Citi nears Morgan Stanley brokerage deal

LONDON/NEW YORK (Reuters) - The break-up of U.S. banking powerhouse Citigroup moved a step closer, and Britain took control of a big stake in another top lender on Monday as the reshaping of the global financial landscape gathered pace.

Citigroup moved close to a deal to join its Smith Barney business with Morgan Stanley's brokerage operation, people familiar with the matter said.

The move would create the largest retail brokerage and mark the boldest step in dismantling what was the world's biggest financial services conglomerate.

The financial services sector is in a state of constant flux as banks recoil under the threat of a long and deep downturn, with governments bailing out the worst-hit lenders while relatively strong banks look for bargain acquisitions.

Britain found itself with another stake in a top bank after investors in Lloyds TSB and its takeover target HBOS shunned a pair of rights issues, leaving the government to supply almost all of the 17 billion pounds ($25.6 billion) they need to rebuild capital.

"The landscape is going to change, and it's unlikely that large banks can go into government hands and come out the other side unchanged," said Simon Maughan, analyst at MF Global in London.

"Whether it's the U.S. government with Citi, the Swiss with UBS or the UK with Royal Bank of Scotland, governments are going to say, 'You are very big institutions to be bailed out, and it would be good if you were a degree smaller and much more manageable'," he added.

Britain will get a 43.4 percent stake in Lloyds Banking Group, the enlarged bank to be formed this week, adding to the 58 percent holding it took in RBS last month.

The U.S. and Britain are not alone in taking potentially long-term stakes in lenders as part of moves to shore up the troubled sector.

Greece's third-largest lender, Alpha Bank, on Monday won approval to raise up to 950 million euros ($1.3 billion) by selling preference shares to the government as part of a 28 billion euro state-backed support package.

Germany last week pumped 10 billion euros into Commerzbank, and though the bank's CEO Martin Blessing said over the weekend he aimed to repay the capital as soon as possible, he expected Berlin would keep its holding for some years.

LEHMAN CARVE-UP

Other deals in the sector were also simmering, with South African billionaire Johann Rupert's investment vehicle in talks about buying out Lehman Brothers' merchant banking business, and UK fund manager New Star Asset Management in receipt of proposals including a possible offer.

RBS was buoyed by a report it might attract interest for the sale of its insurance arm. It had been expected to scrap the insurance sale, but private equity firms Apollo Management and BC Partners are mulling a late bid, a report said.

RBS is expected to shrink its balance sheet and sell assets as part of a strategic review by its new CEO.

By 1100 GMT (6 a.m. EST) RBS shares were up 6 percent, the top performing stock in a flat European bank sector.

For Citi, securing a joint venture deal with Morgan Stanley would be an easier move than selling assets at a bad time. Few buyers have the cash available to buy Smith Barney outright.

The creation of the joint venture would lead to Morgan Stanley making a cash payment to Citi of about $2.5-$3 billion, a source familiar with the situation said on Sunday.

A deal between Citi and Morgan Stanley could be announced this week, two sources said, though one said it was unlikely to come as early as Monday.

(Reporting by Steve Slater and Myles Neligan in London, Megan Davies and Dan Wilchins in New York and Rebecca Harrison in Johannesburg, editing by Will Waterman)