Credit business can be a boost—or it can go bust - Sears Roebuck, Target's credit programs

DSN Retailing Today, Nov 25, 2002 by Laura Heller

NEW YORK -- Credit. It's a subject that seems to turn ugly each time the economy hits a rough patch, and this prolonged downturn is no exception. When sales begin to slow and real retail growth is negligible, companies with credit divisions come under fire for the very component they were once highly valued for. Given the current economic climate, even financial institutions such as Capital One are taking a hit from overexposure to credit and rising delinquencies.

But no retail company has been harder hit by this than Sears, which has seen its stock drop 43% since October 7, when it announced the need to increase the allowance for credit delinquencies and summarily dismissed Kevin Keleghan, president of the credit and financial product division. The company then followed up on the bad news with a 26% drop in earnings for the third quarter ended Sept. 28, missing estimates by 28% and causing the stock to plummet 31.8% in a single day.

The problem is an increasing number of delinquencies largely in the company's new Sears Gold MasterCard portfolio. By mid-October, the allowance for these charge-offs had been raised by nearly $190 million and analysts anticipate those costs will continue to rise in the near future. Continued high unemployment, difficult economic conditions and rising personal bankruptcy rates all contribute to this trend nationally, but the problems at Sears are a bit more complex--problems that are a drag on the entire retail sector, in particular fellow retailers that also have credit card operations.

Last year, Sears launched its Sears Gold MasterCard in addition to its established namesake product. The intent was to widen the company's reach and increase its portfolio. And while this did prove to be the case, it has also yielded higher delinquencies--partially in line with national trends and partially due to what chairman and ceo Alan Lacy referred to as a "learning curve" in the launch. Sears had offered cash advances and check writing privileges, factors that it has turned out, contribute to higher delinquencies.

Because credit balances are held as part of Sears Roebuck Co. rather than a bank, the division in not federally regulated. Therefore Sears has a longer 240-day delinquency period, more generous renewal policies and a zero-pay financing program on some bigger-ticket items helps delay charge-offs, effectively under-weighting them in the company's statements, according to Bernstein analyst Emme Kozloff.

These factors further cloud Sears credit problems, causing analysts to be even more leery of rising delinquencies. According to a recent report from Goldman Sachs analyst George Strachan, Sears may have to increase charge-offs even more in the future and remains cautious on the stock as the relatively young MasterCard portfolio ages.

Sears' problems have shed light on the retail credit business across the board. Not only can Sears not seem to put concerns about its credit business behind it, but its problems are proving a drag on other retailers with credit divisions as well, most notably Target, which has spent a good deal of time outlining why its credit business is different. At the company's analyst meeting held in Minneapolis last month, vice chairman Jerry Storch sought to assure the financial community of this very fact.

True, both retailers operate proprietary cards bearing a store name. Within Target Corp., each of the retail formats offers such a program. Also true, both companies recently launched a broader-scope credit program: Visa at Target and MasterCard at Sears.

The intent for both companies was to increase credit portfolios by allowing consumers to charge in more locations than simply the named stores. Both programs were to be offered to existing "high quality" customers and were touted as methods to attract new consumers to the credit business.

But the similarities end there, according to most analysts. Sears' initial Oct. 7 announcement even prompted Kozloff to issue a report titled "Target Credit: A Conservative, Regulated Approach. This is no Sears."

"There is a marriage in investors minds in that anybody who has a credit (component) has difficulties," said William Blair analyst Mark Miller. "Because it's believed that retailers can't really manage credit and that isn't necessarily the case. Kohls and Target are examples to the contrary."

At Kohl's, delinquencies are down modestly compared to a year ago and the retailer only operates a proprietary card.

Target's credit operation accounts for roughly 15% of operating profits compared to Sears, which garners nearly 60% of its profit from credit. All else being equal, rising delinquencies pose more of a threat to Sears than Target.

But all things are not equal and Sears' credit operations will continue to be closely monitored and the company penalized for rising charge-offs. Fairly or unfairly, other retailers with credit operations will be watched in tandem as the country continues straining toward an economic recovery.