By AnnaMaria Andriotis And Mike Spector 

Another piece of banking is moving to the shadows.

Citigroup Inc., the nation's third-largest bank by assets, confirmed Tuesday that it would sell its large U.S. subprime-lending business, OneMain Financial, to Springleaf Holdings Inc., a nontraditional lender majority-owned by private-equity firm Fortress Investment Group LLC.

The $4.25 billion deal, reported by The Wall Street Journal on Monday, is the latest example of a core banking business, in this case lending to lower-income customers, moving from a financial conglomerate to a smaller rival that aims to serve customers more efficiently in part because it faces a lower regulatory burden.

The move is emblematic of postcrisis regulations forcing banks out of their old mind-set of trying to serve as many customers as possible under one roof. In this case, Citigroup decided that U.S. subprime borrowers, once a lucrative group to deal with because of the high interest rates they pay, aren't attractive enough to keep in a world of tighter regulation.

Subprime loans are given to borrowers who have low credit scores, which can result after borrowers fall behind on loan payments, go through foreclosure, bankruptcy or for other reasons. In recent years, big banks "have shied away from these borrowers," said Cris deRitis, director of consumer-credit economics at Moody's Analytics, a unit of Moody's Corp. "That's exactly what we're seeing today with this merger."

Across trading and lending operations, hedge funds and private-equity firms have plowed into businesses after once-dominant banks retrenched. In the lending business, some private-equity firms have invested in lenders looking to make inroads against banks.

One big impact of the move is that consumers may see fewer protections as smaller, less regulated companies take over bigger portions of the business. Fewer regulators have oversight over nonbank personal loan lenders. However, the Consumer Financial Protection Bureau can bring enforcement actions against them if it finds they are engaging in unfair, deceptive or abusive practices, like deceiving consumers about the interest rates on their loans. It can also supervise them if it determines they may pose a risk to consumers.

The latest deal underscores large banks' reluctance to return to the subprime market after the financial crisis. Before the downturn, subprime lending served as a greater revenue source for lenders that could charge higher interest rates and fees in exchange for lending to risky borrowers. Regulations that kicked in during the downturn crimped that revenue. A credit-card law in 2009, for example, limited charges that banks could impose.

At a panel discussion last year, Citigroup CEO Michael Corbat said that shadow banking would "serve a very important role to society," filling a void to meet demands that banks no longer can.

Tuesday, in a statement, he said: "While this business didn't fit our strategy, it serves customers who deserve and need credit."

The transaction will turn Springleaf into the country's largest subprime lender by number of branches. Shares of the Evansville, Ind., lender climbed $12.19, or 32%, to $50.23, in 4 p.m. trading. Citigroup's shares rose 24 cents, or 0.5%, to $53.73.

The deal means Citigroup will be able to sell the asset quickly rather than go through the sometimes-risky process of selling shares in an initial public offering.

Goldman Sachs Group Inc. noted in a research report Tuesday that U.S. banks could lose $11 billion in annual profit, or about 7% of last year's net income, to nontraditional, more focused lending companies.

The biggest piece of that, $4.9 billion according to the Goldman report, comes from the type of consumer lending that Springleaf and OneMain specialize in: loans to individuals for a variety of items from consolidating high-rate debt to paying for home improvements, medical bills or vacations.

The combined lender, to be named OneMain, will have nearly 2,000 branches. It also will have about 2.5 million customers. The deal, subject to regulatory approval, is expected to close in the third quarter and result in 200 branch closures.

Since the financial crisis, big banks have looked to exit businesses that don't generate a high enough return, in part because of tougher capital rules that reflect regulators' views that certain activities are too risky. Lending to lower-income consumers fell into that bucket for Citigroup, which has also jettisoned other businesses, including the Smith Barney brokerage unit and life insurer Primerica.

The deals have also been encouraged by investors, who have expressed a preference for financial companies with more focused management, and regulators, who have pushed for simpler banking businesses.

"This has been the four-year overnight sensation of ending up with this" company, said Wesley Edens, Springleaf's chairman and co-founder of Fortress. Mr. Edens said he held his first meeting with Citigroup to discuss acquiring OneMain in early 2011.

Springleaf's $4.25 billion purchase price is roughly double what Citigroup had sought for the business several years ago when it neared a deal with other investors. That deal fell through.

Mr. Edens said more opportunities may come for investors looking to buy assets from banks. "The water is still running, but at less of a rate," he said, referring to bank divestitures.

Christina Rexrode contributed to this article.

Write to AnnaMaria Andriotis at AAndriotis@marketwatch.com and Mike Spector at mike.spector@wsj.com

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