Feb. 12 (Bloomberg) -- Citigroup Inc. has never been held in such low esteem by debt investors, and that's why Prince Alwaleed bin Talal isn't the only one in love with the bank whose looks are deceiving.

Pacific Investment Management Co., manager of the world's largest fixed-income fund, and Calvert Asset Management Co. said Citigroup and Bank of America Corp. are attractive because yields on U.S. bank bonds are near record highs relative to Treasuries. Alwaleed, the biggest shareholder in New York-based Citigroup, bought more of the bank's stock even as the Standard & Poor's 500 Financials Index fell 9.1 percent this year.

The world's largest financial companies have incurred $146 billion in losses from securities tied to subprime mortgages, and Pimco and Calvert say bond yields compensate for the risk that there's more to come. The firms raised $84 billion selling equity stakes to investors such as Saudi Arabia's Alwaleed, and bank bonds have returned 2 percent this year, the most of any investment-grade debt, Merrill Lynch & Co. index data show.

``The fact that the banking sector has attracted fresh capital in the last couple of months is huge,'' said Mark Kiesel, an executive vice president at Pimco who oversees $158 billion of corporate bonds from Newport Beach, California. ``We've been playing defense for the better part of two years, and the question we've been asking ourselves is when to go on offense. In the banking sector, we've started to do that.''

Buying Bank Debt

Pimco has been buying new issues from financial firms because the market is ``too bearish,'' Kiesel said in an interview Feb. 5. Relative to benchmark indexes, bank bonds represent a bigger portion of Pimco's holdings, he said. On Jan. 22, Bill Gross, manager of the Pimco Total Return Fund, said Citigroup, Bank of America and Wachovia Corp. were appealing.

Banks account for about half of the $2.3 trillion of securities in Merrill's investment-grade corporate bond index. Yields reached 272 basis points more than Treasuries on Jan. 23, the widest spread since at least 1996, after delinquencies on loans to the riskiest subprime homeowners triggered widespread writedowns. Last year the gap was as small as 76 basis points in January, and during the last decade it averaged about 103 points. Spreads ended yesterday at 268 basis points.

Jeffrey Rosenberg, credit strategist at Bank of America, recommended bank bonds last month because yield spreads are likely to narrow as the industry raises capital.

Puneet Sharma, a Barclays Capital analyst in London, predicted senior bank notes will outperform other company debt this year because prices already reflect the potential for future losses on mortgage-related securities.

Citigroup Sale

When Citigroup sold $3.25 billion of preferred securities rated A2 by Moody's Investors Service and A by Standard & Poor's last month, investors demanded annual interest of 8.125 percent, or about a quarter percentage point less than the average for a high-yield, high-risk bond rated BB, according to Merrill index data.

Citigroup, the largest U.S. bank by assets, said Jan. 15 that it raised $14.5 billion from investors including Alwaleed, the governments of Singapore and Kuwait, and former Chairman Sanford Weill. New York-based Merrill, the world's largest brokerage, announced about $12.2 billion from investors including Tokyo-based Mizuho Financial Group Inc., Korean Investment Corp., and clients of U.S. money managers TPG Axon Capital and T. Rowe Price Associates Inc.

Alwaleed, who owns 4.89 percent of Citigroup, bought more because of his ``belief in its long-term success and profitability,'' he said in January. Citigroup rose 40 cents, or 1.6 percent, to $26.21 today in New York Stock Exchange composite trading. Shares have tumbled 11 percent this year.

Fair Value

``They've cheapened up to the point where there's fair value,'' said Gregory Habeeb, who oversees $8.6 billion of fixed- income investments at Calvert in Bethesda, Maryland. ``You're being compensated. I'm not saying there's not risk there, but at least you're collecting yield.''

Calvert's Habeeb said he bought Citigroup and Bank of America as he increased holdings of bank bonds to ``overweight'' from ``underweight'' over the past three months.

Bank of America, the country's No. 2 bank, issued $12 billion of preferred shares last month, luring buyers with some of the highest yields in 15 years. The Charlotte, North Carolina- based bank said it doubled the size of the sale because of ``strong investor interest.'' The sale included $6 billion of perpetual preferred shares at a yield of 8 percent.

Fed Cuts

Lenders will benefit from the Federal Reserve's five interest rate cuts since September, Kiesel said. Their own borrowing costs are falling faster than their rates on loans after the Fed reduced the target rate for overnight lending between banks 2.25 percentage points to 3 percent, he said. Two- year Treasuries yield 1.7 percentage points less than 10-year notes, almost the widest since September 2004.

``You have to believe those banks will recover,'' Habeeb said. ``You're getting incremental yield versus the risk of default.''

Tom Houghton, who manages $2 billion of corporate bonds at Advantus Capital Management in Minneapolis, said the bonds aren't a bargain if the value of banks' mortgage-related investments erodes further. The Group of Seven industrialized nations estimates banks will ultimately record $400 billion of losses, German Finance Minister Peer Steinbrueck said at a weekend meeting in Tokyo. The value of leveraged loans may fall $148 billion as prices of the debt plummet, analysts at New York-based Goldman Sachs Group Inc. said yesterday.

`More Negative News'

``We still think that there's more negative news to come either on the economy or just more losses to be recognized,'' Houghton said.

Atlantic Asset Management has been ``underweight'' corporate bonds and may increase its bank holdings because of the wide spreads, said Michael Dineen, vice president of fixed-income at the Stamford, Connecticut-based firm. Atlantic manages $15 billion.

``There will be some attractive new entry points as there's been some very good concessions,'' Dineen said.

To contact the reporter on this story: Caroline Salas in New York at csalas1@bloomberg.net

Last Updated: February 12, 2008 16:20 EST