INVESTMENT SECURITIES

6 Months Ended

Jun. 30, 2017

NOTE 4 – INVESTMENT SECURITIES

Investment Securities Available for Sale

The amortized cost, non-credit loss component of other-than-temporary impairment (“OTTI”) recorded in other comprehensive income (“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 June 30, 2017 and December 31, 2016 were as follows:

		June 30, 2017
		Amortized cost		Noncredit Loss Component of OTTI Recorded in OCI						Fair value		Weighted-average yield%
						Gross Unrealized
						gains		losses

(Dollars in thousands)

U.S. Treasury securities:
	After 1 to 5 years	$	7,443	$	-	$	-	$	12	$	7,431	1.29

Obligations of U.S.
government-sponsored
agencies:
Due within one year			69,976		-		-		107		69,869	1.04
After 1 to 5 years			361,964		-		171		1,875		360,260	1.37
After 5 to 10 years			16,943		-		29		159		16,813	2.00
After 10 years			42,592		-		-		239		42,353	1.60

Puerto Rico government
obligations:
After 10 years			7,980		-		68		2,402		5,646	5.00

United States and Puerto Rico
government obligations			506,898		-		268		4,794		502,372	1.42

Mortgage-backed securities:
FHLMC certificates:
After 5 to 10 years			21,643		-		62		-		21,705	2.18
After 10 years			277,351		-		489		4,054		273,786	2.18
			298,994		-		551		4,054		295,491	2.18

GNMA certificates:
After 1 to 5 years			94		-		2		-		96	3.33
After 5 to 10 years			81,006		-		1,635		-		82,641	3.05
After 10 years			114,213		-		8,175		21		122,367	4.35
			195,313		-		9,812		21		205,104	3.81
FNMA certificates:
Due within one year			52		-		-		-		52	4.04
After 1 to 5 years			16,949		-		475		-		17,424	2.56
After 5 to 10 years			19,418		-		19		191		19,246	2.01
After 10 years			646,918		-		4,548		7,058		644,408	2.38
			683,337		-		5,042		7,249		681,130	2.37
Collateralized mortgage obligations
guaranteed by the FHLMC
and GNMA:
After 5 to 10 years			19,074		-		23		-		19,097	1.87
After 10 years			37,948		-		187		-		38,135	1.89
			57,022		-		210		-		57,232	1.88
Other mortgage pass-through
trust certificates:
After 10 years			24,838		6,637		-		-		18,201	2.40
			24,838		6,637		-		-		18,201	2.40
Total mortgage-backed
securities			1,259,504		6,637		15,615		11,324		1,257,158	2.53

Other
After 1 to 5 years			100		-		-		-		100	1.49

Equity Securities ⁽¹⁾			419		-		-		4		415	2.08

Total investment securities
available for sale		$	1,766,921	$	6,637	$	15,883	$	16,122	$	1,760,045	2.21

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

		December 31, 2016
		Amortized cost		Noncredit Loss Component of OTTI Recorded in OCI						Fair value		Weighted-average yield%
						Gross Unrealized
						gains		losses

(Dollars in thousands)

U.S. Treasury securities:
	Due whithin 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 1 to 5 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

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.

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 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 June 30, 2017 and December 31, 2016. 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 June 30, 2017
	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	$	-	$	-	$	1,470	$	2,402	$	1,470	$	2,402
U.S. Treasury and U.S. government
agencies obligations		422,548		2,234		27,918		158		450,466		2,392
Mortgage-backed securities:
FNMA		461,637		7,249		-		-		461,637		7,249
FHLMC		215,527		4,027		867		27		216,394		4,054
GNMA		798		21		-		-		798		21
Other mortgage pass-through trust
certificates		-		-		18,201		6,637		18,201		6,637
Equity securities		410		4		-		-		410		4
	$	1,100,920	$	13,535	$	48,456	$	9,224	$	1,149,376	$	22,759


	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

Assessment for OTTI

Debt securities issued by U.S. government agencies, U.S. government-sponsored entities, and the U.S. Treasury accounted for approximately 99% of the total available-for-sale portfolio as of June 30, 2017 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 private label mortgage-backed securities (“MBS”) and on Puerto Rico government debt securities, 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 of 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:


		Quarter Ended				Six-Month Period Ended
		June 30,				June 30,
		2017		2016		2017		2016
(In thousands)
Total other-than-temporary impairment losses		$	-	$	-	$	(12,231)	$	(1,845)
Portion of other-than-temporary impairment recognized in OCI			-		-		-		(4,842)
Net impairment losses recognized in earnings (1)		$	-	$	-	$	(12,231)	$	(6,687)

(1)	For the six-month periods ended June 30, 2017 and 2016, approximately $12.2 million and $6.3 million, respectively, of the credit impairment recognized in earnings consisted of credit losses on Puerto Rico Government debt securities that were sold in the second quarter of 2017, as further discussed below. For the six-month period ended June 30, 2016, $0.4 million of the credit impairment recognized in earnings was 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		Credit loss
	March 31,		recognized in earnings		recognized in earnings on		reductions for		June 30,
	2017		on securities not		securities that have been		securities sold		2017
	Balance		previously impaired		previously impaired		during the period		Balance
(In thousands)
Available-for-sale securities
Puerto Rico government obligations	$	34,420	$	-	$	-	$	(34,420)	$	-
Private label MBS		6,792		-		-		-		6,792
Total OTTI credit losses for available-for-sale
debt securities	$	41,212	$	-	$	-	$	(34,420)	$	6,792


	Cumulative OTTI credit losses recognized in earnings on securities still held
			Credit impairments		Credit loss
	December 31,		recognized in earnings on		reductions for		June 30,
	2016		securities that have been		securities sold		2017
	Balance		previously impaired		during the period		Balance
(In thousands)
Available-for-sale securities
Puerto Rico government obligations	$	22,189	$	12,231	$	(34,420)	$	-
Private label MBS		6,792		-		-		6,792
Total OTTI credit losses for available-for-sale
debt securities	$	28,981	$	12,231	$	(34,420)	$	6,792


	Cumulative OTTI credit losses recognized in earnings on securities still held
			Credit impairments		Credit impairments
	March 31,		recognized in earnings		recognized in earnings on		June 30,
	2016		on securities not		securities that have been		2016
	Balance		previously impaired		previously impaired		Balance
(In thousands)
Available-for-sale securities
Puerto Rico government obligations	$	22,189	$	-	$	-	$	22,189
Private label MBS		6,792		-		-		6,792
Total OTTI credit losses for available-for-sale
debt securities	$	28,981	$	-	$	-	$	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		June 30,
	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

During the second quarter of 2017, the Corporation sold for an aggregate of $23.4 million three Puerto Rico Government available-for-sale debt securities, specifically bonds of the GDB and the Puerto Rico Public Buildings Authority, carried on its book at an amortized cost at the time of sale of $23.0 million (net of $34.4 million in cumulative OTTI impairment charges). This transaction resulted in a $0.4 million recovery from previous OTTI charges reflected in the statement of income as part of “net gain on sale of investments.” Approximately $12.2 million of the cumulative OTTI charges on these securities was recorded in the first quarter of 2017.

For the OTTI charge recorded in the first quarter of 2017, the Corporation considered revised estimates of recovery rates based on the latest available information about the Puerto Rico government’s financial condition, including the downgrade of credit ratings, and the revised fiscal plan published by the Puerto Rico government in March 2017. 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 derived 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 were 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 were 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 were assumed throughout the life of the bonds, which considered the respective security's credit rating as of the date of the analysis.

The adjusted future cash flows were 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%, as these three non-performing bonds had been in default since the third quarter of 2016. Based on this analysis, the Corporation recorded in the first quarter of 2017, other-than-temporary credit-related impairment charges amounting to $12.2 million, assuming recovery rates ranging from 15% to 80% (with a weighted average of 41%).

In addition, during the first quarter of 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 rates on these private-label MBS are 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
	June 30, 2017		December 31, 2016
	Weighted		Weighted
	Average	Range	Average	Range

Discount rate	14.3%	14.3%	14.1%	12.88% - 14.43%
Prepayment rate	15.3%	12.5% - 25.0%	13.8%	6.5% - 22.5%
Projected Cumulative Loss Rate	4%	0.1% - 6.8%	4%	0.2% - 8.6%

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 June 30, 2017 and December 31, 2016 were as follows:

		June 30, 2017
		Amortized cost						Fair value		Weighted average yield%
				Gross Unrealized
				gains		losses

Puerto Rico Municipal Bonds:
	After 1 to 5 years	$	4,108	$	-	$	149	$	3,959	5.38
	After 5 to 10 years		7,628		-		492		7,136	4.25
	After 10 years		144,313		-		20,464		123,849	4.94
Total investment securities
	held to maturity	$	156,049	$	-	$	21,105	$	134,944	4.92

		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

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 June 30, 2017 and December 31, 2016:

	As of June 30, 2017
	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	$	-	$	-	$	134,944	$	21,105	$	134,944	$	21,105


	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

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.

Approximately 70% of the held-to-maturity municipal bonds were issued by three of the largest municipalities in Puerto Rico. The vast majority of revenues of these three municipalities are independent of the Puerto Rico central government. 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 PROMESA oversight board has not designated any of the Commonwealth’s 78 municipalities as covered entities under PROMESA. However, while the revised fiscal plan submitted by the Puerto Rico government did not contemplate a restructuring of the debt of Puerto Rico’s municipalities, the plan did call for the gradual elimination of budgetary subsidies provided to municipalities. Furthermore, municipalities are also likely to be affected by the negative economic and other effects resulting from expense, revenue or cash management measures taken to address the Puerto Rico Government’s fiscal and liquidity shortfalls, or measures included in fiscal plans of other government entities, such as the gradual reduction of the Municipal Contribution in Lieu of Taxes (“CILT”) included in the Puerto Rico Electric Power Authority (“PREPA”) fiscal plan and the recently approved GDB Restructuring Support Agreement (the “GDB RSA”). The GDB RSA provides for the restructuring under Title VI of PROMESA of substantial portions of the GDB’s indebtedness, including deposits of municipalities, through the issuance of “Participating Bond Claims” in exchange for the release of GDB from liability relating to the bonds, deposits, letters of credit and guarantees. Given the uncertain impact that the negative fiscal situation of the Puerto Rico central government and the measures taken or to be taken by other government entities may have on municipalities, the Corporation cannot be certain if future impairment charges will be required against these securities.

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 June 30, 2017 and December 31, 2016, the Corporation had no outstanding securities held to maturity that were classified as cash and cash equivalents.