UPDATE 1-Austria adopts wind-down unit for Hypo Alpe Adria

* Govt to create wind-down unit for ailing state bank

* Will seek contributions from subordinated creditors

* Balkans banking network may be sold this year

(Adds quotes and background)

VIENNA, March 14 (Reuters) - Austria has decided to bite the bullet and adopt a wind-down unit for ailing state lender Hypo Alpe Adria Href="NewsSearch">HAABI.UL because letting the bank go bust posed incalculable risks, Finance Minister Michael Spindelegger said on Friday.

The decision ends months of wrangling over how to handle the bank that Austria had to nationalise in 2009 to avoid a collapse with regional implications, but comes at a cost for Hypo's home province of Carinthia and perhaps some Hypo investors.

The government demands Carinthia contribute and also intends to bail in holders of nearly 2 billion euros ($2.8 billion) worth of subordinated debt and non-voting participation capital, Spindelegger and central bank Governor Ewald Nowotny said.

Nowotny, who had lobbied hard against letting Hypo go bust or forcing losses on Hypo bondholders, was asked about the treatment of people who own 1 billion euros' worth of subordinated Hypo debt with federal guarantees.

"Federal guarantees will of course be honoured," he told a news conference, but added: "This is a matter where appropriate negotiations and regulation will be done to achieve this effect."

Carinthia guarantees another 900 million euros' worth of such instruments, a finance ministry spokesman said, adding details about how to bail in these creditors were under discussion and may require specific legislation.

Creating a "bad bank" for nearly 18 billion euros in Hypo assets will relieve the bank's chronic need for fresh capital but also push Austrian state debt to around 80 percent of economic output and drive up its budget deficit by around 1.2 percentage points this year.

Talks on reaching an overall settlement with former Hypo owner BayernLB Href="NewsSearch">BAYLB.UL would start soon, Spindelegger added.

Austria this week authorised a quick capital injection even though the exact amount Hypo needs immediately is not yet known.

Hypo Alpe Adria has already got 4.8 billion euros in state aid since 2008 and needs more to be able to meet minimum capital requirements when it finalises its 2013 results.

($1 = 0.7180 euros)

(Reporting by Michael Shields; Editing by Georgina Prodhan)

((Michael.Shields@thomsonreuters.com)(+43 1 531 12 258)(Reuters Messaging: michael.shields.thomsonreuters.com@reuters.net))

Keywords: AUSTRIA HYPO/