Why banks should use migration analysis
While the implementation of migration analysis can be a tough hurdle for many institutions, those that deploy the technique can obtain a more comprehensive and accurate measure of their reserve. By evaluating their pooled loan segments at the risk rating level, for example, and tracking the migration of those loans through time, management will better understand how their loans have performed in each segment over time and calculate a more accurate loss rate.
Utilizing migration analysis forces institutions to properly track and adjust for risk rating changes in its loan portfolio. Therefore, making risk rating adjustments in a prompt manner is critical to the proper execution of migration analysis. Examiners are consistently pushing for exhaustive documentation behind each institution’s calculations, and adopting migration analysis can be helpful in this cause. Using this methodology makes the allowance more defensible and can help institutions stave off bad exams.
Furthermore, the additional insight gained by evaluating loans on a more granular level will allow management to better understand the portfolio: how it is changing over time, the performance of certain segments versus others, data collection lapses within the portfolio, etc. Equipped with this added understanding into the nature of the portfolio, migration analysis can help guide management decision making.
Additionally, an institution that employs migration analysis will be better equipped to comply with evolving regulatory requirements such as current expected credit losses (CECL) model. The proposed model would require institutions to move from projecting current losses to projecting future losses. The new model will place added pressure on institutions’ data collection and tracking.
For more information on migration analysis, view our webinar on Migration Analysis: The Way Forward for an Effective ALLL.