Readers may recall that banks, in their eagerness to depict the final Volcker rule as a terrible miscarriage of justice, made a great deal of noise about the case of Zions Bank, which was blaming $378 million of prospective losses on the Volcker-rule requirement that banks sell these dubious instruments called TruPS CDOs by July 21, 2015. Note that these CDOs were issued mainly by small banks and were attractive because they counted towards capital for regulatory purposes but they were regarded as debt instruments for tax purposes, so payments on them were deductible as interest. They also were bought to a significant degree by small banks.
As we’ve noted, just about every element of this claim is bogus. The final Volcker rule was a victory for the banks. Occupy the SEC gave it a mere C-; Lee Sheppard, in a new Forbes article writes (with gory supporting detail):
Even the dumbest banker can get around the Volcker rule. The regulators started with a weak statute, and managed to make it weaker. It’s as though they want to avoid offending the banks.
As for the case of poor, supposedly victimized Zions, the bank’s tsuris really came from dodgy accounting. As we wrote in December:
Now back to Zions. In a hold to maturity portfolio, banks are required to disclose its value in the financial statements. Thus these losses weren’t “created” by the Volcker rule. Zions was simply fudging its accounting in a big way and the Volcker rule flushed it out.
Alloway makes it clear where she comes out on this mess at the top of her post:
“We haven’t forgotten who keeps us in business,” reads the slogan on the website of Zions Bancorp, Utah’s biggest bank.
We assume they’re talking about their accountants.
Jonathan Weil at Bloomberg is even more pointed in calling out the Zions misdirection:
It turns out that a good-sized chunk of Zions Bancorp’s earnings existed only in its executives’ minds. For this nugget of knowledge, we can thank the Volcker rule. Or at least that’s what the bank is blaming for its newfound losses…
The losses aren’t new. Zions just didn’t have to recognize them before because of the way the accounting rules let companies report their bond holdings. Zions had been classifying the CDOs as “held to maturity,” which let it avoid recognizing the decline in value as part of its earnings. Now that Zions no longer has the ability to hold them to maturity, the bank said it will relabel the CDOs as “available for sale” and write them down to their fair-market values, triggering the earnings hit.
In other words, the accounting rules had been letting Zions maintain a fiction.
And again, this number should not be a bomb from the blue; investors should have been able to determine the value in the footnotes to the financial statements. As George Bailey of Occupy the SEC told us by e-mail:
Zions reported losses appear to have been inevitable given their outsized position and concentration in the TruPS CDOs regardless of Volcker. No other bank came close.
To the extent that Volcker brought the day of reckoning forward for Zion, I think that was an intended consequence. It shouldn’t have been a great surprise that these structures were going to fall foul of the final Volcker rule. The regulators apparently showed some spine in this area.
Back to the current post. The ABA screamed bloody murder and filed suit right before Christmas, claiming that regulators had failed to do an adequate analysis of the economic costs to small banks.
Yesterday, meeting a self-imposed guideline, the relevant regulators issued clarified guidance that was generally depicted as a climbdown. For instance, the Bloomberg headline reads: Volcker Rule Curbs on Banks Owning CDOs Eased in U.S.
George Bailey of Occupy the SEC isn’t convinced that the concessions are as significant as news stories would have you believe (and remember, it is perversely in the regulators’ interest to make the concessions sound meaningful to get the ABA to go away). He writes:
My initial impression is that this is a not a bad compromise.
The TRuPS CDOs for community banks were grandfathered in the Capital Rules (the Collins Amendment) so this tweak appears to be reconcile Volcker to Collins for the community banks. See this discussion last year from Mayer Brown:
Phase-Out of TruPS and Other Non-Qualifying Capital. As required by section 171 of Dodd-Frank, the Final Rule requires that capital instruments such as trust preferred securities (“TruPS”) and cumulative preferred shares be phased-out of tier 1 capital by January 1, 2016, for banking organizations that had $15 billion or more in total consolidated assets as of December 31, 2009. However, unlike the Proposed Rules, which would have required even banking organizations with less than $15 billion in assets to phase out TruPS and similar instruments (albeit over a longer ten-year transition period), the Final Rule adheres to Dodd-Frank and permanently grandfathers as tier 1 capital such instruments issued by these smaller entities prior to May 19, 2010 (provided they do not exceed 25 percent of tier 1 capital). The Final Rule also permanently grandfathers as tier 2 capital TruPS issued before May 19, 2010, by Standardized Banks with assets of $15 billion or more. Advanced Banks, however, will be permitted to include such instruments only as tier 2 capital until year-end 2015, after which they must begin phasing them out from tier 2 capital as well.
However $387 million of the potential $600 million of losses attributed to underwater TRuPS CDOs spread out among 250 odd banks, is attributed to Zions. It appears Zions won’t get much relief from this, so this carve out doesn’t appear to be a big deal. It looks like a hollow ‘victory’ for the banks.
Howevers if it turns out Zion and the larger bank Trups holdings are comprised of small bank TRuPS, then it is a victory for them and a fail for the regulators. The compromise was intended to provide relief to small banks, not to large ones and presumably not for Zions’ dodgy accounting. The list of TruPS that meet the eligibility critea (link in the Fed’s press release) is pretty short and I have no idea what chunk of the Trups universe it covers.
Since the ABA is praising the outcome, perhaps they will declare victory, drop the lawsuit and let Zions swing in the breeze. I don’t think that will be apparent till tomorrow.
Jean Baptiste Colbert, Minister of Finance under Louis XIV, said, “The art of taxation consists in so plucking the goose as to get the most feathers with the least hissing.” This Volcker rule example suggests, sadly, that that’s as good as you are going to get in the world of regulating. And that’s generally not good since banks have come to recognize the advantages of hissing early and often.