Citigroup bad bank article updated with management commentary and share price.

NEW YORK ( TheStreet) - Citigroup ( C - Get Report) continued to wind down its "bad bank" during the second quarter, but the pace of sales is moderating as the bank fights to get a fair price for its local consumer lending businesses.

Citi Holdings- the bank's non-core operations that include brokerage and asset management, local consumer lending and special asset pools- has been a drag on earnings. Investors are counting on the bank to wind down the unit to a point when it can no longer hurt earnings.

Shrinking the Citi Holdings portfolio is also a crucial in order for the bank to achieve regulatory capital standards and ultimately generate returns to shareholders through higher dividends.

The bank has over the last three years managed to sell several of the non-core operations. The $308 billion Holdings portfolio at the end of the second quarter is half a trillion dollars lower than its 2008 peak.

During the second quarter, the portfolio shrank 34% from the year-ago period . The reduction was driven by the local consumer lending business, where revenues declined 30% to $2.9 billion, on the back of declining loan balances.

Citigroup sold $12.7 billion in securities that were transferred to trading in the previous quarter at positive marks, helping to boost special asset pool revenues by 77%. Brokerage and asset management revenues were $47 million, a decrease of 67% compared to the prior year period, due to a lower equity contribution from the Morgan Stanley Smith Barney joint venture.

Citi previously announced that it closed on the sale of its UK credit card business. It also announced the sale of $1.7 billion of limited partnership interests in private equity buyout funds and a portfolio of direct stakes in companies to AXA Private Equity.

As a result of asset disposals and lower loan balances, revenue from the unit dropped 18% to $4 billion.

The bad bank, however, reported a narrower second quarter loss of $218 million, $1 billion less than the year-ago-quarter, as continued improvement in credit costs offset declining revenues.

In the quarters ahead, however, analysts expect the pace of decline in assets to moderate, with the portfolio now saddled with assets that are tougher to sell.

"What we have modeled for in the next three years is a 5% decline per quarter in assets, "said Anthony Polini, analyst at Raymond James. "That is less than half of what it has been so far."

Bank of America Merrill Lynch analyst Guy Moszkowski expects assets to decline 44% from first quarter of 2011 through the end of 2013, assuming an accelerated pace of sales in its "special asset pool" as the bank races to meet Basel 3 requirements.

But he notes that asset sales in the local consumer lending division could slow as retail cards and consumer loans are "less readily saleable".

Citi has already had challenges in selling its consumer finance unit OneMain Financial, according to press reports. Berkshire Hathaway ( BRK.B - Get Report), Centerbridge Capital and Leucadia Partners are reported to be interested in the approximately $13 billion portfolio, but reports suggest that the buyers may be reluctant to pay book value for the assets.

Earlier this week, Financial Times reported that the bank might consider retaining its $40 billion store-card business that it had marked for disposal as credit conditions improved. However, analysts have felt that the bank might have had a tough time selling such a big business, especially given that HSBC's ( HBC) U.S. credit card portfolio is also reportedly on the block.

The management would not comment on its deal negotiations regarding OneMain. It did, however, suggest that it was open to the possibility of reviewing what businesses it puts up for sale.

"When we set up Citi Holdings, it was not so much about good bank, bad bank but it was about whether or not those businesses fit in with Citicorp's strategy," Citibank said. Citicorp houses all of the bank's core businesses. "We need to determine whether any of those businesses fits the Citicorp strategy now," the executives said.

For now, analysts aren't too concerned about the slowdown in bad asset sales.

Polini of Raymond James says that Citigroup is in a relatively stronger position now and that means it does not have to dispose of its assets in a hurry. "They don't have to make any distressed asset sales. Citi can be patient and wait for a better pricing environment," he said. He added that the bank would easily be able to meet its target capital requirements. "In three years, Citigroup will have more capital than JPMorgan."

According to Gerard Cassidy at RBC Capital, Citi will have to shrink its portfolio at approximately $9 billion a quarter in order to achieve a Tier 1 Common capital minimum of 8% by the end of 2012, which he believes is "very achievable."

Shares were up 1.3% to $39.53 in morning trading Friday.

--Written by Shanthi Bharatwaj in New York

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