Bankers Say Clarification of CDOs Under Volcker Falls Short

U.S. banking regulators provided advice on how banks should treat certain securities in a document quickly panned by industry groups for failing to address their concerns that the newly finalized Volcker Rule will force banks to take losses on the securities.

Banking groups had pressed regulators to make clear how smaller banks should account for collateralized debt obligations backed by trust-preferred securities, which were included among investments limited in the Volcker Rule’s ban of certain risky bank trades. The institutions have been preparing for potential writedowns of the holdings under the rule.

“It makes you wonder, why did they go to the trouble to issue it, because there’s really nothing there,” Wayne Abernathy, an executive vice president at the American Bankers Association, said after the regulators issued their advice yesterday. “It’s not answering the issues that have been raised.”

The document released by the banking agencies was in the form of answers to frequently asked questions, and it explained that banks don’t have to immediately sell the securities under the rule and can try to adjust aspects of the holdings until they’re no longer affected.

The banking groups’ reaction is a “disingenuous” complaint that regulators are doing their jobs, said Mark Williams, a former Federal Reserve bank examiner who is a lecturer at Boston University’s School of Management.

Held Accountable

“These instruments were enthusiastically embraced with the hopes of gaining generous tax treatment,” Williams said in an e-mail. “One lesson learned from the recent financial crisis is that bankers need to be held accountable for their decision-making. When decisions go well, bankers expect to collect a profit, and on the downside they should also expect to pay a cost.”

Independent Community Bankers of America President Camden Fine said Dec. 18 that more than 300 banks are “likely to take losses in their capital accounts” if forced to write down the securities.

Fine’s group, the ABA and the Financial Services Roundtable sent letters to regulators this week seeking guidance before the end of the year on the rule adopted by the Federal Reserve, Federal Deposit Insurance Corp. and three other agencies on Dec. 10.

Abernathy said his organization will keep pressing policy makers for help.

‘Rather Arbitrary’

Art Wilmarth, a law professor at George Washington University in Washington, said it seemed “rather arbitrary to suddenly say we’re going to issue a rule that makes this stuff absolutely toxic right away.” Even if it may have been prudent for banks to unload the securities earlier, he said the industry had little warning the rule would crack down on the products and may have been given insufficient time to respond.

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 Fed, FDIC, 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 300 community banks face an estimated negative impact of $600 million, Fine said.

Lawmakers’ Letters

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.

“The Volcker Rule is not the appropriate vehicle for the regulators to revisit how community banks manage their portfolios,” Manchin, Kirk and Wicker wrote.

Regional lender Zions Bancorporation 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 collateralized debt obligations 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.

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