FIRST BANCORP. The following MD&A relates to the accompanying audited consolidated financial statements of First BanCorp. (the "Corporation" or "First BanCorp.") and should be read in conjunction with such financial statements and the notes thereto. This section also presents certain financial measures that are not based on generally accepted accounting principles inthe United States ("GAAP"). See " Basis of Presentation" below for information about why the non-GAAP financial measures are being presented and the reconciliation of the non-GAAP financial measures for which the reconciliation is not presented earlier. Description of Business First BanCorp. is a diversified financial holding company headquartered inSan Juan, Puerto Rico offering a full range of financial products to consumers and commercial customers through various subsidiaries. First BanCorp. is the holding company ofFirstBank Puerto Rico ("FirstBank" or the "Bank") andFirstBank Insurance Agency . Through its wholly-owned subsidiaries, the Corporation operates inPuerto Rico , theUnited States Virgin Islands (the "USVI") andBritish Virgin Islands (the "BVI"), and the state ofFlorida , concentrating on commercial banking, residential mortgage loans, finance leases, credit cards, personal loans, small loans, auto loans, and insurance agency activities. POTENTIAL ACQUISITION OF BSPR OnOctober 21, 2019 , the Corporation announced the signing of a stock purchase agreement forFirstBank to acquireSantander BanCorp , the holding company ofBanco Santander Puerto Rico ("BSPR"). The purchase price is based on a formula set forth in the stock purchase agreement and is subject to adjustment based onSantander BanCorp's consolidated balance sheet as of the closing date of the acquisition (the "Closing"). UsingSantander BanCorp's consolidated balance sheet as ofSeptember 30, 2019 , the purchase price would be a base amount of$440 million (which equals 117.5% ofSantander BanCorp's core tangible common equity of$375 million as ofSeptember 30, 2019 and a$65 million premium on core tangible common equity) plus$815 million (which equals 100% of the deemed excess capital ofSantander BanCorp as ofSeptember 30, 2019 and does not reflect any premium on that excess capital). The transaction is structured as an all-cash acquisition of all of the issued and outstanding common stock ofSantander Bancorp , the sole shareholder of BSPR, immediately followed by the merger of BSPR and its holding company intoFirstBank , withFirstBank being the surviving entity. As part of the transaction,FirstBank will also acquire the operations ofSantander Insurance Agency, Inc. a wholly owned subsidiary of BSPR. As ofSeptember 30, 2019 ,Santander BanCorp had$6.2 billion of assets,$3.0 billion of loans, and$4.9 billion of deposits and operated a branch network of 27 locations spanning 15 municipalities acrossPuerto Rico . As part of the transaction,FirstBank will not assume any of BSPR's non-performing assets orSantander Asset Management, LLC , a limited liability company organized under the laws of theCommonwealth of Puerto Rico and a direct wholly owned subsidiary of BSPR. The Corporation believes that the acquisition will significantly improve its scale and competitiveness inPuerto Rico , while enhancing its funding and risk profile and expanding its talent bench across retail, commercial business banking, and risk management functions. In addition, the Corporation believes the acquisition will result in cost savings and other potential synergies. The stock purchase agreement has been unanimously approved by the Corporation's andFirstBank's Boards of Directors. The transaction is subject to the satisfaction of customary closing conditions, including receipt of all required regulatory approvals, and is expected to close in the middle of 2020. The Corporation expects to incur restructuring charges of approximately$76 million , 50% of which have been incurred or be expected to be incurred at closing with the remainder of the charges to be incurred in 2021. As ofDecember 31, 2019 , the Corporation had incurred approximately$11.4 million in merger and restructuring costs in connection with the pending acquisition of BSPR. Refer to Part I. Item 1 - "Business - Significant Events Since the Beginning of 2019" of this Form 10-K for additional information.
EXECUTIVE Overview of Results of Operations
First BanCorp.'s results of operations depend primarily on its net interest
income, which is the difference between the interest income earned on its
interest-earning assets, including investment securities and loans, and the
interest expense incurred on its interest-bearing liabilities, including
deposits and borrowings. Net interest income is affected by various factors,
including: the interest rate environment; the volumes, mix and composition of
interest-earning assets and interest-bearing liabilities; and the re-pricing
characteristics of these assets and liabilities. The Corporation's results of
operations also depend on the provision for loan and lease losses, non-interest
expenses (such as personnel, occupancy, the deposit insurance premium and other
costs), non-interest income (mainly service charges and fees on deposits, and
insurance income), gains (losses) on sales of investments, gains (losses) on
mortgage banking activities, and income taxes.
59
-------------------------------------------------------------------------------- The Corporation had net income of$167.4 million , or$0.76 per diluted common share, for the year endedDecember 31, 2019 , compared to a$201.6 million , or$0.92 per diluted common share and$67.0 million , or$0.30 per diluted common share, for the years endedDecember 31, 2018 and 2017, respectively.
The key drivers of the Corporation's GAAP financial results for the year ended
?Net interest income for the year endedDecember 31, 2019 was$567.1 million compared to$525.4 million and$491.6 million for the years endedDecember 31, 2018 and 2017, respectively. The increase for 2019 compared to 2018 was driven primarily by: (i) a$34.4 million increase in interest income on consumer loans, mainly due to a$308.9 million increase in the average balance of this portfolio, primarily due to growth in the average balance of auto loans, finance leases, and personal loans; and (ii) a$22.0 million increase in interest income on commercial and construction loans, primarily due to both growth in the average balance of the performing commercial portfolio and higher short-term market interest rates during 2019 compared to 2018 levels, which was reflected in both the upward repricing of variable-rate commercial loans and higher yields on new loan originations, particularly during the first half of 2019 and the second half of 2018. In addition, interest income on commercial and construction loans in 2019 included a$3.0 million accelerated discount accretion from the payoff of an acquired commercial mortgage loan. These increases were partially offset by: (i) a$9.2 million increase in total interest expense, driven by the effect of higher market interest rates on retail certificates of deposit ("CDs") and savings deposits; and (ii) a$7.0 million decrease in interest income on residential mortgage loans, mainly due to a$135.8 million decrease in the average balance of this portfolio. The net interest margin increased to 4.85% for the year endedDecember 31, 2019 , compared to 4.55% for 2018, primarily related to higher loan yields, an improved funding mix, driven by an increase in the proportion of interest-earning assets funded by a growth in non-interest-bearing deposits, and an increase in the proportion of higher yielding loans, such as consumer loans, to total interest-earning assets. The average balance of non-interest bearing deposits increased by$155.8 million to$2.4 billion for 2019, compared to$2.2 billion for 2018. The increase for 2018 compared to 2017 was primarily driven by: (i) a$17.2 million increase in interest income on commercial and construction loans, primarily associated with the upward repricing of variable-rate commercial loans; (ii) a$9.1 million increase in interest income on investment securities, primarily due to the gradual reinvestment of cash balances and proceeds from maturing debt securities into higher-yieldingUnited States ("U.S.") agencies debt securities and mortgage-backed securities ("MBS"); (iii) a$7.5 million increase in interest income on consumer loans, mainly due to a$77.8 million increase in the average balance of this portfolio, primarily auto loans and finance leases; and (iv) a$6.5 million increase in interest income from interest-bearing cash balances, primarily deposits maintained at theFederal Reserve Bank of New York (the "New York Fed"), due to both a higher average balance and increases in the Federal Funds target rate. These variances were partially offset by: (i) a$3.7 million decrease in interest income on residential mortgage loans, primarily associated with an$81.2 million decrease in the average balance of this portfolio; and (ii) a$2.7 million increase in total interest expense, driven by an increase in the use of long-termFederal Home Loan Bank ("FHLB") advances during 2018 and higher market interest rates on the cost of retail CDs and commercial money market accounts tied to variable short-term interest rates, partially offset by a$480.3 million decrease in the average balance of brokered CDs. 60
-------------------------------------------------------------------------------- ?The provision for loan and lease losses for the year endedDecember 31, 2019 was$40.2 million compared to$59.3 million and$144.3 million for the years endedDecember 31, 2018 and 2017, respectively. For the years endedDecember 31, 2019 and 2018, the Corporation recognized a net loan loss reserve release of$6.4 million and$16.9 million , respectively, in connection with revised estimates of the qualitative reserves associated with the effects of Hurricanes Irma and Maria, compared to hurricane-related charges to the provision of$71.3 million recorded for the year endedDecember 31, 2017 . On a non-GAAP basis, excluding the aforementioned effects of the hurricane-related qualitative reserve, the adjusted provision for loan and lease losses for 2019 was$46.7 million compared to$76.2 million and$73.0 million for 2018 and 2017, respectively. The decrease in the adjusted provision for loan and lease losses for 2019 compared to 2018 was primarily driven by a$13.5 million adjusted net loan loss reserve release for commercial and construction loans in 2019, compared to a$29.8 million adjusted charge to the provision in 2018, a positive variance of$43.3 million . The adjusted net loan loss reserve release for commercial and construction loans in 2019 was driven by lower historical loss rates, the upgrade in the credit risk classification of certain commercial loans, the early payoff of two large criticized commercial mortgage loans, and qualitative adjustments to account for developments in non-performing loans resolution strategies. In contrast, the provision for 2018 reflects, among other things, the effect of charges amounting to$22.3 million related to developments in non-performing commercial loans resolution strategies, including$15.7 million related to nonaccrual commercial and construction loans transferred to held for sale in 2018. The aforementioned positive variance was partially offset by a$13.2 million increase in the adjusted provision for consumer loans and a$0.5 million increase in the adjusted provision for residential mortgage loans. The increase in the adjusted provision for loan and lease losses for 2018 compared to 2017 was primarily driven by a$26.2 million increase in the adjusted provision for loan and lease losses for commercial and construction loans, driven by the aforementioned charges of$22.3 million related to developments in non-performing loans resolution strategies, partially offset by a$22.6 million decrease in the adjusted provision for residential mortgage loans, primarily reflecting a decline in charge-offs, nonaccrual and delinquent loan levels, and the overall decrease in the size of this portfolio.
See "Basis of Presentation" below for additional information and reconciliation of the provision for loan and lease losses in accordance with GAAP to the non-GAAP adjusted provision for loan and lease losses.
Net charge-offs totaled$81.4 million for the year endedDecember 31, 2019 , or 0.91% of average loans, a decrease of$13.3 million , compared to net charge-offs of$94.7 million , or 1.09% of average loans, for 2018 and$118.0 million , or 1.33% of average loans, for 2017. The decrease in 2019 compared to 2018 reflects a$13.8 million decrease in net charge-offs taken on commercial and construction loans and a$1.3 million decrease in net charge-offs on residential mortgage loans, partially offset by a$1.8 million increase in net charge-offs on consumer loans. The decrease in net charge-offs on commercial and construction loans was primarily related to the effect in 2018 of charge-offs totaling$22.2 million associated with the transfer to held for sale of$74.4 million in nonaccrual commercial and construction loan, partially offset by a$5.5 million decrease in commercial and construction loan loss recoveries during 2019. The decrease in net charge-offs in 2018 compared to 2017 reflects a$24.0 million decrease in net charge-offs taken on commercial and construction loans and a$4.4 million decrease in net charge-offs on residential mortgage loans, partially offset by a$5.1 million increase in net charge-offs on consumer loans. During 2018, the Corporation recorded a loan loss recovery of$7.4 million on the payoff of a commercial mortgage loan that had been restructured in a troubled debt restructuring ("TDR") compared to charge-offs of$27.3 million taken on that loan in 2017. In addition, there was a$10.7 million decrease associated with the charge-off taken on the sale of the commercial loan of thePuerto Rico Electric Power Authority ("PREPA") in 2017. These variances were partially offset by the effect in 2018 of the aforementioned charge offs of$22.2 million taken on nonaccrual commercial and construction loans transferred to held for sale. See "Results of Operations - Provision for Loan and Lease Losses" and "Risk Management - Allowance for Loan and Lease Losses and Non-Performing Assets" below for analyses of the allowance for loan and lease losses and non-performing assets and related ratios. 61
-------------------------------------------------------------------------------- ?The Corporation recorded non-interest income of$90.6 million for the year endedDecember 31, 2019 compared to$82.3 million and$62.4 million for the years endedDecember 31, 2018 and 2017, respectively. The increase for 2019 compared to 2018 was primarily driven by: (i) a$5.1 million positive variance related to sales of nonaccrual commercial and construction loans held for sale resulting from the recognition by the Corporation of a$2.3 million net gain on the sales of approximately$11.4 million in nonaccrual commercial loans held for sale in 2019 compared to a net loss of$2.8 million recorded on the sales of approximately$61.9 million in nonaccrual commercial construction loans held for sale in 2018; (ii) a$2.6 million increase in transaction fee income from credit and debit cards, as well as merchant-related activities, due to higher transaction volumes; (iii) a$2.2 million increase in service charges on deposits, primarily related to the increase in fees on returned items and overdraft transactions, as well as an increase in the number of cash management transactions of commercial clients; and (iv) a$1.8 million increase in insurance commission income. These variances were partially offset by: (i) the effect in 2018 of a$2.3 million gain recorded on the repurchase and cancellation of$23.8 million in trust-preferred securities ("TRuPs"); and (ii) a$0.5 million other-than-temporary impairment ("OTTI") charge on private label MBS recorded in 2019. The increase for 2018 compared to 2017 was primarily driven by: (i) the effect in 2017 of a$12.2 million OTTI charge on three Puerto Rico Government debt securities, specifically bonds of theGovernment Development Bank for Puerto Rico ("GDB") and thePuerto Rico Public Buildings Authority ; (ii) a$3.7 million increase in revenues from mortgage banking activities, driven by adjustments recorded in 2018 that reduced the valuation allowance of mortgage servicing rights and higher servicing fees; (iii) a$3.6 million increase in fee-based income from automated teller machines ("ATMs"), point of sale ("POS"), credit and debit cards, and merchant-related activities; and (iv) a$1.2 million increase in gains from sales of fixed assets, primarily assets of relocated or closed banking branches inFlorida andPuerto Rico . These variances were partially offset by a$2.8 million net loss recorded on sales of nonaccrual commercial and construction loans held for sale completed in 2018. ?Non-interest expenses for 2019 were$378.1 million compared to$357.8 million and$347.7 million for 2018 and 2017, respectively. The increase for 2019 compared to 2018 was primarily driven by: (i) merger and restructuring costs incurred in 2019 amounting to$11.4 million in connection with the pending acquisition of BSPR; (ii) a$5.2 million increase in occupancy and equipment expenses, primarily related to higher depreciation and amortization expenses in connection with enhancements to technology infrastructure; (iii) a$2.9 million increase in employees' compensation and benefits, primarily related to salary merit increases and other adjustments related to the annual salary review process, a higher headcount and an increase in contributions to the employees' retirement plan; and (iv) a$2.4 million increase in professional service fees, mainly due to an increase in outsourced technology service fees. These variances were partially offset by a$2.6 million decrease in theFederal Deposit Insurance Corporation ("FDIC") insurance premium expense, reflecting, among other things, the effect of improved earnings trends and reductions in brokered CDs. The increase for 2018 compared to 2017 was primarily driven by: (i) a$7.6 million increase in employees' compensation and benefit expenses reflecting, among other things, salary merit increases and adjustments related to the Corporation's annual salary review process, higher headcount, and an increase in the Bank's matching contribution to the employees' retirement plans; (ii) a$3.5 million increase in losses from other real estate owned ("OREO") operations reflecting, among other things, a$2.1 million increase in adverse fair value adjustments to the value of OREO properties and a$1.3 million increase in OREO operating expenses, including taxes, insurance and maintenance fees; (iii) a$2.3 million increase in business promotion expenses, primarily due to increased advertising, marketing, promotions and sponsorship-related activities during 2018; and (iv) a$1.3 million increase in occupancy and equipment costs, primarily due to hurricane-related expenses incurred in 2018 associated with repairs and security matters. These variances were partially offset by a$4.8 million decrease in theFDIC insurance premium expense due to, among other things, improved earnings trends, reduction in brokered CDs, and higher liquidity levels tied to the growth in non-interest bearing deposits. 62 -------------------------------------------------------------------------------- ?For the year endedDecember 31, 2019 , the Corporation recorded an income tax expense of$72.0 million compared to an income tax benefit of$11.0 million for 2018 and an income tax benefit of$5.0 million for 2017. The variances reflect, among other things, the effect in 2018 of a$63.2 million benefit related to a partial reversal of the deferred tax asset valuation allowance, partially offset by a one-time charge of$9.9 million associated with the remeasurement of deferred tax assets resulting from the enactment of the Puerto Rico Tax Reform Act of 2018 ("Act 257") (net of the$5.6 million related impact in the valuation allowance), and a higher proportion of taxable to exempt income in 2019. The income tax benefit recorded in 2017 reflects the effect of the tax benefit related to hurricane-related charges to the provision for loan and lease losses and a$13.2 million tax benefit recorded as a result of the change in tax status of certain subsidiaries from taxable corporations to limited liability companies that elected to be treated as partnerships for income tax purposes inPuerto Rico . As ofDecember 31, 2019 , the Corporation had a deferred tax asset of$264.8 million (net of a valuation allowance of$86.6 million , including a valuation allowance of$55.6 million against the deferred tax assets of the Corporation's banking subsidiary,FirstBank ), compared to a net deferred tax asset of$319.9 million as ofDecember 31, 2018 (net of a valuation allowance of$100.7 million , including a valuation allowance of$68.1 million against the deferred tax assets of the Corporation's banking subsidiary,FirstBank ). See "Results of Operations - Income Taxes" below for additional information. ?As ofDecember 31, 2019 , total assets were approximately$12.6 billion , an increase of$367.7 million fromDecember 31, 2018 . The increase was primarily related to: (i) a$168.5 million increase in total investment securities, driven by purchases of$750.5 million ofU.S. agencies MBS and bonds and a$47.2 million increase in the fair value of available-for sale investment securities primarily attributable to changes in market interest rates, partially offset by$371.3 million ofU.S. agencies bonds that matured or were called prior to maturity, prepayments of$239.2 million ofU.S. agencies MBS and bonds, and a$7.8 million decrease in investment in FHLB stock; (ii) a$140.4 million increase in total loans; (iii) a$61.3 million increase related to the recognition of a right-of-use asset for operating leases in accordance with the adoption of Accounting Standards Update No. ("ASU") 2016-02, "Leases (Topic 842)" ("ASU 2016-02") in the first quarter of 2019; and (iv) a$57.9 million increase in cash and cash equivalents. The$140.4 million increase in total loans reflects a growth of$109.9 million in thePuerto Rico region and$45.3 million in theFlorida region, partially offset by a$14.8 million decrease in theVirgin Islands region. On a portfolio basis, the increase consisted of growth of$336.9 million in consumer loans, and$20.5 million in commercial and construction loans, partially offset by a$217.0 million decrease in the residential mortgage loan portfolio. The increase in commercial and construction loans was achieved despite the early repayment of certain large criticized commercial mortgage loans and a$95.8 million decrease in nonaccrual commercial and construction loans. The aforementioned increases were partially offset by a$55.0 million decrease in the net deferred tax asset and a$29.8 million decrease in the OREO portfolio balance. See "Financial Condition and Operating Data Analysis" below for additional information. ?As ofDecember 31, 2019 , total liabilities were$10.4 billion , an increase of$184.3 million fromDecember 31, 2018 . The increase was mainly due to a$312.8 million increase in non-government deposits, excluding brokered CDs, a$161.4 million increase in government deposits, and a$64.3 million increase related to the effect of the liability for operating leases recorded in connection with the adoption of ASU 2016-02 in 2019. These increases were partially offset by a$170.0 million decrease in FHLB advances, primarily related to the approximately$205.0 million of FHLB advances that matured during the fourth quarter of 2019, the repayment at maturity of a$50.1 million short-term repurchase agreement, and a$120.6 million decrease in brokered CDs. See "Risk Management - Liquidity Risk and Capital Adequacy" below for additional information about the Corporation's funding sources. ?As ofDecember 31, 2019 , the Corporation's stockholders' equity was$2.2 billion , an increase of$183.4 million fromDecember 31, 2018 . The increase was mainly driven by the earnings generated in 2019 and a$47.2 million increase in the fair value of available-for-sale investment securities recorded as part of Other comprehensive income, partially offset by common and preferred stock dividends declared in 2019 totaling$33.2 million . The Corporation's Total Capital, Common Equity Tier 1 Capital, Tier 1 Capital and Leverage ratios were 25.22%, 21.60%, 22.00%, and 16.15%, respectively, as ofDecember 31, 2019 , compared to Total Capital, Common Equity Tier 1 Capital, Tier 1 Capital and Leverage ratios of 24.00%, 20.30%, 20.71%, and 15.37%, respectively, as ofDecember 31, 2018 . See "Risk Management - Capital" below for additional information. 63
-------------------------------------------------------------------------------- ?Total loan production, including purchases, refinancings, renewals and draws from existing revolving and non-revolving commitments, but excluding the utilization activity on outstanding credit cards, was$3.9 billion ,$3.1 billion , and$2.9 billion for the years endedDecember 31, 2019 , 2018, and 2017, respectively. The increase primarily resulted from a$678.7 million increase in commercial and construction loan originations, including both an increase in new loan originations in thePuerto Rico andFlorida regions as well as a higher dollar amount of refinancings and renewals in 2019, and a$158.0 million increase in consumer loan originations. Total loan originations increased by$608.9 million in thePuerto Rico region,$165.3 million in theFlorida region, and$21.8 million in theVirgin Islands region. The increase in 2018 as compared to 2017 consisted of a$304.4 million increase in total loan originations in thePuerto Rico region, including an increase of$237.6 million in consumer loan originations, and a$26.9 million increase in total loan originations in theVirgin Islands region, partially offset by a$92.4 million decrease in total loan originations in theFlorida region, primarily reflected in lower residential mortgage loan originations. ?Total non-performing assets were$317.4 million as ofDecember 31, 2019 , a decrease of$149.7 million fromDecember 31, 2018 . The decrease was primarily attributable to: (i) the repayment of a$31.5 million nonaccrual commercial mortgage loan in theFlorida region, the largest nonaccrual loan in the portfolio; (ii) a$12.9 million reduction related to the split loan restructuring of a commercial mortgage loan in thePuerto Rico region; (iii) charge-offs on nonaccrual commercial and constructions loans amounting to$22.0 million , including a charge-off of$11.4 million on the aforementioned nonaccrual commercial mortgage loan repaid in theFlorida region; (iv) a$25.9 million decrease in nonaccrual residential mortgage loans; (v) sales and repayments of nonaccrual commercial and construction loans held for sale totaling$16.1 million during 2019; and (vi) additional collections on nonaccrual commercial and construction loans of approximately$14.8 million during 2019. In addition, there was a$29.8 million decrease in the balance of the OREO properties portfolio, including as a result of the sale of a$10.8 million commercial OREO property in the third quarter of 2019. See "Risk Management - Non-Accrual Loans and Non-Performing Assets" below for additional information. ?Adversely classified commercial and construction loans, including loans held for sale, decreased by$135.5 million to$220.5 million as ofDecember 31, 2019 , compared to$356.0 million as ofDecember 31, 2018 . The decrease was driven by the aforementioned payoff of a$31.5 million nonaccrual commercial mortgage loan in theFlorida region, the upgrade in the credit risk classification of several commercial loans totaling$45.3 million , charge-offs, collections, and the aforementioned reduction of$16.1 million related to sales and repayments of nonaccrual loans held for sale. The Corporation's financial results for 2019, 2018 and 2017 included the following items that management believes are not reflective of core operating performance, are not expected to reoccur with any regularity or may reoccur at uncertain times and in uncertain amounts (the "Special Items"): Year endedDecember 31, 2019 ?Merger and restructuring costs of$11.4 million ($7.2 million after-tax) in connection with the stock purchase agreement withSantander Holdings USA, Inc. , to acquire BSPR and related restructuring initiatives. Merger and restructuring costs primarily included advisory, legal, valuation, and other professional service fees associated with the pending acquisition of BSPR, as well as a$3.4 million charge related to a voluntary separation program (the "VSP") offered to eligible employees atFirstBank during the fourth quarter of 2019 in connection with initiatives to capitalize on expected operational efficiencies from the acquisition. A total of 56 employees elected to participate in the VSP on or beforeDecember 6, 2019 , the due date established for participation in the program, which represented a participation rate of 53% of eligible employees, with employment separations to occur no later thanFebruary 29, 2020 . Annual savings as a result of the VSP are expected to be approximately$2 million . ?A$3.0 million ($1.8 million after-tax) positive effect in earnings related to the accelerated discount accretion from the payoff of an acquired commercial mortgage loan. 64
--------------------------------------------------------------------------------
?Net loan loss reserve release of
?Benefit of
?Expense recovery of$2.3 million recorded related to an employee retention benefit payment (the "Benefit") received by the Bank by virtue of the Disaster Tax Relief and Airport Extension Act of 2017, as amended (the "Disaster Tax Relief Act"). The Benefit was recorded as an offset to employees' compensation and benefits expenses and is not treated as taxable income by virtue of the Disaster Tax Relief Act.
?A
Year ended
?Tax benefit of
?One-time charge to the income tax expense of
?Net loan loss reserve release of$16.9 million ($10.3 million after-tax) in connection with revised estimates of the qualitative reserves associated with the effects of Hurricanes Maria and Irma.
?Hurricane-related expenses of
?Gain of
?A
?Gain of$2.3 million on the repurchase and cancellation of$23.8 million in TRuPs, reflected in the consolidated statement of income as "Gain on early extinguishment of debt." The gain, realized at the holding company level, had no effect on the income tax expense in 2018. See "Results of Operation - Non-Interest Income" below for additional information. 65
--------------------------------------------------------------------------------
Year ended
?Tax benefit of$13.2 million associated with the change in tax status of certain subsidiaries from taxable corporations to limited liability companies that made an election to be treated as partnerships for income tax purposes inPuerto Rico . See "Income Taxes" discussion below for additional information.
?Charge to the provision for loan and lease losses of
?Hurricane-related expenses of
?Expected insurance recoveries of$1.8 million for compensation and rental costs that the Corporation incurred when Hurricanes Maria and Irma precluded employees from working in 2017. ?OTTI charge of$12.2 million and a$0.4 million recovery of previously recorded OTTI charges on non-performing bonds of the GDB and thePuerto Rico Public Buildings Authority sold in 2017. No tax benefit was recognized for the OTTI charge and the recovery on the sale of the bonds. ?Gain of$1.4 million on the repurchase and cancellation of$7.3 million in trust-preferred securities, reflected in the consolidated statements of income as "Gain on early extinguishment of debt." The gain, realized at the holding company level, had no effect on the income tax expense in 2017. ?Costs of$0.4 million associated with the secondary offerings of the Corporation's common stock by certain of our existing stockholders in 2017. The costs, incurred at the holding company level, had no effect on the income tax expense in 2017. 66
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The following table reconciles for 2019, 2018, and 2017 the reported net income
to adjusted net income, a non-GAAP financial measure that excludes the Special
Items identified above:
Year Ended December 31,
2019 2018 2017
(In thousands)
Net income, as reported (GAAP) $ 167,377 $ 201,608 $ 66,956
Adjustments:
Merger and restructuring costs 11,442 - -
Accelerated discount accretion due to early payoff of acquired loan (2,953) -
-
Partial reversal of deferred tax asset valuation allowance - (63,228)
-
Remeasurement of deferred tax assets due to changes in enacted tax rates (1) - 9,892
-
Income tax benefit related to change in tax-status of certain subsidiaries - -
(13,161)
Hurricane-related loan loss reserve (release) provision (6,425) (16,943)
71,304
Hurricane-related expenses - 2,783
2,544
Benefit from hurricane-related insurance recoveries (1,926) (478)
-
Expected insurance recoveries associated with hurricane-related idle time payroll and rental costs - -
(1,819)
Employee retention benefit - Disaster Tax Relief and Airport Extension Act of 2017 (2,317) -
-
Loss on sale of investment securities - 34
-
OTTI on debt securities 497 50
12,231
Recovery of previously recorded OTTI charges onPuerto Rico government debt securities sold - -
(371)
Gain on early extinguishment of debt - (2,316)
(1,391)
Secondary offering costs - -
392
Income tax impact of adjustments (2) (52) 5,708
(28,800)
Adjusted net income (Non-GAAP)$ 165,643 $ 137,110
(1)Net of the
(2)See "Basis of Presentation" below for the individual tax impact related to reconciling items.
67
--------------------------------------------------------------------------------Critical Accounting Policies and Practices
The accounting principles of the Corporation and the methods of applying these principles conform to GAAP. The Corporation's critical accounting policies relate to: 1) the allowance for loan and lease losses; 2) OTTI; 3) income taxes; 4) the classification and values of financial instruments; and 5) income recognition on loans. These critical accounting policies involve judgments, estimates and assumptions made by management that affect the amounts recorded for assets, liabilities and contingent liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from estimates, if different assumptions or conditions prevail. Certain determinations inherently require greater reliance on the use of estimates, assumptions, and judgments and, as such, have a greater possibility of producing results that could be materially different than those originally reported.
Allowance for Loan and Lease Losses
The Corporation maintains the allowance for loan and lease losses at a level considered adequate to absorb incurred losses that are considered to be inherent in the loan and lease portfolio at that time. The Corporation does not maintain an allowance for held-for-sale loans or PCI loans that are performing in accordance with or better than expectations as of the date of acquisition, as the fair value of these loans already reflect a credit component. The allowance for loan and lease losses provides for probable incurred losses that have been identified with specific valuation allowances for individually evaluated impaired loans and for probable incurred losses believed to be inherent in the loan portfolio that have not been specifically identified. The determination of the allowance for loan and lease losses requires significant estimates, including with respect to the timing and amounts of expected future cash flows on impaired loans, consideration of current economic conditions and business strategies, and historical loss experience pertaining to the portfolios and pools of homogeneous loans, all of which may be susceptible to change. As ofJanuary 1, 2020 , the Corporation will begin estimating credit losses on loans and debt securities in accordance with a new accounting standard. See "Accounting For Financial Instruments - Credit Losses" below. The Corporation evaluates the need for changes to the allowance by portfolio loan segments and classes of loans within certain of those portfolio segments. The Corporation combines loans with similar credit risk characteristics into the following portfolio segments: commercial mortgage, construction, commercial and industrial, residential mortgage, and consumer loans. Classes are usually disaggregations of the portfolio segments. The classes within the residential mortgage segment are residential mortgages guaranteed by theU.S. government and other residential loans. The classes within the consumer portfolio are auto loans, finance leases, and other consumer loans. Other consumer loans mainly include unsecured personal loans, credit cards, home equity lines, lines of credits, and boat loans. The classes within the construction loan portfolio are land loans, construction of commercial projects, and construction of residential projects. The commercial mortgage and commercial and industrial segments are not further segmented into classes. The adequacy of the allowance for loan and lease losses is based on judgments related to the credit quality of each portfolio segment. These judgments consider ongoing evaluations of each portfolio segment, including such factors as the economic risks associated with each loan class, the financial condition of specific borrowers, the geography (Puerto Rico ,Florida or theVirgin Islands ), the level of delinquent loans, historical loss experience, the value of any collateral and, where applicable, the existence of any guarantees or other documented support. In addition to the general economic conditions and other factors described above, additional factors considered include the internal risk ratings assigned to loans. An internal risk rating is assigned to each commercial and construction loan at the time of approval and is subject to subsequent periodic review by the Corporation's senior management. The allowance for loan and lease losses is reviewed on a quarterly basis as part of the Corporation's continued evaluation of its asset quality. The allowance for loan and lease losses is increased through a provision for credit losses that is charged to earnings, based on the quarterly evaluation of the factors previously mentioned, and is reduced by charge-offs, net of recoveries. The allowance for loan and lease losses consists of specific reserves based upon valuations of loans considered to be impaired and general reserves. A specific valuation allowance is established for individual impaired loans in the commercial mortgage, construction, and commercial and industrial portfolios and certain boat loans, residential mortgage loans, and home equity lines of credit, primarily when the collateral value of the loan (if the impaired loan is determined to be collateral dependent) or the present value of the expected future cash flows discounted at the loan's effective rate is lower than the carrying amount of that loan. The loans within the commercial mortgage, construction, commercial and industrial portfolios, and boat loans of$1 million or more are individually evaluated for impairment. Also, certain residential mortgage loans and home equity lines of credit are individually evaluated for impairment purposes based on their delinquency and loan to value levels. When foreclosure of a collateral dependent loan is probable, the impairment measure is based on the fair value of the collateral, less estimated cost to sell. The fair value of the collateral is generally obtained from appraisals. Updated appraisals are obtained when the Corporation determines that loans are impaired and are generally updated annually thereafter according to the Corporation's appraisal policy. In addition, appraisals and/or appraiser price opinions are also obtained for residential mortgage loans based on specific characteristics, such as delinquency levels, age of the appraisal, and loan-to-value ratios. The excess of the recorded investment in a collateral dependent loan over the resulting fair value of the collateral is charged-off when deemed uncollectible. 68
-------------------------------------------------------------------------------- For all other loans, which include small, homogeneous loans, such as auto loans, and the other classes in the consumer loan portfolio, residential mortgages and commercial and construction loans that are not individually evaluated for impairment, the Corporation maintains a general valuation allowance established through a process that begins with estimates of incurred losses based upon various statistical analyses. The general reserve is primarily determined by applying loss factors according to the loan type and assigned risk category (pass, special mention, substandard and doubtful loans that are not considered to be impaired). The Corporation uses a roll-rate methodology to estimate losses on its consumer loan portfolio based on delinquencies and considering credit bureau score bands. The Corporation tracks the historical portfolio performance to arrive at a weighted-average distribution in each subgroup of each delinquency bucket. Roll-to-loss rates (loss factors) are calculated by multiplying the roll rates from each subgroup within the delinquency buckets forward through loss. Once roll rates are calculated, the resulting loss factor is applied to the existing receivables in the applicable subgroups within the delinquency buckets and the end results are aggregated to arrive at the required allowance level. The Corporation's assessment also involves evaluating key qualitative and environmental factors, which include credit and macroeconomic indicators such as unemployment, bankruptcy trends, recent market transactions, and collateral values to account for current market conditions that are likely to cause estimated credit losses to differ from historical loss experience. The Corporation analyzes the expected delinquency migration to determine the future volume of delinquencies. The Corporation performs the cash flow analysis for each residential mortgage pool at the individual loan level and then aggregated to the pool level in determining the overall loss ratio (the "base methodology"). The model applies risk-adjusted prepayment curves, default curves, and severity curves to each loan in the pool. For loans restructured, the present value of future cash flows under the new terms, at the loan's effective interest rate, is taken into consideration. Additionally, estimates of default risk and prepayments related to loan restructurings are based on, among other things, the historical experience of these loans. Loss severity is affected by the house price scenario, which is based in part on recent house price trends. Default curves are used in the model. The attributes that are most significant to the probability of default include present collection status (current, delinquent, in bankruptcy, in foreclosure stage), vintage, loan-to-values, and geography (Puerto Rico ,Florida or theVirgin Islands ). The estimates of the risk-adjusted timing of liquidations and associated costs are used in the model, and are risk-adjusted for the geographic area in which each property is located. For commercial loans, the Corporation calculates historical charge-off rates on a quarterly basis for each commercial loan regulatory-based credit risk category (i.e. pass, special mention, substandard, and doubtful) using the historical charge-offs and portfolio balances over their average loss emergence period (the "raw loss rate") for each credit risk classification. However, when not enough loss experience is observed in a particular risk-rated category and the calculation results in a loss rate for such risk-rated category that is lower than the loss rate of a less severe risk-rated category, the Corporation uses the loss rate of such less severe category. A qualitative factor adjustment is applied to the base rate average utilizing a resulting factor derived from a set of risk-based ratings and weights assigned to credit and economic indicators over a reasonable period applied to a developed expected range of historical losses and a basis point adjustment that is derived from the difference between the average raw loss rate and the highest loss rate observed during a look-back period that management determined was appropriate to use for each region to identify any relevant effect during an economic cycle. 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. Charge-offs are recorded as a reduction to the allowance for loan and lease losses and subsequent recoveries of previously charged-off amounts are credited to the allowance for loan and lease 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 and have an original loan-to-value ratio that is higher than 60% 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. The Corporation does not record charge-offs on PCI loans that are performing in accordance with or better than expectations as of the date of acquisition, as the fair value of these loans already reflects a credit component. The Corporation records charge-offs on PCI loans only if actual losses exceed estimated losses incorporated into the fair value recorded at acquisition and the amount is deemed uncollectible. 69
-------------------------------------------------------------------------------- Accounting For Financial Instruments - Credit Losses - As ofJanuary 1, 2020 , the Corporation is required to adopt ASU 2016-13, "Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments," as amended ("ASC 326"). ASC 326 replaces the above-described incurred loss methodology for accounting for credit losses on loans and debt securities with a methodology referred to as current expected credit losses ("CECL") to estimate the allowance for credit losses ("ACL") for the remaining estimated life of the financial asset (including loans, debt securities, and off-balance sheet credit exposures) using historical experience, current conditions, and reasonable and supportable forecasts. Based on current macro-economic assumptions, the Corporation expects an initial incremental adjustment to the ACL of approximately$93 million related to the cumulative effect of adopting ASC 326 as ofJanuary 1, 2020 . The expected increase is primarily related to longer duration residential mortgage and consumer loan portfolios. The resulting one-time increase to the ACL as a result of adopting the CECL model, will be recorded, net of applicable income taxes, as an adjustment to decrease retained earnings effectiveJanuary 1, 2020 . The Corporation is adopting the option provided by the regulatory capital framework that permits institutions to limit the initial regulatory capital day-one impact by allowing a three-year phase in period for this impact, on a straight-line basis. Based on the three-year phase in option allowed by the regulatory framework, the Corporation expects that the day one impact of adopting CECL will result in a decrease in the Corporation's common equity Tier 1 capital ratio of approximately 13 basis points onJanuary 1, 2020 . The Corporation expects that all capital ratios will remain well in excess of minimum capital ratios. Refer to Note 1 - Nature of Business and Summary of Significant Accounting Policies - Recently Issued Accounting Standards Not Yet Effective, to the audited consolidated financial statements included in Item 8 of this Form 10-K for additional information.
Other-than-temporary impairment ("OTTI")
On a quarterly basis, the Corporation performs an assessment to determine whether there have been any events or economic circumstances indicating that a security with an unrealized loss has suffered an OTTI. A security is considered impaired if the fair value is less than its amortized cost basis. The Corporation employs a systematic methodology that considers all available evidence in evaluating a potential impairment of its investments. The impairment analysis of debt securities places special emphasis on the analysis of 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 length of time and the extent to which the fair value has been 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 of the debt securities. OTTI must be recognized in earnings if the Corporation has the intent to sell the debt security or it is more likely than not that it will be required to sell the debt security before recovery of its amortized cost basis. However, even if the Corporation does not expect to sell a debt security, it must evaluate expected cash flows to be received and determine if a credit loss has occurred. An unrealized loss is generally deemed to be other-than-temporary and a credit loss is deemed to exist if the present value of the expected future cash flows is less than the amortized cost basis of the debt security. For available-for-sale and held-to-maturity debt securities the Corporations intends to hold, the credit loss component of an OTTI, if any, is recorded as net impairment losses on debt securities in the consolidated statements of income, while the remaining portion of the impairment loss is recognized in OCI, net of taxes, and included as a component of stockholders' equity. The previous amortized cost basis less the OTTI recognized in earnings is the new amortized cost basis of the investment. The new amortized cost basis is not adjusted for subsequent recoveries in fair value. Subsequent increases and decreases (if not an OTTI) in the fair value of available-for-sale securities is included in OCI. For held-to-maturity debt securities, any OTTI recognized in OCI should be accreted from OCI to the amortized cost of the debt security over the remaining life of the debt security. However, for debt securities for which OTTI was recognized in earnings, the difference between the new amortized cost basis and the cash flows expected to be collected is accreted as interest income as long as the security is not placed in nonaccrual status. Debt securities held by the Corporation at year-end primarily consisted of securities issued byU.S. government-sponsored entities ("GSEs"), private label MBS, certain bonds issued by thePuerto Rico Housing Finance Authority , a government instrumentality of theCommonwealth of Puerto Rico , and obligations of certain municipalities inPuerto Rico . Given the explicit and implicit guarantees provided by theU.S. federal government, the Corporation believes the credit risk in securities issued by the GSEs is low. The Corporation's OTTI assessment focused onPuerto Rico government debt securities and private label MBS. For further information, including the methodology and assumptions used for the discounted cash flow analyses performed on these securities, refer to Note 6 -Investment Securities , to the consolidated financial statements included in Item 8 of this Form 10-K. 70
-------------------------------------------------------------------------------- As mentioned above, ASC 326, which the Corporation must adopt effectiveJanuary 1, 2020 , is applicable also to available-for-sale and held-to-maturity debt securities. ASC 326 requires credit losses to be presented as an allowance rather than as a write-down on debt securities that management does not intend to sell or believes that it is more likely than not it will not be required to sell. The Corporation is adopting ASC 326 using the prospective transition approach for available-for-sale debt securities for which OTTI had been recognized prior toJanuary 1, 2020 , such as private label MBS. As a result, the amortized cost basis remains the same before and after the effective date of ASC 326. The Corporation does not expect an incremental material adjustment to the ACL related to available-for-sale debt securities in connection with the adoption of ASC 326 onJanuary 1, 2020 . Refer to Note 1 - Nature of Business and Summary of Significant Accounting Policies - Recently Issued Accounting Standards Not Yet Effective, to the audited consolidated financial statements included in Item 8 of this Form 10-K for additional information. Income Taxes The Corporation is required to estimate income taxes in preparing its consolidated financial statements. This involves the estimation of current income tax expense together with an assessment of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The determination of current income tax expense involves estimates and assumptions that require the Corporation to assume certain positions based on its interpretation of current tax regulations. Management assesses the relative benefits and risks of the appropriate tax treatment of transactions, taking into account statutory, judicial and regulatory guidance, and recognizes tax benefits only when deemed probable. Changes in assumptions affecting estimates may be required in the future and estimated tax liabilities may need to be increased or decreased accordingly. The Corporation adjusts the accrual of tax contingencies in light of changing facts and circumstances, such as the progress of tax audits, case law and emerging legislation. The Corporation's effective tax rate includes the impact of tax contingencies and changes to such accruals, as considered appropriate by management. When particular tax matters arise, a number of years may elapse before such matters are audited by the taxing authorities and finally resolved. Favorable resolution of such matters or the expiration of the statute of limitations may result in the release of tax contingencies that the Corporation recognizes as a reduction to its effective tax rate in the year of resolution. Unfavorable settlement of any particular issue could increase the effective tax rate and may require the use of cash in the year of resolution. Income tax expense includesPuerto Rico and USVI income taxes, as well as applicableU.S. federal and state taxes. The Corporation is subject toPuerto Rico income tax on its income from all sources. As aPuerto Rico corporation, First BanCorp. is treated as a foreign corporation forU.S. and USVI income tax purposes and, accordingly, is generally subject toU.S. and USVI income tax only on its income from sources within theU.S. and USVI or income effectively connected with the conduct of a trade or business in those jurisdictions. Any such tax paid in theU.S. and USVI is creditable against the Corporation'sPuerto Rico tax liability, subject to certain conditions and limitations. Under the Puerto Rico Internal Revenue Code of 2011, as amended (the "2011 PR Code"), the Corporation and its subsidiaries are treated as separate taxable entities and are not entitled to file consolidated tax returns and, thus, the Corporation is generally not entitled to utilize losses from one subsidiary to offset gains in another subsidiary. Accordingly, in order to obtain a tax benefit from a net operating loss ("NOL"), a particular subsidiary must be able to demonstrate sufficient taxable income within the applicable NOL carry-forward period. Pursuant to the 2011 PR Code, the carry-forward period for NOLs incurred during taxable years that commenced afterDecember 31, 2004 and ended beforeJanuary 1, 2013 is 12 years; for NOLs incurred during taxable years commencing afterDecember 31, 2012 , the carryover period is 10 years. The 2011 PR Code provides a dividend received deduction of 100% on dividends received from "controlled" subsidiaries subject to taxation inPuerto Rico and 85% on dividends received from other taxable domestic corporations. The Corporation has maintained an effective tax rate lower than the maximum statutory rate, mainly by investing in government obligations and MBS exempt fromU.S. andPuerto Rico income taxes and by doing business through an International Banking Entity ("IBE") unit of the Bank, and through the Bank's subsidiary,FirstBank Overseas Corporation , whose interest income and gain on sales is exempt fromPuerto Rico income taxation.The IBE and FirstBank Overseas Corporation were created under the International Banking Entity Act ofPuerto Rico , which provides for totalPuerto Rico tax exemption on net income derived by IBEs operating inPuerto Rico on the specific activities identified in the IBE Act. An IBE that operates as a unit of a bank pays income taxes at the corporate standard rates to the extent that the IBE's net income exceeds 20% of the bank's total net taxable income. 71
-------------------------------------------------------------------------------- The determination of deferred tax expense or benefit is based on changes in the carrying amounts of assets and liabilities that generate temporary differences. The carrying value of the Corporation's net deferred tax asset assumes that the Corporation will be able to generate sufficient future taxable income based on estimates and assumptions. If these estimates and related assumptions change, the Corporation may be required to record valuation allowances against its deferred tax assets, resulting in additional income tax expense in the consolidated statements of income. Management evaluates its deferred tax assets on a quarterly basis and assesses the need for a valuation allowance, if any. A valuation allowance is established when management believes that it is more likely than not that some portion of its deferred tax assets will not be realized. Changes in the valuation allowance from period to period are included in the Corporation's tax provision in the period of change. After completion of the deferred tax asset valuation allowance analysis for the fourth quarter of 2019, management concluded that, as ofDecember 31, 2019 , it was more likely than not thatFirstBank , the banking subsidiary, will generate sufficient taxable income to realize$206.4 million of its deferred tax assets related to NOLs within the applicable carry-forward periods. The net deferred tax assets ofFirstBank amounted to$264.8 million as ofDecember 31, 2019 , net of a valuation allowance of$55.6 million , compared to a deferred tax asset of$319.8 million , net of a valuation allowance of$68.1 million , as ofDecember 31, 2018 . The positive evidence considered by management in arriving at its conclusion includes factors such as:FirstBank's three-year cumulative income position; sustained periods of profitability; management's proven ability to forecast future income accurately and execute tax strategies; forecasts of future profitability, under several potential scenarios that support the partial utilization of NOLs prior to their expiration between 2021 through 2024; and the utilization of NOLs over the past three-years. The negative evidence considered by management includes uncertainties around the state of thePuerto Rico economy, including considerations relating to the impact of hurricane recovery funds together withPuerto Rico government debt renegotiation efforts and the ultimate sustainability of thePuerto Rico government fiscal plan. Under the authoritative accounting guidance, income tax benefits are recognized and measured based on a two-step analysis: 1) a tax position must be more likely than not to be sustained based solely on its technical merits in order to be recognized; and 2) the benefit is measured at the largest dollar amount of that position that is more likely than not to be sustained upon settlement. The difference between the benefit not recognized in accordance with this analysis and the tax benefit claimed on a tax return is referred to as an Unrecognized Tax Benefit ("UTB"). The Corporation classifies interest and penalties, if any, related to UTBs as components of income tax expense. As ofDecember 31, 2019 and 2018, the Corporation did not have any UTBs recorded on its books.
Refer to Note 27 - Income Taxes, to the consolidated financial statements for
the year ended
Classification and Related Values of
Management determines the appropriate classification of debt securities at the
time of purchase. Management classifies debt securities as held to maturity when
the Corporation has the intent and ability to hold the securities to maturity.
Held-to-maturity ("HTM") securities are stated at amortized cost. Management
classifies debt securities as trading when the Corporation has the intent to
sell the securities in the near term. Debt securities classified as trading
securities, if any, are reported at fair value, with unrealized gains and losses
included in earnings. Debt securities not classified as HTM or trading are
classified as available for sale ("AFS"). AFS securities are reported at fair
value, with unrealized gains and losses excluded from earnings and reported net
of deferred taxes in accumulated OCI (a component of stockholders' equity).
Unrealized gains and losses on AFS securities do not affect earnings until
realized or are deemed to be other-than-temporarily impaired. Management
classifies investments in equity securities that do not have publicly or readily
determinable fair values as equity securities in the statement of financial
condition and recognizes them at the lower of cost or realizable value. The
Corporation recognizes marketable equity securities at fair value with changes
in unrealized gains or losses recorded through earnings. The assessment of fair
value applies to certain of the Corporation's assets and liabilities, including
the investment portfolio. Fair values are volatile and are affected by factors
such as market interest rates, the rates at which prepayments occur and discount
rates.
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Valuation of financial instruments
The measurement of fair value is fundamental to the Corporation's presentation of its financial condition and results of operations. The Corporation holds debt and equity securities, derivatives, and other financial instruments at fair value. The Corporation holds its investments and liabilities mainly to manage liquidity needs and interest rate risks. The Corporation's financial statements reflect a meaningful part of its total assets at fair value.
The following is a description of the valuation methodologies used for instruments measured at fair value on a recurring basis:
Investment securities available for sale
The fair value of investment securities available for sale was the market value based on quoted market prices (as is the case withU.S. Treasury notes), when available (Level 1), or, when available, market prices for identical or comparable assets (as is the case with MBS and callableU.S. agency debt) that are based on observable market parameters, including benchmark yields, reported trades, quotes from brokers or dealers, issuer spreads, bids, offers and reference data, including market research operations (Level 2). Observable prices in the market already consider the risk of nonperformance. If listed prices or quotes are not available, fair value is based upon discounted cash flow models that use unobservable inputs due to the limited market activity of the instrument, as is the case with private label MBS held by the Corporation (Level 3). Private label MBS are collateralized by fixed-rate mortgages on single-family residential properties in theU.S. ; the interest rate on the securities is variable, tied to 3-month LIBOR and limited to the weighted-average coupon of the underlying collateral. The market valuation represents the estimated net cash flows over the projected life of the pool of underlying assets applying a discount rate that reflects market observed floating spreads over LIBOR, with a widening spread based on a nonrated security. The market valuation is derived from a model that utilizes relevant assumptions such as the prepayment rate, default rate, and loss severity on a loan level basis. The Corporation modeled the cash flow from the fixed-rate mortgage collateral using a static cash flow analysis according to collateral attributes of the underlying mortgage pool (i.e., loan term, current balance, note rate, rate adjustment type, rate adjustment frequency, rate caps, and others) in combination with prepayment forecasts based on historical portfolio performance. The Corporation models the variable cash flow of the security using the 3-month LIBOR forward curve. Loss assumptions were driven by the combination of default and loss severity estimates, using an asset-level risk assessment method taking into account loan credit characteristics (loan-to-value, state jurisdiction, delinquency, property type and pricing behavior, and other factors) to provide an estimate of default and loss severity. Derivative instruments The Corporations bases the fair value of most its derivative instruments on observable market parameters and takes into consideration the credit risk component of paying counterparties, when appropriate. On interest caps, only the seller's credit risk is considered. The Corporation valued the caps using a discounted cash flow approach based on the related LIBOR and swap rate for each cash flow.
A credit spread is considered for those derivative instruments that are not secured. The cumulative mark-to-market effect of credit risk in the valuation of derivative instruments in 2019, 2018 and 2017 was immaterial.
Income Recognition on Loans and Impaired Loans
Loans that the Corporation has the ability and intent to hold for the
foreseeable future are classified as held for investment. The substantial
majority of the Corporation's loans are classified as held for investment. Loans
are stated at the principal outstanding balance, net of unearned interest,
cumulative charge-offs, unamortized deferred origination fees and costs, and
unamortized premiums and discounts. 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.
Credit card loans are reported at their outstanding unpaid principal balance
plus uncollected billed interest and fees net of amounts deemed uncollectible.
PCI loans are reported net of any remaining purchase accounting adjustments.
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-------------------------------------------------------------------------------- Nonaccrual and Past-Due Loans - Loans on which the recognition of interest income has been discontinued are designated as nonaccrual. The Corporations classifies loans as nonaccrual when they are 90 days past due for interest and principal, with the exception of residential mortgage loans guaranteed by theFederal Housing Administration (the "FHA") or theVeterans Administration (the "VA") and credit cards. It is the Corporation's policy to report delinquent mortgage loans insured by the FHA, or guaranteed by theVA or thePuerto Rico Housing Authority , as loans past due 90 days and still accruing as opposed to nonaccrual loans since the principal repayment is insured. 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 loans guaranteed by thePuerto Rico Housing Finance Authority when such loans are over 90 days delinquent. As permitted by regulatory guidance issued by theFederal Financial Institutions Examination Council , the Corporation generally charges off credit card loans in the period in which the account becomes 180 days past due. 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 the Corporation places a loan 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 Corporation recognized interest income on nonaccrual loans 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). 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. PCI loans are not reported as nonaccrual as these loans were written down to fair value at the acquisition date and the accretable yield is recognized in interest income over the remaining life of the loans. The Corporation considers loans that are past due 30 days or more as to principal or interest to be delinquent, with the exception of residential mortgage, commercial mortgage, and construction loans, which it considers to be past due when the borrower is in arrears on two or more monthly payments. Impaired Loans - A loan is considered impaired when, based upon current information and events, it is probable that the Corporation will be unable to collect all amounts due (including principal and interest) according to the contractual terms of the loan agreement, or the loan has been modified in a TDR. Loans with insignificant delays or insignificant shortfalls in the amounts of payments expected to be collected are not considered to be impaired. The Corporation individually evaluates for impairment those loans in the construction, commercial mortgage, and commercial and industrial portfolios of$1 million or more as well as any boat loan of$1 million or more. Although the authoritative accounting guidance for a specific impairment of a loan excludes large groups of smaller balance homogeneous loans that are collectively evaluated for impairment (e.g., mortgage and consumer loans), it specifically requires that loan modifications considered TDRs be analyzed under its provision. The Corporation also evaluates for impairment purposes certain residential mortgage loans and home equity lines of credit with high delinquency and loan to value levels. Held-for-sale loans are not reported as impaired, as these loans are recorded at the lower of cost or fair value. The Corporation generally measures impairment and the related specific allowance for individually impaired loans based on the difference between the recorded investment of the loan and the present value of the loans' expected future cash flows, discounted at the effective original interest rate of the loan at the time of modification, or the loan's observable market price. If the loan is collateral dependent, the Corporation measures impairment based upon the fair value of the underlying collateral, instead of discounted cash flows, regardless of whether foreclosure is probable. Loans are identified as collateral dependent if the repayment is expected to be provided solely by the underlying collateral, through liquidation or operation of the collateral. When the fair value of the collateral is used to measure impairment on an impaired collateral-dependent loan and repayment or satisfaction of the loan is dependent on the sale of the collateral, the fair value of the collateral is adjusted to consider estimated costs to sell. If repayment is dependent only on the operation of the collateral, the fair value of the collateral is not adjusted for estimated costs to sell. If the fair value of the loan is less than the recorded investment, the Corporation recognizes impairment by either a direct write-down or establishing a specific allowance for the loan or by adjusting the previously-established specific allowance for the impaired loan. For an impaired loan that is collateral dependent, the Corporation recognizes charge-offs in the period in which it determines that the loan, or a portion of the loan, is uncollectible, and classifies any portion of the loan that is not charged off as adversely credit-risk rated at a level no better than substandard. 74
-------------------------------------------------------------------------------- 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 typically result from the Corporation's loss mitigation activities and the modification of residential mortgage loans in accordance with guidelines similar to those of theU.S. government's Home Affordable Modification Program, and could include rate reductions to a rate that is below market on the loan, principal forgiveness, term extensions, payment forbearance, refinancing of any past-due amounts, including interest, escrow, and late charges and fees, and other actions intended to minimize the economic loss and to avoid foreclosure or repossession of collateral. Residential mortgage loans for which a binding offer to restructure has been extended are also classified as TDR loans. PCI loans are not classified as TDR loans. 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 and restructured as a TDR 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. Refer to Note 9 - Loans Held for Investment, to the consolidated financial statements included in Item 8 of this Form 10-K, for additional qualitative and quantitative information about TDR loans. In connection with commercial loan restructurings, the decision to maintain a loan that has been restructured on accrual status is based on a current, well-documented credit evaluation of the borrower's financial condition and prospects for repayment under the modified terms. The credit evaluation reflects consideration of the borrower's future capacity to pay, which may include evaluation of cash flow projections, consideration of the adequacy of collateral to cover all principal and interest, and trends indicating improving profitability and collectability of receivables. This evaluation also includes an evaluation of the borrower's current willingness to pay, which may include a review of past payment history, an evaluation of the borrower's willingness to provide information on a timely basis, and consideration of offers from the borrower to provide additional collateral or guarantor support. The evaluation of mortgage and consumer loans for restructurings includes an evaluation of the client's disposable income and credit report, the value of the property, the loan-to-value relationship, and certain other client-specific factors that have affected the borrower's ability to make timely principal and interest payments on the loan. The Corporation removes loans from TDR classification, consistent with authoritative accounting guidance that allows for a loan to be removed 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, therefore, is not considered impaired under the revised terms; 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. However, the loan continues to be individually evaluated for impairment. Loans classified as TDRs, including loans in trial payment periods (trial modifications), are considered impaired loans. With respect to the restructuring of a loan into two new loan notes, or loan splits, generally Note A of a loan split is restructured under market terms, and Note B is fully charged off. A partial charge-off may be recorded if the B note is collateral dependent and the source of repayment is independent of Note A. If Note A is in compliance with the restructured terms in years following the restructuring, Note A will be removed from the TDR classification and will continue to be individually evaluated for impairment.
A loan that had previously been modified in a TDR and is subsequently refinanced under 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 Corporation recognizes interest income on impaired loans based on the Corporation's policy for recognizing interest on accrual and nonaccrual loans.
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--------------------------------------------------------------------------------Results of Operations Net Interest Income Net interest income is the excess of interest earned by First BanCorp. on its interest-earning assets over the interest incurred on its interest-bearing liabilities. First BanCorp.'s net interest income is subject to interest rate risk due to the repricing and maturity mismatch of the Corporation's assets and liabilities. Net interest income for the year endedDecember 31, 2019 was$567.1 million , compared to$525.4 million and$491.6 million for the years endedDecember 31, 2018 and 2017, respectively. On a tax-equivalent basis and excluding the changes in the fair value of derivative instruments, net interest income for the year endedDecember 31, 2019 was$587.4 million compared to$546.9 million and$508.0 million for the years endedDecember 31, 2018 and 2017, respectively. The following tables include a detailed analysis of net interest income for the indicated periods. Part I presents average volumes (based on the average daily balance) and rates on an adjusted tax-equivalent basis and Part II presents, also on an adjusted tax-equivalent basis, the extent to which changes in interest rates and changes in the volume of interest-related assets and liabilities have affected the Corporation's net interest income. For each category of interest-earning assets and interest-bearing liabilities, the tables provide information on changes in (i) volume (changes in volume multiplied by prior period rates) and (ii) rate (changes in rate multiplied by prior period volumes). The Corporation has allocated rate-volume variances (changes in rate multiplied by changes in volume) to either the changes in volume or the changes in rate based upon the effect of each factor on the combined totals. 76 --------------------------------------------------------------------------------
The net interest income is computed on an adjusted tax-equivalent basis and excluding the change in the fair value of derivative instruments. For the definition and
reconciliation of this non-GAAP financial measure, refer to the discussion in "Basis of Presentation" below.
Part I
Average volume Interest income(1) / expense Average rate(1)
Year Ended December 31, 2019 2018 2017 2019 2018 2017 2019 2018 2017
(Dollars in thousands)
Interest-earning assets:
Money market and other
short-term investments $ 649,065 $ 623,892
632,959 799,358 687,076 26,300 28,044 17,918 4.16% 3.51% 2.61%
MBS 1,382,589 1,347,979 1,278,968 44,769 45,311 42,476 3.24% 3.36% 3.32%
FHLB stock 40,661 40,389 40,458 2,682 2,728 2,105 6.60% 6.75% 5.20%
Other investments 3,403 2,881 2,702 32 15 8 0.94% 0.52% 0.30%
Total investments (3) 2,708,677 2,814,499 2,425,782 87,175 87,218 67,121 3.22% 3.10% 2.77%
Residential mortgage loans 3,043,672 3,179,487 3,260,715 163,663 170,751 174,524 5.38% 5.37% 5.35% Construction loans 97,605 117,993 140,038 6,253 4,729 4,898 6.41% 4.01% 3.50% Commercial and Industrial and Commercial mortgage loans 3,731,499 3,629,329 3,723,356 213,567 192,632 174,666 5.72% 5.31% 4.69% Finance leases 370,566 287,400 242,303 27,993 21,126 17,538 7.55% 7.35% 7.24% Consumer loans 1,738,745 1,512,984 1,480,265 197,517 169,978 166,107 11.36% 11.23% 11.22% Total loans (4)(5) 8,982,087 8,727,193 8,846,677 608,993 559,216 537,733
6.78% 6.41% 6.08%
Total interest-earning assets
Interest-bearing liabilities: Interest-bearing checking accounts$ 1,320,458 $ 1,288,240 $ 1,116,273 $ 6,071 $ 5,208 $ 4,566 0.46% 0.40% 0.41% Savings accounts 2,377,508 2,364,774 2,394,708 16,017 14,298 12,520 0.67% 0.60% 0.52% Retail CDs 2,540,289 2,404,764 2,397,443 44,658 33,652 30,277 1.76% 1.40% 1.26% Brokered CDs 500,766 816,229 1,296,479 11,036 14,493 19,174 2.20% 1.78% 1.48% Interest-bearing deposits 6,739,021 6,874,007 7,204,903 77,782 67,651 66,537 1.15% 0.98% 0.92% Other borrowed funds 294,798 352,729 514,035 16,071 18,384 19,195 5.45% 5.21% 3.73% FHLB advances 715,433 705,000 680,975 14,963 13,549 11,140 2.09% 1.92% 1.64% Total interest-bearing liabilities$ 7,749,252 $ 7,931,736 $ 8,399,913 $ 108,816 $ 99,584 $ 96,872 1.40% 1.26% 1.15% Net interest income$ 587,352 $ 546,850 $ 507,982 Interest rate spread 4.55% 4.34% 4.22% Net interest margin 5.02% 4.74% 4.51% (1)On an adjusted tax-equivalent basis. The Corporation estimated the adjusted tax-equivalent yield by dividing the interest rate spread on exempt assets by 1 less thePuerto Rico statutory tax rate of 37.5% (39% for 2018 and 2017) and adding to it the cost of interest-bearing liabilities. The tax-equivalent adjustment recognizes the income tax savings when comparing taxable and tax-exempt assets. Management believes that it is a standard practice in the banking industry to present net interest income, interest rate spread and net interest margin on a fully tax-equivalent basis. Therefore, management believes these measures provide useful information to investors by allowing them to make peer comparisons. The Corporation excludes changes in the fair value of derivatives from interest income and interest expense because the changes in valuation do not affect interest received or paid.
(2)Government obligations include debt issued by GSEs.
(3)Unrealized gains and losses on available-for-sale securities are excluded from the average volumes.
(4)Average loan balances include the average of nonaccrual loans.
(5)Interest income on loans includes$9.5 million ,$7.7 million and$6.7 million for the years endedDecember 31, 2019 , 2018 and 2017, respectively, of income from prepayment penalties and late fees related to the Corporation's loan portfolio. 77
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