Capital One’s Sale of $7B Portfolio to Citigroup Surprises ‘Experts’

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This morning, Capital One Financial Corp. (NYSE:COF) agreed to sell Citigroup Inc. (NYSE:C) its $7bn Best Buy Co., Inc. (NYSE:BBY)’s private label portfolio at approximately book value (transaction expected to close in 3Q13). The portfolio was originally part of the HSBC Holdings plc (ADR) (LON:HBS) (NYSE:HBC) deal completed in May 2012 (Capital One had agreed to pay an 8.75% premium for the HSBC receivables).

Capital One's Sale of $7B Portfolio to Citigroup Surprises 'Experts'

At the time the ING Groep N.V. (ADR) (NYSE:ING) and HSBC deals were announced, management made a compelling case for the rationale underlying these deals. Today’s announcement lends further support to the view that these deals have not turned out to be as attractive as management initially hoped. Capital One acquired $84bn in deposits (via ING deal) to fund the acquisition of ~$30bn HSBC (at announcement), which now stands near $20bn.

Analysts at Nomura are disappointed with Capital One’s loss of yet another private label relationship (this time a sizeable one) out of the original 21 retail partnerships that it acquired. It is unclear to us what the motivation for the sale was, but Nomura suspects that (similar to other portfolio switches) Best Buy Co., Inc. (NYSE:BBY) was not satisfied with the relationship.

While this move was not expected by Wells Fargo analysts given the recently acquired portfolio from HSBC Holdings plc (ADR) (NYSE:HBC) (LON:HBS), Wells Fargo believes that Capital One Financial Corp. (NYSE:COF) maintains strong and disciplined underwriting standards in its private label portfolio which could have accounted for the sale of the Best Buy portfolio. While there could be further sales, they believe that this was more of a one off sale.

In a different report issued today, analysts at Nomura note that Capital One experienced the highest level of credit deterioration among credit card issuers in 2012, with its DQ and NCO rates increasing (+10 bps and +20 bps, respectively) as the rest of the industry continued to see credit improve.

COF also has the highest absolute level of DQ rates and the second highest level of NCO rates among the major issuers.

While negative mix shifts associated with the HSBC Holdings plc (ADR) (NYSE:HBC) acquisition are at least partly responsible for its underperformance, Capital One Financial Corp. (NYSE:COF) is experiencing core credit deterioration (42 bps of the 131 bps increase in Capital One’s NCO rate at 4Q12 reflected fundamentally weaker credit). Nomura expects to see continued credit underperformance (and the corresponding revenue suppression) from COF as we move forward through 2013, with its NCO rate rising by 25 bps vs. only 11 bps for DFS and 10 bps for AXP, according to Nomura analysts.

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