Negative headlines continue to linger in the European credit card sector. But while performance may be down on most U.K. master trusts, it won't necessarily translate into a negative ratings action. Just last week, while Egg Banking plc's master trust fate remained a topic of speculation, Capital One's Sherwood trust got the OK from Fitch Ratings despite having its own share of problems.

Fitch analysts said last week that they plan to take no action on Sherwood while waiting for recent improvement measures made by the issuer to take effect. Capital One currently has the highest level of charge-offs among the trusts at 9.03%, while total delinquencies are currently at 6.28%. Fitch attributes its decision to the recent detailed discussions with Capital One's senior management.

"The charge-offs are now 2% above Fitch's base-case assumption and if current trends continue without mitigation, Fitch is concerned that credit enhancement will not remain sufficient to support the Class C's BBB' ratings," Fitch analysts reported. "However, based on recent conversations with Capital One's management, Fitch is comfortable that the company's mitigation efforts over the next two months, if successful, should be sufficient to alleviate the agency's current concerns."

In January 2006, an additional GBP50 million ($64.2 million) double-B tranche was issued to provide further credit enhancement to the transaction. Analysts at Morgan Stanley said that if the performance does not stabilize over the next couple of months, the trust could proceed as before or add collateral to provide support going forward.

Moody's reaction

But as Fitch finds talks with Capital One reassuring, another trust is facing a less than positive outlook. Moody's Investors Service earlier this month placed the Class C notes issued by Pillar Funding between 2002 and 2005 out of the Arch Funding Receivables Trust on review for possible downgrade. The assets backing the notes in the master trust consist of receivables from designated revolving credit card accounts originated by Egg in the U.K. The bank has recently allowed certain borrowers of these accounts to reduce minimum monthly payments to amortize over 10 years from veering away from the more typical 48-month amortization schedule. The minimum monthly payment required for these borrowers is reduced from the usual 2.00% to 0.83% of outstanding principal each month.

Moody's is concerned that the effects of these 0.83% accounts are to increase and lengthen the period of time an account remains in delinquency and to artificially deflate the level of charge-offs for the trust portfolio. No interest or fees are charged on the principal balance. Moody's believes that if borrowers have not paid at least 2% of outstanding balances for over 360 days, then they should be considered nonperforming.

According to Moody's, the industry standard would be to have these 0.83% accounts within the trust charged-off but since the remaining accounts have not been immediately reported as charge-offs, the charge-off levels might appear lower and excess spread could appear higher. In addition, no excess spread will be provided to cover these accounts, and the resultant higher excess spread that might be reflected makes the spread trapping triggers protecting the Class C Notes less effective.

"Moody's concern was that some of these receivables in the Egg program should be charged off and the excess spread reduced accordingly," Royal Bank of Scotland analysts explained. "We also suspect that the 10-year amortization on some receivables begins to chafe the legal final maturity dates under stress scenarios. If Egg were to step up its charge-off policies to be more aggressive, its three-month average of excess spread (which ranged between 6.65% and 6.87% in June, depending on series) would be more than sufficient to sustain a measured phase-in of a tighter charge-off policy."

RBS said it's likely that Egg will comply with Moody's prescriptions because it finds securitization to be a viable funding alternative. Furthermore, under Basel II, bank charge-off policies will have to migrate toward 180 days for capital purposes.

(c) 2006 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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