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UPDATE 2-Bayer cuts Covestro stake to under 45 pct after share sale

* Sells 8.5 pct stake, 4 pct of Covestro goes into pension fund

* Issues bond exchangeable for Covestro shares in 2020

* All told, Bayer's Covestro stake could drop to 34.7 pct

* Bayer aims to wrap up $66 bln Monsanto takeover by yr-end (Adds analyst quote, Monsanto funding)

FRANKFURT, June 7 (Reuters) - Bayer has cut its stake in plastics and chemicals subsidiary Covestro to 44.8 percent after selling an 8.5 percent stake to institutional investors as part of a plan to sever ownership ties completely in the medium term.

Bayer, which is buying U.S. seeds giant Monsanto, has also issued 1 billion euros ($1.1 billion) in bonds that it can pay back with up to 6.1 percent of Covestro's shares and in addition it will transfer another 4 percent stake in Covestro into Bayer's pension trust.

The three measures combined could eventually see drugmaker Bayer's stake in Covestro decline to 34.7 percent but it will be up to Bayer whether to settle the bonds in cash, Covestro shares or a combination of the two when the contract expires in 2020.

Bayer, which floated Covestro in 2015, reaffirmed plans to sell all of its shares in the medium term.

While Bayer has stressed that the sale of assets, Covestro in particular, would not be a necessary part of funding the $66 billion Monsanto deal, analysts said the proceeds will come at an opportune time.

Selling shares serves "to strengthen the balance sheet" ahead of an expected capital increase, said DZ Bank analyst Peter Spengler.

As an initial step on the way to raising $19 billion worth of equity capital for the Monsanto deal - the biggest ever to be paid for in cash - Bayer placed 4 billion euros in mandatory convertible notes in November with a rights issue expected later this year.

Shares in Covestro - a maker of transparent plastics and materials for insulation and padding foams - dropped 4.3 percent to 63.23 euros at 1035 GMT on Wednesday. Bayer slipped 0.7 percent to 118.10 euros.

The price of Covestro shares at which Bayer can pay back the exchangeable bond in 2020 is initially set at 80.93 euros but it may change depending on Covestro's dividend payments.

The 8.5 percent stake was sold via an accelerated bookbuilding procedure for 62.25 euros apiece, generating just over 1 billion euros in gross proceeds as targeted.

The 4 percent Covestro stake transferred into Bayer's retirement fund would be worth about 530 million euros based on Tuesday's closing price, taking the combined value of the three transactions to over 2.5 billion euros.

Since the votes of Covestro shares held by Bayer's pension fund will be ascribed to Bayer, securing a majority of the voting rights, the parent company will continue to consolidate the subsidiary in its financial statements after the transactions.

Bayer transferred a stake of about 5 percent in the business into its pension fund in April last year. ($1 = 0.8886 euros) (Reporting by Harro ten Wolde; Editing by Muralikumar Anantharaman/Keith Weir)