NextBank was closed and placed into Federal Deposit Insurance Corp. receivership by the OCC in February 2002. The most controversial aspect of the receivership was the FDIC's decision to forestall or stop the early amortization of NextCard's credit card ABS. According to the Trust's covenants, "certain bankruptcy, insolvency, liquidation, conservator-ship, receivership or similar events relating to the transferor (including any additional transferor)" will cause an early payout of the outstanding certificates. Early redemption covenants are found in most credit card ABS structures, and most investors rely on them to protect principal.
The FDIC's key motive for exercising its supervisory powers and disregarding this covenant was to buy time and find a buyer for the portfolio. Initially, most note holders viewed this as a neutral-to-positive development, and the prospect of finding a buyer was considered highly likely. Moreover, if a major bank credit card issuer were to purchase and service the portfolio, then NCMNT bond valuations would, theoretically, benefit, as the likelihood of a full repayment of principal increases exponentially. At that time, finding a buyer seemed reasonable given the good credit quality of the portfolio (700 avg. FICO at account origination), its relatively small size ($1.8 billion), and the fact that most of the data processing is handled by First Data Resources (FDR), a major bank credit card processor. However, after five months of searching, it became apparent that the FDIC's inexperience in selling a credit card portfolio and limited knowledge of the bank credit card industry contributed to its inability to complete a sale.
To justify its actions, the FDIC has issued new guidance for credit card banks entitled, Interagency Advisory on the Unsafe and Unsound Use of Covenants Tied to Supervisory Actions in Securitization Documents, May 23. Certain provisions of this guidance are disturbing to some experienced ABS market players. For example, the document notes that, "Such triggers also could potentially inhibit supervisors from taking actions intended to cure problems at a troubled organization because those actions activate a trigger that could cause a worsening of the condition or failure of the organization." In retrospect, halting the amortization was hardly the cure for ailing NextBank.
The abrupt closure of these credit card accounts on July 10 likely will exacerbate credit losses and further reduce principal collections on these accounts as customer payment behavior becomes a guessing game. The FDIC's decision to close the accounts and not to fund new card purchases will dampen NCMNT pool performance, as it was effectively converted to a closed-end, amortizing pool of assets rather than a revolving pool of assets.
Band-aid approach to servicing
Prior to NextBank's closure, NextCard's credit card accounts were serviced by NextCard Inc. and First Data Resources (FDR). NextCard Bank provided all key customer service functions such as collections and in-bound telephone calls while FDR performed certain data processing functions, such as the processing of monthly billing statements. The servicing fee to NCMNT was 2% (annualized), paid monthly from finance charge collections. The 2% service fee is usual and customary and found in most credit card ABS structures and is deemed by the rating agencies to be appropriate.
In March, the FDIC and NextCard amended the servicing agreement and transferred all servicing responsibilities to the FDIC. In turn, the FDIC entered into an agreement with Automated Management Services Co. (AMSC), a third-party employment agency, to retain NextCard's 465 customer service personnel, primarily collectors, to continue the servicing of the credit card portfolio. These employees were paid lucrative financial incentives to continue in their positions. As a result, servicing costs for the NCMNT credit card portfolio increased significantly.
As such, one of the key tasks for the trustee is to find a qualified back-up servicer to take over servicing as the FDIC has indicated it is no longer willing to service the portfolio given the high costs. In addition, noteholders want to ensure that the trust documents, cash flow waterfalls, and distribution of cash from the receivable pool follows the requirements accordingly.
Noteholders will begin to receive their principal distributions commencing on Aug. 15. In hindsight, the FDIC's decision to forestall the early amortization trigger tied to the servicer receivership sets a bad precedent for the credit card ABS market because it highlights a new risk element - the regulators. The FDIC's lack of experience and handling of the NextCard receivership, which cost the Bank Insurance Fund close to $400 million, is hard to swallow.