Aug. 21 (Bloomberg) -- Lone Star Funds, the Dallas-based private equity firm, agreed to buy IKB Deutsche Industriebank AG, Germany's first casualty of the subprime mortgage crisis, for less than 20 percent of what the government initially sought.

The U.S. firm will acquire a 91 percent stake in Dusseldorf-based IKB from state-owned development bank KfW Group after beating a rival bid from RHJ International SA, Timothy Collins's investment firm. Lone Star paid about 150 million euros ($223 million) for the stake, said three people familiar with the talks who declined to be identified because the negotiations were secret.

The agreement ends an 11-month search for a buyer, with the state accepting less than the 800 million-euro valuation it put on the holding. The government led a 10 billion-euro bailout after the part of IKB that bought subprime mortgages ran out of funding last July. KfW has since ousted Chief Executive Officer Stefan Ortseifen and three other top IKB executives after auditors blamed ``flawed'' risk management for the lender's collapse.

``This will finally bring clarity and calm,'' Green party lawmaker and KfW administrative board member Christine Scheel said in a telephone interview today. ``It was the right decision to sell the bank as quickly as possible.''

IKB and its funding units have posted about $15.1 billion in writedowns, more than any other German bank, according to data compiled by Bloomberg. In all, the world's biggest banks and brokerages have announced more than $504 billion in markdowns.

Shares Advance

KfW received a ``low three-digit million-euro sum'' for its stake, KfW Chief Executive Officer Wolfgang Kroh told reporters in Frankfurt today. He described the price as ``reasonable'' and declined to be more specific.

IKB rose 7.8 percent to 2.89 euros in Frankfurt, valuing the bank at about 280 million euros.

Lone Star will inject an additional 225 million euros in fresh capital into IKB as well as a further 200 million euros into a special purpose vehicle that will contain 3.3 billion euros in securities currently owned by IKB. KfW will assume 1.3 billion euros of the bank's remaining securities, for which the German government will provide a 600 million-euro guarantee to cover possible losses.

The U.S. firm plans to boost profit at IKB by charging more for loans, selling other products such as derivatives and possibly wealth-management services to corporate clients, Bruno Scherrer, senior managing director and head of European investments at Lone Star, said in an interview in Frankfurt today.

`Foreign Bank'

The firm expects to own the stake for at least two years, Scherrer said. Lone Star could sell its stake after returning IKB's core business to profit, which it expects to achieve within the next three years, he added.

``IKB could eventually play a role in German banking consolidation or be of interest for a foreign bank,'' he said.

Job cuts aren't a ``primary goal,'' though assessments are still being made, and IKB will remain publicly traded for the time being, Lone Star Germany Chairman Karsten von Koeller told reporters at a press conference today.

Lone Star, which manages more than $13 billion, is targeting distressed financial assets around the world as credit market turmoil deters other investors. The firm agreed last month to buy $30.6 billion of collateralized debt obligations from U.S. securities firm Merrill Lynch & Co. for about a fifth of their face value.

Corealcredit Bank

It also acquired mortgage bank Allgemeine Hypothekenbank Rheinboden AG in 2005, renamed it Corealcredit Bank, and returned it to a profit last year after selling its international loans and targeting commercial property financing in Germany.

John Grayken, 52, started Lone Star in 1995 after prospecting for bad loans with Texas billionaire Robert Bass during the U.S. savings and loan crisis of the early 1990s.

``Lone Star has already successfully restructured a German bank so that track record helped them beat out RHJ,'' said Konrad Becker, a Munich-based analyst at Merck Finck & Co. ``Lone Star will try to drastically cut costs and improve IKB's strong lending position with mid-sized companies.''

Lone Star has also acquired delinquent mortgages from Japanese and South Korean banks, golf courses in Japan and consumer lenders and office towers in both countries. The firm has been trying to sell its stake in Korea Exchange Bank to HSBC Holdings Plc for $6 billion for the past year, as regulators challenged Lone Star's original purchase of the bank in 2003.

Mittelstand companies

IKB provides loans to more than 20,000 of Germany's so- called Mittelstand companies, small and mid-sized businesses with annual sales of between 7.5 million euros and 1 billion euros. The bank also provides real-estate loans and structured finance.

The lender has lost more than three-quarters of its market value since it warned about losses on its subprime mortgage holdings on July 30, 2007, ten days after it said it wouldn't be affected by the U.S. mortgage rout.

Rhineland Funding, a finance affiliate that bought asset- backed securities with money from selling short-term debt, couldn't raise more funding amid the credit crunch at the end of July. KfW stepped in and assumed 8.1 billion euros in IKB's financing obligations to Rhineland Funding, and agreed the following month in cooperation with the country's banking associations to cover as much as 3.5 billion euros of potential losses.

`Vital' Funding

Guenther Braeunig, installed by KfW as IKB's CEO last year, is winding down the business that invested in asset-backed securities to focus on lending to small and medium-sized companies and has said the bank would strengthen risk controls.

KfW helped IKB raise about 1.25 billion euros earlier this month, funding which Braeunig called ``vital'' for the bank to continue business. The move, if approved by regulatory authorities, will boost KfW's stake in IKB to about 91 percent from 45.5 percent.

The deal, expected to close in October, still needs to be approved by Germany's financial regulator BaFin and the European Commission. Lone Star has asked BaFin to exempt it from rules that would otherwise force it to offer to buy out IKB's remaining shareholders.

Rival bidder Timothy Collins teamed up in 2000 with Christopher Flowers to buy Long-Term Credit Bank of Japan Ltd. after the lender had been declared insolvent two years earlier. The group renamed the Tokyo-based lender Shinsei, Japanese for ``new life,'' before taking it public in February 2004 for a $7 billion gain.

Merrill Lynch advised KfW on the transaction. HSBC Holdings Plc advised Lone Star.

To contact the reporter on this story: Aaron Kirchfeld in Frankfurt at akirchfeld@bloomberg.net.

Last Updated: August 21, 2008 11:58 EDT