Repo 105

What Was Repo 105?

Repo 105 was a type of loophole in accounting for repurchase (repo) transactions that the now-stifled Lehman Brothers took advantage of trying to conceal true amounts of leverage during its difficult situations during the 2007-2008 financial crisis. In this repurchase agreement, since refreshed to close the loophole, a company could order a short-term loan as a sale and consequently utilize the cash proceeds from the "sale" to reduce its liabilities.

Understanding Repo 105

In the repo market, a firm can gain access to excess funds of different firms for short periods, normally overnight, in exchange for collateral. The firm that gets the funds vows to pay back the short-term loan with a small amount of interest; the collateral ordinarily never changes hands. This permits firms to record the approaching cash as a sale — the collateral is assumed to have been "auctions off" and bought back later.

Lehman Brothers and Repo 105

Repo 105 stood out as truly newsworthy following the collapse of Lehman Brothers. It was reported that Lehman got a handle on for this accounting maneuver to pay down $50 billion in liabilities to reduce leverage on their balance sheet.

Technically, as per the repo rule as written then, and to the inspired bigger thoughts of CFO Erin Callan and her subordinates, their Repo 105 transactions permitted the recognition of sales rather than borrowings, kept the borrowings off the balance sheet and didn't need disclosure of the debt obligations.

In reality, given the situation at that point, they were not substantial in practice. Under the rule that existed, a repo would be reported as a sale or financing, contingent upon whether a company retained effective control over the collateralized assets for the short-term loan. In the event that a company been able to repurchase the assets, it would be a financing transaction; in the event that it didn't, it would be a sale.

In the Repo 105 transactions, Lehman asserted it surrendered effective control since it received just $100 for each $105 in posted collateral (subsequently the "105"). Subsequently, the investment bank stated, they were sale transactions that produced proceeds for leverage reduction.

Special Considerations

Having taken in an important example about how Wall Street will figure out how to abuse an accounting rule, the Financial Accounting Standards Board (FASB) issued ASU No. 2011-03, "Moves and Servicing (Topic 860): Reconsideration of Effective Control for Repurchase Agreements."

The rule has been developed, the FASB said in a press release, "by wiping out consideration of the transferor's ability to satisfy its contractual rights and obligations from the criteria in determining effective control."

Features

• Under Repo 105, in the event that a company been able to repurchase the assets, it was viewed as a financing transaction and on the off chance that it didn't, it would be a sale.
• In particular, Lehman asserted it surrendered effective control since it received just $100 for each $105 in posted collateral (thus the "105").
• Repo 105 was an accounting loophole that permitted companies to conceal true amounts of leverage.
• Lehman Brothers utilized the loophole to conceal the way that it was profoundly leveraged during the financial crisis.
• Repo 105 was a repurchase agreement that a company used to gain funds through short-term loans that are backed by collateral.