Fallout from a crisis in the U.S. subprime mortgage market rattled the auto sector on Tuesday after the debt package for a General Motors asset sale was postponed and borrowing costs on automakers' debt surged.

The $3.5 billion bank loan financing for the buyout of GM's Allison Transmission unit was the largest leveraged loan deal to be postponed this year and came as hedge funds exited the market for the low-rated bonds, according to Reuters Loan Pricing Corp.

Concerns about fallout from the subprime mortgage crisis and an overhang of about $250 billion in leveraged loan financing that needs to be completed have caused investors to retreat to the sidelines.

Wall Street's very skittish right now and as a result no one is willing to put their necks out, said Brad Rubin, senior auto sector trading specialist for BNP Paribas.

Investors know both Ford Motor Co. and GM are going to have to tap the debt markets at some point, and unfortunately it's at much wider levels than what they've done before, he said.

GM agreed in June to sell the Allison Transmission unit for $5.6 billion to private equity firms Carlyle Group and Onex Corp.

SUBPRIME EXPOSURE WEIGHS

GM spokeswoman Renee Rashid-Merem said the company is not concerned about the unit's financing status.

While the loan transaction has been postponed, it's not expected to impact the close and the buyout remains on track, she said.

Still, the pulled loan deal added to investor jitters, as an even larger financing package for Chrysler Group's buyout from DaimlerChrysler AG has struggled to find buyers.

Chrysler earlier this month sweetened pricing on $12 billion of term loans that will back its buyout by Cerberus Capital Management as investors expressed concerns about prospects for Chrysler's turnaround.

Adding to investor jitters is GM's exposure to the subprime market through Residential Capital, the mortgage lending arm of its former unit GMAC, analysts said. GM still owns 49 percent of GMAC.

Provisioning for subprime mortgage losses at ResCap could eat up all of GMAC's earnings for a while and then some, said Glenn Reynolds, analyst for fixed-income research service CreditSights.

GMAC in May reported a first-quarter net loss of $305 million, driven by a quarterly loss of $910 million at ResCap. GMAC reports second-quarter results on Monday.

YIELDS HIT DOUBLE DIGITS

Automakers' bonds are also bearing the brunt of a general sell-off in junk bonds as investors dump the most liquid, or easily traded debt, Reynolds said.

GM and GMAC are about as liquid and on-the-run as they get in that end of the credit food chain, said Reynolds. So it ends up as the panic proxy.

GM's bonds with a 8.375 percent coupon due 2033 fell to 84 cents on the dollar on Tuesday, down from 86.875 cents on Monday, for a yield of 10.13 percent, according to MarketAxess.

Ford's 7.45 percent bonds due in 2031 fell to 75.75 cents on the dollar, down from 76.25 cents on Monday, according to MarketAxess. Those bonds now yield 10.17 percent.

The Chrysler deal, expected to be placed in the next several weeks, is the bell cow for the high-yield market, Bill Gross, manager of the world's largest bond fund at Pacific Investment Management Co., or PIMCO, said on CNBC.

The high-yield market, a major source of funding for leverage buyouts, has been shaken like a dramatic earthquake of an 8.0 magnitude, he said.

Questions about the outcome of the UAW talks are also weighing on auto bonds, said Shelly Lombard, analyst for fixed-income research service Gimme Credit.

The outlook is still very muddy in the auto sector, she said. Two months from now the UAW could be on strike, so it's the kind of situation where there's a lot of uncertainty, she said.

(Additional reporting by Faris Khan, Caleb Frazier and Jennifer Ablan)

BNP Paribas Investment