By Kristen Haunss and Caroline Salas March 16 (Bloomberg) -- The market for collateralized debt obligations backed by high-yield, high-risk loans is poised to open in the U.S. for the first time in a year after losses on mortgages prompted investors to flee bundled securities. Citigroup Inc. is underwriting a $500 million fund managed by New York-based WCAS Fraser Sullivan Investment Management LLC, scheduled to price as soon as this week, according to people familiar with the offering who declined to be identified because terms are private. The deal refinances an existing collateralized loan obligation and increases its size by more than 50 percent. The offering would mark the first new issue backed by widely syndicated loans in the $440 billion market for CLOs since last March and a return to investments that contributed to $1.76 trillion of writedowns and credit losses at the world’s largest financial institutions. Citigroup and WCAS Fraser Sullivan are marketing the deal after prices on CLO debt staged a record rally on signs of economic recovery. “This is the first baby step to getting the market going again,” said Matt Natcharian, head of Babson Capital Management LLC’s structured credit team in Springfield, Massachusetts. “There is a decent amount of investor interest throughout the capital structure and there are managers that want to do deals.” JPMorgan Chase & Co., Bank of America Corp. and Deutsche Bank AG have also been approaching managers of leveraged loans since last year to offer terms for new CLOs, according to people familiar with the discussions. CLOs pool loans and slice them into securities of varying risk intended to provide higher returns than similarly rated investments. CLO Prices Prices on the highest-rated portions of CLOs have climbed to 90.5 cents on the dollar from a record low of 69 cents in April, according to Morgan Stanley data. Elsewhere in credit markets, the extra yield investors demand to own corporate bonds rather than government debt fell yesterday to 157 basis points, or 1.57 percentage point, the lowest this year, from as much as 174 basis points Jan. 4, the Bank of America Merrill Lynch Global Broad Market Corporate Index shows. Yields averaged 4.015 percent. MF Global Holdings Ltd., Hexagon Securities LLC and at least 19 other firms are pressing regulators to force swaps clearinghouses to lower entry barriers and improve competition in a $605 trillion derivatives market dominated by the world’s biggest banks. Brokers formed an association last month that hired a Washington-based law firm to pursue the issue with lawmakers and regulators, said Mike Hisler, a partner at New York-based Hexagon. They also want tougher conflict-of-interest laws to ensure that a bank’s derivatives desk doesn’t influence clearinghouse decisions that could shut out new competitors. U.S. Treasuries International demand for long-term U.S. financial assets weakened in January as China and Japan, the two biggest holders of Treasuries, reduced their positions, according to U.S. Treasury Department data released yesterday in Washington. Including short-term securities such as stock swaps, total investment flows show foreigners sold a net $33.4 billion after net buying of $53.6 billion the previous month. Kazakhstan, central Asia’s biggest energy producer, may sell Islamic bonds for the first time this year to attract overseas money to finance its budget deficit. The government plans to become a “significant player” in the Islamic finance market by offering debt that complies with Muslim tenets as early as 2010, Finance Minister Bolat Zhamishev said. Phillips-Van Heusen Phillips-Van Heusen Corp. will use two term loans totaling $2 billion and a $450 million undrawn revolving line of credit to help pay for its takeover of Tommy Hilfiger BV, according to people familiar with the plan. Phillips-Van Heusen agreed to buy the clothing maker from Apax Partners LP, the private-equity firm, for 2.2 billion euros ($3 billion). Bombardier Inc., the world’s third-largest commercial- airplane maker, sold $1.5 billion of senior notes in a two-part deal after withdrawing a similar offering a week ago, according to data compiled by Bloomberg. The Montreal-based company is returning to the U.S. corporate bond market after postponing an offering on Feb. 12 and later pulling it as the extra yield investors demanded to own speculative-grade debt instead of Treasuries rose amid concerns Greece couldn’t manage its budget deficit. Anheuser-Busch InBev NV, the world’s largest beer maker, is seeking more lenders for $13 billion of loans, according to two people involved in the transaction. Banks joining the deal will get a fee of 45 basis points, or 0.45 percentage point, for providing $250 million or $500 million, the people said. Credit Risk An indicator of corporate credit risk in the U.S. rose. The Markit CDX North America Investment Grade Index, a credit- default swaps benchmark that investors use to hedge against losses on corporate debt, increased 0.8 basis point to 84 basis points, according to CMA DataVision. The index typically rises as confidence in debt markets deteriorates and falls as it improves. The Markit iTraxx Europe Index, tied to the debt of 125 investment-grade companies, rose 2.25 basis points to 76, JPMorgan prices show. The Markit iTraxx Asia index of 50 investment-grade borrowers outside Japan decreased 1 basis point to 93 basis points, Royal Bank of Scotland Group Plc prices show. In Sydney, the Markit iTraxx Australia index rose 1 basis point to 81.5 basis points, according to Westpac Banking Corp., while the Markit iTraxx Japan index was little changed at 126 basis points in Tokyo, BNP Paribas SA prices show. CLO Market Credit-default swaps pay the buyer face value if a borrower defaults in exchange for the underlying securities or the cash equivalent. A basis point is 0.01 percentage point and equals $1,000 a year on a contract protecting against default on $10 million of debt for five years. In the CLO market, banks are marketing deals after the S&P/LSTA U.S. Leveraged Loan 100 Index returned an unprecedented 52 percent in 2009. High-yield, or leveraged, loans are those rated below Baa3 by Moody’s Investors Service or BBB- by Standard & Poor’s. Issuance Tumbled CLO issuance tumbled to $26.5 billion in 2009, the lowest in more than a decade, and 94 percent deals structured to remove assets from banks’ balance sheets, according to Moody’s. The WCAS Fraser Sullivan deal, COA Tempus CLO Ltd., is partially a refinancing of COA CLO Financing Ltd., issued in January 2009 using some Citigroup-arranged loans, the people said. It’s the first deal S&P has rated since March 2009. Assets in the new WCAS Fraser Sullivan CLO will have a par value of about $500 million, compared with about $320 million for COA CLO when that deal was structured last year, according to one of the people familiar with the offering. COA Tempus CLO had acquired $219.8 million in face value of collateral as of March 11 and planned to purchase another $280.2 million, according to S&P, which assigned preliminary ratings to the transaction. “It seems like it is not all new collateral, but there is some new collateral so it falls in between a new deal and a refinancing,” said Vishwanath Tirupattur, an analyst at Morgan Stanley in New York. “Certainly people are watching this and it’s a positive step.” John Fraser, chief investment officer of WCAS Fraser Sullivan, declined to comment. WCAS Fraser Sullivan was formed in 2007 with the backing of Welsh, Carson Anderson & Stowe, the private equity firm. Alex Samuelson, a Citigroup spokesman, declined to comment. Spreads Narrow Tirupattur predicts there may be 10 or more new CLO deals this year. The extra yield, or spread, investors demand to own debt issued by CLOs above benchmark rates must narrow before issuance will pick up, he said. Spreads over the London interbank offered rate on CLO slices rated AAA have narrowed to 2.25 percentage points from 7.25 percentage points in April, Morgan Stanley data show. That’s still more than double the average spread of 0.9 percentage point in February 2008. Libor is the rate banks charge for loans to one another. ‘Not Quite There’ “At the moment the economics are not quite there,” Tirupattur said. “The recreation value of CLOs is lower than the value of the portfolio value of underlying loans,” he said, meaning there is no arbitrage between the cost of buying individual loans in the open market and bundling them together in a CLO. The $327 million AAA rated portion of COA Tempus CLO is being marketed at a spread of about 1.9 percentage points above three-month Libor, according to S&P. Libor was set at 0.26 percent yesterday. The $15 million of AA rated slices may price at a spread of 2.25 percentage points and the $36.5 million of A rated notes may yield 2.5 percentage points more than benchmark rates, S&P said in a report last week. The CLO will also issue $102.1 million of so-called equity, the unrated piece first in line for losses. “Cash investors, insurance companies and banks will be attracted to higher coupons and well-structured investments,” Babson’s Natcharian said. “Eventually prices will start to tighten in the market, but it will take more than one deal to get there.” To contact the reporters on this story: Kristen Haunss in New York at khaunss@bloomberg.net; Caroline Salas in New York at csalas1@bloomberg.net

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