Guaranteed Investment Contracts: Another Headache for Bond Insurers?

When the question of guaranteed investment contracts and their implications for monolines first came up on this blog, a reader jumped all over us when we ventured that the fallout from GICs might affect claims paying ability. We were told that making a fuss over GICs was tantamount to focusing on a withdrawal by a large depositor. The bank uses cash or liquidates liquid securities, so what’s the worry?

It turns out our initial reaction may not have been so off base, precisely because the bond insurers aren’t in the low risk position that the deposit analogy would indicate.

By way of background, when bond guarantors’ rating drop below certain thresholds, they have to post additional collateral against GICs. That happened to MBIA, which had to post $7.4 billion extra. And the process was not costless; MBIA took a loss of $300 million last quarter as a result. Moreover, rating agency Fitch contended that, separate from the loss on disposition of securities, the collateral-posting process could have further ramifications for the insurance sub. From Bloomberg:

MBIA, based in Armonk, New York, is being forced to post collateral and make payments to some investors after Moody’s Investors Service cut its insurance rating five levels to A2 from Aaa last week. Some of that money may come from assets backing an $8.1 billion medium-term note program, potentially creating a new liability for MBIA’s insurance company, Abruzzo said. MBIA may be forced to sell some securities at a loss to fund the collateral payments, he said…..

The asset management unit has $15.2 billion “available to satisfy” the demands, the bond insurer said in its statement. Those assets, though, also back the medium-term note program run by MBIA Global Funding LLC, the filings show. Taking $7.4 billion as collateral and cash payments would leave $7.8 billion to back the $8.1 billion program, a gap of $300 million that could widen if assets are sold at a loss, [ Fitch Ratings analyst Thomas] Abruzzo said.

An article today in the Financial Times raises further concerns. While the piece keyed off how GICs could hurt FSA, one of the last AAA rated monolines, the discussion has implications for MBIA and Ambac,

From the Financial Times:

Together with heavy losses on subprime mortgage-related bonds they guaranteed, bond insurers such as Ambac and MBIA are exposed to problems in their so-called “guaranteed investment contracts” (GIC) businesses. These problems could result in additional claims on capital at a time when they can least sustain them.

Meanwhile, FSA, one of the last triple-A rated bond insurers because it sidestepped writing protection on so-called collateralised debt obligations, also faces potential problems in its GIC business.

Analysts at Morgan Stanley warned in a recent report: “In our view, issues associated with the GIC businesses have the potential to threaten monolines such as FSA, which have carefully avoided writing protection on [asset-backed] CDOs, and thus have so far been immune from downgrades.”….

Such funds are now under pressure….because the bond insurers invested substantial portions of their multibillion dollar GIC portfolios in subprime mortgage bonds and other related sectors which have since suffered losses.

At Ambac, for example, the face value of mortgage and related asset-backed securities account for around 84 per cent of the bond insurer’s $7bn GIC portfolio, according to Morgan Stanley research. Similarly, subprime-backed securities and related assets account for 69 per cent of FSA’s $18bn GIC portfolio, and 28 per cent of MBIA’s $24bn GIC portfolio.

Meanwhile, GIC funds are also facing pressure from investors pulling out their money, in some cases forcing the GIC to sell assets into distressed markets.

These investors are often structured finance vehicles that are themselves under pressure from market losses and have hit triggers that force them to unwind. Morgan Stanley estimates MBIA, Ambac and FSA have around $15bn of CDO-related funds invested in GICs.

Downgrades below triple-A for MBIA and Ambac have triggered requirements to post collateral for their GIC businesses. MBIA said yesterday its GIC funds were fully collateralised. Dexia, FSA’s Belgian-French financial services parent, last week provided FSA’s GIC business with a $5bn credit line. FSA said in a statement it wanted to remove any doubt that it would be able to meet its liabilities.