OFG Bancorp (OFG) 10-Q 2006 Q2 Quarterly report

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 June 30, 2006

or

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANG ACT OF 1934

For the transition period from                    to                    

Commission File Number001-12647

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 o   No þ

     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

     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:

24,572,557_common shares ($1.00 par value per share)
outstanding as of September 30, 2006

TABLE OF CONTENTS

	Page
Part I FINANCIAL INFORMATION:
Item 1 Financial Statements
Unaudited consolidated statements of financial condition at June 30, 2006 and December 31, 2005		1
Unaudited consolidated statements of income for the quarters and six-month periods ended June 30, 2006 and 2005		2
Unaudited consolidated statements of changes in stockholders’ equity for the six-month periods ended June 30, 2006 and 2005		3
Unaudited consolidated statements of comprehensive income for the quarters and six-month periods ended June 30, 2006 and 2005		3
Unaudited consolidated statements of cash flows for the six-month periods ended June 30, 2006 and 2005		4
Notes to unaudited consolidated financial statements		5
Item 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations		21
Item 3 Quantitative and Qualitative Disclosures About Market Risk		38
Item 4 Controls and Procedures		41
PART II OTHER INFORMATION:
Item 1 Legal Proceedings		41
Item 1A Risk Factors		42
Item 2 Unregistered Sales of Equity Securities and Use of Proceeds		42
Item 3 Defaults Upon Senior Securities		42
Item 4 Submissions of Matters to a Vote of Security Holders		42
Item 5 Other Information		43
Item 6 Exhibits		43
Signatures		44
Certifications		45
EX-10.1 CHANGE IN CONTROL COMPENSATION AGREEMENT/MARI EVELYN RODRIGUEZ
EX-31.1 SECTION 302 CERTIFICATION OF CEO
EX-31.2 SECTION 302 CERTIFICATION OF CFO
EX-32.1 SECTION 906 CERTIFICATION OF CEO
EX-32.2 SECTION 906 CERTIFICATION OF CFO

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 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.

PART — I   FINANCIAL INFORMATION

ITEM — I    FINANCIAL STATEMENTS

UNAUDITED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
JUNE 30, 2006 AND DECEMBER 31, 2005
(In thousands, except share data)

	June 30,			December 31,
	2006			2005
ASSETS
Cash and due from banks	$	35,237		$	13,789
Investments:
Time deposits with other banks		30,000			60,000
Money market investments		5,722			3,480
Short term investments		35,722			63,480
Trading securities, at fair value with amortized cost of $362 (December 31, 2005 - $144)		368			146
Investment securities available-for-sale, at fair value with amortized cost of $1,245,907 (December 31, 2005 - $1,069,649)
Securities pledged that can be repledged		974,763			558,719
Other investment securities		225,481			488,165
Total investment securities available-for-sale		1,200,244			1,046,884
Investment securities held-to-maturity, at amortized cost with fair value of $2,158,770 (December 31, 2005 - $2,312,832)
Securities pledged that can be repledged		1,960,268			1,917,805
Other investment securities		282,951			428,450
Total investment securities held-to-maturity		2,243,219			2,346,255
Federal Home Loan Bank (FHLB) stock, at cost		18,269			20,002
Total investments		3,497,822			3,476,767
Securities sold but not yet delivered		710			44,009
Loans:
Mortgage loans held-for-sale, at lower of cost or market		9,564			8,946
Loans receivable, net of allowance for loan losses of $7,501 (December 31, 2005 - $6,630)		1,144,374			894,362
Total loans, net		1,153,938			903,308
Accrued interest receivable		31,313			29,067
Premises and equipment, net		17,358			14,828
Deferred tax asset, net		14,861			12,222
Foreclosed real estate		4,379			4,802
Other assets		77,044			48,157
Total assets	$	4,832,662		$	4,546,949
LIABILITIES AND STOCKHOLDERS’ EQUITY
Deposits:
Demand deposits	$	141,260		$	146,623
Savings accounts		171,034			82,641
Certificates of deposit		901,553			1,069,304
Total deposits		1,213,847			1,298,568
Borrowings:
Federal funds purchased and other short term borrowings		17,098			4,455
Securities sold under agreements to repurchase		2,856,361			2,427,880
Advances from FHLB		285,500			313,300
Term notes		15,000			15,000
Subordinated capital notes		72,166			72,166
Total borrowings		3,246,125			2,832,801
Securities purchased but not yet received		6,539			43,354
Accrued expenses and other liabilities		25,868			30,435
Total liabilities		4,492,379			4,205,158
Commitments and Contingencies
Stockholders’ equity:
Preferred stock, $1 par value; 5,000,000 shares authorized; $25 liquidation value; 1,340,000 shares of Series A and 1,380,000 shares of Series B issued and outstanding		68,000			68,000
Common stock, $1 par value; 40,000,000 shares authorized; 25,369,875 shares issued (December 31, 2005 - 25,350,125 shares)		25,370			25,350
Additional paid-in capital		208,620			208,454
Legal surplus		37,114			35,863
Retained earnings		52,368			52,340
Treasury stock, at cost 807,713 shares (December 31, 2005 - 770,472 shares)		(10,779	)		(10,332	)
Accumulated other comprehensive loss, net of tax of $3,381 (December 31, 2005 - $1,810)		(40,410	)		(37,884	)
Total stockholders’ equity		340,283			341,791
Total liabilities and stockholders’ equity	$	4,832,662		$	4,546,949

See notes to unaudited consolidated financial statements.

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UNAUDITED CONSOLIDATED STATEMENTS OF INCOME
FOR THE QUARTERS AND SIX-MONTH PERIODS ENDED JUNE 30, 2006 AND 2005
(In thousands, except per share data)

	Quarter Ended June 30,						Six-Month Period Ended June 30,
	2006			2005			2006			2005
				(As Restated)						(As Restated)
Interest income:
Loans	$	18,311		$	14,934		$	34,564		$	28,357
Mortgage-backed securities		23,887			22,626			48,387			47,401
Investment securities		13,973			11,037			28,473			20,335
Short term investments		723			279			1,462			355
Total interest income		56,894			48,876			112,886			96,448
Interest expense:
Deposits		11,146			8,697			21,644			16,320
Securities sold under agreements to repurchase		31,128			17,583			57,491			33,969
Advances from FHLB, term notes and other borrowings		2,568			2,143			5,190			4,188
Subordinated capital notes		1,344			1,165			2,641			2,273
Total interest expense		46,186			29,588			86,966			56,750
Net interest income		10,708			19,288			25,920			39,698
Provision for loan losses		947			850			2,048			1,510
Net interest income after provision for loan losses		9,761			18,438			23,872			38,188
Non-interest income:
Financial service revenues		4,066			3,249			7,317			6,419
Banking service revenues		2,511			2,064			4,687			3,893
Investment banking revenues		852			162			2,561			339
Net gain (loss) on:
Mortgage banking activities		634			1,168			1,070			2,241
Securities available-for-sale		—			1,420			19			4,056
Derivatives		(23	)		(1,866	)		859			(4,670	)
Trading securities		(8	)		(42	)		21			(53	)
Other		(511	)		282			(60	)		311
Total non-interest income, net		7,521			6,437			16,474			12,536
Non-interest expenses:
Compensation and employee benefits		5,627			4,402			11,801			7,697
Occupancy and equipment		2,793			3,066			5,682			5,532
Advertising and business promotion		1,300			1,420			2,366			2,907
Professional and service fees		1,601			1,777			3,225			3,614
Communication		395			410			843			786
Loan servicing expenses		509			430			964			831
Taxes, other than payroll and income taxes		573			471			1,173			934
Electronic banking charges		494			543			962			1,060
Printing, postage, stationery and supplies		359			207			544			416
Insurance		219			188			432			375
Other		914			979			1,675			1,888
Total non-interest expenses		14,784			13,893			29,667			26,040
Income before income taxes		2,498			10,982			10,679			24,684
Income tax expense (benefit)		(21	)		377			110			(2,294	)
Net income		2,519			10,605			10,569			26,978
Less: Dividends on preferred stock		(1,201	)		(1,202	)		(2,401	)		(2,401	)
Income available to common shareholders	$	1,318		$	9,403		$	8,168		$	24,577
Income per common share:
Basic	$	0.05		$	0.38		$	0.33		$	1.00
Diluted	$	0.05		$	0.37		$	0.33		$	0.96
Average common shares outstanding		24,599			24,847			24,608			24,571
Average potential common shares-options		106			601			128			1,104
		24,705			25,448			24,736			25,675
Cash dividends per share of common stock	$	0.14		$	0.14		$	0.28		$	0.28

See notes to unaudited consolidated financial statements.

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UNAUDITED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
SIX-MONTH PERIODS ENDED JUNE 30, 2006 AND 2005
(In thousands)

	Six-Month Period Ended June 30,
CHANGES IN STOCKHOLDERS’ EQUITY:	2006			2005
				(As Restated)
Preferred stock:
Balance at beginning and end of period	$	68,000		$	68,000
Common stock:
Balance at beginning of period		25,350			24,601
Stock options exercised		20			503
Balance at end of period		25,370			25,104
Additional paid-in capital:
Balance at beginning of period — as previously reported					186,405
Prior period adjustment					13,241
Balance at beginning of period — as restated		208,454			199,646
Stock-based compensation expense		16			6,261
Stock options exercised		150			905
Common stock issuance cost		—			(8	)
Balance at end of period		208,620			206,804
Legal surplus:
Balance at beginning of period		35,863			31,280
Transfer from retained earnings		1,251			2,613
Balance at end of period		37,114			33,893
Retained earnings:
Balance at beginning of period — as previously reported					59,884
Prior period adjustment					(28,203	)
Balance at beginning of period — as restated		52,340			31,681
Net income		10,569			26,978
Cash dividends declared on common stock		(6,889	)		(6,940	)
Cash dividends declared on preferred stock		(2,401	)		(2,401	)
Transfer to legal surplus		(1,251	)		(2,613	)
Balance at end of period		52,368			46,705
Treasury stock:
Balance at beginning of period		(10,332	)		(91	)
Stock used to match defined contribution plan 1165(e)		135			235
Stock purchased		(582	)		(3,512	)
Balance at end of period		(10,779	)		(3,368	)
Accumulated other comprehensive income (loss), net of tax:
Balance at beginning of period		(37,884	)		(37,023	)
Other comprehensive income (loss), net of tax		(2,526	)		(1,360	)
Balance at end of period		(40,410	)		(38,383	)
Total stockholders’ equity	$	340,283		$	338,755

UNAUDITED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
QUARTERS AND SIX-MONTH PERIODS ENDED JUNE 30, 2006 AND 2005
(In thousands)

	Quarter Ended June 30,						Six-Month Period Ended June 30,
COMPREHENSIVE INCOME	2006			2005			2006			2005
				(As Restated)						(As Restated)
Net income	$	2,519		$	10,605		$	10,569		$	26,978
Other comprehensive income (loss):
Unrealized (loss) gain on securities available-for-sale arising during the period		(9,788	)		6,717			(21,351	)		(8,991	)
Realized (gain) loss on investment securities available-for-sale included in net income		(19	)		832			(19	)		(1,804	)
Unrealized gain (loss) on derivatives designated as cash flows hedges arising during the period		8,106			(6,565	)		18,022			7,018
Realized loss (gain) on derivatives designated as cash flow hedges included in net income		—			820			(749	)		2,743
Income tax effect related to unrealized loss on securities available-for-sale		992			(405	)		1,571			(326	)
Other comprehensive (loss) income for the period, net of tax		(709	)		1,399			(2,526	)		(1,360	)
Comprehensive income	$	1,810		$	12,004		$	8,043		$	25,618

See notes to unaudited consolidated financial statements.

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UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX-MONTH PERIODS ENDED JUNE 30, 2006 AND 2005
(In thousands)

	Six-Month Period Ended June 30,
	2006			2005
				(As Restated)
Cash flows from operating activities:
Net income	$	10,569		$	26,978
Adjustments to reconcile net income to net cash used in operating activities:
Amortization of deferred loan origination fees, net of costs		(760	)		(982	)
Amortization of premiums, net of accretion of discounts on investment securities		1,045			4,987
Depreciation and amortization of premises and equipment		2,672			3,143
Deferred income tax expense (benefit)		(1,068	)		205
Equity in losses (earnings) of investment in limited liability partnership		271			(247	)
Provision for loan losses		2,048			1,510
Stock-based compensation (benefit)		16			(6,287	)
Loss (gain) on:
Sale of securities available-for-sale		(19	)		(4,056	)
Mortgage banking activities		(1,070	)		(2,241	)
Derivatives		(859	)		4,670
Sale of foreclosed real estate		(115	)		—
Sale of premises and equipment		(8	)		—
Originations of loans held-for-sale		(33,830	)		(107,035	)
Proceeds from sale of loans held-for-sale		13,525			28,893
Net decrease (increase) in:
Trading securities		(222	)		850
Accrued interest receivable		(2,246	)		(2,446	)
Other assets		(7,375	)		(10,454	)
Net increase (decrease) in:
Accrued interest on deposits and borrowings		(2,492	)		3,329
Other liabilities		(2,030	)		7,351
Net cash used in operating activities		(21,948	)		(51,832	)
Cash flows from investing activities:
Net decrease (increase) in time deposits with other banks		30,000			(30,000	)
Purchases of:
Investment securities available-for-sale		(278,566	)		(623,529	)
Investment securities held-to-maturity		(6,500	)		(236,399	)
Equity options and put options		—			(739	)
FHLB stock		(9,733	)		—
Maturities and redemptions of:
Investment securities available-for-sale		73,173			400,720
Investment securities held-to-maturity		108,975			100,340
FHLB stock		11,466			1,102
Proceeds from sales of:
Investment securities available-for-sale		57,130			449,622
Foreclosed real estate		2,142			2,149
Premises and equipment		—			3,355
Loan production:
Origination and purchase of loans, excluding loans held-for-sale		(321,068	)		(164,269	)
Principal repayment of loans		68,474			108,314
Additions to premises and equipment		(5,194	)		(2,340	)
Net cash provided by (used in) investing activities		(269,701	)		8,326
Cash flows from financing activities:
Net increase (decrease) in:
Deposits		(85,449	)		178,064
Securities sold under agreements to repurchase		425,516			(146,070	)
Federal funds purchased and other short term borrowings		12,643			12,310
Proceeds from:
Advances from FHLB		1,322,995			917,570
Exercise of stock options, net		170			1,408
Repayments of advances from FHLB		(1,350,795	)		(917,570	)
Common stocks used to match defined contribution plan 1165(e)		135			(3,157	)
Repurchase of treasury stocks		(582	)		—
Dividends paid		(9,294	)		(9,321	)
Net cash provided by financing activities		315,339			33,234
Net change in cash and cash equivalents		23,690			(10,272	)
Cash and cash equivalents at beginning of period		17,269			34,955
Cash and cash equivalents at end of period	$	40,959		$	24,683
Cash and cash equivalents include:
Cash and due from banks	$	35,237		$	14,892
Money market investments		5,722			9,791
	$	40,959		$	24,683
Supplemental Cash Flow Disclosure and Schedule of Noncash Activities:
Interest paid	$	90,826		$	53,421
Income taxes paid	$	—		$	554
Mortgage loans securitized into mortgage-backed securities	$	20,447		$	33,662
Accrued dividend payable	$	3,441		$	3,487
Other comprehensive loss for the period	$	2,526		$	1,360
Securities sold but not yet delivered	$	710		$	1,034
Securities and loans purchased but not yet received	$	6,539		$	22,772
Transfer from loans to foreclosed real estate	$	1,604		$	1,937

See notes to unaudited consolidated financial statements.

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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”). In the opinion of management, these consolidated financial statements include all adjustments necessary, all of which are of normal recurring nature, to present fairly the consolidated financial condition as of June 30, 2006 and December 31, 2005, and the results of operations, and the cash flows for the six-month periods ended June 30, 2006 and 2005. All significant intercompany balances and transactions have been eliminated in the accompanying unaudited consolidated financial statements. Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such SEC rules and regulations. Management believes that the disclosures made are adequate to make the information presented not misleading. Financial information as of December 31, 2005 has been derived from the Group’s audited consolidated financial statements. The results of operations and cash flows for the six-month periods ended June 30, 2006 and 2005 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 transition period ended December 31, 2005, included in the Group’s Form 10-K.

Nature of Operations

Oriental is a diversified, 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 two special purpose entities, Oriental Financial (PR) Statutory Trust I (the “Statutory Trust I”) and 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, financial planning, insurance sales, money management and investment banking and brokerage services, as well as corporate and individual trust services. Note 9 to the unaudited consolidated financial statements present further information about the operations of the Group’s business segments.

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 operates through twenty-four branches located throughout Puerto Rico and is subject to the supervision, examination and regulation of the Office of the Commissioner of Financial Institutions of Puerto Rico and the Federal Deposit Insurance Corporation (“FDIC”). The Bank offers banking services such as commercial and consumer lending, saving 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. The Bank also operates two international banking entities (“IBEs”) pursuant to the International Banking Center Regulatory Act of Puerto Rico, as amended (the “IBE Act”): O.B.T. International Bank, which is a unit of the Bank, and Oriental International Bank Inc., which is a wholly-owned subsidiary of the Bank. On January 1, 2004, the Group transferred most of the assets and liabilities of O.B.T. International Bank to Oriental International Bank Inc. The IBE offers the Bank certain Puerto Rico tax advantages and its services 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 National Association of Securities Dealers, Inc., the SEC, and the Office of the Commissioner of Financial Institutions of Puerto Rico. Oriental Insurance is subject to the supervision, examination and regulation of the Office of the Commissioner of Insurance of Puerto Rico.

Change of Fiscal Year

On August 30, 2005, the Group’s Board of Directors (the “Board”) approved an amendment to Section 1 of Article IX of the Group’s By-Laws to change its fiscal year to a calendar year. The Group’s fiscal year was from July 1 of each year to June 30 of the following year. The Group’s transition period was from July 1, 2005 to December 31, 2005.

Significant Accounting Policies

The unaudited consolidated financial statements of the Group are prepared in accordance with GAAP 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

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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.

Allowance for Loan Losses

The allowance for loan losses is established through a provision for loan losses based on losses that are estimated to occur. Loan losses are charged against the allowance when the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.

The Group follows a systematic methodology to establish and evaluate the adequacy of the allowance for loan losses. This methodology consists of several key elements. The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectibility of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as more information becomes available.

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, as provided in the Statement of Financial Accounting Standards (“SFAS”) No. 114, “Accounting by Creditors for Impairment of a Loan.” 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 market. The Group measures for impairment all commercial loans over $250,000. The portfolios of mortgage and consumer loans are considered homogeneous, and are evaluated collectively for impairment.

For loans that are not individually graded, the Group uses a methodology that follows a loan credit risk rating process that involves dividing loans into risk categories. The following are the credit risk categories: pass, special mention, substandard, doubtful and loss.

The Group, using an aged-based rating system, applies an overall allowance percentage to each loan portfolio category based on historical credit losses adjusted for current conditions and trends. This delinquency-based calculation is the starting point for management’s determination of the required level of the allowance for loan losses. Other data considered in this determination includes: the overall historical loss trends and other information including underwriting standards and economic trends.

Loan loss ratios and credit risk categories are updated quarterly and are applied in the context of GAAP 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 available information in estimating possible loan losses, future changes to the allowance may be necessary based on factors beyond the Group’s control, such as factors affecting general economic conditions.

Financial Instruments

Certain financial instruments including derivatives, hedged items, 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 other gains and losses 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.

Impairment of Investment Securities

The Group evaluates its securities available-for-sale and held-to-maturity for impairment. An impairment charge in the consolidated statements of income is recognized when the decline in the fair value of investments below their cost basis is judged to be other-than-temporary. The Group considers various factors in determining whether it should recognize an impairment charge, including, but not limited to the length of time and extent to which the fair value has been less than its cost basis, and the Group’s ability and intent to hold the investment for a period of time sufficient to allow for any anticipated recovery in market value. For debt securities, the Group also considers, among other factors, the investors repayment ability on its debt obligations and its cash and capital generation ability.

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Income Taxes

In preparing the 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. The Group’s effective tax rate includes the impact of tax contingency accruals and changes to such accruals, including related interest and surcharges, as considered appropriate by management. 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 rate in the year of resolution. Unfavorable settlement of any particular issue could increase the effective rate and may require the use of cash in the year of resolution.

The Group maintained an effective tax rate lower than the maximum marginal statutory rate of 43.5% as of June 30, 2006, mainly due to the interest income arising from investments exempt from Puerto Rico income taxes, net of 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 entities.

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 income.

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. As of June 30, 2006, a valuation allowance of approximately $2.0 million was recorded to offset deferred tax assets from loss carry forwards that the Group considers it will not be realized in future periods.

Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. Based upon the projections of future taxable income over the periods in which the deferred tax assets are deductible, management believes it is more likely than not that the Group will realize the benefits of these deductible differences, net of the existing valuation allowances at June 30, 2006. The amount of the deferred tax asset considered realizable, however, could be reduced in the near term if estimates of future taxable income during the carry forward period are reduced.

On August 1, 2005 the Puerto Rico Legislature approved Act No. 41 that imposes an additional tax of 2.5% on taxable income exceeding $20,000. The law is effective for tax years beginning after December 31, 2004 and ending on or before December 31, 2006. This additional tax imposition did not have a material effect on the Group’s consolidated operational results for the six-month period ended June 30, 2006 due to the tax exempt composition of the Group’s investments.

On May 13, 2006, the Puerto Rico Governor signed into law Act No. 89 to (i) increase the recapture tax that is imposed on corporations and partnerships generating taxable income in excess of $500,000 with the purpose of increasing the maximum marginal corporate income tax rate for these entities from 39% to 41.5%, and (ii) to impose an additional tax of 2% on the taxable income of banking corporations covered under the Puerto Rico the Group’s investments.

On May 16, 2006, the Puerto Rico Governor also signed into law Act No. 98 to impose a one-time 5% extraordinary tax that is imposed on an amount equal to the net taxable income of non-exempt corporations and partnerships for the last taxable year ended on or before December 31, 2005. On July 31, 2006 Act No. 137 was signed into law to amend various provisions of Act No. 98. The payment of this extraordinary tax constitutes, in effect, a prepayment, as the taxpayer will be allowed to credit the amount so paid against its Puerto Rico income tax liability for taxable years beginning after July 31, 2006 provided the credit claimed in any taxable year does not exceed 25% of the extraordinary tax paid. Since no member of the Group generated taxable income for the year 2005, this additional tax imposition will not apply and, therefore, it will not affect on the Group’s consolidated operational results.

Stock Option Plans

At June 30, 2006, the Group had three stock-based employee compensation plans: the 1996, 1998, and 2000 Incentive Stock Option Plans. These plans offer key officers, directors and employees an opportunity to purchase shares of the Group’s common stock. The Compensation Committee of the Board of Directors has sole authority and absolute discretion as to the number of stock options to be granted to any officer, director or employee, their vesting rights, and the options’ exercise

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prices. The plans provide for a proportionate adjustment in the exercise price and the number of shares that can be purchased in case of merger, consolidation, combination, exchange of shares, other reorganization, recapitalization, reclassification, stock dividend, stock split or reverse stock split in which the number of shares of common stock of the Group as a whole are increased, decreased, changed into or exchanged for a different number or kind of shares or securities. Stock options vest upon completion of specified years of service.

Up to June 30, 2005, the Group accounted for its stock compensation award plans under the recognition and measurement principles of the Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”), and related interpretations. Compensation expense for option awards with traditional terms was generally recognized for any excess of the quoted market price of the Group’s stock at measurement date over the amount an employee must pay to acquire the stock. No stock-based employee compensation cost was reflected for the awards with traditional terms as the options had an exercise price equal to the market value of the underlying common stock on the date of grant. The Financial Accounting Standards Board (“FASB”) Interpretation No. 28 “Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans” (“FIN 28”) an interpretation of APB 25 clarifies aspects of accounting for compensation related to stock appreciation rights and other variable stock option or award plans. With regards to stock option awards with anti-dilution provisions, where the terms are such that the number of shares that the employee is entitled to receive and the purchase price depends on events occurring after the date of the grant, compensation is measured at the end of each period as the amount by which the quoted market value of the shares of the enterprise’s stock covered by a grant exceeds the option price and is accrued as a charge to expense over the periods the employee performs the related services. Changes in the quoted market value are reflected as an adjustment of accrued compensation and compensation expense in the periods in which the changes occur.

On June 30, 2005, the Compensation Committee of the Group’s Board of Directors approved the acceleration of the vesting of all outstanding options to purchase shares of common stock of the Group that were held by employees, officers and directors as of that date. As a result, options to purchase 1,219,333 shares became exercisable. The purpose of the accelerated vesting was to enable the Group to avoid recognizing in its income statement compensation expense associated with these options in future periods, upon adoption of FASB Statement No. 123(R).

Effective July 1, 2005, the Group adopted SFAS No. 123R “Share-Based Payment” (“SFAS 123R”), an amendment of SFAS 123 “Accounting for Stock-Based Compensation” using the modified prospective transition method. SFAS 123R requires measurement of the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award with the cost to be recognized over the service period. SFAS 123R is effective for financial statements as of the beginning of the first interim or annual reporting period of the first fiscal year that began after June 15, 2005. SFAS No. 123R applies to all awards unvested and granted after this effective date and awards modified, repurchased, or cancelled after that date.

The Group recorded approximately $16,000 during the six-month period ended June 30, 2006 related to compensation expense for options issued subsequent to the adoption of SFAS 123R. The remaining unrecognized compensation cost related to unvested awards as of June 30, 2006, was approximately $249,000 and the weighted average period of time over which this cost will be recognized is approximately 7 years.

Had the estimated fair value of the options granted been included in compensation expense for the period indicated below, the Group’s net earnings and earnings per share would have been as follows:

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				Six-month
	Quarter Ended			Period Ended
	June 30, 2005			June 30, 2005
(In thousands, except for per share data)
Net income, as reported	$	10,605		$	26,978
Deduct: Shared-based compensation reduction included in reported earnings		(2,964	)		(6,287	)
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards		(303	)		(716	)
Pro forma net income		7,338			19,975
Less: Dividends on preferred stock		(1,202	)		(2,401	)
Pro forma income available to common shareholders	$	6,136		$	17,574
Earnings per share:
Basic — as reported	$	0.38		$	1.00
Basic — pro forma	$	0.25		$	0.72
Diluted — as reported	$	0.37		$	0.96
Diluted — pro forma	$	0.24		$	0.68
Average common shares outstanding		24,847			24,571
Average potential common share-options		601			1,104
		25,448			25,675

The average fair value of each option granted during the six-month period ended June 30, 2006 and 2005 was $4.05 and $15.32, respectively. The average fair value of each 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 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 following assumptions were used in estimating the fair value of the options granted:

	Six-month period ended
	June 30,
	2006			2005
Weighted Average Assumptions:
Dividend yield		3.87	%		3.71	%
Expected volatility		34.26	%		42.33	%
Risk-free interest rate		4.19	%		3.92	%
Expected life (in years)		8.5			7

The expected term of share options granted represents the period of time that share options granted are expected to be outstanding. Expected volatilities are based on historical volatility of the Group’s shares over the most recent period equal to the expected term of the share option.

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NOTE 2 — INVESTMENT SECURITIES:

The amortized cost, gross unrealized gains and losses, fair value, and weighted average yield of the investment securities as of June 30, 2006 and December 31, 2005, were as follows:

	June 30, 2006 (In thousands)
			Gross		Gross				Weighted
	Amortized		Unrealized		Unrealized		Fair		Average
	Cost		Gains		Losses		Value		Yield
Available-for-sale
US Treasury securities	$	199,746	$	—	$	9,144	$	190,602		3.64	%
Puerto Rico Government and agency obligations		28,396		76		1,355		27,117		5.59	%
Corporate bonds and other		112,383		—		3,112		109,271		4.51	%
Total investment securities		340,525		76		13,611		326,990
FNMA and FHLMC certificates		567,958		—		22,054		545,904		4.71	%
GNMA certificates		48,587		281		543		48,325		5.58	%
Collateralized mortgage obligations (CMO’s)		288,837		6		9,818		279,025		5.11	%
Total mortgage-backed-securities and CMO’s		905,382		287		32,415		873,254
Total securities available-for-sale	$	1,245,907	$	363	$	46,026	$	1,200,244		4.67	%
Held-to-maturity
US Treasury securities		40,059		—		375		39,684		2.52	%
Obligations of U.S. government sponsored entities		1,028,246		—		37,261		990,985		3.74	%
Puerto Rico Government and agency obligations		55,284		—		5,886		49,398		5.29	%
Total investment securities		1,123,589		—		43,522		1,080,067
FNMA and FHLMC certificates		763,141		—		29,956		733,185		5.03	%
GNMA certificates		198,057		—		6,690		191,367		5.33	%
Collateralized mortgage obligations		158,432		—		4,281		154,151		5.13	%
Total mortgage-backed-securities and CMO’s		1,119,630		—		40,927		1,078,703
Total securities held-to-maturity		2,243,219		—		84,449		2,158,770		5.03	%
Total	$	3,489,126	$	363	$	130,475	$	3,359,014		4.85	%

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	December 31, 2005 (In thousands)
			Gross		Gross				Weighted
	Amortized		Unrealized		Unrealized		Fair		Average
	Cost		Gains		Losses		Value		Yield
Available-for-sale
US Treasury securities	$	174,836	$	—	$	5,599	$	169,237		3.45	%
Puerto Rico Government and agency obligations		28,356		183		340		28,199		5.29	%
Corporate bonds and other		92,005		—		1,468		90,537		4.75	%
Total investment securities		295,197		183		7,407		287,973
FNMA and FHLMC certificates		488,356		—		12,193		476,163		5.17	%
GNMA certificates		36,799		630		129		37,300		5.83	%
Collateralized mortgage obligations (CMO’s)		249,297		552		4,401		245,448		5.47	%
Total mortgage-backed-securities and CMO’s		774,452		1,182		16,723		758,911
Total securities available-for-sale		1,069,649		1,365		24,130		1,046,884		4.95	%
Held-to-maturity
US Treasury securities		60,168		—		818		59,350		2.84	%
Obligations of US Government sponsored agencies		1,021,634		77		19,661		1,002,050		4.09	%
Puerto Rico Government and agency obligations		62,084		—		2,987		59,097		5.32	%
Total investment securities		1,143,886		77		23,466		1,120,497
FNMA and FHLMC certificates		822,870		1,238		10,389		813,719		5.05	%
GNMA certificates		216,237		1,371		1,196		216,412		5.52	%
Collateralized mortgage obligations		163,262		129		1,187		162,204		5.42	%
Total mortgage-backed-securities and CMO’s		1,202,369		2,738		12,772		1,192,335
Total securities held-to-maturity		2,346,255		2,815		36,238		2,312,832		4.65	%
Total	$	3,415,904	$	4,180	$	60,368	$	3,359,716		4.75	%

The amortized cost and fair value of the Group’s investment securities available-for-sale and held-to-maturity at June 30, 2006, by contractual maturity, are shown in the next table. 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.

	(In thousands)
	Available-for-sale				Held-to-maturity
	Amortized Cost		Fair Value		Amortized Cost		Fair Value
Investment securities
Due within one year	$	5,000	$	4,975	$	274,860	$	272,055
Due after 1 to 5 years		295,202		283,026		412,359		398,674
Due after 5 to 10 years		1,890		1,835		281,241		264,817
Due after 10 years		38,433		37,154		155,129		144,521
		340,525		326,990		1,123,589		1,080,067
Mortgage-backed securities
Due within one year		228		228		—		—
Due after 1 to 5 years		10,242		10,262		—		—
Due after 5 to 10 years		3,327		3,163		—		—
Due after 10 years		891,585		859,601		1,119,630		1,078,703
		905,382		873,254		1,119,630		1,078,703
	$	1,245,907	$	1,200,244	$	2,243,219	$	2,158,770

Proceeds from the sale of investment securities available-for-sale during the six-month period ended June 30, 2006 totaled approximately $57,130,000 (2005 — approximately $449,622,000). Gross realized gains on those sales during the six-month period ended June 30, 2006 were approximately $19,000 (2005 — gains of approximately $4.6 million and losses of approximately $500,000).

The following table shows the Group’s gross unrealized losses and fair value of investment securities available-for-sale and held-to-maturity, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at June 30, 2006.

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Available-for-sale

(In thousands)

	Less than 12 months
	Amortized		Unrealized			Fair
	Cost		Loss			Value
US Treasury securities	$	24,895	$	(131	)	$	24,764
Puerto Rico Government and agency obligations		18,696		(853	)		17,843
Corporate bonds and other		92,135		(3,040	)		89,095
Mortgage-backed securities and CMO’s		364,510		(5,695	)		358,815
		500,236		(9,719	)		490,517

	12 months or more
	Amortized		Unrealized			Fair
	Cost		Loss			Value
US Treasury securities		174,852		(9,013	)		165,839
Puerto Rico Government and agency obligations		4,207		(502	)		3,705
Corporate bonds and other		91		(72	)		19
Mortgage-backed securities and CMO’s		524,814		(26,720	)		498,094
		703,964		(36,307	)		667,657

	Total
	Amortized		Unrealized			Fair
	Cost		Loss			Value
US Treasury securities		199,747		(9,144	)		190,603
Puerto Rico Government and agency obligations		22,903		(1,355	)		21,548
Corporate bonds and other		92,226		(3,112	)		89,114
Mortgage-backed securities and CMO’s		889,324		(32,415	)		856,909
	$	1,204,200	$	(46,026	)	$	1,158,174

Held-to-maturity

(In thousands)

	Less than 12 months
	Amortized		Unrealized			Fair
	Cost		Loss			Value
US Treasury securities	$	331,086	$	(12,441	)	$	318,645
Puerto Rico Government and agency obligations		9,966		(791	)		9,175
Mortgage-backed securities and CMO’s		774,431		(23,321	)		751,110
		1,115,483		(36,553	)		1,078,930

	12 months or more
	Amortized		Unrealized			Fair
	Cost		Loss			Value
US Treasury securities		737,219		(25,195	)		712,024
Puerto Rico Government and agency obligations		45,318		(5,095	)		40,223
Mortgage-backed securities and CMO’s		345,199		(17,606	)		327,593
		1,127,736		(47,896	)		1,079,840

	Total
	Amortized		Unrealized			Fair
	Cost		Loss			Value
US Treasury securities		1,068,305		(37,636	)		1,030,669
Puerto Rico Government and agency obligations		55,284		(5,886	)		49,398
Mortgage-backed securities and CMO’s		1,119,630		(40,927	)		1,078,703
	$	2,243,219	$	(84,449	)	$	2,158,770

Securities in an unrealized loss position at June 30, 2006 are mainly composed of securities issued or backed by U.S. government agencies. The vast majority of them are rated the equivalent of AAA by nationally recognized rating organizations. The investment portfolio is structured primarily with highly liquid securities, which have a large and efficient secondary market. Valuations are performed on a monthly basis using a third party provider and dealer quotes. Management believes that the unrealized losses in the investment portfolio at June 30, 2006 are mainly related to market interest rate fluctuations and not to deterioration in the creditworthiness of the issuers. The Group is a well capitalized financial institution, which has the ability to hold the investment securities with unrealized losses until maturity or until the unrealized losses are recovered, and expects to continue its pattern of holding the securities until the forecasted recovery of fair value.

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NOTE 3 — LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES:

Loans Receivable

The Group’s credit activities are mainly with customers located in Puerto Rico. The Group’s loan transactions are encompassed within three main categories: mortgage, commercial and consumer. The composition of the Group’s loan portfolio at June 30, 2006, and December 31, 2005, was as follows:

	(In thousands)
	June 30, 2006			December 31, 2005
Residential mortgage loans	$	848,473		$	599,163
Home equity loans and secured personal loans		39,147			41,034
Commercial loans, mainly secured by real estate		228,008			228,163
Consumer		39,074			35,482
Loans receivable, gross		1,154,702			903,842
Less: deferred loan fees, net		(2,827	)		(2,850	)
Loans receivable		1,151,875			900,992
Allowance for loan losses		(7,501	)		(6,630	)
Loans receivable, net		1,144,374			894,362
Mortgage loans held-for-sale		9,564			8,946
Total loans, net	$	1,153,938		$	903,308

Allowance for Loan Losses

The Group maintains an allowance for loan 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 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 losses, future additions to the allowance may be required based on factors beyond the Group’s control. Refer to Table 4 of the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for the changes in the allowance for loan losses for the quarters and six-month periods ended June 30, 2006 and December 31, 2005.

The Group evaluates all loans, some individually and other as homogeneous groups, for purposes of determining impairment. At June 30, 2006 and December 31, 2005, the total investment in impaired loans was $1.8 million and $3.6 million, respectively. The impaired loans were measured based on the fair value of collateral. The Group determined that no specific impairment allowance was required for such loans.

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NOTE 4 — PLEDGED ASSETS

At June 30, 2006, residential mortgage loans amounting to $349,712,000 and investment securities with fair values amounting to $15,663,000 were pledged to secure advances and borrowings from the FHLB. Investment securities with fair values totaling $2,902,985,000, $135,282,000 and $15,860,000 at June 30, 2006, were pledged to secure securities sold under agreements to repurchase, public fund deposits, and term notes, respectively. Also, investment securities with fair value totaling $803,000 at June 30, 2006, were pledged to the Puerto Rico Treasury Department.

As of June 30, 2006, investment securities available-for-sale and held-to-maturity not pledged amounted to $143,215,000 and $71,435,000 respectively. As of June 30, 2006, mortgage loans not pledged amounted to $547,471,000.

NOTE 5 — OTHER ASSETS

Other assets at June 30, 2006 and December 31, 2005 include the following:

	(In thousands)
	June 30, 2006		December 31, 2005
Investment in equity options	$	25,999	$	22,054
Derivative asset		20,347		2,509
Deferred charges		2,814		3,213
Prepaid expenses		2,763		2,698
Investment in Statutory Trusts		2,169		2,169
Goodwill		2,006		2,006
Investment in limited partnership		10,814		11,085
Accounts receivable and other assets, net		10,132		2,423
	$	77,044	$	48,157

NOTE 6 — SUBORDINATED CAPITAL NOTES

Subordinated capital notes amounted to $72,166,000 at June 30, 2006 and December 31, 2005.

In October 2001 and August 2003, the Statutory Trust I and the Statutory Trust II, respectively, special purpose entities of the Group, were formed for the purpose of issuing trust redeemable preferred securities. In December 2001 and September 2003, $35.0 million of trust redeemable preferred securities were issued each by the Statutory Trust I and 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 these issuances were used by the Statutory Trust I and 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 first of these subordinated capital notes has a par value of $36.1 million, bears interest based on 3 month LIBOR plus 360 basis points (9.00% at June 30, 2006; 8.10% at December 31, 2005), provided, however, that prior to December 18, 2006, this interest rate shall not exceed 12.5%, payable quarterly, and matures on December 23, 2031. The second one, has a par value of $36.1 million, bears interest based on 3 month LIBOR plus 295 basis points (8.35% at June 30, 2006; December 31, 2005 — 7.45%), payable quarterly, and matures on September 17, 2033. Both subordinated capital notes may be called at par after five years (Statutory Trust I — December 2006; Statutory Trust II — September 2008). 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. On March 4, 2005, the Federal Reserve Board issued a final rule that continues to allow trust preferred securities to be included in Tier I regulatory capital, subject to stricter quantitative and qualitative limits. Under this rule, 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.

NOTE 7 — OTHER BORROWINGS

At June 30, 2006, 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.

Securities sold under agreements to repurchase at June 30, 2006 mature as follows:

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	(In thousands)
	Balance
Due within 30 days	$	1,391,111
Due after 30 to 90 days		1,365,109
Due after 90 to 120 days		100,141
	$	2,856,361

At June 30, 2006, the contractual maturities of advances from the FHLB and term notes by year are as follows:

	(In thousands)
June 30,	Advances from FHLB		Term Notes
2007	$	210,500	$	—
2008		25,000		15,000
2009		50,000		—
	$	285,500	$	15,000

NOTE 8 — DERIVATIVES ACTIVITIES

The Group utilizes various derivative instruments for hedging purposes 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 or 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.

The Group generally uses interest rate swaps and options in managing its interest rate risk exposure. Certain swaps were entered into to convert the forecasted rollover of short-term borrowings into fixed rate liabilities for longer periods and provide protection against increases in short-term interest rates. Under these swaps, the Group 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 on the forecasted rollover of short-term borrowings.

In August 2004, the Group entered into a $35.0 million notional amount interest rate swap to fix the cost of the subordinated capital notes of the Statutory Trust I. This swap was fixed at a rate of 2.98% and matures on December 18, 2006.

The Group’s swaps, including those not designated as a hedge, and their maturity terms at June 30, 2006 and December 31, 2005 are set forth in the table below:

	(Dollars in thousands)
	June 30,			December 31,
	2006			2005
Swaps:
Pay fixed swaps notional amount	$	1,350,000		$	1,275,000
Weighted average pay rate — fixed		4.48	%		3.90	%
Weighted average receive rate — floating		5.24	%		4.39	%
Maturity in months		3 to 54			1 to 60
Floating rate as a percent of LIBOR		100	%		100	%

The Group offers its customers certificates of deposit with an option tied to the performance of the Standard & Poor’s 500 stock market index. At the end of five years depositors receive a return equal to the greater of 15% of the principal in the account or 125% of the average increase in the month-end value of the 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 in accordance with SFAS No. 133, as amended.

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.

-15-

Derivatives designated as a hedge consist of interest rate swaps primarily used to hedge securities sold under agreements to repurchase with notional amounts of $1.315 billion and $1.240 billion as of June 30, 2006 and December 31, 2005, respectively. Derivatives not designated as a hedge consist of purchased options used to manage the exposure to the stock market on stock indexed deposits with notional amounts of $146,090,000 and $173,280,000 as of June 30, 2006 and December 31, 2005, respectively; embedded options on stock indexed deposits with notional amounts of $137,995,000 and $164,651,000 as of June 30, 2006 and December 31, 2005, respectively; and interest rate swaps with notional amounts of $35 million as of June 30, 2006 and December 31, 2005.

During the six-month periods ended June 30, 2006 and 2005, gains (losses) of $859,000 and ($4.7 million), respectively, were credited (charged) to earnings and reflected as “Derivatives Activities” in the unaudited consolidated statements of income. During the six-month periods ended June 30, 2006 and 2005, unrealized gains of $18.0 million and unrealized losses of $7.0 million, respectively, on derivatives designated as cash flow hedges were included in other comprehensive income (loss).

At June 30, 2006 and December 31, 2005, the fair value of derivatives was recognized as either assets or liabilities in the unaudited consolidated statements of financial condition as follows: the fair value of the interest rate swaps to fix the cost of the forecasted rollover of short-term borrowings represented an asset of $20.3 million and $2.5 million, as of June 30, 2006 and December 31, 2005, respectively, presented in other assets; the purchased options used to manage the exposure to the stock market on stock indexed deposits represented an asset of $26.0 million and $22.1 million, respectively, also presented in other assets; the options sold to customers embedded in the certificates of deposit represented a liability of $24.6 million and $21.1 million, respectively, recorded in deposits.

The Group’s Asset and Liability Management Committee (“ALCO”) decided in July 2006 to unwind interest rate swaps with an aggregate notional amount of $640 million, which had been designated as cash flow hedges and had maturity dates ranging from September 2010 to December 2010. Management concluded that it was beneficial to Oriental to lock-in the fair value of these swaps at approximately $11 million. The net gain of $11 million on this transaction will continue to be included in other comprehensive income, and will be reclassified into earnings during the originally remaining term of the swaps, starting in the September 2006 quarter and through December 2010, by reducing the interest expense on borrowings.

NOTE 9 — SEGMENT REPORTING:

The Group segregates its businesses into the following major reportable segments: Banking, Treasury, and Financial Services. 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 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. During this quarter, Management decided to reclassify and present investment banking revenues in the Treasury segment rather than into the Financial Services segment. This reclassification was retroactively presented in the disclosure.

Banking includes the Bank’s branches and mortgage banking, with traditional banking products such as deposits and mortgage, commercial 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. From time to time, if conditions so warrant, the Group may sell loans directly into the secondary market or securitize conforming loans into mortgage-baked securities certificates. The Group outsourced the servicing of mortgages included in the resulting mortgage-backed securities pools, as well as loans maintained in portfolio.

The Treasury segment encompasses all of the Group’s assets and liability management activities such as: purchases and sales of investment securities, interest rate risk management, derivatives, and borrowings as well as investment banking revenues on public offerings and private placement of debt and equity securities.

Financial services is comprised of the Bank’s trust division (Oriental Trust), the brokerage 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 brokerage services, insurance sales, corporate and individual trust and retirement services, as well as pension plan administration services.

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 followed by the Group, which are described in the “Summary of Significant Accounting Policies” included in the Group’s Form 10-K. Following are the results of operations and the selected financial information by operating segment for the quarters and six-month periods ended June 30, 2006 and 2005:

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Unaudited — quarters ended June 30, (Dollars in thousands)

							Financial			Total						Consolidated
	Banking			Treasury			Services			Segments			Eliminations			Total
June 30, 2006
Interest income	$	18,653		$	38,191		$	50		$	56,894			—		$	56,894
Interest expense		(6,831	)		(39,355	)		—			(46,186	)		—			(46,186	)
Net interest income		11,822			(1,164	)		50			10,708			—			10,708
Non-interest income		4,111			112			3,298			7,521			—			7,521
Non-interest expenses		(12,082	)		(314	)		(2,388	)		(14,784	)		—			(14,784	)
Intersegment revenue		576			—			—			576			(576	)		—
Intersegment expense					(240	)		(336	)		(576	)		576			—
Provision for loan losses		(947	)		—			—			(947	)		—			(947	)
Income before income taxes	$	3,480		$	(1,606	)	$	624		$	2,498		$	—		$	2,498
Total Assets as of June 30, 2006	$	1,583,909		$	3,667,383		$	12,265		$	5,263,557		$	(430,895	)	$	4,832,662
June 30, 2005
Interest income	$	15,006		$	33,857		$	13		$	48,876			—		$	48,876
Interest expense		(5,386	)		(24,202	)		—			(29,588	)		—			(29,588	)
Net interest income		9,620			9,655			13			19,288			—			19,288
Non-interest income		4,348			(430	)		2,519			6,437			—			6,437
Non-interest expenses		(10,163	)		(596	)		(3,134	)		(13,893	)		—			(13,893	)
Intersegment revenue		1,193			—			—			1,193			(1,193	)		—
Intersegment expense		—			(347	)		(846	)		(1,193	)		1,193			—
Provision for loan losses		(850	)		—			—			(850	)		—			(850	)
Income before income taxes	$	4,148		$	8,282		$	(1,448	)	$	10,982		$	—		$	10,982
Total Assets as of June 30, 2005	$	973,296		$	3,655,649		$	9,582		$	4,638,527		$	(391,662	)	$	4,246,865

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Unaudited — six-months period ended June 30, (Dollars in thousands)

							Financial			Total						Consolidated
	Banking			Treasury			Services			Segments			Eliminations			Total
June 30, 2006
Interest income	$	35,253		$	77,547		$	86		$	112,886			—		$	112,886
Interest expense		(12,833	)		(74,133	)		—			(86,966	)		—			(86,966	)
Net interest income		22,420			3,414			86			25,920			—			25,920
Non-interest income		7,544			3,062			5,868			16,474			—			16,474
Non-interest expenses		(24,247	)		(697	)		(4,723	)		(29,667	)		—			(29,667	)
Intersegment revenue		1,189			—			—			1,189			(1,189	)		—
Intersegment expense		—			(407	)		(782	)		(1,189	)		1,189			—
Provision for loan losses		(2,048	)		—			—			(2,048	)		—			(2,048	)
Income before income taxes	$	4,858		$	5,372		$	449		$	10,679		$	—		$	10,679
Total Assets as of June 30, 2006	$	1,583,909		$	3,667,383		$	12,265		$	5,263,557		$	(430,895	)	$	4,832,662
June 30, 2005
Interest income	$	28,577		$	67,833		$	38		$	96,448			—		$	96,448
Interest expense		(10,471	)		(46,279	)		—			(56,750	)		—			(56,750	)
Net interest income		18,106			21,554			38			39,698			—			39,698
Non-interest income		6,617			794			5,125			12,536			—			12,536
Non-interest expenses		(20,035	)		(1,128	)		(4,877	)		(26,040	)		—			(26,040	)
Intersegment revenue		1,954						—			1,954			(1,954	)		—
Intersegment expense					(541	)		(1,413	)		(1,954	)		1,954			—
Provision for loan losses		(1,510	)		—						(1,510	)		—			(1,510	)
Income before income taxes	$	5,132		$	20,679		$	(1,127	)	$	24,684		$	—		$	24,684
Total Assets as of June 30, 2005	$	973,296		$	3,655,649		$	9,582		$	4,638,527		$	(391,662	)	$	4,246,865

NOTE 10 — RECENT ACCOUNTING DEVELOPMENTS:

SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments — an amendment of FASB Statements No. 133 and 140”

In February 2006, FASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments — an amendment of FASB Statements No. 133 and 140.” This statement amends SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” and No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.” SFAS No. 155 resolves issues addressed in Statement 133 Implementation Issue No. D1, “Application of Statement 133 to Beneficial Interests in Securitized Financial Assets.” SFAS No. 155:

• Permits fair value remeasurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation;

• Clarifies, which interest-only strips and principal-only strips are not subject to the requirements of Statement 133;

• Establishes a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation;

• Clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives;

• Amends SFAS No. 140 to eliminate the prohibition on a qualifying special-purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument.

SFAS No. 155 is effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 15, 2006. The fair value election provided for in paragraph 4(c) of SFAS 155 may also be applied upon adoption of this statement for hybrid financial instruments that had been bifurcated under paragraph 12 of SFAS No. 133 prior to the adoption of SFAS No. 155. Earlier adoption is permitted as of the beginning of an entity’s fiscal year, provided the entity has not yet issued financial statements, including financial statements for any interim period for that fiscal year.

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Provisions of this statement may be applied to instruments that an entity holds at the date of adoption on an instrument-by-instrument basis.

At adoption, any difference between the total carrying amount of the individual components of the existing bifurcated hybrid financial instrument and the fair value of the combined hybrid financial instrument should be recognized as a cumulative-effect adjustment to beginning retained earnings. An entity should separately disclose the gross gains and losses that make up the cumulative-effect adjustment, determined on an instrument-by-instrument basis. Prior periods should not be restated.

The Group is evaluating the impact that this recently issued accounting pronouncement may have on its financial condition and results of operations.

SFAS No. 156, “Accounting for Servicing of Financial Assets — an amendment of FASB Statements No. 133 and 140”

In March 2006, FASB issued SFAS No. 156, “Accounting for Servicing of Financial Assets — an amendment to SFAS No. 140”, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,” to (1) require the recognition of a servicing asset or servicing liability under specified circumstances, (2) require that, if practicable, all separately recognized servicing assets and liabilities be initially measured at fair value, (3) create a choice for subsequent measurement of each class of servicing assets or liabilities by applying either the amortization method or the fair value method, and (4) permit the one-time reclassification of securities identified as offsetting exposure to changes in fair value of servicing assets or liabilities from available-for-sale securities to trading securities under SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities. In addition, SFAS No. 156 amends SFAS No. 140 to require significantly greater disclosure concerning recognized servicing assets and liabilities. SFAS No. 156 is effective for all separately recognized servicing assets and liabilities acquired or issued after the beginning of an entity’s fiscal year that begins after September 15, 2006, with early adoption permitted.

The adoption of SFAS No. 156 is not expected to have a material effect on the Group’s consolidated financial position or results of operations.

FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes

During July 2006, the Financial Accounting Standards Board adopted FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”). FIN 48 was issued to clarify the requirements of Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes”, relating to the recognition of income tax benefits. FIN 48 provides a two-step approach to recognizing and measuring tax benefits when the benefits’ realization is uncertain. The first step is to determine whether the benefit is to be recognized; the second step is to determine the amount to be recognized:

• Income tax benefits should be recognized when, based on the technical merits of a tax position, the entity believes that if a dispute arose with the taxing authority and were taken to a court of last resort, it is more likely than not (i.e. a probability of greater than 50 percent) that the tax position would be sustained as filed.

• If a position is determined to be more likely-than not of being sustained, the reporting enterprise should recognize the largest amount of tax benefit that is greater than 50 percent likely of being realized upon ultimate settlement with the taxing authority.

FIN 48 is applicable to the Group beginning in the first quarter of 2007. The cumulative effect of applying the provisions of FIN 48 upon adoption must be reported as an adjustment to beginning retained earnings. Management is assessing the effect of the adoption of FIN 48 on the Group.

SFAS No. 157, “Fair Value Measurements”

In September 2006, FASB issued SFAS No. 157, “Fair Value Measurements,” which defines fair value, establishes a framework for measuring fair value in GAAP, and expands disclosures about fair value measurements. This Statement applies under other accounting pronouncements that require or permit fair value measurements, the Board having previously concluded in those accounting pronouncements that fair value is the relevant measurement attribute. Accordingly, this Statement does not require any new fair value measurements. The changes to current practice resulting from the application of this Statement relate to the definition of fair value, the methods used to measure fair value, and the expanded disclosures about fair value measurements.

This Statement is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. Earlier application is encouraged, provided that the reporting entity has not yet issued financial statements for that fiscal year, including financial statements for an interim period within that fiscal year. Management is assessing the effect of the adoption of SFAS 157 on the Group.

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NOTE 11 — RESTATEMENT OF PREVIOUSLY ISSUED FINANCIAL STATEMENTS

Subsequent to the issuance of the Group’s June 30, 2005 consolidated financial statements, the Group’s management determined that the accounting treatment for certain mortgage-related transactions previously treated as purchases under SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities”, and the treatment of certain employee stock option awards as fixed awards instead of variable awards did not conform to GAAP, as discussed below. As a result, the accompanying unaudited consolidated financial statements as of June 30, 2005 have been restated from the amounts previously reported to correct the accounting for these transactions. Refer to Note 2 to the consolidated financial statements for the transition period ended December 31, 2005, included in the Group’s Form 10-K.

A summary of the significant effects of the restatement as of June 30, 2005 is as follows:

	Quarter Ended June 30, 2005				Six-Month Period Ended June 30, 2005
	(Unaudited)				(Unaudited)
	As Previously				As Previously
	Reported		As Restated		Reported		As Restated
Non-interest expenses:
Compensation and employees’ benefits	$	7,366	$	4,402	$	13,984	$	7,697
Total non-interest expenses		16,857		13,893		32,327		26,040
Income before income taxes		8,018		10,982		18,397		24,684
Net income	$	7,641	$	10,605	$	20,691	$	26,978
Income per common share:
Basic	$	0.26	$	0.38	$	0.74	$	1.00
Diluted	$	0.26	$	0.37	$	0.72	$	0.96

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ITEM 2 — MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

SELECTED FINANCIAL DATA
FOR THE QUARTERS AND SIX-MONTH PERIODS ENDED JUNE 30, 2006 AND 2005
(dollars in thousands)

	Quarter Ended June 30,									Six-Month Period Ended June 30,
	2006			2005			Variance %			2006			2005			Variance %
Interest income	$	56,894		$	48,876			16.4	%	$	112,886		$	96,448			17.0	%
Interest expense		46,186			29,588			56.1	%		86,966			56,750			53.2	%
Net interest income		10,708			19,288			-44.5	%		25,920			39,698			-34.7	%
Provision for loan losses		947			850			11.4	%		2,048			1,510			35.6	%
Net interest income after provision for loan losses		9,761			18,438			-47.1	%		23,872			38,188			-37.5	%
Non-interest income		7,521			6,437			16.8	%		16,474			12,536			31.4	%
Non-interest expenses		14,784			13,893			6.4	%		29,667			26,040			13.9	%
Income before taxes		2,498			10,982			-77.3	%		10,679			24,684			-56.7	%
Income tax (benefit) expense		(21	)		377			-105.6	%		110			(2,294	)		-104.8	%
Net income		2,519			10,605			76.2	%		10,569			26,978			-60.8	%
Less: Dividends on preferred stock		(1,201	)		(1,202	)		-0.1	%		(2,401	)		(2,401	)		0.0	%
Net income available to common shareholders	$	1,318		$	9,403			-86.0	%	$	8,168		$	24,577			-66.8	%
Per share data:
Basic	$	0.05		$	0.38			-86.8	%	$	0.33		$	1.00			-67.0	%
Diluted	$	0.05		$	0.37			-86.5	%	$	0.33		$	0.96			-65.6	%
Average common shares outstanding		24,599			24,847			-1.0	%		24,608			24,571			0.2	%
Average potential common share-options		106			601			82.4	%		128			1,104			-88.4	%
Average shares and shares equivalents		24,705			25,448			-2.9	%		24,736			25,675			-3.7	%
Selected Financial Ratios:
Return on average assets (ROA)		0.22	%		1.01	%					0.92	%		1.29	%
Return on average equity (ROE)		1.94	%		13.86	%					7.93	%		18.22	%
Efficiency ratio		78.76	%		53.58	%					71.39	%		49.52	%
Expense ratio		0.60	%		0.71	%					0.63	%		0.65	%
Interest rate spread		0.70	%		1.68	%					0.89	%		1.75	%
Interest rate margin		0.96	%		1.89	%					1.16	%		1.95	%
Number of financial centers											24			23

PERIOD END BALANCES AND CAPITAL RATIOS:

	June 30,			December 31,
	2006			2005			Variance %
Investments and loans
Investment securities	$	3,497,822		$	3,476,767			0.6	%
Loans and leases (including loans held-for-sale), net		1,153,938			903,308			27.7	%
Securities sold but not yet delivered		710			44,009			-98.4	%
	$	4,652,470		$	4,424,084			5.2	%
Deposits and Borrowings
Deposits	$	1,213,847		$	1,298,568			-6.5	%
Repurchase agreements		2,856,361			2,427,880			17.6	%
Other borrowings		389,764			404,921			-3.7	%
Securities purchased but not yet received		6,539			43,354			-84.9	%
	$	4,466,511		$	4,174,723			7.0	%
Stockholders’ equity
Preferred equity	$	68,000		$	68,000			0.0	%
Common equity		272,283			273,791			-0.6	%
	$	340,283		$	341,791			-0.4	%
Capital ratios
Leverage capital		9.39	%		10.13	%		-7.3	%
Tier 1 risk-based capital		29.60	%		34.70	%		-14.7	%
Total risk-based capital		30.11	%		35.22	%		-14.5	%
Common shares outstanding		24,562			24,580			-0.1	%
Trust assets managed	$	1,933,912		$	1,875,300			3.1	%
Broker-dealer assets gathered		1,172,726			1,132,286			3.6	%
Assets managed		3,106,638			3,007,586			3.3	%
Assets owned		4,832,662			4,546,949			6.3	%
Total financial assets managed and owned	$	7,939,300		$	7,554,535			5.1	%

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 produce a balanced and growing revenue stream.

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During the quarter and six-month period ended June 30, 2006, the Group continued to implement the Oriental Way program to deliver world-class products and services, targeting the personal and commercial needs of Puerto Rico’s mid net-worth individuals, professionals and owners of small and mid-sized businesses. The results of these efforts included continued growth in commercial loans and tight control over non-interest expenses.

Change of Fiscal Year

On August 30, 2005, the Group’s Board of Directors approved an amendment to Section 1 of Article IX of the Group’s By-Laws to change its fiscal year to a calendar year. The Group’s fiscal year was from July 1 of each year to June 30 of the following year. The Group’s transition period was from July 1, 2005 to December 31, 2005.

Net Income

For the quarter and six-month period ended June 30, 2006, the Group’s net income available to common shareholders totaled $1.3 million and $8.2 million, respectively, compared to $9.4 million and $24.6 million in the comparable year ago periods. Earnings per common share fully diluted was $0.05 compared to $0.37 in the year-ago quarter and $0.33 compared to $0.96 in the year ago six-month period. As a result of the Group’s previously disclosed restatement, the year ago quarter and six-month period included a $3.0 million and $6.3 million reduction, respectively, in non-cash compensation expense. These reductions increased income available to common shareholders by $0.12 and $0.25 per common share fully diluted in the quarter and six-month period, respectively.

Return on Assets and Common Equity

Return on common equity (ROE) and return on assets (ROA) for the quarter and six-month period ended June 30,2006 were 1.94%, 0.22%, 7.93% and 0.92%, respectively, which represent decreases of 86.0% and 56.5% in ROE from 13.86% and 18.22% for the quarter and six-month period ended June 30,2005, and a decrease of 78.2% and 28.7% in ROA from 1.01% and 1.29% for the quarter and six-month period ended June 30,2005, mainly due to reduced net income available to common shareholders.

Net Interest Income after Provision for Loan Losses

Net interest income after provision for loan losses decreased 47.1% and 37.5% for the quarter and six-month period ended June 30,2006, totaling $9.8 million and $23.9 million, compared with $18.4 million and $38.2 million for the same periods in the previous year. Increases of 16.4% and 17.0% in interest income for the quarter and six-month period ended June 30, 2006 as compared to same periods last year was mainly due to higher loan volume, and higher average yields on both investment securities and loans. These increases were more than offset by higher interest rates and increased volume on borrowings. Net interest margin for the June 30,2006 quarter and six-month period was 0.96% and 1.16%, respectively compared to 1.89% and 1.95% for the quarter and six-month period. Investment yields increased despite the Group’s continued repositioning of its portfolio, shifting into short-term government securities and away from long-term, mortgage-backed securities. Interest income from commercial and consumer loans also increased on both increased volume and yields.

Non-Interest Income

Total non-interest income was $7.5 million and $16.5 million, an increase of 16.8% and 31.4% over the June 2005 quarter and six-month period, respectively. Financial service revenues totaled $4.1 million and $7.3 million compared to $3.2 million and $6.4 million in the year ago quarter and six-month period, respectively, while banking service revenues totaled $2.5 million and $4.7 million versus $2.1 million and $3.9 million in the June 2005 quarter and six-month period then ended, respectively. Investment banking revenues totaled $0.9 million and $2.6 million, versus $0.2 million and $0.3 million in the June 2005 quarter and six-month period, respectively. Mortgage banking activities totaled $0.6 million and $1.1 million, versus $1.2 million and $2.2 million in the June 2005 quarter and six-month period then ended, respectively. Combined (losses) gains from net (loss) gain on sale of securities, derivatives and other totaled ($0.5 million) and $0.8 million, versus ($0.2 million) and ($0.4 million) in the June 2005 quarter and six-month period, respectively. Improvements of both items reflect the SWAP program mark to market valuation of financial instruments put in place last year to offset partially the effect of rising rates on interest expense.

Non-Interest Expenses

Non-interest expenses totaled $14.8 million and $29.7 million, compared to $13.9 million and $26.0 million, in the June 2005 quarter and six-month period, respectively. The June 2006 quarter reflected sequential declines in compensation expense (excluding non-cash compensation reduction); advertising and business promotion expenses; professional and service fees; and other costs. Even though these expenses declined, non-interest expenses did include higher accounting fees related to the Group’s change in its fiscal year; start-up expenses related to new and expanded branches; and acceleration of amortization of existing leasehold improvements related to the Group’s May 2006 move to new corporate offices, where most non-branch operations have been consolidated for increased efficiencies. Compensation and employee

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benefit expense for the last year’s quarter and six-month period includes reduction in non-cash compensation expense of $3.0 million and $6.3 million, respectively, due to the Group’s previously disclosed restatement.

Income Tax Expense

The income (benefit) tax expense was ($21,000) and $110,000 for the quarter and six-month period June 30,2006, respectively, compared to $377,000 and ($2.3 million) for the same periods ended June 30,2005. The current income tax provision is lower than the provision based on the statutory tax rate for the Group, which is 43.5%, due to the high level of tax-advantaged interest income earned on certain investments and loans, net of the disallowance of related expenses attributable to the exempt income. Exempt interest relates principally to interest earned on obligations of the United States and Puerto Rico governments and certain mortgage-backed securities, including securities held by the Group’s international banking entities. The tax benefit for the quarter ended June 30,2005 takes into account, among other things, the expiration of certain tax contingencies.

Group’s Financial Assets

The Group’s total financial assets include owned assets and the assets managed by the trust division, the securities broker-dealer subsidiary, and the private pension plan administration subsidiary. At June 30,2006, total financial assets reached $7.940 billion compared to $7.555 billion at December 31, 2005, reflecting a 5.1% increase. There was 3.3% increase in assets managed by the trust division and broker-dealer subsidiary when compared to December 31, 2005. Owned assets, the Group’s largest financial asset component, are approximately 99% owned by the Group’s banking subsidiary.

The Group’s second largest financial asset component is assets managed by the trust division and the retirement plan administration subsidiary. The Group’s trust division offers various types of individual retirement accounts (“IRA”) and manages 401(K) and Keogh retirement plans and custodian and corporate trust accounts, while Caribbean Pension Consultants, Inc. (“CPC”) manages the administration of private pension plans. At June 30,2006, total assets managed by the Group’s trust division and CPC amounted to $1.934 billion, compared to the $1.875 billion reported at December 31, 2005. The other financial asset component is assets gathered by the securities broker-dealer. The Group’s securities broker-dealer subsidiary offers a wide array of investment alternatives to its client base such as tax-advantaged fixed income securities, mutual funds, stocks, bonds and money management wrap-fee programs. At June 30, 2006, total assets gathered by the securities broker-dealer from its customer investment accounts, increased to $1.173 billion compared to $1.132 billion as of December 31, 2005. Both financial asset components reflect the Group’s success attracting financial assets, as well as improved equity market conditions.

Interest Earning Assets

The investment portfolio amounted to $3.498 billion as of June 30, 2006, a 0.6% increase compared to $3.477 billion as of December 31, 2005, while the loan portfolio increased 27.7% to $1.154 billion as of June 30, 2006, compared to $903.3 million as of December 31, 2005. The nominal sequential change in investment securities reflects the Group’s strategy of growing loans faster than investment securities.

Mortgage loans totaled $897.2 million as of June 30, 2006, a 38.2% increase from $649.1 million at December 31, 2005, and 38.8% increase from $646.4 million a year ago. Mortgage loan production totaled $70.8 million and $134.0 million, a 9.1% and 4.6% decrease compared to the same quarter and six-month period of the prior fiscal year, excluding purchases from third party originators. Mortgage loans purchased amounted to $174.2 million and $181.8 million for the quarter and six-month period ended June 30, 2006, respectively, compared to $22.2 million and $37.8 million for the June 2005 periods.

Interest Bearing Liabilities

Deposits of $1.214 billion at June 30, 2006 decreased 6.5% compared to December 31, 2005, reflecting reduced IRA CD balances as the Group’s customers transferred funds into Oriental’s Diversified Growth IRA investment product, partially offset by the success of Oriental’s new savings account products. Borrowings at June 30, 2006 totaled $3.246 billion, an increase of 14.6% from December 31, 2005, primarily due to the Group’s use of repurchase agreements. While the Group’s long-term strategy is to use deposits rather than borrowings to fund asset growth, from time to time it is more cost effective for the Group to use repurchase agreements.

Stockholders’ Equity

Stockholders’ equity as of June 30,2006, was $340.3 million, slightly lower than the $341.8 million as of December 31, 2005.

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On August 30, 2005, the Board of Directors of the Group approved a program for the repurchase of up to $12.1 million of the Group’s outstanding shares of common stock, which replaced the former program. On June 20, 2006, the Board of Directors approved an increase of $3.0 million to the initial amount, for the repurchase of up to $15.1 million. During the quarter and six-month period ended June 30, 2006, the Group repurchased 46,600 of its shares of common stock in the open market, at a total cost of $582,000.

The Group continues to be well-capitalized, with ratios significantly above regulatory capital adequacy guidelines. At June 30,2006, Tier 1 Leverage Capital Ratio was 9.39% (more than 2.3 times the minimum of 4.00%), Tier 1 Risk-Based Capital Ratio was 29.60% (more than 7.4 times the minimum of 4.00%), and Total Risk-Based Capital Ratio was 30.11% (more than 3.7 times the minimum of 8.00%).

Dividends

During the quarter and six-month period ended June 30, 2006, the Group declared cash dividends of $3.4 million and $1.2 million and $6.9 million and $2.4 million on its common and preferred stocks, respectively, similar to the $3.5 million and $1.2 million and $6.9 million and $2.4 million declared for the same periods a year ago.

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TABLE 1 — QUARTERLY ANALYSIS OF NET INTEREST INCOME AND CHANGES DUE TO VOLUME/RATE
FOR THE QUARTERS ENDED JUNE 30, 2006 AND 2005
(Dollars in thousands)

	Interest									Average rate									Average balance
							Variance									Variance									Variance
	2006			2005			in %			2006			2005			in BP			2006			2005			in %
A — TAX EQUIVALENT SPREAD
Interest-earning assets	$	56,894		$	48,876			16.4	%		5.08	%		4.78	%		30		$	4,480,608		$	4,091,543			9.5	%
Tax equivalent adjustment		13,051			10,523			24.0	%		1.17	%		1.03	%		14			—			—			0.0	%
Interest-earning assets — tax equivalent		69,945			59,399			17.8	%		6.25	%		5.81	%		44			4,480,608			4,091,543			9.5	%
Interest-bearing liabilities		46,186			29,588			56.1	%		4.38	%		3.10	%		128			4,215,139			3,814,410			10.5	%
Tax equivalent net interest income / spread	$	23,759		$	29,811			-20.3	%		1.87	%		2.71	%		(84	)	$	265,469		$	277,133			-4.2	%
Tax equivalent interest rate margin											2.13	%		2.92	%		(79	)
B — NORMAL SPREAD
Interest-earning assets:
Investments:
Investment securities	$	38,251		$	34,153			12.0	%		4.44	%		4.32	%		12		$	3,443,554		$	3,165,901			8.8	%
Investment management fees		(395	)		(495	)		-20.2	%		-0.05	%		-0.06	%		1			—			—			0.0	%
Total investment securities		37,856			33,658			12.5	%		4.40	%		4.25	%		15			3,443,554			3,165,901			8.8	%
Trading securities		4			5			-20.0	%		7.34	%		5.99	%		135			218			334			-34.7	%
Money market investments		723			279			159.1	%		4.72	%		2.97	%		175			61,269			37,583			63.0	%
		38,583			33,942			13.7	%		4.40	%		4.24	%		16			3,505,041			3,203,818			9.4	%
Loans:
Mortgage		13,003			11,030			17.9	%		7.28	%		7.05	%		23			714,649			625,556			14.2	%
Commercial		4,202			3,190			31.7	%		7.55	%		5.43	%		212			222,574			235,023			-5.3	%
Consumer		1,106			714			54.9	%		11.54	%		10.52	%		102			38,344			27,146			41.3	%
		18,311			14,934			22.6	%		7.51	%		6.73	%		78			975,567			887,725			9.9	%
		56,894			48,876			16.4	%		5.08	%		4.78	%		30			4,480,608			4,091,543			9.5	%
Interest-bearing liabilities:
Deposits:
Non-interest bearing deposits		—			—			0.0	%		—			—			0			39,897			64,573			-38.2	%
Now Accounts		214			232			-7.8	%		1.07	%		1.05	%		2			80,077			88,357			-9.4	%
Savings		1,014			236			329.7	%		2.87	%		1.01	%		186			141,139			93,705			50.6	%
Certificates of Deposit		9,918			8,229			20.5	%		4.12	%		3.41	%		71			961,794			964,839			-0.3	%
		11,146			8,697			28.2	%		3.65	%		2.87	%		78			1,222,907			1,211,474			0.9	%
Borrowings:
Repurchase agreements		32,932			16,598			98.4	%		5.04	%		3.01	%		203			2,616,058			2,202,757			18.8	%
Interest rate risk management		(1,930	)		819			-335.7	%		-0.30	%		0.15	%		(45	)		—			—			0.0	%
Financing fees		126			166			-24.1	%		0.02	%		0.03	%		(1	)		—			—			0.0	%
Total repurchase agreements		31,128			17,583			77.0	%		4.76	%		3.19	%		157			2,616,058			2,202,757			18.8	%
FHLB advances		2,248			2,001			12.3	%		3.22	%		2.60	%		62			279,497			308,389			-9.4	%
Subordinated capital notes		1,344			1,166			15.3	%		7.45	%		6.46	%		99			72,166			72,166			0.0	%
Term Notes		159			107			48.6	%		4.24	%		2.85	%		139			15,000			15,000			0.0	%
Other borrowings		161			34			373.5	%		6.77	%		2.98	%		379			9,511			4,624			105.7	%
		35,040			20,891			67.7	%		4.68	%		3.21	%		147			2,992,232			2,602,936			15.0	%
		46,186			29,588			56.1	%		4.38	%		3.10	%		128			4,215,139			3,814,410			10.5	%
Net interest income / spread	$	10,708		$	19,288			-44.5	%		0.70	%		1.68	%		(98	)
Interest rate margin											0.96	%		1.89	%		(93	)
Excess of average interest-earning assets over average interest-bearing liabilities																			$	265,469		$	277,133			-4.2	%
Average interest-earning assets over average interest-bearing liabilities ratio																				106.30	%		107.27	%

C. Changes in net interest income due to:	Volume			Rate			Total
Interest Income:
Investments		13,617			(8,976	)		4,641
Loans	$	1,884		$	1,493		$	3,377
		15,501			(7,483	)		8,018
Interest Expense:
Deposits	$	325			2,124			2,449
Repurchase agreements		9,187			4,358			13,545
Other borrowings		(833	)		1,437			604
		8,679			7,919			16,598
Net Interest Income	$	6,822		$	(15,402	)	$	(8,580	)

25

TABLE 1A — FISCAL YEAR-TO-DATE ANALYSIS OF NET INTEREST INCOME AND CHANGES DUE TO VOLUME/RATE
FOR THE SIX-MONTHS RERIOD ENDED JUNE 30, 2006 AND 2005
(Dollars in thousands)

	Interest									Average rate									Average balance
							Variance									Variance									Variance
	2006			2005			in %			2006			2005			in BP			2006			2005			in %
A — TAX EQUIVALENT SPREAD
Interest-earning assets	$	112,886		$	96,448			17.0	%		5.06	%		4.74	%		32		$	4,461,132		$	4,072,091			9.6	%
Tax equivalent adjustment		26,773			21,244			26.0	%		1.20	%		1.04	%		16			—			—			0.0	%
Interest-earning assets — tax equivalent		139,659			117,692			18.7	%		6.26	%		5.78	%		48			4,461,132			4,072,091			9.6	%
Interest-bearing liabilities		86,966			56,750			53.2	%		4.17	%		2.99	%		118			4,168,052			3,795,220			9.8	%
Tax equivalent net interest income / spread	$	52,693		$	60,942			-13.5	%		2.09	%		2.79	%		(70	)	$	293,080		$	276,871			5.9	%
Tax equivalent interest rate margin											2.36	%		2.99	%		(63	)
B — NORMAL SPREAD
Interest-earning assets:
Investments:
Investment securities	$	77,570		$	68,671			13.0	%		4.50	%		4.31	%		19		$	3,447,122		$	3,189,098			8.1	%
Investment management fees		(714	)		(941	)		-24.1	%		-0.04	%		-0.06	%		2			—			—			0.0	%
Total investment securities		76,856			67,730			13.5	%		4.46	%		4.25	%		21			3,447,122			3,189,098			8.1	%
Trading securities		3			6			-50.0	%		3.30	%		3.50	%		(20	)		182			343			-46.9	%
Money market investments		1,463			355			312.6	%		4.50	%		2.23	%		227			65,019			31,787			104.5	%
		78,322			68,091			15.0	%		4.46	%		4.23	%		23			3,512,323			3,221,228			9.0	%
Loans:
Mortgage		24,201			21,494			12.6	%		6.75	%		6.63	%		12			716,601			648,321			10.5	%
Commercial		8,298			5,560			49.2	%		8.51	%		6.30	%		221			194,913			176,474			10.4	%
Consumer		2,065			1,303			58.5	%		11.08	%		10.00	%		108			37,295			26,068			43.1	%
		34,564			28,357			21.9	%		7.29	%		6.67	%		62			948,809			850,863			11.5	%
		112,886			96,448			17.0	%		5.06	%		4.74	%		32			4,461,132			4,072,091			9.6	%
Interest-bearing liabilities:
Deposits:
Non-interest bearing deposits		—			—			0.0	%		—			—			0			40,965			59,314			-30.9	%
Now Accounts		433			462			-6.4	%		1.05	%		1.04	%		1			82,617			88,627			-6.8	%
Savings		1,271			469			171.0	%		2.24	%		1.00	%		124			113,717			93,824			21.2	%
Certificates of Deposit		19,940			15,389			29.6	%		4.01	%		3.36	%		65			993,618			916,577			8.4	%
		21,644			16,320			32.6	%		3.52	%		2.82	%		70			1,230,917			1,158,342			6.3	%
Borrowings:
Repurchase agreements		60,487			30,890			95.8	%		4.75	%		2.76	%		199			2,548,638			2,240,004			13.8	%
Interest rate risk management		(3,250	)		2,742			-218.5	%		-0.26	%		0.24	%		(50	)		—			—			0.0	%
Financing fees		254			337			-24.6	%		0.02	%		0.03	%		(1	)		—			—			0.0	%
Total repurchase agreements		57,491			33,969			69.2	%		4.51	%		3.03	%		148			2,548,638			2,240,004			13.8	%
FHLB advances		4,597			3,960			16.1	%		3.15	%		2.58	%		57			292,213			307,383			-4.9	%
Subordinated capital notes		2,641			2,273			16.2	%		7.32	%		6.30	%		102			72,166			72,166			0.0	%
Term Notes		316			194			62.9	%		4.21	%		2.59	%		180			15,000			15,000			21.2	%
Other borrowings		277			34			714.7	%		6.08	%		2.92	%		362			9,118			2,325			155.1	%
		65,322			40,430			61.6	%		4.45	%		3.07	%		138			2,937,135			2,636,878			11.4	%
		86,966			56,750			53.2	%		4.17	%		2.99	%		118			4,168,052			3,795,220			9.8	%
Net interest income / spread	$	25,920		$	39,698			-34.7	%		0.89	%		1.75	%		(86	)
Interest rate margin											1.16	%		1.95	%		(79	)
Excess of average interest-earning assets over average interest-bearing liabilities																			$	293,080		$	276,871			5.9	%
Average interest-earning assets over average interest-bearing liabilities ratio																				107.03	%		107.30	%

C. Changes in net interest income due to:	Volume			Rate			Total
Interest Income:
Investments		28,060			(17,829	)		10,231
Loans	$	19,398		$	(13,191	)	$	6,207
		47,458			(31,020	)		16,438
Interest Expense:
Deposits	$	3,747			1,577			5,324
Repurchase agreements		15,125			8,397			23,522
Other borrowings		(556	)		1,926			1,370
		18,316			11,900			30,216
Net Interest Income	$	29,142		$	(42,920	)	$	(13,778	)

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Net interest income is a function of the difference between rates earned on the Group’s interest-earning assets and rates paid on its interest-bearing liabilities (interest rate spread) and the relative amounts of its interest-earning assets and interest-bearing liabilities (interest rate margin). Typically, bank liabilities re-price in line with changes in short-term rates, while many asset positions are affected by longer-term rates. The Group constantly monitors the composition and re-pricing of its assets and liabilities to maintain its net interest income at adequate levels.

For the quarter and six-month period ended June 30,2006, net interest income amounted to $10.7 million and $25.9 million, respectively, a 44.5% and 34.8% decrease from $19.3 million and $39.7 million in the same period of the previous year. The decrease for the quarter reflects a 16.4% increase in interest income, due to a $15.5 million positive volume variance and a $7.5 million negative rate variance, more than offset by an increase of 56.1% in interest expense, caused by an increase of $8.7 million from borrowings volume and $7.9 million due to interest rate changes. The decrease for the six-month period reflects a 17.0% increase in interest income, due to a $47.5 million positive volume variance and a $31.0 million negative interest rate variance, offset by an increase of 53.2% in interest expense, caused by an increase of $18.3 million from borrowings volume and $11.9 million attributable to interest rate changes. Interest rate spread dropped 98 basis points, to 0.70% from 1.68% in the June 2005 quarter, and 86 basis points to 0.89% from 1.75% in the six-month period ended June 2005. This decline was due to an increase of 30 and 32 basis points, respectively, in the combined average yield of investments and loans for the quarters and six-month periods and an increase of 128 and 118 basis points, respectively, caused by an increase in the average cost of funds.

For the quarter and six-month period ended June 30,2006, the average balance of total interest-earnings assets grew 9.5% to $4.481 billion versus $4.092 billion and 9.6% to $4.461 billion compared to $4.072 billion for the same periods of the previous year. The increase in the average balance reflects growth of 9.4% in the investment portfolio to $3.505 billion and a 9.9%in loans, to $975.6 million for the quarter, and 9.0% in the investment portfolio to $3.512 billion, and 11.5% in loans, to $948.8 million for the six-month period. Most of the dollar increase in loans came from the residential mortgage loan portfolio average balance, which increased by 14.2% to $714.6 million for the quarter ended June 30,2006 from $625.6 million for the quarter ended June 30,2005 and 10.5% to $716.6 million for the six-month period ended June 30,2006 from $648.3 million a year ago.

For the quarter and six-month period ended June 30,2006, the average yield on interest-earning assets was 5.08%and 5.06%, respectively, compared to 4.78% and 4.74% in the comparable year ago periods. Higher average yields were due to increases in both of the investments and loan portfolio yields. The investment portfolio yield increased to 4.40% in the quarter ended June 30,2006, versus 4.24% in the corresponding year ago quarter and to 4.46% in the six-month period ended June 30,2006, versus 4.23% in the corresponding period a year ago, due to additions of higher yield investments. The increase of 78 basis points in the yield of the loan portfolio for the quarter and 62 basis points for the six-month period was due to higher rates on mortgage, commercial and consumer loans new production reflecting higher rates on variable rate loans due to the higher interest rate environment for lending.

For the quarter and six-month period ended June 30, 2006, interest expense increased 56.1% to $46.2 million from $29.6 million for the year ago quarter and 53.2% to $87.0 million from $56.8 million for the year ago six-month period, both resulting from higher volume and rate variances due to the increased interest earnings asset portfolio.

For the quarter and six-month period ended June 30,2006, the cost of deposits increased 78 basis points to 3.65% as compared to 2.87% in the year ago quarter and 70 basis points to 3.52% as compared to 2.82% in the year ago six-month period. The increase reflects higher average rates paid on higher balances, specifically in savings accounts. For the quarter and six-month period ended June 30,2006, the cost of borrowings increased 147 basis points to 4.68% as compared to 3.21% in the year ago quarter and 138 basis points to 4.45% as compared to 3.07% in the year ago six-month period. The increase was mainly the result of higher average rates paid on increased volume of repurchase agreements. Repurchase agreements increased 203 basis points, to 5.04% from 3.01% for the quarter ended June 30,2005 and 199 basis points to 4.75% as compared to 2.76% in the year ago six-month period, reflecting the effect of interest rate increases by the Board of Governors of the Federal Reserve System of 300 basis points since December 2004. The cost of repurchase agreements was offset by a 45 basis point reduction in the Group’s hedging costs for the quarter ended June 30, 2006 and 50 basis points for the six-month period, as the Group’s use of interest rate swaps in a rising interest rate environment partially offset rising borrowing costs. The cost of FHLB advances increased 62 basis points to 3.22% versus 2.60% for the quarter ended June 30,2005, and 57 basis points to 3.15% as compared to 2.58% in the year ago six-month period.

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TABLE 2 — NON-INTEREST INCOME SUMMARY:
FOR THE QUARTERS AND SIX-MONTH PERIODS ENDED JUNE 30, 2006 AND 2005
(Dollars in thousands)

	Quarter Ended June 30,									Six-Month Period Ended June 30,
	2006			2005			Variance %			2006			2005			Variance %
Mortgage banking activities	$	634		$	1,168			-45.7	%	$	1,070		$	2,241			-52.3	%
Commissions and fees from broker, insurance activities		4,066			3,249			25.1	%		7,317			6,419			14.0	%
Investment banking revenues		852			162			425.9	%		2,561			339			655.5	%
Non-banking service revenues		5,552			4,579			21.2	%		10,948			8,999			21.7	%
Fees on deposit accounts		1,315			1,233			6.7	%		2,734			2,392			14.3	%
Bank service charges and commissions		656			367			78.7	%		1,275			929			37.2	%
Other operating revenues		540			464			16.2	%		678			572			18.5	%
Bank service revenues		2,511			2,064			21.6	%		4,687			3,893			20.4	%
Securities net gain		—			1,420			-100.0	%		19			4,056			-99.5	%
Trading net (loss) gain		(8	)		(42	)		-81.0	%		21			(53	)		-139.6	%
Derivatives net (loss) gain		(23	)		(1,866	)		-98.8	%		859			(4,670	)		-118.4	%
Securities, derivatives and trading activities		(31	)		(488	)		-93.6	%		899			(667	)		234.8	%
Other income (loss)		(511	)		282			-281.2	%		(60	)		311			-119.3	%
Other non-interest income		(511	)		282			-281.2	%		(60	)		311			-119.3	%
Total non-interest income	$	7,521		$	6,437			16.8	%	$	16,474		$	12,536			31.4	%

Non-interest income, the second largest source of earnings, is affected by the amount of securities and trading transactions, the level of trust assets under management, transactions generated by the gathering of financial assets by the securities broker-dealer subsidiary, the level of investment and mortgage banking activities, and the fees generated from loans, deposit accounts, and insurance.

Non-interest income totaled $7.5 million and $16.5 million in the quarter and six-months ended June 30,2006, respectively a 16.8% and 31.4% increase when compared to $6.4 million and $12.5 million in the same periods of the previous year. Performance in the quarter and six-months ended June 30, 2006, reflects increases in commissions and fees from brokerage investment banking, and insurance activities reflecting increased activities from the financial services area, as well as higher banking service revenues. This was partially offset by less mortgage banking activities, primarily reflecting the Group’s strategy, initiated during the quarter ended June 30, 2005, to retain more mortgages for their recurring interest income rather than selling the loans for a gain.

Non-banking service revenues, generated from trust, mortgage banking, investment banking, brokerage, and insurance activities, is one of the principal components of non-interest income. For the quarter and six-month period ended June 30,2006, these revenues increased 21.2% and 21.7% to $5.6 million and $10.9 million, respectively, from $4.6 million and $9.0 million for the year ago periods. Mortgage banking activities decreased 45.7%, to $634,000 from $1.2 million in the year ago quarter and 52.3%, to $1.1 million from $2.2 million in the year ago six-month period. Commissions and fees from brokerage and insurance activities increased 25.1% to $4.1 million from $3.2 million in the year ago quarter and 14.0%, to $7.3 million from $6.4 million in the year ago six-month period. Growth reflected the general improvement in the equity markets and increased underwriting activities. Investment banking revenues increased to $852,000 from $162,000 the year ago quarter and to $2.6 million from $339,000 the year ago six-month period.

Banking service revenues, another major component of non-interest income, consists primarily of fees generated by deposit accounts, electronic banking services, and bank service commissions. For the quarter and six-month period ended June 30,2006, these revenues increased 21.6% to $2.5 million compared to the year ago quarter and 20.4% to $4.7 million the year ago six-month period, primarily due to increase in fee income on deposit accounts, mainly overdraft fees, and the ongoing success of the Group’s product and service marketing programs. Fees on deposit accounts increased 6.7% to $1.3 million from $1.2 million in the year ago quarter and 14.3% to $2.7 million from $2.4 million in the year ago six-month period. Bank service charges and commissions increased 78.7% to $656,000 from $367,000 in the year ago quarter and 37.2% to $1.3 million from $929,000 in the year ago reflecting higher transactional volume in the Bank’s debit and credit cards.

For the quarter ended June 30, 2006, (losses) gains from securities, derivatives and trading activities was ($31,000) compared to ($488,000) for the year ago quarter and $899,000 compared to ($667,000) for the year ago six-month period. The improvement for both periods was primarily due to higher mark to market valuation of financial instruments used to partially offset the effect of rising rates on interest expense.

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TABLE 3 — NON-INTEREST EXPENSES SUMMARY
FOR THE QUARTER AND SIX-MONTH PERIODS ENDED JUNE 30, 2006 AND 2005
(Dollars in thousands)

	Quarter Ended June 30,									Six-Month Period Ended June 30,
	2006			2005			Variance %			2006			2005			Variance %
Compensation and employee benefits	$	5,627		$	4,402			27.8	%	$	11,801		$	7,697			53.3	%
Occupancy and equipment		2,793			3,066			-8.9	%		5,682			5,532			2.7	%
Advertising and business promotion		1,300			1,420			-8.5	%		2,366			2,907			-18.6	%
Professional and service fees		1,601			1,777			-9.9	%		3,225			3,614			-10.8	%
Communications		395			410			-3.7	%		843			786			7.3	%
Loan servicing expenses		509			430			18.4	%		964			831			16.0	%
Taxes, other than payroll and income taxes		573			471			21.7	%		1,173			934			25.6	%
Electronic banking charges		494			543			-9.0	%		962			1,060			-9.2	%
Printing, postage, stationery and supplies		359			207			73.4	%		544			416			30.8	%
Insurance, including deposits insurance		219			188			16.5	%		432			375			15.2	%
Other operating expenses		914			979			-6.6	%		1,675			1,888			-11.3	%
Total non-interest expenses	$	14,784		$	13,893			6.4	%	$	29,667		$	26,040			13.9	%
Relevant ratios and data:
Compensation and benefits to non-interest expenses		38.1	%		31.7	%					39.8	%		29.6	%
Compensation to total assets		0.47	%		0.41	%					0.49	%		0.36	%
Average compensation per employee (annualized)	$	42.4		$	33.8					$	44.6		$	28.9
Average number of employees		531			521						529			532
Bank assets per employee	$	9,101		$	8,151					$	9,177		$	7,983
Total work force:											537			519

Non-interest expenses for the quarter and six-month period ended June 30, 2006, were $14.8 million and $29.7 million, respectively, compared to $13.9 million and $26.0 million in the year ago periods, with an efficiency ratio of 78.76% compared to 53.58% in the quarter ended June 30, 2005 and 71.39% compared to 49.52% for the six-month period ended June 30, 2005. The efficiency ratio measures how much of a company’s revenue is used to pay operating expenses. The Group computes its efficiency ratio by dividing operating expenses by the sum of its net interest income and recurring non-interest income, but excluding gains on sale of investments securities, derivatives gains or losses and other income.

The Group has been successful in limiting expense growth to those areas that directly contribute to increase efficiency, service quality, and profitability. Non-interest expenses increased 6.4% and 13.9%, respectively, compared to the year ago quarter and six months ended June 30, 2005, which included a non-cash compensation benefit of $3.0 million and $6.3 million, respectively, as a result of the Group’s previously disclosed restatement. Excluding the year ago non-cash compensation benefit, non interest expense declined 12.3% and 8.2%, respectively, from the comparable year ago periods.

Compensation and employee benefits, the largest non-interest expense category accounted for 38.1% and 39.8% of the total non-interest expense, for the quarter and six-month period ended June 30, 2006, respectively. Total compensation and employee benefits amounted to $5.6 million and $11.8 million, respectively, for the quarter and six-month period ended June 30, 2006, compared to $4.4 million and $11.8 million, in the comparable year ago periods, which benefited from the previously mentioned non-cash variable accounting reduction.

Occupancy and equipment expenses amounted to $2.8 million and $5.7 million, decreasing 8.9% from $3.1 million for the quarter ended June 30, 2005 and increasing 2.7% from $5.5 million for the six-month period ended June 30, 2005. The variation is mainly due to the acceleration of leasehold improvements amortization expense due to the relocation in May 2006 of the Group’s main offices to a new financial center building, where most non-branch operations have been consolidated for increased efficiencies.

Taxes, other than payroll and income taxes, increased 21.6% to $573,000 from $471,000 for the last quarter and 25.6% to $1.2 million from $934,000 for the six-month period a year ago, mainly due to the increase in revenues and income subject to volume of business tax.

The total decrease in advertising and business promotion, professional and service fees, and electronic banking charges was principally due to effective cost controls.

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TABLE 4 — ALLOWANCE FOR LOAN LOSSES SUMMARY
FOR THE QUARTERS AND SIX-MONTH PERIODS ENDED JUNE 30, 2006 AND 2005
(Dollars in thousands)

	Quarter Ended June 30,						Change in			Six-Month Period Ended June 30,						Change in
	2006			2005			%			2006			2005			%
Beginning balance	$	7,160		$	6,980			2.6	%	$	6,630		$	7,565			-12.4	%
Provision for loan losses		947			850			11.4	%		2,048			1,510			35.6	%
Net credit losses — see Table 5		(606	)		(1,335	)		-54.6	%		(1,177	)		(2,580	)		-54.4	%
Ending balance	$	7,501		$	6,495			15.5	%	$	7,501		$	6,495			15.5	%
Selected Data and Ratios:
Outstanding gross loans at June 30,										$	1,161,439		$	910,099			27.6	%
Recoveries to charge-offs											18.4	%		9.9	%		85.9	%
Allowance coverage ratio
Total loans											0.65	%		0.71	%		-8.5	%
Non-performing loans											25.55	%		21.05	%		21.4	%
Non-mortgage non-performing loans											213.52	%		139.02	%		53.6	%

TABLE 5 — NET CREDIT LOSSES STATISTICS
(Dollars in thousands)

	Quarter Ended June 30,						Change in			Six-Month Period Ended June 30,						Change in
	2006			2005			%			2006			2005			%
Mortgage
Charge-offs	$	(178	)	$	(911	)		-80.5	%	$	(377	)	$	(1,663	)		-77.3	%
Recoveries		—			—			0.0	%		—			—			0.0	%
		(178	)		(911	)		-80.5	%		(377	)		(1,663	)		-77.3	%
Commercial
Charge-offs		(196	)		(170	)		15.3	%		(220	)		(485	)		-54.6	%
Recoveries		76			11			590.9	%		83			14			492.9	%
		(120	)		(159	)		-24.5	%		(137	)		(471	)		-70.9	%
Consumer
Charge-offs		(389	)		(378	)		2.9	%		(845	)		(715	)		18.2	%
Recoveries		81			113			-28.3	%		182			269			-32.3	%
		(308	)		(265	)		16.2	%		(663	)		(446	)		48.7	%
Net credit losses
Total charge-offs		(763	)		(1,459	)		-47.7	%		(1,442	)		(2,863	)		-49.6	%
Total recoveries		157			124			26.6	%		265			283			-6.4	%
	$	(606	)	$	(1,335	)		-54.6	%	$	(1,177	)	$	(2,580	)		-54.4	%
Net credit losses to average outstanding (1):
Mortgage		0.10	%		0.58	%					0.11	%		0.95	%
Commercial		0.22	%		0.27	%					0.14	%		0.53	%
Consumer		3.21	%		3.90	%					3.56	%		3.42	%
Total		0.25	%		0.60	%					0.25	%		0.61	%
Average loans:
Mortgage	$	714,649		$	625,556			14.2	%	$	716,601		$	648,321			10.5	%
Commercial		222,574			235,023			-5.3	%		194,913			176,474			10.4	%
Consumer		38,344			27,146			41.3	%		37,295			26,068			43.1	%
Total	$	975,567		$	887,725			9.9	%	$	948,809		$	850,863			11.5	%

(1) Annualized ratios

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TABLE 6 — ALLOWANCE FOR LOSSES BREAKDOWN
(Dollars in thousands)

	June 30,			December 31,			Change in			June 30,
	2006			2005			%			2005
Allowance for loan losses breakdown:
Mortgage	$	3,463		$	3,185			8.7	%	$	3,167
Commercial		1,721			1,723			-0.1	%		1,714
Consumer		2,088			1,417			47.4	%		1,335
Unallocated allowance		229			305			-24.9	%		279
	$	7,501		$	6,630			13.1	%	$	6,495
Allowance composition:
Mortgage		46.2	%		48.0	%					48.7	%
Commercial		22.9	%		26.0	%					26.4	%
Consumer		27.8	%		21.4	%					20.6	%
Unallocated allowance		3.1	%		4.6	%					4.3	%
		100.0	%		100.0	%					100.0	%

The provision for loan losses for the quarter and six-month period ended June 30, 2006, totaled $947,000, an 11.4% increase from the $850,000 reported for the same quarter of the previous year, and $2.0 million, an 35.6% increase from the $1.5 million reported for the same six-month period of the previous year. Based on an analysis of the credit quality and composition of its loan portfolio, the Group determined that the provision for the first six months of the current year was adequate in order to maintain the allowance for loan losses at an appropriate level.

Net credit losses for the quarter and six-month period decreased 54.6%, from $1.3 million in the quarter ended June 30, 2005, to $606,000 in the quarter ended June 30, 2006 and 54.4%, from $2.6 million in the six-month period ended June 30, 2005, to $1.2 million in the six-month period ended June 30, 2006. The decreases were primarily due to reductions in net credit losses for mortgage of $729,000 for the quarter and $1.4 million for the six-month period, respectively, when compared to the same periods in the previous year. For the quarter and six-month period of the current year, the net credit losses average ratio was 0.25% for both periods, compared to 0.60% and 0.61%, respectively reported for the same periods of the prior fiscal year. Non-performing loans of $29.4 million as of June 30, 2006 were 4.8% lower than the $30.9 million as of June 30, 2005, and 3.3% higher than the $28.4 million reported as of December 31, 2005 (Table 9).

At June 30, 2006, the Group’s allowance for loan losses amounted to $7.5 million (0.65% of total loans) compared to $6.6 million (0.73% of total loans) reported at December 31, 2005. Consumer and mortgage loan allowances increased by 47.4% and 8.7%, or $671,000 and $278,000, respectively, when compared with balances recorded at December 31, 2005. Commercial loans allowance decreased 0.1% or $2,000, when compared to December 31, 2005. Unallocated allowance decreased 25.0%, or $76,000, when compared to December 31, 2005.

The Group maintains an allowance for loan losses at a level that management considers adequate to provide for potential losses based upon an evaluation of known and inherent risks. The Group’s allowance for loan losses policy provides for a detailed quarterly analysis of possible losses.

The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectibility of the loans in light of historical loss experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as more information becomes available.

The Group uses a methodology that follows a loan credit risk rating process that involves dividing loans into risk categories. The following are the credit risk categories used:

1.	Pass — loans considered highly collectible due to their repayment history or current status.
2.	Special Mention — loans with potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects of the loan.
3.	Substandard — loans inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.

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4.	Doubtful — loans that have all the weaknesses inherent in substandard, with the added characteristic that collection or liquidation in full is highly questionable and improbable.
5.	Loss — loans considered uncollectible and of such little value that their continuance as bankable assets is not warranted.

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.

The Group evaluates all loans, some individually and others as homogeneous groups, for purposes of determining impairment. The portfolios of mortgages and consumer loans are considered homogeneous and are evaluated collectively for impairment. For the commercial loans portfolio, all loans over $250,000 are evaluated for impairment. At June 30, 2006, the total investment in impaired loans was $1.8 million, a 50% reduction from the $3.6 million at December 31, 2005, mainly due to certain commercial loans collected during the quarter ended June 30, 2006. Impaired loans are measured based on the fair value of collateral. The Group determined that no specific impairment allowance was required for such loans.

The Group, using an aged-based rating system, applies an overall allowance percentage to each loan portfolio category based on historical credit losses adjusted for current conditions and trends. This delinquency-based calculation is the starting point for management’s determination of the required level of the allowance for loan losses. Other data considered in this determination includes:

1. Overall historical loss trends; and

2. Other information including underwriting standards, economic trends and unusual events

Loan loss ratios and credit risk categories are updated quarterly and are applied in the context of GAAP and the Joint Interagency Guidance on the importance of depository institutions having prudent, conservative, but not excessive loan loss allowances that fall within an acceptable range of estimated losses. While management uses available information in estimating possible loan losses, future changes to the allowance may be necessary, based on factors beyond the Group’s control, such as factors affecting general economic conditions.

An unallocated allowance is established recognizing the estimation risk associated with the aged-based rating system and with the specific allowances. It is based upon management’s evaluation of various conditions, the effects of which are not directly measured in determining the aged-based rating system and the specific allowances. These conditions include then-existing general economic and business conditions affecting our key lending areas; credit quality trends, including trends in non-performing loans expected to result from existing conditions, collateral values, loan volumes and concentrations, seasoning of the loan portfolio, recent loss experience in particular segments of the portfolio, regulatory examination results, and findings by the Group’s management. The evaluation of the inherent loss regarding these conditions involves a higher degree of uncertainty because they are not identified with specific problem credits or portfolio segments.

-32-

FINANCIAL CONDITION

TABLE 7 — ASSETS SUMMARY AND COMPOSITION
(Dollars in thousands)

	June 30,			December 31,			Variance			June 30,
	2006			2005			%			2005
Investments:
Mortgage-backed securities	$	1,993,034		$	1,961,285			1.6	%	$	1,959,760
U.S. Government and agency obligations		1,258,975			1,251,058			0.6	%		1,029,980
P.R. Government and agency obligations		82,474			90,333			-8.7	%		108,968
Other investment securities		109,348			90,609			20.7	%		66,023
Short-term investments		35,722			63,480			-43.7	%		39,791
FHLB stock		18,269			20,002			-8.7	%		27,058
		3,497,822			3,476,767			0.6	%		3,231,580
Loans:
Mortgage		884,671			637,318			38.8	%		735,971
Commercial, mainly secured by real estate		227,744			227,846			0.0	%		129,670
Consumer		39,460			35,828			10.1	%		30,282
Loans receivable		1,151,875			900,992			27.8	%		895,923
Allowance for loan losses		(7,501	)		(6,630	)		13.1	%		(6,495	)
Loans receivable, net		1,144,374			894,362			28.0	%		889,428
Mortgage loans held for sale		9,564			8,946			6.9	%		17,963
Total loans receivable, net		1,153,938			903,308			27.7	%		907,391
Securities sold but not yet delivered		710			44,009			-98.4	%		1,034
Total securities and loans		4,652,470			4,424,084			5.2	%		4,140,005
Other assets:
Cash and due from banks		35,237			13,789			155.5	%		14,892
Accrued interest receivable		31,313			29,067			7.7	%		23,735
Premises and equipment, net		17,358			14,828			17.1	%		15,269
Deferred tax asset, net		14,861			12,222			21.6	%		6,191
Foreclosed real estate, net		4,379			4,802			-8.8	%		4,186
Other assets		77,044			48,157			60.0	%		46,374
Total other assets		180,192			122,865			46.7	%		110,647
Total assets	$	4,832,662		$	4,546,949			6.3	%	$	4,250,652
Investment portfolio composition:
Mortgage-backed securities		56.9	%		56.4	%					60.6	%
U.S. Government and agency obligations		36.0	%		36.0	%					31.9	%
P.R. Government and agency obligations		2.4	%		2.6	%					3.4	%
FHLB stock, short term investments and debt securities		4.7	%		5.0	%					4.1	%
		100.0	%		100.0	%					100.0	%
Loan portfolio composition:
Mortgage		77.0	%		71.0	%					82.5	%
Commercial, mainly secured by real estate		19.6	%		25.0	%					14.2	%
Consumer		3.4	%		4.0	%					3.3	%
		100.0	%		100.0	%					100.0	%

At June 30, 2006, the Group’s total assets amounted to $4.833 billion, an increase of 6.3%, when compared to $4.547 billion at December 31, 2005. At June 30, 2006, interest-earning assets were $4.652 billion, a 5.2% increase compared to $4.424 billion at December 31, 2005.

Investments are the Group’s largest interest-earning assets component. Investments principally consist of money market instruments, U.S. government bonds, mortgage-backed securities, collateralized mortgage obligations, and Puerto Rico government bonds. At June 30, 2006, the investment portfolio increased 0.6% to $3.498 billion, from $3.477 billion as of December 31, 2005. The increase reflects additional mortgage-backed securities investments. The Group maintains its strategy in a rising interest rate environment of investing in fixed and variable rate, short-term and medium-term government securities, and the sale of long-term mortgage-backed securities.

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At June 30, 2006, the Group’s loan portfolio, the second largest category of the Group’s interest-earning assets, increased by 27.7% to $1.154 billion when compared to $903.3 million at December 31, 2005. This was principally due to increased production and purchases of mortgage and commercial loans. Mortgage and consumer loans grew by 38.8% and 10.1%, respectively, to $884.7 million and $39.5 million, when compared to $637.3 million and $35.8 million at December 31, 2005. Such increases reflect the Group’s strategy to expand its loan portfolios. During the quarter and six-month period ended June 30, 2006, total loan production amounted to $262.2 million and $354.9, respectively, an increase of 118.0% and 26.7% over the year ago periods. During the quarter and six-month period ended June 30, 2006, the Group purchased $174.2 million and $181.8 million, respectively in real estate mortgage loans. During the six-month ended June 30, 2005, the Group granted $46.8 million in a commercial real estate loan backed by real estate mortgages.

TABLE 8 — NON-PERFORMING ASSETS
(Dollars in thousands)

	June 30,			December 31,			Change in			June 30,
	2006			2005			%			2005
Non-performing assets:
Non- Accruing Loans	$	15,096		$	18,986			-20.5	%	$	21,859
Accruing Loans		14,264			9,447			60.0	%		8,997
Total Non-performing loans		29,360			28,433			3.3	%		30,856
Foreclosed real estate		4,379			4,802			-8.8	%		4,186
	$	33,739		$	33,235			1.5	%	$	35,042
Non-performing assets to total assets		0.70	%		0.73	%					0.83	%

TABLE 9 — NON-PERFORMING LOANS
(Dollars in thousands)

	June 30,			December 31,			Change in			June 30,
	2006			2005			%			2005
Non-performing loans:
Mortgage	$	25,847		$	23,535			9.8	%	$	26,184
Commercial, mainly secured by real estate		2,930			4,600			-36.3	%		4,549
Consumer		583			298			95.6	%		123
Total	$	29,360		$	28,433			3.3	%	$	30,856
Non-performing loans composition:
Mortgage		88.0	%		82.8	%					84.9	%
Commercial, mainly secured by real estate		10.0	%		16.2	%					14.7	%
Consumer		2.0	%		1.0	%					0.4	%
Total		100.0	%		100.0	%					100.0	%
Non-performing loans to:
Total loans		2.53	%		3.12	%		-18.9	%		3.39	%
Total assets		0.61	%		0.63	%		-3.2	%		0.73	%
Total capital		8.63	%		8.32	%		3.7	%		9.11	%

At June 30, 2006, the Group’s non-performing assets totaled $33.7 million (0.70% of total assets) versus $33.2 million (0.73% of total assets) at December 31, 2005. Foreclosed real estate properties decreased 8.8% to $4.4 million, when compared to $4.8 million reported as of December 31, 2005.

Non-performing consumer loans increased to $583,000 as of June 30, 2006, from $298,000 as of December 31, 2005, mainly due to the higher charge-offs due to current economical conditions. Non-performing mortgage loans increased 9.8% to $25.8 million as of June 30, 2006, when compared to December 31, 2005 non-performing level of $23.5 million, and non-performing commercial loans decreased by 36.3% to $2.9 million as of June 30, 2006 compared to $4.6 million at December 31, 2005.

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At June 30,2006, the allowance for loan losses to non-performing loans coverage ratio was 25.55%. Detailed information concerning each of the items that comprise non-performing assets follows:

• Mortgage loans are placed on a non-accrual basis when they become 365 days or more past due and are written-down, if necessary, based on the specific evaluation of the collateral underlying the loan. At June 30,2006, the Group’s non-performing mortgage loans totaled $25.8 million (88.0% of the Group’s non-performing loans), a 9.8% increase from the $23.5 million (82.8% of the Group’s non-performing loans) reported at December 31, 2005. Non-performing loans in this category are primarily residential mortgage loans. Based on the value of the underlying collateral, the loan-to-value ratios and credit loss experience, management considers that no significant losses will be incurred on this portfolio.

• Commercial loans are placed on non-accrual status when they become 90 days or more past due and are written-down, if necessary, based on the specific evaluation of the underlying collateral, if any. At June 30,2006, the Group’s non-performing commercial loans amounted to $2.9 million (10.0% of the Group’s non-performing loans), a 36.3% decrease from $4.6 million reported at December 31, 2005 (16.2% of the Group’s non-performing loans). Most of this portfolio is collateralized by real estate and no significant losses are expected.

• Consumer loans are placed on non-accrual status when they become 90 days past due and written-off when payments are delinquent 120 days in personal loans and 180 days in credit cards and personal lines of credit. At June 30, 2006, the Group’s non-performing consumer loans amounted to $583,000 (2.0% of the Group’s total non-performing loans), which increased from the $298,000 reported at December 31, 2005 (1% of total non-performing loans).

• Foreclosed real estate is initially recorded at the lower of the related loan balance or fair value at the date of foreclosure. Any excess of the loan balance over the fair market value of the property is charged against the allowance for loan losses. Subsequently, any excess of the carrying value over the estimated fair market value less disposition cost is charged to operations.

At June 30,2006, the Group’s total liabilities were $4.492 billion, 6.8% higher than the $4.205 billion reported at December 31, 2005. Deposits and borrowings, the Group’s funding sources, amounted to $4.460 billion at June 30,2006, an increase of 8.0% when compared to $4.131 billion reported at December 31, 2005. At June 30,2006, borrowings represented 73% of interest-bearing liabilities and deposits represented 27%, versus 69% and 31%, respectively, at December 31, 2005.

Borrowings is the Group’s largest interest-bearing liability component. It consists mainly of diversified funding sources through the use of repurchase agreements, FHLB advances, subordinated capital notes, term notes, and lines of credit. At June 30,2006, borrowings amounted to $3.246 billion, 14.6% greater than the $2.833 billion at December 31, 2005, mainly due to an increase of 17.6% in repurchase agreements, reflecting the funding needed to finance the Group’s investment and loan portfolios.

The FHLB system functions as a source of credit to financial institutions that are members of a regional Federal Home Loan Bank. As a member of the FHLB, the Group can obtain advances from the FHLB, secured by the FHLB stock owned by the Group, as well as by certain of the Group’s mortgages and investment securities. FHLB advances totaled $285.5 million at June 30, 2006, and $313.3 million at December 31, 2005. The Group has the capacity to expand FHLB funding up to a maximum of $288.6 million based on the current $18.3 million capital contribution by the Group to the FHLB.

At June 30, 2006, deposits, the second largest category of the Group’s interest-bearing liabilities, reached $1.214 billion, down 6.5%, compared to the $1.299 billion reported as of December 31, 2005. Deposits reflected a quarterly decrease of 15.5% in certificates of deposit, to $896.6 million primarily due to a decrease in brokered deposits, partially offset by an increase in savings accounts of 107.0%, to $171.0 million as of June 30, 2006 from $82.6 million as of December 31, 2005.

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TABLE 10 — LIABILITIES SUMMARY AND COMPOSITION
(Dollars in thousands)

	June 30,			December 31,
	2006			2005			Variance %			June 30, 2005
Deposits:
Non-interest bearing deposits	$	62,266		$	61,473			1.3	%	$	62,205
Now accounts		78,970			85,119			-7.2	%		89,930
Savings accounts		171,030			82,640			107.0	%		93,920
Certificates of deposit		896,571			1,061,401			-15.5	%		1,002,908
		1,208,837			1,290,633			-6.3	%		1,248,963
Accrued interest payable		5,010			7,935			-36.9	%		3,934
		1,213,847			1,298,568			-6.5	%		1,252,897
Borrowings:
Repurchase agreements		2,856,361			2,427,880			17.6	%		2,191,756
Advances from FHLB		285,500			313,300			-8.9	%		300,000
Subordinated capital notes		72,166			72,166			0.0	%		72,166
Term notes		15,000			15,000			0.0	%		15,000
Federal funds purchased and other short term borrowings		17,098			4,455			283.8	%		12,310
		3,246,125			2,832,801			14.6	%		2,591,232
Total deposits and borrowings		4,459,972			4,131,369			8.0	%		3,844,129
Securities purchased but not yet received		6,539			43,354			-84.9	%		22,772
Other liabilities		25,868			30,435			-15.0	%		42,584
Total liabilities	$	4,492,379		$	4,205,158			6.8	%	$	3,909,485
Deposits portfolio composition percentages:
Non-interest bearing deposits		5.2	%		4.8	%					5.0	%
Now accounts		6.5	%		6.6	%					7.2	%
Savings accounts		14.1	%		6.4	%					7.5	%
Certificates of deposit		74.2	%		82.2	%					80.3	%
		100.0	%		100.0	%					100.0	%
Borrowings portfolio composition percentages:
Repurchase agreements		88.0	%		85.7	%					84.6	%
Advances from FHLB		8.8	%		11.1	%					11.6	%
Subordinated capital notes		2.2	%		2.5	%					2.8	%
Term notes		0.5	%		0.5	%					0.6	%
Federal funds purchased and other short term borrowings		0.5	%		0.2	%					0.4	%
		100.0	%		100.0	%					100.0	%
Repurchase agreements
Amount outstanding at quarter-end	$	2,856,361		$	2,427,880					$	2,191,756
Daily average outstanding balance	$	2,548,638		$	2,270,145					$	2,174,312
Maximum outstanding balance at any month-end	$	2,856,361		$	2,427,880					$	2,398,861

Stockholders’ Equity

Stockholders’ equity as of June 30,2006 was $340.3 million, a 0.4% decrease from $341.8 million as of December 31, 2005. This decrease reflects dividend payments and stock repurchased under the Group’s stock repurchase program, partially offset by the impact of earnings retention and the improvement in derivatives valuation from December 31, 2005.

On August 30, 2005, the Board of Directors of the Group approved a new stock repurchase program pursuant to which the Group is authorized to purchase in the open market of up to $12.1 million of its outstanding shares of common stock. The program superseded the program established in March 2003. On June 20, 2006, the Board of Directors approved an increase of $3.0 million to the initial amount, for the repurchase of up to $15.1 million. The shares of common stock so repurchased are to be held by the Group as treasury shares. During the quarter and six-month period ended June 30, 2006, the Group purchased 46,600 of its shares of common stock in the open market, at a total cost of $582,000, under such program.

The Group’s common stock is traded on the New York Stock Exchange (NYSE) under the symbol OFG. At June 30,2006, the Group’s market capitalization for its outstanding common stock was $313.6 million ($12.76 per share).

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Under the regulatory framework for prompt corrective action, banks that meet or exceed a Tier I capital risk-based ratio of 6%, a total capital risk-based ratio of 10% and a leverage ratio of 5% are considered well capitalized. The Bank exceeds those regulatory capital requirements.

The following are the consolidated capital ratios of the Group at June 30, 2006 and December 31, 2005:

TABLE 11 — CAPITAL, DIVIDENDS AND STOCK DATA
(In thousands, except for per share data)

	June 30,			December 31,			Variance			June 30,
	2006			2005			%			2005
Capital data:
Stockholders’ equity	$	340,283		$	341,791			-0.4	%	$	338,755
Regulatory Capital Ratios data:
Leverage Capital Ratio		9.39	%		10.13	%		-7.3	%		10.59	%
Minimum Leverage Capital Ratio Required		4.00	%		4.00	%					4.00	%
Actual Tier 1 Capital	$	435,973		$	447,669			-2.6	%	$	445,131
Minimum Tier 1 Capital Required	$	185,712		$	176,790			5.0	%	$	168,080
Tier 1 Risk-Based Capital Ratio		29.60	%		34.70	%		-14.7	%		36.97	%
Minimum Tier 1 Risk-Based Capital Ratio Required		4.00	%		4.00	%					4.00	%
Actual Tier 1 Risk-Based Capital	$	435,973		$	447,669			-2.6	%	$	445,131
Minimum Tier 1 Risk-Based Capital Required	$	58,912		$	51,602			14.2	%	$	48,163
Total Risk-Based Capital Ratio		30.11	%		35.22	%		-14.5	%		37.51	%
Minimum Total Risk-Based Capital Ratio Required		8.00	%		8.00	%					8.00	%
Actual Total Risk-Based Capital	$	443,474		$	454,299			-2.4	%	$	451,626
Minimum Total Risk-Based Capital Required	$	117,825		$	103,204			14.2	%	$	96,327
Stock data:
Outstanding common shares, net of treasury		24,562			24,580			0.0	%		24,876
Book value	$	11.09		$	11.14			-0.5	%	$	10.88
Market Price at end of period	$	12.76		$	12.36			3.2	%	$	15.26
Market capitalization	$	313,615		$	303,809			3.2	%	$	379,608

	June 30,			June 30,			Variance
	2006			2005			%
Common dividend data:
Cash dividends declared	$	6,889		$	6,940			-0.7	%
Cash dividends declared per share	$	0.28		$	0.28			0.0	%
Payout ratio		84.34	%		28.24	%		198.7	%
Dividend yield		4.24	%		2.57	%		65.0	%

The following provides the high and low prices and dividend per share of the Group’s stock for each quarter of the last three periods. Common stock prices and cash dividend per share were adjusted to give retroactive effect to the stock dividend declared on the Group’s common stock.

					Cash
	Price				Dividend
	High		Low		Per share
2006
June 30, 2006	$	13.99	$	11.96	$	0.14
March 31, 2006	$	14.46	$	12.41	$	0.14
2005
December 31, 2005	$	13.12	$	10.16	$	0.14
September 30, 2005	$	15.98	$	11.91	$	0.14
June 30, 2005	$	23.47	$	13.66	$	0.14
March 31, 2005	$	28.94	$	22.97	$	0.14
2004
December 31, 2004	$	28.41	$	24.37	$	0.14
September 30, 2004	$	26.64	$	22.76	$	0.13
June 30, 2004	$	29.77	$	23.26	$	0.13
March 31, 2004	$	29.55	$	22.45	$	0.13

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Interest Rate Risk and Asset/Liability Management

The Group’s interest rate risk and asset/liability management is the responsibility of the ALCO, which is composed of members of the Group’s senior management. The principal objective of ALCO is to enhance profitability while maintaining an appropriate level of interest rate and liquidity risks. ALCO is also involved in formulating economic projections and strategies used by the Group in its planning and budgeting process. In addition, ALCO oversees the Group’s sources, uses and pricing of funds.

Interest rate risk can be defined as the exposure of the Group’s operating results or financial position to adverse movements in market interest rates, which mainly occur when assets and liabilities reprice at different times and at different rates. This difference is commonly referred to as a “maturity mismatch” or “gap”. The Group employs various techniques to assess its degree of interest rate risk.

The Group is liability sensitive due to its fixed rate and medium to long-term asset composition being funded with shorter-term repricing liabilities. As a result, the Group utilizes various derivative instruments for hedging credit and market risk. The notional amounts are amounts from which calculations and payments are based. Notional amounts do not represent direct credit exposures. Direct credit exposure is limited to the net difference between the calculated amount 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.

The Group generally uses interest rate swaps and interest rate options in managing its interest rate risk exposure. The swaps were entered into to convert short-term borrowings into fixed rate liabilities for longer periods and provide protection against increases in short-term interest rates. Under these swaps, the Group pays a fixed monthly or quarterly cost and receives a floating monthly or quarterly payment based on LIBOR. Floating rate payments received from the swap counterparties correspond to the floating rate payments made on the short-term borrowings thus resulting in a net fixed rate cost to the Group. Please refer to Note 8-Derivatives Activities of the accompanying unaudited consolidated financial statements for more information related to the Group’s swaps, including derivatives used to manage exposure to the stock market on the certificates of deposit with an option tied to the performance of the Standard & Poor’s 500 stock market index.

During the quarter and six-month period ended June 30,2006, (losses) gains of ($23,000) and $859,000, respectively, compared to ($1.9 million) and ($4.7 million) for the same periods a year ago, were charged to earnings and reflected as “Derivatives Activities” in the consolidated statements of income. For the quarter and six-month period ended June 30,2006 unrealized gains of $8.1 million and $18.0 million, respectively, on derivatives designated as cash flow hedges were included in other comprehensive income (loss).

At June 30,2006 and December 31, 2005, the fair value of derivatives was recognized as either assets or liabilities in the unaudited consolidated statements of financial condition as follows: the fair value of the interest rate swaps to fix the cost of the forecasted rollover of short-term borrowings represented an asset of $20.3 million and $2.5 million, as of June 30,2006 and December 31, 2005, respectively, presented in other assets; the purchased options used to manage the exposure to the stock market on stock indexed deposits represented an asset of $26.0 million and $22.1 million, respectively also presented in other assets; the options sold to customers embedded in the certificates of deposit represented a liability of $24.6 million and $21.1 million, respectively, recorded in deposits.

The Group’s ALCO decided in July 2006 to unwind interest rate swaps with an aggregate notional amount of $640 million, which had been designated as cash flow hedges and had maturity dates ranging from September 2010 to December 2010. Management concluded that it was beneficial to Oriental to lock-in the fair value of these swaps at approximately $11 million. The net gain of $11 million on this transaction will continue to be included in other comprehensive income, and will be reclassified into earnings during the originally remaining term of the swaps, starting in the September 2006 quarter and through December 2010, by reducing the interest expense on borrowings.

The Group is exposed to a reduction in the level of net interest income (“NII”) in a rising interest rate environment. NII will fluctuate with changes in the levels of interest rates, affecting interest-sensitive assets and liabilities. The hypothetical rate scenarios as of June 30, 2006 consider a gradual change of plus and minus 200 basis points during a forecasted twelve-month period. The hypothetical rate scenarios as of December 31, 2005 consider a gradual change of plus 200 and minus 100 basis points during a forecasted twelve-month period. If (1) the rates in effect at year-end remain constant, or increase or decrease on instantaneous and sustained changes in the amounts presented for each forecasted period, and (2) all scheduled repricing, reinvestments and estimated prepayments, and reissuances are constant, or increase or decrease accordingly; NII will fluctuate as shown on the following table:

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(Dollars in thousands)
Change in	Expected		Amount			Percent
Interest rate	NII		Change			Change
June 30, 2006:
Base Scenario
Flat	$	34,805	$	—			0.0	%
+ 200 Basis points	$	13,395	$	(21,410	)		-61.5	%
- 200 Basis points	$	59,085	$	24,280			69.8	%
December 31, 2005:
Base Scenario
Flat	$	56,798	$	—			0.0	%
+ 200 Basis points	$	38,043	$	(18,755	)		-33.0	%
- 100 Basis points	$	65,168	$	8,370			14.7	%

Liquidity Risk Management

The objective of the Group’s asset and liability management function is to maintain consistent growth in net interest income within the Group’s policy limits. This objective is accomplished through management of the Group’s balance sheet composition, liquidity, and interest rate risk exposure arising from changing economic conditions, interest rates and customer preferences.

The goal of liquidity management is to provide adequate funds to meet changes in loan demand or unexpected deposit withdrawals. This is accomplished by maintaining liquid assets in the form of investment securities, maintaining sufficient unused borrowing capacity in the national money markets and delivering consistent growth in core deposits. As of June 30,2006, the Group had approximately $313.7 million in investments available to cover liquidity needs. Additional asset-driven liquidity is provided by securitizable loan assets. These sources, in addition to the Group’s 9.39% average equity capital base, provide a stable funding base.

In addition to core deposit funding, the Bank also accesses a variety of other short-term and long-term funding sources. Short-term funding sources mainly include securities sold under agreements to repurchase. Borrowing funding source limits are determined annually by each counterparty and depend on the Bank’s financial condition and delivery of acceptable collateral securities. The Bank may be required to provide additional collateral based on the fair value of the underlying securities. The Group also uses the FHLB as a funding source, issuing notes payable, such as advances, through its FHLB member subsidiary, the Bank. This funding source requires the Bank to maintain a minimum amount of qualifying collateral with a fair value of at least 110% of the outstanding advances. At June 30,2006, the Group has an additional borrowing capacity with the FHLB of $3.1 million.

In addition, the Bank utilizes the National Certificate of Deposit (“CD”) Market as a source of cost effective deposit funding in addition to local market deposit inflows. Depositors in this market consist of credit unions, banking institutions, CD brokers and some private corporations or non-profit organizations. The Bank’s ability to acquire brokered deposits can be restricted if it becomes in the future less than well capitalized. An adequately-capitalized bank, by regulation, may not accept deposits from brokers unless it applies for and receives a waiver from the FDIC.

As of June 30, 2006, the Bank had line of credit agreement with other financial institutions permitting the Bank to borrow a maximum aggregate amount of $15.0 million (no borrowings were made during the six-month period ended June 30, 2006 and December 31, 2005 under such lines of credit). The agreements provide for unsecured advances to be used by the Group on an overnight basis. Interest rates are negotiated at the time of the transaction. The credit agreements are renewable annually.

The Group’s liquidity targets are reviewed monthly by ALCO and are based on the Group’s commitment to make loans and investments and its ability to generate funds.

The principal source of funds for the Group is dividends from the Bank. The ability of the Bank to pay dividends is restricted by regulatory authorities (see “Dividend Restrictions” under “Regulation and Supervision” in Item 1). Primarily, through such dividends the Group meets its cash obligations and pays dividends to its common and preferred stockholders. Management believes that the Group will continue to meet its cash obligations as they become due and pay dividends as they are declared.

Changes in statutes and regulations, including tax laws and rules

The Group, as a Puerto Rico-chartered financial holding company, and its subsidiaries, are each subject to extensive federal and local governmental supervision and regulation relating to its banking, securities, and insurance business. The Group also

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benefits from favorable tax treatment under regulations relating to the activities of its international banking entities. In addition, there are laws and other regulations that restrict transactions between the Group and its subsidiaries. Any change in such tax or other regulations, whether by applicable regulators or as a result of legislation subsequently enacted by the Congress of the United States or the Legislature of Puerto Rico, could have an effect on the Group’s results of operations and financial condition.

Puerto Rico international banking entities, or IBEs, are currently exempt from taxation under Puerto Rico law. The IBE Act, as amended, imposes income taxes at normal statutory rates on each IBE that operates as a unit of a bank if the IBE’s net income exceeds 20 percent of the bank’s net income in taxable years commencing on July 1, 2005 and thereafter. It does not impose income taxation on an IBE that operates as a subsidiary of a bank.

The Group has an IBE that operates as a unit of the Bank. In November 2003, the Group organized a new IBE that operates as a subsidiary of the Bank. The Bank transferred as of January 1, 2004, substantially all of the Bank’s IBE assets to the new IBE subsidiary. Although this transfer of IBE assets allows the Group to continue enjoying tax benefits, there cannot be any assurance that the IBE Act will not be modified in the future in a manner to reduce the tax benefits available to the IBE subsidiary.

On August 1, 2005 the Puerto Rico Legislature approved Act No. 41, known as the “Act for the Educational Future of the Puerto Rican Children.” This law imposes an additional tax of 2.5% on taxable net income. This law is applicable to all corporations and partnerships with a taxable net income over $20,000, according to part (a) of Section 1015 of the Puerto Rico Internal Revenue Code of 1994, as amended. The law is effective for tax years beginning after December 31, 2004 and ending on or before December 31, 2006. Although the effectiveness of this law was subject to the final approval of the Legislature’s Joint Resolution No. 445, concerning the Commonwealth’s General Budget of the 2005-2006 fiscal year, which Joint Resolution was vetoed by the Puerto Rico Governor, the Puerto Rico Treasury Department has taken the position that the law is in effect.

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On October 20, 2005, the Puerto Rico Legislature approved a new tax bill. This bill imposes an additional tax of 1% on the net taxable income of banks. This bill is applicable to all banking corporations covered under the Puerto Rico Banking Act of 1933, as amended. The additional funds expected to be obtained from this tax will be assigned to the Department of Education of Puerto Rico. The additional tax is effective for the tax years commencing after June 30, 2005 and ending on or before December 31, 2006.

On May 13, 2006, the Puerto Rico Governor signed into law Act No. 89, which amends the Puerto Rico Internal Revenue Code of 1994, as amended, to impose an additional tax of 2% on the taxable income exceeding $20,000 of banking corporations covered under the Puerto Rico Banking Act of 1933, as amended. The law is effective for taxable years beginning after December 31, 2005 and ending on or before December 31, 2006. This additional tax imposition is not expected to have a material effect on the Group’s consolidated operational results due to the tax exempt composition of the Group’s investments.

On May 16, 2006, the Puerto Rico Governor also signed into law Act No. 98 to impose a one-time extraordinary tax on the net available income of non-exempt corporations and partnerships for the last taxable year ended on or before December 31, 2005. This extraordinary tax constitutes, in effect, a prepayment, as the taxpayer will be allowed to credit the amount so paid against its Puerto Rico income tax liability for taxable years beginning after December 31, 2005; any “unused credit” can be claimed by the taxpayer in four equal installments, beginning on the taxable year following that in which the extraordinary tax is paid. This additional tax imposition is not expected to have a material effect on the Group’s consolidated operational results due to the tax exempt composition of the Group’s investments.

Item 4. CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

As of the end of the period covered by this quarterly report on Form 10-Q, an evaluation was carried out under the supervision and with the participation of the Group’s management, including the Chief Executive Officer (“CEO”) and the Chief Financial Officer (“CFO”), of the effectiveness of the design and operation of the Group’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act). Based upon such evaluation, the CEO and the CFO have concluded that, as of the end of such period, the Group’s disclosure controls and procedures are effective in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by the Group in the reports that it files or submits under the Exchange Act.

Internal Control over Financial Reporting

During the quarter ended June 30, 2006, the Group enhanced its internal controls to address the material weaknesses identified in management’s report on internal control over financial reporting included in the Group’s Form 10-K for the transition period ended December 31, 2005. Specifically, the Group has strengthened its review and documentation procedures over significant non-routine transactions in order to identify and consider all relevant terms and conditions for the proper accounting treatment. These enhanced controls have been applied to certain non-routine transactions that have taken place during and after the quarter ended June 30, 2006, and their operating effectiveness has been tested accordingly. The Group will continue to monitor the design and operating effectiveness of these controls as part of the current year’s management assessment of internal controls over financial reporting.

PART — II OTHER INFORMATION

Item 1. LEGAL PROCEEDINGS

On August 14, 1998, as a result of a review of its accounts in connection with the admission by a former Group officer of having embezzled funds and manipulated bank accounts and records, the Group became aware of certain irregularities. The Group notified the appropriate regulatory authorities and commenced an intensive investigation with the assistance of forensic accountants, fraud experts, and legal counsel. The investigation determined losses of $9.6 million, resulting from dishonest and fraudulent acts and omissions involving several former Group employees. These losses were submitted to the Group’s fidelity insurance policy (the “Policy”) issued by Federal Insurance Company, Inc. (“FIC”). In the opinion of the Group’s management, its legal counsel and experts, the losses determined by the investigation were covered by the Policy. However, FIC denied all claims for such losses. On August 11, 2000, the Group filed a lawsuit in the United States District Court for the District of Puerto Rico against FIC, a stock insurance corporation organized under the laws of the State of Indiana, for breach of insurance contract, breach of covenant of good faith and fair dealing and damages, seeking payment of the Group’s $9.6 million insurance claim loss and the payment of consequential damages of no less than $13.0 million resulting from FIC capricious, arbitrary fraudulent and without cause denial of the Group’s claim. The losses resulting from such dishonest and fraudulent acts and omissions were expensed in prior years. On October 3, 2005, a jury rendered a verdict of $7.5 million in favor of the Group and against FIC, the defendant. The jury granted the Group $453,219 for fraud and loss documentation in connection with its Accounts Receivable Returned Checks Account. However, the jury could not reach a decision on the Group’s claim for $3.4 million in connection with fraud in its Cash Accounts, thus forcing a new trial on this issue. The jury denied the Group’s claim for $5.6 million in connection with fraud in the Mortgage Loans Account, but the jury determined that FIC had acted in bad faith and with malice. It, therefore, awarded the Group $7.1 million in consequential damages. The court decided not to enter a final judgment for the aforementioned awards until a new trial on

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the fraud in the Cash Accounts claim is held. After a final judgment is entered, the parties would be entitled to exhaust their post-judgment and appellate rights. The Group has not recognized any income on this claim since the appellate rights have not been exhausted and the amount to be collected has not been determined. The Group expects to request and recover prejudgment interest, costs, fees and expenses related to its prosecution of this case. However, no specific sum can be anticipated as they are subject to the discretion of the court. To date, the court has not scheduled this new trial.

In addition, the Group and its subsidiaries are defendants in a number of legal proceedings incidental to their business. The Group is vigorously contesting such claims. Based upon a review by legal counsel and the development of these matters to date, management is of the opinion that the ultimate aggregate liability, if any, resulting from these claims will not have a material adverse effect on the Group’s financial condition or results of operations.

Item 1A. RISK FACTORS

Except as noted below, there have been no material changes to the risk factors as previously disclosed under Item 1A. in the Group’s Form 10-K for the transition period ended December 31, 2005.

Puerto Rico’s current economic condition may have an adverse effect in our loan portfolio and other revenue sources

The economic uncertainty that exists in Puerto Rico, our primary market, caused in part by the disagreements of the legislative and executive branches of the Puerto Rico government regarding the tax and fiscal reform and the budget approval, has resulted in an economic slowdown in the Island. Also, increases in the price of petroleum and other consumer goods and services, coupled with a recently approved sales tax of 7%, are additional concerns impacting the Island’s economic situation. Puerto Rico economic growth remains subdued, with an apparent reduction in private sector employment. Tax and fiscal reforms were recently signed into law by the Puerto Rico government, including the government’s budget for fiscal year 2007.

The above economic concerns and uncertainty in the private and public sectors may also have an adverse effect in the credit quality of our loan portfolios, as delinquency rates may increase in the short-term, until the economy stabilizes. Also, potential reduction in consumer spending may also impact growth in our other interest and non-interest revenue sources.

Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

a)	None
b)	Not applicable
c)	Purchases of equity securities by the issuer and affiliated purchasers

On August 30, 2005, the Board of Directors of the Group approved a program for the repurchase of up to $12.1 million of the Group’s outstanding shares of common stock, which replaced the former program. On June 20, 2006, the Board of Directors approved an increase of $3.0 million to the initial amount, for the repurchase of up to $15.1 million. During May 2006, the Group purchased 46,600 of its shares of common stock in the open market, at an average price of $12.50, for a total cost of $582,000. The approximate dollar value of shares that may yet be purchased under this program amounted to $10.3 million at June 30, 2006.

Item 3. DEFAULTS UPON SENIOR SECURITIES

     None

Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS

     None

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Item 5. OTHER INFORMATION

a)	None
b)	None

Item 6. EXHIBITS

10.1	Change in Control Compensation Agreement between Oriental Financial Group Inc. and Mari Evelyn Rodriguez
31.1	Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2	Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1	Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2	Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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Signatures

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

ORIENTAL FINANCIAL GROUP INC.
(Registrant)

By:	/s/ José Rafael FernándezJosé Rafael Fernández President and Chief Executive Officer	Dated: October 17, 2006
By:	/s/ Norberto GonzálezNorberto González Executive Vice President and Chief Financial Officer	Dated: October 17, 2006

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