UPDATE 2-Bankia shares plunge as rescue wipes out investors
* Analysts say more selling pressure expected
* Shares seen dropping to as low as 0.004 euro (Adds analysts, background)
By Julien Toyer
MADRID, March 25 (Reuters) - Shares in nationalised Spanish lender Bankia slumped on Monday after a rescue fund valued the stock at a rock-bottom 0.01 euro before a planned injection of fresh capital.
The valuation wiped out investors in the country's fourth-biggest bank and was widely expected as the government tries to draw a line under Spain's biggest-ever bank failure and give Bankia a fresh start.
But the pain for investors, many of them small Spanish investors who bought into the lender's July 2011 initial public offering at 3.75 euros a share, is unlikely to end there.
Bankia is expected to dip far below the new bailout price in coming months as investors focus on the bank's weak state, a struggling Spanish economy and a new government plan to partially merge Bankia with two other troubled lenders.
Under Bankia's recapitalisation, hybrid debt and preference shares are due to be converted into discounted ordinary shares.
Analysts believe thousands of the bond and preference share owners will sell their new ordinary stock at the earliest opportunity to try to recoup some their heavy losses, pulling the shares down further.
Bankia stock was at 0.155 euro by 1444 GMT on Monday compared to their Friday close of 0.25 euro. Selling pressure was so great that trading in Bankia shares began more than an hour after the market open.
Analysts expect Bankia shares to progressively adjust to the 1 euro cent valuation before the cash injection due in May, but say it could later fall as low as 0.004 euro.
The bank, formed in 2011 from the merger of seven savings banks, is showing tentative signs of recovery as it prepares to receive an injection of 10.7 billion euros ($13.91 billion) in European bailout funds in May.
Spain's government requested 41 billion euros from its European partners to rescue Bankia and other lenders that had amassed bad debt from the country's 2008 property market crash.
Many preference share owners were unsophisticated investors and the way the instruments were sold was seen as a national scandal. There are frequent protests on the streets and in banks by holders of the preference shares demanding compensation.
Espirito Santo analysts said that both the dilution of current shareholders and the losses imposed upon bondholders represented an additional risk for the bank because they were also some of its best and valuable clients.
Other hybrid debt owners are believed to be credit funds and many of them are likely to sell their new stock, JP Morgan said.
Bankia says it hopes to return to profit in 2012 after reporting a 19.2 billion euros loss for 2012.
But analysts say its prospects still look bleak. Its asset quality is seen as poor, it is beholden to the European Central Bank for funding and the economy is still in a parlous state, with more than a quarter of working-age Spaniards unemployed.
"Short-term earnings will be pressured by the re-pricing of asset yields at the current interest rates, the need to reduce the reliance on the ECB and asset quality deterioration on the mortgage and SME segment," analysts at BPI said in a note.
The conservative government also wants to partially merge Bankia with two other rescued lenders - CatalunyaBanc and NCG Banco - that would operate under a single holding company. . Both are expected to report losses this year and next.
On Monday, credit rating agency Standard and Poor's downgraded Bankia to BB- from BB and its parent company BFA to B- from B.
It removed those ratings from negative outlook but said it would closely monitor the implementation of the bank's restructuring plan, its dependence on ECB funds and Spain's economic and financial performance. ($1 = 0.7694 euros) (Reporting by Julien Toyer; Editing by Tom Pfeiffer)