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* IPO will create new independent challenger bank
* Lloyds had to sell business as condition of bailout
* TSB wants 6 percent market share in 4 to 5 years
* TSB won't pay dividend until 2017 (Adds comments from TSB Chief Executive)
By Matt Scuffham
LONDON, May 27 (Reuters) - Lloyds Banking Group expects to float about 25 percent of its TSB business on theLondon Stock Exchange next month, it said on Tuesday, kickingoff a process regulators hope will create a vibrant challengerto Britain's dominant high-street lenders.
Lloyds was forced by European regulators to sell the 631branches which now form TSB as a condition of receiving stateaid during the financial crisis five years ago and it musttherefore now sell the whole of TSB by the end of 2015.
However, the number of shares being sold in the initial offeris at the bottom end of expectations and banking industrysources said last week they expect them to be priced at lessthan TSB's book value of 1.5 billion pounds ($2.5 billion), meaning Lloyds will make a loss on the sale of the 200-year oldbrand.
That reflects a cooling of investor interest in UK companyflotations in recent weeks following a rush of activity earlierin 2014. Clothing chain Fat Face pulled its planned Londonlisting last week while holidays-to-insurance firm Saga pricedits IPO at the bottom of its original range.
Lloyds had planned to sell the branches to the Co-operativeBank but that sale fell through last year when a 1.5billion-pound funding gap at the Co-op emerged.
It subsequently revived the TSB brand, last seen on Britishhigh streets in the 1990s, with a view to a stockmarket sale.
Lawmakers and banking regulators are keen to see new banksemerge to break the dominance of Britain's biggest five lenders,which control more than three quarters of the personal currentaccount market, and TSB is seen as a viable challenger.
The bank already has 4.5 million customers and 6 percent ofbank branches in the UK, making it Britain's seventh-largestretail bank and giving it a headstart over other new entrants.
"We have the mindset and growth potential of a challengerbut with the scale and capabilities of an established player,"Chief Executive Paul Pester said on Tuesday.
However, TSB has only a 4.2 percent share of the personalcurrent account market and Pester said it would take four tofive years to reach its target of a 6 percent share.
Pester said TSB had picked up more customers than it lostsince the brand was re-introduced to the high street lastOctober.
"We are a net gainer from every major bank in the UK atpresent," he told reporters.
The share sale is expected to be completed by the end ofJune, with a prospectus due to be published in just over twoweeks' time.
TSB is hoping to attract investors looking for exposure toBritain's economic recovery from a bank which is untainted byissues of past misconduct. The bank has agreed an indemnity fromLloyds against historical conduct-related losses meaning it willnot need to pay out for past misconduct such as the mis-sellingof loan insurance, which has cost Lloyds 9.8 billion pounds.
DIVIDEND PROSPECTS
TSB's focus on growth means that it doesn't anticipatepaying a dividend to shareholders until 2017 at the earliest,Pester said. The bank plans to expand its balance sheet by 40 to50 percent over the next five years and is targeting a return onequity of 10 percent or over. On 31 March 2014 it had 23.3billion pounds of deposits and 19.7 billion of assets.
The bank plans to attract retail shareholders with an offerof one free share for every 20 shares acquired in the initialpublic offer, up to a maximum investment of 2,000 pounds,provided they hold them for a year.
Pester said he expected between 15 and 20 percent of theshares will be sold to retail investors, rather thaninstitutions such as pension funds and insurers.
JP Morgan and Citigroup are leading the IPOprocess. UBS is joint bookrunner ($1=0.5936 British Pounds)
(Additional reporting by Huw Jones; Editing by David Goodmanand Greg Mahlich)
