* Draft legislation to bail in some creditors due soon
* Government wants to ensure taxpayers don't pay entire bill
* Moody's cuts Hypo ratings on bail-in concerns
By Michael Shields
VIENNA, May 24 Austria will propose within weeks draft legislation to make Hypo Alpe Adria's subordinated creditors help pay for winding down the nationalised bank despite ratings agency Moody's warning about the impact of imposing haircuts on bondholders.
The legislation will focus on "bailing in" holders of nearly 900 million euros ($1.23 billion) of debt guaranteed by Hypo's home province of Carinthia, not the 1 billion euros of debt with federal guarantees, a finance ministry spokesman said on Saturday.
Late on Friday Moody's cut to junk status its ratings for Hypo's guaranteed subordinated debt, citing the government's plan to hit up holders of subordinated debt backed by Carinthia.
Moody's also downgraded its guaranteed senior unsecured ratings to non-investment grade "to reflect the heightened risk to all bondholders arising from the government's apparent willingness to impose losses on creditors notwithstanding the existence of a statutory guarantee".
Austria decided in March not to let the ailing state lender go bust, ending months of uncertainty that unsettled financial markets and touched off a political storm.
Vienna instead will create a "bad bank" for nearly 18 billion euros of Hypo assets while pressing Carinthia and holders of subordinated debt to contribute to the costs.
The government wants to ensure taxpayers do not end up footing the entire bill for winding down Hypo and could use special legislation to go after some creditors, ministers had said at the time.
"We in the ministry are working intensely on the legislation. We still expect it will be in parliament before the summer break, which means we probably have to send it out for comment in the next two weeks," the ministry spokesman said.
The draft law would set up the "bad bank" for Hypo and spell out how to bail in subordinated creditors, he said, adding: "We expect it will concern the (debt with) provincial guarantees and not the federal guarantees."
He gave no details on the extent of any debt reduction - or haircut - the government had in mind.
The government has demanded that Carinthia - whose generous debt guarantees forced the state to take over Hypo in 2009 after its breakneck expansion at home and in the Balkans drove it to the brink of ruin - chip in at least 500 million euros.
Holders of 1.1 billion in non-voting participation capital - more than 1 billion state-owned but also 55 million at a Carinthia state holding company and 9 million at insurer Grazer Wechselseitige - will also get drawn in, officials have said.
Creating a "bad bank" relieves Hypo's chronic need for fresh capital but will also push up state debt to near 80 percent of economic output and nearly double the budget deficit to 2.7 percent this year.
That will leave a rump business comprising its Balkans banking network that is being sold ahead of a mid-2015 deadline set by the European Commission.
Austria also seeks a settlement with former Hypo owner BayernLB, which has 2.3 billion euros frozen at Hypo and has a say on major strategic decisions at Hypo. ($1 = 0.7336 Euros) (Reporting by Michael Shields; Editing by Stephen Powell)