LONDON, Aug 6 (Reuters) - Private equity firms have approached banks to b
egin financing discussions on a possible multi-billion-pound buyout of Royal Bank of Scotland's insurance division Direct Line Group, banking source said.
RBS has to sell at least 50 percent of the business which owns the Direct Line, Churchill, Privilege and Green flag brands by the end of 2013 under European Commission terms after RBS received state aid in 2008, either through a sale or a stock market flotation.
RBS said last week a flotation looked like offering the best value for selling Direct Line rather than a trade sale, and was looking to sell the first tranche of shares through a public offer in October, subject to market conditions.
However, banks have also been asked to look at private equity buyout financing options in the last two weeks, although size and sector is making it challenging to structure a deal, several bankers said.
Bankers are also questioning whether the leveraged loan market has the capacity to support a 3 to 4 billion-pound private equity sale, which would require a debt package of between 1.5 to 2 billion pounds.
Private equity firms Blackstone Group and Bain Capital are working on a joint offer to pre-empt an initial public share offer. Another group comprising KKR & Co LP, Apax Partners LP and BC Partners Ltd, is putting together a rival offer as buyout firms see value in insurance companies. .
RBS's base case plan remains to seek a public share offer for Direct Line Group starting this autumn, subject to market conditions, an RBS spokesman said without commenting on the private equity firms interest.
The size of a Direct Line private equity sale could require some unsual structuring including a larger equity cheque than the standard 50 percent equity.
Private equity firms would have to tap various sources of debt including the loan, bond and mezzanine markets to raise sufficient sterling debt as banks have become more cautious in underwriting large debt packages due to the eurozone crisis, bankers said.
A deal would be the largest sterling-denominated buyout since June 2008 and would require a large underwriting in volatile markets.
'I don't think the liquidity is there. It's unclear how much sterling you can raise in the bond market and banks just don't want to take and hold big tickets at the moment,' a senior banker said.
Private equity firms also have to pay higher interest for deals denominated in sterling as the currency is relatively illiquid. Most European investors prefer euro loans to avoid currency swap costs.
ATTRACTIVE INSURANCE ASSETS
Nevertheless insurance companies are becoming attractive targets for private equity firms as many listed insurance companies are trading at discounts to their book value, bankers added.
Some private equity firms have started establishing specialist Financial Institutions Groups (FIG) to look at the insurance sector, anticipating an upturn in activity.
'There is a lot of noise around insurance companies and private equity firms, but we have not seen that many deals in this sector to date,' a banker said.
In July, Cinven-owned Guardian Financial Services (GFS) raised a 427 million pound loan to back its acquisition of blocks of in-payment annuities from Phoenix Group. Last year, Carlyle Group acquired UK road rescue and car insurance company RAC from Aviva, in a deal that was backed by 620 million pounds of debt.
In late 2007 Hugh Osmond's insurer Pearl Group - now Phoenix Group - raised one of the largest leveraged financings to finance its buyout of Resolution with 2.3 billion pounds of debt. Bankers struggled to syndicate the deal in 2008 due to market volatility and investors' wariness regarding the sector and the group underwent a complex restructuring in 2009.
Buyouts of insurance companies are challenging to finance as it is difficult to analyse the value of insurance companies' assets and also the way that regulation will affect the sector.
'Insurance companies are complicated businesses to get your head around. You can't put debt on a regulated entity and it is very difficult to find security for the debt,' said a leading private equity financier.
($1=0.6411 British pounds)
(Additional reporting by Tessa Walsh; Editing by Greg Mahlich) Keywords: DIRECTLINE DEBT/
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