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Fair value measurement | 9 Months Ended
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Sep. 30, 2019
Fair Value Disclosures |
Fair Value Measurement | Note 25 – 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 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. S ignificant 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.

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- Definition 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. + References Reference 1: http://fasb.org/us-gaap/role/ref/legacyRef -Publisher FASB -Name Accounting Standards Codification -Topic 820 -URI http://asc.fasb.org/topic&trid=2155941 + Details
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