FASB Approves WARM Methodology for CECL

With the implementation date for CECL getting closer by the day, financial institutions are slowly beginning to get more clarity surrounding acceptable methodologies that can be utilized to comply with the standard. One frequently discussed method, the Weighted Average Remaining Maturity (WARM) methodology, was recently the subject of January 2019 FASB Staff Q&A, which noted, “The FASB staff believes that the WARM method is one of many methods that could be used to estimate an allowance for credit losses for less complex financial asset pools under Subtopic 326-20.

A few key points to note from FASB’s recently released Q&A Statement:

1. FASB has permitted entities to estimate expected credit losses using various methods due to the complexity of the portfolio, size of the entity, access to information, and management of the portfolio, which may result in approaches with varying degrees of sophistication.
2. Common challenges can exist regardless of the loss rate methodology selected by a financial institution. In some instances, these challenges may be minor in nature, rendering the use of WARM acceptable by utilizing a variety of qualitative adjustments to determine the necessary reserves under CECL. In other instances, these challenges may be more complex in nature, which could lead an institution to determine the use of WARM to be inappropriate and the use of a more complex methodology to be necessary.
3. The FASB Q&A Comment provides a couple of different examples on the application of the WARM methodology to comply with CECL. These examples do a good job of explaining the mathematics behind the calculation.

There are numerous tools available to assist in the calculation of CECL, some more simplified then others. The methodology utilized depends entirely upon a number of factors including the complexity of the portfolio, composition of the financial assets, and the amount of information available to be captured by the institution.

For those interested in a simplified approach such as WARM, take a look at the CECL Calculator from BankTrends. This tool does a great job of simplifying the process for both banks and credit unions by utilizing call report information to determine loan balances and calculate average annual loss rates. It then allows the user the ability to customize inputs such as the weighted average remaining maturity by loan pool, qualitative factors, as well as prepayment assumptions and interest only percentages to calculate estimated reserves. More information on this tool can be found here: https://www.bank-trends.com/CECL/

While the CECL implementation date is still a couple of years away for non-public business entity institutions, many institutions with non-complex portfolios are planning on waiting until closer to the implementation date before determining how to comply with the standard. CLA strongly encourages financial institutions to be proactive in the decision-making process in regards to what methodology will be utilized. The CECL calculation should be run parallel to your existing calculation for a period of time to allow the institutions to determine the appropriateness of the methodology selected.