The higher yield of portfolios is one of the key reasons that U.K. credit cards are more attractive to some investors than U.S. cards. Competition and regulation, however, could siphon that advantage away from the U.K. card lenders.
"One of the rating agencies did comparative takes with yields on various trusts, and you'll always see the U.K. trusts at the highest end for yield and at the lowest end for defaults," said one market source. "People pay more for their credit in the U.K., and personal bankruptcy still remains a taboo area in a way that it isn't in the U.S."
In defense of these higher yields, marked not just in the U.K. market but also throughout the growing European credit card sector, U.S. institutions are typically able to employ heavier individual risk assessments that are not available for rating European consumers. How these institutions understand client credit risk in Europe is still an area with which most card issuers grapple, explained one market source.
"Most of the institutions that crossed over from the U.S. market were actually well- known for their marketing ability directly to customers where they wouldn't necessarily have a depositor base like the European-based banks, which could say You have an account here so we'll give you a credit card,' " said the source. "These U.S. institutions relied on targeting customers based on research and credit risk assessment but in the U.K., where do you get that information from, when there is no centralized system like the U.S.?"
Until recently, data protection laws that prevented information from being shared prompted some local European councils, particularly in London, not to divulge information from their electoral role. These rules can often be tougher throughout continental Europe. Card companies argue that they should be allowed to charge higher fees because they don't have access to the same customer-level information; hence, it's not possible to price the risk as efficiently.
Yield slips away?
Meanwhile, recent discussions on the interchange fee may chip away at the higher yields. The interchange fee was designed as a way for cards to dip into profits generated by retailers (see ASR 2/24).
After the preliminary investigation by the Office of Fair-Trading (OFT) earlier this year, analysts argued that this yield loss would have a nominal impact on overall yields generated by securitized portfolios. "Nonetheless, interchange could ultimately affect the way originators are generating yields on portfolios," explained one market source. "There could be some shifting, in general, on who is paying for what because this change is a factor - albeit not exclusively - on yield generated in portfolios."
Thus far, OFT has ruled that the rates charged by the card companies are too high, but it's not entirely clear what card issuers will do to compensate this fee going forward.
Regulators have recently targeted the lack of transparency and conformity in the annual percentage rate (APR) quoted by credit card issuers. According to commentary provided by Deutsche Bank, the concerns resulted from findings by the Consumer Association that different products with the same APR do not necessarily charge their customers the same amount, which skews comparisons between credit card products. "APRs is the dominant component of portfolio yields in credit card securitizations," reported Deutsche Bank. Deutsche's portfolio cash yield index for U.K. card ABS ended May at 19.02%
It's hard to predict where this debate will lead. For example, the investigations may focus more on the disclosure of rates to consumers, rather than the rates themselves. "It may be more of a case of ensuring that consumers get a proper picture of how APR applies," explained one market source.
This type of transparency would bring the U.K. in line with U.S. practices, which could make credit cards more "user-friendly," which, in turn, could lead to greater origination. "Some card issuers in the U.K. already comply with this type of format so it remains to be seen how big of a leap it would be for others to do the same," the source commented.
And then there's accounting...
Most of the participating U.K./European issuers are not interested in local accounting treatment, and it's likely that IAS 39 will only affect how theses banks regulate profit. On the other hand, card issuers are closely following changes to U.S. accounting rules and are perpetually trying to modify existing programs in a way that fits within the parameter of the latest U.S. accounting guidelines.
"These issuers are constantly having to tinker around with structures simply because they are trying to decide whether the program complies and gets the regulatory capital relief," one analyst said. "Regulatory capital relief is being driven by how accountants interpret your program. That has generated quite a bit of activity in the last 24 months."
As for Basel II, it's far enough down the line to cause too much concern, though card issuers are wise to closely follow the sections dealing with revolving credits.
Basel II essentially aims to split capital treatment into two camps: uncontrolled early amortizations and excess spread levels. "Basically, if you have U.S.-styled uncontrolled amortization, you get more penal capital treatment than if you have a U.K.-style, FSA-compliant, controlled amortization profile," said one source. "And if your spread levels go below certain trigger levels, then you have a higher capital charge because the view is that you are closer to amortizing."
It's not likely to negatively impact the credit card market because most institutions aim to sell all of the notes in a transaction to investors. Moreover, it could turn out to be beneficial for these investors. "These originators are not aiming to retain any of the pieces," the source said. "Because at least 85% to 90% will be triple-A issues and the capital costs of triple-A's will go down significantly, the capital costs of investing in credit cards will go down significantly as well."
Whether or not U.S. institutions will play ball under Basel II regulations is still a concern. To the extent that the U.S. exempts their banks from compliance, it could ultimately and unfairly provide advantages to some U.S. issuers with U.K. programs. "They could end up with favorable amortization structures in those programs than what would be allowed in Europe," said one source.
Despite the evolving regulatory environment, which is clearly a concern for the industry, there may be greater headaches down the line. According to market sources, less creditor-friendly bankruptcy laws are taking shape in many European countries. Although the European culture is not as accepting of personal bankruptcy as that of the U.S., if this changes substantially over the next few years, portfolio performance would more than likely be negatively impacted.