Markets & Finance

S&P Cuts Sears Credit Rating


On Feb. 28, 2003, Standard & Poor's lowered its corporate credit ratings on Sears, Roebuck and Co. (S) and its affiliates to 'BBB+' from 'A-'. The ratings were removed from CreditWatch where they were placed Oct. 18, 2002 with negative implications. The 'A-2' short-term corporate credit and commercial paper ratings on Sears Roebuck Acceptance Corp. were not placed on CreditWatch and were previously affirmed.

Standard & Poor's also assigned its 'BBB+' rating to the company's new $3.5 billion bank facility.

The outlook is negative. As of Dec. 28, 2002, the company had approximately $30 billion of debt outstanding.

The rating action reflects greater-than-anticipated charge-offs related to the company's Sears Gold MasterCard, and the adverse impact that the card has had on the credit business as a whole. Although earnings from Sears' credit and financial products segment are still quite significant at approximately $1.5 billion in 2002, they would have been substantially higher had it not been for a more than $460 million increase in the provision for uncollectible accounts.

These losses are attributable to the roll-out of the Sears Gold MasterCard during a weak economy and a period of rising personal bankruptcies, and declining interest rates. Introduction of the card during 2000 was meant to counter a decline in useage of the Sears proprietary credit card in Sears stores. Accounts receivable generated by the Sears Gold MasterCard represented 40% of the $30.8 billion total receivables at year-end 2002, versus 19% at the end of 2001.

Metrics related to the credit card have all deteriorated: the charge-off rate more than doubled in 2002 to 3.41% and is expected to rise to nearly 7% during 2003. Although management has taken a number of steps to remediate the losses, Standard & Poor's remains concerned that Sears' credit business may continue to be impacted by the poor domestic economy.

The company's credit operation is still viewed very positively: it remains strong and is a vital factor in the assessment of Sears' overall credit rating. However, Standard & Poor's has also concluded that the credit business possesses less business strength going forward because of the inherent risk associated with the Sears Gold MasterCard. Although the card may be marketed to higher credit-score accounts, it operates in a more competitive environment than the Sears proprietary card.

Standard & Poor's notes that Hoffman Estates, Ill.-based Sears had a relatively good performance from its retail business in 2002. Operating profits improved to $1.155 billion from $901 million the year before. The addition of Lands' End to the product portfolio continues to bode well for potentially improving Sears' stature in soft goods retailing. Nevertheless, there are still significant challenges ahead for the retail side of the business, where revenue growth and cost control will remain key issues going forward.

Standard & Poor's also reviewed the company's increasing reliance on secured debt in the form of asset-backed securities to determine whether senior unsecured debt may be notched down from the corporate credit rating. Although this usage is in excess of certain guidelines established for industrial-type companies, Sears is also viewed as a finance company with high quality, highly leveragable assets in the form of accounts receivable.

Because Standard & Poor's believes that there is a substantial cushion of unencumbered assets available for senior unsecured debt, and that Sears is working towards balancing its funding sources, senior unsecured debt is not deemed to be disadvantaged.

Standard & Poor's also has some concern that Sears might restart its currently dormant share repurchase program. This program has been inactive since the company acquired Lands' End in June 2002. However, moderate repurchases are factored into the rating, to the extent that funds are not derived from external borrowings.

Liquidity: Sears ended 2002 with a substantial cash position. In late February 2003, the company's Sears Roebuck Acceptance Corp. subsidiary closed on a new $3.5 billion unsecured 364-day revolver, with an option to convert outstandings into a one-year term loan. Sears also maintains a $2.9 billion unsecured commercial paper program, a $3.2 billion asset-backed commercial paper program, and shelf-registered debt totaling over $19 billion (including $3.8 billion for asset-backed securities).

Although liquidity is considered very adequate, a longer-maturity bank facility would be viewed more favorably. Sears' extensive access to alternative sources of funding, including capital from asset-backed securities, is quite strong. Moreover, its ability to tap senior unsecured financing from a variety of shelf registrations adds to flexibility. About 57% of the $4.7 billion of maturities for 2003 is unsecured debt, and Standard & Poor's expects that this will be refinanced with unsecured debt.

In the unlikely event that unsecured refinancing is constrained, Standard & Poor's believes that Sears retains a large portfolio of highly leverageable accounts receivable for which there exists a ready market. Beyond 2003, the overall maturity schedule is not particularly onerous.

Outlook: Although management is taking important steps to control useage and outstandings from its Gold MasterCard, a very difficult economic environment could result in an extension of losses from that business beyond current expectations. The outlook also incorporates potential difficulties at the retail business, where progress in improving sales and successfully integrating Lands' End could be hindered by the poor economy and lagging consumer confidence. From Standard & Poor's CreditWire


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