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.
