Key Takeaways
- The credit card asset-backed securities (ABS) sector has below average exposure to environmental credit factors, given that receivables are unsecured and that the significant collateral pool diversification by obligor and geography reduces exposure to physical climate risks.
- Social credit factors are above average for the credit card ABS sector. Regulators in many jurisdictions are increasingly focused on credit products with relatively high borrowing costs, and ensuring that lenders are considering the borrower's affordability in their underwriting and ongoing management of revolving credit lines.
- Governance credit factors are average for credit card ABS given that collateral pools are typically revolving, the roles and responsibilities of each transaction party and the allocation of cash flows are well defined, and transactions are structured to achieve isolation of the assets from the seller. However, governance weaknesses at the originator or servicer levels could still have a negative rating effect.
Analytic Approach
Environmental, social, and governance (ESG) risks and opportunities can affect an obligor's capacity to meet its financial commitments in many ways. S&P Global Ratings incorporates these factors into its ratings methodology and analytics, which enables analysts to factor near-, medium-, and long-term effects--both qualitative and quantitative--during multiple steps in the credit analysis. Strong ESG credentials do not necessarily indicate strong creditworthiness (see "The Role Of Environmental, Social, And Governance Credit Factors In Our Ratings Analysis," published on Sept. 12, 2019).
Our credit ratings on structured finance transactions incorporate ESG credit factors when, in our opinion, they could affect the likelihood of timely payment of interest or ultimate repayment of principal by the legal final maturity date of the securities. However, in most cases, exposure to ESG credit factors in structured finance transactions is indirect or mitigated by legal and structural features already embedded in typical transactions.
Our ESG industry report cards qualitatively explore the relative exposures (average, below average, above average) of different sectors to ESG credit factors over the short-, medium-, and long-term. This sector comparison is not an input to our credit ratings or a component of our credit rating methodologies; it is based on our current qualitative, forward-looking opinion of potential credit risks across sectors. In addition, the structured finance ESG industry report cards list examples of ESG credit factors for the sector that may have a more positive or negative influence on a transaction's credit quality compared to sector peers or the broader sector.
The qualitative assessment of the relative exposure to ESG credit factors for each sector reflects the potential exposure to ESG risks. It does not consider the presence of structural features that could mitigate these risks (e.g. credit enhancement, short-time horizon of a transaction, insurance, etc.). Therefore, even if there is a material ESG credit factor for a given sector or transaction, there may ultimately be no ratings impact if structural mitigants are present. This is because we assign issue credit ratings to structured finance securities. These credit opinions address the likelihood of repayment of a specific financial obligation, and consider forms of credit enhancement, such as collateral security and subordination. This differs from issuer credit ratings (ICR) that we assign to corporates and sovereigns, for example. Our ICRs are opinions about an obligor's overall creditworthiness, and do not apply to any specific financial obligation, as they do not take into account the nature and provisions of the obligation, their standing in bankruptcy or liquidation, statutory preferences, or their legality and enforceability. Therefore, ESG credit factors that could affect a corporate issuer's ICR may not be material to a structured finance issue credit rating, and vice versa (see "S&P Global Ratings Definitions," published on Jan. 5, 2021).
ESG Credit Factors
We define ESG credit factors as ESG risks, or opportunities, that influence an obligor's capacity and willingness to meet its financial commitments. This influence could be reflected, for example, through reduced ability of the underlying borrowers to repay the securitized receivables, the value of any collateral, disruptions in servicing or transaction cash flows, financial exposures to transaction counterparties, or increased legal and regulatory risks.
This report explores how ESG credit factors could influence the credit quality of credit card ABS and provides a benchmark for typical ESG considerations in the sector. Specific transactions may be exposed to ESG credit factors that could have a more positive or negative influence on the credit rating than the sector benchmark. These comparative views of ESG risks across transactions are typically qualitative at present, because there are currently limited ESG data points that are widely available to quantify the relative risks. Over time, we expect that a common taxonomy for ESG credit factors across structured finance sectors will emerge, at which point more data will become available to strengthen our analysis of ESG credit factors.
In our published rating rationales, we expect to provide more insight and transparency of any ESG credit factors that are material to our credit ratings in a dedicated ESG paragraph. Our goal is to highlight how a transaction compares to our ESG sector benchmark (where applicable), identify the relative ESG risks and opportunities, and discuss any structural mitigants to these risks. However, if in our view ESG credit factors are not material to the credit risk profile of a transaction, we generally would not make any specific disclosures beyond a reference to our ESG sector benchmarks, where applicable. Through this initiative we aim to highlight how our rating analysis has accounted for specific ESG credit factors and add transparency around which ESG credit factors could drive future rating changes, if any.
Credit Card ABS ESG Benchmark
Our ESG sector benchmark for credit card ABS consists of a revolving pool of prime quality, general purpose bankcards (e.g. Visa or Mastercard), originated by a large deposit-taking financial institution with decades of experience in the sector. The accounts and receivables are highly diversified by obligor and geography, and there are concentration limits on new account additions and eligible product types.
Exposure to environmental credit factors for the benchmark is considered below average, given significant obligor and geographic diversification, and that the receivables are unsecured.
Social credit factors are considered above average because of the relatively high interest rates for borrowers who carry a balance month-to-month. Conduct risk presents a direct social exposure for lenders and servicers, particularly as regulators are increasingly focused on ensuring fair treatment of borrowers, predominately retail ones. Aggressive collection practices or failure to underwrite in accordance with applicable regulations would increase legal and regulatory risks. In our view, social risks would be relatively higher for subprime borrowers given affordability considerations.
Exposure to governance credit factors is average. Given the nature of structured finance transactions, most have relatively strong governance frameworks through, for example, the generally very tight restrictions on what activities the special-purpose entity can undertake compared to other entities. Given that our ESG benchmark is a revolving pool, the originator has a more active role over the transaction's life, exposing investors to the risk of loosening underwriting standards or potential adverse selection. Deposit-taking financial institutions are generally highly regulated and have strong internal control frameworks with external audits and oversight in place. In our view, the credit card ABS transactions that would have relatively higher exposure to governance credit factors would be those that securitize accounts from smaller, non-deposit taking originators, which may have relatively weaker internal controls and limited third-party oversight, or accounts from originators with a short track record in the sector.
Environmental Credit Factors
ESG Benchmark: Below Average Exposure
| Environmental Factors | ||||
|---|---|---|---|---|
| Greenhouse gas emissions | Natural conditions | Pollution | Other environmental factors | Environmental benefits |
| Generally not a potential material exposure for this asset class. | Concentrations by obligor, industry, or geography may increase exposure to potential natural disasters or other physical climate-related risks, such as hurricanes, wildfires, earthquakes, and flooding. | Generally not a potential material exposure for this asset class. | Generally not a potential material exposure for this asset class. | Generally not a potential material exposure for this asset class. |
| The servicer's operations may be exposed to physical climate risks, potentially resulting in a disruption in collections. | ||||
| The rating on the sovereign where the securitized assets are domiciled can cap structured finance transaction ratings. The sovereign rating may be affected by natural disasters or other climate change-related risks. | ||||
Social Credit Factors
ESG Benchmark: Above Average Exposure
| Social Factors | |||
|---|---|---|---|
| Health and safety | Consumer related | Human capital management | Social benefits |
| A pandemic could result in cash flow declines that affect required credit enhancement levels and increase liquidity risks. For example, mandatory payment holidays may be offered to consumers who are affected by the pandemic. | Interest rates deemed usurious could result in reduced yield or could challenge the validity of the loans in securitized pools. | High turnover of collections staff or labor disputes/industrial action at the servicer could lead to a disruption in collections, increasing liquidity risk and extending recovery timing. | Regulation designed to prevent borrowers from being in persistent debt could affect collateral performance. |
| Credit scoring methods applied to lend to underserved communities may be untested in stressed economic environments. This could lead to higher defaults than expected. | |||
| Consumer credit legislation and regulation, including affordability considerations or aggressive collection practices, could increase legal and regulatory risk. | |||
Governance Credit Factors
ESG Benchmark: Average Exposure
| Governance Factors | |||
|---|---|---|---|
| Strategy, execution, and monitoring | Risk management and internal controls | Transparency | Other governance factors |
| For management teams with a limited track record in the sector, there may be higher defaults or increased operational risk. | Revolving collateral pools may be subject to deterioration in underwriting or adverse selection. | Concerns on data quantity, quality, and timeliness may affect our ability to rate a transaction, or potentially cap the rating. | Compensation structure and incentives of different transaction parties can result in conflicting interests, which may not have a strong alignment of interest with noteholders. |
| Increasing risk appetite of the originator, aggressive growth, or expansion into new products may result in higher defaults than the historical performance data reflect. | Bankruptcy risk could be heightened for key transaction parties that exhibit weak governance and internal controls. | The lack of a third-party audit, limited scope, or material due diligence findings may increase uncertainty of the collateral's credit quality. | |
| Key-man risk and a lack of succession planning at the originator/servicer may increase operational risk. | Weak documentation regarding restrictions on an issuer's objects and powers, debt limitations, independent directors, restrictions on a merger or reorganization, limitations on amendments to organizational documents, separateness, and security interests over its assets could increase the likelihood of a special-purpose entity entering insolvency proceedings. | Lack of transparency in loan documentation and any related finance or insurance products, such as payment protection insurance, could increase legal and regulatory risk or result in potential set-off. | |
| A successful cyberattack on the servicer could disrupt collections or result in a loss of borrower data that exposes the issuer to legal or regulatory risks. | |||
| The lack of a transition plan for a backup servicer, or inability to replace a key transaction party, may increase operational risk in a transaction. | |||
| A weak compliance culture of the originator and servicer could increase legal and regulatory risk. | |||
| Failure of a transaction counterparty to comply with documented remedies if their credit quality deteriorates could increase counterparty risk. | |||
| Failure of an originator and servicer to comply with applicable regulation could increase legal and regulatory risk, including the enforceability of the loans. | |||
| The lack of replacement provisions for interest rate benchmarks could lead to basis risk, reductions in cash flows, and increased legal and regulatory risk. | |||
| Weak representations and warranties provided by transaction parties may increase uncertainty of the collateral's credit quality. | |||
| Extensive use of manual overrides or exceptions to automated underwriting scorecards may increase uncertainty of the collateral's credit quality. | |||
| Flexibility of key transaction counterparties with respect to definitions, covenants, and performance triggers in the governing documents could lead to release of credit enhancement. For example, the servicer's ability to amend the time period that defines when loans are considered defaulted. | |||
This report does not constitute a rating action.
| Primary Credit Analysts: | Matthew S Mitchell, CFA, Paris +33 (0)6 17 23 72 88; matthew.mitchell@spglobal.com |
| Romil Chouhan, CFA, New York + 1 (212) 438 3512; romil.chouhan@spglobal.com | |
| Secondary Contacts: | Kate R Scanlin, New York + 1 (212) 438 2002; kate.scanlin@spglobal.com |
| Erin Kitson, Melbourne + 61 3 9631 2166; erin.kitson@spglobal.com |
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