Federal banking regulators Tuesday responded to the Independent Community Bankers of America’s repeated calls for them to take action to rectify a Volcker Rule provision that could negatively affect hundreds of community banks.

Volcker Rule Paul Volcker

Exemption for Trups-backed CDOs

The regulators’ proposition would exempt from the Volcker Rule all collateralized debt obligations backed by trust-preferred securities that were issued by banks with less than $15 billion in assets.

Interestingly, the new rule is worded in such a way that many large banks holding Trups-backed CDOs will also get the benefit.

The interim final rule issued Tuesday effectively exempts any Trups CDO in which the trust-preferred security was issued by a bank with less than $15 billion in assets. By keying off the issuer of the Trups – as opposed to the owner – the interim final rule will additionally benefit any larger bank that owns CDOs backed by Trups issued by smaller ones.

The interim final regulation released late Tuesday is designed to fix a problem with the Volcker Rule that would have caused hundreds of banks to take write-downs on certain assets.

Last month, Sterne Agee analysts noted in their report that the Volcker Rule will force Zions Bancorporation (NASDAQ:ZION) to reclassify the entirety of its predominantly bank and insurance Trust-Preferred Collateralized Debt Obligation portfolio as ‘Available for Sale’ and Zions Bancorporation (NASDAQ:ZION) will record a $629 million pre-tax non-cash charge to 4Q13 earnings, translating into post-tax charge of $387 million.

CDOs issued before May 2010

The interim final rule released Tuesday would permit banks to retain TruPS CDOs they owned as of Dec 10, 2013, if the CDOs were issued before May 19, 2010, and are backed by TruPS or subordinated debt of bank holding companies that had less than $15 billion in assets when the securities were issued or of mutual holding companies. The rule will avoid the dramatic market impact of revised accounting treatment and forced divestiture of these securities.

However, the regulators’ exemption narrowly addresses CDOs, not the banking industry’s related complaint that the Volcker Rule could also force losses on certain collateralized loan obligations. Several industry groups warned of market disruptions if banks have to sell off CLO holdings.

The impact of Volcker rule and their criticism

Industry representatives will testify before the House Financial Services Committee Wednesday on the impact of Volcker and their criticism is expected to focus on the CLO treatment.