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TheStreet Open House

Citigroup Acquisition May Signal More to Come

-- Updated with response from Citigroup in seventh paragraph.

NEW YORK ( TheStreet) -- Citigroup's (C) acquisition of a $7 billion portfolio of Best Buy (BBY) credit card receivables from Capital One Financial (COF) may be surprising, given the bank's strategy of cutting costs and returning capital to shareholders. But acquisitions are one way the bank can boost profits to capture its massive $55 billion deferred tax asset (DTA) before it expires.

As part of the deal announced Tuesday, Citigroup will also issue and manage Best Buy-branded cards in the U.S. The price wasn't disclosed. The transaction, expected to close in the third quarter, won't materially affect 2013 earnings, Citigroup said in a press release. A spokesman for the bank declined to elaborate.

Capital One said in its press release that "the proceeds from the sale will approximate the book value of the accounts, resulting in no significant gain or loss on the transaction."

Capital One acquired the portfolio when it bought HSBC's (HBC) U.S. credit card business in a deal announced in 2011. That acquisition, as well as a deal for ING Direct last year, has created the need for Capital One to reduce leverage, according to Richard Bove, analyst at Rafferty Capital Markets.

"As I've been writing for the past two years, the capital raising at Capital One is not over with," Bove says.

From Citigroup's point of view, "I cringe at a deal like this," Bove says. He fears the bank is repeating past mistakes it made when it bought private label credit card portfolios from Home Depot (HD) and Sears Holdings (SHLD).

"They went on a tear there for a period buying these private label situations and in my view they lost a lot of money on every one of them," Bove argues, adding that "private label credit cards suck," because retailers who issue the cards are far more interested in boosting sales than worrying about the credit quality of the borrower. A Citigroup spokesman responded to Bove's remarks by pointing to a statement in the bank's press release announcing the deal in which Bill Johnson, CEO of Citi Retail Services, refers to the portfolio as "high-quality."

In a typical deal for this type of asset, Citigroup would likely earn about 2% annually, or $140 million, according to one investment banker who didn't want to be on the record because he says he has a connection to the deal and is afraid that discussing it publicly could harm business relationships.

That kind of profit wouldn't put a dent in Citigroup's $55 billion DTA. Though Citigroup has had three straight years of profits, the DTA has continued to grow. Citigroup's inability to generate enough profits costs it more than $4 billion annually, because it has $40 billion in tangible common equity sitting on its balance sheet that it isn't able to invest.

Furthermore, the equity doesn't get counted for regulatory purposes in certain cases. Much of the DTA will expire in about 10 years if Citigroup can't generate enough profits to make use of it. If regulators or the bank's auditors lose confidence in Citigroup's ability to earn enough to take advantage of the DTA, Citigroup may be forced to take a writedown.

Shareholders don't appear to favor Citigroup making acquisitions, but the idea has been discussed openly among investors and analysts who follow the stock.

"Making acquisitions of companies with pretty good streams of taxable income going forward is a tremendous way to utilize DTAs and there are very few impediments in the tax law to prevent that from happening," said Robert Willens, an independent tax consultant, on a January conference call with investors hosted by CLSA analyst Mike Mayo.

Credit Suisse polled attendees at a conference last week about what they'd like to see Citigroup do with its excess capital, and included acquisitions as a possible option. Credit Suisse analyst Moshe Orenbuch said during the conference that 60% of respondents voted for a share buyback and 30% wanted to see a dividend increase. He didn't say how many wanted to see the bank make an acquisition.

One executive close to Citigroup says he doesn't expect the bank to make any major acquisitions, but he believes relatively small deals such as this one are plausible.

-- Written by Dan Freed in New York

Disclosure: TheStreet's editorial policy prohibits staff editors, reporters and analysts from holding positions in any individual stocks.

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