Why The Market Isn't Giving Citigroup Credit For Its Q3 Beat

Citigroup Inc C shares settled Thursday's session down 3.43 percent at $72.37 despite reporting forecast-beating third quarter results.

The negative market reaction only to find that it was due to issues with its card business, Wells Fargo analyst Mike Mayo said in a note. 

The research firm has an Overweight and $90 price target for Citigroup shares. 

Dissecting The Card Issues

The stock price decline was likely tied to issues with private label cards, which were marred by a higher loan loss guidance, Mayo said. Citi-branded cards had a less-than-expected yield pick-up and a 1 percent year-over-year drop in revenues, dragged in part by pay-downs and competition, according to Wells Fargo.

While the revelations came close to Citi's investor day, the numbers aren't large enough to warrant an estimate revision, according to Wells Fargo: The private label portfolio accounts for only 2.5 percent of firm assets, and better efficiency helps to mitigate the impact.

Pain For One, Gain For Another

Wells Fargo pointed to the read-through from specialty finance analyst Don Fandetti, who suggested the card issue is negative for Synchrony Financial SYF due to higher credit losses in Citi's private label business.

American Express Company AXP stands to benefit due to less competition for affluent customers, as Citi shifted acquisition toward value/revolvers from reward-driven transactions, Mayo said. 

Brand-New Info

Wells Fargo also gleaned the following from Citi's third-quarter results:

• A $500 billion reserve build, with $150 million for volume, $50 million due to hurricanes and $300 million related to higher loss expectations in 2018.
• A higher credit loss guidance for the period from 2017 to 2018 in Citi-branded and retail services. 
• An unlikelihood of yields in Citi-branded cards improving due to promotional rates.

It's Not As Bad As It Seems 

Recent repricing lead to better sequential yields, revenues and net credit margin, according to Wells Fargo. The firm projects that benefits from efficiency will offset higher credit losses.

Wells Fargo's model assumes a normalization of U.S. credit losses, Mayo said. Credit cards comprise one-fifth of firm-wide earnings and loans and 7 percent of Citi's balance sheet. Most of Citi's card balances are in the U.S., according to Wells Fargo, with the proportion being $86 billion in branded cards and $46 billion in private label cards.

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