Companies, banks, financial institutions are often faced with the dilemma of having to make their businesses leaner and more efficient. This will often include a divestiture of an arm or unit of the company or a significant sector that, due to inefficiencies, high costs, low revenue, or other reasons, is less than optimally profitable. A company, for example, may spin off a particular type of product or service into a subsidiary or separate entity, in which it may retain some ownership stake. The new entity will focus on developing its particular product or service independent of budgetary or management considerations that might ordinarily tie it down as part of the original bigger company. And the original company, by spinning off or jettisoning that particular business, can gear its resources more efficiently toward its other core products or services independent of constraints from previously having the now-spun off entity. A sale of a particular unit may also be wise to help bring in capital for the bigger company. While a spinoff or divestiture may occur with a company’s underperforming unit, sometimes an entity may choose to sell off a profitable entity.
Selling off a profitable unit
In recent financial news, it has been reported that Citigroup, a financial institution colloquially known as one of the “big banks,” sold off OneMain Financial, which as the New York Times Dealbook notes, was its subprime consumer finance unit. Subprime lenders lend specifically to those with less means, meaning they are riskier loans set at higher interest rates. Springleaf Financial Services, which is a financial lender, has purchased the OneMain Financial unit from Citigroup for $4.25 billion. While one might assume that OneMain Financial was not performing to expectations and not benefiting Citigroup, that is apparently not the case here. As indicated in the article, “[t]he unit has generated returns that far exceed anything else at Citigroup,” yet Citigroup has decided to jettison one of its most profitable arms. According to the report, OneMain Financial accounted for 6.7% return on assets, which was worlds better than Citigroup’s overall return rate of 0.9%.The lending unit was apparently a lower cost, higher return part of the overall bank centered on returns from high interest rate loans to customers.
Why sell off an efficient money maker?
While this particular lending arm of Citigroup could produce hundreds of millions of dollars ($574 million according to Dealbook, citing Bernstein analysts), Citigroup has its reasons for selling. Namely, the $4.25 billion earned from the sale will be a substantial cash infusion for the bank. It will also give Citibank the ability to take advantage of tax-related benefits, and it will have access to more capital, while eliminating its somewhat costly financing of the lending arm. By getting rid of that debt, the excess will be an approximately $1 billion boon to Citigroup’s balance sheet. Citigroup can also gear its attention toward other aspects of its business. As far as Springleaf goes, the acquisition will make it “the largest subprime lender in the United States,” according to Reuters, creating $15 billion in assets, and a wider base of subprime loan customers.