" REPO 105" ACCOUNTING IN FOCUS / THE FINANCIAL TIMES ( RECOMMENDED READING )

‘Repo 105’ accounting in focus

By Henny Sender and Jeremy Lemer in New York

Published: March 12 2010 02:16

By the time Lehman Brothers imploded, $25bn in capital was supporting $700bn of assets and liabilities, a leverage ratio that was regarded as extremely high.

Lehman’s rapid growth saw net assets increase by 48 per cent, or almost $128bn, from the fourth quarter of 2006 through the first quarter of 2008. But the bulk of the assets, according to the report by court-appointed examiner Anton Valukas released on Thursday, were in illiquid assets that could not easily be sold. Such assets nearly doubled to $175bn in that same time frame.

Because these assets, primarily in the form of commercial real estate, could not easily be sold, and were financed with borrowed money, Lehman could not easily reduce its leverage.

“In addition to the loss, the perception can be that there is ‘air’ in the valuation of other illiquid assets that remain on the balance sheet, exacerbating the risk of a loss of confidence in the firm’s future,” the examiner notes.

To maintain favourable ratings from the credit ratings agencies, Lehman engaged in what was referred to internally as “Repo 105,” a sort of window-dressing which involved getting $50bn of assets off the firm’s balance sheet at the end of both the first- and second-quarter balance sheets, the report said.

When Lehman first began engaging in such window dressing in approximately 2001, the firm could not get a US law firm to sign off on the transactions, which led Lehman to conduct these repo transactions out of its London unit, with the blessing of a UK law firm, the report said.

A Lehman senior vice president raised questions about the propriety of these transactions as early as May 2008, but the report said that the accountants at Ernst & Young “took no steps to question or challenge the non-disclosure of its use of $50bn of temporary, off balance sheet transactions.

“The Examiner concludes that there are colorable claims that Ernst & Young did not meet professional standards either in investigating these allegations and in connection with its audit and review of Lehman’s financial statements.”

Ernst & Young said: “Lehman’s bankruptcy, which occurred in September 2008, was the result of a series of unprecedented adverse events in the financial markets. Our last audit of the Company was for the fiscal year ending November 30, 2007. Our opinion indicated that Lehman’s financial statements for that year were fairly presented in accordance with Generally Accepted Accounting Principles (GAAP), and we remain of that view.”

Copyright The Financial Times Limited 2010.