UPDATE 2-DEALTALK-Chrysler debts come back to haunt banks

(For more Reuters Dealtalks, please click [DEALTALK/]) (Rewrites paragraph 9 with update on talks with lenders)

By Megan Davies

NEW YORK, April 3 (Reuters) - The star-crossed $7.4 billion Chrysler buyout is not just a headache for private equity firm Cerberus Capital Management, but some of the biggest banks on Wall Street as well.

Chrysler is operating thanks to $4 billion of government loans and seeking more. A possible bankruptcy could be a solution for the company, which is racing to complete a tie-up with Italy's Fiat SpA (FIA.MI).

With a worst-case scenario being liquidation and the best case a deal with Fiat, the way the auto company's future plays out will impact the recovery lenders can expect. Chrysler reached an agreement with Fiat in March on the framework for an alliance.

Five Wall Street banks -- J.P. Morgan Chase & Co (JPM.N), Bear Stearns, Goldman Sachs Group Inc (GS.N), Citigroup Inc (C.N) and Morgan Stanley (MS.N) -- underwrote the financing when the deal was agreed in the summer of 2007. They provided a $7 billion term loan that provided working capital for the automaker.

Portions of that senior secured debt were sold to roughly 50 other institutions, a source familiar with the credit group said. Banks typically look to reduce exposure by selling part or all of their debt, although the syndication hit the markets in the wake of the subprime mortgage meltdown, making it harder to sell this debt on. Some exposure still remains on some of their books.

JPMorgan's purchase of Bear Stearns meant its exposure increased. Two sources familiar with the credit group said JPMorgan has about $2.5 billion in total exposure to Chrysler's auto business, but it is unclear how much of that has been hedged or at what value it is being held on the bank's books. Citi has under $1 billion, one of the sources said.

Goldman Sachs sold some of its loans last year, sources previously told Reuters LPC.