##### Table of Contents



SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549
   FORM 10-K FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934  þ  
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2004 OR  o   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF
1934
 FOR THE TRANSITION PERIOD FROM TO COMMISSION FILE NO. 000-27377 W HOLDING COMPANY, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) COMMONWEALTH OF PUERTO RICO
(State or Other Jurisdiction of
Incorporation or Organization)
    
    66-0573197
(IRS Employer
Identification No.)19 WEST MCKINLEY STREET, MAYAGUEZ, PUERTO RICO
(Address of Principal Executive Offices)

    00681
(Zip Code)
 REGISTRANTS TELEPHONE NUMBER, INCLUDING AREA CODE: (787) 834-8000 SECURITIES REGISTERED PURSUANT TO SECTION 12 (B) OF THE ACT: COMMON STOCK ($1.00 PAR VALUE PER SHARE)
(TITLE OF CLASS) SECURITIES REGISTERED PURSUANT TO SECTION 12 (G) OF THE ACT: 7.125% NONCUMULATIVE, CONVERTIBLE MONTHLY INCOME PREFERRED STOCK, 1998 SERIES A
($1.00 PAR VALUE PER SHARE)
(TITLE OF CLASS) 7.25% NONCUMULATIVE, NON-CONVERTIBLE MONTHLY INCOME PREFERRED STOCK, 1999 SERIES B
($1.00 PAR VALUE PER SHARE)
(TITLE OF CLASS) 7.60% NONCUMULATIVE, NON-CONVERTIBLE MONTHLY INCOME PREFERRED STOCK, 2001 SERIES C
($1.00 PAR VALUE PER SHARE)
(TITLE OF CLASS) 7.40% NONCUMULATIVE, NON-CONVERTIBLE MONTHLY INCOME PREFERRED STOCK, 2001 SERIES D
($1.00 PAR VALUE PER SHARE)
(TITLE OF CLASS) 6.875% NONCUMULATIVE, NON-CONVERTIBLE MONTHLY INCOME PREFERRED STOCK, 2002 SERIES E
($1.00 PAR VALUE PER SHARE)
(TITLE OF CLASS) 6.70% NONCUMULATIVE, NON-CONVERTIBLE MONTHLY INCOME PREFERRED STOCK, 2003 SERIES F
($1.00 PAR VALUE PER SHARE)
(TITLE OF CLASS) 6.90% NONCUMULATIVE, NON-CONVERTIBLE MONTHLY INCOME PREFERRED STOCK, 2003 SERIES G
($1.00 PAR VALUE PER SHARE)
(TITLE OF CLASS) 6.70% NONCUMULATIVE, NON-CONVERTIBLE MONTHLY INCOME PREFERRED STOCK, 2004 SERIES H
($1.00 PAR VALUE PER SHARE)
(TITLE OF CLASS) Indicate by check mark whether the registrant (1) has filed all reports required by Section 13 or
15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter
period that the registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days. Yes þ No o Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is
not contained herein, and will not be contained, to the best of Registrants knowledge, in
definitive proxy or information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. o Indicate by check mark whether the registrant
is an accelerated filer (as defined in Rule 12-b-2 of
the Exchange Act).
YES  þ  NO  o The aggregate market value of the voting and non-voting stock held by nonaffiliates of the
registrant as of June 30, 2004 was $1,832,382,780 based upon the reported closing sales price of
$11.22 (as adjusted) on the New York Stock Exchange as of June 30, 2004. Number of shares of Common Stock outstanding as of
February 28, 2005: 163,954,777. DOCUMENTS INCORPORATED BY REFERENCE Portions of the definitive Proxy Statement for the Registrants Annual Meeting of Shareholders to
be held on May 27, 2005 are incorporated by reference into Part III, Items 10, 11, 12, 13 and 14 of
this Form 10-K.




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TABLE OF CONTENTS  PART IITEM 1. BUSINESSITEM 2. PROPERTIESITEM 3. LEGAL PROCEEDINGSITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERSPART IIITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS ANDITEM 6. SELECTED FINANCIAL DATAITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATAREPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMCONSOLIDATED STATEMENTS OF FINANCIAL CONDITIONCONSOLIDATED STATEMENTS OF INCOMECONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITYCONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)NOTES TO CONSOLIDATED FINANCIAL STATEMENTSITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSUREITEM 9A. CONTROLS AND PROCEDURESITEM 9B. OTHER INFORMATIONPART IIIITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANTITEM 11. EXECUTIVE COMPENSATIONITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENTITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONSITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICESPART IVITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULESSIGNATURESEXHIBIT INDEXEX-10.11 DESCRIPTION OF ARRANGEMENT FOR DIRECTOR FEESEX-10.12 EXECUTIVE OFFICERS COMPENSATION SCHEDULEEX-21.1 SUBSIDIARIES OF THE REGISTRANTEX-23.1 CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMEX-31.1 SECTION 302, CERTIFICATION OF THE CEOEX-31.2 SECTION 302, CERTIFICATION OF THE CFOEX-32.1 SECTION 906, CERTIFICATION OF THE CEOEX-32.2 SECTION 906, CERTIFICATION OF THE CFO    Table of Contents  FORWARD-LOOKING STATEMENTS Certain statements in this Form 10-K, especially within Managements Discussion and Analysis
of Financial Condition and Results of Operations, will include forward-looking statements within
the meaning of the Securities Exchange Act of 1934, as amended. In general, the word or phrases
will likely result, are expected to, will continue, is anticipated, estimate, project,
believe or similar expressions are intended to identify forward-looking statements. In
addition, certain disclosures and information customarily provided by financial institutions, such
as analysis of the adequacy of the allowance for loan losses or an analysis of the interest rate
sensitivity of the Companys assets and liabilities, are inherently based upon predictions of
future events and circumstances. Although the Company makes such statements based on assumptions
which it believes to be reasonable, there can be no assurance that actual results will not differ
materially from the Companys expectations. Some of the important factors which could cause its
results to differ from any results which might be projected, forecasted or estimated, based on such
forward-looking statements include: (i) general economic and competitive conditions in the markets
in which the Company operates, and the risks inherent in its operations; (ii) the Companys ability
to manage its credit risk and control its operating expense, increase earning assets and
non-interest income, and maintain its net interest margin; and (iii) the level of demand for new
and existing products. Should one or more of these risks or uncertainties materialize, or should
underlying assumptions prove incorrect, actual results may vary materially from those described in
the forward-looking statements. Except as required by applicable law, the Company does not intend,
and specifically disclaims any obligation, to update forward-looking statements. 
 PART I 
 ITEM 1. BUSINESS GENERAL W Holding Company, Inc. (the Company) is a financial holding company offering a full range
of financial services. The business of the Company is conducted primarily through its wholly owned
commercial bank subsidiary, Westernbank Puerto Rico
(Westernbank or the Bank). The Companys other direct
subsidiary is Westernbank Insurance Corp. The Company was organized under the laws of the
Commonwealth of Puerto Rico in February 1999 to become the bank holding company of Westernbank.
Westernbank was founded as a savings institution in 1958 operating in the western and southwestern
regions of Puerto Rico, focusing on retail banking and emphasizing long-term fixed-rate residential
mortgage loans on one-to-four family residential properties. In 1994, Westernbank changed its
charter to become a full-service commercial bank. Westernbank offers a full range of business and
consumer financial services, including banking, trust and brokerage services. Westernbank Insurance
Corp. is a general insurance agent placing property, casualty, life and disability insurance. The
assets, liabilities, revenues and expenses of Westernbank Insurance Corp. at December 31, 2004 and
2003, and for each of the three years in the period ended December 31, 2004, were not significant. In July 2000, the Company became a financial holding company under the Bank Holding Company
Act. As a financial holding company, the Company is permitted to engage in financial related
activities, including insurance and securities activities, provided that the Company and its
banking subsidiary meet certain regulatory standards. At December 31, 2004, the Company had total assets of $14.34 billion, a loan portfolio-net of
$5.94 billion, an investment portfolio of $6.93 billion, excluding money market instruments of $1.1
billion, deposits of $6.23 billion, borrowings of $6.93 billion and stockholders equity of $1.08
billion. The Company has improved its efficiency ratio from 47.14% in 2000, to 30.51% for the year
ended December 31, 2004. Westernbank is the second largest commercial bank in Puerto Rico, based on total assets at
December 31, 2004. Westernbank operates through a network of 52 bank branches, including 19
Expresso of Westernbank branches, located throughout Puerto Rico, primarily in the western and
southwestern regions of the island, and a website on the Internet. Westernbank traditional banking
operations include retail operations, such as its branches, including the branches of the Expresso
division, together with consumer loans, mortgage loans, commercial loans (excluding the asset-based
lending operations), investments (treasury) and deposit products. Besides the traditional banking
operations, Westernbank operates other four divisions: Westernbank International Division, which is
an International Banking Entity (IBE) under the Puerto Rico Act No. 52 of August 11, 1989, as
amended, known as the International Banking Regulatory Act, which activities consist of commercial
and related services, and treasury and investment activities outside of Puerto Rico; Westernbank
Business Credit, which specializes in commercial business loans secured principally by real estate,
accounts receivable, inventory and equipment; Westernbank Trust Division, which offers a full array
of trust services; and Expresso of Westernbank, a division which specializes in small, unsecured
consumer loans up to $15,000 and real estate collateralized consumer loans up to $150,000.
Westernbank owns 100% of the voting shares of Westernbank World Plaza, Inc. (WWPI), which owns
and operates Westernbank World Plaza; a 23-story office building, including its related parking
facility, located in Hato Rey, Puerto Rico, the main Puerto Rican business district. Westernbank
also owns 100% of the voting shares of SRG Net, Inc., a Puerto Rico corporation that operates an electronic funds transfer network. The assets, liabilities,
revenues and expenses of SRG Net, Inc. at December 31, 2004 and 2003, and for each of the three
years in the period ended December 31, 2004, were not significant.




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Westernbank seeks to differentiate itself from other banks by focusing on customer
relationships and personalized service, offering customers direct access to senior management. As
part of this strategy, Westernbank strives to make fast and effective decisions locally.
Westernbanks branches offer modern facilities with advanced technology and remain open to
customers for longer hours compared to many other local banks, with a number of branches offering
both Saturday and Sunday hours. In addition, Westernbank trains its employees to promote an
effective and customer-focused sales culture. Westernbank is one of the fastest-growing commercial
banks in Puerto Rico, increasing both total assets and loans at an average annual growth rate of
over 26.07% for the last five fiscal years. The Company has achieved this growth while maintaining
a ratio of non-performing loans to total loans well below 1.00%. The Company continues to emphasize on growing Westernbanks commercial loan portfolio through
commercial real estate, asset-based, unsecured business and construction lending, as well as its
consumer loan and investment securities portfolios. As a result, the Company has shifted its asset
composition from primarily traditional long-term fixed-rate residential mortgage loans to assets
with shorter maturities and greater repricing flexibility. As of December 31, 2004, commercial
loans were $3.92 billion or 66.03% (80.41% collateralized by real estate) and consumer loans were
$866.9 million or 14.59% (67.50% collateralized by real estate) of the $5.94 billion loan
portfolio-net. Investment securities, excluding money market instruments of $1.1 billion, totaled
$6.93 billion at December 31, 2004. These loans and securities tend to have shorter maturities and
reprice faster than traditional residential mortgage loans. The Company also continues to diversify
and grow Westernbanks sources of revenue, while maintaining its status as a secured lender, with
approximately 83% of its loans collateralized by real estate as of December 31, 2004. The Company is focused on the expansion of Westernbank in the San Juan metropolitan area. We
have opened 12 branches in the San Juan metropolitan area since 1998, including seven Expresso of
Westernbank branches in July 2002. In the first quarter of 2002, Westernbank acquired Westernbank
World Plaza; a 23-story office building that is the tallest in Puerto Ricos main business district
and now serves as the Companys San Juan metropolitan area headquarters, our regional commercial
lending office and the headquarters for the Westernbank Business Credit and Expresso of Westernbank
divisions. In addition, the Company continues to build upon its existing platform and further
expand its fee-based businesses, including insurance brokerage, trust services and securities
brokerage. On October 22, 2004, Westernbank opened its most advanced banking branch in the historic
city of Old San Juan, Puerto Rico. Commercial lending, including commercial real estate and asset-based lending, unsecured
business lending and construction lending, generally carry a greater risk than residential lending
because such loans are typically larger in size and more risk is concentrated in a single borrower.
In addition, the borrowers ability to repay a commercial loan or a construction loan depends, in
the case of a commercial loan, on the successful operation of the business or the property securing
the loan and, in the case of a construction loan, on the successful completion and sale or
operation of the project. Substantially all of the Companys borrowers and properties and other
collateral securing the commercial, real estate mortgage and consumer loans are located in Puerto
Rico. These loans may be subject to a greater risk of default if the Puerto Rico economy suffers
adverse economic, political or business developments, or if natural disasters affect Puerto Rico. The Companys financial performance is reported in two primary business segments, the
traditional banking operations of Westernbank Puerto Rico and the activities of Westernbanks
division known as Westernbank International. Other operations of the Company, not reportable in
either segment, include Westernbank Business Credit Division; Westernbank Trust Division; SRG Net,
Inc.; Westernbank Insurance Corp.; Westernbank World Plaza, Inc.; and the transactions of the
parent company only, which mainly consist of other income related to the equity in the net income
of its two wholly owned subsidiaries. Separate condensed financial information of the Parent
Company only is provided in Note 24 (page 120) to the audited consolidated financial statements, included in
Part II, Item 8. The traditional banking operations of Westernbank Puerto Rico include retail operations, such
as its branches, including the branches of the Expresso division, together with consumer loans,
mortgage loans, commercial loans (excluding the asset-based lending operations), investments
(treasury) and deposits products. Consumer loans include loans such as personal, collateralized
personal loans, credit cards, and small loans. Commercial products consist of commercial loans
including commercial real estate, unsecured commercial and construction loans. Westernbank Internationals business activities consist of commercial banking and related
services, and treasury and investment activities outside of Puerto Rico. As of December 31, 2004,
2003, and 2002, and for the periods then ended, substantially all of Westernbank Internationals
business activities consisted of investment in securities and loans. 3




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Established in 2001, Westernbank Insurance Corp. is a general insurance agent placing
property, casualty, life and disability insurance on which it earns commission income. Currently,
most of the agencys volume is derived from two areas  mortgage insurance on residential mortgage
loans and credit life insurance for borrowers of personal loans. The Company and its wholly owned subsidiaries executive offices are located at 19 West
McKinley Street, Mayagüez, Puerto Rico 00681, and the telephone number is (787) 834-8000. The
Company also maintains a website, which can be accessed at
http://www.wholding.com. The information
required by Item 101 (b) of Regulation S-K appears in the Companys
Consolidated Financial Statements, and is included in Part II, Item 8. For
information about the geographic areas in which we operate, see Economic Conditions,
Market Area and Competition and is incorporated herein. See Note 23
(page 117) to the
audited consolidated financial statements, included in Part II, Item 8, for further
information about the Companys business segments. LENDING ACTIVITIES GENERAL. At December 31, 2004, Westernbanks net loans amounted to $5.94 billion or 41.44% of
total assets. The following table sets forth the composition of the Westernbanks loans portfolio at the
dates indicated. At December 31,2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000Amount
    
    
    Percent
    
    
    Amount
    
    
    Percent
    
    
    Amount
    
    
    Percent
    
    
    Amount
    
    
    Percent
    
    
    Amount
    
    
    Percent(Dollars in thousands)Residential real estate:Mortgage
    
    $
    902,937
    
    
    
    15.2

    %
    
    $
    894,007
    
    
    
    19.1
    %
    
    $
    844,803
    
    
    
    22.5
    %
    
    $
    847,462
    
    
    
    29.9
    %
    
    $
    781,213
    
    
    
    35.5
    %Construction
    
    
    328,145
    
    
    
    5.5
    
    
    
    202,600
    
    
    
    4.3
    
    
    
    181,266
    
    
    
    4.8
    
    
    
    117,957
    
    
    
    4.2
    
    
    
    80,905
    
    
    
    3.7Commercial, industrial
and agricultural (1):Real estate
    
    
    3,154,679
    
    
    
    53.1
    
    
    
    2,261,465
    
    
    
    48.3
    
    
    
    1,647,602
    
    
    
    38.9
    
    
    
    1,115,700
    
    
    
    39.3
    
    
    
    887,084
    
    
    
    40.2Business and others
    
    
    768,604
    
    
    
    12.9
    
    
    
    524,747
    
    
    
    11.2
    
    
    
    384,200
    
    
    
    15.2
    
    
    
    378,696
    
    
    
    13.3
    
    
    
    99,483
    
    
    
    4.5Consumer and others (2)
    
    
    866,934
    
    
    
    14.6
    
    
    
    861,907
    
    
    
    18.4
    
    
    
    743,600
    
    
    
    19.8
    
    
    
    416,953
    
    
    
    14.7
    
    
    
    383,903
    
    
    
    17.4Total loans
    
    
    6,021,299
    
    
    
    101.3
    
    
    
    4,744,726
    
    
    
    101.3
    
    
    
    3,801,471
    
    
    
    101.3
    
    
    
    2,876,768
    
    
    
    101.4
    
    
    
    2,232,588
    
    
    
    101.3Allowance for loan losses
    
    
    (80,066
    )
    
    
    (1.3
    )
    
    
    (61,608
    )
    
    
    (1.3
    )
    
    
    (47,114
    )
    
    
    (1.3
    )
    
    
    (38,364
    )
    
    
    (1.4
    )
    
    
    (28,928
    )
    
    
    (1.3
    )Loan - net
    
    $
    5,941,233
    
    
    
    100.0
    %
    
    $
    4,683,118
    
    
    
    100.0
    %
    
    $
    3,754,357
    
    
    
    100.00
    %
    
    $
    2,838,404
    
    
    
    100.00
    %
    
    $
    2,203,660
    
    
    
    100.00
    %
   (1)
    
    Includes $831.1 million, $641.1 million, $427.7 million and $255.8 million of Westernbank Business Credit division outstanding
loans at December 31, 2004, 2003, 2002 and 2001, respectively. Westernbank Business Credit began operations in 2001.(2)
    
    Includes $144.0 million, $155.6 million and $117.4 million of Expresso of Westernbank division outstanding loans at
December 31, 2004, 2003 and 2002, respectively. Expresso of Westernbank began operations on July 10, 2002. Residential real estate mortgage loans are mainly comprised of loans secured by first
mortgages on one-to-four family residential properties. At December 31, 2004, residential mortgage
loans included $11.6 million of mortgages insured or guaranteed by government agencies of the
United States or Puerto Rico. Westernbank originated $1.70 billion of commercial real estate loans, including asset-based
and construction loans, during the year ended December 31, 2004. At December 31, 2004, commercial
real estate loans totaled $3.15 billion. In general, commercial real estate loans are considered by
management to be of somewhat greater risk of uncollectibility than residential lending because such
loans are typically larger in size and more risk is concentrated in a single borrower. In addition,
the borrowers ability to repay a commercial loan or a construction loan depends, in the case of a
commercial loan, on the successful operation of the business or the property securing the loan and,
in the case of a construction loan, on the successful completion and sale or operation of the
project. Substantially all of the Companys borrowers and properties and other collateral securing
the commercial, real estate mortgage and consumer loans are located in Puerto Rico. These loans may
be subject to a greater risk of default if the Puerto Rico economy suffers adverse economic,
political or business developments, or if natural disasters affect Puerto Rico. Foreign loans
amounted to $2.2 million at December 31, 2004. At December 31, 2004, the Company maintained its
status as a secured lender, with approximately 83% of its loans collateralized by real estate. 4




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The portfolio of Consumer and Other loans at December 31, 2004, consisted of consumer loans of
$866.9 million, of which $585.2 million are secured by real estate, $252.1 million are unsecured
consumer loans (consisting of $132.0 million of the Expresso of Westernbank division loans
portfolio, credit card loans of $53.3 million and other consumer loans of $66.8 million) and loans
secured by deposits in Westernbank totaling $29.6 million. During 2004, Westernbank securitized $7.5 million and $3.3 million of residential mortgage
loans into Government National Mortgage Association and Fannie Mae participation certificates,
respectively, and sold loans amounting to $22.0 million to Fannie Mae. Westernbank continues to
service outstanding loans which are securitized and those individually sold to Fannie Mae. The following table summarizes the contractual maturities of Westernbanks total loans for the
periods indicated at December 31, 2004. Contractual maturities do not necessarily reflect the
actual term of a loan, including prepayments. MaturitiesAfter one year to five years
    
    
    After five years(In thousands)Balance outstanding at
    
    
    One year or
    
    
    Fixed
    
    
    Variable
    
    
    Fixed
    
    
    VariableDecember 31, 2004
    
    
    less
    
    
    interest
    
    
    interest
    
    
    interest
    
    
    interestResidential real estate:Mortgage
    
    $
    902,937
    
    
    $
    2,303
    
    
    $
    16,636
    
    
    $
    
    
    
    $
    218,050
    
    
    $
    665,948
    (1)Construction
    
    
    328,145
    
    
    
    153,171
    
    
    
    
    
    
    
    174,974
    
    
    
    
    
    
    
    Commercial, industrial
and agricultural:Real estate
    
    
    3,154,679
    
    
    
    1,023,502
    
    
    
    311,937
    
    
    
    273,272
    
    
    
    77,233
    
    
    
    1,468,735Business and others
    
    
    768,604
    
    
    
    547,083
    
    
    
    28,184
    
    
    
    43,015
    
    
    
    6,447
    
    
    
    143,875Consumer and others
    
    
    866,934
    
    
    
    114,429
    
    
    
    201,569
    
    
    
    
    
    
    
    550,936
    
    
    
    Total
    
    $
    6,021,299
    
    
    $
    1,840,488
    
    
    $
    558,326
    
    
    $
    491,261
    
    
    $
    852,666
    
    
    $
    2,278,558
   (1)
    
    Includes $600.8 million of purchased fixed
rate loans in which seller guarantees the Company a return at a floating rate of interest (three month LIBOR plus a spread). See
Note 19 - On-Balance Sheet Derivative Instruments and Hedging
Activities (page 109) - to the audited consolidated financial
statements, included in Part II, Item 8, and FINANCIAL
INSTRUMENTS - Fair Value Hedging Instruments section on page 18. ORIGINATION, PURCHASE AND SALE OF LOANS. Westernbanks loan originations come from a
number of sources. The primary sources for residential loan originations are depositors and walk-in
customers. Commercial loan originations come from existing customers as well as through direct
solicitation and referrals. Westernbank originates loans in accordance with written, non-discriminatory underwriting
standards and loan origination procedures prescribed in the Board of Directors approved loan
policies. Detailed loan applications are obtained to determine the borrowers repayment ability.
Applications are verified through the use of credit reports, financial statements and other
confirmation procedures. Property valuations by independent appraisers approved by the Board of
Directors are required for mortgage and all real estate loans. Westernbanks Senior Credit Committee approval is required for all loans in excess of $5.0
million ($15.0 million in the case of Westernbank Business Credit Division). The Senior Credit
Committee also reviews and ratifies all loans from $1.0 million, to $5.0 million approved by
Westernbanks regional credit committees. The Senior Credit Committee is composed by a majority of
the members of the Companys Board of Directors and senior lending officers. All loans in excess of
$5.0 million ($15.0 million for Westernbank Business Credit Division) approved by the Senior Credit
Committee are also reviewed and ratified by the Board of Directors. All loans in excess of $50.0
million require the approval of the Board of Directors. It is Westernbanks policy to require borrowers to provide title insurance policies certifying
or ensuring that Westernbank has a valid first lien on the mortgaged real estate. Borrowers must
also obtain hazard insurance policies prior to closing and, when required by the Department of
Housing and Urban Development, flood insurance policies. Borrowers may be required to advance funds
on a
monthly basis together with each payment of principal and interest to a mortgage escrow
account from which Westernbank makes disbursements for items such as real estate taxes, hazard
insurance premiums and private mortgage insurance premiums as they fall due. 5




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Westernbank originates most of its residential real estate loans as conforming loans, eligible
for sale in the secondary market. The loan-to-value ratio at the time of origination on residential
mortgages is generally 75%, except that Westernbank may lend up to 90% of the lower of the purchase
price or appraised value of residential properties if private mortgage insurance is obtained by the
borrower for amounts in excess of 80%. Westernbank originates fixed and adjustable rate residential mortgage loans secured by a first
mortgage on the borrowers real property, payable in monthly installments for terms ranging from
ten to forty-five years. Adjustable rates are indexed to specified prime or LIBOR rate. All 30 year
conforming mortgages are originated with the intent to sell. In addition to its residential loan
originations, Westernbank also purchases residential first mortgage loans from other mortgage
originators in Puerto Rico. During the year ended December 31, 2004, Westernbank purchased $250.1
million of such loans. Westernbank originates primarily variable and adjustable rate commercial business and real
estate loans. Westernbank also makes real estate construction loans subject to firm permanent
financing commitments. As of December 31, 2004, Westernbanks commercial loan portfolio had a total
delinquency ratio, including the categories of 60 days and over, of 0.55% (less than 1%), compared
to 0.84% (less than 1%) at December 31, 2003. For further
explanation on the delinquency ratio of the Companys commercial loan portfolio refer to section NON-PERFORMING LOANS
AND FORECLOSED REAL ESTATE HELD FOR SALE on next page. Westernbank offers different types of consumer loans in order to provide a full range of
financial services to its customers. Within the different types of consumer loans offered by
Westernbank, there are various types of secured and unsecured consumer loans with varying
amortization schedules. In addition, Westernbank makes fixed-rate residential second mortgage
consumer loans. In July 2002, Westernbank launched a new banking division focused on offering
consumer loans through 19 full-service branches, called Expresso of Westernbank, denoting the
branches emphasis on small, unsecured consumer loans up to $15,000 and collateralized consumer
loans up to $150,000. Westernbank offers the service of VISA  and Master Card  credit cards. At
December 31, 2004, there were approximately 24,324 outstanding accounts, with an aggregate
outstanding balance of $53.3 million and unused credit card lines available of $95.4 million. In connection with all consumer loans originated, Westernbanks underwriting standards include
a determination of the applicants payment history on other debts and an assessment of the ability
to meet existing obligations and payments on the proposed loan. As of December 31, 2004,
Westernbanks consumer loan portfolio, including the Expresso of Westernbank loan portfolio, had a
total delinquency ratio, including the categories of 60 days and over, of 1.03%, compared to 0.89%
at December 31, 2003. The increase in the delinquency ratio from 2003 to 2004 was mainly due to an
increased number of delinquencies in regular consumer loans past due over 90 days which are
collateralized by real estate properties. Westernbank has 83% of its loan portfolio as of December 31, 2004, secured by real estate. Our
combined delinquency on all portfolios for the categories of 60 days and over continues to be below
our benchmark of 1% for both periods, being 0.57% at December 31, 2004, and 0.74% at December 31,
2003. INCOME FROM LENDING ACTIVITIES. Westernbank realizes interest income and fee income from its
lending activities. For the most part, interest rates charged by Westernbank on loans depend upon
the general interest rate environment, the demand for loans and the availability of funds.
Westernbank also receives fees for originating and committing to originate or purchase loans and
also charges service fees for the assumption of loans, late payments, inspection of properties,
appraisals and other miscellaneous services. Loan origination and commitment fees vary with the volume and type of loans and commitments
made and sold and with competitive conditions in the residential and commercial mortgage markets.
Loan origination fees net of related direct loan origination costs are deferred and amortized over
the life of the related loans as a yield adjustment using the interest method. Commitment fees are
also deferred and amortized over the life of the related loans as a yield adjustment. If the
commitment expires unexercised, the fee is taken into income. Westernbank recognizes as separate assets the rights to service mortgage loans for others,
regardless of how those servicing rights are acquired and assesses the capitalized mortgage
servicing rights for impairment based on the fair value of those rights. Servicing assets are
evaluated for impairment based upon the fair value of the rights as compared to amortized cost.
Fair value is determined
using prices for similar assets with similar characteristics. Impairment is recognized
through a valuation allowance for an individual 6




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servicing right, to the extent that fair value is
less than the carrying amount for that right. The total cost of mortgage loans to be sold with
servicing rights retained is allocated to the mortgage servicing rights and the loans (without the
mortgage servicing rights), based on their relative fair values. Mortgage servicing rights are
amortized in proportion to, and over the period of, estimated servicing income. NON-PERFORMING LOANS AND FORECLOSED REAL ESTATE. When a borrower fails to make a required
payment on a loan, Westernbank attempts to cure the deficiency by contacting the borrower. In most
cases, deficiencies are cured promptly. If the delinquency exceeds 90 days and is not cured through
normal collection procedures, Westernbank will generally institute measures to remedy the default.
If a foreclosure action is instituted and the loan is not cured, paid in full or refinanced, the
property is sold at a judicial sale at which Westernbank may acquire the property. In the event
that the property is sold at a price insufficient to cover the balance of the loan, the debtor
remains liable for the deficiency. Thereafter, if Westernbank acquires the property, such acquired
property is appraised and included in the foreclosed real estate held for sale account at the fair
value at the date of acquisition. Then, this asset is carried at the lower of fair value less
estimated costs to sell or cost until the property is sold. The accrual of interest on loans is discontinued when there is a clear indication the
borrowers cash flow may not be sufficient to meet payments as they become due, but in no event is
it recognized after 90 days in arrears on payments of principal or interest. When a loan is placed
on nonaccrual status, all previously accrued and unpaid interest is charged against income and the
loan is accounted for on the cash method thereafter, until qualifying for return to accrual status.
Generally, a loan is returned to accrual status when all delinquent interest and principal payments
become current in accordance with the terms of the loan agreement or when the loan is both well
secured and in the process of collection and collectibility is no longer doubtful. The following table sets forth information regarding non-performing loans and foreclosed real
estate held for sale by Westernbank at the dates indicated: December 31,2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000(Dollars in thousands)Commercial, industrial and agricultural loans
    
    $
    25,417
    
    
    $
    24,142
    
    
    $
    13,567
    
    
    $
    7,947
    
    
    $
    6,140Consumer loans
    
    
    7,122
    
    
    
    4,845
    
    
    
    3,812
    
    
    
    3,431
    
    
    
    1,733Residential real estate mortgage and construction loans
    
    
    1,730
    
    
    
    2,259
    
    
    
    2,026
    
    
    
    2,735
    
    
    
    1,817Total non-performing loans
    
    
    34,269
    
    
    
    31,246
    
    
    
    19,405
    
    
    
    14,113
    
    
    
    9,690Foreclosed real estate held for sale
    
    
    3,811
    
    
    
    4,082
    
    
    
    3,679
    
    
    
    3,013
    
    
    
    2,454Total non-performing loans and foreclosed
real estate held for sale
    
    $
    38,080
    
    
    $
    35,328
    
    
    $
    23,084
    
    
    $
    17,126
    
    
    $
    12,144Interest that would have been recorded if the
loans had not been classified as
non-performing
    
    $
    3,557
    
    
    $
    2,500
    
    
    $
    1,102
    
    
    $
    1,123
    
    
    $
    979Interest recorded on non-performing loans
    
    $
    243
    
    
    $
    583
    
    
    $
    775
    
    
    $
    1,716
    
    
    $
    780Total non-performing loans as a percentage
of total loans at end of period
    
    
    0.57
    %
    
    
    0.66
    %
    
    
    0.51
    %
    
    
    0.49
    %
    
    
    0.43
    %Total non-performing loans and foreclosed real estate
held for sale as a percentage of total assets at end of period
    
    
    0.27
    %
    
    
    0.31
    %
    
    
    0.28
    %
    
    
    0.29
    %
    
    
    0.28
    %
 The increase in non-performing loans from year end 2003, to year end 2004 was mostly
attributed to one commercial loan with a principal balance of $1.5 million, collateralized by real
estate. At December 31, 2004, this loan did not require a valuation allowance. At December 31,
2004, the allowance for possible loan losses was 233.64% of total non-performing loans (reserve
coverage). The increase in non-performing loans from year end 2002, to year end 2003 was mostly
attributed to eight commercial loans with principal balances of $1.6 million, $1.5 million, $1.1
million, $1.0 million, and four other loans with outstanding principal balances below $1.0 million,
all of which are collateralized by real estate. At December 31, 2003, two of these loans with
outstanding balances of $1.1 million and $695,000, had a specific valuation allowance of $277,000
and $201,000, respectively. At December 31, 2003, the allowance for possible loan losses was
197.17% of total non-performing loans (reserve coverage). 7




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ALLOWANCE FOR LOAN LOSSES. Westernbank maintains an allowance for loan losses to absorb
probable losses inherent in the loan portfolio. The allowance is based on ongoing, quarterly
assessments of the probable estimated losses inherent in the loan portfolio, based on evaluations
of the collectibility and historical loss experience of loans. The Company follows a systematic
methodology to establish and evaluate the adequacy of the allowance for loan losses. This
methodology consists of several key elements, which include: The Formula Allowance. The formula allowance is calculated by applying loss factors to
outstanding loans not otherwise covered by specific allowances. Loss factors are based on
historical loss experience and may be adjusted for significant factors that, in managements
judgment, reflect the impact of any current condition on loss recognition. Factors that management
considers in the analysis include the effect of the national and local economies, trends in the
nature and volume of loans (delinquencies, charge-offs, non-accrual and problem loans), asset
quality trends, changes in the internal lending policies and credit standards, collection
practices, and examination results from bank regulatory agencies and the Companys internal credit
examiners. Loss factors are described as follows:  
    Loan loss factors for commercial loans, including construction and land acquisition loans,
are based on historical loss trends for three to five years, as adjusted for managements
expected increase in the loss factors given the significant increase in such loan portfolios
over the last few years.
    Pooled loan loss factors are also based on historical loss trends for one to three years.
Pooled loans are loans that are homogeneous in nature, such as consumer installment,
residential mortgage loans and credit cards. Specific Allowances for Identified Problem Loans and Portfolio Segments. Specific allowances
are established and maintained where management has identified significant adverse conditions or
circumstances related to a credit or portfolio segment that management believes indicate the
probability that a loss has been incurred in excess of the amount determined by the application of
the formula allowance. Larger commercial and construction loans that exhibit probable or observed
credit weaknesses are subject to individual review. 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 Westernbank. In addition, the specific allowance incorporates the results of measuring impaired loans as
provided in SFAS No. 114, Accounting by Creditors for Impairment of a Loan, as amended. This
accounting standard prescribes the measurement methods, income recognition and disclosures
concerning impaired loans. The Unallocated Allowance. An unallocated allowance is established recognizing the estimation
risk associated with the formula and specific allowances. It is based upon managements evaluation
of various conditions, the effects of which are not directly measured in determining the formula
and specific allowances. These conditions include then-existing general economic and business
conditions affecting our key lending areas; credit quality trends, including trends in
nonperforming loans expected to result from existing conditions, collateral values, loan volumes
and concentrations, seasoning of the loan portfolio, recent loss experience in particular segments
of the portfolio, regulatory examination results, and findings of our internal credit examiners.
The evaluation of the inherent loss regarding these conditions involves a higher degree of
uncertainty because they are not identified with specific problem credits or portfolio segments. Management assesses these conditions quarterly. If any of these conditions is evidenced by a
specifically identifiable problem credit or portfolio segment as of the evaluation date,
managements estimate of the effect of this condition may be reflected as a specific allowance
applicable to this credit or portfolio segment. Where any of these conditions is not evidenced by a
specifically identifiable problem credit or portfolio segment as of the evaluation date,
managements evaluation of the probable loss concerning this condition is reflected in the
unallocated allowance. The allowance for loan losses is based upon estimates of probable losses inherent in the loan
portfolio. The amount actually observed for these losses can vary significantly from the estimated
amounts. Our methodology includes several features that are intended to reduce the differences
between estimated and actual losses. Historical loss factors for commercial and consumer loans may
be adjusted for significant factors that, in managements judgment, reflect the impact of any
current condition on loss recognition. Factors which management considers in the analysis include
the effect of the national and local economies, trends in the nature and volume of loans
(delinquencies, charge-offs, non-accrual and problem loans), changes in the internal lending
policies and credit standards, collection practices, and examination results from bank regulatory
agencies and the Banks internal credit examiners. Loan loss factors are adjusted quarterly based
upon the level of net charge-offs expected by management in the next twelve months, after taking
into account historical loss ratios adjusted for current trends. By assessing the probable
estimated losses inherent in the loan portfolio on a quarterly basis, we are able to adjust
specific and inherent loss estimates based upon any more recent information that has become
available. 8




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##### Table of Contents



At December 31, 2004, the allowance for loan losses was $80.1 million, consisting of $71.2
million general allowance (including the unallocated allowance) and $8.9 million of specific
allowances. As of December 31, 2004, the allowance for loan losses equals 1.33% of total loans and
233.64% of total non-performing loans, compared with an allowance for loan losses at December 31,
2003 of $61.6 million, or 1.30% of total loans, and 197.17% of total non-performing loans. As of December 31, 2004, there have been no significant changes in estimation methods or
assumptions that affected our methodology for assessing the appropriateness of the allowance for
loan losses. The table below presents a reconciliation of changes in the allowance for loan losses for the
periods indicated: YEARS ENDED DECEMBER 31,2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000(Dollars in thousands)Balance, beginning of year
    
    $
    61,608
    
    
    $
    47,114
    
    
    $
    38,364
    
    
    $
    28,928
    
    
    $
    23,978Loans charged-off:Consumer loans (1)
    
    
    (16,473
    )
    
    
    (12,203
    )
    
    
    (4,576
    )
    
    
    (3,840
    )
    
    
    (4,760
    )Commercial, industrial and agricultural loans
    
    
    (5,433
    )
    
    
    (2,479
    )
    
    
    (3,389
    )(2)
    
    
    (2,970
    )
    
    
    (372
    )Real estate-mortgage and
construction loans
    
    
    (297
    )
    
    
    (184
    )
    
    
    
    
    
    
    (228
    )
    
    
    (231
    )Total loans charged-off
    
    
    (22,203
    )
    
    
    (14,866
    )
    
    
    (7,965
    )
    
    
    (7,038
    )
    
    
    (5,363
    )Recoveries of loans previously
charged-off:Consumer loans (3)
    
    
    1,920
    
    
    
    799
    
    
    
    858
    
    
    
    996
    
    
    
    795Commercial, industrial and agricultural loans
    
    
    1,844
    
    
    
    1,141
    
    
    
    584
    
    
    
    133
    
    
    
    594Real estate-mortgage and
construction loans
    
    
    206
    
    
    
    372
    
    
    
    190
    
    
    
    175
    
    
    
    224Total recoveries of loans previously charged-off
    
    
    3,970
    
    
    
    2,312
    
    
    
    1,632
    
    
    
    1,304
    
    
    
    1,613Net loans charged-off
    
    
    (18,233
    )
    
    
    (12,554
    )
    
    
    (6,333
    )
    
    
    (5,734
    )
    
    
    (3,750
    )Provision for loan losses
    
    
    36,691
    
    
    
    27,048
    
    
    
    15,083
    
    
    
    12,278
    
    
    
    8,700Allowance acquired on loans purchased
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,892
    
    
    
    Balance, end of period
    
    $
    80,066
    
    
    $
    61,608
    
    
    $
    47,114
    
    
    $
    38,364
    
    
    $
    28,928Ratios:Allowance for loan losses to total loans at end of period
    
    
    1.33
    %
    
    
    1.30
    %
    
    
    1.24
    %
    
    
    1.33
    %
    
    
    1.29
    %Provision for loan losses to net loans
charged-off
    
    
    201.23
    %
    
    
    215.45
    %
    
    
    238.17
    %
    
    
    214.13
    %
    
    
    232.00
    %Recoveries of loans to loans charged-off in
previous period
    
    
    26.71
    %
    
    
    29.03
    %
    
    
    23.19
    %
    
    
    24.31
    %
    
    
    21.92
    %Net loans charged-off to average total loans (4)
    
    
    0.34
    %
    
    
    0.29
    %
    
    
    0.19
    %
    
    
    0.23
    %
    
    
    0.19
    %Allowance for loans losses to
non-performing loans
    
    
    233.64
    %
    
    
    197.17
    %
    
    
    242.80
    %
    
    
    271.83
    %
    
    
    298.53
    %
   (1)
    
    Includes $12.4 million, $7.9 million and $62,000 of Expresso of Westernbank charge-offs, for
the years ended December 31, 2004, 2003 and 2002, respectively. Expresso of Westernbank
began operations on July 10, 2002.(2)
    
    Includes $505,000 in 2002 of Westernbank Business Credit division, consisting of one loan
originally acquired in the purchased loan portfolio from Congress Credit Corporation,
a subsidiary of First Union National Bank N.A. on June 15, 2001. This loan was fully
reserved at the acquisition date.(3)
    
    Includes $1.0 million and $17,000 of Expresso of Westernbank recoveries, for the years ended
December 31, 2004 and 2003, respectively.(4)
    
    Average loans were computed using beginning and period-end balances. 9




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The following table presents the allocation of the allowance for credit losses, the loan
portfolio composition percentage and the allowance coverage ratio in each loan category to total
loans, as set forth in the Loans table on page 4, at the end of each year. AT DECEMBER 31,2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000(Dollars in thousands)Allowance for credit losses:Commercial, industrial and
agricultural loans (1)
    
    $
    58,208
    
    
    $
    41,400
    
    
    $
    31,671
    
    
    $
    24,397
    
    
    $
    16,273Consumer loans (2)
    
    
    19,425
    
    
    
    17,472
    
    
    
    12,004
    
    
    
    8,203
    
    
    
    7,194Residential real estate mortgage
and construction loans
    
    
    407
    
    
    
    415
    
    
    
    443
    
    
    
    494
    
    
    
    526Unallocated
    
    
    2,026
    
    
    
    2,321
    
    
    
    2,996
    
    
    
    5,270
    
    
    
    4,935Total allowance for loan losses
    
    $
    80,066
    
    
    $
    61,608
    
    
    $
    47,114
    
    
    $
    38,364
    
    
    $
    28,928Loan portfolio composition percentages:Commercial, industrial and
agricultural loans
    
    
    65.15
    %
    
    
    58.72
    %
    
    
    53.45
    %
    
    
    51.95
    %
    
    
    44.19
    %Consumer loans
    
    
    14.40
    %
    
    
    18.17
    %
    
    
    19.56
    %
    
    
    14.49
    %
    
    
    17.20
    %Residential real estate mortgage
and construction loans
    
    
    20.45
    %
    
    
    23.11
    %
    
    
    26.99
    %
    
    
    33.56
    %
    
    
    38.61
    %Total loans
    
    
    100.00
    %
    
    
    100.00
    %
    
    
    100.00
    %
    
    
    100.00
    %
    
    
    100.00
    %Allowance coverage ratio at
end of year:Applicable to:Commercial, industrial and
agricultural loans
    
    
    1.48
    %
    
    
    1.49
    %
    
    
    1.56
    %
    
    
    1.63
    %
    
    
    1.65
    %Consumer loans
    
    
    2.24
    %
    
    
    2.03
    %
    
    
    1.61
    %
    
    
    1.97
    %
    
    
    1.87
    %Residential real estate mortgage
and construction loans
    
    
    0.03
    %
    
    
    0.04
    %
    
    
    0.04
    %
    
    
    0.05
    %
    
    
    0.06
    %Unallocated (as a percentage
of total loans)
    
    
    0.03
    %
    
    
    0.05
    %
    
    
    0.08
    %
    
    
    0.18
    %
    
    
    0.22
    %Total loans
    
    
    1.33
    %
    
    
    1.30
    %
    
    
    1.24
    %
    
    
    1.33
    %
    
    
    1.29
    %
   (1)
    
    Includes an allowance of $6.0 million, $6.6 million, $4.5 million and $3.1 million for Westernbank Business Credit loans at December 31, 2004,
2003, 2002 and 2001, respectively. Westernbank Business Credit began operations in 2001.(2)
    
    Includes an allowance of $13.8 million, $10.0 million and $1.5 million for Expresso of Westernbank loans portfolio at December 31, 2004,
2003 and 2002, respectively. Expresso of Westernbank began operations on July 10, 2002. Loans are classified as impaired or not impaired in accordance with SFAS No. 114. A loan is
impaired when, based on current information and events, it is probable that Westernbank will be
unable to collect the scheduled payments of principal or interest when due, according to the
contractual terms of the agreement. Westernbank measures the impairment of a loan 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. Significant loans (those exceeding $500,000 in 2004 and 2003, and $250,000 in 2000 to
2002) are individually evaluated for impairment. Large groups of small balance, homogeneous loans
are collectively evaluated for impairment; loans that are recorded at fair value or at the lower of
cost or market are not evaluated for impairment. The portfolios of mortgage and consumer loans are
considered homogeneous and are evaluated collectively for impairment. 10




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Impaired loans for which the discounted cash flows, collateral value or market price exceeds
its carrying value do not require an allowance. The allowance for impaired loans is part of the
Companys overall allowance for loan losses. The following table sets forth information regarding the investment in impaired loans: 2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000(In thousands)Investment in impaired loans:Covered by a valuation allowance
    
    $
    29,975
    
    
    $
    28,217
    
    
    $
    26,074
    
    
    $
    21,996
    
    
    $

    8,040Do not require a valuation allowance
    
    
    24,200
    
    
    
    22,088
    
    
    
    24,515
    
    
    
    20,482
    
    
    
    4,834Total
    
    $
    54,175
    
    
    $
    50,305
    
    
    $
    50,589
    
    
    $
    42,478
    
    
    $
    12,874Valuation allowance for impaired loans
    
    $
    8,412
    
    
    $
    4,646
    
    
    $
    4,752
    
    
    $
    4,181
    
    
    $
    1,157Average investment in impaired loans
    
    $
    46,509
    
    
    $
    46,676
    
    
    $
    46,147
    
    
    $
    20,293
    
    
    $
    11,873Interest collected and recognized as
income on impaired loans
    
    $
    2,460
    
    
    $
    2,452
    
    
    $
    4,041
    
    
    $
    1,716
    
    
    $
    780
 At December 31, 2004, Westernbanks investment in impaired loans increased by $3.9
million or 7.14%, from $50.3 million as of December 31, 2003. The increase was mainly attributed to
a newly classified loan with an aggregate outstanding principal balance of $10.9 million for which
an allowance of $500,000 was established at December 31, 2004. At December 31, 2003, Westernbanks investment in impaired loans remained relatively stable
when compared to year 2002, although the loans comprising the balance may have changed. At December
31, 2002, Westernbanks investment in impaired loans increased $8.1 million or 19.09%, from $42.5
million as of December 31, 2001, to $50.6 million as of December 31, 2002. This increase was
principally attributed to four newly classified loans with an aggregate outstanding principal
balance of approximately $13.0 million as of December 31, 2002. All loans are collateralized by
real estate and required a combined valuation allowance of $823,000. INVESTMENT ACTIVITIES The Companys investments are managed by the Investment Department. Purchases and sales are
required to be reported monthly to the Investment Committee (composed of members of the Board of
Directors, as well as the President and Chief Executive Officer and the Chief Financial Officer). The Investment Department is authorized to purchase and sell federal funds, interest bearing
deposits in banks, bankers acceptances of commercial banks insured by the FDIC, mortgage and
asset-backed securities, Puerto Rico and U.S. Government and agency obligations, municipal
securities rated A or better by any of the nationally recognized rating agencies, commercial paper
and corporate notes rated P-1 by Moodys Investors Service, Inc or A-1 by Standard and Poors, a
Division of the McGraw-Hill Companies, Inc. In addition, the Investment Department is responsible
for the pricing and sale of deposits and repurchase agreements. At the date of purchase, the Company classifies debt and equity securities into one of three
categories: held to maturity; trading; or available for sale. At each reporting date, the
appropriateness of the classification is reassessed. Investments in debt securities for which
management has the intent and ability to hold to maturity are classified as held to maturity and
stated at cost increased by accretion of discounts and reduced by amortization of premiums, both
computed by the interest method. Securities that are bought and held principally for the purpose of
selling them in the near term are classified as trading and measured at fair value in the financial
statements with unrealized gains and losses included in earnings. Securities not classified as
either held to maturity or trading are classified as available for sale and measured at fair value
in the financial statements with unrealized gains and losses reported, net of income tax, as a
component of accumulated other comprehensive income (loss) until realized. Gains and losses on
sales of securities are determined using the specific-identification method. The Companys investment strategy is affected by both the rates and terms available on
competing investments and tax and other legal considerations. 11




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Federal funds sold and resell agreements amounted to $341.9 million and $675.4 million,
respectively, at December 31, 2004. Federal funds sold mature the next business day, while resell
agreements mature as follows: $125.4 million the next business day, $200.0 million in 2009, and
$350.0 million in 2010. The Company monitors the fair value of the underlying securities as
compared to the related receivable, including accrued interest, and requests additional collateral
when the fair value of the underlying collateral falls below the collateral requirement. At
December 31, 2004, the fair value of the underlying collateral amounted to $692.1 million. The following table presents the carrying value of investments as of year end for each of the
years indicated: 2004
    
    
    2003
    
    
    2002(In thousands)Held to maturity :US Government and agencies obligations
    
    $
    6,004,849
    
    
    $
    4,463,493
    
    
    $
    2,671,344Puerto Rico Government and agencies obligations
    
    
    34,822
    
    
    
    34,500
    
    
    
    19,695Commercial paper
    
    
    25,000
    
    
    
    174,976
    
    
    
    74,997Corporate notes
    
    
    26,418
    
    
    
    51,409
    
    
    
    66,697Mortgage and asset-backed securities
    
    
    830,290
    
    
    
    999,332
    
    
    
    668,324Total
    
    
    6,921,379
    
    
    
    5,723,710
    
    
    
    3,501,057Available for sale:Corporate notes
    
    
    
    
    
    
    
    
    
    
    10,381Collateralized mortgage obligations (CMOs)
    
    
    7,881
    
    
    
    49,910
    
    
    
    145,276Equity
securities - preferred stock
    
    
    
    
    
    
    5,170
    
    
    
    5,230Total
    
    
    7,881
    
    
    
    55,080
    
    
    
    160,887Total investments
    
    $
    6,929,260
    
    
    $
    5,778,790
    
    
    $
    3,661,944
 Mortgage and asset-backed securities at December 31, 2004, 2003 and 2002, consists of: 2004
    
    
    2003
    
    
    2002(In thousands)Available for sale:CMOs issued or guaranteed by the Federal National
Mortgage Association (FNMA)
    
    $
    6,116
    
    
    $
    29,948
    
    
    $
    73,742CMOs issued or guaranteed by the Federal Home
Loan Mortgage Corporation (FHLMC)
    
    
    1,765
    
    
    
    19,962
    
    
    
    71,534Total available for sale
    
    
    7,881
    
    
    
    49,910
    
    
    
    145,276Held to maturity:Government National Mortgage Association (GNMA) certificates
    
    
    9,881
    
    
    
    9,753
    
    
    
    13,657FHLMC certificates
    
    
    5,663
    
    
    
    7,297
    
    
    
    10,435FNMA certificates
    
    
    3,642
    
    
    
    4,542
    
    
    
    6,906CMOs certificates issued or guaranteed by FHLMC
    
    
    706,632
    
    
    
    885,408
    
    
    
    517,094CMOs certificates issued or guaranteed by FNMA
    
    
    104,441
    
    
    
    84,322
    
    
    
    4,703CMOs certificates issued or guaranteed by GNMA
    
    
    
    
    
    
    
    
    
    
    1,608CMOs other
    
    
    31
    
    
    
    168
    
    
    
    41,663Asset-backed securities
    
    
    
    
    
    
    7,842
    
    
    
    72,258Total held to maturity
    
    
    830,290
    
    
    
    999,332
    
    
    
    668,324Total mortgage and asset-backed securities
    
    $
    838,171
    
    
    $
    1,049,242
    
    
    $
    813,600
 At December 31, 2004, no investment of a single issuer (in aggregate balance) exceeded 10% of
the consolidated stockholders equity. 12




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##### Table of Contents



The carrying amount of investment securities at December 31, 2004, by contractual maturity
(excluding mortgage and asset-backed securities), are shown below: Carrying
    
    
    Weightedamount
    
    
    average yield(Dollars in thousands)US Government and agencies obligations:Due within one year
    
    $
    99,921
    
    
    
    2.20
    %Due after one year through five years
    
    
    4,108,423
    
    
    
    3.90Due after five years through ten years
    
    
    1,796,505
    
    
    
    4.12Due after ten years
    

    
    
    
    
    
    6,004,849
    
    
    
    3.94Puerto Rico Government and agencies obligations:Due within one year
    
    
    3,000
    
    
    
    4.75Due after one year through five years
    
    
    10,468
    
    
    
    5.25Due after five years through ten years
    
    
    20,004
    
    
    
    4.15Due after ten years
    
    
    1,350
    
    
    
    6.1534,822
    
    
    
    4.61Other:Due within one year
    
    
    25,000
    
    
    
    2.95Due after one year through five years
    
    
    4,993
    
    
    
    6.13Due after five years through ten years
    
    
    
    
    
    
    Due after ten years
    
    
    21,425
    
    
    
    8.3351,418
    
    
    
    5.50Total
    
    
    6,091,089
    
    
    
    3.95Mortgage and asset-backed securities
    
    
    838,171
    
    
    
    4.21Total
    
    $
    6,929,260
    
    
    
    3.99
    %
 The Companys investment portfolio at December 31, 2004 had an average contractual
maturity of 53 months, when compared to an average maturity of 63 months at December 31, 2003. The
Companys interest rate risk model takes into consideration the callable feature of certain
investment securities. Assuming that all call features are exercised, the Companys investment
portfolio as of December 31, 2004, had a remaining average contractual maturity of 10 months.
However, no assurance can be given that such levels will be maintained in future periods. The Company evaluates for impairment its investment securities on a quarterly basis or earlier
if other factors indicative of potential impairment exist. An impairment charge in the consolidated
statements of income is recognized when the decline in the fair value of the securities below their
cost basis is judged to be other-than-temporary. The Company considers various factors in
determining whether it should recognize an impairment charge, including, but not limited to the
length of time and extent to which the fair value has been below its cost basis, the expectations
for that securitys performance, the credit worthiness of the issuer, and the Companys intention
and ability to hold the security to maturity. The impairment analysis on the mortgage and asset-backed securities is done placing special
emphasis on the analysis of the trustee and collateral manager monthly reports, on sensitivity and
expected cash flow analyses made by major brokerage houses and on the credit worthiness of the
issuer. The Company also considers its intent and ability to hold these securities. If management
believes, based on the analysis, that the principal and interest obligations on any mortgage and
asset-backed security will not be received in a timely manner, the security is written down to fair
value based on available secondary market prices from broker/dealers. 13




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##### Table of Contents



The equity securities and corporate notes impairment analyses are performed and reviewed
quarterly based on the latest financial information and any supporting research report made by
major brokerage houses. These analyses are subjective and based, among other things, on relevant
financial data such as capitalization, cash flows, liquidity, systematic risk, and debt
outstanding. Management also considers the industry trends, the historical performance of the
stock, as well as the Companys intent to hold the security. If management believes there is a low
probability of achieving book value in a reasonable time frame, then an impairment is recorded by
writing down the security to fair value. In applying the foregoing analysis, management concluded that at March 31, 2003, its
investments in corporate bond and loan obligations (CBOs and CLOs) were other-than-temporarily
impaired. First, two tranches of a CBO with an amortized cost of $13.0 million were downgraded by
two different rating agencies on April 3 and April 15, 2003. Second, the available secondary market
prices for those two securities and the remaining portfolio of CBOs and CLOs with a carrying
value of $56.0 million continued to deteriorate. Management concluded, based on these facts and the
secondary market prices, that a $15.7 million other-than-temporary impairment write-down adjustment
was warranted. The same was recorded effective for the quarterly period ended March 31, 2003. As of
March 31, 2003, there were no defaults within the securities portfolio underlying the CBOs and
CLOs. In connection with the write-down, and in accordance with applicable accounting
pronouncements, management also reassessed its intent to hold to maturity and reclassified the
securities related to the CBOs that were downgraded as available for sale as of March 31, 2003. During the quarter ended June 30, 2003, the Company, based upon additional information
available from trustees, further ratings downgrading, a default on the scheduled interest payment
in one of the CBO tranches and further declines in quoted market prices for such investments,
reclassified the remaining portfolio of CBOs and CLOs to available for sale and subsequently on
June 6, 2003 sold its entire portfolio of CBOs and CLOs. The sale of the portfolio, with an
original total investment of $62.9 million and adjusted to a fair value of $45.4 million as of
March 31, 2003, was completed at an additional net loss of $7.0 million which was recorded during
the quarter ended June 30, 2003. The Companys investment portfolio as of December 31, 2004 and 2003, consisted principally of
U.S. Government and agencies obligations, Puerto Rico Government and agencies obligations, and
mortgage-backed securities issued or guaranteed by FHLMC, FNMA or GNMA. There were no investment
securities other than those referred to above in unrealized loss position as of December 31, 2004
and 2003. These unrealized losses related to interest rate changes. Investment securities with
prepayment provisions did not have significant unamortized premiums at December 31, 2004 and 2003.
As the Company has the ability and intent to hold debt securities until maturity, or for the
foreseeable future if classified as available for sale, no declines were deemed to be
other-than-temporary at December 31, 2004 and 2003. SOURCES OF FUNDS GENERAL. Deposits, repurchase agreements, Federal Home Loan Bank (FHLB) advances and lines
of credit are the primary sources of Westernbanks funds for use in lending and for other general
business purposes. In addition, Westernbank obtains funds in the form of loan repayments and income
from operations and the maturities and repayments of securities. Loan repayments are a relatively
stable source of funds, while net increases in deposits and repurchase agreements are significantly
influenced by general interest rates and money market conditions. Short-term borrowings from the
FHLB of New York are used to compensate for reductions in normal sources of funds such as savings
inflows at less than projected levels. DEPOSITS. Westernbank offers a diversified choice of deposit accounts. Savings deposits
increased from $692.2 million as of December 31, 2003, to $829.4 million as of December 31, 2004,
an increase of $137.2 million or 19.82%. Also, other deposits represented mainly by time deposits,
brokered deposits and Individual Retirement Account deposits (IRAs), increased from $4.69 billion
as of December 31, 2003, to $5.40 billion as of December 31, 2004, an increase of $708.5 million or
15.09%. Other deposits include brokered deposits amounting to $4.16 billion and $3.51 billion as
of December 31, 2004 and 2003, respectively. These accounts have historically been a stable source
of funds. At December 31, 2004, Westernbank had total deposits of $6.23 billion, of which $829.4 million
or 13.31% consisted of savings deposits, $303.7 million or 4.87% consisted of interest bearing
demand deposits, $249.4 million or 4.00% consisted of noninterest bearing deposits and $4.85
billion or 77.82% consisted of time deposits. Westernbank also offers negotiable order of
withdrawal (NOW) accounts, Super Now accounts, special checking accounts and commercial demand
accounts. 14




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##### Table of Contents



At December 31, 2004, the scheduled maturities of time deposit in amounts of $100,000 or more
are as follows: (In thousands)3 months or less
    
    $
    73,337over 3 months through 6 months
    
    
    27,324over 6 months through 12 months
    
    
    25,520over 12 months
    
    
    86,437Total
    
    $
    212,618
 The following table sets forth the average amount and the average rate paid on the following
deposit categories for the years ended December 31: 2004
    
    
    2003
    
    
    2002Average
    
    
    Average
    
    
    Average
    
    
    Average
    
    
    Average
    
    
    Averageamount
    
    
    rate
    
    
    amount
    
    
    rate
    
    
    amount
    
    
    rate(Dollars in thousands)Time deposits
    
    $
    4,617,785
    
    
    
    2.64
    %
    
    $
    3,775,263
    
    
    
    2.59
    %
    
    $
    2,889,649
    
    
    
    3.40
    %Savings deposits
    
    
    784,589
    
    
    
    2.14
    %
    
    
    605,854
    
    
    
    2.15
    %
    
    
    509,114
    
    
    
    2.46
    %Interest bearing demand
deposits
    
    
    200,190
    
    
    
    2.63
    %
    
    
    160,015
    
    
    
    2.55
    %
    
    
    124,127
    
    
    
    2.90
    %Noninterest bearing demand
deposits
    
    
    306,710
    
    
    
    
    
    
    
    227,358
    
    
    
    
    
    
    
    167,352
    
    
    
    $
    5,909,274
    
    
    
    2.43
    %
    
    $
    4,768,490
    
    
    
    2.41
    %
    
    $
    3,690,242
    
    
    
    3.10
    %
 BORROWINGS. The following table sets forth the borrowings of the Company at the dates
indicated: 2004
    
    
    2003
    
    
    2002(In thousands)Federal funds purchased and repurchase agreements(1)
    
    $
    6,683,527
    
    
    $
    5,046,045
    
    
    $
    3,097,341Advances from Federal Home Loan Bank (FHLB)
    
    
    211,000
    
    
    
    146,000
    
    
    
    120,000Mortgage note payable
    
    
    36,858
    
    
    
    37,234
    
    
    
    37,822$
    6,931,385
    
    
    $
    5,229,279
    
    
    $
    3,255,163
   (1)
    
    Federal funds purchased amounted to $75.0 million at December 31, 2004, at a
weighted average interest rate of 2.37%, and mature the next business day.
No such borrowings were outstanding at December 31, 2003 and 2002. Westernbank has made use of institutional federal funds purchased and repurchase agreements in
order to obtain funding, primarily through investment banks and brokerage firms. Repurchase
agreements are collateralized with investment securities while federal funds purchased do not
require collateral. Westernbank had $6.68 billion in federal funds purchased and repurchase
agreements outstanding at December 31, 2004, at a weighted average rate of 2.85%. Federal funds
purchased and repurchase agreements outstanding as of December 31, 2004, mature as follows: $4.33
billion within 30 days; $704.0 million in 2005; $47.5 million in 2006; $585.3 million in 2007; and
$1.02 billion thereafter. Westernbank also obtains advances from FHLB of New York. As of December 31, 2004, Westernbank
had $211.0 million in outstanding FHLB advances at a weighted average rate of 3.78%. Advances from
FHLB mature as follows: $39.0 million within 30 days; $70.0 million in 2006; $60.0 million in 2007;
and $42.0 million in 2010. 15




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##### Table of Contents



At December 31, 2004, with respect to repurchase agreements amounting to $1.56 billion, the
counterparties have the option to terminate the agreements at the first anniversary date and each
interest payment date thereafter. Also, with respect to repurchase agreements and advances from
FHLB amounting to $1.04 billion at December 31, 2004, at the first anniversary date and each
quarter thereafter, the FHLB has the option to convert them into replacement funding for the same
or a lesser principal amount based on any funding then offered by FHLB at the then current market
rates, unless the interest rate has been predetermined between FHLB and the Company. If the
Company chooses not to replace the FHLBs funding, it will repay the convertible advances and
 repurchase agreements, including any accrued interest, on such optional conversion date. At December 31, 2004, Westernbank World Plaza, Inc., a wholly-owned subsidiary of Westernbank
Puerto Rico, had outstanding $36.9 million of a mortgage note, at a fixed interest rate of 8.05%
per year up to September 11, 2009. Subsequent to September 11, 2009, the mortgage note will bear
interest on the then outstanding principal balance at a rate per year equal to the (1) greater of
13.05% or the Treasury Rate plus five percentage points or (2) 10.05%, depending on the fulfillment
of certain conditions on the repricing date. Westernbank World Plaza has a prepayment option on the
repricing date, without penalty. The mortgage note is collateralized by a 23-story office building,
including its related parking facility, located in Hato Rey, Puerto Rico. A summary of short-term borrowings, including federal funds purchased, repurchase agreements
and advances from Federal Home Loan Bank, and interest rates at and for the year ended December 31,
are indicated below: 2004
    
    
    2003
    
    
    2002(Dollars in thousands)Federal funds purchased:Balance at end of year
    
    $
    75,029
    
    
    $
    
    
    
    $
    Weighted-average interest rate at year end
    
    
    2.37
    %
    
    
    
    %
    
    
    
    %Monthly average outstanding balance
    
    $
    23,753
    
    
    $
    8,500
    
    
    $
    418Weighted-average interest rate for the year
    
    
    1.95
    %
    
    
    1.34
    %
    
    
    2.15
    %Maximum month-end balance
    
    $
    95,005
    
    
    $
    75,000
    
    
    $
    418Repurchase agreements:Balance at end of year
    
    $
    4,138,257
    
    
    $
    1,648,891
    
    
    $
    1,029,493Weighted-average interest rate at year end
    
    
    2.30
    %
    
    
    1.21
    %
    
    
    1.46
    %Monthly average outstanding balance
    
    $
    2,377,042
    
    
    $
    1,093,921
    
    
    $
    1,371,832Weighted-average interest rate for the year
    
    
    1.67
    %
    
    
    1.24
    %
    
    
    1.92
    %Maximum month-end balance
    
    $
    4,206,540
    
    
    $
    1,717,184
    
    
    $
    1,962,319Advances from FHLB:Balance at end of year
    
    $
    25,000
    
    
    $
    40,000
    
    
    $
    Weighted-average interest rate at year end
    
    
    2.41
    %
    
    
    1.20
    %
    
    
    
    %Monthly average outstanding balance
    
    $
    21,250
    
    
    $
    31,917
    
    
    $
    Weighted-average interest rate for the year
    
    
    1.65
    %
    
    
    1.33
    %
    
    
    
    %Maximum month-end balance
    
    $
    50,000
    
    
    $
    64,000
    
    
    $
    Total short-term borrowings:Balance at end of year
    
    $
    4,238,286
    
    
    $
    1,688,891
    
    
    $
    1,029,493Weighted-average interest rate at year end
    
    
    2.30
    %
    
    
    1.21
    %
    
    
    1.46
    %Monthly average outstanding balance
    
    $
    2,422,045
    
    
    $
    1,134,338
    
    
    $
    1,372,249Weighted-average interest rate for the year
    
    
    1.67
    %
    
    
    1.24
    %
    
    
    1.92
    %Maximum month-end balance
    
    $
    4,238,286
    
    
    $
    1,832,184
    
    
    $
    1,962,319
 FINANCIAL INSTRUMENTS DERIVATIVE FINANCIAL INSTRUMENTS. As part of the Companys asset/liability management, the
Company uses interest-rate contracts, which include interest-rate exchange agreements (swaps) and
option agreements, to hedge various exposures or to modify interest rate characteristics of various
statement of financial condition items. 16




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##### Table of Contents



The Company accounts for its derivatives under SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities, as amended. The Standard requires recognition of all
derivatives as either assets or liabilities in the statement of financial condition and requires
measurement of those instruments at fair value through adjustments to either accumulated other
comprehensive income (loss) or current earnings or both, as appropriate. On the date the Company
enters into a derivative contract, the Company designates the derivative instrument as either a
fair value hedge, cash flow hedge or as a derivative instrument not designated as a hedge. For a
fair value hedge, changes in the fair value of the derivative instrument and changes in the fair
value of the hedged asset or liability or of an unrecognized firm commitment attributable to the
hedged risk are recorded in current period net income. For a cash flow hedge, changes in the fair
value of the derivative instrument, to the extent that it is effective, are recorded in accumulated
other comprehensive income (loss) and subsequently reclassified to net income in the same period(s)
that the hedged transaction impacts net income. For derivative instruments not designated as a
hedge, changes in fair values are reported in current period net income. Prior to entering into a hedge transaction, the Company formally documents the relationship
between hedging instruments and hedged items, as well as the risk management objective and strategy
for undertaking various hedge transactions. This process includes linking all derivative
instruments that are designated as fair value or cash flow hedges to specific assets and
liabilities on the statement of financial condition or to specific forecasted transactions along
with a formal assessment at both inception of the hedge and on an ongoing basis as to the
effectiveness of the derivative instrument in offsetting changes in fair values or cash flows of
the hedged item. If it is determined that the derivative instrument is not highly effective as a
hedge, hedge accounting is discontinued and the adjustment to fair value of the derivative
instrument is recorded in net income. 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 should be bifurcated from the host contract and carried at fair value. In the case of interest-rate exchange agreements that qualify for hedging accounting
treatment, net interest income (expense) resulting from the differential between exchanging
floating and fixed-rate interest payment is recorded on a current basis as an adjustment to
interest income or expense on the corresponding hedged assets or liabilities. The Company maintains an overall interest rate risk management strategy that incorporates the
use of derivative instruments to minimize significant unplanned fluctuations in earnings and cash
flows caused by interest rate volatility. The Companys interest rate risk management strategy may
involve modifying the re-pricing characteristics of certain assets and liabilities so that changes
in interest rates do not adversely affect the net interest margin and cash flows. Derivative
instruments that the Company may use as part of its interest rate risk management strategy include
interest rate swaps and indexed options. These transactions involve both credit and market risk.
The notional amounts are amounts on which calculations, payments and the value of the derivative
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. Such
difference, which represents the fair value of the derivative, is reflected on the Companys
statements of financial condition as derivative assets and derivative liabilities. The Company is exposed to credit-related losses in the event of nonperformance by the
counterparties to these agreements. The Company controls the credit risk of its financial contracts
through credit approvals, limits and monitoring procedures, and does not expect any counterparties
to fail their obligations. The Company deals only with primary dealers. Derivative 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. The Company enters into interest-rate swap contracts in managing its interest rate exposure.
Interest-rate swap contracts generally involve the exchange of fixed and floating-rate interest
payment obligations without the exchange of the underlying principal amounts. Entering into
interest-rate swap contracts involves not only the risk of dealing with counterparties and their
ability to meet the terms of the contracts, but also the interest rate risk associated with
unmatched positions. Interest rate swaps are the most common type of derivative contracts that the
Company utilizes. Indexed options are contracts that the Company enters into in order to receive the average
appreciation of the month end value of the Standard & Poors 500 Composite Stock Index over a
specified period in exchange for the payment of a premium when the contract is initiated. The
credit risk inherent in the indexed options is the risk that the exchange party may default. 17




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##### Table of Contents



Fair Value Hedging Instruments The Company currently utilizes interest rate swaps to convert its fixed-rate certificates of
deposit or firm commitments to originate certificates of deposit (liabilities) to a variable rate.
By entering into the swap, the principal amount of the hedged item would remain unchanged but the
interest payment streams would change. These swaps mature between one to twenty years with a right
by the counterparty to call them after the first anniversary. The Company has an identical right to
call the certificates of deposit. Decisions to convert fixed-rate certificates of deposits or firm
commitments to originate certificates of deposit (liabilities) to variable rate are made primarily
by consideration of the asset/liability mix of the Company, the desired asset/liability sensitivity
and by interest rate levels. The Company purchases fixed rate residential mortgage loans for portfolio. Fixed rate loans
expose the Company to variability in their fair value due to changes in the level of interest
rates. Management believes that it is prudent to limit the variability in the fair value of a
portion of its fixed rate loan portfolio. It is the Companys objective to hedge the change in fair
value of fixed rate mortgage loans at coverage levels that are appropriate, given the anticipated
or existing interest rate levels and other market considerations, as well as the relationship of
changes in this asset to other assets of the Company. To meet this objective, the Company enters
into contracts to purchase fixed rate residential mortgage loans with a third party. The third
party agreed to provide the Company a return at a floating rate of interest (three month LIBOR plus
a spread) even though the contractual terms of the loans are fixed rate in nature. This provision
is effectively an interest rate swap (balance guarantee swap). Since the contracts meet with the
sale accounting provisions of SFAS No. 140, Accounting for Transfers and Servicing of Financial
Assets and Extinguishments of Liabilities, SFAS No. 133 and related interpretations, these
interest rate swaps are accounted for separately. Since the hedged item and the hedging
instrument have identical critical terms, no ineffectiveness is assumed and the fair value changes
in the interest rate swaps are recorded as changes in the value of both the interest rate swaps and
the mortgage loans. Derivative Instruments not Designated as Hedge The Company offers its customers certificates of deposit which contain an embedded derivative
tied to the performance of the Standard & Poors 500 Composite Stock Index that is bifurcated from
the host deposit and recognized in the consolidated statements of financial condition in accordance
with SFAS No. 133. At the end of five years, the depositor will receive a specified percent of the
average increase of the month-end value of the stock index. If such index decreases, the depositor
receives the principal without any interest. The Company uses option and interest rate swap
agreements with major broker dealer companies to manage its exposure to the stock market. Under the
option agreements, the Company will receive the average increase in the month-end value of the
index in exchange for the payment of a premium when the contract is initiated. Under the terms of
the swap agreements, the Company also will receive the average increase in the month-end value of
the index in exchange for a quarterly fixed interest cost. Since the embedded derivative instrument
on the certificates of deposit and the option and interest rate swap agreements do not qualify for
hedge accounting, these derivative instruments are marked to market through earnings. See
Note 19 (page 109) to the audited consolidated financial statements for a detail of derivative
transactions, included in Part II, Item 8. Off-balance sheet credit related financial instruments In the ordinary course of business,
Westernbank has entered into off-balance sheet credit related financial instruments consisting of
commitments to extend credit, commitments under credit-card arrangements, commercial letters of
credit and commitments to purchase mortgage loans. Such financial instruments are recorded in the
financial statements when they are funded or related fees are incurred or received. Westernbank
periodically evaluates the credit risks inherent in these commitments, and commercial letters of
credit, and establishes loss allowances for such risks if and when these are deemed necessary. For
the years ended December 31, 2004 and 2003, Westernbank did not record any loss allowances in
connection with risks involved in other off-balance sheet instruments. At December 31, 2004 and
2003, there were no additional off-balance sheet credit related financial instruments other than
those mentioned above. YIELDS EARNED AND RATES PAID The net income of the Company depends primarily upon the difference or spread between the
interest income received on its interest-earning assets and the interest paid on its
interest-bearing liabilities. Net interest income for the year ended December 31, 2004, was $299.5
million, an increase of $60.2 million or 25.17%, from $239.3 million in 2003. The increase in 2004
was the result of increases in interest income from loans and investment securities, mainly in
tax-exempt securities, which was partially offset by increases in interest expense on deposits and
on federal funds purchased and repurchase agreements. For the year ended December 31, 2003, net
interest income reached $239.3 million, compared to $166.3 million reported in 2002, an increase of
$73.0 million or 43.88%. The increase in 2003 was the result of increases in interest income from
loans, investment securities and money market instruments, which was partially offset by increases
in interest expense on deposits and repurchase agreements. 18




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##### Table of Contents



The following table presents, for the periods indicated, the total dollar amount of interest
income from average interest-earning assets and the resultant yields, as well as the interest
expense on average interest-bearing liabilities, expressed both in dollars and rates, as well as in
a normal and tax equivalent basis. Average balances are daily average balances. The yield on the
securities portfolio is based on average historical cost balances and does not give effect to
changes in fair value that are reflected as a component of consolidated shareholders equity. YEARS ENDED DECEMBER 31,2004
    
    
    
    
    
    
    
    
    
    
    2003
    
    
    
    
    
    
    
    
    
    
    2002Average balance
    
    
    Average
    
    
    
    
    
    
    Average balance
    
    
    Average
    
    
    
    
    
    
    Average balance
    
    
    AverageInterest
    
    
    (1)
    
    
    Yield / Rate
    
    
    Interest
    
    
    (1)
    
    
    Yield / Rate
    
    
    Interest
    
    
    (1)
    
    
    Yield / Rate(Dollars in Thousands)Normal Spread:Interest-earning assets:Loans, including loan fees (2)
    
    $
    322,164
    
    
    $
    5,401,955
    
    
    
    5.96
    %
    
    $
    275,848
    
    
    $
    4,278,468
    
    
    
    6.45
    %
    
    $
    220,676
    
    
    $
    3,315,514
    
    
    
    6.66
    %Investment securities (3)
    
    
    212,213
    
    
    
    5,400,997
    
    
    
    3.93
    
    
    
    134,273
    
    
    
    3,571,299
    
    
    
    3.76
    
    
    
    112,759
    
    
    
    2,600,210
    
    
    
    4.34Mortgage and asset-
backed securities (3)
    
    
    37,489
    
    
    
    935,421
    
    
    
    4.01
    
    
    
    40,140
    
    
    
    998,257
    
    
    
    4.02
    
    
    
    44,848
    
    
    
    859,991
    
    
    
    5.21Money market instruments
    
    
    19,510
    
    
    
    745,828
    
    
    
    2.62
    
    
    
    11,633
    
    
    
    534,444
    
    
    
    2.18
    
    
    
    7,451
    
    
    
    314,633
    
    
    
    2.37Total
    
    
    591,376
    
    
    
    12,484,201
    
    
    
    4.74
    
    
    
    461,894
    
    
    
    9,382,468
    
    
    
    4.92
    
    
    
    385,734
    
    
    
    7,090,348
    
    
    
    5.44Interest-bearing liabilities:Deposits
    
    
    143,860
    
    
    
    5,909,274
    
    
    
    2.43
    
    
    
    114,755
    
    
    
    4,768,490
    
    
    
    2.41
    
    
    
    114,374
    
    
    
    3,690,242
    
    
    
    3.10Federal funds purchased and
repurchase agreements
    
    
    141,414
    
    
    
    5,676,595
    
    
    
    2.49
    
    
    
    101,652
    
    
    
    3,891,972
    
    
    
    2.61
    
    
    
    98,233
    
    
    
    2,815,608
    
    
    
    3.49Advances from FHLB
    
    
    6,568
    
    
    
    164,245
    
    
    
    4.00
    
    
    
    6,037
    
    
    
    137,838
    
    
    
    4.38
    
    
    
    6,202
    
    
    
    120,008
    
    
    
    5.17Other borrowings
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    142
    
    
    
    3,698
    
    
    
    3.85
    
    
    
    604
    
    
    
    15,469
    
    
    
    3.90Total
    
    
    291,842
    
    
    
    11,750,114
    
    
    
    2.48
    
    
    
    222,586
    
    
    
    8,801,998
    
    
    
    2.53
    
    
    
    219,413
    
    
    
    6,641,327
    
    
    
    3.30Net interest income
    
    $
    299,534
    
    
    
    
    
    
    
    
    
    
    $
    239,308
    
    
    
    
    
    
    
    
    
    
    $
    166,321Interest rate spread
    
    
    
    
    
    
    
    
    
    
    2.26
    %
    
    
    
    
    
    
    
    
    
    
    2.39
    %
    
    
    
    
    
    
    
    
    
    
    2.14
    %Net interest-earning assets
    
    
    
    
    
    $
    734,087
    
    
    
    
    
    
    
    
    
    
    $
    580,470
    
    
    
    
    
    
    
    
    
    
    $
    449,021Net yield on interest-earning
assets (4)
    
    
    
    
    
    
    
    
    
    
    2.40
    %
    
    
    
    
    
    
    
    
    
    
    2.55
    %
    
    
    
    
    
    
    
    
    
    
    2.35
    %Interest-earning assets to
interest-bearing liabilities
ratio
    
    
    
    
    
    
    106.25
    %
    
    
    
    
    
    
    
    
    
    
    106.59
    %
    
    
    
    
    
    
    
    
    
    
    106.76
    %Tax Equivalent Spread:Interest-earnings assets
    
    $
    591,376
    
    
    $
    12,484,201
    
    
    
    4.74
    %

    
    $
    461,894
    
    
    $
    9,382,468
    
    
    
    4.92
    %
    
    $
    385,734
    
    
    $
    7,090,348
    
    
    
    5.44
    %Tax equivalent adjustment
    
    
    53,555
    
    
    
    
    
    
    
    0.43
    
    
    
    31,522
    
    
    
    
    
    
    
    0.34
    
    
    
    23,704
    
    
    
    
    
    
    
    0.33Interest-earning assets -
tax equivalent
    
    
    644,931
    
    
    
    12,484,201
    
    
    
    5.17
    
    
    
    493,416
    
    
    
    9,382,468
    
    
    
    5.26
    
    
    
    409,438
    
    
    
    7,090,348
    
    
    
    5.77Interest-bearing liabilities
    
    
    291,842
    
    
    $
    11,750,114
    
    
    
    2.48
    
    
    
    222,586
    
    
    $
    8,801,998
    
    
    
    2.53
    
    
    
    219,413
    
    
    $
    6,641,327
    
    
    
    3.30Net interest income
    
    $
    353,089
    
    
    
    
    
    
    
    
    
    
    $
    270,830
    
    
    
    
    
    
    
    
    
    
    $
    190,025Interest rate spread
    
    
    
    
    
    
    
    
    
    
    2.69
    %
    
    
    
    
    
    
    
    
    
    
    2.73
    %
    
    
    
    
    
    
    
    
    
    
    2.47
    %Net yield on interest-
earning assets (4)
    
    
    
    
    
    
    
    
    
    
    2.83
    %
    
    
    
    
    
    
    
    
    
    
    2.89
    %
    
    
    
    
    
    
    
    
    
    
    2.68
    %
   (1)
    
    Average balance on interest-earning assets and interest-bearing liabilities is
computed using daily monthly average balances during the periods.(2)
    
    Average loans exclude non-performing loans. Loans fees, net amounted to $10.6 million;
$8.7 million and $5.6 million for the years ended December 31, 2004, 2003 and 2002, respectively.(3)
    
    Includes trading and available for sale securities.(4)
    
    Net interest income divided by average interest-earning assets. 19




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##### Table of Contents



The following table presents the dollar amount of changes in interest income and interest
expense for the major components of interest-earning assets and interest-bearing liabilities and
distinguishes between the increase (decrease) related to higher outstanding balances and the
volatility of interest rates. Year ended December 31,2004 vs. 2003
    
    
    2003 vs. 2002Volume
    
    
    Rate
    
    
    Total
    
    
    Volume
    
    
    Rate
    
    
    Total(In thousands)Interest income:Loans
    
    $
    64,831
    
    
    $
    (18,515
    )
    
    $
    46,316
    
    
    $
    61,842
    
    
    $
    (6,670
    )
    
    $
    55,172Investment securities (1)
    
    
    71,641
    
    
    
    6,299
    
    
    
    77,940
    
    
    
    33,413
    
    
    
    (11,899
    )
    
    
    21,514Mortgage and asset-backed
securities (1)
    
    
    (2,519
    )
    
    
    (132
    )
    
    
    (2,651
    )
    
    
    11,103
    
    
    
    (15,811
    )
    
    
    (4,708
    )Money market instruments
    
    
    5,216
    
    
    
    2,661
    
    
    
    7,877
    
    
    
    4,828
    
    
    
    (646
    )
    
    
    4,182Total increase (decrease)
in interest income
    
    
    139,169
    
    
    
    (9,687
    )
    
    
    129,482
    
    
    
    111,186
    
    
    
    (35,026
    )
    
    
    76,160Interest expense:Deposits
    
    
    27,757
    
    
    
    1,348
    
    
    
    29,105
    
    
    
    1,618
    
    
    
    (1,237
    )
    
    
    381Federal funds purchased and
repurchase agreements
    
    
    44,217
    
    
    
    (4,455
    )
    
    
    39,762
    
    
    
    9,985
    
    
    
    (6,566
    )
    
    
    3,419Advances from FHLB
    
    
    972
    
    
    
    (441
    )
    
    
    531
    
    
    
    6,304
    
    
    
    (6,469
    )
    
    
    (165
    )Other borrowings
    
    
    (142
    )
    
    
    
    
    
    
    (142
    )
    
    
    (453
    )
    
    
    (9
    )
    
    
    (462
    )Total increase (decrease) in
interest expense
    
    
    72,804
    
    
    
    (3,548
    )
    
    
    69,256
    
    
    
    17,454
    
    
    
    (14,281
    )
    
    
    3,173Increase (decrease) in
net interest income
    
    $
    66,365
    
    
    $
    (6,139
    )
    
    $
    60,226
    
    
    $
    93,732
    
    
    $
    (20,745
    )
    
    $
    72,987
   (1)
    
    Includes trading and available for sale securities. The following table sets forth, for the periods indicated, certain ratios reflecting the
productivity and profitability of the Company: YEARS ENDED DECEMBER 31, (1)2004
    
    
    2003
    
    
    2002Return on assets (2)
    
    
    1.33
    %
    
    
    1.15
    %
    
    
    1.22
    %Return on common stockholders equity (3)
    
    
    28.55
    
    
    
    22.79
    
    
    
    25.39Dividend payout ratio to common stockholders (4)
    
    
    16.24
    
    
    
    19.97
    
    
    
    19.46Equity-to-asset ratio (5)
    
    
    7.39
    
    
    
    7.16
    
    
    
    6.90
   (1)
    
    Averages computed by using beginning and period-end balances.(2)
    
    Net income divided by average total assets.(3)
    
    Net income attributable to common stockholders divided by average common stockholders
equity.(4)
    
    Common stockholders dividend declared divided by net income attributable to common
stockholders.(5)
    
    Average equity divided by average total assets . 20




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##### Table of Contents



ECONOMIC CONDITIONS, MARKET AREA AND COMPETITION Puerto Rico (the Island), a Commonwealth of the United States of America (the U.S.), is
the easternmost of the Greater Antilles and the fourth largest island of the Caribbean. The Island
is located at the crossroads between North and South America, at just 3.5 hours airtime from New
York and 60 minutes from Venezuela and has a population of approximately four (4) million people.
In 1917, the people of Puerto Rico became citizens of the U.S., and therefore Puerto Ricans serve
in the United States Armed Forces. As in the U.S., the Island has a local judicial system. The
Island constitutes a District in the Federal Judiciary and has its own U.S. district court. Also,
most of the U.S. federal agencies are represented on the Island. However, the Island has its own
Internal Revenue system and is not subject to U.S. taxes. Spanish and English are the official
languages of the Island. The Island economy operates as a region within the U.S., and therefore its financial
performance is closely linked to the U.S. performance. The external sector is a key element of the
economy of Puerto Rico, as it has a very open economy, with large flows of trade, investment and
income. The Island uses U.S. currency and forms part of the U.S. financial system. As a
Commonwealth of the U.S., the Island falls within the U.S. for purposes of customs and migration,
and therefore there is a full exchange of funds, people and goods between Puerto Rico and the U.S.
Puerto Rico banks are subject to the same Federal laws, regulations and supervision as those of the
financial institutions operating in the rest of U.S. The Federal Deposit Insurance Corp. insures
the deposits of Puerto Rico chartered commercial banks, including Westernbank, the banking
subsidiary of W Holding Company, Inc. For year 2004, the Puerto Rico economic activity continued in line with overall economic
conditions in the U.S, showing some growth although at a slower rate than expected. Economic
indicators for year 2004 showed some mixed signals, while the job markets continue to strengthen
and retail sales continue to rise, the public-sector construction has remained more or less
stable, the expansion observed in private construction halted and a drop-off occurred in government
income, which should result in cuts in public spending. The Puerto Rico Gross Domestic Product was
approximately 3.0% for year 2004. Inflation rate for year 2004 was considered to be moderate at
approximately 4.0%. Historically, Puerto Rico unemployment rate has been higher than the average
U.S. unemployment rate, being 10% at December 31, 2004, since although the number of jobs was
increasing; the workforce was growing in a parallel fashion. The rate of participation in the
workforce has been estimated in approximately 47.0%. Manufacturing and construction continues to be
the backbone of the Island economy, and many multinational corporations have substantial operations
in the Island. The islands pharmaceutical industry continues to be very strong, being the primary
driver for employment in the Island, along with the construction industry; both of them labor
intensive industries. During the past years there has been a slowdown in both industries, primarily
due to the reduction of tax incentives in the manufacturing sector. Nevertheless, the Island
economy has been able to be somewhat less dependent of these industries thanks to its
diversification into other business areas such as tourism, retail, banking and transportation. The
banking sector has been the main driver of such diversification, being the financial
support for all the industrial and commercial activity on the Island. At December 31, 2004, there
are approximately eleven (11) banks operating in Puerto Rico, with total assets, loans and deposits
of approximately $90.8 billion, $46.9 billion and $46.0 billion, respectively, at September 30,
2004. U.S. banks, foreign banks and the major Puerto Rican banks, all offer commercial banking
services designed to support the emerging requirements of its local clients as well as of its
international clients. The economic strength and liquidity of local financial institutions,
considered as the pillar of the Islands economy, have allowed the Puerto Rico banking sector to
extend credit, without which the Islands economy couldnt be sustained. The growing combination of
loans, deposits and assets has been the key elements to the economic progress for the past years.
Loans, in particular, have played a key role in keeping the Island economy afloat, through either
personal, mortgage or commercial loans. The financial services and banking business are highly competitive, and the profitability of
the Company will depend principally upon the Companys ability to compete in its market area as
well as to a significant extent upon general economic conditions in its market place. The Company
competes with other commercial and non-commercial banks, finance companies, mutual funds, insurance
companies, brokerage and investment banking firms, asset-based non-bank lenders and certain other
non-financial institutions, including certain governmental organizations which may offer subsidized
financing at lower rates than those offered by the Company. The Company has been able to compete
effectively with other financial institutions by emphasizing technology and customer service,
including local office decision-making on loans, establishing long-term customer relationships and
building customer loyalty, and by providing products and services designed to address the specific
needs of its customers. Significant deterioration in the local economy or external economic
conditions, such as inflation, recession, unemployment, real estate values and other factors beyond
the Companys control, could also substantially impact the Companys performance. There can be no
assurance that future adverse changes in the local economy would not have a material adverse effect
on the Companys consolidated financial condition, results of operations or cash flows. 21




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##### Table of Contents



EMPLOYEES At December 31, 2004, the Company had 1,175 full-time employees, including its executive
officers. The Company considers its employees relations to be excellent. REGULATION The Company is a financial holding company subject to the regulation, supervision, and
examination by the Federal Reserve Board (FRB)under the Bank Holding Company Act of 1956, as amended
(the BHC Act). The Company is required to file periodic reports and other information with the
FRB and the FRB may conduct examinations of the Company.
Westernbank is subject to the regulation, supervision and examination
of the Federal Deposit Insurance Corporation (FDIC) and the Puerto
Rico Commissioner of Financial Institutions (the Puerto Rico Commissioner) and, as to certain
matters, the FRB. Westernbank Insurance Corp. is subject to the regulation,
supervision, and examination of the Office of the Commissioner of Insurance of Puerto Rico. FEDERAL
REGULATION. The Company is subject to capital adequacy guidelines of
the FRB. The guidelines apply on a consolidated basis and require bank holding companies to
maintain a ratio of Tier 1 capital to total average assets of 4.0% to 5.0%. There is a minimum
ratio of 3.0% established for the most highly rated bank holding
companies. The FRBs capital adequacy guidelines also require bank holding companies to maintain a minimum ratio
of Tier 1 capital to risk-weighted assets of 4.0% and a minimum ratio of qualifying total capital
to risk-weighted assets of 8.0%. The Companys ability to pay
dividends to its stockholders and other activities can be restricted
if its capital falls below levels established by the FRB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. As of December 31, 2004, the Companys ratio of Tier 1 capital to
total average assets was 7.72%, its ratio of Tier 1 capital to risk-weighted assets was 14.78%, and
its ratio of qualifying total capital to risk-weighted assets was 15.70%. Under the guidelines for qualifying total capital, at least half of the total capital is to be
comprised of common equity, retained earnings, minority interest in unconsolidated subsidiaries,
non-cumulative perpetual preferred stock and the disallowed portion of deferred tax assets (Tier 1
Capital). The remainder may consist of a limited amount of subordinated debt, other preferred
stock and a limited amount of loan and lease loss reserves (Tier 2 Capital). With respect to
risk-based and leverage capital ratios, most intangibles, including core deposit intangibles, are
deducted from Tier 1 Capital. The regulations, however, permit the inclusion of a limited amount of
intangibles related to originated and purchased mortgage servicing rights and purchased credit card
relationships and include a grandfathered provision permitting inclusion of certain existing
intangibles. Under the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA), the
federal banking regulators must take prompt corrective action in respect of depository institutions
that do not meet minimum capital requirements. Prompt corrective action provisions are not
applicable to bank holding companies. The FDICIA and the regulations issued thereunder established
five capital tiers: (i) well capitalized, if a depository institution has a total risk-based
capital ratio of 10.0% or more, has a Tier I risk-based capital ratio of 6.0% or more, has a Tier I
leverage capital ratio of 5.0% or more, and is not subject to any written capital order or
directive; (ii) adequately capitalized, if it has a total risk-based capital ratio of 8.0% or
more, a Tier I risk-based capital ratio of 4.0% or more and a Tier I leverage capital ratio of 4.0%
or more (3.0% under certain circumstances) and does not meet the definition of well capitalized,
(iii) undercapitalized, if it has a total risk-based capital ratio that is less than 8.0%, a Tier
I risk-based ratio that is less than 4.0% or a Tier I leverage capital ratio that is less than 4.0%
(3.0% under certain circumstances), (iv) significantly undercapitalized, if it has a total
risk-based capital ratio that is less than 6.0%, a Tier I risk-based capital ratio that is less
than 3.0% or a Tier I leverage capital ratio that is less than 3.0%, and (v) critically
undercapitalized, if it has a ratio of tangible equity to total assets that is equal to or less
than 2.0%. A depository institution may be deemed to be in a capitalization category that is lower
than is indicated by its actual capital position if it receives a less than satisfactory
examination rating in any of the first four categories. As of March 31, 2004 (latest examination
date), Westernbank was deemed to be a well-capitalized institution. At December 31, 2004, there
are no conditions or events since the latest examination date that management believes have changed
Westernbanks category. As of December 31, 2004,
Westernbanks ratio of Tier I capital to total average assets
was 6.75%, its ratio of Tier I capital to risk-weighted assets was
12.93%, and its ratio of qualifying total capital to risk-weighted
assets was 13.88%. FDICIA generally prohibits a depository institution from making any capital distribution
(including payment of a dividend) or paying any management fees to its holding company if the
depository institution would thereafter be undercapitalized. Undercapitalized depository
institutions are subject to restrictions on borrowing from the Federal Reserve System. In addition,
undercapitalized depository institutions are subject to growth limitations and are required to
submit capital restoration plans. A depository institutions holding company must guarantee the
capital plan, up to an amount equal to the lesser of 5% of the depository institutions assets at
the time it becomes undercapitalized or the amount of the capital deficiency when the institution
fails to comply with the plan. The federal banking agencies may not accept a capital plan without
determining, among other things, that the plan is based on realistic assumptions and is likely to
succeed in restoring the depository institutions capital. Significantly undercapitalized
depository institutions may be subject to a number of requirements and restrictions, including
orders to sell sufficient voting stock to become adequately capitalized, requirements to reduce
total assets, and cessation of receipt of deposits from correspondent banks. Critically
undercapitalized depository institutions are subject to the appointment of a receiver or
conservator. 22




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##### Table of Contents



Failure to meet the capital guidelines could subject an institution to a variety of
enforcement remedies, including the termination of deposit insurance by the FDIC, and to certain
restrictions on its business. At December 31, 2004, the Company and Westernbank were in compliance
with all capital requirements. For more information, refer to Note 15
(page 103) to the audited consolidated financial
statements, included in Part II, Item 8. DIVIDEND RESTRICTIONS. The principal source of funds of the Company is dividends from
Westernbank. The ability of Westernbank to pay dividends on its common stock is restricted by the
Puerto Rico Banking Act, the Federal Deposit Insurance Act (FDIA) and FDIC regulations. In
general terms, the Puerto Rico Banking Act provides that when the expenditures of a bank are
greater than receipts, the excess of expenditures over receipts shall be charged against the
undistributed profits of the bank and the balance, if any, shall be charged against the required
reserve fund of the bank. If there is no sufficient reserve fund to cover such balance in whole or
in part, the outstanding amount shall be charged against the banks capital account. The Puerto
Rico Banking Act provides that until said capital has been restored to its original amount and the
reserve fund restored to 20% of the original capital, the bank may not declare any dividends. In
general terms, the FDIA and the FDIC regulations restrict the payment of dividends when a bank is
undercapitalized, when a bank has failed to pay insurance assessments, or when there are safety and
soundness concerns regarding a bank. The payment of dividends by Westernbank may also be affected by other regulatory requirements
and policies, such as maintenance of adequate capital. If, in the opinion of the regulatory
authority, a depository institution under its jurisdiction is engaged in, or is about to engage in,
an unsafe or unsound practice (that, depending on the financial condition of the depository
institution, could include the payment of dividends), such authority may require, after notice and
hearing, that such depository institution cease and desist from such
practice. The FRB has issued a policy statement that provides that insured banks and bank holding companies
should generally pay dividends only out of operating earnings for the current and preceding two
years. In addition, all insured depository institutions are subject to the capital-based
limitations required by FDICIA. ACQUISITIONS AND CHANGE OF CONTROL. FRB approval is required if the Company
seeks to acquire direct or indirect ownership or control of any voting shares of a bank if, after
such acquisition, the Company would own or control directly or indirectly more than 5% of the
voting stock of the bank. FRB approval also must be obtained if the Company seeks
to acquire all or substantially all of the assets of a bank or merges or consolidates with another
bank holding company. The Company is required to give the FRB prior written notice of any purchase
or redemption of its outstanding equity securities if the gross consideration for the purchase or
redemption, when combined with the net consideration paid for all such purchases or redemptions
during the preceding 12 months, will be equal to 10% or more of the Companys consolidated net
worth. The FRB may disapprove any purchase or redemption if it determines that
the proposal would constitute an unsafe and unsound practice, or would violate any law, regulation,
order or directive of the FRB, or any condition imposed by, or written agreement
with, the FRB. Such notice and approval is not required for a bank holding
company that would be treated as well capitalized under applicable regulations of the FRB, that has received a composite 1 or 2 rating at its most recent bank holding
company inspection by the FRB, and that is not the subject of any unresolved
supervisory issues. Notwithstanding the foregoing, any redemption of the Companys preferred stocks
will require the prior approval of the FRB. PUERTO RICO BANKING LAW. Westernbank is a bank chartered under the Puerto Rico Banking Law.
Westernbank must file reports with the Puerto Rico Commissioner and the
FDIC concerning its activities and financial condition, and it must obtain regulatory approval
prior to entering into certain transactions, such as mergers with, or acquisitions of, other
depository institutions and opening or acquiring branch offices. The Puerto Rico Commissioner and the FDIC conduct periodic examinations to assess Westernbanks
compliance with various regulatory requirements. This regulation and supervision is intended
primarily for the protection of the deposit insurance funds and depositors. The regulatory
authorities have extensive discretion in connection with the exercise of their supervisory and
enforcement activities, including the setting of policies with respect to the classification of
assets and the establishment of adequate loan loss reserves for regulatory purposes. Westernbank derives its lending, investment and other powers primarily from the applicable
provisions of the Puerto Rico Banking Law and the regulations adopted thereunder. That law governs
the responsibilities of directors, officers and stockholders, and the corporate powers, savings,
lending, capital and investment requirements and other activities of Westernbank. The Puerto Rico
Commissioner has extensive rulemaking power and administrative discretion
under the Puerto Rico Banking Law, and generally examines Westernbank on an annual basis. 23




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The Puerto Rico Banking Act requires that at least 10% of the yearly net income of Westernbank
be credited annually to a reserve fund. This must be done every year until the reserve fund is
equal to the total paid-in capital for common stock and preferred stock or 10% of total deposits.
At December 31, 2004, Westernbank had an adequate reserve fund established. The Puerto Rico Banking
Law also provides that when the expenditures of a bank are greater than the receipts, the excess is
charged against the undistributed profits of the bank, and the balance, if any, is charged against
and reduces the reserve fund. If there is no reserve fund sufficient to cover the entire amount,
the excess amount is charged against the capital account and no dividend can be declared until the
capital has been restored to its original amount and the reserve fund to 20% of the original
capital. Under the Puerto Rico Banking Act, Westernbank must maintain a legal reserve in an amount
equal to at least 20% of Westernbanks demand liabilities, except certain government deposits. At
December 31, 2004, Westernbank had a legal reserve of 202.54%. The Puerto Rico Regulatory Financial Board (the Financial Board), which is part of the
Office of the Puerto Rico Commissioner, has the authority to regulate the
maximum interest rates and finance charges that may be charged on loans to individuals and
unincorporated businesses in the Commonwealth of Puerto Rico. In February 1992 and again in
November 1997, the Financial Board approved regulations which provide that the applicable interest
rate on loans to individuals and an unincorporated business is to be determined by free
competition. The Financial Board also has authority to regulate the maximum finance charges on
retail installment sales contracts, including credit card purchases, which are currently set at
21%. There is no maximum rate set for installment sales contracts involving motor vehicles,
commercial, agricultural and industrial equipment, commercial electric appliances, and insurance
premiums. Under Puerto Rico law, no person or company may acquire direct or indirect control of a
holding company without first obtaining the prior approval of the Puerto Rico Commissioner. Control is defined to mean the power, directly or indirectly, to direct or
decisively influence the management or the operations of the holding company. Control is presumed
to exist if a person or entity, or group acting in concert, would become the owner, directly or
indirectly, of more than 5% of the voting stock of the holding company as a result of the transfer
of voting stock, and such person, entity or group did not own more than 5% of the voting stock
prior to the transfer. FDIC DEPOSIT INSURANCE. Westernbank is subject to FDIC deposit insurance assessments. Pursuant
to FDICIA, the FDIC has adopted a risk-based assessment system, under which the assessment rate for
an insured depository institution varies according to the level of risk incurred in its activities.
An institutions risk category is based partly upon whether the institution is well capitalized,
adequately capitalized or less than adequately capitalized. Each insured institution is also
assigned to one of three supervisory subgroups. Group A institutions are financially sound
institutions with only a few minor weaknesses; Group B institutions are institutions that
demonstrate weaknesses that, if not corrected, could result in significant deterioration; and Group
C institutions are institutions with respect to which there is a substantial probability that the
FDIC will suffer a loss in connection with the institution unless effective action is taken to
correct the areas of weakness. FDIC insurance on deposits may be terminated by the FDIC, after notice and hearing, upon a
finding by the FDIC that the insured bank has engaged or is engaging in unsafe or unsound
practices, or is in an unsafe or unsound condition to continue operations as an insured bank, or
has violated any applicable law, regulation, rule or order of or condition imposed by or written
agreement entered into with the FDIC. Westernbank is also subject to quarterly payments on semiannual insurance premium assessments
for its FDIC deposit insurance. Westernbank is subject to separate assessments to repay bonds
(FICO bonds) issued in the late 1980s to recapitalize the former Federal Savings and Loan
Insurance Corporation. The assessment for the payments on the FICO bonds for the quarter beginning
on January 1, 2005 is 1.44 basis points for BIF-assessable and SAIF-assessable deposits. Most of
Westernbanks deposits are presently insured by SAIF. BROKERED DEPOSITS. FDIC regulations govern the receipt of brokered deposits. Under these
regulations, a bank cannot accept, rollover or renew brokered deposits (which term is defined also
to include any deposit with an interest rate more than 75 basis points above prevailing rates)
unless (i) it is well capitalized or (ii) it is adequately capitalized and receives a waiver from
the FDIC. However, a bank that is adequately capitalized may not pay an interest rate more than 75
basis points over prevailing rates under any circumstances. The Company does not believe the
brokered deposits regulation has had or will have a material effect on the funding or liquidity of
Westernbank. 24




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##### Table of Contents



SAFETY AND SOUNDNESS STANDARDS. Section 39 of the FDIA requires each federal banking agency
to prescribe for all insured depository institutions that it regulates standards relating to
internal control, information systems and internal audit system, loan documentation, credit
underwriting, interest rate exposure, asset growth, compensation, fees and benefits and such other
operational and managerial standards as the agency deems appropriate. In addition, each federal
banking agency is required to adopt standards that specify (i) a maximum ratio of classified assets
to capital, (ii) minimum earnings sufficient to absorb losses without impairing capital, (iii) to
the extent feasible, a minimum ratio of market value to book value for publicly-traded shares of
the institution or holding company, and (iv) such other standards relating to asset quality,
earnings and valuation as the agency deems appropriate. Finally, each federal banking agency is
required to prescribe standards for the employment contracts and other compensation arrangements of
executive officers, employees, directors and principal stockholders of insured depository
institutions that would prohibit compensation, benefits and other arrangements that are excessive
or that could lead to a material financial loss for the institution. If an insured depository
institution or its holding company fails to meet any of the standards described above, it will be
required to submit to the appropriate federal banking agency a plan specifying the steps that will
be taken to cure the deficiency. If an institution or holding company fails to submit an acceptable
plan or fails to implement the plan, the appropriate federal banking agency will require the
institution or holding company to correct the deficiency and, until it is corrected, may impose
other restrictions on the institution or holding company, including any of the restrictions
applicable under the prompt corrective action provisions of FDICIA. ACTIVITY RESTRICTIONS ON STATE-CHARTERED BANKS. State banks are limited in their investments
and activities engaged in as principal to those permissible under applicable state law and that are
permissible for national banks and their subsidiaries, unless such investments and activities are
specifically permitted by the FDIA or the FDIC determines that such activity or investment would
pose no significant risk to the SAIF and BIF. The FDIC has by regulation determined that certain
real estate investment activities do not present a significant risk to the SAIF and BIF, provided
they are conducted in accordance with the regulations. Provisions of the Gramm-Leach-Bliley Act of
1999 (GLB Act), permit national banks to establish financial subsidiaries that may engage in the
activities permissible for financial holding companies, other than insurance underwriting, merchant
banking and real estate development and investment activities. In order to exercise this authority,
a bank and its depository institution affiliates must be well-capitalized, well-managed and have
CRA ratings of at least satisfactory. For a state bank, such activities also must be permissible
under relevant state law. TRANSACTIONS WITH AFFILIATES AND INSIDERS OF WESTERNBANK. Transactions between Westernbank and
any of its affiliates, including the Company, are governed by sections 23A and 23B of the Federal
Reserve Act. An affiliate of a bank is any company or entity that controls, is controlled by or is
under common control with the bank. Generally, sections 23A and 23B (1) limit the extent to which a
bank or its subsidiaries may engage in covered transactions with any one affiliate to an amount
equal to 10% of the banks capital stock and surplus, and limit such transactions with all
affiliates to an amount equal to 20% of such capital stock and surplus, and (2) require that all
such transactions be on terms that are consistent with safe and sound banking practices. The term
covered transactions includes the making of loans, purchase of or investment in securities issued
by the affiliate, purchase of assets, issuance of guarantees and other similar types of
transactions. Most loans by a bank to any of its affiliates must be secured by collateral in
amounts ranging from 100 to 130 percent of the loan amount, depending on the nature of the
collateral. In addition, any covered transaction by a bank with an affiliate and any sale of assets
or provision of services to an affiliate must be on terms that are substantially the same, or at
least as favorable, to the bank as those prevailing at the time for comparable transactions with
nonaffiliated companies. On October 31, 2002, the
FRB adopted a new regulation, Regulation W,
effective March 1, 2003, that comprehensively implements sections 23A and 23B. The regulation
unifies and updates staff interpretations issued over the years, incorporates several new
interpretative proposals (such as to clarify when transactions with an unrelated third party will
be attributed to an affiliate), and addresses new issues arising as a result of the expanded scope
of non-banking activities engaged in by banks and bank holding companies in recent years and
authorized for financial holding companies under the Gramm-Leach Bliley Act (GLB Act). Sections 22(g) and (h) of the Federal Reserve Act place restrictions on loans by a bank to
executive officers, directors, and principal stockholders. Under Section 22(h), loans to a
director, an executive officer and to a greater than 10% stockholder of a bank and certain of their
related interests (insiders) and insiders of affiliates, may not exceed, together with all other
outstanding loans to such person and related interests, the banks loans-to-one-borrower limit
(generally equal to 15% of the institutions unimpaired capital and surplus). Section 22(h) also
requires that loans to insiders and to insiders of affiliates be made on terms substantially the
same as offered in comparable transactions to other persons, unless the loans are made pursuant to
a benefit or compensation program that (i) is widely available to employees of the bank and (ii)
does not give preference to insiders over other employees of the bank. Section 22(h) also requires
prior board of directors approval for certain loans, and the aggregate amount of extensions of
credit by a bank to all insiders cannot exceed the institutions unimpaired capital and surplus.
Furthermore, Section 22(g) places additional restrictions on loans to executive officers. 25




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##### Table of Contents



COMMUNITY REINVESTMENT ACT. Under the Community Reinvestment Act (CRA), as implemented by
federal regulations, a financial institution has a continuing and affirmative obligation,
consistent with its safe and sound operation, to help meet the credit needs of its entire
community, including low and moderate income neighborhoods. The CRA does not establish specific
lending requirements or programs for financial institutions nor does it limit an institutions
discretion to develop the types of products and services that it believes are best suited to its
particular community, consistent with the CRA. The CRA requires federal examiners, in connection
with the examination of a financial institution, to assess the institutions record of meeting the
credit needs of its community and to take such record into account in its evaluation of certain
applications by such institution. The CRA also requires all institutions to make public disclosure
of their CRA ratings. The Company has a Compliance Committee, which oversees the planning of
products, and services offered to the community, especially those aimed to serve low and moderate
income communities. The CRA rated the Company as having a high satisfactory record of meeting community
credit needs under the CRA at its most recent examination for CRA performance. CUSTOMER INFORMATION SECURITY. The FRB, the FDIC and other bank
regulatory agencies have adopted final guidelines (the Guidelines) for safeguarding confidential,
personal customer information. The Guidelines require each financial institution, under the
supervision and ongoing oversight of its board of directors or an appropriate committee thereof, to
create, implement and maintain a comprehensive written information security program designed to
ensure the security and confidentiality of customer information, protect against any anticipated
threats or hazards to the security or integrity of such information and protect against
unauthorized access to or use of such information that could result in substantial harm or
inconvenience to any customer. The Company has adopted a customer information security program that
has been approved by the Companys board of directors. FEDERAL HOME LOAN BANK SYSTEM. Westernbank is a member of the Federal Home Loan Bank System.
The System consists of 12 regional Federal Home Loan Banks, with each subject to
supervision and regulation by the Federal Housing Finance Board. The FHLB provides a central credit
facility primarily for member institutions. Westernbank, as a member of the FHLB of New York, is
required to acquire and hold shares of capital stock in that FHLB in an amount equal to the greater
of: 1.0% of the aggregate principal amount of its unpaid residential mortgage loans, home purchase
contracts and similar obligations at the beginning of each year; 5% of its FHLB advances
outstanding; or 0.3% of its total assets. At December 31, 2004, Westernbank held $52.2 million in
capital stock of the FHLB of New York. Advances from a FHLB are secured by a members shares of stock in the institution, certain
type of mortgages and other assets, including investment securities. Interest rates charged for
advances vary depending upon maturity and the cost of funds to the FHLB. As of December 31, 2004,
Westernbank had $211.0 million in outstanding advances and $832.9 million in repurchase agreements
from the FHLB of New York. INTERNATIONAL BUSINESS ENTITY ACT. The business and operations of Westernbank International
Banking Entity are subject to supervision and regulation by the Puerto Rico Commissioner. Under the
International Banking Entity Act (IBE Act), no sale, encumbrance, assignment, merger, exchange or
transfer of shares, interest or participation in the capital of an international banking entity (an
IBE) may be initiated without the prior approval of the Puerto Rico Commissioner, if by such transaction a person would acquire, directly or indirectly, control of 10%
or more of any class of stock, interest or participation in the capital of the IBE. The IBE Act and
the regulations issued thereunder by the Puerto Rico Commissioner (the
IBE Regulations) limit the business activities that may be carried out by an IBE. Such activities
are limited in part to persons and assets located outside of Puerto Rico. The IBE Act provides
further that every IBE must have not less than $300,000 of unencumbered assets or acceptable
financial securities. Pursuant to the IBE Act and the IBE Regulations, the Westernbank IBE must maintain books and
records of all its transactions in the ordinary course of business. The Westernbank IBE also is
required thereunder to submit to the Puerto Rico Commissioner quarterly
and annual reports of its financial condition and results of operations, including annual audited
financial statements. The IBE Act empowers the Puerto Rico
Commissioner to revoke or
suspend, after notice and hearing, a license issued thereunder if, among other things, the IBE
fails to comply with the IBE Act, the IBE Regulations or the terms of its license, or if the Puerto
Rico Commissioner finds that the business or affairs of the IBE are
conducted in a manner that is not consistent with the public interest. Pursuant to the provisions of Act No. 13 of January 8, 2004, for taxable years commencing
after June 30, 2003, the net income earned by an IBE that operates as a unit of a bank under the
Puerto Rico Banking Law, will be considered taxable and subject to income taxes at the current 26




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tax
rates in the amount by which the IBE taxable income exceeds 40% in the first applicable taxable
year (2004), 30% in the second year (2005) and 20% thereafter, of the taxable income of
Westernbank, including its IBE taxable income. Westernbanks IBE carries on its books a significant
amount of securities which are, irrespective of the IBE status, tax exempt by law. Moreover, the
Act provides that IBEs operating as subsidiaries will continue to be exempt from the payment of
income taxes. At December 31, 2004, management estimated that the provisions of this new Act did
not have an effect in the Companys financial position or results of operations. As of December 31,
2004, 2003 and 2002, and for the years then ended, substantially all of Westernbank Internationals
business activities have consisted of investment in securities and
purchasing of loans. Note 23 (page 118) to
the audited consolidated financial statements presents further information about the Companys
business segments. PRIVACY. Under the GLB Act, all financial institutions, including the Company, Westernbank and
Westernbank Insurance Corp., are required to adopt privacy policies, restrict the sharing of
nonpublic customer data with nonaffiliated parties at the customers request, and establish
procedures and practices to protect customer data from unauthorized access. The Company and its
subsidiaries have developed such policies and procedures, and the Company believes these policies
and procedures are in compliance with all privacy provisions of the GLB Act. ANTI-MONEY LAUNDERING. On October 26, 2001, the President signed into law comprehensive
anti-terrorism legislation known as the USA Patriot Act. Title III of the USA Patriot Act requires
financial institutions to help prevent, detect and prosecute international money laundering and the
financing of terrorism. The effectiveness of a financial institution in combating money laundering
activities is a factor to be considered in any application submitted by the financial institution
under the Bank Merger Act, which applies to Westernbank, or the BHC Act, which applies to the
Company. The Company and its subsidiaries, including Westernbank, have adopted systems and
procedures to comply with the USA Patriot Act and regulations adopted thereunder by the Secretary
of the Treasury. REGULATORY ENFORCEMENT AUTHORITY. The enforcement powers available to federal banking
regulators include, among other things, the ability to assess civil money penalties, to issue
cease-and-desist or removal orders, to require written agreements and to initiate injunctive
actions against banking organizations and institution-affiliated parties, as defined. In general,
these enforcement actions may be initiated for violations of laws and regulations and unsafe or
unsound practices. Other actions or inactions may provide the basis for enforcement action,
including misleading or untimely reports filed with regulatory authorities. Federal law requires,
except under certain circumstances, public disclosure of final enforcement actions by the federal
banking agencies. In addition, the FRB may take various other informal actions. THE SARBANES-OXLEY ACT. The Sarbanes-Oxley Act of 2002, (Sarbanes-Oxley) implements a broad
range of corporate governance and accounting measures for public companies (including publicly-held
financial holding companies such as the Company) designed to promote honesty and transparency in corporate
America. Sarbanes-Oxleys principal provisions, many of which have been interpreted through
regulations released in 2003, provide for and include, among other things: (i) the creation of an
independent accounting oversight board; (ii) auditor independence provisions that restrict
non-audit services that accountants may provide to their audit clients; (iii) additional corporate
governance and responsibility measures, including the requirement that the chief executive officer
and chief financial officer of a public company certify financial statements; (iv) the forfeiture
of bonuses or other incentive-based compensation and profits from the sale of an issuers
securities by directors and senior officers in the twelve month period following initial
publication of any financial statements that later require restatement; (v) an increase in the
oversight of, and enhancement of certain requirements relating to, audit committees of public
companies and how they interact with the Companys independent auditors; (vi) requirements that
audit committee members must be independent and are barred from accepting consulting, advisory or
other compensatory fees from the issuer; (vii) requirements that companies disclose whether at
least one member of the audit committee is a financial expert (as such term is defined by the
SEC) and if not discussed, why the audit committee does not have a financial expert; (viii)
expanded disclosure requirements for corporate insiders, including accelerated reporting of stock
transactions by insiders and a prohibition on insider trading during pension blackout periods; (ix)
a prohibition on personal loans to directors and officers, except certain loans made by insured
financial institutions on nonpreferential terms and in compliance with other bank regulatory
requirements; (x) disclosure of a code of ethics and filing a Form 8-K for a change or waiver of
such code; and (xi) a range of enhanced penalties for fraud and other violations. CAPITAL, DIVIDENDS, STOCK SPLIT AND OPTION PLANS Total stockholders equity as a measure of capital increased by $253.2 million in 2004 and by
$243.7 million in 2003. In June 1998, Westernbank issued 1,219,000 shares of its 7.125% Non-cumulative, Convertible
Monthly Income Preferred Stock, Series A, with a liquidation preference of $25 per share. Proceeds
from the issuance of preferred stock amounted to $29.1 million, net of $1.3 million of issuance
costs. Each share is convertible, at the holders option, at any time on or after the 90th date
following the issue date, into .995 shares 27




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of the Companys common stock, subject to adjustment
upon certain events. The per share conversion ratio equates to a price of $25.125 per share of common stock, as adjusted. At December 31, 2004,
the Company had outstanding 520,752 shares of its 7.125% Non-cumulative, Convertible Monthly Income
Preferred Stock, Series A. In April and June 1999, Westernbank issued 2,001,000 shares of its 7.25% Non-cumulative,
Non-convertible Monthly Income Series B Preferred Stock, with a liquidation preference of $25 per
share. Proceeds from the issuance of preferred stock amounted to $48.3 million, net of $1.8 million
of issuance costs. On March 7, 2000, the Companys board of directors adopted the policy of paying dividends on a
monthly basis. Initial dividend payment under this policy, were applied retroactively for dividends
corresponding to the first three-month period ending March 31, 2000. Thereafter, dividends on
common stock and preferred stock are being paid on the 15th day of each month for stockholders of
record as of the last day of the previous month. In March and April 2001, the Company issued 2,208,000 shares of its 7.60% Non-cumulative,
Non-convertible Monthly Income Preferred Stock, Series C, with a liquidation preference of $25 per
share. Proceeds from the issuance of preferred stock amounted to $53.1 million, net of $2.1 million
of issuance cost. In August 2001, the Company issued 1,791,999 shares of its 7.40% Non-cumulative,
Non-convertible Monthly Income Preferred Stock Series D, with a liquidation preference of $25 per
share. Proceeds from the issuance of preferred stock amounted to $43.2 million, net of $1.6 million
of issuance cost. On June 17, 2002, the Companys board of directors declared a three-for-two split on its
common stock, for stockholders of record as of June 28, 2002, and distributed on July 10, 2002. The
effect of the stock split was a decrease to retained earnings and an increase in common stock of
$20.8 million. During 2002, the Company issued 6,095,000 and 1,725,000 shares of the Companys Common Stock
and Series E Preferred Stock, respectively, providing a net capital infusion of $98.0 million and
$41.5 million, respectively. During 2003, the Company issued 4,232,000 and 2,640,000 shares of the Companys Series F and
Series G Preferred Stock, respectively, with a liquidation preference of $25 per share, providing a
net capital infusion of $102.2 million and $63.7 million, respectively. During 2003 and 2002, the Company acquired and retired shares of common stock as follows:
$33,000 (1,903 shares) in 2003 and $42,000 (1,678 shares) in 2002. No shares were acquired and
retired during 2004. On November 4, 2003, the Companys board of directors declared a three-for-two split on its
common stock, for stockholders of record as of November 28, 2003, and distributed on December 10,
2003. The effect of the stock split was a decrease to retained earnings and an increase in common
stock of approximately $34.7 million. On November 11, 2003, the Companys board of directors declared a two percent (2%) stock
dividend, for stockholders of record as of November 28, 2003, and distributed on December 10, 2003.
The effect of the stock dividend was a decrease to retained earnings, an increase in
paid-in-capital and an increase in common stock of approximately $35.2 million, $33.1 million and
$2.1 million, respectively. In December 2004 and in January 2005, the Company issued 2,675,500 and 401,300 shares,
respectively, of the Companys Series H Preferred Stock, with a liquidation price of $50 per share,
providing a net capital infusion of $148.7 million. On December 6, 2004, the Companys board of directors declared a three-for-two split on its
common stock, for stockholders of record as of December 31, 2004, and distributed on January 10,
2005. The effect of the stock split was a decrease to retained earnings and an increase in common
stock of approximately $54.6 million. On December 13, 2004, the Companys board of directors declared a two percent (2%) stock
dividend, for stockholders of record as of December 30, 2004, and distributed on January 10, 2005.
The effect of the stock dividend was a decrease to retained earnings, an increase in
paid-in-capital and an increase in common stock of approximately $45.8 million, $43.7 million and
$2.1 million, respectively. 28




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Total common stock cash dividends declared in 2004 amounted to $23.5 million compared to $18.3
million in 2003. On January 3, 2005, the Company issued 401,300 shares of its 2004 Series H preferred stock
over-allotment option to the underwriter. The preferred shares were issued at a price of $50.00 per
share. Proceeds from the issuance of the 2004 Series H preferred stock amounted to $19,433,000, net
of $632,000 of issuance costs. On January 20, 2005, the Companys board of directors approved an increase in its annual
dividend payments to stockholders for 2005 to $0.19 per share. This represents an increase of
32.14% over the dividends paid in 2004. On February 10, 2005, one of the Companys executive officer exercised 35,113 options under
the Companys 1999 Qualified Option Plan at an exercise price of $2.85. The Company may redeem, in whole or in part, at any time at the following redemption prices,
if redeemed during the twelve month period beginning July 1 for 1998 Series A, May 28 for 1999
Series B, March 30 for the 2001 Series C, August 1 for the 2001 Series D, October 31 for 2002
Series E, May 30 for 2003 Series F, August 29 for 2003 Series G and December 21 for 2004 Series H
of the years indicated below, plus accrued and unpaid dividends, if any, for the current period to
the date of redemption: Redemption Price per ShareDecember 31,
    
    Series A
    
    
    Series B
    
    
    Series C
    
    
    Series D
    
    
    Series E
    
    
    Series F
    
    
    Series G
    
    
    Series H2005
    
    
    25.25
    
    
    
    25.50
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2006
    
    
    25.00
    
    
    
    25.00
    
    
    $
    25.50
    
    
    $
    25.50
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2007
    
    
    25.00
    
    
    
    25.00
    
    
    
    25.25
    
    
    
    25.25
    
    
    $
    25.50
    
    
    
    
    
    
    
    
    
    
    
    2008
    
    
    25.00
    
    
    
    25.00
    
    
    
    25.00
    
    
    
    25.00
    
    
    
    25.25
    
    
    $
    25.50
    
    
    $
    25.50
    
    
    
    2009
    
    
    25.00
    
    
    
    25.00
    
    
    
    25.00
    
    
    
    25.00
    
    
    
    25.00
    
    
    
    25.25
    
    
    
    25.25
    
    
    $
    51.002010
    
    
    25.00
    
    
    
    25.00
    
    
    
    25.00
    
    
    
    25.00
    
    
    
    25.00
    
    
    
    25.00
    
    
    
    25.00
    
    
    
    50.502011 and thereafter
    
    
    25.00
    
    
    
    25.00
    
    
    
    25.00
    
    
    
    25.00
    
    
    
    25.00
    
    
    
    25.00
    
    
    
    25.00
    
    
    
    50.00
 Series A, B, C, D, E, F, G and H Preferred Stocks rank senior to the Companys common
stock as to dividends and liquidation rights. Dividends declared on preferred stock for the years
ended December 31, 2004 and 2003 amounted to $27.2 million and $21.6 million, respectively. The Company has two stock option plans, the 1999 Qualified Stock Option Plan (the 1999
Qualified Option Plan) and the 1999 Nonqualified Stock Option Plan (the 1999 Nonqualified Option
Plan), for the benefit of employees of the Company and its subsidiaries. These plans offer to key
officers, directors and employees an opportunity to purchase shares of the Companys common stock.
Under the 1999 Qualified Option Plan, options for up to 14,747,670 shares (as adjusted) of common
stock can be granted. Also, options for up to 14,747,670 shares (as adjusted) of common stock,
reduced by any share issued under the 1999 Qualified Option Plan can be granted under the 1999
Nonqualified Option Plan. The option price for both plans is determined at the grant date. Both
plans will remain in effect for a term of 10 years. The Board of Directors has sole authority and
absolute discretion as to the number of stock options to be granted, their vesting rights, and the
options exercise price. The options become fully exercisable after five years following the grant
date. The Plans provide for a proportionate adjustment in the exercise price and the number of
shares that can be purchased in the event of a stock split, reclassification of stock and a merger
or reorganization. 29




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##### Table of Contents



The activity in outstanding options for the years ended December 31, 2004, 2003 and 2002, is
set forth below: 2004
    
    
    2003
    
    
    2002Weighted
    
    
    
    
    
    
    Weighted
    
    
    
    
    
    
    WeightedAverage
    
    
    
    
    
    
    Average
    
    
    
    
    
    
    AverageNumber of
    
    
    Exercise
    
    
    Number of
    
    
    Exercise
    
    
    Number of
    
    
    ExerciseOptions
    
    
    Price
    
    
    Options
    
    
    Price
    
    
    Options
    
    
    PriceBeginning of year
    
    
    4,862,723
    
    
    $
    4.62
    
    
    
    3,678,250
    
    
    $
    7.01
    
    
    
    2,370,500
    
    
    $
    10.06Transactions before stock split
and stock dividend:Options granted
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Options exercised
    
    
    (214,750
    )
    
    
    4.52
    
    
    
    (500,000
    )
    
    
    6.67
    
    
    
    
    
    
    
    Options forfeited
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,647,973
    
    
    
    4.62
    
    
    
    3,178,250
    
    
    
    7.06
    
    
    
    2,370,500
    
    
    
    10.06Stock split and stock dividend effect
    
    
    2,463,425
    
    
    
    3.02
    
    
    
    1,684,473
    
    
    
    4.62
    
    
    
    1,185,250
    
    
    
    6.70Transactions after stock split
and stock dividend:Options granted
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    122,500
    
    
    
    15.85Options exercised
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Options forfeited
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    End of year
    
    
    7,111,398
    
    
    $
    3.02
    
    
    
    4,862,723
    
    
    $
    4.62
    
    
    
    3,678,250
    
    
    $
    7.01
 For more information, please refer to
Note 17 (page 107) to the audited consolidated
financial statements, which are included in Part II, Item 8. COMMONWEALTH TAXATION GENERAL. Under the Puerto Rico Internal Revenue Code (the Code), all companies are treated
as separate taxable entities and are not entitled to file consolidated tax returns. The Company,
Westernbank and Westernbank Insurance, Corp. (the Companies) report their income and expenses
based on the accrual basis of accounting and file their Puerto Rico tax returns on a calendar year
basis. INCOME TAXES. The Companies are subject to Puerto Rico regular income tax on income earned
from all sources up to a maximum rate of 39%. The Puerto Rico income tax act disallows any interest deduction which is allocable to income
earned from tax exempt obligations acquired after December 31, 1987. For purposes of the above
determination, each company is required to allocate interest expense to exempt interest income
based on the ratio that the average exempt obligations bear to the total average assets of each
company. The Companies are also subject to an alternative minimum tax (AMT) equal to 22% of the
alternative minimum taxable income. The alternative minimum taxable income is equal to each
Companys taxable income adjusted for certain items. The principal adjustments for determining each
companys alternative minimum taxable income are the following: (i) no deduction may be claimed
with respect to the companys interest expense allocable to interest income derived from tax exempt
obligations acquired before January 1, 1988, other than mortgages guaranteed by the government of
Puerto Rico, its agencies, instrumentalities and political subdivisions, issued before September 1,
1987; and (ii) the alternative minimum taxable income is increased by 50% of the amount by which
the corporations book income (adjusted for certain items) exceeds its alternative minimum taxable
income without regard to this adjustment. 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 Companies income taxes were based on regular income tax rates. 30




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##### Table of Contents



The Puerto Rico Internal Revenue Code provides a dividend received deduction of 100% on
dividends received from wholly owned subsidiaries subject to income taxation in Puerto Rico, like
Westernbank and Westernbank Insurance Corp. Westernbank World Plaza, Inc., a wholly-owned subsidiary of Westernbank, elected to be treated
as a special partnership under the Code; accordingly, its taxable income is taxed by Westernbank. For the year ended December 31, 2004, the Company had approximately $80.7 million of regular
taxable income, on which it is required to pay current income tax of $31.5 million. The income on
certain investments is exempt for income tax purposes. Also, activities relating to the Westernbank
International division are exempt for income tax purposes, subject to certain limitation. As a
result of the above, the Companys effective tax rate is substantially below the statutory rate. Westernbank International operates as an International Banking Entity (IBE) under Puerto Rico
Act No. 52, of August 11, 1989, as amended, known as the International Banking Regulatory Act.
Under Puerto Rico tax law, an IBE can hold non-Puerto Rico assets, and earn interest on these
assets, as well as generate fee income outside of Puerto Rico on a tax-exempt basis under certain
circumstances. Pursuant to the provisions of Act No. 13 of January 8, 2004, for taxable years
commencing after June 30, 2003, the net income earned by an IBE that operates as a unit of a bank
under the Puerto Rico Banking Law, will be considered taxable and subject to income taxes at the
current tax rates in the amount by which the IBE taxable income exceeds 40% in the first applicable
taxable year (2004), 30% in the second year (2005) and 20% thereafter, of the taxable income of
Westernbank, including its IBE taxable income. Westernbanks IBE carries on its books a significant
amount of securities which are, irrespective of the IBE status, tax exempt by law. Moreover, the
Act provides that IBEs operating as subsidiaries will continue to be exempt from the payment of
income taxes. At December 31, 2004, management estimated that the provisions of the Act did not
have an effect on the Companys financial position or results of operations. Any change in these tax laws or other regulations, whether by applicable regulators or as a
result of legislation subsequently enacted by the Congress of the United States or the applicable
local legislatures, may have an impact on the Companys effective tax rate. AVAILABLE INFORMATION We make available free of charge, through our investor relations section at our website,
http://www.wholding.com/, our annual reports on Form 10-K, quarterly reports on Form 10-Q and
current reports on Form 8-K and all amendments to those reports as soon as reasonably practicable
after such material is electronically filed with or furnished to the Securities and Exchange
Commission (SEC). The public may read and copy any materials the Company files with the SEC at the SECs Public
Reference Room at 450 Fifth Street, NW, Washington, DC 20549. The public may obtain information on
the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. In addition, the
SEC maintains an Internet site that contains reports, proxy and information statements, and other
information regarding issuers that file electronically with the SEC at its web site
(http://www.sec.gov). In addition, our Internet website, in
the Investor Relations Section, also includes our Code of Business
Conduct and Ethics, our Code of Ethics for CEO
and Senior Financial Officers, the charters of the Audit Committee,
the Compensation Committee and the Nominating and Corporate
Governance Committee, and the Corporate Governance Guidelines of our Board of
Directors. We also make available in print to any stockholder who requests them copies of our
corporate governance principles, and the charters of each standing committee of our board of
directors. Requests for copies of these documents should be directed to Mr. César A. Ruiz,
Secretary, W Holding Company, Inc., P.O. Box 1180, Mayagüez, Puerto Rico 00681. To the extent
required by SEC rules, we intend to disclose any amendments to our code of conduct and ethics, and
any waiver of a provision of the code with respect to the companys directors, principal executive
officer, principal financial officer, principal accounting officer or controller, or persons
performing similar functions, on our web site referred to above within five business days following
any such amendment or waiver, or within any other period that may be required under SEC rules from
time to time. 31




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##### Table of Contents



ITEM 2. PROPERTIES The Company owns the condominium offices space housing its main offices at 19 West McKinley
Street, Mayagüez, Puerto Rico. As of December 31, 2004, Westernbank owned approximately 13 branch
premises and other facilities, nine (9) lots for future development, and one office building, all
of them located in Puerto Rico. In addition, as of such date, Westernbank leased properties for
branch operations in approximately 44 locations in Puerto Rico. At December 31, 2004, the Companys future rental commitments under non-cancelable operating
leases aggregated $7.6 million, not considering renewal options. The principal property owned by Westernbank for banking operations and other services is
described below:  
    Westernbank World Plaza - a 23-story office building located at Puerto
Ricos main business district and which serves as Westernbank San Juan metropolitan
area headquarters, our regional commercial lending office and the headquarters for
the Westernbank Business Credit and Expresso of Westernbank divisions. The book
value of this property at December 31, 2004, was $51.5 million. The Companys investment in premises and equipment, exclusive of leasehold improvements, at
December 31, 2004, was $85.7 million. The combined net book value of the Companys main offices as
of December 31, 2004 was $969,000. 
 ITEM 3. LEGAL PROCEEDINGS Except as described below, there are no material pending legal proceedings other than ordinary
routine legal proceedings incidental to the business of the Company to which the Company or any of
its subsidiaries is the subject or of which any of their property is the subject. The Company has received from the Securities and Exchange Commission (the SEC) notice of a
formal order of private investigation into matters that were the subject of a previously announced
informal inquiry by the SEC. As previously disclosed, the inquiry appears to be primarily related
to the other-than-temporary impairment charges announced by the Company in April 2003 in connection
with its investments in corporate bond and loan obligations. The Company is cooperating fully with
the SEC and will continue to do so. The Company does not expect to comment further regarding this
matter, as the formal order is a confidential document directing a non-public investigation. 
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable. 32




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##### Table of Contents



PART II 
 ITEM 5. MARKET FOR
REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES The Companys common stock is traded on the New York Stock Exchange (NYSE). The following table sets forth the range of high and low closing sale prices of the Companys
common stock, as quoted in the NYSE system, at the end of each quarter for 2004 and 2003. The
prices reflect inter-dealer quotations, without retail mark-up, mark-down or commissions and do not
necessarily represent actual transactions: Quarter Ended
    
    High(1) (2)
    
    
    Low(1) (2)December 2004
    
    $
    15.41
    
    
    $
    11.74September 2004
    
    
    12.46
    
    
    
    10.60June 2004
    
    
    12.33
    
    
    
    10.29March 2004
    
    
    13.75
    
    
    
    11.95December 2003
    
    $
    12.44
    
    
    $
    7.69September 2003
    
    
    8.28
    
    
    
    7.21June 2003
    
    
    8.84
    
    
    
    5.99March 2003
    
    
    7.88
    
    
    
    6.82
   (1)
    
    Adjusted to reflect a three-for-two stock split and a 2% stock dividend on the Companys
common stock declared on December 6, 2004 and December 13, 2004, respectively, both
distributed on January 10, 2005, and the three-for-two stock split and a 2% stock dividend
declared on November 4, 2003 and November 11, 2003, respectively, both distributed on December
10, 2003.(2)
    
    Prices in table are rounded. As of December 31, 2004, the Company had 566 stockholders of record of its Common Stock, not
including beneficial owners whose shares are held in record names of brokers or other nominees. The
last sales price for the Companys Common Stock on such date, as quoted on NYSE was $15.29 per
share (as adjusted). On November 4, 2003, the Companys board of directors declared a three-for-two stock split on
its common stock, for stockholders of record as of November 28, 2003, and distributed on December
10, 2003. The effect of the stock split was a decrease to retained earnings and an increase in
common stock of $34.7 million. On November 11, 2003, the Companys board of directors declared a 2% stock dividend, for
stockholders of record as of November 28, 2003, and distributed on December 10, 2003. The effect of
the stock dividend was a decrease to retained earnings, an increase in paid-in-capital and an
increase in common stock of $35.2 million, $33.1 million and $2.1 million, respectively. On December 6, 2004, the Companys board of directors declared a three-for-two stock split on
its common stock, for stockholders of record as of December 31, 2004, and distributed on January
10, 2005. The effect of the stock split was a decrease to retained earnings and an increase in
common stock of $54.6 million. On December 13, 2004, the Companys board of directors declared a 2% stock dividend, for
stockholders of record as of December 30, 2004, and distributed on January 10, 2005. The effect of
the stock dividend was a decrease to retained earnings, an increase in paid-in-capital and an
increase in common stock of $45.8 million, $43.7 million and $2.1 million, respectively. On January 15, 2004, the Companys board of directors approved an increase in its annual
dividend payments to stockholders for 2004 to $0.14 per share (as adjusted). This represents an
increase of 26.31% over the dividends paid in 2003. On January 20, 2005, the Companys board of directors approved an increase in its annual
dividend payments to stockholders for 2005 to $0.19 per share. This represents an increase of
32.14% over the dividends paid in 2004. 33




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##### Table of Contents



The Companys cash dividends corresponding to 2004 and 2003 were as follows: RECORD DATE
    
    PAYABLE DATE
    
    AMOUNT PER SHARE(1)(2)YEAR 2004January 31, 2004
    
    February 17, 2004
    
    
    $0.01198February 29, 2004
    
    March 15, 2004
    
    
    0.01198March 31, 2004
    
    April 15, 2004
    
    
    0.01198April 30, 2004
    
    May 17, 2004
    
    
    0.01198May 31, 2004
    
    June 13, 2004
    
    
    0.01198June 30, 2004
    
    July 15, 2004
    
    
    0.01198July 31, 2004
    
    August 16, 2004
    
    
    0.01198August 31, 2004
    
    September 15, 2004
    
    
    0.01198September 30, 2004
    
    October 15, 2004
    
    
    0.01198October 29, 2004
    
    November 15, 2004
    
    
    0.01198November 30, 2004
    
    December 15, 2004
    
    
    0.01198December 31, 2004
    
    January 18, 2005
    
    
    0.01198Total
    
    
    
    
    $0.14376
 YEAR 2003January 31, 2003
    
    February 15, 2003
    
    
    $0.00783February 28, 2003
    
    March 15, 2003
    
    
    0.00961March 31, 2003
    
    April 15, 2003
    
    
    0.00961April 30, 2003
    
    May 15, 2003
    
    
    0.00961May 30, 2003
    
    June 13, 2003
    
    
    0.00961June 30, 2003
    
    July 15, 2003
    
    
    0.00961July 31, 2003
    
    August 15, 2003
    
    
    0.00961August 29, 2003
    
    September 15, 2003
    
    
    0.00961September 30, 2003
    
    October 15, 2003
    
    
    0.00961October 31, 2003
    
    November 14, 2003
    
    
    0.00961November 28, 2003
    
    December 15, 2003
    
    
    0.00961December 31, 2003
    
    January 15, 2004
    
    
    0.00987Total
    
    
    
    
    $0.11380
   (1)
    
    Adjusted to reflect a three-for-two stock split and a 2% stock dividend on the Companys
common stock declared on December 6, 2004 and December 13, 2004, respectively, both
distributed on January 10, 2005, and the three-for-two stock split and a 2% stock dividend
declared on November 4, 2003 and November 11, 2003, respectively, both distributed on December
10, 2003.(2)
    
    Prices in table are rounded to five decimal cents. Information concerning legal or regulatory restrictions on the payment of dividends by the
Company and Westernbank is contained under the caption
Dividend Restrictionsin Part I, Item 1. The Puerto Rico Internal Revenue Code of 1994, as amended, generally imposes a withholding tax
on the amount of any dividends paid by Puerto Rico corporations to individuals, whether residents
of Puerto Rico or not, trusts, estates, and special partnerships at a special 10% withholding tax
rate. Dividends distributed by Puerto Rico corporations to foreign corporations or partnerships not
engaged in trade or business in Puerto Rico are also generally subject to withholding tax at a 10%
rate. Prior to the first dividend distribution for the taxable year, such shareholders may elect to
be taxed on the dividends at the regular rates, in which case the special 10% tax will not be
withheld from such years distributions. 34




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##### Table of Contents



United States citizens who are non-residents of Puerto Rico will not be subject to Puerto Rico
tax on dividends if said individuals gross income from sources within Puerto Rico during the
taxable year does not exceed $1,300 if single, or $3,000 if married, and form AS 2732 of the Puerto
Rico Treasury Department Withholding Tax Exemption Certificate for the Purpose of Section 1147 is
filed with the withholding agent. U.S. income tax law permits a credit against the U.S. income tax
liability, subject to certain limitations, for certain foreign income taxes paid or deemed paid
with respect to such dividends. 
 ITEM 6. SELECTED FINANCIAL DATA The following selected consolidated financial data should be read in conjunction with the
Consolidated Financial Statements of the Company and the Notes thereto, appearing elsewhere in this
Form 10-K, and the information contained in Managements Discussion and Analysis of Financial
Condition and Results of Operations. The selected historical consolidated financial data as of the
end of and for each of the five years in the period ended December 31, 2004, are derived from the
Companys Consolidated Financial Statements which have been audited by the Company independent
registered public accounting firm. Years Ended December 31,2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000(Amounts in thousands, except per share data)Income Statement Data:Interest income
    
    $
    591,376
    
    
    $
    461,894
    
    
    $
    385,734
    
    
    $
    343,335
    
    
    $
    290,587Interest expense
    
    
    291,842
    
    
    
    222,586
    
    
    
    219,413
    
    
    
    218,269
    
    
    
    192,137Net interest income
    
    
    299,534
    
    
    
    239,308
    
    
    
    166,321
    
    
    
    125,066
    
    
    
    98,450Provision for loan losses
    
    
    (36,691
    )
    
    
    (27,048
    )
    
    
    (15,083
    )
    
    
    (12,278
    )
    
    
    (8,700
    )Net interest income after provision for loan losses
    
    
    262,843
    
    
    
    212,260
    
    
    
    151,238
    
    
    
    112,788
    
    
    
    89,750Noninterest income
    
    
    31,233
    
    
    
    6,646
    
    
    
    24,743
    
    
    
    18,181
    
    
    
    13,868Noninterest expenses
    
    
    (100,125
    )
    
    
    (84,821
    )
    
    
    (73,917
    )
    
    
    (60,310
    )
    
    
    (53,216
    )Income before income taxes
    
    
    193,951
    
    
    
    134,085
    
    
    
    102,064
    
    
    
    70,659
    
    
    
    50,402Income taxes
    
    
    22,086
    
    
    
    20,771
    
    
    
    16,101
    
    
    
    8,504
    
    
    
    5,814Net income
    
    
    171,865
    
    
    
    113,314
    
    
    
    85,963
    
    
    
    62,155
    
    
    
    44,588Preferred stock dividends
    
    
    27,158
    
    
    
    21,593
    
    
    
    13,774
    
    
    
    10,264
    
    
    
    5,799Net income available to common stockholders
    
    $
    144,707
    
    
    $
    91,721
    
    
    $
    72,189
    
    
    $
    51,891
    
    
    $
    38,789Share Data:Basic earnings per common share (1)
    
    $
    0.89
    
    
    $
    0.57
    
    
    $
    0.48
    
    
    $
    0.36
    
    
    $
    0.27Diluted earnings per common share (1)
    
    $
    0.86
    
    
    $
    0.55
    
    
    $
    0.47
    
    
    $
    0.36
    
    
    $
    0.27Cash dividend declared per common share (1)(2)
    
    $
    0.14
    
    
    $
    0.11
    
    
    $
    0.09
    
    
    $
    0.07
    
    
    $
    0.05Period end number of common shares outstanding (1)
    
    
    163,919
    
    
    
    162,624
    
    
    
    159,992
    
    
    
    145,721
    
    
    
    145,727Weighted average number of common
shares outstanding (1)
    
    
    163,348
    
    
    
    160,734
    
    
    
    150,712
    
    
    
    145,727
    
    
    
    146,178Weighted average number of common shares
outstanding on a fully diluted basis (1)
    
    
    170,443
    
    
    
    165,330
    
    
    
    152,491
    
    
    
    146,139
    
    
    
    146,178Cash dividends declared on common shares
    
    $
    23,502
    
    
    $
    18,322
    
    
    $
    14,045
    
    
    $
    10,375
    
    
    $
    8,307Dividends payout ratio
    
    
    16.24
    %
    
    
    19.97
    %
    
    
    19.46
    %
    
    
    19.99
    %
    
    
    21.42
    %
 35




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##### Table of Contents



Years Ended December 31,2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000(Amounts in thousands, except per share data)Performance ratios:Return on assets (3)
    
    
    1.33
    %
    
    
    1.15
    %
    
    
    1.22
    %
    
    
    1.22
    %
    
    
    1.17
    %Return on common stockholders equity (3)
    
    
    28.55
    
    
    
    22.79
    
    
    
    25.39
    
    
    
    27.49
    
    
    
    24.75Efficiency ratio
    
    
    30.51
    
    
    
    31.75
    
    
    
    39.15
    
    
    
    41.97
    
    
    
    47.14Operating expenses to total end-of-period assets
    
    
    0.70
    
    
    
    0.74
    
    
    
    0.90
    
    
    
    1.02
    
    
    
    1.25Net yield on interest-earning assets
    
    
    2.40
    
    
    
    2.55
    
    
    
    2.35
    
    
    
    2.63
    
    
    
    2.75Balance Sheet Data:Total assets
    
    $
    14,336,662
    
    
    $
    11,519,440
    
    
    $
    8,205,077
    
    
    $
    5,888,194
    
    
    $
    4,260,857Federal funds sold and resell agreements
    
    
    1,017,303
    
    
    
    649,852
    
    
    
    459,147
    
    
    
    156,133
    
    
    
    169,309Investments securities held to maturity,
securities available for sale and trading securities
    
    
    6,929,260
    
    
    
    5,778,790
    
    

    
    3,661,944
    
    
    
    2,656,066
    
    
    
    1,686,654Loans-net
    
    
    5,941,233
    
    
    
    4,683,118
    
    
    
    3,754,357
    
    
    
    2,838,404
    
    
    
    2,203,660Total liabilities
    
    
    13,254,983
    
    
    
    10,690,931
    
    
    
    7,620,329
    
    
    
    5,500,285
    
    
    
    4,010,239Total deposits
    
    
    6,231,211
    
    
    
    5,385,476
    
    
    
    4,298,744
    
    
    
    3,233,912
    
    
    
    2,636,695Federal funds purchased and repurchase agreements
    
    
    6,683,527
    
    
    
    5,046,045
    
    
    
    3,097,341
    
    
    
    2,059,646
    
    
    
    1,179,073Stockholders equity
    
    
    1,081,679
    
    
    
    828,509
    
    
    
    584,748
    
    
    
    387,909
    
    
    
    250,618Capital Ratios:Total capital to risk-weighted assets
    
    
    15.70
    %
    
    
    14.87
    %
    
    
    13.83
    %
    
    
    12.65
    %
    
    
    11.73
    %Tier I capital to risk-weighted assets
    
    
    14.78
    
    
    
    13.98
    
    
    
    12.93
    
    
    
    11.64
    
    
    
    10.65Tier I capital to average assets
    
    
    7.72
    
    
    
    7.22
    
    
    
    7.21
    
    
    
    7.17
    
    
    
    6.02Equity-to-asset ratio (3)
    
    
    7.39
    
    
    
    7.16
    
    
    
    6.90
    
    
    
    6.29
    
    
    
    6.21Asset Quality Ratios:Total
non-performing loans and foreclosed real estate
held for sale as a percentage of total assets at end of period
    
    
    0.27
    %
    
    
    0.31
    %
    
    
    0.28
    %
    
    
    0.29
    %
    
    
    0.28
    %Total non-performing loans as a percentage of
loans at end of period
    
    
    0.57
    
    
    
    0.66
    
    
    
    0.51
    
    
    
    0.49
    
    
    
    0.43Net loans charged-off to average total loans (4)
    
    
    0.34
    
    
    
    0.29
    
    
    
    0.19
    
    
    
    0.23
    
    
    
    0.19Allowance for loan losses to total loans at end of period
    
    
    1.33
    
    
    
    1.30
    
    
    
    1.24
    
    
    
    1.33
    
    
    
    1.29Allowance for loan losses to non-performing loans
    
    
    233.64
    
    
    
    197.17
    
    
    
    242.80
    
    
    
    271.83
    
    
    
    298.53
   (1)
    
    Adjusted to reflect a three-for-two stock split and a 2% stock dividend on the Companys
common stock declared in December 2004, both distributed on January 10, 2005; the
three-for-two stock split and a 2% stock dividend declared in November 2003, both distributed
on December 10, 2003; and the three-for-two stock split declared in June 2002 and distributed
on July 10, 2002.(2)
    
    Cash dividends amounts are rounded.(3)
    
    The return on assets is computed dividing net income by average total assets for the period.
The return on common stockholders equity is computed by dividing net income less preferred stock dividends
by average common stockholders equity for the period. The equity-to-asset ratio is computed by dividing
average equity by average total assets. Average balances have been computed using beginning and
period-end balances.(4)
    
    Average balances were computed using beginning and period-end balances. 36




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ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Managements Discussion and Analysis of Financial Condition and Results of Operations analyzes
the major elements of the Companys consolidated financial statements and should be read in
conjunction with the Consolidated Financial Statements of the Company and Notes thereto and other
detailed information appearing elsewhere in this Annual Report. FOR THE YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002 OVERVIEW Total assets at December 31, 2004, 2003 and 2002 were $14.34 billion, $11.52 billion, and
$8.21 billion, respectively. This growth was driven by increases in the Companys loan and
investment portfolios. Loans receivable-net grew by $1.26 billion for the year ended December 31,
2004, when compared to the previous year, resulting from the Companys continued strategy of
growing its commercial loan portfolio through commercial real estate, asset-based, unsecured
business and construction lending, as well as its consumer loan portfolios. The investment
portfolio, excluding money market instruments, increased $1.15 billion, from $5.78 billion in 2003,
to $6.93 billion in 2004. The investment portfolio was $3.66 billion at December 31, 2002. Total
deposits reached $6.23 billion, from $5.39 billion at December 31, 2003, and $4.30 billion at year
end 2002. Net income was $171.9 million, $113.3 million and $86.0 million and earnings per basic common
share were $0.89 ($0.86 on a diluted basis), $0.57 ($0.55 on a diluted basis) (split and stock
dividend adjusted), and $0.48 ($0.47 on a diluted basis) (split and stock dividend adjusted) for
the years 2004, 2003 and 2002, respectively. This increase in net income was primarily the result
of strong loan and investment securities growth, maintaining strong asset quality and expense
control and resulting in returns on average assets (ROA) of 1.33%, 1.15% and 1.22% and returns on
average common stockholders equity (ROCE) of 28.55%, 22.79%, and 25.39% for the years ended
2004, 2003 and 2002, respectively. RESULTS OF OPERATIONS NET INTEREST INCOME The Companys principal source of earnings is its net interest income. This is the difference
between interest income on loans and invested assets (interest-earning assets) and its interest
expense on deposits and borrowings, including federal funds purchased and repurchase agreements and
advances from the FHLB (interest-bearing liabilities). Loan origination and commitments fees, net
of related costs, are deferred and amortized over the life of the related loans as a yield
adjustment. Gains or losses on the sale of loans and investments, service charges, fees and other
income, also affect income. In addition, the Companys net income is affected by the level of its
non-interest expenses, such as the provision for loan losses, compensation, employees benefits,
occupancy costs, other operating expenses and income taxes. The main objective of the Companys asset-liability management program is to invest funds
judiciously and reduce interest rate risks while optimizing net income and maintaining adequate
liquidity levels. The Company uses several tools to manage the risks associated with the
composition and repricing of assets and liabilities. Therefore, management has followed a
conservative practice inclined towards the preservation of capital with adequate returns. The
Companys Investment Committee, which includes the entire Board of Directors and senior management,
is responsible for the asset-liability management oversight. The Investment Department is
responsible for implementing the policies established by the Investment Committee. 2004 VERSUS 2003.Net interest income for the year ended December 31, 2004 was $299.5 million,
an increase of $60.2 million, or 25.17%, from $239.3 million for the prior year. The increase in
2004 was the result of increases in interest income from loans and investment securities, mainly in
tax-exempt securities, which was partially offset by increases in interest expense on deposits and
on federal funds purchased and repurchase agreements. 37




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##### Table of Contents



Average interest-earning assets for the year ended December 31, 2004 increased by $3.10
billion or 33.06%, compared to the previous year, primarily driven by a rise in the average loan
portfolio of $1.12 billion, particularly due to increases in the portfolio of commercial real
estate, construction and in the other commercial loans portfolio, and an increase of $1.77 billion
or 38.67% in the average investment portfolio, mainly in tax-exempt securities, such as U.S.
Government and agencies obligations. Notwithstanding, average yields decreased from 4.92% in year
2003, to 4.74% for the year ended 2004. The decrease in the average yield was mainly due to a lower
average yield earned on the loans portfolio, primarily due to a higher volume of commercial real
estate loans and other commercial loans with floating rates. The decrease in the average yield
earned on the loans portfolio was partially offset by higher reinvestment rates on matured and
called securities, and higher yields earned in money market instruments. Reinvestment rates for new
securities were higher when compared to the previous periods, except for the last quarter of 2004,
as the U.S. Treasury yield curve initially steepened ahead of the reaction by the Federal Reserve
which started to increase interest rates in the second week of August 2004. As a result of this
lagging factor, yields earned on floating rate loans were not adjusted as fast as on investment
securities since the Prime Rate (an index used by Westernbank to re-price most of its loans) was
raised at a slower pace following the Federal Reserve action. More recently, during last quarter of
2004, reinvestment rates decreased, primarily due to the flattening of the U.S. Treasury yield
curve. The impact of the strong growth in average interest-earning assets was in part offset by an
increase in the average interest-bearing liabilities of $2.95 billion or 33.49% for the year 2004,
when compared to 2003. The overall cost of funds decreased from 2.53% in 2003, to 2.48% in 2004,
mainly due to certain liabilities that became due during the current year that were of longer terms
and higher costs. These liabilities were part of the strategy in previous periods of increasing the
maturities of a portion of Westernbanks liabilities in anticipation of rising interest rates. As
explained in the preceding paragraph, cost of rates for deposits adjusted immediately as the LIBOR
rate (an index used by Westernbank to re-price its deposits) increased by market conditions
following the change in the U.S. Treasury yield curve. Interest-bearing deposits grew in average by
$1.14 billion during the year 2004, while other borrowings in average (federal funds purchased,
repurchase agreements and advances from FHLB) increased by $1.81 billion for the same period. The Companys net yield on interest-earning assets decreased 15 basis points in 2004, to
2.40%. The decrease in the net interest margin was mainly attributed to a decrease in our loan
portfolio yield and an increase in the rate paid in our deposits. This decrease was partially
offset by an increase in the investment securities yield and a decrease in the rate paid in our
borrowings, as previously explained. 2003 VERSUS 2002.Net interest income for the year ended December 31, 2003 was $239.3 million,
an increase of $73.0 million, or 43.88%, from $166.3 million for the same period in previous year.
The increase in 2003 was the result of increases in interest income from loans, investment
securities and money market instruments, which was partially offset by increases in interest
expense on deposits and repurchase agreements. Average interest-earning assets for the year ended 2003 increased by $2.29 billion or 32.33%,
compared to the same period in previous year, primarily driven by a rise in the average loan
portfolio of $963.0 million, particularly a very diversified growth from all lines of loans and an
increase of $1.33 billion or 35.21% in the average investment portfolio, mainly U.S. Government and
agencies obligations and mortgage-backed securities. Notwithstanding, average yields decreased from
5.44% in year 2002 to 4.92% for the year ended 2003. The decrease on average yields was primarily
due to continued low market interest rates affecting our loan repricing, primarily our commercial
loan portfolio with floating rates and the reinvestment rates on matured, called and purchased
securities. The impact of the strong growth in average interest-earning assets was in part offset by an
increase in the average interest-bearing liabilities of $2.16 billion or 32.53% for the year 2003
when compared to 2002. In order to offset such increase, the Company managed its liability costs
carefully, decreasing the overall cost of rates paid from 3.30% in 2002 to 2.53% in 2003, while
continuing to offer competitive rates. Interest-bearing deposits grew in average by $1.08 billion
during the year 2003, while other borrowings in average (principally federal funds purchased and
repurchase agreements) increased by $1.08 billion for the same period. The Companys net yield on interest-earning assets increased 20 basis points in 2003 to 2.55%,
in spite of industry wide interest margin compression pressures. 38




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##### Table of Contents



The following table presents, for the periods indicated, the total dollar amount of interest
income from average interest-earning assets and the resultant yields, as well as the interest
expense on average interest-bearing liabilities, expressed both in dollars and rates, as well as in
a normal and tax equivalent basis. Average balances are daily average balances. The yield on the
securities portfolio is based on average historical cost balances and does not give effect to
changes in fair value that are reflected as a component of consolidated shareholders equity. YEARS ENDED DECEMBER 31,2004
    
    
    2003
    
    
    2002Average balance
    
    
    Average
    
    
    
    
    
    
    Average balance
    
    
    Average
    
    
    
    
    
    
    Average balance
    
    
    AverageInterest
    
    
    (1)
    
    
    Yield / Rate
    
    
    Interest
    
    
    (1)
    
    
    Yield / Rate
    
    
    Interest
    
    
    ( 1)
    
    
    Yield / Rate(Dollars in Thousands)Normal Spread:Interest-earning assets:Loans, including loan fees (2)
    
    $
    322,164
    
    
    $
    5,401,955
    
    
    
    5.96
    %
    
    $
    275,848
    
    
    $
    4,278,468
    
    
    
    6.45
    %
    
    $
    220,676
    
    
    $
    3,315,514
    
    
    
    6.66
    %Investment securities (3)
    
    
    212,213
    
    
    
    5,400,997
    
    
    
    3.93
    
    
    
    134,273
    
    
    
    3,571,299
    
    
    
    3.76
    
    
    
    112,759
    
    
    
    2,600,210
    
    
    
    4.34Mortgage and asset-
backed securities (3)
    
    
    37,489
    
    
    
    935,421
    
    
    
    4.01
    
    
    
    40,140
    
    
    
    998,257
    
    
    
    4.02
    
    
    
    44,848
    
    
    
    859,991
    
    
    
    5.21Money market instruments
    
    
    19,510
    
    
    
    745,828
    
    
    
    2.62
    
    
    
    11,633
    
    
    
    534,444
    
    
    
    2.18
    
    
    
    7,451
    
    
    
    314,633
    
    
    
    2.37Total
    
    
    591,376
    
    
    
    12,484,201
    
    
    
    4.74
    
    
    
    461,894
    
    
    
    9,382,468
    
    
    
    4.92
    
    
    
    385,734
    
    
    
    7,090,348
    
    
    
    5.44Interest-bearing liabilities:Deposits
    
    
    143,860
    
    
    
    5,909,274
    
    
    
    2.43
    
    
    
    114,755
    
    
    
    4,768,490
    
    
    
    2.41
    
    
    
    114,374
    
    
    
    3,690,242
    
    
    
    3.10Federal funds purchased and
repurchase agreements
    
    
    141,414
    
    
    
    5,676,595
    
    
    
    2.49
    
    
    
    101,652
    
    
    
    3,891,972
    
    
    
    2.61
    
    
    
    98,233
    
    
    
    2,815,608
    
    
    
    3.49Advances from FHLB
    
    
    6,568
    
    
    
    164,245
    
    
    
    4.00
    
    
    
    6,037
    
    
    
    137,838
    
    
    
    4.38
    
    
    
    6,202
    
    
    
    120,008
    
    
    
    5.17Other borrowings
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    142
    
    
    
    3,698
    
    
    
    3.85
    
    
    
    604
    
    
    
    15,469
    
    
    
    3.90Total
    
    
    291,842
    
    
    
    11,750,114
    
    
    
    2.48
    
    
    
    222,586
    
    
    
    8,801,998
    
    
    
    2.53
    
    
    
    219,413
    
    
    
    6,641,327
    
    
    
    3.30Net interest income
    
    $
    299,534
    
    
    
    
    
    
    
    
    
    
    $
    239,308
    
    
    
    
    
    
    
    
    
    
    $
    166,321Interest rate spread
    
    
    
    
    
    
    
    
    
    
    2.26
    %
    
    
    
    
    
    
    
    
    
    
    2.39
    %
    
    
    
    
    
    
    
    
    
    
    2.14
    %Net interest-earning assets
    
    
    
    
    
    $
    734,087
    
    
    
    
    
    
    
    
    
    
    $
    580,470
    
    
    
    
    
    
    
    
    
    
    $
    449,021Net yield on interest-earning
assets (4)
    
    
    
    
    
    
    
    
    
    
    2.40
    %
    
    
    
    
    
    
    
    
    
    
    2.55
    %
    
    
    
    
    
    
    
    
    
    
    2.35
    %Interest-earning assets to
interest-bearing liabilities ratio
    
    
    
    
    
    
    106.25
    %
    
    
    
    
    
    
    
    
    
    
    106.59
    %
    
    
    
    
    
    
    
    
    
    
    106.76
    %Tax Equivalent Spread:Interest-earnings assets
    
    $
    591,376
    
    
    $
    12,484,201
    
    
    
    4.74
    %
    
    $
    461,894
    
    
    $
    9,382,468
    
    
    
    4.92
    %
    
    $
    385,734
    
    
    $
    7,090,348
    
    
    
    5.44
    %Tax equivalent adjustment
    
    
    53,555
    
    
    
    
    
    
    
    0.43
    
    
    
    31,522
    
    
    
    
    
    
    
    0.34
    
    
    
    23,704
    
    
    
    
    
    
    
    0.33Interest-earning assets -
tax equivalent
    
    
    644,931
    
    
    
    12,484,201
    
    
    
    5.17
    
    
    
    493,416
    
    
    
    9,382,468
    
    
    
    5.26
    
    
    
    409,438
    
    
    
    7,090,348
    
    
    
    5.77Interest-bearing liabilities
    
    
    291,842
    
    
    $
    11,750,114
    
    
    
    2.48
    
    
    
    222,586
    
    
    $
    8,801,998
    
    
    
    2.53
    
    
    
    219,413
    
    
    $
    6,641,327
    
    
    
    3.30Net interest income
    
    $
    353,089
    
    
    
    
    
    
    
    
    
    
    $
    270,830
    
    
    
    
    
    
    
    
    
    
    $
    190,025Interest rate spread
    
    
    
    
    
    
    
    
    
    
    2.69
    %
    
    
    
    
    
    
    
    
    
    
    2.73
    %
    
    
    
    
    
    
    
    
    
    
    2.47
    %Net yield on interest-
earning assets (4)
    
    
    
    
    
    
    
    
    
    
    2.83
    %
    
    
    
    
    
    
    
    
    
    
    2.89
    %
    
    
    
    
    
    
    
    
    
    
    2.68
    %
   (1)
    
    Average balance on interest-earning assets and
interest-bearing liabilities is computed using daily
monthly average balances during the periods.(2)
    
    Average loans exclude non-performing loans. Loans fees, net amounted to $10.6 million;
$8.7 million and $5.6 million for the years ended December 31, 2004, 2003 and 2002,
respectively.(3)
    
    Includes trading and available for sale securities.(4)
    
    Net interest income divided by average interest-earning assets. 39




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##### Table of Contents



The following table presents the dollar amount of changes in interest income and interest
expense for the major components of interest-earning assets and interest-bearing liabilities and
distinguishes between the increase (decrease) related to higher outstanding balances and the
volatility of interest rates. Year ended December 31,2004 vs. 2003
    
    
    2003 vs. 2002Volume
    
    
    Rate
    
    
    Total
    
    
    Volume
    
    
    Rate
    
    
    Total(In thousands)Interest income:Loans
    
    $
    64,831
    
    
    $
    (18,515
    )
    
    $
    46,316
    
    
    $
    61,842
    
    
    $
    (6,670
    )
    
    $
    55,172Investment securities (1)
    
    
    71,641
    
    
    
    6,299
    
    
    
    77,940
    
    
    
    33,413
    
    
    
    (11,899
    )
    
    
    21,514Mortgage and asset-backed
securities (1)
    
    
    (2,519
    )
    
    
    (132
    )
    
    
    (2,651
    )
    
    
    11,103
    
    
    
    (15,811
    )
    
    
    (4,708
    )Money market instruments
    
    
    5,216
    
    
    
    2,661
    
    
    
    7,877
    
    
    
    4,828
    
    
    
    (646
    )
    
    
    4,182Total increase (decrease)
in interest income
    
    
    139,169
    
    
    
    (9,687
    )
    
    
    129,482
    
    
    
    111,186
    
    
    
    (35,026
    )
    
    
    76,160Interest expense:Deposits
    
    
    27,757
    
    
    
    1,348
    
    
    
    29,105
    
    
    
    1,618
    
    
    
    (1,237
    )
    
    
    381Federal funds purchased and
repurchase agreements
    
    
    44,217
    
    
    
    (4,455
    )
    
    
    39,762
    
    
    
    9,985
    
    
    
    (6,566
    )
    
    
    3,419Advances from FHLB
    
    
    972
    
    
    
    (441
    )
    
    
    531
    
    
    
    6,304
    
    
    
    (6,469
    )
    
    
    (165
    )Other borrowings
    
    
    (142
    )
    
    
    
    
    
    
    (142
    )
    
    
    (453
    )
    
    
    (9
    )
    
    
    (462
    )Total increase (decrease) in
interest expense
    
    
    72,804
    
    
    
    (3,548
    )
    
    
    69,256
    
    
    
    17,454
    
    
    
    (14,281
    )
    
    
    3,173Increase (decrease) in
net interest income
    
    $
    66,365
    
    
    $
    (6,139
    )
    
    $
    60,226
    
    
    $
    93,732
    
    
    $
    (20,745
    )
    
    $
    72,987
   (1)
    
    Includes trading and available for sale securities. PROVISION FOR LOAN LOSSES The 2004 provision for loan losses was $36.7 million, an increase of $9.6 million from 2003.
Net charge-offs during 2004 amounted to $18.2 million, which when subtracted from the provision for
loan losses of $36.7 million resulted in a net increase in the allowance for loan losses of $18.5
million. The provision for the year ended 2003 was $27.0 million, an increase of $12.0 million from
the year ended December 31, 2002. Net charge-offs during 2003 amounted to $12.5 million, which when
subtracted from the provision for loan losses of $27.0 million resulted in a net increase in the
allowance for loan losses of $14.5 million. The allowance for loan losses is maintained at a level which, in managements judgment, is
adequate to absorb credit losses inherent in the loan portfolio. The amount of the allowance is
based on managements evaluation of various conditions as the existing general economic and
business conditions affecting key lending areas; terms, nature and volume of the portfolio, credit
quality trends including trends in non-performing loans expected to result from existing
conditions, evaluation of the collectibility of the loan portfolio, collateral values, credit
concentrations, trends in historical loss experience, specific impaired loans and delinquency
trends, among other factors. This evaluation is inherently subjective as it requires estimates that
are susceptible to significant revision as more information becomes available. Allowances for
impaired loans are generally determined based on collateral values or the present value of
estimated cash flows. Although no assurance can be given, management believes that the present
allowance for loan losses is adequate considering loss experience, delinquency trends and current
economic conditions. Management regularly reviews the Companys loan loss allowance as its loan
portfolio grows and diversifies. For a more detailed discussion of the factors affecting the
provision for loan losses and changes in the underlying factors affecting the components of the
Allowance for Loan Losses refer to Financial Condition  Allowance for Loan Losses and to Part I,
Item I, Business  Allowance for Loan losses on
page 8. The increase in the provision for loan losses from 2003 to 2004 was mainly attributable to the
overall growth in the Companys loan portfolio, particularly its commercial real estate loan
portfolio, the loan portfolio of its asset-based lending division, Westernbank Business Credit, and the provision associated with the loan portfolio of the Expresso of
Westernbank. The provision for loan losses for the commercial loan portfolio grew by $8.7 million
or 78.47%, from 2003 to 2004. This was primarily due to the increase in the loan portfolio of
Westernbank Business Credit and the strong growth of the Companys commercial real estate loan
portfolio. The provision for loan losses for Westernbank Business Credit accounted for $6.0 million
or 30.35% of the total provision for loan losses 40




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##### Table of Contents



in the commercial loan portfolio for the year
ended December 31, 2004, while for year 2003, it accounted for $2.1 million or 12.43% of the total
provision for loan losses in the commercial loan portfolio. The provision for loan losses for the
consumer loan portfolio grew by $262,000, from 2003 to 2004. The slight increase was primarily due
to the relatively stable delinquency levels at the regular consumer loans portfolio and the
decrease in the loan portfolio of the Expresso of Westernbank. The decrease in the Expresso of
Westernbank loan portfolio was mainly due to managements strategy of stabilizing charge-offs as
the division portfolio matures and average yield continue to increase. At December 31, 2004, the allowance for loan losses was $80.1 million or 1.33% of total loans,
and 233.64% of total non-performing loans (reserve coverage), compared to an allowance for loan
losses at December 31, 2003 of $61.6 million or 1.30% of total loans, and 197.17% of total
non-performing loans. The reserve coverage increased from 197.17% in 2003, to 233.64% in 2004. The
increase was principally due to the increase in the allowance for loan losses, as a result of
increases in the commercial real estate loans portfolio and other commercial loans portfolio,
particularly the loan portfolio of Westernbank Business Credit. During 2004, net charge-offs amounted to $18.2 million, an increase of $5.7 million from $12.6
million in 2003. Net charge-offs to average loans increased to 0.34% in 2004, compared to 0.29% in
2003. Accounts amounting to $22.2 million were written-off against the allowance for loan losses in
2004, compared to $14.9 million in 2003, an increase of $7.3 million. The increase in net
charge-offs was primarily due to loans charged-off in the ordinary course of business, mainly in
our consumer loan portfolio. The increase in consumer loans charged-off for the year ended December
31, 2004, was principally due to loans charged-off by the Expresso of Westernbank Division
amounting to $12.4 million, compared to charge-offs of $7.9 million for 2003. The accounts
written-off are submitted to the Collections Department recovery unit for continued collection
efforts. Recoveries made from accounts previously written-off amounted to $4.0 million in 2004 and
$2.3 million in 2003. The increase in the provision for loan losses from 2002 to 2003 was primarily attributed to
the overall strong growth in the Companys loan portfolio and particularly those of Westernbanks
newest Divisions: Westernbank Business Credit and Expresso of Westernbank. The provision for loan
losses for the commercial loan portfolio grew by $988,000 or 9.80%, from 2002 to 2003. This was
primarily due to the increase in the loan portfolio of Westernbank Business Credit and the strong
growth of the Companys commercial real estate loans portfolio. The provision for loan losses for
Westernbank Business Credit accounted for $2.1 million in 2003 and $1.5 million in 2002 of the
total provision for loan losses in the commercial loan portfolio. The provision for loan losses
for the consumer loan portfolio grew by $9.4 million or 124.39%, from 2002 to 2003. This increase
was primarily due to an increase in the average outstanding loan portfolio of the Expresso of
Westernbank, in addition to the strong growth of the Companys other consumer loan (principally
collateralized by real estate) portfolio. During 2003, net charge-offs amounted to $12.5 million, an increase of $6.2 million, from $6.3
million in 2002. Net charge-offs to average loans increased to 0.29% in 2003 compared to 0.19% in
2002. Accounts amounting to $14.9 million were written-off against the allowance for loan losses in
2003, compared to $8.0 million in 2002, an increase of $6.9 million. The increase in net
charge-offs was primarily due to loans charged-off in the ordinary course of business in our
consumer loan portfolio. The increase in consumer loans charged-off for the year ended December 31,
2003, was principally due to loans charged-off by the Expresso of Westernbank Division amounting to
$7.9 million, compared to write offs of $62,000 for 2002 (Expresso of Westernbank began operations
in July 2002). The accounts written-off are submitted to the Collections Department recovery unit
for continued collection efforts. Recoveries made from accounts previously written-off amounted to
$2.3 million in 2003 and $1.6 million in 2002. NONINTEREST INCOME Noninterest income, excluding derivative transactions and net gain (loss) on sales and
valuation of loans, securities and other assets, grew $780,000, during the year ended December 31,
2004, when compared to $27.8 million in year 2003. Noninterest income also grew $5.3 million or
23.67% during the year ended December 31, 2003, when compared to $22.5 million in year 2002. The
increases for the years ended December 31, 2004 and 2003 were primarily driven by higher activity
associated with service charges on loans and deposit accounts and other fees, including fees
associated to the trust division, insurance commissions earned by Westernbank Insurance Corp., and
fees generated by the asset-based lending operation as well as increases in other areas resulting
from the Companys overall growing volume of business. The increase in other income for 2003 was
partially offset by a net loss on sales and valuation of loans, securities and other assets of
$22.7 million ($17.0 million net of tax) recorded during the first half of year 2003, related to
the corporate bond and loan obligations (CBOs and CLOs) portfolio liquidated on June 6, 2003.
See Note 3  Investment Securities (page 85)  to the audited consolidated financial statements, included in Part II,
Item 8, and Financial Condition - Investments section on page 50. 41




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NONINTEREST EXPENSES Total noninterest expenses increased $15.3 million or 18.04% and $10.9 million or 14.75% in
2004 and 2003, respectively. Salaries and employees benefits accounted for the majority of such increase, rising $4.5
million or 13.23% for the year 2004, as compared to the corresponding period in 2003, which also
increased $5.8 million or 20.78% from $28.0 million during 2002. Such increases are attributed to
the continued expansion of the Company, including increases in personnel, normal salary increases
and related employees benefits, principally attributed to our continued expansion in the San Juan
Metropolitan area. At December 31, 2004, the Company had 1,175 full-time employees, including its
executive officers, an increase of 83 employees or 7.60%, when compared to the prior year. New
personnel and additional infrastructure were added to support the continued expansion of the
Company. At December 31, 2002, the Company had 1,031 full-time employees, including its executive
officers, increasing to 1,092 employees by the end of year 2003. Advertising expense increased $3.8 million or 56.88% for the year ended December 31, 2004,
when compared to $6.7 million in year 2003. Advertising expense for year 2002 amounted to $6.9
million. The increase in 2004 was principally due to various radio, newspaper and television
campaigns promoting Westernbanks institutional image and positioning the Company for its strategy
in the San Juan Metropolitan area, as well as 2004 promotional campaigns for several Westernbanks
products. Noninterest expenses, as a group, excluding salaries and employees benefits and advertising,
increased $7.0 million or 15.85%, during the year ended December 31, 2004, from $44.3 million in
2003, to $51.3 million in 2004, compared to an increase of $5.2 million or 13.44%, from $39.0
million in 2002. These increases resulted primarily from costs associated with the additional
investment in technology and general infrastructure to sustain and coordinate the Companys growth
and expansion in all of its business areas. The Company continued its strict cost control measures, maintaining operating expenses at
adequate levels, as evidenced by its improving efficiency ratios of 30.51%, 31.75% and 39.15% for
the years 2004, 2003 and 2002, respectively. PROVISION FOR INCOME TAXES Under Puerto Rico income tax laws, the Company is required to pay the higher of an alternative
minimum tax of 22% or regular statutory rates raging from 20% to 39%. The provision for income
taxes for the year ended December 31, 2004 amounted to $22.1 million, compared to $20.8 million in
2003 and $16.1 million in 2002. The current provision for Puerto Rico income taxes for the year
ended December 31, 2004 amounted to $28.2 million, compared to $29.3 million in 2003 and $18.6
million in 2002. The increase in the income before the provision for income taxes in 2004 includes
an increase in the Companys exempt interest income derived from a significant investment in tax
exempt securities, primarily in U.S. Government and Agencies Obligations, the interest of which is
exempt under Puerto Rico income tax laws. Also, activities relating to the Westernbank
International division are exempt from income tax purposes. As a result, the Companys effective
tax rate is substantially below the statutory rate, being 11.00%, 15.00% and 16.00% for the years
ended December 31, 2004, 2003 and 2002, respectively. The decrease in the effective tax rate for
the year 2004 is attributable to the significant increase in the Companys exempt interest income.
The 15.00% and 16.00% effective tax rate for the years 2003 and 2002, respectively, was
attributable to higher levels of taxable income resulting from new lines of business commenced in
2001 and 2002. Deferred income taxes reflect the impact of credit, operating and capital losses
carryforwards, and temporary differences between amounts of assets and liabilities for financial
reporting purposes and their respective tax bases. The deferred income tax credit decreased in 2004
and increased in 2003, since in 2003 the Company recorded a deferred income tax asset related to a
capital loss carryforward on the liquidation of the Companys CBOs and CLOs portfolio which is
available to offset capital gains in future years (See Note 11 
Income Taxes (page 98)  to the audited
consolidated financial statements, included in Part II, Item 8). NET INCOME The Companys net income increased $58.6 million or 51.67% from 2003 to 2004 and $27.4 million
or 31.82% from 2002 to 2003. The increase in both years resulted from an increase in net interest
income and noninterest income, which was partially offset by increases in total noninterest
expenses, in the provisions for loan losses and income taxes. Net income for the year 2003 was
affected by the net loss of $22.7 million ($17.0 million net of tax) recorded in the first semester
of 2003, relating to the Companys investment in CBOs and CLOs. 42




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##### Table of Contents



FINANCIAL CONDITION LOANS Loans receivable-net were $5.94 billion or 41.44% of total assets at December 31, 2004, an
increase of $1.26 billion, or 26.86%, from December 31, 2003. Loans, net were $4.68 billion or
40.65% of total assets at December 31, 2003, increasing $928.8 million or 24.74%, from $3.75
billion or 45.76% of total assets at December 31, 2002. The Company continues to focus on growing its commercial loans portfolio through commercial
real estate, construction loans, asset-based lending and other commercial loans. As a result, the
portfolio of real estate loans secured by first mortgages increased from $2.67 billion as of
December 31, 2002, to $3.36 billion as of December 31, 2003, further increasing to $4.39 billion as
of December 31, 2004. Commercial real estate loans secured by first mortgages were $3.15 billion at
December 31, 2004, an increase of $893.2 million or 39.50% from December 31, 2003. Commercial real
estate loans secured by first mortgages were $2.26 billion at December 31, 2003, an increase of
$613.9 million or 37.26%, from $1.65 billion at December 31, 2002. Consumer loans (including credit
cards, loans on deposits and other loans) and commercial loans (principally collateralized by other
than real estate) increased from $1.13 billion as of December 31, 2002, to $1.39 billion as of
December 31, 2003, to $1.64 billion as of December 31, 2004. Westernbanks commercial real estate and other loans are primarily variable and adjustable
rate products. Commercial loan originations come from existing customers as well as through direct
solicitation and referrals. Westernbank offers different types of consumer loans, including secured
and unsecured products, in order to provide a full range of financial services to its retail
customers. In addition, Westernbank offers VISA  and Master Card  accounts to its customers. During the past five years, loans have grown at an average annualized rate of 26.07%. As of
December 31, 2004, commercial loans were 66.03% (80.40% collateralized by real estate) and consumer
loans were 14.59% (67.50% collateralized by real estate) of the $5.94 billion loan portfolio-net,
compared to commercial loans of 59.49% (81.16% collateralized by real estate) and consumer loans of
18.40% (60.51% collateralized by real estate) of the $4.68 billion loan portfolio-net as of
December 31, 2003. This has enabled Westernbank to shift its asset composition to assets with
shorter maturities and greater repricing flexibility. The Company has also continued to diversify
Westernbanks sources of revenue, while maintaining its status as a secured lender, with
approximately 83% of its loans collateralized by real estate as of December 31, 2004. As of
December 31, 2004, Westernbank Business Credit and Expresso of Westernbank divisions loan
portfolios amounted to $831.1 million and $144.0 million, respectively. For the years ended
December 31, 2004 and 2003, the average yields of Westernbank Business Credit and the Expresso of
Westernbank loan portfolios were 6.21% and 5.50%, and 20.34% and 18.41%, respectively. The following table sets forth the composition of the Westernbanks loans portfolio at the
dates indicated. At December 31,2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000Amount
    
    
    Percent
    
    
    Amount
    
    
    Percent
    
    
    Amount
    
    
    Percent
    
    
    Amount
    
    
    Percent
    
    
    Amount
    
    
    Percent(Dollars in thousands)Residential real estate:Mortgage
    
    $
    902,937
    
    
    
    15.2
    %
    
    $
    894,007
    
    
    
    19.1
    %
    
    $
    844,803
    
    
    
    22.5
    %
    
    $
    847,462
    
    
    
    29.9
    %
    
    $
    781,213
    
    
    
    35.5
    %Construction
    
    
    328,145
    
    
    
    5.5
    
    
    
    202,600
    
    
    
    4.3
    
    
    
    181,266
    
    
    
    4.8
    
    
    
    117,957
    
    
    
    4.2
    
    
    
    80,905
    
    
    
    3.7Commercial, industrial
and agricultural (1):Real estate
    
    
    3,154,679
    
    
    
    53.1
    
    
    
    2,261,465
    
    
    
    48.3
    
    
    
    1,647,602
    
    
    
    38.9
    
    
    
    1,115,700
    
    
    
    39.3
    
    
    
    887,084
    
    
    
    40.2Business and others
    
    
    768,604
    
    
    
    12.9
    
    
    
    524,747
    
    
    
    11.2
    
    
    
    384,200
    
    
    
    15.2
    
    
    
    378,696
    
    
    
    13.3
    
    
    
    99,483
    
    
    
    4.5Consumer and others (2)
    
    
    866,934
    
    
    
    14.6
    
    
    
    861,907
    
    
    
    18.4
    
    
    
    743,600
    
    
    
    19.8
    
    
    
    416,953
    
    
    
    14.7
    
    
    
    383,903
    
    
    
    17.4Total loans
    
    
    6,021,299
    
    
    
    101.3
    
    
    
    4,744,726
    
    
    
    101.3
    
    
    
    3,801,471
    
    
    
    101.3
    
    
    
    2,876,768
    
    
    
    101.4
    
    
    
    2,232,588
    
    
    
    101.3Allowance for loan losses
    
    
    (80,066
    )
    
    
    (1.3
    )
    
    
    (61,608
    )
    
    
    (1.3
    )
    
    
    (47,114
    )
    
    
    (1.3
    )
    
    
    (38,364
    )
    
    
    (1.4
    )
    
    
    (28,928
    )
    
    
    (1.3
    )Loan - net
    
    $
    5,941,233
    
    
    
    100.0
    %
    
    $
    4,683,118
    
    
    
    100.0
    %
    
    $
    3,754,357
    
    
    
    100.00
    %
    
    $
    2,838,404
    
    
    
    100.00
    %
    
    $
    2,203,660
    
    
    
    100.00
    %
   (1)
    
    Includes $831.1 million, $641.1 million, $427.7 million and $255.8 million of Westernbank Business Credit division outstanding
loans at December 31, 2004, 2003, 2002 and 2001, respectively. Westernbank Business Credit began operations in 2001.(2)
    
    Includes $144.0 million, $155.6 million and $117.4 million of Expresso of Westernbank division outstanding loans at
December 31, 2004, 2003 and 2002, respectively. Expresso of Westernbank began operations on July 10, 2002. Residential real estate mortgage loans are mainly comprised of loans secured by first
mortgages on one-to-four family residential properties. At December 31, 2004, residential mortgage
loans included $11.6 million of mortgages insured or guaranteed by government agencies of the
United States or Puerto Rico. 43




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##### Table of Contents



Westernbank originated $1.70 billion of commercial real estate loans, including asset-based
and construction loans, during the year ended December 31, 2004. At December 31, 2004, commercial
real estate loans totaled $3.15 billion. In general, commercial real estate loans are considered by
management to be of somewhat greater risk of uncollectibility than residential lending because such
loans are typically larger in size and more risk is concentrated in a single borrower. In addition,
the borrowers ability to repay a commercial loan or a construction loan depends, in the case of a
commercial loan, on the successful operation of the business or the property securing the loan and,
in the case of a construction loan, on the successful completion and sale or operation of the
project. Substantially all of the Companys borrowers and properties and other collateral securing
the commercial, real estate mortgage and consumer loans are located in Puerto Rico. These loans may
be subject to a greater risk of default if the Puerto Rico economy suffers adverse economic,
political or business developments, or if natural disasters affect Puerto Rico. Foreign loans
amounted to $2.2 million at December 31, 2004. At December 31, 2004, the Company maintained its
status as a secured lender, with approximately 83% of its loans collateralized by real estate. The portfolio of Consumer and Other loans at December 31, 2004, consisted of consumer loans of
$866.9 million, of which $585.2 million are secured by real estate, $252.1 million are unsecured
consumer loans (consisting of $132.0 million of the Expresso of Westernbank division loans
portfolio, credit card loans of $53.3 million and other consumer loans of $66.8 million) and loans
secured by deposits in Westernbank totaling $29.6 million. During 2004, Westernbank securitized $7.5 million and $3.3 million of residential mortgage
loans into Government National Mortgage Association and Fannie Mae participation certificates,
respectively, and sold loans amounting to $22.0 million to Fannie Mae. Westernbank continues to
service outstanding loans which are securitized and those individually sold to Fannie Mae. The following table summarizes the contractual maturities of Westernbanks total loans for the
periods indicated at December 31, 2004. Contractual maturities do not necessarily reflect the
actual term of a loan, including prepayments. MaturitiesAfter one year to five years
    
    
    After five years(In thousands)Balance outstanding at
    
    
    One year or
    
    
    Fixed
    
    
    Variable
    
    
    Fixed
    
    
    VariableDecember 31, 2004
    
    
    less
    
    
    interest
    
    
    interest
    
    
    interest
    
    
    interestResidential real estate:Mortgage
    
    $
    902,937
    
    
    $
    2,303
    
    
    $
    16,636
    
    
    $
    
    
    
    $
    218,050
    
    
    $
    665,948
    (1)Construction
    
    
    328,145
    
    
    
    153,171
    
    
    
    
    
    
    
    174,974
    
    
    
    
    
    
    
    Commercial, industrial
and agricultural:Real estate
    
    
    3,154,679
    
    
    
    1,023,502
    
    
    
    311,937
    
    
    
    273,272
    
    
    
    77,233
    
    
    
    1,468,735Business and others
    
    
    768,604
    
    
    
    547,083
    
    
    
    28,184
    
    
    
    43,015
    
    
    
    6,447
    
    
    
    143,875Consumer and others
    
    
    866,934
    
    
    
    114,429
    
    
    
    201,569
    
    
    
    
    
    
    
    550,936
    
    
    
    Total
    
    $
    6,021,299
    
    
    $
    1,840,488
    
    
    $
    558,326
    
    
    $
    491,261
    
    
    $
    852,666
    
    
    $
    2,278,558
   (1)
    
    Includes $600.8 million of purchased fixed rate loans in which seller guarantees the
Company a return at a floating rate of interest (three month LIBOR
plus a spread). See Note 19 -
On-Balance Sheet Derivative Instruments and Hedging Activities (page 109) - to the audited consolidated
financial statements, included in Part II, Item 8. Westernbanks loan originations come from a number of sources. The primary sources for
residential loan originations are depositors and walk-in customers. Commercial loan originations
come from existing customers as well as through direct solicitation and referrals. Westernbank originates loans in accordance with written, non-discriminatory underwriting
standards and loan origination procedures prescribed in the Board of Directors approved loan
policies. Detailed loan applications are obtained to determine the borrowers repayment ability.
Applications are verified through the use of credit reports, financial statements and other
confirmation procedures. Property valuations by independent appraisers approved by the Board of Directors
are required for mortgage and all real estate loans. 44




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##### Table of Contents



Westernbanks Senior Credit Committee approval is required for all loans in excess of $5.0
million ($15.0 million in the case of Westernbank Business Credit Division). The Senior Credit
Committee also reviews and ratifies all loans from $1.0 million, to $5.0 million approved by
Westernbanks regional credit committees. The Senior Credit Committee is composed by a majority of
the members of the Companys Board of Directors and senior lending officers. All loans in excess of
$5.0 million ($15.0 million for Westernbank Business Credit Division) approved by the Senior Credit
Committee are also reviewed and ratified by the Board of Directors. All loans in excess of $50.0
million require the approval of the Board of Directors. It is Westernbanks policy to require borrowers to provide title insurance policies certifying
or ensuring that Westernbank has a valid first lien on the mortgaged real estate. Borrowers must
also obtain hazard insurance policies prior to closing and, when required by the Department of
Housing and Urban Development, flood insurance policies. Borrowers may be required to advance funds
on a monthly basis together with each payment of principal and interest to a mortgage escrow
account from which Westernbank makes disbursements for items such as real estate taxes, hazard
insurance premiums and private mortgage insurance premiums as they fall due. Westernbank originates most of its residential real estate loans as conforming loans, eligible
for sale in the secondary market. The loan-to-value ratio at the time of origination on residential
mortgages is generally 75%, except that Westernbank may lend up to 90% of the lower of the purchase
price or appraised value of residential properties if private mortgage insurance is obtained by the
borrower for amounts in excess of 80%. Westernbank originates fixed and adjustable rate residential mortgage loans secured by a first
mortgage on the borrowers real property, payable in monthly installments for terms ranging from
ten to forty-five years. Adjustable rates are indexed to specified prime or LIBOR rate. All 30 year
conforming mortgages are originated with the intent to sell. In addition to its residential loan
originations, Westernbank also purchases residential first mortgage loans from other mortgage
originators in Puerto Rico. During the year ended December 31, 2004, Westernbank purchased $250.1
million of such loans. Westernbank originates primarily variable and adjustable rate commercial business and real
estate loans. Westernbank also makes real estate construction loans subject to firm permanent
financing commitments. As of December 31, 2004, Westernbanks commercial loan portfolio had a total
delinquency ratio, including the categories of 60 days and over, of 0.55% (less than 1%), compared
to 0.84% (less than 1%) at December 31, 2003. For further explanation on the delinquency ratio of the Companys commercial loan portfolio refer to section NON-PERFORMING LOANS
AND FORECLOSED REAL ESTATE HELD FOR SALE on next page. Westernbank offers different types of consumer loans in order to provide a full range of
financial services to its customers. Within the different types of consumer loans offered by
Westernbank, there are various types of secured and unsecured consumer loans with varying
amortization schedules. In addition, Westernbank makes fixed-rate residential second mortgage
consumer loans. In July 2002, Westernbank launched a new banking division focused on offering
consumer loans through 19 full-service branches, called Expresso of Westernbank, denoting the
branches emphasis on small, unsecured consumer loans up to $15,000 and collateralized consumer
loans up to $150,000. Westernbank offers the service of VISA and Master Card credit cards. At
December 31, 2004, there were approximately 24,324 outstanding accounts, with an aggregate
outstanding balance of $53.3 million and unused credit card lines available of $95.4 million. In connection with all consumer loans originated, Westernbanks underwriting standards include
a determination of the applicants payment history on other debts and an assessment of the ability
to meet existing obligations and payments on the proposed loan. As of December 31, 2004,
Westernbanks consumer loan portfolio, including the Expresso of Westernbank loan portfolio, had a
total delinquency ratio, including the categories of 60 days and over, of 1.03%, compared to 0.89%
at December 31, 2003. The increase in the delinquency ratio from 2003 to 2004 was mainly due to an
increased number of delinquencies in regular consumer loans past due over 90 days which are
collateralized by real estate properties. Westernbank has 83% of its loan portfolio as of December 31, 2004, secured by real estate. Our
combined delinquency on all portfolios for the categories of 60 days and over continues to be below
our benchmark of 1% for both periods, being 0.57% at December 31, 2004, and 0.74% at December 31,
2003. 45




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##### Table of Contents



NON-PERFORMING LOANS AND FORECLOSED REAL ESTATE HELD FOR SALE When a borrower fails to make a required payment on a loan, Westernbank attempts to cure the
deficiency by contacting the borrower. In most cases, deficiencies are cured promptly. If the
delinquency exceeds 90 days and is not cured through normal collection procedures, Westernbank will
generally institute measures to remedy the default. If a foreclosure action is instituted and the
loan is not cured, paid in full or refinanced, the property is sold at a judicial sale at which
Westernbank may acquire the property. In the event that the property is sold at a price
insufficient to cover the balance of the loan, the debtor remains liable for the deficiency.
Thereafter, if Westernbank acquires the property, such acquired property is appraised and included
in the foreclosed real estate held for sale account at the fair value at the date of acquisition.
Then, this asset is carried at the lower of fair value less estimated costs to sell or cost until
the property is sold. The accrual of interest on loans is discontinued when there is a clear indication the
borrowers cash flow may not be sufficient to meet payments as they become due, but in no event is
it recognized after 90 days in arrears on payments of principal or interest. When a loan is placed
on nonaccrual status, all previously accrued and unpaid interest is charged against income and the
loan is accounted for on the cash method thereafter, until qualifying for return to accrual status.
Generally, a loan is returned to accrual status when all delinquent interest and principal payments
become current in accordance with the terms of the loan agreement or when the loan is both well
secured and in the process of collection and collectibility is no longer doubtful. The following table sets forth information regarding non-performing loans and foreclosed real
estate held for sale by Westernbank at the dates indicated: December 31,2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000(Dollars in thousands)Commercial, industrial and agricultural loans
    
    $
    25,417
    
    
    $
    24,142
    
    
    $
    13,567
    
    
    $
    7,947
    
    
    $
    6,140Consumer loans
    
    
    7,122
    
    
    
    4,845
    
    
    
    3,812
    
    
    
    3,431
    
    
    
    1,733Residential real estate mortgage and construction loans
    
    
    1,730
    
    
    
    2,259
    
    
    
    2,026
    
    
    
    2,735
    
    
    
    1,817Total non-performing loans
    
    
    34,269
    
    
    
    31,246
    
    
    
    19,405
    
    
    
    14,113
    
    
    
    9,690Foreclosed real estate held for sale
    
    
    3,811
    
    
    
    4,082
    
    
    
    3,679
    
    
    
    3,013
    
    
    
    2,454Total non-performing loans and foreclosed
real estate held for sale
    
    $
    38,080
    
    
    $
    35,328
    
    
    $
    23,084
    
    
    $
    17,126
    
    
    $
    12,144Interest that would have been recorded if the
loans had not been classified as
non-performing
    
    $
    3,557
    
    
    $
    2,500
    
    
    $
    1,102
    
    
    $
    1,123
    
    
    $
    979Interest recorded on non-performing loans
    
    $
    243
    
    
    $
    583
    
    
    $
    775
    
    
    $
    1,716
    
    
    $
    780Total non-performing loans as a percentage
of total loans at end of period
    
    
    0.57
    %
    
    
    0.66
    %
    
    
    0.51
    %
    
    
    0.49
    %
    
    
    0.43
    %Total non-performing loans and foreclosed real estate
held for sale as a percentage of total assets at end of period
    
    
    0.27
    %
    
    
    0.31
    %
    
    
    0.28
    %
    
    
    0.29
    %
    
    
    0.28
    %
 The increase in non-performing loans from year end 2003, to year end 2004 was mostly
attributed to one commercial loan with a principal balance of $1.5 million, collateralized by real
estate. At December 31, 2004, this loan did not require a valuation allowance. At December 31,
2004, the allowance for possible loan losses was 233.64% of total non-performing loans (reserve
coverage). The increase in non-performing loans from year end 2002, to year end 2003 was mostly
attributed to eight commercial loans with principal balances of $1.6 million, $1.5 million, $1.1
million, $1.0 million, and four other loans with outstanding principal balances below $1.0 million, all of which are collateralized by real estate. At December 31, 2003, two
of these loans with outstanding balances of $1.1 million and $695,000, had a specific valuation
allowance of $277,000 and $201,000, respectively. At December 31, 2003, the allowance for possible
loan losses was 197.17% of total non-performing loans (reserve coverage). 46




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ALLOWANCE FOR LOAN LOSSES Westernbank maintains an allowance for loan losses to absorb probable losses inherent in the
loan portfolio. The allowance is based on ongoing, quarterly assessments of the probable estimated
losses inherent in the loan portfolio, based on evaluations of the collectibility and historical
loss experience of loans. The Company follows a systematic methodology to establish and evaluate
the adequacy of the allowance for loan losses. This methodology consists of several key elements,
which include: The Formula Allowance. The formula allowance is calculated by applying loss factors to
outstanding loans not otherwise covered by specific allowances. Loss factors are based on
historical loss experience and may be adjusted for significant factors that, in managements
judgment, reflect the impact of any current condition on loss recognition. Factors that management
considers in the analysis include the effect of the national and local economies, trends in the
nature and volume of loans (delinquencies, charge-offs, non-accrual and problem loans), asset
quality trends, changes in the internal lending policies and credit standards, collection
practices, and examination results from bank regulatory agencies and the Companys internal credit
examiners. Loss factors are described as follows:  
    Loan loss factors for commercial loans, including construction and land acquisition loans,
are based on historical loss trends for three to five years, as adjusted for managements
expected increase in the loss factors given the significant increase in such loan portfolios
over the last few years.
    Pooled loan loss factors are also based on historical loss trends for one to three years.
Pooled loans are loans that are homogeneous in nature, such as consumer installment,
residential mortgage loans and credit cards. Specific Allowances for Identified Problem Loans and Portfolio Segments. Specific allowances
are established and maintained where management has identified significant adverse conditions or
circumstances related to a credit or portfolio segment that management believes indicate the
probability that a loss has been incurred in excess of the amount determined by the application of
the formula allowance. Larger commercial and construction loans that exhibit probable or observed
credit weaknesses are subject to individual review. 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 Westernbank. In addition, the specific allowance incorporates the results of measuring impaired loans as
provided in SFAS No. 114, Accounting by Creditors for Impairment of a Loan, as amended. This
accounting standard prescribes the measurement methods, income recognition and disclosures
concerning impaired loans. The Unallocated Allowance. An unallocated allowance is established recognizing the estimation
risk associated with the formula and specific allowances. It is based upon managements evaluation
of various conditions, the effects of which are not directly measured in determining the formula
and specific allowances. These conditions include then-existing general economic and business
conditions affecting our key lending areas; credit quality trends, including trends in
nonperforming loans expected to result from existing conditions, collateral values, loan volumes
and concentrations, seasoning of the loan portfolio, recent loss experience in particular segments
of the portfolio, regulatory examination results, and findings of our internal credit examiners.
The evaluation of the inherent loss regarding these conditions involves a higher degree of
uncertainty because they are not identified with specific problem credits or portfolio segments. Management assesses these conditions quarterly. If any of these conditions is evidenced by a
specifically identifiable problem credit or portfolio segment as of the evaluation date,
managements estimate of the effect of this condition may be reflected as a specific allowance
applicable to this credit or portfolio segment. Where any of these conditions is not evidenced by a
specifically identifiable problem credit or portfolio segment as of the evaluation date,
managements evaluation of the probable loss concerning this condition is reflected in the
unallocated allowance. The allowance for loan losses is based upon estimates of probable losses inherent in the loan
portfolio. The amount actually observed for these losses can vary significantly from the estimated
amounts. Our methodology includes several features that are intended to reduce the differences
between estimated and actual losses. Historical loss factors for commercial and consumer loans may
be adjusted for significant factors that, in managements judgment, reflect the impact of any
current condition on loss recognition. Factors which management considers in the analysis include
the effect of the national and local economies, trends in the nature and volume of loans
(delinquencies, charge-offs, non-accrual and problem loans), changes in the internal lending
policies and credit standards, collection practices, and examination results from bank regulatory
agencies and the Banks internal credit examiners. Loan loss factors are adjusted quarterly based
upon the level of net charge-offs expected by management in the next twelve months, after taking
into account historical loss ratios adjusted for current trends. By assessing the probable
estimated losses inherent in the loan portfolio on a quarterly basis, we are able to adjust specific and inherent loss estimates
based upon any more recent information that has become available. 47




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At December 31, 2004, the allowance for loan losses was $80.1 million, consisting of $71.2
million general allowance (including the unallocated allowance) and $8.9 million of specific
allowances. As of December 31, 2004, the allowance for loan losses equals 1.33% of total loans and
233.64% of total non-performing loans, compared with an allowance for loan losses at December 31,
2003 of $61.6 million, or 1.30% of total loans, and 197.17% of total non-performing loans. As of December 31, 2004, there have been no significant changes in estimation methods or
assumptions that affected our methodology for assessing the appropriateness of the allowance for
loan losses. The table below presents a reconciliation of changes in the allowance for loan losses for the
periods indicated: YEARS ENDED DECEMBER 31,2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000(Dollars in thousands)Balance, beginning of year
    
    $
    61,608
    
    
    $
    47,114
    
    
    $
    38,364
    
    
    $
    28,928
    
    
    $
    23,978Loans charged-off:Consumer loans (1)
    
    
    (16,473
    )
    
    
    (12,203
    )
    
    
    (4,576
    )
    
    
    (3,840
    )
    
    
    (4,760
    )Commercial, industrial and agricultural loans
    
    
    (5,433
    )
    
    
    (2,479
    )
    
    
    (3,389
    )(2)
    
    
    (2,970
    )
    
    
    (372
    )Real estate-mortgage and
construction loans
    
    
    (297
    )
    
    
    (184
    )
    
    
    
    
    
    
    (228
    )
    
    
    (231
    )Total loans charged-off
    
    
    (22,203
    )
    
    
    (14,866
    )
    
    
    (7,965
    )
    
    
    (7,038
    )
    
    
    (5,363
    )Recoveries of loans previously
charged-off:Consumer loans (3)
    
    
    1,920
    
    
    
    799
    
    
    
    858
    
    
    
    996
    
    
    
    795Commercial, industrial and agricultural loans
    
    
    1,844
    
    
    
    1,141
    
    
    
    584
    
    
    
    133
    
    
    
    594Real estate-mortgage and
construction loans
    
    
    206
    
    
    
    372
    
    
    
    190
    
    
    
    175
    
    
    
    224Total recoveries of loans previously charged-off
    
    
    3,970
    
    
    
    2,312
    
    
    
    1,632
    
    
    
    1,304
    
    
    
    1,613Net loans charged-off
    
    
    (18,233
    )
    
    
    (12,554
    )
    
    
    (6,333
    )
    
    
    (5,734
    )
    
    
    (3,750
    )Provision for loan losses
    
    
    36,691
    
    
    
    27,048
    
    
    
    15,083
    
    
    
    12,278
    
    
    
    8,700Allowance acquired on loans purchased
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,892
    
    
    
    Balance, end of period
    
    $
    80,066
    
    
    $
    61,608
    
    
    $
    47,114
    
    
    $
    38,364
    
    
    $
    28,928Ratios:Allowance for loan losses to total loans at end of period
    
    
    1.33
    %
    
    
    1.30
    %
    
    
    1.24
    %
    
    
    1.33
    %
    
    
    1.29
    %Provision for loan losses to net loans
charged-off
    
    
    201.23
    %
    
    
    215.45
    %
    
    
    238.17
    %
    
    
    214.13
    %
    
    
    232.00
    %Recoveries of loans to loans charged-off in
previous period
    
    
    26.71
    %
    
    
    29.03
    %
    
    
    23.19
    %
    
    
    24.31
    %
    
    
    21.92
    %Net loans charged-off to average total loans (4)
    
    
    0.34
    %
    
    
    0.29
    %
    
    
    0.19
    %
    
    
    0.23
    %
    
    
    0.19
    %Allowance for loans losses to
non-performing loans
    
    
    233.64
    %
    
    
    197.17
    %
    
    
    242.80
    %
    
    
    271.83
    %
    
    
    298.53
    %
   (1)
    
    Includes $12.4 million, $7.9 million and $62,000 of Expresso of Westernbank charge-offs, for
the years ended December 31, 2004, 2003 and 2002, respectively. Expresso of Westernbank
began operations on July 10, 2002.(2)
    
    Includes $505,000 in 2002 of Westernbank Business Credit division, consisting of one loan
originally acquired in the purchased loan portfolio from Congress Credit Corporation,
a subsidiary of First Union National Bank N.A. on June 15, 2001. This loan was fully
reserved at the acquisition date.(3)
    
    Includes $1.0 million and $17,000 of Expresso of Westernbank recoveries, for the years ended
December 31, 2004 and 2003, respectively.(4)
    
    Average loans were computed using beginning and period-end balances. 48




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The following table presents the allocation of the allowance for credit losses, the loan
portfolio composition percentage and the allowance coverage ratio in each loan category to total
loans, as set forth in the Loans table on page 43, at the end of each year. AT DECEMBER 31,2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000(Dollars in thousands)Allowance for credit losses:Commercial, industrial and
agricultural loans (1)
    
    $
    58,208
    
    
    $
    41,400
    
    
    $
    31,671
    
    
    $
    24,397
    
    
    $
    16,273Consumer loans (2)
    
    
    19,425
    
    
    
    17,472
    
    
    
    12,004
    
    
    
    8,203
    
    
    
    7,194Residential real estate mortgage
and construction loans
    
    
    407
    
    
    
    415
    
    
    
    443
    
    
    
    494
    
    
    
    526Unallocated
    
    
    2,026
    
    
    
    2,321
    
    
    
    2,996
    
    
    
    5,270
    
    
    
    4,935Total allowance for loan
losses
    
    $
    80,066
    
    
    $
    61,608
    
    
    $
    47,114
    
    
    $
    38,364
    
    
    $
    28,928Loan portfolio composition percentages:Commercial, industrial and
agricultural loans
    
    
    65.15
    %
    
    
    58.72
    %
    
    
    53.45
    %
    
    
    51.95
    %
    
    
    44.19
    %Consumer loans
    
    
    14.40
    %
    
    
    18.17
    %
    
    
    19.56
    %
    
    
    14.49
    %
    
    
    17.20
    %Residential real estate mortgage
and construction loans
    
    
    20.45
    %
    
    
    23.11
    %
    
    
    26.99
    %
    
    
    33.56
    %
    
    
    38.61
    %Total loans
    
    
    100.00
    %
    
    
    100.00
    %
    
    
    100.00
    %
    
    
    100.00
    %
    
    
    100.00
    %Allowance coverage ratio at
end of year:Applicable to:Commercial, industrial and
agricultural loans
    
    
    1.48
    %
    
    
    1.49
    %
    
    
    1.56
    %
    
    
    1.63
    %
    
    
    1.65
    %Consumer loans
    
    
    2.24
    %
    
    
    2.03
    %
    
    
    1.61
    %
    
    
    1.97
    %
    
    
    1.87
    %Residential real estate mortgage
and construction loans
    
    
    0.03
    %
    
    
    0.04
    %
    
    
    0.04
    %
    
    
    0.05
    %
    
    
    0.06
    %Unallocated (as a percentage
of total loans)
    
    
    0.03
    %
    
    
    0.05
    %
    
    
    0.08
    %
    
    
    0.18
    %
    
    
    0.22
    %Total loans
    
    
    1.33
    %
    
    
    1.30
    %
    
    
    1.24
    %
    
    
    1.33
    %
    
    
    1.29
    %
   (1)
    
    Includes an allowance of $6.0 million, $6.6 million, $4.5 million and $3.1 million for
Westernbank Business Credit loans at December 31, 2004, 2003, 2002 and 2001, respectively. Westernbank Business Credit began operations in 2001.(2)
    
    Includes an allowance of $13.8 million, $10.0 million and $1.5 million for Expresso of
Westernbank loans portfolio at December 31, 2004, 2003 and 2002, respectively. Expresso of Westernbank began operations on July 10, 2002. Loans are classified as impaired or not impaired in accordance with SFAS No. 114. A loan is
impaired when, based on current information and events, it is probable that Westernbank will be
unable to collect the scheduled payments of principal or interest when due, according to the
contractual terms of the agreement. Westernbank measures the impairment of a loan 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. Significant loans (those exceeding $500,000 in 2004 and 2003, and $250,000 in 2000 to
2002) are individually evaluated for impairment. Large groups of small balance, homogeneous loans
are collectively evaluated for impairment; loans that are recorded at fair value or at the lower of
cost or market are not evaluated for impairment. The portfolios of mortgage and consumer loans are
considered homogeneous and are evaluated collectively for impairment. 49




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Impaired loans for which the discounted cash flows, collateral value or market price exceeds
its carrying value do not require an allowance. The allowance for impaired loans is part of the
Companys overall allowance for loan losses. The following table sets forth information regarding the investment in impaired loans: 2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000(In thousands)Investment in impaired loans:Covered by a valuation allowance
    
    $
    29,975
    
    
    $
    28,217
    
    
    $
    26,074
    
    
    $
    21,996
    
    
    $
    8,040Do not require a valuation allowance
    
    
    24,200
    
    
    
    22,088
    
    
    
    24,515
    
    
    
    20,482
    
    
    
    4,834Total
    
    $
    54,175
    
    
    $
    50,305
    
    
    $
    50,589
    
    
    $
    42,478
    
    
    $
    12,874Valuation allowance for impaired loans
    
    $
    8,412
    
    
    $
    4,646
    
    
    $
    4,752
    
    
    $
    4,181
    
    
    $
    1,157Average investment in impaired loans
    
    $
    46,509
    
    
    $
    46,676
    
    
    $
    46,147
    
    
    $
    20,293
    
    
    $
    11,873Interest collected and recognized as
income on impaired loans
    
    $
    2,460
    
    
    $
    2,452
    
    
    $
    4,041
    
    
    $
    1,716
    
    
    $
    780
 At December 31, 2004, Westernbanks investment in impaired loans increased by $3.9
million or 7.14%, from $50.3 million as of December 31, 2003. The increase was mainly attributed to
a newly classified loan with an aggregate outstanding principal balance of $10.9 million for which
an allowance of $500,000 was established at December 31, 2004. At December 31, 2003, Westernbanks investment in impaired loans remained relatively stable
when compared to year 2002, although the loans comprising the balance may have changed. At December
31, 2002, Westernbanks investment in impaired loans increased $8.1 million or 19.09%, from $42.5
million as of December 31, 2001, to $50.6 million as of December 31, 2002. This increase was
principally attributed to four newly classified loans with an aggregate outstanding principal
balance of approximately $13.0 million as of December 31, 2002. All loans are collateralized by
real estate and required a combined valuation allowance of $823,000. INVESTMENTS The Companys investments are managed by the Investment Department. Purchases and sales are
required to be reported monthly to the Investment Committee (composed of members of the Board of
Directors, as well as the President and Chief Executive Officer and the Chief Financial Officer). The Investment Department is authorized to purchase and sell federal funds, interest bearing
deposits in banks, bankers acceptances of commercial banks insured by the FDIC, mortgage and
asset-backed securities, Puerto Rico and U.S. Government and agency obligations, municipal
securities rated A or better by any of the nationally recognized rating agencies, commercial paper
and corporate notes rated P-1 by Moodys Investors Service, Inc or A-1 by Standard and Poors, a
Division of the McGraw-Hill Companies, Inc. In addition, the Investment Department is responsible
for the pricing and sale of deposits and repurchase agreements. At the date of purchase, the Company classifies debt and equity securities into one of three
categories: held to maturity; trading; or available for sale. At each reporting date, the
appropriateness of the classification is reassessed. Investments in debt securities for which
management has the intent and ability to hold to maturity are classified as held to maturity and
stated at cost increased by accretion of discounts and reduced by amortization of premiums, both
computed by the interest method. Securities that are bought and held principally for the purpose of
selling them in the near term are classified as trading and measured at fair value in the financial
statements with unrealized gains and losses included in earnings. Securities not classified as
either held to maturity or trading are classified as available for sale and measured at fair value
in the financial statements with unrealized gains and losses reported, net of income tax, as a
component of accumulated other comprehensive income (loss) until realized. Gains and losses on
sales of securities are determined using the specific-identification method. The Companys investment strategy is affected by both the rates and terms available on
competing investments and tax and other legal considerations. 50




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##### Table of Contents



Federal funds sold and resell agreements amounted to $341.9 million and $675.4 million,
respectively, at December 31, 2004. Federal funds sold mature the next business day, while resell
agreements mature as follows: $125.4 million the next business day, $200.0 million in 2009, and
$350.0 million in 2010. The Company monitors the fair value of the underlying securities as
compared to the related receivable, including accrued interest, and requests additional collateral
when the fair value of the underlying collateral falls below the collateral requirement. At
December 31, 2004, the fair value of the underlying collateral amounted to $692.1 million. The following table presents the carrying value of investments at December 31, 2004 and 2003: 2004
    
    
    2003(In thousands)Held to maturity :US Government and agencies obligations
    
    $
    6,004,849
    
    
    $
    4,463,493Puerto Rico Government and agencies obligations
    
    
    34,822
    
    
    
    34,500Commercial paper
    
    
    25,000
    
    
    
    174,976Corporate notes
    
    
    26,418
    
    
    
    51,409Mortgage and asset-backed securities
    
    
    830,290
    
    
    
    999,332Total
    
    
    6,921,379
    
    
    
    5,723,710Available for sale:Collateralized mortgage obligations (CMOs)
    
    
    7,881
    
    
    
    49,910Equity
securities - preferred stock
    
    
    
    
    
    
    5,170Total
    
    
    7,881
    
    
    
    55,080Total investments
    
    $
    6,929,260
    
    
    $
    5,778,790
 Mortgage and asset-backed securities at December 31, 2004 and 2003, consists of: 2004
    
    
    2003(In thousands)Available for sale:CMOs issued or guaranteed by the Federal National
Mortgage Association (FNMA)
    
    $
    6,116
    
    
    $
    29,948CMOs issued or guaranteed by the Federal Home
Loan Mortgage Corporation (FHLMC)
    
    
    1,765
    
    
    
    19,962Total available for sale
    
    
    7,881
    
    
    
    49,910Held to maturity:Government National Mortgage Association certificates
    
    
    9,881
    
    
    
    9,753FHLMC certificates
    
    
    5,663
    
    
    
    7,297FNMA certificates
    
    
    3,642
    
    
    
    4,542CMOs certificates issued or guaranteed by FHLMC
    
    
    706,632
    
    
    
    885,408CMOs certificates issued or guaranteed by FNMA
    
    
    104,441
    
    
    
    84,322CMOs other
    
    
    31
    
    
    
    168Asset-backed securities
    
    
    
    
    
    
    7,842Total held to maturity
    
    
    830,290
    
    
    
    999,332Total mortgage and asset-backed securities
    
    $
    838,171
    
    
    $
    1,049,242
 At
December 31, 2004, no investment of a single issuer (in aggregate
balance) exceeded 10% of the consolidated stockholders equity. 51




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##### Table of Contents



The carrying amount of investment securities at December 31, 2004, by contractual maturity
(excluding mortgage and asset-backed securities), are shown below: Carrying
    
    
    Weightedamount
    
    
    average yield(Dollars in thousands)US Government and agencies obligations:Due within one year
    
    $
    99,921
    
    
    
    2.20
    %Due after one year through five years
    
    
    4,108,423
    
    
    
    3.90Due after five years through ten years
    
    
    1,796,505
    
    
    
    4.12Due after ten years
    
    
    
    
    
    
    6,004,849
    
    
    
    3.94Puerto Rico Government and agencies obligations:Due within one year
    
    
    3,000
    
    
    
    4.75Due after one year through five years
    
    
    10,468
    
    
    
    5.25Due after five years through ten years
    
    
    20,004
    
    
    
    4.15Due after ten years
    
    
    1,350
    
    
    
    6.1534,822
    
    
    
    4.61Other:Due within one year
    
    
    25,000
    
    
    
    2.95Due after one year through five years
    
    
    4,993
    
    
    
    6.13Due after five years through ten years
    
    
    
    
    
    
    Due after ten years
    
    
    21,425
    
    
    
    8.3351,418
    
    
    
    5.50Total
    
    
    6,091,089
    
    
    
    3.95Mortgage and asset-backed securities
    
    
    838,171
    
    
    
    4.21Total
    
    $
    6,929,260
    
    
    
    3.99
    %
 The Companys investment portfolio at December 31, 2004 had an average contractual
maturity of 53 months, when compared to an average maturity of 63 months at December 31, 2003. The
Companys interest rate risk model takes into consideration the callable feature of certain
investment securities. Assuming that all call features are exercised, the Companys investment
portfolio as of December 31, 2004, had a remaining average contractual maturity of 10 months.
However, no assurance can be given that such levels will be maintained in future periods. The Company evaluates for impairment its investment securities on a quarterly basis or earlier
if other factors indicative of potential impairment exist. An impairment charge in the consolidated
statements of income is recognized when the decline in the fair value of the securities below their
cost basis is judged to be other-than-temporary. The Company considers various factors in
determining whether it should recognize an impairment charge, including, but not limited to the
length of time and extent to which the fair value has been below its cost basis, the expectations
for that securitys performance, the credit worthiness of the issuer, and the Companys intention
and ability to hold the security to maturity. The impairment analysis on the mortgage and asset-backed securities is done placing special
emphasis on the analysis of the trustee and collateral manager monthly reports, on sensitivity and
expected cash flow analyses made by major brokerage houses and on the credit worthiness of the
issuer. The Company also considers its intent and ability to hold these securities. If management
believes, based on the analysis, that the principal and interest obligations on any mortgage
and asset-backed security will not be received in a timely manner, the security is written down to
fair value based on available secondary market prices from broker/dealers. The equity securities and corporate notes impairment analyses are performed and reviewed
quarterly based on the latest financial information and any supporting research report made by
major brokerage houses. These analyses are subjective and based, among other things, on relevant
financial data such as capitalization, cash flows, liquidity, systematic risk, and debt
outstanding. Management also considers the industry trends, the historical performance of the
stock, as well as the Companys intent to hold the security. If management believes there is a low
probability of achieving book value in a reasonable time frame, then an impairment is recorded by
writing down the security to fair value. 52




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In applying the foregoing analysis, management concluded that at March 31, 2003, its
investments in corporate bond and loan obligations (CBOs and CLOs) were other-than-temporarily
impaired. First, two tranches of a CBO with an amortized cost of $13.0 million were downgraded by
two different rating agencies on April 3 and April 15, 2003. Second, the available secondary market
prices for those two securities and the remaining portfolio of CBOs and CLOs with a carrying
value of $56.0 million continued to deteriorate. Management concluded, based on these facts and the
secondary market prices, that a $15.7 million other-than-temporary impairment write-down adjustment
was warranted. The same was recorded effective for the quarterly period ended March 31, 2003. As of
March 31, 2003, there were no defaults within the securities portfolio underlying the CBOs and
CLOs. In connection with the write-down, and in accordance with applicable accounting
pronouncements, management also reassessed its intent to hold to maturity and reclassified the
securities related to the CBOs that were downgraded as available for sale as of March 31, 2003. During the quarter ended June 30, 2003, the Company, based upon additional information
available from trustees, further ratings downgrading, a default on the scheduled interest payment
in one of the CBO tranches and further declines in quoted market prices for such investments,
reclassified the remaining portfolio of CBOs and CLOs to available for sale and subsequently on
June 6, 2003 sold its entire portfolio of CBOs and CLOs. The sale of the portfolio, with an
original total investment of $62.9 million and adjusted to a fair value of $45.4 million as of
March 31, 2003, was completed at an additional net loss of $7.0 million which was recorded during
the quarter ended June 30, 2003. The Companys investment portfolio as of December 31, 2004 and 2003, consisted principally of
U.S. Government and agencies obligations, Puerto Rico Government and agencies obligations, and
mortgage-backed securities issued or guaranteed by FHLMC, FNMA or GNMA. There were no investment
securities other than those referred to above in unrealized loss position as of December 31, 2004
and 2003. These unrealized losses related to interest rate changes. Investment securities with
prepayment provisions did not have significant unamortized premiums at December 31, 2004 and 2003.
As the Company has the ability and intent to hold debt securities until maturity, or for the
foreseeable future if classified as available for sale, no declines were deemed to be
other-than-temporary at December 31, 2004 and 2003. DEPOSITS Westernbank offers a diversified choice of deposit accounts. Savings deposits increased from
$692.2 million as of December 31, 2003, to $829.4 million as of December 31, 2004, an increase of
$137.2 million or 19.82%. Also, other deposits represented mainly by time deposits, brokered
deposits and Individual Retirement Account deposits (IRAs), increased from $4.69 billion as of
December 31, 2003, to $5.40 billion as of December 31, 2004, an increase of $708.5 million or
15.09%. Other deposits include brokered deposits amounting to $4.16 billion and $3.51 billion as
of December 31, 2004 and 2003, respectively. These accounts have historically been a stable source
of funds. At December 31, 2004, Westernbank had total deposits of $6.23 billion, of which $829.4 million
or 13.31% consisted of savings deposits, $303.7 million or 4.87% consisted of interest bearing
demand deposits, $249.4 million or 4.00% consisted of noninterest bearing deposits and $4.85
billion or 77.82% consisted of time deposits. Westernbank also offers negotiable order of
withdrawal (NOW) accounts, Super Now accounts, special checking accounts and commercial demand
accounts. At
December 31, 2004, the scheduled maturities of time deposits in amounts of $100,000 or more
are as follows: (In thousands)3 months or less
    
    $
    73,337over 3 months through 6 months
    
    
    27,324over 6 months through 12 months
    
    
    25,520over 12 months
    
    
    86,437Total
    
    $
    212,618
 53




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The following table sets forth the average amount and the average rate paid on the following
deposit categories for the years ended December 31: 2004
    
    
    2003
    
    
    2002Average
    
    
    Average
    
    
    Average
    
    
    Average
    
    
    Average
    
    
    Averageamount
    
    
    rate
    
    
    amount
    
    
    rate
    
    
    amount
    
    
    rate(Dollars in thousands)Time deposits
    
    $
    4,617,785
    
    
    
    2.64
    %
    
    $
    3,775,263
    
    
    
    2.59
    %
    
    $
    2,889,649
    
    
    
    3.40
    %Savings deposits
    
    
    784,589
    
    
    
    2.14
    %
    
    
    605,854
    
    
    
    2.15
    %
    
    
    509,114
    
    
    
    2.46
    %Interest bearing demand
deposits
    
    
    200,190
    
    
    
    2.63
    %
    
    
    160,015
    
    
    
    2.55
    %
    
    
    124,127
    
    
    
    2.90
    %Noninterest bearing demand
deposits
    
    
    306,710
    
    
    
    
    
    
    
    227,358
    
    
    
    
    
    
    
    167,352
    
    
    
    $
    5,909,274
    
    
    
    2.43
    %
    
    $
    4,768,490
    
    
    
    2.41
    %
    
    $
    3,690,242
    
    
    
    3.10
    %
 BORROWINGS The following table sets forth the borrowings of the Company at the dates indicated: 2004
    
    
    2003
    
    
    2002(In thousands)Federal funds purchased and repurchase agreements (1)
    
    $
    6,683,527
    
    
    $
    5,046,045
    
    
    $
    3,097,341Advances from Federal Home Loan Bank (FHLB)
    
    
    211,000
    
    
    
    146,000
    
    
    
    120,000Mortgage note payable
    
    
    36,858
    
    
    
    37,234
    
    
    
    37,822$
    6,931,385
    
    
    $
    5,229,279
    
    
    $
    3,255,163
   (1)
    
    Federal funds purchased amounted to $75.0 million at December 31, 2004, at
a weighted average interest rate of 2.37%, and mature the next business day. No
such borrowings were outstanding at December 31, 2003 and 2002. Westernbank has made use of institutional federal funds purchased and repurchase agreements in
order to obtain funding, primarily through investment banks and brokerage firms. Repurchase
agreements are collateralized with investment securities while federal funds purchased do not
require collateral. Westernbank had $6.68 billion in federal funds purchased and repurchase
agreements outstanding at December 31, 2004, at a weighted average rate of 2.85%. Federal funds
purchased and repurchase agreements outstanding as of December 31, 2004, mature as follows: $4.33
billion within 30 days; $704.0 million in 2005; $47.5 million in 2006; $585.3 million in 2007; and
$1.02 billion thereafter. Westernbank also obtains advances from FHLB of New York. As of December 31, 2004, Westernbank
had $211.0 million in outstanding FHLB advances at a weighted average rate of 3.78%. Advances from
FHLB mature as follows: $39.0 million within 30 days; $70.0 million in 2006; $60.0 million in 2007;
and $42.0 million in 2010. At December 31, 2004, with respect to repurchase agreements amounting to $1.56 billion, the
counterparties have the option to terminate the agreements at the first anniversary date and each
interest payment date thereafter. Also, with respect to repurchase agreements and advances from
FHLB amounting to $1.04 billion at December 31, 2004, at the first anniversary date and each
quarter thereafter, the FHLB has the option to convert them into replacement funding for the same
or a lesser principal amount based on any funding then offered by FHLB at the then current market
rates, unless the interest rate has been predetermined between FHLB and the Company. If the
Company chooses not to replace the FHLBs funding, it will repay the convertible advances and
 repurchase agreements, including any accrued interest, on such optional conversion date. At December 31, 2004, Westernbank World Plaza, Inc., a wholly-owned subsidiary of Westernbank
Puerto Rico, had outstanding $36.9 million of a mortgage note, at a fixed interest rate of 8.05%
per year up to September 11, 2009. Subsequent to September 11, 2009, the mortgage note will bear
interest on the then outstanding principal balance at a rate per year equal to the (1) greater of
13.05% or the Treasury 54




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Rate plus five percentage points or (2) 10.05%, depending on the fulfillment
of certain conditions on the repricing date. Westernbank World Plaza has a prepayment option on the repricing date, without
penalty. The mortgage note is collateralized by a 23-story office building, including its related
parking facility, located in Hato Rey, Puerto Rico. A summary of short-term borrowings, including federal funds purchased, repurchase agreements
and advances from Federal Home Loan Bank, and interest rates at and for the year ended December 31,
are indicated below: 2004
    
    
    2003
    
    
    2002(Dollars in thousands)Federal funds purchased:Balance at end of year
    
    $
    75,029
    
    
    $
    
    
    
    $
    Weighted-average interest rate at year end
    
    
    2.37
    %
    
    
    
    %
    
    
    
    %Monthly average outstanding balance
    
    $
    23,753
    
    
    $
    8,500
    
    
    $
    418Weighted-average interest rate for the year
    
    
    1.95
    %
    
    
    1.34
    %
    
    
    2.15
    %Maximum month-end balance
    
    $
    95,005
    
    
    $
    75,000
    
    
    $
    418Repurchase agreements:Balance at end of year
    
    $
    4,138,257
    
    
    $
    1,648,891
    
    
    $
    1,029,493Weighted-average interest rate at year end
    
    
    2.30
    %
    
    
    1.21
    %
    
    
    1.46
    %Monthly average outstanding balance
    
    $
    2,377,042
    
    
    $
    1,093,921
    
    
    $
    1,371,832Weighted-average interest rate for the year
    
    
    1.67
    %
    
    
    1.24
    %
    
    
    1.92
    %Maximum month-end balance
    
    $
    4,206,540
    
    
    $
    1,717,184
    
    
    $
    1,962,319Advances from FHLB:Balance at end of year
    
    $
    25,000
    
    
    $
    40,000
    
    
    $
    Weighted-average interest rate at year end
    
    
    2.41
    %
    
    
    1.20
    %
    
    
    
    %Monthly average outstanding balance
    
    $
    21,250
    
    
    $
    31,917
    
    
    $
    Weighted-average interest rate for the year
    
    
    1.65
    %
    
    
    1.33
    %
    
    
    
    %Maximum month-end balance
    
    $
    50,000
    
    
    $
    64,000
    
    
    $
    Total short-term borrowings:Balance at end of year
    
    $
    4,238,286
    
    
    $
    1,688,891
    
    
    $
    1,029,493Weighted-average interest rate at year end
    
    
    2.30
    %
    
    
    1.21
    %
    
    
    1.46
    %Monthly average outstanding balance
    
    $
    2,422,045
    
    
    $
    1,134,338
    
    
    $
    1,372,249Weighted-average interest rate for the year
    
    
    1.67
    %
    
    
    1.24
    %
    
    
    1.92
    %Maximum month-end balance
    
    $
    4,238,286
    
    
    $
    1,832,184
    
    
    $
    1,962,319
 STOCKHOLDERS EQUITY Stockholders equity increased to $1.08 billion as of December 31, 2004, compared to $828.5
million in 2003, and $584.7 million in 2002. The 2004 increase mainly resulted from the issuance of
2,675,500 shares of the Companys Series H Preferred Stock, with a liquidation preference of $50
per share, completed on December 21, 2004, providing a net capital infusion of $129.3 million, plus
the net income of $171.9 million generated for the year, partially offset by total dividends
declared during the year of $50.7 million on our common stock and preferred stock. The increase in
2003 mainly resulted from the issuance of 4,232,000 and 2,640,000 shares of the Companys Series F
and Series G Preferred Stock, with a liquidation preference of $25 per share, completed in June and
August 2003, respectively, providing a net capital infusion of $102.2 million and $63.7 million,
respectively, plus the net income of $113.3 million generated for the year, partially offset by
total dividends declared during the year of $39.9 million on our common stock and preferred stock. On January 31, 2003, the Companys board of directors approved an increase of its annual
dividend payments to stockholders in 2003 to $0.11 per share (as adjusted). This represents an
increase of 22.73% over the average dividends paid in 2002. On November 4, 2003, the Companys board of directors declared a three-for-two stock split,
for all stockholders of record as of November 28, 2003, and distributed on December 10, 2003. The
effect of the stock split was a decrease to retained earnings and an increase in common stock of
$34.7 million. 55




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On November 11, 2003, the Companys board of directors declared a 2% stock dividend, for all
stockholders of record as of November 28, 2003, and distributed on December 10, 2003. The effect of
the stock dividend was a decrease to retained earnings, an increase in paid-in-capital and an
increase in common stock of $35.2 million, $33.1 million and $2.1 million, respectively. During 2003, the Company issued 500,000 shares of common stock upon exercise of stock options
by an executive officer of the Company. On January 15, 2004, the Companys board of directors approved an increase in its annual
dividend payments to stockholders for 2004 to $0.14 per share (as adjusted). This represents an
increase of 26.31% over the dividends paid in 2003. On December 6, 2004, the Companys board of directors declared a three-for-two stock split for
all stockholders of record as of December 31, 2004, and distributed on January 10, 2005. The effect
of the stock split was a decrease to retained earnings and an increase in common stock of $54.6
million. On December 13, 2004, the Companys board of directors declared a 2% stock dividend, for all
stockholders of record as of December 30, 2004, and distributed on January 10, 2005. The effect of
the stock dividend was a decrease to retained earnings, an increase in paid-in-capital and an
increase in common stock of $45.8 million, $43.7 million and $2.1 million, respectively. During 2004, the Company issued 214,750 shares of common stock upon exercise of stock options
by three of the Companys executive officers. On January 3, 2005, the Company issued 401,300 shares of its 2004 Series H preferred stock
over-allotment option to the underwriter. The preferred shares were issued at a price of $50.00 per
share. Proceeds from the issuance of the 2004 Series H preferred stock amounted to $19,433,000, net
of $632,000 of issuance costs. On January 20, 2005, the Companys board of directors approved an increase in its annual
dividend payments to stockholders for 2005 to $0.19 per share. This represents an increase of
32.14% over the dividends paid in 2004. On February 10, 2005, one of the Companys executive officer exercised 35,113 options under
the Companys 1999 Qualified Option Plan at an exercise price of $2.85. The number of common shares outstanding increased from 106,290,294 at the end of 2003, to
163,918,835 at December 31, 2004, principally as a result of the issuance of 56,781,960 common
shares for the stock split and stock dividend declared in December 2004 and distributed both on
January 10, 2005, the conversion of 276,994 shares of the Companys convertible preferred stock
series A, into 631,831 shares of the Companys common stock, and the issuance of 214,750 common
shares from the exercise of stock options. LIQUIDITY AND CAPITAL RESOURCES Liquidity refers to the Companys ability to generate sufficient cash to meet the funding
needs of current loans demand; deposit withdrawals, principal and interest payments with respect to
outstanding borrowings and to pay operating expenses. The Company monitors its liquidity in
accordance with guidelines established by the Investment Committee and applicable regulatory
requirements. The Companys need for liquidity is affected by loan demand, net changes in deposit
levels and the scheduled maturities of its borrowings. Liquidity demand caused by net reductions in
deposits is usually caused by factors over which the Company has limited control. The Company
derives its liquidity from both its assets and liabilities. Liquidity is derived from assets by
receipt of interest and principal payments and prepayments, by the ability to sell assets at market
prices and by utilizing unpledged assets as collateral for borrowings. At December 31, 2004, the
Company had approximately $1.32 billion in securities and other short-term securities maturing or
repricing within one year or available for sale. Additional asset-driven liquidity is provided by
the remainder of the investment securities available for sale and securitized loans. Liquidity is derived from liabilities by maintaining a variety of funding sources, including
deposits, advances from the FHLB of New York and other short and long-term borrowing, such as
federal funds purchased and repurchase agreements. Other borrowings funding source limits are
determined annually by each counterparty and depend on the Companys financial condition and
delivery of acceptable collateral securities. The Company may be required to provide additional
collateral based on the fair value of the underlying securities. In addition, the Company utilizes
the National Certificate of Deposit (CD) Market as a source of cost effective deposit funding in addition to local market deposit inflows. Depositors in this market consist
of credit unions, banking institutions, CD brokers and some private corporations or non-profit
organizations. Westernbanks ability to acquire brokered deposits can be restricted if it becomes
in the future less than well-capitalized. An adequately-capitalized bank, by regulation, may not
accept deposits from brokers unless it applies for and receives a waiver from the FDIC. 56




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The Company
also uses the Federal Home Loan Bank (FHLB) as a funding source, issuing notes payable, such as advances, and other borrowings, such as repurchase agreements, through its FHLB member subsidiary,
Westernbank. This funding source requires Westernbank to maintain a minimum amount of qualifying
collateral with a fair value of at least 110% and 105% of the outstanding advances and repurchase
agreements, respectively. The Companys liquidity targets are reviewed monthly by the Investment Committee and are based
on the Companys commitment to make loans and investments and its ability to generate funds. The
Committees targets are also affected by yields on available investments and upon the Committees
judgment as to the attractiveness of such yields and its expectations as to future yields. The Companys investment portfolio at December 31, 2004 had an average contractual maturity of
53 months. Assuming that all call features are exercised, the Companys investment portfolio as of
December 31, 2004, had a remaining average contractual maturity of 10 months. However, no
assurance can be given that such levels will be maintained in future periods. As of December 31, 2004, Westernbank had line of credit agreements with six commercial banks
permitting Westernbank to borrow a maximum aggregate amount of $245.0 million, mainly through
federal funds purchased. There were $75.0 million outstanding as of December 31, 2004. The
agreements provide for unsecured advances to be used by the Company on an overnight basis. Interest
rate is negotiated at the time of the transaction usually at Fed Fund rate. The credit agreements
are renewable annually. Payments due by period for the Companys contractual obligations (other than deposit
liabilities) at December 31, 2004 are presented below: Due after one
    
    
    Due after threeDue within one
    
    
    year through
    
    
    years through
    
    
    Due after fiveyear
    
    
    three years
    
    
    five years
    
    
    years
    
    
    Total(In thousands)Short-term borrowings
    
    $
    4,238,286
    
    
    $

    
    
    
    $
    
    
    
    $
    
    
    
    $
    4,238,286Long-term borrowings
    
    
    834,625
    
    
    
    763,782
    
    
    
    1,105
    
    
    
    1,093,587
    
    
    
    2,693,099Operating lease obligations
    
    
    2,373
    
    
    
    3,525
    
    
    
    1,293
    
    
    
    359
    
    
    
    7,550Loan purchase obligation
    
    
    600,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    600,000Total contractual obligations
    
    $
    5,675,284
    
    
    $
    767,307
    
    
    $
    2,398
    
    
    $
    1,093,946
    
    
    $
    7,538,935
 Such commitments will be funded in the normal course of business from the Companys
principal source of funds. At December 31, 2004, the Company had $2.93 billion in certificates of
deposit that mature during the following twelve months. The Company does not anticipate any
difficulty in retaining or replacing such deposits. The contractual amount of the Companys financial instruments with off-balance sheet risk
expiring by period at December 31, 2004 is presented below: PAYMENTS DUE BY PERIODLess than oneTotal
    
    
    year
    
    
    2-5 years(In thousands)Unused lines of credit
    
    $
    316,629
    
    
    $
    266,040
    
    
    $
    50,589Commercial letters of credit
    
    
    27,784
    
    
    
    27,784
    
    
    
    Commitments to extend credit
    
    
    512,086
    
    
    
    161,412
    
    
    
    350,674Commitments to purchase mortgage loans
    
    
    600,000
    
    
    
    600,000
    
    
    
    Total
    
    $
    1,456,499
    
    
    $
    1,055,236
    
    
    $
    401,263
 Due to the nature of the Companys unfunded commitments, including unfunded lines of credit,
the amounts presented above do not necessarily represent the amounts the Company anticipates
funding in the periods presented above. 57




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CRITICAL ACCOUNTING POLICIES The Company has established various accounting policies which govern the application of
accounting principles generally accepted in the United States of
America in the preparation of the Companys
financial statements. The significant accounting policies of the Company are described in the
footnotes to the consolidated financial statements. Certain accounting policies involve significant
judgments and assumptions by management which has a material impact on the carrying value of
certain assets and liabilities; management considers such accounting policies to be critical
accounting policies. The judgments and assumptions used by management are based on historical
experience and other factors, which are believed to be reasonable under the circumstances. Because
of the nature of the judgments and assumptions made by management, actual results could differ from
these judgments and estimates which could have a material impact on the carrying values of assets
and liabilities and the results of operations of the Company. The Company believes that of its
significant accounting policies, the following may involve a higher degree of judgment and
complexity:  
    Allowance for loan losses The allowance for loan losses is a critical accounting
policy that requires the most significant judgments and estimates used in the
preparation of its consolidated financial statements. In estimating the allowance for
loan losses, management utilizes historical experience as well as other factors
including the effect of changes in the local real estate market on collateral values,
the effects on the loan portfolio of current economic indicators and their probable
impact on borrowers and increases or decreases in nonperforming and impaired loans.
Changes in these factors may cause managements estimate of the allowance to increase or
decrease and result in adjustments to the Companys provision for loan losses. See
Financial Condition  Allowance for Loan
Losses (page 47) and Note 1  Summary
of Significant Accounting Policies (page 71) to the audited consolidated financial statements,
included in Part II, Item 8, for a detailed description of the Companys estimation
process and methodology related to the allowance for loan losses.
    Other-than-temporary impairments The Company reviews its investment securities for
impairment on a quarterly basis or earlier if other factors indicative of potential
impairment exist. An impairment charge in the consolidated statements of income is
recognized when the decline in the fair value of the securities below their cost basis
is judged to be other-than-temporary. The Company considers various factors in
determining whether it should recognize an impairment charge, including, but not limited
to the length of time and the extent the fair value of the security has been below its
cost basis, the expectation for that securitys performance, the credit worthiness of
the issuer and the Companys intent and ability to hold the security to maturity. See
Financial Condition  Investments (page 50) and Note 1  Summary of Significant Accounting
Policies (page 71) to the audited consolidated financial statements, included in Item II, Part 8,
for a detailed description of the Companys estimation process and methodology related
to other-than-temporary impairments.
    Financial instruments Certain financial instruments including derivatives, hedged
items and investment securities available-for-sale are recorded at fair value and
unrealized gains and losses are recorded in other comprehensive income or other gains
and losses as appropriate. Fair values are based on listed market prices, if available.
If listed market prices are not available, fair value is determined based on other
relevant factors including price quotations for similar instruments. Fair value 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. See Note 1  Summary of Significant Accounting
Policies (page 71) to the audited consolidated financial statements, included in Item II, Part 8,
for a detailed description of the Companys estimation process and methodology related
to the financial instruments.
    Certain liabilities and contingencies In the ordinary course of business, the
Companys management is required to make certain estimates and assumptions that affect
the reported amounts of liabilities and disclosures of contingent liabilities at the
date of the consolidated financial statements and therefore the reported amounts of
revenues and expenses during the reporting period. Such estimates are subjective in
nature and involve uncertainties and matters of significant judgment regarding past and
expected gains or losses, current economic conditions, and risk characteristics, among other factors. The following is a description of the most significant methods and
assumptions used by the Company in estimating the amounts reported in connection with
certain liabilities and contingencies as disclosed in the financial statements: Income taxes The Company is required to compute income taxes in connection with its
preparation of the consolidated financial statements. This computation involves
estimates and assumptions made by the Companys management based on its interpretation
of current and enacted tax laws and regulations that affect the reported amounts of
current and deferred income tax provisions. 58




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The carrying value of the Companys net
deferred tax asset assumes that the Company will be able to generate sufficient taxable income in the future to realize the tax benefit. If expectations about future
taxable income are not materialized, the Company may be required to record a valuation
allowance to reduce the recorded amount of its deferred tax asset resulting in an
increase of income tax expense in the consolidated statements of income. Contingencies The Company is a defendant in legal actions arising in the normal
course of business. Evaluation of these contingencies requires management of the
Company, after consultation with its legal counsel, to assume certain positions based
on its interpretation of current laws and regulations. Such interpretations are
subjective in nature and involve uncertainties and matters of significant judgment
and, therefore, actual results could differ from management position and estimates. See Note 1 
Summary of Significant Accounting Policies (page 71) to the audited consolidated
financial statements, included in Item II, Part 8, for a detailed description of the Companys
estimation process and methodology related to certain liabilities and contingencies. RECENT ACCOUNTING DEVELOPMENTS Effective January 1, 2002, the Company adopted Statement of Financial Accounting Standards
(SFAS) No. 141, Business Combinationsand SFAS No. 142, Goodwill and Other Intangible Assets.
Those statements changed the accounting for business combinations and goodwill in two significant
ways. SFAS No. 141 requires that the purchase method of accounting be used for all business
combinations. Use of the pooling-of-interest method is prohibited. SFAS No. 142 changes the
accounting for goodwill from an amortization method to an impairment-only approach. Thus,
amortization of goodwill, including goodwill recorded in past business combinations, ceased upon
adoption of this statement. Adoption of SFAS No. 141 and No. 142 did not have a significant effect
on the Companys consolidated financial position or results of operations. In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 143,
Accounting for Asset Retirement Obligations. SFAS No. 143 addresses financial accounting and
reporting for obligations associated with the retirement of tangible long-lived assets and the
associated asset retirement cost. SFAS No. 143 became effective on January 1, 2003 and did not have
a significant effect on the Companys consolidated financial position or results of operations. Effective January 1, 2002, the Company adopted SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets. SFAS No. 144 addresses financial accounting and reporting for the
impairment or disposal of long-lived assets. This statement supersedes SFAS No. 121, Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,and the accounting
and reporting provisions of APB Opinion No. 30, Reporting the Results of Operations  Reporting the
Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions. Implementation of SFAS No. 144 did not have a significant effect
on the Companys consolidated financial position or results of operations. In April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements No. 4, 44 and 64,
Amendment of SFAS No. 13, and Technical Corrections. SFAS No. 145 rescinds SFAS No. 4, Reporting
Gains and Losses from Extinguishment of Debt-an amendment of APB Opinion No. 30, which required all
gains and losses from extinguishment of debt to be aggregated and, if material, classified as
extraordinary item, net of related income tax effect. As a result, the criteria in Opinion No. 30
will now be used to classify those gains and losses. SFAS No. 145 also amends SFAS No. 13,
Accounting for Leases, to require that certain lease modifications that have economic effects
similar to saleleaseback transactions be accounted for in the same manner as sale-leaseback
transactions. SFAS No. 145 did not have a significant effect on the Companys consolidated
financial position or results of operations. In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or
Disposal Activities. This Statement addresses financial accounting and reporting for costs
associated with exit or disposal activities and nullifies Emerging Issues Task Force (EITF) Issue
No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit
an Activity (including Certain Costs Incurred in a Restructuring). The provisions of this Statement
are effective for exit or disposal activities that are initiated after December 31, 2002. Implementation of SFAS No. 146
did not have a significant effect on the Companys consolidated financial position or results of
operations. In October 2002, the FASB issued SFAS No. 147, Acquisitions of Certain Financial Institutions,
an amendment of FASB Statements No. 72 and 144 and FASB Interpretation No. 9. Except for
transactions between two or more mutual enterprises, SFAS No. 147 removes acquisitions of financial
institutions from the scope of both SFAS No. 72 and Interpretation No. 9 and requires that those
transactions be accounted for in accordance with SFAS No. 141, Business Combinationsand SFAS No.
142, Goodwill and Other Intangible Assets. In addition, SFAS No. 147 amends SFAS No. 144,
Accounting for the Impairment or Disposal of Long-Lived Assetsto include in its scope 59




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long-term
customer-relationship intangible assets of financial institutions such as
depositor-and-borrower-relationship intangible assets and credit cardholders intangible assets.
SFAS No. 147 was effective for acquisitions or impairment measurement of such intangibles effective
on or after October 1, 2002. SFAS No. 147 did not have a significant effect on the Companys
financial position or results of operations. In November 2002, the FASB issued FASB Interpretation No. 45 (FIN 45), Guarantors
Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others, an Interpretation of FASB Statements No. 5, 57, and 107 and Rescission of
FASB Interpretation No. 34.This interpretation elaborates on the disclosures to be made by a
guarantor in the financial statements about its obligations under certain guarantees that it has
issued. It also clarifies that a guarantor is required to recognize, at the inception of a
guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee.
The initial recognition and initial measurement provisions of FIN 45 were applicable for guarantees
issued or modified after December 31, 2002. Adoption of the recognition and measurement provisions
did not have a significant effect on the Companys financial position or results of operations. In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation 
Transition and Disclosure, an amendment of FASB Statement No. 123. This Statement amends SFAS No.
123, Accounting for Stock-Based Compensation, to provide alternative methods of transition for a
voluntary change to the fair value based method of accounting for stock-based employee
compensation. In addition, SFAS No. 148 amends the disclosure requirements of Statement 123 to
require prominent disclosures in both annual and interim financial statements about the method of
accounting for stock-based employee compensation and the effect of the method used on reported
results. Effective January 1, 2003, the Company changed the method of accounting for employee stock
options from the intrinsic value method to the fair value method. Under the modified prospective
method selected by the Company under the provisions of SFAS No. 148, compensation cost recognized
since January 1, 2003 is the same that would have been recognized had the recognition provisions of
FASB No. 123 been applied from its original effective date. Results prior to 2003 were not
restated. The effect of implementing this Statement on the Companys financial condition and
results of operations for the years ended December 31, 2004 and 2003 was a charge of $895,000 and
of $1,031,000, respectively to compensation expense included in salaries and employees benefits in
the consolidated statement of income. Prior to January 1, 2003, the Company followed the intrinsic value-based method of accounting
prescribed by APB Opinion No. 25, Accounting for Stock Issued to Employees,and related
interpretations. Compensation expense under this method was generally recognized for any excess of
the quoted market price of the Companys stock at the measurement date over the amount an employee
must pay to acquire the stock. Since all options granted under those plans have an exercise price
equal to the market value of the underlying common stock at the grant date, no compensation expense
was recognized at the measurement date. In January 2003, the FASB issued FASB Interpretation No. 46 (FIN 46), Consolidation of
Variable Interest Entities, an Interpretation of ARB No. 51.FIN 46 addresses consolidation by
business enterprises of variable interest entities. A variable interest entity is a corporation,
partnership, trust, or any other legal structure used for business purposes that either (a) does
not issue voting interests (or other interests with similar rights) or (b) the total equity
investment at risk is not sufficient to permit the entity to finance its activities. FIN 46
requires an enterprise to consolidate a variable interest entity if that enterprise has a variable
interest that will absorb a majority of the entitys expected losses if these occur, receive a
majority of the entitys expected residual returns if these occur, or both. Qualifying Special
Purpose Entities are exempt from the consolidation requirements. In addition to numerous FASB Staff
Positions written to clarify and improve the application of FIN 46, the FASB announced a deferral
for certain entities, and an amendment to FIN 46 entitled FASB Interpretation No. 46 (revised
December 2003), Consolidation of Variable Interest Entities (FIN 46R). FIN 46R must be applied to
interests in all entities subject to the interpretation as of the first interim or annual period
ending after March 15, 2004. FIN 46R did not have any effect on the Companys financial position
or results of operations. In April 2003, the FASB issued SFAS No. 149, Amendment of Statement No. 133 on Derivative
Instruments and Hedging Activities.This Statement amends and clarifies financial accounting and
reporting for derivative instruments, including certain derivative instruments embedded in other
contracts (collectively referred to as derivatives) and for hedging activities under FASB Statement
No. 133, Accounting for Derivative Instruments and Hedging Activities.This Statement (1) clarifies
under what circumstances a contract with an initial net investment meets the characteristic of a
derivative discussed in paragraph 6 (b) of Statement No. 133, (2) clarifies when a derivative contains a financing component, (3) amends
the definition of an underlying to conform it to language used in FASB Interpretation No. 45,
Guarantors Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees
of Indebtedness of Others,and (4) amends certain other existing pronouncements. This Statement was
effective for contracts entered into or modified after June 30, 2003, and for hedging relationships
designated after June 30, 2003. Implementation of SFAS No. 149 did not have a significant effect on
the Companys financial position or results of operations. 60




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In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity. SFAS No. 150 is effective for all freestanding
financial instruments entered into or modified after May 31, 2003. For all other freestanding
financial instruments, it became effective at the beginning of the first interim period beginning
after June 15, 2003. SFAS No. 150 applies to three categories of freestanding financial instruments
(mandatory redeemable instruments, instruments with repurchase obligations and instruments with
obligations to issue a variable number of shares). Instruments within the scope of SFAS No. 150
must be classified as liabilities in the statement of financial condition. Certain provisions of
SFAS No. 150 related to mandatory redeemable financial instruments have been subsequently deferred
indefinitely by the FASB. The Company does not have mandatory redeemable financial instruments
outstanding. Implementation of SFAS No. 150 did not have a significant effect on the Companys
financial position or results of operations. In December 2003, the Accounting Standards Executive Committee of the American Institute of
Certified Public Accountants issued Statement of Position (SOP) 03-3, Accounting for Certain
Loans and Debt Securities Acquired in a Transfer.SOP 03-3 addresses the accounting for acquired
loans that show evidence of having deteriorated in terms of credit quality since their origination
(i.e. impaired loans). SOP 03-3 requires acquired loans to be recorded at their fair value defined
as the present value of future cash flows. SOP 03-3 prohibits the carryover of an allowance for
loan losses on certain acquired loans as credit losses are considered in the future cash flows
assessment. SOP 03-3 is effective for loans that are acquired in fiscal years beginning after
December 15, 2004. The Company will evaluate the applicability of this SOP for all prospective
loans acquired in fiscal years beginning after December 15, 2004. In March 2004, the Emerging Issues Task Force (EITF) reached a consensus on Issue 03-1,
Meaning of Other Than Temporary Impairment(Issue 03-1). The Task Force reached a consensus on an
other-than-temporary impairment model for debt and equity securities accounted for under SFAS No.
115, Accounting for Certain Investments in Debt and Equity Securitiesand cost method investments.
The basic model developed by the Task Force in evaluating whether an investment within the scope of
Issue 03-1 is other-than-temporarily impaired is as follows: Step 1: Determine whether an
investment is impaired. An investment is considered impaired if its fair value is less than its
cost. Step 2: Evaluate whether an impairment is other-than-temporary. For equity securities and
debt securities that can contractually be prepaid or otherwise settled in such a way that the
investor would not recover substantially all of its cost, an impairment is presumed to be
other-than-temporary unless: the investor has the ability and intent to hold the investment for a
reasonable period of time sufficient for a forecasted market price recovery of the investment, and
evidence indicating that the cost of the investment is recoverable within a reasonable period of
time outweighs evidence to the contrary. For other debt securities, an impairment is deemed
other-than-temporary if: the investor does not have the ability and intent to hold the investment
until a forecasted market price recovery (may mean until maturity), or it is probable that the
investor will be unable to collect all amounts due according to the contractual terms of the debt
security. Step 3: If the impairment is other-than-temporary, recognize in earnings an impairment
loss equal to the difference between the investment cost and its fair value. The fair value of the
investment then becomes the new cost basis of the investment and cannot be adjusted for subsequent
recoveries in fair value, unless required by other authoritative literature. On September 30, 2004, the FASB issued FSP EITF Issue 03-01-1, which delayed the effective
date for the measurement and recognition guidance of an impairment loss that is
other-than-temporary (i.e. steps 2 and 3 of the impairment model) contained in paragraphs 10-20 of
EITF 03-1. Application of these paragraphs is deferred pending issuance of proposed FSP EITF Issue
03-1a. This delay does not suspend the requirement to recognize other-than-temporary impairments as
required by existing authoritative literature. The guidance in paragraphs 6 to 9 of EITF 03-1 (i.e.
step 1 of the impairment model), as well as the disclosure requirements in paragraphs 21 and 22
were not deferred and were applied based on the transition provisions in EITF 03-1. Based on the
composition of the investment portfolio held at December 31, 2004, EITF 03-1 is not expected to
have a material effect on the Companys financial position or results of operations. On March 9, 2004, the SEC issued Staff Accounting Bulletin 105, Application of Accounting
Principles to Loan Commitments, (SAB 105) to inform registrants of the Staffs view that the fair
value of the recorded loan commitments should not consider the expected future cash flows related
to the associated servicing of the future loan. The provisions of SAB 105 is applicable to loan
commitments accounted for as derivatives that are entered into after March 31, 2004. The staff will
not object to the application of existing accounting practices to loan commitments accounted for as
derivatives that are entered into on or before March 31, 2004, with appropriate disclosures. The
adoption of SAB 105 did not have a material impact on the Companys financial condition or results
of operations. In December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets  an amendment
of APB Opinion No. 29. The guidance in APB Opinion No. 29, Accounting for Nonmonetary Transactions,
is based on the principle that exchanges of nonmonetary assets should be measured based on the fair
value of the assets exchanged. The guidance in that Opinion, however, included certain exceptions
to that principle. This Statement amends Opinion 29 to eliminate the exception for nonmonetary
exchanges of similar productive assets and 61




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replaces it with a general exception for exchanges of
nonmonetary assets that do not have commercial substance. A nonmonetary exchange has commercial substance if the future cash flows
of the entity are expected to change significantly as a result of the exchange. This Statement
shall be applied prospectively and is effective for nonmonetary asset exchanges occurring in fiscal
periods beginning after June 15, 2005. Earlier application is permitted for nonmonetary asset
exchanges occurring in fiscal periods beginning after the date of issuance of this Statement. SFAS
No. 153 is not expected to have a material effect on the Companys financial position or results of
operations. In December 2004, the FASB issued SFAS No. 123 (revised 2004), Share-Based Payment, that will
require compensation costs related to share-based payment transactions to be recognized in the
financial statements. With limited exceptions, the amount of compensation cost will be measured
based on the grant-date fair value of the equity or liability instruments issued. In addition,
liability awards will be remeasured each reporting period. Compensation cost will be recognized
over the period that an employee provides service in exchange for the
award. SFAS No. 123(R)
replaces FASB Statement No. 123, Accounting for Stock-Based Compensation, and supersedes APB
Opinion No. 25, Accounting for Stock Issued to Employees.
SFAS No. 123 (R) will be effective as of
the first interim or annual reporting period that begins after June 15, 2005 and applies to all
awards granted after the required effective date and to awards modified, repurchased, or cancelled
after that date. The cumulative effect of initially applying this statement, if any, is recognized
as of the required effective date. Entities that used the fair-value-based method for either
recognition or disclosure under SFAS No. 123 will apply this revised statement using a modified
version of prospective application. Under that transition method, for the portion of outstanding
awards for which the requisite service has not yet been rendered, compensation cost is recognized
on or after the required effective date based on the grant-date fair value of those awards
calculated under SFAS No. 123 for either recognition or pro forma disclosures. For periods before
the required effective date, those entities may elect to apply a modified version of retrospective
application under which financial statements for prior periods are adjusted on a basis consistent
with the pro forma disclosures required for those periods by SFAS
No. 123. SFAS No. 123(R) is not
expected to have a significant effect on the Companys financial position or results of operations
since the Company only has employee stock options and it follows the fair value method under the
modified prospective application allowed by the provisions of SFAS No. 148 since January 1, 2003,
as previously explained. 
 ITEM 7A. QUANTITATIVE AND
QUALITATIVE DISCLOSURES ABOUT MARKET RISK OFF-BALANCE SHEET ARRANGEMENTS As of December 31, 2004, the Company had no significant off-balance sheet arrangements with
the exception of operating leases as discussed in Note 13
(page 101) to the audited consolidated financial
statements, included in Part II, Item 8. CONTRACTUAL OBLIGATIONS AND COMMITMENTS For information required in connection with the Companys contractual obligations and
commitments refer to section LIQUIDITY AND CAPITAL RESOURCESof the Managements Discussion and
Analysis of Results of Operations and Financial Condition
(page 56), included in Part II, Item 7. MARKET RISK The Companys financial performance is impacted by among other factors, interest rate risk and
credit risk. Management considers interest rate risk the Companys most significant market risk.
Interest rate risk is the exposure to adverse changes in net interest income due to changes in
interest rates. Consistency of the Companys net interest income is largely dependent upon the
effective management of interest rate risk. The Company does not utilize derivatives to mitigate

its credit risk, relying instead on an extensive counterparty review process. See Managements
Discussion and Analysis of Financial Condition and Results of Operations Financial Condition
Allowance for Loan Losses (page 47), included in Part II, Item 7. Interest rate risk is addressed by the Companys Asset & Liability Committee (ALCO), which
includes the full Board of Directors and certain senior management representatives. The ALCO
monitors interest rate risk by analyzing the potential impact to the net portfolio of equity value
and net interest income from potential changes to interest rates and considers the impact of
alternative strategies or changes in balance sheet structure. The ALCO manages the Companys
balance sheet in part to minimize the potential impact on net portfolio value and net interest
income despite changes in interest rates. The Companys exposure to interest rate risk is reviewed
on a quarterly basis by the ALCO. Interest rate risk exposure is measured using interest rate
sensitivity analysis to determine the change in net portfolio value in the event of hypothetical
changes in interest rates. If potential changes to net portfolio value and net interest income
resulting from hypothetical interest rate changes are not within the limits established by the
Board, the Board may direct management to adjust its asset and liability mix to bring interest rate
risk within Board-approved limits. In order to reduce the exposure to interest rate fluctuations,
the Company has implemented strategies to more closely match its balance sheet composition.
Interest rate sensitivity is computed by estimating the changes in net portfolio 62




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of equity value,
or market value over a range of potential changes in interest rates. The market value of equity is the market value of the
Companys assets minus the market value of its liabilities plus or minus the market value of any
off-balance sheet items. The market value of each asset, liability, and off-balance sheet item is
its net present value of expected cash flows discounted at market rates after adjustment for rate
changes. The Company measures the impact on market value for an immediate and sustained 200 basis
point increase or decrease (shock) in interest rates. The Companys profitability is dependent to a large extent upon its net interest income, which
is the difference between its interest income on interest-earning assets, such as loans and
investments, and its interest expense on interest-bearing liabilities, such as deposits and
borrowings. The Company is subject to interest rate risk to the degree that its interest-earning
assets reprice differently than its interest-bearing liabilities. The Company manages its mix of assets and liabilities with the goals of limiting its exposure
to interest rate risk, ensuring adequate liquidity, and coordinating its sources and uses of funds.
Specific strategies have included securitization and sale of long-term, fixed-rate residential
mortgage loans, shortening the average maturity of fixed-rate loans and increasing the volume of
variable and adjustable rate loans to reduce the average maturity of the Companys interest-earning
assets. All long-term, fixed-rate single family residential mortgage loans underwritten according
to Federal Home Loan Mortgage Corporation, Federal National Mortgage Association and Government
National Mortgage Association guidelines, are sold for cash upon origination. In addition, the
Company enters into certain derivative financial instruments to hedge various exposures or to
modify interest rate characteristics of various statement of financial condition items. The Company is exposed to changes in the level of Net Interest Income (NII) in a changing
interest rate environment. NII will fluctuate pursuant to changes in the levels of interest rates
and of interest-sensitive assets and liabilities. If (1) the weighted average rates in effect at
period end remain constant, or increase or decrease on an instantaneous and sustained change of
plus 200 or minus 100 basis points (50 basis points in 2003), and (2) all scheduled repricing,
reinvestments and estimated prepayments, and reissuances are at such constant, or increase or
decrease accordingly; NII will fluctuate as shown on the table below: December 31, 2004: AmountChange in Interest Rate
    
Expected NII (1)
    
    
    Change
    
    
    % Change(Dollars in thousands)+200 Basis Points
    
    $
    268,838
    
    
    $
    (49,112
    )
    
    
    (15.44
    )%Base Scenario
    
    
    317,950
    
    
    
    
    
    
    
    -100 Basis Points
    
    
    307,734
    
    
    
    (10,216
    )
    
    
    (3.31
    )%
 December 31, 2003: AmountChange in Interest Rate
    
Expected NII (1)
    
    
    Change
    
    
    % Change(Dollars in thousands)+200 Basis Points
    
    $
    280,197
    
    
    $
    (14,573
    )
    
    
    (4.94
    )%Base Scenario
    
    
    294,770
    
    
    
    
    
    
    
    -50 Basis Points
    
    
    291,543
    
    
    
    (3,227
    )
    
    
    (1.09
    )%
   (1)
    
    The NII figures exclude the effect of the amortization of loan fees. Given the fed fund rate of
2.25% and 1.00% at December 31, 2004 and 2003, respectively, a linear 100 and 50 basis points
decrease for 2004 and 2003, respectively, was modeled in the estimated change in interest rate in
place of the linear 200 basis points decrease. The model utilized to create the information presented above makes various estimates at each
level of interest rate change regarding cash flows from principal repayments on loans and
mortgage-backed securities and/or call activity on investment securities. Actual results could
differ significantly from these estimates which would result in significant differences in the
calculated projected change. In addition, the limits stated above do not necessarily represent the
level of change under which management would undertake specific measures to realign its portfolio
in order to reduce the projected level of change. The interest rate sensitivity (GAP) is defined as the difference between interest-earning
assets and interest-bearing liabilities maturing or repricing within a given time period. A GAP is
considered positive when the amount of interest rate sensitive assets exceeds the amount of
interest rate sensitive liabilities. A GAP is considered negative
when the amount of interest rate sensitive liabilities exceeds interest rate 63




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sensitive assets. During a period of rising interest
rates, a negative GAP would tend to adversely affect net interest income, while a positive GAP would tend to result in an increase in net interest
income. During a period of falling interest rates, a negative GAP would tend to result in an
increase in net interest income, while a positive GAP would tend to affect net interest income
adversely. While the GAP is a useful measurement and contributes toward effective asset and
liability management, it is difficult to predict the effect of changing interest rates solely on
that measure. Because different types of assets and liabilities with the same or similar maturities
may react differently to changes in overall market rates or conditions, changes in interest rates
may affect net interest income positively or negatively even if an institution were perfectly
matched in each maturity category. ECONOMIC CONDITIONS, MARKET AREA AND COMPETITION Puerto Rico (the Island), a Commonwealth of the United States of America (the U.S.), is
the easternmost of the Greater Antilles and the fourth largest island of the Caribbean. The Island
is located at the crossroads between North and South America, at just 3.5 hours airtime from New
York and 60 minutes from Venezuela and has a population of approximately four (4) million people.
In 1917, the people of Puerto Rico became citizens of the U.S., and therefore Puerto Ricans serve
in the United States Armed Forces. As in the U.S., the Island has a local judicial system. The
Island constitutes a District in the Federal Judiciary and has its own U.S. district court. Also,
most of the U.S. federal agencies are represented on the Island. However, the Island has its own
Internal Revenue system and is not subject to U.S. taxes. Spanish and English are the official
languages of the Island. The Island economy operates as a region within the U.S., and therefore its financial
performance is closely linked to the U.S. performance. The external sector is a key element of the
economy of Puerto Rico, as it has a very open economy, with large flows of trade, investment and
income. The Island uses U.S. currency and forms part of the U.S. financial system. As a
Commonwealth of the U.S., the Island falls within the U.S. for purposes of customs and migration,
and therefore there is a full exchange of funds, people and goods between Puerto Rico and the U.S.
Puerto Rico banks are subject to the same Federal laws, regulations and supervision as those of the
financial institutions operating in the rest of U.S. The Federal Deposit Insurance Corp. insures
the deposits of Puerto Rico chartered commercial banks, including Westernbank, the banking
subsidiary of W Holding Company, Inc. For year 2004, the Puerto Rico economic activity continued in line with overall economic
conditions in the U.S., showing some growth although at a slower rate than expected. Economic
indicators for year 2004 showed some mixed signals, while the job markets continue to strengthen
and retail sales continue to rise, the public-sector construction has remained more or less
stable, the expansion observed in private construction halted and a drop-off occurred in government
income, which should result in cuts in public spending. The Puerto Rico Gross Domestic Product was
approximately 3.0% for year 2004. Inflation rate for year 2004 was considered to be moderate at
approximately 4.0%. Historically, Puerto Rico unemployment rate has been higher than the average
U.S. unemployment rate, being 10% at December 31, 2004, since although the number of jobs was
increasing; the workforce was growing in a parallel fashion. The rate of participation in the
workforce has been estimated in approximately 47.0%. Manufacturing and construction continues to be
the backbone of the Island economy, and many multinational corporations have substantial operations
in the Island. The islands pharmaceutical industry continues to be very strong, being the primary
driver for employment in the Island, along with the construction industry; both of them labor
intensive industries. During the past years there has been a slowdown in both industries, primarily
due to the reduction of tax incentives in the manufacturing sector. Nevertheless, the Island
economy has been able to be somewhat less dependent of these industries thanks to its
diversification into other business areas such as tourism, retail, banking and transportation. The banking sector has been the main driver of such diversification, being the financial
support for all the industrial and commercial activity on the Island. At December 31, 2004, there
are approximately eleven (11) banks operating in Puerto Rico, with total assets, loans and deposits
of approximately $90.8 billion, $46.9 billion and $46.0 billion, respectively, at September 30,
2004. U.S. banks, foreign banks and the major Puerto Rican banks, all offer commercial banking
services designed to support the emerging requirements of its local clients as well as of its
international clients. The economic strength and liquidity of local financial institutions,
considered as the pillar of the Islands economy, have allowed the Puerto Rico banking sector to
extend credit, without which the Islands economy couldnt be sustained. The growing combination of
loans, deposits and assets has been the key elements to the economic progress for the past years.
Loans, in particular, have played a key role in keeping the Island economy afloat, through either
personal, mortgage or commercial loans. The financial services and banking business are highly competitive, and the profitability of
the Company will depend principally upon the Companys ability to compete in its market area as
well as to a significant extent upon general economic conditions in its market place. The Company
competes with other commercial and non-commercial banks, finance companies, mutual funds, insurance
companies, brokerage and investment banking firms, asset-based non-bank lenders and certain other
non-financial institutions, including certain governmental organizations which may offer subsidized
financing at lower rates than those offered by the Company. The Company has been able to compete
effectively with other financial institutions by emphasizing technology and customer service,
including local office decision-making on loans, establishing long-term customer relationships and
building customer loyalty, and by providing products and services designed to address the 64




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specific
needs of its customers. Significant deterioration in the local
economy or external economic conditions, such as inflation, recession, unemployment, real estate
values and other factors beyond the Companys control, could also substantially impact the
Companys performance. There can be no assurance that future adverse changes in the local economy
would not have a material adverse effect on the Companys consolidated financial condition, results
of operations or cash flows. 
 
 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 
 
 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Stockholders of
W Holding Company, Inc.
Mayagüez, Puerto Rico We have audited the accompanying consolidated statements of financial condition of W Holding
Company, Inc. and subsidiaries (the Company) as of December 31, 2004 and 2003, and the
related
consolidated statements of income, changes in stockholders equity and of comprehensive income, and cash flows
for each of the three years in the period ended December 31, 2004. These financial statements are
the responsibility of the Companys management. Our responsibility is to express an opinion on
these 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, such consolidated financial statements present fairly, in all material respects,
the financial position of W Holding Company, Inc. and subsidiaries as of December 31, 2004 and
2003, and the results of their operations and their cash flows for each of the three years in the
period ended December 31, 2004, in conformity with accounting principles generally accepted in the
United States of America. We have also audited, in accordance with the standards of the Public Company Accounting Oversight
Board (United States), the effectiveness of the Companys internal control over financial reporting
as of December 31, 2004, based on the criteria established in Internal ControlIntegrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated
March 11, 2005 expressed an unqualified opinion on managements assessment of the effectiveness of
the Companys internal control over financial reporting and an unqualified opinion on the
effectiveness of the Companys internal control over financial reporting. /s/ Deloitte & Touche LLP
San Juan, Puerto Rico
March 11, 2005 Stamp No. 2018225
affixed to original. 65




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W HOLDING COMPANY, INC.
AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
DECEMBER 31, 2004 AND 2003  2004
    
    
    2003ASSETSCash and due from banks
    
    $
    77,752
    
    
    $
    92,811Money market instruments:Federal funds sold and resell agreements
    
    
    1,017,303
    
    
    
    649,852Interest-bearing deposits in banks
    
    
    49,476
    
    
    
    37,767Investment securities available for sale, at fair value with an amortized
cost of $8,093 in 2004 and $55,992 in 2003
    
    
    7,881
    
    
    
    55,080Investment securities held to maturity, at amortized cost with a
fair value of $6,836,897 in 2004 and $5,638,816 in 2003
    
    
    6,921,379
    
    
    
    5,723,710Federal Home Loan Bank stock, at cost
    
    
    52,195
    
    
    
    39,750Residential mortgage loans held for sale, at lower of cost or fair value
    
    
    1,633
    
    
    
    2,555Loans, net of allowance for loan losses of $80,066 in 2004
and $61,608 in 2003
    
    
    5,941,233
    
    
    
    4,683,118Accrued interest receivable
    
    
    88,285
    
    
    
    75,567Foreclosed real estate held for sale, net of allowance of
$306 in 2004 and $28 in 2003
    
    
    3,811
    
    
    
    4,082Premises and equipment, net
    
    
    110,051
    
    
    
    103,370Deferred income taxes, net
    
    
    31,027
    
    
    
    24,910Other assets
    
    
    34,636
    
    
    
    26,868TOTAL
    
    $
    14,336,662
    
    
    $
    11,519,440LIABILITIES AND STOCKHOLDERS EQUITYLIABILITIES:Deposits:Noninterest-bearing
    
    $
    249,368
    
    
    $
    192,760Interest-bearing and related accrued interest payable
    
    
    5,981,843
    
    
    
    5,192,716Total deposits
    
    
    6,231,211
    
    
    
    5,385,476Federal funds purchased and repurchase agreements
    
    
    6,683,527
    
    
    
    5,046,045Advances from Federal Home Loan Bank
    
    
    211,000
    
    
    
    146,000Mortgage note payable
    
    
    36,858
    
    
    
    37,234Advances from borrowers for taxes and insurance
    
    
    6,513
    
    
    
    4,307Accrued expenses and other liabilities
    
    
    85,874
    
    
    
    71,869Total liabilities
    
    
    13,254,983
    
    
    
    10,690,931COMMITMENTS AND CONTINGENCIESSTOCKHOLDERS EQUITY:Preferred stock  $1.00 par value per share (liquidation preference  $511,744 in
2004 and $384,894 in 2003); authorized 20,000,000 shares; issued and outstanding
17,794,251 shares in 2004 and 15,395,745 shares in 2003
    
    
    17,794
    
    
    
    15,396Common stock  $1.00 par value per share; authorized 300,000,000 shares; issued
and outstanding 163,918,835 shares in 2004 and 106,290,294 shares in 2003
    
    
    163,919
    
    
    
    106,290Paid-in capital
    
    
    686,493
    
    
    
    514,800Retained earnings:Reserve fund
    
    
    60,672
    
    
    
    43,375Undivided profits
    
    
    153,013
    
    
    
    149,581Accumulated other comprehensive loss, net of income tax
    
    
    (212
    )
    
    
    (933
    )Total stockholders equity
    
    
    1,081,679
    
    
    
    828,509TOTAL
    
    $
    14,336,662
    
    
    $
    11,519,440
 See notes to consolidated financial statements. 66




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##### Table of Contents



W HOLDING COMPANY, INC. AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF INCOME
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002  2004
    
    
    2003
    
    
    2002INTEREST INCOME:Loans, including loan fees
    
    $
    322,164
    
    
    $
    275,848
    
    
    $
    220,676Investment securities
    
    
    212,213
    
    
    
    134,273
    
    
    
    112,759Mortgage and asset-backed securities
    
    
    37,446
    
    
    
    40,092
    
    
    
    44,694Money market instruments
    
    
    19,510
    
    
    
    11,633
    
    
    
    7,451Trading securities
    
    
    43
    
    
    
    48
    
    
    
    154Total interest income
    
    
    591,376
    
    
    
    461,894
    
    
    
    385,734INTEREST EXPENSE:Deposits
    
    
    143,860
    
    
    
    114,755
    
    
    
    114,374Federal funds purchased and repurchase agreements
    
    
    141,414
    
    
    
    101,652
    
    
    
    98,233Advances from Federal Home Loan Bank
    
    
    6,568
    
    
    
    6,037
    
    
    
    6,202Other borrowings
    
    
    
    
    
    
    142
    
    
    
    604Total interest expense
    
    
    291,842
    
    
    
    222,586
    
    
    
    219,413NET INTEREST INCOME
    
    
    299,534
    
    
    
    239,308
    
    
    
    166,321PROVISION FOR LOAN LOSSES
    
    
    36,691
    
    
    
    27,048
    
    
    
    15,083NET INTEREST INCOME AFTER PROVISION
FOR LOAN LOSSES
    
    
    262,843
    
    
    
    212,260
    
    
    
    151,238NONINTEREST INCOME:Service and other charges on loans
    
    
    10,106
    
    
    
    10,795
    
    
    
    8,410Service charges on deposit accounts
    
    
    7,969
    
    
    
    7,053
    
    
    
    6,652Other fees and commissions
    
    
    10,536
    
    
    
    9,983
    
    
    
    7,443Gain (loss) on derivative instruments
    
    
    (7
    )
    
    
    (236
    )
    
    
    1,288Net gain (loss) on sales and valuation of loans, securities,
and other assets
    
    
    2,629
    
    
    
    (20,949
    )
    
    
    950Total noninterest income
    
    
    31,233
    
    
    
    6,646
    
    
    
    24,743TOTAL NET INTEREST INCOME AND NONINTEREST INCOME
    
    
    294,076
    
    
    
    218,906
    
    
    
    175,981NONINTEREST EXPENSES:Salaries and employees benefits
    
    
    38,317
    
    
    
    33,840
    
    
    
    28,017Equipment
    
    
    9,445
    
    
    
    9,044
    
    
    
    9,519Deposits insurance premium and supervisory examination
    
    
    2,907
    
    
    
    2,392
    
    
    
    1,792Occupancy
    
    
    6,694
    
    
    
    6,603
    
    
    
    5,861Advertising
    
    
    10,508
    
    
    
    6,698
    
    
    
    6,865Printing, postage, stationery and supplies
    
    
    3,206
    
    
    
    3,253
    
    
    
    2,836Telephone
    
    
    2,315
    
    
    
    2,279
    
    
    
    2,042Net loss (gain) from operations of foreclosed real estate held for sale
    
    
    418
    
    
    
    205
    
    
    
    (88
    )Municipal taxes
    
    
    3,953
    
    
    
    3,600
    
    
    
    2,992Other
    
    
    22,362
    
    
    
    16,907
    
    
    
    14,081Total noninterest expenses
    
    
    100,125
    
    
    
    84,821
    
    
    
    73,917INCOME BEFORE PROVISION FOR INCOME TAXES
    
    
    193,951
    
    
    
    134,085
    
    
    
    102,064PROVISION FOR INCOME TAXES
    
    
    22,086
    
    
    
    20,771
    
    
    
    16,101NET INCOME
    
    $
    171,865
    
    
    $
    113,314
    
    
    $
    85,963NET INCOME AVAILABLE TO COMMON
STOCKHOLDERS
    
    $
    144,707
    
    
    $
    91,721
    
    
    $
    72,189BASIC EARNINGS PER COMMON SHARE
    
    $
    0.89
    
    
    $
    0.57
    
    
    $
    0.48DILUTED EARNINGS PER COMMON SHARE
    
    $
    0.86
    
    
    $
    0.55
    
    
    $
    0.47
 See notes to consolidated financial statements. 67




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##### Table of Contents



W HOLDING COMPANY, INC. AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY
AND OF COMPREHENSIVE INCOME (IN THOUSANDS)
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002  2004
    
    
    2003
    
    
    2002CHANGES IN STOCKHOLDERS EQUITY:Preferred stock:Balance at beginning of year
    
    $
    15,396
    
    
    $
    8,943
    
    
    $
    7,220Issuance of preferred stock
    
    
    2,675
    
    
    
    6,872
    
    
    
    1,725Conversion of preferred stock
    
    
    (277
    )
    
    
    (419
    )
    
    
    (2
    )Balance at end of year
    
    
    17,794
    
    
    
    15,396
    
    
    
    8,943Common stock:Balance at beginning of year
    
    
    106,290
    
    
    
    68,346
    
    
    
    41,500Stock split
    
    
    54,640
    
    
    
    34,737
    
    
    
    20,750Stock dividend
    
    
    2,142
    
    
    
    2,083
    
    
    
    Purchase and retirement of common stock
    
    
    
    
    
    
    (2
    )
    
    
    (2
    )Issuance of common stock
    
    
    
    
    
    
    
    
    
    
    6,095Issuance of common stock upon conversion of preferred stock
    
    
    632
    
    
    
    626
    
    
    
    3Issuance of common stock upon exercise of stock options
    
    
    215
    
    
    
    500
    
    
    
    Balance at end of year
    
    
    163,919
    
    
    
    106,290
    
    
    
    68,346Paid-in capital:Balance at beginning of year
    
    
    514,800
    
    
    
    319,106
    
    
    
    187,628Issuance of preferred stock
    
    
    126,715
    
    
    
    158,991
    
    
    
    39,738Stock dividend
    
    
    43,684
    
    
    
    33,076
    
    
    
    Stock options exercised
    
    
    754
    
    
    
    2,834
    
    
    
    Effect of stock options granted to employees
    
    
    895
    
    
    
    1,031
    
    
    
    Issuance of common stock upon conversion of preferred stock
    
    
    (355
    )
    
    
    (207
    )
    
    
    Purchase and retirement of common stock
    
    
    
    
    
    
    (31
    )
    
    
    (40
    )Issuance of common stock
    
    
    
    
    
    
    
    
    
    
    91,780Balance at end of year
    
    
    686,493
    
    
    
    514,800
    
    
    
    319,106Reserve fund:Balance at beginning of year
    
    
    43,375
    
    
    
    32,011
    
    
    
    23,476Transfer from undivided profits
    
    
    17,297
    
    
    
    11,364
    
    
    
    8,535Balance at end of year
    
    
    60,672
    
    
    
    43,375
    
    
    
    32,011Undivided profits:Balance at beginning of year
    
    
    149,581
    
    
    
    157,442
    
    
    
    128,583Net income
    
    
    171,865
    
    
    
    113,314
    
    
    
    85,963Cash dividends on common stock
    
    
    (23,502
    )
    
    
    (18,322
    )
    
    
    (14,045
    )Cash dividends on preferred stock
    
    
    (27,158
    )
    
    
    (21,593
    )
    
    
    (13,774
    )Transfer to reserve fund
    
    
    (17,297
    )
    
    
    (11,364
    )
    
    
    (8,535
    )Stock split
    
    
    (54,643
    )
    
    
    (34,737
    )
    
    
    (20,750
    )Stock dividend
    
    
    (45,833
    )
    
    
    (35,159
    )
    
    
    Balance at end of year
    
    
    153,013
    
    
    
    149,581
    
    
    
    157,442Accumulated other comprehensive loss, net of income tax:Balance at beginning of year
    
    
    (933
    )
    
    
    (1,100
    )
    
    
    (498
    )Other comprehensive income (loss), net of income tax for the year
    
    
    721
    
    
    
    167
    
    
    
    (602
    )Balance at end of year
    
    
    (212
    )
    
    
    (933
    )
    
    
    (1,100
    )TOTAL STOCKHOLDERS EQUITY
    
    $
    1,081,679
    
    
    $
    828,509
    
    
    $
    584,748COMPREHENSIVE INCOME:Net income
    
    $
    171,865
    
    
    $
    113,314
    
    
    $
    85,963Other comprehensive income (loss), net of income tax:Unrealized net gains (losses) on securities available for sale:Unrealized gains (losses) arising during the period
    
    
    828
    
    
    
    (7,512
    )
    
    
    718Reclassification adjustment for losses (gains) included in net income
    
    
    (128
    )
    
    
    7,671
    
    
    
    (1,508
    )700
    
    
    
    159
    
    
    
    (790
    )Cash flow hedges:Unrealized net derivative gain arising during the period
    
    
    
    
    
    
    
    
    
    
    356Income tax effect
    
    
    21
    
    
    
    8
    
    
    
    (168
    )Net change in other comprehensive loss, net of income tax
    
    
    721
    
    
    
    167
    
    
    
    (602
    )TOTAL COMPREHENSIVE INCOME
    
    $
    172,586
    
    
    $
    113,481
    
    
    $
    85,361
 See notes to consolidated financial statements. 68




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##### Table of Contents



W HOLDING COMPANY, INC. AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002  2004
    
    
    2003
    
    
    2002CASH FLOWS FROM OPERATING ACTIVITIES:Net income
    
    $
    171,865
    
    
    $
    113,314
    
    
    $
    85,963Adjustments to reconcile net income to net cash provided
by operating activities:Provision (credit) for:Loan losses
    
    
    36,691
    
    
    
    27,048
    
    
    
    15,083Losses on foreclosed real estate held for sale
    
    
    553
    
    
    
    37
    
    
    
    126Deferred income tax credit
    
    
    (6,096
    )
    
    
    (8,575
    )
    
    
    (2,518
    )Depreciation and amortization on:Premises and equipment
    
    
    7,034
    
    
    
    7,293
    
    
    
    6,856Foreclosed real estate held for sale
    
    
    
    
    
    
    308
    
    
    
    60Mortgage servicing rights
    
    
    424
    
    
    
    648
    
    
    
    772Stock options granted to employees
    
    
    895
    
    
    
    1,031
    
    
    
    Amortization of premium (discount), net on:Investment securities available for sale
    
    
    393
    
    
    
    14
    
    
    
    (647
    )Investment securities held to maturity
    
    
    (1,551
    )
    
    
    (1,953
    )
    
    
    (9,062
    )Mortgage-backed securities held to maturity
    
    
    1,136
    
    
    
    4,292
    
    
    
    (555
    )Loans
    
    
    1,320
    
    
    
    1,481
    
    
    
    1,651Amortization of discount on deposits
    
    
    3,796
    
    
    
    2,750
    
    
    
    1,930Amortization of net deferred loan origination fees
    
    
    (9,994
    )
    
    
    (8,581
    )
    
    
    (5,634
    )Net loss (gain) on sale and in valuation of:Investment securities available for sale
    
    
    (128
    )
    
    
    7,671
    
    
    
    (1,508
    )Impairment on investment securities held to maturity
    
    
    
    
    
    
    15,701
    
    
    
    Called investment securities held to maturity
    
    
    (525
    )
    
    
    
    
    
    
    Mortgage loans held for sale
    
    
    (1,649
    )
    
    
    (2
    )
    
    
    (306
    )Derivative instruments
    
    
    (1,790
    )
    
    
    (1,561
    )
    
    
    (1,288
    )Foreclosed real estate held for sale
    
    
    (305
    )
    
    
    (797
    )
    
    
    (119
    )Capitalization of servicing rights
    
    
    (904
    )
    
    
    (1,544
    )
    
    
    (607
    )Originations of mortgage loans held for sale
    
    
    (30,499
    )
    
    
    (17,515
    )
    
    
    (52,317
    )Sales of mortgage loans held for sale
    
    
    23,428
    
    
    
    
    
    
    
    8,690Decrease (increase) in:Trading securities
    
    
    8,383
    
    
    
    22,403
    
    
    
    87,397Accrued interest receivable
    
    
    (12,718
    )
    
    
    (28,914
    )
    
    
    (13,833
    )Other assets
    
    
    605
    
    
    
    (1,628
    )
    
    
    (6,994
    )Increase (decrease) in:Accrued interest on deposits and borrowings
    
    
    12,257
    
    
    
    4,265
    
    
    
    (376
    )Other liabilities
    
    
    (14,762
    )
    
    
    4,361
    
    
    
    21,211Net cash provided by operating activities
    
    
    187,859
    
    
    
    141,547
    
    
    
    133,975CASH FLOWS FROM INVESTING ACTIVITIES:Net (increase) decrease in interest-bearing deposits in banks
    
    
    (11,709
    )
    
    
    (20,308
    )
    
    
    8,755Net (increase) decrease in federal funds sold and resell agreements
    
    
    (17,452
    )
    
    
    9,295
    
    
    
    (303,014
    )Resell agreements with original maturities over three months:Purchases
    
    
    (550,000
    )
    
    
    (350,000
    )
    
    
    Collections
    
    
    200,000
    
    
    
    150,000
    
    
    
    Investment securities available for sale:Sales
    
    
    130,066
    
    
    
    50,803
    
    
    
    661,090Maturities, prepayments and calls
    
    
    42,505
    
    
    
    182,410
    
    
    
    191,175Purchases
    
    
    (124,938
    )
    
    
    (83,261
    )
    
    
    (771,152
    )Investment securities held to maturity:Maturities, prepayments and calls
    
    
    14,602,463
    
    
    
    21,450,415
    
    
    
    14,713,873Purchases
    
    
    (15,967,622
    )
    
    
    (23,340,101
    )
    
    
    (15,600,485
    )Mortgage-backed securities held to maturity:Maturities, prepayments and calls
    
    
    225,783
    
    
    
    821,058
    
    
    
    403,026Purchases
    
    
    (55,081
    )
    
    
    (1,223,736
    )
    
    
    (638,079
    )Loans:Purchases
    
    
    (250,082
    )
    
    
    (344,637
    )
    
    
    (213,418
    )Sales
    
    
    
    
    
    
    50,959
    
    
    
    Loans originations and principal collections, net
    
    
    (1,015,945
    )
    
    
    (655,864
    )
    
    
    (714,924
    )Purchases of derivative options
    
    
    (4,872
    )
    
    
    (3,384
    )
    
    
    (4,968
    )Cash paid on terminated swaps
    
    
    
    
    
    
    
    
    
    
    (208
    )Proceeds from sales of foreclosed real estate held for sale
    
    
    1,494
    
    
    
    882
    
    
    
    462Additions to premises and equipment
    
    
    (13,553
    )
    
    
    (14,450
    )
    
    
    (12,520
    )Redemption of Federal Home Loan Bank stock
    
    
    8,490
    
    
    
    3,572
    
    
    
    Purchase of Federal Home Loan Bank stock
    
    
    (20,935
    )
    
    
    
    
    
    
    (4,872
    )Purchase of partnership interest, net of cash acquired
    
    
    
    
    
    
    
    
    
    
    (11,496
    )Net cash used in investing activities
    
    
    (2,821,388
    )
    
    
    (3,316,347
    )
    
    
    (2,296,755
    )Forward
    
    $
    (2,633,529
    )
    
    $
    (3,174,800
    )
    
    $
    (2,162,780
    )
 (continued) 69




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##### Table of Contents



W HOLDING COMPANY, INC. AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002  2004
    
    
    2003
    
    
    2002Forward
    
    $
    (2,633,529
    )
    
    $
    (3,174,800
    )
    
    $
    (2,162,780
    )CASH FLOWS FROM FINANCING ACTIVITIES:Net increase in deposits
    
    
    833,791
    
    
    
    1,086,251
    
    
    
    1,069,000Net increase (decrease) in federal funds purchased
and repurchase agreements
    
    
    1,365,526
    
    
    
    (326,280
    )
    
    
    451,195Repurchase agreements with original maturities over three months:Proceeds
    
    
    6,531,812
    
    
    
    2,740,548
    
    
    
    1,475,773Payments
    
    
    (6,259,856
    )
    
    
    (465,564
    )
    
    
    (889,273
    )Payments of term notes
    
    
    
    
    
    
    
    
    
    
    (43,000
    )Payments of mortgage note payable
    
    
    (376
    )
    
    
    (588
    )
    
    
    Advances from Federal Home Loan Bank:Proceeds
    
    
    293,000
    
    
    
    189,000
    
    
    
    Payments
    
    
    (228,000
    )
    
    
    (163,000
    )
    
    
    Line of credit:Proceeds
    
    
    
    
    
    
    50,000
    
    
    
    Payments
    
    
    
    
    
    
    (50,000
    )
    
    
    Net increase in advances from borrowers for taxes
and insurance
    
    
    2,206
    
    
    
    1,109
    
    
    
    763Repurchase of common stock for retirement
    
    
    
    
    
    
    (33
    )
    
    
    (42
    )Dividends paid
    
    
    (50,097
    )
    
    
    (39,109
    )
    
    
    (27,308
    )Issuance of common stock
    
    
    
    
    
    
    
    
    
    
    97,875Issuance of preferred stock
    
    
    129,495
    
    
    
    165,863
    
    
    
    41,463Proceeds from stock options exercised
    
    
    969
    
    
    
    3,334
    
    
    
    Net cash provided by financing activities
    
    
    2,618,470
    
    
    
    3,191,531
    
    
    
    2,176,446NET CHANGE IN CASH AND DUE FROM BANKS
    
    
    (15,059
    )
    
    
    16,731
    
    
    
    13,666CASH AND DUE FROM BANKS, BEGINNING OF YEAR
    
    
    92,811
    
    
    
    76,080
    
    
    
    62,414CASH AND DUE FROM BANKS, END OF YEAR
    
    $
    77,752
    
    
    $
    92,811
    
    
    $
    76,080SUPPLEMENTAL DISCLOSURES OF CASH FLOW
INFORMATION:Cash paid during the year for:Interest on deposits and other borrowings
    
    $
    282,635
    
    
    $
    229,504
    
    
    $
    225,146Income taxes
    
    
    45,742
    
    
    
    18,943
    
    
    
    11,235Noncash activities:Accrued dividends payable
    
    
    3,300
    
    
    
    2,737
    
    
    
    1,931Net change in other comprehensive loss
    
    
    721
    
    
    
    167
    
    
    
    (602
    )Mortgage loans securitized and transferred to:Trading securities
    
    
    8,489
    
    
    
    22,403
    
    
    
    41,740Mortgage-backed securities held to maturity
    
    
    2,305
    
    
    
    
    
    
    
    Transfer from available for sale to trading securities
    
    
    
    
    
    
    
    
    
    
    41,048Transfer from held to maturity to available for sale
    
    
    
    
    
    
    51,671
    
    
    
    Transfer from loans to foreclosed real estate held for sale
    
    
    3,015
    
    
    
    3,288
    
    
    
    2,075Mortgage loans originated to finance the sale of foreclosed
real estate held for sale
    
    
    1,545
    
    
    
    2,455
    
    
    
    786Unpaid additions to premises and equipment
    
    
    191
    
    
    
    16
    
    
    
    20Transfer from undivided profits to reserve fund
    
    
    17,297
    
    
    
    11,364
    
    
    
    8,535Effect in valuation of derivatives and their hedged items:Increase in loans
    
    
    23,881
    
    
    
    
    
    
    
    Increase (decrease) in other assets
    
    
    2,920
    
    
    
    (1,495
    )
    
    
    (3,796
    )Decrease (increase) in deposits
    
    
    (5,609
    )
    
    
    1,962
    
    
    
    4,438Decrease (increase) in other liabilities
    
    
    (23,299
    )
    
    
    1,094
    
    
    
    646Conversion of preferred stock into common stock:Common stock
    
    
    632
    
    
    
    626
    
    
    
    3Paid in capital
    
    
    (355
    )
    
    
    (207
    )
    
    
    Preferred stock
    
    
    (277
    )
    
    
    (419
    )
    
    
    (2
    )Building acquired on purchase of partnership interest
    
    
    
    
    
    
    
    
    
    
    49,852Other assets acquired on purchase of partnership interest
    
    
    
    
    
    
    
    
    
    
    249Mortgage note assumed on purchase of partnership interest
    
    
    
    
    
    
    

    
    
    
    37,822
  See notes to consolidated financial statements.
    
    
    
    (concluded)
 70




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W HOLDING COMPANY, INC. AND SUBSIDIARIES 
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTSYEARS ENDED DECEMBER 31, 2004, 2003 AND 2002   1.
    ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:W Holding Company, Inc. (the Company) is a financial holding company offering a full range of
financial services. The business of the Company is conducted primarily through its wholly owned
commercial bank subsidiary, Westernbank Puerto Rico
(Westernbank or the Bank). The Companys other
operating subsidiary is Westernbank Insurance Corp. The Company was organized under the laws of
the Commonwealth of Puerto Rico in February 1999 to become the bank holding company of
Westernbank. Westernbank was founded as a savings institution in 1958 operating in the western
and southwestern regions of Puerto Rico, focusing on retail banking and emphasizing long-term
fixed-rate residential mortgage loans on one-to-four family residential properties. In 1994,
Westernbank changed its charter to become a full-service commercial bank. Westernbank offers a
full range of business and consumer financial services, including banking, trust and brokerage
services. Westernbank Insurance Corp. is a general insurance agent placing property, casualty,
life and disability insurance. The assets, liabilities, revenues and expenses of Westernbank
Insurance Corp. at December 31, 2004 and 2003 and for each of the three years in the period
ended December 31, 2004, were not significant.In July 2000, the Company became a financial holding company under the Bank Holding Company
Act. As a financial holding company, the Company is permitted to engage in financial related
activities, including insurance and securities activities, provided that the Company and its
banking subsidiary meet certain regulatory standards.Westernbank operates through 52 full service branch offices located throughout Puerto Rico,
including 33 in the Southwestern region, 7 in the Northeastern region and 12 in the San Juan
Metropolitan area, and a fully functional banking site on the Internet. Westernbank Puerto Rico
traditional banking operations include retail operations, such as its branches, including the
branches of the Expresso division, together with consumer loans, mortgage loans, commercial
loans (excluding the asset-based lending operations), investments (treasury) and deposit
products. Besides the traditional banking operations, Westernbank operates through other four
divisions: Westernbank International Division, which is an International Banking Entity (IBE)
under the Puerto Rico Act No. 52 of August 11, 1989, as amended, known as the International
Banking Regulatory Act, which activities consist of commercial and related services, and
treasury and investment activities outside of Puerto Rico; Westernbank Business Credit, which
specializes in commercial business loans secured principally by commercial real estate,
accounts receivable, inventory and equipment; Westernbank Trust Division, which offers a full
array of trust services; and Expresso of Westernbank, a division which specializes in small,
unsecured consumer loans up to $15,000 and real estate collateralized consumer loans up to
$150,000 through 19 full-service branches.Westernbank World Plaza, Inc. (WWPI), a wholly owned subsidiary of Westernbank, owns and
operates Westernbank World Plaza, a 23-story office building, including its related parking
facility, located in Hato Rey, Puerto Rico, the main Puerto Rican
business district. Westernbank World Plaza serves as the Companys San Juan metropolitan area headquarters for Westernbanks regional
commercial lending office and headquarters for the Westernbank Business Credit and Expresso
of Westernbank divisions. Westernbank also owns 100% of the voting shares of SRG Net, Inc., a
Puerto Rico corporation that operates an electronic funds transfer network. The assets,
liabilities, revenues and expenses of SRG Net, Inc. at
December 31, 2004 and 2003, and for each
of the three years in the period ended December 31, 2004, were not significant. 71




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The accounting and reporting policies of W Holding Company, Inc. conform to accounting
principles generally accepted in the United States of America and banking industry practices.
Following is a summary of the Companys most significant accounting policies:Principles of Consolidation- The consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiaries, Westernbank Puerto Rico and Westernbank Insurance
Corp. All significant intercompany transactions and balances have been eliminated in
consolidation.Use of Estimates- The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America, requires management to make
estimates and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the consolidated financial
statements and the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.Significant Group Concentrations of Credit Risk- Most of the Companys business activities are
with customers located within Puerto Rico. Notes 2 and 3 discuss the types of securities that
the Company invests in. Note 4 discusses the types of lending that the Company engages in.
Note 19 discusses the types of derivative instruments that the Company enters into. The
Company does not have any significant concentration in any one industry or customer.Cash and Cash Equivalents- For purposes of presentation in the consolidated statements of cash
flows, cash and cash equivalents are those amounts included in the statements of financial
condition as cash and due from banks.Interest-Bearing Deposits in Banks, Federal Funds Sold and Federal Funds Purchased-
Interest-bearing deposits in banks, federal funds sold and federal funds purchased are carried
at cost and mature the next business day.Securities- Securities are classified as held-to-maturity, available-for-sale or trading on
the date of purchase. Only those securities classified as held-to maturity, and which
management has the intent and ability to hold to maturity, are reported at amortized cost.
Available-for-sale and trading securities are reported at fair value with unrealized gains and
losses, net of related deferred income taxes, included in accumulated comprehensive income
(loss) and in income, respectively. The fair value of a security is determined based on
quotations received from securities dealers. If quoted market prices are not available, fair
value is determined based on quoted prices of similar instruments. Realized securities gains or
losses are reported within noninterest income in the consolidated statements of income. The
cost of securities sold is based on the specific identification method. Available-for-sale and
held-to-maturity securities are reviewed at least quarterly for possible other-than-temporary
impairment. The review includes an analysis of the facts and circumstances of each individual
investment such as the length of time and the extent to which the fair value has been below
cost, the expectation for that securitys performance, the credit worthiness of the issuer and
the Companys intent and ability to hold the security to maturity. A decline in value that is
considered to be other-than-temporary is recorded as a loss within noninterest income in the
consolidated statements of income.The impairment analysis on the mortgage and other asset-backed securities is done placing
special emphasis on the analysis of the trustee and collateral manager monthly reports, on
sensitivity and expected cash flow analysis made by major brokerage houses and on the credit
worthiness of the issuer. The Company also considers its intent and ability to hold these
securities. If management believes, based on the analysis, that the principal and interest
obligations on any mortgage and other asset-backed security will not be received in a timely
manner, the security is written down to fair value based on available secondary market prices
from broker/dealers. 72




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The equity securities and corporate notes impairment analyses are performed and reviewed
quarterly based on the latest financial information and any supporting research report made by
major brokerage houses. These analyses are subjective and based, among other things, on
relevant financial data such as capitalization, cash flows, liquidity, systematic risk, and
debt outstanding. Management also considers the industry trends, the historical performance of
the stock, as well as the Companys intent to hold the security. If management believes that
there is a low probability of achieving book value in a reasonable time frame, then an
impairment is recorded by writing down the security to fair value.Residential Mortgage Loans Held for Sale Residential mortgage loans originated and intended
for sale in the secondary market are carried at the lower of aggregate cost or fair value.
Fair value is based on the contract price at which the mortgage loans will be sold. The
Company generally has commitments to sell residential mortgage loans held for sale in the
secondary market. 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. Commitments to sell residential loans held for sale in the secondary
market were not significant at December 31, 2004 and 2003.Loans- 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, and any deferred fees or costs on originated
loans. Interest income is accrued on the unpaid principal balance computed using the effective
interest method. Loan origination fees, net of certain direct origination costs, are deferred
and recognized as an adjustment of the related loan yield using the interest method. Discounts
and premiums on purchased loans are amortized to income over the expected lives of the loans
using methods that approximate the interest method.The accrual of interest on loans is discontinued when there is a clear indication the
borrowers cash flow may not be sufficient to meet payments as they become due, but in no event
is it recognized after 90 days in arrears on payments of principal or interest. When a loan is
placed on nonaccrual status, all previously accrued and unpaid interest is charged against
income and the loan is accounted for on the cash method thereafter, until qualifying for return
to accrual status. Generally, a loan is returned to accrual status when all delinquent interest
and principal payments become current in accordance with the terms of the loan agreement or
when the loan is both well secured and in the process of collection and collectibility is no
longer doubtful.Allowance for Loan Losses The Company maintains an allowance to absorb probable loan losses
inherent in the portfolio. The allowance for loan losses is maintained at a level the Company
considers to be adequate to absorb probable loan losses, based on evaluations of the
collectibility and historical loss experience of loans. Estimates of losses inherent in the
loan portfolio involve the exercise of judgement and the use of assumptions. This evaluation
is inherently subjective as it requires estimates that are susceptible to significant revision
as more information becomes available. The allowance is increased by a provision for loan
losses, which is charged to expense and reduced by charge-offs, net of recoveries. Provision
for loan losses are based on the Companys review of the historical loan loss experience and
such factors that, in managements judgment, deserve consideration under existing economic
conditions in estimating probable loan losses. Changes in the allowance relating to impaired
loans are charged or credited to the provision for loan losses. Because of uncertainties
inherent in the estimation process, managements estimate of credit losses in the loan
portfolio and the related allowance may change in the near term.The allowance for loan losses is based on ongoing quarterly assessments of the probable
estimated losses inherent in the loan portfolio. The Company follows a systematic methodology
to establish and evaluate the adequacy of the allowance for loan losses. This methodology
consists of several key elements. Larger commercial and construction loans that exhibit
probable or observed credit weaknesses are subject to individual review. 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 Company. 73




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Included in the review of individual loans are those that are impaired as provided in Statement
of Financial Accounting Standards (SFAS) No. 114, Accounting by Creditors for
Impairment of a
Loan, as amended.Any allowances for impaired loans are measured based on the
present value of
expected future cash flows discounted at the loans effective interest rate or fair value of
the underlying collateral. Commercial business, commercial real estate and construction loans,
exceeding $500,000 in 2004 and 2003, and $250,000 in 2002, are individually evaluated
for impairment. Other loans are evaluated in homogeneous groups and collectively evaluated for
impairment. Loans that are recorded at fair value or at the lower of cost or fair value are
not evaluated for impairment. Impaired loans for which the discounted cash flows or collateral
value exceeds its carrying value do not require an allowance. The Company evaluates the
collectibility of both principal and interest when assessing the need for loss accrual.Historical loss rates are applied to other commercial and construction loans not subject to
specific allowance allocations. The loss rates are generally derived from historical loss
trends for three to five years.Homogeneous loans, such as consumer installments, residential mortgage loans, and credit cards
are not individually risk graded. Allowances are established for each pool of loans based on
the expected net charge-offs for one year. Loss rates are based on the average net charge-off
history for one to three years by loan category.Historical loss rates may be adjusted for significant factors that, in managements judgement,
reflect the impact of any current condition on loss recognition. Factors that management
considers in the analysis include the effect of the national and local economies, trends in the
nature and volume of loans (delinquencies, charge-offs, non-accrual and problem loans), asset
quality trends, changes in the internal lending policies and credit standards, collection
practices, and examination results from bank regulatory agencies and the Companys internal
credit examiners.An unallocated allowance is maintained to recognize the imprecision in estimating and measuring
loss when evaluating allowances for individual loans or pools of loans. Allowances on
individual loans and historical loss rates are reviewed quarterly and adjusted as necessary
based on changing borrower and/or collateral conditions and actual collection and charge-off
experience.The Company has not substantively changed any aspect of its overall approach in the
determination of the allowance for loan losses. There have been no material changes in
assumptions or estimation techniques as compared to prior years that impacted the determination
of the current year allowance for loan losses.Foreclosed Real Estate Held for Sale- Assets acquired through, or in lieu of, loan foreclosure
are held for sale and are initially recorded at fair value at the date of foreclosure,
establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed
by management and the assets are carried at the lower of carrying amount or fair value less
cost to sell. Revenue and expenses from operations and changes in the valuation allowance are
included in net expenses from foreclosed real estate held for sale.Premises and Equipment- Premises and equipment, including leasehold improvements, are stated
at cost, less accumulated depreciation and amortization. Depreciation is calculated using the
straight-line method over the estimated useful lives of the assets, which range from two to 40
years. 74




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Amortization of leasehold improvements is computed using the straight-line method over the
lives of the related leases or the estimated useful lives of the related assets, whichever is
shorter. Costs of maintenance and repairs that do not improve or extend the lives of the
respective assets are charged to expense as incurred.Impairment of Long-Lived Assets The Company periodically reviews long-lived assets for
impairment whenever events or changes in circumstances indicate that the carrying amount of an
asset may not be recoverable. No indications of impairment are evident as a result of such
review during 2004, 2003 and 2002.Transfer of Financial Assets Transfer of financial assets are 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.Mortgage Servicing Rights- The Company recognizes as separate assets the rights to service
mortgage loans for others, regardless of how those servicing rights are acquired and assesses
the capitalized mortgage servicing rights for impairment based on the fair value of those
rights. Servicing assets are evaluated for impairment based upon the fair value of the rights
as compared to amortized cost. Fair value is determined using prices for similar assets with
similar characteristics. Impairment is recognized through a valuation allowance for an
individual servicing right, to the extent that fair value is less than the carrying amount for
that right.The total cost of mortgage loans sold with servicing rights retained is allocated to the
mortgage servicing rights and the loans (without the mortgage servicing rights), based on their
relative fair values. Mortgage servicing rights are amortized in proportion to, and over the
period of, estimated servicing income.Stock Option Plans- As further discussed in Note 17 to the consolidated financial statements,
the Company has two stock option plans. Up to December 31, 2002, the Company accounted for
those plans following the intrinsic value-based method of accounting prescribed by Accounting
Principles Board (APB) Opinion No. 25, Accounting for Stocks Issued to Employees,and Related
Interpretations. Compensation expense under this method was generally recognized for any excess
of the quoted market price of the Companys stock at the measurement date over the amount an
employee must pay to acquire the stock. Since all options granted under those plans had an
exercise price equal to the market value of the underlying common stock at the grant date, no
compensation expense was recognized at the measurement date.Effective January 1, 2003, the Company adopted the fair value recognition provisions of SFAS
No. 123, Accounting for Stock-Based Compensation. Under the modified prospective method which
was selected by the Company under the provisions of SFAS No. 148, Accounting for Stock-Based
Compensation  Transition and Disclosure, an amendment of SFAS No. 123, compensation cost
recognized since January 1, 2003 is the same that would have been recognized had the
recognition provisions of SFAS No. 123 been applied from its original effective date. Results
prior to 2003 were not restated. 75




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The following table illustrates the effect on net income and earnings per share had the fair
value method been applied to all outstanding options in each period: Years Ended December 31,2004
    
    
    2003
    
    
    2002(In thousands, except per share data)Net income as reported
    
    $
    171,865
    
    
    $
    113,314
    
    
    $
    85,963Add: Stock based employee
compensation expense included
inreported net income
    
    
    895
    
    
    
    1,031
    
    
    
    Deduct: Total stock based employee
compensation expense determinedunder the fair value based method for
all options
    
    
    (895
    )
    
    
    (1,031
    )
    
    
    (648
    )Pro-forma net income
    
    $
    171,865
    
    
    $
    113,314
    
    
    $
    85,315Earnings per share:Basic  as reported (1)
    
    $
    0.89
    
    
    $
    0.57
    
    
    $
    0.48Diluted  as reported (1)
    
    $
    0.86
    
    
    $
    0.55
    
    
    $
    0.47Basic  pro forma (1)
    
    $
    0.89
    
    
    $
    0.57
    
    
    $
    0.48Diluted  pro forma (1)
    
    $
    0.86
    
    
    $
    0.55
    
    
    $
    0.47
   (1)
    
    Adjusted to reflect the three-for-two split and a 2% stock dividend on our common stock
declared in December 2004, and distributed both on January 10, 2005, and the three-for-two split and a
2% stock dividend on our common stock declared in November 2003, and distributed both on December 10,
2003.  The fair value of the options granted in year 2002 was $1.37 per option (as adjusted). The
fair value was estimated on the grant date using the Black-Scholes option pricing model with
the following weighted average assumptions: (1) the dividend yield was 0.91% (as adjusted); (2)
the expected life was 7 years; (3) the expected volatility was 21.84%; and, (4) the risk-free
interest rate was 4.43%. The weighted average market price of the stock at the grant date was
$6.77 (as adjusted). No options were granted in 2004 and 2003.Income Taxes- Deferred income taxes are accounted for using the asset and liability method of
accounting for income taxes. Under the asset and liability method, deferred tax assets and
liabilities are recognized for the future tax consequences attributable to differences between
the financial statement carrying amounts of existing assets and liabilities and the respective
tax bases and operating and capital losses and tax credit carry-forwards. Deferred tax assets
and liabilities are measured using enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to be recovered or settled. The effect
on deferred tax assets and liabilities of a change in tax rates is recognized in income in the
period that includes the enactment date. Valuation allowances are established, when necessary,
to reduce deferred tax assets to the amount expected to be realized. 76




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Financial Instruments:  
    Derivative Financial Instruments- As part of the Companys asset/liability
management, the Company uses interest-rate contracts, which include interest-rate exchange
agreements (swaps) and option agreements, to hedge various exposures or to modify interest
rate characteristics of various statement of financial condition items.The Company accounts for its derivatives under SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities, as amended. The Standard requires recognition of all
derivatives as either assets or liabilities in the statement of financial condition and
requires measurement of those instruments at fair value through adjustments to either
accumulated other comprehensive income (loss) or current earnings or both, as appropriate.
On the date the Company enters into a derivative contract, the Company designates the
derivative instrument as either a fair value hedge, cash flow hedge or as a derivative
instrument not designated as a hedge. For a fair value hedge, changes in the fair value of
the derivative instrument and changes in the fair value of the hedged asset or liability or
of an unrecognized firm commitment attributable to the hedged risk are recorded in current
period net income. For a cash flow hedge, changes in the fair value of the derivative
instrument, to the extent that it is effective, are recorded in accumulated other
comprehensive income (loss) and subsequently reclassified to net income in the same
period(s) that the hedged transaction impacts net income. For derivative instruments not
designated as a hedge, changes in fair values are reported in current period net income.The Company formally documents the relationship between hedging instruments and hedged
items, as well as the risk management objective and strategy for undertaking various hedge
transactions. This process includes linking all derivative instruments that are designated
as fair value or cash flow hedges to specific assets and liabilities on the statement of
financial condition or to specific forecasted transactions along with a formal assessment
at both inception of the hedge and on an ongoing basis as to the effectiveness of the
derivative instrument in offsetting changes in fair values or cash flows of the hedged
item. If it is determined that the derivative instrument is not highly effective as a
hedge, hedge accounting is discontinued and the adjustment to fair value of the derivative
instrument is recorded in net income.In the case of interest-rate exchange agreements that qualify for hedging accounting
treatment, net interest income (expense) resulting from the differential between exchanging
floating and fixed-rate interest payments is recorded on a current basis as an adjustment
to interest income or expense on the corresponding hedged assets or liabilities.
    Off-Balance Sheet Credit Related Financial Instruments- In the ordinary course of
business, the Company enters into off-balance sheet credit related financial instruments
consisting of commitments to extend credit, commitments under credit card arrangements,
commercial letters of credit and commitments to purchase mortgage loans. Such financial
instruments are recorded in the financial statements when they are funded or related fees
are incurred or received. The Company periodically evaluates the credit risks inherent in
these commitments and commercial letters of credit, and establishes loss allowances for
such risks if and when these are deemed necessary. For the years ended December 31, 2004,
2003 and 2002, the Company did not record any loss allowances in connection with risks
involved in off-balance sheet credit related financial instruments. At December 31,
2004 and 2003, there were no additional off-balance sheet credit related financial
instruments other than those mentioned above. 77




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Earnings per Share Basic earnings per share represents income attributable to common
stockholders divided by the weighted average number of common shares outstanding during the
period. Diluted earnings per share reflect additional common shares that would have been
outstanding if dilutive potential common shares had been issued, as well as any adjustment to
income that would result from the assumed issuance. Potential common shares that may be issued
by the Company relate to the outstanding convertible preferred stock, which are determined
using the if-converted method, and the outstanding stock options, which are determined using
the treasury stock method. The effect of convertible preferred stock (1,819,400 shares in 2004,
1,821,673 shares in 2003, and 1,852,700 shares in 2002, as adjusted) was dilutive in 2004 and
antidilutive in 2003 and 2002. The effect of stock options was dilutive in 2004, 2003 and
2002.Basic and diluted earnings per common share were computed as follows: 2004
    
    
    2003
    
    
    2002(Amounts in thousands, except per share data)Basic and diluted earnings per common share:Net income
    
    $
    171,865
    
    
    $
    113,314
    
    
    $
    85,963Less preferred stock dividends
    
    
    (27,158
    )
    
    
    (21,593
    )
    
    
    (13,774
    )Income attributable to common stockholders  basic
    
    
    144,707
    
    
    
    91,721
    
    
    
    72,189Plus convertible preferred stock dividends
    
    
    1,189
    
    
    
    
    
    
    
    Income attributable to common stockholders  diluted
    
    $
    145,896
    
    
    $
    91,721
    
    
    $
    72,189Weighted average number of common
shares outstanding for the year (1)
    
    
    163,348
    
    
    
    160,734
    
    
    
    150,712Dilutive potential common shares  stock options (1)
    
    
    5,276
    
    
    
    4,596
    
    
    
    1,779Assumed conversion of preferred stock
    
    
    1,819
    
    
    
    
    
    
    
    Total
    
    
    170,443
    
    
    
    165,330
    
    
    
    152,491Basic earnings per common share (1)
    
    $
    0.89
    
    
    $
    0.57
    
    
    $
    0.48Diluted earnings per common share (1)
    
    $
    0.86
    
    
    $
    0.55
    
    
    $
    0.47
  (1)
    
    Adjusted to reflect the three-for-two stock split and a 2% stock dividend on our common stock declared in December
2004 and distributed both on January 10, 2005, and the three-for-two stock split and a 2% stock dividend on our common
stock declared in November 2003 and distributed both on December 10, 2003.  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 those resulting from investments by owners and distributions to owners. Accounting
principles generally accepted in the United States of America require 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 on available for sale securities, are reported
as a separate component of the stockholders equity section of the statement of financial
condition, such items, along with net income, are components of comprehensive income.
Accumulated other comprehensive loss, net of income tax, as of December 31, 2004 and 2003
consisted of the unrealized loss on investment securities available for sale. 78




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Recent Accounting DevelopmentsEffective January 1, 2002, the Company adopted SFAS No. 141, Business Combinationsand SFAS No.
142, Goodwill and Other Intangible Assets. Those statements changed the accounting for
business combinations and goodwill in two significant ways. SFAS No. 141 requires that the
purchase method of accounting be used for all business combinations. Use of the
pooling-of-interest method is prohibited. SFAS No. 142 changes the accounting for goodwill from
an amortization method to an impairment-only approach. Thus, amortization of goodwill,
including goodwill recorded in past business combinations, ceased upon adoption of this
statement. Adoption of SFAS No. 141 and No. 142 did not have a significant effect on the
Companys consolidated financial position or results of operations.In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 143, Accounting
for Asset Retirement Obligations. SFAS No. 143 addresses financial accounting and reporting for
obligations associated with the retirement of tangible long-lived assets and the associated
asset retirement
cost. SFAS No. 143 became effective on January 1, 2003 and did not have a significant effect on
the Companys consolidated financial position or results of operations.Effective January 1, 2002, the Company adopted SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets. SFAS No. 144 addresses financial accounting and reporting for
the impairment or disposal of long-lived assets. This statement supersedes SFAS No. 121,
Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,
and the accounting and reporting provisions of APB Opinion No. 30, Reporting the Results of
Operations  Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary,
Unusual and Infrequently Occurring Events and Transactions. Implementation of SFAS No. 144 did
not have a significant effect on the Companys consolidated financial position or results of
operations.In April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements No. 4, 44 and 64,
Amendment of SFAS No. 13, and Technical Corrections. SFAS No. 145 rescinds SFAS No. 4,
Reporting Gains and Losses from Extinguishment of Debt-an amendment of APB Opinion No. 30,
which required all gains and losses from extinguishment of debt to be aggregated and, if
material, classified as an extraordinary item, net of related income tax effect. As a result,
the criteria in Opinion No. 30 will now be used to classify those gains and losses. SFAS No.
145 also amends SFAS No. 13, Accounting for Leases, to require that certain lease modifications
that have economic effects similar to saleleaseback transactions be accounted for in the same
manner as sale-leaseback transactions. SFAS No. 145 did not have a significant effect on the
Companys consolidated financial position or results of operations.In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or
Disposal Activities. This Statement addresses financial accounting and reporting for costs
associated with exit or disposal activities and nullifies Emerging Issues Task Force (EITF)
Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs
to Exit an Activity (including Certain Costs Incurred in a Restructuring). The provisions of
this Statement are effective for exit or disposal activities that are initiated after December
31, 2002. Implementation of SFAS No. 146 did not have a significant effect on the Companys
consolidated financial position or results of operations.In October 2002, the FASB issued SFAS No. 147, Acquisitions of Certain Financial Institutions,
an amendment of FASB Statements No. 72 and 144 and FASB Interpretation No. 9. Except for
transactions between two or more mutual enterprises, SFAS No. 147 removes acquisitions of
financial institutions from the scope of both SFAS No. 72 and Interpretation No. 9 and requires
that those transactions be accounted for in accordance with SFAS No. 141, Business Combinations
and SFAS No. 142, Goodwill and Other Intangible Assets. In addition, SFAS No. 147 amends SFAS
No. 144, Accounting for the Impairment or Disposal of Long-Lived Assetsto include in its scope
long-term customer-relationship intangible assets of financial institutions such as
depositor-and-borrower-relationship intangible assets and credit cardholders intangible
assets. SFAS No. 147 was effective for acquisitions or impairment measurement of such
intangibles effective on or after October 1, 2002. SFAS No. 147 did not have a significant
effect on the Companys financial position or results of operations. 79




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In November 2002, the FASB issued FASB Interpretation No. 45 (FIN 45), Guarantors Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others, an Interpretation of FASB Statements No. 5, 57, and 107 and Rescission of FASB
Interpretation No. 34.This interpretation elaborates on the disclosures to be made by a
guarantor in the financial statements about its obligations under certain guarantees that it
has issued. It also clarifies that a guarantor is required to recognize, at the inception of a
guarantee, a liability for the fair value of the obligation undertaken in issuing the
guarantee. The initial recognition and initial measurement provisions of FIN 45 were applicable
for guarantees issued or modified after December 31, 2002. Adoption of the
recognition and measurement provisions did not have a significant effect on the Companys
financial position or results of operations.In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation 
Transition and Disclosure, an amendment of FASB Statement No. 123. This Statement amends SFAS
No. 123, Accounting for Stock-Based Compensation, to provide alternative methods of transition
for a voluntary change to the fair value based method of accounting for stock-based employee
compensation. In addition, SFAS No. 148 amends the disclosure requirements of Statement 123 to
require prominent disclosures in both annual and interim financial statements about the method
of accounting for stock-based employee compensation and the effect of the method used on
reported results. Effective January 1, 2003, the Company changed the method of accounting for
employee stock options from the intrinsic value method to the fair value method. Under the
modified prospective method selected by the Company under the provisions of SFAS No. 148,
compensation cost recognized since January 1, 2003 is the same that would have been recognized
had the recognition provisions of FASB No. 123 been applied from its original effective date.
Results prior to 2003 were not restated. The effect of implementing this Statement on the
Companys financial condition and results of operations for the years ended December 31, 2004
and 2003 was a charge of $895,000 and of $1,031,000, respectively to compensation expense
included in salaries and employees benefits in the consolidated statement of income.Prior to January 1, 2003, the Company followed the intrinsic value-based method of accounting
prescribed by APB Opinion No. 25, Accounting for Stock Issued to Employees,and related
interpretations. Compensation expense under this method was generally recognized for any excess
of the quoted market price of the Companys stock at the measurement date over the amount an
employee must pay to acquire the stock. Since all options granted under those plans have an
exercise price equal to the market value of the underlying common stock at the grant date, no
compensation expense was recognized at the measurement date.In January 2003, the FASB issued FASB Interpretation No. 46 (FIN 46), Consolidation of
Variable Interest Entities, an Interpretation of ARB No. 51.FIN 46 addresses consolidation by
business enterprises of variable interest entities. A variable interest entity is a
corporation, partnership, trust, or any other legal structure used for business purposes that
either (a) does not issue voting interests (or other interests with similar rights) or (b) the
total equity investment at risk is not sufficient to permit the entity to finance its
activities. FIN 46 requires an enterprise to consolidate a variable interest entity if that
enterprise has a variable interest that will absorb a majority of the entitys expected losses
if these occur, receive a majority of the entitys expected residual returns if these occur, or
both. Qualifying Special Purpose Entities are exempt from the consolidation requirements. In
addition to numerous FASB Staff Positions written to clarify and improve the application of FIN
46, the FASB announced a deferral for certain entities, and an amendment to FIN 46 entitled
FASB Interpretation No. 46 (revised December 2003), Consolidation of Variable Interest Entities
(FIN 46R). FIN 46R must be applied to interests in all entities subject to the interpretation
as of the first interim or annual period ending after March 15, 2004. FIN 46R did not have any
effect on the Companys financial position or results of operations. 80




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In April 2003, the FASB issued SFAS No. 149, Amendment of Statement No. 133 on Derivative
Instruments and Hedging Activities.This Statement amends and clarifies financial accounting
and reporting for derivative instruments, including certain derivative instruments embedded in
other contracts (collectively referred to as derivatives) and for hedging activities under SFAS
No. 133, Accounting for Derivative Instruments and Hedging Activities.This Statement (1)
clarifies under what circumstances a contract with an initial net investment meets the
characteristic of a derivative discussed in paragraph 6 (b) of SFAS No. 133, (2) clarifies when
a derivative contains a financing component, (3) amends the definition of an underlying to
conform it to language used in FIN No. 45, and (4) amends certain other existing
pronouncements. This Statement was effective for contracts entered into or modified after June
30, 2003, and for hedging relationships designated after June 30, 2003. Implementation of SFAS
No. 149 did not have a significant effect on the Companys financial position or results of
operations.In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity. SFAS No. 150 is effective for all freestanding
financial instruments entered into or modified after May 31, 2003. For all other freestanding
financial instruments, it became effective at the beginning of the first interim period
beginning after June 15, 2003. SFAS No. 150 applies to three categories of freestanding
financial instruments (mandatory redeemable instruments, instruments with repurchase
obligations and instruments with obligations to issue a variable number of shares). Instruments
within the scope of SFAS No. 150 must be classified as liabilities in the statement of
financial condition. Certain provisions of SFAS No. 150 related to mandatory redeemable
financial instruments have been subsequently deferred indefinitely by the FASB. The Company
does not have mandatory redeemable financial instruments outstanding. Implementation of SFAS
No. 150 did not have a significant effect on the Companys financial position or results of
operations.In December 2003, the Accounting Standards Executive Committee of the American Institute of
Certified Public Accountants issued Statement of Position (SOP) 03-3, Accounting for Certain
Loans and Debt Securities Acquired in a Transfer.SOP 03-3 addresses the accounting for
acquired loans that show evidence of having deteriorated in terms of credit quality since their
origination (i.e. impaired loans). SOP 03-3 requires acquired loans to be recorded at their
fair value defined as the present value of future cash flows. SOP 03-3 prohibits the carryover
of an allowance for loan losses on certain acquired loans as credit losses are considered in
the future cash flows assessment. SOP 03-3 is effective for loans that are acquired in fiscal
years beginning after December 15, 2004. The Company will evaluate the applicability of this
SOP for all prospective loans acquired in fiscal years beginning after December 15, 2004.In March 2004, the Emerging Issues Task Force (EITF) reached a consensus on Issue 03-1,
Meaning of Other Than Temporary Impairment(Issue 03-1). The Task Force reached a consensus
on an other-than-temporary impairment model for debt and equity securities accounted for under
SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securitiesand cost method
investments. The basic model developed by the Task Force in evaluating whether an investment
within the scope of Issue 03-1 is other-than-temporarily impaired is as follows: Step 1:
Determine whether an investment is impaired. An investment is considered impaired if its fair
value is less than its cost. Step 2: Evaluate whether an impairment is other-than-temporary.
For equity securities and debt securities that can contractually be prepaid or otherwise
settled in such a way that the investor would not recover substantially all of its cost, an
impairment is presumed to be other-than-temporary unless: the investor 81




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has the ability and
intent to hold the investment for a reasonable period of time sufficient for a forecasted
market price recovery of the investment, and evidence indicating that the cost of the
investment is recoverable within a reasonable period of time outweighs evidence to the
contrary. For other debt securities, an impairment is deemed other-than-temporary if: the
investor does not have the ability and intent to hold the investment until a forecasted market
price recovery (may mean until maturity), or it is probable that the investor will be unable to
collect all amounts due according to the contractual terms of the debt security. Step 3: If the
impairment is other-than-temporary, recognize in earnings an impairment loss equal to the
difference between the investment cost and its fair value. The fair value of the investment
then becomes the new cost basis of the investment and cannot be adjusted for subsequent
recoveries in fair value, unless required by other authoritative literature.On September 30, 2004, the FASB issued FSP EITF Issue 03-01-1, which delayed the effective date
for the measurement and recognition guidance of an impairment loss that is other-than-temporary
(i.e. steps 2 and 3 of the impairment model) contained in paragraphs 10-20 of EITF 03-1.
Application of these paragraphs is deferred pending issuance of proposed FSP EITF Issue 03-1a.
This delay does not suspend the requirement to recognize other-than-temporary impairments as
required by existing authoritative
literature. The guidance in paragraphs 6 to 9 of EITF 03-1 (i.e. step 1 of the impairment
model), as well as the disclosure requirements in paragraphs 21 and 22 were not deferred and
were applied based on the transition provisions in EITF 03-1. Based on the composition of the
investment portfolio held at December 31, 2004, EITF 03-1 is not expected to have a material
effect on the Companys financial position or results of operations.On March 9, 2004, the SEC issued Staff Accounting Bulletin 105, Application of Accounting
Principles to Loan Commitments, (SAB 105) to inform registrants of the Staffs view that the
fair value of the recorded loan commitments should not consider the expected future cash flows
related to the associated servicing of the future loan. The provisions of SAB 105 is applicable
to loan commitments accounted for as derivatives that are entered into after March 31, 2004.
The staff will not object to the application of existing accounting practices to loan
commitments accounted for as derivatives that are entered into on or before March 31, 2004,
with appropriate disclosures. The adoption of SAB 105 did not have a material impact on the
Companys financial condition or results of operations.In December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets  an amendment
of APB Opinion No. 29. The guidance in APB Opinion No. 29, Accounting for Nonmonetary
Transactions, is based on the principle that exchanges of nonmonetary assets should be measured
based on the fair value of the assets exchanged. The guidance in that Opinion, however,
included certain exceptions to that principle. This Statement amends Opinion 29 to eliminate
the exception for nonmonetary exchanges of similar productive assets and replaces it with a
general exception for exchanges of nonmonetary assets that do not have commercial substance. A
nonmonetary exchange has commercial substance if the future cash flows of the entity are
expected to change significantly as a result of the exchange. This Statement shall be applied
prospectively and is effective for nonmonetary asset exchanges occurring in fiscal periods
beginning after June 15, 2005. Earlier application is permitted for nonmonetary asset exchanges
occurring in fiscal periods beginning after the date of issuance of this Statement. SFAS No.
153 is not expected to have a material effect on the Companys financial position or results of
operations.In December 2004, the FASB issued SFAS No. 123 (revised 2004), Share-Based Payment, that will
require compensation costs related to share-based payment transactions to be recognized in the
financial statements. With limited exceptions, the amount of compensation cost will be measured
based on the grant-date fair value of the equity or liability instruments issued. In addition,
liability awards will be remeasured each reporting period. Compensation cost will be recognized
over the period that an employee provides service in exchange for the award. SFAS No. 123®
replaces FASB Statement No. 123, Accounting for Stock-Based Compensation, and supersedes APB 82




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Opinion No. 25, Accounting for Stock Issued to Employees. SFAS No. 123 (R) will be effective as
of the first interim or annual reporting period that begins after June 15, 2005 and applies to
all awards granted after the required effective date and to awards modified, repurchased, or
cancelled after that date. The cumulative effect of initially applying this statement, if any,
is recognized as of the required effective date. Entities that used the fair-value-based method
for either recognition or disclosure under SFAS No. 123 will apply this revised statement using
a modified version of prospective application. Under that transition method, for the portion of
outstanding awards for which the requisite service has not yet been rendered, compensation cost
is recognized on or after the required effective date based on the grant-date fair value of
those awards calculated under SFAS No. 123 for either recognition or pro forma disclosures. For
periods before the required effective date, those entities may elect to apply a modified
version of retrospective application under which financial statements for prior periods are
adjusted on a basis consistent with the pro forma disclosures required for those periods by
SFAS No. 123. SFAS No. 123® is not expected to have a significant effect on the Companys
financial position or results of operations since the Company only has employee stock options
and it follows the fair value method under the modified prospective application allowed by the
provisions of SFAS No. 148 since January 1, 2003, as previously explained.2.
    FEDERAL FUNDS SOLD AND RESELL AGREEMENTS:The Company sold federal funds and enters into purchases of securities under agreements to
resell the same securities (resell agreements). These agreements are classified as secured
loans and are reflected as assets in the consolidated statements of financial condition.At December 31, 2004 and 2003, federal funds sold and resell agreements (classified by
counterparty) were as follows: 2004
    
    
    2003(In thousands)Federal funds sold:Citibank N.A.  Puerto Rico
    
    $
    291,900
    
    
    $
    313,501Government Development Bank for Puerto Rico
    
    
    25,000
    
    
    
    Firstbank Puerto Rico
    
    
    25,000
    
    
    
    Subtotal
    
    
    341,900
    
    
    
    313,501Resell agreements:Credit Suisse First Boston
    
    
    500,000
    
    
    
    200,000UBS Financial Services Incorporated of Puerto Rico
    
    
    70,396
    
    
    
    75,076Popular Securities, Inc.
    
    
    55,007
    
    
    
    55,074Citibank N.A.  Puerto Rico
    
    
    50,000
    
    
    
    Doral Securities, Inc.
    
    
    
    
    
    
    6,201Subtotal
    
    
    675,403
    
    
    
    336,351Total
    
    $
    1,017,303
    
    
    $
    649,852
 83




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A comparative summary of resell agreements as of December 31, were as follows: 2004

    
    
    2003Fair
    
    
    
    
    
    
    FairValue of
    
    
    
    
    
    
    Value ofReceivable
    
    
    Underlying
    
    
    Receivable
    
    
    UnderlyingUnderlying Collateral
    
    Balance
    
    
    Collateral
    
    
    Balance
    
    
    Collateral(In thousands)Investment securities:U.S. Government and
agencies obligations
    
    $
    
    
    
    $
    
    
    
    $
    63,096
    
    
    $
    64,371Puerto Rico Government and
agencies obligations
    
    
    70,396
    
    
    
    76,249
    
    
    
    67,054
    
    
    
    68,403U.S. municipal bonds
    
    
    20,522
    
    
    
    21,476
    
    
    
    
    
    
    
    Mortgage and asset-backed
securities:Federal Home Loan Mortgage
Corporation (FHLMC) certificates
    
    
    200,000
    
    
    
    198,694Federal National Mortgage
Association (FNMA) certificates
    
    
    350,000
    
    
    
    360,525
    
    
    
    201,660
    
    
    
    268,567Government National Mortgage
Association (GNMA) certificates
    
    
    
    
    
    
    
    
    
    
    4,541
    
    
    
    4,678Other mortgage and asset-backed
securities
    
    
    34,485
    
    
    
    35,193
    
    
    
    
    
    
    
    Total  excluding accrued
interest receivable
    
    $
    675,403
    
    
    $
    692,137
    
    
    $
    336,351
    
    
    $
    406,019Accrued interest receivable
on resell agreements
    
    $
    2,943
    
    
    
    
    
    
    $
    2,159
  Information about the fair value of collateral received that the Company is permitted by
contract or custom to sell or repledge at December 31, 2004 and 2003 is as follows: 2004
    
    
    2003Collateral Sold
    
    
    
    
    
    
    Collateral SoldCollateral
    
    
    under Repurchase
    
    
    Collateral
    
    
    under RepurchaseReceived
    
    
    Agreements
    
    
    Received
    
    
    Agreements(In thousands)Mortgage-backed securities:FNMA certificates
    
    $
    326,605
    
    
    $
    326,605
    
    
    $
    266,855
    
    
    $
    266,855FHLMC certificates
    
    
    198,694
    
    
    
    198,694
    
    
    
    
    
    
    
    Total
    
    $
    525,299
    
    
    $
    525,299
    
    
    $
    266,855
    
    
    $
    266,855
 84




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The Company monitors the fair value of the underlying securities as compared to the related
receivable, including accrued interest, and requests additional collateral when the fair value
of the underlying collateral falls to less than the collateral requirement. The collateral
requirement is equal to 102 percent of the related receivable, including interest. At December
31, 2004, resell agreements amounting to $125.4 million mature the next business day, $200.0
million mature in 2009 and $350.0 million mature in 2010. At December 31, 2004, there are
$550.0 million in resell agreements where the counterparty has the option to terminate the
agreement quarterly, at each interest payment date. Securities purchased under resell
agreements may be held in safekeeping, in the name of the Company, by Citibank N.A., the
Companys custodian, or held by the counterparty. At December 31, 2004, all collateral was held
by the counterparties.  3.
    INVESTMENT SECURITIES: The amortized cost, gross unrealized gains and losses, and fair value of investment securities
at December 31, were as follows: Gross
    
    
    GrossAmortized
    
    
    Unrealized
    
    
    Unrealized
    
    
    FairDecember
31, 2004
    
    Cost
    
    
    Gains
    
    
    Losses
    
    
    Value(In thousands)Available for sale:Collateralized mortgage obligations (CMOs) issued
or guaranteed by FNMA
    
    $
    6,298
    
    
    $
    
    
    
    $
    182
    
    
    $
    6,116CMOs issued or guaranteed by FHLMC
    
    
    1,795
    
    
    
    
    
    
    
    30
    
    
    
    1,765Total
    
    $
    8,093
    
    
    $
    
    
    
    $
    212
    
    
    $
    7,881Held to maturity:U.S. Government and agencies obligations
    
    $
    6,004,849
    
    
    $
    6,181
    
    
    $
    32,457
    
    
    $
    5,978,573Puerto Rico Government and
agencies obligations
    
    
    34,822
    
    
    
    303
    
    
    
    540
    
    
    
    34,585Commercial paper
    
    
    25,000
    
    
    
    87
    
    
    
    
    
    
    
    25,087Corporate notes
    
    
    26,418
    
    
    
    2,193
    
    
    
    
    
    
    
    28,611Subtotal
    
    
    6,091,089
    
    
    
    8,764
    
    
    
    32,997
    
    
    
    6,066,856Mortgage-backed securities:GNMA certificates
    
    
    9,881
    
    
    
    484
    
    
    
    
    
    
    
    10,365FHLMC certificates
    
    
    5,663
    
    
    
    334
    
    
    
    
    
    
    
    5,997FNMA certificates
    
    
    3,642
    
    
    
    245
    
    
    
    
    
    
    
    3,887CMOs issued or guaranteed by FHLMC
    
    
    706,632
    
    
    
    14
    
    
    
    58,171
    
    
    
    648,475CMOs issued or guaranteed by FNMA
    
    
    104,441
    
    
    
    20
    
    
    
    3,175
    
    
    
    101,286CMOs other
    
    
    31
    
    
    
    
    
    
    
    
    
    
    
    31Subtotal
    
    
    830,290
    
    
    
    1,097
    
    
    
    61,346
    
    
    
    770,041Total
    
    $
    6,921,379
    
    
    $
    9,861
    
    
    $
    94,343
    
    
    $
    6,836,897
 85




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Gross
    
    
    GrossAmortized
    
    
    Unrealized
    
    
    Unrealized
    
    
    FairDecember 31, 2003
    
    Cost
    
    
    Gains
    
    
    Losses
    
    
    Value(In thousands)Available for sale:CMOs issued or guaranteed by FNMA
    
    $
    30,647
    
    
    $
    
    
    
    $
    699
    
    
    $
    29,948CMOs issued or guaranteed by FHLMC
    
    
    20,345
    
    
    
    
    
    
    
    383
    
    
    
    19,962Equity
securities - preferred stock
    
    
    5,000
    
    
    
    170
    
    
    
    
    
    
    
    5,170Total
    
    $
    55,992
    
    
    $
    170
    
    
    $
    1,082
    
    
    $
    55,080Held to maturity:U.S. Government and agencies obligations
    
    $
    4,463,493
    
    
    $
    15,632
    
    
    $
    35,811
    
    
    $
    4,443,314Puerto Rico Government and
agencies obligations
    
    
    34,500
    
    
    
    287
    
    
    
    292
    
    
    
    34,495Commercial paper
    
    
    174,976
    
    
    
    
    
    
    
    
    
    
    
    174,976Corporate notes
    
    
    51,409
    
    
    
    3,196
    
    
    
    
    
    
    
    54,605Subtotal
    
    
    4,724,378
    
    
    
    19,115
    
    
    
    36,103
    
    
    
    4,707,390Mortgage and asset-backed
securities:FHLMC certificates
    
    
    7,297
    
    
    
    445
    
    
    
    
    
    
    
    7,742GNMA certificates
    
    
    9,753
    
    
    
    475
    
    
    
    
    
    
    
    10,228FNMA certificates
    
    
    4,542
    
    
    
    303
    
    
    
    
    
    
    
    4,845CMOs issued or guaranteed by FHLMC
    
    
    885,408
    
    
    
    442
    
    
    
    67,390
    
    
    
    818,460CMOs issued or guaranteed by FNMA
    
    
    84,322
    
    
    
    2
    
    
    
    2,183
    
    
    
    82,141CMOs other
    
    
    168
    
    
    
    
    
    
    
    
    
    
    
    168Asset-backed securities
    
    
    7,842
    
    
    
    
    
    
    
    
    
    
    
    7,842Subtotal
    
    
    999,332
    
    
    
    1,667
    
    
    
    69,573
    
    
    
    931,426Total
    
    $
    5,723,710
    
    
    $
    20,782
    
    
    $
    105,676
    
    
    $
    5,638,816
 The amortized cost and fair value of investment securities held to maturity at December
31, 2004, by contractual maturity (excluding mortgage-backed securities), are shown below. Held to MaturityAmortized
    
    
    FairCost
    
    
    Value(In thousands)Due within one year
    
    $
    127,921
    
    
    $
    128,025Due after one year through five years
    
    
    4,123,884
    
    
    
    4,111,365Due after five years through ten years
    
    
    1,816,509
    
    
    
    1,802,670Due after ten years
    
    
    22,775
    
    
    
    24,796Total
    
    
    6,091,089
    
    
    
    6,066,856Mortgage-backed securities
    
    
    830,290
    
    
    
    770,041Total
    
    $
    6,921,379
    
    
    $
    6,836,897
 86




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The following table provides the gross unrealized losses, fair value and number of
investment positions, aggregated by investment category and length of time the individual
securities have been in a continuous unrealized loss position, at December 31, 2004: Less than 12 months
    
    
    12 months or more
    
    
    TotalGross
    
    
    
    
    
    
    Gross
    
    
    
    
    
    
    Gross
    
    
    Number ofFair
    
    
    Unrealized
    
    
    Fair
    
    
    Unrealized
    
    
    Fair
    
    
    Unrealized
    
    
    InvestmentValue
    
    
    Losses
    
    
    Value
    
    
    Losses
    
    
    Value
    
    
    Losses
    
    
    Positions(In thousands)Available for sale:CMOs issued or
guaranteed by FNMA
    
    $
    6,116
    
    
    $
    182
    
    
    $
    
    
    
    $
    
    
    
    $
    6,116
    
    
    $
    182
    
    
    
    1CMOs issued or
guaranteed by FHLMC
    
    
    1,765
    
    
    
    30
    
    
    
    
    
    
    
    
    
    
    
    1,765
    
    
    
    30
    
    
    
    1$
    7,881
    
    
    $
    212
    
    
    $
    
    
    
    $
    
    
    
    $
    7,881
    
    
    $
    212
    
    
    
    2Held to maturity:U.S. Government and
agencies obligations
    
    $
    2,069,646
    
    
    $
    6,359
    
    
    $
    1,503,901
    
    
    $
    26,098
    
    
    $
    3,573,547
    
    
    $
    32,457
    
    
    
    40Puerto Rico Government and
agencies obligations
    
    
    17,493
    
    
    
    540
    
    
    
    
    
    
    
    
    
    
    
    17,493
    
    
    
    540
    
    
    
    6Subtotal
    
    
    2,087,139
    
    
    
    6,899
    
    
    
    1,503,901
    
    
    
    26,098
    
    
    
    3,591,040
    
    
    
    32,997
    
    
    
    46Mortgage and asset-backed
securities:CMOs issued or
guaranteed by FHLMC
    
    
    41,553
    
    
    
    810
    
    
    
    592,513
    
    
    
    57,361
    
    
    
    634,066
    
    
    
    58,171
    
    
    
    12CMOs issued or
guaranteed by FNMA
    
    
    39,430
    
    
    
    888
    
    
    
    56,148
    
    
    
    2,287
    
    
    
    95,578
    
    
    
    3,175
    
    
    
    5Subtotal
    
    
    80,983
    
    
    
    1,698
    
    
    
    648,661
    
    
    
    59,648
    
    
    
    729,644
    
    
    
    61,346
    
    
    
    17Total
    
    $
    2,168,122
    
    
    $
    8,597
    
    
    $
    2,152,562
    
    
    $
    85,746
    
    
    $
    4,320,684
    
    
    $
    94,343
    
    
    
    63
 At December 31, 2003, all of the Companys investment securities in an unrealized loss
position were in such position for less than twelve months. The Companys investment portfolio as of December 31, 2004, consisted principally of U.S.
Government and agencies obligations, Puerto Rico Government and agencies obligations, and
mortgage-backed securities issued or guaranteed by FHLMC, FNMA or GNMA. There were no
investment securities other than those referred to above in unrealized loss position as of
December 31, 2004. These unrealized losses relate to interest rate changes. Investment
securities with prepayment provisions did not have significant unamortized premiums at December
31, 2004. As the Company has the ability and intent to hold debt securities until maturity, or
for the foreseeable future if classified as available for sale, no declines are deemed to be
other-than-temporary. 87




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Proceeds from sales of investment securities available for sale and the respective gross
realized gains and losses for the years ended December 31, 2004, 2003 and 2002, were as
follows: 2004
    
    
    2003
    
    
    2002(In thousands)Proceeds
from sales
    
    $
    130,066
    
    
    $
    50,803
    
    
    $
    661,090Gross
realized gains
    
    
    128
    
    
    
    1,313
    
    
    
    3,250Gross
realized losses
    
    
    
    
    
    
    8,984
    
    
    
    1,742
 Unencumbered investment securities held to maturity at December 31, 2004, amounted to
$462,176,000 after taking into account the investment securities pledged (Note 7), those sold
under agreements to repurchase (Note 8), those pledged to the Federal Reserve Bank of
$6,000,000 and those pledged to the Puerto Rico Treasury Department (for Westernbanks
International Division) of $500,000. Pledged investment securities amounting to $6,380,665,000
and $5,184,176,000 at December 31, 2004 and 2003, respectively, can be repledged. Nontaxable interest income for the years ended December 31, 2004, 2003 and 2002, amounted to
$267,392,000, $188,669,000, and $163,387,000, respectively. Nontaxable interest income relates
mostly to interest earned on government and agencies obligations of the United States and
Puerto Rico, and certain mortgage-backed securities, loans and investments of Westernbanks
International division. The Company evaluates for impairment its investment securities on a quarterly basis or earlier
if other factors indicative of potential impairment exist. An impairment charge in the
consolidated statements of income is recognized when the decline in the fair value of the
securities below their cost basis is judged to be other-than-temporary. The Company considers
various factors in determining whether it should recognize an impairment charge, including, but
not limited to the length of time and extent to which the fair value has been below its cost
basis, the expectations for that securitys performance, the credit worthiness of the issuer,
and the Companys intention and ability to hold the security to maturity. The impairment analysis on the mortgage and asset-backed securities is done placing special
emphasis on the analysis of the trustee and collateral manager monthly reports, on sensitivity
and expected cash flow analyses made by major brokerage houses and on the credit worthiness of
the issuer. The Company also considers its intent and ability to hold these securities. If
management believes, based on the analysis, that the principal and interest obligations on any
mortgage and asset-backed security will not be received in a timely manner, the security is
written down to fair value based on available secondary market prices from broker/dealers. The equity securities and corporate notes impairment analyses are performed and reviewed
quarterly based on the latest financial information and any supporting research report made by
major brokerage houses. These analyses are subjective and based, among other things, on
relevant financial data such as capitalization, cash flows, liquidity, systematic risk, and
debt outstanding. Management also considers the industry trends, the historical performance of
the stock, as well as the Companys intent to hold the security. If management believes there
is a low probability of achieving book value in a reasonable time frame, then an impairment is
recorded by writing down the security to fair value. In applying the foregoing analysis, management concluded that at March 31, 2003, its
investments in corporate bond and loan obligations (CBOs and CLOs) were
other-than-temporarily impaired. First, two tranches of a CBO with an amortized cost of $13.0
million were downgraded by two different rating agencies on April 3 and April 15, 2003. Second,
the available secondary market prices for those two securities and the remaining portfolio of
CBOs and CLOs with a carrying value of $56.0 million continued to deteriorate. Management concluded, based on these facts and the secondary market prices, that
a $15.7 million other-than-temporary impairment write-down adjustment was warranted. The same
was recorded effective for the quarterly period ended March 31, 2003. As of March 31, 2003,
there were no defaults within the securities portfolio underlying the CBOs and CLOs. In
connection with the write-down, and in accordance with applicable accounting pronouncements,
management also reassessed its intent to hold to maturity and reclassified the securities
related to the CBOs that were downgraded as available for sale as of March 31, 2003. 88




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During the quarter ended June 30, 2003, the Company, based upon additional information
available from trustees, further ratings downgrading, a default on the scheduled interest
payment in one of the CBO tranches and further declines in quoted market prices for such
investments, reclassified the remaining portfolio of CBOs and CLOs to available for sale and
subsequently on June 6, 2003 sold its entire portfolio of CBOs and CLOs. The sale of the
portfolio, with an original total investment of $62.9 million and adjusted to a fair value of
$45.4 million as of March 31, 2003, was completed at an additional net loss of $7.0 million
which was recorded during the quarter ended June 30, 2003. As of December 31, 2004 and 2003, management concluded that there was no other-than-temporary
impairment on its investment securities portfolio.  4.
    LOANS: The loan portfolio at December 31, consisted of the following: 2004
    
    
    2003(In thousands)REAL ESTATE LOANS SECURED BY FIRST MORTGAGES:Commercial real estate
    
    $
    3,167,439
    
    
    $
    2,269,380Residential real estate, mainly
one-to-four-family residences
    
    
    903,967
    
    
    
    894,695Construction and land acquisition
    
    
    331,221
    
    
    
    207,593Total
    
    
    4,402,627
    
    
    
    3,371,668Plus (less):Undisbursed portion of loans in process
    
    
    (3,076
    )
    
    
    (4,993
    )Premium on loans purchased
    
    
    690
    
    
    
    1,016Deferred
loan fees - net
    
    
    (14,480
    )
    
    
    (9,615
    )Total
    
    
    (16,866
    )
    
    
    (13,592
    )Real estate
loans - net
    
    
    4,385,761
    
    
    
    3,358,076OTHER LOANS:Commercial loans
    
    
    768,845
    
    
    
    526,105Consumer loans:Loans on deposits
    
    
    29,587
    
    
    
    30,805Credit cards
    
    
    53,268
    
    
    
    54,832Installment
    
    
    789,095
    
    
    
    777,573Plus (less):Premium on loans purchased
    
    
    1,337
    
    
    
    2,281Deferred
loan fees - net
    
    
    (6,594
    )
    
    
    (4,946
    )Other loans - net
    
    
    1,635,538
    
    
    
    1,386,650TOTAL LOANS
    
    
    6,021,299
    
    
    
    4,744,726ALLOWANCE FOR LOAN LOSSES
    
    
    (80,066
    )
    
    
    (61,608
    )LOANS - NET
    
    $
    5,941,233
    
    
    $
    4,683,118
 89




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##### Table of Contents



The Company originated commercial real estate loans, including construction loans, during
2004 amounting to $1,699,693,000. The outstanding balances of these loans totaled
$3,167,439,000 at December 31, 2004. In general, commercial real estate loans are considered by
management to be of somewhat greater risk of uncollectibility due to the dependency on income
production or future development of the real estate. The commercial real estate loans are
principally collateralized by property dedicated to wholesale, retail and rental business
activities. Foreign loans amounted to $2,237,000 and $2,485,000 at December 31, 2004 and 2003,
respectively. The Company originates mortgage loans for portfolio investment or sale in the secondary market.
During the period of origination, mortgage loans are designated as held for either sale or
investment purposes. Mortgage loans held for sale are carried at the lower of cost or fair
value. At December 31, 2004 and 2003, mortgage loans with a cost of $1,642,000 and $2,568,000,
respectively, were designated as held for sale. The following table reflects the outstanding principal balance of non-accrual loans and the
corresponding effect on earnings: 2004
    
    
    2003
    
    
    2002(In thousands)Outstanding principal balance
at end of year
    
    $
    34,269
    
    
    $
    31,246
    
    
    $
    19,405Interest that would have been recorded
if the loans had been performing and not been
classified as non-accrual
    
    $
    3,557
    
    
    $
    2,500
    
    
    $
    1,102
 Residential mortgage loans serviced for others are not included in the consolidated statements
of financial condition. At December 31, 2004 and 2003, the unpaid principal balance of these
loans amounted to $296,626,000 and $309,974,000, respectively. Servicing loans for others
generally consists of collecting payments, maintaining escrow accounts, disbursing payments to
investors and foreclosure processing. Loan servicing income includes servicing fees from
investors and certain charges collected from borrowers, such as late payment fees. In
connection with the loans serviced for others, the Company held borrowers escrow balances of
$1,013,000 and $951,000 at December 31, 2004 and 2003, respectively. Mortgage servicing rights, included as other assets, amounted to $3,302,000 and $2,822,000 at
December 31, 2004 and 2003, respectively. In 2004, 2003 and 2002, the Company capitalized
mortgage servicing rights amounting to $904,000, $1,544,000 and $607,000, respectively.
Amortization of mortgage servicing rights was $424,000, $648,000, and $772,000 in 2004, 2003,
and 2002, respectively. At December 31, 2004 and 2003, the carrying value of mortgage
servicing rights approximates fair value. In the normal course of business, the Company engages in business transactions with its
directors, executive officers, principal shareholders and organizations associated with them.
Loans to related parties, mainly mortgage loans for purchase of the principal residence, are
substantially on the same terms as loans to non-related parties. The aggregate amount of loans
outstanding to related parties at December 31, 2004 and 2003 totaled $797,000 and $718,000,
respectively. 90




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##### Table of Contents



Changes in the allowance for loan losses are summarized below: 2004
    
    
    2003
    
    
    2002(In thousands)Balance - at January 1
    
    $
    61,608
    
    
    $
    47,114
    
    
    $
    38,364Provision charged to income
    
    
    36,691
    
    
    
    27,048
    
    
    
    15,083Recoveries
of loans previously written off
    
    
    3,970
    
    
    
    2,312
    
    
    
    1,632Write-off of uncollectible accounts
    
    
    (22,203
    )
    
    
    (14,866
    )
    
    
    (7,965
    )Balance - at December 31
    
    $
    80,066
    
    
    $
    61,608
    
    
    $
    47,114
 The total investment in impaired commercial and construction loans at December 31, 2004 and
2003 was $54,175,000 and $50,305,000, respectively. All impaired commercial and construction
loans were measured based on the fair value of collateral at December 31, 2004 and 2003.
Impaired commercial and construction loans amounting to $29,975,000 and $28,217,000 at December
31, 2004 and 2003, respectively, were covered by a valuation allowance of $8,412,000 and
$4,646,000, respectively. Impaired commercial and construction loans amounting to $24,200,000
and $22,088,000 at December 31, 2004 and 2003, respectively, did not require a valuation
allowance in accordance with SFAS No. 114. The average investment in impaired commercial and
construction loans during the years ended December 31, 2004, 2003 and 2002, amounted to
$46,509,000, $46,676,000 and $46,147,000, respectively. The Companys policy is to recognize
interest income related to impaired loans on a cash basis, when these are over 90 days in
arrears on payments of principal or interest. Interest on impaired commercial and construction
loans collected and recognized as income during the years ended December 31, 2004, 2003 and
2002, amounted to $2,460,000, $2,452,000 and $4,041,000, respectively.  5.
    FORECLOSED REAL ESTATE HELD FOR SALE: Foreclosed real estate held for sale at December 31, consisted of the following: 2004
    
    
    2003(In thousands)Balance, foreclosed real estate held for sale:Residential (1 - 4 units)
    
    $
    1,739
    
    
    $
    1,832Commercial
    
    
    2,378
    
    
    
    2,278Total
    
    
    4,117
    
    
    
    4,110Less valuation allowance
    
    
    306
    
    
    
    28Foreclosed
real estate held for sale - net
    
    $
    3,811
    
    
    $
    4,082
 Changes in the allowance for foreclosed real estate held for sale are summarized below: 2004
    
    
    2003
    
    
    2002(In thousands)Balance - at January 1
    
    $
    28
    
    
    $
    51
    
    
    $
    318Provision
    
    
    553
    
    
    
    37
    
    
    
    126Write-offs
    
    
    (275
    )
    
    
    (60
    )
    
    
    (393
    )Balance - at December 31
    
    $
    306
    
    
    $
    28
    
    
    $
    51
 91




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##### Table of Contents



6.
    PREMISES AND EQUIPMENT: Premises and equipment at December 31, consisted of the following: 2004
    
    
    2003(In thousands)Land and improvements
    
    $
    30,019
    
    
    $
    30,722Buildings and improvements
    
    
    54,958
    
    
    
    55,086Furniture and equipment
    
    
    20,633
    
    
    
    20,961Leasehold improvements
    
    
    11,744
    
    
    
    13,124Construction in progress
    
    
    10,079
    
    
    
    4,459Total
    
    
    127,433
    
    
    
    124,352Less accumulated depreciation and amortization
    
    
    17,382
    
    
    
    20,982Total
    
    $
    110,051
    
    
    $
    103,370
 Depreciation and amortization expense for the years ended December 31, 2004, 2003 and 2002,
amounted to $7,034,000, $7,293,000 and $6,856,000, respectively.  7.
    DEPOSITS AND INTEREST EXPENSE: Deposits at December 31, consisted of the following: 2004
    
    
    2003(In thousands)Noninterest bearing accounts
    
    $
    249,368
    
    
    $
    192,760Passbook accounts
    
    
    829,424
    
    
    
    692,190NOW accounts
    
    
    269,716
    
    
    
    218,616Super NOW accounts
    
    
    33,864
    
    
    
    27,723Money market accounts
    
    
    100
    
    
    
    198Certificates of deposit
    
    
    4,818,892
    
    
    
    4,230,477Total
    
    
    6,201,364
    
    
    
    5,361,964Accrued interest payable
    
    
    29,847
    
    
    
    23,512Total
    
    $
    6,231,211
    
    
    $
    5,385,476
 The weighted average interest rate of all deposits at December 31, 2004 and 2003, was
approximately 2.75% and 2.26%, respectively. At December 31, 2004, the aggregate amount of
deposits in denominations of $100,000 or more was $875,272,000 ($719,933,000 at December 31,
2003). Certificates of deposit include brokered deposits of $4,159,016,000 and $3,510,482,000
at December 31, 2004 and 2003, respectively. Deposits of directors, executive officers,
principal shareholders and organizations associated with them amounted to $13,112,000 and
$9,255,000 at December 31, 2004 and 2003, respectively. 92




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##### Table of Contents



At December 31, 2004, the scheduled maturities of certificates of deposit are as follows: Year Ending
    
    AmountDecember 31,
    
    (In thousands)2005
    
    $
    2,927,5462006
    
    
    345,6872007
    
    
    361,7972008
    
    
    231,5582009
    
    
    428,752Thereafter
    
    
    523,552Total
    
    $
    4,818,892
 At December 31, 2004, the Company had pledged investment securities held to maturity with a
carrying value of $64,134,000 and mortgage-backed securities held to maturity with a carrying
value of $10,090,000 to secure public funds, and mortgage-backed securities held to maturity
with a carrying value of $338,000 as bond requirement for individual retirement accounts. A summary of interest expense on deposits for the years ended December 31, follows: 2004
    
    
    2003
    
    
    2002(In thousands)Passbook
    
    $
    16,787
    
    
    $
    13,014
    
    
    $
    12,520NOW, Super NOW and Money
Market accounts
    
    
    5,267
    
    
    
    4,085
    
    
    
    3,598Certificates of deposit
    
    
    121,806
    
    
    
    97,656
    
    
    
    98,256Total
    
    $
    143,860
    
    
    $
    114,755
    
    
    $
    114,374
  8.
    FEDERAL FUNDS PURCHASED AND REPURCHASE AGREEMENTS: Federal funds purchased and repurchase agreements, and the related weighted interest rates at
December 31, 2004 and 2003, consisted of the following: 2004
    
    
    2003Weighted
    
    
    
    
    
    
    WeightedInterest
    
    
    
    
    
    
    InterestAmount
    
    
    Rate
    

    
    Amount
    
    
    Rate(Dollars in thousands)Federal funds purchased
    
    $
    75,029
    
    
    
    2.37
    %
    
    $
    
    
    
    
    
    %Repurchase agreements
    
    
    6,608,498
    
    
    
    2.86
    
    
    
    5,046,045
    
    
    
    2.36Total
    
    $
    6,683,527
    
    
    
    
    
    
    $
    5,046,045
 93




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##### Table of Contents



The Company enters into sales of securities under agreements to repurchase the same
securities (repurchase agreements). Repurchase agreements are classified as secured
borrowings and are reflected as a liability in the consolidated statements of financial
condition. During the years ended December 31, 2004 and 2003, all of the Companys
transactions were fixed-coupon repurchase agreements including $482,848,000 at December 31,
2004 and 2003 of long-term agreements with fixed rate step-up schedule. During the period of
such agreements, the securities were delivered to the counterparties. The dealers may have
sold, loaned, or otherwise disposed of such securities to other parties in the normal course of
their operations, and have agreed to resell to the Company the same securities at the
maturities of the agreements. The Company may be required to provide additional collateral
based on the fair value of the underlying securities. Repurchase agreements at December 31, 2004, mature as follows: within 30 days  $4,254,508,000;
31 days to one year  $703,956,000; in 2006  $47,500,000; in 2007  $585,336,000; and in 2010
and thereafter  $1,017,198,000. At December 31, 2004, with respect to repurchase agreements
amounting to $1,556,348,000, the counterparties have the option to terminate the agreements at
the first anniversary date and each interest payment date thereafter. For FHLB repurchase
agreements, see Note 10. At December 31, 2004 and 2003, repurchase agreements (classified by counterparty) were as
follows: 2004
    
    
    2003Fair Value
    
    
    
    
    
    
    Fair ValueBorrowing
    
    
    of Underlying
    
    
    Borrowing
    
    
    of UnderlyingBalance
    
    
    Collateral
    
    
    Balance
    
    
    Collateral(In thousands)UBS Financial Services Incorporated
of Puerto Rico
    
    $
    1,442,685
    
    
    $
    1,484,428
    
    
    $
    1,382,725
    
    
    $
    1,435,734Federal Home Loan Bank of New York
    
    
    832,893
    
    
    
    851,527
    
    
    
    649,000
    
    
    
    648,936Lehman Brothers Inc. and affiliates
    
    
    504,448
    
    
    
    604,556
    
    
    
    504,448
    
    
    
    612,581Merrill Lynch Government
Securities Inc. and affiliates
    
    
    869,340
    
    
    
    878,663
    
    
    
    529,951
    
    
    
    535,440Bear, Stearns and Company, Inc.
    
    
    278,391
    
    
    
    301,852
    
    
    
    534,273
    
    
    
    564,947Credit Suisse First Boston LLC
    
    
    640,154
    
    
    
    625,851
    
    
    
    339,508
    
    
    
    414,672Salomon Smith Barney Inc. and affiliates
    
    
    599,025
    
    
    
    617,572
    
    
    
    441,800
    
    
    
    469,819Morgan Stanley Dean Witter
    
    
    1,012,000
    
    
    
    1,024,200
    
    
    
    431,950
    
    
    
    445,362Wachovia Securities, LLC
    
    
    161,244
    
    
    
    165,019
    
    
    
    182,390
    
    
    
    184,217Doral Securities, Inc.
    
    
    49,245
    
    
    
    50,062
    
    
    
    50,000
    
    
    
    50,766Barclays Capital, Inc.
    
    
    49,450
    
    
    
    49,641
    
    
    
    
    
    
    
    J.P. Morgan Securities, Inc.
    
    
    169,623
    
    
    
    172,122
    
    
    
    
    
    
    
    Total
    
    $
    6,608,498
    
    
    $
    6,825,493
    
    
    $
    5,046,045
    
    
    $
    5,362,474
 94




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##### Table of Contents



Borrowings under repurchase agreements at December 31, were collateralized as follows: 2004
    
    
    2003Carrying
    
    
    Fair
    
    
    Carrying
    
    
    FairSecurities Underlying
    
    Value of
    
    
    Value of
    
    
    Value of
    
    
    Value ofRepurchase
    
    Underlying
    
    
    Underlying
    
    
    Underlying
    
    
    UnderlyingAgreements
    
    Collateral
    
    
    Collateral
    
    
    Collateral
    
    
    Collateral(In thousands)U.S. Government and agencies
obligations - held to maturity
    
    $
    5,596,079
    
    
    $
    5,573,172
    
    
    $
    4,255,219
    
    
    $
    4,234,831Mortgage-backed securities purchased
under agreements to resell
    
    
    529,305
    
    
    
    525,299
    
    
    
    200,000
    
    
    
    266,855Mortgage-backed securities - held
to maturity
    
    
    778,287
    
    
    
    720,906
    
    
    
    880,486
    
    
    
    813,352Mortgage-backed securities -
available for sale
    
    
    6,116
    
    
    
    6,116
    
    
    
    47,436
    
    
    
    47,436Total
    
    
    6,909,787
    
    
    $
    6,825,493
    
    
    
    5,383,141
    
    
    $
    5,362,474Accrued interest receivable
of underlying securities
    
    
    54,029
    
    
    
    
    
    
    
    48,973Total
    
    $
    6,963,816
    
    
    
    
    
    
    $
    5,432,114
 95




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##### Table of Contents



A summary of short-term borrowings, including federal funds purchased, repurchase
agreements and advances from Federal Home Loan Bank (see Note 10), and interest rates at and
for the year ended December 31, are indicated below: 2004
    
    
    2003(Dollars in thousands)Federal funds purchased:Balance at end of year
    
    $
    75,029
    
    
    $
    Weighted-average interest rate at year end
    
    
    2.37
    %
    
    
    
    %Monthly average outstanding balance
    
    $
    23,753
    
    
    $
    8,500Weighted-average interest rate for the year
    
    
    1.95
    %
    
    
    1.34
    %Maximum month-end balance
    
    $
    95,005
    
    
    $
    75,000Repurchase agreements:Balance at end of year
    
    $
    4,138,257
    
    
    $
    1,648,891Weighted-average interest rate at year end
    
    
    2.30
    %
    
    
    1.21
    %Monthly average outstanding balance
    
    $
    2,377,042
    
    
    $
    1,093,921Weighted-average interest rate for the year
    
    
    1.67
    %
    
    
    1.24
    %Maximum month-end balance
    
    $
    4,206,540
    
    
    $
    1,717,184Advances from FHLB:Balance at end of year
    
    $
    25,000
    
    
    $
    40,000Weighted-average interest rate at year end
    
    
    2.41
    %
    
    
    1.20
    %Monthly average outstanding balance
    
    $
    21,250
    
    
    $
    31,917Weighted-average interest rate for the year
    
    
    1.65
    %
    
    
    1.33
    %Maximum month-end balance
    
    $
    50,000
    
    
    $
    64,000Total short-term borrowings:Balance at end of year
    
    $
    4,238,286
    
    
    $
    1,688,891Weighted-average interest rate at year end
    
    
    2.30
    %
    
    
    1.21
    %Monthly average outstanding balance
    
    $
    2,422,045
    
    
    $
    1,134,338Weighted-average interest rate for the year
    
    
    1.67
    %
    
    
    1.24
    %Maximum month-end balance
    
    $
    4,238,286
    
    
    $
    1,832,184
  9.
    LINES OF CREDIT: As of December 31, 2004 and 2003, Westernbank had line of credit agreements with six and four
commercial banks, respectively, permitting Westernbank to borrow a maximum aggregate amount of
$245,000,000 and $125,000,000, mainly through federal funds purchased. There were $75.0 million
outstanding as of December 31, 2004 (there were no borrowings outstanding as of December 31,
2003, under such lines of credit). The agreements provide for unsecured advances to be used by
Westernbank on an overnight basis. Interest rate is negotiated at the time of the transaction
usually at Fed Fund rate. The credit agreements are renewable annually. 96




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##### Table of Contents



10.
    ADVANCES FROM FEDERAL HOME LOAN BANK AND MORTGAGE NOTE PAYABLE: Advances from Federal Home Loan Bank (FHLB) and mortgage note payable, and the related
weighted interest rates at December 31, consisted of the following: 2004
    
    
    2003Weighted
    
    
    
    
    
    
    WeightedInterest
    
    
    
    
    
    
    InterestAmount
    
    
    Rate
    
    
    Amount
    
    
    Rate(Dollars in thousands)ADVANCES FROM FHLB:Fixed rate convertible advances
(2.41 % to 6.66 %)
    
    $
    211,000
    
    
    
    3.78
    %
    
    $
    146,000
    
    
    
    4.06
    %MORTGAGE NOTE:Fixed rate mortgage note
    
    $
    36,858
    
    
    
    8.05
    %
    
    $
    37,234
    
    
    
    8.05
    %
 Advances and repurchase agreements (Note 8) are received from the FHLB under an agreement
whereby the Company is required to maintain a minimum amount of qualifying collateral with a
fair value of at least 110% and 105% of the outstanding advances and repurchase agreements,
respectively. At December 31, 2004, convertible advances were secured by mortgage loans
amounting to $331,481,000. At the advances and repurchase agreements first anniversary date
and each quarter thereafter, the FHLB has the option to convert them into replacement funding
for the same or a lesser principal amount based on any funding then offered by FHLB at the then
current market rates, unless the interest rate has been predetermined between FHLB and the
Company. If the Company chooses not to replace the funding, it will repay the convertible
advances and reverse repurchase agreements, including any accrued interest, on such optional
conversion date. At December 31, 2004 and 2003, Westernbank World Plaza, Inc., a wholly owned subsidiary of
Westernbank Puerto Rico, had outstanding $36.9 million and $37.2 million, respectively, of a
mortgage note, at an interest rate of 8.05% per year up to September 11, 2009. Subsequent to
September 11, 2009, the mortgage note will bear interest on the then outstanding principal
balance at a rate per year equal to the (1) greater of 13.05% or the Treasury Rate plus five
percentage points or (2) 10.05%, depending on the fulfillment of certain conditions on the
repricing date. Westernbank World Plaza, Inc. has a prepayment option on the repricing date,
without penalty. The mortgage note is collateralized by a 23-story office building, including
its related parking facility, located in Hato Rey, Puerto Rico. 97




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##### Table of Contents



Advances from FHLB and the mortgage note payable by contractual maturities at December 31,
2004, were as follows: Advances
    
    
    MortgageYear Ending
    
    from FHLB
    
    
    Note PayableDecember 31,
    
    (In thousands)2005
    
    $
    39,000
    
    
    $
    4182006
    
    
    70,000
    
    
    
    4542007
    
    
    60,000
    
    
    
    4922008
    
    
    
    
    
    
    5262009
    
    
    
    
    
    
    579Thereafter
    
    
    42,000
    
    
    
    34,389Total
    
    $
    211,000
    
    
    $
    36,858
  11.
    INCOME TAXES: Under the Puerto Rico Internal Revenue Code (the Code), all companies are treated as separate
taxable entities and are not entitled to file consolidated tax returns. The Company,
Westernbank, Westernbank Insurance Corp. and SRG Net, Inc. 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. Westernbank World Plaza, Inc., a wholly owned subsidiary of Westernbank, elected to be treated
as a special partnership under the Code; accordingly, its taxable income is taxed by
Westernbank. The Code provides a dividend received deduction of 100%, on dividends received from wholly
owned subsidiaries subject to income taxation in Puerto Rico. The income on certain investments
is exempt for income tax purposes. Also, Westernbank International division operates as an
International Banking Entity (IBE) under the International Banking Regulatory Act. Under
Puerto Rico tax law, an IBE can hold non-Puerto Rico assets, and earn interest on these assets,
as well as generate fee income outside of Puerto Rico on a tax-exempt basis under certain
circumstances. As a result of the above, the Companys effective tax rate is substantially
below the statutory rate. Pursuant to the provisions of Act No. 13 of January 8, 2004 (the Act), for taxable years
commencing after June 30, 2003, the net income earned by an IBE that operates as a unit of a
bank under the Puerto Rico Banking Law, will be considered taxable and subject to income taxes
at the current tax rates in the amount by which the IBE taxable income exceeds 40% in the first
applicable taxable year (2004), 30% in the second year (2005) and 20% thereafter, of the
taxable income of Westernbank, including its IBE taxable income. Westernbanks IBE carries on
its books a significant amount of securities which are, irrespective of the IBE status, tax
exempt by law. Moreover, the Act provides that IBEs operating as subsidiaries will continue to
be exempt from the payment of income taxes. At December 31, 2004, management estimated that
the provisions of the Act did not have an effect on the Companys financial position or results
of operations. 98




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##### Table of Contents



Accrued income tax payable amounted to $2,444,000 and $19,826,000 at December 31, 2004 and
2003, respectively, and is included as part of Accrued expenses
and other liabilities in the accompanying statements
of financial condition. The provision for income taxes for the years ended December 31,
consisted of the following: 2004
    
    
    2003
    
    
    2002(In thousands)Current
    
    $
    28,182
    
    
    $
    29,346
    
    
    $
    18,619Deferred credit
    
    
    (6,096
    )
    
    
    (8,575
    )
    
    
    (2,518
    )Total
    
    $
    22,086
    
    
    $
    20,771
    
    
    $
    16,101
 A reconciliation of the provision for income taxes computed by applying the Puerto Rico income
tax statutory rate to the tax provision as reported for the years ended December 31, was as
follows: 2004
    
    
    2003
    
    
    2002% of Pre-
    
    
    
    
    
    
    % of Pre-
    
    
    
    
    
    
    % of Pre-tax
    
    
    
    
    
    
    tax
    
    
    
    
    
    
    taxAmount
    
    
    Income
    
    
    Amount
    
    
    Income
    
    
    Amount
    
    
    Income(Dollars in thousands)Computed at Puerto Rico
statutory rate
    
    $
    75,641
    
    
    
    39
    %
    
    $
    52,293
    
    
    
    39
    %
    
    $
    39,805
    
    
    
    39
    %Effect on provision of:Exempt interest income, net
    
    
    (50,940
    )
    
    
    (26
    )
    
    
    (34,078
    )
    
    
    (25
    )
    
    
    (25,700
    )
    
    
    (25
    )Nondeductible expenses, net
    
    
    159
    
    
    
    
    
    
    
    169
    
    
    
    
    
    
    
    12
    
    
    
    Other
    
    
    (2,774
    )
    
    
    (2
    )
    
    
    2,387
    
    
    
    1
    
    
    
    1,984
    
    
    
    2Provision for income tax
as reported
    
    $
    22,086
    
    
    
    11
    %
    
    $
    20,771
    
    
    
    15
    %
    
    $
    16,101
    
    
    
    16
    %
 99




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##### Table of Contents



Deferred income tax assets (liabilities) as of December 31, consisted of the following: 2004
    
    
    2003(In thousands)Deferred tax assets:Allowance for loan losses
    
    $
    30,098
    
    
    $
    22,899Capital losses on sale of investment securities, expire in 2008
    
    
    4,912
    
    
    
    5,604Net operating loss carryfowards, expire through 2009
    
    
    620
    
    
    
    Unrealized loss in valuation of derivative instruments
    
    
    415
    
    
    
    Other
    
    
    172
    
    
    
    154Total deferred tax assets
    
    
    36,217
    
    
    
    28,657Less valuation allowance
    
    
    5,032
    
    
    
    1,718Subtotal
    
    
    31,185
    
    
    
    26,939Deferred tax liabilities:Unrealized gain in valuation of derivative instruments
    
    
    
    
    
    
    746Unrealized gain in securities available for sale
    
    
    
    
    
    
    21Other
    
    
    158
    
    
    
    1,262Total deferred tax liabilities
    
    
    158
    
    
    
    2,029Deferred income taxes, net
    
    $
    31,027
    
    
    $
    24,910
 Changes in the valuation allowance for deferred income tax assets were as follows: 2004
    
    
    2003
    
    
    2002(In thousands)Balance - at January 1
    
    $
    1,718
    
    
    $
    6
    
    
    $
    39Increase (decrease) in valuation allowance
    
    
    3,314
    
    
    
    1,712
    
    
    
    (33
    )Balance - at December 31
    
    $
    5,032
    
    
    $
    1,718
    
    
    $
    6
 Realization of deferred tax assets is dependent on generating sufficient future taxable income
or capital gains. The amount of the deferred tax asset considered realizable could be reduced
in the near term if estimates of future taxable income or capital gains are not met. 100




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##### Table of Contents



12.
    NET GAIN (LOSS) ON SALES AND VALUATION OF LOANS, SECURITIES AND OTHER ASSETS: Net gain (loss) on sales and valuation of loans, securities and other assets for the years
ended December 31, consisted of the following: 2004
    
    
    2003
    
    
    2002(In thousands)Trading account securities, mainly related
to loans securitized
    
    $
    314
    
    
    $
    1,657
    
    
    $
    (866
    )Investment securities available for sale
    
    
    128
    
    
    
    (7,671
    )
    
    
    1,508Impairment on investment securities held to maturity
    
    
    
    
    
    
    (15,701
    )
    
    
    Mortgage loans held for sale
    
    
    1,649
    
    
    
    2
    
    
    
    306Other
    
    
    538
    
    
    
    764
    
    
    
    2Total
    
    $
    2,629
    
    
    $
    (20,949
    )
    
    $
    950
  13.
    COMMITMENTS AND CONTINGENCIES: In the ordinary course of business, the Company has various outstanding commitments and
contingent liabilities that are not reflected in the accompanying consolidated financial
statements. In addition, the Company is a defendant in certain claims and legal actions
arising in the ordinary course of business. In the opinion of management, after consultation
with legal counsel, the ultimate disposition of these matters is not expected to have a
material adverse effect on the Companys financial condition or results of operations. The Company, as a Puerto Rico chartered financial holding company, and its subsidiaries are
each subject to extensive federal and local government supervision and regulation relating to
its financial holding company status and the banking and insurance businesses. There are laws
and regulations that restrict transactions between the Company and its subsidiaries. In
addition, the Company benefits from favorable tax treatment of activities relating to the
Westernbanks International Division. Any change in such regulations, whether by applicable
regulators or as a result of legislation subsequently enacted by the Congress of the United
States or the applicable local legislature, could have a substantial impact on the companies
operations. Westernbank has open to investigation its taxable years from 2000 to 2004. The last income tax
investigation of the Puerto Rico Treasury Department (the PRTD), which covered taxable years
1996 to 1999, resulted in an income tax deficiency of approximately $1.2 million. This
deficiency mainly resulted from a differing interpretation in the methodology used to allocate
expenses to the exempt income. Westernbank settled the income tax deficiency and agreed to
close the investigation without accepting the PRTDs position. At December 31, 2004 and 2003,
management recorded an accrual of $1.6 million to cover this income tax contingency. The Company has received from the Securities Exchange Commission (the SEC) notice of a formal
order of private investigation into matters that were the subject of a previously announced
informal inquiry by the SEC. The inquiry appears to be primarily related to the
other-than-temporary impairment charges announced by the Company in April 2003 in connection
with its investments in corporate bond and loan obligations. The Company is cooperating fully
with the SEC and will continue to do so. The formal order is a confidential document directing
a non-public investigation. 101




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##### Table of Contents



At December 31, 2004, the Company is obligated under non-cancelable operating leases for
banking premises. Certain leases contain escalation clauses providing for increased rental.
Rent expense, including the proportionate share of maintenance expenses of common areas,
administrative expenses, property taxes, utilities and insurance expenses, amounted to
$2,629,000, $2,576,000, and $2,435,000 for the years ended December 31, 2004, 2003 and 2002,
respectively. The projected minimum rental payments under the leases with initial or remaining terms of more
than one year, without considering renewal options, and expiring through 2025 are as follows: MinimumYear Ending
    
    RentDecember 31,
    
    (In thousands)2005
    
    $
    2,3732006
    
    
    2,1122007
    
    
    1,4132008
    
    
    8702009
    
    
    423Thereafter
    
    
    359Total
    
    $
    7,550
  14.
    RETIREMENT BENEFIT PLANS: Pension Plan The Company established a retirement plan for directors who were not also executive officers
and who elected to retire after January 1, 1988. The Plan generally provided pension benefits
ranging from 80% to 100% of the Directors average remuneration based on consecutive years of
service (vesting started after six years) and average earnings during the last five years
(three years if the Director has served longer than 25 years). On February 24, 1989, the Plan
was substantially amended to limit the pension benefits to only those directors who were
founders of the Company, had attained the age of 50 years and had served for 25 consecutive
years on the Board. The amended plan provided for pension benefits equal to the Directors
average remuneration during the last three years of service. The other Directors
(non-founders) by approving this amendment waived and renounced their pension benefits under
the Plan. The accumulated benefit obligation under this Plan was $136,000 as of December 31,
2003. Effective October 2004, all obligations under this plan were extinguished. Profit-Sharing and Defined Contributions Plans The Company has a non-contributory deferred profit-sharing plan, covering substantially all of
its employees, which provides for retirement and disability benefits. The Companys
contribution to the profit-sharing plan is discretionary. The Companys contributions for the
years ended December 31, 2004, 2003 and 2002 were $250,000 for each year. The Company has a defined contribution plan under Section 1165(e) of the Puerto Rico Treasury
Department Internal Revenue Code, covering all full-time employees of the Company who have one
year of service and are twenty-one years or older. Under the provisions of this Plan,
participants may contribute each year from 2% to 10% of their compensation after deducting
social security, up to the maximum deferral amount specified by local law. The Company
contributes 50 percent of the first 6 percent of base compensation that a participant
contributes to the Plan. Participants are immediately vested in their contributions plus
actual earnings thereon. The Companys contributions plus actual earnings thereon are 100
percent vested after three years of credited service. In case of death or
disability, a participant or his/her beneficiary will be 100 percent vested regardless of the
number of years of credited service. The Companys contributions for the years ended December
31, 2004, 2003 and 2002, amounted to $376,000, $329,000 and $305,000, respectively. 102




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##### Table of Contents



15.
    MINIMUM REGULATORY CAPITAL REQUIREMENTS: The Company is subject to examination, regulation and periodic reporting under the Bank Holding
Company Act of 1956, as amended, which is administered by the Board of Governors of the Federal
Reserve System. Westernbank is regulated by the Federal Deposit Insurance Corporation (FDIC)
and by the Office of the Commissioner of Financial Institutions of Puerto Rico. Westernbanks
deposits are insured by the Savings Association Insurance Fund and by the Bank Insurance Fund,
which are administered by the FDIC, up to $100,000 per depositor. The Federal Reserve Board has established guidelines regarding the capital adequacy of bank
holding companies, such as the Company. These requirements are substantially similar to those
adopted by the FDIC for depository institutions, such as Westernbank, as set forth below. The Company (on a consolidated basis) and Westernbank 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 Companys and
Westernbanks financial statements. Under capital adequacy guidelines and the regulatory
framework for prompt corrective action, the Company and Westernbank 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 Company
and Westernbank 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)
and of Tier 1 capital (as defined) to average assets (as defined). Management believes, as of
December 31, 2004 and 2003, that the Company and Westernbank meet all capital adequacy
requirements to which they are subject. As of March 31, 2004 (latest examination date), Westernbank qualified as a well capitalized
institution under the regulatory framework for prompt corrective action. To be categorized as
well capitalized, an institution must maintain minimum total risk-based, Tier I risk-based, and
Tier I leverage ratios as set forth in the following table. At December 31, 2004, there are no
conditions or events since the latest examination date that management believes have changed
Westernbanks category. 103




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##### Table of Contents



The Companies actual capital amounts and ratios as of December 31, 2004 and 2003, are also
presented in the table below: Minimum To BeMinimum
    
    
    Well Capitalized UnderCapital
    
    
    Prompt CorrectiveActual
    
    
    Requirement
    
    
    Action ProvisionsAmount
    
    
    Ratio
    
    
    Amount
    
    
    Ratio
    
    
    Amount
    
    Ratio(Dollars in thousands)As of December 31, 2004:Total Capital to Risk Weighted Assets:Consolidated
    
    $
    1,158,444
    
    
    
    15.70
    %
    
    $
    590,227
    
    
    
    8
    %
    
    
    N/A
    
    
    
    N/AWesternbank
    
    
    1,020,296
    
    
    
    13.88
    
    
    
    587,987
    
    
    
    8
    
    
    $
    734,983
    
    
    
    10
    %Tier I Capital to Risk Weighted Assets:Consolidated
    
    $
    1,078,377
    
    
    
    14.78
    %
    
    $
    291,911
    
    
    
    4
    %

    
    
    N/A
    
    
    
    N/AWesternbank
    
    
    940,230
    
    
    
    12.93
    
    
    
    290,791
    
    
    
    4
    
    
    $
    436,186
    
    
    
    6
    %Tier I Capital to Average Assets:Consolidated
    
    $
    1,078,377
    
    
    
    7.72
    %
    
    $
    419,230
    
    
    
    3
    %
    
    
    N/A
    
    
    
    N/AWesternbank
    
    
    940,230
    
    
    
    6.75
    
    
    
    417,582
    
    
    
    3
    
    
    $
    695,971
    
    
    
    5
    %As of December 31, 2003:Total Capital to Risk Weighted Assets:Consolidated
    
    $
    886,360
    
    
    
    14.87
    %
    
    $
    476,996
    
    
    
    8
    %
    
    
    N/A
    
    
    
    N/AWesternbank
    
    
    880,001
    
    
    
    14.76
    
    
    
    462,167
    
    
    
    8
    
    
    $
    577,709
    
    
    
    10
    %Tier I Capital to Risk Weighted Assets:Consolidated
    
    $
    826,618
    
    
    
    13.98
    %
    
    $
    236,034
    
    
    
    4
    %
    
    
    N/A
    
    
    
    N/AWesternbank
    
    
    819,393
    
    
    
    13.87
    
    
    
    228,619
    
    
    
    4
    
    
    $
    342,929
    
    
    
    6
    %Tier I Capital to Average Assets:Consolidated
    
    $
    826,618
    
    
    
    7.22
    %
    
    $
    343,586
    
    
    
    3
    %
    
    
    N/A
    
    
    
    N/AWesternbank
    
    
    819,393
    
    
    
    7.19
    
    
    
    341,507
    
    
    
    3
    
    
    $
    569,179
    
    
    
    5
    %
 The Company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 guidelines. In
addition, any bank financial holding company whose capital falls below levels specified in the
guidelines can be required to implement a plan to increase capital. Management believes that
the Company will continue to meet its capital requirements, cash obligations as they become
due and pay dividends as they are declared. The principal source of income and funds for the Company (parent company) are dividends from
its subsidiaries. Federal and Puerto Rico banking regulations place certain restrictions on
dividends paid and loans or advances made by Westernbank to the Company. The total amount of
dividends which may be paid at any date is generally limited to the retained earnings of
Westernbank, and loans or advances are limited to 10 percent of Westernbanks capital stock and
surplus on a secured basis. During 2004, the amount of dividends Westernbank can pay to the Company without prior approval
of regulatory agencies is limited to its 2004 eligible net profits, as defined, and its
adjusted retained 2003 and 2002 net income. In addition, dividends paid by Westernbank to the Company would be
prohibited if the effect thereof would cause Westernbanks capital to be reduced below
applicable minimum capital requirements. 104




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##### Table of Contents



16. COMMON AND PREFERRED STOCK TRANSACTIONS: During 2003 and 2002, the Company acquired and retired shares of common stock as follows:
$33,000 (1,903 shares) in 2003; and $42,000 (1,678 shares) in 2002. On December 6, 2004, the Companys board of directors declared a three-for-two split on its
common stock, for stockholders of record as of December 31, 2004 and distributed on January 10,
2005. The effect of the stock split was a decrease in retained earnings and an increase in
common stock of approximately $54.6 million. On December 13, 2004, the Companys board of directors declared a two percent (2%) stock
dividend, for stockholders of record as of December 30, 2004 and distributed on January 10,
2005. The effect of the stock dividend was a decrease in retained earnings, an increase in
paid-in-capital and an increase in common stock of approximately $45.8 million, $43.7 million
and $2.1 million, respectively. During 2004, the Company issued 214,750 shares of common stock upon exercise of stock options
by three of the Companys executive officers (Note 17  Stock Compensation Plans). On November 4, 2003, the Companys board of directors declared a three-for-two split on its
common stock, for stockholders of record as of November 28, 2003 and distributed on December
10, 2003. The effect of the stock split was a decrease in retained earnings and an increase in
common stock of approximately $34.7 million. On November 11, 2003, the Companys board of directors declared a two percent (2%) stock
dividend, for stockholders of record as of November 28, 2003 and distributed on December 10,
2003. The effect of the stock dividend was a decrease in retained earnings, an increase in
paid-in-capital and an increase in common stock of approximately $35.2 million, $33.1 million
and $2.1 million, respectively. During 2003, the Company issued 500,000 shares of common stock upon exercise of stock options
by an executive officer of the Company (Note 17  Stock Compensation Plans). On June 17, 2002, the Companys board of directors declared a three-for-two split on its common
stock, for all stockholders of record as of June 28, 2002 and distributed on July 10, 2002. The
effect of the stock split was a decrease to retained earnings and an increase in common stock
of approximately $20.8 million. During 2002, the Company issued 6,095,000 shares of the Companys Common Stock, providing a net
capital infusion of approximately $97.9 million. 105




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##### Table of Contents



The Company has issued the following non-cumulative, monthly income preferred stock: IssuancePrice andLiquidation
    
    
    
    
    
    
    Proceeds FromIssuance
    
    
    
    Dividend
    
    Preference
    
    
    Shares
    
    
    Issuance, Net of
    
    
    IssuanceYear
    
    Type of Preferred Stock
    
    Rate
    
    Per Share
    
    
    Issued
    
    
    Issuance Costs
    
    
    Costs1998
    
    Convertible, 1998 Series A
    
    7.125%
    
    $
    25
    
    
    
    1,219,000
    
    
    $
    29,143,000
    
    
    $
    1,332,0001999
    
    Non-convertible, 1999 Series B
    
    7.250
    
    
    25
    
    
    
    2,001,000
    
    
    
    48,273,000
    
    
    
    1,752,0002001
    
    Non-convertible, 2001 Series C
    
    7.600
    
    
    25
    
    
    
    2,208,000
    
    
    
    53,103,000
    
    
    
    2,097,0002001
    
    Non-convertible, 2001 Series D
    
    7.400
    
    
    25
    
    
    
    1,791,999
    
    
    
    43,238,000
    
    
    
    1,562,0002002
    
    Non-convertible, 2002 Series E
    
    6.875
    
    
    25
    
    
    
    1,725,000
    
    
    
    41,463,000
    
    
    
    1,662,0002003
    
    Non-convertible, 2003 Series F
    
    6.700
    
    
    25
    
    
    
    4,232,000
    
    
    
    102,192,000
    
    
    
    3,608,0002003
    
    Non-convertible, 2003 Series G
    
    6.900
    
    
    25
    
    
    
    2,640,000
    
    
    
    63,671,000
    
    
    
    2,329,0002004
    
    Non-convertible, 2004 Series H
    
    6.700
    
    
    50
    
    
    
    2,675,500
    
    
    
    129,311,000
    
    
    
    4,464,000Total
    
    
    
    
    
    
    
    
    18,492,499
    
    
    $
    510,394,000
    
    
    $
    18,806,000
 The preferred stock ranks senior to the Companys common stock as to dividends and
liquidation rights. Each share of the 1998 Series A preferred stock is convertible, at the
holders option, at any time on or after the 90th day following the issue date, into
..995 shares of the Companys common stock, subject to adjustment upon certain events. The per
share conversion ratio equates to a price of $7.12 (as adjusted) per share of common stock. During 2004, 2003 and 2002, 276,994, 419,254 and 2,000 shares, respectively, of the convertible
preferred stock Series A were converted into 632,523, 625,717 and 2,984 shares of common stock,
respectively. At December 31, 2004 and 2003, the Company had outstanding 520,752 and 797,746
shares, respectively, of its 7.125% Non-cumulative, Convertible Monthly Income Preferred Stock,
Series A. The Company may redeem, in whole or in part, at any time at the following redemption prices, if
redeemed during the twelve month period beginning July 1 for the 1998 Series A, May 28 for the
1999 Series B, March 30 for the 2001 Series C, August 1 for the 2001 Series D, October 31 for
the 2002 Series E, May 30 for the 2003 Series F, August 29 for the 2003 Series G and December
21 for the 2004 Series H of the years indicated below, plus accrued and unpaid dividends, if
any, to the date of redemption: Redemption Price per ShareDecember 31,
    
    Series A
    
    
    Series B
    
    
    Series C
    
    
    Series D
    
    
    Series E
    
    
    Series F
    
    
    Series G
    
    
    Series H2005
    
    $
    25.25
    
    
    $
    25.50
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2006
    
    
    25.00
    
    
    
    25.00
    
    
    $
    25.50
    
    
    $
    25.50
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2007
    
    
    25.00
    
    
    
    25.00
    
    
    
    25.25
    
    
    
    25.25
    
    
    $
    25.50
    
    
    
    
    
    
    
    
    
    
    
    2008
    
    
    25.00
    
    
    
    25.00
    
    
    
    25.00
    
    
    
    25.00
    
    
    
    25.25
    
    
    $
    25.50
    
    
    $
    25.50
    
    
    
    2009
    
    
    25.00
    
    
    
    25.00
    
    
    
    25.00
    
    
    
    25.00
    
    
    
    25.00
    
    
    
    25.25
    
    
    
    25.25
    
    
    $
    51.002010
    
    
    25.00
    
    
    
    25.00
    
    
    
    25.00
    
    
    
    25.00
    
    
    
    25.00
    
    
    
    25.00
    
    
    
    25.00
    
    
    
    50.502011 and thereafter
    
    
    25.00
    
    
    
    25.00
    
    
    
    25.00
    
    
    
    25.00
    
    
    
    25.00
    
    
    
    25.00
    
    
    
    25.00
    
    
    
    50.00
 106




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##### Table of Contents



17. STOCK COMPENSATION PLANS: The Company has two stock option plans, the 1999 Qualified Stock Option Plan (the 1999
Qualified Option Plan) and the 1999 Nonqualified Stock Option Plan (the 1999 Nonqualified
Option Plan), for the benefit of employees of the Company and its subsidiaries. These plans
offer to key officers, directors and employees an opportunity to purchase shares of the
Companys common stock. Under the 1999 Qualified Option Plan, options for up to 14,747,670
shares (as adjusted) of common stock can be granted. Also, options for up to 14,747,670 shares
(as adjusted) of common stock, reduced by any share issued under the 1999 Qualified Option Plan
can be granted under the 1999 Nonqualified Option Plan. The option price for both plans is
determined at the grant date. Both plans will remain in effect for a term of 10 years. The
Board of Directors has sole authority and absolute discretion as to the number of stock options
to be granted, their vesting rights, and the options exercise price. The options become fully
exercisable after five years following the grant date. The Plans provide for a proportionate
adjustment in the exercise price and the number of shares that can be purchased in the event of
a stock split, reclassification of stock and a merger or reorganization. The activity in outstanding options for the years ended December 31, 2004, 2003 and 2002, is
set forth below: 2004
    
    
    2003
    
    
    2002Weighted
    
    
    
    
    
    
    Weighted
    
    
    
    
    
    
    WeightedAverage
    
    
    
    
    
    
    Average
    
    
    
    
    
    
    AverageNumber of
    
    
    Exercise
    
    
    Number of
    
    
    Exercise
    
    
    Number of
    
    
    ExerciseOptions
    
    
    Price
    
    
    Options
    
    
    Price
    
    
    Options
    
    
    PriceBeginning of year
    
    
    4,862,723
    
    
    $
    4.62
    
    
    
    3,678,250
    
    
    $
    7.01
    
    
    
    2,370,500
    
    
    $
    10.06Transactions before stock split
and stock dividend:Options granted
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Options exercised
    
    
    (214,750
    )
    
    
    4.52
    
    
    
    (500,000
    )
    
    
    6.67
    
    
    
    
    
    
    
    Options
forfeited
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,647,973
    
    
    
    4.62
    
    
    
    3,178,250
    
    
    
    7.06
    
    
    
    2,370,500
    
    
    
    10.06Stock split and stock dividend effect
    
    
    2,463,425
    
    
    
    3.02
    
    
    
    1,684,473
    
    
    
    4.62
    
    
    
    1,185,250
    
    
    
    6.70Transactions after stock split
and stock dividend:Options granted
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    122,500
    
    
    
    15.85Options exercised
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Options forfeited
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    End of year
    
    
    7,111,398
    
    
    $
    3.02
    
    
    
    4,862,723
    
    
    $
    4.62
    
    
    
    3,678,250
    
    
    $
    7.01
 107




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##### Table of Contents



The Company has only three exercise prices for options granted, all of them granted at
three different dates. The following table summarizes the exercise prices and the weighted
average remaining contractual life of the options outstanding at December 31, 2004: Outstanding
    
    
    ExercisableWeightedAverageNumber of
    
    
    Contract
    
    
    Number ofExercise Prices (1)
    
    Options (1)
    
    
    Life (Years)
    
    
    Options (1)$2.85
    
    
    6,631,513
    
    
    
    5.12
    
    
    
    4,574,360$3.35
    
    
    193,124
    
    
    
    6.38
    
    
    
    115,875$6.77
    
    
    286,761
    
    
    
    7.55
    
    
    
    114,704Total
    
    
    7,111,398
    
    
    
    5.25
    
    
    
    4,804,939
   (1)
    
    Adjusted to reflect the three-for-two stock split and a 2% stock dividend on
our common stock declared in December 2004 and distributed both on January 10,
2005, the three-for-two stock split and a 2% stock dividend on our common stock
declared in November 2003 and distributed both on December 10, 2003, and the
three-for-two stock split on our common stock declared on June 17, 2002 and
distributed on July 10, 2002. 18. OFF-BALANCE SHEET ACTIVITIES: In the normal course of business, the Company becomes a party to credit related financial
instruments with off-balance sheet risk to meet the financing needs of its customers. These
financial instruments include commitments to extend credit and commercial letters of credit.
These instruments involve, to varying degrees, elements of credit and interest rate risk in
excess of the amount recognized in the consolidated statements of financial condition. The
contract or notional amounts of those instruments reflect the extent of involvement the Company
has in particular classes of financial instruments. Commitments to Extend Credit and Commercial Letters of Credit The Companys exposure to credit loss in the event of nonperformance by the other party to the
financial instrument for commitments to extend credit, commitments under credit card
arrangements, commercial letters of credit and commitments to purchase loans, is represented by
the contractual notional amount of those instruments, which do not necessarily represent the
amounts potentially subject to risk. In addition, the measurement of the risks associated with
these instruments is meaningful only when all related and offsetting transactions are
identified. The Company uses the same credit policies in making commitments and conditional
obligations as it does for on-balance sheet instruments. Commitments to extend credit are agreements to lend to a customer as long as there is no
violation of any condition established in the contract. Commitments generally have fixed
expiration dates or other termination clauses and may require payment of a fee. Since many of
the commitments are expected to expire without being drawn upon, the total commitment amounts
do not necessarily represent future cash requirements. The Company evaluates each customers
credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed
necessary upon extension of credit, is based on managements credit evaluation of the
counterparty. Collateral held varies but may include accounts receivable, inventory, property,
plant and equipment, and income producing commercial properties. Commercial letters of credit are conditional commitments issued by the Company on behalf of a
customer authorizing a third party to draw drafts on the Company up to a stipulated amount and
with specified terms and conditions. 108




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##### Table of Contents



The contract
amount of financial instruments, whose amounts represent credit risk
at December 31, was as follows: 2004
    
    
    2003(In thousands)Commitments to extend credit:Fixed rates
    
    $
    7,576
    
    
    $
    11,541Variable rates
    
    
    504,510
    
    
    
    243,825Unused lines of credit:Commercial
    
    
    177,893
    
    
    
    80,008Credit cards and other
    
    
    138,736
    
    
    
    94,259Commercial letters of credit
    
    
    27,784
    
    
    
    12,287Commitments to purchase mortgage loans
    
    
    600,000
    
    
    
    200,000Total
    
    $
    1,456,499
    
    
    $
    641,920
 19. ON-BALANCE SHEET DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES: Derivative Financial Instruments The Company maintains an overall interest rate risk management strategy that incorporates the
use of derivative instruments to minimize significant unplanned fluctuations in earnings and
cash flows caused by interest rate volatility. The Companys interest rate risk management
strategy may involve modifying the re-pricing characteristics of certain assets and liabilities
so that changes in interest rates do not adversely affect the net interest margin and cash
flows. Derivative instruments that the Company may use as part of its interest rate risk
management strategy include interest rate swaps and indexed options. These transactions involve
both credit and market risk. The notional amounts are amounts on which calculations, payments
and the value of the derivative 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. Such difference, which represents the fair value of
the derivative, is reflected on the Companys statements of financial condition as derivative
assets and derivative liabilities. The Company is exposed to credit-related losses in the event of nonperformance by the
counterparties to these agreements. The Company controls the credit risk of its financial
contracts through credit approvals, limits and monitoring procedures, and does not expect any
counterparties to fail their obligations. The Company deals only with primary dealers. Derivative 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. The Company enters into interest-rate swap contracts in managing its interest rate exposure.
Interest-rate swap contracts generally involve the exchange of fixed and floating-rate interest
payment obligations without the exchange of the underlying principal amounts. Entering into
interest-rate swap contracts involves not only the risk of dealing with counterparties and
their ability to meet the terms of the contracts, but also the interest rate risk associated
with unmatched positions. Interest rate swaps are the most common type of derivative contracts
that the Company utilizes. 109




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Indexed options are contracts that the Company enters into in order to receive the average
appreciation of the month end value of the Standard & Poors 500 Composite Stock Index over a
specified period in exchange for the payment of a premium when the contract is initiated. The
credit risk inherent in the indexed options is the risk that the exchange party may default. Fair Value Hedging Instruments The Company currently utilizes interest rate swaps to convert its fixed-rate certificates of
deposit or firm commitments to originate certificates of deposit (liabilities) to a variable
rate. By entering into the swap, the principal amount of the hedged item would remain unchanged
but the interest payment streams would change. These swaps mature between one to twenty years
with a right by the counterparty to call them after the first anniversary. The Company has an
identical right to call the certificates of deposit. Decisions to convert fixed-rate
certificates of deposits or unrecognized firm commitments to originate certificates of deposit
(liabilities) to variable rate are made primarily by consideration of the asset/liability mix
of the Company, the desired asset/liability sensitivity and by interest rate levels. The notional amount of the interest rate swaps used to hedge the fixed rate certificates of
deposit and the firm commitments to originate certificates of deposit amounted to $778,105,000
and $636,818,000 at December 31, 2004 and 2003, respectively. Firm commitments to originate
certificates of deposit at December 31, 2004 amounted to $20,000,000. At December 31, 2003,
there were no firm commitments to originate certificates of deposit (liabilities). At December
31, 2004, the fair value of these derivatives qualifying for fair value hedge represented an
unrealized net loss of $13.0 million, which was recorded as
Accrued expenses and other liabilities, before right
to offset effect, and as a decrease to the hedged Deposits of $12.9 million and as an
increase in Other assets of $101,000 in the accompanying 2004 consolidated statement of
financial condition. At December 31, 2003, the fair value of derivatives qualifying for fair
value hedge represented an unrealized net loss of $12.2 million,
which was recorded as Accrued expenses and other liabilities, before right to offset effect, and as a decrease to the hedged Deposits in the
accompanying 2003 consolidated statement of financial condition. The right to offset effect of
$4.3 million and $2.8 million was recorded at December 31, 2004 and 2003, respectively, as a
decrease in Other assets and Accrued expenses and other liabilities in the accompanying consolidated statements
of financial condition. The Company purchases fixed rate residential mortgage loans for its portfolio. Fixed rate loans
expose the Company to variability in their fair value due to changes in the level of interest
rates. Management believes that it is prudent to limit the variability in the fair value of a
portion of its fixed rate loan portfolio. It is the Companys objective to hedge the change in
fair value of fixed rate mortgage loans at coverage levels that are appropriate, given the
anticipated or existing interest rate levels and other market considerations, as well as the
relationship of changes in this asset to other assets of the Company. To meet this objective,
the Company enters into contracts to purchase fixed rate residential mortgage loans with a
third party. The third party agreed to provide the Company a return at a floating rate of
interest (three month LIBOR plus a spread) even though the contractual terms of the loans are
fixed rate in nature. This provision is effectively an interest rate swap (balance guarantee
swap). Since the contracts meet with the sale accounting provisions of SFAS No. 140, Accounting
for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, SFAS No.
133 and related interpretations, these interest rate swaps are accounted for
separately. Since the hedged item and the hedging instrument have identical critical terms, no
ineffectiveness is assumed and the fair value changes in the interest rate swaps are recorded
as changes in the value of both the interest rate swaps and the mortgage loans. At December 31,
2004, the notional amount of these interest rate swaps and the principal balance of the
mortgage loans amounted to $600,848,000; the weighted average receive floating rate at year end
was 3.65%; the weighted average pay fixed rate at year end was 7.39%; and the floating rate
spread ranged from 120 to 160 basis points. 110




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##### Table of Contents



At December 31, 2004, the fair value of these derivatives qualifying for fair value hedge
represented an unrealized loss of $23.9 million, which was
recorded as Accrued expenses and other liabilities and
as an increase to Loans in the accompanying 2004 consolidated statement of financial condition. Derivative Instruments not Designated as Hedge The Company offers its customers certificates of deposit which contain an embedded derivative
tied to the performance of the Standard & Poors 500 Composite Stock Index that is bifurcated
from the host deposit and recognized in the consolidated statements of financial condition in
accordance with SFAS No. 133. At the end of five years, the depositor will receive a specified
percent of the average increase of the month-end value of the stock index. If such index
decreases, the depositor receives the principal without any interest. The Company uses option
and interest rate swap agreements with major broker dealer companies to manage its exposure to
the stock market. Under the option agreements, the Company will receive the average increase in
the month-end value of the index in exchange for the payment of a premium when the contract is
initiated. Under the terms of the swap agreements, the Company also will receive the average
increase in the month-end value of the index in exchange for a quarterly fixed interest cost.
Since the embedded derivative instrument on the certificates of deposit and the option and
interest rate swap agreements do not qualify for hedge accounting, these derivative instruments
are marked to market through earnings. Information pertaining to the notional amounts of the Companys derivative instruments not
designated as hedge as of December 31, was as follows: Notional Amount2004
    
    
    2003(In thousands)Interest rate swaps (unmatched portion)
    
    $
    8,895
    
    
    $
    3,182Interest rate swaps used to manage exposure
to the stock market
    
    
    36,329
    
    
    
    36,329Embedded options on stock indexed deposits
    
    
    112,407
    
    
    
    85,811Purchased options used to manage exposure
to the stock market on stock indexed deposits
    
    
    78,212
    
    
    
    50,343Total
    
    $
    235,843
    
    
    $
    175,665
 At December 31, 2004, the fair value of derivatives not qualifying as a hedge represented
an unrealized net gain of $26.4 million and was recorded as part
of Other assets of $12.1
million, as part of a reduction of Deposits of
$14.5 million and as part of Accrued expenses and other liabilities of $254,000, in the accompanying 2004 consolidated statement of financial
condition. At December 31, 2003, the fair value of derivatives not qualifying as a hedge represented an
unrealized net loss of $4.5 million and was recorded as part of Other assets $2.8 million, as
part of Deposits $7.2 million and as part of
Accrued expenses and other liabilities $99,000, in the accompanying
2003 consolidated statement of financial condition. 111




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##### Table of Contents



Other Derivative Instruments Information A summary of the types of swaps used, excluding those used to manage exposure to the stock
market and to the variability in the fair value of fixed rate residential mortgage loans, and
their terms at December 31, follows: 2004
    
    
    2003(Dollars in thousands)Pay floating/receive fixed:Notional amount
    
    $
    787,000
    
    
    $
    640,000Weighted average receive rate at year end
    
    
    4.09
    %
    
    
    4.85
    %Weighted average pay rate at year end
    
    
    2.35
    %
    
    
    1.28
    %Floating rate as a percentage of three month LIBOR,
plus a spread ranging from minus .40% to plus .36%
    
    
    100
    %
    
    
    100
    %
 The changes in notional amount of swaps outstanding during the years ended December 31,
follows: 2004
    
    
    2003(In thousands)Beginning balance
    
    $
    676,329
    
    
    $
    566,329New swaps
    
    
    415,500
    
    
    
    437,500Called and matured swaps
    
    
    (268,500
    )
    
    
    (327,500
    )End balance
    
    $
    823,329
    
    
    $
    676,329
 At December 31, 2004, the maturities of interest rate swaps, embedded options and purchased
options by year were as follows: Embedded
    
    
    Purchased
    
    
    BalanceYear Ending
    
    Swaps
    
    
    Options
    
    
    Options
    
    
    Guarantee SwapsDecember 31,
    
    
    (In thousands)2005
    
    $
    165,000
    
    
    $
    
    
    
    $
    
    
    
    

$         2006
    
    
    61,329
    
    
    
    36,940
    
    
    
    1,623
    
    
    
    2007
    
    
    7,500
    
    
    
    26,573
    
    
    
    27,150
    
    
    
    2008
    
    
    
    
    
    
    21,206
    
    
    
    21,571
    
    
    
    2009
    
    
    30,500
    
    
    
    27,688
    
    
    
    27,868
    
    
    
    Thereafter
    
    
    559,000
    
    
    
    
    
    
    
    
    
    
    
    600,848Total
    
    $
    823,329
    
    
    $
    112,407
    
    
    $
    78,212
    
    
    
    $ 600,848
 Swap agreements amounting to $554,000,000 at December 31, 2004, provide the counterparties the
option to cancel the swap agreements on any interest payment date after the first anniversary
(matching the call option that the Company has purchased on hedged certificates of deposit).
During the years ended December 31, 2004 and 2003, various counterparties of swap agreements
exercised their option to cancel their swaps and immediately, the Company exercised its option to call the hedged
certificates of deposit. No gains or losses resulted from above cancellations. At December 31, 2004, the carrying value of the specific collateral held by the counterparties
consisted of money market instruments of $9,711,000. 112




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20. FAIR VALUE OF FINANCIAL INSTRUMENTS: The fair value of a financial instrument is the current amount that would be exchanged between
willing parties, other than in a forced liquidation. Fair value is best determined based upon
quoted market prices. However, in many instances, there are no quoted market prices for the
Companys various financial instruments (such as loans and financial liabilities). In cases
where quoted market prices are not available, fair values are based on estimates using present
value or other valuation techniques. Those techniques are significantly affected by the
assumptions used, including the discount rate and estimates of future cash flows. Accordingly,
the fair value estimates may not be realized in an immediate settlement of the instrument. SFAS
No. 107, Disclosure about Fair Value of Financial Instruments, excludes certain financial
instruments and all non-financial instruments from its disclosure requirements. In addition,
the tax ramifications related to the realization of the unrealized gains and losses can have a
significant effect on fair value estimates and have not been considered in the estimates.
Accordingly, the aggregate fair value amounts presented should not be construed as the
underlying value of the Company. The following methods and assumptions were used by the Company in estimating fair values of
financial instruments as disclosed in these consolidated financial statements:  
    Short-term Financial Assets and Liabilities For financial instruments with a
short-term or no stated maturity, at prevailing market rates and limited credit risk,
carrying amounts approximate fair value. Those financial instruments include cash and due
from banks, money market instruments, certain deposits (passbook accounts, money market
and checking accounts), federal funds purchased and accrued interest.
    Investment Securities Available for Sale, Held to Maturity and Trading
Securities- The fair values of investment securities available for sale, held to maturity
and trading securities are estimated based on quotations received from securities dealers.
If a quoted market price is not available, fair value is estimated using quoted market
prices for similar securities.
    Federal Home Loan Bank (FHLB) Stock- FHLB stock is valued at its redemption
value.
    Mortgage Loans Held for Sale- Fair value is based on the contract price at
which the mortgage loans will be sold.
    Loans- Fair values are estimated for portfolios of loans with similar
financial characteristics. Loans are segregated by type such as residential mortgage,
commercial, consumer, credit cards and other loans. Each loan category is further
segmented into fixed and adjustable interest rate terms and by performing, nonperforming
and loans with payments in arrears.The fair value of performing loans, except residential mortgages and credit card loans is
calculated by discounting scheduled cash flows through the estimated maturity dates using
estimated market discount rates that reflect the credit and interest rate risk inherent in
the loan. For performing residential mortgage loans, fair value is computed using an
estimated market rate based on secondary market sources adjusted to reflect differences in
servicing and credit costs. For credit card loans, cash flows and maturities are estimated based on contractual interest rates and
historical experience and are discounted using estimated market rates.Fair value for significant nonperforming loans and certain loans with payments in arrears
is based on recent external appraisals of collateral. If appraisals are not available,
estimated cash flows are discounted using a rate that is commensurate with the risk
associated with the estimated cash flows. Assumptions regarding credit risk, cash flows,
and discount rates are judgmentally determined using available market information and
specific borrower information. 113




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##### Table of Contents




    Mortgage Servicing Rights- The carrying amount of mortgage servicing rights,
which is evaluated periodically for impairment, approximates the fair value (fair value is
estimated considering prices for similar assets).
    Deposits- The fair value of fixed rate certificates of deposit is based on
the discounted value of contractual cash flows using current rates for certificates of
deposit with similar terms and remaining maturities. The discount rate is estimated using
the rates currently offered for deposits of similar remaining maturities.
    Repurchase Agreements, Advances from FHLB and Mortgage Note Payable- The fair
value of repurchase agreements, advances from FHLB and mortgage note payable is based on
the discounted value using rates currently available to the Company for debt with similar
terms and remaining maturities.
    Derivative Assets and Derivative Liabilities The fair value of interest rate
swaps (excluding balance guarantee swaps) and index option contracts were obtained from
dealer quotes. In the case of balance guarantee swaps, the fair values were estimated by
management based on the present value of expected future cash flows using discount rates
of the swap yield curve and considering prepayment assumptions for similar mortgage loans.
These fair values represent the estimated amount the Company would receive or pay to
terminate the contracts taking into account the current interest rates and the current
creditworthiness of the counterparties.
    Commitments to Extend Credit and Commercial Letters of Credit- The fair value
of commitments to extend credit and commercial letters of credit are based on fees
currently charged to enter into similar agreements, taking into account the remaining
terms of the agreements and the counterparties credit standings. 114




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##### Table of Contents



The estimated fair values of the Companys financial instruments at December 31, were as
follows: 2004
    
    
    2003Carrying
    
    
    Fair
    
    
    Carrying
    
    
    FairValue
    
    
    Value
    
    
    Value
    
    
    Value(In thousands)Financial Assets:Cash and due from banks
    
    $
    77,752
    
    
    $
    77,752
    
    
    $
    92,811
    
    
    $

    92,811Federal funds sold and resell agreements
    
    
    1,017,303
    
    
    
    1,017,303
    
    
    
    649,852
    
    
    
    649,852Interest-bearing deposits in banks
    
    
    49,476
    
    
    
    49,476
    
    
    
    37,767
    
    
    
    37,767Investment securities available for sale
    
    
    7,881
    
    
    
    7,881
    
    
    
    55,080
    
    
    
    55,080Investment securities held to maturity
    
    
    6,921,379
    
    
    
    6,836,897
    
    
    
    5,723,710
    
    
    
    5,638,816Federal Home Loan Bank stock
    
    
    52,195
    
    
    
    52,195
    
    
    
    39,750
    
    
    
    39,750Mortgage loans held for sale
    
    
    1,633
    
    
    
    1,633
    
    
    
    2,555
    
    
    
    2,555Loans (excluding allowance for loan losses)
    
    
    6,021,299
    
    
    
    5,980,836
    
    
    
    4,744,726
    
    
    
    4,766,373Accrued interest receivable
    
    
    88,285
    
    
    
    88,285
    
    
    
    75,567
    
    
    
    75,567Mortgage servicing rights
    
    
    3,302
    
    
    
    3,302
    
    
    
    2,822
    
    
    
    2,822Derivative options purchased
    
    
    7,792
    
    
    
    7,792
    
    
    
    
    
    
    
    Financial Liabilities:Deposits:Non-interest bearing
    
    
    249,368
    
    
    
    249,368
    
    
    
    192,760
    
    
    
    192,760Interest bearing
    
    
    5,951,996
    
    
    
    5,940,243
    
    
    
    5,169,204
    
    
    
    5,168,656Federal funds purchased and repurchase agreements
    
    
    6,683,527
    
    
    
    6,771,099
    
    
    
    5,046,045
    
    
    
    5,223,733Advances from FHLB
    
    
    211,000
    
    
    
    212,608
    
    
    
    146,000
    
    
    
    148,788Mortgage note payable
    
    
    36,858
    
    
    
    39,170
    
    
    
    37,234
    
    
    
    40,916Accrued interest payable
    
    
    51,961
    
    
    
    51,961
    
    
    
    39,801
    
    
    
    39,801Interest rate swaps in a net payable position
    
    
    32,777
    
    
    
    32,777
    
    
    
    16,663
    
    
    
    16,663Other
    
    
    6,513
    
    
    
    6,513
    
    
    
    4,307
    
    
    
    4,307Off-Balance Sheet Credit Related
Financial Instruments:Liabilities:Commitments to extend credit
    
    
    
    
    
    
    (5,345
    )
    
    
    
    
    
    
    (1,628
    )Unused lines of credit:Commercial
    
    
    
    
    
    
    (507
    )
    
    
    
    
    
    
    (236
    )Credit cards and other
    
    
    
    
    
    
    (218
    )
    
    
    
    
    
    
    (236
    )Commercial letters of credit
    
    
    
    
    
    
    (278
    )
    
    
    
    
    
    
    (123
    )
 21. RESERVE FUND: The Banking Law of Puerto Rico requires that a reserve fund be established by Westernbank and
that annual transfers of at least 10% of its net income be made, until such reserve fund equals
its total paid-in capital on common and preferred shares. Such transfers restrict its retained
earnings, which would otherwise be available for dividends. 115




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22. QUARTERLY FINANCIAL DATA (UNAUDITED): The following is a summary of the unaudited quarterly results of operations (in thousands,
except for per share data): 2004
    
    March 31
    
    
    June 30
    
    
    Sept. 30
    
    
    Dec. 31Total interest income
    
    $
    134,407
    
    
    $
    141,016
    
    
    $
    151,545
    
    
    $
    164,408Total interest expense
    
    
    63,201
    
    
    
    66,452
    
    
    
    74,499
    
    
    
    87,690Net interest income
    
    
    71,206
    
    
    
    74,564
    
    
    
    77,046
    
    
    
    76,718Provision for loan losses
    
    
    8,941
    
    
    
    10,821
    
    
    
    10,379
    
    
    
    6,550Net interest income after
provision for loan losses
    
    
    62,265
    
    
    
    63,743
    
    
    
    66,667
    
    
    
    70,168Total noninterest income
    
    
    6,908
    
    
    
    7,005
    
    
    
    8,373
    
    
    
    8,947Total noninterest expenses
    
    
    (23,647
    )
    
    
    (25,241
    )
    
    
    (25,308
    )
    
    
    (25,929
    )Income before income taxes
    
    
    45,526
    
    
    
    45,507
    
    
    
    49,732
    
    
    
    53,186Provision for income taxes
    
    
    5,032
    
    
    
    4,484
    
    
    
    5,489
    
    
    
    7,081Net income
    
    $
    40,494
    
    
    $
    41,023
    
    
    $
    44,243
    
    
    $
    46,105Basic earnings per common share (1)
    
    $
    0.21
    
    
    $
    0.21
    
    
    $
    0.23
    
    
    $
    0.24Diluted earnings per common share (1)
    
    $
    0.20
    
    
    $
    0.21
    
    
    $
    0.22
    
    
    $
    0.23
 2003
    
    March 31
    
    
    June 30
    
    
    Sept. 30
    
    
    Dec. 31Total interest income
    
    $
    103,348
    
    
    $
    110,507
    
    
    $
    116,435
    
    
    $
    131,604Total interest expense
    
    
    53,711
    
    
    
    54,230
    
    
    
    54,323
    
    
    
    60,322Net interest income
    
    
    49,637
    
    
    
    56,277
    
    
    
    62,112
    
    
    
    71,282Provision for loan losses
    
    
    6,228
    
    
    
    6,597
    
    
    
    7,892
    
    
    
    6,331Net interest income after
provision for loan losses
    
    
    43,409
    
    
    
    49,680
    
    
    
    54,220
    
    
    
    64,951Total noninterest income (loss)
    
    
    (8,299
    )
    
    
    285
    
    
    
    7,473
    
    
    
    7,187Total noninterest expenses
    
    
    (19,199
    )
    
    
    (19,766
    )
    
    
    (21,872
    )
    
    
    (23,984
    )Income before income taxes
    
    
    15,911
    
    
    
    30,199
    
    
    
    39,821
    
    
    
    48,154Provision for income taxes
    
    
    1,032
    
    
    
    4,545
    
    
    
    5,183
    
    
    
    10,011Net income
    
    $
    14,879
    
    
    $
    25,654
    
    
    $
    34,638
    
    
    $
    38,143Basic earnings per common share (1)
    
    $
    0.07
    
    
    $
    0.13
    
    
    $
    0.18
    
    
    $
    0.19Diluted earnings per common share (1)
    
    $
    0.07
    
    
    $
    0.13
    
    
    $
    0.17
    
    
    $
    0.18
  (1)
    
    Adjusted to reflect the three-for-two stock split and a 2% stock dividend on our common stock declared in December 2004, and distributed both on January 10, 2005, and the three-for-two stock split and a 2% stock dividend on our common stock declared in November
2003, and distributed both on December 10, 2003.
 The decrease in the provision for loan losses for the fourth quarters of 2004 and 2003,
was attributed to lower net charge offs during both quarters. The provision for income taxes in proportion to income before income taxes (the effective
income tax rate) for the 2004 quarters resulted lower than for the 2003 quarters as a result
of a significant increase in the Companys exempt interest income derived from the investment in tax exempt securities,
primarily in U.S. Government and agencies obligations. 116




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##### Table of Contents



For the first quarter of 2003, the provision for income tax resulted lower than in other 2003
quarters, since the Company recorded a deferred income tax asset related to a capital loss
carryforward on the liquidation of the Companys CBOs and CLOs portfolio which is available
to offset capital gains in future years. 23. SEGMENT INFORMATION: The Companys management monitors and manages the financial performance of two reportable
business segments, the traditional banking operations of Westernbank Puerto Rico and the
activities of the division known as Westernbank International. Other operations of the
Company not reportable in either segment include Westernbank Business Credit Division, which
specializes in asset-based commercial business lending; Westernbank Trust Division, which
offers trust services; SRG Net, Inc., which operates an electronic funds transfer network;
Westernbank Insurance Corp., which operates a general insurance agency; Westernbank World
Plaza, Inc., which operates the Westernbank World Plaza, a 23-story office building located
in Hato Rey, Puerto Rico; and the transactions of the parent company only, which mainly
consist of other income related to the equity in the net income of its two wholly owned
subsidiaries. Separate condensed financial information of the Parent Company is provided in
Note 24. Management determined the reportable segments based on the internal reporting used to
evaluate performance and to assess where to allocate resources. Other factors such as the
Companys organizational structure by divisions, nature of the products, distribution
channels, and the economic characteristics of the products were also considered in the
determination of the reportable segments. The Company evaluates performance based on net
interest income and other income. Operating expenses and the provision for income taxes are
analyzed on a combined basis. Westernbank Puerto Ricos traditional banking operations consist of Westernbanks retail
operations, such as its branches, including the branches of the Expresso division, together
with consumer loans, mortgage loans, commercial loans (excluding the asset-based lending
operations), investments (treasury) and deposit products. Consumer loans include loans such
as personal, collateralized personal loans, credit cards, and small loans. Commercial
products consist of commercial loans including commercial real estate, unsecured commercial
and construction loans. Westernbank International operates as an IBE under the International Banking Regulatory Act.
Westernbank Internationals business activities consist of commercial banking and related
services, and treasury and investment activities outside of Puerto Rico. As of December 31,
2004, 2003, and 2002, and for the periods then ended, substantially all of Westernbank
Internationals business activities consisted of investment in securities and loans. Loans
outstanding at December 31, 2004, 2003 and 2002 amounted to $122,723,000, $73,581,000 and
$56,833,000, respectively. Intersegment sales and transfers, if any, are accounted for as if the sales or transfers were
to third parties, that is, at current market prices. The accounting policies of the segments
are the same as those described in the summary of significant accounting policies. 117




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##### Table of Contents



The financial information presented below was derived from the internal management
accounting system and does not necessarily represent each segments financial condition and
results of operations as if these were independent entities. As of and for the year endedDecember 31, 2004Puerto Rico
    
    
    International
    
    
    Total major segments
    
    
    Other Segments
    
    
    Eliminations
    
    
    Total(In thousands)Interest income:Consumer loans
    
    $
    76,091
    
    
    $
    
    
    
    $
    76,091
    
    
    $
    
    
    
    $
    
    
    
    $
    76,091Commercial loans
    
    
    151,610
    
    
    
    5,508
    
    
    
    157,118
    
    
    
    
    
    
    
    
    
    
    
    157,118Asset-based loans
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    42,158
    
    
    
    
    
    
    
    42,158Mortgage loans
    
    
    46,796
    
    
    
    
    
    
    
    46,796
    
    
    
    
    
    
    
    
    
    
    
    46,796Treasury and investment activities
    
    
    167,093
    
    
    
    101,799
    
    
    
    268,892
    
    
    
    2,391
    
    
    
    (2,070
    )
    
    
    269,213Total interest income
    
    
    441,590
    
    
    
    107,307
    
    
    
    548,897
    
    
    
    44,549
    
    
    
    (2,070
    )
    
    
    591,376Interest expense
    
    
    226,743
    
    
    
    51,202
    
    
    
    277,945
    
    
    
    15,967
    
    
    
    (2,070
    )
    
    
    291,842Net interest income
    
    
    214,847
    
    
    
    56,105
    
    
    
    270,952
    
    
    
    28,582
    
    
    
    
    
    
    
    299,534Provision for loan losses
    
    
    (30,697
    )
    
    
    
    
    
    
    (30,697
    )
    
    
    (5,994
    )
    
    
    
    
    
    
    (36,691
    )Noninterest income, net:Service and other charges on loans
    
    
    7,115
    
    
    
    112
    
    
    
    7,227
    
    
    
    
    
    
    
    
    
    
    
    7,227Service charges on deposit accounts
    
    
    7,969
    
    
    
    
    
    
    
    7,969
    
    
    
    
    
    
    
    
    
    
    
    7,969Other fees
and commissions
    
    
    7,385
    
    
    
    10
    
    
    
    7,395
    
    
    
    226
    
    
    
    (226
    )
    
    
    7,395Trust account fees
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,170
    
    
    
    
    
    
    
    1,170Insurance commission fees
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,923
    
    
    
    (9
    )
    
    
    1,914Asset-based lending related fees
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,936
    
    
    
    
    
    
    
    2,936Other
    
    
    2,622
    
    
    
    
    
    
    
    2,622
    
    
    
    
    
    
    
    
    
    
    
    2,622Total noninterest income, net
    
    
    25,091
    
    
    
    122
    
    
    
    25,213
    
    
    
    6,255
    
    
    
    (235
    )
    
    
    31,233Equity in income (loss) of subsidiaries
    
    
    (698
    )
    
    
    
    
    
    
    (698
    )
    
    
    174,002
    
    
    
    (173,304
    )
    
    
    Total net interest income and noninterest income
    
    $
    208,543
    
    
    $
    56,227
    
    
    $
    264,770
    
    
    $
    202,845
    
    
    $
    (173,539
    )
    
    $
    294,076Total assets
    
    $
    11,814,402
    
    
    $
    2,938,374
    
    
    $
    14,752,776
    
    
    $
    1,561,795
    
    
    $
    (1,977,909
    )
    
    $
    14,336,662
 As of and for the year endedDecember 31, 2003Puerto Rico
    
    
    International
    
    
    Total major segments
    
    
    Other Segments
    
    
    Eliminations
    
    
    Total(In thousands)Interest income:Consumer loans
    
    $
    74,562
    
    
    $
    
    
    
    $
    74,562
    
    
    $
    
    
    
    $
    
    
    
    $
    74,562Commercial loans
    
    
    117,132
    
    
    
    4,250
    
    
    
    121,382
    
    
    
    
    
    
    
    
    
    
    
    121,382Asset-based loans
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    33,652
    
    
    
    
    
    
    
    33,652Mortgage loans
    
    
    46,253
    
    
    
    
    
    
    
    46,253
    
    
    
    
    
    
    
    
    
    
    
    46,253Treasury and investment activities
    
    
    95,269
    
    
    
    90,090
    
    
    
    185,359
    
    
    
    2,378
    
    
    
    (1,692
    )
    
    
    186,045Total interest income
    
    
    333,216
    
    
    
    94,340
    
    
    
    427,556
    
    
    
    36,030
    
    
    
    (1,692
    )
    
    
    461,894Interest expense
    
    
    170,303
    
    
    
    43,703
    
    
    
    214,006
    
    
    
    10,272
    
    
    
    (1,692
    )
    
    
    222,586Net interest income
    
    
    162,913
    
    
    
    50,637
    
    
    
    213,550
    
    
    
    25,758
    
    
    
    
    
    
    
    239,308Provision for loan losses
    
    
    (24,961
    )
    
    
    
    
    
    
    (24,961
    )
    
    
    (2,087
    )
    
    
    
    
    
    
    (27,048
    )Noninterest income (loss), net:Service and other charges on loans
    
    
    7,474
    
    
    
    470
    
    
    
    7,944
    
    
    
    
    
    
    
    
    
    
    
    7,944Service charges on deposit accounts
    
    
    7,053
    
    
    
    
    
    
    
    7,053
    
    
    
    
    
    
    
    
    
    
    
    7,053Other fees and commissions
    
    
    6,952
    
    
    
    11
    
    
    
    6,963
    
    
    
    221
    
    
    
    (221
    )
    
    
    6,963Trust account fees
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    933
    
    
    
    
    
    
    
    933Insurance commission fees
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,087
    
    
    
    
    
    
    
    2,087Asset-based lending related fees
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,851
    
    
    
    
    
    
    
    2,851Other
    
    
    (20,608
    )
    
    
    (577
    )
    
    
    (21,185
    )
    
    
    
    
    
    
    
    
    
    
    (21,185
    )Total noninterest income (loss), net
    
    
    871
    
    
    
    (96
    )
    
    
    775
    
    
    
    6,092
    
    
    
    (221
    )
    
    
    6,646Equity in income of subsidiaries
    
    
    380
    
    
    
    
    
    
    
    380
    
    
    
    114,756
    
    
    
    (115,136
    )
    
    
    Total net interest income and noninterest income
    
    $
    139,203
    
    
    $
    50,541
    
    
    $
    189,744
    
    
    $
    144,519
    
    
    $
    (115,357
    )
    
    $
    218,906Total assets
    
    $
    9,252,118
    
    
    $
    2,769,292
    
    
    $
    12,021,410
    
    
    $
    1,791,343
    
    
    $
    (2,293,313
    )
    
    $
    11,519,440
 118




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##### Table of Contents



As of and for the year endedDecember 31, 2002Puerto Rico
    
    
    International
    
    
    Total major segments
    
    
    Other Segments
    
    
    Eliminations
    
    
    Total(In thousands)Interest income:Consumer loans
    
    $
    52,818
    
    
    $
    
    
    
    $
    52,818
    
    
    $
    
    
    
    $
    
    
    
    $
    52,818Commercial loans
    
    
    100,328
    
    
    
    2,615
    
    
    
    102,943
    
    
    
    
    
    
    
    
    
    
    
    102,943Asset-based loans
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    15,800
    
    
    
    
    
    
    
    15,800Mortgage loans
    
    
    49,114
    
    
    
    
    
    
    
    49,114
    
    
    
    
    
    
    
    
    
    
    
    49,114Treasury and investment activities
    
    
    66,485
    
    
    
    97,821
    
    
    
    164,306
    
    
    
    1,875
    
    
    
    (1,122
    )
    
    
    165,059Total interest income
    
    
    268,745
    
    
    
    100,436
    
    
    
    369,181
    
    
    
    17,675
    
    
    
    (1,122
    )
    
    
    385,734Interest expense
    
    
    161,948
    
    
    
    51,914
    
    
    
    213,862
    
    
    
    6,673
    
    
    
    (1,122
    )
    
    
    219,413Net interest income
    
    
    106,797
    
    
    
    48,522
    
    
    
    155,319
    
    
    
    11,002
    
    
    
    
    
    
    
    166,321Provision for loan losses
    
    
    (13,179
    )
    
    
    
    
    
    
    (13,179
    )
    
    
    (1,904
    )
    
    
    
    
    
    
    (15,083
    )Noninterest income, net:Service and other charges on loans
    
    
    6,807
    
    
    
    31
    
    
    
    6,838
    
    
    
    
    
    
    
    
    
    
    
    6,838Service charges on deposit accounts
    
    
    6,652
    
    
    
    
    
    
    
    6,652
    
    
    
    
    
    
    
    
    
    
    
    6,652Other fees and commissions
    
    
    5,218
    
    
    
    207
    
    
    
    5,425
    
    
    
    199
    
    
    
    (199
    )
    
    
    5,425Trust account fees
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    604
    
    
    
    
    
    
    
    604Insurance commission fees
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,414
    
    
    
    
    
    
    
    1,414Asset-based lending related fees
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,572
    
    
    
    
    
    
    
    1,572Other
    
    
    1,805
    
    
    
    433
    
    
    
    2,238
    
    
    
    
    
    
    
    
    
    
    
    2,238Total noninterest income, net
    
    
    20,482
    
    
    
    671
    
    
    
    21,153
    
    
    
    3,789
    
    
    
    (199
    )
    
    
    24,743Equity in income of subsidiaries
    
    
    217
    
    
    
    
    
    
    
    217
    
    
    
    86,048
    
    
    
    (86,265
    )
    
    
    Total net interest income and noninterest income
    
    $
    114,317
    
    
    $
    49,193
    
    
    $
    163,510
    
    
    $
    98,935
    
    
    $
    (86,464
    )
    
    $
    175,981Total assets
    
    $
    6,649,595
    
    
    $
    2,083,259
    
    
    $
    8,732,854
    
    
    $
    1,292,391
    
    
    $
    (1,820,168
    )
    
    $
    8,205,077
 119




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##### Table of Contents



24. CONDENSED FINANCIAL STATEMENTS OF PARENT COMPANY: Condensed
financial information pertaining only to W Holding Company, Inc. is as follows:  CONDENSED STATEMENTS OF FINANCIAL CONDITION
(PARENT COMPANY ONLY)
 December 31,2004
    
    
    2003(In thousands)ASSETSCash
    
    $
    2,356
    
    
    $
    1,803Money market
instruments
    
    
    129,000
    
    
    
    Dividends and other accounts receivable
from bank subsidiary
    
    
    3,012
    
    
    
    1,539Investment security held to maturity
    
    
    5,570
    
    
    
    5,569Investment in bank subsidiary
    
    
    943,320
    
    
    
    820,282Investment in nonbank subsidiary
    
    
    2,214
    
    
    
    2,089Accrued interest receivable
    
    
    77
    
    
    
    70Other assets
    
    
    6
    
    
    
    43TOTAL ASSETS
    
    $
    1,085,555
    
    
    $
    831,395LIABILITIES AND
STOCKHOLDERS EQUITYLiabilities:Dividends payable
    
    $
    3,300
    
    
    $
    2,737Other liabilities
    
    
    576
    
    
    
    149Total Liabilities
    
    
    3,876
    
    
    
    2,886Stockholders equity
    
    
    1,081,679
    
    
    
    828,509TOTAL LIABILITIES AND
STOCKHOLDERS EQUITY
    
    $
    1,085,555
    
    
    $
    831,395
 CONDENSED STATEMENTS OF INCOME
(PARENT COMPANY ONLY)
 Years EndedDecember 31,2004
    
    
    2003
    
    
    2002(In thousands)Dividends from subsidiaries:Bank subsidiary
    
    $
    50,660
    
    
    $
    26,925
    
    
    $
    27,820Nonbank subsidiary
    
    
    900
    
    
    
    1,500
    
    
    
    Subtotal
    
    
    51,560
    
    
    
    28,425
    
    
    
    27,820Interest income on investment security
    
    
    302
    
    
    
    686
    
    
    
    752Total income
    
    
    51,862
    
    
    
    29,111
    
    
    
    28,572Operating expenses
    
    
    2,405
    
    
    
    2,110
    
    
    
    842Income before income taxes and increase
in undistributed earnings of subsidiaries
    
    
    49,457
    
    
    
    27,001
    
    
    
    27,730Provision
(credit) for income taxes - current
    
    
    34
    
    
    
    18
    
    
    
    (4
    )Income before increase in undistributed
earnings of subsidiaries
    
    
    49,423
    
    
    
    26,983
    
    
    
    27,734Increase in undistributed earnings from :Bank subsidiary
    
    
    122,317
    
    
    
    85,217
    
    
    
    57,527Nonbank subsidiary
    
    
    125
    
    
    
    1,114
    
    
    
    702Net income
    
    $
    171,865
    
    
    $
    113,314
    
    
    $
    85,963
 120




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##### Table of Contents



CONDENSED STATEMENTS OF CASH FLOWS
(PARENT COMPANY ONLY)
 Year EndedDecember 31,2004
    
    
    2003
    
    
    2002(In thousands)Cash flows from operating activities:Net income
    
    $
    171,865
    
    
    $
    113,314
    
    
    $
    85,963Adjustments to reconcile net income
to net cash provided by operating activities:Increase in undistributed earnings
of subsidiaries
    
    
    (122,442
    )
    
    
    (86,331
    )
    
    
    (58,229
    )Effect of stock options granted to employees
    
    
    895
    
    
    
    1,031
    
    
    
    Amortization of premium (discount) on
investment securities held to maturity
    
    
    (1
    )
    
    
    138
    
    
    
    Decrease (increase) in dividends and other accounts
receivable from bank subsidiary
    
    
    (491
    )
    
    
    (983
    )
    
    
    14,973Decrease (increase) in other assets
    
    
    37
    
    
    
    (43
    )
    
    
    Increase (decrease) in other liabilities
    
    
    323
    
    
    
    (41
    )
    
    
    678Net cash provided by operating activities
    
    
    50,186
    
    
    
    27,085
    
    
    
    43,385Cash flows from investing activities:Net decrease (increase) in money market instruments
    
    
    (129,000
    )
    
    
    1,000
    
    
    
    (1,000
    )Investment securities available for sale:Purchases
    
    
    
    
    
    
    
    
    
    
    (30,000
    )Maturities
    
    
    
    
    
    
    
    
    
    
    30,000Capital contributions to subsidiaries
    
    
    
    
    
    
    (166,113
    )
    
    
    (139,338
    )Investment securities held to maturity:Purchases
    
    
    
    
    
    
    (10,867
    )
    
    
    (15,755
    )Proceeds from redemptions and repayment
    
    
    
    
    
    
    19,368
    
    
    
    994Net cash used in investing activities
    
    
    (129,000
    )
    
    
    (156,612
    )
    
    
    (155,099
    )Cash flows from financing activities:Advances from bank subsidiary
    
    
    
    
    
    
    1,000
    
    
    
    Repayment of advances from bank subsidiary
    
    
    (1,000
    )
    
    
    
    
    
    
    Issuance of stocks
    
    
    129,495
    
    
    
    165,863
    
    
    
    139,338Repurchase of common stock for retirement
    
    
    
    
    
    
    (33
    )
    
    
    (42
    )Stock options exercised
    
    
    969
    
    
    
    3,334
    
    
    
    Dividends paid
    
    
    (50,097
    )
    
    
    (39,109
    )
    
    
    (27,308
    )Net cash provided by financing activities
    
    
    79,367
    
    
    
    131,055
    
    
    
    111,988Net increase in cash
    
    
    553
    
    
    
    1,528
    
    
    
    274Cash at beginning of year
    
    
    1,803
    
    
    
    275
    
    
    
    1Cash at end of year
    
    $
    2,356
    
    
    $
    1,803
    
    
    $
    275
 121




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25. SUBSEQUENT EVENTS: On January 3, 2005, the Company issued 401,300 shares of its 2004 Series H preferred stock
over-allotment option to the underwriter. The preferred shares were issued at a price of
$50.00 per share. Proceeds from the issuance of the 2004 Series H preferred stock amounted to
$19,433,000, net of $632,000 of issuance costs. On February 10, 2005, one of the Companys executive officer exercised 35,113 options under
the Companys 1999 Qualified Option Plan (See Note 17) at an exercise price of $2.85. ****** 122




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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. 
 ITEM 9A. CONTROLS AND PROCEDURES The Company maintains disclosure controls and procedures that are designed to ensure that
information required to be disclosed in the Companys Securities Exchange Act of 1934 (Exchange
Act) reports is recorded, processed, summarized and reported within the time periods specified in
the Securities and Exchange Commissions rules and forms, and that such information is accumulated
and communicated to the Companys Management, including its Chief Executive Officer and Chief
Financial Officer, as appropriate, to allow timely decisions regarding required disclosure based
closely on the definition of disclosure controls and procedures in Exchange Act Rules 13a-15(e)
and 15d-15(e). In designing and evaluating the disclosure controls and procedures, management
recognized that any controls and procedures, no matter how well designed and operated, can provide
only reasonable assurance of achieving the desired control objectives, and management necessarily
was required to apply its judgment in evaluating the cost-benefit relationship of possible controls
and procedures. As of the end of the period covered by this report, the Company carried out an evaluation,
under the supervision and with the participation of the Companys Management, including the
Companys Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design
and operation of the Companys disclosure controls and procedures. Based on the foregoing, the
Companys Chief Executive Officer and Chief Financial Officer concluded that the Companys
disclosure controls and procedures were effective, in all material respects, to ensure that
information required to be disclosed in the reports the Company files and submits under the
Exchange Act is recorded, processed, summarized and reported as and when required. The Companys Management also conducted an evaluation of internal control over financial
reporting to determine whether any changes occurred during the year covered by this report that
have materially affected, or are reasonably likely to materially affect, the Companys internal
control over financial reporting. Based on this evaluation, there has been no such change during
the year covered by this report. MANAGEMENTS ASSESSMENT AS TO THE EFFECTIVENESS OF INTERNAL CONTROL OVER FINANCIAL REPORTING The Management of W Holding Company, Inc. is responsible for establishing and maintaining
adequate internal control, 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. Internal control over financial reporting of W
Holding Company, Inc. and subsidiaries (the Company) includes those policies and procedures that:
(1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect
the transactions 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. All internal control systems, no matter how well designed, have inherent limitations,
including the possibility of human error and the circumvention of overriding controls. Accordingly,
even effective internal control can provide only reasonable assurance with respect to financial
statement preparation. Further, because of changes in conditions, the effectiveness of internal
control may vary over time. 123




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The Companys Management assessed the effectiveness of the Companys internal control over
financial reporting as of December 31, 2004 as required by Section 404 of the Sarbanes Oxley Act of
2002. Managements assessment is based on the criteria established in the Internal Control
Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission
and was designed to provide reasonable assurance that the Company maintained effective internal
control over financial reporting as of December 31, 2004. Based on this assessment, Management
believes that the Company maintained effective internal control over financial reporting as of
December 31, 2004. The Companys independent registered public accounting firm, that audited the Companys
consolidated financial statements included in this annual report, has issued an attestation report
on our internal control over financial reporting as of December 31, 2004 and the Company
Managements assessment of the internal control over financial reporting. This report appears
below. /s/ Frank C. Stipes
Chairman of the Board, Chief Executive Officer and President /s/ Freddy Maldonado
Chief Financial Officer and Vice President of Finance and Investment March 11, 2005 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Stockholders of
W Holding Company, Inc.
Mayagüez, Puerto Rico We have audited managements assessment, included in the accompanying Managements Assessment as to
the Effectiveness of Internal Control Over Financial Reporting, that W Holding Company, Inc. and
subsidiaries (the Company) maintained effective internal control over financial reporting as of
December 31, 2004, based on criteria established in Internal ControlIntegrated Frameworkissued by
the Committee of Sponsoring Organizations of the Treadway Commission. The Company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. Our responsibility
is to express an opinion on managements assessment and an opinion on the effectiveness of the
Company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, evaluating managements assessment, testing, and evaluating the
design and operating effectiveness of internal control, and performing such other procedures as we
considered necessary in the circumstances. We believe that our audit provides a reasonable basis
for our opinions. A companys internal control over financial reporting is a process designed by, or under the
supervision of, the companys principal executive and principal financial officers, or persons
performing similar functions, and effected by the companys board of directors, management, and
other personnel 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. Because of the inherent limitations of internal control over financial reporting, including the
possibility of collusion or improper management override of controls, material misstatements due to
error or fraud may not be prevented or detected on a timely basis. Also, projections of any
evaluation of the effectiveness of the internal control over financial reporting to future periods
are subject to the risk that the controls may become inadequate because of changes in conditions,
or that the degree of compliance with the policies or procedures may deteriorate. 124




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In our opinion, managements assessment that the Company maintained effective internal control over
financial reporting as of December 31, 2004, is fairly stated, in all material respects, based on
the criteria established in Internal ControlIntegrated Frameworkissued by the Committee of
Sponsoring Organizations of the Treadway Commission. Also, in our opinion, the Company maintained,
in all material respects, effective internal control over financial reporting as of December 31,
2004, based on the criteria established in Internal ControlIntegrated Frameworkissued by the
Committee of Sponsoring Organizations of the Treadway Commission. We have also audited, in accordance with the standards of the Public Company Accounting Oversight
Board (United States), the consolidated statements of financial condition as of December 31, 2004
and 2003, and the related consolidated statements of income, changes in stockholders equity and of
comprehensive income, and cash flows for each of the three years in the period ended December 31,
2004 of the Company and our report dated March 11, 2005 expressed an unqualified opinion on those
financial statements. /s/ Deloitte & Touche LLP
San Juan, Puerto Rico
March 11, 2005 Stamp No. 2018226
affixed to original. 
 ITEM 9B. OTHER INFORMATION Not applicable. 
 PART III 
 ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Information responsive to this Item 10 is incorporated herein by reference to the Companys
definite proxy statement for its 2005 annual meeting of shareholders. The Company has adopted a charter for each of the standing committees and corporate governance
guidelines that address make-up and functioning of the Board. The Board has also adopted a code of
conduct that applies to all of our employees, officers and Directors. You can find links to these
materials on our website at www.wholding.com. On June 15, 2004, the Company filed its Section 303A Annual Written Affirmation form with the
New York Stock Exchange. 
 ITEM 11. EXECUTIVE COMPENSATION Information responsive to this Item 11 is incorporated herein by reference to the Companys
definitive proxy statement for its 2005 annual meeting of shareholders. 
 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Information responsive to this Item 12 is incorporated herein by reference to the Companys
definitive proxy statement for its 2005 annual meeting of shareholders. 
 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Information responsive to this Item 13 is incorporated herein by reference to the Companys
definitive proxy statement for its 2005 annual meeting of shareholders. 125




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ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES Information responsive to this Item 14 is incorporated herein by reference to the Companys
definitive proxy statement for its 2005 annual meeting of shareholders. 
 PART IV 
 ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES (a) Documents filed as part of this Report  (1)
    Index to financial statementsThe following financial statements are incorporated by reference from Item 8 hereof:  
    Report of Independent Registered Public Accounting Firm
    Consolidated Statements of Financial Condition as of December 31, 2004 and 2003
    Consolidated Statements of Income for each of
the three years in the period ended December 31, 2004
    Consolidated Statements of Changes in
Stockholders Equity and of Comprehensive Income for each of the three
years in the period ended December 31, 2004
    Consolidated Statements of Cash Flows for
each of the three years in the period ended December 31, 2004
    Notes to Consolidated Financial Statements  (2)
    Financial Statement SchedulesThe schedules for the Company and its subsidiaries are
omitted because of the absence of conditions under which they are
required, or because the information is set forth in the consolidated
financial statements or the notes thereto.(3)
    ExhibitsThe following exhibits are filed as part of this
Form 10-K, and this list includes the Exhibit Index. NO.
    
    EXHIBIT3.1
    
    Articles of Incorporation (incorporated by reference herein to Exhibit 3.1 to the
Companys Registration Statement on Form S-4, File
No. 333-76975).3.2
    
    Bylaws (incorporated by reference herein to Exhibit 4 to the Companys Registration Statement
on Form 8-A, filed on November 29, 2001).4.1
    
    Certificate of Resolution establishing the rights of the Series B Preferred Stock
(incorporated by reference to Exhibit 3.1.1 to the Registrants Registration Statement on Form
S-4, Reg. No. 333-76975)).4.2
    
    Certificate of Resolution establishing the rights of the Series C Preferred Stock
(incorporated by reference to Exhibit 4.2 to the Registrants Current Report on Form 8-K as
filed on March 30, 2001).4.3
    
    Certificate of Resolution establishing the rights of the Series D Preferred Stock
(incorporated by reference to Exhibit 4.2 to the Registrants Current Report on Form 8-K as
filed on August 1, 2001).4.4
    
    Certificate of Resolution establishing the rights of the Series E Preferred Stock
(incorporated herein by reference as Exhibit 4.2 to the Registrants Current Report on Form
8-K, as filed on October 31, 2002).4.5
    
    Certificate of Corporate Resolution establishing the rights of the Series F Preferred Stock
(incorporated herein by reference as Exhibit 4.1 to the Registrants Current Report on Form
8-K, as filed on May 29, 2003).4.6
    
    Certificate of Corporate Resolution establishing the rights of the Series G Preferred Stock
(incorporated herein by reference as Exhibit 4.1 to the Registrants Current Report on Form
8-K, as filed on August 28, 2003).4.7
    
    Certificate of Corporate Resolution designating the terms of W Holdings Series H Preferred
Stock (incorporated by reference to Exhibit 4.1 to the Registrants Current Report on Form
8-K, as filed on December 17, 2004).10.1
    
    Form of 1999 Qualified Stock Option Plan (incorporated by reference herein to Exhibit 10.1 to
the Companys Registration Statement on Form S-4, File No. 333-76975).10.2
    
    Form of 1999 Nonqualified Stock Option Plan (incorporated by reference herein to Exhibit 10.2
to the Companys Registration Statement on Form S-4, File
No. 333-76975).10.3
    
    Payment Agreement in the Event of a Change in Control between Westernbank Puerto Rico and Mr.
Alfredo Archilla (incorporated by reference herein to
Exhibit 10.4 to the Companys Form 10-K for the year
ended December 31, 2001, filed on March 29, 2002).10.4
    
    Payment Agreement in the Event of a Change in Control between Westernbank Puerto Rico and Mr.
Mike Vazquez (incorporated by reference herein to Exhibit 10.3 to the Companys Form 10-K for the year ended
December 31, 2001, filed on March 29, 2002).10.5
    
    Employment agreement between Westernbank Puerto Rico and Mrs. Migdalia Rivera (incorporated
by reference herein to Exhibit 10.3 to the Companys Form 10-K for the year ended December 31, 2002, filed on
March 31, 2003).
 10.6
    
    Payment Agreement in the Event of a Change in Control between Westernbank Puerto Rico and Mr.
Andres Morgado (incorporated by reference herein to Exhibit 10.6 to the Companys Form 10-K for the year ended
December 31, 2002, filed on March 31, 2003).10.7
    
    Payment Agreement in the Event of a Change in Control between Westernbank Puerto Rico and Mr.
William Vidal (incorporated by reference herein to Exhibit 10.7 to the Companys Form 10-K for the year ended
December 31, 2002, filed on March 31, 2003).10.8
    
    Payment Agreement in the Event of a Change in Control between Westernbank Puerto Rico and Mr.
Ricardo Hernandez (incorporated by reference herein to Exhibit 10.8 to the Companys Form 10-K for the year
ended December 31, 2002, filed on March 31, 2003).10.9
    
    Payment Agreement in the Event of a Change in Control between Westernbank Puerto Rico and Mr.
Pedro Dominguez (incorporated by reference herein to Exhibit 10.9 to the Companys Form 10-K for the year
ended December 31, 2002, filed on March 31, 2003).10.10
    
    Payment Agreement in the Event of a Change in Control between Westernbank Puerto Rico and
Mr. Freddy Maldonado (incorporated by reference herein to Exhibit 10.10 to the Companys Form 10-K for the year
ended December 31, 2002, filed on March 31, 2003).10.11
    
    Description of Arrangement for Director Fees10.12
    
    Executive Officers Compensation Schedule21.1
    
    Subsidiaries of the Registrant23.1
    
    Consent of Independent Registered Public Accounting Firm31.1
    
    CEO Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.31.2
    
    CFO Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.32.1
    
    CEO Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to the
Sarbanes-Oxley Act of 2002.32.2
    
    CFO Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to the
Sarbanes-Oxley Act of 2002.
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##### Table of Contents



SIGNATURES Pursuant to the requirements of Section 13 of the Securities Exchange Act of 1934 the
registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized. W Holding Company, Inc.By: /s/ FRANK C. STIPESDate: March 16, 2005Frank C. Stipes, Chairman of theBoard, Chief Executive Officerand President
 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been
signed by the following persons on behalf of the registrant and in the capacities and on the dates
indicated. /s/ FRANK C. STIPESFrank C. Stipes,Chairman of the Board,
    
    Date: March 16, 2005Chief Executive Officer and President/s/ CESAR A. RUIZCesar A. Ruiz, Director
    
    Date: March 16, 2005/s/ PEDRO R. DOMINGUEZPedro R. Dominguez,Director
    
    Date: March 16, 2005/s/ CORNELIUS TAMBOERCornelius Tamboer,Director
    
    Date: March 16, 2005/s/ FREDESWINDA G. FRONTERAFredeswinda G. Frontera,Directress
    
    Date: March 16, 2005/s/ HECTOR L. DEL RIOHector L. del Rio,Director
    
    Date: March 16, 2005/s/ JUAN C. FRONTERAJuan C. Frontera,Director
    
    Date: March 16, 2005/s/ FREDDY MALDONADOFreddy Maldonado
    
    Date: March 16, 2005Chief Financial Officer and VicePresident of Finance and Investment
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##### Table of Contents



EXHIBIT INDEX NO.
    
    EXHIBIT3.1
    
    
    Articles of Incorporation (incorporated by reference herein to Exhibit
3.1 to the Companys Registration Statement on Form S-4, File No.
333-76975).3.2
    
    
    Bylaws (incorporated by reference herein to Exhibit 4 to the Companys
Registration Statement on Form 8-A, filed on November 29,
2001).4.1
    
    
    Certificate of Resolution establishing the rights of the Series B
Preferred Stock (incorporated by reference to Exhibit 3.1.1 to the
Registrants Registration Statement on Form S-4, Reg.
No. 333-76975).4.2
    
    
    Certificate of Resolution establishing the rights of the Series C
Preferred Stock (incorporated by reference to Exhibit 4.2 to the
Registrants Current Report on Form 8-K as filed on
March 30, 2001).4.3
    
    
    Certificate of Resolution establishing the rights of the Series D
Preferred Stock (incorporated by reference to Exhibit 4.2 to the
Registrants Current Report on Form 8-K as filed on
August 1, 2001).4.4
    
    
    Certificate of Resolution establishing the rights of the Series E
Preferred Stock (incorporated herein by reference as Exhibit 4.2 to the
Registrants Current Report on Form 8-K, as filed on
October 31, 2002).4.5
    
    
    Certificate of Corporate Resolution establishing the rights of the
Series F Preferred Stock (incorporated herein by reference as Exhibit
4.1 to the Registrants Current Report on Form 8-K, as
filed on May 29,
2003).4.6
    
    
    Certificate of Corporate Resolution establishing the rights of the
Series G Preferred Stock (incorporated herein by reference as Exhibit
4.1 to the Registrants Current Report on Form 8-K, as filed on August
28, 2003).4.7
    
    
    Certificate of Corporate Resolution designating the terms of W
Holdings Series H Preferred Stock (incorporated by reference to
Exhibit 4.1 to the Registrants Current Report on
Form 8-K, as filed on
December 17, 2004).10.1
    
    
    Form of 1999 Qualified Stock Option Plan (incorporated by reference
herein to Exhibit 10.1 to the Companys Registration Statement on Form
S-4, File No. 333-76975).10.2
    
    
    Form of 1999 Nonqualified Stock Option Plan (incorporated by reference
herein to Exhibit 10.2 to the Companys Registration Statement on Form
S-4, File No. 333-76975).10.3
    
    
    Payment Agreement in the Event of a Change in Control between
Westernbank Puerto Rico and Mr. Alfredo Archilla (incorporated by
reference herein to Exhibit 10.4 to the Companys Form 10-K for the year ended December
31, 2001, filed on March 29, 2002).10.4
    
    
    Payment Agreement in the Event of a Change in Control between
Westernbank Puerto Rico and Mr. Mike Vazquez (incorporated by reference
herein to Exhibit 10.3 to the Companys Form 10-K for the year ended December 31, 2001,
filed on March 29, 2002).10.5
    
    
    Employment agreement between Westernbank Puerto Rico and Mrs. Migdalia
Rivera (incorporated by reference herein to Exhibit 10.3 to the Companys Form 10-K for
the year ended December 31, 2002, filed on March 31, 2003).10.6
    
    
    Payment Agreement in the Event of a Change in Control between
Westernbank Puerto Rico and Mr. Andres Morgado (incorporated by
reference herein to Exhibit 10.6 to the Companys Form 10-K for the year ended December
31, 2002, filed on March 31, 2003).10.7
    
    
    Payment Agreement in the Event of a Change in Control between
Westernbank Puerto Rico and Mr. William Vidal (incorporated by
reference herein to Exhibit 10.7 to the Companys Form 10-K for the year ended December
31, 2002, filed on March 31, 2003).10.8
    
    
    Payment Agreement in the Event of a Change in Control between
Westernbank Puerto Rico and Mr. Ricardo Hernandez (incorporated by
reference herein to Exhibit 10.8 to the Companys Form 10-K for the year ended December
31, 2002, filed on March 31, 2003).10.9
    
    
    Payment Agreement in the Event of a Change in Control between
Westernbank Puerto Rico and Mr. Pedro Dominguez (incorporated by
reference herein to Exhibit 10.9 to the Companys Form 10-K for the year ended December
31, 2002, filed on March 31, 2003).10.10
    
    
    Payment Agreement in the Event of a Change in Control between
Westernbank Puerto Rico and Mr. Freddy Maldonado (incorporated by
reference herein to Exhibit 10.10 to the Companys Form 10-K for the year ended December
31, 2002, filed on March 31, 2003).10.11
    
    
    Description of Arrangement for Director Fees10.12
    
    

Executive
Officers Compensation Schedule21.1
    
    
    Subsidiaries of the Registrant23.1
    
    
    Consent of Independent Registered Public Accounting Firm31.1
    
    
    CEO Certification pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.31.2
    
    
    CFO Certification pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.32.1
    
    
    CEO Certification pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to the Sarbanes-Oxley Act of 2002.32.2
    
    
    CFO Certification pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to the Sarbanes-Oxley Act of 2002.
 128