The deal will begin to dissolve what has been a troubled relationship between Citigroup and the government, which bailed out the bank with three rescues last year and this year but also pressured it to sell businesses and remove executives.
The transaction is also a sign of a shift in the financial crisis, as regulators worry less about injecting capital into banks to stabilize them and more about properly monitoring banks to prevent the next crisis.
Under the deal, Citigroup will sell immediately $17 billion of common stock and about $3.5 billion of securities that turn into common shares in three years. Early next year, the bank may sell more than $4 billion of additional securities.
The government will stop guaranteeing a pool of toxic Citigroup assets against excessive losses, and will sell the nearly $30 billion of Citi shares it owns over the next year. Up to $5 billion of the shares will be sold alongside the bank's share sale this week. (Click on [nN14112870] for a FACTBOX detailing the deal's terms)
The government estimates it could see a profit of $13 billion to $14 billion on its investment in the bank.
Analysts cautioned that like other banks repaying the government, Citigroup -- which has struggled to turn a profit from its main operations in recent quarters -- is still subject to extensive U.S. regulation and pressure.
They're still in the government's embrace. It's just not a bear hug now, said Anton Schutz, president of Mendon Capital Advisors, which owns Citigroup shares.
Executives from Citigroup and other leading banks were scheduled to meet with U.S. President Obama on Monday, but Citigroup Chairman Richard Parsons was one of three executives whose flight to Washington was canceled because of foggy weather.
Citigroup's exit from the Troubled Asset Relief Program puts even more pressure on Wells Fargo & Co
Citigroup shares were down 6.6 percent, or 26 cents, at $3.69 in afternoon trading on the New York Stock Exchange.
The shares have fallen about 45 percent this year, compared with a decline of about 1.8 percent for the banking industry as measured by the KBW Banks index <.BKX>.
The cost of protecting Citigroup's debt against default in the credit derivatives market fell by around 0.18 percentage point, to 1.41 percent, or $141,000 per year for five years to insure $10 million in debt, according to Markit. That cost has fallen from around 2.0 percent a week ago.
A VICTORY, BUT AT A COST
The TARP deal is a victory for Citigroup CEO Vikram Pandit, who has repeatedly clashed with regulators who have called for his ouster.
Citigroup's multiple bailouts left the government with extraordinary say over the bank's operations, most notably with regard to compensation. The Obama administration's pay czar, Kenneth Feinberg, had say over the pay of Citigroup's top 100 employees.
In 2010, when Citigroup repays the $20 billion of TARP securities and ends its loss-sharing agreement with the government, it will no longer be deemed a beneficiary of exceptional financial assistance, which would presumably end Feinberg's oversight.
Citigroup will also reduce annual interest expenses by about $2 billion as part of the deal with the government, according to a report from UBS analyst Glenn Schorr.
Some investors cheered the moves. Prince Alwaleed bin Talal, a major Citigroup investor, said he commends the bank's exit from TARP and plans to hold onto his shares.
Still, the agreement also represents a calculated gamble by Pandit and regulators that the bank will be able to ride out an uneven economic recovery.
Significant declines in U.S. housing prices or another rise in unemployment could result in big losses for Citigroup and force the bank, along with some of its rivals, to seek additional government aid.
And the deal is in some respects bruising for the bank. Citigroup is taking an $8 billion pre-tax loss on the trust preferred purchase, because the securities were recorded on the bank's books at less than their face amount. Canceling securities linked to the government's asset guarantee will result in another $2.1 billion of pre-tax losses.
Those losses eat into the benefit of raising capital.
Citigroup's employees are essentially being forced to receive equity instead of $1.7 billion of cash compensation they would have otherwise received.
And the dilution to shareholders from this deal is about 15 percent, which is higher than the dilution Bank of America Corp
TREASURY HAILS DEAL
The Treasury said it was pleased Citigroup was moving forward with the plans.
While much work lies ahead to improve lending and spur job creation, today's announcement by Citigroup takes us another step in the right direction, the Treasury Department said in a statement.
Citigroup's stock offering -- initially set at $17 billion -- may swell to $19.55 billion depending on investor demand. The bank is also selling $3.5 billion of securities known as mandatory convertibles.
Bank of America, which sold $19.3 billion of shares earlier this month to exit TARP, found extremely strong demand for its offering. Investors told Reuters they received only about half the shares they ordered in that deal.
When Citigroup's transactions are done, the bank will be left with a Tier 1 common ratio of 9 percent, putting it above Bank of America's 8.4 percent and JPMorgan's 8.2 percent, according to a Citigroup presentation to investors.
Citigroup borrowed $45 billion last year under TARP. This year, the government agreed to convert $25 billion of those funds into Citigroup common stock, leaving the United States with a roughly 34 percent stake in the bank. That stake is now worth nearly $30 billion.
(Reporting by Dan Wilchins; Additional reporting by Christopher Kaufman and Elinor Comlay; Editing by John Wallace)