When institutions that issue consumer credit cards do not wish to keep the receivables on their balance sheets, these institutions can issue credit card receivable backed securities.
Credit card loans are non-amortizing and are issued by banks, retailers, as well as travel companies.
The cash flows from credit cards consist of finance charges (interest), fees (annual fee and late payment fee) and principal repayments.
Because a principal retirement schedule does not exist for the credit card receivables, a lock out period may be established for the ABS.
During the lock-out period, any principal paid by the borrowers is loaned to other credit card users (invested in receivables) to maintain the size of the pool. Therefore the investors only receive interest payments during the lockout period. The lockout period ranges from 18 months to 10 years. After the lock-out period the principal is not reinvested, instead it is pad back to the investors. This period is called principal amortization period.
Principal payment can be structured as:
- Pass-through: Principal is paid to ABS investors as received
- Controlled Amortization Schedule: Principal is returned at a set schedule or there can be some range of prepayment speeds.
- Soft Bullet: Principal payments are held by the trustee during an accumulation speed and then paid to investors at once; the title soft bullet is used because the maturity of the payment is a goal rather than a legal guarantee.
Performance Measure: Portfolio Yield
- A large credit card portfolio will have defaults.
- These losses are charged against the portfolio’s gross yield to obtain a net yield for the ABS.
- ABS investors will be paid from net yield.
Performance Measure: Monthly Payment Rate & Early Amortization Provisions
- Monthly Payment Rate (MPR) is the ratio of monthly payments as a percentage of the prior month’s loan balance.
- When MPR is low, the investor can be exposed to extension risk.
- When MPR is extremely low, it could be inferred that the borrowers in the credit card pool may fail to repay principal (i.e. it is a sign of default risk).
- Early Amortization Provisions: offer credit card backed ABS investors protections which force early principal repayment if specified monthly payment metric levels are crossed (or triggered).