The three largest U.S. banks are preparing for a comeback in the market for collateralized debt obligations backed by high-yield, high-risk loans, two years after issuance tumbled when credit markets seized up.

JPMorgan Chase & Co., Bank of America Corp. and Citigroup Inc. are approaching managers of leveraged loans to offer terms for new collateralized loan obligations following a record rally this year in the debt, according to people familiar with the discussions who declined to be identified because the talks are private. The highest-rated portions of CLOs have climbed to 89 cents on the dollar from a record low of 69 cents in April, according to Morgan Stanley data.

The $440 billion market for CLOs, which pool loans and slice them into securities of varying risk, largely disappeared at the end of 2007 as losses on subprime mortgages led investors to flee bundled debt. Though new sales would signal Wall Street's return to investments that contributed to $1.7 trillion of writedowns and credit losses worldwide, they may help companies refinance $1.5 trillion of high-yield loans and bonds maturing by the end of 2014.

"Market conditions have improved dramatically over the course of this year, which we see carrying on into 2010," said Philippe Roger, JPMorgan Chase's global head of structured credit trading. "We are actively discussing the market environment with our clients, and think that they are going to be increasingly attracted both to the leveraged-loan asset class and securitization technology and applications related to the high-yield space."

Spokeswomen for Citigroup, Deutsche Bank and Bank of America declined to comment.

Leveraged loans have returned a record 49.3% this year after losing an unprecedented 28.2% in 2008 following the failure of Lehman Brothers Holdings Inc., according to the Standard & Poor's/LSTA U.S. Leveraged Loan 100 Index.

New issues of CLOs may reach $3 billion to $6 billion next year, Wells Fargo Securities LLC senior analyst Dave Preston wrote in a report Monday.

For banks to be able to create new CLOs, leveraged-loan prices need to be less volatile and financing costs for the top-rated portions must be lower, said David Yan, a Credit Suisse Group AG analyst, who predicts issuance may return in the first quarter of 2010.

CLO sales swelled to about $100 billion in both 2006 and 2007, from $32 billion in 2004, according to data from Credit Suisse. Investors bought the securities because they had higher returns than similarly rated debt, boosting demand for the leveraged loans packaged inside them.

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