10/24/2008

Card Squeeze Creating Liquidation Buzz

Rising defaults among private-label credit-card accounts are prompting some lenders to think about unwinding securitizations backed by those assets.

Companies rumored to be mulling such moves include clothing retailer Charming Shoppes and Sterling Jewelers, the operator of the Kay Jewelers and Jared chains.

At issue is a jump in the number of accounts that retailers are deeming uncollectable. According to Fitch, securitized pools of private-label credit cards saw their charge-off rates climb to nearly 9.4% last month, from 8% in March and 6.4% last September.

In some cases, those losses are large enough to make it uneconomical for lenders to continue operating trusts that were used to securitize the cashflows. Now the preferred strategy among those shops appears to be to liquidate the underlying receivables, including defaulted accounts, and use the proceeds to repay bondholders. "There is a lot of stress building around the edge of the private-label sector," said one buyer of charged-off portfolios.

Some bondholders also favor trust liquidations in cases where issuers can no longer turn profits through their securitization programs. It's possible they fear that losses will only rise going forward, threatening the principal they are owed. "The money that is coming in from these trusts isn't enough to pay the service providers, like the lawyers and trustees that maintain it, and give bondholders their cut too. Liquidating is becoming the best option," the charge-off buyer said.

The liquidations might follow a format similar to the one used by bankrupt Spiegel last November to unload a store-card portfolio from apparel unit Eddie Bauer. Working with Harrison, N.Y., advisor Garnet Capital, the company auctioned $930 million of card receivables, including $100 million of accounts that were closed but still performing. The other $830 million consisted of charged-off accounts.

For now, the prospects for trust liquidations appear confined to retailers that operate their own credit-card businesses. Bigger institutions like Citigroup, GE Capital and HSBC that run card programs for retailers - HSBC, for instance, lends for electronics chain Best Buy - have also seen some weakening in their portfolios. But their lending efforts don't appear to be in danger of turning unprofitable.

Those companies' securitizations have also typically been regarded as safer investments, as they contain accounts from multiple stores and benefit from more credit enhancement than offerings from stand-alone retailers. Overall, "while one might expect that the retail credit card trusts would show evidence of weakening performance sooner than prime general purpose credit card trusts, that hasn't happened. Although charge-offs have increased by 300 bp over the last year, three month average excess spread has declined only 125 bp, and remains robust at 9.56%," according to Fitch.

There have also been some rumblings that Wells Fargo has considered selling unsecuritized card accounts it wrote for retailers whose customers are defaulting in higher numbers. Wells holds $7.7 billion of card accounts.

The mere consideration of unwinding securitizations of credit-card accounts underscores how deeply consumer credit quality has weakened since the debt market fell apart last year. While rising card defaults have been widely expected, most bonds in the sector have appeared to be on solid ground - unlike their cousins in the mortgage market.

The moves also highlight the ways that easy lending terms have come back to haunt lenders across consumer-credit sectors. Many of the card-pool sales are expected to be driven by losses resulting from promotions in which borrowers were allowed to make large purchases with deferred interest, lengthy grace periods and no money down.

Some lenders are stepping up their monitoring of those borrowers, in hopes of stopping defaults within their accounts from reaching the proportions seen among mortgages with borrower-friendly terms.

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