Buyout shops eye U.S. banks but wary of regulators

NEW YORK (Reuters) - Private equity firms are searching for ways to invest in U.S. banks and thrifts while avoiding restrictions that bar owners of these institutions from other businesses.

As bank stocks sink and leveraged buyouts deals dry up amid the global credit crunch, private equity firms are eyeing investments in the financial sector. Financial institutions globally have raised more than $250 billion of capital to offset massive credit losses and are likely to need more.

Last month, Washington Mutual Inc (WM.N) and National City Corp NCC.N each raised $7 billion, including minority investments from buyout firms.

But big investments from private equity have been few. A controlling stake in a bank or thrift brings with it regulatory oversight, capital requirements and restrictions on the nature and scope of businesses activities.

Loath to give in to such oversight but attracted to the sector, private equity shops are exploring various deal structures that would allow them to make larger investments in banks and thrifts -- and even own some -- without the whole firm coming under regulatory purview.

"The issue they are dealing with is making sure they can get a large enough investment, have influence on the company, but work within the construct of the regulatory regime," said Brian Sterling, co-head of the investment banking group of Sandler O'Neill. "It's hard to do."

EXPLORING OPTIONS

Private equity firms are looking at buying stakes in banks and thrifts, although they are also talking about working together to buy these institutions in their entirety, said Neil Carragher, a managing director at Credit Suisse.

"Really, the last time private equity firms looked at banks seriously was at the last major credit crunch," Carragher said, referring to the savings-and-loan meltdown of the late 1980s and early 1990s. "A lot of them see this as an opportunity to do it again."

The KBW Bank Index .BKX is down roughly 36 percent since the beginning of 2007.

Castle Creek Capital, a private equity firm that became a bank holding company in 1995, has been approached by other buyout shops looking to invest in banks, as well as institutions looking to raise funds.

"We have had numerous discussions with most of the high-profile private equity firms in the country on how we might work in partnership," said co-founder William Ruh. "So Castle Creek can be the bank holding company and they can be investors alongside of us."

"We do have some ability to potentially structure investments that are permissible by the Federal Reserve and also something that would still allow the private equity firm to have a voice in the outcome of their investment," Ruh said.

Private equity firms typically look to take majority control of their investments so they can decide how to exit.

Castle Creek primarily invests in U.S. banks with assets between $100 million to $5 billion, and an expert said private equity is likely to become more active in that area.

"The focus is going to shift from just the big banks to all sizes of banks," said Chip MacDonald, a partner at law firm Jones Day. "There is probably more opportunity because there are less people focused on it."

NO STANDARD APPROACH

The structures of investments so far generally involve a combination of private equity firms and other investors owning less than 10 percent of the voting stock of a bank or thrift, and individuals taking a more controlling role such as a seat on the board, experts say.

In the case of National City, private equity firm Corsair Capital and other investors put in $985 million and the bank agreed to have Richard Thornburgh, a Corsair vice chairman, join its board.

The deal's structure resembled that for Washington Mutual's capital raising, which included a $2 billion investment from private equity giant TPG TPG.UL and a board seat for its founding partner, David Bonderman.

Other options being looked at include raising separate funds that only invest in financial institutions and focusing on thrifts, whose regulation is seen as less onerous than those for banks, experts say.

"Most come to us to help structure arrangements so that they have significant equity stakes but not controlling equity stakes," said Gregory Lyons, head of law firm Goodwin Procter's financial services practice. "There are a few that actually are willing to be bank holding companies or have funds that are bank holding companies."

"There is no one standard approach," Lyons said.

(Editing by Tim Dobbyn)