April 30 (Bloomberg) -- The Federal Deposit Insurance Corp. may offer investors financing to buy distressed U.S. bank assets without requiring them to share an equity stake with the Treasury, people familiar with the matter said.

Treasury capital probably won’t be applied to the FDIC’s pilot program to buy as much as $1 billion of so-called legacy loans that is planned for June, the people said on condition of anonymity because no final decision has been made.

The proposal reflects officials’ efforts to make the program more attractive to hedge funds and other investors fearing government attempts to impose limits on their pay. Regulators are hoping the initiative will bolster lenders’ capital levels after stress tests to gauge their health are completed next week.

“Treasury putting in equity was not an attractive element for investors,” said Douglas Elliott, a fellow at the Brookings Institution in Washington and former investment banker. “From a public-policy view, it’s a distinctly less-good thing, but maybe it’s the only reasonable way to alleviate the investor concern about executive-compensation rules.”

The FDIC and Treasury are still discussing how the final program will work. The government may still get warrants from investors if the deals yield large profits, and the FDIC might set triggers for when and how taxpayers would benefit, they said.

‘Repair Balance Sheets’

“Treasury is working closely with the FDIC in developing the Legacy Loan program to repair balance sheets throughout our financial system to help drive us toward economic recovery,” Treasury spokesman Andrew Williams said.

The Treasury has not yet released its guidelines on how it will apply pay caps imposed by Congress and the White House on banks that receive government aid. The department has said that passive investors in public-private partnerships won’t be affected by the pay caps.

It isn’t clear how the limits might apply to investors in the FDIC’s legacy loan program. Many investors who buy loans will also be actively involved in servicing and managing them.

As initially laid out, the FDIC plans to provide financing of as much as six times the amount of capital invested. By effectively trading illiquid loans in exchange for cash or FDIC- guaranteed notes, the selling banks would strengthen their balance sheets.

Talks With Bankers

FDIC program spokesman Andrew Gray said it’s too early to say how the final program will shape up. The FDIC has been talking to bankers, investors and lawmakers about how to structure the initiative. “The FDIC continues to actively craft a workable framework,” he said.

The asset purchases are designed to start after regulators complete stress tests on the nation’s biggest 19 banks, final results of which are scheduled for release next week. People briefed on the matter said earlier this week that at least six lenders will be pushed to increase their capital, including Citigroup Inc. and Bank of America Corp..

Finance ministers and central bankers who met in Washington last weekend singled out banks’ impaired balance sheets as the biggest threat to a sustainable recovery. Their remarks showed a continued focus on whether the U.S. and other governments will be able to follow through on their efforts to heal the financial system.

Follow-Up

As the FDIC assembles its new toxic-asset auction plan, the agency may use financing techniques it has developed for selling the troubled assets of firms that have already failed, said Chip MacDonald, a partner specializing in financial services at law firm Jones Day in Atlanta. If the FDIC program catches on, he said, it will help regulators follow up on the stress tests to strengthen banks’ capital levels.

“If banks can get rid of some of their most toxic assts, they’ll need less capital and there will be less stress in the system,” MacDonald said.

The legacy loans program is one part of the Treasury’s Public Private Investment Program, which aims to remove as much as $1 trillion from lenders’ balance sheets. The other initiative targets distressed mortgage-backed securities. The Treasury is in the process of hiring asset managers for the Legacy Securities program; yesterday the department said it had received more than 100 applications from interested firms.

To contact the reporter on this story: Rebecca Christie in Washington at Rchristie4@bloomberg.net

Last Updated: April 30, 2009 00:01 EDT