Profit pipeline from Sears' credit-card operations leaks

Interest on credit cards bring in huge profits for retailer, but uncollectable debts are on the rise

Web posted August 10, 1997

By Susan Chandler
Chicago Tribune

For years, Sears, Roebuck and Co.'s credit-card business was an overlooked diamond in the rough.

Even when the retail chain was losing money in the early 1990s, the interest Sears was charging shoppers on their purchases added billions to revenue and hundreds of millions to profit each year.

That wasn't lost on Sears Chief Executive Officer Arthur Martinez, the former Saks Fifth Avenue chief financial officer, when he took over Sears' retail operation in late 1992. After downsizing the company by closing more than 100 stores and eliminating the venerable Sears catalog, Mr. Martinez settled on revving up the credit side as a major growth strategy.

It worked. In the last three years alone, Sears has added 17 million accounts, expanding its portfolio of credit-card debt to $26.7 billion at year-end 1996. It's far and away the largest card issuer among retailers. Indeed, Sears is the fifth-largest credit card issuer in the country, ahead of First Chicago NBD Corp., AT&T Corp. and Chase Manhattan Corp.

With 60 million Sears cards in circulation, ``nobody is even in the same league (in the retail industry). There isn't a second place,'' said Pete Hisey, editor of Credit Card News, a Chicago-based industry newsletter.

But now Sears' impressive credit machine is hitting some painful bumps. Last year, Sears was forced to write off $1.08 billion in uncollectable credit-card debts, a 59 percent increase from 1995. And its reputation has suffered from revelations that the company had illegally collected money from more than 200,000 bankrupt Sears card holders since 1992.

In the recently finished second quarter, Sears' credit-card writeoffs soared again, rising 57.2 percent from the year-earlier quarter. And that wasn't the only bad news. The provision that Sears makes for future bad debts increased $143 million to $397 million, or 56 percent, on top of a 73 percent increase last year from 1995.

Since 1993, Sears' revenue from credit cards has risen 26 percent, while writeoffs have ballooned 73 percent. That's a frightening trend for Sears that threatens to crimp the credit division's hefty earnings, which represented an estimated 53 percent of corporate profits last year. It's even scarier, considering the economy has been healthy and unemployment has been falling during the same period.

Of course, the Hoffman Estates-based retailer is hardly alone in feeling the pain. With credit-card delinquencies across the industry hitting all-time highs and personal bankruptcies expected to break rec

ords for a third year, many creditcard companies are seeing their profits squeezed.

For the banking industry, credit-card delinquencies hit a record 3.72 percent at the end of 1996, but declined slightly, to 3.51 percent, by March. ``Our belief is they will decline further this year as the economy continues to expand,'' said Keith Leggett, an economist with the American Bankers Association in Washington.

While the bad news is moderating at other issuers, however, that's not happening at Sears. Its delinquencies continued to rise in the second quarter, hitting 5.93 percent, up from 5.65 percent in the first quarter and 5.43 percent at year-end. Analysts attribute the trend to the large number of new accounts added in the past two years.

Steven D. Goldstein, president of Sears' credit division, admits he is unhappy with the loss trends but says credit made a strong showing in the last quarter with ``very substantial top-line growth.''

Some retail analysts are equally as optimistic. Edward Weller, retail analyst at Robertson, Stephens & Co. in San Francisco, estimates Sears' credit division will contribute $731 million to earnings in 1997, a 7 percent increase from 1996, although it's half the 15 percent growth rate from a year earlier.

Privately, the company has been telling analysts that 1997 earnings growth for credit will still be positive, though it has been cagey about predicting when charge-offs will moderate. Publicly, Mr. Martinez hasn't backed off his prediction that Sears will report double-digit earnings growth in 1997.

Credit ``is a huge profit and cash flow generator for the company,'' said Richard Nelson, retail analyst with Nesbitt Burns Securities in Chicago. ``When you lend at 21 percent and borrow at prime, there's a nice spread there.''

Sears couldn't agree more. Other credit-card issuers are drastically curtailing their new-account solicitations, but Sears is forging ahead with plans to expand its credit business even further. ``We are aggressively pursuing new accounts,'' Mr. Goldstein said. Sears will add about 6 million accounts this year, slightly less than the number it added last year.

As part of its growth strategy, the retailer is experimenting with a ``starter card'' for recent immigrants who have no established credit history. And it's also looking at college students and divorced women with no credit history in their own names as potential new markets.

Although it's perceived to be riskier to lend to those with scanty or no credit records, Sears is in a good position to do it well, says Mr. Weller.

The company can reach out to immigrants who are shopping in its stores through in-store promotions, something that bank-card issuers can't. And Sears has an extensive database of customers it previously rejected because of ``thin'' credit histories that it can go back to. Sears says it is limiting its risk by setting small credit limits until cardholders establish a track record.

Yet the continued expansion could exacerbate Sears' bad debt problems. The retailer, which targets families with incomes between $20,000 and $60,000, has been particularly hard hit by the trend of ``surprise bankruptcies,'' where account holders file bankruptcy without ever missing a payment. The trend is most prevalent among moderate income households where debt levels have been rising much faster than income.

``The surprises are mostly people in their 30s; they own a house, and it's chock full of Sears stuff,'' said Mr. Hisey of Credit Card News.

Sears' widening exposure to bankruptcies is a logical outcome of its growth strategy. The Sears card historically has been an accessible credit card for moderate-income families, many of whom didn't hold a Visa or MasterCard. But with its big growth push in 1993, Sears lowered its credit standards and reduced minimum payments, making the card even easier to obtain and maintain.

It also made the Sears card more costly, by raising interest rates to 21 percent across the country and instituting late fees. Sears hiked its late fee to $15 last November and in June raised it again, to $20, which the company says is now the industry standard. It also recently moved to daily compounding of interest rather than monthly. All those moves have boosted profits as bad debts skyrocketed.

Another concern: Will Sears losses increase now that it won't be able to collect as aggressively from bankrupt debtors? In the second quarter, Sears took a huge $475 million charge related to its failure to file debt repayment plans with bankruptcy courts around the country.

Although Sears has said it will continue to pursue ``reaffirmation'' plans with bankrupt customers, its recoveries are expected to decline significantly as debtors' attorneys drive harder bargains and courts reject some of the plans.

But Weller of Robertson, Stephens notes that may actually be a good thing. ``They will collect less money, but they will be treating the customer more pleasantly, and the customer will probably feel better about Sears,'' he predicts.

Goldstein isn't ready to say that Sears already has seen the worst of delinquencies and bankruptcies, even though the trends in June improved. ``We need a few more months before we feel better,'' he admits.

Of course, if the economy hits a bump, it could be a lot longer than that before Sears' credit business is a shining star again.