Asset-Backed Securitizations (ABS), a Wall Street function, provide a funding source for top credit card issuers. You can learn more about how the process works at this Mercator Advisory Report. The short story is that credit card issuers can pool receivables into a dedicated trust, then sell portions to institutional investors. The issuing bank retains servicing rights, and investors have the potential to yield higher returns. The process works well for top issuers, who can create billion-dollar pools that provide predictable income. Smaller issuers do not usually have the critical mass to make the trusts attractive to institutional investors.
Each trust gets reviewed by a rating agency, an independent party that examines the trust, tests the claims made in the prospectus, and the quality of the receivable. The use of FICO Scores is almost universal. Mercator’s research has established that nearly 100% of credit card trusts, and many other collateral classes, use the FICO Score as a basis for quality. In fact, in the few instances where FICO Scores are not used, portfolio performance tends to be beneath the quality of top issuers who rely on the score.
Today’s read comes from Fitch, one of the eight certified rating agencies, and it screams caution to investors, downgrading their ratings for Canadian credit card issuers, posing a gray cloud for ABS Trusts in Canada. The driver, of course, is the economy and the impact of COVID-19 on consumers everywhere.
- Fitch Ratings has revised its 2020 asset performance outlook for Canadian credit card and auto loan and lease (auto ABS) ABS to negative from stable, as a result of the negative impact on the Canadian economy and consumers, and effects to individual sectors from the coronavirus pandemic.
- With recent weekly unemployment filings breaking historical records and negative GDP forecast for 2020, Fitch expects consumer delinquencies, asset-specific recovery rates, and ultimately losses to face pressures in 2020 and lead to weaker ABS performance.
The way ABS deals work is that investors receive the potential of increased returns based on the performance of the trust. Assuming that the prime rate might be 3.25%, under normal conditions, the trust will outperform the prime rate. Though, when credit losses surge, the trust may not return a better yield. Right now, numbers look fair, but if you consider that the write-off surge will come in 4Q20, investors need to brace their expectations.
- Fitch currently rates seven (Canadian) credit card ABS programs listed below, with 35+ transactions totaling roughly $20 billion in outstanding notes. Ratings issued include ‘AAAsf’ notes down to ‘BBBsf’ rated notes by Fitch. All transactions have been performing within expectations to date, including major metrics for yield, chargeoffs, and monthly payment rates through the March distribution period.
It’s the economy, not credit quality. The numbers that follow are in line with the United States, perhaps somewhat higher on a percentage basis.
- A record number of Canadians filed for income assistance during March due to government ordered shutdowns across the country, resulting in a spike in the unemployment rate to 7.8% in March from 5.6% in February, marking the worst single-month increase in over 40 years. This metric is expected to materially worsen in April, with over 5 million applications filed between March 15 and April 10 under the unemployment insurance and new CERB programs, which equates to over 25% of the total workforce.
- Fitch expects these programs will cushion some of the impacts to customer delinquencies in the short term. However, card and auto ABS performance will likely be weaker compared with pre-crisis levels, as many Canadians were already stretched financially with household debt remaining elevated near record highs (over $2.2 trillion and debt to income ratio of 176%).
The nicest way to summarize the current environment came in a read from the Economist today, as they discussed top U.S. issuers adding $24.1 billion to the loan loss reserve:
- If doctors and nurses are on the front-line of the health crisis caused by the pandemic, then bankers are on the front-line of the economic response.
Though the quote of the week goes to Chase’s Jamie Dimon, who certainly has experience during economic storms.
- “If we can help the country get through this, everybody’s better off. If we lose a little more money in the meantime, then so be it,” JPMorgan Chief Executive Officer Jamie Dimon said on a call with analysts. “We’re adults, we know that if the economy gets worse, we’ll bear additional loss. We know we can handle really, really adverse consequences.”
Now, that’s wisdom, not panic!
Overview provided by Brian Riley, Director, Credit Advisory Service at Mercator Advisory Group.