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GICs: What’s the Trade-off?

By: Georgina Walleshauser

At Blue Rose, we’re often asked about the usage of Guaranteed Investment Contracts (“GICs”) and the trade-off between risk and return. Utilizing a GIC as opposed to a Repurchase Agreement (“Repo”) for the reinvestment of bond proceeds can result in a higher yield of approximately 25 basis points, depending on the balance invested, the time period for which the balance is invested, and the type of collateral that is eligible under a Repo agreement. Both investment structures offer the certainty of a fixed interest rate, capital preservation, and intended liquidity, but one of the main differences is the risk associated with each.

Under a GIC, the client deposits their proceeds directly with an institution, and is guaranteed to receive principal plus interest at a specified rate. Essentially, the issuer becomes an unsecured creditor of the financial institution, which is why many issuers only enter into GICs with financial institutions that have a credit rating of at least “A” or better and for some clients, a “AA” category rating is required. To mitigate credit risk, a typical GIC also includes a provision that collateral must be posted in the event that the institution is downgraded below a specified rating. In theory, an issuer’s GIC would then be secured as the financial institution’s credit deteriorates.  One risk, though, is the possibility that the financial institution’s rating is downgraded below this specified rating and the bank then soon fails prior to posting collateral.

During the financial crisis of 2008 several banks did go bankrupt, or they were “rescued” just prior to failure while still having reasonably strong ratings in place.  This list includes Lehman Brothers,  Bear Sterns, Merrill Lynch, and Wachovia.  While we believe that the rating agencies (and the marketplace as a whole including regulators) have learned from these events and have improved their rating practices, rapid bankruptcy risk is not fully eliminated. Nevertheless, while there is risk involved with GICs, we encourage issuers to consider them in particular for shorter dated investments, such as project funds and capitalized interest funds. Utilizing shorter-dated investments with higher-rated financial institutions can mitigate some of the risk involved with GICs and provide issuers with a greater return.

To discuss these types of investments as they relate to your specific needs and risk tolerance, please contact your Blue Rose advisor.


About the Author:

Georgina Walleshauser, Analyst

Georgina joined Blue Rose in April 2017. She is responsible for providing analytical, research, and transactional support to senior managers serving higher education, non-profit, and government clients with debt advisory, derivatives advisory, and reinvestment services.


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