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From Securities Regulation Daily, December 31, 2013

Banking associations drop request to block application of Volcker Rule to trust-preferred securities

By Lene Powell, J.D.

The American Bankers Association (ABA) and other banking associations have dropped their request in federal court to stay the provisions of the Volcker Rule that treat debt interests in trust-preferred securities (TruPS) as ownership interests in a covered fund, “in light of intervening regulatory developments.” After the associations filed suit, the five federal financial regulators that adopted the Volcker Rule announced they are reviewing whether it is appropriate to cover pooling vehicles that invest in TruPS (ABA v. FDIC, December 30, 2013).

Background. The recently adopted Volcker Rule was mandated by Dodd-Frank Act Sec. 619, which added a new Sec. 13 to the Bank Holding Company Act of 1956. The rule generally prohibits banking entities from engaging in proprietary trading and from investing in, sponsoring, or having certain relationships with a hedge fund or private equity fund (covered funds). Banking entities engaged in covered activities or investments must restructure and limit certain investments in and relationships with covered funds, including securitizations of non-loan assets.

TruPS are created when a bank issues debt to a trust created by that bank, and then sells its right to receive interest and principal payments to third-party investors. A TruPS-backed collateralized debt obligation (CDO) is created when an investment bank purchases multiple TruPS, packages those securities into a single security, and issues new debt instruments based on that security to investors. These debt instruments entitle the holder only to fixed returns without any sharing of profits. Dodd-Frank Act Sec. 171 specifically provides that TruPS issued by depository institution holding companies must be phased out of the companies’ calculations of regulatory capital for purposes of determining Tier 1 capital. However, Sec. 171 further provides for the permanent grandfathering of TruPS issued before May 19, 2010, by certain depository institution holding companies with total consolidated assets of less than $15 billion.

The banking associations are concerned that if TruPS CDOs are treated as ownership interests in covered funds, banks would have to divest their TruPS holdings by July 2015. Under Generally Accepted Accounting Principles (GAAP), the associations contend the banks would need to recognize significant write-downs to their capital accounts on or before December 31, 2013. The write-downs would impact more than 200 community banks and cause an estimated $600 million in capital to vanish overnight, constricting lending to individuals and small businesses. Also, the write-downs could trigger serious regulatory consequences and intrusive and costly enforcement actions. This is unnecessary, said the associations, because investment by banking entities in pooled TruPS does not pose the kind of systemic risk the Volcker Rule is intended to capture.

Regulators reviewing treatment of TruPS. According to the regulators’ joint statement, they are aware that the provisions of Sec. 171(b)(4)(C) are important to community banking organizations. Further, they understand that the investments and capital levels of many community banks might be adversely affected if pooling vehicles formed for holding TruPS are treated as covered funds. The regulators said they intend to address the matter by January 15, 2014, and any change in the regulatory provisions that occurs in January before banks’ financial statements or regulatory reports are filed can be reflected on banks’ financial statements as of December 31, 2013.

In light of the regulatory review, the associations withdrew their request for a temporary restraining order. However, they did not request dismissal of the underlying action, and the parties have jointly requested a briefing schedule.

The case is 1:13-cv-02050-RJL.

Attorneys: Anthony Herman (Covington & Burling LLP) for American Bankers Association, CB&T Bancshares, Inc., Citizens Bank & Trust Co., MBT Financial Corp., and Monroe Bank & Trust Co. Jerome A. Madden for FDIC.

Companies: American Bankers Association; CB&T Bancshares, Inc.; Citizens Bank & Trust Co.; MBT Financial Corp.; Monroe Bank & Trust Co.

MainStory: TopStory Enforcement DoddFrankAct RiskManagement

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