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Fair value measurement
 6 Months Ended
Jun. 30, 2011
Fair value measurement

Note 22 – 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.

 

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 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 June 30, 2011, December 31, 2010 and June 30, 2010:

 

At June 30, 2011

  

(In thousands)

    Level 1      Level 2     Level 3      Balance at
June 30, 2011		  

Assets

           

Investment securities available-for-sale:

           

U.S. Treasury securities

    $ —         $ 38,192     $ —         $ 38,192  

Obligations of U.S. Government sponsored entities

      —           1,248,688       —           1,248,688  

Obligations of Puerto Rico, States and political subdivisions

      —           34,266       —           34,266  

Collateralized mortgage obligations - federal agencies

      —           1,613,062       —           1,613,062  

Collateralized mortgage obligations - private label

      —           70,486       —           70,486  

Mortgage-backed securities

      —           2,341,390       7,634        2,349,024  

Equity securities

      3,779        4,486       —           8,265  

Other

      —           27,508       —           27,508  
  

 

 

     

 

 

    

 

 

     

 

 

  

Total investment securities available-for-sale

    $ 3,779      $ 5,378,078     $ 7,634      $ 5,389,491  
  

 

 

     

 

 

    

 

 

     

 

 

  

Trading account securities, excluding derivatives:

           

Obligations of Puerto Rico, States and political subdivisions

    $ —         $ 10,315     $ —         $ 10,315  

Collateralized mortgage obligations

      —           710       2,638        3,348  

Residential mortgage-backed securities - federal agencies

      —           721,731       27,079        748,810  

Other

      —           18,942       3,571        22,513  
  

 

 

     

 

 

    

 

 

     

 

 

  

Total trading account securities

    $ —         $ 751,698     $ 33,288      $ 784,986  
  

 

 

     

 

 

    

 

 

     

 

 

  

Mortgage servicing rights

    $ —         $ —        $ 162,619      $ 162,619  

Derivatives

      —           69,232       —           69,232  
  

 

 

     

 

 

    

 

 

     

 

 

  

Total

    $ 3,779      $ 6,199,008     $ 203,541      $ 6,406,328  
  

 

 

     

 

 

    

 

 

     

 

 

  

Liabilities

           

Derivatives

    $ —         $ (68,766 )    $ —         $ (68,766 ) 
  

 

 

     

 

 

    

 

 

     

 

 

  

Total

    $ —         $ (68,766 )    $ —         $ (68,766 ) 
  

 

 

     

 

 

    

 

 

     

 

 

  

 

At December 31, 2010

  

(In thousands)

    Level 1      Level 2     Level 3      Balance at
December 31,
2010		  

Assets

           

Investment securities available-for-sale:

           

U.S. Treasury securities

    $ —         $ 38,136     $ —         $ 38,136  

Obligations of U.S. Government sponsored entities

      —           1,211,304       —           1,211,304  

Obligations of Puerto Rico, States and political subdivisions

      —           52,702       —           52,702  

Collateralized mortgage obligations - federal agencies

      —           1,238,294       —           1,238,294  

Collateralized mortgage obligations - private label

      —           84,938       —           84,938  

Mortgage-backed securities

      —           2,568,396       7,759        2,576,155  

Equity securities

      3,952        5,523       —           9,475  

Other

      —           25,848       —           25,848  
  

 

 

     

 

 

    

 

 

     

 

 

  

Total investment securities available-for-sale

    $ 3,952      $ 5,225,141     $ 7,759      $ 5,236,852  
  

 

 

     

 

 

    

 

 

     

 

 

  

Trading account securities, excluding derivatives:

           

Obligations of Puerto Rico, States and political subdivisions

    $ —         $ 16,438     $ —         $ 16,438  

Collateralized mortgage obligations

      —           769       2,746        3,515  

Residential mortgage-backed securities - federal agencies

      —           472,806       20,238        493,044  

Other

      —           30,423       2,810        33,233  
  

 

 

     

 

 

    

 

 

     

 

 

  

Total trading account securities

    $ —         $ 520,436     $ 25,794      $ 546,230  
  

 

 

     

 

 

    

 

 

     

 

 

  

Mortgage servicing rights

    $ —         $ —        $ 166,907      $ 166,907  

Derivatives

      —           72,993       —           72,993  
  

 

 

     

 

 

    

 

 

     

 

 

  

Total

    $ 3,952      $ 5,818,570     $ 200,460      $ 6,022,982  
  

 

 

     

 

 

    

 

 

     

 

 

  

Liabilities

           

Derivatives

    $ —         $ (76,344 )    $ —         $ (76,344 ) 

Trading liabilities

      —           (10,459 )      —           (10,459 ) 

Equity appreciation instrument

      —           (9,945 )      —           (9,945 ) 
  

 

 

     

 

 

    

 

 

     

 

 

  

Total

    $ —         $ (96,748 )    $ —         $ (96,748 ) 
  

 

 

     

 

 

    

 

 

     

 

 

  

 

At June 30, 2010

  

(In thousands)

    Level 1      Level 2     Level 3      Balance at
June 30,
2010		  

Assets

           

Investment securities available-for-sale:

           

U.S. Treasury securities

    $ —         $ 140,687     $ —         $ 140,687  

Obligations of U.S. Government sponsored entities

      —           1,749,475       —           1,749,475  

Obligations of Puerto Rico, States and political subdivisions

      —           55,632       —           55,632  

Collateralized mortgage obligations - federal agencies

      —           1,445,018       —           1,445,018  

Collateralized mortgage obligations - private label

      —           101,987       —           101,987  

Mortgage-backed securities

      —           2,947,312       32,372        2,979,684  

Equity securities

      3,469        5,235       —           8,704  
  

 

 

     

 

 

    

 

 

     

 

 

  

Total investment securities available-for-sale

    $ 3,469      $ 6,445,346     $ 32,372      $ 6,481,187  
  

 

 

     

 

 

    

 

 

     

 

 

  

Trading account securities, excluding derivatives:

           

Obligations of Puerto Rico, States and political subdivisions

    $ —         $ 9,726     $ —         $ 9,726  

Collateralized mortgage obligations

      —           908       2,667        3,575  

Residential mortgage-backed securities - federal agencies

      —           261,150       114,281        375,431  

Other

      —           9,539       3,232        12,771  
  

 

 

     

 

 

    

 

 

     

 

 

  

Total trading account securities

    $ —         $ 281,323     $ 120,180      $ 401,503  
  

 

 

     

 

 

    

 

 

     

 

 

  

Mortgage servicing rights

    $ —         $ —        $ 171,994      $ 171,994  

Derivatives

      —           79,611       —           79,611  
  

 

 

     

 

 

    

 

 

     

 

 

  

Total

    $ 3,469      $ 6,806,280     $ 324,546      $ 7,134,295  
  

 

 

     

 

 

    

 

 

     

 

 

  

Liabilities

           

Derivatives

    $ —         $ (86,846 )    $ —         $ (86,846 ) 
  

 

 

     

 

 

    

 

 

     

 

 

  

Total

    $ —         $ (86,846 )    $ —         $ (86,846 ) 
  

 

 

     

 

 

    

 

 

     

 

 

  

 

The following tables present the changes in Level 3 assets and liabilities measured at fair value on a recurring basis for the quarters and six months ended June 30, 2011 and 2010.

 

Quarter ended June 30, 2011

  

(In millions)

    Balance at
March 31,
2011		      Gains
(losses)
included
in
earnings/
OCI		     Purchases      Sales     Settlements     Balance
at June 30,
2011		      Changes  in
unrealized
gains
(losses)
included in
earnings/OCI
related to
assets still
held at
June 30,
2011		  

Assets

                  

Investment securities available-for-sale:

                  

Mortgage-backed securities

    $ 8      $ —        $ —         $ —        $ —        $ 8      $ —     
  

 

 

     

 

 

    

 

 

     

 

 

    

 

 

    

 

 

     

 

 

  

Total investment securities available-for-sale

    $ 8      $ —        $ —         $ —        $ —        $ 8      $ —     
  

 

 

     

 

 

    

 

 

     

 

 

    

 

 

    

 

 

     

 

 

  

Trading account securities:

                  

Collateralized mortgage obligations

    $ 3      $ —        $ —         $ —        $ —        $ 3      $ —     

Residential mortgage-backed securities - federal agencies

      21        1       8        (2 )      (1 )      27        —     

Other

      3        —          1        (1 )      —          3        1  
  

 

 

     

 

 

    

 

 

     

 

 

    

 

 

    

 

 

     

 

 

  

Total trading account securities

    $ 27      $ 1     $ 9      $ (3 )    $ (1 )    $ 33      $ 1  [a] 
  

 

 

     

 

 

    

 

 

     

 

 

    

 

 

    

 

 

     

 

 

  

Mortgage servicing rights

    $ 168      $ (10 )    $ 5      $ —        $ —        $ 163      $ (6 )[b] 
  

 

 

     

 

 

    

 

 

     

 

 

    

 

 

    

 

 

     

 

 

  

Total

    $ 203      $ (9 )    $ 14      $ (3 )    $ (1 )    $ 204      $ (5 ) 
  

 

 

     

 

 

    

 

 

     

 

 

    

 

 

    

 

 

     

 

 

  

 

[a] Gains (losses) are included in “Trading account profit” in the Statement of Operations.
[b] Gains (losses) are included in “Other services fees” in the Statement of Operations.

 

Six months ended June 30, 2011

  

(In millions)

    Balance at
December 31,
2010		      Gains
(losses)
included
in
earnings/
OCI		     Purchases      Sales     Settlements     Balance
at June 30,
2011		      Changes in
unrealized
gains
(losses)
included in
earnings/OCI
related to
assets still
held at
June 30,
2011		  

Assets

                  

Investment securities available-for-sale:

                  

Mortgage-backed securities

    $ 8      $ —        $ —         $ —        $ —        $ 8      $ —     
  

 

 

     

 

 

    

 

 

     

 

 

    

 

 

    

 

 

     

 

 

  

Total investment securities available-for-sale

    $ 8      $ —        $ —         $ —        $ —        $ 8      $ —     
  

 

 

     

 

 

    

 

 

     

 

 

    

 

 

    

 

 

     

 

 

  

Trading account securities:

                  

Collateralized mortgage obligations

    $ 3      $ —        $ —         $ —        $ —        $ 3      $ —     

Residential mortgage-backed securities - federal agencies

      20        1       10        (3 )      (1 )      27        —     

Other

      3        —          1        (1 )      —          3        1  
  

 

 

     

 

 

    

 

 

     

 

 

    

 

 

    

 

 

     

 

 

  

Total trading account securities

    $ 26      $ 1     $ 11      $ (4 )    $ (1 )    $ 33      $ 1  [a] 
  

 

 

     

 

 

    

 

 

     

 

 

    

 

 

    

 

 

     

 

 

  

Mortgage servicing rights

    $ 167      $ (16 )    $ 12      $ —        $ —        $ 163      $ (8 )[b] 
  

 

 

     

 

 

    

 

 

     

 

 

    

 

 

    

 

 

     

 

 

  

Total

    $ 201      $ (15 )    $ 23      $ (4 )    $ (1 )    $ 204      $ (7 ) 
  

 

 

     

 

 

    

 

 

     

 

 

    

 

 

    

 

 

     

 

 

  

 

[a] Gains (losses) are included in “Trading account profit” in the Statement of Operations.
[b] Gains (losses) are included in “Other services fees” in the Statement of Operations.

 

Quarter ended June 30, 2010

  

(In millions)

    Balance at
March 31,
2010		      Gains
(losses)
included
in
earnings/
OCI		     Issuances      Purchases      Sales     Paydowns     Transfers
in (out) of
Level 3		     Balance
at June 30,
2010		      Changes in
unrealized
gains
(losses)
included in
earnings/OCI
related to
assets still
held at
June 30,
2010		  

Assets

                       

Investment securities available-for-sale:

                       

Mortgage-backed securities

    $ 36      $ —        $ —         $ —         $ —        $ (1 )    $ (3 )    $ 32      $ —     
  

 

 

     

 

 

    

 

 

     

 

 

     

 

 

    

 

 

    

 

 

    

 

 

     

 

 

  

Total investment securities available-for-sale

    $ 36      $ —        $ —         $ —         $ —        $ (1 )    $ (3 )    $ 32      $ —     
  

 

 

     

 

 

    

 

 

     

 

 

     

 

 

    

 

 

    

 

 

    

 

 

     

 

 

  

Trading account securities:

                       

Collateralized mortgage obligations

    $ 3      $ —        $ —         $ —         $ —        $ —        $ —        $ 3      $ —     

Residential mortgage-backed securities - federal agencies

      197        (5 )      —           4        (4 )      (2 )      (76 )      114        1  

Other

      3        —          —           —           —          —          —          3        —     
  

 

 

     

 

 

    

 

 

     

 

 

     

 

 

    

 

 

    

 

 

    

 

 

     

 

 

  

Total trading account securities

    $ 203      $ (5 )    $ —         $ 4      $ (4 )    $ (2 )    $ (76 )    $ 120      $ 1  [a] 
  

 

 

     

 

 

    

 

 

     

 

 

     

 

 

    

 

 

    

 

 

    

 

 

     

 

 

  

Mortgage servicing rights

    $ 173      $ (9 )    $ —         $ 8      $ —        $ —        $ —        $ 172      $ (5 )[b] 
  

 

 

     

 

 

    

 

 

     

 

 

     

 

 

    

 

 

    

 

 

    

 

 

     

 

 

  

Total

    $ 412      $ (14 )    $ —         $ 12      $ (4 )    $ (3 )    $ (79 )    $ 324      $ (4 ) 
  

 

 

     

 

 

    

 

 

     

 

 

     

 

 

    

 

 

    

 

 

    

 

 

     

 

 

  

 

[a] Gains (losses) are included in “Trading account profit” in the Statement of Operations.
[b] Gains (losses) are included in “Other services fees” in the Statement of Operations.

 

Six months ended June 30, 2010

  

(In millions)

    Balance at
December 31,
2009		      Gains
(losses)
included
in
earnings/
OCI		     Issuances      Purchases      Sales     Paydowns     Transfers
in (out) of
Level 3		     Balance
at June 30,
2010		      Changes in
unrealized
gains
(losses)
included in
earnings/OCI
related to
assets still
held at
June 30,
2010		  

Assets

                       

Investment securities available-for-sale:

                       

Mortgage-backed securities

    $ 34      $ —        $ 2      $ —         $ —        $ (1 )    $ (3 )    $ 32      $ —     
  

 

 

     

 

 

    

 

 

     

 

 

     

 

 

    

 

 

    

 

 

    

 

 

     

 

 

  

Total investment securities available-for-sale

    $ 34      $ —        $ 2      $ —         $ —        $ (1 )    $ (3 )    $ 32      $ —     
  

 

 

     

 

 

    

 

 

     

 

 

     

 

 

    

 

 

    

 

 

    

 

 

     

 

 

  

Trading account securities:

                       

Collateralized mortgage obligations

    $ 3      $ —        $ —         $ —         $ —        $ —        $ —        $ 3      $ —     

Residential mortgage-backed securities - federal agencies

      224        (5 )      —           14        (37 )      (6 )      (76 )      114        1  

Other

      3        —          —           —           —          —          —          3        —     
  

 

 

     

 

 

    

 

 

     

 

 

     

 

 

    

 

 

    

 

 

    

 

 

     

 

 

  

Total trading account securities

    $ 230      $ (5 )    $ —         $ 14      $ (37 )    $ (6 )    $ (76 )    $ 120      $ 1  [a] 
  

 

 

     

 

 

    

 

 

     

 

 

     

 

 

    

 

 

    

 

 

    

 

 

     

 

 

  

Mortgage servicing rights

    $ 170      $ (10 )    $ —         $ 12      $ —        $ —        $ —        $ 172      $ (2 )[b] 
  

 

 

     

 

 

    

 

 

     

 

 

     

 

 

    

 

 

    

 

 

    

 

 

     

 

 

  

Total

    $ 434      $ (15 )    $ 2      $ 26      $ (37 )    $ (7 )    $ (79 )    $ 324      $ (1 ) 
  

 

 

     

 

 

    

 

 

     

 

 

     

 

 

    

 

 

    

 

 

    

 

 

     

 

 

  

 

[a] Gains (losses) are included in “Trading account profit” in the Statement of Operations.
[b] Gains (losses) are included in “Other services fees” in the Statement of Operations.

There were no transfers in and/or out of Level 3 for financial instruments measured at fair value on a recurring basis during the quarters and six months ended June 30, 2011. There were $79 million in transfers out of Level 3 for financial instruments measured at fair value on a recurring basis during the quarter and six months ended June 30, 2010. These transfers resulted from exempt FNMA mortgage-backed securities, which were transferred out of Level 3 and into Level 2, as a result of a change in valuation methodology from an internally-developed matrix pricing to pricing them based on a bond’s theoretical value from similar bonds defined by credit quality and market sector. Their fair value incorporates an option adjusted spread. Pursuant to the Corporation’s policy, these transfers were recognized as of the end of the reporting period. There were no transfers in and/or out of Level 1 during the quarters and six months ended June 30, 2011 and 2010.

Gains and losses (realized and unrealized) included in earnings for the quarter and six months ended June 30, 2011 and 2010 for Level 3 assets and liabilities included in the previous tables are reported in the consolidated statement of operations as follows:

 

     Quarter ended June 30, 2011     Six months ended June 30, 2011  

(In millions)

    Total gains
(losses) included
in earnings		     Changes in unrealized to
gains (losses) relating
assets still held at
reporting date		     Total gains
(losses) included
in earnings		     Changes in unrealized to
gains (losses) relating
assets still held at
reporting date		  

Other service fees

    $ (10 )    $ (6 )    $ (16 )    $ (8 ) 

Trading account profit

      1       1       1       1  
  

 

 

    

 

 

    

 

 

    

 

 

  

Total

    $ (9 )    $ (5 )    $ (15 )    $ (7 ) 
  

 

 

    

 

 

    

 

 

    

 

 

  

 

     Quarter ended June 30, 2010     Six months ended June 30, 2010  

(In millions)

    Total gains
(losses) included
in earnings		     Changes in unrealized to
gains (losses) relating
assets still held at
reporting date		     Total gains
(losses) included
in earnings		     Changes in unrealized to
gains (losses) relating
assets still held at
reporting date		  

Other service fees

    $ (9 )    $ (5 )    $ (10 )    $ (2 ) 

Trading account profit

      (5 )      1       (5 )      1  
  

 

 

    

 

 

    

 

 

    

 

 

  

Total

    $ (14 )    $ (4 )    $ (15 )    $ (1 ) 
  

 

 

    

 

 

    

 

 

    

 

 

  

Additionally, in accordance with generally accepted accounting principles, the Corporation may be required to measure certain assets at fair value on a nonrecurring basis in periods subsequent to their initial recognition. The adjustments to fair value usually result from the application of lower of cost or fair value accounting, identification of impaired loans requiring specific reserves under ASC Section 310-10-35 “Accounting by Creditors for Impairment of a Loan”, or write-downs of individual assets. The following tables present financial and non-financial assets that were subject to a fair value measurement on a nonrecurring basis during the six months ended June 30, 2011 and 2010, and which were still included in the consolidated statement of condition as of such dates. The amounts disclosed represent the aggregate fair value measurements of those assets as of the end of the reporting period.

 

Carrying value at June 30, 2011

  

(In millions)

    Level 1      Level 2      Level 3      Total      Write-
downs		  

Loans[1]

      —           —         $ 25      $ 25      $ (4 ) 

Loans held-for-sale [2]

      —           —           139        139        (14 ) 

Other real estate owned [3]

      —           —           25        25        (9 ) 
  

 

 

     

 

 

     

 

 

     

 

 

     

 

 

  

Total

      —           —         $ 189      $ 189      $ (27 ) 
  

 

 

     

 

 

     

 

 

     

 

 

     

 

 

  

 

[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.
[2] Relates to lower of cost or fair value adjustments of loans held-for-sale and loans transferred from loans held-in-portfolio to loans held-for-sale. These adjustments were principally determined based on negotiated price terms for the loans.
[3] Represents the fair value of foreclosed real estate owned that were measured at fair value.

 

Carrying value at June 30, 2010

  

(In millions)

    Level 1      Level 2      Level 3      Total      Write-
downs		  

Loans[1]

      —           —         $ 610      $ 610      $ (240 ) 

Loans held-for-sale[2]

      —           —           2        2        (11 ) 

Other real estate owned[3]

      —           —           42        42        (18 ) 
  

 

 

     

 

 

     

 

 

     

 

 

     

 

 

  

Total

      —           —         $ 654      $ 654      $ (269 ) 
  

 

 

     

 

 

     

 

 

     

 

 

     

 

 

  

 

[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.
[2] Relates to lower of cost or fair value adjustments of loans held-for-sale and loans transferred from loans held-in-portfolio to loans held-for-sale. These adjustments were principally determined based on negotiated price terms for the loans.
[3] Represents the fair value of foreclosed real estate owned that were measured at fair value.

Following is a description of the Corporation’s valuation methodologies used for assets and liabilities measured at fair value. The disclosure requirements exclude certain financial instruments and all non-financial instruments. Accordingly, the aggregate fair value amounts of the financial instruments disclosed do not represent management’s estimate of the underlying value of the Corporation.

 

Trading Account Securities and Investment Securities Available-for-Sale

 

  •  

U.S. Treasury securities: The fair value of U.S. Treasury securities is based on yields that are interpolated from the constant maturity treasury curve. These securities are classified as Level 2.

 

  •  

Obligations of U.S. Government sponsored entities: The Obligations of U.S. Government sponsored entities include U.S. agency securities, which fair value is based on an active exchange market and on quoted market prices for similar securities. The U.S. agency securities are classified as Level 2.

 

  •  

Obligations of Puerto Rico, States and political subdivisions: Obligations of Puerto Rico, States and political subdivisions include municipal bonds. The bonds are segregated and the like characteristics divided into specific sectors. Market inputs used in the evaluation process include all or some of the following: trades, bid price or spread, two sided markets, quotes, benchmark curves including but not limited to Treasury benchmarks, LIBOR and swap curves, market data feeds such as MSRB, discount and capital rates, and trustee reports. The municipal bonds are classified as Level 2.

 

  •  

Mortgage-backed securities: Certain agency mortgage-backed securities (“MBS”) are priced based on a bond’s theoretical value from similar bonds defined by credit quality and market sector. Their fair value incorporates an option adjusted spread. The agency MBS are classified as Level 2. Other agency MBS such as GNMA Puerto Rico Serials are priced using an internally-prepared pricing matrix with quoted prices from local brokers dealers. These particular MBS are classified as Level 3.

 

  •  

Collateralized mortgage obligations: Agency and private collateralized mortgage obligations (“CMOs”) are priced based on a bond’s theoretical value from similar bonds defined by credit quality and market sector and for which fair value incorporates an option adjusted spread. The option adjusted spread model includes prepayment and volatility assumptions, ratings (whole loans collateral) and spread adjustments. These CMOs are classified as Level 2. Other CMOs, due to their limited liquidity, are classified as Level 3 due to the insufficiency of inputs such as broker quotes, executed trades, credit information and cash flows.

 

  •  

Equity securities: Equity securities with quoted market prices obtained from an active exchange market are classified as Level 1. Other equity securities that do not trade in highly liquid markets are classified as Level 2.

 

  •  

Corporate securities, commercial paper and mutual funds (included as “other” in the “trading account securities” category): Quoted prices for these security types are obtained from broker dealers. Given that the quoted prices are for similar instruments or do not trade in highly liquid markets, these securities are classified as Level 2. The important variables in determining the prices of Puerto Rico tax-exempt mutual fund shares are net asset value, dividend yield and type of assets in the fund. All funds trade based on a relevant dividend yield taking into consideration the aforementioned variables. In addition, demand and supply also affect the price. Corporate securities that trade less frequently or are in distress are classified as Level 3.

Mortgage servicing rights

Mortgage servicing rights (“MSRs”) do not trade in an active market with readily observable prices. MSRs are priced internally using a discounted cash flow model. The valuation model considers servicing fees, portfolio characteristics, prepayments 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 MSRs are classified as Level 3.

Derivatives

Interest rate swaps, interest rate caps and indexed options are traded in over-the-counter active markets. These derivatives are indexed to an observable interest rate benchmark, such as LIBOR or equity indexes, and are priced using an income approach based on present value and option pricing models using observable inputs. Other derivatives are liquid and have quoted prices, such as forward contracts or “to be announced securities” (“TBAs”). All of these derivatives are classified as Level 2. The non-performance risk is determined using internally-developed models that consider the collateral held, the remaining term, and the creditworthiness of the entity that bears the risk, and uses available public data or internally-developed data related to current spreads that denote their probability of default.

 

Loans held-in-portfolio considered impaired under ASC Section 310-10-35 that are collateral dependent

The impairment is 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. Currently, the associated loans considered impaired are classified as Level 3.

Loans measured at fair value pursuant to lower of cost or fair value adjustments

Loans measured at fair value on a nonrecurring basis pursuant to lower of cost or fair value were priced based on bids received from potential buyers, secondary market prices, and discounted cash flow models which incorporate internally-developed assumptions for prepayments and credit loss estimates. These loans are classified as Level 3.

Other real estate owned and other foreclosed assets

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