U.S. credit card ABS shielded by risk management tools

By Nancy Leinfuss - Analysis

NEW YORK (Reuters) - U.S. credit card lenders have written down unpaid debt faster than the unemployment rate has risen, raising concerns about another meltdown in the asset-backed securities market (ABS).

But whereas the collapse in securities backed by sub-prime mortgages was driven by poor lending standards, the weakness in the credit card ABS market is being driven by rising unemployment during a recession that has left consumers struggling to pay their bills.

Chargeoffs, or credit card defaults, soared to 10 percent in May, the latest month for which data is available. That is more than the 9.5 percent unemployment rate recorded in June. Both the chargeoff rate and the unemployment rate are expected to rise further through the coming year.

"There's a one-to-one relationship between chargeoffs and the unemployment rate and we expect the unemployment rate to reach 10.6 percent by mid-2010, at which time, we would expect chargeoff rates to reach 10.6 percent as well," said Cynthia Ullrich, credit card ABS analyst at credit rating agency Fitch.

But even at those levels, credit card ABS securities prices are expected to remain resilient. Sturdier protection measures built into the securities are shielding investors from losses.

"We still feel that credit card trusts at those levels have sufficient credit enhancement to withstand that level of chargeoffs," said Ullrich, referring to the underlying credit support that secures the transaction.

The excess spread, the bottom layer of protection in a credit card securitization, is the first line of defense against losses. That layer comprises revenues generated from the interest rate charged borrowers along with any late and annual fees minus the servicing and chargeoff expenses.

While the excess spread recently fell below 5.0 percent to 4.61 percent, according to Citi's credit card index, analysts said the level remains healthy given the writedowns taken to date.

"An excess spread of about 5.0 percent, offers a strong cushion of support for investors. There's no question that the credit card sector is under pressure but still, even after taking losses this hasn't cost issuers anything," said Janet Braggs, ABS analyst at Dwight Asset Management, in Burlington, Vermont.

MANAGING RISK

Amid declining excess spread levels, most issuers have moved very quickly to support their deals by creating an additional layer of subordination in their transactions. Some have added an entirely new class of notes that would absorb first losses, creating a bigger buffer of protection.

Still, issuers have an arsenal of different tools at their disposal to manage risks in their portfolios, including re-underwriting credit on a monthly basis, by adjusting or cutting credit lines or adjusting borrower interest rates to reprice for risks.

The recent passage of credit card legislation has led issuers to reprice their portfolios so that revenues grow along with rising chargeoffs. Portfolio yields in credit card trusts rose to 17.98 percent, according to Citi's credit card index.

Credit card issuers, traditionally, have kept some skin in the game by retaining 5.0 percent or more of bonds in their portfolios. Many see this ensuring better performance.

"Credit card issuers have always been very diligent about owning a substantial part of their portfolios and making sure they perform well. It is a different ethic than clearly we saw on the mortgage side," said Braggs. "In some cases the holdings have been upwards of 30 to 40 percent."