At a time when most credit card issuers are pulling back, Alliance Data Systems Corp. is trying to navigate the recession by expanding its private-label portfolio.

The Dallas company, the fifth-largest issuer of store cards for retailers, says it can pick up large numbers of highly creditworthy cardholders in this environment, notwithstanding the strains on consumer finances.

"We play in a certain sandbox, and that sandbox has about 300 retailers, and they tend to be a little bit on the higher end," Edward Heffernan, Alliance Data's chief executive, said in an interview this week.

Because it has a relatively small portfolio ($4.3 billion of managed receivables), and "because we only play in one part of the pool, we're not faced with the issue of stopping because we've exhausted that pool," he said. "We can expand for a long, long time."

Growth will be critical in the company's efforts to meet its targets this year. Additional accounts generate more revenue, and accounts that do go bad typically do not do so right away. So an expansion in a pool of receivables can precede an increase in unrecoverable loans while suppressing a portfolio's chargeoff rate.

Heffernan said in an investor presentation last month that credit loss rates could "skyrocket" for competitors.

But for Alliance Data, "the difference is, the bank card industry is shrinking," he said. "We are growing, not because we changed credit [standards], but because we signed retailers. We're going to skim the cream off the crop with those retailers."

Some analysts accept the premise, citing chastened lending terms across the industry and the withdrawal of large credit card issuers from the hunt for new business because they were burned by excessive growth during the bubble, or because they are part of conglomerates hamstrung by problems elsewhere.

"As competitors retrenched, the market is becoming more rational," said John Grund, a partner at First Annapolis Consulting Inc. who advises retailers on private-label cards. Alliance Data is "basically looking to capitalize on areas or relationships that their competitors are either underserving or exiting."

Still, the company has been dogged by doubters. Last month short interest surged to over 35% of Alliance Data's stock float — one of the highest levels for any company in the country. Robert Napoli, an analyst at Piper Jaffray Cos., said the negative bets may have reflected "the hope that credit losses are going to blow up sometime."

Napoli said he does not think that will happen. "The way they're growing, I think, is more important than the fact that they're growing. If you looked at their portfolio on a same-customer basis, they're definitely shrinking" — old cardholders' balances have declined. "But because they don't have any competition, they've been able to sign up new customers or have bought a few portfolios."

Last year operating income at Alliance Data's credit card lending unit fell 28.7%, to $240.9 million. Heffernan, who became the CEO last month after almost eight years as the chief financial officer, said profits from the card business will probably slip this year, but not by much. He cited increased charges on borrowers who fall behind, lower funding costs — resulting partly from the government's Term Asset-Backed Securities Loan Facility — and more lending.

"We're seeing those positives come in, but they're not quite at the point of offsetting the higher credit losses," he said in the interview. "You're beginning to build up some steam as a mitigant to higher credit losses, and it's just a question of when we hit the point during the year where we finally fully offset it."

Alliance Data's February managed chargeoff rate fell 40 basis points from January, to 8.5%. At press time the company had not reported March data.

Growth in its credit card portfolio as measured by average receivables stalled last year, in part because of the loss of Charming Shoppes Inc.'s Lane Bryant business in late 2007.

In December, Alliance Data bought $138.9 million of receivables as a part of a deal to take over the credit card program at HSN Inc. Those accounts contributed to a 9.7% increase in Alliance Data's managed portfolio from a year earlier, to $4.3 billion in February. (Its biggest retail client is Limited Brands Inc.)

Alliance Data says its focus is on initiating programs, though it plans to buy two or three portfolios each of the next two or three years. It has said the HSN portfolio is about the size it is looking for.

"We're not big on buying files, but there are files out there," Heffernan said during the investor presentation.

"There are no bidders. We're it, and with Talf, we have the liquidity."

Alliance Data issued $560 million of Talf-eligible card securities to investors this week. It plans to place a total of $2 billion through the government program this year.

"We are going to bulk up private label and let them roll," Heffernan said last month. "Why bulk it up if they're going to have [credit] losses? I make 1,300 basis points on assets. Unless you think unemployment's going to 22%, I should be buying. So we're going to take advantage of this weakness in private label, bulk it up, set it off to the side, and then when this thing passes, they're just going to have one heck of a fun run."

As of the market's close Wednesday, Alliance Data stock had rebounded 79.6% since the investor presentation, when the company once again reiterated its projection of 17% to 18% growth in cash earnings per share this year.

The company is scheduled to report its first-quarter results on April 22.

Analysts like Napoli said they expect to see a further rise in Alliance Data's chargeoff rate, which increased 2.5 percentage points last year, to 7.3%. Nevertheless, "their credit losses can go up a lot more" without stopping the company from meeting its projections, Napoli said.

Robert Dodd, an analyst at Regions Financial Corp.'s Morgan Keegan & Co. Inc., said the trends in loss rates are not as alarming as some have feared. He projects that chargeoffs will peak in the double digits in the first quarter of next year, but there's "nothing I've seen so far that makes me worried that, instead of going to 10%, 11%, you're going to 14%, 15% or anything like that."

In the investor presentation, Heffernan said an increase of 1 percentage point in his company's chargeoff rate would translate to a $40 million hit, or about 8% of projected cash earnings per share — a problem he said it could solve with a "tweak" to its share-repurchase program.

He acknowledged in the interview, "When times like this hit … for sure we're going to get whacked by the macro trends in that private-label business."

Alliance Data's chargeoff rate is "going to drift up probably another 50 basis points or so this year," he said. "But we're not seeing the spiking that we saw last year." And competitors whose portfolios contract are "going to have more of a challenge to control that loss rate, because it's just a percentage."

When asked if growth would allow risks to build in an environment of rising unemployment — creating more exposure if his company had to pull back because chargeoffs accelerated more than it anticipated — Heffernan said, "If growth stops or reverses itself, we have a problem, no question about it."

However, the company is not "picking up a bunch of portfolios so we're growing 30% a year," he said. "We don't want to do that. What we want to do is grow primarily through signing of new retailers and starting programs from scratch."

For mature portfolios, about a third of a retailer's sales go through Alliance Data's cards, but it takes about three years to "ramp up" to that point, Heffernan said. "Even if that retailer is doing lousy, we're still going to have very strong growth, because we're ramping up our wallet share. If that happens, then you've got basically three separate years of vintages that are growing, no matter what, and you avoid that big drop-off that could occur."

The difference between Alliance Data and its largest competitors in the private-label business — Citigroup Inc., HSBC Holdings PLC and General Electric Co. — is that they are "by very definition" a "bank or finance company," he said. "The services you provide are financial in nature, and that means you want a balance."

But for Alliance Data, which gets about half of its revenue from noncard businesses like direct marketing, "what we're in business for is not to provide credit; it's to collect information," Heffernan said. "So we'll give up the big balances in return for someone who visits a Pottery Barn or a Crate and Barrel or a Restoration Hardware — someone like that — 20 times a year."

This year Citi put its private-label card business into Citi Holdings, a repository created for noncore assets the New York company is seeking to sell or wind down, including $301 billion of loans, securities and unfunded commitments subject to a loss-sharing agreement with the government. At the end of last year, Citi's "retail partners" portfolio of $56 billion represented 37% of its managed card receivables.

GE said in December 2007 that it was looking for a buyer for its private-label card business. But in September the conglomerate said it planned to hold on to the unit, because of the poor environment for such a sale.

In a presentation last month, GE said delinquencies in its portfolio had started to lag unemployment in the middle of last year, because of actions it started taking in early 2007 to tighten credit, though collections of overdue amounts had become progressively difficult. Citing small account balances, which limit credit risk, and higher borrower pricing relative to general-purpose bank cards, Mark Begor, the leader of GE's credit card operation, said, "You can see why we like this business."

GE said balances on its private-label cards averaged $620 last year.

At Alliance Data, the average amount borrowed on cards with outstanding balances increased 9.4% last year, to $394.

Grund said other lenders besides Alliance Data could benefit during the pullback.

JPMorgan Chase & Co. "could buy any portfolio," and new entrants that "have been strong co-branders" could dive into private label, he said. "You've got to tread very carefully," because of instability in the retail sector and the recession, "but there are opportunities."

Heffernan said Alliance Data has kept its cutoff FICO score for new accounts about the same — they average around 720 — but fewer applicants qualify because credit scores have dropped as a result of the recession.

Industry advisers said the reduced competition has also given Alliance Data more power in negotiating prices and other terms with partners in private-label programs.

In its March presentation, GE said it had been able to extract substantial concessions on rebates and discount rate arrangements with retailers to compensate for weakened consumers.

In a February conference call, Heffernan said Alliance Data would handle a smaller share of HSN's revenue than it does with some other clients, "primarily because the credit quality across the HSN base is quite diverse" and includes some weaker credits. "We do not target subprime."

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