Continental Finance Co., a consumer-finance company headquartered in Wilmington, Delaware, is marketing $65 million of bonds backed entirely by subprime credit card receivables, according to Morningstar Credit Ratings.
The transaction, dubbed Continental Credit Card ABS 2016-1, will issue three classes of notes with preliminary ratings from Morningstar: a $40.7 million tranche of class A notes with a weighted average life of one year is rated A+, a $13.58 million tranche of class B notes with a WAL of 2.3 years is rated BBB+, and a $10.18 million tranche with a WAL of 3.3 years is rated BB+.
Natixis and Griffin Financial Group are the initial purchasers.
Investors must consider two very different kinds of risk, according to Morningstar. First, the credit risk of the collateral: CFC focuses on borrowers with either limited credit history or a below prime credit score. Most of the underlying credit card accounts are unsecured, with a small number being partially or fully secured. (Besides the outstanding principal balance, the annual credit card fees, late payment charges, and the annual percentage rate charges make up the bulk of the receivables.)
Morningstar’s expects cumulative charge-off rate is between 45% and 50% of the original pool balance.
However, Morningstar believes that these risks are mitigated by the low expected weighted average lives of the notes.
However, the high interest rates that CRC charges on outstanding balances results in a high level of excess spread over the expected interest rates on the credit card-backed notes. That’s even after taking into account a 3% annual attrition rate among credit card holders and approximately 10% expenses on various fees and interest on the notes. It does not assume any defaults.
Morningstar also takes comfort from the experience of CRC’s management team and the seasoning of the pool. All accounts will be at least 12 months old when the deal closes.
Continental Finance Co.’s business model itself is also a risk. It relies on what is known as a “rent a bank” model. The credit card accounts backing this transaction are originated by Mid America Bank & Trust and Celtic Bank, and purchased by Continental Purchasing, a wholly-owned subsidiary of Continental Finance Co., or CFC.
There are legal threats to this business model, which allows CFC to charge higher interest rates than it could in many states as a nonbank. In a recent cases, the courts have found that the buyer of loans originated by banks, and not the banks themselves, are the true lenders. “If a court finds CFC to be the true lender or finds CFC’s credit card program to be in violation of a state’s usury laws, it may significantly reduce the value of receivables and deteriorate the deal’s performance,” the presale report states.
Since March 2006, CRC has approved more than 2.2 million MasterCard and Discover Card accounts. As of Oct. 31, 2016, it had a credit card portfolio of approximately $171 million.