LOS ANGELES — As Orange County, Calif. makes the final payments on the debt from its 1994 bankruptcy, a key player warns that other cities and counties in the state are struggling.

“There is something brewing in the state,” said state Sen. John Moorlach, R-Costa Mesa. “If we didn’t have Silicon Valley, we would be toast. We have job growth, but not in high-paying jobs. And we have cities scrambling right now trying to figure out how they are going to pay next year’s pension contribution.”

Pensions are a weakness for the state’s cities and counties.

Orange County had $3.8 billion in unfunded actuarial accrued liability and its pensions were 73% funded as of Dec. 31. It hopes to hit 80% funded by Dec. 31 at the current assumed rate of return of 7.25%.

But Moorlach said public safety benefits eat up a significant portion of the county's revenues. And Orange County looks good compared to some other counties and cities.

The Orange County bankruptcy -- though many have looked to it for wisdom on how to weather a bankruptcy -- was an anomaly. The affluent area was impacted by risky investment decisions, in contrast with California's three high-profile Chapter 9 cases in the last decade, involving cities that had cash flow problems or were weighed down by employee pensions and salaries.

The county entered Chapter 9 bankruptcy December 1994 after its investment pool reported losses of $1.64 billion from highly leveraged positions that unraveled when interest rates rose.

Robert Citron, Orange County's treasurer, resigned in disgrace and faced criminal prosecution.

The county is about to make its final bond payment stemming from the bankruptcy. The county made its final base rental payment of $488,398 on lease revenue refunding bonds Series 2005 issued for the county’s bankruptcy on June 15. It will make its final payment to bondholders of $5.7 million on July 1. The original debt related to the bankruptcy totaled $1.58 billion in principal and interest.

A settlement agreement with the 240 other municipalities impacted should be paid off by next year, at which point it will ask the judge to approve repayment of its plan of adjustment, so it can finally close the door on its bankruptcy.

Moorlach attributes the state’s and some cities' high bond ratings, somewhat jokingly, to the weather.

The state government is rated at the AA-minus level across the board.

The state is very reliant on income taxes – and particularly those paid by the top 1% of earners, who pay 48% of all income tax in the state, S&P Global Ratings analyst Gabriel Petek told The Bond Buyer.

As S&P report on the state government in March was largely upbeat though it did end with a cautionary note about the deficits the state’s Department of Finance projects in its multi-year forecast. The state forecasts a balanced budget through fiscal 2019 and then operating deficits of $1.4 billion in 2020 and $1.5 billion in 2021.

Moorlach was right once – and it led the certified public accountant into a full-time career as an elected official. He had only planned to serve out Citron's term. But he ultimately won election to the treasurer-tax collector's office three times, moving on to then serve as a county supervisor until he termed out. He ran for the Senate two years ago.

The Orange County bankruptcy itself was an anomaly and served mainly as a warning to cities not to place cash reserves in risky investments. Few listened in early 1994 when Moorlach was running for Orange County’s tax collector-treasurer and saying the county was at danger of losing billions from its investment.

He warned that falling interest rates would result in massive losses in the derivatives incumbent Citron had in the county’s investment fund.

“I lost, because you could still see interest rates rising,” Moorlach said. “I was called Chicken Little. By September 1994, the top headline in the Orange County Register said: “The Sky Did Not Fall.”

Three months later the county would enter Chapter 9 bankruptcy – and Moorlach’s warnings would look prophetic. When his predictions came true, and the investments made by Citron tanked, county residents vied to have Moorlach step in and get the county out of the mess.

First Tom Daxon was retained to act as interim for four months. When he left to become Oklahoma's finance director, the Los Angeles Times ran a poll on who should replace him. The clear candidate: Moorlach.

The experience made Moorlach the go-to guy as other municipalities entered bankruptcy. He now wears what were once referred to as “Chicken Little” warnings as a badge of honor. His license plate reads: “Sky Fell.”

In 1994 the Orange County case was the largest municipal bankruptcy in U.S. history. It has since been surpassed by Detroit and Jefferson County, making it the third largest, Moorlach said.

"I thought $1.7 billion was an eternal number," he said. "It took 17 years for Jefferson County to surpass that amount."

The fallout not only impacted the county, but approximately 240 other local agencies, including school districts, cities and special districts with money in the investment fund. The county has restored funds to those municipalities as part of the bankruptcy settlement totaling $271.1 million. The county expects to the make the final payment to those so-called plan B-13 payments of $19.7 million in fiscal 2018-19.

“I think it’s very instructive for how people deal with fiscal constraints that exist because of the state and local government system that exists,” said Mark Baldassare, with the Public Policy Institute of California, who has written a book about the bankruptcy. “In Orange County’s case – and it’s true for so many municipalities — the residents want a lot more services than they are willing to support with raising taxes.”

In the interest of trying to meet the wants, rather than the needs of the residents, local governments looked for ways they could get some free money into their budgets, Baldassare said.

“That led to taking risks with the Orange County Investment Pool that they might not otherwise have,” he said.

Citron’s investments were earning 8% interest. The current investments in money market funds are earning less than 1%, but that earnings rate comes with the certainty the money will be there when needed, Moorlach said.

“It is a good reminder for local government officials not to take unnecessary risks with taxpayers’ money,” Baldassare said. “And to not get into financial vehicles they don’t understand.”

The bright side in the bankruptcy is that it demonstrated that local governments and business leaders who understand the financial system and legal system can come together and provide a united front in a financial crisis, Baldassare said.

“That they can find a way out of difficult situations in a relatively short period of time,” he said.

The difference in loss between Orange County and more recent bankruptcies is that the investment fund, often compared to money sitting in a checking account, gave the county the breathing room to figure out a solution, Baldassare said. The county was affluent compared to Detroit and Stockton.

“It was short-term money that was needed, but not immediately to pay the bills,” he said.

But the broader effect of being bankrupt, he said, is that it limits access to markets. It took Orange County 18 months to get out of bankruptcy and have access to the markets again. When it did it was to issue debt to pay off its bankruptcy.

The only other long-term debt the county has issued since its bankruptcy was $32 million issued for its electricity system that will be retired in 2018 and $68 million for a central utility upgrade issued in May 2016. The proceeds were to upgrade the heating and cooling infrastructure that supports the civic center campus, the Orange County Jail and federal and state buildings.

The double-A-rated county threw off the reputational taint of the bankruptcy long ago.

California state Sen. John Moorlach, R-Cosa Mesa, in a hallway at the State Capitol in Sacramento.
“There is something brewing in the state,” said state Sen. John Moorlach, R-Costa Mesa, who rose to prominence by predicting Orange County's 1994 bankruptcy.

Investors don’t even bring up the bankruptcy when the county issues bonds, and it does not have an impact on bond pricing. The county’s bonds are oversubscribed when they sell, but the county has issued virtually no long-term debt other than that related to the bankruptcy in 22 years.

“Any time you pay off long-term debt and make that last payment, there is a sense of accomplishment and relief,” said Orange County Executive Frank Kim. “And, it hasn’t been easy. In order to make those debt payments, the county has had to curtail spending in other areas.”

Kim gave credit to current and past supervisors – naming Moorlach specifically.

“We had board members focused diligently on our fiscal condition,” Kim said. “We had a number of initiatives that generated capacity, so we could make the debt payments.”

That included funding from the Orange County park system and former redevelopment agencies. The county took on imported waste from Los Angeles County because it had so much capacity in its landfill system, he said.

“All those various enterprise streams contributed to accomplishing this,” he said.

The money spent could have gone to items such as improving its park infrastructure.

“In Orange County, we are blessed with a large amount of wilderness parks and trails,” Kim said. “Our ability to finance the infrastructure that allows safe access into those areas was limited, because we were making bankruptcy payments.”

After it makes its final payments to the B-13 participants, it will petition the bankruptcy court to sign off on the completion of its plan of adjustment. When that day comes, there won’t be a parade, or any visible celebration.

"It is not something to celebrate," Kim said. "It was just the right thing to do."

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