U.S. Regulators Said to Consider Volcker Exemption for CDOs

U.S. financial regulators are trying to determine how they can let some smaller banks keep certain collateralized debt obligations that lenders said they’d have to divest under Volcker Rule trading restrictions, according to two people with knowledge of the discussions.

The federal agencies are considering giving the banks grandfathering protection or other means to hold onto the securities and have yet to decide how to do it, according to the people, who requested anonymity because the talks are private. They want to grant a narrow exemption to limit banks’ ability to apply it to other restricted funds, the people said.

Banking groups have pressed regulators since the Volcker Rule was enacted last month to make clear how community and regional banks such as Zions Bancorporation should account for CDOs backed by trust-preferred securities, which have been targeted by regulators because they can make banks appear better capitalized than they are.

To head off year-end accounting problems at the more than 300 banks that hold the CDOs, the Federal Reserve, Federal Deposit Insurance Corp., Securities and Exchange Commission and Office of the Comptroller of the Currency said on Dec. 27 that they would determine by Jan. 15 whether they should be exempted to avoid Volcker Rule “consequences that are inconsistent with the relief Congress intended” for smaller banks.

ABA Lawsuit

Less than a week after regulators approved the rule named for former Fed Chairman Paul Volcker on Dec. 10, Zions said it would have to get rid of its TruPS CDO holdings by year’s end at a cost of about $387 million. The American Bankers Association sued to block implementation of the rule after industry group said CDO losses could total about $600 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 roil 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. Funds such as Anchorage Capital Group LLC and Third Point LLC have been drawn to the investment as prices climbed, according to people with direct knowledge of the matter who asked not to be named because the trades are private.

“We believe regulators have the authority to exempt banks with less than $15 billion in assets from the requirement to divest of TruPS CDOs.” U.S. Representative Maxine Waters of California, the top Democrat on the House Financial Services Committee, and 21 other committee Democrats, wrote in a Jan. 7 letter to the agencies. The lawmakers encouraged regulators to give “important relief to the community banking sector.”

Before it's here, it's on the Bloomberg Terminal.