UPDATE 1-Monte dei Paschi debt swap targets bonds for up to 5.3 bln euros

(Adds details, background)

MILAN, Nov 14 (Reuters) - Ailing Italian lender Monte dei Paschi di Siena on Monday announced the terms of a planned debt-to-equity conversion, a key plank of a rescue scheme aimed at averting the bank being wound down.

The bank said the voluntary debt swap offer would target 4.289 billion euros ($4.6 billion) of subordinated bonds. It was also considering converting a hybrid financial instrument known as Fresh 2008 worth 1 billion euros.

The debt-to-equity swap is a crucial leg of a 5 billion euro ($5.4 billion) rescue plan aimed at meeting regulators’ concerns about the bank’s capital position and bad loans.

The bank aims to raise its equity by more than 1 billion euros as a result of the debt conversion, according to a source with knowledge of the matter, with the rest of the 5 billion euros coming from one or more cornerstone investors and a share sale on the market.

Under the rescue plan, the bank also aims to transfer some 28 billion euros of bad loans to a special vehicle, which will securitise them and put them up for sale.

A debt swap would reduce the amount of cash Monte dei Paschi needs to raise on the market, boosting its chances of pulling off the rescue plan which is seen as a test of investor confidence in Italy’s battered banking sector.

The bank said that if take-up of the planned conversion offer was judged not to be successful, it would be unable to launch the share sale and could be subject to European bail-in rules for dealing with bank crises, which include among other things the forced conversion of subordinated bonds.

Monte dei Paschi di Siena, the world’s oldest bank, emerged as the weakest lender in the latest round of European stress tests this summer.

The bank said that under the terms of the conversion scheme, it would offer between 85 percent and 100 percent of the bonds’ nominal value - except for a Fresh note with an outstanding amount of 28.6 million euros where it will be offering 20 percent.

A source close to the matter said retail bondholders would be offered the full nominal value of their notes, while institutional investors would mostly get 85 percent.

No senior bonds would be targeted in the conversion.

The bank aims to launch the debt swap by the end of this month, after a Nov. 24 shareholder meeting which is due to approve the rescue scheme.

The bank has so far failed to secure firm investor backing for its third stock sale in as many years partly due to rising political risks in Italy ahead of a constitutional referendum on Dec. 4 that could unseat the government of Prime Minister Matteo Renzi. ($1 = 0.9314 euros) (Editing by Cynthia Osterman)