Moody's cuts Citi debt as subprime fallout spreads

By Andrew Hurst and Richard Barley

ZURICH/LONDON (Reuters) - Moody's Investors Service cut its ratings on Citigroup (C.N) debt by a notch, the latest embarrassment for the largest U.S. bank, and putting it under renewed pressure to shore up its shrinking capital base.

While stocks fell in Asia as investors saw the move as a sign that the global credit crisis could be worsening, banking shares rose or were stable in Europe and Citigroup's bonds were unchanged.

Moody's lowered Citigroup's rating to "Aa3", saying it doubted that the U.S. bank could rebuild its capital ratios any time soon, and said Citi's failure to restore its capital ratios in the medium term could lead to a further downgrade.

Moody's analyst Sean Jones said weak earnings at Citigroup would prevent it from restoring capital ratios quickly even after it raised $7.5 billion (3.7 billion pounds) from the Gulf emirate of Abu Dhabi in November.

The agency suggested ways to rebuild included raising more outside capital and reducing its dividend. A growing number of analysts see Citi as likely to reduce its dividend, which costs the bank about $2.7 billion a quarter.

The downgrade came as Citigroup said it planned to rescue $49 billion of structured investment vehicles (SIV) in a move that further strains the firm's capital levels and may mean a U.S. government-endorsed "Super-SIV" bailout plan is no longer needed.

"It says the super SIV is dead in the water. That shows it was a bad idea in the first place and as with (British bank) HSBC (HSBA.L) they have realized they have to sort their own problems and not seek help from someone else," said Alan Webborn at SG Securities in London.

The DJ Stoxx index of banking shares edged 0.11 percent higher by 9:30 a.m. British time. Germany's Allianz (ALVG.DE), whose banking unit Dresdner Kleinwort has a large SIV, was 0.12 percent lower.

CITI BONDS UNCHANGED

SIVS are off-balance-sheet vehicles set up by banks to invest in mortgage-backed securities whose value has been slashed by a collapse in U.S. subprime mortgages, which were loans made to people with poor or non-existent credit histories.

Citigroup's euro-denominated bonds were unchanged in early trading on Friday, a trader in London said.

"The downgrade will likely be met with some equanimity," analysts at Royal Bank of Scotland wrote.

The subprime mess has already hit ratings on a number of the world's leading banks and securities firms. UBS (UBSN.VX), Merrill Lynch MER.N and Bear Stearns BSC.N have all had their credit ratings chopped by various ratings agencies.

Ratings downgrades can raise a company's borrowing costs in the corporate bond markets. Citi funds itself through the corporate debt markets to a greater extent than many of its peers, which have proportionately more deposit funding.

However, ratings analysts have said that many banks are entering the credit downturn from a position of strength, having spent the past few years shifting risk from their balance sheets to end investors.