Rate rise would knock UK Credit Card ABS, warns Moody's

Tue Feb 18, 2014 10:40am EST

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LONDON, Feb 18 (IFR) - Following the Bank of England's explanation last week of which factors will determine the level of the base rate, Moody's has warned that a rise in short-term interest rates could prove a setback for the UK credit card asset-backed securities (ABS) market.

The Bank said in August that it was unlikely to raise the base rate before the unemployment rate dropped below 7%. And while this rate dropped to 7.1% last month, it clarified last week that this is only one of many factors that will drive the decision.

The Bank said there is no immediate pressure to raise rates, but added that it expects the base rate to rise gradually once the economy is able to sustain higher interest rates.

Moody's says that such a rise would decrease the excess spread in UK credit card ABS, which would be credit negative for the asset class. This is because originators would not be able to raise asset yield in line with the rise in the Libor-linked expenses of UK credit card transactions.

Asset yield comprises many components that cannot be changed to reflect a rate increase, such as fees and recoveries, and even the interest component of yield is generally subject to certain restrictions and a time lag.

The rating agency estimates that, on average, around 25% of trust yield comes from sources that are independent of interest rate movements. While the majority of UK credit cards have a variable interest rate, originators cannot reset it within the first 12 months of the account being open, and no more than every six months

Moody's further believes that the ability of credit card lenders to reset variable interest rates could be curbed by competitive pressures, noting that credit card interest rates have poorly tracked base rate movements in the past.

Despite these potential pressures, Moody's says that the prevailing high level of excess spread will cushion the effect of interest rate increases. Trust excess spread levels are at their historical peaks, owing to the low Libor rate and strong collateral performance.

The underlying credit card market is also showing tentative signs of growth. UK credit card lending grew in 2013 for the first time since 2008, according to British Bankers' Association data released on February 7 2014, due to a deceleration in the rate of debt repayment growth compared to the growth rate for new purchases. (Reporting by Robert Smith; Editing by Philip Wright and Julian Baker)

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