WARMing up for CECL

By Baker Newman Noyes May 3, 2019

As the Current Expected Credit Loss (CECL) standard draws closer to implementation, more specific questions are being addressed by the regulatory agencies. On April 11th, financial institution regulators hosted a webinar based on one acceptable CECL model known as the Weighted Average Remaining Maturity (WARM) method.

The WARM method uses average annual charge-off rates and remaining asset lives to estimate the allowance for credit losses (ACL). Institutions must first calculate an annual charge-off rate for each pool of assets with similar risk. This calculation is comparable to the historical loss calculations many institutions currently utilize. The historical loss period used is subject to management determination and should represent the institution’s most appropriate business cycle for each pool of assets. The WARM method then calculates the weighted average remaining life of the assets which is multiplied by the historical loss rate to arrive at an “unadjusted historical charge-off rate.” The unadjusted historical charge-off rate for the remaining balance is adjusted with qualitative factors and applied to the period ending balance to arrive at the required ACL. This method is the closest to the traditional ALLL model with the primary difference being that this model incorporates the expected average life of each pool of loans, taking into account projected prepayments. The regulators advised institutions to look to their asset/liability management programs and external data for calculating estimated pay down rates.

The webinar highlighted the benefits of this model for smaller and less complex loan portfolios. This method is ideal for institutions with evenly distributed loss rates and portfolio run-offs that are generally consistent over the life of a pool. The regulators advised institutions that the more complex their portfolio, the more reliance they would need to place on qualitative factors and forecasts in order to support this approach. They stressed the importance of ensuring all forecasts and qualitative adjustments are reasonable and supportable.

The regulators noted that while the WARM model is a practical method for institutions to implement, it is not necessarily the preferred methodology. They further noted that there is no single preferred approach and that various methodologies may be used for different segments of an institution’s portfolio. The webinar reiterated the fact that all models will need extensive qualitative support. The expectation will be the less precise the quantitative data, the more comprehensive the qualitative analysis should be.

A recording of the webinar can be accessed by registering here.

If you would like to discuss these matters further, please contact your BNN advisor at 800.244.7444.