NEW YORK (The Deal) -- Citigroup(C) - Get Report has agreed to sell its consumer finance unit OneMain Financial to subprime lender Springleaf Holdings(LEAF) - Get Report for roughly $4.25 billion in cash, the company said Tuesday. The deal is the latest in the too-big-to-fail bank's efforts to reduce its size as it faces severe regulatory limits on capital distributions.

In a view into what the financial crisis wrought for Citi's OneMain business, which is primarily a subprime business that caters to lower-income borrowers, Citi said as of Dec. 31 it represented about 5% of the bank's assets, down from its peak of more than 30%. The sale and retirement of related funding is expected to result in additional earnings before taxes for Citigroup of roughly $1 billion.

The deal, which must be approved by the Federal Reserve, is expected in close in the third quarter of 2015. At closing, the combined Springleaf-OneMain is expected to have 1,967 branches in 43 states and roughly 2.5 million customers and $15 billion in assets, which will make it the largest subprime lender in the U.S. The resulting personal lending institution will also have nearly $14 billion in core consumer net finance receivables.

The sale announcement by Citigroup comes as the mega-bank undergoes tough stress tests orchestrated by the Federal Reserve to see if banks can handle a hypothetical crisis similar to the one that shook the economy in 2008.

Last year, Citigroup was among the poorest performers in the exercise, failing a second set of tests on qualitative grounds that resulted in severe limits on its 2014 total net payout. (In 2014 it distributed a paltry 2% of earnings). An institutional investor familiar with Citigroup said the mega-bank is under so much pressure to hike distributions this year that if they are unable to produce a significant hike in stock buybacks and dividends then "heads ought to roll" at the executive level, perhaps including Citigroup CEO Michael Corbat.

Keefe Bruyette & Woods estimated in February that Citigroup may be permitted to have a total net payout of 35% of earnings over the five quarters starting in April, still among the lowest distributions permitted, but a significant uptick from 2014.

And while KBW developed its estimate last month, the announcement Tuesday could help bolster Citigroup's efforts to have its 2015 capital distribution proposal approved by the central bank, in part, because in a small way it reduces the bank's complexity.

Last year, the Fed said Citigroup has not made "sufficient" improvement in its risk-management, capital planning and control practices. A sale of OneMain, which is based in Baltimore, will mean less risk-management for Citigroup and a smaller size overall, albeit only a slight reduction overall, all of which could help it obtain permission for a higher capital distribution. It comes after the mega-bank has taken other steps to reduce in size over the years since the crisis, including its 2009 sale of its controlling stake in its Smith Barney brokerage business and its 2010 spinout of life insurer Primerica (PRI) - Get Report.

Bert Ely, analyst at Ely & Co. in Alexandria Virginia, argues that the sale is the latest step in Citigroup's efforts to reduce its size, adding that it is a "net positive" from the point of view of Citigroup's effort to hike capital distributions. "It doesn't hurt, it's a net positive but how much does it help remains to be seen," said Ely. "There is no silver bullet for Citigroup."

The deal was announced just two days before Citigroup and 30 other big banks are privately expected to receive a private preliminary decision on whether the Fed has approved their capital distribution proposals for the next five quarters. Those that get a thumbs down on Thursday can revise their capital plans downwards to ensure that they don't fail a second set of stress tests revealed on March 11. The 31 banks, including Citigroup, are expected to reveal their capital distribution plans for five quarters starting in April on March 11.

Citigroup has been trying to sell its consumer finance business for years after renaming the unit from CitiFinancial to OneMain in 2011. The OneMain sale is a major step for the mega-bank to slim down under regulatory pressures and concentrate on wealthier clients and borrowers.

"We believe the opportunistic sale of non-core assets such as OneMain will allow Citigroup to simplify is business and focus on delivering sustainable, high quality returns from its core franchise," said Gerard Cassidy, analyst at RBC Capital Markets, in a note Tuesday.

Springleaf, which is majority-owned by buyout shop Fortress Investment Group (FIG) , has reportedly been interested in acquiring OneMain for a number of years. "As a significant shareholder of Springleaf, we believe this is a compelling transaction, both strategically and financially," said Fortress co-chairman Wes Edens in a statement. Other private equity firms reportedly looked at OneMain but Springleaf won the auction process.

The combined Springleaf-OneMain will likely face a lower-income lending market that is undergoing substantial disruption under the oversight of the Consumer Financial Protection Bureau, a recently-formed agency mandated by the post-crisis Dodd-Frank Act. The CFPB oversees banks and nonbanks, like the soon-to-be-formed Springleaf-OneMain combination, and has been taking a tougher tack than its predecessor regulators to enforcing federal consumer protection and fair lending laws.

"CFBP is swinging into action in the subprime lending area," said Ely. "There is renewed concern among subprime lending."

Bank of America Merrill Lynch, Barclays, Credit Suisse and Goldman Sachs provided financial advice to Springleaf, while Skadden, Arps, Slate, Meagher & Flom partners, Thomas Greenberg, David Ingles, Jose Esteves, David Polster and Regina Olshan provided legal advice. Citi's institutional clients group advised Citi on this transaction. Advising OneMain on the transaction was Citi as financial adviser and Davis Polk & Wardwell as legal adviser.

Shares of Citigroup recently traded at $53.78.

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