April 2010 is almost gone and I haven't posted! Been busy filing taxes for various companies and partnerships. However, the Lehman Brother's non-transparent use of Repo 105 has been in the news lately. I was wondering if any MFI in our industry has used this same technique to enhance its current published financial numbers. Repo 105 allows a company to temporarily transfer a big chunk of its bad assets - delinquent and potential write-off loans - off the books. During the temporary period, about one year, the company can publish its financial statistics showing a good P&L and Balance Sheet. Potential investors and creditors only see the good if not aware of the use of Repo 105.
This is what I imagine would happen if an MFI uses Repo 105 or 108.:
- An MFI would sell its delinquent and ready-for-write-off loans to a shell company in another country.
- The shell company is funded by investors who are most likely also investors in the MFI through loans and/or equity, possibly a holding company.
- The sale money is used to lower liabilities - pay down loans from banks, investors, and so forth. This makes the MFI look good on the balance sheet and hides the level of delinquency and write-off potentials.
- The modified balance sheet is published at the end of the fiscal year. The P&L also takes a smaller hit for provisions for possible loan losses - this non-cash expense is charged as part of the expenses and lowers the net income. All the financial numbers will look good for one year as reported to the rating agencies.
- The MFI then gets immediately to work. It borrows new money (hopefully it has enough credibility to land new loan money) to buy back the original loans sold to the shell company. The cost of such a transaction which is paid in Step 1 - Repo 105 is 5% of the total portfolio of loans sold while Repo 108 is 8%.
- The MFI essentially buys a year to fix the delinquency problem without the public knowing what's going on.
- I assume that if the one year is not enough time to rectify the problem, Repo 105 can be used again and again.
I'm sure there are other variations to the process I imagined above. However, if you are a potential investor in an MFI, it would not be unreasonable to ask if said institution has any Repo 105s or 108s hidden in its financial portofolio.