FIRST BANCORP /PR/ - Quarter Report: 2020 June (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 June 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: 218,157,639 shares outstanding as of July 31, 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,” “look forward,” “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, uncertainties, estimates, and assumptions by us that 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 the recent increase in, and any additional waves of, COVID-19 cases and the development and availability of a vaccine or effective treatments for COVID-19, 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 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 (CARES) Act of 2020, including lower net interest margins resulting from the significant number of loans made under the Paycheck Protection Program and 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;

 risks, uncertainties and other factors related to the proposed acquisition of Banco Santander Puerto Rico (“BSPR”), including the impact of the COVID-19 pandemic on the ability to meet any pending closing conditions to the acquisition on a timely basis; the risk that deposit attrition, customer loss and/or revenue loss prior to or following the acquisition may exceed expectations, including because of the impact of the COVID-19 pandemic on customers or the time period that has elapsed since the acquisition was first announced; the risk that significant costs, expenses, and resources associated with or in funding the acquisition 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; and 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;

 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 the recent increase in, and any additional waves of, COVID-19 cases, or other global or regional health crises or 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;

 uncertainty as to the timing of the receipt of disaster relief funds allocated to Puerto Rico;

 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, underemployment and government restrictions imposed as a result of the COVID-19 pandemic, including the recent increase 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 loss (“CECL”) 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 (the “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 the recent increase 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 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 allowance for credit losses related to the Corporation’s remaining $8.1 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 address cyber-security incidents, such as data security breaches, malware, “denial of service” attacks, “hacking” and identity theft, a failure of which could disrupt our business, may result in misuse or misappropriation of confidential or proprietary information, and could result in the disruption or damage to our systems, increased costs and losses or an adverse effect to 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 pending 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 the recent increase 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”), 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 six-month period ended June 30, 2020 are not necessarily indicative of the results to be expected for the entire year.

Risks and Uncertainties related to COVID-19

On March 11, 2020, the outbreak of COVID-19 (coronavirus) caused by a novel strain of the coronavirus was recognized as a pandemic by the World Health Organization, and since then has widely spread to many countries, including in the markets in which the Corporation operates. The COVID-19 pandemic has severely restricted the level of economic activity in the Corporation’s markets. In response to the COVID-19 pandemic, Puerto Rico’s Governor issued an executive order implementing a stay-at-home mandate on March 15, 2020, which she subsequently extended until May 3, 2020. In addition to mandating that every citizen stay at home except to conduct certain essential activities, the order set out a nightly curfew and a lockdown of non-essential businesses. Subsequently, the governor instituted additional restrictive measures, including limiting travel by car and requiring the use of protective equipment, such as face masks, the maintenance of a distance of at least six feet between citizens, and a curfew between 7 p.m. to 5 a.m. Some of these restrictions have been modified.

On May 1, 2020, Puerto Rico’s Governor announced a gradual reopening of the economy, allowing the reopening on May 4, 2020 of sectors such as mortgage financial services, insurance, and professional services, including lawyers, engineers, accountants and dental offices. On May 11, 2020, the construction and manufacturing sectors were allowed to resume operations. On May 21, 2020, Puerto Rico’s Governor issued an executive order that, among other things, extended the stay-at-home order and curfew issued on March 15, 2020, and expanded the list of businesses and commercial operations that were allowed to resume operations. The May 21, 2020 executive order also established preconditions for certain businesses to begin resuming operations, which preconditions include developing and submitting to the Puerto Rico Department of Labor and Human Resources a COVID-19 Exposure Control Plan and self-certification. On June 12, 2020, Puerto Rico’s Governor issued an executive order terminating the stay-at-home order effective June 16, 2020 and reducing the curfew to 10 p.m. to 5 a.m. Additionally, this executive order again expanded the categories of businesses that were allowed to resume operations to include certain food, consumer retail and high-traffic consumer and entertainment businesses. On June 28, 2020, Puerto Rico’s Governor issued an executive order that extended the curfew through July 22, 2020 and permits certain government offices to resume operations, universities and colleges to reopen, a resumption of mass transportation operations, and a reopening of certain additional businesses, subject to occupancy restrictions. On July 3, 2020, Puerto Rico’s Governor issued an executive order establishing new requirements for travelers entering Puerto Rico, including the requirement that a traveler obtain a negative COVID-19 test result within 72 hours prior to arrival, and mandatory quarantines in certain circumstances.

On July 16, 2020, amidst an increase in COVID-19 cases, Puerto Rico’s Governor issued an executive order that included, among other things, reimplementing certain prior restrictions, such as the closure of bars, gyms, marinas, theaters and casinos and restrictions in the use of beaches, and extending the curfew through July 31, 2020. Lastly, on July 31, 2020, Puerto Rico’s Governor issued an executive order that extended the curfew through August 15, 2020, extends the closure and restrictions included in the July 16, 2020 order, and bans the sale of alcohol and the operation of non-essential businesses on Sundays. As of August 2, 2020, more than 7,000 people had tested positive for COVID-19 and over 200 deaths that were caused by or related to the illness have been reported, according to data provided by the Puerto Rico government.

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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 June 5, 2020, portions of Florida entered phase 2 of their reopening process. In response to a subsequent rise in the number of reported COVID-19 cases, state and local officials reimplemented significant restrictions on local businesses and social gatherings. Additionally, in the U.S. Virgin Islands, the government issued a stay-at-home order on March 23, 2020. On March 30, 2020, the U.S. Virgin Islands government issued an order extending the stay-at-home mandate through April 30, 2020 and on April 29, 2020 the USVI government issued an order lifting the stay-at-home order and permitting certain categories of businesses to resume operations, subject to safety protocols and limitations, effective May 4, 2020. The U.S. Virgin Islands tourism-based economy reopened on June 1, 2020, with new requirements for travelers and new guidance on how to conduct businesses while protecting the public health. Due to the recent increase in COVID-19 cases, bars, gaming centers and casinos are closed until further notice. The USVI is conducting routine temperature checks and health screenings at the ports of entry. No quarantine is required if travelers meet certain criteria. However, travelers whose state of residence has a COVID-19 positivity rate greater than 10 percent are required to produce evidence of a negative COVID-19 antigen test result that was received within five days prior to travel to the USVI.

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 Corporation’s primary markets in which it operates. Governments globally intervened with fiscal policies to mitigate the impact, including the Coronavirus Aid, Relief, and Economic Security Act of 2020 (the “CARES Act of 2020”) in the U.S., which aimed to provide economic relief to businesses and individuals. Some of these provisions may improve the ability of impacted borrowers to repay their loans, including by providing direct cash payments to eligible taxpayers below specified income limits, including Puerto Rico residents, expanded unemployment insurance benefits and eligibility, and relief designed to prevent layoffs and business closures at small businesses. In addition, the Puerto Rico Government and the PROMESA oversight board has allocated over $900 million aimed to stimulate the Puerto Rico economy and provide cash flow relief to those affected by the COVID-19 pandemic.

The COVID-19 pandemic, and governmental, regulatory authorities’, and societal responses have also affected the Corporation’s financial results. The COVID-19 pandemic and its associated impacts on trade (including supply chains and export levels), travel, underemployment and unemployment, consumer spending, residential and commercial construction and other economic activities has resulted in less economic activity, volatile equity market valuations and significant volatility and disruption in financial markets. For instance, on March 3, 2020, the Federal Reserve reduced the target federal funds rate by 50 basis points, followed by an additional reduction of 100 basis points on March 16, 2020. These reductions in interest rates and economic uncertainties, as a result of the spread of COVID-19, have adversely affected and might further adversely affect the Corporation’s results of operations. The Corporation may experience other financial impacts, including as a result of the recent increase in, and any additional waves of, COVID-19 cases, though such potential impacts are unknown at this time.

Financial results for the six-month period ended June 30, 2020 included the effect of a reserve build of $88.9 million (i.e., the amount by which the provision for credit losses of $116.4 million exceeds net charge-offs of $27.5 million), driven by the effect of the COVID-19 pandemic on forecasted economic conditions considered for the determination of the Allowance for Credit Losses (“ACL”), as further discussed below. In addition to the impact of COVID-19 on the Corporation’s ACL, the COVID-19 pandemic and 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), point-of-sale transactions, a reduction in the Corporation’s volume of loan originations and closings, and 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 and disruptions in loan origination and closing processes has adversely affected the Corporation’s net interest income and margin.

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In working with borrowers affected by the COVID-19 pandemic, the Corporation implemented payment deferral programs to alleviate the hardships being experienced by the Corporation’s borrowers. The payment deferral programs, which the Corporation implemented in March 2020, provided deferred repayment arrangements up to June 30, 2020 to consumer borrowers (i.e., residential mortgages, personal loans, auto loans, finance leases, small loans, and credit cards) who qualify for the program based on, among other things, the delinquency status of the loan on March 16, 2020, with the possibility of further extension up to September 30, 2020, if needed (August 31, 2020 in the case of credit card or individual lines of credit). For commercial loans, any request for payment deferral is analyzed on a case by case basis. As of June 30, 2020, the Corporation had under deferred payment arrangements approximately $3.4 billion, or 36%, of its total loan portfolio consisting of 5,860 residential mortgage loans totaling $849.6 million, 69,619 consumer loans totaling $784.0 million, and 726 commercial and construction loans totaling $1.7 billion. Most of these deferred repayment arrangements have been done under the provisions of the 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 are mandated by local law. On July 15, 2020, Puerto Rico’s Governor signed a Senate Joint Resolution that extended the moratorium period on residential mortgage loans by two additional months (up to August 2020) for those borrowers that have been affected by the pandemic and were current in their payments. 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 unless the borrower was previously experiencing financial difficulty and the concession granted was significant in relation to the exposure based on criteria established by the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC” or “Codification”) Subtopic 310-40, “Receivables-Troubled Debt Restructurings by Creditors.”

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 second quarter of 2020, the Corporation originated 5,423 loans under this program, totaling approximately $375.2 million, of which $368.7 million (book value - $359.6 million) was still outstanding as of June 30, 2020. Furthermore, as of July 31, 2020, the Corporation had received approvals for 632 additional client applications and funded $14.9 million during the month of July. These loans provide for below market interest rates, thereby adversely affecting net interest margins.

As of June 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 21.0%, compared to 15.8% as of December 31, 2019. As of June 30, 2020, the Corporation had approximately $386.4 million in available unused lines of credit at the Federal Home Loan Bank, and $997.1 million availability in the Primary Credit FED Discount Window Program.

While most industries have and will continue to experience adverse impacts as a result of the COVID-19 pandemic in the immediate future, higher increases in the ACL were made for loans in the hospitality, office and retail real estate industries in the quarter and six-month period ended June 30, 2020. The exposure to these industries represented approximately 31% of the total construction and commercial loan portfolio as of June 30, 2020. 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 July 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 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 current expected credit loss (“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 PCD loans that were previously classified as purchased credit impaired (“PCI”) loans and accounted for under ASC Topic 310-30 (ASC 310-30). As allowed by ASC 326, the Corporation elected to maintain pools of loans accounted for under ASC 310-30 as “units of accounts,” conceptually treating each pool as a single asset. As of June 30, 2020, such PCD loans consisted of $131.9 million of residential mortgage loans and $2.5 million of commercial mortgage loans acquired by the Corporation as part of previously completed asset acquisitions. These previous transactions include a transaction closed on February 27, 2015, in which FirstBank acquired 10 Puerto Rico branches of Doral Bank, acquired certain assets, including PCD loans, and assumed deposits, through an alliance with Banco Popular of Puerto Rico, which was the successful lead bidder with the FDIC on the failed Doral Bank, as well as other co-bidders, and the acquisition from Doral Financial in the first quarter of 2014 of all of its rights, title and interest in first and second residential mortgage loans in full satisfaction of secured borrowings owed by such entity to FirstBank. As the Corporation elected to maintain pools of units of account for loans previously accounted for under ASC 310-30, the Corporation is not able to remove loans from the pools until they are paid off, written off or sold (consistent with the previous practice), but is required to follow ASC 326 for purposes of the ACL. Regarding interest income recognition, the prospective transition approach for PCD loans was applied at a pool level, which froze the effective interest rate of the pools as of January 1, 2020. According to regulatory guidance, the determination of nonaccrual or accrual status for PCD loans that the Corporation has elected to maintain in previously existing pools pursuant to the policy election right upon adoption of ASC 326 should be made at the pool level, not the individual asset level. In addition, the guidance provides that the Corporation can continue accruing interest and not report the PCD loans as being in nonaccrual status if the following criteria are met: (i) the Corporation can reasonably estimate the timing and amounts of cash flows expected to be collected, and (ii) the Corporation did not acquire the asset primarily for the rewards of ownership of the underlying collateral, such as use of collateral in operations or improving the collateral for resale. Thus, the Corporation continues to exclude these pools of PCD loans from nonaccrual loan statistics. In accordance with ASC 326, the Corporation did not reassess whether modifications to individual acquired loans accounted for within pools were TDR as of the date of adoption.

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 June 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 June 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 June 30, 2020, the held-to-maturity securities portfolio consisted of Puerto Rico municipal bonds totaling $138.5 million. Approximately 70% 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 $3.6 million as of June 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 ($9.3 million as of June 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 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, 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 second quarter and first six months of 2020.

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.

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The ACL for available-for-sale securities as of June 30, 2020 amounted to $1.6 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 24, – Fair Value, to the consolidated financial statements. Accrued interest receivable on available-for-sale debt securities totaled $6.5 million as of June 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 $50.9 million as of June 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 unamortized net deferred fee (cost) is credited (charged) to income.

Nonaccrual and Past-Due Loans - Loans on which the recognition of interest income has been discontinued are designated as nonaccrual. Loans are classified as nonaccrual when they are 90 days past due for interest and principal, with the exception of residential mortgage loans guaranteed by the Federal Housing Administration (the “FHA”), the Veterans Administration (the “VA”) or the PRHFA and credit card loans. It is the Corporation’s policy to report delinquent mortgage loans insured by the FHA, or guaranteed by the VA or the PRHFA, as loans past due 90 days and still accruing as opposed to nonaccrual loans since the principal repayment is insured or guaranteed. However, the Corporation discontinues the recognition of income relating to FHA/VA loans when such loans are over 15 months delinquent, taking into consideration the FHA interest curtailment process, and relating to PRHFA loans when such loans are over 90 days delinquent. Credit card loans continue to accrue finance charges and fees until charged off at 180 days. Loans generally may be placed on nonaccrual status prior to when required by the policies described above when the full and timely collection of interest or principal becomes uncertain (generally based on an assessment of the borrower’s financial condition and the adequacy of collateral, if any). When a loan is placed on nonaccrual status, any accrued but uncollected interest income is reversed and charged against interest income and amortization of any net deferred fees is suspended. The amount of accrued interest reversed against interest income totaled $0.3 million and $0.8 million for the quarter and six-month period ended June 30, 2020, respectively. Interest income on nonaccrual loans is recognized only to the extent it is received in cash. However, when there is doubt regarding the ultimate collectability of loan principal, all cash thereafter received is applied to reduce the carrying value of such loans (i.e., the cost recovery method). Under the cost-recovery method, interest income is not recognized until the loan balance is reduced to zero. Generally, the Corporation returns a loan to accrual status when all delinquent interest and principal becomes current under the terms of the loan agreement, or after a sustained period of repayment performance (6 months) and the loan is well secured and in the process of collection, and full repayment of the remaining contractual principal and interest is expected. Regarding interest income recognition for PCD loans, the prospective transition approach for PCD assets required by ASC 326 was applied at a pool level, which froze the effective interest rate of the pools as of January 1, 2020. PCD loan pools accounted for as a single unit of accounting are not reported as nonaccrual as long as the Corporation is able to reasonably estimate the timing and amounts of cash flows expected to be collected. Loans that are past due 30 days or more as to principal or interest are considered delinquent, with the exception of residential mortgage, commercial mortgage, and construction loans, which are considered past due when the borrower is in arrears on two or more monthly payments.

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Charge-off of Uncollectible Loans - Net charge-offs consist of the unpaid principal balances of loans held for investment that the Corporation determines are uncollectible, net of recovered amounts. The Corporation records charge-offs as a reduction to the allowance for credit losses and subsequent recoveries of previously charged-off amounts are credited to the allowance for credit losses. Collateral dependent loans in the construction, commercial mortgage, and commercial and industrial loan portfolios are charged off to their net realizable value (fair value of collateral, less estimated costs to sell) when loans are considered to be uncollectible. Within the consumer loan portfolio, auto loans and finance leases are reserved once they are 120 days delinquent and are charged off to their estimated net realizable value when the collateral deficiency is deemed uncollectible (i.e., when foreclosure/repossession is probable) or when the loan is 365 days past due. Within the other consumer loan portfolio, closed-end loans are charged off when payments are 120 days in arrears, except small personal loans. Open-end (revolving credit) consumer loans, including credit card loans, and small personal loans are charged off when payments are 180 days in arrears. On a quarterly basis, residential mortgage loans that are 180 days delinquent are reviewed and charged-off, as needed, to the fair value of the underlying collateral. Generally, all loans may be charged off or written down to the fair value of the collateral prior to the application of the policies described above if a loss-confirming event has occurred. Loss-confirming events include, but are not limited to, bankruptcy (unsecured), continued delinquency, or receipt of an asset valuation indicating a collateral deficiency when the asset is the sole source of repayment.

Troubled Debt Restructurings - A restructuring of a loan constitutes a TDR if the creditor, for economic or legal reasons related to the debtor’s financial difficulties, grants a concession to the debtor that it would not otherwise consider. TDR loans are classified as either accrual or nonaccrual loans. Loans in accrual status may remain in accrual status when their contractual terms have been modified in a TDR if the loans had demonstrated performance prior to the restructuring and payment in full under the restructured terms is expected. Otherwise, loans on nonaccrual status and restructured as TDRs will remain on nonaccrual status until the borrower has proven the ability to perform under the modified structure, generally for a minimum of six months, and there is evidence that such payments can, and are likely to, continue as agreed.

The Corporation removes loans from TDR classification, consistent with authoritative accounting guidance that permits the removal of a loan from the TDR classification in years following the modification, only when the following two circumstances are met:

 The loan is in compliance with the terms of the restructuring agreement; and

 The loan yields a market interest rate at the time of the restructuring. In other words, the loan was restructured with an interest rate equal to or greater than what the Corporation would have been willing to accept at the time of the restructuring for a new loan with comparable risk.

If both of the conditions are met, the loan can be removed from the TDR classification in calendar years after the year in which the restructuring took place. A loan that had previously been modified in a TDR and is subsequently refinanced under then-current underwriting standards at a market rate with no concessionary terms is accounted for as a new loan and is no longer reported as a TDR. The allowance for credit losses on a TDR loan is generally measured using a discounted cash flow method, as further explained below, where the expected future cash flows are discounted at the rate of the loan prior to the restructuring. For credit cards, personal loans, and nonaccrual auto loans and finance leases modified in a TDR, the ACL is measured using the same methodologies as those used for all other loans in those portfolios.

Collateral dependent loans - The Corporation elected the practical expedient for loans for which the repayment is expected to be provided substantially through the operation or sale of the collateral when the borrower is experiencing financial difficulties based on the Corporation’s assessment as of the reporting date. Accordingly, when the Corporation determines that foreclosure is probable, expected credit losses on collateral dependent loans are based on the fair value of the collateral at the reporting date, adjusted for undiscounted selling costs as appropriate.

Loans individually evaluated for credit loss determination - Loans are individually evaluated for purposes of the ACL determination when, based upon current information and events, including consideration of internal credit risk ratings, the Corporation assesses that it is probable that it will be unable to collect all amounts due (including principal and interest) according to the contractual terms of the loan agreement, primarily collateral dependent commercial and construction loans, or loans that have been modified or are reasonably expected to be modified in a TDR (except for credit cards, personal loans and nonaccrual auto loans). The Corporation individually evaluates loans having balances of $500 thousand or more and with the aforementioned conditions in the construction, commercial mortgage, and commercial and industrial portfolios. The Corporation also evaluates individually for ACL purposes certain residential mortgage loans and home equity lines of credit with high delinquency levels. Interest income on loans individually evaluated for ACL determination is recognized based on the Corporation’s policy for recognizing interest on accrual and nonaccrual loans.

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Allowance for credit losses – Loans: The ACL for loans and finance leases is a valuation account that is deducted from the loans’ amortized cost basis to present the net amount expected to be collected on loans. Loans are charged-off against the allowance when management believes the uncollectibility of a loan balance is confirmed. Expected recoveries do not exceed the aggregate of amounts previously charged-off.

The Corporation estimates the allowance using relevant available information, from internal and external sources, relating to past events, current conditions, and reasonable and supportable forecasts. Historical credit loss experience is a significant input for the estimation of expected credit losses, as well as adjustments to historical loss information made for differences in current loan-specific risk characteristics, such as any difference in underwriting standards, portfolio mix, delinquency level, or term. Additionally, the Corporation’s assessment involves evaluating key factors, which include credit and macroeconomic indicators, such as changes in unemployment rates, property values, and other relevant factors, to account for current and forecasted market conditions that are likely to cause estimated credit losses over the life of the loans to differ from historical credit losses. Expected credit losses are estimated over the contractual term of the loans, adjusted by prepayments when appropriate. The contractual term excludes expected extensions, renewals, and modifications unless either of the following applies: the Corporation has a reasonable expectation at the reporting date that a TDR will be executed with an individual borrower or the extension or renewal options are included in the original or modified contract at the reporting date and are not unconditionally cancellable by the Corporation.

The ACL is primarily measured based on a PD/LGD modeled approach, or individually for collateral dependent loans and certain TDR loans. The Corporation evaluates the need for changes to the ACL by portfolio segments and classes of loans within certain of those portfolio segments. Factors such as the credit risk inherent in a portfolio and how the Corporation monitors the related quality, as well as the estimation approach to estimate credit losses, were considered in the determination of such portfolio segments and classes. The Corporation has identified the following portfolio segments and measures the ACL using the following methods:

Residential mortgage – Residential mortgage loans are loans secured by residential real property together with the right to receive the payment of principal and interest on the loan. The majority of the Corporation’s residential loans are first lien closed-end loans secured by 1-4 single-family residential properties. As of June 30, 2020, the Corporation’s outstanding balance of residential mortgages in the Puerto Rico and Virgin Islands regions were fixed-rate loans, while in the Florida region approximately 57% of the residential mortgage loan portfolio consisted of hybrid adjustable rate mortgages. For purposes of the ACL determination, the Corporation stratifies the portfolio by two main regions (i.e., Puerto Rico/Virgin Islands region and Florida region) and by the following two classes: (i) government-guaranteed residential mortgage loans, and (ii) conventional mortgage loans. Government-guaranteed loans are those originated to qualified borrowers under the FHA and the VA standards. Originated loans that meet the FHA’s standards qualify for the FHA’s insurance program whereas loans that meet the standards of the VA are guaranteed by such entity. No credit losses are determined for loans insured or guaranteed by the FHA or the VA due to the explicit guarantee of the U.S. federal government. Residential mortgage loans that do not qualify under the FHA or VA programs are referred to as conventional residential mortgage loans.

For conventional residential mortgage loans, the Corporation calculates the ACL using a PD/LGD modeled approach, or individually for collateral dependent loans with high delinquency levels or loans that have been modified or are reasonably expected to be modified in a TDR. The ACL for residential mortgage loans measured using a PD/LGD model is calculated based on the product of a PD, LGD, and the amortized cost basis determined for each loan over the remaining expected life of the loan, considering prepayments. PD estimates represent the point-in-time as of which the PD is developed for each residential mortgage loan, updated quarterly based on, among other things, historical payment performance and relevant current and forward-looking macroeconomic variables, such as regional unemployment rates, over the expected life of the loans to determine a lifetime term structure PD curve. The Corporation determines LGD estimates based on, among other things, historical charge-off events and recovery payments, loan-to-value attributes, and relevant current and forecasted macroeconomic variables expectations, such as the regional housing price index, to determine a lifetime term structure LGD curve. Under this approach, the Corporation calculates losses for each loan for all future periods using the PD and LGD loss rates derived from the term structure curves applied to the amortized cost basis of the loans, considering prepayments. For loans that have been modified or are reasonably expected to be modified in a TDR and loans previously-charged off to their respective realizable values, the Corporation determines the ACL based on a risk-adjusted discounted cash flow methodology using PDs and LGDs developed as explained above. Under this approach, all future cash flows (interest and principal) for each loan are adjusted by the PDs and LGDs derived from the term structure curves and prepayments and then discounted at the effective interest rate as of the reporting date (or original rate for TDRs) to arrive at the net present value of future cash flows. For these loans, the estimated credit loss amount recorded in a period represents the excess of the loss amount resulting from the model in excess of any previously-recorded partial charge-off of the loan. Residential mortgage loans that are 180 days or more past due are considered collateral dependent loans and are individually reviewed and charged-off, as needed, to the fair value of the collateral.

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Commercial mortgage – Commercial mortgage loans are loans secured primarily by commercial real estate properties for which the primary source of repayment comes from rent and lease payments that are generated by an income-producing property. For purposes of the ACL determination, the Corporation stratifies the portfolio by two main regions (i.e., Puerto Rico/Virgin Islands region and Florida region). An internal risk rating (i.e., pass, special mention, substandard, doubtful, loss) is assigned to each loan at the time of origination and monitored on a continuous basis with a formal assessment completed quarterly, at a minimum. For commercial mortgage loans, the Corporation calculates the ACL using a PD/LGD modeled approach, or individually for those loans that meet the definition of collateral dependent loans or loans that have been modified or are reasonably expected to be modified in a TDR. The ACL for commercial mortgage loans measured using a PD/LGD model is calculated based on the product of a cumulative PD and LGD, and the amortized cost basis determined for each loan over the remaining expected life of the loan, considering prepayments. PD estimates represent the point-in-time as of which the PD is developed for each commercial mortgage loan, updated quarterly based on, among other things, the payment performance experience, industry historical loss experience, property type, occupancy, and relevant current and forward-looking macroeconomic variables over the expected life of the loans to determine a lifetime term structure PD curve. The Corporation determines LGD estimates based on historical charge-off events and recovery payments, industry historical loss experience, specific attributes of the loans such as loan-to-value, debt service coverage ratios, and net operating income, as well as relevant current and forecasted macroeconomic variables expectations, such as real estate price indexes, the gross domestic product (“GDP”), interest rates, and unemployment rates, among others, to determine a lifetime term structure LGD curve. Under this approach, the Corporation calculates losses for each loan for all future periods using the PD and LGD loss rates derived from the term structure curves applied to the amortized cost basis of the loans, considering prepayments. The ACL for collateral dependent loans, including loans modified or reasonably expected to be modified in a TDR, is determined based on the fair value of the collateral at the reporting date, adjusted for undiscounted selling costs as appropriate.

Commercial and Industrial – Commercial and Industrial (“C&I”) loans are unsecured and secured loans for which the primary source of repayment comes from the ongoing operations and activities conducted by the borrower and not from rental income or the sale or refinancing of any underlying real estate collateral; thus, credit risk is largely dependent on the commercial borrower’s current and expected financial condition. As of June 30, 2020, the C&I loan portfolio consisted of loans granted to large corporate customers as well as middle-market customers across several industries, and the government sector. For purposes of the ACL determination, the Corporation stratifies the C&I portfolio by two main regions (i.e., Puerto Rico/Virgin Islands region and Florida region). An internal risk rating (i.e., pass, special mention, substandard, doubtful, loss) is assigned to each loan at the time of origination and monitored on a continuous basis with a formal assessment completed quarterly, at a minimum. For C&I loans, the Corporation calculates ACL using a PD/LGD modeled approach, or, in some cases, based on a risk-adjusted discounted cash flow method or the fair value of the collateral. The ACL for C&I loans measured using a PD/LGD model is calculated based on the product of a cumulative PD and LGD, and the amortized cost basis determined for each loan over the remaining expected life of the loan, considering prepayments. PD estimates represent the point-in-time as of which the PD is developed for each C&I loan, updated quarterly based on the industry historical loss experience, financial performance and market value indicators, and current and forecasted relevant forward-looking macroeconomic variables over the expected life of the loans to determine a lifetime term structure PD curve. The corporation determines LGD estimates based on historical charge-off events and recovery payments, industry historical loss experience, specific attributes of the loans, such as loan to value, as well as relevant current and forecasted macroeconomic variables expectations, such as, unemployment rates, interest rates, and market risk factors based on industry performance and the equity market, to determine a lifetime term structure LGD curve. Under this approach, the Corporation calculates losses for each loan for all future periods using the PD and LGD loss rates derived from the term structure curves applied to the amortized cost basis of the loans, considering prepayments. The Corporation determines the ACL for those C&I loans that it has determined, based upon current information and events, that it is probable that the Corporation will be unable to collect all amounts due according to the contractual terms, and for any non-collateral dependent C&I loans that have been modified or are reasonably expected to be modified in a TDR, based on a risk-adjusted discounted cash flow methodology using PDs and LGDs developed as explained above. Under this approach, the Corporation adjusts all future cash flows (interest and principal) for each loan by the PDs and LGDs derived from the term structure curves and prepayments and then discounted at the effective interest rate as of the reporting date (original rate for TDRs) to arrive at the net present value of future cash flows and the ACL is calculated as the excess of the amortized cost basis over the net present value of future cash flows. The ACL for collateral dependent C&I loans is determined based on the fair value of the collateral at the reporting date, adjusted for undiscounted selling costs as appropriate.

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Construction – As of June 30, 2020, construction loans consisted generally of loans secured by real estate made to finance the construction of industrial, commercial, or residential buildings and include loans to finance land development in preparation for erecting new structures. These loans involve an inherent higher level of risk and sensitivity to market conditions. Demand from prospective tenants or purchasers may erode after construction begins because of a general economic slowdown. For purposes of the ACL determination, the Corporation stratifies the construction loan portfolio by two main regions (i.e., Puerto Rico/Virgin Island region and Florida region). An internal risk rating (i.e., pass, special mention, substandard, doubtful, loss) is assigned to each loan at the time of origination and monitored on a continuous basis with a formal assessment completed, at a minimum, on a quarterly basis. For construction loans, the Corporation calculates the ACL using a PD/LGD modeled approach, or individually for those loans that meet the definition of collateral dependent loans or loans that have been modified or are reasonably expected to be modified in a TDR. The ACL for construction loans measured using a PD/LGD model is calculated based on the product of a cumulative PD and LGD, and the amortized cost basis determined for each loan over the remaining expected life of the loan, considering prepayments. PD estimates represent the point-in-time as of which the PD is developed for each construction loan, updated quarterly based on, among other things, historical payment performance experience, industry historical loss experience, underlying type of collateral, and relevant current and forward-looking macroeconomic variables over the expected life of the loans to determine a lifetime term structure PD curve. The Corporation determines LGD estimates based on historical charge-off events and recovery payments, industry historical loss experience, specific attributes of the loans, such as loan-to-value, debt service coverage ratios, and relevant current and forecasted macroeconomic variables expectations, such as unemployment rates, GDP, interest rates, and real estate price indexes, to determine a lifetime term structure LGD curve. Under this approach, the Corporation calculates losses for each loan for all future periods using the PD and LGD loss rates derived from the term structure curves applied to the amortized cost basis of the loans, considering prepayments. The ACL for collateral dependent loans, including loans modified or reasonably expected to be modified in a TDR, is determined based on the fair value of the collateral at the reporting date, adjusted for undiscounted selling costs as appropriate.

Consumer – As of June 30, 2020, consumer loans generally consisted of unsecured and secured loans extended to individuals for household, family, and other personal expenditures, including several classes of products. For purposes of the ACL determination, the Corporation stratifies the portfolio by two main regions (i.e., Puerto Rico/Virgin Islands region and Florida region) and by the following five classes: (i) auto loans; (ii) finance leases; (iii) credit cards; (iv) personal loans; and (v) other consumer loans, such as open-end home equity revolving lines of credit and other types of consumer credit lines, among others.

For auto loans and finance leases, the Corporation calculates the ACL using a PD/LGD modeled approach, or individually for loans modified or reasonably expected to be modified in a TDR and performing in accordance with restructured terms. The ACL for auto loans and finance leases measured using a PD/LGD model is calculated based on the product of a PD, LGD, and the amortized cost basis determined for each loan over the remaining expected life of the loan, considering prepayments. PD estimates represent the point-in-time as of which the PD is developed for each loan, updated quarterly based on, among other things, the historical payment performance and relevant current and forward-looking macroeconomic variables, such as regional unemployment rates, over the expected life of the loans to determine a lifetime term structure PD curve. The Corporation determines LGD estimates primarily based on historical charge-off events and recovery payments to determine a lifetime term structure LGD curve. Under this approach, the Corporation calculates losses for each loan for all future periods using the PD and LGD loss rates derived from the term structure curves applied to the amortized cost basis of the loans, considering prepayments. For loans modified or reasonably expected to be modified in a TDR and performing in accordance with restructured terms, the Corporation determines the ACL based on a risk-adjusted discounted cash flow methodology using PDs and LGDs developed as explained above. Under this approach, all future cash flows (interest and principal) for each loan are adjusted by the PDs and LGDs derived from the term structure curves and prepayments and then discounted at the effective interest rate of the loan prior to the restructuring to arrive at the net present value of future cash flows and the ACL is calculated as the excess of the amortized cost basis over the net present value of future cash flows for each loan.

For the credit card and personal loan portfolios, the Corporation determines the ACL on a pool basis based on a product of PDs and LGDs developed considering historical losses for each origination vintage by length of loan terms, by geography, and by credit score. The PD and LGD for each cohort consider key macroeconomic variables, such as regional GDP, unemployment rates, and retail sales, among others. Under this approach, all future period losses for each instrument are calculated using the PDs and LGDs applied to the amortized cost basis of the loans, considering prepayments.

In addition, home equity lines of credit that are 180 days or more past due are considered collateral dependent and are individually reviewed and charged-off, as needed, to the fair value of the collateral.

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For the ACL determination of all portfolios, the relevant macroeconomic variables expectations related to the Puerto Rico/Virgin Islands region consider an initial 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. For the Florida region, the methodology considers a reasonable and supportable forecast period and an implicit reversion towards the historical trend that varies for each macroeconomic variable, achieving the steady state by year 5. After the reversion period, a historical loss forecast period covering the remaining contractual life, adjusted for prepayments, is used based on the changes in key historical economic variables during representative historical expansionary and recessionary periods.

Refer to Note 8, - Allowance for Credit Losses for Loans and Finance Leases, to the consolidated financial statements for additional information about reserve balances for each portfolio, activity during the period, and information about changes in circumstances that caused changes in the ACL for loans and finance leases during the quarter and six-month period ended June 30, 2020.

Allowance for Credit Losses on Off-Balance Sheet Credit Exposures: The Corporation estimates expected credit losses over the contractual period in which the Corporation is exposed to credit risk via a contractual obligation to extend credit, unless the obligation is unconditionally cancellable by the Corporation. The ACL on off-balance sheet credit exposures is adjusted as a provision for credit loss expense. The estimate includes consideration of the likelihood that funding will occur and an estimate of expected credit losses on commitments expected to be funded over its estimated life. As of June 30, 2020, the off-balance sheet credit exposures primarily consisted of unfunded loans commitments and standby letters of credit for commercial and construction loans. The Corporation utilized the PDs and LGDs derived from the above-explained methodologies for the commercial and construction loan portfolios. Under this approach, all future period losses for each loan are calculated using the PD and LGD loss rates derived from the term structure curves applied to the usage given default exposure. The ACL on off-balance sheet credit exposures is included as part of accounts payable and other liabilities in the consolidated statement of financial condition with adjustments included as part of the provision for credit loss expense in the consolidated statements of income.

Refer to Note 8, - Allowance for Credit Losses for Loans and Finance Leases, to the consolidated financial statements for additional information about reserve balances for unfunded loan commitments, activity during the period, and information about changes in circumstances that caused changes in the ACL for loans and finance leases during the quarter and six-month period ended June 30, 2020.

Allowance for Credit Losses on Other Assets Measured at Amortized Cost: The Corporation also estimates expected credit losses for certain accounts receivable, primarily claims from government-guaranteed loans, loan servicing-related receivables, and other receivables. The adoption of ASC 326 did not result in an adjustment to retained earnings at the time of adoption on January 1, 2020, and a material change was not reflected during the quarter and six-month period ended June 30, 2020. The ACL on other assets measured at amortized cost is included as part of other assets in the consolidated statement of financial condition with adjustments included as part of other non-interest expenses in the consolidated statements of income.

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Subsequent Measurement of Goodwill

In January 2017, the FASB updated the Codification to simplify the subsequent measurement of goodwill by eliminating Step 2 from the two-step goodwill impairment test. Step 1 involves a comparison of the estimated fair value of the reporting unit to its carrying value, including goodwill. If the estimated fair value of a reporting unit exceeds its carrying value, goodwill is not considered impaired. If the carrying value exceeds the estimated fair value, there is an indication of potential impairment and a second step is required to measure the amount of the impairment. Step 2, when necessary, calculated an implied fair value of the goodwill impairment for each reporting unit for which Step 1 indicated a potential impairment. The 2017 guidance provides that a goodwill impairment test must be conducted by comparing the fair value of a reporting unit with its carrying amount. Entities must recognize an impairment charge for goodwill that is equal to the excess of the carrying amount over the reporting unit’s fair value. Entities have the option to perform a qualitative assessment for a reporting unit to determine if the quantitative impairment is necessary. This guidance took effect for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. The adoption of this guidance during the first quarter of 2020 did not have an effect on the Corporation’s consolidated financial statements or results of operations. Subsequent effects will depend upon the performance of the reporting units that have goodwill, the market conditions affecting the fair value of each reporting unit going forward, and subsequent acquisitions.

Changes to the Disclosure Requirements for Fair Value Measurement

In August 2018, the FASB updated the Codification and amended ASC Topic 820, “Fair Value Measurement and Disclosures,” to add, remove, and modify fair value measurement disclosure requirements. The requirements that were removed for public entities include disclosure about: (i) transfers between Level 1 and Level 2 of the fair value hierarchy; (ii) the policy for determining when transfers between any of the three levels have occurred; and (iii) the valuation processes used for Level 3 measurements. The disclosure requirements that were modified for public entities include: (i) for certain investments in entities that calculate the net asset value, revisions to require disclosures about the timing of liquidation and lapses of redemption restrictions, if the latter has been communicated to the reporting entity; and (ii) revisions to clarify that the disclosure of Level 3 measurement uncertainty should communicate information about the uncertainty as of the balance sheet date. The additional or new disclosure requirements include: (i) the changes in unrealized gains and losses for the period must be included in OCI for recurring Level 3 instruments held as of the balance sheet date; and (ii) the range and weighted average of significant unobservable inputs used for Level 3 measurements must be disclosed, but an entity has the option to disclose other quantitative information in place of the weighted average to the extent that it would be a more reasonable and rational method to reflect the distribution of certain unobservable inputs.

This update took effect for all entities in fiscal years, including interim periods within those fiscal years, beginning after December 15, 2019. Immediate early adoption was permitted for any of the removed or modified disclosures even if adoption of the new disclosures was delayed until the effective date. In the third quarter of 2018, the Corporation early adopted the amendments that removed or modified disclosure requirements. The adoption of additional or new disclosure requirements required by the update during the first quarter of 2020 did not affect the Corporation’s consolidated financial statements as the Corporation’s Level 3 instruments consisted primarily of available-for-sale private label MBS for which unrealized gains and losses are recognized in OCI and information about significant inputs for the fair value determination has been provided historically.

Collaborative Arrangements

In November 2018, the FASB issued new guidance to clarify the interaction between ASC Topic 808, “Collaborative Arrangements” (“ASC Topic 808”), and ASC Topic 606, “Revenue from Contracts with Customers” (“ASC Topic 606”). The guidance (i) clarifies that certain transactions between collaborative arrangement participants should be accounted for under the ASC Topic 606 guidance; (ii) adds unit of account guidance to ASC Topic 808 to align with ASC Topic 606; and (iii) clarifies presentation guidance for transactions with a collaborative arrangement participant that is not accounted for under ASC Topic 606. The guidance took effect for annual reporting periods beginning after December 1, 2019, including interim reporting periods within these annual reporting periods, with early adoption permitted. The adoption of this guidance during the first quarter of 2020 did not have an effect on the Corporation’s consolidated financial statements or results of operations.

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