May 13 (Bloomberg) -- British financier Guy Hands said private equity firms that are buying leveraged buyout loans risk repeating the mistakes of investors in subprime mortgages.

Hands's Terra Firma Capital Partners Ltd. rejected offers from banks for the loans because they didn't offer an attractive enough risk-adjusted rate of return, he said in an interview at his London office.

Citigroup Inc. and Deutsche Bank AG are selling as much as $22 billion of LBO loans to free up capital. The banks are trying to lure private equity buyers such as Apollo Management LP, Blackstone Group LP and TPG Inc. by offering the debt at a discount and providing them with financing to buy the loans. If the global rate of company defaults rises five-fold to 10 percent, buyout firms' equity in the loans will disappear and the debt will return to the banks, Hands said.

``What the private equity firms are doing is what the hedge funds were doing when they were buying the subprime mortgages,'' Hands said. ``They were effectively putting up a small amount of equity and hoping the amount they would receive back in positive spread would pay off that equity before the market went down.''

Hands, 48, built up Nomura Holdings Inc.'s buyout business in the 1990s before quitting to run his own firm with Nomura's backing in 2002. Terra Firma bought EMI Group Plc, the record label of the Beatles, for 2.4 billion pounds ($4.9 billion) last year. New York-based Citigroup, which financed Terra Firma's bid, postponed plans last month to sell the loans because of investor anxiety about EMI's turnaround under Hands.

`Window-Dressing'

The banks wouldn't have needed to sell the loans if the market remains flat for the next three years, Hands said. Still, the sales will help the companies solve their capital problems, he said.

Citigroup spokesman Jeff French and Oonagh Baerveldt, a spokeswoman for Frankfurt-based Deutsche Bank, declined to comment. Citigroup is the biggest U.S. bank by assets and Deutsche Bank is the largest in Germany.

``It's window-dressing,'' Hands said. ``What they've done is lent the money for people to buy the loans. And having lent the money for people to buy the loans, they're hoping they don't come back to them.''

To contact the reporter on this story: Edward Evans in London at at eevans3@bloomberg.net

Last Updated: May 13, 2008 04:05 EDT