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Thursday
May272010

FRAUD: Documents Show Bank Of America & Citigroup Utilized Lehman-Style Repo 105s To Hide Debt

As I wrote at the time, it wasn't just Lehman Brothers.  Eventually, I'm sure we will learn that Goldman Sachs, Morgan Stanley and JPMorgan were doing the same.  The good news is that there's a new FASB Rule just now being implemented that makes these practices explicitly forbidden.  So the loophole should be closed.

Hiding true leverage ratios and debt at quarter's end is FRAUD

It's but one of many Wall Street practices federal prosecutors should be examining.  And it wouldn't hurt if Robert Khuzami at the SEC started to make some noise about this blatantly corrupt accounting.  And while we're at it, why did the auditors sign off on these techniques?  Where are the investigations of KPMG and others?

Nothing as thrilling as asking my questions into an echo chamber of enforcement.  Now on to the story.

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Bank Of America, Citigroup Incorrectly Hid Billions In Repo Debt (WSJ)

Reprinted with permission.

Bank of America Corp. (BAC) and Citigroup Inc. (C) incorrectly hid from investors billions of dollars of their debt, similar to what Lehman Brothers Holdings Inc. did to obscure its level of risk, company documents show.

In recent filings with regulators, the two big banks disclosed that over the past three years, they at times erroneously classified some short-term repurchase agreements, or "repos," as sales when they should have been classified as borrowings. Though the classifications involved billions of dollars, they represented relatively small amounts for the banks.

A bankruptcy-court examiner said Lehman had been doing the same thing to make its balance sheet look better before it filed for bankruptcy in September 2008, using a strategy dubbed "Repo 105" that helped the Wall Street firm move $50 billion in assets off its balance sheet.

Bank of America and Citigroup say their misclassifications were due to errors--not an attempt to make themselves look less risky, which examiner Anton Valukas said was Lehman's motivation. The disclosures, made after federal securities regulators began asking financial firms about their repo accounting, were included in quarterly filings earlier this month but not highlighted.

The disclosures come amid a series of revelations about how banks obscure their risk-taking before reporting their finances to the public, a practice known in the financial world as "window dressing."

Bank of America and Citigroup were among the banks cited in a page-one Wall Street Journal article on Wednesday detailing how financial firms temporarily shed repo debt at the ends of quarters, when they report their finances to investors. Since the financial crisis began, both banks often have reduced their quarter-end repo debt from their average borrowings for the same quarter. That activity didn't involve misclassifying repo loans as sales.

Repos are short-term loans that allow banks to take bigger risks on securities trades; classifying the transactions as sales instead of borrowings allows a firm to take assets off its balance sheet and thus reduces its reported leverage, or assets as a multiple of equity capital.

Federal securities rules bar financial firms from intentionally masking debt to deceive investors. There is no indication that Bank of America or Citigroup misclassified their repos intentionally or that the Securities and Exchange Commission will take any action against them. An SEC spokesman declined to comment.

The amounts Bank of America and Citigroup cite are relatively small. The misclassifications had tiny impacts on the banks' reported leverage, and none at all on their earnings or shareholder equity. The banks didn't restate any financial statements.

Bank of America said the misclassified transactions in certain quarters over the past three years-ranging from $573 million to as much as $10.7 billion-"represented substantially less than 1% of our total assets" and had no material impact on its balance sheet, earnings or borrowing ratios.

Citigroup said the misclassified transactions-of $5.7 billion as of the end of 2009, and as much as $9.2 billion over the past three years-involved "a very limited number of our business units" that "used this type of transaction in very small amounts." It also said its errors were immaterial to its financial statements. "At no point in time was the impact of these sales transactions large enough to have a noticeable impact on our published leverage ratios."

By comparison, both banks have more than $2 trillion in assets.

The SEC had asked big banks in March for more information about their repo accounting in the wake of the Lehman bankruptcy report. That inquiry hasn't found any widespread inappropriate practices, SEC Chief Accountant James Kroeker told a congressional subcommittee last week.

But Kroeker said the SEC has asked several companies to provide more disclosure about their repo accounting in their securities filings. Bank of America and Citigroup indicated they had found their errors on their own initiative.

More broadly, the SEC is now considering stricter disclosure and a clearer rationale from firms about quarter-end borrowing activities. The agency may extend these rules to all companies, not just banks. The potential new rules, disclosed by SEC Chairman Mary Schapiro at a congressional hearing last month, came two weeks after the Journal's initial article about banks' debt-masking activity.

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The ‘Repos’ of Citigroup and BofA — Honest Mistakes?

Oops, that “sale” was really a loan.

All across the financial industry, banks have been quietly admitting that, like Lehman Brothers, they too used a Repo 105-like strategy to lower their leverage at quarter end.

The Wall Street Journal reports that Citigroup, Bank of America and Bank of New York Mellon used short term loans to temporarily reduce their holdings, while classifying the transaction as sales.

The banks said the transactions were mistakenly classified as sales and involved relatively small amounts.

BofA, for example, reported in its last quarterly SEC filing that it recorded as high as $10.7 billion of certain sales of mortgage - backed securities — which should have been recorded as borrowings. Citigroup said in a May 7 filing that its repo transactions were as high as $13 billion.

Lehman, by contrast, made such Repo 105 transactions of up to $50 billion, according to the bankruptcy court examiner’s report. (The company’s former CEO Dick Fuld testified recently that he was unaware that Repo 105 transactions were being used as “window dressing” for Lehman’s earnings)

The Lehman report may have helped spur other banks to report similar transactions. But will they be able to make such moves in the future?

A new rule by the Financial Accounting Standards Board is just starting to take affect now which should close the Repo 105 loophole used by Lehman .

Under the old rules, an asset would have to remain on a bank’s books if it temporary sold them off, but agreed to buy them back for a price between 98% and 102% of what they originally sold them for.

The banks would typically buy the assets back at 105%, which allowed them to move the assets off their books temporarily.

The new rule, FAS 166, replaces the 98%-102% test with one designed to get at the intent behind a repurchase agreement, according to this article in Knowledge@Wharton, the online business journal of the Wharton School at the University of Pennsylvania.

“The new rule looks at whether a transaction truly involves a transfer of risk and reward. If it does not, the agreement is deemed a loan and the assets stay on the borrower’s balance sheet.”

The Wharton article argues that the current accounting system – in which independent auditor Ernst & Young signed off on Lehman’s Repo 105s – remains flawed.

“As long as accounting firms are paid by the companies they audit, there will be an incentive to dress up the client’s appearance,” the article says.

 

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Reader Comments (10)

LEHMAN ACCOUNTING FRAUD: Attention Prosecutors: Watch This Video About Lehman, Geithner, Fuld & The NY Fed

http://dailybail.com/home/lehman-accounting-fraud-attention-prosecutors-watch-this-vid.html
May 27, 2010 at 3:21 PM | Registered CommenterDailyBail
http://dailybail.com/home/lies-more-lies-richard-fuld-lehmans-fraudulent-dick.html

Lies, More Lies & Richard Fuld: Lehman's Fraudulent Dick
May 27, 2010 at 3:21 PM | Registered CommenterDailyBail
BUT NOT MATT DAMON, HARVARD DROPOUT, OH WELL...

Manhattan financial adviser to celebs is charged with scamming clients

As a result, Starr was able to use some of his clients’ funds to purchase a posh $7.6 million East Side apartment. The five-bedroom apartment includes a rec room with a wet bar, a 32-foot granite lap pool and a 1,500 square-foot garden.

Kissinger and Caroline Kennedy said to have paid for his posh apartment.

http://www.nypost.com/p/news/local/nyc_financial_adviser_to_celebrities_DXslLxEwDlkAkxcooYs4pN
May 27, 2010 at 4:44 PM | Unregistered CommenterZarathustra
"The good news is that there's a new FASB Rule just now being implemented that makes these practices explicitly forbidden."

Pardon the irreverance, but whoopty-friggin'-doo.

The so called "Repo 105"'s already were fraud, and fraud (last time I checked) is illegal. What difference does it make what the rules are when nobody's willing to enforce them? Are we supposed to get excited that congress is going to write new rules?

Take your all your money away from Wall Street right now.

It's been less than two years since the last collapse and I'm telling you, they're on the ropes again. They desperately need Main Street to believe that all is well, so they can resume siphoning what's left of America's wealth.

"....the only thing that can save the financial system is, paradoxically, its destruction."
~Tyler Durden

We have to kill it before it kills us.
May 27, 2010 at 5:11 PM | Unregistered Commentermark mchugh
I bet the phrase "liquidity injection" resurfaces before the fourth of July.
May 27, 2010 at 5:22 PM | Unregistered Commentermark mchugh
And you're absolutely right about KPMG, DB.

What, no $13 Trillion National Debt party?
May 27, 2010 at 5:25 PM | Unregistered Commentermark mchugh
What, no $13 Trillion National Debt party?

----

yep...story coming up probably tomorrow...we've celebrated $12 trillion and $12.5 trillion...can't miss the $13 trillion national debt party...
May 27, 2010 at 5:44 PM | Registered CommenterDailyBail
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Apr 4, 2012 at 6:01 AM | Unregistered Commenterckjvsp ckjvsp

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