Asset-Backed Securities: The Key to Funding Credit Card Issuing

by Brian Riley 0

securities

Asset-backed securities (ABS) were hot before the recession, then after few years of languishing, bounced back to be an essential financing vehicle for card issuers.  This article proposes that the ABS market is a healthy play for investors seeking a steady return on their investment.

The concept of ABS goes back to the mid-1980s.  Credit card issuers book pools of accounts with a predictable return.  Instead of holding them on the banking books, investors can share in the profits when they buy into an Asset Securitization deal.  By doing so, investors, not issuers, bear the credit risk; banks can free up large blocks of cash so they can reinvest in more card holders; and issuing banks can make money by charging the ABS entity for servicing the day-to-day operational needs.

The market relies on FICO scores as an indicator of risk and reward.  If accounts do not perform as expected, issuers can supplement the receivable to enhance the return.  An ABS pool might contain $1 billion in Citi or Chase credit cards, that generate an average of 14% return, yielding 4% to investors, and 3% to the issuer for servicing, on a revolving term of 60 months, with a profit share opportunity back to the issuer.

In short order, consider the bank as the marketing channel that books the account, see the ABS entity as the one that holds the cardholder risk, and understand the bank has servicing rights and a revenue share stream.

The cycle is fascinating.  Book a billion in credit lines.  Let the accounts begin charging; flip the portfolio into the ABS Master Trust; Service the account; then rebook another billion.  Simple as Lather, Rinse, and Repeat.

Before Dodd-Frank, issuers had no risk associated with the sale of receivables to the ABS entity; since the reform act, issuing banks must keep an interest in the pool to ensure that the ABS portfolio does not become a dumping ground for bad credits.

As Wall Street experiences ups and downs from the current economy, this article proposes that

  • The outlook for the financial markets has turned cloudier over the past couple of weeks.

  • Investors seeking an alternative from the gloom of recent markets, should look at the asset-backed securities (ABS) sector, an area within the fixed income market that we believe still has clear skies.

ABS requires a level of investor sophistication; this is not for the typical 401-K investor, though it is likely that the 401-K investment owns several billion in ABS credit card debt.  These debt pools can pay five to seven times more than the savings rate paid by commercial banks.  Today, about $200 billion goes into these pools each year.

  • In our opinion, the ABS sector offers a compelling safe haven from the market turmoil with a combination of high quality, short maturity, strong liquidity and attractive yields.

  • ABS is a unique fixed income asset class with the bonds secured typically by consumer-related collateral, such as auto loans, credit card receivables or student loans.

Your card might have the Amex, Citi, or Chase logo on it, but it is more than likely that the debt is owned by an ABS trust and distributed to the investment community.  This is harder for small issuers to do because the loan packages are typically sold in billions, or at least hundreds of millions.

But, for Wall Street, investors and banks, the flow of cash has a wide range of opportunities.

Overview by Brian Riley, Director, Credit Advisory Service at Mercator Advisory Group