Lloyds Banking Group said CEO Antonio Horta-Osorio will return in January after two months off with exhaustion and it had picked The Co-Operative Group as the preferred bidder for 632 branches it has to sell.

Lloyds, which is 40-percent owned by the government after a state bail-out during the 2008 credit crisis, said 47-year old Horta-Osorio would resume his post on January 9 after independent medical advice said he had made a full recovery from his illness.

He believes and we believe that he overdid it, it was certainly not stress, Lloyds Chairman Sir Win Bischoff told reporters.

Bischoff said Horta-Osorio's illness was due to overwork, sleep deprivation and exhaustion.

He's very keen to come back, his family are fully behind him, and we continue to believe he's the best man for the job, Bischoff said. He added it was best for Horta-Osorio to have a couple more weeks off work and that his illness was very, very unlikely to recur.

Lloyds said it will restructure and reduce Horta-Osorio's reporting lines and give other members of his senior management team more responsibility.

Some analysts said it could take some time before Horta-Osorio regained the full trust of investors.

Only time will tell, but it does not necessarily draw a line under the issue, and the new responsibilities of other members of his management carry the risk of undermining him, said Shore Capital analyst Gary Greenwood.

SVM Asset Management fund manager Colin McLean added that the new management structure around Horta-Osorio lacked some clarity.

It still begs questions about the management structure and whether this may dilute his influence and leadership, he said.

Lloyds had named non-executive director David Roberts as an interim CEO in case Horta-Osorio's return to work was delayed, and there was speculation that Antonio Lorenzo, who led Lloyds' strategic review, could become a deputy to Horta-Osorio.

Lloyds shocked investors last month by saying that Horta-Osorio would take a break due to his illness.

Lloyds, under Horta-Osorio's leadership, embarked on a restructuring that entails 15,000 job cuts and a retreat from many overseas operations. He took up the CEO role in March, having joined at the end of last year from Spanish rival Santander.

His tenure has seen the departure of Lloyds executives who were associated with the previous management under former CEO Eric Daniels, but UKFI - the state body that manages Britain's stake in the bank -- felt he was doing a good job, sources said.

Lloyds shares were up 0.3 percent at 24.80 pence in early afternoon trade - still well below the 63 pence average price at which the British taxpayer acquired its stake in the bank.

BRANCH SALE

Horta-Osorio had also been involved in Lloyds' sale of retail branches -- codenamed Project Verde by the bank -- which had been forced upon it by regulators as pay-back for the state aid it received in the credit crisis.

The Co-Op had been in competition with new bank venture NBNK for these assets. A Reuters poll earlier had shown that the Co-Op was seen as the favourite to buy them.

Lloyds said it would now enter into more detailed and exclusive talks with the Co-Op, which runs a financial services division along with a supermarket retail arm, and wants to agree a deal by the end of March.

It will keep open the option of spinning off the assets into a separate entity and then listing them on the stock market, in case of failing to agree a deal with the Co-Op.

The deal will create Britain's seventh-biggest bank, with the Verde assets representing 4.6 percent of personal current or checking accounts and 5 percent of the mortgage market, contributing about 500 million pounds of pretax profit in 2008 and income of about 1.4 billion.

Acquiring the Lloyds branches would mark a further expansion in Co-Op's banking business after the company bought Britannia Building Society in 2009.

Some analysts had felt that after Britain decided against selling bailed-out bank Northern Rock to a mutually-owned company -- choosing instead to sell Northern Rock to Richard Branson's Virgin Money -- authorities would look to balance this out by pushing for a Lloyds branch sale to the mutual Co-Op

We think a combination of these branches and our own would significantly strengthen our position as a real challenger in relationship banking in the UK, said Co-Op Group Chief Executive Peter Marks.

(Additional reporting by Steve Slater; Editing by Jon Loades-Carter and Jane Merriman)