UPDATE 1-Co-op works on scheme to avoid paying extra into bank - report

Sun May 4, 2014 8:20am EDT

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(Adds Co-op Bank comment in paragraphs 6 and 7)

LONDON May 4 (Reuters) - Britain's Co-op Bank will announce details this week of a 400 million pound ($675 million) rights issue that is expected to leave its former owner holding just over 20 percent in the troubled lender.

According to Britain's Sunday Telegraph newspaper, the Co-op Group is expected to tell its old banking arm it will take up only some of the 120 million pounds worth of shares it can buy due to its 30 percent stake in the firm.

The struggling mutual, which is already committed to handing the Co-op Bank more than 200 million pounds this year under the terms of a 1.5 billion pound emergency recapitalisation, could undertake a 'tail swallow', whereby it sells enough of its options to avoid having to put any new money into the business, the newspaper said without citing sources.

The Sunday Telegraph said the technique was seen as a better option than selling all its rights and avoids the possibility of the Co-op's stake being diluted below 20 percent, which would mean it would lose any effective control over the bank.

The newspaper said Co-op Bank's boss, Niall Booker, and UBS bankers saw enough interest from existing and potential investors in buying some of the mutual's share of the rights issue to allow the Co-op Group to go ahead with its plan.

"The Bank's capital raise will be unaffected by the group's decision whether or not it participates, and to what extent it participates," a Co-op Bank spokesman said in a statement to Reuters.

"The Bank is confident that it will raise the 400 million pounds with or without the group's involvement."

The Co-op Group declined to comment on the report.

The Co-op Bank came close to collapse last year after a 1.5 billion pound capital shortfall was exposed. A recapitalisation brought it under the control of bondholders including U.S. hedge funds.

On Wednesday, an independent review found its problems were rooted in its 2009 takeover of the Britannia Building Society and poor management controls. ($1 = 0.5927 British Pounds) (Reporting by Neil Maidment; Editing by Ruth Pitchford)

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