Private-Label Credit Cards: Risky Business?

There’s little doubt that offering private-label credit cards to your customers encourages them to make repeat purchases. “The use of private-label credit is extremely important in generating loyalty and increasing retention,” says George Ittner, president/CEO of women’s apparel cataloger Newport News, part of The Spiegel Group. “Customers who buy with house credit buy more often. It’s a tremendous boost to retention.”

But while extending house credit can be a boon to business in a strong economy, catalogers can suffer when a recession hits. Or as John Dailey, chief financial officer at multititle mailer Bear Creek Corp., says, “Offering credit to your customers can be beneficial, but when it goes bad, it can go really bad.”

A cautionary tale

According to Standard & Poor’s (S&P’s) credit-card quality indexes, the rate for monthly charge-offs — debts that are written off and deemed uncollectible — were 6.5% for September (the most recent figure available at press time). That’s unchanged from August, but up 140 basis points from the previous September. What’s more, S&P shows an increase in the number of accounts moving into 30-plus, 60-plus, and 90-plus days delinquency. And that barely reflects the economic fallout from Sept. 11.

The Spiegel Group, for one, is suffering from these delinquencies. The $1.7 billion marketer blames higher charge-offs in its credit-card operations for much of its $12.3 million loss for the third quarter of fiscal 2001.

For the third quarter of fiscal 2000, though, Spiegel had recorded earnings of $13.5 million. And again, much of that was due to its credit-card operations, run by subsidiary First Consumers National Bank (FCNB). For the year ended Dec. 31, 2000, operating income from the private-label card division was $96 million, up 78% from the previous year. What’s more, 42% of the company’s net sales were charged to the FCNB card, of which there were 3 million active accounts.

But during the past 18 months, FCNB began extending more credit to lower-income consumers — in other words, lowering its credit criteria to gain more cardholders. Then came the economic downturn.

Spiegel and FCNB were repeating some of the mistakes made by Minnetonka, MN-based Fingerhut Cos., part of Federated Department Stores. Fingerhut had traditionally targeted lower-income consumers by offering installment plans, in which customers use payment-coupon books, similar to those used with mortgages and car loans, to pay a fixed amount each month. In April 1999, the general merchant began shifting from installment credit to revolving credit via private-label cards; it also began extending credit to higher-risk prospects. Within a year, Fingerhut had lost up to $400 million in unpaid credit-card payments from delinquent customers. (See “Fingerhut Cleans Up Credit Mess,” March 1, 2001, issue.)

Reducing the risk

If nothing else, Fingerhut’s and Spiegel’s problems underscore the importance of careful modeling and evaluation to determine credit-worthiness. For instance, Warren, PA-based Blair Corp., a $574.6 million apparel cataloger, has avoided high charge-off rates by developing highly automated proprietary techniques and models to determine who should and shouldn’t be extended credit, says Steven Wiedmaier, vice president of credit management.

Nor are charge-backs much of an issue for Hingham, MA-based women’s clothing cataloger/retailer The Talbots, says spokesperson Margery Myers. Orders charged to its private-label card now account for 38% of Talbots’ sales, up from 29% just a year ago. Myers attributes the low delinquency rate (which she won’t quantify) to Talbots customers’ average income of $70,000 — which is appreciably higher than the average income of the Fingerhut customer.

“You have to watch to whom you mail [credit card] offers,” notes Bear Creek’s Dailey. “It took us a few times to get the scoring down. We prescreen lists through a credit bureau before mailing a special offer through the catalog.” Bear Creek also limits the amount of credit it extends to $500.

The $395 million Bear Creek, which mails the Harry and David food gifts catalog and the Jackson & Perkins horticulture title, began offering private-label credit cards in 1998. Since then, Dailey says, the average order size has increased — though he won’t say by how much — and about 20% of the Medford, OR-based company’s sales are now charged on the cards.

To minimize the risks, catalogers such as L.L. Bean and T. Shipley offer cobranded credit cards rather than private-label cards. With a cobranded card, the bank bears the responsibility for any delinquency; then again, the bank also reaps all of the interest income. The cataloger does gain increased customer loyalty, though most agree that cobranded cards don’t generate as much loyalty as private-label cards.

Regardless of customer affluence and scoring capabilities, extending any type of credit carries a risk. And “with declining consumer confidence and rising unemployment, it is inevitable that credit quality among the [store and catalog] credit portfolios will deteriorate over the next several quarters,” says Mark Picard, senior research analyst at New York-based investment bank Lazard Freres & Co.

Moreover, private-label cards generally suffer higher delinquency rates than bank cards such as Visa and Mastercard, says Tim Litle, president/founder of Lowell, MA-based investment bank Litle & Co. If they can’t pay both their bank-card bill and their private-label card bill in a given month, “customers will likely pay their Visa or Mastercards first, because it affects many relationships.”

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