S&P Casts Wary Eye on Credit Card ABS in 2008

There’s no getting away from the bad news about collateralized debt obligations (CDOs), those pools of debt that contain untold amounts of hidden or bad debt that may never be paid off.

And there are always been plenty of stories of the way credit cards cause consumers to spend beyond their means, leading to delinquencies, charge offs, bankruptcy and the general end of the human race.

Despite the headlines, there is good news about some debt pools and credit cards.

Last year, credit card asset-backed securities (ABS), a grandfather of CDOs, actually had a pretty good year, with issuance up 37 percent in the first half of 2007, according to Standard & Poor’s, the rating and research house. Even as many of the subprime mortgages that made up portions of CDOs disintegrated, investors continued to purchase credit card ABS in the second half of the year. Indeed, the $90.6 billion of ABS issued in 2007 was a record, according to S&P.

S&P tracks the ABS market through its Credit Card Quality Index (CCQI), an index made up of a $430.1 billion pool of credit card receivables. Put simply, this pool consists of the debt that consumers owe on their cards and represents about two-thirds of the U.S. bank card market, according to S&P.

The CCQI primarily includes receivables from major bank card issuers, the big seven that together hold a 94 percent market share of the U.S. market. Each issuer sells a pool of receivables and uses the returns to fund further credit card loans.

In other words, the CCQI is a surrogate for the general health of the credit card market.

First some good news. In November, the CCQI’s excess spread rate, essentially the cash coming in minus charge offs, was 9.0 percent. That was 70 basis points higher than the average excess spread in 2006 and 240 basis points higher than the average for 2005.

Still, all is not rosy. The charge off rate on the CCQI rose to an average of 4.4 percent in the 11 months through Nov. 2007, up from 3.7 percent in the same period in 2006. S&P is projecting that if current trends continue this will rise 40 percent to 6.6 percent before the end of this year. (The all-time high was 7.6 percent, set in March 2002).

S&P also is detailing problems as the country appears to be heading into a recession. A mild recession could send card charge offs on the CCQI up to 7.8 percent by the fourth quarter of 2008, and increase the unemployment rate to 6.2 percent in early 2009, up from 5.0 percent today, S&P projects.

S&P reports this mild recession could occur this year if there is a combination of a “deeper housing downturn, higher bond yields resulting from a falling dollar, and higher oil prices.” Since S&P made that projection, an index that tracks home prices nationally saw its fourth quarter 2006 value fall by nearly 9 percent. And oil hit $102 a barrel.

A more severe recession would send unemployment levels to 7 percent by the spring of 2009 and card losses could exceed 9 percent that year.

Whatever its severity, a recession will mean a decline in the amount of card ABS issued this year. A healthy economy would bring $85 billion to $95 billion in credit card ABS issued this year, according to S&P, but a recession will reduce that by 20 percent to 30 percent.

Keep in mind that credit card ABS have a history of stability, with only nine defaults in the 20 years that S&P has been following the market. In the first 10 months of 2007, the ratings on nearly 92 percent of all ABS issued that year were unchanged, 7.75 percent of the ABS had been upgraded, and a meager 0.35 percent were downgraded. 

Research in this analysis included the following reports from S&P: “U.S. Credit Card ABS Investors Will Focus on Consumer Credit Quality in 2008,” “U.S. Credit Card Quality Index: Despite Weaker Trends in November, Trust Performance Remains Stable,” and “U.S. Credit Card ABS is Expected to Withstand Higher Losses in a Recession.”

Burney Simpson is editor-in-chief of Kaulkin Media’s insideARM.com, Arm Insider, Inside Card & Creditor Receivables, and Inside Collections & Debt.