Costco may be a discount retailer, but the acquisition of its credit card portfolio looks set in the coming months to help Citigroup erase a discount of another sort: the stubbornly low price at which its stock trades relative to its tangible book value.
Thanks to the Costco deal, third-quarter revenue from Citi-branded cards climbed 15% to $2.2 billion in North America over the same period last year. While Citi doesn't expect the acquisition, completed in mid-June, to be truly accretive until 2017, Chief Financial Officer John Gerspach called the early signs "very encouraging."
That looks like an understatement in light of the fact that when not counting Costco, revenue for Citi cards increased by only 1%. Indeed, while the Costco portfolio amounted to $10.6 billion four months ago, when Citi took it over from American Express, now it is worth in excess of $14 billion.
But the encouraging signs go well beyond Citi's cards business. The once-beleaguered megabank posted double-digit growth in both loans and checking-account deposits despite continuing to shrink its retail network.
Total trading revenue increased 16% to $4.13 billion, growth largely driven by a 35% spike in fixed-income trading and trouncing Chief Executive Michael Corbat's early predictions of growth in the "mid-single digits."
And while both total revenue and net income were down, Citi's profits beat analysts' expectations — something they have done every quarter this year.
"You're really starting to feel an inflection point approaching," said Marty Mosby, an analyst at Vining Sparks. "If you look at quarter-to-quarter, you have a net positive between revenue and expenses, where if you went back a year ago you were at a significant negative drag between revenue going down and expenses going up."
Mosby now expects Citi's stock price to fall back in line with its tangible book value in 2017. Citi's tangible book value is $64.71 per share, but on Friday afternoon the megabank's stock was trading at only $48.83.
Overall net income dropped 11% from the third quarter of 2015, from $4.29 billion to $3.84 billion. Revenue declined 5% to $17.8 billion — beating analysts' predictions of $17.3 billion — mostly due to the continued wind-down of Citi Holdings, the business unit consisting of Citi's unwanted assets.
Just as Citi's deal with Costco caused a steep year-over-year decline in net income last quarter, so this quarter the cost could be felt in the bank's provision for loan losses. It set aside $1.75 billion, an increase of 26% over last quarter and of 10% over the same period last year. A portion of the increase — between $150 million and $200 million — was directly related to Costco.
But the additional reserves are not to be deplored, said Mosby.
"What's encouraging is that upfront you incur that allowance build, you incur some investment for the transition, and then once you get past that, what we're seeing — and what's most important — is that revenues come in stronger and growth accelerates off the things they're able to accomplish with Costco on board," he said.
The bank's reserves have allowed it to open the floodgates to a surge of new customers. Since becoming the backer of Costco's co-branded cards — netting 11 million cardmembers in the process — Citi has clocked nearly 800,000 new sign-ups for the joint product.
"New account acquisitions have far exceeded our expectations," Gerspach said on a conference call Friday.
The bank's leaders cautioned that pent-up demand for Costco cards, which were not being issued during the transition period, was largely responsible for the surge, and that it might not be sustainable.
Even so, Mosby said the growth means that Citi is likely to break even sooner on the Costco deal, perhaps as early as the second quarter of next year.
"I have to admit, we've been favorably, nicely surprised by the way that the Costco portfolio has grown," Gerspach told analysts on the call. "The portfolio performance so far, the relationship with Costco, the overall relationship is just exceeding our expectations."
The multinational bank continues to reduce its footprint in foreign countries as it refocuses on core markets. Earlier this month, Citi sold retail units in Brazil and Argentina, continuing a trend that last quarter saw the bank divest itself of operations in nearly a dozen Central and South American countries.
Citi Holdings, the weak sister of Citicorp, faded further while managing to post its ninth profitable quarter in a row, with net income of $74 million. The division, once known as the company's "bad bank" because of its toxic assets, now holds $61 billion in assets — a reduction of 48% since the third quarter of last year and 8% since last quarter.
Citi Holdings contributed scarcely more than 2% of Citi's total net income this quarter, and the bank has already signed agreements to sell off another $10 billion of the division's assets. Soon it will be only a memory.
Said Mosby, "We're not going to be talking about it next year."