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Portfolio Risk & CECL Allowance Calculation CECL Accounting CECL Methodologies

Demystifying DCF vs. remaining life for CECL models

Neekis Hammond, CPA
Mary Ellen Biery
September 15, 2025
Read Time: 0 min

Discounted cash flow or WARM for the allowance? 

Two commonly deployed approaches for the allowance for credit losses under CECL are the discounted cash flow model and the remaining life methodology, also called WARM. How do you know when to select which?

This article covers these key topics: 

CECL's flexibility is both a strength and a responsibility

Since its adoption in ASU 2016-13, the current expected credit loss (CECL) model has introduced a forward-looking approach to estimating credit losses. The guidance intentionally avoids prescriptive formulas, empowering financial institutions to choose from a variety of acceptable methodologies for calculating the allowance for credit losses:

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However, with this flexibility comes the responsibility for financial institutions to align their chosen methodology with portfolio characteristics, data capabilities, and risk management practices.

Two of the most commonly deployed approaches to CECL are the discounted cash flow model and the remaining life methodology. This guide unpacks the strengths and challenges of both. It offers a practical decision framework to help community financial institutions make defensible, scalable choices as they select, or transition to, an approach that aligns with their unique situation and supports defensibility and operational efficiency.

 

What is the discounted cash flow method?

The DCF method estimates credit losses by projecting future contractual cash flows, applying assumptions for prepayments, defaults, and recoveries, and discounting those expected loan-level cash flows back to present value using the effective interest rate (EIR) as defined by the FASB.

 As ASC 326-20-30-4 says, “The allowance for credit losses shall reflect the difference between the amortized cost basis and the present value of expected cash flows.” 

How it works

The discounted cash flow methodology, in essence, uses contractual schedules adjusted for prepayments to estimate future balances by month. This is extraordinarily helpful when adhering to ASC 326-20-30-6, which instructs institutions to model “expected credit losses over the contractual term of the financial asset(s).”

ASC 326-20-30-6 also says “ An entity shall consider prepayments as a separate input in the method or prepayments may be embedded in the credit loss information.” Speaking from experience, it’s neither an easy nor fun task to defend changing expected lives due to changes in prepayment speeds in varying rate environments when prepayments are “embedded in the credit loss.”

This approach, whether discounted or undiscounted, offers the opportunity to eliminate a life assumption, which is the most difficult and material assumption to support in a remaining life model (described below).

In fact, in order to support the remaining life input, one must run cash flows adjusted for prepayments, which begs the question – why not just stop there? As an added opportunity, forward-looking amortization schedules, interest income, and periodic expected loss all provide a strong foundation from which to manage. After all, it is the language of banking.

Armed with this kind of output, estimating future balances is accurate, which can allow for production budgeting. Loan-level detail on interest income that considers the default probability is also helpful in its own right. Lastly, timing-specific loss estimates make backtesting, monitoring, and scenario analysis feasible.

When to use DCF for CECL

Financial institutions have a number of considerations when selecting a CECL methodology. If using the discounted cash flow model is a possibility, remember that the methodology is best suited for specific situations.

These include the following:

  • While the discounted cash flow method works for nearly all loan types, it’s best for loan portfolios with contractual obligations extending beyond a year.
  • When an institution wants to quantify the impact of an economic forecast
  • When an institution wants to quantify the impact of a prepayment speed input
  • When an institution has loan-level fair market value adjustments resulting from an acquisition or whole loan purchase
  • When an institution prefers loan-level modeling and/or loan-level auditability
  • When industry or peer data is necessary or helpful

Pros

Some advantages of calculating the allowance using the discounted cash flow methodology include that it:

  • Is highly flexible, granular, and precise
  • Accurately reflects timing of losses, recoveries, and prepayments
  • Natively integrates reasonable and supportable forecasts
  • Supports layering of external or peer-derived inputs where internal data is sparse

Cons

Banks and credit unions have found that some of the challenges tied to using DCF are that it:

  • Requires detailed loan-level data (e.g., cash flow schedules, EIR, risk ratings)
  • Involves a heavier computing power burden

What is the remaining life method?

The remaining life method estimates losses using historical annualized loss rates and then applies those losses to balances using some form of life-of-loan assumption. Adjustments for prepayment speed changes, current conditions, and reasonable and supportable forecasts are usually estimated and applied through qualitative overlays or adjusting a life-of-loan input.

When to use it

Some of the reasons a financial institution might select WARM for the allowance for credit losses include:

  • When an institution is seeking an expedient
  • Comfortable with qualitative factors for forecasting and prepayment changes
  • Limited access to loan-level data or modeling capacity
  • As a transitional methodology

Pros

The remaining life method has the following qualities that might cause a bank or credit union to choose this methodology:

  • Easy to implement and maintain
  • No need for extensive historical or loan-level data
  • Easily understandable and auditable
  • Widely used and regulator-accepted for community institutions

Cons

Some of the feedback we’ve gotten about why financial institutions might not want to select WARM includes:

  • Difficult to support in changing rate environments (prepayment speed changes)
  • Loss timing is not explicitly modeled
  • Limited flexibility for dynamic economic forecasts
  • Assumes flat distribution of risk across remaining life
  • May misstate risk for longer-duration or prepayment-sensitive assets

Choosing the right method: A practical decision framework

Making a choice of CECL methodology involves many factors. Below is a simplified framework to help guide your selection.

chart of DCF vs. WARM methods for CECL

Both methods are fully compliant with CECL, but DCF offers better alignment with forward-looking credit risk modeling. The remaining life method offers an alternative for institutions prioritizing ease of implementation over support and defensibility.

Documentation and validation best practices

Regardless of the method used, institutions should:

  • Document method selection rationale, tying it to portfolio characteristics
  • Clearly define all inputs, assumptions, and external data sources
  • Perform annual CECL model validations or revalidations whenever portfolios materially change
  • Monitor and backtest model performance
  • Retain version control for model updates and assumption changes
  • Align CECL methodology with internal ALM, stress testing, and strategic planning frameworks where possible

Aligning methodology with institutional maturity

There is no universally “right” method for CECL compliance—only the method best aligned with your institution’s size, systems, staffing, and risk complexity.

  • Start with WARM if you're prioritizing ease of implementation and are comfortable re-implementing later as you grow or experience changes in rates or economy.
  • Evolve toward DCF as your institution builds stronger data pipelines, economic forecasting capabilities, and strategic modeling needs.
  • DCF provides not only more refined allowance estimates but also enhanced insight into credit risk behavior. These can enable better pricing, strategy, and capital planning.

Abrigo has guided hundreds of financial institutions through CECL implementation, tailoring the process to their unique goals and operational realities. Whether adopting a simplified model like remaining life, or ready to unlock the full potential of loan-level DCF modeling, Abrigo's allowance solutions and CECL advisors can help you navigate every step—from methodology selection and model validation to reporting and examiner readiness.

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About the Authors

Neekis Hammond, CPA

Vice President, Portfolio Risk Sales and Services
Neekis Hammond has amassed a wealth of knowledge on ALLL, CECL preparation and methodologies, and various portfolio analysis and risk topics. Prior to his consulting work, he worked on acquisitions up to $2 billion in size at a multi-billion-dollar financial institution.

Full Bio

Mary Ellen Biery

Senior Strategist & Content Manager
Mary Ellen Biery is Senior Strategist & Content Manager at Abrigo, where she works with advisors and other experts to develop whitepapers, original research, and other resources that help financial institutions drive growth and manage risk. A former equities reporter for Dow Jones Newswires whose work has been published in

Full Bio

About Abrigo

Abrigo enables U.S. financial institutions to support their communities through technology that fights financial crime, grows loans and deposits, and optimizes risk. Abrigo's platform centralizes the institution's data, creates a digital user experience, ensures compliance, and delivers efficiency for scale and profitable growth.

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