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As part of its ongoing restructuring process, Citigroup (C) was again in the news recently for selling its Consumer Business Operations in Brazil.

Citigroup's Credicard unit will be acquired by Itau-Unibanco Holding S.A. (ITUB), Brazil's biggest local bank in terms of market value. The deal will result in Citigroup quitting some of its non-core international operations. This is aimed at increasing revenues by 2015, along with reducing costs to generate higher returns for other mainstream operations.

Citigroup has been going through a challenging business environment and is now working to quit its non-profitable operations in growth markets. This particular step has been taken by the bank to monitor its risky assets and control its capital adequacy ratio.

Citigroup's consumer business operates in 40 countries for more than 100 million clients. Its Global Consumer Banking business is one of the largest retail banks in the world. The business units covered under this include: Retail Banking, Citi Mortgage, Citi Branded Cards, Retail Services and Citi Commercial Bank.

A look inside the deal

Itau-Unibanco acquired Citigroup's Brazilian consumer finance division in a recent deal for $1.37 billion. Citigroup's Credicard unit is a $3.96 billion business unit which takes care of Credicard credit cards with 96 other consumer finance outlets. This deal will increase Itau's market share in Brazil from 30% to 40%, and will give it an edge in the Brazilian card market. Its credit card base has also increased from 32.8 million to 37.7 million as of April, 2013.

According to recently filed securities by the bank, the Banco Citicard SA, Credicard card brand and Citifinancial Promotora Ltda under Citigroup will be taken over by Itau in the deal. The deal will end in an after-tax gain of $300 million (i.e. $0.10 per share) for Citigroup. However, Itau is also expecting to get some tax benefits which will increase its dominance in the Brazilian credit card market.

Vikram Pandit's strategy to shape up Citigroup's structure

Under Vikram Pandit's tenure, the bank transformed its operations by reorganizing it into two entities, namely Good Bank and Bad Bank. He categorized Citicorp as the good bank, and Citi Holdings as the bad bank, dealing with all the company's non-core assets.

Citicorp consists of the core businesses that the company had decided to retain and includes divisions like Corporate and Institutional Banking, Consumer Banking and Transaction Services, thereby constituting 96% of the overall Citigroup revenues.

On the other hand, Citi Holdings consisted of the non-core assets that the bank was willing to sell in order to minimize its losses and expenses.

The main reason to follow this strategy was to reduce its non-core businesses as quickly as possible and to generate good returns for the shareholders by focusing on its client-centered business operations. This step also resulted in higher capital ratios for the company, over the years, to have stronger balance sheets. This can be understood by the fact that in 2012, Citi Holdings' balance sheet represented only 8% of total assets, accounting for $148 billion of their total value.

By following the above strategy, the company recorded a total capital ratio of 17.1% along with a Tier-1 ratio of 13.9% in 2012 in comparison to 16.9% and 13.5% recorded in the previous year. In other words, it can be said that Citigroup has been making efforts to meet its debt obligations with the capital resulting from selling off its non-core assets.

How are other banks improving by selling off their non-core units?

Vikram Pandit was able to improve the performance of the bank with the help of this strategy. This effort has not only improved the company's balance sheet but also encouraged other banks across the world to follow similar steps and thereby improving their operations.

Bank of America (BAC): Bank of America was considered to have a very low capital ratio as compared to its peers like Wells Fargo (WFC), JPMorgan Chase (JPM) and Citigroup ,etc., prior to 2012. In order to raise capital for meeting new requirements, the bank started to sell its non-core business units, thereby reducing risky weighted assets.

According to the company's CEO Brian T. Moynihan, the bank has already shed more than $50 billion in non-core assets since 2010, and is planning to do more in future. The bank sold almost everything from a minority stake in a Chinese bank to overseas Merrill Lynch's wealth management units. The bank's Tier-1 capital ratio and total capital ratios have increased drastically over the years and reached 12.22% and 15.50% in 2013.

Even the European Banks' capital ratios have increased significantly in recent months. The banks have started to sell their risky assets, thereby increasing their capital through retained earnings and other debt management exercises. After the 2008 financial crisis and the Cyprus bailout, most European banks have gone through a tough phase while dealing with their capital and earnings structure. In previous years, they had much weaker balance-sheets as compared to other banks. According to a report, the capital ratios of the 32 largest European banks have increased to 11.23% in the current year.

Deutsche Bank (DB): In the latter half of 2012, Deutsche Bank had started a non-core operations unit to reduce $128.6 billion worth of its risky assets. This was done to improve its capital position in the market. It also sold $3.7 billion of stock in order to strengthen its balance sheet, thereby increasing its Basel III Tier1 capital ratio to 9.5% this year. It was able to meet financial regulations via its retained earnings and the reduction of its risky assets. It is expected to improve its capital position by following such practices in the near future. The bank has also outperformed its peers having capital ratios of 8.4% for Barclays, 8.9% for JPMorgan, 9.4% for Bank of America, etc.

Financials of Citigroup show impact of this strategy

Citigroup posted better than expected results in its Q1 2013 report. The reported net income was $3.8 billion in Q1 2013, up from $2.9 billion in Q1 2012. This increase was driven by high revenue growth along with lower operating and credit losses in 2013. The revenues in Q1 2013 came in at $20.5 billion, compared to $19.4 billion in Q1 2012 mainly due to lesser risky assets and funding costs.

The bank also posted a net interest margin of 2.94 showing that Citigroup has made better investment decisions with respect to its debt situations in its Q1 2013 compared to Q1 2012.

Non-Core Units: Citigroup's Global Consumer Banking segment reported revenues of $10 billion. Its net income has shown a decrease of 11% over the last year. The revenues and the net income of the Transaction services segment have also declined in its Q1, 2013. These figures show that Citigroup is losing money in its non-core business units.

Citigroup also posted increased capital levels in its Q1 2013 report. Its Basel I (international standard for capital requirements) Tier 1 Capital Ratio was 13.1% and Basel I Tier 1 Common Ratio was 11.8%, each reflecting the new U.S capital rules. Its estimated Basel III Tier1 common ratio was 9.3%.

(Source: Bank's Quarterly Statements.)

Stock Performance

Citigroup's stock is current trading at $51.60. It has improved nearly 100% in the last one year due to its improved balance sheet.

Capital Ratios

Tier 1 capital ratios basically describe the capital adequacy of a bank. This includes the company's equity capital (that can be redeemed later) and its disclosed reserves. The capital adequacy is the minimum amount of capital (or cash) a bank can hold as per the financial regulators. It is a measure of a bank's capital and its risks. The capital adequacy ratio for any bank shows the bank's capacity to overcome its debt and all kinds of risks.

By posting a high Tier 1 capital ratio, Citigroup has proved that it is one of the best capitalized banks in the world. It shows that the bank has recovered from the losses it faced due to the 2008 financial crisis. The main reason for this performance was selling off its risky assets in its non-core operations. In 2012 also, Citigroup sold off $500 billion of its assets placed in Citi Holdings and posted a tier-1 capital adequacy ratio of 12.4%.

Over the past few years, Citigroup has been following a restructuring process by quitting its non-core international businesses to counter falling revenues. It has been selling its risky assets - assets which are guaranteed to result in losses - for quite some time. This step has helped the bank to build up its cash reserves to deal with its debt obligations, thereby making its balance-sheet stronger than others. As of June 2012, Citigroup had around $420 billion in its cash and reserves. With the ongoing selling of its non performing units, Citigroup is expected to increase its cash and cash equivalent to have a better capital adequacy ratio in the future.

Citigroup has always worked to increase the efficiency of its overall business operations, thereby optimizing its resources. However, this restructuring process is just a part of its overall efforts to become profitable.

Conclusion

Citigroup has been maintaining its capital ratios by handling its risky assets properly. With selling off its non operational units, Citigroup is trying to concentrate on its mainstream businesses and is aiming to increase its efficiency. This step would not only generate revenues for the bank but also deliver better results in the challenging banking environment.

Source: Non-Core Asset Sell-Off: How Banks Like Citigroup Are Restructuring Themselves