By Ronald Fink
Lehman Brothers' external auditor insists the transactions the bank used to temporarily shift assets off of its balance sheet to make it look less leveraged than it really was were not as significant as press coverage suggests.
In the year before the bank failed in September 2008, Lehman moved as much as $50 billion in assets off of its books a few days before the end of each quarter through repurchase agreements that it treated as sales, and brought them back on a few days afterward, the bankruptcy examiner's report found.
But in a letter to Lehman's audit committee that Ernst & Young is circulating within the accounting industry (source: re:The Auditors), the audit firm claimed that the asset sales, known as Repo 105 transactions, had little effect on the bank's reported leverage, and thus played only a minor role in its collapse.
According to the letter, E&Y says Lehman's reported leverage would have been a mere 5 percent higher if all of the $38 billion in assets it shed before the end of the quarter that ended in November 2007 had stayed on its books. It's unclear why the E&Y letter didn't address the transactions undertaken in 2008, when since the firm examined those as well at request of Lehman's internal auditors.
E&Y said Lehman's assets would have been 34.2 times equity instead of 32.7 in that case.
Lehman moved another $12 billion off of its books in subsequent quarters on top of the $38 billion, but that wouldn't have made much more of a difference, since the firm had total assets of nearly $700 billion.
"Lehman's bankruptcy was caused by a collapse in its liquidity, which was in turn caused by declining asset values and loss of market confidence in Lehman," E&Y's letter stated. "It was not caused by accounting issues or disclosure issues."
In his report concerning Lehman's collapse, the bankruptcy examiner, Anton Valukas, found that the bank's results were "materially misleading," largely because the Repo 105 transactions weren't disclosed. "Lehman's directors, the rating agencies, and Government regulators - all of whom were unaware of Lehman's use of Repo 105 transactions - have advised the Examiner that Lehman's Repo 105 usage was material or significant information that they would have wanted to know," the report said.
Ernst & Young conceded that no specific disclosures concerning the transactions were reflected in Lehman's financial statement footnotes, but insisted that the 2007 financial statements conformed to GAAP. The firm noted that, "they clearly portrayed Lehman as a leveraged entity operating in a risky and volatile industry." E&Y also noted that Lehman's 2007 financial statements included footnote disclosure of off-balance-sheet commitments of almost $1 trillion.
The bank failed before its 2008 results could be audited.
The letter circulated by Ernst & Young did not address Valukas' finding that no US law firm would sign off on the Repo 105 transactions.