* Government to meet with five investment banks
* Foreign investment would lend credibility
* Non-equity part of bad bank to be financed by senior debt
By Jesús Aguado
MADRID, Nov 16 Spain's bad bank is generating a lot of interest among foreign investors, an economy ministry source said, and the government will meet with five investment banks on Monday to start the search for private capital.
The bad bank could go ahead with just domestic participation but non-resident investors would give the vehicle credibility, the source said on Friday.
Talks with domestic investors were ongoing, and the government hopes to meet five investment banks as of Monday in the search for private interest, the source added.
Spain has set up a bad bank to siphon off toxic real estate assets dating from a 2008 property crash from balance sheets as a condition of receiving up to 100 billion euros ($127 billion) of aid in a European bail-out of the sector.
The Spanish government expects to apply for between 35 billion and 40 billion euros of that aid.
The reduced final bill takes into account the transfer of assets to the bad bank, capital raising operations, such as Popular's 2.5 billion euros capital increase, and the forced losses on holders of hybrid and junior debtholders.
A source involved in the negotiations said on Friday that Bankia's junior debt holders will likely take a loss of less than 50 percent
The bad bank, known as Sareb, is due to be up and running by the end of November and will have a maximum asset value of 90 billion euros.
It will initially receive assets from four state-rescued banks, including Bankia, worth 45 billion euros.
The bad bank will have an initial equity tranche of 3.9 billion euros. Around 800 million euros of that will be capital and 3.1 billion euros will be subordinated debt.
In a second stage, after including the assets of a further group of lenders in need of public aid who will be forced to transfer assets, the total volume could be worth around 60 billion euros over time and the equity tranche could go up to 5 billion euros.
"In the end our objective is that international lenders will have to invest around 500 million euros of pure capital," the source said.
The rest of the bad bank will be financed by senior state-backed bonds with an average maturity of 1.9 years priced at Euribor plus 200 basis points, according to the source. These can be used as collateral with the European Central Bank to get liquidity.
Government sources said Spain's bank restructuring fund, the FROB, could use part of the European aid to invest in the bad bank as laid out in the Framework Agreement for Financial Assistance (FAFA), subscribed to in July as part of the banking bailout. The fund did not therefore need to tap the markets, the sources said.
Sources told Reuters earlier this month that Spain's main banks, Santander, BBVA and Caixabank would likely be the main investors in the bad bank.
Spain's government wants to keep its stake in the bad bank below 50 percent to reduce the burden on state finances and a direct impact on public debt and expects private investors to own at least 55 percent.
It is applying steep discounts to property assets transferred into the bad bank and has pledged significant returns in a move to lure reluctant investors.
It has also promised tax breaks for investors.
Since peaking in 2007, housing prices have fallen around 30 percent on average but analysts consider the bottom of the market may still be two years off, with prices potentially falling a further 20-30 percent.
The bad bank will operate for up to 15 years and will mainly manage bad loans, repossessed homes and buildings and unfinished or unsold housing developments.
Madrid wants the bad bank to have a return on equity of 14 percent to 15 percent in a conservative scenario, though Spanish authorities do not rule out the vehicle registering losses in the first years of its existence.