Are Retailers Heading for Credit Crunch?

October 19, 2002

CHICAGO — Buy now, pay later.

That has been an American ideal for years but some U.S. retailers may end up paying the price for easy money as the slumping U.S. economy makes it harder for people to pay credit card bills, analysts and economists said Friday.

Sears, Roebuck and Co. (S), which led the charge into store-branded credit cards in 2000, warned Thursday its annual profits would fall well short of targets because it needed to set aside more money for people unable to pay bills, sending its shares to 10-year lows.

Other stores including Target Corp. (TGT) also offer branded cards with higher credit limits that can be used both in their stores and elsewhere. That means bigger interest profits for retailers — who are increasingly relying on that money to compensate for weak sales — but it could come back to haunt stores if customers have trouble paying bills.

Consumer credit is a growing issue for retailers as they offer easy terms like zero-percent financing to entice shoppers to buy big-ticket items in a tough economy. With consumers increasingly debt-laden through home refinancing or car purchases, it could prove a big problem down the road.

"I expect significant credit problems in the consumer and institutional sectors in the second half of next year," said Richard Hastings, chief economist and retail sector analyst with Cyber Business Credit.

"Lower borrowing rates in the past helped build credit sales, but now we see many consumers have too much debt and this is the beginning of a correction in the credit cycle."

Sears, which fired the head of its credit card unit earlier this month for sugar-coating the outlook, started offering a high credit limit Gold MasterCard two years ago, hoping to get customers to spend more money at its stores and others.

Its store cards started losing popularity in the 1990s when Sears began accepting other cards like Visa, MasterCard, so Sears was eager to get that business back.

The business has been kicking out huge profits as people transferred balances and made big-ticket purchases, but Sears said Thursday it set aside an extra $222 million for uncollectable accounts as the economic outlook worsened.

Analysts and asset managers have been increasingly concerned about Sears' exposure to higher-limit cards. The typical Sears Gold Card offers a $7,000 credit limit, compared with a normal Sears store card, which would typically have a $1,500 limit, Sears said at an analyst meeting Thursday.

Credit rating agency Fitch said Thursday it may lower its ratings covering some $16 billion of Sears debt because of concerns about the credit business.

Standard & Poor's said Friday it may cut its long-term ratings for Sears for the same reason.

Sears' problems cast a shadow across the retail sector, with analysts wondering whether other stores may be affected.

"Sears' MasterCard issues raise a red flag for the Target Visa business, since Target's expansion into Visa is reminiscent of Sears' push into MasterCard," said Shari Eberts, retail analyst with J.P. Morgan.

"There are some differences, though, with most of the Sears MasterCard problems in accounts that utilized balance transfer, a feature not offered by Target's Visa card."

Sears and other card issuers offer special low interest rates to entice customers to transfer high balances from other credit cards. The practice has been a money-maker for Sears but raises its exposure to high balances which may or may not be paid off, analysts said.

Carl Steidtmann, chief economist with Deloitte Consumer Business Research, said Sears is one of the only retailers that manages its own credit business instead of outsourcing it to a bank, which means Sears carries greater risk than most.

"Sears in many ways is a bank masquerading as a retailer," he said, adding that it had served them well so far and generated huge profits. "Sears would have gone the way of (bankrupt discount retailer) Kmart years ago if it weren't for their credit business."

GE Capital, General Electric Co. (GE)'s finance arm, handles credit cards for several top U.S. retailers including Wal-Mart Stores Inc. (WMT) and Gap Inc. (GPS), which means those retailers have less exposure to bad debt.

For its part, Sears said its current credit problems cloud an overall strong business, which has been propping up earnings as its retail unit struggles.

"If we could snap our fingers today and have our retail business achieve best-in-class profitability as a retail company, we would still make half of our profits in credit," Sears Chairman and Chief Executive Alan Lacy told Reuters in an interview on Thursday.

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