Retail Credit Cards: The Correlation between Retailer Health and Payment Performance

retail credit card

This is the first of a two-part blog series written by guest author, Cristian deRitis, senior director of Consumer Credit Analytics at Moody’s Analytics. Cristian develops credit models for a variety of asset classes and provides regular analysis and commentary on consumer credit, housing, mortgage markets, securitization, and financial regulatory. 

Based on data from CreditForecast.com, delinquency rates on private label retail credit cards has been rising over the past five years. That’s faster than any other consumer credit product, including bank-issued credit cards.

credit card performance

The deterioration in performance hasn’t been confined to subprime or near-prime borrowers either.  Delinquency and loss rates have risen across the board – despite the fact that the economy overall is growing, the unemployment rate is near historically low levels, and average hourly earnings are growing.  What’s going on?

retail card performance

At the same time that losses on retail credit cards have risen, the retail sector in the United States has been undergoing a stunning transformation.  First, department stores and other traditional Main Street retailers lost market share to big box stores.  Then, just as retailers were adjusting to this new reality, the industry transformed again as e-commerce grew and consumer preferences shifted.  While announcements of the death of malls and brick-and-mortar shopping may be premature, the transformation of the industry is clearly here to stay with augmented and virtual reality destined to bring shopping out of physical stores.

Given all of these changes, we might ask how retail credit card portfolios have performed and how they will be expected to fare in the future.  Unlike general purpose credit cards that consumers can use to make purchases at a variety of retailers, retail credit card accounts can only be used at specific retailers.  As a preview of our results, we find that financial trouble at a retailer appears to negatively influence borrower behavior as well.

Retail Under Pressure

Nine retail chains defaulted on their loans in the first quarter of 2018, according to Moody’s Investor Services.  Four retailers defaulted in February and March, the most in a single month since five retailers defaulted in December 1998.  This poor performance was after a harsh environment for traditional retailers in 2017, which saw the demise of such high-profile names as Toys “R” Us and Payless Shoe Source.  More defaults are likely to follow in 2018 and 2019, as rising interest rates put pressure on highly-leveraged retailers.

In addition to the rising number of bankruptcies, store counts point to a similar consolidation trend.  The number of department and office supply store outlets declined in 2017, while the number of discount retailers grew.  As more consumers shop online, brick-and-mortar retailers are having to slash prices and differentiate themselves in order to compete.

retail and apparel

Tighter profit margins have caused some retailers to earn a more significant portion of profits from their credit card affiliate programs than from the goods they actually sell.  Nearly 40% of one leading department store’s profit came from credit card fees in 2016.  In contrast, a leading online retailer, which only recently started its credit card programs, earned less than 5% of its profits from cards.

Contrary to popular belief, the vast majority of retailers do not actually own or manage their credit card programs.  A retailer may earn a share of the revenue from credit card borrowers, but the bulk of the profit – as well as the bulk of the default risk in the event a borrower doesn’t pay – is owned by the card issuer.

Given this relationship, we may wonder why borrower behavior would be influenced at all by the financial condition of retailers.  When a retailer is in financial trouble, why should consumers with that store’s credit card have cared?  After all, they made their monthly bill payments to a credit card issuer, not to the retailer.

And yet, the data suggest that the on-time payment performance of retail cards is influenced by – or at least correlated with – the performance of the affiliated retailer.  Performance data from investment securities backed by retailer-affiliated credit card trusts suggest a correlation between the financial condition of the retailer and performance on their affiliated credit cards.  When retailers have filed for bankruptcy in the past, delinquency and default rates on their associated credit cards increased.

Why Might This be the Case?

Performance on retail credit cards may deteriorate for several reasons:

  • First, the borrower population of the credit card portfolio may shift in the months or quarters leading up to a retailer’s bankruptcy. A retailer in financial trouble may attempt to run aggressive promotions – including pushing consumers to finance their spending with store credit cards in exchange for discounts – in a last-ditch effort to avoid financial collapse.  The borrowers who may be attracted by these offers may skew towards the riskier part of the population leading to higher delinquency rates.
  • Second, some retail card holders may be under the belief that if a retailer closes its doors, then they are no longer obligated to pay their credit card bills. This may explain the initial jump in delinquency, but would be expected to reverse as consumers receive the unfortunate news that, in fact, their outstanding balances have not been dismissed.
  • Finally, the incentive for consumers to stay current on their accounts will decline if a retailer either restructures or goes out of business. The discounts that retailers often provide to customers who pay with their store-branded card go away with a bankruptcy, thereby diminishing the value of keeping the account in good standing.  A consumer facing the choice between making a payment on a card linked to a defunct store and an operating store will choose the latter, pushing the defunct store credit card down the payment hierarchy.

For more information on the correlation between retail store closures and private label card performance, watch our latest US Economic & Credit Trends webinar.

And stay tuned for part two in our series on retail card performance, “Retail Credit Cards: What’s Driving Delinquencies?”