Bank of America Corporation (BAC: 15.21 0.00 0.00%) has confessed that it had incorrectly reported approximately $573 million to $10.7 billion in short-term lending and repurchase deals – or ‘repos’ – as sales over a period of three years (2007 to 2009).This is similar to what Lehman Brothers Holdings Inc. did using a strategy called Repo 105 to remove $50 billion out of its balance sheet and make its financials look better, according to the bankruptcy-court examiner. The Repo 105 strategy allows a company to remove assets from its balance sheet and helps in reducing its financial leverage.
BofA had admitted this in a letter to Securities and Exchange Commission (SEC) in April 2010, as the SEC prepares to disclose the results of its inquiry in to companies’ accounting for such repo deals later this week. Repos are short-term loans that permit banks to take a much larger risk on securities trades.
In March 2010, the SEC had started its own inquiry into the repo practices of companies and had asked many top notch financial companies to furnish more data regarding their repo accounting. The SEC is considering more transparent and strict disclosure about the companies’ account for repo, following the Lehman’s bankruptcy enquiry report.
BofA stated that it had formulated the deals in such a manner that securities coming back to the company were similar but not “significantly the same” as those that were removed. This would require the trade to be recognized as sales and remove the assets from the balance sheet. But the securities that were added back were “significantly the same”, i.e. with the same coupon and guarantor. Hence, this should have been accounted as borrowing and not as sales.
Such deals, where mortgage-backed securities are assigned a trading partner with a concurrent contract to repurchase similar securities from the same partner soon thereafter, are known as Dollar deals.
By categorizing such deals as sales, BofA was able to reduce the size of its balance sheet and thus decrease its reported leverage. This improved the company’s Tier 1 capital leverage ratio by 0.01% for the September 2008 quarter. BofA had first recognized these mistakes in its first quarter 2010 results but the details were not divulged at that time.
This practice, also known as window dressing, is not illegal, but deliberately concealing debt is against regulatory rules. But BofA claims that its mistakes were not on purpose, mentioning that the SEC has not taken any action against the company.
The amount mentioned above is relatively small as compared with the total assets worth $2.3 trillion. While acknowledging that there were six such transactions during the period reported above, BofA said that the accounting errors did not have a significant impact on its financial results and earnings.
Earlier in May, the Wall Street Journal had reported that both BofA and Citigroup Inc. (C: 4.11 0.00 0.00%) had unethically hidden billions of dollars of their debts from the investors. Since the beginning of the financial turmoil, both these companies had often reduced their assets while reporting the quarterly results.
Separately, Bank of New York Mellon Corporation (BK: 26.27 0.00 0.00%)declared in a securities filing that it had found certain mistakes in its repo accounting over the past three years. According to the company, these errors were corrected and will not have any financial impact.
Following these disclosures, many financial companies will also come under the radar of SEC and investors will also think twice before investing in such companies. This will likely have a negative impact on BofA’s share price and financial results, which were stabilizing a bit following huge losses in 2009.
BofA’s first quarter 2010 earnings came in at 28 cents per share, substantially ahead of the Zacks Consensus Estimate of 9 cents. However, this compares unfavorably with the earnings of 44 cents per share in the year-ago quarter. Strong capital market activity and lower provision for credit losses were the primary factors that helped BofA bounce back to profitability after incurring huge losses for the last couple of quarters.
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