Petrobras Probe Blindsides Odebrecht Bondholders on CEO Arrest

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Just when bond investors were getting comfortable with the idea that most of the fallout from Brazil’s largest bribery probe was behind them, new arrests are sending a painful reminder that it isn’t over yet.

Bonds issued by Odebrecht SA plunged on Friday after Chief Executive Officer Marcelo Odebrecht was detained by police investigating allegations that construction companies paid bribes to the state-run oil producer in return for contracts.

It was a surprise turn for a builder that had avoided the defaults and bankruptcies that hit smaller rivals earlier this year, and highlights the risks for investors as Latin America’s largest economy grapples with a scandal that prompted street protests, calls for the president’s impeachment and routs in the nation’s bond and equity markets. While little known outside Brazil, the empire controlled by the billionaire Odebrecht family generated more revenue last year than global giants including 3M Co., Morgan Stanley and Oracle Corp.

“The strength and scope of the evidence will be the determining factor as to how meaningful all of this is,” said Jason Trujillo, an Atlanta-based money manager at Invesco Ltd., which oversees $800 billion and holds Odebrecht bonds. “But it’s certain that this does not make things better for Brazil.”

Perpetual Bonds

Odebrecht’s $750 million of bonds with no set maturity tumbled 1.84 cents to 81.29 cents on the dollar on Monday in New York after falling 4.04 cents Friday. While the securities traded as low as 66.34 cents in February, they recovered as investors bet the probe would leave Odebrecht relatively unscathed.

Odebrecht’s construction unit said in an e-mail Friday that its offices had been searched and arrest warrants executed. Detentions weren’t necessary since the company and its executives have cooperated with the investigation, it said.

The company will appeal Odebrecht’s arrest, lawyer Dora Cavalcanti told journalists in Sao Paulo the same day.

The allegations of bribery involving state-controlled Petroleo Brasileiro SA first became public in March 2014, when prosecutors said they were looking into ties between Petrobras’s former head of refining and a money launderer. The investigation uncovered an alleged cartel of construction companies that colluded to bribe Petrobras officials and divvy up contract work.

In November, police arrested more than 20 people tied to the investigation, though no one from Odebrecht.

Bankruptcy Protection

Three major builders cited in the probe -- OAS SA, Galvao Engenharia and Grupo Schahin -- filed for bankruptcy protection for some of their units this year. Petrobras has banned some builders, including Odebrecht and Andrade Gutierrez, from bidding on new contracts amid the investigation.

Odebrecht wasn’t the only CEO arrested on Friday. Andrade Gutierrez’s chief, Otavio Azevedo, was also taken into custody. Its $500 million of notes due 2018 slumped a record 18 cents to 65 cents on the dollar that day. The company said that it was aiding the investigation and denied any wrongdoing.

Prosecutors are looking at about 17 billion reais ($5.5 billion) of contracts between Odebrecht and Petrobras, and 9 billion reais of contracts between Andrade Gutierrez and Petrobras. There’s evidence the CEOs of both companies were aware of criminal activities being carried out, a prosecutor and federal police official told reporters Friday.

Moody’s Investors Service put its ratings for Andrade Gutierrez and Odebrecht under review for downgrade on Saturday, citing the arrests. Andrade’s Ba2 rating is two steps below investment grade, while Odebrecht’s Baa3 rating is one step above junk.

‘Will Survive’

While it’s never good for a company to be under investigation for bribery, Petrobras contracts represent less than 1 percent of Odebrecht’s backlog, and public works are only about 5 percent of contracts of the company’s building arm. Odebrecht has operations in 21 countries, as well as stakes in energy, infrastructure and petrochemicals businesses. Revenue grew 11 percent last year to 108 billion reais.

“While this process will certainly be painful, Odebrecht will survive,” said Carlos Gribel, the head of fixed income at Andbanc Brokerage LLC in Miami. “They are too big to fail.”

Bernardo Rodarte, who oversees 1 billion reais of assets as a money manager at Sita Corretora, says things could get worse before they get better.

“The arrests show this is just the beginning,” he said in an interview from Belo Horizonte, Brazil. “I can’t see how this would not worsen the prospects for these companies with regards to money raising and new projects.”