is Target Corpâs Credit Too Generous?Eavis, P. (Mar. 11, 2008). Is Target Corp.’s credit too generous? Wall Street Journal.For this discussion, read âIs Targetâs Corp.âs Credit too Generous? â (read below). Then, post a short reflection outlining three key points from the article.***ARTICLE***Is Target Corp.’s Credit Too Generous?Retailer’s Loans Rose 29% From Year Earlier As Others’ Books ShrinkBy Peter EavisThe Wall Street JournalMarch 11, 2008Ben Bernanke must love retailer Target Corp., because its credit-card business is one of the fewoperations in the country that has strongly increased lending in the face of the credit crunch.Now, though, some analysts are wondering whether the torrid expansion of the card business inthe current tough environment could lead to higher-than-expected bad loans.At the end of Target’s fiscal fourth quarter, which ended Feb. 2, the company had $8.62 billion ofloans outstanding on its Visa cards, which can be used at other retailers as well as Target, and itsprivate-label cards, which are for purchases at Target only.That total was up 29% from the $6.71 billion a year earlier — and the growth rate was even greaterthan the 25% year-on-year rise posted in the fiscal third quarter. The card business has beenresponsible for a large part of the retailer’s overall earnings growth.Other credit-card lenders’ loan books have either shrunk or grown much more slowly. For instance,Discover Financial Services’ U.S. credit-card business reported a 5% annual increase in loans inits fiscal fourth quarter, ended Nov. 30. Loans outstanding at Capital One Financial Corp.’s U.S.card business declined 2.8% in its fourth quarter, while Citigroup Inc.’s rose 3.6% and J.P. MorganChase & Co.’s was up 3%.Some fear that Target has lent too much at a time when a slowing economy makes it harder forborrowers to repay. And that it may be attracting struggling borrowers who can’t get as much creditas they would like from other companies.”Target appears to have pursued very aggressive credit growth at the wrong time,” says WilliamRyan, consumer-credit analyst at Portales Partners, a New York-based research firm.Not so, says Target’s chief financial officer, Douglas Scovanner. The growth in the credit-cardportfolio “is absolutely not a function of a loosening of credit standards or a lowering of creditquality in our portfolio,” he says.For several years, critics have been predicting a blowup in Target’s credit business. It neverhappened. And Mr. Scovanner notes that the company has yet to report credit losses that exceedcompany forecasts. He expects that to remain the case this year and predicts the company willreport credit losses of about 7% of loans this year, up from 5.9% in the last fiscal year. Discover’scredit losses were 3.82% of loans in its latest fiscal year, while Capital One’s were 2.88%.Last year, Target made a choice to significantly increase its credit-card loans because it identifiedmore borrowers that it felt comfortable lending to, Mr. Scovanner says. He adds that the loanslikely won’t increase at high rates in the near future from their level at the end of the latest fiscalyear.”Target has a proven track record of managing its credit business,” says Robert Botard, analyst forthe AIM Diversified Dividend Fund, which holds Target shares. “Because of that track record, it’sdifficult to bet against them.”But bears think this could be the point at which Target stumbles, because the high growth in itscard portfolio has happened just as the economy has slowed and lenders have become tight-fisted.And if problems were to arise in the credit-card operations, they would happen at a time when theweak economy is slamming retail operations as well.Target’s stock is up 2.5% this year, while the Standard & Poor’s 500 index has slumped 13%. At aprice/earnings ratio of 14.4 times expected per-share earnings for 2008, Target shares also tradeabove the market’s multiple of 12.9 times. Yesterday, at 4 p.m. in New York Stock Exchangecomposite trading, Target shares fell 77 cents, or 1.5%, to $51.23.Investors often buy retailers to bet on an economic recovery, but Target may look less attractive tothose sorts of buyers if it is grappling with problems in its credit-card operations. Target’s pretaxearnings rose by $128 million in the latest fiscal year. The lion’s share of the increase — $103million — came from the credit-card business.And Mr. Ryan at Portales expects Target’s credit losses to be considerably higher than thecompany predicts. Indeed, the high growth may make it harder to see credit deterioration thatalready is happening, he says.That is because reported credit-loss calculations at fast-growing lenders include a largepercentage of new loans. A large amount of new loans skews the overall credit-loss calculation toa lower number because losses are typically lower on recently made credit-card loans.To offset some of this new-loan effect, Mr. Ryan calculates credit losses for the latest quarter as apercentage of loans outstanding a year earlier. Done in this fashion, Target’s loss rate was 8.1% inthe latest quarter, he says. That is higher than the 6.4% credit loss rate for the fourth quarter, usingthe regular, nonlagged approach.Mr. Ryan says this lagged approach is an early indicator that the regular credit-loss number couldexceed 8%.”The high lagged loss rate suggests the company relaxed its underwriting standards too much as itconverted some of its private-label cardholders to Target Visa cards with much greater creditlines,” Mr. Ryan wrote in a recent research note.Target’s Mr. Scovanner says using a lagged approach is valid, but he reasserts his forecast thatthe company’s loss rate will be close to 7% of loans this year.In trying to gauge the creditworthiness of Target’s borrowers, analysts follow a metric that trackshow much of the loans’ principal is paid down each month. If the proportion is low, it can point toborrowers with poorer credit. Target’s payment rate was 14.2% in 2007, according to the company.By contrast, Discover’s was 20.9%, according to company data.Mr. Scovanner responds that the low payment rate is the by-product of a lending strategy thatfocuses on borrowers who are likely to shop regularly at Target’s stores.Mr. Scovanner doesn’t expect credit losses to exceed company expectations and climb to 8% ofloans or higher. But if they do, he says, Target’s card operations would still post solid results,because of this relatively high profitability.But profitable lenders’ earnings can get shellacked in future periods if they suddenly have to startadding large amounts to their bad-loan reserve to catch up with credit losses. And if losses rampup, Target may get hit in this way. Despite the problems in the economy, Target let its bad-loanreserve drop to 6.6% of loans in its latest quarter, down from 7.7% a year earlier.
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