April 9 (Bloomberg) -- Wall Street firms may be bundling high-yield, high-risk corporate loans into securities to use as collateral to borrow from the U.S. government, according to a report by Morgan Stanley analysts.

Securities firms can borrow against collateralized loan obligations at the Federal Reserve's Primary Dealer Credit Facility, the analysts said. The Fed set up the facility last month, its first extension of credit to non-banks since the Great Depression.

The creation last month of CLOs comprised of loans for private-equity buyouts or other leveraged loans to larger companies totaling $11.4 billion ended ``the deep freeze'' in the market, and many arose from unusual motives, today's report said. ``At least one'' recent CLO was probably done to take advantage of the Fed's new facility, it said.

``It's not cheap to finance loans today in the market,'' Vishwanath Tirupattur, a Morgan Stanley analyst in New York, said in a telephone interview.

Lehman Brothers Holdings Inc., the fourth-largest U.S. securities firm, last month created the $2.8 billion Freedom CLO, the largest this year, out of loans that couldn't be readily sold to investors, such as for buyouts of payment processor First Data Corp. and power producer TXU Corp. JPMorgan Chase & Co., Deutsche Bank AG and Barclays Plc also underwrote CLOs in March, according to data complied by Bloomberg.

CDO Issuance

Issuance of collateralized debt obligations, a subset of which repackage company loans into new securities with varying risks, totaled $16.7 billion last quarter, tumbling from $165 billion a year earlier, according to the report. CLOs created last month -- including $2 billion comprised of high-yield loans to ``middle market'' companies -- represented 80 percent of all the CDOs created in the first quarter.

Only about a third of the CLOs issued this year have been created for the traditional reason, the analysts including Tirupattur and Sivan Mahadevan wrote in the report. The typical model is for a CLO ``equity'' investor to profit by selling off its safest classes, keeping the difference between the coupons on those securities and on the underlying loans.

The pipeline of unsold debt from leveraged buyouts has shrunk to $118 billion from more than $230 billion in July, Bank of America Corp. analysts said in a report yesterday. High-yield loan prices climbed 1.3 cents in the past week to 90.14 cents on the dollar yesterday, according to Standard & Poor's. Prices are still 4.67 cents below the beginning of the year, according to S&P, which tracks loan prices.

Massive Overhang

Recent CLO deals have been ``eating into the massive overhang of leveraged bank loans and alleviating some of the stress in the capital markets,'' said Peter Plaut, an analyst at hedge fund Sanno Point Capital Management in New York.

They're also ``an easy way for banks to reduce balance sheet risk, which indirectly helps reduce capital requirements, by funding the AAA through the Fed and selling the equity, which provides high yield to investors,'' Plaut said.

Morgan Stanley's Tirupattur declined to say which firm he believed recently repackaged buyout loans into CLOs with investment-grade rated classes to enable Fed borrowing. Randy Whitestone, a spokesman for New York-based Lehman Brothers, declined to comment.

Borrowing through the Fed facility rose 16 percent to $38.1 billion in the week ended April 2. The Fed accepts ``all investment-grade corporate securities, municipal securities, mortgage-backed securities, and asset-backed securities for which a price is available,'' along with safer debt, according to the Federal Reserve Bank of New York's Web site.

Taxpayer Risk

Andrew Williams, a Fed spokesman, declined to comment.

The Fed set up the facility to shore up financial companies and debt markets with cheap and stable lending after a tightening of terms on bond-secured borrowing that contributed to the collapse of New York-based Bear Stearns Cos. The company is being acquired by JPMorgan Chase & Co., with the aid of $29 billion of Fed loans backed by Bear Stearns assets.

U.S. lawmakers such as Senator Charles Grassley, a Republican from Iowa, and investors such as First Pacific Advisors LLC Chief Executive Officer Robert Rodriguez in Los Angeles have said the central bank has been taking unusual risks that may cost taxpayers.

Hung Warehouses

Another atypical motivation for the creation of CLOs in recent months has been to restructure ``market-value'' CLOs, a type that can be forced to liquidate when their collateral's prices fall by a certain amount, according to Morgan Stanley.

``A few other CLOs that priced during the past few weeks are hung warehouses from mid-to-late 2007,'' or loans sitting on the lines of credit granted by banks and securities firms to CLO arrangers, the analysts wrote.

The ten U.S. commercial banks with the most mortgage-backed bonds boosted holdings of securities that lack guarantees from government-linked entities such as Fannie Mae by $48 billion in the fourth quarter, partly because they were making the loans for consumer customers anyway, Barclays Plc analysts Ajay Rajadhyaksha and Derek Chen wrote in February.

The 12 Federal Home Loan Banks, the government-chartered cooperatives that lend to U.S. banks, thrifts, insurers and credit unions, generally extend more against AAA bonds than loans. The Fed also last month began to temporarily swap U.S. Treasuries for non-guaranteed mortgage bonds, a form of lending meant to restore liquidity to financial companies.

To contact the reporter on this story: Jody Shenn in New York at jshenn@bloomberg.net.; or Pierre Paulden in New York at ppaulden@bloomberg.net

Last Updated: April 9, 2008 18:40 EDT