A day after the Lehman Repo 105 scandal erupted, one, just one bank stepped up and said it had never used Repo 105-type transactions. The bank was Goldman Sachs. Of course, Goldman's claim is completely useless without a context as the proper refusal would be for Goldman's counsel to say that the firm had not used anything "substantially similar" to a Repo 105. The difference between that and the verbatim phrasing is like night from day. But at least the soundbite chasers bought it, and the whole topic of Goldman and Repo 105 promptly died away. We'll let that be... for now. Yet one bank which not only has not provided voluntary disclosure, but which has now gotten itself bogged down in semantics, after recently speculation had emerged that BofA had used "substantially similar" devices to Repo 105. Today, BofA provided a response on the record as to whether it had (ab)used Repo 105s and it appears, that inasmuch the firm is unable to say no, the answer is a resounding yes.
Marian Wang, who apparently caught some green admin over in legal at Bryant Park 2 to spill their guts, shares the following:
I’d put in several calls and emails with Bank of America both yesterday and today asking for a response to the allegations. The bank’s rep said he wanted to be thoughtful about the response, and this afternoon, sent me this carefully crafted statement:
“Efforts to manage the size of our balance sheet are routine and appropriate, and we believe our actions are consistent with all applicable accounting and legal requirements.”
My only thought is that this is very similar to what Lehman’s auditors, Ernst & Young, said in response to criticism about their review of Lehman’s accounting, right after Repo 105 hit the news earlier this month. Here’s what the auditor’s spokesman, Charles Perkins, said at the time :
“Our opinion indicated that Lehman’s financial statements for that year were fairly presented in accordance with Generally Accepted Accounting Principles, and we remain of that view.”
Sorry BofA, the proper response to Marian's question would have been "Hell no, we did not do Repo 105s." Alas, BofA, which recently lost its CEO, proves yet again that it has so much more to learn from its so much more integrated in the government apparatus, peer Goldman Sachs.
And in order to pursue this topic further, Zero Hedge has sent an email to Bank of America auditors PricewaterhouseCoopers. We are confident that at least PwC will know that the proper response is No... of course, assuming that is true. Which we have a feeling may be not be the case. In that case the E&Y stigmata will soon result in a "Big 3," then "Big 2," then "Big Last One," until no auditors are left in this country of endless corruption.
A cursory search uncovers the following discussion of SFAS 140 treatment in Bank of America's 2005 10-K, when discussing Qualified Special Purpose Entitites:
Qualified Special Purpose Entities
In addition, to control our capital position, diversify funding sources and provide customers with commercial paper investments, we will, from time to time, sell assets to off-balance sheet commercial paper entities. The commercial paper entities are Qualified Special Purpose Entities (QSPEs) that have been isolated beyond our reach or that of our creditors, even in the event of bankruptcy or other receivership. The accounting for these entities is governed by SFAS 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities—a replacement of FASB Statement No. 125,” (SFAS 140) which provides that QSPEs are not included in the consolidated financial statements of the seller. Assets sold to the entities consist of high-grade corporate or municipal bonds, collateralized debt obligations and asset-backed securities. These entities issue collateralized commercial paper or notes with similar repricing characteristics to third party market participants and passive derivative instruments to us. Assets sold to the entities typically have an investment rating ranging from Aaa/AAA to Aa/AA. We may provide liquidity, SBLCs or similar loss protection commitments to the entity, or we may enter into derivatives with the entity in which we assume certain risks. The liquidity facility and derivatives have the same legal standing with the commercial paper.
The derivatives provide interest rate, currency and a pre-specified amount of credit protection to the entity in exchange for the commercial paper rate. These derivatives are provided for in the legal documents and help to alleviate any cash flow mismatches. In some cases, if an asset’s rating declines below a certain investment quality as evidenced by its investment rating or defaults, we are no longer exposed to the risk of loss. At that time, the commercial paper holders assume the risk of loss. In other cases, we agree to assume all of the credit exposure related to the referenced asset. Legal documents for each entity specify asset quality levels that require the entity to automatically dispose of the asset once the asset falls below the specified quality rating. At the time the asset is disposed, we are required to reimburse the entity for any credit-related losses depending on the pre-specified level of protection provided.
In BofA's case it seems more of a pure off balance sheet sweep in SPE. Yet digging into the definition of BofA's QSPEs we uncover the following:
To improve our capital position and diversify funding sources, we also sell assets, primarily loans, to other off-balance sheet QSPEs that obtain financing primarily by issuing term notes. We may retain a portion of the investment grade notes issued by these entities, and we may also retain subordinated interests in the entities which reduce the credit risk of the senior investors. We may provide liquidity support in the form of foreign exchange or interest rate swaps. We generally do not provide other forms of credit support to these entities, which are described more fully in Note 9 of the Consolidated Financial Statements. In addition to the above, we had significant involvement with variable interest entities (VIEs) other than the commercial paper conduits. These VIEs were not consolidated because we will not absorb a majority of the expected losses or expected residual returns and are therefore not the primary beneficiary of the VIEs. These entities are described more fully in Note 9 of the Consolidated Financial Statements.
We would love for PwC to confirm that there was no Repo 105 comparable shennanigans associated with BofA's use of SFAS 140 loopholes over the past several years in order to make its balance sheet look more attractive to investors.