By Al Yoon
NEW YORK (Reuters) - Potential pitfalls in the $1 trillion market for collateralized debt obligations (CDOs) tied to subprime mortgages is drawing closer attention from regulators, U.S. Comptroller John Dugan said on Wednesday.
The market for CDOs, created by bundling portions of other securities including mortgage-backed bonds, has come under scrutiny by the Office of the Comptroller of the Currency (OCC) since many banks it regulates may be exposed, Dugan said at the Reuters Real Estate Summit.
Concerns that CDOs held by banks, hedge funds and other investors are worth less than currently valued increased after Wall Street mortgage leader Bear Stearns Cos. Inc. BSC.N last week bailed out one of its troubled funds that was heavily invested in CDOs.
Investors in the hedge fund failed to sell much of the debt at acceptable prices, fueling speculation that widespread price markdowns across the industry may be in the offing.
"To the extent that banks' exposure rests on valuations, yes, absolutely, we're concerned about it and watching it," Dugan told the summit via telephone from Washington. "The fact that valuations can change so significantly when there are market disruptions is one of the things that I think all the regulators are paying very close attention to."
Subprime mortgage bonds have lost value this year as delinquencies and foreclosures rose more than expected.
The U.S. Securities and Exchange Commission said on Tuesday it opened 12 investigations into CDOs linked to subprime mortgages. CDOs that include subprime mortgages, sold on Wall Street as home-equity asset-backed securities, rose in issue volume to about $189 billion last year from just over $100 billion in 2005, according to Barclays Capital.
Since the CDOs aren't often traded, the valuations are left for dealers to decide using a combination of views from rating companies and proprietary models.
"We expect there to be a transparent process that management can understand how their traders and their financing arrangers are valuing the exposures that they have in a way that we can see it and examine," he said.
The OCC isn't about to issue guidance to banks on CDOs, however, preferring to see results from SEC scrutiny, he said.
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