Migration Analysis: Combining Approaches for Better Results

Lenders increasigly use migration analysis to measure his torical default and loss rates, primarily in commercial portfolios, by risk rating. KPMG’s Sixth Annual Survey of Bank Credit Risk Management Practices revealed that 51% of all bank respondents use migration analysis. Of those banks with assets greater than $10 billion, 70% report using migration analysis. However, there are, perhaps, as many different twists on migration methodology as there are institutions using migration analysis. In the past, migration analysis models were developed solely to derive loss factors necessary to support the reserving process. As the need for relevant and timely information intensifies in the current competitive environment, however, management seeks more responsive, flexible, and more accurate models. Many leading institutions also recognize the value of migration analysis in supporting a number of relatively new risk management objectives. For example, output from migration models is used to support capital allocation, risk-based pricing, and portfolio management models. Migration models can help to evaluate the effectiveness of risk-rating systems, or align risk ratings with third party rating systems, such as Standard & Poor’s or Moody’s. And, when constructed properly, migration models can help to provide valuable information about trends in the portfolio and facilitate “what-if” loss forecasting under different scenarios.