topic Re: Credit Card Asset-Backed Securities (ABS) and why some subprime card never grow or graduate in General Credit Topics

Credit Card Asset-Backed Securities (ABS) and why some subprime card never grow or graduate

Anonymous — Wed, 01 Nov 2017 17:56:26 GMT

I've posted a few comments on more than a few threads that are usually covering the same topic: "Why won't my secured card graduate?" or "Why won't my limit grow ever?"

Normally these topics seem to concern Capital One but they're not the only ones. Capital One is a rare lender because they have a prime credit card pool but they also have a mid-prime pool of cards and also a sub-prime pool of cards...and sometimes these three tiers of creditworthiness get cards with the same name!

Asset-Backed Securities

Credit card debt, meaning the "money" that you borrow when you make a charge, do not just come out of thin air. The creditor who is giving you a credit limit needs that money from somewhere to pay the companies you buy from. The credit card industry in the US is well over $1 trillion in amount owed, but credit limits are much higher than this. That means that the creditors need to be able to make payments of over $1 trillion to vendors. It's a staggering amount.

The way that credit card companies can pay out your purchases is by using their own cash assets, or by enticing investors to put money in. The latter is how they make an ABS, or an Asset-Backed Security.

Because Capital One is the most public in disclosing their use of ABS to generate credit limits to generate spending to generate profit, I'll focus on them, but they are not that much different from other banks. While Capital One does get money deposited into their CDs, savings accounts and other cash investments, most of their credit line liquidity is provided by their ABS groups.

You can read Capital One's most recent public ABS disclosure at this link (PDF warning!): https://www.spratings.com/documents/20184/769219/Capital+One+Multi-Asset+Execution+Trust+(Class+A(2017-1))/96e2a004-564d-48a5-bd01-17557fe63e06

Using this particular disclosure as an example, you can see that they're issuing and requesting up to $500 million in investments. In fact, it isn't Capital One that's requesting this money, it's a totally separate company called the Capital One Multi-Asset Execution Trust, a trust that operates to protect investors from Capital One going bankrupt. Some investors call this trust "COMET" for what I hope is clear reasoning.

If you look at the "Profile" area on the first page, you see a whole bunch of different companies that are involved, including sponsors, depositors, trustees, and agents. It's pretty complex, and very complicated.

One thing to note is that this $500 million trust ABS is for "Class A". Capital One as a lender actually has 4 different trusts for 4 different groups of credit. Class A has a security rating of AAA, meaning the best rating and the last likely to default. In this write-up, the type of borrower that is invested in is:

As of Feb. 15, 2017, the consumer segment consisted of $24.3 billion of receivables with the following characteristics:

An average principal balance of $1,663;
An average credit limit of $8,712;
A utilization rate of 19.43%;
A weighted average age of 152 months;
100.00% are from accounts older than 60 months;
None are from accounts equal to or less than 24 months old;
50.56% have FICO scores of 720 or higher; and
8.79% made minimum payments, and 21.26% made full payments

This is just one portion of the Class A ABS -- the other portion listed below this part is for business credit, which has similar statistics but is much smaller in size ($3 billion versus $24 billion for consumer Class A credit).

Further own the page you'll see that they believe the loss percentage is 5.5% -- that means a charge-off or total loss is about 1 in 20 borrowers in this prime lending group.

Scroll down more and you'll see the expected yield ("profit") of this trust invested in prime credit card borrowers. A neat insight is provided here, too: "Yield for this trust is relatively low because of the high credit quality of the obligors. The smaller haircut for this trust (relative to our example of haircut ranges listed in our criteria) reflect our assumption that because of high credit quality, seasoned cardholders are more likely to experience smaller increases in delinquencies than nonprime accounts in a downturn, resulting in less volatility in stressed yield compared with pools that include a high portion of nonprime accounts." So prime credit borrowers are less likely to default so there's less volatility. Duh.

Under the Payment Rate heading, there's more interesting information: "Of the receivables in the pool, approximately 20% are generated from convenience users who pay down their balances each month. Convenience usage is typically tied to rewards programs, which attract obligors who charge their cards to receive rewards, such as cash or airline miles, and then pay the outstanding balance in full each month." What they're saying here is that about 20% of their receivables (payments made on debt) is about 1 in 5 borrowers. So if you say you PIF every month and never pay interest, you're 1 in 5. Whenever I bark at people who are obviously BSing on the internet that they pay in full, it's because I know the details: not more than 20% of people actually do pay in full. And the comedy of the statement is clear in the next sentence given: " we assume in our stress scenarios that the number of convenience users in the pool declines before the amortization period's first month and that the portion of revolvers who carry at least some of their debt over to subsequent months increases" -- this is hilarious. What they're saying is that some people start out paying in full, but wait, then they stop and carry a balance.

Scroll a bit more and you'll get to Payment Priority which is a magnificent flow of what happens with money earned. The top income first goes to cover unpaid interest not only of the class A borrowers but also of the other borrowing groups, but not class D which are the worst of the worst subprime borrowers yet. In fact, servicing fees get paid before the interest of the worst subprime group! After that, defaults and collection costs come next, then reserve account balances are topped off for each subprime class (C & D which default more often so need a reserve cash balance to cover those expected and assumed defaults), followed by other finance charges, and finally if all that stuff is paid, the investor gets some money back.

Amazing that even though an investor is investing in prime credit borrowers, the "profit" from those borrowers first goes to cover subprime borrowers who default or are late or are accruing unpaid interest charges.

Now, why won't Capital One or another credit card company increase your credit limit, or graduate your secured card?

Well, it's probably because you're already in an ABS based on your initial credit card application and starting limit provided. It is not so easy for a lender to take a subprime borrower with a $300 limit from ABS Class D and toss them into a $20,000 limit from ABS Class A just because their FICO scores went up 250 in 6 months. It doesn't work that way. In order for them to upgrade you, they would have to remove you from the Class D ABS somehow and put you into the Class A ABS. It can't happen magically, there has to be other things considered and confirmed and let's be honest: it isn't worth it. It's way more worth it for them to tell you to apply for a brand new card and contract, and upon approval you will be sold off to the ABS you should be in now. Your old card may forever stay in the subprime category...and this is done for an exeptionally good reason (turn your brain on here):

Capital One likes prime borrowers who still have subprime tier credit cards from years ago. Why? Because when they sell subprime debt (Class D) to investors, they want to keep the FICO score average a little higher, and the default rate a little lower. By keeping prime borrower in a subprime card, they can skew the analysis when investors ask. If it wasn't for these useless subprime cards being open (even for 2-3 extra months), truly bad credit borrowers may not even get that $200 credit limit because investors might be scared off from the group average delinquency and FICO score.

Capital One likely relies on some borrowers not wanting to close an old credit card even though they went from 550 FICO to 800 FICO since opening it. By keeping it open, it helps skew the results for the class D gutter subprime risk ratio so investors are more likely to invest in it.

This is also why Capital One gives second chances: because not only do they have investors who want a piece of profitable-but-risky subprime debt, but they have prime credit borrowers who still retain subprime cards to help the pool look better overall.

More to come as I have time to write it.

Re: Credit Card Asset-Backed Securities (ABS) and why some subprime card never grow or graduate

Shooting-For-800 — Thu, 02 Nov 2017 00:09:17 GMT

WOW - a lot of infomation there. Thank you.

Re: Credit Card Asset-Backed Securities (ABS) and why some subprime card never grow or graduate

Adidas — Fri, 03 Nov 2017 16:40:22 GMT

Thanks for all that info! I really appreciated your summary / analysis of how a CCC operates and in particular their use of ABS. I'm anxiously awaiting your next post. However I'm not sure you have enough to prove your main point of explaining why they don't like to graduate/CLI people. Wouldn't investors in the risky group be okay with more volatility? That's the point of the risky group after all. Also doesn't capital one have to share more of their profits to entice people to take on this risk? If so then capital one is better off accurately categorizing people as they move up.

On a slightly different theme I'm curious where people with very high limits that don't use it all fit in how the business operates? Do the ABS investors have to front money based on credit limits or actual spend? Where in the bigger picture does unused credit limits create a drag on profits?

Re: Credit Card Asset-Backed Securities (ABS) and why some subprime card never grow or graduate

Anonymous — Fri, 03 Nov 2017 16:50:52 GMT

My theory on the reason why super subprime credit borrowers can't upgrade is because:

they were super subprime at the time and most creditors will say no, but Capital One says yes because the investors are willing to take a big risk for massive reward potential,
when they aren't subprime anymore, their new better FICO scores are baked into the subprime group which raises the overall average FICO score of that group and helps Capital One attract investors because that portfolio now is slightly lower risk, and/or
even though they're no longer subprime FICO-wise, that account may still be in a tranch that is "open" and not closed and over

Based on these 3 possibilities and likelihoods, if you still have that account, Capital One may not be able to upgrade that account if they don't have positions within the tranch to do so. Maybe the tranch agreement allows only a limited number of upgrades. Closing an account is always valid because the tranch agreement (with investors) allows Capital One to dump someone out of the tranch on account closure.

And even if they could upgrade you, it may be in their interest to keep you stuck in a tranch because it helps raise the FICO score of their subprime category and that matters going forward just on paper!

@Adidas wrote:

On a slightly different theme I'm curious where people with very high limits that don't use it all fit in how the business operates? Do the ABS investors have to front money based on credit limits or actual spend? Where in the bigger picture does unused credit limits create a drag on profits?

That one is tough for two reasons:

Customers with very high limits typically have very high credit scores and incomes and typically don't default enough to matter. Since they're very low risk, many banks will self finance those accounts and not roll them into ABS. The problem with ABS is that the bank has to show investors a profit potential, and high limit borrowers may never use that limit, so their potential is weak. Why would I invest $30,000 to bank up a guy with perfect credit who uses it for $3000 spend monthly and pays it off, offering me maybe a 2.5% return on $0, when I could take a $30,000 risk on 100 people with $300 credit limits and 500 FICO scores and I may make a 25% return on them minus an 8% chargeoff? See my point?
Customers in this category are "known" to the banks themselves as to their spending habits. 100 people with $30,000 credit limits and perfect credit need an exposure reach of $3 million in capital to pay in case they all max out their cards, but chances are they won't do it at the same time. The bank may estimate that they will pay out an average of $510,000 on those 100 accounts at any period and maybe during Christmas season the bank may need to stretch this to $1.2 million which they can easily do from balances in other customers' savings accounts or money markets or whatever. It's a low risk for low reward opportunity here.

Hope I made that clear, not sure if it makes sense or not.

Re: Credit Card Asset-Backed Securities (ABS) and why some subprime card never grow or graduate

Adidas — Fri, 03 Nov 2017 19:29:26 GMT

That makes a lot of sense. So you're saying the bank can adjust their reserves based on expected spend and not necessarily credit limit? I figured they based it on limit?

Re: Credit Card Asset-Backed Securities (ABS) and why some subprime card never grow or graduate

Anonymous — Fri, 03 Nov 2017 19:42:02 GMT

The reserves by investors go into reserves for tranches and they get paid out based on any profits from each tranch, but only after that list of all other expenses is deducted.

Banks themselves who don't package accounts into ABSes may also originate and service and fund accounts directly.

Note: banks actually don't fund accounts a snuch as they may even just own ABSes that their subsidiary investment companies manage through a subsidiary trust that each ABS is owned by.

If Capital One credit provides you a subprime card, the funding may come from Capital One MET (COMET) and Capital One credit may just be an investor in that tranch. So calling credit to argue about an account that will never upgrade is useless if your account is part of an investment ABS. And there's no way to know if you are.

Re: Credit Card Asset-Backed Securities (ABS) and why some subprime card never grow or graduate

Anonymous — Sun, 05 Nov 2017 15:10:19 GMT

Interesting read ABC, good post. Dv

Re: Credit Card Asset-Backed Securities (ABS) and why some subprime card never grow or graduate

Anonymous — Tue, 07 Nov 2017 05:07:43 GMT

So, knowing this.... how do you apply this to moving on from Capital One? Is this information grounds to close cards? I like Capital 1 but I don't want to be stuck with a QS1, they have a history of not upgrading QS1 cards but easily upgrading Platnium cards, which makes no sense.

Re: Credit Card Asset-Backed Securities (ABS) and why some subprime card never grow or graduate

Anonymous — Tue, 07 Nov 2017 11:47:56 GMT

Show them responsible usage and they’ll reward you with way higher SL on new apps. Then just close or merge limits!

Is capital one your oldest trade line by more than a few years?

Re: Credit Card Asset-Backed Securities (ABS) and why some subprime card never grow or graduate

Anonymous — Tue, 07 Nov 2017 21:37:12 GMT

It’s 1 year and 4 months old which is my oldest. I know they’ll give you more on new apps but they pull all three bureaus. I’m never applying for a new capital one card, there’s better lenders.

Re: Credit Card Asset-Backed Securities (ABS) and why some subprime card never grow or graduate

Anonymous — Tue, 07 Nov 2017 21:44:47 GMT

Even better lenders are starting to become inquiry crazy. Chase and others pull 2 to apply and then demand an inquiry for every cli request which adds up.

Capital One also tends to give better starting limits once you’re out of subprime prison — and higher limits with one lender can and should get you high limits with others!

But their cards aren’t for everyone. Only doing the math for your spend and balance average tells you what’s best.

Re: Credit Card Asset-Backed Securities (ABS) and why some subprime card never grow or graduate

Blackswizz750 — Fri, 10 Nov 2017 20:47:34 GMT

@Anonymous wrote:
I've posted a few comments on more than a few threads that are usually covering the same topic: "Why won't my secured card graduate?" or "Why won't my limit grow ever?"

Normally these topics seem to concern Capital One but they're not the only ones. Capital One is a rare lender because they have a prime credit card pool but they also have a mid-prime pool of cards and also a sub-prime pool of cards...and sometimes these three tiers of creditworthiness get cards with the same name!

Asset-Backed Securities

Credit card debt, meaning the "money" that you borrow when you make a charge, do not just come out of thin air. The creditor who is giving you a credit limit needs that money from somewhere to pay the companies you buy from. The credit card industry in the US is well over $1 trillion in amount owed, but credit limits are much higher than this. That means that the creditors need to be able to make payments of over $1 trillion to vendors. It's a staggering amount.

The way that credit card companies can pay out your purchases is by using their own cash assets, or by enticing investors to put money in. The latter is how they make an ABS, or an Asset-Backed Security.

Because Capital One is the most public in disclosing their use of ABS to generate credit limits to generate spending to generate profit, I'll focus on them, but they are not that much different from other banks. While Capital One does get money deposited into their CDs, savings accounts and other cash investments, most of their credit line liquidity is provided by their ABS groups.

You can read Capital One's most recent public ABS disclosure at this link (PDF warning!): https://www.spratings.com/documents/20184/769219/Capital+One+Multi-Asset+Execution+Trust+(Class+A(2017-1))/96e2a004-564d-48a5-bd01-17557fe63e06

Using this particular disclosure as an example, you can see that they're issuing and requesting up to $500 million in investments. In fact, it isn't Capital One that's requesting this money, it's a totally separate company called the Capital One Multi-Asset Execution Trust, a trust that operates to protect investors from Capital One going bankrupt. Some investors call this trust "COMET" for what I hope is clear reasoning.

If you look at the "Profile" area on the first page, you see a whole bunch of different companies that are involved, including sponsors, depositors, trustees, and agents. It's pretty complex, and very complicated.

One thing to note is that this $500 million trust ABS is for "Class A". Capital One as a lender actually has 4 different trusts for 4 different groups of credit. Class A has a security rating of AAA, meaning the best rating and the last likely to default. In this write-up, the type of borrower that is invested in is:

As of Feb. 15, 2017, the consumer segment consisted of $24.3 billion of receivables with the following characteristics:
An average principal balance of $1,663;
An average credit limit of $8,712;
A utilization rate of 19.43%;
A weighted average age of 152 months;
100.00% are from accounts older than 60 months;
None are from accounts equal to or less than 24 months old;
50.56% have FICO scores of 720 or higher; and
8.79% made minimum payments, and 21.26% made full payments
This is just one portion of the Class A ABS -- the other portion listed below this part is for business credit, which has similar statistics but is much smaller in size ($3 billion versus $24 billion for consumer Class A credit).

Further own the page you'll see that they believe the loss percentage is 5.5% -- that means a charge-off or total loss is about 1 in 20 borrowers in this prime lending group.

Scroll down more and you'll see the expected yield ("profit") of this trust invested in prime credit card borrowers. A neat insight is provided here, too: "Yield for this trust is relatively low because of the high credit quality of the obligors. The smaller haircut for this trust (relative to our example of haircut ranges listed in our criteria) reflect our assumption that because of high credit quality, seasoned cardholders are more likely to experience smaller increases in delinquencies than nonprime accounts in a downturn, resulting in less volatility in stressed yield compared with pools that include a high portion of nonprime accounts." So prime credit borrowers are less likely to default so there's less volatility. Duh.

Under the Payment Rate heading, there's more interesting information: "Of the receivables in the pool, approximately 20% are generated from convenience users who pay down their balances each month. Convenience usage is typically tied to rewards programs, which attract obligors who charge their cards to receive rewards, such as cash or airline miles, and then pay the outstanding balance in full each month." What they're saying here is that about 20% of their receivables (payments made on debt) is about 1 in 5 borrowers. So if you say you PIF every month and never pay interest, you're 1 in 5. Whenever I bark at people who are obviously BSing on the internet that they pay in full, it's because I know the details: not more than 20% of people actually do pay in full. And the comedy of the statement is clear in the next sentence given: " we assume in our stress scenarios that the number of convenience users in the pool declines before the amortization period's first month and that the portion of revolvers who carry at least some of their debt over to subsequent months increases" -- this is hilarious. What they're saying is that some people start out paying in full, but wait, then they stop and carry a balance.

Scroll a bit more and you'll get to Payment Priority which is a magnificent flow of what happens with money earned. The top income first goes to cover unpaid interest not only of the class A borrowers but also of the other borrowing groups, but not class D which are the worst of the worst subprime borrowers yet. In fact, servicing fees get paid before the interest of the worst subprime group! After that, defaults and collection costs come next, then reserve account balances are topped off for each subprime class (C & D which default more often so need a reserve cash balance to cover those expected and assumed defaults), followed by other finance charges, and finally if all that stuff is paid, the investor gets some money back.

Amazing that even though an investor is investing in prime credit borrowers, the "profit" from those borrowers first goes to cover subprime borrowers who default or are late or are accruing unpaid interest charges.

Now, why won't Capital One or another credit card company increase your credit limit, or graduate your secured card?

Well, it's probably because you're already in an ABS based on your initial credit card application and starting limit provided. It is not so easy for a lender to take a subprime borrower with a $300 limit from ABS Class D and toss them into a $20,000 limit from ABS Class A just because their FICO scores went up 250 in 6 months. It doesn't work that way. In order for them to upgrade you, they would have to remove you from the Class D ABS somehow and put you into the Class A ABS. It can't happen magically, there has to be other things considered and confirmed and let's be honest: it isn't worth it. It's way more worth it for them to tell you to apply for a brand new card and contract, and upon approval you will be sold off to the ABS you should be in now. Your old card may forever stay in the subprime category...and this is done for an exeptionally good reason (turn your brain on here):

Capital One likes prime borrowers who still have subprime tier credit cards from years ago. Why? Because when they sell subprime debt (Class D) to investors, they want to keep the FICO score average a little higher, and the default rate a little lower. By keeping prime borrower in a subprime card, they can skew the analysis when investors ask. If it wasn't for these useless subprime cards being open (even for 2-3 extra months), truly bad credit borrowers may not even get that $200 credit limit because investors might be scared off from the group average delinquency and FICO score.

Capital One likely relies on some borrowers not wanting to close an old credit card even though they went from 550 FICO to 800 FICO since opening it. By keeping it open, it helps skew the results for the class D gutter subprime risk ratio so investors are more likely to invest in it.

This is also why Capital One gives second chances: because not only do they have investors who want a piece of profitable-but-risky subprime debt, but they have prime credit borrowers who still retain subprime cards to help the pool look better overall.

More to come as I have time to write it.

You sure you are not a retired derivatives analyst with crazy loot in the tropics. JK This is great insight in this world and glad to learn something everyday. This looks like 2006-2007 again with the mortgage back securites. I read a book on this but never knew this is how credit card lenders operate(at least CAP one and some others we love to hate).

Re: Credit Card Asset-Backed Securities (ABS) and why some subprime card never grow or graduate

Anonymous — Fri, 10 Nov 2017 20:51:25 GMT

Discover also uses ABS to finance credit lending -- they have public reports available for reading such as: https://investorrelations.discover.com/investor-relations/debt-investor-info/discover-credit-card-abs-reporting/default.aspx

What's really odd sometimes is that it appears that Chase actually may invest in ABS issued by other creditors. I have no actual evidence of this but some of their reports talk about it.

I was never involved in finance directly, but as a consultant for a long time, I did in fact work with some very well known lenders and they always tipped me off to structural changes in the markets.

Re: Credit Card Asset-Backed Securities (ABS) and why some subprime card never grow or graduate

Anonymous — Fri, 10 Nov 2017 21:40:40 GMT

Outstanding thread and information ABCD2199.

Re: Credit Card Asset-Backed Securities (ABS) and why some subprime card never grow or graduate

Anonymous — Wed, 10 Jan 2018 17:24:42 GMT

Bumping this thread because I came across Barclays offering ABS for their consumer products.

Link here: https://www.home.barclays/prospectuses-and-documentation/secured-funding-documentation/securitisation/dryrock-us-cards.html

Really interesting details in those PDFs!

Re: Credit Card Asset-Backed Securities (ABS) and why some subprime card never grow or graduate

Anonymous — Fri, 19 Jan 2018 20:35:12 GMT

Bumping thread as Synchrony also uses ABS for their products (PDF warning): http://investors.synchronyfinancial.com/~/media/Files/S/Synchrony-Financial-IR/abs-prospectuses/synchrony-mnt-2017-1-prospectus.pdf

VERY interesting FICO data in this PDF.

Re: Credit Card Asset-Backed Securities (ABS) and why some subprime card never grow or graduate

Tricky3 — Mon, 14 May 2018 20:23:00 GMT

Nice read, very interesting and pretty much what I assumed.

For the record, I am 1 of the '5' and have been since Post BK in 2003 that payoff balances before interest occurs. I only carry balances on cards where I have deferred (0%) interest. I generally carry around 15k on these various cards (Citi, Discover, BOA) and never occurring interest (with my total CLs that’s about 4% utilization). I am all about getting whatever deal a card is offering and having whatever balance that got me into that ‘deal’ paid off 90 days before expiring. You got to be COD about it to be a 1 and 5 - IMO. Also getting burnt in CC debt is a great way to learn your lesson too!

It’s funny though out time getting a CLI and then my FICO goes up, because my utilization has gone down and I have not paid anything down. It’s a fun game play with FICO – last year before I made some large purchases and got a new car I had of my FICOs at the magical 850!

Re: Credit Card Asset-Backed Securities (ABS) and why some subprime card never grow or graduate

19eighty5 — Tue, 29 May 2018 03:29:42 GMT

Awesome read with incredible, easily digestable information! I never knew this is how CCCs worked.

Re: Credit Card Asset-Backed Securities (ABS) and why some subprime card never grow or graduate

Anonymous — Sat, 09 Mar 2019 09:53:15 GMT

Quite an interesting read. I actually always assumed that bucketing with Capital One and Discover was something similar to this but it was a guess, had no idea it was factual, it just made sense to me. Thanks for sharing!

Re: Credit Card Asset-Backed Securities (ABS) and why some subprime card never grow or graduate

Anonymous — Sat, 09 Mar 2019 21:46:15 GMT

I bet the card issuers have data that supports a statement something like this:

"If in your life you were EVER a sub-prime borrower, even if your score is now 850, you are more likely to default than someone who has NEVER been a sub-prime borrower"

And I suspect that's the reason why they are reluctant to upgrade you.