Structured Finance. Global Credit Card ABS Rating Criteria. Asset-Backed Securities / Global. Sector-Specific Criteria. Scope. Key Rating Drivers

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1 Global Credit Card ABS Rating Criteria Sector-Specific Criteria Asset-Backed Securities / Global Inside this Report Page Key Rating Drivers 1 Data Adequacy 2 Rating Approach 2 Asset Analysis 3 Rating Stresses 8 Legal Structure 12 Liability Structure 12 Cash Flow Analysis 15 Performance Analytics 19 Appendices This report replaces Global Credit Card ABS Rating Criteria, dated June This updated criteria report is substantially unchanged from the prior criteria, with minor changes/updates. Analysts U.S. Michael R. Dean Steven Stubbs Herman Poon Lauren Tierney Europe Andreas Wilgen Joanne Wong, CFA Markus Papenroth Asia Pacific April Chen Keum Hee Oh Scope This global criteria report describes Fitch Ratings methodology for analyzing securitizations of credit card receivables and may be applied to both international and national credit ratings. Global Credit Card ABS Rating Criteria is effective for new and existing ratings as of and replaces the criteria report of the same name dated June This criteria report has not materially changed from the previously published version. Key Rating Drivers Credit Card Receivables Performance: Credit card ABS transactions are exposed to performance variations within the underlying receivables pool. Key performance parameters are chargeoff rates, yield rates, monthly payment rates, and purchase rates. In addition, delinquency rates and excess spread rates are important performance indicators. Fitch s asset analysis addresses the risk of performance variations and expects that these risks will be mitigated by available credit enhancement (CE). Account Originator Linkage: Credit cards provide revolving credit lines to obligors; therefore, relative to amortizing receivables, the asset performance exhibits a closer link to the ongoing performance of the originator. While Fitch s asset analysis stresses performance parameters, performance may be impacted by originator actions or events, including a deterioration of the originator s financial profile. Fitch closely monitors all originators and may adjust its rating assumptions for specific transactions in response to actual or potential changes in the position or strategy of an originator. Securitization Structural and Legal Risks: Securitization structures are intended to de-link the performance of the issued notes from the credit quality of the originator. This is typically achieved by a true sale of the assets from the originator to a bankruptcy-remote specialpurpose vehicle (SPV). Interest Rate and Basis Risk: The vast majority of credit card ABS trusts carry a degree of interest rate mismatch, since the asset yield and note interest are usually linked to different indices. In instances where both the assets and liabilities are indexed to separate floating interest rates, there can be basis risk from the rapidly rising investor coupon and lagging floating-rate or low fixed-rate credit card pricing. Such risks are also expected to be mitigated by available CE. Counterparty Risk: Counterparty risks arise in all situations where the transaction places either operational reliance or dependency on payment obligations from counterparties or other supporting parties. These parties can include the originator, servicer, guarantee provider, and account bank as well as an interest rate swap or currency swap provider. Fitch s ratings of credit card ABS transactions are dependent on the financial strength of certain counterparties while being directly linked to the performance of the securitized pool. Macroeconomic Risks: The economic environment can have a material impact on credit card ABS ratings. As such, Fitch takes into consideration the strength of the economy, as well as future expectations, by assessing key macroeconomic indicators, such as unemployment.

2 Data Adequacy Fitch relies on originators and servicers to provide accurate historical information in order to perform steady state and credit analyses. Fitch expects to receive originator-specific historical performance data relevant to the securitized asset pool for the longer of five years or a period covering all phases of at least one economic cycle. Appendix 8 on page 41 lists data items Fitch typically receives to analyze and rate a transaction. In the absence of certain data items, Fitch will assess the materiality and relevance of such data in accordance with its Criteria for Rating Caps and Limitations in Global Structured Finance Transactions, dated June 2013, available on Fitch s website at Depending on the outcome of such assessment, Fitch will either adjust its approach, cap the rating(s), or decline to rate the transaction. Where these alternative adjustments are applied, such approach and corresponding criteria will be highlighted in Fitch s transaction rating reports. The availability of highly relevant and comparable market performance data may serve as a proxy for originator-specific data in the scenario where the available originator-specific data do not cover all phases of at least one economic cycle. In addition, adjustments may be made to the steady state assumptions if historical data provided do not cover an entire economic cycle or lack consistency. In some instances, structural considerations, such as early amortization triggers, will also be considered in setting steady states. In analyzing the appropriateness of the rating stresses set out in this criteria report, Fitch has reviewed historical credit card performance data. With respect to the U.S., Fitch has 20 years of market performance data on credit card collateral. Fitch s U.K. credit card indices track collateral of U.K. credit card ABS transactions since January In Asia, Fitch has more than nine years of market and transaction performance data in South Korea. Related Research Fitch Fundamentals Index (April 2014) Related Criteria Global Structured Finance Rating Criteria (May 2014) Criteria for Interest Rate Stresses in Structured Finance Transactions and Covered Bonds (January 2014) Counterparty Criteria for Structured Finance Transactions and Covered Bonds (May 2014) Criteria for Servicing Continuity Risk in Structured Finance (July 2013) Criteria for Rating Caps and Limitations in Global Structured Finance Transactions (May 2014) The stresses were developed by studying the historical observations of U.S. credit card performance from and were further validated by an analysis of performance during the recession. Fitch s study examined aggregate performance as well as performance for the prime, subprime, and retail categories. Fitch will continue to perform periodic validation studies and update stresses as necessary. Appendix 3 on page 26 details the most current validation study as well as information on the Northeast study, which is the source of the original dataset from which Fitch s stresses are derived. Rating Approach Fitch s rating process begins with an initial review of detailed collateral stratification data and performance history of the portfolio of receivables being securitized. As part of its initial analysis, Fitch will apply a filtering process to determine the key risks associated with the collateral and the structure; this is particularly relevant for transactions with atypical risks. The originator/servicer review is an integral part of Fitch s initial rating process, which focuses on understanding the originator s corporate risk profile, underwriting standards, asset growth strategy, credit risk management policies, and servicing capabilities. The ramifications of regulatory developments faced by the originator will also be covered. Since the originator and servicer are often the same entity, the review encompasses both components in conjunction with each other. Following the initial review, Fitch derives steady state assumptions for three key performance variables chargeoffs, yield, and monthly payment rate (MPR) by analyzing historical Global Credit Card ABS Rating Criteria 2

3 performance and volatility for each one. In addition to its quantitative analysis, Fitch will also make qualitative adjustments in its approach where it deems necessary, and any adjustments will be disclosed in its transaction rating report. Transaction documentation is reviewed to understand the rights and obligations of each party to the documents and to consider how the structure will operate, particularly under certain circumstances (e.g. servicer replacement). Legal opinions are also reviewed to determine whether the transaction conforms to the legal assumptions that Fitch has relied on in its credit analysis. Fitch will utilize its proprietary credit card ABS cash flow model in evaluating the CE across all rating categories. The steady state assumptions are input into the cash flow model, and applicable stresses are modeled at each rating level to calculate the shortfall that would be required to be fulfilled by the available CE for the notes. Other inputs for the cash flow model are adjusted to reflect the basis risk, fee expenses, and structural features for the trust, as set out in the transaction s legal documents. Rating modifiers, if assigned, are derived through the linear interpolation of model outputs between rating category. While the cash flow model is an important consideration in determining the expected and final rating, ratings are ultimately assigned by a Fitch credit committee, which takes into consideration both available CE and the structural features of the transaction. When assigning expected and final ratings, Fitch will publish transaction-specific presale and new issue reports, respectively. The reports will highlight key features and risks of the transaction in the context of the rating criteria. After the transaction has closed, analysts monitor the transaction s performance using Fitch s monthly surveillance process to ensure the assigned ratings remain appropriate. Asset Analysis Fitch s asset analysis typically begins with a review of the originator and servicer as described below and in Appendix 1 on page 22. Fitch will analyze pool data to understand the specific collateral characteristics. Fitch will also analyze dynamic historical data with respect to annual yield, monthly payment, and annual chargeoff rates. In reviewing the historical data, Fitch will consider the impact of any changes to the receivables balance and any debt management programs operated by the servicer. The objective of this part of the analysis is to assign steady state assumptions to annual yield, monthly payment, and annual chargeoff rates, as elaborated on below. Originator/Servicer Operational Analysis Due to the revolving nature of credit card trusts, the collateral performance of a credit card portfolio relies heavily on continuous origination of new receivables and active management by the servicer; therefore, the evaluation of a credit card originator and servicer is a critical part of Fitch s rating process. Fitch will apply higher purchase rate stress to transactions if the financial strength of originators appears weak. Fitch s originator/servicer review process determines the quality and effectiveness of an organization s origination and servicing operations as well as its compliance with stated guidelines, operational stability, and soundness of internal control procedures. The review focuses on three principal factors: corporate performance; originations; and servicing using standard industry benchmarks and qualitative measures. If Fitch determines that the risk Global Credit Card ABS Rating Criteria 3

4 associated with a particular servicer is significant, the rating may be capped or the issuer may elect to mitigate the risk by including a back-up servicer in the transaction. For more details on Fitch s approach in analyzing originator and servicer operations, see Appendix 1: Originator/Servicer Operational Evaluation on page 22. In addition, Appendix 2 on page 25 provides a sample of the discussion guide used during our originator/servicer review. Collateral Characteristics Fitch analyzes characteristics of the underlying collateral to better understand the overall asset performance. This analysis supplements Fitch s analysis of the originator s historical data and Fitch s originator review findings when determining steady state performance assumptions. Major collateral characteristics that Fitch considers include the following: Credit score. Geographic concentration. Seasoning. Annual percentage rates (APRs). Credit limit. Product and segment mix. Credit scores can be good predictors of credit card defaults. Many card issuers use sophisticated credit-scoring models to determine the cardholder s probability of default. Generally, portfolios are defined as prime or subprime based on their credit score distributions. Fitch applies higher purchase rate stresses to portfolios with a higher concentration of subprime receivables. A pool of credit card receivables that exhibits geographic diversification minimizes potential exposure to regional economic downturns and natural disasters. Most prime issuers have welldiversified portfolios resulting from a national issuance strategy. Fitch may apply adjustments in stresses if significant regional concentrations are present. Seasoning is also important, as unseasoned portfolios tend to have higher chargeoffs and volatile performance. Fitch may apply adjustments to steady state assumptions in evaluating less seasoned portfolios. The issuers use the credit quality of each cardholder to set the credit limit and APR; these are usually assigned based on the cardholder s ability to meet debt payments (i.e. the higher the risk, the lower the credit limit and the higher the APR). The steady state for portfolio yield is largely dependent on the APR level and its distribution. Product mix may also impact collateral performance. Reward credit cards typically have higher payment rates and lower loss rates than nonreward products. Small business cards can exhibit different performance from those of consumer credit cards. When a portfolio is composed of different product types with different risk profiles, to mitigate the risk of portfolio shift, the transaction documentation often sets the maximum product ratio as a percentage of the total receivable pool at closing and on an ongoing basis. Setting Steady State Assumptions (Base Cases) The steady state concept is Fitch s forward-looking determination of how a given variable will perform over the next months, taking into consideration recent performance trends, competitive landscape, regulatory changes, and Fitch s forecast of the macroeconomic environment. Fitch s process for setting steady states seeks to further the goal that ratings Global Credit Card ABS Rating Criteria 4

5 generally should not change due to normal movements in the economic cycle, a concept known as rating through the cycle. Steady states are determined as forward-looking performance expectations that, at any point, would be reasonably reflected in the current rating. Rating changes would only be expected when performance is outside these expectations. Fitch derives steady states by analyzing the historical performance and volatility of key variables, including vintage data analysis. The term vintage refers to a group of accounts originated at approximately the same time, the performance of which is tracked as a group over time. Pools of accounts exhibit distinct performance patterns as they season. Chargeoffs, yield, and MPR tend to flatten out and achieve a steady state level approximately months after origination. This allows time for teaser rates, balance transfers, attrition, and early delinquencies to work their way through the pool. If changes in macroeconomic conditions, business practices, credit policy, or legislative landscape lead Fitch to believe future performance may deviate from past performance, further adjustments will be applied to the steady states. For unseasoned portfolios (less than 36 months), vintage data are key tools in setting steady states, in addition to historical performance and peer comparisons. Vintage data help remove the effects of portfolio growth by tracking a campaign of originations throughout its life. This enables Fitch to identify changes in underwriting guidelines and cardholder behavior. For highly seasoned pools, Fitch relies on a combination of vintage data and historical performance to derive steady states. In addition to vintage analysis, Fitch evaluates historical performance volatility for each variable and calculates standard deviations, which are then applied to historical averages. The resulting expectation is used in conjunction with the vintage analysis to create a more accurate steady state assumption. If there are several distinct subproducts within a portfolio, and each carries significant weight (greater than 10%), steady states may be established for each subproduct, and the steady states of the portfolio would be the weighted average of the aggregate according to the collateral weight for each subpool. When transaction documents stipulate the maximum product ratios, Fitch will utilize these concentration limits to form the portfolio steady states. Fitch will likely assume that during the revolving period, the portfolio migrates to the worst case possible under the concentration limits. Portfolio Yield Rate Portfolio yield is made up of periodic APR charges, annual fees, late payment fees, over-limit fees, and, in most cases, recoveries on charged-off accounts and interchange. Interchange is income from the card associations (Visa, MasterCard, American Express, Discover, and Novus, among others) that is paid to the issuing bank as compensation for taking credit risk and funding receivables, the amount of which varies from 1% 5% of charge volume. Most of these components are relatively stable and represent a small percentage of the yield. Interest income, as derived from an account s APR, on the other hand, often accounts for a large majority of the yield and is the most volatile. Since issuing entities price accounts for their individual level of risk, those catering to the subprime market or specializing in private label cards generally have higher yields than those in the prime market. In assigning steady state of portfolio yield, Fitch considers the expected impact on the yield components from regulatory changes and competitive environment. As such, Fitch typically gives full credit to the core components of yield, such as interest income, applies a haircut to fee income and interchange, and gives no credit to recoveries on charged off accounts. Global Credit Card ABS Rating Criteria 5

6 A proposal by the EU Commission that targets interchange fees for card-based payment transactions is in the advanced stages of the legislative process. If the regulation comes into force, it will cap interchange fees on both national and international credit card transactions within the EU at 0.3% of the value of the transaction. Haircuts are typically applied to fee income and interchange in order to account for possible changes in the regulatory or competitive landscape facing issuers. Regulatory changes can impact the number and level of fees charged cardholders, while competitive pressure may impact card usage and thus interchange income. Where regulatory interventions introduce tight limits on interchange charges, Fitch may assume further action to be more muted and may therefore no longer apply a haircut to interchange going forward to derive the steady state yield. In addition, as credit card debt has historically shown only very low recovery rates in the major U.S. and U.K. markets, Fitch generally does not give credit to recoveries in its determination of steady states. However, Fitch acknowledges that in some jurisdictions the legal framework and the credit culture can give rise to substantial recoveries on credit card chargeoffs. When an originator is able to demonstrate a substantial, consistent and stable recovery history, some credit may be given to it when determining the steady state portfolio yield. Payment Rate The MPR includes monthly collections of principal, finance charges, and fees paid by the cardholder; it is stated as a percentage of the outstanding balance as of the beginning of the month. It is an important variable, as it determines how quickly principal is likely to be repaid to bondholders if an early amortization event were to occur. Unlike amortizing assets, cardholders don t have level payments but instead have minimum payment requirements. Minimum payment requirements are determined by card issuers but are subject to regulations. They vary by country, ranging from 2% 3% in the U.S. to 10% in some Asian countries. Many credit cardholders elect to pay higher than minimum payment requirements each month. Customer profile (subprime versus prime) and product type (reward versus nonreward) can have a significant impact on MPR. Reductions in MPR may come from a decrease in the number of cardholders who pay off their entire bill every month and/or from an increase in the number of cardholders making smaller monthly payments. Fitch assigns a steady state assumption for monthly payment rate based on total payment. In Fitch s model, principal payment rate is derived by subtracting the interest component from the total monthly payment. Chargeoffs Chargeoffs are receivables written off as uncollectible by the issuing entity. Chargeoffs occur either through contractual delinquency or bankruptcy of the cardholder. In most countries, card issuers follow guidelines requiring issuing entities to charge off accounts at 180 days of delinquency and 60 days after notification of the bankruptcy of an obligor. Typically, in the U.S., 20% 50% of chargeoffs for an issuing entity can be attributed to bankruptcy. The variation depends on economic factors and the quality of the underlying receivables; for example, subprime borrowers have demonstrated high overall chargeoffs with lower bankruptcies relative to contractual chargeoffs. The chargeoff steady state is typically based on gross defaults. If net chargeoff is reported, it will be grossed up with an assessment of a recovery rate. Credit cards are unsecured debts and as such, Fitch has historically not given credit to recoveries in its analysis despite a typical 10% 25% recovery rate observed in the industry. However, as mentioned above, some credit may be given in certain jurisdictions when an originator is able to demonstrate a consistent and stable recovery history. Global Credit Card ABS Rating Criteria 6

7 In assigning a steady state for chargeoffs, Fitch considers any recent credit policy changes, delinquency trends and macroeconomic forecasts in addition to historical performance. Purchase Rate and Receivables Balance In a base case scenario, Fitch typically assumes a purchase rate of 100%, i.e. new purchases are set equal to principal collections. As a result of this assumption, the receivables balance will be constant in a base case scenario. The purchase rate will be stressed in higher rating scenarios. The stability of the receivables balance directly impacts other performance variables, as most variables are calculated using the receivables balance as denominator. A rapidly growing or shrinking portfolio can distort the coincidental chargeoff rate, as the change of receivables outpaces the change of credit loss. Vintage analysis and lagged analysis are necessary when receivable balances are volatile. Lagged analysis helps reduce the effects of portfolio change, as chargeoffs are compared to the receivables balance six months earlier when the delinquencies started to occur. Debt Management Programs Debt management programs are another consideration. Credit card receivables are normally defined as delinquent if the cardholder fails to make the minimum contractual payment in a given month and defined as defaulted if the duration of delinquency reaches a predefined threshold (e.g. 180 days). However, Fitch has observed an increasing trend for servicers to amend the repayment terms for certain financially distressed borrowers, under programs referred to as debt management programs. Typically under such programs, receivables will be classified as delinquent and subsequently defaulted only if the cardholder fails to make the reduced repayment amount. Fitch analyzes the extent of debt management programs by looking at data showing the percentage of total trust receivables that are subject to such programs. To analyze the severity of debt management programs, Fitch will consider: the qualification criteria applied by the servicer; payment terms of the program relative to the original contractual minimum payment amount; the actual repayment performance of the cardholders; the degree of monitoring applied to debt management accounts; and the method and timeliness with which debt management accounts are resolved. Fitch considers the following as negative factors: broad or vague qualification criteria; very low minimum payment requirements; a large portion of borrowers paying the reduced amount; minimal monitoring of the borrowers financial positions or performance; and long durations in which a high proportion of cardholders ultimately default. Fitch will consider the extent and severity of any debt management programs when setting base case assumptions, as the operation of the programs may have distorted historical data. Because debt management programs may delay the recognition of defaults and lead to a negative migration in credit quality, Fitch may decline to rate transactions in cases when Fitch is of the opinion that the severity and extent of the originator s debt management program may materially distort the reported transaction performance. Global Credit Card ABS Rating Criteria 7

8 Asset Migration Risk In many structures, future receivables on designated accounts (created by future purchases by obligors) are automatically transferred to the trust. Card issuers can also elect to add receivables/accounts to the trust to offset attrition or build up collateral for future transactions. The purchase price of the new receivables is satisfied either by payment from available principal collections (typical when notes are revolving) or by an increase in the seller s share of trust receivables (typical when notes are amortizing). As additional receivables/accounts are added, there is a risk that the new receivables could reduce the credit quality of the pool. Such risk is low if the originator has a long track record of consistent underwritings. The risk can be mitigated by eligibility and portfolio criteria (such as concentration limits) for additions, which are usually stipulated in transaction documents at day one for new receivables or new accounts. Strict eligibility criteria facilitate maintenance of minimum collateral quality, so that a transaction is insulated from unexpected adverse underwriting changes over time. Fitch assumes that originators will comply with such documented provisions, and as such, the credit analysis does not address the risk of ineligible assets being sold into the pool. Fitch may assume the portfolio to migrate to the worst-case scenario under concentration limits in setting steady states. Fitch has seen many South Korean transactions that set a product composition limit in the securitization portfolio to prevent negative migration and significant deterioration in pool performance. Based on the limits, Fitch usually assumes a composition that derives the highest expected loss rate of the pool and validates the transaction-available CE by contemplating the worst model loss rate. Accounts and receivables can also be removed from trusts in certain circumstances. Like additions, removals can lead to negative asset selection risk if issuers selectively remove assets. It is common that transaction documents specify conditions that need to be met for any removal, and most removals are selected randomly. Fitch monitors additions and removals closely to measure collateral quality over time. Rating Stresses Fitch s rating analysis incorporates performance stresses to address the risk that actual asset performance will deteriorate from steady state assumptions. Fitch applies stresses to the yield, monthly payment, chargeoff, and purchase rates. Fitch develops custom stress scenarios at every rating level for each ABS issuing entity and financial structure by evaluating the collateral composition and performance variables. Both the scenarios and the assumptions are determined on a case-by-case basis and compared with an industrywide benchmark. For performance variables, the extent to which each variable is then stressed is dictated by the level of steady states, portfolio concentrations, and the quality and volatility of historical data. The Level of Steady States Portfolios with low expected losses have more potential for higher volatility than those with higher expected losses. For instance, a pool with a loss steady state of 4% is more likely to quadruple to 16% under stressed scenarios than another pool, which has a loss steady state of 12%. Therefore, Fitch may apply a higher loss multiple to the first pool than to the second pool. Global Credit Card ABS Rating Criteria 8

9 Similarly, a portfolio with a 30% MPR is more likely to experience a significant decline in payments in an economic downturn than another pool with an 8% MPR. Hence, higher stress to MPR would be applied to the 30% MPR portfolio. Concentrations in the Pool Geographic concentrations expose the portfolio to regional economic recessions or natural disasters, and product or population concentrations introduce additional risk affecting such segments. Portfolios lacking diversification are more vulnerable to random events, and performance is likely to be more variable. Fitch applies higher stresses to such pools to address the potential variability of performances. As of late, Fitch has not observed the presence of any major concentration risks in U.S. or U.K. portfolios. Historically, some portfolios contained geographic concentration; however, securitized pools now typically reflect national demographics. As part of its credit analysis, Fitch examines any product concentrations on a case by case basis and would adjust stresses accordingly, if needed. Any such adjustment would be detailed in the related transaction research report. Quality and Volatility of Historical Data Limited data history and volatile performance give rise to concerns regarding the consistency of the origination and servicing process. Higher stresses may be applied to such portfolios. Conversely, if historical data are consistent and include a period of economic downturn, lower stresses will be applied. In addition, factors that drive purchase rate stress, i.e. portfolio composition, portfolio transferability, and originator strength, also affect the stress levels applied to yield, payment rate, and chargeoffs. When the utility of the credit cards is restricted or revoked, cardholders are less incentivized to prepay and more likely to become delinquent. Therefore, portfolios subject to higher purchase rate stress are likely to experience higher stresses in payment and defaults as well. Yield Stresses When determining yield stresses, Fitch considers the potential for performance deterioration as well as interaction between the interest rate charged to cardholders and market interest rates. In the first scenario, haircuts as shown in the table to the right are applied to the steady state yield assumption such an event could be driven by reduced pricing, increased delinquency levels, or an increase in the portion of promotional interest-free balance within the portfolio. When testing cash flows in increasing interest rate scenarios, Fitch will also consider the ability of the originator to increase interest rates in response to increasing market rates, since most card portfolios are dominated by floating rate APR and therefore Yield Stresses maintain a minimum, albeit (%, Haircut to Steady States) compressed, margin between yield Rating level Lower Higher and market interest rates after AAAsf factoring in basis spread. In stressing a portfolio s yield, competitive position is a critical factor, since a highly priced portfolio will be AAsf Asf BBBsf BBsf Global Credit Card ABS Rating Criteria 9

10 under pressure to reduce rates to maintain market share. Regulatory risk is another consideration in Fitch s stresses, as a change in legislation can have a significant impact on the way card revenue can be generated. For example, some business practices, such as double cycle billing, universal default, and certain over-limit fees, have already been discontinued in the U.S. due to the introduction of the Credit Card Accountability Responsibility and Disclosure Act in Lastly, Fitch will also look at the interaction between the yield stress and the purchase rate stress. In scenarios where no new receivables are assumed to be generated, the impact on the interchange component and fees that are based on further use by cardholders are likely more severe than on finance charges and fees such as for late payments. For standard portfolios, Fitch stresses will be close to the lower levels stated above. For the base case AAAsf rating category example on page 17, Fitch applies an overnight stress of 35% to the yield steady state of 17%, which creates a model input of 11.05%. Payment Rate Stresses When consumers are experiencing economic hardship, the risk of a missed payment is coupled with the risk of decreased magnitude of the payments that are made. Missed and/or insufficient payments will result in escalating delinquency statuses that, if uncured, will result in higher chargeoff rates. In both instances, MPR will be depressed. However, the MPR will also suffer if hardship results in payments that are lower than usual but in excess of the minimum due. Fitch develops a custom payment rate stress for each portfolio, with higher stresses for portfolios that are dependent on high MPRs. Depending on the collateral composition, the payment rate could vary significantly from portfolio to portfolio, which causes the stress applied to differ. In cases where Fitch does not believe the high payment rates are sustainable under a stressed Payment Rate Stresses (%, Haircuts to Steady States) environment, higher stresses will be applied. For standard portfolios, Fitch Rating level Lower Median Higher AAAsf stresses will be close to the median AAsf levels stated above. For the base case Asf AAAsf rating category example on BBBsf page 17, Fitch applies an overnight BBsf stress of 45% to the MPR steady state of 12%, which creates a model input of 6.60% Chargeoff Stresses Fitch applies multiples to the steady state assumption for chargeoffs via a linear Chargeoff Stresses increase over a six-month period, holding (x, Multiples to Steady States) the stressed level in place until bonds are repaid. At the AAAsf rating level, Fitch applies multiples ranging from 3.50x to 5.50x or higher. Fitch may apply a higher chargeoff multiple to transactions backed by pools with low default rates. The higher multiple seeks to address the increased performance volatility that pools that are assigned low base case default rates can exhibit under Rating level Lower Median Higher AAAsf AAsf Asf BBBsf BBsf Global Credit Card ABS Rating Criteria 10

11 stress. The rationale for application of a chargeoff multiple in excess of 5.50x will be detailed in the related rating action commentary and transaction rating report. The six-month period is commensurate with the 180-day chargeoff guidelines in many countries. Securities rated AAAsf generally withstand scenarios in which one in three or four cardholders is defaulting. For the base case AAAsf rating category example on page 17, a multiple of 4.50x is applied to the 7% chargeoff assumption, which creates a model input of 31.50%. Purchase Rate Stress The purchase rate is defined as the value of aggregate new purchases divided by the value of aggregate principal repayments in a given month, expressed as a percentage. A portfolio with a 100% purchase rate will have a constant principal receivables balance during the note amortization period. In contrast, a 0% purchase rate is commensurate with a purely amortizing portfolio and receivables, and the note will amortize in parallel. In a base case ( Bsf ) scenario, Fitch typically assumes a 100% purchase rate; however, stresses are applied in higher rating scenarios to reflect the risk of a reduced level of purchases. When considering an appropriate level of stress to apply in each rating scenario, Fitch will have consideration for the following factors in particular: Portfolio Composition The future purchase rate will be exposed to the willingness of the originator to allow ongoing charging privileges on the credit card accounts. A decision by the originator whether it is the original company, the third-party purchaser, or a receiver such as the Federal Deposit Insurance Corp. in the U.S. to restrict charging abilities of obligors will have a negative impact on the purchase rate. Fitch expects that such originator decisions will be driven by considerations of portfolio risk. In addition, the portfolio credit risk will likely be an important consideration for any potential acquirers of the credit card accounts in an originator insolvency event. A diversified, high-quality portfolio is more likely to be acquired and maintain ongoing charging abilities than a risky and less diversified portfolio. Portfolio Transferability Credit card accounts utilizing universal acquiring networks such as Visa or MasterCard and industry standard operating systems will be subject to lower purchase rate stresses relative to cards that can only be used in a limited number of outlets, such as outlet-specific store cards and/or those that operate on bespoke software systems. While a 100% purchase rate stress, which assumes no future purchases are permitted, may be applied for store cards, in the case of a universal card it may be presumed that the cardholders would continue to see benefit in using the card and that portions of such portfolios could feasibly be transferred to alternative originators. Strength of Originator The ability of the originator to fund the acquisition of new purchases within the trust while principal collections for existing receivables are being used to redeem investor notes is a factor in the originator s financial strength and diversity in sources of funding. Fitch will apply higher purchase rate stresses, which create lower effective purchase rates, to lower rated originators. Portfolios from originators with a broad retail bank franchise and diverse sources of funding will be assumed to have a greater ability to finance new purchases; therefore, they will be subject to lower purchase rate stress assumptions. Global Credit Card ABS Rating Criteria 11

12 The purchase rate stress has significant implications from a cash flow modeling perspective. Assuming all else is equal, a transaction with a full purchase rate stress (i.e. no new purchases being allocated to the trust) needs more CE to cover shortfalls during a stressed, early amortization environment. This is because the generation of additional receivables by the trust leads to greater monthly principal collections in absolute terms, relative to a fully amortizing scenario. Furthermore, in most trusts, principal collections are allocated between the seller and investor interests on a fixed basis during the early amortization period. The fixed percentage is established at the onset of the early amortization period and held constant until the investor interest is paid in full. This is an important structural attribute, as investors benefit from a larger allocation of principal collections throughout the payout period if receivables are replenished than they would in a fully amortizing or liquidating pool scenario. Consequently, continued receivable purchases by a trust facilitate a quicker repayment of the investor note in such structures. Counterparty Risks Fitch s ratings of credit card ABS transactions include an element of reliance on the financial strength of certain counterparties, either in the form of operational reliance or through credit dependency in the form of payment obligations. These parties can include the collection account bank, servicer, and interest rate swap provider. To address the issue of counterparty risk, transaction documents typically include structural mechanics that aim to reduce the reliance on specific counterparties. Counterparty risk is evaluated based on the type of exposure as well as the counterparty ratings. Fitch applies the criteria described in its report titled Counterparty Criteria for Structured Finance and Covered Bonds, dated May 2013, available on Fitch s website at (the counterparty criteria). Commingling and Payment Interruption Risk In credit card ABS transactions, collections from cardholders are typically remitted to the servicer s account bank before being transferred to the accounts of the trust. The commingling period refers to the number of days that collections are held by the servicer or its account bank before being transferred to the trust accounts. In an insolvency or bankruptcy event related to the servicer or its account bank, there is a risk that cardholder collections can be commingled with the funds of the insolvent servicer or account bank if not fully isolated (commingling risk). In addition, payments to the trust accounts are likely to be interrupted while alternative payment arrangements are established (payment interruption risk). In instances where the servicer and/or its account banks do not meet the minimum rating thresholds outlined in the counterparty criteria, liquidity support is generally provided to mitigate the risk of interruptions to the payment of interest for any of the rated notes. For more details, see Fitch s counterparty criteria. Legal Structure and Opinions As with other ABS transactions, credit card securitizations are structured to isolate the receivables from the bankruptcy or insolvency risks of the other entities involved in the transaction. This is typically accomplished by the seller/originator transferring the receivables (either directly or indirectly, depending on the chosen structure and the type of entity making the transfer) by means of a true sale or series of true sales to one or more bankruptcy-remote Global Credit Card ABS Rating Criteria 12

13 entities, one of which will ultimately issue the ABS to the investors. For more detail on considerations related to the analysis of SPVs, see Fitch Research on Global Structured Finance Rating Criteria, dated May 2013, available on Fitch s website at Fitch expects to receive legal opinions confirming that the cash flow derived from the assets (or any other relevant transaction party such as a swap counterparty) will not be impaired or diminished. Depending on the legal structure of the transaction, Fitch expects to see opinions addressing, among other things, (i) the isolation of the assets from the bankruptcy/insolvency risk of the originator, (ii) the grant of a first priority perfected security interest for the benefit of the noteholders, and (iii) the tax status of the SPV issuer, either as a tax neutral entity, or if the SPV issuer is taxable, the nature and amount of such taxes. Opinions provided may vary for different jurisdictions, and material differences will be noted in the transaction rating report. In jurisdictions outside the U.S., assignment of security interest may follow different laws as dictated by local security laws. Liability Structure Fitch reviews the liability structure of transactions that are presented by originators and their arrangers. Fitch identifies risks under different rating scenarios and forms a view on the ability of given structures to mitigate such risks. The following section outlines standard features of typical credit card ABS transactions and Fitch s analytical approach; however, it should be noted that Fitch does not recommend or approve any particular structural features. Further details of typical credit card ABS structural features are presented in Appendix 4 on page 28. Credit Enhancement The first layer of CE is provided by excess spread. Under certain structures this may be accumulated into a spread account. Mezzanine and senior notes typically benefit from hard CE in the form of subordination or overcollateralization. CE is often also provided in the form of a cash reserve. Certain structures provide an option to the originator to apply a discount rate and therefore increase levels of yield and excess spread; this may support trust performance, but Fitch normally does not assume that such options are exercised. Master trust structures also feature a minimum seller share; however, this typically does not provide CE. Fitch will review the relevant CE structure of each transaction and include it within the agency s cash flow model. Excess Spread The yield on credit cards, which is high relative to other types of consumer receivables, is usually sufficient to cover investor interest and servicing fees and still make a contribution towards reimbursing charged-off receivables. Excess spread is reported on a net basis, after the reimbursement of chargeoffs. In periods of benign performance, excess spread after chargeoffs will typically be positive, and this surplus is either paid to the seller or retained within the trust in a spread account. Negative excess spread rates after covering chargeoffs indicate that the trust is in a state of stress and that the notes will only be fully paid if they have sufficient hard CE. Spread Account Under credit card ABS structures, excess spread may be retained on a monthly basis for the benefit of the junior note according to predefined performance triggers. However, excess spread may decline rapidly and may not be able to accumulate sufficient amounts to cover Global Credit Card ABS Rating Criteria 13

14 losses. Therefore, Fitch does not typically give credit to spread accounts in rating scenarios above BBB+. In evaluating the available CE that a spread account can provide, Fitch assesses the transaction s ability to generate excess spread to fund the spread account over a given stress scenario. The focus is on the rate of change in a stress environment corresponding to the rating categories of the junior notes. A base case for spread account funding will be established by analyzing historical excess spread volatility and trigger structure. The base case represents the amount of credit enhancement that Fitch believes can be derived from the spread account. If historical excess spread levels are low or too volatile, little or no credit will be given to the ability to fund the spread account in the base case. Therefore transactions with the same trigger structures may not have the same CE because of varying historical excess spread performance. While historical performance is an important consideration, Fitch is aware the future performance of excess spread can deviate from history in terms of any factors that can significantly affect portfolio yield or chargeoffs. Therefore, Fitch takes into consideration other qualitative variables when evaluating spread accounts, such as regulatory changes, competitive landscape and economic environment. In addition, Fitch considers the structural nuances for each individual spread account and makes qualitative adjustments to the cash flow base case. For example, additional credit may be given when the structure is designed with a slow release mechanism in the event of shortterm performance improvements. During the life of a transaction, a spread account can be funded or unfunded in different periods. Fitch gives full credit to upfront deposits that are funded regardless of excess spread levels, but only gives partial credit to a fully funded spread account if the structure allows immediate cash release on performance improvement, unless the release is to facilitate commencement of early amortization or acceleration of note payment. Overcollateralization and Subordination Receivables in excess of the amount of any given class of notes protect the rated notes against the risk of defaulted receivables. Typically, losses will be allocated first to lower rated notes. The allocation of losses and the amortization profile of the senior and junior notes impact the degree of protection provided. Cash Collateral Account A cash collateral account (CCA) is simply an account funded at the outset of the transaction that can be drawn on to cover certain shortfalls. The availability of a CCA provides liquidity in the event of servicing disruptions. If cash in the CCAs is invested in short-term securities, Fitch will assess the counterparty risk associated with this CE. Discount Option Certain credit card ABS trusts may elect to use a discount option, which effectively reclassifies principal receivables collections as finance charge collections as a way to increase portfolio yield and excess spread. There are two principal methods through which the discount option is typically implemented: one in which the discount option is applied to all existing principal receivables and another in Global Credit Card ABS Rating Criteria 14

15 which the discount option is applied to new principal receivables that are added or purchased after a particular date. In either case, Fitch does not give any credit to the discount option if it does not extend until the full life of the longest dated bond in the issuance trust or the final maturity date of a series in the master trust. Seller Share Credit card trusts typically require the transferor to maintain an ownership interest (referred to as the transferor s participation or seller s interest) in the trust, often in the range of 4% 7%. The seller s share of the trust generally ranks pari passu with the noteholder share; therefore, this is not available to protect against general asset performance deterioration such as chargeoffs. However, the seller is typically obligated to reimburse the trust for any losses from fraudulent transactions, dilutions, or setoff. If the seller needs to reimburse the trust and is unable to use other sources of funds, then the seller share can be used to cover this. Therefore, Fitch analyzes the size of these risks relative to the documented minimum level for the seller share. Note Amortization Credit card notes often feature a scheduled amortization date and a legal final maturity date. In the case of transactions with a bullet maturity, the scheduled amortization date may be preceded by a controlled accumulation period. Fitch s ratings address the repayment of the note principal by the legal final maturity date. Fitch reviews transaction documentation and servicing reports to identify when notes begin to amortize. Typically amortization commences upon the earlier of a breach of an amortization trigger or at a predefined date, for example the scheduled amortization date. Fitch will review transaction-specific documents to identify the extent to which there are triggers to mitigate the identified risks. Performance Triggers Given that the rated notes are exposed to the performance of the underlying assets, most structures typically include a range of performance-based triggers. Typical performance-based triggers may include the following: Three-month average excess spread falling below zero. Three-month average monthly payment falling below a stated level. Three-month average delinquency ratio exceeding a stated level. Failure to pay principal in full on the scheduled maturity date. Seller s participation falling below a stated level. Portfolio principal balance falling below the invested amount. In Fitch s opinion, excess spread is the key performance indicator, as it incorporates the combined impact of yield rates, expense rates, and chargeoff rates. A negative development in either parameter, without a positive offset, will lead to a reduction in excess spread levels. Negative excess spread occurs when net yield is insufficient to fully reimburse chargeoffs, exposing the trust to a depleting asset base. Therefore, Fitch expects that such an event would trigger an early amortization of the notes. Structures that feature additional performance-based triggers offer higher protection to the bonds for example, triggers on individual performance parameters such as yield, chargeoffs, Global Credit Card ABS Rating Criteria 15

16 or the monthly payment rate. The relevance of such triggers would be increased in the scenario where parameters for certain originators had shown an unstable history or where Fitch has specific concerns about future performance. Seller and Servicer Triggers Given that notes are also exposed to the performance of certain counterparty obligations, early amortization triggers will often be based on the ongoing performance of such obligations. Typical triggers are stated below: Failure or inability to make required deposits or payments as per the legal documents. Failure or inability to transfer receivables to the trust when necessary. False representations or warranties that remain unremedied, typically for 60 days. Certain events of default, bankruptcy, insolvency, or receivership of the seller or servicer. Cash Flow Analysis Fitch s proprietary cash flow model is used to analyze the projected asset and liability cash flows for the structure. The objective of the analysis is to test the ability of the trust to use cash collections from a stressed asset pool to make timely interest payments and full principal repayment in advance of the legal final maturity date for the given notes. The table on page 17 provides an example of the CE necessary to cover accumulated shortfalls during the early amortization period for the different rating categories using both fixed- and floating-rate coupons. Fitch will model the amortizing phase of the transaction, commencing at the point of scheduled amortization. In practice, amortization may commence earlier as the result of a breach of a trigger; however, such a scenario would be less stressful since the maximum permitted amortization period would be lengthened. Fitch will customize its cash flow model to incorporate any additional transaction-specific features. While the cash flow model is an important consideration in determining the final rating, ratings are ultimately assigned by a Fitch credit committee, which takes into consideration both quantitative and qualitative factors. Global Credit Card ABS Rating Criteria 16

17 Fitch Base Case Stress Scenarios Example (%) Steady State Fitch Stress Scenarios Variable Assumption AAAsf Asf BBBsf Timing Yield Down Overnight Monthly Payment Rate Down Overnight Chargeoffs Six-Month Ramp Purchase Rate Model Inputs Yield Monthly Payment Rate Chargeoffs Purchase Rate Enhancement (Fixed Rate) Enhancement (Floating Rate) With 100% Purchase Rate Stress Yield Down Overnight Monthly Payment Rate Down Overnight Chargeoffs Six-Month Ramp Purchase Rate Model Inputs Yield Monthly Payment Rate Chargeoffs Purchase Rate Enhancement (Fixed Rate) Enhancement (Floating Rate) Asset Modeling The asset structure is intended to represent the receivables of the trust. Fitch determines total monthly collections by applying a stressed monthly payment rate to the beginning-of-month receivables balance. The interest element of total collections is calculated by applying the stressed yield assumption to the beginning-of-period receivables balance, and the principal element of total collections is calculated by deducting the interest element from the total amount of collections. Monthly chargeoffs are calculated by applying the stressed chargeoff rate to the beginning-of-period receivables balance. New purchases are calculated by applying the stressed purchase rate to the amount of principal collections for the month. The receivables balance for the end of the month is calculated by taking the beginning-of-month balance, deducting the principal collections and defaults, and adding new purchases. The stresses will be applied overnight to yield, payment rate, and purchase rate; chargeoffs will ramp up to the stressed level over a six-month period. Liability Modeling The liability structure is intended to represent the notes that are the subject of Fitch s analysis. Fitch allocates monthly principal collections, interest collections, and chargeoffs to the notes Global Credit Card ABS Rating Criteria 17

18 based on the relevant fixed- or floating-share allocations. Principal collections are allocated to redeem the note balance. Interest collections are reduced by servicing fees, note interest expenses, and chargeoffs; during a stressed period, the result can become negative on a monthly basis. The sum of monthly shortfalls over the amortization period plus unpaid note balance by the legal final maturity date is compared to the available CE amounts to determine whether the note is able to withstand the given rating stresses. Principal collections during an early amortization period are allocated on a fixed basis as a percentage of the invested amount to the receivable balance at the onset of early amortization. However, finance charge collections can be allocated either on a fixed or floating basis. For further details see Appendix 4: Trust Types and Master Trust Features on page 29. A fixed allocation of finance charge collections is favorable to the transaction if new receivables are being added during the early amortization period. This feature does not provide any benefit if Fitch determines that new receivables will not flow into the trust, as is the case with small retailers that are likely to file for bankruptcy protection, where the principal balance of the trust declines in lock step with the amortization of the securitization. Fitch generally gives full credit to the fixed allocation of finance charge collections in cash flow modeling. If Fitch decides to give partial or no credit to this feature, the disclosure will be made at transaction-specific rating reports. Sensitivity Analysis In addition to testing whether a note can withstand given rating stresses, Fitch will also use its proprietary cash flow model to perform sensitivity analysis on a note. The sensitivity analysis will provide insight into the ability of the note to withstand alternative scenarios with respect to steady state assumptions. For more details, see Appendix 5 on page 34. Rating sensitivity results should only be considered as one potential outcome given that the transaction is exposed to multiple dynamic risk factors. Rating sensitivity should not be used as an indicator of future rating performance. Servicing Fees Fitch models servicing fees in a senior position in its stress scenario. This approach is based on Fitch s expectation that a replacement or backup servicer will always command a senior position during distressed situations. From a ratings perspective, assumptions regarding the size and priority of servicing fees are important considerations, as they influence available cash flow and ultimate loss coverage. In situations when Fitch believes the stated servicing fee does not adequately cover actual costs, a higher fee is modeled throughout the stressed environment. Fitch evaluates the presence of any alternative servicing agreement as per the legal documents. In some trusts, a third party typically consents to service the portfolio for a predetermined fee if the original seller/servicer is no longer able to do so or if certain conditions are breached. Credit for the predetermined fee is based on a review of the backup servicing agreement, the types and level of servicing to be provided, the transferability of servicing operations and platforms, and the financial and operational strength of the parties involved. Depending on the terms of the agreement, any ongoing backup servicing fees would be modeled out of the trust cash flows. Global Credit Card ABS Rating Criteria 18

19 Interest Rate Risk and Basis Risk When modeling the interest expense on notes, Fitch takes into account the interest structure of the notes and considers different interest rate environments. Floating-Rate Notes Transactions with floating-rate notes are exposed to the risk of increasing market interest rates as the interest expense burden on the notes is increased. Fitch tests the cash flows in an increasing interest rate scenario in accordance with Fitch Research on Criteria for Interest Rate Stresses in Structured Finance Transactions and Covered Bonds, dated January 2013, available on Fitch s website at As credit card transactions are more exposed during the early part of the amortization period, when note balances are the greatest, Fitch will typically apply the short-term stress, described in the interest rate criteria, at the beginning of the amortization period. In such scenarios, the interaction of asset yield rates and market interest rates is a key consideration. Where yield rates are not directly linked to market interest rates but do contain flexibility, Fitch will assume that a positive minimum, albeit compressed, margin is maintained between the asset yield and market interest rates. However, the net impact of increasing market interest rates is invariably stressful to a transaction with floating-rate notes, as the asset yield is compressed while the note expenses are increased. This analysis is reflected in another scenario for yield stress. For further details, see the Rating Stresses section on page 8 of this report. When the underlying credit card agreements contain specific rate reset provisions, Fitch will give credit to this in an increasing rate scenario; however, Fitch will take into account any basis risk or timing mismatches on an ad hoc basis. Fixed-Rate or Swapped Notes When notes feature fixed interest rates or are swapped by interest rate derivatives, Fitch will model the contractual rates. In a scenario where market rates may still impact the transaction via the yield rate, Fitch may model a scenario of stable or decreasing market interest rates. Performance Analytics Fitch s performance analytics team maintains timely ratings for every Fitch-rated credit card ABS transaction, with the ongoing surveillance of credit card receivables based on both the current performance of the underlying pool and an in-depth cash flow analysis of the receivables. Performance Indicators The ongoing surveillance of any credit card receivables-backed trust takes into consideration both the actual reported performance of the trust and Fitch s expectations on the future performance of the key underlying performance indicators, namely (but not exclusively): monthly payment rates, yield, delinquency levels, chargeoffs, excess spread, and CE levels. Fitch reviews key performance data and pertinent information provided from servicer reports on each monthly reporting date that detail the trust s note paydown, asset performance, and portfolio characteristics. The data are then compared with initial expectations, peer performance, and trends. Any deviations from historical levels are researched. Global Credit Card ABS Rating Criteria 19

20 Review Frequency If a transaction is identified as performing outside expectations, a full review will be conducted, and any recommendations will be presented to a rating committee. If performance remains within expectations, the transaction will receive an in-depth review annually. Methodology The methodology for surveillance is consistent with Fitch s initial rating approach, where collateral performance and structural changes, if any, are reviewed prior to the cash flow analysis. The analysis focuses on levels of enhancement available for the protection of the various classes of notes and whether, under the stressed conditions, the transaction can withstand a level of losses commensurate with the risk associated with a rating level. The break-even loss level output for the notes provides an indication of the remoteness of the class of notes to stressed performance deterioration. Over time, performance may trend positively or negatively away from historical levels. If the performance of a trust s collateral begins to deviate significantly from the steady state assumptions and trust composition expectations for that portfolio, Fitch will conduct an in-depth review of the portfolio that may result in the assignment of new steady state assumptions, which, in turn, could have an effect on CE levels and ratings for tranches issued from that trust. The cash flow analysis does not, on its own, provide a full analysis of a consumer ABS credit card transaction, and any rating action will be the result of a full analysis of the trust/series, reflecting Fitch s overall view on how the transaction is expected to perform given the aforementioned factors and the likely impact of a change in performance on the rated notes. Stressed Environment Due to the nature of the receivables, the impact of external factors on the performance of the trusts can be pronounced, and as such any rating action will incorporate Fitch s view on the impact of, among other things, unemployment levels, credit card borrowing, consumer indebtedness, and insolvency levels on the performance of the securitized assets. For the purpose of ongoing surveillance, and during stressful economic periods, a certain amount of loss multiple compression may be taken into account when monitoring a credit card ABS transaction s performance. Fitch s through the cycle rating approach allows for highly rated notes in the AAA to AA categories to experience some amount of multiple compression before warranting a downgrade. This approach reflects the intention that most highly rated notes remain stable over time and do not generally respond to the evolution of a typical economic cycle. Fitch uses a loss multiple range (surveillance multiples) for each rating category that can vary from the multiples used when ratings are first assigned to the transaction. The surveillance multiples allow compression at each rating level to absorb performance changes due to economic conditions. As with the multiple range used for rating new transactions, the multiples are lower for pools with higher expected chargeoffs since the loss volatility is expected to decrease for pools with higher remaining default levels. Loss coverage multiples are determined by comparing the projected net loss amount with available CE. Fitch may also give credit to, among other things, the seasoning of the transaction and the stresses already incorporated into the analysis at closing. Global Credit Card ABS Rating Criteria 20

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