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UPDATE 2-US govt to sell most of Ally Financial stake in IPO

* U.S. Treasury to sell 95 mln shares of Ally in IPO

* Successful IPO will see govt turn profit on Ally bailout

* Ally expects IPO to be priced at $25-$28/share

* Market value to be about $13.5 bln at top of price range

(Adds details, background)

March 27 (Reuters) - Bailed-out auto lender Ally Financial Inc said the U.S. government would sell the bulk of its stake in the company in an initial public offering that could raise up to $2.66 billion.

A successful IPO will mean the U.S. Treasury has turned a profit on the bailout, while still owning at least 14.1 percent of the company.

The Treasury is selling 95 million shares at between $25 and $28 per share, Ally said in a regulatory filing with the Securities and Exchange Commission on Thursday. (http://link.reuters.com/qyd97v)

The auto lender was bailed out for $17.2 billion during the 2008 financial crisis. Ahead of the IPO, taxpayers have recovered $15.3 billion.

The Treasury currently owns 36.8 percent of Ally, which will have a market value of about $13.5 billion at the top of the expected IPO price range.

The U.S. government's stake will fall to 14.1 percent if underwriters exercise an option to sell additional shares on behalf of the government.

The government injected funds into Ally after the bank's Residential Capital mortgage unit suffered deep losses from home loans that went bad.

Reuters reported in February that Ally was hoping for an IPO of as much as $4.5 billion.

Ally initially filed for an IPO in March 2011, but the company delayed its plans several times due to market conditions and as it faced potential fines over its mortgage lending.

The pricing of the IPO is scheduled for April 9, two underwriters to the offering told Reuters.

Activist investor Daniel Loeb's hedge fund Third Point LLC and Cerberus Capital Management are not selling any of their shares in Ally in the IPO.

Third Point has a 9.5 percent stake in Ally, while Cerberus Capital owns an 8.6 percent stake.

LOST TRACTION

Ally was among the auto, housing and finance companies bailed out in 2009 under the $423 billion Troubled Asset Relief Program (TARP). Taxpayers have recovered $418 billion from TARP as of Wednesday.

After its bailout, the company sold most of its international operations, exited home loans and cut its cost of funds by raising deposits and redeeming expensive legacy debt.

However, Ally faces challenges and increased competition in its main auto finance business, especially as it is no longer the preferred lender for General Motors Co and Fiat Chrysler.

Ally's fourth-quarter profit was hurt by a charge to settle allegations by regulators that it discriminated against minorities in auto lending.

The company's auto finance business also slowed in the quarter, with new loans falling 8 percent to $8.2 billion as its agreement as Chrysler's preferred lender expired.

Ally reported earnings of $361 million and revenue of $4.26 billion for the year ended Dec. 30.

Citigroup, Goldman Sachs & Co, Morgan Stanley and Barclays are lead underwriters for the offering.

Ally will list on the New York Stock Exchange under the symbol "ALLY".

(Reporting by Tanya Agrawal and Aman Shah in Bangalore; Editing by Savio D'Souza and Kirti Pandey)