Where are the new collateralized loan obligations? That question, fundamental to those concerned about the health of the leveraged loan market, gained urgency last week, when Bloomberg reported what seemed to be good news: "CLO to End 12-Month Drought in Citigroup Deal: Credit Markets."

The story said that Citigroup Inc. was underwriting a $500 million CLO, managed by WCAS Fraser Sullivan Investment Management LLC, that was scheduled to price last week. Bloomberg noted that the transaction would amount to a refinancing of an existing CLO, increasing its size by more than 50%, and would be the "first new issue backed by widely syndicated loans in the $440 billion market for CLOs since last March."

Market sources confirm that Citi was indeed shopping such a structure to investors, but optimism that the CLO market is back may be a bit premature. According to one source, Citi failed to syndicate it and pulled the refinancing on March 12. "The deal is dead," the source says, noting that Citi had already pushed off final pricing several times this year. A Citi representative didn't return calls.

Citi's potential CLO refinancing is important because loan markets are anxiously awaiting the revival of CLO issuance to help refinance a wave of loans coming due in the next three years. CLO vehicles essentially funded the leveraged finance boom of 2005-2007 by buying up loans off bank balance sheets. Considering that some $400 billion of loans will need to be refinanced through 2014, several market participants say that, absent the creation of a new CLO buying base, many of those existing loans won't turn over, resulting in a wave of defaults.

The trouble is any scenario that envisions a resurrection of the CLO is complicated by the difficulty fund managers are having finding investors willing to lend money to the securitized vehicles at any price that would make the structures economical.

For the unfamiliar: CLOs are pools of money that buy loans from banks. Interest payments from loans are used to pay CLO investors, with the highest-rated tranches getting their money first and the remainder flowing down the capital structure to the most subordinate equity holders. At the height of the credit boom, investors in the triple-A-rated senior tranches were willing to accept rates as low as LIBOR plus 25 basis points to put money into the CLOs. This meant that there was usually enough money flowing through the structures to ensure returns well over 20% to the equity investors.

All that changed with the credit crunch and subsequent financial crisis. Today CLO managers would likely have to pay between LIBOR plus 200 basis points and LIBOR plus 300 to any willing triple-A investors. That means there isn't enough of a return built into the capital structure to entice any equity into the vehicles. "I wouldn't be surprised if there were no CLOs created at all this year," says one banker. Others are more optimistic. One source said that it's likely the market will see a loan financing of more than $2.5 billion in coming days. "They're asking exactly how much we can get through this market," the source says.

According to Standard & Poor's Leveraged Commentary & Data unit, the largest loan that has been priced so far this year has been the $1.45 billion financing backing Apollo Global Management LLC's pending $2.4 billion buyout of Cedar Fair LP.

Some borrowers have become so confident about the market's capacity to buy loans that they have begun pushing through dividend recapitalizations. Indeed, LCD reports that as of March 12, $5.5 billion of dividend recaps had been priced this year. That's on pace for $27.1 billion this year. In 2007, borrowers were able to push $49.3 billion through the loan market.

With borrowers eager to refinance maturing debt, many are turning to the bond market to fund pay-downs of existing loans. Those repayments are leaving cash in the hands of the CLOs, which must then reinvest it in new deals. How long that's able to continue, absent new CLO issuance, is the big question.

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