UPDATE 2-S&P, Moody's may cut Citigroup ratings

(Adds Moody's note on Wachovia)

NEW YORK, Sept 29 (Reuters) - Standard & Poor's and Moody's Investors Service on Monday placed Citigroup (C.N) ratings on review for a possible downgrade after the bank agreed to buy Wachovia Corp's banking operations.

"The acquisition imposes integration challenges at a time when Citigroup's asset quality is being undermined by weakening consumer and commercial markets," said Moody's analyst Robert Young.

Moody's rates Citigroup's senior debt at 'Aa3,' while S&P rates Citigroup's counterparty credit at 'AA-'. Both ratings are fourth-highest investment grade in the agencies' different scales.

S&P agreed integrating Wachovia WB.N may be a distraction for management at a time when it is struggling with a difficult operating environment. But overall, it does not materially add to Citigroup's risk because it is structured as the takeover of a "clean" bank, said S&P analyst Tanya Azarchs.

However, "on a stand-alone basis, Citigroup's own market-disrupted assets and mortgage loan exposures pose significant risk," said Azarchs.

Citigroup has about $100 billion of residential and commercial mortgage-related securities, leveraged loans and auction-rate securities, she said. The continued slide in asset values in recent months, particularly in Alt-A mortgages, could lead to "substantial further write-downs" in the next year.

Citigroup has already booked about $34 billion worth of write-downs related to the housing sector downturn.

"The $206 billion North American mortgage book is deteriorating rapidly, and we believe this could bring about a sharp escalation in provisioning," said Azarchs.

The Wachovia deal is a positive and will allow Citi expand its domestic network, she said. Wachovia's retail deposit base and strong franchise in the South, especially among medium-sized businesses, make it a "choice acquisition" for Citi, especially at the low price it is paying, she said.

"However, integration risk and the distractions of dealing with a poor business environment, asset risks, and corporate restructuring could prove daunting," Azarchs added.

Separately, the agencies cut some of their ratings on Wachovia and said they may cut others in the wake of the acquisition.

The deal, which was brokered by the Federal Deposit Insurance Corp., is "highly unusual," said S&P analyst Victoria Wagner.

"Clearly, this approach by U.S. regulators in the face of distressed global capital markets is driving swift negotiations among regulators, advisors, potential investors, and the troubled banks for sales and acquisitions to contain systemic risk. This environment -- combined with a need to raise capital in a stressed market with a limited pool of potential investors -- lead to this highly unusual acquisition structure," said Wagner.

S&P and Moody's said their review of Wachovia will be dependent on the outcome of their review of Citigroup. (Reporting by Ciara Linnane; Editing by Chizu Nomiyama)