(Adds details on talks, background on Recovery from paragraph 3)
By Guillermo Parra-Bernal and Tatiana Bautzer
SAO PAULO, Dec 2 (Reuters) - Grupo BTG Pactual SA is in talks to sell stake in Recovery do Brasil SA, Latin America's largest debt collector, three people directly involved in the talks said on Wednesday, as local and global investors look to enter the burgeoning sector.
Lone Star Funds is among the firms specializing in distressed debt investments that have held talks to enter Recovery, said the sources, who requested anonymity because negotiations are under way.
The move follows the arrest of BTG Pactual founder André Esteves in a corruption probe. Latin America's No. 1 independent investment bank is rushing to sell assets and pools of loans to rivals to shore up cash holding and restore investor confidence.
São Paulo-based BTG Pactual could fetch between 400 million reais and 1.2 billion reais ($103 million to $312 million) from the sale, depending on whether it includes the bank's platform that Recovery uses to price loans, two of the sources said.
The first source said talks on the sale of BTG Pactual's approximately 50 percent stake in Recovery were advancing fast. BTG Pactual controls Recovery, with the remaining stake in the company held by the World Bank's International Finance Corp and the company's founders from Argentina.
An unidentified São Paulo-based distressed debt company, which is teaming up with undisclosed partners to explore the purchase of Recovery's bad debt portfolio or collection platform, has also entered talks and is considering bidding, said the second source.
The third source said interested parties were already preparing due diligence proceedings on Recovery's portfolio and platform, without elaborating. Recovery oversees about 50 billion reais in distressed debt loans and is a large buyer of bad credit from Brazil's biggest financial institutions.
BTG Pactual did not comment. A press representative working for Lone Star did not immediately return calls and messages.
With unemployment spiking and inflation eroding disposable income, Brazilian households are defaulting on their loans at the fastest pace in six years. Toxic debt is also increasing for companies, which are succumbing to flagging sales and rising borrowing costs.
Industry players estimate sales of toxic loans will rise 40 percent this year to more than 25 billion reais. State-controlled lender Caixa Econômica Federal, which only entered this market last year, has sold almost 11 billion reais in bad loans this year, executives told Reuters this month.
Taking advantage of that trend, Goldman Sachs Group Inc , Credit Suisse Group AG and Cerberus Capital Management LP are considering ventures to invest in soured consumer and corporate loans, joining local companies to pay record amounts for distressed assets.
Distressed debt companies acquire a large portfolio of credit from a bank at a steep discount and then rework each loan individually, profiting after repackaging them into securities, taking over the collateral or restructuring them. For banks, bad-loan sales help them clean up their balance sheets in times of economic hardship.
$1 = 3.8550 Brazilian reais Additional reporting by Paula Arend Laier in São Paulo; Editing by Chizu Nomiyama and Lisa Von Ahn