Non-amortizing loans not subject to prepayment risk, why?

CFA Level II
#1

I know that’s because there is no schedule of repayment of principal (because there is no principal…they cite credit card loans as an example), but if consumers pay off their credit cards, or they pay more than the minimum payment due, isn’t that like a prepayment?

#2

… they make a distinction between individual loans (which have no prepayment risk), and securities based on these loans (which do have a prepayment risk), which I still don’t fully understand!

#3

i may be wrong but look carefully at ABS CC loans, I believe the CF only includes fees and late charges?? could be wrong though

#4

It is a revolving loan structure. As people pay of their balance, the cash flows are used to invest in new loans (i.e. new loans are added to the pool).

#5

I disagree that the loans are not subject to prepayment risk. However, the ABS structured based on credit card loans typically have a prepayment lockout feature.

#6

Simple answer, I learned a long time ago, forget logic on this one I actually thought about it for about the first 2 months of work before co-worker explained it like this. If there is no amortization schedule there can be no prepayments. An amm schedule is a contract guaranteeing “timely payment of principal and interest.” In non-amm ABS the loans have no principal payment schedule, since they are unscheduled revolving loans a payment on day t or day T makes no difference and although a payment on day t is sooner than day T it is not a prepayment because there is no schedule. Don’t think about the logic come exam day just remember that…

#7

This is my understanding Suppose I bought $ 100 worth of goods in Jan and the card charges me 3% per mo as interest. Either I can repay only the minimum interest to the card company ie $3 ( let the principal be outstanding) or repay back the entire interest + principal ( 103) Now the card company that securitized the loans can either give the principal to the holder of the Card Backed Security or make new loans with the 100. Generally, the Card company makes new loans with the principal that it gets. Upto 18 months, the Principal that is paid to the Card company is used to make further loans. No payments of principal are made to the Security holder. This is called the “lockout stage”, where the principal is not paid to the Security holder.

#8

thanks all…good explanation RahulM.

#9

b/c’s there’s no payment schedule. also as mentioned above, they’re a revoling structure, thus payments for first few years purchase more CC debt or “defeasance” occurs where they purchase treasuries