Experts across the ABS market agree the latest bankruptcy reform proposal from Capitol Hill will likely cause a rush of bankruptcy filings before the rule actually goes into effect. However, if the credit-card sector can ease through that period without a hitch, the same law should work to decrease charge-offs and help collateral performance by making it harder for potential filers to discharge credit card debt.
The U.S. House of Representatives Judiciary Committee approved the bill last week, after the Senate approved it earlier in the month. The bill now waits on approval by the entire House and the President, both of which are all but certain. The rule, as currently drafted, would require a means test for anyone attempting to file Chapter 7 bankruptcy. If a filer fails the means test, the bankruptcy will be pushed into Chapter 13. Chapter 13 is more beneficial to creditors, while Chapter 7 bankruptcy allows a debtor to discharge all debt.
President George W. Bush is expected to sign the bill sometime in April, and 180 days after that, the means test goes into effect, making an automatic Chapter 7 bankruptcy less frequent. Multiple sources expect filings to increase in advance of that deadline. Fitch Ratings Managing Director Mike Dean, said he expects "a spike in filings as people rush to file under the old rules." After that, in approximately six to 12 months, Dean expects an increase in charge-offs as some of those filers have their credit card debt discharged.
Analysts at Moody's Investors Service are singing a similar tune. "Consumers contemplating bankruptcy protection under the present law may rush to file,' which would manifest itself as a spike in the loan loss rate reported by credit card issuers," write the Moody's analysts. Moody's continues to note that it is difficult to predict the magnitude of the increase, however, at its worst, it will only last six months.
In the long run, most expect the more stringent means test will both push filers out of Chapter 7 and prevent some from filing altogether, benefiting all ABS sectors. The American Bankers Association estimates the means test will push 10% of Chapter 7 filers into Chapter 13. Some see this as a positive because it will force at least some filers into re-payment plans, however, Bear Stearns analysts note an increase in Chapter 13 filings may not necessarily be a boon to debt collection.
"The quality of receivables due from Chapter 13 filers will probably decline as more people will be filing under Chapter 13 than may be willing and able to stick to the plan. Only about one-third of Chapter 13 filers succeed with their payment plans under the current law, and diluting the pool of Chapter 13 filers could decrease the success rate further," according to Bear Stearns. Still, unsecured creditors, such as credit card companies, will benefit to some appreciable degree. Bear Stearns predicts there will be less bankruptcy related write-downs under the new law, and there will be a 3% reduction in credit card losses.
The new law could also lower the total number of people who even attempt filing for bankruptcy. "The means test will also discourage many debtors from filing at all, and could increase financial accountability in the long term as debtors realize that Chapter 7 does not exist to bail them out of their financial problems," according to Bear Stearns. Dean says the effects of the law will be "slightly positive in the long term as the incentive to file goes away for some people."
"The increase in bankruptcy filings will likely marginally weaken credit card ABS performance through the end of the year," according to Lehman Brothers analyst Brian Zola. "This deterioration in credit performance will persist through the end of 2005, due to FFIEC (Federal Financial Institutions Examination Council) guidelines that state that charge-offs must be recognized within 60 days of receipt of a bankruptcy notice filing."
Zola believes that most major master trusts have strong and stable excess spread, providing investors with ample protection against the expected rise in charge-offs. Dean also says that excess spread is generally enough to buffer most credit card deals. "Excess spread remains very healthy," said Dean.
The effects of the new law will take years to fully materialize, however, for now, it appears as if the law will be a long-term positive for the ABS sector.
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