INVESTMENT SECURITIES

12 Months Ended

Dec. 31, 2016

NOTE 5 – INVESTMENT SECURITIES

Investment Securities Available for Sale

The amortized cost, non-credit loss component of OTTI recorded in OCI, gross unrealized gains and losses recorded in OCI, approximate fair value, and weighted-average yield of investment securities available for sale by contractual maturities as of December 31, 2016 and 2015 were as follows:

		December 31, 2016
		Amortized cost		Noncredit Loss Component of OTTI Recorded in OCI		Gross				Fair value		Weighted-average yield%
						Unrealized
						Gains		Losses
(Dollars in thousands)

U.S. Treasury securities:
	Due within one year	$	7,508	$	-	$	1	$	-	$	7,509	0.57

Obligations of U.S. government-sponsored
agencies:
	After 1 to 5 years		440,438		-		142		2,912		437,668	1.33
	After 5 to 10 years		16,942		-		9		256		16,695	1.91
	After 10 years		44,145		-		8		166		43,987	1.12

Puerto Rico government
obligations:
	After 1 to 5 years		21,422		12,222		-		-		9,200	-
	After 10 years		21,245		2,028		73		1,662		17,628	1.86

United States and Puerto
Rico government
obligations			551,700		14,250		233		4,996		532,687	1.29

Mortgage-backed securities:
FHLMC certificates:
	After 5 to 10 years		5,908		-		72		-		5,980	2.25
	After 10 years		314,906		-		261		5,827		309,340	2.17
			320,814		-		333		5,827		315,320	2.17
GNMA certificates:
	After 1 to 5 years		83		-		3		-		86	3.82
	After 5 to 10 years		91,744		-		1,635		92		93,287	3.06
	After 10 years		123,548		-		9,706		-		133,254	4.36
			215,375		-		11,344		92		226,627	3.81
FNMA certificates:
	Due within one year		152		-		2		-		154	4.71
	After 1 to 5 years		24,409		-		435		-		24,844	2.18
	After 5 to 10 years		17,181		-		-		261		16,920	1.87
	After 10 years		690,625		-		4,136		9,406		685,355	2.35
			732,367		-		4,573		9,667		727,273	2.33
Collateralized mortgage obligations issued
or guaranteed by the FHLMC and GNMA:
	After 5 to 10 years		19,851		-		4		31		19,824	1.42
	After 10 years		39,120		-		-		132		38,988	1.44
			58,971		-		4		163		58,812	1.43
Other mortgage pass-through
trust certificates:
	After 10 years		28,815		8,122		-		-		20,693	2.40
			28,815		8,122		-		-		20,693	2.40
Total mortgage-backed
securities			1,356,342		8,122		16,254		15,749		1,348,725	2.49

Other
	After 1 to 5 years		100		-		-		-		100	1.50

Equity securities ⁽¹⁾			415		-		-		7		408	2.44

Total investment securities
	available for sale	$	1,908,557	$	22,372	$	16,487	$	20,752	$	1,881,920	2.14

⁽¹⁾ Equity securities consisted of investment in a Community Reinvestment Act Qualified Investment Fund.

		December 31, 2015
		Amortized cost		Noncredit Loss Component of OTTI Recorded in OCI		Gross				Fair value		Weighted-average yield%
						Unrealized
						Gains		Losses
(Dollars in thousands)

U.S. Treasury securities:
	After 1 to 5 years	$	7,530	$	-	$	-	$	33	$	7,497	0.57

Obligations of U.S. government-sponsored
agencies:
	Due within one year		14,624		-		4		10		14,618	0.68
	After 1 to 5 years		384,323		-		174		4,305		380,192	1.32
	After 5 to 10 years		58,150		-		343		242		58,251	2.34

Puerto Rico government
obligations:
	After 1 to 5 years		25,663		14,662		-		-		11,001	4.38
	After 5 to 10 years		855		-		-		-		855	5.20
	After 10 years		23,162		5,255		134		1,680		16,361	5.40

United States and Puerto Rico
government obligations			514,307		19,917		655		6,270		488,775	1.75

Mortgage-backed securities:
FHLMC certificates:
	After 5 to 10 years		336		-		31		-		367	4.95
	After 10 years		287,711		-		1,073		1,706		287,078	2.14
			288,047		-		1,104		1,706		287,445	2.15
GNMA certificates:
	Due within one year		2		-		-		-		2	1.70
	After 1 to 5 years		109		-		5		-		114	4.26
	After 5 to 10 years		120,298		-		3,182		-		123,480	3.07
	After 10 years		165,175		-		12,822		20		177,977	4.38
			285,584		-		16,009		20		301,573	3.83
FNMA certificates:
	After 1 to 5 years		2,552		-		74		-		2,626	3.32
	After 5 to 10 years		21,557		-		433		233		21,757	2.73
	After 10 years		759,247		-		5,628		6,063		758,812	2.34
			783,356		-		6,135		6,296		783,195	2.35

Other mortgage pass-through
trust certificates:
	After 5 to 10 years		92		-		1		-		93	7.26
	After 10 years		34,905		9,691		-		-		25,214	2.26
			34,997		9,691		1		-		25,307	2.26
Total mortgage-backed
securities			1,391,984		9,691		23,249		8,022		1,397,520	2.61

Other
	After 1 to 5 years		100		-		-		-		100	1.50

Total investment securities
	available for sale	$	1,906,391	$	29,608	$	23,904	$	14,292	$	1,886,395	2.38

Maturities of mortgage-backed securities are based on contractual terms assuming no prepayments. Expected maturities of investments might differ from contractual maturities because they may be subject to prepayments and/or call options. The weighted-average yield on investment securities available for sale is based on amortized cost and, therefore, does not give effect to changes in fair value. The net unrealized gain or loss on securities available for sale and the noncredit loss component of OTTI are presented as part of OCI.

The aggregate amortized cost and approximate market value of investment securities available for sale as of December 31, 2016 by contractual maturity, are shown below:


	Amortized Cost		Fair Value
(Dollars in thousands)

Within 1 year	$	7,660	$	7,663
After 1 to 5 years		486,452		471,898
After 5 to 10 years		151,626		152,706
After 10 years		1,262,404		1,249,245
Total	$	1,908,142	$	1,881,512

Equity securities		415		408
Total investment securities available for sale	$	1,908,557	$	1,881,920

The following tables show the Corporation’s available-for-sale investments’ fair value and gross unrealized losses, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, as of December 31, 2016 and 2015. The tables also include debt securities for which an OTTI was recognized and only the amount related to a credit loss was recognized in earnings. For unrealized losses for which OTTI was recognized, the related credit loss was charged against the amortized cost basis of the debt security.

	As of December 31, 2016
	Less than 12 months				12 months or more				Total
			Unrealized				Unrealized				Unrealized
	Fair Value		Losses		Fair Value		Losses		Fair Value		Losses
(In thousands)
Debt securities:
Puerto Rico government obligations	$	-	$	-	$	22,609	$	15,912	$	22,609	$	15,912
U.S Treasury and U.S. government
agencies obligations		469,046		3,334		-		-		469,046		3,334
Mortgage-backed securities:
FNMA		519,008		9,667		-		-		519,008		9,667
FHLMC		244,839		5,827		-		-		244,839		5,827
GNMA		43,388		92		-		-		43,388		92
Collateralized mortgage obligations
issued or guaranteed by FHLMC and GNMA		55,309		163		-		-		55,309		163
Other mortgage pass-through trust certificates		-		-		20,693		8,122		20,693		8,122
Equity securities		408		7		-		-		408		7
	$	1,331,998	$	19,090	$	43,302	$	24,034	$	1,375,300	$	43,124


	As of December 31, 2015
	Less than 12 months				12 months or more				Total
			Unrealized				Unrealized				Unrealized
	Fair Value		Losses		Fair Value		Losses		Fair Value		Losses
(In thousands)
Debt securities:
Puerto Rico government obligations	$	-	$	-	$	23,008	$	21,597	$	23,008	$	21,597
U.S Treasury and U.S. government
agencies obligations		198,243		929		210,504		3,661		408,747		4,590
Mortgage-backed securities:
FNMA		437,305		4,516		88,013		1,780		525,318		6,296
FHLMC		141,890		1,338		19,306		368		161,196		1,706
GNMA		1,047		20		-		-		1,047		20
Other mortgage pass-through trust certificates		-		-		25,214		9,691		25,214		9,691
	$	778,485	$	6,803	$	366,045	$	37,097	$	1,144,530	$	43,900

Assessment for OTTI

Debt securities issued by U.S. government agencies, government-sponsored entities, and the U.S. Treasury accounted for approximately 97% of the total available-for-sale portfolio as of December 31, 2016 and no credit losses are expected, given the explicit and implicit guarantees provided by the U.S. federal government. The Corporation’s OTTI assessment was concentrated mainly on Puerto Rico government debt securities, with an amortized cost of $42.7 million, and on private label MBS with an amortized cost of $28.8 million, and for which credit losses are evaluated on a quarterly basis. The Corporation considered the following factors in determining whether a credit loss exists and the period over which the debt security is expected to recover:

The length of time and the extent to which the fair value has been less than the amortized cost basis;
Any adverse change to the credit conditions and liquidity of the issuer, taking into consideration the latest information available about the financial condition of the issuer, credit ratings, the failure of the issuer to make scheduled principal or interest payments, recent legislation and government actions affecting the issuer’s industry and actions taken by the issuer to deal with the present economic climate;
Changes in the near term prospects of the underlying collateral for a security, if any, such as changes in default rates, loss severity given default, and significant changes in prepayment assumptions; and
The level of cash flows generated from the underlying collateral, if any, supporting the principal and interest payments of the debt securities.

The Corporation recorded OTTI losses on available-for-sale debt securities as follows:

		Year Ended
		2016		2015			2014
(In thousands)
Total other-than-temporary impairment losses		$	(1,845)	$	(35,806)	$	-
Portion of other-than-temporary impairment recognized in OCI			(4,842)		19,289		(388)
Net impairment losses recognized in earnings (1)		$	(6,687)	$	(16,517)	$	(388)

(1)	For the years ended December 31, 2016 and 2015, approximately $6.3 million and $15.9 million, respectively, of the credit impairment recognized in earnings consisted of credit losses on Puerto Rico government debt securities. The remaining impairment losses were associated with credit losses on private label MBS.

The following tables summarize the roll-forward of credit losses on debt securities held by the Corporation for which a portion of an OTTI is recognized in OCI:

	Cumulative OTTI credit losses recognized in earnings on securities still held
			Credit impairments		Credit impairments
	December 31,		recognized in earnings		recognized in earnings on		December 31,
	2015		on securities not		securities that have been		2016
	Balance		previously impaired		previously impaired		Balance
(In thousands)
Available for sale securities
Puerto Rico government obligations	$	15,889	$	-	$	6,300	$	22,189
Private label MBS		6,405		-		387		6,792
Total OTTI credit losses for available-for-sale
debt securities	$	22,294	$	-	$	6,687	$	28,981


	Cumulative OTTI credit losses recognized in earnings on securities still held
			Credit impairments		Credit impairments
	December 31,		recognized in earnings		recognized in earnings on		December 31,
	2014		on securities not		securities that have been		2015
	Balance		previously impaired		previously impaired		Balance
(In thousands)
Available for sale securities
Puerto Rico government obligations	$	-	$	15,889	$	-	$	15,889
Private label MBS		5,777		-		628		6,405
Total OTTI credit losses for available-for-sale
debt securities	$	5,777	$	15,889	$	628	$	22,294

Cumulative OTTI credit losses recognized in earnings on securities still held

Credit impairments

December 31,

recognized in earnings

recognized in earnings on

December 31,

2013

on securities not

securities that have been

2014

Balance

previously impaired

Balance

(In thousands)

Available for sale securities

Private label MBS

5,389

388

5,777

In the first quarter of 2016, the Corporation recorded a $6.3 million OTTI charge on three Puerto Rico government debt securities held by the Corporation as part of its available-for-sale securities portfolio, specifically bonds of the government Development Bank for Puerto Rico (“GDB”) maturing on February 1, 2019 and the Puerto Rico Public Buildings Authority maturing on July 1, 2028. This was the third OTTI charge on these securities recorded since June 30, 2015, as OTTI charges of $12.9 million and $3.0 million were booked in the second and fourth quarters of 2015, respectively, and reduced the amortized cost basis of these three Puerto Rico government debt securities to $35.6 million as of December 31, 2016, including accrued interest of $0.9 million.

During 2016, in consideration of the latest available information about the Puerto Rico government’s financial condition, including the enactment of a debt moratorium law and the declaration of a state of emergency at the GDB, the issuance of the GDB and the Commonwealth’s audited financial statements for the fiscal year ended June 30, 2014, as well as issuance of exchange proposals with the Commonwealth’s creditors related to its outstanding bond obligations, the Corporation applied a discounted cash flow analysis to its Puerto Rico government debt securities in order to calculate the cash flows expected to be collected and to determine if any portion of the decline in market value of these securities was considered a credit-related other-than-temporary impairment. The analysis derives an estimate of value based on the present value of risk-adjusted cash flows of the underlying securities and included the following components:

The contractual future cash flows of the bonds are projected based on the key terms as set forth in the official statements for each security. Such key terms include, among others, the interest rate, amortization schedule, if any, and maturity date.
The risk-adjusted cash flows are calculated based on a probability of default analysis and recovery rate assumptions, including the weighting of different scenarios of ultimate recovery, considering the credit rating of each security. Constant monthly default rates are assumed throughout the life of the bonds, which considers the respective security's credit rating as of the date of the analysis.
The adjusted future cash flows are then discounted at the original effective yield of each investment based on the purchase price and expected risk-adjusted future cash flows as of the purchase date of each investment.

The discounted risk-adjusted cash flow analysis for the three Puerto Rico government bonds mentioned above assumed a default probability of 100%, thus reflecting that it is more likely than not that these three bonds will default during their remaining terms. Based on this analysis, the Corporation determined that it is unlikely to receive all of the remaining contractual interest and principal amounts when due on these bonds and recorded, in the first quarter of 2016, other-than-temporary credit-related impairment charges amounting to $6.3 million, assuming recovery rates ranging from 35% to 80% (with a weighted average of 61%). On August 1, 2016, the GDB defaulted on a $28 million payment of interest due to its creditors, including interest due on the GDB’s bonds held by the Corporation. Similarly, the Puerto Rico Public Buildings Authority made only a partial payment on its interest payment due on October 1, 2016. In the third quarter of 2016, as a result of these defaults, the Corporation discontinued income recognition related to, and placed in non-performing status, the bonds of the GDB and the Puerto Rico Public Buildings Authority. As of December 31, 2016, the amortized cost of these bonds, including accrued interest of $0.9 million, was $35.6 million ($22.3 million of GDB bonds and $13.3 million of Puerto Rico Public Buildings Authority bonds), recorded at their aggregate fair value of $20.5 million ($9.2 million of GDB bonds and $11.3 million of Puerto Rico Public Buildings Authority bonds).

The Corporation does not have the intention to sell these securities and has sufficient capital and liquidity to hold these securities until a recovery of the fair value occurs; as such, only the credit loss component was reflected in earnings. Given the significant and prolonged uncertainty of a debt restructuring process, the Corporation cannot be certain that future impairment charges will not be required against these securities.

In addition, during 2016, the Corporation recorded a $0.4 million credit-related impairment loss associated with private label MBS, which are collateralized by fixed-rate mortgages on single-family residential properties in the United States. The interest rate on these private-label MBS is variable, tied to 3-month LIBOR and limited to the weighted-average coupon of the underlying collateral. The underlying mortgages are fixed-rate, single-family loans with original high FICO scores (over 700) and moderate original loan-to-value ratios (under 80%), as well as moderate delinquency levels.

Based on the expected cash flows, and since the Corporation does not have the intention to sell the securities and has sufficient capital and liquidity to hold these securities until a recovery of the fair value occurs, only the credit loss component was reflected in earnings. Significant assumptions in the valuation of the private label MBS were as follows:

	As of		As of
	December 31, 2016		December 31, 2015
	Weighted		Weighted
	Average	Range	Average	Range

Discount rate	14.1%	12.88-14.43%	14.5%	14.5%
Prepayment rate	13.8%	6.5-22.5%	25%	15.92% - 31.25%
Projected Cumulative Loss Rate	4%	0.2-8.6%	4%	0.18% - 6.66%

Refer to Note 28 – Fair Value, for additional information about the valuation model for private label MBS.

Total proceeds from the sale of securities available for sale during 2016 amounted to approximately $219.8 million, including proceeds of $204.8 million on the sale of U.S. agency MBS and $15.0 million on the sale of a U.S. Treasury bill. For the year ended December 31, 2016, the Corporation recorded a $6.1 million gain on the sale of U.S. agency MBS and an $8 thousand gain on the sale of the U.S. Treasury bill. In addition, a $1.5 million gain from recovery of a residual private label CMO previously written off was recorded in 2016. No sales of securities available for sale were completed in 2015. Total proceeds from the sale of securities available for sale during 2014 amounted to approximately $4.9 million.

The following table states the names of issuers, and the aggregate amortized cost and market value of the securities of such issuers, when the aggregate amortized cost of such securities exceeds 10% of the Corporation’s stockholders’ equity. This information excludes securities of the U.S. and Puerto Rico government. Investments in obligations issued by a state of the U.S. and its political subdivisions and agencies that are payable and secured by the same source of revenue or taxing authority, other than the U.S. government, are considered securities of a single issuer and include debt and mortgage-backed securities.

		As of				As of
	December 31, 2016				December 31, 2015
	Amortized				Amortized
	Cost		Fair Value		Cost		Fair Value
(In thousands)
FHLMC	$	399,955	$	394,249	$	323,437	$	322,772
GNMA		254,495		265,615		285,584		301,573
FNMA		849,584		843,818		954,178		953,866
FHLB		231,666		229,792		223,049		219,320

Investments Held to Maturity

The amortized cost, gross unrealized gains and losses, approximate fair value, weighted-average yield and contractual maturities of investment securities held to maturity as of December 31, 2016 and December 31, 2015 were as follows:

		December 31, 2016
		Amortized cost						Fair value		Weighted average yield%
				Gross Unrealized
				gains		losses

Puerto Rico Municipal Bonds:
	After 1 to 5 years	$	1,136	$	-	$	20	$	1,116	5.38
	After 5 to 10 years		10,741		-		718		10,023	4.47
	After 10 years		144,313		-		22,693		121,620	4.74
Total investment securities
	held to maturity	$	156,190	$	-	$	23,431	$	132,759	4.73

		December 31, 2015
		Amortized cost						Fair value		Weighted average yield%
				Gross Unrealized
				gains		losses

Puerto Rico Municipal Bonds:
	After 1 to 5 years	$	1,371	$	-	$	37	$	1,334	5.38
	After 5 to 10 years		11,523		-		1,041		10,482	4.25
	After 10 years		148,589		-		28,861		119,728	4.64
Total investment securities
	held to maturity	$	161,483	$	-	$	29,939	$	131,544	4.62

The following tables show the Corporation’s held-to-maturity investments’ fair value and gross unrealized losses, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, as of December 31, 2016 and 2015:

	As of December 31, 2016
	Less than 12 months				12 months or more				Total
			Unrealized				Unrealized				Unrealized
	Fair Value		Losses		Fair Value		Losses		Fair Value		Losses
		(In thousands)
Debt securities:
Puerto Rico Municipal Bonds	$	-	$	-	$	132,759	$	23,431	$	132,759	$	23,431


	As of December 31, 2015
	Less than 12 months				12 months or more				Total
			Unrealized				Unrealized				Unrealized
	Fair Value		Losses		Fair Value		Losses		Fair Value		Losses
		(In thousands)
Debt securities:
Puerto Rico Municipal Bonds	$	4,163	$	140	$	127,381	$	29,799	$	131,544	$	29,939

Approximately 87% of the held-to-maturity municipal bonds were issued by five of the largest municipalities in Puerto Rico (San Juan, Carolina, Bayamon, Mayaguez and Guaynabo). These obligations typically are not issued in bearer form, nor are they registered with the SEC and are not rated by external credit agencies. In most cases, these bonds have priority over the payment of operating costs and expenses of the municipality, which are required by law to levy special property taxes in such amounts as are required for the payment of all of their respective general obligation bonds and loans.

The Corporation determines the fair market value of Puerto Rico Municipal Bonds based on a discounted cash flow analysis using risk-adjusted discount rates. A security with similar characteristics traded in the open market is used as a proxy for each municipal bond. Then the cash flow is discounted at the average spread over the discount curve exhibited by the proxy security at the end of each quarter.

When evaluating if the decrease in fair value could be classified as other-than-temporary, management considered aspects such as the fact that all municipalities are current on their payments and the fact that the bonds are subject to periodic credit reviews and are supported by assigned property tax revenues.

Based on the quarterly analysis performed and the circumstances discussed above, management concluded that the unrealized loss is attributable to the time value of money and liquidity assumptions and no individual municipal bond was other-than-temporarily impaired as of December 31, 2016.

From time to time, the Corporation has securities held to maturity with an original maturity of three months or less that are considered cash and cash equivalents and classified as money market investments in the consolidated statements of financial condition. As of December 31, 2016 and 2015, the Corporation had no outstanding securities held to maturity that were classified as cash and cash equivalents.