Attached files

file filename
EX-31.2 - EX-31.2 - OFG BANCORPg24975exv31w2.htm
EX-32.1 - EX-32.1 - OFG BANCORPg24975exv32w1.htm
EX-31.1 - EX-31.1 - OFG BANCORPg24975exv31w1.htm
EX-10.1 - EX-10.1 - OFG BANCORPg24975exv10w1.htm
EX-32.2 - EX-32.2 - OFG BANCORPg24975exv32w2.htm
Table of Contents

 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
     
þ   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2010
or
     
o   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 001-12647
Oriental Financial Group Inc.
     
Incorporated in the Commonwealth of Puerto Rico,   IRS Employer Identification No. 66-0538893
Principal Executive Offices:
997 San Roberto Street
Oriental Center 10th Floor
Professional Offices Park
San Juan, Puerto Rico 00926
Telephone Number: (787) 771-6800
     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 þ No o
     Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post such files).
Yes o No o
     Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.
             
Large Accelerated Filer o   Accelerated Filer þ   Non-Accelerated Filer o   Smaller Reporting Company o
        (Do not check if a smaller reporting company)    
     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o No þ
     Number of shares outstanding of the registrant’s common stock, as of the latest practicable date:
46,317,008 common shares ($1.00 par value per share) outstanding as of October 31, 2010
 
 

 


 

TABLE OF CONTENTS
         
    Page  
       
       
    1  
    2  
    3  
    4  
    5  
    7  
    53  
    79  
    82  
       
    83  
    83  
    86  
    86  
    86  
    86  
    86  
    87  
 EX-10.1
 EX-31.1
 EX-31.2
 EX-32.1
 EX-32.2

 


Table of Contents

FORWARD-LOOKING STATEMENTS
When used in this Form 10-Q or future filings by Oriental Financial Group Inc. (the “Group”) with the Securities and Exchange Commission (the “SEC”), in the Group’s press releases or other public or shareholder communications, or in oral statements made with the approval of an authorized executive officer, the words or phrases “would be,” “will allow,” “intends to,” “will likely result,” “are expected to,” “will continue,” “is anticipated,” “estimated,” “project,” “believe,” “should” or similar expressions are intended to identify “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995.
The future results of the Group could be affected by subsequent events and could differ materially from those expressed in forward-looking statements. If future events and actual performance differ from the Group’s assumptions, the actual results could vary significantly from the performance projected in the forward-looking statements.
The Group wishes to caution readers not to place undue reliance on any such forward-looking statements, which speak only as of the date made and are based on management’s current expectations, and to advise readers that various factors, including local, regional and national economic conditions, substantial changes in levels of market interest rates, credit and other risks of lending and investment activities, competitive, and regulatory factors, legislative changes and accounting pronouncements, could affect the Group’s financial performance and could cause the Group’s actual results for future periods to differ materially from those anticipated or projected. The Group 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.

 


Table of Contents

ORIENTAL FINANCIAL GROUP INC.
UNAUDITED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
SEPTEMBER 30, 2010 AND DECEMBER 31, 2009
                 
    September 30,     December 31,  
    2010     2009  
    (In thousands, except share data)  
ASSETS
               
Cash and cash equivalents
               
Cash and due from banks
  $ 89,703     $ 247,691  
Money market investments
    53,233       29,432  
 
           
Total cash and cash equivalents
    142,936       277,123  
 
           
Investments:
               
Trading securities, at fair value, with amortized cost of $100 (December 31, 2009 - $522)
    102       523  
Investment securities available-for-sale, at fair value, with amortized cost of $4,304,055 (December 31, 2009 - $5,044,017)
    4,317,088       4,953,659  
Other investments
    150       150  
Federal Home Loan Bank (FHLB) stock, at cost
    22,496       19,937  
 
           
Total investments
    4,339,836       4,974,269  
 
           
Securities sold but not yet delivered
    317,209        
 
           
Loans:
               
Mortgage loans held-for-sale, at lower of cost or fair value
    31,432       27,261  
Loans not covered under shared loss agreements with the FDIC, net of allowance for loan and lease losses of $29,640 (December 31, 2009 - $23,272)
    1,107,338       1,112,808  
Loans covered under shared loss agreements with the FDIC
    722,858        
 
           
Total loans, net
    1,861,628       1,140,069  
 
           
FDIC shared-loss indemnification asset
    562,364        
Foreclosed real estate covered under shared loss agreements with the FDIC
    19,322        
Foreclosed real estate not covered under shared loss agreements with the FDIC
    13,765       9,347  
Accrued interest receivable
    30,644       33,656  
Deferred tax asset, net
    30,650       31,685  
Premises and equipment, net
    17,125       19,775  
Core deposit intangible
    1,363        
Servicing asset
    9,647       7,120  
Other assets
    56,568       57,789  
 
           
Total assets
  $ 7,403,057     $ 6,550,833  
 
           
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
Deposits:
               
Demand deposits
  $ 888,011     $ 693,506  
Savings accounts
    234,501       86,792  
Certificates of deposit
    1,472,763       965,203  
 
           
Total deposits
    2,595,275       1,745,501  
 
           
Borrowings:
               
Short-term borrowings
    29,959       49,179  
Securities sold under agreements to repurchase
    3,541,520       3,557,308  
Advances from FHLB
    281,753       281,753  
FDIC-guaranteed term notes
    105,112       105,834  
Subordinated capital notes
    36,083       36,083  
 
           
Total borrowings
    3,994,427       4,030,157  
 
           
Securities purchased but not yet received
          413,359  
FDIC net settlement payable
    41,601        
Accrued expenses and other liabilities
    54,694       31,650  
 
           
Total liabilities
    6,685,997       6,220,667  
 
           
Stockholders’ equity:
               
Preferred stock, $1 par value; 10,000,000 shares authorized; 1,340,000 shares of Series A and 1,380,000 shares of Series B issued and outstanding, $25 liquidation value
    68,000       68,000  
Common stock, $1 par value; 100,000,000 shares authorized as of September 30, 2010 (December 31, 2009 - 40,000,000); 47,807,734 shares issued; 46,317,008 shares outstanding (December 31, 2009 - 25,739,397; 24,235,088)
    47,808       25,739  
Additional paid-in capital
    498,486       213,445  
Legal surplus
    46,958       45,279  
Retained earnings
    59,845       77,584  
Treasury stock, at cost, 1,490,726 shares (December 31, 2009 - 1,504,309 shares)
    (17,116 )     (17,142 )
 
               
Accumulated other comprehensive income (loss), net of tax of ($128) (December 31, 2009 - $7,445)
    13,079       (82,739 )
 
           
Total stockholders’ equity
    717,060       330,166  
 
           
Total liabilities and stockholders’ equity
  $ 7,403,057     $ 6,550,833  
 
           
See notes to unaudited consolidated financial statements.

1


Table of Contents

ORIENTAL FINANCIAL GROUP INC.
UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE QUARTERS AND NINE-MONTH PERIODS ENDED SEPTEMBER 30, 2010 AND 2009
                                 
    Quarter Ended September 30,     Nine-Month Period Ended September 30,  
    2010     2009     2010     2009  
            (In thousands, except per share data)          
Interest income:
                               
Loans
  $ 34,347     $ 18,248     $ 81,382     $ 55,329  
Mortgage-backed securities
    40,429       48,750       125,542       151,179  
Investment securities and other
    6,445       11,552       24,476       38,078  
 
                       
Total interest income
    81,221       78,550       231,400       244,586  
 
                       
Interest expense:
                               
Deposits
    12,680       13,990       35,874       41,962  
Securities sold under agreements to repurchase
    25,128       27,209       75,900       90,937  
Advances from FHLB and other borrowings
    3,082       3,106       9,147       9,277  
Note Payable to the FDIC
    823             1,887        
FDIC-guaranteed term notes
    1,021       1,021       3,063       2,154  
Subordinated capital notes
    327       333       930       1,158  
 
                       
Total interest expense
    43,061       45,659       126,801       145,488  
 
                       
Net interest income
    38,160       32,891       104,599       99,098  
Provision for loan and lease losses
    4,100       4,400       12,214       11,250  
 
                       
Net interest income after provision for loan and lease losses
    34,060       28,491       92,385       87,848  
 
                       
Non-interest income:
                               
Wealth management revenues
    4,554       3,764       13,157       10,163  
Banking service revenues
    3,414       1,424       8,030       4,330  
Mortgage banking activities
    3,418       2,232       7,555       7,191  
Investment banking revenues (losses)
    59             93       (4 )
 
                       
Total banking and wealth management revenues
    11,445       7,420       28,835       21,680  
 
                       
Total loss on other-than-temporarily impaired securities
    (14,739 )     (44,737 )     (39,674 )     (107,331 )
Portion of loss on securities recognized in other comprehensive income
          36,478       22,508       94,656  
 
                       
Other-than-temporary impairments on securities
    (14,739 )     (8,259 )     (17,166 )     (12,675 )
 
                       
Net gain (loss) on:
                               
Sale of securities
    13,954       35,528       37,807       56,388  
Derivatives
    (22,580 )     (64 )     (59,832 )     19,778  
Early extinguishment of repurchase agreements
          (17,551 )           (17,551 )
Trading securities
    4       (505 )     2       12,427  
Bargain purchase from FDIC-assisted acquisition
                9,940        
Fair value adjustment on FDIC equity appreciation instrument
                909        
Accretion of FDIC loss-share indemnification asset
    1,756             3,314        
Foreclosed real estate
    (140 )     (278 )     (283 )     (576 )
Other
    (8 )     31       61       94  
 
                       
Total non-interest income (loss), net
    (10,308 )     16,322       3,587       79,565  
 
                       
Non-interest expenses:
                               
Compensation and employee benefits
    11,732       7,882       30,440       23,626  
Occupancy and equipment
    5,620       3,747       13,815       10,994  
Professional and service fees
    5,480       2,459       11,552       7,461  
Insurance
    1,651       1,273       5,218       5,560  
Taxes, other than payroll and income taxes
    1,611       834       3,759       2,129  
Advertising and business promotion
    1,275       1,097       3,339       3,329  
Electronic banking charges
    1,322       471       3,112       1,607  
Communication
    826       382       1,905       1,163  
Loan servicing expenses
    443       397       1,321       1,167  
Clearing and wrap fees expenses
    579       293       1,217       860  
Foreclosure and repossession expenses
    545       204       1,117       650  
Director and investors relations
    396       348       1,098       1,029  
Printing, postage, stationery and supplies
    299       194       795       665  
Training and travel
    167       194       639       444  
Other
    759       710       1,623       1,287  
 
                       
Total non-interest expenses
    32,705       20,485       80,950       61,971  
 
                       
Income (loss) before income taxes
    (8,953 )     24,328       15,022       105,442  
Income tax expense (benefit)
    (2,358 )     3,001       (262 )     8,452  
 
                       
Net income (loss)
    (6,595 )     21,327       15,284       96,990  
Less: Dividends on preferred stock
    (1,200 )     (1,201 )     (4,134 )     (3,602 )
Less: Deemed dividend on preferred stock beneficial conversion feature
    (22,711 )           (22,711 )      
 
                       
Income available (loss) to common shareholders
  $ (30,506 )   $ 20,126     $ (11,561 )   $ 93,388  
 
                       
Income (loss) per common share:
                               
Basic
  $ (0.67 )   $ 0.83     $ (0.33 )   $ 3.85  
 
                       
Diluted
  $ (0.67 )   $ 0.83     $ (0.33 )   $ 3.84  
 
                       
Average common shares outstanding
    45,354       24,303       34,823       24,284  
Average potential common shares-options
    128       65       105       17  
 
                       
Average diluted common shares outstanding
    45,482       24,368       34,928       24,301  
 
                       
Cash dividends per share of common stock
  $ 0.04     $ 0.04     $ 0.12     $ 0.12  
 
                       
See notes to unaudited consolidated financial statements.

2


Table of Contents

ORIENTAL FINANCIAL GROUP INC.
UNAUDITED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
FOR THE NINE-MONTH PERIODS ENDED SEPTEMBER 30, 2010 AND 2009
                 
    Nine-Month Period Ended September 30,  
    2010     2009  
    (In thousands)  
Preferred stock:
               
Balance at beginning of period
  $ 68,000     $ 68,000  
Issuance of preferred stock
    177,289        
Conversion of preferred stock to common stock
    (177,289 )      
 
           
Balance at end of period
    68,000       68,000  
 
           
Additional paid-in capital from beneficial conversion feature
               
Balance at beginning of period
           
Issuance of preferred stock — beneficial conversion feature
    22,711        
Conversion of preferred stock to common stock — beneficial conversion feature
    (22,711 )      
 
           
Balance at end of period
           
 
           
Common stock:
               
Balance at beginning of period
    25,739       25,739  
Issuance of common stock
    8,740        
Conversion of preferred stock to common stock
    13,320        
Exercised stock options
    9        
 
           
Balance at end of period
    47,808       25,739  
 
           
Additional paid-in capital:
               
Balance at beginning of period
    213,445       212,625  
Issuance of common stock
    90,896        
Conversion of preferred stock to common stock
    186,680        
Deemed dividend on preferred stock beneficial conversion feature
    22,711        
Exercised stock options
    64        
Stock-based compensation expense
    865       550  
Capital contribution
          89  
Common stock issuance costs
    (5,250 )      
Preferred stock issuance costs
    (10,925 )      
 
           
Balance at end of period
    498,486       213,264  
 
           
Legal surplus:
               
Balance at beginning of period
    45,279       43,016  
Transfer from retained earnings
    1,679       9,643  
 
           
Balance at end of period
    46,958       52,659  
 
           
Retained earnings:
               
Balance at beginning of period
    77,584       51,233  
Cumulative effect on initial adoption of accounting principle
          14,359  
Net income
    15,284       96,990  
Cash dividends declared on common stock
    (4,499 )     (2,916 )
Cash dividends declared on preferred stock
    (4,134 )     (3,602 )
Deemed dividend on preferred stock beneficial conversion feature
    (22,711 )      
Transfer to legal surplus
    (1,679 )     (9,643 )
 
           
Balance at end of period
    59,845       146,421  
 
           
Treasury stock:
               
Balance at beginning of period
    (17,142 )     (17,109 )
Stock purchased
          (182 )
Stock used to match defined contribution plan
    26       144  
 
           
Balance at end of period
    (17,116 )     (17,147 )
 
           
Accumulated other comprehensive income (loss), net of tax:
               
Balance at beginning of period
    (82,739 )     (122,187 )
Cumulative effect on initial adoption of accounting principle
          (14,359 )
Other comprehensive income, net of tax
    95,818       30,179  
 
           
Balance at end of period
    13,079       (106,367 )
 
           
Total stockholders’ equity
  $ 717,060     $ 382,569  
 
           
See notes to unaudited consolidated financial statements.

3


Table of Contents

ORIENTAL FINANCIAL GROUP INC.
UNAUDITED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
FOR THE QUARTERS AND NINE-MONTH PERIODS ENDED SEPTEMBER 30, 2010 AND 2009
                                 
                    Nine-Month Period Ended  
    Quarter Ended September 30,     September 30,  
    2010     2009     2010     2009  
            (In thousands)          
Net income (loss)
  $ (6,595 )   $ 21,327     $ 15,284     $ 96,990  
 
                       
Other comprehensive income:
                               
Unrealized gain (loss) on securities available-for-sale arising during the period
    (15,072 )     30,026       124,302       75,015  
Realized gain on investment securities included in net income
    (14,224 )     (35,528 )     (38,077 )     (56,388 )
Total loss on other- than-temporarily impaired securities
    14,739       44,737       39,674       107,331  
Portion of loss on securities recognized in other comprehensive income
          (36,478 )     (22,508 )     (94,656 )
Income tax effect related to unrealized gain on securities available-for-sale
    2,274       716       (7,573 )     (1,123 )
 
                       
Other comprehensive income (loss) for the period
    (12,283 )     3,473       95,818       30,179  
 
                       
 
                               
Comprehensive income (loss)
  $ (18,878 )   $ 24,800     $ 111,102     $ 127,169  
 
                       
See notes to unaudited consolidated financial statements.

4


Table of Contents

ORIENTAL FINANCIAL GROUP INC.
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE-MONTH PERIODS ENDED SEPTEMBER 30, 2010 AND 2009
                 
    Nine-Month Period Ended September 30,  
    2010     2009  
    (In thousands)  
Cash flows from operating activities:
               
Net income
  $ 15,284     $ 96,990  
 
           
Adjustments to reconcile net income to net cash used in operating activities:
               
Amortization of deferred loan origination fees, net of costs
    565       151  
Amortization of premiums, net of accretion of discounts
    24,663       9,070  
Amortization of core deposit intangible
    60        
Accretion of FDIC loss-share indemnification asset
    (3,314 )      
Amortization of accretable yield on loans covered by FDIC shared-loss agreements
    (28,592 )      
Other-than-temporary impairments on securities
    17,166       12,675  
Depreciation and amortization of premises and equipment
    4,152       4,505  
Deferred income tax expense (benefit)
    (6,538 )     750  
Provision for loan and lease losses
    12,214       11,250  
Stock-based compensation
    865       550  
Fair value adjustment of servicing asset
    (1,538 )     (4,430 )
Bargain purchase gain from FDIC assisted acquisition
    (9,940 )      
(Gain) loss on:
               
Sale of securities
    (37,807 )     (56,388 )
Sale of mortgage loans held for sale
    (4,332 )     (2,761 )
Derivatives
    59,832       (19,778 )
Early extinguishment of repurchase agreements
          17,551  
Sale of foreclosed real estate
    283       576  
Sale of premises and equipment
    44       (60 )
Originations and purchases of loans held-for-sale
    (169,205 )     (169,598 )
Proceeds from sale of loans held-for-sale
    58,646       88,838  
Net (increase) decrease in:
               
Trading securities
    422       217  
Accrued interest receivable
    3,012       3,944  
Other assets
    (226 )     (4,679 )
Net increase (decrease) in:
               
Accrued interest on deposits and borrowings
    (260 )     (3,525 )
Accrued expenses and other liabilities
    34,808       10,954  
 
           
Net cash used in operating activities
    (29,735 )     (3,198 )
 
           
Cash flows from investing activities:
               
Purchases of:
               
Investment securities available-for-sale
    (5,308,688 )     (9,290,454 )
FHLB stock
    (2,560 )     (13,355 )
Equity options
    (1,747 )     (3,738 )
Maturities and redemptions of:
               
Investment securities available-for-sale
    2,370,912       3,251,327  
FHLB stock
    10,077       14,431  
Proceeds from sales of:
               
Investment securities available-for-sale
    3,052,533       6,090,572  
Foreclosed real estate
    5,197       6,594  
Premises and equipment
    573       114  
Origination and purchase of loans, excluding loans held-for-sale
    (101,595 )     (60,370 )
Principal repayment of loans
    180,140       92,437  
Additions to premises and equipment
    (1,483 )     (3,577 )
Cash and cash equivalents received in FDIC-assisted transaction
    89,777        
 
           
Net cash provided by investing activities
    293,137       83,981  
 
           
Cash flows from financing activities:
               
Net increase (decrease) in:
               
Deposits
    119,544       142,761  
Securities sold under agreements to repurchase
    (15,000 )     (217,551 )
Short term borrowings
    (19,220 )     6,135  
Proceeds from:
               
Issuance of FDIC-guaranteed term notes
          105,000  
Advances from FHLB
          761,380  
Exercise of stock options
    73        
Issuance of common stock, net
    94,386        
Issuance of preferred stock, net
    189,075        
Capital contribution
          89  
Repayments of advances from FHLB
          (788,080 )
Repayments of advances from note payable to the FDIC
    (715,970 )      
Purchase of treasury stock
          (182 )
Termination of derivative instruments
    (42,727 )     20,254  
Dividends paid on preferred stock
    (2,934 )     (3,602 )
Dividends paid on common stock
    (4,816 )     (2,916 )
 
           
Net cash provided by (used in) financing activities
    (397,589 )     23,288  
 
           
Net change in cash and cash equivalents
    (134,187 )     104,071  
Cash and cash equivalents at beginning of period
    277,123       66,372  
 
           
Cash and cash equivalents at end of period
  $ 142,936     $ 170,443  
 
           
See notes to unaudited consolidated financial statements.

5


Table of Contents

ORIENTAL FINANCIAL GROUP INC.
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS (CONT.)
FOR THE NINE-MONTH PERIOD ENDED SEPTEMBER 30, 2010 AND 2009
                 
    Nine-Month Period Ended September 30,  
    2010     2009  
    (In thousands)  
Supplemental Cash Flow Disclosure and Schedule of Non-cash Activities:
               
Interest paid
  $ 126,569     $ 149,012  
 
           
Income taxes paid
  $ 6,281     $ 74  
 
           
Mortgage loans securitized into mortgage-backed securities
  $ 109,386     $ 105,676  
 
           
Securities sold but not yet delivered
  $ 317,209     $ 417,280  
 
           
Securities purchased but not yet received
  $     $ 30,945  
 
           
Transfer from loans to foreclosed real estate
  $ 11,693     $ 6,327  
 
           
Reclassification of loans held for investment portfolio to the held for sale portfolio
  $     $ 19,832  
 
           
Supplemental Schedule of Non-cash Investing Activities:
               
Acquisitions:
               
Non-cash assets acquired:
               
FHLB stock
  $ 10,077     $  
Loans covered under shared-loss agreements with FDIC
    787,177        
Loans not covered under shared-loss agreements with FDIC
    2,987        
Foreclosed real estate covered under shared-loss agreements with FDIC
    17,527        
Other repossessed assets covered under shared-loss agreements with FDIC
    3,062        
FDIC loss-share indemnification asset
    559,050        
Core deposit intangible
    1,423        
Other assets
    5,301        
 
           
Total non-cash assets acquired
    1,386,604        
Liabilities assumed:
               
Deposits
    729,546        
Deferred income tax liability, net
    3,876        
Other liabilities
    9,426        
 
           
Total liabilities assumed
    742,848        
 
           
Net non-cash assets acquired
    643,756        
Cash and cash equivalents received in the FDIC-assisted transaction
    89,777        
 
           
Net assets acquired
  $ 733,533     $  
 
           
Consideration at fair value:
               
Note payable issued to the FDIC
    715,970        
Net settlement payable to the FDIC
    10,590        
Equity appreciation instrument
    909        
 
           
 
    727,469        
Net after tax bargain purchase gain from FDIC-assisted acquisition
    6,064        
 
           
 
  $ 733,533     $  
 
           
See notes to unaudited consolidated financial statements.

6


Table of Contents

ORIENTAL FINANCIAL GROUP INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 — BASIS OF PRESENTATION
The accounting and reporting policies of Oriental Financial Group Inc. (the “Group” or “Oriental”) conform with U.S. generally accepted accounting principles (“GAAP”) and to financial services industry practices.
The unaudited consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). All significant intercompany balances and transactions have been eliminated in consolidation. These unaudited statements are, in the opinion of management, a fair statement of the results for the periods reported and include all necessary adjustments, all of a normal recurring nature, for a fair statement of such results. Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to SEC rules and regulations. Management believes that the disclosures made are adequate to make the information presented not misleading. The results of operations and cash flows for the periods ended September 30, 2010 and 2009 are not necessarily indicative of the results to be expected for the full year. For further information, refer to the consolidated financial statements and footnotes thereto for the year ended December 31, 2009, included in the Group’s 2009 annual report on Form 10-K, as amended.
Nature of Operations
The Group is a publicly-owned financial holding company incorporated under the laws of the Commonwealth of Puerto Rico. It has four direct subsidiaries, Oriental Bank and Trust (the “Bank”), Oriental Financial Services Corp. (“Oriental Financial Services”), Oriental Insurance, Inc. (“Oriental Insurance”) and Caribbean Pension Consultants, Inc., which is located in Boca Raton, Florida. The Group also has a special purpose entity, Oriental Financial (PR) Statutory Trust II (the “Statutory Trust II”). Through these subsidiaries and its divisions, the Group provides a wide range of financial services such as mortgage, commercial and consumer lending, leasing, financial planning, insurance sales, money management and investment banking and brokerage services, as well as corporate and individual trust services.
The main offices of the Group and its subsidiaries are located in San Juan, Puerto Rico. The Group is subject to examination, regulation and periodic reporting under the U.S. Bank Holding Company Act of 1956, as amended, which is administered by the Board of Governors of the Federal Reserve System.
The Bank is subject to the supervision, examination and regulation of the Office of the Commissioner of Financial Institutions of Puerto Rico (“OCFI”) and the Federal Deposit Insurance Corporation (“FDIC”). The Bank offers banking services such as commercial and consumer lending, leasing, savings and time deposit products, financial planning, and corporate and individual trust services, and capitalizes on its commercial banking network to provide mortgage lending products to its clients. Oriental International Bank Inc. (“OIB”), a wholly-owned subsidiary of the Bank, operates as an international banking entity (“IBE”) pursuant to the International Banking Center Regulatory Act of Puerto Rico, as amended. OIB offers the Bank certain Puerto Rico tax advantages. OIB activities are limited under Puerto Rico law to persons and assets/liabilities located outside of Puerto Rico.
Oriental Financial Services is subject to the supervision, examination and regulation of the Financial Industry Regulatory Authority (“FINRA”), the SEC, and the OCFI. Oriental Insurance is subject to the supervision, examination and regulation of the Office of the Commissioner of Insurance of Puerto Rico.
The Group’s mortgage banking activities are conducted through a division of the Bank. The mortgage banking activities consist of the origination and purchase of residential mortgage loans for the Group’s own portfolio and, if the conditions so warrant, the Group engages in the sale of such loans to other financial institutions in the secondary market. The Group originates Federal Housing Administration (“FHA”) insured and Veterans Administration (“VA”)-guaranteed mortgages that are primarily securitized for issuance of Government National Mortgage Association (“GNMA”) mortgage-backed securities which can be resold to individual or institutional investors in the secondary market. Conventional loans that meet the underwriting requirements for sale or exchange under standard Federal National Mortgage Association (the “FNMA”) or Federal Home Loan Mortgage Corporation (the “FHLMC”) programs are referred to as conforming mortgage loans and are also securitized for issuance of FNMA or FHLMC mortgage-backed securities. The Group is an approved seller of FNMA, as well as FHLMC, mortgage loans for issuance of FNMA and FHLMC mortgage-backed securities. The Group is also an approved issuer of GNMA mortgage-backed securities. The Group outsources the servicing of the GNMA, FNMA and FHLMC pools that it issues or originates and of its mortgage loan portfolio.

7


Table of Contents

Effective April 30, 2010, the Bank assumed all of the retail deposits and other liabilities and acquired certain assets and substantially all of the operations of Eurobank from the FDIC as receiver for Eurobank, pursuant to the terms of a purchase and assumption agreement entered into by the Bank and the FDIC on April 30, 2010. This transaction is referred to as the “FDIC-assisted acquisition”.
Pursuant to a waiver granted by the SEC to the Group on May 28, 2010, and in accordance with the guidance provided in the SEC Staff Accounting Bulleting Topic 1.K, Financial Statements of Acquired Troubled Financial Institutions (“SAB 1:K”), the Group has omitted certain financial information of the FDIC-assisted acquisition otherwise required by Rule 3-05 of Regulation S-X. SAB 1:K provides relief from the requirements of Rule 3-05 of Regulation S-X under certain circumstances, including a transaction such as the Eurobank acquisition, in which the registrant engages in an acquisition of a troubled financial institution for which audited financial statements are not reasonably available and in which federal assistance is so pervasive as to substantially reduce the relevance of such information to an assessment of future operations.
Significant Accounting Policies
The unaudited consolidated financial statements of the Group are prepared in accordance with GAAP as prescribed by the Financial Accounting Standards Board Accounting Standards Codification (“ASC”) and with the general practices within the financial services industry. In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The Group believes that, of its significant accounting policies, the following may involve a higher degree of judgment and complexity.
Loans and Allowance for Loan and Lease Losses
Because of the loss protection provided by the FDIC, the risks of the Eurobank FDIC-assisted transaction acquired loans are significantly different from those loans not covered under the FDIC loss sharing agreements. Accordingly, the Group presents loans subject to the loss sharing agreements as “covered loans” and loans that are not subject to the FDIC loss sharing agreements as “non-covered loans”. Non-covered loans include any loans made outside of the FDIC shared-loss agreements before or after the April 30, 2010 FDIC-assisted acquisition. Non-covered loans also include credit cards balances acquired in the FDIC-assisted acquisition.
Non-covered loans
Non-covered loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off are reported at their outstanding unpaid principal balances adjusted for charge-offs, the allowance for non-covered loan and lease losses, unamortized discount related to mortgage servicing right sold and any deferred fees or costs on originated loans. Interest income is accrued on the unpaid principal balance. Loan origination fees and costs and premiums and discounts on loans purchased are deferred and amortized over the estimated life of the loans as an adjustment of their yield through interest income using the interest method. When a loan is paid off or sold, any unamortized deferred fee (cost) is credited (charged) to income.
Credit cards balances acquired as part of the FDIC-assisted acquisition are to be accounted for under the guidance of ASC 310-20, which requires that any differences between the contractually required loan payment in excess of the Group’s initial investment in the loans be accreted into interest income on a level-yield basis over the life of the loan. Loans accounted for under ASC 310-20 are placed on non-accrual status when past due in accordance with the Group’s non-accruing policy and any accretion of discount is discontinued. These assets were written-down to their estimated fair value on their acquisition date, incorporating an estimate of future expected cash flows. To the extent actual or projected cash flows are less than originally estimated, additional provisions for loan and lease losses will be recognized.
Interest recognition is discontinued when loans are 90 days or more in arrears on principal and/or interest based on contractual terms, except for well collateralized residential mortgage loans in process of collection for which recognition is discontinued when they become 365 days or more past due based on contractual terms and are then written down, if necessary, based on the specific evaluation of the collateral underlying the loan. Loans for which the recognition of interest income has been discontinued are designated as non-accruing. Collections are accounted for on the cash method thereafter, until qualifying to return to accrual status. Such loans are not reinstated to accrual status until interest is received on a current basis and other factors indicative of doubtful collection cease to exist.

8


Table of Contents

The Group follows a systematic methodology to establish and evaluate the adequacy of the allowance for loan and lease losses to provide for inherent losses in the non-covered loan portfolio. This methodology includes the consideration of factors such as economic conditions, portfolio risk characteristics, prior loss experience, and results of periodic credit reviews of individual loans. The provision for loan and lease losses charged to current operations is based on such methodology. Loan and lease losses are charged and recoveries are credited to the allowance for loan and lease losses on non-covered loans.
Larger commercial loans that exhibit potential or observed credit weaknesses are subject to individual review and grading. Where appropriate, allowances are allocated to individual loans based on management’s estimate of the borrower’s ability to repay the loan given the availability of collateral, other sources of cash flow and legal options available to the Group.
Included in the review of individual loans are those that are impaired. A loan is considered impaired when, based on current information and events, it is probable that the Group will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Impaired loans are measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate, or as a practical expedient, at the observable market price of the loan or the fair value of the collateral, if the loan is collateral dependent. Loans are individually evaluated for impairment, except large groups of small balance homogeneous loans that are collectively evaluated for impairment, and loans that are recorded at fair value or at the lower of cost or fair value. The Group measures for impairment all commercial loans over $250 thousand and over 90-days past-due. The portfolios of mortgage, leases and consumer loans are considered homogeneous, and are evaluated collectively for impairment.
The Group, using a rating system, applies an overall allowance percentage to each non-covered loan portfolio category based on historical credit losses adjusted for current conditions and trends. This calculation is the starting point for management’s systematic determination of the required level of the allowance for loan and lease losses. Other data considered in this determination includes: the credit grading assigned to commercial loans, delinquency levels, loss trends and other information including underwriting standards and economic trends.
Loan loss ratios and credit risk categories are updated at least quarterly and are applied in the context of GAAP as prescribed by the Financial Accounting Standards Board Accounting Standards Codification (“ASC”) and the importance of depository institutions having prudent, conservative, but not excessive loan allowances that fall within an acceptable range of estimated losses. While management uses current available information in estimating possible loan and lease losses, factors beyond the Group’s control such as those affecting general economic conditions may require future changes to the allowance.
Covered loans
Covered loans acquired in the FDIC-assisted acquisition are accounted under the provisions of ASC 310-30, “Loans and Debt Securities Acquired with Deteriorated Credit Quality”, which are applicable when (a) the Group acquires loans deemed to be impaired when there is evidence of credit deterioration and it is probable, at the date of acquisition, that the Group would be unable to collect all contractually required payments and (b) as a general policy election for non-impaired loans that the Group acquires.
The acquired covered loans were recorded at their estimated fair value at the time of acquisition. Fair value of acquired loans is determined using a discounted cash flow model based on assumptions about the amount and timing of principal and interest payments, estimated prepayments, estimated default rates, estimated loss severity in the event of defaults, and current market rates. Estimated credit losses are included in the determination of fair value; therefore, an allowance for loan and lease losses is not recorded on the acquisition date.
In accordance with ASC 310-30 and in estimating the fair value of covered loans at the acquisition date, the Group (a) calculated the contractual amount and timing of undiscounted principal and interest payments (the “undiscounted contractual cash flows”) and (b) estimated the amount and timing of undiscounted expected principal and interest payments (the “undiscounted expected cash flows”). The difference between the undiscounted contractual cash flows and the undiscounted expected cash flows is the non-accretable difference. The non-accretable difference represents an estimate of the loss exposure in the covered loan portfolio, and such amount is subject to change over time based on the performance of the covered loans. The carrying value of covered loans is reduced by payments received and increased by the portion of the accretable yield recognized as interest income.
The excess of undiscounted expected cash flows at acquisition over the initial fair value of acquired loans is referred to as the “accretable yield” and is recorded as interest income over the estimated life of the loans using the effective yield method if the timing and amount of the future cash flows is reasonably estimable. Subsequent to acquisition, the Group aggregates loans into

9


Table of Contents

pools of loans with common risk characteristics to account for the acquired loans. Increases in expected cash flows over those originally estimated increase the accretable yield and are recognized as interest income prospectively. Decreases in expected cash flows compared to those originally estimated decrease the accretable yield and are recognized by recording a provision for loan and lease losses and establishing an allowance for loan and lease losses.
Loans accounted for under ASC 310-30 are generally considered accruing and performing loans as the loans accrete interest income over the estimated life of the loan when cash flows are reasonably estimable. Accordingly, acquired impaired loans that are contractually past due are still considered to be accruing and performing loans. If the timing and amount of cash flows is not reasonably estimable, the loans may be classified as nonaccrual loans and interest income may be recognized on a cash basis or as a reduction of the principal amount outstanding.
Under the accounting guidance of ASC 310-30 for acquired loans, the allowance for loan and lease losses on covered loans is measured at each financial reporting period, or measurement date, based on expected cash flows. Accordingly, decreases in expected cash flows on the acquired covered loans as of the measurement date compared to those initially estimated are recognized by recording a provision for credit losses on covered loans. The portion of the loss on covered loans reimbursable from the FDIC is recorded as an offset to provision for credit losses and increases the FDIC shared-loss indemnification asset.
Financial Instruments
Certain financial instruments, including derivatives, trading securities and investment securities available-for-sale, are recorded at fair value and unrealized gains and losses are recorded in other comprehensive income or as part of non-interest income, as appropriate. Fair values are based on listed market prices, if available. If listed market prices are not available, fair value is determined based on other relevant factors, including price quotations for similar instruments. The fair values of certain derivative contracts are derived from pricing models that consider current market and contractual prices for the underlying financial instruments as well as time value and yield curve or volatility factors underlying the positions.
The Group determines the fair value of its financial instruments based on the fair value measurement framework, which establishes a fair value hierarchy that prioritizes the inputs of valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (level 1 measurements) and the lowest priority to unobservable inputs (level 3 measurements). The three levels of the fair value hierarchy are described below:
Level 1 — Level 1 asset and liabilities include equity securities that are traded in an active exchange market, as well as certain U.S. Treasury and other U.S. government agency securities that are traded by dealers or brokers in active markets. Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.
Level 2 — Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 2 assets and liabilities include (i) mortgage-backed securities for which the fair value is estimated based on valuations obtained from third-party pricing services for identical or comparable assets, (ii) debt securities with quoted prices that are traded less frequently than exchange-traded instruments and (iii) derivative contracts and financial liabilities (e.g. callable brokered CDs and medium-term notes elected for fair value option under the fair value measurement framework), whose value is determined using a pricing model with inputs that are observable in the market or can be derived principally from or corroborated by observable market data.
Level 3 — Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, for which the determination of fair value requires significant management judgment or estimation.
A financial instrument’s level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement.

10


Table of Contents

Impairment of Investment Securities
The Group conducts periodic reviews to identify and evaluate each investment in an unrealized loss position for other-than-temporary impairments. The Group follows ASC 320-10-65-1, which changed the accounting requirements for other-than-temporary impairments for debt securities, and in certain circumstances, separates the amount of total impairment into credit and noncredit-related amounts. The corresponding review takes into consideration current market conditions, issuer rating changes and trends, the creditworthiness of the obligor of the security, current analysts’ evaluations, failure of the issuer to make scheduled interest or principal payments, the Group’s intent to not sell the security or whether it is more-likely-than-not that the Group will be required to sell the debt security before its anticipated recovery, as well as other qualitative factors. The term “other-than-temporary impairment” is not intended to indicate that the decline is permanent, but indicates that the prospects for a near-term recovery of value is not favorable, or that there is a lack of evidence to support a realizable value equal to or greater than the carrying value of the investment. Any portion of a decline in value associated with credit loss is recognized in income with the remaining noncredit-related component being recognized in other comprehensive income. A credit loss is determined by assessing whether the amortized cost basis of the security will be recovered, by comparing the present value of cash flows expected to be collected from the security, discounted at the rate equal to the yield used to accrete current and prospective beneficial interest for the security. The shortfall of the present value of the cash flows expected to be collected in relation to the amortized cost basis is considered to be the “credit loss.”
The Group’s review for impairment generally entails:
    intent to sell the debt security;
 
    if it is more likely than not that the entity will be required to sell the debt securities before the anticipated recovery;
 
    identification and evaluation of investments that have indications of possible other-than-temporary impairment;
 
    analysis of individual investments that have fair values less than amortized cost, including consideration of the length of time the investment has been in an unrealized loss position and the expected recovery period;
 
    discussion of evidential matter, including an evaluation of factors or triggers that could cause individual investments to qualify as having other-than-temporary impairment and those that would not support other-than-temporary impairment.
FDIC Shared-Loss Indemnification Asset
The Group has determined that the FDIC shared-loss indemnification asset will be accounted for as an indemnification asset measured separately from the covered loans acquired in the FDIC-assisted acquisition as it is not contractually embedded in any of the covered loans. The shared-loss indemnification asset related to estimated future loan and lease losses is not transferable should the Group sell a loan prior to foreclosure or maturity. The fair value of the shared-loss indemnification asset represents the present value of the estimated cash payments expected to be received from the FDIC for future losses on covered assets, based on the credit adjustment estimated for each covered asset and the loss sharing percentages. These cash flows are then discounted at a market-based rate to reflect the uncertainty of the timing and receipt of the loss sharing reimbursements from the FDIC. The amount ultimately collected for this asset is dependent upon the performance of the underlying covered assets, the passage of time, and claims submitted to the FDIC. The time value of money incorporated into the present value computation is accreted into earnings over the shorter of the life of the shared-loss agreements or the holding period of the covered assets.
The FDIC shared-loss indemnification asset will be reduced as losses are recognized on covered loans and loss sharing payments are received from the FDIC. Realized credit losses in excess of acquisition-date estimates will result in an increase in the FDIC shared-loss indemnification asset. Conversely, if realized credit losses are less than acquisition-date estimates, the FDIC shared-loss indemnification asset will be reduced.

11


Table of Contents

Core Deposit Intangible
Core deposit intangible (“CDI”) is a measure of the value of checking and savings deposits acquired in a business combination. The fair value of the CDI stemming from any given business combination is based on the present value of the expected cost savings attributable to the core deposit funding, relative to an alternative source of funding. CDI is amortized straight-line over a 10 year period. The Group evaluates such identifiable intangibles for impairment when an indication of impairment exists. No impairment charges were required to be recorded in the nine-month period ended September 30, 2010. If an impairment loss is determined to exist in the future, the loss would be reflected as a non-interest expense in the consolidated statement of operations for the period in which such impairment is identified.
Foreclosed Real Estate and Other Repossessed Property
Non-covered Foreclosed Real Estate
Foreclosed real estate is initially recorded at the lower of the related loan balance or the fair value less cost to sell of the real estate at the date of foreclosure. At the time properties are acquired in full or partial satisfaction of loans, any excess of the loan balance over the estimated fair value of the property is charged against the allowance for loan and lease losses on non-covered loans. After foreclosure, these properties are carried at the lower of cost or fair value less estimated cost to sell, based on recent appraised values or options to purchase the foreclosed property. Any excess of the carrying value over the estimated fair value, less estimated costs to sell, is charged to non-interest expense. The costs and expenses associated to holding these properties in portfolio are expensed as incurred.
Covered Foreclosed Real Estate and Other Repossessed Property
Covered foreclosed real estate and other repossessed property were initially recorded at their estimated fair value on the acquisition date based on appraisal value less estimated selling costs. Any subsequent write downs due to declines in fair value are charged to non-interest expense with a partially offsetting non-interest income for the loss reimbursement under the FDIC shared-loss agreement. Any recoveries of previous write downs are credited to non-interest expense with a corresponding charge to non-interest income for the portion of the recovery that is due to the FDIC.
Income Taxes
In preparing the unaudited consolidated financial statements, the Group is required to estimate income taxes. This involves an estimate of current income tax expense together with an assessment of temporary differences resulting from 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 Group to assume certain positions based on its interpretation of current tax laws and regulations. Changes in assumptions affecting estimates may be required in the future and estimated tax assets or liabilities may need to be increased or decreased accordingly. The accrual for tax contingencies is adjusted in light of changing facts and circumstances, such as the progress of tax audits, case law and emerging legislation. When particular matters arise, a number of years may elapse before such matters are audited and finally resolved. Favorable resolution of such matters could be recognized as a reduction to the Group’s 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.
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 Group’s net deferred tax assets assumes that the Group will be able to generate sufficient future taxable income based on estimates and assumptions. If these estimates and related assumptions change in the future, the Group may be required to record valuation allowances against its deferred tax assets resulting in additional income tax expense in the consolidated statements of operations.
Management evaluates the realizability of the deferred tax assets on a regular basis and assesses the need for a valuation allowance. 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 valuation allowance from period to period are included in the Group’s tax provision in the period of change.

12


Table of Contents

In addition to valuation allowances, the Group establishes accruals for uncertain tax positions when, despite the belief that the Group’s tax return positions are fully supported, the Group believes that certain positions are likely to be challenged. The uncertain tax positions accruals are adjusted in light of changing facts and circumstances, such as the progress of tax audits, case law, and emerging legislation. The Group’s uncertain tax positions accruals are reflected as income tax payable as a component of accrued expenses and other liabilities. These accruals are reduced upon expiration of the statute of limitations.
The Group follows a two-step approach for recognizing and measuring uncertain tax positions. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation process, if any. The second step is to measure the tax benefit as the largest amount that is more than 50% likely of being realized upon ultimate settlement.
The Group’s policy is to include interest and penalties related to unrecognized income tax benefits within the provision for income taxes on the unaudited consolidated statements of operations.
Equity-Based Compensation Plans
The Group’s Amended and Restated 2007 Omnibus Performance Incentive Plan (the “Omnibus Plan”), provides for equity-based compensation incentives through the grant of stock options, stock appreciation rights, restricted stock, restricted units and dividend equivalents, as well as equity-based performance awards. The Omnibus Plan was adopted in 2007, amended and restated in 2008, and it was further amended in 2010.
The purpose of the Omnibus Plan is to provide flexibility to the Group to attract, retain and motivate directors, officers, and key employees through the grant of awards based on performance and to adjust its compensation practices to the best compensation practice and corporate governance trends as they develop from time to time. The Omnibus Plan is further intended to motivate high levels of individual performance coupled with increased shareholder returns. Therefore, awards under the Omnibus Plan (each, an “Award”) are intended to be based upon the recipient’s individual performance, level of responsibility and potential to make significant contributions to the Group. Generally, the Omnibus Plan will terminate as of (a) the date when no more of the Group’s shares of common stock are available for issuance under the Omnibus Plan, or, if earlier, (b) the date the Omnibus Plan is terminated by the Group’s Board of Directors.
The Board’s Compensation Committee (the “Committee”), or such other committee as the Board may designate, has full authority to interpret and administer the Omnibus Plan in order to carry out its provisions and purposes. The Committee has the authority to determine those persons eligible to receive an Award and to establish the terms and conditions of any Award. The Committee may delegate, subject to such terms or conditions or guidelines as it shall determine, to any employee or group of employees any portion of its authority and powers under the Omnibus Plan with respect to participants who are not directors or executive officers subject to the reporting requirements under Section 16(a) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Only the Committee may exercise authority in respect of Awards granted to such participants.
The Omnibus Plan replaced and superseded the Group’s 1996, 1998 and 2000 Incentive Stock Option Plans (the “Stock Option Plans”). All outstanding stock options under the Stock Option Plans continue in full force and effect, subject to their original terms and conditions.
The expected term of stock options granted represents the period of time that such options are expected to be outstanding. Expected volatilities are based on historical volatility of the Group’s shares of common stock over the most recent period equal to the expected term of the stock options.
Subsequent Events
The Group has evaluated other events subsequent to the balance sheet date and prior to the filing of this Quarterly Report on Form 10-Q and has adjusted and disclosed those events that have occurred that would require adjustment or disclosure in the consolidated financial statements.

13


Table of Contents

Reclassifications
When necessary, certain reclassifications have been made to prior year amounts to conform to the current year presentation.
Recent Accounting Developments:
Derivatives and Hedging — In March 2010, FASB issued a clarification on the scope exception for embedded credit derivatives. The guidance eliminates the scope exception for bifurcation of embedded credit derivatives in interests in securitized financial assets, unless they are created solely by subordination of one financial debt instrument to another. The guidance is effective beginning in the first reporting period after June 15, 2010, with earlier adoption permitted for the quarter beginning after March 31, 2010. This clarification did not have a material impact on the Group’s financial position or results of operations.
Loan Modification — In April 2010, FASB issued an update affecting accounting for loan modifications for those loans that are acquired with deteriorated credit quality and are accounted for on a pool basis. It clarifies that the modifications of such loans do not result in the removal of those loans from the pool even if the modification of those loans would otherwise be considered a troubled debt restructuring. An entity will continue to be required to consider whether the pool of assets in which the loan is included is impaired if expected cash flows for the pool change. The new guidance is effective prospectively for modifications occurring in the first interim or annual period ending on or after July 15, 2010. Early application is permitted. The Group adopted this guidance for loans acquired on the FDIC-assisted acquisition accounted for under ASC 310-30. Its adoption did not have a material effect on the Group’s unaudited consolidated financial statements.
Credit Quality and Allowance for Credit Losses Disclosures — In July 2010, FASB issued ASU No. 2010-20, Disclosures about Credit Quality of Financing Receivables and Allowance for Credit Losses. The ASU requires a greater level of disaggregated information about the allowance for credit losses and the credit quality of financing receivables. The period-end balance disclosure requirements for loans and the allowance for loan and lease losses will be effective for reporting periods ending on or after December 15, 2010, while disclosures for activity during a reporting period that occurs in the loan and allowance for loan and lease losses accounts will be effective for reporting periods beginning on or after December 15, 2010.
Other accounting standards that have been issued by FASB or other standards-setting bodies are not expected to have a material impact on the Group’s financial condition, statement of operations or cash flows.
NOTE 2 — FDIC-ASSISTED ACQUISITION
On April 30, 2010 the Bank acquired certain assets and assumed certain deposits and other liabilities of Eurobank from the FDIC as receiver of Eurobank, San Juan, Puerto Rico. As part of the Purchase and Assumption Agreement between the Bank and the FDIC (the “Purchase and Assumption Agreement”), the Bank and the FDIC entered into shared-loss agreements (each, a “shared-loss agreement” and collectively, the “shared-loss agreements”), whereby the FDIC will cover a substantial portion of any future losses on loans (and related unfunded loan commitments), foreclosed real estate and other repossessed properties.
The acquired loans, foreclosed real estate, and other repossessed property subject to the shared-loss agreements are collectively referred as “covered assets.” Under the terms of the shared-loss agreements, the FDIC will absorb 80% of losses and share in 80% of loss recoveries on covered assets. The term for loss share on single family residential mortgage loans is ten years with respect to losses and loss recoveries, while the term for loss share on commercial loans is five years with respect to losses and eight years with respect to loss recoveries, from the April 30, 2010 acquisition date. The shared-loss agreements also provide for certain costs directly related to the collection and preservation of covered assets to be reimbursed at an 80% level.
The operating results of the Group for the nine-month period ended September 30, 2010 include the operating results produced by the acquired assets and liabilities assumed for the period of May 1, 2010 to September 30, 2010. The Group believes that given the nature of assets and liabilities assumed, the significant amount of fair value adjustments, the nature of additional consideration provided to the FDIC and the FDIC shared-loss agreements now in place, historical results of Eurobank are not meaningful to the Group’s results, and thus no pro-forma information is presented.

14


Table of Contents

The assets acquired and liabilities assumed as of April 30, 2010 were presented at their fair value. In many cases, the determination of these fair values required management to make estimates about discount rates, expected cash flows, market conditions and other future events that are highly subjective in nature and subject to change. The fair values initially assigned to the assets acquired and liabilities assumed were preliminary and subject to refinement for up to one year after the closing date of the acquisition as new information relative to closing date fair values became available. During the quarter ended September 30, 2010, the Group recorded preliminary measurement period adjustments to the carrying value of loans, FDIC shared-loss indemnification asset, and deferred income tax liability. This was the result of additional analysis on the estimates of fair value, and the Group’s decision to account for all loans acquired in the FDIC-assisted acquisition, except for credit cards balances, in accordance with ASC 310-30, “Loans and Debt Securities Acquired with Deteriorated Credit Quality”. The Bank and the FDIC are engaged in ongoing discussions that may impact certain assets acquired or certain liabilities assumed by the Bank. The amount that the Group realizes on these assets could differ materially from the carrying value included in the unaudited consolidated statements of financial condition primarily as a result of changes in the timing and amount of collections on the acquired loans in future periods. Because of the shared-loss agreements with the FDIC on the covered assets, the Group does not expect to incur significant losses.
Preliminary net-assets acquired and the respective preliminary measurement period adjustments are reflected in the table below:
                                         
                    April 30, 2010     Preliminary        
    Book value April     Fair Value     (As initially     Measurement     April 30, 2010  
    30, 2010     Adjustments     reported)     Period Adjustments     (As remeasured)  
                    (in thousands)                  
Assets
                                       
Cash and cash equivalents
  $ 89,777     $     $ 89,777     $     $ 89,777  
Federal Home Loan Bank stock
    10,077             10,077             10,077  
Loans covered by shared-loss agreements
    1,536,416       (699,910 )     836,506       (49,328 )     787,178  
Loans not covered by share-loss agreements
    4,275       (1,298 )     2,977       (9 )     2,986  
Foreclosed real estate covered by shared-loss agreements
    26,082       (8,555 )     17,527             17,527  
Other repossessed properties covered by shared-loss agreements
    3,401       (339 )     3,062             3,062  
FDIC loss-share indemnification asset
          516,250       516,250       42,800       559,050  
Core deposit intangible
          1,423       1,423             1,423  
Other assets
    20,168       (14,867 )     5,301             5,301  
 
                             
Total assets acquired
  $ 1,690,196     $ (207,296 )   $ 1,482,900     $ (6,519 )   $ 1,476,381  
 
                             
Liabilities
                                       
Deposits
  $ 722,442     $ 7,104     $ 729,546     $     $ 729,546  
Deferred income tax liability, net
                6,419       (2,543 )     3,876  
Other liabilities
    9,426             9,426             9,426  
 
                             
Total liabilities assumed
  $ 731,868     $ 7,104     $ 745,391     $ (2,543 )   $ 742,848  
 
                             
 
                                       
Net assets acquired
  $ 958,328     $ (214,400 )   $ 737,509     $ (3,976 )   $ 733,533  
 
                             
 
                                       
Consideration
                                       
Note payable issued to the FDIC
  $ 715,536     $ 434     $ 715,970     $     $ 715,970  
Net settlement payable to the FDIC
    15,244       (4,654 )     10,590             10,590  
Equity appreciation instrument
          909       909             909  
 
                             
 
  $ 730,780     $ (3,311 )   $ 727,469     $     $ 727,469  
 
                             
Net after tax bargain purchase gain from the FDIC-assisted acquisition
                  $ 10,040     $ (3,976 )   $ 6,064  
 
                                 

15


Table of Contents

The preliminary measurement period adjustments affected the following items presented in the June 30, 2010 unaudited consolidated financial statements:
         
Net Income for the Six-Month Period Ended June 30, 2010 (As initially reported)
  $ 29,285  
 
     
Preliminary Measurement Period Adjustments:
       
 
       
Interest income from covered loans accretable discount
    (1,711 )
Bargain purchase from FDIC-assisted acquisition
    (6,519 )
Accretion of FDIC loss-share indemnification asset
    114  
Income tax provision
    710  
 
     
Total Preliminary Measurement Period Adjustments
    (7,406 )
 
     
 
       
Net Income for the Six-Month Period Ended June 30, 2010 (As re-measured)
  $ 21,879  
 
     
                 
    (As initially        
    reported)     (As re-measured)  
Earnings per share (for the six-month period ended June 30, 2010):
               
Basic
    0.79       0.15  
Diluted
    0.79       0.15  
 
               
Total Stockholder’s Equity at June 30, 2010
  $ 746,042     $ 738,636  
Fair Value of Assets Acquired and Liabilities Assumed
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date reflecting assumptions that a market participant would use when pricing an asset or liability. In some cases, the estimation of fair values requires management to make estimates about discount rates, future expected cash flows, market conditions and other future events that are highly subjective in nature and subject to change. The methods used to determine the fair values of the significant assets acquired and liabilities assumed are described below.
Cash and cash equivalents — Cash and cash equivalents include cash and due from banks, and interest-earning deposits with banks and the Federal Reserve Bank. Cash and cash equivalents have a maturity of 90 days or less at the time of purchase. The fair value of financial instruments that are short-term or re-price frequently and that have little or no risk were considered to have a fair value that approximates to carrying value.
Federal Home Loan Bank stock — The fair value of acquired FHLB stock was estimated to be its redemption value. Subsequent to April 30, 2010 the FHLB stock was redeemed at its carrying amount.
Loans - Loans acquired in the FDIC-assisted acquisition, excluding extensions of credit pursuant to a credit card plan, are referred as “covered loans” as the Bank will be reimbursed by the FDIC for a substantial portion of any future credit losses on them under the terms of the shared-loss agreements. At the April 30, 2010 acquisition date, the estimated fair value of the FDIC-assisted acquisition loan portfolio was $790.2 million. Loans fair values were estimated by discounting the expected cash flows from the portfolio. In estimating such fair value and expected cash flows, management made several assumptions regarding prepayments, collateral cash flows, the timing of defaults, and the loss severity of defaults. Other factors expected by market participants were considered in determining the fair value of acquired loans, including loan pool level estimated cash flows, type of loan and related collateral, risk classification status (i.e. performing or nonperforming), fixed or variable interest rate, term of loan and whether or not the loan was amortizing and current discount rates.
The methods used to estimate fair value are extremely sensitive to the assumptions and estimates used. While management attempted to use assumptions and estimates that best reflected the acquired loan portfolios and current market conditions, a greater degree of subjectivity is inherent in these values than in those determined in active markets. Accordingly, readers are cautioned in using this information for purposes of evaluating the financial condition and/or value of the Group in and of itself or in comparison with any other company.

16


Table of Contents

Foreclosed real estate and other repossessed properties — Foreclosed real estate and other repossessed properties (primarily vehicles) are presented at their estimated fair value and are also subject to the FDIC shared-loss agreements. The fair values were determined using expected selling price, less selling and carrying costs, discounted to present value.
FDIC shared-loss indemnification asset— The FDIC shared-loss indemnification asset, also known as the indemnification asset, is measured separately from each of the covered asset categories as it is not contractually embedded in any of the covered asset categories. The $559.1 million fair value of the FDIC shared-loss indemnification asset represents the present value of the estimated cash payments (net of amount owed to the FDIC) expected to be received from the FDIC for future losses on covered assets based on the credit assumptions on estimated cash flows for each covered asset pool and the loss sharing percentages. The ultimate collectability of the FDIC shared-loss indemnification asset is dependent upon the performance of the underlying covered loans, the passage of time and claims paid by the FDIC which are impacted by the Bank’s adherence to certain guidelines established by the FDIC.
Core deposit intangible (“CDI”) — CDI is a measure of the value of non-interest checking, savings, and NOW and money market deposits that are acquired in business combinations. The fair value of the CDI stemming from any given business combination was based on the present value of the expected cost savings attributable to the core deposit funding, relative to an alternative source of funding.
Deposit liabilities — The fair values used for demand and savings deposits are, by definition, equal to the amount payable on demand at the reporting date. The fair values for time deposits were estimated using a discounted cash flow method that applies interest rates currently being offered on time deposits to a schedule of aggregated contractual maturities of such time deposits.
Deferred taxes — Deferred income taxes relate to the differences between the financial statement and tax bases of assets acquired and liabilities assumed in this transaction. The Group’s effective tax rate used in measuring deferred taxes resulting from the FDIC-assisted acquisition is 39%.
Other assets and other liabilities — Given the short-term nature of these financial instruments the carrying amounts reflected in the statement of assets acquired and liabilities assumed approximated fair value.
NOTE 3 — INVESTMENTS
Money Market Investments
The Group considers as cash equivalents all money market instruments that are not pledged and that have maturities of three months of less at the date of acquisition. At September 30, 2010, and December 31, 2009, cash equivalents included as part of cash and due from banks amounted to $53.2 million and $29.4 million, respectively.

17


Table of Contents

Investment Securities
The amortized cost, gross unrealized gains and losses, fair value, and weighted average yield of the securities owned by the Group at September 30, 2010 and December 31, 2009, were as follows:
                                         
    September 30, 2010  
            Gross     Gross             Weighted  
    Amortized     Unrealized     Unrealized     Fair     Average  
    Cost     Gains     Losses     Value     Yield  
                    (In thousands)                  
Available-for-sale
                                       
Obligations of US Government sponsored agencies
  $ 301,565     $     $ 15     $ 301,550       0.12 %
Puerto Rico Government and agency obligations
    71,318       89       3,002       68,405       5.37 %
Structured credit investments
    61,724             19,281       42,443       3.77 %
 
                             
Total investment securities
    434,607       89       22,298       412,398          
 
                             
 
                                       
FNMA and FHLMC certificates
    3,469,102       41,989       1,965       3,509,126       4.06 %
GNMA certificates
    128,951       8,939             137,890       5.05 %
CMOs issued by US Government sponsored agencies
    185,641       8,793       6       194,428       5.03 %
Non-agency collateralized mortgage obligations
    85,754             22,508       63,246       4.87 %
 
                             
Total mortgage-backed-securities and CMOs
    3,869,448       59,721       24,479       3,904,690          
 
                             
Total securities available-for-sale
  $ 4,304,055     $ 59,810     $ 46,777     $ 4,317,088       3.89 %
 
                             
                                         
    December 31, 2009  
            Gross     Gross             Weighted  
    Amortized     Unrealized     Unrealized     Fair     Average  
    Cost     Gains     Losses     Value     Yield  
                    (In thousands)                  
Available-for-sale
                                       
Obligations of US Government sponsored agencies
  $ 1,037,722     $ 359     $ 30,990     $ 1,007,091       3.18 %
Puerto Rico Government and agency obligations
    71,537       9       6,181       65,365       5.37 %
Structured credit investments
    61,722             23,340       38,382       3.69 %
 
                             
Total investment securities
    1,170,981       368       60,511       1,110,838          
 
                             
FNMA and FHLMC certificates
    2,766,317       22,154       24,298       2,764,173       4.62 %
GNMA certificates
    339,830       7,317       1,044       346,103       4.81 %
CMOs issued by US Government sponsored agencies
    279,454       7,057       3       286,508       5.20 %
Non-agency collateralized mortgage obligations
    487,435             41,398       446,037       5.78 %
 
                             
Total mortgage-backed-securities and CMOs
    3,873,036       36,528       66,743       3,842,821          
 
                             
Total securities available-for-sale
  $ 5,044,017     $ 36,896     $ 127,254     $ 4,953,659       4.48 %
 
                             
As of September 30, 2010, the Group’s investment securities portfolio included $301.6 million of obligations of US Government sponsored agencies in the form of discount notes. These securities were all used as collateral for repurchase agreements, and had a remaining maturity of less than three months. In October 2010, such securities were sold at a minimum gain of less than $1 thousand and the proceeds reinvested in US agency mortgage-backed securities with a coupon of 4.50%, and an estimated yield of 4.04%.

18


Table of Contents

The amortized cost and fair value of the Group’s investment securities at September 30, 2010, by contractual maturity, are shown in the next table. Securities not due on a single contractual maturity date, such as collateralized mortgage obligations, are classified in the period of final contractual maturity. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.
                 
    September 30, 2010  
    Available-for-sale  
    Amortized Cost     Fair Value  
    (In thousands)  
Investment securities
               
Due less than 1 year
               
Obligations of US Government sponsored agencies
  $ 301,476     $ 301,460  
 
           
Due from 1 to 5 years
               
Puerto Rico Government and agency obligations
    382       388  
 
           
 
               
Due after 5 to 10 years
               
Obligations of US Government sponsored agencies
    89       89  
Puerto Rico Government and agency obligations
    13,662       12,669  
Structured credit investments
    11,976       8,344  
 
           
Total due after 5 to 10 years
    25,727       21,102  
 
           
Due after 10 years
               
Puerto Rico Government and agency obligations
    57,274       55,349  
Structured credit investments
    49,748       34,099  
 
           
Total due after 10 years
    107,022       89,448  
 
           
 
               
 
           
Total investment securities
    434,607       412,398  
 
           
Mortgage-backed securities
               
Due after 5 to 10 years
               
FNMA and FHLMC certificates
    14,998       15,781  
 
           
Due after 10 years
               
CMOs issued by US Government sponsored agencies
    185,641       194,427  
FNMA and FHLMC certificates
    3,454,104       3,493,346  
GNMA certificates
    128,951       137,890  
Non-agency collateralized mortgage obligations
    85,754       63,246  
 
           
Total due after 10 years
    3,854,450       3,888,909  
 
           
Total mortgage-backed securities
    3,869,448       3,904,690  
 
           
Total securities available-for-sale
  $ 4,304,055     $ 4,317,088  
 
           
Keeping with the Group’s investment strategy, during the nine-month periods ended September 30, 2010 and 2009, there were certain sales of available-for sale securities because the Group felt at the time of such sales that gains could be realized while at the same time having good opportunities to invest the proceeds in other investment securities with attractive yields and terms that would allow the Group to continue to protect its net interest margin. Also, the Group, as part of its asset and liability management, purchases agency discount notes close to their maturities as a short term vehicle to reinvest the proceeds of sale transactions until similar investment securities with attractive yields can be purchased. The discount notes are pledged as collateral for repurchase agreements. During the nine-month period ended September 30, 2010, the Group sold $282.5 million of discount notes with minimal aggregate gross gains amounting to $1 thousand and sold $387.9 million of discounted notes with minimal aggregate gross losses amounting to $1 thousand.

19


Table of Contents

In December 2009, the Group made the strategic decision to sell $116.0 million of collateralized debt obligations at a loss of $73.9 million. For the same strategic reasons, in early January 2010, the Group sold $374.3 million of non-agency collateralized mortgage obligations with a loss of $45.8 million. This loss was accounted for as other-than-temporary impairment in the fourth quarter of 2009 and no additional gain or loss was realized on the sale in January 2010, since these assets were sold at the same value reflected at December 31, 2009.
The tables below present an analysis of the gross realized gains and losses by category for the nine-month period ended September 30, 2010 and 2009:
                                                 
    Nine-Month Period Ended September 30, 2010  
Description   Face Value     Cost     Sale Price     Sale Book Value     Gross Gains     Gross Losses  
                        (In thousands)                      
Sale of Securities Available-for-Sale
                                               
Investment securities
                                               
Obligations of U.S. Government sponsored agencies
  $ 945,425     $ 968,451     $ 972,642     $ 967,926     $ 4,716     $ 1  
 
                                   
Total investment securities
    945,425       968,451       972,642       967,926       4,716       1  
 
                                   
 
                                               
Mortgage-backed securities and CMOs
                                               
FNMA and FHLMC certificates
    2,070,159       1,940,384       1,783,631       1,755,808       27,823        
GNMA certificates
    259,386       267,147       245,254       239,985       5,269        
Non-agency collateralized mortgage obligations
    626,619       623,695       368,216       368,216              
 
                                   
Total mortgage-backed securities and CMOs
    2,956,164       2,831,226       2,397,101       2,364,009       33,092        
 
                                   
 
                                               
Total
  $ 3,901,589     $ 3,799,677     $ 3,369,743     $ 3,331,935     $ 37,808     $ 1  
 
                                   
                                                 
    Nine-Month Period Ended September 30, 2009  
Description   Face Value     Cost     Sale Price     Sale Book Value     Gross Gains     Gross Losses  
                (In thousands)                              
Sale of Securities Available-for-Sale
                                               
Investment securities
                                               
Obligations of U.S. Government sponsored agencies
  $ 2,237,785     $ 2,238,556     $ 2,237,600     $ 2,237,414     $ 203     $ 17  
Puerto Rico Government and agency obligations
    90,000       90,612       90,000       90,000              
 
                                   
Total investment securities
    2,327,785       2,329,168       2,327,600       2,327,414       203       17  
 
                                   
Mortgage-backed securities and CMOs
                                               
FNMA and FHLMC certificates
    3,910,151       3,808,523       3,500,406       3,450,661       50,894       1,150  
CMOs issued by U.S. Government sponsored agencies
    330,000       330,938       336,993       330,584       6,410        
GNMA certificates
    112,406       113,157       113,155       113,107       48        
 
                                   
Total mortgage-backed securities and CMOs
    4,352,557       4,252,618       3,950,554       3,894,352       57,352       1,150  
 
                                   
Total
  $ 6,680,342     $ 6,581,786     $ 6,278,154     $ 6,221,766     $ 57,555     $ 1,167  
 
                                   

20


Table of Contents

The following table shows the Group’s gross unrealized losses and fair value of investment securities available-for-sale, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at September 30, 2010 and December 31, 2009:
September 30, 2010
Available-for-sale
(In thousands)
                         
    Less than 12 months  
    Amortized     Unrealized     Fair  
    Cost     Loss     Value  
FNMA and FHLMC certificates
  $ 311,297     $ 1,965     $ 309,332  
Obligations of US Government sponsored agencies
    301,476       15       301,461  
CMOs issued by US Government sponsored agencies
    2,588       6       2,582  
 
                 
 
    615,361       1,986       613,375  
 
                 
                         
    12 months or more  
    Amortized     Unrealized     Fair  
    Cost     Loss     Value  
Non-agency collateralized mortgage obligations
    85,754       22,508       63,246  
Structured credit investments
    61,723       19,281       42,442  
Puerto Rico Government and agency obligations
    50,964       3,002       47,962  
 
                 
 
    198,441       44,791       153,650  
 
                 
                         
    Total  
    Amortized     Unrealized     Fair  
    Cost     Loss     Value  
FNMA and FHLMC certificates
    311,297       1,965       309,332  
Obligations of US Government sponsored agencies
    301,476       15       301,461  
Non-agency collateralized mortgage obligations
    85,754       22,508       63,246  
Structured credit investments
    61,723       19,281       42,442  
Puerto Rico Government and agency obligations
    50,964       3,002       47,962  
CMOs issued by US Government sponsored agencies
    2,588       6       2,582  
 
                 
 
  $ 813,802     $ 46,777     $ 767,025  
 
                 

21


Table of Contents

December 31, 2009
Available-for-sale
(In thousands)
                         
    Less than 12 months  
    Amortized     Unrealized     Fair  
    Cost     Loss     Value  
FNMA and FHLMC certificates
  $ 1,772,575     $ 24,287     $ 1,748,288  
Obligations of US Government sponsored agencies
    602,926       30,990       571,936  
GNMA certificates
    154,916       1,030       153,886  
CMOs issued by US Government sponsored agencies
    2,701       3       2,698  
 
                 
 
    2,533,118       56,310       2,476,808  
 
                 
                         
    12 months or more  
    Amortized     Unrealized     Fair  
    Cost     Loss     Value  
FNMA and FHLMC certificates
    605       11       594  
GNMA certificates
    350       14       336  
Non-agency collateralized mortgage obligations
    113,122       41,398       71,724  
Puerto Rico Government and agency obligations
    71,155       6,181       64,974  
Structured credit investments
    61,722       23,340       38,382  
 
                 
 
    246,954       70,944       176,010  
 
                 
                         
    Total  
    Amortized     Unrealized     Fair  
    Cost     Loss     Value  
FNMA and FHLMC certificates
    1,773,180       24,298       1,748,882  
Obligations of US Government sponsored agencies
    602,926       30,990       571,936  
GNMA certificates
    155,266       1,044       154,222  
Non-agency collateralized mortgage obligations
    113,122       41,398       71,724  
Puerto Rico Government and agency obligations
    71,155       6,181       64,974  
Structured credit investments
    61,722       23,340       38,382  
CMOs issued by US Government sponsored agencies
    2,701       3       2,698  
 
                 
 
  $ 2,780,072     $ 127,254     $ 2,652,818  
 
                 
The Group conducts quarterly reviews to identify and evaluate each investment in an unrealized loss position for other-than-temporary impairments. On April 1, 2009, the Group adopted FASB Accounting Standard Codification (“ASC”) 320-10-65-1, which changed the accounting requirements for other than temporary impairments for debt securities, and in certain circumstances, separates the amount of total impairment into credit and noncredit-related amounts.
ASC 320-10-5-1 requires the Group to consider various factors during its review, which include, but are not limited to:
    analysis of individual investments that have fair values less than amortized cost, including consideration of the length of time the investment has been in an unrealized loss position and the expected recovery period;
 
    the financial condition of the issuer or issuers;
 
    the creditworthiness of the obligor of the security;
 
    actual collateral attributes;
 
    any rating changes by a rating agency;
 
    the payment structure of the debt security and the likelihood of the issuer being able to make payments;
 
    current market conditions
 
    adverse conditions specifically related to the security, industry, or a geographic area;
 
    the Group’s intent to sell the debt security;
 
    whether it is more-likely-than-not that the Group will be required to sell the debt security before its anticipated recovery;
 
    and other qualitative factors that could support or not an other-than-temporary impairment.

22


Table of Contents

Any portion of a decline in value associated with credit loss is recognized in income with the remaining noncredit-related component being recognized in other comprehensive income. A credit loss is determined by assessing whether the amortized cost basis of the security will be recovered, by comparing the present value of cash flows expected to be collected from the security, discounted at the rate equal to the yield used to accrete current and prospective beneficial interest for the security. The shortfall of the present value of the cash flows expected to be collected in relation to the amortized cost basis is considered to be the “credit loss.”
Other-than-temporary impairment analysis is based on estimates that depend on market conditions and are subject to further change over time. In addition, while the Group believes that the methodology used to value these exposures is reasonable, the methodology is subject to continuing refinement, including those made as a result of market developments. Consequently, it is reasonably possible that changes in estimates or conditions could result in the need to recognize additional other-than-temporary impairment charges in the future.
With regards to the structured credit investments and non-agency collateralized mortgage obligations with an unrealized loss position, the Group performs a more detailed analysis of other-than-temporary impairments, which is explained in more detail in the following paragraphs. Other securities in an unrealized loss position at September 30, 2010 are mainly composed of securities issued or backed by U.S. government agencies and U.S. government-sponsored agencies. These investments are primarily highly liquid securities that have a large and efficient secondary market. Valuations are performed on a monthly basis. The Group’s management believes that the unrealized losses of such other securities at September 30, 2010, are temporary and are substantially related to market interest rate fluctuations and not to deterioration in the creditworthiness of the issuer or guarantor. At September 30, 2010, the Group does not have the intent to sell these investments in unrealized loss position.
The determination of the credit loss assumption in the discounted cash flow analysis related to the Group’s structured credit investments is similar to the one used for the non-agency collateralized mortgage obligations, the difference being that the underlying data for each type of security is different, which affects the cash flow calculations. In the case of the CLOs, the determination of the future cash flows is based on the following factors:
    Identification of the estimated fair value of the contractual coupon of the loans underlying the CLO. This information is obtained directly from the trustee’s reports for each CLO security.
 
    Calculation of the yield-to-maturity for each loan in the CLO, and determination of the interest rate spread (yield less the risk-free rate).
 
    Estimated default probabilities for each loan in the CLO. These are based on the credit ratings for each company in the structure, and this information also is obtained directly from the trustee’s reports for each CLO security. The default probabilities are adjusted based on the credit rating assuming the highest default probabilities for the loans of those entities with the lowest credit ratings. In addition to determining the current default probabilities, estimates are developed to calculate the cumulative default probabilities in successive years. To establish the reasonability of the default estimates, market-implied default rates are compared to historical credit ratings-based default rates.
 
    Once the default probabilities are estimated, the average numbers of defaults is calculated for the loans underlying each CLO security. In those cases where defaults are deemed to occur, a recovery rate is applied to the cash flow determination at the time in which the default is expected to occur. The recovery rate is based on average historical information for similar securities, as well as the actual recovery rates for defaults that have occurred within the pool of loans underlying the securities owned by the Group.
 
    One hundred simulations are carried out and run through a cash flow engine for the underlying pool of loans in each CLO security. Each one of the simulations uses different default estimates and forward yield curve assumptions.
At September 30, 2010, the Group’s portfolio of structured credit investments amounted to $61.7 million (amortized cost) in the available-for-sale portfolio, with net unrealized losses of approximately $19.3 million. The Group’s structured credit investments portfolio consist of two types of instruments: synthetic collateralized debt obligations (CDOs) and collateralized loan obligations (CLOs).
The CLOs are collateralized mostly by senior secured (via first liens) “middle market” commercial and industrial loans, which are securitized in the form of obligations. The Group invested in three of such instruments in 2007, and as of September 30, 2010, have an aggregate amortized cost of $36.2 million and unrealized losses of $10.9 million. These investments are all floating rate notes, which reset quarterly based on the three-month LIBOR rate.

23


Table of Contents

The Group estimates that it will recover all interest and principal for the Group’s specific tranches of these securities. This assessment is based on the cash flow analysis mentioned above in which the credit quality of the Group’s positions was evaluated through a determination of the expected losses on the underlying collateral. The model results show that the estimated future collateral losses, if any, are lower than the Group’s subordination levels for each one of these securities. Therefore, these securities are deemed to have sufficient credit support to absorb the estimated collateral losses.
The Group owns a corporate bond that is partially invested in a synthetic CDO with an amortized cost of $25.5 million and unrealized losses of $8.4 million as of September 30, 2010. Due to the nature of this corporate bond, the Group’s analysis focuses primarily on the CDO. The basis for the determination of other-than-temporary impairments on this security consists on a series of analyses that include: the ongoing review of the level of subordination (attachment and detachment) that the structure maintains at each quarter end to determine the level of protection that remains after events of default may affect any of the entities in the CDO’s reference portfolio; simulations performed on such reference portfolio to determine the probability of default by any of the remaining entities; the review of the credit default spreads for each entity in the reference portfolio to monitor their specific performance; and the constant monitoring of the CDO’s credit rating.
As a result of the aforementioned analysis, the Group estimates that it will recover all interest and principal invested in the bond. This is based on the results of the analysis mentioned above which show that the subordination level (attachment/detachment) available under the structure of the CDO is sufficient to allow the Group to recover the value of its investment.
The credit loss assumptions used by the Group in its discounted cash flow analysis for non-agency collateralized mortgage obligations are based on a model developed by a third party that uses individual loan-level inputs. The Group analyzes the underlying loan data based on the security’s structure and based on the following factors to determine the expected cash flows that the security will receive from the underlying pool of loans: loan stages and transitions; prepayment modeling; and severity modeling.
Residential mortgage loans are identified by transition stages that are based on the delinquency status of each loan, and for modeling purposes, roll rates are used in the model to estimate the transition of such loans from one stage to another as part of a loan default modeling process. Loan transition estimates are based on several drivers that include, to the extent available, the following: property type; product type; occupancy; loan purpose; loan documentation; lien type; time to payment shock (which primarily applies to adjustable rate mortgages (ARMs)); effective loan to value ratio (LTV); change of monthly LTV; credit scores of borrowers; debt to income ratio; mortgage rate; initial interest rate spread; loan age; delinquent history; and macroeconomic factors.
Prepayment estimates are applied also on a loan-level basis. The main factor of prepayment modeling is refinancing behavior, which is tied to market interest rates. In addition to market rates and how these affect prepayment modeling, prepayment estimates are calculated based on additional drivers that include the following: housing turnover; refinancing purpose; cash-out purpose; consideration of full pay-offs, partial prepayments and curtailments; and seasonality.
In addition to being able to forecast the rate of default on residential mortgage loans, particularly “subprime” loans, the model also includes projections of the realized loss amount on the loans that do default. Such “loss severity” projections are based on the following drivers: property values, which are affected by its location; property type; occupancy type, which relates to whether the properties are for investment purposes, owner-occupied (primary residence) or second homes; and delinquency status at time of liquidation.

24


Table of Contents

The Group constantly monitors the non-agency mortgage-backed security to measure the collateral performance and gauge trends for such positions, and the effect of collateral behavior on credit enhancements, cash flows, and fair values of the bonds. The Group also periodically monitors any rating migration, and takes into account the time lag between underlying performance and rating agency actions.
The factors listed above are used to determine the security’s future expected cash flows. These future cash flows are then discounted based on the instrument’s book yield to arrive at their present value. The present value is then compared to the amortized cost of the security, and any shortfall in the present value is considered to be the credit loss, which is recognized in earnings.
Non-agency mortgage-backed securities in an unrealized loss position consist of only one security, with an amortized cost of $85.8 million and unrealized losses of $22.5 million as of September 30, 2010. The following table summarizes other-than-temporary impairment losses (in thousands) on this security for the quarter and nine-month period ended September 30, 2010:
                 
            Nine-Month  
    Quarter Ended     Period Ended  
    September 30, 2010     September 30, 2010  
Total loss other-than-temporarily impaired securities
  $ (14,739 )   $ (39,674 )
Portion of loss on securities recognized in other comprehensive income
          22,508  
 
           
Net impairment losses recognized in earnings
  $ (14,739 )   $ (17,166 )
 
           
The Group does not intend to sell this security, and it is more likely than not, that it will not be required to sell this security prior to the recovery of its amortized cost basis less any current period credit losses.
The following table presents a summary of credit-related impairment losses recognized in earnings (in thousands) on the aforementioned security:
Credit-related impairment losses recognized in earnings in:
         
2008
  $ 21,080  
2009
    4,309  
2010
    17,166  
 
     
Total credit related impairment losses recognized in earnings up to September 30, 2010
  $ 42,555  
 
     
During the quarter ended September 30, 2010, the Group revised the assumption related to home-price appreciation values used in the cash flow analysis of its non-agency mortgage-backed security. Such cash flow analysis is used to determine the expected losses on the underlying collateral. The revision provided the Group with more detailed information on the real estate values of the security’s underlying collateral, which had the effect of increasing the severity of the losses projected by the cash flow analysis. This is the main reason for the increase in the credit-related impairment losses recognized in earnings during the quarter ended September 30, 2010, as compared to prior periods.
Based on the aforementioned analysis, during the nine-month period ended September 30, 2010, net credit-related impairment losses of $17.2 million were recognized in earnings and $22.5 million of noncredit-related impairment losses were recognized in other comprehensive income for a non-agency collateralized mortgage obligation pool not expected to be sold. Major inputs to measure the amount related to the credit losses were 8.15% of default rate, 63.3% of severity, and 4.05% for prepayment rate.

25


Table of Contents

NOTE 4 — PLEDGED ASSETS
At September 30, 2010, residential mortgage loans amounting to $517.7 million were pledged to secure advances and borrowings from the FHLB. Investment securities with fair values totaling $3.9 billion, $75.8 million and $50.8 million at September 30, 2010, were pledged to secure securities sold under agreements to repurchase, public fund deposits and the Puerto Rico Money Market Fund, respectively. Also, at September 30, 2010, investment securities with fair values totaling $20.4 million were pledged against interest rate swaps contracts, while others with fair values of $124 thousand were pledged as a bond for Trust operations to the OCFI. At December 31, 2009, residential mortgage loans amounting to $546.7 million were pledged to secure advances and borrowings from the FHLB. Investment securities with fair values totaling $3.9 billion, $72.6 million and $85.3 million at December 31, 2009, were pledged to secure securities sold under agreements to repurchase, public fund deposits and other funds, respectively. Also, at December 31, 2009, investment securities with fair values totaling $8.4 million were pledged against interest rate swaps contracts, while others with fair value of $128 thousand and $119 thousand, were pledged to the Puerto Rico Treasury Department and as a bond for Trust operations to the OCFI, respectively.
As of September 30, 2010 and December 31, 2009, investment securities available-for-sale not pledged amounted to $555.9 million and $887.1 million, respectively. As of September 30, 2010 and December 31, 2009, mortgage loans not pledged amounted to $397.2 million and $396.2 million, respectively.
NOTE 5 — LOANS RECEIVABLE AND ALLOWANCE FOR LOAN AND LEASE LOSSES
Loans Receivable Composition
The composition of the Group’s loan portfolio at September 30, 2010 and December 31, 2009 was as follows:
                 
    September 30, 2010     December 31, 2009  
    (In thousands)  
Loans not-covered under shared loss agreements with FDIC:
               
Loans secured by real estate:
               
Residential - 1 to 4 family
  $ 861,464     $ 898,790  
Home equity loans, secured personal loans and others
    25,787       20,145  
Commercial
    163,565       157,631  
Deferred loan fees, net
    (3,815 )     (3,318 )
 
           
 
    1,047,001       1,073,248  
 
           
Other loans:
               
Commercial
    53,715       40,146  
Personal consumer loans and credit lines
    30,757       22,864  
Leasing
    5,926        
Deferred loan fees, net
    (421 )     (178 )
 
           
 
    89,977       62,832  
 
           
Loans receivable
    1,136,978       1,136,080  
Allowance for loan and lease losses
    (29,640 )     (23,272 )
 
           
Loans receivable, net
    1,107,338       1,112,808  
Mortgage loans held-for-sale
    31,432       27,261  
 
           
Total loans not-covered under shared loss agreements with FDIC, net
    1,138,770       1,140,069  
 
               
Loans covered under shared loss agreements with FDIC:
               
Loans secured by 1-4 family residential properties
    175,125        
Construction and development secured by 1-4 family residential properties
    18,165        
Commercial and other construction
    414,661        
Leasing
    95,207        
Consumer
    19,700        
 
           
Total loans covered under shared loss agreements with FDIC
    722,858        
 
           
Total loans, net
  $ 1,861,628     $ 1,140,069  
 
           

26


Table of Contents

Non-covered Loans
The Group’s credit activities are mainly with customers located in Puerto Rico. The Group’s loan transactions are encompassed within four main categories: mortgage, commercial, consumer and leases. The latter business was added to the Group’s credit activities as a result of the recent FDIC-assisted acquisition.
At September 30, 2010 and December 31, 2009, the Group had $59.6 million and $57.1 million, respectively, of non-accrual non-covered loans including credit cards accounted under ASC 310-20. Covered loans are considered to be performing due to the application of the accretion method under the ASC 310-30, as furthered discussed in Note 2, “FDIC-assisted acquisition.”
The following table presents information regarding the Group’s non-performing loans at September 30, 2010 and December 31, 2009:
                 
    September 30,     December 31,  
    2010     2009  
    (In thousands)  
Non-performing loans:
               
Residential Mortgage
  $ 96,286     $ 88,238  
Commercial
    13,862       15,688  
Consumer
    604       445  
 
           
Total
  $ 110,752     $ 104,371  
 
           
In accordance with GAAP, the Group is required to account for certain loan modifications or restructurings as “troubled debt restructurings”. In general, a modification or restructuring of a loan constitutes a troubled debt restructuring if the Group grants a concession to a borrower experiencing financial difficulty. Loans modified in a troubled debt restructuring are placed on non-accrual status until the Group determines that future collection of principal and interest is reasonably assured. Loans modified in a troubled debt restructuring totaled $32.9 million at September 30, 2010 ($10.7 million — December 31, 2009).
Loans Acquired in the FDIC-Assisted Acquisition
Loans acquired in the FDIC-assisted acquisition, except for credit cards, are accounted for by the Group in accordance with ASC 310-30, “Loans and Debt Securities Acquired with Deteriorated Credit Quality.” Under ASC 310-30, these loans were aggregated into pools based on similar characteristics. Each loan pool is accounted for as a single asset with a single composite interest rate and an aggregate expectation of cash flows. The covered loans which are accounted for under ASC 310-30 by the Group are not reported as non-performing and will continue to have an accretable yield as long as there is a reasonable expectation about the timing and amount of cash flows expected to be collected.
The accretable yield on loans represents the amount by which the undiscounted expected cash flows exceed the estimated fair value. The fair values initially assigned to the assets acquired and liabilities assumed were preliminary and are subject to refinement for up to one year after the closing date of the acquisition as new information relative to closing date fair values becomes available. At April 30, 2010, the accretable yield initially reported was $198.5 million. After preliminary measurement period adjustments such accretable yield was approximately $201.3 million, which is expected to amortize as interest income over the life of the loans. The undiscounted contractual cash flows for the loans under ASC 310-30 are $1.775 billion. The undiscounted estimated cash flows expected to be collected for loans under ASC 310-30 are $988.5 million. The non-accretable discount on loans under ASC 310-30 amounted to $786.2 million.
The following summarizes the accretable yield from the loans acquired during the nine-month period ended September 30, 2010:
         
    Nine-Month Period  
    Ended  
    September 30, 2010  
    (In thousands)  
Accretable yield at beginning of period
  $  
Accretable yield determined at date of FDIC — assisted acquisition, as initially reported
    198,450  
Preliminary measurement period adjustment
    2,827  
Accretable yield amortized to interest income:
       
During the quarter ended June 30, 2010
    (11,704 )
During the quarter ended September 30, 2010
    (16,746 )
 
     
Accretable yield at end of period
  $ 172,827  
 
     

27


Table of Contents

Allowance for Loan and Lease Losses
Non-Covered Loans
The Group maintains an allowance for loan and lease losses at a level that management considers adequate to provide for probable losses based upon an evaluation of known and inherent risks. The Group’s allowance for loan and lease losses policy provides for a detailed quarterly analysis of probable losses. The analysis includes a review of historical loan loss experience, value of underlying collateral, current economic conditions, financial condition of borrowers and other pertinent factors. While management uses available information in estimating probable loan and lease losses, future additions to the allowance may be required based on factors beyond the Group’s control.
The changes in the allowance for loan and lease losses for the quarters and nine-month periods ended September 30, 2010 and 2009 were as follows:
                                 
    Quarter Ended September 30,     Nine-Month Period Ended September 30,  
    2010     2009     2010     2009  
            (In thousands)          
Balance at beginning of period
  $ 28,002     $ 16,718     $ 23,272     $ 14,293  
Provision for loan and lease losses
    4,100       4,400       12,214       11,250  
Charge-offs
    (2,517 )     (1,037 )     (6,124 )     (5,652 )
Recoveries
    55       95       278       285  
 
                       
Balance at end of period
  $ 29,640     $ 20,176     $ 29,640     $ 20,176  
 
                       
The Group evaluates all loans, some individually and others as homogeneous groups, for purposes of determining impairment. The Group’s recorded investment in commercial and mortgage loans that were individually evaluated for impairment, excluding FDIC covered loans, and the related allowance for loan and lease losses as of September 30, 2010 and December 31, 2009 are as follows:
                                                 
    September 30, 2010   December 31, 2009
    Recorded     Specific             Recorded     Specific        
    Investment     Allowance     Coverage   Investment     Allowance     Coverage
                    (In thousands)                  
Impaired loans with specific allowance
                                               
Commercial
  $ 10,769     $ 524       5 %   $ 9,355     $ 709       8 %
Mortgage
    27,934       1,990       7 %     10,717       684       6 %
Impaired loans with no specific allowance
                                               
Commercial
    13,997             0 %     6,227             0 %
 
                               
Total investment in impaired loans
  $ 52,700     $ 2,514       5 %   $ 26,299     $ 1,393       5 %
 
                               
The impaired commercial loans were measured based on the fair value of collateral. Impairment on mortgage loans assessed as troubled debt restructuring was measured using the present value of cash flows.

28


Table of Contents

Covered Loans under ASC 310-30
The covered loans were recognized at fair value as of April 30, 2010, which included the impact of expected credit losses and therefore, no allowance for credit losses was recorded at the acquisition date. To the extent credit deterioration occurs after the date of acquisition, the Group would record an allowance for loan and lease losses. Also, the Group would record an increase in the FDIC shared-loss indemnification asset for the expected reimbursement from the FDIC under the shared-loss agreements, which will partially offset the provision. For the nine-month period ended September 30, 2010, there have been deviations between actual and expected cash flows in several pools of loans acquired under the FDIC-assisted acquisition. These deviations are both positive and negative in nature. The Group continues to monitor these deviations at the pool level consistent with relevant accounting literature to assess whether these deviations are due to differences in time lags of collections or due to credit issues of the loans comprising the pools. At September 30, 2010 the Group concluded that the deviations between actual and expected cash flows arise from insignificant timing differences in time lags of collections and therefore no change to the original assumptions used at the acquisition date to determine the expected cash flows were required. In the event that positive trends on certain portfolios continue, there could be the need to adjust the accretable discount which will increase the interest income prospectively on the pools prospectively. On the other hand, if negative trends continue on certain portfolios, these could lead to a recognition of a provision for loan and lease losses and establishing an allowance for loan and lease losses.
NOTE 6 — SERVICING ASSETS
The Group periodically sells or securitizes mortgage loans while retaining the obligation to perform the servicing of such loans. In addition, the Group may purchase or assume the right to service mortgage loans originated by others. Whenever the Group undertakes an obligation to service a loan, management assesses whether a servicing asset and/or liability should be recognized. A servicing asset is recognized whenever the compensation for servicing is expected to more than adequately compensate the Group for servicing the loans. Likewise, a servicing liability would be recognized in the event that servicing fees to be received are not expected to adequately compensate the Group for its expected cost.
All separately recognized servicing assets are recognized at fair value using the fair value measurement method. Under the fair value measurement method, the Group measures servicing rights at fair value at each reporting date and reports changes in fair value of servicing asset in earnings in the period in which the changes occur, and includes these changes, if any, with mortgage banking activities in the unaudited consolidated statement of operations. The fair value of servicing rights is subject to fluctuations as a result of changes in estimated and actual prepayment speeds and default rates and losses.
The fair value of servicing rights is estimated by using a cash flow valuation model which calculates the present value of estimated future net servicing cash flows, taking into consideration actual and expected loan prepayment rates, discount rates, servicing costs, and other economic factors, which are determined based on current market conditions.
At September 30, 2010 servicing assets are composed of $8.7 million ($6.1 million — September 30, 2009) related to residential mortgage loans and $990 thousand of leasing servicing assets acquired in the FDIC-assisted acquisition on April 30, 2010.
The following table presents the changes in servicing rights measured using the fair value method for the quarter and nine-month periods ended September 30, 2010 and 2009:
                                 
    Quarter Ended September 30,     Nine-Month Period Ended September 30,  
    2010     2009     2010     2009  
    (In thousands)     (In thousands)  
Fair value at beginning of period
  $ 9,285     $ 5,242     $ 7,120     $ 2,819  
 
                               
Acquisition of leasing servicing assets from FDIC assisted acquisition
                1,190        
Servicing from mortgage securitizations or assets transfers
    819       896       2,229       2,174  
Changes due to payments on loans
    (398 )     (101 )     (614 )     (218 )
Changes in fair value due to changes in valuation model inputs or assumptions
    (59 )     98       (278 )     1,360  
 
                       
Fair value at end of period
  $ 9,647     $ 6,135     $ 9,647     $ 6,135  
 
                       

29


Table of Contents

The following table presents key economic assumptions ranges used in measuring the mortgage related servicing asset fair value:
                                 
    Quarter Ended September 30,     Nine-Month Period Ended September 30,  
    2010     2009     2010     2009  
Constant prepayment rate
    9.24% - 38.76 %     9.23%-31.64 %     8.40% - 38.76 %     7.52% - 32.22 %
Discount rate
    11.00% - 14.00 %     10.50% - 13.50 %     11.00% - 14.00 %     10.50% - 13.50 %
The discount rate used in measuring the leasing servicing asset fair value ranged from 13.06% to 20.00% from April 30, 2010 (acquisition date) to September 30, 2010.
The sensitivity of the current fair value of servicing assets to immediate 10 percent and 20 percent adverse changes in the above key assumptions were in isolation as follow:
         
    September 30, 2010  
    (in thousands)  
Mortgage related servicing asset
       
Carrying value of mortgage servicing asset
  $ 8,657  
 
     
Constant prepayment rate
       
Decrease in fair value due to 10% adverse change
  $ (325 )
Decrease in fair value due to 20% adverse change
  $ (629 )
Discount rate
       
Decrease in fair value due to 10% adverse change
  $ (390 )
Decrease in fair value due to 20% adverse change
  $ (749 )
 
       
Leasing servicing asset
       
Carrying value of leasing servicing asset
  $ 990  
 
     
Discount rate
       
Decrease in fair value due to 10% adverse change
  $ (12 )
Decrease in fair value due to 20% adverse change
  $ (24 )
These sensitivities are hypothetical and should be used with caution. As the figures indicate, changes in fair value based on a 10 percent variation in assumptions generally cannot be extrapolated because the relationship of the change in assumption to the change in fair value may not be linear. Also, in this table, the effect of a variation in a particular assumption on the fair value of the retained interest is calculated without changing any other assumption.
In reality, changes in one factor may result in changes in another (for example, increases in market interest rates may result in lower prepayments), which may magnify or offset the sensitivities.
Mortgage banking activities, a component of total banking and wealth management revenues in the unaudited consolidated statements of operations, include the changes from period to period in the fair value of the servicing rights, which may result from changes in the valuation model inputs or assumptions (principally reflecting changes in discount rates and prepayment speed assumptions) and other changes, including changes due to collection/realization of expected cash flows.
Servicing fee income is based on a contractual percentage of the outstanding principal and is recorded as income when earned. Servicing fees on mortgage loans totaled $627 thousand and $422 thousand for the quarters ended September 30, 2010 and 2009, respectively. These fees totaled $1.6 million and $1.1 million for the nine-month periods ended September 30, 2010 and 2009, respectively. There were no late fees and ancillary fees recorded in such periods. Servicing fees on leases amounted to $135 thousand and $373 thousand for the quarter and nine-month period ended September 30, 2010, respectively. There were no fees during 2009.

30


Table of Contents

NOTE 7 — PREMISES AND EQUIPMENT
Premises and equipment at September 30, 2010 and December 31, 2009 are stated at cost less accumulated depreciation and amortization as follows:
                         
    Useful Life     September 30,     December 31,  
    (Years)     2010     2009  
    (In thousands)  
Land
      $ 978     $ 978  
Buildings and improvements
  40       3,096       2,982  
Leasehold improvements
  5 — 10       19,504       19,198  
Furniture and fixtures
  3 — 7       8,760       8,527  
Information technology and other
  3 — 7       17,467       16,944  
Vehicles
  3       123        
 
                   
 
            49,928       43,429  
Less: accumulated depreciation and amortization
            (32,803 )     (28,854 )
 
                   
 
          $ 17,125     $ 19,775  
 
                   
Depreciation and amortization of premises and equipment for the quarters ended September 30, 2010 and 2009 totaled $1.6 million and $1.5 million, respectively. For the nine-month periods ended September 30, 2010 and 2009, these expenses amounted to $4.2 million and $4.5 million, respectively. These are included in the unaudited consolidated statements of operations as part of occupancy and equipment expenses.
During the quarter ended September 30, 2010 the Group communicated to the FDIC that it will exercise its option under the Purchase and Assumption Agreement executed in connection with the Eurobank acquisition to purchase certain real properties where two branch banking operations are conducted for an aggregate amount of $4.6 million. In connection with the purchase of such real properties, the Group has also exercised its option to purchase furniture, equipment and information technology equipment for the aggregate amount of $518 thousand.
NOTE 8 — ACCRUED INTEREST RECEIVABLE AND OTHER ASSETS
Accrued interest receivable at September 30, 2010 and December 31, 2009 consists of the following:
                 
    September 30,     December 31,  
    2010     2009  
    (In thousands)  
Loans
  $ 11,186     $ 10,888  
Investments
    19,458       22,768  
 
           
 
  $ 30,644     $ 33,656  
 
           

31


Table of Contents

Other assets at September 30, 2010 and December 31, 2009 consist of the following:
                 
    2010     2009  
    (In thousands)  
Prepaid FDIC insurance
  $ 18,235     $ 22,568  
Investment in equity indexed options
    7,106       6,464  
Mortgage tax credits
    1,954       3,819  
Other prepaid expenses
    7,134       4,269  
Debt issuance costs
    2,607       3,531  
Goodwill
    2,006       2,006  
Investment in Statutory Trusts
    1,086       1,086  
Forward settlement swaps
          8,511  
Other repossessed assets (covered under shared-loss agreements with the FDIC)
    2,748        
Third party servicing advances
    2,162        
Accounts receivable and other assets
    11,530       5,535  
 
           
 
  $ 56,568     $ 57,789  
 
           
On November 12, 2009, the FDIC adopted a final rule requiring insured depository institutions to prepay their estimated quarterly risk-based assessments for the fourth quarter of 2009, and for all of 2010, 2011, and 2012, on December 30, 2009, along with each institution’s risk-based deposit insurance assessment for the third quarter of 2009. The prepayment of the assessment covering fiscal years 2010, 2011 and 2012 amounted to $18.2 million and $22.6 million at September 30, 2010 and December 31, 2009, respectively.
The Group offers its customers certificates of deposit with an option tied to the performance of the Standard & Poor’s 500 stock market index. The Group uses option agreements with major broker-dealer companies to manage its exposure to changes in this index. Under the terms of the option agreements, the Group receives the average increase in the month-end value of the index in exchange for a fixed premium. The changes in fair value of the option agreements used to manage the exposure in the stock market in the certificates of deposit are recorded in earnings. At September 30, 2010 and December 31, 2009, the purchased options used to manage the exposure to the stock market on stock indexed deposits represented an asset of $7.1 million (notional amount of $149.9 million) and $6.5 million (notional amount of $150.7 million), respectively. The options sold to customers embedded in the certificates of deposit and recorded as deposits in the unaudited consolidated statement of financial condition, represented at September 30, 2010 and December 31, 2009, a liability of $10.1 million (notional amount of $144.4 million) and $9.5 million (notional amount of $145.4 million), respectively, and are included in other liabilities on the unaudited consolidated statements of financial condition.
In December 2007, the Commonwealth of Puerto Rico established mortgage loan tax credits to financial institutions that provided financing for the acquisition of homes by new homeowners in the period from December 2007 to December 2008 up to a maximum aggregate amount of $220 million in tax credits overall. At September 30, 2010 and December 31, 2009, the Group’s mortgage loan tax credits amounted to $2.0 million and $3.8 million, respectively.
In March 2009, the Group’s banking subsidiary issued $105 million in notes guaranteed under the FDIC Temporary Liquidity Guarantee Program. Shortly after issuance of the notes, the Group paid $3.2 million (equivalent to an annual fee of 100 basis points) to the FDIC to maintain the FDIC guarantee coverage until the maturity of the notes. These costs have been deferred and are being amortized over the term of the notes. At September 30, 2010 and December 31, 2009, this deferred issue cost was $2.6 million and $3.5 million, respectively.

32


Table of Contents

At September 30, 2010 and December 31, 2009, there were open forward settlement swaps with an aggregate notional amount of $1.250 billion. The forward settlement date of these swaps is December 28, 2011 for $900.0 million and May 9, 2012 for $350.0 million, with final maturities ranging from December 28, 2013 through December 28, 2015. A derivative liability of $8.3 million and a derivative asset of $8.5 million were recognized at September 30, 2010 and December 31, 2009, respectively, related to the valuation of these swaps.
Other repossessed assets amounting to $2.7 million at September 30, 2010 represent covered assets under the FDIC shared-loss agreements and are related to the Eurobank leasing portfolio acquired under the FDIC-assisted acquisition.
Third-party servicing advances amounting to $2.2 million at September 30, 2010 relates to advances made to a third party acting as servicer of certain commercial and construction loans acquired in the FDIC-assisted acquisition.
NOTE 9 — DEPOSITS AND RELATED INTEREST
Total deposits as of September 30, 2010, and December 31, 2009 consist of the following:
                 
    September 30, 2010     December 31, 2009  
    (In thousands)  
Non-interest bearing demand deposits
  $ 168,590     $ 73,548  
Interest-bearing savings and demand deposits
    953,922       706,750  
Individual retirement accounts
    351,743       312,843  
Retail certificates of deposit
    436,706       312,410  
 
           
Total retail deposits
    1,910,961       1,405,551  
Institutional deposits
    406,266       136,683  
Brokered deposits
    278,048       203,267  
 
           
 
  $ 2,595,275     $ 1,745,501  
 
           
At September 30, 2010 and December 31, 2009, the weighted average interest rate of the Group’s deposits was 1.98%, and 3.13%, respectively, inclusive of non-interest bearing deposit of $168.6 million, and $73.5 million, respectively. Interest expense for the quarters and nine-month periods ended September 30, 2010 and 2009 is set forth below:
                                 
    Quarter Ended September 30,     Nine-Month Period Ended September 30,  
    2010     2009     2010     2009  
    (In thousands)     (In thousands)  
Demand and savings deposits
  $ 4,586     $ 5,295     $ 13,047     $ 13,766  
Certificates of deposit
    8,094       8,695       22,827       28,196  
 
                       
 
  $ 12,680     $ 13,990     $ 35,874     $ 41,962  
 
                       
At September 30, 2010 and December 31, 2009, certificates of deposit in denominations of $100 thousand or higher amounted to $684.3 million and $359.1 million, respectively, including public fund deposits from various local government agencies of $67.4 million and $63.4 million, which were collateralized with investment securities with fair value of $75.8 million and $72.6 million, respectively.

33


Table of Contents

Excluding equity indexed options in the amount of $10.1 million, which are used by the Group to manage its exposure to the Standard & Poor’s 500 stock market index, and also excluding accrued interest of $5.6 million, unamortized deposit premium in the amount of $3.9 million and unamortized deposit discounts in the amount of $12.6 million, the scheduled maturities of time deposits at September 30, 2010 are as follows:
         
    (In thousands)  
Within one year:
       
Three (3) months or less
  $ 288,221  
Over 3 months through 1 year
    714,410  
 
     
 
    1,002,631  
Over 1 through 2 years
    245,683  
Over 2 through 3 years
    137,231  
Over 3 through 4 years
    52,093  
Over 4 through 5 years
    28,142  
 
     
 
  $ 1,465,780  
 
     
The aggregate amount of overdraft in demand deposit accounts that were reclassified to loans amounted to $4.3 million as of September 30, 2010 (December 31, 2009 — $1.6 million).
NOTE 10 — BORROWINGS
Short Term Borrowings
At September 30, 2010, short term borrowings amounted to approximately $30.0 million (December 31, 2009 — $49.2 million), which mainly consisted of overnight borrowings with a weighted average cost of 0.58% (December 31, 2009 — 0.44%).
Securities Sold under Agreements to Repurchase
At September 30, 2010, securities underlying agreements to repurchase were delivered to, and are being held by, the counterparties with whom the repurchase agreements were transacted. The counterparties have agreed to resell to the Group the same or similar securities at the maturity of the agreements.
At September 30, 2010, securities sold under agreements to repurchase (classified by counterparty), excluding accrued interest in the amount of $6.5 million, were as follows:
                 
            Fair Value of  
            Underlying  
    Borrowing Balance     Collateral  
    (In thousands)  
Citigroup Global Markets Inc.
  $ 1,600,000     $ 1,782,220  
Credit Suisse Securities (USA) LLC
    1,250,000       1,334,907  
UBS Financial Services Inc.
    500,000       605,277  
JP Morgan Chase Bank NA
    185,000       210,857  
 
           
Total
  $ 3,535,000     $ 3,933,261  
 
           

34


Table of Contents

The terms of the Group’s structured repurchase agreements range between three and ten years, and the counterparties have the right to exercise at par on a quarterly basis put options before their contractual maturity from one to three years after the agreements’ settlement dates. The following table shows a summary of these agreements and their terms, excluding accrued interest in the amount of $6.5 million, at September 30, 2010:
                                         
            Weighted-Average                    
Year of Maturity   Borrowing Balance     Coupon     Settlement Date     Maturity Date     Next Put Date  
    (In thousands)                                  
2011
                                       
 
  $ 100,000       4.17 %     12/28/2006       12/28/2011       12/28/2010  
 
    350,000       4.13 %     12/28/2006       12/28/2011       12/28/2010  
 
    100,000       4.29 %     12/28/2006       12/28/2011       12/28/2010  
 
    350,000       4.25 %     12/28/2006       12/28/2011       12/28/2010  
 
                                     
 
    900,000                                  
 
                                     
 
                                       
2012
                                       
 
    350,000       4.26 %     5/9/2007       5/9/2012       11/9/2010  
 
    100,000       4.50 %     8/14/2007       8/14/2012       11/16/2010  
 
    100,000       4.47 %     9/13/2007       9/13/2012       12/13/2010  
 
    150,000       4.31 %     3/6/2007       12/6/2012       12/6/2010  
 
                                     
 
    700,000                                  
 
                                     
 
                                       
2014
                                       
 
    100,000       4.72 %     7/27/2007       7/27/2014       10/27/2010  
 
                                     
 
    100,000                                  
 
                                     
 
                                       
2017
                                       
 
    500,000       4.51 %     3/2/2007       3/2/2017       12/2/2010  
 
    250,000       0.25 %     3/2/2007       3/2/2017       12/2/2010  
 
    100,000       0.00 %     6/6/2007       3/6/2017       12/6/2010  
 
    900,000       0.00 %     3/6/2007       6/6/2017       12/6/2010  
 
    1,750,000                                  
 
                                   
 
  $ 3,450,000       2.72 %                        
 
                                   
None of the structured repurchase agreements referred to above with put dates up to the date of this filing were put by the counterparties at their corresponding put dates. The repurchase agreements include $1.25 billion, which reset at the put date at a formula which is based on the three-month LIBOR rate less fifteen times the difference between the ten-year SWAP rate and the two-year SWAP rate, with a minimum of 0.00% on $1.0 billion and 0.25% on $250 million, and a maximum of 10.6%. These repurchase agreements bear the respective minimum rates of 0.0% (from March 6, 2009) and 0.25% (from March 2, 2009) to at least their next put dates scheduled for December 2010.
During the quarter ended September 30, 2010, the Group entered into a short-term repurchase agreement in the amount of $85.0 million at a cost of 0.30%. This repurchase agreement was paid off on October 7, 2010.
Advances from the Federal Home Loan Bank
During 2007, the Group restructured most of its FHLB advances portfolio into longer-term, structured advances. The terms of these advances range between five and seven years, and the FHLB has the right to exercise at par on a quarterly basis put options before the contractual maturity of the advances from six months to one year after the advances’ settlement dates.

35


Table of Contents

The following table shows a summary of these advances and their terms, excluding accrued interest in the amount of $1.8 million, at September 30, 2010:
                                         
            Weighted-Average                    
Year of Maturity   Borrowing Balance     Coupon     Settlement Date     Maturity Date     Next Put Date  
    (In thousands)                                  
2012
                                       
 
  $ 25,000       4.37 %     5/4/2007       5/4/2012       11/4/2010  
 
    25,000       4.57 %     7/24/2007       7/24/2012       10/25/2010  
 
    25,000       4.26 %     7/30/2007       7/30/2012       10/30/2010  
 
    50,000       4.33 %     8/10/2007       8/10/2012       11/10/2010  
 
    100,000       4.09 %     8/16/2007       8/16/2012       11/16/2010  
 
                                     
 
    225,000                                  
 
                                     
2014
                                       
 
    25,000       4.20 %     5/8/2007       5/8/2014       11/9/2010  
 
    30,000       4.22 %     5/11/2007       5/11/2014       11/11/2010  
 
                                     
 
    55,000                                  
 
                                   
 
  $ 280,000       4.24 %                        
 
                                   
None of the structured advances from the FHLB referred to above with put dates up to the date of this filing were put by the counterparty at their corresponding put dates.
Subordinated Capital Notes
Subordinated capital notes amounted to $36.1 million at September 30, 2010 and December 31, 2009.
In August 2003, the Statutory Trust II, special purpose entity of the Group, was formed for the purpose of issuing trust redeemable preferred securities. In September 2003, $35.0 million of trust redeemable preferred securities were issued by the Statutory Trust II as part of pooled underwriting transactions. Pooled underwriting involves participating with other bank holding companies in issuing the securities through a special purpose pooling vehicle created by the underwriters.
The proceeds from this issuance were used by the Statutory Trust II to purchase a like amount of floating rate junior subordinated deferrable interest debentures (“subordinated capital notes”) issued by the Group. The subordinated capital notes have a par value of $36.1 million, bear interest based on 3-month LIBOR plus 295 basis points (3.24% at September 30, 2010; 3.20% at December 31, 2009), payable quarterly, and mature on September 17, 2033. The subordinated capital notes purchased by the Statutory Trust II may be called at par after five years and quarterly thereafter (next call date December 2010). The trust redeemable preferred securities have the same maturity and call provisions as the subordinated capital notes. The subordinated deferrable interest debentures issued by the Group are accounted for as a liability denominated as subordinated capital notes on the unaudited consolidated statements of financial condition.
The subordinated capital notes are treated as Tier 1 capital for regulatory purposes. Under Federal Reserve Board rules, restricted core capital elements, which are qualifying trust preferred securities, qualifying cumulative perpetual preferred stock (and related surplus) and certain minority interests in consolidated subsidiaries, are limited in the aggregate to no more than 25% of a bank holding company’s core capital elements (including restricted core capital elements), net of goodwill less any associated deferred tax liability. However, under the Dodd-Frank Wall Street Reform and Consumer Protection Act (The “Dodd-Frank Act”), bank holding companies are prohibited from including in their Tier 1 capital hybrid debt and equity securities, including trust preferred securities, issued on or after May 19, 2010. The Group is therefore permitted to continue to include its existing trust preferred securities as Tier 1 capital.

36


Table of Contents

FDIC- Guaranteed Term Notes — Temporary Liquidity Guarantee Program
The Group’s banking subsidiary issued in March 2009 $105 million in notes guaranteed under the FDIC Temporary Liquidity Guarantee Program. These notes are due on March 16, 2012, bear interest at a 2.75% fixed rate, and are backed by the full faith and credit of the United States. Interest on the notes is payable on the 16th of each March and September, beginning September 16, 2009. Shortly after issuance of the notes, the Group paid $3.2 million (equivalent to an annual fee of 100 basis points) to the FDIC to maintain the FDIC guarantee coverage until the maturity of the notes. This cost has been deferred and is being amortized over the term of the notes.
Note Payable to the FDIC
As part of the FDIC-assisted acquisition, the Bank issued to the FDIC a purchase money promissory note (the “Note”) in the amount of $715.5 million. The Note was secured by the loans (other than certain consumer loans) acquired under the Purchase and Assumption Agreement and all proceeds derived from such loans. The entire outstanding principal balance of the Note was due one year from issuance, or such earlier date as such amount became due and payable pursuant to the terms of the Note. The Bank paid interest in arrears on the Note at the annual rate of 0.881% on the 25th day of each month or, if such day was not a business day, the next succeeding business day, commencing June 25, 2010, on the outstanding principal amount of the Note. Interest was calculated on the basis of a 360-day year consisting of twelve 30-day months. On September 27, 2010, the Group made the strategic decision to repay the Note prior to maturity. At the time of repayment the Note had an outstanding principal balance of $595.0 million. For the cancelation of the Note, the Group used approximately $200.0 million of proceeds from the sale of available for sale securities, brokered certificates of deposit amounting to $134.7 million, short-term repurchase agreements amounting to $85.0 million, and $175.3 million of cash.
NOTE 11 — DERIVATIVE ACTIVITIES
The Group may use various derivative instruments as part of its asset and liability management. These transactions involve both credit and market risks. The notional amounts are amounts on which calculations, payments, and the value of the derivatives are based. Notional amounts do not represent direct credit exposures. Direct credit exposure is limited to the net difference between the calculated amounts to be received and paid, if any. The actual risk of loss is the cost of replacing, at market, these contracts in the event of default by the counterparties. The Group controls the credit risk of its derivative financial instrument agreements through credit approvals, limits, monitoring procedures and collateral, when considered necessary.
Derivative instruments are generally negotiated over-the-counter (“OTC”) contracts. Negotiated OTC derivatives are generally entered into between two counterparties that negotiate specific contractual terms, including the underlying instrument, amount, exercise price, and maturity.
The Group generally uses interest rate swaps and options in managing its interest rate risk exposure. Under the swaps, the Group usually pays a fixed monthly or quarterly cost and receives a floating thirty or ninety-day payment based on LIBOR. Floating rate payments received from the swap counterparties partially offset the interest payments to be made. If market conditions warrant, the Group might terminate the swaps prior to their maturity.
The following table shows a summary of these swaps and their terms, at September 30, 2010:
                                         
    Notional Amount     Fixed Rate     Trade Date     Settlement Date     Maturity Date  
    (In thousands)                                  
Forward settlement into two year contract
  $ 300,000       1.5040 %     08/18/10       12/28/11       12/28/13  
Forward settlement into three year contract
    300,000       1.8450 %     08/18/10       12/28/11       12/28/14  
Forward settlement into four year contract
    300,000       2.1550 %     08/18/10       12/28/11       12/28/15  
Forward settlement into two year contract
    350,000       1.8275 %     08/13/10       05/09/12       05/09/14  
 
                                       
 
                                     
 
  $ 1,250,000                                  
 
                                     

37


Table of Contents

During the quarter and nine-month period ended September 30, 2010, losses of $22.6 million and $59.8 million, respectively, were recognized and reflected as “Derivatives” in the unaudited consolidated statements of operations. These losses on derivative activities included realized losses of $17.3 million and $42.0 million in the quarter and nine-month period ended September 30, 2010, respectively, due to the terminations of forward-settle swaps with a notional amount of $900 million. These terminations allowed the Group to enter into new forward-settle swap contracts for the same notional amount and maturity, and effectively reduce the interest rate of the pay-fixed side of such deals from an average rate of 3.53% to an average rate of 1.83%. The remaining losses mainly represent unrealized losses on new interest rate swaps. A derivative liability of $8.3 million and a derivative asset of $8.5 million were recognized at September 30, 2010 and December 31, 2009, respectively, related to the valuation of these swaps.
The Group offers its customers certificates of deposit with an option tied to the performance of the Standard & Poor’s 500 stock market index. The Group uses option agreements with major broker-dealer companies to manage its exposure to changes in this index. Under the terms of the option agreements, the Group receives the average increase in the month-end value of the index in exchange for a fixed premium. The changes in fair value of the option agreements used to manage the exposure in the stock market in the certificates of deposit are recorded in earnings.
There were no derivatives designated as a hedge as of September 30, 2010 and December 31, 2009. At September 30, 2010 and December 31, 2009, the purchased options used to manage the exposure to the stock market on stock indexed deposits represented an asset of $7.1 million (notional amount of $149.9 million) and $6.5 million (notional amount of $150.7 million), respectively; the options sold to customers embedded in the certificates of deposit and recorded as deposits in the unaudited consolidated statement of financial condition, represented a liability of $10.1 million (notional amount of $144.4 million) and $9.5 million (notional amount of $145.4 million), respectively, and are included in other liabilities on the unaudited consolidated statements of financial condition.
NOTE 12 — INCOME TAX
Under the Puerto Rico Internal Revenue Code of 1994, as amended, all companies are treated as separate taxable entities and are not entitled to file consolidated returns. The Group and its subsidiaries are subject to Puerto Rico regular income tax or alternative minimum tax (“AMT”) on income earned from all sources. The AMT is payable if it exceeds regular income tax. The excess of AMT over regular income tax paid in any one year may be used to offset regular income tax in future years, subject to certain limitations. The Group maintained an effective tax rate lower than the maximum marginal statutory rate of 40.95% as of September 30, 2010 and 2009, mainly due to the income from the Bank’s international banking entity whose tax rate is 5% on both periods, and interest income arising from investments exempt from Puerto Rico income taxes, net of disallowed expenses attributable to the exempt income. Exempt interest relates mostly to interest earned on obligations of the United States and Puerto Rico governments and certain mortgage-backed securities, including securities held by the Bank’s international banking entity. Pursuant to the Declaration of Fiscal Emergency and Omnibus Plan for Economic Stabilization and Restoration of the Puerto Rico Credit Act of March 9, 2009, for tax years beginning after December 31, 2008, and ending before January 1, 2012, every taxable corporation engaged in trade or business in Puerto Rico, including banks and insurance companies, are subject to an additional 5% surcharge on corporate income tax, increasing the maximum tax rate from 39% to 40.95%. Also, income earned by international banking entities, which was previously fully exempt, is subject to a 5% income tax during the same period. These temporary taxes were enacted as a measure to generate additional revenues to address the fiscal crisis that the government of Puerto Rico is currently facing.
The Group classifies unrecognized tax benefits in income taxes payable. These gross unrecognized tax benefits would affect the effective tax rate if realized. The balance of unrecognized tax benefits at September 30, 2010 was $6.6 million (December 31, 2009 — $6.3 million), and variance is mainly associated with accrued interests. The tax periods from 2005 to 2009, remain subject to examination by the Puerto Rico Department of Treasury.
The Group’s policy to include interest and penalties related to unrecognized tax benefits within the provision for taxes on the consolidated statements of operations did not change as a result of implementing these provisions. The Group had accrued $2.4 million at September 30, 2010 (December 31, 2009 — $2.1 million) for the payment of interest and penalties relating to unrecognized tax benefits.

38


Table of Contents

NOTE 13 — STOCKHOLDERS’ EQUITY
Treasury Stock
Under the Group’s current stock repurchase program it is authorized to purchase in the open market up to $15.0 million of its outstanding shares on common stock. The shares of common stock repurchased are to be held by the Group as treasury shares. There were no repurchases during the quarters ended September 30, 2010 and 2009. The approximate dollar value of shares that may yet be repurchased under the program amounted to $11.3 million at September 30, 2010.
The activity in connection with common shares held in treasury by the Group for the nine-month period ended September 30, 2010 and 2009 is set forth below:
                                 
    Nine-Month Period Ended September 30,  
    2010     2009  
            Dollar             Dollar  
    Shares     Amount     Shares     Amount  
    (In thousands)  
Beginning of period
    1,504     $ 17,142       1,442     $ 17,109  
Common shares repurchased /(used) to match defined contribution plan, net
    (14 )     (26 )     65       38  
 
                       
End of period
    1,490     $ 17,116       1,507     $ 17,147  
 
                       
Equity—Based Compensation Plans
The Omnibus Plan was amended and restated in 2008 and further amended in 2010. It provides for equity-based compensation incentives through the grant of stock options, stock appreciation rights, restricted stock, restricted units, and dividend equivalents, as well as equity-based performance awards. The Omnibus Plan replaced and superseded the Stock Option Plans. All outstanding stock options under the Stock Option Plans continue in full force and effect, subject to their original terms.
The activity in outstanding stock options for the nine-month period ended September 30, 2010 is set forth below:
                 
    Nine-Month Period Ended  
    September 30, 2010  
            Weighted  
    Number     Average  
    Of     Exercise  
    Options     Price  
Beginning of period
    514,376     $ 16.86  
Options granted
    162,700       11.98  
Options exercised
    (8,337 )     8.60  
Options forfeited
    (3,000 )     22.21  
 
           
End of period
    665,739     $ 15.75  
 
           

39


Table of Contents

The following table summarizes the range of exercise prices and the weighted average remaining contractual life of the options outstanding at September 30, 2010:
                                         
    Outstanding     Exercisable  
                    Weighted             Weighted  
            Weighted     Average             Average  
    Number of     Average     Contract     Number of     Exercise  
Range of Exercise Prices   Options     Exercise Price     Life (Years)     Options     Price  
$5.63 to $8.45
    15,677     $ 8.28       8.6       1     $ 7.74  
8.45 to 11.27
    2,000       10.29       6.9       500       10.29  
11.27 to 14.09
    408,527       12.24       6.9       144,452       12.41  
14.09 to 16.90
    62,035       15.60       3.9       54,035       15.68  
19.72 to 22.54
    29,600       20.70       4.4       22,100       20.30  
22.54 to 25.35
    88,850       23.98       3.6       88,850       23.98  
25.35 to 28.17
    59,050       27.46       4.1       59,050       27.46  
 
                             
 
    665,739     $ 15.75       5.8       368,988       18.55  
 
                             
Aggregate Intrinsic Value
  $ 552,439                     $ 134,721          
 
                                   
The average fair value of each stock option granted in 2010 was $6.02. The average fair value of each stock option granted was estimated at the date of the grant using the Black-Scholes option pricing model. The Black-Scholes option-pricing model was developed for use in estimating the fair value of traded options that have no restrictions and are fully transferable and negotiable in a free trading market. Black-Scholes does not consider the employment, transfer or vesting restrictions that are inherent in the Group’s employee stock options. Use of an option valuation model, as required by GAAP, includes highly subjective assumptions based on long-term predictions, including the expected stock price volatility and average life of each option grant.
The activity in restricted units under the Omnibus Plan for the nine-month period ended September 30, 2010 is set forth below:
                 
    Nine-Month Period Ended  
    September 30, 2010  
            Weighted  
            Average  
    Restricted     Grant Date  
    Units     Fair Value  
Beginning of period
    147,625     $ 14.64  
Restricted units granted
    81,000       12.33  
Restricted units exercised
           
Restricted units forfeited
    (5,100 )     14.12  
 
           
End of period
               
 
    223,525     $ 13.72  
 
           

40


Table of Contents

Earnings per Common Share
The calculation of earnings per common share for the quarters and nine-month periods ended September 30, 2010 and 2009 is as follows:
                                 
    Quarter Ended September 30,     Nine-Month Period Ended September 30,  
    2010     2009     2010     2009  
    (In thousands, except per share data)  
Net income (loss)
  $ (6,595 )   $ 21,327     $ 15,284     $ 96,990  
Less: Dividends on preferred stock
    (1,200 )     (1,201 )     (4,134 )     (3,602 )
Less: Deemed dividend on preferred stock beneficial conversion feature
    (22,711 )           (22,711 )      
 
                       
 
                               
Income available (loss) to common shareholders
  $ (30,506 )   $ 20,126     $ (11,561 )   $ 93,388  
 
                       
Weighted average common shares and share equivalents:
                               
Average common shares outstanding
    45,354       24,303       34,823       24,284  
Average potential common shares-options
    128       65       105       17  
 
                       
Total
    45,482       24,368       34,928       24,301  
 
                       
Earnings (loss) per common share — basic
  $ (0.67 )   $ 0.83     $ (0.33 )   $ 3.85  
 
                       
Earnings (loss) per common share — diluted
  $ (0.67 )   $ 0.83     $ (0.33 )   $ 3.84  
 
                       
For the quarter and nine-month period ended September 30, 2010, weighted-average stock options with an anti-dilutive effect on earnings per share not included in the calculation amounted to 312,700 and 420,200, respectively, compared to 303,046 and 494,874 for the same periods in 2009. The conversion of mandatorily convertible non-cumulative non-voting perpetual preferred stock, Series C, into shares of the Group’s common stock, resulted in a non-cash beneficial conversion feature of $22.7 million, representing the intrinsic value between the conversion rate of $15.015 and the common stock closing price of $16.72 on April 30, 2010, the date the preferred shares were offered. Upon conversion the beneficial conversion feature was recorded as a deemed dividend to the preferred stockholders reducing retained earnings, with a corresponding offset to surplus (paid in capital), and thus did not affect total stockholders’ equity or the book value of the common stock. However, the deemed dividend increased the net loss applicable to common stock and affected the calculation of basic and diluted EPS for the quarter and nine months ended September 30, 2010. Moreover, in computing diluted EPS, dilutive convertible securities that remained outstanding for the period prior to actual conversion were not included as average potential common shares because the effect would have been antidilutive. In computing both basic and diluted EPS, the common shares issued upon actual conversion were included in the weighted average calculation of common shares, after the date of conversion, that they remained outstanding.
Legal Surplus
The Banking Act requires that a minimum of 10% of the Bank’s net income for the year be transferred to a reserve fund until such fund (legal surplus) equals the total paid in capital on common and preferred stock. At September 30, 2010, legal surplus amounted to $47.0 million (December 31, 2009 - $45.3 million). The amount transferred to the legal surplus account is not available for the payment of dividends to shareholders. In addition, the Federal Reserve Board has issued a policy statement that bank holding companies should generally pay dividends only from operating earnings of the current and preceding two years.
Preferred Stock
On May 28, 1999, the Group issued 1,340,000 shares of 7.125% Noncumulative Monthly Income Preferred Stock, Series A, at $25 per share. Proceeds from issuance of the Series A Preferred Stock, were $32.4 million, net of $1.1 million of issuance costs. The Series A Preferred Stock has the following characteristics: (1) annual dividends of $1.78 per share, payable monthly, if declared by the Board of Directors; missed dividends are not cumulative, (2) redeemable at the Group’s option beginning on May 30, 2004, (3) no mandatory redemption or stated maturity date and (4) liquidation value of $25 per share.

41


Table of Contents

On September 30, 2003, the Group issued 1,380,000 shares of 7.0% Noncumulative Monthly Income Preferred Stock, Series B, at $25 per share. Proceeds from issuance of the Series B Preferred Stock, were $33.1 million, net of $1.4 million of issuance costs. The Series B Preferred Stock has the following characteristics: (1) annual dividends of $1.75 per share, payable monthly, if declared by the Board of Directors; missed dividends are not cumulative, (2) redeemable at the Group’s option beginning on October 31, 2008, (3) no mandatory redemption or stated maturity date, and (4) liquidation value of $25 per share.
At the annual meeting of shareholders held on April 30, 2010, a majority of the outstanding shares entitled to vote approved an increase of the number of authorized shares of preferred stock, par value $1.00 per share, from 5,000,000 to 10,000,000.
On April 30, 2010, the Group issued 200,000 shares of Mandatorily Convertible Non-Cumulative Non-Voting Perpetual Preferred Stock, Series C (the “Series C Preferred Stock”), through a private placement. The preferred stock had a liquidation preference of $1,000 per share. At a special meeting of shareholders of the Group held on June 30, 2010, the majority of the shareholders approved the issuance of 13,320,000 shares of the Group’s common stock upon the conversion of the Series C Preferred Stock, which was converted on July 8, 2010 at a conversion price of $15.015 per share.
The difference between the $15.015 per share conversion price and the market price of the common stock on April 30, 2010 ($16.72) was considered a contingent beneficial conversion feature on June 30, 2010, when the conversion was approved by the majority of the shareholders. Such feature amounted to $22.7 million at June 30, 2010 and was recorded as a dividend of preferred stock upon conversion to common stock.
Common Stock
On March 19, 2010, the Group completed the public offering of 8,740,000 shares of its common stock. The offering resulted in net proceeds of $94.5 million after deducting offering costs.
At the annual meeting of shareholders held on April 30, 2010, a majority of the outstanding shares entitled to vote approved an increase of the number of authorized shares of common stock, par value $1.00 per share, from 40,000,000 to 100,000,000.
At a special meeting of shareholders of the Group held on June 30, 2010, the majority of the shareholders approved the issuance of 13,320,000 shares of the Group’s common stock upon the conversion of the Series C Preferred Stock, which was converted on July 8, 2010 at a conversion price of $15.015 per share.
Accumulated Other Comprehensive Income
Accumulated other comprehensive income (loss), net of income tax, as of September 30, 2010 and December 31, 2009 consisted of:
                 
    September 30,     December 31,  
    2010     2009  
    (In thousands)  
Unrealized gain (loss) on securities available-for-sale which are not other-than-temporarily impaired
  $ 27,566     $ (48,786 )
Unrealized loss on securities available-for-sale for which a portion of other-than-temporary impairment has been recorded in earnings
    (14,359 )     (41,398 )
Tax effect of accumulated other comprehensive (loss) income
    (128 )     7,445  
 
           
 
  $ 13,079     $ (82,739 )
 
           

42


Table of Contents

Regulatory Capital Requirements
The Group (on a consolidated basis) and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Group’s and the Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Group and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Under the Dodd-Frank Act, federal banking regulators are required to establish minimum leverage and risk-based capital requirements, on a consolidated basis, for insured institutions, depository institution holding companies, and non-bank financial companies supervised by the Federal Reserve Board. The minimum leverage and risk-based capital requirements are to be determined based on the minimum ratios established for insured depository institutions under prompt corrective action regulations.
Quantitative measures established by regulation to ensure capital adequacy require the Group and the Bank to maintain minimum amounts and ratios (set forth in the following table) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined in the regulations) and of Tier I capital to average assets (as defined in the regulations). As of September 30, 2010 and December 31, 2009, the Group and the Bank met all capital adequacy requirements to which they are subject.
As of September 30, 2010 and December 31, 2009, the FDIC categorized the Bank as “well capitalized” under the regulatory framework for prompt corrective action. To be categorized as well capitalized, an institution must maintain minimum total risk-based, Tier I risk-based and Tier I leverage ratios as set forth in the following tables.
The Group’s and the Bank’s actual capital amounts and ratios as of September 30, 2010 and December 31, 2009 are as follows:
                                 
                    Minimum Capital
    Actual   Requirement
    Amount   Ratio   Amount   Ratio
    (Dollars in thousands)
Group Ratios
                               
As of September 30, 2010
                               
Total Capital to Risk-Weighted Assets
  $ 739,062       25.02 %   $ 236,269       8.00 %
Tier I Capital to Risk-Weighted Assets
  $ 708,869       24.00 %   $ 118,134       4.00 %
Tier I Capital to Total Assets
  $ 708,869       8.99 %   $ 315,235       4.00 %
As of December 31, 2009
                               
Total Capital to Risk-Weighted Assets
  $ 437,975       19.84 %   $ 176,591       8.00 %
Tier I Capital to Risk-Weighted Assets
  $ 414,702       18.79 %   $ 88,295       4.00 %
Tier I Capital to Total Assets
  $ 414,702       6.52 %   $ 254,323       4.00 %

43


Table of Contents

                                                 
                                    Minimum to be Well
                                    Capitalized Under
                    Minimum Capital   Prompt Corrective
    Actual   Requirement   Action Provisions
    Amount   Ratio   Amount   Ratio   Amount   Ratio
    (Dollars in thousands)
Bank Ratios
                                               
As of September 30, 2010
                                               
Total Capital to Risk-Weighted Assets
  $ 701,715       23.98 %   $ 234,112       8.00 %   $ 292,640       10.00 %
Tier I Capital to Risk-Weighted Assets
  $ 671,522       22.95 %   $ 117,056       4.00 %   $ 175,584       6.00 %
Tier I Capital to Total Assets
  $ 671,522       8.68 %   $ 309,548       4.00 %   $ 386,934       5.00 %
As of December 31, 2009
                                               
Total Capital to Risk-Weighted Assets
  $ 382,611       17.59 %   $ 174,042       8.00 %   $ 217,553       10.00 %
Tier I Capital to Risk-Weighted Assets
  $ 359,339       16.52 %   $ 87,021       4.00 %   $ 130,532       6.00 %
Tier I Capital to Total Assets
  $ 359,339       5.78 %   $ 248,678       4.00 %   $ 310,847       5.00 %
The Group’s ability to pay dividends to its stockholders and other activities can be restricted if its capital falls below levels established by the Federal Reserve Board’s guidelines. In addition, any bank holding company whose capital falls below levels specified in the guidelines can be required to implement a plan to increase capital.
NOTE 14 — FAIR VALUE
As discussed in Note 1, the Group follows the fair value measurement framework under GAAP.
Fair Value Measurement
The fair value measurement framework defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. This framework also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs previously described that may be used to measure fair value.
Money market investments
The fair value of money market investments is based on the carrying amounts reflected in the consolidated statements of financial condition as these are reasonable estimates of fair value given the short-term nature of the instruments.
Investment securities
The fair value of investment securities is based on quoted market prices, when available, or market prices provided by recognized broker-dealers. If listed prices or quotes are not available, fair value is based upon externally developed models that use both observable and unobservable inputs depending on the market activity of the instrument. Structured credit investments and non-agency collateralized mortgage obligations are classified as Level 3. The estimated fair value of the structured credit investments and the non-agency collateralized mortgage obligations are determined by using a third-party cash flow valuation model to calculate the present value of projected future cash flows. The assumptions, which are highly uncertain and require a high degree of judgment, include primarily market discount rates, current spreads, duration, leverage, default, home price depreciation, and loss rates. The assumptions used are drawn from a wide array of data sources, including the performance of the collateral underlying each deal. The external-based valuation, which is obtained at least on a quarterly basis, is analyzed by management and its assumptions are evaluated and incorporated in either an internal-based valuation model when deemed necessary or compared to counterparties prices and agreed by management.

44


Table of Contents

Derivative instruments
The fair values of the derivative instruments were provided by valuation experts and counterparties. Certain derivatives with limited market activity are valued using externally developed models that consider unobservable market parameters. Based on the valuation methodology, derivative instruments are classified as Level 3. The Group offers its customers certificates of deposit with an option tied to the performance of the Standard & Poor’s 500 stock market index (“S&P 500 Index”), and uses equity indexed option agreements with major broker-dealer companies to manage its exposure to changes in this index. Their fair value is obtained through the use of an external based valuation that was thoroughly evaluated and adopted by management as its measurement tool for these options. The payoff of these options is linked to the average value of the S&P 500 Index on a specific set of dates during the life of the option. The methodology uses an average rate option or a cash-settled option whose payoff is based on the difference between the expected average value of the S&P 500 Index during the remaining life of the option and the strike price at inception. The assumptions, which are uncertain and require a degree of judgment, include primarily S&P 500 Index volatility, forward interest rate projections, estimated index dividend payout, and leverage.
Fair value of interest rate swaps is based on the net discounted value of the contractual projected cash flows of both the pay-fixed receive-variable legs of the contracts. The projected cash flows are based on the forward yield curve, and discounted using current estimated market rates.
Servicing assets
Servicing assets do not trade in an active market with readily observable prices. Servicing assets are priced using a discounted cash flow model. The valuation model considers servicing fees, portfolio characteristics, prepayment assumptions, delinquency rates, late charges, other ancillary revenues, cost to service and other economic factors. Due to unobservable nature of certain valuation inputs, the servicing assets are classified as Level 3.
Loans receivable considered impaired that are collateral dependent
The impairment is measured based on the fair value of the collateral, which is derived from appraisals that take into consideration prices in observed transactions involving similar assets in similar locations, in accordance with the provisions of ASC 310-10-35. The associated loans considered impaired are classified as Level 3.
Foreclosed real estate
Foreclosed real estate includes real estate properties securing residential mortgage and commercial loans. The fair value of foreclosed real estate may be determined using an external appraisal, broker price option or an internal valuation. These foreclosed assets are classified as Level 3 given certain internal adjustments that may be made to external appraisals.
Assets and liabilities measured at fair value on a recurring basis, including financial liabilities for which the Group has elected the fair value option, are summarized below:
                                 
    September 30, 2010  
    Fair Value Measurements  
    Level 1     Level 2     Level 3     Total  
            (In thousands)          
Investment securities available-for-sale
  $     $ 4,211,399     $ 105,689     $ 4,317,088  
Money market investments
    53,233                   53,233  
Derivative assets
                7,106       7,106  
Derivative liabilities
          (8,289 )     (10,108 )     (18,397 )
Servicing assets
                9,647       9,647  
 
                       
 
  $ 53,233     $ 4,203,110     $ 112,334     $ 4,368,677  
 
                       

45


Table of Contents

The table below presents reconciliation for all assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the quarter ended September 30, 2010:
                                 
    Total Fair Value Measurements  
    (Quarter Ended September 30, 2010)  
    Investment                    
    securities     Derivative     Derivative     Servicing  
    available-for-sale     asset     liability     assets  
Level 3 Instruments Only           (In thousands)                  
Balance at beginning of period
  $ 113,411     $ 4,433     $ (7,473 )   $ 9,285  
Gains (losses) included in earnings
    (14,739 )     2,392       (2,440 )      
Changes in fair value of investment securities available for sale included in other comprehensive income
    10,419                    
New instruments acquired
          281       (278 )     819  
Principal repayments and amortization
    (3,402 )           83       (398 )
Changes in fair value of servicing assets
                      (59 )
 
                       
Balance at end of period
  $ 105,689     $ 7,106     $ (10,108 )   $ 9,647  
 
                       
The table below presents reconciliation for all assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the nine-month period ended September 30, 2010:
                                 
    Total Fair Value Measurements  
    (Nine-Month period Ended September 30, 2010)  
    Investment                    
    securities                    
    available-     Derivative     Derivative     Servicing  
    for-sale     asset     liability     assets  
Level 3 Instruments Only           (In thousands)          
Balance at beginning of period
  $ 110,106     $ 6,464     $ (9,543 )   $ 7,120  
Gains (losses) included in earnings
    (17,166 )     (177 )     (128 )      
Changes in fair value of investment securities available for sale included in other comprehensive income
    22,949                    
New instruments acquired
          1,147       (1,157 )     3,419  
Principal repayments and amortization
    (10,200 )     (328 )     720       (614 )
Changes in fair value of servicing assets
                      (278 )
 
                       
Balance at end of period
  $ 105,689     $ 7,106     $ (10,108 )   $ 9,647  
 
                       
There were no transfers into and out of Level 1 and Level 2 fair value measurements during the nine-month period ended September 30, 2010.

46


Table of Contents

The table below presents a detail of investment securities available-for-sale classified as Level 3 at September 30, 2010:
                                         
    September 30, 2010  
    Amortized     Unrealized             Weighted Average     Principal  
Type   Cost     Losses     Fair Value     Yield     Protection  
                    (In thousands)                  
Non-agency collateralized mortgage obligations
                                       
Alt-A Collateral
  $ 85,754     $ 22,508     $ 63,246       4.87 %     0.00 %
 
                               
Structured credit investments
                                       
CDO
    25,548       8,419       17,129       5.80 %     6.22 %
CLO
    15,000       4,803       10,197       2.53 %     7.64 %
CLO
    11,975       3,632       8,344       2.06 %     26.18 %
CLO
    9,200       2,427       6,773       2.38 %     20.64 %
 
                               
 
    61,723       19,281       42,443       3.77 %        
 
                               
 
  $ 147,477     $ 41,789     $ 105,689       4.41 %        
 
                               
Additionally, the Group may be required to measure certain assets at fair value in periods subsequent to initial recognition on a nonrecurring basis in accordance with GAAP. The adjustments to fair value usually result from the application of lower of cost or fair value accounting, identification of impaired loans requiring specific reserves under ASC 310-10-35 or write-downs of individual assets.
The following table presents financial and non-financial assets that were subject to a fair value measurement on a nonrecurring basis during the quarter ended September 30, 2010 and which were still included in the unaudited consolidated statement of financial condition at such date. The amounts disclosed represent the aggregate of the fair value measurements of those assets as of the end of the reporting period.
                 
    Carrying value at  
    September 30, 2010     December 31, 2009  
    Level 3     Level 3  
    (In thousands)     (In thousands)  
Impaired commercial loans
  $ 24,766     $ 26,299  
Foreclosed real estate
    33,087       9,347  
 
           
 
  $ 57,853     $ 35,646  
 
           
Impaired commercial loans relates mostly to certain impaired collateral dependent loans. The impairment of commercial loans was measured based on the fair value of collateral, which is derived from appraisals that take into consideration prices on observed transactions involving similar assets in similar locations, in accordance with provisions of ASC 310-10-35. Foreclosed real estate represents the fair value of foreclosed real estate (including those covered under FDIC shared-loss agreements) that was measured at fair value less estimated costs to sell.
Impaired commercial loans, which are measured using the fair value of the collateral for collateral dependent loans, had a carrying amount of $24.8 million and $9.4 million at September 30, 2010 and December 31, 2009, respectively, with a valuation allowance of $524 thousand and $709 thousand at September 30, 2010 and December 31, 2009, respectively.
Fair Value of Financial Instruments
The information about the estimated fair value of financial instruments required by GAAP is presented hereunder. The aggregate fair value amounts presented do not necessarily represent management’s estimate of the underlying value of the Group.

47


Table of Contents

The estimated fair value is subjective in nature and involves uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. Changes in assumptions could affect these fair value estimates. The fair value estimates do not take into consideration the value of future business and the value of assets and liabilities that are not financial instruments. Other significant tangible and intangible assets that are not considered financial instruments are the value of long-term customer relationships of the retail deposits, and premises and equipment.
The estimated fair value and carrying value of the Group’s financial instruments at September 30, 2010 and December 31, 2009 is as follows:
                                 
    September 30, 2010     December 31, 2009  
    Fair     Carrying     Fair     Carrying  
    Value     Value     Value     Value  
            (In thousands)          
Financial Assets:
                               
Cash and cash equivalents
  $ 142,936     $ 142,936     $ 277,123     $ 277,123  
Trading securities
    102       102       523       523  
Investment securities available-for-sale
    4,317,088       4,317,088       4,953,659       4,953,659  
FHLB stock
    22,496       22,496       19,937       19,937  
Securities sold but not yet delivered
    317,209       317,209              
Total loans (including loans held-for-sale)
    1,823,093       1,861,628       1,150,340       1,140,069  
Investment in equity indexed options
    7,106       7,106       6,464       6,464  
FDIC loss-share indemnification asset
    567,898       562,364              
Accrued interest receivable
    30,644       30,644       33,656       33,656  
Derivative asset
                8,511       8,511  
Servicing asset
    9,647       9,647       7,120       7,120  
Financial Liabilities:
                               
Deposits
    2,595,109       2,595,275       1,741,417       1,745,501  
Securities sold under agreements to repurchase
    3,856,245       3,541,520       3,777,157       3,557,308  
Advances from FHLB
    308,591       281,753       301,004       281,753  
FDIC-guaranteed term notes
    106,939       105,112       111,472       105,834  
Subordinated capital notes
    36,083       36,083       36,083       36,083  
Short term borrowings
    29,959       29,959       49,179       49,179  
Securities purchased but not yet received
                413,359       413,359  
Derivative liability
    8,289       8,289              
Accrued expenses and other liabilities
    88,006       88,006       31,650       31,650  
The following methods and assumptions were used to estimate the fair values of significant financial instruments at September 30, 2010 and December 31, 2009:
    Cash and cash equivalents, money market investments, time deposits with other banks, securities sold but not yet delivered, accrued interest receivable and payable, securities and loans purchased but not yet received, short term borrowings, accrued expenses and other liabilities have been valued at the carrying amounts reflected in the consolidated statements of financial condition as these are reasonable estimates of fair value given the short-term nature of the instruments.
    Investments in FHLB stock are valued at their redemption value.

48


Table of Contents

    The fair value of investment securities is based on quoted market prices, when available, or market prices provided by recognized broker dealers. If listed prices or quotes are not available, fair value is based upon externally developed models that use both observable and unobservable inputs depending on the market activity of the instrument. The estimated fair value of the structured credit investments and the non-agency collateralized mortgage obligations are determined by using a third-party cash flow valuation model to calculate the present value of projected future cash flows. The assumptions used, which are highly uncertain and require a high degree of judgment, include primarily market discount rates, current spreads, duration, leverage, default, home price depreciation, and loss rates. The assumptions used are drawn from a wide array of data sources, including the performance of the collateral underlying each security. The external-based valuation, which is obtained at least on a quarterly basis, is analyzed and its assumptions are evaluated and incorporated in either an internal-based valuation model when deemed necessary or compared to counterparties prices and agreed by management.
    The FDIC shared-loss indemnification asset is measured separately from each of the covered asset categories as it is not contractually embedded in any of the covered asset categories. The $562.4 million fair value of the FDIC shared-loss indemnification asset represents the present value of the estimated cash payments (net of amount owed to the FDIC) expected to be received from the FDIC for future losses on covered assets based on the credit assumptions on estimated cash flows for each covered asset pool and the loss sharing percentages. The ultimate collectability of the FDIC shared-loss indemnification asset is dependent upon the performance of the underlying covered loans, the passage of time and claims paid by the FDIC which are impacted by the Bank’s adherence to certain guidelines established by the FDIC.
    The fair values of the derivative instruments are provided by valuation experts and counterparties. Certain derivatives with limited market activity are valued using externally developed models that consider unobservable market parameters. The Group offers its customers certificates of deposit with an option tied to the performance of the S&P 500 Index, and uses equity indexed option agreements with major broker-dealer companies to manage its exposure to changes in this index. Their fair value is obtained through the use of an external based valuation that was thoroughly evaluated and adopted by management as its measurement tool for these options. The payoff of these options is linked to the average value of the S&P 500 Index on a specific set of dates during the life of the option. The methodology uses an average rate option or a cash-settled option whose payoff is based on the difference between the expected average value of the S&P 500 Index during the remaining life of the option and the strike price at inception. The assumptions, which are uncertain and require a degree of judgment, include primarily S&P 500 Index volatility, forward interest rate projections, estimated index dividend payout, and leverage.
    Fair value of interest rate swaps is based on the net discounted value of the contractual projected cash flows of both the pay-fixed receive-variable legs of the contracts. The projected cash flows are based on the forward yield curve, and discounted using current estimated market rates.
    The fair value of the loan portfolio (including loans held-for-sale) is estimated by segregating by type, such as mortgage, commercial, consumer and leases. Each loan category is further segmented into fixed and adjustable interest rates and by performing and non-performing categories. The fair value of performing loans is calculated by discounting contractual cash flows, adjusted for prepayment estimates, if any, using estimated current market discount rates that reflect the credit and interest rate risk inherent in the loan, which is not currently an indication of an exit price. An exit price valuation approach could result in a different fair value estimate.
    The fair value of demand deposits and savings accounts is the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposit is based on the discounted value of the contractual cash flows, using estimated current market discount rates for deposits of similar remaining maturities.
    For short-term borrowings, the carrying amount is considered a reasonable estimate of fair value. The subordinated capital note has a par value of $36.1 million, bears interest based on 3-month LIBOR plus 295 basis points (3.24% at September 30, 2010; 3.20% at December 31, 2009), payable quarterly. The fair value of long-term borrowings is based on the discounted value of the contractual cash flows, using current estimated market discount rates for borrowings with similar terms and remaining maturities and put dates.
    The fair value of commitments to extend credit and unused lines of credit is based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standings.
    The fair value of servicing assets is estimated by using a cash flow valuation model which calculates the present value of estimated future net servicing cash flows, taking into consideration actual and expected loan prepayment rates, discount rates, servicing costs, and other economic factors, which are determined based on current market conditions.

49


Table of Contents

NOTE 15 — SEGMENT REPORTING
The Group segregates its businesses into the following major reportable segments of business: Banking, Wealth Management, and Treasury. Management established the reportable segments based on the internal reporting used to evaluate performance and to assess where to allocate resources. Other factors such as the Group’s organization, nature of its products, distribution channels and economic characteristics of the products were also considered in the determination of the reportable segments. The Group measures the performance of these reportable segments based on pre-established goals of different financial parameters such as net income, net interest income, loan production, and fees generated. The Group’s methodology for allocating non-interest expenses among segments is based on several factors such as revenues, employee headcount, occupied space, dedicated services or time, among others. These factors are reviewed on a periodical basis and may change if the conditions warrant.
Banking includes the Bank’s branches and mortgage banking, with traditional banking products such as deposits and mortgage, commercial, leasing and consumer loans. Mortgage banking activities are carried out by the Bank’s mortgage banking division, whose principal activity is to originate mortgage loans for the Group’s own portfolio. As part of its mortgage banking activities, the Group may sell loans directly into the secondary market or securitize conforming loans into mortgage-backed securities.
Wealth Management is comprised of the Bank’s trust division (Oriental Trust), the broker-dealer subsidiary (Oriental Financial Services Corp.), the insurance agency subsidiary (Oriental Insurance, Inc.), and the pension plan administration subsidiary (Caribbean Pension Consultants, Inc.). The core operations of this segment are financial planning, money management and investment banking, brokerage services, insurance sales activity, corporate and individual trust and retirement services, as well as pension plan administration services.
The Treasury segment encompasses all of the Group’s asset and liability management activities such as: purchases and sales of investment securities, interest rate risk management, derivatives, and borrowings. Intersegment sales and transfers, if any, are accounted for as if the sales or transfers were to third parties, that is, at current market prices. The accounting policies of the segments are the same as those described in the “Summary of Significant Accounting Policies” included in the Group’s annual report on Form 10-K, as amended.

50


Table of Contents

Following are the results of operations and the selected financial information by operating segment as of and for the quarters ended September 30, 2010 and 2009:
                                                 
            Wealth             Total Major             Consolidated  
    Banking     Management     Treasury     Segments     Eliminations     Total  
                    (In thousands)                  
Quarter Ended September 30, 2010
                                               
Interest income
  $ 34,345     $ 3     $ 46,873     $ 81,221     $     $ 81,221  
Interest expense
    (10,727 )           (32,334 )     (43,061 )           (43,061 )
 
                                   
Net interest income
    23,618       3       14,539       38,160             38,160  
Provision for loan and lease losses
    (4,100 )                 (4,100 )           (4,100 )
Non-interest income (loss)
    9,303       3,693       (23,304 )     (10,308 )           (10,308 )
Non-interest expenses
    (24,670 )     (4,690 )     (3,345 )     (32,705 )           (32,705 )
Intersegment revenues
    449                   449       (449 )      
Intersegment expenses
          (384 )     (65 )     (449 )     449        
 
                                   
Income (loss) before income taxes
  $ 4,600     $ (1,378 )   $ (12,175 )   $ (8,953 )   $     $ (8,953 )
 
                                   
 
                                               
Total assets as of September 30, 2010
  $ 3,310,914     $ 11,249     $ 4,801,370     $ 8,123,533     $ (720,476 )   $ 7,403,057  
 
                                   
 
                                               
Quarter Ended September 30, 2009
                                               
Interest income
  $ 18,248     $ 5     $ 60,297     $ 78,550     $     $ 78,550  
Interest expense
    (9,370 )           (36,289 )     (45,659 )           (45,659 )
 
                                   
Net interest income
    8,878       5       24,008       32,891             32,891  
Provision for loan and lease losses
    (4,400 )                 (4,400 )           (4,400 )
Non-interest income (loss)
    3,404       3,755       9,163       16,322             16,322  
Non-interest expenses
    (13,153 )     (4,224 )     (3,108 )     (20,485 )           (20,485 )
Intersegment revenues
    297                   297       (297 )      
Intersegment expenses
          (299 )     2       (297 )     297        
 
                                   
Income (loss) before income taxes
  $ (4,974 )   $ (763 )   $ 30,065     $ 24,328     $     $ 24,328  
 
                                   
Total assets as of September 30, 2009
  $ 1,667,257     $ 8,981     $ 5,093,235     $ 6,769,473     $ (388,427 )   $ 6,381,046  
 
                                   

51


Table of Contents

Following are the results of operations and the selected financial information by operating segment as of and for the nine-month periods ended September 30, 2010 and 2009:
                                                 
            Wealth             Total Major             Consolidated  
    Banking     Management     Treasury     Segments     Eliminations     Total  
                    (In thousands)                  
Nine-Month period ended September 30, 2010
                                               
Interest income
  $ 81,381     $ 10     $ 150,009     $ 231,400     $     $ 231,400  
Interest expense
    (29,238 )           (97,563 )     (126,801 )           (126,801 )
 
                                   
Net interest income
    52,143       10       52,446       104,599             104,599  
Provision for loan and lease losses
    (12,214 )                 (12,214 )           (12,214 )
Non-interest income (loss)
    29,762       12,910       (39,085 )     3,587             3,587  
Non-interest expenses
    (58,576 )     (12,714 )     (9,660 )     (80,950 )           (80,950 )
Intersegment revenues
    1,169       763             1,932       (1,932 )      
Intersegment expenses
          (1,784 )     (148 )     (1,932 )     1,932        
 
                                   
Income (loss) before income taxes
  $ 12,284     $ (815 )   $ 3,553     $ 15,022     $     $ 15,022  
 
                                   
 
                                               
Nine-Month period ended September 30, 2009
                                               
Interest income
  $ 55,329     $ 39     $ 189,218     $ 244,586     $     $ 244,586  
Interest expense
    (26,923 )           (118,565 )     (145,488 )           (145,488 )
 
                                   
Net interest income
    28,406       39       70,653       99,098             99,098  
Provision for loan and lease losses
    (11,250 )                 (11,250 )           (11,250 )
Non-interest income (loss)
    11,034       10,169       58,362       79,565             79,565  
Non-interest expenses
    (41,994 )     (11,411 )     (8,566 )     (61,971 )           (61,971 )
Intersegment revenues
    979                   979       (979 )     -  
Intersegment expenses
          (874 )     (105 )     (979 )     979       -  
 
                                   
Income (loss) before income taxes
  $ (12,825 )   $ (2,077 )   $ 120,344     $ 105,442     $     $ 105,442  
 
                                   

52


Table of Contents

ITEM 2 — MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
SELECTED FINANCIAL DATA
FOR THE QUARTERS AND NINE-MONTH PERIODS ENDED SEPTEMBER 30, 2010 AND 2009

(IN THOUSANDS, EXCEPT PER SHARE DATA)
                                                 
    Quarter Ended September 30,     Nine-Month Period Ended September 30,  
    2010     2009     Variance %     2010     2009     Variance %  
EARNINGS DATA:
                                               
Interest income
  $ 81,221     $ 78,550       3.4 %   $ 231,400     $ 244,586       -5.4 %
Interest expense
    43,061       45,659       -5.7 %     126,801       145,488       -12.8 %
 
                                   
Net interest income
    38,160       32,891       16.0 %     104,599       99,098       5.6 %
Provision for loan and lease losses
    4,100       4,400       -6.8 %     12,214       11,250       8.6 %
 
                                   
Net interest income after provision for loan and lease losses
    34,060       28,491       19.5 %     92,385       87,848       5.2 %
Non-interest income
    (10,308 )     16,322       -163.2 %     3,587       79,565       -95.5 %
Non-interest expenses
    32,705       20,485       59.7 %     80,950       61,971       30.6 %
 
                                   
Income (loss) before taxes
    (8,953 )     24,328       -136.8 %     15,022       105,442       -85.8 %
Income tax expense
    (2,358 )     3,001       -178.6 %     (262 )     8,452       -103.1 %
 
                                   
Net Income (loss)
    (6,595 )     21,327       -130.9 %     15,284       96,990       -84.2 %
Less: Dividends on preferred stock
    (1,200 )     (1,201 )     -0.1 %     (4,134 )     (3,602 )     14.8 %
Less: Deemed dividend on preferred stock beneficial conversion feature
    (22,711 )           -100.0 %     (22,711 )           -100.0 %
 
                                   
Income available (loss) to common shareholders
  $ (30,506 )   $ 20,126       -251.6 %   $ (11,561 )   $ 93,388       -112.4 %
 
                                   
PER SHARE DATA:
                                               
Basic
  $ (0.67 )   $ 0.83       -181.2 %   $ (0.33 )   $ 3.85       -108.6 %
 
                                   
Diluted
  $ (0.67 )   $ 0.83       -181.2 %   $ (0.33 )   $ 3.84       -108.6 %
 
                                   
Average common shares outstanding
    45,354       24,303       86.6 %     34,823       24,284       43.4 %
Average potential common share-options
    128       65       96.9 %     105       17       517.6 %
 
                                   
Average shares and shares equivalents
    45,482       24,368       86.6 %     34,928       24,301       43.7 %
 
                                   
Book value per common share
  $ 14.01     $ 12.98       7.9 %   $ 14.01     $ 12.98       7.9 %
 
                                   
Market price at end of period
  $ 13.30     $ 12.70       4.7 %   $ 13.30     $ 12.70       4.7 %
 
                                   
Cash dividends declared per common share
  $ 0.04     $ 0.04       -0.2 %   $ 0.12     $ 0.12       -19.3 %
 
                                   
Cash dividends declared on common shares
  $ 1,855     $ 972       90.8 %   $ 4,500     $ 2,916       54.3 %
 
                                   
PERFORMANCE RATIOS:
                                               
Return on average assets (ROA)
    -0.33 %     1.32 %     -125.1 %     0.28 %     1.98 %     -85.8 %
 
                                   
Return on average common equity (ROE)
    -19.28 %     28.12 %     -168.6 %     -3.40 %     51.61 %     -106.6 %
 
                                   
Equity-to-assets ratio
    9.69 %     6.00 %     61.6 %     9.69 %     6.00 %     61.6 %
 
                                   
Efficiency ratio
    65.93 %     50.82 %     29.7 %     60.67 %     51.31 %     18.2 %
 
                                   
Expense ratio
    1.24 %     0.86 %     43.5 %     1.09 %     0.88 %     24.0 %
 
                                   
Interest rate spread
    2.31 %     2.07 %     11.6 %     2.24 %     2.02 %     10.9 %
 
                                   
Interest rate margin
    2.22 %     2.17 %     2.3 %     2.18 %     2.15 %     1.4 %
 
                                   

53


Table of Contents

                         
    September 30,     December 31,        
    2010     2009     Variance %  
PERIOD END BALANCES AND CAPITAL RATIOS:
                       
Investments and loans
                       
Investments securities
  $ 4,339,836     $ 4,974,269       -12.8 %
Loans and leases not covered under shared loss agreements with the FDIC, net
    1,138,770       1,140,069       -0.1 %
Loans and leases covered under shared loss agreements with the FDIC, net
    722,858             100.0 %
Securities sold but not yet delivered
    317,209             100.0 %
 
                 
 
  $ 6,518,673     $ 6,114,338       6.6 %
 
                 
 
                       
Deposits and borrowings
                       
Deposits
  $ 2,595,275     $ 1,745,501       48.7 %
Securities sold under agreements to repurchase
    3,541,520       3,557,308       -0.4 %
Other borrowings
    452,907       472,849       -4.2 %
Securities purchased but not yet received
          413,359       -100.0 %
 
                 
 
  $ 6,589,702     $ 6,189,017       6.5 %
 
                 
 
                       
Stockholders’ equity
                       
Preferred stock
    68,000       68,000       0.0 %
Common stock
    47,808       25,739       85.7 %
Additional paid-in capital
    498,486       213,445       133.5 %
Legal surplus
    46,958       45,279       3.7 %
Retained earnings
    59,845       77,584       -22.9 %
Treasury stock, at cost
    (17,116 )     (17,142 )     -0.2 %
Accumulated other comprehensive income (loss)
    13,079       (82,739 )     -115.8 %
 
                 
 
  $ 717,060     $ 330,166       117.2 %
 
                 
 
                       
Capital ratios
                       
Leverage capital
    8.99 %     6.52 %     37.9 %
 
                 
Tier I risk-based capital
    24.00 %     18.79 %     27.7 %
 
                 
Total risk-based capital
    25.02 %     19.84 %     26.1 %
 
                 
Financial assets managed and owned
                       
Trust assets managed
  $ 2,120,833     $ 1,818,498       16.6 %
 
                 
Broker-dealer assets gathered
  1,425,445     1,269,284       12.3 %
 
                 
Total assets managed
  $ 3,546,278     $ 3,087,782       14.8 %
 
                 
Assets owned
  $ 7,403,057     $ 6,550,833       13.0 %
 
                 

54


Table of Contents

OVERVIEW OF FINANCIAL PERFORMANCE
Introduction
The Group’s diversified mix of businesses and products generates both the interest income traditionally associated with a banking institution and non-interest income traditionally associated with a financial services institution (generated by such businesses as securities brokerage, fiduciary services, investment banking, insurance and pension administration). Although all of these businesses, to varying degrees, are affected by interest rate and financial markets fluctuations and other external factors, the Group’s commitment is to continue producing a balanced and growing revenue stream.
From time to time, the Group uses certain non-GAAP measures of financial performance to supplement the financial statements presented in accordance with GAAP. The Group presents non-GAAP measures when its management believes that the additional information is useful and meaningful to investors. Non-GAAP measures do not have any standardized meaning and are therefore unlikely to be comparable to similar measures presented by other companies. The presentation of non-GAAP measures is not intended to be a substitute for, and should not be considered in isolation from, the financial measures reported in accordance with GAAP. The Group’s management has reported and discussed the results of operations herein both on a GAAP basis and on a pre-tax operating income basis. The Group’s management believes that, given the nature of the items excluded from the definition of pre-tax operating income, it is useful to state what the results of operations would have been without them so that investors can see the financial trends from the Group’s continuing business.
For the quarter ended September 30, 2010, the Group’s loss to common shareholders totaled $30.5 million, or ($0.67) per basic and diluted earnings per common share. This compares to $20.1 million in income available to common shareholders, or $0.83 per basic and diluted earnings per common share for the quarter ended September 30, 2009. The income available for common shareholders for the quarter ended September 30, 2010 has been affected by a $22.7 million deemed dividend on the Series C Preferred Stock, which corresponds to the difference between the $15.015 per share conversion price and the market price of the common stock on April 30, 2010 ($16.72) the date the Preferred Stock was offered.
Highlights
  Greater proportion of interest income from loans. For the quarter ended September 30, 2010, interest income of $81.2 million increased 3.4% compared to the same period in 2009, as 88.2% growth from loans more than offset a 22.3% decline from investment securities due to lower yields and reduced size of the portfolio. Interest income from loans represented a record 42.3% of total interest income compared to 23.2% in the year ago quarter. Interest income included $16.7 million from acquired Eurobank loans for the three months.
 
  Deleveraged balance sheet. The Group paid off a 4.39%, $100 million repurchase agreement that matured August 16, 2010 and redeemed the $595 million remaining balance of its 0.88% note to the FDIC, which originated as part of the Eurobank transaction. As a result of these transactions, total investments declined to 58.6% of assets at September 30, 2010 compared to 75.9% at December 31, 2009, and borrowings declined to 60.6% of interest-bearing liabilities compared to 69.8%, respectively.
 
  Strong growth in commercial production. While total loan production and purchases increased 49.4%, to $103.4 million during the quarter ended September 30, 2010, from the same period in 2009, production of commercial loans and leases combined increased 194.3% to $31.0 million. To date for the year, commercial loans and lease production is up 102.3% to $73.1 million, representing 27.0% of total loan production and purchases, versus 15.7% for the year ago period.
 
  Continued growth of banking and wealth management revenues. These revenues totaled $11.4 million during the quarter ended September 30, 2010, up 54.2% from the same period in 2009. Bank service revenues increased 139.7%, primarily reflecting the former Eurobank commercial point of sale business and deposit fees. Mortgage banking activities increased 53.1% due in part to higher production, reflecting expanded market share. Year to date, total banking and wealth management revenues are up 33.0%, to $28.8 million, representing 23.8% of total net revenues versus 19.8% a year ago.
 
  Increased growth of wealth management assets. Total assets managed of $3.5 billion at September 30, 2010 grew 14.8% from December 31, 2009, with 16.6% growth of trust assets and 12.3% growth of broker-dealer assets. Growth is benefitting from improved market values as well as increased asset gathering from the Group’s strong capital position in the local market.

55


Table of Contents

  Continued growth of core retail deposits. Total retail deposits increased $505.4 million, to $1.9 billion from December 31, 2009, reflecting growth from both Group customers as the Group began to benefit from its larger and more strategically located network of 30 branches and core deposits assumed on the FDIC-assisted acquisition. Core retail deposits, which have grown sequentially nine quarters in a row, increased to 29.0% of interest bearing liabilities at September 30, 2010 compared to 24.3% in December 31, 2009.
Other Highlights
  Net interest margin of 2.22% for the quarter ended September 30, 2010 increased 5 basis points from the same period in 2009. Higher yield from three months of former Eurobank loans and lower cost of funds were able to offset the decline in yield from investments. Cost of funds is expected to decline further in the fourth quarter as a result of the third quarter deleveraging.
 
  Non interest expenses of $32.7 million for the quarter ended September 30, 2010 were $12.2 million higher than in the same period in 2009. The third quarter included $10.2 million related to Eurobank. In late September, the Group closed nine former Eurobank branches and consolidated two Oriental branches into the 11 Eurobank branches retained. The Group’s network now consists of 30 branches, most of them concentrated in greater San Juan. In late October, most former Eurobank Information Technology functions transferred to the Group’s platform. These actions are expected to reduce Eurobank related expenses in the fourth quarter, and along with other steps, achieve 30-35% Eurobank cost savings by the start of 2011.
 
  Net credit losses (excluding loans covered under shared-loss agreements with the FDIC) of $2.5 million increased $1.5 million during the quarter ended September 30, 2010 from the same period in 2009 and total $5.8 million year to date, in line with the Group’s previously stated expectations of $8-$9 million in 2010. Non-performing loans (NPLs) increased 6.1% from December 31, 2009. The Group’s NPLs generally reflect the economic environment in Puerto Rico. The Group does not expect NPLs to result in significantly higher losses as most are well-collateralized residential mortgages with adequate loan-to-value ratios.
 
  Approximately 96% of the Group’s investment portfolio consists of fixed-rate mortgage-backed securities or notes, guaranteed or issued by FNMA, FHLMC or GNMA, and U.S. agency senior debt obligations, backed by a U.S. government sponsored entity or the full faith and credit of the U.S. government.
Capital
  Total stockholders’ equity of $717.1 million increased $386.9 million from December 31, 2009, reflecting issuances of common and preferred stock, the net income for the nine-month period, and an improvement of approximately $95.8 million in the fair value of the investment securities portfolio.
 
  The Group continues to maintain regulatory capital ratios well above the requirements for a well-capitalized institution. At September 30, 2010, the Leverage Capital Ratio was 8.99%, Tier-1 Risk-Based Capital Ratio was 24.00%, and Total Risk-Based Capital Ratio was 25.02%. In addition, Tangible Common Equity to risk-weighted assets was 21.86%.
Non-Operating Items
These included the following major items:
  Deemed dividend of $22.7 million related to the conversion of the Group’s Mandatorily Convertible Non-Cumulative Non-Voting Perpetual Preferred Stock, Series C, which raised a net $189 million in connection with the Eurobank acquisition, which was converted into 13.32 million shares of common stock on July 8, 2010. The deemed dividend did not affect total stockholders’ equity or book value per common share, but did reduce income per common share for the quarter and nine months ended September 30, 2010. The $22.7 million represents the intrinsic value between the conversion rate of $15.01 and the common stock closing price of $16.62 on April 30, 2010, the date the Preferred Stock was offered.
 
  Gain of $14.0 million on the sale of securities for the quarter ended September 30, 2010, as the Group took further advantage of the low interest rate environment to lock in profits. For the quarter ended September 30, 2009 the Group had a $35.5 million gain on the sale of securities.

56


Table of Contents

  Charges of $14.8 million in other-than-temporary impairment on the BALTA private label CMO during the quarter ended September 30, 2010. The other-than-temporary impairment was the result of increasingly conservative modeling that now takes into consideration the macro economic effect of the recent foreclosure moratorium in some states and other economic uncertainties. For the quarter ended September 30, 2009, other-than-temporary impairment on securities amounted to $8.3 million.
 
  Loss of $22.6 million on derivative activities for the quarter ended September 30, 2010. This reflected realized losses of $17.3 million due to the termination of forward-settle swaps with a notional amount of $1.25 billion. These terminations allowed the Group to enter into new forward-settle swap contracts for the same notional amount, while effectively reducing the interest rate of the pay-fixed side of such deals from an average rate of 2.45% to an average rate of 1.83%. The balance reflected an unrealized valuation loss of $4.9 million on the new swaps. These forward-settle swaps will enable the Group to fix, at 1.83%, the price of $1.25 billion in repurchase agreement funding ($900 million up for renewal in December 2011 and $350 million in May 2012) that currently have a blended cost of 4.40%. During the quarter ended September 30, 2009 the Group had a loss of $64 thousand on derivative activities.
 
  Accretion of $1.8 million of the FDIC loss share indemnification asset related to the former Eurobank loan portfolio. The estimated fair value of this asset was determined by discounting the projected cash flows related to the loss sharing agreements based on expected reimbursements, primarily for credit losses on covered assets. The time value of money incorporated into the present value computation is accreted over the shorter life of the loss sharing agreements or the holding period of the covered assets.

57


Table of Contents

TABLE 1 — QUARTERLY ANALYSIS OF NET INTEREST INCOME AND CHANGES DUE TO VOLUME/RATE
FOR THE QUARTERS ENDED SEPTEMBER 30, 2010 AND 2009

(Dollars in thousands)
                                                 
    Interest     Average rate     Average balance  
    September     September     September     September     September     September  
    2010     2009     2010     2009     2010     2009  
A — TAX EQUIVALENT SPREAD
                                               
Interest-earning assets
  $ 81,221     $ 78,550       4.73 %     5.19 %   $ 6,868,971     $ 6,055,662  
Tax equivalent adjustment
    26,358       27,038       1.53 %     1.79 %            
 
                                   
Interest-earning assets — tax equivalent
    107,579       105,588       6.26 %     6.98 %     6,868,971       6,055,662  
Interest-bearing liabilities
    43,061       45,659       2.42 %     3.12 %     7,116,702       5,855,924  
 
                                   
Tax equivalent net interest income / spread
    64,518       59,929       3.84 %     3.86 %     (247,731 )     199,738  
 
                                   
Tax equivalent interest rate margin
                    3.76 %     3.96 %                
 
                                   
 
                                               
B — NORMAL SPREAD
                                               
Interest-earning assets:
                                               
Investments:
                                               
Investment securities
    46,794       60,161       3.84 %     5.11 %     4,876,274       4,708,209  
Trading securities
    2       5       4.00 %     5.88 %     200       340  
Money market investments
    78       136       0.37 %     0.31 %     84,054       177,555  
 
                                   
 
    46,874       60,302       3.78 %     4.94 %     4,960,528       4,886,104  
 
                                   
 
                                               
Loans not covered under shared loss agreements with the FDIC:
                                               
Mortgage
    14,007       15,081       6.08 %     6.32 %     921,802       954,820  
Commercial
    2,862       2,689       5.53 %     5.53 %     206,838       194,646  
Leasing
    93             10.09 %     0.00 %     3,688        
Consumer
    639       478       8.80 %     9.52 %     29,037       20,092  
 
                                   
 
    17,601       18,248       6.06 %     6.24 %     1,161,365       1,169,558  
 
                                   
 
                                               
Loans covered under shared loss agreements with the FDIC:
                                               
Loans secured by residential properties
    3,883             7.90 %     0.00 %     196,510        
Commercial and construction
    9,106             8.64 %     0.00 %     421,448        
Leasing
    3,103             11.49 %     0.00 %     107,989        
Consumer
    654             12.38 %     0.00 %     21,131        
 
                                   
 
    16,746             8.97 %     0.00 %     747,078        
 
                                   
 
    34,347       18,248       7.20 %     6.24 %     1,908,443       1,169,558  
 
                                   
 
    81,221       78,550       4.73 %     5.19 %     6,868,971       6,055,662  
 
                                   
 
                                               
Interest-bearing liabilities: Deposits:
                                               
Non-interest bearing deposits
                0.00 %     0.00 %     165,524       46,234  
Now accounts
    3,646       5,046       2.05 %     3.01 %     712,072       671,454  
Savings and money market
    940       249       1.69 %     1.50 %     223,140       66,424  
Certificates of deposit
    8,094       8,695       2.32 %     3.41 %     1,393,430       1,019,343  
 
                                   
 
    12,680       13,990       2.03 %     3.10 %     2,494,167       1,803,455  
 
                                   
 
                                               
Borrowings:
                                               
Securities sold under agreements to repurchase
    25,128       27,209       2.84 %     3.04 %     3,542,785       3,582,362  
Advances from FHLB and other borrowings
    3,082       3,106       3.82 %     3.83 %     322,512       324,024  
FDIC-guaranteed term notes
    1,021       1,021       3.86 %     3.71 %     105,818       110,000  
Purchase money note issued to the FDIC
    823             0.53 %     0.00 %     615,337        
Subordinated capital notes
    327       333       3.62 %     3.69 %     36,083       36,083  
 
                                   
 
    30,381       31,669       2.63 %     3.13 %     4,622,535       4,052,469  
 
                                   
 
    43,061       45,659       2.42 %     3.12 %     7,116,702       5,855,924  
 
                                   
 
                                               
Net interest income / spread
  $ 38,160     $ 32,891       2.31 %     2.07 %                
 
                                   
 
                                               
Interest rate margin
                    2.22 %     2.17 %                
 
                                           
 
                                               
Excess of average interest-earning assets over average interest- bearing liabilities (excess of average interest-bearing liabilities over average interest-earning assets)
                                  $ (247,731 )   $ 199,738  
 
                                           
Average interest-earning assets to average interest-bearing liabilities ratio
                                    96.52 %     103.41 %
 
                                           
C — CHANGES IN NET INTEREST INCOME DUE TO:
                         
    Volume     Rate     Total  
Interest Income:
                       
Investments
  $ 919     $ (14,347 )   $ (13,428 )
Loans
    16,618       (519 )     16,099  
 
                 
 
    17,537       (14,866 )     2,671  
 
                 
 
                       
Interest Expense:
                       
Deposits
    2,056       (3,366 )     (1,310 )
Repurchase agreements
    (301 )     (1,780 )     (2,081 )
Other borrowings
    769       24       793  
 
                 
 
    2,524       (5,122 )     (2,598 )
 
                 
Net Interest Income
  $ 15,013     $ (9,744 )   $ 5,269  
 
                 

58


Table of Contents

TABLE 1/A — YEAR-TO-DATE ANALYSIS OF NET INTEREST INCOME AND CHANGES DUE TO VOLUME/RATE
FOR THE NINE-MONTH PERIODS ENDED SEPTEMBER 30, 2010 AND 2009

(Dollars in thousands)
                                                 
    Interest     Average rate     Average balance  
    September     September     September     September     September     September  
    2010     2009     2010     2009     2010     2009  
A — TAX EQUIVALENT SPREAD
                                               
Interest-earning assets
  $ 231,400     $ 244,586       4.82 %     5.32 %   $ 6,402,316     $ 6,135,733  
Tax equivalent adjustment
    75,625       80,690       1.57 %     1.75 %            
 
                                   
Interest-earning assets — tax equivalent
    307,025       325,276       6.39 %     7.07 %     6,402,316       6,135,733  
Interest-bearing liabilities
    126,801       145,488       2.58 %     3.30 %     6,560,613       5,887,022  
 
                                   
Tax equivalent net interest income / spread
    180,224       179,788       3.81 %     3.77 %     (158,296 )     248,711  
 
                                   
Tax equivalent interest rate margin
                    3.75 %     3.91 %                
 
                                   
 
                                               
B — NORMAL SPREAD
                                               
Interest-earning assets:
                                               
Investments:
                                               
Investment securities
    149,750       187,770       4.22 %     5.24 %     4,731,213       4,781,345  
Trading securities
    5       933       3.06 %     3.65 %     218       34,128  
Money market investments
    263       554       0.39 %     0.55 %     88,930       134,341  
 
                                   
 
    150,018       189,257       4.15 %     5.10 %     4,820,361       4,949,814  
 
                                   
 
                                               
Loans not covered under shared loss agreements with the FDIC:
                                               
Mortgage
    42,656       46,170       6.14 %     6.30 %     926,513       977,032  
Commercial
    8,592       7,677       5.69 %     5.43 %     201,364       188,425  
Leasing
    117             5.26 %     0.00 %     2,963        
Consumer
    1,567       1,482       8.03 %     9.66 %     26,023       20,462  
 
                                   
 
    52,932       55,329       6.10 %     6.22 %     1,156,863       1,185,919  
 
                                   
 
                                               
Loans covered under shared loss agreements with the FDIC:
                                               
Loans secured by residential properties
    6,493             7.81 %     0.00 %     110,844        
Commercial and construction
    15,350             8.61 %     0.00 %     237,744        
Leasing
    5,436             11.28 %     0.00 %     64,271        
Consumer
    1,171             12.76 %     0.00 %     12,234        
 
                                   
 
    28,450             8.92 %     0.00 %     425,092        
 
                                   
 
    81,382       55,329       6.86 %     6.22 %     1,581,955       1,185,919  
 
                                   
 
    231,400       244,586       4.82 %     5.32 %     6,402,316       6,135,733  
 
                                   
 
                                               
Interest-bearing liabilities: Deposits:
                                               
Non-interest bearing deposits
                0.00 %     0.00 %     120,054       42,586  
Now accounts
    10,973       13,151       2.17 %     3.12 %     672,826       562,885  
Savings and money market
    2,074       615       1.67 %     1.38 %     165,988       59,382  
Certificates of deposit
    22,827       28,196       2.48 %     3.49 %     1,225,099       1,077,891  
 
                                   
 
    35,874       41,962       2.19 %     3.21 %     2,183,967       1,742,744  
 
                                   
 
                                               
Borrowings:
                                               
 
                                               
Securities sold under agreements to repurchase
    75,900       90,937       2.84 %     3.28 %     3,566,354       3,696,862  
Advances from FHLB and other borrowings
    9,147       9,277       3.78 %     3.75 %     322,507       329,899  
FDIC-guaranteed term notes
    3,063       2,154       3.86 %     3.53 %     105,676       81,434  
Purchase money note issued to the FDIC
    1,887             0.73 %     0.00 %     346,027        
Subordinated capital notes
    930       1,158       3.44 %     4.28 %     36,083       36,083  
 
                                   
 
    90,927       103,526       2.77 %     3.33 %     4,376,646       4,144,278