The credit card sector saw a number of interesting developments during the second quarter of 2002. Arguably the most significant was the announcement by U.S. bank regulators that early amortization triggers tied to regulatory actions will no longer be permitted. To date, most bank-sponsored credit card deals have included an early amortization trigger based on the appointment of the FDIC as receiver or conservator of the sponsoring bank. Other adverse regulatory actions also sometimes appear as triggers. Regulators assert that such triggers create or exacerbate liquidity or earnings problems that led to supervisory action in the first place. The premise underlying such triggers is that operational difficulties including a deterioration of servicing are likely to accompany adverse regulatory actions such as the appointment of a receiver or conservator. However, since late May, all such triggers in bank-sponsored credit card deals are essentially null and void.
The NextCard developments
The new regulatory stance is likely a reaction to the NextCard situation. NextCard issued two series of securities from its credit card master trust, series 2000-1 in December 2000 and series 2001-1 in May 2001. In the fall of 2001, the regulators forced NextCard to reclassify as "credit losses" certain losses that it had previously booked as "fraud losses." The reclassification of losses made NextCard's securitizations ineligible for "low-level recourse treatment" under bank capital regulations. The result was that, as of Sept. 30, 2001, NextCard was a significantly undercapitalized institution.
NextCard's situation failed to improve over the following months and, on Feb. 7 2002, the Office of the Comptroller of the Currency (OCC) closed the bank and appointed the Federal Deposit Insurance Corp. (FDIC) as receiver. The FDIC promptly notified the trustee for NextCard's securitizations that an "early amortization based solely on the insolvency or the appointment of the FDIC as receiver is not enforceable against the FDIC." The rating agencies quickly placed the NextCard deals under review.
Ironically, the NextCard deals are entering early amortization anyway. Weak performance of the underlying portfolios has tripped the main performance-based trigger. On the last business day of the second quarter, both Moody's and S&P reacted to the weakened performance by downgrading all classes of securities issued in the NextCard deals. Those rating actions were the second time in the history of the ABS market that triple-A rated bank credit card ABS were downgraded (the first time was in May; see below).
Spiegel non-early AM
Another example of an early amortization that did not happen involved Spiegel Corp. retail credit card securitizations. The Spiegel situation does not involve regulatory events as early amortization triggers but it does bear some important similarities to the NextCard case.
Spiegel issued two series of ABS from its retail (i.e., store) credit card master trust in 2000 and 2001. Both of the deals used bond insurance from MBIA as part of their credit enhancement. On April 10, MBIA declared a "pay out event" for the two series. With eerie similarity to the NextCard situation, the basis of MBIA's declaration of a pay out event was the reclassification of certain fraud losses as credit losses. MBIA argued that the reclassification caused the trust to trip its asset performance trigger. MBIA's declaration of a pay out event normally would have started the early amortization of the deals. However, the day after MBIA declared the pay out event, Spiegel's special purpose bank sued MBIA in New York State court and obtained a temporary restraining order to prevent MBIA from enforcing it. Spiegel argued that no pay out event actually had occurred.
Subsequently, Spiegel announced that it had settled its litigation with MBIA. Spiegel agreed to dismiss its litigation against MBIA and MBIA agreed to rescind its declaration of a pay out event.
The NextCard and Spiegel events together raise questions about the strength of early amortization triggers in credit card deals. Ultimately, both situations related to the manner in which issuers classified losses. This leaves market participants to wonder about the degree to which such classification practices might be used in the future to forestall early amortization events in other credit card deals.
Somewhat surprisingly, the market is treating the demise of "receivership/conservatorship" early amortization triggers as a non-event. Spreads on bank credit card deals have remained tight following the regulators' announcement. The rating agencies have not started downgrading the deals. This implies that market participants generally did not ascribe significant value to the deals' "receivership/conservatorship" early amortization triggers. More precisely, it suggests that market participants may have been skeptical about the enforceability of such triggers all along. The market fully recognizes that similar provisions cannot be enforceable against an entity subject to the Bankruptcy Code (i.e., a regular corporation). The market seemingly has suspected that bank regulators would embrace a similar view for the administration of bank insolvencies.
First performance-related triple-A downgrade
The second quarter of 2002 brought the first performance-related downgrade of triple-A rated bank credit card ABS. The affected deals were First Consumers Master Trust series 1999-A and First Consumers Credit Card Master Note Trust series 2001-A.
Although First Consumers National Bank is wholly owned by Spiegel, the downgraded deals here had absolutely nothing to do with the early amortization issue described above. The downgraded deals are backed by receivables from Visa and MasterCard accounts rather than retail (i.e., store) card accounts. A portion of the underlying accounts are with subprime consumers; some are even "secured" credit card accounts.
In March, both Moody's Investors Service and Standard & Poor's placed First Consumers series 1999-A and 2001-A under review. Two months later, both rating agencies lowered their ratings on the senior classes of the deals. As of this writing, the senior classes of each series carry ratings of Aa1'/AA'. The rating agencies cited a trend of deteriorating performance, including charge-offs exceeding 18%.
Fitch had rated First Consumers series 2001-A. Fitch placed the senior class A securities under review in March and downgraded them from AAA' to AA-' in May.
The downgrades of the senior classes of the First Consumers deals are significant because they are a first for the ABS market. The NextCard downgrades, discussed above, demonstrate that lightning can strike twice in rapid succession. Although we do not expect significant ratings volatility in the bank credit card sector, the First Consumers and NextCard experiences are meaningful. They illustrates that even bank credit card ABS often considered the citadel of ABS credit quality can be vulnerable to credit quality deterioration.
New structures hit market
In April, Banc of America Securities executed a credit card derivative securitization to transfer away some of the credit risk associated with its credit card portfolio. The deal is called CRISP Consumer Credit Reference Index Securities. CRISP is based on an index of the credit performance of selected bank credit card portfolios. The deal uses a swap tied to the performance of the index. If the index performs poorly (i.e., the underlying credit card portfolios experience high levels of charge-offs), BofA will receive net payments under the swap.
In essence, investors in the deal sell credit protection to BofA; if the underlying index.