Regulators OK guidance on covered bonds, capital

WASHINGTON (Reuters) - Players in the fledgling U.S. covered bond industry were given assurances on how they can access collateral if an issuing bank fails, under guidance approved on Tuesday by the Federal Deposit Insurance Corp.

Covered bonds, a security that is familiar in Europe, but relatively unknown in the United States, could offer a new funding source for lenders and lower the cost of mortgage financing.

They are issued by financial institutions against pools of assets, like home loans, that they hold on their books, in contrast to the mortgage securitization model that passes all risk on to investors.

"I think it's useful to get additional liquidity tools, particularly to the mortgage markets in these circumstances," said John Dugan, U.S. Comptroller of the Currency and a member of the FDIC board.

The FDIC guidance is designed to clear up uncertainty in how covered bonds might be treated in the event of a bank failure, and thereby encourage more demand for the bonds.

U.S. policy-makers have said that they want to clear regulatory hurdles for covered bonds. In a speech last week, Treasury Secretary Henry Paulson said he sees them as a tool to "increase the availability and lower the cost of mortgage financing (and) to accelerate the return of normal homebuying activity."

Covered bonds were first issued in the United States in September 2006, and Bank of America Corp (BAC.N) and Washington Mutual Inc (WM.N) are the only two U.S. banks to have issued outstanding covered bonds.

According to the FDIC guidance, a holder of covered bonds can access collateral if the FDIC is 10 days late on a failed or troubled bank's bond obligation.

The FDIC said the guidance only applies to covered bond issuances approved by the bank's federal regulator and as long as the obligations do not exceed 4 percent of the bank's total liabilities.

But FDIC Chairman Sheila Bair said the 4 percent figure may change as the FDIC gets a better handle on what the U.S. covered bond industry will look like and how much risk it may pose to the FDIC's insurance fund.

"The 4 percent, I think, is not going to be there forever," she said. "We need to get some experience with this market."

BASEL II GUIDANCE

The FDIC also adopted more guidance on capital adequacy rules known as Basel II, which will apply to about a dozen of the largest, internationally active U.S. banks.

The new interagency guidance updates the supervisory review process for banks, or how bank supervisors determine that the institutions are meeting capital requirements.

The FDIC issued the guidance along with the Federal Reserve, Office of the Comptroller of the Currency, and the Office of Thrift Supervision.

Fed Governor Randall Kroszner said in a statement that "banks must have a rigorous process to ensure that they hold enough capital to support their entire risk profile."

The biggest U.S. banks such as Bank of America, Citigroup Inc (C.N) and JPMorgan Chase & Co (JPM.N) are required to use the advanced version of Basel II rules, which were issued last year. They face an October deadline to tell U.S. regulators how they will implement the new rules.

FDIC staff members said this latest piece of guidance integrates some recent market developments. One issue addressed is the reputational risks from off-balance sheet activities and how some institutions may need to carry more capital if they are likely to assume assets if they become troubled.

"I'm pleased the guidance has been refined due to recent events," Dugan said.

(Reporting by Karey Wutkowski; editing by Gary Crosse)