(Adds Aurelius filing, closing stock price)
By Jonathan Stempel
NEW YORK, March 17 (Reuters) - Citigroup Inc said on Tuesday it plans to exit its custody business in Argentina as soon as possible, after a U.S. judge refused to lift an injunction that blocked the bank from processing interest payments on $2.3 billion of Argentina bonds.
In a defeat for the bank, clients and Argentina itself, Citigroup said it made its decision in light of U.S. District Judge Thomas Griesa's March 12 order letting the injunction stand, and Argentina's renewed threats to strip its banking license and impose criminal, civil and administrative sanctions.
Citigroup may sell portions of the business or end some customer relationships, according to a letter to Griesa from Citigroup's lawyer, Karen Wagner.
The New York-based bank also again asked Griesa to put his order, which it hopes to overturn, on hold as it prepares to exit the custody business. Citigroup called itself the victim of an "unprecedented international conflict of laws."
Argentina's economy ministry had no immediate comment.
Citigroup's decision may further complicate Argentina's efforts to pay bondholders and return to global debt markets, more than 13 years after its 2001 default on roughly $100 billion of bonds.
Most investors holding Argentina bonds exchanged them for bonds worth much less, but a group of bondholder holdouts rejected the swaps.
These holdouts, including billionaire Paul Singer's Elliott Management LP hedge fund and its NML Capital affiliate, as well as the Aurelius Capital Management hedge fund, have insisted they be paid in full if holders of exchanged bonds are paid.
In his March 12 order, Griesa ordered Citigroup not to process a $3.7 million interest payment due March 31 on bonds issued under Argentine law.
The judge had previously blocked payments on bonds governed by New York and English law. His injunction last year set off another Argentina default on July 31.
As custodian, Citigroup is supposed to transfer interest payments to clearinghouses that in turn pay bondholders.
Griesa's repeated rulings in favor of the holdouts have prompted defiance from Argentina and its president Cristina Fernandez, who has labeled the holdouts as "vultures" bent on astronomical profits.
Fernandez cannot seek a third term, and her successor will take office in December.
The March 12 order "put an end to any serious thought for Argentina to issue foreign currency debt to foreign investors," said Mark Weidemaier, a University of North Carolina law professor specializing in sovereign debt disputes.
"It now becomes a waiting game," he said. "The decision gives holdouts more leverage, but it might be that the current administration in Argentina is not interested in settling, and will hand the problem to its successor."
In a letter late Tuesday, Aurelius' lawyers urged Griesa not to put the order on hold, saying Citigroup neither committed to ending its role in making bond payments, nor showed how exiting the custody business created an "emergency need" for a stay.
A spokesman for Elliott declined to comment.
The bank has portrayed itself as an innocent third party stuck with an untenable choice between ignoring Griesa, or putting its Argentina banking license in jeopardy.
In his March 12 order, Griesa expressed sympathy for Citigroup, but said Argentina's recalcitrance caused Citigroup's predicament, and that any third party that aids the country's payment process would violate his injunction.
Griesa also again urged Argentina to work with court-appointed mediator Daniel Pollack to end its disputes with the holdouts. Pollack declined to comment.
Citigroup tried to downplay its decision to quit the Argentina custody business, saying that business has "no meaningful connection with banking business in general," and concerns only servicing assets belonging to clients.
Shares of Citigroup closed up 15 cents at $53.84.
The case is NML Capital Ltd v. Argentina, U.S. District Court, Southern District of New York, No. 08-06978. (Reporting by Jonathan Stempel in New York; Additional reporting by Hugh Bronstein and Richard Lough in Buenos Aires; Editing by Jeffrey Benkoe, Tom Brown and Richard Chang)