Citigroup's bad bank is starting to make good.
Citi Holdings, a unit formed six years ago to house Citigroup's bad assets and unwanted business lines, has gone from a dead weight to a modest engine of profit.
It earned $163 million in the second quarter, its fourth consecutive quarter in the black — not a bad result for a bunch of assets that Citigroup is trying to get rid of.
The profit was a modest contribution to Citi's $4.8 billion in second-quarter net income, which beat analysts' estimates and sent the company's stock up nearly 4% by the close of trading.
Yet Citi Holdings still is not, despite the profits, an asset to Citigroup. It brings down Citi's return on equity, because the riskiness of its assets requires a disproportionate amount of capital as a buffer against losses.
But after losing $3.4 billion last year and $1.9 billion the year before, Citi Holdings' recent profitability streak lightens the load on its parent company.
"While it's a drag, it's not a horrible drag on the overall performance," Chief Financial Officer John Gerspach said on a call with reporters Thursday.
Citigroup is not the only bank finding that onetime "toxic waste" — noncore, risky businesses or assets marked for closure or sale — is starting to look downright healthy. Bank of America, for instance, has earned a $329 million profit this year from its Legacy Assets & Servicing business line, a division set up in 2011 to house discontinued mortgage businesses and deal with legal claims.
Citi Holdings' U-turn to profitability reflects the world economy's gradual improvement, as well as the fact that most of the riskiest assets have already been sold.
It was established in 2009, when Citigroup was losing billions per quarter and on government life support, in order to make it easier to work through bad assets and to shift focus to business lines Citi planned to keep. It had around $850 billion in assets when it was formed, which included asset-management, consumer-finance and mortgage businesses, as well as hundreds of billions in loans backstopped by the government.
Then-Chief Executive Vikram Pandit insisted that he was not planning a fire sale, and that Citi Holdings included some valuable businesses. Citi's patient approach to selling assets sometimes puzzled observers, but it appeared to be validated earlier this year when Citi agreed to sell the subprime lender OneMain Financial for $4.25 billion — more than double the price it was reportedly asking in 2011. Citi said it expects $1 billion in pretax profit from the deal.
After six years of sales and wind-downs, Citi Holdings' assets were $116 billion at the end of the second quarter, 22% less than a year earlier. During the quarter it closed on the sale of consumer-banking businesses in Peru and Nicaragua.
Citi Holdings' profit comes from more than stripping off and selling assets. The $1.7 billion in interest and fee revenue it earned last quarter was 19% less than a year ago, but expenses — including litigation and closure costs — have declined faster than revenue.
Company executives expect Citi Holdings to remain a boon to the bottom line even after completing the sale of OneMain, which is expected in the third quarter.
"OneMain certainly is a significant contributor to [Citi] Holdings' profitability, but it's by no means the only profitable business in that portfolio," Gerspach said.
Citi executives said Thursday it has contracted to sell $32 billion of Citi Holdings assets and that these deals should close by yearend. These include consumer businesses in Japan, Egypt, Costa Rica and Panama, along with OneMain.
"Citi Holdings should be a much slimmer version of itself after this year," Gerspach said.
Selling assets could get a bit tricky after that. Of the roughly $80 billion in assets that will be left in Citi Holdings after the pending sales close, about 25% are second-lien mortgages, which have very little secondary market, Gerspach said. It also held $29 billion in first-lien North American mortgages at the end of the second quarter.
"The next focus area for us will be to try to work to develop a secondary market so that we can do some additional sales of our second mortgages," Gerspach said.
The pace may slow, but analysts are optimistic that Citi will be able to wind down its bad bank to a negligible size — and also expect that, in the meantime, it can continue to earn money.
Most of the remaining assets in Citi Holdings are mortgages, and many of them should become healthier, and easier to sell, as the economy improves, said Brian Kleinhanzl, an analyst at Keefe, Bruyette and Woods. Even if Citi cannot unload them right away, they will wind down over time, he said.
Citi executives will likely be happy when that happens and its bad bank, profitable or not, is in the rearview mirror. The unit is only 6% of Citi's total assets, but accounts for 13% of its risk-weighted assets.
Gerspach estimates that there's about $10 billion of capital "trapped" in Citi Holdings — money that Citi could reinvest in business lines it actually wants to be in.