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Note: Migration analysis is a rigorous analytical process recommended by the regulatory agencies; yet it is underutilized
Since January 2009, a total of 427 banks have failed in the U.S. As the global economic crisis drug on, these institutions were ill-prepared to absorb the volume of loan and lease losses they were forced to recognize. Consequently, regulatory agencies have increased pressure on the surviving institutions to appropriately calculate adequate Allowances for Loan and Lease Losses (ALLL).
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), many methodologies, including both historical loss and migration analysis techniques, are accepted.
Migration analysis is a rigorous analytical process recommended by the regulatory agencies to determine financial institutions' ALLL; yet it is underutilized. 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. The purpose of migration analysis is to determine what rate of loss an institution has incurred on similarly criticized or past due loans. This...