Untapped private equity could help banks recover

By John Poirier and Karey Wutkowski - Analysis

WASHINGTON (Reuters) - Private equity firms, who have a combined $1 trillion to tap, might need to become more involved in rescuing troubled U.S. banks if the government's bailout plans are to work.

Washington lawmakers would certainly welcome it, and experts say private equity could play a vital role in a broad array of options being considered by the Federal Reserve, Treasury Department and the Federal Deposit Insurance Corp.

The problem is that many private equity firms are timid about taking the plunge because of regulatory constraints and concerns about future losses.

"There's an awful lot of money sitting on the sidelines," said Kenneth Rogoff, Harvard University professor and former chief economist of the International Monetary Fund.

Washington is considering setting up a bank to absorb toxic assets, widely known as an "aggregator bank" or "bad bank."

Under one scenario, private equity firms could invest in banks that sell assets to the aggregator bank, according to academics and private equity industry insiders.

Private equity funds have already dipped their toes in the water when it comes to bank investments. MatlinPatterson invested $250 million in a small Michigan bank, Flagstar Bancorp Inc (FBC.N), in December. And a group of private equity and hedge fund firms agreed recently to buy the assets of failed U.S. mortgage lender IndyMac.

But private equity firms are hampered by rules restricting the amount of a bank they can own.

Last year, the Fed eased bank ownership rules by raising the threshold that triggers bank holding company requirements to 33.3 percent from 25 percent of the total equity stake, as long as no more than 15 percent represents voting powers.

Private equity firms would much rather be able to own an entire institution and replace management, according to private equity insiders and academics.

"They want to clean things up," an industry insider said.

Private equity managers are already trying to find ways around these ownership rules -- most notably through making the investments outside their firms.

Wilbur Ross, who made a fortune buying distressed companies, earlier this month personally bought a nearly 70 percent stake in a small community bank in Florida.

"We want to buy a big bank in distress," Ross told Reuters.

J. Christopher Flowers, famous for making private equity investments in distressed financial institutions last year, personally bought a Missouri bank, which he may use as a platform for buying more banks.