Nov. 3 (Bloomberg) -- Banco Itau Holding Financeira SA agreed to acquire Uniao de Bancos Brasileiros SA in a stock transaction that may be valued at 26.5 billion reais ($12.5 billion), creating Latin America's biggest financial group as Brazil's banks contend with the spreading credit crisis.

The combination -- billed by the two firms as a merger -- will create a bank with 575 billion reais ($261.4 billion) in assets, the companies said in a statement today. Itau will own 66 percent of the new company, which will have 19 percent of the local credit market, while Unibanco's shareholders get one share for each 1.7391 of the most traded unit.

The transaction may signal more consolidation ahead among Brazilian financial institutions after local credit markets dried up. Brazil's central bank has injected more than 100 billion reais in the banking system since Sept. 24 to spur lending and prevent smaller institutions from failing.

``The deal was presented as a merger, but the fact that they are paying a premium makes it looks more like an acquisition,'' said Carlos Camacho, who helps manage the equivalent of $2.5 billion at Gap Asset Management in Rio de Janeiro.

Talks between Itau, the second-largest non-government bank, and Unibanco, the third-largest, ``accelerated'' as the global credit crisis deepened recently, Itau Chief Executive Roberto Egydio Setubal said at a press conference in Sao Paulo today. He said the decision to join forces with Unibanco was ``a direct result'' of the acquisition of ABN Amro Holding NV's Banco Real Brazilian unit by Banco Santander SA of Spain last year.

Competition from Santander

``When Santander bought Banco Real last year, Brazil's financial sector got a new kind of player and a new level of competition we had never had before,'' Setubal said. ``Suddenly the foreigners had bigger scale than the locals. We knew we needed to do something if we wanted to compete and grow,'' he said, adding that talks with Unibanco started in August last year. Itau Unibanco plans to expand across Latin America, he said.

While Itau and Unibanco controlling shareholders will each have half of the voting shares in IU Participacoes, the holding company that will control Itau Unibanco, Itau will hold all the preferred stock. The accord will create a lender that leapfrogs government-controlled Banco do Brasil SA to become the nation's largest lender. Both banks are based in Sao Paulo and have a combined market value of 80 billion reais, according to Setubal.

Estimated Value

Itau paid an estimated 26.5 billion reais for Unibanco, said Frederico Saraiva, equity analyst at BNY Mellon Arx in Rio de Janeiro, which manages about $5.6 billion in assets. Analysts at Goldman Sachs Group Inc. estimated in a note today that Itau paid 162 percent more than last Friday's closing price of Unibanco's voting shares and 42 percent more for the non-voting stock.

Itau shares climbed 16.27 percent to 27.09 as of 3:26 p.m. New York time, after rising as much as 18 percent. Unibanco rose 8.05 percent to 14.97 reais after surging as much as 16 percent earlier. Banco do Brasil shares fell 3.05 percent to 14.32 reais after losing its position as Brazil's number one bank.

Setubal, 54, will be CEO of the new company, while Unibanco Chief Executive Pedro Moreira Salles, 49, will be chairman. Itau's controlling shareholders and the Moreira Salles family will name 6 of the 14 board members of Itau Unibanco, according to the statement. Independent executives will have the remaining eight seats.

Derivatives Losses

Unibanco units, the most-traded class of stock, represent one preferred share of Unibanco and one preferred share of Unibanco Holding. The statement didn't outline terms for Itau investors. Shareholders of both banks will vote in the last week of November or first week of December, the banks said.

Bank of America Corp. will own 5.4 percent of the holding company for the new bank, according to a filing with CVM, Brazil's securities regulator.

Although there may be some overlap in Itau and Unibanco's staff, the executives aren't planning any job cuts, Moreira Salles said at today's press conference. He also said the banks will maintain all its 4,800 branches.

The takeover is a sign that ``Unibanco had serious losses'' possibly tied to large corporate clients in foreign exchange derivatives or in its car-leasing operations that forced Unibanco into Itau's hands, Nick Chamie, head of emerging markets research at RBC Capital Markets in Toronto, wrote in a note to clients today. ``No doubt today's moves were partly engineered and coaxed by Brazil's central bank,'' he said.

Both Unibanco and Itau released third-quarter earnings ahead of schedule to ease investors' concern about potential losses related to currency derivative contracts after the Brazilian real plunged.

Cost Savings

Itau said clients owed the bank 2.4 billion reais from currency derivatives contracts as of Oct. 24, at an exchange rate of 2.3 reais per dollar. The amount is less than 1.5 percent of Itau's loan portfolio, the bank said Oct. 27. Unibanco's clients would have to pay 1 billion reais to cancel leveraged positions that are losing money in the derivatives, less than 0.5 percent of total assets, Unibanco said Oct. 24.

``We started to hear stories about a subprime crisis in Brazil, which was contaminating the entire financial sector,'' Moreira Salles said. ``We heard stories about our derivatives losses that were completely out of proportion.''

The combined bank may gain 3 billion reais to 4 billion reais in cost savings, tax benefits and lower technology costs, said Henrique Navarro, analyst at Santander Investment Securities Inc. based in Sao Paulo.

``Both banks benefits from the deal,'' he said. The new bank will have Unibanco's expertise in consumer credit and Itau's lower fund-raising costs, Navarro said. The banks said their combined private banking business will reach 90 billion reais and will be Latin America's largest.

`Fragility of the Players'

Brazilian Finance Minister Guido Mantega said the combination will strengthen the country's financial system and spur lending.

``A crisis situation usually triggers takeovers as it exposes the fragilities of the players,'' Carlos Eduardo de Freitas, former director of the central bank, said in a telephone interview from Brasilia. ``We can see other acquisitions in the banking system, but not as significant.''

Unibanco urged policy makers last week to lend more foreign currency to the financial system to help finance trade after international banks severed credit lines.

``The global crisis worsened, we started to have severe credit problems in Brazil, and there's the problem with the derivatives contracts,'' said Adilson Goes, currency-trading director in Sao Paulo at brokerage Levycam CCV Ltda, in a phone interview from Sao Paulo. ``Both banks have clients who bought those so-called `toxic' contracts and are somehow involved in the losses.''

To contact the reporter on this story: Adriana Brasileiro in Rio de Janeiro at abrasileiro@bloomberg.net; Telma Marotto in Sao Paulo at tmarotto1@bloomberg.net

Last Updated: November 3, 2008 16:05 EST