UPDATE 2-Private equity slams proposed banking rules

(Adds background on industry, comments in paragraphs 7-14)

By Megan Davies

NEW YORK, July 2 (Reuters) - Private equity investment in troubled banks will be deterred and curbed by stringent guidelines proposed by U.S. bank regulators, executives and an industry body said on Thursday.

The industry, with around $1 trillion of uncommitted capital to invest, provides a pool of potential capital for struggling companies to tap.

But preliminary guidelines proposed by the Federal Deposit Insurance Corp on Thursday will deter the industry from investing in banks, executives warned.

"The issue that the regulators have to deal with is that banks need capital, but they don't want people to make too much money," said Steven Kaplan, a professor of finance specializing in private equity at the University of Chicago. The FDIC proposals would make it harder for investors to make money, he said.

"If you're a private equity investor you have to be a little crazy to want to deal with the FDIC and the government," Kaplan added.

The guidelines call for a Tier 1 leverage ratio of 15 percent for three years. Currently, well-capitalized banks must have Tier 1 captial of at least 6 percent of risk-weighted assets.

The new regulations would call for private equity groups to maintain their investments in banks for three years, unless they get special approval from the FDIC. For full story [nN0272484].

One private equity executive, who declined to be named called the capital levels proposed highly excessive, and questioned whether there was a level playing field for private equity investors.

Further, they would require private equity groups to provide a "contractual cross guarantee," meaning that, if one firm owns two banks, the healthier institution must provide support to the weaker bank if it falters.

"The cross guarantee is incredibly unclear," a second private equity executive said. "It is a big cause of concern."

Another guideline says investors would be expected to serve as a source of strength for their subsidiary depository institutions.

CAPITAL DETERRED

The result could be that private equity firms either won't participate in auctions, or will bid low, those executives said.

"If people decide they can't get enough return from investing in banks, they'll take their private capital and go elsewhere and that will mean more banks fail without being purchased," the second executive said.

Three other private equity executives and other industry participants, who all declined to be named, echoed the sentiment.

The Washington-based Private Equity Council said in an emailed statement that the proposed guidance would deter future private investments in banks that need fresh capital.

The FDIC intends to reach out to the private equity community by inviting them to a roundtable discussion on Monday. The agency is likely to hear the investment community's concerns, which are shared by officials at other bank regulatory bodies.

Both the Office of the Comptroller of the Currency and the Office of Thrift Supervision said on Thursday the proposed regulations may go too far, chilling the interest of private equity investors. (Reporting by Megan Davies; Additional reporting by Karey Wutkowski in Washington and Paritosh Bansal in New York; Editing by Richard Chang, Leslie Gevirtz)