Agencies Appear to Signal Retreat on Collateralized Debt Obligations (CDOs) backed by Trust Preferred Securities (TruPS) Issue
In the wake of the American Bankers Association’s lawsuit challenging the Volcker Rule’s treatment of collateralized debt obligations (CDOs) backed by trust preferred securities (TruPS), the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation and the Securities and Exchange Commission (the Agencies) have issued a statement which appears to signal that they are considering walking the rule back. The question is to what extent the Agencies will reverse themselves. The December 27 statement states in pertinent part as follows:
[The Agencies] are currently reviewing this matter and are considering whether it is appropriate and consistent with the provisions of the Dodd-Frank Act not to subject pooled investment vehicles for TruPS, such as collateralized debt obligations (CDOs) backed by TruPS (TruPS CDOs), to the prohibitions on ownership of covered funds in section 619 of the Dodd-Frank Act. The Agencies are aware that the provisions of section 171(b)(4)(C) are important to community banking organizations and, based on information recently received, understand that the investments and capital levels of a number of these organizations might be adversely affected if pooling vehicles formed for the purpose of holding TruPS are treated as covered funds. The Agencies are therefore evaluating whether it is appropriate not to cover pooling vehicles that invest in TruPS in order to eliminate restrictions that might otherwise have consequences that are inconsistent with the relief Congress intended to provide community banking organizations under section 171(b)(4)(C) of the Dodd-Frank Act.
What remains to be seen is where the Agencies will draw the line, i.e., will a rule pullback encompass all financial institutions holding CDOs backed by TruPS, or will it merely grandfather the treatment of CDOs backed by TruPS for smaller institutions such as those that are less than $15 billion in footings? One potential clue may be found in the release itself, in which the Agencies stated:
[A] provision of the Dodd-Frank Act, section 171, separately provides that [TruPS] issued by depository institution holding companies must be phased out of such companies’ calculation of regulatory capital for purposes of determining Tier 1 capital. However, section 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.
It is unknown at this writing whether the Agencies will attempt to leverage a compromise result in return for dismissal of the lawsuit. If the Agencies protect smaller institutions, but leave larger institutions subject to the rule as is, the American Bankers Association will have an interesting decision to make; i.e., will it dismiss the lawsuit it filed, or will it continue the lawsuit with a somewhat weaker case? The Agencies gave themselves a self-imposed deadline of January 15 to address the issue, which theoretically should leave institutions enough time to incorporate the effects of a change in policy into their call reports, which are due 30 days after year end. Meanwhile, it appears that proceedings have been stayed in the US Court of Appeals for the District of Columbia Circuit until January 17, two days after the Agencies are expected to take action.