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UPDATE 3-RBS sets milestone with upbeat Direct Line flotation

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* RBS sells 30 pct of Direct Line at 175p/shr

* Raises $1.3 bln from sale of 450 mln shares

* Retail investors take up 15 percent of offer

* Shares set first-day premium, trade at 184p

(Recasts, adds detail, background and quotes)

By Matt Scuffham and Myles Neligan

LONDON, Oct 11 (Reuters) - Shares in Direct Lineset a premium on their stock market debut on Thursday, marking amilestone for parent Royal Bank of Scotland (RBS) whichneeded a successful float of the insurance unit as a key part ofits recovery plan.

Strong demand from private investors helped RBS raise 787million pounds ($1.3 billion) through the sale of 30 percent ofDirect Line's shares at 175 pence per share, near the middle ofthe initially stated range and valuing the business at 2.6billion pounds ($4.2 billion).

The shares were trading at 184p by 0900 GMT, a firmperformance which also highlighted a recovery in Europe's IPOmarkets from an extended hiatus.

In the same sector, Germany's third-biggest insurer TalanxAG has also performed well after its recent IPO, withits shares trading 8 percent ahead of the offer price.

RBS is selling Direct Line - whose frequent TV adverts havemade its four-wheeled red phone motif a well-known corporatesymbol - in return for winning approval from European Union (EU)regulators for a bailout during the 2008 financial crisis thatleft it 82 percent state-owned.

The bank said on Thursday the sale marked the nextimportant step in its recovery plan, having earlier this yearfinished paying back emergency loans to Britain and the UnitedStates.

It is also poised to exit a government insurance schemedesigned to protect its weakest assets later this year.

RBS has said it plans a three-stage sale of Direct Lineunder which further share sales will take place next year and in2014. Under the EU directive, it must sell more than 50 percentby the end of 2013 and the rest of its shares a year later.

The successful flotation defies recent concerns thatinvestor appetite would be damaged by a British anti-trustinquiry into allegations of over-charging in the car insurancemarket in which Direct Line is a major player.

STRONG DEMAND

The sale was boosted by strong demand from retail investors,who have been starved of opportunities to participate inlarge-scale IPOs in recent years. The Direct Line IPO was thebiggest retail share offering in Britain since money managerHargreaves Lansdown Plc five years ago.

On a conference call with reporters, Direct Line ChiefExecutive Paul Geddis said retail investors had purchasedbetween 5,000 pounds and 6,000 pounds worth of shares on averageand had taken up 15 percent of the shares sold.

Geddis added that the offering had been "comfortablyoversubscribed".

London Stock Exchange Chief Executive Xavier Roletsaid the level of retail interest in the issue had underlinedthe appeal of London's equity markets to private investors.

Brokerages had on Tuesday reported a surge in late demandfor the shares from private investors, with Redmayne-Bentley forinstance saying orders had almost doubled since the weekend.

RBS had been under pressure to secure a good price for thebusiness, with taxpayers sitting on a loss of 21 billion poundsafter Britain pumped in 45 billion to rescue the bank.

Analyst Eamonn Flanagan at brokerage Shore Capital said theprice for Direct Line stock was a "reasonable outcome", althoughthe company's value is below the cut-off point of about 3billion pounds for membership of Britain's elite FTSE 100 index.

The price was near the middle of the 160 to 195 pence rangeset by RBS when it launched the IPO on Sept. 28.

Goldman Sachs and Morgan Stanley ran theDirect Line offering, acting as joint bookrunners along with UBS. They are in line to share fees of as much as 17.4million pounds with the other eight banks involved in theinstitutional portion of the share sale.

RBS sold 450 million Direct Line shares in the offer,representing 30 percent of the business, with a 15 percentover-allotment option.

($1 = 0.6242 British pounds)

(Addirional reporting by Kylie MacLellan; Editing by Dan Lalorand David Holmes)

((matthew.scuffham@thomsonreuters.com)(02075426734)(Reuters

Messaging: matthew.scuffham.reuters.com@reuters.net))

Keywords: DIRECTLINE IPO/