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Fair Value of Financial Instruments
 3 Months Ended
Mar. 31, 2019
Fair Value of Financial Instruments [Abstract]  
Fair Value of Financial Instruments

NOTE 20 - FAIR VALUE OF FINANCIAL INSTRUMENTS

Oriental follows the fair value measurement framework under U.S. Generally Accepted Accounting Principles (“GAAP”).

Fair Value Measurement

The fair value measurement framework defines fair value as the exchange price that would be received for an asset or paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. This framework also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.

Money market investments

The fair value of money market investments is based on the carrying amounts reflected in the consolidated statements of financial condition as these are reasonable estimates of fair value given the short-term nature of the instruments.

Investment securities

The fair value of investment securities is based on valuations obtained from an independent pricing provider, ICE Data Pricing (formerly known as IDC). ICE is a well-recognized pricing company and an established leader in financial information. Such securities are classified as Level 1 or Level 2 depending on the basis for determining fair value. If listed prices or quotes are not available, fair value is based upon externally developed models that use both observable and unobservable inputs depending on the market activity of the instrument, and such securities are classified as Level 3. At March 31, 2019 and December 31, 2018, Oriental did not have investment securities classified as Level 3.

Derivative instruments

The fair value of the interest rate swaps is largely a function of the financial market’s expectations regarding the future direction of interest rates. Accordingly, current market values are not necessarily indicative of the future impact of derivative instruments on earnings. This will depend, for the most part, on the shape of the yield curve, the level of interest rates, as well as the expectations for rates in the future. The fair value of most of these derivative instruments is based on observable market parameters, which include discounting the instruments’ cash flows using the U.S. dollar LIBOR-based discount rates, and also applying yield curves that account for the industry sector and the credit rating of the counterparty and/or Oriental. Certain other derivative instruments with limited market activity are valued using externally developed models that consider unobservable market parameters. Based on their valuation methodology, derivative instruments are classified as Level 2 or Level 3.

Servicing assets

Servicing assets do not trade in an active market with readily observable prices. Servicing assets are priced using a discounted cash flow model. The valuation model considers servicing fees, portfolio characteristics, prepayment assumptions, delinquency rates, late charges, other ancillary revenues, cost to service and other economic factors. Due to the unobservable nature of certain valuation inputs, the servicing rights are classified as Level 3.

Impaired Loans

Impaired loans are carried at the present value of expected future cash flows using the loan’s existing rate in a discounted cash flow calculation, or the fair value of the collateral if the loan is collateral-dependent. Expected cash flows are based on internal inputs reflecting expected default rates on contractual cash flows. This method of estimating fair value does not incorporate the exit-price concept of fair value described in ASC 820-10 and would generally result in a higher value than the exit-price approach. For loans measured using the estimated fair value of collateral less costs to sell, fair value is generally determined 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 310-10-35 less disposition costs. Currently, the associated loans considered impaired are classified as Level 3.

Foreclosed real estate

Foreclosed real estate includes real estate properties securing residential mortgage and commercial loans. The fair value of foreclosed real estate may be determined using an external appraisal, broker price option or an internal valuation. These foreclosed assets are classified as Level 3 given certain internal adjustments that may be made to external appraisals.

Other repossessed assets

Other repossessed assets include repossessed automobiles. The fair value of the repossessed automobiles may be determined using internal valuation and an external appraisal. These repossessed assets are classified as Level 3 given certain internal adjustments that may be made to external appraisals.

Assets and liabilities measured at fair value on a recurring and non-recurring basis are summarized below:

March 31, 2019
Fair Value Measurements
Level 1 Level 2 Level 3 Total
(In thousands)
Recurring fair value measurements:
Investment securities available-for-sale$-$1,239,469$-$1,239,469
Trading securities-381-381
Money market investments7,665--7,665
Derivative assets-110-110
Servicing assets--10,62310,623
Derivative liabilities-(439)-(439)
$7,665$1,239,521$10,623$1,257,809
Non-recurring fair value measurements:
Impaired commercial loans$-$-$89,362$89,362
Foreclosed real estate--30,86530,865
Other repossessed assets--3,5743,574
$-$-$123,801$123,801

December 31, 2018
Fair Value Measurements
Level 1 Level 2 Level 3 Total
(In thousands)
Recurring fair value measurements:
Investment securities available-for-sale$-$841,857$-$841,857
Trading securities-360-360
Money market investments4,930--4,930
Derivative assets-347-347
Servicing assets--10,71610,716
Derivative liabilities-(333)-(333)
$4,930$842,231$10,716$857,877
Non-recurring fair value measurements:
Impaired commercial loans$-$-$81,976$81,976
Foreclosed real estate--33,76833,768
Other repossessed assets--2,9862,986
$-$-$118,730$118,730

The table below presents a reconciliation of all assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the quarters ended March 31, 2019 and 2018:

Level 3 Instruments OnlyServicing Assets
(In thousands)
Quarter Ended March 31,
20192018
Balance at beginning of period$10,716$9,821
New instruments acquired302352
Principal repayments(201)(199)
Changes in fair value of servicing assets(194)559
Balance at end of period$10,623$10,533

During the quarters ended March 31, 2019, and 2018, there were purchases and sales of assets and liabilities measured at fair value on a recurring basis. There were no transfers into and out of Level 1 and Level 2 fair value measurements during such periods.

The table below presents quantitative information for all assets and liabilities measured at fair value on a recurring and non-recurring basis using significant unobservable inputs (Level 3) at March 31, 2019:

March 31, 2019
Fair ValueValuation TechniqueUnobservable InputRange
(In thousands)
Servicing assets$10,623Cash flow valuation Constant prepayment rate4.38% -8.96%
Discount rate10.00% - 12.00%
Collateral dependent impaired loans$44,717Fair value of property or collateralAppraised value less disposition costs16.20% - 36.20%
Other non-collateral dependent impaired loans$44,645Cash flow valuation Discount rate4.25% - 12.25%
Foreclosed real estate$30,865Fair value of property or collateralAppraised value less disposition costs16.20% - 36.20%
Other repossessed assets$3,574Fair value of property or collateralEstimated net realizable value less disposition costs40.00% - 60.00%

Information about Sensitivity to Changes in Significant Unobservable Inputs

Servicing assets – The significant unobservable inputs used in the fair value measurement of Oriental’s servicing assets are constant prepayment rates and discount rates. Changes in one factor may result in changes in another (for example, increases in market interest rates may result in lower prepayments), which may magnify or offset the sensitivities. Mortgage banking activities, a component of total banking and financial service revenue in the consolidated statements of operations, include the changes from period to period in the fair value of the mortgage loan servicing rights, which may result from changes in the valuation model inputs or assumptions (principally reflecting changes in discount rates and prepayment speed assumptions) and other changes, including changes due to collection/realization of expected cash flows.

Fair Value of Financial Instruments

The information about the estimated fair value of financial instruments required by GAAP is presented hereunder. The aggregate fair value amounts presented do not necessarily represent management’s estimate of the underlying value of Oriental.

The estimated fair value is subjective in nature, involves uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. Changes in assumptions could affect these fair value estimates. The fair value estimates do not take into consideration the value of future business and the value of assets and liabilities that are not financial instruments. Other significant tangible and intangible assets that are not considered financial instruments are the value of long-term customer relationships of retail deposits, and premises and equipment.

The estimated fair value and carrying value of Oriental’s financial instruments at March 31, 2019 and December 31, 2018 is as follows:

March 31,December 31,
20192018
FairCarryingFairCarrying
Value Value Value Value
(In thousands)
Level 1
Financial Assets:
Cash and cash equivalents $ 505,993 $ 505,993 $ 447,033 $ 447,033
Restricted cash$3,030$3,030$3,030$3,030
Level 2
Financial Assets:
Trading securities $ 381 $ 381 $ 360 $ 360
Investment securities available-for-sale$1,239,469$1,239,469$841,857$841,857
Investment securities held-to-maturity $ - $ - $ 410,353 $ 424,740
Federal Home Loan Bank (FHLB) stock$12,800$12,800$12,644$12,644
Other investments $ 3 $ 3 $ 3 $ 3
Derivative assets$110$110$347$347
Financial Liabilities:
Derivative liabilities$439$439$333$333
Level 3
Financial Assets:
Total loans (including loans held-for-sale) $ 4,074,348 $ 4,401,401 $ 4,106,628 $ 4,431,594
Accrued interest receivable$33,152$33,152$34,254$34,254
Servicing assets $ 10,623 $ 10,623 $ 10,716 $ 10,716
Accounts receivable and other assets$35,482$35,482$37,842$37,842
Financial Liabilities:
Deposits$4,868,473$4,897,101$4,881,903$4,908,115
Securities sold under agreements to repurchase $ 429,250 $ 431,566 $ 453,135 $ 455,508
Advances from FHLB$81,366$81,111$78,503$77,620
Other borrowings $ 286 $ 286 $ 1,214 $ 1,214
Subordinated capital notes$35,458$36,083$36,184$36,083
Accrued expenses and other liabilities $ 87,004 $ 87,004 $ 87,664 $ 87,664

The following methods and assumptions were used to estimate the fair values of significant financial instruments at March 31, 2019 and December 31, 2018:

• Cash and cash equivalents (including money market investments and time deposits with other banks), restricted cash, accrued interest receivable, accounts receivable and other assets, accrued expenses and other liabilities, and other borrowings have been valued at the carrying amounts reflected in the consolidated statements of financial condition as these are reasonable estimates of fair value given the short-term nature of the instruments.

• Investments in FHLB-NY stock are valued at their redemption value.

• The fair value of investment securities, including trading securities and other investments, is based on quoted market prices, when available or prices provided from contracted pricing providers, or market prices provided by recognized broker-dealers. If listed prices or quotes are not available, fair value is based upon externally developed models that use both observable and unobservable inputs depending on the market activity of the instrument.

• The fair value of servicing asset is estimated by using a cash flow valuation model which calculates the present value of estimated future net servicing cash flows, taking into consideration actual and expected loan prepayment rates, discount rates, servicing costs, and other economic factors, which are determined based on current market conditions.

• The fair values of the derivative instruments are provided by valuation experts and counterparties. Certain derivatives with limited market activity are valued using externally developed models that consider unobservable market parameters.

• Fair value of derivative liabilities, which include interest rate swaps and forward-settlement swaps, are based on the net discounted value of the contractual projected cash flows of both the pay-fixed receive-variable legs of the contracts. The projected cash flows are based on the forward yield curve, and discounted using current estimated market rates.

• The fair value of the loan portfolio (including loans held-for-sale and non-performing loans) is based on the exit market price, which is estimated by segregating by type, such as mortgage, commercial, consumer, auto and leasing. Each loan segment is further segmented into fixed and adjustable interest rates. The fair value is calculated by discounting contractual cash flows, adjusted for prepayment estimates (voluntary and involuntary), if any, using estimated current market discount rates that reflect the credit and interest rate risk inherent in the loan.

• The fair value of demand deposits and savings accounts is the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposit is based on the discounted value of the contractual cash flows, using estimated current market discount rates for deposits of similar remaining maturities.

• The fair value of long-term borrowings, which include securities sold under agreements to repurchase, advances from FHLB, and subordinated capital notes is based on the discounted value of the contractual cash flows using current estimated market discount rates for borrowings with similar terms, remaining maturities and put dates.