* Sale to institutions expected as early as September
* Govt cool on private equity/sovereign wealth interest
* Up to a quarter of govt stake could be sold in 1st round
* Sovereign wealth would need to offer premium - source
* "Accelerated bookbuild" could allow overnight sale
By Matt Scuffham
LONDON, July 12 (Reuters) - Britain will start selling its shares in Lloyds Banking Group to pension funds and insurers later this year, rejecting interest from private equity and sovereign wealth funds, industry and political sources said.
The government could sell up to a quarter of its 39 percent stake as early as September, the sources said, especially if the bank's first-half results, due in August, are well received.
Lloyds is expected to report a sharp rise in profit, which would raise hopes it can start paying dividends again in 2014 and increase its attractiveness to investors.
Britain's Conservative-led coalition government sees a sale as a milestone in Britain's recovery from the 2008 crisis, during which taxpayers pumped a combined 66 billion pounds ($100 billion) into Lloyds and Royal Bank of Scotland.
Sources with knowledge of government thinking said it was cool on the idea of a sale to private equity or sovereign wealth funds, despite a number of parties expressing an interest, and would require such investors to pay at least market price or a premium to guarantee value for taxpayers.
It wants to avoid the possibility of being seen at a later date to have sold off the assets too cheaply to overseas buyers.
The government wants the deal to be free of controversy in order to garner maximum political benefit in the run-up to a 2015 general election.
The sale will take the form of an "accelerated book build" in which up to 10 percent of shares in the bank would be sold to financial institutions over a period of one or two days, raising between 4 billion pounds ($6.1 billion)and 5 billion.
A sale to institutions could be made at around a 5 percent discount to the market price, banking sources said.
The government would ideally like to follow the example of Deutsche Bank, which raised 3 billion euros overnight in April, placing new shares at the previous day's close.
Officials are aware of the kind of backlash endured by Barclays, accused of offering too-generous terms in return for billions of pounds worth of investment from Qatar's sovereign wealth fund during the 2008 financial crisis, a deal which has since come under scrutiny from UK authorities.
That stacks the odds against sovereign wealth funds, from which sources said the government has received tentative approaches, and a consortium led by ex-Standard Chartered boss Mervyn Davies, which includes U.S. private equity firm Corsair Capital, in which Davies is a partner.
However, the government may seek "cornerstone" investors to underwrite a placing, sweeping up any shares not bought by the institutions, banking sources said, possibly handing private equity players a route into the sale process.
Osborne had always been keen to kick off the sale before the next general election, but the strong performance of Lloyds shares, which were the top performer on the FTSE 100 last year and hit a 2-1/2-year high this week, has made an earlier sale possible.
In his annual address to London's financial elite last month, Osborne said Britain was ready to start selling the shares.
Bankers now see September as a realistic date for kicking off the sale, and UK Financial Investments (UKFI), which manages the government's stakes in Lloyds and RBS, is in the process of appointing advisors for a sale.
Shares in Lloyds are trading comfortably about the 61.2 pence level which the government regards as its break-even.
The government had been expected to sell the shares in four tranches, leaving a year's gap between each sale, but that could be accelerated if enough interest is evident. The U.S. offloaded $32 billion worth of shares in Citigroup in 2010.
Subsequent placings are likely to include sales to private retail investors, which will require the bank to draw up a prospectus, taking a number of weeks.
Britain is also selling a majority stake in the Royal Mail postal service on the stock market in what will be the country's biggest privatisation in over 20 years.
Britain's finance ministry, Lloyds and UKFI declined to comment.