OFG Bancorp 10K 2008 Annual report | OFG Filing

EXHIBIT 13.0

ORIENTAL FINANCIAL GROUP INC.

FORM-10K

FINANCIAL DATA INDEX


FINANCIAL STATEMENTS
Reports of Independent Registered Public Accounting Firm		F-1
Management’s Report on Internal Control Over Financial Reporting		F-2
Attestation Report of Independent Registered Public Accounting Firm on Internal Control over Financial Reporting		F-3
Consolidated Statements of Financial Condition as of December 31, 2008 and 2007		F-4
Consolidated Statements of Operations for the years ended December 31, 2008, 2007, and 2006		F-5
Consolidated Statements of Changes in Stockholders’ Equity and of Comprehensive Income (Loss) for the years ended December 31, 2008, 2007, and 2006		F-6 to F-7
Consolidated Statements of Cash Flows for the years ended December 31, 2008, 2007, and 2006		F-8 to F-9
Notes to the Consolidated Financial Statements		F-10 to F-56
FINANCIAL REVIEW AND SUPPLEMENTARY INFORMATION
Selected Financial Data		F-57 to F-58
Management’s Discussion and Analysis of Financial Condition and Results of Operations		F-59 to F-84
Risk Management		F-84 to F-88
Quarterly Financial Data		F-89 to F-90
Critical Accounting Policies		F-91 to F-96
Exhibit 10.27 — Form of restricted unit award and agreement
Exhibit 21.0 — List Of Subsidiaries
Exhibit 23.1 — Consents Of Independent Registered Public Accounting Firm
Exhibit 31.1 and Exhibit 31.2 — Management Certifications Pursuant To Section 302 of The Sarbanes-Oxley Act Of 2002
Exhibit 32.1 and Exhibit 32.2 — Certifications Pursuant To Section 906 of The Sarbanes-Oxley Act Of 2002 (18 U.S.C. §1350)

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Stockholders of

Oriental Financial Group Inc:

We have audited the accompanying consolidated statements of financial condition of Oriental Financial Group Inc. and subsidiaries (the “Group”) as of December 31, 2008 and 2007, and the related consolidated statements of operations, changes in stockholders’ equity, comprehensive income (loss) and cash flows for each of the years in the three-year period ended December 31, 2008. These consolidated financial statements are the responsibility of the Group’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Oriental Financial Group, Inc. and subsidiaries as of December 31, 2008 and 2007, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2008, in conformity with U.S. generally accepted accounting principles.

As discussed in Note 1 to the consolidated financial statements effective January 1, 2006, the Group changed its method of evaluating prior year misstatements.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Oriental Financial Group Inc. and subsidiaries’ internal control over financial reporting as of December 31, 2008, based on criteria established inInternal Control — Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated March 16, 2009 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.

/s/ KPMG LLP

San Juan, Puerto Rico

March 16, 2009

Stamp No. 2376374 of the Puerto Rico

Society of Certified Public Accountants

was affixed to the record copy of this report.

F-1

ORIENTAL FINANCIAL GROUP INC.

MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

To the Board of Directors and stockholders of Oriental Financial Group Inc.:

The management of Oriental Financial Group Inc. (the “Group”) is responsible for establishing and maintaining effective internal control over financial reporting, as defined inRules 13a-15(f) and15d-15(f) under the Securities Exchange Act of 1934, and for the assessment of internal control over financial reporting. The Group’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America.

The Group’s internal control over financial reporting includes those policies and procedures that:

(1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Group;

(2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States of America, and that receipts and expenditures of the Group are being made only in accordance with authorization of management and directors of the Group; and

(3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Group’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

As called for by Section 404 of the Sarbanes-Oxley Act of 2002, management has assessed the effectiveness of the Group’s internal control over financial reporting as of December 31, 2008. Management made its assessment using the criteria set forth inInternal Control-Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission (the “COSO Criteria”).

Based on its assessment, management has concluded that the Group maintained effective internal control over financial reporting as of December 31, 2008 based on the COSO Criteria.

The effectiveness of the Group’s internal control over financial reporting as of December 31, 2008, has been audited by KPMG LLP, the Group’s independent registered public accounting firm, as stated in their report dated March 16, 2009.


By: /s/ José Rafael Fernández		By: /s/ Norberto González
José Rafael Fernández President and Chief Executive Officer Date: March 16, 2009		Norberto González Executive Vice President and Chief Financial Officer Date: March 16, 2009

F-2

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Stockholders

Oriental Financial Group Inc:

We have audited Oriental Financial Group Inc.’s (the “Group”) internal control over financial reporting as of December 31, 2008, based onInternal Control-Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). The Group’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Group’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

In our opinion, Oriental Financial Group Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2008, based on criteria established inInternal Control-Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated statements of financial condition of Oriental Financial Group Inc. and subsidiaries as of December 31, 2008 and 2007, and the related consolidated statements of operations, stockholders’ equity, comprehensive income (loss) and cash flows for each of the years in the three-year period ended December 31, 2008, and our report dated March 16, 2009, expressed an unqualified opinion on those consolidated financial statements.

/s/ KPMG LLP

San Juan, Puerto Rico

March 16, 2009

Stamp No. 2376375 of the Puerto Rico

Society of Certified Public Accountants

was affixed to the record copy of this report.

F-3

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
DECEMBER 31, 2008 AND 2007


	December 31,
	2008			2007
	(In thousands, except share data)

ASSETS
Cash and cash equivalents
Cash and due from banks	$	14,370		$	22,858
Money market investments		52,002			66,125

Total cash and cash equivalents	$	66,372		$	88,983

Investments:
Trading securities, at fair value with amortized cost of $255 (December 31, 2007 — $1,103)		256			1,122

Investment securitiesavailable-for-sale, at fair value with amortized cost of $4,052,574 (December 31, 2007 — $3,063,763)
Securities pledged that can be repledged		3,790,733			2,903,078
Other investment securities		133,474			166,204

Total investment securitiesavailable-for-sale		3,924,207			3,069,282

Investment securitiesheld-to-maturity, at amortized cost with fair value at December 31, 2007 of $1,478,112
Securities pledged that can be repledged		—			1,348,159
Other investment securities		—			144,728

Total investment securitiesheld-to-maturity		—			1,492,887

Other investments		150			1,662

Federal Home Loan Bank (FHLB) stock, at cost		21,013			20,658

Total investments		3,945,626			4,585,610

Securities sold but not yet delivered		834,976			—

Loans:
Mortgage loansheld-for-sale, at lower of cost or fair value		26,562			16,672
Loans receivable, net of allowance for loan losses of $14,293 (December 31, 2007 — $10,161)		1,192,550			1,162,894

Total loans, net		1,219,112			1,179,566

Accrued interest receivable		43,914			52,315
Premises and equipment, net		21,184			21,779
Deferred tax asset, net		28,463			10,362
Foreclosed real estate		9,162			4,207
Investment in equity indexed options		12,801			40,709
Other assets		23,926			16,324

Total assets	$	6,205,536		$	5,999,855

LIABILITIES AND STOCKHOLDERS’ EQUITY
Deposits:
Demand deposits	$	453,798		$	119,152
Savings accounts		50,152			387,790
Certificates of deposit		1,281,350			739,478

Total deposits		1,785,300			1,246,420

Borrowings:
Federal funds purchased and other short-term borrowings		29,193			27,460
Securities sold under agreements to repurchase		3,761,121			3,861,411
Advances from FHLB		308,442			331,898
Subordinated capital notes		36,083			36,083

Total borrowings		4,134,839			4,256,852

Securities purchased but not yet received		398			111,431
Accrued expenses and other liabilities		23,682			25,691

Total liabilities		5,944,219			5,640,394

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; 25,739,397 shares issued; 24,297,132 shares outstanding (December 31, 2007 — 25,557,197; 24,120,771 )		25,739			25,557
Additional paid-in capital		212,625			210,073
Legal surplus		43,016			40,573
Retained earnings		51,233			45,296
Treasury stock, at cost 1,442,265 shares (December 31, 2007 — 1,436,426 shares)		(17,109	)		(17,023	)
Accumulated other comprehensive loss, net of tax of $6,004 (December 31, 2007 — $2,166)		(122,187	)		(13,015	)

Total stockholders’ equity		261,317			359,461

Commitments and Contingencies
Total liabilities and stockholders’ equity	$	6,205,536		$	5,999,855

The accompanying notes are an integral part of these consolidated financial statements.

F-4

CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 2008, 2007, AND 2006


	Year Ended December 31,
	2008			2007			2006
	(In thousands, except per share data)

Interest income:
Loans	$	79,165		$	85,802		$	76,815
Mortgage-backed securities		184,019			111,006			98,058
Investment securities		73,948			88,868			55,381
Short term investments		1,907			3,688			2,057

Total interest income		339,039			289,364			232,311

Interest expense:
Deposits		49,781			52,794			46,701
Securities sold under agreements to repurchase		161,363			147,690			125,714
Advances from FHLB, term notes and other borrowings		14,280			12,042			10,439
Subordinated capital notes		2,304			3,108			5,331

Total interest expense		227,728			215,634			188,185

Net interest income		111,311			73,730			44,126
Provision for loan losses		8,860			6,550			4,388

Net interest income after provision for loan losses		102,451			67,180			39,738

Non-interest income (loss):
Financial service revenues		16,481			17,295			16,029
Banking service revenues		5,726			7,862			9,006
Investment banking revenues		950			126			2,701
Mortgage banking activities		3,685			2,401			3,368
Net gain (loss) on:
Sale of securities		35,070			2,953			(15,171	)
Other than temporary impairments		(58,804	)		—			(2,466	)
Derivatives		(12,943	)		10,997			3,218
Mortgage tax credits		(2,480	)		—			—
Early extinguishment of subordinated capital notes		—			—			(915	)
Trading securities		(13	)		23			28
Other investments		148			1,174			1,008
Foreclosed real estate		(670	)		(349	)		180
Other		608			20			252

Total non-interest income (loss), net		(12,242	)		42,502			17,238

Non-interest expenses:
Compensation and employees’ benefits		30,572			28,376			24,630
Occupancy and equipment		13,843			12,624			11,573
Professional and service fees		9,203			7,161			6,821
Advertising and business promotion		3,970			4,472			4,466
Taxes, other than payroll and income taxes		2,514			2,151			2,405
Insurance		2,421			848			861
Electronic banking charges		1,726			1,826			1,914
Loan servicing expenses		1,383			1,740			2,017
Clearing and wrap fees expenses		1,250			1,070			1,383
Communication		1,292			1,302			1,598
Director and investors relations		1,159			2,103			2,323
Other		3,409			3,186			3,722

Total non-interest expenses		72,742			66,859			63,713

Income (loss) before income taxes		17,467			42,823			(6,737	)
Income tax expense (benefit)		(9,323	)		1,558			(1,631	)

Net income (loss)		26,790			41,265			(5,106	)
Less: Dividends on preferred stock		(4,802	)		(4,802	)		(4,802	)

Income available (loss) to common shareholders	$	21,988		$	36,463		$	(9,908	)

Income (loss) per common share:
Basic	$	0.91		$	1.50		$	(0.40	)

Diluted	$	0.90		$	1.50		$	(0.40	)

Average common shares outstanding		24,260			24,326			24,562
Average potential common shares-options		67			41			101

Average diluted common shares outstanding		24,327			24,367			24,663

Cash dividends per share of common stock	$	0.56		$	0.56		$	0.56

The accompanying notes are an integral part of these consolidated financial statements.

F-5

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2008, 2007, AND 2006


	Year Ended December 31,
CHANGES IN STOCKHOLDERS’ EQUITY:	2008			2007			2006
	(In thousands)

Preferred stock:
Balance at beginning and end of year	$	68,000		$	68,000		$	68,000

Common stock:
Balance at beginning of year		25,557			25,431			25,350
Stock options exercised		182			126			81

Balance at end of year		25,739			25,557			25,431

Additional paid-in capital:
Balance at beginning of year		210,073			209,033			208,454
Stock-based compensation expense		559			86			15
Stock options exercised		1,993			954			564

Balance at end of year		212,625			210,073			209,033

Legal surplus:
Balance at beginning of year		40,573			36,245			35,863
Transfer from retained earnings		2,443			4,328			382

Balance at end of year		43,016			40,573			36,245

Retained earnings:
Balance at beginning of year		45,296			26,772			52,340
Cumulative effect on initial adoption of SAB 108		—			—			(1,525	)
Net income (loss)		26,790			41,265			(5,106	)
Cash dividends declared on common stock		(13,608	)		(13,611	)		(13,753	)
Cash dividends declared on preferred stock		(4,802	)		(4,802	)		(4,802	)
Transfer to legal surplus		(2,443	)		(4,328	)		(382	)

Balance at end of year		51,233			45,296			26,772

Treasury stock:
Balance at beginning of year		(17,023	)		(12,956	)		(10,332	)
Stock purchased		(235	)		(4,297	)		(2,819	)
Stock used to match defined contribution plan		149			230			195

Balance at end of year		(17,109	)		(17,023	)		(12,956	)

Accumulated other comprehensive income (loss), net of tax:
Balance at beginning of year		(13,015	)	��	(16,099	)		(37,884	)
Other comprehensive income (loss), net of tax		(109,172	)		3,084			21,785

Balance at end of year		(122,187	)		(13,015	)		(16,099	)

Total stockholders’ equity	$	261,317		$	359,461		$	336,426

F-6

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
FOR THE YEARS ENDED DECEMBER 31, 2008, 2007, AND 2006


	Year Ended December 31,
COMPREHENSIVE INCOME (LOSS)	2008			2007			2006
	(In thousands)

Net income (loss)	$	26,790		$	41,265		$	(5,106	)

Other comprehensive income (loss):
Unrealized gain (loss) on securitiesavailable-for-sale arising during the year		(121,204	)		17,492			607
Realized (gain) loss on investment securities included in net income (loss)		(35,070	)		(2,953	)		15,172
Other than temporary impairments		38,932			—			2,466
Unrealized loss on derivatives designated as cash flows hedges arising during the year		—			—			(720	)
Realized gain on derivatives designated as cash flow hedges included in net loss		—			(773	)		(3,218	)
Realized gain on termination of derivative activities, net		—			—			8,998
Gain from termination of cash flow hedging		—			(8,225	)		—
Income tax effect related to unrealized (gain) loss on securitiesavailable-for-sale		8,170			(2,457	)		(1,520	)

Other comprehensive income (loss) for the year, net of tax		(109,172	)		3,084			21,785

Comprehensive income (loss)	$	(82,382	)	$	44,349		$	16,679

The accompanying notes are an integral part of these consolidated financial statements.

F-7

CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2008, 2007, AND 2006.


	Year Ended December 31,
	2008			2007			2006
	(In thousands)

Cash flows from operating activities:
Net income (loss)	$	26,790		$	41,265		$	(5,106	)

Adjustments to reconcile net income (loss) to net cash used in operating activities:
Amortization of deferred loan origination fees, net of costs		(428	)		(721	)		(1,625	)
Amortization of premiums, net of accretion of discounts on investment securities		(787	)		792			5,584
Other than temporary impairments		58,804			—			2,466
Realized gains on termination of derivative instruments		—			—			(852	)
Depreciation and amortization of premises and equipment		5,443			5,419			5,481
Deferred income tax expense (benefit)		(9,931	)		1,332			(3,448	)
Equity in losses (earnings), of investment in limited liability partnership		—			279			(828	)
Provision for loan losses		8,860			6,550			4,388
Stock-based compensation		559			86			15
(Gain) loss on:
Sale of securities		(35,070	)		(3,799	)		15,172
Mortgage banking activities		(3,685	)		(2,401	)		(3,368	)
Derivatives		12,943			(10,997	)		(3,218	)
Mortgage tax credits		2,480			—			—
Sale of foreclosed real estate		670			349			(180	)
Sale of premises and equipment		1			(20	)		(253	)
Early extinguishment of subordinated capital notes		—			—			915
Originations of loansheld-for-sale		(140,080	)		(114,722	)		(95,713	)
Proceeds from sale of loansheld-for-sale		59,339			54,510			41,842
Net (increase) decrease in:
Trading securities		866			(879	)		(97	)
Accrued interest receivable		8,401			(24,375	)		1,127
Other assets		(10,082	)		(2,680	)		(3,559	)
Net increase (decrease) in:
Accrued interest on deposits and borrowings		2,717			4,787			(15,096	)
Other liabilities		(2,312	)		6,358			(2,466	)

Net cash used in operating activities		(14,502	)		(38,867	)		(58,819	)

Cash flows from investing activities:
Purchases of:
Investment securitiesavailable-for-sale		(4,159,014	)		(3,434,208	)		(1,273,841	)
Investment securitiesheld-to-maturity		(14,000	)		(158,842	)		(6,500	)
Other investments		—			—			(30,982	)
FHLB stock		(22,164	)		(43,390	)		(29,520	)
Equity options		(5,596	)		(10,474	)		(3,702	)
Maturities and redemptions of:
Investment securitiesavailable-for-sale		970,543			744,976			134,949
Investment securitiesheld-to-maturity		304,133			633,052			384,594
FHLB stock		21,809			36,339			35,915
Other investments		1,511			29,274			—
Investment in limited liability partnership		—			11,634			—

F-8


	Year Ended December 31,
	2008			2007			2006
	(In thousands)

Proceeds from sales of:
Investment securitiesavailable-for-sale		1,687,779			787,255			1,252,995
Investment securitiesheld-to-maturity		834,976			—			—
Foreclosed real estate		3,264			4,017			2,589
Fixed assets		14			—			—
Loan production:
Origination and purchase of loans, excluding loansheld-for-sale		(157,063	)		(189,773	)		(459,975	)
Principal repayment of loans		111,869			219,108			150,704
Additions to premises and equipment		(4,863	)		(7,025	)		(10,553	)
Net decrease in time deposits with other banks		—			—			60,000

Net cash provided by (used in) investing activities		(426,802	)		(1,378,057	)		206,673

Cash flows from financing activities:
Net increase (decrease) in:
Deposits		564,516			19,016			(69,452	)
Securities sold under agreements to repurchase		(100,023	)		1,320,609			111,844
Federal funds purchased		1,733			13,892			9,113
Proceeds from:
Advances from FHLB		2,098,070			5,279,620			4,703,325
Exercise of stock options, net		2,175			1,080			645
Repayments of advances from FHLB		(2,121,370	)		(5,131,520	)		(4,834,725	)
Repayments of subordinated capital notes		—			—			(36,083	)
Repayment of term notes		—			(15,000	)		—
Termination of derivative instruments		(7,912	)		1,620			10,459
Common stock purchased		(86	)		(4,067	)		(2,624	)
Dividends paid		(18,410	)		(18,413	)		(18,555	)

Net cash provided by (used in) financing activities		418,693			1,466,837			(126,053	)

Net change in cash and cash equivalents		(22,611	)		49,913			21,801
Cash and cash equivalents at beginning of year		88,983			39,070			17,269

Cash and cash equivalents at end of year	$	66,372		$	88,983		$	39,070

Supplemental Cash Flow Disclosure and Schedule of Noncash Activities:
Interest paid	$	225,011		$	213,764		$	203,280

Income taxes paid	$	54		$	—		$	82

Mortgage loans securitized into mortgage-backed securities	$	72,753		$	56,544		$	52,214

Investment securitiesheld-to-maturity transferred toavailable-for-sale	$	375,780		$	—		$	—

Securities sold but not yet delivered	$	834,976		$	—		$	6,430

Securities purchased but not yet received	$	398		$	111,431		$	—

Transfer from loans to foreclosed real estate	$	8,889		$	3,709		$	2,471

The accompanying notes are an integral part of these consolidated financial statements.

F-9

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AS OF DECEMBER 31, 2008, 2007, AND 2006


1.	SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The accounting and reporting policies of Oriental Financial Group Inc. (the “Group” or “Oriental”) conform to U.S. generally accepted accounting principles (“GAAP”) and to financial services industry practices. The following is a description of the Group’s most significant accounting policies:

Nature of Operations

The Group is a publicly-owned financial holding company incorporated under the laws of the Commonwealth of Puerto Rico. It has four direct subsidiaries, Oriental Bank and Trust (the “Bank”), Oriental Financial Services Corp. (“Oriental Financial Services”), Oriental Insurance, Inc. (“Oriental Insurance”) and Caribbean Pension Consultants, Inc., which is located in Boca Raton, Florida. The Group also has two special purpose entities, Oriental Financial (PR) Statutory Trust I (the “Statutory Trust I”, presently inactive) 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.

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 23 financial centers 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 (“OCIF”) 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. Oriental International Bank Inc. (“OIB”), a wholly-owned subsidiary of the Bank, operates as an international banking entity (“IBE”) pursuant to the International Banking Center Regulatory Act of Puerto Rico, as amended. OIB offers the Bank certain Puerto Rico tax advantages. OIB activities are limited under Puerto Rico law to persons andassets/liabilities located outside of Puerto Rico.

Oriental Financial Services is subject to the supervision, examination and regulation of the Financial Industry Regulatory Authority (“FINRA”), the SEC, and the OCIF. Oriental Insurance is subject to the supervision, examination and regulation of the Office of the Commissioner of Insurance of Puerto Rico.

Use of Estimates in the Preparation of Financial Statements

The preparation of financial statements in conformity with GAAP requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the consolidated financial statements and the reported amount of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate mainly to the determination of the allowance for loan losses, the valuation of securities and derivative instruments, and the determination of income taxes and other-than-temporary impairment of securities.

Principles of Consolidation

The accompanying consolidated financial statements include the accounts of the Group and its wholly-owned subsidiaries. All significant intercompany transactions and balances have been eliminated in consolidation. The special purpose entities are exempt from the consolidation requirements, under the provisions of Financial Accounting Standards Board (“FASB”) Interpretation No. 46 (Revised),“Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51.”

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Cash Equivalents

The Group considers as cash equivalents all money market instruments that are not pledged and that have maturities of three months or less at the date of acquisition.

Earnings per Common Share

Basic earnings per share is calculated by dividing income available to common shareholders (net income reduced by dividends on preferred stock) by the weighted average of outstanding common shares. Diluted earnings per share is similar to the computation of basic earnings per share except that the weighted average of common shares is increased to include the number of additional common shares that would have been outstanding if the dilutive potential common shares (options) had been issued, assuming that proceeds from exercise are used to repurchase shares in the market (treasury stock method). Any stock splits and dividends are retroactively recognized in all periods presented in the consolidated financial statements.

Securities Purchased/Sold Under Agreements to Resell/Repurchase

The Group purchases securities under agreements to resell the same or similar securities. Amounts advanced under these agreements represent short-term loans and are reflected as assets in the consolidated statements of financial condition. It is the Group’s policy to take possession of securities purchased under resale agreements while the counterparty retains effective control over the securities. The Group monitors the fair value of the underlying securities as compared to the related receivable, including accrued interest, and requests additional collateral when deemed appropriate. The Group also sells securities under agreements to repurchase the same or similar securities. The Group retains effective control over the securities sold under these agreements; accordingly, such agreements are treated as financing arrangements, and the obligations to repurchase the securities sold are reflected as liabilities. The securities underlying the financing agreements remain included in the asset accounts. The counterparty to repurchase agreements generally has the right to repledge the securities received as collateral.

Investment Securities

Securities are classified asheld-to-maturity,available-for-sale or trading. Securities for which the Group has the intent and ability to hold to maturity are classified asheld-to-maturity and are carried at amortized cost. Securities that might be sold prior to maturity because of interest rate changes, to meet liquidity needs, or to better match the repricing characteristics of funding sources are classified asavailable-for-sale. These securities are reported at fair value, with unrealized gains and losses excluded from earnings and reported net of tax in other comprehensive income.

The Group classifies as trading those securities that are acquired and held principally for the purpose of selling them in the near future. These securities are carried at fair value with realized and unrealized changes in fair value included in earnings in the period in which the changes occur.

The Group’s investment in the Federal Home Loan Bank (FHLB) of New York stock, a restricted security, has no readily determinable fair value and can only be sold back to the FHLB at cost. Therefore, the carrying value represents its fair value.

Premiums and discounts are amortized to interest income over the life of the related securities using the interest method. Net realized gains or losses on sales of investment securities, and unrealized loss valuation adjustments considered other than temporary, if any, on securities classified as eitheravailable-for-sale orheld-to-maturity are reported separately in the statements of operations. The cost of securities sold is determined on the specific identification method.

Financial Instruments

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non-interest income, as appropriate. Fair values are based on listed market prices, if available. If listed market prices are not available, fair value is determined based on other relevant factors, including price quotations for similar instruments. The fair values of certain derivative contracts are derived from pricing models that consider current market and contractual prices for the underlying financial instruments as well as time value and yield curve or volatility factors underlying the positions.

Effective January 1, 2008, the Group determines the fair value of its financial instruments based on the fair value framework established in SFAS No. 157,“Fair Value Measurements” (“SFAS 157”), which establishes a fair value hierarchy that prioritizes the inputs of valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (level 1 measurements) and the lowest priority to unobservable inputs (level 3 measurements). The three levels of the fair value hierarchy under SFAS 157 are described below:

Basis of Fair Value Measurement

Level 1-Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities;

Level 2-Quoted prices in markets that are not considered to be active or financial instruments for which all significant inputs are observable, either directly or indirectly;

Level 3-Prices or valuations that require inputs that are both significant to the fair value measurement and unobservable.

A financial instrument’s level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement.

Impairment of Investment Securities

The Group conducts periodic reviews to identify and evaluate each investment in an unrealized loss position, in accordance with FASB Staff Position No. 115-1, “The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments” (FSPFAS 115-1). An unrealized loss exists when the current fair value of an individual security is less than its amortized cost basis. Unrealized losses that are determined to be temporary in nature are recorded, net of tax, in accumulated other comprehensive income for available-for-sale securities, while such losses related to held-to-maturity securities are not recorded, as these investments are carried at their amortized cost (less any other-than-temporary impairment). Regardless of the classification of the securities as available-for-sale or held-to-maturity, the Group has assessed each position for credit impairment.

Factors considered in determining whether a loss is temporary include:


	•	the length of time and the extent to which fair value has been below cost;

	•	the severity of the impairment;

	•	the cause of the impairment and the financial condition and near-term prospects of the issuer;

	•	activity in the market of the issuer which may indicate adverse credit conditions; and

	•	the Group’s ability and intent to hold the investment for a period of time sufficient to allow for any anticipated recovery.

The Group’s review for impairment generally entails:


	•	identification and evaluation of investments that have indications of possible other-than-temporary impairment;

	•	analysis of individual investments that have fair values less than amortized cost, including consideration of the length of time the investment has been in an unrealized loss position and the expected recovery period;

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	•	discussion of evidential matter, including an evaluation of factors or triggers that could cause individual investments to qualify as having other-than-temporary impairment and those that would not support other-than-temporary impairment; and

	•	documentation of the results of these analyses.

The extent of the Group’s analysis regarding credit quality and the stress on assumptions used in the analysis have been refined for securities where the current fair value or other characteristics of the security warrant. Given the declines in fair values and length of time in which non-agency collateralized mortgage obligations and structured credit investments have been in an unrealized loss position, general concerns regarding housing prices and the delinquency and default rates on the mortgage loans and credit spreads underlying these securities, the Group’s analysis for identifying securities for which all principal and interest contractually due might not be recovered have been performed.

Derivative Financial Instruments

As part of the Group’s asset and liability management, the Group may use option agreements and interest rate contracts, which include interest rate swaps to hedge various exposures or to modify interest rate characteristics of various statements of financial condition accounts.

The Group follows Statement of Financial Accounting Standards (“SFAS”) No. 133:“Accounting for Derivative Instruments and Hedging Activities,” (refer to Note 9), which establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. The statement requires that all derivative instruments be recognized as assets and liabilities at fair value. If certain conditions are met, the derivative may qualify for hedge accounting treatment and be designated as one of the following types of hedges: (a) hedge of the exposure to changes in the fair value of a recognized asset or liability or an unrecognized firm commitment (“fair value hedge”); (b) a hedge of the exposure to variability of cash flows of a recognized asset, liability or forecasted transaction (“cash flow hedge”) or (c) a hedge of foreign currency exposure (“foreign currency hedge”).

In the case of a qualifying fair value hedge, changes in the value of the derivative instruments that have been highly effective are recognized in current period earnings along with the change in value of the designated hedged item. In the case of a qualifying cash flow hedge, changes in the value of the derivative instruments that have been highly effective are recognized in other comprehensive income, until such time as those earnings are affected by the variability of the cash flows of the underlying hedged item. In either a fair value hedge or a cash flow hedge, net earnings may be impacted to the extent the changes in the fair value of the derivative instruments do not perfectly offset changes in the fair value or cash flows of the hedged items. If the derivative is not designated as a hedging instrument, the changes in fair value of the derivative are recorded in earnings.

Certain contracts contain embedded derivatives. When the embedded derivative possesses economic characteristics that are not clearly and closely related to the economic characteristics of the host contract, it is bifurcated and carried at fair value.

The Group uses several pricing models that consider current fair value and contractual prices for the underlying financial instruments as well as time value and yield curve or volatility factors underlying the positions to derive the fair value of certain derivatives contracts.

Off-Balance Sheet Instruments

In the ordinary course of business, the Group enters into off-balance sheet instruments consisting of commitments to extend credit and commitments under credit card arrangements, further discussed in Note 14 to the consolidated financial statements. Such financial instruments are recorded in the financial statements when they are funded or related fees are incurred or received. The Group periodically evaluates the credit risks inherent in these commitments, and establishes accruals for such risks if and when these are deemed necessary.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Mortgage Banking Activities and LoansHeld-For-Sale

The residential mortgage loans reported asheld-for-sale are stated at thelower-of-cost-or-fair value, cost being determined on the outstanding loan balance less unearned income, and fair value determined in the aggregate. Net unrealized losses are recognized through a valuation allowance by charges to income. Realized gains or losses on these loans are determined using the specific identification method. Loansheld-for-sale include all conforming mortgage loans originated and purchased, which from time to time the Group sells to other financial institutions or securitizes conforming mortgage loans into Government National Mortgage Association (GNMA), Federal National Mortgage Association (FNMA) and Federal Home Loan Mortgage Corporation (FHLMC) pass-through certificates.

Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities

The Group recognizes the financial and servicing assets it controls and the liabilities it has incurred, derecognizes financial assets when control has been surrendered, and derecognizes liabilities when extinguished.

The Group is not engaged in sales of mortgage loans and mortgage-backed securities subject to recourse provisions except for those provisions that allow for the repurchase of loans as a result of a breach of certain representations and warranties other than those related to the credit quality of the loans included in the sale transactions.

According to SFAS 140“Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities”(“SFAS 140”), a transfer of financial assets (all or a portion of the financial asset) in which the Group surrenders control over these financial assets shall be accounted for as a sale to the extent that consideration, other than beneficial interests in the transferred assets, is received in exchange. The Group has surrendered control over transferred assets if all of the following conditions are met:


	a.	The transferred assets have been isolated from the Group — put presumptively beyond the reach of the Group and its creditors even in bankruptcy or other receivership.

	b.	Each transferee has the right to pledge or exchange the assets it received and no condition both constrains the transferee from taking advantage of its rights to pledge or exchange and provided more than a trivial benefit to the Group.

	c.	The Group does not maintain effective control over the transferred assets through either (1) an agreement that both entitles and obligates the Group to repurchase or redeem them before their maturity or (2) the ability to unilaterally cause the holder to return specific assets other than through a cleanup call.

If a transfer of financial assets in exchange for cash or other consideration (other than beneficial interests in the transferred assets) does not meet the criteria for a sale as described above, the Group would account for the transfer as a secured borrowing.

Servicing assets

The Group periodically sells or securitizes loans while retaining the obligation to perform the servicing of such loans. In addition, the Group may purchase or assume the right to service loans originated by others. Whenever the Group undertakes an obligation to service a loan, management assesses whether a servicing assetand/or liability should be recognized. A servicing asset is recognized whenever the compensation for servicing is expected to more than adequately compensate the servicer for performing the servicing. Likewise, a servicing liability would be recognized in the event that servicing fees to be received are not expected to adequately compensate the Group for its expected cost. Servicing assets are presented as other assets in the consolidated statements of condition.

Upon adoption of SFAS No. 156“Accounting for Servicing of Financial Assets — an Amendment of FASB Statements No. 133 and 140” in January 2007, all separately recognized servicing assets are initially recognized at fair value. For subsequent measurement of servicing rights, the Group has elected the amortization method with periodic testing for impairment. Under the amortization method, servicing assets are amortized in proportion to, and over the period of, estimated servicing income and assessed for impairment based on fair value at each reporting

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period. Contractual servicing fees, as well as fair value adjustments, and impairment losses, if any, are reported in banking service revenues in the consolidated statements of operations. Loan servicing fees, which are based on a percentage of the principal balances of the loans serviced, are credited to income as loan payments are collected.

The fair value of servicing rights is estimated by using a cash flow valuation model which calculates the present value of estimated future net servicing cash flows, taking into consideration actual and expected loan prepayment rates, discount rates, servicing costs, and other economic factors, which are determined based on current market conditions. For purposes of evaluating and measuring impairment of capitalized servicing assets that are accounted under the amortization method, the amount of impairment recognized, if any, is the amount by which the capitalized servicing assets per stratum exceed their estimated fair value.

Prior to 2007, the total cost of loans to be sold with servicing assets retained was allocated to the servicing assets and the loans (without servicing assets), based on their relative fair values. Servicing assets were amortized in proportion to, and over the period of, estimated net servicing income.

Loans and Allowance for Loan Losses

Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off are reported at their outstanding unpaid principal balances adjusted for charge-offs, the allowance for loan losses, unamortized discount related to mortgage servicing right “(“MSR”) sold and any deferred fees or costs on originated loans. Interest income is accrued on the unpaid principal balance. Loan origination fees and costs and premiums and discounts on loans purchased are deferred and amortized over the estimated life of the loans as an adjustment of their yield through interest income using a method that approximates the interest method. When a loan is paid off or sold, any unamortized net deferred fee (cost) is credited (charged) to income.

Interest recognition is discontinued when loans are 90 days or more in arrears on principaland/or interest based on contractual terms, except for collateralized residential mortgage loans for which recognition is discontinued when they become 365 days or more past due based on contractual terms and are then written down, if necessary, based on the specific evaluation of the collateral underlying the loan. Loans for which the recognition of interest income has been discontinued are designated as non-accruing. Collections are accounted for on the cash method thereafter, until qualifying to return to accrual status. Such loans are not reinstated to accrual status until interest is received on a current basis and other factors indicative of doubtful collection cease to exist.

The Group follows a systematic methodology to establish and evaluate the adequacy of the allowance for loan losses to provide for inherent losses in the loan portfolio. This methodology includes the consideration of factors such as economic conditions, portfolio risk characteristics, prior loss experience, and results of periodic credit reviews of individual loans. The provision for loan losses charged to current operations is based on such methodology. Loan losses are charged and recoveries are credited to the allowance for loan losses.

Included in the review of individual loans are those that are impaired, as provided in 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 under the provisions of SFAS No. 5,“Accounting for Contingencies”, as amended, and loans that are recorded at fair value or at the lower of cost or market. The Group measures for impairment all

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commercial loans over $250,000 and over90-days past due. The portfolios of mortgages and consumer loans are considered homogeneous, and are evaluated collectively for impairment.

The Group, using a rating system, applies an overall allowance percentage to each 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 systematic 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 current available information in estimating probable loan losses, factors beyond the Group’s control, such as factors affecting general economic conditions may require future changes to the allowance.

Premises and Equipment

Premises and equipment are carried at cost less accumulated depreciation. Depreciation is provided using the straight-line method over the estimated useful life of each type of asset. Amortization of leasehold improvements is computed using the straight-line method over the terms of the leases or estimated useful lives of the improvements, whichever is shorter.

Long-lived assets and identifiable intangibles, except for financial instruments, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. In performing the review for recoverability, an estimate is made of the future cash flows expected to result from the use of the asset and its eventual disposition. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount of the asset, an impairment loss is recognized if the fair value is less than the carrying amount of the related asset. Otherwise, an impairment loss is not recognized. There were no such impairment losses in periods presented in the accompanying consolidated financial statements.

Foreclosed Real Estate

Foreclosed real estate is initially recorded at the lower of the related loan balance or the fair value of the real estate at the date of foreclosure. At the time properties are acquired in full or partial satisfaction of loans, any excess of the loan balance over the estimated fair value of the property is charged against the allowance for loan losses. After foreclosure, these properties are carried at the lower of cost or fair value less estimated costs to sell based on recent appraised values or options to purchase the foreclosed property. Any excess of the carrying value over the estimated fair value, less estimated costs to sell, is charged to operations. The costs and expenses associated to holding these properties in portfolio are expensed as incurred.

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 regulations. Changes in assumptions affecting estimates may be required in the future and estimated tax assets or liabilities may need to be increased or decreased accordingly. The accrual for tax contingencies is adjusted in light of changing facts and circumstances, such as the progress of tax audits, case law and emerging legislation. When particular matters arise, a number of years may elapse before such matters are audited and finally resolved. Favorable resolution of such matters could be recognized as a reduction to the Group’s effective 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.

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The determination of deferred tax expense or benefit is based on changes in the carrying amounts of assets and liabilities that generate temporary differences. The carrying value of the Group’s net deferred tax assets assumes that the Group will be able to generate sufficient future taxable income based on estimates and assumptions. If these estimates and related assumptions change in the future, the Group may be required to record valuation allowances against its deferred tax assets resulting in additional income tax expense in the consolidated statements of operations.

Management evaluates the realizability of the deferred tax assets on a regular basis and assesses the need for a valuation allowance. A valuation allowance is established when management believes that it is more likely than not that some portion of its deferred tax assets will not be realized. Changes in the valuation allowance from period to period are generally included in the Group’s tax provision in the period of change.

In addition to valuation allowances, the Group establishes accruals for uncertain tax positions when, despite the belief that the Group’s tax return positions are fully supported, the Group believes that certain positions are likely to be challenged. The uncertain tax positions accruals are adjusted in light of changing facts and circumstances, such as the progress of tax audits, case law and emerging legislation. The Group’s uncertain tax positions accruals are reflected as income tax payable as a component of accrued expenses and other liabilities.

Effective at the beginning of the first quarter of 2007, the Group adopted the provisions of Financial Accounting Standard Board (“FASB”) Interpretation No. 48 (“FIN 48”),“Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109”, which contains a two-step approach to recognizing and measuring uncertain tax positions accounted for in accordance with SFAS 109. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount that is more than 50% likely of being realized upon ultimate settlement.

The Group’s policy to include interest and penalties related to unrecognized tax benefits within the provision for taxes on the audited consolidated statements of operations did not change as a result of implementing the provisions of FIN 48.

Equity-Based Compensation Plans

On April 25, 2007, the Board of Directors (the “Board”) formally adopted the Oriental Financial Group Inc. 2007 Omnibus Performance Incentive Plan (the “Omnibus Plan”), which was subsequently approved at the annual meeting of stockholders held on June 27, 2007. The Omnibus Plan provides for equity-based compensation incentives through the grant of stock options, stock appreciation rights, restricted stock, restricted stock units and dividend equivalents, as well as equity-based performance awards.

The purpose of the Omnibus Plan is to provide flexibility to the Group to attract, retain and motivate directors, officers, and key employees through the grant of awards based on performance and to adjust its compensation practices to the best compensation practice and corporate governance trends as they develop from time to time. The Omnibus Plan is further intended to motivate high levels of individual performance coupled with increased shareholder returns. Therefore, awards under the Omnibus Plan (each, an “Award”) are intended to be based upon the recipient’s individual performance, level of responsibility and potential to make significant contributions to the Group. Generally, the Omnibus Plan will terminate as of (a) the date when no more of the Group’s shares of common stock are available for issuance under the Omnibus Plan, or, if earlier, (b) the date the Omnibus Plan is terminated by the Group’s Board.

The Compensation Committee of the Group’s Board, or such other committee as the Board may designate (the “Committee”), has full authority to interpret and administer the Omnibus Plan in order to carry out its provisions and purposes. The Committee has the authority to determine those persons eligible to receive an Award and to establish the terms and conditions of any Award. The Committee may delegate, subject to such terms or conditions or guidelines as it shall determine, to any employee or group of employees any portion of its authority and powers under the Omnibus Plan with respect to participants who are not directors or executive officers subject to the

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reporting requirements under Section 16(a) of the Securities Exchange Act of 1934. Only the Committee may exercise authority in respect of Awards granted to such participants.

The Omnibus Plan replaced and superseded the Oriental Financial Group Inc. 1996, 1998 and 2000 Incentive Stock Option Plans (the “Stock Option Plans”). All outstanding stock options under the Stock Option Plans continue in full force and effect, subject to their original terms and conditions.

The Group follows the fair value method of recording stock-based compensation. Effective July 1, 2005, the Group adopted SFAS No. 123R“Share-Based Payment” (“SFAS 123R”), an amendment of SFAS No. 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 No. 123R applies to all awards unvested and granted after this effective date and awards modified, repurchased, or cancelled after that date.

Comprehensive Income

Comprehensive income is defined as the change in equity of a business enterprise during a period from transactions and other events and circumstances, except for those resulting from investments by owners and distributions to owners. GAAP requires that recognized revenue, expenses, gains and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and losses onavailable-for-sale securities and on derivative activities that qualify and are designated for cash flows hedge accounting, are reported as a separate component of the stockholders’ equity section of the consolidated statements of financial condition, such items, along with net income, are components of comprehensive income.

Evaluation of Prior Year Misstatements

In September 2006, the SEC issued Staff Accounting Bulletin No. 108 (“SAB 108”),“Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements”. SAB 108 provides the SEC staff’s views regarding the process of quantifying financial statement misstatements. It requires the use of two different approaches to quantifying misstatements — (1) the “rollover approach” and (2) the “iron curtain approach” — when assessing whether such a misstatement is material to the current period financial statements. The rollover approach focuses on the impact on the income statement of a misstatement originating in the current reporting period. The iron curtain approach focuses on the cumulative effect on the balance sheet as of the end of the current reporting period of uncorrected misstatements regardless of when they originated. If a material misstatement is quantified under either approach, after considering quantitative and qualitative factors, the financial statements would require adjustment. Depending on the magnitude of the correction with respect to the current period financial statements, changes to financial statements for prior periods could result. SAB 108 was effective for the Group on January 1, 2006.

The Group had three unrecorded accounting adjustments that were considered in the SAB 108 analysis. The Group historically deferred commissions to certain employees as part of the Bank’s deposit-gathering campaigns, instead of charging compensation expenses in the year paid. The balance of deferred commission as of January 1, 2006, was $719,000 and was corrected as of January 1, 2006, as a credit to cumulative retained earnings at that date.

The second accounting adjustment was the reversal of a prior year over-accrual of income taxes. As of December 31, 2005, utilizing the rollover method to evaluate differences, the Group decided not to correct $589,000 of excess income taxes provision. Such difference was corrected as of January 1, 2006, against cumulative retained earnings at that date.

The third accounting adjustment was the Group’s method of recognizing interest on a structured note carried asheld-to-maturity investment. The structured note pays interest depending on whether LIBOR is within a range or not. In the past, the Group had recorded interest on such note on a cash basis instead of using the retrospective interest method required by Financial Accounting Standards Board Emerging Issues Task Force Abstracts IssueNo. 96-12,“Recognition of Interest Income and Balance Sheet Classification of Structured Notes”. As a result of

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

the adoption of SAB 108, approximately $1.4 million of interest previously recognized on a cash basis in prior periods was reversed and recorded as interest income for 2006.

After considering all of the quantitative and qualitative factors, the Group determined that these accounting adjustments had not previously been material to prior periods when measured using the rollover method. Given that the effect of correcting these misstatements during 2006 would be material to the Group’s 2006 consolidated financial statements using this dual method, the Group concluded that the cumulative effect adjustment method of initially applying the guidance in SAB 108 was appropriate, and adjusted $1.525 million as a cumulative effect on the beginning retained earnings on the 2006 Consolidated Statements of Changes in Stockholder’s Equity.

Commitments and Contingencies

Liabilities for loss contingencies, arising from claims, assessments, litigation, fines, and penalties and other sources are recorded when it is probable that a liability has been incurred and the amount of the assessment can be reasonably estimated. Legal costs incurred in connection with loss contingencies are expensed as incurred.

Reclassifications

Certain amounts in prior years have been reclassified to conform to the presentation adopted in the current year.

Recently Issued Accounting Pronouncements and Interpretations:

SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51”

In December 2007, the FASB issued SFAS No. 160,“Noncontrolling Interest in Consolidated Financial Statements, an amendment of ARB No. 51”(“SFAS No. 160”), which will change the accounting and reporting for minority interests, which will be recharacterized as noncontrolling interests and classified as a component of equity within the consolidated balance sheets. FAS No. 160 is effective as of the beginning of the first fiscal year beginning on or after December 15, 2008. Earlier adoption is prohibited. The Group is currently evaluating the effect, if any, of the adoption of SFAS 160 on its consolidated financial statements, including disclosures. The effects of adopting this standard, if any, are not expected to be significant.

SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities, an amendment of SFAS No. 133”

In March 2008, FASB issued SFAS No. 161,“Disclosures about Derivative Instruments and Hedging Activities, an amendment of SFAS No. 133”, which requires additional disclosures for derivative instruments and hedging activities and thereby improves the transparency of financial reporting. Entities are required to provide enhanced disclosures about how and when an entity uses derivative instruments, how derivative instruments and related hedged items are accounted for under Statement 133 and its related interpretations, and how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows.

This Statement is effective for financial statements issued for fiscal years beginning after November 15, 2008, and interim periods within those fiscal years. Earlier application was encouraged. This statement encourages, but does not require, comparative disclosures for earlier periods at initial adoption. While the Group already provides some of these disclosures, enhancements will be incorporated into the Group’s annual and quarterly reports for the year 2009.

SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles”

In May 2008, FASB issued SFAS No. 162,“ The Hierarchy of Generally Accepted Accounting Principles”, This Statement identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles (GAAP) in the United States (the GAAP hierarchy).

F-19

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

This Statement is effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board amendments to AU Section 411,The Meaning ofPresent Fairly in Conformity With Generally Accepted Accounting Principles. The adoption of this standard is not expected to have a material effect on the Group’s results of operations or financial position. The Board does not expect that this statement will result in a change in current accounting practice. However, transition provisions have been provided in the unusual circumstance that the application of the provisions of this statement results in a change in accounting practice.

FASB Staff Position (FSP)FAS 140-3, “Accounting for Transfers of Financial Assets and Repurchase Financing Transactions”

The objective of FSPFAS 140-3, issued by the FASB in February 2008, is to provide implementation guidance on whether the security transfer and contemporaneous repurchase financing involving the transferred financial asset must be evaluated as one linked transaction or two separate delinked transactions. Current practice records the transfer as a sale and the repurchase agreement as a financing. The FSPFAS 140-3 requires the recognition of the transfer and the repurchase agreement as one linked transaction, unless all of the following criteria are met: (1) the initial transfer and the repurchase financing are not contractually contingent on one another; (2) the initial transferor has full recourse upon default, and the repurchase agreement’s price is fixed and not at fair value; (3) the financial asset is readily obtainable in the marketplace and the transfer and repurchase financing are executed at market rates; and (4) the maturity of the repurchase financing is before the maturity of the financial asset. The scope of this FSP is limited to transfers and subsequent repurchase financings that are entered into contemporaneously or in contemplation of one another. The impact of this FSP is not expected to be material.

FASB Staff Position (FSP)FAS 142-3, “Determination of the Useful Life of Intangible Assets”

FSPFAS 142-3, issued by the FASB in April 2008, amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under FASB Statement No. 142“Goodwill and Other Intangible Assets”. In developing these assumptions, an entity should consider its own historical experience in renewing or extending similar arrangements adjusted for entity’s specific factors or, in the absence of that experience, the assumptions that market participants would use about renewals or extensions adjusted for the entity specific factors. FSPFAS 142-3 shall be applied prospectively to intangible assets acquired after the effective date. This FSP was adopted by the Group on January 1, 2009. The Group will be evaluating the potential impact of adopting this FSP to prospective transactions.

FSP No. FAS 132(R)-1 “Employers’ Disclosures about Postretirement Benefit Plan Assets”

FSP No. FAS 132(R)-1 applies to employers who are subject to the disclosure requirements of FAS 132(R), and is effective for fiscal years ending after December 15, 2009. Early application is permitted. Upon initial application, the provisions of this FSP are not required for earlier periods that are presented for comparative periods. The FSP requires the following additional disclosures: (a) the investment allocation decision making process, including the factors that are pertinent to an understanding of investment policies and strategies, (b) the fair value of each major category of plan assets, disclosed separately for pension plans and other postretirement benefit plans, (c) the inputs and valuation techniques used to measure the fair value of plan assets, including the level within the fair value hierarchy in which the fair value measurements in their entirety fall, and (d) significant concentrations of risk within plan assets. Additional detailed information is required for each category above. The Group will apply the new disclosure requirements commencing with the December 31, 2009 financial statements. This FSP impacts disclosures only and will not have an effect on the Group’s consolidated statements of condition or operations.

FSP No. EITF03-6-1 “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities”

F-20

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

“Earnings per Share”. Unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of EPS pursuant to the two-class method. This FSP shall be effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those years. All prior-period EPS data presented shall be adjusted retrospectively (including interim financial statements, summaries of earnings, and selected financial data) to conform with the provisions of this FSP. Early application is not permitted. This FSP will not have an impact on the Group’s EPS computation upon adoption.

EITF IssueNo. 07-5 “Determining Whether an Instrument (or Embedded Feature) is Indexed to an Entity’s Own Stock”

In June 2008, the EITF reached consensus on IssueNo. 07-5. EITF IssueNo. 07-5 provides guidance about whether an instrument (such as outstanding common stock warrants) should be classified as equity and not marked to market for accounting purposes. EITF IssueNo. 07-5 is effective for financial statements for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. The guidance in this issue shall be applied to outstanding instruments as of the beginning of the fiscal year in which this issue is initially applied.The Group is currently evaluating the effect, if any, of the adoption of EITF IssueNo. 07-5 on its consolidated financial statements, including disclosures. The effects of adopting this standard, if any, are not expected to be significant.

EITF08-6 “Equity Method Investment Accounting Considerations”

EITF 08-6 clarifies the accounting for certain transactions and impairment considerations involving equity method investments. This EITF applies to all investments accounted for under the equity method. This issue is effective for fiscal years beginning on or after December 15, 2008. Early adoption is not permitted.EITF 08-6 provides guidance on (1) how the initial carrying value of an equity method investment should be determined, (2) how an impairment assessment of an underlying indefinite-lived intangible asset of an equity method investment should be performed, (3) how an equity method investee’s issuance of shares should be accounted for, and (4) how to account for a change in an investment from the equity method to the cost method. Management is evaluating the impact that the adoption ofEITF 08-6 could have on the Group’s financial condition or results of operations.

EITF08-7 “Accounting for Defensive Intangible Assets”

EITF 08-7 clarifies how to account for defensive intangible assets subsequent to initial measurement.EITF 08-7 applies to acquired intangible assets in situations in which an entity does not intend to actively use the asset but intends to hold (lock up) the asset to prevent others from obtaining access to the asset (a defensive intangible asset), except for intangible assets that are used in research and development activities. A defensive intangible asset should be accounted for as a separate unit of accounting. A defensive intangible asset shall be assigned a useful life in accordance with paragraph 11 of SFAS. No 142.EITF 08-7 is effective for intangible assets acquired on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. Management will be evaluating the impact of adopting this EITF for future acquisitions commencing in January 2009.

F-21

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


2.	INVESTMENTS

Investment Securities

The amortized cost, gross unrealized gains and losses, fair value, and weighted average yield of the securities owned by the Group at December 31, 2008 and 2007, were as follows:


	December 31, 2008
			Gross		Gross				Weighted
	Amortized		Unrealized		Unrealized		Fair		Average
	Cost		Gains		Losses		Value		Yield
	(In thousands)

Available-for-sale
Obligations of US Government sponsored agencies	$	941,144	$	7,172	$	6,400	$	941,916		5.37	%
Puerto Rico Government and agency obligations		91,599		597		9,307		82,889		5.40	%
Structured credit investments		176,127		3,469		43,415		136,181		6.18	%

Total investment securities		1,208,870		11,238		59,122		1,160,986

FNMA and FHLMC certificates		1,521,428		25,527		205		1,546,750		5.51	%
GNMA certificates		332,071		4,206		496		335,781		5.76	%
CMOs issued by US Government sponsored agencies		352,579		202		1,755		351,026		5.34	%
Non-agency collateralized mortgage obligations		637,626		—		107,962		529,664		8.49	%

Total mortgage-backed-securities and CMOs		2,843,704		29,935		110,418		2,763,221

Total securitiesavailable-for-sale	$	4,052,574	$	41,173	$	169,540	$	3,924,207		5.98	%


	December 31, 2007
			Gross		Gross				Weighted
	Amortized		Unrealized		Unrealized		Fair		Average
	Cost		Gains		Losses		Value		Yield
	(In thousands)

Available-for-sale
Obligations of US Government sponsored agencies	$	1,279,977	$	14,933	$	—	$	1,294,910		5.91	%
Puerto Rico Government and agency obligations		18,331		63		937		17,457		5.69	%
Structured credit investments		85,548		—		7,188		78,360		5.46	%

Total investment securities		1,383,856		14,996		8,125		1,390,727

FNMA and FHLMC certificates		998,008		10,681		223		1,008,466		5.85	%
GNMA certificates		48,907		869		216		49,560		5.69	%
Non-agency collateralized mortgage obligations (CMOs)		632,992		42		12,505		620,529		5.49	%

Total mortgage-backed-securities and CMOs		1,679,907		11,592		12,944		1,678,555

Total securitiesavailable-for-sale		3,063,763		26,588		21,069		3,069,282		5.78	%

Held-to-maturity
Obligations of US Government sponsored agencies		418,731		902		1,980		417,653		4.92	%
Puerto Rico Government and agency obligations		55,206		—		3,781		51,425		5.29	%
Structured credit investments		96,171		—		11,949		84,222		6.69	%

Total investment securities		570,108		902		17,710		553,300

FNMA and FHLMC certificates		624,267		4,331		3,560		625,038		5.03	%
GNMA certificates		161,647		1,504		1,204		161,947		5.36	%
CMOs issued by US Government sponsored agencies		136,865		1,489		527		137,827		5.14	%

Total mortgage-backed-securities and CMOs		922,779		7,324		5,291		924,812

Total securitiesheld-to-maturity		1,492,887		8,226		23,001		1,478,112		5.16	%

Total	$	4,556,650	$	34,814	$	44,070	$	4,547,394		5.58	%

F-22

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

For 2008, 2007, and 2006 the Group’s investment securities portfolio generated tax-exempt interest income of $193.4 million, $184.7 million and $146.7 million, respectively. Exempt interest relates mostly to interest earned on obligations of the United States and Puerto Rico governments and certain mortgage-backed securities, including securities held by the Bank’s international banking entity. For 2008, 2007, and 2006, the Group’s investment securities portfolio generated taxable interest income of $64.6 million, $18.9 million and $8.8 million, respectively.

The next table shows the amortized cost and fair value of the Group’s investment securities at December 31, 2008, by contractual maturity. Securities not due on a single contractual maturity date, such as collateralized mortgage obligations, are classified in the period of final contractual maturity. The expected maturities of collateralized mortgage obligations and certain other securities may differ from their contractual maturities because they may be subject to prepayments or may be called by the issuer.


	December 31, 2008
	Available-for-sale
	Amortized Cost		Fair Value
	(In thousands)

Investment securities
Due within one year	$	91,995	$	91,996
Due after 1 to 5 years		20,000		20,595
Due after 5 to 10 years		740,290		720,448
Due after 10 years		356,585		327,947

		1,208,870		1,160,986

Mortgage-backed securities
Due after 5 to 10 years		48,291		48,315
Due after 10 years		2,795,413		2,714,906

		2,843,704		2,763,221

	$	4,052,574	$	3,924,207

In keeping with the Group’s investment strategy, during 2008 and 2007, there were certain sales of securities because the Group felt at the time of such sales that gains could be realized while at the same time having good opportunities to invest the proceeds in other investment securities with attractive yields and terms that would allow the Group to continue to protect its net interest margin.

Gains on sales of securities for 2008 included $14.4 million from the sale on December 31, 2008 of $820.6 million of agency-issuedheld-to-maturity securities. On that date, the remaining securities in theheld-to-maturity portfolio were transferred to theavailable-for-sale portfolio at a fair value of $354.5 million with a net unrealized loss of $23.2 million.

Net proceeds from the sale of investment securitiesavailable-for-sale during 2008, 2007, and 2006, totaled $1.7 billion, $787.3 million and $1.3 billion, respectively. Gross realized gains on those sales during 2008 and 2007 were $20.7 million and $3.8 million, respectively. There were no losses on such sales during 2007 and $61,000 in losses during 2008 (all related to securities with unamortized cost at the time of sale which represented less than 15% of the original face value). Gross realized gains and losses for 2006 were $5.6 million and $20.8 million, respectively.

During the fourth quarter of 2006, the Group completed an evaluation of itsavailable-for-sale investment portfolio considering changing market conditions, and strategically repositioned this portfolio. The repositioning involved open market sales of approximately $865 million of securities with a weighted average yield of 4.60% at a loss of approximately $16.0 million, and the purchase of $860 million of securities with a weighted average yield of 5.55%. Proceeds were used to repay repurchase agreements with a weighted average rate paid of 5.25%.

F-23

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The tables below present an analysis of the gross realized gains and losses by category for the years ended December 31, 2008 and 2007:


	Year Ended December 31, 2008
Description	Original Face		Original Cost		Sale Proceeds		Sale Book Value		Gains		Losses
	In thousands

Gain on Sale of SecuritiesAvailable-for-Sale
Investment securities
Obligations of U.S. Government sponsored agencies	$	793,300	$	792,957	$	791,278	$	782,063	$	9,215	$	—
Puerto Rico Government and agency obligations		1,830		1,843		1,862		1,804		58		—

Total investment securities		795,130		794,800		793,140		783,867		9,273		—

Mortgage-backed securities and CMOs
FNMA and FHLMC certificates		821,488		817,883		703,921		693,370		10,551		—
GNMA certificates		196,578		199,030		190,718		189,872		907		(61	)

Total mortgage-backed securities and CMOs		1,018,066		1,016,913		894,639		883,242		11,458		(61	)

		1,813,196		1,811,713		1,687,779		1,667,109		20,731		(61	)

Gain on Sale of SecuritiesHeld-to-Maturity
Investment securities
Obligations of U.S. Government sponsored agencies		125,000		124,981		127,870		125,000		2,870		—

Total investment securities		125,000		124,981		127,870		125,000		2,870		—

Mortgage-backed securities and CMOs
FNMA and FHLMC certificates		1,028,748		906,544		488,628		481,518		7,110		—
GNMA certificates		319,223		272,090		115,358		113,441		1,917		—
CMOs issued by U.S. Government sponsored agencies		140,473		140,979		103,119		100,616		2,503		—

Total mortgage-backed securities and CMOs		1,488,444		1,319,613		707,105		695,575		11,530		—

		1,613,444		1,444,594		834,975		820,575		14,400		—

Total	$	3,426,640	$	3,256,307	$	2,522,754	$	2,487,684	$	35,131	$	(61	)


	Year Ended December 31, 2007
Description	Original Face		Original Cost		Sale Proceeds		Sale Book Value		Gains		Losses
	In thousands

Gain on Sale of SecuritiesAvailable-for-Sale
Investment securities
Obligations of U.S. Government sponsored agencies	$	200,000	$	200,000	$	200,575	$	200,000	$	575	$	—
Corporate bonds and others		25,000		24,909		25,322		24,964		358		—

Total investment securities		225,000		224,909		225,897		224,964		933		—

Mortgage-backed securities and CMOs
FNMA and FHLMC certificates		533,823		516,991		515,463		513,562		1,901		—
GNMA certificates		45,168		43,824		45,895		45,779		120		—

Total mortgage-backed securities and CMOs		578,991		560,815		561,358		559,341		2,021		—

Total	$	803,991	$	785,724	$	787,255	$	784,305	$	2,954	$	—

F-24

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The following table shows the Group’s gross unrealized losses and fair value of investment securitiesavailable-for-sale andheld-to-maturity, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2008 and 2007:

December 31, 2008
Available-for-sale


	Less than 12 months
	Amortized		Unrealized		Fair
	Cost		Loss		Value
	(In thousands)

CMOs issued by US Government sponsored agencies	$	334,690	$	1,756	$	332,934
Obligations of US Government sponsored agencies		325,500		6,400		319,100
Non-agency collaterized mortgage obligations		234,198		48,564		185,634
FNMA and FHLMC certificates		52,519		148		52,371
Structured credit investments		50,262		11,815		38,447
GNMA certificates		19,582		229		19,353
Puerto Rico Government and agency obligations		252		1		251

		1,017,003		68,913		948,090


	12 months or more
	Amortized		Unrealized		Fair
	Cost		Loss		Value

Non-agency collaterized mortgage obligations		403,428		59,398		344,030
Structured credit investments		100,548		31,599		68,949
Puerto Rico Government and agency obligations		71,218		9,306		61,912
GNMA certificates		9,084		267		8,817
FNMA and FHLMC certificates		1,025		57		968

		585,303		100,627		484,676


	Total
	Amortized		Unrealized		Fair
	Cost		Loss		Value

Non-agency collaterized mortgage obligations		637,626		107,962		529,664
CMOs issued by US Government sponsored agencies		334,690		1,756		332,934
Obligations of US Government sponsored agencies		325,500		6,400		319,100
Structured credit investments		150,810		43,414		107,396
Puerto Rico Government and agency obligations		71,470		9,307		62,163
FNMA and FHLMC certificates		53,544		205		53,339
GNMA certificates		28,666		496		28,170

	$	1,602,306	$	169,540	$	1,432,766

F-25

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

December 31, 2007
Available-for-sale


	Less than 12 months
	Amortized		Unrealized		Fair
	Cost		Loss		Value
	(In thousands)

FNMA and FHLMC certificates	$	110,224	$	223	$	110,001
Structured credit investments		85,548		7,188		78,360
GNMA certificates		8,392		113		8,279
Puerto Rico Government and agency obligations		1,996		325		1,671

		206,160		7,849		198,311


	12 months or more
	Amortized		Unrealized		Fair
	Cost		Loss		Value

Non-agency collaterized mortgage obligations		630,429		12,505		617,924
Puerto Rico Government and agency obligations		14,152		613		13,539
GNMA certificates		4,481		102		4,379

		649,062		13,220		635,842


	Total
	Amortized		Unrealized		Fair
	Cost		Loss		Value

Non-agency collaterized mortgage obligations		630,429		12,505		617,924
FNMA and FHLMC certificates		110,224		223		110,001
Structured credit investments		85,548		7,188		78,360
Puerto Rico Government and agency obligations		16,148		938		15,210
GNMA certificates		12,873		215		12,658

	$	855,222	$	21,069	$	834,153

Held-to-maturity


	Less than 12 months
	Amortized		Unrealized		Fair
	Cost		Loss		Value
	(In thousands)

Structured credit investments	$	96,171	$	11,949	$	84,222
CMOs issued by US Government sponsored agencies		17,176		25		17,151
Puerto Rico Government and agency obligations		4,238		54		4,184
GNMA certificates		1,227		104		1,123

		118,812		12,132		106,680

F-26

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


	12 months or more
	Amortized		Unrealized		Fair
	Cost		Loss		Value

FNMA and FHLMC certificates		304,536		3,560		300,976
Obligations of US Government sponsored agencies		124,998		1,980		123,018
Puerto Rico Government and agency obligations		50,968		3,727		47,241
GNMA certificates		49,299		1,100		48,199
CMOs issued by US Government sponsored agencies		19,287		502		18,785

		549,088		10,869		538,219


	Total
	Amortized		Unrealized		Fair
	Cost		Loss		Value

FNMA and FHLMC certificates		304,536		3,560		300,976
Obligations of US Government sponsored agencies		124,998		1,980		123,018
Structured credit investments		96,171		11,949		84,222
Puerto Rico Government and agency obligations		55,206		3,781		51,425
GNMA certificates		50,526		1,204		49,322
CMOs issued by US Government sponsored agencies		36,463		527		35,936

	$	667,900	$	23,001	$	644,899

At December 31, 2008, the Group’s available-for-sale investment securities portfolio included approximately $637.6 million in non-agency collateralized mortgage obligations with unrealized losses of $108.0 million. The Group constantly monitors such non-agency mortgage-backed securities to measure the collateral performance and gauge trends for these positions, and the effect of collateral behavior on credit enhancements, cash flows, and fair values of the bonds. The Group also periodically monitors any rating migration, and takes into account the time lag between underlying performance and rating agency actions. The collateral for all of the non-agency collateralized mortgage obligations, except for the ALT A CMO which is more thoroughly discussed below, has performed well since the issuance of each security, and the estimated future collateral losses are lower than the subordination levels of these securities. This assessment is made using a cash flow model that estimates the cash flows on the underlying mortgages, based on the security-specific collateral and deal structure, and also includes inputs such as constant default rates, prepayment rates, and loss severity. The cash flows estimated by the model are distributed through the different tranches of each security, considering subordination for the different tranches. The model results as of December 31, 2008 show that the estimated future collateral losses, if any, are lower than the Group’s subordination levels for each one of these securities. Therefore, these securities are deemed to have sufficient credit support to absorb the estimated collateral losses.

In the specific case of the ALT A CMO, this security has been carefully monitored during the past year. As of September 30, 2008, the Group considered that the deterioration in the performance of underlying loans, including increases in delinquency and loss experience, resulted in projected losses which exceeded the tranche subordination. As a result, an other than temporary impairment amounting to $38.9 million was recorded at that time. As of December 31, 2008, the Group updated its estimate of the fair value of the security considering new market information, including a higher yield of 18% as a result of continued higher spreads under current market conditions. Based on the Group’s estimate using market participant data, projected losses in excess of remaining subordination at that date were not greater than the estimated losses contemplated by projected cash flow estimates determined upon previous impairment of the security. Consequently, the Group has determined that no additional impairment charge is necessary as of December 31, 2008.

At December 31, 2008, the Group held structured credit investments amounting to $176.1 million in the available-for-sale portfolio, with unrealized losses of approximately $39.9 million. The Group’s structured credit investments

F-27

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

portfolio consists of two types of instruments: synthetic collateralized debt obligations (CDOs) and collateralized loan obligations (CLOs). At December 31, 2008, the Group estimated that it will recover all interest and principal for the Group’s specific tranches of these securities. This assessment is based on an analysis in which the credit quality of the Group’s positions was evaluated through a determination of the expected losses on the underlying collateral. The losses on the underlying corporate pools were inferred by observations on the credit spreads of the reference entities or market quotes used to derive the credit spreads. The spreads of the portfolios were converted to loss probabilities, and these were applied to a cash flow model that provided estimated projected losses for each security. The model results as of December 31, 2008 show that the estimated future collateral losses, if any, are lower than the Group’s subordination levels for each one of these securities. Therefore, these securities are deemed to have sufficient credit support to absorb the estimated collateral losses.

Other than temporary impairment analysis is based on estimates that depend on market conditions and are subject to further change over time. In addition, while the Group believes that the methodology used to value these exposures is reasonable, the methodology is subject to continuing refinement, including those made as a result of market developments. Consequently, it is reasonably possible that changes in estimates or conditions could result in the need to recognize other than temporary impairment in the future.

All other securities in an unrealized loss position at December 31, 2008, are mainly composed of securities issued or backed by U.S. government agencies and U.S. government sponsored agencies. These investments are primarily highly liquid securities that have a large and efficient secondary market. Valuations are performed on a monthly basis using a third party provider and dealer quotes. The Group’s management believes that the unrealized losses of such other securities at December 31, 2008, are temporary and are substantially related to market interest rate fluctuations and not to deterioration in the creditworthiness of the issuer or guarantor. At December 31, 2008, the Group has the intent and ability to hold these investments until a period of time sufficient to allow for any recovery in fair value or maturity up to (or beyond) the cost of these investments.


3.	PLEDGED ASSETS

At December 31, 2008, residential mortgage loans with principal outstanding balances amounting to $639.8 million were pledged to secure advances and borrowings from the FHLB. Investment securities with fair values totaling $3.8 billion, $82.1 million and $36.2 million at December 31, 2008, were pledged to secure investment securities sold under agreements to repurchase (see Note 8), public fund deposits (see Note 7) and other funds, respectively. Also, investment securities with fair values totaling $112,000 at December 31, 2008, were pledged to the Puerto Rico Treasury Department.

As of December 31, 2008, investment securitiesavailable-for-sale not pledged amounted to $133.5 million. As of December 31, 2008, mortgage loans not pledged amounted to $383.6 million.

F-28

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


4.	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 December 31, 2008 and 2007 was as follows:


	December 31,
	2008			2007
	(In thousands)

Loans secured by real estate:
Residential — 1 to 4 family	$	976,569		$	960,704
Home equity loans, secured personal loans and others		23,507			28,783
Commercial		145,377			135,070
Deferred loan fees, net		(3,197	)		(2,887	)

		1,142,256			1,121,670

Other loans:
Commercial		41,700			22,128
Personal consumer loans and credit lines		23,054			29,245
Deferred loan cost (fees), net		(167	)		12

		64,587			51,385

Loans receivable		1,206,843			1,173,055
Allowance for loan losses		(14,293	)		(10,161	)

Loans receivable, net		1,192,550			1,162,894
Mortgage loansheld-for-sale		26,562			16,672

Total loans, net	$	1,219,112		$	1,179,566

At December 31, 2008 and 2007, loans on which the accrual of interest has been discontinued amounted to $38.8 and $27.3 million, respectively. The gross interest income that would have been recorded in the years ended December 31, 2008, 2007, and 2006 if non-accrual loans had performed in accordance with their original terms amounted to $2.5 million, $2.0 million and $1.3 million, respectively. The Group’s investment in loans past due 90 days or more and still accruing amounted to $38.7 million and $38.8 million at December 31, 2008, 2007, respectively.

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.

F-29

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The changes in the allowance for loan losses for the years ended December 31, 2008, 2007, and 2006 were as follows:


	Year Ended December 31,
	2008			2007			2006
	(In thousands)

Balance at beginning of year	$	10,161		$	8,016		$	6,630
Provision for loan losses		8,860			6,550			4,388
Loans charged-off		(5,104	)		(4,906	)		(3,678	)
Recoveries		376			501			676

Balance at end of year	$	14,293		$	10,161		$	8,016

The Group evaluates all loans, some individually and others as homogeneous groups, for purposes of determining impairment. At December 31, 2008, the total investment in impaired commercial loans was $4.6 million (December 31, 2007 — $1.1 million). The impaired commercial loans were measured based on the fair value of collateral. The average investment in impaired commercial loans for the years ended December 31, 2008, 2007 and 2006, amounted to $1.9 million, $1.5 million, and $2.2 million, respectively. The Group’s management determined that impaired loans required a valuation allowance in accordance with FASB Statement No. 114“Accounting by Creditors for Impairment of a Loan” of approximately $1.1 million at December 31, 2008. No allowance was required at December 31, 2007.


5.	PREMISES AND EQUIPMENT

Premises and equipment at December 31, 2008 and 2007 are stated at cost less accumulated depreciation and amortization as follows:


	December 31,
	Useful Life
	(Years)	2008			2007
	(In thousands)

Land	—	$	1,014		$	1,014
Buildings and improvements	40		4,234			4,682
Leasehold improvements	5 — 10		16,540			13,411
Furniture and fixtures	3 — 7		7,490			7,162
Information technology and other	3 — 7		12,527			14,072

			41,805			40,341
Less: accumulated depreciation and amortization			(20,621	)		(18,562	)

		$	21,184		$	21,779

Depreciation and amortization of premises and equipment for the years ended December 31, 2008, 2007, and 2006, totaled $5.4 million, $5.4 million, and $5.5 million, respectively. These are included in the consolidated statements of operations as part of occupancy and equipment expenses.

F-30

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


6.	ACCRUED INTEREST RECEIVABLE AND OTHER ASSETS

Accrued interest receivable at December 31, 2008 and 2007 consists of $10.9 million and $10.6 million, respectively from loans, and $33.0 million and $41.7 million, respectively from investments.

Other assets at December 31, 2008 and 2007 consist of the following:


	December 31,
	2008		2007
	(In thousands)

Mortgage tax credits	$	5,047	$	69
Prepaid expenses		3,433		2,645
Servicing asset		2,819		2,526
Goodwill		2,006		2,006
Investment in Statutory Trusts		1,086		1,086
Deferred charges		900		910
Accounts receivable and other assets		8,635		7,082

	$	23,926	$	16,324

In December 2007, the Commonwealth of Puerto Rico established mortgage loan tax credits to financial institutions that provided financing for the acquisition of new homeowners for the period from December 2007 to December 2008 up to a maximum amount of $220 million in tax credits overall. At December 31, 2008 and 2007 mortgage loan tax credits amounted to $5.0 million and $69,000, respectively. A loss of $2.5 million was included in the Consolidated Statements of Operations for the year ended December 31, 2008, representing a provision for loss on mortgage loan tax credits for new homeowners which surpassed the $220 million limit established by the government and is now doubtful whether these tax credits will be granted. No provision for loss on mortgage tax credits was recorded for the years ended December 31, 2007 or 2006.


7.	DEPOSITS AND RELATED INTEREST

At December 31, 2008, 2007, the weighted average interest rate of the Group’s deposits was 3.54%, and 4.42%, respectively, inclusive of non-interest bearing deposits of $53.2 million, and $50.0 million, respectively. Interest expense for the years ended December 31, 2008 and 2007, and 2006 is set forth below:


	Year Ended December 31,
	2008		2007		2006
	(In thousands)

Demand deposits	$	4,197	$	817	$	857
Savings deposits		10,199		13,959		5,366
Certificates of deposit		35,385		38,018		40,479

	$	49,781	$	52,794	$	46,701

At December 31, 2008 and 2007, time deposits in denominations of $100,000 or higher amounted to $548.4 million, and $615.8 million including: (i) public fund deposits from various local government agencies of $72.3 million and $95.8 million at a weighted average rate of 2.04% and 4.56%, which were collateralized with investment securities with fair value of $82.1 million and $100.4 million, respectively.

F-31

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Excluding equity indexed options in the amount of $16.6 million, which are used by the Group to manage its exposure to the Standard & Poor’s 500 stock market index, and also excluding accrued interest of $6.5 million and unamortized deposit discounts in the amount of $16.7 million, the scheduled maturities of certificates of deposit at December 31, 2008 are as follows:


	(In thousands)

Within one year:
Three (3) months or less	$	301,337
Over 3 months through 1 year		676,661

		977,998
Over 1 through 2 years		128,337
Over 2 through 3 years		59,729
Over 3 through 4 years		73,277
Over 4 through 5 years		34,573
Over 5 years		1,086

	$	1,275,000

At December 31, 2008 and 2007 brokered certificates of deposits amounted to $515.6 million and $35.0 million, respectively, at a weighted average rate of 2.97% and 4.79%.

The aggregate amount of overdraft in demand deposit accounts that were reclassified to loans amounted to $2.2 million as of December 31, 2008, (December 31, 2007 — $1.8 million).


8.	BORROWINGS

Short Term Borrowings

At December 31, 2008, short term borrowings amounted to $29.2 million (December 31, 2007 — $27.5 million) which mainly consist of federal funds purchased with a weighted average rate of 1.49% (December 31, 2007 — 1.83%).

Securities Sold under Agreements to Repurchase

At December 31, 2008, securities underlying agreements to repurchase were delivered to, and are being held by, the counterparties with whom the repurchase agreements were transacted. The counterparties have agreed to resell to the Group the same or similar securities at the maturity of the agreements.

At December 31, 2008, securities sold under agreements to repurchase (classified by counterparty), excluding accrued interest in the amount of $11.1 million, were as follows:


			Fair Value of
	Borrowing		Underlying
	Balance		Collateral
	(In thousands)

Citigroup	$	1,800,000	$	2,138,837
Credit Suisse First Boston Corporation		1,250,000		1,438,233
UBS Financial Services		500,000		595,583
JP Morgan Chase		100,000		118,764
Merrill Lynch		100,000		107,007

Total	$	3,750,000	$	4,398,424

F-32

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The fair value of underlying collateral includes agency-issued investment securities with a fair value of $834.9 million sold on December 31, 2008 for which the transaction settled after that date. The proceeds from such sale were reinvested after year-end in similar quality agency-issued securities, which were then placed as collateral for the corresponding repurchase agreements.

During the fourth quarter of 2006 and throughout 2007, the Group restructured most of its short-term repurchase agreements portfolio into longer-term, structured repurchase agreements. The terms of these structured positions range between three and ten years, and the counterparties have the right to exercise put options before their contractual maturity from one to three years after the agreements’ settlement dates. The following table shows a summary of these agreements and their terms, excluding accrued interest in the amount of $11.1 million, at December 31, 2008:


			Weighted-Average
Year of Maturity	Borrowing Balance		Coupon			Settlement Date		Maturity Date		Next Put Date
	(In thousands)

2010
	$	100,000		4.39	%		8/14/2007		8/16/2010		2/14/2009

		100,000

2011
		100,000		4.17	%		12/28/2006		12/28/2011		3/28/2009
		350,000		4.23	%		12/28/2006		12/28/2011		3/28/2009
		100,000		4.29	%		12/28/2006		12/28/2011		3/28/2009
		350,000		4.35	%		12/28/2006		12/28/2011		3/28/2009

		900,000

2012
		350,000		4.26	%		5/9/2007		5/9/2012		2/9/2009
		100,000		4.50	%		8/14/2007		8/14/2012		8/14/2009
		300,000		4.47	%		9/13/2007		9/13/2012		9/13/2009
		150,000		4.31	%		3/6/2007		12/6/2012		12/7/2009

		900,000

2014
		100,000		4.67	%		7/27/2007		7/27/2014		1/27/2010

		100,000


2017		250,000		4.44	%		3/2/2007		3/2/2017		3/2/2009
		500,000		4.46	%		3/2/2007		3/2/2017		3/2/2009
		1,000,000		3.71	%		3/6/2007		3/6/2017		3/6/2009

		1,750,000

Total	$	3,750,000		4.19	%

None of the structured repurchase agreements referred to above with put dates up to March 6, 2009 were put by the counterparties at their corresponding put dates. Such repurchase agreements include $1.25 billion which reset at the put dates at a formula which is based on the three-month LIBOR rate less fifteen times the difference between the ten-year SWAP rate and the two-year SWAP rate, with a minimum of 0.0% on $1.0 billion and 0.25% on $250 million, and a maximum of 10.6%. These repurchase agreements will bear the respective minimum rates of 0.0% and 0.25% from March 2009 to at least their next put dates scheduled for June 2009.

F-33

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The following table presents the borrowings under repurchase agreements, excluding accrued interest in the amount of $11.1 million and $11.4 million, respectively, at December 31, 2008 and 2007, their maturities and approximate fair values of their collateral as follows:


	December 31,
	2008				2007
			Fair Value of				Fair Value of
			Underlying				Underlying
	Borrowing Balance		Collateral		Borrowing Balance		Collateral
			(In thousands)

GNMA certificates
Within 30 days	$	—	$	215,923	$	4,832	$	27,672
1 — 3 years		24,232		25,127		—		—
3 — 5 years		80,264		84,364		10,729		11,241
Over 5 years		109,621		82,977		76,816		72,861

		214,117		408,391		92,377		111,774

FNMA certificates
Within 30 days		—		239,966		32,000		101,982
1 — 3 years		8,701		9,050		3,261		3,401
3 to 5 years		404,596		424,447		437,719		450,431
Over 5 years		853,669		786,220		316,228		299,115

		1,266,966		1,459,683		789,208		854,929

FHLMC certificates
Within 30 days		—		24,883		48,168		80,613
1 — 3 years		67,067		70,128		96,739		100,901
3 to 5 years		113,903		117,852		242,470		254,043
Over 5 years		371,557		340,142		229,075		221,558

		552,527		553,005		616,452		657,115

CMOs
Within 30 days		—		12,059		—		17,512
3 to 5 years		801,237		876,170		746,355		743,807
Over 5 years		77,134		81,600		—		—

		878,371		969,829		746,355		761,319

US Agency securities
Within 30 days		—		147,118		15,023		64,841
3 to 5 years		50,000		51,117		362,727		385,621
Over 5 years		788,019		809,281		1,227,881		1,237,606

		838,019		1,007,516		1,605,631		1,688,068

Total	$	3,750,000	$	4,398,424	$	3,850,023	$	4,073,205

F-34

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

At December 31, 2008 and 2007, the weighted average interest rate of the Group’s repurchase agreements was 4.34% and 4.20%, respectively and included agreements with interest ranging from 3.71% to 4.67% and 3.71% to 5.25%, respectively. The following summarizes significant data on securities sold under agreements to repurchase as of December 31, 2008 and 2007, excluding accrued interest:


	December 31,
	2008			2007
	(In thousands)

Average daily aggregate balance outstanding	$	3,800,673		$	3,154,369

Maximum amount outstanding at any month-end	$	3,836,635		$	3,850,023

Weighted average interest rate during the year		4.25	%		4.68	%

Weighted average interest rate at year end		4.34	%		4.20	%

Advances from the Federal Home Loan Bank

At December 31, 2008 and 2007, advances from the FHLB consisted of the following, excluding accrued interest of $1.7 million and $1.9 million, respectively:


	December 31,
Maturity Date	Fixed Interest Rate			2008			2007
				(In thousands)

August-2008		4.07	%	$	—		$	50,000
January-2009		0.44	%		26,700			—
May-2012		4.37	%		25,000			25,000
July-2012		4.57	%		25,000			25,000
July-2012		4.26	%		25,000			25,000
August-2012		4.33	%		50,000			50,000
August-2012		4.09	%		100,000			100,000
May-2014		4.20	%		25,000			25,000
May-2014		4.22	%		30,000			30,000

				$	306,700		$	330,000

Weighted average interest rate					3.91	%		4.21	%

Advances are received from the FHLB under an agreement whereby the Group is required to maintain a minimum amount of qualifying collateral with a fair value of at least 110% of the outstanding advances. At December 31, 2008, these advances were secured by mortgage loans amounting to $639.8 million. Also, at December 31, 2008, the Group has an additional borrowing capacity with the FHLB of $235.3 million. At December 31, 2008, the weighted average maturity of FHLB’s advances was 43.6 months (December 31, 2007 — 51.3 months).

F-35

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

During 2007, the Group restructured most of its FHLB advances portfolio into longer-term, structured advances. The terms of these advances range between five and seven years, and the FHLB has the right to exercise put options before the contractual maturity of the advances from six months to one year after the advances’ settlement dates and quarterly thereafter. The following table shows a summary of these advances and their terms, excluding accrued interest in the amount of $1.7 million, at December 31, 2008:


			Weighted-Average
Year of Maturity	Borrowing Balance		Coupon			Settlement Date		Maturity Date		Next Put Date
	(In thousands)

2012
	$	25,000		4.37	%		5/4/2007		5/4/2012		2/5/2009
		25,000		4.57	%		7/24/2007		7/24/2012		1/24/2009
		25,000		4.26	%		7/30/2007		7/30/2012		1/30/2009
		50,000		4.33	%		8/10/2007		8/10/2012		2/10/2009
		100,000		4.09	%		8/16/2007		8/16/2012		2/16/2009

		225,000

2014
		25,000		4.20	%		5/8/2007		5/8/2014		2/8/2009
		30,000		4.22	%		5/11/2007		5/11/2014		2/13/2009

		55,000

	$	280,000		4.24	%

None of the structured advances from the FHLB referred to above with put dates up to February 16, 2009 were put by the counterparty at their corresponding put dates.

Subordinated Capital Notes

Subordinated capital notes amounted to $36.1 million at December 31, 2008 and 2007.

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 each issued by the Statutory Trust I and the Statutory Trust II, respectively, 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 call provision of the subordinated capital notes purchased by the Statutory Trust I was exercised by the Group in December 2006 and the Group recorded a $915,000 loss related to the write-off of unamortized issuance costs of the notes. The second one, has a par value of $36.1 million, bears interest based on 3 months LIBOR plus 295 basis points (December 31, 2008 and 2007 — 4.82% and 7.94%, respectively;), payable quarterly, and matures on September 17, 2033. Statutory Trust II may be called at par after five years and quarterly thereafter (next call date March 2009). The trust redeemable preferred security has 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 consolidated statements of financial condition.

The subordinated capital note is treated as Tier 1 capital for regulatory purposes. Under Federal Reserve Board rules, restricted core capital elements, which are qualifying trust preferred securities, qualifying cumulative perpetual preferred stock (and related surplus) and certain minority interests in consolidated subsidiaries, are limited in the aggregate to no more than 25% of a bank holding company’s core capital elements (including restricted core capital elements), net of goodwill less any associated deferred tax liability.

F-36

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Temporary Liquidity Guarantee Program

The Group’s banking subsidiary issued in March 2009 $105 million in notes guaranteed under the FDIC Temporary Liquidity Guarantee Program. These notes are due on March 16, 2012, bear interest at a 2.75% fixed rate, and are backed by the full faith and credit of the United States. Interest on the notes is payable on the 16th of each March and September, beginning September 16, 2009. An annual fee of 100 basis points will also be paid to the FDIC to maintain the FDIC guarantee coverage until the maturity of the notes.


9.	DERIVATIVE ACTIVITIES

The Group may use various derivative instruments as part of its asset and liability management. These transactions involve both credit and market risks. The notional amounts are amounts on which calculations, payments, and the value of the derivatives are based. Notional amounts do not represent direct credit exposures. Direct credit exposure is limited to the net difference between the calculated amounts to be received and paid, if any. The actual risk of loss is the cost of replacing, at market, these contracts in the event of default by the counterparties. The Group controls the credit risk of its derivative financial instrument agreements through credit approvals, limits, monitoring procedures and collateral, when considered necessary.

Derivative instruments are generally negotiated over-the-counter (“OTC”) contracts. Negotiated OTC derivatives are generally entered into between two counterparties that negotiate specific contractual terms, including the underlying instrument, amount, exercise price and maturity.

The Group generally uses interest rate swaps and options in managing its interest rate risk exposure. 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 paid a fixed monthly or quarterly cost and received a floating thirty orninety-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.

During the year ended December 31, 2008, losses of $12.9 million were recognized and reflected as “Derivatives” in the consolidated statements of operations. This was mainly due to a $4.9 million loss in connection to equity index option agreements in which performance by the counterparty (Lehman Brothers Finance S.A.), which filed for bankruptcy on October 3, 2008, is uncertain, resulting in a credit risk exposure for such amount, and an interest-rate swap contract that the Group entered into in January 2008 to manage the Group’s interest rate risk exposure with a notional amount of $500 million. Such contract was subsequently terminated, resulting in a loss to the Group of approximately $7.9 million. For the years ended December 31, 2007 and 2006, gains of $11.0 million and $3.2 million, respectively, were recognized and reflected as “Derivatives” in the consolidated statements of operations. There were no outstanding interest-rate swap contracts at December 31, 2008 and 2007.

The Group offers its customers certificates of deposit with an option tied to the performance of the Standard & Poor’s 500 stock market index. The Group uses option agreements with major broker-dealer companies to manage its exposure to changes in this index. Under the terms of the option agreements, the Group receives the average increase in the month-end value of the index in exchange for a fixed premium. The changes in fair value of the option agreements used to manage the exposure in the stock market in the certificates of deposit are recorded in earnings in accordance with SFAS No. 133, as amended.

There were no derivatives designated as a hedge at December 31, 2008 and 2007. 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 $149.8 million and $152.5 million at December 31, 2008 and 2007, respectively; and embedded options on stock indexed deposits with notional amounts of $155.4 million and $147.0 million at December 31, 2008 and 2007, respectively.

F-37

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

At December 31, 2008, the yearly contractual maturities of derivative instruments were as follows:


Year Ending	Equity Indexed		Equity Indexed
December 31,	Options Purchased		Options Written
	(In thousands)

2009		22,085		20,578
2010		9,045		8,559
2011		21,415		20,417
2012		64,285		64,037
2013		38,590		36,198

		155,420		149,789

At December 31, 2008 and 2007, the purchased options used to manage the exposure to the stock market on stock indexed deposits represented an asset of $17.4 million and $40.7 million, respectively; the options sold to customers embedded in the certificates of deposit and recorded as deposits in the consolidated statement of financial condition, represented a liability of $31.9 million and $38.8 million, respectively.


10.	EMPLOYEE BENEFIT PLAN

The Group has a cash or deferred arrangement profit sharing plan qualified under Section 1165(e) of the Puerto Rico Internal Revenue Code of 1994, as amended (the “Puerto Rico Code”) and the Section 401(a) and (e) of the United States Revenue Code of 1986, as amended (the “U.S. Code”), covering all full-time employees of the Group who have six months of service and are age twenty-one or older. Under this plan, participants may contribute each year from 2% to 10% of their compensation, as defined in the Puerto Rico Code and U.S. Code, up to a specified amount. The Group currently contributes 80 cents for each dollar contributed by an employee, up to $832 per employee. The Group’s matching contribution is invested in shares of its common stock. The plan is entitled to acquire and hold qualified employer securities as part of its investment of the trust assets pursuant to ERISA Section 407. For the years ended December 31, 2008 and 2007, the Group contributed 9,697, 17,216 and 12,787, respectively, shares of its common stock with a fair value of approximately $148,600, $204,200 and $168,200, respectively at the time of contribution. The Group’s contribution becomes 100% vested once the employee completes three years of service.

Also, the Group offers to its senior management a non-qualified deferred compensation plan, where executives can defer taxable income. Both the employer and the employee have flexibility because non-qualified plans are not subject to ERISA contribution limits nor are they subject to discrimination tests in terms of who must be included in the plan. Under this plan, the employee’s current taxable income is reduced by the amount being deferred. Funds deposited in a deferred compensation plan can accumulate without current income tax to the individual. Taxes are due when the funds are withdrawn, at the current income tax rate which may be lower than the individual’s current tax bracket.


11.	RELATED PARTY TRANSACTIONS

The Bank grants loans to its directors, executive officers and to certain related individuals or organizations in the ordinary course of business. These loans are offered at the same terms as loans to non-related parties. The activity and balance of these loans were as follows:


	December 31,
	2008			2007

Balance at the beginning of year	$	1,960		$	4,033
New loans		605			199
Repayments		(226	)		(25	)
Other		225			(2,247	)

Balance at the end of year	$	2,564		$	1,960

F-38

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


12.	INCOME TAX

Under the Puerto Rico Code, all companies are treated as separate taxable entities and are not entitled to file consolidated returns. The Group and its subsidiaries are subject to Puerto Rico regular income tax or alternative minimum tax (“AMT”) on income earned from all sources. The AMT is payable if it exceeds regular income tax. The excess of AMT over regular income tax paid in any one year may be used to offset regular income tax in future years, subject to certain limitations.

The components of income tax expense (benefit) for the years ended December 31, 2008, 2007, and 2006 are as follows:


	Year Ended December 31,
	2008			2007		2006
	(In thousands)

Current income tax expense	$	608		$	226	$	1,817
Deferred income tax expense (benefit)		(9,931	)		1,332		(3,448	)

Income tax expense (benefit)	$	(9,323	)	$	1,558	$	(1,631	)

The Group maintained an effective tax rate lower than the statutory rate of 39% as of December 31, 2008 and 2007, and 43.5% as of December 31, 2006, mainly due to the interest income arising from certain mortgage loans, investments and mortgage-backed securities exempt for P.R. income tax purposes, net of expenses attributable to the exempt income. In addition, the Puerto Rico Code provides a dividend received deduction of 100% on dividends received from wholly-owned subsidiaries subject to income taxation in Puerto Rico. For the years ended December 31, 2008 and 2007 and 2006, the Group generated tax-exempt interest income of $193.4 million, $184.7 million and $146.7 million, respectively. Exempt interest relates mostly to interest earned on obligations of the United States and Puerto Rico governments and certain mortgage-backed securities, including securities held by the Bank’s international banking entity. Pursuant to the Declaration of Fiscal Emergency and Omnibus Plan for Economic Stabilization and Restoration of the Puerto Rican Credit Act of March, 2, 2009, for tax years beginning after December 31, 2008, and ending before January 1, 2012, every corporation engaged in trade or business in Puerto Rico, including banks, insurance companies, and international banking entities, will be subject to an additional five percent (5%) surcharge on corporate income tax. This temporary tax was enacted as a measure to generate additional revenues to address the fiscal crisis that the government of Puerto Rico is currently facing.

The reconciliation between the Puerto Rico income tax statutory rate and the effective tax rate as reported for the years ended December 31, 2008, 2007, and 2006 are as follows:


	Year Ended December 31,
	2008						2007						2006
	Amount			Rate			Amount			Rate			Amount			Rate
	(Dollars in thousands)						(Dollars in thousands)						(Dollars in thousands)

Statutory rate	$	6,813			39.0	%	$	16,701			39.0	%	$	(2,931	)		43.5	%
Increase (decrease) in rate resulting from:
Exempt interest income, net		(11,285	)		−64.6	%		(16,052	)		−37.5	%		(3,527	)		52.3	%
Non-deductible charge		42			0.2	%		35			0.1	%		37			−0.5	%
Change in valuation allowance		(3,340	)		−19.1	%		573			1.3	%		2,029			−30.1	%
Provision/(credit) for income tax contingencies, net		(1,956	)		−11.2	%		529			1.2	%		(465	)		6.9	%
Other items, net		403			2.3	%		(228	)		−0.5	%		3,226			−47.9	%

Income tax expense (benefit)	$	(9,323	)		−53.4	%	$	1,558			3.6	%	$	(1,631	)		24.2	%

F-39

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Deferred income tax reflects the net tax effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting and the amounts used for income tax purposes. The components of the Group’s deferred tax asset, net at December 31, 2008 and 2007, are as follows:


	December 31,
	2008			2007
	(In thousands)

Allowance for loan losses	$	5,611		$	3,978
Unamortized discount related to mortgage servicing rights sold		1,028			1,360
Deferred gain on sale of assets		180			261
Deferred loan origination fees		2,561			2,157
Other-than-temporary impairment		7,681			—
Unrealized net loss included in accumulated other comprehensive income		6,004			—
Charitable contributions		66			66
S&P option contracts		6,644			7,121
Net operating loss carryforwards		1,698			4,233
Other		147			67

Total gross deferred tax asset		31,620			19,243

Less: Valuation allowance		(1,253	)		(4,593	)

Net deferred tax asset		30,367			14,650

Unrealized net gain included in accumulated other comprehensive income		—			(2,166	)
Deferred loan origination costs		(1,904	)		(2,122	)

Total deferred tax liabilities		(1,904	)		(4,288	)

Deferred tax asset, net	$	28,463		$	10,362

In assessing the realizability of the deferred tax asset, management considers whether it is more likely than not that some portion or all of the deferred tax asset will not be realized. The ultimate realization of the deferred tax asset is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. Based upon the level of historical taxable income and projections for future taxable income over the periods in which the deferred tax asset 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 December 31, 2008. 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 carryforward period are reduced.

At December 31, 2008, the holding company and its subsidiaries have loss carryfowards for income tax purposes of approximately $3.7 million, which are available to offset future taxable income, if any, through December 2013.

The Group benefits from favorable tax treatment under regulations relating to the activities of the Bank’s IBE subsidiary. Any change in such tax regulations, whether by applicable regulators or as a result of legislation subsequently enacted by the Legislature of Puerto Rico, could adversely affect the Group’s profits and financial condition.

Effective at the beginning of the first quarter of 2007, the Group adopted the provisions of FIN 48, which contains a two-step approach to recognizing and measuring uncertain tax positions accounted for in accordance with SFAS 109. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of

F-40

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount that is more than 50% likely of being realized upon ultimate settlement.

The total amount of gross unrecognized tax benefits as of the date of adoption that would affect the effective tax rate was $5.8 million. The Group classifies unrecognized tax benefits in income taxes payable. No adjustments resulted from the implementation of FIN 48. For the year ended December 31, 2007 there were no changes (new, expiring or settled) unrecognized tax benefits. For the year ended December 31, 2008 $2.5 million of unrecognized tax benefits expired due to the statute of limitation. The balance at December 31, 2008 was $4.0 million. The tax periods ended June 30, 2004, and 2005, and December 31, 2005, 2006, and 2007 remain subject to examination by the Puerto Rico Department of Treasury.

The Group’s policy to include interest and penalties related to unrecognized tax benefits within the provision for taxes on the consolidated statements of income did not change as a result of implementing the provisions of FIN 48. As of the date of adoption of FIN 48, the Group had accrued $1.3 million (December 31, 2008-$1.5 million; $1.9 million as of December 31, 2007) for the payment of interest and penalties relating to unrecognized tax benefits. On January 13, 2009, $325,000 in unrecognized tax benefits expired due to statute of limitation. The Group does not anticipate any other significant changes in unrecognized tax benefits during 2009.


13.	STOCKHOLDERS’ EQUITY

Treasury Stock

On July 27, 2007, the Group’s Board approved a new stock repurchase program pursuant to which the Group is authorized to purchase in the open market up to $15.0 million of its outstanding shares of common stock. The shares of common stock so repurchased are to be held by the Group as treasury shares. There were no repurchases during 2008. The approximate dollar value of shares that may yet be repurchased under the plan amounted to $11.3 million at December 31, 2008.

The activity in connection with common shares held in treasury by the Group for 2008, 2007, and 2006 is set forth below:


	Year Ended December 31,
	2008				2007						2006
			Dollar					Dollar						Dollar
	Shares		Amount		Shares			Amount			Shares			Amount
	(In thousands)

Beginning of year		1,436	$	17,023		989		$	12,956			770		$	10,332
Common shares repurchased under the repurchase program		—		—		459			4,236			233			2,817
Common shares repurchased /used to match defined contribution plan, net		6		86		(12	)		(169	)		(14	)		(193	)

End of year		1,442	$	17,109		1,436		$	17,023			989		$	12,956

Equity-Based Compensation Plans

Effective April 25, 2007, the Board formally adopted the Omnibus Plan, which provides for equity-based compensation incentives through the grant of stock options, stock appreciation rights, restricted stock, restricted stock units and dividend equivalents, as well as equity-based performance awards. The Omnibus Plan replaced and superseded the Oriental Financial Group Inc. 1996, 1998 and 2000 Incentive Stock Option Plans (the “Stock Option Plans”). All outstanding stock options under the Stock Option Plans continue in full force and effect, subject to their original terms. Under the Omnibus Plan, the group granted 23,000 options and 70,316 restricted shares in 2008.

F-41

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The activity in outstanding options for 2008, 2007 and 2006, is set forth below:


	Year Ended December 31,
	2008					2007					2006
				Weighted					Weighted					Weighted
	Number of			Average		Number of			Average		Number of			Average
	Options			Exercise Price		Options			Exercise Price		Options			Exercise Price

Beginning of year		717,700		$	16.15		833,533		$	15.61		946,855		$	15.51
Options granted		23,000			17.93		140,500			12.22		30,000			12.20
Options exercised		(182,200	)		11.93		(134,586	)		8.52		(72,486	)		8.04
Options forfeited		(58,300	)		21.49		(121,747	)		17.09		(70,836	)		19.60

End of year		500,200		$	17.14		717,700		$	16.15		833,533		$	15.61

The total intrinsic value of stock options exercised during the year ended December 31, 2008 was $1.4 million.

The following table summarizes the range of exercise prices and the weighted average remaining contractual life of the options outstanding at December 31, 2008:


	Outstanding						Exercisable
			Weighted		Weighted Average				Weighted
	Number of		Average		Contract Life		Number of		Average
Range of Exercise Prices	Options		Exercise Price		(Years)		Options		Exercise Price

$ 5.63 to $ 8.45		6,826	$	7.55		8.3		6,826	$	7.55
8.45 to 11.27		3,000		10.29		1.4		—		—
11.27 to 14.09		247,339		12.42		3.3		69,939		12.51
14.09 to 16.90		62,035		15.60		5.5		38,035		15.92
19.73 to 22.55		31,100		20.75		4.4		19,600		20.10
22.55 to 25.37		88,850		23.98		4.3		88,850		23.98
25.37 to 28.19		61,050		27.48		4.2		61,050		27.48

		500,200	$	17.14		4.5		284,300	$	20.17

Aggregate Intrinsic Value	$	—					$	—

The average fair value of each option granted during 2008, 2007, and 2006, was $5.39, $2.67, and $3.24, 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:


	2008	2007	2006

Weighted Average Assumptions:
Dividend yield	4.78%	4.96%	4.26%
Expected volatility	35%	33%	34%
Risk-free interest rate	3.23%	4.82%	4.46%
Expected life (in years)	8.5	8.5	8.5

During 2008 the Group granted 70,316 restricted shares at a weighted average granted date fair value of $21.14 under the Omnibus Plan. During 2008, 8,408 restricted shares were forfeited and no restricted shares were exercised.

F-42

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Earnings (loss) per Common Share

The calculation of earnings (loss) per common share for the years ended December 31, 2008 and 2007, and 2006 is as follows:


	Year Ended December 31,
	2008			2007			2006
	(In thousands, except per share data)

Net income (loss)	$	26,790		$	41,265		$	(5,106	)
Less: Dividends on preferred stock		(4,802	)		(4,802	)		(4,802	)

Income available (loss) to common shareholders’	$	21,988		$	36,463		$	(9,908	)

Weighted average common shares and share equivalents:
Average common shares outstanding		24,260			24,326			24,562
Average potential common shares-options		67			41			101

Total		24,327			24,367			24,663

Earnings (loss) per common share — basic	$	0.91		$	1.50		$	(0.40	)

Earnings (loss) per common share — diluted	$	0.90		$	1.50		$	(0.40	)

For the years ended December 31, 2008 and 2007, and 2006, weighted-average stock options with an anti-dilutive effect on earnings per share not included in the calculation amounted to 193,399, 635,934, and 494,179, respectively.

Legal Surplus

The Banking Act requires that a minimum of 10% of the Bank’s net income for the year be transferred to a reserve fund until such fund (legal surplus) equals the total paid in capital on common and preferred stock. At December 31, 2008, legal surplus amounted to $43.0 million (December 31, 2007 — $40.6 million). The amount transferred to the legal surplus account is not available for the payment of dividends to shareholders. In addition, the Federal Reserve Board has issued a policy statement that bank holding companies should generally pay dividends only from operating earnings of the current and preceding two years.

Preferred Stock

On May 28, 1999, the Group issued 1,340,000 shares of 7.125% Noncumulative Monthly Income Preferred Stock, Series A, at $25 per share. Proceeds from issuance of the Series A Preferred Stock, were $32.4 million, net of $1.1 million of issuance costs. The Series A Preferred Stock has the following characteristics: (1) annual dividends of $1.78 per share, payable monthly, if declared by the Board of Directors; missed dividends are not cumulative, (2) redeemable at the Group’s option beginning on May 30, 2004, (3) no mandatory redemption or stated maturity date and (4) liquidation value of $25 per share.

On September 30, 2003, the Group issued 1,380,000 shares of 7.0% Noncumulative Monthly Income Preferred Stock, Series B, at $25 per share. Proceeds from issuance of the Series B Preferred Stock, were $33.1 million, net of $1.4 million of issuance costs. The Series B Preferred Stock has the following characteristics: (1) annual dividends of $1.75 per share, payable monthly, if declared by the Board of Directors; missed dividends are not cumulative, (2) redeemable at the Group’s option beginning on October 31, 2008, (3) no mandatory redemption or stated maturity date, and (4) liquidation value of $25 per share.

F-43

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Accumulated Other Comprehensive Income

Accumulated other comprehensive income (loss), net of income tax, as of December 31, 2008 and 2007, consisted of:


	December 31,
	2008			2007
	(In thousands)

Unrealized loss on securities available-for-sale transfered to held to maturity	$	—		$	(16,543	)
Unrealized gain (loss) on securities available-for-sale		(128,191	)		5,694
Tax effect of accumulated other comprehensive income		6,004			(2,166	)

	$	(122,187	)	$	(13,015	)

Minimum Regulatory Capital Requirements

The Group (on a consolidated basis) and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Group’s and the Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Group and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Prompt corrective action provisions are not applicable to bank holding companies.

Quantitative measures established by regulation to ensure capital adequacy require the Group and the Bank to maintain minimum amounts and ratios (set forth in the following table) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined in the regulations) and of Tier 1 capital to average assets (as defined in the regulations). As of December 31, 2008 and 2007, the Group and the Bank met all capital adequacy requirements to which they are subject.

As of December 31, 2008 and 2007, the FDIC categorized the Bank as “well capitalized” under the regulatory framework for prompt corrective action. To be categorized as well capitalized, an institution must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the following tables. There are no conditions or events since the notification that have changed the Bank’s category. The Group’s and the Bank’s actual capital amounts and ratios as of December 31, 2008 and 2007 are as follows:


	Actual					Minimum Capital Requirement
Group Ratios	Amount		Ratio			Amount		Ratio
	(Dollars in thousands)

As of December 31, 2008
Total Capital to Risk-Weighted Assets	$	403,528		17.73	%	$	182,044		8.00	%
Tier I Capital to Risk-Weighted Assets	$	389,235		17.11	%	$	91,022		4.00	%
Tier I Capital to Total Assets	$	389,235		6.38	%	$	244,101		4.00	%
As of December 31, 2007
Total Capital to Risk-Weighted Assets	$	406,470		19.06	%	$	170,583		8.00	%
Tier I Capital to Risk-Weighted Assets	$	396,309		18.59	%	$	85,292		4.00	%
Tier I Capital to Total Assets	$	396,309		6.69	%	$	236,847		4.00	%

F-44

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

												��
											Minimum to be Well
						Minimum Capital					Capitalized Under
	Actual					Requirement					Prompt Corrective Action Provisions
	Amount		Ratio			Amount		Ratio			Amount		Ratio
	(Dollars in thousands)

Bank Ratios
As of December 31, 2008
Total Capital to Risk-Weighted Assets	$	325,593		14.86	%	$	175,281		8.00	%	$	219,101		10.00	%
Tier I Capital to Risk-Weighted Assets	$	311,300		14.21	%	$	87,640		4.00	%	$	131,461		6.00	%
Tier I Capital to Total Assets	$	311,300		5.42	%	$	229,903		4.00	%	$	287,378		5.00	%
As of December 31, 2007
Total Capital to Risk-Weighted Assets	$	341,713		17.12	%	$	159,657		8.00	%	$	199,572		10.00	%
Tier I Capital to Risk-Weighted Assets	$	331,552		16.61	%	$	79,829		4.00	%	$	119,743		6.00	%
Tier I Capital to Total Assets	$	331,552		5.80	%	$	228,768		4.00	%	$	285,960		5.00	%

The Group’s ability to pay dividends to its stockholders and other activities can be restricted if its capital falls below levels established by the Federal Reserve Board’s guidelines. In addition, any bank holding company whose capital falls below levels specified in the guidelines can be required to implement a plan to increase capital.


14.	COMMITMENTS

Loan Commitments

At December 31, 2008, there were $47.0 million in loan commitments, which represents unused lines of credit provided to customers. Commitments to extend credit are agreements to lend to customers as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates, bear variable interest and may require payment of a fee. Since the commitments may expire unexercised, the total commitment amounts do not necessarily represent future cash requirements. The Group evaluates each customer’s credit-worthiness on acase-by-case basis. The amount of collateral obtained, if deemed necessary by the Group upon extension of credit, is based on management’s credit evaluation of the customer.

At December 31, 2008, commitments to sell or securitize mortgage loans, expiring on or before November 30, 2009, amounted to approximately $316.3 million. At December 31, 2007, commitments to sell or securitize mortgage loans amounted to approximately $13.7 million.

Lease Commitments

The Group has entered into various operating lease agreements for branch facilities and administrative offices. Rent expense for the years ended December 31, 2008, 2007 and 2006 amounted to $5.1 million, $4.2 million and $3.9 million, respectively. Future rental commitments under terms of leases in effect at December 31, 2008, exclusive of taxes, insurance and maintenance expenses payable by the Group, are summarized as follows:


Year Ending December 31,	Minimum Rent
	(In thousands)

2009	$	3,940
2010		3,734
2011		3,727
2012		3,720
2013		3,505
Thereafter		12,982

	$	31,608

F-45

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


15.	LITIGATION

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.


16.	FAIR VALUE

As discussed in Note 1, effective January 1, 2008, the Group adopted SFAS 157, which provides a framework for measuring fair value under GAAP.

Fair Value Measurement

SFAS 157 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. SFAS 157 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:

Level 1- Level 1 asset and liabilities include equity securities that are traded in an active exchange market, as well as certain U.S. Treasury and other U.S. government agency securities that are traded by dealers or brokers in active markets. Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.

Level 2- Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 2 assets and liabilities include (i) mortgage-backed securities for which the fair value is estimated based on valuations obtained from third-party pricing services for identical or comparable assets, (ii) debt securities with quoted prices that are traded less frequently than exchange-traded instruments and (iii) derivative contracts and financial liabilities (e.g. callable brokered CDs and medium-term notes elected for fair value option under SFAS 159) whose value is determined using a pricing model with inputs that are observable in the market or can be derived principally from or corroborated by observable market data.

Level 3- Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, for which the determination of fair value requires significant management judgment or estimation.

The following is a description of the valuation methodologies used for instruments measured at fair value:

Investment securities

The fair value of investment securities is based on quoted market prices, when available, or market prices provided by recognized broker dealers. If listed prices or quotes are not available, fair value is based upon externally developed models that use both observable and unobservable inputs depending on the market activity of the instrument. Structured credit investments and non-agency collateralized mortgage obligations are not trading actively in the current market; accordingly, they do not exhibit readily observable prices. Based on their valuation methodology, such investments are classified as Level 3. The estimated fair value of the structured credit investments and the non-agency collateralized mortgage obligations are determined by using a third-party cash flow valuation model to calculate the present value of projected future cash flows. The assumptions used which are highly uncertain and require a high degree of judgment, include primarily market discount rates, current spreads, duration, leverage, delinquency and loss rates. The assumptions used are drawn from a combination of internal and external data sources. A third-party valuation of these investments, in which all economic assumptions are

F-46

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

determined by this third-party (external-based valuation), is obtained at least on a quarterly basis and is used by management as a benchmark to evaluate the adequacy of the cash flow model and the reasonableness of the assumptions and fair value estimates developed internally for the internal-based valuation. The external-based valuations are analyzed and assumptions are evaluated and incorporated in the internal-based valuation model when deemed necessary and agreed by management.

Derivative instruments

The fair values of the derivative instruments were provided by valuation experts and counterparties. Certain derivatives with limited market activity are valued using externally developed models that consider unobservable market parameters. The Group offers its customers certificates of deposit with an option tied to the performance of the Standard & Poor’s 500 stock market index (S&P Index), and uses equity indexed option agreements with major broker-dealer companies to manage its exposure to changes in this index. Their fair value is obtained from counterparties or an external pricing source and validated by management. Based on their valuation methodology, derivative instruments are classified as Level 3. These options are tied in to Asian options whose payoff is linked to the average value of the S&P Index on a specific set of dates during the life of the option. The methodology uses an average rate option or a cash-settled option whose payoff is based on the difference between the expected average value of the S&P Index during the remaining life of the option and the strike price at inception. The assumptions used which are uncertain and require a degree of judgment, include primarily S&P Index volatility and leverage. The external-based valuations are analyzed and assumptions are evaluated and incorporated in either an internal-based valuation model when deemed necessary or compared to counterparties prices and agreed by management.

Assets and liabilities measured at fair value on a recurring basis, including financial liabilities for which the Group has elected the fair value option, are summarized below:


	December 31, 2008
	Fair Value Measurements
	Level 1		Level 2		Level 3
	(In thousands)

Investment securities available-for-sale	$	—	$	3,258,359	$	665,848
Money market instruments		52,002		—		—
Derivative asset		—		—		12,801
Derivative liability		—		—		(16,588	)

	$	52,002	$	3,258,359	$	662,061

F-47

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The table below presents a reconciliation of all assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the year ended December 31, 2008.


	Total Fair Value Measurements
	(Year Ended December 31, 2008)
	Investment
	Securities
Level 3 Instruments Only	Available-for-sale			Derivative Asset			Derivative Liability
	(In thousands)

Balance at beginning of year	$	78,360		$	40,709		$	(38,793	)
Total gains (losses) (realized/unrealized):
Included in earnings		(38,932	)		(19,257	)		14,226
Included in other comprehensive income		(37,935	)		—			—
New instruments acquired		—			6,676			(6,626	)
Principal repayment and amortization		(19,931	)		(15,327	)		14,605
Transfer of non-agency CMOs to Level 3		609,149			—			—
Transfers from held-to-maturity portfolio		75,137			—			—

Balance at end of year	$	665,848		$	12,801		$	(16,588	)

The information about the estimated fair value of financial instruments required by GAAP is presented hereunder. The aggregate fair value amounts presented do not necessarily represent management’s estimate of the underlying value of the Group.

The estimated fair value is subjective in nature and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. Changes in assumptions could affect these fair value estimates. The fair value estimates do not take into consideration the value of future business and the value of assets and liabilities that are not financial instruments. Other significant tangible and intangible assets that are not considered financial instruments are the value of long-term customer relationships of the retail deposits, and premises and equipment.

F-48

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The estimated fair value and carrying value of the Group’s financial instruments at December 31, 2008 and 2007 is as follows:


	December 31,
	2008				2007
	Fair		Carrying		Fair		Carrying
	Value		Value		Value		Value

Financial Assets:
Cash and cash equivalents	$	66,372	$	66,372	$	88,983	$	88,983
Trading securities		256		256		1,122		1,122
Investment securities available-for-sale		3,921,958		3,921,958		3,069,282		3,069,282
Investment securities held-to-maturity		—		—		1,478,112		1,492,887
FHLB stock		21,013		21,013		20,658		20,658
Securities sold but yet not delivered		834,976		834,976		—		—
Total loans (including loans held-for-sale)		1,216,398		1,219,112		1,170,493		1,179,566
Investment in equity indexed options		12,801		12,801		40,709		40,709
Accrued interest receivable		43,914		43,914		52,315		52,315
Financial Liabilities:
Deposits		1,789,309		1,785,300		1,228,205		1,246,420
Securities sold under agreements to repurchase		4,016,479		3,761,121		3,954,699		3,861,411
Advances from FHLB		333.906		308,442		340,259		331,898
Subordinated capital notes		36,083		36,083		36,083		36,083
Federal funds purchased and other short term borrowings		29,193		29,193		27,460		27,460
Securities purchased but not yet received		398		398		111,431		111,431
Accrued expenses and other liabilities		23,682		23,682		25,691		25,691

The following methods and assumptions were used to estimate the fair values of significant financial instruments at December 31, 2008 and 2007:


•	Cash and cash equivalents, money market investments, time deposits with other banks, securities sold but not yet delivered, accrued interest receivable and payable, securities and loans purchased but not yet received, federal funds purchased, accrued expenses, other liabilities, term notes and subordinated capital notes have been valued at the carrying amounts reflected in the consolidated statements of financial condition as these are reasonable estimates of fair value given the short-term nature of the instruments.

•	The fair value of trading securities and investment securities available-for-sale and held-to-maturity is estimated based on bid quotations from securities dealers. If a quoted market price is not available, fair value is estimated using either quoted market prices for similar securities, or valuations provided by securities dealers. Investments in FHLB stock are valued at their redemption value.

•	The fair value of the loan portfolio (including loans held-for-sale) has been estimated for loan portfolios with similar financial characteristics. Loans are segregated by type, such as mortgage, commercial and consumer. Each loan category is further segmented into fixed and adjustable interest rates and by performing and non-performing categories. The fair value of performing loans is calculated by discounting contractual cash flows, adjusted for prepayment estimates, if any, using estimated current market discount rates that reflect the credit and interest rate risk inherent in the loan.

•	The fair value of demand deposits and savings accounts is the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposit is based on the discounted value of the contractual cash flows, using estimated current market discount rates for deposits of similar remaining maturities.

F-49

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


•	For short-term borrowings, the carrying amount is considered a reasonable estimate of fair value. The fair value of long-term borrowings is based on the discounted value of the contractual cash flows, using current estimated market discount rates for borrowings with similar terms and remaining maturities and put dates.

•	The fair value of interest rate swaps and equity index option contracts were estimated by management based on the present value of expected future cash flows using discount rates of the swap yield curve. These fair values represent the estimated amount the Group would receive or pay to terminate the contracts taking into account the current interest rates and the current creditworthiness of the counterparties.

•	The fair value of commitments to extend credit and unused lines of credit is based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standings.


17.	SEGMENT REPORTING

The Group segregates its businesses into the following major reportable segments of business: Banking, Financial Services, and Treasury. Management established the reportable segments based on the internal reporting used to evaluate performance and to assess where to allocate resources. Other factors such as the Group’s organization, nature of its products, distribution channels and economic characteristics of the products were also considered in the determination of the reportable segments. The Group measures the performance of these reportable segments based on pre-established goals of different financial parameters such as net income, net interest income, loan production, and fees generated.

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, and Oriental Mortgage Corporation, the Bank’s mortgage lending subsidiary. As part of its mortgage banking activities, the Group may sell loans directly into the secondary market or securitize conforming loans into mortgage-backed securities.

Financial services are comprised of the Bank’s trust division (Oriental Trust), the broker dealer subsidiary (Oriental Financial Services Corp.), the insurance agency subsidiary (Oriental Insurance, Inc.), and the pension plan administration subsidiary (Caribbean Pension Consultants, Inc.). The core operations of this segment are financial planning, money management and investing banking, brokerage services, insurance sales activity, corporate and individual trust and retirement services, as well as pension plan administration services.

The Treasury segment encompasses all of the Group’s asset and liability management activities such as: purchases and sales of investment securities, interest rate risk management, derivatives, and borrowings.

Intersegment sales and transfers, if any, are accounted for as if the sales or transfers were to third parties, that is, at current market prices. The accounting policies of the segments are the same followed by the Group, which are described in the “Summary of Significant Accounting Policies” included in the Group’s annual report on Form 10K Following

F-50

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

are the results of operations and the selected financial information by operating segment as of and for the years ended December 31, 2008, 2007, and 2006:


				Financial						Total Major
Year Ended December 31, 2008	Banking			Services			Treasury			Segments			Eliminations			Total
	(In thousands)

Interest income	$	80,725		$	97		$	258,217		$	339,039		$	—		$	339,039
Interest expense		(33,128	)		—			(194,600	)		(227,728	)		—			(227,728	)

Net interest income (expense)		47,597			97			63,617			111,311			—			111,311
Non-interest income (loss)		7,104			17,236			(36,582	)		(12,242	)		—			(12,242	)
Non-interest expenses		(57,210	)		(11,413	)		(4,119	)		(72,742	)		—			(72,742	)
Intersegment revenue		3,702			—			—			3,702			(3,702	)		—
Intersegment expense		—			(2,954	)		(748	)		(3,702	)		3,702			—
Provision for loan losses		(8,860	)		—			—			(8,860	)		—			(8,860	)

Income (loss) before income taxes	$	(7,667	)	$	2,966		$	22,168		$	17,467		$	—		$	17,467

Total assets as of December 31, 2008	$	1,524,979		$	10,763		$	4,912,694		$	6,446,187		$	(242,900	)	$	6,205,536


				Financial						Total Major
Year Ended December 31, 2007	Banking			Services			Treasury			Segments			Eliminations			Total
	(In thousands)

Interest income	$	85,797		$	226		$	203,341		$	289,364		$	—		$	289,364
Interest expense		(34,364	)		(926	)		(180,344	)		(215,634	)		—			(215,634	)

Net interest income (expense)		51,433			(700	)		22,997			73,730			—			73,730
Non-interest income (loss)		14,092			14,300			14,110			42,502			—			42,502
Non-interest expenses		(51,715	)		(12,413	)		(2,731	)		(66,859	)		—			(66,859	)
Intersegment revenue		3,681			—			—			3,681			(3,681	)		—
Intersegment expense		—			(2,944	)		(737	)		(3,681	)		3,681			—
Provision for loan losses		(6,550	)		—			—			(6,550	)					(6,550	)

Income before income taxes	$	10,941		$	(1,757	)	$	33,639		$	42,823		$	—		$	42,823

Total assets as of December 31, 2007	$	1,604,690		$	11,082		$	4,738,719		$	6,354,491		$	(354,636	)	$	5,999,855

F-51

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


				Financial						Total Major
Year Ended December 31, 2006	Banking			Services			Treasury			Segments			Eliminations			Total
	(In thousands)

Interest income	$	79,267		$	214		$	152,830		$	232,311		$	—		$	232,311
Interest expense		(25,683	)		(973	)		(161,529	)		(188,185	)		—			(188,185	)

Net interest income (expense)		53,584			(759	)		(8,699	)		44,126			—			44,126
Non-interest income (loss)		9,452			16,216			(8,430	)		17,238			—			17,238
Non-interest expenses		(50,177	)		(10,963	)		(2,573	)		(63,713	)		—			(63,713	)
Intersegment revenue		3,952			—			—			3,952			(3,952	)		—
Intersegment expense		—			(3,146	)		(806	)		(3,952	)		3,952			—
Provision for loan losses		(4,388	)		—			—			(4,388	)					(4,388	)

Income before income taxes	$	12,423		$	1,348		$	(20,508	)	$	(6,737	)	$	—		$	(6,737	)

Total assets as of December 31, 2006	$	1,677,446		$	12,014		$	2,995,634		$	4,685,094		$	(313,108	)	$	4,371,986


18.	ORIENTAL FINANCIAL GROUP INC. (HOLDING COMPANY ONLY) FINANCIAL INFORMATION

As a bank holding company subject to the regulations of the Federal Reserve Board, the Group must obtain approval from the Federal Reserve Board for any dividend if the total of all dividends declared by it in any calendar year would exceed the total of its consolidated net profits for the year, as defined by the Federal Reserve Board, combined with its retained net profits for the two preceding years. The payment of dividends by the Bank to the Group may also be affected by other regulatory requirements and policies, such as the maintenance of certain regulatory capital levels. For the year ended December 31, 2008 and 2006, the Bank paid $33.1 million and $10.0 million, respectively, in dividends to the Group. No dividends were paid during the year ended December 31, 2007.

F-52

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The following condensed financial information presents the financial position of the holding company only as of December 31, 2008 and 2007, and the results of its operations and its cash flows for the years ended December 31, 2008, 2007 and 2006:

ORIENTAL FINANCIAL GROUP INC.

CONDENSED STATEMENTS OF FINANCIAL POSITION INFORMATION

(Holding Company Only)


	December 31,
	2008		2007
	(In thousands)

ASSETS
Cash and cash equivalents	$	27,037	$	38,409
Investment securities available-for-sale, at fair value		344,610		319,221
Other investment securities		150		1,675
Investment in bank subsidiary, equity method		216,691		325,130
Investment in nonbank subsidiaries, equity method		9,065		9,225
Due from bank subsidiary, net		45		1,433
Deferred tax asset, net		428		—
Other assets		4,074		6,299

Total assets	$	602,100	$	701,392


LIABILITIES AND STOCKHOLDERS’ EQUITY
Securities sold under agreements to repurchase	$	300,708	$	300,708
Subordinated capital notes		36,083		36,083
Dividend payable		3,402		3,377
Due to bank subsidiary		—		656
Deferred tax liability, net		—		808
Accrued expenses and other liabilities		590		299

Total liabilities		340,783		341,931
Stockholders’ equity		261,317		359,461

Total liabilities and stockholders’ equity	$	602,100	$	701,392

F-53

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

CONDENSED STATEMENTS OF OPERATIONS INFORMATION
(Holding Company Only)


	Year Ended December 31,
	2008			2007			2006
	(In thousands)

Income:
Dividends from bank subsidiary	$	33,000		$	—		$	10,000
Interest income		18,148			6,968			2,468
Investment and trading activities, net and other		4,350			3,972			(1,127	)

Total income		55,498			10,940			11,341

Expenses:
Interest expense		15,939			7,234			5,337
Operating expenses		4,084			4,767			5,408

Total expenses		20,023			12,001			10,745

Income (loss) before income taxes		35,475			(1,061	)		596
Income tax (expense) benefit		41			33			(5	)

Income (loss) before equity in undistributed earnings (losses) of subsidiaries		35,516			(1,028	)		591
Equity in undistributed earnings (losses) from:
Bank subsidiary		(8,566	)		43,239			(6,631	)
Nonbank subsidiaries		(160	)		(946	)		934

Net income (loss)	$	26,790		$	41,265		$	(5,106	)

F-54

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

CONDENSED STATEMENTS OF COMPREHENSIVE INCOME INFORMATION
(Holding Company Only)


	Year Ended December 31,
	2008			2007			2006
	(In thousands)

Net Income (loss)	$	26,790		$	41,265		$	(5,106	)

Other comprehensive income (loss), net of tax:
Unrealized gain (loss) on securities available-for-sale arising during the year		(3,748	)		4,965			(130	)
Realized gain on securities available-for-sale arising during the year		(1,558	)		(719	)		—
Other comprehensive income (loss) from bank subsidiary		(104,873	)		(333	)		21,887
Income tax effect related to unrealized loss (gain) on securities available-for-sale		1,007			(829	)		28

Total other comprehensive income (loss) for the year		(109,172	)		3,084			21,785

Total comprehensive income (loss)	$	(82,382	)	$	44,349		$	16,679

F-55

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

CONDENSED STATEMENTS OF CASH FLOWS INFORMATION
(Holding Company Only)


	Year Ended December 31,
	2008			2007			2006
	(In thousands)

Cash flows from operating activities:
Net income (loss)	$	26,790		$	41,265		$	(5,106	)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Equity in undistributed (earnings) losses from banking subsidiary		8,566			(43,239	)		6,631
Equity in undistributed losses (earnings) from non-banking subsidiaries		160			946			(934	)
Amortization of premiums, net of accretion discounts on investment securities		(649	)		(454	)		(8	)
Write-down of other investment securities		—			330			—
Loss (gain) on derivative activities		—			(1,620	)		610
Realized gain (loss) on sale of investments		(1,575	)		(1,049	)		905
Stock based compensation		559			86			15
Deferred income tax (benefit) expense		(229	)		(33	)		1
(Increase) decrease in other assets		2,225			(2,028	)		699
Increase (decrease) in accrued expenses, other liabilities, and dividend payable		316			761			(2,303	)

Net cash provided by (used in) operating activities		36,163			(5,035	)		510

Cash flows from investing activities:
Purchase of securities available for sale		(1,016,855	)		(944,199	)		(2,844	)
Redemptions and sales of securities available-for-sale		671,809			314,692			275
Proceeds from sale of investment securities available-for-sale		316,575			317,774			—
Transfer of security held-to-maturity to a subsidiary		—			10,792			—
Purchase of securities held-to-maturity		—			—			(6,500	)
Redemptions of securities held-to-maturity		—			11,100			6,745
Purchase of other securities		—			—			(30,982	)
Redemptions and sales of other securities		1,525			28,944			—
Net (increase) decrease in due from bank subsidiary, net		1,388			(982	)		100,804
Net (increase) decrease in due from non bank subsidiary, net		—			(451	)		—
Capital contribution to banking subsidiary		(5,000	)		—			—
Acquisition of and capital contribution to non-banking subsidiary		—			—			(909	)

Net cash provided by (used in) investing activities		(30,558	)		(262,330	)		66,589

Cash flows from financing activities:
Net increase in securities sold under agreements to repurchase		—			300,000			—
Proceeds from exercise of stock options		2,175			1,080			645
Net (decrease) increase in due to nonbank subsidiaries, net		—			—			(200	)
Net (decrease) increase in due to bank subsidiaries, net		(656	)		(3,528	)		4,184
Net proceeds from redemptions of subordinated notes payable to nonbank subsidiary		—			—			(36,998	)
Proceeds from termination of derivative instruments		—			1,620			—
Purchase of treasury stock		(86	)		(4,067	)		(2,624	)
Dividends paid		(18,410	)		(18,413	)		(18,555	)

Net cash provided by (used in) financing activities		(16,977	)		276,692			(53,548	)

Increase in cash and cash equivalents		(11,372	)		9,327			13,551
Cash and cash equivalents at beginning of year		38,409			29,082			15,531

Cash and cash equivalents at end of year	$	27,037		$	38,409		$	29,082

F-56

ORIENTAL FINANCIAL GROUP INC.

SELECTED FINANCIAL DATA
YEARS ENDED DECEMBER 31, 2008, 2007, 2006 AND 2005,
SIX-MONTH PERIODS ENDED
DECEMBER 31, 2005 AND 2004
AND FOR THE FISCAL YEAR PERIOD ENDED JUNE 30, 2005


													Six-Month
													Period Ended			Fiscal Year Ended
	Year Ended December 31,												December 31,			June 30,
	2008			2007			2006			2005			2005			2004			2005
	(In thousands, except per share data)
													(Unaudited)			(Unaudited)

EARNINGS:
Interest income	$	339,039		$	289,364		$	232,311		$	201,534		$	105,086		$	92,864		$	189,312
Interest expense		227,728			215,634			188,185			127,456			70,706			46,149			102,899

Net interest income		111,311			73,730			44,126			74,078			34,380			46,715			86,413
Provision for loan losses		8,860			6,550			4,388			3,412			1,902			1,805			3,315

Net interest income after provision for loan losses		102,451			67,180			39,738			70,666			32,478			44,910			83,098
Non-interest income (loss)		(12,242	)		42,502			17,238			28,920			16,382			22,347			34,885
Non-interest expenses		72,742			66,859			63,713			57,856			31,814			33,921			59,963

Income (loss) before taxes		17,467			42,823			(6,737	)		41,730			17,046			33,336			58,020
Income tax (benefit) expense		(9,323	)		1,558			1,631			2,168			(127	)		(645	)		1,649

Net Income (loss)		26,790			41,265			(5,106	)		43,898			16,919			32,691			59,669
Less: dividends on preferred stock		(4,802	)		(4,802	)		(4,802	)		(4,802	)		(2,401	)		(2,401	)		(4,802	)

Income available (loss) to common shareholders	$	21,988		$	36,463		$	(9,908	)	$	39,096		$	14,518		$	30,290		$	54,867

PER SHARE AND DIVIDENDS DATA(1):
Income (loss) per common share (basic)	$	0.91		$	1.50		$	(0.40	)	$	1.58		$	0.59		$	1.24		$	2.23

Income (loss) per common share (diluted)	$	0.90		$	1.50		$	(0.40	)	$	1.56		$	0.58		$	1.17		$	2.14

Average common shares outstanding		24,260			24,326			24,562			24,750			24,777			24,407			24,571
Average potential common share-options		67			41			101			333			154			1,546			1,104

Average shares and shares equivalents		24,327			24,367			24,663			25,083			24,931			25,953			25,675

Book value per common share	$	7.96		$	12.08		$	10.98		$	11.13		$	11.14		$	10.17		$	10.88

Market price at end of period	$	6.05		$	13.41		$	12.95		$	12.36		$	12.36		$	28.31		$	15.26

Cash dividends declared per common share	$	0.56		$	0.56		$	0.56		$	0.56		$	0.28		$	0.27		$	0.55

Cash dividends declared on common shares	$	13,608		$	13,612		$	13,753		$	13,583		$	6,913		$	6,582		$	13,522

F-57


	December 31,												June 30,
	2008			2007			2006			2005			2005			2004

PERIOD END BALANCES:
Investments and loans
Investments	$	3,945,626		$	4,585,610		$	2,992,236		$	3,473,287		$	3,221,789		$	2,839,003
Loans and leases (including loans held-for-sale), net		1,219,112			1,179,566			1,212,370			903,308			903,604			743,456
Securities sold but not yet delivered		834,976			—			6,430			44,009			1,034			47,312

	$	5,999,714		$	5,765,176		$	4,211,036		$	4,420,604		$	4,126,427		$	3,629,771

Deposits and Borrowings Deposits	$	1,785,300		$	1,246,420		$	1,232,988		$	1,298,568		$	1,252,897		$	1,024,349
Repurchase agreements		3,761,121			3,861,411			2,535,923			2,427,880			2,191,756			1,895,865
Other borrowings		373,718			395,441			247,140			404,921			399,476			387,166
Securities and loans purchased but not yet received		398			111,431			—			43,354			22,772			89,068

	$	5,920,537		$	5,614,703		$	4,016,051		$	4,174,723		$	3,866,901		$	3,396,448

Stockholders’ equity
Preferred equity	$	68,000		$	68,000		$	68,000		$	68,000		$	68,000		$	68,000
Common equity		193,317			291,461			268,426			273,791			270,755			213,646

	$	261,317		$	359,461		$	336,426		$	341,791		$	338,755		$	281,646

Capital ratios
Leverage capital		6.38	%		6.69	%		8.42	%		10.13	%		10.59	%		10.88	%

Tier 1 risk-based capital		17.11	%		18.59	%		21.57	%		34.70	%		36.97	%		36.77	%

Total risk-based capital		17.73	%		19.06	%		22.04	%		35.22	%		37.51	%		37.48	%

SELECTED FINANCIAL RATIOS AND OTHER INFORMATION:
Return on average assets (ROA)		0.43	%		0.76	%		—0.11	%		1.02	%		1.46	%		1.79	%

Return on average common equity (ROE)		9.51	%		13.52	%		—3.59	%		15.00	%		21.34	%		32.35	%

Equity-to-assets ratio		4.21	%		5.99	%		7.69	%		7.52	%		7.98	%		7.56	%

Efficiency ratio		52.65	%		65.93	%		84.69	%		57.51	%		51.39	%		52.92	%

Expense ratio		0.77	%		0.77	%		0.73	%		0.75	%		0.75	%		0.97	%

Interest rate spread		1.62	%		1.27	%		0.70	%		1.53	%		2.00	%		2.64	%

Number of financial centers		23			25			25			24			24			23

Trust assets managed	$	1,706,286		$	1,962,226		$	1,848,596		$	1,875,300		$	1,823,292		$	1,670,651
Broker-dealer assets gathered		1,195,739			1,281,168			1,143,668			1,132,286			1,135,115			1,051,812

Assets managed		2,902,025			3,243,394			2,992,264			3,007,586			2,958,407			2,722,463
Assets owned		6,205,536			5,999,855			4,371,986			4,546,949			4,246,865			3,725,695

Total financial assets managed and owned	$	9,107,561		$	9,243,249		$	7,364,250		$	7,554,535		$	7,205,272		$	6,448,158


(1)		Per share related information has been retroactively adjusted to reflect stock splits and stock dividends, when applicable.

F-58

MANAGEMENT’S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 2008

OVERVIEW OF FINANCIAL PERFORMANCE

The following discussion of our financial condition and results of operations should be read in conjunction with Item 6, “Selected Financial Data,” and our consolidated financial statements and related notes in Item 8. This discussion and analysis contains forward-looking statements. Please see “Forward Looking Statements” and “Risk Factors” for discussions of the uncertainties, risks and assumptions associated with these statements.

Comparison of the years ended December 31, 2008 and 2007:

The Group’s mix of businesses and products generates both the interest income traditionally associated with a banking institution and non-interest income traditionally associated with a financial services institution (generated by such businesses as securities brokerage, fiduciary services, investment banking, insurance and pension administration). Although all of these businesses, to varying degrees, are affected by interest rate and financial markets fluctuations and other external factors, the Group’s commitment is to continue producing a balanced and growing revenue stream.

Major highlights for the year ended December 31, 2008 follows:


•	Strong performance in core revenues, with net interest income of $111.3 million or 51.0% higher than in the previous year, and mortgage banking activities of $3.7 million or 53.5% higher than in the previous year.

•	Gain of $35.0 million on the sale of securities, as Oriental took advantage of the sharp increase in fair values, the result of the U.S. Treasury’s plan to purchase such securities in the secondary market, combined with reductions in the federal funds target rate, twice in October and once in December. This gain included $14.4 million from the sale on December 31, 2008 of $820.6 million of agency-issued securities that had been classified as held-to-maturity (HTM). The remaining securities in the HTM portfolio were transferred to the available-for-sale (AFS) portfolio on that date. The proceeds from the sale were reinvested after year-end in similar quality agency-issued securities at a higher average yield.

•	During the third quarter of 2008, the Group reported an other-than-temporary impairment of $55.8 million, net of tax ($2.29 per diluted share).

While the economic environment in Puerto Rico continues to be challenging from a credit point of view, in particular, our conservative strategies have minimized our exposure, putting us in a good position going forward. Because of our favorable FICO scores, loan to value ratios and sufficient reserves, we should continue to experience low net credit losses and provide credit to homeowners and businesses in Puerto Rico.

For the year ended December 31, 2008, the Group reported income available to common shareholders of $22.0 million compared to $36.5 million in 2007, with income per common share (diluted) of $0.90 compared to $1.50. Excluding the other than temporary impairment (OTTI) non-cash loss of $55.8 million, net of tax ($2.29 per diluted share), reported in the third quarter of 2008, the Group had income available to common shareholders of $77.8 million, with income per common share (basic and diluted) of $3.19.

Return on common equity (ROE) and return on assets (ROA) for the year ended December 31, 2008 were 9.51% and 0.43%, respectively, from 13.52% and 0.76%, respectively, in the same period of 2007.

Net interest income represented 112.4% of the Group’s total revenues (defined as net interest income plus non-interest income) in the year ended December 31, 2008. During the year ended December 31, 2008, net interest income was $111.3 million, an increase of 51.1% from the $73.7 million recorded for the same period of 2007. Higher interest income reflected increased investment securities and loan volume and lower average costs of deposits and borrowings. Interest rate spread for the year ended December 31, 2008 was 1.62% compared to 1.19% in the same period of 2007. At December 31, 2008 average interest earning assets increased 16.9% to $6.0 billion, compared to $5.1 billion at December 31, 2007, reflecting a 21.2% increase in investments from $3.9 billion to $4.8 billion.

F-59

The provision for loan losses for the year ended December 31, 2008 increased 35.27% to $8.9 million from $6.6 million for the same period of 2007, reflecting higher allowance requirements related to increased mortgage and commercial loan business in the period and local economic conditions. Based on an analysis of the credit quality and the composition of the Group’s loan portfolio, management determined that the provision for loan losses for the year ended December 31, 2008 was adequate in order to maintain the allowance for loan losses at an appropriate level.

Assets under management, which generate recurring fees for the Group’s financial service businesses, stood at $2.9 billion at December 31, 2008, down 10.5% from December 31, 2007. A relatively high proportion of fixed income investments in the mix helped to offset the general decline in equity markets.

Non-interest expenses for the year ended December 31, 2008 increased 8.8% to $72.7 million, compared to $66.9 million for the same period of 2007. Effective cost control has enabled the Group to restrain the growth of overhead costs. Refer to Table 3 for additional information on the Group’s non-interest expenses.

Loan production of $290.1 million was up 43.0% compared to 2007, as Oriental’s low credit losses and capital levels enabled it to continue prudent lending. Mortgage originations of $229.9 million increased 56.5% year over year. Commercial originations of $55.8 million increased 14.5% year over year to an average of about $14.0 million a quarter.

Total deposits of $1.8 billion increased 43.2% from the year 2007, representing 30.2% of interest bearing liabilities, versus 22.6% at December 31, 2007. The increase was primarily due to an increase in brokered certificates of deposit. Total borrowings decreased 2.9%, from $4.3 billion at December 31, 2007, to $4.1 at December 31, 2008.

Stockholders’ equity as of December 31, 2008 was $261.3 million, a decrease of 27.3% from $359.5 million as of December 31, 2007 reflecting a decreased mark-to-market valuation on the available for sale investment securities portfolio. The Group’s capital ratios are above regulatory capital requirements. At December 31, 2008, the Tier 1 Leverage Capital Ratio was 6.38%, Tier 1 Risk-Based Capital Ratio was 17.11%, and Total Risk-Based Capital Ratio was 17.73%.

Comparison of the years ended December 31, 2007 and 2006

For the year ended December 31, 2007, net income available to common shareholders was $36.5 million, compared with net loss to common shareholders of $9.9 million reported in the same period of 2006. Earnings available to common shareholders per diluted share were $1.50, compared to a loss per diluted share of $0.40 reported for 2006. Results for the fourth quarter and year ended December 31, 2006 included $20.7 million, or $0.87 per share, in losses and write-offs, the majority of which related to the sale of lower yielding securities stemming from the repositioning of the available-for-sale securities portfolio that led to a sizeable increase in net interest income in 2007.

Return on common equity (ROE) and return on assets (ROA) for the year ended December 31, 2007 were 13.52% and 0.76, respectively, from (3.59%) and (0.11%), respectively, in the same period of 2006.

Net interest income represented 63.4% of the Group’s total revenues (defined as net interest income plus non-interest income) in the year ended December 31, 2007. During the year ended December 31, 2007, net interest income was $73.7 million, an increase of 67.1% from the $44.1 million recorded for the same period of 2006. Higher interest income on increased investment securities and loan volume and average yields was partially offset by higher volume and interest rates on borrowings. Interest rate spread for the year ended December 31, 2007 was 1.19% compared to 0.70% in the same period of 2006. At December 31, 2007 average interest earning assets increased 14.0% to $5.1 billion, compared to $4.5 billion at December 31, 2006, reflecting a 14.7% increase in investments from $3.4 billion to $3.9 billion.

The provision for loan losses for the year ended December 31, 2007 increased 49.3% to $6.6 million from $4.4 million for the same period of 2006, reflecting higher allowance requirements related to increased mortgage and commercial loan business in the period and local economic conditions. For the quarters ended December 31, 2007 and 2006, the provision for loan losses was $2.5 million and $1.5 million, respectively, an increase of 69.1%. Based on an analysis of the credit quality and the composition of the Group’s loan portfolio, management

F-60

determined that the provision for loan losses for the year ended December 31, 2007 was adequate in order to maintain the allowance for loan losses at an appropriate level.

Non-interest income for 2007 reflects financial service revenue growth of 7.9% to $17.3 million in 2007, compared to $16.0 million in 2006, due to the Group’s success in expanding its business in corporate and personal trusts, retirement, wealth management, and asset protection services for mid and high net worth customers. As a result, trust assets managed increased 6.1% year-over-year, to $2.0 billion at December 31, 2007, and broker-dealer assets gathered increased 12.0% year-over-year, to $1.3 billion. Refer to Table 2 for additional information on the Group’s non-interest income.

Non-interest expenses for the year ended December 31, 2007 increased 4.9% to $66.9 million, compared to $63.7 million for the same period of 2006. Effective cost control has enabled the Group to restrain the growth of overhead costs. Refer to Table 3 for additional information on the Group’s non-interest expenses.

Total Group financial assets (including assets managed by the trust department, the retirement plan administration subsidiary, and securities broker-dealer subsidiary) increased 25.5% to $9.2 billion as of December 31, 2007, compared to $7.4 billion as of December 31, 2006. Assets managed by the Group’s trust department, the retirement plan administration subsidiary, and the securities broker-dealer subsidiary increased to $3.2 billion from $3.0 billion as of December 31, 2006, an increase of 8.4%. The Group’s assets owned totaled $6.0 billion as of December 31, 2007, an increase of 37.2%, compared to $4.4 billion as of December 31, 2006, mainly as a result of an increase in the investment securities portfolio, which increased 53.4% or $1.6 billion.

On the liability side, total deposits increased 1.1%, from $1.2 billion at December 31, 2006, to $1.2 billion at December 31, 2007, mainly from increases in savings accounts. Total borrowings increased 53.0%, from $2.8 billion at December 31, 2006, to $4.3 billion at December 31, 2007, mainly from increased securities sold under agreements to repurchase to finance the increase in investments.

Stockholders’ equity as of December 31, 2007 was $359.5 million, an increase of 6.8% from $336.4 million as of December 31, 2006. The Group’s capital ratios remain significantly above regulatory capital requirements. At December 31, 2007, the Tier 1 Leverage Capital Ratio was 6.69%, Tier 1 Risk-Based Capital Ratio was 18.59%, and Total Risk-Based Capital Ratio was 19.06%.

F-61

TABLE 1 — ANALYSIS OF NET INTEREST INCOME AND CHANGES DUE TO VOLUME/RATE:

For the Years Ended December 31, 2008 and 2007


	Interest					Average rate						Average balance
	December 31,		December 31,			December 31,			December 31,			December 31,			December 31,
	2008		2007			2008			2007			2008			2007
	(Dollars in thousands)

A — TAX EQUIVALENT SPREAD
Interest-earning assets	$	339,039	$	289,364			5.68	%		5.66	%	$	5,973,225		$	5,108,910
Tax equivalent adjustment		112,077		96,460			1.88	%		1.89	%		—			—

Interest-earning assets — tax equivalent		451,116		385,824			7.56	%		7.55	%		5,973,225			5,108,910
Interest-bearing liabilities		227,728		215,634			4.06	%		4.47	%		5,602,622			4,822,058

Tax equivalent net interest income / spread	$	223,388	$	170,190			3.50	%		3.08	%	$	370,603		$	286,852

Tax equivalent interest rate margin							3.74	%		3.33	%

B — NORMAL SPREAD
Interest-earning assets:
Investments:
Investment securities	$	257,947	$	200,057			5.49	%		5.18	%	$	4,702,428		$	3,863,221
Investment management fees		—		(210	)		0.00	%		—0.01	%		—			—

Total investment securities		257,947		199,847			5.49	%		5.17	%		4,702,428			3,863,221
Trading securities		20		27			3.70	%		3.33	%		540			810
Money market investments		1,907		3,688			3.35	%		5.78	%		56,856			63,818

		259,874		203,562			5.46	%		5.18	%		4,759,824			3,927,849

Loans:
Mortgage		66,087		66,343			6.44	%		6.59	%		1,026,779			1,007,391
Commercial		10,610		16,061			6.57	%		11.17	%		161,541			143,819
Consumer		2,468		3,398			9.84	%		11.38	%		25,081			29,851

		79,165		85,802			6.52	%		7.26	%		1,213,401			1,181,061

		339,039		289,364			5.68	%		5.66	%		5,973,225			5,108,910

Interest-bearing liabilities:
Deposits:
Non-interest bearing deposits		—		—			—			—			36,697			35,589
Now accounts		4,197		817			2.44	%		1.28	%		171,725			64,010
Savings		10,199		13,958			3.36	%		4.39	%		303,298			318,207
Certificates of deposit		35,385		38,019			3.96	%		4.90	%		894,209			775,315

		49,781		52,794			3.54	%		4.42	%		1,405,929			1,193,121

Borrowings:
Repurchase agreements		161,363		147,847			4.25	%		4.45	%		3,800,673			3,323,696
Interest rate risk management		—		(773	)		0.00	%		—0.02	%		—			—
Financing fees		—		586			0.00	%		0.02	%		—			—

Total repurchase agreements		161,363		147,660			4.25	%		4.44	%		3,800,673			3,323,696
FHLB advances		13,457		10,883			4.20	%		4.45	%		320,594			244,445
Subordinated capital notes		2,304		3,138			6.39	%		8.70	%		36,083			36,083
Term notes		—		176			0.00	%		5.05	%		—			3,493
Other borrowings		823		983			2.09	%		4.63	%		39,343			21,220

		177,947		162,840			4.24	%		4.49	%		4,196,693			3,628,937

		227,728		215,634			4.06	%		4.47	%		5,602,622			4,822,058

Net interest income / spread	$	111,311	$	73,730			1.62	%		1.19	%

Interest rate margin							1.86	%		1.44	%

Excess of interest-earning assets over interest-bearing liabilities												$	370,603		$	286,852

Interest-earning assets over interest-bearing liabilities ratio													106.61	%		105.95	%

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C.	CHANGES IN NET INTEREST INCOME DUE TO:


	December 31, 2008 versus December 31, 2007
	Volume		Rate			Total

Interest Income:
Investments	$	43,118	$	13,195		$	56,313
Loans		2,349		(8,987	)		(6,638	)

		45,467		4,208			49,675

Interest Expense:
Deposits		9,417		(12,430	)		(3,013	)
Repurchase agreements		21,191		(7,491	)		13,700
Other borrowings		4,514		(3,110	)		1,404

		35,122		(23,031	)		12,091

	$	10,345	$	27,239		$	37,584

F-63

TABLE 1A — ANALYSIS OF NET INTEREST INCOME AND CHANGES DUE TO VOLUME/RATE:

For the Years Ended December 31, 2007 and 2006


	Interest						Average rate						Average balance
	December 31,			December 31,			December 31,			December 31,			December 31,			December 31,
	2007			2006			2007			2006			2007			2006
	(Dollars in thousands)

A — TAX EQUIVALENT SPREAD
Interest-earning assets	$	289,364		$	232,311			5.66	%		5.18	%	$	5,108,910		$	4,480,729
Tax equivalent adjustment		96,460			57,657			1.89	%		1.29	%		—			—

Interest-earning assets — tax equivalent		385,824			289,968			7.55	%		6.47	%		5,108,910			4,480,729
Interest-bearing liabilities		215,634			188,185			4.47	%		4.48	%		4,822,058			4,198,401

Tax equivalent net interest income / spread	$	170,190		$	101,783			3.08	%		1.99	%	$	286,852		$	282,328

Tax equivalent interest rate margin								3.33	%		2.27	%

B — NORMAL SPREAD
Interest-earning assets:
Investments:
Investment securities	$	200,057		$	154,942			5.18	%		4.57	%	$	3,863,221		$	3,386,999
Investment management fees		(210	)		(1,522	)		−0.01	%		−0.04	%		—			—

Total investment securities		199,847			153,420			5.17	%		4.53	%		3,863,221			3,386,999
Trading securities		27			19			3.33	%		5.01	%		810			379
Money market investments		3,688			2,057			5.78	%		5.36	%		63,818			38,360

		203,562			155,496			5.18	%		4.54	%		3,927,849			3,425,738

Loans:
Mortgage		66,343			55,278			6.59	%		6.86	%		1,007,391			805,285
Commercial		16,061			17,417			11.17	%		8.20	%		143,819			212,294
Consumer		3,398			4,120			11.38	%		11.01	%		29,851			37,412

		85,802			76,815			7.26	%		7.28	%		1,181,061			1,054,991

		289,364			232,311			5.66	%		5.18	%		5,108,910			4,480,729

Interest-bearing liabilities:
Deposits:
Non-interest bearing deposits		—			—			—			—			35,589			39,177
Now accounts		817			857			1.28	%		1.09	%		64,010			78,826
Savings		13,958			5,366			4.39	%		3.25	%		318,207			165,249
Certificates of deposit		38,019			40,478			4.90	%		4.26	%		775,315			950,695

		52,794			46,701			4.42	%		3.78	%		1,193,121			1,233,947

Borrowings:
Repurchase agreements		147,847			133,646			4.45	%		5.09	%		3,323,696			2,627,484
Interest rate risk management		(773	)		(8,494	)		—0.02	%		−0.32	%		—			—
Financing fees		586			562			0.02	%		0.02	%		—			—

Total repurchase agreements		147,660			125,714			4.44	%		4.78	%		3,323,696			2,627,484
FHLB advances		10,883			8,968			4.45	%		3.74	%		244,445			239,590
Subordinated capital notes		3,138			5,331			8.70	%		7.54	%		36,083			70,732
Term notes		176			846			5.05	%		5.64	%		3,493			15,000
Other borrowings		983			625			4.63	%		5.37	%		21,220			11,648

		162,840			141,484			4.49	%		4.77	%		3,628,937			2,964,454

		215,634			188,185			4.47	%		4.48	%		4,822,058			4,198,401

Net interest income / spread	$	73,730		$	44,126			1.19	%		0.70	%

Interest rate margin								1.44	%		0.98	%

Excess of interest-earning assets over interest-bearing liabilities													$	286,852		$	282,328

Interest-earning assets over interest-bearing liabilities ratio														105.95	%		106.72	%

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C.	CHANGES IN NET INTEREST INCOME DUE TO:


	December 31, 2007 versus December 31, 2006
	Volume			Rate			Total

Interest Income:
Investments	$	26,022		$	22,044		$	48,066
Loans		9,159			(172	)		8,987

		35,181			21,872			57,053

Interest Expense:
Deposits		(1,807	)		7,900			6,093
Repurchase agreements		30,930			(8,984	)		21,946
Other borrowings		(1,578	)		988			(590	)

		27,545			(96	)		27,449

	$	7,636		$	21,968		$	29,604

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Net Interest Income

Comparison of the years ended December 31, 2008 and 2007:

Net interest income is affected by 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). As further discussed in the Risk Management section of this report, the Group monitors the composition and repricing of its assets and liabilities to maintain its net interest income at adequate levels. Table 1 shows the major categories of interest-earning assets and interest-bearing liabilities, their respective interest income, expenses, yields and costs, and their impact on net interest income due to changes in volume and rates for the years ended December 31, 2008 and 2007.

Net interest income increased 51.0% to $111.3 million in the year ended December 31, 2008, from $73.7 million in the same period of 2007. This increase was due to a positive volume variance of $10.4 million, and a positive rate variance of $27.2 million, as average interest earning assets increased 16.9% to $6.0 billion as of December 31, 2008, from $5.1 billion as of December 31, 2007. The interest rate margin increased 42 basis points to 1.86% for the year ended December 31, 2008, from 1.44% for the same period of 2007. The interest rate spread increased 43 basis points to 1.62% for the year ended December 31, 2008, from 1.19% for the same period of 2007, due to a 41 basis point decrease in the average cost of funds to 4.06% from 4.47%, and a 2 basis point increase in the average yield of interest earning assets to 5.68% from 5.66%.

Interest income increased 17.2% to $339.0 million for the year ended December 31, 2008, as compared to $289.4 million for the period of 2007, reflecting the increase in the average balance of interest earning assets and yields. Interest income is generated by investment securities, which accounted for 76.7% of total interest income, and from loans, which accounted for 23.3% of total interest income. Interest income from investments increased 27.7% to $259.9 million, due to a 21.2% increase in the average balance of investments, which grew to $4.8 billion from $3.9 billion, mostly due to an increase in yield of 28 basis point from 5.18% to 5.46%. Interest income from loans decreased 7.7% to $79.2 million, mainly due to a 41.8% increase in loans on which the accrual of interest has been discontinued, which grew to $38.8 million from $27.3 million. Yields decreased from 7.26% in 2007 to 6.52% in 2008.

Interest expense increased 5.6%, to $227.7 million for year ended December 31, 2008, from $215.6 million for the same period of 2007. The increase is due to higher average interest-bearing liabilities which grew to $5.6 billion, from $4.8 billion, year over year, in order to fund the growth of the Group’s investment and loan portfolios, which was partially offset by a 41 basis point decrease in the average cost of retail and wholesale funds, to 4.06% for 2008, from 4.47% for the same period of 2007. The average cost of retail deposits decreased 88 basis points, to 3.54% for the year ended December 31, 2008, from 4.42% for the same period of 2007, and the average cost of wholesale funding sources decreased 25 basis points, to 4.24%, from 4.49%, specifically reflected in repurchase agreements, which decreased 19 basis points, to 4.25% from 4.44% due to the strategic repositioning of the repurchase agreements portfolio and the increase in broker certificates of deposit that are used as a more economical and flexible alternative for replacing higher cost deposits and short-term repurchase agreements.

Comparison of the years ended December 31, 2007 and 2006:

Table 1A shows the major categories of interest-earning assets and interest-bearing liabilities, their respective interest income, expenses, yields and costs, and their impact on net interest income due to changes in volume and rates for the years ended December 31, 2007 and 2006.

Net interest income increased 67.1% to $73.7 million in the year ended December 31, 2007, from $44.1 million in the same period of 2006. This increase was due to a positive volume variance of $7.6 million, and a positive rate variance of $22.0 million, as average interest earning assets increased 14.0% to $5.1 billion as of December 31, 2007, from $4.5 billion as of December 31, 2006. The interest rate margin increased 46 basis points to 1.44% for the year ended December 31, 2007, from 0.98% for the same period of 2006. The interest rate spread increased 49 basis points to 1.19% for the year ended December 31, 2007, from 0.70% for the same period of 2006, due to a 64 basis point increase in the average yield of interest earning assets to 5.18% from 4.54%, and a 1 basis point decrease in the average cost of funds to 4.47% from 4.48%. Overall improvement was due to the repositioning of the Group’s

F-66

investment portfolio and related funding to improve margin in line with what the Group correctly anticipated would be a more positively sloped yield curve.

Interest income increased 24.6% to $289.4 million for the year ended December 31, 2007, as compared to $232.3 million for the period of 2006, reflecting the increase in the average balance of interest earning assets and yields. Interest income is generated by investment securities, which accounted for 70.3% of total interest income, and from loans, which accounted for 29.7% of total interest income. Interest income from investments increased 30.9% to $203.6 million, due to an 14.7% increase in the average balance of investments, which grew to $3.9 billion from $3.4 billion, and by 64 basis point increase in yield from 4.54% to 5.18%. Interest income from loans increased 11.7% to $85.8 million, mainly due to a 11.9% increase in the average balance of loans, which grew to $1.2 billion from $1.1 billion. Yields remained constant at 7.26% in 2007 and 7.28% in 2006.

Interest expense increased 14.6%, to $215.6 million for year ended December 31, 2007, from $188.2 million for the same period of 2006. The increase is due to higher average interest-bearing liabilities which grew to $4.8 billion, from $4.2 billion, year over year, in order to fund the growth of the Group’s investment and loan portfolios. The average cost of retail deposits increased 64 basis points, to 4.42% for the year ended December 31, 2007, from 3.78% for the same period of 2006, and the average cost of wholesale funding sources decreased 28 basis points, to 4.49%, from 4.77%, specifically reflected in repurchase agreements, which decreased 34 basis points, to 4.44% from 4.78% due to the strategic repositioning of the repurchase agreements portfolio.

TABLE 2 — NON-INTEREST INCOME (LOSS) SUMMARY

FOR THE YEARS ENDED ENDED DECEMBER 31, 2008, 2007, AND 2006


	Year Ended December 31,
	2008			2007			Variance %			2006
	(Dollars in thousands)

Financial service revenues	$	16,481		$	17,295			−4.7	%	$	16,029
Banking service revenues		5,726			7,862			−27.2	%		9,006
Investment banking revenues		950			126			654.0	%		2,701
Mortgage banking activities		3,685			2,401			53.5	%		3,368

Total banking and financial service revenues		26,842			27,684			−3.0	%		31,104

Net gain (loss) on:
Sale of securities		35,070			2,953			−1087.6	%		(15,171	)
Other than temporary impairments		(58,804	)		—			−100.0	%		(2,466	)
Derivatives		(12,943	)		10,997			−217.7	%		3,218
Mortgage tax credits		(2,480	)		—			−100.0	%		—
Early extinguishment of subordinated capital notes		—			—			100.0	%		(915	)
Trading securities		(13	)		23			−156.5	%		28
Other investments		148			1,174			−87.4	%		1,008
Foreclosed real estate		(670	)		(349	)		92.0	%		180
Other		608			20			2940.0	%		252

		(39,084	)		14,818			−363.8	%		(13,866	)

Total non-interest income (loss)	$	(12,242	)	$	42,502			−128.8	%	$	17,238

Non-Interest Income

Comparison of the years ended December 31, 2008 and 2007:

Non-interest income 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 and investment activities by the securities broker-dealer subsidiary, the level of mortgage banking activities, and fees from deposit accounts and insurance

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products. As shown in Table 2, the Group recorded non-interest losses in the amount of $12.2 million for the year ended December 31, 2008, a decrease of 128.8% when compared to income of $42.5 during the same period in 2007.

Financial services revenues, which consist of commissions and fees from fiduciary activities, and commissions and fees from securities brokerage, and insurance activities, decreased 4.7%, to $16.5 million in the year ended December 31, 2008, from $17.3 million in the same period of 2007, mainly the result of reduced financial service revenues. Banking service revenues, which consist primarily of fees generated by deposit accounts, electronic banking and customer services, decreased 27.2% to $5.7 million in the year ended December 31, 2008, from $7.9 million in the same period of 2007, mainly driven by reduced consumer banking activity. Investment banking revenues increased due to more transactions in 2008 as compared to 2007. Income generated from mortgage banking activities increased 53.5% in the year ended December 31, 2008, from $2.4 million in the year ended December 31, 2007, to $3.7 million in the same period of 2008 mainly the result of increased mortgage banking revenues due to the securitization and sale of conventional mortgages into the secondary market and increased financial services revenues from brokerage activity. Year ended December 31, 2008 results also included a loss of $2.5 million, representing a provision for loss on mortgage loan tax credits for new homeowners. The credits were instituted by the Commonwealth of Puerto Rico in 2008, but it is now doubtful whether they will be granted.

Securities, derivatives and trading activities revenues for the year ended December 31, 2008 amounted to a loss of $36.5 million compared to a gain of approximately $15.1 million in the same period of 2007. During the third quarter of 2008, the Group recorded an other-than-temporary non cash loss of $58.8 million. This loss was partially offset by a gain of $35.1 million on the sale of securities.

Comparison of the years ended December 31, 2007 and 2006:

As shown in Table 2, non-interest income for the year ended December 31, 2007 increased 146.6%, from $17.2 million to $42.5 million, when compared to the same period in 2006.

Revenues from securities, derivatives and trading activities for the year ended December 31, 2007 reflects the Group’s previously disclosed net gain of approximately $11 million from the July 2006 unwinding of interest rate swaps that had been used to hedge rising interest costs of short-term repurchase agreements. This gain was included in other comprehensive income, and was being recognized into earnings as a reduction of interest expense on remaining short-term borrowings. The repurchase agreements restructuring, however, significantly reduced the Group’s short-term borrowings during the March 2007 quarter, eliminating the forecasted transactions that the swaps were intended to hedge. As a result, Oriental recognized the remaining balance of $8.2 million (equal to $0.33 per basic and fully diluted share) of the gain as non-interest income in the quarter ended March 31, 2007. Revenues from securities, derivatives and trading activities in the year ended December 31, 2006 reflects the $16.0 million loss incurred with respect to the repositioning of the investment securities portfolio.

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TABLE 3 — NON-INTEREST EXPENSES SUMMARY
FOR THE YEARS ENDED ENDED DECEMBER 31, 2008, 2007, AND 2006


	Year Ended December 31,
	2008			2007			Variance %			2006
	(Dollars in thousands)

Compensation and employees’ benefits	$	30,572		$	28,376			7.7	%	$	24,630
Occupancy and equipment		13,843			12,624			9.7	%		11,573
Professional and service fees		9,203			7,161			28.5	%		6,821
Advertising and business promotion		3,970			4,472			−11.2	%		4,466
Taxes, other than payroll and income taxes		2,514			2,151			16.9	%		2,405
Insurance		2,421			848			185.5	%		861
Electronic banking charges		1,726			1,826			−5.5	%		1,914
Loan servicing expenses		1,383			1,740			−20.5	%		2,017
Communication		1,292			1,302			−0.8	%		1,598
Clearing and wrap fees expenses		1,250			1,070			16.8	%		1,383
Director and investors relations		1,159			2,103			−44.9	%		2,323
Other operating expenses		3,409			3,186			7.0	%		3,722

Total non-interest expenses	$	72,742		$	66,859			8.8	%	$	63,713

Relevant ratios and data:
Efficiency ratio		52.65	%		65.93	%					86.33	%

Expense ratio		0.77	%		0.77	%					0.73	%

Compensation and benefits to non-interest expenses		42.0	%		42.4	%					38.7	%

Compensation to total assets		0.50	%		0.47	%					0.56	%

Average compensation per employee	$	56.9		$	53.5					$	46.4

Average number of employees		537			522						530

Assets per employee	$	11,552		$	11,320					$	8,552

Total workforce		539			518						535

Non-Interest Expenses

Comparison of the years ended December 31, 2008 and 2007:

Non-interest expenses for the year ended December 31, 2008 increased 8.8% to $72.7 million, compared to $66.9 million for the same period of 2007. During the year ended December 31, 2008, compensation and employees’ benefits increased 7.7% to $30.6 million from $28.4 million in the year ended December 31, 2007. Professional fees increased 28.5% from $7.2 million in the year ended December 31, 2007 to $9.2 million in the year ended December 31, 2008.

In the year ended December 31, 2008, advertising and business promotion, electronic banking charges, loan servicing expenses, director and investor relations expenses, and other operating expenses decreased 11.2%, 5.5%, 20.5%, 44.9% and 11.7%, respectively, compared to the year ended December 31, 2007.

Comparison of the years ended December 31, 2007 and 2006:

Non-interest expenses for the year ended December 31, 2007 increased 4.9% to $66.9 million, compared to $63.7 million for the same period of 2006. During the year ended December 31, 2007, compensation and employees’ benefits increased 15.2% to $28.4 million from $24.6 million in the year ended December 31, 2006. Such increase was mainly due to lower deferred costs pursuant to SFAS No. 91 (“Accounting for Non Refundable

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Fees Associated with Originating or Acquiring Loans and Initial Direct Cost of Leases and Amendment of FASB Statement No. 13, 60 and 65 and a rescission of FASB Statement No. 17”) due to reduced mortgage loan production.

In the year ended December 31, 2007, taxes, other than payroll and income taxes, director and investor relations, loan servicing expense, communication and other operating expenses decreased 10.6%, 9.5%, 13.7%, 18.5% and 16.9%, respectively, compared to the year ended December 31, 2006.

Provision for Loan Losses

Comparison of the years ended December 31, 2008 and 2007:

The provision for loan losses for the year ended December 31, 2008 totaled $8.9 million, a 35.3% increase from the $6.6 million reported for 2007, which is in line with the increase in non-performing loans of the Group. Based on an analysis of the credit quality and the composition of the Group’s loan portfolio, management determined that the provision for 2008 was adequate in order to maintain the allowance for loan losses at an adequate level.

Net credit losses increased 7.4% during 2008 primarily due to the overall deterioration of the economy in Puerto Rico. Recoveries decreased from $501,000 for 2007 to $376,000 for 2008. As result, the recoveries to charge-offs ratio decreased from 10.2% in 2007, to 7.4% in 2008. Mortgage loan charge-offs in 2008 remained constant at $2.0 million compared to 2007. Commercial loans net credit losses increased to $407,000 in 2008, when compared with $253,000 in 2007. The commercial loans that the Group originates are mainly collateralized by mortgages.

Net credit losses on consumer loans increased when compared to 2007. In 2008, net credit losses on consumer loans were $2.3 million, an increase of 9.7% when compared to 2007 in which the Group had net credit losses of $2.1 million.

The Group evaluates all loans, some individually and others as homogeneous groups, for purposes of determining impairment. At December 31, 2008, the total investment in impaired commercial loans was $4.6 million. Impaired commercial loans are measured based on the fair value of collateral. The Group determined an impairment allowance of $1.1 million. The average investment in impaired commercial loans for the year ended December 31, 2008 amounted to $1.8 million compared to $1.5 million for the year ended December 31, 2007.

The Group follows a residential mortgage lending policy, in which more than 90% of its residential mortgage portfolio consists of fixed-rate, fully amortizing, well-documented loans. Furthermore, the Group has never been active in negative amortization loans or adjustable-rate mortgage loans, including those with teaser rates, and does not originate construction and development loans.

Please refer to the Allowance for Loan Losses and Non-Performing Assets section on Table 8 through Table 12 for a more detailed analysis of the allowances for loan losses, net credit losses and credit quality statistics.

Comparison of the years ended December 31, 2007 and 2006:

The provision for loan losses for the year ended December 31, 2007 totaled $6.6 million, a 49.3% increase from the $4.4 million reported for 2006, which is in line with the increase in non-performing loans of the Group. Based on an analysis of the credit quality and the composition of the Group’s loan portfolio, management determined that the provision for 2007 was adequate in order to maintain the allowance for loan losses at an adequate level.

Net credit losses increased 46.8% during 2007 primarily due to increased net credit losses from mortgage loans due to the overall deterioration of the economy in Puerto Rico. Recoveries decreased from $677,000 for 2006 to $501,000 for 2007. As result, the recoveries to charge-offs ratio decreased from 18.4% in 2006, to 10.2% in 2007. Mortgage loan charge-offs in 2007 were $2.0 million as compared to $896,000 in 2006. Commercial loans net credit losses increased to $252,000 in 2007, when compared with $161,000 in 2006. The commercial loans that the Group originates are mainly collateralized by mortgages.

Net credit losses on consumer loans increased when compared to 2006. In 2007, net credit losses on consumer loans were $2.1 million, an increase of 7.7% when compared to 2006 in which the Group had net credit losses of $2.0 million.

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At December 31, 2007, the total investment in impaired commercial loans was $1.1 million. Impaired commercial loans are measured based on the fair value of collateral. The Group determined that no specific impairment allowance was required for such loans. The average investment in impaired commercial loans for the year ended December 31, 2007 amounted to $1.5 million compared to $2.2 million for the year ended December 31, 2006.

Income Taxes

The income tax benefit was $9.3 million for the year ended December 31, 2008, as compared to an expense of $1.6 million for 2007. The tax benefit in 2008 takes into account, among other things, the expiration of certain tax contingencies and a reduction in the Group’s valuation allowance for deferred tax asset. Also, the effective income tax rate in 2007 was lower than the 39% statutory tax rate for the Group, 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 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 entity.

FINANCIAL CONDITION

Assets Owned

At December 31, 2008, the Group’s total assets amounted to $6.2 billion, an increase of 3.4% when compared to $6.0 billion at December 31, 2008, and interest-earning assets reached $6.0 billion, up 16.9%, versus $5.1 billion at December 31, 2007.

As detailed in Table 4, investments are the Group’s largest interest-earning assets component. Investments principally consist of money market instruments, U.S. government and agency bonds, mortgage-backed securities and Puerto Rico government and agency bonds. At December 31, 2008, the investment portfolio increased 4.2% to $4.8 billion, including $835 million of securities sold but not yet delivered at that date, from $4.6 billion.

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TABLE 4 — ASSETS SUMMARY AND COMPOSITION
AS OF DECEMBER 31, 2008, 2007 AND 2006


	December 31,			December 31,			Variance			December 31,
	2008			2007			%			2006
	(Dollars in thousands)									(Dollars in thousands)

Investments:
Mortgage-backed securities	$	2,763,401		$	2,602,766			6.2	%	$	1,955,566
U.S. Government and agency obligations		941,917			1,698,748			−44.6	%		863,019
P.R. Government and agency obligations		82,927			72,667			14.1	%		100,729
Other investment securities		136,218			189,109			−28.0	%		23,366
FHLB stock		21,013			20,658			1.7	%		13,607
Other investments		150			1,662			−91.0	%		30,949

		3,945,626			4,585,610			−14.0	%		2,987,236

Loans:
Loans receivable		1,206,843			1,173,055			2.9	%		1,209,783
Allowance for loan losses		(14,293	)		(10,161	)		40.7	%		(8,016	)

Loans receivable, net		1,192,550			1,162,894			2.6	%		1,201,767
Mortgage loans held for sale		26,562			16,672			59.3	%		10,603

Total loans		1,219,112			1,179,566			3.4	%		1,212,370

Securities sold but not yet delivered		834,976			—			100.0	%		6,430

Total securities and loans		5,999,714			5,765,176			4.0	%		4,206,036

Other assets:
Cash and due from banks		14,370			22,858			−37.1	%		15,341
Money Market Investments		52,002			66,125			−21.4	%		23,729
Accrued interest receivable		43,914			52,315			−16.1	%		27,940
Premises and equipment, net		21,184			21,779			−2.7	%		20,153
Deferred tax asset, net		28,463			10,362			174.7	%		14,150
Foreclosed real estate		9,162			4,207			117.8	%		4,864
Investment in equity indexed options		12,801			40,709			−68.6	%		34,216
Other assets		23,926			16,324			46.6	%		25,557

Total other assets		205,822			234,679			−12.3	%		165,950

Total assets	$	6,205,536		$	5,999,855			3.4	%	$	4,371,986

Investments portfolio composition:
Mortgage-backed securities		70.0	%		56.8	%					65.5	%
U.S. Government and agency obligations		23.9	%		37.0	%					28.9	%
P.R. Government and agency obligations		2.1	%		1.6	%					3.4	%
FHLB stock, short term investments and other investment securities		4.0	%		4.6	%					2.3	%

		100.0	%		100.0	%					100.0	%

Refer to Note 2 of the accompanying consolidated financial statements for information related to the carrying amount of available-for-sale and held-to-maturity investment securities at December 31, 2008, by contractual maturity.

At December 31, 2008, the Group’s loan portfolio, the second largest category of the Group’s interest-earning assets, amounted to $1.2 billion, an increase of 3.4% when compared to the $1.2 billion at December 31, 2007. The

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Group’s loan portfolio is mainly comprised of residential loans, home equity loans, and commercial loans collateralized by mortgages on real estate in Puerto Rico. As shown in Table 5, the mortgage loan portfolio amounted to $996.7 million or 82.6% of the loan portfolio as of December 31, 2008, compared to $986.6 million or 84.1% of the loan portfolio at December 31, 2007. Mortgage production and purchases of $236.9 million for the year ended December 31, 2008 decreased 4.7%, from $248.5 million, when compared to the year ended December 31, 2007.

The second largest component of the Group’s loan portfolio is commercial loans. At December 31, 2008, the commercial loan portfolio totaled $187.1 million (15.5% of the Group’s total loan portfolio), in comparison to $157.2 million at December 31, 2007 (13.4% of the Group’s total loan portfolio).

The consumer loan portfolio totaled $23.1 million (1.9% of total loan portfolio at December 31, 2008), a decrease of 21.2% when compared to the December 31, 2007 portfolio of $29.2 million (2.5% total loan portfolio at such date). Consumer loan production decreased 38.7% for the year ended December 31, 2008 from $7.2 million in 2007 to $4.4 million in 2008.

The following table summarizes the remaining contractual maturities of the Group’s total loans segmented to reflect cash flows as of December 31, 2008. Contractual maturities do not necessarily reflect the actual term of a loan, considering prepayments.


			Maturities
					After One Year to Five Years				After Five Years
	Balance				Fixed		Variable		Fixed		Variable
	Outstanding at		One Year		Interest		Interest		Interest		Interest
	December 31, 2008		or Less		Rates		Rates		Rates		Rates
	(In thousands)

Mortgage, mainly residential	$	1,024,981	$	4,932	$	35,620	$	—	$	984,429	$	—
Commercial, mainly real estate		187,077		75,222		38,922		52,439		12,940		7,554
Consumer		23,054		6,747		14,678		—		1,629		—

Total	$	1,235,112	$	86,901	$	89,220	$	52,439	$	998,998	$	7,554

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TABLE 5 — LOANS RECEIVABLE COMPOSITION:
Selected Financial Data
As of December 31, 2008, 2007 and 2006


	December 31,
	2008			2007			2006
	(Dollars in thousands)

Mortgage, mainly residential	$	996,712		$	986,612		$	932,285
Commercial, mainly real estate		187,077			157,198			241,433
Consumer		23,054			29,245			36,065

Loans receivable		1,206,843			1,173,055			1,209,783
Allowance for loan losses		(14,293	)		(10,161	)		(8,016	)

Loans receivable, net		1,192,550			1,162,894			1,201,767
Mortgage loans held for sale		26,562			16,672			10,603

Total loans, net	$	1,219,112		$	1,179,566		$	1,212,370

Loans portfolio composition percentages:
Mortgage, mainly residential		82.6	%		84.1	%		77.1	%
Commercial, mainly real estate		15.5	%		13.4	%		19.9	%
Consumer		1.9	%		2.5	%		3.0	%

Total loans		100.0	%		100.0	%		100.0	%

Liabilities and Funding Sources

As shown in Table 6, at December 31, 2008, the Group’s total liabilities reached $5.9 billion, 5.3% higher than the $5.6 billion reported at December 31, 2007. Interest-bearing liabilities, the Group’s funding sources, amounted to $5.9 billion at December 31, 2008 versus $5.5 billion at December 31, 2007, a 7.6% increase, mainly driven by the increase in brokered certificates of deposit that are used as a more economical and flexible alternative for replacing higher cost deposits and short-term repurchase.

Borrowings are the Group’s largest interest-bearing liability component. Borrowings consist mainly of diversified funding sources through the use of FHLB advances and borrowings, repurchase agreements, subordinated capital notes, other borrowings and lines of credit. At December 31, 2008, borrowings amounted to $4.1 billion, 2.9% lower than the $4.3 billion recorded at December 31, 2007. Repurchase agreements as of December 31, 2008 amounted to $3.8 billion, a 2.7% decrease when compared to $3.9 billion as of December 31, 2007.

The FHLB system functions as a source of credit for 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 mortgage loans and investment securities. FHLB funding amounted to $308.4 million at December 31, 2008, versus $331.9 million at December 31, 2007. These advances mature from January 2009 through May 2014.

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TABLE 6 — LIABILITIES SUMMARY AND COMPOSITION
AS OF DECEMBER 31, 2008, 2007 AND 2006


	December 31,			December 31,			Variance			December 31,
	2008			2007			%			2006
	(Dollars in thousands)

Deposits:
Non-interest bearing deposits	$	53,165		$	50,149			6.0	%	$	59,603
Now accounts		400,623			68,994			480.7	%		72,810
Savings accounts		50,152			387,788			−87.1	%		266,181
Certificates of deposit		1,274,862			736,186			73.2	%		829,867

		1,778,802			1,243,117			43.1	%		1,228,461
Accrued interest payable		6,498			3,303			96.7	%		4,527

		1,785,300			1,246,420			43.2	%		1,232,988

Borrowings:
Federal funds purchases and other short term borrowings		29,193			27,460			6.3	%		13,568
Repurchase agreements		3,761,121			3,861,411			−2.6	%		2,535,923
Advances from FHLB		308,442			331,898			−7.1	%		181,900
Subordinated capital notes		36,083			36,083			0.0	%		36,083
Term notes		—			—			0.0	%		15,000

		4,134,839			4,256,852			−2.9	%		2,782,474

Total deposits and borrowings		5,920,139			5,503,272			7.6	%		4,015,462
Securities and loans purchased but not yet received		398			111,431			−99.6	%		—
Other liabilities		23,682			25,691			−7.8	%		21,802

Total liabilities	$	5,944,219		$	5,640,394			5.4	%	$	4,037,264

Deposits portfolio composition percentages:
Non-interest bearing deposits		3.0	%		4.0	%					4.8	%
Now accounts		22.5	%		5.6	%					5.9	%
Savings accounts		2.8	%		31.2	%					21.7	%
Certificates of deposit		71.7	%		59.2	%					67.6	%

		100.0	%		100.0	%					100.0	%

Borrowings portfolio composition percentages:
Federal funds purchased and other short term borrowings		0.7	%		0.7	%					0.5	%
Repurchase agreements		91.0	%		90.7	%					91.1	%
Advances from FHLB		7.5	%		7.8	%					6.5	%
Subordinated capital notes		0.8	%		0.8	%					1.3	%
Term notes		0.0	%		0.0	%					0.6	%

		100.0	%		100.0	%					100.0	%

Securities sold under agreements to repurchase
Amount outstanding at year-end	$	3,761,121		$	3,861,411					$	2,535,923

Daily average outstanding balance	$	3,800,673		$	3,154,369					$	2,627,323

Maximum outstanding balance at any month-end	$	3,858,680		$	3,861,411					$	2,923,796

Weighted average interest rate:
For the year		4.25	%		4.68	%					5.09	%

At year end		4.34	%		4.20	%					4.94	%

At December 31, 2008, deposits, the second largest category of the Group’s interest-bearing liabilities reached $1.8 billion, up 43.2% from $1.2 billion at December 31, 2007. Deposits reflected a 73.2% increase in certificates of deposit, to $1.275 million, primarily due to an increase of $448.5 million in brokered certificates of deposit.

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At December 31, 2008, the scheduled maturities of time deposits and individual retirement accounts (IRAs) of $100,000 or more were as follows:


	(In thousands)

3 months or less	$	88,347
Over 3 months through 6 months		79,685
Over 6 months through 12 months		95,858
Over 12 months		63,026

Total	$	326,916

Stockholders’ Equity

At December 31, 2008, the Group’s total stockholders’ equity was $261.3 million, a 27.3% decrease, when compared to $359.5 million at December 31, 2007. The Group’s capital ratios are above regulatory capital requirements. At December 31, 2008, the Tier 1 Leverage Capital Ratio was 6.38%, the Tier 1 Risk-Based Capital Ratio was 17.11%, and the Total Risk-Based Capital Ratio was 17.73%.

The Bank is considered “well-capitalized” under the regulatory framework for prompt corrective action if it meets or exceeds a Tier I risk-based capital ratio of 6%, a total risk-based capital ratio of 10% and a leverage capital ratio of 5%. In addition, the Group and the Bank meet the following minimum capital requirements: a Tier I risk-based capital ratio of 4%, a total risk-based capital ratio of 8% and a Tier 1 leverage capital ratio of 4%. As shown in Table 7 and in Note 13 to the consolidated financial statements, the Group and the Bank comfortably exceed these benchmarks due to the high level of capital and the quality and conservative nature of its assets.

The Group’s common stock is traded on the New York Stock Exchange (NYSE) under the symbol OFG. At December 31, 2008, the Group’s market capitalization for its outstanding common stock was $147.0 million ($6.05 per share).

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TABLE 7 — CAPITAL, DIVIDENDS AND STOCK DATA
AS OF DECEMBER 31, 2008, 2007 AND 2006


	December 31,			December 31,			Variance			December 31,
	2008			2007			%			2006
	(In thousands, except for per share data)

Capital data:
Stockholders’ equity	$	261,317		$	359,461			−27.3	%	$	336,426

Regulatory Capital Ratios data:
Leverage Capital Ratio		6.38	%		6.69	%		−4.6	%		8.42	%

Minimum Leverage Capital Ratio Required		4.00	%		4.00	%					4.00	%

Actual Tier 1 Capital	$	389,235		$	396,309			−1.8	%	$	372,558

Minimum Tier 1 Capital Required	$	244,101		$	236,847			3.1	%	$	176,987

Tier 1 Risk-Based Capital Ratio		17.11	%		18.59	%		−8.0	%		21.57	%

Minimum Tier 1 Risk-Based Capital Ratio Required		4.00	%		4.00	%					4.00	%

Actual Tier 1 Risk-Based Capital	$	389,235		$	396,309			−1.8	%	$	372,558

Minimum Tier 1 Risk-Based Capital Required	$	91.022		$	85,292			6.7	%	$	67,830

Total Risk-Based Capital Ratio		17.73	%		19.06	%		−7.0	%		22.04	%

Minimum Total Risk-Based Capital Ratio Required		8.00	%		8.00	%					8.00	%

Actual Total Risk-Based Capital	$	403,523		$	406,470			−0.7	%	$	380,574

Minimum Total Risk-Based Capital Required	$	182,044		$	170,583			6.7	%	$	135,677

Stock data:
Outstanding common shares, net of treasury		24,297			24,121			0.7	%		24,453

Book value per common share	$	7.96		$	12.08			−34.2	%	$	10.98

Market price at end of year	$	6.05		$	13.41			−54.9	%	$	12.95

Market capitalization	$	146,991		$	323,463			−54.6	%	$	316,671

Common dividend data:
Cash dividends declared	$	13,608		$	13,612			0.0	%	$	13,753

Cash dividends declared per share	$	0.56		$	0.56			0.0	%	$	0.56

Payout ratio		61.89	%		37.33	%		65.8	%		−140.12	%

Dividend yield		3.11	%		4.78	%		−34.9	%		4.39	%

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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

2008
December 31, 2008	$	18.56	$	5.37	$	0.14

September 30, 2008	$	20.99	$	14.21	$	0.14

June 30, 2008	$	20.57	$	14.26	$	0.14

March 31, 2008	$	23.28	$	12.79	$	0.14

2007
December 31, 2007	$	14.56	$	11.01	$	0.14

September 30, 2007	$	11.63	$	8.39	$	0.14

June 30, 2007	$	12.42	$	10.58	$	0.14

March 31, 2007	$	14.04	$	11.25	$	0.14

2006
December 31, 2006	$	13.57	$	11.47	$	0.14

September 30, 2006	$	12.86	$	11.82	$	0.14

June 30, 2006	$	13.99	$	11.96	$	0.14

March 31, 2006	$	14.46	$	12.41	$	0.14

Group’s Financial Assets

The Group’s total financial assets include the Group’s assets and the assets managed by the Group’s trust division, the retirement plan administration subsidiary, and the securities broker-dealer subsidiary. At December 31, 2008, such assets totaled $9.1 billion, a decrease of 1.5% from $9.2 billion at December 31, 2007. This was mainly due to a decrease of 13.0% in the Trust assets managed, when compared to December 31, 2007.

Another component of financial assets is the assets managed by the Group’s trust division and the retirement plan administration subsidiary. The Group’s trust division offers various types of IRA products and manages 401(K) and Keogh retirement plans, custodian and corporate trust accounts, while the retirement plan administration subsidiary manages private pension plans.

The other financial asset component is the assets gathered by the Group’s securities broker-dealer subsidiary. The Group’s broker-dealer subsidiary offers a wide array of investment alternatives to its client base, such as tax-advantaged fixed income securities, mutual funds, stocks and bonds. At December 31, 2008, total assets gathered by the broker-dealer from its customer investment accounts decreased 6.7%, to $1.2 billion as of December 31, 2008, from $1.3 billion as of December 31, 2007.

Allowance for Loan Losses and Non-Performing Assets

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. Tables 8 through 12 set forth an analysis of activity in the allowance for loan losses and present selected loan loss statistics. In addition, refer to Table 5 for the composition (“mix”) of the loan portfolio.

At December 31, 2008, the Group’s allowance for loan losses amounted to $14.3 million or 1.16% of total loans versus $10.2 million or 0.85% of total loans at December 31, 2007. The allowance for residential mortgage loans

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increased by 42.9% or $2.6 million, when compared with balances recorded at December 31, 2007. The allowance for commercial loans increased by 117.8% or $2.2 million, when compared with balances recorded at December 31, 2007. The allowance for consumer loans decreased by 16.7% or $343,000 to $1.7, when compared to $2.0 million recorded at December 30, 2007.

The provision for loan losses for 2008 totaled $8.9 million, a 34.8% increase from the $6.6 million reported for 2007. Based on an analysis of the credit quality and the composition of the Group’s loan portfolio, management determined that the provision for 2008 was adequate in order to maintain the allowance for loan losses at an appropriate level.

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 collectability 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.

TABLE 8 — ALLOWANCE FOR LOAN LOSSES SUMMARY

YEARS ENDED DECEMBER 31, 2008, 2007, AND 2006


	Year Ended December 31,
	2008			2007			2006
	(Dollars in thousands)

Balance at beginning of year	$	10,161		$	8,016		$	6,630
Provision for loan losses		8,860			6,550			4,388
Net credit losses — see Table 10		(4,728	)		(4,405	)		(3,002	)

Balance at end of year	$	14,293		$	10,161		$	8,016

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TABLE 9 — ALLOWANCE FOR LOAN LOSSES BREAKDOWN

AS OF DECEMBER 31, 2008, 2007 AND 2006


	Year Ended December 31,
	2008			2007			2006
	(Dollars in thousands)

Mortgage	$	8,514		$	5,958		$	3,721
Commercial		4,004			1,838			1,831
Consumer		1,714			2,006			1,944
Unallocated allowance		61			359			520

	$	14,293		$	10,161		$	8,016

Allowance composition:
Mortgage		59.6	%		58.7	%		46.4	%
Commercial		28.0	%		18.1	%		22.8	%
Consumer		12.0	%		19.7	%		24.3	%
Unallocated allowance		0.4	%		3.5	%		6.5	%

		100.0	%		100.0	%		100.0	%

Allowance coverage ratio at end of period Applicable to:
Mortgage		0.83	%		0.59	%		0.39	%
Commercial		2.14	%		1.17	%		0.76	%
Consumer		7.43	%		6.86	%		5.36	%
Unallocated allowance to total loans		0.00	%		0.03	%		0.04	%

Total allowance to total loans		1.16	%		0.85	%		0.66	%

Other selected data and ratios:
Allowance coverage ratio to:
Non-performing loans		18.5	%		15.4	%		20.9	%

Non-real estate non-performing loans		239.9	%		314.5	%		205.9	%

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TABLE 10 — NET CREDIT LOSSES STATISTICS:

YEARS ENDED DECEMBER 31, 2008, 2007, AND 2006

(Dollars in thousands)


	Year Ended December 31,
	2008			2007			2006

Mortgage
Charge-offs	$	(1,977	)	$	(2,030	)	$	(896	)
Recoveries		—			15			40

		(1,977	)		(2,015	)		(856	)

Commercial
Charge-offs		(459	)		(359	)		(277	)
Recoveries		52			107			116

		(407	)		(252	)		(161	)

Consumer
Charge-offs		(2,668	)		(2,517	)		(2,505	)
Recoveries		324			379			520

		(2,344	)		(2,138	)		(1,985	)

Net credit losses
Total charge-offs		(5,104	)		(4,906	)		(3,678	)
Total recoveries		376			501			676

	$	(4,728	)	$	(4,405	)	$	(3,002	)

Net credit losses to average loans:
Mortgage		0.19	%		0.20	%		0.11	%

Commercial		0.25	%		0.18	%		0.08	%

Consumer		9.35	%		6.91	%		5.31	%

Total		0.39	%		0.37	%		0.28	%

Recoveries to charge-offs		7.4	%		10.2	%		18.4	%

Average loans:
Mortgage	$	1,026,779		$	1,005,751		$	805,285
Commercial		161,541			143,802			212,294
Consumer		25,081			30,989			37,412

Total	$	1,213,401		$	1,180,542		$	1,054,991

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TABLE 11 — NON-PERFORMING ASSETS


	December 31,
	2008			2007			2006
	(Dollars in thousands)

Non-performing assets:
Non-performing loans
Non-accruing loans	$	38,779		$	27,347		$	17,845
Accruing loans over 90 days past due		38,710			38,762			20,453

Total non-performing loans (see Table 12 below)		77,489			66,109			38,298
Foreclosed real estate		9,162			4,207			4,864

Total non-performing assets	$	86,651		$	70,316		$	43,162

Non-performing assets to total assets		1.40	%		1.17	%		0.99	%

Year Ended December 31,

2008

2007

2006

Interest that would have been recorded for the year if the loans had not been classified as non-accruing loans

2,545

2,043

1,298

TABLE 12 — NON-PERFORMING LOANS:
AS OF DECEMBER 31, 2008, 2007 AND 2006


	December 31,
	2008			2007			2006
	(Dollars in thousands)

Non-performing loans:
Mortgage	$	71,531		$	62,878		$	34,404
Commercial, mainly real estate		5,186			2,413			3,167
Consumer		772			818			727

Total	$	77,489		$	66,109		$	38,298

Non-performing loans composition percentages:
Mortgage		92.3	%		95.1	%		89.8	%
Commercial, mainly real estate		6.7	%		3.7	%		8.3	%
Consumer		1.0	%		1.2	%		1.9	%

Total		100.0	%		100.0	%		100.0	%

Non-performing loans to:
Total loans		6.28	%		5.56	%		3.14	%

Total assets		1.25	%		1.10	%		0.88	%

Total capital		29.65	%		18.39	%		11.38	%

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, following the provisions of SFAS No. 114. 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

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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 under the provisions of SFAS No. 5, and for 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 and 90 days past due. The portfolios of residential mortgages 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 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 overall historical loss trends and 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 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.

During the year ended December 31, 2008, net credit losses amounted to $4.7 million, a 7.3% increase when compared to $4.4 million reported for the same period of 2007. The increase was primarily due to a $206,000 in net credit losses for consumer loans and $155,000 for commercial loans. Total recoveries decreased from $501,000 in 2007 to $376,000 in 2008. As a result, the recoveries to charge-offs ratio decreased from 10.2% in 2007, to 7.4% in 2008.

The Group’s non-performing assets include non-performing loans and foreclosed real estate (see Tables 11 and 12). At December 31 2008, the Group’s non-performing assets totaled $86.8 million (1.40% of total assets) versus $70.3 million (1.17% of total assets) at December 31, 2007.

At December 31, 2008, the allowance for loan losses to non-performing loans coverage ratio was 18.5% (15.4% at December 31, 2007. Excluding the lesser-risk mortgage loans, the ratio is 239.9% (314.5% at December 31, 2007).

The Group follows a conservative residential mortgage lending policy, with more than 90% of its residential mortgage portfolio consisting of fixed-rate, fully amortizing, fully documented loans that do not have the level of risk associated with subprime loans offered by certain major US mortgage loan originators. Furthermore, Oriental has never been active in negative amortization loans or adjustable rate mortgage loans, including those with teaser rates, and does not originate construction and development loans.

Detailed information concerning each of the items that comprise non-performing assets follows:


•	Mortgage loans — are placed in non-accrual status when they become 365 days or more past due, or earlier if other factors indicate that the collection of principal and interest is doubtful, and are written down, if necessary, based on the specific evaluation of the collateral underlying the loan. At December 31, 2008, the Group’s non-performing mortgage loans totaled $71.5 million or 92.3% of the Group’s non-performing loans, compared to $62.9 million or 95.1% at December 31, 2007, and to $34.4 million or 89.8% at December 31, 2006.

•	Commercial business loans — are placed in non-accrual status when they become 90 days or more past due and are charged-off based on the specific evaluation of the underlying collateral. At December 31, 2008, the Group’s non-performing commercial business loans amounted to $5.2 million or 6.7% of the Group’s non-performing loans, compared to $2.4 million or 3.7% at December 31, 2007, and $3.2 million or 8.3% at December 31, 2006.

•	Consumer loans — are placed in non-accrual status when they become 90 days past due and charged-off when payments are delinquent 120 days. At December 31, 2008, the Group’s non-performing consumer loans amounted to $772,000 or 1.0% of the Group’s total non-performing loans, compared to $818,000 or 1.2% at December 31, 2007, and $727,000 or 1.9% at December 31, 2006.

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•

Foreclosed real estate assets — are 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 value of the property is charged against the allowance for loan losses. Subsequently, any excess of the carrying value over the estimated fair value less selling costs is charged to operations. Management is actively seeking prospective buyers for these foreclosed properties. Foreclosed real estate amounted to $9.2 million at December 31, 2008, $4.2 million at December 31, 2007 and $4.9 million at December 31, 2006.

Contractual Obligations and Commercial Commitments

As disclosed in the notes to the Group’s consolidated financial statements, the Group has certain obligations and commitments to make future payments under contracts. At December 31, 2008, the aggregate contractual obligations and commercial commitments are:


	Payments Due by Period
	Total		Less than 1 year		1 - 3 years		3 - 5 years		After 5 years
	(Dollars in thousands)

CONTRACTUAL OBLIGATIONS:(1)
Federal funds purchased and other short term borrowings	$	29,193	$	29,043	$	—	$	150	$	—
Securities sold under agreements to repurchase		3,750,000		—		1,000,000		900,00		1,850,000
Advances from FHLB		306,700		26,700		—		225,000		55,000
Subordinated capital notes		36,083		—		—		—		36,083
Annual rental commitments under noncancelable operating leases		31,608		3,940		7,461		7,225		12,982

Total	$	4,153,584	$	59,683	$	1,007,461	$	1,132,375	$	1,954,065


(1)		Excluding accrued interest

Such commitments will be funded in the normal course of business from the Bank’s principal sources of funds.

Impact of Inflation and Changing Prices

The financial statements and related data presented herein have been prepared in accordance with U.S. generally accepted accounting principles in the United States of America which require the measurement of financial position and operating results in terms of historical dollars without considering changes in the relative purchasing power of money over time due to inflation.

Unlike most industrial companies, virtually all of the assets and liabilities of a financial institution are monetary in nature.

As a result, interest rates have a more significant impact on a financial institution’s performance than the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or with the same magnitude as the prices of goods and services since such prices are affected by inflation.

RISK MANAGEMENT

Background

The Group’s risk management policies are established by its Board of Directors (the “Board”), implemented by management, through the adoption of a risk management program, which is overseen and monitored by the Chief Risk Officer and the Risk Management Committee (RMC). During 2008, the Group continued to refine and enhance its risk management program by strengthening policies, processes and procedures necessary to maintain effective risk management.

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All aspects of the Group’s business activities are susceptible to risk. Consequently, risk identification and monitoring are essential to risk management. As more fully discussed below, the Group’s primary risks exposure include, market, interest rate, credit, liquidity, operational and concentration risks.

Market Risk

Market risk is the risk to earnings or capital arising from adverse movements in market rates or prices, such as interest rates or prices. The Group evaluates market risk together with interest rate risk (See “Interest Rate Risk” below).

The Group’s financial results and capital levels are constantly exposed to market risk. The Board and management are primarily responsible for ensuring that the market risk assumed by the Group complies with the guidelines established by Board approved policies. The Board has delegated the management of this risk to the Asset and Liability Management Committee (“ALCO”) which is composed of certain executive officers from the business, treasury and finance areas. One of ALCO’s primary goals is to ensure that the market risk assumed by the Group is within the parameters established in the policies adopted by the Board.

Interest Rate Risk

Interest rate risk is the exposure of the Group’s earnings or capital to adverse movements in interest rates. It is a predominant market risk in terms of its potential impact on earnings.

The Group manages its asset/liability position in order to limit the effects of changes in interest rates on net interest income. ALCO is responsible for monitoring compliance with the market risk policies approved by the Board and adopting interest risk management strategies. In that role, ALCO oversees interest rate risk, liquidity management and other related matters.

In discharging its responsibilities, ALCO examines current and expected conditions in world financial markets, competition and prevailing rates in the local deposit market, liquidity, unrealized gains and losses in securities, recent or proposed changes to the investment portfolio, alternative funding sources and their costs, hedging and the possible purchase of derivatives such as swaps and caps, and any tax or regulatory issues which may be pertinent to these areas. ALCO approves funding decisions in light of the Group’s overall growth strategies and objectives.

Each quarter, the Group performs a net interest income simulation analysis on a consolidated basis to estimate the potential change in future earnings from projected changes in interest rates. These simulations are carried out over a one-year time horizon, assuming gradual upward and downward interest rate movements of 200 basis points, achieved during a twelve-month period. Simulations are carried out in two ways:

(1) using a static balance sheet as the Group had on the simulation date, and

(2) using a growing balance sheet based on recent growth patterns and strategies.

The balance sheet is divided into groups of assets and liabilities detailed by maturity or re-pricing and their corresponding interest yields and costs. As interest rates rise or fall, these simulations incorporate expected future lending rates, current and expected future funding sources and cost, the possible exercise of options, changes in prepayment rates, deposits decay and other factors which may be important in projecting the future growth of net interest income.

The Group uses an asset-liability management software to project future movements in the Group’s balance sheet and income statement. The starting point of the projections generally corresponds to the actual values of the balance sheet on the date of the simulations.

These simulations are highly complex, and use many simplifying assumptions that are intended to reflect the general behavior of the Group over the period in question. There can be no assurance that actual events will match these assumptions in all cases. For this reason, the results of these simulations are only approximations of the true

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sensitivity of net interest income to changes in market interest rates. The following table presents the results of the simulations at December 31, 2008, assuming a one-year time horizon:


	Net Interest Income Risk (one year projection)
	Static Balance Sheet						Growing simulation
	Amount			Percent			Amount			Percent
Change in interest rate	Change			Change			Change			Change
	(In thousands)

+ 200 Basis points	$	4,519			3.91	%	$	1,883			1.43	%

+ 100 Basis points	$	10,120			8.75	%	$	2,527			1.91	%

− 100 Basis points	$	(7,902	)		−6.83	%	$	(10,939	)		−8.29	%

− 200 Basis points	$	(12,104	)		−10.47	%	$	(18,530	)		−14.04	%

Future net interest income could be affected by the Group’s investments in callable securities, prepayment risk related to mortgage loans and mortgage-backed securities, and its structured repurchase agreements and advances from the FHLB. As part of the strategy to limit the interest rate risk and reduce the re-pricing gaps of the Group’s assets and liabilities, the maturity and the repricing frequency of the liabilities has been extended to longer terms. The concentration of long-term fixed rate securities has also been reduced.

The Group uses derivative instruments and other strategies to manage its exposure to interest rate risk caused by changes in interest rates beyond management’s control. The following summarizes strategies, including derivative activities, used by the Group in managing interest rate risk:

Interest rate swaps — Interest rate swap agreements generally involve the exchange of fixed and floating-rate interest payment obligations without the exchange of the underlying principal. The interest rate swaps have been utilized to convert short term repurchase agreements into fixed rate to better match the repricing nature of these borrowings. There were no outstanding interest rate swaps as of December 31, 2008 or 2007.

Structured borrowings — The Group uses structured repurchase agreements and from advances from FHLB, with embedded call options, to reduce the Group’s exposure to interest rate risk by lengthening the contractual maturities of its liabilities, while keeping funding costs low.

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, the depositor receives a minimum return or a specified percentage of the average increase of the month-end value of the stock index. The Group uses option agreements with major money center banks and major broker-dealer companies to manage its exposure to changes in those indexes. Under the terms of the option agreements, the Group receives the average increase in the month-end value of the corresponding index in exchange for a fixed premium. The changes in fair value of the options purchased and the options embedded in the certificates of deposit are recorded in earnings.

Derivatives instruments are generally negotiated over-the-counter (“OTC”) contracts. Negotiated OTC derivatives are generally entered into between two counterparties that negotiate specific agreement terms, including the underlying instrument, amount, exercise price and maturity.

At December 31, 2008 and 2007, the fair value the purchased options used to manage the exposure to the stock market on stock indexed deposits represented an asset of $12.8 million, and $40.7 million, respectively; and the options sold to customers embedded in the certificates of deposit represented a liability of $18.0 million and $38.8 million, respectively, recorded in deposits.

Credit Risk

Credit risk is the possibility of loss arising from a borrower or counterparty in a credit-related contract failing to perform in accordance with its terms. The principal source of credit risk for the Group’s is its lending activities.

The Group manages its credit risk through a comprehensive credit policy which establishes sound underwriting standards, by monitoring and evaluating loan portfolio quality, and by the constant assessment of reserves and loan concentrations. The Group also employs proactive collection and loss mitigation practices.

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The Group may also encounter risk of default in relation to its securities portfolio. The securities held by the Group are principally mortgage-backed securities and U.S. Treasury and agency securities. Thus, a substantial portion of these instruments are guaranteed by mortgages, a U.S. government-sponsored entity or the full faith and credit of the U.S. government, and are deemed to be of the highest credit quality. The available-for-sale securities portfolio also includes approximately $529.7 million in non-government agency pass-through collateralized mortgage obligations. and $136.2 in structured credit investments that are considered of a higher credit risk than agency securities.

Management’s Credit Committee, composed of the Group’s Chief Executive Officer, Chief Credit Risk Officer and other senior executives, has primary responsibility for setting strategies to achieve the Group’s credit risk goals and objectives. Those goals and objectives are set forth in the Group’s Credit Policy.

Liquidity Risk

Liquidity risk is the risk of the Group not being able to generate sufficient cash from either assets or liabilities to meet obligations as they become due, without incurring substantial losses. The Group’s cash requirements principally consist of deposit withdrawals, contractual loan funding, repayment of borrowings as they mature, and funding of new and existing investment as required.

Effective liquidity management requires that the Group have sufficient cash available at all times to meet its financial commitments, finance planned growth and have a reasonable safety margin for normal as well as unexpected cash needs. ALCO is responsible for managing the Group’s liquidity risk in accordance with the policies adopted by the Board. In discharging its liquidity risk management obligations, ALCO approves operating and contingency procedures and monitors their implementation. The Group’s Treasurer and Chief Investment Officer is responsible for the implementation of the liquidity risk management policies adopted by the Board and of the operating and contingency procedures adopted by ALCO, and for monitoring the Group’s liquidity position on an ongoing basis. Using measures of liquidity developed by the Group’s Treasury Division under several different scenarios, the Treasury Division, ALCO and the Board review the Group’s liquidity position on a daily, monthly and quarterly basis, respectively.

The Group meets its liquidity management objectives by maintaining (i) liquid assets in the form of investment securities,(ii) sufficient unused borrowing capacity in the national money markets, and achieving (iii) consistent growth in core deposits. As of December 31, 2008, the Group had approximately $133.5 million in investments available to cover liquidity needs. Additional asset-driven liquidity is provided by the availability of loan assets to pledge. These sources, in addition to the Group’s 6.38% average equity capital base, provide a stable funding base.

The Group utilizes different sources of funding to help ensure that adequate levels of liquidity are available when needed. Diversification of funding sources is of great importance as it protects the Group’s liquidity from market disruptions. The principal sources of short-term funds are deposits, securities sold under agreements to repurchase, and lines of credit with the FHLB. ALCO reviews credit availability on a regular basis. The Group securitizes and sells mortgage loans as supplemental source of funding. Long-term certificates of deposit as well as long-term funding through the issuance of notes have also provided additional funding. The cost of these different alternatives, among other things, is taken into consideration. The Group’s principal uses of funds are the origination of loans and the repayment of maturing deposit accounts and borrowings.

Operational Risk

Operational risk is the risk of loss from inadequate or failed internal processes, personnel and systems or from external events. All functions, products and services of the Group are susceptible to operational risk.

The Group faces ongoing and emerging risk and regulatory pressure related to the activities that surround the delivery of banking and financial products. Coupled with external influences such as market conditions, security risks, and legal risk, the potential for operational and reputational loss has increased. In order to mitigate and control operational risk, the Group has developed, and continues to enhance, specific internal controls, policies and procedures that are designed to identify and manage operational risk at appropriate levels throughout the

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organization. The purpose of these policies and procedures is to provide reasonable assurance that the Group’s business operations are functioning within established limits.

The Group classifies operational risk into two major categories: business specific and corporate-wide affecting all business lines. For business specific risks, a risk assessment group works with the various business units to ensure consistency in policies, processes and assessments. With respect to corporate wide risks, such as information security, business recovery, legal and compliance, the Group has specialized groups, such as Information Security, Corporate Compliance, Information Technology and Operations. These groups assist the lines of business in the development and implementation of risk management practices specific to the needs of the business groups. All these matters are reviewed and discussed in the RMC.

The Group is subject to extensive regulation in the different jurisdictions in which it conducts its business, and this regulatory scrutiny has been significantly increasing over the last several years. The Group has established and continues to enhance procedures based on legal and regulatory requirements that are reasonably designed to ensure compliance with all applicable statutory and regulatory requirements. The Group has a corporate compliance function, headed by a Senior Compliance Officer who reports to the Chief Risk Officer and is responsible for the oversight of regulatory compliance and implementation of an enterprise-wide compliance program.

Concentration Risk

Substantially all of the Group’s business activities and a significant portion of its credit exposure are concentrated in Puerto Rico. As a consequence, the Group’s profitability and financial condition may be adversely affected by an extended economic slowdown, adverse political or economic developments in Puerto Rico or the effects of a natural disaster, all of which could result in a reduction in loan originations, an increase in non-performing assets, an increase in foreclosure losses on mortgage loans, and a reduction in the value of its loans and loan servicing portfolio.

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QUARTERLY FINANCIAL DATA (Unaudited)

The following is a summary of the unaudited quarterly results of operations:

TABLE 13A — SELECTED QUARTERLY FINANCIAL DATA:


	Quarter Ended
	March 31,			June 30,			September 30,			December 31,
Year Ended December 31, 2008	2008			2008			2008			2008
	(In thousands, except for per share data)

Interest income	$	82,101		$	85,158		$	84,744		$	87,036
Interest expense		57,192			56,573			56,703			57,260

Net interest income		24,909			28,585			28,041			29,776
Provision for loan losses		1,650			1,980			1,950			3,280

Net interest income after provision for loan losses		23,259			26,605			26,091			26,496
Total non-interest income (loss)		8,864			6,650			(57,167	)		29,411
Total non-interest expenses		17,730			18,080			18,197			18,735

Income before taxes		14,393			15,175			(49,273	)		37,172
Income tax expense (benefit)		(2,455	)		598			(4,226	)		(3,240	)

Net income		16,848			14,577			(45,047	)		40,412
Less: Dividends on preferred stock		(1,201	)		(1,200	)		(1,200	)		(1,201	)

Income available (loss) to common shareholders	$	15,647		$	13,377		$	(46,247	)	$	39,211

Per share data:
Basic	$	0.65		$	0.54		$	(1.90	)	$	1.61

Diluted	$	0.64		$	0.54		$	(1.89	)	$	1.61

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TABLE 13B — SELECTED QUARTERLY FINANCIAL DATA:


	Quarter Ended
	March 31,			June 30,			September 30,			December 31,
Year Ended December 31, 2007	2007			2007			2007			2007
	(In thousands, except for per share data)

Interest income	$	61,500		$	70,801		$	74,926		$	82,138
Interest expense		48,234			53,111			55,276			59,135

Net interest income		13,266			17,690			19,650			23,003
Provision for loan losses		(1,075	)		(1,375	)		(1,614	)		(2,486	)

Net interest income after provision for loan losses		12,191			16,315			18,036			20,517
Total non-interest income		15,251			7,796			7,134			12,442
Total non-interest expenses		15,827			17,477			16,522			17,032

Income before taxes		11,615			6,634			8,648			15,927
Income tax expense		624			187			196			551

Net income		10,991			6,447			8,452			15,376
Less: Dividends on preferred stock		(1,200	)		(1,201	)		(1,200	)		(1,201	)

Income available to common shareholders	$	9,791		$	5,246		$	7,252		$	14,175

Per share data:
Basic	$	0.40		$	0.21		$	0.30		$	0.59

Diluted	$	0.40		$	0.21		$	0.30		$	0.59

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Critical Accounting Policies

Transfers and Servicing of Financial Assets and Extinguishments of Liabilities

A transfer of financial assets is accounted for as a sale when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the transferor, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the transferor does not maintain effective control over the transferred assets through an agreement to repurchase them before maturity. As such, the Group recognizes the financial assets and servicing assets it controls and the liabilities it has incurred. At the same time, it ceases to recognize financial assets when control has been surrendered and liabilities when they are extinguished.

Financial Instruments

Certain financial instruments including derivatives, trading securities and investment securities available-for-sale are recorded at fair value and unrealized gains and losses are recorded in other comprehensive income or as part of non-interest income, as appropriate. Fair values are based on listed market prices, if available. If listed market prices are not available, fair value is determined based on other relevant factors, including price quotations for similar instruments. The fair values of certain derivative contracts are derived from pricing models that consider current market and contractual prices for the underlying financial instruments as well as time value and yield curve or volatility factors underlying the positions.

SFAS No. 157, “Fair Value Measurements” (“SFAS 157”), establishes a fair value hierarchy that prioritizes the inputs of valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (level 1 measurements) and the lowest priority to unobservable inputs (level 3 measurements). The three levels of the fair value hierarchy under SFAS 157 are described below:

Basis of Fair Value Measurement


Level 1 —	Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities;

Level 2 —	Quoted prices in markets that are not considered to be active or financial instruments for which all significant inputs are observable, either directly or indirectly;

Level 3 —	Prices or valuations that require inputs that are both significant to the fair value measurement and unobservable.

A financial instrument’s level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement.

Impairment of Investment Securities

The Group conducts periodic reviews to identify and evaluate each investment in an unrealized loss position, in accordance with FSPFAS 115-1. An unrealized loss exists when the current fair value of an individual security is less than its amortized cost basis. Unrealized losses that are determined to be temporary in nature are recorded, net of tax, in accumulated other comprehensive income for available-for-sale securities, while such losses related to held-to-maturity securities are not recorded, as these investments are carried at their amortized cost (less any other-than-temporary impairment). Regardless of the classification of the securities as available-for-sale or held-to-maturity, the Group has assessed each position for credit impairment.

Factors considered in determining whether a loss is temporary include:


	•	the length of time and the extent to which fair value has been below cost;

	•	the severity of the impairment;

	•	the cause of the impairment and the financial condition and near-term prospects of the issuer;

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	•	activity in the market of the issuer which may indicate adverse credit conditions; and

	•	the Group’s ability and intent to hold the investment for a period of time sufficient to allow for any anticipated recovery.

The Group’s review for impairment generally entails:


	•	identification and evaluation of investments that have indications of possible other-than-temporary impairment;

	•	analysis of individual investments that have fair values less than amortized cost, including consideration of the length of time the investment has been in an unrealized loss position and the expected recovery period;

	•	discussion of evidential matter, including an evaluation of factors or triggers that could cause individual investments to qualify as having other-than-temporary impairment and those that would not support other-than-temporary impairment; and

	•	documentation of the results of these analyses.

Derivative Financial Instruments

As part of the Group’s asset and liability management, the Group uses interest-rate contracts, which include interest-rate swaps to hedge various exposures or to modify interest rate characteristics of various statement of financial condition accounts.

The Group follows Statement of Financial Accounting Standards (“SFAS”) No. 161“Disclosures about Derivative Instruments and Hedging Activities an Amendment of FASB Statement No. 133: Accounting for Derivative Instruments and Hedging Activities,” which establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. The statement requires that all derivative instruments be recognized as assets and liabilities at fair value. If certain conditions are met, the derivative may qualify for hedge accounting treatment and be designated as one of the following types of hedges: (a) hedge of the exposure to changes in the fair value of a recognized asset or liability or an unrecognized firm commitment (“fair value hedge”); (b) a hedge of the exposure to variability of cash flows of a recognized asset, liability or forecasted transaction (“cash flow hedge”) or (c) a hedge of foreign currency exposure (“foreign currency hedge”).

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The Group may use several 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 to derive the fair value of certain derivatives contracts.

Allowance for Loan Losses

The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectability of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.

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 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 penalties, 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.

Recently Issued Accounting Pronouncements and Interpretations:

SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51”

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SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities, an amendment of SFAS No. 133”

SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles”

In May 2008, FASB issued SFAS No. 162,‘” The Hierarchy of Generally Accepted Accounting Principles”, This Statement identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles (GAAP) in the United States (the GAAP hierarchy).

This Statement is effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board amendments to AU Section 411,The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles. The adoption of this standard is not expected to have a material effect on the Group’s results of operations or financial position. The Board does not expect that this statement will result in a change in current accounting practice. However, transition provisions have been provided in the unusual circumstance that the application of the provisions of this statement results in a change in accounting practice.

FASB Staff Position (FSP)FAS 140-3, “Accounting for Transfers of Financial Assets and Repurchase Financing Transactions”

FASB Staff Position (FSP)FAS 142-3, “Determination of the Useful Life of Intangible Assets”

FSPFAS 142-3, issued by the FASB in April 2008, amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under FASB Statement No. 142 “Goodwill and Other Intangible Assets”. In developing these assumptions, an entity should consider its own historical experience in renewing or extending similar arrangements adjusted for entity’s specific factors or, in the absence of that experience, the assumptions that market participants would use about renewals or extensions adjusted for the entity specific factors. FSPFAS 142-3 shall be applied prospectively to intangible assets acquired after the effective date. This FSP was adopted by the Group on January 1, 2009. The Group will be evaluating the potential impact of adopting this FSP to prospective transactions.

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FSP No. FAS 132(R)-1 “Employers’ Disclosures about Postretirement Benefit Plan Assets”

FSP No. EITF03-6-1 “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities”

FSPNo. EITF 03-6-1 addresses whether instruments granted in share-based payment transactions are participating securities prior to vesting and, therefore, need to be included in the earnings allocation in computing earnings per share (“EPS”) under the two-class method described in paragraphs 60 and 61 of FASB Statement No. 128, “Earnings per Share” . Unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of EPS pursuant to the two-class method. This FSP shall be effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those years. All prior-period EPS data presented shall be adjusted retrospectively (including interim financial statements, summaries of earnings, and selected financial data) to conform with the provisions of this FSP. Early application is not permitted. This FSP will not have an impact on the Group’s EPS computation upon adoption.

EITF IssueNo. 07-5 “Determining Whether an Instrument (or Embedded Feature) is Indexed to an Entity’s Own Stock”

EITF08-6 “Equity Method Investment Accounting Considerations”

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EITF08-7 “Accounting for Defensive Intangible Assets”

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Positive
Negative
Uncertain
Constraining
Legalese
Litigous
Readability	H.S. sophomore Bad

OFG Bancorp (OFG) 10-K2008 FY Annual report

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