Legal Definitions - repo

The term "repo" is a common abbreviation used in two distinct legal and financial contexts:

• Reposession
• Repurchase Agreement

Let's explore each meaning:

1. Repossession

Reposession refers to the act of a lender taking back property that was used as collateral for a loan, because the borrower failed to make payments as agreed. This legal right is typically outlined in the loan agreement and allows the lender to reclaim the asset when the borrower defaults on their financial obligations.

• Example 1: Vehicle Loan Default

  After losing her job, Maria was unable to make her monthly car payments for three consecutive months. The bank, which held the loan on her car, sent a tow truck to her residence to take the vehicle back. This action is known as a repo or repossession.

  Explanation: The bank, as the lender, exercised its right to repossess the car (the collateral) because Maria, the borrower, defaulted on the terms of her loan agreement by failing to make the required payments.

• Example 2: Appliance Purchase on Credit

  A consumer purchased a new refrigerator from an appliance store using an in-store credit plan. The credit agreement stipulated that the store retained a security interest in the appliance until it was fully paid off. When the consumer missed several payments, the store initiated a process to reclaim the refrigerator from the consumer's home.

  Explanation: The appliance store is performing a repo by taking back the refrigerator, which served as collateral for the credit extended, due to the consumer's failure to meet their payment obligations.

2. Repurchase Agreement

A repurchase agreement (often shortened to "repo") is a form of short-term borrowing for dealers in government securities. In a repo, a dealer sells government securities to investors, usually on an overnight basis, and buys them back the next day at a slightly higher price. For the party selling the securities, it's a way to borrow money using the securities as collateral. For the party buying the securities, it's a way to earn interest on a short-term, low-risk loan.

• Example 1: Bank Short-Term Liquidity

  A regional bank finds itself with a temporary shortfall of cash needed to meet its daily reserve requirements. To quickly raise funds, the bank sells a portion of its U.S. Treasury bonds to a larger financial institution, with a contractual agreement to buy those same bonds back the following morning at a slightly increased price. This transaction is a repo.

  Explanation: The regional bank is using a repurchase agreement to secure a very short-term loan, collateralized by its Treasury bonds, to manage its liquidity needs. The larger institution provides the cash in exchange for temporary ownership of the bonds and a small return.

• Example 2: Corporate Cash Management

  A large technology company has a significant amount of surplus cash that it doesn't need for immediate operations but wants to invest for a few days to earn a modest, low-risk return. The company enters into a repo agreement, purchasing government securities from a brokerage firm with the understanding that the firm will repurchase them in three days for a slightly higher amount.

  Explanation: In this scenario, the technology company is on the "buy" side of the repurchase agreement, effectively providing a short-term loan to the brokerage firm, secured by the government securities, and earning a small profit on its idle cash.