Implementing Migration Analysis for the ALLL?

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.