Credit Quality Raising Hurdles for Card Debt

Continued growth in consumer loan demand has led many large credit card issuers to step up their receivables securitization activities in recent months.

But as AT&T Universal Card made its long-awaited arrival in the securitization market, investor concerns about credit quality have forced issuers to strengthen their reserve mechanisms.

"There is evidence issuers have been moving down the credit spectrum," said Linda Stesney, a senior analyst in the structured finance group at Moody's Investors Service. "We will likely start to see a continued increase in the charge-off rate, which has been inching up since late last year."

In fact, a report on credit card loan quality issued by Moody's last month shows that chargeoffs averaged 4.07% during the first four months of the year, up from an average of 3.85% reported for the last five months of 1994. In April alone - the latest month available - average chargeoffs reached 4.09%, following a low of 3.74% recorded in December.

Even AT&T Universal Card's $930 million offering had to overcome credit quality concerns. According to Bob Franklin, a senior analyst and colleague of Ms. Stesney at Moody's, the issuer relaxed its credit standards in 1993 and 1994 to boost earnings.

The strategy led to a rise in chargeoffs, and as a result the company is said to have raised its underwriting standards. However, investors needed assurance.

The company enhanced the offering by subordinating a $60 million, or 6%, tranche of the issue. It also established a 7% collateral invested amount as a mechanism for providing additional security to the offering. The deal's $870 million senior tranche received triple 'A' ratings from both Moody's and Standard & Poor's Corp. and was priced at eight basis points over the three-month London Interbank Offering Rate.

And the market seems poised for even more credit card offerings during the rest of 1995. Moody's estimates that second-half volume will approach $48 billion, and $100 billion for the year.

Phillip Wiengord, a director with CS First Boston in the asset finance group, said a portion of the growth is attributable to commercial banks.

"We're starting to see a return of commercial banks to this market for a whole host of reasons," he said. In particular, he said securitizing low- yielding credit card receivables allows these institutions to boost return on assets and equity while providing capital for more loans, share repurchases, or acquisitions.

However, the heated battle among issuers for such a mature market is still a cause for concern. Since most potential customers already use some kind of credit card, issuers marketing strategies are increasing shifting toward poaching competitors' customers through higher credit limits and low interest rates on transferred balances.

Moody's Mr. Franklin said this is troubling because "people typically charge up their credit cards" as they start to get into financial trouble.

And Ms. Stesney warned that problems could mount if the economy sours.

"A lot of the positive performance of the past couple years has been due to the economy," she said. "We're seeing that performance detiorating slighlty and we would expect to see that continue in an economic downturn."

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