(Adds rights trading, analyst comment)
By Michael Steen and Jane Barrett
FRANKFURT/MILAN, July 22 (Reuters) - Deutsche Bank said on Tuesday it would not take part in a key capital increase at Fiat , leaving banks and other investors in the loss-mired Italian carmaker to stump up the money.
Fiat is raising 1.8 billion euros ($2 billion) via a rights issue to help fund its latest turnaround plan, but while Italian investors have rallied to the cash call from the country's largest private employer, foreign funds are turning their backs.
"In line with Deutsche Bank's stated policy to reduce its industrial portfolio, Deutsche Bank will not participate in the current rights issue," the German bank said in a statement.
Deutsche Bank owns about 1.6 percent of Fiat so would have had to pay 28.8 million euros to keep its stake stable in the rights issue. Its stake will now be diluted to one percent.
Earlier this month, U.S. fund Dodge & Cox said it had sold almost its entire 7.6 percent stake in Fiat, leaving other investors or the banks backing the issue to pick up its expected share of new stock. Deutsche Bank is one of the 11 guarantors.
"I wouldn't subscribe to a Fiat capital increase if you paid me," said one Milan-based trader. "The downside is way too big."
Fiat unveiled a 19.5 billion-euro rescue plan last month, betting that an almost total revamp of its car-to-tractor product range will push it to a net profit by 2006 from a record loss of 4.3 billion euros last year.
Many analysts doubt the plan is radical enough to pull Fiat out of the worst crisis in its 104-year history.
But Deutsche Bank said Fiat's plan was "appropriate and necessary" and that its board member Hermann-Josef Lamberti would stay on the carmaker's board. Its decision to stay out of the capital increase was due to its own portfolio strategy.
ORDERS IN
Orders for the capital increase are due in by close of play on Tuesday, when trading in the related rights options ends.
The rights fell sharply in heavy trade and by 1500 were worth 0.09 euros, down 36 percent.
Under the terms of the capital increase -- Fiat's second in less than two years -- shareholders have the right to buy three new shares at five euros for every five they hold. Fiat will issue a total of 368.5 million new shares.
Almost 300 million rights changed hands by late Tuesday, which under the three-for-five ratio means the right to buy 180 million of the new shares -- or almost 49 percent of the capital increase -- was decided on the last day.
"Much of the ordinary stock is trading in small packs, which suggests a lot of smaller investors are piling out rather than buying into the capital hike. The guarantee banks risk picking up a lot of slack," said an analyst who declined to be named.
Fiat's ordinary shares were down 1.5 percent at 5.25 euros, bouncing back from the 5.20 level they skirted for much of the day. The DJ Stoxx index of European car stocks was flat.
"If the big boys don't want anything more to do with Fiat, why should smaller funds? There are better places to put cash -- especially if stock markets recover," said another analyst.
While Deutsche Bank locks the safe, Italian insurer Generali said it would subscribe to the rights issue in line with its stake of around 2.5 percent. Sources have said bank Mediobanca will also buy in to the capital increase to keep its near three percent stake stable.
The lion's share of the capital increase is being swallowed by Ifil , the holding company owned by Fiat's founding Agnelli family, which will stump up about 565 million euros, partly raised via its own capital hike which closes next week. (Additional reporting by Mirko Wollrab, Paola Arosio and Svetlana Kovalyova)