January 3, 2014
Authored by: Robert Klingler
According to a story in the American Banker (subscription required), the federal banking regulators are looking at exempting all existing collateralized debt obligations backed by trust-preferred securities from compliance with the Volcker Rule.
From a technical perspective, it seems likely that the regulators would effect such an exemption by excluding the debt tranches of CDO’s backed by TRuPS from the definition of an “ownership interest” under the Volcker Rule, thereby allowing continued ownership by banking entities. Whether the revision is limited to existing TRuPS CDO’s or all is likely largely irrelevant, as the elimination of preferred capital treatment for Trust Preferred securities has eliminated the creation of new TRuPS CDO’s.
As previewed by the regulators’ late Christmas gift, the regulators are considering limiting the relief to banking entities with less than $15 billion in total assets. Without getting into the merits of whether its appropriate to treat TRuPS CDO investments differently based on the size of the institution with the investment, it seems that limiting the relief to banking entities with less than $15 billion could also limit the effectiveness of such relief. To the extent larger financial institutions still need to dispose of their TRuPS CDO investments (by July 2015, but potentially earlier in light of accounting treatment), it could still unsettle TRuPS CDO markets, widening market losses for community banks. While not impacting regulatory capital levels, this could still represent a GAAP hit for community banks that seems inconsistent with the Collins amendment and the regulators general statements that the Volcker Rule is not intended to impact community banks.