The UK credit card ABS sector has been battered in recent times by a multitude of problems, and as a result, ABS issuance has dropped from highs of around £8bn in 2005 to virtually nothing in 2007 to date. However, the majority of market participants are confident that from the second half of 2007 things will improve. Anna Borrett reports.
The UK credit card market, once one of the most profitable in the world, has certainly seen better days. The sector has seen a 43% fall in profits since 2005, according to Lafferty Group’s global credit card profit pool index. The research house links those reduced profits to the large rise in bad debts and impairments amongst consumers, as well as the restriction of penalty fees on late payments.
Several observers are positive about the sector's prospects. "Credit performance in the credit card ABS market has plateaued over recent months, and the second half of the year could be more positive," said Mike Slevin, managing director FI debt capital markets in RBS's global banking and markets division.
"Since the tightening of market underwriting standards at the end of 2005 and beginning of 2006, the majority of susceptible credit has now passed through. Rising interest rates may push any positive outlook back slightly, but unless there is a real shock in the market, performance should gradually improve going forward."
However, issuers and originators have been taking action in order to protect trusts and investors against further negative developments.
A number of trusts have issued Double B notes over the past year in an attempt to bolster vulnerable Triple B notes, and it is possible that more of these are to come this year. The Double B notes bring relief to deals as they have their own spread account, which is separate from the spreads supporting the Triple B notes.
Arran (RBS), Gracechurch (Barclays) and Sherwood Castle (Capital One) have issued such Double B notes, and Arran’s Double B notes were the only credit card ABS issuance to price during 2007 up to mid May.
Pillar, which is backed by receivables from the purely on-line bank Egg, has also issued £90m of privately placed Double B notes to provide additional credit enhancement to the existing notes in the trust.
Egg has had a difficult 12 months, reporting losses of £145m earlier this year, but Citi paid Prudential £575m in February for the business, and since then Egg has returned to more conservative reporting policies, such as charging off IVAs (individual voluntary arrangement) immediately. Fitch has placed the Class C notes from Pillar Funding on Rating Watch Positive, while Moody's has confirmed the Baa2 rating for that class. In August last year Moody’s had placed the notes on review for a possible downgrade, while Fitch had downgraded the notes from BBB to BBB–.
Credit card originators have been joining in the effort to rejuvenate the ailing sector by lowering limit increase programmes, and reducing exposure to segments that they believe to be risky. Moreover, the banks in question are less prepared to grant IVAs to customers.
"Originators have been tightening origination underwriting over the past few years in attempt to manage future exposure to losses," confirmed Christophe Germain, vice president and senior analyst at Moody’s.
Structurers are likely to take into account the higher numbers of IVAs when readying new deals.
“Since the number of IVAs has been fairly high along with other issues affecting yield, structurers may need to consider building extra credit enhancement into new deals. However, I understand the number of IVAs seems to be stabilising and banks appear to be less prepared to grant clients IVAs than previously so this may help pick up net yield in the medium term,” said Kevin Ingram, a partner at Clifford Chance.
What went wrong?
The reasons behind the recent troubles of the UK credit card industry are fairly simple. Ruthless competition between credit card issuers over the past few years has resulted in originators attracting customers from the lower end of the credit scale, with detrimental results in the long term, as those customers are less able to service their debt.
As a result, delinquencies in credit card transactions have maintained a steady upward trend. Figures put UK consumers high up in the European ranking for levels of personal indebtedness, despite UK GDP growth remaining strong.
“Issuers are faced by an unknown environment,” said Heather Dyke, senior director with Fitch's consumer ABS team. “Although the fundamental economic backdrop is strong and employment levels are robust, due to the huge growth in availability of unsecured consumer credit there is a sector of highly indebted customers that is teetering on the edge of insolvency.”
The deterioration in collateral started as early as 2004 when collective payment rates started to decline. And that deterioration has still not stabilised. When this is combined with a slow-down in credit card lending, it has resulted in diminishing outstanding credit card balances, which has in turn stunted ABS issuance volumes.
“Growth in delinquencies does not appear to be slowing, and bankruptcy and IVA filings continue to increase,” said Cher Chua, associate analyst, structured finance at Moody’s. “In light of this trend and an expected interest rate rise, we do not expect credit card defaults to go down dramatically in the near future."
Charge-offs have been rising significantly too. They reached 8% in March 2007, a marked rise when compared to 4.11% January 2005 (Barclays Capital data), and are continuing to rise as well. Some originators have expressed some surprise at the number of charge-offs, particularly when a significant proportion of customers had not given any indication, such as defaults, before obtaining IVAs.
Bankruptcies are also still on the rise, and recent increases in interest rates will be sure to claim more casualties. On some estimates, 50,000–100,000 people go bankrupt following an interest rate rise.
Yields have remained fairly constant across the board, despite external pressures. Last year the Office of Fair Trading (OFT) halved credit card default fees. Those lost fees have had to be compensated in other areas, such as by introducing balance transfer fees, higher interest rates, and fewer fee waivers. Several credit card companies are likely to charge for accounts kept in credit, and are likely to introduce annual card fees in the near future.
Payment rates have remained fairly stable. The Royal Bank of Scotland’s Arran trust, for example, has a relatively high monthly payment rate in comparison with the rest of the industry. However, RBS’ card business, which is backed by MINT and NatWest receivables, targets the prime sector of the market.
Capital One, on the other hand, has targeted customers ranging from the super-prime down to non-prime segments. That trust has seen some of the worst performance in the industry in terms of charge-offs and monthly payment rates.
Excess spreads levels, however, have deteriorated, reaching new lows in December last year. As a result several credit card transactions have been trapping excess spread in order to increase credit enhancement for the class C notes.
But despite the gloomy circumstances at present, the UK economic backdrop bodes better for the future of the sector. While delinquencies, IVAs and charge-offs are still rising, the rate at which they are doing so appears to be levelling off.
“Delinquencies have started to stabilise, and provided the economic background remains healthy, performance should stabilise before the end of the year,” said Anca Badea of Barclays Capital research.
“However, charge-offs are still rising and will continue to do so until those bad accounts are written off. Hopefully there should be some stabilisation in charge-offs before the end of the year too."
Outlook
Views on the prospects for future issuance remain mixed, however. Whereas some market participants expect issuance to pick up in the second half of the year, others doubt that we will see more than a few more Double B notes issued.
“We are not expecting to see any significant issuance in the near future, although there may be some further BB notes if performance continues to deteriorate,” said Fitch’s Dyke.
However, Clifford Chance's Ingram is more optimistic. “The consumer credit environment is generally better than it was, and the market may well see more credit card securitisation issuance before the end of the year. It is probable that there would be a number of private deals alongside the public deals though,” he said.
Refinancings may be the most natural source of new paper. Several transactions are maturing this year, including Sherwood Castle Funding 2002-1 and 2002-2, Affinity 001, Chester Asset Receivables 2002-B, Cumbernaud Funding 2004-1, Gracechurch 2 and 7, and Pillar 2002-1.
“It is possible that re-financings will follow [the down-paying deals]. If there is any new issuance, it will come towards the end of the year,” said Barclays Capital’s Badea.