When Zions Bank announced last month that it expected to take a big loss because of the Volcker Rule, it set off alarms all over Washington. Regulators scrambled to say they were considering changing the rule, but that was evidently not enough for some legislators.
Representative Jeb Hensarling, a Republican of Texas and chairman of the House Financial Services Committee, is expected to propose a bill that could open up a huge loophole in the rule. The proposed change could allow banks to create and own securities with many types of investments that are barred under the Volcker Rule, which is intended to prohibit speculative trading by banks while allowing them to both make markets for customers and hedge other investments.
Jeff Emerson, an aide to Mr. Hensarling, said on Tuesday that the chairman expected to propose the bill later in the day. A copy of it was provided by another Congressional aide, who declined to be identified because he was not authorized to speak on the issue. It was that aide who raised the possibility of widespread abuse if the legislation were enacted.
Zions, based in Salt Lake City, said it expected to post the loss because it owned a large number of collateralized-debt obligations that contained Trust Preferred Securities, known as TruPS, issued by other banks. The bank said it would have to post the loss, which it estimated at $387 million before taxes, because it would no longer be able use an accounting rule that allowed it to keep losses on those securities off its earnings statement, although they were disclosed in footnotes.
That accounting treatment depended on the bank being able to say it expected to retain the securities until they matured, something it would not be able to do if the Volcker Rule would require the sale of the securities, even if the sales could be delayed for several years.
The proposed legislation, notable for its brevity, provides that nothing in the Volcker Rule “shall be construed to require the divestiture of any collateralized-debt obligations backed by trust-preferred securities issued before December 10, 2013.â€
The wording appears to indicate that new collateralized-debt obligations could be created that banks could hold and trade, as long as they contained at least one TruPS security issued before Dec. 10. The vast bulk of the assets in the collateralized-debt obligation could be other securities.
After the Zions announcement, regulators promised on Dec. 27 that they would issue a clarification of the rule by Jan. 15, which they said would be in time to affect year-end financial statements. A banking trade group, the American Bankers Association, also filed a motion in federal court in Washington last month seeking to quickly suspend the provision of the Volcker Rule.
One possibility would be for the regulators to exempt C.D.O.’s held by smaller banks â€" perhaps those with assets of less than $15 billion â€" while still barring larger banks from holding the securities. Such a change would mean community banks faced no threat from the rule, but would not affect Zions, which had $55 billion in assets at the end of September.
The regulators did not say whether any exemption they might consider would include only C.D.O.’s created before a certain date, or bar those with a substantial amount of non-TruPS assets.
Trust preferred securities became popular with bank holding companies in the 1990s because bank regulators allowed them to be treated as capital by the issuing bank, just like common stock, but they were treated as debt securities by the Internal Revenue Service, allowing the issuing bank to deduct interest payments from income on its tax return. The C.D.O.’s were created to allow many small banks to issue such securities, with the buyers reassured by the apparent diversification.
The regulators permitted that treatment because the securities allowed the banks to halt payment of the interest for as long as five years, without penalty, so long as they paid the back interest within that five-year period. If not, they would be in default and could face bankruptcy.
Many banks took advantage of the five-year window during the financial crisis, and it is unclear how many of them will be able to make back payments before the periods end this year and in 2015. The market prices of such securities, and of C.D.O.’s that own them, are depressed because of that prospect.
The copy of the proposed legislation indicated that it would be sponsored by Representative Shelley Moore Capito, a West Virginia Republican, as well as by Mr. Hensarling.
