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All Repos Will Be Treated as Secured Loans

The FASB is now requiring that all repurchase agreements be accounted for as secured loans. The board is also instituting a disclosure requirement for transactions that are economically similar to repurchase agreements in which a seller of a contract, or transferor, remains exposed to the assets’ risks until the contract is closed out, usually by repurchasing the assets.

The FASB amended U.S. GAAP on June 12, 2014, to require that all repurchase agreements be accounted for as secured loans.

The accounting board said the changes will lead to more consistent financial reporting for various classes of repurchase agreements.

The changes were issued in Accounting Standards Update (ASU) No. 2014-11, Transfers and Servicing (Topic 860): Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures . The update also requires repurchase financing arrangements to have separate accounting for a sale of a financial asset that happens at the same time as an agreement to buy back, or repurchase, the asset from the firm that bought it. The result will be that the trade is treated as a secured borrowing.

The changes include a disclosure requirement for transactions that are economically similar to repurchase agreements in which a seller of a contract, or transferor, remains exposed to the assets’ risks until the contract is closed out, usually by repurchasing the assets. Companies that use repurchase agreements will also have to disclose more information about the nature of the collateral pledged in the trades.

“The new guidance addresses investor concerns about the distinction in GAAP between repurchase agreements that settle at the same time as the maturity of the transferred financial asset and those that settle any time before maturity,” stated FASB Chairman Russell Golden. “Eliminating that distinction will result in financial reporting that more appropriately reflects the transferor’s obligations and risks across similar transactions.”

The FASB said public companies will have to follow the amended standard for the first quarter or fiscal year that begins after December 15, 2014. The disclosure for secured borrowings won’t have to be included until the second-quarter financial statements are submitted. Privately held companies, not-for-profit groups, and other types of organizations will also begin applying the changes in their fiscal years that start after December 15, 2014. But they have the option of waiting a year before they begin applying the changes to quarterly or other interim reports.

Public companies won’t be permitted to adopt the changes before they become effective, the FASB said.

The amendments in ASU No. 2014-11 were sparked by the October 2011 failure of commodities broker MF Global Inc., which prompted calls to the SEC to amend the financial reporting requirements for securities and commodities firms that rely on repurchase agreements, also called repos, to fund their daily trading. The SEC responded by delegating the job to the FASB.

Headed by former New Jersey Gov. Jon Corzine, MF Global masked the extent of its indebtedness by interpreting FASB ASC 860-10, Transfers and Servicing, formerly SFAS No. 140, to treat the trades as sales. The accounting let the firm book immediate revenues on its repurchase-to-maturity agreements, but it failed to capture the firm’s obligation to buy back the securities at a later date. As the European financial crisis deepened and the value of MF Global’s holdings in Portuguese and Irish bonds dropped, the firm was required to post more collateral. Ultimately, the demands for collateral exceeded the firm’s ability to cover the loans.

A similar issue had arisen after it was learned that Lehman Brothers Holdings Inc. was using a questionable interpretation of FASB ASC 860-10 in the months leading up to its September 2008 bankruptcy. The FASB responded with the April 2011 publication of ASU No. 2011-03, Transfers and Servicing (Topic 860): Reconsideration of Effective Control for Repurchase Agreements, which limited banks’ ability to record repos as sales. MF Global, which relied heavily on a class of repos called repo-to-maturity, went bankrupt six months after the amendment was published but before it went into effect.

In a repo-to-maturity, the trade is closed out when the underlying collateral securing the loan matures. Typically, repos are short-term trades that are closed out a day after they’re booked.

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