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Abcs of Credit Card ABS
Abcs of Credit Card ABS
This program also provides an incen- tage to cardholders of using store cards banks, such as Fleet Bank, Capital
tive for cardholders to pay their bills on is that available credit on the custom- One, First USA Bank, and MBNA,
time, since the reward benefits will be ers’ other cards is not used up, allowing benefit from funding at ‘AAA’ rates and
revoked if the cardholder becomes de- cardholders to “compartmentalize” low capital charges and, in some cases,
linquent. Household and General Mo- their debt burden. For example, a con- rely on off balance sheet treatment to
tors Corp. (GM), Citibank, N.A. and sumer might use a Sears, Roebuck and meet regulatory requirements. Without
American Airlines, and Chase Manhat- Co. card to purchase a new refrigerator securitization, some of these banks
tan and Shell Oil Co. are several joint and pay it off evenly over time without could not have grown as rapidly. As of
ventures in the co-branded arena. Each using up a Visa or MasterCard line. The May 31, 1998, more than $216 billion in
program has different arrangements for retailer benefits by building customer credit card securities had been issued.
expense and revenue sharing. loyalty and increasing the profitability
of its lending operation. Stand-Alone vs. Master Trust
Discover Card A vast majority of card securitizations
Discover is the only significant issuer of Other Cards have been completed using two differ-
general purpose credit cards to success- Travel and entertainment cards, such as ent vehicles — the stand-alone trust
fully break into the U.S. market with- American Express and Diners Club, and and the master trust. The former is
out relying on Visa or MasterCard full-service cards, like Citibank and simply a single pool of receivables sold
associations. Discover developed its Chase Manhattan Bank, round out the to a trust and used as collateral for a
own merchant network across the U.S. spectrum of card types. single security, although there may be
13 years ago and, since then, has several classes within that security.
achieved notable market penetration. Securitization When the issuer intends to issue an-
The barriers to entry into this arena are As with credit cards, the use of securi- other security, it must designate a new
high due to significant start-up costs tization as a financing tool has increased pool of card accounts and sell the re-
and intense competition. Discover’s in volume and importance. The first ceivables in those accounts to a sepa-
card has been extremely successful be- deals were done in 1987 to diversify rate trust. This structure was used from
cause of the company’s cash rebate for sources of bank funding. As the banks the first credit card securitization in
purchases strategy and clear, simple came under pressure to free up on bal- 1987 until 1991, when the master trust
pricing structure. ance sheet capital in 1990 and 1991, became the preferred vehicle.
securitization filled that need. (Bank
Retail Cards regulators treat securitization as asset The master trust structure allows an
Many retail stores offer their customers sales.) More recently, securitization has issuer to sell multiple securities from
the choice of using a national credit been the primary funding source for the same trust, all of which rely on the
card or the store’s own card. An advan- specialized credit card banks. These same pool of receivables as collateral.
For example, an issuer could transfer Other efficiencies can be included in a accumulation), and early amortization.
the receivables from one million ac- master trust, including sharing of prin- Each period performs a different func-
counts (representing $1 billion of re- cipal and sharing of excess spread (see tion and allocates cash flows differently.
ceivables) to a trust, then issue multiple Master Trust Features, page 8). This structure is designed to mimic a
securities in various denominations and traditional bond, in which interest pay-
sizes. When more financing is needed, In addition to issuing investor securities, ments are made every month and prin-
the issuer transfers receivables from every seller is required to maintain an cipal is paid in a single “bullet”
more accounts to the same trust. It can ownership interest in the trust. This par- payment on the maturity date.
then issue more securities. The receiv- ticipation performs several critical func-
ables are not segregated in any way to tions. It acts as a buffer to absorb seasonal Since the average life of a credit card
indicate which series of securities they fluctuations in credit card receivables receivable is a short five to 10 months,
support. Instead, all the accounts sup- balance, is allocated all dilutions (bal- an amortizing structure, like the ones
port all the securities. ances canceled due to returned goods) used in automobile and mortgage deals,
and fraudulently generated receivables does not work very well. In this type of
This structure allows the issuer much that have been transferred to the trust, structure, the principal and interest col-
more flexibility, since the cost and ef- and ensures that the seller will maintain lections on the pool of loans are passed
fort involved with issuing a new series the credit quality of the pool since the directly through to investors on a
from a master trust is lower than creat- seller owns a portion of it. To ensure that monthly basis. An amortizing structure
ing a new trust for every issue. In addi- the certificateholders’ invested amount for credit card-backed securities would
tion, credit evaluation of each series in is always fully invested in credit card result in a short average life and lumpy,
a master trust is easier since the pool of receivables, the size of the seller’s partici- unpredictable repayment to investors.
receivables will be larger and not as pation must remain at or above a mini- Use of a revolving structure gives the
subject to seasonal or demographic mum percentage of the trust receivables issuer medium- to long-term financing,
concentrations. For example, if an is- balance, usually 7%. The seller’s partici- and it gives the investor a predictable
suer transferred only receivables from pation does not provide credit enhance- schedule of principal and interest pay-
accounts originated in 1989 into a ment for the investors. ments.
stand-alone trust and the next year
transferred all the receivables from The seller is obligated to add credit All collections on the receivables are split
1990 accounts into a different trust, the card accounts to the trust if the amount into finance charge income and principal
two would perform differently based on of its participation falls below the re- payments. Each of the three periods treats
the underwriting standards used, the quired minimum. If the seller cannot finance charge income in the same man-
terms (annual payment rate [APR] and provide additional accounts, an amorti- ner. Monthly finance charges are used to
minimum monthly payment) offered, zation event will occur (see Amortization pay the investor coupon and servicing
and the competing offers available at Triggers, page 5). In most circumstances, fees, as well as to cover any receivables that
that time. the seller must receive rating agency have been charged off in the month. Any
approval before any accounts can be income remaining after paying these ex-
If a master trust had been used in the added. Sellers do not need approval penses is usually called excess spread and
same example, both series would de- when the addition is a small percentage is released to the seller. Principal collec-
pend on the same pool of accounts, of the trust (10%–15%) or when the tions, however, are allocated differently
one-half of which were originated in minimum seller’s participation level during each of the periods.
1989 and one-half of which were origi- has been breached. Of course, rating
nated in 1990. Credit differences be- agencies will receive notification of Revolving Period
tween the two series would be these events. During the revolving period, monthly
contained in the structure of the deal, principal collections are used to pur-
rather than the receivables. Investors Structures chase new receivables generated in the
must keep in mind, however, that the Regardless of whether the trust is a designated accounts or to purchase a
makeup of accounts in a master trust stand-alone or a master trust, the same portion of the seller’s participation if
pool may change dramatically over time general structure is used for every deal. there are no new receivables. If there
as new accounts are added and as some The typical setup has three different are not enough new receivables to rein-
existing cardholders cancel or stop us- cash flow periods: revolving, controlled vest in, an early amortization will be
ing their accounts. amortization (in some cases, controlled triggered because the seller’s participa-
Early Amortization
Severe asset deterioration, problems
with the seller or servicer, or certain legal
troubles can trigger early amortization at
any point in the deal, whether it is revolv-
ing, amortizing, or accumulating. The
box on page 5 shows common amortiza-
tion triggers. In such cases, the deal auto-
tion has fallen below the required mini- cess of the controlled amount will be matically enters the early amortization
mum, or, in some cases, the excess prin- reinvested in new receivables, as in the period and begins to repay investors im-
cipal collections will be deposited in an revolving period. Interest will be paid mediately. This feature helps protect in-
excess funding account and held until only on the outstanding amount of se- vestors from a long exposure to a
the seller can generate more credit card curities as of the beginning of the deteriorating transaction.
receivables. The risk of early amortiza- monthly period.
tion gives the seller adequate incentive Fast Pay Allocation
to maintain the seller’s participation at Controlled accumulation follows a In the event that an early amortization
a level well above the minimum. The similar procedure, except that the con- is triggered and not cured, the investors
revolving period continues for a prede- trolled payments are deposited into a will begin to be repaid immediately on
termined length of time, which has trust account, or principal funding ac- a fast pay, or uncontrolled, basis. All
ranged from two to 11 years. Investors count (PFA), every month and held un- principal collections and any amounts
will receive only interest payments til the expected maturity date. At the in the PFA will be distributed to inves-
during this period. end of the accumulation period, the full tors, with senior certificates being paid
Controlled Amortization/
Accumulation
At the end of the revolving period, the
controlled amortization or controlled
accumulation period begins. In the
case of controlled amortization (see
chart above), which typically runs for
12 months, principal collections are no
longer reinvested but are paid to inves-
tors in 12 equal controlled amortization
payments. The payments are sized at
exactly one-twelfth of the invested
amount so investors can be repaid on a
predetermined schedule. (Some series
may have longer or shorter controlled
periods and, thus, will have smaller or
larger controlled amortization pay-
ments.) Any principal collected in ex-
ever, excess falls below zero, other CCA, or the CIA. Like the CCA and should repay investors 100% of their
credit enhancement must be available CIA, draws on the subordinate certifi- original investment plus interest. Secu-
to make up the shortfall. cates may be reimbursed from future rities rated in the ‘A’ category (subordi-
excess spread. Principal collections will nated certificates) are subject to less
Cash Collateral Account be allocated to the subordinate inves- severe recessionary scenarios than
A CCA is simply a segregated trust ac- tors only after the senior certificates are those used for ‘AAA’; however, they are
count, funded at the outset of the deal, fully repaid. considered to be investment grade and
that can be drawn on to cover shortfalls of high credit quality. The trust’s ability
in interest, principal, or servicing ex- Letter of Credit to pay interest and repay principal to
pense for a particular series if excess From the inception of credit card secu- class B is strong, but it may be more
spread is reduced to zero. The account ritization until 1991, the letter of credit vulnerable to adverse changes in eco-
is funded by a loan from a third-party (LOC) was a common form of enhance- nomic conditions and circumstances
bank, which will be repaid only after all ment. It is an unconditional, irrevoca- than class A.
classes of certificates of that series have ble commitment from a bank to provide
been repaid in full. Cash in the account cash payments, up to the face amount Credit card ABS performance can be
will be invested in the highest rated of the LOC, to the trustee in the event influenced by many variables, with
short-term securities, all of which will that there is a shortfall in cash needed both positive and negative effects.
mature on or before the next distribu- to pay interest, principal, or servicing. Fitch IBCA develops stress scenarios at
tion date. Draws on the CCA may be Usage as a form of enhancement was every rating level for each ABS issuer
reimbursed from future excess spread. discontinued when a number of banks and structure by evaluating the per-
providing LOCs were downgraded and formance variables described in the
Collateral Invested Amount the transactions they enhanced were box below.
The CIA represents an uncertificated, downgraded as a result. The CCA was
privately placed ownership interest in developed to remove downgrade risk Current/historical performance or, if
the trust, subordinate in payment rights caused by enhancer credit quality, and the portfolio is unseasoned, a conserva-
to all investor certificates. Acting like a this marked the end of the use of LOCs tive projection of performance is used
layer of subordination, the CIA serves in credit card transactions. as a benchmark by which to assess fu-
the same purpose as the CCA; it makes ture performance. The stress scenarios
up for deficiencies if excess spread is Stress Scenarios applied to a transaction are determined
reduced to zero. The CIA is tradition- Under the most severe depression sce- on a case-by-case basis and compared
ally placed with banks, which may re- narios, properly structured ‘AAA’ credit to a hypothetical industry benchmark.
quire investment-grade ratings on the card asset-backed securities (ABS) The major variables influencing credit
CIA as a condition to purchase. The
CIA itself is protected by a spread ac-
count (not available to any other inves-
Performance Variables
tors) and available monthly excess ❑ Underwriting standards
spread. If the CIA is drawn on, it can be ❑ Cardholder credit scores
reimbursed from future excess spread. ❑ Card type — retail, low-price, affinity, and co-branded, among others
❑ Fixed- or floating-card annual percentage rate
This class of enhancement also goes by ❑ Flexibility of issuer to reprice card rates
other names — CA investor interest, ❑ Frequency of floating-rate resets
collateral interest, enhancement in- ❑ Use of teaser rates
vested amount, or “C” tranche. ❑ Attrition
❑ Geographic and demographic diversification
Subordination ❑ Interchange
A senior/subordinate structure offers ❑ Convenience usage
two different types of investor owner- ❑ Seasoning
ship in the trust — senior participation ❑ Servicing
in the form of class A certificates and ❑ Competitive position
subordinate participation in the form of ❑ Management
class B certificates. Class B will absorb ❑ Discounting of new receivables into trust
losses allocated to class A that are not ❑ Other structural features
already covered by excess spread, the
Sears Credit Card Master Trust — Stress Scenarios ceptions may be made if the retailer is
(%) unlikely to file under Chapter 7.
ment date. All principal must be paid Early amortization risk is not a focus of ➢ Fixed- or floating-rate investor coupon.
on or before this date. It is extremely investors when deals perform strongly. ➢ Seller/servicer strength.
unlikely that MPR would be so slow However, before consumer delinquen- ➢ Ability to discount new receivables
that principal would not be repaid by cies and chargeoffs increase, portfolio into trust.
the series termination date. yields come down dramatically, or inter- ➢ Sharing of excess spread.
est rates shoot up, investors should look ➢ Percentage of total bank receiv-
The amount of enhancement any deal very closely at their investments to deter- ables that have been securitized.
has does not affect the probability of mine their exposure to prepayment risk. ➢ Existence of variable funding, ex-
early amortization. And investors must Several topics should be considered tendible, or commercial paper series.
keep in mind that ratings do not reflect when evaluating early amortization risk,
the likelihood of this occurrence. In including:
fact, it is possible that a deal’s ‘AAA’ ➢ Variability of chargeoffs.
rating would be affirmed if an early ➢ APR pricing position (competitive
amortization commenced. or not).
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