fitch cc abs

8/14/2019 Fitch Cc Abs

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Special Report

ABCs of Credit Card ABS

Analyst

David R. Howard(212) 908-0677

Credit Card Securitization Group

Michael R. Dean(212) 908-0556

David R. Howard(212) 908-0677

Chris Mrazek(212) 908-0667

Giovanni Pini(212) 908-0664

Mario F. Verna(212) 908-0603

Summary

Over the past several years, competition inthe U.S. credit card industry has been fierce.This competition has led many banks, includ-ing large, full-service institutions, to lose cus-tomers to issuers that are aggressively

expanding their card portfolios. Some of themore visible winners of this competition areAdvanta Corp., AT&T Corp., Capital OneBank, First USA Bank, Household Bank, N.A.,and MBNA America Bank, N.A. The tremen-dous volume of card loans generated hascreated an equally immense need for inexpen-sive, reliable funding. For many of these insti-tutions, securitization has fulfilled this need.

Credit Cards

The credit card market has grown significantly in thelast five years, increasing from $234 billion of totalreceivables outstanding in 1990 to $349 billion out-standing as of June 30, 1995. This growth came fromcontinual reliance on credit cards by consumers,along with more acceptance of cards by merchantsand service providers, such as doctors and grocerystores. In addition to growth of outstanding receiv-ables, a wide diversity in the types of cards beingissued has developed.

Affinity CardsAffinity programs target members of groups sharing

common interests. For example, associations of medi-cal professionals, fans of auto racing, or alumni of thesame university can have the logo of their association,a picture of their favorite driver, or their school sealon credit cards. This group loyalty builds a bond tothe card. MBNA is the standout issuer of affinity cards.

April 1, 1996

FitchResearch

Structured Finance


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Low-Price CardsThis issuers strategy is to attract an interest rate-sensitiveborrower with a low teaser rate offer, run up the bor-rowers balance quickly by offering instant and easy trans-fers of existing credit card balances from other banks, and

keep the cardholder with competitive go to rates after theintroductory period has ended.To be successful in the low-price business, an issuer must

have sophisticated risk-based pricing computer models todetermine the rate it can offer to a particular marketsegment based on that segments risk profile. Advanta,Capital One, and First USA have grown their portfoliosdramatically using this strategy.

Co-Branded CardsMany companies, especially automobile manufacturers,airlines, and telephone companies, have allied with card-issuing banks to jointly market cards. The intent is to

promote the companys product and increase receivablesfor the bank. These co-branded cards reward the card-holder for usage. The rewards may be rebates on new carpurchases, free airline tickets, or discounts on long dis-tance telephone calls. This program also provides anincentive for cardholders to pay their bills on time, sincethe reward benefits will be revoked if the cardholderbecomes delinquent. Household and General MotorsCorp. (GM), Citibank, N.A. and American Airlines, andChemical Bank and Shell Oil Co. are several joint venturesin the co-branded arena. Each program has differentarrangements for expense and revenue sharing.

Discover CardDiscover is the only significant issuer of general purposecredit cards to successfully break into the U.S. marketwithout relying on Visa or MasterCard associations. Dis-cover developed its own merchant network across the U.S.

10 years ago and, since then, has achieved notable marketpenetration. The barriers to entry into this arena are highdue to significant start-up costs and intense competition.Discovers card has been extremely successful because ofthe companys cash rebate for purchases strategy and

clear, simple pricing structure.

Retail CardsMany retail stores offer their customers the choice of usinga national credit card or the stores own card. An advan-tage to cardholders of using store cards is that availablecredit on the customers other cards is not used up, allowingcardholders to compartmentalize their debt burden. Forexample, a consumer might use a Sears, Roebuck and Co.card to purchase a new refrigerator and pay it off evenlyover time without using up a Visa or MasterCard line. Theretailer benefits by building customer loyalty and increas-ing the profitability of its lending operation.

Other CardsTravel and entertainment cards, such as American Expressand Diners Club, and full-service cards, like Citibank, Chemi-cal, and Chase Manhattan Bank, N.A., round out the spec-trum of card types.

SecuritizationAs with credit cards, the use of securitization as a financingtool has increased in volume and importance. The firstdeals were done in 1987 to diversify sources of bankfunding. As the banks came under pressure to free up onbalance sheet capital in 1990 and 1991, securitization

filled that need. (Bank regulators treat securitization asasset sales.) More recently, securitization has been theprimary funding source for specialized credit card banks.These banks, such as Advanta, Capital One, First USA,

Top 10 Card Portfolios* Top 10 Securitizers*

($ Bil.) ($ Bil.)

1. Citibank, N.A. 44.80 1. Citibank, N.A. 41.522. Discover Card 27.82 2. MBNA America Bank, N.A. 22.303. MBNA America Bank, N.A. 25.25 3. Sears, Roebuck and Co. 14.004. First USA Bank 17.45 4. Discover Card 13.565. First Chicago Corp. 17.21 5. First USA Bank 12.066. AT&T Universal Card 14.10 6. First Chicago Corp. 11.907. Household Bank, N.A. 12.93 7. Household Bank, N.A. 10.218. Chase Manhattan Bank, N.A. 12.83 8. Capital One Bank 7.139. Chemical Bank 10.80 9. Chase Manhattan Bank, N.A. 6.0210. Capital One Bank 10.45 10. Advanta Corp. 5.14

*General purpose card portfolios in the U.S. as of Dec. 31, 1995. Source:The Ni lson Report, Oxnard, CA. Note: One notable exception to this listis Sears, Roebuck and Co., a retailer with a $23.44 billion portfolio.

*Total amount publicly securitized as of Dec. 31, 1995. Source: Asset-Backed Alert. Note: The securitized total is historical issuance. Some ofthese issuers have resecuritized the same accounts after a deal hasmatured, thus inflating their historical issuance figure.


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and MBNA, benefit from funding at AAA rates and lowcapital charges and, in some cases, rely on off balancesheet treatment to meet regulatory requirements. Withoutsecuritization, some of these banks could not have grownas rapidly. As of Dec. 31, 1995, more than $180 billion

in credit card securities had been issued.

Stand-Alone vs. Master TrustA vast majority of card securitizations have been com-pleted using two different vehicles the stand-alone trustand the master trust. The former is simply a single pool ofreceivables sold to a trust and used as collateral for a singlesecurity, although there may be several classes within thatsecurity. When the issuer intends to issue another security,it must designate a new pool of card accounts and sell thereceivables in those accounts to a separate trust. Thisstructure was used from the first credit card securitizationin 1987 until 1991, when the master trust became the

preferred vehicle.The master trust structure allows an issuer to sell multiplesecurities from the same trust, all of which rely on the samepool of receivables as collateral. For example, an issuercould transfer the receivables from one million accounts(representing $1 bill ion of receivables) to a trust, then issuemultiple securities in various denominations and sizes.When more financing is needed, the issuer transfers re-ceivables from more accounts to the same trust. It can thenissue more securities. The receivables are not segregatedin any way to indicate which series of securities theysupport. Instead, all the accounts support all the securities.

This structure allows the issuer much more flexibility,

since the cost and effort involved with issuing a new seriesfrom a master trust is lower than creating a new trust forevery issue. In addition, credit evaluation of each series ina master trust is easier since the pool of receivables will belarger and not as subject to seasonal or demographicconcentrations. For example, if an issuer transferred onlyreceivables from accounts originated in 1989 into a stand-alone trust and the next year transferred all the receivablesfrom 1990 accounts into a different trust, the two wouldperform differently based on the underwriting standardsused, the terms (annual payment rate [APR] and minimummonthly payment) offered, and the competing offers avail-able at that time.

If a master trust had been used in the same example,both series would depend on the same pool of accounts,one-half of which were originated in 1989 and one-halfof which were originated in 1990. Credit differencesbetween the two series would be contained in the structureof the deal, rather than the receivables. Investors must keepin mind, however, that the makeup of accounts in a mastertrust pool may change dramatically over time as newaccounts are added and as some existing cardholderscancel or stop using their accounts.

Other efficiencies can be included in a master trust,including sharing of pr incipal and sharing of excess spread(see Master Trust Features, page 9).

In addition to issuing investor securities, every seller isrequired to maintain an ownership interest in the trust. This

participation performs several critical functions. It acts as abuffer to absorb seasonal fluctuations in credit card receiv-ables balance, is allocated all dilutions (balances canceleddue to returned goods) and fraudulently generated receiv-ables that have been transferred to the trust, and ensures thatthe seller will maintain the credit quality of the pool since theseller owns a portion of it. To ensure that the certificateholdersinvested amount is always fully invested in credit card receiv-ables, the size of the sellers participation must remain at orabove a minimum percentage of the trust receivables balance,usually 7%. The sellers participation does not provide creditenhancement for the investors.

The seller is obligated to add credit card accounts to the

trust if the amount of its participation falls below therequired minimum. If the seller cannot provide additionalaccounts, an amortization event will occur (see Amortiza-tion Triggers, page 5). In most circumstances, the sellermust receive rating agency approval before any accountscan be added. Sellers do not need approval when theaddition is a small percentage of the trust (10%15%) orwhen the minimum sellers participation level has beenbreached. Of course, rating agencies will receive notifica-tion of these events.

StructuresRegardless of whether the trust is a stand-alone or a mastertrust, the same general structure is used for every deal. Thetypical setup has three different cash flow periods: revolv-ing, controlled amortization (in some cases, controlledaccumulation), and early amortization. Each period per-forms a different function and allocates cash flows differ-ently. This structure is designed to mimic a traditional bond,in which interest payments are made every month andprincipal is paid in a single bullet payment on thematurity date.

Since the average life of a credit card receivable is ashort five to 10 months, an amortizing structure, like theones used in automobile and mortgage deals, does not

work very well. In this type of structure, the principal andinterest collections on the pool of loans are passed directlythrough to investors on a monthly basis. An amortizingstructure for credit card-backed securities would result in ashort average life and lumpy, unpredictable repayment toinvestors. Use of a revolving structure gives the issuermedium- to long-term financing, and it gives the investora predictable schedule of principal and interest payments.

All collections on the receivables are split into financecharge income and principal payments. Each of the three


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periods treats finance charge income in the same manner.Monthly finance charges are used to pay the investorcoupon and servicing fees, as well as to cover any receiv-ables that have been charged off in the month. Any incomeremaining after paying these expenses is usually calledexcess spread and is released to the seller. Principal collec-tions, however, are allocated differently during each of theperiods.

Revolving PeriodDuring the revolving period, monthly principal collections

are used to purchase new receivables generated in thedesignated accounts or to purchase a portion of the sellersparticipation if there are no new receivables. If there arenot enough new receivables to reinvest in, an early amor-tization will be triggered because the sellers participationhas fallen below the required minimum, or, in some cases,the excess principal collections will be deposited in anexcess funding account and held until the seller can gen-erate more credit card receivables. The risk of early amor-tization gives the seller adequate incentive to maintain thesellers participation at a level well above the minimum. Therevolving period continues for a predetermined length oftime, which has ranged from two to 11 years. Investors will

receive only interest payments during this period.

Controlled Amortization/ AccumulationAt the end of the revolving period, the controlled amor-tization or controlled accumulation period begins. In thecase of controlled amortization (see chart above), whichtypically runs for 12 months, principal collections are nolonger reinvested but are paid to investors in 12 equalcontrolled amortization payments. The payments are sizedat exactly one-twelfth of the invested amount so investors

can be repaid on a predetermined schedule. (Some seriesmay have longer or shorter controlled periods and, thus,will have smaller or larger controlled amortization pay-ments.) Any principal collected in excess of the controlledamount will be reinvested in new receivables, as in the

revolving period. Interest will be paid only on the outstand-ing amount of securities as of the beginning of the monthlyperiod.

Controlled accumulation follows a similar procedure,except that the controlled payments are deposited into atrust account, or principal funding account (PFA), everymonth and held until the expected maturity date. At the endof the accumulation period, the full invested amount willhave been deposited into the PFA and investors will berepaid their principal in a single payment (see chartbelow). Of course, interest payments will be made eachmonth on the total invested amount. With this structure,investors will not see any difference in monthly payments

when the deal converts from revolving to accumulation.

Early AmortizationSevere asset deterioration, problems with the seller orservicer, or certain legal troubles can trigger early amortiza-tion at any point in the deal, whether i t is revolving, amortiz-ing, or accumulating. The box on page 5 shows commonamortization triggers. In such cases, the deal automaticallyenters the early amortization period and begins to repayinvestors immediately. This feature helps protect investors froma long exposure to a deteriorating transaction.

Fast Pay Allocation

In the event that an early amortization is triggered and notcured, the investors will begin to be repaid immediately on




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a fast pay, or uncontrolled, basis. All principal collectionsand any amounts in the PFA wil l be distributed to investors,with senior certificates being paid off first. Principal distri-butions will be made to subordinate investors only aftersenior investors are fully repaid. To help speed repayment

to investors, a portion of principal collections that wouldnormally be allocated to the sellers participation will bereallocated to the investors.

In the history of credit card securitization, the only threedeals that have triggered early amortization events wereissued by RepublicBank, Delaware, Southeast Bank, andChevy Chase FSB. None was rated by Fitch. In the ChevyChase deal, investors voted to waive the trigger event, andthe transaction continued to operate as normal. The secu-rities were repaid as originally scheduled, and no investorsuffered a loss. In both the Southeast Bank and Repub-licBank deals, early amortization was commenced andinvestors were repaid without a loss, but earlier than they

had expected. In modern transactions, certain features areavailable to protect investors from early amortization risk(see Master Trust Features, page 9).

Credit Enha ncementAs unsecured revolving debt obligations, credit card re-ceivables offer no collateral in the event of cardholderdefault. As a result, recoveries are limited. To achieveinvestment-grade ratings, credit enhancement is needed toinsulate investors from fluctuating payment patterns andcardholder chargeoffs. Common forms of credit enhance-ment are excess spread, a cash collateral account (CCA),a collateral invested amount (CIA), and subordination.Most recent transactions use a combination of enhance-ments, the most common being senior/ subordinate/ CIA.

Excess SpreadThe yield on credit cards, which is high relative to othertypes of consumer loans, should cover the payment ofinvestor interest in addition to the servicing fees and still besufficient to reimburse the trust for any receivables chargedoff during the month. The remaining yield, or excessspread, provides a rough indication of the financial healthof a transaction.

Available excess spread may be shared with other series,used to pay fees to credit enhancers, deposited into aspread account for the benefit of the enhancers, or releasedto the seller.

If the deal is performing as expected, the cash flow fromthe pool of credit cards will be sufficient to make all

Amortization Triggers*

Seller/ Servicer1. Failure or inability to make required deposits or

payments.

2. Failure or inability to transfer receivables to thetrust when necessary.

3. False representations or warranties that remainunremedied.

4. Certain events of default, bankruptcy, insolvency,or receivership of the seller or servicer.

Legal5. Trust becomes classified as an investment com-

pany under the Investment Company Act of 1940.

Performance6. Three-month average of excess spread falls be-

low zero.7. Sellers participation falls below the required level.8. Portfolio principal balance falls below the in-

vested amount.

Fitch believes these basic triggers address all possibleworst-case scenarios as well as any unforeseen eventsapplicable to the seller/ servicer, trust, or portfolio. Somesample scenarios are outlined below.

Scenario Covered By

Seller/ Servicer Fraud 1, 2, and 3

Default of Seller/ Servicer 4Taxation of Trust 5 and 6Rapidly Rising Chargeoffs 6Federally Imposed Interest Rate

Caps 6Whipsaw Interest Rate Scenarios 6Economic Recession/ Depression 6Spikes in Dilution and/ or

Fraudulent Charges 7 and 8Declining Pool Balance due

to Competition 7 and 8Reduction in Credit Card Usage 7 and 8

*All credit card transactions contain deal- and issuer-specificamortization events. The following events are basic, commontriggers that are necessary for most transactions.Excess Spread

%

Gross Portfolio Yield 18Investor Coupon (7)Servicing Expense (2)Chargeoffs (5)

Excess Spread 4




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principal and interest payments to investors and to pay allexpenses, with plenty of excess remaining. In the exampleon page 5, the 4% excess spread would have to be depleted(i.e. decrease in yield, increase in coupon, and/ or increasein chargeoffs) before there would be a cash shortfall. If,

however, excess falls below zero, other credit enhancementmust be available to make up the shortfall.

Cash Collateral AccountA CCA is simply a segregated trust account, funded at theoutset of the deal, that can be drawn on to cover shortfallsin interest, principal, or servicing expense for a particularseries if excess spread is reduced to zero. The account isfunded by a loan from a third-party bank, which will berepaid only after all classes of certificates of that series havebeen repaid in full. Cash in the account will be invested inthe highest rated short-term securities, all of which willmature on or before the next distribution date. Draws on

the CCA may be reimbursed from future excess spread.

Collateral Invested AmountThe CIA represents an uncertificated, privately placedownership interest in the trust, subordinate in paymentrights to all investor certificates. Acting like a layer ofsubordination, the CIA serves the same purpose as theCCA; it makes up for deficiencies if excess spread isreduced to zero. The CIA is traditionally placed with banks,which may require investment-grade ratings on the CIA asa condition to purchase. The CIA itself is protected by aspread account (not available to any other investors) andavailable monthly excess spread. If the CIA is drawn on, it

can be reimbursed from future excess spread.This class of enhancement also goes by other names CA investor interest, collateral interest, enhancement in-vested amount, or C tranche.

SubordinationA senior/ subordinate structure offers two different types ofinvestor ownership in the trust senior participation in theform of class A certificates and subordinate participationin the form of class B certificates. Class B will absorb lossesallocated to class A that are not already covered by excessspread, the CCA, or the CIA. Like the CCA and CIA, drawson the subordinate certificates may be reimbursed from

future excess spread. Principal collections will be allocatedto the subordinate investors only after the senior certificatesare fully repaid.

Letter of CreditFrom the inception of credit card securitization until 1991,the letter of credit (LOC) was a common form of enhance-ment. It is an unconditional, irrevocable commitment froma bank to provide cash payments, up to the face amountof the LOC, to the trustee in the event that there is a shortfall

in cash needed to pay interest, principal, or servicing.Usage as a form of enhancement was discontinued whena number of banks providing LOCs were downgraded andthe transactions they enhanced were downgraded as aresult. The CCA was developed to remove downgrade risk

caused by enhancer credit quality, and this marked the endof the use of LOCs in credit card transactions.

Stress Scena riosUnder the most severe depression scenarios, properlystructured AAA credit card asset-backed securities (ABS)should repay investors 100% of their original investmentplus interest. Securities rated in the A category (subordi-nated certificates) are subject to less severe recessionaryscenarios than those used for AAA; however, they areconsidered to be investment grade and of high creditquality. The trusts ability to pay interest and repay principalto class B is strong, but it may be more vulnerable to

adverse changes in economic conditions and circum-stances than class A.

Credit card ABS performance can be influenced bymany variables, with both positive and negative effects.Fitch develops stress scenarios at every rating level for eachABS issuer and structure by evaluating the performancevariables described in the box below.

Current/ historical performance or, if the portfolio isunseasoned, a conservative projection of performance isused as a benchmark by which to assess future perform-ance. The stress scenarios applied to a transaction aredetermined on a case-by-case basis and compared to a

Performance Variables

u Underwriting standardsu Cardholder credit scoresu Card type retail, low-price, affinity, and co-

branded, among othersu Fixed- or floating-card annual percentage rateu Flexibility of issuer to reprice card ratesu Frequency of floating-rate resetsu Use of teaser ratesu Attritionu Geographic and demographic diversification

u Interchangeu Convenience usageu Seasoningu Servicingu Competitive positionu Managementu Discounting of new receivables into trustu Other structural features




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hypothetical industry benchmark. The major variables in-fluencing credit enhancement levels are chargeoffs, port-folio yield, monthly payment rate (MPR), and investorcoupon.

ChargeoffsCredit cards are unique among loans in that the creditquality of each cardholder is reflected in the cardholderscredit limit and annual percentage rate (APR), which arebased on the cardholders ability to meet debt payments(i.e. the higher the risk, the lower the credit limit and thehigher the APR). Many issuers use sophisticated credit-scoring models, or well trained credit analysts, to determinethe cardholders probability of default. This probability dic-tates what credit limit should be granted, and at what APR.

Examining the credit limits and APRs of a portfolio,however, does not always give a true picture of the issuerstotal risk. Some issuers might be more aggressive in as-

signing high limits to lower credit quality borrowers. Somemight not have well developed scoring models. Finally,some may try to gain market share by offering very lowinterest rates, possibly at the expense of credit quality.

All these factors must be analyzed when determining theappropriate chargeoff stress to apply to a portfolio. Thestress level shown in the benchmark table below indicatesthat one in every four or five cardholders defaults on theirobligation to pay.

Portfolio YieldYield is made up of periodic APRcharges, annual fees, latepayment fees, overlimit fees, and, in some cases, recoveries oncharged-off accounts and interchange. Interchange is incomefrom the card associations (Visa, MasterCard, and Novus,among others) that is paid to the issuing bank as compensationfor taking credit risk and funding receivables, the amount of

which varies from 1%2% annually. Most of these compo-nents are relatively stable and only comprise a smallpercentage of the yield. APR, on the other hand, accountsfor a large majority of the yield and is the most volatile.

In stressing a portfolios yield, competitive position is a

critical factor, since a highly priced portfolio will be underpressure to reduce rates to maintain market share. Anotherimportant factor is the possibility of a federally imposedinterest rate cap on credit card APRs. In November 1991,the U.S. Senate proposed a measure to lower credit cardinterest rates to a cap of 14%. If the measure had beenenacted, some portfolios would have suffered a reductionin yield of more than 30%.

Monthly Payment RateThe MPR includes monthly collections of principal, financecharges, and fees paid by the cardholder and is stated asa percentage of the outstanding balance as of the begin-

ning of the month. Reductions in MPR may come from adecrease in the number of cardholders who pay off theirentire bill every month and from cardholders makingsmaller monthly payments.

Fitch Credit Card Default ModelWhen run through Fitchs default model, the benchmarkscenario in the table at left gives a generic AAA level fora portfolio. However, since every credit card is not createdequal, more attention must be paid to the dynamics of eachvariable stressed in context with that portfolio and Fitchsbenchmark. For example, the stress test outlined in the tablebelow applies to the Household Affinity Credit Card Master

Trust, which is made up solely of GM co-branded cards.Households underwriting criteria is strong, and, to date,the trusts performance has been better than expected. How-ever, since Households portfolio is not heavily seasoned andhas not been tested during a recessionary environment, Fitchimposes a slightly more conservative chargeoff multiple. Asthe average age of the accounts increases, Fitch will revisitthis stress and adjust it accordingly.

The payment rate stress on this portfolio is also veryconservative. Since all the accounts are under the GMrelationship, it is important to keep in mind what wouldhappen if the co-branding agreement were canceled.

Benchmark Stress Scenarios

AAA A

Chargeoffs 5.00x Multiple 3.00x Multiple

Portfol io Yield 35% Decline 25% Decline

Monthly Payment Rate 50% Decline 35% Decline

Household Affinity Credit Card Master Trust Stress Scenarios(%)

Current* Benchmark Household Affinity Stress

Chargeoffs 4.32 5.00x Multiple 5.25x Multiple 22.68Portfolio Yield 19.16 35% Decline 40% Decline 11.50Monthly Payment Rate 25.91 50% Decline 65% Decline 9.07

*As of Dec. 31, 1995.




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Many cardholders using their cards to generate GM rebatepoints would cease making purchases, and payment rateswould fall dramatically.

As another example of customizing stresses, the tableabove shows a scenario applied to the Sears Credit CardMaster Trust.

Since more than 60% of Searss accounts are greaterthan five years old, portfolio statistics are very consistent.

Even during the 19901991 recession, Fitch gives Searscredit for stable underwriting and reduces the companysworst-case multiple. In addition, payment rates cannot fallmuch farther, even under severe economic stress.

Investor CouponFor f ixed-rate ABS, Fitch uses the expected pricing level ofthe securities as the transactions investor coupon expense.For floating-rate ABS, Fitch assumes that the investor cou-pon will increase dramatically. The interest rate environ-ment of the early 1980s specifically, the second half of1980 is used as a stress scenario, since that was themost volatile period of the last 20 years.

Additional credit enhancement is needed to cover thepotential basis risk and interest rate risk between a rapidly

rising investor coupon and lagging floating-rate or lowfixed-rate credit cards, where trust expenses increase fasterthan trust earnings. This risk is issuer- and deal-specific andis estimated based on credit card interest rates, frequencyof credit card floating-rate resets, investor coupon index,frequency of investor coupon resets, and, to a limitedextent, the issuers ability to change credit card interestrates. The amount of additional enhancement required

may vary from 2.5% to more than 4.0%.For example, if the ABS investors coupon floats off the

one-month London Interbank Offered Rate (LIBOR), a dealwith credit cards that are priced off the prime rate and resetmonthly would be exposed to less interest rate risk than adeal with cards that are fixed rate or reset quarterly.Therefore, the monthly reset portfolio would require lessadditional credit enhancement than the portfolio withfixed-rate cards.

Receivables BalanceAn additional variable that must be examined is the poolsreceivables balance. If the outstanding principal receiv-

ables of the portfolio decline, especially during earlyamortization, the amount of principal collections reallo-cated from the sellers participation would be drasticallyreduced. This results in a longer payout period and in-creased exposure to a deteriorating pool. The primaryconcern is how cardholders will behave with regard to thesolvency of the seller.

For credit cards issued by small, regional retailers, Fitchbelieves that if the retailer files bankruptcy under Chapter 7of the U.S. Bankruptcy Code, consumers would no longerbe able to use their cards since all the stores have beenclosed or sold, and the principal receivables balance of the

trust will decline in lockstep with the amortization of thesecuritization. Exceptions may be made if the retailer isunlikely to file under Chapter 7.

For well underwritten, geographically diverse, general-purpose card portfolios, insolvency of the seller will nothave such a dramatic effect. Most consumers probably willnot even know that their bank has gone into insolvency andwill continue to use their cards. With the profitability of thecard business, the heavy premiums at which pools ofaccounts are bought and sold, and the aggressive compe-

Sea rs Cred it Card M aster Trust Stress Scena rios(%)

Current* Benchmark Sears Stress

Chargeoffs 5.64 5.00x Multiple 4.50x Multiple 25.38

Portfolio Yield 19.06 35% Decline 35% Decline 12.39Monthly Payment Rate 6.42 50% Decline 35% Decline 4.17

*As of Dec. 31, 1995.




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tition for market share, Fitch believes that portfolios suchas these should continue to remain active, with consumerscontinuing to charge and the portfolio continuing to beserviced, even if not by the original servicer.

Some issuers fall between these two extremes. For exam-

ple, a portfolio that is heavily concentrated in a singleco-branding relationship or affinity group may experienceheavy runoff if that relationship is canceled or becomes lessa value to cardholders. It is unlikely, however, that allcardholders would simultaneously cease using their cards,as they would for a bankrupt retailer.

M aster Trust Fea turesMaster trusts may be set up with one or several reallocationgroups. For example, AT&T Universal Card Master Trustcurrently has two groups: Group I for series with fixed-ratecoupons and Group II for series with floating-rate coupons.Most other trusts have only one group, in which all series

are included. Depending on the structure of the trust, serieswithin the same group may share principal and/ or excessspread, have the ability to discount, or fix allocations offinance charges.

Principal SharingFor all series in the same group, the trust allows distributionof excess principal collections to any series in its accumu-lation or amortization period. Since a series in its revolvingperiod has no principal payment requirements, principalcollections allocated to that series are available for reallo-cation. In addition, principal collections in excess of aseries controlled amount are available for reallocation.

The principal reallocation feature provides investors withmore assurance of timely principal repayment, with noadditional risk to other series.

Excess Spread SharingThere are several ways excess spread may be sharedwithin series of a group. Some groups may be set up as asocialized group, whereby finance charge collectionsare allocated to each series based on need. The interestexpense for all series in the group will be the weightedaverage expense for each series. Thus, the highest couponseries will receive the largest allocation, and the lowestcoupon will receive the smallest allocation. The excess

spread for each series will be the same, since each has thesame coupon expense. In effect, socialized groups shareexcess spread at the top of the cash flow waterfall. AT&TUniversal Credit Card Master Trust, Household AffinityCredit Card Master Trust, and Citibank Credit Card MasterTrust are examples of socialized trusts.

Other trusts may allocate finance charge collections ona pro rata basis, based on size. Thus, each series willreceive the same proportionate amount of finance charges,and the series with the lowest coupon expense will have

the largest amount of excess spread. This amount will beavailable for reallocation to other series, particularly high-coupon series, if their excess spread is reduced to zero.

Discount OptionMany trusts permit the transfer of receivables to the trust ata discount, which increases the portfolios yield by includ-ing principal collections as finance charge collections. Thisallows an issuer to artificially increase excess spread. Apotential risk of discounting is that a deteriorating pool ofassets can continue to revolve with deeper discounts, whichincreases potential economic exposure during early amor-tization. The issuer must obtain rating agency approvalprior to discounting or changing the discount rate.

Fixed Allocation of Finance ChargesThis innovative feature permits a larger percentage offinance charge collections to be allocated to investors afteran amortization event, when cash is needed most. Beforeearly amortization, investors receive their pro rata shareof finance charge collections, and the seller receives its prorata share. After an event is triggered, a portion of thesellers share will be made available to cover shortfalls ininterest or servicing expense, or chargeoffs, in the inves-tors share. Cash flow simulations show that, even understressful scenarios, this overallocation of finance chargesprovides a significant amount of support, thus reducing theneed for credit enhancement.

Early Amortization RiskFitch ratings address the likelihood of repayment of all

principal and interest in a full and timely manner aspromised. Credit card transactions, however, do not prom-ise repayment of principal on any specific date. Instead,they define an expected payment date, and caveat thatprincipal may be paid earlier or later than that date. Thecircumstance that would lead to earlier payment would becommencement of an early amortization. Later repaymentcould be caused by very low payment rates, which wouldmean that controlled amortization or controlled accumula-tion payments would not be made in full, and extra monthsof collection would be needed to pay off the entire investedamount. Every series defines a termination date, which isusually set 2436 months after the expected payment date.

All principal must be paid on or before this date. It isextremely unlikely that MPR would be so slow that principalwould not be repaid by the series termination date.

The amount of enhancement any deal has does not affectthe probability of early amortization. And investors mustkeep in mind that ratings do not reflect the likelihood of thisoccurrence. In fact, it is possible that a deals AAA ratingwould be affirmed if an early amortization commenced.

Early amortization risk is not a focus of investors whendeals perform strongly. However, before consumer delin-




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quencies and chargeoffs increase, portfolio yields comedown dramatically, or interest rates shoot up, investorsshould look very closely at their investments to determinetheir exposure to prepayment risk. Several topics shouldbe considered when evaluating early amortization risk,including:

Variability of chargeoffs. APR pricing position (competitive or not).

Fixed- or floating-rate investor coupon. Seller/ servicer strength. Ability to discount new receivables into trust. Sharing of excess spread. Percentage of total bank receivables that have been

securitized. Existence of variable funding, extendible, or commer-

cial paper series.




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Copyright 1996 by Fitch Investors Service, L.P., O ne State Street Plaza, N Y, NY 10004Telephone 1-800-75 FITCH, (212) 908-0500, Fax (212) 480-4435Barbara A. Besen, Publisher; John Forde, Editor-in-Chief; Madeline OConnell, Director, Subscriber Services; Diane Lupi, Nicholas T. Tresniowski,Managing Editors; Terry Peters, Editor; Kelly Briney, Sr. Publishing Specialist; Richard L. Farruggio, Martin E. Guzman, Paula M. Sirard, Linda Trudeau,Publishing Special ists. Printed by American Direct Mail Co., Inc. NY, N Y 10014. Reproduction in whole or in part prohibited except by permission.

Fitch ratings are based on information obtained from issuers, other obligors, underwriters, their experts, and other sources Fitch believes to be reliable. Fitchdoes not audit or verify the truth or accuracy of such information. Ratings may be changed, suspended, or wi thdrawn as a result of changes in, or the unavailabili tyof, 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 marketprice, 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 receivesfees from issuers, insurers, guarantors, other obligors, and underwriters for rating securities. Such fees generally vary from $1,000 to $750,000 per issue. Incertain cases, Fitch 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 singleannual fee. Such fees are expected to vary from $10,000 to $1,500,000. The assignment, publication, or dissemination of a rating by Fitch shall not constitutea consent by Fitch to use its name as an expert in connection with any registration statement filed under the federal securities laws.



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