Orange County taps L.A. law firm for bankruptcy guidance.

Stutman, Treister lawyers to aid in record proceeding

Beleaguered Orange County officials battling financial turmoil have tapped the legal and financial firefighting services of Stutman, Treister & Glatt, the Los Angeles law firm nationally recognized for its bankruptcy practice.

Leading the effort to assist Orange County in its Chapter 9 bankruptcy filing is Bruce Bennett, from the law firm's Mid-Wilshire office. Joining him are Alan Pedlar, Kenneth Klee and Jim Johnson. Other Stutman, Treister lawyers are being consulted frequently, according to Bennet.

Asked about his strategy for resolving one of the most complicated and largest bankruptcies ever, Bennett replied last week, "We are a firm with 30 lawyers. We will keep a small team on this. We will use other lawyers from the firm on a discreet basis, in small slices."

Last week, Orange County defaulted on a $1.2 billion loan and sought Chapter 9 bankruptcy protection. That series of events is said to be the biggest municipal financial collapse in history.

Stutman, Treister has handled many other major bankruptcies, including the Carter Hawley Hale Inc., Wickes Cos. and the recent filing of former Los Angeles Kings majority owner Bruce McNall.

The big question in many people's minds is still, "What went wrong? How could a major county, with a fund of surplus cash invested in U.S. government securities, suddenly be forced to its knees and declare bankruptcy?"

Even veterans of the securities industry expressed puzzlement at the turn of events, which include Orange County's $7.5 billion fund borrowing enough to own $20 billion in U.S. government securities.

"Well, they seemed to have violated one of the natural laws of investing, which is do not borrow short to buy long (because if the value of long-term securities falls, such bonds may have to be sold at a loss to pay off short-term borrowings come due). And how they stretched out $7.5 billion (in assets) to buy $20 billion (in bonds) -- that's a lot of leverage for public money," observed Joseph Di Lillo, chairman of Drake Capital Securities in Santa Monica. "But I still don't understand the whole thing."

Fund for funds

In a nutshell, Orange County ran an investment fund for its surplus cash, into which 180 other cities and public entities also entrusted their money. Most securities purchased were U.S. government bonds.

Advised by Merill Lynch & Co. broker Michael Stamenson, Orange County heavily leveraged its $7.5 billion in assets, both by borrowing and by use of an exotic investment device known as a derivative.

In simple terms, for every $100 in the Orange County fund, another $200 was borrowed. The hope was that the interest earned on the $200 would exceed the interest paid out to borrow it.

Large counties, including Los Angeles, have done variations of this before. Los Angeles County, with its good credit rating, has borrowed and then re-invested the money at a higher rate -- in effect, making money on the spread. Orange County did the same thing, but leveraged also.

But when Alan Greenspan and the Federal Reserve Board pushed up interest rates this year, the Orange County fund got hit with "calls." In essence, the county was supposed to cough up more money to make up for the depressed value of the $20 billion in bonds it owned.

Soon the Orange County fund ran out of money to meet calls. And some cities wanted their money out of the fund -- much like depositors making a run on a bank.

Seeking financial advisers

The Stutman, Treister lawyers last week announced they are launching a national search to find financial advisers to help devise a financial plan to take care of the 180 cities and entities in the fund, and to wrangle with Wall Street brokerage houses, which are owed huge sums of money by Orange County.

Too, there is the issue of Merrill Lynch, which advised Orange County on its ill-fated course. By one account, Merrill Lynch earned $80 million from Orange County in just two years.

Last week, the Stutman, Treister lawyers declined to discuss Merrill Lynch, but did say the subject of the brokerage's fees would be looked at along with all other issues.

Meanwhile, Los Angeles' distressed-securities investors already have their ears and noses pointed south. The Southland is something of a capital for investors seeking to buy out-of-favor stocks and bonds, defaulted securities and run-down IOUs.

"Well, of course, we buy distressed securities from motivated sellers. It will be a couple of weeks before we can fully assess the situation in Orange County, but I believe we are going to sink our teeth into it," said Neil Dabney, co-founder of the Dabney/Resnick securities firm in Beverly Hills.

Dabney's traders may, in several weeks, be looking to buy general obligation bonds issued by Orange County -- but which have been re-rated by ratings agencies as very risky.

"There are institutions and other blue-chip type investors who cannot have that (bonds rated as risky) in their portfolios," said Dabney.

Too, at Di Lillo's Drake Capital, traders are gearing up to take a plunge.

"I have occasionally purchased a distressed municipal," said Ron Vannuki. "It takes a lot of research -- and one problem is that, unlike corporate debt instruments, one doesn't always know who to turn to, to get information. But it looks like an opportunity."