What the market may have overlooked in the last quarter and this one, handily written up by Florida-based accountants MBAF (back in August):
During the final months of 2011, banks will need to begin preparing for compliance with a recent Financial Accounting Standards Board requirement on the accounting treatment of repurchase agreements.
The FASB issued Accounting Standards Update (ASU) No. 2011-03, Transfers and Servicing (Topic 860): Reconsideration of Effective Control for Repurchase Agreements on April 29. The ASU establishes new determinations on whether the accounting treatment should be a sale or a financing on repurchase agreements, generically known as repos, and other agreements that both entitle and obligate a transferor to repurchase or redeem financial assets before their maturity.
Among community banks, it is common to arrange short-term repurchase agreements in which government securities are traded in return for cash. Short-term sales and repurchases of a portion of a loan to another bank also are subject to accounting rules for repurchases.
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Under ASU 2011-03, the transferor’s maintaining of effective control of the financial asset remains the determining factor as to whether it can account for the repo as a sale of assets. The FASB concluded that the assessment of effective control should focus on a transferor’s contractual rights and obligations with respect to transferred financial assets, not on whether the transferor has the practical ability to perform in accordance with those rights or obligations. In an important change, the ASU removed two criteria that previously had been used in determining effective control:
- The criterion requiring the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms, even in the event of default by the transferee.
- The collateral maintenance implementation guidance related to that criterion.
You can read the full Financial Accounting Standards Board ruling here.
While these rules were designed to stamp out Lehman-style Repo 105 practices, they seem also to have hit such things as repo-to-maturity trades — traditionally booked as sales (since most of the time the securities being repurchased were considered to be low risk).
Cue a slew of bank 10-q filings either announcing no material exposure to the rule change, ongoing assessment of the rule change or warnings of prospective transfers back on balance sheet.
In the latter group were, for example, banks like Nomura:
Nomura will therefore adopt ASU 2011-03 from January 1, 2012 and does not expect these to have a material impact on these consolidated financial statements. Certain Japanese securities lending transactions undertaken after adoption date will be accounted for as secured borrowings rather than sales in these consolidated financial statements as the criteria for derecognition of the transferred financial assets under ASC 860 will no longer be met. The amounts of securities derecognized from the consolidated balance sheets under open securities lending transactions as of March 31, 2011 and as of June 30, 2011 were ¥291,870 million and ¥189,156 million, respectively.
And Morgan Stanley:
At June 30, 2011, the Company recorded approximately $5.6 billion in Financial instruments owned—Corporate and other debt, $3.4 billion of physical commodities within Financial instruments owned—Physical commodities, and $9.0 billion of financing obligations within Other secured financing in the condensed consolidated statements of financial condition in connection with certain physical commodities swap transactions. Prior to June 30, 2011, the Company accounted for these types of transfers of assets as sales and purchases instead of financings. There was no impact on the Company’s results of operations in any period presented as a result of this change. The Company did not restate the balances in connection with such transactions at December 31, 2010 as amounts did not materially affect the Company’s condensed consolidated statement of financial condition.
Then there were those who claimed they had no repo-to-maturity sitting off balance sheet, like Goldman Sachs:
Even though repurchase and resale agreements involve the legal transfer of ownership of financial instruments, they are accounted for as financing arrangements because they require the financial instruments to be repurchased or resold at the maturity of the agreement. However, ―repos to maturity‖ are accounted for as sales. A repo to maturity is a transaction in which the firm transfers a security that has very little, if any, default risk under an agreement to repurchase the security where the maturity date of the repurchase agreement matches the maturity date of the underlying security. Therefore, the firm effectively no longer has a repurchase obligation and has relinquished control over the underlying security and, accordingly, accounts for the transaction as a sale. The firm had no such transactions outstanding as of June 2011.
But would be affected via other types of repo deals, like those previously matching client flows or those sitting in Variable Interest Entities (VIEs):
As of June 2011, the firm had $9.28 and $13.13 billion, respectively, of securities received under resale agreements and securities borrowed transactions that were segregated to satisfy certain regulatory requirements. These securities are included in ―Cash and securities segregated for regulatory and other purposes.
Other secured financings include arrangements that are nonrecourse. As of June 2011, nonrecourse other secured financings were $328 million.
And then there were companies like MF Global, who warned as far back as May 2011 that:
The Company also enters into certain resale and repurchase transactions that mature on the same date as the underlying collateral (“reverse repo-to-maturity” and “repo-to-maturity” transactions, respectively). These transactions are accounted for as sales and purchases and accordingly the Company de-recognizes the related assets and liabilities from the consolidated balance sheets, recognizes a gain or loss on the sale/purchase of the collateral assets, and records a forward repurchase or forward resale commitment at fair value, in accordance with the accounting standard for transfers and servicing. For these specific repurchase transactions that are accounted for as sales and are de-recognized from the consolidated balance sheets, the Company maintains the exposure to the risk of default of the issuer of the underlying collateral assets, such as U.S. government securities or European sovereign debt, consisting of Italy, Spain, Belgium, Portugal and Ireland. The forward repurchase commitment represents the fair value of this exposure and is accounted for as a derivative. The value of the derivative is subject to mark to market movements which may cause volatility in the Company’s financial results until maturity of the underlying collateral at which point these instruments will be redeemed at par. At March 31, 2011, securities purchased under agreements to resell of $1,495,682, at contract value, were de-recognized. At March 31, 2011, securities sold under agreements to repurchase of $14,520,341, at contract value, were de-recognized, of which 52.6% were collateralized with European sovereign debt. At March 31, 2010, this consisted of securities purchased under agreements to resell and securities sold under agreements to repurchase of $1,199,842 and $5,702,980, respectively, at contract value.
Hence Finra’s desperation to make sure MF Global kept the market up to date on its ongoing net exposure (we presume).
Though, as Brad DeLong has noted, what the point of any of these MF trades really was (since it’s hard to understand how they would have benefited either MF or its counterparties) is still hard to rationalise.
Related links:
MF Global and echoes of Repo 105 – FT Alphaville
European bet triggered MF Global’s demise – FT
Did accounting help sink Corzine’s MF Global? – Reuters