Implementing Migration Analysis for the ALLL?

June 23, 2014
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It’s recognized that migration analysis is a more comprehensive loss rate calculation for banks and credit unions, as it more accurately reflects loan performance and loss over time.

But it’s not a process that can be started overnight. Successful implementation of migration analysis requires several, initial steps.

The first step is to ensure proper data collection, which includes the careful and consistent application of the institution’s risk rating methodology. For migration analysis, the loan portfolio must be segmented into homogenous pools and then sub-segmented by risk classification or delinquency status. In order for these pools to be accurate, it is critical that the loan risk classifications are updated promptly on an ongoing basis.

A hypothetical example of this could be pools based first on concentration (C&I) and then risk (Pass, Special Mention, etc.), and those sub-segmented pools are tracked over time to measure actual loss experience and use it to predict future loss experience for similarly classified loans.

Once the proper systems are in place for data capture and retention, institutions must determine the time period over which they will calculate loss rates.

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Eight quarters is a commonly used timeframe; however, the period will vary by institution. In some cases, institutions will choose to weight the different periods according to management’s judgment, with the most recent loss experiences carrying a higher weight in the loss rate calculation.

In the Comptroller’s Handbook, the OCC advises: “Generally speaking, if the migration analysis is being done on a fixed pool of loans, the analysis timeframe should cover the resolution of all loans in the pool (i.e., the time period over which the loans are paid off, returned to performing status, or charged off).” Whatever the specifics chosen, it is critical to refer to and follow guidance when forming a methodology and executing the calculation.

Lastly, it is extremely important to document the procedures put in place for executing the analysis. From data retention systems (i.e., risk rating methodologies and how often risk ratings are updated) to the actual calculation, it is vital the institution’s ALLL manager can defend the analysis and each assumption therein for examiners and auditors. This is especially important for the more subjective components of the calculation such as weighting the migration periods.

Though it may prove initially challenging for banks and credit unions to make the transition from existing methodologies to migration analysis, the benefits may far outweigh the initial intricacies. Once a financial institution has substantive data and procedures in place to conduct migration analysis, it can provide a more holistic and defensible ALLL calculation, a better understanding of its loan portfolio with more insight for management decisions and increased readiness to remain compliant despite an ever-changing regulatory landscape.

About the Author


Raleigh, N.C.-based Sageworks, a leading provider of lending, credit risk, and portfolio risk software that enables banks and credit unions to efficiently grow and improve the borrower experience, was founded in 1998. Using its platform, Sageworks analyzed over 11.5 million loans, aggregated the corresponding loan data, and created the largest real-time database of private-company financial information in the United States. The company was acquired in 2018 and is now part of Abrigo.

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Abrigo is a leading technology provider of compliance, credit risk, and lending solutions that community financial institutions use to manage risk and drive growth. Our software automates key processes — from anti-money laundering to fraud detection to lending solutions — empowering our customers by addressing their Enterprise Risk Management needs.

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