Fair Value

6 Months Ended

Jun. 30, 2011

20 — FAIR VALUE

Fair Value Option

FASB authoritative guidance permits the measurement of selected eligible financial instruments at fair value.

Medium-Term Notes

The Corporation elected the fair value option for certain medium term notes that were hedged with interest rate swaps that were previously designated for fair value hedge accounting. As of June 30, 2011 and December 31, 2010, these medium-term notes with a principal balance of $15.4 million, had a fair value of $12.4 million and $11.8 million, respectively, recorded in notes payable. Interest paid/accrued on these instruments is recorded as part of interest expense and the accrued interest is part of the fair value of the notes. Electing the fair value option allows the Corporation to eliminate the burden of complying with the requirements for hedge accounting (e.g., documentation and effectiveness assessment) without introducing earnings volatility.

Medium-term notes for which the Corporation elected the fair value option were priced using observable market data in the institutional markets.

Fair Value Measurement

The FASB authoritative guidance for fair value measurement defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. This guidance also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. Three levels of inputs may be used to measure fair value:


Level 1		Valuations of Level 1 assets and liabilities are obtained from readily available pricing sources for market transactions involving identical assets or liabilities. Level 1 assets and liabilities include equity securities that are traded in an active exchange market, as well as certain U.S. Treasury and other U.S. government and agency securities and corporate debt securities that are traded by dealers or brokers in active markets.

Level 2		Valuations of Level 2 assets and liabilities are based on observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 2 assets and liabilities include (i) mortgage-backed securities for which the fair value is estimated based on the value of identical or comparable assets, (ii) debt securities with quoted prices that are traded less frequently than exchange-traded instruments and (iii) derivative contracts and financial liabilities (e.g., medium-term notes elected to be measured at fair value) whose value is determined using a pricing model with inputs that are observable in the market or can be derived principally from or corroborated by observable market data.

Level 3		Valuations of Level 3 assets and liabilities are based on unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models for which the determination of fair value requires significant management judgment or estimation.

For 2011, there have been no transfers into or out of Level 1 and Level 2 measurement of the fair value hierarchy.

Estimated Fair Value of Financial Instruments

The information about the estimated fair value of financial instruments required by GAAP is presented hereunder. The aggregate fair value amounts presented do not necessarily represent management’s estimate of the underlying value of the Corporation.

The estimated fair value is subjective in nature and involves uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. Changes in the underlying assumptions used in calculating fair value could significantly affect the results. In addition, the fair value estimates are based on outstanding balances without attempting to estimate the value of anticipated future business.

The following table presents the estimated fair value and carrying value of financial instruments as of June 30, 2011 and December 31, 2010.


	Total Carrying					Total Carrying
	Amount in					Amount in
	Statement of					Statement of
	Financial			Fair Value		Financial			Fair Value
	Condition			Estimated		Condition			Estimated
	6/30/2011			6/30/2011		12/31/2010			12/31/2010
	(In thousands)
Assets:
Cash and due from banks and money market investments	$	353,697		$	353,697	$	370,283		$	370,283
Investment securities available for sale		2,834,086			2,834,086		2,744,453			2,744,453
Investment securities held to maturity		—			—		453,387			476,516
Other equity securities		42,252			42,252		55,932			55,932
Loans held for sale		20,781			20,781		300,766			300,766
Loans, held for investment		10,765,525					11,655,436
Less: allowance for loan and lease losses		(540,878	)				(553,025	)

Loans held for investment, net of allowance		10,224,647			9,813,271		11,102,411			10,581,221

Derivatives, included in assets		1,409			1,409		1,905			1,905

Liabilities:
Deposits		11,072,728			11,179,891		12,059,110			12,207,613
Securities sold under agreements to repurchase		1,200,000			1,306,715		1,400,000			1,513,338
Advances from FHLB		420,440			441,600		653,440			677,866
Notes Payable		19,715			18,647		26,449			24,909
Other borrowings		231,959			86,401		231,959			71,488
Derivatives, included in liabilities		7,125			7,125		6,701			6,701

Assets and liabilities measured at fair value on a recurring basis, including financial liabilities for which the Corporation has elected the fair value option, are summarized below:


	As of June 30, 2011								As of December 30, 2010
	Fair Value Measurements Using								Fair Value Measurements Using
							Assets / Liabilities								Assets / Liabilities
(In thousands)	Level 1		Level 2		Level 3		at Fair Value		Level 1		Level 2		Level 3		at Fair Value
Assets:
Securities available for sale :
Equity securities	$	83	$	—	$	—	$	83	$	59	$	—	$	—	$	59
U.S. Treasury Securities		1,141,675		—		—		1,141,675		608,714		—		—		608,714
Non-callable U.S. agency debt		343,554		—		—		343,554		304,257		—		—		304,257
Callable U.S. agency debt and MBS		—		1,118,258		—		1,118,258		—		1,622,265		—		1,622,265
Puerto Rico Government Obligations		—		159,104		3,211		162,315		—		134,165		2,676		136,841
Private label MBS		—		—		66,822		66,822		—		—		72,317		72,317
Corporate bonds		—		—		1,379		1,379		—		—		—		—
Derivatives, included in assets:
Interest rate swap agreements		—		368		—		368		—		351		—		351
Purchased interest rate cap agreements		—		—		—		—		—		1		—		1
Purchased options used to manage exposure to the stock market on embeded stock indexed options		—		988		—		988		—		1,553		—		1,553
Forward Contracts		—		53		—		53		—		—		—		—
Liabilities:
Medium-term notes		—		12,374		—		12,374		—		11,842		—		11,842
Derivatives, included in liabilities:
Interest rate swap agreements				6,051		—		6,051		—		5,192		—		5,192
Written interest rate cap agreements		—		—		—		—		—		1		—		1
Embedded written options on stock index deposits and notes payable		—		988		—		988		—		1,508		—		1,508
Forward Contracts		—		86		—		86		—		—		—		—


	Changes in Fair Value for the Quarter Ended			Changes in Fair Value for the Six-Month Period Ended
	June 30, 2011, for items Measured at Fair Value			June 30, 2011, for items Measured at Fair Value
	Pursuant to Election of the Fair Value Option			Pursuant to Election of the Fair Value Option
	Unrealized Loss			Unrealized Loss
	and Interest Expense			and Interest Expense
	included in			included in
(In thousands)	Current-Period Earnings ⁽¹⁾			Current-Period Earnings ⁽¹⁾
Medium-term notes		($169	)		($993	)


(1)		Changes in fair value for the quarter and six-month period ended June 30, 2011 include interest expense on medium-term notes of $0.2 million and $0.5 million, respectively. Interest expense on medium-term notes that have been elected to be carried at fair value is recorded in interest expense in the Consolidated Statement of Loss based on their contractual coupons.


	Changes in Fair Value for the Quarter Ended		Changes in Fair Value for the Six-Month Period Ended
	June 30, 2010, for items Measured at Fair Value		June 30, 2010, for items Measured at Fair Value
	Pursuant to Election of the Fair Value Option		Pursuant to Election of the Fair Value Option
	Unrealized Gains		Unrealized Gains
	and Interest Expense		and Interest Expense
	included in		included in
(In thousands)	Current-Period Earnings ⁽¹⁾		Current-Period Earnings ⁽¹⁾
Medium-term notes	$	3,602	$	2,432

	$	3,602	$	2,432


(1)		Changes in fair value for the quarter and six-month period ended June 30, 2010 include interest expense on medium-term notes of $0.2 million and $0.4 million, respectively. Interest expense on medium-term notes that have been elected to be carried at fair value is recorded in interest expense in the Consolidated Statement of (Loss) Income based on their contractual coupons.

The table below presents a reconciliation for all assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the quarter and six-month period ended June 30, 2011 and 2010.


	Total Fair Value Measurements			Total Fair Value Measurements
	(Quarter Ended June 30, 2011)			(Six-Month Period Ended June 30, 2011)
Level 3 Instruments Only	Securities Available For Sale⁽¹⁾			Securities Available For Sale⁽¹⁾
(In thousands)
Beginning balance	$	72,733		$	74,993
Total gains or (losses) (realized / unrealized):
Included in earnings		(607	)		(607	)
Included in other comprehensive income		1,825			1,871
Held-to-Maturity investment securities reclassified to Available-for-Sale		—			2,000
Principal repayments and amortization		(2,539	)		(6,845	)

Ending balance	$	71,412		$	71,412


(1)		Amounts mostly related to certain private label mortgage-backed securities.


	Total Fair Value Measurements						Total Fair Value Measurements
	(Quarter Ended June 30, 2010)						(Six-Month Period Ended June 30, 2010)
				Securities Available For						Securities Available For
Level 3 Instruments Only	Derivatives ⁽¹⁾			Sale ⁽²⁾			Derivatives ⁽¹⁾			Sale ⁽²⁾
(In thousands)
Beginning balance	$	3,487		$	80,883		$	4,199		$	84,354
Total gains or (losses) (realized / unrealized):
Included in earnings		(440	)		—			(1,152	)		—
Included in other comprehensive income		—			3,647			—			3,970
Purchases		—			2,584			—			2,584
Principal repayments and amortization		—			(3,672	)		—			(7,466	)
Other (1)		(3,047	)		—			(3,047	)		—

Ending balance	$	—		$	83,442		$	—		$	83,442


(1)		Amounts related to the valuation of interest rate cap agreements. The counterparty to these interest rate cap agreements failed on April 30, 2010 and was acquired by another financial institution in an FDIC assisted transaction. The Corporation currently has a claim with the FDIC.

(2)		Amounts mostly related to private label mortgage-backed securities.

The table below summarizes changes in unrealized gains and losses recorded in earnings for the quarter and six-month period ended June 30, 2011 and 2010 for Level 3 assets and liabilities that are still held at the end of such periods.


	Changes in Unrealized			Changes in Unrealized
	Gains (Losses)			Gains (Losses)
	Quarter Ended			Six-Month Period Ended
Level 3 Instruments Only	June 30, 2011			June 30, 2011
(In thousands)	Securities Available for Sale			Securities Available for Sale
Changes in unrealized gains (losses) relating to assets still held at reporting date

Net impairment losses on investment securities	$	(607	)	$	(607	)

Additionally, fair value is used on a non-recurring basis to evaluate certain assets in accordance with GAAP. Adjustments to fair value usually result from the application of lower-of-cost-or-market accounting (e.g., loans held for sale carried at the lower of cost or fair value and repossessed assets) or write-downs of individual assets (e.g., goodwill, loans, investments in unconsolidated entities).

As of June 30, 2010, impairment or valuation adjustments were recorded for assets recognized at fair value on a non-recurring basis as shown in the following table:


							Losses recorded for			Losses recorded for
	Carrying value as of June 30, 2011						the Quarter Ended			the Six-month period
	Level 1		Level 2		Level 3		June 30, 2011			ended June 30, 2011
(In thousands)
Loans receivable ⁽¹⁾	$	—	$	—	$	947,185	$	(40,293	)	$	(127,364	)
Other Real Estate Owned ⁽²⁾		—		—		96,618		(3,532	)		(5,350	)
Loans held for sale ⁽³⁾		—		20,781		—		(30	)		(372	)


(1)		Mainly impaired commercial and construction loans. The impairment was generally measured based on the fair value of the collateral. The fair values are derived from appraisals that take into consideration prices in observed transactions involving similar assets in similar locations but adjusted for specific characteristics and assumptions of the collateral (e.g. absorption rates), which are not market observable.

(2)		The fair value is derived from appraisals that take into consideration prices in observed transactions involving similar assets in similar locations but adjusted for specific characteristics and assumptions of the properties (e.g. absorption rates), which are not market observable. Losses are related to market valuation adjustments after the transfer from the loan to the Other Real Estate Owned (“OREO”) portfolio.

(3)		Fair value is primarily derived from quotations based on the mortgage-backed securities market.

As of June 30, 2010, impairment or valuation adjustments were recorded for assets recognized at fair value on a non-recurring basis as shown in the following table:


							(Losses) gains recorded for			Losses recorded for
	Carrying value as of June 30, 2010						the Quarter Ended			the Six-month period
(In thousands)	Level 1		Level 2		Level 3		June 30, 2010			ended June 30, 2010
Loans receivable ⁽¹⁾	$	—	$	—	$	1,443,045	$	(126,622	)	$	(272,859	)
Other Real Estate Owned ⁽²⁾		—		—		72,358		(7,631	)		(8,669	)
Loans held for sale ⁽³⁾		—		100,626		—		3			(137	)


(1)		Mainly impaired commercial and construction loans. The impairment was generally measured based on the fair value The fair values are derived from appraisals of the collateral. that take into consideration prices in observed transactions involving similar assets in similar locations but adjusted for specific characteristics and assumptions of the collateral (e.g. absorption rates), which are not market observable.

(2)		The fair value is derived from appraisals that take into consideration prices in observed transactions involving similar assets in similar locations but adjusted for specific characteristics and assumptions of the properties (e.g. absorption rates), which are not market observable. Losses are related to market valuation adjustments after the transfer from the loan to the OREO portfolio.

(3)		Fair value is primarily derived from quotations based on the mortgage-backed securities market.

The following is a description of the valuation methodologies used for instruments for which an estimated fair value is presented as well as for instruments for which the Corporation has elected the fair value option. The estimated fair value was calculated using certain facts and assumptions, which vary depending on the specific financial instrument.

Cash and due from banks and money market investments

The carrying amounts of cash and due from banks and money market investments are reasonable estimates of their fair value. Money market investments might include held-to-maturity U.S. Government obligations, which have a contractual maturity of three months or less. The fair value of these securities is based on quoted market prices in active markets that incorporate the risk of nonperformance.

Investment securities available for sale and held to maturity

The fair value of investment securities is the market value based on quoted market prices (as is the case with equity securities, U.S. Treasury notes and non-callable U.S. Agency debt securities), when available, or market prices for identical or comparable assets (as is the case with MBS and callable U.S. agency debt) that are based on observable market parameters including benchmark yields, reported trades, quotes from brokers or dealers, issuer spreads, bids, offers and reference data including market research operations. Observable prices in the market already consider the risk of nonperformance. If listed prices or quotes are not available, fair value is based upon models that use unobservable inputs due to the limited market activity of the instrument, as is the case with certain private label mortgage-backed securities held by the Corporation.

Private label MBS are collateralized by fixed-rate mortgages on single-family residential properties in the United States; the interest rate on the securities is variable, tied to 3-month LIBOR and limited to the weighted-average coupon of the underlying collateral. The market valuation represents the estimated net cash flows over the projected life of the pool of underlying assets applying a discount rate that reflects market observed floating spreads over LIBOR, with a widening spread bias on a nonrated security. The market valuation is derived from a model that utilizes relevant assumptions such as prepayment rate, default rate, and loss severity on a loan level basis. The Corporation modeled the cash flow from the fixed-rate mortgage collateral using a static cash flow analysis according to collateral attributes of the underlying mortgage pool (i.e. loan term, current balance, note rate, rate adjustment type, rate adjustment frequency, rate caps, others) in combination with prepayment forecasts obtained from a commercially available prepayment model (ADCO). The variable cash flow of the security is modeled using the 3-month LIBOR forward curve. Loss assumptions were driven by the combination of default and loss severity estimates, taking into account loan credit characteristics (loan-to-value, state, origination date, property type, occupancy loan purpose, documentation type, debt-to-income ratio, other) to provide an estimate of default and loss severity. Refer to Note 4 for additional information about assumptions used in the valuation of private label MBS.

Other equity securities

Equity or other securities that do not have a readily available fair value are stated at the net realizable value, which management believes is a reasonable proxy for their fair value. This category is principally composed of stock that is owned by the Corporation to comply with FHLB regulatory requirements. Their realizable value equals their cost as these shares can be freely redeemed at par.

Loans receivable, including loans held for sale

The fair value of loans held for investment and for mortgage loans held for sale was estimated using discounted cash flow analyses, based on interest rates currently being offered for loans with similar terms and credit quality and with adjustments that the Corporation’s management believes a market participant would consider in determining fair value. Loans were classified by type such as commercial, residential mortgage, and automobile. These asset categories were further segmented into fixed- and adjustable-rate categories. The fair values of performing fixed-rate and adjustable-rate loans were calculated by discounting expected cash flows through the estimated maturity date. Loans with no stated maturity, like credit lines, were valued at book value. Prepayment assumptions were considered for non-residential loans. For residential mortgage loans, prepayment estimates were based on recent historical prepayment experience of the Corporation’s residential mortgage portfolio. Discount rates were based on the Treasury and LIBOR/Swap Yield Curves at the date of the analysis, and included appropriate adjustments for expected credit losses and liquidity. For impaired collateral dependent loans, the impairment was primarily measured based on the fair value of the collateral, which is derived from appraisals that take into consideration prices in observable transactions involving similar assets in similar locations. For construction, commercial mortgage and commercial loans transferred to held for sale during the fourth quarter of 2010, the fair value equals the established sales price of these loans. The Corporation completed the sale of substantially all of these loans on February 16, 2011.

Deposits

The estimated fair value of demand deposits and savings accounts, which are deposits with no defined maturities, equals the amount payable on demand at the reporting date. The fair values of retail fixed-rate time deposits, with stated maturities, are based on the present value of the future cash flows expected to be paid on the deposits. The cash flows were based on contractual maturities; no early repayments are assumed. Discount rates were based on the LIBOR yield curve.

The estimated fair value of total deposits excludes the fair value of core deposit intangibles, which represent the value of the customer relationship measured by the value of demand deposits and savings deposits that bear a low or zero rate of interest and do not fluctuate in response to changes in interest rates.

The fair value of brokered CDs, which are included within deposits, is determined using discounted cash flow analyses over the full term of the CDs. The valuation of embedded call options used a “Hull-White Interest Rate Tree” approach option valuation and estimated a duration and convexity adjusted update based on market rate movement. The fair value of the CDs is computed using the outstanding principal amount. The discount rates used are based on brokered CD market rates as of June 30, 2011. The fair value does not incorporate the risk of nonperformance, since interests in brokered CDs are generally sold by brokers in amounts of less than $250,000 and, therefore, insured by the FDIC.

Securities sold under agreements to repurchase

Some repurchase agreements reprice at least quarterly, and their outstanding balances are estimated to be their fair value. Where longer commitments are involved, fair value is estimated using exit price indications of the cost of unwinding the transactions as of the end of the reporting period. Securities sold under agreements to repurchase are fully collateralized by investment securities.

Advances from FHLB

The fair value of advances from FHLB with fixed maturities is determined using discounted cash flow analyses over the full term of the borrowings, using indications of the fair value of similar transactions. The cash flows assume no early repayment of the borrowings. Discount rates are based on the LIBOR yield curve. For advances from FHLB that reprice quarterly, their outstanding balances are estimated to be their fair value. Advances from FHLB are fully collateralized by mortgage loans and, to a lesser extent, investment securities.

Derivative instruments

The fair value of most of the derivative instruments is based on observable market parameters and takes into consideration the credit risk component of paying counterparties when appropriate, except when collateral is pledged. That is, on interest rate swaps, the credit risk of both counterparties is included in the valuation; and, on options and caps, only the seller’s credit risk is considered. The derivative instruments, namely swaps and caps, were valued using a discounted cash flow approach using the related US LIBOR and swap rate for each cash flow. Derivatives include interest rate swaps used for protection against rising interest rates. For these interest rate swaps, a credit component was not considered in the valuation since the Corporation has fully collateralized with investment securities any mark to market loss with the counterparty and, if there were market gains, the counterparty had to deliver collateral to the Corporation.

Although most of the derivative instruments are fully collateralized, a credit spread is considered for those that are not secured in full. The cumulative mark-to-market effect of credit risk in the valuation of derivative instruments resulted in an unrealized gain of approximately $0.6 million as of June 30, 2011.

Term notes payable

The fair value of term notes is determined using a discounted cash flow analysis over the full term of the borrowings. The valuation of embedded call options used a “Hull-White Interest Rate Tree” approach option valuation and estimated a duration and convexity adjusted update based on market rate movement. The model assumes that the embedded options are exercised economically. The fair value of medium-term notes is computed using the notional amount outstanding. The discount rates used in the valuations are based on estimated US dollar CCC Financials yield curve. The net loss from fair value changes attributable to the Corporation’s own credit to the medium-term notes for which the Corporation has elected the fair value option recorded for the first half of 2011 amounted to $0.5 million, compared to an unrealized gain of $2.7 million for the first half of 2010. The cumulative mark-to-market unrealized gain on the medium-term notes since measured at fair value attributable to credit risk amounted to $3.2 million as of June 30, 2011.

Other borrowings

Other borrowings consist of junior subordinated debentures. Projected cash flows from the debentures were discounted using the LIBOR yield curve plus a credit spread. This credit spread was estimated using the difference in yield curves between Swap rates and a yield curve that considers the industry and credit rating of the Corporation as issuer of the note at a tenor comparable to the time to maturity of the debentures.

- Definition

This item represents the complete disclosure regarding the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments, assets, and liabilities. Such disclosures about the financial instruments, assets, and liabilities would include: (1) the fair value of the required items together with their carrying amounts (as appropriate); (2) for items for which it is not practicable to estimate fair value, disclosure would include: (a) information pertinent to estimating fair value (including, carrying amount, effective interest rate, and maturity, and (b) the reasons why it is not practicable to estimate fair value; (3) significant concentrations of credit risk including: (a) information about the activity, region, or economic characteristics identifying a concentration, (b) the maximum amount of loss the Company is exposed to based on the gross fair value of the related item, (c) policy for requiring collateral or other security and information as to accessing such collateral or security, and (d) the nature and brief description of such collateral or security; (4) quantitative information about market risks and how such risk is are managed; (5) for items measured on both a recurring and nonrecurring basis information regarding the inputs used to develop the fair value measurement; and (6) for items presented in the financial statement for which fair value measurement is elected: (a) information necessary to understand the reasons for the election, (b) discussion of the effect of fair value changes on earnings, (c) a description of [similar groups] items for which the election is made and the relation thereof to the balance sheet, the aggregate carrying value of items included in the balance sheet that are not eligible for the election; (7) all other required (as defined) and desired information.

+ References+ Details