The Wall Street Journal | July 10, 2010
By Michael Rapoport

Bank of America Corp. admitted to making six transactions that incorrectly hid from view billions of dollars of debt, following a bid to cut the size of a unit's balance sheet and meet internal financial targets.

The disclosure, made in a letter to the Securities and Exchange Commission, comes as the agency prepares to unveil the results of an inquiry into banks' accounting for borrowing deals known as repurchase agreements, or "repos."

BofA's letter was sent in April in response to the inquiry, but this is the first time the details of the six trades in question have been disclosed. The bank had acknowledged in its last quarterly report that its accounting for the transactions, made at the ends of quarters from 2007 to 2009, was incorrect.

The bank's disclosure also suggests the trades may be an example of end-of-quarter "window dressing" on Wall Street, in which banks temporarily shed debt just before reporting their finances to the public. The practice, which The Wall Street Journal has uncovered in a series of articles, suggests the banks are carrying more risk most of the time than their investors or customers can easily see, and then juggling it during quarter-end reporting of financials.

Window dressing isn't illegal in itself. But intentionally masking debt to deceive investors violates regulatory guidelines. BofA said its incorrect accounting wasn't intentional.

Apart from requiring more disclosure about the bank's repo accounting, the SEC hasn't taken any action against BofA over the matter. The fact that the letter was released suggests the SEC has concluded its review.

Though much smaller in scope, Bank of America's accounting of the six trades is similar to what a bankruptcy-court examiner said Lehman Brothers Holdings Inc. did to make its balance sheet look better before it filed for bankruptcy in 2008. Lehman used a strategy dubbed "Repo 105" that helped the Wall Street firm move $50 billion in assets off its balance sheet, the examiner said in March.

Following the Lehman examiner's report and the Journal disclosures, the SEC said it is considering stricter disclosure and a clearer rationale from firms about quarter-end borrowing activities.

The SEC review on repo activity could be released as early as this coming week. A spokesman said Friday that the SEC will release the banks' responses after the agency completes its review.

In its letter to the SEC, which has been posted as a regulatory filing, BofA disclosed details of how it erroneously classified some short-term repos as sales when they should have been classified as borrowings over the past few years. Repos are short-term financing arrangements that allow banks to take bigger risks on securities trades. Classifying the transactions as sales instead of borrowings—as in the Repo 105 strategy—allows a bank to take assets off its balance sheet and thus reduce its reported leverage.

In the letter, the bank said its incorrect accounting for the six trades wasn't intentional. "We do not deliberately structure transactions that are economically disadvantageous simply for the purpose of recording a sale or reducing recorded liabilities."

The bank also said, "We believe that our efforts to manage the size of our balance sheet are appropriate and our policies are consistent with all applicable accounting and legal requirements." The intent of the transactions, it said, "was to reduce the specific business unit's balance sheet to meet [the bank's] internal quarter-end limits for balance sheet capacity."

The classifications involved as much as $10.7 billion in repos, a relatively small amount for the bank, which has $2.3 trillion in total assets.

The six transactions are known as "dollar roll" trades, executed by Bank of America's investment-banking and capital-markets unit with an unidentified trading partner at the ends of fiscal quarters from 2007 to 2009. Dollar rolls are deals in which mortgage-backed securities are transferred to a trading partner with a simultaneous agreement to repurchase similar securities from the same partner soon thereafter.

The practice amounts to a bank renting out its balance sheet for short periods; the bank gets fees, and the client on the other end of the trade gets short-term cash.

BofA says it designed the trades so that the securities coming back to BofA would be similar to but not "substantially the same" as those it transferred out. That would require the trades to be treated as sales that would remove assets from the unit's balance sheet. But the securities that came back to Bank of America were in fact "substantially the same"—the same type, for instance, with the same guarantor and coupon. That means they should have been accounted for not as sales, but as borrowings that wouldn't have reduced the unit's balance sheet.

BofA said the accounting error was immaterial to its financial results and had no effect on its earnings.

BofA says it hasn't entered into such trades since early 2009. The errors in accounting for the trades resulted from a deficiency in internal controls, according to a separate letter the bank sent the SEC.

The bank says it since has strengthened its controls and re-emphasized to its staff the need to "escalate" consideration of any unusual balance-sheet changes, in particular if they result from "non-normal" transactions near the end of a quarter.

The SEC sent letters in March to 19 large financial institutions asking about their repo accounting. SEC Chief Accountant James Kroeker said in May that the inquiry hadn't found any widespread inappropriate practices.

But Mr. Kroeker said the SEC had asked several companies to provide more disclosure about their repo accounting in their securities filings. At least three banks, including BofA, already have done so.