The Allowance for Loan and Lease Losses (ALLL) calculation can be one of the more complex processes in running an efficient and regulatory compliant financial institution.
Specifically, determining the most appropriate ALLL methodology is a significant challenge institutions face in calculating an adequate allowance.
While regulatory guidance is scarce, latitude is given to each institution to select the valuation methodology best suited for its own unique characteristics and complexities. According to the Office of the Comptroller of the Currency (OCC), multiple methodologies are accepted.
“The OCC does not require that banks use a specific method to determine historical loss experience. The method a bank uses will depend to a large degree upon the capabilities of its information systems. Acceptable methods range from a simple average of the bank’s historical loss experience over a period of years, to more complex migration analysis techniques.” *
Migration analysis is a rigorous analytical process recommended by the regulatory agencies to determine financial institutions’ ALLL; yet it is often underutilized in lieu of other, easier processes. This type of analysis uses loan level attributes to track the movement of loans through the various loan classifications in order to estimate the percentage of losses likely to be incurred in a financial institution’s current portfolio.
Streamline the serve calculation process and impress examiners.
The purpose of migration analysis is to determine what rate of loss an institution has incurred on similarly criticized or past due loans. This purpose is the same as that of historical loss rate analysis, but it is more granular and therefore can give a truer reflection of the losses inherent in the current portfolio. For proper application, migration analysis requires extensive data collection and consistent, prudent risk rating methodology.
Find out more about Sageworks ALLL, an ALLL solution that is equipped to support migration analysis.
To read more about potential problems as well as benefits of migration analysis and assuring a proper ALLL calculation, download this free whitepaper: Pros and Cons of Migration Analysis
* Comptroller’s Handbook: Allowance for Loan and Lease Losses; The Office of the Comptroller of the Currency; June 1996 – May 1998; Guidance still applicable as of May 17th, 2012