Relief Approved for TruPS CDOs Under Volcker Rule
Author: Anne Coughlan
On December 10, 2013, the Federal Reserve, Federal Deposit Insurance Corporation, Office of the Comptroller of the Currency, Securities Exchange Commission and Commodities Futures Trading Commission issued a final rule implementing the Volcker Rule. In general, the Volcker Rule prohibits banking entities from engaging in proprietary trading, acquiring or retaining ownership interest in a hedge fund or private equity fund (“covered funds”) and sponsoring a hedge fund or private equity fund. The final rule contained changes from the 2011 proposal, which would have required banks to divest themselves of Trust Preferred Collateralized Debt Obligations (TruPS CDOs), which are primarily held by community and regional banks.
The American Bankers Association quickly filed a legal motion for relief on divestiture requirements for these securities. On January 14, 2014, the agencies responded by approving an interim final rule allowing banks to retain interests in TruPS CDOs if the following conditions are met:
- The TruPS CDO was established, and the interest was issued, before May 19, 2010.
- The banking entity reasonably believes the offering proceeds received by the TruPS CDO were primarily invested in qualifying TruPS collateral.
- The banking entity’s interest in the TruPS CDO was acquired on or before December 10, 2013.
Qualifying TruPS collateral is defined as any trust-preferred security or subordinated debt instrument meeting either of these criteria:
- Issued before May 19, 2010, by a depository institution holding company with total consolidated assets of less than $15 billion
- Issued before May 19, 2010, by a mutual holding company
TruPS CDOs with a majority of collateral issued by real estate investment trusts or insurance companies would not benefit from the exemption and may still be subject to divestiture by July 21, 2015.
To expedite the review process, the agencies have provided a nonexclusive list of issuers that meet the requirements of the interim final rule, which includes 85 of the 108 TruPS CDOs issued. If a TruPS CDO is not on this list, you will need to determine if another exemption is available.
The relief allows banks to continue activities related to existing role(s) as sponsor or trustee for these securitizations and to continue acting as a market maker in TruPS CDOs.
Accounting Implications & Next Steps
Without this interim rule, banks would have been required under generally accepted accounting principles to take an immediate write-down of TruPS CDOs with a fair value less than their carrying value by recognizing an other-than-temporary impairment.
“The agencies’ accounting staffs believe that, ‘consistent with GAAP, any actions in January 2014 that occur before the issuance of December 31, 2013, financial reports, including the FR Y-9C and the Call Report, should be considered when preparing those financial reports.’ The agencies’ decision in this interim final rule to permit a banking entity to retain certain TruPS CDOs should be factored into the accounting analysis," the agencies stated in a combined news release.
Banks should quickly review and document that their holdings comply with the interim rule’s requirements to support the nonwrite-down of TruPS CDOs.
BKD will be issuing a more in-depth paper reviewing the definition of covered funds and highlighting other common investments that may be prohibited by the final rule. If you have any questions, contact your BKD advisor.