UPDATE 1-Lloyds increases TSB share sale after strong demand -sources
* Bank to sell more than expected 25 pct -sources
* IPO priced at 260 pence per share vs 220-290 range
* Values TSB at 1.3 bln stg, 0.8 times book value
* At least a quarter of shares sold to retail investors
* Sale at least 10 times oversubscribed -sources (Adds IPO price, size of stake to be sold)
By Matt Scuffham
LONDON, June 19 (Reuters) - Britain's Lloyds Banking Group has increased the number of TSB shares it is selling following strong investor demand for the stock market listing, sources familiar with the matter said on Thursday.
Lloyds, which was ordered to divest 631 branches by European regulators, will sell a 38.5 percent stake in the rebranded TSB business on Friday, the sources said. It had originally planned to begin the disposal by selling only a quarter.
The shares will be sold at 260 pence each, towards the upper end of the 220-290 pence range the bank had set. That values the business at 1.3 billion pounds ($2.2 billion), about 0.8 times its valuation on Lloyds' books.
The initial public offering (IPO) has attracted interest from investors in Britain, the United States and Asia, the sources said, including both private retail investors and financial institutions such as pension funds and insurers.
Sources familiar with the matter said demand for the shares outstripped the amount on offer by more than 10 times. At least a quarter of the shares will be sold to retail investors, the sources said.
The valuation is lower than the 1.3 times net asset value at which Lloyds itself trades, but it is ahead of the 0.7 multiple of rivals Barclays and Royal Bank of Scotland, based on their current share prices.
Lloyds, which is 25 percent owned by the government, was told by European competition regulators to sell the branches as a condition for approval of state aid received by the banking group during the 2008 financial crisis.
Lawmakers are keen for new challengers to emerge to break the dominance of Britain's "Big Four" lenders, including Barclays, RBS and HSBC.
The re-emergence of TSB after it disappeared from Britain's high streets in the 1990s is expected to create a credible competitor.
TSB has a head start over other new players, with 4.5 million customers and 6 percent of Britain's bank branches. But it has only a 4.2 percent share of the personal current account market and has said it will take four to five years to hit its 6 percent target.
Lloyds is expected to sell the shares in three stages, employing a similar strategy to that of RBS when it sold its Direct Line insurance business, with each tranche priced higher than the previous sale.
The European Commission's original sale deadline of November 2013 had to be extended to the end of 2015 after the collapse of a planned sale to the Co-operative Bank, which sparked a parliamentary inquiry and inflated the cost of the sale process to 1.6 billion pounds.
The success of the listing comes after investor interest in British flotations had cooled in recent weeks. Clothing chain Fat Face pulled its planned listing last month, while shares in insurance-to-holidays firm Saga have fallen below their issue price.
Industry sources say that a successful sale will depend largely on the performance of the stock in its first days of trading. Lloyds and its advisers will be looking for a strong showing to smooth the path for future share sales.
Though the IPO has attracted investors looking to tap into Britain's economic recovery through a bank that is untainted by the scandals that have dogged the sector since the financial crisis, banking industry sources said that some had needed convincing after TSB indicated that initiatives to win new customers would rule out dividend payments until 2017.
Demand received a timely boost from comments by Bank of England Governor Mark Carney last week, who indicated that UK interest rates could rise sooner than financial markets expect, potentially boosting TSB's profitability.
TSB could be the first of a number of British banks to list on the London Stock Exchange over the next two years. Banking sources say that fledgling lender Aldermore is considering a listing this year and that Virgin Money and Santander UK could float next year, followed by Williams & Glyn, which is being spun out of RBS, in 2016.
The government also plans to sell its remaining 25 percent stake in Lloyds before the next election in May 2015. (Editing by David Goodman and Jane Baird)