By Pamela Barbaglia, Jesús Aguado and Iain Withers

LONDON/MADRID (Reuters) - Britain's Virgin Money and OneSavings Bank are among a group of challenger banks expected to show interest in British lender TSB ahead of an auction process which is due to start next year, sources familiar with the matter told Reuters.

British residential mortgage lender Kensington Group and credit card provider NewDay are also likely to join the race as their respective private equity owners are seeking ways to add scale and banking capabilities to their portfolio investments, the sources said, speaking on condition of anonymity as the matter is confidential.

A consortium of Cinven and CVC bought NewDay in 2017 in a deal worth roughly 1 billion pounds ($1.35 billion) while Blackstone and TPG Special Situations Partners took control of Kensington in 2014 from Investec for 180 million pounds.

TSB's Spanish owner Sabadell has hired Goldman Sachs to put the business up for sale following the collapse of merger talks with BBVA.

It is currently sounding out possible bidders as it wants to launch an auction process in the first quarter of 2021 and wrap up the sale by next summer, the sources said.

A TSB spokesperson declined to comment on the bidders but said the lender was making progress on its growth strategy.

Sabadell, Virgin Money, OneSavings Bank, Kensington and NewDay declined to comment.

Britain's mid-tier banks, also known as challenger banks as they seek to challenge the dominance of big high street lenders, are best placed to pursue a tie-up with TSB as they could extract synergies and IT efficiencies without cutting costs as much or undertaking a drastic restructuring of its branch network, the sources said.

"The challengers have a much stronger case in terms of scale, integration and PR," one of the sources said.

"For any big bank there would be a significant restructuring job to do after buying TSB and no one has any desire to be all over the papers for cutting jobs in the middle of the pandemic," he added.

However, Virgin Money and OneSavings Bank recently merged with Clydesdale Bank and Charter Court respectively, and may need more time to embark on any new deal, the sources said, adding TSB's price tag is a key element in reviewing any bid.

Sabadell paid 1.7 billion pounds in 2015 to take control of TSB but its valuation has since dropped and was one of the main sticking points in negotiations with BBVA, sources have said.

BBVA, which barely has a British presence, put a "zero valuation" on TSB, one source has said, but UK challenger banks may value it differently depending on the synergies, or cost efficiencies, they could extract.

BIG BANKS LIKELY TO SNUB TSB

Most large banks including Santander and HSBC have no interest in scaling up their UK network and are expected to turn their back on TSB, the sources said.

Others, including Barclays, may look at the dossier when the sale kicks off but they are not expected to go far, they said.

HSBC and Barclays declined to comment while a Santander spokesperson - asked specifically about the bank's potential interest in TSB - referred to comments made recently by the bank's Chairman Ana Botin indicating that Santander was not interested in buying traditional banks.

A successful sale of TSB would help Sabadell resume talks with BBVA or other Spanish lenders over a possible tie-up, the sources said.

In the meantime, Sabadell is considering more job cuts and striking product distribution alliances with other European banks in segments such as consumer and insurance services. (

$1 = 0.7419 pounds)

(Reporting by Pamela Barbaglia and Iain Withers in London and Jesus Aguado in Madrid; Editing by Kirsten Donovan)