Volcker Rule CDO Limits Eased

Regulators announce they'll allow banks to keep certain CDOs; banks avoid losses and CDO market avoids mass selloff. CLOs remain off-limits.

U.S. regulators will grant banks an exemption from Volcker Rule limits for collateralized debt obligations (CDOs) composed mostly of small-bank securities, according to a statement from regulators today.

The adjustment to the rule would allow banks to keep CDOs backed by trust-preferred securities (TruPS) established before May 19, 2010, and obtained by Dec. 10, 2013, five financial agencies said in a joint news release.

After regulators approved the Volcker Rule on Dec. 10, smaller U.S. banks said it could force them to take as much as $600 million in losses on certain CDOs held by about 300 firms. U.S. regulators said they would consider exempting the securities and set tomorrow as the deadline.

“I understand the challenge that community banks face in managing new regulations, and by clarifying this exemption, we are working to alleviate unnecessary regulatory burden,” said Comptroller of the Currency Thomas J. Curry, in a statement.

The exemption—granted by the OCC, Federal Reserve, Federal Deposit Insurance Corp., Securities and Exchange Commission, and Commodity Futures Trading Commission—gives grandfathering protection to CDOs as long as they meet thresholds ensuring they are tied primarily to securities issued by banks with less than $15 billion in assets. As a so-called interim final rule, it will be implemented while the agencies also open a 30-day public-comment period.

Based on earlier objections from smaller banks, the American Bankers Association had sued to block implementation of the Volcker Rule. Salt Lake City-based Zions Bancorporation—a holder of such CDOs—said it could lose about $387 million under Volcker, a centerpiece of the 2010 Dodd-Frank Act’s overhaul of U.S. financial regulation.

“Our initial review of today’s action by the regulators suggests that the Interim Final Rule provides a broad exemption for banks holding trust preferred securities from the original Volcker Rule,” ABA president Frank Keating said in a statement. “The ABA will be conducting a more comprehensive review of the amended language and will announce a decision regarding the pending litigation on this issue tomorrow.”

Zions owned $1.2 billion of bank-issued TruPS CDOs as of Sept. 30, the most among all U.S. banks, according to analysts at Sterne Agee & Leach Inc. About 3 percent of U.S. banks held similar CDOs and a sudden sale by Zions could disrupt the market, Sterne Agee said.


CLOs Still Off-Limits

The regulators’ exemption narrowly addresses CDOs, not the banking industry’s related complaint that Volcker could also force losses on certain collateralized loan obligations (CLOs). Several industry groups, including the Financial Services Roundtable and Securities Industry and Financial Markets Association, have written letters to regulators warning of market disruptions if banks have to sell off CLO ownership interests.

Hedge funds have gravitated to the $41.2 billion market in these securities, which after losing most of their value in the 2008 crisis have returned to almost 40 cents on the dollar in some cases, according to prices from JPMorgan Chase & Co.

Lawmakers from both parties had objected to making small banks sell off the securities. Senators Joe Manchin, a West Virginia Democrat, and Roger Wicker, a Mississippi Republican, introduced a bill yesterday providing grandfathering protection for banks with less than $50 billion in assets. House Financial Services Committee Chairman Jeb Hensarling, a Texas Republican, introduced a similar bill with Representative Shelley Moore Capito, a West Virginia Republican.

Industry representatives will testify before the House Financial Services Committee tomorrow on the Volcker Rule’s impact, concentrating much of their criticism on the CLO treatment, according to their prepared testimony.

“CLOs provide over $300 billion in financing to thousands of businesses,” said David C. Robertson, a partner at Treasury Strategies Inc., in testimony on behalf of the U.S. Chamber of Commerce. He argued that Volcker was too broad in defining ownership in CLOs that would be affected by the rule’s limits.

“The regulators, acting without prior notice, far exceeded the requirements of the statute,” Robertson said. Banks could be forced to restructure $70 billion in CLO debt, he said, which could create a “rush to liquidate.”

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