As the number of U.S. consumer bankruptcy filings have returned to earth in recent weeks, the industry has been busy digesting the impact of the surge in filings and what it will mean for credit card ABS. Last week, a team of experts assembled by Barclays Capital put forth some perspectives on what it all will mean for the sector.
As of last week, the number of filings for the year was 46% higher than year-to-date 2004, and 28% higher than 2004's total, according to Juliet Jones, a research strategist with Barclays and the host of a conference call. The surge in filings has begun a correspondent surge in chargeoffs from credit card trusts, but many sources have said credit card ABS trusts in general are well poised to absorb the surge.
In spite of the expected soft landing, Jones said many investors are looking for the increased chargeoffs to widen secondary spreads as compensation for the additional risk. "Although the market seems to understand this whole bankruptcy [-related spike in chargeoffs], the sentiment is that it should pressure spreads wider and investors are looking for a reason to demand more yield. We believe that any volatility in spreads on the back of the surge in chargeoffs would present a very good buying opportunity for credit card ABS," said Jones.
Fitch Ratings Managing Director Mike Dean, also a participant on the call, said that chargeoffs are expected to increase 30% to 40% over the next three to four months, which could push Fitch's chargeoff index for the credit card sector above the 7.50% threshold. However, Dean noted no early amortizations are expected.
Dean said higher fixed-rate coupon series are the ones expected to feel the impact the greatest, such as those issued through the Fleet, Discover and Chase Master Trust. "At the very least we are going to see a lot of trusts start trapping excess spread," said Dean. He said trusts such as the Chase Issuance Trust, Citibank's credit card master trust, Metris Master Trust and National City Master Trust were possible candidates to take the trapping route, and the First National Bank of Omaha and Fleet have already begun trapping. Dean wrapped up by saying he expected chargeoffs to normalize by the end of 1Q06.
Barclays Managing Director Mark Girolamo was also on the call to break down some of the chargeoff numbers as they relate to corporate earnings and losses. Girolamo used Capital One Financial as an example of the spike in losses for credit card issuers. CapOne had a 4.13% loss rate for the first three quarters of 2005, and in September, as the first wave of the bankruptcy surge began to hit the managed loss rate rose to 4.62%, keeping in mind that 40% to 50% of chargeoffs in prime card portfolios result from bankruptcy filings. The monthly rate for October for CapOne spiked to 7.93%, but the chargeoff rate for the entire 4Q05 should be closer to 5%, according to CapOne's estimates, and should return to normal levels thereafter. "Other companies will be affected similarly," said Girolamo. "The timeline of the effect will depend on the company's specific bankruptcy chargeoff policy."
Michael Richman, partner at Mayer Brown Rowe & Maw, weighed in on the call with his thoughts on why the bankruptcy rule will be a positive for credit card ABS. Richman outlined the guidelines of the means test, which defines that any Chapter 7 filer who earns more than their state's median income and has $100 left over every month after their necessary expense will be pushed into Chapter 13. "This necessarily means over time that greater amounts of credit card debt, as well as other unsecured debt, is going to be paid off," he said.
Richman also put forth a little- discussed aspect of the rule that states filers pushed to Chapter 13 will have to attend credit-counseling courses. Richman said this could portend a proliferation of professional credit counseling companies that will work with debtors who have been through the bankruptcy process, and could also mean these companies could begin working with troubled debtors outside of court as well. "That leads me to the conclusion that greater amounts of debt are going to be repaid," Richman said.
From an earnings perspective, Girolamo also said the effects of higher chargeoffs would wear off after 1Q06. The higher chargeoffs could compress net income slightly in 4Q05 and 1Q06 but that trend should reverse in later quarters, he said. "Changes to the bankruptcy laws will have a modestly negative effect on [4Q05] for the corporate issuers, but it should sort out in the early stages of 06. Longer term, however, this should be positive," said Girolamo.
On Oct. 17, the nearly eight-year-old bankruptcy reform proposal became effective, making it more difficult for consumers to file Chapter 7 bankruptcy and making it more likely many of them will be pushed into the creditor-friendly Chapter 13. In anticipation of the law coming into effect, U.S. consumers filed for Chapter 7 in record numbers.
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