Collections received on behalf of financiers: on or off the servicer's balance sheet

A servicer may handle very large borrower collections that belong to the financiers it serves. Whether those amounts appear on its balance sheet, as restricted cash with a matching liability, or stay off balance sheet in accounts held in the financier's name or under an effective trust, depends on the legal structure of the collection accounts and on who bears the risks, not on the mandate's description. Getting this wrong can multiply total assets and liabilities, distort liquidity ratios and, worst of all, lead to collections being reported as revenue.

In whose name are the collection accounts held: the financier's, the servicer's, or the servicer's as trustee or agent under a documented arrangement? Would the funds form part of the servicer's estate if it became insolvent, according to legal advice? Who bears the risk of the account bank failing? Can the servicer use the cash, even temporarily, or earn and keep interest on it? Are collections commingled with the servicer's own operating cash, even briefly? Does the mandate require remittance within a fixed period, and does the servicer have any obligation to the financier other than to pass the cash through?

1. Obtain the mandate, account opening documents and, where significant, a legal opinion on the status of each collection account.
2. Where borrowers pay directly into an account in the financier's name and the servicer only has operating authority to reconcile and instruct transfers, do not recognise the cash or a liability; keep memorandum records and disclose the arrangement.
3. Where collections are received into an account in the servicer's own name, without an effective trust, or are commingled with its own funds, recognise the cash and a matching liability to the financier, because the servicer has become party to the cash and owes it onward.
4. Where an account in the servicer's name is subject to a documented trust or agency arrangement, treat the funds as off balance sheet only if all of the following hold: legal advice confirms the funds are outside the servicer's estate on insolvency; the servicer cannot use the funds or keep the interest on them; collections never pass through or mix with its own accounts; and its obligation to the financier is limited to passing on what the account receives, so that it does not bear the account bank risk. If any condition fails or the evidence is unclear, recognise the cash and the liability; this is the conservative default.
5. Never recognise collections as revenue; only the servicer's fee, deducted or invoiced, is revenue.
6. Derecognise the liability only when it is extinguished, normally on remittance to the financier or settlement by agreed deduction of fees.
7. Present recognised collection cash as a separate line item, never within the servicer's own cash, and disclose the restrictions (see the cash flow presentation issue for whether it forms part of cash and cash equivalents).

On balance sheet, measure collection cash at the bank balance and the liability to financiers at the amount owed, which normally equals the cash plus any amounts in transit less any fees the servicer is entitled to deduct. Recognised bank balances are within the expected credit loss requirements; the allowance is usually immaterial for short-term balances with sound banks, but large concentrations with one bank should be considered. Interest earned on collection balances belongs to whichever party the mandate assigns it to; if it belongs to the financier, it increases the liability rather than the servicer's income. Off balance sheet, nothing is measured, but the amounts held and the controls over them are disclosed.

Disclose: (1) the nature of collection arrangements and the basis for on or off balance sheet treatment; (2) restricted cash held for financiers and the matching liability; (3) amounts held off balance sheet in accounts in the financier's name or in trust, where informative; (4) concentration of collection balances with account banks; (5) restrictions on the use of collection cash and remittance terms; (6) any client-money requirements imposed by the regulator or the mandate.

• Recording collections as revenue and remittances as expenses
• netting the collection cash against the liability to the financier, although the cash is a claim on the bank and the liability is owed to the financier, so the offsetting conditions are rarely met
• presenting collection cash within the servicer'
• s own cash line or including it in cash and cash equivalents without disclosure
• treating funds in the servicer'
• s own name as off balance sheet merely because the mandate calls them financier funds
• keeping interest on collection balances as income when the mandate assigns it to the financier
• using collection cash to fund the servicer'
• s operations temporarily.