While corporate credit and equity analysts are skeptical about the financial condition of Sears, Roebuck & Co., most ABS researchers believe that headline-induced widening represents a buy opportunity. Despite rising delinquencies and loss reserves, the Sears credit card portfolios rival those of the leading finance companies that dominate the sector, analysts said, and there is ample capacity in the ABS market to fund Sears through this and next year.
Though ABS analysts painted Sears a relatively rosy picture, the company no doubt has challenges ahead, as troubles in the broader debt and equity markets have led to wider spreads. Sears fell into the camp of having "perceived headline risk," according to Credit Suisse First Boston, following the October dismissal of its head of credit and financial products division and the disappointing third-quarter earnings that followed.
During an Oct. 17 analyst conference Sears disclosed it added $189 million to its loan loss reserve, in anticipation of rising delinquencies. Since then, spreads for Sears Credit Account Master Trust paper widened up to 18 basis points in some classes.
ABS researchers at CSFB, Banc One Capital Markets and Merrill Lynch view the widening that has occurred since the news as a buy opportunity. By contrast, Barclays Capital recommends investors "continue to hold SCAMT and not sell at wider levels," but added it is too early to buy, based on a belief there is further downside ahead in the near term.
"I believe all ABS sell-side analysts agree that the credit fundamentals of SCAMT are sound," Barclay's researcher Jeff Salmon said. "Our view, however, is there is more downside than upside on SCAMT spreads as negative headlines on consumer lenders will continue to impact the market."
The role of the new (mid-2000) MasterCard portfolio is a hot topic in the debate. It currently accounts for 37% of the company's $29.3 billion portfolio and has grown at a pace of nearly 300%. Growth is expected to slow, pressuring excess spread slightly and Sears' management anticipates upward pressure on losses as the newly originated accounts age, according to Barclays.
If other funding sources dry up, Sears could easily issue $5 billion with little impact to current spread levels, and, if necessary, as much as $7 billion to $9 billion in the coming year, albeit at even wider spreads, according to CSFB's Neil McPherson. This would easily cover the $2.7 billion in unsecured debt obligations and $1.96 billion of ABS coming due as well as $4.4 billion in bank credit facilities that expire in 2003.
McPherson cites the "fraction [of ABS supply] of what other major issuers bring to market annually," as an indication that there is the capacity for Sears to fulfill its funding needs strictly via ABS, if needed. To date Sears has issued roughly $3.6 billion of credit card ABS, versus the $6 billion-plus securitized by American Express, Capital One Financial, Citibank, Chase Manhattan and MBNA Bank America.
But, Sears's increased reliance on securitization combined with its rapidly growing MasterCard portfolio has non-ABS analysts potentially viewing Sears more like its ABS-reliant bank counterparts. CSFB notes that Sears already reaps 60% of its income from the credit lending aspect of its operations, adding "as Sears increases its exposure to the ABS market, its equity is likely to trade more like a finance company and less like a retailer."
CSFB fixed-income researcher Filippe Goossens argues that additional ABS structures decrease funding cost but increase structural subordination risk. "Debt holders may be de-leveraged from their senior positions" in the recovery process, as assets are removed from the parent's balance sheet and into the credit card issuance trust.
"While there could be some negative stigma associated with this, [CSFB] believes this should be offset by more attractive funding costs [in ABS markets]," Goossens adds. But "if the [SCAMT] deterioration is worse than current expectations, we could see renewed pressure on the company's credit spreads," Goossens says.
Carol Levinson, director of research at independent corporate bond research firm Gimme Credit, concurs, saying she "is not confident all the bad news is out for this credit." Levinson expects an increase in delinquencies in the company's portfolio due to the seasoning effect on the MasterCard portfolio, as well as allowance/receivables ratio on par with its net chargeoffs, leaving an insufficient cushion for future deterioration.
Banc One views future credit deterioration as being manageable though, as do its competing ABS researchers. "Collateral performance is still robust and protection offered by excess spread should withstand even substantial credit deterioration, particularly on the more recently issued floating rate series," says Banc One's Alessandro Pagani.
As for the high-coupon fixed-rate coupons that signaled a false alarm in some Chase credit card deals during the summer, Sears - as an on-balance-sheet issuer - has the flexibility to discount receivables or even remove accounts without jeopardizing its recourse treatment, adds CSFB.