The CECL Debate: SCALE Vs. WARM

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Which CECL methodology is right for your community bank or credit union?

Choosing a CECL method that is right for your bank or credit union depends on many factors. Between the historical data available, management objectives, and associated operational costs, it can get complicated to learn about all the different options available. While different methodologies can be used for various portfolios, some methods stand out as being the simplest for community banks or credit unions like yours.

For smaller institutions, the most straightforward solutions are the Weighted Average Remaining Maturity (WARM) method or the newly-released Scaled CECL Allowance for Losses Estimated (SCALE) model. Let us start by telling you a little more about these methodologies at their core.

THE WARM MODEL

The WARM Method uses your bank or credit unions historical charge-off rates and your loan portfolio’s remaining life to estimate the Allowance for Credit Losses (ACL). For amortizing assets, the remaining contractual life is adjusted by the expected scheduled payments and prepayments (i.e., pay downs). The average annual charge-off rate is applied to the amortization adjusted remaining life of the loan to determine the unadjusted lifetime historical charge-off rate.

WARM is an ideal methodology for most banks or credit unions because it leverages your historical Call Report data and portfolio characteristics to calculate the Allowance for Credit Loss under CECL.

THE SCALE METHOD

SCALE is a new methodology option in the form of a spreadsheet template offered by the Federal Reserve. As of Q1 2021, It is only based on information derived from the 87 banks that meet the criteria of “Community Banks under $10B that have already adopted CECL.” This methodology uses Call Report data to derive a proxy “CECL ACL lifetime loss rate.” This proxy loss rate is then adjusted with q-factors and multiplied against loan balances, and the loss rate is a “peer-based expected loss rate.” 

CURINOS RECOMMENDS WARM MODEL

The proxy loss rate used in the SCALE model doesn’t consider an individual bank or credit unions historical credit performance and is based on a very small national average. National proxy loss rates may not be appropriate for every bank or credit union and they are a self-proclaimed “blunt approach” that may not make sense for all banks and credit unions. The SCALE tool is also provided as-is, with no support for the calculation, q-factors or documentation and is essentially a manual spreadsheet you can use to get your DIY calculation started.

The WARM method can be more accurate for many banks or credit unions because it uses your historical loss information instead of a peer-based proxy rate. Moreover, the proxy rate is based on data from banks with portfolios that are much different from the typical bank or credit union and often have much higher loss rates. 

Michael Stinson
President, BankTrends
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