Citi Pays a Price for 11 Million Costco Customers

Citigroup wanted to scoop up a bunch of new credit card customers this past quarter — and where better to buy in bulk than Costco?

The bank has replaced American Express as the backer of Costco's cobranded cards, taking over the partnership after 16 years and, in the process, netting 11 million new credit card customers. But Citi has paid for the privilege with a steep year-over-year decline in net income, especially in its consumer banking business. Global consumer banking reported net income of $1.3 billion for the second quarter of this year, down 18% from a year earlier.

Overall net income dropped from $4.85 billion to $4 billion, surprising analysts who had anticipated an even worse result of about $3.5 billion. A decline in revenue was partially offset by lower-than-expected operating expenses, which were $10.4 billion for the quarter, down 5% from the same period last year.

Citi has managed for some time now to goose revenue by cutting costs, selling off bad assets and finding efficiencies, but it may be more difficult to shrink expenses in the future. Most of the low-hanging fruit has already been picked, said Marty Mosby, an analyst at Vining Sparks. What the bank needs now is to add revenue.

"Costco is an initiative that can start to begin that process," Mosby said, adding that he expects revenue from the portfolio to balance out the initial acquisition expense by the end of the year. After that, it will begin to help Citi's bottom line.

"We're definitely in growth mode when it comes to our branded-cards book," said John Gerspach, Citi's chief financial officer. "We're going to get a tremendous pickup from Costco."

But the process of onboarding millions of Costco customers has been anything but smooth. In June, Citi was deluged with calls about card activation, statements and payments, and hundreds of customer complaints surfaced on social media.

"We're working through that, we're gaining on it, we're very focused on it, we've got a lot of resources deployed against it," Citi's chief executive, Michael Corbat, said during a conference call with analysts on Friday. "And we think it's something we can fix in short order."

Despite the bumpy transition, Citi has already managed to add 330,000 new customers since taking over the portfolio, in addition to the customers it had inherited, Gerspach said. Still, he was at pains to remind analysts of the difficulties inherent in issuing new cards and integrating millions of customers into Citi's system.

"If it's not the largest, it's got to be one of the largest portfolio transfers on a single day that's ever been attempted," he said. "And that's not to give us excuses. We should be performing better than we are. We're working on that. But again, it's a massive program."

It may prove to be worth the headaches. "Credit card is a core business for [Citi]. The relationships they're getting out of Costco are good customer relationships they can nurture," Mosby saud. "It's less risky than being in Asian emerging markets, let's put it that way."

Over the past several months, as it continues to streamline its business, Citi has been selling off operations in nearly a dozen Central and South American countries as well as pulling back from Japan and South Korea.

The mantra among Citi executives continues to be "simpler, smaller, safer and stronger" — a vision for restructuring the bank of which one manifestation is the continued winding down of Citi Holdings. Its total assets contracted by 47% from mid-2015 to mid-2016.

Despite being a vehicle for unwanted assets, Citi Holdings is no longer the drag on the business it once was. It has strung together eight profitable quarters in a row, while shrinking from 30% of Citi's balance sheet in 2009 to a mere 4% of the company's total assets today. It has been going down at "a nice pace," Mosby said.

The portfolio is now so small, in fact, that Citi plans to stop breaking out its results in quarterly reports later this year.