No Volcker Rule Uncertainty for This Community Bank

NEW YORK (TheStreet) -- Community Bank System (CBU) took a major step to eliminate regulatory uncertainty as 2013 came to an end.

The bank -- based on DeWitt, N.Y., and with $7.3 billion in total assets as of Sept. 30 -- on Tuesday announced it had "sold its entire portfolio of bank and insurance trust preferred collateralized debt obligation (CDO) securities in response to uncertainties created by the announcement of the final rules implementing the Volcker Rule."

Community Bank System took several steps to ease the pain, including the prepayment of $226.4 million in advances from the Federal Home Loan Bank of New York and the sale of $417.6 million in U.S. Treasury securities that had previously been classified as held-to-maturity. 

Altogether, the actions announced Tuesday will result in a pre-tax loss of $6.9 million, coming to 12 cents a share after tax.  The pre-tax loss from the sale of the CDO sales was $15.5 million, with a $23.8 million charge from the FHLBNY prepayment, partially offset by $32.4 million in gains on the sale of U.S. Treasury securities.

The bank said it had reinvested the net proceeds of the above transactions "into Treasury securities with similar durations to the assets sold in order to replace the net interest income impact of the security sales and debt extinguishment."

The Federal Reserve, Federal Deposit Insurance Corp., and the Office of the Comptroller of the Currency on Dec. 10 finalized their regulations to implement the Volcker Rule, the part of the Dodd-Frank banking reform legislation that bans "proprietary trading" among banks.  It took nearly two years after the initial regulations were proposed for the finalize regulations to be developed.

"Covered funds" are among the investments banks are no longer allowed to hold under Volcker, and the banks have until July 2015 to get rid of them.

Zions Bancorporation (ZION) of Salt Lake City was the first publicly traded bank to take action over the securities in question. The bank on Dec 16 announced it had determined that "substantially all" of its investments in trust preferred collateralized debt obligations (CDOs) 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."

With an uproar brewing among community banks concerned over the possibility of large and quick fourth-quarter write-downs, the regulators on Dec. 19 issued a FAQ document, saying the banks might be able to restructure the CDOs in question, before the July 2015 deadline.

The problem with this approach is that the Securities and Exchange Commission requires publicly traded banks to mark to market any securities that might have to be sold.

After the American Bankers Association and several community banks sued the regulators in federal court to throw out the ban on "covered funds" investments, the bank regulators and the SEC last week said they would review the Volcker Rule again and make a final determination on the CDOs backed by trust preferred securities by Jan. 15.

The FDIC in a letter on Monday helpfully advised the banks that "any actions [by the regulators] in January 2014 that occur before the issuance of December 31, 2013, financial reports... should be considered when preparing those financial reports."

This means banks holding the CDOs in question may still have to write down the CDOs in question.

So the move by Community Banking System seems to be a very well thought out, conservative step to take.

KBW analyst Collyn Gilbert in a note to clients late Tuesday wrote, "As usual, CBU has acted to efficiently address industry-driven challenges and minimize the potential impacts on the bank. We think this swift and decisive style should help to insulate the bank's premium [return on assets, or] ROA profile in the face of various obstacles."

Community Bank System for the third quarter of 2013 reported an ROA of 1.22%, increasing from 0.98% in the second quarter of 2012.  The bank also reported a solid return on tangible equity of 17.57%, up from 13.27% a year earlier.

The bank's stock closed at $39.68 Tuesday and returned 50% during 2013, assuming the reinvestment of dividends.  Based on a quarterly payout of 28 cents, the shares have a dividend yield of 2.82%.

The shares trade for 17.3 times the consensus 2015 earnings estimate of $2.30, among analysts polled by Thomson Reuters.  The consensus 2014 EPS estimate is $2.13.

Gilbert rates Community Bank System "market perform," with a price target of $35.00. 

Investors weren't necessarily pleased with CBU's move.  The stock was down 1.7% in morning trading Thursday, to $38.99.

When discussing the Volcker/CDO issue in general, Gilbert wrote "we are somewhat surprised by the speed at which certain banks are disposing of its CDO/CLOs that are in potential violation of the Volcker Rule, as various lobbying groups are seeking a grandfathering clause that could potentially negate some of these security exclusions."

The following chart shows the performance of Community Bank System against the KBW Bank Index (I:BKX) over the past year:

CBU ChartCBU data by YCharts

Interested in more on Community Bank System? See TheStreet Ratings' report card for this stock.

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

>Contact by Email.

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 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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