Far-reaching changes to credit card industry securitization

The U.S. credit cards industry is battling the challenge of rising net charge-offs on its receivables base of about $800 billion, thanks to the credit crisis and rising unemployment. But that is not all – industry leaders are having to contend with a host of other forces at play, some helpful and others potentially detrimental to the profitability of card companies. A.T. Kearney’s banking clients, many with large credit card portfolios, are at the center of the storm.

Over the years, card issuers have fine-tuned the mechanics of asset securitization, which allows them to take a chunk of their receivables off balance sheet and make room for more lending. However, it might be time to go back to the drawing board, as a lot is changing in this space.

Regulations on re-pricing card interest rates
Take for instance the new federal regulations that would restrict credit card issuers' ability to re-price card interest rates. In the near term, this change could improve master trust performance for credit card asset-backed securities. But we believe the Fed rules are more likely to have a negative long-term effect on securitized master trusts.

Anticipating the restrictions, card issuers may quickly raise interest rates before the door closes. And although overall underwriting standards may be tightened, these constraints on raising interest rates are likely to cause problems. The ability to dynamically re-price credit cards is one of the keys to credit card profitability and master trust performance. (Srini Venkateswaran, a partner in A.T. Kearney’s Financial Institutions Group, contributed to a CardLine article on this topic, 20 April 2009, subscription required).

Accounting rules
Another force at play is impending changes to the FAS 140 accounting rule. If approved, the changes would force credit card issuers to bring a large subset of their securitized loans back on their balance sheets. They would then have to set aside additional capital towards loan loss reserves.

However, some good news is on the horizon. The Term Asset-Backed Securities Loan Facility (TALF) is likely to usher in a new and improved 'TALF 2.0.’ While the government has already promised to lend up to $1 trillion to private investors to buy new asset-backed securities, usage has been limited, due in part to the restricted list of eligible assets. TALF 2.0 is expected to be broader in its reach and potentially include a host of assets – card debt, auto loans and even residential and commercial real estate debt. Done correctly, it could infuse enthusiasm into the securitization market.

Clearly there is more to managing the profitability of the credit cards business than the securitization of debt. A.T. Kearney continues to help card and payment companies on a host of topics ranging from marketing effectiveness and rewards optimization to enterprise cost reduction and collections.

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