INVESTMENT SECURITIES

9 Months Ended

Sep. 30, 2018

Debt and Equity Securities [Abstract]

Investments In Debt And Marketable Equity Securities And Certain Trading Assets Disclosure

NOTE 5 – INVESTMENT SECURITIES

Investment Securities Available for Sale

The amortized cost, non-credit loss component of OTTI recorded in OCI, gross unrealized gains and losses recorded in OCI, estimated fair value, and weighted-average yield of investment securities available for sale by contractual maturities as of September 30, 2018 and December 31, 2017 were as follows:

		September 30, 2018
		Amortized cost		Noncredit Loss Component of OTTI Recorded in OCI						Fair value
						Gross Unrealized						Weighted-
						gains		losses				average yield%
(Dollars in thousands)

U.S. Treasury securities:
	Due within one year	$	7,481	$	-	$	-	$	55	$	7,426	1.29

U.S. government-sponsored
agencies obligations:
Due within one year			156,575		-		-		1,584		154,991	1.25
After 1 to 5 years			236,368		-		-		4,480		231,888	1.82
After 5 to 10 years			191,119		-		47		5,505		185,661	2.94
After 10 years			43,638		-		-		241		43,397	2.50

Puerto Rico government
obligations:
After 5 to 10 years			4,013		-		129		-		4,142	3.14
After 10 years			4,111		-		-		1,313		2,798	6.97

United States and Puerto Rico
government obligations			643,305		-		176		13,178		630,303	2.10

Mortgage-backed securities (“MBS”):
Freddie Mac (“FHLMC”) certificates:
After 5 to 10 years			96,598		-		8		3,527		93,079	2.09
After 10 years			274,233		-		-		9,636		264,597	2.50
			370,831		-		8		13,163		357,676	2.39

Ginnie Mae (“GNMA”) certificates:
After 1 to 5 years			160		-		2		-		162	3.52
After 5 to 10 years			65,411		-		305		714		65,002	2.89
After 10 years			122,975		-		2,962		1,030		124,907	3.93
			188,546		-		3,269		1,744		190,071	3.57
Fannie Mae (“FNMA”) certificates:
Due within one year			379		-		8		-		387	1.91
After 1 to 5 years			25,872		-		-		468		25,404	2.75
After 5 to 10 years			191,965		-		-		6,982		184,983	2.22
After 10 years			557,882		-		1,055		18,909		540,028	2.65
			776,098		-		1,063		26,359		750,802	2.55
Collateralized mortgage obligations
guaranteed by the FHLMC
and GNMA:
After 1 to 5 years			7,462		-		4		10		7,456	2.91
After 10 years			59,575		-		348		81		59,842	3.07
			67,037		-		352		91		67,298	3.05
Other mortgage pass-through
trust certificates:
After 10 years			20,038		5,467		-		-		14,571	4.57
Total MBS			1,422,550		5,467		4,692		41,357		1,380,418	2.70

Other
After 1 to 5 years			500		-		-		-		500	2.96

Total investment securities
available for sale		$	2,066,355	$	5,467	$	4,868	$	54,535	$	2,011,221	2.51

		December 31, 2017
		Amortized cost		Noncredit Loss Component of OTTI Recorded in OCI		Gross Unrealized				Fair value
						Gross Unrealized						Weighted-
						gains		losses				average yield%

(Dollars in thousands)

U.S. Treasury securities:
	After 1 to 5 years	$	7,458	$	-	$	-	$	57	$	7,401	1.29

U.S. government-sponsored
agencies obligations:
	Due within one year		122,471		-		-		319		122,152	1.06
	After 1 to 5 years		309,472		-		28		3,735		305,765	1.42
	After 5 to 10 years		133,451		-		117		319		133,249	2.72
	After 10 years		40,769		-		1		149		40,621	1.84

Puerto Rico government
obligations:
	After 5 to 10 years		4,071		-		47		-		4,118	3.14
	After 10 years		3,972		-		-		1,277		2,695	6.97

United States and Puerto Rico
government obligations			621,664		-		193		5,856		616,001	1.70

MBS:

FHLMC certificates:
	After 5 to 10 years		18,658		-		14		63		18,609	2.14
	After 10 years		297,733		-		217		4,853		293,097	2.23
			316,391		-		231		4,916		311,706	2.23
GNMA certificates:
	After 1 to 5 years		81		-		1		-		82	3.23
	After 5 to 10 years		69,661		-		1,244		-		70,905	3.05
	After 10 years		145,067		-		5,910		334		150,643	3.81
			214,809		-		7,155		334		221,630	3.56
FNMA certificates:
	After 1 to 5 years		20,831		-		294		109		21,016	2.69
	After 5 to 10 years		49,934		-		-		818		49,116	1.83
	After 10 years		613,129		-		3,180		6,401		609,908	2.43
			683,894		-		3,474		7,328		680,040	2.39

Collateralized mortgage
	obligations issued or guaranteed
	by the FHLMC and GNMA:
	After 1 to 5 years		5,918		-		14		-		5,932	2.21
	After 5 to 10 years		2,556		-		11		-		2,567	2.23
	After 10 years		35,331		-		231		-		35,562	2.22
			43,805		-		256		-		44,061	2.22

Other mortgage pass-through
trust certificates:
	After 10 years		22,791		5,731		-		-		17,060	2.44

Total MBS			1,281,690		5,731		11,116		12,578		1,274,497	2.54

Other
	Due within one year		100		-		-		-		100	1.48

Equity securities (1)			424		-		-		6		418	2.11

Total investment securities
	available for sale	$	1,903,878	$	5,731	$	11,309	$	18,440	$	1,891,016	2.27


⁽¹⁾	As of January 1, 2018, the Corporation adopted ASU 2016-01, resulting in the reclassification of $0.4 million in equity securities from available-for-sale investment securities to other investment securities.

Maturities of MBS are based on the period of final contractual maturity. Expected maturities of investments might differ from contractual maturities because they may be subject to prepayments and/or call options. 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 noncredit 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, 2018 and December 31, 2017. The tables also include debt securities for which an OTTI was recognized and only the amount related to a credit loss was recognized in earnings. For unrealized losses for which OTTI was recognized, the related credit loss was charged against the amortized cost basis of the debt security.

		As of September 30, 2018
		Less than 12 months				12 months or more				Total
				Unrealized				Unrealized				Unrealized
		Fair Value		Losses		Fair Value		Losses		Fair Value		Losses
	(In thousands)
	Debt securities:
	Puerto Rico-government obligations	$	-	$	-	$	2,798	$	1,313	$	2,798	$	1,313
	U.S. Treasury and U.S. government
	agenciesʼ obligations		251,555		5,585		366,761		6,280		618,316		11,865
	MBS:
	FNMA		342,334		6,489		369,408		19,870		711,742		26,359
	FHLMC		183,780		3,508		173,733		9,655		357,513		13,163
	GNMA		34,354		491		32,999		1,253		67,353		1,744
	Collateralized mortgage obligations
	issued or guaranteed by
	FHLMC and GNMA		31,963		91		-		-		31,963		91
	Other mortgage pass-through
	trust certificates		-		-		14,571		5,467		14,571		5,467
		$	843,986	$	16,164	$	960,270	$	43,838	$	1,804,256	$	60,002


		As of December 31, 2017
		Less than 12 months				12 months or more				Total
				Unrealized				Unrealized				Unrealized
		Fair Value		Losses		Fair Value		Losses		Fair Value		Losses
(In thousands)
Debt securities:
Puerto Rico-government obligations		$	-	$	-	$	2,695	$	1,277	$	2,695	$	1,277
U.S. Treasury and U.S. government
agenciesʼ obligations			136,459		494		362,050		4,085		498,509		4,579
MBS:
FNMA			189,699		1,705		274,963		5,623		464,662		7,328
FHLMC			91,174		590		166,331		4,326		257,505		4,916
GNMA			39,145		334		-		-		39,145		334
Other mortgage pass-through
trust certificates			-		-		17,060		5,731		17,060		5,731
Equity securities (1)			-		-		407		6		407		6
		$	456,477	$	3,123	$	823,506	$	21,048	$	1,279,983	$	24,171

(1)	As of January 1, 2018, the Corporation adopted ASU 2016-01, resulting in the reclassification of $0.4 million in equity securities from available-for-sale investment securities to other investment securities.

Assessment for OTTI

Debt securities issued by U.S. government agencies, U.S. government-sponsored entities, and the U.S. Treasury accounted for approximately 99% of the total available-for-sale portfolio as of September 30, 2018, and no credit losses are expected, given the explicit and implicit guarantees provided by the U.S. federal government. The Corporation’s OTTI assessment was concentrated mainly on private label MBS, and on Puerto Rico government debt securities, 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;
Any adverse change to the credit conditions and liquidity of the issuer, taking into consideration the latest information available about the financial condition of the issuer, credit ratings, the failure of the issuer to make scheduled principal or interest payments, recent legislation and government actions affecting the issuer’s industry, and actions taken by the issuer to deal with the present economic climate;
Changes in the near term prospects of the underlying collateral for a security, if any, such as changes in default rates, loss severity given default, and significant changes in prepayment assumptions; and
The level of cash flows generated from the underlying collateral, if any, supporting the principal and interest payments of the debt securities.

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


		Quarter Ended				Nine-Month Period Ended
		September 30,				September 30,
		2018		2017		2018		2017
(In thousands)
Total OTTI losses		$	-	$	-	$	-	$	(12,231)
Portion of OTTI recognized in OCI			-		-		-		-
Net impairment losses recognized in earnings (1)		$	-	$	-	$	-	$	(12,231)

(1)	Credit losses on Puerto Rico government debt securities, recorded in the first quarter of 2017.

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

Cumulative OTTI credit losses recognized in earnings on securities still held

Credit impairments

Credit loss

June 30,

recognized in earnings on

reductions for

September 30,

2018

securities that have been

securities sold

2018

Balance

previously impaired

during the period

Balance

(In thousands)

Available-for-sale securities

Private label MBS

6,792

Cumulative OTTI credit losses recognized in earnings on securities still held

Credit impairments

Credit loss

December 31,

recognized in earnings on

reductions for

September 30,

2017

securities that have been

securities sold

2018

Balance

previously impaired

during the period

Balance

(In thousands)

Available-for-sale securities

Private label MBS

6,792


	Cumulative OTTI credit losses recognized in earnings on securities still held
			Credit impairments
	June 30,		recognized in earnings		Credit loss reductions		September 30,
	2017		on securities that have been		for securities sold		2017
	Balance		previously impaired		during the period		Balance
(In thousands)
Available-for-sale securities
Private label MBS	$	6,792	$	-	$	-	$	6,792


	Cumulative OTTI credit losses recognized in earnings on securities still held
			Credit impairments
	December 31,		recognized in earnings		Credit loss reductions		September 30,
	2016		on securities that have been		for securities sold		2017
	Balance		previously impaired		during the period		Balance
(In thousands)
Available-for-sale securities
Puerto Rico government obligations	$	22,189	$	12,231	$	(34,420)	$	-
Private label MBS		6,792		-		-		6,792
Total OTTI credit losses for available-for-sale
debt securities	$	28,981	$	12,231	$	(34,420)	$	6,792

During the second quarter of 2017, the Corporation sold for an aggregate of $23.4 million three Puerto Rico government available-for-sale debt securities, specifically bonds of the Government Development Bank for Puerto Rico (the “GDB”) and the Puerto Rico Public Buildings Authority, carried on its book at an amortized cost at the time of sale of $23.0 million (net of $34.4 million in cumulative OTTI impairment charges). Approximately $12.2 million of the cumulative OTTI charges on these securities was recorded in the first quarter of 2017.

For the OTTI charge recorded on the Puerto Rico government debt securities in the first quarter of 2017, the Corporation considered the latest available information about the Puerto Rico government’s financial condition, including but not limited to credit, ratings downgrades, revised estimates of recovery rates, and other relevant developments such as government actions, including debt exchange proposals and the fiscal plan published by the Puerto Rico government in March 2017, as applicable. The Corporation applied a discounted cash flow analysis to its Puerto Rico government debt securities in order to calculate the cash flows expected to be collected and to determine if any portion of the decline in market value of these securities was considered a credit-related OTTI. The analysis derived an estimate of value based on the present value of risk-adjusted cash flows of the underlying securities and included the following components:

The contractual future cash flows of the bonds were projected based on the key terms as set forth in the official statements for each security. Such key terms included, among others, the interest rate, amortization schedule, if any, and maturity date.

The risk-adjusted cash flows were calculated based on a probability of default analysis and recovery rate assumptions, including the weighting of different scenarios of ultimate recovery, considering the credit rating of each security. Constant monthly default rates were assumed throughout the life of the bonds, which considered the respective security’s credit rating as of the date of the analysis.

The adjusted future cash flows were then discounted at the original effective yield of each investment based on the purchase price and expected risk-adjusted future cash flows as of the purchase date of each investment.

The discounted risk-adjusted cash flow analysis for the three Puerto Rico government bonds mentioned above assumed a default probability of 100%, as these three non-performing bonds had been in default since the third quarter of 2016. Based on this analysis, the Corporation recorded in the first quarter of 2017 credit-related OTTI amounting to $12.2 million, assuming recovery rates ranging from 15% to 80% (with a weighted average of 41%).

In addition, the Corporation performed an OTTI assessment on its 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 on the underlying collateral. The underlying mortgages are fixed-rate, single-family loans with original high FICO scores (over 700) and moderate loan-to-value ratios (under 80%), as well as moderate delinquency levels.

Based on the expected cash flows, 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, if any, is reflected in earnings. Significant assumptions in the valuation of the private label MBS were as follows:

	As of		As of
	September 30, 2018		December 31, 2017
	Weighted		Weighted
	Average	Range	Average	Range

Discount rate	14.8%	14.8%	14.0%	14.0%
Prepayment rate	11.7%	3.5% - 22.5%	16.4%	12.0% - 29.0%
Projected Cumulative Loss Rate	4%	0% - 7.8%	3%	0% - 6.8%

No OTTI charges on private label MBS were recorded in either the first nine months of 2018 or the first nine months of 2017.

Investments Held to Maturity

The amortized cost, gross unrecognized gains and losses, estimated fair value, weighted-average yield and contractual maturities of investment securities held to maturity as of September 30, 2018 and December 31, 2017 were as follows:

		September 30, 2018
		Amortized cost						Fair value
				Gross Unrecognized
				gains		losses				Weighted- average yield%

Puerto Rico Municipal Bonds:
	After 1 to 5 years	$	6,096	$	-	$	364	$	5,732	4.73
	After 5 to 10 years		53,006		-		3,374		49,632	5.94
	After 10 years		85,697		-		9,358		76,339	5.78
Total investment securities
	held to maturity	$	144,799	$	-	$	13,096	$	131,703	5.79

		December 31, 2017
		Amortized cost						Fair value
				Gross Unrecognized
				gains		losses				Weighted- average yield%

Puerto Rico Municipal Bonds:
	After 1 to 5 years	$	3,853	$	-	$	173	$	3,680	5.38
	After 5 to 10 years		39,523		-		3,048		36,475	5.28
	After 10 years		107,251		-		16,374		90,877	4.93
Total investment securities
	held to maturity	$	150,627	$	-	$	19,595	$	131,032	5.03

The following tables show the Corporation’s held-to-maturity investments’ fair value and gross unrecognized losses, aggregated by investment category and length of time that individual securities have been in a continuous unrecognized loss position, as of September 30, 2018 and December 31, 2017:

	As of September 30, 2018
	Less than 12 months				12 months or more				Total
			Unrecognized				Unrecognized				Unrecognized
	Fair Value		Losses		Fair Value		Losses		Fair Value		Losses
		(In thousands)
Debt securities:
Puerto Rico Municipal Bonds	$	-	$	-	$	131,703	$	13,096	$	131,703	$	13,096


	As of December 31, 2017
	Less than 12 months				12 months or more				Total
			Unrecognized				Unrecognized				Unrecognized
	Fair Value		Losses		Fair Value		Losses		Fair Value		Losses
		(In thousands)
Debt securities:
Puerto Rico Municipal Bonds	$	-	$	-	$	131,032	$	19,595	$	131,032	$	19,595

The Corporation determines the fair market value of Puerto Rico Municipal Bonds based on a discounted cash flow analysis using risk-adjusted discount rates. A security with similar characteristics traded in the open market is used as a proxy for each municipal bond. Then the cash flow is discounted at the average spread over the discount curve exhibited by the proxy security at the end of each quarter.

All of the Puerto Rico Municipal Bonds are performing and current as to scheduled contractual payments as of September 30, 2018. Approximately 70% of the held-to-maturity municipal bonds were issued by three of the largest municipalities in Puerto Rico. The vast majority of revenues of these three municipalities is independent of the Puerto Rico central government. These obligations typically are not issued in bearer form, nor are they registered with the SEC, and are not rated by external credit agencies. In most cases, these bonds have priority over the payment of operating costs and expenses of the municipality, which are required by law to levy special property taxes in such amounts as are required for the payment of all of their respective general obligation bonds and loans. The Corporation performs periodic credit quality reviews on these issuers. Based on the quarterly analysis performed, management concluded that no individual debt security held to maturity was other-than-temporarily impaired as of September 30, 2018.

The PROMESA oversight board has not designated any of Puerto Rico’s 78 municipalities as covered entities under PROMESA. However, while the latest fiscal plan certified by the PROMESA oversight board did not contemplate a restructuring of the debt of Puerto Rico’s municipalities, the plan did call for the gradual elimination of budgetary subsidies provided to municipalities by the central government. Furthermore, municipalities are also likely to be affected by the negative economic and other effects resulting from expense, revenue or cash management measures taken by the Puerto Rico government to address its fiscal and liquidity shortfalls, or measures included in fiscal plans of other government entities, such as the fiscal plans of the GDB and the Puerto Rico Electric Power Authority (“PREPA”). Given the uncertain effect that the negative fiscal situation of the Puerto Rico central government and the measures taken, or to be taken, by other government entities may have on municipalities, the Corporation cannot be certain whether future impairment charges will be required relating to these securities.

From time to time, the Corporation has securities held to maturity with an original maturity of three months or less that are considered cash and cash equivalents and are classified as money market investments in the consolidated statements of financial condition. As of September 30, 2018 and December 31, 2017, the Corporation had no outstanding securities held to maturity that were classified as cash and cash equivalents.