Lloyds TSB is in talks with sovereign wealth funds and UK insurance groups about selling stakes in a merged Lloyds-HBOS group, with a preliminary deal expected by January.

Lloyds intends to use the cash to help to redeem £4 billion of expensive and restrictive government preference shares in Lloyds and HBOS at the earliest opportunity in order to allow the bank’s board to keep its promise to restart dividend payments next year.

It is understood that Lloyds is in negotiations with up to ten Middle Eastern and Asian sovereign wealth funds about selling the stake. Funds from Dubai, Kuwait and Brunei are obvious contenders, as is Temasek of Singapore. Chinese funds – which have made loss-making investments in Western financial institutions including Barclays – are not candidates.

Eric Daniels, the chief executive of Lloyds, refused to comment on the talks. “We have not disclosed whether we have been approached by sovereign wealth funds,” he said.

Sources said that British insurers and pension funds – some of them on the Lloyds shareholder register – are in serious talks about taking a stake and that the bank’s advisers would keep as many potential investors in contention for as long as possible to extract the best deal for shareholders.

Private investors are expected to contribute only a minority of the £4 billion needed to fund the preference share buyback. Lloyds said yesterday it intended to redeem the Government’s shareholding next year using funds from cost-cutting, disposals, equity injections and reduction of Tier 1 Capital.

Sources said that Lloyds, which is advised by Merrill Lynch, UBS and Citigroup, has been in talks with a number of sovereign funds for more than a month. The talks were put on hold as the state-sponsored funds concentrated on a potential investment in Barclays, but are now said to be back on in earnest. The board of Lloyds is understood to be keen to seal a deal by January – when Lloyds and HBOS will formally merge – to demonstrate confidence in the business.

Speaking before the Treasury Select Committee yesterday, Alistair Darling said he would leave it up to Lloyds and HBOS shareholders whether to approve the merger. If they do not, “both will have to go back to the FSA, and we’ll have to recalculate the capital requirements and proceed accordingly.”

He cautioned that HBOS would have been in deep difficulty without the Lloyds bailout. “The idea that HBOS was a perfectly happy, functioning bank and there was nothing wrong with it, and then along came Lloyds TSB and put in a bid for it, that isn’t quite right,” the Chancellor said. “The problem we had was, if we had not intervened, if we had not allowed the Lloyds bid to have gone forward, HBOS would have been in an extraordinarily difficult situation.”

After speculation about a rival bid for HBOS, Mr Darling said: “It is open to anybody else to come along and put in a bid for HBOS. The only thing I’d have to say to you is that so far no other bid has been put in place.”

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