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FAIR VALUE

9 Months Ended

Sep. 30, 2020

Fair Value Disclosures [Abstract]

NOTE 25 – FAIR VALUE

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 for classifying financial instruments. The hierarchy is based on whether the inputs to the valuation techniques used to measure fair value are observable or unobservable. One of 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 trade 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) MBS 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 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 are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined by using pricing models for which the determination of fair value requires significant management judgments as to the estimation.

Financial Instruments Recorded at Fair Value on a Recurring Basis

Investment securities available for sale and marketable equity securities held at fair value

The fair value of investment securities was the market value based on quoted market prices (as is the case with U.S. Treasury notes, non-callable U.S. agencies debt securities, and equity securities with readily determinable fair values), when available (Level 1), or, when available, market prices for identical or comparable assets (as is the case with MBS and callable U.S. agency debt securities) 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 (Level 2). Observable prices in the market already consider the risk of nonperformance. If listed prices or quotes are not available, fair value is based upon discounted cash flow models that use unobservable inputs due to the limited market activity of the instrument, as is the case with certain private label MBS held by the Corporation (Level 3).

Derivative instruments

The fair value of most of the Corporation’s derivative instruments is based on observable market parameters and takes into consideration the credit risk component of paying counterparties, when appropriate. On interest caps, only the seller's credit risk is considered. The Corporation valued the caps using a discounted cash flow approach based on the related LIBOR and swap rate for each cash flow The Corporation valued the interest rate swaps using a discounted cash flow approach based on the related LIBOR and swap forward rate for each cash flow.

The Corporation considers a credit spread for those derivative instruments that are not secured. The cumulative mark-to-market effect of credit risk in the valuation of derivative instruments for the quarters and nine-month periods ended September 30, 2020 and 2019 was immaterial.

Assets and liabilities measured at fair value on a recurring basis are summarized below as of September 30, 2020 and December 31, 2019:

	As of September 30, 2020												As of December 31, 2019
	Fair Value Measurements Using												Fair Value Measurements Using
(In thousands)	Level 1			Level 2			Level 3			Assets/Liabilities at Fair Value			Level 1			Level 2			Level 3			Assets/Liabilities at Fair Value

Assets:
Securities available for sale:
U.S. Treasury securities	$	7,531		$	-		$	-		$	7,531		$	7,479		$	-		$	-		$	7,479
Noncallable U.S. agency debt securities		-			74,837			-			74,837			-			146,777			-			146,777
Callable U.S. agency debt securities and MBS		-			3,195,869			-			3,195,869			-			1,950,331			-			1,950,331
Puerto Rico government obligations		-			4,016			2,907			6,923			-			4,348			2,974			7,322
Private label MBS		-			-			8,839			8,839			-			-			11,116			11,116
Other investments		-			-			650			650			-			-			500			500
Equity securities		1,475			-			-			1,475			1,428			-			-			1,428
Derivatives, included in assets:
Interest rate swap agreements		-			1,762			-			1,762			-			-			-			-
Purchased interest rate cap agreements		-			1			-			1			-			11			-			11
Interest rate lock commitments		-			951			-			951			-			341			-			341
Forward contracts		-			364			-			364			-			-			-			-
Forward loan sales commitments		-			20			-			20			-			20			-			20
Liabilities:
Derivatives, included in liabilities:
Interest rate swap agreements		-			1,789			-			1,789			-			-			-			-
Written interest rate cap agreements		-			1			-			1			-			11			-			11
Forward contracts		-			31			-			31			-			138			-			138

The table below presents a reconciliation of the beginning and ending balances of all assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the quarters and nine-month periods ended September 30, 2020 and 2019:

		Quarter Ended September 30,
		2020			2019
Level 3 Instruments Only		Securities			Securities
(In thousands)		Available For Sale⁽¹⁾			Available For Sale⁽¹⁾

Beginning balance		$	12,643		$	15,906
Total gains (losses) (realized/unrealized):
Included in other comprehensive income			649			15
Included in earnings			-			(497)
BSPR securities acquired			150			-
Principal repayments and amortization			(1,046)			(414)
Ending balance		$	12,396		$	15,010

(1) Amounts mostly related to private label MBS.

		Nine-Month Period Ended September 30,
		2020			2019
Level 3 Instruments Only		Securities			Securities
(In thousands)		Available For Sale⁽¹⁾			Available For Sale⁽¹⁾

Beginning balance		$	14,590		$	17,238
Total gains (realized/unrealized):
Included in other comprehensive income			1,615			46
Included in earnings			(1,631)			(497)
BSPR securities acquired			150			-
Principal repayments and amortization			(2,328)			(1,777)
Ending balance		$	12,396		$	15,010

(1) Amounts mostly related to private label MBS.

The tables below present qualitative information for significant assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) as of September 30, 2020 and December 31, 2019:

	September 30, 2020
	Fair Value			Valuation Technique		Unobservable Input		Range			Weighted Average
(Dollars in thousands)	Fair Value			Valuation Technique		Unobservable Input		Minimum	Maximum		Weighted Average

Investment securities available-for-sale:

Private label MBS	$	8,839		Discounted cash flows		Discount rate		12.4%	12.4%		12.4%
						Prepayment rate		2.6%	13.7%		10.9%
						Projected cumulative loss rate		2.4%	26.3%		11.8%

Puerto Rico government obligations		2,907		Discounted cash flows		Discount rate		8.5%	8.5%		8.5%
						Projected cumulative loss rate		13.4%	13.4%		13.4%

	December 31, 2019
	Fair Value			Valuation Technique		Unobservable Input		Range			Weighted Average
(Dollars in thousands)	Fair Value			Valuation Technique		Unobservable Input		Minimum	Maximum		Weighted Average

Investment securities available-for-sale:

Private label MBS	$	11,116		Discounted cash flows		Discount rate		13.7%	13.7%		13.7%
						Prepayment rate		6.8%	10.3%		7.9%
						Projected cumulative loss rate		0.0%	7.4%		2.8%

Puerto Rico government obligations		2,974		Discounted cash flows		Discount rate		6.9%	6.9%		6.9%
						Prepayment rate		3.0%	3.0%		3.0%

Information about Sensitivity to Changes in Significant Unobservable Inputs

Private label MBS: The significant unobservable inputs in the valuation include probability of default, the loss severity assumption, and prepayment rates. Shifts in those inputs would result in different fair value measurements. Increases in the probability of default, loss severity assumptions, and prepayment rates in isolation would generally result in an adverse effect on the fair value of the instruments. The Corporation modeled meaningful and possible shifts of each input to assess the effect on the fair value estimation.

Puerto Rico Government Obligations: The significant unobservable input used in the fair value measurement is the assumed loss rate of the underlying residential mortgage loans that collateralize these obligations, which are guaranteed by the PRHFA. A significant increase (decrease) in the assumed rate would lead to a (lower) higher fair value estimate. The fair value of these bonds during 2020 was based on a discounted cash flow methodology that considers the structure and terms of the underlying collateral. The Corporation utilizes PDs and LGDs that consider, among other things, historical payment performance, loan-to value attributes and relevant current and forward-looking macroeconomic variables, such as regional unemployment rates, the housing price index and expected recovery of PRHFA guarantee. Under this approach, all future cash flows (interest and principal) from the underlying collateral loans, adjusted by prepayments and the PDs and LGDs derived from the above-described methodology, are discounted at the internal rate of return as of the reporting date and compared to the amortized cost.

The table below summarizes changes in unrealized gains and losses recorded in earnings for the quarters and nine-month periods ended September 30, 2020 and 2019 for Level 3 assets and liabilities that were still held at the end of each period:

	Changes in Unrealized Losses
	Quarter Ended September 30,						Nine-Month Period Ended September 30,
	2020			2019			2020			2019
Level 3 Instruments Only	Securities Available for Sale			Securities Available for Sale			Securities Available for Sale			Securities Available for Sale
(In thousands)
Changes in unrealized losses relating to assets
still held at reporting date:
OTTI on available-for-sale investment
securities (credit component) ⁽¹⁾	$	-		$	(497)		$	-		$	(497)
Provision for credit losses (2)		-			-			(1,631)			-
Total	$	-		$	(497)		$	(1,631)		$	(497)

Additionally, fair value is used on a nonrecurring 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 and loans).

As of September 30, 2020, the Corporation recorded losses or valuation adjustments for assets recognized at fair value on a non-recurring basis as shown in the following table:

		Carrying value as of September 30, 2020									Losses recorded for the Quarter Ended September 30, 2020			Losses recorded for the Nine-Month Period Ended September 30, 2020
		Level 1			Level 2			Level 3
(In thousands)

Loans receivable (1)		$	-		$	-		$	239,256		$	(193)		$	(5,906)
OREO (2)			-			-			89,049			(999)			(1,775)

(1)	Consists mainly of collateral dependent commercial and construction loans. The Corporation generally measured losses based on the fair value of the collateral. The Corporation derived the fair values from external appraisals that took 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 Corporation derived the fair values from appraisals that took 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 and net operating income of income producing properties), which are not market observable. Losses were related to market valuation adjustments after the transfer of the loans to the OREO portfolio.

As of September 30, 2019, the Corporation recorded losses or valuation adjustments for assets recognized at fair value on a non-recurring basis as shown in the following table:

											Losses recorded			Losses recorded
												for the Quarter Ended			for the Nine-Month Period Ended
		Carrying value as of September 30, 2019									September 30, 2019			September 30, 2019
		Level 1			Level 2			Level 3
(In thousands)

Loans receivable (1)		$	-		$	-		$	211,406		$	(6,221)		$	(14,546)
OREO (2)			-			-			103,033			(1,311)			(5,513)
Loans held for sale (3)			-			-			6,906			-			-

(1)	Consists mainly of collateral dependent commercial and construction loans. The Corporation generally measured losses based on the fair value of the collateral. The Corporation derived the fair values from external appraisals that took 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 Corporation derived the fair values from appraisals that took 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 and net operating income of income producing properties), which are not market observable. Losses were related to market valuation adjustments after the transfer of the loans to the OREO portfolio.
(3)	Represents nonaccrual commercial and construction loans transferred to held for sale in 2018 and still in inventory at period-end. The Corporation derived the fair value of these loans primarily from broker price opinions that the Corporation considered.

Qualitative information regarding the fair value measurements for Level 3 financial instruments as of September 30, 2020 are as follows:

	September 30, 2020
	Method		Inputs
Loans	Income, Market, Comparable Sales, Discounted Cash Flows		External appraised values; probability weighting of broker price opinions; management assumptions regarding market trends or other relevant factors
OREO	Income, Market, Comparable Sales, Discounted Cash Flows		External appraised values; probability weighting of broker price opinions; management assumptions regarding market trends or other relevant factors

The following tables present the carrying value, estimated fair value and estimated fair value level of the hierarchy of financial instruments as of September 30, 2020 and December 31, 2019:

	Total Carrying Amount in Statement of Financial Condition September 30, 2020			Fair Value Estimate September 30, 2020			Level 1			Level 2			Level 3

(In thousands)
Assets:
Cash and due from banks and money
market investments (amortized cost)	$	2,469,507		$	2,469,507		$	2,469,507		$	-		$	-
Investment securities available
for sale (fair value)		3,294,649			3,294,649			7,531			3,274,722			12,396
Investment securities held to maturity (amortized cost)		189,156
Less: allowance for credit losses on held to maturity securities		(10,176)
Investment securities held to maturity, net of allowance	$	178,980			166,974			-			-			166,974
Equity Securities (fair value)		39,290			39,290			1,475			37,815			-
Loans held for sale (lower of cost or market)		48,670			50,518			-			50,518			-
Loans held for investment (amortized cost)		11,847,275
Less: allowance for credit losses for loans and finance leases		(384,718)
Loans held for investment, net of allowance	$	11,462,557			11,502,824			-			-			11,502,824
Derivatives, included in assets (fair value)		3,098			3,098			-			3,098			-

Liabilities:
Deposits (amortized cost)	$	15,202,898		$	15,243,104		$	-		$	15,243,104		$	-
Securities sold under agreements
to repurchase (amortized cost)		300,000			330,551			-			330,551			-
Advances from FHLB (amortized cost)		490,000			498,322			-			498,322			-
Other borrowings (amortized cost)		183,762			143,785			-			-			143,785
Derivatives, included in liabilities (fair value)		1,821			1,821			-			1,821			-

	Total Carrying Amount in Statement of Financial Condition December 31, 2019			Fair Value Estimate December 31, 2019			Level 1			Level 2			Level 3

(In thousands)
Assets:
Cash and due from banks and money
market investments (amortized cost)	$	644,099		$	644,099		$	644,099		$	-		$	-
Investment securities available
for sale (fair value)		2,123,525			2,123,525			7,479			2,101,456			14,590
Investment securities held to maturity (amortized cost)		138,675			110,374			-			-			110,374
Equity securities (fair value)		38,249			38,249			1,428			36,821			-
Loans held for sale (lower of cost or market)		39,477			40,234			-			40,234			-
Loans held for investment (amortized cost)		9,002,205
Less: allowance for credit losses for loans and finance leases		(155,139)
Loans held for investment, net of allowance	$	8,847,066			8,715,144			-			-			8,715,144
Derivatives, included in assets (fair value)		372			372			-			372			-

Liabilities:
Deposits (amortized cost)	$	9,348,429		$	9,372,591		$	-		$	9,372,591		$	-
Securities sold under
agreements to repurchase (amortized cost)		100,000			120,020			-			120,020			-
Advances from FHLB (amortized cost)		570,000			578,498			-			578,498			-
Other borrowings (amortized cost)		184,150			180,577			-			-			180,577
Derivatives, included in liabilities (fair value)		149			149			-			149			-

The short-term nature of certain assets and liabilities result in their carrying value approximating fair value. These include cash and cash due from banks and other short-term assets, such as FHLB stock. Certain assets, the most significant being premises and equipment, mortgage servicing rights, core deposit, and other customer relationship intangibles, are not considered financial instruments and are not included above. Accordingly, this fair value information is not intended to, and does not, represent the Corporation’s underlying value. Many of these assets and liabilities that are subject to the disclosure requirements are not actively traded, requiring management to estimate fair values. These estimates necessarily involve the use of assumptions and judgment about a wide variety of factors, including but not limited to, relevancy of market prices of comparable instruments, expected futures cash flows, and appropriate discount rates.

The entire disclosure for the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments as well as disclosures related to the fair value of non-financial 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 entity 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 risks 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.

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