updated 7/17/2009 11:04:23 AM ET 2009-07-17T15:04:23

Citigroup Inc. surprised Wall Street Friday, reporting a $3 billion second-quarter profit instead of the big loss analysts expected.

Citigroup became the fourth big bank to report strong results for the quarter. Citi announced its results shortly after Bank of America Corp. also beat expectations with earnings of $2.42 billion. The pair of profit reports follows strong earnings from Goldman Sachs Group Inc. and JPMorgan Chase & Co. earlier in the week.

However, Citi's profit was not driven by improved trading like other banks, and instead came from the gain on the sale of its Smith Barney unit and the increasing values of some of its riskier assets that had plunged during the credit crisis. Citi recorded an after-tax gain of $6.7 billion on the sale of a majority stake in its Smith Barney brokerage unit to Morgan Stanley.

After paying preferred dividends, the New York-based Citigroup earned 49 cents per share versus a loss of $2.59 billion, or 55 cents per share, during the same quarter last year. Analysts forecast a loss of 37 cents per share for the quarter, according to Thomson Reuters.

Citi has been among the hardest hit by the credit crisis and ongoing recession. It has received $45 billion in funds from the government and guarantees to protect against losses on more than $300 billion in risky assets. The government is in the process of acquiring a 34 percent stake in the bank as part of a broader debt exchange program.

The exchange program will provide Citi a better mix of capital to withstand additional loan losses and further weakening in the economy. By turning preferred shares into common stock, Citi also no longer has to pay out dividends on the preferred shares, thus helping improve its cash flow.

Like other large retail banks, such as Bank of America, Citi is still facing mounting loan losses as the recession continues. Citi set aside $12.68 billion to cover loan losses during the second quarter, compared with $7.1 billion during the year-ago period.

Christine Barry, a research director at Aite Group, said credit losses are "still a big concern" at Citigroup. "As long as unemployment continues to rise, any consumer credit is still at risk."

Big banks have faced mounting losses across a wide range of credit, from mortgages to home equity loans to credit cards, as more customers struggle to repay loans during the recession.

Trying to better manage the mounting losses and return to profitability, Citi took a radical step to realign its operations in January, splitting its operations into two entities. After suffering a fifth-straight quarterly loss during the last three months of 2008, Citi split its operations into Citicorp and Citi Holdings. The first is focused on traditional banking around the world, while the second will hold the company's riskier assets and tougher-to-manage ventures.

The move allows it to more easily sell off those riskier assets and keep their losses separate from the traditional businesses — the operations where Citi is now squarely focused.

Citi Holdings generated an operating profit of $1.36 billion during the second quarter, compared with a loss of $5.23 billion thanks to the gain on the Smith Barney sale. Citi Holdings also recorded an increase of $1 billion in the value of some of its risky assets, primarily related to subprime mortgages. The value of those same investments was cut by $6.6 billion during the same quarter last year.

A collapse of the housing market in 2007, primarily due to rising defaults among subprime mortgages, was one of the primary causes of the credit crisis and recession.

At Citicorp, operating profit fell 11 percent to $3.06 billion during the second quarter. The decline was primarily the result of foreign currency exchange and rising credit losses.

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