Federal Agencies Approve Interim Final Rule Intended to Benefit Community Banks

January 17, 2014

On Jan. 14, 2014, five federal agencies approved an interim final rule (the Interim Final Rule) that would permit banks to continue to hold certain collateralized debt obligations (CDOs) backed primarily by trust preferred securities (TruPS). Section 619 of the Dodd-Frank Act (known as the Volcker Rule) added a new section to the Bank Holding Company Act (the BHCA) that generally prohibits banking entities from having an ownership interest in, or certain relationships with, a covered fund. The Volcker Rule’s definition of covered fund includes hedge funds, private equity funds and pooled investment structures, including many CDOs backed by TruPS. The Interim Final Rule, which would not amend the BHCA or Volcker Rule but would stand as a “companion rule,” would permit a banking entity to retain an ownership interest in certain CDOs backed by TruPS, so long as:

  1. the issuer was established, and the interest was issued, before May 19, 2010;
  2. the bank reasonably believes that the offering proceeds received by the issuer were invested primarily in Qualifying TruPS Collateral (defined in the Interim Final Rule); and
  3. the bank acquired such interest on or before Dec. 10, 2013.

Community banks may benefit from the Interim Final Rule because, prior to May 19, 2010, issuing TruPS through pooled investment structures was the primary method of using TruPS for regulatory capital purposes. In connection with the Interim Final Rules, three federal banking agencies published a non-exclusive list of qualified CDOs backed by TruPS that are not covered funds. The guidance provides that the three federal banking agencies will recognize that those qualified CDOs backed by TruPS will meet the requirements of the Interim Final Rule, but does not include any clarification on whether comparable debt securities of collateralized loan obligations (CLOs) issued before May 19, 2010, may satisfy the Interim Final Rule. Banks should consider how CDOs backed by TruPS and debt securities of CLOs issued before May 19, 2010, should be treated when calculating regulatory capital levels and preparing financial reports under applicable accounting standards.

In addition to the Interim Final Rule, the American Bankers Association recently announced its support for Senate Bill 1907, which, if passed, would formally amend the BHCA to allow community banks to retain CDOs backed by TruPS or debt securities of CLOs issued before Dec. 10, 2013. Click here for more information on Senate Bill 1907.

McGuireWoods will continue to monitor the Interim Final Rule, Senate Bill 1907 and other developments with respect to the Volcker Rule.