Mess at Brazil's Cruzeiro riles investors

Aug 17 (IFR) - Investors holding Banco Cruzeiro do Sul bonds may have to accept substantial haircuts or take their chances with a liquidation of the Brazilian mid-tier bank. This is the stark choice facing bondholders after the local deposit insurance fund, FGC, unveiled plans to cover capital shortfalls at Cruzeiro and prepare the bank for a possible sale.

The move has left much of the buyside up in arms, feeling they are taking the fall for what they see as poor oversight by the central bank. Cruzeiro is the fourth Brazilian mid-tier bank to go bankrupt in recent years.

"Clients think they have to pay for the lack of work that the central bank should have done," noted one US-based trader.

Law firm Bingham McCutchen is trying to organize a critical mass of investors to contest a tender offer for some US$1.6bn in outstanding dollar bonds. The tender is conditional on participation from local and international creditors holding at least 90% of the principal amount, so Bingham is said to be trying to get 10%-plus on board to gain some leverage against the FGC proposal.

While FGC is also offering to pay discounted prices on the bank's local unsecured obligations that are not guaranteed, some investors are arguing that international bondholders are bearing the brunt of the pain -- and that the burden could be shared more broadly, given that the R$2.45bn in securities issued abroad is just a small portion of the approximately R$11bn in liabilities.

"There are deposits, credit lines that banks gave to Cruzeiro, there are interbank deposits and CDBs (bank deposit certificates)," said the trader. "There must be other creditors involved with Cruzeiro, but the FGC is only asking bondholders to take the hit."

MISREADING THE SIGNS?

Yet with close to 60% of the bank's unsecured debt obligations in the form of international bonds, it is hardly surprising that foreign accounts are feeling particularly exposed. Some analysts wonder if investors have been negligent by ignoring clear signs that the bank was facing severe problems -- and misreading how regulators would tackle the fourth Brazilian bank bankruptcy in recent years.

FGC has revealed that Cruzeiro would have to take a R$3.11bn write-down after accounting discrepancies were found earlier this year.

"If anyone had looked at Cruzeiro's balance sheet, they would have seen there was something wrong," one analyst said. "A lot of people buying thought it was a Panamericano story, a free lunch -- and it was not."

Speculation about the fate of Cruzeiro has made for volatile price action, as many investors bet that the bank would meet a fate similar to that of Panamericano, where the discovery of accounting discrepancies sent its paper south in 2010 before BTG Pactual stepped in to buy a stake the following year.

Yet some analysts think that the size of the write-down at Cruzeiro -- and the fact that it was less systemically important than Panamericano -- means that this situation is different. In the case of Panamericano, then-owner Silvio Santos was willing to put up collateral to help cover the capital shortfall.

Either way, the situation with Cruzeiro has deepened scepticism about regulatory oversight in the Brazilian banking system, and investors are more likely than ever to think twice before buying into this sector.

"By doing this, the FGC is shutting down the market for fifth-tier and small banks abroad," noted one LatAm-based investor. "The myth that the central bank has any oversight over the Brazilian financial industry is over."

The FGC, which was appointed as the bank's administrator after the central bank's intervention earlier this year, on Wednesday unveiled what it was willing to pay for Banco Cruzeiro do Sul bonds, after hiring HSBC and Bank of America Merrill Lynch as dealer managers on a tender offer to buy the securities.

For holders who tender by the early-bird date of August 28, FGC is offering 61 cents on the dollar for the 2012s, 31 for the 2020s and 56 for the 2013s, 2014s, 2015s and 2016s. Creditors who don't tender by then, but do so before the expiration date of September 12, will receive 56, 26 and 51, respectively.

According to one trader, the 2012s dropped about two to three points on the news; by Thursday the senior bonds were being offered at around 50, after being bid at 60 earlier in the week, while the subordinated 2020s were being offered at 26.00.

That investors are offering the bonds well below where FGC is tendering them shows how little faith they have in a debt buyback that is conditional upon a 90% participation rate as well as a "white knight" coming to Cruzeiro's rescue once the liability management exercise cleans up Cruzeiro's books for a sale. The FGC has said the tender is contingent upon a firm offer to purchase control of the bank, with local newspaper Valor pointing to Itau, BTG Pactual and Bradesco as possible buyers.

However the difficulties of getting the vast majority of creditors on board -- and finding a buyer for a bank whose value has been called into question -- may mean FGC has set the bar too high. At the tender levels, according to the calculations of one Sao Paulo-based analyst, holders of senior secured paper were taking about a 40% haircut, subordinated creditors 70% and local depositors just 20%. Even then, it is thought that creditors are better advised to take what they can at this stage rather than take their chances with liquidation.

During the tender period, FGC is looking to sell a controlling stake in the bank to an institution that must meet certain criteria. The bank will subsequently seek a capital increase.