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Debt fears heighten in U.S. and Europe

Section: Daily Dispatches

By Michael Mackenzie and Henny Sender
Financial Times, London
Friday, February 8, 2008

Fears about corporate and commercial property debt reached new heights in the US and Europe on Friday as investors liquidated holdings in a sign of spreading credit turmoil.

Investors were responding to worries that economic weakness would hit corporate profits, leveraged buyouts, and commercial property developments. This represents an escalation of the crisis that began with concerns about US subprime mortgages.

Some of the biggest losses were reported in the market for leveraged loans -- used by private equity firms to finance deals. Mutual funds that invest in these loans have been hit with redemptions, forcing them to dump some of their holdings.

This has put pressure on banks and other investors who are holding $200 billion of leveraged loans that they had been hoping to sell. "The overhang of bank debt from last year's leveraged buyout activity is becoming more problematic," said Kevin Cronin, portfolio manager at Putnam Investments. "Loans are being liquidated at distressed prices and banks  are looking to reduce risk."

Loans used to finance two of last year's biggest buyouts, utility TXU, and credit card processor First Data, were among those hit, Mr Cronin said. While First Data would be affected by a severe economic slowdown, the debt of TXU, which has strong collateral and is less vulnerable to recession, has held up well until recently.

Closely followed measures of credit risk in the US and Europe reached new peaks. Europe's Markit iTraxx index -- which measures the cost of buying credit insurance against defaults by investment grade companies -- hit a record 97.75 basis points. The US Markit CDX index of 125 investment-grade companies hit a record 133 basis points -- up from 78 bp at the start of the year.

Another index that measures the performance of commercial mortgage bond deals hit a record as fears spread that the commercial real estate market would emulate the residential property market. The triple-A index of the CMBX series hit 235 bp, up from a record 213 bp on Thursday.

"Investor worries about potential further writedowns are shifting in a big way from subprime residential mortgages to commercial real estate lending," said Ted Wieseman, economist at Morgan Stanley. The dark mood boosted the appeal of US, UK and European government bonds. The yield on the two-year US Treasury note fell 11 bp to 1.94 percent.

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