Fair value measurement

6 Months Ended

Jun. 30, 2021

Fair Value Disclosures

Fair Value Measurement

Note 23 – Fair value measurement

ASC 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 2020 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 June 30, 2021 and December 31, 2020:

At June 30, 2021
(In thousands)	Level 1		Level 2		Level 3		Total
RECURRING FAIR VALUE MEASUREMENTS
Assets
Debt securities available-for-sale:
U.S. Treasury securities	$	399,994	$	11,579,320	$	-	$	11,979,314
Obligations of U.S. Government sponsored entities		-		90		-		90
Collateralized mortgage obligations - federal agencies		-		282,922		-		282,922
Mortgage-backed securities		-		10,071,727		938		10,072,665
Other		-		176		-		176
Total debt securities available-for-sale	$	399,994	$	21,934,235	$	938	$	22,335,167
Trading account debt securities, excluding derivatives:
U.S. Treasury securities	$	10,060	$	-	$	-	$	10,060
Obligations of Puerto Rico, States and political subdivisions		-		96		-		96
Collateralized mortgage obligations		-		64		250		314
Mortgage-backed securities		-		25,100		-		25,100
Other		-		-		361		361
Total trading account debt securities, excluding derivatives	$	10,060	$	25,260	$	611	$	35,931
Equity securities	$	-	$	33,781	$	-	$	33,781
Mortgage servicing rights		-		-		119,467		119,467
Derivatives		-		23,573		-		23,573
Total assets measured at fair value on a recurring basis	$	410,054	$	22,016,849	$	121,016	$	22,547,919
Liabilities
Derivatives	$	-	$	(20,960)	$	-	$	(20,960)
Total liabilities measured at fair value on a recurring basis	$	-	$	(20,960)	$	-	$	(20,960)

At December 31, 2020
(In thousands)	Level 1		Level 2		Level 3		Total
RECURRING FAIR VALUE MEASUREMENTS
Assets
Debt securities available-for-sale:
U.S. Treasury securities	$	3,499,781	$	7,288,259	$	-	$	10,788,040
Obligations of U.S. Government sponsored entities		-		60,184		-		60,184
Collateralized mortgage obligations - federal agencies		-		392,132		-		392,132
Mortgage-backed securities		-		10,319,547		1,014		10,320,561
Other		-		235		-		235
Total debt securities available-for-sale	$	3,499,781	$	18,060,357	$	1,014	$	21,561,152
Trading account debt securities, excluding derivatives:
U.S. Treasury securities	$	11,506	$	-	$	-	$	11,506
Obligations of Puerto Rico, States and political subdivisions		-		103		-		103
Collateralized mortgage obligations		-		68		278		346
Mortgage-backed securities		-		24,338		-		24,338
Other		-		-		381		381
Total trading account debt securities, excluding derivatives	$	11,506	$	24,509	$	659	$	36,674
Equity securities	$	-	$	29,590	$	-	$	29,590
Mortgage servicing rights		-		-		118,395		118,395
Derivatives		-		20,785		-		20,785
Total assets measured at fair value on a recurring basis	$	3,511,287	$	18,135,241	$	120,068	$	21,766,596
Liabilities
Derivatives	$	-	$	(18,925)	$	-	$	(18,925)
Total liabilities measured at fair value on a recurring basis	$	-	$	(18,925)	$	-	$	(18,925)

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 six months ended June 30, 2021 and 2020 and excludes nonrecurring fair value measurements of assets no longer outstanding as of the reporting date.

Six months ended June 30, 2021
(In thousands)	Level 1		Level 2		Level 3		Total
NONRECURRING FAIR VALUE MEASUREMENTS
Assets										Write-downs
Loans[1]	$	-	$	-	$	19,369	$	19,369	$	(2,957)
Loans held-for-sale[2]		-		-		8,700		8,700		(596)
Other real estate owned[3]		-		-		7,942		7,942		(1,503)
Long-lived assets held-for-sale[4]		-		-		2,728		2,728		(303)
Total assets measured at fair value on a nonrecurring basis	$	-	$	-	$	38,739	$	38,739	$	(5,359)
[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. Costs to sell are excluded from the reported fair value amount.
[2] Relates to a quarterly valuation on loans held-for-sale. Costs to sell are excluded from the reported fair value amount.
[3] 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.
[4] Represents the fair value of long-lived assets held-for-sale that were written down to their fair value.

Six months ended June 30, 2020
(In thousands)	Level 1		Level 2		Level 3		Total
NONRECURRING FAIR VALUE MEASUREMENTS
Assets										Write-downs
Loans[1]	$	-	$	-	$	5,121	$	5,121	$	(872)
Other real estate owned[2]		-		-		17,581		17,581		(2,636)
Other foreclosed assets[2]		-		-		1,021		1,021		(152)
Total assets measured at fair value on a nonrecurring basis	$	-	$	-	$	23,723	$	23,723	$	(3,660)
[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. 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 six months ended June 30, 2021 and 2020.

	Quarter ended June 30, 2021
		MBS		CMOs		Other
		classified		classified		securities
		as debt		as trading		classified
		securities		account		as trading		Mortgage
		available-		debt		account debt		servicing		Total
(In thousands)		for-sale		securities		securities		rights		assets
Balance at March 31, 2021		$	934	$	251	$	372	$	122,543	$	124,100
Gains (losses) included in earnings			-		-		(11)		(6,249)		(6,260)
Gains (losses) included in OCI			4		-		-		-		4
Additions			-		23		-		3,173		3,196
Settlements			-		(24)		-		-		(24)
Balance at June 30, 2021		$	938	$	250	$	361	$	119,467	$	121,016
Changes in unrealized gains (losses) included in earnings relating to assets still held at June 30, 2021		$	-	$	-	$	5	$	(2,036)	$	(2,031)

	Six months ended June 30, 2021
		MBS				Other
		classified		CMOs		securities
		as investment		classified		classified
		securities		as trading		as trading		Mortgage
		available-		account		account		servicing		Total
(In thousands)		for-sale		securities		securities		rights		assets
Balance at January 1, 2021		$	1,014	$	278	$	381	$	118,395	$	120,068
Gains (losses) included in earnings			-		-		(20)		(5,737)		(5,757)
Gains (losses) included in OCI			(1)		-		-		-		(1)
Additions			-		24		-		6,809		6,833
Settlements			(75)		(52)		-		-		(127)
Balance at June 30, 2021		$	938	$	250	$	361	$	119,467	$	121,016
Changes in unrealized gains (losses) included in earnings relating to assets still held at June 30, 2021		$	-	$	-	$	9	$	3,126	$	3,135

	Quarter ended June 30, 2020
		MBS				Other
		classified		CMOs		securities
		as investment		classified		classified
		securities		as trading		as trading		Mortgage
		available-		account		account		servicing		Total
(In thousands)		for-sale		securities		securities		rights		assets
Balance at March 31, 2020		$	1,177	$	467	$	428	$	147,311	$	149,383
Gains (losses) included in earnings			-		(1)		(5)		(7,640)		(7,646)
Gains (losses) included in OCI			(1)		-		-		-		(1)
Additions			-		-		-		1,473		1,473
Settlements			(25)		(24)		-		-		(49)
Balance at June 30, 2020		$	1,151	$	442	$	423	$	141,144	$	143,160
Changes in unrealized gains (losses) included in earnings relating to assets still held at June 30, 2020		$	-	$	(1)	$	2	$	(4,947)	$	(4,946)

	Six months ended June 30, 2020
		MBS				Other
		classified		CMOs		securities
		as investment		classified		classified
		securities		as trading		as trading		Mortgage
		available-		account		account		servicing		Total
(In thousands)		for-sale		securities		securities		rights		assets
Balance at January 1, 2020		$	1,182	$	530	$	440	$	150,906	$	153,058
Gains (losses) included in earnings			-		-		(17)		(12,869)		(12,886)
Gains (losses) included in OCI			(6)		-		-		-		(6)
Additions			-		2		-		3,107		3,109
Settlements			(25)		(90)		-		-		(115)
Balance at June 30, 2020		$	1,151	$	442	$	423	$	141,144	$	143,160
Changes in unrealized gains (losses) included in earnings relating to assets still held at June 30, 2020		$	-	$	1	$	8	$	(7,386)	$	(7,377)

Gains and losses (realized and unrealized) included in earnings for the quarters and six months ended June 30, 2021 and 2020 for Level 3 assets and liabilities included in the previous tables are reported in the consolidated statement of operations as follows:

	Quarter ended June 30, 2021				Six months ended June 30, 2021
			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	$	(6,249)	$	(2,036)	$	(5,737)	$	3,126
Trading account profit (loss)		(11)		5		(20)		9
Total	$	(6,260)	$	(2,031)	$	(5,757)	$	3,135

	Quarter ended June 30, 2020				Six months ended June 30, 2020
			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	$	(7,640)	$	(4,947)	$	(12,869)	$	(7,386)
Trading account profit (loss)		(6)		1		(17)		9
Total	$	(7,646)	$	(4,946)	$	(12,886)	$	(7,377)

The following tables include 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 at June 30, 2021 and 2020.

			Fair value
			at June 30,
(In thousands)			2021		Valuation technique	Unobservable inputs	Weighted average (range) [1]
CMO's - trading		$	250		Discounted cash flow model	Weighted average life	1.0 years (0.3 - 1.2 years)
						Yield	3.6% (3.6% - 4.1%)
						Prepayment speed	13.1% (10.2% - 18.1%)
Other - trading		$	361		Discounted cash flow model	Weighted average life	3.6 years
						Yield	12.0%
						Prepayment speed	10.8%
Mortgage servicing rights		$	119,467		Discounted cash flow model	Prepayment speed	6.0% (0.3% - 33.1%)
						Weighted average life	6.2 years (0.1 - 13.1 years)
						Discount rate	11.1% (9.5% - 14.7%)
Loans held-in-portfolio		$	18,565	[2]	External appraisal	Haircut applied on
						external appraisals	11.1% (10.0% - 30.5%)
Other real estate owned		$	6,672	[3]	External appraisal	Haircut applied on
						external appraisals	20.3% (5.0% - 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.

			Fair value
			at June 30,
(In thousands)			2020		Valuation technique	Unobservable inputs	Weighted average (range) [1]
CMO's - trading		$	442		Discounted cash flow model	Weighted average life	1.4 years (0.7 - 1.5 years)
						Yield	3.8% (3.7% - 4.3%)
						Prepayment speed	18.3% (15.2% - 19.6%)
Other - trading		$	423		Discounted cash flow model	Weighted average life	3.8 years
						Yield	12.0%
						Prepayment speed	10.8%
Mortgage servicing rights		$	141,144		Discounted cash flow model	Prepayment speed	6.7% (0.3% - 24.6%)
						Weighted average life	6.2 years (0.1 - 14.4 years)
						Discount rate	11.2% (9.5% - 14.7%)
Loans held-in-portfolio		$	5,121	[2]	External appraisal	Haircut applied on
						external appraisals	24.6% (10.0% - 40.1%)
Other real estate owned		$	11,853	[3]	External appraisal	Haircut applied on
						external appraisals	21.7% (5.0% - 30.0%)
[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.