Structured Finance

Asset-Backed Special Report

ABCs of Credit Card ABS

standing as of May 31, 1998. This growth came from
Credit Card Securitization Group continual reliance on credit cards by consumers, along
Michael R. Dean with more acceptance of cards by merchants and service
(212) 908-0556 providers, such as doctors and grocery stores. In addi-
[email protected] tion to growth of outstanding receivables, a wide diver-
sity in the types of cards being issued has developed.
Chris Mrazek
(212) 908-0667
[email protected] Affinity Cards
Affinity programs target members of groups sharing
Richard C. Drason
common interests. For example, associations of medical
(212) 908-0641
[email protected] professionals, fans of auto racing, or alumni of the same
university can have the logo of their association, a pic-
Mark Sun
ture of their favorite driver, or their school seal on credit
(212) 908-0609
cards. This group loyalty builds a bond to the card.
[email protected]
MBNA is the standout issuer of affinity cards, followed
Kathy Moon by First USA Bank.
(212) 908-0715
[email protected]
Low-Price Cards
Michelle Galvez This issuer’s strategy is to attract an interest rate-sensi-
(212) 908-0868 tive borrower with a low “teaser” rate offer, run up the
[email protected]
borrower’s balance quickly by offering instant and easy
transfers of existing credit card balances from other
Summary banks, and keep the cardholder with competitive “go
Over the past several years, competition in the U.S. to” rates after the introductory period has ended.
credit card industry has been fierce. This competition
has led many banks, including large, full-service insti- To be successful in the low-price business, an issuer
tutions, to lose customers to issuers that are aggressively must have sophisticated risk-based pricing computer
expanding their card portfolios. Some of the more vis- models to determine the rate it can offer to a particular
ible winners of this competition are Capital One Bank, market segment based on that segment’s risk profile.
Citibank, First USA Bank, N.A., Fleet Bank (formerly Fleet Bank, Capital One, and First USA Bank have
Advanta), Household Bank, N.A., MBNA America grown their portfolios dramatically using this strategy.
Bank, N.A., and Universal Card (formerly AT&T). The
tremendous volume of card loans generated has created Co-Branded Cards
an equally immense need for inexpensive, reliable Many companies, especially automobile manufactur-
funding. For many of these institutions, securitization ers, airlines, and telephone companies, have allied
has fulfilled this need. with card-issuing banks to jointly market cards. The
intent is to promote the company’s product and in-
Credit Cards crease receivables for the bank. These co-branded
The credit card market has grown significantly in the cards reward the cardholder for usage. The rewards
last eight years, increasing from $234 billion of total may be rebates on new car purchases, free airline
receivables outstanding in 1990 to $356 billion out- tickets, or discounts on long distance telephone calls.

July 17, 1998

www.fitchibca.com
ABCs of Credit Card ABS

This program also provides an incen- tage to cardholders of using store cards banks, such as Fleet Bank, Capital
tive for cardholders to pay their bills on is that available credit on the custom- One, First USA Bank, and MBNA,
time, since the reward benefits will be ers’ other cards is not used up, allowing benefit from funding at ‘AAA’ rates and
revoked if the cardholder becomes de- cardholders to “compartmentalize” low capital charges and, in some cases,
linquent. Household and General Mo- their debt burden. For example, a con- rely on off balance sheet treatment to
tors Corp. (GM), Citibank, N.A. and sumer might use a Sears, Roebuck and meet regulatory requirements. Without
American Airlines, and Chase Manhat- Co. card to purchase a new refrigerator securitization, some of these banks
tan and Shell Oil Co. are several joint and pay it off evenly over time without could not have grown as rapidly. As of
ventures in the co-branded arena. Each using up a Visa or MasterCard line. The May 31, 1998, more than $216 billion in
program has different arrangements for retailer benefits by building customer credit card securities had been issued.
expense and revenue sharing. loyalty and increasing the profitability
of its lending operation. Stand-Alone vs. Master Trust
Discover Card A vast majority of card securitizations
Discover is the only significant issuer of Other Cards have been completed using two differ-
general purpose credit cards to success- Travel and entertainment cards, such as ent vehicles — the stand-alone trust
fully break into the U.S. market with- American Express and Diners Club, and and the master trust. The former is
out relying on Visa or MasterCard full-service cards, like Citibank and simply a single pool of receivables sold
associations. Discover developed its Chase Manhattan Bank, round out the to a trust and used as collateral for a
own merchant network across the U.S. spectrum of card types. single security, although there may be
13 years ago and, since then, has several classes within that security.
achieved notable market penetration. Securitization When the issuer intends to issue an-
The barriers to entry into this arena are As with credit cards, the use of securi- other security, it must designate a new
high due to significant start-up costs tization as a financing tool has increased pool of card accounts and sell the re-
and intense competition. Discover’s in volume and importance. The first ceivables in those accounts to a sepa-
card has been extremely successful be- deals were done in 1987 to diversify rate trust. This structure was used from
cause of the company’s cash rebate for sources of bank funding. As the banks the first credit card securitization in
purchases strategy and clear, simple came under pressure to free up on bal- 1987 until 1991, when the master trust
pricing structure. ance sheet capital in 1990 and 1991, became the preferred vehicle.
securitization filled that need. (Bank
Retail Cards regulators treat securitization as asset The master trust structure allows an
Many retail stores offer their customers sales.) More recently, securitization has issuer to sell multiple securities from
the choice of using a national credit been the primary funding source for the same trust, all of which rely on the
card or the store’s own card. An advan- specialized credit card banks. These same pool of receivables as collateral.

Top 10 Card Portfolios* Top 10 Securitizers*

($ Bil.) ($ Bil.)
1. Citibank, N.A. 45.30 1. MBNA America Bank, N.A. 32.1
2. MBNA America Bank, N.A. 42.60 2. Citibank, N.A. 31.1
3. First USA Bank, N.A. 37.80 3. First USA Bank, N.A. 27.2
4. American Express 36.20 4. Chase Manhattan Bank, N.A. 17.2
5. Discover Card 33.89 5. Discover Card 15.8
6. Chase Manhattan Bank, N.A. 31.39 6. Sears, Roebuck and Co. 12.1
7. Household Bank, N.A. 17.34 7. Household Bank, N.A. 10.8
8. First Chicago NBD 16.99 8. Capital One Bank 8.5
9. Universal Card 15.00 9. Fleet Bank (formerly Advanta) 8.5
10. Fleet Bank (formerly Advanta) 14.38 10. First Chicago Corp. 8.3
*General purpose card portfolios in the U.S. as of March 31, 1998. *Total amount of credit card-backed securities securitized as of
Note: One notable exception to this list is Sears, Roebuck and Co., May 31, 1998. Note: The securitized total is historical issuance.
a retailer with a $28.95 billion portfolio in Sears domestic managed Some of these issuers have resecuritized the same accounts after a
credit card receivables in fiscal 1997. Source: The Nilson Report, deal has matured, thus inflating their historical issuance figure.
Oxnard, CA. Source: Asset-Backed Alert.

2 Fitch IBCA, Inc.

 ABCs of Credit Card ABS

For example, an issuer could transfer Other efficiencies can be included in a accumulation), and early amortization.
the receivables from one million ac- master trust, including sharing of prin- Each period performs a different func-
counts (representing $1 billion of re- cipal and sharing of excess spread (see tion and allocates cash flows differently.
ceivables) to a trust, then issue multiple Master Trust Features, page 8). This structure is designed to mimic a
securities in various denominations and traditional bond, in which interest pay-
sizes. When more financing is needed, In addition to issuing investor securities, ments are made every month and prin-
the issuer transfers receivables from every seller is required to maintain an cipal is paid in a single “bullet”
more accounts to the same trust. It can ownership interest in the trust. This par- payment on the maturity date.
then issue more securities. The receiv- ticipation performs several critical func-
ables are not segregated in any way to tions. It acts as a buffer to absorb seasonal Since the average life of a credit card
indicate which series of securities they fluctuations in credit card receivables receivable is a short five to 10 months,
support. Instead, all the accounts sup- balance, is allocated all dilutions (bal- an amortizing structure, like the ones
port all the securities. ances canceled due to returned goods) used in automobile and mortgage deals,
and fraudulently generated receivables does not work very well. In this type of
This structure allows the issuer much that have been transferred to the trust, structure, the principal and interest col-
more flexibility, since the cost and ef- and ensures that the seller will maintain lections on the pool of loans are passed
fort involved with issuing a new series the credit quality of the pool since the directly through to investors on a
from a master trust is lower than creat- seller owns a portion of it. To ensure that monthly basis. An amortizing structure
ing a new trust for every issue. In addi- the certificateholders’ invested amount for credit card-backed securities would
tion, credit evaluation of each series in is always fully invested in credit card result in a short average life and lumpy,
a master trust is easier since the pool of receivables, the size of the seller’s partici- unpredictable repayment to investors.
receivables will be larger and not as pation must remain at or above a mini- Use of a revolving structure gives the
subject to seasonal or demographic mum percentage of the trust receivables issuer medium- to long-term financing,
concentrations. For example, if an is- balance, usually 7%. The seller’s partici- and it gives the investor a predictable
suer transferred only receivables from pation does not provide credit enhance- schedule of principal and interest pay-
accounts originated in 1989 into a ment for the investors. ments.
stand-alone trust and the next year
transferred all the receivables from The seller is obligated to add credit All collections on the receivables are split
1990 accounts into a different trust, the card accounts to the trust if the amount into finance charge income and principal
two would perform differently based on of its participation falls below the re- payments. Each of the three periods treats
the underwriting standards used, the quired minimum. If the seller cannot finance charge income in the same man-
terms (annual payment rate [APR] and provide additional accounts, an amorti- ner. Monthly finance charges are used to
minimum monthly payment) offered, zation event will occur (see Amortization pay the investor coupon and servicing
and the competing offers available at Triggers, page 5). In most circumstances, fees, as well as to cover any receivables that
that time. the seller must receive rating agency have been charged off in the month. Any
approval before any accounts can be income remaining after paying these ex-
If a master trust had been used in the added. Sellers do not need approval penses is usually called excess spread and
same example, both series would de- when the addition is a small percentage is released to the seller. Principal collec-
pend on the same pool of accounts, of the trust (10%–15%) or when the tions, however, are allocated differently
one-half of which were originated in minimum seller’s participation level during each of the periods.
1989 and one-half of which were origi- has been breached. Of course, rating
nated in 1990. Credit differences be- agencies will receive notification of Revolving Period
tween the two series would be these events. During the revolving period, monthly
contained in the structure of the deal, principal collections are used to pur-
rather than the receivables. Investors Structures chase new receivables generated in the
must keep in mind, however, that the Regardless of whether the trust is a designated accounts or to purchase a
makeup of accounts in a master trust stand-alone or a master trust, the same portion of the seller’s participation if
pool may change dramatically over time general structure is used for every deal. there are no new receivables. If there
as new accounts are added and as some The typical setup has three different are not enough new receivables to rein-
existing cardholders cancel or stop us- cash flow periods: revolving, controlled vest in, an early amortization will be
ing their accounts. amortization (in some cases, controlled triggered because the seller’s participa-

Fitch IBCA, Inc. 3

ABCs of Credit Card ABS

invested amount will have been depos-

ited into the PFA and investors will be
repaid their principal in a single pay-
ment (see chart below). Of course, inter-
est payments will be made each month
on the total invested amount. With this
structure, investors will not see any dif-
ference in monthly payments when the
deal converts from revolving to accu-
mulation.

Early Amortization
Severe asset deterioration, problems
with the seller or servicer, or certain legal
troubles can trigger early amortization at
any point in the deal, whether it is revolv-
ing, amortizing, or accumulating. The
box on page 5 shows common amortiza-
tion triggers. In such cases, the deal auto-
tion has fallen below the required mini- cess of the controlled amount will be matically enters the early amortization
mum, or, in some cases, the excess prin- reinvested in new receivables, as in the period and begins to repay investors im-
cipal collections will be deposited in an revolving period. Interest will be paid mediately. This feature helps protect in-
excess funding account and held until only on the outstanding amount of se- vestors from a long exposure to a
the seller can generate more credit card curities as of the beginning of the deteriorating transaction.
receivables. The risk of early amortiza- monthly period.
tion gives the seller adequate incentive Fast Pay Allocation
to maintain the seller’s participation at Controlled accumulation follows a In the event that an early amortization
a level well above the minimum. The similar procedure, except that the con- is triggered and not cured, the investors
revolving period continues for a prede- trolled payments are deposited into a will begin to be repaid immediately on
termined length of time, which has trust account, or principal funding ac- a fast pay, or uncontrolled, basis. All
ranged from two to 11 years. Investors count (PFA), every month and held un- principal collections and any amounts
will receive only interest payments til the expected maturity date. At the in the PFA will be distributed to inves-
during this period. end of the accumulation period, the full tors, with senior certificates being paid

Controlled Amortization/
Accumulation
At the end of the revolving period, the
controlled amortization or controlled
accumulation period begins. In the
case of controlled amortization (see
chart above), which typically runs for
12 months, principal collections are no
longer reinvested but are paid to inves-
tors in 12 equal controlled amortization
payments. The payments are sized at
exactly one-twelfth of the invested
amount so investors can be repaid on a
predetermined schedule. (Some series
may have longer or shorter controlled
periods and, thus, will have smaller or
larger controlled amortization pay-
ments.) Any principal collected in ex-

4 Fitch IBCA, Inc.

 ABCs of Credit Card ABS

off first. Principal distributions will be

made to subordinate investors only af- Amortization Triggers*
ter senior investors are fully repaid. To
help speed repayment to investors, a
Seller/Servicer
1. Failure or inability to make required deposits or payments.
portion of principal collections that
2. Failure or inability to transfer receivables to the trust when necessary.
would normally be allocated to the
3. False representations or warranties that remain unremedied.
seller’s participation will be reallocated
4. Certain events of default, bankruptcy, insolvency, or receivership of
to the investors.
the seller or servicer.
In the history of credit card securitiza- Legal
tion, the only three deals that have trig- 5. Trust becomes classified as an “investment company” under the Invest-
gered early amortization events were ment Company Act of 1940.
issued by RepublicBank, Delaware,
Southeast Bank, and Chevy Chase Performance
FSB. None was rated by Fitch IBCA. 6. Three-month average of excess spread falls below zero.
In the Chevy Chase deal, investors 7. Seller’s participation falls below the required level.
voted to waive the trigger event, and 8. Portfolio principal balance falls below the invested amount.
the transaction continued to operate as Fitch IBCA believes these basic triggers address all possible worst-case
normal. The securities were repaid as scenarios as well as any unforeseen events applicable to the seller/servicer,
originally scheduled, and no investor trust, or portfolio. Some sample scenarios are outlined below.
suffered a loss. In both the Southeast
Bank and RepublicBank deals, early Scenario Covered By
amortization was commenced and in- Seller/Servicer Fraud 1, 2, and 3
vestors were repaid without a loss, but Default of Seller/Servicer 4
earlier than they had expected. In mod- Taxation of Trust 5 and 6
ern transactions, certain features are Rapidly Rising Chargeoffs 6
Federally Imposed Interest Rate Caps 6
available to protect investors from early
Whipsaw Interest Rate Scenarios 6
amortization risk (see Master Trust Fea- Economic Recession/Depression 6
tures, page 8). Spikes in Dilution and/or Fraudulent Charges 7 and 8
Declining Pool Balance due to Competition 7 and 8
Credit Enhancement Reduction in Credit Card Usage 7 and 8
As unsecured revolving debt obliga- *All credit card transactions contain deal- and issuer-specific amortization events. The
tions, credit card receivables offer no following events are basic, common triggers that are necessary for most transactions.
collateral in the event of cardholder de-
fault. As a result, recoveries are limited.
To achieve investment-grade ratings, amount (CIA), and subordination. Available excess spread may be shared
credit enhancement is needed to insu- Most recent transactions use a combi- with other series, used to pay fees to
late investors from fluctuating payment nation of enhancements, the most com- credit enhancers, deposited into a spread
patterns and cardholder chargeoffs. mon being senior/subordinate/CIA. account for the benefit of the enhancers,
Common forms of credit enhancement or released to the seller.
are excess spread, a cash collateral ac- Excess Spread
count (CCA), a collateral invested The yield on credit cards, which is high If the deal is performing as expected, the
relative to other types of consumer cash flow from the pool of credit cards will
Excess Spread loans, should cover the payment of in- be sufficient to make all principal and
% vestor interest in addition to the servic- interest payments to investors and to pay
Gross Portfolio Yield 18 ing fees and still be sufficient to
all expenses, with plenty of excess re-
Investor Coupon (7) reimburse the trust for any receivables maining. In the example at left, the 4%
Servicing Expense (2) charged off during the month. The re- excess spread would have to be depleted
Chargeoffs (5) maining yield, or excess spread, pro- (i.e. decrease in yield, increase in coupon,
Excess Spread 4 vides a rough indication of the financial and/or increase in chargeoffs) before
health of a transaction. there would be a cash shortfall. If, how-

Fitch IBCA, Inc. 5

ABCs of Credit Card ABS

ever, excess falls below zero, other CCA, or the CIA. Like the CCA and should repay investors 100% of their
credit enhancement must be available CIA, draws on the subordinate certifi- original investment plus interest. Secu-
to make up the shortfall. cates may be reimbursed from future rities rated in the ‘A’ category (subordi-
excess spread. Principal collections will nated certificates) are subject to less
Cash Collateral Account be allocated to the subordinate inves- severe recessionary scenarios than
A CCA is simply a segregated trust ac- tors only after the senior certificates are those used for ‘AAA’; however, they are
count, funded at the outset of the deal, fully repaid. considered to be investment grade and
that can be drawn on to cover shortfalls of high credit quality. The trust’s ability
in interest, principal, or servicing ex- Letter of Credit to pay interest and repay principal to
pense for a particular series if excess From the inception of credit card secu- class B is strong, but it may be more
spread is reduced to zero. The account ritization until 1991, the letter of credit vulnerable to adverse changes in eco-
is funded by a loan from a third-party (LOC) was a common form of enhance- nomic conditions and circumstances
bank, which will be repaid only after all ment. It is an unconditional, irrevoca- than class A.
classes of certificates of that series have ble commitment from a bank to provide
been repaid in full. Cash in the account cash payments, up to the face amount Credit card ABS performance can be
will be invested in the highest rated of the LOC, to the trustee in the event influenced by many variables, with
short-term securities, all of which will that there is a shortfall in cash needed both positive and negative effects.
mature on or before the next distribu- to pay interest, principal, or servicing. Fitch IBCA develops stress scenarios at
tion date. Draws on the CCA may be Usage as a form of enhancement was every rating level for each ABS issuer
reimbursed from future excess spread. discontinued when a number of banks and structure by evaluating the per-
providing LOCs were downgraded and formance variables described in the
Collateral Invested Amount the transactions they enhanced were box below.
The CIA represents an uncertificated, downgraded as a result. The CCA was
privately placed ownership interest in developed to remove downgrade risk Current/historical performance or, if
the trust, subordinate in payment rights caused by enhancer credit quality, and the portfolio is unseasoned, a conserva-
to all investor certificates. Acting like a this marked the end of the use of LOCs tive projection of performance is used
layer of subordination, the CIA serves in credit card transactions. as a benchmark by which to assess fu-
the same purpose as the CCA; it makes ture performance. The stress scenarios
up for deficiencies if excess spread is Stress Scenarios applied to a transaction are determined
reduced to zero. The CIA is tradition- Under the most severe depression sce- on a case-by-case basis and compared
ally placed with banks, which may re- narios, properly structured ‘AAA’ credit to a hypothetical industry benchmark.
quire investment-grade ratings on the card asset-backed securities (ABS) The major variables influencing credit
CIA as a condition to purchase. The
CIA itself is protected by a spread ac-
count (not available to any other inves-
Performance Variables
tors) and available monthly excess ❑ Underwriting standards
spread. If the CIA is drawn on, it can be ❑ Cardholder credit scores
reimbursed from future excess spread. ❑ Card type — retail, low-price, affinity, and co-branded, among others
❑ Fixed- or floating-card annual percentage rate
This class of enhancement also goes by ❑ Flexibility of issuer to reprice card rates
other names — CA investor interest, ❑ Frequency of floating-rate resets
collateral interest, enhancement in- ❑ Use of teaser rates
vested amount, or “C” tranche. ❑ Attrition
❑ Geographic and demographic diversification
Subordination ❑ Interchange
A senior/subordinate structure offers ❑ Convenience usage
two different types of investor owner- ❑ Seasoning
ship in the trust — senior participation ❑ Servicing
in the form of class A certificates and ❑ Competitive position
subordinate participation in the form of ❑ Management
class B certificates. Class B will absorb ❑ Discounting of new receivables into trust
losses allocated to class A that are not ❑ Other structural features
already covered by excess spread, the

6 Fitch IBCA, Inc.

 ABCs of Credit Card ABS

Benchmark Stress Scenarios every month and from cardholders

making smaller monthly payments.
‘AAA’ ‘A’
Chargeoffs 4.5x–5.0x Multiple 3.0x Multiple Fitch IBCA Credit Card Default
Portfolio Yield 35% Decline 25% Decline Model
Monthly Payment Rate 50% Decline 35% Decline When run through Fitch IBCA’s default
model, the benchmark scenario in the
table at left gives a generic ‘AAA’ level
enhancement levels are chargeoffs, tions (Visa, MasterCard, and Novus, for a portfolio. However, since every
portfolio yield, monthly payment rate among others) that is paid to the issuing credit card is not created equal, more
(MPR), and investor coupon. bank as compensation for taking credit risk attention must be paid to the dynamics
and funding receivables, the amount of of each variable stressed in context with
Chargeoffs which varies from 1%–2% annually. Most that portfolio and Fitch IBCA’s bench-
Credit cards are unique among loans in of these components are relatively stable mark. For example, the stress test out-
that the credit quality of each card- and only comprise a small percentage of the lined in the table below applies to the
holder is reflected in the cardholder’s yield. APR, on the other hand, accounts for Household Affinity Credit Card Master
credit limit and APR, which are based a large majority of the yield and is the most Trust, which is made up solely of GM
on the cardholder’s ability to meet debt volatile. co-branded cards.
payments (i.e. the higher the risk, the
lower the credit limit and the higher the In stressing a portfolio’s yield, competi- Household’s underwriting criteria is
APR). Many issuers use sophisticated tive position is a critical factor, since a strong, and, to date, the trust’s perform-
credit-scoring models, or well trained highly priced portfolio will be under ance has been better than expected.
credit analysts, to determine the card- pressure to reduce rates to maintain However, since Household’s portfolio is
holder’s probability of default. This prob- market share. Another important factor not heavily seasoned and has not been
ability dictates what credit limit should is the possibility of a federally imposed tested during a recessionary environ-
be granted, and at what APR. interest rate cap on credit card APRs. In ment, Fitch IBCA imposes a slightly
November 1991, the U.S. Senate pro- more conservative chargeoff multiple. As
Examining the credit limits and APRs posed a measure to lower credit card the average age of the accounts increases,
of a portfolio, however, does not always interest rates to a cap of 14%. If the Fitch IBCA will revisit this stress and
give a true picture of the issuer’s total measure had been enacted, some port- adjust it accordingly.
risk. Some issuers might be more ag- folios would have suffered a reduction
gressive in assigning high limits to in yield of more than 30%. The payment rate stress on this portfo-
lower credit quality borrowers. Some lio is also very conservative. Since all
might not have well developed scoring Monthly Payment Rate the accounts are under the GM rela-
models. Finally, some may try to gain The MPR includes monthly collec- tionship, it is important to keep in mind
market share by offering very low inter- tions of principal, finance charges, and what would happen if the co-branding
est rates, possibly at the expense of fees paid by the cardholder and is agreement were canceled. Many card-
credit quality. stated as a percentage of the outstand- holders using their cards to generate
ing balance as of the beginning of the GM rebate points would cease making
All these factors must be analyzed month. Reductions in MPR may come purchases, and payment rates would
when determining the appropriate from a decrease in the number of card- fall dramatically.
chargeoff stress to apply to a portfolio. holders who pay off their entire bill
The stress level shown in the bench-
mark table above indicates that one in
every four or five cardholders defaults Household Affinity Credit Card Master Trust — Stress Scenarios
on their obligation to pay. (%)
Current* Benchmark Household Affinity
Portfolio Yield Chargeoffs 7.27 4.50–5.00x Multiple 5.25x Multiple
Yield is made up of periodic APR charges, Portfolio Yield 18.07 35% Decline 40% Decline
annual fees, late payment fees, overlimit Monthly Payment Rate 23.90 50% Decline 65% Decline
fees, and, in some cases, recoveries on *As of May 31, 1998.
charged-off accounts and interchange. In-
terchange is income from the card associa-

Fitch IBCA, Inc. 7

ABCs of Credit Card ABS

Sears Credit Card Master Trust — Stress Scenarios ceptions may be made if the retailer is
(%) unlikely to file under Chapter 7.

Current* Benchmark Sears For well underwritten, geographically

Chargeoffs 8.57 4.5–5.0x Multiple 4.5x Multiple diverse, general-purpose card portfo-
Portfolio Yield 19.22 35% Decline 35% Decline lios, insolvency of the seller will not
Monthly Payment Rate 7.28 50% Decline 35% Decline have such a dramatic effect. Most con-
*As of May 31, 1998. sumers probably will not even know
that their bank has gone into insolvency
and will continue to use their cards.
With the profitability of the card busi-
As another example of customizing amount of additional enhancement re-
ness, the heavy premiums at which
stresses, the table above shows a sce- quired may vary from 2.5% to more
pools of accounts are bought and sold,
nario applied to the Sears Credit Card than 4.0%.
and the aggressive competition for mar-
Master Trust.
ket share, Fitch IBCA believes that
For example, if the ABS investor’s cou-
portfolios such as these should con-
Since more than 60% of Sears’ accounts pon floats off the one-month London
tinue to remain active, with consumers
are greater than five years old, portfolio Interbank Offered Rate (LIBOR), a
continuing to charge and the portfolio
statistics are very consistent. Even dur- deal with credit cards that are priced off
continuing to be serviced, even if not
ing the 1990–1991 recession, Fitch the prime rate and reset monthly would
by the original servicer.
IBCA gives Sears credit for stable un- be exposed to less interest rate risk than
derwriting and reduces the company’s a deal with cards that are fixed rate or
Some issuers fall between these two
worst-case multiple. In addition, pay- reset quarterly. Therefore, the monthly
extremes. For example, a portfolio that
ment rates cannot fall much farther, reset portfolio would require less addi-
is heavily concentrated in a single co-
even under severe economic stress. tional credit enhancement than the
branding relationship or affinity group
portfolio with fixed-rate cards.
may experience heavy runoff if that
Investor Coupon
relationship is canceled or becomes less
For fixed-rate ABS, Fitch IBCA uses Receivables Balance
a value to cardholders. It is unlikely,
the expected pricing level of the secu- An additional variable that must be ex-
however, that all cardholders would si-
rities as the transaction’s investor cou- amined is the pool’s receivables bal-
multaneously cease using their cards, as
pon expense. For floating-rate ABS, ance. If the outstanding principal
they would for a bankrupt retailer.
Fitch IBCA assumes that the investor receivables of the portfolio decline, es-
coupon will increase dramatically. The pecially during early amortization, the
interest rate environment of the early amount of principal collections reallo-
Master Trust Features
Master trusts may be set up with one or
1980s — specifically, the second half of cated from the seller’s participation
several reallocation groups. For exam-
1980 — is used as a stress scenario, would be drastically reduced. This re-
ple, Universal Card Master Trust cur-
since that was the most volatile period sults in a longer payout period and in-
rently has several groups: Group I for
of the last 20 years. creased exposure to a deteriorating
series with fixed-rate coupons and
pool. The primary concern is how card-
Group II for series with floating-rate
Additional credit enhancement is holders will behave with regard to the
coupons; other groups accomodate vari-
needed to cover the potential basis risk solvency of the seller.
able funding series. Most other trusts
and interest rate risk between a rapidly
have only one group, in which all series
rising investor coupon and lagging For credit cards issued by small, re-
are included. Depending on the struc-
floating-rate or low fixed-rate credit gional retailers, Fitch IBCA believes
ture of the trust, series within the same
cards, where trust expenses increase that if the retailer files bankruptcy un-
group may share principal and/or ex-
faster than trust earnings. This risk is der Chapter 7 of the U.S. Bankruptcy
cess spread, have the ability to dis-
issuer- and deal-specific and is esti- Code, consumers would no longer be
count, or fix allocations of finance
mated based on credit card interest able to use their cards since all the
charges.
rates, frequency of credit card floating- stores have been closed or sold, and the
rate resets, investor coupon index, fre- principal receivables balance of the
quency of investor coupon resets, and, trust will decline in lockstep with the
Principal Sharing
For all series in the same group, the
to a limited extent, the issuer’s ability amortization of the securitization. Ex-
trust allows distribution of excess prin-
to change credit card interest rates. The

8 Fitch IBCA, Inc.

 ABCs of Credit Card ABS

tial risk of discounting is that a deterio-

Fitch IBCA, Inc. — Rated General Purpose Card Issuers rating pool of assets can continue to re-
BankAmerica volve with deeper discounts, which
Capital One Bank increases potential economic exposure
Chase Manhattan Bank, N.A. during early amortization. The issuer must
Chevy Chase Bank, FSB obtain rating agency approval prior to dis-
Citibank, N.A. counting or changing the discount rate.
Discover Card
First Chicago Corp. Fixed Allocation of Finance
First National Bank of Omaha Charges
First Omni Bank This innovative feature permits a larger
First USA Bank, N.A. percentage of finance charge collec-
Fleet Bank, N.A. (formerly Advanta Corp.) tions to be allocated to investors after
Household Bank, N.A. an amortization event, when cash is
MBNA America Bank, N.A. needed most. Before early amortiza-
MBNA International Corp. tion, investors receive their pro rata
Mellon Bank share of finance charge collections, and
People’s Bank the seller receives its pro rata share.
Providan National Bank After an event is triggered, a portion of
Universal Card (formerly AT&T) the seller’s share will be made available
Wachovia Bank to cover shortfalls in interest or servic-
ing expense, or chargeoffs, in the inves-
tors’ share. Cash flow simulations show
cipal collections to any series in its ac- each has the same coupon expense. In that, even under stressful scenarios,
cumulation or amortization period. effect, socialized groups share excess this overallocation of finance charges
Since a series in its revolving period has spread at the top of the cash flow water- provides a significant amount of sup-
no principal payment requirements, fall. Universal Credit Card Master port, thus reducing the need for credit
principal collections allocated to that Trust, Household Affinity Credit Card enhancement.
series are available for reallocation. In Master Trust, and Citibank Credit Card
addition, principal collections in excess Master Trust are examples of socialized Early Amortization Risk
of a series’ controlled amount are avail- trusts. Fitch IBCA ratings address the likeli-
able for reallocation. The principal re- hood of repayment of all principal and
allocation feature provides investors Other trusts may allocate finance interest in a full and timely manner as
with more assurance of timely principal charge collections on a pro rata basis, promised. Credit card transactions,
repayment, with no additional risk to based on size. Thus, each series will however, do not promise repayment of
other series. receive the same proportionate amount principal on any specific date. Instead,
of finance charges, and the series with they define an expected payment date,
Excess Spread Sharing the lowest coupon expense will have and caveat that principal may be paid
There are several ways excess spread the largest amount of excess spread. earlier or later than that date. The cir-
may be shared within series of a group. This amount will be available for real- cumstance that would lead to earlier
Some groups may be set up as a “social- location to other series, particularly payment would be commencement of
ized” group, whereby finance charge high-coupon series, if their excess an early amortization. Later repayment
collections are allocated to each series spread is reduced to zero. could be caused by very low payment
based on need. The interest expense rates, which would mean that control-
for all series in the group will be the Discount Option led amortization or controlled accumu-
weighted average expense for each se- Many trusts permit the transfer of receiv- lation payments would not be made in
ries. Thus, the highest coupon series ables to the trust at a discount, which full, and extra months of collection
will receive the largest allocation, and increases the portfolio’s yield by includ- would be needed to pay off the entire
the lowest coupon will receive the ing principal collections as finance charge invested amount. Every series defines
smallest allocation. The excess spread collections. This allows an issuer to arti- a termination date, which is usually set
for each series will be the same, since ficially increase excess spread. A poten- 24–36 months after the expected pay-

Fitch IBCA, Inc. 9

ABCs of Credit Card ABS

ment date. All principal must be paid Early amortization risk is not a focus of ➢ Fixed- or floating-rate investor coupon.
on or before this date. It is extremely investors when deals perform strongly. ➢ Seller/servicer strength.
unlikely that MPR would be so slow However, before consumer delinquen- ➢ Ability to discount new receivables
that principal would not be repaid by cies and chargeoffs increase, portfolio into trust.
the series termination date. yields come down dramatically, or inter- ➢ Sharing of excess spread.
est rates shoot up, investors should look ➢ Percentage of total bank receiv-
The amount of enhancement any deal very closely at their investments to deter- ables that have been securitized.
has does not affect the probability of mine their exposure to prepayment risk. ➢ Existence of variable funding, ex-
early amortization. And investors must Several topics should be considered tendible, or commercial paper series.
keep in mind that ratings do not reflect when evaluating early amortization risk,
the likelihood of this occurrence. In including:
fact, it is possible that a deal’s ‘AAA’ ➢ Variability of chargeoffs.
rating would be affirmed if an early ➢ APR pricing position (competitive
amortization commenced. or not).

10 Fitch IBCA, Inc.

ABCs of Credit Card ABS

Fitch IBCA, Inc. 11

ABCs of Credit Card ABS

Copyright © 1998 by Fitch IBCA, Inc., One State Street Plaza, NY, NY 10004
Telephone: New York, 1-800-753-4824, (212) 908-0500, Fax (212) 480-4435; Chicago, IL, 1-800-483-4824, (312) 214-3434, Fax (312) 214-3110;
London, 011 44 171 638 3800, Fax 011 44 171 374 0103; San Francisco, CA, 1-800-953-4824, (415) 732-5770, Fax (415) 732-5610
Barbara A. Besen, Publisher; John Forde, Editor-in-Chief; Madeline O’Connell, Director, Subscriber Services; Jason H. Kantor, Manager, Publishing Technology;
Nicholas T. Tresniowski, Senior Managing Editor; Diane Lupi, Managing Editor; Jennifer Hickey, Andrew Simpson, Editors; Jay Davis, Martin E. Guzman, Paula
Sirard, Senior Publishing Specialists; Harvey Aronson, Publishing Specialist; Robert Rivadeneira, Publishing Assistant. Printed by American Direct Mail Co., Inc.
NY, NY 10014. Reproduction in whole or in part prohibited except by permission.
Fitch IBCA ratings are based on information obtained from issuers, other obligors, underwriters, their experts, and other sources Fitch IBCA believes to be reliable.
Fitch IBCA does not audit or verify the truth or accuracy of such information. Ratings may be changed, suspended, or withdrawn as a result of changes in, or the
unavailability of, information or for other reasons. Ratings are not a recommendation to buy, sell, or hold any security. Ratings do not comment on the adequacy
of market price, the suitability of any security for a particular investor, or the tax-exempt nature or taxability of payments made in respect to any security. Fitch
IBCA receives fees from issuers, insurers, guarantors, other obligors, and underwriters for rating securities. Such fees generally vary from $1,000 to $750,000 per
issue. In certain cases, Fitch IBCA will rate all or a number of issues issued by a particular issuer, or insured or guaranteed by a particular insurer or guarantor,
for a single annual fee. Such fees are expected to vary from $10,000 to $1,500,000. The assignment, publication, or dissemination of a rating by Fitch IBCA shall
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12 Fitch IBCA, Inc.