Trump's proposed credit card interest cap would hit $70 bn market for debt

By Scott Carpenter and Ameya Karve

 

A proposed ceiling on credit card interest rates would deal a heavy blow to the $70 billion market that bundles the debt into bonds, according to analysts, even as investors shrug off the likelihood any actual policy comes to pass. 

The additional yield that investors demand as compensation for the risk of owning these securities has barely moved since President Donald Trump floated a one-year cap of 10 per cent on credit card interest rates last Friday, according to market participants.

 

A cap, however, would hurt bond investors. For bonds backed by bank-issued credit cards, a 10 per cent cap would cause a key measure of bond income — called excess spread — to drop to levels similar to those seen during the 2008 financial crisis, JPMorgan Chase & Co. strategists Amy Sze and Siddharth Tripathy said in a note on Tuesday. That measure helps absorb losses and reduces risk by providing a cushion of extra cash flow. 

 

 

The credit card asset-backed securities market would be “very exposed” to such a ceiling, according to Daniel Schaeffer, a trader at Academy Securities. “A cap would cut out a significant number of borrowers who are currently paying rates between 10 per cent and usury-level rates in the 30-50 per cent range, especially bonds backed by lower-tier consumers.”

 

Bonds backed by credit card debt tied to riskier, “nonprime” borrowers would fare worse, according to JPMorgan. Forcing interest rates down to 10 per cent would mean there isn’t enough money coming in to pay off all the debt owed to bondholders, they wrote. 

 

Faced with a cap, the market would likely shrink over time. Fewer firms would look to securitize credit card debt, leaving less for investors to snatch up. Credit card debt has already declined as a share of the overall ABS market, making up 9 per cent of total issuance compared with 36 per cent at its peak in 2009, according to data from Morgan Stanley. 

 

“Issuance of credit card ABS will go down as lending will go down because banks would avoid high-risk borrowers and tighten lending rules,” said Harry Murray, a portfolio manager at Deer Park Road Management. Generally, there’s been little trading activity as investors wait to see whether such a move is possible, he said. 

 

In the meantime, new issuance of credit card ABS and secondary trading “will likely be limited” until investors get more clarity, JPMorgan strategists wrote in their note.

 

The lack of movement in the bond market contrasts with the equity world, where investors have hammered shares of banks and credit-card issuers, including Mastercard Inc., Capital One Financial Corp. and American Express Co.

 

A 10 per cent rate cap on credit card interest would be negative across the board for credit card bonds, according to Moody’s Ratings. However, Moody’s also said putting a cap in place may be difficult for the administration to do.