VideoBut the hit to earnings wouldn't be disastrous. Reason: Sears has taken such bold measures to increase the profitability of its credit card operation in recent years that it will remain easily in the black during a recession. For one thing, the divestiture of Allstate and Dean Witter, Discover strengthened Sears's balance sheet. And Sears paid off or refinanced high-interest debt from earlier years. The result was an upgrade in Sears's credit ratings and a reduction in the company's cost of debt.
"Sears basically has no debt except credit card debt," that is, debt to fund its credit card operations, says Joseph Ronning, an analyst for Brown Brothers Harriman & Co., in New York. So the company's lending arm, Sears Roebuck Acceptance Corp., "is a prime credit," he says. This allows Sears to fund its credit card operations at a lower cost than other retailers, who are more highly leveraged and have lower credit ratings.
BALANCING COMPETEING GOALS
To be sure, Sears, like other retailers, imposes a fixed interest rate on its card balances. In contrast, banks levy a floating rate, which allows banks to more closely manage the spread between that rate and their cost of funds. But unlike most other retailers, Sears, in 1995, jettisoned a policy of letting its fixed rate vary by locale. Now it has established a uniform rate in all markets, and at 21 percent recently, it is two to three percentage points higher than that charged by most banks. Also, the company has developed a funding strategy that allows it to balance the competing goals of keeping costs as low as possible while managing interest rate risk. "We try to solve for the lowest cost over time with an acceptable volatility [in interest rates] in the short term," says Alan Lacy, Sears's executive vice president and CFO. To achieve that goal, Sears typically seeks to issue a mix of notes, commercial paper, and credit card securities whose maturities average out to intermediate, he says.
By contrast, GE Capital, which issues variable- rate cards for Montgomery Ward, Macy's, Home Depot, and others, funds its credit card operations by leaning heavily on commercial paper, according to Edward Stewart, executive vice president at GE Capital.
And while Sears began securitizing its credit card portfolio several years ago to diversify its funding, the company is currently holding back. For one thing, says Lacy, the spread between medium-term notes and credit card backed securities isn't particularly wide. "There's not a big rate incentive," he says. And he notes that by restraining securitization now, Sears is engaged in some "rainy-day planning." If, for instance, the economy falls into a recession, Lacy says the spread most likely would widen, prompting Sears to take securitization back to a higher level. But it would have that much less to securitize if it were going full bore now.
Sears has taken still more steps to strengthen the profitability of its credit card operations. At the end of 1993, after Sears began to allow the use of Master Card, Visa, and American Express to make purchases at Sears, it took steps to assure that the Sears Card would remain competitive in its appeal to Sears customers. "The credit organization wanted to make sure that sales associates were advising customers about the advantages of using the Sears Card," Lacy says. Sears clerks actively encouraged customers to set up new accounts, pointing out such advantages as access to special sales offers. The company also marketed preapproved cards and offered discounts on initial purchases made on a new Sears Card.
A SOURCE OF FUNDING
The effort to raise prices and lower costs "has allowed us to have growth in credit profitability in spite of a rise in charge- offs," says Lacy.
Why not just get out of the business, as so many other retailers have? "For hard-line retailers" like Sears, says Lacy, "it's important to have credit," if for no other reason than it "gives us a significant amount of free cash flow as a source of internal funding." And although he says he can't imagine Sears building up such a credit operation from scratch today, he contends that retailers that have sold their private-label credit card businesses to GE Capital operate at a disadvantage as a result. These retailers "got a fee for allowing someone else to use their customers to earn assets," he says. "They work together to do promotions," Lacy notes, such as making offers of zero percent for six months. "We can do that on our own," he says.
But the other retailers haven't been able to make enough money in the credit card business to prosper. Montgomery Ward transferred its credit card business to GE Capital in 1987 as part of a management buyout of the business that was financed by GE Capital. Macy's sold its credit card business when it was sinking into bankruptcy (irony of ironies), and before the company was sold to Federated Stores. Many midsized and smaller retailers have worked with GE Capital Services to gain economies of scale, management expertise, and financing, says Stewart. "Retailers need to look in every nook and cranny for profits," he says.
Those retailers still in the business earn far less than Sears. While Sears derives 50 percent of its earnings from credit cards, J.C. Penney Co., for instance, reports a loss on its credit card operations. And the typical contribution to earnings is about 10 percent. For others, such as Nordstrom and Bloomingdale's, the credit card business is viewed more as a means of stimulating business and as a convenience to the customer than a profit center, says Ronning. Because they, as well as other department stores, typically have lower average balances, lack the expertise and economies of scale of Sears, and see more customers switch to cash purchases in economic downturns, their profitability is more vulnerable to recession, says Sally Schaadt, an analyst with The Fourteen Research Corp., an institutional research firm in New York.
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