Home Depot, Citigroup reach credit deal

ATLANTA — Home Depot, which has one of the largest consumer credit card portfolios in the country, has signed a new deal with its outside credit vendor, Citigroup Inc., the world's largest card issuer.

The deal may seem like inside baseball. But it's a big deal for the country's second-largest retailer, as the cost of maintaining the portfolio under the old agreement was depressing earnings.

The new deal with New York-based Citi pleased Wall Street analysts and company executives because it stabilizes and lowers Atlanta-based Home Depot's fixed costs related to its private-label credit card and Home Depot-branded MasterCard.

In addition to a $220 million payment from Citi covering the life of the deal, Home Depot could save several hundred million dollars a year on credit costs. And the deal minimizes reliance on profit-sharing at a time when some consumers are having financial difficulties and credit guidelines are stricter. There still is some profit-sharing in the deal, but only after a certain threshold is met for Citi.

The eight-year contract with Citi was announced Aug. 19 during Home Depot's second-quarter earnings call and will take effect in 2009.

In an interview with the Atlanta Journal-Constitution, Home Depot's chief financial officer, Carol Tomé, called it a "mammoth deal to get done."

"We've been working on this for a while," said Tomé, who explained that Home Depot, as a retailer, needed to get out of the credit business.

Tomé said that when the economy was strong, the cost of the portfolio was low. But when the economy worsened, costs rose. "We wanted something more predictable," she said.

Tomé said Home Depot has "millions of outstanding accounts." New account openings have been down, along with the number of transactions.

But the approval rate for opening new accounts at Home Depot, she said, is "one of the highest," at 68 percent.

Citi has been Home Depot's credit card provider for five years. General Electric had the portfolio before that.

"This extension between the world's largest home improvement retailer and the world's largest provider of credit cards creates significant new opportunities for growth," said Citi spokesman Samuel Wang. Wang said Citi has credit card deals with more than 30 major brands, including American Airlines, Macy's and Sears.

Tomé was particularly pleased the new deal was inked early. Citi's original contract expired in 2011. The new contract will expire in 2017.

Over the last two quarters, Home Depot has been offering fewer credit card promotions as another way to make the portfolio more profitable, the company said. On the private-label credit card, the company often will offer six months with no interest and no payments. The company now rarely uses the 12-month offer, to make the portfolio more profitable based on interest rates.

Home Depot's new contract with Citi includes several components, including the private-label credit card and the Home Depot MasterCard.

Aside from Tomé comments and broad details during the earnings call with analysts, the company would not discuss specifics of the Citi deal.

But a person familiar with the deal who spoke on condition of anonymity said the $220 million payment is mostly related to the Home Depot MasterCard, which is a points-based, no-fee loyalty credit card that can be used any where MasterCard is accepted. The $220 million payment is largely for Citi's access to Home Depot's deep customer base for promoting the MasterCard product. Home Depot will receive the $220 million payment on Jan. 2, and it will be counted as income.

According to an analysis by Lehman Brothers, Home Depot could save more than $200 million a year in the cost of credit, and those savings could go to shareholders. Lehman Brothers estimates that earnings per share could improve by 8 to 25 cents in fiscal 2009 because of the new Citi deal.

Here's how the firm broke it down: Home Depot's future cost of credit as a percentage of private-label credit sales over the new term will be about 1 percent, not to exceed 1.5 percent. Under the old deal, the cost of credit could range from 2 percent to 4 percent.

About 30 percent of Home Depot's sales are on the company's private-label credit card, the retailer has said.

So, of $77.4. billion in sales in 2007, about $23 billion was rung up on the Citi/Home Depot credit cards. Two percent of that is $464 million. The new agreement will cut that cost almost in half, to $232 million, and in no case will the cost of credit be more than $345 million, based on 2007 sales figures.

"We think the company is improving its position for an eventual market rebound," wrote Lehman Brothers' Michael Lasser in a report. "Next year, the company's earnings power should benefit from reduced credit costs."

In 2007, Home Depot had net earnings of $4.4 billion, or $2.37 a share.

For Stephanie Hoff, a senior retail analyst for investment banking firm Edward Jones in St. Louis, the Citi deal was one of the bright spots that she listed for the company.

Other firms also liked the deal: Deutsch Bank called the Citi agreement "a positive." Merrill Lynch said it will "benefit the company longer-term." And JP Morgan said that Home Depot's share in the credit portfolio performance had been "dragging down operating profit."

Rachel Tobin Ramos writes for The Atlanta Journal-Constitution.