Fitch Lowers Sears' Senior Notes To 'BBB+'; Affirms CP; Rating Outlook Negative

Business Wire, Jan 9, 2003

Business Editors

CHICAGO--(BUSINESS WIRE)--Jan. 9, 2003

Fitch Ratings has lowered its ratings of the senior unsecured notes of Sears, Roebuck and Co. (Sears), Sears Roebuck Acceptance Corp. (SRAC), and Sears DC Corp to 'BBB ' from 'A-', and has removed these entities from Rating Watch Negative, where they were placed on Oct. 17, 2002. At the same time, Fitch has affirmed SRAC's commercial paper rating at 'F2'. The Rating Outlook is Negative, reflecting weak operating trends and uncertainty as to the timing of a turnaround of the retail businesses. Sears had $12.2 billion of domestic senior debt and $4.3 billion of domestic commercial paper outstanding as of Sept. 28, 2002.

The downgrade considers heightened competitive pressures facing the company's retail operation, challenges in executing a new full-line store strategy, concerns surrounding the overall retail environment and Fitch's revised internal capital allocations for the credit business. The rating action also reflects recent softness in Sears' credit operation, due primarily to higher provisioning in the company's receivables portfolios. In response Sears has made changes in senior credit management, tightened underwriting criteria and is actively pursuing other risk mitigation initiatives. These steps are viewed as positive, particularly in light of what will continue to be a challenging competitive and credit environment in 2003.

Sears' credit business has a tangible equity to managed assets ratio on a stand-alone basis which Fitch views as more indicative of the current rating level, particularly as Fitch's assessment of the credit operation's risk profile has increased recently. The change in risk profile has occurred as the company has substituted a portion of its declining private label card base with MasterCard accounts, which has exhibited a mixed performance to date. Fitch recognizes that the consolidated operation maintains abundant sources of alternative liquidity which could be used to bolster the credit operations capital position if necessary.

Profitability of the credit card operation remains strong, although performance in 2002 has been negatively impacted by higher provisions for losses. Increased provisions were due to higher loss levels and the company moving to a more conservative reserve methodology which effectively began assigning reserves more broadly to include current accounts and other fees in addition to delinquent borrowers and finance charges. Future provisioning will mirror net write-offs, although levels will be influenced by the company's historically longer charge-off period (write-off loans at 240 days delinquent compared to 180 days for banks) and its historic re-age policy, which effectively cures accounts that are currently delinquent. Fitch expects reported net chargeoffs to rise moderately during 2003.

Within its retail business, Sears has recorded mid-to-high single digit comparable store sales declines over the past few months, due to weak apparel sales and disruptions from store repositioning activities. Despite these challenges, Sears has made good progress in reducing costs, and has managed its inventories carefully, enabling it to generate improved profit margins in 2002. The company's retail operating margin increased to 3.6% in the twelve months ended Sept. 28, 2002, from 2.8% in 2001. Nevertheless, going forward Sears will be challenged to generate meaningful margin improvement in the face of weak sales trends and growing competition from the discounters, as well as specialty apparel and hard goods retailers. A particular concern is the expansion of appliance offerings by the home improvement retailers, which could affect Sears' core appliance business over the intermediate term.

The lower ratings incorporate Fitch's expectations that Sears' funding profile is likely to shift to more secured sources, effectively subordinating existing unsecured bondholders. The company has indicated its longer-term strategy is to rebalance its debt portfolio consistent with its historic diversified funding mix. As of Sept. 28, 2002, the Sears' domestic operations maintained secured debt to total capitalization of about 34%, compared to 31% at year-end 2001. Fitch believes that Sears has ample available liquidity to fund operations over the near-to-intermediate term and repay maturing debt obligations. Much of the near-term liquidity appears to be in the form of eligible collateral for term securitizations or asset-backed commercial paper, along with other one-time transactions. While Sears' has expansive contingent sources of liquidity, it relies heavily on the capital markets to fund its day-to-day operations. If these markets prove more discriminating, Sears has other sources liquidity, including unencumbered real estate properties and other proprietary assets.

Future rating actions will center on the company's ability to deal with the competitive pressures present in the retail environment and its success in stabilizing the asset quality in its credit operations.