Tag: custodial reconciliation

[List] 5 more best practices for custodial reconciliation

Thanks to all the response I got from my previous article, Best Practice: 5 Considerations for Custodial Reconciliation, I was inspired to share 5 MORE Considerations for a sound Custodial Reconciliation process.  Please share your thoughts and let me know what you think of this list.

6. Clearly classify current reconciling items into research buckets.    

Aside the standard TOEC formulas, an additional set of calculation that may be included within the Bank Reconciliation process is an automatic classification of reconciling items by research bucket. This classification applies to current outages and is intended to help analysts in their research activities when identifying reconciling items. The following list represents a highly generalized classification of reconciling items classified by research category using data that should already be present to fuel the process. Far more refined research categories (and perhaps even automatic reconciling item identification!) may be accomplished depending on the overall quality, consistency and detail available within the source data inputs. The research categories provided below also represent a hierarchy meaning that items are classified as they meet the criteria of each bucket per the order below:

  • Paid in Full – Check for ending actual remittance balance to be zero along with a payoff date provided in the source data.
  • Liquidation – Applies to S/S remittance deals only. This classification is given when the actual remittance balance is zero and both the beginning and ending scheduled remittance value is not zero.
  • Reinstatement – Check for the beginning scheduled remittance balance to be zero and the ending scheduled remittance balance to not be zero. Also check for the beginning actual balance to be zero and the ending actual balance to not be zero as either of these conditions can be true for a reinstatement.
  • Modification – Simple; check if there is a modification date provided in the data.
  • Stop Advance – Similar to Modification; check for a stop advance date provided in the data.
  • Miscellaneous – This category catches any outages not linked to a research category above.

7. Apply a standard description to reconciling items.    

This one is key. Any outages or reconciling items resulting from the Bank Reconciliation process should be identified and categorized using a standard description that is meaningful to the business (i.e. reason codes). We suggest defining a comprehensive list of coded values representing all the different types of reconciling items in a typical reconciliation cycle. For example, consider grouping all reconciling items related to liquidations under a standard notation – LIQ1 to represent liquidation net loss, LIQ2 to record a service fee outage, and so forth. Another important detail to add to this master list of standard descriptions is the expected resolution type – in other words, if the item is expected to be resolved via wire, remittance adjustment or perhaps a system-level adjustment as would be the case for non-cash outages. Keeping in discipline with this consideration helps in fulfilling #8 below.  

8. Meticulously clear ageing reconciling items; start with the oldest first.    

It is both tempting and (theoretically) time effective to simply bump the list of reconciling items against wires /remittance adjustments by amount and delete these off the spreadsheet as resolved items. Unfortunately, any virtue found in this approach quickly goes away when a discrepancy is identified a couple months later (i.e. clearing a wrong item) and an analyst is tasked with trying to unravel the components in an effort to correct the issue. We recommend implementing a mechanism for tracking the resolution of reconciling items which also ensures that the correct wire /remittance adjustment is paired with the intended outage. Adopting a practice of applying standard descriptions along with an expected resolution type as suggested in #7 addresses the first part of this recommendation. A solution to the second part of the recommendation related to pairing wires /remittance adjustments to outages is offered under #9 below.    

9. Optimize Wire /Remit Adjustments for future clearing.   

This suggestion may require some coordination to accomplish and some discipline to maintain, but the added value of this effort will be well worth the work. The simplest and most effective way to properly pair wire /remittance adjustments to corresponding reconciling items is to link these together using a common reference number. Implement this consideration by assigning a unique reference number to outages identified during the current period. If a standard description and corresponding resolution type is assigned to each reconciling item as suggested in #7, a listing of required wires and remittance adjustments should be readily available at the conclusion of each Cutoff. Passing along this unique reference number to the wire /remittance adjustments request as the transaction identifier creates an immediate link between both items that can be leveraged for clearing. The real trick in having this work is convincing the downstream processors (i.e. Investor Reporting and Treasury or team responsible for wires) to include this value as part of their process from request through transaction settlement. As an extra credit bonus, include a unique identifier for these transactions at the account-level as well (i.e. remember, items in TOEC are at loan /pool-level but these settlements typically disburse as a rolled-up transaction by bank account). This additional step will save a lot of time pairing bank statement items to corresponding book wires, thus enabling book-to-bank reconciliation for Cashbook.

10. Track and measure the process.    

All the considerations leading up to this one focus on ensuring a sound Bank Reconciliation end result, which is fantastic. However; visibility and metrics gathering over the process as it is happening in real-time distinguishes a proactive team vs. a proactive team. What’s the difference? A reactive team sees smoke and eventually reaches the fire with whatever tools happen to be on-hand to try to extinguish the flames, and a proactive team sees the spark that started the fire – this level of visibility is afforded by adopting well-defined work assignments and developing a dashboard to track the resulting metrics. We recommend doing what most companies already do: create a spreadsheet to assign analyst resources to specific Bank Reconciliation reports, but we push it one step further by suggesting the inclusion of triggers to track the progress within a Cutoff as it is happening. Create a spreadsheet or tool that listens for status changes in Bank Recon reports (i.e. Pending to Approved) as well as a means to collect metrics (i.e. number of reconciling items by ageing or number of items resolved vs. outstanding) in an effort to get a meaningful pulse of the process as a whole. The development of the dashboard is certainly an evolutionary process; the trick is to subscribe to this mentality or management overview philosophy if the terminology is more fitting. Either way, evaluating the health of a process needs to occur as the process is happening and not after the process is completed – test this statement by applying it to a living body. Find creative metrics (and corresponding triggers) to track the process as it is unfolding to prevent a spark from becoming a forest fire.

 What considerations can you share about how you manage your Bank Reconciliation business process?

[List] 5 best practices in custodial reconciliation

An accurate and effective Custodial Reconciliation process is the cornerstone of a healthy Investor Accounting function.  Completing a monthly Bank Reconciliation for each Custodial account (i.e. P&I and T&I) accomplishes two important goals: (1) it confirms the Custodial bank account is in balance at the aggregate level; and (2) it ensures the individual loans /pools within the Custodial account are also in balance by performing Test of Expected Cash (TOEC) calculations.  Every company servicing loans in-house adopts some sort of Bank Reconciliation process – after all, it is a compliance requirement under Regulation AB.  Here are 5 considerations for building an optimum Bank Reconciliation business process based on our experiences working with companies like yours:

1. Clearly define Cutoff start and end dates.    

I know it sounds intuitive, but we’ve seen this mistake consistently – make sure that there is no overlap between Cutoff start and end dates as you define processing calendars. More importantly, verify that all activity considered by the process is restricted to this range; that is, all wires, remittances, remit adjustments, servicing data and investor reporting inputs must fall within the criteria. Not following this simple guideline will lead to a lot of transactional “noise” and incorrect TOEC calculations.

2. Roll from a previous period.    

Again, it may sound intuitive but it is surprising the number of companies we’ve seen that essentially “start anew” with their Bank Reconciliation process. Lesson learned – live with your results (and calculations). The true power of a Bank Reconciliation summary is in rolling it forward; in other words, tie together Beginning Balance from the current period to Ending Balance of the previous period. The value of this practice is accentuated for PLS. For these reconciliation reports, the following balances should roll forward from a previous period: (a) cashbook balance; (b) beginning scheduled balance for the expected remittances; (c) beginning actual balance per the actual UPB; and (d) actual remittance rolled forward from last period’s expected balance.

3. Ensure the bank account is in balance before digging into loan /pool level balances.       

Often overlooked and oversimplified, the Cashbook process serves a fundamental purpose in achieving an accurate and effective Bank Reconciliation process. It is important to actively balance the custodial bank account as a precursor to performing reconciliations at the loan /pool level rather than assuming than any discrepancies will simply float to the surface.  

4. Perform simple data integrity checks.    

Because we are working with two related but DISTINCT data sets when performing Bank Reconciliations (i.e. bank statement and cashbook vs. servicing and investor reporting inputs), there are some simple data integrity checks that can help verify that source data is complete and accurate before relying on these values for balancing. It is a good idea to perform the following sanity checks: 

  • Test that wire and remit adjustment amounts collected at the loan /pool level roll up to the amount reported at the bank account level. In theory, these values are extracted from the same transaction set, however; invalid translations /mappings between bank accounts and associated loans /pools can lead to different results. The potential for this discrepancy is magnified as the volume of bank accounts and loans /pool increases.    
  • Perform a Custodial Reconciliation Difference calculation to verify that all necessary inputs are collected in the Test of Expected Cash calculation. The sum of (a) P&I advance; (b) remittance adjustments; and (c) current period outages /reconciling items should equal zero, thus certifying that Servicing and Investor Reporting inputs are captured completely and accurately.

5. Have a clean TOEC formula.    

A whole new article could be written about best practices regarding TOEC formulas given the intricacies between PLS vs. GSE and considerations within Sch/Sch, Sch/Act and Act/Act remittances. For argument’s sake, let’s assume a consensus that a TOEC formula, at its most high level, should include (a) prepaids;  (b) delinquencies; and (c) remittance information (i.e. scheduled interest and principal, additional principal collections, etc). For extra credit, you could include curtailments and other items but these would point to a specific type of deal. More to the point, a TOEC formula SHOULD NOT include remittance adjustments as part of the calculation.  Including items such as HAMP incentives, claims and refunds, interest adjustments and other similar items unnecessarily abstracts the meaning of the calculated figure and misrepresents any true discrepancy in cash. In addition, including any of these items in the calculation prevents a clean roll-forward (see #2 above) particularly when one of these “expected” items does not materialize for whatever reason.