Most of the time, credit cards are used for spending, but they also offer an opportunity for fixed-income investors.
There are about $32 billion worth of securities outstanding that are backed by the money people owe on their credit cards. Here's how it works.
A bank that runs a credit card program sells its receivables, which are placed in a trust account. The pool may be many thousands of dollars; certificates are sold in increments of $1,000. Essentially, a person who buys a certificate gets a pro-rated portion of the money when credit card users pay up.
Because credit card bills are paid quickly (compared with, say, mortgages), a reinvestment period is set; during that time, payments received on the credit cards are used to buy new receivables, rather than paying down the certificates. This keeps the trust account at a steady level.
During the reinvestment period, certificate holders usually receive semiannual payments of interest only. When the period ends, principle and interest are paid out monthly until all the money available has been paid. It can take as little as six months to pay a certificate down.
There are two ways issuers try to keep AAA ratings on the certificates. One way is to obtain a letter of credit from a major bank to support the transaction. The other way is to structure the securities as senior and subordinated. For example, a Class A certificate would be the senior part of the pool, and a Class B certificate would be the subordinated piece. If there are delinquent credit card payments, the Class B certificate would take the losses first. The B certificates more than likely would be rated A or even BBB and usually are purchased by institutions.
Credit card certificates are mostly rated AAA and come in $1,000 denominations. They yield about 85 basis points (0.85 percent) more than a comparable Treasury security. Maturities can be three, five, seven or 10 years, with most in the three- to five-year range.
The Resolution Funding Corp., the agency paying for the savings and loan cleanup, will sell a 30-year bond on Tuesday, and the Treasury will offer a seven-year note on Wednesday. Both will come in $1,000 denominations, and should return 8.88 percent and 8.58 percent, respectively.