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Credit Crunch to Impact Retailers Into 2009

Rising tide of credit problems expected despite bailout package.

Cash is king again.

This story first appeared in the October 2, 2008 issue of WWD.  Subscribe Today.

Even if Congress approves a $700 billion government bailout plan, the credit crunch is expected to roil on well into 2009 — and more retailers and vendors will be pushed to the wall. Retailers are rapidly finding they have credit problems on several fronts — difficulties in getting their own bank loans and bond renewals as well as consumers’ credit card delinquencies and rising debt service costs.

Already, the yearlong credit troubles on Wall Street — which began with the subprime mortgage crisis, kicked into high gear last month and are continuing as Congress works on a bailout for banks — has made it more expensive for even strong retailers to borrow money and pushed weaker players closer to the edge. The Senate was poised to vote Wednesday night on a revised and expanded emergency financial bailout package in an effort to revive legislation defeated by the House of Representatives on Monday that sent the stock market plummeting and the credit markets reeling.

As markets waited anxiously Wednesday to see if the Senate would manage to push through its version of the $700 billion bailout, the Dow Jones Industrial Average receded a relatively minor 19.59 points, or 0.2 percent, to 10,831.07. However, the Standard & Poor’s Retail Index dropped 1.7 percent to 356.46 after spending much of the day down 2 percent or more.

Perhaps more encouraging than the Dow’s small drop was the large decline in LIBOR, the London Interbank Offer Rate, which was being watched closely amid signs the credit markets had slowed to the point of near paralysis. LIBOR, which reflects the rates banks charge each other for money and tends to move higher as financial fears mount, hit a record 6.88 percent on Tuesday but eased to 3.78 percent on Wednesday.

Retailers often tap several banks that together extend lines of credit that are used as rainy day funds and to help keep operations chugging along.

The biggest problem for retailers, however, may turn out to be consumers, who have relied heavily on credit to maintain their lifestyles and are nervously watching the bad news from Wall Street. Higher interest rates on credit cards and personal loans — or an inability to even get them — would throw yet more cold water on the rapidly cooling embers of consumer demand for everything from apparel and accessories to home furnishings and cars.

“Investor confidence, shaken by the collapse of major financial institutions and the serious disruptions in credit and stock markets, remains vulnerable to new shocks,” Daniel Gates, managing director at Moody’s Investors Service, said in his third-quarter wrap up. “We expect that the market turmoil will have lasting effects on the availability and terms of credit, on business and consumer confidence, and on global economic growth. This will exacerbate the trends that are causing deterioration in corporate credit quality.”

Globally, 43 percent of the apparel companies tracked by Moody’s had a negative outlook or were under review for a possible credit downgrade during the third quarter this year, up from 23 percent from the end of last year.

A credit downgrade, particularly if it pushes debt into the non-investment or “junk” category, can even in the best of times make it more expensive to refinance.

Weak consumer spending only exacerbates the problem.

“Spending by overleveraged U.S. consumers was surprisingly resilient until recent months, but we are seeing signs that household consumption is beginning to buckle,” Gates wrote. “Consumers in some European countries, particularly in the U.K. and Spain, share some of the same vulnerable characteristics as households in the U.S.: high debt burdens, declining home prices, stagnant or falling disposable incomes, and rising debt delinquencies.”

With the bankruptcy of Lehman Brothers and rapid fire sales of Wachovia and Merrill Lynch last month and Bear Stearns in March, credit tightened considerably and the number of banks available to extend credit shrank through attrition.

Some retailers with lower debt ratings, and greater need of cash, have found the pool of money they can borrow under their credit facilities withering as the banking sector shrinks, said Tiffany Co, Fitch Ratings debt analyst, who covers specialty stores.

“There are some retailers that were exposed to Lehman,” Co said, noting certain chains didn’t have the Lehman portion of their credit facilities picked up by the successor bank. A bankruptcy judge approved the sale of Lehman’s investment banking and trading services to Barclays, and other elements of its operations have been picked up by other firms.

For companies already scrambling for cash and looking down the barrel of the weakest holiday season in years, this could be too much to bear.

“For the ones that are not generating the cash flow and cannot access capital from the outside resource, we could see another spate of bankruptcies,” Co predicted. “I actually don’t think the bankruptcy cycle is anywhere close to the end. It’s still ongoing for the rest of this year and probably into next year.”

Already this year, Mervyns, Boscov’s, Goody’s Family Clothing Inc. and Steve & Barry’s have found themselves in Chapter 11.

In the specialty store sector, Co said apparel was probably weakest, in part because fashion is more of a discretionary purchase compared with home improvement goods or office supplies.

In addition to the cash flowing through their registers and their bank credit facilities, retailers finance their operations by tapping into the so-called paper markets for short-term loans and by selling bonds.

Bonds amount to a loan from the bondholder to the company, which makes regular payments on the debt and promises to repay the principal amount on a certain date. Companies often simply issue new bonds to repay the old ones, but firms with fast-approaching maturity dates might not find the public debt markets all that receptive to their needs.

Ed Henderson, vice president and senior analyst at Moody’s, who tracks department store debt, said most of the companies he covers probably won’t be borrowing as much in the short term as they adjust inventory to their sales levels.

“I’m not as concerned about getting through this holiday season,” said Henderson, who would not discuss specific companies. “What I’m concerned about is somebody who would have a maturity coming up in the next six months or so.”

That goes for a bank facility or bonds, he said.

Upheaval in the credit markets could make it more expensive or perhaps impossible for companies to refinance maturing bonds by issuing additional ones.

According to Fitch Ratings, a number of large retail firms have bonds maturing this year, including Nordstrom Inc. ($258 million), Dillard’s Inc. ($101 million), Gap Inc. ($138 million) and Saks Inc. ($89 million). Nordstrom has a 2.28 debt-to-equity ratio while Dillard’s is 0.57, Gap’s is 0.05 and Saks’ is 0.50, according to data provided by Capital IQ through Yahoo Finance.

Retailers with their own credit card portfolios are set to get a double whammy from the credit crunch. For instance, net charge-offs in Target Corp.’s credit card portfolio rose significantly to 9.86 percent in August from 9.08 in July.

“The increase in [net chargeoffs] reflects the difficult consumer environment, rising consumer debt levels and Target’s product change from last year — recall, Target offered higher limit Visa cards to certain Target card customers starting last summer,” Citi equity analyst Deborah Weinswig, wrote in a recent report.

Target sold a 47 percent interest in its credit card receivables to J.P. Morgan Chase in May. The discounter’s shares declined 3.7 percent Wednesday to $47.24.

Department stores and national chains endured an even tougher trading day Wednesday. Nordstrom’s shares declined 5 percent to $27.37, Gottschalks Inc. dipped 4.9 percent to $1.36 and Sears Holdings Corp. fell 4.8 percent to $89.04. Macy’s was down 3.7 percent to $17.31, Kohl’s Corp. was off 3.5 percent to $44.48 and Saks dropped 2.7 percent to $9.

Overseas stocks were generally higher Wednesday, with London’s FTSE 100 up 57.14 points, or 1.2 percent, to 4,959.59 while, in Tokyo, the Nikkei 225 gained 108.40 pints, or 1 percent, to end its session at 11,368.26, off the three-year low of the day before.

Among European issues, Marks and Spencer Group plc gained 4.3 percent on the day while Hermès International picked up 3.2 percent. LVMH Moët Hennessy Louis Vuitton and PPR managed gains of 1.2 and 0.6 percent, respectively.

However, decliners outnumbered advancers by a wide margin in the fashion world, and some of the former included IT Holding SpA, down 13.8 percent; French Connection Group plc, down 8.1 percent; Asos plc, down 5.2 percent, and Benetton Group SpA, down 3.3 percent.

In Tokyo, Mitsubishi Rayon Co. Ltd. was up 4.7 percent and Onward Holdings Co. Ltd. ahead 3.6 percent, while Shiseido Co. Ltd., Isetan Mitsukoshi Holdings Ltd. and Link Theory Holdings Co. Ltd. managed more modest pickups of 3, 2.8 and 1.3 percent, respectively. The Nikkei had fallen heavily on Tuesday as it digested Monday’s rejection by the House of the government’s financial bailout plan.

In an effort to move recovery legislation forward, Senate leaders added tax breaks for businesses and the middle class. The revised legislation would also provide an increase in the federal insurance for deposits to $250,000 from the current coverage of $100,000.