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ABA Banking Journal | ‘WARM’ing Up: Pros and Cons of Using WARM for CECL Implementation

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ABA Banking Journal

By Kylee Wooten, Abrigo
August 22, 2019

As the Current Expected Credit Loss model’s effective date for SEC filers nears, the pressure to find the right CECL methodology is on. The remaining life—also known as Weighted-Average Remaining Maturity, or WARM—methodology, first introduced in February 2018, is one of the newest methodologies on the scene. The methodology has been building steam in recent months, specifically for community institutions that are seeking simpler, more practical methodologies for implementing CECL than those being used by larger institutions.

While the WARM methodology has some similarities to other CECL methodologies, there are also significant differences that are important to address if your institution is considering applying this method.

When should you use the remaining life methodology?

The WARM methodology, while not appropriate for all institutions, can be applicable in some circumstances. Data has consistently been one of the biggest challenges for financial institutions transitioning to CECL. For institutions struggling with gaps in their data or lacking in loan-level data, the WARM method may be a viable option. Since the WARM method uses an average annual charge-off rate, institutions are able to use aggregated data from Call Reports or peer data.

“While we might prefer something that’s a little bit more robust, we’re asked to do this in a reasonable manner, and for an institution that doesn’t have a bunch of quality assurance analysts on staff to be able to do this, I think that the WARM method can be a viable option,” says Jared Mills, a senior consultant at Abrigo, which offers two American Bankers Association Endorsed Solutions for CECL. “This methodology has some upsides to it compared to some of the more historically driven approaches.”

One of the advantages of WARM is the fact that it is forward-looking, similar to the discounted cash flow method, for example. However, the WARM method takes a more simplistic way of applying loss rates. It requires less data than other methodologies, which can be beneficial for institutions that don’t have enough loan-level data and need to use pool-level data.

Institutions and segments best-suited for the remaining life methodology

No CECL methodology is a one-size-fits-all solution, and the WARM methodology is no exception. Since some components of this methodology seem more simplistic than other methods, it may be subjected to more scrutiny than others. It’s important to ensure that your institution or portfolio segment is suited to use the WARM methodology.

Less complex portfolios or segments. The WARM method is not as sophisticated as other methods for calculating CECL. Therefore, WARM is most applicable to less complex portfolios or segments. This includes institutions that lack significant loan-level data or loss history.

“It’s going to be critical for each institution to define what a ‘complex’ portfolio or segment is, as it pertains to them,” says Baker Eddraa, senior manager for advisory services at Abrigo. “This should be well-documented and supported in order to be able to defend this methodology election to your auditors and regulators.”

Segments with potential data limitations. Data limitations, both operational and numerical, are a primary driver for employing the WARM method. If an institution recently went through a conversion and had its data purged, this could be an example of an operational limitation. A numerical limitation would include situations in which an institution lacked statistical data or had not observed enough historical losses to derive meaningful loss rates.

Immaterial acquired portfolios. Even if this methodology isn’t a fit across the board, it may make sense for a particular segment within the portfolio. For example, the WARM methodology can offer a temporary solution for institutions that have acquired an immaterial portfolio. Oftentimes, these institutions may not have all the data necessary to perform one of the other methodologies on a less material acquired portfolio. In the interim, institutions can use Call Report data to help with CECL compliance until the institution is able to gather all of the necessary data components.

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To read the full article featuring Abrigo, visit ABA Banking Journal, “‘WARM’ing UP: Pros and Cons of Using WARM for CECL.”