Are your Internal Controls like Swiss Cheese? Part 8 - Gene Bucciarelli, MBA CPA

Are your Internal Controls like Swiss Cheese?
Part 8
by Gene Bucciarelli, MBA CPA

"Collateral for a loan is good, but lack of custody control over that collateral is bad, very bad"
Note Department Issues - Collateral
There are a number of internal controls issues in the Note Department. This article and future ones will discuss some of the most important control issues. The first topic is collateral. Loan collateral comes in many forms including deeds of trust, pink slips, UCC filings, stock, and cash. Custody control over these various forms of collateral is important at all times. If the loan goes into default and the collateral is missing, there will be heck to pay!

Internal control over collateral depends on the type of collateral. To start looking at those controls proceed as follows:

Review the list of collateral codes and ensure it is up to date.
Run a report writer loan balance report sorted by collateral code with collateral description. The type of loan, the collateral code, and the description should all agree. For example a vehicle would probably not be the correct collateral for a real estate secured loan. Collateral descriptions should be brief but understandable.

Control issues over the different types of collateral are as follows:

Deeds of Trust and Pink Slips.

a. Use a tickler system for follow up if not obtained when boarding the loan. This should be a rare exception for Deeds but does happen with pink slips due to DMV issues.
b. Ensure the maximum physical protection possible for both types of collateral. Many institutions will separate the deeds and pinks from the loan files and file them in a vault. At a minimum use a fire resistant cabinet.
c. Use and enforce check out cards when removing collateral from the filing area.
d. Conduct annual audits to ensure that none of the collateral is missing or misplaced. If the number of loans is very large than a periodic sampling is a reasonable compromise.
UCC filings
a. A tickler system for follow up if not filed when boarding the loan.
b. A tickler system for renewal.
Stock
a. Check certain types of stock taken for collateral for the possibility of a fraudulent certificate. Inquire with the Securities Information Center. Refer to REG U for the details.
b. Obtain monthly or quarterly updates of the price of the stock for loan to value limits. The minimum price should be calculated and set up as an email alert on one of the many Internet sites that give stock quotes, for example Yahoo. Have the alert email sent to more than one person in the event the key person is on vacation or on medical leave.
c. Ensure the maximum physical protection for the stock certificates. The vault or a fire resistant cabinet is appropriate. Store in dual custody.
d. Properly execute a collateral receipt for the customer and the Bank.
e. Conduct periodic audits of the physical certificates.
Cash
a. Ensure that CD's and savings accounts used as collateral have a hold status. Memo fields for the deposit accounts should be descriptive of the reason for the hold. For example; collateral for loan number 12345.
b. Review the CD's or savings accounts monthly to verify that the hold has not been inadvertently removed.
c. Properly execute a collateral receipt for the customer and the bank if the CD instrument is in the Bank's custody. Many community banks consider the CD instrument a non negotiable receipt and feel no need for that receipt to be in custody.

Finally it is important to release the collateral within a reasonable time after payoff. Within thirty days is a best practice. Send by registered mail or obtain a collateral receipt release signature from the customer. Remove the hold status on cash collateral and file proper UCC release forms on a timely basis.

There are many functions to perform in a Note Department, are there holes in your collateral controls?

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Gene Bucciarelli, MBA CPA is the principal of Internal Control Systems, a community bank auditing and consulting firm. He can be reached at genebucc@aol.com and 925.828.7360.

Access the previous articles in the Swiss Cheese series

First published on BankersOnline.com 7/14/03