Melbourne: The risk of the Rio Tinto Group defaulting on its debt rose to a record following a report Blackstone Group LP is planning a bid for the mining company that may include China’s sovereign wealth fund.

The annual cost to protect $10 million (Rs39.40 crore) of Rio’s debt from default, as measured by credit-default swaps, increased $4,000 to an all-time high of $83,000, Citigroup Inc. prices show.

Blackstone has appointed lawyers and is in talks with banks and public relations companies for the potential offer, the London-based Daily Telegraph reported, without saying where it got the information.

Any offer would compete with a $137 billion takeover proposal from Melbourne-based BHP Billiton Ltd, the world’s biggest mining company.

Investors are concerned an acquisition by Blackstone, manager of the world’s largest leveraged buyout fund, will increase Rio’s debt and push its credit ranking to speculative grade.

Private equity firms are being forced to pay more to raise debt after losses tied to rising defaults on US subprime mortgages triggered about $70 billion of asset write-downs and losses since July.

“Blackstone and the China wealth fund don’t have shares to offer as equity," said Anita Yadav, head of credit and hybrid research at UBS AG in Sydney. “They will have to find the cash somewhere to fund the bid."

A buyout could add as much as A$80 billion (Rs2.76 trillion) to Rio’s existing debt of about $50 billion, she said. Rio, the third-largest mining company in the world, got $40 billion in loans in August for the purchase of Alcan Inc., a Montreal-based aluminium producer.

London-based Rio has the third-lowest investment grade rating of BBB+ from Standard & Poor’s. High-risk, high-yield or speculative-grade debt is rated below Baa3 by Moody’s Investors Service and BBB- by S&P and Fitch Ratings.

China Investment Corp., which paid $3 billion in May for a 9.4% stake in Blackstone, denied this month that it may bid for Rio. A BHP takeover of Rio would concentrate supplies of copper, iron ore and coal and may spur Chinese companies to step up global takeovers to secure raw materials.

“I don’t think China Investment Corp.’s current position in Blackstone is big enough to use Blackstone as an investment tool," said Lu Yizhen, who helps manage $640 million at Citic Prudential Fund Management Co., in Shanghai.

The rise in Rio’s contracts fuelled an increase in the Markit iTraxx Australia Series 8 Index, a benchmark for the cost of protecting Australian corporate debt from default. Contracts on the index, which gain as perceptions of credit quality deteriorate, rose about 0.75 basis point to 59.75 basis points.

A basis point, or 0.01 percentage point, is worth $1,000 on a swap that protects $10 million of debt.

Credit-default swaps, contracts conceived to protect bond holders against default, pay the buyer face value in exchange for the underlying securities or the cash equivalent should a company fail to adhere to its debt agreements.

Banks have slowed lending to finance buyouts as losses from the US subprime mortgage market led to $65 billion of debt-related writedowns. SP AusNet, an Australian energy distributor, on Monday scrapped a proposed A$8.3 billion ($7.3 billion) purchase of assets from its parent company, citing deteriorating debt markets.

“Most of these acquisitions by private equity require debt so we’ll have to see what funding exists," said Jason Teh, who helps manage the equivalent of about $5.3 billion at Investors Mutual and holds Rio and BHP. “The question is whether debt funding an acquisition in this type of environment is feasible."

The perceived risk of Rio Tinto defaulting on its debt, as measured using credit-default swaps, increased about 4 basis points to a record high 83 basis points at 2:35pm in Sydney, Citigroup Inc. prices show.

Investors use the contracts to speculate on credit quality and the costs, or spreads, increase as the perceptions of credit quality deteriorate.

Blackstone co-founder Stephen Schwarzman said last month rising borrowing costs are crimping the pace of large leveraged buyouts. Buyout firms relied on cheap debt in the past two years to finance record deals.

Madelene Pearson in Melbourne contibuted to the story.