After Thursday's events,

Sears

(S) - Get Report

investors must be feeling more anxious than ever.

Thursday morning brought word of an

earnings-crushing credit charge, which set off a stunning 32% plunge in the stock. On a subsequent conference call, a senior Sears executive hotly disputed this column's skeptical take on Sears' lending operations. But the company's view notwithstanding, its stock isn't likely to recover until Sears grows more forthcoming with information about its massive and troubled credit card arm.

Sears' decision to substantially increase its credit loss reserve was toxic for the stock because it indicates the company expects more borrowers to have trouble paying back their loans. A sizable but undisclosed number of these borrowers are categorized as subprime, which means they have a history of default or being past due on loans.

A whopping $603 million addition to the bad-loan reserve caused third-quarter earnings to come in well below expectations, at 59 cents per share. The company said it didn't expect to fulfill its full-year target for 2002 profits, which it affirmed only last week.

Confidence Crisis

Investor alarm over developments at Sears' credit division, which has written around $30 billion of consumer loans on store cards and MasterCards, were heightened by the departure earlier this month of its top executive, Kevin Keleghan.

Soft Lines
Sears on the slide

Soon after Keleghan left, Sears CEO Alan Lacy said he had asked Keleghan to leave because he had "lost confidence in his personal credibility," adding that business performance had not played a role in the decision to let Keleghan go. But on Thursday, Lacy said that Keleghan and another executive had failed to give him a clear picture of what was going on in the credit business, which accounts for more than 60% of the retailer's profits and finances some 40% of its sales.

The new head of Sears' credit division, Paul Liska, strongly objected to two issues raised by an

Oct. 9 Detox column, which he indicated he had read.

One question asked in the column was whether a large amount of loans with zero or extremely low credit limits were in fact troubled loans that weren't included in the past-due loan total because Sears was helping the borrowers through tough times by allowing them to defer repayments. "That could not be further from the truth," said Liska.

Tables regularly published in documents filed by the trust that sells Sears loans show that 19.8% of Sears accounts in the trust had a sub-$100 credit limit at the end of last year, the latest date available. "Over 90% of balances showing up as zero in there are closed accounts," Liska said.

But it is not clear whether some of these accounts are closed because they belong to borrowers whose loans are being worked out, or "re-aged," to use the industry term. Liska said Thursday that some Sears loans are re-aged, but didn't give a specific number. A person familiar with the company's loan portfolio said more than $1 billion of loans are undergoing some sort of re-aging.

Sears didn't immediately return a call seeking comment.

At

Target

(TGT) - Get Report

, by contrast, about 10% of its loans have super-low limits.

Long Way Home

Also a source of concern is the fact that Sears takes a lot longer than its peers to write off bad loans, doing it at 240 days of nonpayment rather than the industry norm of 180 days. Skeptics argue that this could delay loss recognition and allow Sears to delay adding to its bad-loan provision. And they add that if Sears' credit business were overseen by bank regulators, it would have to comply with the 180-day rule.

Liska responded that Sears charges off loans at 240 days because it enables the company to collect a larger amount of the past-due balance than it would if it did so at 180 days. The executive said Sears is able to collect 30% of that balance, whereas banks using 180 days manage only 5%. He added the longer charge-off time didn't mean reserving is delayed, because Sears assesses the size of the reserve addition on how loans are performing before they reach 240 days past due.

One way Sears could get its battered stock back up is to disclose re-aging data and the composition of its low-limit loans, as well as fuller delinquency numbers, in its third-quarter

Securities and Exchange Commission

filing. Liska's rebuttals Thursday lacked precision.

For now, though, the higher credit costs that depleted third-quarter earnings should serve as enough of a warning to investors. Stay away from Sears stock, as you would from its

auto repair shops.