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Target a Slave To Two Masters?


Deal with JP Morgan exposes industry-wide identity crisis.

Last August, my first piece for Minyanville related to Target's credit card portfolio, so I felt it was important to say something about the recently announced transaction between Target (TGT) and JP Morgan Chase (JPM).

I would like to say that it makes complete sense, but I can't. Especially when I read things like this in the press release:

"Under the terms of the agreement, Target and JP Morgan Chase have agreed to share the expected profits from this arrangement pro rata to their respective ownership interests, subject to a cap. To the extent that the cash-basis portfolio yield continues to exceed the cap, profits from the entire portfolio in excess of the cap will be retained by Target. The cap is initially set at an annualized yield of approximately 3.4 percent of the principal amount of JP Morgan Chase's interest in the receivables, and will vary over time with changes in one-month LIBOR. JP Morgan Chase will earn an additional return over the initial five-year term of the transaction as a result of accretion from an agreed-upon initial purchase discount of 7% of the gross amount of principal receivables sold. Unless extended by mutual agreement, repayment of JP Morgan Chase's invested capital is scheduled to begin on the fifth anniversary of the transaction closing. Subject to portfolio performance, repayment is expected to be completed by the sixth anniversary of closing."

To these eyes, the transaction looks more like a typical credit card securitization with some limited upside and downside being borne transferred to JP Morgan Chase.

But wait: Credit card securitizations a normally off-balance sheet, and the press release goes on to state:

"Accounting for this transaction will be consistent with Target's current accounting treatment of its outstanding receivables-backed financings. As a result, all of Target's credit card portfolio will remain on its consolidated financial statements, even in light of the occurrence of this sale and the related transfer of risks of ownership. The alternative of structuring this transaction as an off-balance sheet arrangement under FAS140 was rejected after careful consideration of the uncertainty created by the current review of FAS140 by the Financial Accounting Standards Board, as well as the inherent complexity of its application."

So the deal, for which the press release headline reads "Target Corporation Announces Agreement to Sell Interest in Credit Card Receivables to JP Morgan Chase for Initial Investment of $3.6 Billion," isn't really a sale at all. It's financing and financing that reminds me of the old Saturday Night Live skit, where "It's a desert and floor wax."

Behind all of this complexity, however, is an incredibly important issue facing financiers of consumer purchases – "What business am I really in?" Over the past several years we have seen a number of retailers jettison their captive credit card companies to lower their reported leverage and free up capital. Sears (SHLD), Macy's (M), Kohl's (KSS) and many others sold their businesses lock stock and barrel to banks – who had both lower funding costs and higher leverage. But the trade off was control – and the ability to use cheap credit as a sales incentive.

Similarly, last year, General Motors (GM) sold an interest in GMAC to Cerberus with a similar goal, but now faces even greater challenges as problems in GMAC's home mortgage business jeopardize GMAC's own market access for automobile loan funding.

Finally, earlier this week, GECC announced that it was getting out of the RV and Boat purchase financing businesses, leaving Monaco (MNC) and Coachman to go it alone.

All of this is a very longwinded way of saying that these lenders, who have historically effectively managed being a "slave of two masters" must now choose: "Am I a 'for profit' lender or am I a 'for profit' retailer of consumer goods, cars, boats, etc.?" With higher loss rates and lower retail sales volumes, the tension at managing both goals simultaneously has grown too great.

And while it may not seem obvious, I think it's important to add Fannie Mae (FNM) and Freddie Mac (FRE) to this discussion as well, because as Fannie Mae's own web site states: "We [Fannie Mae] are a shareholder-owned company with a public mission. We exist to expand affordable housing and bring global capital to local communities in order to serve the U.S. housing market." But for whose benefit?

I think the announced transaction by Target this week epitomizes the struggle and the difficulty in creating a balanced solution. However, as even Target admits, in the limited nature of the transaction (albeit five years), the kinds of "Push Me/Pull You" solutions can only be a temporary fix.

Ultimately, like GECC, these lenders will have to choose. And, as I hope you can now appreciate, the consequences across all major consumer purchase categories will be profound.
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