Default spike may end retailers in-house credit

SAN FRANCISCO (Reuters) - Retailers may run credit card operations to keep close ties with their shoppers, but a spike in late payments and defaults is threatening to ring the death knell for in-house credit.

While the economic crisis that has virtually frozen global credit markets has hurt all U.S. credit card issuers, retailers with their own credit card units, like Target (TGT.N), are most at risk. After all, their lending standards tend to be lower and they have fewer funding resources than banks, experts say.

Moreover, consumers are more likely to avoid repaying a store for smaller-ticket items when more pressing bills like rent, mortgages or electricity pile up.

"When your Visa card is maxed out and your MasterCard is maxed out, what are you going to do with your Target card? You're just not going to pay it," said Laura Nishikawa, an analyst with Innovest Strategic Value Advisors.

The issue also affects Charming Shoppes Inc (CHRS.O) and Cabela's (CAB.N), among a handful of retailers that still operate their credit cards in-house.

"Everyone's concerned we're in a spiraling downward slope where delinquencies will increase substantially and they'll get left holding a bag of horrible receivables that will lead to horrible write-offs and losses," C.L. King analyst Scott Krasik said of Charming Shoppes. "How bad does it have to get until they get there?"

"UNPRECEDENTED TERRITORY"

The historically resilient credit card industry is now in "unprecedented territory" with write-off rates expected to peak at 10 percent next quarter, Nishikawa noted.

So far, issuers from Citigroup (C.N) to American Express (AXP.N) have pushed up reserves for loan losses.

Target said this month it is cracking down on late accounts and warned that more credit card losses could lead to lower-than-expected third-quarter profit.

"In retail, with nontraditional players involved, people are surprised to see how much consumer finance exposure they have," Nishikawa said.

While high late fees have historically made retailers' in-house cards profitable, "the benefits from the late fees will pale in comparison to the losses (retailers) will incur," she said.

Retailers like to issue credit cards -- whether those used exclusively for purchases in their stores, or co-branded cards that can be used elsewhere -- for their marketing benefits.

Many stores give shoppers points later redeemable for free merchandise, and credit cards holders are a good audience for promotions that drive future traffic.

Most retailers outsource their credit operations to issuers like GE Money (GE.N) or Citigroup (C.N), which bear the brunt of bad loans. GE Money holds the largest portfolio of U.S. store cards, including those for Wal-Mart Stores Inc (WMT.N), Lowe's Companies Inc (LOW.N), and Gap Inc (GPS.N).

Given the credit environment, GE has abandoned a plan to sell the unit.

But retailers that operate their own credit cards still carry that financial risk. Their credit card holders are more likely to include more subprime obligors who end up defaulting sooner and more frequently than less risky borrowers, said ratings agency Moody's Investors Service.

"Performance of private label credit card portfolios is more susceptible to downturns in the economy as these cards have limited utility ... and may not rank high in cardholders' priority of payments if they are under financial duress," said a recent Moody's report.

RAISING MONEY GETS HARDER

Retailers also face the increasing cost of raising capital to fund lending. Moody's is considering downgrading certain asset-backed securities from Cabela's and Charming Shoppes, which operate trusts that issue debt backed by receivables.

Cabela's has seen more bad debts in its credit card portfolio since this summer, and has nearly doubled its provision for loan losses from last year.

Charming Shoppes, which is planning a new securitization next May, claims its credit card unit remains very profitable.

But the unanswered question, Krasik said, is: "Can they sell these asset-backed securities and even if they can will they have to sell them at much higher rates, which would make it less profitable for them?"

At Target, for instance, the delinquency rate -- or number of accounts 60 or more days late in paying as a percent of total monthly receivables -- has been rising over the past five months.

Target has increased its bad debt provision, signaling it expects the trend to continue. Full-year write-offs are expected at around 9 percent, with rates peaking in the first or second quarter next year.

Given the risks, retailers have become more proactive. Target has reduced credit lines and called defaulting credit card holders earlier than in the past.

Signet Jewelers (SIG.N), which operates in the United States as Kay Jewelers and where credit sales make up 53 percent of total sales, has added staff to handle more outstanding balances, which averaged $997 at the end of 2007. It is also investing more in collections systems.

The retailer said its 6.5 percent rate of bad debt as a percentage of credit sales is at the high end of a range tracked over the past 10 years. But it said further increases should be somewhat offset by income from the credit portfolio.

However, at Nordstrom (JWN.N), the upscale department store whose customer service has generated a loyal following, delinquencies were 2.5 percent in the second quarter ended August 2, unchanged from the prior quarter.

Company spokeswoman Brooke White said Nordstrom is willing to incur the extra risk of operating a credit card in the current economy given the benefits: "The card really helps drive loyalty and repeat business."

Rather than de-emphasizing credit, Nordstrom is encouraging use of its card with double rewards points through December.

Whether or not retailers weather the current economic crisis, the era of in-house store credit cards may be nearing its end, Nishikawa said.

"I think they'll exit the business -- but not before they lose a lot of money."

(Reporting by Alexandria Sage, editing by Richard Chang)