Fair value measurement

3 Months Ended

Mar. 31, 2012

Notes to Financial Statements [Abstract]

Fair Value Disclosures [Text Block]

Note 21 –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 March 31,2012, December 31, 2011 and March 31,2011:

At March 31, 2012
(In thousands)	Level 1		Level 2		Level 3		Total
Assets
Investment securities available-for-sale:
U.S. Treasury securities	$	-	$	38,084	$	-	$	38,084
Obligations of U.S. Government sponsored entities		-		1,091,798		-		1,091,798
Obligations of Puerto Rico, States and political subdivisions		-		56,836		-		56,836
Collateralized mortgage obligations - federal agencies		-		1,858,807		-		1,858,807
Collateralized mortgage obligations - private label		-		54,668		-		54,668
Mortgage-backed securities		-		1,997,298		7,226		2,004,524
Equity securities		3,846		3,613		-		7,459
Other		-		26,440		-		26,440
Total investment securities available-for-sale	$	3,846	$	5,127,544	$	7,226	$	5,138,616
Trading account securities, excluding derivatives:
Obligations of Puerto Rico, States and political subdivisions	$	-	$	28,038	$	-	$	28,038
Collateralized mortgage obligations		-		734		2,750		3,484
Mortgage-backed securities - federal agencies		-		335,961		16,363		352,324
Other		-		16,372		3,988		20,360
Total trading account securities	$	-	$	381,105	$	23,101	$	404,206
Mortgage servicing rights	$	-	$	-	$	156,331	$	156,331
Derivatives		-		58,691		-		58,691
Total assets	$	3,846	$	5,567,340	$	186,658	$	5,757,844
Liabilities
Derivatives	$	-	$	(62,717)	$	-	$	(62,717)
Contingent consideration		-		-		(100,834)		(100,834)
Total liabilities	$	-	$	(62,717)	$	(100,834)	$	(163,551)

At December 31, 2011
(In thousands)	Level 1		Level 2		Level 3		Total
Assets
Investment securities available-for-sale:
U.S. Treasury securities	$	-	$	38,668	$	-	$	38,668
Obligations of U.S. Government sponsored entities		-		985,546		-		985,546
Obligations of Puerto Rico, States and political subdivisions		-		58,728		-		58,728
Collateralized mortgage obligations - federal agencies		-		1,697,642		-		1,697,642
Collateralized mortgage obligations - private label		-		57,792		-		57,792
Mortgage-backed securities		-		2,132,134		7,435		2,139,569
Equity securities		3,465		3,451		-		6,916
Other		-		24,962		-		24,962
Total investment securities available-for-sale	$	3,465	$	4,998,923	$	7,435	$	5,009,823
Trading account securities, excluding derivatives:
Obligations of Puerto Rico, States and political subdivisions	$	-	$	90,332	$	-	$	90,332
Collateralized mortgage obligations		-		737		2,808		3,545
Mortgage-backed securities - federal agencies		-		303,428		21,777		325,205
Other		-		13,212		4,036		17,248
Total trading account securities	$	-	$	407,709	$	28,621	$	436,330
Mortgage servicing rights	$	-	$	-	$	151,323	$	151,323
Derivatives		-		61,887		-		61,887
Total assets	$	3,465	$	5,468,519	$	187,379	$	5,659,363
Liabilities
Derivatives	$	-	$	(66,700)	$	-	$	(66,700)
Contingent consideration		-		-		(99,762)		(99,762)
Total liabilities	$	-	$	(66,700)	$	(99,762)	$	(166,462)

At March 31, 2011
(In thousands)	Level 1		Level 2		Level 3		Total
Assets
Investment securities available-for-sale:
U.S. Treasury securities	$	-	$	37,682	$	-	$	37,682
Obligations of U.S. Government sponsored entities		-		1,461,087		-		1,461,087
Obligations of Puerto Rico, States and political subdivisions		-		52,569		-		52,569
Collateralized mortgage obligations - federal agencies		-		1,607,345		-		1,607,345
Collateralized mortgage obligations - private label		-		77,148		-		77,148
Mortgage-backed securities		-		2,405,753		7,715		2,413,468
Equity securities		4,007		5,427		-		9,434
Other		-		27,608		-		27,608
Total investment securities available-for-sale	$	4,007	$	5,674,619	$	7,715	$	5,686,341
Trading account securities, excluding derivatives:
Obligations of Puerto Rico, States and political subdivisions	$	-	$	21,578	$	-	$	21,578
Collateralized mortgage obligations		-		713		2,678		3,391
Mortgage-backed securities - federal agencies		-		566,795		20,862		587,657
Other		-		18,132		2,883		21,015
Total trading account securities	$	-	$	607,218	$	26,423	$	633,641
Mortgage servicing rights	$	-	$	-	$	167,416	$	167,416
Derivatives		-		66,327		-		66,327
Total	$	4,007	$	6,348,164	$	201,554	$	6,553,725
Liabilities
Derivatives	$	-	$	(66,902)	$	-	$	(66,902)
Equity appreciation instrument		-		(578)		-		(578)
Contingent consideration		-		-		(94,483)		(94,483)
Total	$	-	$	(67,480)	$	(94,483)	$	(161,963)

The following tables present the changes in Level 3 assets and liabilities measured at fair value on a recurring basis for the quarters ended March 31,2012and 2011.

	Quarter ended March 31, 2012
																		Changes in
																		unrealized
																		gains
																		(losses)
																		included in
				Gains														earnings
				(losses)														related to
				included														assets still
		Balance at		in								Transfers		Transfers		Balance		held at
		January 1,		earnings/								into		out of		at March 31,		March 31,
(In millions)		2012		OCI		Purchases		Sales		Settlements		Level 3		Level 3		2012		2012
Assets
Investment securities available-for-sale:
Mortgage-backed securities		$	7	$	-	$	-	$	-	$	-	$	-	$	-	$	7	$	-
Total investment securities available-for-
	sale	$	7	$	-	$	-	$	-	$	-	$	-	$	-	$	7	$	-	[a]
Trading account securities:
Collateralized mortgage obligations		$	3	$	-	$	-	$	-	$	-	$	-	$	-	$	3	$	-
Residential mortgage- backed securities -
	federal agencies		22		1		3		(4)		-		2		(8)		16		1
Other			4		-		-		-		-		-		-		4		-
Total trading account securities		$	29	$	1	$	3	$	(4)	$	-	$	2	$	(8)	$	23	$	1	[b]
Mortgage servicing rights		$	151	$	1	$	4	$	-	$	-	$	-	$	-	$	156	$	6	[c]
Total assets		$	187	$	2	$	7	$	(4)	$	-	$	2	$	(8)	$	186	$	7
Liabilities
Contingent consideration		$	(100)	$	(1)	$	-	$	-	$	-	$	-	$	-	$	(101)	$	(1)
Total liabilities		$	(100)	$	(1)	$	-	$	-	$	-	$	-	$	-	$	(101)	$	(1)	[d]

[a] Gains (losses) are included in OCI.

[b] Gains (losses) are included in “Trading account profit” in the consolidated statement of operations.

[c] Gains (losses) are included in “Other services fees” in the consolidated statement of operations.

[d] Gains (losses) are included in “FDIC loss share (expense) income” in the consolidated statement of operations.

	Quarter ended March 31, 2011
																Changes in
																unrealized
																gains
																(losses)
																included in
				Gains												earnings
				(losses)												related to
				included												assets still
		Balance at		in								Transfers		Balance at		held at
		January 1,		earnings/								in (out) of		March 31,		March 31,
(In millions)		2011		OCI		Purchases		Sales		Settlements		Level 3		2011		2011
Assets
Investment securities available-for-sale:
Mortgage-backed securities		$	8	$	-	$	-	$	-	$	-	$	-	$	8	$	-
Total investment securities available-for-
	sale	$	8	$	-	$	-	$	-	$	-	$	-	$	8	$	-	[a]
Trading account securities:
Collateralized mortgage obligations		$	3	$	-	$	-	$	-	$	-	$	-	$	3	$	-
Residential mortgage- backed securities -
	federal agencies		20		-		2		(1)		-		-		21		-
Other			3		-		-		-		-		-		3		-
Total trading account securities		$	26	$	-	$	2	$	(1)	$	-	$	-	$	27	$	-	[b]
Mortgage servicing rights		$	167	$	(6)	$	7	$	-	$	-	$	-	$	168	$	(2)	[c]
Total assets		$	201	$	(6)	$	9	$	(1)	$	-	$	-	$	203	$	(2)
Liabilities
Contingent consideration		$	(93)	$	(1)	$	-	$	-	$	-	$	-	$	(94)	$	(1)
Total liabilities		$	(93)	$	(1)	$	-	$	-	$	-	$	-	$	(94)	$	(1)	[d]

[a] Gains (losses) are included in OCI.

[b] Gains (losses) are included in “Trading account profit” in the consolidated statement of operations.

[c] Gains (losses) are included in “Other services fees” in the consolidated statement of operations.

[d] Gains (losses) are included in “FDIC loss share (expense) income” in the consolidatedstatement of operations.

There were $2million in transfers from Level 2 to Level 3 and $8million in transfers from Level 3 to Level 2 for financial instruments measured at fair value on a recurring basis during the quarter ended March 31,2012. The transfers from Level 2 to Level 3 of trading mortgage-backed securities were the result of a changein valuation technique to a matrix pricing model, based onindicative prices provided by brokers.The transfers from Level 3 to Level 2 of trading mortgage-backed securities resulted from observable market data becoming available for these securities.There were no transfers in and/or out of Level 1 during the quarter ended March 31,2012.

There were no transfers in and/or out of Level 3 for financial instruments measured at fair value on a recurring basis during the quarter ended March 31,2011. There were no transfers in and/or out of Level 1 and Level 2 during the quarter ended March 31,2011.

Gains and losses (realized and unrealized) included in earnings for the quarters ended March 31,2012 and 2011 for Level 3 assets and liabilities included in the previous tables are reported in the consolidated statements of operations as follows:

	Quarter ended March 31, 2012				Quarter ended March 31, 2011
			Changes in unrealized to				Changes in unrealized to
	Total gains		gains (losses) relating		Total gains		gains (losses) relating
	(losses) included		assets still held at		(losses) included		assets still held at
(In millions)	in earnings		reporting date		in earnings		reporting date
FDIC loss share (expense) income	$	(1)	$	(1)	$	(1)	$	(1)
Other service fees		1		6		(6)		(2)
Trading account loss		1		1		-		-
Total	$	1	$	6	$	(7)	$	(3)

The following table includes quantitative information about significant unobservable inputs used to derive the fair value of Level 3 instruments, excluding those instruments for which the unobservable inputs were not developed by the Corporation such as prices of prior transactions and/or unadjusted third-party pricing sources.

			Fair Value at			Weighted
			March 31,	Valuation	Unobservable	Average
(In thousands)			2012	Technique	Inputs	(Range)
Collateralized				Discounted	Weighted average life	2.4 years (0.4 - 3.4 years)
	mortgage			cash flow	Yield	4.15	%
	obligations - trading	$	2,750	model	Constant prepayment rate	24.2% (19.5% - 28.0%)
Other - trading				Discounted	Weighted average life	5.8	years
				cash flow	Yield	12.9	%
		$	1,325	model	Constant prepayment rate	9.0	%
Mortgage servicing				Discounted	Prepayment speed	7.9% (4.2% - 24.7%)
	rights			cash flow	Weighted average life	12.7 years (4.0 - 24.0 years)
		$	156,331	model	Discount rate	12.1% (10.0 - 15.5%)
Contingent				Discounted	Credit loss rate on covered loans	27.4% (0.0% - 100.0%)
	consideration			cash flow	Risk premium component
		$	(100,834)	model	of discount rate	4.8	%
Loans				External	Haircut applied on
		$	49,876	Appraisal	external appraisals	25.3% (5.0% - 48.0%)
Other real estate owned				External	Haircut applied on
		$	76,648	Appraisal	external appraisals	19.1% (5.0% - 40.0%)

The significant unobservable inputs used in the fair value measurement of the Corporation's collateralized mortgage obligations and interest-only collateralized mortgage obligation (reported as “other”), which are classified in the “trading” category, are yield, constant prepayment rate, and weighted average life. Significant increases (decreases) in any of those inputs in isolation would result in significantly lower (higher) fair value measurement. Generally, a change in the assumption used for the constant prepayment rate will generate a directionally opposite change in the weighted average life. For example, as the average life is reduced by a higher constant prepayment rate, a lower yield will be realized, and when there is a reduction in the constant prepayment rate, the average life of these collateralized mortgage obligations will extend, thus resulting in a higher yield. These particular financial instruments are valued internally by the Corporation's investment banking and broker-dealer unit utilizing internal valuation techniques. The unobservable inputs incorporated into the internal discounted cash flow models used to derive the fair value of collateralized mortgage obligations and interest-only collateralized mortgage obligation (reported as “other”), which are classified in the “trading” category, are reviewed by the Corporation's Corporate Treasury unit on a quarterly basis. In the case of Level 3 financial instruments which fair value is based on broker quotes, the Corporation's Corporate Treasury unit reviews the inputs used by the broker-dealers for reasonableness utilizing information available from other published sources and validates that the fair value measurements were developed in accordance with ASC Topic 820. The Corporate Treasury unit also substantiates the inputs used by validating the prices with other broker-dealers, whenever possible.

The significant unobservable inputs used in the fair value measurement of the Corporation's mortgage servicing rights are constant prepayment rates and discount rates. Increases in interest rates may result in lower prepayments.

	Carrying value at March 31, 2012										Carrying value at March 31, 2011
(In millions)	Level 1		Level 2		Level 3			Total		Write-downs	Level 1		Level 2		Level 3		Total			Write-downs
Loans[1]	$	-	$	-	$	50	$	50	$	(11)	$	-	$	-	$	19	$	19	$	(3)
Loans held-for-sale [2]		-		-		8		8		(1)		-		-		10		10		(1)
Other real estate owned [3]		-		-		77		77		(13)		-		-		13		13		(4)
Total	$	-	$	-	$	135	$	135	$	(25)	$	-	$	-	$	42	$	42	$	(8)

[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 on loans held-for-sale and loans transferred from loans held-in-portfolio to loans held-for-sale.

[3] Represents the fair value of foreclosed real estate and other collateral ownedthat were written down to their fair value. Costs to sell

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 those obtained from municipal market sources, 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 derived 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-label collateralized mortgage obligations (“CMOs”) are priced based on a bond's theoretical value derived 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 discounted cash flow model incorporates assumptions that market participants would use in estimating future net servicing income, including portfolio characteristics, prepayments assumptions, discount rates, delinquency and foreclosure rates, late charges, other ancillary revenues, cost to service and other economic factors. Prepayment speeds are adjusted for the Corporation's loan characteristics and portfolio behavior. 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.

Contingent consideration liability

The fair value of the true-up payment obligation (contingent consideration) to the FDIC as it relates to the Westernbank FDIC-assisted transaction was estimated using projected cash outflows related to the loss sharing agreements at the true-up measurement date. It took into consideration the intrinsic loss estimate, asset premium/discount, cumulative shared loss payments, and the cumulative servicing amount related to the loan portfolio. Refer to Note 9 to the consolidated financial statements for a description of the formula established in the loss share agreements for determining the true-up payment.

On a quarterly basis, management evaluates and revises the estimated credit loss rates that are used to determine expected cash flows on the covered loan pools. The expected credit losses on the loan pools are used to determine the loss share cash outflows expected to be paid to the FDIC when the true-up payment is due.

The loss share cash outflows expected to be paid to the FDIC were discounted using a term rate consistent with the time remaining until the payment is due.  The discount rate was an estimate of the sum of the risk-free benchmark rate for the term remaining before the true-up payment is due and a premium to account for the credit risk profile of BPPR owing the payment and a liquidity premium.  Two methodologies were used to realize this estimate. One consisted of adding a risk premium determined by an independent third party to the US Treasury benchmark. This resulted in a discount rate of 6.6%. The second methodology involved using an index of the yields on corporate bonds with credit ratings similar to BPPR. This index amounted to 6.7%. Both observations were averaged, resulting in a discount rate of 6.6%, which was used for estimating the value of the true-up payment obligation.

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, and which could be subject to internal adjustments based on the age of the appraisal. 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 onsecondary 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.