Aug. 14 (Bloomberg) -- Citigroup Inc., the biggest U.S. bank by assets, may forfeit as much as $1 billion of third- quarter profit because of the credit crunch in mortgages and high-yield debt, according to analysts at Sanford C. Bernstein & Co. LLC.

The ``worst-case scenario'' for Citigroup is that the New York-based company marks down leveraged-loan commitments by $1.5 billion, takes a $500 million to $1 billion markdown for credit lines to mortgage lenders and posts a trading loss of $700 million on so-called structured products, Howard Mason and Michael Howard, two Bernstein analysts in New York, said today in a note to clients.

The bottom-line impact would be an earnings reduction of $650 million to $1 billion, after accounting for compensation and taxes, the analysts said while maintaining their ``outperform'' rating and $65 price target on the stock. Citigroup, which currently trades at about $46 a share, is expected to report third-quarter profit of $5.72 billion, the average estimate of six analysts in a Bloomberg survey.

``Investors are concerned with credit exposure at Citi in subprime mortgage, leveraged lending and structured products,'' Mason and Howard said in the note.

Dan Noonan, a Citigroup spokesman in New York, declined to comment.

Shares of Citigroup have dropped about 17 percent since May 30, the fifth-biggest decline in the 24-member Philadelphia KBW Bank Index. They fell 88 cents, or 1.9 percent, to $45.66 in New York Stock Exchange composite trading today.

Loan Markdowns

Citigroup already may have taken an unreported $200 million to $300 million markdown for leveraged loans in the second quarter, the analysts said. That figure may triple this quarter because the risk premium that investors demand on the yields of such loans widened by 3 percentage points in July and may return to those highs in September, according to the report.

``The key question is how the market absorbs deals coming in September, when spreads may widen out to July levels or worse, or may renormalize, with spreads coming in to June levels,'' the analysts wrote.

Mason and Howard said mark-to-market losses on leveraged loans in July could have been 15 percent to 20 percent. Lending spreads have tightened so far in August, they said.

Citigroup is the third-ranked provider of leveraged loans in the U.S. this year, behind JPMorgan Chase & Co. and Bank of America Corp., according to data compiled by Bloomberg.

Mortgage Defaults

The rising rate of defaults on U.S. subprime mortgages has triggered a broader credit crunch and frozen markets such as those for collateralized debt obligations. The rout bankrupted two hedge funds run by Bear Stearns Cos. and forced BNP Paribas SA to halt withdrawals from three of its funds.

The Financial Times reported on Aug. 11 that Citigroup may have lost $700 million on credit trading in July, a figure the Bernstein analysts cite while noting that it's ``un-estimable and unverifiable.''

Citigroup also is at risk of losses on the $13 billion of subprime mortgages at its investment bank, Mason and Howard said. The loans typically were originated through warehouse lines of credit to other lenders and held for sale, subject to mark-to-market accounting. Now that prices for subprime mortgages have declined by about 20 percent, Citigroup may face losses of as much as $1 billion after hedging, the analysts said.

Mason and Howard said they don't see much of a risk of losses on the $22 billon of subprime mortgages or the $60 billion of prime second mortgages originated by Citigroup's consumer-banking unit.

To contact the reporter on this story: Sebastian Boyd in London at sboyd9@bloomberg.net

Last Updated: August 14, 2007 19:56 EDT