UPDATE 2-Spain bad bank pricing to favour lenders over investors

* Property assets to be transferred at 45-50 percent discount

* That would be 5-10 pct on top of existing average writedown

* Foreign investors could be put off by the pricing

* Spain's healthy banks also reluctant to participate

By Jesús Aguado and Julien Toyer

MADRID, Sept 24 (Reuters) - Spain's so-called "bad bank" is planning to take over soured property assets from struggling lenders at a modest additional discount to book value in order to protect struggling banks from further losses, three senior banking sources told Reuters.

But if the pricing is too generous for lenders, Spain may struggle to find foreign investors to participate in the scheme and it could end up costing the state more money, they warned.

Spain, the latest centre of the euro zone debt crisis, is setting up the "bad bank" as a condition of receiving up to 100 billion euros in European money for its ailing financial system.

The Spanish government is now in talks with euro zone peers and the European Central Bank over a bond-buying programme which would bring down its borrowing costs and give the country breathing room to reform its economy and its banks.

Three senior banking sources told Reuters on Monday that assets would be moved into the "bad bank" at a discount of 45 to 50 percent from their original book value before a decade-long property bubble burst in 2007.

The figure is obtained by applying an additional discount of 5 to 10 percent over average writedowns of around 40 percent that the government has already forced banks to take on real estate assets, the sources said.

Pricing is key. If the discount is too high it could force fragile lenders - such as the four nationalised banks that will provide the bulk of the property assets going to the bad bank -- to book further losses.

If it is too low it could make the scheme unattractive for investors and force the state to use more taxpayer money to take the property off of banks' books.

"As an average we could see further writedowns of 10 percent," said one of the sources - a manager at a Spanish bank.

A second source said the additional discount would be equivalent to a capital buffer lenders were asked to set aside earlier this year but which has now been made irrelevant by new, higher capital requirements.

By assuring that the new writedowns would be compensated by the capital buffer, Spanish authorities would protect banks from booking new losses.

"This is the trick that is being used so that everything fits," the source said when describing the valuation method.

The sources cautioned that the discount was still being discussed and could vary depending on the type of assets that will be transferred, a key question that has yet to be answered.

The Bank of Spain and the European Commission, which are leading the negotiations and will have the final say on the assets pricing, declined to comment on the matter.

INVESTORS

The bad bank, to be up and running by the end of November, will operate for up to 15 years and manage up to 100 billion euros of bad loans, repossessed homes and buildings and unfinished or unsold housing developments.

It will hope to repeat the success of its Irish equivalent, known as NAMA, which began to generate profits only two years after it was formed, but acquired assets with a steeper discount of more than 56 percent.

Although the state wants to limit its ownership at under 50 percent, to a void an i mpact on public debt, it could take time to find private investment.

A piecemeal reform of the banking sector has failed to lure a single foreign investor and experts and banking sources see a clear need for Spanish authorities to impose major discounts on assets given that housing prices may still have a way to fall.

Home prices have fallen 20 percent to 30 percent since 2007, but experts say the bottom of the market is still at least two years away.

Uncertainty over Spain's real estate prices as well as a psychological barrier to investing in the country, will make the bad bank a hard sell, since its valuation floor is the ceiling for many investors in distressed assets.

"For distressed investors to get the returns they look for, they would look to get assets at discounts of 50 percent and below," said a partner at a firm that brokers deals for investors looking at assets coming out of banks.

Spain hopes to remove doubts when it publishes on Friday the results of an independent stress test of its banks. Economy Minister Luis de Guindos has said Spanish lenders would need around 60 billion euros in new capital.

If Spain cannot lure foreign investors another option is to convince Spain's sound banks, under no obligation to participate in the "bad bank", to transfer assets or invest in the scheme.

A source at the Bank of Spain, however, said he didn't see much sense in healthy banks getting into the bad bank as they would likely want to continue managing their own troubled assets to minimise losses.

According to the sources, Santander and BBVA are coming under political pressure to step in, and the state bank rescue fund FROB is trying to lure them into the scheme by negotiating incentives such as improved conditions for snapping up retail branches being sold by nationalised lenders.

Last week, Francisco Gonzalez, the chairman of BBVA, Spain's second-biggest lender, said foreign investors would likely shy away from the bad bank, but opened the door for his bank to participate.

Santander, the euro zone's biggest bank, has not made public its decision on the matter and declined to comment on the issue.