UPDATE 2-RBS races ahead with Direct Line sell-off
* RBS sells further 17 pct Direct Line stake for 507 mln pounds
* Takes holding below 50 pct before end-2013 deadline
* Scrutiny on UK banks' capital before key regulator meeting
* Direct Line shares down 3 pct, RBS down 2 pct (Adds analyst's comments, details)
By Steve Slater
LONDON, March 13 (Reuters) - Royal Bank of Scotland has sold off a further stake in UK insurer Direct Line for 507 million pounds ($755 million), taking advantage of a buoyant market to cut its holding well ahead of an end-of-year regulatory deadline.
The state-backed bank, which sold 34.72 percent of Direct Line in its stock market float in October, said on Wednesday it sold a further 17 percent stake to institutional investors for 201 pence per share, a 4 percent discount to Tuesday's close but 20 percent up on the flotation price in October.
The sale will have a minimal impact on RBS's capital position, as it has exchanged an asset that was on its books for 216p per share for cash, but comes at a time when banks rescued in the financial crisis are under pressure from the UK government and regulators to bolster their capital and restructure to focus on their core domestic banking businesses.
The Bank of England's Financial Policy Committee (FPC), which looks out for trouble spots in the financial system, has said banks need to strengthen their capital, a message which analysts say is seen as being directed particularly to the part-nationalised lenders RBS and Lloyds Banking Group.
The BoE said banks need more capital to cushion themselves against losses from loans, compensation bills for mis-selling to customers and regulatory fines. The FPC has been discussing the issue with the banks before a March 19 meeting.
Banks should be able to address capital shortfalls by restructurings, shrinking their balance sheets, using debt that can convert into capital and other methods, but there was a risk the FPC sees RBS in particular as short of capital, said Investec analyst Ian Gordon.
"The FPC looks less willing to look through to what balance sheets will look like in the future," he said.
Lloyds, which is 39 percent state-owned, this week sold a 20 percent stake in wealth manager St. James's Place to boost its capital by about 600 million pounds and its core capital ratio by around 20 basis points.
Prime Minister David Cameron last month called on RBS, which is 82 percent-owned by the taxpayer, to speed up its restructuring, despite the fact that CEO Stephen Hester has already shrunk its assets by 900 billion pounds.
The government is keen to start selling shares in RBS in 2014, a year before the next general election, but the bank's shares are still more than a third below the price the government paid for them under its 45 billion-pound ($67 billion) rescue during the banking crisis.
Hester last month said he planned to partially sell the U.S. business Citizens, saying he had "accommodated" concerns held by the regulator.
The lender will also further shrink its investment bank, which should improve its capital ratio by reducing its assets, and will sell or float a portfolio of 315 UK branches.
The sale of the branches and Direct Line are required by the European Commission as the EU's competition regulator in return for allowing the bank's bailout by the UK government following the 2008 financial crisis.
RBS had to sell at least half of Direct Line by the end of this year, and the latest sale cuts its holding to 48.5 percent.
It has to sell the remainder by the end of 2014.
RBS had agreed to a 180-day "lock-up" not to sell more shares at the time of last year's IPO until April 9, but that was waived by the bookrunners. It said it will not sell any more shares for 180 days unless it gets consent again from the bookrunners. The sale was handled by Goldman Sachs, Morgan Stanley and UBS.
Direct Line shares were down 3.3 percent at 203 pence by 1315 GMT, when RBS shares were down 2.3 percent at 299 pence, and the Stoxx 600 Europe banking sector index was down 0.9 percent.
The RBS sale comes just before Direct Line's younger rival esure, is due to make its own London market debut on March 22. ($1=0.6718 British pounds) (Editing by Kylie MacLellan and Greg Mahlich)
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