the current'mar-
personal style.The treasurer,who regu-, ket,'"he wrote in another.A third said:
larly divvies up lunch tabs to the penny on "The evidence strongly indicates that the
his wristwatch calculator,is so conserva- investment policies of the Orange County
tive in his private investments that, ac- Treasury are superior to the vast major-
cording to his testimony yesterday,he has ity"of other public portfolio managers.
never owned a share of stock in his life. Knowing No Limits _
But early on, Mr. Citron set out to But while he boasted about his abilities,
remake his sleepy office.He was one of the Mr.Citron didn't seem to understand his
nation's first county portfolio managers to own limitations, say people who have
use a Telerate machine.Before the days of worked with him. "The real clue to Bob
multiline phones, he had a row of color- Citron is that he knows 300/6 of what he
coded telephones mounted on his office thinks he knows,"says Henry Griffiths,a
wall,each directly connected to a different former Merrill Lynch salesman who dealt
New York brokerage firm. He hired a with the treasurer from time to time.
former engineering professor to develop a "When you asked Citron about his strat-
software program to precisely forecast egy,he had the words down but he didn't
cash flows by matching investment matu- have the concepts."
rities to the cash needs of local agencies, Mr.Citron laid out his strategy to the
He consolidated so much power over his county's board of supervisors every year in
office that in the mid-1970s,a county grand long, rambling oral reports that some
jury took notice.During a routine audit it members say they found incomprehensi-
was conducting,the grand jury suggested ble.Finally,they told him to file written
that county supervisors"exercise greater reports instead, but those weren't much
control" over the treasurer. The report different.As interest rates rose last fall,
was ignored. for example,he argued in a Sept.26 report
Riskier Investments that they wouldn't rise much more:"We do
Still,to be a bigger player,Mr.Citron not have the large inflationary wage in-
needed a bigger playing field.Moreover, creases,runaway building,both in homes,
as a result of Proposition 13,a 1978 meas- commercial, and those tall glass-office
ure that limited California taxes,he was buildings. ... Few, if any, tall office
under pressure to earn more money for the buildings are being built,' he wrote.
county to make up the slack.So starting in Did anyone notice that Mr. Citron's
the late 1970s,he lobbied the state legisla- reasoning didn't make a lot of sense?Well,
ture hard to expand investment powers for yes,says Thomas Riley,who earlier this
county treasurers.He wanted them to be month retired as the board's chairman.,
able to invest in riskier and more exotic But Mr. Citron's reports had been so
instruments, unintelligible for years that officials just
His lobbying efforts helped greatly lib- ignored them, Mr. Riley says. He adds,
eralize state regulations,Now he was able "He would go on and on,and no one much
to invest in,among other securities,"re- understood what he was saying."
verse repurchase"agreements —and he Occasionally,Mr.Citron himself didn't
did so in a big way.Those arrangements seem to know what he was saying.During
allowed the county to sell a security to a an interview a few years ago,he showed
purchaser while promising to buy it back In off his investment style for a reporter by
the future at a higher price.Meantime,the ringing up Wall Street brokers on his bank
county invested the proceeds with the aim of telephones,asking,"What do you have
of getting an even higher rate of return. for me today?"and explaining as he went
Mr.Citron took enormous pride in his along what he was doing."Now I'm talking
legislative victories."He'd say,'Well,I'm to Merrill. ...Now I'm talking to Solly
the one that wrote the legislation to make [Salomon Brothers Inc.]."Minutes later,
these types of investments possible,'" he was forced to sheepishly call back one of
says Mr. Fullerton, the Merced County the brokers: He.had accidentally bought
treasurer. bonds he didn't want.
Wall Street firms took advantage of
what they perceived as Mr.Citron's hu-
bris,and none more so than Merrill.Over
the years,the giant investment firm had
become an integral part of his investment
empire, underwriting major Orange
County bond offerings,lending the money
to leverage.the county's holdings, and
introducing the treasurer to ever-riskier
and more-esoteric investments.
Merrill's lead salesman on the account
was a smart,smooth-talking broker named The auditor also recommended that
Michael Stamenson. Ten years ago he there should be more oversight for any
helped sell the city of San Jose on a failed "risky or unusual transactions"—at least
leverage strategy using reverse repur- the third time such a suggestion had been
chases that the city says cost it$60 million. made during Mr. Citron's tenure. Mr.
But the San Jose experience didn't give Citron,y a written reply,said such terms
Mas"risky"or unusual"were"difficult for
Mr.Citron any pause.In a 1985 letter to a
us to objectively evaluate," and that
state legislator,he proclaimed he wasn't "transactions that are usual for us may in
worried about the incident,and that"no- fact be unusual for others."
body knows more about the San Jose
situation than I do." A First Warning
'Imperialistic and Dictatorial' As interest rates fell sharply in 1992 and
When some investors began to question 1993,Mr.Citron's highly leveraged portfo-
his investments,though,Mr.Citron lashed lio looked golden.But below the surface,
out at them. "He was imperialistic and there were signs of nervousness even from
dictatorial."says Bruce Moore,a former some who helped design the strategy.
member of the county retirement board. Beginning in late 1992 and through
Mr.Moore locked horns with Mr.Citron in early last year,Mr.Stamenson and others
the mid-1980s, after he says Mr. Citron from Merrill Lynch began warning Mr.
refused to discuss investment practices; Citron about the"price volatility"of the
the county Board of Supervisors ended up Orange County portfolio and the potential
taking away control of the then-51.4 billion losses it faced if interest rates began
retirement fund from the treasurer. rising,which they did in February 1994.In
"If you wanted to know what Bob was early 1993, the broker even offered to
doing,maybe he'd tell you and maybe he repurchase the more interest-sensitive se-
wouldn't," adds Robert E. Thomas, a curities Merrill had sold to Orange County.
former county administrator who remains The firm says that its nearly$3.5 billion
on the retirement board. offer would have left the county with a 8100
As his portfolio grew,Mr.Citron again million profit..
shrugged off recommendations for greater Mr.Citron wasn't in any mood to sell.
outside scrutiny of his investment prac- He wrote back that he was"aware of the
tices.A 1987 report by the county auditor vicissitudenary [sic] nature" of some of
praised the treasurer's yields,but said it the county's investments, according to a
would be "prudent" to set up an invest- letter recently released by Merrill. (In
ment oversight committee that included yesterday's testimony,he added that a top
other county officials.In a reply letter,Mr. Merrill official had assured him that inter-
Citron argued that such a committee could est rates would stay low for years.)
"materially affect interest earnings" by By early 1994, rising interest rates
removing investment responsibilities weren't Mr.Citron's only problem.He was
"from those most capable to perform this facing his first contested election in 20
important task" — that is, himself. The years. His opponent, John Moorlach, a
committee was never formed. Costa Mesa accountant, based his cam-
"The treasurer's office was his fief- paign almost completely on Mr. Citron's
dom," says Bruce Nestande, a county investing practices."A public official in a
supervisor from 1981 to 1987. fiduciary role should not have made such
Threatening Libel risky investments,"Mr.Moorlach said in a
If Mr.Citron was dismissive with col May 31 letter to the county supervisors.
leagues, he could become furious at out- Top county politicians — all Republi-
side criticism.In 1992,Mark Robles,a local cans—rallied around Mr.Citron,their lone
manager for the brokerage firm A.G.Ed- Democratic colleague.Yet Mr.Citron took
wards&Sons,drafted a list of questions for the challenge hard. Gary Granville, the
the treasurer about county investing poli- county clerk and a longtime friend,called
cies,on behalf of several local municipali- the treasurer the day he heard about Mr.
ties."In my experience,when any invest- Moorlach's candidacy.Mr.Citron was too
ment sounds too good to be true,it usually upset to discuss it. "He mumbled some-
is,"Mr.Robles wrote.He added,"I think thing unintelligible" and wouldn't talk
there may be risks which aren't being about it.Mr.Granville says.
adequately disclosed." Incomprehensible Monologues
Mr. Citron immediately fired off an Over lunch at his favorite eatery,the
irate letter to Ben Edwards, the firm's local Elk's club,Mr.Citron began deliver-
chairman, in St. Louis. "Many of his ing long,largely incomprehensible mono-
statements are libelous to the Orange logues on arbitrage,leverage and the like,
County treasurer,"he wrote.Mr.Edwards friends say.Mr.Citron began arriving at
phoned Mr.Citron back."We don't muzzle work later and leaving earlier, says one
our people,"he says he told Mr.Citron. longtime treasurer's office employee.
In his determination to get the highest Mr.Granville says Mr.Citron became
yields,meanwhile,Mr.Citron on at least noticeably more hunched over, "as if he
two occasions purchased riskier securities were physically withdrawing and making
than allowed by state law. The county himself smaller."Mr.Thomas,the former
auditor identified the two instances during county administrator and another long-
a 1991 review of his office,and reported time acquaintance, noticed that Mr. Ci-
that Mr.Citron had made"conscious deci- tron's habit of whistling quietly to himself
sions"to purchase the off-limits securities
in order to "maximize returns." In his
testimony yesterday,Mr.Citron said that
"when it was brought to my attention, I
sold those securities."
through his teeth grew more pronounced The Final Blow
during the campaign. By then,even former allies were turn-
When Mr,'Mooriach's warnings were ing on Mr.Citron.Mr. Swan, the board
mentioned at the treasurer's office one member of two local agencies with$850
day,Mr..Citron dismissed them as"a pack million in the county investment pool and a
of lies,"one employee says.The.treasurer vocal Citron supporter during the election,
agreed to debate Mr.Moorlach on a local quietly pulled out$100 million on behalf of
television station, but then changed his one agency in early November.
mind."He told me it was too painful,"says It was Mr.Citron's own loyal lieuten-
James Cooper,executive producer at the ant, assistant treasurer Matthew Raabe,
station.At one point Mr.Citron said this who helped administer the final blow.In
would be his last race because of the early November,Mr.Raabe privately went
anguish the campaign was causing.him to top county officials to warn of the crisis
and his wife. enveloping the portfolio.In testimony yes-
Mr.Citron won the election last June terday, Mr. Raabe said he had become
with 60%Gra v the vote,but the pain lingered, concerned over the amount of leverage
clu d then ole, who had eventually can- being used in the pool.
cluded there was merited Mr.old friend.rlach's The Raabe alert caused the county to
charges, the of endorsed his old friend, finally hire an outside consultant to thor-
Four months after the election,when myMr. oughly analyze the'investment portfolio.
Granville bumped into him Citron
a county On Dec.1,the county issued a statement
function and sold hello,Mr.Citron ignored that its portfolio had experienced a$1.5
him. "I said 'Hi' twice and he didn't billion drop answer, so I halfway shouted, 'Bob, p in value and that a strategy
hello:'"Mr. Granville says. "He turned was being developed to reposition the fund
his head and said, 'I heard you, Gary.' to protect it against further interest rate
That was it." swings.
Paper Losses 'Nothing Irresponsible'
Interest rates were continuing to rise Mr.Raabe ran the press conference at
and Mr.Citron's investment portfolio was which the statement was issued.Mr.Ci-
piling up hundreds'of millions of dollars of tron,who had circles under his eyes and
losses as he continued betting rates would appeared dejected,said little."I have not
drop—or at least stop climbing.The dam- done anything irresponsible in any man-
age was multiplied by the fact that Mr, ner,shape or form,"he said.The treasurer
Citron had leveraged up the county's$7.4 nervously twirled a large silver and black
billion investment pot to as high as $20 ring on his finger throughout.
billion,thanks to loans from obliging Wail Even then, some county officials ex-
Street bankers.Mr.Citron testified yester- pected Mr.Citron to work his magic. "I
day that he was under"great pressure"by' stili felt he would get his arms around Ithe
county officials to boost earnings: problem)and save the day,"says county
However,the losses were still only on supervisor William Steiner,
paper, and Mr. Citron was apparently Wall Street quickly quashed any such
convinced that he could still weather the hopes.Brokerage firms,nervous about the
typhoon.For years,he had boasted about: security of their loans,began selling off
how he almost invariably held securities' their collateral—the very thing that Mr.
until maturity,when he could cash them in Citron had wanted to avoid.To try to halt
at face value.That way,he explained,he" such a forced liquidation of its holdings,
was able to avoid the losses that come from the county sought bankruptcy-court pro-
selling a security that has been adversely, tection.
affected by a rise in interest rates. By then, Mr. Citron was no longer
He clung fiercely to that philosophy in county treasurer.On the Sunday after the
his last annual report, on Sept. 26. Mr, fund's problems were announced,a group
Citron noted that there was concern over of county leaders arrived on his doorstep
"'paper losses"due to rising interest rates. with a brief resignation letter in hand.Mr.
But he said that the county didn't pian to Citron signed it,visibly shaken.When Mr.
record any such losses and didn't plan to Granville called the next morning to offer
sell its securities" condolences,the former treasurer choked The report served mostly as a ram- up.He was unable to speak.
bling,,at times disjointed defense of his At yesterday's hearing, -Mr. Citron
turned reflective. 'In retrospect, I find
philosophy and career. It ranged from that I wasn't the sophisticated treasurer
quoting George Bernard Shaw about.the that I said I was,"he testified.But Paul W.
fallibility of economists to Harry Truman Critchlow,a senior vice president of Mer-
on the fallibility of leaders and how suc- rill Lynch, saw things differently.Mr.
cessful ones need only be correct 8(R6 of the a
time. I believe that the many years of Citron's portrayal of himself as an ansphisticated investor"Just doesn't hold wa-
consistent positive results of our invest-' ter,"he said in an interview ."If he says
have strategy indicates that our decisions what he did was based on advice from
have been correct much more than i36%of
the time."Mr.Citron wrote. Merrill,he was ignoring most of it.".
After Mr.Citron's testimony,one of the
legislators on the panel,state Sen.Quentin
Kopp of San Francisco, also expressed
skepticism."What he did basically today
is adopt the 'I'm too stupid to know'
defense,"Sen.Kopp said."He is not at all
stupid.".
Merrill Lynch Is Ordered
To Separate County Funds
By a WALL STREET JOURNAL Staff Reporter
SANTA ANA,Calif.—A federal bank-
ruptcy-court judge ordered Merrill
Lynch & Co. to segregate some $220
million received from sales of collateral
on Orange County loans formerly held by
the brokerage firm, but he left unre-
solved the status of an additional $800
million.
While stopping short of granting a
temporary restraining order requested
by the county, the ruling allows the
county to begin discovery to determine
the circumstances surrounding what it
contends was the improper sale of the
$800 million in collateral.Lawyers for the
county asked for the order as part of a
previously reported lawsuit seeking as
much as $3 billion in restitution and
damages from the brokerage firm.
Yesterday's hearing didn't deal with
the.broader legal issues raised by the
county in that suit.But under the ruling,
Merrill has 70 days to try to transfer some
of the legal issues in the bankruptcy
proceeding to federal district court.Mer-
rill has said it will vigorously defend
itself against the suit.
•
THE WALL STREET JOURNAL WEDNESDAY, DECEMBER 7, 1994 . A3
SEC IS Probing taxable notes to borrow about$900 million, unexpectedly,according to a federal regu--
apparently to place into the troubled Or- lator familiar with the memo.When rates
ange County fund. By failing to disclose did rise,. however, they devastated the
that this money would be used to hold Orange County fund,producing the paper.
y derivatives positions, the county and the losses of$1.5 billion.
Orange Count
agencies may have violated the SEC's "Our staff is looking at what represen-.
disclosure rules, a high-ranking SEC offi- tations were made,"the SEC official said:
On Two Front S cial said yesterday. "If he made misleading statements',
"Our Los Angeles office has.been Iook- there's a possibility that you might have a
ing at this for a while," the official said. garden-variety fraud case."
"But our inquiry intensified last week, But despite the SEC scrutiny of the
Agency Seeks t0 Determine when Orange County had its meeting with Orange County mess, the agency isn't
If Laws Were Broken investors. At that point, the L.A. office likely to impose any new rules stipulating
jumped into gear." whether and how cities and counties
In California Debacle SEC investigators are also probing should be allowed to trade derivatives,SEC-
statements that former Orange County officials said. "A blanket prohibition on
Treasurer Robert L. Citron may have the use of derivatives by municipalities
By JEFFREY TAYLOR made to participants in the fund;the SEC wouldn't in my judgment be an appropri-
StaJJ Reporter OJ THE WALL STREET JOURNAL official said.For instance,on March 9,Mr. ate response to the situation," SEC Chair-
WASHINGTON — The Securities and Citron sent a memo to Mary-Jean Hack- man Arthur Levitt said. Added Brandon
Exchange Commission has mounted a two- wood,administrator of the Orange County Becker, director of the agency's
pronged investigation of the Orange Employees Retirement System,which said market-regulation division: "Just because
County debacle, focusing on whether the he had a plan to protect the Orange County these products can produce more dramatic.
county failed to meet its obligations as a fund's holdings if interest .rates rose Please Turn to Page All,Column 6
public bond issuer and whether its trea-
surer violated securities laws.
Cities and agencies that issue munici-
pal bonds and notes are required to dis-
close pertinent information about their
financial health to investors who buy the Continued From Page
losses than other instruments doesn't
securities.Among the factors these issuers mean they're inappropriate for municipali-
must disclose are "their activities as end ties."
users of derivative products,"the SEC said SEC Commissioner Richard Roberts
in a policy statement last March. said his agency shatknd be in the busf-
P Y ness of dictating what kinds of instruments
The $7.5 billion,county-fund invest- cities can and can't use. "I think that's
ment portfolio has plunged at least $1.5 basically a decision for the state govern-
ments to make,"Mr.Roberts said."The
billion in value and last night Orange state governments are responsible for em-
County officials decided to file for protec- powering or limiting what most focal gov-
tion under Chapter 9 of the U.S. Bank ernments can do from an investment per-
p spective. To change that would require
! ruptcy Code. The fund had leveraged its federal legislation,and it would be very
portfolio up to $20 billion, using arrange- difficult to do."
ments known as"repurchase agreements"
and large purchases of derivative securi-
ties.But as interest rates climbed in recent
months,the fund was caught short.
In June and July, Orange County and
other California agencies issued one-year
orange County seeks
Advice on Bond Sales '
By Bloomberg Business News New York State legislators created
Orange County, Calif., is asking the state Municipal Assistance Cor-
some of the nation's top brokerage poration, a bond agency that fi-
firms to devise ways for it to sell nanced the city through its fiscal
bonds to help pay its debts in the crisis.
wake of its bankruptcy filing. Philadelphia also weathered a
Salomon Brothers,the county's fi. cash-flow crisis in the early 1990's
nancial adviser, has sent a request with the help of a specially created
for proposals to 17 municipal bond state bond agency,the Pennsylvania
firms, asking them for plans to un- Intergovernmental Cooperation Au-
derwrite securities sales"in connec- thority.
tion with a restructuring of the coun- "Anything's possible,"said David
ty's financial liabilities." Herships,municipal bond analyst at
Orange County and an investment Kemper Securities Inc. in Chicaga
fund it managed for about 180 mu- "As part of an overall plan it's feasi-
nicipalities declared bankruptcy ble" if the county can identify
Dec.6,after the fund lost more than sources of revenue that would back
$2 billion on risky investments that the bonft
fell when interest rates rose. The Orange County is probably just
fund's assets total about;5.4 billion. trying. to determine,whether bond
Separately yesterday, Orange firms are interested in taking oo
County bailed out two financially what is likely to be a daunting task;
troubled Southern California cities some municipal market participants
that placed money in its investment said : -+.I:
fund.Santa Ana and Montebello each For the time being, the county's
received about $14 million to cover financial advisers are concentra
emergengy payments on their debts on liquidating the pool's investment
and prevent further defaults. holdings to protect the fund`against
Montebello,located in Los Angeles further losses and to raise cash to
County,owes noteholders$25 million paylenders and investova In the last
due on Dec. 30. Santa Ana, the Or- two weeks,Orange County's invest►
ange County seat,defaulted on Dec. meat pool raised $3.34'. billion
15 on a $5.24 million payment. Its through the sale of secures, rain'
bondholders will be paid on Jan.3,an Ing$1.81 billion for the pool W$1.33
oificIal said. billion to-pay back lender&-,_
The Orange County board of su- Orange County solidtO,a bond.
pervisars is considering various: plan from some of the Up oeouritie s
plans to raise money to pay the firms. The 17 companies asked for
thqty's debts,including the sale of
county's John Wayne Airport proposals inclundeckGo�d% Sachs,
and other properties, budget cuts Lehman Brothers; Smi rrtey•
and securities sales. CS First Boston; Pabne W bbel
A bond sale is not necessarily go. Bear,Sterna; J. n 1 y-,- Prudential
r -de ntial
ing to occur,Orange County officials ties; Morgan Stanley-,•i,.A tial
said. The request for proposals Securities; BA Securitiesi.,A.G.E&
"does not constitute a commitment wards&Sons;Dillon,Read;:.Stone A
on the part of the county to effect an Youngberg; Merrill Lynch; Donal&son, Lufkin 8i Jenrette!;
,Artem1#
offering, the three-page document Capital Grou and P
said. pr ryor,_�McClen-
don,Counts
The plan is being drawn up"in the
event the county wants to go to the The,proposal asked underwriters
bond market," said Sandra Stern- to acknowledge that they would be
berg,an Orange Couflty spokeswom- paid fees elnly at compledtin of an
an."There is no offering on the table. underwriting. It also asked each
There is no date or time"even tenta. firm to describe the services It
tively set for a sale. ' would provide and to prwMe its
There are precedents for bond- qualifications,a list of personnel as-
financed bailouts of municipalities, signed to the underwriting anet expe-
When New York City teetered rience in such types of underwrit-
near insolvency in the mid-1990s, ings.
r i u m
How Contra Costa Avoided `Meltdown'
EDITOR:
Some"taxpayers";iuissed.the:lcey°point in the
Orange. County investment"disaster. This has.
caused unnecessary worry about Contra Costa's
financial"health.
There are two>issues here.-One'is investment
rules and risk,that is,the safety of the principal
and earnings.The other is the strategy of barrow-
ing,rooney:to.invest:,.They giust:he:considered
sepsretsly,' t <. +
Most of us are lfomzhar:with the ,phrase;,
"substantial `Int,—SVS pettiaIty •for" .early'
withdraws}."It means that:ifyqu'invest$1,000 in
a 12-month",certificate'of deposit(CD)at 5 percent
interest expecting to earn$50,you can't.earn half
that amountif you.cash in after only six months.
You may just"get your$1,000 back.That is the'
early withdrawal.penalty rule.
If CD*rates go up to.51i: percent six;months
after you invest,you cannot reluvest:to'iLke ad-
vantage of the higher return.Yop aze.30cked in.
- ,r.,.
You lose money if you cash fn earlya:reinvest."
at a higher rate.Of course,youlook smart if CD
rates go down.That is the earnings risk
In the bonds in whichgovernments invest the,.
penalty for early withdraw4ilso canIiidude a
loss of principal,This poteutiia-loss(the`soocallecY:
paper lose" is toiai vafua is,especially great for,.
investments caped+derivatixes;,for which earn'
ings move:up or doWvn fastel;tlan'urtergst rates
Although the value.of26ivativesbef6Waturi
ty moves tip and;dgj4va substantially,4..beld to
maturity,derivatives(atdeast'sk
It 6 nd-held,by:
Contra Costa.Cgiuity)do.not,rzg;incipal
Whether a particular investment choice is good
or bad is,of course xbe subject of endless debate .
that has recently shifted ironi theffinancial press
to the front page.:thanks.to Orang@F. ou�ts
travails.But keep in mind that derivatiy.�4 lone
didn't sink.Orange"County It,was their 644—::
rowing u z , tr, irty `.a
Orange County umo'rtga 4its�nves en n
invested:the loaurproceedsjn:more.investments.
When the value of some:ot:tl ese,mortgaged-in-
vestments fell,belowtbe'amount of the loan they
secured,.thelenders:demanded.additional cash to
protect the loan,When Oiapge:Couuty eeuldrf't:;..
come up with enough cash;theaenders foreclos-;.
ed'on`the mortgag'41tivestments and cashed.
them out early;at:a;loss.Orange County's paper.
loss bemmwa reai:loss""
Why borrow;to•invest?Because you;can make,
money if you.can borrow atlower rates than you,
can earn.You"also.iisk losing money.if your earn
ing rate falls Moreover;yeu:r'isk losing your mor-^
tgaged assets(youi�ollateral)as well,gyou can't'
fulfill your promiseA6 put:up more casb d.the-'
value,:of;the.asset!falls belowe:them
aount of thee,
•loan" s
Contra Costa County,has.seen the value of the
derivative portion,ofdits.investments decUne,',;in.
value,too:But these'assets,,are;not,i t danger of:
being" sold %early: NThey•,.are,:not..mortgaged,
Treasurer Al Lomeli says his:first duty is tq pro-
tect.the principal.His-total$3.50 W' llion.por4olio
is reportedly yt ldiug 4 95 percent You.are fres,
to speculate 8btiut'whether h s.could'do better.,It
is easy toiecond guess:Even.the:Board of Super:.
visors,aay8 theyt;want••to.take a.closer look:-But,
while questiOIDin g:t7easurer Loxneli'sryfelds,you"
have to give,him'.credit fan avoiding;;thie;kind of
borrowing that,.baukruptedOraage�ouktY"
Tazpayers5ieedtakeep separate these admit
telly comp lcsted,issues of":investment ri-l turn•,
and mortgagmg.assetsias they follow this story.
In media' {Iti�tz
?Contra Costa Tazpayera Aea'n,
Merrill Lynch Warned Orange County
Of Investment Strategy Risk,Firm Says
By Brad Altman
LOS ANGELES—Merrill Lynch sure that they were aware of and un.
&Co.released documents this week detxtood the extent of the risks in.
that indicate is 1992 and 1993 for- volved in purchasing derivative secu-
ma Orange County treasurer-tax ml- cities and doing reverse repurchase
lector Robert L.Citron was warned agrermmix:*
by the firm at least a half-dozen The Merrill Lynch aweiaksreleased
times that his investment strategy was Tuesday included copies of corn-
risky. spondence between veteran Merrill
But Orange County officals ignored Lynch salesman Michael 0.Stamen.
Merrill Lynch's warnings,Daniel P. son and Cihvo,
Tully.the New York City-based bio. to March 1993, Stamenson
kerage firm's chairman and chid ex: offered to rtptndsase the derivative so-
ecutive officer,said in an interoffice curitiu that the,firm had sold to the
memorandum sent Tuesday to the county.writing Citron that the securi-
firm's employees in soutbssn Collins- ties might be"volatile,due to lever.
Us. ago"
The utas Trues office made it cies, Citron iniicared his rejection of the
that they had their own outlook.that it offer in a reply to Stsmeason the fol.
was contrary to ours,and that they lowing month::Although that may
would jotlow their own analysis in be an alleged interest rate risk in arae
managing the cotmry's podow,Tu► of securtces,we believe because
of
ty wrote, furore low lowest rata that the
In what marked Merrill Lynch's securities that we now own may be
mat aggtesave seifdetmse an far•the eves mese valuable than they arts to
four-page memo—along with 19 ad- day."
ditionalgages of inion+!doeumeau Tully's memo said firm represent-
-was fuel to news media by the tatives met with the county last Ftb-
rum's torpgrate communications do- rusty and warned them that for ewA
partmeat 100•batis point interest rata increase.
Despite an avalanche of negative the marlru value of derivatives in the
publicity,the firm had previously din- portfolio would drop by$270 mil-
closed few details about its Orange lion.At that meeting,Merrill Lynch
County relationship.Merrill Lynch is suggested strategies the county
under investigation by California and "could implement in a rising law-
federal rtgulam and tapes the specaQ ear rate environment."the memo
of years of litigation over its role in the ssirL
collapsed Orange County investment Rising business raw did na prompt
pool. Merrill Lynchtocad its underwriting
Merrill Lynch has reputedly said relationship with the county.The firm
it acted properly in all its dealings continued to underwrite county ba-
with Orange County,including the sowings,including now-coutrover-
salee of derivative investments cts Cit- sial 5600 million taxable cote
offer-
ron,who coutroiltd a portfolio rep- ing last July.That transaction is the
resenting the assets of 187 county subject of state and federal iuvcsdSa-
agencies,school districts,and cities, cons.Merrill Lynch has said its cons.
He resigned after the disclosure of duct in underwriting the note was
huge losses in the highly leveraged proper
$7.5 billion portfolio that led m the Citron's attorney, David W.
county's and investment pool's back- Wiechert,could nes be reached yes-
ruptey filings last Dec.6.Losses in terday,
the fund are now estimated at$2.02 Merrill Lynch has declined to say
billion. how much it extend from its business
The Securities and Exchange dealings with OranpnCounty.Pub.
Commissiou on Dec.9 subpoenaed lisbat reports have said the faro acted
Merrill Lynch concerning its dealings 280 millim to SIOD million in fan and
with Orange County,and the California commissions.
Department of Corporations is to otherdevelopmeas:
looking for state law violations in •A class action lawsuit on behalf
the county's relationship with the of investment pool participants was
firm. filed Monday in federal district mitt
Tully said the memo was prepared in Santa Asa.Calif.,against Merrill
to correct"a significant amount of Lynch.Citron,and Stamenson,by the
misinformation"contained in me. Schools Excess I iability Pond a oxo-
diaaccounts"re8afdingMerrill sorcusiofCalifornia school disoicu
Lynch's relationship with the coun- that has about$47 million invested in
ty and the role we played as one of the fund.
the broker-dealers with which the •Damage county o[fxialsaetmmced
county did business"over a two- Tuesday that more than 400 county
decade pcn d, workers will lone their jobs in an ef-
"Whije we regret the county's cur. fort to make$41.9 million in budget
trot fiaanial plight.the Merrill Lynch cuts—a Brat step toward covering a
story is a good ort."Tully wrote. S172 million general fund cash shat.
. 'And it is one that will eventually be fall in the fiscal year that ends June 30.
reported.as we an called upon to as, The shordall was caused by lost inter.
sist various regulators and others in est Income from the investment port-
piecing together the true facts sur- folio.
rounding the county's current diffi- •Standard&Pox's Corp.on Thea-
culties." day lowered to speculative-grade is
Tully said Merrill Lynch"neverraungsoofourusuersthat placed
pro-
served as Orange County's finan- reeds of thcir taxable nae borrow
ngs
cial adviser.nor did we create or in the county investment fund:Irvine
direct the county's investment Unified School District.Newpoit-Mesa
strategies.Nevertheless.as with all Unified School District.North Orange
clients,we offered the county our County Community College Distinct.
investment and economic outlooks, and Orange County Board of Educa-
and our views with regard to risk tion.
profiles in light of our interest rate "Riese governments'inability mac-
forecasts." cess cash from the bankrupt pool
The Merrill Lynch official wrote, leaves them with a significantly re-
"As early as February 1992,senior duced capacity to meet their debt re-
Nemlt Lynch managers met with the payment obligations in a timely man-
Orange County treasurer's otfice to en- net."Standard&poor'<<aid.
•
TUESDAY,JANUARY 3,1"S
Orange County Must Borrow to Operate
Deep cutbacks will not make up loss of interest income
Reuters ruptcy on December 6 after dis- "I'm sure Orange County will
• closing massive investment losses find a way. I think we'll sue our
Bankrupt Orange County will in its portfolio. Those losses are way,borrow our way and cut our
have to issue more debt to meet its now estimated at more than$2 bil- way out of this,"he said.
operating needs over the coming lion.
months,a member of the county's County Supervisor William
budget team said yesterday. Orange County should save Steiner also said in an Interview
"We're going to have to borrow about$40 million over the next six last week that the county would
months by downsizing depart- have borrow money.
money,"said Tom Uram, a mem- ments but will not take in$120 mil- In particular,Steiner said there
ber of the county council and di- lion in interest earnings as expec. was a need to issue tax and reve-
rector of the county's health care ted,he said.This will leave the op- nue anticipation notes "because
agency,in an.interview. erating budget in the red at the property tax revenues come In
Orange County declared bank- end of the fiscal year,he said. sporadically."
6 Counties Cited
For Risky Approach
By David B.Kalish was prompted by Orange Coun-
A"pcWedPrew ty's shocking financial tumble
New York this past month.
The county,one of the most
Treasurers in six California affluent in the nation,filed for
counties other than Orange bankruptcy protection two
County used the sort of aggres- weeks ago after incurring$2 bil-
sive investment strategies that lion-plus losses in its investment
got the wealthy enclave's in- fund.The filing cast doubts on
vestment pool in trouble,a ma- the financial stability of the 188
jor credit rating agency said local governments, school dis-
yesterday. tricts and other municipalities
But the counties, ranging that invested taxpayer money
from Placer in Northern Cali- in the county fund.
fornia to San Bernardino in the Moody's broad search for
south, did not go to the risky risky investments was trigger-
extremes said to be employed ed by sharp criticism that it and
by former Orange County Trea- other rating agencies failed to
surer Robert Citron, Moody's sound the alarm about Orange
Investors Service said.The Wall County.
Street rating agency concluded As previously reported,
that the counties were in no im- Moody's also re-examined about
mediate danger but said it 1,400 municipalities outside Cal-
would further review their con- ifornia and found problems In
dition. only two previously undetected
Moody's assessment comes localities—in Cuyahoga Coun-
after a sweeping nationwide re-
view of local fiscal health that COUNTY: Page D2 Col.l
COUNTY: 6 California Counties Cited
From Page D1 terey, Placer, San Bernardino, 10 percent,most investing mu-
t in Ohio and Wisconsin's Wal- San Diego,Solano and Sonoma. nicipalities had no immediate
Y They were cited for investing in need for their money. There.
worth County, risky derivative securities or fore,the funds potentially can
The Moody's survey—and a borrowing heavily,investment ride out the paper losses—pre-
concurrent review by ratings strategies blamed for the down- sumably until the financial
agency Standard & Poor's — fall of Orange County's invest- markets recover from their re-
found that although many local ment fund. cent slump and spur a rebound
governments routinely invest in the funds.
taxpayer money to try to put it But unlike Orange County,.-
to work before bills come due, these municipalities were in no In contrast, many munici-
most investments are conserva. immediate trouble.One reason palities investing in the Orange
tive. is that even though their invest- County fund were dependent
This was not the case in the ment funds commonly incurred on investment income to pay
six California counties—Mon- losses ranging from 5 percent to their bills.
Orange County Sells Back at a Discount
X630 Million of Fannie Mae Securities
By Michael Utley
LOS ANGELES—In the first sale ers Inc.
of high-risk derivatives held by Orange A spokesman for Fannie Mae, the
County,Calif.,brokers working for the nation's largest home mortgage lender,
bankrupt municipality yesterday un- would not comment on the purchase
loaded$630 million of structured notes price,except to say it was"fair for both
issued by the Federal National Mort- sides of the table."
gage Association. "No one is doing anyone any favors,
Fannie Mae agreed to buy back the but this has certainly been a coopera-
securities at a discount,following two tive,helpful relationship,"said David
weeks of negotiations between the fed- R.Jeffers,Fannie Mae's vice president
erally chartered agency and the coun- for corporate relations.
ty's financial adviser,Salomon Broth- The structured notes—a large por-
tion of which were made up of ex-
tremely interest-rate sensitive deriva-
tives called inverse floaters—are the
same type of investments that con-
tributed greatly to a$2.02 billion loss
for the county's investment portfolio.
Rising interest rates gutted the value
of those notes and other risky invest-
Please turn to ORANGE COUNTY page 24
•
Oran e County A Salomon Brothers spokesman in other agencies—the Federal Home assets;and the airport is just one of
g J New York refused to comment on the Loan Banks;the Federal Home Loan many options.
Contin nedfromfront page sale yesterday afternoon.He said the Mortgage Corp., and the Student •The cities of Santa Ana and Mon-
ments made by the county,trigger- firm planned to release a statement Loan Marketing Association. tebello announced Wednesday that
ing its Dec.6 bankruptcy filing.The later in the day. In other Orange County develop- they had received enough funds from
county still holds a little less than$4 Fannie Mae's Jeffers said previous ments: the county investment pool to meet
...billion of these complex securities news reports that the county and the •The Board of Supervisors on most of their upcoming debt obliga-
and plans eventually to sell them all agency were entering into a securi- Wednesday afternoon authorized tions.
at a loss. ties swap were incorrect. He said payment of$3.9 million in interest Santa Ana said the county wired
County officials did not return Fannie Mae paid cash for the notes, due Jan. I on six bond issues,sub- $5.24 million to cover a Dec. 15 debt
phone calls yesterday,but they have and will not assume any of the risk ject to bankruptcy court approval. service payment,and Montebello
said in the past that they plan to use associated with them. But the board also suspended a said it received$14.1 million for a
the cash to buy new"plain vanilla" "When we buy back our own se- December$34.7 million set aside and payment due today.
securities to ensure the future safety curities,we are essentially canceling a January$18.7 million set aside for •The Huntington Beach citte>!�
of county funds. them,"Jeffers said."Since we issued ,payment of principal on its Series A cil voted Wednesday night to yAmk
Yesterday's sale was seen as a pos- them in the first place,the obligation tax and revenue anticipation notes. county if an agreement is not
itive step in that direction,provided no longer exists." The county's lead bankruptcy at- by Jan.6 to release all city property
that the county sold at the price it has Jeffers said the sale began at 9 a.m. torney,Bruce Bennett,said the deci- tax revenues being held in the now-
asked for in the past—around 84 yesterday and involved 10 separate sion to forgo the set-asides was made frozen pool.
cents on the dollar. transactions. He was unsure if this because of the county's need to Officials in Costa Mesa indicated
"If they can get at least 84 cents was a first-of-its-kind agreement,but "meet short-term operating commit- that they may do the same.
on the dollar,or more,then that's he said,"I guess it could be,in that ments." •The county's largest employee
good news;'said John Moorlach,a the whole Orange County situation •Responding to a flurry of news union again threatened to file a law-
Costa Mesa accountant often named is a first of its kind" reports that the county wants to sell suit if the supervisors continue with
as a possible successor to county In the past two weeks,Salomon John Wayne Airport,a miffed super- plans to disregard all negotiated
treasurer-tax collector Robert L.Cit- Brothers on behalf of the county has visor called an impromptu press con- agreements and lay off hundreds of
ron,who resigned. sold more than$3.3 billion of secu- ference Wednesday afternoon to tell county workers.
"Because these structured notes rities,but until yesterday,they were reporters that"Orange County is not John Sawyer Jr.,general manager
have no secondary market,this is ba- all conventional,easy-to-sell paper. for sale" of the 11,000-member Orange Coun-
sically a good move;'Moorlach said. Salomon Brothers is reportedly Gaddy Vasquez,chairman of the ty Employees Association,said the
"it is one of the few moves they have hoping to arrange similar buy-backs Board of Supervisors,said the coun- union will probably file its suit early
available" or swaps on securities issued by three ty is considering selling dozens of next week. p-
Local Governments in Orange County
Prepare Suit for Overdue Tax Revenues
By Michael Utley
LOS ANGELES—Numerous lo- lion in local government deposits be-
cal governments in Orange County, fore the county filed for bankruptcy
Calif.,are preparing to file suit against Dec.6.
the county this week in an attempt to Most local agencies argue that they
shake loose tax revenues that have been should get their funds back at 100 cents
held up in the bankrupt county's frozen on the dollar, and that the county
investment pool. should be solely responsible for an es-
Cities,water districts,and other spe- timated$2.02 billion loss on its highly
cial districts are becoming increasing- leveraged portfolio.
ly frustrated with the county's unwill- "When you give money to some-
ingness to share information about the body and they-hold it in trust,they are
status of the pool,which held$7.8 bil- responsible for it," said Richard D.
Barnard,deputy city administrator of
Huntington Beach,Calif."If they begin
to lose money, the money they lose
should be their own."
County officials have not indicated
whether that will be the case. The
county has $2.4 billion of its own
money in the pool — conceivably
Please turn to'ORANGE COUNTY page 2
Grange County Attorneys for the 186 local agencies
with money in the pool estimate that
Connnued from front page about$164 million in property tax rev-
enough to cover the loss. But last enues are being withheld by the coun-
month,county officials said that any ty.
agency attempting to make unusual "We anticipate that the results of a
withdrawals would have to share in decision in favor of Costa Mesa would
that loss: benefit the$164 million in property
The Huntington Beach city coun- taxes withheld from other public enti-
cil in a special meeting last week ties,"said Costa Mesa city attorney
voted unanimously to take legal ac- Thomas Kathe.
tion if the county fails to release the It is unclear what that would mean
city's property tax revenues by Fri- for the county. County officials
day. could not be reached for comment.
City officials in Costa Mesa,Calif., They put out a press statement last
have indicated that they may join week saying they are studying the
forces with Huntington Beach.Sever- issue.
al other cities and special districts are Two water districts have already
also considering jumping in on some asked the U.S. Bankruptcy Court in
sort of class action lawsuit. Santa Ana to lift its ban on legal
action against the county. That them back on Thursday for$484.8 mil-
would allow the districts and any lion.
other investors to sue in state court Thomas Hayes, director of the
for return of property taxes. A county's financial restructuring team,
decision is expected sometime this said in a press release that the notes
week. were sold for"a price better than we
Huntipgton Beach has$43.6 million could have gotten on the open mar-
in the pool,and the city believes the ket."
county is withholding$2 million to -The county fell into technical
$2.5 million in property tax revenues default Thursday by suspending
that should have been paid in Decem- payments on $169 millions of
her. bonds sold six months ago. Con-
The$6 million payment the coun- cerned about liquidity,officials said
ty made to Huntington Beach in De- they would not set aside$53.4 mil-
cember was smaller than usual.City lion in regularly scheduled principal
officials do not know for sure how payments due on the bonds this sum-
much they are due,because county of- mer.
ficials have not returned their phone A technical default is a warning to
calls or answered their written ques-
tions.
"We get most of our information 'If the In to lose
out of the newspapers;'said Barnard y
of Huntington Beach."We've sent let- money,the money they
ters,we've requested information,and
we just haven't gotten it." lose should be their
County staff members continue to own/ says a Pool
remain tight-lipped,despite a memo
sent by county supervisor Roger Stan- Participant.
ton to county administrative officer
Ernie Schneider ordering him to re-
spond. bondholders.Actual default occurs
"Please initiate some dialogue with when a payment is missed.
Huntington Beach(and Costa Mesa) At the same time,the county agreed
ASAP this evening or early am to- to make interest payments on sanita-
morrow,Stanton wrote in the Dec.27 tion district sewer bonds,general oblig-
memo obtained by The Bond Buyer. ation bonds, certain tax and revenue
By Friday morning of last week, anticipation notes,and taxable notes
Huntington Beach had not been con- sold in July.
tatted,leaving city officials with the -Standard&Poor's Corp.said Fri-
impression that they will have to take day that it views the county's Thurs-
legal action. day actions as a good-faith attempt to
"We are looking forward to hav- honor debt payments.
ing all of our money returned to us "Me lack of set-asides and a draw-
-all of it, with interest," Barnard down on debt service reserve funds,
said. while clearly not positive from a cred-
In other Orange County develop- it perspective,are reflective of the spec-
ments: ulative-grade ratings and are seen as
--County officials announced last part of the county's effort to manage
Thursday afternoon that they were paid its cash flow needs;'Standard&Poor's
91 cents on the dollar for$634.6 mil- said.
lion of structured notes issued by the The rating agency downgraded Or-
Federal National Mortgage Associa- ange County debt from AA to CCC
tion. junk-bond status on Dec.7,just hours
The notes were the first of Orange after the county filed for protection un-
County's risky derivative investments der Chapter 9 of the Federal Bank-
to be sold.Fannie Mae agreed to buy ruptcy Code. ❑
•
Flurry of Probes �-
On Orange County
To Start This Week
By Michael Utley
SACRAMENTO,Calif.—Ground
zero in the Orange County fiscal dis-
aster will shift this week and next to
the state capital as a number of inde-
pendent investigations are launched
and proposed bills begin moving
through the California legislature.
The flurry of activity is expected to
climax here on Tuesday with the tes-
timony of former Orange County trea-
surer-tax collector Robert L. Citron,
who is scheduled to appear before a
• See related story, page 3
special legislative committee.
Despite pending civil and possible
criminal charges.Citron has respond-
ed to the committee's subpoena and
agreed to testify.
.'He has nothing to hide.- Citron's
attorney. David Wiechert. said in a
press statement.
The hearing before the newly creat-
ed Senate Special Committee on Lo-
cal Government Investment is also ex-
pected to include testimony from as-
sistant county treasurer Matthew Raabe
and Michaef Stamenson.a broker with
Merrill Lynch&Co. who advised the
county on many of its ill-fated invest-
ments.
"We knew we had to do something
Orange bounty vereux, a spokesman for the state
treasurer's office.
Continuedfromfront page Tomorrow, state Assemblvman
ASAP about this crisis,"said Andrew Curt Pringle has scheduled a forum
Govnar,a spokesman for Senate pres- in Garden Grove, Calif.. to discuss
ident pro tempore Bill Lockyer,who solutions to the county's fiscal mess.
established the committee a week af- The Orange County Republican is
ter the county filed for bankruptcy. expected to be joined at the meeting
"The committee will not only be by state Sen. John Lewis. U.S. Rep.
looking at Orange County,but others Christopher Cox, and several expert
as welI,"Govnar said yesterday."Or- speakers addressing various aspects
ange County is not the only govern-, of the crisis.
ment having trouble these days" Meanwhile,at least three proposed.
After the hearings are over, the bills inspired by Orange County are
committee will attempt to determine moving their way through the state
whether local governments should legislature:
have the power to void labor contracts - State Sen. Quentin L. Kopp in-
during bankruptcy, as Orange Coun- troduced a bill on Dec. 8 that would
ty has done, and under what circum- eliminate reverse repurchase agree-
stances local governments should be ments from the list of authorized in-
allowed to file for protection under vestments for local governments.
Chapter 9 of the Federal Bankruptcy -Pringle introduced legislation in
Code. the Assembly on Dec. 12 that would -
Next week's main event will be require all public investment pools to
preceded by at least two other gov- follow the same conservative guide-
ernmental probes into the unprece- lines used by the state's local agency
dented crisis. investment fund.The bill would also
Today in Sacramento, state Trea- prohibit local governments from bor-
surer Matt Fong is scheduled to hear rowing solely for the purpose of in-
testimony from four public-sector in- vesting.
vestment experts during the first - State Sen. Tom Hayden intro-
meeting of a separate task force duced legislation on Jan. 4 that
formed to review state and local in- would increase the minimum credit
vestment practices. rating required for pool investments.
The 1 I-member panel,established ban political contributions to local
at the request of Gov. Pete Wilson,is officials from investment bankers
expected to submit a series of rec- who do business with them. and re-
ommendations "to prevent another quire county treasurers to file month-
Orange County-type situation from ly reports on their investment strate-
happening elsewhere,"said Stan De- gies.
orange CountyGets
Moody' Downgrade
Following Shortfall
In General Budget
By Michael Utley
LOS ANGELES—Moody's In-
vestors Service on Friday downgrad-
ed Orange County'$long-term debt rat-
ing from Aa1 to Caa,following last
week's disclosure of a$172 million
shortfall in the bankrupt county's gen-
eral fund budget
A Moody's representative said the
rating action was based on the revised
shortfall amount and clear indications
that the county will not be able to repay
its debt without some sort of a refi-
nancing.
"As we look at the cash flows,there
is a big,deep hole that they are in,and
they can't make enough cuts to bal,
ance their budget, nor can they raise
Please tura to ORM►GB COUN"page 19'
Orange County bankruptcy protection because of mas- government pool invcstors wno all ure mat owoccu rcpurwo caruea.
gsive losses on their pooled investment want their deposits back in full. The shortfall is in the county's gen-
CoAdn d Jrow front page fund. "Given the county's lack of inten- eral fund budget.And while that bud-
revenues;'said Barbara Flickinger,an At that time,Moody's put the coun- tion,and perceived fiscal inability to get is estimated at$1.6 billion,the dis-
assistant director and manager with ty's debt rating on suspension,but did absorb fully the losses in the general cretionary amount is only$463 mil-
Moody's New York office. not downgrade until last Friday be- fund,much negotiation and perhaps lion.The rest of the money goes to-
"We are seeing pretty dire things;' cause the agency was waiting for more litigation will likely surround the ward mandated services.
she said. information on the county's cash flow process of meting out the losses;'Stan- In other Orange County develop-
Bonds rated Caa are considered to problems,Flickinger said. dard&Poor's said in its re rt. ments,investigators with the county
be"of poor standing,"may be.in de- "We still expect that the county will "The size of the[budget gap is es- district attorney's office raided the
fault,and may include elements of dan- try to make its debt service payments;' pecially overbearing given that the fis- Santa Ana home of former treasurer-
ger with respect to principal and inter- Flickinger added."We expect that they cal year is half over;'Standard& tax collector Robert L.Citron on
est,according to Moody's rating guide. will stand by their obligations,and we Poor's said. Thursday afternoon,seizing five.a#,
The rating action affects$1.35 bil- think it's important that they make that The credit-agency said it will ques- dio cassette tapes and about 30 docu,
lion in Orange County debt.The fig- effort if they ever want to get back to tion all local governments in the pool meats.
ure takes in bonds,notes,and certifi- investment-grade status in the fore- ,that have issued taxable notes.The A search warrent was issued by dis-
cates of participation. seeable future." agency wants to know how the gov- trict attorney Michael Capizzi to enter
County officials on Friday did not Moody's also downgraded all of the eroments will repay those notes if they the home and take any tapes.record-
return phone calls seeking a response county's taxable and non-taxable notes are not allowed to make withdrawals ing devices,computer disks,docu-
f to the downgrade.They announced a to speculative grade.The agony left from the pool. ments,or personal correspondence W
tentative recovery plan on Wednesday on suspension two other issues:a rev- Ratings on those notes may be and from Citron.
that includes more layoffs,possible elute bond issue by the county airport, downgraded this week,Standard& The county's$2 billion investment
debt refinancing,and lawsuits against. and a school bond issue—both of Poor's said,if alternative repayment fund loss has been blamed on Citmn's
the county's previous financial advis- which may not be severely damaged plane am oar in placerisky strategy of using derivatives and
ers. by the bankruptcy. rte v=zomMoody's and reverse repurchase agreeroe.Is to mit-.
Last month,Standard& Poor's Standard&Poor's on Thursday also Standard & Pogr's were present iniize yield.
Corp.also downgraded Orange Coun- released a grim analysis of the eoun- Weanesuav morning wncu qty of- Citron and several other players in
ty's debt to speculative grade.The rat- ty's$172 million shortfall,noting that ficiais aisciosea the 4172 million the debacle are now under civil and
ing agency took that action on Dec.7, officials do not have a plata in place to denctt—wnica is mores roan your criminal investigation by a number of
one day after county officials filed for address the detnaods of 186 other local Mmes greater than the$40 million fig- local,state,and federal agencies. O
•
California Official Defends His Strategy of Managing Pooled Investment Fund
By Brad Altman
LOS ANGELES—Rising interest meats is Moodach's primary campaign agency rates Orange County's lease ly here who all of a sudden thought this
rates have taken the luster off the Or- issue.He is highly critical of the port- obligatioac A-plus."We probably have up,"Citron said of the pool's invest-
ange County,Calif.,pooled investment folio's leveraged status. put the Orange County pool undo tae mens strategy.'M1Ve fel that we are pro
fund,forcing county treasurer-tax col- scrutiny than any other investment fessional managers and know what we
lector Robert L.Citron,embroiled in a Straightforward Deal pool,"Brosen said.`The reverse re- are doing:'
reelection campaign,to justify his than- purchase agreements don't cava us any Citron said that during the past five
agement of the pool's$7.5 billion of But from Citron and Rube's per. concern: years the average portfolio yield has
assets, spective,using reverse repurchase "It appears they've managed the re- been 8.84%;over nine years,9.03%;
Citron's often-praised investment agreements is a straightforward,com- verse repurchase agreements portion and over 10 years,9.21%.In fiscal
strategy is in fact too risky because it monly accepted investment strategy,al- of their portfolio well,"said David 1993,the pool earned about 3154 mil-
leverages the money of 187 local gov- lowing the pool to borrow money Brodsly,a vice president for Moody's Eon on reverse repurchase agreements.
ernment participants through reverse against the market value of its securi- investors Service:The agency rates the 'Last fiscal year.the yield was 8.5%
repurchase agreements,according to a ties. county's lease debt Aal.'They have . 'The yield would have been 6%if we
political opponent and Tustin,Calif., "When the market value falls— sufficient liquidity to mat their needs:' didn't do"reverse repurchase agree-
which recently withdrew$4 million which happens during periods of ris- Nevertheless,"Mr.Citron is highly ments,Raabe said.Orange County's
from the pool. ing interest rates—additional collar- leveraged"Tustin finance director and fiscal year begins July I.
Citron's investing approach has con- eral must be posted for the remaining treasurer Ronald A.Nault said.Tustin 'The whole idea behind reverse re-
sistemly enabled the pool to outper- term of a reverse repo."Raabe said. placed$4 million—10%of the city's purchase agreements is the concept of
forth the market as a whole during his For example,last month the invest- general fund—with the pool last Oc-- managing risk,"Raabe said.He said
nearly 24 years in office,but in recent mem pool turned over$140 million in tober.The city withdrew$1 million the county's investment strategy is to
weeks the pool has had to post 3215 cash to a brokerage firm as part of a March 14 and$3 million April 7. hold investments to maturity.By con-
million in collateral calls to brokerage collateral call against the pool's reverse The pool's high-yield approach is in- trast,some governments trade or buy
houses because of increases in interest repurchase agreements,This week,the consistent with Tustin's more conser- and sell government securities,and face
rates. pool turned over an additional$75 mil- vative nature,Nault said. the prospers of taking lasses and gains.
Over the last 10 years,the pool has lion. "Maybe it's ma inappropriate to tarn For those governments,'market val-
retur ed 9.2146.For the nine months of "We are in a period of rising inter- 4%when somebody else is earning ue becomes critical:'Raabe said.For
this fiscal year,it has earned interest at est rates,so we have to post more col- 8%'Nault said."The responsibility of Orange County's pool."market value
an annualized rate of 7A%.By con- lateral:'Raabe said.While this was the the treasurer is safety,liquidity,and means absolutely nothing because
trast,the California treasurer's local first time the pool has had collateral yield.If you move yield up front, when out securities mature,we get the
agency investment fund,which does calls in recent years,the pool was well you're heading to a nasty business." principal back.We generally don't
not use reverse repurchase agreements, prepared for the event. He said 7ltstin's withdrawal from the trade.Out main strategy is to hold un- .
currently pays 4.19%interest. A total of$1.5 billion in liquid in- pool was not influenced by politics,al- til manrity and do"reverse repurchase
Citron and county assistant treasurer vestments has been set aside to cover though Councilman Jeffery Thomas— agreements.
Matthew Raabe defended the pool's in- collateral calls,Raabe said.To position a contributor to Moorlach's campaign Moorlach has vowed to do an infor-
vesting approach in interviews this for future collateral calls,the fund will —recommended the trove. mal audit of the pool,but said his ef-
week.They said only Tustin has pulled expand its liquidity by$500 million to forts have been hamstrung by Citron,
out of the pool,a decision guided by a Sl billion in the coming moodts,he said. Violated Guidelines who released 700 pages of investment
Tustin councilman who has endorsed "This is more liquidity than we nor- data to Moorlach on Monday.Moor-
Citron's opponent for the June 7 elec- matly have:'Raabe said."But we want Thomas,a vice president and West- lath called the materials"a joke"be.
tion. to be ready because we think rates are em regional director for institutional cause they contained incomplete infor-
"Everybody else has strongly sup- going to rise a little bit more" money management for Van Kampen 'mation,and said he would go back to
ported us:'said Raabe,who sees polit- Recently,collateral calls have caused Merritt Investrnem Advisory Corp.,said Citron for more banking records and
ical overtones to the concerns being havoc for others investors who did not he made the recommendation afterbroker information.
raised about the pool's investment strat- have lots of cash m hand.Granite Capi- noticing that"our investment guide- 'The information we gave is exactly
egy. tol and Granite Partners,two hedge lines did not support this type of pur- what he asked fa,"Raabe said.'This is
John M.W.Moorlach,a Costa Mesa, funds managed by David Askin,im- chase by the pool.I mentioned it to the information anybody could get,but no-
Calif.certified public accountant and ploded after Askin had to sell his pat- city"s audit committee.So we pulled body has eves asked for it."
certified financial planner,is challeng- folio of mortgage securities at a dis- out." If elected,Moorlach said he defi-
ing Citron.The 38-year-old Moodach, tressed price to meet collateral calls. Raabe said Tustin's pullback showed nitely would stop the pool's use of re.
assistant treasurer to the executive com- Raabe said the collateral calls have its concern that the pool was"doing verse repurchase agreements.He would
minee of the Orange County Republi- no credit ramifications for the county's too much"with reverse repurchase find investments that pay a tower—
can Parry Central Committee,said he long-term obligations.The Pool's liq- agreements. but,he says,a safer—interest rate re-
*,wouldn't challenge Citron if he were a uidity prevents it from having to sell "Our response is that—with any in- turn.
Republican." securities to meet collateral calls,and vestment strategy—you will have peo- 'There are a lot of good funds do.
Citron,who is 69,is the only elected this protects the pool from selling the ple who agree with it,and people who ing quite well without reverse repur-
Democrat in Change County govern- securities at a reduced value. disagree with it.They have a right to chase agreements,"Moorlach said.
ment.This is his first contested reeler- "We are not overly concerned about disagree with it We've been doing this "Why should our county have the kind
tion bid since he was elected in 1970 the investment strategies"of Orange for a long time.We stand on our of exposure and liability represented
to the nonpartisan office. I County,said Diane P.Brosen,a diem- record:'Raabe said. by these reverse repos if serious prob-
The use of reverse repurchase agree- for for Standard At Poor's Corp.The "We're not some Johnny-come-late- leets develop?"
More Tumult in Orange County:
800 Layoffs Seen, Treasurer Out
By Michael Utley
LOS ANGELES —The long holi- to make a final decision until next
day weekend provided no respite for week.
officials in Orange County, Calif., as Union members were outraged at
lawsuits and personnel shake-ups the county's decision last Thursday to
joined a grim mix of budget cuts and reduce its current fiscal budget by
bomb threats. $40.2 million, with most of the cuts
In the most recent development,top coming from layoffs among the coun-
officials met with union leaders yes- ty's 18,000 workers. The reductions
terday to try to avoid yet another law= are expected to take place during the
suit—this one over the county's plan next six months.
to lay off hundreds of county work- The county expects to cut an addi-
ers. tional$80 million from its fiscal 1996
Leaders of the 11,000-member Or- budget next summer.Fiscal 1996 starts
ange County Employees Association, July 1.
in several emergency meetings Sun- "There is a.profound sense of
day and Monday,authorized legal ac- betrayal here," said union attorney
tion against the county,but agreed not John Sawyer Jr., in a press statement
Monday. Sawyer estimated that
800 employees would lose their
jobs.
The county board of supervisors ap-
proved the budget cuts Thursday af-
ternoon,without citing a specific num-
ber of layoffs.The action is part of the
county's extraordinary bankruptcy pro-
ceedings,which began Dec.6 after of-
ficials disclosed a multibillion loss on
the county's pooled investment port-
folio and filed for protection under
Chapter 9 of the federal bankruptcy
code.
The supervisors did not say which
jobs should be eliminated.They gave
department heads the latitude to trim
personnel on a merit basis, not ac-
cording to seniority.
Supervisor Thomas R Riley said
yesterday that the layoffs are neces-
sary because employee salaries—at
about$7 million a week—are one of
the county's largest expenses. -
"God knows, I wish I was smart
enough to think of some other way to
settle this than to cause human mis-
ery,"Riley said."I'd be very happy if
someone came up with a plan that
would require less drastic action.But I
haven't found anybody that has given
me an alternative:'
Please turn to ORANGE COUNTY page 6
Wednesday.December 28.199'4
Oran e CountMatthew Raabe Thursday afternoon,
g ! following reports that Raabe was the
Continuedfrom front page chief salesman for the county's invest-
Riley, 82, is retiring on Monday. ment pool.
He will be replaced by Marian Berg- The board moved Raabe back to his
erson,a Republican state senator who position of assistant treasurer and ap-
gave up her seat to take the supervi- pointed Thomas E.Daxon,a former
sor's job. Oklahoma state auditor,as treasurer-
Riley and two other supervisors re- tax collector.
ported receiving bomb threats late Daxon was brought in this month as
Thursday after the budget-slashing plan a financial adviser to the county. He
was announced. has left his position with the account-
The call came into Riley's Santa Ana ing firm of Arthur Andersen&Co.to
office while he was at home.Police take the four-month treasurer appoint-
checked his office and home and found meat.
nothing. Raabe,meanwhile,has hired a pri-
"I was not that concerned," vate attorney and has not returned
Riley said."It just seemed like an phone calls since the investment deba-
angry person who wanted to talk to cle began.He is scheduled to testify
me." before the Securities and Exchange
Also late Thursday,Moody's In- Commission next month regarding his
vestors Service issued a report not- role in the crisis.
ing that treasurers in six other Cali- •Local government investors in
fornia counties have used the kinds the Orange County portfolio said
of aggressive investment strategies Friday they have received SEC
that sank Orange County's portfolio. questionnaires asking about their
The report was included in a nation- dealings with the county treasurer's of-
wide survey of 1,450 municipal is- fice.
suers. Officials with the Orange County
Moody's said the six treasurers did Department of Education and several
not go as far as former Orange County other investors told Reuters that the •
treasurer-tax collector Robert L.Cit- questionnaires asked whether the
ron,and that the other counties are not county adequately explained the risks
in any immediate danger of going of investing in the highly leveraged
bankrupt. pool.
The six counties are Monterey,Plac- The SEC is just one of several agen-
er,San Bernardino,San Diego,Solano, cies investigating possible criminal
and Sonoma. misconduct in the management of the
"The indicators in those six coun- county portfolio.The Orange County
ties suggest a significantly different district attorney last week served search
risk category"than Orange County, warrants on the offices of Citron,
Moody's analyst David Brodsly told Raabe,and several other county offi-
the Associated Press. "We haven't ciats.
sorted through the risk factors -Outside of Orange County,the city
enough to say it couldn't happen of Montebello said Thursday that it is
there.But the fact we didn't put any talking with investors about rolling
ratings under review reflects over$11 million of$20 million in
something less than immediate con- notes that require a debt payment by
cern." this Friday.
In the six counties,investment de- Montebello,a Los Angeles suburb,
clines this year ranged from 5%to has$47 million in the now frozen Or-
10%,but Moody's said the portfolios ange County investment pool.The city
are strong enough to ride out the pa- had been counting on a portion of the N.
per losses. money to meet the debt service pay-
The Moody's nationwide survey meats.
found that most public investments are •Yesterday proved to be the first
conservative. quiet day in Orange County since the
"Most issuers have represented Dec. 1 announcement of the multi-
that either they do not engage in billion dollar loss on its portfolio.A
leveraging strategies,or are not autho- 9:30 a.m.board of supervisors meet-
rized to borrow for investment. ing was canceled for lack of busi-
purposes,"the credit rating agency ness.
said. "We think it's a quiet day,but there
In other Orange County develop- are no guarantees it will stay that.
ments: way,"said county spokeswoman San-.
•The board of supervisors replaced dra Sternberg."It's a day-by-day
acting county treasurer-tax collector thing."
S&P: Solano County, CA Investment Pool No Rtg Action
NY -- S&P CreditWire 12/28/94 -- S&P concludes that after completing an
initial review of Solano Country, Calif. 's investment pool, no rating action
is warranted at this time. S&P will continue to monitor the pool's
performance and cash position in light of potential movements in interest
rates and cash flow needs of participants. The investment pool holds funds
for the county and its underlying school districts.
The structure of the county's investment portfolio reflects an
aggressive strategy that utilizes leverage and derivative instruments to
achieve higher returns in a declining interest rate environment. This
investment portfolio is distinguished from many other pools in California by
the degree of leverage it employs -- a feature that leaves it more
susceptible to asset erosion as interest rates rise. Although the portfolio
has not been independently marked to market recently, the past year's trend
in interest rates certainly has reduced the portfolio's market value.
However, since participation in the pool is 100t mandatory, according to
county officials, the risk of wholesale withdrawals .by participants is
remote. Additionally, the county's cash flow projections for the pool suggest
that there is sufficient liquidity to meet normal operating requirements for
all participants, without liquidating positions. Moreover, the county has
identified $49 million of highly liquid investments that should be sufficient
to meet potential margin calls or other unscheduled draws.
Specifically, the pool, as of Nov. 30, 1994, includes:
• -- The use of $182 million in reverse repurchase agreements to leverage
a $245 million (book value) core portfolio to $427 million. Some of these
reverse repurchase agreements are collateralized with derivatives, and
therefore may be very illiquid;
-- A significant position in .structured notes and inverse floaters; and
-- Investments with relatively long maturities. The weighted average
maturity of the pool was 875 days.
While the county's plan is to hold most of these instruments to
maturity, this strategy depends upon an arrangement with Merrill Lynch & Co.
to continue to roll over the reverse repurchase agreements. If these
positions need to be liquidated, some of the pool's unrealized losses will
have to be recognized. The county estimates that for every 50 basis-point
rise in interest rates, it will cost the county an additional $6 million to
satisfy collateral calls on its reverse repurchase positions, S&P said. --
CreditWire
Contact: Daniel W. Stone, San Francisco (415) 765-5016,
G. Kris Rao (212) 208-8848,
Jeffrey J. Thiemann, San Francisco (415) 765-5006
SMviaNewsEDGE
:SUBJECT: MUBC MUBR SPRG SRTG CMKT CORP
Copyright (c) 1994 Standard & Poor's Ratings Group
Received by NewsEDGE/LAN: 12/28/94 4:06 PM
Monterey Cnty, CA Investment Pool: No Action by SSP
NY -- S&P Creditwire 12/28/94 -- After completing an initial review of
Monterey County, Calif. 's investment pool, SSP has concluded that no rating
action is warranted at this time. The investment pool is comprised entirely
of mandatory participant funds, with 623 from county sources, 313 from the
county's underlying school districts, and 7% from underlying special
districts. SSP will continue to monitor the pool's performance and cash
position in light of movements in interest rates and cash flow needs of the
county and the participants.
The structure of the county's investment portfolio reflects an
aggressive strategy that utilizes leveraged and derivative instruments to
attempt to realize higher returns. This investment pool employs a high degree
of leverage relative to other pools in California, making it more vulnerable
to asset erosion in a rising interest rate environment. Although the
portfolio is not currently marked to market, this year's rise in interest
rates has eroded the market value of the portfolio's longer-term securities.
Since participation in the pool is 1003 mandatory according to county
officials, the risk of wholesale withdrawals by participants is remote.
Additionally, the county's cash flow projections for the pool appear to show
sufficient fund liquidity to meet normal operating requirements for all
participants, without the need to liquidate positions. The county has
identified $85 million of current liquid assets which should be sufficient to
meet unscheduled cash flow needs or to satisfy collateral calls.
Specifically, the pool as of Nov. 30, 1994, includes $237 million in
reverse repurchase agreements leveraging a $338 million (book value) core •
portfolio to $574. million. Some of these reverse repurchase agreements are
collateralized with derivative products, and therefore may be highly
illiquid. The pool also has a significant position in inverse floaters and
structured notes. However, some of these instruments have protection in the
form of interest-rate floors and fined-rate step-up features. While the
county plans to hold these instruments to maturity, this strategy depends
upon an arrangement with Merrill Lynch 6 Co. to continue to roll over the
reverse repurchase agreements. If these positions need to be liquidated, some
of the unrealized losses would be recognized. Current weighted average
maturity of the fund is approximately 28 months.
In 1994, the county has applied $22 million from pool cash reserves to
meet increased collateral needs of its reverse repurchase agreements. Given
the fund's continuing vulnerability to rising interest rates, the county has
budgeted $1 million per month in 1995 from cash resources to offset higher
collateral requirements, if necessary, SSP said. -- CreditWire
Contact: Jeffrey J. Thiemann, San Francisco (415) 765-5006,
G. Kris Rao (212) 208-8848,
Susan Schaffer, San Francisco (415) 765-5020
SMviaNewsEDGE
:SUBJECT: MUBC MUBR SPRG SRTG CMKT CORP
Copyright (c) 1994 Standard 8 Poor's Ratings Group
Received by NewsEDGE/LAN: 12/28/94 4:07 PM
Al2 IN(\londay,Decernher N, 1994 Marin Independent Jourpal
Citron fiasco reportedly not his first
;tss,reah,l I'r,•,,. —_ _ cif which he attributes to Citron in. until rising interest rates upset. his Wiechert said he found little vele-
_..... ....___ vestments in abysmally poor credits. risky investment strategy and the vance in comparing the Citron who
SANTA ANA - Robert L. Cit. By the time the Century Finance county fund this year. sat in a small finance office 35 years
downtown office was closed, Good Citron resigned this month fol- ego to the Mari who ran ode of the
ron not a delinquency-plagued fi- man said. nine &ollectors worked lowingthe disclosure of huge losses nations biggest investment parts
nanc-e operation T,y decades hefore there and delinquencies increased to in thfund he managed for the with advice from Wall Street's larg-
his heaey harrowing and risky in- 70 percent during liquidation. county and 186 cities,local agencies est brokerage,Merrill Lynch.
cestnte•nls sent Orange Counl;v $2
billion int„ richt and hankruplcy Citron, who Goodman said was and school districts.Several federal The top executives who ran Fidel-
court. fired from Century Finance about and state investigations are examin• ity Acceptance during Citron's ten-
Citron managed the first office set 1960,was elected Orange County tax ing if adequate disclosures were ure have died,said F.A.Stang,a 47-
up by Fidelity Achefir t o Corp. cnllector in 1970 and became trgea- madof the fund's vulnerability In year Fidelity employee who rose to
when the Minneapolis financial ser. surer when the offices were merged risinginterest rates. chief executive before retiring last
vices he Mincompana opened shop in in 1973. In 1979, he began a long Asked to discuss Citron's role at year.
downtown lets Angeles using the reign as the king of high returns— Century Finance, his lawyer David
• name('es Go Fame•Co.
Charles(�nndm;ut,who was hired
r
h
lreptt as assistant manager hot
never
County may not pay
neveer liked him, saide found a
mess like nothing he's ever seen in
his more than four decades in the
bill-collection husiness. lie cited or Citron's defense
piles of delinquent.consumer debts
on transmission repairs, rebuilt en- don't want all the facts to come
gines and meat filled freezers on As•sociatedPres'sout because we don'twant there-
which payments stopped when the sponsibility to he shared as it
steak ran out. SANTA ANA — Orange should be.Maybe we want to put
Goodman expected his primary County officials are threatening all the blame on one man and
role would he to make 1ps•o:unot to pay legal costs for former take away his ability to defend
"Rut('item dt rnmuled;tll the em- Treasurer Robert Citron — a himself,"Wiechert said.
fileryees slay atHl work collect inns for move his attorney says is an ef- "I feel totally betrayed by the
Four hours on Tuesday nights and fort.to shield other officials from board and their administrators
fd11r on Thursday nighis.I le said.'I sharing blame for the c•ounly s who have done a complete about
will not pay yell.11111 if vo11 want In bankruptcy.
I face after all these years."Citron
keep your jobs you'll do this.'" The only basis for refusing to said in a statement released by
Goodman said in an ince rview last pay costs in civil suits and inves- Wiechert. "They were certainly
week with The Associated Press. ligations such as those Citron supportive when the county's in-
faces would be fraudulent,mali-
"It was n slraighl 'clean-up-my- vestments were yielding a suh-
cious or curruptconduct and Cit-
dirty-laundn'oIH•rNion."said tL eHl run is guilty of none df those,his stantial return."rna1 62.of'leps Angeles."The pr-h- g
attorney, David Wiechert said
lem is we couldn'I work Ihsl enough Io y, The county is the largest local
clean up his dirty laundn.' yesterday government ever to seek bank-
Goodman said Century Finance's "Maybe the agenda is: 'We ruptcy protection.
ultimate loss was$1.:45 million,much
Wednesday,December 21,1994
Orange County tend to disburse most taxes and oth-
er revenues collected after the Dec.6
Condnued from front page bankruptcy filing.
County's filing for Chapter 9 municipal The county, however, probably
bankruptcy. will not release taxes collected be-
"This action is not intended to dis- tween Nov.30 and Dec.6,Standard
rupt or hamper the county's efforts to &Poor's said.
untangle the financial situation,and The county's plan should allow tax
cooperation will be extended to those apportionments to be made on sched-
departments and agencies requiring ac- ule Friday,Dec.23,with local gov-
cess to the records,"Capizzi said."No ernments having immediate access
further announcements concerning the to the funds.
investigation will be made at this time:' •Duff&Phelps Credit Rating Co.
The district attorney's office is just announced yesterday that it has
the latest in a slew of agencies look- placed three Anaheim,Calif. bond
ing into the Orange County investment issues on"Rating Watch-Down:'
debacle,including the U.S.attorney's The action affects$202 million of
office,the Securities and Exchange electric revenue bonds,$27 million
Commission,the state auditor-con- of water revenue bonds,and$13 mil-
troller and the state Depattnttnt of Cor- lion of public finance authority water
porations. revenue bonds—all currently rated
Investigators are believed to be fo- AA.
Orange County DA
curing on whether the county treasur- The Chicago-based rating agency
er's office misled the other pool fund said the city's investment of 20%of
Is Latest Agency participants about the status of their its portfolio in the Orange County
investments,and whether brokers such fund is viewed as"deleterious but
To Join Probe Effort as Merrill Lynch&Co.gained undue not traumatic"to the credit quality
influence through political campaign of the debt obligations.
Into Fund Debacle contributions to former county trea- •Two private holders of Orange
surer-tax collector Robert L.Citron, County bonds have filed a class ac-
who resigned on Dec.4. tion lawsuit against Citron and Mer-
By Michael Utley Citron lost more than$2 billion this rill Lynch broker Michael Stamen-
LOS ANGELES — Signaling the year on the county's$7.8 billion in- son charging that they steered the
launch of criminal robes into the Or- vestment fund,which included billions county fund into a series of reckless
P of dollars in deposits from 187 local investments.
ange County, Calif., financial crisis, governments.Many of thost govern- The suit was filed in federal court
county district attorney Michael R. meats also are now facing financial Friday by attorneys working for
Capizzi served search warrants Mon- ruin. Floyd Demanes and Charles Schon-
day on the offices of the county trea- Although investigators were an- fell on behalf of themselves and oth-
surer and the county auditor-controller. swenng no questions yesterday,the er buyers of county-issued debt.
A team of 30 investigators worked alsentenc s haof avvennot ruled oprosecutions� filed atc civil ys for damage clain young der-
into the evening,loading two vans full "They've certainly been playing a al court Monday accusing Citron and
of documents and computers seized major obfuscation game here by not Merrill Lynch of squandering settle-
from the offices — some of which revealing the true facts of the port- ment money from accidents in which
were sealed off with yellow crime- folio;'said John Moorlach,an ac- the girls were badly injured.
scene tape. countant who warned of the fund's Settlement awards of$260,000 and
Capizzi said in a prepared statement risky investments while running $96,000 were put into the county
P P P against Citron for the treasurer's post fund at the urging of judges who be-
that the warrants were served Monday earlier this year. lieved the girls would earn higher in-
morning as part of his investigation "We've had Bob Citron and[as- terest rates there.
into the events surrounding Orange sistant treasurer] Matt Raabe reas- Both may be forced to share in the
Please turn to ORANGE COUNTY page 6 suring everyone to the bitter end," investment fund's 27%loss.
Moorlach said."They were certainly •A U.S.bankruptcy judge ruled
going through a major case of denial, Monday afternoon that the county
but I don't know if that's criminal or will be allowed to release emergency
not:' funds to other public agencies, in-
Both Citron and Raabe retained cluding$115 million to the county
private attorneys and stopped an- Department of Education,$4.6 mil-
swering questions shortly after the lion to the Orange County Water Dis-
bankruptcy filing.Their lawyers,Ter- trict,and$3 million to the Orange
ry W. Bird and David Wiechert, County Transportation Authority.
could not be reached for comment •A county investment adviser said
yesterday. Monday that a major portion of the
The county transportation agency proceeds received to date from the
and the county sewer agency have both sale of Orange County bonds are go-
said that Citron promised to put a por- ing to pay off the numerous loans
tion of their money into a separate,pro- that got the county into trouble in the
tected account. It is still unclear first place.
whether those accounts exist or About$800 million of the$1.39 bil-
whether Citron commingled them with lion raised so far has gone to satisfy
. the county's doomed investment fund. collateral calls from the county's
In other developments: lenders,said Christopher Varelas,an
• Standard & Poor's Corp. an- executive with Salomon Brothers Inc.,
nounced late Tuesday that county of- hired by the county last week to help
frcials told the credit agency they in- manage the fund. O
PSA's Putman Says Orange County Crisis
Doesn't Call for New Legislation, Rules
By Lynn Stevens Hume
WASHINGTON—Orange Coun- market, Putman, a managing director
ty,Calif's financial troubles will make at Lehman Brothers who will step
issuers more aware of their disclosure down as PSA chairman next week,said
obligations, but new disclosure rules in a series of recent interviews.
or legislation aren't called for,F Fenn Putman said the municipal bond
Putman,the outgoing chairman of the market faces at least three major chal-
Public Securities Association,said last lenges in the new year:
week. -Implementing the SEC's new sec-
Legislation requiring issuers to reg- ondary market disclosure rules.
ister their bond offerings with the Se- -Moving to a three-day clearance
curities and Exchange Commission and settlement period.
would be disastrous for the municipal -Dealing with the new Republican
leaders in Congress, whose views
about tax-exempt bonds are still large-
ly unknown.
He also said that there should be"a
level playing field"on campaign con-
tributions so that bond lawyers,finan-
Please turn to PUTMAN page 24
wrdoradry.gamester 21.1444
Putman writing to provideergo ng and disclosure deakn will be paying for the NPM- money supply,do not pick up the
of annual financial information ano- SIRS with their fees. money in those accounts,he said.
mr, aces of metrial events that could affect Putman said that some press nd aporss Republicans'
cud advisers,aother municipal mar. Neu bonds. suggesting tsar the SEC's new disc to e'Pu Agenda Unclean,
ket participants are subject to some of Under the Ivies,issuers must mnu- safe rules were forced upon the Indus- Asked about the new Republican-
the same restrictions as broker-deal- ally update the key financial and op- try are"backwards:` led Congress.Putman said.'There's
ers. crating information that appears in the "We have been pushing for this:'he still a great unknown here as to what
Putman said the Orange County official statements for their primary of- said."The PSA has been on record their specific policies will be"
controversy"should sensitize people ferings.If an issuer prepares an audit- saying for some time that we do need Before the election,Rep.Edward
to the types of things that have to be ed financial statement it will also have more information or at toast the abili- Markey.D-Mass.,the chairman of
disclosed that people in the past did to be submined to a nationally recog- try to access information without being the House Energy and Commerce
not think were very impor[atiC nized information repository. smamrolled:' Committee's subcommittee on
At may be painful.It may be ex- One open issue.Putman said is how Putman said he believes that the telecommunications and finance.had
pensive.But it's a very good lesson far municipal issuers will go to satisfy PSA and MSRB initiatives to make said one of his priorities for the cum-
that kind of dovetails with the rules" the requirements to disclose annual fi- boat prices and other information pub- ing year would be to hold hearings
on secondary market disclosure that nancial information and notice of ma- licly available will eventually lead on municipal bonds and to introduce
were adopted last month by the SEC, terial events. newspapers across the country to rou- legislation requiring the registration
he said. For general obligation bonds.issuers finely publish the prices of municipal of conduit bonds.
Putman said the SEC's disclosure should be able to satisfy the annual fi- bonds that arc sold or ended on a dai- Putman said he told Markey,who
rules,along with previously issued nancial information requirement by ly basis. will become ranking minority mem.
SEC disclosure euidelines and ongo- disclosing their annual financial report On the issue of political eontribu- her of the subcommittee in January.
ing industry initiatives on price trans. he said.For revenue bonds or more tions.Putman said that while most ben that registration would be a death
parency,should be sufficient to deal complex financings,they may only ker-dealers are supportive of the knell for some conduit bond issues.
with most of the disclosure issues be. need to supplement that report with ?iSRB rule aimed at banning pay-to- "I reminded the congressman that
ing raised in connection with Orange some additional information,he said, play practices,dire ase still some is- in Massachusetts there's some S20
County. 1 think there's going to be a lot of sues to be resolved with regard to the billion worth of conduit issuers in-
The county filed for bankmptcy ear- time and motion and energy gnawing rule. eluding hospitals and universities.for
tier this month after suffering deriva- over the nits and grits here,but I think The to.which took effect on April which Massachusetts is known,and
tives and leveraged investment-relat- some of it is going to be unnecessary:' 25,bars brokerdealen who make po- that perhaps before he put those folks
ed losses and liquidity problems with he said. litical contributions to issuet-clients out of business he should talk to his
its multibillion dollar investment pool. Putman predicted that the Mies will from doing business with those clients local constituents:'Putman said.
Putman said the SEC's investiga- spawn a whole new,sector of the in- for two years afterwards, Rep.Jack Fields,R-Tex.,who will
tions of Orange County may show drat dustry whose mission will be!o re- One unresolved issue is whether an now chair the subcommittee with ju-
county officials failed to follow some search,analyze,and abstract issuers' official of a municipal securities fimn risdicuon over securities,"is going
of the disclosure practices that the SEC annual financial reports.He envisions should be allowed to be part of the to have a lot on his plate"in trying
recommended issuers employ to avoid a future in which broker-dealers not transition team of a newly elected local to implement his part of the Repub-
running afoul of the securities lawn only routinely call up these abstracts official without triggering the rte's re. lican leadership's Contract With
antifraud provisions.The commission electronically,but also provide them stricaons. America,and municipal bonds may
Made dose recommendations in an in. to investors. "It's an in-kind contribution. be leu of a priority,he said.
terpresative release it issued last March. "That's the whole concept behind Whether you give dollars or your tune The Republicans have talked about
Contract With America Cited the Mies.If someone now he
has the data. its still its a sense a contribution:'said putting more responsibilities on r
were going to have a larger msponsi- Putman."But does that mean that suis and reducing the capital gains
Both Rep.Christopher Cox,a Re- bility to understand it and to access it" politicians can consult with everybody tax,both of which would be good for
publican representing Orange County, he said."It's pretty clear that we,as else except the financial community municipal bonds.Putman said.
and Rep.Jim Leach,R-Iowa,the in- business people,should take a very when they come into to office?That The PSA would film any legisla.
coming House Banking Committee hard look at how we operate under doesn't make sense" tion aimed at reducing the capital
chairman,have said the county trea. these Mies,particularly now that we'll Asked about bond attorneys who say gains sax to include a measure to
surer's risky investment strategies have the information available." lawyers should not be subjected to to overturn a recently enacted tax bill
should have been disclosed and that Putman is worried that some issuers same coastralnts on political eontribu- provision that treats the discount
they plan to introduce legislation call- may overload to system with ounces eons as broker-dealers because they from bonds sold at a market discount
ing for municipal bond issuers to be of events that ate am sully material in help scam and local lawmakers-fire after April 30,1993,as ordinary in-
subject to the same disclosure require- their bond issues. laws,Putman joked that thou lawyers come rather than as capful gains,he
ments as corporate issuers,possibly "There obviously will be some de- must see"a deeper philosophical dif- said-
including registration. bate on material events:'he said. lercnct between the lawyers and the But it is not yet clear what will
But Putman said last week 1 don't The fan that New York State is run- dealer"and must feel that"they're happen to infrastructure and other
think legislation is needed" ning a budget deficit nay be material, professionals and we'rejust out to get initiatives launched by the Clinton
"ihe[Housel Republirans'Contract but every little change in that deficit money."AmAdministration before the election,
With erica is for toss,nor more.reg- might not be,he said. "I think we have to have a level Putman said
ulations:'he said. "I don't think every time they have a playing field"he said. Turning to the business side of the
"Forced registration would be a tet- hiccup in Albany,it means they have At a minimum.bond lawyers,fi- bond market Putman said that while
able mistake"and would be costly for to file all kinds of daeuaints"he said fhancial advisers,and oilier market pa- the huge drop in municipal bond sal-
both issuers and the SEC,he said. y Repository Overkill feared ticipants should disclose their politi- ume this you may result in some
Registration statements for one p� a7 ai co mibutiau and mfnia ltom mak- downsizing and some reductions in
about 3300 corporate issues were filed Putman is also concemed that too ing any contributions to obtain band bonuses at funis,it should not result
with the SEC last year,while sum and many nationally recognized munici- business,he said in a major retenchmcn[of munici-
Ioca(govttnmeatsissuedroughly pal securities information reposito- "iii bigger problem with all of this, pal bond departments.
14.O00 municipal bond issues.Putnam ries(NRMSIRs)may be established however,that nobody likes to focus on, 1 don't we any wholesale with.
said. under the rules and that broker-dead- a the whole issue of campaign finaaoe di awal from the business;'he said.
"You don't have to be a genius to ers will be expected to pay for all of reform"Putman said"It's gotten out "People learned some pretty good
figure out how the SEC would handle them of hand" lessons in de 198N and didn't bulk
this under their current budget The rules require broker-dealers Politicians have to raise huge up"in the early 1990s when volume
squeeze,"he said. to have in place by Jan.1,1996,to amounts of money.Putman said,and was rising,
Putman said that white the SEC's systems and procedures needed to much of that money goes for political Putman sees municipal bond vol-
disclosure rules and guidelines do monitor material events that could consultants and advertising."We've ume increasing steadily over to next
not specify the form and content of affect the bonds they recommend to built a-hole new infrastructure that few yeah to over$200 billion in the
the disclosures that issuers should investors. has a vested interest"in political con- year 2000.There is some pem-up de-
make,they"in essence minor what Issuers must send notices of ma- rributions.he said mand for new issues,because a las
the SEC has asked corporations to terial events either to each of the of issuers were focused on refund-
do:'The Mies become effective bp. NRMSIRs or the Municipal Securi. &9 Changes From T Plus 3 ings last your.as well as ongoing in.
ginning next July. t ties Rulemaking Board as well as to Putman said the move from a five- frastructure needs,he said.
The Orange County controversy al- any depository set up in that state. to a three-day clearance and wide- Summing up the past year.Put-
ready has led some issuers to disclose They must send annual financial in- ment period will be a"dramatic" man said the SEC's new disclosure
information about their investments formation to each NRMSIR and to change for the municipal bond mar- rules,the MSRB's political conti-
and to begin marking to market their any depository in their state. ket.particularly for regional or small butions rule.the ongoing industry
portfolios on a periodic basis.Putman "If you've got 20 NRMSIRs tak. bond firms that are used to accept- price transparency programs.and
said. ing in 50.000 documents.that's a ing chocks from individual investors other initiatives have created a huge
Unresolved kstaes Over SEC Rules rather redundant system:'he sai& buying bonds. "sea change"in the municipal mar.
Practically speaking and from an Under the so-called T plus 3 sys- ket.
In an earlier interview.Putman said economic standpoint,it does not mm.which takes effect next June, "I'd say 1994 was as big a year in
that while the SEC's new secondary make sense to have more than five investors are going to have to have terms of changing the industry as the
market disclosure miles am"very work. or six repositories under the Mies.he cash management accounts with year they created the MSRB"in
able."them are still some"open issues" said. - broker-dealers or some means of 1975,he said.
about how they will be implemented 'Putmasaid that people should re. transferring money electronically, These new initiatives will have to
by market participant& member that while taxpayers pay for he said. be digested and they may have to be
The rotes bar broker-dealcn from EDGAR—the SEC's Electronic Data A increase in cash management foe-tuned,"but in essence everything
underwriting bonds as of July 3.1995. Gathering Analysis and Retrieval sys- accounts,however,could cause prob- is in place"for a sung,well-mgu-
unless they have"masonably deter. tem,which is used to receive corpo- kms for monetarists because MI art fated market that serves investor
mind"that the issuer has agreed in rate filings electronically—broker- M2,the two key measures of the needs.Putman said. ']
GFOA to Consider Disclosure Revisions
In Response to Orange County's Mishap
By Brad Altman
LOS ANGELES—In the wake of S.Green,general counsel for the Port
Orange County, Calif.'s financial de- Authority of New York and New Jer-
bacle, the Government Finance Offi- sey.
cers Association will look at whether "One of the issues we will look at
its disclosure guidelines need to be re- is whether any revisions are necessary
vised to assist investors in detecting because of the Orange County situa-
high-risk investment tactics by issuers. tion,"Green,who chairs the task force,
A GFOA disclosure task force will said yesterday."We will consider that
begin a review of the association's ex- and act accordingly."
isting disclosure guidelines by March, Even before Orange County's woes
and a draft of its recommendations will surfaced at the beginning of Decem-
be ready by next summer,said Jeffrey ber, the association was planning to
update its disclosure guidelines to re-
flect last month's adoption by the Se-
curities and Exchange Commission of
new secondary market disclosure rules.
The association's publication,"Dis-
closure Guidelines for State and Lo-
cal Government Securities,"is intend-
ed to be the backbone of what should
Please turn to GFOA page 15
bet triggered his resignation,the coun- rather rapid rate at this particular point GFOA disclosure guidelines need to be.
Continued from front page ty's filing for bankruptcy,rating agency with the recent rulings of the SEC,and Petersen of Government Finance
be included in an official statement. downgrades,and a Securities and Ex- 1 think that[Orange County and the Group said it is not realistic for investors
The guidelines were most recently re- change Commission investigation. SEC guidelines)will push disclosure to rely on disclosure guidelines to"an-
vised in January 1991. The pool disaster also has spurred issues further,"he said. ticipate everything that can go wrong
Since 1976,the GFOA has pub- industry discussion on how many oth- The SEC currently has little regulato- with a government'"
lished disclosure guidelines for offi- er intergovernmental investment funds ry authority over tax-exempt issuers,but For example,Petersen said,Orange
cial statements,as well as recommen- have racked up paper losses and may it does have authority over underwriters. County's use of derivatives was not the
dations for continuing disclosure in the be overleveraged. State and local government issuers are problem—"it is rather the leveraging
secondary market.Because issuers are John E.Petersen,president of Gov- subject to the SEC's antifraud rules in of the fund that caused the problems"
told they are only a recommended ap- ernment Finance Group Inc.in Ar- much the same manner as corporate debt The leveraging strategy,which count-
proach,"in the real world,people don't lington,Va.,said he would not be sur- issuers. ed on low interest rates,ultimately back-
use them:'one market participant said. prised if as many as"15 or 20"mu- Thus,issuers are required to ensure fired,and the investment pool experi-
"They are a quasi-gimmick:" nicipalities nationally eventually suf- that all items of a material nature,both enced an estimated$2.02 billion in lost
But,while the guidelines"are not fer some losses in their investment positive and negative,are adequately dis- value.'Ilse real question is when in fact
a legal standard by any means," funds. closed in the official statement. those losses that were potentially to be
Green said many issuers use them He said he believes that Orange The Tower Amendment prohibits the experienced really became material:'Pe-
"because their bond counsel or their County's problems will spur greater SEC and the Municipal Securities tersen said.
financial advisers just tell them what attention to municipalities'cash man- Rulemaking Board from adopting rules That pool loss"would have been an
to do." agement practices in the future. requiring municipal issuers to file reg- item needing disclosure"to investors,he
If government finance officials were However,Jeffrey L.Esser,GFOA istration documents before their offer- said.
asked whether they follow the guide- executive director,said Orange Coun- ings are made.The amendment was Petersen,who was director of the
lines,some"wouldn't know what you ty's investment pool strategy is"set added to the Securities and Exchange GFOA finance research center in the
are talking about:'Green said."But, apart"from other intergovernmental Act of 1934 when the MSRB was cre- mid-1970s when the associate ts-
if you look at-their disclosure,it is con- pools. ated in 1975. closure guidelines were develd
sistent with the guidelines:' For example,this past summer the Green,the GFOA's disclosure task financial asset holdings of gen v-
Green said he could not comment county issued bonds for the sole pur- force chairman,said the SEC's release emments—excluding pension systems
on whether Orange County followed pose of investing proceeds in the pool. last month on secondary market disclo- and various trust funds—are roughly
GFOA's guidelines in the preparation Esser said that borrowing practice, sure"is consistent with many of the rec- $800 billion.
of its now-notorious official statements along with the pool's size and lever- ommendations in the GFOA guidelines- "We would probably need to have
that are at the center of the disclosure aging,"put Orange County in a class with respect to periodic disclosure:' something on the scale of Orange Coun-
controversy. all by itself:' He said disclosure is always the is- ty four times over for it to amount to I%
"There is no way I can second-guess Don Beatty,a former executive di- suer's responsibility:"They certainly can of the sector:"Petersen said."1 only want
somebody else's disclosure,particu- rector of GFOA who had a hand in designate a bond counsel or a financial to point out that the record of financial
larl y when 1 haven't read it and.I am drawing up the original disclosure adviser to do it,but the ultimate respon- losses,including defaults,is much high-
not involved in that transaction,"Omen guidelines in 1976,said"it is proba- sibility is the issuer." er in the private sector than the public
said. bly time to look seriously at direct reg- Nobody is sure how comprehensive sector."0 O
The county has not commented on ulation"of the municipal bond Indus-
whether it used GFOA guidelines in try.
the drafting of its official statements. Beatty,a Bank of America vice pres-
However,the county has said in gen- ident for institutional trust services,
eral that it followed the advice of bond said at present"there is really very lit-
counsel in preparing bond-offering-re- tle incentive for issuers to do much
lated indentures. more than they are doing currently"
A class action lawsuit filed Friday regarding disclosure.
alleges that Orange County's official The market might be better served
statements hid the risky nature of the if issuers were required to undertake
investment fund managed by former "some sort of reasonable filing of in-
treasurer-tax collector Robert L.Cit- formation in a central repositoryso in-
ron. vestors can go and look at the infor-
The pool's collapse early this month rnadon,"Beatty said.
because of Citron's bad interest-rate "Disclosure is moving forward at a
• Tuesday,December 20, 1994
Next Banking Chairman Plans
Bill to Repeal Tower Amendment
By Joanne Morrison and Lynn Steens Hume
WASHINGTON—Rep.Jim Leach, Leach said repeal of the Tower
R-Iowa,the incoming chairman of the Amendment is needed now more than
House Banking Committee, plans to ever in the wake of the Orange Coun-
introduce legislation to repeal the so- ty,Calif.,debacle.
called Tower Amendment so that reg- The amendment, which was added
ulators can subject municipal issuers in 1975 to the Securities Exchange Act
to the same disclosure requirements as of 1934, bars the Securities and Ex-
corporate issuers. change Commission and the Munici-
Leach told a news conference yes- pal Securities Rulemaking Board from
terday that his plan to repeal the Tow- taking any action to require municipal
er Amendment is one of five bills he bond issuers to register their bond of-
intends to introduce when Congress ferings.
convenes on Jan.4. "It has the effect of stipulating that
The other bills include measures to municipalities do not have to make the
modernize banking laws, streamline same full disclosures as private sector
the regulation of financial institutions, enterprises that go to the market,"
create clearer regulation of derivatives Leach told the reporters at the press
under existing federal agencies, and conference.
impose sanctions against foreign fi- "In my judgment, in a democracy,
nancial institutions whose countries municipalities ought to lead the way
discriminate against U.S. financial in full disclosure,"he said,
firms. The incoming banking committee
chairman is the second congressman
to call for such legislation during the
last few days. Rep. Christopher Cox,
a Republican representing Orange
County who will have a seat on the
House Commerce Committee,said last
Tuesday that he will propose a bill ear-
ly next year requiring municipal is-
suers to meet corporate disclosure re-
quirements.
Leach said that if Orange County
had been subjected to corporate dis-
closure requirements, its treasurer
would have had to disclose his risky
investment strategies and the county
would never have gotten into such se-
rious financial trouble.
The county filed for bankruptcy ear-
lier this month because of the losses
and liquidity problems stemming from
derivatives and leveraged investments
in its multibillion dollar investment
pool.
In addition to seeking more disclo-
sure from state and local governments,
Leach said he thinks municipal mar-
ket participants should be barred from
Please turn to AMENDMENT page 15
Tuesday,December 20,1994
rules on political contributions;' eliminated this year."
Amendment
Leach told reporters. Meanwhile,Leach said Orange
Conrinuedfrom fronfpage Leach noted that he would County's recently reported loss-
making any political contribu- share jurisdiction on any mu- es and subsequent bankruptcy
tions to issuer clients."I think it nicipal bond legislation that he make derivatives an even more yr
ought to be eliminated entirely;' introduces with the House Com- important and urgent topic for the
he said. merce Committee. committee.
At the same time,-however,the As far as changes to the bank- Leach said the Banking Com-
lawmaker noted that there are ing laws are concerned, Leach mittee is expected to hold hear-
constitutional concerns about said reform to the Glass-Stea- ings about Orange County in the ;p. .
banning political contributions gall Act will be atop priority for second or third week of the new
and that there is an ongoing court his committee. congressional session.
case over a recent rule aimed at "The Banking Committee is In light of the county's losses,
banning pay-to-play practices in going to lead off with a legisla- Leach said derivatives will be giv-
the municipal market. tion agenda and the first and en"significant review this year
Leach introduced legislation most important single issue will with the possibility of serious leg- r
in the last Congress to repeal the be reform of Glass-Steagall islation on the table the follow-
Tower Amendment and to re- laws;'Leach said. ing year." '
quire municipal market partici- He said the inability of banks To me one of the most re- `+
pants to disclose the political to provide the services cus- markable aspects of[Orange
contributions they make to mu- tomers want is a greater risk County] is that there is no ac- "In my judgment,Ina democra ,
nicipal issuers. than allowing banks to enter into countability here in Washington municipalities ought to lead the way
But he told reporters that he the securities business. because no accountability has In full disclosure":Rep.Jim Leach,the
may not reintroduce legislation "I believe relevance in com- been decisively and thoughtfully next chairman of the House Banking
on political contributions,or that mercial banking can only be ob- placed;'he said. Committee,takes aim at the Tower
he may introduce it as a stand- tained by recognizing that finance Asked whether the county's fi- Amendment.
alone bill,because the SEC has is now a much more intermingled nancial troubles presented any
already.acted to curb pay-to-play industry and that therefore Glass- systemic risk for the financial committee,Leach said Whitewa-
practices. Steagall reform is still in order," markets, he said, they are "a ter will also be considered.
The SEC earlier this year ap- Leach said. tremor'but"not a systemic-risk However,the lawmaker said he
proved a Municipal Securities The lawmaker added that reg- earthquake." isn't going to act immediately
Rulemaking Board rule aimed ulatory consolidation is needed Systemic risk is the risk that with issues surrounding White-
at banning pay-to-play practices and will be a big issue for the a financial disaster in one market water to allow completion of oth-
in the municipal market.The Banking Committee and the in- will spill into, and have disas- er investigations.
rule generally bars broker-deal- dustry. trous consequences for, other But Leach said he hopes to hold
ers who give political contribu- "I personally believe that there markets. Leach said Orange hearings to"wrap up"Whitewater
tions to issuer clients from do- are too many regulated institu- County was"symbolic of what in late spring or early summer.
ing business with those clients tions and regulators," he said. could become a larger systemic "I would stress that it's very im-
for two years afterward. "OTS [Office of Thrift Supervi- risk problem" portant that we all recognize that
"I personally think that legis- sion]in particular looks to me as Nonetheless, while improved issues that have effects of weak-
lation had some effect in caus- to be increasingly superfluous, municipal bond disclosure, de- ening or debilitating the presi-
ing and allowing the SEC to and we hope that all of the RTC rivatives oversight,and banking dency should be resolved;'Leach
move in the direction of new [Resolution Trust Corp.]can be law reforms are top issues for the said. U
On the road to ruin, in white patent leather shoes
By David Margolick David Margolick is a reporter for lunchtimes,Citron,who was forced to gan winning awards for his acumen,
the New York Times. resign the week before last after the he bought all clothes at C&R;he was
THE SANTA Ana Elks Club is disclosure that the Orange County in. the type to wear,along with white pa-
not the sort of placewhere I,- vestment fund he managed had lost tent leather shoes and belts,red polyes-
nancial moguls,whose deci- ping in the Chrysler he bought every more than$1.5 billion,was quiet,even ter pants and a green blazer at Christ-
sions can shake far-off Wall Street to 18 months or so since 1940,he arrived introverted.Every year,tens of thou- mas.pastels at Easter and orange and
its foundations,usually dine.The decor at 10 past 12 and left at 10 to 1,off to sands of local residents might have black on Halloween.
is heavy on Formica,Naugahyde and juggle billions more.Always,he picked made out their property tax checks to The county clerk,Gary Granville,
Styrofoam.On the tables,the only cen- up his own check. "Robert L.'Bob'Citron,"and every four . recalled seeing Citron,who earned
terpiecea are Keno coupons and bottles By workday,Citron,for 24 years the years they voted for him,the only Dem- $104,353 a year,decked out in red,
of Heinz Ketchup and Mcllhenny s Ta- treasurer of Orange County,was a so- ocratic ballots many in this famously white and blue one Fourth of July."I
basco sauce.The fare is cheap—unlim. phisticated,aggressive and daring in- conservative bastion ever cast.But few said to him,'Gee,I'll put a fuse in your
ited soup and salad for$4.50—and ba- vestor.The high returns he earned would have recognized him on the head and see if you explode,'"Granville
sic. made him not only a legend in financial street. recalled in an interview.
But three times each week until ear- circles nationwide but a hero to local Citron rarely ventures outside the
lier this month,between time spent politicians desperate to do more with WAY FROM the world of high quadrilateral framed by his ranch-style
moving around billions of dollars be- less.His alchemy spared them from finance,of"reverse repurchase house in Santa Ana,the Elks club,his
longing to a dizzying array of cities,au- politically suicidal tax increases and Aagreements"and"derivatives," office and the football stadium at the
thorities and administrative districts gave them a few extra police officers Citron led a life that was cautious and University of Southern California,
throughout Orange County,Robert L. to patrol the streets or teachers to conventional,almost corny.He kept where he spent four years,but from
Citron came here like clockwork.It was teach school. all of his own money in savings ac-
but one routine in a life of them;hop- But by nights and weekends and counts and tax-free funds.Until he be. Please see D0,back pare,Forum s
•
Did aU the praise cloud
the treasurer's judgment?
Continued from Forum t fight song.The welcome mat at devotion to his work.Though he
which he never graduated.For his home here, behind a will turn?OnextApril,fewwere
all his calls to Wali Street,he parched lawn and well-trimmed surprised earlier this year when
has been to New York only a palm trees, features the USC he sought another term as tries.
handful of times;he had never Trojan,but no one is welcome surer;what else,they thought,
been east of Tucson before 1980, there these days: would he have done?
and apart from an occasional When a visitor appeared Some say that Citron,who
trip to Mexico,has never been there the week before last.Cit- with no children,as
voled bring
outside the United States. ron'e wife of 89 years opened the a savior.Though shy, he was
"Bob was in a position where, door a crack.Rubbing the door never too shy to tout his acc om-
if he wanted to go to the Bobs- knob nervously, her eyes plashments,particularly before
Ines tar two weeks,all he had to watering,Terry Citron spoke of the Orange County Board of Su-
do was mention it and some- the brutality of the press and pervisors. And he loved being
body would have picked up a how it was too bad that Orange touted in return,as Thomas F.
ticket for him,"said Fred Pren. County's collapse had not aur- Riley, the board's chairman,
dergast of Irvine,a regular at faced during a more active once did.
Citron's table at the Elks,and phase of the O.J.Simpson trial, "He lived off the praise,"said
one of many there who say Cit- when attentions would have John M.W.Moorlach,an ac-
ron has been betrayed by fair- been elsewhere.She said her countant in Costa Mesa,who
weather politicians."Bob never husband had retained a lawyer, ran against
po who had told him to sa nothin scon Caron ecus spring,
went to the Bahamas.He never y g his first contacted election since
wentan here." for now.
y"' 1970."Thee was the source of
No one shares the county's
Citron's passions include tar- pain more than Mr.Citron," his doingstrokesa in life. He felt he
quoise jewelry,upholstering his p was doing everyone a big favor.'
own furniture and W.C.Fields; said his lawyer, David W. Citron's friends say that just as
his father was Fields'doctor in Wiechert of Costs Mesa.'That he lived for adulation,he was
Riverside County,the one who pain has been amplified by the sensitive,even hypersensitive,
almost weaned him off liquor disheartening lack of support
q to criticism.When he was
iri
once. As members of a group Mr.Citron has received from posed for re-election last ceL
called"The Bank Dicks,"Citron various public officials and por- he described the experience an
and his wife picketed the near- tions of the press." 'gut wrenching'With many Ro-
by Knott's Berry Farm and per. T IRTUALLY overnight, publicans fearful that his defeat
suaded it to erect a wear
statue V Citron has seen his rep- sold jeopardize the county's fi-
of the comedian. 'these pas- utation shattered,and minces,Citron won handily.But
times pale,however,when com- become the butt of bad puns this potent combination of ego
pared with his love for USC, about citrons—French for tem- and insecurity,officials say,
where he took classes in the ons—in Orange County. But may have preased him to out-
1940s and played clarinet in the Citron's friends defend him as a perform himself,clouded his
marching band. pillar of rectitude. Of the bil- judgment and led to his fall.
The license plate on Citron's lions he handled, they said, "Bob Citron is absolutely four-
car is LOV SC, and until it none ever stuck to his fingers. square honest," said Robert
hr„ke the horn wab pro- With equal unanimity, they Thomas,a former chief admin-
It,play the schuol's speak of his almost monklike islrutiveofficer ofOrangeCoun-
l
paw-
i D 51641? I! I
sx stt�s ABWE yl i(�;
WALL qW• f -_
1 ( ft
I �
nl
San Jose Mercury News/Mant
ty. But Bob's been so successful quiet. ing.
for the past 15 years that he Citrus came to the Elks Club I'u go to a man's home Sun-
started believing he was infalli. a week ago Thursday, but, us day afternoon,intrude in his
ble,believing his own press clip- one friend put it,"he was not personul life and practically
pingo.Like so many of us,he is the usual Bob."On the next day force him it;resign,is the most
very susceptible o praise.One he did not come at all.But he cowardly thing a person lean
hundred and eighty-seven or- was still on the minds of people do),"he said bitterly."All they
ganizations told him how greet like Prendergast,whose com- had to du was wait for eight
he was,and Its believed it" passion for his friend is o'clock in the morning,or seven
Citron survived politically in matched only by his anger at in Bob's case,and he'd have
Orange County,whose airport the Orange County supervisors, been right in his office,where
is named after John Wayne,in who sang Citrons praises when he's supposed to be. They.
the only way Democrats can:by times were good,only to dump treated him like an animal-'
being extremely successful and him when the Buk started By- New York Times
Orange County's Fatal Error .
The bankruptcy of Orange Cotmty. Caliiornia But this year the Federal Reserve has been
the biggest municipal bankruptcy ever — is jacking up interest rates to clamp down on infiatiom
turning chaotic The county's investment fund. The rates at which Mr.Citron was forced to borrow
whose contributors include 60 school districts and rose above the return the fund could earn on long-
11 water districts, is no longer returning principal term securities.The rate hikes sent the value of Mr.
or interest to its partidparim The cutoff forced the Citron's long-term bonds on a downward spiral: a
eotuuy to suspend highway repairs and taxrefunds. prescription for bankruptcy. The fund appears to
Schools,which were legally required to invest in the have lost more than 25 percent of its value.
'fund,health clinics and social service agencies may It is a matter of detail which securities —
nm out of money to pay saiarim derivatives or plain-vanilla stocks and bonds—Mr.
The fiasco raises two questions. What caused Citron chose to trade.17he strategy,not the securi-
the bankruptcy?What can prevent similar episodes ties,proved fatal.
across the country? = ` What, thent was needed to stop him? Some
The county fund lost money by buying complex, members of Congress have picked the wrong an.
volatile securities known as derivatives,whose val. swes: prohibiting county frauds from purchasing
*,ue rises and falls with the price of underlying bonds. derivatives or borrowing to purchase securitim
stocks,currencies and interest rues.Many observ- The danger with such blanket prohibitions is that
c:s have leaped to the presumption that money- they rule out the use of derivatives and bow to
losing derivatives.caused the bankruptcy.. • reduce investment risk Mr.Citron's mistake was to
The presumption is unwarranted. The fund's make me-way bets on the direction of interest
flagrant mistake was not which securities it bought, rates. But prudent investment managers use the
..but its choice of an irresponsibly risky investment same tactics to insulate funds from movements in
`strategy.Robert Citron,the County Treasurer,bra interest rates in either direction.
'-zenly borrowed billions of dollars at low short-term What Orange County needed was oversight.Mr.
„rates of interest in order to buy higher-yielding Citron was seemingly left to ran amok. Arthur
.tong-term bands and other securities. Levitt, chairman of the Securities and Exchange
The strategy amounted to a risky gamble that Commission,calls on state and local governments
�interest rates would fall; if they did, Mr. Citron's to monitor investment managers of taxpayer mon-
,borrowing costs would fall and the value of his)ong- ey. The primary objective of government funds
.term bonds would rise. For years he racked up must be safety and liquidity (the ability to convert
fabulous gains, becoming a local hero by earning investments into cash for emergencies),not profit. .
'profits in excess of 7 percent when other county If fund managers were forced to assess and report
funds settled for haN as much. indeed,Mr. Citron risks, and government supervisors were responsi-
'was elected as a Democrat in s ferociously Republi- ble for overseeing the managers,then Orange Coun-
can county even though his opponent ridiculed Mr. ty—one of the wealthiest in America—would not
tNrrnn'Q riekv strate8v. now be threatening to lay off teachers and nurses.
Wednesday,December 14, 1994
Orange County Adviser Says Loss
By Troubled Fund Is $2 Billion
By Michael Utley
SANTA ANA, Calif. — Orange sors that the investment firm Salomon
County Calif.'s investment portfolio Brothers—brought aboard last week
loss has reached $2.02 billion, or to help with the pool restructuring—
roughly 27% of what investors have take over day-to-day operations of the
put into the fund, a financial adviser fund from the treasurer's office. "As
to the county said yesterday. we are going through the restructur-
If the entire portfolio were sold to- ing, it is important to restore confi-
day, it would be worth "73 cents on dence" among Wall Street investors,
the dollar,"said Thomas W.Hayes,the Hayes said.
former California treasurer who is Following the Dec.4 resignation of
heading a team trying to restructure
the county's finances. See related stories,pages 3 4.
County officials will begin to re-
structure the investment pool "in an
orderly manner,"and they will not con- county treasurer-tax collector Robert
duct a"fire sale"of the remaining se- L.Citron,assistant treasurer Matthew
curities in the pool,Hayes said. Raabe was named acting treasurer.
Although there is no realistic sce- Raabe was not present yesterday as
nario that could return the portfolio to Hayes briefed reporters on the portfo-
its original value,Hayes said"it is im- lio at the county hall of administration.
portant that we don't panic," In the most complete accounting of
Hayes is recommending to supervi- the pool's structure since the liquidity
crisis was disclosed Dec. 1,the coun-
ty said the current market price of the
portfolio is$8 billion,including$230
million in"cash and equivalents."
About$2.5 billion of the$8 billion
is due to securities dealers from bor-
rowings,leaving net equity in the fund
of$5.4 billion,the county said.
A total of b0% of the portfolio is
composed of structured notes,consist-
ing primarily of inverse floaters, and
40%is fixed-rate,corporate,and gov-
Please turn to ORANGE COUNTY page 28
Orange COtltlt Asked who would buy the secu- III llwt unique situation,where the district
g y rities the county plans to sell,Hayes used the county commingled fund
Contlnuedfromfranrpage said he believed that sophisticated �" much like a checking account:'the
ernment agency debt,the county investors will be interested:"They ,;, district's general manager,William
added, are good credits,but they are struc- R.Mills Jr.,said in a statement.The
Hayes'assessment of the pool, cured in a risky form." district invested$110 million in the
based on an analysis by Salomon "What happened is going to be county pool,representing"the great
Brothers,was the first time the coun- a problem for a number of years to majority of the district's operating
ty has publicly confirmed what many come:'Hayes told reporters before funds and cash reserves:'a district
observers had widely speculated in supervisors began a closed-door statement said.
recent days — that losses were session yesterday. in other Orange County-related
greater than the original estimate of "Orange County can get out of news:
$1.5 billion,or 20%of capital. it,"Hayes said."It will be painful. •Standard& Poor's Corp.yes-
That initial estimate of the loss But,we have to execute [it] pro- terday lowered its rating on Mon-
to the county's highly leveraged fessionally and do it in the best in- tebello.Calif.'s$25 million of tax-
$7.5 billion investment fund— terests of the citizens." able notes to SP3 from SPI-plus.
blamed on rising interest rates— "If you look at the underlying The downgrade reflects the notes'
touched off a chain of events high- strength of Orange County,eco- Dec.30 maturity date and th fact
lighted by Citron's resignation and nomically, there is strong job that the county has froze
the county filing for Chapter 9 growth,the unemployment rate is drawals from the pool,w
bankruptcy protection on Dec.6. going down,the household income city's note repayment fun re
Yesterday,the county said that in this county is over$12,000 fitrpam° held.The rating agency also down-
when the restructuring is complet- above the national average,there is "it is important that we don't panic": graded Montebello's$6 million of
ed,it will eliminate its practice of a diversified economy,there is good Thomas W.Hayes,former treasurer of tax-exempt notes due Sept. 29 of
leveraging the portfolio.The fund infrastructure,and,basically,you California,Is sizingg up the damage to next year.,
will no longer contain derivatives have good people in this county:' Orange County,Calif.'s Investment •Supervisors said they have hired
or structured notes. In other developments yesterday, pool: accounting firm Arthur Andersen&
A county press release said the William Bennett,the county's Co.as a special consultant.Thomas
restructuring should"eliminate fur- bankruptcy lawyer,said the county Meanwhile, 11 of the largest in- E.Daxon,the former state auditor of
ther downside risk:'and will focus is working on a plan to allow pool vestors in the pool were scheduled Oklahoma,will lead the team,which
on eliminating interest-rate sensi- participants to tap into the now- to meet yesterday with county of- will be,in place for at least 90 days.
tive positions.Higher-quality in- frozen investment pool. ficials in a last-ditch effort to avoid Daxon was recommended by Hayes,
vestments will be sought,and the On Monday,county supervisors litigation over the frozen pool the county said.
average maturity of the portfolio voted to curtail any spending in the funds. •Assemblyman Mickey Conroy,
will be shortened. county that was not related to the The Orange County Water Dis- R-Orange,said supervisors should
But, Hayes said, the dollar- "health,welfare,or safety of coun- trict last Friday filed a motion in appoint John Moorlach to fill the
amount estimate of the investment ty residents: federal bankruptcy court to allow now vacant position of county trea-
fund loss could change,depending As a result,Bennett said county con- it access to$34 million of district surer-tax collector. Moorlach,an
on market forces. tractors and vendors who are owed funds in the pool.Over the week- accountant who was defeated by
re
"Markets by their very natuare 'money might have to be patient. end,the county tentatively agreed Citron in last June's election,had
very volatile:'he said. For exam- "Me problem is that we have a to release$5.8 million to the dis- charged during the campaign that
ple,he said,a 1%move in interest good deal less money than we trict,but the action was temporari- Citron's investment policy was
rates could drop the underlying vat- ought to have," Bennett said. ly delayed until the I 1 agencies risky.
ue of the portfolio by another$300 "There is just not enough money could discuss the matter. Brad Altman contributed to this
Tuesday,December 13,19%
State Auditors Plan Assessment
Of Orange County Pool's Losses
By Michael Utley
SANTA ANA, Calif. —A team of Media reports over the weekend told
state auditors descended on Orange of losses skyrocketing to $2 billion,
County,Calif.,yesterday to assess the $2.5 billion, and even$3 billion, de-
investment fund crisis as losses in the pending on the source of the rumor.
fund reportedly grew to more than$2 Peer Swan, president of the Irvine
billion. Ranch Water District, said yesterday
Led by state auditor general Kurt that his latest estimate of the portfolio
Sjoberg, the team plans to review all value is equivalent to a loss of about
activities of the troubled fund since $2.5 billion. He said this means the
summer 1994,as well as annual coun- losses could be between 25%and 33%
ty audits dating back to 1991. for each of the roughly 185 local gov-
Sjoberg joins former state Treasurer ernment participants in the fund.
Thomas W. Hayes and the New York
firm of Salomon Brothers — all See related story page S
brought in to help assess the county's
woes and come up with a restructur- Swan said the updated figure is
ing plan. based on"what the securities are worth
State officials are jumping into the in today's_market".The Irvine Ranch
fray at a time when analysts and others Water District has invested$300 mil-
. are speculating that the fund has lost lion in the pool.
much more than the $1.5 billion first The additional losses were blamed
reported on Dec. 1. on more than $11 billion of sales of
Orange County collateral last week by
nervous Wall Street investment firms.
Orange County supervisor William
G.Steiner yesterday denied a story in
the Sunday Los Angeles Times that he
had put the fund's losses at$2 billion.
"Mat was taken totally out of con-
text,"Steiner said of a front-page sto-
ry in the newspaper attributing the
amount to him.
"They said they heard the loss was
$2 billion,and I said, 'I don't know.It
could be:And that was it,"'Steiner
said. "I don't know the bottom line.
That was inaccurately reported"
The supervisor said county officials
are expecting a written assessment of
the losses from Hayes and Salomon
Brothers some time this week.
The county's public relations firm,
Sitrick, Krantz&Co.,could not say
whether the loss has reached-$2 bil-
lion or more.
"I'm getting back to you with basi-
cally a no comment,"said spokesman
Jim Bourne."People here are looking
• into reports such as the one you men-.
Please nun to ORANGE COUNTY page 20
Orane Count Orange County and other pool panic- participants'long-term obligations, for investment arbitrage purposes
gy ipants'debt obligations"is highly un- Moody's said. ..are extremely vulnerable to the
C'ontinuedfrom front page certain" "Some of the moneys intended to pool's illiquidity and eventual loss
tinned....as of now,they're just as- The rating agency yesterday identi- pay upcoming debt service were un- allocation'
sessing everything" fled seven issuers with interest and doubtedly accumulated and invested The agency added that"there are
The Board of Supervisors had principal payments due in January and in the pool,"Moody's said. many uncertainties relating to the
scheduled a meeting for 9:30 a.m.yes- 12 issuers with interest-only payments The rating agency said the Orange Chapter 9 bankruptcy. Because of
terday,but it was postponed to I p.m. due next month. County pool is subdivided into a com- questions as to the legal ability of the
so county staff could prepare for an Moody's said the"most immediate mingled pool and a bond pool,which parties to avail themselves of the pro-
expected announcement from Hayes concern"for investors is the invest- together contain"some 1,000 accounts lection of Chapter 9,the limited prece-
regarding the county treasurer's office. ment pool's illiquidity. for various purposes.Sorting out pri- dent of Chapter 9 bankruptcy filings,
Officials would not say what that So far,there has only been one de- orities for payment is expected to be a and the resulting uncertainties of in-
announcement would be,and details fault—last Thursday's$110 million complex process" - terpretation,we cannot speculate as to
were not available at press time yes- issue of taxable pension obligation Moody's said the$600 million of how and when these issues will be re-
terday. bonds,issued in September by Orange taxable tax and revenue anticipation solved and what impact they will have
Steiner,who is also on the board of County.The default occurred after the notes issued by the county and$485 on debt repayment"
the Orange County Transportation Au- county said it was not able to access million of other taxable Trans issued Brad Altman contributed to this ar-
thority,which has$1 billion in the unrestricted funds in the pool in an by various pool participants solely rich.
fund,said the agency met yesterday amount sufficient to redeem tendered
morning and announced a 100-day bonds.
plan to keep the county's transit sys- However,Moody's said"the poten- •
terns running. tial of a default"remains for nine Or-
Buses and commuter trains will con- ange County sanitation districts with
tinue operating,he said,and the au- $46 million of outstanding taxable
thority will make good on$46 million commercial paper notes.The agency
in debt service due Feb. 15. lowered those districts'commercial pa-
"That was good news this morning," per to Not Prime because of their in- .
Steiner said. ability to access funds in the pool.
The supervisor said he wanted to Moody's said Anaheim has$2.5 mil-
urge market participants that Orange lion in revenue anticipation notes due
County is still a vibrant region and will Thursday,but city officials"have in-
undoubtedly rebound from last week's formed us that this payment will be
dramatic bankruptcy filing. made from funds not invested in the
"Despite this crisis,the essential county pool."
foundation of Orange County in terms Because of the bankruptcy filing,
of its economic condition and future Moody's said there also are"questions
remain strong;'Steiner said."Ms is about the legal standing and payment
a county with an$82 billion gross priorities"for long-term obligations.
county product,2.6 million people,an "It remains to be clarified how these
employment rate of only about 5%, obligations will be treated."
and over the"g haul,people should Beginning in late December and
stick with us." January"there are semi-annual inter-
Meanwhile,Moody's Investors Ser- est and maturing principal require-
vice said the outlook for investors in melts"on the county's and other pool
Friday,December 9, 1994
Orange County
Should Have Told
Of Troubles Sooner,
Levitt Suggests
By Lynn Stevens Hume
Orange County,Calif.,should have
disclosed sooner that its multibillion
investment pool was having financial
troubles from derivatives and lever-
aged investments, Securities and Ex-
change Commission chairman Arthur
Levitt indicated yesterday.,
"I think events might suggest that;'
Levitt told reporters after speaking at a
Public Securities Association confer-
ence on municipal bond disclosure in
New York City.
Levitt's remarks come one day af-
ter federal regulators and market par-
ticipants said that county officials may
have run afoul of the securities laws'
antifraud provisions by failing to fully
Please turn to LEV/7T page24
I
Levitt
marketed do not involve a
L 'security'and therefore do
C.„i d/....1/ t pr. not fall under the umbrella
disclose its financial troubles and of the securities laws and
the risks associated with some of its antifraud provisions"
its investments to investors and "I have always had an
ptrol participants. expansive view of the de-
Levitt refused h>confimt reports finition of'security'and
that the SEC is investigating the my view appears to be pre-
county's disclosures or the securi- vailing at the commission
ties firms that sold the county de- these days;'he said.
rivatives.structured notes,and re- Roberts urged state bond
verse repurchase agreements. issuers to consider mark-
The county,which filed for bank- ing to market pooled secu-
ruptcy Tuesday,seemed to domi- cities on a daily basis.He
nate the PSA conference,whose also said issuers should re-
focus was supposed to be the SEC's member that"higher than
new secondary market disclosure average rewards are usual-
rules for the municipal market. ly accompanied by higher
"When'sthe last time amajor is- than average risks"and
suer was AA-rated,put on Credit- that,with any heavy in-
Watch,and filed for bankruptcy in volvement in securities,
the space of four days?'one of the "cash is key"and"lack of -
conference speakers asked a re- liquidity can mean death"
porter,requesting anonymity. The PSA,meanwhile,is-
Levitt told reporters at the con- sued a statement on Or-
ference that he does not expect the ange County aimed at
SEC to take action to prevent Wall calming municipal bond
Street firms from liquidating secu- investors. The SEC rules bar broker-deal- recognized information reposito-
ritics or taking other actions that The municipal bond market is ers from underwriting bonds as of ries or the Municipal Securities
could hurt the pool. "fundamentally sound"and mu- July 3.1995,unless they have"rea- Rulemaking Board with notices of
In his speech opening the con- nicipal governments"are not go- sonabty determined"that the issuer events that are not realty material
ference.Levitt applauded the mu- ing out of business;'Heather Ruth, has agreed in writing to provide on- to their bond issues.If they do,he
nicipal market for its calm reaction the PSA's president,said in the going disclosure of annual finan- said,the repositories and the
to Orange County's problems, statement.'As facts unfold(about tial information and notices of ma- MSRB"are going to be overbur-
which he said were"significant" the Orange County situation],the terial events. dened with a lot of fluff"
and"Wray cause grief and loss to impacts will become clearer,'she Robert Colby,deputy director of Green seemed to agree."We
many people" said. the SEC's division of market reg- need to interpret the rule broadly
"I would hope that a balanced Ruth said that the PSA's confer- ulation,said that once a broker- and with common sense and not
and calm approach to the problems ence on the SEC's new secondary dealer is satisfied that an issuer has nitpick the little details"
in Orange County will continue;' market disclosure rules illustrates made such an agreement,it is not The rules call for broker-deafen
he said. that market participants are work- responsible for ensuring that the is. to have procedures and systems in
Orange County concerns prompt- ing to improve the bond informa- suer meets the terms of the agree- place to monitor material events
ed SEC commissioner Richard tion that is available to investors ment. that could affect the bonds they rec-
Roberts.who also spoke at the con- and to maintain their confidence. The broker-dealer would proba- ommend to investors,
ference,to urge securities ficins and At the conference,Jeff Green and bly not be able to recommend that Green.Putman,and Becker all
financial advisers"to take some Fenn Putman said that while the issuer's bonds,however,if the is- said they are concerned about
reasonable steps to make sure that SEC secondary market disclosure suer failed to follow rho agreement, whether the information reposito-
whatever financial instruments you rules apply only to bond offerings panel members said, ties will be operating in an efficient
are recommending or marketing are done as of July 3,1995,within two Putman said the rules should not and cost-effective manner by the
appropriate for an investor and con- years the rules will affect 90%of lead issuers to reduce the amount time the rules take effect.
sistent with their,investment phi- the outstanding bonds in the mar- of key information that is in their Becker urged the information
losophy." ket, official statements for primary of- vendors and other would-be repos-
"Too often it appears to me that This is likely because once a ferings.The rules use official state- itories to find out how analysts reed
compensation,the profit margin,is large issuer like New York City dis- ments as a disclosure benchmark to receive disclosures.This will
what is driving the creation of some closes annual financial information, by requiting issuers to annually up- avoid"expensive mistakes"that
of these exotic instruments.You are analysts and traders will rely on date the key financial and opera(- would have to be paid for by the
left with the notion that they ap- that information for all of its out- ing information that is in them. dealers,she said.
pear to be concocted more in a boil- standing issues,said Green,gener. Joanne Mays Becker,senior vice Becker said she was disappoint-
er room than a conference room," al counsel for The Port Authority president with Dillon,Read&Co., ed that the SEC rules did not re-
he told reporters, of New York and New Jersey,and said she expects the rules to lead quite electronic disclosures because
Roberts also said he is concerned Putman,chairman of the PSA and a to a two-tiered market,with deal- scanning printed material is time-
that"there's been a great deal of managing director at Lehman ers favoring the bonds of issuers consuming and expensive.Some-
discussion from members of the se- Brothers. that fully meet their disclosureone in the audience said most rc-
curities industry and others that a Putman said the PSA plans to de- obligations over those of issuers tail investors do not generally have
number of the financial instruments velop a model contract that issuers that do not. access to electronic information yet,
being sold and strategies being can use to commit to ongoing dis- Putman said that he hopes that though that may change with in-
closure, issuers will not inundate nationally creasing computer sales. 0
SEC Looks Into Underwriter of
California School District's Notes
By Brad Altman
LOS ANGELES—The Securities lion paper loss was first disclosed.
and Exchange Commission has in- "They had questions about the un-
quired into the role played by Rausch- derwriter,"Fine added,but he said he
er Pierce Refsnes Inc. as underwriter did not know what areas the SEC was
for a school district that issued taxable probing.
notes that were invested in the Orange Leslie O.Lynch,executive vice pres-
County, Calif., investment pool, a
school district official said. See related story
The Newport-Mesa Unified School page 2
District issued$46.96 million of tax-
able notes in June that were then in-
vested in the Orange County invest- ident and comanager of Rauscher
ment pool for purposes of earning ar- Pierce's fixed-income department,yes-
bitragd income,according to Michael terday said he is not aware of an SEC
H. Fine,director of fiscal services for inquiry.
the Newport Beach-based school dis- "We have not been contacted; this
trict. is the first I have heard of it," Lynch
Fine said yesterday that the district said.
has had "a couple of conversations" Orange County officials have said
with SEC officials since Dec. 1,when the SEC contacted them following the
word of the investment pool's$1.5 bil- Please turn to CALIFORNIA page 19
surer following the resignation of Cit- in the future in these financings:'heinancin
California surer g
actions was Fieldman,Rolapp&As- ron,wrote to the district to explain how said.Noting the scrutiny of the Orange
Conrieueefeom front page sociates. proceeds from the note issuance would County pool,he added,"I would ex-
announcement last week of losses in "The disclosure was made in the of- be invested. pest that everybody else"is also reeval-
the Orange County pool.The disclo- ficial statements that proceeds of the Raabe,then assistant treasurer,de- uating such financings.
sure set off a dramatic chain of events, notes would be held by the Orange scribed the transaction as a"compli- While acknowledging that Rausch-
including the resignation of county County treasurer-tax collector on be- cated matter'involving reverse repur- er Pierce bankers originally ap-
treasurer-tax collector Robert L.Cit- half of the district,and the transaction chase agreements.The repos are a key proached the four school districts and
ron on Sunday and the county's filing was rated by Standard&Poor's on that to the pool's leverage-based investment suggested that they consider the tax-
of Chapter 9 bankruptcy on Tuesday. basis;'Tom Johnsen,a principal with strategy that ultimately led to the coun- able note investment,Lynch said his
Newport-Mesa is one of three local the Irvine,Calif.-based independent fi- ty's portfolio losses. firm"didn't develop"the taxable
districts that last June issued taxable nancial advisory firm,said yesterday. "Only after relating the positives and structure.
notes underwritten by Rauscher Pierce. He added that his firm was unaware of negatives to you,and that the negatives The transactions have raised eyebrows
The combined proceeds from the four an SEC inquiry. , or risks were very minimal,did we among some observers who wonder if
financings,totaling about$200 mil- The rating agency rated the four note agree to this financial transaction;'the straight arbitrage deals make sense for gov-
lion,were placed in the pool. issuances SPI-plus.Earlier this week, Raabe letter said.'"I'here is no risk re- emment entities.
In addition to the Newport-Mesa dis- all local obligations in the county's lated to the$46,960,000 principal Newport-Mesa's Fine said yesterday said
trict,three other school-related public pool were placed on CreditWatch with amount,"the letter added. he was in no mood to discuss whether the
agencies issued taxable notes,which negative ramifications. Fine said the district's taxable notes financing was good public policy.
mature June 13,1995.They are the Or- Newport-Mesa's Fine said yesterday that issuance in the first fiscal year turned '"Chat's why we hire high-priced
ange County Board of Education, each of the four districts issued roughly the out to be"a winner."He said the dis- bond counsel and others to make
which placed$42.18 million of pro- same amount of taxable notes in the fiscal trict made$1.1 million on the deal. sure that what we're doing is in fact
ceeds in the pool; Irvine Unified year that ended June 30. Originally Fine thought this year's is- legal and that it is above board;'he
School District,which placed$54.58 In last fiscal years inaugural group suance would earn the district said.
million;and the North Orange County of financings,Rauscher Pierce ap- $700,000,a figure revised downward Fine said he is not sure if litiga-
Community College District,which proached Newport-Mesa and said it to$300,000 following last week's pool tion will be the result of the pool cat-
placed$56.29 million. wanted to be a financial adviser on the loss announcement. astrophe,but said that his district has
Rutan&Tucker,a Costa Mesa, transaction,Fine said. "We have sufficient reserves to hired special counsel"that was not
Calif.-based law firm,was bond coun- "As the deal started to structure it- take care of that decrease."Fine involved in the deal just to review
sel on the Newport-Mesa,Irvine Uni- self...Rauscher said it would be the 'added. documents'
fied,and Board of Education frnanc- underwriter—nicer fees that way;' Rauscher Pierce underwrites about "We don't make public policy,"said
ings, LeBoeuf, Lamb, Greene & Fine said. one-fifth of California's taxable tax Lawrence G.Rolapp,a principal in Field-
Macrae was bond counsel on the com- After the Newport-Mesa notes were and revenue anticipation notes,Lynch man,Rolapp."The agencies make the
munity college district financing. priced,Matthew R.Raabe,who is cur- said,but added that the firm is reeval- public policies.We were brought in sub-
Financial adviser on all three trans- rently Orange County's acting trea- uating its role in this market segment. sequent to Rauscher Pierce and we pro-
"We're in the process of reviewing vided advice regarding the negotiations
the entire situation and making a de- with the underwriter,including the
termination regarding how we proceed pricing." O
Thursday, December 8, 1994
o-lalra.
Costa' s
investment
Two derivatives sold t r_._.3iittttitr i'
by Moragan who dealt ,w
with Orange County
By MICHAEL LIEDTKE
Staff writer
Contra Costa County purchased a pair of volatile 1
investments from the same Moraga broker who sold
the securities that bankrupted Orange County, ac-
cording to Contra Costa's top money manager.
In an interview Wednesday, Contra Costa Trea-
surer Ai Lomeli acknowledged that the county owns }
at least two investments—costing a total of$34.75
million—that fall under the broad definition of de- ;
rivatives.
"Derivatives"is a Wall Street term for securities
whose values are tied to underlying notes and index- BOB LARSON/nmes Men994
es. Contra Costa's were sold to the county by Mor- CONTRA COSTA Treasurer Al Lomeli
aga resident Michael Stamenson,a broker specializ-
ing In municipal.investment for Merrill Lynch in San foresees no major lasses on derivatives.
Francisco.Stamenson also sold Contra Costa a vari-
ety of other conventional securities,Lomeli said. Wednesday. He has rebuffed all interview requests
Stamenson masterminded many of the securities in the wake of the Orange County debacle,
deals that saddled. range County.with an invest- Stamenson "has been very good io us," Lomeli
ment loss of$1.5 billion'and.culminated'ih theafflu said-"He never forced anything on us."
ent county's staggering;bankrupt&/. Stamenson'. '
couldn't be"reached,at.his'.home or office-,late Please see INVEST,back.page
Not all derivatives are bad invest-
ments. The type of derivatives pur-
chased by Contra Costa and many
other institutional inve-tors have be-
come losers because of the sharp
Mvest rise in interest rates this year.When
Contra Costa bought its derivatives
FROM PAGE 1A in 1992 and 1993, Lomeli essentially
Contra Costa's derivative expo- bet that interest rates would remain
sure represents about 10 percent of more stable than they did.
its portfolio. Unlike Orange County, Orange County did more than
neither of Contra Costa's derivative just make the wrong call on interest
rates. The county ran into trouble
investments were purchased with
fbecause it borrowed heavily ti or
funds borrowed from Wall Street
leveraged — to buy its derivatives,
firms, reducingthe chance that the forcing a fire sale at huge losses af-
county will be forced to sell the se- ter the lenders demanded more col-
curities at a loss. lateral.
Solano County and Alameda Contra Costa's derivatives are
County also hold derivatives in their worth less than what the county
portfolios, administrators con- paid for them, but the magnitude of
firmed...Neither,county bought the the paper loss is unclear. Lomeli
derivatives with borrowed money. and the county's chief investment
':A:_�knowledgeable..municipal fi- officer, Clarissa Javier, said they
nance_:insider said.-Solano County haven't even tried to price the cur-
also bought its derivatives through rent market value of the derivatives
Stamenson. Solaro Treasurer:Bob- because they have no plans to sell.
by Stow didn't tef calls;from the Derivatives are so complex that
Times on Wednesday,.but in a state- not even experts can agree on a def-
ment he acknowledged,the county inition. While acknowledging that
holds investments similar.jo Orange
County's. Stow said.le'doesn't ex- many investors regard some of Con-
pect to suffer any`rosses.,, tra Costa's holdings as derivatives,
;Alameda County's.derivatives Lomeli disagrees with the de.
represent about 66..;percent.of its scription.
roughly$1.billion portfolio,.officials Contra Costa's investments don't
said. "I have been inclose contact fit the strict definition of a deriva- •
with (Alameda Treasurer ) Donald tive, Lomeli reasons, because they
White and feel confident.our trea don't involve financial contracts.
sury pool has been invested in a
prudent way," said County Admin- Moody's Investor Service,one of the
strator Steve Szalay, major Wall Street firms that assigns
Lomeli, ecloing:.;;comments he credit ratings to counties, agrees
made after 0'`.;g.f ._11?. s.:Is�tua- with this rationale, Lomeli said.
Other experts regard Contra
tion became:�p`utlic;a�trld�vledge last p g
week, stressed ftiat''}Contra.Costa's Costa's Federal Home Loan Bank
money xs safe �fi- ; investments as derivatives because
there any,dan ersoEa loss their values are linked to a Europe
for:'ds T;don't thirf 'So,"said Lo an interest rate index known as the
meli,who last mon elected to London Interbank Offered Rate, or
his fifth term as Contra'Costa.trea- LIBOR.
surer and;is `currer)tgreside nt of "There are 100 million deriva.
the National Association & County tives out there," Lomeli said. "You
Treasurers and Finance Officers. could almost call anything a deriva-
lbfneli's confidence stems large- tive these days."
ly from Contra Costa's relatively Contra Costa Supervisor Tom
large reservoir of Cash and liquid in- Torlakson expressed his confidence
vestments. The county has $91.3 in Lomeli on Wednesday. "We have
million in cash and$110.8 million in a very fiscally conservative manage-
short-term securities. ment team, but we will continue to
Contra Costa's derivatives are ask questions."
five-year Federal Home Loan Bank If interest rates continue to climb
notes that mature in August 1997 as they have since February, Lo-
and September 1998. The county's meli said he will consider selling the
ability to meet any unexpected de- county's derivatives at a loss or bor-
mands for cash should enable it to rowing against the securities to pur-
chase better-yielding investments.
hold on to its nettlesome derivatives
until they mature and repay the "Who knows if interest rates are
principal investment. going to go up again or how long
they will stay there. Lomeli said."I
think we will get a better idea next
year."
More reports of Investment losses
Times wire services Orange County supervisors took the action because of"lack.
said Wednesday all county and, of specific detail"about the coun-
NEW YORK -=+.Huhdreds of kchool payrolls would be met and ty's bankruptcy petition and how
millions of dollars in losses are no one's taxes would be raised be- it may restructure its debts.
showing up at state and local in- cause of the financial turmoil.But The downgrade affected nine
vestment funds around the nation the fate of some major projects— debt issues out of more than 100
in the aftermath of Orange Coun- such as new courthouses and a that are followed by rating agen-
ty's bankruptcy court filing. possible stadium in Anaheim — cies.Such downgrades are signifi-
San Diego County and Florida remained uncertain. cant because they can increase
have racked up more than $550 Wall Street's major credit rat- borrowing costs in the market and
million in paper losses.Texas offi- ing agencies downgraded certain restrict the ability of some inves.
cials said Wednesday a fund there bonds issued by local govern- tors to acquire the securities..
lost$70 million. ments wrapped up in the Orange Moody's Investor Service sus-
The disclosures came in the County financial crisis. pended the ratings on 15 unin-
wake of Orange County's disas- . Standard& Poor's lowered its sured bonds issued by Orange
trous financial strategy that result- rating on $1.58 billion of Orange County due to the bankruptcy.
ed in a $1.5 billion paper loss County's debt to the speculative
from derivative investments. category.The rating agency said it Please see LOSS,back page
Uss
FROM PAGE 1A
The Florida Treasury portfolio,
currently valued at $8 billion, has
lost $200 million on paper after in-
vesting in collateralized mortgage
obligations, according to Treasury
spokeswoman Karen Chandler.
Collateralized mortgage obliga-
tions, or CMOs, represent an inves-
tor's stake in pools of home mort-
gages. The mortgages are marketed
as an array of bonds of varying ma-
turity, interest rate and risk.
When interest rates rose, the val-
ue of Florida's long-term holdings
declined, resulting in the paper
losses, Chandler said. Actual losses
won't be known unless the holdings
are sold.
Chandler said that since the in-
ception of the program four years
ago, Florida has earned about $200
million more than it would have
had the Treasury kept the money
and invested it internally.
"Some. people are getting the
sense that this is trouble, and we're
losing money.That is absolutely not
the case. There is no need for us to
sell these bonds off and we have no
intention to do so," Chandler said.
In San Diego County, Treasurer
Paul Boland blamed six interest rate
increases by the Federal Reserve
this year for the county's unrealized
losses of $357 million.
He said that while derivatives —
mostly mortgage-backed securities
in the case of the County—make up
25 percent of the fund's holdings,
they were'not solely responsible for
the unrealized losses.
Wednesday,December 7, 1994
Glare Is on Orange County Pool
As Rumors Fly, Options Studied
By Michael Utley and Brad Altman
LOS ANGELES—A combination I think it may be misinterpretation
of grim news and rumors swirled or rumors feeding on one another,"
around Orange County's investment McConnell said of the uproar. "There
pool yesterday are an infinite number of options for
The specter of a Chapter 9 munici- Orange County, so people say bank-
pal bankruptcy filing was raised by ruptcy is one,and that catches people's
U.S. Rep.Christopher Cox,who rep- attention."
resents parts of the California coun- Reached at midday, Dave Kiff,ex-
ty, The Republican told reporters he ecutive assistant to Thomas Riley,
heard the report from a county lob- chairman of the Orange County Board
byist. of Supervisors, said he heard the ru-
County officials,meeting in closed mor of the possible bankruptcy, but
session, were not immediately avail- could neither confirm nor deny it was
able to comment on the report that the being discussed.
county might file for bankruptcy. Supervisors are"in closed session:'
The lobbyist,Jim McConnell, told Kiff said. I know they are trying to
The Bond Buyer yesterday afternoon look at all the options to get out of the
that he never said the county was going crisis,and I imagine that Chapter 9 is
to file for bankruptcy. He said he was on the list."The board was not ex-
merely di;cussing possible options pected to take action yesterday, he
with the county's legislative delega- added.
tion in Washington. Pkase tam to ORANGE COUNTYpage 31
0' Co County tan orcasfiso]nY oi(the dtsdr to
lenders everyday."
r* . Street said litigation might be the
Many of the pool's 187 government next step.
participants held emergency meetings "Ibere could be taxpayer lawsuits"
yesterday,where they weighed their he said."There's any number of pos-
options,including wbexbe r they should sibilities.We don't know.We've never
cash out their holdings: had this since the Depression.This is
Several government participants ex- all new stuff.".
pressed alarm over the disclosure late Foreshadowing the likelihood of tit-
Monday that veteran Orange County igation in the wake of the investment
treasurer-tax collector Robert L.Cit- pool crisis,Jeffrey Niven,finance di-
ron has resigned over his handling of rector for Irvine,said yesterday that
the investment fund. the county has been ignoring a request
The participants questioned whether he made last Thursday to allow the city
Citron would have stayed aboard if he to withdraw$27 million of its$209
had any practical approach to shore up million from the pool.
the beleaguered$18.5 billion fund, Of the$27 million the city wants to
which since January has suffered$1.5 withdraw,$12 million of the invest-
billion in paper losses. ment is from the city's defined contri-
In another development,John Moor- bution pension plan and$15 million is
lath,a certified public accountant who from its defined benefit retirement pro-
ran against Citron last spring,said yes- gram.
terday he expects to be offered the job The Irvine council has scheduled a
later this month when supervisors must meeting late today to discuss its in-
appoint a new treasurer-tax collectorvestment options,Niven said.
Matthew Raabe,the county's assis- "We're not discussing the[with-
taut treasurer-tax collector,was named drawal of the]other hundreds of mil-
acting treasurer Monday. lions of dollars we've got invested"
"Right now,it's rehabilitation time, with the pool,Niven said.
and I'm ready to serve,"said Moor- Niven said he called Raabe,the
Tach,a Republican from Cana Mesa'T county assistant treasurer,but nurs-
got 40%of the vote against an incum- day,but"I was unable to reach him"A
bent,so I would think,even if they did- request to withdraw funds was hand-
n't want me,it would just be courte- delivered to county officials on Moo-
ous to put me in the mix." day,but as of midday yesterday,the
Moodach said whether he is offered county had not responded.
the job or not,he will contimte to pur- A legal showdown between Irvine
sue changes in the laws that have con- and the county could be brewing,Niv-
tributed to Orange County's financial en said,if the county insists on a
mess. mandatory 20%penalty R said it.wouH
He has been helping state Assent- impose on withdrawals.
blyman Curt Pringle,a Garden Grove "It is the city's position right now
Republican,draft a bill that would cub that that withdrawal sbould not be sub.
the use of risky investment sawcgies ject to any 20%reduction by the cam-
by public agencies. ty,"Niven said.
Moorlach said he would also like to The Irvine city attamry'tis looking
eliminate the law requiring Orange at the legality of the coumty's statement
County school districts to invest their: that they_wovld,teduce e- r deposits
funds with the county. down to an approximation of market
"Why can't they just go to a bank if value,"Niven said."We would view
they want to?"Moorlach asked. that to be contrary to the state Bove=-
Meanwhile,several city councils mrarcode which precludes the county
met in closed session yesterday to dis- foam anKiting any principal go deposit
cuss their options. with it
Anaheim,home to Disneyland and Irvine has arrested in the pool since
two professional sports teams,said it 1989,Niven said.In the final year
would announoe after a closed meet- ended hme 30,hvme earmdW md-
ing last night whether it plans to pull its lion on the ism of$60minicn of.
$169 million out of the fund, one-year taxable noon whose proceeds
Officials of Orange plan to hire a were invested in the pool The city has
consultant to explore the city's legal a similarly structured SW million in-
and investment prospects relating to vestment in the pool that marim July
the$1.28 million the city has in the 27,Niven said-
county pool.Newport Beach is also Noting that twine has'ho written
considering putting out its$16.2 mil- guarantee with the county"that the
lion. principal is sense,"I am wowed about
County officials have said that gay what is going to happen"to the cmm-
agency that pulled money out would ty pool's irmeres1 rye,Niven said."Cer
take a 20%penalty as its share of the tainly if the interest rate that the cote=
loss.The 20%penalty was intended to ty pays drops below the interest ex-
prevent paper losses from turning into pense on the notes I've issued,then
real losses. that would be a concem to us."
Some observers said concerns are Moorlach said he believes Irvine's
grog that cash-outs by a large num- "legal position is correct"to pursue its
ber of participants could cause a run demand for cash without a 20%penal-
on the pool. ty."We might even be taking about
'"Ibe portfolio has got negative car- constitutional issues like the Fifth _
ry,and rash is going out the door,"said Amendment—illegal seizure by a
Chriss Street,a Newport Beach in- government*
vestment banker and longtime critic of "They're only asking for$27 mil-
the county's investment practices. lion;'Moorlach said."Whether that
"Mere's probably over a million dol- starts a run,I don't know." 0
COUNTY OF LOS ANGELES s '
TREASURER AND TAX COLLECTOR t
NAIL Of ADMNSTRAr"
600 WW TEMPLE STREET.RWM
PA.80X 4917
LOS ANGELES,CALIFORNIA 90061-2917
LARRY J.MONTEILH
TREAYJAeR AND TAR COUMMA TELE%10NE
CZW M2101
TELECOPTER
01n 6za u1z
Release date: December 8, 1994
LOB ANGELES COUNTY TRnSUM 8TATZXZNT ON
COUNTY 07 LOS ANGELES TREASURY BOOL
LOB ANOELEB; D40e11bar 8 - The Los Angeles County Treasurer issued
a statement today in response to the number of inquiries regarding
the status of the Los Angeles Pooled Investment Portfolio,
The County Treasurer maintains a $5.7 billion Pooled Investment
Portfolio. Investments are made according to policies and
guidelines which are more stringent than those allowed by the
California Government Code.
The investment guidelines establish credit and maturity limits to
reasonably ensure that the goals to preserve principal, provide
liquidity and produce yield are met at all times. Adherence to
these guidelines is ensured through daily reviews by the
Treasurer's Compliance Office and regularly audited independently
by the County Auditor-Controller, Investment maturities are
monitored against daily and annual cash projections to ensure
sufficient liquidity.
The investment guidelines provide for controlled leveraging. The
Treasurer has determined that, prudently managed and controlled,
the use of reverse repurchase agreements will provide incremental
gains thereby adding value to the portfolio. our maximum cash
exposure due to an unmatched reverse repurchase position is limited
to $200 million and is currently at $50 million. As of
November 30, 1994, our reverse repurchase agreements amounted to
less than 3% of the portfolio.
Floating rate notes and therefore derivatives are used as part of
the Treasurer's investment strategy. The Treasurer's guidelines
preclude the use of complex or hybrid structured instruments.
currently, all of our variable rate notes adjust in the same
direction as the market. That is, we currently have no inverse
floating rate notes.
Treasurer Press Release
December 8, 1994
Page 2
in today's bond market, Where bond prices continue to fall, the
Pooled Investment Portfolio has an unrealized market value decrease
of only $68 million. This is mainly due to the portfolio's average
days to maturity of 347 days with approximately 38% of the holdings
maturing within 60 days.
For Information, contact: Joseph H. Spillane
Compliance Auditor
(213) 974-2139
• Tuesday,December 6,19%
Orange County, Calif., Treasurer
Resigns Over Investment Pool
By Michael Utley and Brad Altman
SANTA ANA,Calif.—Under fire trative officer,said that Securities and
for investment decisions that led to the Exchange Commission officials were
Orange County,Calif.,investment fund "here over the weekend." Schneider
crisis, county treasurer-tax collector said that he believed an official SEC
Robert L. Citron resigned Sunday, it investigation had been launched and
was revealed yesterday. that litigation also might be forthcom-
The bombshell announcement was ing.
made before Orange County supervi- On Friday,Standard&Poor's Corp.
sors met behind closed doors late yes- placed the county on CreditWatch with
terday afternoon as rumors flew that negative implications, a possible pre-
the board might consider total liquida- cursor to a downgrade, following
tion of the fund. Thursday's announcement that the
Assistant county treasurer-tax col- county portfolio had suffered an esti-
lector Matthew Raabe was named act- mated $1.5 billion paper loss. The
ing treasurer. county blamed interest rate increases
"After much thought and soul- and problems linked to derivatives trad-
searching and with much regret,I have ing.
decided for the benefit of the County of Late yesterday,Moody's Investors
Orange, to resign," said Citron, who Service said it placed under review the
• previously defended his aggressive in- ratings of issuers that have funds in-
vestment practices." vested in obligations secured by the
Ernie Schneider, county adminis- pool.
'"These guys have put public funds at
major risk,'said David Herships,a se-
nior municipal analyst and first vice
president at Kemper Securities Inc.,
referring to Citron and other county
officials.`"They've got a major,major
problem on their hands:'
'In one development yesterday, a
number of market observers expressed
concern about four Orange County
school groups that had borrowed$200
million and invested the proceeds in
the pool.
Public documents show that the four
Orange County school groups bor-
rowed the$200 million just to invest
it with a special Citron pool and reap
the profits of his controversial strate-
gy.
The school groups have "issued a
bunch of taxable notes due next sum-
mer, and there is no place to repay
those off except from the moneys in
the county's investment pool,' Her-
ships said.
"This is preposterous,"he added.
• "Especially with all the fiscal pressures
Please turn to ORANGE COUNTY page 23
•
Orange County has so far lost $7.3 million on its in-
vestment.
Continued from front page "So what started out as an attempt
on school districts.These guys are out to avoid small pain has now turned into
'arbing'for a minuscule amount of an enormous crisis that could lead to
money." massive cuts in services,maintenance,
Chriss Street,an investment banker and staffing,"Street said.
and father of an Orange County high "It was easier for the school board
school student,has spent the last year to throw up a Hail Mary with risk gr-
and a half digging into the financial bitrage,rather than to do the heavy lift-
mess and has uncovered what he calls ing of cutting programs and control-
"an enormous crisis," separate from ling salaries,"he said.
last week's disastrous report of a$1.5 But Michael H.Fine,director of fis-
billion value loss. cal services for the Newport-Mesa dis-
Street believes there are numerous trict,said that for the current fiscal year
other accounts separate from the main the district initially projected$500,000
fund that represent more than a billion in earnings based on the borrowing,
dollars of borrowing by Orange Coun- but"with the decrease in earnings the
ty local governments and several bil- county is now alluding to,"the district
lion dollars in bonds. expects to make$200,000 or$300,000
"Nobody knows about this yet," on the deal.
Street said. "We don't know if the "That is still pretty much a winner,"
funds are commingled or segregated. Fine said."It may not be worth all the
Citron won't answer his phone .... I gray hair I have.But,for the most part, •
mean,people are jumping out of win- we are making more than zero and that
dows on this. It's the next big gorilla is extra money for our kids."
that'll come marching through here." Herships disagreed with Fine's rea-
Street provided The Bond Buyer soning. "He should be worried about
with public documents detailing the retaining the principal,let alone break-
$200 million in borrowing by the four ing even. He is missing the point—
school groups. the county investment pool doesn't
The documents show borrowed have the money to pay the notes back.
amounts of$42.2 million for the Or- Fine is in a state of denial."
ange County Board of Education, Fine countered that his district had
$54.6 million for the Irvine Unified both written and oral guarantees with
School District, $47 million for the the county that the district could"get
Newport-Mesa Unified School Dis- out of the deal at par value,basically,
trict, and $56.3 million for the North when our piece of it matured:'
Orange County Community College Even if that is the case,Peggy Eck-
District. roth,an advisory board member to the
In the case of Newport-Mesa— state's Local Agency Investment Fund
where Street's daughter attends high and a principal for Autumn Capital In-
school —the district pledged its en- vestment Services in Dana Point,
tire$55 million of annual property tax Calif., said the county's guarantee to
revenue to earn a triple-A credit rating the district of"no principal loss" is
and back up the loans,Street said.The "very unusual."
borrowed amount represents more than "There is no way that a pool can
half the district's annual budget of$80 guarantee no principal loss or give any
million,he said. one deposit preferential treatment over
Street said he believes the district another,"Eckroth said. ❑
•
Monday,December 5, 1994
Largest Depositors Pledge to Stay
In Orange County, Calif., Pool
By Michael Utley
SANTA ANA,Calif.—The largest any of its outstanding debt service
discretionary depositors in the trou- obligations"The authority has$1 bil-
bled Orange County investment pool lion in the pool and is its largest in-
have so far agreed to stay in the fund, vestor.
despite last week's dramatic report of a Late Friday, Standard & Poor's
potentially crippling$1.5 billion loss. Corp.placed Orange County on Cred-
A final decision from all 187 mem- itWatch with negative implications.
bers of the$7.8 billion pool is expect- The move affects$1.58 billion of the
ed by tomorrow. In the meantime, county's direct debt.The agency will
county officials are working feverish- be meeting Thursday with county of-
ly to head off a panic that could turn ficials.
the"paper loss"into an actual loss. Moody's Investors Service also
The Orange County Transportation plans to meet with the county, Karen
• Authority and the Orange County San- S.Krop,a Moody's assistant vice pres-
itation Districts, with a combined in- ident,said Friday.
vestment of$1.45 billion in the fund, Analysts believe the$1.5 billion val-
have pledged not to make any un- ue decline is the largest municipal fund
scheduled withdrawals. loss ever disclosed. County officials
A Transportation Authority state- blame the decline on rising interest
ment released Friday said bondhold- rates.
ers can be assured"there is no risk of In a statement released to The Bond
delayed payment or nonpayment on Buyer on Friday,Matt Raabe,Orange
County's assistant treasurer,said fund
participants have been told"if they did
pull out of the fund,it would be a 2010
loss"on the original investment.
"There has not been an announce-
ment of any freeze;'Raabe said,mean-
ing participants can withdraw funds if
they are willing to take the loss.
In a heavily covered press conference
last Thursday afternoon,Raabe said the
county desperately needs cooperation
from its depositors and creditors.
Please turn to ORANGE COUNTY page 22
22 01901 THE BOND BUYER Monday.December 5.1994
Orange County won't be determined until after some county officials said they would be value to$20 billion at the beginning
court battle,"Swan said. forced to liquidate the fund and all 187 of 1994.
Continued from front page Walter D.Kreutzen,executive vice members would have to share in the But starting last February,rising in-
"At this point in time,the only dan- president for finance and administra- $1.5 billion loss. terest rates drastically reduced the
ger is that people will decide not to tion with the Santa Ana,Calif.-based County administrative officer Ernie fund's earnings and forced the county
work with us,and we will have to sell Transportation Corridor Agencies,said Schneider said it is too soon to tell to put up additional collateral for the
securities"at market value,said Raabe. he would support an external contunittee whether that would bankrupt the coun- first time in years.
'Our team is trying to avoid that'" review of county investment decisions. ty.But he said he is confident that a On Thursday,Citron announced that
Peer Swan,president of the Irvine The agencies are building several liquidation will not be necessary. the fund's value had declined to$18.5
Ranch Water District,said Friday that toll roads in Orange County,and have The investment pool includes all billion.
he has asked the county to set up an $306 million of discretionary funds in- county agencies and school districts, Orange County Assemblyman
investor oversight committee as soon vested with the county. and all but two Orange County cities. Mickey Conroy called last Thursday
as possible composed of the top four "We are going to ride this market Orange County Treasurer Robert for Citron's resignation,but treasury
or five pool participants. out;'he said.He also said the county Citron,once widely praised for his suc- officials say he has no plans to leave
"I believe that they have a respon- "knows our liquidity needs;'and it has cessful but risky investment strategies, office.
sibility to accommodate that"request, pledged to let the agencies withdraw briefly defended himself at the tele- The 69-year-old treasurer is the only
said Swan,whose district has invest- $20 million a month as was previous- vised press conference after a reporter elected Democrat in Orange County
ed$300 million in the pool. If the ly scheduled. asked if he had"gone too far." —an overwhelmingly conservative,
county declines,"I would have to Regarding credit implications for the In a terse statement,Citron stepped Republican stronghold located south
reevaluate our situation;'he said,with corridor agencies'outstanding bonds, up to the podium and said,"For 15 of Los Angeles County.
the possibility of withdrawing funds Kreutzen said he would have no com- years I have been managing the port- During the campaign leadinVc from the pool. ment until he received answers from folio this way...What I did was not Citron's June 7 reelection,Repu
In the short-term,Swan said the wa- the county to"a number of our own irresponsible in any manner,shape,or candidate John Moorlach heavily
ter district has no plans to withdraw questions." form:' icized the treasurer for taking too much
money because of the county's threat to In a worst-case scenario—with a Citron answered no other questions, risk with public funds.
withhold 20%. large number of depositors pulling out, but assistant treasurer Raabe said the Moorlach,a certified public ac-
"Whether that is legal or not,it or a severe rise in interest rates— county is standing behind Citron's in- countant and financial planner,lost
vestment decisions. with 40%of the vote.
"'Those of us who are in government "I feel vindicated,"Moorlach said
are used to being second-guessed,and Friday,"but I'm not going to gloat.1
we know that we will be second- live here and this is a real crisis for the
guessed"said Raabe. residents of Orange County."
"Certainly as we go forward in eval- Moorlach said he would not join
uating the strategy,we'll take these others.in calling for Citron's resigna-
kinds of circumstances into account;' tion.Nor would he speculate on the
he added."But we're really not at the future of the fund because,he said,its
point of second-guessing ourselves." complexity makes the future difficult
For more than a decade,the fund's to predict.
returns have consistently outpaced the "That's the problem with this kind
market,averaging more than 9%an- of portfolio;'Moorlach said."When
nually. it's going right,you're a king,but when
Citron's investment strategy relies it's going wrong,you're a goat.And if
heavily on the use of derivatives and you're doing that with your own mon-
reverse repurchase agreements.The ey,hey,fine.But with public dollars,
strategy allows the pool to borrow it's a tragedy."
money against the market value of its
securities. Brad Altman in Los Angeles con-
That leveraging raised the fund's iributed to this report.
Congress May Hold
Hearings in Wake
Of California Pool's
Derivatives Losses
By Joanne Morrison
and Martha M.Canan
WASHINGTON-The$1.5 billion
in paper derivatives losses suffered by
Orange County,Calif.,is triggering in-
creased scrutiny by Congress and reg-
ulators,including a vow by a top law-
maker to hold hearings early next year
on the risks derivatives pose to states
and localities.
Sen.Alfonse D'Amato,who will be
the new head of the Senate Banking
Committee,said Friday that the coun-
ty's loss"is by far the biggest loss to
date from derivatives instruments.'The
New York Republican said, however,
that legislation is not warranted at this
time.
Please turn to DERIVATIVES Page 28
•
28(11%) THE B01m Btralt Monday.December 5.1994
who thought they could beat the Richard Fisher,the chairman and
Derivatives
house,"Gonzalez said. managing director of Morgan Stanley
Com—edf om frompase Last Thursday,officials from Group Inc.,said that while the major-
Despite the magnitude of the coun- Orange County said the county's ity of derivatives activities is risk-re-
ty's loss,a top banking regulator said pooled investment fund,which duction activity,some investors use de-
yesterday that he could not comment has about$7.5 billion in assets, rivatives to speculate on market trends.
on the county's situation. has experienced a paper loss of "The enormous majority of deriv-
"This is a new and growing area about$1.5 billion,largely as a re- atives trading is really managing risk
which does present risks:"and it is sult of its investments in deriva- and reducing risk rather than specu-
important that banks adhere to ap- tives,including some government, lative."Fisher said at a conference
propriateness standards contained in securities derivatives. hosted by the Securities Industry As-
federal guidance when they sell de- SEC officials said the agency sociation in Boca Raton,Fla.He es-
rivatives products to purchasers such is aware of Orange County's ex- timated that 75%to 80%is risk man-
as municipalities,said Eugene Lud- petted losses and is monitoring agement with the remaining activity
wig,the U.S.comptroller of the cur- the situation. being speculation.
rency. SEC commissioner Richard "Sales practices are something that
But Ludwig said that while indi- Roberts said the agency is con- every firm takes seriously,and you
vidual losses will occur in the mar- cerned that volatile instruments have to be sure you are providing an
ket from use of derivatives,"this is a have been making their way into investor with adequate information:'
period in which the banking industry less sophisticated investor markets. Fisher said.
is very strong." "Now investor makeups in- Zachary Snow,managing director
The comptroller's office has been clude state and local governments at Salomon Brothers Inc.and chair-
working with other bank regulators and pension funds:'Robert said. man of the Securities Industry Asso-
to develop suitability standards with Meanwhile,recent efforts by I ciation's swap and over-the-counter
respect to government securities. lawmakers may set the stage for Filiph- derivative products committee,said
Orange County's woes in its de- increased protections when mu- that even with sales practice standards
rivatives investment activities is like- nicipalities invest in some deriv- Rep.Jim Leach,the Incoming chairman in place,it would be difficult for deal-
ly to spark even more congressional atives,which would include of the Mouse Banking Committee."the ers to determine if an investor is mak-
inquiries into the risks these lsize of this loss and Its effect on nun"
local sional aide said.structured notes,one congres- palltles Is going to spark careful con- ing speculative or risk management
gents may pose for state and local gressional review,"an aide says of Or- investments.Snow was also speak-
governments,acongressional aide "This is an area where Con- ange County,Calif.'s Investment pool ing at the Florida conference.
said. gress has made progress:'said an troubles, Federal Reserve Board governor
"The size of this loss and its effect aide to Rep.Edward Markey,D- . Lawrence Lindsey said Friday that he
on municipalities is going to spark Mass.,adding that regulators now ment securities market area,particu- saw no"systemic risk"to the ftnan-
careful congressional review,"said need to establish improved sales prat- larly with respect to structured notes, tial system as a result of moves by
an aide to Rep.Jim Leach.R-Iowa. tice rules for dealers that sell gov- the Markey aide said.The telecom- municipalities to invest in derivatives.
Leach,who is expected to head the emment securities including govern- munications and finance subcommit- In an interview on CNBC,Lindsey
House Banking Committee,has said ment-issued structured notes. tee of the House Energy and Com- said"my preference as a voter would
that derivatives will be on his com- "The ball is in the regulators' merce Committee held hearings in be that my county not do that,"but
n-ittee's agenda. court:'the Markey aide said. 1991. he stressed that it is up to the voters
Last year Leach introduced legis- The SEC's Roberts noted that those Lawmakers maintain that the gov- of Orange County do decide how to
lation that would bring oversight of rules aren't going to help municipal- ernment securities.market has handle their money.
over-the-counter derivatives under ities this year because they haven't changed."This is not your grandfa- Lindsey said his understanding of
one regulatory body headed by the been implemented. ther's government securities market," the situation in Orange County was
Federal Reserve and consisting of "It's a shame that those rules are the aide said.More than just the tra- that the region's investment pool did
regulatory leaders from the Securi- not in place,"Roberts said.Roberts ditional government securities are be- "very well"during the past 15 years,
ties and Exchange Commission,the agreed that stronger sales practice ing sold,he added. enabling taxpayers to cam more on
Commodities Futures Trading Com- rules may result in less speculative Many of the losses reported by their investments than they would
mission,and the banking agencies. investments in derivatives by munic- state and local governments have have otherwise."So they have been
Rep.Henry Gonzalez,D-Tex.,the ipalities. been the result of investments in in- winners;now,they have lost,"he said.
current chairman of the House Bank- '"lite existence of strong sales prat- terest rate-sensitive structured notes Meanwhile,the Government Fi-
ing Committee,agreed that Orange tices are in demand and would damp- issued by government-sponsored nance Officers Association issued a
County's reported losses make the is- en enthusiasm for many investors agencies. warning to its members in the wake
sue of derivatives even more critical wanting to invest in derivatives:'he "With respect to Orange County, of the Orange County revelation.The
for lawmakers.In a statement re- said.Regulators have emphasized that the manager seemed to dive head first association,which represents 13,000
leased late last Thursday.Gonzalez derivatives serve a better purpose into some investments:'the Markey state and local governments,said mu-
urged Republicans in the next Con- when used as a risk management tool aide said,adding that a large portion nicipalities need to"exercise extreme
gress to address the issues. as opposed to a speculative invest- of the investment activity was specu- caution and to consider their use only
"I urge the incoming Republicans ment. lation as opposed to risk manage- when they have developed a sufficient
to do the right thing and work to curb Last December the Government ment. understanding of the products and the
derivatives speculation:'Gonzalez Securities Act was signed into law, The National Association of Secu- expertise to manage them."
said,adding that the Orange County giving regulators—including bank- rities Dealers is currently in the The association recommended that
loss"is further proof of the hazards ing regulators—the authority to set process of establishing sales practice its members use the derivatives in-
posed by these often misunderstood stringent sales practice rules for deal- rules that could be finalized in the vestment guidelines it released in
exotic financial instruments. ers that sell government securities. coming months. June.
"Now you can add Orange County Congress recognized years ago This also is a concern among se- Stephen A.Davies contributed to
to the ever-growing list of investors there were problems in the govern- curities industry officials. this article.
•
Munis, Treasuries
Post Sharp Gains
Despite Increase
In Nonfarm Jobs
By Kathie O'Donnell
Municipal bond prices shot higher
with Treasuries Friday,despite a larg-
er-than-expected gain in November
nonfarm payrolls.
"We're going to lag Treasuries,but
we are definitely moving on the up-
side with"them,one trader said.
Municipal prices gained 3/4 point to
a point overall,though more improve-
ment was seen
in spots at the
• close of Friday's
fairly active ses-
sion.
Yields on high-
grade issues im-
proved by eight
basis points
overall, while
dollar bond
prices gained a
point.
In addition to
the boost it re-
MUNICIPAL ceived from
Treasuries, the
MARKET cash market was
pulled up by the
contract Friday, the trader said. The
March municipal contract was up 114/32
to 851/3x.
"I think that the muni contract is cre-
ating an arbitrage opportunity for peo-
ple,so that the cash is kind of chasing
that,"the trader said.
The contract is perceived as rich to
Please turn to MUNICIPALS page 28
•
Municipals slow considerably in 1995:'Lonski said. such as motor vehicles. pens,consumer confidence will increase.
C "1 think it was in response to those very "You could still argue that in some and pent-up consumer demand will be
Caaeaaeef—haat page strongly held expectations that bonds ways money is cheap:'he said. unleashed he said.
cash,prompting investors to buy cash managed to rally despite a much steeper As for the next tightening move,Lon- "I still believe that the labor market
and sell the contract,he added. than anticipated increase in nonfarm pay- ski sees a 60%chance for a 50-basis- has yet to fully participate in this eco-
"Meanwhile,the contract keeps going rolls,as well as the sharp drop in the un- point move at the Federal Open Market nomic recovery:"Lonski said."As the
up because people are buying the con- employment rate:' Committee meeting on Dec.20. participation of the labor market catches
tract to sell Treasuries:'he said."So it's But Lonski suspects that belief may "Repeatedly,the Federal Reserve up with the overall economy,we will con-
kind of the dog chasing his own tail:' be flawed and said Friday's rally could Board governors have described the aeon- tinue to be surprised by the vibrancy of
Friday's March MOB spread was reg- , be a mistake. omy as being robust:'he said."Cone- consumer expenditures:'
ative 442,compared with negative 452 "1 think the economy is strong and that quently,the Fed will most likely hike in- Also on Friday,AMG Data President
on Thursday.In the government market, t it's going to do better than anticipated in terest rates on Dec.20 for the purpose of Robert Adler said that the$193 million
the 30-year bond was up I'/4 points to 1995:'he said,adding,"'Ree only force trying to cool off what appears to be an that flowed out of municipal bond funds
yield 7.89%.The gains came despite a that supports the argument of a significant inflation-bound U.S.economy." for the week ended Nov.30 was the
350,000 increase in nonfarm payrolls. slowing of U.S.economic activity in 1995 Lorsld also sees possible inflation wor- smallest outflow since mid-October.
"Investors downplayed the very large would be the loss of economic activity to ries on the horizon.The drop in the em- Seventy-five percent,or S 172 billion,
increase by nonfarm payrolls and instead the continuation of Fed tightening:' ployment rate to 5.6%in November from of the$230 billion of municipal bond
focused on the contraction of average Aside from that,very title else exists to 5.8%in October should give employees fund asses tracked by AMG Data repon
hourly earnings and the average work- support the notion dim the economy will more bargaining power,which eventual- on a weekly basis.
week:'said John Lonski,senior econo- slow in 1995,the economist said.The ly may lead to faster wage growth,he The 30-day visible supply of municipal
mist at Moodv's Investors Service. economy isn't seeing the excesses of sup- said. bonds Friday totaled 53.18 billion,up
Investors also ignored an increase in ply over demand or dee"dangerous spec- Though investors took heart from the S".6 million from Thursday.That com-
Columbia University's Leading Inflation ulative fervor'of the late 1980s,Lonski drop in average hourly earnings report- prised 31.174 billion of competitive
Index,he said. said. . ed on Friday,the data only applies to non- bonds.down 3115.9 million from Thurs-
Lonski said that while short-covering While investors may believe that Fed supervisory personnel.The data covers day,and$2.011 billion of negotiated
may have played a role in Friday's rally, tightening will slow the ecorlOmv in 1995. a number of unskilled workers who face bonds.up 5160.5 million from Thursday.
it was not the main factor. Lonski said the central bank's actions so foreign competition,he said. Standard&Poor's Blue List of mu-
"There seems to be a very strongly far have"not done a great deal of dam- The economist sees the employment nicipal bonds was down 346.6 million
held belief that the economy is going to age"to interest rate-sensitive purchases, rate continuing to decbne.When that hap- Frida,to 51.37 billion. J
COUNTY INVESTMENT POOL
The recent filing of bankruptcy by Orange County, California, occasioned by excessive losses
in that county's investment pool, has highlighted the importance of County investment policy to potential
investors. The Director of Finance of Santa Clara County manages the Santa Clara County Investment Pool(the
"County Pool") which consists of commingled and direct investments for the County and over forty local entities
located in Santa Clara County, most of which are school districts. Over$1.3 billion is currently invested in the
County Pool, approximately$950 million of which is in the commingled pool and approximately$400,000,000 of
which consists of directed investments. The current average life of the commingled pool is 359 days with only
29% being invested longer than one year; at present, the longest maturity is August 2, 1949. The County marks
to market all investments in the County Pool that are longer than one year on a monthly basis. The County has
no reverse repurchase agreements or any investments in derivative products commonly referred to as "inverse
floaters." The County's practice is to have proceeds of County financings segregated and invested in specific
investments which are not in the commingled pool..However,minor portions of the moneys held by the Director
of Finance on behalf of the Authority may be invested in the commingled pool. The County's investment policy
and philosophy for the County Pool has been one of safety of investments and assuring the availability of funds
to meet the ongoing needs of those who participate in the pool.
�I
• CCS,��,. al Q,to H $1.15 plus tax
$25 In-Hellion
put into
e
investment
Contra Costa's
derivatives
take a beating
By MICHAEL LIEDTKE
Staff writer
As the financial markets tossed
and turned with uncertainty 10
months ago,Contra Costa Treasurer
AI Lomeli made a $25 million bet
that interest rates would remain low
for the rest of the 1990s.
He could hardly have been more .
wrong.
As the economy picked up steam .
this year, federal policy-makers Cox s rri
raised rates with a fervor unseen
since the early 1980s.The net result
for Contra Costa taxpayers was an
investment boondoggle likely to We are going to put'-
cost the county millions of dollars in the kibosh on these
squandered interest payments.
Lomeli, Contra Costa's chief things. . . . I am going
money manager since 1978, not
only guessed wrong about the direc- to revise the
tion of interest rates,but compound-
ed his error by putting the$25 mil- investment policy
lion in a risky security that punishes
investors when rates rise.The pen- —Treasurer Al Lomeli
ally is exacerbated by inflation,
which is generally higher in periods
of rising interest rates. 11 INSIDE
The security,known among pro-
fessional investors as an "inverse Orange County's community
floater," will yield 3 percent at a colleges face fiscal crisis. 18A
time when the county could be
earning twice that amount. In a mon among county treasurers
worst-case scenario, the interest throughout the nation and in Cali-
rate could drop to zero between fornia, where liberal regulations
1997 and 1999, when the county's give municipal money managers
principal investment is repaid. looser rein than in most states.
One securities trader who re- From the perspective of money
quested anonymity said, "I can't managers and traders,most treasur-
even understand how this bond got ers are viewed as political-minded
sold in the first place." bureaucrats who lack the business
Several securities traders de- savvy.to match wits with the
scribed Lomeli's ill-fated.dalliance
with inverse Floaters as far too com- Please see LOMELI,back page.
i
Lomeli Contra Costa is in no danger of Despite the high anxiety.Lomeli now vows to take steps to ensure ber's election.Lomeli said he might
bankruptcy because it didn't borrow said he felt comfortable locking Contra Costa never again invests in retire at the end of 1995.
to buy its inverse floaters,but the Contra Costa's money into a five- exotic securities. The job even runs in Lomeli's
FROM PAGE 1A bad investments are a financial burry year inverse floater because he be-
smooth-talking sellers who pitch in- den at'a time counties throughout lieved that interest rates would stay "We are going to put the kibosh family.His second wife,Patsy Stair
creasingly complicated investment the state are scraping for every pos• on stable ground for at least three on these things," Lomeli said. Lomeli,is the treasurer for Antler.
ideas.To make matters worse,there Bible penny. years. When something unfortunate like son County. Tenn., and his son,
are few checks and balances in the The inverse floaters,more broad• this happens,it makes you sit back Chuck,is Sofano County's assistant
system to ensure someone looks ly known as"derivatives."are cur- Stamenson's inverse floater en- and take a look at yourself.1 am go• treasurer,
over the treasurer's shoulder. rently worth about$11 million Tess ticed Lomeli with the promise of a 5 ing to revise the investment policy Respected financier
than Contra Costa paid for tht in- percent rate during the first year of so we knock off this crap."
No danger of bankruptcy the inverse floater, 6 percent in A genial man, Lomeli is well-
vestments,according to market 1995 and 7 percent in 1996.Those Concerned by taxpayers' expo• liked both by his colleagues and the
In Contra Costa's cast. Lomeli quotesuotesobtained from securities alluring rates became irrelevant sure to inverse floaters,the Contra voters.Running unopposed in this
bought all his troublesome invest. dealers. Derivatives are securities when rising interest rates triggered Costa Board of Supervisors last years election,Lomeli garnered the
merits from Merrill Lynch broker with values tied to underlying notes a formula that locked the rate at 3 week demanded a review of the most votes in Contra Costa.1 am
Michael Stamenson,a Moraga resi- and indexes. percent,about the same pace of in- county's 'investment portfolio. La•
dent who also created and sold To avoid a potential loss of tax• realty s i aware that ."has any Contra
many of the securities that sunk Or-. payer money.Lomeli intends to Flation. melt is expected to report back to tractors in this county,"said Comm
ange County. Solaro County was hold on to the notes until they ma, If Lomeli was determined to buy the board in January.The supervi• Costa Auditor Ken Corcoran.
also a regular Stamenson customer lure and return the count initial a bond with a five•year maturity in sors so far have expressed support
Ys for Lomeli. Lomeli is also well respected
and holds some high-risk invest. investment. In the meantime, the February, the county would have within his profession. He has won
ments,according to Treasurer Bob- notes are structured to lower the been much better off if he had Dur• Treasuring is in the family high marks for processing property,
b Scow,Alameda County's money yields aid to Contra Costa as over- chased a conventional security.A If them were a prototypical coon• payments Y ry' y Yi P tax a ents with a lean staff.As a 0
so far all five-year U.S.Treasurybond of- P tyP
avoided r'inverse floaters. they have the lost t investmest rates nt climb.
interest Conceivably,
fered a fixed yield of 5.51 percent at ty treasurer.the 69-year-old Lomeli measure of the esteem his counter•
g the time Lomeli bought the$25 mil• might fit the mold. parts have for him,Lomeli is cur-
Including three other notes pur• prevent the county from providing tion floater, g rently president of the National As.
chased by Lomeli bet-ten October more services or,worse,ford After serving in various branch• sociation of County Treasurers and
1992 and last February,Contra cutbacks, '.1 know the average guy is prob- level jobs at Welts Fargo Bank for Finance Officers, a 450-member
Costa is now stuck with four inverse looked like a good deal ably saying,'Gee,you really took a 21 years,Lomeli went to work fortrade group.He previously headed
floaters, costing 584.75 million, in big risk(by buying the inverse float. Contra Costa in 1967 as tax office the California Trade Association.
its$350 million investment portfo• Lomeli bought his last$25 mil- ers),'"Lomeli said."But if you put manager before becoming assistant Lomeli said he regularly attends
tio, according to a review by the lion inverse floater just two weeks it in perspective, you can see we treasurer in 1970.In 1978,he was the tmelimde a conventions and
Times.The holdings are greater after the Federal Reserve Bank aren't going to lose any principal.I elected treasurer, a job that pays other workshops� so a can stay
than the Times initially discovered raised short-term rates for the first do agree that we have lost an invest- him$84,678 annually. abreast of the latest developments
stay
eari,er this month after Orange time in five years.The Fed's move ment opportunity." Next month he will be sworn in in the world of finance."You have
County filed for bankruptcy and roiled the stock and bond markets Although he believed the county as treasurer for the fifth time,al- to have knowledge of investment
was forced to liquidate its inverse as investors fretted over where rates was getting a good deal when he though he might not finish the four- vehicles to do this job.It's a con•
flvaeis to pay outstanding loans. would move next. bought the inverse floaters,Lomeli year term that he won in Novem- stant education."
OrangSells RiskSecurifies
y
Associated Press were"plain vanilla"notes,howev- of the derivatives.When Salomon
Santa Ana,Orange County er, less sensitive to interest rates announced on December 13 that it
Orange County arranged an than the roughly $4 billion in de- would liquidate the county fund,it
important mass sale of risky deriv- rivatives that remained. estimated the exotic securities
ative securities from its invest. The deal yesterday was with would sell for an average of 10.1
ment pool yesterday but defaulted the Federal National Mortgage As- percent below their face amount.
• on two bond obligations to con- sociation, which agreed to buy The county said it would use
serve operating cash. back$634.6 million in face value of $92.2 million of the$577 million to
The derivatives sale opened the structured notes for $577 million. reduce the fund's heavy borrow-
final phase of the process of liqui- in cash. That was.all the deriva- ings.
dating the fund following a$2 bil- tives Fannie Mae had sold to Or-
ange County,said David Jeffers,a The rest will help improve the
lion loss. Fannie Mae vice president. liquidity of the fund,which is sub-
The county's financial adviser, ject to heavy emergency demands
Salomon Brothers,earlier had sold The repurchase, which is to from many of the 186 school dis-
about $3.3 billion in securities close Wednesday, is at a price 9.1 tricts,cities and other government
from the fund.Nearly all of those percent lower than the face value entities with money in it.
•
LongMunis Go Begging
Orange County fallout alters landscape
BY TOM PETRUNO -'This Year,however,some bond $94,250 in 1995 for marrieds filing
r pros are dubious about a January jointly).
Lm
rally in the muni market overall. As most yield-savvy investors
Los Angeles One big negative is the continuing know,you simply cannot find 10
An unfortunate confluence of fallout from the Orange County percent taxable yields today ex;
events in the tax-exempt confluence
O- bankruptcy debacle, which has cept on high-risk corporate"junk
p made investors wary of other po- bends.And the highest yield you
pal bond market is making for ex- tential credit-related problems can find on U.S.Treasury issues is
ceptional bargains among longer- lurking among muni Issuers. 7.84 percent on 30 year bonds.
term issues where yields are Indeed, on Tuesday bond-rat- Which suggests that anyone inter-
fictively in doublerange foorr Ing agency Fitch Investors Service ested in locking In long-term yields
inter-
high-tax-bracket invvestoesto rs. downgraded Washington's gener• at this point ought to be looking to
But muni investors who favor al obligation bonds to BBB-plus muni bonds,not Treasuries.
shorter-term bonds will find that from A-minus,citing the city's de. The opposite is true if you are
yields on those issues are down- teriorating financial situation. shopping for shorter-term bonds.
right lousy right now.In fact,tax- The bidding war between the Example: The average yield on
able U.S.Treasury notes may be a White House and Congress over a AAA-rated general obligation mu-
far better buy for investors other- federal income tax-cut bill also is ni bonds ma is
wise inclined to buy shorter-term toting t three years
monis causing some investors to step about 52 percent, according to
Year's end is normally time back from the muni market, ex-_ yield-tracker Municipal Market
Y a Data.For a married couple in the
when sharp investors hunt for mu- 31 percent tax bracket, that is
ni bond bargains, because sellers Some bond pros equivalent to a 7.5 percent taxable
often dominate the marketare dubious about Yield.
. through December 31. Then, his
torically,the muni market rallies a Januar rallyBut given that three-year U.S.
in January, sending yields down Treasury notes themselves now
and bond prices up. yieldd 7 7.7.7 percent,they are obvious-
The yearend selling pressure perts say.The reason:Lower feder• ly a better buy than monis
typically arises as individual inves- al tax rates would remove some of To express the differences in
tors(who dominate the muni mar- the incentive to seek the tax-ex- the muni and Treasury market an-
ket)often clean up their portfolios empt income paid by muni bonds. other way,consider the"spread"
for tax reasons. In years when Finally,expectations of further between two-year and 30year
bond prices decline—as they have interest rate increases by the Fed- Yields in each market-
this
arketthis year — many investors do eral Reserve in 1995 make mdnY ■Top-rated, two-year muni
bond"swaps,"selling depressed is- Investors leery of locking money general obligation yields average
sues to get a tax loss, then using up in any type of long-term bond. about 4.9 percent,while the Bond
the proceeds to buy another bond So what demand there is for muni Buyer index of long-term muni Is•
or bond-like investment paying an Issues is concentrated in shorter- sues now is 8.94 percent.So the in-
even higher yield. term bonds, generally those ma- centive for"going long"in munis
Institutional muni investors, turfing in less than five years,bond Is two full percentage point&
such as mutual funds, also fre- pros say. ■In contrast,30-year Treasury
quently rearrange their portfolios But as a result of all of this,mu• bonds,now yielding 7.89 percent,
at the end of the year, selling nl experts say long-term muni pay just 029-point more in interest
bonds and raising their"cash"les bonds are going begging for buy- than two-year T-notes,which.yleld
els so that they're prepared for po- ers—and are offering yields that 7.55 percent.
tential redemptions by sharehold• should be high enough to compen. Of course,many investors may
ers. sate for all of the inherent risks. rationally balk at buying long-
Once January arrives, howev- The Bond Buyer index of 40 term bonds of any kind.But if you
er,the muni market often sees the high-quality, long-term muni are shopping for yield,long-term
selling dry up. Meanwhile, semi- bonds now sports an average yield monis(or long-term muni mutual
annual interest payments received of 8.94 percent, tax-free. That is funds) are worth a close look,
on outstanding muni bonds as of the same as a 10 percent taxable many pros say. And if you're In.
January 1 create billions of dollars yield—such as on a Treasury bond clined to stay short-term with your
of cash looking for a home—and —for investors In the 31 percent money, the smarter investment
many of those dollars wind up be. marginal federal tax bracket may be shorter-term Treasuries
ing reinvested In the muni market. (which begins at taxable income of than shorter-term mums.
-
■Municipal Bond Yteid Trends ■Figuring Taxable Equivdent Yields
Weekly closes To find out whether a tax-free investment makes sense for
8.5% you,compare its taxable equivalent yield to the yieH avoil-
able on taxable investments with a similar maturity,using
r
8.0 this simple calculation:
Tax free yield
,ed IPA Taxable equivalent yield.
i 75 (1-Your tax bracket*)
.` Suppose a taxpayer in the 31 percent federal tax bracket
:: a►
7.0 can get 7 percent on a 30-year Treasury bond or 5 percent
1!\. on'a 30-year California municipal bond.The taxable equiv.
t
6.5 alent yield on the municipal bond is 7.25 percent.
At f5.0
'a 60 7.2s- (1-0.31)
• From a tax standpoint alone,this investor is better off in
5.5 municipals,because 7.25 percentis higher than 7 percent.
yq _
S0 If you're comparing California municipals,which are free
'
e �: of Isderol and state taxes,to a fully taxable investment,use your ,
combined federal-state tax rah from the table below.If you're
'i Y •j
4.5 comparing a California municipal to a Treasury security,use on-
1 F M A •••M 1 1 A s O H D IyyourfederaltaxrateinthecalculationbecauseTreasurysecu-
1yM4 rities are free from state,but not federal taxes.
a ■Fixed-Income Yields ■ 1994 Income Tax Brackets M
Lost Previous s Combined
Friday Week Change °.€ Taxable Taxable Tax Rata EffMm
`i California Bond Yields Joint Income Single Income Fed. State Rate
5-Year Cal GO 5.85% 5.85% - $38,001 to$48,456 28.0 6.0 32.3%
10•Year Cal GO 6.35 6.35 v d8,d57 to 61,240 22,751 to 30,620 28.0 8.0 33.8
30-Year Cal GO 6.95 6.95
5-Year AAA Insured 5.75 5.75 61,241 to 91,850 30,621 to 55,100 28.0 9.3 34.7
10-Year AAA Insured 6.25 6.25 91,851 to 140,000 55,101 to 106,190 31.0 9.3 37.4
30-Year AAA Insured 6.85 6.85 106,191 to 115,000 31.0 10.0 37.9 µ§
Treasury Bond Yields = 140,001 to 212,380 36.0 9.3 42.0 "
5-Year Treasury 7.84 7.74 + 10 ". 212,381 to 250,000 115,001 to 212,380 36.0 10.0 42.4
10-Year Treasury 7.82 7.80 +.02
212,381 to 250,000 36.0 11.0 43.0
30-Year Treasury 7.83 7.85 02
Money Market Funds (30-day average) 250,001 to 424,760 39.6 10.0 45.6
Tax-free money funds 3.07 2.98 +.09 Over 424,760 Over 250,000 39.6 11.0 46.2ga
Taxable money funds 4.93 4.86 +.07 Note:People below the 28%federal tax bracket generally do not benefit
Bond yields may vary due to locality, purchase from tax-free investing. 3 n
and rating,and do not reflect transaction charges. a State taxes are deductible onfederaltaxreturn.
Source:Piper Jaffray,Donoghue's Money Fund Report R Source:CofilorniaMuniripa/Bond Advisor
I OTT 37711TW7
i�
•
Orange County Mulls Mall Street
Swap Proposals to Defray Losses
By Charles Gasparino and Peter Heap
Officials in Orange Countv, Calif.. Now. the county is once avain
are considering swap proposals from IookinJ to Wall Street and deriva-
Wall Street that would allow the coun- tives in order to cap its losses. Deal-
ty to minimize its losses on a heavily ers said the county is considering
leveraged investment pool. swap strategies that would effec-
Dealers told The Bond Buyer that tively reverse its current ime.tment
they have approached officials in strategy.
Orange County with ideas on how The county has invested a .ignifi-
thev can staunch approximately 51.5 cant amount of monev in structured
billion in potential losses with so- notes, a derivative instrument that in
called swap reversals on the coun- this case pays the county less when in-
ty's huge portfolio of derivative terest rates rise.
products. The result is equivalent to a swap in
The county, dealers said, would which the county pays a floating in-
consider the proposals, but dealers terest rate and receives a fixed interest
offered no timetable as to when they rate.
could begin any investment strate- To change course, dealers say the
gY• county would enter into another swap
The offers from Wall Street came as in which it pays a fixed interest rate
rumors spread through the market that and receives a floating interest rate
. Orange County would take the unusu- based on the London Interbank Offered
al step of declaring municipal bank- Rate.
ruptcy. Dealers said the rumors,if true, As a result,Orange County ends up
could short-circuit any attempt by Wall paying the difference between two
Street to minimize the county's losses fixed rates.The county still loses mon-
using derivatives. ey,but these losses are capped for the
Officials from Orange County did life of the notes.
not return telephone calls. Last week,Orange County circulat-
The county's problems with its de- ed a document on Wall Street, which
rivatives portfolio became national it characterized as a"bid list:' stating
news last Thursday, when officials an- some of its derivative investments, a
nounced huge potential losses on its managing director at one Wall Street
investment pool. firm said. The county circulated the
Robert L. Citron, who on Monday list before revealing the size of its loss-
resigned as county treasurer, used a es.
series of leveraging strategies to cre- ''It was originally characterized as
ate an investment portfolio worth a bid list:' the executive said. "They
close to $20 billion. Citron started (the county] really were looking for
with 57.8 billion of pooled money valuations to get a better level on the
from approximately 170 municipal real value:'
authorities. The executive added the list revealed
Citron invested the $20 billion in if the county tried to unwind its deriv-
several derivative instruments that do atives position immediately, it would
well only when interest rates decline. incur much higher losses than it has
But over the past year, interest rates reported.
have bottomed out and started rising, Although the executive, who asked
causing massive losses in the county's not to be named,couldn't put a figure
investments.The county relied on Wall on the losses, he said it would be "a
Street investment houses to leverage its material difference" compared to the
position and purchase the derivatives. figure announced on Thursday. J
greater than $20 million. Four cities
plan to spend$11 million to$20 mil-
lion, 18 cities said they will spend$6
million to $10 million, 32 cities will
spend $t million to $5 million, and
16 cities will spend less than$1 mil-
lion.
"ylany California cities have de-
ferred major maintenance and new
construction because of the prolonged
recession:'Lawrence G. Rolapp,pres-
ident of Fieldman Rolapp, said in a
statement."Judging by the survey re-
sponses, the smaller cities are cau-
tiously increasing their spending."
CALIFORNIA -Michael Utley, Lot Angeles
In the next three years,94%bf small
and medium-size cities in California
plan to use new financing soorces,pri-
marily municipal bonds, for capital For the second year in a row,Cali-
projects'funding, a new survey says. forma's general fund generated a
Onlv 617c of cities will be able to fi- surplus,according to a preliminary ac-
nance capital spending needs during counting by state Controller Gray
the next three years entirely from ex- Davis.
isting revenues or cash on hand, ac- For fiscal 1994,the state generated
cording to the survey by Fieldman, an$836 million operating surplus,re-
Rolapp&.associates. ducing the state's accumulated bud-
The survey of 83 cities was con- get deficit to $1.2 billion at the June
ducted in late October by the Irvine, 30 fiscal yearend.
Calif.-based independent advisory 'This is another indication that the
firm• economy is on the mend and the state
For the current fiscal year that be- is getting its financial house back in
gan July 1,6717c of the cities surveyed order,"Davis said in a statement.
said they have increased their capital In fiscal 1994, California spent
spending budget from the earlier fiscal 3836 million less than it received,with
year's plan, reflecting the state's im- 340.15 billion in income and $39.32
proved economic outlook. billion in"outgo the controller's of-
A total of 5317c of respondents said Tice said. "During the year, the state
the largest portion of their fiscal 1995 spent $836 million less than it re-
capital budget is earmarked for newceived:'
projects, while 4717c said the 1 gest California's general fund started fis-
portion covers renovation and rest a- cal 1994 with a negative fund balance,
tion projects. or deficit,of$2.04 billion,and ended
Only seven of the responding cities the year with a negative fund balance
have fiscal 1995 capital budgets of$1.21 billion.
In mid-November,Davis announced
that a gradual improvement in the
state's finances meant that it would
not be necessary to pull the trigger on
automatic across-the-board spending
cuts. At that time, Davis said he ex-
pected the general fund cash condi-
tion of next June 30—the end of the
current fiscal year—to be healthier..
than was projected last July.
—Brad Altman. Lot Arfelej
•
•
s
Merrill
Tiedto Mess in
OrangeCounty
81"mUrg&"In p News Merrill salesman. "Know your
When Orange County,Calif., customer."
made its wrong-way bets on in- That includes knowing
terest rates this year, it called when your customer is taking
on Merrill Lynch & Co. sales- too much risk.Money managers
man Michael Stamenson. who have examined Orange
The Merrill institutional County's portfolio said it was
salesman was among the big• clear the county was taking ex-
gest sellers of derivatives and traordinary risks by continu-
structured notes — securities ously betting interest rates
whose returns are often based would go down this year and by
on complex formulas — that using borrowed money that In-
contributed to a 20 percent de• creased its losses if they did not.
cline in the value of the Orange Merrill said it did nothing
Country Investment Pool, mu- w'r'ong. "We obviously were a
nicipal officials and brokers at supplier of product to the Or.
competing firma said. ange County treasurer," said
"When we started question- Paul Critchlow, chief spokes-
• ing a lot of the more esoteric man for the nation's biggest re-
investments, on a month-by curities firmroriate . "We think all the
edure@ were
month basis, generally speak. followed. Theme was ample di&
ing, they were Merrill invest. closure."
menta, or Merrill-created in. ,These issues are wader a
vestments," said Andrew Czor•
ny, director of finance for the s powt now because Robert L.
Orange County Water District, Citron,who resigned yesterday
which has$110 million invested lea. Orange
eon�e value of
in the pool.
The roles Merrill and Sta. the Orange County fund fell to
menson played as top suppliers i•billion from$7.5 billion as in.
of hard-to-value,illiquid securi• terest rates soared. The losses
ties to Orange County places were exacerbated by the use of
them in a sensitive spot if the leverage,or borrowed money.
county's investment crisis leads Stamenson. director of mu-
to losses for taxpayers or mu- nicipalities at Merrill's 101 Cali-
nicipal bond investors.The firm forma St.office in San Francis•
could be at risk of lawsuits al- co, had a 'very clone re ation.
leging it failed to meet its obli. ship"with Citron,said 13ecnard
gations by allowing the county Mikell, a senior vice president
to take undue risks, legal ex. at Sutro&Co..a regional bond
perts and securities broken firm.
said. "When he first appeared on
"There is a basic moral tenet the scene,he was very willing to
in the brokerage business,"said hold hands of people who were
Leopold Korens,chairman and less sophisticated,to help them
chief executive of the Pacific
Stock Exchange and a former ORANGE Pape D4Col.1
•
vestment vehicles not sold by
ORANGE
securities firms like Merrill
Lynch,said Sutro's Mikell.
From Page Dl At a 1988 conference of mu-
understand the marketplace;' nicipal treasurers in San Mateo,
said Dan Daly,chief investment a proposal by Citicorp in favor
officer for the city of San Fran. of these sales erupted into
cisco. "He's a super salesman. shouting,Mikell said.
The people who lire him love Later, Mikell said, Stamen-
him.,,
Stamensoa's abilities paid son approached him in a hall
outside the conference room.
off.He lives in a 13-room house ,.'We're going to se*tle this
with a swimming pool and four right now,"' Mikell recalled
baths,assessed at more than$1 Stamenson saying. "He put •
million, in the Contra Costa down his head,and he charged
County town of Moraga. me, knocked me across the
The gray-haired Stamenson hal„
joined Merrill Lynch in Novem- Taxpayers and some of the
ber 1970 after growing up in 180 municipal entities in the Or-
Southern California and serv-
ange County fund could file
ing in the military
lawsuits against anyone
He declined to comment last he
week at his office. volved in the losses.Today,.the
Orange County board of super-
Stamenson can turn hot- visors scheduled a special meet-
.tempered, such as when he ar- ing to discuss potential litiga-
gued against new municipal in- tion arising from the situation.
i
County's Bankruptcy Decision
Called a Desperate Move
Chronfr(r n'iro-Semlers Ilond Investors Association,a non-
Santa Ana profit group in Miami Lakes, Fla.,
that tracks risky bonds."The coun-
Orange County's filing for mu- twould go to the state or even the
nicipal bankruptcy is viewed by Ie- I.I.S.Treasury first,rather than de-
gal experts as a move of last resort Clare bankruptcy."
that can send shock waves through So far,the state treasurer's of-
every level of government and fice isn't planning to help Orange
trigger severe economic conse- County, nor has it been asked to,
quences for years to come. said.lennifer Openshaw,a spokes-
Orange County's bankruptcy is woman for California Treasurer
"the seminal event for the bond Kathleen Brown."There's nothing
market," said James Gammon, we're considering doing at this
president of Lebenthal Asset Man- time,'•Openshaw said.
agement Inc., which has about Some traders speculate the
$125 million under management. Federal Reserve will he less will-
Some analysts said they cannot ing to raise interest rates for fear
believe that the county would be of triggering financial crises
allowed to fail. among other municipalities in-
"This would he a terrible stain volved with the Orange County
on the municipal bond market," fund and other local investment
said Richard Lehmann, head of funds.
Orange CountyReports Loss
Of $1.4 Billion on Investments
By Leslie Wayne and Roberts,a commissioner of the Securi-
Nem York?lmes Nems Service ties and Exchange Commission. "It's wor-
risome to the SEC.These securities,which
Orange County, Calif., one of the were dreamed up more In a boiler room
wealthiest counties in the nation,is facing than a conference room, are sold to a
one of the biggest investment losses ever broad range of investors and are sprinkled
—$1.4 billion—from purchases of highly around the country."
volatile investments known as derivatives, Orange County Is one of hundreds of
which have fallen:a value as interest rates municipalities,mutual funds,colleges and
have risen. corporations that tried to increase their
The Orange County loss appears to be Investment returns by buying highly com-
the largest by an investment fund,either plex securities that were,in effect,high-
corporate or municipal, from these com- risk bets on the direction of interest rates.
plex instruments. And it overshadows As interest rates have risen, the value of
such well-publicized problems that deriva- these instruments have tumbled.
tives have caused at Procter&Gamble,the
investment firm of Piper Jaffray and,just The$20 billion Orange County fund In-
last week,the Mellon Bank. cluded some $8 billion in reserve money
In a statement announcing the losses for future needs from more than 180 mu-
yesterday, Robert Citron, the Orange nicipalities In California and$12 billion in
County treasurer,said they were still only borrowed funds.The largest investors In
on paper. But critics of Citron's invest- the fund are the county,the county trans-
ment policy assert that many of the securi- portation authority, sanitation districts
ties may never recover In value, and California titles outside the county.
"Orange County has joined t.tie ranks Citron took some$8 billion in the mon-
of these problems in a big way,"said Rich- ey of these municipalities,borrowed some
$12 billion more,and used it to buy a wide
variety of securities that go by the name of
floating-rate derivatives and reverse re-
purchee agreements.
Orange
County
Goes Broke
Crisis came when
investments soured
By Hark Place and Man Loft
La.AASWm Ila"
Santa Ana
Orange County yesterday be-
came the largest municipality In
• U.S. history to (tie for federal
bankruptcy, with Its top elected
leaders declaring that the emty
had run out of cash when several
big investment houses demanded
repayment of$12 billion fil ans
Do*vu! we Dnbade Coyl�l
fpr*M to fall Area
CAMMMO 01011 W PGE Dl
they extended to the county's low
stricken investment pool.
The stunning news that one of
the nation's largest and wealthiest
counties was seeking protection
from Its creditors capped a day of
political and financial turmoil that
shook not just Orange County and
Its residents but also the nation's
financial markets.
Officials said the filing will.
BANKRUPTCY: Pape A8 Col.l
•
BANKRUPTCY: County Files Chapter 9
From Page 1 value this year. perate last step for any public entl-
have no effect on the county's abll- "Then, everybody walked." ty.because the stigma attached to
ity to maintain police protection Wieder said.'The bond dealers— such a move can lead to a bad cred-
and other basic services. they walked." It rating and make It difficult,It
'There was no alternative giv- On Monday, the county an. not Impossible,to borrow for pub-
en to us,"said Supervisor Harriett nounced that Treasurer-Tax Col- lic projects,legal and financial ex-
Wieder."We were concerned with lector Robert Citron,whose risky perts said.
the fart that we are here to protect investment pracUces are blamed "It's rare,It's quite rare...for
the public and to protect the Inves. for the portfolio's plunge,had ro. any government to take that step
tors." signed after 24 years In office. —and unprecedented fora county
Until yesterday morning, the The bankruptcy filing came a of that size,"Bald Bennett Murphy,
supervisors thought they could day later,after 12 hours of closed a bankruptcy expert and partner
work out the crisis, spawned by meetings by the board and other in the law firm of Ltham 4 Wat-
the disclosure last week that the top county officials. tins.
county's once-vaunted Investment Filing under Chapter Y of the Murphy said Chapter 0 func-
pool had dropped $1.5 billion in federal bankruptcy code Is a des- tions much like Chapter 11 of the
bankruptcy code for businesses—
it provides a government with pro-
lection from Its creditors while It
attempts to work out a plan for re-
habilitating Its finances.
"Drastic financial distress —
It's there for that purpose,"Mur-
phy said.
Faced with criticism from fed-
eral regulators that state officials
have failed to step In swiftly to
help,sePete Wilson Issued
a terse,, one-sentence statement
through his press office.
"We will assist Orange County
in analyzing the situation to identi- The rumors of a bankruptcy fil- were roused at 3 a.m and called to
fy the alternatives necessary so Ing-- an almost unthinkable turn the Hall of Administration in San-
that Orange County can bring It's of events for the affluent,conser- to Ana for a 4 a.m. briefing. But
finances back into solvency,"Wil- vative county—spread from Wall IK-cause of potential violations of
son said. Street to Washington to Calllornla the state's open meeting laws,the
Meanwhile, a spokesman ncfore through the day. supervisors had to be sequestered
the state Department of FinaRepresentative Christopher In different parts of the building,
Cox,R-Calif.,had been the first to with Information shuttled among
said officials there were gathering at a
Information in hopes of develop ba bankruptcy filing. Cox a fppear on television ormer em m the county's financial
rmer advisers
Ing a strategy to help the county securities lawyer,said he bad been The bankruptcy filing appar-
find a way out of the mesa. In contact with county officials as ently was triggered when CS First
"Job One Is to get a complete the financial crisis exploded and Boston Corp.,one of several large
picture of what the situation Is," will hold hearings to sort out what brokerages that has lent the coun-
sald spokesman H.D. Psltper. happened and find ways to pre. ty money to purchase securities,
"What we'B do depends on what vent such catastrophes in the fu- demanded additional collateral for
we fled out.l wouldn't want to pre ture. Its loans yesterday after the coun-
judge any of that." Yesterday,county supervisors ty failed to make a payment.
Orange County Axes Hawkins Delafield
After Only One Week as Bond Counsel
3.Berl A!;.-:un
LOS ANGELES—A well-respect- Sanders&Dempsey as co-h4ind,:owi-
ed bond counsel firm hired by Orange sel.
County shortly after the county tiled Hawkins Delafield was replaced
for bankruptcy protection was abrupt- the international law firm of%Vil!kte
Iv dismissed after only a week on the Farr&Gallagher.
job,it was disclosed this week. Observers said<.ervine as co-h nj
The county ended its bond counsel counsel is a plum assignment for,he
contract with New York-based chosen law firms.%, hich stand to••-,:in
Hawkins. Delatield&Wood on Dec. considerable remuneration for pro, -d-
_0. seven days after it issued a press ing legal services to the count% :n :he
release touting the hiring of the firm precedent-setting case.the !;Urea rr:•t,-
alopg with Cleveland-based Squire, nicipal bankruptcy tiling in U& !us-
Wry.
– Squire. Sanders, and Wilikie Farr
are working with the county to deter-
mine"possible bond issue uructure.
and note issue structures.— aid'.%;! k:e
Farr senior partner Peter J. Kenn.%
Pease turn t,,Q2t.\t,E COU\1*1 -
211221
orange County
Continued from front page
The bond counsel shake-up was pre-
cipitated by a difference in philoso-
phy between Hawkins Delafield
lawyers and other members of the
county's financing team,sources said
yesterday.
Bruce Bennett, the bankruptcy
lawyer who helped the county prepare
its Dec.6 bankruptcy filing,said yes-
terday that"the rumor that I was re-
sponsible for firing Hawkins Delafield
is categorically wrong."
Bennett,a senior partner with Stat-
man,Treister&Glatt in Los Angeles,
said he could not address the circum-
stances that led to Hawkins Delafield's
dismissal.
Other individuals with knowledge
of the circumstances leading to
Hawkins Delafield's departure also de-
clined to puhlicly discuss what prompt-
ed it.
"You are going to open up a can of
worms,"said one lawyer.
'If you read between the lines,
there may be a particular personali-
ty or two that weren't meshing with
the other personalities,"a county
source said."There is just no time to
stand on ceremony.We're in a crisis
situation."
Late yesterday,Arto C. Becker,
Hawkins Delafield's lead partner in
California, issued a statement on be-
half of the firm:
"During the course of our engage-
ment with the county,the firm applied
its unique expertise and experience in
municipal finance in a professional
manner.And we believe we rendered view was not being effectively con-
the best legal advice to the county un- veyed,or perhaps wasn't being listened
der the circumstances." to,for whatever reason,"the source
Terry C.Andrus,the county's lead said."It was just more of a chemistry
lawyer, said the decision to remove issue;'the source added.
Hawkins Delafield was"technically" The county's Dec. 14 release tout-
made by county administrative officer ing its appointment of Hawkins De-
Ernie Schneider,and Andrus added that lafield along with Squire, Sanders
"I really don't want to comment"on &Dempsey said the two firms'pur-
his role. pose would be "to restore confi-
He said Orange County continues dente in Orange County's financial
to retain Hawkins Delafield"in other operations ... and to enhance the
capacities,"including as a legal advis- county's ability to quickly'reenter
er on solid-waste financings."They are the capital market for cash flow and
an excellent firm and we are very hap- other needs."
py with our relationship with them," Despite the high-profile an-
Andrus said, nouncement,Hawkins Delafield and
Several sources said Hawkins De- Squire,Sanders were hired in"a hap-
]afield was dropped because of dis- hazard"way,according to one attor-
agreements with advice given to coun- ney.
ty officials and outside financial ad- Andrus,the county counsel, said
visers by Richard L.Sigal,a Hawkins the two firms were chosen from a
Delafield partner. pool of prequalified bond counsel
Sigal,reached late yesterday,said firms that the county taps into when it
he was not"at liberty to discuss" needs to issue bonds.Many firms on
Or+ange County either"on the record the list were disqualified because of
or off the record:' "certain bond issues that the firms
In an interview Monday,Hawkins were previously involved in,"Andrus
Delafield's Becker said,"If someone said.
is saying there was a personality play In other Orange County develop-
here and decisions were made on that ments yesterday,the Bond Investors
basis,I would think that would be a Association of Miami Lakes, Fla.,
silly way to make a decision." said it has invited Securities and Ex-
A county source also downplayed change Commissioner Richard
suggestions that the Hawkins Delafield Roberts to speak at a meeting of Or-
dumping was personality-driven. ange County bondholders "and oth-
"Hawkins Delafield had a very im- er interested parties"next month in
portant point of view in determining Anaheim,Calif.
alternatives"for the county to con- The meeting, scheduled for 9 a.m.
sider,the source said.Those alterna- Feb.7 at the Inn at the Park hotel, ,will
tives included whether the county also provide an opportunity for bond-
should"borrow our way out, versus holders to organize themselves and
sue our way out,or,a combination of seek representation on the creditor
the two, committee in the bankruptcy proceed-
'But the Hawkins Delafield point of ings,"a press release said. J.
•
Thursday.December 29. 1994
'Orange County May Sell Assets
In Bid to Stem Investment Losses
By Michael Utley
LOS ANGELES —Orange Coun- pervisor Thomas F. Riley. "There is
ty,Calif.,officials are considering sell- a lot of behind-the-scenes work go-
ing dozens of county assets,including ing on in terms of trying to get a bet-
John Wayne Airport, to help offset a ter handle on the cash flow,and look-
$2.02 billiorr loss on their battered in- ing at other potential cuts or costs
vestment pool savings.But nothing is on the agenda
The asset sales were suggested yes- yet."
terday and Tuesday by several coun- Based on previous attempts to sell
ty supervisors following last week's the airport,there would be substantial
flurry of closed-door meetings. Two public opposition, and no one is sure
meetings were canceled this week for how much_the airport is worth.
lack of business, allowing officials The idea was first put forth by
more time to air their concerns pub- supervisor William G. Steiner
licly. during a budget crunch two years
In addition to selling the airport,su- ago. He brought it up again Tues-
pervisors are considering auctioning day in an interview with local re-
off county-owned land, altering the porters at the county Hall of Ad-
public defender's office, and opening ministration.
up county landfills to trash from neigh- "Anybody offering a billion dollars
boring communities. for the airport can have it right away,"
"These are all just ideas," said Steiner said.
Dave Kiff, executive assistant to su- But not all the supervisors agree.Ri-
ley,the outgoing board chairman,has
publicly opposed past sale plans.The
82-year-old supervisor is retiring from
the board Monday,but he still wields a
great deal of influence in Orange
County.
"He thinks the most accountable
group to operate the airport remains
the county," said Kiff. "He lives in
Newport Beach under the flight path,
and he likes to know that it's in demo-
cratically elected hands:'
Please turn to ORANGE COUNTY page 20
s
Orange County cents involved in the same case be-
cause of conflict of interest.
CondRued from front page That has forced the county to rou-
It is also uncertain whether the sale finely hire outside attorneys, costing
of the airport would be approved by in excess of$3 million a year.An in-
the federal government,which has in- ternal split would allow county attor-
vested millions of transportation dol:. neys to handle those cases at a sub-
lars in the facility. stantiglly smallercost.
At least one company, Lockheed In perhaps the most ridiculed cost-
Air Terminal, has expressed interest cutting proposal,the county nsay al$o
in buying the airport.The company is "look to others'garbage to dig itself
a subsidiary of Lockheed Corp., and out of the fiscal dumps," as a head-
has managed the Burbank,Calif.,air- line in the Orange County Register
port in Los Angeles County for 35 put it.
years. Officials estimate Orange.County
John Wayne Airport, located just could earn $60,000 a day for taking
south of Santa Ana, is an extremely refuse from trash jammed Los Ange-
successful operation, generating , lea and San Diego counties. That
$58.1 million in revenue last yea& would generate$18 million annually
Flights and passenger loads are up to help alleviate the county's m4ii at-
this year thanks to new low-fare40 c4$4Q.2 milljou in necessary bwdgpt
carvers. cuts.
The supervisors are hoping that County spokeswoman Sandra Stern-
other land sales might also prove to berg on Tuesday said widespread re-
be a lucrative-source of income.They pons that the actual budges-cuttiag fig-
have asked cpunty staff to come up ure includes an additional$80 million
with a prioritized list of properties are incorrect..,
•
Competing Firms
Say Orange County
RFP Is for Show
By Charles Gasparino
Municipal bond underwriters are
betting that Orange County,Calif.,has
all but settled on a lead underwriter for
a possible public finance solution to
the county's fiscal troubles.
The vast majority of bankers who
have responded to a request for pro-
posals from the county say that,if and
when a deal takes place,officials will
probably chose either J.P.Morgan Se-
curities or Goldman Sachs&Co.
Unlike many of their competitors,
J.P. Morgan and Goldman can answer
the RFP's detailed conflict-of-interest
• question without much trouble.
Both firms also have large and ex-
perienced public finance staffs. And
neither has had much contact with the
county and its former treasurer-tax col-
lector Robert Citron, who with the
help of many Wall Street firms, de-
veloped an aggressive investment strat-
egy that caused about $2 billion in
losses for the county's pooled invest-
ment fund.
Most bankers say the RFP was win-
dow dressing. "Everybody on the
Sweet believes this is wired to J.P. Mor-
gan or Goldman," said the head of
large municipal department,who asked
not to be identified."The only way to
do it on the up and up is to issue an
RFP."
Pietist,nan w RFP page 15
RFP quired firms to provide an account of
their dealings with Orange County,or
Continued from front page municipalities that participated in the
The county, through its advisers at county's investment pool,whose trou-
Salomon Brother Inc., mailed the re- bles have forced the county to file for
quest last Wednesday. Public finance bankruptcy protection.
executives at 17 firms spent their Firms were asked to specify if they
Christmas vacation responding to the "acted as principal or agent in con-
questionnaire, which was to be com- nection with the purchase or sale to the
pleted by Tuesday night. county of any securities in the period
With about$2 billion in losses,the from January 1, 1992 to the present."
pool represents a huge liability to Or- The RPP also asked if the firms
ange County,and a big payday for the made loans or extended credit to the
municipal bond firm that develops a county, or if the firms are "aware of
bonding or public finance strategy that any litigation,pending or threatened"
leads to recovery. that"would be adverse to the coun-
Still,most investment bankers that ty."
responded to the RFP say the county Michael D.McCarthy,the Goldman
has"wired,' or steered, the potential partner in charge of municipal bonds,
transaction to J.P.Morgan or Goldman did not return telephone calls. A
Sachs. spokesman at J.F.Morgan had no com-
Orange County spokeswoman San- meat on the matter.
dra Sternberg said the county"is very The problem faced by firms other
concerned with conflict of interests:' than J.P.Morgan and Goldman is that
When asked if J.P.Morgan and Gold- in one way or another they worked
man are front-runners,Sternberg said: with the county on past transactions
"We need to find firms with no con- and may be the target of litigation in
flicts of interest:' the future.
Sternberg said:"rbe [RFPs] went Orange County has already said it
out to the usual suspects.I don't know may sue several of the funis that re-
if they are wired.Did we know ahead sponded to the request for proposals.
of time there would be only two?Well These firms sold securities that were
you know, I'm sure there were sup- held as collateral on loans made to the
positions, but I wouldn't say it is county.
wired:' Other firms,such as Merrill Lynch
The county has not chosen a firm &Co.,sold Citron many of the deriv-
and doesn't expect to do so this week alive investments that contributed to
this week, Sternberg said. "It's not a investment pool's losses.Merrill Lynch
huge priority." was one of the 17 firms that received
The conflict of interest question re- the questionnaire. ❑
Orange County
Boulder Hits Pond;
Big Waves Just
Starting to Be Felt
By Kathie O'Donnell
Orange County,Calif.'s bankruptcy
declaration Tuesday helped knock mu-
nicipals back a point to I 1 points yes-
terday,rudely cutting short what many
had hoped was the long-awaited supply
shortage rally.
"What exacerbates the whole thing
is that here we are,it looks like we are
about to turn the corner, and boom,
you get sucked
in at the tap of
the market," a
municipal trad-
er said."It's re-
ally dishearten-
ing„
_ Orange County
announced late
--- Tuesday that it
was seeking
protection under
Chapter 9 of the
U.S. Bankrupt-
cy Code.,In a
MUNICIPAL release,the Or-
ange County
MARKET Board of Super-
visors said it
took the action after various investment
banks declined to roll over or renew
existing reverse repurchase agreements
held by investors totaling$1.2 billion.
That refusal resulted in a default on
the agreements, which "necessitated
immediate action; the release said.
The trader noted that many buyers
Please turn to MUNICIPALS page 7
Thursday,December R,1994 THE BOND BUYER
(1267)7
Municipals While the depth of the investors'ex- "It's kind of like:Wait a minute.We a source familiar with the offering said.
posure remains unclear at this point, look at our triple B hospitals,but we Late yesterday,the issuer was in the
Continued from front page one thing is a virtual certainty,the trad- didn't think we had to worry about process of deciding how to proceed
have"major exposure"to Califomia er said. double-A Orange County,Calif.,"he with the deal,he said.
credits.And,aside from Orange Coun- "They'll all come out swinging. said. In the competitive arena,the market
ty,all the other counties,cities,school Everyone of them will feel as if they Another trader agreed,saying the conditions resulted in postponements
districts,and agencies that put money are entitled to get all there money back. county's predicament is surprising be- of the a$7.5 million Folsom-Cordova
in the county's investment pool could Therefore none of them will get any cause of the level of sophistication Unified School District deal and an
face trouble as well.That means many of their money back until all the there. $8.5 million Sacramento County Of-
portfolio managers are concentrating lawyers have been paid,"the trader "You naturally wonder why they Tice of Education offering,both of
on what kind of exposure they have, said,"that much f can guarantee you." would get themselves into this sort of a which had been scheduled for yester-
instead of what's happening in the mu- He also noted that amid the turmoil, predicament,"he said,"As Moody's day.
nicipal market, there is a silver lining for one segment and Standard&Poor's do their re- Christopher Ailman,chief invest-
"That's taking a lot of people off the of the market—the bond insurers. views,maybe they'll be a little bit more ment officer with the Sacramento
desk,which means that you are not go- The insurers may not be happy disclosure as to what the status of the County Treasurer's office,said while
ing to sell bonds to people today,"he about losing money,"but if you've got situation is." his deals have nothing to do with Or-
said, two bonds and one is insured and one Standard&Poor's Corp.yesterday ange County,they were postponed be-
A second trader said the municipal is uninsured,and the irmired one's pay- ' downgraded$1.58 billion of Orange cause of market conditions related to
market could not blame all of its trou- ing money,that's the cheapest,most County.California debt to junk yes- the filing.
bles on Orange County, effective advertising they can get:' terday as a result of the County's fil- "We were told this morning that on
"I guess its effect on the market as a In light secondary activity yester- ing for protection under Chapter 9 of the muni side bids were very weak if
whole is to dampen things just a little day,yields on high-grade bonds rose the bankruptcy code.The county pre- not non-existent for California paper,
bit,but we had come a little bit too far, by 10 basis points,while dollar bonds viously had enjoyed a AA-minus rating and that in terms of a day to issue,this
a little bit too fast anyway,"he said, lost 1'/2 points.In debt futures,the on some of its debt. was not the key day:'he said.
adding that the Orange County situa- March municipal contract was down '"Phe triple-C ratings are based on Ailman said Sacramento will w
tion should have some interesting ef- 116 points to 83nfaz kt
Yesterday's March banuptcy filing procedures that may for the hysteria to die down an
fects on the market. MOB spread was negative 488 com- allow the county to continue paying its market to return to some level o
"There's 11871 different municipal- pared to negative 466 on Tuesday.In obligations pursuant to the court's di- malcy,and then we'll issue them.
ities involved in the pool.That makes the government market,the 30-year rection:'the rating agency said in a re- Asked when that might be, he
this bankruptcy a lot more interesting bond was down t/z point to yield lease. replied,"We'll just have to watch mar-
that others have been:'he said,"The 7.89%. Standard&Poor's also revised its ket conditions,I heard this morning
intrinsic value in a general obligation A municipal bond trader said that CreditWatch implication to"devel- that even California insured GOs were
bond or any other bond that has a guar- among those likely to be most dis- oping"'from negative"due to the down in value,now how that relates
anteed revenue stream hasn't really heartened by yesterday's plunged are lack of specific detail regarding the has got me a little baffled:'
been tested with a municipal bank- the mutual funds who liquidated two process by which the county may at- The 30-day visible supply of mu-
ruptcy with a number of participants weeks ago at rock bottom prices. tempt to restructure it's financial nicipal bonds totaled$2.77 billion yes-
before.' They wanted to reload,but decided obligations" terday,down$445.2 million from
The workout process is likely to to take their time Then,"the market "During the past week,there has Tuesday.That comprised$1.226 bil-
drag on"interminably,"and the full snaps back 40 basis points,so they get been a paucity information ema- lion of competitive bonds,down$96.4
impact on the municipalities or agen- very little invested.But then,they nating from the county:'the release million from Tuesday,and$1.545 bil-
cies that invested in the pool remains chase it this week.They buy it and now said,"S&P has asked to meet with lion of negotiated bonds,down$348.8
murky,he said. they're down again,"he said. county officials as soon as possi- million..
"The fact of the matter is you don't In addition,with no paper around, ble,and will keep investors in- Standard&Poor's Blue List of mu-
know what the exposure of some of some funds decided to buy the contract formed to the extent possible as the nicipal bonds declined$230 million
these agencies is/If this is the cash hoping to enjoy the price appreciation. situation develops" yesterday to$1.22 billion.
they had intended to make interest pay- Yesterday,futures dropped I 1 points. In the new issue market,the bank- In other news,New York State plans
ments with in the near future,you "I'm telling you people are about ruptcy's impact was felt in the negoti- to issue$60 million in general obliga-
could see that interest payment in dan- ready to jump out the windows.the ated sector as an$88 million Michi- tion bonds on dee.13 through a com-
ger;he said. muni bond trader said,"It's like what- gan Municipal Bond Authority deal petitive bid.The proceeds of the bonds
If that is the case,investors will have ever you want to do,do the opposite scheduled for yesterday was post- will be used to finance project under
to wait a long time before those issuers because you'll probably be right:' ported. the state's 1986 Environmental Quali-
"have the ability to levy charges,fees. The bankruptcy is particularly un- "We wanted to a avoid any turmoiP' ty Bond Act. Q
taxes or any other revenue producing settling because it happened to Orange
scheme in order to fund their debt ser- County,one of the richest counties in
vire renuirement."the trader said. the nation,the trader said.
ja-
i
Orange County Bankruptcy Move
Praised by Some Pool Members
By Michael Utley and Brad Altman
LOS ANGELES—A number of lo- pool"
cal governments with investments in Thai's good for the city,he said,be-
Orange County's ill-fated investment cause the most pressing transactions
portfolio said yesterday that they wel- were the satisfaction of its short-term
coined the news of the county's bank- debt obligations with Wail Street.
ruptcy filing. Had the county not declared bank-
"Our initial response to Chapter 9 ruptcy, the county's creditors could
is that it's a positive move," said have redeemed some of the collateral
Michael H.Fine,director of fiscal ser- that they have held as it relates to the
vices for the Newport-Mesa unified
school district, which has about$75
million in the fund."We we that as of- See related stories,
fering some initial stability."
"I think it was a good decision,"said pages 8 & 9
Jeffrey Niven,treasurer-finance direc-
tor for Irvine,Calif., which has$209
million in the county fund. county's debt,and sold it.
As the largest city investor, Irvine Niven said that Irvine has enough
has had difficulty getting answers out money in the rest of its $309 million
of the county,Niven said,but"as I un- portfolio to cover any cash flow prob-
derstand it,declaring bankruptcy froze lems for now.
all financial transactions of the county But,he added,"the negative side is
that [the bankruptcy] leaves a large
question as to the distribution of prop-
erty taxes to the city,"Niven said.
Dec. 10 is the delinquency date for
making property tax payments in Or-
ange County, Niven said,and that is
typically when most of the revenue
comes in.
"So I'm very concerned as to the
timeliness with which those disburse-
ments will be made;'Niven said."I've
got 14 bond issues outstanding and 10
of those relate to debt service on prop-
erty tax-related levies."
Niven said he has assured all of his
bondholders that the city has enough
liquid cash—more than$80 million
—to satisfy all debt service payments
for at least two years,even if the coun-
ty makes no tax disbursements.
`But,there's still a lot of uncertain-
ly out there,"Niven said.
Fallout from the county's financial
and political crisis prompted Standard
& Poor's Corp. to lower the county's
debt rating to CCC junk-bond status
yesterday, and forced the postpone-
Please turn to ORANGE COUNTY Page 8
i
Orange County reaping huge profits on our invest- priorities,review our resources,sec Robinson,who doesn't expect a cut
Cantinuedfromfrowpage ntents,"said Bergeson,a former state what needs to be rationed or limited in the city's credit rating,said Milpi-
ment of scheduled pricings of at least senator who resigned from her posi- or cut. tas was attracted to the Orange Coun-
two debt transactions in California tion yesterday to take the county so- "Whatever the county does,it's got ty pool because of"the liquidity,yield,
related storied. pervisor job. to be organized,fair,feasible,and eq- and what appeared to be a safe invest-
Orange County supervisors an- "The main thing is,we don't want uitable,"Moorlach said,"and it's got ment"
nounced their decision to file for pro- it to ever happen again,"she said. to be ready as soon as possible:' In Mountain View,finance director
Lection at 5:30 p.m.Pacific standard Bergeson said that she had second Orange County has hired an outside Kong said she wrote a memo Tuesday
time Tuesday,capping a day of rumors thoughts about jumping into county consulting firm to review its invest- to city manager Kevin C.Duggan,ex-
that such an action was imminent. government at a time of such crisis, ment portfolio and make recommen- plaining why Mountain View invested
The filing occurred less than a week but those worries have faded. dations.The report is scheduled to be in the Orange County investment fund.
after the county disclosed that it had "I wondered if I could rescind rely completed by next Thursday and a "After evaluating other alternatives,
sustained paper losses of$1.5 billion resignation yesterday,"she laughed. meeting of Orange County investment the Orange County pool was selected
on its$20 billion portfolio this year, "But,no,I still have faith in Orange fund participants is expected to occur due to its long track record of being
and a day after the county announced County and in the leadership provid- the following week. able to obtain a strong return with safe
the resignation of county treasurer-tax ed by the board of supervisors...Ul- The catastrophe sparked by the investment practices,"the memo said.
collector Robert L.Citron. timately,the economy will bring us out county's troubled investment portfolio "While bond investment funds have
Citron,a 24-year countyveteran, of this" has spread to local governments far be- generally proven to be consistent and
blamed the investment drop on higher To bolster the county's legal efforts, yond Orange County,including the relatively safe investment alternatives,
interest rates,but analysts believe loss- officials have hired Ken Klee of the cities of Santa Barbara,Milpitas,and both public and private funds have
es were accelerated by his purchases law firm Stutman,Treister&Glatt in Mountain View,Calif. been significantly impacted by the un-
of highly speculative derivative secu- Los Angeles. Mark Paul,finance director for San- usually sharp rise in interest rates in
rities. Chriss Street,a Newport Beach in- to Barbara,predicted the'coastal city recent months;'Kong wrote.
Chapter 4"is clearly the right thing vestment banker who has been inves- would be forced to pursue legal action "Prior citystaff consultations with
to do,"said David Kiff,executive as- tigating Orange County's investment against the Orange County investment Orange County investment managers
sistant to Thomas F.Riley,chairman strategies for more than a year,said he fund.Paul said it is likely the city gave the city the impression that rea-
of the Orange County Board of Su- was pleased with the county's choice would join with other pool participants sonable investment strategies were be-
pervisor—& of legal representation. in litigation. ing utilized to manage the portfolio'In
Kiff said supervisors were not ex- Street said Klee is a"brilliant"bank- Santa Barbara has$37 million,or addition,the city had an outside in-
pected to be available to the media yes- ruptcy attorney,and'he added that if about 25%of its investment portfolio, vestment broker review the[Orange
terday. anyone can get the county out of this in the Orange County pool,Paul said. County]portfolio in the past year,and
However,Orange County supervi- mess,it's Klee. Santa Barbara's single-A credit rat- they did not identify any areas of con-
sor-elect Marian Bergeson,who takes "This is bigger than IBM,General ing will probably be affectcsd,Paul said. cern.The city had no prior knowledge
office Jan.2,said she supports the Motors,and U.S.Steel in size and "Clearly...[as]actual losses are real- that the[pool]had any investmentAiq-
bankruptcy filing. complexity,"said Street ized,they'll want to review"the city's uidity problem:'
"We are all pretty surprised and '"Rte question now is whether some rating,he added. Mark Calvey contributed to this ar-
shocked at what is happening,but I of the losses will be realized,"Street Mountain View has$40 trillion,or ticle.
think it's probably the best thing for said."What's the impact on the finan- about one-third of its investment pool,
the county right now,"Bergeson said. cial community?Are brokers going to invested in the Orange County fund.
Bergeson said the county's top pri- fail because they owe money?Are "Right now the city of Mountain
ority is to reassure creditors and the these school districts going to be able View is fortunate to have enough short-
investment community that the county to make payroll?Will any other gov- term investtnents and casts coming in to
is going to regain its stature:The coun- cmments declare bankruptcy? cover operations,"said Patty J.Kong,
ty,with a populationof 2.6 million,is "And then,the real frightening is- the city's assistant finance and admin-
one of the nation's wealthiest and sue is how widespread these activities istrative services director.The city also
fastest growing. are-How many other county treasur- has enough cash to cover debt service,
In retrospect,Bergeson said,many ers and city finance officers have been she said.
of the county's decisions seem to have throwing the Hail Mary in the deriva- Kong doesn't expect the city's creel-
been driven by investment bankers, lives market?" it rating to be affected.
rather than the public interest. John Moorlach,a Costa Mesa ac- The Silicon Valley city of Milpitas
She plans to insist on the hiring of countant who ran unsuccessfully against has$5 million,or about 6%of its$85
an independent investment adviser Citron for the treasurer-tax collector post mullion investment portfolio,in the Or-
when she takes office.But she stressed last spring,said he was surprised by the ange County fund,
she is not blaming Wall Street for Or- bankruptcy announcement. "I don't want to minimize the im-
ange County's woes. "Hopefully,our county leaders will portance of$5 million,but it won't af-
It's hard to blame anyone now,be- bring some form of a good rehabilita- feet the city's day-to-day operations;'
cause everybody was reveling in all the tion plan to the forefront;he said. said Starla Jerome Robinson,Milpi-
successes and the fact that we were "What we need to do now is establish tas'financial services director.
•
Thursday,Decemher R, 1994
California County's
Disclosures May
Not Have Followed
Securities Laws
By Lynn Stevens Hume and Joanne
Morrison
WASHINGTON—Orange Coun-
ty, Calif., officials may have violated
securities laws by failing to disclose
that the county's multi-billion dollar
investment pool was having financial
troubles because of derivatives and
leveraged investments, according to
federal regulators, a California ac-
countant,and a review of bond docu-
ments.
County officials also may not have
properly disclosed the market risks as-
sociated with the pool's investments
or strategies for mitigating those risks
in public statements and in the offer-
ing documents for their municipal
Ptease turn to DISCLOSURE page 9
contain a section on the county's invesunent consumers are fully informed,although in
pool that said the pool contained derivatives as this case you have some investors who are
well as fixed-and floating-rate securities,a supposed to be fairly sophisticated.the
— "significant portion"of which"are pledged aide said.
Disclosure asset values. with respect to repurchase agreements." Moorlach said that because of Orange
The concerns about possible secu- The document said that"the price and County's losses and its bankruptcy firing,
Continued from froru page rities law violations stem from reports income volatility"of the securities"is the time is ripe for regulators and law-
bonds,the sources said. that Robert Citron,the former county greater than standard-fixed income securi- makers to take a look at the investment
These are some of the issues surround- treasurer,may have painted too rosy a ties and may serve to increase the volatili- abuses and lack of adequate disclosure.
ing the county that are under investigation financial picture of the pool in state- ty of the[pool's]return and market value in '"Phe SEC makes mutual funds mark to
by the Securities and Exchange Commis- mens to voters during the election and various interest rate environments." market at net asset value for a very specif-
sion,an SEC official said.The county filed in a recent meeting with fund partici- Eric Tashman,a lawyer with Brown& is and honest reason:that no one gets
for bankruptcy Tuesday. pants. Wood,which represented heifer Capital cheated out of a penny,"Moorlach said.
"All aspects[of this]will be seruti- "He seemed to be saying that there was Inc.,the county's financial adviser in the The accountant said he will help law-
nized,"the SEC official said."Me fo- no risk and that everything was fine and deal,said,"We believe that the disclosure makers,both in Washington and in Cali-
cus is on Orange County right now,but dandy when clearly it was not,"the SEC was adequate"on the deal. forma,draft legislation.
sooner or later the scope is going to official said. But the SEC,in its interpretative release, "It's.time to look at some of the abus-
widen to take a careful look at the bro- The SEC's interpretative release says calls for issuers to disclose"the market es.Why in the world should a public end-
ker-dealers[involved]and other is- that"issuers in the municipal market rou- risks to which[they]are exposed"and the ty,government-run,be able to circumvent
sues,"the SEC official added. tinely snake public statements and issue re- "strategies used to alter such risks"as well the SEC's rules;'Moorlach added.
Municipal issuers are required to ports that can affect the market for their as the market risks and credit risks that Moorlach ran against Citron in the most
disclose information that could affect securities"and that misstatements or omis- could arise from such strategies. recent election and had expressed concerns
the market's evaluation of their mu- sions of material information may violate Attached to the official statement for the that the fund would face potential losses
nicipal bond issues under the securi- the antifraud provisions. deal was the county's audited financial because of Citron's investment practices.
ties laws'antifraud provisions,he said. John Moorlach,an accountant that ran statement for the fiscal year ending June Moorlach said he is currently providing
The SEC reminded issuers of their against Citron and lost in the recent elec- 1993,but neither document appears to con- assistance to Rep.Chris Cox,R ' who
disclosure obligations under the secu- tion,said Citron kept pool investors in the tain any information about the pool's trou- Moorlach expects to most Uel ce
rities laws in an interpretative release dark. bles,even though the county reportedly legislation.
issued last March. The term I would use is obfuscation," was borrowing heavily in the taxable mar- Meanwhile,Federal Resery oard
"People have not really focused on said Moorlach, who is with Balser, ket at the lime to shore up its cash-flaw sit- chairman Alan Greenspan played down the
that interpretative release and they re- Horowitz,Frank&Wakeling."He used pa- uation because of the pool's problems. risk of any fallout from the events in Or-
ally should;'said Christopher Taylor, tronizing language,he used euphemisms, Both Dana Rohrabacber,a Republican ange County when he testified before the
executive director of the Municipal Se- he used his arrogance." congressman from Orange County,and congressional Joint Economic Commit-
curities Rulemaking Board. "If you pulled out of his fund you were Moorlach said the county's debacle could tee.
Meanwhile,one bond lawyer who berated publicly like the city of Tustin was," prompt calls for legislation. Rep.Ron Wyden,D-Ore.,asked
did not want to be identified,predicted the accountant said yesterday. '9vfy personal view is it appears that they Greenspan whether"there are other Or-
that the Orange County debacle"is Tustin,Calif.,had pulled out of the in- did not even give the most elementary dis- ange Counties out there that face
only the tip of the iceberg." vestment pool because of a provision in its closure that any mutual fund investor would very serious exposure"from deriva-
1 would not be surprised if there investment policy prohibiting it from in- expect-from a mutual fund;'an aide to tives losses.Greenspan replied that
are other governmental units across the vesting in reverse repurchase agreements. Robrabacher said.`"12tey never told their he didn't know,and if he did he
country who find their portfolios lever- In addition,the offering documents for investors what the net asset value was even would not comment.
aged in derivatives such that they recent county bond issues do not appear to in their annual report." But the Fed chairman then went
should have concerns about rising in- contain information about the pool's fi- "We'll have to see what people believe is on to say that the market for deriva-
terest rates,"be said. nancial troubles or an adequate description necessary on the federal level,"the tives has been absorbing losses all
In addition,some lawmakers are of the potential market risks of the fund's Rohrabacher aide said,adding that the year."I don't consider this to be an
saying the Orange County controversy i0estments,according to sources and a re- lawmaker doesn't plan to introduce legis- issue which gives me great concern;'
could prompt calls for legislation to view of the documents. lation but might support a measure in the he said.
require pooled funds to make more dis- The official statement for a$64 million future. Steven A.Davies contributed tc
closures,incTading're3ealirig daily tiet* tax-exempt note issue sold last August did Rohrabacher"believes in making sure this article.
O
Orange Countytreasurer allegedly
increased danger with loan Po' licy
By ROB WELLS concerned about the financial poli- securities portfolio as collateral tc
AP Business Writer tion when they cut from five months obtain loans that at one point ex-
Amid criticism that the Orange to two-and-a-bsX"said Jon Schotz, ceeded $14 billion. He used the
County investment fund had lost president of Saybrook Capital,a Los borrowings to buy risky investments
more than$1 billion,former treasurer Angeles investment banking firm. that would rise in value if interest
Robert L. Citron compounded the Schots said there was general talk rates fell.The strategy boomeranged.
danger by obtaining shorter-term earlier this summer in investment when interest rates began climbing.
loans, county treasury documents banking circles that the county's It's unclear from the county trea-
show. leaders had tightened teras, con- sury documents whether Citron was
These loans,which carried the risk cerned that Citron had borrowed pressured into shortening terms of
of increasingly higher interest pay- beyond the county's ability to pay. the loans or whether he did so
ments,also suggest that the affluent "People who dealt with the county willingly.
California county's investment bank- knew it was way down because they Citron may have sought to lower
ers had grown nervous about the were overleveraged,"Schotz said. his cost of borrowing by shortening
fund's financial condition. They Citron's aggressive borrowing the loan maturities. However, the
wanted to limit their exposure by played a central role in the rise and documents suggest he wound up
reducing the time for repayment, fall of the Orange County investment paying more anyway.
experts said. fund, leading to losses of about $2 The interest paid on these borrow-
Orange County's investment bank- billion. . Ings in March averaged 3.6 percent,
ers have declined to discuss their role The losses forced the nation's fifth- and Jumped nearly 2 percentage
in the fund's financial plight.But the largest county, home of Disneyland points to 5.4 percent at the end of
county documents,reviewed by The and Knott's Berry Fans, to seek November,the documents show.
Associated Press,provide more sub- bankruptcy protection earlier this Merrill lynch&Co.,which provid-
stantive detail than previously known month, the biggest municipal bank- ed about 15 percent of the loans,said
about what the bankers did as the ruptcy in history. Citron was forced it would be "inappropriate to com-
fund's losses grew. to resign. ment to conversations with a client.,,
The average maturity of county The debacle focused attention on The county's other mayor lenders,
borrowings,known as reverse repur- the money-management practices of including CS First Boston Inc., de-
chase agreements, was halved be- municipal treasurers around the clined comment, as did Citron's
tween March 31 and Nov. 30, fromcountry and whether they were using lawyer, David Wiechert. Orange
about five months to about two-and- taxpayer money to dabble in risky County spokeswoman Sandra Stern-
a-halt months,the documents show. investment strategies. berg said county officials wouldn't
"That definitely says DeoDle were ritrnn iispd 57.6 billion of the Hind's comment.
•
Orange County looking
at one possible solution
By E.SCOTT RECKARD from Orange County and the
AP Business Writer other agencies in the pools will
SANTA ANA - One proposed dissolve if payments continue to
answer to Orange County s crisis the bondholders.
is to repay other investors in its Orange County,with about$2.7
fund,have the county take all or billion in the investment fund,
most of the $2 billion loss and would lose about$730 million if
then sue the brokerages that the loss was spread proportion
placed its disastrous bets on ately among the 187 investors.
interest rates. The possibility of it assuming
The scenario has obvious ap- the entire$2.02 billion loss came
peal to the 188 school districts, u in separate interviews this
cities and local agencies in the week with Brea city officials and
Orange County Investment
Pools,since they could return to Orange County Supervisor Wil-
business more or less as usual County officials stressed that
The county would still face
major uncertainties but at least no decision was near on that or
other proposals.
the inevitable litigation would be
streamlined. Thomas Hayes, the former
It would require refinancing a state treasurer hired to help sort
huge debt, though - in effect out the county mess, said
spreading the county's big loss through county spokeswoman
over years,to be repaid through Sandra Sternberg that compari-
painhil budget cuts and legal sons to West Virginia oversimpli-
settlements and awards. fy the county's straits. West
That's a big 4 considering the Vuginia's losses were far smaller
wrath of voters and the fact that and did not lead to a bankruptcy
brokerages might have to be fig he noted
asked to underwrite new bond
offerings. Terry Andrus,the county's top
The West-Virginia Consolidat- in-house lawyer,would say only:
ed Investment Fund used a semi- "There are so many different
lar strategy after its 1987 loss of ideas.Nothing has been ruled in
more than$100 million on specu- or out."
lative investments like Orange
County's, according to Michael Steiner, a self-described lay-
G. Mayer, a financial consultant man in financial matters,said the
brought in as an analyst and need to restructure the county
witness by West Virginia. debt had been presented to him
Mayer said West Virginia has as like refinancing a house to pay
won more than half its losses for pressing needs such as college
back in settlements and judg- tuition.
ments,though the biggest award
- about $50 million counting To ensure the county can do
interest-is still under appeal by so, it's essential that payments
the Morgan Stanley investment are made on existing bonds to
bank. The final recovery figure prove its 'credit-worthiness, he
could go as high as 75 percent,he
said.
"In that situation the state In a letter to 18 investment
made all the individual entities banks, the county already has
whole and went after the broker- laid the groundwork to refinance
dealers on its own,"he said its debt,with or without assum-
The strategy greatly reduces ing all the investment losses.The
the numbers of parties involved letter from the county's financial
in lawsuits. For example, the adviser, Salomon Bros., invited
many class-action suits already bankers to submit restructuring
tiled on behalf of holders of bonds ply,
Northern California Counties Don't Escape Derivatives Losses
that unlike Orange County,which had ton peak and think they want to cut more collateral.u they couldn't float a
So far they've
Dearly all of Its portfolio In derivatives, HERB their loom,the same thing could happen bond Issue.or somehow find the cash,
they have substantially ices here,"says one Industry Insider with a they would be tweed a sell.avoided the fate
Fluthermore, the trasuren Inalat GREENBERG close working knowledge ofmunklpalfl- Interestingly,the Northern Califor.
of Orange County they won't lee a dime It they're not nance Rix counties that have bought derivatives
forced to sell their derivative securtiles Business Insider Of equal concern Is the possibility of purchased all or most of them from W
Mivativm dollops:A quick check of before they mature.Orange County faces margin ca W.Most derivatives ate bought chad Stamenson,the same San Francisco
er
Northers California counties shows premature liquldatloos of its porvollo with bans supplied by the Wall Stroet Merrill Lynch broker who sold them to
that at lead three—Solan.Sonoma and er a op Wates what amounts to a ate small Investment tunds)they could be firms setting the ncurltles. Orange County.
ttooterey—have exposure M the same Private mutual tuad,who"Iavedafa an forced b liquidate their portfolios for at Stamenson has dealed all requests for
kind of derivative securttie that doomed more than 100 other eels and muoldPv lead two other ream" can
a result,$10 million In securities interviews,but treasurers from the rnua•
Orange County's-Investment tun& in Wea.MW canteen Is that tboss Investors can be taught with a 1500.1100 Invest-
The first would be a replay of San Ment.But to get the loan,the municipal tin be did bushes Wlth may they were
each case,thoseportfolios are raw pow would sudde ly demand thdr money, Jose's 11-1.1 flow of the mid. never pressured to buy derivatie.
v
Ing big paper lore—losses that exceed aYbg the county to o l as seeurWm at wbm a
onfat tlir mud put up collateral,usually Tres-
never
Iavetmsotturned turned surle and other securities. 7Le were merely offered ass res a
the drubbing their general bond portio. the going—depressed—tnsrkst Pr1ce- into a political broubabs.City ad-la,r get superior Investment returns—way
Ilos have taken While mad at the countis hen don't traton reacted by forcing the sale at the As interest rates rise,and the value of
Trmwess from those counties note ran that problem talthough some open- 110011ey40"seatrldea"If admlalsim. the derivatives faW,they mud put up WSIDtg; PapeWoL S
INSIDER:
Herb. Greenberg
Prom Page Di Interest rates go," says Bill Par-
they dA for a while. sons. finance director for Santa
In Solaro County, they were Clan County.
7M percent tiltraturer v tiveMichael
Mann
venerating returns of 9
Pint County,Treasurer Michael Smith
A yearago;this quarter'reasurer says the first responsibility of his
Bobby Stow ays the yields will be department is preservation of cap-
closer to d percent in Monterey, Ital.followed by liquidity and then
the yields have fallen to around 5 yield. In Contra Costs County,
percent from 7 pa t But Mon- Treasurer Al Lomeli says he
terey Treasurer Lou Softon says he doesn't buy derivatives"beelike I
'Vrepared for evmtuabtW@ in the don't fully understand them."Yes
muketplace u best we COOK" terday he was summoned to ap-
� feeb his portfolio's poor• pear before the county's board of
mance 11 being bolstered by cur* supervisors,where the first quer
rent investalonto in high-yeelding tion was whether the county has
short-term 14easurlee as well u de• any derivatives e=pontre."It was a
rivatives that actually ria In value wonderful f"to ay, 'rm a
u interest rates ria.
pure vanilla
1 be mys.
If any of these counties do have Coming up Rating &Mcy
problems, they won't get much Standard 4 Pooes ist
sympathy from counties that taws a on hlgNt
to
didn't buy derivatives."It's Iml» In Perhaps a early a
dent to bet the farm on the way today.
•
s
Agencies and Districts May Be Hiding Derivatives Problems
Some treasurers requited by n,me oot be uad bums HERB matwhty t,o be ealeoded.',nee tbmp could go doro We dam,
be ra aurora W aeeray;be dW om dl, me Called eat"'loemum,"We loved
arepraying' civa lbs Wm Whee d lbs damimal TW toeol maneser plea I ar toe tbal ru Yraorb 1r, h Lb 0—gdoang aC.�.
Valor of one dWrYa'e dejlrWva porno for u moeW....a!.,Yue been tWu oo bur much We exaogr County
for a turnaround m.m4isWr wt at w moven.m GREENBERG wetcbd out W Il yar: fund baa u4u,uy IW.71e u adY fee
pl.,.-.d by me the.31 pvm1,lie b cast o!{I 5 Oi114+o Y owNy bawl oo We
aemmt auoara aya.tb older,vLL B1tS21tCSS Irl$I.IIG/ 7Le IorWmenl wo.rer a,Yr ILr tr, curnnl yuule fw hoe eswllw Y ob:bl
Orange C'uuuty ra: tuY udw,Y. card u uouod{ls ellWoq r Cor rorth W dietrYb rant tbrlr brut,rub dertrt It It tried w aeu W,rr encwura,rhrb
W iW,t 1r {IS bubo m coatro Nna W w aolaluo. urs"busbed up Tbey're praylog fw, are fairly luiyud,mma)pro my they
rer,W delrallvateLLed lore.Is rY Wal Wey rete aovernmeil ruanoteed. Weer-und.- r.old flub lar bar Waa Weir cwn,l
yW Im big w bde. -Rey ewe aW buylN yYdd,"be But"W Wat reWy ouaa Y Wal Wey'a marls valve.frri BrY Mrs muncetpW
Wd it CertYnlY YOY ewer.Ooe Elly tri�11ey e0'me Y4cto from dere as Ibtlr money�t ante dy. But W<BkrlWued of a turoarowW u tie are Wlrvd W be ioraud m W<
dreg Wveatmeoi manager.rho rpecWb b Tease-t war.sY II,a Ibe'YuYe Tl>e raW dlrhv,m uaalbq rete �•apecuuy Y mutat nW ao nY duumd Orange CoUely mratmeol
e w bond,.uYr he tetra o/at las tro fin'-Cad old Ween up,d aye.7 ��tab Inrsr floelere-u Canoe hither.-A Wt o/people are bopug b Ix luwl.t
u>vU CWto, r,W dWrlcY that b,vr,yOver°meat;u,raolad lrcururl lWledoldOyfaulo{rata.-
DM rW uapsrral yield then lL bah you eauraY.rhea Y�fW rhea Isurm yl,wl wee:Some tMuslrY ola.ervea
<Wu<b lova)b 1W Ielaid teem tet V a fl'eaaury rate percml• nW rYa Tbey`n tnuWY Cold rlth■ If Wry cash,the oolY ray wd-Iw rxy.ct w ea,udituyl fYou anard by
Orange Couay fund to boy derlrWva hilly abort auturlly,bard m e,M of We raW dWMU,,t kir-W--byre
uo uwu oro OLe loloe m et embefa A try,edlo{polos DeaWa yWd,ra ee u eptloa.Bel If IWWM rata rbe. olore(w their waw.OtlurrYe Wey GaUAMr. Paw f tCul l
the derivatives mess ouch the
same way they were naled In the
savings and loan induvy's Junk
bond fiasco.Yunicipalkes aren't
required to value their hvestment
portfolios using the hurt market
price, and CPA firms routinely
sign off on what might aro out to
be Inflated numbers.
M*eW vlslUPa
Yedla Visionn Technlogy and
the SEC apparently ba„struck■
deal.According to doctaenu fli-
ed to connection With left VI•
.ion's bankruptcy procedings.the
SEC won't pursue any charges
against the Fremont-band mutt
media company If It coninues to
cooperate with tnvestigaors.The
Implication,according It observ-
ers,is the government rants to
make sure it gets W of tie tater•
matlon it needs It lacy enfocement
offleWs decide to build a cane
against Itxmer company psecu•
tives. SEC otflrJaL deemed to
comment.
Meanwhile, Media lisions
sleek,which was as bights 46Vk
Isst February,continues b trade.
It closed yesterday at 5/32A com-
pany spokesman says It wWmatin.
ue to trade unW the conpany
emerges from bankruptcy.it that
point, the exWing stock vW be
worthless.
APPENDIX E
STRUCTURED NOTES
STRUCTURED NOTES**
STRUCTURED NOTES U.S.TREASURIES
IF U.S.TREASURY
PURCHASED ON DATE*
EARNEDINTEREST EARNEDINTEREST
FROM PURCHASE TO HAVE BEEN
DATE TO 12/31194 RECEIVED FROM
PAR INCLUDING TREASURY PURCHASE DATE
DESCRIPTION (MIL) ACCRUAL RATE TO 12131/94
1. BAYERICHE LANDESBANK NCD $25.00 $2,916,466.74 4.87% $2,779,958.33
9/16/92 TO 12/18/96
2. FEDERAL HOME LOAN BANK $24.75 $4,366,054.69 5.35% $2,949,856.25
10/8/92 TO 8/4/97
3. FEDERAL HOME LOAN BANK $10.00 $787,053.33 4.75% $630,694.44
9/2/93 TO 9/2/98
4. BAYERICHE LANDESBANK NCD $25.00 $841,145.83 5.06% $1,120,930.56
2/11/94 TO 2/11/99
5. FED. NATIONAL MORT.ASSN. 25.00 $894,894.50 5.34% $1,157,000.00
2/18/94 TO 2/18/99
$109.75 $9,805,615.09 $8,638,439.58
DIFFERENCE IN INTEREST INCOME $1,167,175.51
` U.S.TREASURY NOTES WITH THE SAME INVESTMENT PERIOD,I.E.,4.25 YEARS FOR#1
" STRUCTURED NOTES HAVE VARIABLE RATES.
News Concerning Worldwide Seeurthes Processing Services
g.
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of »`r���r�,'ra'.�", f; �j�, ��f,�e�^�,Y��� .!� i i i i- • i• • i i
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*�r'21 F
}} � ?
The Use of Derivatives
}rp s tLr � Equity Portfolio Management
gk
Page I !
x,5 u.f+t)G7y 1 � v1PS
tftis; % Further Developments
on the
European Pension Front
Page 3
iz� Country Focus:
N•tli• '�lw;ra ld
South Africa
v;V;
•lr'�ft ''J�7� g
e 5
'+sr.',' �'� • ! T Plus 3's
Impact on Corporations and
da,
r.� Y
their Shareholders
Page 6
Securities Issues The Batik of New.York
(DERIVATIVES, Futures offer a cost amount of correlation between
continued from page 1) advantage to the sale and most equity portfolios and equity
repurchase of stocks futures indices, such as the
The successful use of deriva- Standard and Poor's 500.
tives lies in allowing a derivative An alternative would be to sell By trading the S+P 500 futures, 40
security to further the goals estab- a desired amount of stock futures a portfolio manager has a tremen-
lished in managing the equity as a hedge. Selling a desired dous amount of liquidity available
portfolio. In other words,deriva- amount, in notional terms, of to hedge a portfolio. The daily
tives should not be used just futures is the equivalent of selling trading value in stock futures is as
because they are available. the same amount in actual stocks. great as the daily trading value on
Derivatives should be used only (Assuming there is no tracking the New York Stock Exchange.
when they can provide a higher error between the portfolio and the In addition,one can easily trade
return for a given risk level. Or, desired underlying index.) $25 -$50 million in futures much
conversely,to reduce the portfo- Overall, futures offer a cost faster and with less market impact
lio's risk level while maintaining advantage to the sale and repur- than one could trade an equivalent
the same level of expected return. chase of stocks. If the investment amount of individual stocks.
goal is to reduce equity market The speed and liquidity that
Developing strategies,to exposure,the use of futures is Sim- futures offer make them ideal for
achieve your goals ply the optimal method given the hedging a portfolio of stocks or, as
lower costs. discussed later,a means of gaining
Generally,derivative strategies I equity exposure until individual
'X41'1�1f,:!Sr 'Trl- r_,k;VMJ- stocks are actually bought.
can be broken down into three
n
Lt� b
types: hedging,generation of "K-'.
.g.qW01.7yanvekshould
incremental return and facilitation ,W2 Options offer another
of trade/portfolio management.
k,-Wsea46n1,Y;-50h hedging alternative
N4 M
Each strategy has its own clear
provg6gt� I
Options offer another vehicle to
benefits and potential costs. The (eve
effective use of derivatives hedge an expected market decline.
UC
vers Through the purchase of put
requires an understanding of the
Wre )Vg
V,ry -up
WYYKS-keve
potential risk/reward tradeoff 1,h options, either on the market as a
whole or on specific stocks in a
made with each strategy. If the ink, -hill may? tMng,1hV--. F.
portfolio, any resulting decline can
risk/reward tradeoff is not attrac- V 1 F,
rgsame leve- expected r-, be avoided.
tive,derivatives should not be
The difference between options
used.
and futures as hedging vehicles lies
Hedging in the way each instrument reacts
to changes in the underlying index
or stock.
One strategy is the ability to
Neither the use of futures nor Options, unlike futures,require
use stock futures as a means to
the raising of cash can guarantee an up-front cost. With a put
hedge an equity portfolio. Trading improved performance to the port- option, a premium is paid for the
in stock futures is cheaper than folio(the expected decline might right, but not the obligation,to sell
trading in actual stocks. Analyz- never materialize), but the use of the underlying asset up to some
ing costs requires the comparison futures can be a less costly way to point in the future at a predeter-
of trading commissions,bid-ask implement the desired strategy. mined price.
spreads and liquidity costs. Buying put options is like buy-
In the case of a portfolio man- Plus speed and liquidity ing an insurance policy. If the
ager expecting a decline in the directional move is up and not
market,one method to reduce risk A second advantage to the use down, a put option expires worth-
is to decrease holdings of stocks of futures is speed and liquidity. less and all the upside is retained,
and increase the cash in a portfo- Equity futures allow a portfolio
less the put cost. With futures, if
lio. If the expected decline in the manager to trade"the market" the move is up and not down, the
market occurs, a portfolio not fully faster than trading individual secu- hedge will result in a significant
invested will decline less than a rities. While there is a certain portion of the up move being
fully invested portfolio. When the amount of risk when a portfolio missed.
manager feels the decline is over, does not track the futures index (DERIVATIVES,
the equities are repurchased. directly,there is still a significant continued on page 4
Page 2 Third Quarter 1994
Securities Issues The Batik of New York
(DERIVATIVES, owning an interest paying debt and then swap both positions to a
continued from page 2) instrument. A convertible bond is broker for cash.
nothing more than a debt instru-
r The futures alternative is the ment and a long call option on the Using futures to create liquidity
best choice if the decline is small. issuer's common stock.
On the other hand, if the decline is If the common stock depreci- Certain trading strategies, more
large, the put hedge is best. If ates, the imbedded call option in technical in nature than the scope
there is no market decline, the put effect becomes worthless and the of this article, use futures as a
hedge still allows most of the convertible owner is typically left means of creating the liquidity
upside to be retained. Conversely, with a subordinated debt instru- necessary to invest or to liquidate
the futures hedge results in half of ment of the issuer. a portfolio. It is possible to buy
the upside being missed. stock futures and at a later date
Trade facilitation and portfolio swap the futures position for a
Using derivatives to generate management strategies desired equity portfolio.
incremental returns These techniques, known as
Derivatives are also useful in basis trades and exchange for
Derivatives are sometimes used trading and facilitation of portfolio physical trades,allow the liquidity
to generate incremental return for management strategies. Equity of the futures market to assist in
a portfolio—often accomplished and fixed-income futures are an trading portfolios, thus reducing
through the sale of call options. ideal vehicle to use in adjusting the overall transaction costs. The
This occurs when the seller of a the asset allocation mix of a bal- key to both these strategies is the
call option gives the buyer the anced portfolio. ability to reduce trading costs and
right, but not the obligation, to If the desired goal is to thus improve investment returns.
purchase the stock at a specified increase equity exposure and
price(the strike price) up to some decrease fixed-income exposure, Gain instant access to
point in the future(the expiration equity futures are purchased in the international markets
date). amount of the desired exposure
In exchange for giving up some increase,and bond futures are sold Finally,derivatives offer instant
upside in a stock, the call seller in the amount of the desired access to international markets. A
retains the premium and all divi- decrease. plan seeking international expo-
dends. This strategy, when done Trading futures makes rebal- sure can go out and hire an inter-
with individual equity options or ancing the portfolio less expensive national investment manager. An
with index options,can add from and allows completion of asset alternative is to buy futures or
one percent to three percent annu- allocation shifts to occur in less enter into swap transactions.
ally in incremental return to an time. Global custody costs can be
equity portfolio over a full market In addition, futures can be used reduced through an investment
cycle. as a substitute for actual invest- created out of derivative securities.
When incorporated into a ments in the desired market. Cash A swap, for example,can provide
plan's asset allocation, this strate- equitization is a technique in the rate of return of a desired
gy can result in higher returns for which cash held in an account benchmark index, such as the
a given level of risk when com- converts to equity or fixed-income Morgan Stanley EAFE, without
pared to traditional stock/bond exposure through the purchase of purchasing the underlying shares.
mixes. futures.
Using this structure,transac-
tion costs are minimized.There
Using derivatives to generate This may be appropriate when are no dividend collection charges,
incremental return can also be a portfolio manager is holding too dividend withholding taxes,
achieved by utilizing structured much cash in a portfolio but can- and no diviv global custody costs. With
instruments, such as convertible not find the specific securities to a swap,the cash for the investment
bonds and convertible preferreds. buy. The strategy is often used to is held in money market investment
instru ,
These issues allow the adjustment manage cash flows arising out of is held
a floating rate.
of the risk/retum tradeoff for par- contributions and withdrawals to a ments
ticular securities. plan.
For example, convertible bonds The opposite is also possible. (DERIVATIVES,
allow capturing some of a com- A portfolio manager can sell stock continued on page 7)
mon stock's appreciation while futures,fully hedging a portfolio,
Page 4 Third Quarter 1994
The Bank of New York Securities Issues
(DERIVATIVES, did not allow significant additional transferring shares, as well as the
continued from page 4) purchases. - fees for requesting a physical stock
This may change in the near certificate.
These money market instru- future with the lifting of exchange
ments are U.S. dollar-denominated controls. When that happens, the The Investor Registration
if no currency exposure is taken,or non-mining stocks, which have so Option (IRO)
foreign-denominated if currency far been only minimally represent- .
exposure is desired. The floating ed in investors' portfolios, will The Investor Registration
rate is then exchanged for the become more widely held. Some Option (IRO)will accommodate
EAFE return. This structure can $5 billion of ADRs in South book-entry transactions on the
replicate a portfolio created to African mining shares are now in books of the company's transfer
track the EAFE index, but at a circulation with American and agent. Developed under the aus-
lower cost. international investors, so it is like- pices of The Securities Transfer
ly that ADR programs for the com- Association,The Corporate
Better tradeoff between panies in other sectors will begin to Transfer Agents Association and
risk and return expand as foreign investors accu- The Securities Industry Committee
mulate shares in these sectors also. of the American Society of
Derivative instruments offer a Finally,despite the historic Corporate Secretaries, IRO pro-
portfolio manager great flexibility socialist roots and philosophy of motes direct share ownership and
in managing assets. Whether in the the controlling ANC party,there is easy-to-use,direct and cost-effec-
form of listed options and futures, likely to be a major privatization tive investor services provided by a
over-the-counter transactions, such drive in South Africa to raise capi- corporation or its transfer agent. In
as forwards and swaps, or through tal for development, which should addition to book-entry registration,
company issued instruments, such promote further operating efficien- the IRO concept encompasses the
as convertibles—derivatives can cies in state-run companies. As a offering of enhanced service pro-
help alter the tradeoff between risk result, state companies;such as grams to the general investing pub-
and return. Eskom,power generation and dis- lic. Broadly,direct and enhanced
The key to effective use of any tribution;Telkom, telecommuni- service programs under the IRO
derivative instrument or strategy is cations,and Transnet, public trans- umbrella will include all dividend
to further the investment goals of portation, are all potential candi- reinvestment plans,enhanced divi-
the investment plan. Trouble, such dates for investment in the next few dend reinvestment plans, shareown-
as increased risk and large losses, years. O
g er investor plans,employee plans,
stock option plans,etc.
develops when the investment Basically,under IRO, stock
goals are disregarded. O (T+3, will be held in the name of the
Editor's Note: This article is the continued from page 6) investor,but on the books of the
first in a series. It gives a broad corporation's transfer agent.
fi g The facts about Because the shares will be held by
overview on the use of derivatives shareowner savings the transfer agent, a physical secu-
in equity portfolio management rity can be issued at any time by the
from a plan sponsor or portfolio Brokers so far have focused investor's request. Individual
manager's perspective. Future their marketing efforts on convinc- shareowners will receive transac-
articles will discuss more specific ing investors to register their hold- tion advices (similar to those
topics and strategies. ings in street name. Under this received by mutual fund partici-
system,new investors will not be pants) and shareowners may
offered the option of receiving a request physical certificates at any
(SOUTH AFRICA, physical stock certificate. time.
continued from page 5) Certificates will only be issued Brokers clearly recognize that
upon request on an exception basis IRO presents a viable alternative to
But,the influx of foreign and a charge will be incurred. street name registration. IRO will
investment that was expected has Much less publicized is the give investors a choice between cer-
only so far partially materialized. fact that, many brokerage firms -tificates and book-entry accounts on
Throughout 1993,funds flowed plan to implement additional the issuers' records. Enhancements
into the JSE,pushing it to record charges which will be passed on to would also allow individual
highs in the anticipation of a favor- the investor, including: custody investors to move their shares to
able election result in 1994. Post- fees for inactive accounts to cover issuer-sponsored programs automat-
election,there has been a gradual the costs of recordkeeping, mailing ically to any broker they choose.
selling off as investors took profits of statements,etc.; exit fees for Most important,IRO will give indi-
and the overall liquidity situation closing an account; and fees for vidual investors a choice. O
Third Quarter 1994 Page 7