Credit card ABS issuers poured significantly greater amounts of new paper into the securitization market so far this year. From January through Feb. 11, about $19 billion in card ABS deals were completed, according to the ASR Scorecard database. Other industry tallies put issuance at about $13 billion, but either figure easily outpaces the $10 billion that was done in the same period the year before.
The activity also underscored how heavily the securitization business has come to rely on the consumer ABS sectors to keep business going. Credit card issuance has accounted for almost 60% of total issuance so far this year, according the ASR database's figures.
Such a performance comes off of a record year for issuance in 2007, when $94.6 billion in credit card ABS hit the market, according to Moody's Investors Service. The rating agency said it expects another year of record issuance, owing to the potential refinancing of $67.2 billion in card ABS expected to mature this year.
Rosy issuance expectations aside, a couple of major developments, such as expectations of a recession and legislative reforms in the credit card industry, have prompted market watchers to question whether credit card trusts can maintain their integrity in the coming years.
Given those two prospects, the outlook for credit card ABS performance is mixed, according to industry observers. During previous recessions, U.S. consumers collectively maintained momentum in their spending by tapping into home-equity lines of credit. Also, those home-equity lines kept debt service ratios (DSR), which usually fall during recessions, artificially high during the 2001/2002 recession.
"Overall, there is no doubt that there will be pain in the short term as performance gets worse, and pessimism points that way," an industry analyst said. "Still, relative value spreads are at all-time highs."
Usually, spikes in credit card charge-offs and delinquencies parallel unemployment rates. Only twice have there been exceptions: during the 1997/1998 credit cycle, when underwriting standards were loosened significantly and in October 2005, during the Bankruptcy Code reform. During the late-90s credit cycle, charge-offs increased sharply as unemployment dipped to a range of 5.3% to 4.5%, according to data presented by UBS. While bankruptcy code reform was underway, charge-offs spiked to about 7.3%.
As far as previous recessions go, credit card charge-offs increased to 6.4% in the 1990/1991 recession and hit a peak of 7.1% in the 2001/2002 recession. While credit card charge-offs are currently up on a year-over-year basis, they still remain below the historical 5.5% average.
Delinquencies rose 10.1% on a year-over-year basis, and have reached levels that are higher than pre-October 2005 levels, according to UBS. During the 1990/1991 and 2001/2002 recessions, they hit peaks of 6.3% and 5.5% respectively.
There is another cause for comfort, according to UBS. Although underwriting standards deteriorated, they did not decline as much as they did in the 1997/1998 credit cycle or as much as they did in the subprime mortgage market. More importantly, standards did tighten in yearend 2006 and early 2007. Further, the credit card sector went through its downturn and shakeout cycle in the 1997/1998 credit cycle, so there were a lot of bankruptcies and consolidations.
"The ... credit card industry has a stronger set of firms due to consolidation and weeding out of weak firms post the 1997/1998 credit cycle," wrote UBS analysts. "Among credit card trusts, the required minimum payment of principal will help mitigate overall losses. Also, some studies show that subprime consumers are paying off credit card debt over mortgage debt."
UBS is not alone in its measured optimism for the performance of credit card trusts. In late January, Standard & Poor's said that if the U.S. economy experiences a recession similar to that of 2001, or endures a more severe one, then investors holding triple-B-rated credit card ABS are unlikely to experience payment defaults for timely interest and ultimate repayment of principal by the transactions' legal final maturity dates.
The rating agency came up with a cashflow model using its Credit Card Quality Index from March 2001 to June 2003, adding the extra time to allow for the fact that credit card losses typically lag recessions by about 12 months.
Such resilience might entail a few sacrifices, though, according to the rating agency.
"It is conceivable that a number of trusts would be required to trap excess spread and some securities may be placed on CreditWatch with negative implications or downgraded," wrote S&P analysts.
Moody's Investors Service said it held a negative outlook on the credit card sector, citing technical and fundamental reasons. Like UBS, Moody's acknowledged that performance of the credit card sector has moved in step with broad economic factors like unemployment and income fundamentals. According to its November 2007 credit card index, charge-off rates remain below 5%, short of the long-term average of 5.5%. Many credit card portfolios continued to report charge-off rates below its range of expectations.
"Even so, both the charge-off and delinquency rates are clearly on the rise and, in the coming months, will likely continue to rise," analysts wrote. "For some trusts, charge-off rates may increase close to the upper bound of Moody's range of expected performance by year end."
Moody's also highlighted an important aspect relating to interest rates, saying that the average yield on credit cards had been stable and improving through November, despite the significant drop in interest rates. Not only have many card issuers exercised discretion in rates charged to cardholders, but risk-based pricing and the presumed increase in late fees collected on the increasing proportion of delinquent borrowers has bolstered some yield.
"Should the Fed ease further, as anticipated, issuers' ability to re-price and maintain portfolio yield in a falling rate environment will again be tested," Moody's wrote.
In the near term, Federal Reserve actions might not be the only test of yield integrity. Earlier this month, Rep. Carolyn Maloney (D-N.Y.), introduced the Credit Cardholders' Bill of Rights Act of 2008, which calls for reforms in the way that credit card issuers charge fees and raise rates.
Among other provisions, Maloney's bill seeks to protect cardholders against arbitrary interest rate increases, abolish penalties for cardholders who pay on time, allow cardholders to set limits on their credit, ban excessive fees on cardholders and prevent card companies from giving subprime credit cards to people who cannot afford them.
Maloney wants to require that card companies give their customers 45 days notice of any interest rate increases. Cardholders should also have the right to cancel their card and pay off their existing balance at the existing interest rate and repayment schedule if they get hit with an interest rate hike. Cardholders would also have three billing cycles after the rate increase to say no to these new terms.
The bill would also prohibit card companies from charging interest on debt that is paid on time during a grace period, preventing what is commonly called the "double-cycle billing" practice. Card companies would also be prohibited from charging fees on remaining interest-only balances of cardholders who have paid their bills on time.
The direction of the economy and the outcome of Maloney's bill are still unclear, but for now some investors are keeping an eye on enhancement levels and triggers in credit card portfolios.
"My concern is there have been a lot of deals that have struggled, because folks are hesitant to believe the rating agencies on these triggers," said one investor, referring to recent issuances. "Charge-offs are now 4%. If they go to 6% or 7%, they better work. Maybe [some investors] are waiting for rating agencies to raise the requirements."
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