The term Repo 105 became popular after the collapse of Lehman Brothers, a US-based investment bank. Lehman`s accountants used the accounting gimmick to repay $50 billion in liabilities, with the goal of reducing liabilities on the balance sheet prior to the release of the company`s financial statementsThree financial statementsThe three financial statements are the income statement, the balance sheet and the cash flow statement. These three key messages are complicated. The manipulation of the balance sheet was neither made public to the company`s shareholders nor included in the footnotes to the financial report. The bank used technology to give the impression that it was less dependent on loans than it actually was. While the report sheds light on Lehman`s inner workings as the crisis simmered, it did not resolve the debate over whether the government was right to let Lehman sink. Many experts believe that bankruptcy is the appropriate outcome for companies that take too much risk. But in this case, many believe that Lehman was so big that its collapse caused an uproar in the markets and exacerbated the crisis, as if the government had supported Lehman, as was the case with a number of other companies. Lehman`s use of the Repo 105 was clearly intended to deceive, according to the Vakulas report. A management email cited in the report described the program as nothing more than a « window dressing. » But the company, which operated internationally, managed to get legal advice from a British law firm claiming the technique was legal. But when Lehman Brothers wanted to give the impression that it wasn`t borrowing as much money, the company used a special technique to get around that rule.
He entered into repo transactions where he took a little less money than the value of the asset. Lehman doubled or tripled the use of Repo 105 before the end of a billing period to mask financial emergencies. It would transfer ownership of high-value securities at 105% or 108% of the amount received (hence the names Repo 105 and Repo 108). Lehman would then use the proceeds from the sale of securities to reduce its liabilities and improve its debt ratios. Shortly after the start of a new quarter, the Bank raised funds to repay the previous cash loan plus interest, repurchase the securities and return these assets to its balance sheet. For example, Lehman used $38 billion in the last quarter of 2007 and the reported net debt ratio was 16.1, while the real leverage ratio excluding repo 105 was 17.8. Similarly, the bank used $49.1 billion in the first quarter of 2008 and reported the net debt ratio at 15.4, while the company`s actual debt ratio was 17.3. The collapse of Lehman Brothers in September 2008 is widely seen as the trigger for the financial crisis and panic that crippled lending. Now, a 2,200-page report indicates that before the collapse — the biggest bankruptcy in U.S. history — investment banking executives made extraordinary efforts to hide the risks they had taken.
A new term describing how Lehman converted securities and other assets into cash has entered the financial vocabulary: « Repo 105. » Repo 105 was a kind of loophole in the accounting of repurchase agreements, which the now-defunct Lehman Brothers exploited to hide true debt levels in their difficult times during the 2007-2008 financial crisis. In this buyback agreement, which has since been updated to close the loophole, a company could classify a short-term loan as a sale and then use the cash proceeds from the « sale » to reduce its liabilities. A word for Repo 105 comes to mind that I always thought I was created as Lehman`s legal opinion in the UK: « Shenanigans ». It turns out that its origin is uncertain, but it sounds Irish, so I think it`s pretty close. The out of 11. The report was released in March 2010 and was titled « Lehman Brothers Holdings Inc. Chapter 11 Proceedings. » The auditor in this case was Anton R. Valukas, president of Jenner & Block.
The report describes the use of « Repo 105 » and « Repo 108 », which are identical procedures, with the former costing 4.76% and the latter 7.41% of the assets traded. In other words, assets worth 105 will produce 100 in cash, assets worth 108 will each produce 100 in cash. For example, if Lehman owned a $105 bond, she would « sell » it in the repo market for $100. (The « 105 » in Repo 105 refers to the fact that the assets were worth at least 105% of what Lehman got for them.) Under previous accounting rules, whether a reverse repurchase agreement was reported as a sale or financing depended in part on whether an entity retained effective control over the transferred assets. Effective control, in turn, depended on the company`s ability to buy back the assets. The Financial Accounting Standards Board said on Friday it had changed the rule to address questions raised during the global financial crisis, such as how to view pensions, essentially a type of short-term borrowing. The IASB and the FASB, which are responsible for setting accounting standards, met in April 2010 to review the accounting treatment of these repurchase transactions. [7] The auditor`s report also concluded that the bank`s auditors, Ernst & Young, were technically negligent in failing to question the accuracy of the published financial statements. In addition, the company did not investigate allegations of misuse of Repo 105 by Matthew Lee, then senior vice president of Lehman. The Wall Street Journal also pointed to a potential conflict of interest when Ernst & Young received an increased commission level from Lehman from 2001 to 2008.
Under standard accounting rules, ordinary repo transactions are considered loans, and assets remain on the company`s books, Bushee says. But Lehman found a way around the negotiations so he could count the deal as a sale that removed assets from his books, often just before the end of the quarterly financial reporting period, according to the Valukas report. This decision temporarily made the company`s debt levels appear lower than they really were. About $39 billion was withdrawn from the balance sheet at the end of the fourth quarter of 2007, $49 billion at the end of the first quarter of 2008 and $50 billion at the end of the following quarter, according to the report. Technically, according to the written reverse repurchase rule at the time and the overflowing imagination of CFO Erin Callan and her subordinates, their Repo 105 transactions made it possible to record sales instead of loans, remove loans from the balance sheet, and not require disclosure of debt obligations. « Like all rests, short for `buy-back agreements,` it was a short-term loan, exchanging collateral for money in advance and reversing exchanges overnight. Unlike other repurchase agreements, the value of the securities pledged by Lehman in the Repo 105 transactions was worth 105% of the money received. But the beauty of Repo 105 was that,. .
. . The company could account for transactions as a « sale » rather than a « financing » because most pensions are considered. This meant that Lehman could dispose of tens of billions of dollars in assets for a few days — and in the fourth quarter of 2007, that meant the end of the quarter — to appear financially healthier than it actually was. In reality, given the situation at the time, they were not valid in practice. Under the current rule, a reverse repurchase agreement would be reported as a sale or financing, depending on whether or not a company retained effective control over the assets secured for the short-term loan. If a company had the opportunity to buy back the assets, it would be a financing transaction; If it weren`t, it would be a sale. Investment banks use the repo market all the time. It`s essentially a way for banks to borrow money from large companies that have extra money lying around. Prior to the bankruptcy, Lehman had worked hard to improve his financial situation to where it was, according to the Valukas report.
An important step was to withdraw $50 billion in assets from its books to hide its high borrowing or leverage. The repo-105 maneuver that achieved this was a distortion of a standard funding method known as a buyout agreement. Lehman first used repo 105 in 2001 and became dependent on it in the months leading up to the bankruptcy. As the financial crisis worsened in 2007 and 2008, Lehman knew she needed to reduce her reliance on borrowed money. But it was a bad time to sell things and pay off debts. Lehman therefore made special use of the so-called repo market. Former directors of Lehman Brothers have defended their use of Repo 105, arguing that other financial institutions practice some form of eyewashing to adjust their financial reports. They claimed that the $50 billion excluded from their balance sheets was too insignificant compared to the amount of money lost during the global financial crisis. The bank used repo to lower its net debt ratio and mislead rating agencies so that they did not give the company a bad rating that would give its stakeholders a negative image. Between March and September 2008, the three main credit rating agencies took turns downgrading Lehman`s credit outlook and rating.
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