April 29 (Bloomberg) -- If the credit crunch really is close to ending, as Citigroup Inc. Chief Executive Officer Vikram Pandit says, then why is he offering below-market terms to rid the bank of some of its $26 billion in leveraged buyout loans?

Citigroup sold $8 billion of the debt to private-equity firms this month only after giving buyers $6 billion of financing at cheaper rates than it can borrow itself, according to people familiar with the transaction, who declined to be identified because the terms aren't public. Deutsche Bank AG and Royal Bank of Scotland Plc are also offering credit to buyers to help cut their holdings.

While the deals helped shrink the global overhang to $91 billion from $230 billion, don't expect banks to open their doors to new borrowers anytime soon, said Nigel Sillis, director of fixed-income and currency research at Baring Asset Management in London. That's because the arrangements shift one type of loan for another.

``It's too optimistic to say the backlog has been cleared and everything is back to normal,'' said Sillis, whose firm oversees $48 billion. ``The forced sellers are cutting deals with the only buyers in town. Getting bona-fide lending going again is way down the line.''

$65 Billion

Banks escaped about $65 billion of LBO commitments in the past four months in part by lending money to private equity firms such Blackstone Group LP's GSO Capital Partners and Apollo Management Inc. Wall Street is getting rid of the debt individually, in packages or placing it into structures such as collateralized loan obligations, which pool loans and slice them into pieces with various ratings to sell to investors.

``They're substituting one credit for another but they're still ultimately on the hook for the debt,'' said Robert Willens, a former managing director Lehman Brothers Holdings Inc. who runs a tax-advisory firm in New York.

The rest of the inventory was reduced because acquisitions such as Blackstone's $6.6 billion of Dallas-based credit card processor Alliance Data Systems Corp. were canceled, eliminating the bank commitments.

By offering to finance the sales, banks can receive higher prices for the loans.

Financing

Deutsche Bank sold loans for about 90 cents on the dollar, according to people familiar with the offering. By contrast Goldman Sachs Group Inc., which didn't provide financing, has dumped some loans for as little as 63 cents. Goldman Sachs dropped 11 percent this year in New York Stock Exchange trading, compared with Citigroup's 9.6 percent drop.

Financial institutions ended up with the buyout debt after agreeing to lend a record $735 billion for LBOs last year. When credit investors began fleeing in 2007 to safer bonds, the banks were left holding the debt, which is rated below Baa3 by Moody's Investors Service and BBB- by Standard & Poor's.

Citigroup was stuck with $69 billion of commitments to companies including Dallas-based TXU Corp., Texas' biggest electricity provider now known as Energy Future Holdings Corp.

Pandit, 51, was put in charge of Citigroup in December. He cut the firm's backlog in the first quarter by $5.5 billion to $37.7 billion, according to regulatory filings. It has since sold $8 billion with financing and $4 billion without, the bank said.

In some cases Citigroup provided private-equity firms with $4 of financing for every dollar of they invested, said people familiar with the terms.

Blackstone, TPG

The loans to buyout firms, including Blackstone and TPG, were offered at as low as 1.5 percent above the London interbank offered rate, or about 4.3 percent. That compares with Citigroup's sale of preferred securities last week at a yield of 8.4 percent.

Citigroup spokeswoman Danielle Romero-Apsilos declined to comment.

The purge helped drive overall loan prices higher and enabled Pandit to tell investors last month the credit crisis is abating.

``We think it's important to think about the credit crisis in terms of two phases,'' Pandit said at the bank's shareholder meeting this month. ``During the first phase, there were meaningful liquidity and price adjustments that resulted in meaningful marks, and therefore, capital adjustments. I think we are closer to the end of this phase than the beginning.''

In the second phase, depending on housing and the economy, credit losses will increase in Citigroup's loan portfolios, Pandit said. ``We have significant earnings potential to offset them,'' he said.

Loan Prices

The S&P index of actively traded loans rose to 92.1 on April 24, up from a record low of 86.28 cents in February as investors bet the reduction of the backlog would buoy prices.

While the banks remain stuck with lending commitments, the loans to private-equity firms are generally higher quality than the LBO financing, said Janet Tavakoli, president of Chicago- based Tavakoli Structured Finance, which advises banks and hedge funds. That reduces the amount of capital they are required to put up to cushion against potential losses.

Carlyle Group Chairman David Rubenstein said he's eager to participate in the sales. Banks are offering the debt at discounts lower than the prices on their book and are willing to finance the sales, he said.

Other private equity firms are going to do it and ``we're going to do it too,'' Rubenstein told a conference in Baltimore yesterday.

Deutsche Bank provided Blackstone and Apollo with loans with similar leverage to Citigroup, according to investors who saw the terms. The German bank also gave below-market rates to entice buyers, offering to lend the money at as little as Libor plus 1.25 percent, the investors said. John Ford, a Blackstone spokesman, and Steven Anreder, an Apollo spokesman, declined to comment. Blackstone and Apollo are based in New York.

Deutsche Bank Loss

Deutsche Bank Chief Financial Officer Anthony Di Iorio told analysts on a conference call today the bank sold 1.4 billion euros ($2.2 billion) of loans in April, in addition to sales earlier this year. He didn't discuss prices or financing arrangements with buyers.

The Frankfurt-based bank reported its first quarterly loss in five years today after writing down the value of loan obligations by 1.8 billion euros. The bank reduced commitments to 33.1 billion euros from 36.2 billion euros at the end of last year. Deutsche Bank sold $5 billion of the debt to private-equity firms in the U.S., analysts at Charlotte, North Carolina-based Bank of America Corp. wrote last week.

Goldman Sachs

Goldman Sachs reduced its loans to $20 billion from $43 billion since the start of the year without providing credit to buyers, said people familiar with the trades.

The bank ditched its portion of $7 billion of financing for Auburn Hills, Michigan-based automaker Chrysler LLC for as little as 63 cents on the dollar and sold debt of Bain Capital's Bavaria Yachtbau, a German yacht maker, for 65 cents on the dollar, the people said.

``Goldman bit the bullet, leaving no doubt about the risk transfer,'' Tavakoli said. Michael DuVally, a Goldman Sachs spokesman in New York, declined comment.

Until banks can shed last year's LBO commitments, they'll be unable to make new loans, sacrificing the ability to earn fees that average 2.5 percent on high-yield debt, the most lucrative part of the capital markets, according to estimates by Mercer Oliver Wyman, a financial-services consulting firm in London.

``A lot of financial institutions have big holes in their balance sheets and haven't begun to scratch the surface yet,'' Rubenstein said. ``We may be getting closer to the bottom but it may be that the bottom is a number of months away.''

Lending Drops

Bank lending has already slumped 73 percent in the past year, according to data compiled by Bloomberg. U.S. banks made $85 billion of leveraged loan commitments in the first quarter, down from $320 billion in the same period in 2007.

``They have to free up balance sheet space so they can become active again in new lending activity,'' said Axel Potthof, who oversees European high-yield debt in Munich for Pacific Investment Management Co., manager of the world's biggest bond fund and a unit of Munich-based Allianz SE. ``The problem is they're blocked, they can't do new lending business because they still have this on the balance sheet.''

To contact the reporter on this story: Pierre Paulden in New York at ppaulden@bloomberg.net; Cecile Gutscher in London at cgutscher@bloomberg.net

Last Updated: April 29, 2008 15:24 EDT