4 – INVESTMENT SECURITIES

Investment Securities Available for Sale

The amortized cost, non-credit loss component of other-than-temporary impairment (“OTTI”) on securities with changes in fair value recorded in other comprehensive income (“OCI”), gross unrealized gains and losses recorded in OCI, approximate fair value, weighted-average yield and contractual maturities of investment securities available for sale were as follows:


	September 30, 2012												December 31, 2011
	Amortized cost		Non-Credit Loss Component of OTTI Recorded in OCI		Gross Unrealized				Fair value		Weighted average yield%		Amortized cost		Non-Credit Loss Component of OTTI Recorded in OCI		Gross Unrealized				Fair value		Weighted average yield%
(Dollars in thousands)	Amortized cost		Non-Credit Loss Component of OTTI Recorded in OCI		gains		losses		Fair value		Weighted average yield%		Amortized cost		Non-Credit Loss Component of OTTI Recorded in OCI		gains		losses		Fair value		Weighted average yield%
U.S. Treasury securities:
Due within one year	$	7,494	$	—	$	1	$	—	$	7,495		0.17	$	476,665	$	—	$	327	$	—	$	476,992		0.34
Obligations of U.S. Government sponsored agencies:
Due within one year		—		—		—		—		—		—		300,381		—		1,204		—		301,585		1.15
After 1 to 5 years		25,650		—		11		—		25,661		0.35		—		—		—		—		—		—
Puerto Rico Government obligations:
Due within one year		—		—		—		—		—		—		8,560		—		110		—		8,670		4.20
After 1 to 5 years		—		—		—		—		—		—		70,590		—		171		1		70,760		2.63
After 5 to 10 years		39,744		—		1,335		—		41,079		4.49		118,186		—		76		13		118,249		5.07
After 10 years		21,102		—		1,190		25		22,267		5.78		24,154		—		781		1		24,934		5.74

United States and Puerto Rico Government obligations		93,990		—		2,537		25		96,502		3.31		998,536		—		2,669		15		1,001,190		1.47

Mortgage-backed securities:
FHLMC certificates:
Due within one year		206		—		1		—		207		3.57		—		—		—		—		—		—
After 1 to 5 years		—		—		—		—		—		—		928		—		8		—		936		3.67
After 10 years		135,512		—		4,186		—		139,698		2.28		24,974		—		238		—		25,212		2.59

		135,718		—		4,187		—		139,905		2.28		25,902		—		246		—		26,148		2.62

GNMA certificates:
After 1 to 5 years		159		—		8		—		167		3.59		179		—		9		—		188		3.88
After 5 to 10 years		562		—		45		—		607		3.60		596		—		47		—		643		4.09
After 10 years		604,294		—		44,793		—		649,087		4.00		717,237		—		43,938		—		761,175		3.98

		605,015		—		44,846		—		649,861		4.00		718,012		—		43,994		—		762,006		3.98

FNMA certificates:
Due within one year		282		—		10		—		292		3.55		—		—		—		—		—		—
After 1 to 5 years		—		—		—		—		—		—		1,019		—		42		—		1,061		3.82
After 5 to 10 years		14,517		—		810		—		15,327		4.04		18,826		—		1,007		—		19,833		3.97
After 10 years		624,983		—		15,872		—		640,855		2.56		47,485		—		3,285		—		50,770		5.46

		639,782		—		16,692		—		656,474		2.59		67,330		—		4,334		—		71,664		5.02

Collateralized Mortgage Obligations issued or guaranteed by FHLMC,
After 5 to 10 years		377		—		—		1		376		3.01		—		—		—		—		—		—

Other mortgage pass-through trust certificates:
After 10 years		72,555		31,951		14,085		—		54,689		2.34		85,014		31,951		8,143		—		61,206		2.19

Total mortgage-backed securities		1,453,447		31,951		79,810		1		1,501,305		3.13		896,258		31,951		56,717		—		921,024		3.85

Corporate bonds:
After 10 years		—		—		—		—		—		—		1,447		434		—		—		1,013		5.80

Equity securities (without contractual maturity)⁽¹⁾		77		—		—		37		40		—		77		—		—		36		41		—

Total investment securities available for sale	$	1,547,514	$	31,951	$	82,347	$	63	$	1,597,847		3.15	$	1,896,318	$	32,385	$	59,386	$	51	$	1,923,268		2.60

(1)	Represents common shares of another financial institution in Puerto Rico.

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 as was the case with approximately $194.5 million of Puerto Rico Government Obligations called during the first nine months of 2012. 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 non-credit 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 September 30, 2012 and December 31, 2011. It also includes debt securities for which an OTTI was recognized and only the amount related to a credit loss was recognized in earnings. Unrealized losses for which OTTI had been recognized have been reduced by any subsequent recoveries in fair value:


	As of September 30, 2012
	Less than 12 months				12 months or more				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
	(In thousands)
Debt securities:
Puerto Rico Government obligations	$	2,065	$	25	$	—	$	—	$	2,065	$	25
Mortgage-backed securities:
Collateralized mortgage obligations issued or guaranteed by FHLMC		376		1		—		—		376		1
Other mortgage pass-through trust certificates		—		—		54,540		17,867		54,540		17,867
Equity securities		—		—		40		37		40		37

	$	2,441	$	26	$	54,580	$	17,904	$	57,021	$	17,930


	As of December 31, 2011
	Less than 12 months				12 months or more				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
	(In thousands)
Debt securities:
Puerto Rico Government obligations	$	15,982	$	15	$	—	$	—	$	15,982	$	15
Mortgage-backed securities:
Other mortgage pass-through trust certificates		—		—		61,017		23,809		61,017		23,809
Corporate bonds		—		—		1,013		434		1,013		434
Equity securities		41		36		—		—		41		36

	$	16,023	$	51	$	62,030	$	24,243	$	78,053	$	24,294

Total proceeds from the sale of securities available for sale during the first nine months of 2011 amounted to approximately $1.2 billion, none in the first nine months of 2012.

Assessment for OTTI

On a quarterly basis, the Corporation performs an assessment to determine whether there have been any events or economic circumstances indicating that a security with an unrealized loss has suffered an OTTI. A debt security is considered impaired if the fair value is less than its amortized cost basis at the reporting date. The accounting literature requires the Corporation to assess whether the unrealized loss is other-than-temporary.

OTTI losses must be recognized in earnings if an investor has the intent to sell the debt security or it is more likely than not that it will be required to sell the debt security before recovery of its amortized cost basis. However, even if an investor does not expect to sell a debt security, it must evaluate expected cash flows to be received and determine if a credit loss has occurred.

An unrealized loss is generally deemed to be other-than-temporary and a credit loss is deemed to exist if the present value of the expected future cash flows is less than the amortized cost basis of the debt security. The credit loss component of an OTTI, if any, is recorded as a component of net impairment losses on investment securities in the accompanying consolidated statements of income (loss), while the remaining portion of the impairment loss is recognized in OCI, provided the Corporation does not intend to sell the underlying debt security and it is “more likely than not” that the Corporation will not have to sell the debt security prior to recovery.

Debt securities issued by U.S. government agencies, government-sponsored entities and the U.S. Treasury accounted for more than 92% of the total available-for-sale portfolio as of September 30, 2012 and no credit losses are expected, given the explicit and implicit guarantees provided by the U.S. federal government. The Corporation’s assessment was concentrated mainly on private label mortgage-backed securities with an amortized cost of $72.6 million 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.

•

Changes in the near term prospects of the underlying collateral of a security such as changes in default rates, loss severity given default and significant changes in prepayment assumptions;

•

The level of cash flows generated from the underlying collateral supporting the principal and interest payments of the debt securities; and

•

Any adverse change to the credit conditions and liquidity of the issuer, taking into consideration the latest information available about the overall financial condition of the issuer, credit ratings, recent legislation and government actions affecting the issuer’s industry and actions taken by the issuer to deal with the present economic climate.

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


	Private label MBS						Private label MBS
	Quarter ended September 30,						Nine-Month Period Ended September 30,
(In thousands)	2012			2011			2012			2011
Total other-than-temporary impairment losses	$	—		$	—		$	—		$	—
Portion of loss previously recognized in other comprehensive income		(557	)		(350	)		(1,933	)		(957	)

Net impairment losses recognized in earnings	$	(557	)	$	(350	)	$	(1,933	)	$	(957	)

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


	Quarter ended September 30,				Nine-Month Period Ended September 30,
(In thousands)	2012		2011		2012		2011
Credit losses at the beginning of the period	$	5,199	$	2,459	$	3,823	$	1,852
Additions:
Credit losses on debt securities for which an OTTI was previously recognized ⁽¹⁾		557		350		1,933		957

Ending balance of credit losses on debt securities held for which a portion of an OTTI was recognized in OCI	$	5,756	$	2,809	$	5,756	$	2,809

(1)	Related to private label MBS.

During the first nine-months of 2012, the $1.9 million credit related impairment loss is related to 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 derived from the model, 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 follow:


	September 30, 2012			December 31, 2011
	Weighted Average		Range	Weighted Average		Range
Discount rate		14.5%	14.5%		14.5%	14.5%
Prepayment rate		33%	23.81% - 43.58%		27%	21.33% -37.97%
Projected Cumulative Loss Rate		7%	0.71% - 17.51%		6%	1.94% - 11.89%

No OTTI losses on equity securities held in the available-for-sale investment portfolio were recognized for the first nine-months of 2012 or 2011.