Jan. 15 (Bloomberg) -- U.S. regulators granted banks an exemption from Volcker Rule limits for collateralized debt obligations composed mostly of small-bank securities, according to a statement from regulators.
The adjustment to Volcker answers concerns from smaller U.S. banks that they would have to rush into taking millions in losses on their holdings. Instead, the regulators let banks keep CDOs backed by trust-preferred securities established before May 19, 2010, and obtained by Dec. 10, 2013, five financial agencies said yesterday in a joint news release.
After regulators approved the Volcker Rule on Dec. 10, the smaller 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 spent more than two weeks hashing out a fix before their self-imposed deadline today.
“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,” Comptroller of the Currency Thomas J. Curry, said 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.
The regulators’ exemption narrowly addresses CDOs, not the banking industry’s related complaint that the Volcker Rule could also force losses on certain collateralized loan obligations. 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 holdings.
Industry representatives will testify before the House Financial Services Committee today on the impact of Volcker, a centerpiece of the 2010 Dodd-Frank Act’s overhaul of U.S. financial regulation. Much of their criticism will focus 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., a Chicago-based consulting firm, 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.”
Also today, The American Bankers Association will indicate its plans for the lawsuit it filed to block implementation of the Volcker Rule as smaller banks objected that it would force a CDO sell-off.
“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,” ABA president Frank Keating said yesterday in a statement. In a first look, he said the Volcker changes provided “a broad exemption” for CDOs.
Trust-preferred securities, issued by banks and insurers, are hybrid instruments that occupy territory between stocks and bonds. Investors -- including other banks -- are drawn to their favorable tax treatment, and regulators targeted them at banks because they can make the institutions appear better capitalized than they are.
The regulators published a list of 86 CDOs that are backed by these securities and won’t be covered by Volcker Rule limits, including such names as Trapeza Edge CDO and ALESCO Preferred Funding XVII.
Salt Lake City-based Zions Bancorp had said Volcker could cause it to lose about $387 million. 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.
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 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.
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