KfW said Lone Star would assume a 90.8 percent stake in the Düsseldorf-based IKB, which ran into trouble during the subprime lending crisis in the United States.
KfW and other German banks were forced to offer IKB a financial lifeline of €8.5 million earlier this year to keep the bank afloat. KfW currently holds a 45.5 stake in IKB, which will now be transferred to Lone Star. The US investment group specializes in turning troubled companies around.
The sale price for KfW's in IKB was not disclosed with KfW saying only that it was a "low three digit million euro amount" - meaning presumably anything between €100-300 million ($150-450 million).
IKB, a specialist in loans to small- and medium-sized business, invested heavily in securities tied to high risk subprime mortgages in the United States. When US homeowners began defaulting on these home loans, these securities plunged in value and cost banks around the world hundreds of billions of dollars as they wrote off their investments.
In Germany, Europe's biggest economy, the first and biggest casualty was IKB. To prevent it going bankrupt it was bailed out by the government, KfW and private German lenders.
IKB's management made a sharp exit, and KfW alone pumped in billions of euros to keep IKB a going concern.
Berlin was desperate to ensure that a German bank lending to the vital "Mittelstand" sector - small- and medium-sized businesses - did not collapse, but the adventure has cost the KfW dear.
It provided last year €6 billion in guarantees, a writedown on its stake has cost it €400 million and Ingrid Matthäus-Maier, the bank's head, was shown the door last September.
It is also the only bank among IKB's rescuers to subscribe to a capital increase currently being carried out, an exercise that it has guaranteed to the tune of €1.25 billion and that has effectively left it with a 90 percent holding.
KfW also said Thursday that it will be saddled by another charge of up to €720 million when the deal closes. After nearly a year trying to find a buyer it was reportedly looking for a price tag of €800 million.
"In order to attain the goals of the IKB rescue mission, KfW took on an extraordinarily heavy burden, but one that is not too heavy to handle," KfW chairman of the board Wolfgang Kroh said.
"What is important is that we have now closed the chapter on IKB's rescue. We do not face any more unforeseeable risks with regard to IKB. We can now go back to concentrating fully on our work as a promotional bank."
Dallas-based Lone Star saw off bids from Swedish bank SEB and fellow US private equity group Ripplewood, sources said. Two state-owned German banks, BayernLB and WestLB, were also interested but withdrew from the bidding. The sale still needs to be approved by KfW's supervisory board and by others including BaFin, the German financial supervisory authority and the European Commission.