"Since the beginning of 2007, we have seen a tightening of lending standards and a reduction of introductory offers to new borrowers, which has set the ground for improvement in performance and better positioned these structures to weather a downturn," said Anca Gagea, ABS research analyst at Barclays Capital. "That said, the biggest driver for consumer asset performance is unemployment, and we are seeing that go up in the U.K., which has begun to have an impact on performance."
Gagea explained that the meat of European credit securitization transactions originate in the U.K.
The anticipated impact of the current slowing U.K. economy, together with factors such as increased costs of living, increasing unemployment and the tightening of the availability of credit, continues to provide some concerns regarding U.K. consumers' ability to meet payments on their future credit card debt.
Fitch Ratings said that inflationary pressure continued to be in evidence in 3Q08, with its consumer price index (CPI) continuing to rise after having increased every quarter since September 2007 (3Q07 - 1.8%; 4Q07 - 2.1%; 1Q08 - 2.5%; 2Q08 - 3.8%; 3Q08 - 5.2%). In 3Q08, the index picked up further, increasing to 4.4% in July, 4.7% in August and 5.2% in September, the highest CPI annual rate recorded in a month since June 1992.
Following its increase from the end of 1Q08 to the end of 2Q08, to £55.3 billion ($83.3 billion) from £54.6 billion, the outstanding amount of credit card debt held by U.K. borrowers increased again at the end of the third quarter this year, to its highest level since December 2007 - £55.9 billion in September 2008.
"Worryingly, having fallen from June to July 2008, the outstanding amount of credit card debt held by U.K. borrowers subsequently increased over each of the last three months," Fitch analysts said. The rating agency said that this rise in recent quarters is concerning given the expectations of a tougher economic environment.
As a result, the rating agencies are becoming more pessimistic about the U.K. credit card sector. Moody's Investors Service said that the sector will see deterioration over the coming months, despite relatively stable September credit card indicators. The agency said that the recent increase in delinquencies likely anticipates a rise in delinquencies and subsequent charge-offs over the coming months.
Standard & Poor's likewise expects an increase in its charge-off index over the next 12 months. S&P said that in the U.K., losses rose from 4% to 7.9% over the 26 months between January 2005 and March 2007. This time around, they expect the deterioration in the credit card charge-off index to happen faster.
"If the growth in charge-offs continues, 'BB' and 'BBB' tranches might come under pressure," analysts said. "However, in the medium term, we do not expect any tranche to default, because of the high seller share in individual trusts, and performance remains within our expectations."
Fitch said that the pressure on U.K. credit card issuers to reduce interest rates - following the recent 1.5% interest rate cut by the Bank of England - will also add stress to the asset class's current performance, because it might lead to reduced levels of yield for credit card trusts. As these trusts typically pay Libor-based interest, any reduction of yield aside from those resulting from Libor changes would cut current excess spread levels.
As Bad as Subprime Mortgages?
The slowdown in growth, tighter lending criteria limiting refinancing options for borrowers, and rising unemployment, sound similar to the factors that led to the fall of subprime structures.
However, market analysts said that suggesting a subprime-like fall for credit cards is an exaggeration. Markus Ernst, a senior ABS research analyst at Unicredit, said that while further deterioration is to be expected, he doesn't believe that credit card troubles will escalate to become the world economy's next "problem child." "Downgrades on tranches will accelerate, but actual tranche losses should be limited," he said.
While most analysts agree that the market will see some rating downgrades, the asset class still looks well placed to avoid defaults. Barclays' Gagea said that credit card deals still have quite a bit of cushion, and as such are not likely to suffer any losses. Even as late as September, performance improved for most trusts, with portfolio yields rising from 19.19% to 20.82% and monthly payment rates moving from 16.14% to 17.29%, owing mostly to extra collection days in September compared to August. Barclays analysts said that the rise in yields was sufficient to offset slight increases in charge-offs and expense rates, so excess spread went up overall to 6.78% from 5.31%.
Fitch reported that the overall performance of U.K. credit card ABS transactions in the third quarter of 2008 resulted in a slight improvement for some of the performance indicators in September (compared to the end of 2Q08); the Fitch excess spread index (Fitch ESI) also registered an 80 basis point increase from June to September 2008.
The Fitch monthly payment rate index (Fitch MPRI) was 17.2% in September 2008, a quarter-on-quarter increase of 20 basis points from June 2008 and a 100 basis points year-on-year rise from September 2007. Having increased 160 basis points to 18.6% in July 2008, the Fitch MPRI then dropped 250 basis points in August, before increasing again, from 16.1% to 17.2% in September.
The Fitch Yield Index (Fitch YI) also increased from June 2008, by 70 basis points, to 20.9% in September, this represents a 210-basis-point year-on-year increase from the September 2007 YI value. In July 2008, the Fitch YI was 20.9%, dropping 180 basis points to 19.1% in August, before increasing back up to 20.9% in September.
Still Looking Better Than the U.S.
European performance figures have painted a better, less intimidating picture than that seen in the U.S., where market prices and spread levels suggest that the country's credit card securitizations will experience a clear downturn.
Unicredit's Ernst said that although U.S. credit card volume has grown steadily over the past few years, many European countries continue to see trends where credit card debt is generally capped and repaid on a monthly basis. U.S. credit card debt is more like a consumer credit; the limitations are more generous and monthly debits are more flexible.
"An increase in risk related to U.S. credit cards is a logical consequence of the crisis," Ernst said. "Following the subprime meltdown in the U.S., borrowers' affordability is becoming more and more constrained and over-indebtedness is rising. This is reflected in worsening consumer credit performance - from subprime auto loans to subprime credit cards. Given a recession, this process will become even more severe."
According to S&P, excess spread has increased in Europe in 3Q08, rising from 6.19% in June 2008 to 6.98% in September; whereas in the U.S., excess spread, which had been increasing for 18 months and reached 9.01% in November 2007, has continued to decrease in 3Q08, hitting 6.41% in August 2008.
Principal receivables in U.S. trusts also decreased by $1.2 billion to $443.1 billion in August 2008. They are down from $444.3 billion in July 2008 and $444.4 billion in June 2008.
European principal receivables, which had been contracting since the beginning of 2007, remained stable in 3Q08. In September 2008, trust balances were at £30.03 million, down only 2.10% from the previous year. The U.S. payment rate decreased slightly in the third quarter, falling to 18.85% in August 2008. Since rising from a low of 18.58% in February 2008 to reach 19.72% in May 2008, the rate has again started to fall. Comparing quarterly averages, it stands at its lowest point since the end of 2005.
Gagea also said that Europe, and specifically the U.K., benefited from earlier problems within the sector. By the start of 2007, the Continent already had originators tightening lending standards, which set the ground for improved performance, and thereby put related securitization structures in a better position to weather the downturn.
"As far as the U.K. is concerned, I would be reluctant to say that it will be the next subprime," she said. "Performance has deteriorated, but it happened before the economic crisis of today. So in a way these transactions have benefited because early on originators had already taken a proactive stance."
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