ORANGE COUNTY IN BANKRUPTCY : Creditors Put Crimp in Recovery Note Plan : Bankruptcy: Challenge of county’s tentative deal to raise $275 million to repay schools scares bond insurer.

A plan to raise $275 million to help repay cash-strapped Orange County school districts now faces an unexpected glitch because several of the county’s creditors on Friday challenged a recovery bonds sale that would raise partial repayments for the schools.

Last Monday, MBIA Insurance Inc., the nation’s largest municipal bond insurer, agreed to back $275 million in recovery bonds needed to repay school districts, cities and special districts that had money in the county’s collapsed investment pool.

But the deal stalled on Friday when several of the county’s creditors challenged it, claiming “the recovery notes should not be superior to their own claims,” County Chief Executive Officer William J. Popejoy said Saturday.

“MBIA has said that until these challenges are resolved . . . they would have difficulty moving forward,” Popejoy said.

Popejoy said there are ways the county could attempt to overcome this “temporary setback,” including taking the issue to court, getting legal opinions that would appease whatever hesitation MBIA might have, or going ahead and issuing the recovery bonds without the insurance company’s backing.

However, the last option would not bode well for investors because without MBIA’s backing, bankrupt Orange County would have ratings below investment grade. With MBIA’s insurance, the bonds would carry triple-A ratings, the highest available.

The county is looking to see whether there are other ways to raise the $275 million to repay pool investors by June 15, Popejoy said.

The recovery bonds are the linchpin of a complex reimbursement plan approved by the county, pool investors and U.S. Bankruptcy Judge John E. Ryan.

Under the agreement, school districts would receive recovery bonds worth about 13% of what they had in the pool when $1.7 billion in losses from risky investments sent the county into bankruptcy on Dec. 6.

Cities and other agencies would get about 3% of their investment back in recovery bonds.

Without the bond proceeds, several school districts might be pushed into bankruptcy by the end of June.

Under the terms of a deal negotiated over the past two months, the county would pay 1.7% of the total principal and interest on the bonds to MBIA. The premium is as much as four times typical rates, but still far less than the penalty the county would suffer on the market trying to sell bonds without insurance.

The insurance was estimated to cost about $10 million but could save the county more than $100 million over the next 30 years.

“We view this [the creditors’ challenges] as a setback, but right now we’re working to get it resolved,” Popejoy said. “We thought we had the creditors under control . . . but [what happened] was nothing we had any control over.”