Friedman's Inc. - Credit Operations Before 2004

Credit Operations Before 2004

There were dire consequences for the company and its credit portfolio as a result of their credit practices.

With sales operations in charge of their own credit lending, a “fox guarding the hen house” atmosphere was created, which resulted in undisciplined, inconsistent, and damaging business practices. Loans were made to borrowers based on unsophisticated, simplistic scoring models, and many decisions were derived from emotion and a sales team’s immediate need for results instead of a customer’s credit worthiness. Store managers dealt with influences such as sales quotas, pressure from superiors, and the customer’s presence in the store expecting to be approved for a credit line. From time to time, regional supervisors and group vice presidents would also issue credit approvals.

What made this process even more volatile was the fact that none of the sales operations personnel had any type of formal training in credit evaluation or analysis by Friedman’s, nor was such knowledge of credit made a prerequisite in order to hold a sales associtate, or even a management position.

Most loans made at Friedman’s locations were considered to be in the subprime category by many creditors’ definition. This further complicated Friedman’s efforts to maintain a good portfolio as subprime borrowers (many with no credit history at all) in general were either not credit savvy, or lacked the ability or willingness to pay their bills on time, and in some cases, at all. Compounding these issues was the fact that many of these customers were allowed to continually make additional purchases on their accounts, thereby increasing the risk exposure to the company.

Due to an extremely poor anti-fraud system, credit fraud, committed by both customers and store personnel, was rampant. In many cases, delinquent customers were allowed by store personnel to make additional purchases on their accounts. This, along with a myriad of other credit policy violations occurred frequently.

Optically, Friedman’s attempted to make their portfolio look in better condition than it was by reporting recency instead of currency. While currency would report accounts in a portfolio less than 30 days contractually current, recency reported accounts that had made at least one full payment within a 90 day time period as contractually current. Subsequently, this practice prevented accounts from being charged off that were severely contractually past due. For example, an account opened in December of 2001, and scheduled to pay 12 payments, would only have to pay four in the months of March, June, September, and December of 2002 to be considered recent by January of 2003.

Along with a decentralized credit issuance policy, Friedman’s also attempted to maintain a decentralized collection approach. This was, however, a handicapped attempt at best as very few Friedman’s locations had dedicated collectors and collections were expected to be made by store managers and other store personnel. Obviously, as with the case of credit granting, sales were given top priority by managers and sales people alike, while credit and collections took a noticeable back seat.

Although Friedman’s did have a Vice President of Credit, it was largely viewed as an obligatory role, having no authority over underwriting or collections. Being in charge of Friedman’s credit largely dealt with administrative responsibilities, and had little influence over anything substantive. Any suggestion made by the VP of Credit that hinted of improving underwriting standards at the expense of sales was met with companywide protests from the sales team, as well as opposition, and at times, open hostility from executive management. Enforcement of credit policies was also not in the hands of the VP of Credit. That was left up to sales operations, and resulting disciplinary action was rare.

In the face of mounting delinquencies and increasing potential charge offs, Friedman’s would heavily pressure its sales operations to improve collection results, going so far as to threaten certain incentive pay checks if specific goals were not met. However, there was also a constant pressure to obtain comparable store sales increases. Thus, a vicious circle was created for sales operations to make sales goals by doing ill advised credit deals, and then try to dig themselves out of the delinquency mess those same deals created.

Ultimately, Friedman’s downfall rested upon their continual misstating of quarterly and yearly earnings whose bottom lines were heavily influenced by the amount of dollars the credit portfolio charged off. Friedman’s executives routinely engaged in the practice of holding accounts that had no chance of paying from being charged off when they should have been, thereby lessening a negative impact to the bottom line. In some cases, accounts could go almost a year without making a payment of any amount, and still not be charged off of the company’s portfolio.

The health of the credit portfolio was misrepresented numerous times by CEO Brad Stinn and CFO Vic Suglia on shareholder conference calls and U.S. Securities and Exchange Commission (SEC) filings.

In the end, Friedman's became a company that did not rely on (or even develop) its abilities in marketing, merchandising, and selling jewelry. Instead, its survival became overly dependent on abusing what should have been only a tool to procure sales: in-house credit.