WASHINGTON — Federal banking regulators are exploring whether to exempt collateralized debt obligations backed by trust-preferred securities from the Volcker Rule, the agencies said on Friday.

The announcement was the most recent in a rapidly developing stand-off between banks and regulators over the controversial rule, which is designed to ban proprietary trading and prevent banks from investing in hedge and equity funds.

The issue has already sparked a lawsuit by the American Bankers Association, which is seeking emergency court relief before some community banks may be forced to take millions of dollars in write-downs on certain CDOs at yearend. Regulators are due to respond to that lawsuit by Monday morning.

Prior to that, however, the agencies acknowledged Friday they are looking to see whether it would be "appropriate and consistent" with the Dodd-Frank Act to carve out all CDOs backed by Trups from the Volcker Rule.

"The agencies intend to address the matter no later than January 15, 2014," the regulators said. "The accounting staffs of the agencies believe that, consistent with generally accepted accounting principles, any actions in January 2014 that occur before the issuance of Dec. 31, 2013, financial reports should be considered when preparing those financial reports."

At issue are whether banks are required to shed CDOs that are made up of trust-preferred holdings and how quickly. Under the final Volcker Rule issued two weeks ago, regulators said that certain CDOs that relied on a particular legal exemption from investment registration might be restricted.

As a result, at least three banks said they would have to write down or sell such assets immediately, potentially at a substantial loss, despite the fact that the Volcker Rule does not go into effect until July 2015. Zions Bancorp. in Salt Lake City said it may take a $387 million charge on its portfolio of CDOs.

The problem is primarily accounting-related. If these Trup CDOs are covered by the Volcker Rule, banks could no longer treat them as available-to-maturity securities, starting by the end of the fourth quarter. Instead, they would have to mark them as available-for-sale, taking significant write-downs in the process.

The ABA filed a lawsuit on Tuesday against the regulators, asking the court to delay implementation of the Volcker Rule as it relates to CDOs backed by Trups. If granted, that would allow banks additional time to convince regulators to exempt such obligations from the Volcker Rule.

In their release, the regulators said they "understand that the investments and capital levels of a number of these organizations might be adversely affected if pooling vehicles formed for the purpose of holding Trups are treated as covered funds."

They noted that many banks feel the Volcker Rule provision covering Trups-related CDOs conflicted with another part of Dodd-Frank which specifically grandfathered trust-preferred securities for banks with less than $15 billion of assets for certain capital requirements.

"The agencies are therefore evaluating whether it is appropriate not to cover pooling vehicles that invest in Trups in order to eliminate restrictions that might otherwise have consequences that are inconsistent with the relief Congress intended to provide community banking organizations under section 171(b)(4)(C) of the Dodd-Frank Act," the regulators said.

It was not immediately clear whether the announcement Friday would be sufficient for the ABA.

Regulators are clearly trying to convince banks that they do not need to take write-downs at the end of the fourth quarter while the issue is still being debated. However, bankers fear accountants and auditors may take a different view and conclude banks acted inappropriately by putting off a decision.

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