Reserve Funds: Found Money...

Or what’s been hiding in our Reserve Funds? 

By Bill Chaffee, RRP

After 33 years of being involved with asset management, investments and reserve management plans/reserves studies for common-interest-developments, we didn’t expect to find anything new in the analysis after all this time.  Not only new, but potentially substantial in regard to the impact it may have on the entire industry by changing the way people look to utilize the reserve management plans/reserve studies with accompanying cash flows and investment analyses.

It is apparent, sadly, that over the history of reserve management plans/reserve studies, reserve funds are pretty much taken for granted. They are what they are, just monies collected from the owners utilized for maintaining or replacing reserve items. The time associated with tracking and scheduling reserve items usually encompasses more than 80% of a reserve management plan/reserve study preparation time. Unfortunately, the time spent projecting reserve fund returns, properly planning and investing funds, or utilizing a proactive process for prudently placing investments is usually zero or reactive at best.  Just rolling over CDs or leaving money in low interest  bearing money market funds has been the norm but doesn’t cut it anymore,  especially in the current interest rate environment.

The maximization of return on investments is not seriously addressed in most reserve studies and history shows that usually an estimated, ball park, overall single interest rate is incorporated in reserve management plans/reserve studies. Based on the specific needs and the liquidity of available reserve funds, in concert with actual expenditures for repair, replacement or refurbishment; utilizing proper planning, investment research and placement, the potential for higher yields may be achieved.

In the past reserve funds merely got a “quick and dirty” projection of what the balance should be as of the analysis date, the initial start date of the reserve management plan/reserve study. This projection is usually done two to four months prior to the analysis date.  Not much thought, other than a casual “what-if” and OK we’re done for the year.

Here we present the “usual” approach and beyond that, what we have found should become the “standard” revised AICPA-GAAP analysis/projection procedures for determining the beginning reserve fund balance as of the analysis date:

  • Money Market account – current balance adding projected maintenance fees to be collected, and minus projected expenditures
  • Certificate of Deposits (CDs): add the current principal amount of all CDs (assumes that any CDs maturing before the analysis date, that the principal would be deposited into the money market account upon maturity if before the analysis date)
  • Add the two items above together to be used as the beginning reserve fund balance

What hasn’t been accounted for, for years now in these calculations? Is there any found or hidden money not taken into account?

Yes! Found money and more focus on the investment of reserve funds. What has been neglected in virtually every reserve management plan/reserve study that has ever been prepared is the accrued/earned interest that has not yet been paid/received on active CDs, or other investments as of the analysis date (this assumes that there are financial instruments where the interest compounds and is paid in the future opposed to financial instruments that are calculated as simple interest which would “sweep” to the money market account, hence these financial instrument types would not have accrued/earned interest not paid).

These unaccounted for monies are in fact receivables, due to the association within the scope of the reserve management plan/reserve study parameters and should be included in the beginning reserve fund balance. How much money could this be and should it be considered? That all depends if the amount is considered material to the overall balance or just a lot of money regardless if it is material or not. Remember, even a few dollars may make a difference in not raising fees or a special assessment.

Here are a couple of hypothetical examples:

1)    Current reserve fund $4,800,000 – Let’s assume $800,000 in money market funds and $4,000,000 in various CDs. We will assume the CDs (initially 6 month to 5 year terms) average weighted life term as of the analysis date is approximately 18 months. Based on an average weighted interest rate of 2.50%, the accrued/earned interest not yet paid, compounded monthly would be approximately $153,000. This amount is only 3.825% of the original beginning balance of $4,800,000, which may or may not be considered material. But it would be highly advantageous to reflect this amount when optimizing the current and future year’s budgets and the owner’s projected contributions.

2)    In example # 2 we assume an $850,000 reserve fund balance of which - $350,000 is invested in money market funds and $500,000 in CDs. We assume the CDs (initially 6 month to 5 year terms) average weighted life term as of the analysis date is 24 months.  Based on an average weighted interest rate of 2.75%, the accrued/earned interest not paid yet, but compounded monthly would be approximately $21,000. This amount is only 2.470% of the original beginning balance of $850,000. Once again for illustrative purposes and arguments sake, this may or may not be considered a lot of money, but you wouldn’t want to be held responsible or worse, liable if it were not accounted for or lost.

So the conclusion after all these years is relatively simple: the accrued/earned interest was never really lost. It just hasn’t been considered and or reflected in most reserve management plans/reserve studies and budget calculations in the past. But that was until now. Wow, found money!

Calculating the accrued/earned interest and including it into the beginning reserve fund balance as of the analysis date will not only supply more accuracy and reality, it may potentially lower the contribution by owners and more; provide a more responsible reserve management plan/reserve study and useful tool for the association, board of directors and management going forward.

Comments (4)

  1. Ted Salgado, P.E., PRA, RS:
    Jan 31, 2012 at 03:32 PM

    A couple of thoughts: any analysis should consider the actual committed rates of return of the association, exclude interest earned if the association excludes it, disclose the affect if any that taxes may have on the interest earned, and in general, reflect the association's policy regarding investments, how it does or does not reinvest interest earnings.

  2. bchaffee12:
    Feb 01, 2012 at 12:53 PM

    If I understand Ted's comment correctly, obtain the information that is available. Present it the best way possible and then disclose, disclose and disclose. Education and disclosure should be synonymous in this profession.

  3. Rich Thompson PRA:
    Feb 02, 2012 at 02:08 AM

    Your assumption that reserve studies do not address reserve investment strategies is false. I have made it one of my coverletter recommendations for 14 years. One of the advantages of the reserve study is that it allows informed investment decision making. There are a variety of ways to maximize returns. Granted, many boards fail to do so, presumably, because it's not their personal money at risk.

  4. bchaffee12:
    Feb 02, 2012 at 12:30 PM

    The article stated that, "The maximization of return on investments is not seriously addressed in most reserve studies..." I agree with the rest of Richard's comments. I have reviewed numerous reserve study reports over the years and have not seen much disclosure on this subject. It would probably be helpful to other reserve study preparers / PRA's, if Richard could expand on how he approaches this area?

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