The iconic department store, Sears, has filed for protection under Chapter 11 of the US bankruptcy code. Retail has changed a lot in recent years. And for Sears specifically, this bankruptcy has been coming for a long time. It was signalled last week. So, it’s not a surprise to anyone.
The key, however, is that Sears is filing under Chapter 11 to restructure its debt rather than Chapter 7, which means liquidation. That doesn’t mean Sears won’t get liquidated though. And so, we should watch how this progresses to ascertain what it tells us about where we are in the business cycle.
As I put it in April regarding late-cycle rate hike regimes:
“at some point, there will be a negative impact on credit and that will feed through into the real economy.” The question is when. My assumption is that the Fed will continue to raise rates right up until the curve is almost completely flat. And at that point, it will pause. We will then see how the existing policy stance feeds through into credit markets and the real economy.
Telltale signs that tightening is having an effect will come via increased high yield default rates and company liquidations. Let’s call it “The Bonton Effect”. I think of Bonton, the Pennsylvania retailer that just declared bankruptcy, as an intrinsically healthy department store. But it is struggling with changing industry dynamics and a mountain of debt.
At one point, Bonton was considered a speculative borrower. But as rates rose, the leverage caught up to it and Bonton became a Ponzi borrower. And it defaulted. The unique thing with Bonton is that it may go into liquidation. The Columbus Dispatch says the liquidation has already begun. And that’s going to have a very negative real economy impact in Pennsylvania and the surrounding states.
In the last economic cycle, I flagged Linens ‘N Things as a similar credit because I looked at it as largely indistinguishable in terms of brand from Bed, Bath and Beyond. The biggest difference was the financial distress. The end result was liquidation and the loss of thousands of jobs. But this was later in the cycle, during a financial crisis.
In this cycle, once the Bonton Effect begins in earnest, the Fed will have to swiftly move into reverse. If it doesn’t, that’s when you really need to think about risk off strategies to protect your wealth.
We’re not there yet. But a Sears liquidation would be a bad signpost.
Last week, I was just at White Flint mall, the suburban Maryland mall of my youth, looking at the rubble remains, since its been torn down. Lord & Taylor is all that remains there. And it reminded me of how much the retail sector has changed over the past 30-od years and how Sears represents ‘old retail’.
Now, White Flint is a shopping mall in Rockville, about 10 miles from the DC line, that opened in 1977, initially anchored by Bloomingdale’s, Lord & Taylor, and the defunct I. Magnin brand. Later, after I had left DC and malls started to wobble, Borders took over I. Magnin’s location in 1992. Eventually, the mall added large restaurants like the Cheesecake Factory and PF Chang’s instead of anchor stores to attract patrons. It didn’t work. The mall closed and the site is now being touted as the future location of Amazon’s second headquarters, a fitting destination of ‘new retail’ for the old.
On Sears note the part from the New York Times that I have bolded:
In the last decade, Sears had been run by a hedge fund manager, Edward S. Lampert, who sold off many of the company’s valuable properties and brands but failed to develop a winning strategy to entice consumers who increasingly shopped online.
The result has been a long painful decline. A decade ago, the company employed 302,000. Today, there are about 68,000 people working at Sears and Kmart, which Mr. Lampert also runs.
Now, the retailer is aiming to use a Chapter 11 bankruptcy filing in federal court in New York to cut its debts and keep operating at least through the holidays.
As part of the reorganization plan, Sears has negotiated a $300 million loan from Wall Street lenders to help keep its shelves stocked and employees paid.
The company said it was still negotiating with Mr. Lampert’s hedge fund, ESL Investments, for an additional $300 million loan.
Liquidation is still a distinct possibility here. That’s 68,000 jobs on the line. And a lot of that is going to depend not just on the factors affecting Sears alone, but the credit conditions at the end of this year and early next year.
Again, a Sears liquidation would be an end-of-cycle signpost. And were it to happen, we should be prepared to see other marginal debtors face the same fate in 2019. The sectors to think about in that context are retail, commercial real estate, and financial services.
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