Volcker Rule

While federal regulators finalized their regulations to implement the Volcker Rule on Dec. 10, the Volcker Rule saga appears far from being over

The Volcker Rule bans "proprietary trading" by banks and was included in the Dodd-Frank banking reform legislation signed into law by President Obama in July 2010.  Under the final set of regulations to implement Volcker, banks are banned from holding investments in "covered funds," which include collateralized debt obligations (CDOs) backed by trust preferred securities.

The American Bankers Association and several community banks filed suit on Tuesday seeking the suspension of the the "covered funds" portion of the rules, claiming over 275 banks would see "an estimated $600 million in capital... vanish overnight."

Zions Bancorporation (ZION) of Salt Lake City on Dec. 16 said it had determined that "substantially all" of its investments in CDOs backed by trust preferred securities would be disallowed under Volcker. The company said it would record a fourth-quarter other-than-temporary impairment charge of $629 million on the transfer of disallowed held-to-maturity securities to held-for-sale.  The bank also said it had until July 21, 2015 to sell the trust preferred CDOs, "unless, upon application, the Federal Reserve grants extensions to July 21, 2017."

Federal bank regulators on Dec 19 released a FAQ Regarding Collateralized Debt Obligations Backed by Trust Preferred Securities under the Final Volcker Rule.  In the FAQ, the regulators said banks could evaluate their CDOs backed by trust preferred securities to determine if they "could be restructured during the conformance period" to take advantage of "another exclusion or exemption under the Investment Company Act."

While restructuring their CDOs could eventually allow affected banks to avoid selling the banned investments, the bank regulators neglected to consider publicly traded banks' needs to follow generally accepted accounting principals when reporting their Dec. 31 financial condition.  With Volcker unresolved, the publicly traded banks holding the CDOs in question are required by the Securities and Exchange Commission -- which requires GAAP reporting -- to move the CDOs to "held-for-sale," even if there's only a chance the securities may have to be sold.   This will result in significant losses -- unanticipated by the banks and apparently unanticipated by tone-deaf bank regulators -- for many of the affected banks.

An ironic result of the Volcker Rule -- meant to curb perceived "excesses" of the largest U.S. banks -- could be the slipping of several community banks to "undercapitalized" status per regulations.

The federal regulators have until Monday to respond to the ABA's court complaint.  A reasonable outcome would be for at least a short suspension of Volcker's rules on "covered funds," to enable the banks to avoid an artificial year-end deadline that the regulators created on Dec. 10.

The following chart shows this year's stock performance for Capital One, Northern Trust and State Street against the KBW Bank Index and the S&P 500:

COF Chart data by YCharts

-- Written by Philip van Doorn in Jupiter, Fla.

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Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for TheStreet.com Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.

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