Wednesday, June 29, 2022

Credit Card Asset-backed Securities: The Complex Reality

What is a credit card asset-backed security?

Credit Card Asset-backed securities (CABs) are securities that have a credit card account on the account and the securities are secured by the credit line. In essence, a credit card creditor issues a security, typically a subordinated class, that is backed by a credit line that the issuer has with a bank or other financial institution. A traditional secured note, or asset-backed security, is used to issue the security to a bank or other institution to back the credit line. These notes, if initially outstanding, will not have credit lines but the issuer must provide collateral to the creditor that will guarantee the amount of the note.

The Basics on Credit Card Asset-backed Securities

Q4 2008 is now history, and the results of 2008 (re)insurance transactions for credit card asset-backed securities (ABS) have begun to emerge. It is a clear picture of a complex, capital-intensive and volatile asset class with significant stresses being applied by rating agencies. More importantly, the reality of the economic environment is starting to play out through a range of economic data, as well as through firms’ balance sheets and profitability metrics. There are certainly both good and bad outcomes for investors in credit card ABS, as a whole.

How do credit card asset-backed securities work?

Normally, credit card issuers sell outstanding lines of credit to investors. These lines of credit usually require no collateral. As long as consumers continue to pay their monthly payments on time, they will keep receiving their credit.

But this credit line comes at a price.

As the credit line matures, the issuer must either refinance the credit line with a new line of credit, pay off the outstanding credit line using funds from a different line of credit, or buy back the outstanding credit line with the money it received as collateral.

Each time a credit card issuer chooses a new line of credit, it must repay investors, and many times it chooses the most expensive option — repaying investors with funds from a new line of credit, or repaying investors with cash.

Risks of Credit Card Asset-backed Securities

The Form IV requirements to report Form IV assets on Form 10-K and 10-Q may expose an issuer to fines and an issuer’s future bond rating may be impaired by future adverse selection.

The use of credit card asset-backed securities (ABC) as a funding source for securitization of receivables in the mid-2000s was an innovation in financial services. These asset-backed securities (ABCs) provided a means for securitization of receivables using the general obligation of the issuing bank as an asset backing. ABC issuers were able to be less risky because their asset-backed securities obligations did not carry a default risk like other securitization liabilities did.

While the existence of ABCs was a catalyst for the growth of securitization in the U.S.

Why are credit card asset-backed securities important?

First, because they represent an important component of the short-term credit card market, even though they account for only 11% of credit card loans (compared to credit card loans, which account for 90%).

Secondly, because the prices of these assets are a highly concentrated, often inefficient market, reflecting a long history of institutional involvement.

And thirdly, because the outstanding credit card loans are in a state of deleveraging. They are falling in line with the portfolio standards established by the credit card issuers. Hence, although market participants use credit card asset-backed securities to judge the overall health of the credit card market, the prices of the assets are unlikely to reflect the actual price levels of the underlying collateral.

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