Non-Consolidated Variable Interest Entities and Servicing Assets

6 Months Ended

Jun. 30, 2011

Non-Consolidated Variable Interest Entities and Servicing Assets [Abstract]

NON-CONSOLIDATED VARIABLE INTEREST ENTITIES AND SERVICING ASSETS

11 — NON-CONSOLIDATED VARIABLE INTEREST ENTITIES AND SERVICING ASSETS

     The Corporation transfers residential mortgage loans in sale or securitization transactions in which it has continuing involvement, including servicing responsibilities and guarantee arrangements. All such transfers have been accounted for as sales as required by applicable accounting guidance.

     When evaluating transfers and other transactions with Variable Interest Entities (“VIEs”) for consolidation under the recently adopted guidance, the Corporation first determines if the counterparty is an entity for which a variable interest exists. If no scope exception is applicable and a variable interest exists, the Corporation then evaluates if it is the primary beneficiary of the VIE and whether the entity should be consolidated or not.

     Below is a summary of transfers of financial assets to VIEs for which the Corporation has retained some level of continuing involvement:

Ginnie Mae

     The Corporation typically transfers first lien residential mortgage loans in conjunction with Ginnie Mae securitization transactions whereby the loans are exchanged for cash or securities that are readily redeemed for cash proceeds and servicing rights. The securities issued through these transactions are guaranteed by the issuer and, as such, under seller/servicer agreements the Corporation is required to service the loans in accordance with the issuers’ servicing guidelines and standards. As of June 30, 2011, the Corporation serviced loans securitized through GNMA with principal balance of $541.9 million.

Trust Preferred Securities

     In 2004, FBP Statutory Trust I, a financing subsidiary of the Corporation, sold to institutional investors $100 million of its variable rate trust preferred securities. The proceeds of the issuance, together with the proceeds of the purchase by the Corporation of $3.1 million of FBP Statutory Trust I variable rate common securities, were used by FBP Statutory Trust I to purchase $103.1 million aggregate principal amount of the Corporation’s Junior Subordinated Deferrable Debentures. Also in 2004, FBP Statutory Trust II, a statutory trust that is wholly-owned by the Corporation, sold to institutional investors $125 million of its variable rate trust preferred securities. The proceeds of the issuance, together with the proceeds of the purchase by the Corporation of $3.9 million of FBP Statutory Trust II variable rate common securities, were used by FBP Statutory Trust II to purchase $128.9 million aggregate principal amount of the Corporation’s Junior Subordinated Deferrable Debentures. The trust preferred debentures are presented in the Corporation’s Consolidated Statement of Financial Condition as Other Borrowings, net of related issuance costs. The variable rate trust preferred securities are fully and unconditionally guaranteed by the Corporation. The $100 million Junior Subordinated Deferrable Debentures issued by the Corporation in April 2004 and the $125 million issued in September 2004 mature on September 17, 2034 and September 20, 2034, respectively; however, under certain circumstances, the maturity of Junior Subordinated Debentures may be shortened (such shortening would result in a mandatory redemption of the variable rate trust preferred securities). The trust preferred securities, subject to certain limitations, qualify as Tier I regulatory capital under current Federal Reserve rules and regulations. The Collins Amendment to the Dodd-Frank Wall Street Reform and Consumer Protection Act eliminates certain trust preferred securities from Tier 1 Capital, but TARP preferred securities are exempted from this treatment. These “regulatory capital deductions” for trust preferred securities are to be phased in incrementally over a period of 3 years beginning on January 1, 2013.

Grantor Trusts

     During 2004 and 2005, a third party to the Corporation, from now on identified as the seller, established a series of statutory trusts to effect the securitization of mortgage loans and the sale of trust certificates. The seller initially provided the servicing for a fee, which is senior to the obligations to pay trust certificate holders. The seller then entered into a sales agreement through which it sold and issued the trust certificates in favor of the Corporation’s banking subsidiary. Currently, the Bank is the sole owner of the trust certificates; the servicing of the underlying residential mortgages that generate the principal and interest cash flows, is performed by another third party, which receives a fee compensation for services provided, the servicing fee. The securities are variable rate securities indexed to 90 day LIBOR plus a spread. The principal payments from the underlying loans are remitted to a paying agent (servicer) who then remits interest to the Bank; interest income is shared to a certain extent with the FDIC, that has an interest only strip (“IO”) tied to the cash flows of the underlying loans, whereas it is entitled to received the excess of the interest income less a servicing fee over the variable rate income that the Bank earns on the securities. This IO is limited to the weighted average coupon of the securities. The FDIC became the owner of the IO upon the intervention of the seller, a failed financial institution. No recourse agreement exists and the risk from losses on non accruing loans and repossessed collateral are absorbed by the Bank as the sole holder of the certificates. As of June 30, 2011, the outstanding balance of Grantor Trusts amounted to approximately $92 million with a weighted average yield of 2.28%.

Investment in unconsolidated entities

     On February 16, 2011, FirstBank sold an asset portfolio consisting of performing and non-performing construction, commercial mortgage and C&I loans with an aggregate book value of $269.3 million to CPG/GS PR NPL, LLC (“CPG/GS” or the “Joint Venture”) organized under the Laws of the Commonwealth of Puerto Rico and majority owned by PRLP Ventures LLC (“PRLP”), a company created by Goldman, Sachs & Co. and Caribbean Property Group. In connection with the sale, the Corporation received $88.5 million in cash and a 35% interest in the CPG/GS, and made a loan in the amount of $136.1 million representing seller financing provided by FirstBank. The loan has a 7-year maturity and bears variable interest at 30-day LIBOR plus 300 basis points and is secured by a pledge of all of the acquiring entity’s assets as well as the PRLP’s 65% ownership interest in CPG/GS. As of June 30, 2011, the carrying amount of the loan is $136.1 million and is included in the Corporation’s C&I loan receivable portfolio; the carrying value of FirstBank’s equity interest in CPG/GS is $46.1 million as of June 30, 2011, accounted under the equity method and included as part of Investment in unconsolidated entities in the Consolidated Statements of Financial Condition. When applying the equity method, the Bank follows the Hypothetical Liquidation Book Value method (“HLBV”) to determine its share in CPG/GS earnings or losses. Under HLBV, the Bank determines its share in CPG/GS earnings or losses by determining the difference between its “claim on CPG/GS’s book value” at the end of the period as compared to the beginning of the period. This claim is calculated as the amount the Bank would receive if CPG/GS were to liquidate all of its assets at recorded amounts determined in accordance with GAAP and distribute the resulting cash to the investors, PRLP and FirstBank, according to their respective priorities as provided in the contractual agreement. CPG/GS will be accounting for its loans receivable under the fair value option.

     FirstBank also provided an $80 million advance facility to CPG/GS to fund unfunded commitments and costs to complete projects under construction, which was fully disbursed in the first half of 2011, and a $20 million working capital line of credit to fund certain expenses of CPG/GS. These loans bear variable interest at 30-day LIBOR plus 300 basis points. As of June 30, 2011, the carrying value of the advance facility and working capital line were $80.0 million and $0, respectively, and are included in the Corporation’s C&I loan receivable portfolio.

     Cash proceeds received by CPG/GS are first used to cover operating expenses and debt service payments, including the note receivable, the advanced facility and the working capital line, described above, which must be fully repaid before proceeds can be used for other purposes, including the return of capital to both PRLP and FirstBank. FirstBank will not receive any return on its equity interest until PRLP receives an aggregate amount equivalent to its initial investment and a priority return of at least 12%, resulting in FirstBank’s interest in CPG/GS being subordinate to PRLP’s interest. CPG/GS will then begin to make payments pro rata to PRLP and FirstBank, 35% and 65%, respectively, until FirstBank has achieved a 12% return on its invested capital and the aggregate amount of distributions is equal to FirstBank’s capital contributions to CPG/GS. FirstBank may experience further losses associated with this transaction due to this subordination in an amount equal to up to the value of its interest in CPG/GS. Factors that could impact FirstBank’s recoverability of its equity interest include lower than expected sale prices of units underlying CPG/GS assets and/or lower than projected liquidation value of the underlying collateral and changes in the expected timing of cash flows, among others.

     The Bank has determined that CPG/GS is a VIE in which the Bank is not the primary beneficiary. In determining the primary beneficiary of CPG/GS, the Bank considered applicable guidance that requires the Bank to qualitatively assess the determination of the primary beneficiary (or consolidator) of CPG/GS based on whether it has both the power to direct the activities of CPG/GS that most significantly impact the entity’s economic performance and the obligation to absorb losses of CPG/GS that could potentially be significant to the VIE or the right to receive benefits from the entity that could potentially be significant to the VIE. The Bank determined that it does not have the power to direct the activities that most significantly impact the economic performance of CPG/GS as it does not have the right to manage the loan portfolio, impact foreclosure proceedings, or manage the construction and sale of the property; therefore, the Bank concluded that it is not the primary beneficiary of CPG/GS. As a creditor to CPG/GS, the Bank has certain rights related to CPG/GS, however, these are intended to be protective in nature and do not provide the Bank with the ability to manage the operations of CPG/GS. Because CPG/GS is not a consolidated subsidiary of the Bank and given that the transaction met the criteria for sale accounting under authoritative guidance, the Bank accounted for this transaction as a true sale, recognizing the cash received, the notes receivable and the interest in CPG/GS and derecognizing the loan portfolio sold.

     Equity in losses of unconsolidated entities of approximately $1.5 million presented in the Statement of Loss, relates to the Bank’s investment in CPG/GS. Approximately $1.9 million of such charges represents an out of period adjustment to correct an overstatement of the carrying value of the Bank’s investment CPG/GS recognized as of March 31, 2011. The overstatement was the result of the use of a discount factor in calculating the initial fair value of investment in unconsolidated entity of 16.24% based on the expected rate of return at the transaction date whereas, upon further consideration and additional information considered during the second quarter of 2011, the Corporation believes that a discount factor of 17.57% is more appropriate. In accordance with the Corporation’s policy, which is based on the principles of Staff Accounting Bulletin (“SAB”) 99 and SAB 108, management concluded, with the agreement of the Corporation’s Audit Committee, that the overstatement of the carrying value of the investment in CPG/GS was not individually or in the aggregate material to the first quarter or the second quarter of 2011.

     The initial fair value of the investment in CPG/GS was determined using techniques with significant unobservable (Level 3) inputs. The valuation inputs included an estimate of future cash flows, expectations about possible variations in the amount and timing of cash flows, and a discount factor based on a rate of return. The Corporation researched available market data and internal information (i.e. proposals received for the servicing of distressed assets and public disclosures and information of similar structures and/or of distressed asset sales) and determined reasonable ranges of expected returns for FirstBank’s equity interest.

      The rate of return of 17.57% was used as the discount factor used to estimate the value of the FirstBank’s equity interest and validated from a market participants perspective. A reasonable range of equity returns was assessed considering the range of company specific risk premiums. The valuation of this type of equity interest is highly subjective and somewhat dependent on non-observable market assumptions, which may result in variations from market participant to market participant.

Servicing Assets

     The Corporation is actively involved in the securitization of pools of FHA-insured and VA-guaranteed mortgages for issuance of GNMA mortgage-backed securities. Also, certain conventional conforming-loans are sold to FNMA or FHLMC with servicing retained. The Corporation recognizes as separate assets the rights to service loans for others, whether those servicing assets are originated or purchased.

     The changes in servicing assets are shown below:

	Quarter ended						Six-month period ended
	June 30,			June 30,			June 30,			June 30,
	2011			2010			2011			2010
				(In thousands)
Balance at beginning of period	$	16,243		$	12,594		$	15,597		$	11,902
Capitalization of servicing assets		1,291			1,377			2,522			3,063
Amortization		(573	)		(497	)		(1,097	)		(932	)
Adjustment to servicing assets for loans repurchased (1)		(84	)		(139	)		(145	)		(698	)
Balance before valuation allowance at end of period		16,877			13,335			16,877			13,335
Valuation allowance for temporary impairment		(2,239	)		(282	)		(2,239	)		(282	)
Balance at end of period	$	14,638		$	13,053		$	14,638		$	13,053

(1) Amount represents the adjustment to fair value related to the repurchase of $8.8 million and $20.8 million for the quarter and six-month period ended June 30, 2011, respectively, and, $13.9 million and $67.4 million for the quarter and six-month period ended June 30, 2010, respectively, in principal balance of loans serviced for others.

     Impairment charges are recognized through a valuation allowance for each individual stratum of servicing assets. The valuation allowance is adjusted to reflect the amount, if any, by which the cost basis of the servicing asset for a given stratum of loans being serviced exceeds its fair value. Any fair value in excess of the cost basis of the servicing asset for a given stratum is not recognized. Other-than-temporary impairments, if any, are recognized as a direct write-down of the servicing assets.

     Changes in the impairment allowance were as follows:

	Quarter ended						Six-month period ended
	June 30,			June 30,			June 30,			June 30,
	2011			2010			2011			2010
	(In thousands)
Balance at beginning of period	$	1,237		$	180		$	434		$	745
Temporary impairment charges		1,149			216			2,123			352
Recoveries		(147	)		(114	)		(318	)		(815	)
Balance at end of period	$	2,239		$	282		$	2,239		$	282

     The components of net servicing income are shown below:

	Quarter ended						Six-month period ended
	June 30,			June 30,			June 30,			June 30,
	2011			2010			2011			2010
	(In thousands)
Servicing fees	$	1,411		$	1,008		$	2,662		$	1,936
Late charges and prepayment penalties		123			207			367			321
Adjustment for loans repurchased		(84	)		(140	)		(145	)		(698	)
Servicing income, gross		1,450			1,075			2,884			1,559
Amortization and impairment of servicing assets		(1,575	)		(599	)		(2,902	)		(469	)
Servicing (loss) income, net	$	(125	)	$	476		$	(18	)	$	1,090

     The Corporation’s servicing assets are subject to prepayment and interest rate risks. Key economic assumptions used in determining the fair value at the time of sale ranged as follows:

	Maximum			Minimum
Six-month period ended June 30, 2011:
Constant prepayment rate:
Government guaranteed mortgage loans		12.3	%		10.6	%
Conventional conforming mortgage loans		12.9	%		12.7	%
Conventional non-conforming mortgage loans		13.9	%		11.7	%
Discount rate:
Government guaranteed mortgage loans		11.5	%		11.3	%
Conventional conforming mortgage loans		9.5	%		9.3	%
Conventional non-conforming mortgage loans		15.0	%		13.8	%
Six-month period ended June 30, 2010:
Constant prepayment rate:
Government guaranteed mortgage loans		12.7	%		11.3	%
Conventional conforming mortgage loans		16.2	%		14.8	%
Conventional non-conforming mortgage loans		13.4	%		11.5	%
Discount rate:
Government guaranteed mortgage loans		11.6	%		10.3	%
Conventional conforming mortgage loans		9.3	%		9.2	%
Conventional non-conforming mortgage loans		13.1	%		13.1	%

     At June 30, 2011, fair values of the Corporation’s servicing assets were based on a valuation model that incorporates market driven assumptions, adjusted by the particular characteristics of the Corporation’s servicing portfolio, regarding discount rates and mortgage prepayment rates. The weighted-averages of the key economic assumptions used by the Corporation in its valuation model and the sensitivity of the current fair value to immediate 10 percent and 20 percent adverse changes in those assumptions for mortgage loans at June 30, 2011, were as follows:

	(Dollars in thousands)
Carrying amount of servicing assets	$	14,638
Fair value	$	15,366
Weighted-average expected life (in years)		8.6
Constant prepayment rate (weighted-average annual rate)		12.69	%
Decrease in fair value due to 10% adverse change	$	721
Decrease in fair value due to 20% adverse change	$	1,389
Discount rate (weighted-average annual rate)		10.58	%
Decrease in fair value due to 10% adverse change	$	561
Decrease in fair value due to 20% adverse change	$	1,084

     These sensitivities are hypothetical and should be used with caution. As the figures indicate, changes in fair value based on a 10 percent variation in assumptions generally cannot be extrapolated because the relationship of the change in assumption to the change in fair value may not be linear. Also, in this table, the effect of a variation in a particular assumption on the fair value of the servicing asset is calculated without changing any other assumption; in reality, changes in one factor may result in changes in another (for example, increases in market interest rates may result in lower prepayments), which may magnify or counteract the sensitivities.