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Fair Value of Financial Instruments
 9 Months Ended
Sep. 30, 2021
Fair Value of Financial Instruments [Abstract]  
Fair Value of Financial Instruments

NOTE 22 - FAIR VALUE OF FINANCIAL INSTRUMENTS

 

OFG 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. OFG holds one security categorized as other debt that is classified as Level 3. The estimated fair value of the other debt security is determined by using an adjusted third-party model to calculate the present value of projected future cash flows. The assumptions are highly uncertain and include primarily market discount rates and current spread. The assumptions used are drawn from similar securities that are actively traded in the market and have similar risk characteristics. The valuation is performed on a quarterly basis.

 

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 OFG. 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.

 

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:

 

September 30, 2021

 

Fair Value Measurements

 

Level 1

 

Level 2

 

Level 3

 

Total

 

(In thousands)

Recurring fair value measurements:

 

 

 

 

 

 

 

 

 

 

 

Investment securities available-for-sale

$

10,875

 

$

496,725

 

$

1,507

 

$

509,107

Trading securities

 

-

 

 

22

 

 

-

 

 

22

Money market investments

 

9,837

 

 

-

 

 

-

 

 

9,837

Servicing assets

 

-

 

 

-

 

 

48,227

 

 

48,227

Derivative liabilities

 

-

 

 

(1,136)

 

 

-

 

 

(1,136)

 

$

20,712

 

$

495,611

 

$

49,734

 

$

566,057

Non-recurring fair value measurements:

 

 

 

 

 

 

 

 

 

 

 

Collateral dependent loans

 

-

 

 

-

 

 

10,439

 

 

10,439

Foreclosed real estate

 

-

 

 

-

 

 

13,904

 

 

13,904

Other repossessed assets

 

-

 

 

-

 

 

1,528

 

 

1,528

 

$

-

 

$

-

 

$

25,871

 

$

25,871

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2020

 

Fair Value Measurements

 

Level 1

 

Level 2

 

Level 3

 

Total

 

(In thousands)

Recurring fair value measurements:

 

 

 

 

 

 

 

 

 

 

 

Investment securities available-for-sale

$

10,983

 

$

435,455

 

$

-

 

$

446,438

Trading securities

 

-

 

 

22

 

 

-

 

 

22

Money market investments

 

11,908

 

 

-

 

 

-

 

 

11,908

Servicing assets

 

-

 

 

-

 

 

47,295

 

 

47,295

Derivative liabilities

 

-

 

 

(1,712)

 

 

-

 

 

(1,712)

 

$

22,891

 

$

433,765

 

$

47,295

 

$

503,951

Non-recurring fair value measurements:

 

 

 

 

 

 

 

 

 

 

 

Collateral dependent loans

$

-

 

$

-

 

$

29,279

 

$

29,279

Foreclosed real estate

 

-

 

 

-

 

 

11,596

 

 

11,596

Other repossessed assets

 

-

 

 

-

 

 

1,816

 

 

1,816

 

$

-

 

$

-

 

$

42,691

 

$

42,691

The fair value information included in the tables above for non-recurring fair value measurements 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, 2021 and 2020 and excludes nonrecurring fair value measurements of assets no longer outstanding as of the reporting date.

 

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 and nine-month periods ended September 30, 2021 and 2020:

 

Quarter Ended September 30,

 

2021

 

2020

 

Other debt securities available for sale

 

Servicing Assets

 

Total

 

Servicing Assets

 

(In thousands)

 

 

 

 

 

 

 

 

 

 

 

 

Balance at beginning of period

$

-

 

$

47,712

 

 

47,712

 

$

47,926

New instruments acquired

 

-

 

 

1,339

 

 

1,339

 

 

656

Transfers from Level 2

 

1,500

 

 

-

 

 

1,500

 

 

-

Principal repayments and amortization

 

-

 

 

(1,740)

 

 

(1,740)

 

 

(1,365)

Gains included in earnings

 

-

 

 

916

 

 

916

 

 

25

Gains included in other comprehensive income

 

7

 

 

-

 

 

7

 

 

-

Balance at end of period

$

1,507

 

$

48,227

 

$

49,734

 

$

47,242

 

 

 

 

 

 

 

 

 

 

 

 

 

Nine-Month Period Ended September 30,

 

2021

 

2020

 

Other debt securities available for sale

 

Servicing Assets

 

 

Total

 

Servicing Assets

 

(In thousands)

 

 

 

 

 

 

 

 

 

 

 

 

Balance at beginning of period

$

-

 

$

47,295

 

 

47,295

 

$

50,779

New instruments acquired

 

-

 

 

4,782

 

 

4,782

 

 

1,236

Transfers from Level 2

 

1,500

 

 

-

 

 

1,500

 

 

-

Principal repayments and amortization

 

-

 

 

(5,109)

 

 

(5,109)

 

 

(2,810)

Gains (losses) included in earnings

 

-

 

 

1,259

 

 

1,259

 

 

(1,963)

Gains included in other comprehensive income

 

7

 

 

-

 

 

7

 

 

-

Balance at end of period

$

1,507

 

 

48,227

 

$

49,734

 

$

47,242

The transfer of other debt securities available for sale amounting to $1.5 million during the quarter and nine-month period ended September 30, 2021 from level 2 to level 3 corresponded to a convertible note purchased on June 25, 2021. The fair value used at June 30, 2021 was its initial value due to the proximity of its acquisition date, where the transaction price equaled the fair value at acquisition. During the quarter ended September 30, 2021, it was reclassified as level 3 due to the significant unobservable inputs used to determine its fair value at September 30, 2021. There were no transfers into or out of level 3 during the quarter and nine-month period ended September 30, 2020.

 

Servicing assets gains (losses) included in earnings during the quarters and nine-month periods ended September 30, 2021 and 2020 were included as mortgage servicing activities in the consolidated statement of operations. There were no changes in unrealized gains and losses from recurring level 3 fair value measurements held at September 30, 2020 during the quarter and nine-month period then ended included in other comprehensive income. For more information on the qualitative information about level 3 fair value measurements, see Note 7 – Servicing Assets.

 

During the quarters and nine-month periods ended September 30, 2021 and 2020, there were purchases and sales of assets and liabilities measured at fair value on a recurring basis.

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 September 30, 2021:

 

 

September 30, 2021

 

 

 

 

Fair Value

 

Valuation Technique

 

Unobservable Input

 

Range

 

Weighted Average

 

 

(In thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other debt securities available-for-sale

 

$

1,507

 

Cash flow valuation

 

Credit Rating

 

Baa1 - Baa3

 

Baa2

 

 

 

 

 

 

 

Probability of Default Rate

 

0.16% - 2.28%

 

0.35%

 

 

 

 

 

 

 

Recovery Rate

 

33.08%

 

33.08%

 

 

 

 

 

 

 

 

 

 

 

 

Servicing assets

 

$

48,227

 

Cash flow valuation

 

Constant prepayment rate

 

4.37% - 21.09%

 

6.25%

 

 

 

 

 

 

 

Discount rate

 

10.00% - 15.50%

 

11.47%

 

 

 

 

 

 

 

 

 

 

 

 

Collateral dependent loans

 

$

10,439

 

Fair value of property

or collateral

 

Appraised value less disposition costs

 

14.20% - 29.20%

 

20.20%

 

 

 

 

 

 

 

 

 

 

 

 

Foreclosed real estate

 

$

13,904

 

Fair value of property

or collateral

 

Appraised value less disposition costs

 

14.20% - 29.20%

 

16.06%

 

 

 

 

 

 

 

 

 

 

 

 

Other repossessed assets

 

$

1,528

 

Fair value of property

or collateral

 

Estimated net realizable value less disposition costs

 

46.00% - 68.00%

 

57.66%

Information about Sensitivity to Changes in Significant Unobservable Inputs

 

 

Other debt security available for sale – The significant unobservable inputs used in the fair value measurement of one of OFG’s other debt securities is a discounted cash flow methodology (DCF). DCF is a valuation method that uses the concept of the time value of money. The methodology used the future cash flows discounted through a yield to obtain a net present value. Assumptions applied in the model are obtained from Moody’s Default Trends.

 

Servicing assets – The significant unobservable inputs used in the fair value measurement of OFG’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 OFG.

 

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 OFG’s financial instruments at September 30, 2021 and December 31, 2020 is as follows:

 

September 30,

 

December 31,

 

2021

 

2020

 

Fair

 

Carrying

 

Fair

 

Carrying

 

Value

 

Value

 

Value

 

Value

 

(In thousands)

Level 1

 

 

 

 

 

 

 

 

 

 

 

Financial Assets:

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

$

2,755,512

 

$

2,755,512

 

$

2,154,202

 

$

2,154,202

Restricted cash

$

179

 

$

179

 

$

1,375

 

$

1,375

Investment securities available-for-sale

$

10,875

 

$

10,875

 

$

10,983

 

$

10,983

Level 2

 

 

 

 

 

 

 

 

 

 

 

Financial Assets:

 

 

 

 

 

 

 

 

 

 

 

Trading securities

$

22

 

$

22

 

$

22

 

$

22

Investment securities available-for-sale

$

496,725

 

$

496,725

 

$

435,455

 

$

435,455

Investment securities held-to-maturity

$

371,827

 

$

375,214

 

$

-

 

$

-

Federal Home Loan Bank (FHLB) stock

$

7,496

 

$

7,496

 

$

8,278

 

$

8,278

Other investments

$

10,434

 

$

10,434

 

$

3,962

 

$

3,962

Financial Liabilities:

 

 

 

 

 

 

 

 

 

 

 

Derivative liabilities

$

1,136

 

$

1,136

 

$

1,712

 

$

1,712

Level 3

 

 

 

 

 

 

 

 

 

 

 

Financial Assets:

 

 

 

 

 

 

 

 

 

 

 

Investment securities available-for-sale

$

1,507

 

$

1,507

 

$

-

 

$

-

Total loans (including loans held-for-sale)

$

6,086,493

 

$

6,282,485

 

$

6,323,689

 

$

6,501,259

Accrued interest receivable

$

56,815

 

$

56,815

 

$

65,547

 

$

65,547

Servicing assets

$

48,227

 

$

48,227

 

$

47,295

 

$

47,295

Accounts receivable and other assets

$

84,581

 

$

84,581

 

$

78,845

 

$

78,845

Financial Liabilities:

 

 

 

 

 

 

 

 

 

 

 

Deposits

$

9,277,633

 

$

9,244,389

 

$

8,422,599

 

$

8,415,640

Advances from FHLB

$

64,049

 

$

62,559

 

$

68,147

 

$

65,561

Other borrowings

$

375

 

$

375

 

$

707

 

$

707

Subordinated capital notes

$

36,405

 

$

36,083

 

$

33,325

 

$

36,083

Accrued expenses and other liabilities

$

120,555

 

$

120,555

 

$

154,418

 

$

154,418

The following methods and assumptions were used to estimate the fair values of significant financial instruments at September 30, 2021 and December 31, 2020:

 

• 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 estimated fair value of the convertible note is determined by using an adjusted third-party cash flow valuation model to calculate the present value of projected future cash flows. The assumptions used which are highly uncertain and require a high degree of judgment, include primarily market discount rates, current spreads, duration, leverage, default, and loss rates. The assumptions used are drawn from a wide array of data sources, including the performance of the collateral underlying each deal. The valuation, which is obtained at least on a quarterly basis, is analyzed and its assumptions are evaluated and incorporated in either an internal-based valuation model, when deemed necessary, or compared to counterparties’ prices and agreed by management.

 

• 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, 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.