The bond insurers will soon be subject to new accounting rules intended to bring greater transparency and consistency of reporting practices at a time that is perhaps the most difficult in the industry's history, an environment most recently illustrated by the first-quarter loss reported by Financial Guaranty Insurance Co. last week.
On Friday, the Financial Accounting Standards Board issued a new policy intended to bring increased transparency and consistency to the financial guaranty industry. The new rules, outlined under FASB Statement No. 163, require a number of changes for insurance companies that write financial guaranty contracts, like the bond insurers.
Under the new rules, a company would be required to: report a claim liability if there is evidence of credit deterioration, even before a default occurs; recognize revenue under a cost-of-capital construct; and disclose risk management procedures and the credits it is surveilling on its watch list.
The statement is intended to clarify FASB Statement 60 and FASB Statement 5, which have led to inconsistencies in measuring and recognizing claim liabilities across financial guaranty contracts, FASB said in the statement.
"One of the reasons we were asked to do this project was that there were differences in how claims were recognized," said Mark Trench, the FASB project manager in charge of the initiative. "The goal was to get consistency and comparability and come up with information useful to [investors]."
While many of the bond insurers already report similar information in their supplemental operating statements, the FASB rules bring the disclosure into Generally Accepted Accounting Principles and make them subject to third party audits, Trench said.
Executives with Ambac Financial Group Inc., parent of Ambac Assurance Corp., said they were still examining the new provisions with respect to how they might affect the bond insurer's financial statements.
"While there are certain nuances of the new statement regarding recognition of claim liabilities that we need to analyze further, the concept of recognizing such liabilities upon observing credit deterioration and before an actual default is consistent with our current loss recognition methodology," said Ambac chief financial officer Sean Leonard in a statement.
MBIA Inc. chief financial officer Chuck Chaplin also commented on the new rules, saying: "The increased disclosure requirements will be welcomed by our investors and good for the industry as a whole."
Chaplin said the new rules will not materially change MBIA's financial statements and would disclose similar information about credit default swaps, despite their exclusion from the statement.
The proposal has been under review for about three years and follows an extensive comment period. When the FASB asked for comments on an exposure draft last year, they received 86 response letters.
A portion of those suggestions made it into the final statement, Trench said, including the provisions to allow the bond insurers to claim revenue based on the accreted principle of each period, and the fact that the payment for claim liability can be discounted using a risk-free rate, to be determined by each individual company.
The change comes at a particularly difficult time for the bond insurers, as they seek to weather the deterioration in subprime mortgage-related securities they have insured. As the value of these securities has deteriorated, the bond insurers have had to report billions of dollars in mark-to-market losses and had to calculate the claims that could eventually be paid out.
"Its issuance is particularly timely in light of recent concerns about the financial health of financial guaranty insurers, and will help bring about much needed transparency and comparability to financial statements," Trench said.
The statement will be effective for financial statements issued for fiscal years beginning after Dec. 15, 2008, though the risk management disclosures are to be included in the first reporting period after Friday's announcement.
Also Friday, FGIC Corp., parent of the financial guarantor, said it lost $33.4 million for the first quarter of 2008 because of increased reserves set aside to cover losses for collateralized debt obligations tied to asset-backed securities. It was a 149% drop from last year's first quarter profits of $68.5 million.
FGIC said its loss adjustment and reserve expenses were $279.2 million for the quarter, based on further deterioration in residential mortgage-backed securities and CDOs of ABS written between 2005 and 2007. Those losses were offset by an unrealized gain of $157 million earned on certain CDS contracts.
The gains on CDS contracts resulted from FGIC's adoption of SFAS 157, which governs the way fair value accounting works and incorporates the market perception of FGIC's non-performance risk. Under the rule, which went into effect on Jan. 1, the value of the bond insurer's liabilities, like CDS contracts, can be recalculated. Radian Group Inc. also used SFAS 157 to offset losses in the quarter, reporting a first quarter gain earlier this month.
In accordance with SFAS 157, FGIC announced a $1.57 billion gain in the value of its CDS for the quarter, which offset the $1.4 billion in losses on similar contracts. Of those losses, $228 million related to actual credit impairments.
Net premiums written for the quarter fell 64% to $30.5 million, from $84.9 in the quarter last year. The decline relates to FGIC's ratings and its decision to stop writing new business in the quarter.
While FGIC was rated triple-A by all three rating agencies last year, the bond insurer is now rated Baa3 by Moody's Investors Service, BB by Standard & Poor's, and BBB by Fitch Ratings.
Current claims-paying resources for FGIC stood at $5.3 billion at the end of the quarter, including qualified statutory capital of $1 billion, according to the bond insurer. Unearned premium and loss reserves total $3.2 billion, the company said.
In February, FGIC asked the New York State Insurance Department to split it into two companies, with the municipal bond business to become separate from the structured finance portfolio. Such a split has not occurred, partly because of concerns that it would not value the rights of the policyholders for the structured credits as equal to those of the muni bond holders.
Earlier this month, FGIC said it had received significant interest from potential partners who could contribute capital or partner with the bond insurer. Further details about a deal to keep FGIC afloat have not been announced.