UPDATE 1-FDIC plan may spur debt issuance by banks -BofA

(Updates with FDIC approval)

By Dena Aubin

NEW YORK, Nov 21 (Reuters) - Changes to an FDIC debt guarantee program for U.S. banks could smooth the way for several hundred billion dollars of top-rated bank debt issuance, Bank of America said in a new report.

The Federal Deposit Insurance Corp on Friday approved a program to guarantee to banks' new senior unsecured debt, potentially allowing the firms to issue debt with top "AAA" ratings.

The market could see roughly $50 billion in issuance per month until the deadline for debt issuance next June, Bank of America estimated in a report.

The so-called Temporary Liquidity Guarantee Program is expected to fill a financing gap for banks shut out of the corporate bond market by skyrocketing yields.

Bond issuance from the financial sector has come to a standstill since Lehman Brothers filed for bankruptcy on Sept. 15, triggering a sell-off in banks' and brokers' bonds.

More than $600 billion of dollar-denominated U.S. financial debt is set to mature through the end of 2009, Morgan Stanley has estimated. Without the guarantee program, banks may have been forced to pay some of the highest yields in decades to help refinance the debt.

Since late October, European banks have issued about $34 billion under similar guarantee programs, Bank of America said. That experience suggests U.S. guaranteed bank debt could be issued at around 25 basis points over the London interbank offered rate, the bank said. Three-month Libor was 2.16 percent on Friday.

In the corporate bond market, by contrast, JPMorgan's (JPM.N) three-year notes are yielding about 6.8 percent, according to MarketAxess. Citigroup's (C.N) three-year bonds are yielding 11.3 percent.

EASING SUPPLY PRESSURE

In a rule passed on Friday, the FDIC's board approved the guarantee program with several changes to provide greater certainty for investors.

In particular, the program now includes a mechanism for prompt payment in case of default and also allows tiered pricing, depending on the debt maturity.

The changes address two main sticking points that could have limited use of the program.

In its earlier form, investors would have had to work through a bankruptcy process to obtain their principal back if a bank got in trouble, Bank of America said.

Rating agency Standard & Poor's said earlier this month that it would not give the debt an "AAA" rating without a guarantee for timely payment.