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  **UNITED STATES SECURITIES AND EXCHANGE COMMISSION****Washington, D.C. 20549** **FORM 10-K**   þ **ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934****For the Fiscal Year Ended December 31, 2006****Or**   o **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF1934****Commission File No. 000-27377****W HOLDING COMPANY, INC.**(Exact name of registrant as specified in its charter)   **Commonwealth of Puerto Rico** **66-0573197**(State or Other Jurisdiction of (IRS EmployerIncorporation or Organization) Identification No.)   **19 West McKinley Street, Mayagüez, Puerto Rico** **00681**(Address of Principal Executive Offices) (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)** **New York Stock Exchange**(Title of Each Class) (Name of Each Exchange in Which Registered)Securities registered pursuant to Section 12 (g) of the Act:(Title of Each Class)7.125% Noncumulative, Convertible Monthly Income Preferred Stock, 1998 Series A ($1.00 Par Value per Share)7.25% Noncumulative, Non-Convertible Monthly Income Preferred Stock, 1999 Series B ($1.00 Par Value per Share)7.60% Noncumulative, Non-Convertible Monthly Income Preferred Stock, 2001 Series C ($1.00 Par Value per Share)7.40% Noncumulative, Non-Convertible Monthly Income Preferred Stock, 2001 Series D ($1.00 Par Value per Share)6.875% Noncumulative, Non-Convertible Monthly Income Preferred Stock, 2002 Series E ($1.00 Par Value per Share)6.70% Noncumulative, Non-Convertible Monthly Income Preferred Stock, 2003 Series F ($1.00 Par Value per Share)6.90% Noncumulative, Non-Convertible Monthly Income Preferred Stock, 2003 Series G ($1.00 Par Value per Share)6.70% Noncumulative, Non-Convertible Monthly Income Preferred Stock, 2004 Series H ($1.00 Par Value per Share)Indicate by check mark if the registrant is a well known seasoned issuer, as defined in Rule 405 ofthe Securities Act. Yes o No þIndicate by check mark if the registrant is not required to file reports pursuant to Section 13 or15(d) of the Act. Yes o No þIndicate by check mark whether the registrant (1) has filed all reports required by Section 13 or15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorterperiod that the registrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days. Yes þ No oIndicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K(§229.405 of this chapter) is not contained herein, and will not be contained, to the best ofregistrant’s knowledge, in definitive proxy or information statements incorporated by reference inPart III of this Form 10-K or any amendment to this Form 10-K. oIndicate by check mark whether the registrant is a large accelerated filer, an accelerated filer,or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” inRule 12b-2 of the Exchange Act. (Check one):Large Accelerated Filer þ      Accelerated Filer o       Non-Accelerated Filer oIndicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).Yes o No þThe aggregate market value of the voting and non-voting stock held by nonaffiliates of theregistrant as of June 30, 2006, was $1,093,827,185 based upon the reported closing price of $6.65on the New York Stock Exchange as of June 30, 2006.Number of shares of Common Stock outstanding as of January 31, 2007: 164,772,600**DOCUMENTS INCORPORATED BY REFERENCE**Portions of the definitive Proxy Statement for the Registrant’s 2007 Annual Meeting of Shareholdersexpected to be held on May 10, 2007 are incorporated by reference into Part III, Items 10, 11, 12, 13 and 14of this Form 10-K.  
 

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PART IITEM 1. BUSINESSITEM 1A. RISK FACTORSITEM 1B. UNRESOLVED STAFF COMMENTS ITEM 2. PROPERTIESITEM 3. LEGAL PROCEEDINGSITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS PART IIITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIESITEM 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 DATAITEM 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 MANAGEMENT AND RELATED STOCKHOLDER MATTERSITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONSITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICESPART IVITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULESSIGNATURESEXHIBIT INDEXEX-10.13 DESCRIPTION OF ARRANGEMENT FOR DIRECTOR FEESEX-10.14 EXECUTIVE OFFICERS COMPENSATION SCHEDULEEX-10.20 PAYMENT AGREEMENTEX-21.1 SUBSIDIARIES OF THE REGISTRANTEX-23.1 CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMEX-31.1 SECTION 302 CERTIFICATION OF CEOEX-31.2 SECTION 302 CERTIFICATION OF CAOEX-32.1 SECTION 906 CERTIFICATION OF CEOEX-32.2 SECTION 906 CERTIFICATION OF CAO

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FORWARD-LOOKING STATEMENTS     Certain statements in this filing and future filings by the Company, especially withinManagement’s Discussion and Analysis of Financial Condition and Results of Operations, includeforward-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”, “isanticipated”, “estimate”, “project”, “believe” or similar expressions are intended to identifyforward-looking statements. In addition, certain disclosures and information customarily providedby financial institutions, such as analysis of the adequacy of the allowance for loan losses or ananalysis of the interest rate sensitivity of the Company’s assets and liabilities, are inherentlybased upon predictions of future events and circumstances. Although the Company makes suchstatements based on assumptions which it believes to be reasonable, there can be no assurance thatactual results will not differ materially from the Company’s expectations. Important factors whichcould cause its results to differ from any results which might be projected, forecasted orestimated, based on such forward-looking statements include, but are not limited to: (i) generaleconomic and competitive conditions in the markets in which the Company operates, and the risksinherent in its operations; (ii) the Company’s ability to manage its credit risk and control itsoperating expenses, increase interest-earning assets and non-interest income, and maintain its netinterest margin; (iii) fluctuations in interest rate and inflation; and (iv) the level of demandfor new and existing products. Should one or more of these risks or uncertainties materialize,other risks or uncertainties arise, or should underlying assumptions prove incorrect, actualresults may vary materially from those described in the forward-looking statements. Except asrequired by applicable law, the Company does not intend, and specifically disclaims any obligation,to update forward-looking statements.PART IITEM 1. BUSINESSGENERAL     W Holding Company, Inc. (the “Company”) is a financial holding company offering a full rangeof financial services. The business of the Company is conducted primarily through its wholly-ownedcommercial bank subsidiary, Westernbank Puerto Rico (“Westernbank” or the “Bank”). The Company’sother direct subsidiary is Westernbank Insurance Corp. The Company was organized under the laws ofthe 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 southwesternregions of Puerto Rico, focusing on retail banking and emphasizing long-term fixed-rate residentialmortgage loans on one-to-four family residential properties. In 1994, Westernbank changed itscharter to become a full-service commercial bank. Westernbank offers a full range of business andconsumer financial services, including banking, trust and brokerage services. Westernbank InsuranceCorp. is a general insurance agent placing property, casualty, life and disability insurance. Theassets, liabilities, revenues and expenses of Westernbank Insurance Corp. at December 31, 2006 and2005, and for each of the three years in the period ended December 31, 2006, were not significant.     In July 2000, the Company became a financial holding company under the Bank Holding CompanyAct. As a financial holding company, the Company is permitted to engage in financial relatedactivities, including insurance and securities activities, provided that the Company and itsbanking subsidiary meet certain regulatory standards.     At December 31, 2006, the Company had total assets of $17.15 billion, a loan portfolio-net of$8.64 billion, an investment portfolio of $7.03 billion, excluding short-term money marketinstruments of $971.6 million, deposits of $9.34 billion, borrowings of $6.48 billion andstockholders’ equity of $1.23 billion. The Company has improved its efficiency ratio from 40.66% in2002, to 34.94% for the year ended December 31, 2006.     Westernbank is the second largest commercial bank in Puerto Rico, based on total assets atDecember 31, 2006. Westernbank operates through a network of 56 bank branches (including 20Expresso of Westernbank branches) located throughout Puerto Rico, including 33 in the Western andSouthwestern regions, 14 in the San Juan metropolitan area, 7 in the Northeastern region, and 2 inthe Eastern region, and a website on the Internet. Westernbank’s deposits, excluding IndividualRetirement Accounts (IRAs), are insured by the Deposit Insurance Fund (“DIF”), which isadministered by the FDIC, up to $100,000 per depositor. IRAs are insured by DIF up to $250,000 perdepositor. Westernbank traditional banking operations include retail operations, such as itsbranches, including the branches of the Expresso division, together with consumer loans, mortgageloans, commercial loans (excluding the asset-based lending operations), investments (treasury) anddeposit products. Besides the traditional banking operations, Westernbank operates five otherdivisions: 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 BankingCenter Regulatory Act, which offers commercial banking and related services, and treasury andinvestment activities outside of Puerto Rico; Westernbank Business Credit, which specializes incommercial business loans secured principally by commercial real estate, accounts receivable,inventory and equipment; Westernbank Trust Division, which offers a full array of trust services;Expresso of
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Westernbank, a division which specializes in small, unsecured consumer loans up to $15,000 and real estate collateralized consumer loans up to $150,000 andWesternbank International Trade Services, established during the first quarter of year 2006, adivision which specializes in international trade products and services. Westernbank owns 100% ofthe voting shares of Westernbank World Plaza, Inc., which owns and operates Westernbank WorldPlaza; 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 votingshares of SRG Net, Inc., a Puerto Rico corporation that operates an electronic funds transfernetwork. The assets, liabilities, revenues and expenses of SRG Net, Inc. at December 31, 2006 and2005, and for each of the three years in the period ended December 31, 2006, were not significant.Westernbank also owns 100% of the issued and outstanding common stock of Westernbank FinancialCenter Corp. (“WFCC”). WFCC was incorporated under the laws of the State of Florida to carrycommercial lending and other related activities in the United States of America. WFCC commencedoperations in February 2007.     Westernbank seeks to differentiate itself from other banks by focusing on customerrelationships and personalized service, offering customers direct access to senior management. Aspart of this strategy, Westernbank strives to make fast and effective decisions locally.Westernbank’s branches offer modern facilities with advanced technology and remain open tocustomers for longer hours compared to many other local banks, with a number of branches offeringboth Saturday and Sunday hours. In addition, Westernbank trains its employees to promote aneffective and customer-focused sales culture. Westernbank is one of the fastest-growing commercialbanks in Puerto Rico, increasing both total assets and loans at an average annual growth rate ofover 24.58% for the last five fiscal years. The Company has achieved this growth while consistentlymaintaining a combined delinquency ratio on all loan portfolios for the categories of 60 days andover below 1.00%.     The Company continues to emphasize growing Westernbank’s commercial loan portfolio throughcommercial real estate, asset-based, unsecured business and construction lending. As a result, theCompany’s asset composition is mainly composed of assets with shorter maturities and greaterrepricing flexibility. At December 31, 2006, commercial real estate, commercial, industrial andagricultural (“Commercial and C&I”) and construction loans were $6.94 billion or 80.35% (81.65% ofwhich are collateralized by real estate) and consumer loans were $810.0 million or 9.37% (60.59% ofwhich are collateralized by real estate) of the $8.64 billion loan portfolio-net. Investmentsecurities, excluding money market instruments of $971.6 million, totaled $7.03 billion at December31, 2006. These loans and securities tend to have shorter maturities and reprice faster thantraditional residential mortgage loans. The Company also continues to diversify and growWesternbank’s sources of revenue, while maintaining its status as a secured lender, withapproximately 83% of its loans collateralized by real estate as of December 31, 2006.     The Company is focused on the expansion of Westernbank in the San Juan metropolitan area. TheCompany has opened 14 branches in the San Juan metropolitan area since 1998, including sevenExpresso of Westernbank branches in July 2002. In the first quarter of 2002, Westernbank acquiredWesternbank World Plaza; a 23-story office building that is the tallest in Puerto Rico’s mainbusiness district and now serves as the Company’s San Juan metropolitan area headquarters, theBank’s regional commercial lending office and the headquarters for Westernbank Business Credit, theExpresso of Westernbank and Westernbank International Trade Services divisions. In addition, theCompany continues to build upon its existing platform and further expand its fee-based businesses,including insurance brokerage, trust services and securities brokerage. In March 2005, the Companyopened its first mega branch in the eastern region of Puerto Rico, in the town of Humacao and inDecember 2005, it opened a mega branch in the Condado area in the city of San Juan. In September2006, the Company opened its newest mega branch in the city of Bayamón.     Commercial lending, including commercial real estate and asset-based lending, unsecuredbusiness lending and construction lending, generally carry a greater risk than residential lendingbecause 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, inthe case of a commercial loan, on the successful operation of the business or the property securingthe loan and, in the case of a construction loan, on the successful completion and sale oroperation of the project. Substantially all of the Company’s borrowers and properties and othercollateral securing the commercial, real estate mortgage and consumer loans are located in PuertoRico. These loans may be subject to a greater risk of default if the Puerto Rico economy suffersadverse economic, political or business developments, or if natural disasters affect Puerto Rico.     The Company’s financial performance is reported in two primary business segments, thetraditional banking operations of Westernbank Puerto Rico and the activities of Westernbank’sdivision known as Westernbank International. Other operations of the Company, not reportable ineither segment, include Westernbank Business Credit Division; Westernbank Trust Division;Westernbank International Trade Services Division; SRG Net, Inc.; Westernbank Insurance Corp.;Westernbank World Plaza, Inc.; and the transactions of the parent company only, which mainlyconsist of other income related to the equity in the net income of its two wholly-ownedsubsidiaries.
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     The traditional banking operations of Westernbank Puerto Rico include retail operations, suchas 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, collateralizedpersonal loans, credit cards, and small loans. Commercial products consist of commercial loansincluding commercial real estate, unsecured commercial and construction loans.     Westernbank International’s business activities consist of commercial banking and relatedservices, and treasury and investment activities outside of Puerto Rico. As of December 31, 2006,2005, and 2004, and for the periods then ended, substantially all of Westernbank International’sbusiness activities consisted of investment in securities of and loans to entities located in theUnited States of America. At December 31, 2006, Westernbank International had $335.4 million inloans receivable-net of which $109.3 million were foreign loans (see Note 23 to the consolidatedfinancial statements).     Established in 2001, Westernbank Insurance Corp. is a general insurance agent placingproperty, 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 mortgageloans and credit life insurance for borrowers of personal loans.     The Company and its wholly owned subsidiaries’ executive offices are located at 19 WestMcKinley Street, Mayagüez, Puerto Rico 00681, and the telephone number is (787) 834-8000. TheCompany’s Internet address is www.wholding.com. Our annual report on Form 10-K, quarterly reportson Form 10-Q, current reports on Form 8-K, and amendments to those reports are available, withoutcharge, on our website, http://www.wholding.com/InvestorRelations.asp, as soon as reasonablypracticable after they are filed electronically with the SEC. Copies are also available, withoutcharge, from W Holding Company, Inc, Corporate Communications and Investor Relations, 19 WestMcKinley Street, 4th Floor, Mayagüez, PR 00680.     The information required by Item 101 (b) of Regulation S-K appears in the Company’sConsolidated Financial Statements, and is included herein in Part II, Item 8. See Note 23 to theconsolidated financial statements for further information about the Company’s business segments.COMPETITION     The financial services and banking business are highly competitive, and the profitability ofthe Company will depend principally upon the Company’s ability to continue to compete in its marketarea as well as to a significant extent upon general economic conditions in its market place. TheCompany competes with other commercial and non-commercial banks, finance companies, mutual funds,insurance companies, brokerage and investment banking firms, asset-based non-bank lenders andcertain other non-financial institutions, including certain governmental organizations which mayoffer subsidized financing at lower rates than those offered by the Company. The Company has beenable to compete effectively with other financial institutions by emphasizing technology andcustomer service, including local office decision-making on loans, establishing long-term customerrelationships and building customer loyalty, and by providing products and services designed toaddress the specific needs of its customers. Significant deterioration in the local economy orexternal economic conditions, such as inflation, recession, unemployment, real estate values andother factors beyond the Company’s control, could also substantially impact the Company’sperformance. There can be no assurance that future adverse changes in the local economy would nothave a material adverse effect on the Company’s consolidated financial condition, results ofoperations or cash flows.
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LENDING ACTIVITIES     GENERAL. At December 31, 2006, the Company’s net loans amounted to $8.64 billion or 50.37% oftotal assets.     The following table sets forth the composition of the Company’s loan portfolio at the datesindicated.                                           **At December 31,**   **2006**  **2005**  **2004**  **2003**  **2002**   **Amount**  **Percent**  **Amount**  **Percent**  **Amount**  **Percent**  **Amount**  **Percent**  **Amount**  **Percent**   **(Dollars in thousands)** Commercial real estate -mortgage (1) $4,945,932   57.2% $4,260,258   54.5% $3,154,679   53.3% $2,261,465   48.3% $1,647,602   38.9%Residential real estate -mortgage (2)  1,014,957   11.8   1,298,535   16.6   879,056   14.9   894,007   19.1   844,803   22.5 Construction — mortgage  722,789   8.4   505,760   6.5   328,145   5.5   202,600   4.3   181,266   4.8 Commercial, industrial andagricultural (1)  1,274,236   14.7   1,013,092   13.0   768,604   13.0   524,747   11.2   384,200   15.2 Consumer and others (3) (4)  809,953   9.4   830,384   10.6   866,934   14.6   861,907   18.4   743,600   19.8                                                                         Total loans  8,767,867   101.5   7,908,029   101.2   5,997,418   101.3   4,744,726   101.3   3,801,471   101.2                                          Allowance for loan losses  (126,844)  (1.5)  (92,406)  (1.2)  (80,066)  (1.3)  (61,608)  (1.3)  (47,114)  (1.2)                                                                        Loans — net $8,641,023   100.0% $7,815,623   100.0% $5,917,352   100.0% $4,683,118   100.0% $3,754,357   100.00%                                (1) Includes $1.46 billion, $1.26 billion, $831.1 million, $641.1 million and$427.7 million of Westernbank Business Credit division outstandingloans at December 31, 2006, 2005, 2004, 2003 and 2002, respectively. (2) Includes fixed and floating interest rate loans to two mortgage originatorgroups in Puerto Rico mainly secured by mortgages on one-to-four familyresidential propertiesas follows: $940.0 million, $1.14 billion, $745.0 million, $750.6million, and $701.6 million at December 31, 2006, 2005, 2004, 2003 and2002, respectively. (3) Includes $129.0 million, $135.0 million, $144.0 million, $155.6 million and$117.4 million of Expresso of Westernbank division outstanding loans atDecember 31, 2006, 2005, 2004, 2003 and 2002, respectively. (4) Includes $490.7 million, $585.9 million, $585.2 million, $521.6 million and$447.9 million collateralized by real estate at December 31, 2006,2005, 2004, 2003, 2002, respectively.     Residential real estate — mortgage loans are mainly comprised of loans secured by firstmortgages on one-to-four family residential properties. At December 31, 2006, residential andcommercial real estate loans included $940.0 million in commercial loans, mainly secured byindividual mortgages on one-to-four family residential properties, to two mortgage originatorgroups in Puerto Rico and $26.0 million of mortgages insured or guaranteed by government agenciesof the United States or Puerto Rico.     Westernbank has a significant fixed rate lending concentration with an aggregate unpaidprincipal balance of $894.0 million in one mortgage originator group in Puerto Rico at December 31,2006. In addition, Westernbank has outstanding $46.0 million of fixed and floating rate loans toanother mortgage originator group in Puerto Rico, for total outstanding loans to mortgageoriginator groups amounting to $940.0 million at December 31, 2006. These commercial loans aresecured by 11,672 individual mortgage loans on residential and commercial real estate with anaverage principal outstanding balance of $80,534. Westernbank’s historical experiencewith the mortgage originator groups is that they have paid these loans in accordance withtheir terms. On March 16, 2006, Westernbank obtained a waiver from the Office of the Commissionerof Financial Institutions of the Commonwealth of Puerto Rico with respect to the statutory limitfor individual borrowers (loan to one borrower limit), which allows the Company to retain the abovesignificant commercial loans in its portfolio until these are paid in full.     On June 30, 2006, Westernbank entered into an agreement to restructure the terms of theoriginal transactions of the $894.0 million lending relationship described above. The agreementeliminated the recourse provisions on the underlying loans, terminated the counterparties’ callrights, converted the return from variable to a fixed rate, and resulted in a net compensation of$25.8 million to Westernbank. One of the purposes of that transaction was to give Westernbank theability to use sale accounting treatment. However, because most of the individual mortgage loanswere originally transferred to the ultimate transferor within the mortgage originator group by twoof its affiliates, the Company has not been able to obtain persuasive evidence that the transfersof loans from the affiliates to the entity that subsequently transferred the loans to Westernbankmet all the criteria for sale accounting under the provisions of SFAS No. 140, Accounting forTransfers and Servicing of Financial Assets and Extinguishments of Liabilities. As a result, theCompany continues to present these transactions as commercial loans secured by real estatemortgages. The net compensation of $25.8 million received by Westernbank in connection with theJune 30, 2006 transaction is being amortized over the remaining life of these loans as a yieldadjustment.     Westernbank originated $1.87 billion of commercial real estate mortgage loans, includingconstruction loans, during the year ended December 31, 2006. At December 31, 2006, commercial realestate mortgage loans totaled $4.96 billion. In general, commercial real estate mortgage loans areconsidered by management to be of somewhat greater risk of uncollectibility than residentiallending because such loans are typically larger in size and more risk is concentrated in a singleborrower. In addition, the borrower’s ability to repay a commercial loan or a construction loandepends, in the case of a commercial loan, on the successful operation of the business or theproperty securing the loan and,
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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 propertiesand other collateral securing the commercial, real estate mortgage and consumer loans are locatedin Puerto Rico. These loans may be subject to a greater risk of default if the Puerto Rico economysuffers adverse economic, political or business developments, or if natural disasters affect PuertoRico. Foreign loans, mainly to entities in Canada and in the United Kingdom, amounted to $109.3million at December 31, 2006.     The portfolio of Consumer and other loans at December 31, 2006, consisted of consumer loans of$810.0 million, of which $490.7 million are secured by real estate, $282.7 million are unsecuredconsumer loans (consisting of $104.3 million of Expresso of Westernbank division unsecured loansportfolio, credit card loans of $48.7 million and other consumer loans of $129.7 million) and loanssecured by deposits in Westernbank totaling $36.6 million.     During 2006, Westernbank securitized $4.6 million and $4.0 million of residential mortgageloans into Government National Mortgage Association and Fannie Mae participation certificates,respectively, and sold loans amounting to $16.6 million to Fannie Mae. Westernbank continues toservice 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 theperiods indicated at December 31, 2006. Contractual maturities do not necessarily reflect theexpected term of a loan, including prepayments.                               **Maturities**           **After one year to five years**  **After five years**   **Balance**  **One year or**  **Fixed**  **Variable**  **  Fixed**  **Variable**   **outstanding**  **less**  **interest**  **interest**  **interest**  **interest**   **(In thousands)**  Commercial real estate — mortgage $4,945,932  $1,503,741  $349,206  $774,960  $125,973  $2,192,052 Residential real estate — mortgage (1)  1,014,957   8,194   51,921   7   918,186   36,649 Construction — mortgage  722,789   502,411   —   220,378   —   — Commercial, industrial and agricultural  1,274,236   491,124   17,310   636,541   54,349   74,912 Consumer and others  809,953   135,469   167,245   8,188   82,826   416,225                     Total $8,767,867  $2,640,939  $585,682  $1,640,074  $1,181,334  $2,719,838                     (1) Includes fixed and floating interest rate loans to two mortgage originator groups in Puerto Rico mainly secured by mortgage on one-to-four familiy residential propertieswith an outstanding principal balance of $940.0 million at December 31, 2006.     ORIGINATION, PURCHASE AND SALE OF LOANS. Westernbank’s loan originations come from anumber of sources. The primary sources for residential loan originations are depositors and walk-incustomers. Commercial loan originations come from existing customers as well as through directsolicitation and referrals.     Westernbank originates loans in accordance with written, non-discriminatory underwritingstandards and loan origination procedures prescribed in the Board of Directors approved loanpolicies. Detailed loan applications are obtained to determine the borrower’s repayment ability.Applications are verified through the use of credit reports, financial statements and otherconfirmation procedures. Property valuations by independent appraisers approved by the Board ofDirectors are required for mortgage and all real estate loans.     Westernbank’s Senior Credit Committee approval is required for all loans in excess of $20.0million ($15.0 million in the case of Westernbank Business Credit Division). The Senior CreditCommittee also reviews and ratifies all loans from $1.0 million to $20.0 million approved byWesternbank’s regional credit committees. The Senior Credit Committee is composed of a majority ofthe members of the Company’s Board of Directors and senior lending officers. All loans in excess of$20.0 million ($15.0 million for Westernbank Business Credit Division) approved by the SeniorCredit Committee are also reviewed and ratified by the Board of Directors of the Company. All loansin excess of $50.0 million require the approval of the Board of Directors of the Company.     It is Westernbank’s policy to require borrowers to provide title insurance policies certifyingor ensuring that Westernbank has a valid first lien on the mortgaged real estate. Borrowers mustalso obtain hazard insurance policies prior to closing and, when required by the Department ofHousing and Urban Development, flood insurance policies. Borrowers may be required to advance fundson a monthly basis together with each payment of principal and interest to a mortgage escrowaccount from which Westernbank makes disbursements for items such as real estate taxes, hazardinsurance premiums and private mortgage insurance premiums as they fall due.
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     Westernbank originates fixed and adjustable rate residential mortgage loans secured by a firstmortgage on the borrower’s real property, payable in monthly installments for terms ranging fromten to forty-five years. Adjustable rates are indexed to specified prime or LIBOR rate.Westernbank’s practice is that its limited production and origination of residential real estateloans are mostly conforming loans, eligible for sale in the secondary market. The loan-to-valueratio at the time of origination on residential mortgages is generally 75%, except that Westernbankmay lend up to 90% of the lower of the purchase price or appraised value of residential propertiesif private mortgage insurance is obtained by the borrower for amounts in excess of 80%.     Westernbank originates primarily variable and adjustable rate commercial business and realestate loans. Westernbank also makes real estate construction loans subject to firm permanentfinancing commitments. As of December 31, 2006, Westernbank’s Commercial and C&I and constructionloan portfolios had a total delinquency ratio, including the categories of 60 days and over, of0.63% (less than 1%), compared to 0.85% (less than 1%) at December 31, 2005. For furtherexplanation on the delinquency ratio of the Company’s commercial loan portfolio refer to section“NON-PERFORMING LOANS AND FORECLOSED REAL ESTATE HELD FOR SALE”.     Westernbank offers different types of consumer loans in order to provide a full range offinancial services to its customers. Within the different types of consumer loans offered byWesternbank, there are various types of secured and unsecured consumer loans with varyingamortization schedules. In addition, Westernbank makes fixed-rate residential second mortgageconsumer loans. In July 2002, Westernbank launched a banking division focused on offering consumerloans that now has 20 full-service branches, called “Expresso of Westernbank”, denoting thebranches’ emphasis on small, unsecured consumer loans up to $15,000 and collateralized consumerloans up to $150,000.     Westernbank offers the service of VISA TM and MasterCard TM creditcards. At December 31, 2006, there were approximately 21,499 outstanding accounts, with anaggregate outstanding balance of $48.7 million and unused credit card lines available of $81.8million.     In connection with all consumer loans originated, Westernbank’s underwriting standards includea determination of the applicants’ payment history on other debts and an assessment of the abilityto meet existing obligations and payments on the proposed loan. As of December 31, 2006,Westernbank’s consumer loan portfolio, including the Expresso of Westernbank loan portfolio, had atotal delinquency ratio, including the categories of 60 days and over, of 1.52%, compared to 1.13%at December 31, 2005. The increase inthe delinquency ratio from 2005 to 2006 was mainly due to delinquencies in regular consumerloans past due over 90 days which are collateralized by real estate properties.     Westernbank has 83% of its loan portfolio as of December 31, 2006, secured by real estate. Ourcombined delinquency on all portfolios for the categories of 60 days and over continues to be below1% for both periods, being 0.66% at December 31, 2006, and 0.72% at December 31, 2005. Theimprovement in the combined delinquency ratio arises from a reduction in delinquent loans of theCommercial and C&I and construction loan portfolios.     INCOME FROM LENDING ACTIVITIES. Westernbank realizes interest income and fee income from itslending activities. For the most part, interest rates charged by Westernbank on loans depend uponthe 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 andalso 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 commitmentsmade 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 overthe life of the related loans as a yield adjustment using the interest method or a method whichapproximates the interest method. Commitment fees are also deferred and amortized over the life ofthe related loans as a yield adjustment. If the commitment expires unexercised, the fee is takeninto 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 mortgageservicing rights for impairment based on the fair value of those rights. Servicing assets areevaluated 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. Impairmentis recognized through a valuation allowance for an individual servicing right, to the extent thatfair value is less than the carrying amount for that right. The total cost of mortgage loans to besold 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 servicingrights are amortized in proportion to, and over the period of, estimated servicing income. As ofDecember 31, 2006, Westernbank had $3.0 million in mortgage servicing assets.
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     NON-PERFORMING LOANS AND FORECLOSED REAL ESTATE. When a borrower fails to make a requiredpayment on a loan, Westernbank attempts to cure the deficiency by contacting the borrower. In mostcases, deficiencies are cured promptly. If the delinquency exceeds 90 days and is not cured throughnormal 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, theproperty is sold at a judicial sale at which Westernbank may acquire the property. In the eventthat the property is sold at a price insufficient to cover the balance of the loan, the debtorremains liable for the deficiency. Thereafter, if Westernbank acquires the property, such acquiredproperty is appraised and included in the foreclosed real estate held for sale account at the fairvalue at the date of acquisition. Then, this asset is carried at the lower of fair value lessestimated costs to sell or cost until the property is sold.     The accrual of interest on loans is discontinued when there is a clear indication that theborrower’s cash flows may not be sufficient to meet payments as they become due, but in no event isit recognized after a borrower is 90 days in arrears on payments of principal or interest. When aloan is placed on nonaccrual status, all previously accrued and unpaid interest is charged againstincome and the loan is accounted for on the cash method thereafter, until qualifying for return toaccrual status. Generally, a loan is returned to accrual status when all delinquent interest andprincipal payments become current in accordance with the terms of the loan agreement or when theloan is both well secured and in the process of collection and collectibility is no longerdoubtful. Consumer loans that have principal and interest payments that have become past due onehundred and twenty days and credit cards and other consumer revolving lines of credit that haveprincipal and interest payments that have become past due one hundred and eighty days arecharged-off against the allowance for loan losses.     The following table sets forth information regarding non-performing loans and foreclosed realestate held for sale by the Company at the dates indicated:                       **December 31,**   **2006**  **2005**  **2004**  **2003**  **2002**   **(Dollars in thousands)** Commercial real estate mortgage andcommercial, industrial and agricultural loans $154,862  $55,585  $25,417  $24,142  $13,567 Residential real estate mortgage and construction loans  1,641   2,125   1,730   2,259   2,026 Consumer loans  9,309   6,288   7,122   4,845   3,812                 Total non-performing loans  165,812   63,998   34,269   31,246   19,405 Foreclosed real estate held for sale  5,917   4,137   3,811   4,082   3,679                 Total non-performing loans and foreclosedreal estate held for sale $171,729  $68,135  $38,080  $35,328  $23,084                  Interest that would have been recorded if the loans hadnot been classified as non-performing $9,052  $4,916  $3,557  $2,500  $1,102                 Interest recorded on non-performing loans $4,785  $743  $243  $583  $775                 Total non-performing loans as a percentageof total loans at end of period  1.89%  0.81%  0.58%  0.66%  0.51%                Total non-performing loans and foreclosed real estateheld for sale as a percentage of total assets at end of period  1.00%  0.42%  0.27%  0.31%  0.28%                     The increase in non-performing loans from year end 2005, to year end 2006 mainly comesfrom the Company’s Commercial and C&I loan portfolio. Non-performing loans on the Commercial andC&I loan portfolio increased by $99.3 million, when compared to December 31, 2005. The increase ismainly attributed to four loans of the Company’s asset based lending division, with outstandingprincipal balances of $44.9 million, $40.5 million, $14.2 million and $7.3 million at December 31,2006. These loans are current and have not missed their payment schedules but have shortfalls inthe collaterals and in the financial condition of the borrowers. These loans required valuationallowances as follows: $11.4 million for the $44.9 million loan, $15.2 million for the $40.5million loan, $4.7 million for the $14.2 million loan and $2.5 million for the $7.3 million loan.During the year ended December 31, 2006, five loans related to one single borrower that were innon-performing status at December 31, 2005, with an aggregate outstanding principal balance of $8.4million, were collected. Non-performing loans on the consumer loans portfolio increased by $3.0million or 48.04% at December 31, 2006, when compared to December 31, 2005. Such increase wasmainly due to non-performing loans in the regularconsumer loans portfolio which are collateralizedby real estate. At December 31, 2006, the allowance for possible loan losses was 76.50% of totalnon-performing loans (reserve coverage).
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     The increase in non-performing loans from year end 2004, to year end 2005 mainly comes fromthe Company’s Commercial and C&I loan portfolio. Non-performing loans on the Commercial and C&Iloan portfolio increased by $30.2 million, when compared to December 31, 2004. The increase isprimarily attributed to one loan of Westernbank Business Credit division originally acquired in thepurchased loan portfolio, with an outstanding principal balance of $10.1 million. There is also oneborrower with five commercial loans with an aggregate principal balance of $8.4 million, and fiveother commercial loans with outstanding principal balances between $1.0 million to $3.0 million,with an aggregate outstanding principal balance of $8.2 million. These loans are collateralizedwith real estate and did not require any valuation allowance. At December 31, 2005, the allowancefor possible loan losses was 144.39% of total non-performing loans (reserve coverage).     ALLOWANCE FOR LOAN LOSSES. Westernbank maintains an allowance for loan losses to absorbprobable losses inherent in the loan portfolio. The allowance is based on ongoing, quarterlyassessments of the probable estimated losses inherent in the loan portfolio, based on evaluationsof the collectibility and historical loss experience of loans. The Company follows a systematicmethodology to establish and evaluate the adequacy of the allowance for loan losses. Thismethodology consists of several key elements, which include:     **The Formula Allowance**. The formula allowance is calculated by applying loss factors tooutstanding loans not otherwise covered by specific allowances. Loss factors are based onhistorical loss experience and may be adjusted for significant factors that, in management’sjudgment, reflect the impact of any current condition on loss recognition. Factors that managementconsiders in the analysis include the effect of the national and local economies, trends in thenature and volume of loans (delinquencies, charge-offs, non-accrual and problem loans), assetquality trends, changes in the internal lending policies and credit standards, collectionpractices, and examination results from bank regulatory agencies and the Company’s internal creditexaminers. Loss factors are described as follows: **•** Loan loss factors for commercial loans, including construction and land acquisition loans, arebased on average loss trends (historical net charge-offs and changes in the specific allowances)for three to five years, as adjusted for management’s expected increase in the loss factors giventhe significant increase in such loan portfolios over the last few years.  **•** Pooled loan loss factors are also based on average loss trends (historical net charge-offs andchanges in the specific allowances) for one to three years. Pooled loans are loans that arehomogeneous in nature, such as consumer installment, residential mortgage loans and credit cards.     **Specific Allowances for Identified Problem Loans and Portfolio Segments**. Specific allowancesare established and maintained where management has identified significant adverse conditions orcircumstances related to a credit or portfolio segment that management believes indicate theprobability that a loss has been incurred in excess of the amount determined by the application ofthe formula allowance. Larger commercial and construction loans that exhibit probable or observedcredit weaknesses are subject to individual review. Where appropriate, allowances are allocated toindividual loans based on management’s estimate of the borrower’s ability to repay the loan giventhe availability of collateral, other sources of cash flow and legal options available toWesternbank.     In addition, the specific allowance incorporates the results of measuring impaired loans asprovided in SFAS No. 114, Accounting by Creditors for Impairment of a Loan, as amended. Thisaccounting standard prescribes the measurement methods, income recognition and disclosuresconcerning impaired loans.     **The Unallocated Allowance**. An unallocated allowance is established recognizing the estimationrisk associated with the formula and specific allowances. It is based upon management’s evaluationof various conditions, the effects of which are not directly measured in determining the formulaand specific allowances. These conditions include then-existing general economic and businessconditions affecting our key lending areas; credit quality trends, including trends innonperforming loans expected to result from existing conditions, collateral values, loan volumesand concentrations, seasoning of the loan portfolio, recent loss experience in particular segmentsof 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 ofuncertainty because these are not identified with specific problem credits or portfolio segments.     Management assesses these conditions quarterly. If any of these conditions is evidenced by aspecifically 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 allowanceapplicable to this credit or portfolio segment. Where any of these conditions is not evidenced by aspecificallyidentifiable problem credit or portfolio segment as of the evaluation date,management’s evaluation of the probable loss concerning this condition is reflected in theunallocated allowance.
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     The allowance for loan losses is based upon estimates of probable losses inherent in the loanportfolio. The amount actually observed for these losses can vary significantly from the estimatedamounts. Our methodology includes several features that are intended to reduce the differencesbetween estimated and actual losses. Historical loss factors for commercial and consumer loans maybe adjusted for significant factors that, in management’s judgment, reflect the impact of anycurrent condition on loss recognition. Factors which management considers in the analysis includethe 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 lendingpolicies and credit standards, collection practices, and examination results from bank regulatoryagencies and the Bank’s internal credit examiners. Loan loss factors are adjusted quarterly basedupon the level of net charge-offs expected by management in the next twelve months, after takinginto account historical loss ratios adjusted for current trends. By assessing the probableestimated losses inherent in the loans portfolio on a quarterly basis, we are able to adjustspecific and inherent loss estimates based upon any more recent information that has becomeavailable.     At December 31, 2006, the allowance for loan losses was $126.8 million, consisting of $86.6million formula allowance (general allowance) and $40.2 million of specific allowance. As ofDecember 31, 2006, the allowance for loan losses equals 1.45% of total loans, compared with anallowance for loan losses at December 31, 2005, of $92.4 million, or 1.17% of total loans.     As of December 31, 2006, there have been no significant changes in estimation methods orassumptions that affected our methodology for assessing the appropriateness of the allowance forloan losses.     The table below presents a reconciliation of changes in the allowance for loan losses for theperiods indicated:                       **YEAR ENDED DECEMBER 31,**   **2006**  **2005**  **2004**  **2003**  **2002**   **(Dollars in thousands)**  Balance, beginning of year $92,406  $80,066  $61,608  $47,114  $38,364                 Loans charged-off:                    Commercialreal estate mortgage and commercial,industrial and agricultural loans (1)  (22,606)  (8,233)  (5,433)  (2,479)  (3,389)Residential real estate mortgage andconstruction loans  (94)  (121)  (297)  (184)  — Consumer loans (2)  (12,576)  (13,809)  (16,473)  (12,203)  (4,576)                Total loans charged-off  (35,276)  (22,163)  (22,203)  (14,866)  (7,965)                Recoveries of loans previouslycharged-off:                    Commercial real estate mortgage and commercial,industrial and agricultural loans  2,846   1,008   1,844   1,141   584 Residential real estate mortgage andconstruction loans  66   212   206   372   190 Consumer loans (3)  2,252   2,283   1,920   799   858                 Total recoveries of loans previously charged-off  5,164   3,503   3,970   2,312   1,632                 Net loans charged-off  (30,112)  (18,660)  (18,233)  (12,554)  (6,333)Provision for loan losses  64,550   31,000   36,691   27,048   15,083                 Balance, end of year $126,844  $92,406  $80,066  $61,608  $47,114                 Ratios:                    Allowance for loan losses to total loansat end of period  1.45%  1.17%  1.34%  1.30%  1.24%Provision for loan losses to net loanscharged-off  214.37%  166.13%  201.23%  215.45%  238.17%Recoveries of loans to loans charged-offin previous period  23.30%  15.78%  26.71%  29.03%  23.19%Net loans charged-off to averagetotal loans (4)  0.36%  0.27%  0.34%  0.29%  0.19%Allowance for loans losses tonon-performing loans  76.50%  144.39%  233.64%  197.17%  242.80% (1) Includes partial charge-offs of $15.8 million and $5.3 million for the years ended December31, 2006 and 2005, respectively, and a $505,000 charge-off in 2002 of Westernbank BusinessCredit division loans. (2) Includes $8.9 million, $9.8 million, $12.4 million, $7.9 million and $62,000 of Expresso ofWesternbank loan charge-offs, for the years ended December 31, 2006, 2005, 2004, 2003 and2002, respectively. Expresso of Westernbank began operations on July 10, 2002. (3) Includes $1.0 million, $1.1 million, $1.0 million and $17,000 of Expresso of Westernbank loanrecoveries, for the years ended December 31, 2006, 2005, 2004 and 2003, respectively. (4) Average loans were computed using beginning and period-end balances.
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     For the year ended December 31, 2006, net loan charge-offs amounted to $30.1 million or0.36% of average loans, an increase of $11.5 million or 61.37%, when compared to $18.7 million or0.27% to average loans in 2005. The increase in loans charged-off for the year ended December 31,2006, when compared to the same period in 2005, is mainly attributed to an increase of $14.6million in Commercial and C&I loans charged-off. Such increase in the Commercial and C&I loanscharged-off resulted principally from loans charged-off on the Company’s asset based lendingdivision. During the year 2006, the Company partially charged-off three loans of its asset basedlending division with outstanding principal balances after charge-offs of $44.9 million, $7.3million and $3.1 million, at December 31, 2006, as follows: $7.5 million on the $44.9 million loan,$3.0 million of the $7.3 million loan and $5.3 million on the $3.1 million loan. These loans arecurrent and have not missed their payment schedules but have shortfalls in the collaterals and inthe financial condition of the borrowers. At December 31, 2006, these loans required valuationallowances as follows: $11.4 million for the $44.9 million loan and $2.5 million for the $7.3million loan. The $3.1 million loan did not require a valuation allowance at December 31, 2006.     Consumer loan charge-offs for the year ended December 31, 2006, were $12.6 million, animprovement of $1.2 million or 8.93%, when compared to $13.8 million for the same period in 2005.Such improvement is principally attributed to lower charge-offs by the Expresso of Westernbankdivision, the principal component of the consumer loan charge-offs. Loans charged-off by theExpresso of Westernbank division decreased from $9.8 million for the year ended December 31, 2005,to $8.9 million for the same period in 2006, a decrease of $836,000. This is the result ofmanagement’s strategy of stabilizing loan losses and increasing the overall rates charged on theExpresso loan portfolio by continuously reviewing its underwriting policies and increasing thelevel of collateralized loans. Theaverage yield of the Expresso of Westernbank loan portfolio was 23.74% at December 31, 2006.Also, the portion of the loan portfolio of Expresso of Westernbank collateralized by real estate atDecember 31, 2006, already accounts for 20% of the outstanding balance.     The accounts written-off are submitted to the Collections Department recovery unit forcontinued collection efforts. Recoveries made from accounts previously written-off amounted to $5.2million in 2006 and $3.5 million in 2005, an improvement of $1.7 million or 47.42%.     At December 31, 2006, the allowance for possible loan losses was 76.50% of totalnon-performing loans (reserve coverage). The decrease in the allowance for loan losses tonon-performing loans ratio was principally due to the increase in Commercial & C&I non-performingloans, mainly from the Company’s asset based lending division.     The decrease in the provision for loan losses from 2004 to 2005 was attributed to lower netcharge offs of the Expresso of Westernbank division loan portfolio and relatively stabledelinquencies in our commercial and consumer loan portfolios during the year 2005, when compared tothe same period in 2004. The provision for loan losses for Westernbank Business Credit divisionaccounted for $22.4 million or 72.33% of the total provision for loan losses for the year endedDecember 31, 2005, while for year 2004, it accounted for $6.0 million or 16.33% of the totalprovision for loan losses. The increase of $16.4 million in the provision for loan losses forWesternbank Business Credit division is mainly attributable to two factors; first, an increase inthe division loss ratio as a result of a $5.3 million partial charge-off of one loan that wasacquired in the original purchased loan portfolio of this division on June 15, 2001. Second, theincrease in the specific reserves of two loans of the division loan portfolio during the fourthquarter of year 2005. Outstanding principal balances on these loans were $10.1 million and $14.1million at December 31, 2005, with specific reserves of $6.8 million and $4.8 million,respectively. The provision for loan losses for the consumer loan portfolio decreased by $10.0million, from 2004 to 2005. This decrease was primarily due to the relatively stable delinquencylevels at the consumer loans portfolio, the decrease in the outstanding balance of the loanportfolio of the Expresso of Westernbank and the decrease in net charge-offs, principally in theExpresso of Westernbank division loan portfolio. The decrease in the Expresso of Westernbank loanportfolio was mainly due to management’s strategy of stabilizing charge-offs as the division’sportfolio matures and average yield continues to increase.     For the year ended December 31, 2005, net charge-offs to average loans decreased from 0.34%for the year 2004, to 0.27% for the year 2005. In absolute dollar amounts, net charge-offs remainedrelatively unchanged at $18.7 million, when compared to $18.2 million in 2004. Commercial loanscharged-off were $8.2 million for the year ended December 31, 2005, when compared to $5.4 millionfor the year ended December 31, 2004, an increase of $2.8 million or 51.54%. The increase inCommercial and C&I loans charged-off was primarily due to the partial charge-off of $5.3 million ofone loan that was acquired in the original purchased loan portfolio of Westernbank Business Creditdivision on June 15, 2001. Loans charged-off in the consumer loans portfolio decreased by $2.7million or 16.17%, from $16.5 million in 2004, to $13.8 million in 2005. The decrease isprincipally attributed to lower charge-offs by the Expresso of Westernbank division, the principalcomponent of the consumer loans charged- offs. Loans charged-off by the Expresso of Westernbankdivision decreased from $12.4 million for year 2004, to $9.8 million for year 2005, a decrease of$2.6 million or 20.97%. Management strategy of stabilizing charge-offs and increasing the yield ofthe Expresso loan portfolio by continuously reviewing its underwriting policies, increasing thelevel of collateralized loans, and increasing the overall rates charged has resulted in lowerlevels in net charge-offs and a higher yield. The average yield of the Expresso of Westernbank loanportfolio was 23.15% at December 31, 2005. Also, the loan portfolio of Expresso of Westernbankcollateralized by real
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estate at December 31, 2005, already accounts for 15% of the outstandingbalance. The accounts written-off are submitted to the Collections Department recovery unit forcontinued collection efforts. Recoveries made from accounts previously written-off amounted to $3.5million in 2005 and $4.0 million in 2004.     The Expresso loan portfolio includes small, unsecured consumer loans up to $15,000 and realestate collateralized consumer loans up to $150,000. These loans generally have a higher creditrisk when compared to the rest of Westernbank’s consumer loan portfolio, since the ExpressoDivision principally targets the typical small consumer loan customers that are usually low incomeearners. Therefore, the Expresso of Westernbank division loan portfolio carries a higher risk ofdefault when compared to the total consumer loans portfolio in general.     The Expresso of Westernbank division has established policies, procedures and controls toassess, monitor and adequately manage the specific credit risk posed by this loan portfolio underthe FDIC guidelines for sub-prime lending programs, even though this program does not exceed the25% of capital applicable for such guidelines. The division’s loan analyses and applications areprocessed in the system software that has embedded controls to help enforce the lending policiesand limits as approved by the division’s senior management. Lending parameters and authority levelsare programmed in a loan process application, restricting individuals to their level of authority.Also, the system uses tools to assist the loan officer in identifying critical information in thecustomer’s credit report based on a credit scoring process. The system returns a suggested decisionand loan amount, based on the customer’s net disposable income, FICO Score, and credit profiletests. In addition to this package, the division branches obtain acredit report from a second credit bureau to ensure that the lending officer possesses allinformation needed to make an informed decision and to reduce the division’s credit risk exposure.Overall credit scores for the portfolio are analyzed periodically.
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     The following table presents the allocation of the allowance for credit losses, the loanportfolio composition percentage and the allowance coverage ratio in each loan category to totalloans, as set forth in the “Loans” table on page 5, at the end of each year.                       **AT DECEMBER 31,**   **2006**  **2005**  **2004**  **2003**  **2002**   **(Dollars in thousands)** Allowance for loan losses:                                         Commercial real estate mortgage andcommercial, industrial and agricultural loans (1) $103,806  $68,664  $54,493  $39,217  $30,271 Residential real estate mortgage  4,654   3,275   407   415   443 Construction mortgage  3,616   4,059   3,715   2,183   1,400 Consumer and others (2)  12,029   14,430   19,425   17,472   12,004 Unallocated  2,739   1,978   2,026   2,321   2,996                 Total allowance for loan losses $126,844  $92,406  $80,066  $61,608  $47,114                                      Loan portfolio composition percentages:                                         Commercial real estate mortgage andcommercial, industrial and agricultural loans  70.94%  66.68%  65.42%  58.72%  53.45%Residential real estate mortgage  11.58%  16.42%  14.66%  18.84%  22.22%Construction mortgage  8.24%  6.40%  5.47%  4.27%  4.77%Consumer and others  9.24%  10.50%  14.45%  18.17%  19.56%                Total loans  100.00%  100.00%  100.00%  100.00%  100.00%                                     Allowance coverage ratio atend of year:                                         Applicable to:                                         Commercial real estate mortgage andcommercial, industrial and agricultural loans  1.67%  1.30%  1.39%  1.41%  1.49%Residential real estate mortgage  0.46%  0.25%  0.05%  0.05%  0.05%Construction mortgage  0.50%  0.80%  1.13%  1.08%  0.77%Consumer and others  1.49%  1.74%  2.24%  2.03%  1.61%Unallocated (as a percentage of total loans)  0.03%  0.03%  0.03%  0.05%  0.08%                Total loans  1.45%  1.17%  1.34%  1.30%  1.24%                 (1) Includes an allowance of $74.3 million, $30.0 million, $12.9 million, $6.6 million and $4.5 million for Westernbank Business Creditloans at December 31, 2006, 2005, 2004, 2003 and 2002, respectively. (2) Includes an allowance of $7.8 million, $8.4 million, $13.8 million, $10.0 million and $1.5 million for Expresso of Westernbank loansportfolio at December 31, 2006, 2005, 2004, 2003 and 2002, respectively. Expresso of Westernbank began operations on July 10, 2002.     The increase in the allowance for credit losses is attributable to the following factors:first, the overall growth in the Company’s loan portfolio, mainly those of its Commercial and C&Iloans; and second, to higher non-performing loans, net loans charged-off andspecific reserves during the period, principally in the loan portfolio of the Company’sasset-based lending division, which increased the loan loss factor of this portfolio and itscorresponding general allowance.     In 2006 and 2005, the allowance for credit losses on consumer loans decreased as a result oflower net charge-offs, principally in the Expresso of Westernbank division loans. The decrease inthe allowance for credit losses in the Expresso of Westernbank loan portfolio was mainly due tomanagement’s strategy of stabilizing charge-offs as the division portfolio matures and its averageyieldcontinues to increase. For periods before 2005, the increases in the allowance for creditlosses on consumer loans is mainly due to higher net charge-offs, principally in the Expresso ofWesternbank loan portfolio.
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     As explained before, the Company has outstanding commercial loans to two mortgage originatorgroups in Puerto Rico. These commercial loans are collateralized by mortgages on real estateproperty, mainly one-to-four family residences. In the first quarter of 2005, as a result of theannouncements by the mortgage originator groups of the need for them to restate their previouslyissued financial statements and other negative news, the Company decided to assign a generalallowance to these loans. These commercial loans are nevertheless performing in accordance withtheir contractual terms. At December 31, 2006, these loans have an outstanding balance of $940.0million and a general allowance of $4.2 million.     Loans are classified as impaired or not impaired in accordance with SFAS No. 114. A loan isimpaired when, based on current information and events, it is probable that Westernbank will beunable to collect the scheduled payments of principal or interest when due, according to thecontractual terms of the agreement.     Westernbank measures the impairment of a loan based on the present value of expected futurecash flows discounted at the loan’s effective interest rate, or as a practical expedient, at theobservable market price of the loan or the fair value of the collateral, if the loan is collateraldependent. Significant loans (those exceeding $500,000 in 2006, 2005, 2004 and 2003, and $250,000in 2002) are individually evaluated for impairment. Large groups of small balance, homogeneousloans are collectively evaluated for impairment; loans that are recorded at fair value or at thelower of cost or market are not evaluated for impairment. The portfolios of mortgage and consumerloans are considered homogeneous and are evaluated collectively for impairment.     Impaired loans for which the discounted cash flows, collateral value or market price exceedsits carrying value do not require an allowance. The allowance for impaired loans is part of theCompany’s overall allowance for loan losses.     The following table sets forth information regarding the investment in impaired loans:                       **2006**  **2005**  **2004**  **2003**  **2002**   **(In thousands)** Investment in impaired loans:                     Covered by a valuation allowance $139,498  $32,542  $29,975  $28,217  $26,074 Do not require a valuation allowance  22,174   49,069   24,200   22,088   24,515                 Total $161,672  $81,611  $54,175  $50,305  $50,589                                      Valuation allowance for impaired loans $39,106  $14,185  $8,412  $4,646  $4,752                                      Average investment in impaired loans $120,147  $61,113  $46,509  $46,676  $46,147                                      Interest collected and recognized asincome on impaired loans $5,815  $4,044  $2,460  $2,452  $4,041                      At December 31, 2006, Westernbank’s investment in impaired loans increased by $80.1million, from $81.6 million at December 31, 2005. The investment in impaired loans covered by avaluation allowance increased from $32.5 million at December 31, 2005, to $139.5 million atDecember 31, 2006, an increase of $107.0 million. This increase was mainly attributed to threeloans of the Company’s asset-based lending division, with outstanding principal balances of $44.9million, $40.5 million and $7.3 million at December 31, 2006. These loans are current and have notmissed their payment schedules but have shortfalls in the collaterals and in the financialcondition of the borrowers. These loans required valuation allowances at December 31, 2006 asfollows: $11.4 millionfor the $44.9 million loan, $15.2 million for the $40.5 million loan and $2.5 million for the$7.3 million loan. The investment in impaired loans that did not require a valuation allowancedecreased from $49.1 million at December 31, 2005 to $22.2 million at December 31, 2006, a decreaseof $26.9 million. Such decrease was due to loans classified as impaired loans as of December 31,2005, that were either collected or charged-off during the year ended December 31, 2006. During theyear ended December 31, 2006, one borrower with five loans, with an aggregate outstanding principalbalance of $8.4 million and one additional loan with an outstanding principal balance of $1.5million were paid-off. None of these loans required a valuation allowance as of December 31, 2005.     At December 31, 2005, Westernbank’s investment in impaired loans increased by $27.4 million or50.64%, from $54.2 million at December 31, 2004. The investment in impaired loans that did notrequire a valuation allowance increased from $24.2 million at December 31, 2004, to $49.1 millionat December 31, 2005, an increase of $24.9 million. The $27.4 million increase was mainlyattributed to one borrower with five commercial loans with an aggregate principal balance of $8.4million, and four other commercial loans with outstanding principal balances between $1.0 millionto $3.0 million, with an aggregate outstanding principal balance of$8.2 million. Also, at December31, 2005, there were four additional commercial loans with outstanding principal balances between$500,000 to $1.0 million, with an aggregate outstanding principal balance of $2.6 million. All ofthese loans were collateralized with real estate.
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INVESTMENT ACTIVITIES     The Company’s investments are managed by the Investment Department. Purchases and sales arerequired to be reported monthly to the Investment Committee (composed of members of the Board ofDirectors, the Chief Executive Officer of the Company, the President and Chief Investment Officerof the Company, the President and Chief Executive Officer of Westernbank, the Treasurer and ChiefInvestment Officer of Westernbank and the Chief Accounting Officer).     The Investment Department is authorized to purchase and sell federal funds, interest bearingdeposits in banks, banker’s acceptances of commercial banks insured by the FDIC, mortgage andasset-backed securities, Puerto Rico and U.S. Government and agencies obligations, municipalsecurities rated A or better by any of the nationally recognized rating agencies, commercial paperand corporate notes rated P-1 by Moody’s Investors Service, Inc. or A-1 by Standard and Poor’s, aDivision of the McGraw-Hill Companies, Inc. In addition, the Investment Department is responsiblefor the pricing and sale of deposits and repurchase agreements.     At the date of purchase, the Company classifies debt and equity securities into one of threecategories: held to maturity; trading; or available for sale. At each reporting date, theappropriateness of the classification is reassessed. Investments in debt securities for whichmanagement has the intent and ability to hold to maturity are classified as held to maturity andstated at cost increased by accretion of discounts and reduced by amortization of premiums, bothcomputed by the interest method. Securities that are bought and held principally for the purpose ofselling them in the near term are classified as trading and measured at fair value in the financialstatements with unrealized gains and losses included in earnings. Securities not classified aseither held to maturity or trading are classified as available for sale and measured at fair valuein the financial statements with unrealized gains and losses reported, net of income tax, as acomponent of accumulated other comprehensive income (loss) until realized. Gains and losses onsales of securities are determined using the specific-identification method.     The Company’s investment strategy is affected by both the rates and terms available oncompeting investments and tax and other legal considerations.     Federal funds sold and resell agreements amounted to $360.2 million and $590.4 million,respectively, at December 31, 2006. Federal funds sold mature within the next two business days,while resell agreements mature as follows: $40.4 million the next business day, $200.0 million in2009, and $350.0 million in 2010. The Company monitors the fair value of the underlying securitiesas compared to the related receivable of the resell agreement, including accrued interest, andrequests additional collateral when the fair value of the underlying collateral falls below thecollateral requirement. At December 31, 2006, the fair value of the underlying collateral forresell agreements amounted to $633.6 million.     The following table presents the carrying value of investments as of year end for each of theyears indicated:               **2006**  **2005**  **2004**   **(In thousands)** Held to maturity :            US Government and agencies obligations $6,314,091  $6,314,316  $6,004,849 Puerto Rico Government and agencies obligations  11,663   31,824   34,822 Corporate notes  21,433   26,429   51,418 Mortgage-backed securities  660,392   701,456   830,290           Total  7,007,579   7,074,025   6,921,379           Available for sale:            Puerto Rico Government and agencies obligations  18,050   —   — Equity securities — common stock  2,491   4,981   — Mortgage-backed securities  —   185   7,881           Total  20,541   5,166   7,881           Total investments $7,028,120  $7,079,191  $6,929,260           
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     Mortgage-backed securities at December 31, 2006, 2005 and 2004, consist of:               **2006**  **2005**  **2004**       **(In thousands)**     Available for sale:            Collateralized mortgage obligations (CMO’s) issued or guaranteedby the Federal National Mortgage Association (FNMA) $—  $185  $6,116 CMO’s issued or guaranteed by the Federal HomeLoan Mortgage Corporation (FHLMC)  —   —   1,765           Total available for sale  —   185   7,881                        Held to maturity:            Government National Mortgage Association (GNMA) certificates  7,140   8,082   9,881 FHLMC certificates  3,055   4,180   5,663 FNMA certificates  3,358   2,828   3,642 CMO’s certificates issued or guaranteed by FHLMC  573,735   607,659   706,632 CMO’s certificates issued or guaranteed by FNMA  73,104   78,707   104,441 CMO’s other  —   —   31           Total held to maturity  660,392   701,456   830,290           Total mortgage and asset-backed securities $660,392  $701,641  $838,171                At December 31, 2006, no investment of a single issuer (in aggregate balance) exceeded10% of the Company’s consolidated stockholders’ equity.     The carrying amount of investment securities at December 31, 2006, by contractual maturity(excluding mortgage-backed securities), are shown below:           **Carrying**  **Weighted**   **amount**  **average yield**   **(Dollars in thousands)** US Government and agencies obligations:        Due within one year $379,602   4.48%Due after one year through five years  5,759,489   3.98 Due after five years through ten years  175,000   4.00           6,314,091   4.01                 Puerto Rico Government and agencies obligations:        Due within one year  3,015   6.00 Due after one year through five years  18,111   4.20 Due after five years through ten years  8,587   4.89           29,713   4.58                 Other:        Due after ten years  21,433   8.33                 Total  6,365,237   4.03          Mortgage-backed securities  660,392   4.26 Equity securities  2,491   2.21        Total $7,028,120   4.05%       
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     The Company’s investment portfolio at December 31, 2006, had an average contractualmaturity of 31 months, when compared to an average maturity of 44 months at December 31, 2005. TheCompany’s interest rate risk model takes into consideration the callable feature of certaininvestment securities. Assuming that all call features are exercised, the Company’s investmentportfolio as of December 31, 2006, had a remaining average contractual maturity of 5 months. Underthe present interest rate scenario, no single security may be called. However, no assurance can begiven that such levels will be maintained in future periods.     Available for sale and held to maturity securities are reviewed at least quarterly forpossible other-than-temporary impairment. The review includes an analysis of the facts andcircumstances of each individual investment such as the length of time and the extent to which thefair value has been below cost, the expectation for that security’s performance, the creditworthiness of the issuer and the Company’s intent and ability to hold the security to allow for anyanticipated recovery in fair value if classified as available for sale, or to maturity. A declinein value that is considered to be other-than-temporary is recorded as a loss within noninterestincome in the consolidated statements of income. During the quarter ended June 30, 2006, managementconcluded that certain held to maturity investments in Puerto Rico Government Obligations(“PRGO’s”), with an amortized cost of $21,615,000 were other-than-temporarily impaired and recordedan impairment loss of $1.1 million. These securities were downgraded by one notch below investmentgrade in May 2006. As a result of the downgrade just below investment grade of these PRGO’s, theywere transferred to the available for sale category at their fair value of $20,552,000. Inaddition, during the quarter ended December 31, 2006, the Company recorded an impairment loss of$750,000 on its equity securities available for sale.     The equity securities and corporate notes impairment analyses are performed and reviewed atleast quarterly based on the latest financial information and any supporting research report madeby major brokerage houses. These analyses are subjective and based, among other things, on relevantfinancial data such as capitalization, cash flows, liquidity, systematic risk, and debtoutstanding. Management also considers the industry trends, the historical performance of thestock, as well as the Company’s intent to hold the security. If management believes there is a lowprobability of achieving book value in a reasonable time frame, then an impairment is recorded bywriting down the security to fair value.     The Company’s investment portfolio as of December 31, 2006, consisted principally of U.S.Government and agencies obligations, Puerto Rico Government and agencies obligations, andmortgage-backed securities issued or guaranteed by FHLMC, FNMA or GNMA. There were no investmentsecurities other than those referred to before in a significant unrealized loss position as ofDecember 31, 2006. In addition, the Company does not have investments in residual tranches.     Except for the PRGO’s mentioned before, at December 31, 2006 and 2005, the significantunrealized loss position relates to interest rate changes and not to market or credit deteriorationof any of the securities issuers. The Company assessed the ratings of the different agencies forthe mortgage-backed securities, noting that all of them have maintained the highest rating by allthe rating agencies and reflect a stable outlook. In addition, the held to maturity PRGO’s continueto be rated as investment grade as of December 31, 2006. Investment securities with prepaymentprovisions did not have significant unamortized premiums at December 31, 2006 and 2005. Theaggregate unrealized gross losses of the investment securities available for sale and held tomaturity amounted to $214.3 million and $224.9 million at December 31, 2006 and 2005, respectively,a decrease of $10.6 million. As management has the ability and intent to hold debt securities untilmaturity, or for the foreseeable future, if classified as available for sale, no declines aredeemed to be other-than-temporary at December 31, 2006 and 2005.SOURCES OF FUNDS     GENERAL. Deposits, federal funds purchased, repurchase agreements, Federal Home Loan Bank(“FHLB”) advances and lines of credit are the primary sources of Westernbank’s funds for use inlending and for other general business purposes. In addition, Westernbank obtains funds in the formof loan repayments and income from operations and the maturities and repayments of securities. Loanrepayments are a relatively stable source of funds, while net increases in deposits and repurchaseagreements 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 normalsources of funds such as savings inflows at less than projected levels.     DEPOSITS. Westernbank offers a diversified choice of deposit accounts. Savings depositsdecreased from $774.7 million as of December 31, 2005, to $728.9 million as of December 31, 2006, adecrease of $45.8 million or 5.92%. Other deposits represented mainly by time deposits, brokereddeposits and Individual Retirement Account deposits (IRA’s), increased from $7.60 billion as ofDecember 31, 2005, to $8.61 billion as of December 31, 2006, an increase of $1.01 billion or13.25%. Other deposits include brokered deposits amounting to $6.72 billion and $5.98 billion asof December 31, 2006 and 2005, respectively. These accounts have historically been a stable sourceof funds.
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     In connection with its asset/liability management, the Company uses brokered deposits sincethese deposits provide the flexibility of selecting short, medium and long term maturities tobetter match its asset/liability management strategies. Typically, brokered deposits tend to behighly rate-sensitive deposits, and therefore, these are considered under many circumstances to bean unstable source of funding for an institution as compared to deposits generated primarily in abank’s local markets. Brokered deposits come primarily from brokers that provide intermediaryservices for banks and investors, therefore providing banks, such as Westernbank, increased accessto a broad range of potential depositors who have no relationship with Westernbank and who activelyseek the highest returns offered within the financial industry. However, due to the competitivemarket for deposits in Puerto Rico, coupled with generally low interest rates in the United States,the rates paid by Westernbank on these deposits are often lower than those paid for local marketarea retail deposits. The Puerto Rico deposit market is more challenging than the deposit market onthe U.S. mainland. Puerto Rico has a relatively stable population base, a number of verycompetitive local banks looking to expand, and a large proportion of citizens that do not have bankaccounts. Also, the difference between the tax rate on interest earned from bank deposits, versusthe much lower tax rate on returns from investments held in local mutual funds, preferred stock andlocal GNMAs makes those other investments more attractive than deposits to some investors. Thesedynamics present significant challenges for gathering and retaining local retail deposits. Theresult is a high cost local deposits market. The Company believes that the benefits of brokereddeposits outweigh the risk of deposits instability.     At December 31, 2006, Westernbank had total deposits of $9.34 billion, of which $728.9 millionor 7.81% consisted of savings deposits, $274.5 million or 2.94% consisted of interest bearingdemand deposits, $373.6 million or 4.00% consisted of noninterest bearing deposits, and $7.96billion or 85.25% consisted of time deposits. Westernbank also offers negotiable order ofwithdrawal (“NOW”) accounts, Super Now accounts, special checking accounts and commercial demandaccounts.     At December 31, 2006, the scheduled maturities of time deposits in amounts of $100,000 or moreare as follows:       **(In thousands)**  3 months or less $206,827 over 3 months through 6 months  83,502 over 6 months through 12 months  98,498 over 12 months  92,225     Total $481,052          The following table sets forth the average amount and the average rate paid on the followingdeposit categories for the years ended December 31:                           **2006**  **2005**  **2004**   **Average**  **Average**  **Average**  **Average**  **Average**  **Average**   **amount**  **rate**  **amount**  **rate**  **amount**  **rate**   **(Dollars in thousands)**  Time deposits $7,305,932   4.72% $6,004,119   3.64% $4,630,244   3.12%Savings deposits  755,800   2.06%  802,994   2.09%  784,589   2.14%Interest bearing demanddeposits  279,886   2.08%  200,804   2.88%  200,190   2.63%Noninterest bearing demanddeposits  429,913   —   368,688   —   306,710   —                      $8,771,531   4.17% $7,376,605   3.27% $5,921,733   2.81%                   
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**BORROWINGS**     The following table sets forth the borrowings of the Company at the dates indicated:               **December 31,**   **2006**  **2005**  **2004**   **(In thousands)**  Federal funds purchased and repurchase agreements (1) $6,320,481  $6,260,029  $6,683,527 Advances from Federal Home Loan Bank (FHLB)  127,000   172,000   211,000 Mortgage note payable  35,968   36,432   36,858             $6,483,449  $6,468,461  $6,931,385            (1) Federal funds purchased amounted to $75.0 million at December 31, 2004, at aweighted average interest rate of 2.37%, and mature the next business day.No such borrowings were outstanding at December 31, 2006 and 2005.     Westernbank has made use of institutional federal funds purchased and repurchaseagreements in order to obtain funding, primarily through investment banks and brokerage firms.Repurchase agreements are collateralized with investment securities while federal funds purchaseddo not require collateral. Westernbank had $6.32 billion in repurchase agreements outstanding atDecember 31, 2006, at a weighted average interest rate of 4.96%. Repurchase agreements outstandingas of December 31, 2006, mature as follows: $1.07 billion within 30 days; $651.6 million within 31days to one year; $1.49 billion in 2008; $1.24 billion in 2009; $1.21 billion in 2010; and $657.7million thereafter.     Westernbank also obtains advances from FHLB of New York. As of December 31, 2006, Westernbankhad $127.0 million in outstanding FHLB advances at a weighted average interest rate of 5.54%.Advances from FHLB mature as follows: $25.0 million within 30 days; $60.0 million within 31 days toone year; and $42.0 million in 2010.     At December 31, 2006, with respect to repurchase agreements amounting to $3.42 billion, thecounterparties have the option to terminate the agreements at the first anniversary date and eachinterest payment date thereafter. Also, with respect to repurchase agreements and advances fromFHLB amounting to $380.0 million at December 31, 2006, at the first anniversary date and eachquarter thereafter, the FHLB has the option to convert them into replacement funding for the sameor a lesser principal amount based on any funding then offered by FHLB at the then current marketrates, unless the interest rate has been predetermined between FHLB and the Company. If theCompany chooses not to replace the FHLB’s funding, it will repay the convertible advances andrepurchase agreements, including any accrued interest, on such optional conversion date.     At December 31, 2006, Westernbank World Plaza, Inc., a wholly-owned subsidiary of WesternbankPuerto Rico, had outstanding $36.0 million of a mortgage note, at an interest rate of 8.05% peryear up to September 11, 2009. Subsequent to September 11, 2009, the mortgage note will bearinterest on the then outstanding principal balance at a rate per year equal to the greater of13.05% or the Treasury Rate plus five percentage points; or 10.05%, depending on the fulfillment ofcertain conditions on the repricing date. Westernbank World Plaza has a prepayment option on therepricing 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.
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     A summary of short-term borrowings, including federal funds purchased, repurchase agreementsand advances from Federal Home Loan Bank, and interest rates at and for the years ended December31, are indicated below:               **2006** **2005** **2004**  **(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 $3,077  $8,851  $23,753 Weighted-average interest rate for the year  4.69%  2.43%  1.95%Maximum month-end balance $40,000  $40,039  $95,005              Repurchase agreements:            Balance at end of year $1,070,582  $1,545,725  $4,138,257 Weighted-average interest rate at year end  5.33%  4.34%  2.30%Monthly average outstanding balance $1,731,600  $2,377,629  $2,377,042 Weighted-average interest rate for the year  4.97%  3.03%  1.67%Maximum month-end balance $2,282,650  $3,514,422  $4,206,540              Advances from FHLB:            Balance at end of year $25,000  $50,000  $25,000 Weighted-average interest rate at year end  5.43%  4.45%  2.41%Monthly average outstanding balance $33,462  $21,923  $21,250 Weighted-average interest rate for the year  5.01%  3.49%  1.65%Maximum month-end balance $50,000  $50,000  $50,000              Total short-term borrowings:            Balance at end of year $1,095,582  $1,595,725  $4,238,286 Weighted-average interest rate at year end  5.33%  4.34%  2.30%Monthly average outstanding balance $1,768,139  $2,408,403  $2,422,045 Weighted-average interest rate for the year  4.97%  3.03%  1.67%Maximum month-end balance $2,322,650  $3,579,461  $4,238,286 FINANCIAL INSTRUMENTS     DERIVATIVE FINANCIAL INSTRUMENTS. As part of the Company’s asset/liability management, theCompany uses interest-rate contracts, which include interest-rate exchange agreements (swaps), andoption agreements, to hedge various exposures or to modify interest rate characteristics of variousstatement of financial condition items.     The Company accounts for its derivatives under SFAS No. 133, Accounting for DerivativeInstruments and Hedging Activities**,**as amended. This Standard requires recognition of allderivatives as either assets or liabilities in the statement of financial condition and requiresmeasurement of those instruments at fair value through adjustments to either accumulated othercomprehensive income (loss) or current earnings or both, as appropriate. The Company designatesderivative instruments as either a fair value hedge, cash flow hedge or as a derivative instrumentnot designated as a hedge. For a fair value hedge, changes in the fair value of the derivativeinstrument and changes in the fair value of the hedged asset or liability or of an unrecognizedfirm commitment attributable to the hedged risk are recorded in current period net income. For acash flow hedge, changes in the fair value of the derivative instrument, to the extent that it iseffective, are recorded in accumulated other comprehensive income (loss) and subsequentlyreclassified to net income in the same period(s) that the hedged transaction impacts net income.For all hedging relationships, derivative gains and losses that are not effective in hedging thechanges in fair value or expected cash flows of the hedged item are recognized immediately incurrent period net income. Similarly, the changes in fair value of derivative instruments thatdo not qualify for hedge accounting under SFAS No. 133 are also reported in current period netincome, in noninterest income.     The net cash settlements on derivatives that qualify for hedge accounting are recorded ininterest income or interest expense, based on the item being hedged. The net cash settlements onderivatives that do not qualify for hedge accounting are reported in noninterest income within netgain (loss) on derivative instruments.
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     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 cashflow hedges to specific assets and liabilities on the statement of financial condition or tospecific firm commitments or forecasted transactions along with a formal assessment at bothinception of the hedge and on an ongoing basis as to the effectiveness of the derivative instrumentin offsetting changes in fair values or cash flows of the hedged item. The Company discontinueshedge accounting prospectively when it is determined that the derivative is or will no longer beeffective in offsetting changes in the fair value or cash flows of the hedged item, the derivativeexpires, is sold, or terminated, or management determines that designation of the derivative as ahedging instrument is no longer appropriate.     When hedge accounting is discontinued, the future gains and losses arising from any change infair value of the derivative are recorded as noninterest income. When a fair value hedge isdiscontinued, the hedged asset or liability is no longer adjusted for changes in fair value and theexisting basis adjustment is amortized or accreted over the remaining life of the asset orliability. When a cash flow hedge is discontinued but the hedged cash flows or forecastedtransaction is still expected to occur, gains or losses that were accumulated in othercomprehensive income are amortized or accreted into earnings over the same periods which the hedgedtransactions would have affected earnings.     The fair values of the indexed option contracts and the interest rate swaps used to manage theexposure to the stock market were obtained from dealer quotes. In the case of other interest rateswaps, the fair values were obtained using an independent valuation model and periodically comparedto dealer quotes. The fair values produced by this proprietary valuation model are in parttheoretical and therefore can vary between derivative dealers and are not necessarily reflective ofthe actual price at which the contract could be traded. Small changes in assumptions can result insignificant changes in valuation. The risks inherent in the determination of the fair value of aderivative may result in income statement volatility.     Certain contracts contain embedded derivatives. When the embedded derivative possesseseconomic characteristics that are not clearly and closely related to the economic characteristicsof the host contract, it is bifurcated from the host contract and carried at fair value.     The Company maintains an overall interest rate risk management strategy that incorporates theuse of derivative instruments to minimize significant unplanned fluctuations in earnings and cashflows caused by interest rate volatility. The Company’s interest rate risk management strategy mayinvolve modifying the repricing characteristics of certain assets and liabilities so that changesin interest rates do not adversely affect the net interest margin and cash flows. Derivativeinstruments that the Company may use as part of its interest rate risk management strategy includeinterest 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 derivativeare based. Notional amounts do not represent direct credit exposures. Direct credit exposure islimited to the net difference between the calculated amounts to be received and paid, if any. Thefair value of a derivative is based on the estimated amount the Company would receive or pay toterminate the derivative contract, taking into account the current interest rates and thecreditworthiness of the counterparty. The fair value of the derivatives is reflected on theCompany’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 thecounterparties to these agreements. The Company controls the credit risk of its financial contractsthrough credit approvals, limits and monitoring procedures, and does not expect any counterpartiesto fail their obligations. The Company deals only with primary dealers.     Derivative instruments are generally negotiated over-the-counter (“OTC”) contracts. NegotiatedOTC derivatives are generally entered into between two counterparties that negotiate specificagreement 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 interestpayment obligations without the exchange of the underlying principal amounts. Entering intointerest-rate swap contracts involves not only the risk of dealing with counterparties and theirability to meet the terms ofthe contracts, but also the interest rate risk associated with unmatched positions. Interestrate 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 averageappreciation of the month end value of the Standard & Poor’s 500 Composite Stock Index over aspecified period in exchange for the payment of a premium when the contract is initiated. Thecredit risk inherent in the indexed options is the risk that the exchange party may default.
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     The Company utilizes interest rate swaps (“CD Swaps”) to convert a portion of its fixed-ratebrokered certificates of deposit (“CDs”) (liabilities) or firm commitments to originate fixed-ratebrokered CDs to a variable rate. The purpose of entering into these CD swaps is to hedge the riskof changes in the fair value of certain brokered CDs or firm commitments to originate brokered CDsattributable to changes in the LIBOR rate (interest rate risk). The hedged brokered CDs aretypically structured with terms of 3 to 20 years with a call option on the Company’s part, but nosurrender option for the CD holder, other than for death or disability. The extended term of thebrokered CDs minimizes liquidity risk while the option to call the CDs after the first yearprovides the Company with funding flexibility.     On January 3, 2006, the Company redesignated most of its CD Swaps relating to certain CDsutilizing the “long-haul” method of SFAS No. 133 and completed new contemporaneous hedgingdocumentation. In cases in which the hedging relationship is effective, the changes in the fairvalue of both the hedged items (the CDs) and the interest rate swaps are recorded through earnings.At December 31, 2006, the notional amount of these CD Swaps and the principal balance of the hedgedCDs amounted to $516,020,000.     The Company offers its customers certificates of deposit which contain an embedded derivativetied to the performance of the Standard & Poor’s 500 Composite Stock Index that is bifurcated fromthe host deposit and recognized in the consolidated statements of financial condition in accordancewith SFAS No. 133. At the end of five years, the depositor will receive a specified percent of theaverage increase of the month-end value of the stock index. If such index decreases, the depositorreceives the principal without any interest. The Company uses option and interest rate swapagreements with major broker dealer companies to manage its exposure to the stock market. Under theoption agreements, the Company will receive the average increase in the month-end value of theindex in exchange for the payment of a premium when the contract is initiated. Under the terms ofthe swap agreements, the Company also will receive the average increase in the month-end value ofthe index in exchange for a quarterly fixed interest cost. Since the embedded derivative instrumenton the certificates of deposit and the option and interest rate swap agreements do not qualify forhedge accounting, these derivative instruments are marked to market through earnings.     See Note 19 to the consolidated financial statements for a detail of derivative transactions,included herein in Part II, Item 8.     **Off-balance sheet credit related financial instruments**— In the ordinary course of business,Westernbank enters into off-balance sheet credit related financial instruments consisting ofcommitments to extend credit, commitments under credit-card arrangements and standby and commercialletters of credit. Such financial instruments are recorded in the financial statements when theyare funded or related fees are incurred or received. Westernbank periodically evaluates the creditrisks inherent in these commitments, and standby and commercial letters of credit, and establishesloss allowances for such risks if and when these are deemed necessary. For the years ended December31, 2006 and 2005, Westernbank did not record any loss allowances in connection with risks involvedin off-balance sheet instruments. At December 31, 2006 and 2005, there were no additionaloff-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 theinterest income received on its interest-earning assets and the interest paid on itsinterest-bearing liabilities. Net interest income for the year ended December 31, 2006, was $318.8million, an increase of $7.2 million or 2.32%, from $311.6 million for the prior year. The increasein 2006 was the result of increases in interest income from loans and from investment securities,mainly in tax-exempt securities, which was partially offset by increases in interest expense ondeposits and on federal funds purchased and repurchase agreements. Net interest income for theyear ended December 31, 2005, was $311.6 million, an increase of $34.4 million or 12.42%, from$277.2 million for the prior year. The increase in 2005 was the result of increases in interestincome from loans, investment securities, mainly in tax-exempt securities, and money marketinstruments, which was partially offset by increases in interest expense on deposits, on federalfunds purchased and repurchase agreements and on advances from the Federal Home Loan Bank.
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     The following table presents, for the periods indicated, the total dollar amount of interestincome from average interest-earning assets and the resultant yields, as well as the interestexpense on average interest-bearing liabilities, expressed both in dollars and rates, as well as ina normal and tax equivalent basis. Average balances are daily monthly average balances. The yieldon the securities portfolio is based on average amortized cost balances and does not give effect tochanges in fair value that are reflected as a component of consolidated stockholders’ equity forinvestment securities available for sale.                                       **YEAR ENDED DECEMBER 31,**   **2006**  **2005**  **2004**       **Average**  **Average**      **Average**  **Average**      **Average**  **Average**   **Interest**  **balance (1)**  **Yield / Rate**  **Interest**  **balance (1)**  **Yield / Rate**  **Interest**  **balance (1)**  **Yield / Rate**   **(Dollars in Thousands)** Normal Spread:                                    Interest-earning assets:                                    Loans, including loan fees (2) $671,530  $8,308,353   8.08% $479,042  $6,986,626   6.86% $322,164  $5,401,955   5.96%Investment securities (3)  261,971   6,519,398   4.02   247,533   6,267,159   3.95   212,213   5,400,997   3.93 Mortgage-backed securities (4)  28,489   632,792   4.50   32,321   752,839   4.29   37,489   935,421   4.01 Money market instruments  38,235   845,375   4.52   36,433   950,980   3.83   19,510   745,828   2.62                             Total  1,000,225   16,305,918   6.13   795,329   14,957,604   5.32   591,376   12,484,201   4.74                                                                  Interest-bearing liabilities:                                    Deposits  366,063   8,771,531   4.17   241,268   7,376,605   3.27   166,237   5,921,733   2.81 Federal funds purchased andrepurchase agreements  307,463   6,290,818   4.89   234,791   6,398,451   3.67   141,414   5,676,595   2.49 Advances from FHLB  7,893   147,780   5.34   7,688   184,153   4.17   6,568   164,245   4.00                             Total  681,419   15,210,129   4.48   483,747   13,959,209   3.47   314,219   11,762,573   2.67                                                                  Net interest income $318,806          $311,582          $277,157                                           Interest rate spread          1.65%          1.85%          2.07%                                  Net interest-earning assets     $1,095,789          $998,395          $721,628                                       Net yield on interest-earningassets (5)          1.96%          2.08%          2.22%                                  Ratio of interest-earning assetsto interest-bearing liabilities      107.20%          107.15%          106.13%                                                                           Tax Equivalent Spread:                                    Interest-earning assets $1,000,225  $16,305,918   6.13% $795,329  $14,957,604   5.32% $591,376  $12,484,201   4.74%Tax equivalent adjustment  16,502   —   0.11   41,305   —   0.27   53,555   —   0.43                             Interest-earning assets -tax equivalent  1,016,727   16,305,918   6.24   836,634   14,957,604   5.59   644,931   12,484,201   5.17                                                                  Interest-bearing liabilities  681,419  $15,210,129   4.48   483,747  $13,959,209   3.47   314,219  $11,762,573   2.67                             Net interest income $335,308          $352,887          $330,712                                           Interest rate spread          1.76%          2.12%          2.50%                                  Net yield on interest-earning assets (5)          2.06%          2.36%          2.65%                                   (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 $16.3 million for each of the years   ended December 31, 2006 and 2005, and $10.0 million for the year ended December 31, 2004. (3) Includes available for sale securities. (4) Includes trading and available for sale securities. (5) Net interest income divided by average interest-earning assets.
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     The following table presents the dollar amount of changes in interest income and interestexpense for the major components of interest-earning assets and interest-bearing liabilities anddistinguishes between the increase (decrease) related to changes in outstanding balances andchanges in interest rates.                           **Year ended December 31,**   **2006 vs. 2005** **2005 vs. 2004**   **Volume**  **Rate**  **Total**  **Volume**  **Rate**  **Total**   **(In thousands)** Interest income:                        Loans $98,956  $93,532  $192,488  $103,874  $53,004  $156,878 Investment securities (1)  10,084   4,354   14,438   34,205   1,115   35,320 Mortgage-backed securities (2)  (5,515)  1,683   (3,832)  (8,138)  2,970   (5,168)Money market instruments  (4,324)  6,126   1,802   6,294   10,629   16,923                    Total increase in interest income  99,201   105,695   204,896   136,235   67,718   203,953                    Interest expense:                        Deposits  50,744   74,051   124,795   44,875   30,156   75,031 Federal funds purchased andrepurchase agreements  (3,880)  76,552   72,672   19,785   73,592   93,377 Advances from FHLB  (495)  700   205   822   298   1,120                    Total increase in interest expense  46,369   151,303   197,672   65,482   104,046   169,528                    Increase (decrease) innet interest income $52,832  $(45,608) $7,224  $70,753  $(36,328) $34,425                     (1) Includes available for sale securities. (2) Includes trading and available for sale securities.     The following table sets forth, for the periods indicated, certain ratios reflecting theproductivity and profitability of the Company:               **YEAR ENDED DECEMBER 31, (1)**  **2006** **2005** **2004** Return on assets **(2)**  0.60%  1.07%  1.33%Return on common stockholders’ equity **(3)**  9.36   20.53   28.79 Dividend payout ratio to common stockholders **(4)**  49.10   24.25   16.24 Equity-to-asset ratio **(5)**  7.27   7.45   7.36  (1) Averages computed using beginning and period-end balances. (2) Net income divided by average total assets. (3) Income available to common stockholders divided by average common stockholders’ equity. (4) Common stockholders’ dividend declared divided by income available to common stockholders. (5) Average equity divided by average total assets.
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ECONOMIC CONDITIONS, MARKET AREA AND COMPETITION     Puerto Rico (the “Island”), a Commonwealth of the United States of America (the “U.S.”), isthe easternmost of the Greater Antilles and the fourth largest island of the Caribbean. The Islandis located at the crossroads between North and South America, at just 3.5 hours airtime from NewYork 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 servein the United States Armed Forces. As in the U.S., the Island has a local judicial system. TheIsland 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 ownInternal Revenue system and is not subject to U.S. taxes. Spanish and English are the officiallanguages of the Island.     The Island uses U.S. currency and forms part of the U.S. financial system. As a Commonwealthof the U.S., the Island falls within the U.S. for purposes of customs and migration, and thereforethere is a full exchange of funds, people and goods between the Island and the U.S. Puerto Ricobanks are subject to the same Federal laws, regulations and supervision as those of the financialinstitutions operating in the rest of U.S. The Federal Deposit Insurance Corporation insures thedeposits of Puerto Rico chartered commercial banks, including Westernbank, the banking subsidiaryof W Holding Company, Inc.     The Island economy operates as a region within the U.S., and therefore factors affecting theUS economy usually have a significant impact on the performance of Island economy. These includeexports, direct investment, the amount of federal transfer payments, the level of interest rates,the level of oil prices, the rate of inflation, and tourist expenditures. In the past, the economyof the Island has generally followed economic trends in the overall U.S. economy. However, inrecent years economic growth in Puerto Rico has lagged behind growth in the U.S.     The economy of the Island is mainly driven by the manufacturing and service sectors. Themanufacturing sector has experienced positive and negative changes over the past years as a resultof increased emphasis on higher wage, high technology industries such as pharmaceuticals,biotechnology, electronics, computers, microprocessors, professional and scientific instruments,and certain high technology machinery and equipment; in addition to the reduction of taxincentives. In recent years, the service sector also has played a major role in the economy,leading all sectors in providing employment.     In 2006, the Island economy continued its trend of decreasing growth, primarily due to weakermanufacturing, softer consumption and decreased government investment in construction. Considerabledeclines were recorded during year 2006 in the local manufacturing sector. Three important pointsfor the manufacturing sector (jobs, hours worked and payroll) pointed toward the continuedweakening of local manufacturing activity. During 2006, the manufacturing sector lost approximately5,600 jobs in comparison with figures reported in 2005, for a decrease of 5.0%, although manymultinational corporations continue to have substantial operations in the Island. As in year 2005,the construction sector, a historical backbone of the Island economy, remained relatively weakduring year 2006, as the combination of rising interest rates, the Commonwealth’s fiscal situationand decreasing public investment in construction projects affected the sector. The value ofconstruction permits during the year ended December 31, 2006declined by approximately 23.2% when compared to 2005, withmost of the drop coming from the public sector. The multiplier effect of a decrease in capitalinvestment has been already felt in other areas of the Island economy, with the banking sector oneof the most affected.     The banking sector has been historically the financial support for all the industrial andcommercial activity on the Island. At December 31, 2006, there were approximately twelve (12) banksoperating in Puerto Rico, with total assets, loans and deposits of approximately $95.39 billion,$60.23 billion and $56.80 billion, respectively. U.S. banks, foreign banks and the major PuertoRican banks all offer commercial banking services designed to support the emerging requirements oftheir local clients as well as of their international clients. The economic strength and liquidityof local financial institutions, considered the pillar of the Island’s economy, have allowed thePuerto Rico banking sector to extend credit, without which the Island’s economy could not besustained. The growing combination of loans, deposits and assets has been the key to the economicprogress for the past years. Loans, in particular, have played a key role in keeping the Islandeconomy afloat, through either personal, mortgage or commercial loans.     Other economic indicators for year 2006 showed additional signals of weakness, as the Islandunemployment rate, which has been historically higher than the average U.S. unemployment rate,stands at 10% at December 31, 2006, since although the number of jobs was increasing; the workforcewas growing at a faster tempo. The rate of participation in the Island workforce has been estimatedin approximately 47.5%. The Puerto Rico Gross Domestic Product remained unchanged in fiscal year2006. The increase in the consumer price index in year 2006 was approximately 12.0%.     Tourism is the one sector that has been resilient. Activity in the sector has expandedconsistently since 2004, and in the year ended December 31, 2006 it registered the strongestincrease in four years. Factors that may be boosting the tourism sector are geo-political tensionsthroughout the world and a relative stable U.S. economy.
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     The financial services and banking business are highly competitive, and the profitability ofthe Company will depend principally upon the Company’s ability to continue to compete in its marketarea as well as to a significant extent upon general economic conditions in its market place. TheCompany competes with other commercial and non-commercial banks, finance companies, mutual funds,insurance companies, brokerage and investment banking firms, asset-based non-bank lenders andcertain other non-financial institutions, including certain governmental organizations which mayoffer subsidized financing at lower rates than those offered by the Company. The Company has beenable to compete effectively with other financial institutions by emphasizing technology andcustomer service, including local office decision-making on loans, establishing long-term customerrelationships and building customer loyalty, and by providing products and services designed toaddress the specific needs of its customers. Significant deterioration in the local economy orexternal economic conditions, such as inflation, recession, unemployment, real estate values andother factors beyond the Company’s control, could also substantially impact the Company’sperformance. There can be no assurance that future adverse changes in the local economy would nothave a material adverse effect on the Company’s consolidated financial condition, results ofoperations or cash flows.**Current Fiscal Situation**     During 2005 and 2006, the Commonwealth of Puerto Rico considered several alternatives for acomprehensive tax and fiscal reform. On July 4, 2006, the Puerto Rico legislature approvedlegislation amending the PR Code to provide, among other things, for a general sales and use tax of5.5%, a municipal sales and use tax of 1.5% and certain tax relief measures to be implemented aspart of the tax reform. Although the tax and fiscal reforms have been adopted, there is noassurance that such measures will generate the projected revenues or savings. It is impossible forthe Company to predict the impact that the current fiscal situation of the Commonwealth will haveon the Island economy and thus on the Company’s results of operations.**Rating Downgrades on the Government of Puerto Rico’s Debt Obligations**     Even though the Island economy is closely integrated to that of the U.S. mainland and itsgovernment and many of its instrumentalities are investment-grade rated borrowers in the U.S.capital markets, the current fiscal situation of the Island has led nationally recognized ratingagencies to downgrade its debt obligations.     In May 2006, Moody’s Investors Service downgraded the Government’s general obligation bondrating to Baa3 from Baa2, and put the credit on “watch list” for possible further downgrades. TheCommonwealth’s appropriation bonds and some of the subordinated revenue bonds were also downgradedby one notch and are now rated just below investment grade at Ba1. Moody’s commented that thisaction reflects the Government’s strained financial condition, the ongoing political conflict andlack of agreement regarding the measures necessary to end the government’s multi-year trend offinancial deterioration. Standard & Poor’s Rating Services (“S&P”) still rates the Government’sgeneral obligations two notches above junk at BBB, and the Commonwealth’s appropriation bonds andsome of the subordinated revenue bonds BBB-, a category that continues to be investment-graderated.     In July 2006, S&P and Moody’s affirmed their credit ratings on the Commonwealth debt, andremoved the debt from their respective watch lists, thus reducing the possibility of an immediateadditional downgrade. These actions resulted after the Government approved the budget for thefiscal year 2007, which runs from July 2006 through June 2007, which included the adoption of a newsales tax. Revenues from the sales tax will be dedicated primarily to fund the government’soperating expenses, and to a lesser extent, to repay government debt and fund local municipalgovernments.     Both rating agencies maintained the negative outlook for the Puerto Rico obligation bonds.Factors such as the government’s ability to implement meaningful steps to curb operatingexpenditures, improve managerial and budgetary controls, and eliminate the government’s reliance onoperating budget loans from the Government Development Bank for Puerto Rico will be keydeterminants of future rating stability and restoration of a stable long-term outlook. Also, theinability to agree on future fiscal year Commonwealth budgets could result in ratings pressure fromthe rating agencies.     It is uncertain how the financial markets may react to any potential future ratings downgradein Puerto Rico’s debt obligations. However, the fallout from recent budgetary crisis and a possibleratings downgrade could adversely affect the value of Puerto Rico’s Government obligations.     During the quarter ended June 30, 2006, management concluded that certain held to maturityinvestments in Puerto Rico Government Obligations (“PRGO’s”), with an amortized cost of $21,615,000were other-than-temporarily impaired and recorded an impairment loss of $1.1 million. Thesesecurities were downgraded by one notch below investment grade in May 2006. As a result of thedowngrade just below investment grade of these PRGO’s, they were transferred to the available forsale category at their fair value of $20,552,000.
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EMPLOYEES     At December 31, 2006, the Company had 1,363 full-time employees, including its executiveofficers. The Company considers its employee relations to be excellent.REGULATION     The Company is a registered bank holding company under the Bank Holding Company Act of 1956,as amended (the “BHC Act”), that has elected to become a financial holding company. The Company issubject to the regulation, supervision, and examination by the Board of Governors of the FederalReserve System (“FRB”). The Company is required to file periodic reports and other information withthe FRB and the FRB may conduct examinations of the Company. Westernbank is subject to theregulation, supervision and examination of the Federal Deposit Insurance Corporation (“FDIC”) andthe Puerto Rico Commissioner of Financial Institutions (the “Puerto Rico Commissioner”) and, as tocertain 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. Theguidelines apply on a consolidated basis and generally require bank holding companies to maintain aratio of Tier 1 capital to total average assets of at least 4.0%. There is a minimum ratio of 3.0%established for the most highly rated bank holding companies. The FRB’s capital adequacy guidelinesalso require bank holding companies to maintain a minimum ratio of Tier 1 capital to risk-weightedassets of 4.0% and a minimum ratio of qualifying total capital to risk-weighted assets of 8.0%. TheCompany’s ability to pay dividends to its stockholders and other activities can be restricted ifits capital falls below levels established by the FRB’s guidelines. In addition, any bank holdingcompany whose capital falls below levels specified in the guidelines can be required to implement aplan to increase capital. As of December 31, 2006, the Company’s ratio of Tier 1 capital to averageassets was 7.23%, its ratio of Tier 1 capital to risk-weighted assets was 11.47%, and its ratio oftotal capital to risk-weighted assets was 12.51%.     Under the guidelines for qualifying total capital, at least half of the total capital is to becomprised of Tier 1 Capital. Tier 1 capital generally consists of common stock, retained earnings,noncumulative perpetual preferred stock, qualifying trust preferred securities and minorityinterests in certain subsidiaries, less any amounts of goodwill, other intangible assets,interest-only strips receivables, deferred tax asset, nonfinancial equity investments, and otheritems that are required to be deducted under FRB guidelines. The remainder may consist ofsupplementary capital elements, including subordinated debt, other preferred stock and loan andlease loss reserves, all subject to various qualifications and limitations (“Tier 2 Capital”). Withrespect to risk-based and leverage capital ratios, most intangibles, including core depositintangibles, are deducted from Tier 1 Capital. The regulations, however, permit the inclusion of alimited amount of intangibles related to originated and purchased mortgage servicing rights andpurchased credit card relationships and include a “grandfathered” provision permitting inclusion ofcertain existing intangibles.     Under the Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”), thefederal banking regulators must take prompt corrective action with respect to depositoryinstitutions that do not meet minimum capital requirements. Prompt corrective action provisions arenot applicable to bank holding companies. The FDICIA and the regulations issued thereunderestablished five capital tiers: (i) “well capitalized”, if a depository institution has a totalrisk-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 capitalorder or directive; (ii) “adequately capitalized”, if it has a total risk-based capital ratio of8.0% or more, a Tier I risk-based capital ratio of 4.0% or more and a Tier I leverage capital ratioof 4.0% or more (3.0% under certain circumstances) and does not meet the definition of “wellcapitalized”, (iii) “undercapitalized”, if it has a total risk-based capital ratio that is lessthan 8.0%, a Tier I risk-based ratio that is less than 4.0% or a Tier I leverage capital ratio thatis less than 4.0% (3.0% under certain circumstances), (iv) “significantly undercapitalized”, if ithas a total risk-based capital ratio that is less than 6.0%, a Tier I risk-based capital ratio thatis less than 3.0% or a Tier I leverage capital ratio that is less than 3.0%, and (v) “criticallyundercapitalized”, if it has a ratio of tangible equity to total assets that is equal to or lessthan 2.0%. Generally, a depository institution may be deemed to be in a capitalization categorythat is lower than is indicated by its actual capital position if it received a less thansatisfactory examination rating at its most recent examination and did not subsequently address theexaminer’s concerns or if its primary federal regulator determines, after notice and theopportunity for a hearing, that the depository institution’s condition is unsafe or unsound. As ofthe most recently completed fiscal quarter, December 31, 2006, Westernbank was well capitalized,with a ratio of Tier I capital to average assets of 6.81%, a ratio of Tier I capital torisk-weighted assets of 10.77%, and a ratio of total capital to risk-weighted assets of 11.81%.     FDICIA generally prohibits a depository institution from making any capital distribution(including the payment of a dividend) or paying any management fees to its holding company if thedepository institution would thereafter be undercapitalized. Undercapitalized depositoryinstitutions are subject to restrictions on borrowings from the Federal Reserve System. Inaddition, undercapitalized depository institutions are subject to growth limitations and arerequired to submit capital restoration plans. A depository institution’s holding company mustguarantee
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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 capitaldeficiency when the institution fails to comply with the plan. The federal banking agencies may notaccept a capital plan without determining, among other things, that the plan is based on realisticassumptions and is likely to succeed in restoring the depository institution’s capital.Significantly undercapitalized depository institutions may be subject to a number of requirementsand restrictions, including orders to sell sufficient voting stock to become adequatelycapitalized, requirements to reduce total assets, and cessation of receipt of deposits fromcorrespondent banks. Critically undercapitalized depository institutions are subject to theappointment of a receiver or conservator.     Failure to meet the capital guidelines could subject an institution to a variety ofenforcement remedies, including the termination of deposit insurance by the FDIC, and to certainrestrictions on its business. At December 31, 2006, the Company and Westernbank were in compliancewith all capital requirements. For more information, refer to Note 15 to the consolidated financialstatements, included in Part II, Item 8.     DIVIDEND RESTRICTIONS. The principal source of funds of the Company is dividends fromWesternbank. The ability of Westernbank to pay dividends on its common stock is restricted by thePuerto Rico Banking Act, the Federal Deposit Insurance Act (“FDIA”) and FDIC regulations. Ingeneral terms, the Puerto Rico Banking Act provides that when the expenditures of a bank aregreater than receipts, the excess of expenditures over receipts shall be charged against theundistributed profits of the bank and the balance, if any, shall be charged against the requiredreserve fund of the bank. If there is no sufficient reserve fund to cover such balance in whole orin part, the outstanding amount shall be charged against the bank’s capital account. The PuertoRico Banking Act provides that until said capital has been restored to its original amount and thereserve fund restored to 20% of the original capital, the bank may not declare any dividends. Ingeneral terms, the FDIA and the FDIC regulations restrict the payment of dividends when a bank isundercapitalized, when a bank has failed to pay insurance assessments, or when there are safety andsoundness concerns regarding a bank.     The payment of dividends by Westernbank may also be affected by other regulatory requirementsand policies, such as maintenance of adequate capital. If, in the opinion of the regulatoryauthority, a depository institution under its jurisdiction is engaged in, or is about to engage in,an unsafe or unsound practice, which depending on the financial condition of the depositoryinstitution, could include the payment of dividends, such authority may require, after notice andhearing, that such depository institution cease and desist from such practice. The FRB has issued apolicy statement that provides that bank holding companies should generally pay dividends only outof operating earnings for the current and preceding two years. In addition, all insured depositoryinstitutions are subject to the capital-based limitations required by FDICIA.     ACQUISITIONS AND CHANGE OF CONTROL. FRB approval is required if the Company seeks to acquiredirect or indirect ownership or control of any voting shares of a bank or bank holding company if,after such acquisition, the Company would own or control directly or indirectly more than 5% of thevoting stock of the bank or bank holding company. FRB approval also must be obtained if the Companyseeks to acquire all or substantially all of the assets of a bank or merges or consolidates withanother bank holding company.     The Company is required to give the FRB prior written notice of any purchase or redemption ofits outstanding equity securities if the gross consideration for the purchase or redemption, whencombined with the net consideration paid for all such purchases or redemptions during the preceding12 months, will be equal to 10% or more of the Company’s consolidated net worth. The FRB maydisapprove any purchase or redemption if it determines that the proposal would constitute an unsafeand unsound practice, or would violate any law, regulation, order or directive of the FRB, or anycondition imposed by, or written agreement with, the FRB. Such notice and approval is not requiredfor a bank holding company that would be, both before and after the purchase or redemption,considered “well capitalized” under applicable regulations of the FRB, that received a rating of“1” or “2” overall and for management at its most recent examination, and that is not the subjectof any unresolved supervisory issues. Notwithstanding the foregoing, any redemption of theCompany’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 itsactivities and financial condition, and it must obtain regulatory approval prior to entering intocertain transactions, such as mergers with, or acquisitions of, other depository institutions andopening or acquiring branch offices. The Puerto Rico Commissioner and the FDIC conduct periodicexaminations to assess Westernbank’s compliance with various regulatory requirements. Thisregulation and supervision is intended primarily for the protection of the deposit insurance fundsand depositors. The regulatory authorities have extensive discretion in connection with theexercise of their supervisory and enforcement activities, including the setting of policies withrespect to the classification of assets and the establishment of adequate loan loss reserves forregulatory purposes.
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     Westernbank derives its lending, investment and other powers primarily from the applicableprovisions of the Puerto Rico Banking Law and the regulations adopted thereunder. That law governsthe responsibilities of directors, officers and stockholders, and the corporate powers, savings,lending, capital and investment requirements and other activities of Westernbank. The Puerto RicoCommissioner has extensive rulemaking power and administrative discretion under the Puerto RicoBanking Law, and generally examines Westernbank on an annual basis.     The Puerto Rico Banking Act requires that at least 10% of the yearly net income of Westernbankbe credited annually to a reserve fund. This must be done every year until the reserve fund isequal to the total paid-in capital for common stock and preferred stock or 10% of total deposits.At December 31, 2006, Westernbank had an adequate reserve fund established. The Puerto Rico BankingLaw also provides that when the expenditures of a bank are greater than the receipts, the excess ischarged against the undistributed profits of the bank, and the balance, if any, is charged againstand 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 thecapital has been restored to its original amount and the reserve fund to 20% of the originalcapital.     Under the Puerto Rico Banking Act, Westernbank must maintain a legal reserve in an amountequal to at least 20% of Westernbank’s demand liabilities, except certain government deposits. AtDecember 31, 2006, Westernbank had a legal reserve of 490.27%.     The Puerto Rico Finance Board (the “Finance Board”), which includes as its members the PuertoRico Commissioner, the Secretary of the Treasury, the Secretary of Commerce, the Secretary ofConsumer Affairs, the President of the Economic Development Bank, the President of the GovernmentDevelopment Bank and the President of the Planning Board, has the authority to regulate maximuminterest rates and finance charges that may be charged on loans to individuals and unincorporatedbusinesses in Puerto Rico. The current regulations of the Finance Board provide that the applicableinterest rate on loans to individuals and unincorporated businesses, including real estate loans,is to be determined by free competition. In addition, the current regulations of the Finance Boarddo not set a maximum interest rate for retail sales installment contracts, for credit cardpurchases and for installment sales contracts involving motor vehicles, commercial, agriculturaland industrial equipment, commercial electric appliances, and insurance premiums.     Under Puerto Rico law, no person or company may acquire direct or indirect control of abank or a bank holding company without first obtaining the prior approval of the Puerto Rico Commissioner. Controlis defined to mean the power, directly or indirectly, to direct or decisively influence themanagement or the operations of the bank or the bank holding company. Control is presumed to exist if a person orentity, or group acting in concert, would become the owner, directly or indirectly, of more than 5%of the voting stock of the bank or the bank holding company as a result of the transfer of voting stock, and suchperson, 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. OnFebruary 8, 2006 the President signed the Federal Deposit Insurance Reform Act of 2005 (the “ReformAct”). The Reform Act provides for the merger of the Bank Insurance Fund (“BIF”) and the SavingsAssociation Fund (“SAIF”) into a single Deposit Insurance Fund (“DIF”) increases the maximum amountof the insurance coverage for certain retirement accounts and possible “inflation adjustments” inthe maximum amount of coverage available with respect to other insured accounts, and gave the FDICmore discretion to price deposit insurance according to risk for all insured institutionsregardless of the level of the level of the fund reserve ratio. On November 2, 2006, the FDICpromulgated final regulations implementing a revised risk-based assessment system based on thegreater discretion given to the FDIC under the Reform Act (“FDIC Assessment Rule”).     Pursuant to the FDIC Assessment rule, assessment rates for an insured depository institutioncontinue to vary based on the level of risk incurred in its activities. The FDIC Assessment Ruleestablishes four risk categories. An institution’s risk category is based partly upon whether theinstitution is well capitalized, adequately capitalized or less than adequately capitalized. Eachinsured institution is also assigned to one of three supervisory subgroups. Subgroup “A”institutions are financially sound institutions with only a few minor weaknesses; subgroup “B”institutions are institutions that demonstrate weaknesses that, if not corrected, could result insignificant deterioration; and subgroup “C” institutions are institutions with respect to whichthere is a substantial probability that the FDIC will suffer a loss in connection with theinstitution unless corrective action is taken to correct the areas of weakness. Well-capitalizedand well-managed banks are generally assigned to risk category I, while undercapitalized banks insupervisory subgroup “C” are generally assigned to risk category IV. Within risk category I, theFDIC Assessment rule combines supervisory ratings with other measures, such as measuring certainfinancial ratios or looking to long-term debt issuer ratings, to further differentiate risk and thepricing of deposit insurance coverage.
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     Well-capitalized and well managed banks, including the Company’s bank subsidiaries, have paidno premiums for FDIC insurance in recent years. However, under the FDIC Assessment Rule beginningin 2007, premiums related to deposits assessed by the DIF are to be assessed at an annual rate ofbetween 5 basis points and 7 basis points of deposits for institutions in risk category I, and upto 43 basis points of deposits for institutions in risk category IV. As part of the Reform Act,Congress provided credits to institutions that paid high premiums in the past to bolster the FDIC’sinsurance reserves.     FDIC insurance on deposits may be terminated by the FDIC, after notice and hearing, upon afinding by the FDIC that the insured bank has engaged or is engaging in unsafe or unsoundpractices, or is in an unsafe or unsound condition to continue operations as an insured bank, orhas violated any applicable law, regulation, rule or order of or condition imposed by or writtenagreement entered into with the FDIC.     Westernbank is also subject to quarterly payments on semiannual insurance premium assessmentsfor 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 LoanInsurance Corporation. The assessment for the payments on the FICO bonds for the quarter beginningon January 1, 2007 is 1.22 basis points for DIF-assessable deposits.     BROKERED DEPOSITS. FDIC regulations govern the receipt of brokered deposits. Under theseregulations, a bank cannot accept, rollover or renew brokered deposits (which term is defined alsoto 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 fromthe FDIC. However, a bank that is adequately capitalized may not pay an interest rate more than 75basis points over prevailing rates under any circumstances. The Company does not believe thebrokered deposits regulation has had or will have a material effect on the funding or liquidity ofWesternbank.     SAFETY AND SOUNDNESS STANDARDS. Section 39 of the FDIA requires each federal banking agencyto prescribe for all insured depository institutions that it regulates standards relating tointernal control, information systems and internal audit systems, loan documentation, creditunderwriting, interest rate exposure, asset growth, compensation, fees and benefits and such otheroperational and managerial standards as the agency deems appropriate. In addition, each federalbanking agency is required to adopt standards that specify (i) a maximum ratio of classified assetsto capital, (ii) minimum earnings sufficient to absorb losses without impairing capital, (iii) tothe extent feasible, a minimum ratio of market value to book value for publicly-traded shares ofthe 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 isrequired to prescribe standards for the employment contracts and other compensation arrangements ofexecutive officers, employees, directors and principal stockholders of insured depositoryinstitutions that would prohibit compensation, benefits and other arrangements that are excessiveor that could lead to a material financial loss for the institution. If an insured depositoryinstitution or its holding company fails to meet any of the standards described above, it may berequired to submit to the appropriate federal banking agency a plan specifying the steps that willbe taken to cure the deficiency. If an institution or holding company fails to submit an acceptableplan or fails to implement the plan, the appropriate federal banking agency will require theinstitution or holding company to correct the deficiency and, until it is corrected, may imposeother restrictions on the institution or holding company, including any of the restrictionsapplicable under the prompt corrective action provisions of FDICIA.     ACTIVITY RESTRICTIONS ON STATE-CHARTERED BANKS. State banks and their subsidiaries arelimited in their investments and activities engaged in as principal to those permissible underapplicable state law and that are permissible for national banks and their subsidiaries, unlesssuch investments and activities are specifically permitted by the FDIA or the FDIC determines thatsuch activity or investment would pose no significant risk to the DIF and the banks are, andcontinue to be, in compliance with applicable capital standards. The FDIC has by regulationdetermined that certain real estate investment activities do not present a significant risk to theDIF, provided they are conducted in accordance with the regulations. Provisions of theGramm-Leach-Bliley Act of 1999 (“GLB Act”), permit national banks to establish financialsubsidiaries that may engage in the activities permissible for financial holding companies, otherthan insurance underwriting, merchant banking and real estate development and investmentactivities. In order to exercise this authority, a bank and its depository institution affiliatesmust be well-capitalized, well-managed and have CRA ratings of at least “satisfactory”. For a statebank, such activities also must be permissible under relevant state law.     TRANSACTIONS WITH AFFILIATES AND INSIDERS OF WESTERNBANK. Transactions between Westernbank andany of its affiliates, including the Company, are governed by sections 23A and 23B of the FederalReserve Act, as implemented by the FRB’s Regulation W. An affiliate of a bank is generallyconsidered to be a company or entity that controls, is controlled by or is under common controlwith the bank. Generally, sections 23A and 23B (1) limit the extent to which a bank or itssubsidiaries 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 anamount equal to 20% of such capital stock and surplus, and (2) require that all such transactionsbe on terms that are consistent
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with safe and sound banking practices. The term “coveredtransactions” 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 itsaffiliates must be secured by collateral in amounts ranging from 100 to 130 percent of the loanamount, depending on the nature of the collateral. In addition, any covered transaction by a bankwith an affiliate and any sale of assets or provision of services to an affiliate must be on termsthat are substantially the same, or at least as favorable, to the bank as those prevailing at thetime for comparable transactions with nonaffiliated companies.     Sections 22(g) and (h) of the Federal Reserve Act place restrictions on loans by a bank toexecutive officers, directors, and principal stockholders. Under section 22(h), loans to adirector, an executive officer and to a stockholder controlling greater than 10% of a bank andcertain 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’sloans-to-one-borrower limit (generally equal to 15% of the institution’s unimpaired capital andsurplus for unsecured loans and an additional 10% of the institution’s unimpaired capital andsurplus for loans fully secured by readily marketable securities). Section 22(h) also requires thatloans to insiders and to insiders of affiliates be made on terms substantially the same as offeredin comparable transactions to other persons, unless the loans are made pursuant to a benefit orcompensation program that (i) is widely available to employees of the bank and (ii) does not givepreference to insiders over other employees of the bank. Section 22(h) also requires prior board ofdirector’s approval for certain loans, and the aggregate amount of extensions of credit by a bankto all insiders cannot exceed the institution’s unimpaired capital and surplus. Furthermore,Section 22(g) places additional restrictions on loans to executive officers.     COMMUNITY REINVESTMENT ACT. Under the Community Reinvestment Act (“CRA”), as implemented byfederal 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 entirecommunity, including low and moderate income neighborhoods. The CRA does not establish specificlending requirements or programs for financial institutions, nor does it limit an institution’sdiscretion to develop the types of products and services that it believes are best suited to itsparticular community, consistent with the CRA. The CRA requires federal examiners, in connectionwith the examination of a financial institution, to assess the institution’s record of meeting thecredit needs of its community and to take such record into account in its evaluation of certainapplications by such institution. The CRA also requires all institutions to make public disclosureof their CRA ratings. The Company has a Compliance and Risk Management Committee, which overseesthe planning of products, and services offered to the community, especially those aimed to servelow and moderate income communities. Westernbank, at its most recent evaluation of performanceunder the CRA, was rated satisfactory by FDIC examiners.     CUSTOMER INFORMATION SECURITY. The FRB, the FDIC and other bank regulatory agencies haveadopted final guidelines (the “Guidelines”) for safeguarding confidential, personal customerinformation. The Guidelines require each financial institution, under the supervision and ongoingoversight of its board of directors or an appropriate committee thereof, to create, implement andmaintain a comprehensive written information security program designed to ensure the security andconfidentiality of customer information, protect against any anticipated threats or hazards to thesecurity or integrity of such information and protect against unauthorized access to or use of suchinformation that could result in substantial harm or inconvenience to any customer. The FRB, FDICand the other banking regulatory agencies later supplemented the Guidelines to include arequirement that the security programs of financial institutions include the development andimplementation of a risk-based response program to address incidents of unauthorized access tocustomer information in customer information systems. The Company has adopted a customerinformation security program that has been approved by the Company’s board of directors.     ACTIVITIES AND INVESTMENTS. The activities as “principal” and equity investments ofFDIC-insured, state-chartered banks such as Westernbank are generally limited to those that arepermissible for national banks. Under regulations dealing with equity investments, an insuredstate-chartered bank generally may not directly or indirectly acquire or retain any equityinvestments of a type, or in an amount, that is not permissible for a national bank.     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 andregulation by the Federal Housing Finance Board. Each Federal Home Loan Bank provides a centralcredit facility primarily for member institutions. Westernbank, as a member of the FHLB of NewYork, is required to acquire and hold shares of capital stock in that FHLB in an amount equal tothe 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 FHLBadvances outstanding; or 0.3% of its total assets. At December 31, 2006, Westernbank held $38.0million in capital stock of the FHLB of New York.
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     Advances from a FHLB are secured by a member’s shares of stock in the institution, certaintype of mortgages and other assets, including investment securities. Interest rates charged foradvances vary depending upon maturity and the cost of funds to the FHLB. As of December 31, 2006,Westernbank had $127.0 million in outstanding advances and $448.0 million in repurchase agreementsfrom the FHLB of New York.     INTERNATIONAL BANKING CENTER REGULATORY ACT. The business and operations of WesternbankInternational Banking Entity are subject to supervision and regulation by the Puerto RicoCommissioner. Under the International Banking Center Regulatory Act, which provides for thecreation of international banking entities (“IBEs”) (“IBE Act”), no sale, encumbrance, assignment,merger, exchange or transfer of shares, interest or participation in the capital of an IBE may beinitiated without the prior approval of the Puerto Rico Commissioner, if by such transaction aperson 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 issuedthereunder by the Puerto Rico Commissioner (the “IBE Regulations”) limit the business activitiesthat may be carried out by an IBE. Such activities are limited in part to those involving personsand assets located outside of Puerto Rico. The IBE Act provides further that every IBE must havenot 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 segregatedbooks and records of all its transactions in the ordinary course of business. The Westernbank IBEalso is required thereunder to submit to the Puerto Rico Commissioner quarterly and annual reportsof its financial condition and results of operations, including annual audited financialstatements.     The IBE Act empowers the Puerto Rico Commissioner to revoke or suspend, after notice andhearing, a license issued thereunder if, among other things, the IBE fails to comply with the IBEAct, the IBE Regulations or the terms of its license, or if the Puerto Rico Commissioner finds thatthe business or affairs of the IBE are conducted in a manner that is not consistent with the publicinterest.     Pursuant to the provisions of Act No. 13 of January 8, 2004 (the “Act”), for taxable yearscommencing after June 30, 2003, the net income earned by an IBE that operates as a unit of a bankunder the Puerto Rico Banking Law, will be considered taxable and subject to income taxes at thecurrent tax rates in the amount by which the IBE taxable income exceeds 40% in the first applicabletaxable year (2004), 30% in the second year (2005) and 20% thereafter, of the taxable income ofWesternbank, including its IBE taxable income. Westernbank’s IBE carries on its books a significantamount of securities which are, irrespective of the IBE status, tax exempt by law. Moreover, theAct provides that IBE’s operating as subsidiaries will continue to be exempt from the payment ofincome taxes. For the years ended December 31, 2006 and 2005, the provisions of the Act did nothave any effect in the Company’s financial position or results of operations. As of December 31,2006, 2005 and 2004 and for the years then ended, substantially all of Westernbank International’sbusiness activities have consisted of investment in securities of and loans to entities principallylocated in the United States of America. Note 23 to the consolidated financial statements presentsfurther information about the Company’s business segments.     PRIVACY. Under the GLB Act, all financial institutions, including the Company, Westernbank andWesternbank Insurance Corp., are required to adopt privacy policies, restrict the sharing ofnonpublic customer data with nonaffiliated parties pursuant to their privacy policies or at thecustomer’s request, and establish procedures and practices to protect customer data fromunauthorized 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 privacyprovisions of the GLB Act.     ANTI-MONEY LAUNDERING. On October 26, 2001, the President signed into law comprehensiveanti-terrorism legislation known as the USA PATRIOT Act of 2001 (the “USA Patriot Act”). Title IIIof the USA Patriot Act substantially broadened the scope of the U.S. anti-money laundering laws andregulations by imposing significant new compliance and due diligence obligations, creating newcrimes and penalties and expanding the extra-territorial jurisdiction of the United States ofAmerica. The U.S. Treasury Department and federal banking agencies have issued a number ofregulations and other guidance implementing the USA Patriot Act requirements that apply tofinancial institutions. The regulations impose new obligations on financial institutions tomaintain appropriate policies, procedures and controls to detect, prevent and report moneylaundering and terrorist financing and to verify the identity of customers. The effectiveness of afinancial institution in establishing such policies, procedures and controls to combat moneylaundering activities is a factor to be considered in any application submitted by a financialinstitution under the Bank Merger Act, which applies to Westernbank, or any expansionary bankingproposal under the BHC Act, which applies to the Company.     REGULATORY ENFORCEMENT AUTHORITY. The enforcement powers available to federal bankingregulators include, among other things, the ability to assess civil money penalties, to issuecease-and-desist or removal orders, to require written agreements and to initiate injunctiveactions 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 orunsound 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 finalenforcement actions by the federal banking agencies. In addition, the FRB and FDIC may take variousother informal actions.
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     THE SARBANES-OXLEY ACT. The Sarbanes-Oxley Act of 2002, (“Sarbanes-Oxley”) implemented a broadrange of corporate governance and accounting measures for public companies (including publicly-heldfinancial holding companies such as the Company) designed to promote honesty and transparency incorporate America. Sarbanes-Oxley’s principal provisions, many of which have been interpretedthrough SEC regulations, provide for and include, among other things: (i) the creation of anindependent accounting oversight board; (ii) auditor independence provisions that restrictnon-audit services that accountants may provide to their audit clients; (iii) additional corporategovernance and responsibility measures, including the requirement that the chief executive officerand chief financial officer of a public company certify financial statements; (iv) the forfeitureof bonuses or other incentive-based compensation and profits from the sale of an issuer’ssecurities by directors and senior officers in the twelve month period following initialpublication of any financial statements that later require restatement; (v) an increase in theoversight of, and enhancement of certain requirements relating to, audit committees of publiccompanies and how they interact with the Company’s independent auditors; (vi) requirements thataudit committee members must be independent and are barred from accepting consulting, advisory orother compensatory fees from the issuer; (vii) requirements that companies disclose whether atleast one member of the audit committee is a ‘financial expert’ (as such term is defined by theSEC) 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 stocktransactions 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 insuredfinancial institutions on nonpreferential terms and in compliance with other bank regulatoryrequirements; (x) disclosure of a code of ethics and filing a Form 8-K for a change or waiver ofsuch code; and (xi) a range of enhanced penalties for fraud and other violations.     FUTURE LEGISLATION. Changes to federal and local laws and regulations (including changes ininterpretation or enforcement) can affect the operating environment of the Company and itssubsidiaries in substantial and unpredictable ways. From time to time, various legislative andregulatory proposals are introduced. These proposals, if codified, may change banking statutes andregulations and the Company’s operating environment and can have retroactive effect. If codified,these proposals could increase or decrease the cost of doing business, limit or expand permissibleactivities or affect the competitive balance among banks, savings associations, credit unions andother financial institutions. The Company cannot accurately predict whether those changes in lawsand regulations will occur, and, if those changes occur, the ultimate effect they would have uponour financial condition or results of operations. It is likely, however, that the current highlevel of enforcement and compliance-related activities of federal and local authorities willcontinue and potentially increase.CAPITAL, DIVIDENDS, STOCK SPLITS AND OPTION PLANS     Total stockholders’ equity as a measure of capital increased by $34.4 million in 2006 and by$115.9 million in 2005.     Since year 2000, the Company’s board of directors adopted the policy of paying dividends on amonthly basis. Initial dividend payments under this policy, were applied retroactively fordividends corresponding to the first three-month period ended March 31, 2000. Thereafter, dividendson common stock and preferred stock are being paid on the 15th day of each month for stockholdersof record as of the last day of the previous month.     On June 17, 2002, the Company’s board of directors declared a three-for-two split on itscommon stock, for stockholders of record as of June 28, 2002, and distributed on July 10, 2002. Theeffect of the stock split was a decrease to retained earnings and an increase in common stock of$20.8 million.     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 andretired during 2006, 2005 and 2004.     On November 4, 2003, the Company’s board of directors declared a three-for-two split on itscommon 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 commonstock of approximately $34.7 million.     On November 11, 2003, the Company’s board of directors declared a two percent (2%) stockdividend, 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 inpaid-in-capital and an increase in common stock of approximately $35.2 million, $33.1 million and$2.1 million, respectively.
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     On December 6, 2004, the Company’s board of directors declared a three-for-two split on itscommon 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 commonstock of approximately $54.6 million.     On December 13, 2004, the Company’s board of directors declared a two percent (2%) stockdividend, 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 inpaid-in-capital and an increase in common stock of approximately $45.8 million, $43.7 million and$2.1 million, respectively.     During 2006, 2005, 2004 and 2003 certain key officers and employees of the Company exercised376,051; 56,113; 328,568 (as adjusted for stock splits and stock dividends); and 1,170,450 (asadjusted) shares, respectively, under the Company’s 1999 Qualified Option Plan. No stock optionswere exercised during 2002.     On May 27, 2005, the stockholders of the Company approved the amendments to the Company’sArticles of Incorporation (Exhibit 3.1) to increase the authorized shares of the Company’spreferred stock, par value $1.00 per share, from 20,000,000 shares to 50,000,000 shares, and toincrease the authorized shares of the Company’s common stock, par value $1.00 per share, from300,000,000 shares to 500,000,000 shares.     On January 18, 2007, two of the Company’s executive officers exercised 175,568 and 105,341stock options under the Company’s 1999 Qualified Option Plan at the exercise prices of $2.85 and$3.35, respectively.     On January 30, 2007, the Company’s Board of Directors granted a total of 45,000 stock optionsto two officers of Westernbank pursuant to the shareholders-approved 1999 Qualified Option Plan at an exerciseprice of $6.05. The market price of the stock was $5.79 at January 30, 2007.     InFebruary 2007, the Company forfeited 250,000 stock options froma former officer of Westernbank.     Total common stock cash dividends declared in 2006 amounted to $31.2 million compared to $30.6million in 2005.     The Company has issued the following non-cumulative, monthly income preferred stock:                               **Issuance**                   **Price and**                   **Liquidation**      **Proceeds From**    **Issuance**   **Dividend**  **Preference**  **Shares**  **Issuance, Net of**  **Issuance** **Year** **Type of Preferred Stock** **Rate**  **Per Share**  **Issued**  **Issuance Costs**  **Costs**   1998 Convertible, 1998 Series A  7.125%  $25   1,219,000  $29,143,000  $1,332,000 1999 Non-convertible, 1999 Series B  7.250   25   2,001,000   48,273,000   1,752,000 2001 Non-convertible, 2001 Series C  7.600   25   2,208,000   53,103,000   2,097,000 2001 Non-convertible, 2001 Series D  7.400   25   1,791,999   43,238,000   1,562,000 2002 Non-convertible, 2002 Series E  6.875   25   1,725,000   41,463,000   1,662,000 2003 Non-convertible, 2003 Series F  6.700   25   4,232,000   102,192,000   3,608,000 2003 Non-convertible, 2003 Series G  6.900   25   2,640,000   63,671,000   2,329,000 2004 Non-convertible, 2004 Series H  6.700   50   2,675,500   129,311,000   4,464,000 2005 Non-convertible, 2004 Series H  6.700   50   401,300   19,450,000   615,000                                              Total          18,893,799  $529,844,000  $19,421,000                     
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     The Company may redeem, in whole or in part, at any time at the following redemptionprices, if redeemed during the twelve month period beginning July 1 for 1998 Series A, May 28 for1999 Series B, March 30 for the 2001 Series C, August 1 for the 2001 Series D, October 31 for 2002Series E, May 30 for 2003 Series F, August 29 for 2003 Series G and December 21 for 2004 Series Hof the years indicated below, plus accrued and unpaid dividends, if any, for the current period tothe date of redemption, subject to regulatory approval:                                 **Redemption Price per Share****December 31,** **Series A** **Series B** **Series C** **Series D** **Series E** **Series F** **Series G** **Series H**  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   51.00 2010  25.00   25.00   25.00   25.00   25.00   25.00   25.00   50.50 2011 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 asto dividends and liquidation rights. Dividends declared on preferred stock for the years endedDecember 31, 2006 and 2005, amounted to $36.9 million and $37.0 million, respectively.     In June 1998, Westernbank issued 1,219,000 shares of its 7.125% Non-cumulative, ConvertibleMonthly Income Preferred Stock, Series A, with a liquidation preference of $25 per share. Eachshare is convertible, at the holder’s option, at any time on or after the 90th day following theissue date, into .995 shares of the Company’s common stock, subject to adjustment upon certainevents. The per share conversion ratio equates to a price of $7.12 per share of common stock, asadjusted. At December 31, 2006, the Company had outstanding 481,910 shares of its 7.125%Non-cumulative, Convertible Monthly Income Preferred Stock, Series A.     During 2006, 2005, 2004, 2003 and 2002, 3,550; 35,292; 276,994; 419,254; and 2,000 shares,respectively, of the convertible preferred stock Series A were converted into 12,403; 123,289;967,760 (as adjusted for stock splits and stock dividends); 1,464,741 (as adjusted); and 10,478 (asadjusted) shares of common stock, respectively.     The Company has two shareholders’ approved stock option plans, the 1999 Qualified Stock OptionPlan (the “1999 Qualified Option Plan”) and the 1999 Nonqualified Stock Option Plan (the “1999Nonqualified Option Plan”), for the benefit of employees of the Company and its subsidiaries. Theseplans offer to key officers, directors and employees an opportunity to purchase shares of theCompany’s common stock. Under the 1999 Qualified Option Plan, options for up to 14,747,670 shares(as adjusted for stock splits and stock dividends) of common stock can be granted. Also, optionsfor up to 14,747,670 shares (as adjusted) of common stock, reduced by any share issued under the1999 Qualified Option Plan can be granted under the 1999 Nonqualified Option Plan. The option pricefor both plans is determined at the grant date. Both plans will remain in effect for a term of 10years. The Board of Directors has sole authority and absolute discretion as to the number of stockoptions to be granted, their vesting rights, and the options’ exercise price. The options becomefully exercisable after five years following the grant date and the maximum contractual term of theoptions is ten years. The Company’s policy is to issue new shares when share options are exercised.The Plans provide for a proportionate adjustment in the exercise price and the number of sharesthat can be purchased in the event of a stock split, reclassification of stock and a merger orreorganization.
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     The activity in outstanding options under the 1999 Qualified Option Plan for the years endedDecember 31, 2006, 2005 and 2004, is set forth below. The activity for the years ended December 31, 2004was adjusted to reflect the three-for-two stock split and 2% stock dividend declared in December2004 and distributed on January 10, 2005, and the three-for-two stock split and 2% stock dividenddeclared in November 2003 and distributed on December 10, 2003.                           **2006**  **2005**  **2004**       **Weighted**      **Weighted**      **Weighted**       **Average**      **Average**      **Average**   **Number of**  **Exercise**  **Number of**  **Exercise**  **Number of**  **Exercise**   **Options**  **Price**  **Options**  **Price**  **Options**  **Price**  **Beginning of year**  7,845,285  $3.79   7,111,398  $3.02   7,439,966  $3.02 Options granted  485,000   5.96   790,000   10.65   —   — Options exercised  (376,051)  2.85   (56,113)  2.85   (328,568)  2.95 Options forfeited  (245,568)  7.84   —   —   —   —                    **End of year**  7,708,666  $3.84   7,845,285  $3.79   7,111,398  $3.02                         For more information, please refer to Note 17 to the 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 treatedas 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 expensesbased on the accrual basis of accounting and file their Puerto Rico tax returns on a calendar yearbasis.     INCOME TAXES. The Companies are subject to Puerto Rico regular income tax on income earnedfrom all sources up to a maximum rate of 39%, except for years 2005 and 2006, in which a transitoryadditional surtax of 2.5% over net taxable income was imposed by the Governor of Puerto Rico underLaw No. 41, signed on August 1, 2005. This transitory additional tax is in effect for taxable years2005 and 2006 and had a retroactive effect to January 1, 2005. On May 13, 2006, with an effectivedate of January 1, 2006, the Government of Puerto Rico approved Law No. 89 which imposes anadditional 2.0% income tax on all companies covered by the Puerto Rico Banking Act, as amended,such as Westernbank. Therefore, Westernbank is now subject to a maximum tax rate of 43.5%. Thistransitory income tax of 2% amounted to $3.0 million for the year ended December 31, 2006. Thesetransitory income taxes were intended to be temporary in nature and ended on December 31, 2006.     On May 16, 2006, the Government of Puerto Rico approved Law No. 98 which imposes a 5%additional tax (the “prepayment requirement”) to businesses that have a gross income in excess of$10,000,000, such as Westernbank. This tax constitutes a prepayment of income tax and can be usedas a credit to the tax liability of years 2007 and thereafter. A maximum of 25% of the credit canbe used in each year. This prepayment requirement was computed using Westernbank’s 2005 taxableincome as the base. The prepayment requirement amounted to $6.4 million and was paid by Westernbankin July 2006.     The Puerto Rico income tax act disallows any interest deduction which is allocable to incomeearned from tax exempt obligations acquired after December 31, 1987. For purposes of the abovedetermination, each company is required to allocate interest expense to exempt interest incomebased on the ratio that the average exempt obligations bear to the total average assets of eachcompany.     The Companies are also subject to an alternative minimum tax (“AMT”) equal to 22% of thealternative minimum taxable income. The alternative minimum taxable income is equal to eachCompany’s taxable income adjusted for certain items. The principal adjustments for determining eachcompany’s alternative minimum taxable income are the following: (i) no deduction may be claimedwith respect to the company’s interest expense allocable to interest income derived from tax exemptobligations acquired before January 1, 1988, other than mortgages guaranteed by the government ofPuerto 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 whichthe corporation’s book income (adjusted for certain items) exceeds its alternative minimum taxableincome without regard to this adjustment.
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     The AMT is payable if it exceeds regular income tax. The excess of AMT over regular income taxpaid in any one year may be used to offset regular income tax in future years, subject to certainlimitations. The Companies income taxes were based on regular income tax rates.     The Puerto Rico Internal Revenue Code provides a dividend received deduction of 100% ondividends received from wholly owned subsidiaries subject to income taxation in Puerto Rico, likeWesternbank and Westernbank Insurance Corp.     Westernbank World Plaza, Inc., a wholly owned subsidiary of Westernbank, elected to be treatedas a special partnership under the Code; accordingly, its taxable income is taxed at Westernbank.     For the year ended December 31, 2006, the Company had approximately $152.5 million of regulartaxable income, on which it is required to pay current income tax of $66.3 million. The income oncertain investments is exempt for income tax purposes. Also, activities relating to the WesternbankInternational division are exempt for income tax purposes, subject to certain limitations. As aresult of the above, the Company’s effective tax rate is below the statutory rate.     The Company evaluates and assesses the relative risks and appropriate tax treatment oftransactions and filing positions after considering statutes, regulations, judicial precedent andother information and maintains tax accruals consistent with its evaluation of these relative risksand merits. Changes to the estimate of accrued taxes occur periodically due to changes in taxrates, interpretations of tax laws, the status of examinations being conducted by taxingauthorities and changes to statutory, judicial and regulatory guidance that impact the relativerisks of tax positions. These changes, when they occur, can affect the income tax accruals as wellas the current period’s income tax expense and can be significant to the operating results of theCompany. The Company’s consolidated statements of financial condition include an accrual of $10.9million at December 31, 2006, for the exposures resulting from tax positions identified by theCompany in connection with this evaluation.     Westernbank International operates as an International Banking Entity (IBE) under Puerto RicoAct No. 52, of August 11, 1989, as amended, known as the International Banking Center Regulatory Act.Under Puerto Rico tax law, an IBE can hold non-Puerto Rico assets, and earn interest on theseassets, as well as generate fee income outside of Puerto Rico on a tax-exempt basis under certaincircumstances. Pursuant to the provisions of Act No. 13 of January 8, 2004, for taxable yearscommencing after June 30, 2003, the net income earned by an IBE that operates as a unit of a bankunder the Puerto Rico Banking Law, will be considered taxable and subject to income taxes at thecurrent tax rates in the amount by which the IBE taxable income exceeds 40% in the first applicabletaxable year (2004), 30% in the second year (2005) and 20% thereafter, of the taxable income ofWesternbank, including its IBE taxable income. Westernbank’s IBE carries on its books a significantamount of securities which are, irrespective of the IBE status, tax exempt by law. Moreover, theAct provides that IBE’s operating as subsidiaries will continue to be exempt from the payment ofincome taxes. For the years ended December 31, 2006 and 2005, the provisions of the Act did nothave any 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 aresult of legislation subsequently enacted by the Congress of the United States or the applicablelocal 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 andcurrent reports on Form 8-K and all amendments to those reports as soon as reasonably practicableafter such material is electronically filed with or furnished to the Securities and ExchangeCommission (“SEC”).     The public may read and copy any materials the Company files with the SEC at the SEC’s PublicReference Room at 100 F Street, NE, Washington, DC 20549. The public may obtain information on theoperation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. In addition, the SECmaintains an Internet site that contains reports, proxy and information statements, and otherinformation 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, alsoincludes our Code of Business Conduct and Ethics, our Code of Ethics for CEO and Senior FinancialOfficers, the charters of the Audit Committee, the Compensation Committee and the Nominating andCorporate Governance Committee, and the Corporate Governance Guidelines of our Board of Directors.We also make available free of charge in print to any stockholder who requests them copies of ourcorporate governance principles, and the charters of each standing committee of our board ofdirectors. 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 extentrequired by SEC rules, we intend to disclose any amendments to our code of conduct and ethics, andany waiver of a provision of the code with
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respect to the company’s directors, principal executive officer, principal financial officer, principal accounting officer orcontroller, or persons performing similar functions, on our web site referred to above within fivebusiness days following any such amendment or waiver, or within any other period that may berequired under SEC rules from time to time.ITEM 1A. RISK FACTORS     The material risks and uncertainties that management believes affect the Company are describedbelow. The risks and uncertainties described below are not the only ones facing the Company.Additional risks and uncertainties that management is not aware of, or that it currently deemsimmaterial, may also impair business operations.     If any of the following risks actually occur, our financial condition and results ofoperations could be materially and adversely affected. If this were to happen, the value of ourcommon stock could decline significantly.**We have experienced significant growth in recent years**     We have grown significantly in recent years, and we intend to continue to expand operationsand asset size. Our total assets, consisting primarily of loans and investments, have increased atan average annual growth rate of 24.58% for the last five fiscal years, to $17.15 billion atDecember 31, 2006. There can be no assurance that we will be able to sustain this rate of growth inthe future. Moreover, we are continually exploring other avenues of growth, including the possibleacquisition of assets and deposits from other financial institutions as well as acquisitions ofother banks, either in Puerto Rico or outside of Puerto Rico.**Westernbank is subject to default risk in its loan portfolio**     Westernbank is subject to the risk of loss from loan defaults and foreclosures with respect tothe loans it originates or acquires. Westernbank establishes provisions for loan losses, which leadto reductions in its income from operations, in order to maintain its allowance for future loanlosses at a level which is deemed appropriate by its management based upon an assessment of thequality of its loan portfolio in accordance with established procedures and guidelines. AlthoughWesternbank’s management utilizes its best judgment in providing for loan losses, there can be noassurance that management has accurately estimated the level of future loan losses or thatWesternbank will not have to increase its provision for loan losses in the future as a result offuture increases in non-performing loans or for other reasons beyond its control. Any suchincreases in Westernbank’s provision for loan losses or any loan losses in excess of its provisionfor loan losses would have an adverse effect on our future financial condition and results ofoperations.**Westernbank is exposed to commercial and consumer credit risks**     In recent years, Westernbank has emphasized commercial and consumer lending activities.Commercial lending, including commercial real estate and asset-based lending, unsecured businesslending and construction lending, is generally recognized as involving greater credit risk becauseit is larger in size and more risk is concentrated in a single borrower. In addition, theborrower’s ability to repay a commercial loan or a construction loan depends, in the case of acommercial 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 theproject. The properties or assets securing these loans may also be harder to dispose of inforeclosure. We have expanded our consumer lending activities through our Expresso of WesternbankDivision. These loans generally have a higher credit risk when compared to the rest ofWesternbank’s consumer loan portfolio, since the Expresso Division principally targets the typicalsmall consumer loan customers that are usually low income earners. Therefore, delinquencies in theExpresso of Westernbank division tend to be higher when compared to the total consumer loanportfolio in general. Consumer loans are subject to associated consumer defaults. Westernbank has asignificant fixed rate lending concentration with an aggregate unpaid principal balance of $894.0million in one mortgage originator group in Puerto Rico at December 31, 2006. In addition,Westernbank has outstanding $46.0 million of fixed and floating rate loans to another mortgageoriginator group in Puerto Rico, for total outstanding loans to mortgage originator groupsamounting to $940.0 million at December 31, 2006. These commercial loans are secured by 11,672individual mortgage loans on residential and commercial real estate with an average principaloutstanding balance of $80,534. Westernbank’s historical experience with the mortgage originatorgroups is that they have paid these loans in accordance with their terms. On March 16, 2006,Westernbank obtained a waiver from the Office of the Commissioner of Financial Institutions of theCommonwealth of Puerto Rico with respect to the statutory limit for individual borrowers (loan toone borrower limit), which allows the Company to retain the above significant commercial loans inits portfolio until these are paid in full. If Westernbank experiences loan losses that are higherthan its allowance for loan losses, our profits and financial condition may be adversely affected.
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**Our performance is subject to interest rate risk**     Our results of operations depend to a large extent on the success of Westernbank. Among therisks related to Westernbank are those related to interest rate fluctuations, lending operationsand our ability to manage growth. Interest-rate fluctuations could adversely affect net interestincome if our cost of funds increases faster than our yield on interest-earning assets. Increasesin interest rates also increase the costs of loans to businesses and consumers and may reducedemand for such loans, which negatively affects the ability of the Company to maintain the loangrowth it has experienced in recent years.**Increases in interest rates may reduce the value of the Company and Westernbank’s loans andsecurities holdings**     Increases in interest rates may reduce the value of the Company and Westernbank’s fixed-ratefinancial assets and may have an adverse impact on its earnings and financial condition. TheCompany and Westernbank owns a substantial portfolio of real estate loans, mortgage-backedsecurities and other debt securities with fixed interest rates. The market value of an obligationwith a fixed interest rate generally decreases when prevailing interest rates rise.**Competition with other financial institutions could adversely affect our profitability**     Westernbank faces substantial competition in originating loans and in attracting deposits. Thecompetition in originating loans comes principally from other U.S., Puerto Rico and foreign banks,mortgage banking companies, consumer finance companies, insurance companies and other institutionallenders and purchasers of loans. A number of institutions with which Westernbank competes may havesignificantly greater assets, capital and other resources. In addition, certain of Westernbank’scompetitors are not subject to the same extensive federal regulation that governs Westernbank’sbusiness. As a result, certain of Westernbank’s competitors may have advantages in conductingcertain businesses and providing certain services. Additionally, much of our growth has focused onthe San Juan metropolitan area, which is a competitive market where a number of establishedfinancial institutions already exist. Increased competition could require Westernbank to increaseits rates offered on deposits or lower the rates charged on loans, which could adversely affect ourprofitability.**Changes in statutes and regulations, including tax laws and rules, could adversely affect us**     Our company, as a Puerto Rico-chartered financial holding company, and our subsidiaries, areeach subject to extensive federal and local governmental supervision and regulation relating to ourbanking and insurance businesses. In addition, there are laws and other regulations that restricttransactions between us and our subsidiaries. Any change in such laws or regulations, whether byapplicable regulators or as a result of legislation subsequently enacted by the Congress of theUnited States or the local legislature, could adversely affect our profits and financial condition.**We are subject to the general risks associated with the Puerto Rico economy**     Substantially all of the properties and other collateral securing our real estate, commercialand consumer loans are located in Puerto Rico. These loans may be subject to a greater risk ofdefault if the Puerto Rico economy suffers adverse economic, political or business developments, orif natural disasters affect Puerto Rico. If any such developments or risks adversely affect PuertoRico, our profitability may decrease.**Applicable laws restrict our ability to pay dividends**     Our main sources of liquidity are dividends from Westernbank, interest and dividends onportfolio securities we own and net proceeds from capital borrowings and offerings of our capitalstock. Westernbank may not pay dividends if upon payment it would become undercapitalized under theregulations enforced by the FDIC. Westernbank also could be subject to these dividend restrictionsif the FDIC determines that it is in an unsafe or unsound condition or engaging in an unsafe orunsound practice. We are also subject to restrictions on dividends generally imposed on Puerto Ricocorporations and may be restricted in our ability to pay dividends by minimum capital requirementsimposed by the Federal Reserve Board. The Federal Reserve Board issued a policy statement thatprovides that insured banks and financial holding companies should generally pay dividends only outof current operating earnings.**Provisions of our charter and applicable law may prevent a change of control**     Provisions of our certificate of incorporation, as well as United States federal banking law,could make it more difficult for a third party to acquire us even if doing so would provide ourstockholders with a “premium” to prevailing market prices or otherwise be beneficial to ourstockholders. These provisions in our charter documents include a staggered board of directors; aprovision thatprohibits stockholders from calling special meetings of stockholders; and advance noticeprocedures for nomination of directors and for stockholder proposals. 
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**A prolonged economic downturn or recession would likely result in a reduction of Westernbank’s loanorigination activity which would adversely affect our financial results**     A period of prolonged general economic downturn or a recession has historically resulted in areduction in lending activity and an increase in the rate of defaults in commercial loans, consumerloans and residential mortgages. A continued recession may have a significant adverse impact onWesternbank’s net interest income and fee income. We may also experience larger than previouslyreported losses on Westernbank’s loan portfolio due to a higher level of defaults on Westernbank’scommercial loans, consumer loans and residential mortgage loans.**The loss of a key employee may adversely affect our prospects**     We believe that our management team is one of our most valuable assets and has a very highlevel of experience, depth and expertise. They are largely responsible for our growth anddevelopment to date. The loss of the services of any member of our management team could adverselyaffect our business prospects. Most of our executive officers do not have an employment agreementwith us.**The Company is subject to risks associated with the Commonwealth of Puerto Rico’s temporary budgetcrisis**     Due to a budget impasse, the Commonwealth of Puerto Rico (“the Commonwealth”) closed allpublic agencies on May 1, 2006, except those related to safety, health and other essentialservices. All agencies were subsequently opened two weeks later and a budget approved by theLegislature was signed into law by the Commonwealth’s Governor. Subsequently, Moody’s InvestorsService (“Moody’s) downgraded the Commonwealth’s general obligation bond rating to Baa3 from Baa2,and kept the rating on “watch list” for possible future downgrade.     According to Moody’s, this action reflects the Commonwealth’s strained financial condition,and ongoing political conflict and lack of agreement regarding the measures necessary to end thegovernment’s multi-year trend of financial deterioration. A fiscal reform was later approved, wherethe Commonwealth House and Senate approved a tax reform authorizing a 7% sales tax, with theoption, if expected revenues do not materialize, to raise it to 8% after December 2006.Notwithstanding, significant budget deficit and fiscal imbalance could continue in the comingyears. Any significant adverse political or economic developments in Puerto Rico resulting from thebudget impasse could have a negative impact on the Company’s future financial condition and resultsof operations.**Rating downgrades on the Government of Puerto Rico’s debt obligation may affect Westernbank’scredit exposure**     Even though Puerto Rico’s economy is closely integrated to that of the U.S. mainland and itsgovernment and many of its instrumentalities are investment-grade rated borrowers in the U.S.capital markets, the current fiscal situation of the Government of Puerto Rico has led nationallyrecognized rating agencies to downgrade its debt obligations.     In May 2006, Moody’s downgraded the Commonwealth’s general obligation bond rating to Baa3 fromBaa2, and put the credit on “watch list” for possible further downgrades. The Commonwealth’sappropriation bonds and some of the subordinated revenue bonds were also downgraded by one notchand are now rated just below investment grade at Ba1. Standard & Poor’s Rating Services (“S&P”)still rates the Commonwealth’s general obligations two notches above junk at BBB, and theCommonwealth’s appropriation bonds and some of the subordinated revenue bonds BBB-, a category thatcontinues to be investment-grade rated.     In July 2006, S&P and Moody’s affirmed their credit ratings on the Commonwealth’s debt, andremoved the debt from their respective “watch lists”, thus reducing the possibility of an immediateadditional downgrade. These actions resulted after the Government of the Commonwealth approved thebudget for the fiscal year 2007, which runs from July 2006 through June 2007, which included theadoption of a new sales tax. Revenues from the sales tax will be dedicated primarily to fund theGovernment of Puerto Rico’s operating expenses, and to a lesser extent, to repay government debtand fund local municipalities.     Both rating agencies maintained the negative outlook for the Puerto Rico obligation bonds.Factors such as the government’s ability to implement meaningful steps to curb operatingexpenditures, improve managerial and budgetary controls, and eliminate the government’s reliance onoperating budget loans from the Government Development Bank of Puerto Rico will be key determinantsof future rating stability and restoration of a stable long-term outlook. Also, the inability toagree on future fiscal year Commonwealth budgets could result in ratings pressure from the ratingagencies.
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     It is uncertain how the financial markets may react to any potential future ratings downgradein Puerto Rico’s debt obligations. However, the fallout from the recent budgetary crisis and apossible ratings downgrade could adversely affect the value of Puerto Rico’s Governmentobligations. In addition, the above uncertainty in the public sector may also have an adverseeffect on the Puerto Rico economy, which in turn may adversely affect in the credit quality ofWesternbank’s loan portfolio.**Westernbank’s credit quality may be adversely affected by Puerto Rico’s current economic condition**     The slowdown on the island’s growth rate, which appears to have started in 2005, according tothe Puerto Rico Planning Board statistics, has continued in 2006. Manufacturing has declined inoverall activity for 2006 as compared to the same period in 2005, for the first time since 2002.     Construction remains relatively weak during 2006, as the combination of rising interest rates,the Commonwealth’s fiscal condition and decreasing public investment in construction projectsaffected the sector. The value of construction permits during the year ended December 2006 declined by approximately23.2% when compared to 2005, with most of the drop coming from the public sector. Retail sales during the year 2006 alsoreflected the uncertainty prevalent at the time related to the Commonwealth’s fiscal situation, aswell as increased oil and utility prices. Sales registered a decline of 3.2% as compared to thesame period in 2005, as the months surrounding the temporary government shutdown were particularlyaffected. The unemployment rate was 10.2% as of December 31, 2006.     Tourism is the one sector that has been resilient. Activity in the sector has expandedconsistently since 2004, and in 2006 it registered the strongest increase in four years. Factorsthat may be boosting the tourism sector are geo-political tensions throughout the world, a relativebenign hurricane season for the past two years, and a relatively firm U.S. economy.     In general, it is apparent that in 2006 the Puerto Rican economy continued its trend ofdecreasing growth and ended the first half of the year with minimal momentum, primarily due toweaker manufacturing, softer consumption and decreased government investment in construction.     The above economic concerns and uncertainty in the private and public sectors may also have anadverse effect in the credit quality of Westernbank’s loan portfolio, as delinquency rates areexpected to increase in the short-term, until the economy stabilizes. Also, a potential reductionin consumer spending may also impact growth in interest revenue sources of the Company.     ITEM 1B. UNRESOLVED STAFF COMMENTS     None.     ITEM 2. PROPERTIES     The Company owns the condominium offices space housing its main offices at 19 West McKinleyStreet, Mayagüez, Puerto Rico. As of December 31, 2006, Westernbank owned approximately 10 branchpremises and other facilities, eight (8) lots for future development, and one office building, allof them located in Puerto Rico. In addition, as of such date, Westernbank leased properties, mainlyfor branch operations, in approximately 48 locations in Puerto Rico. Also, Westernbank FinancialCenter Corp. is leasing an office location in West Palm Beach, Florida, United States of America.     At December 31, 2006, the Company’s future rental commitments under non-cancelable operatingleases aggregated $10.6 million, not considering renewal options.     The principal property owned by Westernbank World Plaza, Inc., a wholly owned subsidiary ofWesternbank, for banking operations and other services is described below: **•** **Westernbank World Plaza** — a 23-story office building located at PuertoRico’s main business district and which serves as Westernbank San Juan metropolitanarea headquarters, our regional commercial lending office and the headquarters forthe Westernbank Business Credit and Expresso of Westernbank divisions. The bookvalue of this property at December 31, 2006, was $52.5 million.     The Company’s investment in premises and equipment, exclusive of leasehold improvements, atDecember 31, 2006, was $116.4 million. The combined net book value of the Company’s main offices asof December 31, 2006 was $793,000.
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ITEM 3. LEGAL PROCEEDINGS     Except as described below, there are no material pending legal proceedings other than ordinaryroutine legal proceedings incidental to the business of the Company to which the Company or any ofits subsidiaries is the subject or of which any of their property is the subject. Managementbelieves, after consultation with legal counsel, that the ultimate disposition of these matterswill not have a material adverse effect on the Company’s financial condition or results ofoperations.     As previously disclosed, 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 ofa previously announced informal inquiry by the SEC. The inquiry appears to be primarily related tothe other-than-temporary impairment charges announced by the Company in April 2003 in connectionwith its investments in corporate bond and loan obligations. The Company does not expect to commentfurther regarding this matter, as the formal order is a confidential document directing anon-public investigation.ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS     Not applicable.PART IIITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OFEQUITY SECURITIES     The Company’s common stock is traded in the New York Stock Exchange (“NYSE”).     The following table sets forth the range of high and low closing sale prices of the Company’scommon stock, as quoted in the NYSE system, at the end of each quarter for 2006 and 2005. Theprices reflect inter-dealer quotations, without retail mark-up, mark-down or commissions and do notnecessarily represent actual transactions:         **Quarter Ended** High **(1)** Low **(1)** December 2006 $6.60  $5.57 September 2006  6.67   5.05 June 2006  7.93   6.22 March 2006  9.01   7.33          December 2005 $9.47  $7.33 September 2005  11.50   9.32 June 2005  10.23   8.09 March 2005  15.29   9.88  **(1)** Prices in table are rounded.     On January 20, 2005, the Company’s board of directors approved an increase in its annualdividend payments to stockholders for 2005 to $0.19 per share. This represents an increase of32.14% over the dividends paid in 2004.     On January 31, 2006, and on January 30, 2007, the Company’s board of directors approved anannual dividend payment of $0.19 per share to its stockholders for years 2006 and 2007,respectively.     As of January 31, 2007 the Company had 616 stockholders of record of its common stock, notincluding beneficial owners whose shares are held in record names of brokers or other nominees. Thelast sales price for the Company’s common stock on such date, as quoted on NYSE was $5.26 pershare.
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DIVIDENDS     On March 7, 2000, the Company’s board of directors adopted the policy of paying dividends on amonthly basis. Initial dividend payment under this policy, were applied retroactively for dividendscorresponding to the first three-month period ended March 31, 2000. Thereafter, dividends on commonstock and preferred stock are being paid on the 15th day of each month for stockholders of recordas of the last day of the previous month.     The Company’s cash dividends corresponding to 2006 and 2005 were as follows:       **RECORD DATE** **PAYABLE DATE** **AMOUNT PER SHARE****(1)** **YEAR 2006**             January 31, 2006 February 15, 2006 $0.01583 February 28, 2006 March 15, 2006  0.01583 March 31, 2006 April 17, 2006  0.01583 April 28, 2006 May 15, 2006  0.01583 May 31, 2006 June 15, 2006  0.01583 June 30, 2006 July 17, 2006  0.01583 July 31, 2006 August 15, 2006  0.01583 August 31, 2006 September 15, 2006  0.01583 September 29, 2006 October 16, 2006  0.01583 October 31, 2006 November 15, 2006  0.01583 November 30, 2006 December 15, 2006  0.01583 December 29, 2006 January 16, 2007  0.01583       Total   $0.18996              **YEAR 2005**             January 31, 2005 February 15, 2005 $0.01198 February 28, 2005 March 15, 2005  0.01583 March 31, 2005 April 15, 2005  0.01583 April 28, 2005 May 16, 2005  0.01583 May 31, 2005 June 15, 2005  0.01583 June 30, 2005 July 15, 2005  0.01583 July 31, 2005 August 15, 2005  0.01583 August 31, 2005 September 15, 2005  0.01583 September 30, 2005 October 17, 2005  0.01583 October 31, 2005 November 15, 2005  0.01583 November 30, 2005 December 15, 2005  0.01583 December 30, 2005 January 16, 2006  0.01583       Total   $0.18611        **(1)** Dividends amounts in the table are rounded.     Information concerning legal or regulatory restrictions on the payment of dividends by theCompany 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 taxon the amount of any dividends paid by Puerto Rico corporations to individuals, whether residentsof Puerto Rico or not, trusts, estates, and special partnerships at a special 10% withholding taxrate. Dividends distributed by Puerto Rico corporations to foreign corporations or partnerships not
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engaged in trade or business in Puerto Rico are also generally subject to withholding tax at a10% rate. Prior to the first dividend distribution for the taxable year, such shareholders mayelect to be taxed on the dividends at the regular rates, in which case the special 10% tax will notbe withheld from such year’s distributions.     United States citizens who are non-residents of Puerto Rico will not be subject to Puerto Ricotax on dividends if said individual’s gross income from sources within Puerto Rico during thetaxable year does not exceed $1,300 if single, or $3,000 if married, and form AS 2732 of the PuertoRico Treasury Department “Withholding Tax Exemption Certificate for the Purpose of Section 1147” isfiled with the withholding agent. U.S. income tax law permits a credit against the U.S. income taxliability, subject to certain limitations, for certain foreign income taxes paid or deemed paidwith respect to such dividends.SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS AS OF DECEMBER 31, 2006     The following table provides information as of December 31, 2006, regarding shares of commonstock that may be issued to key employees under the Company’s stock option plans. The 1999Qualified Stock Option Plan and the 1999 Nonqualified Stock Option Plan are the only equity basedcompensation plans currently in effect. At December 31, 2006, the Company had outstanding 7,708,666options under the 1999 Qualified Stock Option Plan. No options have been granted under the 1999Nonqualified Stock Option Plan.               **Number of securities remaining available**   **Weighted-average exercise**  **for future issuance under equity** **    Number of securities to be issued upon** **price of outstanding options**  **compensation plans (excluding securities** **       exerciseof outstanding options (1) (2) (a)** **(1) (b)**  **reflected in column (a))(1) (c)** ** ** ** **  ** **          6,629,427 $3.84   5,107,823         (1) Adjusted to reflect a three-for-two stock split and a 2% stock dividend on theCompany’s common stock declared on December 6, 2004 and December 13, 2004, respectively,distributed on January 10, 2005; the three-for-two stock split and a 2% stock dividenddeclared on November 4, 2003 and November 11, 2003, respectively, distributed on December10, 2003; and the three-for-two stock split declared on June 17, 2002 and distributed onJuly 10, 2002. (2) Excludes 1,800,698 shares issued upon exercise of stock options through December 31,2006.RECENT SALES OF UNREGISTERED SECURITIES     No sales of unregistered securities were made by the Company in 2006.PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASES     No purchases of the Company’s common stock were made by or on behalf of the Company in 2006.
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ITEM 6. SELECTED FINANCIAL DATA     The following selected consolidated financial data should be read in conjunction with theConsolidated Financial Statements of the Company and the Notes thereto, appearing elsewhere in thisForm 10-K, and the information contained in “Management’s Discussion and Analysis of FinancialCondition and Results of Operations.” The selected historical consolidated financial data as of theend of and for each of the five years in the period ended December 31, 2006, are derived from theCompany’s Consolidated Financial Statements.                       **Year Ended December 31,**  **2006** **2005** **2004** **2003** **2002**  **(Amounts in thousands, except per share data)**Income Statement Data:                                         Interest income $1,000,225  $795,329  $591,376  $461,894  $385,734 Interest expense  681,419   483,747   314,219   245,102   252,673    Net interest income  318,806   311,582   277,157   216,792   133,061 Provision for loan losses  (64,550)  (31,000)  (36,691)  (27,048)  (15,083)   Net interest income after provision for loan losses  254,256   280,582   240,466   189,744   117,978 Noninterest income  37,098   35,820   53,628   25,295   59,244 Noninterest expenses  (124,518)  (108,230)  (100,125)  (84,821)  (73,917)   Income before income taxes  166,836   208,172   193,969   130,218   103,305 Income taxes  (66,305)  (45,086)  (22,093)  (19,263)  (16,585)   Net income  100,531   163,086   171,876   110,955   86,720 Preferred stock dividends  36,911   36,985   27,158   21,593   13,774    Income available to common stockholders $63,620  $126,101  $144,718  $89,362  $72,946                         Share Data:                    Basic earnings per common share **(1)** $0.39  $0.77  $0.89  $0.56  $0.48 Diluted earnings per common share **(1)** $0.38  $0.74  $0.86  $0.54  $0.48 Cash dividends declared per common share **(1)(2)** $0.19  $0.19  $0.14  $0.11  $0.09 Period end number of common shares outstanding **(1)**  164,487   164,098   163,919   162,624   159,992 Weighted average number of commonshares outstanding **(1)**  164,380   164,024   163,348   160,734   150,712 Weighted average number of common sharesoutstanding on a fully diluted basis **(1)**  168,051   170,619   170,443   165,330   152,491 Cash dividends declared on common shares $31,235  $30,575  $23,502  $18,322  $14,045 Dividend payout ratio  49.10%  24.25%  16.24%  20.50%  19.26%Book value per share data **(1)** $4.24  $4.04  $3.45  $2.70  $2.25 
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                       **Year Ended December 31,**  **2006** **2005** **2004** **2003** **2002**  **(Amounts in thousands, except per share data)**Performance ratios:                    Return on assets **(3)**  0.60%  1.07%  1.33%  1.12%  1.23%Return on common stockholders’ equity **(3)**  9.36   20.53   28.79   22.37   25.84 Efficiency ratio  34.94   30.67   30.66   32.17   40.66 Operating expenses to total end-of-period assets  0.73   0.67   0.70   0.74   0.90 Net yield on interest-earning assets  1.96   2.08   2.22   2.31   1.88                      Balance Sheet Data:                    Total assets $17,154,688  $16,151,864  $14,321,620  $11,527,509  $8,211,345 Federal funds sold and resell agreements  950,573   746,539   1,017,303   649,852   459,147 Investments securities held to maturity,securities available for sale and trading securities  7,028,120   7,079,191   6,929,260   5,778,790   3,661,944 Loans-net  8,641,023   7,815,623   5,917,352   4,683,118   3,754,357 Total liabilities  15,926,801   14,958,386   13,244,061   10,703,131   7,628,369 Total deposits  9,337,063   8,375,609   6,244,170   5,397,676   4,306,784 Federal funds purchased and repurchase agreements  6,320,481   6,260,029   6,683,527   5,046,045   3,097,341 Stockholders’ equity  1,227,887   1,193,478   1,077,559   824,378   582,976                      Capital Ratios:                    Total capital to risk-weighted assets  12.51%  13.13%  14.90%  13.90%  12.79%Tier I capital to risk-weighted assets  11.47   12.30   14.01   13.06   11.94 Tier I capital to average assets  7.23   7.48   7.69   7.18   7.19 Equity-to-asset ratio **(3)**  7.27   7.45   7.36   7.13   6.87                      Asset Quality Ratios:                    Total non-performing loans and foreclosed real estateheld for sale as a percentage of total assets at end ofperiod  1.00%  0.42%  0.27%  0.31%  0.28%Total non-performing loans as a percentage ofloans at end of period  1.89   0.81   0.58   0.66   0.51 Net loans charged-off to average total loans **(4)**  0.36   0.27   0.34   0.29   0.19 Allowance for loan losses to total loans at end of period  1.45   1.17   1.34   1.30   1.24 Allowance for loan losses to non-performing loans  76.50   144.39   233.64   197.17   242.80  (1) Adjusted to reflect a three-for-two stock split and 2% stock dividend declared in December2004 and distributed on January 10, 2005; the three-for-two stock split and 2% stock dividenddeclared in November 2003 and distributed on December 10, 2003; and the three-for-two stocksplit 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 preferredstock dividends by average common stockholders’ equity for the period. The equity-to-assetratio is computed by dividing average equity by average total assets. Average balances havebeen computed using beginning and period-end balances. (4) Average balances were computed using beginning and period-end balances.
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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS     This section analyzes the major elements of the Company’s consolidated financial statementsand should be read in conjunction with the Consolidated Financial Statements of the Company andNotes thereto and other detailed information appearing elsewhere in this Annual Report.**FOR THE YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004****OVERVIEW**     Total assets at December 31, 2006, 2005 and 2004 were $17.15 billion, $16.15 billion, and$14.32 billion, respectively. This growth was driven by increases in the Company’s loan portfolio.Loans receivable-net grew by $825.4 million for the year ended December 31, 2006, when compared tothe previous year, as a result of the Company’s continued strategy of growing its variable rateloan portfolio mainly through commercial real estate collateralized, construction and landacquisition, asset-based and other industrial and agricultural commercial loans. The investmentportfolio, excluding short-term money market instruments, decreased $51.1 million, from $7.08billion at December 31, 2005, to $7.03 billion at December 31, 2006. The investment portfolio was$6.93 billion at December 31, 2004. Total deposits reached $9.34 billion, from $8.38 billion atDecember 31, 2005, and $6.24 billion at year end 2004.     Net income was $100.5 million, $163.1 million and $171.9 million and earnings per basic commonshare were $0.39 ($0.38 on a diluted basis), $0.77 ($0.74 on a diluted basis), and $0.89 ($0.86 ona diluted basis) for the years 2006, 2005 and 2004, respectively. The decrease in net income forthe year ended December 31, 2006, when compared to year 2005, was attributed to an increase of$33.6 million in the provision for loan losses (mainly attributed to the loan portfolio of theCompany’s asset-based lending division), an increase of $16.3 million in noninterest expenses andan increase of $21.2 million in the provision for income taxes. Such increases were partiallyoffset by an increase of $7.2 million in net interest income. In 2005, even though net interestincome for the year ended December 31, 2005 increased by $34.4 million and the provision for loanlosses was $5.7 million lower than that for the comparable prior year, net income was also impactedby the flat to inverted yield curve effect, a decrease of $20.5 million in net gain on derivativeinstruments, an increase of $8.1 million on noninterest expense and a significantly higherprovision for income taxes of $23.0 million. In the year 2005, the Company recorded a charge of$6.7 million ($4.1 million, net of taxes), mainly as a result of the change in the fair valueduring the year of certain interest rate swaps on a portion of the Company’s brokered deposits. TheCompany has maintained strong asset quality control, resulting in returns on average assets (“ROA”)of 0.60%, 1.07% and 1.33% and returns on average common stockholders’ equity (“ROCE”) of 9.36%,20.53%, and 28.79% for the years ended 2006, 2005 and 2004, respectively.**RESULTS OF OPERATIONS****NET INTEREST INCOME**     The Company’s principal source of earnings is its net interest income. This is the differencebetween interest income on loans and invested assets (“interest-earning assets”) and its interestexpense on deposits and borrowings, including federal funds purchased and repurchase agreements andadvances from the FHLB (“interest-bearing liabilities”). Loan origination and commitments fees, netof related costs, are deferred and amortized over the life of the related loans as a yieldadjustment. Gains or losses on the sale of loans and investments, service charges, fees and otherincome, also affect income. In addition, the Company’s net income is affected by the level of itsnon-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 and Liability Management program is to invest fundsjudiciously and reduce interest rate risks while optimizing net income and maintaining adequateliquidity levels. As further discussed in Item 7A: “Quantitative and Qualitative Disclosures AboutMarket Risk”, the Company uses several tools to manage the risks associated with the compositionand repricing of assets and liabilities. Therefore, management has followed a conservative practiceinclined towards the preservation of capital with adequate returns. The Company’s InvestmentCommittee, which includes the entire Board of Directors and senior management, is responsible forthe asset-liability management oversight. The Investment Department is responsible for implementingthe policies established by the Investment Committee.
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     **2006 VERSUS 2005.**Net interest income for the year ended December 31, 2006 was $318.8 million,an increase of $7.2 million or 2.32%, from $311.6 million for the prior year. The increase in 2006was the result of increases in interest income from loans, investment securities, mainly inshort-term tax-exempt securities such as U.S. Government Agencies discount notes, and money marketinstruments, which was partially offset by a decrease in interest income on mortgage-backedsecurities and increases in interest expense on all the components of the interest-bearingliabilities.     Average interest-earning assets for the year ended December 31, 2006 increased by $1.35billion or 9.01%, compared to year 2005, primarily driven by a rise in the average loan portfolioof $1.32 billion or 18.92%, particularly in the commercial real estate collateralized andcommercial, industrial and agricultural loan (“Commercial and C&I loans”) and in the constructionloan portfolios, and an increase of $252.2 million or 4.02% in the average investment portfolio,excluding short-term money market instruments. The average mortgage-backed securities and theaverage money market instruments decreased by $120.0 million or 15.95% and $105.6 million or11.10%, respectively. Changes in the investments portfolio are attributable to the reinvestment onshort-term tax-exempt securities, specifically U.S. Government Agencies discount notes, as part ofmanagement’s strategy of growing the Company’s tax exempt interest income. The average yield earnedon interest-earning assets increased 81 basis points from 5.32% to 6.13%, for the year endedDecember 31, 2006, when compared to year 2005. The increase in the average yield for the year endedDecember 31, 2006, was mainly due to higher average yields earned on the loan portfolio, higherreinvestment rates on matured and called securities and higher yields earned on mortgage-backedsecurities and money market instruments. The increase in the average yield earned on the loanportfolio was due to new higher yielding loans and the repricing of existing floating andadjustable rate Commercial and C&I loans. During the year ended December 31, 2006, the FederalReserve increased the discount rate by 100 basis points, which is reflected equally on the PrimeRate, the index used by the Bank to reprice most of its floating and adjustable rate commercialloans.     The impact of the strong growth in average interest-earning assets was in part offset by anincrease in the average interest-bearing liabilities of $1.25 billion or 8.96% for the year 2006,when compared to year 2005. The overall cost of funds increased 101 basis points, from 3.47% foryear 2005, to 4.48% for year 2006. The average interest rate paid on deposits increased 90 basispoints, from 3.27% in 2005, to 4.17% for 2006, and the average interest rates paid on federal fundspurchased and repurchase agreements increased 122 basis points, from 3.67% in 2005, to 4.89% in2006. The average interest rate paid on advances from the Federal Home Loan Bank also increased by117 basis points, from 4.17% in 2005, to 5.34% in 2006. As explained before, during the year endedDecember 31, 2006, short-term interest rates continued rising with the LIBOR rate, the rate used bythe Company to reprice most of its interest-bearing liabilities, increasing 82 basis points.Meanwhile, the Company’s rates paid for the year ended December 31, 2006 increased by 101 basispoints or 123.17%, of said increase of the LIBOR rate.     The Company’s net yield on interest-earning assets decreased 12 basis points in 2006, to1.96%. The decrease in the net interest margin was due to the fact that the upwardrepricing of the Company’s interest-earning assets lagged behind the increase in the cost of fundsof its interest-bearing liabilities.     **2005 VERSUS 2004.**Net interest income for the year ended December 31, 2005, was $311.6million, an increase of $34.4 million, or 12.42%, from $277.2 million for the prior year. Theincrease in 2005 was the result of increases in interest income from loans, investment securities,mainly in tax-exempt securities, and money market instruments, which was partially offset by adecrease in interest income on mortgage-backed securities and increases in interest expense ondeposits, on federal funds purchased and repurchase agreements and advances from the Federal HomeLoan Bank.     Average interest-earning assets for the year ended December 31, 2005, increased by $2.47billion or 19.81%, compared to year 2004, primarily driven by a rise in the average loan portfolioof $1.58 billion, particularly due to increases in the portfolio of commercial real estate andcommercial, industrial and agricultural loan (“Commercial and C&I Loans) portfolios, includingasset-based, in the residential real estate-mortgage loans portfolio (including commercial loansmainly secured by individual mortgages on one-to-four family residential properties), and anincrease of $866.2 million or 16.04% in the average investment portfolio, excluding short-termmoney market instruments. The average mortgage-backed securities decreased by $182.6 million or19.52%, while the average money market instruments increased by $205.2 million or 27.51%. Theincrease in the average investment portfolio was primarily in tax exempt securities, such as U.S.Government and agencies obligations as a result of the securities bought during the latter part of2004 and the reinvestment of approximately $150.0 million previously invested in short-term moneymarket instruments into short-term tax exempt securities, specifically US Government Agenciesdiscount notes. Notwithstanding, average yields earned in interest-earning assets increased 58basis points, from 4.74% in year 2004, to 5.32% for the year ended 2005. The increase in theaverage yield was mainly due to higher average yields earned on the loan portfolio, mortgage-backedsecurities and money market instruments, while the remaining investment portfolio yield remainedrelatively flat increasing by only 2 basis points to 3.95% at December 31, 2005. The increase inthe average yield earned on the loan portfolio was due to new higher yielding and the repricing ofexisting Commercial and C&I loans and residential real estate at floating rates. During the lastquarter of 2004 and the year ended December 31, 2005, the Federal Reserve increased the discountrate by 250 basis points, reflected equally on the Prime Rate, an index used by the Bank to repricemost of its floating rate loans.
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     The impact of the strong growth in average interest-earning assets was in part offset by anincrease in the average interest-bearing liabilities of $2.20 billion or 18.67% for the year 2005,when compared to 2004. In addition, deposits grew on average by $1.45 billion or 24.57%, during theyear ended December 31, 2005. Other borrowings on average (federal funds purchased, repurchaseagreements and advances from FHLB) also increased by $741.8 million or 12.70% when compared to2004. The overall cost of funds increased 80 basis points, from 2.67% for the year ended December31, 2004, to 3.47% for year 2005. The average interest rate paid on deposits increased 46 basispoints, from 2.81% in 2004, to 3.27% for 2005, and the average interest rates paid on federal fundspurchased and repurchase agreements increased 118 basis points, from 2.49% in 2004, to 3.67% in2005. The average interest rate paid on advances from the Federal Home Loan Bank also increased by17 basis points, from 4.00% in 2004, to 4.17% in 2005. The Company was able to successfully lag itscost of rates paid during the year ended December 31, 2005, despite a rising rate trend. Duringthe last quarter of 2004 and the year 2005, short-term interest rates continued rising with theLIBOR rate, the rate used by the Company to reprice most of its interest-bearing liabilities,increasing 251 basis points. Meanwhile, the Company’s cost of funds paid for the year endedDecember 31, 2005, increased by 80 basis points or 31.87%, of said increase of the LIBOR rate.     The Company’s net yield on interest-earning assets decreased 14 basis points in 2005, to2.08%. The decrease in the net interest margin was due to an increase in the general cost offunding of the Company, which increased at a faster pace than the increase in our yield on interestearning assets. This contraction is primarily due to the flat to inverted yield curve effect.
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     The following table presents, for the periods indicated, the total dollar amount of interestincome from average interest-earning assets and the resultant yields, as well as the interestexpense on average interest-bearing liabilities, expressed both in dollars and rates, as well as ina normal and tax equivalent basis. Average balances are daily monthly average balances. The yieldon the securities portfolio is based on average amortized cost balances and does not give effect tochanges in fair value that are reflected as a component of consolidated stockholders’ equity forinvestment securities available for sale.                                       **YEARS ENDED DECEMBER 31,**   **2006**  **2005**  **2004**       **Average**  **Average**      **Average**  **Average**      **Average**  **Average**   **Interest**  **balance (1)**  **Yield / Rate**  **Interest**  **balance (1)**  **Yield / Rate**  **Interest**  **balance (1)**  **Yield / Rate**   **(Dollars in Thousands)** Normal Spread:                                    Interest-earning assets:                                    Loans, including loan fees (2) $671,530  $8,308,353   8.08% $479,042  $6,986,626   6.86% $322,164  $5,401,955   5.96%Investment securities (3)  261,971   6,519,398   4.02   247,533   6,267,159   3.95   212,213   5,400,997   3.93 Mortgage-backed securities (4)  28,489   632,792   4.50   32,321   752,839   4.29   37,489   935,421   4.01 Money market instruments  38,235   845,375   4.52   36,433   950,980   3.83   19,510   745,828   2.62                             Total  1,000,225   16,305,918   6.13   795,329   14,957,604   5.32   591,376   12,484,201   4.74                                                                  Interest-bearing liabilities:                                    Deposits  366,063   8,771,531   4.17   241,268   7,376,605   3.27   166,237   5,921,733   2.81 Federal funds purchased andrepurchase agreements  307,463   6,290,818   4.89   234,791   6,398,451   3.67   141,414   5,676,595   2.49 Advances from FHLB  7,893   147,780   5.34   7,688   184,153   4.17   6,568   164,245   4.00                             Total  681,419   15,210,129   4.48   483,747   13,959,209   3.47   314,219   11,762,573   2.67                                                                  Net interest income $318,806          $311,582          $277,157                                           Interest rate spread          1.65%          1.85%          2.07%                                  Net interest-earning assets     $1,095,789          $998,395          $721,628                                       Net yield on interest-earningassets (5)          1.96%          2.08%          2.22%                                  Ratio of interest-earning assetsto interest-bearing liabilities      107.20%          107.15%          106.13%                                                                           Tax Equivalent Spread:                                    Interest-earnings assets $1,000,225  $16,305,918   6.13% $795,329  $14,957,604   5.32% $591,376  $12,484,201   4.74%Tax equivalent adjustment  16,502   —   0.11   41,305   —   0.27   53,555   —   0.43                             Interest-earning assets -tax equivalent  1,016,727   16,305,918   6.24   836,634   14,957,604   5.59   644,931   12,484,201   5.17                             Interest-bearing liabilities  681,419  $15,210,129   4.48   483,747  $13,959,209   3.47   314,219  $11,762,573   2.67                             Net interest income $335,308          $352,887          $330,712                                           Interest rate spread          1.76%          2.12%          2.50%                                  Net yield on interest-earning assets (5)          2.06%          2.36%          2.65%                                   (1) Average balance on interest-earning assets and interest-bearing liabilities is computed usingdaily monthly average balances during the period. (2) Average loans exclude non-performing loans. Loans fees, net amounted to $16.3 million for each of the yearsended December 31, 2006 and 2005, and $10.0 million for the year ended December 31, 2004. (3) Includes available for sale securities. (4) Includes trading and available for sale securities. (5) Net interest income divided by average interest-earning assets.
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     The following table presents the dollar amount of changes in interest income and interestexpense for the major components of interest-earning assets and interest-bearing liabilities anddistinguishes between the increase (decrease) related to changes in outstanding balances and thechanges in interest rates.                           **Year ended December 31,**   **2006 vs. 2005**  **2005 vs. 2004**   **Volume**  **Rate**  **Total**  **Volume**  **Rate**  **Total**   **(In thousands)** Interest income:                        Loans $98,956  $93,532  $192,488  $103,874  $53,004  $156,878 Investment securities (1)  10,084   4,354   14,438   34,205   1,115   35,320 Mortgage-backed securities (2)  (5,515)  1,683   (3,832)  (8,138)  2,970   (5,168)Money market instruments  (4,324)  6,126   1,802   6,294   10,629   16,923                    Total increase in interest income  99,201   105,695   204,896   136,235   67,718   203,953                    Interest expense:                        Deposits  50,744   74,051   124,795   44,875   30,156   75,031 Federal funds purchased andrepurchase agreements  (3,880)  76,552   72,672   19,785   73,592   93,377 Advances from FHLB  (495)  700   205   822   298   1,120                    Total increase in interest expense  46,369   151,303   197,672   65,482   104,046   169,528                    Increase (decrease) innet interest income $52,832  $(45,608) $7,224  $70,753  $(36,328) $34,425                     (1) Includes available for sale securities. (2) Includes trading and available for sale securities.**PROVISION FOR LOAN LOSSES**     The 2006 provision for loan losses was $64.6 million, an increase of $33.6 million or 108.29%when compared to 2005. Net charge-offs during 2006 amounted to $30.1 million, which when subtractedfrom the provision for loan losses of $64.6 million resulted in a net increase in the allowance forloan losses of $34.5 million. The 2005 provision for loan losses was $31.0 million, a decrease of$5.7 million or 15.51% when compared to 2004. Net charge-offs during 2005 amounted to $18.7million, which when subtracted from the provision for loan losses of $31.0 million resulted in anet increase in the allowance for loan losses of $12.3 million.     The increase in the provision for loan losses for 2006 is attributable to the followingfactors: first, the overall growth in the Company’s loan portfolio, mainly those of its Commercialand C&I loans; and second, to higher non-performing loans, net loans charged-off and specificreserves during the periods, principally in the loan portfolio of the Company’s asset-based lendingdivision. Commercial and C&I loan portfolio grew to $6.22 billion at December 31, 2006, an increaseof $946.8 million or 17.95%, when compared to December 31, 2005. Westernbank Business Credit loanportfolio grew to $1.46 billion at December 31, 2006, an increase of $193.2 million or 15.28%, whencompared to December 31, 2005.     The provision for loan losses for Westernbank Business Credit division accounted for $57.5million or 89.01% of the total provision for loan losses for the year ended December 31, 2006,while for year 2005, it accounted for $22.4 million or 72.33% of the total provision for loanlosses. The increase of $35.1 million in the provision for loan losses for Westernbank BusinessCredit division for 2006 is mainly attributable to two factors: first, the increase in theDivision’s loan portfolio from $1.26 billion at December 31, 2005, to $1.46 billion at December 31,2006; and second, the increase in classified loans of the Division’s loans portfolio. During theyear ended December 31, 2006, the Company classified three loans of the Division’s loan portfoliowith outstanding principal balances of $44.9 million, $40.5 million and $7.3 million at December31, 2006. These loans required valuation allowances as follows: $11.4 million for the $44.9 millionloan (after a partial charge-off of $7.5 million), $15.2 million for the $40.5 million loan and$2.5 million for the $7.3 million loan (after a partial charge-off of $3.0 million). These loansare current and have not missed their payment schedules but have shortfalls in the collaterals andin the financial condition of the borrowers. The average yield ofWesternbank Business Credit Division’s loan portfolio at December 31, 2006, was 9.47%.
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     The provision for loan losses for the consumer loan portfolio, including the Expresso ofWesternbank loan portfolio, increased by $824,000 or 11.58%, from $7.1 million for the year 2005 to$7.9 million for the year 2006. The increase was primarily due to an increase in the delinquencylevels of the consumer loan portfolio at December 31, 2006. The delinquency ratio on the consumerloan portfolio, including the Expresso of Westernbank loan portfolio, for the categories of 60 daysand over increased by 39 basis points, to 1.52% at December 31, 2006, when compared to 1.13% forthe comparable period last year. The increase in the delinquency ratio of the consumer loansportfolio is mainly attributable to regular consumer loans past due over 60 days which arecollateralized by real estate properties.     At December 31, 2006, the allowance for loan losses was $126.8 million or 1.45% of totalloans, and 76.50% of total non-performing loans (reserve coverage), compared to an allowance forloan losses at December 31, 2005, of $92.4 million or 1.17% of total loans, and 144.39% of totalnon-performing loans. The decrease in the allowance for loan losses to non-performing loans ratiowas principally due to the increase in non-performing loans in Commercial & C&I non-performingloans, mainly from the Company’s asset based lending division.     For the year ended December 31, 2006, net loan charge-offs amounted to $30.1 million or 0.36%to average loans, an increase of $11.5 million or 61.37%, when compared to $18.7 million or 0.27%to average loans in 2005. The increase in loans charged-off for the year ended December 31, 2006,when compared to the same period in 2005, is mainly attributed to an increase of $14.6 million inCommercial and C&I loans charged-off. Such increase in the Commercial and C&I loans charged-offresulted principally from loans charged-off on the Company’s asset based lending division. Duringthe year 2006, the Company partially charged-off three loans of its asset based lending divisionwith outstanding principal balances after charge-offs of $44.9 million, $7.3 million and $3.1million, at December 31, 2006, as follows: $7.5 million on the $44.9 million loan, $3.0 million onthe $7.3 million loan and $5.3 million on the $3.1 million loan. These loans are current and havenot missed their payment schedules but have shortfalls in the collaterals and in the financialcondition of the borrowers. At December 31, 2006, these loans required valuation allowances asfollows: $11.4 million for the $44.9 million loan and $2.5 million for the $7.3 million loan. The$3.1 million loan did not require a valuation allowance at December 31, 2006.     Consumer loan charge-offs for the year ended December 31, 2006, were $12.6 million, animprovement of $1.2 million or 8.93%, when compared to $13.8 million for the same period in 2005.Such improvement is principally attributed to lower charge-offs by the Expresso of Westernbankdivision, the principal component of the consumer loan charge-offs. Loans charged-off by theExpresso of Westernbank division decreased from $9.8 million for the year ended December 31, 2005,to $8.9 million for the same period in 2006, a decrease of $836,000. This is the result ofmanagement’s strategy of stabilizing loan losses and increasing the overall rates charged of theExpresso loan portfolio by continuously reviewing its underwriting policies and increasing thelevel of collateralized loans. The average yield of the Expresso of Westernbank loan portfolio was23.74% at December 31, 2006. Also, the portion of the loan portfolio of Expresso of Westernbankcollateralized by real estate at December 31, 2006, already accounts for 20% of the outstandingbalance.     The Expresso loan portfolio includes small, unsecured consumer loans up to $15,000 and realestate collateralized consumer loans up to $150,000. These loans generally have a higher creditrisk when compared to the rest of Westernbank’s consumer loan portfolio, since the ExpressoDivision principally targets the typical small consumer loan customers that are usually low incomeearners. Therefore, the Expresso of Westernbank division loan portfolio carries a higher risk ofdefault when compared to the total consumer loans portfolio in general.     The accounts written-off are submitted to the Collections Department recovery unit forcontinued collection efforts. Recoveries made from accounts previously written-off amounted to $5.2million in 2006 and $3.5 million in 2005, an improvement of $1.7 million or 47.42%.     The decrease in the provision for loan losses from 2004 to 2005 was attributed to lower netcharge offs of the Expresso of Westernbank division loan portfolio and relatively stabledelinquencies in our commercial and consumer loan portfolios during the year 2005, when compared tothe same period in 2004. The provision for loan losses for Westernbank Business Credit divisionaccounted for $22.4 million or 72.33% of the total provision for loan losses for the year endedDecember 31, 2005, while for year 2004, it accounted for $6.0 million or 16.33% of the totalprovision for loan losses. The increase of $16.4 million in the provision for loan losses forWesternbank Business Credit division is mainly attributable to two factors; first, an increase inthe division loss ratio as a result of a $5.3 million partial charge-off of one loan that wasacquired in the original purchased loan portfolio of this division on June 15, 2001. The remainingoutstanding principal balance of this loan at December 31, 2005, is $10.1 million, with a specificvaluation allowance of $6.8 million. Second, the increase in the specific reserves of two loans ofthe division loan portfolio during the fourth quarter of year 2005. Outstanding principal balanceson these loans were $10.1 million (as explained above) and $14.1 million at December 31, 2005, withspecific reserves of $6.8 million and $4.8 million, respectively. The provision for loan losses forthe consumer loan portfolio decreased by $10.0 million, from 2004 to 2005. This decrease wasprimarily due to the relatively stable delinquency levels at the consumer loans portfolio, thedecrease in the outstanding balance of the loan
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portfolio of the Expresso of Westernbank and the decrease in net charge-offs, principally in the Expresso of Westernbankdivision loan portfolio. The decrease in the Expresso of Westernbank loan portfolio was mainly dueto management’s strategy of stabilizing charge-offs as the division’s portfolio matures and averageyield continues to increase.     For the year ended December 31, 2005, net charge-offs to average loans decreased from 0.34%for the year 2004, to 0.27% for the year 2005. In absolute dollar amounts, net charge-offs remainedrelatively unchanged at $18.7 million, when compared to $18.2 million in 2004. Commercial loanscharged-off were $8.2 million for the year ended December 31, 2005, when compared to $5.4 millionfor the year ended December 31, 2004, an increase of $2.8 million or 51.54%. The increase inCommercial and C&I loans charged-off was primarily due to the partial charge-off of $5.3 million ofone loan that was acquired in the original purchased loan portfolio of Westernbank Business Creditdivision on June 15, 2001. The remaining outstanding principal balance of this loan at December 31,2005, was $10.1 million with a specific allowance of $6.8 million. Loans charged-off in theconsumer loans portfolio decreased by $2.7 million or 16.17%, from $16.5 million in 2004, to $13.8million in 2005. The decrease is principally attributable to lower charge-offs by the Expresso ofWesternbank division, the principal component of the consumer loans charged- offs. Loanscharged-off by the Expresso of Westernbank division decreased from $12.4 million for year 2004, to$9.8 million for year 2005, a decrease of $2.6 million or 20.97%. Management strategy ofstabilizing charge-offs and increasing the yield of the Expresso loan portfolio by continuouslyreviewing its underwriting policies, increasing the level of collateralized loans, and increasingthe overall rates charged has resulted in lower levels in net charge-offs and a higher yield. Theaverage yield of the Expresso of Westernbank loan portfolio was 23.15% at December 31, 2005. Also,the loan portfolio of Expresso of Westernbank collateralized by real estate at December 31, 2005,already accounts for 15% of the outstanding balance. The accounts written-off are submitted to theCollections Department recovery unit for continued collection efforts. Recoveries made fromaccounts previously written-off amounted to $3.5 million in 2005 and $4.0 million in 2004.     The allowance for loan losses is maintained at a level which, in management’s judgment, isadequate to absorb credit losses inherent in the loan portfolio. The amount of the allowance isbased on management’s evaluation of various conditions as the existing general economic andbusiness conditions affecting key lending areas; terms, nature and volume of the portfolio, creditquality trends including trends in non-performing loans expected to result from existingconditions, evaluation of the collectibility of the loan portfolio, collateral values, creditconcentrations, trends in historical loss experience, specific impaired loans and delinquencytrends, among other factors. This evaluation is inherently subjective as it requires estimates thatare susceptible to significant revision as more information becomes available. Allowances forimpaired loans are generally determined based on collateral values or the present value ofestimated cash flows. Although no assurance can be given, management believes that the presentallowance for loan losses is adequate considering loss experience, delinquency trends and currenteconomic conditions. Management regularly reviews the Company’s loan loss allowance as its loanportfolio grows and diversifies. For a more detailed discussion of the factors affecting theprovision for loan losses and changes in the underlying factors affecting the components of theAllowance for Loan Losses refer to “Financial Condition — Allowance for Loan Losses” and Item I,“Business — Allowance for Loan Losses”.     **NONINTEREST INCOME**     For the year ended December 31, 2006, noninterest income increased $1.3 million or 3.57%, whencompared to year 2005. This increase was mainly the result of an increase of $4.2 million or 12.61%in service fees and other fees and commissions due to higher activity resulting from the Company’soverall growing volume of business. Such increase was partially offset by a negative variance of$1.2 million on net gain on derivative instruments, as a result of the mark to market of suchpositions. Also, during the year ended December 31, 2006, the Company recorded a loss of $1.8million on other-than-temporarily impaired investments, mainly related to certain investments inPuerto Rico Government Obligations that were downgraded by one notch below investment grade in May2006.     For the year ended December 31, 2005, noninterest income decreased $17.8 million or 33.21%,when compared to the same period in 2004. This decrease was mainly due to a decrease of $20.5million in the net gain on derivative instruments as a result of the change in the fair valueduring the year, including the net cash settlements, of certain interest rate swaps. Net gain onsales and valuation of loans held for sale, securities, and other assets also decreased by $2.1million, as a result of a realized gain of $525,000 on an investment security during the thirdquarter of 2004 and higher realized gains on loans securitized or sold in the secondary market in2004. Such decreases were partially offset by an increase of $4.8 million or 16.72% in service andother charges on loans, deposits and other fees and commissions.
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     **NONINTEREST EXPENSES**     Total noninterest expenses increased $16.3 million or 15.05% and $8.1 million or 8.09% in 2006and 2005, respectively.     Salaries and employees’ benefits, the largest component of total noninterest expenses,increased $7.7 million or 16.56% and $8.3 million or 21.76% in 2006 and 2005, respectively. Suchincreases are attributed to the increases in personnel, normal salary increases and relatedemployees’ benefits, principally related to the Company’s continued expansion in all of itsbusiness areas, mainly in the San Juan Metropolitan area. In March 2005, the Company opened its newstate of the art mega branch in the eastern region of Puerto Rico, in the city of Humacao. InOctober 2005, the Company opened its second branch in the eastern region of Puerto Rico, in thecity of Fajardo. In December 2005, the Company opened a mega branch in the Condado area in the cityof San Juan and in September 2006, the Company opened its newest mega branch in the city ofBayamón. Also, during the first quarter of year 2006, the Company established WesternbankInternational Trade Services (“WITS”), a division of Westernbank Puerto Rico that providesinternational trade products and services to customers. At December 31, 2006, the Company had 1,363full-time employees, including its executive officers, an increase of 52 employees or 3.97% sinceDecember 31, 2005. At December 31, 2005, the Company had 1,311 full-time employees, including itsexecutive officers, an increase of 136 employees or 11.57% since December 31, 2004.     Depreciation, maintenance and related equipment expenses increased $2.1 million or 21.52% and$109,000 or 1.15%, for the years ended December 31, 2006 and 2005, respectively. This is the resultof the continued growth of the Company’s branch network, as explained in the above paragraph.     For the year ended December 31, 2006, advertising expense remained relatively unchanged at$9.1 million, when compared to year 2005. Such stability was mainly due to strict control measuresimplemented during the year 2006. For the year ended December 31, 2005, advertising expensedecreased by $1.3 million or 12.83%, when compared to year 2004, as the Company concluded itsradio, newspaper and television campaign promoting Westernbank’s institutional image andpositioning the Company for its strategy in the San Juan metropolitan area that was in effectduring most of the year 2004.     Noninterest expenses, as a group, excluding salaries and employees’ benefits, depreciation,maintenance and related equipment expenses, and advertising, increased $6.5 million or 15.23%,during the year ended December 31, 2006, from $42.9 million in 2005, to $49.4 million in 2006,compared to an increase of $1.0 million or 2.41%, from $41.9 million in 2004. These increasesresulted primarily from costs associated with the additional investment in technology and generalinfrastructure to sustain and coordinate the Company’s growth and expansion in all of its businessareas.     The Company continued its strict cost control measures, maintaining operating expenses atadequate levels, as evidenced by its efficiency ratios of 34.94%, 30.67% and 30.66% for the years2006, 2005 and 2004, respectively.     **PROVISION FOR INCOME TAXES**     Under Puerto Rico income tax laws, the Company is required to pay the higher of an alternativeminimum tax of 22% or regular statutory rates ranging from 20% to 39%, except for years 2005 and2006, in which two transitory additional income taxes of 2.5% and 2.0% over net taxable income wereimposed by the Governor of Puerto Rico under Law No. 41, signed on August 1, 2005, effectivelyincreasing the maximum statutory regular tax rate to 41.5% in 2005 and 43.5% in 2006. Thetransitory income taxes of 2% and 2.5% (the latter was approved by the Government of Puerto Rico onAugust 1, 2005) were intended to be temporary in nature and ended on December 31, 2006. TheCompany’s effective tax rate is below the statutory rate, being 39.7%, 21.7% and 11.4% for theyears ended December 31, 2006, 2005 and 2004, respectively. The significant increase in theeffective tax rate in year 2006 when compared to years 2005 and 2004 is attributed to the factorsexplained below.     The provision for income taxes increased $21.2 million or 47.06% for the year ended December31, 2006, when compared to the same period in 2005. The current provision for income taxes for theyear ended December 31, 2006, amounted to $76.6 million, compared to $52.5 million in 2005 and$28.2 million in 2004. The increase in the current provision for income taxes for the year endedDecember 31, 2006, when compared to 2005, is attributed to three factors. First, on May 13, 2006,with an effective date of January 1, 2006, the Puerto Rico Legislature approved Law No. 89, whichimposes an additional 2.0% tax on all companies covered by the Puerto Rico Banking Act, as amended,such as Westernbank. This transitory income tax of 2% amounted to $3.0 million for the year endedDecember 31, 2006. Second, the increase in the Company’s taxable income derived from the increasein its loan portfolio has changed the mix between exempt and taxable income, therefore increasingthe Company’s effective tax rate. Third, for the year ended December 31, 2006, the Company accrued$10.2 million for income tax contingencies.
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     For year 2005, the increase in the current provision for income taxes for 2005, when comparedto 2004, is attributed to two factors. First, the transitory additional surtax of 2.5% over nettaxable income, explained above, resulted in an additional current income tax provision of $3.2million during the year ended December 31, 2005. Second, the significant increase in the Company’staxable income derived from increases in the loans portfolio; changing the proportion betweenexempt and taxable income, and therefore increasing the Company’s effective tax rate.     The Company evaluates and assesses the relative risks and appropriate tax treatment oftransactions and filing positions after considering statutes, regulations, judicial precedent andother information and maintains tax accruals consistent with its evaluation of these relative risksand merits. Changes to the estimate of accrued taxes occur periodically due, among other, tochanges in tax rates, interpretations of tax laws, the status of examinations being conducted bytaxing authorities and changes to statutory, judicial and regulatory guidance that impact therelative risks of tax positions. These changes, when they occur, can affect the income tax accrualsas well as the current period’s income tax expense and can be significant to the operating resultsof the Company. The Company’s consolidated statements of financial condition include an accrual of$10.9 million and $667,000 at December 31, 2006 and 2005, respectively, for the exposures resultingfrom tax positions identified by the Company in connection with this evaluation.     Deferred income taxes reflect the impact of credit, operating and capital lossescarryforwards, and “temporary differences” between amounts of assets and liabilities for financialreporting purposes and their respective tax bases. The deferred income tax credit increased in 2006and in 2005. Changes in years 2006 and 2005, are attributable to temporary differences in therecognition of certain items for tax and books, principally changes in the allowance for loanlosses and in the unrealized loss on derivative instruments (See Note 11 — Income Taxes — to theconsolidated financial statements).     **NET INCOME**     The Company’s net income decreased $62.6 million or 38.36% from 2005 to 2006 and $8.8 millionor 5.11% from 2004 to 2005. The decrease in net income for the year ended December 31, 2006, whencompared to year 2005, was attributed to an increase of $33.6 million in the provision for loanlosses, an increase of $16.3 million in noninterest expenses and an increase of $21.2 million inthe provision for income taxes. Such increases were partially offset by an increase of $7.2 millionor 2.32% in net interest income. The decrease in net income for the year ended December 31, 2005,when compared to year 2004, was impacted by an increase of $34.4 million in net interest income asa result of higher yields on the average loan portfolio and in the average money market instrumentsportfolio, a provision for loan losses $5.7 million lower than that for the comparable prior year,a decrease of $20.5 million in the gain on derivative instruments, an increase of $8.1 million innoninterest expense and a significantly higher provision for income taxes of $23.0 million.     **FINANCIAL CONDITION**     **LOANS**     Loans receivable-net were $8.64 billion or 50.37% of total assets at December 31, 2006, anincrease of $825.4 million, or 10.56%, from December 31, 2005. Loans, net were $7.82 billion or48.39% of total assets at December 31, 2005, an increase of $1.90 billion or 32.08%, from $5.92billion or 41.32% of total assets at December 31, 2004.     The Company continues to focus on growing its commercial loans portfolio through commercialreal estate, construction and land acquisition, asset-based and other commercial loans. As aresult, the commercial real estate mortgage loan portfolio increased $685.7 million or 16.09%, from$4.26 billion at December 31, 2005, to $4.95 billion at December 31, 2006. Commercial real estatemortgage loan portfolio increased $1.11 billion or 35.05%, from $3.15 billion at December 31, 2004.The commercial, industrial and agricultural loan portfolio was $1.27 billion as of December 31,2006, an increase of $261.1 million or 25.78%, from $1.01 billion at December 31, 2005. Thecommercial, industrial and agricultural loan portfolio increased by $244.5 million or 31.81%, from$768.6 million at December 31, 2004. The residential real estate-mortgage loan portfolio, whichincludes commercial loans mainly secured by individual mortgages on one-to-four family residentialproperties, decreased from $1.30 billion as of December 31, 2005, to $1.01 billion as of December31, 2006. The residential real estate-mortgage loans portfolio was $879.1 million as of December31, 2004. Consumer and other loans portfolio, including the Expresso of Westernbank loan portfolio,credit cards and loans on deposits decreased from $830.4 million as of December 31, 2005, to $810.0million as of December 31, 2006. Consumer and other loans portfolio was $866.9 million at December31, 2004.     Westernbank’s commercial real estate and other loans are primarily variable and adjustablerate products. Commercial loan originations come from existing customers as well as through directsolicitation and referrals. Westernbank offers different types of consumer loans, including securedand unsecured products, in order to provide a full range of financial services to its retailcustomers. In addition, Westernbank offers VISA(TM)and MasterCard(TM)accounts to its customers.
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     During the last five fiscal years, loans have grown at an average annualized rate of 24.58%.As of December 31, 2006, Commercial and C&I and construction loans were 80.35% (81.65% of which arecollateralized by real estate) and consumer loans were 9.37% (60.59% of which are collateralized byreal estate) of the $8.64 billion loan portfolio-net, compared to Commercial and C&I andconstruction loans of 67.47% (80.79% collateralized by real estate) and consumer loans of 10.62%(70.56% collateralized by real estate) of the $7.82 billion loan portfolio-net as of December 31,2005. This has enabled Westernbank to shift its asset composition to assets with shorter maturitiesand greater repricing flexibility. The Company has also continued to diversify Westernbank’ssources of revenue, while maintaining its status as a secured lender, with approximately 83% of itsloans collateralized by real estate as of December 31, 2006. As of December 31, 2006, WesternbankBusiness Credit and Expresso of Westernbank divisions’ loan portfolios amounted to $1.46 billionand $129.0 million, respectively, compared to loan portfolios of $1.26 billion and $135.0 million,respectively, as of December 31, 2005. For the years ended December 31, 2006 and 2005, the averageyields of Westernbank Business Credit and the Expresso of Westernbank loan portfolios were 9.47%and 8.24%, and 23.74% and 23.15%, respectively.     The following table sets forth the composition of the Westernbank’s loan portfolio at thedates indicated.                                           **At December 31,**   **2006**  **2005**  **2004**  **2003**  **2002**   **Amount**  **Percent**  **Amount**  **Percent**  **Amount**  **Percent**  **Amount**  **Percent**  **Amount**  **Percent**   **(Dollars in thousands)**  Commercial real estate — mortgage (1) $4,945,932   57.2% $4,260,258   54.5% $3,154,679   53.3% $2,261,465   48.3% $1,647,602   38.9%Residential real estate — mortgage (2)  1,014,957   11.8   1,298,535   16.6   879,056   14.9   894,007   19.1   844,803   22.5 Construction — mortgage  722,789   8.4   505,760   6.5   328,145   5.5   202,600   4.3   181,266   4.8 Commercial, industrial and agricultural (1)  1,274,236   14.7   1,013,092   13.0   768,604   13.0   524,747   11.2   384,200   15.2 Consumer and others (3) (4)  809,953   9.4   830,384   10.6   866,934   14.6   861,907   18.4   743,600   19.8                                Total loans  8,767,867   101.5   7,908,029   101.2   5,997,418   101.3   4,744,726   101.3   3,801,471   101.2                                          Allowance for loan losses  (126,844)  (1.5)  (92,406)  (1.2)  (80,066)  (1.3)  (61,608)  (1.3)  (47,114)  (1.2)                                Loans — net $8,641,023   100.0% $7,815,623   100.0% $5,917,352   100.0% $4,683,118   100.0% $3,754,357   100.00%                                (1) Includes $1.46 billion, $1.26 billion, $831.1 million, $641.1 million and $427.7 million of Westernbank Business Credit division outstandingloans at December 31, 2006, 2005, 2004, 2003 and 2002, respectively. (2) Includes fixed and floating interest rate loans to two mortgage originators groups in Puerto Rico mainly secured by mortgages on one-to-fourfamily residential properties as follows: $940.0 million, $1.14 billion, $745.0 million, $750.6 million and $701.6 million at December 31, 2006,2005, 2004, 2003 and 2002, respectively. (3) Includes $129.0 million, $135.0 million, $144.0 million, $155.6 million and $117.4 million of Expresso of Westernbank division outstanding loans atDecember 31, 2006, 2005, 2004, 2003 and 2002, respectively. (4) Includes $490.7 million, $585.9 million, $585.2 million, $521.6 million and $447.9 million collateralized by real estates at December 31, 2006,2005, 2004, 2003, 2002, respectively.     Residential real estate — mortgage loans are mainly comprised of loans securedby first mortgages on one-to-four family residential properties. At December 31, 2006, residentialand commercial real estate loans included $940.0 million in commercial loans, mainly secured byindividual mortgages on one-to-four family residential properties, to two mortgage originatorgroups in Puerto Rico and $26.0 million of mortgages insured or guaranteed by government agenciesof the United States or Puerto Rico.     Westernbank has a significant fixed rate lending concentration with an aggregate unpaidprincipal balance of $894.0 million in one mortgage originator group in Puerto Rico at December 31,2006. In addition, Westernbank has outstanding $46.0 million of fixed and floating rate loans toanother mortgage originator group in Puerto Rico, for total outstanding loans to mortgageoriginator groups amounting to $940.0 million at December 31, 2006. These commercial loans aresecured by 11,672 individual mortgage loans on residential and commercial real estate with anaverage principal outstanding balance of $80,534. Westernbank’s historical experience with themortgage originator groups is that they have paid these loans in accordance with their terms. OnMarch 16, 2006, Westernbank obtained a waiver from the Office of the Commissioner of FinancialInstitutions of the Commonwealth of Puerto Rico with respect to the statutory limit for individualborrowers (loan to one borrower limit), which allows the Company to retain the above significantcommercial loans in its portfolio until these are paid in full.     On June 30, 2006, Westernbank entered into an agreement to restructure the terms of theoriginal transactions of the $894.0 million lending relationship described above. The agreementeliminated the recourse provisions on the underlying loans, terminated the counterparties’ callrights, converted the return from variable to a fixed rate, and resulted in a net compensation of$25.8 million to Westernbank. One of the purposes of that transaction was to give Westernbank theability to use sale accounting treatment. However, because most of the individual mortgage loanswere originally transferred to the ultimate transferor within the mortgage originator group by twoof its affiliates, the Company has not been able to obtain persuasive evidence that the transfersof loans from the affiliates to the entity that subsequently transferred the loans to Westernbankmet all the criteria for sale accounting under theprovisions of SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets andExtinguishments of Liabilities. As a result, the Company continues to present these transactions ascommercial loans secured by real estate mortgages. The netcompensation of $25.8 million receivedby Westernbank in connection with the June 30, 2006 transaction is being amortized over theremaining life of these loans as a yield adjustment.
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     Westernbank originated $1.87 billion of commercial real estate mortgage loans, includingconstruction loans, during the year ended December 31, 2006. At December 31, 2006, commercial realestate mortgage loans totaled $4.96 billion. In general, commercial real estate mortgage loans areconsidered by management to be of somewhat greater risk of uncollectibility than residentiallending because such loans are typically larger in size and more risk is concentrated in a singleborrower. In addition, the borrower’s ability to repay a commercial loan or a construction loandepends, in the case of a commercial loan, on the successful operation of the business or theproperty securing the loan and, in the case of a construction loan, on the successful completionand sale or operation of the project. Substantially all of the Company’s borrowers and propertiesand other collateral securing the commercial, real estate mortgage and consumer loans are locatedin Puerto Rico. These loans may be subject to a greater risk of default if the Puerto Rico economysuffers adverse economic, political or business developments, or if natural disasters affect PuertoRico. Foreign loans, mainly to entities in Canada and in the United Kingdom, amounted to $109.3million at December 31, 2006.     The portfolio of Consumer and other loans at December 31, 2006, consisted of consumer loans of$810.0 million, of which $490.7 million are secured by real estate, $282.7 million are unsecuredconsumer loans (consisting of $104.3 million of Expresso of Westernbank division unsecured loansportfolio, credit card loans of $48.7 million and other consumer loans of $129.7 million) and loanssecured by deposits in Westernbank totaling $36.6 million.     During 2006, Westernbank securitized $4.6 million and $4.0 million of residential mortgageloans into Government National Mortgage Association and Fannie Mae participation certificates,respectively, and sold loans amounting to $16.6 million to Fannie Mae. Westernbank continues toservice 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 theperiods indicated at December 31, 2006. Contractual maturities do not necessarily reflect theexpected term of a loan, including prepayments.                               **Maturities**           **After one year to five years**  **After five years**       **One year or**  **Fixed**  **Variable**  **Fixed**  **Variable**   **Balance outstanding**  **less**  **interest**  **interest**  **interest**  **interest**   **(In thousands)**  Commercial real estate — mortgage $4,945,932  $1,503,741  $349,206  $774,960  $125,973  $2,192,052 Residential real estate — mortgage (1)  1,014,957   8,194   51,921   7   918,186   36,649 Construction — mortgage  722,789   502,411   —   220,378   —   — Commercial, industrial and agricultural  1,274,236   491,124   17,310   636,541   54,349   74,912 Consumer and others  809,953   135,469   167,245   8,188   82,826   416,225                    Total $8,767,867  $2,640,939  $585,682  $1,640,074  $1,181,334  $2,719,838                     (1) Includes fixed and floating interest rate loans to two mortgage originator groups in Puerto Rico mainly secured by mortgages on one-to-four familiyresidential properties with an outstanding principal balance of $940.0 million at December 31, 2006.     Westernbank’s loan originations come from a number of sources. The primary sources forresidential loan originations are depositors and walk-in customers. Commercial loan originationscome from existing customers as well as through direct solicitation and referrals.     Westernbank originates loans in accordance with written, non-discriminatory underwritingstandards and loan origination procedures prescribed in the Board of Directors approved loanpolicies. Detailed loan applications are obtained to determine the borrower’s repayment ability.Applications are verified through the use of credit reports, financial statements and otherconfirmationprocedures. Property valuations by independent appraisers approved by the Board of Directorsare required for mortgage and all real estate loans.     Westernbank’s Senior Credit Committee approval is required for all loans in excess of $20.0million ($15.0 million in the case of Westernbank Business Credit Division). The Senior CreditCommittee also reviews and ratifies all loans from $1.0 million to $20.0 million approved byWesternbank’s regional credit committees. The Senior Credit Committee is composed of a majority ofthe members of the Company’s Board of Directors and senior lending officers. All loans in excess of$20.0 million ($15.0 million forWesternbank Business Credit Division) approved by the SeniorCredit Committee are also reviewed and ratified by the Board of Directors of the Company. All loansin excess of $50.0 million require the approval of the Board of Directors of the Company.
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     It is Westernbank’s policy to require borrowers to provide title insurance policies certifyingor ensuring that Westernbank has a valid first lien on the mortgaged real estate. Borrowers mustalso obtain hazard insurance policies prior to closing and, when required by the Department ofHousing and Urban Development, flood insurance policies. Borrowers may be required to advance fundson a monthly basis together with each payment of principal and interest to a mortgage escrowaccount from which Westernbank makes disbursements for items such as real estate taxes, hazardinsurance premiums and private mortgage insurance premiums as they fall due.     Westernbank’s practice is that its limited production and origination of residential realestate loans are mostly conforming loans, eligible for sale in the secondary market. Theloan-to-value ratio at the time of origination on residential mortgages is generally 75%, exceptthat Westernbank may lend up to 90% of the lower of the purchase price or appraised value ofresidential properties if private mortgage insurance is obtained by the borrower for amounts inexcess of 80%.     Westernbank originates fixed and adjustable rate residential mortgage loans secured by a firstmortgage on the borrower’s real property, payable in monthly installments for terms ranging fromten to forty-five years. Adjustable rates are indexed to specified prime or LIBOR rate. All 30 yearconforming mortgage loans are originated with the intent to sell. Westernbank has also grantedloans, mainly secured by first mortgages on one-to-four residential properties, to mortgageoriginators in Puerto Rico. During the first half of the year ended December 31, 2005, Westernbankgranted $600.5 million of such loans.     Westernbank originates primarily variable and adjustable rate commercial business and realestate loans. Westernbank also makes real estate construction loans subject to firm permanentfinancing commitments. As of December 31, 2006, Westernbank’s Commercial and C&I and constructionloan portfolios had a total delinquency ratio, including the categories of 60 days and over, of0.63% (less than 1%), compared to 0.85% (less than 1%) at December 31, 2005. For furtherexplanation on the delinquency ratio of the Company’s commercial loan portfolio refer to section“NON-PERFORMING LOANS AND FORECLOSED REAL ESTATE HELD FOR SALE”.     Westernbank offers different types of consumer loans in order to provide a full range offinancial services to its customers. Within the different types of consumer loans offered byWesternbank, there are various types of secured and unsecured consumer loans with varyingamortization schedules. In addition, Westernbank makes fixed-rate residential second mortgageconsumer loans. In July 2002, Westernbank launched a new banking division focused on offeringconsumer loans that now has 20 full-service branches, called “Expresso of Westernbank”, denotingthe branches’ emphasis on small, unsecured consumer loans up to $15,000 and collateralized consumerloans up to $150,000.     Westernbank offers the service of VISA TM and MasterCard TM creditcards. At December 31, 2006, there were approximately 21,499 outstanding accounts, with anaggregate outstanding balance of $48.7 million and unused credit card lines available of $81.8million.     In connection with all consumer loans originated, Westernbank’s underwriting standards includea determination of the applicants’ payment history on other debts and an assessment of the abilityto meet existing obligations and payments on the proposed loan. As of December 31, 2006,Westernbank’s consumer loan portfolio, including the Expresso of Westernbank loan portfolio, had atotal delinquency ratio, including the categories of 60 days and over, of 1.52%, compared to 1.13%at December 31, 2005. The increase in the delinquency ratio from 2005 to 2006 was mainly due todelinquencies in regular consumer loans past due over 90 days which are collateralized by realestate properties.     Westernbank has 83% of its loan portfolio as of December 31, 2006, secured by real estate. Ourcombined delinquency on all portfolios for the categories of 60 days and over continues to be below1% for both periods, being 0.66% at December 31, 2006, and 0.72% at December 31, 2005. Theimprovement in the combined delinquency ratio arises from a reduction in delinquent loans of theCommercial and C&I and construction loan portfolios.
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     **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 thedeficiency by contacting the borrower. In most cases, deficiencies are cured promptly. If thedelinquency exceeds 90 days and is not cured through normal collection procedures, Westernbank willgenerally institute measures to remedy the default. If a foreclosure action is instituted and theloan is not cured, paid in full or refinanced, the property is sold at a judicial sale at whichWesternbank may acquire the property. In the event that the property is sold at a priceinsufficient 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 includedin 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 untilthe property is sold.     The accrual of interest on loans is discontinued when there is a clear indication that theborrower’s cash flows may not be sufficient to meet payments as they become due, but in no event isit recognized after a borrower is 90 days in arrears on payments of principal or interest. When aloan is placed on nonaccrual status, all previously accrued and unpaid interest is charged againstincome and the loan is accounted for on the cash method thereafter, until qualifying for return toaccrual status. Generally, a loan is returned to accrual status when all delinquent interest andprincipal payments become current in accordance with the terms of the loan agreement or when theloan is both well secured and in the process of collection and collectibility is no longerdoubtful. Consumer loans that have principal and interest payments that have become past due onehundred and twenty days and credit cards and other consumer revolving lines of credit that haveprincipal and interest payments that have become past due one hundred and eighty days arecharged-off against the allowance for loan losses.     The following table sets forth information regarding non-performing loans and foreclosed realestate held for sale by Westernbank at the dates indicated:                       **December 31,**   **2006**  **2005**  **2004**  **2003**  **2002**   **(Dollars in thousands)** Commercial real estate — mortgage andcommercial, industrial and agricultural loans $154,862  $55,585  $25,417  $24,142  $13,567 Residential real estate mortgage and construction loans  1,641   2,125   1,730   2,259   2,026 Consumer loans  9,309   6,288   7,122   4,845   3,812                 Total non-performing loans  165,812   63,998   34,269   31,246   19,405 Foreclosed real estate held for sale  5,917   4,137   3,811   4,082   3,679                 Total non-performing loans and foreclosedreal estate held for sale $171,729  $68,135  $38,080  $35,328  $23,084                                      Interest that would have been recorded if theloans had not been classified as non-performing $9,052  $4,916  $3,557  $2,500  $1,102                 Interest recorded on non-performing loans $4,785  $743  $243  $583  $775                 Total non-performing loans as a percentageof total loans at end of period  1.89%  0.81%  0.58%  0.66%  0.51%                Total non-performing loans and foreclosed real estateheld for sale as a percentage of total assets at end of period  1.00%  0.42%  0.27%  0.31%  0.28%                     The increase in non-performing loans from year end 2005, to year end 2006 mainly comesfrom the Company’s Commercial and C&I loan portfolio. Non-performing loans on the Commercial andC&I loan portfolio increased by $99.3 million, when compared toDecember 31, 2005. The increase is mainly attributed to four loans of the Company’s assetbased lending division, with outstanding principal balances of $44.9 million, $40.5 million, $14.2million and $7.3 million at December 31, 2006. These loans are current and have not missed theirpayment schedules but have shortfalls in the collaterals and in the financial condition of theborrowers. These loans required valuation allowances as follows: $11.4 million for the $44.9million loan, $15.2 million for the $40.5 million loan, $4.7 million for the $14.2 million loan and$2.5 million for the $7.3 million loan. During the year ended December 31, 2006, five loans relatedto one single borrower that were in non-performing status at December 31, 2005, with an aggregateoutstanding principal balance of $8.4 million, were collected. Non-performing
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loans on the consumerloans portfolio increased by $3.0 million or 48.04% at December 31, 2006, when compared to December31, 2005. Such increase was mainly due to non-performing loans in the regular consumer loansportfolio which are collateralized by real estate. At December 31, 2006, the allowance for possibleloan losses was 76.50% of total non-performing loans (reserve coverage).     The increase in non-performing loans from year end 2004, to year end 2005 mainly comes fromthe Company’s Commercial real estate-mortgage and Commercial, Industrial and Agricultural loans(“C&I”) portfolio. Non-performing loans on the Commercial and C&I loan portfolio increased by $30.2million, when compared to December 31, 2004. The increase is primarily attributed to one loan ofWesternbank Business Credit division originally acquired in the purchased loan portfolio, with anoutstanding principal balance of $10.1 million. There is also one borrower with five commercialloans with an aggregate principal balance of $8.4 million, and five other commercial loans withoutstanding principal balances between $1.0 million to $3.0 million, with an aggregate outstandingprincipal balance of $8.2 million. These loans are collateralized with real estate and did notrequire any valuation allowance. At December 31, 2005, the allowance for possible loan losses was144.39% of total non-performing loans (reserve coverage).     **ALLOWANCE FOR LOAN LOSSES**     Westernbank maintains an allowance for loan losses to absorb probable losses inherent in theloan portfolio. The allowance is based on ongoing, quarterly assessments of the probable estimatedlosses inherent in the loan portfolio, based on evaluations of the collectibility and historicalloss experience of loans. The Company follows a systematic methodology to establish and evaluatethe 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 tooutstanding loans not otherwise covered by specific allowances. Loss factors are based onhistorical loss experience and may be adjusted for significant factors that, in management’sjudgment, reflect the impact of any current condition on loss recognition. Factors that managementconsiders in the analysis include the effect of the national and local economies, trends in thenature and volume of loans (delinquencies, charge-offs, non-accrual and problem loans), assetquality trends, changes in the internal lending policies and credit standards, collectionpractices, and examination results from bank regulatory agencies and the Company’s internal creditexaminers. Loss factors are described as follows:**•** Loan loss factors for commercial loans, including construction and land acquisition loans, arebased on average loss trends (historical net charge-off and changes in the specific allowances)for three to five years, as adjusted for management’s expected increase in the loss factors giventhe significant increase in such loan portfolios over the last few years.**•** Pooled loan loss factors are also based on average loss trends (historical net charge-off andchanges in the specific allowances) for one to three years. Pooled loans are loans that arehomogeneous in nature, such as consumer installment, residential mortgage loans and credit cards.     **Specific Allowances for Identified Problem Loans and Portfolio Segments**. Specific allowancesare established and maintained where management has identified significant adverse conditions orcircumstances related to a credit or portfolio segment that management believes indicate theprobability that a loss has been incurred in excess of the amount determined by the application ofthe formula allowance. Larger commercial and construction loans that exhibit probable or observedcredit weaknesses are subject to individual review. Where appropriate, allowances are allocated toindividual loans based on management’s estimate of the borrower’s ability to repay the loan giventhe availability of collateral, other sources of cash flow and legal options available toWesternbank.     In addition, the specific allowance incorporates the results of measuring impaired loans asprovided in SFAS No. 114, Accounting by Creditors for Impairment of a Loan, as amended. Thisaccounting standard prescribes the measurement methods, income recognition and disclosuresconcerning impaired loans.     **The Unallocated Allowance**. An unallocated allowance is established recognizing the estimationrisk associated with the formula and specific allowances. It is based upon management’s evaluationof various conditions, the effects of which are not directly measured in determining the formulaand specific allowances. These conditions include then-existing general economic and businessconditions affecting our key lending areas; credit quality trends, including trends innonperforming loans expected to result fromexisting conditions, collateral values, loan volumes and concentrations, seasoning of the loanportfolio, recent loss experience in particular segments of the portfolio, regulatory examinationresults, and findings of our internal credit examiners. The evaluation of the inherent lossregarding these conditions involves a higher degree of uncertainty because these are not identifiedwith specific problem credits or portfolio segments.
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     Management assesses these conditions quarterly. If any of these conditions is evidenced by aspecifically 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 allowanceapplicable to this credit or portfolio segment. Where any of these conditions is not evidenced by aspecifically identifiable problem credit or portfolio segment as of the evaluation date,management’s evaluation of the probable loss concerning this condition is reflected in theunallocated allowance.     The allowance for loan losses is based upon estimates of probable losses inherent in the loanportfolio. The amount actually observed for these losses can vary significantly from the estimatedamounts. Our methodology includes several features that are intended to reduce the differencesbetween estimated and actual losses. Historical loss factors for commercial and consumer loans maybe adjusted for significant factors that, in management’s judgment, reflect the impact of anycurrent condition on loss recognition. Factors which management considers in the analysis includethe 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 lendingpolicies and credit standards, collection practices, and examination results from bank regulatoryagencies and the Bank’s internal credit examiners. Loan loss factors are adjusted quarterly basedupon the level of net charge-offs expected by management in the next twelve months, after takinginto account historical loss ratios adjusted for current trends. By assessing the probableestimated losses inherent in the loans portfolio on a quarterly basis, we are able to adjustspecific and inherent loss estimates based upon any more recent information that has becomeavailable.     At December 31, 2006, the allowance for loan losses was $126.8 million, consisting of $86.6million formula allowance (general allowance) and $40.2 million of specific allowance. As ofDecember 31, 2006, the allowance for loan losses equals 1.45% of total loans, compared with anallowance for loan losses at December 31, 2005, of $92.4 million, or 1.17% of total loans.     As of December 31, 2006, there have been no significant changes in estimation methods orassumptions that affected our methodology for assessing the appropriateness of the allowance forloan losses.
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     The table below presents a reconciliation of changes in the allowance for loan losses for theperiods indicated:                       **YEARS ENDED DECEMBER 31,**   **2006**  **2005**  **2004**  **2003**  **2002**   **(Dollars in thousands)**  Balance, beginning of year $92,406  $80,066  $61,608  $47,114  $38,364                 Loans charged-off:                    Commercialreal estate — mortgage and commercial,industrial and agricultural loans (1)  (22,606)  (8,233)  (5,433)  (2,479)  (3,389)Residential real estate-mortgage andconstruction loans  (94)  (121)  (297)  (184)  — Consumer loans (2)  (12,576)  (13,809)  (16,473)  (12,203)  (4,576)                Total loans charged-off  (35,276)  (22,163)  (22,203)  (14,866)  (7,965)                Recoveries of loans previouslycharged-off:                    Commercialreal estate — mortgage and commercial,industrial and agricultural loans  2,846   1,008   1,844   1,141   584 Residential real estate-mortgage andconstruction loans  66   212   206   372   190 Consumer loans (3)  2,252   2,283   1,920   799   858                 Total recoveries of loans previously charged-off  5,164   3,503   3,970   2,312   1,632                 Net loans charged-off  (30,112)  (18,660)  (18,233)  (12,554)  (6,333)Provision for loan losses  64,550   31,000   36,691   27,048   15,083                 Balance, endof year $126,844  $92,406  $80,066  $61,608  $47,114                 Ratios:                    Allowance for loan losses to total loans at end of period  1.45%  1.17%  1.34%  1.30%  1.24%Provision for loan losses to net loans charged-off  214.37%  166.13%  201.23%  215.45%  238.17%Recoveries of loans to loans charged-off in previous period  23.30%  15.78%  26.71%  29.03%  23.19%Net loans charged-off to average total loans (4)  0.36%  0.27%  0.34%  0.29%  0.19%Allowance for loans losses to non-performing loans  76.50%  144.39%  233.64%  197.17%  242.80% (1) Includes partial charge-offs of $15.8 million and $5.3 million in 2006 and 2005,respectively, and a $505,000 charge-off in 2002 of Westernbank Business Credit division loans. (2) Includes $8.9 million, $9.8 million, $12.4 million, $7.9 million and $62,000 of Expresso ofWesternbank loan charge-offs, for the years ended December 31, 2006, 2005, 2004, 2003 and2002, respectively. Expresso of Westernbank began operations on July 10, 2002. (3) Includes $1.0 million, $1.1 million, $1.0 million and $17,000 of Expresso of Westernbank loanrecoveries, for the years ended December 31, 2006, 2005, 2004 and 2003, respectively. (4) Average loans were computed using beginning and period-end balances.     For the year ended December 31, 2006, net loan charge-offs amounted to $30.1 million or0.36% of average loans, an increase of $11.5 million or 61.37%, when compared to $18.7 million or0.27% to average loans in 2005. The increase in loans charged-off for the year ended December 31,2006, when compared to the same period in 2005, is mainly attributed to an increase of $14.6million in Commercial and C&I loans charged-off. Such increase in the Commercial and C&I loanscharged-off resulted principally from loans charged-off on the Company’s asset based lendingdivision. During the year 2006, the Company partially charged-off three loans of its asset basedlending division with outstanding principal balances after charge-offs of $44.9 million, $7.3million and $3.1 million, at December 31, 2006, as follows: $7.5 million on the $44.9 million loan,$3.0 million of the $7.3 million loan and $5.3 million on the $3.1 million loan. These loans arecurrent and have not missed their payment schedules but have shortfalls in the collaterals and inthe financial condition of the borrowers. At December 31, 2006, these loans required valuationallowances as follows: $11.4 million for the $44.9 million loan and $2.5 million for the $7.3million loan. The $3.1 million loan did not require a valuation allowance at December 31, 2006.     Consumer loan charge-offs for the year ended December 31, 2006, were $12.6 million, animprovement of $1.2 million or 8.93%, when compared to $13.8 million for the same period in 2005.Such improvement is principally attributed to lower charge-offs by theExpresso of Westernbank division, the principal component of the consumer loan charge-offs.Loans charged-off by the Expresso of Westernbank division decreased from $9.8 million for the yearended December 31, 2005, to $8.9 million for the same period in 2006, a decrease of $836,000. Thisis the result of management’s strategy of stabilizing loan losses and increasing the overall ratescharged on the Expresso loan portfolio by continuously reviewing its underwriting policies andincreasing the level of collateralized loans. Theaverage yield of the Expresso of Westernbank loanportfolio was 23.74% at December 31, 2006. Also, the portion of the loan portfolio of Expresso ofWesternbank collateralized by real estate at December 31, 2006, already accounts for 20% of theoutstanding balance.
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     The accounts written-off are submitted to the Collections Department recovery unit forcontinued collection efforts. Recoveries made from accounts previously written-off amounted to $5.2million in 2006 and $3.5 million in 2005, an improvement of $1.7 million or 47.42%.     At December 31, 2006, the allowance for possible loan losses was 76.50% of totalnon-performing loans (reserve coverage). The decrease in the allowance for loan losses tonon-performing loans ratio was principally due to the increase in non-performing loans inCommercial & C&I non-performing loans, mainly from the Company’s asset based lending division.     The decrease in the provision for loan losses from 2004 to 2005 was attributed to lower netcharge offs of the Expresso of Westernbank division loan portfolio and relatively stabledelinquencies in our commercial and consumer loan portfolios during the year 2005, when compared tothe same period in 2004. The provision for loan losses for Westernbank Business Credit divisionaccounted for $22.4 million or 72.33% of the total provision for loan losses for the year endedDecember 31, 2005, while for year 2004, it accounted for $6.0 million or 16.33% of the totalprovision for loan losses. The increase of $16.4 million in the provision for loan losses forWesternbank Business Credit division is mainly attributable to two factors; first, an increase inthe division loss ratio as a result of a $5.3 million partial charge-off of one loan that wasacquired in the original purchased loan portfolio of this division on June 15, 2001. The remainingoutstanding principal balance of this loan at December 31, 2005, is $10.1 million, with a specificvaluation allowance of $6.8 million. Second, the increase in the specific reserves of two loans ofthe division loan portfolio during the fourth quarter of year 2005. Outstanding principal balanceson these loans were $10.1 million (as explained above) and $14.1 million at December 31, 2005, withspecific reserves of $6.8 million and $4.8 million, respectively. The provision for loan losses forthe consumer loan portfolio decreased by $10.0 million, from 2004 to 2005. This decrease wasprimarily due to the relatively stable delinquency levels at the consumer loans portfolio, thedecrease in the outstanding balance of the loan portfolio of the Expresso of Westernbank and thedecrease in net charge-offs, principally in the Expresso of Westernbank division loan portfolio.The decrease in the Expresso of Westernbank loan portfolio was mainly due to management’s strategyof stabilizing charge-offs as the division’s portfolio matures and average yield continues toincrease.     For the year ended December 31, 2005, net charge-offs to average loans decreased from 0.34%for the year 2004, to 0.27% for the year 2005. In absolute dollar amounts, net charge-offs remainedrelatively unchanged at $18.7 million, when compared to $18.2 million in 2004. Commercial loanscharged-off were $8.2 million for the year ended December 31, 2005, when compared to $5.4 millionfor the year ended December 31, 2004, an increase of $2.8 million or 51.54%. The increase inCommercial and C&I loans charged-off was primarily due to the partial charge-off of $5.3 million ofone loan that was acquired in the original purchased loan portfolio of Westernbank Business Creditdivision on June 15, 2001. The remaining outstanding principal balance of this loan at December 31,2005, was $10.1 million, with a specific valuation allowance of $6.8 million. Loans charged-off inthe consumer loans portfolio decreased by $2.7 million or 16.17%, from $16.5 million in 2004, to$13.8 million in 2005. The decrease is principally attributed to lower charge-offs by the Expressoof Westernbank division, the principal component of the consumer loans charged- offs. Loanscharged-off by the Expresso of Westernbank division decreased from $12.4 million for year 2004, to$9.8 million for year 2005, a decrease of $2.6 million or 20.97%. Management strategy ofstabilizing charge-offs and increasing the yield of the Expresso loan portfolio by continuouslyreviewing its underwriting policies, increasing the level of collateralized loans, and increasingthe overall rates charged has resulted in lower levels in net charge-offs and a higher yield. Theaverage yield of the Expresso of Westernbank loan portfolio was 23.15% at December 31, 2005. Also,the loan portfolio of Expresso of Westernbank collateralized by real estate at December 31, 2005,already accounts for 15% of the outstanding balance. The accounts written-off are submitted to theCollections Department recovery unit for continued collection efforts. Recoveries made fromaccounts previously written-off amounted to $3.5 million in 2005 and $4.0 million in 2004.     The Expresso loan portfolio includes small, unsecured consumer loans up to $15,000 and realestate collateralized consumer loans up to $150,000. These loans generally have a higher creditrisk when compared to the rest of Westernbank’s consumer loan portfolio, since the ExpressoDivision principally targets the typical small consumer loan customers that are usually low incomeearners. Therefore, the Expresso of Westernbank division loan portfolio carries a higher risk ofdefault when compared to the total consumer loans portfolio in general.     The Expresso of Westernbank division has established policies, procedures and controls toassess, monitor and adequately manage the specific credit risk posed by this loan portfolio underthe FDIC guidelines for sub-prime lending programs, even though thisprogram does not exceed the 25% of capital applicable for such guidelines. The division’s loananalyses and applications are processed in the system software that has embedded controls to helpenforce the lending policies and limits as approved by the division’s senior management. Lendingparameters and authority levels are programmed in a loan process application, restrictingindividuals to their level of authority. Also, the
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 system uses tools to assist the loan officer inidentifying critical information in the customer’s credit report based on a credit scoring process.The system returns a suggested decision and loan amount, based on the customer’s net disposableincome, FICO Score, and credit profile tests. In addition to this package, the division branchesobtain a credit report from a second credit bureau to ensure that the lending officer possesses allinformation needed to make an informed decision and to reduce the division’s credit risk exposure.Overall credit scores for the portfolio are analyzed periodically.     The following table presents the allocation of the allowance for credit losses, the loanportfolio composition percentage and the allowance coverage ratio in each category to total loans,as set forth in the “Loans” table on page 56, at the end of each year.                       **AT DECEMBER 31,**   **2006**  **2005**  **2004**  **2003**  **2002**   **(Dollars in thousands)** Allowance for loan losses:                                         Commercial real estate mortgage andcommercial, industrial and agricultural loans (1) $103,806  $68,664  $54,493  $39,217  $30,271 Residential real estate mortgage  4,654   3,275   407   415   443 Construction mortgage  3,616   4,059   3,715   2,183   1,400 Consumer and others (2)  12,029   14,430   19,425   17,472   12,004 Unallocated  2,739   1,978   2,026   2,321   2,996                 Total allowance for loan losses $126,844  $92,406  $80,066  $61,608  $47,114                                      Loan portfolio composition percentages:                                         Commercial real estate mortgage andcommercial, industrial and agricultural loans  70.94%  66.68%  65.42%  58.72%  53.45%Residential real estate mortgage  11.58%  16.42%  14.66%  18.84%  22.22%Construction mortgage  8.24%  6.40%  5.47%  4.27%  4.77%Consumer and others  9.24%  10.50%  14.45%  18.17%  19.56%                Total loans  100.00%  100.00%  100.00%  100.00%  100.00%                                     Allowance coverage ratio atend of year:                                         Applicable to:                                         Commercial real estate mortgage andcommercial, industrial and agricultural loans  1.67%  1.30%  1.39%  1.41%  1.49%Residential real estate mortgage  0.46%  0.25%  0.05%  0.05%  0.05%Construction mortgage  0.50%  0.80%  1.13%  1.08%  0.77%Consumer and others  1.49%  1.74%  2.24%  2.03%  1.61%Unallocated (as a percentage of total loans)  0.03%  0.03%  0.03%  0.05%  0.08%                Total loans  1.45%  1.17%  1.34%  1.30%  1.24%                 (1) Includes an allowance of $74.3 million, $30.0 million, $12.9 million, $6.6 million and $4.5 million for Westernbank Business Creditloans at December 31, 2006, 2005, 2004, 2003 and 2002, respectively. (2) Includes an allowance of $7.8 million, $8.4 million, $13.8 million, $10.0 million and $1.5 million for Expresso of Westernbank loansportfolio at December 31, 2006, 2005, 2004, 2003 and 2002, respectively. Expresso of Westernbank began operations on July 10, 2002.     The increase in the allowance for credit losses is attributable to the following factors:first, the overall growth in the Company’s loan portfolio, mainly those of its Commercial and C&Iloans; and second, to higher non-performing loans, net loans charged-off and specific reservesduring the period, principally in the loan portfolio of the Company’s asset-based lending division,which increased the loan loss factor of this portfolio and its corresponding general allowance.
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     In 2006 and 2005, the allowance for credit losses on consumer loans decreased as a result oflower net charge-offs, principally in the Expresso of Westernbank division loans. The decrease inthe allowance for credit losses in the Expresso of Westernbank loan portfolio was mainly due tomanagement’s strategy of stabilizing charge-offs as the division portfolio matures and its averageyield continues to increase. For periods before 2005, the increases in the allowance for creditlosses on consumer loans is mainly due to higher net charge-offs, principally in the Expresso ofWesternbank loan portfolio.     As explained before, the Company has outstanding commercial loans to two mortgage originatorgroups in Puerto Rico. These commercial loans are collateralized by mortgages on commercial andresidential real estate. In the first quarter of 2005, as a result of the announcements by themortgage originator groups of the need to restate their previously issued financial statements andother negative views, the Company decided to assign a general allowance to these loans.Westernbank’s historical experience with the mortgage originator groups is that they have paidthese loans in accordance with their terms. At December 31, 2006 and 2005, these loans have anoutstanding balance of $940.0 million and $1.14 billion, respectively, and a general allowance of$4.2 million and $2.8 million, respectively.     Loans are classified as impaired or not impaired in accordance with SFAS No. 114. A loan isimpaired when, based on current information and events, it is probable that Westernbank will beunable to collect the scheduled payments of principal or interest when due, according to thecontractual terms of the agreement.     Westernbank measures the impairment of a loan based on the present value of expected futurecash flows discounted at the loan’s effective interest rate, or as a practical expedient, at theobservable market price of the loan or the fair value of the collateral, if the loan is collateraldependent. Significant loans (those exceeding $500,000 in 2006, 2005, 2004 and 2003, and $250,000in 2002) are individually evaluated for impairment. Large groups of small balance, homogeneousloans are collectively evaluated for impairment; loans that are recorded at fair value or at thelower of cost or market are not evaluated for impairment. The portfolios of mortgage and consumerloans are considered homogeneous and are evaluated collectively for impairment.     Impaired loans for which the discounted cash flows, collateral value or market price exceedsits carrying value do not require an allowance. The allowance for impaired loans is part of theCompany’s overall allowance for loan losses.     The following table sets forth information regarding the investment in impaired loans:                       **2006**  **2005**  **2004**  **2003**  **2002**   **(In thousands)** Investment in impaired loans:                     Covered by a valuation allowance $139,498  $32,542  $29,975  $28,217  $26,074 Do not require a valuation allowance  22,174   49,069   24,200   22,088   24,515                 Total $161,672  $81,611  $54,175  $50,305  $50,589                  Valuation allowance for impaired loans $39,106  $14,185  $8,412  $4,646  $4,752                  Average investment in impaired loans $120,147  $61,113  $46,509  $46,676  $46,147                  Interest collected and recognized asincome on impaired loans $5,815  $4,044  $2,460  $2,452  $4,041                      At December 31, 2006, Westernbank’s investment in impaired loans increased by $80.1million, from $81.6 million at December 31, 2005. The investment in impaired loans covered by avaluation allowance increased from $32.5 million at December 31, 2005, to $139.5 million atDecember 31, 2006, an increase of $107.0 million. This increase was mainly attributed to threeloans of the Company’s asset-based lending division, with outstanding principal balances of $44.9million, $40.5 million and $7.3 million at December 31, 2006. These loans are current and have notmissed their payment schedules but have shortfalls in the collaterals and in the financialcondition of the borrowers. These loans required valuation allowances at December 31, 2006 asfollows: $11.4 million for the $44.9 million loan, $15.2 million for the $40.5 million loan and$2.5 million for the $7.3 million loan. The investment in impaired loans that do not require avaluation allowance decreased from $49.1 million at December 31, 2005 to $22.2 million at December31, 2006, a decrease of $26.9 million. Such decrease was due to loans classified as impaired loansas of December 31, 2005, that were either collected or charged-off during the year ended December31, 2006. During the year ended December 31, 2006, one borrower with five loans, with an aggregateoutstanding principal balance of $8.4 million and one additional loan with an outstanding principalbalance of $1.5 million were paid-off. None of these loans required a valuation allowance as ofDecember 31, 2005.
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     At December 31, 2005, Westernbank’s investment in impaired loans increased by $27.4 million or50.64%, from $54.2 million at December 31, 2004. The investment in impaired loans that do notrequire a valuation allowance increased from $24.2 million at December 31, 2004, to $49.1 millionat December 31, 2005, an increase of $24.9 million. The $27.4 million increase was mainlyattributed to one borrower with five commercial loans with an aggregate principal balance of $8.4million, and four other commercial loans with outstanding principal balances between $1.0 millionto $3.0 million, with an aggregate outstanding principal balance of $8.2 million. Also, at December31, 2005, there are four additional commercial loans with outstanding principal balances between$500,000 to $1.0 million, with an aggregate outstanding principal balance of $2.6 million. All ofthese loans are collateralized with real estate.**INVESTMENTS**     The Company’s investments are managed by the Investment Department. Purchases and sales arerequired to be reported monthly to the Investment Committee (composed of members of the Board ofDirectors, the Chief Executive Officer of the Company, the President and Chief Investment Officerof the Company, the President and Chief Executive Officer of Westernbank, the Treasurer and ChiefInvestment Officer of Westernbank and the Chief Accounting Officer).     The Investment Department is authorized to purchase and sell federal funds, interest bearingdeposits in banks, banker’s acceptances of commercial banks insured by the FDIC, mortgage andasset-backed securities, Puerto Rico and U.S. Government and agencies obligations, municipalsecurities rated A or better by any of the nationally recognized rating agencies, commercial paperand corporate notes rated P-1 by Moody’s Investors Service, Inc. or A-1 by Standard and Poor’s, aDivision of the McGraw-Hill Companies, Inc. In addition, the Investment Department is responsiblefor the pricing and sale of deposits and repurchase agreements.     At the date of purchase, the Company classifies debt and equity securities into one of threecategories: held to maturity; trading; or available for sale. At each reporting date, theappropriateness of the classification is reassessed. Investments in debt securities for whichmanagement has the intent and ability to hold to maturity are classified as held to maturity andstated at cost increased by accretion of discounts and reduced by amortization of premiums, bothcomputed by the interest method. Securities that are bought and held principally for the purpose ofselling them in the near term are classified as trading and measured at fair value in the financialstatements with unrealized gains and losses included in earnings. Securities not classified aseither held to maturity or trading are classified as available for sale and measured at fair valuein the financial statements with unrealized gains and losses reported, net of income tax, as acomponent of accumulated other comprehensive income (loss) until realized. Gains and losses onsales of securities are determined using the specific-identification method.     The Company’s investment strategy is affected by both the rates and terms available oncompeting investments and tax and other legal considerations.     Federal funds sold and resell agreements amounted to $360.2 million and $590.4 million,respectively, at December 31, 2006. Federal funds sold mature within the next two business days,while resell agreements mature as follows: $40.4 million the next business day, $200.0 million in2009, and $350.0 million in 2010. The Company monitors the fair value of the underlying securitiesas compared to the related receivable, including accrued interest, and requests additionalcollateral when the fair value of the underlying collateral falls below the collateral requirement.At December 31, 2006, the fair value of the underlying collateral amounted to $633.6 million.
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     The following table presents the carrying value of investments at December 31, 2006 and 2005:           **2006**  **2005**   **(In thousands)** Held to maturity :        US Government and agencies obligations $6,314,091  $6,314,316 Puerto Rico Government and agencies obligations  11,663   31,824 Corporate notes  21,433   26,429 Mortgage-backed securities  660,392   701,456        Total  7,007,579   7,074,025        Available for sale:        Puerto Rico Government and agencies obligations  18,050   — Equity securities — common stock  2,491   4,981 Mortgage-backed securities  —   185        Total  20,541   5,166        Total investments $7,028,120  $7,079,191        Mortgage-backed securities at December 31, 2006 and 2005, consists of:           **2006**  **2005**   **(In thousands)** Available for sale — Collateralized Mortgage Obligations (CMO’s) certificatesissued