* Lloyds sells 35 percent stake at 260 pence per share
* Shares rise by 15 percent on market debut
* IPO was 10 times oversubscribed
* Next sale could happen as early as September
* Carney comments on interest rates boosted sentiment (Adds comments from analyst, industry source)
By Matt Scuffham
LONDON, June 20 Shares in TSB rose sharply following its debut on the London stock market after Lloyds Banking Group sold more of the offshoot business than originally planned, raising the prospect of a further sale this year.
Lloyds said on Friday it had sold a 35 percent stake in TSB, Britain's 7th-largest lender, at 260 pence a share. That valued the business at 1.3 billion pounds ($2.2 billion), less than the figure on Lloyds' books.
The TSB share sale is another step on the recovery path for Lloyds following its 20 billion pound state bailout in 2008 and will help clear the way for the government to sell its remaining 25 percent Lloyds stake.
Lloyds was ordered to sell the 631 TSB branches by European regulators by the end of 2015 as a condition of the bailout, and initially planned to sell one quarter of the business.
Shares in TSB hit a high of 299.75 pence on Friday, up 15 percent on the initial public offering (IPO) price. That pushed the bank's market value up to 1.5 billion pounds, or 0.95 times book value.
TSB attracted investors looking to tap into Britain's economic recovery through a bank that was untainted by the scandals such as interest-rate rigging that have dogged the sector since the financial crisis.
Demand was also boosted by comments from 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.
"One element of investor interest has centred on the rate sensitivity of the name but you've also got a general recovery in the UK economically," said Jefferies analyst Joe Dickerson.
TSB is seen to be a "clean" bank, having reached an agreement with Lloyds ensuring it will not have to pay for past errors. That means, for instance, that it won't have to compensate customers mis-sold loan insurance, a scandal that has cost British banks more than 20 billion pounds.
"People are attracted to it because it's a pure, clean retail bank. It doesn't have any of the sins of the past or any of the potential issues that others have. There's not a lot of downside risk to it. They also like that it's a growth story in banking," one industry source told Reuters.
However, other banking industry sources said that some investors were doubtful about the stock after TSB indicated that initiatives to win new customers would rule out dividend payments until 2017.
Lawmakers are keen for new banks to break the dominance of Britain's "Big Four", which includes HSBC, Royal Bank of Scotland and Barclays alongside Lloyds.
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.
The bank wants to expand its personal current account market share to 6 percent from 4.2 percent. It also plans to grow its balance sheet by 40 to 50 percent over the next five years and is targeting a return on equity (RoE), a key performance measure, of 10 percent or more.
By comparison, Lloyds achieved an RoE of 13 percent last year, while state-backed rival RBS managed 4.6 percent and Barclays' was just 4.5 percent.
MORE TO COME
Lloyds, which made gross proceeds of 455 million pounds from the sale, has agreed not to sell any more TSB shares for 90 days but the strong debut will increase the likelihood of the bank looking to offload its remaining stake significantly ahead of the end of 2015 deadline set by regulators.
Lloyds is expected to sell the remaining shares in two further stages. The next sale could happen as early as September, the sources said, although that may depend on whether the British government decides to sell more of its remaining 25 percent stake in Lloyds that month as the bank's advisors would not want the two sales to compete against each other.
TSB's 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 RBS based on their current share prices.
The European Commission's original sale deadline of November 2013 had to be extended 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.
However, the price fetched by the IPO has far outstripped the 750 million pounds which Lloyds had agreed to sell the business to the Co-op for.
Sources with knowledge of the transaction said TSB shares were 10 times oversubscribed, after attracting strong demand from British and U.S. investors and interest from Asia.
Thirty percent of the shares were sold to 60,000 retail investors with those that applied for up to 2,000 pounds worth of shares receiving their full amount.
Another 3.5 percent is expected be taken by JP Morgan Cazenove as part of its role as underwriter on the initial public offering (IPO).
($1 = 0.5864 British Pounds) (Editing by Erica Billingham)