Fair value measurement

9 Months Ended

Sep. 30, 2019

Fair Value Disclosures

Fair Value Measurement

Note 25 – Fair value measurementASC Subtopic 820-10 “Fair Value Measurements and Disclosures” establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three levels in order to increase consistency and comparability in fair value measurements and disclosures. The hierarchy is broken down into three levels based on the reliability of inputs as follows:

Level 1 - Unadjusted quoted prices in active markets for identical assets or liabilities that the Corporation has the ability to access at the measurement date. Valuation on these instruments does not necessitate a significant degree of judgment since valuations are based on quoted prices that are readily available in an active market.

Level 2 - Quoted prices other than those included in Level 1 that are observable either directly or indirectly. Level 2 inputs include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, or other inputs that are observable or that can be corroborated by observable market data for substantially the full term of the financial instrument.Level 3 - Inputs are unobservable and significant to the fair value measurement. Unobservable inputs reflect the Corporation’s own assumptions about assumptions that market participants would use in pricing the asset or liability.

The Corporation maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the observable inputs be used when available. Fair value is based upon quoted market prices when available. If listed prices or quotes are not available, the Corporation employs internally-developed models that primarily use market-based inputs including yield curves, interest rates, volatilities, and credit curves, among others. Valuation adjustments are limited to those necessary to ensure that the financial instrument’s fair value is adequately representative of the price that would be received or paid in the marketplace. These adjustments include amounts that reflect counterparty credit quality, the Corporation’s credit standing, constraints on liquidity and unobservable parameters that are applied consistently. There have been no changes in the Corporation’s methodologies used to estimate the fair value of assets and liabilities from those disclosed in the 2018 Form 10-K.

The estimated fair value may be subjective in nature and may involve uncertainties and matters of significant judgment for certain financial instruments. Changes in the underlying assumptions used in calculating fair value could significantly affect the results.

Fair Value on a Recurring and Nonrecurring Basis

The following fair value hierarchy tables present information about the Corporation’s assets and liabilities measured at fair value on a recurring basis at September 30, 2019 and December 31, 2018:

At September 30, 2019
(In thousands)	Level 1		Level 2		Level 3		Total
RECURRING FAIR VALUE MEASUREMENTS
Assets
Debt securities available-for-sale:
U.S. Treasury securities	$	4,487,422	$	6,016,866	$	-	$	10,504,288
Obligations of U.S. Government sponsored entities		-		187,092		-		187,092
Obligations of Puerto Rico, States and political subdivisions		-		6,931		-		6,931
Collateralized mortgage obligations - federal agencies		-		630,636		-		630,636
Mortgage-backed securities		-		5,148,581		1,209		5,149,790
Other		-		373		-		373
Total debt securities available-for-sale	$	4,487,422	$	11,990,479	$	1,209	$	16,479,110
Trading account debt securities, excluding derivatives:
U.S. Treasury securities	$	2,758	$	2	$	-	$	2,760
Obligations of Puerto Rico, States and political subdivisions		-		649		-		649
Collateralized mortgage obligations		-		79		557		636
Mortgage-backed securities		-		28,772		26		28,798
Other		-		3,004		456		3,460
Total trading account debt securities, excluding derivatives	$	2,758	$	32,506	$	1,039	$	36,303
Equity securities	$	-	$	19,778	$	-	$	19,778
Mortgage servicing rights		-		-		150,652		150,652
Derivatives		-		15,234		-		15,234
Total assets measured at fair value on a recurring basis	$	4,490,180	$	12,057,997	$	152,900	$	16,701,077
Liabilities
Derivatives	$	-	$	(14,069)	$	-	$	(14,069)
Total liabilities measured at fair value on a recurring basis	$	-	$	(14,069)	$	-	$	(14,069)

At December 31, 2018
(In thousands)	Level 1		Level 2		Level 3		Total
RECURRING FAIR VALUE MEASUREMENTS
Assets
Debt securities available-for-sale:
U.S. Treasury securities	$	2,719,740	$	5,552,456	$	-	$	8,272,196
Obligations of U.S. Government sponsored entities		-		333,309		-		333,309
Obligations of Puerto Rico, States and political subdivisions		-		6,742		-		6,742
Collateralized mortgage obligations - federal agencies		-		728,671		-		728,671
Mortgage-backed securities		-		3,957,545		1,233		3,958,778
Other		-		488		-		488
Total debt securities available-for-sale	$	2,719,740	$	10,579,211	$	1,233	$	13,300,184
Trading account debt securities, excluding derivatives:
U.S. Treasury securities	$	6,278	$	-	$	-	$	6,278
Obligations of Puerto Rico, States and political subdivisions		-		134		-		134
Collateralized mortgage obligations		-		48		611		659
Mortgage-backed securities		-		27,214		43		27,257
Other		-		2,974		485		3,459
Total trading account debt securities, excluding derivatives	$	6,278	$	30,370	$	1,139	$	37,787
Equity securities	$	-	$	13,296	$	-	$	13,296
Mortgage servicing rights		-		-		169,777		169,777
Derivatives		-		13,603		-		13,603
Total assets measured at fair value on a recurring basis	$	2,726,018	$	10,636,480	$	172,149	$	13,534,647
Liabilities
Derivatives	$	-	$	(12,320)	$	-	$	(12,320)
Total liabilities measured at fair value on a recurring basis	$	-	$	(12,320)	$	-	$	(12,320)

The fair value information included in the following tables is not as of period end, but as of the date that the fair value measurement was recorded during the quarters and nine months ended September 30, 2019 and 2018 and excludes nonrecurring fair value measurements of assets no longer outstanding as of the reporting date.

Nine months ended September 30, 2019
(In thousands)		Level 1		Level 2		Level 3		Total
NONRECURRING FAIR VALUE MEASUREMENTS
Assets											Write-downs
Loans[1]		$	-	$	-	$	65,922	$	65,922	$	(10,761)
Other real estate owned[2]			-		-		17,942		17,942		(3,486)
Other foreclosed assets[2]			-		-		1,221		1,221		(153)
Long-lived assets held-for-sale[3]			-		-		2,500		2,500		(2,591)
Total assets measured at fair value on a nonrecurring basis		$	-	$	-	$	87,585	$	87,585	$	(16,991)
[1]	Relates mostly to certain impaired collateral dependent loans. The impairment was measured based on the fair value of the collateral, which is derived from appraisals that take into consideration prices in observed transactions involving similar assets in similar locations, in accordance with the provisions of ASC Section 310-10-35. Costs to sell are excluded from the reported fair value amount.
[2]	Represents the fair value of foreclosed real estate and other collateral owned that were written down to their fair value. Costs to sell are excluded from the reported fair value amount.
[3]	Represents the fair value of long-lived assets held-for-sale that were written down to their fair value.

Nine months ended September 30, 2018
(In thousands)		Level 1		Level 2		Level 3		Total
NONRECURRING FAIR VALUE MEASUREMENTS
Assets											Write-downs
Loans[1]		$	-	$	-	$	79,347	$	79,347	$	(28,769)
Other real estate owned[2]			-		-		42,572		42,572		(8,744)
Other foreclosed assets[2]			-		-		2,596		2,596		(957)
Total assets measured at fair value on a nonrecurring basis		$	-	$	-	$	124,515	$	124,515	$	(38,470)
[1]	Relates mostly to certain impaired collateral dependent loans. The impairment was measured based on the fair value of the collateral, which is derived from appraisals that take into consideration prices in observed transactions involving similar assets in similar locations, in accordance with the provisions of ASC Section 310-10-35. Costs to sell are excluded from the reported fair value amount.
[2]	Represents the fair value of foreclosed real estate and other collateral owned that were written down to their fair value. Costs to sell are excluded from the reported fair value amount.

The following tables present the changes in Level 3 assets and liabilities measured at fair value on a recurring basis for the quarters and nine months ended September 30, 2019 and 2018.

	Quarter ended September 30, 2019
		MBS		CMOs				Other
		classified		classified				securities
		as debt		as trading		MBS		classified
		securities		account		classified as		as trading		Mortgage
		available-		debt		trading account		account debt		servicing		Total
(In thousands)		for-sale		securities		debt securities		securities		rights		assets
Balance at June 30, 2019		$	1,235	$	618	$	26	$	468	$	153,021	$	155,368
Gains (losses) included in earnings			-		(1)		-		(12)		(4,842)		(4,855)
Gains (losses) included in OCI			(1)		-		-		-		-		(1)
Additions			-		1		-		-		2,473		2,474
Settlements			(25)		(61)		-		-		-		(86)
Balance at September 30, 2019		$	1,209	$	557	$	26	$	456	$	150,652	$	152,900
Changes in unrealized gains (losses) included in earnings relating to assets still held at September 30, 2019		$	-	$	1	$	-	$	5	$	(1,575)	$	(1,569)

	Nine months ended September 30, 2019
		MBS						Other
		classified		CMOs				securities
		as investment		classified		MBS		classified
		securities		as trading		classified as		as trading		Mortgage
		available-		account		trading account		account		servicing		Total
(In thousands)		for-sale		securities		securities		securities		rights		assets
Balance at January 1, 2019		$	1,233	$	611	$	43	$	485	$	169,777	$	172,149
Gains (losses) included in earnings			-		-		(1)		(29)		(25,853)		(25,883)
Gains (losses) included in OCI			1		-		-		-		-		1
Additions			-		65		25		-		6,728		6,818
Settlements			(25)		(119)		(41)		-		-		(185)
Balance at September 30, 2019		$	1,209	$	557	$	26	$	456	$	150,652	$	152,900
Changes in unrealized gains (losses) included in earnings relating to assets still held at September 30, 2019		$	-	$	-	$	1	$	13	$	(15,993)	$	(15,979)

	Quarter ended September 30, 2018
		MBS						Other
		classified		CMOs				securities
		as investment		classified		MBS		classified
		securities		as trading		classified as		as trading		Mortgage
		available-		account		trading account		account		servicing		Total
(In thousands)		for-sale		securities		securities		securities		rights		assets
Balance at June 30, 2018		$	1,264	$	670	$	43	$	506	$	164,025	$	166,508
Gains (losses) included in earnings			-		-		-		(8)		(4,194)		(4,202)
Gains (losses) included in OCI			(1)		-		-		-		-		(1)
Additions			-		7		-		-		2,946		2,953
Settlements			-		(33)		-		-		-		(33)
Balance at September 30, 2018		$	1,263	$	644	$	43	$	498	$	162,777	$	165,225
Changes in unrealized gains (losses) included in earnings relating to assets still held at September 30, 2018		$	-	$	-	$	-	$	3	$	-	$	3

	Nine months ended September 30, 2018
		MBS						Other
		classified		CMOs				securities
		as investment		classified		MBS		classified
		securities		as trading		classified as		as trading		Mortgage
		available-		account		trading account		account		servicing		Total		Contingent		Total
(In thousands)		for-sale		securities		securities		securities		rights		assets		consideration [1]		liabilities
Balance at January 1, 2018		$	1,288	$	529	$	43	$	529	$	168,031	$	170,420	$	(164,858)	$	(164,858)
Gains (losses) included in earnings			-		6		-		(31)		(13,123)		(13,148)		(6,112)		(6,112)
Gains (losses) included in OCI			1		-		-		-		-		1		-		-
Additions			-		260		-		-		7,869		8,129		-		-
Settlements			(26)		(151)		-		-		-		(177)		170,970		170,970
Balance at September 30, 2018		$	1,263	$	644	$	43	$	498	$	162,777	$	165,225	$	-	$	-
Changes in unrealized gains (losses) included in earnings relating to assets still held at September 30, 2018		$	-	$	6	$	-	$	14	$	-	$	20	$	-	$	-
[1]	Effective May 22, 2018, the Corporation entered into a Termination Agreement with the FDIC to terminate the Corporation's loss share arrangement ahead of their contractual maturities. Refer to Note 10 for additional information.

Gains and losses (realized and unrealized) included in earnings for the quarters and nine months ended September 30, 2019 and 2018 for Level 3 assets and liabilities included in the previous tables are reported in the consolidated statement of operations as follows:

	Quarter ended September 30, 2019				Nine months ended September 30, 2019
			Changes in unrealized				Changes in unrealized
	Total gains		gains (losses) relating to		Total gains		gains (losses) relating to
	(losses) included		assets still held at		(losses) included		assets still held at
(In thousands)	in earnings		reporting date		in earnings		reporting date
Mortgage banking activities	$	(4,842)	$	(1,575)	$	(25,853)	$	(15,993)
Trading account profit (loss)		(13)		6		(30)		14
Total	$	(4,855)	$	(1,569)	$	(25,883)	$	(15,979)

	Quarter ended September 30, 2018				Nine months ended September 30, 2018
			Changes in unrealized				Changes in unrealized
	Total gains		gains (losses) relating to		Total gains		gains (losses) relating to
	(losses) included		assets still held at		(losses) included		assets still held at
(In thousands)	in earnings		reporting date		in earnings		reporting date
FDIC loss share expense	$	-	$	-	$	(6,112)	$	-
Mortgage banking activities		(4,194)		-		(13,123)		-
Trading account profit (loss)		(8)		3		(25)		20
Total	$	(4,202)	$	3	$	(19,260)	$	20

The following table includes quantitative information about significant unobservable inputs used to derive the fair value of Level 3 instruments, excluding those instruments for which the unobservable inputs were not developed by the Corporation such as prices of prior transactions and/or unadjusted third-party pricing sources.

			Fair value
			at September 30,
(In thousands)			2019		Valuation technique	Unobservable inputs	Weighted average (range) [1]
CMO's - trading		$	557		Discounted cash flow model	Weighted average life	1.7 years (1.4 - 1.8 years)
						Yield	4.0% (3.9% - 4.4%)
						Prepayment speed	18.5% (15.2% - 20.7%)
Other - trading		$	456		Discounted cash flow model	Weighted average life	5.2 years
						Yield	12.0%
						Prepayment speed	10.8%
Mortgage servicing rights		$	150,652		Discounted cash flow model	Prepayment speed	6.8% (0.2% - 19.9%)
						Weighted average life	6.2 years (0.1 - 13.9 years)
						Discount rate	11.2% (9.5% - 14.7%)
Loans held-in-portfolio		$	62,442	[2]	External appraisal	Haircut applied on
						external appraisals	10.3% (10.0% - 21.0%)
Other real estate owned		$	15,003	[3]	External appraisal	Haircut applied on
						external appraisals	23.5% (10.0% - 35.0%)
[1]	Weighted average of significant unobservable inputs used to develop Level 3 fair value measurements were calculated by relative fair value.
[2]	Loans held-in-portfolio in which haircuts were not applied to external appraisals were excluded from this table.
[3]	Other real estate owned in which haircuts were not applied to external appraisals were excluded from this table.

The significant unobservable inputs used in the fair value measurement of the Corporation’s collateralized mortgage obligations and interest-only collateralized mortgage obligation (reported as “other”), which are classified in the “trading” category, are yield, constant prepayment rate, and weighted average life. Significant increases (decreases) in any of those inputs in isolation would result in significantly lower (higher) fair value measurement. Generally, a change in the assumption used for the constant prepayment rate will generate a directionally opposite change in the weighted average life. For example, as the average life is reduced by a higher constant prepayment rate, a lower yield will be realized, and when there is a reduction in the constant prepayment rate, the average life of these collateralized mortgage obligations will extend, thus resulting in a higher yield.The significant unobservable inputs used in the fair value measurement of the Corporation’s mortgage servicing rights are constant prepayment rates and discount rates. Increases in interest rates may result in lower prepayments. Discount rates vary according to products and / or portfolios depending on the perceived risk. Increases in discount rates result in a lower fair value measurement.