Worry Builds in Junk Markets

Cerberus' abandonment of United Rentals renews fears as the Alltel deal is set to close Friday.
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Two months ago, credit market investors would have cheered news that private-equity firm Cerberus Capital scrapped its plans to take

United Rentals

(URI) - Get Report

private.

The idea of chipping away at the over $300 billion pipeline of leveraged buyout-related junk bonds and loans left over after the summer's credit markets correction would have been a welcome development. But that was when investors thought the credit markets correction was "technical," or driven by hedge funds squeezed by subprime exposure and needing to raise liquidity.

Now that signs of a flailing U.S. economy are growing by the day, a lukewarm reception to $3.2 billion in loans related to

Goldman Sachs'

(GS) - Get Report

buyout of

Alltel

(AT) - Get Report

set to close Friday and Cerberus' willingness to pay $100 million to get out of the deal rings yet another warning bell for bond and loan investors keen to finish the year on a strong note.

"We put Cerberus in the penalty box," says one loan fund manager who spoke on the condition of anonymity. He said the private-equity firm pulled the plug at the eleventh hour, after bond holders had tendered their bonds, placed their orders and were "ready for the high fives."

"The way I read between the lines here is that Cerberus has too much to deal with, given its investments in GMAC and Chrysler," he says. "This was an easy one to let go of."

According to a regulatory filing late Wednesday, Cerberus stated it was unwilling to proceed with the United Rentals acquisition under the current terms, and said it was willing to pay the $100 million breakup fee or renegotiate the purchase terms. Cerberus cited deteriorating credit market conditions from the original July deal as reason for its reluctance to go forward.

Indeed, two of Cerberus' high-profile, economically sensitive investments in both the finance and auto space are suffering in the wake of the summer's credit crunch, and could be in for more pain as the economy ratchets down.

Cerberus bought a 51% stake in

General Motors'

(GM) - Get Report

finance arm last year. At the time, GMAC's mortgage arm, ResCap, was considered a stabilizer for the finance company, as it was making money hand over fist during the heyday of subprime mortgage lending. But ResCap ran into liquidity troubles this summer, leading GMAC to inject $1 billion into the company in the third quarter. Many analysts question how much more GMAC could or should support it.

Adding to Cerberus' headaches may also be its buyout of automaker Chrysler earlier this year, particularly as consumer sentiment slumps and economists expect spending to follow. Its ex-parent company

Daimler

(DAI)

was so eager to get rid of Chrysler, it ended up paying to unload it. Recently, the automaker announced more job cuts.

As another loan and junk bond fund manager suggests, "It does seem that Cerberus may want to keep some powder dry to deal with some of these companies."

Cerberus did not return calls seeking comment.

Whether Cerberus was ringing a warning bell or not, evidence of another leg down in the junk credit markets may be afoot.

Overall, junk bond and loan risk premiums are higher again -- but only to July's levels. More telling are prices in the cyclical parts of the market, which have taken a beating. In particular, retail companies like

Linens N Things

,

Claires Stores

and

Michaels Stores

are trading at distressed or stressed levels. Linens N Things' bonds trade just under 60 cents on the dollar, while some of Claires' and Michaels' trade around 80 cents on the dollar, according to a bond trader.

The next test for the bond market is also faring poorly.

The same fund manager that put Cerberus in "the penalty box" says he's staying far away from the loan deal to finance TPG and Goldman Sachs' buyout of Alltell that's currently in the market and expected to close Friday.

"I'm not touching it," he says. "I'm still feeling the singes of First Data and TXU deals, and why mess up the end of the year?"

After a volatile autumn in the credit markets, investors who took the risk of buying bonds of mega-LBO's TXU and First Data have seen their prices fall slightly. With less assurance that the economy will ride through the winter without recession, they are not keen to take on any unnecessary risk in their portfolios as their year-end targets and bonuses approach, he says.

Earlier Thursday, underwriters canceled plans to sell $4.8 billion of Alltel loans, seeking only to sell $3.2 billion. The smaller portion offers more protection to investors, according to a report by Standard & Poor's Leveraged Commentary and Data.

In keeping with TSC's editorial policy, Rappaport doesn't own or short individual stocks. She also doesn't invest in hedge funds or other private investment partnerships. She appreciates your feedback. Click

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