abcs of credit card abs

8/8/2019 ABCs of Credit Card ABS

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ABCs of Credit Card ABS

SummaryOver the past several years, competition in the U.S.credit card industry has been fierce. This competitionhas led many banks, including large, full-service insti-tutions, to lose customers to issuers that are aggressivelyexpanding their card portfolios. Some of the more vis-ible winners of this competition are Capital One Bank,Citibank, First USA Bank, N.A., Fleet Bank (formerlyAdvanta), Household Bank, N.A., MBNA AmericaBank, N.A., and Universal Card (formerly AT&T). Thetremendous volume of card loans generated has createdan equally immense need for inexpensive, reliablefunding. For many of these institutions, securitizationhas fulfilled this need.

Credit CardsThe credit card market has grown significantly in thelast eight years, increasing from $234 billion of totalreceivables outstanding in 1990 to $356 billion out-

standing as of May 31, 1998. This growth came fromcontinual reliance on credit cards by consumers, alongwith more acceptance of cards by merchants and serviceproviders, such as doctors and grocery stores. In addi-tion to growth of outstanding receivables, a wide diver-sity in the types of cards being issued has developed.

Affinity CardsAffinity programs target members of groups sharing

common interests. For example, associations of medicalprofessionals, fans of auto racing, or alumni of the sameuniversity can have the logo of their association, a pic-ture of their favorite driver, or their school seal on creditcards. This group loyalty builds a bond to the card.MBNA is the standout issuer of affinity cards, followedby First USA Bank.

Low-Price CardsThis issuers strategy is to attract an interest rate-sensi-tive borrower with a low teaser rate offer, run up theborrowers balance quickly by offering instant and easytransfers of existing credit card balances from other

banks, and keep the cardholder with competitive goto rates after the introductory period has ended.

To be successful in the low-price business, an issuermust have sophisticated risk-based pricing computermodels to determine the rate it can offer to a particularmarket segment based on that segments risk profile.Fleet Bank, Capital One, and First USA Bank havegrown their portfolios dramatically using this strategy.

Co-Branded CardsMany companies, especially automobile manufactur-ers, airlines, and telephone companies, have allied

with card-issuing banks to jointly market cards. Theintent is to promote the companys product and in-crease receivables for the bank. These co-brandedcards reward the cardholder for usage. The rewardsmay be rebates on new car purchases, free airlinetickets, or discounts on long distance telephone calls.

Structured Finance

Asset-Backed Special Report

www.fitchibca.com

July 17, 1998

Credit Card Securitization Group

Michael R. Dean(212) [email protected]

Chris Mrazek(212) [email protected]

Richard C. Drason

(212) [email protected]

Mark Sun(212) [email protected]

Kathy Moon(212) [email protected]

Michelle Galvez(212) [email protected]


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This program also provides an incen-tive for cardholders to pay their bills ontime, since the reward benefits will berevoked if the cardholder becomes de-linquent. Household and General Mo-tors Corp. (GM), Citibank, N.A. andAmerican Airlines, and Chase Manhat-tan and Shell Oil Co. are several jointventures in the co-branded arena. Eachprogram has different arrangements forexpense and revenue sharing.

Discover CardDiscover is the only significant issuer ofgeneral purpose credit cards to success-fully break into the U.S. market with-out relying on Visa or MasterCardassociations. Discover developed its

own merchant network across the U.S.13 years ago and, since then, hasachieved notable market penetration.The barriers to entry into this arena arehigh due to significant start-up costsand intense competition. Discoverscard has been extremely successful be-cause of the companys cash rebate forpurchases strategy and clear, simplepricing structure.

Retail CardsMany retail stores offer their customers

the choice of using a national creditcard or the stores own card. An advan-

tage to cardholders of using store cardsis that available credit on the custom-ers other cards is not used up, allowingcardholders to compartmentalizetheir debt burden. For example, a con-sumer might use a Sears, Roebuck andCo. card to purchase a new refrigeratorand pay it off evenly over time withoutusing up a Visa or MasterCard line. Theretailer benefits by building customerloyalty and increasing the profitabilityof its lending operation.

Other CardsTravel and entertainment cards, such asAmerican Express and Diners Club, andfull-service cards, like Citibank andChase Manhattan Bank, round out the

spectrum of card types.

SecuritizationAs with credit cards, the use of securi-tization as a financing tool has increasedin volume and importance. The firstdeals were done in 1987 to diversifysources of bank funding. As the bankscame under pressure to free up on bal-ance sheet capital in 1990 and 1991,securitization filled that need. (Bankregulators treat securitization as assetsales.) More recently, securitization has

been the primary funding source forspecialized credit card banks. These

banks, such as Fleet Bank, CapitalOne, First USA Bank, and MBNA,benefit from funding at AAA rates andlow capital charges and, in some cases,rely on off balance sheet treatment tomeet regulatory requirements. Withoutsecuritization, some of these bankscould not have grown as rapidly. As ofMay 31, 1998, more than $216 billion incredit card securities had been issued.

Stand-Alone vs. Master TrustA vast majority of card securitizationshave been completed using two differ-ent vehicles the stand-alone trustand the master trust. The former issimply a single pool of receivables soldto a trust and used as collateral for a

single security, although there may beseveral classes within that security.When the issuer intends to issue an-other security, it must designate a newpool of card accounts and sell the re-ceivables in those accounts to a sepa-rate trust. This structure was used fromthe first credit card securitization in1987 until 1991, when the master trustbecame the preferred vehicle.

The master trust structure allows anissuer to sell multiple securities from

the same trust, all of which rely on thesame pool of receivables as collateral.

Top 10 Card Portfolios* Top 10 Securitizers*

($ Bil.) ($ Bil.)

1. Citibank, N.A. 45.30 1. MBNA America Bank, N.A. 32.12. MBNA America Bank, N.A. 42.60 2. Citibank, N.A. 31.13. First USA Bank, N.A. 37.80 3. First USA Bank, N.A. 27.24. American Express 36.20 4. Chase Manhattan Bank, N.A. 17.25. Discover Card 33.89 5. Discover Card 15.86. Chase Manhattan Bank, N.A. 31.39 6. Sears, Roebuck and Co. 12.17. Household Bank, N.A. 17.34 7. Household Bank, N.A. 10.88. First Chicago NBD 16.99 8. Capital One Bank 8.59. Universal Card 15.00 9. Fleet Bank (formerly Advanta) 8.510. Fleet Bank (formerly Advanta) 14.38 10. First Chicago Corp. 8.3

*General purpose card portfolios in the U.S. as of March 31, 1998.Note: One notable exception to this list is Sears, Roebuck and Co.,a retailer with a $28.95 billion portfolio in Sears domestic managedcredit card receivables in fiscal 1997. Source: The Nilson Report,Oxnard, CA.

*Total amount of credit card-backed securities securitized as ofMay 31, 1998. Note: The securitized total is historical issuance.Some of these issuers have resecuritized the same accounts after adeal has matured, thus inflating their historical issuance figure.Source: Asset-Backed Alert.


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For example, an issuer could transferthe receivables from one million ac-counts (representing $1 billion of re-ceivables) to a trust, then issue multiplesecurities in various denominations andsizes. When more financing is needed,the issuer transfers receivables frommore accounts to the same trust. It canthen issue more securities. The receiv-ables are not segregated in any way toindicate which series of securities theysupport. Instead, all the accounts sup-port all the securities.

This structure allows the issuer muchmore flexibility, since the cost and ef-fort involved with issuing a new seriesfrom a master trust is lower than creat-

ing a new trust for every issue. In addi-tion, credit evaluation of each series ina master trust is easier since the pool ofreceivables will be larger and not assubject to seasonal or demographicconcentrations. For example, if an is-suer transferred only receivables fromaccounts originated in 1989 into astand-alone trust and the next yeartransferred all the receivables from1990 accounts into a different trust, thetwo would perform differently based onthe underwriting standards used, the

terms (annual payment rate [APR] andminimum monthly payment) offered,and the competing offers available atthat time.

If a master trust had been used in thesame example, both series would de-pend on the same pool of accounts,one-half of which were originated in1989 and one-half of which were origi-nated in 1990. Credit differences be-tween the two series would becontained in the structure of the deal,

rather than the receivables. Investorsmust keep in mind, however, that themakeup of accounts in a master trustpool may change dramatically over timeas new accounts are added and as someexisting cardholders cancel or stop us-ing their accounts.

Other efficiencies can be included in amaster trust, including sharing of prin-cipal and sharing of excess spread (see

Master Trust Features, page 8).

In addition to issuing investor securities,every seller is required to maintain anownership interest in the trust. This par-ticipation performs several critical func-tions. It acts as a buffer to absorb seasonalfluctuations in credit card receivablesbalance, is allocated all dilutions (bal-ances canceled due to returned goods)and fraudulently generated receivablesthat have been transferred to the trust,and ensures that the seller will maintainthe credit quality of the pool since theseller owns a portion of it. To ensure that

the certificateholders invested amountis always fully invested in credit cardreceivables, the size of the sellers partici-pation must remain at or above a mini-mum percentage of the trust receivablesbalance, usually 7%. The sellers partici-pation does not provide credit enhance-ment for the investors.

The seller is obligated to add creditcard accounts to the trust if the amountof its participation falls below the re-quired minimum. If the seller cannot

provide additional accounts, an amorti-zation event will occur (see AmortizationTriggers, page 5). In most circumstances,the seller must receive rating agencyapproval before any accounts can beadded. Sellers do not need approvalwhen the addition is a small percentageof the trust (10%15%) or when theminimum sellers participation levelhas been breached. Of course, ratingagencies will receive notification ofthese events.

StructuresRegardless of whether the trust is astand-alone or a master trust, the samegeneral structure is used for every deal.The typical setup has three differentcash flow periods: revolving, controlledamortization (in some cases, controlled

accumulation), and early amortization.Each period performs a different func-tion and allocates cash flows differently.This structure is designed to mimic atraditional bond, in which interest pay-ments are made every month and prin-cipal is paid in a single bulletpayment on the maturity date.

Since the average life of a credit cardreceivable is a short five to 10 months,an amortizing structure, like the onesused in automobile and mortgage deals,does not work very well. In this type ofstructure, the principal and interest col-lections on the pool of loans are passeddirectly through to investors on amonthly basis. An amortizing structure

for credit card-backed securities wouldresult in a short average life and lumpy,unpredictable repayment to investors.Use of a revolving structure gives theissuer medium- to long-term financing,and it gives the investor a predictableschedule of principal and interest pay-ments.

All collections on the receivables are splitinto finance charge income and principalpayments. Each of the three periods treatsfinance charge income in the same man-

ner. Monthly finance charges are used topay the investor coupon and servicingfees, as well as to cover any receivables thathave been charged off in the month. Anyincome remaining after paying these ex-penses is usually called excess spread andis released to the seller. Principal collec-tions, however, are allocated differentlyduring each of the periods.

Revolving PeriodDuring the revolving period, monthlyprincipal collections are used to pur-

chase new receivables generated in thedesignated accounts or to purchase aportion of the sellers participation ifthere are no new receivables. If thereare not enough new receivables to rein-vest in, an early amortization will betriggered because the sellers participa-


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tion has fallen below the required mini-mum, or, in some cases, the excess prin-cipal collections will be deposited in anexcess funding account and held untilthe seller can generate more credit cardreceivables. The risk of early amortiza-tion gives the seller adequate incentiveto maintain the sellers participation ata level well above the minimum. Therevolving period continues for a prede-termined length of time, which hasranged from two to 11 years. Investors

will receive only interest paymentsduring this period.

Controlled Amortization/AccumulationAt the end of the revolving period, thecontrolled amortization or controlledaccumulation period begins. In thecase of controlled amortization (seechart above), which typically runs for12 months, principal collections are nolonger reinvested but are paid to inves-tors in 12 equal controlled amortizationpayments. The payments are sized atexactly one-twelfth of the investedamount so investors can be repaid on apredetermined schedule. (Some seriesmay have longer or shorter controlledperiods and, thus, will have smaller orlarger controlled amortization pay-ments.) Any principal collected in ex-

cess of the controlled amount will bereinvested in new receivables, as in therevolving period. Interest will be paidonly on the outstanding amount of se-curities as of the beginning of themonthly period.

Controlled accumulation follows asimilar procedure, except that the con-trolled payments are deposited into atrust account, or principal funding ac-count (PFA), every month and held un-

til the expected maturity date. At theend of the accumulation period, the full

invested amount will have been depos-ited into the PFA and investors will berepaid their principal in a single pay-ment (see chart below). Of course, inter-est payments will be made each monthon the total invested amount. With thisstructure, investors will not see any dif-ference in monthly payments when thedeal converts from revolving to accu-mulation.

Early AmortizationSevere asset deterioration, problemswith the seller or servicer, or certain legaltroubles can trigger early amortization atany point in the deal, whether it is revolv-ing, amortizing, or accumulating. Thebox on page 5 shows common amortiza-

tion triggers. In such cases, the deal auto-matically enters the early amortizationperiod and begins to repay investors im-mediately. This feature helps protect in-vestors from a long exposure to adeteriorating transaction.

Fast Pay AllocationIn the event that an early amortizationis triggered and not cured, the investorswill begin to be repaid immediately ona fast pay, or uncontrolled, basis. Allprincipal collections and any amounts

in the PFA will be distributed to inves-tors, with senior certificates being paid


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off first. Principal distributions will bemade to subordinate investors only af-ter senior investors are fully repaid. Tohelp speed repayment to investors, aportion of principal collections thatwould normally be allocated to thesellers participation will be reallocatedto the investors.

In the history of credit card securitiza-tion, the only three deals that have trig-gered early amortization events wereissued by RepublicBank, Delaware,Southeast Bank, and Chevy ChaseFSB. None was rated by Fitch IBCA.In the Chevy Chase deal, investorsvoted to waive the trigger event, andthe transaction continued to operate as

normal. The securities were repaid asoriginally scheduled, and no investorsuffered a loss. In both the SoutheastBank and RepublicBank deals, earlyamortization was commenced and in-vestors were repaid without a loss, butearlier than they had expected. In mod-ern transactions, certain features areavailable to protect investors from earlyamortization risk (see Master Trust Fea-tures, page 8).

Credit Enhancement

As unsecured revolving debt obliga-tions, credit card receivables offer nocollateral in the event of cardholder de-fault. As a result, recoveries are limited.To achieve investment-grade ratings,credit enhancement is needed to insu-late investors from fluctuating paymentpatterns and cardholder chargeoffs.Common forms of credit enhancementare excess spread, a cash collateral ac-count (CCA), a collateral invested

amount (CIA), and subordination.Most recent transactions use a combi-nation of enhancements, the most com-mon being senior/subordinate/CIA.

Excess SpreadThe yield on credit cards, which is highrelative to other types of consumerloans, should cover the payment of in-

vestor interest in addition to the servic-ing fees and still be sufficient toreimburse the trust for any receivablescharged off during the month. The re-maining yield, or excess spread, pro-vides a rough indication of the financialhealth of a transaction.

Available excess spread may be sharedwith other series, used to pay fees tocredit enhancers, deposited into a spreadaccount for the benefit of the enhancers,or released to the seller.

If the deal is performing as expected, thecash flow from the pool of credit cards willbe sufficient to make all principal and

interest payments to investors and to payall expenses, with plenty of excess re-maining. In the example at left, the 4%excess spread would have to be depleted(i.e. decrease in yield, increase in coupon,and/or increase in chargeoffs) beforethere would be a cash shortfall. If, how-

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

Excess Spread 4

Amortization Triggers*

Seller/Servicer1. Failure or inability to make required deposits or payments.2. Failure or inability to transfer receivables to the trust when necessary.

3. False representations or warranties that remain unremedied.4. Certain events of default, bankruptcy, insolvency, or receivership of

the seller or servicer.

Legal5. Trust becomes classified as an investment company under the Invest-

ment Company Act of 1940.

Performance6. Three-month average of excess spread falls below zero.7. Sellers participation falls below the required level.8. Portfolio principal balance falls below the invested amount.

Fitch IBCA believes these basic triggers address all possible worst-case

scenarios as well as any unforeseen events applicable to the seller/servicer,trust, or portfolio. Some sample scenarios are outlined below.

Scenario Covered By

Seller/Servicer Fraud 1, 2, and 3Default 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 Competi tion 7 and 8Reduction in Credit Card Usage 7 and 8

*All credit card transactions contain deal- and issuer-specific amortization events. Thefollowing events are basic, common triggers that are necessary for most transactions.


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ever, excess falls below zero, othercredit enhancement must be availableto make up the shortfall.

Cash Collateral AccountA CCA is simply a segregated trust ac-count, funded at the outset of the deal,that can be drawn on to cover shortfallsin interest, principal, or servicing ex-pense for a particular series if excessspread is reduced to zero. The accountis funded by a loan from a third-partybank, which will be repaid only after allclasses of certificates of that series havebeen repaid in full. Cash in the accountwill be invested in the highest ratedshort-term securities, all of which willmature on or before the next distribu-

tion date. Draws on the CCA may bereimbursed from future excess spread.

Collateral Invested AmountThe CIA represents an uncertificated,privately placed ownership interest inthe trust, subordinate in payment rightsto all investor certificates. Acting like alayer of subordination, the CIA servesthe same purpose as the CCA; it makesup for deficiencies if excess spread isreduced to zero. The CIA is tradition-ally placed with banks, which may re-

quire investment-grade ratings on theCIA as a condition to purchase. TheCIA itself is protected by a spread ac-count (not available to any other inves-tors) and available monthly excessspread. If the CIA is drawn on, it can bereimbursed from future excess spread.

This class of enhancement also goes byother names CA investor interest,collateral interest, enhancement in-vested amount, or C tranche.

SubordinationA senior/subordinate structure offerstwo different types of investor owner-ship in the trust senior participationin the form of class A certificates andsubordinate participation in the form ofclass B certificates. Class B will absorblosses allocated to class A that are notalready covered by excess spread, the

CCA, or the CIA. Like the CCA andCIA, draws on the subordinate certifi-cates may be reimbursed from futureexcess spread. Principal collections willbe allocated to the subordinate inves-tors only after the senior certificates arefully repaid.

Letter of CreditFrom the inception of credit card secu-ritization until 1991, the letter of credit(LOC) was a common form of enhance-ment. It is an unconditional, irrevoca-ble commitment from a bank to providecash payments, up to the face amountof the LOC, to the trustee in the eventthat there is a shortfall in cash neededto pay interest, principal, or servicing.

Usage as a form of enhancement wasdiscontinued when a number of banksproviding LOCs were downgraded andthe transactions they enhanced weredowngraded as a result. The CCA wasdeveloped to remove downgrade riskcaused by enhancer credit quality, andthis marked the end of the use of LOCsin credit card transactions.

Stress ScenariosUnder the most severe depression sce-narios, properly structured AAA credit

card asset-backed securities (ABS)

should repay investors 100% of theiroriginal investment plus interest. Secu-rities rated in the A category (subordi-nated certificates) are subject to lesssevere recessionary scenarios thanthose used for AAA; however, they areconsidered to be investment grade andof high credit quality. The trusts abilityto pay interest and repay principal toclass B is strong, but it may be morevulnerable to adverse changes in eco-nomic conditions and circumstancesthan class A.

Credit card ABS performance can beinfluenced by many variables, withboth positive and negative effects.Fitch IBCA develops stress scenarios at

every rating level for each ABS issuerand structure by evaluating the per-formance variables described in thebox below.

Current/historical performance or, ifthe portfolio is unseasoned, a conserva-tive projection of performance is usedas a benchmark by which to assess fu-ture performance. The stress scenariosapplied to a transaction are determinedon a case-by-case basis and comparedto a hypothetical industry benchmark.

The major variables influencing credit

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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As another example of customizingstresses, the table above shows a sce-nario applied to the Sears Credit CardMaster Trust.

Since more than 60% of Sears accountsare greater than five years old, portfoliostatistics are very consistent. Even dur-

ing the 19901991 recession, FitchIBCA gives Sears credit for stable un-derwriting and reduces the companysworst-case multiple. In addition, pay-ment rates cannot fall much farther,even under severe economic stress.

Investor CouponFor fixed-rate ABS, Fitch IBCA usesthe expected pricing level of the secu-rities as the transactions investor cou-pon expense. For floating-rate ABS,Fitch IBCA assumes that the investorcoupon will increase dramatically. Theinterest rate environment of the early1980s specifically, the second half of1980 is used as a stress scenario,since that was the most volatile periodof the last 20 years.

Additional credit enhancement isneeded to cover the potential basis riskand interest rate risk between a rapidlyrising investor coupon and laggingfloating-rate or low fixed-rate credit

cards, where trust expenses increasefaster than trust earnings. This risk isissuer- and deal-specific and is esti-mated based on credit card interestrates, frequency of credit card floating-rate resets, investor coupon index, fre-quency of investor coupon resets, and,to a limited extent, the issuers abilityto change credit card interest rates. The

amount of additional enhancement re-quired may vary from 2.5% to morethan 4.0%.

For example, if the ABS investors cou-pon floats off the one-month LondonInterbank Offered Rate (LIBOR), adeal with credit cards that are priced off

the prime rate and reset monthly wouldbe exposed to less interest rate risk thana deal with cards that are fixed rate orreset quarterly. Therefore, the monthlyreset portfolio would require less addi-tional credit enhancement than theportfolio with fixed-rate cards.

Receivables BalanceAn additional variable that must be ex-amined is the pools receivables bal-ance. If the outstanding principalreceivables of the portfolio decline, es-pecially during early amortization, theamount of principal collections reallo-cated from the sellers participationwould be drastically reduced. This re-sults in a longer payout period and in-creased exposure to a deterioratingpool. The primary concern is how card-holders will behave with regard to thesolvency of the seller.

For credit cards issued by small, re-gional retailers, Fitch IBCA believes

that if the retailer files bankruptcy un-der Chapter 7 of the U.S. BankruptcyCode, consumers would no longer beable to use their cards since all thestores have been closed or sold, and theprincipal receivables balance of thetrust will decline in lockstep with theamortization of the securitization. Ex-

ceptions may be made if the retailer isunlikely to file under Chapter 7.

For well underwritten, geographicallydiverse, general-purpose card portfo-lios, insolvency of the seller will nothave such a dramatic effect. Most con-sumers probably will not even knowthat their bank has gone into insolvencyand will continue to use their cards.With the profitability of the card busi-ness, the heavy premiums at whichpools of accounts are bought and sold,and the aggressive competition for mar-ket share, Fitch IBCA believes thatportfolios such as these should con-tinue to remain active, with consumerscontinuing to charge and the portfolio

continuing to be serviced, even if notby the original servicer.

Some issuers fall between these twoextremes. For example, a portfolio thatis heavily concentrated in a single co-branding relationship or affinity groupmay experience heavy runoff if thatrelationship is canceled or becomes lessa value to cardholders. It is unlikely,however, that all cardholders would si-multaneously cease using their cards, asthey would for a bankrupt retailer.

Master Trust FeaturesMaster trusts may be set up with one orseveral reallocation groups. For exam-ple, Universal Card Master Trust cur-rently has several groups: Group I forseries with fixed-rate coupons andGroup II for series with floating-ratecoupons; other groups accomodate vari-able funding series. Most other trustshave only one group, in which all seriesare included. Depending on the struc-ture of the trust, series within the same

group may share principal and/or ex-cess spread, have the ability to dis-count, or fix allocations of financecharges.

Principal SharingFor all series in the same group, thetrust allows distribution of excess prin-

Sears Credit Card Master Trust Stress Scenarios(%)

Current* Benchmark Sears

Chargeoffs 8.57 4.55.0x Multiple 4.5x MultiplePortfolio Yield 19.22 35% Decline 35% DeclineMonthly Payment Rate 7.28 50% Decline 35% Decline

*As of May 31, 1998.


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cipal collections to any series in its ac-cumulation or amortization period.Since a series in its revolving period hasno principal payment requirements,principal collections allocated to thatseries are available for reallocation. Inaddition, principal collections in excessof a series controlled amount are avail-

able for reallocation. The principal re-allocation feature provides investorswith more assurance of timely principalrepayment, with no additional risk toother series.

Excess Spread SharingThere are several ways excess spreadmay be shared within series of a group.Some groups may be set up as a social-ized group, whereby finance chargecollections are allocated to each seriesbased on need. The interest expense

for all series in the group will be theweighted average expense for each se-ries. Thus, the highest coupon serieswill receive the largest allocation, andthe lowest coupon will receive thesmallest allocation. The excess spreadfor each series will be the same, since

each has the same coupon expense. Ineffect, socialized groups share excessspread at the top of the cash flow water-fall. Universal Credit Card MasterTrust, Household Affinity Credit CardMaster Trust, and Citibank Credit CardMaster Trust are examples of socializedtrusts.

Other trusts may allocate financecharge collections on a pro rata basis,based on size. Thus, each series willreceive the same proportionate amountof finance charges, and the series withthe lowest coupon expense will havethe largest amount of excess spread.This amount will be available for real-location to other series, particularlyhigh-coupon series, if their excessspread is reduced to zero.

Discount OptionMany trusts permit the transfer of receiv-ables to the trust at a discount, whichincreases the portfolios yield by includ-ing principal collections as finance chargecollections. This allows an issuer to arti-ficially increase excess spread. A poten-

tial risk of discounting is that a deterio-rating pool of assets can continue to re-volve with deeper discounts, whichincreases potential economic exposureduring early amortization. The issuer mustobtain rating agency approval prior to dis-counting or changing the discount rate.

Fixed Allocation of FinanceChargesThis innovative feature permits a largerpercentage of finance charge collec-tions to be allocated to investors afteran amortization event, when cash isneeded most. Before early amortiza-tion, investors receive their pro ratashare of finance charge collections, andthe seller receives its pro rata share.

After an event is triggered, a portion ofthe sellers share will be made availableto cover shortfalls in interest or servic-ing expense, or chargeoffs, in the inves-tors share. Cash flow simulations showthat, even under stressful scenarios,this overallocation of finance chargesprovides a significant amount of sup-port, thus reducing the need for creditenhancement.

Early Amortization RiskFitch IBCA ratings address the likeli-

hood of repayment of all principal andinterest in a full and timely manner aspromised. Credit card transactions,however, do not promise repayment ofprincipal on any specific date. Instead,they define an expected payment date,and caveat that principal may be paidearlier or later than that date. The cir-cumstance that would lead to earlierpayment would be commencement ofan early amortization. Later repaymentcould be caused by very low paymentrates, which would mean that control-

led amortization or controlled accumu-lation payments would not be made infull, and extra months of collectionwould be needed to pay off the entireinvested amount. Every series definesa termination date, which is usually set2436 months after the expected pay-

Fitch IBCA, Inc. Rated General Purpose Card Issuers

BankAmericaCapital One BankChase Manhattan Bank, N.A.

Chevy Chase Bank, FSBCitibank, N.A.Discover CardFirst Chicago Corp.First National Bank of OmahaFirst Omni BankFirst USA Bank, N.A.Fleet Bank, N.A. (formerly Advanta Corp.)Household Bank, N.A.MBNA America Bank, N.A.MBNA International Corp.Mellon BankPeoples Bank

Providan National BankUniversal Card (formerly AT&T)Wachovia Bank


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ment date. All principal must be paidon or before this date. It is extremelyunlikely that MPR would be so slowthat principal would not be repaid bythe series termination date.

The amount of enhancement any dealhas does not affect the probability ofearly amortization. And investors mustkeep in mind that ratings do not reflectthe likelihood of this occurrence. Infact, it is possible that a deals AAArating would be affirmed if an earlyamortization commenced.

Early amortization risk is not a focus ofinvestors when deals perform strongly.However, before consumer delinquen-cies and chargeoffs increase, portfolioyields come down dramatically, or inter-est rates shoot up, investors should lookvery closely at their investments to deter-mine their exposure to prepayment risk.Several topics should be consideredwhen 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 receiv-

ables that have been securitized.- Existence of variable funding, ex-

tendible, or commercial paper series.


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Copyright 1998 by Fitch IBCA, Inc., One State Street Plaza, NY, NY 10004Telephone: New York, 1-800-753-4824, (212) 908-0500, Fax (212) 480-4435; Chicago, IL, 1-800-483-4824, (312) 214-3434, Fax (312) 214-3110;London, 011 44 171 638 3800, Fax 011 44 171 374 0103; San Francisco, CA, 1-800-953-4824, (415) 732-5770, Fax (415) 732-5610Barbara A. Besen, Publisher; John Forde, Editor-in-Chief; Madeline OConnell, Director, Subscriber Services; Jason H. Kantor, Manager, Publishing Technology;

Nicholas T. Tresniowski, Senior Managing Editor; Diane Lupi, Managing Editor; Jennifer Hickey, Andrew Simpson, Editors; Jay Davis, Martin E. Guzman, PaulaSirard, Senior Publishing Specialists; Harvey Aronson, Publishing Specialist; Robert Rivadeneira, Publishing Assistant. Printed by American Direct Mail Co., Inc.NY, NY 10014. Reproduction in whole or in part prohibited except by permission.

Fitch IBCA ratings are based on information obtained from issuers, other obligors, underwriters, their experts, and other sources Fitch IBCA believes to be reliable.Fitch IBCA does not audit or verify the truth or accuracy of such information. Ratings may be changed, suspended, or withdrawn as a result of changes in, or theunavailability of, information or for other reasons. Ratings are not a recommendation to buy, sell, or hold any security. Ratings do not comment on the adequacyof market price, the suitability of any security for a particular investor, or the tax-exempt nature or taxability of payments made in respect to any security. FitchIBCA receives fees from issuers, insurers, guarantors, other obligors, and underwriters for rating securities. Such fees generally vary from $1,000 to $750,000 perissue. In certain cases, Fitch IBCA 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 single annual fee. Such fees are expected to vary from $10,000 to $1,500,000. The assignment, publication, or dissemination of a rating by Fitch IBCA shallnot constitute a consent by Fitch IBCA to use its name as an expert in connection with any registration statement filed under the federal securities laws. Due tothe relative efficiency of electronic publishing and distribution, Fitch IBCA Research may be available to electronic subscribers up to three days earlier than printsubscribers.


12 Fitch IBCA, Inc.

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