Credit card ABS solid even as delinquencies climb

NEW YORK (Reuters) - Despite concerns over a weakening U.S. economy and an increasingly cash-strapped consumer, investors in asset-backed securities supported by consumer credit debt should not expect their market to be roiled.

Delinquencies still remain in line with historic norms, borrowers are repaying nearly 20 percent of balances each month, and the poor lending standards that fueled the subprime mortgage crisis are largely absent from the mostly prime credit card asset type, leaving it better able to weather an economic downturn.

"A monthly payment rate near 20 percent indicates that consumers are paying their credit card balances," said Glenn Schultz, analyst at Wachovia Securities. "If you saw payment rates fall as charge-offs rose, then that would tell you something."

Delinquencies of 60 days or more on prime credit cards climbed 0.04 percent to 3.16 percent in March but have still just reached their long-term historical average. Prime delinquencies are up 0.55 percent on a year-over-year basis, said Fitch Ratings.

Charge-offs have climbed by 100 basis points over the last six months to 5.73 percent in March but remain below their 6 percent long-term average, said Fitch. Charge-offs are write-downs of uncollectible debt.

"Credit cards didn't have the explosive growth and the weakening of underwriting standards that you saw in mortgage or home equity line of credit product," said Cynthia Ullrich, a Fitch analyst. "It didn't climb as high, so it doesn't have that far to fall," the analyst said.

While overall issuance of ABS securities has tumbled by over 80 percent from year ago levels, the credit card segment has been the only asset class to experience growth. Appetite for deals has been strong. Sales of credit card ABS totaled $35 billion through April, jumping 14 percent above the same year ago period.

In yet another positive sign for the market, yield spreads have narrowed about 20 to 30 basis points since mid-April.

April's better-than-expected reading on the U.S. labor front, showing a decline in the unemployment rate to 5 percent from 5.1 percent, also was an encouraging sign.

"The health of the U.S. consumer and the ABS market will be determined in large part by the labor market. If consumers have jobs, then they can most likely pay their obligations," said Schultz.

Still, the housing market slump has cut into consumers' other funding sources, like home equity lines of credit and cash-out refinancings, leading borrowers to rely on more traditional means for purchases -- their credit cards.

Revolving consumer credit, led largely by credit card receivables, grew over 7.5 percent in 2007 and now stands at almost $952 billion according to the Federal Reserve.

Analysts said, however, that credit card issuers remain better equipped to manage the risks. "If they need to cut the credit line or prohibit authorizations on accounts that belong to people experiencing financial stress, they can actually do that. Credit card issuers have a pretty well-rounded tool kit with which to manage risks," said Ullrich.

Unlike mortgages, where terms often are pretty much set for 30 years, credit cards are not static products and offer a bit more flexibility due to the revolving nature of the asset class, which allows terms to be modified to fit a borrower's risk profile.

Also supporting sector performance are the significant credit enhancement and structural protections embedded in credit card transactions to mitigate investor risks.

"The excess spread (credit support) along the top tiers of the credit card market have more than adequate protection to limit potential losses to investors in an economic downturn," said Derrick Wulf, portfolio manager at Dwight Asset Management Co. In addition, the market had already factored in a rise in delinquencies and charge-off rates, he said.

ABS transactions offer various layers of protection against default for investors. The excess spread, the amount of cash assets earn in excess of the cost of funding and servicing, is the first layer of defense and has remained at historical highs. If losses exceed that spread, bottom "BBB"-rated tranches would begin to incur losses before they traveled up the spectrum to "AAAs."

Dislocations in the overall structured finance market, which drove yield spreads to historic wides, had raised concerns about the resilience of credit card ABS in a gloomier economic scenario.

Even if the economy were to experience more than a mild recession, however, credit card ABS investors were unlikely to experience payment defaults even on "BBB" tranches.

"Securities are structured to actually withstand macro-economic stresses, so even an increase in unemployment is not going to cause the bonds to fail," said Ullrich.

(Editing by Andrea Ricci))