Since 2018, Signet Jewelers (SIG), a diamond jewelry retailer, has sold a portion of its subprime receivables to investors. Under the agreements, the company takes a significant haircut to instantly turn the receivables into cash:

“...the Company completed the sale of the non-prime in-house accounts receivable at a price expressed as 72% of the par value of the accounts receivable. The purchase price was settled with 95% received as cash upon closing. ”

The remaining 5% is deferred until June 2020. Final payment of the deferred purchase price is contingent upon the non-prime in-house finance receivable portfolio achieving a pre-defined yield. In its latest 10-K, Signet disclosed the remaining 5% will not be paid unto June 2021 as part of a new agreement with investors:

“During the fourth quarter of Fiscal 2021, the Company reached additional agreements with the Investors (as described in Note 13) to further amend the purchase agreements described above. CarVal will continue to purchase add-on receivables for existing accounts and will purchase 50% of new forward flow non-prime receivables through June 30, 2021. Genesis will purchase the remaining 50% of new forward flow non-prime receivables through June 30, 2021. Castlelake will not purchase any new forward flow non-prime receivables but will continue to purchase add-on receivables for existing accounts through June 30, 2021. Signet will continue to retain add-ons receivables for existing accounts.”
With plans to offload 100% of its new subprime receivables through mid-year, Signet has created an incentive to sell more jewelry to subprime customers. The only thing preventing Signet from doing more subprime business is the 500 basis points it’ll lose if the loans don’t meet yield requirements.

There is no sign yet that Signet is significantly loosening its credit standards. The allowance for credit losses related to the non-prime receivables currently on Signet’s balance sheet is 26% of non-prime receivables. This is comparable to the 28% discount at which Signet is selling its subprime receivables.

Note: The 28% discount assumes Signet receives the remaining 5% at the end of the agreement.

However, the credit loss allowance—subprime receivables ratio won’t be a good indicator in the future for investors trying to determine if a subprime fueled spike in sales is in the cards since Signet will retain only add-on subprime receivables from existing customers. Though any increase in the credit loss allowance might tell investors about the overall health of subprime diamond buyers, investors are likely better off tracking the ratio of receivables sold to total receivables.

Historically, approximately 7% of Signet’s receivables were non-prime. If the percentage of receivables the company sells rises significantly above this level, investors will know Signet is bottom fishing to boost sales. While this may bode well for Signet shareholders, the same may not be true for the institutional investors that provided capital to the buyers Signet;s subprime receivables.