UPDATE 2-Brazil state banks may swap Petrobras debt for stock -sources

(Recasts with government sources confirming swap option and context)

BRASILIA/SAO PAULO, Feb 16 (Reuters) - Brazilian state-run lenders are considering converting part or all of their outstanding loans to Petróleo Brasileiro SA into equity in a bid to help the embattled oil producer, two sources familiar with the plan told Reuters on Tuesday.

The swap would offer a government lifeline to Petrobras , the world’s most indebted oil company, struggling with a sharp drop in crude prices and a multi-billion dollar corruption scandal.

State development bank BNDES, Banco do Brasil SA and Caixa Econômica Federal are analyzing the option of debt-to-equity conversion, the sources said.

“Ideally, we would like to convert the loans into stocks and have the freedom to sell them later when its value improves,” said a senior BNDES executive, who asked for anonymity because he was not allowed to speak publicly. He said BNDES already holds about 20 billion reais ($4.92 billion) worth of Petrobras stocks and 30 billion reais in loans.

A member of the government’s economic team confirmed that authorities were considering that option among others, but declined to elaborate on the other proposals.

After repeatedly denying the possibility of a bailout, President Dilma Rousseff in January for the first time said her government does not rule out injecting new capital into Petrobras if oil prices continue to drop.

Banco BTG Pactual was first to raise that option to swap about 87 billion reais ($22 billion) worth of loans to Petrobras into equity.

In a client note distributed late on Monday, BTG analysts led by Antonio Junqueira said that under current rules, a full debt-to-equity conversion was possible for Banco do Brasil SA and Caixa Econômica.

For BNDES, whose exposure to the oil producer known as Petrobras is already above the legal threshold, waivers in the loan contracts allow for full conversion of debt into equity, the note added.

Petrobras owes about $130 billion to banks, bondholders and other creditors.

While this would hurt shareholders of the state-controlled company considerably, Petrobras’ debt metrics would improve dramatically, Junqueira and his team said. The extent of the improvement would hinge on the degree of participation of investors in the plan, since many of them would seek to avoid dilution of their stakes, the note added.

“First things first: Yes, conversion is a genuine possibility,” Junqueira wrote. He did not say whether this would amount to a renationalization of a company - the government sold a stake in Petrobras to private investors in 1997.

The swap option underscores concerns over state lenders’ exposure to Rio de Janeiro-based Petrobras, which spent and borrowed heavily in recent years as the government sought to develop vast offshore oil finds. BNDES is Petrobras’ largest creditor, highlighting the fact that Rousseff used state lenders to help fund Petrobras and foster industrial production, employment and economic growth.

Petrobras, whose market value is about $18 billion now, and the banks did not have an immediate comment.

A continuing investigation into an alleged kickback scheme at Petrobras has triggered concerns about banks with exposure to companies involved in the scandal.

The note stressed that information about a potential debt-for-equity swap was not public. Local media have speculated that government officials were considering such a step, while several Petrobras bondholders have told Reuters in recent months that they would support the idea.

“As far as public banks are concerned, such a conversion could be made without breaching the Brazilian financial system’s regulatory requirements,” the note said. “It seems the most viable way to do this conversion is to book converted debt as permanent assets.”

Nonvoting shares of Petrobras reversed early losses and gained 0.6 percent to 4.54 reais in midafternoon trading on Tuesday. The stock has fallen 55 percent in the past 12 months. ($1 = 4.0237 Brazilian reais) (Writing by Guillermo Parra-Bernal and Alonso Soto; Editing by Lisa Von Ahn, Jonathan Oatis and Andrew Hay)