Lehman balance sheet massaging may not be unusual

* Others boost assets early in quarter, pare them later

* Lehman may have been most aggressive

By Dan Wilchins and Matthew Goldstein

NEW YORK, March 12 (BestGrowthStock) – On Wall Street, massaging
the balance sheet is a time-honored practice.

But did Lehman Brothers Holding Inc (LEHMQ.PK: ) cross a line
in the routine manipulation of its balance sheet, as described
by an independent examiner?

That is the central question to emerge from the
examiner’s report, released late on Thursday by the bankruptcy
court in Manhattan, which details examples of Lehman concealing
assets and liabilities through accounting techniques.

Thomas Baxter, general counsel of the Federal Reserve Bank
of New York, one of the main banking regulators, told the
examiner, Anton Valukas, that he was generally aware of firms
using “balance-sheet window dressing,” but had no specific
information on Lehman.

Banks have wrestled with this issue for years. The old
Bankers Trust, for instance, struggled to fend off bank clients
that wanted to use BT to help conceal assets, said Ray Soifer,
a consultant who previously worked at BT and sat on a task
force designed to reduce that business.

“Reducing leverage is something that banks do. It’s
cosmetic,” Soifer said.

In 2003, an internal review into accounting irregularities
at Freddie Mac (FRE.N: ) found the government-sponored mortgage
finance firm had periodically rented out its balance sheet to a
Credit Suisse Group AG (CSGN.VX: ) mortgage trader.

The review found that Freddie Mac entered into a series of
deals with Credit Suisse that allowed the investment bank’s
trading desk to “park” some $8 billion in mortgage-backed
securities on the mortgage firm’s balance sheet.

Over the years, one common trick has been to borrow money
at the beginning of the quarter and invest it in short-term
bonds that mature before the end of the quarter. When the bonds
mature, the bank pays back its debt and it has fewer assets and

The upshot is that the bank generates more profit off what
appears to be fewer assets, giving it a better return on
assets, a commonly watched measure of profitability.

One former chief executive at a bank noted this method can
goose earnings higher, but is terrible for the company long
term because it does not build the overall franchise.

For commercial banks, regulators caught onto this trick
years ago, which is why banks typically report average assets
during the quarter in addition to assets at the end of the
quarter, both to the public and to regulators.

But major investment banks did not have that obligation
and, even now, often do not report their average assets to

“Nobody knows if other banks are doing this kind of thing,”
said Brad Hintz, an analyst at Sanford Bernstein who was
Lehman’s Chief Financial Officer in the 1990s. But he said the
question is sure to come up in conference calls for Morgan
Stanley (MS.N: ) and Goldman Sachs Group Inc (GS.N: ).


The mechanism that Lehman used for concealing assets and
liabilities was much more complicated than borrowing at the
beginning of the quarter and paying down debt at the end.

It involved a series of short-term transactions similar to
repurchase or repo deals, which entail selling assets and
agreeing to buy them back in the future, according to the

Lehman’s deals were known as Repo 105 transactions. But
instead of treating them as financings, Lehman classified these
repo deals as “sales,” which permitted the investment bank to
keep the transactions off balance sheet.

Here is how it worked: Lehman essentially transferred
assets to its London unit, which was the only jurisdiction
where the bank could get lawyers at Linklaters to sign off on
the deals. At the end of a quarter, Lehman would sell high
quality assets to a counterparty — the examiner’s report
mentions multiple European and Japanese banks — for cash. The
investment bank typically got cash equal to about 5 percent
less than the face value of the asset. Lehman used the cash to
pay down debt.

At the start of the next quarter, Lehman would buy back the
assets and borrow funds again.
Graphic detailing Lehman’s Repo 105 transactions:

The net impact was the bank had lower assets and
liabilities, making it appear to have less debt relative to its
equity than it really did.

These transactions may have started out small in 2001, but
by 2008 Lehman was using them to move big chunks of assets.

The bank did about $50 billion of these transactions in the
second quarter of 2008, which reduced its reported assets by
about 7 percent, based on the company’s financial statements
for that quarter. That reduced its leverage ratios by nearly 2

The massaging allowed Lehman’s leverage numbers to look
much better than competitors. According to data compiled by
Bernstein’s Hintz, Lehman’s net leverage ratio was 14.7 in the
second quarter of 2008, compared with 20.8 for Goldman Sachs.
Net leverage excludes repo assets and looks at assets compared
with equity.


Lynn Turner, a former chief accountant for the Securities
and Exchange Commission and now senior advisor to the
consulting firm LECG, said the decision by Lehman executives to
make greater use of Repo 105 is consistent with what companies
do when they get themselves into trouble.

“Companies never just fudge it a little bit,” said Turner.
“They start out just doing it a little bit and over time it
grows and grows.”

While Turner said he was not aware of the Repo 105
transactions during this time at the SEC, he said it is fair
“to wonder if anyone else is doing it.”

Turner added: “No one is going to stand up and say so.”


(Reporting by Dan Wilchins and Matthew Goldstein; editing by
Andre Grenon)

Lehman balance sheet massaging may not be unusual