Volcker Rule Challenged in U.S. Court by Bank Group

The final version of the Volcker Rule was challenged in a lawsuit over claims that requiring small banks to divest their holdings in some collateralized debt obligations will cause them about $600 million in losses.

The American Bankers Association, which represents mostly community banks, objects to a portion of the rule that will force lenders to get rid of CDOs backed by trust-preferred securities, according to the complaint filed yesterday in federal court in Washington. The association seeks a court order blocking the rule from taking effect before the end of the year.

“Without the requested relief, hundreds of community banks across the nation will be required to recognize unexpected and, in many cases, significant earnings and capital losses on or before December 31, 2013,” according to the complaint.

The rule named for former Fed Chairman Paul Volcker, who championed it as an adviser to President Barack Obama, was included in the 2010 Dodd-Frank Law that overhauled U.S. financial regulation as a way to restrict banks’ proprietary trading and other risky bets after the 2008 credit crisis. The Fed has given banks a delay until July 21, 2015, to comply.

The final version approved by the Federal Reserve System, Federal Deposit Insurance Corp., Securities and Exchange Commission, Commodity Futures Trading Commission and Office of the Comptroller of the Currency includes CDOs in the definition of covered funds subject to restriction. The Federal Reserve, the FDIC and the OCC are named as defendants in yesterday’s complaint.

Community Banks

How the Volcker Rule Got Supersized

Letters urging the regulators to help community banks deal with the rule’s impact on trust-preferred securities were sent Dec. 18 by Democratic Senators Mike Crapo of Idaho and Joe Manchin of West Virginia, and Republican Senators Mark Kirk of Illinois and Roger Wicker of Mississippi. Independent Community Bankers of America President Camden Fine said that day that more than 300 banks are “likely to take losses in their capital accounts” if forced to write down the securities.

“If hundreds of small, community banks are unexpectedly required to take significant capital losses on December 31, 2013, they likely will be forced to immediately decrease their lending activity,” according to yesterday’s complaint. “This would have a devastating impact on their prospective borrowers, including on the many small businesses that rely on local community banks.”

“We will review the suit, confer with the other agencies and determine a response,” Dave Skidmore, a Fed spokesman, said by e-mail.

Utah Bank

Regional lender Zions Bancorporation (ZION) said on Dec. 16 that the Volcker Rule would force it to get rid of some prohibited holdings at a cost of about $387 million. Utah’s biggest bank would no longer be able to keep trust-preferred CDOs issued by banks and insurers until they mature, the Salt Lake City-based company said in a statement.

Zions owned $1.23 billion of bank-issued trust-preferred 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 roil the market, Sterne Agee said.

The case is American Bankers Association v. Federal Deposit Insurance Corp., 13-cv-02050, U.S. District Court, District of Columbia (Washington).

To contact the reporter on this story: Joel Rosenblatt in San Francisco at jrosenblatt@bloomberg.net.

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