FIRST BANCORP /PR/ - Quarter Report: 2020 September (Form 10-Q)

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

____________

FORM 10-Q

(Mark One)

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2020

or

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ___________________ to ___________________

COMMISSION FILE NUMBER 001-14793

First BanCorp.

(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes☑ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).

Yes☑ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13 (a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐No ☑

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Common stock: 218,228,901 shares outstanding as of October 30, 2020.

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Forward Looking Statements

This Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), which are subject to the safe harbor created by such sections. When used in this Form 10-Q or future filings by First BanCorp. (the “Corporation,” “we,” “us,” or “our”) with the U.S. Securities and Exchange Commission (the “SEC”), in the Corporation’s press releases or in other public or stockholder communications made by the Corporation, or in oral statements made on behalf of the Corporation by, or with the approval of, an authorized executive officer of the Corporation, the words or phrases “would,” “intend,” “will,” “expect,” “should,” “anticipate,” “believe,” and other terms of similar meaning or import in connection with any discussion of future operating, financial or other performance are meant to identify “forward-looking statements.”

The Corporation cautions readers not to place undue reliance on any such “forward-looking statements,” which speak only as of the date made, and advises readers that these forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, as well as estimates and assumptions made by us, all of which are difficult to predict. Various factors, some of which are beyond our control, could cause actual results to differ materially from those expressed in, or implied by, such forward-looking statements.

Factors that could cause results to differ from those expressed in the Corporation’s forward-looking statements include, but are not limited to, risks described or referenced in Part II, Item 1A., “Risk Factors,” below and in Part I, Item 1A., “Risk Factors,” in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2019 (the “2019 Annual Report on Form 10-K”) and the following:

 uncertainties relating to the impact of the COVID-19 pandemic, including recent increases in, and any additional waves of, COVID-19 cases and the development and availability of a vaccine and treatments for the disease, on the Corporation’s business, operations, employees, credit quality, financial condition and net income, including because of uncertainties as to the extent and duration of the pandemic and the impact of the pandemic on consumer spending, borrowing and saving habits, the underemployment and unemployment rates, which can adversely affect repayment patterns, the Puerto Rico economy and the global economy, as well as the risk that COVID-19 may exacerbate any other factor that could cause our actual results to differ materially from those expressed in or implied by any forward-looking statements;

 risks related to the effectiveness of our preventative actions to protect the Corporation’s information and that of its customers and to strengthen our data security systems in response to the cyber incident that we recently experienced, including the integrity of our data and data security systems, increased mitigation costs or adverse effect to our reputation;

 risks related to the effect on the Corporation and its customers of governmental, regulatory, or central bank responses to COVID-19 and the Corporation’s participation in any such responses or programs, such as the Paycheck Protection Program established by the Coronavirus Aid, Relief, and Economic Security Act of 2020 (the “CARES Act of 2020”), including any judgments, claims, damages, penalties, fines or reputational damage resulting from claims or challenges against the Corporation by governments, regulators, customers or otherwise, relating to the Corporation’s participation in any such responses or programs;

 the risk that costs, expenses, and resources associated with the Corporation’s recent acquisition of Banco Santander Puerto Rico (“BSPR”) may be higher than expected; the ability to successfully complete the integration of systems, procedures, and personnel of BSPR into FirstBank Puerto Rico (“FirstBank” or the “Bank”) that are necessary to make the transaction economically successful; the risk that the Corporation may not be able to effectively integrate BSPR into the Corporation’s internal control over financial reporting; the risk that the cost savings and any other synergies from the acquisition may not be fully realized or may take longer to realize than expected, such as the risk that deposit attrition, customer loss and/or revenue loss following the acquisition may exceed expectations, including because of the impact of the COVID-19 pandemic on customers;

 uncertainty as to the ultimate outcomes of actions taken, or those that may be taken, by the Puerto Rico government, or the oversight board established by the Puerto Rico Oversight, Management, and Economic Stability Act (“PROMESA”) to address the Commonwealth of Puerto Rico’s financial problems, including a court-supervised debt restructuring process similar to U.S. bankruptcy protection undertaken pursuant to Title III of PROMESA, the designation by the PROMESA oversight board of Puerto Rico municipalities as instrumentalities covered under PROMESA, the effects of measures included in the Puerto Rico government fiscal plan, or any revisions to it, on our clients and loan portfolios, and any potential impact from future economic or political developments in Puerto Rico;

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 changes in economic and business conditions, including those caused by the COVID-19 pandemic, including recent increases in, and any additional waves of, COVID-19 cases, or other global or regional health crises as well as past or future natural disasters, such as the earthquakes affecting Puerto Rico’s southern coast, that directly or indirectly affect the financial health of the Corporation’s customer base in the geographic areas we serve and may result in increased costs or losses of property and equipment and other assets;

 the impact that a slowing economy and increased unemployment or underemployment may have on the performance of our loan and lease portfolio, the market price of our investment securities, the availability of sources of funding and the demand for our products;

 a decrease in demand for the Corporation’s products and services, resulting in lower revenues and earnings because of the continued economic recession in Puerto Rico;

 uncertainty as to the availability of certain funding sources, such as brokered CDs;

 the deteriorating weakness of the real estate markets and of the consumer and commercial sectors, which may be exacerbated by unemployment and underemployment and government restrictions imposed as a result of the COVID-19 pandemic, including recent increases in, and any additional waves of, COVID-19 cases, and their impact on the credit quality of the Corporation’s loans and other assets, which have contributed and may continue to contribute to, among other things, higher than targeted levels of non-performing assets, charge-offs and provisions for credit losses, and may subject the Corporation to further risk from loan defaults and foreclosures;

 the impact of changes in accounting standards or assumptions in applying those standards, including the impact of the COVID-19 pandemic on the determination of the allowance for credit losses required by the current expected credit losses accounting standard effective since January 1, 2020;

 the ability of FirstBank to realize the benefits of its net deferred tax assets;

 the ability of FirstBank to generate sufficient cash flow to make dividend payments to the Corporation;

 adverse changes in general economic conditions in Puerto Rico, the United States (“U.S.”), the U.S. Virgin Islands (the “USVI”), and the British Virgin Islands (the “BVI”), including the interest rate environment, market liquidity, housing absorption rates, real estate prices, and disruptions in the U.S. capital markets, including as a result of the COVID-19 pandemic and recent increases in, and any additional waves of, COVID-19 cases, which may further reduce interest margins, affect funding sources and demand for all of the Corporation’s products and services, and reduce the Corporation’s revenues and earnings and the value of the Corporation’s assets;

 uncertainty related to the effect of the discontinuation of the London Interbank Offered Rate (“LIBOR”) at the end of 2021;

 an adverse change in the Corporation’s ability to attract new clients and retain existing ones;

 the risk that additional portions of the unrealized losses in the Corporation’s investment portfolio are determined to be credit-related, including additional charges to the provision for credit losses on the Corporation’s remaining $8.0 million exposure to the Puerto Rico government’s debt securities held as part of the available-for-sale securities portfolio;

 uncertainty about legislative, tax or regulatory changes that affect financial services companies in Puerto Rico, the U.S. and the USVI and BVI, which could affect the Corporation’s financial condition or performance and could cause the Corporation’s actual results for future periods to differ materially from prior results and anticipated or projected results;

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 changes in the fiscal and monetary policies and regulations of the U.S. federal government and the Puerto Rico and other governments, including those determined by the Board of the Governors of the Federal Reserve System (the “Federal Reserve Board”), the Federal Reserve Bank of New York (the “New York FED” or “Federal Reserve”), the Federal Deposit Insurance Corporation (the “FDIC”), government-sponsored housing agencies, and regulators in Puerto Rico, and the USVI and BVI;

 the risk of possible failure or circumvention of the Corporation’s internal controls and procedures and the risk that the Corporation’s risk management policies may not be adequate;

 the Corporation’s ability to identify and prevent cyber-security incidents, such as data security breaches, malware, “denial of service” attacks, “hacking” and identity theft, a failure of which most recently caused a cyber incident, and which may result in the misuse or misappropriation of confidential or proprietary information, could result in the disruption or damage to our systems, increased costs and losses or could adversely affect our reputation;

 the risk that the FDIC may increase the deposit insurance premium and/or require special assessments to replenish its insurance fund, causing an additional increase in the Corporation’s non-interest expenses;

 the impact on the Corporation’s results of operations and financial condition of business acquisitions, such as the recent acquisition of BSPR, and dispositions;

 a need to recognize impairments on the Corporation’s financial instruments, goodwill and other intangible assets relating to business acquisitions, including as a result of the COVID-19 pandemic;

 the effect of changes in the interest rate environment, including as a result of the impact of the COVID-19 pandemic, including recent increases in, and any additional waves of, COVID-19 cases, on the global economy and on the Corporation’s businesses, business practices and results of operations;

 the risk that the impact of the occurrence of any of these uncertainties on the Corporation’s capital would preclude further growth of the Bank and preclude the Corporation’s Board of Directors from declaring dividends;

 uncertainty as to whether FirstBank will be able to continue to satisfy its regulators regarding, among other things, its asset quality, liquidity plans, maintenance of capital levels and compliance with applicable laws, regulations, and related requirements; and

 general competitive factors and industry consolidation.

The Corporation does not undertake, and specifically disclaims any obligation, to update any “forward-looking statements” to reflect occurrences or unanticipated events or circumstances after the date of such statements, except as required by the federal securities laws.

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FIRST BANCORP.

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

(Unaudited)

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FIRST BANCORP.

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

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FIRST BANCORP.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

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FIRST BANCORP.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

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FIRST BANCORP.

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

(Unaudited)

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FIRST BANCORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 1 – BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES

The consolidated financial statements (unaudited) of First BanCorp. (the “Corporation”) have been prepared in conformity with the accounting policies stated in the Corporation’s audited consolidated financial statements included in the 2019 Annual Report on Form 10-K, which were affected by the adoption, on January 1, 2020, of ASU 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments,” as amended (“ASC 326”) and the acquisition of Banco Santander Puerto Rico (“BSPR”) effective September 1, 2020, as further described below. Certain information and note disclosures normally included in the financial statements prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”) have been condensed or omitted from these statements pursuant to the rules and regulations of the SEC and, accordingly, these financial statements should be read in conjunction with the audited consolidated financial statements of the Corporation for the year ended December 31, 2019, which are included in the 2019 Annual Report on Form 10-K. All adjustments (consisting only of normal recurring adjustments) that are, in the opinion of management, necessary for a fair presentation of the statement of financial position, results of operations and cash flows for the interim periods have been reflected. All significant intercompany accounts and transactions have been eliminated in consolidation.

The results of operations for the quarter and nine-month period ended September 30, 2020 are not necessarily indicative of the results to be expected for any other interim period or for the entire year.

Acquisition of Banco Santander Puerto Rico

Effective September 1, 2020, FirstBank Puerto Rico (“FirstBank” or the “Bank”) completed the acquisition of Santander Bancorp, a wholly-owned subsidiary of Santander Holdings USA, Inc. and the holding company of BSPR pursuant to a Stock Purchase Agreement dated as of October 21, 2019, by and among FirstBank and Santander Holding, USA, Inc. (the “Stock Purchase Agreement”). The transaction was structured as an all-cash acquisition of all of the issued and outstanding common stock of Santander Bancorp, the sole shareholder of BSPR, a corporation incorporated under the laws of the Commonwealth of Puerto Rico and the sole shareholder of Santander Insurance Agency, Inc. (Santander Bancorp is referred together with BSPR collectively as “Santander,” “BSPR” or the “Acquired Companies”). Immediately following the closing, Santander Bancorp was merged with and into FirstBank (the “HoldCo Merger”), with FirstBank surviving the HoldCo Merger. Immediately following the effectiveness of the HoldCo Merger, BSPR was merged with and into FirstBank, with FirstBank as the surviving entity in the merger. In consideration for the acquisition of BSPR, the Corporation paid cash in an amount of approximately (i) $394.8 million for 117.5% of BSPR’s core tangible common equity, comprised of a $58.8 million premium on $336 million of core tangible common equity, plus (ii) $882.8 million for BSPR’s excess capital (paid at par), which represents the estimated closing payment pursuant to the terms of the Stock Purchase Agreement. At closing, prior to purchase accounting adjustment, BSPR had $5.5 billion in total assets, $2.6 billion in gross loans, and $4.2 billion in total deposits. BSPR operated 27 banking branches in Puerto Rico. Refer to Note 2 – Business Combination to the consolidated financial statements for more information about this acquisition.

The Corporation accounts for acquisitions in accordance with the accounting guidance issued by the Financial Accounting Standards Board (“FASB”) in Accounting Standards Codification (“ASC” or “Codification”) Topic No. 805, “Business Combination” (“ASC 805”), with FirstBank treated as the acquirer for accounting purposes. Under ASC 805, a business combination is defined as a transaction or other event in which an acquirer obtains control of one or more businesses. In addition, under ASC 805, a business is considered to be an integrated set of activities and assets capable of being conducted and managed for the purpose of providing a return in the form of dividends, lower costs, or other economic benefits directly to investors or other owners, members, or participants. If the net assets acquired meet the definition of a business and the transaction meets the definition of a business combination in ASC 805, the transaction is accounted for using the acquisition method pursuant to ASC 805.

Under the acquisition method, the identifiable assets acquired, the liabilities assumed, and any non-controlling interest in the acquiree are recorded at their estimated fair values as of the date of acquisition. Goodwill is recognized as the excess of the sum of the consideration transferred, plus the fair value of any non-controlling interest in the acquiree, over the fair value of the net assets acquired and liabilities assumed as of the acquisition date. The Corporation has a measurement period, in which it may retrospectively adjust the initially recorded fair values to reflect new information obtained during the measurement period that, if known, would have affected the acquisition date fair value measurements. This measurement period cannot be more than one year after the acquisition date and ends as soon as the acquirer (i) receives the information it had been seeking about facts and circumstances that existed as of the acquisition date or (ii) learns that it cannot obtain further information. The BSPR acquisition resulted in the recognition of goodwill in the amount of $6.3 million, on a provisional basis.

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Risks and Uncertainties related to COVID-19

The COVID-19 pandemic has caused significant disruption in economic activity in the Corporation’s markets. In response to the COVID-19 pandemic, Puerto Rico’s Governor has issued several executive orders including, among other things, a stay-at-home mandate on March 15, 2020, which was subsequently extended until June 15, 2020, the lockdown of non-essential businesses, and a nightly curfew. On May 4, 2020, the Puerto Rico government began to implement a plan for the gradual reopening of the economy. While substantially all parts of the economy of Puerto Rico have reopened, under new guidelines that affect how individuals interact and how businesses and governments operate, the operations and financial results of the Corporation have been and could continue to be adversely affected by the COVID-19 pandemic.

The Corporation’s businesses in the other jurisdictions in which it operates have also been adversely affected by the COVID-19 pandemic. On March 26, 2020, Florida’s Governor issued a stay-at-home order, and the state began to reopen essential operations through a phase-in process on May 4, 2020. On September 25, 2020, the state of Florida entered phase 3 of their reopening process, which essentially lifted all COVID-19 restrictions on restaurants and other businesses across the state. Additionally, in the U.S. Virgin Islands “(USVI”,) the government issued a stay-at-home order on March 23, 2020, which was subsequently extended until May 3, 2020. The USVI reopened tourism-based economy on June 1, 2020 but closed its borders once again on August 19, 2020 and reinstated stay-at-home orders for locals after a surge in COVID-19 cases. After cases decreased, the USVI reopened for tourism once again on September 19, 2020, with entry testing requirements expanded to include all travelers having ages of five years and older.

The Corporation’s business, financial condition and results of operations generally rely upon the ability of the Corporation’s borrowers to repay their loans, the value of collateral underlying the Corporation’s secured loans, and demand for loans and other products and services that the Corporation offers, which are highly dependent on the business environment in the primary markets in which the Corporation operates. Governments globally intervened with fiscal policies to mitigate the impact of the COVID-19 pandemic, including through the Coronavirus Aid, Relief, and Economic Security Act of 2020 (the “CARES Act of 2020”) in the U.S., which were intended to provide economic relief to businesses and individuals. Some of the provisions of the CARES Act of 2020 improved the ability of impacted borrowers to repay their loans, including by providing direct cash payments to eligible taxpayers, including Puerto Rico residents, below specified income limits, expanded unemployment insurance benefits and eligibility, and relief designed to prevent layoffs and business closures at small businesses. The absence of further relief in light of the continuing pandemic may adversely affect the ability of borrowers to continue to repay their loans.

Financial results for the nine-month period ended September 30, 2020 included a $163.3 million provision for credit losses, an increase of $132.0 million compared to the same period in 2019. While the reserves initially required by the current expected credit losses (“CECL”) methodology for the loans acquired in the BSPR acquisition that were not purchased credit deteriorated (“non-PCD”) loans resulted in a charge to the provision of $38.9 million in the third quarter of 2020, the remainder of the increase in the provision was largely related to the effect of the COVID-19 pandemic on economic forecasts employed in the Corporation’s CECL model. In addition, although increased customer activity was reflected in the third quarter of 2020, the various stay-at-home and lockdown orders have resulted in a reduction of the Corporation’s transaction fee income, such as that from credit and debit cards, automated teller machines (ATMs), and point-of-sale (POS) transactions for the nine-month period ended September 30, 2020, as compared to the same period in 2019. There was also an increase in deposit balances resulting from benefits received by customers, which requires the Corporation to maintain higher liquidity levels. Further, the lower interest rate environment has adversely affected the Corporation’s net interest income and margin.

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During the third quarter of 2020, the Corporation continued to support its customers affected by the COVID-19 pandemic and, consistent with regulatory guidance, continued with its payment deferral and relief programs. As of September 30, 2020, the Corporation had deferred payment arrangements involving approximately $1.2 billion, or 10%, of its total loan portfolio consisting of 3,227 residential mortgage loans totaling $511.9 million, 21,750 consumer loans totaling $168.7 million, and 196 commercial and construction loans totaling $540.8 million. Most of these deferred repayment arrangements have been done under the provisions of Section 4013 of the CARES Act of 2020 or the Revised Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus (the “Interagency Revised Statement”). In addition, moratoriums on loan repayments for consumer and residential mortgage products in Puerto Rico were mandated by local law. A loan modification covered by the provisions of the CARES Act of 2020 and the Interagency Revised Statement is not required to be considered as a troubled debt restructuring (“TDR”) loan.

In addition, as a certified Small Business Administration (“SBA”) lender, the Corporation is participating in the SBA Paycheck Protection Program (“PPP”) to help provide loans to the Corporation’s small business customers to provide them with additional working capital. During the first nine months of 2020, the Corporation originated over 6,000 loans under this program, totaling approximately $390.3 million in the two rounds of the program. The acquisition of BSPR added $77.6 million of SBA PPP loans as of September 30, 2020. As of September 30, 2020, the total amount of SBA PPP loans carried on books amounted to $453.4 million.

As of September 30, 2020, the Corporation’s and the Bank’s capital ratios were well in excess of all regulatory requirements and the Corporation maintained high liquidity levels with the cash and liquid securities to total assets ratio exceeding 19.2%, compared to 15.8% as of December 31, 2019. As of September 30, 2020, the Corporation had approximately $1.4 billion in available unused lines of credit at the Federal Home Loan Bank, and $936.1 million availability in the Primary Credit FED Discount Window Program.

While most industries have experienced and may continue to experience adverse impacts as a result of the COVID-19 pandemic, higher increases in the allowance for credit losses (“ACL”) were made for loans in the hospitality, office and retail real estate sectors in the nine-month period ended September 30, 2020 than loans in other sectors. We have continued to monitor unfunded commitments for evidence of increased credit exposure as borrowers utilize these lines for liquidity given the pandemic. Thus far, however, the amount of draws has not increased significantly due to the COVID-19 pandemic as of October 31, 2020.

The ultimate extent of the impact of the COVID-19 pandemic on the Corporation’s business, financial condition and results of operations is currently uncertain and will depend on various developments and other factors, including, among others, the duration and scope of the pandemic, as well as the overall effectiveness of governmental, regulatory and private sector responses to the pandemic, and the associated impacts on the economy, financial markets and our clients, employees and vendors.

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Adoption of New Accounting Requirements and Recently Issued but Not Yet Effective Accounting Requirements

Accounting for Financial Instruments – Credit Losses

On January 1, 2020, the Corporation adopted ASC 326, which replaces the incurred loss methodology with an expected loss methodology that is referred to as the CECL methodology to estimate the ACL for the remaining estimated life of certain financial assets. The measurement of expected credit losses under the CECL methodology is applicable to financial assets measured at amortized cost, including loans held for investment and held-to-maturity debt securities. It also applies to off-balance sheet credit exposures not accounted for as insurance (e.g., unfunded loan commitments, standby letters of credit, financial guarantees, and other similar instruments). In addition, ASC 326 made changes to the accounting for available-for-sale debt securities. One such change is to require credit losses to be presented as an allowance rather than as a write-down on available-for-sale debt securities that management does not intend to sell or believes that it is more likely than not that the Corporation will not be required to sell such securities.

The Corporation adopted ASC 326 using the modified retrospective method for financial assets measured at amortized cost, including loans held for investment and held-to-maturity debt securities, and off-balance sheet credit exposures. Results for reporting periods beginning after January 1, 2020 are presented under ASC 326 while prior period amounts continue to be reported in accordance with previously applicable GAAP.

(1)Reflects the effect of the release of the excess of the previously-established ACL for loans purchased with credit deterioration (“PCD”) over the ACL determined for such loans following the CECL methodology, which resulted in a corresponding decrease to loans.

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The Corporation adopted ASC 326 using the prospective transition approach for debt securities for which other-than-temporary impairment (“OTTI”) had been recognized prior to January 1, 2020, such as available-for-sale private label mortgage-backed securities (“MBS”). As a result, the amortized cost basis for such debt securities remained the same before and after the effective date of ASC 326. The effective interest rate on these debt securities was not changed. Amounts previously recognized in accumulated other comprehensive income (“OCI”) as of January 1, 2020 relating to improvements in cash flows expected to be collected will be accreted into income over the remaining life of the asset. Recoveries of amounts previously written off relating to improvements in cash flows after January 1, 2020 will be recorded in earnings when received.

Significant Accounting Policies affected by the adoption of ASC 326

Investment securities: The Corporation classifies its investments in debt and equity securities into one of four categories:

Held-to-maturity — Securities that the entity has the intent and ability to hold to maturity. These securities are carried at amortized cost. The Corporation may not sell or transfer held-to-maturity securities without calling into question its intent to hold other debt securities to maturity, unless a nonrecurring or unusual event that could not have been reasonably anticipated has occurred.

Trading — Securities that are bought and held principally for the purpose of selling them in the near term. These securities are carried at fair value, with unrealized gains and losses reported in earnings. As of September 30, 2020, and December 31, 2019, the Corporation did not hold investment securities for trading purposes.

Available-for-sale — Securities not classified as held-to-maturity or trading. These securities are carried at fair value, with unrealized holding gains and losses, net of deferred taxes, reported in OCI as a separate component of stockholders’ equity. The unrealized holding gains and losses do not affect earnings until they are realized, or an ACL is recorded.

Equity securities — Equity securities that do not have readily available fair values are classified as equity securities in the consolidated statements of financial condition. These securities are stated at the lower of cost or realizable value. This category is principally composed of FHLB stock that is owned by the Corporation to comply with FHLB regulatory requirements. The realizable value of the stock equals its cost. Also included in this category are marketable equity securities held at fair value with changes in unrealized gains or losses recorded through earnings pursuant to the requirements of ASU 2016-01, “Recognition and Measurement of Financial Assets and Financial Liabilities.”

Premiums and discounts on debt securities are amortized as an adjustment to interest income on investments over the life of the related securities under the interest method without anticipating prepayments, except for MBS where prepayments are anticipated. Premiums on callable debt securities, if any, are amortized to the earliest call date. Purchases and sales of securities are recognized on a trade-date basis. Gains and losses on sales are determined using the specific identification method.

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A debt security is placed on nonaccrual status at the time any principal or interest payments become 90 days delinquent. Interest accrued but not received for a security placed on non-accrual is reversed against interest income. No debt security is in a nonaccrual status as of September 30, 2020 and December 31, 2019.

Allowance for Credit Losses – Held-to-Maturity Debt Securities: The Corporation measures expected credit losses on held-to-maturity securities by major security type. As of September 30, 2020, the held-to-maturity securities portfolio consisted of Puerto Rico municipal bonds totaling $189.2 million. Approximately 60% of the held-to-maturity municipal bonds were issued by three of the largest municipalities in Puerto Rico. The vast majority of revenues of these three municipalities is independent of the Puerto Rico central government. These obligations typically are not issued in bearer form, nor are they registered with the SEC, and are not rated by external credit agencies. In most cases, these bonds have priority over the payment of operating costs and expenses of the municipality, which are required by law to levy special property taxes in such amounts as are required for the payment of all of their respective general obligation bonds and loans. Accrued interest receivable on held-to-maturity debt securities totaled $1.8 million as of September 30, 2020 ($3.9 million as of December 31, 2019) and was excluded from the estimate of credit losses.

The ACL for the held-to-maturity Puerto Rico municipal bonds ($10.2 million as of September 30, 2020) considers historical credit loss information that is adjusted for current conditions and reasonable and supportable forecasts. These financing arrangements with Puerto Rico municipalities were issued in bond form and accounted for as securities but underwritten as loans with features that are typically found in commercial loans. Accordingly, similar to commercial loans, an internal risk rating (i.e., pass, special mention, substandard, doubtful, loss) is assigned to each bond at the time of issuance or acquisition, and monitored on a continuous basis with a formal assessment completed, at a minimum, on a quarterly basis. The Corporation determines the ACL for held-to-maturity Puerto Rico municipal bonds based on the product of a cumulative probability of default (PD) and loss given default (LGD), and the amortized cost basis of each bond over its remaining expected life. PD estimates represent the point-in-time as of which the PD is developed, and are updated quarterly based on, among other things, the payment performance experience, financial performance and market value indicators, and current and forecasted relevant forward-looking macroeconomic variables over the expected life of the bonds to determine a lifetime term structure PD curve. LGD estimates are determined based on, among other things, historical charge-off events and recovery payments (if any), government sector historical loss experience, as well as relevant current and forecasted macroeconomic expectations of variables, such as unemployment rates, interest rates, and market risk factors based on industry performance, to determine a lifetime term structure LGD curve. Under this approach, all future period losses for each instrument are calculated using the PD and LGD loss rates derived from the term structure curves applied to the amortized cost basis of each bond. For the relevant macroeconomic expectations of variables, the methodology considers an initial forecast period (“reasonable and supportable period”) of 2 years and a reversion period of up to 3 years, utilizing a straight-line approach and reverting back to the historical macroeconomic mean. After the reversion period, the Corporation uses a historical loss forecast period covering the remaining contractual life based on the changes in key historical economic variables during representative historical expansionary and recessionary periods.

Refer to Note 5 - Investment Securities, to the consolidated financial statements for additional information about reserve balances for held-to-maturity debt securities, activity during the period, and information about changes in circumstances that caused changes in the ACL for held-to-maturity debt securities during the third quarter and first nine months of 2020.

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Allowance for Credit Losses – Available-for-Sale Debt Securities: For available-for-sale debt securities in an unrealized loss position, the Corporation first assesses whether it intends to sell, or it is more likely than not that it will be required to sell, the security before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the security’s amortized cost basis is written off to fair value through income. For available-for-sale debt securities that do not meet the aforementioned criteria, the Corporation evaluates whether the decline in fair value has resulted from credit losses or other factors. In making this assessment, management considers the cash position of the issuer and its cash and capital generation capacity, which could increase or diminish the issuer’s ability to repay its bond obligations, the extent to which the fair value is less than the amortized cost basis, any adverse change to the credit conditions and liquidity of the issuer, taking into consideration the latest information available about the financial condition of the issuer, credit ratings, the failure of the issuer to make scheduled principal or interest payments, recent legislation and government actions affecting the issuer’s industry, and actions taken by the issuer to deal with the economic climate. The Corporation also takes into consideration changes in the near-term prospects of the underlying collateral of a security, if any, such as changes in default rates, loss severity given default, and significant changes in prepayment assumptions and the level of cash flows generated from the underlying collateral, if any, supporting the principal and interest payments on the debt securities. If this assessment indicates that a credit loss exists, the present value of cash flows expected to be collected from the security is compared to the amortized cost basis of the security. If the present value of cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and the Corporation records an ACL for the credit loss, limited by the amount by which the fair value is less than the amortized cost basis. The Corporation recognizes in OCI any impairment that has not been recorded through an ACL.

The Corporation records changes in the ACL as a provision for (or reversal of) credit loss expense. Losses are charged against the allowance when management believes the uncollectibility of an available-for-sale security is confirmed or when either of the criteria regarding intent or requirement to sell is met.

The ACL for available-for-sale securities as of September 30, 2020 amounted to $1.4 million. Available-for-sale debt securities held by the Corporation at quarter-end primarily consisted of securities issued by U.S. government-sponsored entities (“GSEs”), private label MBS, and certain bonds issued by the Puerto Rico Housing Finance Authority (“PRHFA”), a government instrumentality of the Commonwealth of Puerto Rico. Given the explicit and implicit guarantees provided by the U.S. federal government, the Corporation believes the credit risk in securities issued by the GSEs is low. The Corporation’s credit loss-impairment assessment was concentrated on private label MBS and PRHFA debt securities. For further information, including the methodology and assumptions used for the discounted cash flow analyses performed on private label MBS and bonds issued by the PRHFA, refer to Note 5 – Investment Securities, and Note 25, – Fair Value, to the consolidated financial statements. Accrued interest receivable on available-for-sale debt securities totaled $7.9 million as of September 30, 2020 ($5.5 million as of December 31, 2019) and is excluded from the estimate of credit losses.

Loans Held for Investment: Loans that the Corporation has the ability and intent to hold for the foreseeable future are classified as held for investment and are reported at amortized cost, net of its ACL. The substantial majority of the Corporation’s loans are classified as held for investment. Amortized cost is the principal outstanding balance, net of unearned interest, cumulative charge-offs, unamortized deferred origination fees and costs, and unamortized premiums and discounts. The Corporation reports credit card loans at their outstanding unpaid principal balance plus uncollected billed interest and fees net of such amounts deemed uncollectible. Accrued interest receivable on loans totaled $67.2 million as of September 30, 2020 ($39.1 million as of December 31, 2019), was reported as part of accrued interest receivable on loans and investment securities in the consolidated statements of financial condition, and is excluded from the estimate of credit losses. Interest income is accrued on the unpaid principal balance. Fees collected and costs incurred in the origination of new loans are deferred and amortized using the interest method or a method that approximates the interest method over the term of the loan as an adjustment to interest yield. Unearned interest on certain personal loans, auto loans and finance leases and discounts and premiums are recognized as income under a method that approximates the interest method. When a loan is paid-off or sold, any remaining unamortized net deferred fees, or costs, discounts and premiums are included in loan interest income in the period of payoff.

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