CHAPTER 18
Asset‐Backed Securities
Daniel I. Castro, Jr.
Starting in about 1985, non‐mortgage asset‐backed securities (ABSs) were created and offered to the public. One of the very first deals was a securitization that was backed by auto loans and equipment leases. Since that time, we have seen ABS collateralized by myriad financial assets, including auto loans, credit card receivables, home equity loans, and student loans. We have also seen the creation of ABS backed by off‐the‐run assets such as burglar alarm and cell tower receivables, mutual fund fees, tax liens, property and casualty insurance policies (catastrophe bonds), and loans for timeshare condos. The famed Bowie Bonds, collateralized by David Bowie's music royalties, received much outsized attention from the press. While the issuance of ABS collateralized by intellectual property (i.e., music and film royalties) comprises an insignificant part of the ABS market, it is worth mentioning as it hammers home the point that all sorts of financial assets can be securitized.1
Since 1985, the ABS market showed consistent growth during its first decade, followed by explosive growth in the mid‐1990s through the mid‐2000s. Issuance peaked from 2005 through 2008 and then dropped dramatically following the financial crisis. ABS issuance first topped $100 billion in 1996, $200 billion in 2001, and topped out at almost $300 billion in 2007. The Fed's Term Asset‐Backed Securities Loan Facility (TALF) program helped restart the market in 2009, but still bottomed in 2010 before rebounding in 2012.2 (See Figure 18.1.)
Figure 18.1: U.S. ABS issuance
According to SIFMA, as of December 31, 2015, $4.3 trillion of non‐mortgage ABS has been issued. SIFMA data also shows that ABS bonds outstanding peaked at almost $2 trillion in 2007 and have fallen to just under $1.4 trillion ABS outstanding at year‐end 2014. Clearly ABS is a major source of funding for issuers, a significant part of the fixed‐income market, and a major holding for many institutional investors. (See Figure 18.2.)
Figure 18.2: U.S. ABS outstanding
What follows is a description of how the two largest ABS sectors, Auto ABS and Credit Card ABS, originate, structure, and issue their securitizations.
AUTOMOBILE SECURITIZATION
ABSs backed by automobile loans were the first major sector of the non‐mortgage ABS market, beginning in 1985. Today, auto ABS is the largest new‐issue market among non‐mortgage ABSs. Figure 18.3 shows issuance from 1985 through 2015.3
Figure 18.3: Auto ABS issuance (in millions)
Auto ABS issuance peaked at over $108 billion in 2005 and dropped to $59 billion in 2010 after the financial crisis. Figure 18.4 shows auto ABS outstanding at year‐end from 1985 to 2014.4 Auto ABS outstanding peaked at over $195 billion in 2005–2006 and bottomed out at roughly $116 in 2010–2011 and has been rising since 2012.
Figure 18.4: Automobile ABS outstanding (in $ billions)
Collateral
Automobile ownership is a hallmark of American society. Census estimates suggest that there were about 1.8 vehicles per household in the United States in 2013.5 Outside of a few large urban areas, autos are necessary for transportation throughout the United States. Autos are often associated with particular lifestyles and sometimes social status. Defaults on auto loans are substantially lower than on unsecured loans, such as credit cards, and default and repossession of a vehicle is a hardship for almost anyone.
Auto loans are originated by banks, credit unions, and finance companies, including captive financing subsidiaries of all of the major automobile manufacturers and specialty finance companies focusing on retail auto loans. Auto loans are one of the most basic of consumer loans. Auto loans typically have 2‐ to 7‐year (24‐ to 84‐month) terms, are fully amortizing, are fixed‐rate, and are collateralized by the physical vehicles being purchased. Auto loans provide financing for both new and used vehicles. Down payments for new vehicles come from both cash and trade‐ins and typically represent anywhere from 10% to 20% of the auto's value. Stronger quality buyers sometimes put down 5% or less, and some borrowers may choose to put down 30% to 40% or more. Voluntary prepayments typically are the result of a trade‐in or outright sale of the vehicle; involuntary prepayments are the result of defaults.
Collateral Credit Quality Segments
Auto ABS market participants break the auto loan market down into three credit quality segments:
- Prime: Expected cumulative losses of 3% or below. Primary lenders are banks and captive finance companies financing mostly new cars. FICO scores are typically above 680.
- Mid‐prime: Expected cumulative losses between 3% and 7%. Main lenders are banks and captive and specialty finance companies financing more new than used cars. FICO scores typically range from 640 to 680.
- Subprime: Expected cumulative losses over 7% (and typically up to 15%). Lenders are primarily specialty finance companies (and some banks) financing mostly used cars. FICO scores are generally below 640.
Prepayments
The market standard for auto loan prepayments is “ABS,” which, depending on whom you are talking to, stands for either absolute prepayment speed or asset‐backed speed. If an auto securitization had an ABS of 1.3, it would mean that 1.3% of the securitization's loans were prepaying monthly. This prepayment metric is unique to auto loans and distinctively different from the conditional prepayment rate (CPR) metric used in the MBS market—CPR measures prepayments on an annualized basis as a percentage of the security's pool balance.
Historically, auto loan prepayment speeds are relatively stable and generally insensitive to interest rate changes. In contrast to mortgages, auto loans have short terms and small balances, so a reduction of interest rates would have a small impact on the payment size. Besides, auto loans are not generally refinanced anyway because used car loan rates are higher than new car rates primarily due to the rapid depreciation of automobile values. An additional factor keeping prepayment speeds down is the proliferation of below‐market interest rate incentive financing programs over the past dozen years or so, which has reduced consumers' incentive to prepay their loans.
Prime auto loans historically have prepaid between 1% and 1.5% ABS; mid‐prime auto loans prepay slightly faster, up to 1.8% ABS; and subprime auto loans prepay the fastest, up to 2% ABS. FitchRatings says their historical experience for subvented, below‐market‐rate auto loans is 0.50% ABS, 1.80% for market rate collateral, compared with an overall prepayment speed of 1.20% ABS.6
Structures
Auto ABS securitizations are structured similarly to other ABS transactions: The sponsor creates a special‐purpose vehicle (SPV) to isolate the auto loans from its bankruptcy or insolvency. Auto loans earmarked for securitization typically have a first‐perfected security interest in the loan receivables as well as the underlying vehicles. The assets also are isolated from the seller‐servicer to achieve bankruptcy‐remote status. Several legal opinions are provided addressing bankruptcy and insolvency, that cash flow from the loans will not be impaired or diminished, the tax status of the SPV, and that a first‐perfected security interest in the underlying assets has been established for the benefit of investors.
The two most widely used structures for auto ABS are the grantor trust and the owner trust. Depending on the trust structure, multiple classes of securities (e.g., Class A, Class B, Class C), fixed‐ or floating‐rate bonds, varying amortization schedules, maturities, and ratings can be tailored to meet investor appetite.
Grantor Trusts
The original format used in the auto ABS sector was the grantor trust. As the more basic of the two trust formats, a grantor trust only requires one trustee and allows non‐bank (i.e., unregulated) issuers the flexibility to retain or sell subordinated classes/tranches of securities. The grantor trust structure only allows pro‐rata principal distributions to each investor based on their percentage ownership of the entire transaction. As a result, all classes in the structure, whether senior or subordinate, receive principal payments at the same rate. The pro‐rata feature means that each class maintains a constant percentage of subordination unless subordinated classes are partially written down due to high defaults (very rare).
Owner Trusts
For more than a dozen years, owner trusts have been the most popular format for auto ABS. Owner trusts are more complex, providing the ability for cash flows to be carved up and be reallocated among senior and subordinated investors. The owner trust structure allows for tranches of varying average lives, credit ratings, and cash flow characteristics that can be tailored to meet investor needs, thereby broadening the investor base. The creation of money market tranches eligible for purchase under Rule 2a7 has been popular with money market investors. Investors prefer tight principal repayment windows and the owner trust structure can accommodate that desire by creating sequential classes where all principal payments are allocated to the most senior class outstanding before allocating principal payments to the next class once the most senior class is paid down. Using a sequential pay structure in an owner trust, classes with one‐year, two‐year, and three‐year average lives follow the money market tranche at the top of the structure.
Closing Date Cash Flows
The sponsor sells and assigns the pool of auto loans/contracts to the securitization SPV. Legal opinions supporting a true sale of assets and a non‐consolidation opinion that trust assets will not be consolidated in the event of insolvency are rendered. The Seller (SPV) transfers the auto loans and pledges a security interest to the Issuer (typically an owner trust). The Issuer funds its purchase of the auto loans by issuing notes. Most auto ABSs issue Class A, Class B, and Class C notes, which are characterized as senior, mezzanine or subordinate, and subordinate, respectively.
On a monthly basis, the typical cash flow waterfall (priority of payments) for auto ABS looks like this:7:
- Return of servicer advances
- Servicing fee
- Trustee and other fees
- Net swap payments (if applicable)
- Class A, B, and C interest paid sequentially
- Class A‐1, A‐2, A‐3, etc. paid sequentially
- After Class A notes paid down to zero, Class B principal
- After Class B notes paid down to zero, Class C principal
- Required deposits to reserve account to maintain required amount
- Remaining funds released to seller
Credit Enhancement
Similar to other securitization markets, investors are primarily protected by internal credit enhancement. The first line of defense, as in other securitization markets, is excess spread. Every month, the excess cash flow after investors and fees are paid is used to cover losses. Credit enhancement is provided by subordination of all tranches below any given tranche as well as a reserve account (in most deals), typically established by an initial deposit from a portion of the proceeds from the sale of the notes. Occasionally, some trusts do not fund the reserve fund initially or only partially fund them. When that happens, excess spread is used to fund the reserve account, which may take months to be fully funded. Most auto ABSs utilize a reserve account for both credit support and liquidity. Reserve Accounts can be set at a fixed amount or decline with a floor. Minimum cash reserve account balances typically range from 0.25% to 2% of the collateral balance.8 If a reserve fund is used, it is usually replenished with excess spread. When an auto ABS is backed in part or in whole by subvented loans at below‐market rates, auto ABS will include a Yield Supplement Account to fund the difference between market interest rates and below‐market rates. Yield Supplement Accounts are not credit enhancement, but rather they effectively bring the subvented loans up to market rates.
Mid‐prime and subprime deals sometimes incorporate triggers and/or a third‐party guarantee or bond insurance—prime collateral generally does not use triggers or bond insurance. Triggers are used to enhance the credit support if the collateral fails to meet specified performance levels. When poor collateral performance hits a trigger level, auto ABS typically requires an increased in reserve fund levels, which are funded by excess spread.
When auto ABSs issue money market tranches, the notes usually pay a floating‐rate coupon. Since the underlying auto loans are fixed‐rate, an interest rate swap is usually incorporated to mitigate interest rate risk. Securitization documents generally require that if the swap terminates for any reason, the coupon to investors will become a fixed‐rate payment payable by the Trust.
Auto ABSs, similar to other ABS securities, have a cleanup call provision that provides a call option to the issuer when the collateral balance falls to 10% (typically). Factors such as the higher cost of servicing a small collateral pool and capital tied up in reserve funds make the cleanup call an attractive option for most issuers. Exercising the cleanup call is also attractive because it can free up seasoned loans to be included in a new issue ABS, which can be useful for improving both pricing and credit enhancement levels. Most issuers do exercise the cleanup call, but some don't. Not exercising the cleanup call can potentially extend a transaction by a year or more, depending on the amortization and prepayment speed of the collateral.
Credit Analysis
In order to determine the adequacy of the credit enhancement described earlier, credit analysis is critical. The first step is to assess the legal and structural protections. If the legal structure and opinions are not adequate, nothing else really matters. Next, a thorough understanding of structural enhancements (e.g., triggers) and credit enhancements (excess spread, subordination, overcollateralization, reserve funds, etc.) and fees (servicing, trustee) explained earlier is necessary. Once that is done, an analysis of collateral quality is required. The following characteristics, among others, must be evaluated to determine potential credit losses:
- Pool diversification by geography
- Loan quality
- Loan type
- Loan size
- APR
- Down payment
- Advance on vehicle value (LTV)
- Loan seasoning/original term/remaining term
- Stratification of loan yields
- FICO score distribution
- New vehicle percentage
- Vehicle types
- Prepayment history
- Delinquency history
- Gross loss history
- Recovery history/loss severity
- Servicer financial strength (servicer risk)
- Underwriting standards
CREDIT CARD SECURITIZATION
Credit card ABSs were introduced to the market in 1987. Today, credit card ABS is the second largest sector of the non‐mortgage ABS market (after auto ABS) with issuance volume of over $51 billion in 2014.9 The dollar volume of credit card ABS issued correlates closely to consumer lending and varies considerably over time. According to SIFMA, Table 18.1 shows the issuance of credit card ABS from 2006 to 2014.
Table 18.1: Issuance of Credit Card ABS (in $ millions)
| Year | Issuance |
| 2006 | 67,049 |
| 2007 | 99,527 |
| 2008 | 118,119 |
| 2009 | 46,089 |
| 2010 | 7,372 |
| 2011 | 16,152 |
| 2012 | 39,699 |
| 2013 | 34,885 |
| 2014 | 52,911 |
Most of the major credit card lenders are the largest credit card ABS sponsors, including JPMorgan Chase, Bank of America, Citigroup, American Express, and Capital One, among others. Since none of these banks have AAA ratings, credit card ABS sponsors generally incur lower funding costs in the ABS market than they would in the unsecured corporate bond market. Additional benefits include diversifying their funding sources and improving liquidity.
Unlike other underlying asset types in the ABS market, credit card loans/receivables do not have a fixed amortization period or payment amount. Auto loans, student loans, mortgages, and other types of consumer or business loans typically have a fixed maturity or term (3 years, 5 years, 10 years, 30 years) over which monthly loan payments are spread. Credit card loans, on the other hand, can be added to or paid down subject to certain constraints, such as their credit limit and minimum monthly payments (typically 2% of the outstanding balance).
Most credit card ABSs are supported by either (1) general‐purpose credit cards such as VISA and MasterCard, (2) travel and entertainment cards such as American Express, or (3) retail credit cards such as Gap, Dillard's, Nordstrom, or Staples. Although the vast majority of credit cards are unsecured, secured credit cards are offered (with low credit limits and high interest rates) to subprime borrowers with poor or no credit history. According to the Federal Reserve, charge‐off rates (annualized percentage of credit card account balances written off as uncollectible) for bank credit cards were over 10% as recently as 2010, and have fallen to roughly 3% in 2015.10 Thirty‐day delinquencies on bank credit cards, according to the Federal Reserve, were over 6% as recently as 2009, and have fallen to roughly 2% in 2015.11
In addition to charge‐offs and delinquencies, credit card ABS investors should also pay close attention to the portfolio yield, excess servicing spread, and payment rates of credit card portfolios. The portfolio yield is the annualized income generated primarily from finance charges and fees as a percentage of receivables outstanding. Excess servicing spread is a strong indicator of credit card portfolio profitability and is measured as the difference between portfolio yield and expenses (coupon to investors, servicing fees, and charge‐offs). The payment rate is the percentage of credit card debt paid back each month by cardholders. The payment rate is the best indicator of a credit card portfolio's credit quality. Generally speaking, the higher the payment rate, the higher the credit profile of the portfolio. Stronger borrowers will pay their debt back faster, and weaker borrowers tend to make smaller payments or the minimum payment due each month. Despite that, most credit card issuers prefer customers who carry large balances with lower payment rates because they generate higher income from finance charges.
In order to be earmarked for a securitization, credit card accounts and their related receivables must meet eligibility requirements. Most bank‐issued credit card ABSs define eligible accounts as having the following characteristics:12
- Is in existence and maintained by the bank or an affiliate;
- Is payable in United States dollars;
- Has not identified as an account the credit cards or checks, if any, that have been lost or stolen;
- The accountholder of which has provided, as his or her most recent billing address, an address located in the United States (or its territories or possessions or a military address);
- Has not been, and does not have, any receivables that have been sold, pledged, assigned, or otherwise conveyed to any person (except pursuant to the receivables purchase agreements or the pooling agreement);
- Which is a VISA or MasterCard revolving credit card account;
- Does not have any receivables that have been charged off as uncollectible;
- Does not have any receivables that have been identified as having been incurred as a result of the fraudulent use of any related credit card or check;
- Relates to an accountholder who is not identified by the bank or an affiliate or the transferor in its computer files as being the subject of a voluntary or involuntary bankruptcy proceeding; and
- Is not an account for which the accountholder has requested discontinuance of responsibility.
Most bank‐issued credit card ABSs define eligible receivables as having the following characteristics:13
- Which has arisen in an eligible account;
- Which was created in compliance in all material respects with the bank's or an affiliate's lending guidelines and all applicable requirements of law, the failure to comply with which would have a material adverse effect on investor certificate holders, and pursuant to a lending agreement which complies with all requirements of law applicable to the bank or an affiliate, the failure to comply with which would have a material adverse effect on investor certificate holders;
- With respect to which all material consents, licenses, approvals, or authorizations of, or registrations or declarations with, any governmental authority required to be obtained or given by the bank or an affiliate in connection with the creation of such receivable or the execution, delivery, and performance by the bank or an affiliate of the related lending agreement have been duly obtained or given and are in full force and effect as of the date of the creation of such receivable;
- As to which, at the time of its transfer to the master trust trustee, the transferor or the master trust will have good and marketable title, free and clear of all liens and security interests (including a prior lien or security interest of the bank or an affiliate, but other than any lien for municipal or other local taxes if such taxes are not then due and payable or if the transferor is then contesting the validity thereof in good faith by appropriate proceedings and has set aside on its books adequate reserves with respect thereto);
- Which has been the subject of either:
- A valid transfer and assignment from the transferor to the master trust trustee of all its right, title, and interest therein (including any proceeds thereof), or
- The grant of a first priority perfected security interest therein (and in the proceeds thereof), effective until the termination of the master trust;
- Which at and after the time of transfer to the master trust trustee is the legal, valid, and binding payment obligation of the accountholder thereof, legally enforceable against such accountholder in accordance with its terms (with certain bankruptcy and equity‐related exceptions);
- Which, at the time of its transfer to the master trust trustee, has not been waived or modified;
- Which, at the time of its transfer to the master trust trustee, is not subject to any right of rescission, setoff, counterclaim, or other defense of the accountholder (including the defense of usury), other than certain bankruptcy and equity‐related defenses;
- Which constitutes an “account” under and as defined in Article 9 of the UCC;
- As to which, at the time of its transfer to the master trust trustee, the transferor has satisfied all obligations on its part to be fulfilled; and
- As to which, at the time of its transfer to the master trust trustee, the transferor has not taken any action which, or failed to take any action the omission of which, would, at the time of its transfer to the master trust trustee, impair in any material respect the rights of the master trust or investor certificate holders therein.
Credit Card ABS Structures
Credit card securitization requires the transfer of receivables from credit card accounts into a bankruptcy‐remote trust, which in turn issues credit card ABSs. The credit card ABS trust funds the purchase of a revolving pool of credit card receivables assigned to the trust. In order to replenish receivables from inactive and closed accounts, the receivables from new accounts are assigned to the trust on an ongoing basis. Every month, the trust receives cardholder payments related to the assigned accounts. After covering interest, principal, servicing fees, and other expenses each month, the trust uses cardholder payments and other proceeds to purchase new receivables arising under assigned accounts and existing receivables assigned to the trust. It is important to note that, although the receivables in the designated credit card accounts are transferred to the credit card ABS trust, the accounts are not, and they continue to be maintained and managed by the originator. As the account owner, the originator continues to maintain its relationship with the cardholders and, because the accounts are revolving accounts, the originator continues to maintain its relationship with the cardholders and continues to make credit granting and underwriting decisions in connection with ongoing extensions of credit in accordance with the credit card account terms.
The trust itself is required to maintain a minimum receivables balance. In credit card ABS, the seller of the receivables must retain an interest in the trust consisting of required receivables and excess receivables. Daily fluctuations in receivables balances are absorbed by the seller's interest in the trust, and it also receives an allocation of cardholders' payments and defaults. Generally, credit card securitizations require a minimum seller's interest of 4% to 7% of the trust note balance.14 The seller's interest is typically higher for private‐label (retail) credit card ABS because merchandise returns are generally higher in retail portfolios. The seller's interest is recorded on the seller's balance sheet.15 Generally, if the seller's interest falls below the level required to satisfy the minimum seller's interest test, the sponsor must add receivables in an amount that restores the seller's interest to the minimum level. This is one reason why credit card issuers cannot securitize all of their credit card receivables; they must keep a sufficient quantity back to enable them to transfer additional receivables into credit card trusts if necessary. For example, the Capital One Credit Card Portfolio, at year‐end, is shown in Table 18.2.16 Capital One during this period before the financial crisis securitized between roughly 60% and 65% of its credit card portfolio. This was typical of bankcard issuers at the time—it was rare to see more than 70% of a credit card portfolio securitized. After the financial crisis, they only securitized between 30% and 50% of their portfolio, far more conservative than before the financial crisis.
Table 18.2: Capital One Credit Card Portfolio
Source: Capital One Multi‐Asset Execution Trust Prospectus Supplement, October 16, 2006, Annex I, page A‐I‐1, and Capital One Multi‐Asset Execution Trust Prospectus Supplement, August 19, 2015, Annex I, pp. A‐I‐1–A‐I‐3.
| Year | Total Credit Card Portfolio | Securitized Credit Card Portfolio | Percent Securitized |
| 2014 | $28.8 billion | $14.1 billion | 49.0% |
| 2013 | $30.8 billion | $9.8 billion | 31.8% |
| 2012 | $34.2 billion | $10.3 billion | 30.1% |
| 2005 | $49.5 billion | $32.3 billion | 65.3% |
| 2004 | $48.6 billion | $31.0 billion | 63.8% |
| 2003 | $46.3 billion | $27.8 billion | 60.0% |
Given the revolving nature of credit cards, credit card ABSs typically have a revolving period followed by an amortization period. During the revolving period, principal collections are used to buy additional receivables or add to the seller's interest—investors only receive interest payments during the revolving period. Because principal and interest payments vary considerably from month to month on credit card portfolios, the seller's interest grows or shrinks to accommodate varying receivables balances (see Figure 18.6). Following the revolving period, the amortization period commences, where principal collections on the receivables are used to repay credit card ABS investors. Many credit card ABSs utilize a controlled amortization period, where equal principal payments to investors are made over a specified time, often a year. Other credit card ABSs are structured so that principal payments are like corporate bond payments and principal is paid at maturity. This method is achieved using a controlled accumulation period where principal collections are paid into a trust account and held until maturity, when it is paid to investors.
Figure 18.6: Receivables Allocation
Figure 18.6 shows how receivables might be allocated in a typical (hypothetical) credit card trust.17
Credit enhancement for credit card ABS is similar to other securitizations, and generally it is provided through internal credit enhancements (rarely, external credit enhancement has been used in the form of a third‐party guarantee). The primary difference is that the revolving structure and reinvestment period can be ended by what are known as early payout or amortization events. Internal credit enhancement for credit card ABS can include any of the following:
- Discounted receivables—credit card receivables can be transferred into the trust at a discount, which in turn creates overcollateralization and/or incremental yield on the collateral.
- Excess spread—the difference between portfolio yield and trust expenses
Hypothetical Excess Spread Calculation:Portfolio yield 17% Investor coupon −5% Servicing fee −2% Charge‐offs −4% Excess spread = 6% - Subordination.
- Reserve accounts (usually supports Class C only)—a reserve account is a specific amount of cash set aside to provide liquidity and cover losses from the collateral pool. Reserve accounts may be filled by an up‐front cash deposit or from excess cash flow from the trust's assets.
The primary protection provided to credit card ABS investors is early amortization. If there are problems with the seller/servicer, legal issues, or the collateral performance (portfolio yield, charge‐offs, payment rates) deteriorates, early amortization triggers are created to end the revolving period prematurely, and immediately divert principal payments to repay investors before their credit enhancements are exhausted. Typical payout or amortization triggers include:
- Collateral events:
- Excess spread below specified minimum
- Seller interest or receivables balance falls below specified levels
- Seller/Servicer events:
- Failure to make deposits or transfer receivables
- Breaches of representations and warranties and/or covenants
- Occurrence of receivership/bankruptcy
- Legal events: Trust becomes an investment company.
When credit card ABSs were first issued, the standalone trust was the primary structure used. In a standalone trust structure, a single pool of receivables supports each transaction. Subsequent transactions from the same issuer would require a new trust and a new pool of receivables. In 1991, the master trust structure was introduced to the credit card ABS market. A master trust structure allows an issuer to issue multiple sets of securities from the same trust. The master trust and all of the securities it issues are all supported by a large group of receivables. For an issuer, a master trust is much more cost effective than creating a new trust for every new issue, and a larger pool/portfolio should be much more representative of an issuer's overall credit card business than several smaller standalone portfolios. A master trust would simultaneously issue Class A, B, and C certificates.
In 1998, the owner trust structure was introduced within the framework of the master trust. Initially, the owner trust structure was created to improve the salability of the subordinated Class C debt. This was accomplished by selling the Class C to an owner trust, which in turn issued notes that could be purchased by a broader group of investors. In 1999, the owner trust structure was enlarged to encompass the entire structure of the deal. A “collateral certificate” would be issued from the master trust to an owner trust so that the underlying cash flows could be further tranched up. Master trusts were the predecessor of de‐linked trusts, which is the most frequently used structure today. The master trust issues a collateral certificate to the de‐linked trust. The collateral certificate represents an undivided interest in the master trust, receives pro‐rata principal and interest payments, and pays its pro‐rata share of losses and servicing fees.
Over the past few years, the credit card ABS market has evolved to a de‐linked structure utilizing an issuance trust (see Figure 18.7).18 Some market participants refer to this structure as the master owner trust (MOT) structure.
Figure 18.7: Basic credit card de‐linked structure
Utilizing the issuance trust structure allows an issuer to both issue traditional credit card ABS, where the Class A, B, and C notes all have matching maturities, and issue de‐linked notes, where senior, mezzanine, and subordinate notes have differing, unmatched maturities. This more flexible structuring technology allows issuers to be more opportunistic in tapping investor demand and provides more flexibility on when to issue various bonds with disparate sizes, maturities, and ratings.
The master trust/owner trust/de‐linked structure provides numerous benefits versus older structures. Some of those benefits include:
- Ability to participate in relatively large subordinated classes.
- Ability to purchase public, ERISA‐eligible classes in all rating categories.
- Ability to issue specific rating categories and/or specific maturities when market conditions and/or investor demand favors such rating categories and/or maturities and not others.
- Issuance of Class A (triple‐A rated), Class B (single‐A rated), Class C (triple‐B rated), and Class D (below investment grade or unrated) can occur on separate dates (Class A, Class B, and Class C can only be issued if a sufficient amount of subordinated classes are outstanding).
- Collateral includes a certificate representing an interest in receivables of a related master trust and for certain de‐linked trusts receivables.
- Entities with de‐linked and master trusts use the de‐linked trusts to issue notes.
Table 18.3 summarizes the major structural differences between older and newer credit card structures.
Table 18.3: Credit Card ABS Structural Innovations: Credit Card Owner Trust Structural Features
| Attribute | New Structure | Old Structure |
| Assets | Participation interest in credit card receivables | Credit card receivables |
| Legal form for liabilities | Notes | Certificates |
| Registration | Public for all classes | Public for Class A and Class B only |
| Enhancement structure | Both series specific and shared enhancement structure allowed | Series specific enhancement only |
| Cash flow sharing among liabilities | Yes | Principal only |
| Size, timing, and maturity flexibility | At the tranche level | At the series level |
In 2016, credit card ABS remains a core sector of the ABS market. The performance of securitized credit card accounts is robust with charge‐offs near record lows in 1Q, 2016 at just above 2.5% and delinquencies near 1%, according to a credit card index managed by Fitch.19 Although new issuance has dropped from prior years, according to life‐to‐date TRACE transaction data, credit card ABS constitutes 33% of ABS secondary trading volume by current face amount.20