With the Office of Fair Trading's statement this month that credit card interchange fees breach both U.K., and European Union competition laws, the regulator has recommended a reduction be made in the fees charged. If changed, a forced reduction is likely to impact U.K. credit card ABS trust yields and excess spread, as interchange fees typically contribute between 50 and 200 basis points to total portfolio yield.
The Office of Fair Trade issued its statement of objections against Visa and its members earlier this month. In an almost identical case, it issued a ruling against MasterCard last month. Visa has approximately 43 million cards in the U.K., according to market reports. If the Office of Fair Trade upholds its objections, Visa could be forced to reduce the fees or face fines. Barclays Capital's Paul Geertsema said that while this reduction in yield could drive originators to revise pricing, this re-pricing would be selective and may not fully compensate for the loss of interchange fees.
"It would be wrong to say that there will be no impact - I think there will be an impact, but that is likely to last a few months rather than for years," said Geertsema. "This is a sector where you have a lot of competition - if something changes that affects the whole industry, originators will try to adjust their pricing structure to maintain profitability. Furthermore, the [Office of Fair Trade] is only suggesting a reduction of fees, not a complete cut."
"Over the medium and long term, the portfolio yield of credit card portfolios will be determined by inter-issuer competition, as issuers adapt their credit card pricing to changes in the interchange regime," Geertsema added.
Some deals - Affinity, ARRAN, Gracechurch, CARDS, Sherwood, Cumbernauld and Pillar - have features to mitigate the impact of an interchange fee reduction. In these particular deals, a certain portion of the servicing fee, called the servicer interchange fee, can be paid only out of interchange fee income. To the extent that interchange fee income is insufficient, the servicer interchange fee is correspondingly reduced, explained Geertsema. "This mechanism serves to move some of the risk associated with a reduction in interchange fees from the securitization to the servicer," he said.
In July Fitch Ratings said that it gave zero credit to interchange income in its analysis. Additionally, according to Debashis Dey at Clifford Chance, "in ABS, interchange is not a material component of the cashflow, as its not used to enhance deals - the rating agencies don't give it a lot of credit either. Securitization is in the same place that it was before, in structuring we haven't been very pressed with the issue and neither have originators."
But what will be impacted is the way credit cards do business in the U.K. Lenders hit by the fee reductions will have to replace this income and it is most likely to come out of the consumer pocket. The interchange fee reduction can be offset by the lenders ability to initiate yield-generating measures such as raising account APRs and scaling back product offerings - MBNA Corp., Egg Bank and Barclays Capital all raised credit card APRs recently, said analysts at Deutsche Bank Securities.
The Office of Fair Trade may have been under the impression that the interchange fee hurt the consumer but the biggest lobbying against the fee came from merchants, like the U.K. supermarket retail chain TESCO. "As a consumer, what you think about are late fees, interest rate charges and, up to now, consumers have reaped the benefits of low interest rate charges and no annual fees," said one market source. "Now, without interchange fees absorbing some of the costs, it's the consumer that will be paying the difference."
The average U.K. credit card ABS trust yield has remained stable over the past year (averaging 19.7% last month) while chargeoffs have been trending upward (5% currently versus 4.1% one year ago), resulting in generally lower excess spread. At the moment the bigger concern for the industry is the slowdown in U.K. consumer spending, which has reduced credit card origination volume this year.
The British Bankers Association recently reported that net credit card lending was negative in August. "Against the backdrop of slowing credit card debt, we expect the activity in the U.K. credit card ABS market to remain subdued over the fourth quarter, with the exception of a potential deal from Egg, which has yet to come to market this year," said Deutsche Bank analysts. Additionally, HSBC announced its intentions to securitize credit card receivables from its $10.1 billion portfolio in the coming year.
On a separate issue, the Office of Fair Trade is now investigating credit card advertising. New legislation on the financial promotion and advertising of loans and credit cards, implemented last October, forbids banks from offering teaser rates unless 66% of all customers are successful in their application. In a survey conducted last month The Office of Fair Trade found that more than 60% of all advertisements for loans and credit cards did not meet the current advertising rules and said that some lenders failed to offer the headline APR to the majority of customers. The OFT announced that it will embark on a "targeted sweep" of non-compliant credit card providers.
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