ALLOWANCE FOR LOAN AND LEASE LOSSES |
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ALLOWANCE FOR LOAN AND LEASE LOSSES | NOTE 8 – ALLOWANCE FOR LOAN AND LEASE LOSSES
As described in Note 2 – “Natural Disasters Affecting First BanCorp. in Third Quarter 2017” two strong hurricanes affected the Corporation’s service areas during September 2017. These storms caused widespread property damage, flooding, power outages, and water and communication services interruptions, and severely disrupted normal economic activity in the affected areas. Damages associated with the storm-related events will have significant short-term economic repercussions, both positive and negative, for the Corporation’ s commercial and individual loan customers in the most severely affected parts of Puerto Rico and the Virgin Islands. While these events have affected certain asset quality metrics, including higher delinquencies and non-performing loans, the storms’ ultimate effect on loan collections is uncertain. However, the Corporation’s loan officers are making individual storm-impact assessments for all commercial customers. The recent occurrence of the events makes it difficult to estimate the immediate impact at such level. The expectation is that the assessment will be substantially completed by the fourth quarter of 2017. The Corporation’s loan portfolio in Puerto Rico and the Virgin Islands totaled $7.3 billion as of September 30, 2017, or 82% of the entire portfolio. The composition of these loans generally reflects the composition of the entire portfolio, which is close to 60% of residential and consumer loans to individual customers and 40% of commercial and construction loans. Management has determined a separate qualitative element of the allowance to represent the estimate of inherent losses associated with the impact of the storm-related events on the Corporation’s Puerto Rico and Virgin Islands loan portfolios. This estimate is judgmental and subject to changes as conditions evolve. This qualitative element of the allowance was determined based on the estimated impact the storms could have on current employment levels (e.g unemployment rate that doubles current levels in Puerto Rico based on statistics observed in the aftermath of similar natural disasters in the U.S mainland like Hurricane Katrina) economic activity in the Corporation’s geographic regions, and the time it could take for the affected regions to return to a more normalized operating environment. It is expected that the rebuilding efforts will stimulate economic activity and accelerate the pace of economic recovery from the hurricanes. The Corporation’s credit risk modeling framework used to determine the storm-related estimate is similar to the one used for benchmarking purposes as part of the annual Dodd-Frank Act Stress Testing (“DFAST”) regulatory exercise. Models were developed following a regression modeling approach in which relationships between portfolio-level loss rates and key economic indicators were derived based on historical behavior. These models went through an extensive model specification and selection process that resulted in the use of certain variables, such as the unemployment rate and the Puerto Rico Economic Activity Index, which showed the highest predictive power of potential losses in our outstanding loan portfolio. Resulting loss factors were assigned to the overall performing balance of each major loan portfolio category in the affected regions, resulting in a total charge of $66.5 million (composed of $59.2 million for Puerto Rico and $7.3 million for Virgin Islands) that consisted of: (i) a $13.7 million charge to the provision for residential mortgage loans, (ii) an $18.1 million charge to the provision of commercial mortgage loans, (iii) an $8.0 million charge to the provision for commercial and industrial loans, (iv) a $0.8 million charge to the provision for construction loans, and (v) a $25.9 million charge to the provision for consumer loans. Residential and consumer loans are underwritten principally on income streams, with collateral viewed as a second source of repayment. The storms’ impact varies widely within the residential and consumer portfolio, with some individual borrowers experiencing the devastation of loss of both home and employment and others with both homes and jobs intact. Properties used as collateral generally require insurance, minimizing the potential loss from property damages. For the commercial portfolio, the Corporation conducted a preliminary review of all loans in the Puerto Rico and Virgin Islands regions in amounts over $10 million, which accounts for 74.5% of the total commercial portfolio of such regions, and determined that 100% of the real estate-backed loans have property insurance. As such, the Corporation understands that credit losses and/or credit deterioration will mainly occur from the overall economic effect the storms will have on the economy of Puerto Rico and the Virgin Islands. Estimates of the storms’ effect on loan losses will change over time as additional information becomes available, and any related revisions in the allowance calculation will be reflected in the provision for loan losses as they occur. Such revisions could be material. As of September 30, 2017, the Corporation maintained a $0.9 million reserve for unfunded loan commitments (December 31, 2016 - $1.6 million), mainly related to outstanding commitments on floor plan revolving lines of credit. The reserve for unfunded loan commitments is an estimate of the losses inherent in off-balance sheet loan commitments to borrowers that are experiencing financial difficulties at the balance sheet date. It is calculated by multiplying an estimated loss factor by an estimated probability of funding, and then by the period-end amounts for unfunded commitments. The reserve for unfunded loan commitments is included as part of accounts payable and other liabilities in the consolidated statement of financial condition and any change to the reserve is included as part of other non-interest expenses in the consolidated statements of income. |