One Recovery Hurdle Overcome, Many to Go : Crisis: Orange County won sufficient support for its pool settlement plan, but obstacles ahead loom even larger.

SANTA ANA — Orange County has cleared a major hurdle by winning the required support for a plan to disburse the $5.7 billion left in its sunken investment pool, but its race to escape financial disaster has miles to go.

And the hurdles ahead are taller, and stacked closer together, than the ones successfully left behind.

“This is just one battle in one very long war,” sighed Paul Sachs, head of the Arthur Andersen accounting team that has crunched the county’s numbers nearly nonstop since December. “The hurdles that have been accomplished are just phenomenal in themselves. But when you look at the gravity of the entire situation, they’re minute.”

In the 4 1/2 months since a stunning $1.7-billion plunge in its investment pool’s portfolio sent the county on an unprecedented journey to bankruptcy court, a cadre of consultants and county officials has carefully liquidated the massive pool, slashed the county budget nearly in half and, last week, shored up support for a complex pay-back plan to some 200 schools, cities and special districts that had entrusted their money to the county.

But the settlement agreement, in essence, merely divides up the cash at hand. Still ahead lie some of the trickiest elements of the recovery, in which the county must find new sources of money to repay a mountain of debts.

By June 5, the county must find a way to convert the recovery warrants it has promised pool investors into $236 million in cash. Between June 30 and Aug. 10, $1.28 billion more in bond debt comes due--and how the county handles this debt will be critical to its future on Wall Street. A dozen legislative proposals are pending in Sacramento, their fates unclear.

Looming over all these issues is a special election on June 27, in which some of the nation’s most conservative voters will be asked to increase their own sales tax.

And somewhere close to the finish line is the county’s massive lawsuit against brokerage giant Merrill Lynch--a lawsuit that has barely gotten off the ground as the two sides bicker over the mutual discovery of documents.

“Each (event) by itself is not the solution,” acknowledged Supervisor Marian Bergeson. “But collectively, as we see all of this unraveling, we’re on a road toward identifying the solutions we have to provide to get the whole package together.”

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Chief Executive Officer William J. Popejoy said he is “pleased, but not complacent” with the county’s progress during his first 50 days in office.

“This is a first-semester grade. It may even be the first quarter,” he said over lunch in his office last week. “There are many pieces that are still unresolved. You try and march ahead and take them as you can, logically. We’ve made what I think is unbelievable progress.”

But the litany of problems looms large, and the clock is running.

“The team is getting tired--we all need a vacation,” confided one top county official. “Seven-day weeks, 12-hour days, start to get to people after awhile.”

Even problems with the pool settlement persist, and are not yet safely behind the county.

The 60 pages of legalese and technical finance formulas were hammered out during six weeks of private negotiations between the county and pool participants, with business leaders lending a hand. Nearly 200 investing entities controlling more than $4.4 billion in pool assets have signed up for the settlement, sending it to U. S. Bankruptcy Court Judge John E. Ryan for a daylong hearing May 2.

“It’s unbelievable,” said county attorney James Mercer, echoing many who praised the speed of the pool resolution. “It’s like the eighth wonder of the modern world. It’s stunning.”

If Ryan gives the nod, there will yet be an 11-day grace period in which dissenters can file an appeal. Then the county has five extra days before releasing cash--an average of 77% of what each participant had in the pool Dec. 6.

No mechanism is now in place for distributing that cash, and that’s “a very significant job to get it done,” said Bruce Bennett, the county’s lead bankruptcy attorney. “It’s very detail-oriented, and it’s a lot of work.”

More daunting still is finding the cash to back the recovery warrants, the linchpin of the whole settlement plan.

County officials have vowed to make the warrants--which schools get for 13% of their investments and others get for 3%--”as good as gold” by June 5. If they fail, individual investors regain their rights to sue the county for their money, rather than settle for county IOUs for the difference between 77% and 100%.

Bennett and Chris Varelas of Salomon Bros., the county’s financial adviser, said there are about five different plans for ensuring that the $236 million in warrants are convertible into cash--but none are yet in place.

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In plans presented to the Board of Supervisors and to Superior Court, the county intends to sell slightly more than $250 million in “recovery bonds.”

Beyond that, the county might buy bond insurance, which ups the price for issuing the new bonds; get a bank to guarantee the interest payments with a letter of credit; sell the entire issue to a single institutional investor at a discount; have the state guarantee the bonds, or unlock money now in restricted county funds to redeem the warrants.

The first three options probably involve added expense for the county. The latter two require legislative or administrative action from the state, which thus far has been loath to provide a bailout.

“It’s going to work,” Bennett insisted. “We don’t know how yet. We still haven’t narrowed the options. But we’re working hard.”

From the beginning, there have been two separate bankruptcies: one for the investment pool managed by former Treasurer-Tax Collector Robert L. Citron, and one for the county itself.

The pool agreement would, effectively, end its bankruptcy. But that just sends the pending problems over to the other bankruptcy case, where bondholders owed $1.275 billion this summer, vendors holding $100 million in unpaid bills and other creditors await.

“You’re now down to the hard problem: You have far more creditors than you have cash and the ability to pay,” observed James E. Spiotto, a Chicago lawyer who specializes in municipal bankruptcies. “The pool settlement, while an important step, was an allocation of the funds (already) there, and a promise to pay more when it’s received. When you go back to the county, there is a hole and it has to be filled.”

The county’s legal and financial team has assembled a slew of options for raising revenue. None, however, can be put into place quickly enough to pay off this summer’s looming debts.

“The hole is so big, I don’t see how they can fill that hole just through budget cutbacks and tax increases. The only way they can fill it is over time,” said Daniel J. Bussel, a bankruptcy expert who teaches at UCLA law school. “It’s a huge amount of money. You can’t fund it by changing operations for a year, you need to fund it by borrowing the money and paying it back over time.”

But Wall Street experts have repeatedly stressed that the county cannot return to the market to borrow unless it makes good on its current debt. That brings up another set of secret negotiations, between the county and its bondholders.

Last month, Popejoy, Bennett and Varelas unveiled a proposal that no one would buy: Roll over the $1.275 billion in bonds coming due this summer for another year at last year’s interest rate. Bondholders countered by asking for an increase of 2.5% in the interest rate for the second year.

The county has not responded, at least in public, but last week added a new twist to the mix, suggesting that it might ask a court to invalidate $600 million of the bonds as illegally incurred debt. Such a move could keep the issue ensnarled in lawsuits for years to come--effectively giving the county a lengthy extension on that debt, even if it ultimately lost the case in court.

Negotiations with bondholders may be tougher than those concerning the pool, because most pool participants are local government agencies whose own futures depend, in part, on Orange County’s solvency and stability. The bonds belong to individuals and institutions less likely to care about the county’s long-term financial health.

But if the choice is between default and rollover--never getting paid, or getting paid next year--people on both sides expressed confidence that bondholders will be willing to wait. Ultimately, the issue will fall on how much interest gets paid, not whether the financing is extended.

“I can’t imagine Orange County letting this ($600-million) issue go into default because they couldn’t come to a meeting of the minds on 1% or 2% of interest. That would be the height of lunacy,” said Richard Lehmann, president of the Florida-based Bond Investors Assn. “Can you imagine if, in the end, somebody says, ‘Well, we defaulted because we were 25 basis points (.25%) apart?’ I’m optimistic that this (rollover) will come.”

Still, Lehmann and others said the key to resolution of the current debt obligations, or of any new financings, is establishing a new revenue stream.

Popejoy and others have proposed selling John Wayne Airport, turning the county’s garbage dumps into money-makers, and grabbing motor vehicle license fees out of the current budget. But each of these faces major legal hurdles.

The quickest way to raise the most cash, financial experts and county officials contend, is with the half-cent sales tax on the June ballot as Measure R.

Bondholders probably will not roll over this summer unless the sales tax passes. If the tax fails, it could throw the newly crafted budget out of balance. Without it, all the county’s plans fall through.

A Times poll published Tuesday, however, shows 57% of the voters opposing the tax.

“It’s an uphill battle,” conceded Popejoy, the chief proponent of the controversial measure. “We have a long job to do to help inform the people of this county. That’s a process that is just beginning--though we don’t have a lot of time.”

The most unpredictable revenue stream, in terms of timing and size, has been lurking quietly in the background for months, as headlines focused on budget axes, bond debt and pool negotiations.

But virtually every other project in the vast recovery effort depends, in part, on reaping cash from Merrill Lynch and other firms the county is blaming in lawsuits for its losses.

Mercer, who is handling litigation for the county, said there have been no settlement talks with Merrill, the nation’s largest brokerage and the top financier for Citron’s investments. So far, he said, Merrill has given the county only seven boxes of documents; the county was preparing last week to turn over 200 boxes of paperwork.

The court file in the $2.4-billion suit remains thin. When asked about progress on litigation, Popejoy pointed only to recent news accounts about Merrill’s role in the county’s finances.

“The main focus has been to get the pool plan approved, to get the tax thing in effect, to negotiate on the rollover,” said Mercer. “Come May, June, all of a sudden the litigation is going to become front and center. Then we’re going to go into high gear.”

From the beginning, the county has targeted Merrill and other Wall Street firms because they are the only players with pockets deep enough to deal with the $2-billion hole left in the county’s wallet. The lawsuit, however, involves an untested legal strategy that contends Merrill orchestrated the county’s investments, which violated various state laws.

“If they win the lottery, I guess, in the lawsuits, that would go a long way,” Bussel said. “But litigation is a slow and painful process. Banking on litigation to get you out of the crisis doesn’t seem to be a very sound plan.”

One more in a long line of hurdles.

* BRING ON THE LAWYERS

For 17 agencies, settlement portends years of litigation. B1