How Retailers Avoid The Credit Crunch

How Retailers Avoid The Credit Crunch


Protecting cash and credit during an economic downturn is a matter of survival: Squander your cash or credit power, and you’re dead.

Money is just not flowing in like it used to. Not only are consumers more hesitant to spend, lenders are more hesitant to loan to just anybody. Unfortunately, most retailers find themselves stuck in the middle of the dilemma. While the impact of consumers’ recent belt-tightening can be immediately felt, tightening in the credit market has been more subtle but no less significant.

Dealers such as Abt Electronics in the Chicago area, Starpower Home Entertainment Systems in the Dallas market and DataVision in New York City report business as usual, with no major changes to their credit power or vendors lines of credit. DBL Distributing reports business is up and no evidence of a credit crunch hitting its dealers.

But the credit environment has indeed changed. Until mid-to-late 2007, U.S. businesses still enjoyed a borrower-friendly market, said Bill J. Mayer, president and COO of Wells Fargo Retail Finance, which provides senior secured debt to retailers. The company has more than $5 billion in committed credit lines, ranging from $10 million to hundreds of millions of dollars, extended to more than 100 retailers.

“There was tons of liquidity and the rates were really, really cheap,” Mayer continued. “There were deals being done without any financial covenants whatsoever.”

Fast forward to Spring 2008 when, in the aftershocks of the sub-prime mess, banks were taking huge write-offs and losses of reserves. “Banks are still extending credit, but they’re getting paid more to do it. It’s a tough time right now,” Mayer said, noting that major banks are now pulling huge letters of credit from major retailers.

A few months back, for example, Bank of America refused to renew a $1 billion credit agreement with Sears Holding Corp. under its existing terms. BOA and HSBC Holdings PLC also cut off credit lines, totaling $265 million, to Talbots.

One of the reasons for the restrictions is that banks have “more of a pessimistic view (of the economy) than some of the retail companies,” Mayer said.

“Banks are huge providers of mortgages, consumer loans, credit card debt, so banks have a pretty good view into how the underlying consumer is performing across all those sectors.”

With gas hitting more than $4 per gallon, plus food and commodity prices rising, “consumers are going to start tightening their discretionary spending,” Mayer said. “The banks view is it’s really, really tough out there for the consumer right now, which translates into retailers definitely having a tough time.”

With the credit market tightening up, retailers of all categories are seeing more unsecured lines of credit pulled, increased borrowing costs, a scarcity of financing for new shopping centers, and, in some cases, a tightening of customer loan programs.

For example, Costco last year negotiated with a bank to offer small business loans to its small business members. Although Costco was an intermediary in setting up the program, “Ultimately it (the individual business loan) was an arms-length transaction between the bank and the member,” said Costco CFO Richard Galanti

Costco offered the program about six months when the bank pulled the program on Costco and other retailers during the spring, a move Galanti attributed to a rise in delinquent payments.

Credit is still available, industry leaders note, but lending restrictions have increased. Wells Fargo, for example, is one banks that recently lent Circuit City a $1.3 billion revolving line of credit. “There’s still credit out there to the end retailers, but I will tell you that over the last six to nine months structures have been tightening down a little bit: banks are adding financial covenants, pricing has gone up,” Mayer said.

Dave Workman, executive director of PRO Buying Group, has witnessed the phenomenon first hand. “All credit is being scrutinized,” he said, adding that PRO Group members’ long-standing relationships with their banks have added some layers of protection. “Banks are all managing their credit risk very closely right now.”

Dealers with strong balance sheets and a solid collateral base are less likely to feel the credit crunch then those that are highly leveraged, said Dave Dreyer, marketing leader at GE Capital Solutions. “Access to capital and its corresponding price is more challenging today,” he added.

At Nationwide Marketing Group, executive vice president Les Kirk said its private label credit portfolio has remained unchanged. Rejection/approval rates are comparative to prior years, and member retail credit volume significantly increased for first-quarter 2008. Delinquency rates, though, are up, he said. “Nationwide members have not seen any major restrictions of credit from any of our financing partners other than unsecured credit lines, i.e. furniture flooring,” he added.

Throughout the industry, though, loans for expansion projects are taking longer to gain approval, require more background information and generally have a tougher time passing through the loan committee, said David Moore, financial consultant at The Panamint Group, a finance and operations consulting firm. Floor planning and product line expansion programs are also more difficult to qualify, he said.

“Lines of credit have been lowered if the collateral has lost value,” Moore said. “Lines are hard to expand, and the risk is now the main deterrent.”

Several established dealers said there has been little change in their access to credit, although they are fully aware of the changes in the market.

DataVision encountered no problems when it redid the second level of its showroom in New York City last summer, bringing in 40 new manufacturers. “Out of the 40, maybe 25 were direct. We had no issues with credit lines at all with any of them,” said company president Albert Liniado. “We’ve been in business a very long time, we have a very good reputation.”

But Liniado has seen distributors and manufactures getting a “little tighter” on new businesses, especially with dealers opening for the first time. “They’re very tough with these guys, asking for personal guarantees and things like that,” he said.

Wells Fargo’s Mayer cautioned that the status quo for vendor credit lines is also changing. “The Sonys, the Sharps of the world, all those manufacturers, they’re not dumb. They have sophisticated credit departments doing the same thing the banks are doing: reviewing the financial information that they are getting from end customers.”

To reduce their risk, manufacturers are starting to lower credit levels down, he said, from a $5 million open line of credit, to $4 million, $3 million or even $2 million.

That the credit market will tighten on businesses is an “eventuality,” said Daniel Pidgeon, chairman and co-founder of Starpower Home Entertainment Systems. Starpower, however, has not seen “any real change in our banking covenants, restrictions or access to capital,” Pidgeon said. In fact, the company recently signed a lease to open a new store – its fourth location – in Scottsdale, Ariz., in November. Pidgeon also said that Starpower has not seen any change in consumer credit approvals. Only about 20 percent of Starpower’s customers use third-party financing for their purchase.

The tightening of the home refinance market and consumer’s perception of their personal wealth will have a deep impact on retail sales, Pidgeon and others said. Starpower’s business is up over last year, but “It’s certainly not as robust as it has been the last three years,” Pidgeon said, adding that average order price has declined by approximately 20 percent.

“Now we have to have 25 percent more transactions to cover the 20 percent loss of average sales price,” he said. “We believe consumers access to capital is restricted due to lack of ability refinance a home, or even borrow against a new home purchases to the levels that they had in previous years.”

Henry Chiarelli, president of DBL, said he hasn’t seen any evidence of a credit crunch within the industry. But the categories that have been hardest hit by the housing slow-down – terminated and unterminated cables, in-wall and in-ceiling speakers, security and observation solutions, remotes, mounts and power devices – are the most profitable.

“We were up 12 (percent) last month, up close to 20 this month, but if those installation categories were performing better there’s no telling where we’d be,” he said in late May.

In tough economic times, the most important survival strategy for retailers is to protect their cash, industry leaders said. “During difficult times, you shift from managing profit and loss to managing a balance sheet,” said Starpower’s Pidgeon. “The most important rule is do not run out of cash. You run with leaner inventory than you typically run. You try to limit your borrowing, so you don’t get yourself in a situation where you are borrowing too much money and causing yourself to be managed by somebody else.”

Workman suggested that retailers closely watch capital expenses. “Really challenge return on investment on every dollar you’re going to spend,” he said. “Go through and look for efficiencies.”

Dealers should also carefully manage their cash conversion cycle, said Capital Solution’s Dreyer. A cash conversion cycle longer then an accounts payable cycle can add up to increased borrowing costs or lower a dealer’s ability to purchase new inventory. “Lenders are looking closer at accounts receivable delinquency more closely,” he said.