By Peter A. DiMartino, director and head of ABS and Mortgage Credit Research, Salomon Smith Barney
The triple-B rated1 credit card market has grown to about $3.4 billion outstanding in only a few years. Two structural innovations in credit card securitization technology have the potential to create compelling opportunities for issuers and investors.
In this article, we describe the Block & "TRAP" technologies that enable block size and medium-term-note-like (MTN) issuance. It is a natural progression in the evolution of the asset-backed market for the credit card sector to lead the way to a new era in ABS structure. These technologies provide the same flexibility as the MTN market, which grew out of the corporate underwritten market. Credit cards have the most diverse pools, solid performance history, and strong credit enhancement and are the logical pioneer for these concepts.
Blocking creates the ability to issue public, ERISA-eligible credit card subordinated classes in larger sizes.
"TRAP"ing (for titanium rapid accumulation of principal), allows issuers to issue subordinated classes delinked in maturity from any senior classes of the bond issue. It allows an issuer to issue subordinated classes at any time, not necessarily concurrent with a senior bond issuance. Class C notes could mature before the senior classes, if replaced by equal credit enhancement. The C classes will not be repaid before a senior class maturity unless the ability to refinance exists and full principal due to the Cs has fully accumulated. Importantly, the subordinated classes are secured by the same collateral pool that collateralizes the entire Master Trust.
These innovations will have several important benefits, including the following:
*Greater investment efficiency as a result of larger purchases;
*Class size eligible for aggregate index inclusion, appealing to investors benchmarking to an index;
*Public issuance format, unrestricted transferability, and ERISA eligibility widening distribution potential;
*Class size and broader distribution enhancing liquidity; and
*Relative-value opportunity.
The following describes the new technology associated with Block & TRAP technology2 and an overview of 1999 triple-B card issuance. In an upcoming report, we will examine historical new-issue spreads and supply and look at relative values of subordinated cards versus other asset classes and higher-rated ABSs.
Structural Explanation
The new two-tier structure using Block and TRAP technology will be somewhat modified from historical structures. A new Master Owner Trust is created to purchase the unencumbered seller's interest of the original Master Trust3, and notes (as opposed to certificates) are issued to all traditional classes of investors: triple-A, single-A, and triple-B. This will allow all classes of the notes to be registered at the SEC, publicly issued, and ERISA-eligible. Certificates of the Master Trust will be retained by the seller, allowing them to receive excess spread and cash flows allocated to the seller's interest. The seller's interest will continue to insulate investors from fluctuations in the amount of receivables as a result of seasonality, attrition, disputes, or other factors.
The seller sells a pool of receivables to the Master Trust, which is revolving. Investors and sellers are undivided beneficial interest holders in the receivables of the Master Trust. Principal and interest collections are allocated pro rata among the beneficial interest holders of the Master Trust (the Master Owner Trust will be one such holder). Collections may be shared among the outstanding series in the Master Trust, to the extent not required for that series.
Block Size
The significant structural enhancement enables issuing larger tranche sizes ($100$200 million or larger, and seller issuance needs). This is, of course, subject to conforming to the credit enhancement requirements of the ratings agencies. We expect that tranche size will be sufficiently large to be eligible for inclusion in aggregate fixed-income indexes. This has obvious appeal for investors seeking improved efficiency and liquidity in ABS subordinates.
Trapping
This technology enables tailored maturities to meet the needs of issuers and investors, creating the flexibility of an MTN-like program. Therefore maturities need not precisely match notes issued in the senior classes. This provides significant maneuverability for the issuer and may benefit investors who are more likely to be filled on a reverse-inquiry order.
How It Works
An interesting aspect for the Class C investor is that the notes may mature before the senior classes. The C class may not be repaid, however, unless sufficient cash exists to fully repay them.
At some time before the maturity of an outstanding triple-B class, a determination will be made concerning the ability to replace the triple-B credit enhancement layer. If there is no ability to replace, an accumulation period will begin for the senior classes that rely on the triple-Bs for credit enhancement. The issuer will begin to accumulate cash in the principal funding account. These funds are for the benefit of the senior notes until sufficient cash exists to repay them and the senior noteholders are, in essence, defeased.
The length of time needed before the refinancing of the triple-B class will depend on the characteristics unique to each issuer's pool. Large issuers with substantial excess unallocated monthly principal collections will benefit from using the new technology. The senior classes will never be in a position where the triple-B class is repaid without first being replaced.
Historical Supply
Triple-B credit card issues in 1998 aggregated $829 million. A total $1.8 billion was issued in 1999, and year-to-date 2000 issuance amounts to almost $800 million. ERISA-eligible subordinated cards contributed to the market's progress. Maturities ranged from three to ten years, and both floating and fixed classes have been issued. We show 1999 monthly issuance activity in the bar chart at the bottom of the opposite page.
Total fixed and floating issuance was about equal, and the five-year sector was the most popular maturity, followed by three-years. Three-years dominated floating-rate issuance, making up 57% of 1999 floater issuance, followed by five-years, with 33% issued as floaters. In fixed-rate issuance, five-years made up 63%, so it can be inferred that investors' preference is for short- to medium-term maturities, although some demand exists in seven- to ten-years. The pie charts below illustrate investors' preference for three- and five-year paper.
1 By extension, this technology applies as well to single-A rated classes, although the focus of this article is the triple-B sector.
2 See "Class C Notes: Opening the Next Frontier in Credit Card Asset-Backed Securities," November 23, 1998, Salomon Smith Barney, for a complete review of the credit issues associated with Class C cards.
3 For issuers without an existing Master Trust, the two-tier structure will not be necessary.
