Asset-backed Securities (ABS), a behind-the-scenes function of bank cards, plays an essential role in credit cards because it frees up funds for future lending. Credit card issuers, primarily the top tier who can create pools valued in hundreds of million or billion dollar tranches, participate in this funding strategy. Issuer benefits include the isolation of credit risk, the ability to fund credit card usage at lower rates, and the creation of a perpetual stream that can provide a funding edge.
After accounts book and balances build, card issuers can pool the debt into groups that can be sold to special purpose investment entities. In doing so, the issuer actually removes the debt from their balance sheet, and creates a vehicle available to sophisticated investors and in some cases, the general market. As an example, “Bank X” might create a pool of $1 billion in credit card receivables, create a special purpose entity know as “Bank X Vintage Pool 1”, then file with the US Securities and Exchange Commission, and pursue investors through investment banks such as Goldman Sachs.
The industry was loosely regulated before the economic downturn; Dodd-Frank brought clearer disclosures, risk sharing by the issuing bank, and standardized reporting. Portfolios are rated by risk agencies who often rely on FICO scores. Today’s read comes from the American Banker in their Asset Securitization Report.
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TD Bank is marketing its second offering of the year of notes secured by credit-card receivables, undeterred by headwinds that have slowed issuance across the bank-card sector in 2018.
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According to Fitch Ratings, Evergreen Credit Card Trust Series 2018-2 will include a U.S. dollar $500 million Class A notes tranche with an expected AAA rating. The trust will also issue two subordinate classes in Canadian dollars (size to be determined), which will be retained by TD Bank itself.
Securitizations in the first half of 2014 were $25 billion; the following year fell to $16.6 billion and then $12.6 billion in 2016. The market rebounded in 2017 when it peaked at $27.9 billion but slipped to $21.1 billion in 2018. A current challenge is that interest rates are rising which decreases the yield benefit.
When interest rates are low, ABS products are particularly attractive; as rates rise, they decrease the spread between the Prime rate and the ABS product yield. You can see it in the numbers.
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Through Monday, issuance of bank-sponsored credit and charge cards totaled $21.05 billion, some $6.4 billion short of the $27.9 billion volume through the same period a year ago. That narrows the gap from $9 billion at the end of last month, when S&P cited interest-rate hikes that were increasing the cost of funds for issuers.
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Although higher rates have increased absolute yield for investors, S&P said spreads have tightened as a result of higher credit costs and expenses, including rewards programs.
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The six largest bank issuers’ trusts had a first-quarter yield of 19.3%.
Our view is that 2018 securitizations will catch up to 2017 volumes, or at least be in the 90% range.
If you have questions on the securitization market, please feel free to contact Mercator Advisory Group.
Overview by Brian Riley, Director, Credit Advisory Service at Mercator Advisory Group
