* Commodities unit's success makes it candidate for part sale
* BTG Pactual Commodities has only modest physical assets
* Capital from new investor would benefit "all concerned" - source
* But sale to another bank would be difficult
* Banks pulling back from commodities due to tighter regulation (Repeats to add link to Breakingviews column)
By Sarah McFarlane and Dmitry Zhdannikov
LONDON, Nov 30 (Reuters) - Brazil's Grupo BTG Pactual SA is reviewing its assets and may sell part of its commodities unit to raise capital after the arrest of the bank's chief executive, a source familiar with the matter said on Monday.
BTG Pactual declined to comment.
Brazilian financier André Esteves resigned as chief executive officer and chairman of BTG Pactual late on Sunday after he was jailed as part of a corruption inquiry rapidly ensnaring Latin America's largest independent investment bank. Esteves, through his lawyer, has denied the allegations.
The bank is now seeking to shore up its balance sheet, after Esteves' arrest prompted clients to pull over $1 billion in investments held at the bank's asset management division.
The success of BTG Pactual's recent venture into commodities makes the unit an obvious candidate for partial disposal.
"Clearly a new investor that brought additional capital to the commodities business and provided cash flow for the bank would be beneficial for all concerned," a second source told Reuters.
In November the Sao Paulo-based bank reported third-quarter profits that beat analysts' estimates by a large margin. BTG Pactual partly attributed this to a surge in income from commodities sales and trading.
But the commodities unit relies for its profitability on proprietary trading, rather than conducting deals on behalf of clients. This might make it difficult to find a buyer among other banks which have been reducing their exposure to risk due to tighter regulations.
"It would be very unlikely that U.S. or European banks would be interested in commodity acquisitions, given the trend has been for divestments, particularly in the U.S.," said Robert Piller, commodities lecturer at the Geneva Business School.
What kind of investor might be interested in a stake remains unclear. The unit owns relatively few physical assets, meaning it has been largely insulated from the dive in commodities prices which has so badly hurt others, notably the mining giant Glencore.
This leaves the knowledge, experience and skills of the unit's trading team as it main asset.
Brazil's nearly 2-year-long investigation into kickbacks on state-run oil firm Petrobras contracts has resulted in dozens of arrests, including of Esteves, the billionaire who is BTG Pactual's controlling shareholder.
The bank's main partners gathered on Sunday to finalise the sale of its 12 percent stake in Rede D'Or São Luiz SA, Brazil's largest hospital chain.
The stake will be sold for almost 2.5 billion reais, a source directly involved in the deal told Reuters. The bank had been negotiating the deal since August, but the arrest sped up talks, two other sources said.
More action will probably be needed to shore up BTG Pactual's balance sheet, and the commodities business, as a star performer, could be on the block next.
BTG Pactual Commodities, launched in April 2013 and backed by $1 billion in equity capital from the bank, now has about 750 staff and achieved a gross margin of around $650 million for the year to Nov. 30, 2015, said the second source.
Globally, banks have generally pulled back from commodities trading in recent years, making BTG Pactual an exception when it launched its commodities operation after hiring Ricardo Leiman, former CEO of Noble Group Ltd.
Leiman quickly built a team including ex-Noble colleagues Nick Brewer, now chief operating officer of BTG Pactual Commodities, and Dean Morris, the unit's head of risk.
With an "asset-light" model, the unit makes its profit from market volatility and has prospered while some commodity companies have struggled due to the downturn in markets from oil to copper.
BTG Pactual Commodities has been particularly active in Latin American agriculture markets, U.S. power and gas, and the European power, gas and coal markets.
"It has a physical element to it but it's fair to say that the business model is to understand what is happening in the physical market and then trading on top of that," said the second source.
This is similar to some of the Swiss-based commodity trade houses including Vitol, Trafigura, Mercuria and Gunvor. Although these own physical assets such as refineries and infrastructure, their exposure is not so great that they are effectively taking a long position in a commodity, as mining firms or oil majors do.
BTG Pactual Commodities has participated in prepayment deals, helping to finance the production of commodities in return for a share of subsequent output.
The source said it is interested in transportation, tolling and storage deals but would be more likely to enter joint ventures with entities rather than becoming a sole operator of physical assets.
However, it does not provide hedging and other risk management services for clients. Instead, it purely trades on its own behalf, meaning it is not subject to regulation by the British Financial Conduct Authority.
One reason why banks including Deutsche, Barclays and Credit Suisse have been exiting commodities is regulatory pressure, as U.S. and European lawmakers tightened rules on commodity trading. This could complicate the sale of a stake.
BTG Pactual is regulated by the central bank of Brazil, a country whose exports of commodities including iron ore, soybeans and sugar have been central to economic growth.
Editing by David Holmes, David Stamp and Giles Elgood