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 Citigroup and Costco have not disclosed terms of the deal, and
outsiders can only speculate about the reasons Citigroup bid
aggressively enough to win the business.
But officials at two rival banks said they suspect Citigroup's tax
credits allowed it to offer Costco better terms than competitors
could. They declined to be identified because the negotiations were
confidential.
At the end of last year, Citigroup had $49.5 billion in net tax
credits, known as "deferred tax assets." They are a boon to the bank
because they can reduce - or even eliminate - its federal income tax
liability. Other banks could pay as much as 35 percent of their U.S.
income in federal tax, though many also use tax-reduction strategies
that push their rates lower.
American Express said last month that it would not renew its deal
with Costco because the retailer was demanding terms that were not
economic, an indication that the profit margins for anyone taking on
the business were likely to be razor thin.
"The deferred tax assets would be quite a dramatic advantage," said
Robert Willens, an independent accounting and taxation consultant.
Citigroup, he said, may well have won the deal by being able to
offer far better terms to Costco than banks that pay more in taxes.
Citigroup responded to questions about its tax advantage in the deal
with a written statement: "As the world's largest issuer of consumer
credit cards, Citi has unrivaled scale, expertise and capabilities
in servicing our partnerships with industry leaders. Costco brings
the opportunity for consumer spending growth – when you add Costco's
customer loyalty with increased Visa acceptance, it is a win for all
parties."
It declined to comment on whether its tax credits helped in winning
the business.
In 2014, Citigroup used about $3 billion of deferred tax assets to
reduce tax liability.
To competitors, the bank's tax credits are an irritant. A big chunk
of the bank's deferred tax assets stem from the billions of dollars
of losses it generated during the financial crisis. Citigroup was
rescued three times by the U.S. government between 2008 and 2009,
and one of the rescues threatened to wipe out some of the bank's
deferred tax assets. However, the Treasury and the Internal Revenue
Service - which were concerned about the stability of the banking
system - relaxed the rules governing such assets to help Citigroup
and other banks during the crisis.
The government's tax rules were relaxed again for Citigroup when the
United States looked to sell its roughly one-third stake of the
company after the crisis, Willens said.
In both cases, the bank came close to triggering a 1986 tax rule
designed to prevent healthy corporations from avoiding taxes by
buying weak companies with large deferred tax assets.
"In an odd kind of way, the U.S. government essentially put
Citigroup in a more competitive position” to bid for business like
the Costco deal, said Charles Peabody, a veteran bank analyst at
Portales Partners, a broker focused on research.
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The Costco transaction is not without risks for Citigroup,
especially in the event of an economic downturn that would cause
more cardholders to default on payments. But such deals typically
last for five to seven years, so Citigroup will have an out down the
road.
Citigroup could continue to benefit from its deferred tax assets in
bidding for assets in the future, Willens said, and the bank has
done so in the past. In 2013, the bank bought a portfolio of about
$7 billion of credit card loans to customers of Best Buy Inc.
Banks, like all U.S. companies, keep two sets of books, one for
financial markets and a second for the Internal Revenue Service.
Many of the losses on loans and securities that Citigroup recognized
during the financial crisis were reported on the bank's books for
investors, but cannot be reported for tax purposes until the loss
actually happens. When the loss happens and the bank has enough
taxable income, Citigroup gets a tax credit, but until then, the
bank keeps a deferred tax asset on its books, to recognize the
future benefit.
The bank's $50 billion of tax credits expire over several decades
starting in 2017.
Based on how credit card deals are typically negotiated, Citigroup
would have factored a number of considerations into its bid for the
Costco portfolio: how generous to make rewards programs for the
store's customers, how much of a break it would give the retailer on
transaction processing costs and how much revenue it would share
with the company from fees for processing transactions when Costco
cardholders use their cards outside of the store.
Banks have been competing intensely for the right to issue cards
with retailers, airlines and hotel companies. In the next year or so
American Airlines is expected to review its current deal with
Citigroup, which issues cards carrying both the bank and the
airline's brand.
(Reporting by David Henry in New York; Editing by Dan Wilchins,
Martin Howell and Sue Horton)
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