Friday, March 12, 2010

What’s in Repo 105

While Repo 105 was created in 2001, it proved very useful for Lehman Brothers in terms of publicly reducing leverage as the financial crisis intensified in 2007 and 2008.

Lehman had lots of assets — CMBS, subprime mortgages, and the like — which were falling in value in a very illiquid market. Merely selling off those assets to decrease leverage would have resulted in significant losses for the beleaguered bank. Repo 105, explained here, provided an alternative.

But what exactly was Lehman Bros stuffing into the Repo 105 sausage?

Perhaps counter-intuitively it was not using the stuff on its balance sheet that was hardest to sell into markets.

Rather, it was the most liquid — things like A- to AAA-rated securities, Treasuries and Agency debt, which you can see in the below table, from the Examiner’s Report (Appendix 17):

Lehman’s own accounting policy required assets used for Repo 105 “be readily obtainable” — i.e. liquid — according to the report. Lehman’s lawyers also recommended they be liquid so that “the Buyer could easily dispose of the Purchased Securities and acquire equivalent securities if it wished.”

But that doesn’t mean Lehman didn’t try to shift other things into the thing as the crisis worsened.

From the footnotes:

Certain documents, however, suggest that Lehman perhaps attempted to use less liquid collateral in Repo 105 transactions. See e‐mail from Michael McGarvey, Lehman, to Gerard Reilly, Lehman, et al. (Aug. 17, 2007) [LBEX‐DOCID 3213312] (“There was call this morning with John Feraca on getting Mortgages out on 105. London is going to show some examples of fixed AAA non‐agency mortgages to Mizuho (who we have a good relationship with) to see if they would be open to taking them. Based on Mizuho’s reaction we are going to meet again Monday to determine [how] much we can do.”); e‐mail from Kentaro Umezaki, Lehman, to Christopher M. O’Meara, Lehman, et al. (Aug. 17, 2007) [LBEXDOCID 1533678]

Even whole deals — specifically the $2bn Windermere securitisation — were attempted:

. . . (discussing whether, if Lehman can transfer all Windermere securities using Repo 105, Lehman “can…eliminate the gross up in addition to netting down the bonds?”); e‐mail from Marie Stewart, Lehman, to Mark Cosaitis, Lehman, et al. (Aug. 17, 2007) [LBEX‐DOCID 3223801] (indicating that Stewart planned to have a meeting that day with Grieb to discuss possibility of placing Windermere bonds into Repo 105 program);

And it looks like Lehman was semi-successful in moving some of its less-valuable assets through Repo 105. The below table, also from the report, shows Repo 105 usage by rating.

You can see that by May 2008, the bank had managed to shift some $47m of CCC-rated assets through Repo 105. The vast majority of Repo 105 usage, however, was still for A-range assets.

Without the knowledge of Repo 105, anyone watching the bank would probably have thought Lehman was tring to reduce its leverage by getting rid of its most illiquid (and probably least valuable) assets.

Unfortunately, the exact opposite would have been true based on this report.

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