”
Is Target Corp.’s Credit Too Generous?

Retailer’s Loans Rose 29% From
Year Earlier As Others’ Books Shrink

By Peter Eavis

THE WALL STREET JOURNAL

March 11, 2008

Ben Bernanke must love
retailer Target Corp., because its
credit-card business is one of the few operations 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 in the
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 of
loans outstanding on its Visa cards, which can be used at other retailers as
well as Target, and its private-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 greater
than the 25% year-on-year rise posted in the fiscal third quarter. The card business
has been responsible 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. Morgan Chase& Co.’s
was up 3%.

Some fear that Target
has lent too much at a time when a slowing economy makes it harder for
borrowers to repay. And that it may be attracting struggling borrowers who
can’t get as much credit as they would like from other companies.

“”Target appears to
have pursued very aggressive credit growth at the wrong time,”” says
William Ryan, 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-card
portfolio “”is absolutely not a function of a loosening of credit standards
or a lowering of credit quality in our portfolio,”” he says.

For several years,
critics have been predicting a blowup in Target’s credit business. It never
happened. And Mr. Scovanner notes that the company has yet to report credit
losses that exceed company forecasts. He expects that to remain the case this
year and predicts the company will report credit losses of about 7% of loans
this year, up from 5.9% in the last fiscal year. Discover’s credit 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 identified
more borrowers that it felt comfortable lending to, Mr. Scovanner says. He adds
that the loans likely won’t increase at high rates in the near future from
their level at the end of the latest fiscal year.

“”Target has a
proven track record of managing its credit business,”” says Robert Botard,
analyst for the AIM Diversified Dividend Fund, which holds Target shares.
“”Because of that track record, it’s difficult to bet against them.””

But
bears think this could be the point at which Target stumbles, because the high
growth in its card 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 the weak 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 a
price/earnings ratio of 14.4 times expected per-share earnings for 2008, Target
shares also trade

above the market’s
multiple of 12.9 times. Yesterday, at 4 p.m. in New York Stock Exchange
composite 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
to those sorts of buyers if it is grappling with problems in its credit-card
operations. Target’s pretax earnings rose by $128 million in the latest fiscal
year. The lion’s share of the increase — $103 million — came from the
credit-card business.

And Mr. Ryan at
Portales expects Target’s credit losses to be considerably higher than the
company predicts. Indeed, the high growth may make it harder to see credit
deterioration that already is happening, he says.

That is because
reported credit-loss calculations at fast-growing lenders include a large
percentage of new loans. A large amount of new loans skews the overall
credit-loss calculation to a 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 a
percentage of loans outstanding a year earlier. Done in this fashion, Target’s
loss rate was 8.1% in the latest quarter, he says. That is higher than the 6.4%
credit loss rate for the fourth quarter, using the regular, nonlagged approach.

Mr. Ryan says this lagged
approach is an early indicator that the regular credit-loss number could exceed
8%.

“”The high lagged
loss rate suggests the company relaxed its underwriting standards too much as
it converted some of its private-label cardholders to Target Visa cards with
much greater credit lines,”” Mr. Ryan wrote in a recent research note.

Target’s Mr. Scovanner
says using a lagged approach is valid, but he reasserts his forecast that the
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 tracks how much of the loans’ principal is paid down each month. If
the proportion is low, it can point to borrowers 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 that focuses
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% of loans 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 start
adding large amounts to their bad-loan reserve to catch up with credit losses.
And if losses ramp up, Target may get hit in this way. Despite the problems in
the economy, Target let its bad-loan reserve drop to 6.6% of loans in its
latest quarter, down from 7.7% a year earlier.
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 few operations 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 in the
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 of
loans outstanding on its Visa cards, which can be used at other retailers as
well as Target, and its private-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 greater
than the 25% year-on-year rise posted in the fiscal third quarter. The card business
has been responsible 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. Morgan Chase& Co.’s
was up 3%.Some fear that Target
has lent too much at a time when a slowing economy makes it harder for
borrowers to repay. And that it may be attracting struggling borrowers who
can’t get as much credit as they would like from other companies.””Target appears to
have pursued very aggressive credit growth at the wrong time,”” says
William Ryan, 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-card
portfolio “”is absolutely not a function of a loosening of credit standards
or a lowering of credit quality in our portfolio,”” he says.For several years,
critics have been predicting a blowup in Target’s credit business. It never
happened. And Mr. Scovanner notes that the company has yet to report credit
losses that exceed company forecasts. He expects that to remain the case this
year and predicts the company will report credit losses of about 7% of loans
this year, up from 5.9% in the last fiscal year. Discover’s credit 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 identified
more borrowers that it felt comfortable lending to, Mr. Scovanner says. He adds
that the loans likely won’t increase at high rates in the near future from
their level at the end of the latest fiscal year.””Target has a
proven track record of managing its credit business,”” says Robert Botard,
analyst for the AIM Diversified Dividend Fund, which holds Target shares.
“”Because of that track record, it’s difficult to bet against them.””But
bears think this could be the point at which Target stumbles, because the high
growth in its card 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 the weak 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 a
price/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 Exchange
composite 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
to those sorts of buyers if it is grappling with problems in its credit-card
operations. Target’s pretax earnings rose by $128 million in the latest fiscal
year. The lion’s share of the increase — $103 million — came from the
credit-card business.And Mr. Ryan at
Portales expects Target’s credit losses to be considerably higher than the
company predicts. Indeed, the high growth may make it harder to see credit
deterioration that already is happening, he says.That is because
reported credit-loss calculations at fast-growing lenders include a large
percentage of new loans. A large amount of new loans skews the overall
credit-loss calculation to a 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 a
percentage of loans outstanding a year earlier. Done in this fashion, Target’s
loss rate was 8.1% in the latest quarter, he says. That is higher than the 6.4%
credit loss rate for the fourth quarter, using the regular, nonlagged approach.Mr. Ryan says this lagged
approach is an early indicator that the regular credit-loss number could exceed
8%.””The high lagged
loss rate suggests the company relaxed its underwriting standards too much as
it converted some of its private-label cardholders to Target Visa cards with
much greater credit lines,”” Mr. Ryan wrote in a recent research note.Target’s Mr. Scovanner
says using a lagged approach is valid, but he reasserts his forecast that the
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 tracks how much of the loans’ principal is paid down each month. If
the proportion is low, it can point to borrowers 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 that focuses
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% of loans 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 start
adding large amounts to their bad-loan reserve to catch up with credit losses.
And if losses ramp up, Target may get hit in this way. Despite the problems in
the economy, Target let its bad-loan reserve drop to 6.6% of loans in its
latest quarter, down from 7.7% a year earlier.”