The issue of how to deal with repos to maturity is still bouncing around. A January 16, 2014 article in Compliance Week by Tammy Whitehouse “FASB Readies Final Standard on Repurchase Agreements” said that the FASB will be coming out with final rules soon.
The genesis of this particular storm was Lehman and MF Global moving repo assets off their balance sheet. The distinction was made between repos that ended short of the maturity date of the underlying asset and those that went until the scheduled end date (a/k/a repos to maturity). The latter were interpreted as eligible to be taken off the balance sheet since “effective control” is relinquished. All totally kosher with the FASB.
We wrote back in a January, 2013 post “FASB plans to update the repo to maturity rules, but will they go too far and impact liquidation risk?”
“…We have never understood the repo to maturity rules. Accounting for the trade as a sale didn’t make any sense. A sale means that whatever happens after the sale of the underlying securities, it’s not your problem. But in repo-land, it could be counted as a sale even though you are still responsible for margin calls. If the underlying bonds default, the loss hits the sellers’ books – even though they have “sold” them. And any coupon still comes back to the seller, interest on the cash to the buyer…”
The CW article said that the FASB proposed rules last January (and sought comments), then changed their minds, but ultimately went back to their original idea. From the article,
“…After changing its mind about its January 2013 proposal, FASB ultimately determined it would stick with the approach it initially proposed. That would require a company to consider whether it retains effective control over an asset and account for any transfer as a secured borrowing rather than a sale if the company is obligated to buy it back. FASB says it has concluded its discussion of the proposal and plans to issue a final standard in the first half of 2014…”
“…The proposed guidance would eliminate the distinction between agreements that settle before the maturity of the transferred asset and those that settle at the same time as the transferred asset matures. As a result, both types of transfers with forward agreements to repurchase the transferred assets or “substantially-the-same” assets at a fixed price would maintain the transferor’s effective control during the term of the agreement and would be accounted for as secured borrowings…”
All very confusing but it looks like repos to maturity will have to stay on the balance sheet, accounted like a secured loan (which is no different than repos that do not go to maturity). We would bet there might be some knock on effects, particularly in the TBA mortgage markets, that aren’t particularly pleasant. But, by and large, repos to maturity were an economic fiction and begging for abuse. Getting rid of the “effective control” loophole when, in substance, the seller of the repo to maturity still has economic exposure seems appropriate.
One really interesting part of the FASB rules is around disclosure. In “Transfers and Servicing: Repurchase Agreements and Similar Transactions” (updated December 20, 2013) the FASB decided to require the following be included in financial statements:
- The carrying amounts of assets derecognized as of the date of the initial transfer in transactions for which an agreement with the transferee remains outstanding at the reporting date, by type of transaction (for example, repurchase agreement, securities lending, sale and total return swap, and so forth). If the amounts have changed significantly from prior periods or are not representative of the activity throughout the period, a discussion of the reasons for the change should be disclosed.
- Information about the transferor’s ongoing exposure to the transferred financial assets by type of transaction
- A description of the arrangements that result in the transferor retaining exposure to the transferred financial assets by type of transaction
- The risks related to the transferred financial assets to which the transferor continues to be exposed after the transfer
- As of the reporting date, the following amounts to provide users of financial statements with information about the reporting entity’s maximum exposure to financial assets that are not recognized in its statement of financial position:
- The fair value of assets derecognized by the transferor for transactions described in paragraph (1) by type of transaction
- Amounts recorded in the statement of financial position arising from the transaction by type of transaction in paragraph (1), for example, the carrying value or fair value of forward repurchase agreements or swap contracts. To the extent these amounts are captured in the derivative disclosure requirements under paragraph 815-10-50-4B, an entity should provide a cross-reference to the appropriate line item in the disclosure.
These additional disclosures will allow analysts to figure out what the hell they are looking at. You know what they say about sunlight being the best disinfectant.