* Popular says share issue planned by mid-November
* CFO says discount could be as steep as 50 percent
* Bank says scraps October dividend
* Spain banks shares rise after audit removes uncertainty
(Adds quotes from conference call, details, background)
By JesÃºs Aguado and TomÃ¡s Cobos
MADRID, Oct 1 (Reuters) - Spain's Popular , the largest non-nationalised bank to fail a stress test, is hoping to do a 2.5 billion euro($3.22 billion) share issue by mid-November to bolster its capital and avoid taking international aid.
Spain's banks are saddled with bad debts and economists say returning the sector to health is essential for pulling the economy out of a deep recession. Investors are waiting to see if Spain will ask for a sovereign bailout in addition to a credit line already offered to the banking sector.
The government asked consultant Oliver Wyman to audit 14 Spanish banks to see how much they needed to plug holes in their balance sheet. The results were released on Friday and found the banks needed an extra 59.3 billion euros.
It said Popular, Spain's sixth largest lender by assets and one of seven to fail the stress test, needed an extra 3 billion euros to make sure it could survive a serious economic downturn.
Popular shares fell after it said it would not tap into the 100 billion euro bank rescue package offered by euro zone countries but would do a share issue, sell assets and scrap its October dividend to fill the gap.
Other Spanish banking stocks rose on Monday after the publication of the audit removed uncertainty from the sector but analysts said there were still risks for the sector.
"The low-ball figure generates downside risks, being possibly perceived as falling short of market expectations for a far more complete (though more expensive) balance sheet clean-up," said Flemming Barton, analyst at CM Capital Markets.
At 1307 GMT, Popular shares were down 9.6 percent compared with a 1.2 percent gain in Spain's leading index Ibex-35 and with a 1.5 percent rise in the European banking index
Many Spanish banks became saddled with repossessed property and sour loans to real estate developers after a construction boom collapsed in 2007. Defaults on mortgages and loans to other sectors of the economy have also risen as the recession deepens.
Spain has said it would only need to use 40 billion euros of the euro zone aid since some banks could meet part of the extra capital needs themselves.
Popular said it would go the market shortly.
"We expect to launch the share increase in the next five weeks, probably by mid-November," Popular's Chief Financial Officer Jacobo Gonzalez-Robatto told a conference call with analysts on Monday.
Gonzalez-Robatto said the terms of the share issue would be favourable to its existing shareholders and the discount could be as steep as 50 percent compared to Friday's closing prices of 1.701 euros.
"The exact discount will be known just days before the share issue takes places and will also depend on the final volume," he said. The deal would be made easier if Spain's government requests aid for the sovereign, from Europe, he added.
The 2.5 billion euros rights issue is equivalent to 80 percent of Popular's current market capitalization or 50 percent taking into account an obligatory convertible bond of 1.5 billion euros.
Banco Popular said it has already lined up more than a dozen investment banks to underwrite the capital increase, with commitments of up to 7.5 billion euros.
Popular needs to reduce its capital shortfall to around 2 billion euros by December if it wants to avoid a public capital injection in the short term.
In addition to selling new shares, Popular plans to raise more capital through sale of non-core assets.
However, the bank does not rule out receiving state aid by issuing contingent convertibles, or CoCos, low interest bonds that the state would subscribe and that would convert into equity if the bank could not pay them back.
"If the public CoCos are extremely favourable we may have to take a look at that but frankly our initial reaction is not to depend on third parties," Gonzalez-Robatto said.
The Wyman report said Popular's estimated capital needs were based on an adverse scenario in which the economy contracts more sharply than economists currently forecast.
Popular is not planning to merge or acquire another bank in the near future, Gonzalez-Robatto said.
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Of the seven banks that need capital, four of them have already been taken over by the state. Bankia , Spain's biggest failed bank, was seen needing almost 25 billion euros of capital in a stressed scenario.
Banco Mare Nostrum, which the audit showed needing 2 billion euros in capital, said on Friday it would sell assets to reduce needs by 1 billion euros. Banco Mare Nostrum and Popular had been in talks for a merger, but the government said on Friday it would not promote tie-ups between weaker banks.
Another bank with capital needs, a three way merger known as Liberbank-Ibercaja-Caja3, said it would put soured assets into a "bad bank" the government is setting up as part of the conditions for receiving European aid for the banks.
Popular said it would form its own asset management company to handle toxic assets left over from Spain's property market crash four years ago and announced it would book record provisions of 9.3 billion euros in 2012.
Government banking reforms and the stress test forced Popular to accelerate the clean-up of its real estate book and to restate its forecast for profit this year.
The bank said it expected to book a 2.3 billion euro net loss in 2012 from a previous outlook for profit of 400 million euros. But the lender said it maintained its capacity to generate 7.2 billion euros of revenue during the period 2012-2014.
Popular said it would not pay its October dividend, saving the bank 82 million euros. However, the bank hoped to maintain plans for a 50 percent payout in 2013.
(Editing by Fiona Ortiz and Anna Willard)
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Keywords: SPAIN POPULAR/