Citigroup Inc.; Market Cap (as of 06/03/2015): $160.98bn

Springleaf Holdings Inc.; Market Cap (as of 06/03/2015): $5.58bn

Introduction

On March 3, 2014, Springleaf Holdings, Inc. (NYSE:LEAF), a leading personal finance company focused on consumer lending, credit insurance and other credit relating products, entered into a definitive agreement with Citigroup Inc. (NYSE:C) to purchase its wholly-owned subsidiary OneMain Financial, provider of subprime loans, in a $4.3bn all-cash transaction. The combined entity creates the largest subprime lender in United States, with 1,967 branches across 43 states and $14bn in net finance receivables. The deal, which is estimated to generate approximately $470m in 2017, is immediately accretive to Springleaf’s 2015 after-tax earnings, excluding one-time items related to the transaction. In addition, the combined company will maintain both brands until mid-2016 and is expected to continue its operations under One Main brand afterwards. Due to the branch networks of the two companies being highly complementary, Springleaf expects to consolidate approximately 200 branches beginning in mid-2016.

As mentioned in our previous article, OneMain Financial is one of the largest providers of installment loans in the US, handing out personal loans to people with below-average credit ratings for amounts between $3,000 and $15,000. The company, which has suffered major losses during the financial crisis, it has been profitable since 2012: earning $407m in 2012, and $536m in 2013 – making it one of the most profitable business units at Citigroup post-crisis. Indeed, in 2013 alone, the subprime unit realized a return on assets of 5.4% and return on equity of 19.9%. For 2014 H1, the unit had net income of $287m, representing an annualized return on assets of 6.0% and a return on equity of 19.1%.

The rationale

The deal is in line with Citigroup’s strategy of focusing on core business and targeting wealthier customers, as well as cutting off several of its non-core subsidiaries with the aim of making the business leaner. Indeed, the sale of OneMain Financial will reduce the total assets under Citi Holdings by roughly $9bn, thus marking an important step towards the eventual divestment of all of Citigroup’s non-core operations.

2008: Good Bank – Bad Bank

At the end of 2008, when it seemed like at any moment “Uncle Sam” would step in and nationalize the group, the ailing institution decided to restructure itself into two separate units: the “good bank”, Citigroup, and the “bad bank”, Citiholdings, in which were segregated roughly $850bn of non-core assets in order to better managing the recovery process under strict regulatory pressure. As a result, in recent years, through a strategy aimed at disinvesting non-core businesses, Citi has made CitiHoldings shrink, reducing its share on the group’s balance sheet to only 5% of its $1.8tn assets (down from 35% in 2008).

2009: Smith Barney and Asian Operations

In 2009, just after the split between Citi and CitiHoldings took effect, asset sales began at a frenetic pace. Indeed, that January, Citi divested part of its brokerage business, the venerable Smith Barney, to Morgan Stanley, in a joint venture that formed the world’s largest brokerage company, thus netting Citi almost $3bn in more needed cash. Subsequently, within a few months, Citi also sold its Japanese brokerage business Nikko Cordial to Sumitomo Mitsui Financial Group, the third largest bank in Japan, for nearly $8bn, receiving another $2bn in cash. Finally, the group ended its ambitious foray into Asia that was initiated by former CEO Chuck Prince when it later sold its Asian brokerage unit, Nikko Asset Management, to Sumimoto for roughly $1.3bn.

2010: Insurance and Consumer Loans

During 2010, Citi continued its disinvestment plan and reduced its assets by over $140bn — nearly 28%. Among the most publicized divestitures there was the spin-off of its insurance unit, Primerica, which combined the IPO of the company with a private sale of an additional share to the private equity fund Warburg Pincus. That divestiture reduced CitiHoldings’ assets by roughly $5bn and allowed the company to raise over $230m. Subsequently, in September of the same year, Citi sold its stake in Student Loan Corp. to Discover Financial for $600m and a $3.5bn-worth portfolio of commercial real estate debt to JPMorgan Chase. Later that fall, CitiHoldings also sold a portfolio of credit card debt issued by retailers using Citi’s balance sheet to General Electric for a total consideration of $1.6bn. This was part of a push to sell off a $50bn-worth portfolio of loans made by retail partners that had shown higher delinquency rates than its own CitiCard consumer loans.

Today: One Main and Akbank

The recent spin-off of OneMain Financial it clearly represents one of the last steps of Citi’s re-focusing strategy, which has seen a reduction of roughly $700bn of non-core assets in less than a decade. Following the mentioned strategy of disposing assets that do not fit the “Citi Model”, Citigroup announced another deal only a day later. Indeed, on March 4, 2014, the bank completed the sale of its 9.9% stake in Akbank T.A.S, the second lender by market value in Turkey. The deal was performed through an accelerated equity offering of TRY7.45 per share or $1.2bn of total value. Citigroup, which acquired a 20% stake in Akbank for $3.1bn in 2007, realised a loss of roughly $800m from this investment if we exclude dividend payments; a number clearly demonstrating why the unit was considered non-core by the bank’s management.

Is it working? Stress Test

It is perhaps no coincidence that the sale of OneMain comes about a week before the results of the Fed’s stress tests were made public.

After having its capital plans rejected by the Fed twice, in both 2014 and 2012, on March 5, 2014, Citigroup came out from the test in a better shape than many expected. Indeed, in the Adverse Scenario, Citigroup’s Tier 1 common ratio, which measures high-quality capital as a share of risk-weighted assets is 11.5% while in the Severely Adverse Scenario, which represents the estimated low point of a hypothetical recession, the ratio stands at a solid level of 8.2%, above the 5% level the Fed views as a minimum allowance. As for the Tier 1 leverage ratio, which measures high-quality capital as a share of all assets, Citigroup shows a ratio of 8.5% in the Adverse Scenario and of 4.6% in the Severely Adverse one, being both of them well above the minimum of 4.0% according to the Fed requirement.

The tests simulate a substantial weakening in global economic activity, huge declines in asset prices, and a large increase in financial market volatility. In particular, the Severely Adverse Scenario in the U.S. results in unemployment hitting 10% in mid-2016, real gross domestic product falling about 4.5% by the end of 2015 and a 25% decline in house prices. In addition, a jump in oil prices to about $110 a barrel is also incorporated.

But what could be the impact of the two mentioned divestitures on the above mentioned capital ratios? Offloading a company with $14bn of core consumer net finance receivables, for cash, frees about $1.4bn of capital, if we assume a 10% risk-weighting. Moreover, under the various stress test scenarios which are modelled by the Fed, that capital figure could even be higher, thus improving both the Tier 1 common ratio and Tier 1 leverage ratio.

Financial Advisors

Bank of America Merrill Lynch, Barclays, Credit Suisse and Goldman Sachs acted as financial advisors to Springleaf while Citi acted as financial advisor to One Main Financial. The transaction is expected to close in the third quarter of 2015, subject to the regulatory approval.

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