Credit card holders are keeping a lid on spending, and banks are flush with cheap deposits to fund new accounts. These might not seem like the ideal conditions for credit card securitization to take off, but that's just what is happening.

In the first nine months of 2012, issuance of credit card ABS reached $29 billion, nearly double the $16.2 billion issued for all of 2011, according to data compiled by Standard & Poor's. By comparison, revolving debt fell at a 6.6% annual rate in July, following an annualized drop of 4.4% in June, according to data from the Federal Reserve. (Revolving debt was flat at about $815 billion between May and July before adjusting for seasonal factors.) In fact, at a seasonally adjusted $851 billion, revolving debt is about where it was when it pulled out of a sharp contraction in early 2011.

What seems to be driving banks to securitize the receivables they still have on their books is the falling cost of financing available in the ABS market, making it competitive with deposits once again. Issuers also want to maintain their relationships in the ABS market to preserve their funding alternatives. "Deposits are very cheap, but so are credit card spreads," said Ildiko Szilank, a director in ABS ratings at S&P. "When the costs of funds are tight from deposits, ABS and unsecured credit, it makes sense to diversify funding sources based on large investor demand for good quality ABS, despite the regulatory headwinds."

According to Tom Knox, managing director at PwC's financial instruments, structured products and real estate group, which represents clients that are broker dealers within the credit card securitization space, the pricing level of triple-A rated tranches have reverted back to levels not seen since before the 2007-2008 financial crisis. Floating-rate tranches are trading at Libor plus 12 basis points and fixed-rate tranches are trading at 60 basis points. Those are very attractive funding rates for banks issuing securitizations and, relative to deposit funding, ABS offer the benefit of locking in these rates over a longer term.

"There is an advantage to getting the certainty of that three-year money versus the volatility that can come with deposits, particularly with the uncertainty of the future interest rate environment," Knox said. Knox also said that issuers recognize that they need to maintain relationships with institutional investors that they might need down the road.

 

Scarcity Value

Two things are keeping down the cost of securitization funding, according to market observers.

David Bondy, a managing director, head of ABS origination, Natixis U.S. structured credit and solutions group, also pointed out the "scarcity factor" of credit card securitization combined with relatively higher credit enhancement levels and signficantly improved losses producing low credit risk for investors at a time when they have to cash to put to work. "With low issuance, the supply and demand imbalance has driven spreads down," he said.

The low level of issuance over the past few years combined with banks not replacing the amount maturing means that credit card volumes are likely to remain a fraction of peak 2007 volumes. Even with the $29 billion-plus in issuance year to date, outstanding ABS in the sector are expected to eventually stabilize in the $120 billion to $125 billion range, according to an Aug. 20 report published by Wells Fargo. The report said that the total amount of receivables in credit card master trusts has been falling since early 2009. The number of accounts pledged to master trusts has also been decreasing, in some cases at a faster rate than the rate of decline in receivables. American Express' master trust, for example, saw a drop of 5% in the amount of receivables outstanding, while the number of accounts pledged to the trust declined by 17%.

Looser underwriting during the market's peak kept credit flowing and receivables growing; it also motivated issuers to keep designating new accounts to their trusts. But today, the decline in receivables has reduced the pool of assets available to securitize. Instead, issuers are looking at maturing receivables, which exist already in the trusts, for securitization.

Even with this shrinking, there still continues to be a need to roll over the maturing series in those master trusts. This year credit card ABS had $66.4 billion of bonds maturing and approximately $16 billion of that total is expected to mature over the remaining months of 2012, as well as $34.3 billion in 2013 and $26.1 billion in 2014.

For the securitization market, issuers looking to replace maturing bonds represent new-issue volume in a range of $25 billion to $30 billion over the next two years, according to the Wells Fargo report. "Issuers have started to push the maturities of some of their new bonds out to 2017 and 2019 to take advantage of low long-term interest rates and increased demand from investors seeking longer-duration assets," wrote John McElravey, head of consumer ABS research at Wells Fargo.

Still, without new receivables added to the mix, the level of outstanding ABS will keep declining. As of September 2012, about $141 billion of credit card ABS was outstanding in 16 trusts, down from $292 billion outstanding in 26 trusts in 2010, according to a number reported by S&P at a Sept. 19 credit card conference.

 

Credit Performance

But credit card ABS have not just become scarce, they have also become safer as issuers purge riskier borrowers from pools of receivables. Once the receivables were charged off, they disappeared from the credit card universe and the securitization pool. Credit card borrowers who did not default have opted to deleverage their debt positions. In other words, these people use credit cards not so much for credit but for convenience. S&P's Szilank said that the percentage of obligors who are able to pay down their debt each month and mostly use their credit cards for rewards or points increased in the securitization pools over the recession. "If you add those factors together - involuntary and voluntary deleveraging and the fact that credit card originators are still really not tapping the subprime obligor universe - this has led to better performance," she said.

Month over month, August charge-off rates, or the annualized amount of receivables written off as a percentage of outstanding balances, fell at five of the country's six largest domestic card lenders, in line with the typical seasonal pattern. The percentage of balances overdue by one to two months was roughly flat, bucking the usual seasonal increase. Fitch Ratings' 60-day delinquency index reached 1.76% in August. The six basis-point decline brought delinquencies down to their lowest level since Fitch launched its index 21 years ago. The index also showed delinquencies down year-over-year, and they are below the long-term average of 3.02%. Also, many issuers dramatically changed their underwriting. That is important because defaulted borrowers, who had been eligible for credit cards with obligors with lower credit quality, can't really get access to credit cards today.

"As a result of the crisis, they got more conservative, more thorough and more diligent about who they extended the credit to and how much credit they extended," Bondy said. "They also changed the way they monitored their card holders. The result is that everyone's portfolio has improved in terms of overall credit quality."

Despite credit quality and loss rates improving, there are still some headwinds that the sector faces such as unemployment remaining elevated.

S&P said at its credit card conference on Sept. 19 that it considered "the key risk factors to the performance of U.S. credit card ABS collateral to be the continuing pattern of weak macroeconomic conditions, weak employment growth and soft income growth." These risk factors could result from either the European debt crisis and/or the forthcoming U.S. fiscal cliff. Rising oil prices could also hurt purchasing power and consumer confidence while reducing economic growth.

However, Szilank told ASR that the actual credit support levels banks offer today in credit card master trusts are higher than in previous transactions. When loss rates increased, most issuers of credit card ABS stepped in and supported their transactions, which also contributed to rating performance stability.

S&P has also revised its criteria to make the ratings more stable. Szilank said that the rating approach created a floor for an annualized loss assumption for benchmark credit card pools such that if and when the unemployment rate decreases to 5% or 6%, the stressed loss rate will still be similar to what the rating agency assumed in the recession. "In addition, the underlying credit support offered by issuers hasn't declined despite the strong performance," she said.

 

Accounting Changes

As attractive and cheap as financing in the securitization market is for credit card companies, it is likely to remain an alternative, not a primary, source of funding, in part because of regulatory headwinds.

Two years ago, the accounting treatment for securitizations and other special purpose entities changed. The Financial Accounting Standards Board now requires banks to keep these assets in these vehicles on their balance sheets.

"The issuance volume, even though it's up this year, is still a shadow of its former self because a lot of the big bank credit card issuers are either out of the market completely or are infrequent issuers," Bondy said.

Some of the major credit card lenders, as a result of the new accounting regime, abandoned the ABS market entirely. Bank of America Merrill Lynch analysts said that, for instance, American Express Issuance Trust retired its last public term ABS and Wells Fargo said that Capital One Multi-Asset Execution Trust, Bank of America Credit Card Trust and Citibank Credit Card Issuance Trust have not issued new ABS in several years.

"These players have opted out of the market because of the accounting disadvantages that FAS represented, the higher collateral loss range so the rating agencies were effectively penalizing issuers by increasing credit enhancement levels to reflect that rising level of losses in the portfolio and a declining level of excess spread and at the same time you had the banks flowing into deposits for funding," BofA Merrill analysts said.

Still, some of the regular players stayed in the market, including Discover Financial Services, GE Capital, Cabela's, World Financial Network Bank and American Express. These companies have recently been rejoined by JPMorgan Chase, which has accessed the securitization market a number of times this year.

After some talk in the market that Citibank was going to stage a return this year, the bank filed a prospectus with the Securities and Exchange Commission to issue a credit card deal under its Citibank Credit Card Issuance Trust.

While the regular issuers are still expected to remain active, there might also be less motivation to securitize in the future with the looming regulatory challenges the market faces. Final amendments to Regulation AB and Dodd-Frank can still affect credit cards.

One of the many new provisions under Reg AB requires securitization asset classes to provide asset level details about the loans that are in the securitization trusts. Under the proposed rule, credit card issuers would be allowed to provide information in grouped or pooled data because of the size of the pool. This regulation could create extra liquidity in the market because it will bring investors back who feel there is more transparency in these transactions.

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