In a securitization, what is an early amortization provision?

What will be an ideal response?

There are provisions in credit card receivable-backed securities that require early amortization of the principal if certain events occur. Such a provision, which is referred to as either an early amortization provision or a rapid amortization provision, is included to safeguard the credit quality of the structure. The only way that the principal cash flows can be altered is by triggering the early amortization provision. Typically, early amortization allows for the rapid return of principal in the event that the three-month average excess spread earned on the receivables falls to zero or less. When early amortization occurs, the bond classes are retired sequentially (i.e., first the AAA bond then the AA rated bond, etc.). This is accomplished by distributing the principal payments to the specified bond class instead of using those payments to acquire more receivables.

The length of time until the return of principal is largely a function of the monthly payment rate (MPR). MPR expresses the monthly payment (which includes finance charges, fees, and any principal repayment) of a credit card receivable portfolio as a percentage of credit card debt outstanding in the previous month. For example, suppose a $600 million credit card receivable portfolio in February realized $60 million of payments in March. The MPR for March would then be 10% ($60 million divided by $600 million). The MPR is important for two reasons. First, if the MPR reaches an extremely low level, there is a chance that there will be extension risk with respect to the principal payments to the bond classes. Second, if the MPR is very low, then there is a chance that there will not be sufficient cash flows to pay off principal. This is one of the events that could trigger the early amortization provision.