Shaky economy hits credit card ABS

NEW YORK (Reuters) - As the U.S. economy teeters on the brink of recession the credit-card asset-backed market is showing signs of stress as rising unemployment squeezes consumers further, forcing defaults on credit card payments.

Delinquencies on credit cards are rising, investors are demanding higher yield spreads for credit card-backed securities, and issuance is down as the sector's largest buyers retreat.

"This is typical borrower performance as we enter a recession. This is not a replay of the subprime mortgage disaster but the market is pricing it in that way," said Glenn Schultz, analyst at Wachovia Securities. "Underwriting in the credit card segment was much better than subprime."

Fears that the problems in the subprime mortgage market would spread to the ABS market saw spreads widen in the last year or so. Spreads rated "AAA" on three-year credit cards reached 110 basis points over the London interbank offered rate in March, after trading close to Libor a year earlier, said Schultz.

Citigroup Inc (C.N), one of the banks hardest hit in the year-long global credit crisis, last week posted a quarterly net loss of $176 million from securitization of credit cards, compared with a year-ago $243 million profit.

Delinquencies and chargeoffs, or balances written off as uncollectable, have both risen past historical norms.

May's charge-off rate rose to 6.41 percent from 4.68 percent a year earlier, according to Moody's Investors Service.

After the last two economic contractions, in 1991 and 2001, charge-off rates peaked at just over 7.0 percent, it said, versus an historical average of 6.0 percent.

The monthly delinquency rate, often a harbinger of the near-term trend in future charge-off rates, reached 4.47 percent rate, versus 3.68 percent a year ago and an historical average of 4.0 percent, Moody's said.

Another worry is the rising U.S. jobless rate, which is raising the risk that consumers will fall further behind on their bills. The unemployment rate hit 5.7 percent in July, the highest in four years after employers cut jobs for a seventh straight month.

Despite a gloomier economic scenario, analysts and issuers argue that credit card securities are structured to withstand macro-economic stresses, so that even an increase in unemployment is not going to cause the bonds to fail.

"Losses we know have risen and will continue to rise, especially if the economy weakens. That being said, most of the credit card trusts are in a position where they can withstand significantly higher losses without seeing any type of downgrade let alone loss to investors," said Janet Braggs, ABS analyst at Dwight Asset Management in Burlington, Vermont.

ABS securities, which are pools of consumer loans or receivables packaged and sold to investors as securities, are structured with significant protections to mitigate risks.

The excess spread, the amount of cash assets earned in excess of the cost of funding and servicing, is the first layer of defense. If losses exceed that spread, "BBB"-rated classes would begin to incur losses before spiraling up to "AAAs."

Moody's Investors Service said while the credit card industry is in the midst of a challenging period and collateral performance is likely to get worse before it gets better, its excess spread index, which measured 7.09 percent in May, remained, on average, relatively high.

Still, falling demand from some of the sector's largest buyers, and reluctance by new investors to step in and buy, as economic uncertainty drags consumer confidence lower, has led issuance to soften over recent months.

After posting strong issuance in the first half of the year, credit card ABS supply slowed in July to $4.5 billion, representing a 43 percent decline in average monthly volume in the first half. Through July, issuance totaled $52.1 billion, a drop of 6.4 percent from 2007's level, Deutsche Bank said.

While some appetite remains for higher quality "AAA"-rated securities, tranches most insulated from losses, investors are demanding more yield spread for the perceived risk.

Last week, American Express Issuance Trust sold $1.0 billion of "AAA"-rated credit card ABS at a spread of 82 basis points over eurodollar swap futures, four basis points above a similar deal by Banc of America in late July.

"What you are experiencing in the credit card sector right now is that the natural buyers aren't there," said Patrick DeCatalogne, head of fixed income and trading at Castle Oak Securities. "Yankee banks, because of their conduit holdings, are out, and the securities lenders haven't put any money to work. Without them in the game that's forced a lot of liquidity out of the market," he said.

(Additional reporting by Jonathan Stempel)