**UNITED
STATES**
 **SECURITIES
AND EXCHANGE COMMISSION**
 **Washington,
D.C. 20549**
  **FORM
10 - K**
  **ANNUAL
REPORT PURSUANT TO SECTION 13 OR 15(D)**
 **OF
THE SECURITIES EXCHANGE ACT OF 1934**
  **For
the fiscal year ended December 31, 2004**
  Commission
File Number 000-50872
  **EUROBANCSHARES,
INC.**
 (Exact
name of registrant as specified in its charter)
  **Commonwealth
      of Puerto Rico**
    
    **66-0608955**(State
      or other jurisdiction of
    
    (I.R.S.
      Employerincorporation
      or organization)
    
    Identification
      No.)270
      Muñoz Rivera Avenue, San Juan, Puerto Rico 00918(Address
      of principal executive offices, including zip code)(787)
      751-7340(Registrant’s
      telephone number, including area code)Securities
      registered pursuant to Section 12(b) of the Act: NoneSecurities
      registered pursuant to Section 12(g) of the Act:Common
      Stock, par value$1.00
      per share
 Indicate
by check mark whether the registrant: (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.
 Yes x No o
  Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best
of registrant’s knowledge, in definitive proxy or information statements
incorporated by reference in Part III of the Form 10-K or any amendment of this
Form 10-K. o
  Indicate
by check mark whether the registrant is an accelerated filer (as defined in Rule
12b-2 of the Exchange Act.)
 Yes o No x
  As of
June 30, 2004, the last business day of the registrant’s most recently completed
second fiscal quarter, the aggregate market value of the shares of Common Stock
held by non-affiliates, based on the estimated value of the Common Stock on our
records on such date, was approximately $47.6 million.
  The
number of shares outstanding of the issuer’s Common Stock as of March 28, 2005,
was 19,564,086 shares.
  
 **Documents
Incorporated by Reference**
  Portions
of the Company’s Proxy Statement relating to the 2005 Annual Meeting of
Stockholders, which will be filed within 120 days after December 31, 2004, are
incorporated by reference into Part III, Items 10-14 of this Form 10-K.
 ****
 
 
 
 **EUROBANCSHARES,
INC.**
  INDEX
 PAGEPART
      I
    1ITEM
      1.BUSINESS
    2ITEM
      2.PROPERTIES
    28ITEM
      3.LEGAL PROCEEDINGS
    30ITEM
      4.SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
    30PART
      II
    30ITEM
      5.MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
      ISSUER PURCHASES OF EQUITY SECURITIES
    30ITEM
      6.SELECTED FINANCIAL DATA
    32ITEM
      7.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
      RESULTS OF OPERATION
    34ITEM
      7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
    RISK
    66ITEM
      8.FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
    66ITEM
      9.CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
      DISCLOSURE
    66ITEM
      9A. CONTROLS AND PROCEDURES
    66ITEM
      9B. OTHER INFORMATION
    66PART
      III
    66ITEM
      10.DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
    66ITEM
      11.EXECUTIVE COMPENSATION
    67ITEM
      12.SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
    MANAGEMENT
    67ITEM
      13.CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
    67ITEM
      14.PRINCIPAL ACCOUNTING FEES AND SERVICES
    67PART
      IV
    67ITEM
      15.EXHIBITS, FINANCIAL STATEMENT SCHEDULES
    67
 ****
 i
 ****
 **PART
I**
  **SPECIAL
CAUTIONARY NOTICE REGARDING FORWARD-LOOKING INFORMATION**
  Statements
contained in this Annual Report on Form 10-K that are not purely historical are
forward-looking statements within the meaning of Section 21E of the Securities
Exchange Act of 1934, as amended, including our expectations, intentions,
beliefs, or strategies regarding the future. Any
statements in this document about expectations, beliefs, plans, objectives,
assumptions or future events or performance are not historical facts and are
forward-looking statements. These statements are often, but not always, made
through the use of words or phrases such as “may,” “should,” “could,” “predict,”
“potential,” “believe,” “will likely result,” “expect,” “will continue,”
“anticipate,” “seek,” “estimate,” “intend,” “plan,” “projection,” “would” and
“outlook,” and similar expressions. Accordingly, these statements involve
estimates, assumptions and uncertainties, which could cause actual results to
differ materially from those expressed in them. Any forward-looking statements
are qualified in their entirety by reference to the factors discussed throughout
this document. All
forward-looking statements concerning economic conditions, rates of growth,
rates of income or values as may be included in this document are based on
information available to us on the dates noted, and we assume no obligation to
update any such forward-looking statements. It is important to note that our
actual results may differ materially from those in such forward-looking
statements due to fluctuations in interest rates, inflation, government
regulations, economic conditions, customer disintermediation and competitive
product and pricing pressures in the geographic and business areas in which we
conduct operations, including our plans, objectives, expectations and intentions
and other factors discussed under the section entitled “Risk Factors,” in our
Prospectus on Form S-1 dated August 11, 2004, including the
following:
  ●
    if
      a significant number of our clients fail to perform under their loans, our
      business, profitability, and financial condition would be adversely
      affected;
  ●
    our
      current level of interest rate spread may decline in the future, and any
      material reduction in our interest spread could have a material impact on
      our business and profitability;
  ●
    the
      modification of the Federal Reserve Board’s current position on the
      capital treatment of our junior subordinated debt and trust preferred
      securities could have a material adverse effect on our financial condition
      and results of operations;
  ●
    adverse
      changes in domestic or global economic conditions, especially in the
      Commonwealth of Puerto Rico, could have a material adverse effect on our
      business, growth, and profitability;
  ●
    we
      could be liable for breaches of security in our online banking services,
      and fear of security breaches could limit the growth of our online
      services;
  ●
    maintaining
      or increasing our market share depends on market acceptance and regulatory
      approval of new products and services;
  ●
    significant
      reliance on loans secured by real estate may increase our vulnerability to
      downturns in the Puerto Rico real estate market and other variables
      impacting the value of real estate;
  ●
    if
      we fail to retain our key employees, growth and profitability could be
      adversely affected;
  ●
    we
      may be unable to manage our future growth;
  ●
    we
      have no current intentions of paying cash dividends on common
      stock;
  ●
    increases
      in our allowance for loan and lease lossescould
      materially adversely affect our earnings;
  ●
    our
      directors and executive officers beneficially own a significant portion of
      our outstanding common stock;
  ●
    the
      market for our common stock is limited, and potentially subject to
      volatile changes in price;
  ●
    we
      face substantial competition in our primary market
area;
  1
 ●
    we
      are subject to significant government regulation and legislation that
      increases the cost of doing business and inhibits our ability to
      compete;
  ●
    we
      could be negatively impacted by downturns in the Puerto Rican economy.
  These
factors and the risk factors referred to in our Prospectus on Form S-1 dated
August 11, 2004 could cause actual results or outcomes to differ materially from
those expressed in any forward-looking statements made by us, and you should not
place undue reliance on any such forward-looking statements. Any forward-looking
statement speaks only as of the date on which it is made and we do not undertake
any obligation to update any forward-looking statement or statements to reflect
events or circumstances after the date on which such statement is made or to
reflect the occurrence of unanticipated events. New factors emerge from time to
time, and it is not possible for us to predict which will arise. In addition, we
cannot assess the impact of each factor on our business or the extent to which
any factor, or combination of factors, may cause actual results to differ
materially from those contained in any forward-looking statements.
  **ITEM
1.** **Business.**
  **Overview**
  We are a
diversified financial holding company headquartered in San Juan, Puerto Rico,
offering a broad array of financial services through our wholly owned banking
subsidiary, Eurobank, and our wholly owned insurance subsidiary, EuroSeguros. As
of December 31, 2004, we had, on a consolidated basis, total assets of $2.1
billion, net loans and leases of $1.4 billion, total deposits of $1.4 billion,
and stockholders’ equity of $158.3 million. On May 3, 2004, we acquired all of
the capital stock of The Bank & Trust of Puerto Rico (BankTrust), a
commercial bank headquartered in San Juan, Puerto Rico with approximately $522.0
million in assets.
  Eurobank
is a full-service Puerto Rico commercial bank with 21 branches located
throughout the Island. The Bank is engaged in substantially all of the business
operations customarily conducted by independent financial institutions in Puerto
Rico and the United States, including the acceptance of checking, savings and
time deposits and the making of commercial and consumer loans, mortgage loans,
real estate loans, lease financing, and other installment and term loans.
Eurobank also offers trust and wealth management services. As a traditional
commercial bank, Eurobank earns interest on loans, leases and investment
securities that are funded by customer deposits, borrowings, retained earnings
and equity. The difference between the interest received and the interest paid
has historically comprised the majority of our earnings.
  We are a
relationship-driven financial services company focused on providing personalized
banking services. We established our position in the small and middle market
business community as a secondary alternative to our larger competitors, who we
believed were under-serving the market. Today, we compete head to head with all
Puerto Rico commercial banks for the primary banking relationship of these
customers. Our personalized customer service and experienced and focused
management team are at the core of our strategy. While we have grown in size, we
remain focused on providing services with a personal touch. Additionally, we
have sought to further develop our footprint throughout the entire Island by
opening branches along the main vehicular arteries that circle Puerto Rico. By
the year 2007, we intend to have a branch located within a convenient drive of
approximately 80% of the population of Puerto Rico, achievable with a 27 branch
network.
  Our niche
is to provide one-on-one services to small and mid-sized commercial businesses
in Puerto Rico. Most of these businesses are involved in service industries,
wholesale and retail distribution, dairy farming, construction, manufacturing,
transportation and professional services, and have annual sales between $2.0 and
$40.0 million. However, we also provide responsive customer service and
convenient banking products to smaller companies with sales ranging from
$500,000 to $2.0 million, consisting of lawyers, healthcare providers, CPAs,
engineers and small contractors. While we do not mass market to the retail
segment, we do provide retail banking services to the owners and families of our
targeted commercial and small business customers, their employees and
individuals who reside or work near our branch offices. These customers are
usually also depositors of Eurobank. We seek to provide all of our customers
with quick, responsive service and foster a culture in which customers are
valued and respected.
  We target
experienced real estate developers and provide them with acquisition development
and construction loans. We place particular emphasis on single-family homes,
townhouses and walk-up developments throughout the Island. We also finance
commercial real estate development and construction projects, particularly if
they are owner-occupied, generally limiting our maximum credit exposure to $7.5
million for these types of credits. Under the tradename “EuroMortgage,” we
support these activities by providing financing to the purchasers of these real
estate units. In addition, through a staff of salespeople, today we also provide
mortgages to our branch customers and the general public. On a selective basis,
we provide financing to owner-occupied properties and to a lesser extent to
income producing properties.
  2
 In 1999
under the tradename “EuroLease,” we began providing open-end lease financing
pursuant to which the lessee is responsible for the residual value, if any, of
the leased asset. This short to medium-term fixed rate financing blends well
with our primarily floating rate commercial loan portfolio.
  Long-term,
it is our objective to leverage our relationships with our primary customers by
cross-selling to them a complete array of banking products and services directly
or through third-party providers. Through our trust department, EuroSeguros, and
under the tradename “Eurofinancial,” we seek to assist our customers with a full
array of wealth management products and services.
  **Our
Strategic Plan**
  Our
primary business objectives are to enhance our profitability and to establish
Eurobank as the premier small and middle market commercial bank in Puerto Rico.
Our core customers are small and mid-sized businesses, real estate development
companies and the owners, executives and employees of these businesses. Our
success is largely based on our personalized service philosophy. We specifically
target customers who want to deal directly with people they know and trust. As
convenience remains an overriding factor in customer choice, we have continued
to establish de novo branches throughout the Island to provide such convenience,
and at the same time we have continued to enhance our technology
platform.
  We have
developed a strategy that focuses on providing superior service through highly
qualified and relationship-oriented employees who are committed to their
respective communities. Through this strategy we intend to grow our business,
expand our customer base and improve profitability. We believe this strategy has
already proven successful as evidenced by our four-year compounded annual growth
in earnings of 54.08% and diluted earnings per share of 34.27% from 2000 to
2004. The key elements of our strategy are:
  ●
    *Focus
      on Our Targeted Customers.*We
      focus our time and resources on the following types of customers: small
      and mid-sized businesses, real estate development companies and the
      owners, executives and employees of these businesses. In this regard, we
      seek to leverage our business banking relationships by cross-selling to
      the personal financial needs of these business owners, executives and
      employees.
  ●
    *Provide
      Superior and Convenient Service to Our Customers.*We
      strive to provide superior customer service through convenient access to
      Eurobank’s branches and personalized relationship banking. We have 21
      branch offices strategically located throughout Puerto Rico. Eurobank
      intends to open six additional branches by the end of 2007. After the
      addition of these new branch offices, we will have a branch office located
      within a convenient drive of approximately 80% of the Island’s population.
      Under our business model we provide each commercial customer with its own
      relationship manager for all its banking needs. These relationship
      managers and our executive management team regularly visit customers at
      their places of business.
  ●
    *Hire
      and Retain Well-Trained and Qualified Employees.*We
      are continuing to grow our franchise by providing superior customer
      service through committed, qualified and relationship-oriented employees.
      We seek to hire experienced and qualified employees that prefer our
      relationship banking approach. These employees are specifically incented
      through our compensation program to leverage our commercial relationships
      by cross-selling our products and services to the owners, executives and
      employees of our business customers.
  ●
    *Use
      the Lease Financing Business to Mitigate Interest Rate
      Risk.*We
      use our lease financing business to mitigate our interest rate risk by
      offsetting the variable rate nature of our commercial loan portfolio with
      a short to medium-term fixed rate product. We plan to maintain the
      approximate size of the lease portfolio relative to the size of the total
      loan portfolio, while increasing the volume of leases originated for
      resale to other financial institutions.
  3
 ●
    *De
      Novo Branching and Acquisitions.*We
      seek to increase our presence throughout the Island through selective
      acquisitions and the opening of de novo branches in attractive locations.
      Our de novo expansion outside of the San Juan metropolitan market has
      followed Puerto Rico’s primary traffic arteries to areas that have been
      growing.
  ●
    *Maximize
      Growth of our International Banking Entity.*Because EBS Overseas, Eurobank’s IBE subsidiary, is generally not subject
      to federal or Puerto Rico income tax, we will seek to maximize the growth
      of this IBE as interest rates and applicable law
permit.
  **Our
De Novo Branch and Acquisition Strategy**
  Our
growth strategy is concentrated on increasing our banking presence throughout
the island of Puerto Rico. Our recent expansion has been the result of internal
growth, acquisitions and the opening of de novo branch offices. Consistent with
our operating philosophy and growth strategy, we regularly evaluate
opportunities to acquire other banks or bank branches, expand our market
coverage and share through de novo branching and enhance our product and service
offerings. Eurobank’s expansion out of the San Juan metropolitan area has
followed Puerto Rico’s primary traffic arteries to new locations poised for
growth. We believe that the Puerto Rico banking environment, which is dominated
by large banks, has afforded us a continuing opportunity to gain new customer
relationships and to expand existing relationships. The growth in our branch
network has expanded our presence throughout the Island and increased our
customer base, providing tangible benefits that include an increase of total
deposits of 43.11%, core deposits of 25.93% and earnings of 129.89% for the year
ended 2004 compared to the levels for the year ended 2003. Each branch now has
the ability to sell not only traditional products such as commercial credit,
leasing, construction, mortgages, consumer credit and personal secured loans,
but also to cross-sell our entire product line, including insurance through
EuroSeguros, and investment products through our trust department and through
Eurofinancial account representatives.
  *De
Novo Branches*
  During
the past three years, we have opened four new banking offices in Humacao,
Manatí, Mayagüez and Luquillo. Furthermore, in March 2004, we opened our newest
branch in Hatillo, Puerto Rico. We are currently planning to open branches in
the following municipalities: Aguadilla, Cabo Rojo/San Germán, Yauco, Canóvanas
and Cayey. Our newer branches are located along the major vehicular arteries
that encircle the island of Puerto Rico. By the year 2007, we expect to have a
branch located within a convenient drive of approximately 80% of the population
of Puerto Rico.
  *Mergers
and Acquisitions*
  Since
1997, we have completed acquisitions of three banks in Puerto Rico with combined
assets of approximately $679.4. million. In the early 1990s, we acquired two
branches from Banco Financiero and certain assets and liabilities of a failed
bank from the FDIC. The following is a summary of our material acquisitions
since 1997.
  *BankTrust
Acquisition*
  On May 3,
2004, we acquired all of the capital stock of BankTrust, a Puerto Rico chartered
commercial bank, through the merger of BankTrust with and into Eurobank. The
aggregate purchase price for the capital stock of BankTrust was $23.4 million,
and consisted of the issuance of 683,304 shares of our common stock, 430,537
shares of our Series A Preferred Stock, and $6.5 million in cash. There were no
changes in our Board of Directors or our senior management team as a result of
the BankTrust acquisition. We funded a portion of the purchase price with
proceeds we received from the issuance of 733,316 shares of our common stock at
$8.13 per share in a private placement of our common stock to our existing
stockholders and optionholders. In connection with the private placement and the
acquisition of BankTrust, our Board of Directors engaged an independent
third-party financial advisor, Feldman Financial Advisors, Inc., to determine
the fairness, from a financial point of view, to our stockholders of the merger
consideration paid to BankTrust’s stockholders and the terms of the private
placement. The acquisition was accounted for using the purchase method of
accounting under generally accepted accounting principles.
  4
 BankTrust
provided a broad range of financial products and services to its customers,
including commercial, mortgage and personal loans, financial leases, checking
and savings accounts, asset management and trust services. BankTrust operated
five branch offices — two were located in San Juan and the other three were
located in Guaynabo, Mayagüez and Ponce. BankTrust also had one loan production
office in San Juan and operated an IBE under the name “BT International.” As of
June 1, 2004, we had closed four of the five BankTrust branches, as well as the
loan production office, and consolidated these operations into our existing
branch network. Eurobank will continue to operate BT International as a division
of Eurobank and the Guaynabo branch office as a branch of Eurobank. Prior to our
acquisition, BankTrust was operating under a cease and desist order issued by
the FDIC and the Commissioner of Financial Institutions of Puerto Rico dated as
of September 16, 2003, that imposed certain compliance and reporting
requirements upon BankTrust. The cease and desist order included various
requirements and limitations that affected BankTrust’s operations. One of the
principal requirements of the cease and desist order was that BankTrust achieve
a leverage capital ratio equal to or greater than 5.5% of its assets on or
before October 31, 2003, and a requirement that BankTrust achieve a leverage
capital ratio equal to or greater than 6.0% of its assets on or before December
31, 2003 and thereafter maintain such leverage capital ratio of 6.0% or greater.
BankTrust was unable to raise additional capital through an equity offering made
in October of 2003. As of December 31, 2003, BankTrust was unable to achieve the
6% leverage capital ratio required under the cease and desist order. On that
date, BankTrust had a 5.2% leverage capital ratio, and its external auditors had
expressed substantial doubt about BankTrust’s ability to continue as a going
concern. However, as a result of our acquisition of BankTrust, the cease and
desist order was lifted, and we do not anticipate that the prior existence of
the cease and desist order will have any effect on our operations. As of March
31, 2004, BankTrust had total assets of $550.4 million, total deposits of $415.1
million, stockholders’ equity of $41.7 million and $326.5 million in assets
under management. On the closing date, the estimated fair value of the assets
acquired was $522.0 million and the estimated fair value of the deposits and
other liabilities assumed was $492.9 million.
  The
BankTrust acquisition is consistent with our growth strategy. Its product
offering and customer mix complement our existing product offering and customer
mix. We believe the acquisition affords us certain revenue synergies. A
substantial portion of the assets we acquired are of high quality with yields
that are at or above market rates. Likewise, we have the opportunity to
cross-sell our other products and services to the newly acquired customers of
BankTrust. This acquisition also provides us with a significant trust and wealth
management group that enhances our own efforts in this area. We believe that
this will allow us to grow our trust business faster than if we had grown it
organically.
  In
connection with the BankTrust acquisition, we retained 41 of the 180 BankTrust
employees and closed four of the five branches, which should result in immediate
cost savings to us. Under the terms of the merger agreement, a substantial
portion of the costs and expenses associated with the branch closings, the
liquidation of its operations, and employee reductions were effectively borne by
the stockholders of BankTrust through a reduction in the aggregate purchase
price. These costs and expenses also included prepayment penalties and fees on
all FHLB advances BankTrust had prior to closing. In addition, a substantial
portion of the problem assets of BankTrust were transferred to a special purpose
vehicle immediately prior to closing for the benefit of the BankTrust
stockholders. These problem assets were comprised primarily of (1) loans and
leases generated by BankTrust that we identified as having additional loss
potential, (2) loans and leases related to boat financing, automobile or
equipment leasing and personal installment loans financing, that were in
nonaccrual status and/or were 90 days past due as of the effective date of our
acquisition of BankTrust, and (3) loans and leases previously charged off by
BankTrust. In addition, BankTrust transferred the following assets to the
special purpose vehicle under the terms of the merger agreement:
  ●
    sufficient
      funds to pay lease payments on BankTrust’s operating leases until their
      expiration date;
  ●
    certain
      furniture and equipment of BankTrust;
  ●
    certain
      causes of action of BankTrust; and
  ●
    $200,000
      in cash.
  On the
effective date of the merger, the special purpose vehicle entered into an
indemnification and security agreement with us for the purpose of securing the
indemnification obligations of BankTrust to us under the merger agreement, (1)
up to an aggregate limit of $1.0 million ($500,000 with respect to any claims
brought or notified in writing after six months following the effective date of
the merger), with respect to a breach by BankTrust of the representations,
warranties, covenants and other agreements set forth in the merger agreement and
the other agreements contemplated by the merger agreement, (2) without limit as
to amount, with respect to losses resulting from certain third party actions,
and (3) up to an amount agreed upon by a majority of the members of a joint
committee comprised of certain of our officers and certain officers of BankTrust
on or before six months after the effective date of the merger or, absent such
agreement, an amount established by a third party acceptable to a majority of
the members of the joint committee on or before six months after the effective
date of the merger, with respect to certain specified matters. We do not hold
any equity interest in the special purpose vehicle.
  5
 The
indemnification and security agreement terminates one year following the
effective date of the merger, except with respect to claims brought or notified
by us in writing to the special purpose vehicle prior to the first anniversary
of the effective date of the merger. In the event that, prior to the first
anniversary of the effective date of the merger, we or our related parties incur
a loss, bring a claim, or give notice of a potential third party claim or a
claim resulting from a breach by BankTrust of any of the representations,
warranties, covenants and other agreements set forth in the merger agreement and
the other agreements contemplated in the merger agreement, then the special
purpose vehicle will pay to us, from its reserve account and from any other
assets of the special purpose vehicle, an amount equal to all costs, expenses,
fees and losses incurred in connection with such claim. Upon the final
resolution of all such claims and potential claims, any remaining funds in the
reserve account of the special purpose vehicle will be released and will be
available for distribution to the stockholders of the special purpose
vehicle.
  *Banco
Financiero de Puerto Rico and Banco del Comercio de Puerto Rico
Acquisitions*
  On
December 15, 2002, we acquired all of the issued and outstanding capital stock
of Banco Financiero de Puerto Rico for an aggregate purchase price of $1.5
million, consisting of the issuance of common stock valued at $1.2 million and
$326,000 in cash. Banco Financiero was merged with and into Eurobank. Banco
Financiero operated through three branch offices in Ponce, Puerto Rico. The
acquisition was accounted for using the purchase method of accounting under
generally accepted accounting principles. The estimated fair value of the assets
acquired and liabilities assumed of $2.8 million exceeded the acquisition price
of $1.8 million including additional cost associated with the acquisition of
$214,000. The Banco Financiero acquisition was accretive to our earnings for the
year ended December 31, 2003, as we reduced the pre-closing level of noninterest
expense associated with its operations by more than 75.0% within the first 60
days after closing.
  On
October 26, 1997, we acquired all of the issued and outstanding capital stock of
Banco del Comercio de Puerto Rico through a share exchange and the merger of
Banco del Comercio with and into Eurobank. Prior to our acquisition, Banco del
Comercio operated six branch offices in the San Juan, Carolina and Caguas
regions. On the closing date, the net book value of the assets and liabilities
of Banco del Comercio were $69.3 million and $65.6 million, respectively. The
acquisition was accounted for as a pooling of interests under generally accepted
accounting principles. The Banco del Comercio acquisition was accretive to our
earnings for the year ended December 31, 1998, as we reduced the pre-closing
level of noninterest expense associated with its operations by more than 70.0%
within the first 60 days after closing.
  Both
Banco Financiero and Banco del Comercio were also operating subject to cease and
desist orders issued by the FDIC prior to their acquisition by Eurobank.
Nevertheless, we were able to integrate the operations of both banks with our
operations and, in both instances, achieve significant cost savings within a
short period of time after the respective closing dates of each
acquisition.
  Because
both Banco Financiero and Banco del Comercio were classified as
“undercapitalized” under applicable capital adequacy guidelines, the cease and
desist orders of these institutions were similar in scope. The directives of the
cease and desist orders provided, among other measures, emphasis on
capitalization requirements and mandated several procedures to strengthen the
lending practices and the respective loan portfolios. The directives required
the board of directors of each institution to revise and implement acceptable
policies and procedures for liquidity, and for guidance and control over
internal controls and procedures. Moreover, they also required the development
of a written earnings plan, elimination and correction of all violations of law,
to attain and thereafter maintain a leverage capital ratio of 6.0%, and the
implementation of policies to ensure the effective guidance and control of the
lending and collection functions. Except with respect to the requisite capital
ratio requirements, each of Banco Financiero and Banco del Comercio generally
were in compliance with most of the directives of their respective cease and
desist orders.
  6
 No
particular corrective actions were necessary at the time of the acquisitions
because the operations of Banco Financiero and Banco del Comercio were fully and
completely integrated into our policies, controls and procedures under the
guidance of our management team. These acquisitions had no impact on our
operations, liquidity or capital. However, our asset quality was slightly
impacted by the increase in nonperforming loans and corresponding delinquency.
While in the years immediately after each acquisition the volume of net
charge-offs increased, the increased income generated by these acquisitions was
more than sufficient to offset the increases in net charge-offs.
  **Products
and Services**
  Eurobank
is engaged in substantially all of the business operations customarily conducted
by independent financial institutions in Puerto Rico, including the acceptance
of checking, savings and time deposits and the making of commercial and consumer
loans, mortgage loans, real estate loans, lease financing, and other installment
and term loans. Eurobank also offers trust and wealth management services. We
provide our customers with internet banking, electronic funds transfers through
ACH services, cash management, vault services, loan and deposit sweep accounts
and lock box services. While we offer a wide variety of financial services to
our customers, our primary products and services are grouped in the following
categories: commercial banking, leasing (“EuroLease”), mortgage banking
(“EuroMortgage”), and trust and wealth management. In addition, we provide
automobile, property and casualty, and guaranteed auto protection insurance to
customers in our market area through our other wholly owned subsidiary,
EuroSeguros. The following provides a summary description of our core products
and services:
  *Commercial
Banking*
  Eurobank
markets commercial banking products and services primarily to small and
mid-sized businesses located in Puerto Rico. Commercial banking products and
services offered include commercial loans, residential construction loans and,
to a lesser extent, consumer credit and personal secured loans, as well as a
broad range of deposit products and other non-deposit banking services,
including internet banking and cash management services tailored to meet the
needs of these businesses.
  While we
market a wide range of commercial banking products and services, emphasis is
placed on our loan products. Each commercial lending branch has senior
management with extensive lending experience. These managers exercise
substantial authority over credit presentation and pricing initiatives, subject
to centralized loan approvals for most secured credits over $100,000 and
unsecured credits over $50,000. This decentralized management approach, coupled
with continuity of service by the same staff members, enables us to develop
long-term customer relationships, maintain high quality service and respond
quickly to customer needs. The centralized approval process, however, provides
credit control. We believe that our emphasis on local relationship banking,
together with a conservative approach to lending, are important factors in our
success and growth. As a result of the development of broad banking
relationships with customers and the convenience and service of our banking
offices, we have experienced growth in core deposits.
  We
centralize most credit and support functions in order to achieve credit quality
consistency and cost efficiencies in the delivery of products and services by
each banking office. The central office provides services such as data
processing, bookkeeping, accounting, treasury management, credit approval, loan
review, compliance, risk management and internal auditing to enhance our
delivery of quality service. We also provide overall direction in the areas of
credit policy and administration, strategic planning, marketing, investment
portfolio management and other financial and administrative services. The branch
offices work closely with our central office to develop new products and
services needed by our customers and to introduce enhancements to existing
products and services.
  *Construction
and Commercial Loans*
  In the
commercial banking area, Eurobank focuses on providing commercial and
construction loans to local businesses. These business generally have annual
sales ranging from $2.0 million to $40.0 million, and financing requirements
between $1.0 million and $10.0 million.
  At
December 31, 2004, construction loans totaled $80.5 million, or 5.8% of our
gross loan and lease portfolio. We seek to market our construction loans to
experienced developers who develop residential units throughout the Island in
the $125,000 to $185,000 price range and whose peak maximum credit needs for a
particular project generally are less than $7.5 million. Construction loans
generally have terms of 18 months, with options to extend for additional periods
to complete construction and sale of the units. We usually require a 20.0%
equity capital investment by the developer and loan-to-value ratios of not more
than 80.0% of anticipated completion value.
  7
 At
December 31, 2004, commercial loans totaled $706.0 million, or 51.2% of our
gross loan and lease portfolio. Commercial loans include lines of credit and
commercial term loans to finance operations and to provide working capital for
specific purposes, such as to finance the purchase of assets, equipment or
inventory. Since a borrower’s cash flow from operations is generally the primary
source of repayment, our analysis of the credit risk focuses heavily on the
borrower’s debt repayment capacity.
  Lines of
credit are extended to businesses based on the financial strength and integrity
of the borrower and are secured primarily by real estate, accounts receivable
and inventory, and have a maturity of one year or less. Such lines of credit
bear an interest rate that floats with our base rate, the prime rate, LIBOR or
another established index.
  Commercial
term loans are typically made to finance the acquisition of fixed assets,
provide permanent working capital or to finance the purchase of businesses.
Commercial term loans generally have terms from one to five years. They may be
collateralized by the asset being acquired or other available assets and bear
interest rates that either float with Eurobank’s base rate, prime rate, LIBOR or
another established index or is fixed for the term of the loan.
  Over the
last five years, our commercial and construction loans have grown 41.01% on a
compounded basis. The following table shows end of period balances of commercial
and construction loans for the periods indicated below:
 **As
      of December 31,****2004**
    
    **2003**
    
    **2002**
    
    **2001**
    
    **2000****(In
      thousands)**$
    786,438
    
    $
    525,251
    
    $
    435,322
    
    $
    276,447
    
    $
    198,923
 Our
portfolio of commercial and construction loans is subject to certain risks,
including: (1) a possible downturn in the Puerto Rico economy; (2) interest rate
increases; (3) the deterioration of a borrower’s or guarantor’s financial
capabilities; and (4) environmental risks, including natural disasters. We
attempt to reduce the exposure to such risks through: (1) reviewing each loan
request and renewal individually; (2) utilizing a centralized approval system
for loans in excess of $100,000 for secured credits and $50,000 for unsecured
credits; (3) strictly adhering to written loan policies; and (4) conducting an
independent credit review. In addition, loans based on short-term asset values
are monitored on a monthly or quarterly basis. In general, we receive and review
financial statements of borrowing customers on an ongoing basis during the term
of the relationship and respond to any deterioration noted.
  *Consumer
Loans*
  Although
Eurobank focuses on marketing commercial loans to local businesses, it also
provides consumer credit and personal secured loans to the owners and employees
of these businesses. At December 31, 2004, consumer loans totaled $74.8 million,
or 5.4% of our gross loan and lease portfolio. Our consumer loan portfolio is
subject to certain risks, including: (1) amount of credit offered to consumers
in the market; (2) interest rate increases; and (3) consumer bankruptcy laws
which allow consumers to discharge certain debts. We attempt to reduce the
exposure to such risks through the direct approval of all consumer loans by: (1)
reviewing each loan request and renewal individually; (2) utilizing a
centralized approval system for loans in excess of $25,000; (3) strictly
adhering to written credit policies; and (4) conducting an independent credit
review.
  The only
major consumer loan category acquired from BankTrust not previously marketed by
Eurobank was BankTrust’s boat financing portfolio, which amounted to $45.9
million as of December 31, 2004. In 2004, the total
loss on the sale of repossessed boats at the date of repossession was
approximately $39,000. We did not have any marine loans during 2003 and
2002.
  *Leasing
Activities*
  We
entered the leasing business in order to assist us in managing our interest rate
risk. We determined that a short to medium-term fixed rate product, such as
lease financings, was needed to mitigate our interest rate risk resulting from
our high volume of variable rate commercial loans. Our entry into the lease
financing market was facilitated by our ability to attract a veteran management
team, low entry costs and the opportunity to gain market share.
  8
 Under the
tradename “EuroLease,” Eurobank offers open-ended leases pursuant to which the
lessee is responsible for the residual value of the leased unit. At December 31,
2004, we held $459.3 million in leases, representing 33.3% of our gross loan and
lease portfolio. During 2004, approximately 98.3% of all originations were
automobile leases. The remaining originations were primarily medical equipment
and construction equipment leases. While the granting of leases is governed by
many aspects of our general credit policies and procedures, due to the nature of
the exposure, additional specific parameters are applied to leases. Our
automobile leasing is done by way of finance leases, where the lessee is
responsible for any residual at the end of the lease term. Practically all
automobile leasing in Puerto Rico is done in this manner and the large majority
of banks compete in this market. Although we believe that the risk in this
product is generally higher than commercial lending, we believe the higher risks
are acceptable due to the obligation of the lessee for the residual value, the
numerous risk mitigation parameters that we utilize in the credit underwriting
process and the higher yields we earn on lease products. All lease requests are
reviewed by our credit department and are subjected to numerous credit tests.
There are varying levels of credit approval authority within the department,
although none is as high as the approval authority of the senior leasing
officer, who has the authority to approve aggregate credit extensions of up to
$125,000 to any one borrower. We apply the same “total to one borrower” concept
in the commercial lending area as well. Additional risk mitigation is practiced
through a series of parameters and controls, which include but are not limited
to, minimum dollar amounts on new vehicle leases, maximum amounts on residuals,
maximum terms, obligatory insurance, minimum income parameters, maximum debt
service-to-income parameters, certain credit history parameters, down payments
and employment history parameters.
  Approximately
65.81% of our new automobile leases are financed on a no residual value basis
because the automobiles are transferred to the lessee at the end of the lease
term. For those that do have a residual value, the lessee is contractually
responsible for the full residual amount at the end of the lease term. We do not
have the risk of fluctuations in automobile values relative to residual value.
Instead, our risk is a credit risk regarding whether the lessee will perform on
its obligation to purchase the automobile at the end of the contract at residual
value. In addition, in some instances EuroLease will refinance the automobile
purchased at the residual value.
  New
automobile leases are offered for terms of up to 72 months. Leases with terms of
72 months will be financed based on no residual value. Lessees may also choose a
60-month lease term, in which case we offer financing with a maximum of a 35.0%
residual value. This higher residual value product is usually offered only on
high-end European and Japanese automobiles based on historical used automobile
resale values.
  Under
current Puerto Rican law, the lessee is deemed to be the title holder of a
leased automobile and therefore is responsible for all tort liability associated
with the operation and possession of the automobile.
  We have
developed procedures designed to facilitate the success of our lease financing
business. Our salespeople generate the leases at the automobile dealer level. We
are highly selective with respect to our customers, and are aided in this
selection by referrals from the automobile dealers. We also market this service
to our targeted customers. While most of our leases are for automobiles, in some
cases we have been willing to provide equipment lease financing for our
commercial customers.
  We
believe the collection process is an integral component to a successful leasing
business. Our collection efforts with respect to leases start 10 days after the
due date of each lease. A collections staff of seven internal collectors, three
outside collectors, and four collection officers is managed by two Collections
Managers and five supervisors. Our internal collectors are responsible for all
efforts to collect on leases under 30 days past due. If a customer cannot be
reached by phone, the account is then assigned to the outside collectors staff.
When the account reaches 60 days past due, repossession efforts are started. If
a customer does not deliver the automobile voluntarily, the case is referred to
our outside collections lawyers. Most of our repossessions are voluntary. Court
proceedings for repossession take approximately 60 days. Once repossessed,
vehicles and equipment are initially recorded at the lower of fair value or book
value at the date of repossession, establishing a new cost basis. Any resulting
loss is charged to the allowance for loan and lease losses. A valuation of
repossessed assets is made quarterly after its repossession. Additional declines
in value after repossession, if any, are charged to current operations. Gains or
losses on disposition of repossessed assets and related maintenance expenses are
included in current operations. The total loss on the sale of repossessed
vehicles and equipment as a percentage of the lease balance at the date of
repossession was 16.0% in 2004, 14.2% in 2003, and 7.5% in 2002. The increase in
our loss on the sale of repossessed vehicles and equipment as a percentage of
the lease balance at the date of repossession for the last three years was due
in part to increases in the size of our lease portfolio, which increased our
volume of repossessed assets. The increased volume of repossessed assets
resulted in more aggressive disposition efforts, a strategy that permitted us to
move inventory at a faster pace decreasing our balance of repossessed assets,
but increasing our total losses per unit. Repossessed vehicles and equipment
were $2.9 million, $3.6 million and $5.7 million for the years ended December
31, 2004, 2003 and 2002, respectively. The ratio of loss on the sale of
repossessed assets to our leasing portfolio calculated using the year end
balance was 0.68% in 2004, 0.82% in 2003, and 0.51% in 2002. These fluctuations
were mainly due to aforementioned aggressive efforts and the increase in our
lease portfolio from $256.1 million at the end of fiscal 2002 to
$459.3 million at the end of fiscal 2004, an increase of
79.3%.
  9
 The
following table sets forth the dollar volume of leases originated by Eurobank
and the end of period balances of leases for the periods indicated
below:
  **As
      of or for the Year Ended December 31,****2004**
    
    **2003**
    
    **2002**
    
    **2001**
    
    **2000****(In
      thousands)**Originations
    
    $
    257,808
    
    $
    185,321
    
    $
    138,922
    
    $
    78,835
    
    $
    64,138End
      of period balance
    
    $
    459,251
    
    $
    315,935
    
    $
    256,087
    
    $
    138,629
    
    $
    80,270
 Eurobank
intends to continue to increase its lease origination volume by expanding the
number of full-time representatives and increasing its marketing efforts to its
existing portfolio of more than 17,000 lease customers. It also intends to focus
on improving the overall quality and service to its network of dealers. We seek
to avoid an excess concentration of leases as a percentage of interest-earning
assets. We plan to maintain the approximate size of the lease portfolio relative
to the size of the total loan portfolio, while increasing the volume of leases
originated for resale to other financial institutions. Typically, we retain the
right to service the leases we sell. During 2004, we sold approximately $30.0
million in leases. For more information regarding the accounting treatment of
these servicing assets, see “ *Management’s
Discussion and Analysis of Financial Condition and Results of Operations —
Critical Accounting Policies — Servicing Assets,* ” and
“ *Note
2 — Summary of Significant Accounting Policies* ” to our
consolidated financial statements.
  *Mortgage
Banking*
  Under the
tradename “EuroMortgage,” Eurobank offers Federal National Mortgage Association,
or FNMA, Veterans Affairs, or VA, and Federal Housing Administration, or FHA,
and Freddie Mac loans, as well as conforming and non-conforming mortgage loans.
In 2004 and 2003, Eurobank increased mortgage production significantly, taking
advantage of prevailing low mortgage rates to continue boosting loan
originations, as well as refinancing existing mortgages. We are an approved
seller/servicer for FNMA and Freddie Mac. Eurobank has continued to make inroads
in the market by providing for the efficient and expeditious turnaround of new
loan applications and by establishing certain strategic relationships that allow
access to secondary mortgage markets on a best price basis. At December 31,
2004, mortgage loans totaled $51.7 million, representing 3.7% of our gross loan
and lease portfolio.
  Our
targeted market for mortgage banking is the financing of the homes or units
financed by our construction lending department. We also provide mortgage
banking services to our retail customers and to the owners, executives and
employees of our targeted commercial customers. In addition, our salespeople
engage in marketing and direct selling efforts to the general community. All
mortgages originated by Eurobank are fixed-rate mortgages with a maximum term of
30 years. A majority of the mortgage loans we originate are sold into the
secondary market with servicing released. We have been authorized by FNMA and
Freddie Mac to create mortgage loan pools to be sold in the secondary market or
marketed in connection with our wealth management activities. However, as of
December 31, 2004, we had not created any such pool. It is our intention to
create such pools in the future.
  10
 The
following table sets forth the dollar volume of mortgage originations by
Eurobank and the end of period balances of mortgages for the periods indicated
below:
  **As
      of or for the Year Ended December 31,****2004**
    
    **2003**
    
    **2002**
    
    **2001**
    
    **2000****(In
      thousands)**Originations
    
    $
    257,808
    
    $
    185,321
    
    $
    138,922
    
    $
    78,835
    
    $
    64,138End
      of period balance
    
    $
    459,251
    
    $
    315,935
    
    $
    256,087
    
    $
    138,629
    
    $
    80,270
 Our
strategy is to sell conforming FNMA and Freddie Mac mortgages either as whole
loans or in the form of mortgage-backed securities. We also sell the servicing
rights to the mortgage loans that we originate except for those mortgage loans
we hold for long-term investment.
  Our
portfolio of mortgage loans is subject to certain risks, including: (1) a
possible downturn in the Puerto Rico economy affecting real estate values; (2)
interest rate increase; (3) the deterioration of a borrower’s or guarantor’s
financial capabilities; and (4) environmental risks, including natural
disasters. We attempt to reduce the exposure to such risks through: (1)
reviewing each loan request and renewal individually; (2) utilizing a
centralized approval system for loans in excess of $400,000; (3) strictly
adhering to written loan policies; and (4) conducting an independent credit
review. In general, we receive and review financial statements of borrowing
customers on an ongoing basis during the term of the relationship and respond to
any deterioration noted.
  *Trust
and Wealth Management*
  In 2002,
we established Eurobank’s trust and wealth management business to cross-sell
retirement benefits, personal trust and wealth management services to the
owners, executives and employees of our business customers. As of December 31,
2004, Eurobank had approximately $283.2 million in trust assets under
management, including $269.1 million of trust assets which were acquired in the
BankTrust merger. Historically, the revenues associated with our trust and
wealth management group have not been material, but as a result of the BankTrust
acquisition, we expect a significant increase in revenues generated by this
group.
  As part
of our trust and wealth management business, we began offering brokerage
services under the tradename “Eurofinancial” during the fourth quarter of 2002.
We offer a full array of investment products and services through a third-party
broker dealer in order to serve our customers’ investment needs. This is part of
our strategy of creating financial centers in which each customer may access a
variety of integrated financial products and services. Investment products are
offered through an association with Financial Networks, Inc., a registered
broker-dealer. In relation to our wealth management efforts, we offer financial
planning and investment management/brokerage services through third-party
providers to the owners or executives of our targeted customers. During 2004 and
2003, we sold approximately $18.9 million and $7.0 million, respectively, in
investments to our customers. We currently employ three registered
brokers.
  *Insurance*
  EuroSeguros,
our general insurance agency, was organized in the fourth quarter of 2002 as a
wholly owned subsidiary of EuroBancshares. EuroSeguros primarily offers
automobile, property and casualty, and guaranteed auto protection insurance to
customers in our market area. While EuroSeguros represents several insurance
companies in Puerto Rico, it primarily offers its insurance products through its
association with Marsh-Saldaña, Inc., Puerto Rico’s largest insurance brokerage
firm, and a subsidiary of Marsh & McLennan, Inc. EuroSeguros is licensed and
regulated by the Office of the Commissioner of Insurance of Puerto
Rico.
  EuroSeguros’
goals for the year 2005 are to expand to offer title insurance products and to
continue to work closely with Eurobank’s mortgage customers, leasing customers
and branch professionals, while continuing to enhance personalized service to
all of these customers.
  **International
Banking Entities**
  During
the first six months of 2004, we transferred all of the assets and liabilities
of Eurobank International, an IBE that operated as a division of Eurobank, to a
recently organized IBE subsidiary of Eurobank, EBS Overseas, Inc. We also have
an IBE that operates as a division of Eurobank under the name BT International.
This IBE was acquired in connection with the acquisition of BankTrust. We have
continued to operate BT International as a division of Eurobank and do not have
immediate plans to transfer its assets to our subsidiary, EBS Overseas, Inc.
  11
 IBEs are
limited under the IBE Act with respect to the types of activities they can
undertake. In general, IBEs may accept deposits or borrow money from other IBEs
and from “foreign persons.” For purposes of the IBE Act, a “foreign person” is
defined as anyone who is not a resident of Puerto Rico. IBEs are also permitted
to engage in any activity that is financial in nature outside of Puerto Rico
that is permissible for a bank holding company or a foreign office or subsidiary
of a United States bank under applicable United States law. Typically, we borrow
funds in the United States in the form of repurchase obligations or brokered
deposits (considered foreign under the IBE Act) and invest those funds primarily
in United States Treasury Obligations, U.S. Government Agencies Obligations,
U.S. Government Sponsored Agencies Obligations, Mortgage Back Securities issued
or guaranteed by U.S. Government Agencies or U.S. Government Sponsored Agencies
and obligations issued by U.S. Corporations. The income earned from this
activity is tax exempt. For more information regarding the regulation of IBEs,
see the section of this prospectus captioned *“Supervision
and Regulation — International Banking Center Regulatory
Act.”*
  EBS
Overseas, Inc. is authorized to invest in notes and bonds issued by the
U.S. government, the Commonwealth of Puerto Rico, other foreign governments
and their agencies, and U.S. and foreign corporations. As of December 31,
2004, EBS Overseas’ investment portfolio consisted of the following: 57.3% in
mortgage-backed securities issued or guaranteed by government or government
sponsored agencies, 18.5% in U.S. Treasury obligations, 13.6% in
U.S. government agency obligations, 10.1% in mortgage-backed securities
issued by U.S. corporations, and 0.5% in Puerto Rico Public Authorities.
  We have
structured EBS Overseas’ investment portfolio so that it can perform well in
different interest rate environments. The interest and market risk of EBS
Overseas’ investment portfolio is generally lower than that of other IBEs in
Puerto Rico. The typical IBE investment portfolio includes debt securities with
maturities of up to 10 years and mortgage-backed securities with expected
average maturities of up to 12 years funded primarily with short-term
brokerage deposits and loans secured by repurchase obligations. The maturities
on debt obligations in EBS Overseas’ investment portfolio range from 1.5 to 7
years with an estimated average maturity as of December 31, 2004 of
20 months. The estimated maturities of mortgage-backed securities in the
portfolio also range from 1.5 to 7 years, with an average maturity as of
December 31, 2004 of approximately 39 months.
  As of
December 31, 2004, EBS Overseas had total assets of approximately
$477.4 million, repurchase obligations of approximately
$286.6 million, borrowings from BT International of approximately
$180.0 million and stockholders’ equity of approximately
$10.0 million. Further, as of December 31, 2004, BT International had
total assets of approximately $280.5 million, deposits of approximately
$122.0 million, repurchase agreements and other borrowings of approximately
$157.2 million and stockholders’ equity attributable to the IBE of
approximately $600,000.
  **Eurobank
Statutory Trust I and II**
  On
November 11, 2001, Eurobank Statutory Trust I, a special purpose statutory trust
subsidiary of EuroBancshares, was formed for the purpose of issuing $25.0
million in trust preferred securities, which were issued on December 18, 2001.
On December 10, 2002, Eurobank Statutory Trust II, a special purpose statutory
trust subsidiary of EuroBancshares was formed for the purpose of issuing $20.0
million in trust preferred securities, which were issued on December 19, 2002.
For additional information, see the sections of this Annual Report on Form 10-K
captioned *“Management’s
Discussion and Analysis of Financial Condition and Results of Operations — Other
Sources of Funds.”*
  **Market**
  We
consider our primary market area to be the island of Puerto Rico. We serve this
market through our main office and branches in the greater metropolitan area of
San Juan and our branches in Bayamón, Caguas, Carolina, Cidra, Condado,
Guaynabo, Hatillo, Ponce, Humacao, Luquillo, San Lorenzo, Manatí and Mayagüez,
Puerto Rico. Puerto Rico is the fourth largest of the Caribbean Islands and is
located approximately 1,100 miles southeast of Miami. It is approximately 100
miles long and 35 miles wide.
  Puerto
Rico came under United States sovereignty in 1898 and obtained commonwealth
status in 1952. Puerto Ricans have been citizens of the United States since
1917. The United States and Puerto Rico share a common defense, market and
currency. The Commonwealth of Puerto Rico exercises virtually the same control
over its internal affairs as do the fifty states. Most federal taxes, except
those such as Social Security taxes which are imposed by mutual consent, are not
levied in Puerto Rico. No federal income tax is collected from Puerto Rico
residents on income earned in Puerto Rico, except for certain federal employees
who are subject to taxes on their salaries. According to the United States
Census Bureau, the population of Puerto Rico was 3.8 million in 2000, compared
to 3.5 million in 1990. As of 2000, the population of San Juan, the Island’s
capital and largest city, was approximately 434,000.
  12
 The
economy of Puerto Rico is closely linked to that of the United States. As such,
factors affecting the United States economy usually have a significant impact on
the performance of the Puerto Rico economy. These include exports, direct
investment, the amount of federal transfer payments, the level of interest
rates, the level of oil prices, and the rate of inflation and tourist
expenditures. Consequently, the economic slowdowns in the United States in 2001
and 2002 and the subsequent recovery in 2003, which continued in 2004, have also
been reflected in the Puerto Rico economy. During the fiscal year 2003,
preliminary reports of the Puerto Rico Planning Board indicated that the economy
registered an increase of 1.9% in real gross product. Gross product was $47.4
billion in fiscal year 2003 compared to $45.0 billion in fiscal year 2002.
According to the Puerto Rico Department of Labor and Human Resources, the
average unemployment rate in Puerto Rico was 12.0% in fiscal year 2003. However,
this figure does not take into account the self-employment rate of individuals
in Puerto Rico which is estimated to be approximately 15.0%, more than double
the level in the United States.
  The
dominant sectors of the Puerto Rico economy are manufacturing and services. The
manufacturing sector has undergone fundamental changes over the years as a
result of increased emphasis on higher wages, high technology industries, such
as pharmaceuticals, biotechnology, electronics, computers, microprocessors,
professional and scientific instruments and certain high technology machinery
and equipment. The services sector, including finance, insurance, real estate,
wholesale and retail trade and tourism, also plays a major role in the economy.
It ranks second only to manufacturing in contribution to the gross domestic
product and leads all sectors in providing employment. The other material
sectors of the Puerto Rican economy include government, transportation and
agriculture.
  As of
December 31, 2004, there were 14 FDIC insured commercial bank and trust
companies operating in Puerto Rico. Total assets of these institutions as of
December 31, 2004 were $94.3 billion. As of December 31, 2004, there were 36
International Banking Entities operating in Puerto Rico licensed to conduct
offshore banking transactions, with total assets of $66.8 billion. As of
December 31, 2004, Eurobank held 3.0% of the deposits held by FDIC insured
financial institutions in Puerto Rico.
  **Environmental
Compliance**
  In
addition to our obligations under environmental laws with respect to property
that we own, there are several federal and state statutes that govern the rights
and obligations of financial institutions with respect to environmental issues.
In addition to being directly liable under these statutes for its own conduct, a
financial institution may also be held liable under certain circumstances for
the actions of borrowers or other third parties on property that collateralizes
a loan held by the institution. This potential liability may far exceed the
original amount of the loan made by the financial institution, which is secured
by the property. Currently, we are not a party to any legal proceedings
involving potential liability under applicable environmental laws.
  **Employees**
  We had
approximately 464 full-time equivalent employees as of December 31, 2004. Our
future success will depend in part on our ability to attract, retain and
motivate highly qualified management and other personnel. We provide health,
life and disability coverage for our employees and make contributions on behalf
of eligible employees under a plan intended to qualify as a simplified employee
pension plan under the Puerto Rico Internal Revenue Code. Our employees are not
represented by a collective bargaining agreement and we have never experienced a
strike or similar work stoppage. We consider our relationship with our employees
to be good.
  **Available
Information**
  Our
Internet website address is www.eurobankpr.com . We make
available free of charge on or through our website our annual report on Form
10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all
amendments to those reports filed or furnished pursuant to Section 13(a) or
15(d) of the Securities and Exchange Act of 1934, as amended, as soon as
reasonably practicable after such material is electronically filed with or
furnished to the Securities and Exchange Commission. However, the information
found on our website is not part of this or any other report.
  13
 **SUPERVISION
AND REGULATION**
  This
following is a summary description of the relevant laws, rules and regulations
governing banks and bank and financial holding companies. The descriptions of,
and references to, the statutes and regulations below are brief summaries and do
not purport to be complete. The descriptions are qualified in their entirety by
reference to the specific statutes and regulations discussed.
  **General**
  The
supervision and regulation of bank holding companies and their subsidiaries are
intended primarily for the protection of depositors, the deposit insurance funds
of the FDIC and the banking system as a whole, and not for the protection of the
bank holding company stockholders or creditors. The banking agencies have broad
enforcement power over bank holding companies and banks, including the power to
impose substantial fines and other penalties for violations of laws and
regulations.
  Legislation
is from time to time introduced in Congress and Puerto Rico’s legislature,
including proposals to overhaul the bank regulatory system, expand the powers of
depository institutions and limit the investments that depository institutions
may make with insured funds. Such legislation may change applicable statutes and
the operating environment of EuroBancshares and Eurobank in substantial and
unpredictable ways. We cannot determine the ultimate effect that future
legislation or implementing regulations would have upon the financial condition
and results of operations of EuroBancshares or Eurobank, or any of their
subsidiaries.
  **EuroBancshares**
  EuroBancshares
is a financial holding company registered under the Bank Holding Company Act,
and is subject to supervision, regulation and examination by the Federal Reserve
Board. The Bank Holding Company Act and other federal laws subject bank holding
companies to particular restrictions on the types of activities in which they
may engage, and to a range of supervisory requirements and activities, including
regulatory enforcement actions for violations of laws and
regulations.
  *Regulatory
Restrictions on Dividends; Source of Strength*
  EuroBancshares
is regarded as a legal entity separate and distinct from its other subsidiaries.
The principal source of our revenue is dividends received from Eurobank. Various
federal and state statutory provisions limit the amount of dividends Eurobank
can pay to EuroBancshares without regulatory approval. It is the policy of the
Federal Reserve Board that bank holding companies should pay cash dividends on
common stock only out of income available over the past year and only if
prospective earnings retention is consistent with the organization’s expected
future needs and financial condition. The policy provides that bank holding
companies should not maintain a level of cash dividends that undermines the bank
holding company’s ability to serve as a source of strength to its banking
subsidiaries.
  Under
Federal Reserve Board policy, a bank holding company is expected to act as a
source of financial strength to each of its banking subsidiaries and commit
resources to their support. Such support may be required at times when, absent
this Federal Reserve Board policy, a holding company may not be inclined to
provide it. As discussed below, a bank holding company, in certain
circumstances, could be required to guarantee the capital plan of an
undercapitalized banking subsidiary.
  In the
event of a bank holding company’s bankruptcy under Chapter 11 of the United
States Bankruptcy Code, the trustee will be deemed to have assumed, and is
required to cure immediately, any deficit under any commitment by the debtor
holding company to any of the federal banking agencies to maintain the capital
of an insured depository institution, and any claim for breach of such
obligation will generally have priority over most other unsecured
claims.
  14
 *Activities
“Closely Related” to Banking*
  The Bank
Holding Company Act prohibits a bank holding company, with certain limited
exceptions, from acquiring direct or indirect ownership or control of any voting
shares of any company which is not a bank or from engaging in any activities
other than those of banking, managing or controlling banks and certain other
subsidiaries, or furnishing services to or performing services for its
subsidiaries. One principal exception to these prohibitions allows the
acquisition of interests in companies whose activities are found by the Federal
Reserve Board, by order or regulation, to be so closely related to banking or
managing or controlling banks, as to be a proper incident thereto. These
activities include, among other things, numerous services and functions
performed in connection with lending, investing, and financial counseling and
tax planning. In approving acquisitions by bank holding companies of companies
engaged in banking-related activities, the Federal Reserve Board considers a
number of factors, and weighs the expected benefits to the public (such as
greater convenience and increased competition or gains in efficiency) against
the risks of possible adverse effects (such as undue concentration of resources,
decreased or unfair competition, conflicts of interest, or unsound banking
practices). The Federal Reserve Board is also empowered to differentiate between
activities commenced *de
novo* and
activities commenced through acquisition of a going concern.
  *Gramm-Leach
Bliley Act; Financial Holding Companies*
  The
Gramm-Leach-Bliley Financial Modernization Act of 1999, revised and expanded the
provisions of the Bank Holding Company Act by including a new section that
permits a bank holding company to elect to become a financial holding company to
engage in a full range of activities that are “financial in nature.” The
qualification requirements and the process for a bank holding company that
elects to be treated as a financial holding company require that all of the
subsidiary banks controlled by the bank holding company at the time of election
to become a financial holding company must be and remain at all times
“well-capitalized” and “well managed.” EuroBancshares made an election to become
a financial holding company on September 20, 2002.
  The
Gramm-Leach-Bliley Act further requires that, in the event that the bank holding
company elects to become a financial holding company, the election must be made
by filing a written declaration with the appropriate Federal Reserve Bank
that:
  ●
    states
      that the bank holding company elects to become a financial holding
      company;
  ●
    provides
      the name and head office address of the bank holding company and each
      depository institution controlled by the bank holding
    company;
  ●
    certifies
      that each depository institution controlled by the bank holding company is
      “well-capitalized” as of the date the bank holding company submits its
      declaration;
  ●
    provides
      the capital ratios for all relevant capital measures as of the close of
      the previous quarter for each depository institution controlled by the
      bank holding company; and
  ●
    certifies
      that each depository institution controlled by the bank holding company is
      “well managed” as of the date the bank holding company submits its
      declaration.
  The bank
holding company must have also achieved at least a rating of “satisfactory
record of meeting community credit needs” under the Community Reinvestment Act
during the institution’s most recent examination.
  Financial
holding companies may engage, directly or indirectly, in any activity that is
determined to be:
  ●
    financial
      in nature;
  ●
    incidental
      to such financial activity; or
  ●
    complementary
      to a financial activity provided it “does not pose a substantial risk to
      the safety and soundness of depository institutions or the financial
      system generally.”
  The
Gramm-Leach-Bliley Act specifically provides that the following activities have
been determined to be “financial in nature”: lending, trust and other banking
activities; insurance activities; financial or economic advisory services;
securitization of assets; securities underwriting and dealing; existing bank
holding company domestic activities; existing bank holding company foreign
activities and merchant banking activities. In addition, the Gramm-Leach-Bliley
Act specifically gives the Federal Reserve Board the authority, by regulation or
order, to expand the list of “financial” or “incidental” activities, but
requires consultation with the United States Treasury Department, and gives the
Federal Reserve Board authority to allow a financial holding company to engage
in any activity that is “complementary” to a financial activity and does not
“pose a substantial risk to the safety and soundness of depository institutions
or the financial system generally.”
  15
 *Privacy
Policies*
  Under the
Gramm-Leach-Bliley Act, all financial institutions are required to adopt privacy
policies, restrict the sharing of nonpublic customer data with nonaffiliated
parties and establish procedures and practices to protect customer data from
unauthorized access. EuroBancshares and its subsidiaries have established
policies and procedures to assure our compliance with all privacy provisions of
the Gramm-Leach-Bliley Act.
  *Safe
and Sound Banking Practices*
  Bank
holding companies are not permitted to engage in unsafe and unsound banking
practices. The Federal Reserve Board’s Regulation Y, for example, generally
requires a holding company to give the Federal Reserve Board prior notice of any
redemption or repurchase of its own equity securities, if the consideration to
be paid, together with the consideration paid for any repurchases or redemptions
in the preceding year, is equal to 10% or more of the company’s consolidated net
worth. The Federal Reserve Board may oppose the transaction if it believes that
the transaction would constitute an unsafe or unsound practice or would violate
any law or regulation. Depending upon the circumstances, the Federal Reserve
Board could take the position that paying a dividend would constitute an unsafe
or unsound banking practice.
  The
Federal Reserve Board has broad authority to prohibit activities of bank holding
companies and their nonbanking subsidiaries which represent unsafe and unsound
banking practices or which constitute violations of laws or regulations, and can
assess civil money penalties for certain activities conducted on a knowing and
reckless basis, if those activities caused a substantial loss to a depository
institution. The penalties can be as high as $1 million for each day the
activity continues.
  *Annual
Reporting; Examinations*
  We are
required to file annual reports with the Federal Reserve Board, and such
additional information as the Federal Reserve Board may require pursuant to the
Bank Holding Company Act. The Federal Reserve Board may examine a bank holding
company or any of its subsidiaries, and charge the company for the cost of such
the examination.
  *Capital
Adequacy Requirements*
  The
Federal Reserve Board has adopted a system using risk-based capital guidelines
to evaluate the capital adequacy of bank holding companies having $150.0 million
or more in assets on a consolidated basis. EuroBancshares currently has
consolidated assets in excess of $150.0 million is therefore subject to the
Federal Reserve Board’s capital adequacy guidelines.
  Under the
guidelines, specific categories of assets are assigned different risk weights,
based generally on the perceived credit risk of the asset. These risk weights
are multiplied by corresponding asset balances to determine a “risk-weighted”
asset base. The guidelines require a minimum total risk-based capital ratio of
8.0% (of which at least 4.0% is required to consist of Tier 1 capital elements).
Total capital is the sum of Tier 1 and Tier 2 capital. To be considered
“well-capitalized,” a bank holding company must maintain, on a consolidated
basis, (i) a Tier 1 risk-based capital ratio of at least 6.0%, and (ii) a total
risk-based capital ratio of 10.0% or greater. As of December 31, 2004, our Tier
1 risk-based capital ratio was 12.73% and its total risk-based capital ratio was
13.94%. Thus, EuroBancshares is considered “well-capitalized” for regulatory
purposes.
  In
addition to the risk-based capital guidelines, the Federal Reserve Board uses a
leverage ratio as an additional tool to evaluate the capital adequacy of bank
holding companies. The leverage ratio is a company’s Tier 1 capital divided by
its average total consolidated assets. Certain highly-rated bank holding
companies may maintain a minimum leverage ratio of 3.0%, but other bank holding
companies are required to maintain a leverage ratio of at least 4.0%. As of
December 31, 2004, our leverage ratio was 9.91%.
  16
 The
federal banking agencies’ risk-based and leverage ratios are minimum supervisory
ratios generally applicable to banking organizations that meet certain specified
criteria. The federal bank regulatory agencies may set capital requirements for
a particular banking organization that are higher than the minimum ratios when
circumstances warrant. Federal Reserve Board guidelines also provide that
banking organizations experiencing internal growth or making acquisitions will
be expected to maintain strong capital positions, substantially above the
minimum supervisory levels, without significant reliance on intangible
assets.
  *Imposition
of Liability for Undercapitalized Subsidiaries*
  Bank
regulators are required to take “prompt corrective action” to resolve problems
associated with insured depository institutions whose capital declines below
certain levels. In the event an institution becomes “undercapitalized,” it must
submit a capital restoration plan. The capital restoration plan will not be
accepted by the regulators unless each company having control of the
undercapitalized institution guarantees the subsidiary’s compliance with the
capital restoration plan up to a certain specified amount. Any such guarantee
from a depository institution’s holding company is entitled to a priority of
payment in bankruptcy.
  The
aggregate liability of the holding company of an undercapitalized bank is
limited to the lesser of 5% of the institution’s assets at the time it became
undercapitalized or the amount necessary to cause the institution to be
“adequately capitalized.” The bank regulators have greater power in situations
where an institution becomes “significantly” or “critically” undercapitalized or
fails to submit a capital restoration plan. For example, a bank holding company
controlling such an institution can be required to obtain prior Federal Reserve
Board approval of proposed dividends, or might be required to consent to a
consolidation or to divest the troubled institution or other
affiliates.
  *Acquisitions
by Bank Holding Companies*
  The Bank
Holding Company Act requires every bank holding company to obtain the prior
approval of the Federal Reserve Board before it may acquire all, or
substantially all, of the assets of any bank, or ownership or control of any
voting shares of any bank, if after such acquisition it would own or control,
directly or indirectly, more than 5% of the voting shares of such bank. In
approving bank acquisitions by bank holding companies, the Federal Reserve Board
is required to consider the financial and managerial resources and future
prospects of the bank holding company and the banks concerned, the convenience
and needs of the communities to be served, and various competitive
factors.
  *Control
Acquisitions*
  The
Change in Bank Control Act prohibits a person or group of persons from acquiring
“control” of a bank holding company unless the Federal Reserve Board has been
notified and has not objected to the transaction. Under a rebuttable presumption
established by the Federal Reserve Board, the acquisition of 10% or more of a
class of voting stock of a bank holding company with a class of securities
registered under Section 12 of the Exchange Act would, under the circumstances
set forth in the presumption, constitute acquisition of control.
  In
addition, any company is required to obtain the approval of the Federal Reserve
Board under the Bank Holding Company Act before acquiring 25% (5% in the case of
an acquiror that is a bank holding company) or more of the outstanding common
stock of the company, or otherwise obtaining control or a “controlling
influence” over the company.
  *Cross-guarantees*
  Under the
Federal Deposit Insurance Act, or FDIA, a depository institution (which
definition includes both banks and savings associations), the deposits of which
are insured by the FDIC, can be held liable for any loss incurred by, or
reasonably expected to be incurred by, the FDIC in connection with (1) the
default of a commonly controlled FDIC-insured depository institution or (2) any
assistance provided by the FDIC to any commonly controlled FDIC-insured
depository institution “in danger of default.” “Default” is defined generally as
the appointment of a conservator or a receiver and “in danger of default” is
defined generally as the existence of certain conditions indicating that default
is likely to occur in the absence of regulatory assistance. In some
circumstances (depending upon the amount of the loss or anticipated loss
suffered by the FDIC), cross-guarantee liability may result in the ultimate
failure or insolvency of one or more insured depository institutions in a
holding company structure. Any obligation or liability owed by a subsidiary bank
to its parent company is subordinated to the subsidiary bank’s cross-guarantee
liability with respect to commonly controlled insured depository institutions.
Eurobank is currently the only FDIC-insured depository institution subsidiary of
EuroBancshares.
  17
 Because
EuroBancshares is a legal entity separate and distinct from Eurobank, its right
to participate in the distribution of assets of any subsidiary upon the
subsidiary’s liquidation or reorganization will be subject to the prior claims
of the subsidiary’s creditors. In the event of a liquidation or other resolution
of Eurobank, the claims of depositors and other general or subordinated
creditors of Eurobank would be entitled to a priority of payment over the claims
of holders of any obligation of Eurobank to its shareholders, including any
depository institution holding company (such as EuroBancshares) or any
shareholder or creditor of such holding company.
  *USA
Patriot Act*
  On
October 26, 2001, President Bush signed into law comprehensive anti-terrorism
legislation known as the USA Patriot Act. Title III of the USA Patriot Act
requires financial institutions to help prevent, detect and deter international
money laundering and the financing of terrorism. The effectiveness of a
financial institution in combating money laundering activities is a factor to be
considered in any application submitted by the financial institution under the
Bank Merger Act or the Bank Holding Company Act, which acts apply to Eurobank
and EuroBancshares, respectively. EuroBancshares and its subsidiaries, including
Eurobank, have adopted systems and procedures to comply with the USA Patriot Act
and regulations adopted thereunder by the Secretary of the
Treasury.
  *Sarbanes-Oxley
Act of 2002*
  In
July 2002, President Bush signed into law the Sarbanes-Oxley Act of 2002,
or the Sarbanes-Oxley Act, which implemented legislative reforms intended to
address corporate and accounting fraud. The Sarbanes-Oxley Act contains reforms
of various business practices and numerous aspects of corporate governance. Most
of these requirements have been implemented pursuant to regulations issued by
the SEC. The following is a summary of certain key provisions of the
Sarbanes-Oxley Act.
  In
addition to the establishment of a new accounting oversight board that enforces
auditing, quality control and independence standards and is funded by fees from
all registered public accounting firms and publicly traded companies, the
Sarbanes-Oxley Act places restrictions on the scope of services that may be
provided by accounting firms to their public company audit clients. Any
non-audit services being provided to a public company audit client requires
pre-approval by the client’s audit committee. Also, the Sarbanes-Oxley Act makes
certain changes to the requirements for partner rotation after a period of time.
The Sarbanes-Oxley Act requires chief executive officers and chief financial
officers, or their equivalent, to certify to the accuracy of periodic reports
filed with the SEC, subject to civil and criminal penalties if they knowingly or
willingly violate this certification requirement. Furthermore, counsel is
required to report evidence of a material violation of securities laws or a
breach of fiduciary duties to the company’s chief executive officer or its chief
legal officer, and, if such officer does not appropriately respond, to report
such evidence to the audit committee or other similar committee of the board of
directors or the board itself.
  Under
this law, longer prison terms apply to corporate executives who violate federal
securities laws; the period during which certain types of suits can be brought
against a company or its officers is extended and bonuses issued to top
executives prior to restatement of a company’s financial statements are now
subject to disgorgement if such restatement was due to corporate misconduct.
Executives are also prohibited from insider trading during retirement plan
“blackout” periods, and loans to company executives (other than loans by
financial institutions permitted by federal rules or regulations) are
restricted. In addition, the legislation accelerates the time frame for
disclosures by public companies, as they must immediately disclose any material
changes in their financial condition or operations. Directors and executive
officers required to report changes in ownership in a company’s securities must
now report any such change within two business days of the change.
  The
Sarbanes-Oxley Act increases responsibilities and codifies certain requirements
relating to audit committees of public companies and how they interact with the
company’s registered public accounting firm. Audit committee members must be
independent and are barred from accepting consulting, advisory or other
compensatory fees from the company. In addition, companies are required to
disclose whether at least one member of the committee is a “financial expert”
(as such term is defined by the SEC) and if not, why not. A company’s registered
public accounting firm is prohibited from performing statutorily mandated audit
services for a company if the company’s chief executive officer, chief financial
officer, controller, chief accounting officer or any person serving in
equivalent positions had been employed by such firm and participated in the
audit of such company during the one-year period preceding the audit initiation
date. The Sarbanes-Oxley Act also prohibits any officer or director of a company
or any other person acting under their direction from taking any action to
fraudulently influence, coerce, manipulate or mislead any independent public or
certified accountant engaged in the audit of the company’s financial statements
for the purpose of rendering the financial statements materially misleading.
  18
 The
Sarbanes-Oxley Act also has provisions relating to inclusion of certain internal
control reports and assessments by management in the annual report to
stockholders. Commencing with its 2005 annual report, Eurobancshares will be
required to include an internal control report containing management’s
assertions regarding the effectiveness of its internal control structure and
procedures over financial reporting. The internal control report must include
statements regarding management’s responsibility for establishing and
maintaining adequate internal control over financial reporting; management’s
assessment as to the effectiveness of the company’s internal control over
financial reporting, based on management’s evaluation of it  as of
year-end; and of the framework used as criteria for evaluating the effectiveness
of the company’s internal control over financial reporting. The law also
requires the company’s registered public accounting firm that issues the audit
report to attest to, and report on, management’s assessment of the company’s
internal controls over financial reporting in accordance with standards for
attestation engagements issued or adopted by the Public Company Accounting
Oversight Board.
  **Eurobank**
  Eurobank
is subject to extensive regulation and examination by the Commissioner of
Financial Institutions of Puerto Rico and the FDIC, which insures its deposits
to the maximum extent permitted by law, and is subject to certain Federal
Reserve Board regulations of transactions with its affiliates. The federal and
Puerto Rico laws and regulations which are applicable to Eurobank, regulate,
among other things, the scope of its business, its investments, its reserves
against deposits, the timing of the availability of deposited funds and the
nature and amount of and collateral for certain loans. In addition to the impact
of such regulations, commercial banks are affected significantly by the actions
of the Federal Reserve Board as it attempts to control the money supply and
credit availability in order to influence the economy.
  *Transactions
with Affiliates*
  There are
various statutory and regulatory limitations, including those set forth in
sections 23A and 23B of the Federal Reserve Act and Regulation W, governing the
extent to which Eurobank will be able to purchase assets from or securities of
or otherwise finance or transfer funds to EuroBancshares or its nonbanking
subsidiaries. Among other restrictions, such transfers by Eurobank to
EuroBancshares or any of its nonbanking subsidiaries generally will be limited
to 10.0% of Eurobank’s capital and surplus and, with respect to EuroBancshares
and all such nonbanking subsidiaries, to an aggregate of 20.0% of Eurobank’s
subsidiary’s capital and surplus. Furthermore, loans and extensions of credit
are required to be secured in specified amounts and are required to be on terms
and conditions consistent with safe and sound banking practices.
  In
addition, any transaction by a bank with an affiliate and any sale of assets or
provision of services to an affiliate generally must be on terms that are
substantially the same, or at least as favorable, to the bank as those
prevailing at the time for comparable transactions with nonaffiliated
companies.
  *Loans
to Insiders*
  Sections
22(g) and (h) of the Federal Reserve Act and its implementing regulation,
Regulation O, place restrictions on loans by a bank to executive officers,
directors, and principal stockholders. Under Section 22(h), loans to a director,
an executive officer and to a greater than 10% stockholder of a bank and certain
of their related interests, or insiders, and insiders of affiliates, may not
exceed, together with all other outstanding loans to such person and related
interests, the bank’s loans-to-one-borrower limit (generally equal to 15% of the
institution’s unimpaired capital and surplus). Section 22(h) also requires that
loans to insiders and to insiders of affiliates be made on terms substantially
the same as offered in comparable transactions to other persons, unless the
loans are made pursuant to a benefit or compensation program that (i) is widely
available to employees of the bank and (ii) does not give preference to insiders
over other employees of the bank. Section 22(h) also requires prior Board of
Directors approval for certain loans, and the aggregate amount of extensions of
credit by a bank to all insiders cannot exceed the institution’s unimpaired
capital and surplus. Furthermore, Section 22(g) places additional restrictions
on loans to executive officers.
  19
 *Dividends*
  The
ability of Eurobank to pay dividends on its common stock is restricted by the
Puerto Rico Banking Act of 1933, as amended, the FDIA and FDIC regulations. In
general terms, the Puerto Rico Banking Act provides that when the expenditures
of a bank are greater than receipts, the excess of expenditures over receipts
shall be charged against the undistributed profits of the bank and the balance,
if any, shall be charged against the required reserve fund of the bank. If there
is no sufficient reserve fund to cover such balance in whole or in part, the
outstanding amount shall be charged against the bank’s capital account. The
Puerto Rico Banking Act provides that until said capital has been restored to
its original amount and the reserve fund to 20% of the original capital, the
bank may not declare any dividends. In general terms, the FDIA and the FDIC
regulations restrict the payment of dividends when a bank is undercapitalized,
when a bank has failed to pay insurance assessments, or when there are safety
and soundness concerns regarding a bank.
  The
payment of dividends by Eurobank may also be affected by other regulatory
requirements and policies, such as maintenance of adequate capital. If, in the
opinion of the regulatory authority, a depository institution under its
jurisdiction is engaged in, or is about to engage in, an unsafe or unsound
practice (that, depending on the financial condition of the depository
institution, could include the payment of dividends), such authority may
require, after notice and hearing, that such depository institution cease and
desist from such practice. The Federal Reserve Board has issued a policy
statement that provides that insured banks and bank holding companies should
generally pay dividends only out of operating earnings for the current and
preceding two years. In addition, all insured depository institutions are
subject to the capital-based limitations required by the Federal Deposit
Insurance Corporation Improvement Act of 1991.
  *FDIC
Capital Requirements*
  Eurobank
is also subject to certain restrictions on the payment of dividends as a result
of the requirement that it maintain adequate levels of capital in accordance
with guidelines promulgated from time to time by applicable
regulators.
  The FDIC
and the Commissioner of Financial Institutions of Puerto Rico monitor the
capital adequacy of Eurobank by using a combination of risk-based guidelines and
leverage ratios. The agencies consider the bank’s capital levels when taking
action on various types of applications and when conducting supervisory
activities related to the safety and soundness of individual banks and the
banking system.
  Under the
risk-based capital guidelines, a risk weight factor of 0% to 100% is assigned to
each category of assets based generally on the perceived credit risk of the
asset class. The risk weights are then multiplied by the corresponding asset
balances to determine a “risk-weighted” asset base. At least half of the
risk-based capital must consist of core (Tier 1) capital, which is comprised
of:
  ●
    common
      stockholders’
      equity (includes common stock and any related surplus, undivided profits,
      disclosed capital reserves that represent a segregation of undivided
      profits, and foreign currency translation adjustments; less net unrealized
      losses on marketable equity securities);
  ●
    certain
      noncumulative perpetual preferred stock and related surplus;
      and
  ●
    minority
      interests in the equity capital accounts of consolidated subsidiaries, and
      excludes goodwill and various intangible
assets.
  The
remainder, supplementary (Tier 2) capital, may consist of:
  ●
    allowance
      for loan and lease losses, up to a maximum of 1.25% of risk-weighted
      assets;
  ●
    certain
      perpetual preferred stock and related surplus;
  20
 ●
    hybrid
      capital instruments;
  ●
    perpetual
      debt;
  ●
    mandatory
      convertible debt securities;
  ●
    term
      subordinated debt;
  ●
    intermediate-term
      preferred stock; and
  ●
    certain
      unrealized holding gains on equity securities.
  “Total
risk-based capital” is determined by combining core capital and supplementary
capital.
  Under the
regulatory capital guidelines, Eurobank must maintain a total risk-based capital
to risk-weighted assets ratio of at least 8.0%, a Tier 1 capital to
risk-weighted assets ratio of at least 4.0%, and a Tier 1 capital to adjusted
total assets ratio of at least 4.0% (3.0% for banks receiving the highest
examination rating) to be considered adequately capitalized. See discussion in
the section below captioned *“The
FDIC Improvement Act.”*
  *FIRREA*
  The
Financial Institutions Reform, Recovery and Enforcement Act of 1989, or FIRREA,
includes various provisions that affect or may affect Eurobank. Among other
matters, FIRREA generally permits bank holding companies to acquire healthy
thrifts as well as failed or failing thrifts. FIRREA removed certain
cross-marketing prohibitions previously applicable to thrift and bank
subsidiaries of a common holding company. Furthermore, a multi-bank holding
company may now be required to indemnify the federal deposit insurance fund
against losses it incurs with respect to such company’s affiliated banks, which
in effect makes a bank holding company’s equity investments in healthy bank
subsidiaries available to the FDIC to assist such company’s failing or failed
bank subsidiaries.
  In
addition, pursuant to FIRREA, any depository institution that has been chartered
less than two years, is not in compliance with the minimum capital requirements
of its primary federal banking regulator, or is otherwise in a troubled
condition must notify its primary federal banking regulator of the proposed
addition of any person to the Board of Directors or the employment of any person
as a senior executive officer of the institution at least 30 days before such
addition or employment becomes effective. During such 30-day period, the
applicable federal banking regulatory agency may disapprove of the addition of
employment of such director or officer. Eurobank is not subject to any such
requirements.
  FIRREA
also expanded and increased civil and criminal penalties available for use by
the appropriate regulatory agency against certain “institution-affiliated
parties” primarily including (i) management, employees and agents of a financial
institution, as well as (ii) independent contractors such as attorneys and
accountants and others who participate in the conduct of the financial
institution’s affairs and who caused or are likely to cause more than minimum
financial loss to or a significant adverse affect on the institution, who
knowingly or recklessly violate a law or regulation, breach a fiduciary duty or
engage in unsafe or unsound practices. Such practices can include the failure of
an institution to timely file required reports or the submission of inaccurate
reports. Furthermore, FIRREA authorizes the appropriate banking agency to issue
cease and desist orders that may, among other things, require affirmative action
to correct any harm resulting from a violation or practice, including
restitution, reimbursement, indemnifications or guarantees against loss. A
financial institution may also be ordered to restrict its growth, dispose of
certain assets or take other action as determined by the ordering agency to be
appropriate.
  *The
FDIC Improvement Act*
  The
Federal Deposit Insurance Corporation Improvement Act of 1991, or FDICIA, made a
number of reforms addressing the safety and soundness of the deposit insurance
system, supervision of domestic and foreign depository institutions, and
improvement of accounting standards. This statute also limited deposit insurance
coverage, implemented changes in consumer protection laws and provided for
least-cost resolution and prompt regulatory action with regard to troubled
institutions.
  21
 FDICIA
requires every bank with total assets in excess of $500 million to have an
annual independent audit made of the bank’s financial statements by a certified
public accountant to verify that the financial statements of the bank are
presented in accordance with generally accepted accounting principles and comply
with such other disclosure requirements as prescribed by the FDIC.
  FDICIA
also places certain restrictions on activities of banks depending on their level
of capital. FDICIA divides banks into five different categories, depending on
their level of capital. Under regulations adopted by the FDIC, a bank is deemed
to be “well-capitalized” if it has a total Risk-Based Capital Ratio of 10.0% or
more, a Tier 1 Capital Ratio of 6.0% or more and a Leverage Ratio of 5.0% or
more, and the bank is not subject to an order or capital directive to meet and
maintain a certain capital level. Under such regulations, a bank is deemed to be
“adequately capitalized” if it has a total Risk-Based Capital Ratio of 8.0% or
more, a Tier 1 Capital Ratio of 4.0% or more and a Leverage Ratio of 4.0% or
more (unless it receives the highest composite rating at its most recent
examination and is not experiencing or anticipating significant growth, in which
instance it must maintain a Leverage Ratio of 3.0% or more). Under such
regulations, a bank is deemed to be “undercapitalized” if it has a total
Risk-Based Capital Ratio of less than 8.0%, a Tier 1 Capital Ratio of less than
4.0% or a Leverage Ratio of less than 4.0%. Under such regulations, a bank is
deemed to be “significantly undercapitalized” if it has a Risk-Based Capital
Ratio of less than 6.0%, a Tier 1 Capital Ratio of less than 3.0% and a Leverage
Ratio of less than 3.0%. Under such regulations, a bank is deemed to be
“critically undercapitalized” if it has a Leverage Ratio of less than or equal
to 2.0%. In addition, the FDIC has the ability to downgrade a bank’s
classification (but not to “critically undercapitalized”) based on other
considerations even if the bank meets the capital guidelines. According to these
guidelines, Eurobank was classified as “well-capitalized” as of December 31,
2004.
  In
addition, if a state non-member bank is classified as undercapitalized, the bank
is required to submit a capital restoration plan to the FDIC. Pursuant to
FDICIA, an undercapitalized bank is prohibited from increasing its assets,
engaging in a new line of business, acquiring any interest in any company or
insured depository institution, or opening or acquiring a new branch office,
except under certain circumstances, including the acceptance by the FDIC of a
capital restoration plan for the bank.
  Furthermore,
if a state non-member bank is classified as undercapitalized, the FDIC may take
certain actions to correct the capital position of the bank; if a bank is
classified as significantly undercapitalized or critically undercapitalized, the
FDIC would be required to take one or more prompt corrective actions. These
actions would include, among other things, requiring: sales of new securities to
bolster capital; improvements in management; limits on interest rates paid;
prohibitions on transactions with affiliates; termination of certain risky
activities and restrictions on compensation paid to executive officers. If a
bank is classified as critically undercapitalized, FDICIA requires the bank to
be placed into conservatorship or receivership within ninety days, unless the
FDIC determines that other action would better achieve the purposes of FDICIA
regarding prompt corrective action with respect to undercapitalized
banks.
  The
capital classification of a bank affects the frequency of examinations of the
bank and impacts the ability of the bank to engage in certain activities and
affects the deposit insurance premiums paid by such bank. Under FDICIA, the FDIC
is required to conduct a full-scope, on-site examination of every bank at least
once every twelve months. An exception to this rule is made, however, that
provides that banks (i) with assets of less than $100 million, (ii) are
categorized as “well-capitalized,” (iii) were found to be well managed and its
composite rating was outstanding and (iv) has not been subject to a change in
control during the last twelve months, need only be examined by the FDIC once
every eighteen months.
  *Brokered
Deposits*
  Under
FDICIA, banks may be restricted in their ability to accept brokered deposits,
depending on their capital classification. “Well-capitalized” banks are
permitted to accept brokered deposits, but all banks that are not
well-capitalized are not permitted to accept such deposits. The FDIC may, on a
case-by-case basis, permit banks that are adequately capitalized to accept
brokered deposits if the FDIC determines that acceptance of such deposits would
not constitute an unsafe or unsound banking practice with respect to the bank.
Deposits obtained from financial intermediaries, so-called “brokered deposits,”
represented approximately 36.3% of Eurobank’s total deposits as of December 31,
2004. As previously mentioned, Eurobank is currently well-capitalized and
therefore is not subject to any limitations with respect to its brokered
deposits.
  22
 *Federal
Limitations on Activities and Investments*
  The
equity investments and activities as a principal of FDIC-insured state-chartered
banks such as Eurobank are generally limited to those that are permissible for
national banks. Under regulations dealing with equity investments, an insured
state bank generally may not directly or indirectly acquire or retain any equity
investment of a type, or in an amount, that is not permissible for a national
bank.
  *FDIC
Deposit Insurance Assessments*
  In
addition, under FDICIA, the FDIC is authorized to assess insurance premiums on a
bank’s deposits at a variable rate depending on the probability that the deposit
insurance fund will incur a loss with respect to the bank. (Under prior law, the
deposit insurance assessment was a flat rate, regardless of the likelihood of
loss.) In this regard, the FDIC has issued regulations that provide for a
transitional risk-based deposit assessment that determines the deposit insurance
assessment rates on the basis of the bank’s capital classification and
supervisory evaluations. Each of these categories have three subcategories,
resulting in nine assessment risk classifications. The three subcategories with
respect to capital are “well-capitalized,” “adequately capitalized” and “less
than adequately capitalized” (which would include “undercapitalized,”
“significantly undercapitalized” and “critically undercapitalized” banks). The
three subcategories with respect to supervisory concerns are “healthy,”
“supervisory concern” and “substantial supervisory concern.” A bank is deemed
“healthy” if it is financially sound with only a few minor weaknesses. A bank is
deemed subject to “supervisory concern” if it has weaknesses that, if not
corrected, could result in significant deterioration of the bank and increased
risk to the Bank Insurance Fund, or BIF. A bank is deemed subject to
“substantial supervisory concern” if it poses a substantial probability of loss
to the BIF.
  On June
30, 1996, the Deposit Insurance Funds Act of 1996, or DIFA, was enacted and
signed into law as part of the Economic Growth and Regulatory Paperwork
Reduction Act of 1996. DIFA established the framework for the eventual merger of
the BIF and the Savings Association Insurance Fund, or SAIF, into a single
Deposit Insurance Fund. It repealed the statutory minimum premium and, under
implementing FDIC regulations promulgated in 1997, premiums assessed by both the
BIF and the SAIF are to be assessed using the matrix described above at a rates
between 0 cents and 27 cents per $100 of deposits.
  DIFA also
separated, effective January 1, 1997, the Financing Corporation, or FICO,
assessment to service the interest on its bond obligations from the BIF and SAIF
assessments. The amount assessed on individual institutions by the FICO will be
in addition to the amount, if any, paid for deposit insurance according to the
FDIC’s risk-related assessment rate schedules. The FICO rate may be adjusted
quarterly to reflect changes in assessment bases for the BIF and the SAIF.
Accordingly, Eurobank may be subject to two separate premiums (for servicing
interest on bond obligations and for the BIF/SAIF insurance), if such premiums
are assessed.
  The FDIC
may terminate the deposit insurance of any insured depository institution,
including Eurobank, if it determines after a hearing that the institution has
engaged or is engaging in unsafe or unsound practices, is in an unsafe or
unsound condition to continue operations, or has violated any applicable law,
regulation, order or any condition imposed by an agreement with the FDIC. It
also may suspend deposit insurance temporarily during the hearing process for
the permanent termination of insurance, if the institution has no tangible
capital. If insurance of accounts is terminated, the accounts at the institution
at the time of the termination, less subsequent withdrawals, shall continue to
be insured for a period of six months to two years, as determined by the FDIC.
Management is aware of no existing circumstances which would result in
termination of Eurobank’s deposit insurance.
  *Check
Clearing for the 21* *st* *Century Act*
  On
October 28, 2003, President Bush signed into law the Check Clearing for the
21 st Century
Act, also known as Check 21. The new law, which was not effective until October
28, 2004, gives “substitute checks,” such as a digital image of a check and
copies made from that image, the same legal standing as the original paper
check. Some of the major provisions include:
  ●
    allowing
      check truncation without making it
mandatory;
  ●
    demanding
      that every financial institution communicate to accountholders in writing
      a description of its substitute check processing program and their rights
      under the law;
  23
 ●
    legalizing
      substitutions for and replacements of paper checks without agreement from
      consumers;
  ●
    retaining
      in place the previously mandated electronic collection and return of
      checks between financial institutions only when individual agreements are
      in place;
  ●
    requiring
      that when accountholders request verification, financial institutions
      produce the original check (or a copy that accurately represents the
      original) and demonstrate that the account debit was accurate and valid;
      and
  ●
    requiring
      recrediting of funds to an individual’s account on the next business day
      after a consumer proves that the financial institution has
      erred.
  This new
legislation will likely affect bank capital spending as many financial
institutions assess whether technological or operational changes are necessary
to stay competitive and take advantage of the new opportunities presented by
Check 21.
  *Community
Reinvestment Act*
  Under the
Community Reinvestment Act, or CRA, as implemented by the Congress in 1977, a
financial institution has a continuing and affirmative obligation, consistent
with its safe and sound operation, to help meet the credit needs of its entire
community, including low and moderate income neighborhoods. The CRA does not
establish specific lending requirements or programs for financial institutions
nor does it limit an institution’s discretion to develop the types of products
and services that it believes are best suited to its particular community,
consistent with the CRA. The CRA requires federal examiners, in connection with
the examination of a financial institution, to assess the institution’s record
of meeting the credit needs of its community and to take such record into
account in its evaluation of certain applications by such institution. The CRA
also requires all institutions to make public disclosure of their CRA ratings.
EuroBancshares has a Compliance Committee, which oversees the planning of
products, and services offered to the community, especially those aimed to serve
low and moderate income communities. The FDIC rated Eurobank as “satisfactory”
in meeting community credit needs under the CRA at its most recent examination
for CRA performance.
  *Consumer
Laws and Regulations*
  In
addition to the laws and regulations discussed herein, Eurobank is also subject
to certain consumer laws and regulations that are designed to protect consumers
in transactions with banks. While the list set forth herein is not exhaustive,
these laws and regulations include the Truth in Lending Act, the Truth in
Savings Act, the Electronic Funds Transfer Act, the Expedited Funds Availability
Act, the Equal Credit Opportunity Act, and the Fair Housing Act, among others.
These laws and regulations mandate certain disclosure requirements and regulate
the manner in which financial institutions must deal with customers when taking
deposits or making loans to such customers. Eurobank must comply with the
applicable provisions of these consumer protection laws and regulations as part
of its ongoing customer relations.
  *Interstate
Branching*
  Effective
June 1, 1997, the Riegle-Neal Interstate Banking and Branching Efficiency Act of
1994 amended the FDIA and certain other statutes to permit state and national
banks with different home states to merge across state lines, with approval of
the appropriate federal banking agency, unless the home state of a participating
bank had passed legislation prior to May 31, 1997 expressly prohibiting
interstate mergers. Under the Riegle-Neal Act amendments, once a state or
national bank has established branches in a state, that bank may establish and
acquire additional branches at any location in the state at which any bank
involved in the interstate merger transaction could have established or acquired
branches under applicable federal or state law. If a state opts out of
interstate branching within the specified time period, no bank in any other
state may establish a branch in the state which has opted out, whether through
an acquisition or de novo.
  For
purposes of the Riegle-Neal Act’s amendments to the FDIA, Eurobank is treated as
a state bank and is subject to the same restrictions on interstate branching as
other state banks. However, for purposes of the International Banking Act of
1978, Eurobank is considered to be a foreign bank and may branch interstate by
merger or de novo to the same extent as a domestic bank in Eurobank’s home
state. It is not yet possible to determine how these statutes will be
harmonized, with respect either to which federal agency will approve interstate
transactions or to which “home state” determination rules will
apply.
  24
 Eurobank
currently does not have any branches outside Puerto Rico.
  *Federal
Home Loan Bank System*
  The FHLB
system, of which Eurobank is a member, consists of 12 regional FHLBs governed
and regulated by the Federal Housing Finance Board. The FHLBs serve as reserve
or credit facilities for member institutions within their assigned regions. They
are funded primarily from proceeds derived from the sale of consolidated
obligations of the FHLB system. They make loans ( *i.e.* ,
advances) to members in accordance with policies and procedures established by
the FHLB and the boards of directors of each regional FHLB.
  As a
system member, Eurobank is entitled to borrow from the FHLB of New York, or
FHLB-NY, and is required to own capital stock in the FHLB-NY in an amount equal
to the greater of 1% of the aggregate of the unpaid principal of its home
mortgage loans, home purchase contracts, and similar obligations at the
beginning of each fiscal year, which for this purpose is deemed to be not less
than 30% of assets or 5% of the total amount of advances by the FHLB-NY to
Eurobank. Eurobank is in compliance with the stock ownership rules described
above with respect to such advances, commitments and letters of credit and home
mortgage loans and similar obligations. All loans, advances and other extensions
of credit made by the FHLB-NY to Eurobank are secured by a portion of the its
mortgage loan portfolio, certain other investments and the capital stock of the
FHLB-NY held by Eurobank.
  **Mortgage
Banking Operations**
  Eurobank
is subject to the rules and regulations of FHA, VA, FNMA, FHLMC and GNMA with
respect to originating, processing, selling and servicing mortgage loans and the
issuance and sale of mortgage-backed securities. Those rules and regulations,
among other things, prohibit discrimination and establish underwriting
guidelines which include provisions for inspections and appraisals, require
credit reports on prospective borrowers and fix maximum loan amounts and, with
respect to VA loans, fix maximum interest rates. Mortgage origination activities
are subject to, among others, the Equal Credit Opportunity Act, Federal
Truth-in-Lending Act and the Real Estate Settlement Procedures Act and the
regulations promulgated thereunder which, among other things, prohibit
discrimination and require the disclosure of certain basic information to
mortgagors concerning credit terms and settlement costs. Eurobank is also
subject to regulation by the Commissioner of Financial Institutions of Puerto
Rico, with respect to, among other things, the establishment of maximum
origination fees on certain types of mortgage loan products.
  **Puerto
Rico Regulation**
  As a
commercial bank organized under the laws of Puerto Rico, Eurobank is subject to
the supervision, examination and regulati o n of the
Commissioner of Financial Institutions of Puerto Rico, pursuant to the Puerto
Rico Banking Act of 1933, as amended. Certain of those activities are described
in this *“Supervision
and Regulation”* section
above.
  *Puerto
Rico Banking Law*
  Section
12 of the Puerto Rico Banking Law requires the prior approval of the
Commissioner of Financial Institutions of Puerto Rico with respect to a transfer
of capital stock of a bank that results in a change of control of the bank.
Under Section 12, a change of control is presumed to occur if a person or group
of persons acting in concert, directly or indirectly, acquire more than 5.0% of
the outstanding voting capital stock of the bank. The Commissioner of Financial
Institutions of Puerto Rico has interpreted the restrictions of Section 12 as
applying to acquisitions of voting securities of entities controlling a bank,
such as a bank holding company. Under the Puerto Rico Banking Law, the
determination of the Commissioner of Financial Institutions of Puerto Rico
whether to approve a change of control filing is final and non-
appealable.
  Section
16 of the Puerto Rico Banking Law requires every bank to maintain a legal
reserve which shall not be less than 20% of its demand liabilities, except
government deposits (federal, state and municipal) which are secured by actual
collateral. The reserve is required to be composed of any of the following
securities or combination thereof: (1) legal tender of the United States; (2)
checks on banks or trust companies located in any part of Puerto Rico, to be
presented for collection during the day following that on which they are
received; (3) money deposited in other banks or depository institutions, subject
to immediate collection; (4) federal funds sold to any Federal Reserve Bank and
securities purchased under agreement to resell executed by the bank with such
funds that are subject to be repaid to the bank on or before the close of the
next business day and (5) any other asset that the Commissioner of Financial
Institutions of Puerto Rico determines from time to time.
  25
 Section
17 of the Puerto Rico Banking Law permits Puerto Rico commercial banks to make
unsecured loans to any one person, firm, partnership or corporation, up to an
aggregate amount of 15.0% the sum of (i) paid-in capital; (ii) reserve fund of
the commercial bank; (iii) 50.0% of the commercial bank’s retained earnings and
(iv) any other components that the Commissioner of Financial Institutions of
Puerto Rico may determine from time to time. As of December 31, 2004, the legal
lending limit for Eurobank under this provision was approximately $17.1 million.
If such loans are secured by collateral worth at least 25.0% more than the
amount of the loan, the aggregate maximum amount may reach one-third of the sum
of Eurobank’s paid-in capital, reserve fund, retained earnings and any other
components that the Commissioner of Financial Institutions of Puerto Rico may
determine from time to time. As of December 31, 2004, the legal lending limit
for Eurobank under this provision was approximately $37.6 million. There are no
restrictions under Section 17 of the Puerto Rico Banking Law on the amount of
loans which are fully secured by bonds, securities and other evidences of
indebtedness of the Government of the United States, of the Commonwealth of
Puerto Rico, or by bonds, not in default, of authorities, instrumentalities or
dependencies of the Commonwealth of Puerto Rico or its
municipalities.
  Section
17 of the Puerto Rico Banking Law also prohibits Puerto Rico commercial banks
from making loans secured by their own stock and from purchasing their own
stock, unless such purchase is necessary to prevent losses because of a debt
previously contracted in good faith. The stock so purchased by the Puerto Rico
commercial bank must be sold by the bank in a public or private sale within one
year from the date of purchase.
  Section
27 of the Puerto Rico Banking Law also requires that at least 10.0% of the
yearly net income of a Puerto Rico commercial bank be credited to a reserve fund
until the amount deposited to the credit of the reserve fund is equal to 100.0%
of total paid-in capital (common and preferred) of the commercial bank. As of
December 31, 2004, Eurobank had $4.7 million in its reserve fund.
  Section
27 of the Puerto Rico Banking Law also provides that when the expenditures of a
Puerto Rico commercial bank are greater than receipts, the excess of the
expenditures over receipts shall be charged against the undistributed profits of
the bank, and the balance, if any, shall be charged against the reserve fund, as
a reduction thereof. If there is no reserve fund sufficient to cover such
balance in whole or in part, the outstanding amount shall be charged against the
capital account and no dividends shall be declared until said capital has been
restored to its original amount and the reserve fund to 20% of the original
capital of the bank.
  Section
14 of the Puerto Rico Banking Law authorizes Eurobank to conduct certain
financial and related activities directly or through subsidiaries, including
lease financing of personal property, operating small loans companies and
mortgage loans activities. Eurobank recently organized an IBE subsidiary, EBS
Overseas.
  *Puerto
Rico Usury Law*
  The rate
of interest that Eurobank may charge on real estate and other types of loans to
individuals in Puerto Rico is subject to Puerto Rico’s usury law. That law is
administered by the Finance Board, which consists of the Secretaries of the
Treasury, Commerce and Consumer Affairs Departments, the Commissioner of
Financial Institutions of Puerto Rico, the President of the Planning Board, the
President of the Government Development Bank for Puerto Rico, the Secretary of
Economic Development and Commerce Department and a representative of the private
financial industry. The Finance Board promulgates regulations which specify
maximum rates on various types of loans to individuals and revises those
regulations periodically as general interest rates change.
  Among the
most important regulations enforced on interest rates are Regulations 5722, 5782
and 6070. Pursuant to Regulation 5782, there is no limitation on interest rates
that may be charged on small personal loans. The same rule applies to retail
installment sale contracts and credit card loans as provided by Regulation 6070.
The rates on these loans are established as a result of the market and
competition.
  Interest
rates that may be charged on personal loans, personal lines of credit, cash
advances on credit cards, commercial loans or commercial lines of credit and
residential and commercial mortgage loans are not restricted by Regulation 5722.
The rates on these loans are established as a result of the market and
competition. Regulation 5722 does establish restrictions on prepayment penalties
and late charges for all loans, except commercial loans.
  26
 **International
Banking Center Regulatory Act**
  We
recently transferred all of the assets and liabilities of our IBE Eurobank
International, which operated as a division of Eurobank, to a recently organized
IBE subsidiary of Eurobank, EBS Overseas. We also have an IBE that operates as a
division of Eurobank under the name BT International. We acquired this IBE in
connection with the acquisition of BankTrust. Due to statutory limitations on
the amount of assets that can be transferred to subsidiary IBEs while still
preserving tax benefits, we will continue to operate the acquired IBE as a
division of Eurobank and will not immediately transfer its assets to our new
subsidiary IBE, EBS Overseas.
  The
business and operations of our IBEs are subject to supervision and regulation by
the Commissioner of Financial Institutions of Puerto Rico. Under the IBE Act, no
sale, encumbrance, assignment, merger, exchange or transfer of shares, interest
or participation in the capital of an IBE may be initiated without the prior
approval of the Commissioner of Financial Institutions of Puerto Rico, if by
such transaction a person would acquire, directly or indirectly, control of 10%
or more of any class of stock, interest or participation in the capital of the
IBE. The IBE Act and the regulations issued thereunder by the Commissioner of
Financial Institutions of Puerto Rico limit the business activities that may be
carried out by an IBE. Such activities are limited in part to persons and assets
located outside of Puerto Rico. The IBE Act provides further that every IBE must
have not less than $300,000 of unencumbered assets or acceptable financial
guarantees.
  Pursuant
to the IBE Act and the IBE regulations, our IBEs must maintain books and records
of all their transactions in the ordinary course of business. The IBEs are also
required to submit to the Commissioner of Financial Institutions of Puerto Rico
quarterly and annual reports of their financial condition and results of
operations, including annual audited financial statements.
  The IBE
Act empowers the Commissioner of Financial Institutions of Puerto Rico to revoke
or suspend, after notice and hearing, a license issued thereunder if, among
other things, the IBE fails to comply with the IBE Act, the IBE regulations or
the terms of its license, or if the Commissioner of Financial Institutions of
Puerto Rico finds that the business or affairs of the IBE are conducted in a
manner that is not consistent with the public interest.
  IBEs
generally are exempt from taxation under United States federal law and Puerto
Rico law. Recently, the Legislature of Puerto Rico and the Governor of Puerto
Rico approved a law amending the IBE Act. This law imposes income taxes at
normal statutory rates on each IBE that operates as a unit of a bank, if the
IBE’s net income generated after December 31, 2003 exceeds 40% of the bank’s net
income in the taxable year commenced on July 1, 2003, 30% of the bank’s net
income in the taxable year commencing on July 1, 2004, and 20% of the bank’s net
income in the taxable year commencing on July 1, 2005, and thereafter. It does
not impose income taxation on an IBE that operates as a subsidiary of a bank.
Thus, only BT International, which operates as a division of Eurobank rather
than a subsidiary, is impacted by the new law. However, we cannot give you any
assurance that the IBE Act will not be modified in the future in a manner to
reduce the tax benefits available to EBS Overseas. A reduction of such tax
benefits may reduce our earnings.
  **EuroSeguros,
Inc.**
  EuroSeguros
is a wholly owned subsidiary of EuroBancshares and is registered as a corporate
agent and general agency with the Office of the Commissioner of Insurance of the
Commonwealth of Puerto Rico. EuroSeguros is subject to regulation by the
Commissioner of Insurance relating to, among other things, licensing of
employees, sales practices, charging of commissions and obligations to
customers.
  **Future
Legislation and Economic Policy**
  Management
of EuroBancshares and Eurobank cannot predict what other legislation or economic
and monetary policies of the various regulatory authorities might be enacted or
adopted or what other regulations might be adopted or the effects thereof.
Future legislation and policies and the effects thereof might have a significant
influence on overall growth and distribution of loans, investments and deposits
and affect interest rates charged on loans or paid from time and savings
deposits. Such legislation and policies have had a significant effect on the
operating results of commercial banks in the past and are expected to continue
to do so in the future.
  27
 **ITEM
2.** **Properties.**
  Our
principal offices, including the principal offices of the Bank, are located in
our main office building at 270 Muñoz Rivera Avenue in San Juan, Puerto Rico. In
addition to the main office, we operate at 25 locations. While all of Eurobank’s
21 branch facilities provide full banking services, we consider 16 of these to
be primarily commercial loan generating facilities. In connection with the
BankTrust acquisition we added one additional branch office located in Guaynabo,
Puerto Rico. All other branches acquired in the BankTrust acquisition were
closed and their operations consolidated with our other branches. A substantial
portion of the expenses associated with these branch closings were effectively
borne by the stockholders of BankTrust through a reduction in the aggregate
purchase price. The following is a list of our operating locations:
  **Location**
    **Lease
      Expiration Date****(1)**
    **Owned
      or Leased**Main
      Office:270
      Muñoz Rivera Avenue
    N/A
    Owned(2)San
      Juan, Puerto Rico 00918Departments:Accounting,
      Marketing and Human Resources:Fourth
      Floor
    12/31/2007
    Leased270
      Muñoz Rivera AvenueSan
      Juan, Puerto Rico 00918EuroLease:State
      Road #2, Km. 2.5
    8/31/2007
    LeasedKennedy
      AvenueSan
      Juan, Puerto Rico 00920EuroMortgage:State
      Road #190
    5/31/2007
    LeasedLot
      #1, Km. 0.7La
      Cerámica Industrial ParkCarolina,
      Puerto Rico 00983Branch
      Administration and Compliance:1302
      Jesús T. Piñero Avenue
    12/31/2011
    LeasedSan
      Juan, Puerto Rico 00918Credit
      Administration:Old
      Corona Building
    4/30/2007
    LeasedBuilding
      #5, Fifth FloorSanturce,
      Puerto Rico 00907Operations:Old
      Corona Building
    8/31/2007
    LeasedBuilding
      #5, Second Floor, Local #3Santurce,
      Puerto Rico 00907Branches:Bayamón
      Branch
    9/30/2017
    LeasedComerío
      Avenue, corner of Sierra BayamónBayamón,
      Puerto Rico 00961Caguas
      I Branch
    5/31/2007
    LeasedA-1
      Muñoz Rivera AvenueCaguas,
      Puerto Rico 00725Caguas
      II Branch
    6/30/2005
    Leased32
      Acosta Street, corner of Ruiz BelvisCaguas,
      Puerto Rico 00725Carolina
      Branch
    9/30/2007
    LeasedState
      Road #190Lot
      #1, Km. 0.7La
      Cerámica Industrial ParkCarolina,
      Puerto Rico 00983
  28
  **Location**
    **Lease
      Expiration Date****(1)**
    **Owned
      or Leased**
 Cidra
      Branch
    4/30/2006
    LeasedLuis
      Muñoz Rivera Streetcorner
      of José de DiegoCidra,
      Puerto Rico 00739Condado
      Branch
    3/31/2009
    Leased1408
      Magdalena AvenueSanturce,
      Puerto Rico 00907Hato
      Rey Branch
    N/A
    Owned(2)270
      Muñoz Rivera AvenueSan
      Juan, Puerto Rico 00918Humacao
      Branch
    5/31/2026
    LeasedPlaza
      Mall Lot #3, State Road No. PR52Corner
      State Road No. PR3Humacao,
      Puerto Rico 00791Luquillo
      Branch
    4/29/2006
    LeasedState
      Road No. PR3, Km. 36.2Luquillo,
      Puerto Rico 00773Manatí
      Branch
    8/30/2011
    LeasedState
      Road No. PR2, Km. 49.5Manatí,
      Puerto Rico 00674Ponce
      Plaza Branch
    12/31/2006
    LeasedMayor
      Street, corner of Isabel StreetPonce,
      Puerto Rico 00731Ponce
      Hostos Branch
    10/31/2008
    Leased26
      Hostos AvenuePonce,
      Puerto Rico 00731Ponce
      Morell Campos Branch
    12/31/2005
    LeasedState
      Road #10, Km. 1.5Ponce,
      Puerto Rico 00731Ponce
      Marvesa Branch
    Expired(3)
    LeasedMarvesa
      Building #100La
      RamblaPonce,
      Puerto Rico 00731Puerto
      Nuevo Branch
    12/31/2011
    Leased1302
      Jesús T. Piñerocorner
      de Diego AvenueSan
      Juan, Puerto Rico 00921San
      Francisco Branch
    4/30/2006
    LeasedVillas
      de San Francisco Shopping Center85
      de Diego AvenueRío
      Piedras, Puerto Rico 00927San
      Lorenzo Branch
    8/01/2008
    Leased155
      South Luis Muñoz Rivera StreetSan
      Lorenzo, Puerto Rico 00754
  29
  **Location**
    **Lease
      Expiration Date****(1)**
    **Owned
      or Leased**
 San
      Patricio Branch
    2/15/2010
    LeasedSan
      Patricio Office Center8
      Tabonuco StreetGuaynabo,
      Puerto Rico 00969Villa
      Palmera Branch
    12/31/2008
    LeasedEduardo
      Conde Avenuecorner
      of Tapia StreetSanturce,
      Puerto Rico 00915Mayagüez
      Branch
    11/30/2025
    LeasedState
      Road No. PR2, Km. 153.2Mayagüez,
      Puerto Rico 00681Hatillo
      Branch
    11/30/2007
    LeasedState
      Road No. PR2, Km. 87.0Hatillo,
      Puerto Rico 00659
 __________
 
 (1)
    Most
      of these leases have options for extensions. In addition, several have
      early termination clauses.
 
 (2)
    The
      properties owned by EuroBancshares located at 270 Muñoz Rivera Avenue are
      part of a 180,000 square foot commercial office building. EuroBancshares
      owns a portion of the lobby area on the ground floor where it operates a
      branch and also owns the first floor of this office building where its
      headquarters are located. In addition, EuroBancshares also owns certain
      parking spaces and a portion of the common areas of this office
      building.
 
 (3)
    The
      lease at this location expired on January 1, 1997, but Eurobank continues
      to pay rent to the lessor on a month-to-month basis. Eurobank believes
      that the lessor will not require Eurobank to vacate the premises in the
      immediate future.
 
 **ITEM
3.** **Legal
Proceedings.**
  We are
currently the defendant in a suit filed on November 14, 1994 by Carlos Gonzalez
Jusino in the Superior Court of Puerto Rico, Ponce Section ( *Carlos
Gonzalez Jusino v. Eurobank & Trust Company* — Civil
#JAC 1994-0608). The complaint alleges that money was permitted to be withdrawn
from a corporate account at the Bank without full written authorization, and
seeks restoration of $890,075.99 in funds, interest thereon, and attorney’s
fees. While the trial court found in favor of the plaintiff, we have appealed
the ruling and believe that we should ultimately prevail based on legal
precedent we feel favors our position.
  Except
for the foregoing, there are no material pending legal proceedings to which we
or Eurobank is a party or to which any of our properties are subject; nor are
there material proceedings known to us, in which any director, officer or
affiliate or any principal stockholder is a party or has an interest adverse to
us or Eurobank.
  **ITEM
4.** **Submission
of Matters to a Vote of Security Holders.**
  No
matters were submitted to a vote of security holders during the fourth quarter
of 2004.
  **PART
II**
  **ITEM
5.** **Market
for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases
of Equity Securities.**
  **Market
Information**
  Our
common stock began trading on August 11, 2004 and is listed on the Nasdaq
National Market System under the symbol “EUBK”. Prior to that date, our common
stock was privately held and not listed on any public exchange or actively
traded. As of December 31, 2004, there were 19,564,086 shares issued
and outstanding held by 398 stockholders of record, including all directors and
officers of Eurobancshares, Inc., excluding beneficial owners whose shares are
held in “street” name by securities broker-dealers or other nominees. The number
of beneficial owners is unknown to us at this time.
  30
 The
following table presents the high and low sales prices for our common stock
reported on the Nasdaq National Market System since August 11,
2004:
  **2004****High**
    
    **Low**Third
      Quarter (beginning August 11, 2004)
    
    $
    18.64
    
    $
    15.78Fourth
      Quarter
    
    $
    21.40
    
    $
    18.32
  **Dividends**
  We have
not paid cash dividends historically, nor do we anticipate paying any cash
dividends on our common stock in the foreseeable future. Instead, we anticipate
that all of our earnings in the foreseeable future will be used for working
capital, to support our operations and to finance the growth and development of
our business. Any future determination relating to dividend policy will be made
at the discretion of our Board of Directors and will depend on a number of
factors, including our future earnings, capital requirements, financial
condition, future prospects and other factors that our Board of Directors may
deem relevant.
  As a
holding company, we ultimately depend on Eurobank to provide funding for our
noninterest expenses and dividends. Various banking laws applicable to Eurobank
limit the payment of dividends, management fees and other distributions by
Eurobank to us, and may therefore limit our ability to pay dividends on our
common stock. We are also restricted from paying dividends on our common stock
if we have deferred payments of the interest, or if an event of default has
occurred, on our junior subordinated debentures. In addition, we generally are
unable to declare and pay dividends on our common stock if there are any accrued
and unpaid dividends on our Series A Preferred Stock for the preceding 12
months. For additional information, see the sections of this report captioned *“Supervision
and Regulation — EuroBancshares — Regulatory Restrictions on Dividends; Source
of Strength” and “Supervision and Regulation — Eurobank —
Dividends.”*
  **Securities
Authorized for Issuance Under Equity Compensation Plans**
  The
following table presents information regarding our equity compensation plan at
December 31, 2004:
  **Equity
      Compensation Plan Information****Plan
      Category**
    
    **Number
      of securities to be issued upon exercise of outstanding options, warrants
      and rights**
      **(a)**
    
    **Weighted-average
      exercise price of outstanding options, warrants and
      rights**
      **(b)**
    
    **Number
      of securities remaining available for future issuance under equity
      compensation plans (excluding securities reflected in column
      (a))**
      **(c)**Equity
      compensation plans approved by security holders
    
    
    1,091,312
    
    $
    5.22
    
    
    1,208,864
 **Recent
Sales of Unregistered Securities**
  Not
applicable.
  31
 **Use
of Proceeds**
  On August
11, 2004, we completed our initial public offering of 3,894,988 shares of our
common stock, $0.01 par value. On September 15, 2004, we completed our initial
public offering with respect to an additional 584,248 shares pursuant to an
underwriters overallotment. The shares of our common stock sold in the offering
were registered under the Securities Act of 1933, as amended, on a Registration
Statement on Form S-1, No. 333-115510, that was declared effective by the
Securities and Exchange Commission on August 11, 2004. On August 11, 2004, our
common stock commenced trading on the Nasdaq National Market under the symbol
“EUBK.” The managing underwriters in the offering were Keefe, Bruyette &
Woods, UBS Investment Bank and Brean Murray & Co., Inc. All 4,479,236 shares
of our common stock registered under our Registration Statement were sold at a
price of $14.00 per share.
  We issued
and sold 3,967,500 of the aggregate 4,479,236 shares sold in the offering. The
aggregate price of the shares registered and sold by us was $55.5 million. In
connection with the offering, we paid an aggregate of approximately $3.9 million
in underwriting discounts and commissions to the underwriters and paid other
estimated expenses of approximately $1.5 million. After deducting the
underwriting discounts and commissions and the estimated offering expenses
described above, we received net proceeds from the offering of approximately
$50.1 million. We have invested the net proceeds from the offering for the
normal course of our operation, which included investing in United States
government securities and other investments, loans and other banking assets as
presented on the cosolidated balance sheet.
  Certain
of our stockholders issued and sold the remaining 511,736 of the aggregate
4,479,236 shares sold in the offering. The aggregate price of the shares
registered and sold by the selling stockholders was $7.2 million. The selling
stockholders paid an aggregate of approximately $501,501 in underwriting
discounts and commissions to the underwriters in connection with the offering.
After deducting the underwriting discounts and commissions described above, the
selling stckholders received net proceeds from the offering of approximately
$6.7 million.
  **ITEM
6.** **Selected
Financial Data.**
  We
derived our selected consolidated financial data as of and for each of the years
in the five year period ended December 31, 2004 from our audited consolidated
financial statements and the notes thereto. Our audited consolidated financial
statements as of December 31, 2004 and 2003 and for each of the years in the
three-year period ended December 31, 2004 and the report thereon by KPMG LLP are
included elsewhere in this Annual Report on Form 10-K.
  EuroBancshares
was incorporated on November 21, 2001. As a result, the financial information
below for the years 2004, 2003 and 2002 includes consolidated information for
both EuroBancshares and Eurobank. Financial data shown for the years 2001 and
2000 includes the financial information for Eurobank only.
  You
should read this information in conjunction with *“Management’s
Discussion and Analysis of Financial Condition and Results of
Operations”* and the
financial statements and the related notes included elsewhere in this Annual
Report. Results from past periods are not necessarily indicative of results that
may be expected for any future period. Average balances have been computed using
daily averages.
  32
  ****
    
    **As
      of or for the Year Ended December 31,****2004**
    
    **2003**
    
    **2002**
    
    **2001**
    
    **2000****(dollars
      in thousands, except per share data)****Income
      Statement Data:**Total
      interest income
    
    $
    103,476
    
    $
    71,516
    
    $
    54,968
    
    $
    44,590
    
    $
    34,788Total
      interest expense
    
    
    41,481
    
    
    31,922
    
    
    25,124
    
    
    21,379
    
    
    16,872Net
      interest income
    
    
    61,995
    
    
    39,594
    
    
    29,844
    
    
    23,211
    
    
    17,916Provision
      for loan and lease losses
    
    
    7,100
    
    
    6,451
    
    
    3,354
    
    
    2,377
    
    
    1,343Net
      interest income after provision for
      loan
      and lease losses
    
    
    54,895
    
    
    33,143
    
    
    26,490
    
    
    20,834
    
    
    16,573Noninterest
      income:Service
      charges and other fees
    
    
    8,057
    
    
    5,456
    
    
    4,331
    
    
    3,641
    
    
    3,059Gain
      on sale of loans and leases, net
    
    
    1,395
    
    
    3,547
    
    
    —
    
    
    975
    
    
    —Gain
      on sale of securities, net
    
    
    —
    
    
    707
    
    
    —
    
    
    195
    
    
    354Loss
      on sale of other real estate owned and repossessed assets,
    net
    
    
    (359
    )
    
    (663
    )
    
    (310
    )
    
    (86
    )
    
    —Total
      noninterest income
    
    
    9,093
    
    
    9,047
    
    
    4,021
    
    
    4,725
    
    
    3,413Noninterest
      expense:Salaries
      and benefits
    
    
    19,194
    
    
    15,434
    
    
    11,943
    
    
    9,375
    
    
    7,640Professional
      fees
    
    
    2,196
    
    
    1,402
    
    
    1,055
    
    
    951
    
    
    576Other
      noninterest expense
    
    
    15,635
    
    
    12,039
    
    
    8,936
    
    
    7,282
    
    
    5,831Total
      noninterest expense
    
    
    37,025
    
    
    28,875
    
    
    21,934
    
    
    17,608
    
    
    14,047Income
      before income taxes and extraordinary gain
    
    
    26,963
    
    
    13,315
    
    
    8,577
    
    
    7,951
    
    
    5,939Income
      taxes
    
    
    8,663
    
    
    3,432
    
    
    2,724
    
    
    2,147
    
    
    1,908Extraordinary
      gain(1)
    
    
    4,419
    
    
    —
    
    
    1,081
    
    
    —
    
    
    —Net
      income
    
    $
    22,719
    
    $
    9,883
    
    $
    6,934
    
    $
    5,804
    
    $
    4,031**Common
      Share Data:**Earnings
      per common share — basic:Income
      before extraordinary gain
    
    $
    1.08
    
    $
    0.71
    
    $
    0.43
    
    $
    0.47
    
    $
    0.40Extraordinary
      gain
    
    
    0.27
    
    
    —
    
    
    0.08
    
    
    —
    
    
    —Net
      income
    
    
    1.35
    
    
    0.71
    
    
    0.51
    
    
    0.47
    
    
    0.40Earnings
      per common share — diluted:Income
      before extraordinary gain
    
    
    1.04
    
    
    0.69
    
    
    0.42
    
    
    0.46
    
    
    0.40Extraordinary
      gain
    
    
    0.26
    
    
    —
    
    
    0.08
    
    
    —
    
    
    —Net
      income
    
    
    1.30
    
    
    0.69
    
    
    0.50
    
    
    0.46
    
    
    0.40Cash
      dividends declared
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —Book
      value per common share
    
    
    8.12
    
    
    4.67
    
    
    4.13
    
    
    3.53
    
    
    2.99Common
      shares outstanding at end of period
    
    
    19,564,086
    
    
    13,947,396
    
    
    13,879,370
    
    
    13,556,994
    
    
    12,054,004Average
      diluted shares outstanding
    
    
    17,152,261
    
    
    14,234,168
    
    
    13,724,248
    
    
    12,427,640
    
    
    10,127,258**Balance
      Sheet Data (at end of period):**Total
      assets
    
    $
    2,102,789
    
    $
    1,320,934
    
    $
    1,035,305
    
    $
    607,715
    
    $
    452,009Investment
      securities available-for-sale
    
    
    555,482
    
    
    324,938
    
    
    145,795
    
    
    88,709
    
    
    103,737Investment
      securities held-to-maturity
    
    
    49,504
    
    
    —
    
    
    —
    
    
    225
    
    
    228Gross
      loans and leases
    
    
    1,387,613
    
    
    899,392
    
    
    767,792
    
    
    458,680
    
    
    312,197Allowance
      for loan and lease losses
    
    
    19,039
    
    
    9,394
    
    
    6,918
    
    
    4,513
    
    
    3,050Deposits
    
    
    1,409,036
    
    
    984,549
    
    
    843,045
    
    
    485,663
    
    
    350,395Other
      borrowings
    
    
    520,206
    
    
    264,616
    
    
    127,963
    
    
    67,614
    
    
    61,313Total
      stockholders’ equity
    
    
    158,302
    
    
    65,075
    
    
    57,335
    
    
    47,806
    
    
    36,063**Performance
      Ratios:**Return
      on average common stockholders’equity(2)
    
    
    18.67
    %
    
    16.50
    %
    
    11.45
    %
    
    14.34
    %
    
    15.39
    %Return
      on average assets(3)
    
    
    1.03
    
    
    0.87
    
    
    0.77
    
    
    1.10
    
    
    1.04Net
      interest margin(4)
    
    
    3.77
    
    
    3.75
    
    
    4.29
    
    
    4.97
    
    
    5.53Efficiency
      ratio(5)
    
    
    50.57
    
    
    57.86
    
    
    62.85
    
    
    59.70
    
    
    59.86Loans
      and leases to deposits
    
    
    98.48
    
    
    91.35
    
    
    91.07
    
    
    94.44
    
    
    89.10**Asset
      Quality Data:**Nonperforming
      loans andleases
    
    $
    40,533
    
    $
    26,758
    
    $
    22,060
    
    $
    10,208
    
    $
    7,609Other
      real estate owned and repossessed assets
    
    
    6,441
    
    
    6,417
    
    
    7,644
    
    
    3,036
    
    
    1,657Total
      nonperforming assets
    
    
    46,974
    
    
    33,175
    
    
    29,704
    
    
    13,244
    
    
    9,266Nonperforming
      assets to total assets
    
    
    2.23
    %
    
    2.51
    %
    
    2.87
    %
    
    2.18
    %
    
    2.05
    %Nonperforming
      loans to total loans and leases
    
    
    2.92
    
    
    2.98
    
    
    2.87
    
    
    2.23
    
    
    2.44Allowance
      for loan and lease losses to nonperforming loans
    
    
    46.97
    
    
    35.11
    
    
    31.36
    
    
    44.21
    
    
    40.08Allowance
      for loan and lease losses to totalloans
    
    
    1.37
    
    
    1.04
    
    
    0.90
    
    
    0.98
    
    
    0.98Net
      charge-offs to average loans
    
    
    0.69
    
    
    0.47
    
    
    0.51
    
    
    0.24
    
    
    0.18**Capital
      Ratios:**Leverage
      ratio
    
    
    9.91
    %
    
    6.76
    %
    
    7.93
    %
    
    8.27
    %
    
    8.15
    %Tier
      1 risk-based capital
    
    
    12.73
    
    
    8.30
    
    
    8.63
    
    
    9.57
    
    
    10.86Total
      risk-based capital
    
    
    13.94
    
    
    11.60
    
    
    12.79
    
    
    15.26
    
    
    11.78Tangible
      common equity to tangible assets
    
    $
    7.54
    
    $
    4.93
    
    $
    5.54
    
    $
    7.87
    
    $
    7.98
 
 33
 
 __________
  (1)
    Extraordinary
      gains resulting from the negative goodwill on the acquisition of BankTrust
      and Banco Financiero in 2004 and 2002, respectively. The excess of the
      fair value of the assets acquired over the purchase price resulted in a
      negative goodwill of $5.7 million and 1.5 million, respectively. The
      negative goodwill of BankTrust was allocated between a $4.4 million
      extraordinary gain, $670,000 of the fair value of intangible assets, net
      of their tax effect, and the $627,000 of the fair value of the acquired
      furniture, fixtures and equipment. The negative goodwill of Banco
      Financiero was allocated between a $1.1 million extraordinary gain and the
      $456,000 of the fair value of the acquired furniture, fixtures and
      equipment.
 
 (2)
    Return
      on average common equity is determined by dividing net income before
      extraordinary gain by average common equity.
 
 (3)
    Return
      on average assets is determined by dividing net income before
      extraordinary gain by average assets.
 
 (4)
    Net
      interest margin is determined by dividing net interest income (fully
      taxable equivalent) by average interest-earning
assets.
 
 (5)
    The
      efficiency ratio is determined by dividing total noninterest expense by an
      amount equal to net interest income (fully taxable equivalent) plus
      noninterest income.
  **ITEM
7.** **Management’s
Discussion and Analysis of Financial Condition and Results of
Operation.**
  The
following discussion and analysis presents our consolidated financial condition
and results of operations for the years ended December 31, 2004, 2003 and 2002.
This discussion should be read together with the *“Selected
Consolidated Financial Data,”* our
consolidated financial statements and the notes related thereto which appear
elsewhere in this Annual Report on Form 10-K.
  **Executive
Overview**
  ***Introduction***
  We are a
diversified financial holding company headquartered in San Juan, Puerto Rico,
offering a broad array of financial services through our wholly owned banking
subsidiary, Eurobank, and our wholly owned insurance agency subsidiary,
EuroSeguros. As of December 31, 2004, we had, on a consolidated basis, total
assets of $2.1 billion, net loans and leases of $1.4 billion, total deposits of
$1.4 billion, and stockholders’ equity of $158.3 million. We currently operate
through a network of 21 branch offices located throughout Puerto Rico. On
May 3, 2004, we acquired all of the capital stock of The Bank & Trust
of Puerto Rico, a commercial bank headquartered in San Juan, Puerto Rico. On the
closing date, the estimated fair value of assets acquired was $522.0 million and
the estimated fair value of the deposits and other liabilities assumed was
$492.9 million.
  We were
incorporated on November 21, 2001 and became the parent bank holding company for
Eurobank on July 1, 2002. Our consolidated financial statements include the
results of operations of our wholly owned subsidiaries. Additionally, Eurobank
Statutory Trust I and Eurobank Statutory Trust II are special purpose vehicles
that were used to issue the trust preferred securities. It should be noted,
however, that in December 2003, the FASB issued a revision to Financial
Accounting Standards Board Interpretation No. 46, *Consolidation
of Variable Interest Entities,* that
required the deconsolidation of certain “variable interest entities,” such as
our statutory trust subsidiaries that issued the trust preferred securities.
Effective December 31, 2003, we adopted the provisions of FIN No. 46R,
requiring the deconsolidation of these trusts. As a result, our statutory trusts
are no longer consolidated with us or Eurobank. Commencing on December 31,
2003, we refer to the trust preferred securities we issued through Eurobank
Statutory Trust I and Eurobank Statutory Trust II as “Notes Payable to Statutory
Trusts” instead of trust preferred securities, as we had prior to that
date.
  34
 Over the
past three years, we have experienced significant balance sheet growth. Our
management team has implemented a strategy of building our core banking
franchise by focusing on commercial loans, business transaction accounts, our
lease financing business and acquisitions. We believe that this strategy will
increase recurring revenue streams, enhance profitability, broaden our product
and service offerings and continue to build stockholder value.
  In 2001
and 2002, we raised an aggregate of $46.4 million through the issuance of junior
subordinated debentures in connection with the trust preferred securities
issuances. We believe that the supplemental capital raised in connection with
the issuance of these securities will allow us to achieve and maintain our
status as a well-capitalized institution and to sustain our continued loan
growth.
  We
completed our initial public offering in August 2004 in which we sold 3,450,000
shares of our common stock at the initial offering price of $14.00 per share. In
September 2004, we sold an additional 517,500 shares in connection with the
exercise of the underwriters’ over-allotment option, also at the initial
offering price of $14.00 per share. The net proceeds that we received from the
offering plus the exercise of the underwriters’ over-allotment option, after
deducting offering expenses, including underwriting discounts and commissions,
were approximately $50.1 million.
  ***2004
Key Performance Indicators***
  We
believe the following were key
indicators of our performance and results of operations in 2004:
  ● our
total assets grew to $2.1 billion at the end of 2004, representing an increase
of 59.19%, from $1.3 billion at the end of 2003;
  ●  our total
loans and leases grew to $1.4 billion at the end of 2004, representing an
increase of 53.77%, from $890.0 million at the end of 2003;
  ●  our total
deposits grew to $1.4 billion at the end of 2004, representing an increase of
43.11%, from $984.5 million at the end of 2003;
  ●  our total
revenue grew to $112.6 million in 2004, representing an increase of 39.73%, from
$80.6 million in 2003; and
  ●  our net
income before extraordinary gain grew to $18.3 million in 2004, representing an
increase of 85.18%, from $9.9 million in 2003; and
  ●  we
recognized an extraordinary gain amounting to $4.4 million on the acquisition of
BankTrust.
  These
items, as well as other factors, contributed to the increase in net income for
2004 to $22.7 million from $9.9 million in 2003, or $1.30 per common share as
compared to $0.69 per common share for 2003, assuming dilution, and are
discussed in further detail throughout this *“Management’s
Discussion and Analysis of Financial Condition and Results of Operations”* section
of this Annual Report on Form 10-K.
  ***Critical
Accounting Policies***
  This
discussion and analysis of our financial condition and results of operations is
based upon our financial statements, which have been prepared in accordance with
generally accepted accounting principles in the United States. The preparation
of these consolidated financial statements requires management to make estimates
and judgments that affect the reported amounts of assets and liabilities,
revenues and expenses, and related disclosures of contingent assets and
liabilities at the date of our financial statements. Actual results may differ
from these estimates under different assumptions or conditions. The following is
a description of our significant accounting policies used in the preparation of
the accompanying consolidated financial statements.
  35
 *Loans
and Allowance for Loan and Lease Losses*
  Loans
that management has the intent and ability to hold for the foreseeable future,
or until maturity or payoff, are reported at their outstanding unpaid principal
balances adjusted by any charge-offs, unearned finance charges, allowance for
loan and lease losses, and net deferred nonrefundable fees or costs on
origination. The allowance for loan and lease losses is an estimate to provide
for probable collection losses in our loan and lease portfolio. Losses are
charged and recoveries are credited to the allowance account at the time a loss
is incurred or a recovery is received. The allowance for loan and lease losses
amounted to $19.0 million, $9.4 million, and $6.9 million as of December 31,
2004, 2003 and 2002, respectively. Losses charged to the allowance amounted to
$10.5 million, $5.1 million, and $3.4 million as of December 31, 2004, 2003 and
2002, respectively. Recoveries were credited to the allowance in the amounts of
$2.1 million, $1.1 million, and $421,000 for those same periods,
respectively.
  We follow
a consistent procedural discipline and account for loan and lease loss
contingencies in accordance with Statement of Financial Accounting Standards
(SFAS) No. 5, Accounting for Contingencies, and SFAS No. 114, Accounting by
Creditors for Impairment of a Loan, as amended by SFAS No. 118, Accounting by
Creditors for Impairment of a Loan — Income Recognition and
Disclosures.
  To
mitigate any difference between estimates and actual results relative to the
determination of the allowance for loan and lease losses, our loan review
department is specifically charged with reviewing monthly delinquency reports to
determine if additional reserves are necessary. Delinquency reports and analysis
of the allowance for loan and lease losses are also provided to senior
management and the Board of Directors on a monthly basis.
  The loan
review department evaluates significant changes in delinquency with regard to a
particular loan portfolio to determine the potential for continuing trends, and
loss projections are estimated and adjustments are made to the historical loss
factor applied to that portfolio in connection with the calculation of loss
reserves. Portfolio performance is also monitored through the monthly
calculation of the percentage of non-performing loans to the total portfolio
outstanding. A significant change in this percentage may trigger a review of the
portfolio and eventually lead to additional reserves. We also track the ratio of
net charge-offs to total portfolio outstanding.
  With the
exception of the commercial loans pool and loans secured by real estate with a
60% or lower loan-to-value, loans that are more than 90 days delinquent result
in an additional reserve. When commercial loans become 90 days delinquent, each
is subjected to full review by the loan review officer including, but not
limited to, a review of financial statements, repayment ability and collateral
held. Depending on the findings, our allowance may be increased. In connection
with this review, the loan review officer will determine what economic factors
may have led to the change in the client’s ability to service the obligation,
and this in turn may result in an additional review of a particular sector of
the economy. For additional information relating to how each portion of the
allowance for loan and lease losses is determined, see the section of this
discussion and analysis captioned *“Allowance
for Loan and Lease Losses.”*
  We
believe that our allowance for loan and lease losses is adequate; however,
regulatory agencies, including the Commissioner of Financial Institutions of
Puerto Rico and the FDIC, as an integral part of their examination process,
periodically review our allowance for loan and lease losses and may from time to
time require us to reclassify our loans and leases or make additional provisions
to our allowance for loan and lease losses.
  We
classify loans as nonperforming when they become 90 days past due. Nonperforming
loans amounted to $40.5 million, $26.8 million and $22.1 million as of December
31, 2004, 2003 and 2002, respectively.
  *Servicing
Assets*
  We have
no contracts to service loans for others, except for servicing rights retained
on lease sales. The total cost of loans or leases to be sold with servicing
assets retained is allocated to the servicing assets and the loans or leases
(without the servicing assets), based on their relative fair values. Servicing
assets are amortized in proportion to, and over the period of, estimated net
servicing income. In addition, we assess capitalized servicing assets for
impairment based on the fair value of those assets.
  36
 To
estimate the fair value of servicing assets we consider prices for similar
assets and the present value of expected future cash flows associated with the
servicing assets calculated using assumptions that market participants would use
in estimating future servicing income and expense, including discount rates,
anticipated prepayment and credit loss rates. For purposes of evaluating and
measuring impairment of capitalized servicing assets, we evaluate separately
servicing retained for each loan portfolio sold. The amount of impairment
recognized, if any, is the amount by which the capitalized servicing assets
exceed its estimated fair value. Impairment is recognized through a valuation
allowance with changes included in net income for the period in which the change
occurs. The key assumptions we utilized in measuring the servicing assets at the
dates the sales were completed during the year ended December 31, 2004, were as
follows: prepayment rate of 15.12%; weighted average live (in years) of 3.70;
and a discount rate of 8.68%. The key assumptions we utilized in measuring the
servicing assets at the dates the sales completed during the year ended
December 31, 2003, were as follows: prepayment rate of 5.50%; weighted
average life (in years) of 3.90 to 4.03; and a discount rate of 9.35% to 9.95%.
Impairment analyses were performed in December 2004 by an independent third
party and it was determined that there was an impairment, which resulted in an
adjustment of approximately $214,000 on the servicing assets acquired from
BankTrust. Servicing assets are included as part of other assets in the balance
sheets. Servicing assets recorded amounted to $3.6 million, and $3.0 million as
of December 31, 2004 and 2003, respectively. Servicing assets in 2004 increased
as a result of sale of loans made during the year and our acquisition of
BankTrust. As of December 31, 2004, servicing assets acquired from BankTrust
amounted to approximately $615,000. There were no servicing assets recorded as
of December 31, 2002.
  *Other
Real Estate Owned and Repossessed Assets*
  Other
real estate owned, or OREO, and repossessed assets, normally obtained through
foreclosure or other workout situations, are initially recorded at the lower of
fair value or book value at the date of foreclosure, establishing a new cost
basis. Any resulting loss is charged to the allowance for loan and lease losses.
An appraisal of other real estate properties and repossessed assets is made
periodically after its acquisition, and comparison between the appraised value
and the carrying value is performed. Additional declines in value after
acquisition, if any, are charged to current operations. Other real estate owned
amounted to $2.9 million, $2.8 million, and $2.0 million as of December 31,
2004, 2003 and 2002, respectively. Other repossessed assets amounted to $3.6
million, $3.6 million and $5.7 million for those same periods,
respectively.
  **Results
of Operations as of and for the Years Ended December 31, 2004, 2003 and
2002**
  ***Net
Interest Income and Net Interest Margin***
  Net
interest income is the difference between interest income, principally from
loan, lease and investment securities portfolios, and interest expense,
principally on customer deposits and borrowings. Net interest income is our
principal source of earnings. Changes in net interest income result from changes
in volume, spread and margin. Volume refers to the average dollar level of
interest-earning assets and interest-bearing liabilities. Spread refers to the
difference between the average yield on interest-earning assets and the average
cost of interest-bearing liabilities. Margin refers to net interest income
divided by average interest-earning assets, and is influenced by the level and
relative mix of interest-earning assets and interest-bearing
liabilities.
  Net
interest income was $62.0 million during the year ended December 31, 2004, as
compared to $39.6 million during the year ended December 31, 2003 and $29.8
million during the year ended December 31, 2002, representing an increase of
$22.4 million, or 56.6%, in 2004 and a increase of $9.8 million, or 32.7%, in
2003. These increases were primarily the result of higher volumes of
interest-earning assets. However, the level of increase was partially offset by
a decline in our net interest margin, mainly on the year 2003. Our net interest
margin increased to 3.77% for the year ended December 31, 2004, as compared to
3.75% for the year ended December 31, 2003, and 4.29% during 2002. Our net
interest spread also increased to 3.47% in 2004, from 3.41% in 2003, and from
3.73% in 2002. The increase between year ended December 31, 2004 and 2003 was
mainly attributable to increased volume of interest earnings assets and
liabilities combined with the rises in interest rates experienced since the
second quarter of 2004. Because the rises in interest rates experienced during
2004 began in the second quarter, the positive impact on year-to-date ratios is
reduced when comparing the years ended December 31, 2004 and 2003. During 2003
and 2002, the Federal Reserve Board’s interest rate cuts deteriorated our net
interest margin due to our asset sensitive position.
  37
 Our
average interest-earning assets were $1.7 billion in 2004, as compared with
$1.1 billion in 2003 and $719.7 million in 2002, representing increases of
56.3% in 2004 and 51.3% in 2003. Average net loans were $1.2 billion in
2004, compared to $833.6 million in 2003 and $572.8 million in 2002,
representing increases of 44.0% and 45.5% in 2004 and 2003, respectively. The
average interest yield we received for interest-earning assets decreased to
6.37% in 2004, from 6.80% in 2003, and from 7.94% in 2002. During 2004, the
Federal Reserve Board’s interest rate rises positively impacted average yields
on our commercial and construction loans since approximately 74% and 92%,
respectively, were variable rate loans. However, due to the market competition,
decreases in the yields on the consumer and leasing loans outpaced yield
increases on the commercial and construction loans portfolios during the same
period. In addition, during 2004, the average interest yield we received for
other investment securities was impacted by the maturity of high-yield
investments at the end of 2003. The Federal Reserve Board’s interest rate cuts
in June 2003 and November 2002 lowered the average yields on our
interest-earning assets to 6.80% in 2003 from 7.94% in 2002. Prime interest rate
reductions in 2003 and 2002 offset most of the improvements in portfolio
composition that would have otherwise resulted. However, due to the growth of
interest-earning assets in 2004 and 2003 (attributable in part to our
acquisition of The Bank & Trust of Puerto Rico on May 3, 2004 and Banco
Financiero de Puerto Rico on December 15, 2002), our total interest income
significantly increased by 44.7% to $103.5 million in 2004 and by 30.1% to
$71.5 million in 2003.
  Average
interest-bearing liabilities also increased by 55.8% to $1.5 billion in
2004, compared to $979.6 million in 2003, after increasing by 57.1% from
$623.5 million in 2002. Total interest expense increased by 29.9% to $41.5
million in 2004, compared to $31.9 million, after increasing by 27.1% from
$25.1 million in 2002. These increases in our interest expense are due
mainly to the significant growth of our deposit portfolio, which, in turn, is
attributable in part to our acquisition of BankTrust and Banco Financiero. The
average interest rate we paid for interest-bearing liabilities decreased to
2.90% in 2004, from 3.39% in 2003, and from 4.21% in 2002. During 2003, the
decline in our average interest rate was influenced by the fact that the prime
interest rate during that period was the lowest it has been in 45 years.
  The
following tables set forth, for the periods indicated, our average balances of
assets, liabilities and stockholders’ equity, in addition to the major
components of net interest income and our net interest margin. Net loans and
leases shown on these tables include nonaccrual loans although interest accrued
but not collected on these loans is placed in nonaccrual status and reversed
against interest income.
 
 **Year
      Ended December 31,****2004**
    
    **2003**
    
    **2002****Average
      Balance**
    
    **Interest**
    
    **Average
      Rate/ Yield****(1)**
    
    **Average
      Balance**
    
    **Interest**
    
    **Average
      Rate/ Yield****(1)**
    
    **Average
      Balance**
    
    **Interest**
    
    **Average
      Rate/ Yield****(1)****(Dollars
      in thousands)**ASSETS:Interest-earning
      assets:Net
      loans and leases(2)
    
    $
    1,200,445
    
    $
    90,873
    
    
    7.61
    %
    $
    833,557
    
    $
    64,952
    
    
    7.82
    %
    $
    572,750
    
    $
    48,959
    
    
    8.58
    %Securities
      of U.S. government agencies
    
    
    433,456
    
    
    11,180
    
    
    3.53
    
    
    187,070
    
    
    5,135
    
    
    3.85
    
    
    97,602
    
    
    4,858
    
    
    6.84Other
      investment securities
    
    
    18,116
    
    
    602
    
    
    4.34
    
    
    16,133
    
    
    682
    
    
    5.29
    
    
    7,336
    
    
    382
    
    
    6.45Puerto
      Rico government obligations
    
    
    7,515
    
    
    306
    
    
    5.66
    
    
    4,679
    
    
    192
    
    
    5.70
    
    
    2,294
    
    
    102
    
    
    6.16Securities
      purchased under agreements to resell and federal funds
sold
    
    
    29,556
    
    
    380
    
    
    1.29
    
    
    24,379
    
    
    281
    
    
    1.17
    
    
    22,168
    
    
    366
    
    
    1.66Interest-earning
      deposits
    
    
    12,754
    
    
    135
    
    
    1.06
    
    
    22,957
    
    
    274
    
    
    1.19
    
    
    17,581
    
    
    301
    
    
    1.76Total
      interest-earning assets
    
    $
    1,701,842
    
    $
    103,476
    
    
    6.37
    %
    $
    1,088,775
    
    $
    71,516
    
    
    6.80
    %
    $
    719,731
    
    $
    54,968
    
    
    7.94
    %Total
      noninterest-earning assets
    
    
    71,084
    
    
    
    
    
    
    
    
    52,075
    
    
    
    
    
    
    
    
    35,953TOTAL
      ASSETS
    
    $
    1,772,926
    
    
    
    
    
    
    
    $
    1,140,850
    
    
    
    
    
    
    
    $
    755,684LIABILITIES
      AND STOCKHOLDERS’ EQUITY:Interest-bearing
      liabilities:Money
      market deposits
    
    $
    62,346
    
    $
    1,335
    
    
    2.17
    %
    $
    47,896
    
    $
    1,294
    
    
    2.71
    %
    $
    26,843
    
    $
    941
    
    
    3.59
    %NOW
      deposits
    
    
    40,931
    
    
    738
    
    
    1.81
    
    
    26,579
    
    
    570
    
    
    2.15
    
    
    18,939
    
    
    569
    
    
    3.02Savings
      deposits
    
    
    261,660
    
    
    6,217
    
    
    2.38
    
    
    197,242
    
    
    5,811
    
    
    2.95
    
    
    98,408
    
    
    3,471
    
    
    3.53Time
      certificates of deposit in denominations of $100,000 or
    more
    
    
    599,660
    
    
    19,409
    
    
    3.38
    
    
    392,611
    
    
    14,396
    
    
    3.86
    
    
    288,711
    
    
    12,383
    
    
    4.51Other
      time deposits
    
    
    192,046
    
    
    5,610
    
    
    2.92
    
    
    161,811
    
    
    5,313
    
    
    3.29
    
    
    102,230
    
    
    4,103
    
    
    4.01Other
      borrowings
    
    
    369,064
    
    
    8,172
    
    
    2.73
    
    
    153,424
    
    
    4,538
    
    
    3.27
    
    
    88,386
    
    
    3,657
    
    
    4.65Total
      interest-bearing liabilities
    
    $
    1,525,707
    
    $
    41,481
    
    
    2.90
    %
    $
    979,563
    
    $
    31,922
    
    
    3.39
    %
    $
    623,517
    
    $
    25,124
    
    
    4.21
    %Noninterest-bearing
      liabilities:Noninterest-bearing
      deposits
    
    
    119,847
    
    
    
    
    
    
    
    
    92,643
    
    
    
    
    
    
    
    
    73,189Other
      liabilities
    
    
    19,234
    
    
    
    
    
    
    
    
    8,740
    
    
    
    
    
    
    
    
    7,844Total
      noninterest-bearing liabilities
    
    
    139,081
    
    
    
    
    
    
    
    
    101,383
    
    
    
    
    
    
    
    
    81,033STOCKHOLDERS’
      EQUITY
    
    
    108,138
    
    
    
    
    
    
    
    
    59,904
    
    
    
    
    
    
    
    
    51,134TOTAL
      LIABILITIES AND STOCKHOLDERS’ EQUITY
    
    $
    1,772,926
    
    
    
    
    
    
    
    $
    1,140,850
    
    
    
    
    
    
    
    $
    755,684Net
      interest income(3)
    
    
    
    
    $
    61,995
    
    
    
    
    
    
    
    $
    39,594
    
    
    
    
    
    
    
    $
    29,844Net
      interest spread(4)
    
    
    
    
    
    
    
    
    3.47
    %
    
    
    
    
    
    
    
    3.41
    %
    
    
    
    
    
    
    
    3.73
    %Net
      interest margin(5)
    
    
    
    
    
    
    
    
    3.77
    %
    
    
    
    
    
    
    
    3.75
    %
    
    
    
    
    
    
    
    4.29
    %
 
 38
 __________
 (1)
    Yields
      on tax-exempt securities, loans and leases are calculated on a fully
      taxable equivalent basis assuming a 39% tax rate.
  (2)
    Loan
      fees (costs) have been included in the calculation of interest income.
      Loan fees were approximately $8.3 million, $6.7 million and $5.4 million
      for the years ended December 31, 2004, 2003 and 2002, respectively. Loans
      are net of the allowance for loan and lease losses, deferred fees,
      unearned income, and related direct costs.
  (3)
    Net
      interest income on a tax equivalent basis was $64.1 million, $40.9 million
      and $30.9 million for the years ended December 31, 2004, 2003 and 2002,
      respectively.
  (4)
    Represents
      the average rate earned on interest-earning assets less the average rate
      paid on interest-bearing liabilities on a fully taxable equivalent
      basis.
  (5)
    Represents
      net interest income on a fully taxable equivalent basis as a percentage of
      average interest-earning assets.
  The
following table sets forth, for the periods indicated, the dollar amount of
changes in interest earned and paid for interest-earning assets and
interest-bearing liabilities and the amount of change attributable to changes in
average daily balances (volume) or changes in average daily interest rates
(rate). All changes in interest owed and paid for interest-earning assets and
interest-bearing liabilities are attributable to either volume or rate. The
impact of changes in the mix of interest-earning assets and interest-bearing
liabilities is reflected in our net interest income.
  **Year
      Ended December 31,****2004
      Over 2003**
      **Increases/(Decreases)**
      **Due
      to Change in**
    
    **2003
      Over 2002**
      **Increases/(Decreases)**
      **Due
      to Change in****Volume**
    
    **Rate**
    
    **Net**
    
    **Volume**
    
    **Rate**
    
    **Net****(In
      thousands)**INTEREST
      EARNED ON:Net
      loans(1)
    
    $
    28,588
    
    $
    (2,667
    )
    $
    25,921
    
    $
    22,294
    
    $
    (6,301
    )
    $
    15,993Securities
      of U.S. government agencies
    
    
    6,763
    
    
    (718
    )
    
    6,045
    
    
    4,453
    
    
    (4,176
    )
    
    277Other
      investment securities
    
    
    84
    
    
    (164
    )
    
    (80
    )
    
    458
    
    
    (158
    )
    
    300Puerto
      Rico government obligations
    
    
    116
    
    
    (2
    )
    
    114
    
    
    106
    
    
    (16
    )
    
    90Securities
      purchased under agreements to resell and federal funds
sold
    
    
    60
    
    
    39
    
    
    99
    
    
    37
    
    
    (122
    )
    
    (85
    )Interest-earning
      deposits
    
    
    (122
    )
    
    (17
    )
    
    (139
    )
    
    92
    
    
    (119
    )
    
    (27
    )Total
      interest-earning assets
    
    $
    35,489
    
    $
    (3,529
    )
    $
    31,960
    
    $
    27,440
    
    $
    (10,892
    )
    $
    16,548INTEREST
      PAID ON:Money
      market deposits
    
    $
    390
    
    $
    (349
    )
    $
    41
    
    $
    738
    
    $
    (385
    )
    $
    353NOW
      deposits
    
    
    308
    
    
    (140
    )
    
    168
    
    
    230
    
    
    (229
    )
    
    1Savings
      deposits
    
    
    1,898
    
    
    (1,492
    )
    
    406
    
    
    3,486
    
    
    (1,146
    )
    
    2,340Time
      certificates of deposit in denominations of $100,000 or
    more
    
    
    7,592
    
    
    (2,579
    )
    
    5,013
    
    
    4,456
    
    
    (2,443
    )
    
    2,013Other
      time deposits
    
    
    993
    
    
    (696
    )
    
    297
    
    
    2,391
    
    
    (1,181
    )
    
    1,210Other
      borrowings
    
    
    6,378
    
    
    (2,744
    )
    
    3,634
    
    
    2,691
    
    
    (1,810
    )
    
    881Total
      interest-bearing liabilities
    
    $
    17,559
    
    $
    (8,000
    )
    $
    9,559
    
    $
    13,992
    
    $
    (7,194
    )
    $
    6,798Net
      interest income
    
    $
    17,930
    
    $
    4,471
    
    $
    22,401
    
    $
    13,448
    
    $
    (3,698
    )
    $
    9,750
 
 __________
 (1)
    Loan
      fees (costs) have been included in the calculation of interest income.
      Loan fees were approximately $8.3 million, $6.7 million and $5.4 million
      for the years ended December 31, 2004, 2003 and 2002, respectively. Loans
      are net of the allowance for loan and lease losses, deferred fees,
      unearned income, and related direct costs.
  39
 ***Provision
for Loan and Lease Losses***
  We
determine a provision for loan and lease losses that we consider sufficient to
maintain an allowance to absorb probable losses inherent in our portfolio as of
the balance sheet date. For additional information concerning this
determination, see the section of this discussion and analysis captioned *“Allowance
for Loan and Lease Losses.”*
  Our
provision for loan and lease losses increased to $7.1 million in 2004, from
$6.5 million in 2003, and from $3.4 million in 2002. These increases
in our provisions were mainly due to the growth of our total loan and lease
portfolio, resulting in an increase in nonperforming loans and leases, and an
increase in our net charges-offs to $8.4 million in 2004, from
$4.0 million in 2003, and $3.0 million 2002. The increase in our
nonperforming loans and net charge-offs was also, in part, a result of our
acquisition of The Bank & Trust of Puerto Rico on May 3, 2004 and Banco
Financiero de Puerto Rico on December 15, 2002. We acquired a $336.3 million and
$72.2 million loan portfolio as a result of the BankTrust and Banco
Financiero mergers, respectively.
  Steady
growth in our commercial lending and automobile lease financing portfolios has
dictated continual increases in our provision for loan and lease losses. In the
other lending categories, such as consumer lending, residential construction
lending and mortgage lending, growth has not been robust. We believe existing
reserve levels are appropriate. While our allowance for loan and lease losses is
established in different portfolio components, we maintain an allowance that we
believe is sufficient to absorb all credit losses inherent in our portfolio.
  In order
to maintain an adequate level of our allowance for loan and lease losses, we
monitor our portfolio performance on a monthly basis and determine the
additional provision for loan and lease losses. For the past three years, our
provisions have increased in a uniform manner, in concert with the increases and
losses in our commercial loan portfolio and our lease portfolio. Risk levels and
losses in these portfolios have been fairly constant. Individual credits that
are less than satisfactory or delinquent are reviewed on an ongoing basis to
determine whether additional provisions are necessary.
  Because
we do not have any major industry concentrations, our monthly determination of
our provision for loan and lease losses is not impacted by such industry
concentrations.
  ***Noninterest
Income***
  The
following tables set forth the various components of our noninterest income for
the periods indicated:
  **Year
      Ended December 31,****2004**
    
    **2003**
    
    **2002**Amount
    
    %
    
    Amount
    
    %
    
    Amount
    
    %**(Dollars
      in thousands)**Service
      charges and other fees
    
    $
    8,057
    
    
    88.6
    %
    $
    5,456
    
    
    60.3
    %
    $
    4,331
    
    
    107.7
    %Gain
      on sale of loans and leases, net
    
    
    1,395
    
    
    15.3
    
    
    3,547
    
    
    39.2
    
    
    —
    
    
    —Gain
      on sale of securities, net
    
    
    —
    
    
    —
    
    
    707
    
    
    7.8
    
    
    —
    
    
    —Loss
      on sale of other real estate owned, repossessed assets, andon
      disposition of other assets, net
    
    
    (359
    )
    
    (3.9
    )
    
    (663
    )
    
    (7.3
    )
    
    (311
    )
    
    (7.7
    )Total
      noninterest income
    
    $
    9,093
    
    
    100.0
    %
    $
    9,047
    
    
    100.0
    %
    $
    4,020
    
    
    100.0
    %
 
 Our total
noninterest income was $9.1 million in 2004, as compared to $9.0 million in
2003, and $4.0 million in 2002, representing an annual growth rate of 0.5% in
2004 and 125.0% in 2003. Noninterest income represented approximately 0.5%, 0.8%
and 0.5% of average assets in 2004, 2003 and 2002, respectively.
  As a
result of our efforts to diversify our revenue sources, we currently earn
noninterest income from various sources. Our largest noninterest income source
is service charges, primarily on deposit accounts, representing 88.6%, 60.3% and
107.7% of total noninterest income in 2004, 2003 and 2002, respectively. This
income source increased to $8.1 million in 2004, from $5.5 million in 2003, and
$4.3 million in 2002. These increases were primarily due to an increase in our
number of transactional and savings accounts.
  40
 Gain on
the sale of loans and leases of $1.4 million was the second largest source
of noninterest income in 2004, as compared to $3.5 million in 2003, and $0 in
2002. Income from gain on sale of loans and leases as a percentage of total
noninterest income was 15.3%, 39.2% and 0.0% in 2004, 2003 and 2002,
respectively. This source of noninterest income is derived primarily from the
sale of lease financing contracts and mortgage loans. During November 2004 and
June 2003, we sold lease financing contracts on a limited recourse basis to a
third party with carrying values of $30.0 million, in each month, and
$20.0 million in December 2003. We retained servicing responsibilities for
the lease financing contracts sold. We surrendered control of the lease
financing receivables, as defined by SFAS No. 140, Accounting for Transfers
and Servicing of Financial Assets and Extinguishment of Liabilities, and
accounted for these transactions as sales, recognizing net gains of
approximately $978,000 for the November 2004 sale, $1.8 million for the
June 2003 sale and $1.0 million for the December 2003 sale. Also, during
2004, we sold $28.9 million in mortgage loans to other financial institutions,
as compared to sales of $42.8 million in September 2003. We did not retain the
servicing rights on these mortgage loans and we accounted for this transaction
as a sale, resulting in a gain of approximately $309,000 and $700,000 for those
same periods. We did not sell any of our mortgage loans in 2002. In addition,
during 2004, we sold $5.4 million in mortgage and consumer loans, which were
acquired from BankTrust and serviced by another entity. We accounted for this
transaction as a sale resulting in a gain of approximately $108,000. While the
estimated losses on the limited recourse obligations assumed in the sale of our
lease financing contracts is not significant, we established an allowance of
$210,000 on November 30, 2004, $120,000 on June 20, 2003 and $110,000 on
December 31, 2003 and have included such estimates in the other liabilities
section of our balance sheets for the years ended December 31, 2004 and
2003.
  The third
largest source of noninterest income during 2003 was the net gain on the sale of
securities. During the year ended December 31, 2003, proceeds from sales of
investment securities were approximately $83.2 million, with approximately
$707,000 in gains realized. There were no sales of investment securities during
2004 and 2002.
  Our final
component of net noninterest income is the net loss on the sale of our OREO,
repossessed assets and other assets. We experienced net losses in this component
of $359,000, $663,000 and $311,000 for the years ended December 31, 2004,
2003 and 2002, respectively. The net loss on the sale of our OREO, repossessed
assets and other assets decreased by $304,000, or 45.9%, in 2004. This decrease
was mainly due to our decision to evaluate in a more aggressive way our
repossessed assets, which increased charge-offs at the date of repossession. The
loss on the sale of our OREO, repossessed assets and other assets increased by
113.2% in 2003, as compared to 2002. In 2003, the increase of $352,000, or
113.2%, was attributable primarily to an increased volume of losses in our lease
financing portfolio as such portfolio has increased in size, which created net
losses on the sale of repossessed automobiles and equipment totaling $655,000
and $305,000 for the years 2003 and 2002, respectively. Also, as our volume of
lease financing contracts has increased, in order to avoid building up our
inventory of repossessed automobiles, we have been more aggressive in our
disposition efforts.
  In 2004,
the loss on the sale of OREO as a percentage of the loan balance at the date of
repossession was 5.1%, or $37,000, over three properties sold with a book value
of approximately $724,000. There were no losses on the sale of OREO for 2003 and
2002.
  41
 ***Noninterest
Expense***
  The
following tables set forth a summary of noninterest expenses for the periods
indicated:
  **Year
      Ended December 31,****2004**
    
    **2003**
    
    **2002**Amount
    
    %
    
    Amount
    
    %
    
    Amount
    
    %**(Dollars
      in thousands)**Salaries
      and employee benefits
    
    $
    19,194
    
    
    51.7
    %
    $
    15,434
    
    
    53.4
    %
    $
    11,943
    
    
    54.4
    %Occupancy
      and equipment
    
    
    6,943
    
    
    18.7
    
    
    5,910
    
    
    20.5
    
    
    4,592
    
    
    20.9Professional
      services, including directors’ fees
    
    
    2,196
    
    
    5.9
    
    
    1,402
    
    
    4.8
    
    
    1,055
    
    
    4.8Office
      supplies
    
    
    1,033
    
    
    2.8
    
    
    984
    
    
    3.4
    
    
    747
    
    
    3.4Other
      real estate owned and other repossessed assets expenses
    
    
    1,060
    
    
    2.9
    
    
    693
    
    
    2.4
    
    
    516
    
    
    2.4Promotion
      and advertising
    
    
    545
    
    
    1.5
    
    
    511
    
    
    1.8
    
    
    357
    
    
    1.6Lease
      expenses
    
    
    687
    
    
    1.9
    
    
    565
    
    
    2.0
    
    
    247
    
    
    1.1Insurance
    
    
    804
    
    
    2.2
    
    
    628
    
    
    2.2
    
    
    385
    
    
    1.8Municipal
      and other taxes
    
    
    1,254
    
    
    3.4
    
    
    725
    
    
    2.5
    
    
    498
    
    
    2.3Commissions
      and service fees credit and debit cards
    
    
    1,206
    
    
    3.3
    
    
    1,051
    
    
    3.6
    
    
    765
    
    
    3.5Other
      noninterest expense
    
    
    2,103
    
    
    5.7
    
    
    972
    
    
    3.4
    
    
    829
    
    
    3.8Total
      noninterest expense
    
    $
    37,025
    
    
    100.0
    %
    $
    28,875
    
    
    100.0
    %
    $
    21,934
    
    
    100.0
    %
 Our total
noninterest expense increased to $37.0 million in 2004, from $28.9 million
in 2003 and $21.9 million in 2002. This represents a year over year
increase in noninterest expense of 28.2% for 2004 and 31.6% for 2003. These
increases can be attributed to the expanded personnel and occupancy costs
associated with our business growth, our acquisition of Banco Financiero and
BankTrust, and the recent opening of our five new branch offices (Hatillo in
2004, Mayagüez in 2003, Humacao and Ponce (2) in 2002). Our expansion of
various groups, including EuroLease, our construction lending activities and our
trust and wealth management group, also contributed to the increase in our total
noninterest expense. Due to our continuing efforts to minimize noninterest
expense, however, noninterest expenses as a percentage of average assets
declined to 2.1% in 2004, from 2.5% in 2003, and from 2.9% in 2002. We believe
that our efforts to expand without comparative increases in our number of
employees, in addition to the effect of the Banco Financiero and BankTrust
acquisitions, have improved our operational efficiency. Our efficiency
improvement is evidenced by the decrease in our efficiency ratio to 50.6% in
2004, 57.9% in 2003 and 62.9% in 2002.
  We
anticipate that the overall volume of our noninterest expense will continue to
increase as we grow. However, we remain committed to controlling costs and
efficiency and expect to moderate these increases relative to our revenue
growth.
  Salaries
and employee benefit expenses increased to $19.2 million in 2004, from $15.4
million in 2003. This increase was mainly attributable to an increase of
approximately $2.0 million in salary adjustments and expanded personnel for
business growth, an increase of approximately $1.3 million resulting from our
BankTrust acquisition, an increase of approximately $321,000 related to
employees benefits and activities, and an increase of approximately $131,000
resulting from a new branch opening at Hatillo, Puerto Rico.
  Salaries
and employee benefit expenses increased to $15.4 million in 2003, from $11.9
million in 2002. This increase was mainly attributable to an increase of
approximately $1.9 million in expanded personnel for business growth in lease
financing, construction and mortgage lending, an increase of approximately
$392,000 resulting from our Banco Financiero acquisition, and an increase of
approximately $266,000 resulting from new branch openings.
  Occupancy
and equipment expenses increased to $6.9 million in 2004, from $5.9 million in
2003. This increase was mainly attributable to an increase of approximately
$327,000 in occupancy expenses related to business growth in lease financing and
construction and mortgage lending, an increase of approximately $255,000
resulting from new branch openings, and an increase of approximately $202,000
related to support departments, and an increase of approximately $110,000
resulting from our BankTrust acquisition.
  Occupancy
and equipment expenses increased to $5.9 million in 2003, from $4.6 million in
2002. This increase was mainly attributable to an increase of approximately
$461,000 in occupancy expenses related to business growth in lease financing and
construction and mortgage lending, an increase of approximately $428,000
resulting from our Banco Financiero acquisition, and an increase of
approximately $193,000 resulting from new branch openings.
  42
 Professional
and directors’ fees were $2.2 million, $1.4 million and $1.1 million, or
6.0%, 4.8% and 4.8% of total noninterest expenses, in 2004, 2003 and 2002,
respectively. These increases are attributable primarily to the growth of our
business and also to legal, audit, consulting and professional fees related to
our capital raising efforts, acquisitions, becoming a publicly-traded company
and our other actions to implement our strategic plan.
  Office
supplies expenses were $1.0 million, $984,000 and $747,000, or 2.8%, 3.4% and
3.4% of our total noninterest expenses, in 2004, 2003 and 2002, respectively.
These increases are attributable primarily to the expansion of our branch
network and franchise.
  Our
expenses related to OREO and repossessed assets were $1.1 million, $693,000 and
$516,000, or 2.9%, 2.4% and 2.4% of total noninterest expenses in 2004, 2003 and
2002, respectively. This increase is attributable primarily to the growth of our
loan and lease portfolio, and in particular, our lease financing portfolio.
Repossessed assets are initially recorded at the lower of fair value or book
value upon repossession and resulting losses are charged to the allowance for
loan and lease losses. These assets are then periodically evaluated and recorded
at fair value. Any subsequent decline in the fair value is charged to current
operations.
  Insurance
expenses were $804,000, $628,000 and $385,000, or 2.2%, 2.2% and 1.8% of our
total noninterest expense in 2004, 2003 and 2002, respectively. Increases in
insurance expenses are attributable primarily to the expansion of our branch
network, becoming a publicly-traded company and our general growth.
  Municipal
and other taxes increased to $1.2 million in 2004, from $725,000 in 2003 and
$498,000 in 2002. These increases are directly attributable to our asset growth.
  Commissions
and service fees on credit and debit cards increased to $1.2 million in 2004,
from $1.1 million in 2003 and $765,000 in 2002. This increase is
attributable primarily to the increase in the size of our commercial loan
portfolio, which provides us with merchant point-of-sale business.
  Other
noninterest expenses also increased annually during the prior three-year period,
however, these increases were related in large part to our asset growth over
this period. Due in part to management’s commitment to overhead control, these
expense increases were significantly outpaced by our revenue growth rate.
  We also
expect our noninterest expense to increase as a result of our becoming a
publicly-traded company. Specifically, we expect increases in audit fees, legal
fees associated with public reporting, printing costs, proxy solicitation costs,
additional directors, and officers’ insurance cost and other expenses generally
associated with publicly-traded companies.
  ***Provision
for Income Taxes***
  Puerto
Rico income tax law does not provide for the filing of a consolidated tax
return; therefore, the income tax expense reflected in our consolidated income
statement is the sum of our income tax expense and the income tax expenses of
our individual subsidiaries. Our revenues are generally not subject to U.S.
federal income tax.
  Income
tax expense is the sum of two components: current tax expense and deferred tax
expense (benefit). Current tax expense is calculated by applying our current tax
rate to taxable income. The deferred tax expense (benefit) reflects the net tax
effects of temporary differences between the carrying amounts of assets and
liabilities for financial reporting purposes and the amounts used for income tax
purposes. Deferred income tax assets and liabilities represent the tax effects,
based on current tax law, of future deductible or taxable amounts attributable
to events that have been recognized in our financial statements.
  For the
year ended December 31, 2004, we recorded an $8.7 million income tax expense, as
compared to $3.4 million in 2003, and $2.7 million in 2002. Our current income
tax expense increased to $3.9 million in 2004, from $3.0 million in 2003 and
from $2.4 million in 2002, representing an increase of 33.4% in 2004 and 22.3%
in 2003. These increases were due to the increase in our income before taxes of
102.5% in 2004 and 55.3% in 2003, but primarily due to a decrease in our exempt
income as a percentage of total income. Our deferred tax expense increased to
$4.7 million in 2004, as compared to $473,000 in 2003 and $304,000 in 2002. The
increase in our deferred tax expense is due to the increase in the deferred tax
assets, as further explained below. Our income tax provision is lower than a
provision based on the statutory tax rate applicable to Eurobank, which is
39.0%, because we have interest income from certain investments that is exempt
from Puerto Rico income tax. Exempt interest relates mostly to interest earned
on securities held by EBS Overseas.
  43
 At
December 31, 2004, 2003 and 2002, we had net deferred tax assets of $12.5
million, $4.0 million and $3.7 million, respectively. The net increase of $8.5
during 2004 was mainly due to an increase of $10.8 million in our deferred tax
asset offset by an increase of $2.3 million in our deferred tax liability. The
increment in the deferred tax assets was mainly due to the tax effect of the net
operating losses acquired from BankTrust and the increase in the allowance for
loan and lease losses. The increment in our deferred tax liability was mainly
due to the increase in the deferred loan costs, the servicing assets and the
loans market value allowance.
  In
assessing the realizability of deferred tax assets, management considers whether
it is more likely than not that some portion or all of the deferred tax assets
will not be realized. The ultimate realization of deferred tax assets is
dependent upon the generation of future taxable income during the periods in
which those temporary differences become deductible. Management considers the
scheduled reversal of deferred tax liabilities, projected future taxable income,
and tax planning strategies in making this assessment. In order to fully realize
the deferred tax asset that resulted from our acquisition of Banco Financiero
and BankTrust, we will need to generate future taxable income of approximately
$5.2 million and $14.7 million related to their operations, respectively,
prior to the expiration of the net operating loss carryforwards through years
2006 and 2011, respectively. Such operations yielded approximately
$10.0 million of taxable income during 2004 and considering economies of
scale to be achieved from the merger and projected future taxable income over
the periods in which the deferred tax assets are deductible, we believe it is
more likely than not that the benefits of these deductible differences at
December 31, 2004 will be realized. The amount of the deferred tax asset
considered realizable, however, could be reduced in the near term if estimates
of future taxable income during the carryforward period are
reduced.
  At
December 31, 2004, the Bank has net operating loss carryforwards for income
tax purposes of approximately $19.9 million, which are available to offset
future taxable income of the former Banco Financiero and BankTrust operations,
if any, through 2011. Please refer to *“Note
21 - Income Taxes”* to our
2004 consolidated financial statements for further details.
  In
February 2005, the Puerto Rico Treasury Department (PRTD) completed an
examination of Eurobank’s income tax return for the year ended December 31,
2000. The PRTD assessed an income tax deficiency of $688,938, which included
$193,933 of accrued interest. The deficiency relates to a portion of the net
operating losses acquired as a result of Banco del Comercio acquisition, which
was not adjusted in the year 2000 by the Bank’s exempt income net of related
expenses. Such deficiency was formally assessed by the PRTD on March 10, 2005,
and recorded as of December 31, 2004. Because our earnings
release for the fourth quarter and year ended 2004 was issued in January 2005,
the assessment of the income tax deficiency in March 2005 will have an
immaterial effect on a  number of disclosures in our 2004 earnings
release.
  ***Extraordinary
Gain on Acquisition of BankTrust***
  On
May 3, 2004, we acquired all of the capital stock of BankTrust. The
estimated fair value of assets acquired less liabilities assumed exceeded the
purchase price by approximately $5.7 million. This was allocated to eliminate
the fair value of intangible assets acquired, and the value of the furniture,
fixtures and equipment acquired. Since all other remaining assets were either
financial assets, assets to be disposed of in the near term or prepaid assets,
the remaining negative goodwill amounting to $4.4 million resulted in an
extraordinary gain on the acquisition. As established by the Statement of
Financial Accounting Standards No. 141, Business Combinations, we have an
allocation period of one year from the consummation date to identify and measure
the fair value of the assets acquired and the liabilities assumed in a business
combination. Consequently, the allocation of the purchase price to the assets
and liabilities acquired could be subject to revision based on the outcome of
any future evaluations of these assets and liabilities. Please refer to *“Note
3 - Acquisition”* to our
2004 consolidated financial statements for further details.
  ***Extraordinary
Gain on Acquisition of Banco Financiero de Puerto
Rico***
  On
December 15, 2002, we acquired all of the capital stock of Banco Financiero
de Puerto Rico for a purchase price of $1.5 million. The purchase price
consisted of the issuance of our common stock, valued at $1.2 million at
that time, and $326,000 in cash. The estimated fair value of the assets acquired
less liabilities assumed of $2.8 million exceeded the acquisition price of
$1.8 million, including additional costs associated with the acquisition of
$215,000. This excess resulted in an extraordinary gain on business acquisition
of $1.1 million after reducing the value of certain assets acquired by
$456,000.
  44
 **Financial
Condition**
  Our total
assets as of December 31, 2004 were $2.1 billion, compared to
$1.3 billion and $1.0 billion as of December 31, 2003 and 2002,
respectively. The increase during 2004 was primarily the result of growth in
loans and leases from current operations, investment securities and from those
assets acquired in the acquisition of The Bank & Trust of Puerto Rico. The
increase in our total assets during 2003 was primarily the result of organic
growth in our investment securities and loan and lease portfolio.
  Our total
deposits increased by 43.1% to $1.4 billion as of December 31, 2004,
after increasing $141.5 million, or 16.8%, to reach $984.5 million as
of December 31, 2003, as compared to $843.0 million as of
December 31, 2002. The increases during 2004 and 2003 were due to the
organic growth of the Bank, but in 2004 it was primarily impacted by our
acquisition of BankTrust in May 2004, in which we assumed $398.6 million of
deposits. Asset growth during 2004 and 2003 was also funded with increases in
securities sold under agreements to repurchase of $255.9 million and $143.4
million, respectively.
  Stockholders’
equity increased by 143.3% to $158.3 million as of December 31, 2004,
representing an increase of $93.2 million from $65.1 million as of December 31,
2003. As of December 31, 2003, our total stockholders’ equity was
$65.1 million, representing an increase of 13.5% from $57.3 million as
of December 31, 2002. In addition to earnings from operations, stock
options exercised, a private placement and our initial public offering, our
stockholders’ equity was also impacted by a $2.4 million decrease during 2004
and 2003 in our unrealized gain (loss) on investment securities available
for sale.
  ***Short-Term
Investments and Interest-bearing Deposits in Other Financial
Institutions***
  We sell
federal funds, purchase securities under agreements to resell, and deposit funds
in interest-bearing accounts in other financial institutions to help meet
liquidity requirements and provide temporary holdings until the funds can be
otherwise deployed or invested. As of December 31, 2004, 2003 and 2002, we had
$3.3 million, $19.3 million and $29.9 million, respectively, in interest-bearing
deposits in other financial institutions. Also, we had $42.8 million, $20.5
million and $45.0 million in securities purchased under agreements to resell,
respectively, for those same periods, respectively.
  ***Investment
Securities***
  Our
investment portfolio primarily serves as a source of interest income and,
secondarily, as a source of liquidity and a management tool for our interest
rate sensitivity. We manage our investment portfolio according to a written
investment policy implemented by our Asset/Liability Management Committee. Our
investment policy is reviewed at least annually by our Board of Directors.
Investment balances, including cash equivalents and interest-bearing deposits in
other financial institutions, are subject to change over time based on our
asset/liability funding needs and our interest rate risk management objectives.
Our liquidity levels take into consideration anticipated future cash flows and
all available sources of credits and are maintained at levels management
believes are appropriate to assure future flexibility in meeting our anticipated
funding needs.
  Our
investment portfolio consists of securities we intend to hold until maturity, or
“held-to-maturity securities,” and all other securities are classified as
“available-for-sale.” The carrying values of our available-for-sale securities
are adjusted for unrealized gain or loss as a valuation allowance, and any gain
or loss is reported on an after-tax basis as a component of other comprehensive
income.
  45
 The
following table presents the composition, book value and fair value of our
investment portfolio by major category as of the dates indicated:
  **Available-for-Sale**
    
    **Held-to-Maturity**
    
    **Total****Amortized**
      **Cost**
    
    **Estimated**
      **Fair
      Value**
    
    **Amortized**
      **Cost**
    
    **Estimated**
      **Fair
      Value**
    
    **Amortized**
      **Cost**
    
    **Estimated**
      **Fair
      Value****(Dollars
      in thousands)****December
      31, 2004:**U.S.
      treasury securities
    
    $
    84,882
    
    $
    84,392
    
    $
    —
    
    $
    —
    
    $
    84,882
    
    $
    84,392U.S.
      government agencies obligations
    
    
    89,376
    
    
    88,799
    
    
    4,813
    
    
    4,775
    
    
    94,189
    
    
    93,574Collateralized
      mortgage obligations
    
    
    303,016
    
    
    301,070
    
    
    37,128
    
    
    36,991
    
    
    340,144
    
    
    338,061Mortgage-backed
      securities
    
    
    71,304
    
    
    71,707
    
    
    7,563
    
    
    7,540
    
    
    78,867
    
    
    79,247State
      and municipal obligations
    
    
    9,477
    
    
    9,514
    
    
    —
    
    
    —
    
    
    9,477
    
    
    9,514Total
    
    $
    558,055
    
    $
    555,482
    
    $
    49,504
    
    $
    49,306
    
    $
    607,559
    
    $
    604,788**December
      31, 2003:**U.S.
      treasury securities
    
    $
    84,748
    
    $
    85,116
    
    $
    —
    
    $
    —
    
    $
    84,748
    
    $
    85,116U.S.
      government agencies obligations
    
    
    39,867
    
    
    39,930
    
    
    —
    
    
    —
    
    
    39,867
    
    
    39,930Collateralized
      mortgage obligations
    
    
    144,885
    
    
    143,189
    
    
    —
    
    
    —
    
    
    144,885
    
    
    143,189Mortgage-backed
      securities
    
    
    49,027
    
    
    49,134
    
    
    —
    
    
    —
    
    
    49,027
    
    
    49,134State
      and municipal obligations
    
    
    4,519
    
    
    4,575
    
    
    —
    
    
    —
    
    
    4,519
    
    
    4,575Other
      debt securities
    
    
    2,968
    
    
    2,994
    
    
    —
    
    
    —
    
    
    2,968
    
    
    2,994Total
    
    $
    326,014
    
    $
    324,938
    
    $
    —
    
    $
    —
    
    $
    326,014
    
    $
    324,938**December
      31, 2002:**U.S.
      treasury securities
    
    $
    29,945
    
    $
    30,260
    
    $
    —
    
    $
    —
    
    $
    29,945
    
    $
    30,260U.S.
      government agencies obligations
    
    
    21,547
    
    
    21,863
    
    
    —
    
    
    —
    
    
    21,547
    
    
    21,863Collateralized
      mortgage obligations
    
    
    57,687
    
    
    58,722
    
    
    —
    
    
    —
    
    
    57,687
    
    
    58,722Mortgage-backed
      securities
    
    
    23,900
    
    
    24,127
    
    
    —
    
    
    —
    
    
    23,900
    
    
    24,127State
      and municipal obligations
    
    
    4,659
    
    
    4,758
    
    
    —
    
    
    —
    
    
    4,659
    
    
    4,758Other
      debt securities
    
    
    5,919
    
    
    6,065
    
    
    —
    
    
    —
    
    
    5,919
    
    
    6,065Total
    
    $
    143,657
    
    $
    145,795
    
    $
    —
    
    $
    —
    
    $
    143,657
    
    $
    145,795
 Available-for-sale
securities, which are stated at their fair value, increased to $555.5 million as
of December 31, 2004, from $324.9 million in 2003, and $145.8 million in 2002.
These increases are representative of our strategy to enhance our liquidity
level through the use of available-for-sale securities in addition to
immediately available funds. The majority of our immediately available funds are
maintained in the form of overnight investments. As of December 31, 2004,
investment securities having a carrying value of approximately $519.0 million
were pledged to secure borrowings and deposits of public funds and to comply
with other pledging requirements.
  46
 ******
 ***Investment
Portfolio — Maturity and Yields***
  The
following table summarizes the contractual maturity of investment securities
held in our investment portfolio and their weighted average yields:
  **Year
      Ended December 31, 2004****Within****One
      Year**
    
    **After
      One but Within Five Years**
    
    **After
      Five but Within Ten Years**
    
    **After
      Ten Years**
    
    **Total****Amount**
    
    **Yield**
    
    **Amount**
    
    **Yield**
    
    **Amount**
    
    **Yield**
    
    **Amount**
    
    **Yield**
    
    **Amount**
    
    **Yield****(Dollars
      in thousands)****Investments
      available-for-sale:**(1)(2)U.S.
      treasury obligations
    
    $
    84,392
    
    
    1.79
    %
    $
    —
    
    
    —
    %
    $
    —
    
    
    —
    %
    $
    —
    
    
    —
    %
    $
    84,392
    
    
    1.79
    %U.S.
      government agencies obligations
    
    
    38,277
    
    
    3.15
    
    
    50,522
    
    
    3.36
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    88,799
    
    
    3.27Mortgage
      backed securities(3)
    
    
    6,363
    
    
    4.13
    
    
    19,204
    
    
    4.62
    
    
    35
    
    
    9.18
    
    
    46,105
    
    
    5.01
    
    
    71,707
    
    
    4.83Collateral
      mortgage obligations(3)
    
    
    —
    
    
    —
    
    
    99
    
    
    6.00
    
    
    41,339
    
    
    5.03
    
    
    259,632
    
    
    5.17
    
    
    301,070
    
    
    5.15State
      & political subdivisions
    
    
    —
    
    
    —
    
    
    7,805
    
    
    3.90
    
    
    1,709
    
    
    6.24
    
    
    —
    
    
    —
    
    
    9,514
    
    
    4.32Other
      debt securities
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —Total
      investments available-for-sale
    
    $
    129,032
    
    
    2.31
    %
    $
    77,630
    
    
    3.73
    %
    $
    43,083
    
    
    5.09
    %
    $
    305,737
    
    
    5.15
    %
    $
    555,482
    
    
    4.28
    %**Investments
      held-to-maturity:**(2)U.S.
      treasury obligations
    
    $
    —
    
    
    —
    %
    $
    —
    
    
    —
    %
    $
    4,814
    
    
    3.84
    %
    $
    —
    
    
    —
    %
    $
    4,813
    
    
    3.84
    %U.S.
      government agencies obligations
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —Mortgage
      backed securities(3)
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    29,393
    
    
    5.10
    
    
    29,393
    
    
    5.10Collateral
      mortgage obligations(3)
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    15,298
    
    
    4.67
    
    
    15,298
    
    
    4.67State
      & political subdivisions
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —Other
      debt securities
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —Total
      investments held-to-maturity
    
    $
    —
    
    
    —
    %
    $
    —
    
    
    —
    %
    $
    4,814
    
    
    3.84
    %
    $
    44,691
    
    
    4.95
    %
    $
    49,504
    
    
    4.84
    %**Other
      Investments:**FHLB
      stock
    
    
    7,330
    
    
    3.05
    %
    
    —
    
    
    —
    %
    
    —
    
    
    —
    %
    
    —
    
    
    —
    %
    
    7,330
    
    
    3.05
    %Investment
      in statutory trust
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    1,386
    
    
    5.91
    
    
    1,386
    
    
    5.91Total
      other investments
    
    $
    7,330
    
    
    3.05
    %
    $
    —
    
    
    —
    %
    $
    —
    
    
    —
    %
    $
    1,386
    
    
    5.91
    %
    $
    8,716
    
    
    3.50
    %Total
      investments
    
    $
    136,362
    
    
    2.35
    %
    $
    77,630
    
    
    3.73
    %
    $
    47,897
    
    
    4.96
    %
    $
    351,814
    
    
    5.13
    %
    $
    613,702
    
    
    4.32
    %
 __________
 (1)
    Based
      on estimated fair value.
  (2)
    Almost
      all of our income from investments in securities is tax exempt because
      98.1% of these securities are held in our IBE. The yields shown in the
      above table are not calculated on a fully taxable equivalent
    basis.
  (3)
    Maturities
      of mortgage-backed securities and collateralized mortgage obligations, or
      CMOs, are based on anticipated lives of the underlying mortgages, not
      contractual maturities. CMO maturities are based on cash flow (or payment)
      windows derived from broker market consensus.
  ***Other
Earning Assets***
  For
various business purposes, we make investments in earning assets other than the
interest-earning securities discussed above. As of December 31, 2004, our
investment in other earning assets included $7.3 million in FHLB stock and $1.4
million equity in our statutory trusts. The following table presents the
balances of other earning assets as of the dates indicated:
  **Year
      Ended December 31,****Type**
    
    **2004**
    
    **2003**
    
    **2002****(In
      thousands)**Statutory
      trusts
    
    $
    1,386
    
    $
    1,388
    
    $
    —FHLB
      stock
    
    
    7,330
    
    
    1,954
    
    
    2,405Total
    
    $
    8,716
    
    $
    3,342
    
    $
    2,405
  47
 ***Loan
and Lease Portfolio***
  Our
primary source of income is interest on loans and leases. The following table
presents the composition of our loan and lease portfolio by category as of the
dates indicated, excluding loans held for sale secured by real estate amounting
to $2.7 million, $6.8 million, $5.2 million, $5.1 million, and $1.1 million as
of December 31, 2004, 2003, 2002, 2001 and 2000, respectively:
  **Year
      Ended December 31,****2004**
    
    **2003**
    
    **2002**
    
    **2001**
    
    **2000****(In
      thousands)**Real
      estate secured
    
    $
    516,542
    
    $
    317,491
    
    $
    263,600
    
    $
    156,757
    
    $
    123,238Leases
    
    
    459,251
    
    
    315,935
    
    
    256,087
    
    
    138,629
    
    
    80,270Other
      commercial and industrial
    
    
    243,603
    
    
    177,989
    
    
    155,622
    
    
    110,447
    
    
    83,981Consumer
    
    
    74,755
    
    
    26,592
    
    
    31,376
    
    
    18,052
    
    
    17,725Real
      estate - construction
    
    
    79,334
    
    
    47,370
    
    
    52,226
    
    
    29,371
    
    
    7,768Other
      loans
    
    
    6,134
    
    
    4,236
    
    
    3,665
    
    
    2,613
    
    
    2,130Gross
      loans and leases
    
    $
    1,379,619
    
    $
    889,613
    
    $
    762,576
    
    $
    455,869
    
    $
    315,112Plus:
      Deferred loan costs, net
    
    
    6,480
    
    
    4,707
    
    
    3,018
    
    
    1,777
    
    
    688Total
      loans, including deferred loan costs, net
    
    $
    1,386,099
    
    $
    894,320
    
    $
    765,594
    
    $
    457,646
    
    $
    315,800Less:
      Unearned income
    
    
    (1,170
    )
    
    (1,774
    )
    
    (3,041
    )
    
    (4,019
    )
    
    (4,682
    )Total
      loans, net of unearned income
    
    $
    1,384,929
    
    $
    892,546
    
    $
    762,553
    
    $
    453,627
    
    $
    311,118Less:
      Allowance for loan and lease losses
    
    
    (19,039
    )
    
    (9,394
    )
    
    (6,918
    )
    
    (4,513
    )
    
    (3,051
    )Loans,
      net
    
    $
    1,365,890
    
    $
    883,152
    
    $
    755,635
    
    $
    449,114
    
    $
    308,067
  As of
December 31, 2004, 2003 and 2002, our total loans and leases, net of unearned
income, were $1.4 billion, $892.5 million and $762.6 million, respectively. The
significant increase in our loan and lease volume in 2004 was the result of
organic growth, but also largely impacted by our acquisition of BankTrust, in
which we acquired $336.3 million of loans and leases. The increase in our loan
and lease portfolio during 2003 resulted primarily from the organic growth of
our operations. Our total loans and leases, net of unearned income as a
percentage of total assets, however, declined to 66.0% as of December 31,
2004, from 68.1% in 2003, and from 74.2% in 2002, as growth in other assets,
such as our investment securities, outpaced the growth of our loan and lease
portfolio.
  Real
estate secured loans, the largest component of our loan and lease portfolio,
consist primarily of commercial real estate loans and/or commercial lines of
credit that are extended to finance the purchase and/or improvement of
commercial real estate and/or businesses thereon or for business working capital
purposes. The properties may be either owner-occupied or for investment
purposes. Our loan policy adheres to the real estate loan guidelines promulgated
by the FDIC in 1993. The policy provides guidelines including, among other
things, review of appraised value, limitation on loan-to-value ratio, and
minimum cash flow requirements to service debt. Loans secured by real estate
equaled $516.5 million, $317.5 million and $263.6 million as of December 31,
2004, 2003 and 2002, respectively. The volume of our real estate loans has
increased significantly as a result of our growth and as a result of our
acquisition of BankTrust and Banco Financiero. In the acquisitions, we acquired
real estate loans totaling $106.2 million and $11.8 million, respectively. The
percentage of our real estate secured loans in relation to our total loan and
lease portfolio, however, has remained relatively constant. Real estate secured
loans, excluding real estate secured construction loans, as a percentage of
total loans and leases were 37.4%, 35.7% and 34.6% for the fiscal years ended
2004, 2003 and 2002, respectively.
  Lease
financing contracts, the second largest component of our loan portfolio, consist
of automobile and equipment leases made to individuals and corporate customers.
In the last two years, we have deemphasized equipment leasing and focused on
automobile leasing. For 2004, approximately 78.74% of our lease financing
contracts originations were for new automobiles, approximately 19.53% were for
used automobiles and the remaining 1.73% consisted primarily of construction and
medical equipment leases. The volume of our lease financing contracts increased
to $459.3 million, $315.9 million and $256.1 million as of December 31, 2004,
2003 and 2002, respectively. Lease financing contracts, as a percentage of total
loans and leases were 33.3%, 35.5% and 33.6% at the end of 2004, 2003 and 2002,
respectively. During November 2004, December and June 2003, we sold to another
financial institution lease financing contracts with carrying values of $30
million, $20.0 million and $30.0 million, respectively. We retained servicing
responsibilities over all lease financing contracts sold. All lease contracts
were sold on a limited recourse basis. The recourse is limited to a maximum of
5.0% of the outstanding aggregate principal balance of all leases sold at
repossession date. In December 2001, we sold $9.0 million in lease
contracts to Banco Financiero de Puerto Rico. Upon the acquisition of Banco
Financiero in December 2002, these leases once again became part of our lease
portfolio.
  48
 Other
commercial and industrial loans include revolving lines of credit as well as
term business loans. Commercial and industrial loans increased to $243.6 million
as of December 31, 2004 from $178.0 million in 2003, and from $155.6 million in
2002. The significant increase in commercial and industrial loans in 2004 was
mainly attributable to our acquisition of BankTrust and to organic growth as
well. The increase in 2003 was attributable to organic growth. Commercial and
industrial loans as a percentage of total loans were 17.7%, 20.0% and 20.4% at
the end of 2004, 2003 and 2002, respectively.
  Consumer
loans have historically represented a small part of our total loan and lease
portfolio. The majority of consumer loans consist of personal installment loans,
credit cards, boat loans, and consumer lines of credit. We make consumer loans
only to complement our commercial business, and these loans are not emphasized
by our branch managers. As a result, repayment on this portfolio has generally
exceeded or equaled origination, except for 2004 and 2002, when we acquired
consumer loans in connection with our acquisition of BankTrust and Banco
Financiero, respectively. In the acquisition, we acquired consumer loans
totaling $60.2 million, including a $51.4 million boat financing portfolio, and
$12.2 million, respectively. Consumer loans increased to $74.8 million as of
December 31, 2004 from $26.6 million in 2003, and from $31.4 million in 2002.
Consumer loans as a percentage of total loans and leases were 5.4%, 3.0% and
4.1% at the end of 2004, 2003 and 2002, respectively.
  Construction
loans are not a significant part of our total loan portfolio. Construction loans
totaled $79.3 million, $47.4 million and $52.2 as of December 31, 2004, 2003 and
2002, respectively. Construction loans as a percentage of total loans and leases
were 5.8%, 5.3% and 6.8% for those same periods, respectively. During 2004, the
volume of our construction loans has increased significantly as a result of our
growth and as a result of our acquisition of BankTrust. In the acquisition of
BankTrust, we acquired construction loans totaling $42.4 million.
  Our loan
terms vary according to loan type. Commercial term loans generally have
maturities of three to five years, while we generally limit real estate loan
maturities to five to eight years. Lines of credit, in general, are extended on
an annual basis to businesses that need temporary working capital and/or
import/export financing. The following table shows our maturity distribution of
loans and leases, including loans held for sale of $2.7 million, as of December
31, 2004, excluding non-accrual loans amounting to $32.2 million as of the same
date. A significant part of our non-consumer loan portfolio is floating rate
loans which comprise both commercial and industrial loans and commercial real
estate loans. By contrast, residential mortgage loans originated by Eurobank are
fixed rate. Residential mortgage loans are included in the real estate - secured
category in the following table.
  **As
      of December 31, 2004******
      ****
    
    
    
    **Over
      1 Year**
      **through
      5 Years**
    
    **Over
      5 Years******
    
    **One
      Year**
      **or
      Less****(1)**
    
    **Fixed**
      **Rate**
    
    **Floating
      or Adjustable Rate**
    
    **Fixed**
      **Rate**
    
    **Floating
      or Adjustable Rate**
    
    **Total****(In
      thousands)**Real
      estate — construction
    
    $
    83,136
    
    $
    —
    
    $
    8,058
    
    $
    650
    
    $
    2,555
    
    $
    94,399Real
      estate — secured
    
    
    127,341
    
    
    64,011
    
    
    223,202
    
    
    57,514
    
    
    15,691
    
    
    487,759Other
      commercial and industrial
    
    
    162,943
    
    
    27,609
    
    
    38,382
    
    
    7,395
    
    
    1,456
    
    
    237,785Consumer
    
    
    7,489
    
    
    21,295
    
    
    45
    
    
    43,884
    
    
    632
    
    
    73,345Leases
    
    
    6,465
    
    
    346,564
    
    
    —
    
    
    104,295
    
    
    —
    
    
    457,324Other
      loans
    
    
    4,833
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    4,833Total
    
    $
    392,207
    
    $
    459,479
    
    $
    269,687
    
    $
    213,738
    
    $
    20,334
    
    $
    1,355,445
 __________
 (1)
    Maturitiesare based upon contract dates. Demand loans are included in the one year
      or less category and totaled $257.8 million as of December 31,
    2004.
  
 49
  ***Nonperforming
Loans, Leases and Assets***
  Nonperforming
assets consist of loans and leases on nonaccrual status, loans 90 days or more
past due and still accruing interest, loans that have been restructured
resulting in a reduction or deferral of interest or principal, OREO, and other
repossessed assets.
  The
following table sets forth the amounts of nonperforming assets (net of the
portion guaranteed by the United States government) as of the dates
indicated:
  **As
      of December 31,****2004**
    
    **2003**
    
    **2002**
    
    **2001**
    
    **2000****(Dollars
      in thousands)**Loans
      contractually past due 90 days or more but still accruing
      interest
    
    $
    8,365
    
    $
    9,700
    
    $
    6,171
    
    $
    3,668
    
    $
    2,688Nonaccrual
      loans
    
    
    32,168
    
    
    17,058
    
    
    15,889
    
    
    6,540
    
    
    4,921Total
      nonperforming loans
    
    
    40,533
    
    
    26,758
    
    
    22,060
    
    
    10,208
    
    
    7,609Other
      real estate owned
    
    
    2,875
    
    
    2,774
    
    
    1,963
    
    
    29
    
    
    535Other
      repossessed assets
    
    
    3,566
    
    
    3,643
    
    
    5,681
    
    
    3,007
    
    
    1,122Total
      nonperforming assets
    
    $
    46,974
    
    $
    33,175
    
    $
    29,704
    
    $
    13,244
    
    $
    9,266Nonperforming
      loans to total loans and leases
    
    
    2.92
    %
    
    2.98
    %
    
    2.90
    %
    
    2.25
    %
    
    2.46
    %Nonperforming
      assets to total loans and leases plus repossessed property
    
    
    3.37
    
    
    3.66
    
    
    3.87
    
    
    2.90
    
    
    2.98Nonperforming
      assets to total assets
    
    
    2.23
    
    
    2.51
    
    
    2.87
    
    
    2.18
    
    
    2.05
 We
continually review present and estimated future performance of the loans and
leases within our portfolio and risk-rate such loans in accordance with a risk
rating system. More specifically, we attempt to reduce the exposure to risks
through: (1) reviewing each loan request and renewal individually; (2) utilizing
a centralized approval system for loans in excess of $100,000 for secured loans
and $50,000 for unsecured loans; (3) strictly adhering to written loan policies;
and (4) conducting an independent credit review. In addition, loans based on
short-term asset values are monitored on a monthly or quarterly basis. In
general, we receive and review financial statements of borrowing customers on an
ongoing basis during the term of the relationship and respond to any
deterioration noted. We do not engage in sub-prime lending.
  Loans are
generally placed on nonaccrual status when they become 90 days past due, unless
we believe the loan is adequately collateralized and we are in the process of
collection. The nonrecognition of interest income on an accrual basis does not
constitute forgiveness of the interest, and collection efforts are continuously
pursued. Loans may be restructured by management when a borrower has experienced
some change in financial status, resulting in an inability to meet the original
repayment terms, and when we believe the borrower will eventually overcome
financial difficulties and repay the loan in full.
  All
interest accrued but not collected for loans and leases that are placed on
nonaccrual status or charged-off is reversed against interest income. The
interest on these loans is accounted for on a cash basis or cost recovery
method, until qualifying for return to accrual status.
  Generally,
our nonperforming loans and leases have increased in connection with the growth
of our loan and lease portfolio. The recent economic downturn and our
acquisition of BankTrust further increased our nonperforming loans and leases to
$40.5 million as of December 31, 2004 from $26.8 million and $22.1 million as of
December 31, 2003 and 2002, respectively. As of December 31, 2004,
nonaccrual loans acquired from BankTrust amounted to $7.5 million. However, the
ratio of nonperforming loans and leases over total loans and leases remained
relatively constant at 2.92%, 2.98% and 2.90% as of December 31, 2004, 2003 and
2002, respectively.
  We
believe all loans and leases, with which we have serious doubts as to
collectibility, are classified within the category of nonperforming loans and
leases and are appropriately reserved.
  OREO
consists of properties acquired by foreclosure or similar means and that
management intends to offer for sale. Other repossessed assets are comprised of
repossessed automobiles, boats and equipment subject to lease contracts. OREO
and repossessed assets are initially recorded at the lower of fair value or book
value. Any resulting loss is charged to the allowance for loan and lease losses.
An appraisal of OREO and repossessed assets is made periodically after a
property is acquired, and a comparison between the appraised value and the
carrying value is performed. Additional declines in value after acquisition, if
any, are charged to current operations. Gains or losses on disposition of OREO
and repossessed assets, and related operating income and maintenance expenses,
are included in current operations.
  50
 As of
December 31, 2004, our OREO consisted of 12 properties with an aggregate value
of $2.9 million, compared to 13 properties with an aggregate value of $2.8
million as of December 31, 2003, and 10 properties valued at $2.0 million as of
December 31, 2002.
  Other
repossessed assets as of December 31, 2004 and 2003 were $3.6 million and $5.7
million as of December 31, 2002. As our volume of lease financings has
increased, in order to avoid building our inventory of repossessed automobiles,
we have been more aggressive in our disposition efforts. The reduction in
repossessed assets during 2004 and 2003 was attributable to these increased
disposition efforts.
  Together
with OREO, the ratio of nonperforming assets as a percentage of total loans and
leases plus repossessed property improved to 3.4% as of December 31, 2004 from
3.7% and 3.9% as of December 31, 2003 and 2002, respectively.
  ***Allowance
for Loan and Lease Losses***
  We have
established an allowance for loan and lease losses to provide for loans in our
portfolio that may not be repaid in their entirety. The allowance is based on
our regular, monthly assessments of the probable estimated losses inherent in
the loan and lease portfolio. Our methodology for measuring the appropriate
level of the allowance relies on several key elements, which include the formula
described below, specific allowances for identified problem loans and portfolio
segments and the unallocated allowance.
  When
analyzing the adequacy of our allowance, our portfolio is segmented into as many
components as practical. Although the evaluation of the adequacy of our
allowance focuses on loans and leases and pools of similar loans and leases, no
part of our allowance is segregated for, or allocated to, any particular asset
or group of assets. Our allowance is available to absorb all credit losses
inherent in our portfolio.
  Each
component would normally have similar characteristics, such as classification,
type of loan or lease, industry or collateral. As needed, we separately analyze
the following components of our portfolio and provide for them in our
allowance:
  ●  credit
quality;
  ●  sufficiency
of credit and collateral documentation;
  ●  proper
lien perfection;
  ●  appropriate
approval by the loan officer and the loan committees;
  ●  adherence
to any loan agreement covenants; and
  ●  compliance
with internal policies and procedures and laws and regulations.
  The
general portion of our allowance is calculated by applying loss factors to all
categories of loans and leases outstanding i n our
portfolio. We use historic loss rates, determined over a period of years, plus
migration analysis techniques. The resulting loss factors are then multiplied
against the current period’s balance of loans outstanding to derive an estimated
loss. We adjust the historical loss percentage for each pool of loans to reflect
any current conditions that are expected to result in loss recognition. Factors
that we consider include, but are not limited to:
  ●  effects
of any changes in lending policies and procedures, including those for
underwriting, collection, charge-offs, and recoveries;
  ●  changes
in the experience, ability and depth of our lending management and
staff;
  51
  ●  concentrations
of credit that might affect loss experience across one or more components of the
portfolio;
  ●  levels
of, and trends in, delinquencies and nonaccruals; and
  ●  national
and local economic business trends and conditions.
  Historical
loss rates are reviewed and adjusted for the above factors on a pool-by-pool
basis. Rates for each pool are based on those factors management believes are
applicable to that pool. When applied to a pool of loans or leases, the adjusted
historical loss rate is a measure of the total inherent losses in the portfolio
that would have been estimated if each individual loan or lease had been
reviewed. For such pools of loans or leases, management believes that coverage
of one year’s losses in the current portfolio is an appropriate
measure.
  Net
charge offs as a percentage of our year end portfolio balance, or “net loss
experience,” has averaged 0.47% for our commercial loan portfolio over the past
five years. However, because a significant portion of our business is focused on
commercial lending, we have generally maintained a conservative reserve for our
commercial loan portfolio. For the portion of our commercial loan portfolio
adequately secured with real estate collateral, we maintain a general reserve
equal to 0.35% of the outstanding balance of such portfolio. The reserve for
commercial loans that are not secured by real estate is equal to 2.67% of the
outstanding portfolio balance.
  Our
consumer installment closed end loan portfolio has averaged a 3.32% net loss
experience over the past five years. This is partially attributable to the fact
that, in connection with our acquisitions of other banks, additional charge-offs
have been recorded and additional reserves have been built into the transaction
pricing to compensate for future losses. For our consumer loan portfolio we
maintain a general reserve equal to 2.55% of the outstanding balance of such
portfolio.
  Our four
year old construction loan portfolio has no loss experience. Nevertheless, we
maintain a general reserve for this portfolio equal to 1.51% of the portfolio
balance.
  Our
leasing portfolio has averaged a 0.40% net loss experience over the past five
years. We maintain a reserve equal to 0.83% of the balance of this portfolio for
general reserve purposes.
  The
mortgage portfolio has no loss experience. The large majority of mortgage
originations are sold into the secondary market or to other financial
institutions and the existing portfolio is generally of a mature nature.
Nevertheless, we maintain a general reserve equal to 0.70% of the mortgage
portfolio for general reserve purposes.
  As of May
3, 2004 Eurobank acquired loan portfolios from BankTrust, totaling $347.2
million with accompanying general, specific and unallocated allowances of $10.9
million. Because a number of BankTrust’s problem loans were acquired by a
special purpose vehicle immediately prior to closing, and as a result of a
series of charge-offs performed prior to the closing, except with regard to the
newly acquired boat financing portfolio described below, we have determined that
the portfolios acquired from BankTrust generally have a risk level comparable to
our portfolio prior to the BankTrust transaction. Consequently, we will continue
to apply the same reserve guidelines previously used to our
portfolio.
  The only
major loan category acquired from BankTrust not previously marketed by Eurobank
was BankTrust’s boat financing portfolio, which amounted to $45.9 million as of
December 31, 2004. As with all other BankTrust consumer loans, the special
purpose vehicle assumed all loans in the BankTrust boat financing portfolio that
were more than 90 days delinquent. In the six months prior to its acquisition,
BankTrust maintained a boat financing reserve between 1.6% and 1.9% of the
outstanding portfolio. We currently maintain a $2.5 million general allowance on
the boat financing portfolio, or 5.37% of the outstanding portfolio. While we
may adjust this allowance in the future, we believe it is appropriate at this
time.
  All
internal and external factors that may impact the adequacy of our general
allowances are reviewed on an ongoing basis with formal recommendations being
made to the Board of Directors at least annually, and more frequently if deemed
necessary.
  In
addition to our general portfolio allowances, specific allowances are
established in cases where management has identified significant conditions or
circumstances related to a credit that management believes indicate a high
probability that a loss will be incurred. This amount may be determined either
by a method prescribed by SFAS No. 114, Accounting by Creditors for Impairment
of a Loan, or by a method that identifies certain qualitative
factors.
  52
 Through
periodic management review at branch and executive level and utilization of
internal delinquency processes, both portfolios and individual loans and leases
are monitored on an ongoing basis. When considered appropriate, a specific
allowance will be considered on individual loan or lease accounts. A review is
generally conducted of all the conditions surrounding any particular account
such as the borrower’s character, existing and potential financial condition,
realizable value of collateral, prospects for additional collateral and payment
record. As a result, the loss potential is determined and specific allowances
may be established. The level of allowance will vary depending on the analysis
but we utilize the same classification categories as federal regulators, which
result in varying amounts of reserve depending on loss potential.
  The
unallocated portion of the allowance contains amounts that are based on
management’s evaluation of conditions that are not directly measured in the
determination of the formula and specific allowances. The evaluation of the
inherent loss with respect to these conditions is subject to a higher degree of
uncertainty because they are not identified with specific problem credits or
portfolio segments. The conditions evaluated in connection with the unallocated
portion of the allowance include the following:
  ●
    general
      economic and business conditions affecting our key lending
      areas;
  ●
    then-existing
      economic and business conditions of areas outside the lending areas, such
      as other sections of the United States and
Caribbean;
  ●
    credit
      quality trends, including trends in nonperforming loans and leases
      expected to result from existing
conditions;
  ●
    loan
      and lease concentrations by collateral and by obligor;
  ●
    specific
      industry conditions within portfolio segments;
  ●
    recent
      loss experience in particular segments of the portfolio;
  ●
    duration
      of the current business cycle;
  ●
    bank
      regulatory examination results and guidance; and
  ●
    findings
      of our internal and external loan review examiners.
  Our loan
review officer reviews these conditions on an ongoing basis in discussion with
our executive management, senior lenders and credit officers. To the extent that
any of these conditions is evidenced by a specifically identifiable problem
credit or portfolio segment as of the evaluation date, management’s estimate of
the effect of such condition may be reflected as a specific allowance,
applicable to such loan or portfolio segment. When any of these conditions is
not evidenced by a specifically identifiable problem loan or portfolio segment,
management’s evaluation of the probable loss related to such conditions is
reflected in the unallocated portion of the allowance.
  Although
our management believes that the allowance for loan and lease losses is adequate
to absorb probable losses on existing loans and leases that may become
uncollectible, there can be no assurance that our allowance will prove
sufficient to cover actual loan and lease losses in the future. In addition,
various regulatory agencies, as an integral part of their examination process,
periodically review the adequacy of our allowance for loan and lease losses.
Such agencies may require us to make additional provisions to the allowance
based upon their judgments about information available to them at the time of
their examinations.
  The table
below summarizes, for the periods indicated, loan and lease balances at the end
of each period, the daily averages during the period, changes in the allowance
for loan and lease losses arising from loans and leases charged-off, recoveries
on loans and leases previously charged-off, and additions to the allowance, and
certain ratios related to the allowance for loan and lease losses:
  53
 **Year
      Ended December 31,****2004**
    
    **2003**
    
    **2002**
    
    **2001**
    
    **2000****(Dollars
      in thousands)**Average
      total loans and leases outstanding during period
    
    $
    1,217,723
    
    $
    842,033
    
    $
    577,995
    
    $
    383,970
    
    $
    246,352Total
      loans and leases outstanding at end of period, including loans held for
      sale
    
    
    1,387,613
    
    
    899,392
    
    
    767,791
    
    
    458,680
    
    
    312,198Allowance
      for loan and lease losses:Allowance
      at beginning of period
    
    
    9,394
    
    
    6,918
    
    
    4,513
    
    
    3,051
    
    
    2,143Charge-offs:Real
      estate — secured
    
    
    5
    
    
    —
    
    
    —
    
    
    —
    
    
    —Commercial
      and industrial
    
    
    3,329
    
    
    966
    
    
    887
    
    
    290
    
    
    125Consumer
    
    
    1,196
    
    
    1,347
    
    
    1,718
    
    
    710
    
    
    553Leases
    
    
    5,806
    
    
    2,715
    
    
    767
    
    
    339
    
    
    55Other
      loans
    
    
    164
    
    
    37
    
    
    16
    
    
    57
    
    
    33Total
      charge-offs
    
    
    10,500
    
    
    5,065
    
    
    3,388
    
    
    1,396
    
    
    766Recoveries:Real
      estate — secured
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —Commercial
      and industrial
    
    
    154
    
    
    160
    
    
    97
    
    
    201
    
    
    126Consumer
    
    
    233
    
    
    254
    
    
    180
    
    
    182
    
    
    190Leases
    
    
    1,741
    
    
    675
    
    
    142
    
    
    96
    
    
    15Other
      loans
    
    
    15
    
    
    1
    
    
    2
    
    
    2
    
    
    —Total
      recoveries
    
    
    2,143
    
    
    1,090
    
    
    421
    
    
    481
    
    
    331Net
      loan and lease charge-offs
    
    
    8,357
    
    
    3,975
    
    
    2,967
    
    
    915
    
    
    435Provision
      for loan and lease losses
    
    
    7,100
    
    
    6,451
    
    
    3,354
    
    
    2,377
    
    
    1,343Allowance
      of acquired bank — BankTrust (2004) and Banco Financiero
      (2002)
    
    
    10,902
    
    
    —
    
    
    2,018
    
    
    —
    
    
    —Allowance
      at end of period
    
    $
    19,039
    
    $
    9,394
    
    $
    6,918
    
    $
    4,513
    
    $
    3,051Ratios:Net
      loan and lease charge-offs to average total loans
    
    
    0.69
    %
    
    0.47
    %
    
    0.51
    %
    
    0.24
    %
    
    0.18
    %Allowance
      for loan and lease losses to total loans at end of period
    
    
    1.37
    
    
    1.04
    
    
    0.90
    
    
    0.98
    
    
    0.98Net
      loan and lease charge-offs to allowance for loan losses at end of
      period
    
    
    43.89
    
    
    42.31
    
    
    42.89
    
    
    20.27
    
    
    14.26Net
      loan and lease charge-offs to provision for loan and lease
      losses
    
    
    117.70
    
    
    61.62
    
    
    55.23
    
    
    38.49
    
    
    32.39
 The rapid
growth of our loan and lease portfolio in the past five years required an
increased allowance for loan and lease losses. The allowance for loan and lease
losses increased by 102.7%, or $9.6 million, to $19.0 million at December 31,
2004, as compared to $9.4 million as of December 31, 2003, and by 35.8%, or $2.5
million, as compared to December 31, 2002. The allowance for loan and lease
losses as a percentage of total loans and leases increased to 1.37% at the end
of year 2004 from 1.04% in 2003, and from 0.90% in 2002. The increase in 2004
was mainly related to our acquisition of BankTrust and also reflects our
decision to amend our credit policy to charge off a portion of our lease finance
contracts that are over 120 days past due and to fully charge off most of
our lease contracts that are over 365 days past due. In connection with our
BankTrust acquisition, we acquired $10.9 million of additional allowance for
loan and lease losses.
  In June
2004, we commenced the practice of charging-off most of our lease finance
contracts that were over 365 days past due. This fully charge-off is made on a
quarterly basis. Accordingly, most of our lease finance contracts that are over
365 days past due at the end of the quarter are fully charged-off. As of
December 31, 2004, $1.5 million was charged off for this purpose.
  In March
2003, we commenced the practice of effecting partial charge-off on all lease
finance contracts that were over 120 days past due. This is done based on our
historical lease loss experience. For 2004, we used a historical loss ratio in
lease finance contracts of approximately 12.0%. This partial charge-off is made
on a quarterly basis. Accordingly, all lease finance contracts that are over 120
days past due at the end of the quarter are partially charged-off. As of
December 31, 2004, $1.1 million was charged off for this purpose.
  Net
charge-offs as a percentage of average loans was 0.69%, 0.47% and 0.51% at the
end of year 2004, 2003 and 2002, respectively. The increase in this ratio for
2004 was attributable to increased volumes in the loan and lease portfolio, and
also as a result of our acquisition of BankTrust and our decision to fully
charge off our lease finance contracts that are over 365 days past due. Also,
during 2004, the commercial and industrial charge-offs included the unsecured
portion of a loan granted to a construction company amounting to $885,000. The
increase in this ratio for 2003 when compared to 2002 was primarily due to our
decision to amend our credit policy to charge off a portion of our lease finance
contracts that are over 120 days past due. In 2002, additional charge-offs
were taken after our acquisition of Banco Financiero, primarily of commercial
and lease financing contracts acquired in the acquisition.
  54
 Net
charge-offs as a percentage of provision for loan and lease losses increased to
117.7% as of December 31, 2004, from 61.6% in 2003 and from 55.2% in 2002. The
increase in this ratio for 2004 was mainly attributable to our acquisition of
BankTrust and our decision to fully charge off most of our lease finance
contracts that are over 365 days past due. The increase in this ratio for 2003
was primarily due to our decision to amend our credit policy to charge off a
portion of our lease finance contracts that are over 120 days past due.
  The table
below presents an allocation for loan and lease losses among the various loan
categories and sets forth the percentage of loans and leases in each category to
gross loans or leases. The allocation of the allowance for loan and lease losses
as shown in the table should neither be interpreted as an indication of future
charge-offs, nor as an indication that charge-offs in future periods will
necessarily occur in these amounts or in the indicated proportions:
  **As
      of December 31,****2004**
    
    **2003**
    
    **2002**
    
    **2001**
    
    **2000****Amt.**
    
    **Loan
      Category to Gross****Loans(1)**
    
    **Amt.**
    
    **Loan
      Category to Gross****Loans(1)**
    
    **Amt.**
    
    **Loan
      Category to Gross****Loans(1)**
    
    **Amt.**
    
    **Loan
      Category to Gross****Loans(1)**
    
    **Amt.**
    
    **Loan
      Category to Gross****Loans(1)****(Dollars
      in thousands)****Allocated:**Real
      estate — construction
    
    $
    1,200
    
    
    5.75
    %
    $
    464
    
    
    5.32
    %
    $
    495
    
    
    6.85
    %
    $
    249
    
    
    6.44
    %
    $
    41
    
    
    2.47
    %Real
      estate — secured
    
    
    1,997
    
    
    37.44
    
    
    1,212
    
    
    35.69
    
    
    1,037
    
    
    34.57
    
    
    753
    
    
    34.39
    
    
    490
    
    
    39.11Commercial
      and industrial
    
    
    6,470
    
    
    17.66
    
    
    4,067
    
    
    20.01
    
    
    2,265
    
    
    20.41
    
    
    1,589
    
    
    24.23
    
    
    1,232
    
    
    26.65Consumer
    
    
    3,239
    
    
    5.42
    
    
    750
    
    
    2.99
    
    
    992
    
    
    4.11
    
    
    535
    
    
    3.96
    
    
    489
    
    
    5.62Leases
    
    
    3,815
    
    
    33.29
    
    
    1,950
    
    
    35.51
    
    
    1,825
    
    
    33.58
    
    
    1,360
    
    
    30.41
    
    
    785
    
    
    25.47Other
      loans
    
    
    134
    
    
    0.44
    
    
    21
    
    
    0.48
    
    
    18
    
    
    0.48
    
    
    13
    
    
    0.57
    
    
    10
    
    
    0.68Unallocated
    
    
    2,184
    
    
    —
    
    
    930
    
    
    —
    
    
    286
    
    
    —
    
    
    14
    
    
    —
    
    
    4
    
    
    —Total
      allowance for loan and lease losses
    
    $
    19,039
    
    
    100.00
    %
    $
    9,394
    
    
    100.00
    %
    $
    6,918
    
    
    100.00
    %
    $
    4,513
    
    
    100.00
    %
    $
    3,051
    
    
    100.00
    %
 __________
 (1)
    Excludes
      mortgage loans held-for-sale.
  ***Nonearning
Assets***
  Premises,
leasehold improvements and equipment, net of accumulated depreciation and
amortization, totaled $11.3 million at December 31, 2004, as compared to $10.5
million and $9.4 at the end of year 2003 and 2002, respectively. We have no
definitive agreements regarding acquisition or disposition of owned or leased
facilities and, for the near-term future, we do not expect significant changes
in our total occupancy expense.
  55
  **Deposits**
  Deposits
are our primary source of funds. The following table sets forth, for the periods
indicated, the distribution of our average deposit account balances and average
cost of funds on each category of deposits:
  **Year
      Ended December 31,****2004**
    
    **2003**
    
    **2002****Average
      Balance**
    
    **Percent
      of Deposits**
    
    **Average
      Rate**
    
    **Average
      Balance**
    
    **Percent
      of Deposits**
    
    **Average
      Rate**
    
    **Average
      Balance**
    
    **Percent
      of Deposits**
    
    **Average
      Rate****(Dollars
      in thousands)**Noninterest-bearing
      demand deposits
    
    $
    119,847
    
    
    9.39
    %
    
    —
    %
    $
    92,643
    
    
    10.09
    %
    
    —
    %
    $
    73,189
    
    
    12.03
    %
    
    —
    %Money
      market deposits
    
    
    62,346
    
    
    4.88
    
    
    2.14
    
    
    47,896
    
    
    5.21
    
    
    2.70
    
    
    26,843
    
    
    4.41
    
    
    3.51NOW
      deposits
    
    
    40,931
    
    
    3.21
    
    
    1.80
    
    
    26,579
    
    
    2.89
    
    
    2.14
    
    
    18,939
    
    
    3.11
    
    
    3.00Savings
      deposits
    
    
    261,660
    
    
    20.50
    
    
    2.38
    
    
    197,242
    
    
    21.47
    
    
    2.95
    
    
    98,408
    
    
    16.18
    
    
    3.53Time
      certificates of deposit in denominations of $100,000 or
    more
    
    
    203,129
    
    
    15.91
    
    
    2.16
    
    
    176,216
    
    
    19.18
    
    
    3.03
    
    
    131,728
    
    
    21.65
    
    
    3.71Brokered
      certificates of deposits in denominations of $100,000 or
    more
    
    
    396,531
    
    
    31.07
    
    
    3.79
    
    
    216,395
    
    
    23.55
    
    
    4.19
    
    
    156,983
    
    
    25.81
    
    
    4.78Other
      time deposits
    
    
    192,046
    
    
    15.04
    
    
    2.92
    
    
    161,811
    
    
    17.61
    
    
    3.28
    
    
    102,230
    
    
    16.81
    
    
    4.01Total
      deposits
    
    $
    1,276,490
    
    
    100.00
    %
    
    
    
    $
    918,782
    
    
    100.00
    %
    
    
    
    $
    608,320
    
    
    100.00
    %
 Total
deposits as of December 31, 2004, 2003 and 2002 were $1.4 billion,
$984.5 million and $843.0 million, respectively, representing an
increase of $424.5 million, or 43.1%, in 2004 and $141.5 million, or 16.8%,
in 2003. Average deposits for the years ended December 31, 2004, 2003 and
2002 were $1.3 billion, $918.8 million and $608.3 million,
respectively. Thus, average deposits grew by $357.7 million, or 38.9%, in 2004
and $310.5 million, or 51.0%, in 2003. The dramatic increase in average
deposits in 2004 and 2003 is mainly attributable to our acquisition of BankTrust
in May 2004 and Banco Financiero in December 2002. Our methodology for
calculating average deposits and the timing of the Banco Financiero acquisition
causes the related increase to show up in our average deposits for 2003, instead
of for 2002. We assumed $398.6 million in total deposits in connection with our
acquisition of BankTrust and $84.2 million upon our acquisition of Banco
Financiero.
  Our core
deposits increased to $720.7 million as of December 31, 2004 from
$572.3 million and $450.5 million at the end of years 2003 and 2002,
respectively. As a result, the percentage of our core deposits to total deposits
decreased to 51.1% at December 31, 2004, from 58.1% and 53.4% at December 31,
2003 and 2002, respectively. The decrease in our core deposits as a percentage
of total deposits during 2004 is mainly attributed to our acquisition of
BankTrust. In our acquisition of BankTrust, we assumed deposits totaling $398.6
million, including time deposits in denominations of $100,000 or more totaling
$232.4 million, or 58.4% of total deposits assumed. We attribute growth in our
core deposits during 2003, both to our organic growth and also to the increasing
number of deposits from our expanding commercial lending customer base. The
average rate paid on time deposits in denominations of $100,000 or more was
3.2%, 3.7% and 4.3% for the years ended December 31, 2004, 2003 and 2002,
respectively.
  In
addition to the deposits we generate locally, we have also accepted brokered
deposits to augment retail deposits and to fund asset growth. In order to take
advantage of historically low funding costs, we increased brokered deposits to
$511.2 million, $228.2 million and $214.7 million as of
December 31, 2004, 2003 and 2002, respectively. Most of our brokered
deposits have maturities of one to seven years. Because brokered deposits are
generally more volatile and interest rate sensitive than other sources of funds,
management closely monitors growth in this category.
  56
  The
following table sets forth the amount and maturities of the time deposits of
$100,000 or more as of December 31, 2004:
  **December
      31, 2004****(In
      thousands)**Three
      months or less
    
    $
    140,228Over
      three months through six months
    
    
    74,461Over
      six months through 12 months
    
    
    108,084Over
      12 months
    
    
    365,591Total
    
    $
    688,364
 ***Other
Sources of Funds***
  *Securities
Sold Under Agreements to Repurchase*
  To
support our asset base, we sell securities subject to obligations to repurchase
to securities dealers and the FHLB. These repurchase transactions generally have
maturities of one month to less than five years. The following table summarizes
certain information with respect to securities under agreements to repurchase
for the fiscal years ended December 31, 2004, 2003 and 2002:
  **Year
      Ended December 31,******
    
    **2004**
    
    **2003**
    
    **2002****(Dollars
      in thousands)**Balance
      at period-end
    
    $
    463,409
    
    $
    207,523
    
    $
    64,113Average
      monthly aggregate balance outstanding during the period
    
    
    312,169
    
    
    92,069
    
    
    44,472Maximum
      aggregate balance outstanding at any month-end
    
    
    465,302
    
    
    207,523
    
    
    64,113Weighted
      average interest rate for the period
    
    
    1.70
    %
    
    1.71
    %
    
    2.60
    %Weighted
      average interest rate at period-end
    
    
    2.47
    %
    
    1.25
    %
    
    2.04
    %
 *FHLB
Advances*
  Although
deposits and repurchase agreements are the primary source of funds for our
lending and investment activities and for general business purposes, we may
obtain advances from the Federal Home Loan Bank of New York as an alternative
source of liquidity. The following table provides a summary of FHLB advances for
the fiscal years ended December 31, 2004, 2003 and 2002:
  **Year
      Ended December 31,******
    
    **2004**
    
    **2003**
    
    **2002****(Dollars
      in thousands)**Balance
      at period-end
    
    $
    10,404
    
    $
    10,700
    
    $
    18,850Average
      balance during the period
    
    
    10,450
    
    
    14,954
    
    
    18,186Maximum
      amount outstanding at any month-end
    
    
    10,700
    
    
    18,850
    
    
    18,850Average
      interest rate during the period
    
    
    5.59
    %
    
    5.30
    %
    
    5.73
    %Average
      interest rate at period-end
    
    
    4.97
    %
    
    5.64
    %
    
    5.66
    %
 *Notes
Payable to Statutory Trusts*
  On
December 19, 2002, Eurobank Statutory Trust II (“Trust II”) issued $20 million
of floating rate Trust Preferred Capital Securities (the “Trust II Preferred
Securities”) due in 2032 with a liquidation amount of $1,000 per security.
Distributions payable on each capital security will be payable at an annual rate
equal to 4.7% beginning on (and including) the date of original issuance and
ending on (but excluding) March 26, 2003, and at an annual rate for each
successive period equal to the three-month London Interbank Offered Rate
(LIBOR), plus 3.3% with a ceiling rate of 11.8%. The Trust II Preferred
Securities are fully and unconditionally guaranteed by EuroBancshares. Following
the issuance of the Trust II Preferred Securities by Trust II, EuroBancshares
issued $20.6 million of floating rate Junior Subordinated Deferrable Interest
Debentures (the “2002 Debentures”) due in 2032 to Trust II. The terms of the
2002 Debentures, which comprise substantially all of the assets of Trust II, are
identical to the terms of the Trust II Preferred Securities. The 2002 Debentures
are conditionally guaranteed by EuroBancshares. Eurobank subsequently issued an
unsecured promissory note to EuroBancshares for the issued amount and at an
annual rate equal to that being paid on the Trust II Preferred Securities. See *“Recent
accounting pronouncements,”* below.
  57
 On
December 18, 2001, Eurobank Statutory Trust I (“Trust I”) issued $25.0 million
of floating rate Trust Preferred Capital Securities Series I (“Trust I Preferred
Securities”) due in 2031 with a liquidation amount of $1,000 per security.
Distributions payable on each Trust I Preferred Security will be payable at an
annual rate equal to 5.6% beginning on (and including) the date of original
issuance and ending on (but excluding) March 18, 2002, and at an annual rate for
each successive period equal to the three-month LIBOR, plus 3.6% with a ceiling
rate of 12.5%. The Trust I Preferred Securities are fully and unconditionally
guaranteed by EuroBancshares, which was a wholly owned subsidiary of Eurobank in
2001. Following the issuance of the Trust I Preferred Securities, EuroBancshares
issued $25.8 million of floating rate Junior Subordinated Deferrable Interest
Debentures (the “2001 Debentures”) to Trust I due in 2031. The terms of the 2001
Debentures, which comprise substantially all of the assets of Trust I, are equal
to the terms of the capital securities issued by Trust I. These trust preferred
securities are conditionally guaranteed by EuroBancshares. Eurobank subsequently
issued an unsecured promissory note to us for the issued amount and at an annual
rate equal to that being paid on the Trust Preferred Capital Securities Series I
due in 2031.
  On July
2, 2003, the Federal Reserve indicated in supervisory letter SR 03-13 (the
Supervisory Letter) that trust preferred securities will be treated as Tier 1
capital until notice is given of the contrary. In March 2005, the Federal
Reserve Board adopted the final rule that allows the continued limited inclusion
of trust preferred securities in the tier 1 capital of bank holding companies
(BHCs). Under the final rule, trust preferred securities and other restricted
core capital elements would be subject to stricter quantitative limits. The
Board’s final rule limits restricted core capital elements to 25 percent of all
core capital elements, net of goodwill less any associated deferred tax
liability. Internationally active BHCs, defined as those with consolidated
assets greater than $250 billion or on-balance-sheet foreign exposure greater
than $10 billion, will be subject to a 15 percent limit. But they may include
qualifying mandatory convertible preferred securities up to the generally
applicable 25 percent limit. Amounts of restricted core capital elements in
excess of these limits generally may be included in tier 2 capital. The final
rule provides a five year transition period, ending March 31, 2009, for
application of the quantitative limits. In the last year, we have raised $45.0
million in regulatory tier 1 capital through the issuance of the Debentures.
Please refer to *“Note
18 - Notes Payable to Statutory Trusts”* to our
2004 consolidated financial statements for further details.
  ***Capital
Resources and Capital Adequacy Requirements***
  We are
subject to various regulatory capital requirements administered by federal
banking agencies. Failure to meet minimum capital requirements can trigger
regulatory actions that could have a material adverse effect on our business,
financial condition, results of operations, cash flows and/or future prospects.
Under capital adequacy guidelines and the regulatory framework for prompt
corrective action, we must meet specific capital guidelines that rely on
quantitative measures of our assets, liabilities and certain off-balance-sheet
items as calculated under regulatory accounting practices. Our capital amounts
and classification are also subject to qualitative judgments by the regulators
about components, risk weightings and other factors.
  We
monitor compliance with bank regulatory capital requirements, focusing primarily
on the risk-based capital guidelines. Under the risk-based capital method of
capital measurement, the ratio computed is dependent on the amount and
composition of assets recorded on the balance sheet and the amount and
composition of off-balance sheet items, in addition to the level of capital.
Generally, Tier 1 capital includes common stockholders’ equity our Series A
Preferred Stock, our junior subordinated debentures (subject to certain
limitations) less goodwill. Total capital represents Tier 1 plus the allowance
for loan and lease losses (subject to certain limits).
  In the
past three years, our primary sources of capital have been internally generated
operating income through retained earnings, our initial public offering, a
private placement and capital derived from the issuance of the 2002 Debentures.
As of December 31, 2004, 2003 and 2002, total stockholders’ equity was $158.3
million, $65.1 million and $57.3 million, respectively.
  58
 On
August 11, 2004, we completed an initial public offering in which we sold
3,450,000 shares of commons tock, plus an additional 517,500 shares in
connection with the exercise of the underwriters’ over-allotment option
effective September 15, 2004, at the initial offering price of $14.00 per share.
Total proceeds received from the offering, after deducting offering expenses,
including underwriting discounts and commissions, were approximately $50.1
million.
  On
June 21, 2004, our board of directors authorized a two-for-one common stock
split in the form of a stock dividend. The stock dividend was distributed on
July 15, 2004 to stockholders of record on July 1, 2004. All share
data and earnings per share data in these financial statements give effect to
the stock split, applied retroactively, to all periods.
  On May
12, 2004, in connection with the acquisition of BankTrust, we issued 733,316
(valued at $8.13) shares of common stock to our common stockholders and to
holders of options who were not otherwise stockholders to purchase our common
stock through a private placement offering.
  On
May 3, 2004, we acquired all of the capital stock of BankTrust for
approximately $23.4 million for which we issued 683,304 common shares (valued at
$8.13 per share) and 430,537 shares of perpetual non-cumulative preferred stock,
Series A (valued at $25 per share) and made cash payments of approximately $6.5
million. BankTrust was a commercial bank operating in Puerto Rico through an
existing network of five branches and whose total assets at the closing date
amounted to approximately $522.0 million. The BankTrust acquisition is
consistent with our growth strategy.
  During
2004, a total of 230,802 options were exercised for the aggregate exercise price
of $976,335. A total of 65,552 options were exercised on November 30 and
December 1, 2004 at an aggregate exercise price of $217,960, and 165,250 options
were exercised during the first quarter of 2004 at an aggregate exercise price
of $758,375.
  Also, on
December 15, 2002, we acquired all of the capital stock of Banco Financiero for
approximately $1.5 million for which we issued 244,456 common shares (valued at
$5.00 per share) and made cash payments of $326,391. Banco Financiero was a
commercial bank which operated through three branches in Ponce, Puerto Rico and
whose total assets at the closing date amounted to approximately $88.1 million.
The Banco Financiero acquisition is consistent with our growth
strategy.
  We are
not aware of any material trends that could materially affect our capital
resources other than those described in the section entitled “ *Risk
Factors,* ” in our
Prospectus on Form S-1 dated August 11, 2004.
  As of
December 31, 2004, we and Eurobank both qualified as “well-capitalized”
institutions under the regulatory framework for prompt corrective action. The
following table presents the regulatory standards for well-capitalized
institutions, compared to our capital ratios for Eurobank as of the dates
specified:
  59
  **Actual**
    
    ****
      **For
      Minimum Capital**
      **Adequacy
      Purposes**
    
    **To
      Be Well Capitalized****Under
      Prompt Corrective****Action
      Provision******
      ****
    
    **Amount
      Is**
    
    **Ratio
      Is**
    
    **Amount**
      **Must
      Be**
    
    **Ratio**
      **Must
      Be**
    
    **Amount**
      **Must
      Be**
    
    **Ratio**
      **Must
      Be****(Dollars
      in thousands)****As
      of December 31, 2004:**Total
      Capital (to Risk Weighted Assets)EuroBancshares,
      Inc
    
    $
    220,585
    
    
    13.94
    %
    
    ≥
      $126,564
    
    
    ≥
      8.00
    %
    
    N/AEurobank.
    
    
    169,705
    
    
    10.67
    
    
    ≥
      127,286
    
    
    ≥
      8.00
    
    
    ≥
      159,108
    
    
    ≥
      10.00
    %Tier
      1 Capital (to Risk Weighted Assets)EuroBancshares,
      Inc
    
    
    201,342
    
    
    12.73
    
    
    ≥
      63,282
    
    
    ≥
      4.00
    
    
    N/AEurobank
    
    
    130,461
    
    
    8.20
    
    
    ≥
      63,643
    
    
    ≥
      4.00
    
    
    ≥
      95,465
    
    
    ≥
      6.00Leverage
      (to average assets)EuroBancshares,
      Inc
    
    
    201,342
    
    
    9.91
    
    
    ≥
      81,303
    
    
    ≥
      4.00
    
    
    N/AEurobank
    
    
    130,461
    
    
    6.42
    
    
    ≥
      81,244
    
    
    ≥
      4.00
    
    
    ≥
      101,555
    
    
    ≥
      5.00**As
      of December 31, 2003:**Total
      Capital (to Risk Weighted Assets)EuroBancshares,
      Inc
    
    $
    117,934
    
    
    11.60
    %
    
    ≥
      $81,308
    
    
    ≥
      8.00
    %
    
    N/AEurobank
    
    
    117,614
    
    
    11.57
    
    
    ≥
      81,315
    
    
    ≥
      8.00
    
    
    ≥
      101,643
    
    
    ≥
      10.00
    %Tier
      1 Capital (to Risk Weighted Assets)EuroBancshares,
      Inc
    
    
    84,400
    
    
    8.30
    
    
    ≥
      40,654
    
    
    ≥
      4.00
    
    
    N/AEurobank
    
    
    75,638
    
    
    7.44
    
    
    ≥
      40,657
    
    
    ≥
      4.00
    
    
    ≥
      60,986
    
    
    ≥
      6.00Leverage
      (to average assets)EuroBancshares,
      Inc
    
    
    84,400
    
    
    6.76
    
    
    ≥
      49,958
    
    
    ≥
      4.00
    
    
    N/AEurobank
    
    
    75,638
    
    
    6.06
    
    
    ≥
      49,958
    
    
    ≥
      4.00
    
    
    ≥
      50,822
    
    
    ≥
      5.00**As
      of December 31, 2002:**Total
      Capital (to Risk Weighted Assets)EuroBancshares,
      Inc
    
    $
    105,461
    
    
    12.79
    %
    
    ≥
      $65,952
    
    
    ≥
      8.00
    %
    
    N/AEurobank
    
    
    104,033
    
    
    12.78
    
    
    ≥
      65,960
    
    
    ≥
      8.00
    
    
    ≥
      82,450
    
    
    ≥
      10.00
    %Tier
      1 Capital (to Risk Weighted Assets)EuroBancshares,
      Inc
    
    
    71,110
    
    
    8.63
    
    
    ≥
      32,976
    
    
    ≥
      4.00
    
    
    N/AEurobank
    
    
    64,692
    
    
    7.99
    
    
    ≥
      32,980
    
    
    ≥
      4.00
    
    
    ≥
      49,470
    
    
    ≥
      6.00Leverage
      (to average assets)EuroBancshares,
      Inc
    
    
    71,110
    
    
    7.93
    
    
    ≥
      35,879
    
    
    ≥
      4.00
    
    
    N/AEurobank
    
    
    64,692
    
    
    7.37
    
    
    ≥
      35,879
    
    
    ≥
      4.00
    
    
    ≥
      41,225
    
    
    ≥
      5.00
 ***Liquidity
Management***
  Maintenance
of adequate liquidity requires that sufficient resources be available at all
times to meet our cash flow requirements. Liquidity in a banking institution is
required primarily to provide for deposit withdrawals and the credit needs of
customers and to take advantage of investment opportunities as they arise.
Liquidity management involves our ability to convert assets into cash or cash
equivalents without incurring significant loss, and to raise cash or maintain
funds without incurring excessive additional cost. For this purpose, we maintain
a portion of our funds in cash and cash equivalents, deposits in other financial
institutions and loans and securities available for sale. Our liquid assets at
December 31, 2004, 2003 and 2002 totaled approximately $171.2 million, $144.0
million and $137.0 million, respectively. Our liquidity level measured as a
percentage of net cash, short-term and marketable assets to net deposits and
short-term liabilities was 14.2%, 15.2% and 16.9% for those same periods,
respectively.
  As a
secondary source of liquidity, we rely on advances from the FHLB to supplement
our supply of lendable funds and to meet deposit withdrawal requirements.
Advances from the FHLB are typically secured by qualified residential and
commercial mortgage loans, and investment securities. Advances are made pursuant
to several different programs. Each credit program has its own interest rate and
range of maturities. Depending on the program, limitations on the amount of
advances are based either on a fixed percentage of an institution’s net worth or
on the FHLB’s assessment of the institution’s creditworthiness. Other funding
alternatives available are local and United States conventional and brokered
time deposits, unsecured lines of credit with correspondent banks, borrowing
lines with brokers and the Federal Reserve Bank of New York. To participate in
the broker time deposits market, we must be categorized as “well capitalized”
under the regulatory framework for prompt corrective action unless we obtain a
waiver from the FDIC. Restrictions on our ability to participate in this market
could place limitations on our growth strategy or could result in our
participation in other more expensive funding sources. Our expansion strategies
will have to be reviewed to reflect the possible limitation to funding sources
and changes in cost structures. We do not foresee any changes in our capital
ratios that would restrict our ability to participate in the brokered deposit
market. Our target liquidity ratio established in our Liquidity Policy of liquid
assets as a percentage of net deposits and short-term liabilities is 10.0%. Our
liquidity demands are not seasonal and all trends have been stable over the last
three years. We are not aware of any trends or demands, commitments, events or
uncertainties that will result in or that are reasonably likely to materially
impair our liquidity. Generally, financial institutions determine their target
liquidity ratios internally, based on the composition of their liquidity assets
and their ability to participate in different funding markets that can provide
the required liquidity. In addition, the local market characteristics has make
it impossible to compare our liquidity needs and sources to the liquidity needs
and sources of our peers in the rest of the nation. After careful analysis of
the diversity of liquidity sources available to us, our asset quality and the
historic stability of our core deposits, we have determined that our target
liquidity ratio is adequate.
  60
 In
addition to the normal influx of liquidity from core deposit growth, together
with repayments and maturities of loans and investments, we utilize brokered and
out-of-market certificates of deposit, FHLB borrowings and broker-dealer
repurchase agreements to meet our liquidity needs. The FHLB borrowings are
collateralized by first mortgage residential loans, selected investment
securities and FHLB stock. Pre-approved repurchase agreement availability with
major brokers and banks totaled $320.0 million at December 31, 2004, subject to
acceptable unpledged marketable securities available for sale. In addition,
Eurobank is able to borrow from the Federal Reserve Bank using securities as
collateral. Eurobank also maintains pre-approved overnight borrowing lines at
various correspondent banks, which provided additional short-term borrowing
capacity of $17.5 million at December 31, 2004.
  During
2004, asset growth was funded with growth in deposits and borrowings. The
deposit growth was distributed as follows: $75.0 million in demand
deposits; $48.7 million in savings accounts; $301.6 million in time
deposits of which $282.9 million was comprised of brokered deposits. The
increase in the level of borrowings was primarily attributable to securities
sold under agreements to repurchase of $255.9 million. During 2004, cash
inflows from operating activities exceeded cash outflows by
$38.3 million.
  As of
December 31, 2003, deposit growth was distributed as follows:
$19.3 million in demand deposits; $83.6 million in savings accounts;
$29.1 million in time deposits of which $13.5 million was comprised of
brokered deposits. The increase in the level of borrowings was primarily
attributable to securities sold under agreements to repurchase of
$143.4 million. During 2003, cash inflows from operating activities
exceeded cash outflows by $7.2 million.
  During
2002, asset growth was funded with growth in deposits and borrowings. The
deposit growth was distributed as follows: $101.4 million in demand
deposits; $80.0 million in savings accounts; $225.9 million in time
deposits of which $112.7 million was comprised of brokered deposits. The
increase in the level of borrowings was primarily attributable to securities
sold under agreements to repurchase of $36.7 million and the issuance of
$26.6 million of junior subordinated debentures. During 2002, cash inflows from
operating activities exceeded cash outflows by $9.7 million.
  Our net
cash outflows from investing activities for the years 2004, 2003 and 2002 were
$294.7 million, $279.4 million and $349.3 million, respectively. The higher net
investing cash outflows experienced in 2003 were primarily due to growth in the
investment securities portfolio, which provided additional collateral in that
year to support wholesale funding increases. In 2002, the higher net investing
outflow was attributable to growth of our loan and lease portfolio.
  Our net
cash inflows from financing activities for the years 2004, 2003 and 2002 were
$252.5 million and $277.0 million and $333.6 million, respectively. In 2004, the
net financing cash inflows were primarily provided by repurchase agreements
growth and the net proceeds from the issuance of common stock. During 2002 and
2003, the net financing cash inflows were mostly provided by deposit and
repurchase agreements growth.
  **Impact
of Inflation and Changing Prices**
  The
financial statements and related data presented herein have been prepared in
accordance with accounting principles generally accepted in the United States of
America which require the measurement of financial position and operating
results in terms of historical dollars without considering changes in the
relative purchasing power of money over time due to inflation.
  61
 Unlike
most industrial companies, virtually all of the assets and liabilities of a
financial institution are monetary in nature. As a result, interest rates have a
more significant impact on a financial institution’s performance than the
effects of general levels of inflation. Interest rates do not necessary move in
the same direction or with the same magnitude as the prices of goods and
services since such prices are affected by inflation.
  ***Quantitative
and Qualitative Disclosure About Market Risks***
  Interest
rate risk is the most significant market risk affecting us. Other types of
market risk, such as foreign currency risk and commodity price risk, do not
arise in the normal course of our business activities. Interest rate risk can be
defined as the exposure to a movement in interest rates that could have an
adverse effect on our net interest income or the market value of our financial
instruments. The ongoing monitoring and management of this risk is an important
component of our asset and liability management process, which is governed by
policies established by Eurobank’s Board of Directors and carried out by
Eurobank’s Asset/Liability Management Committee. The Asset/Liability Management
Committee’s objectives are to manage our exposure to interest rate risk over
both the one year planning cycle and the longer term strategic horizon and, at
the same time, to provide a stable and steadily increasing flow of net interest
income. Interest rate risk management activities include establishing guidelines
for tenor and repricing characteristics of new business flow, the maturity
ladder of wholesale funding, investment security purchase and sale strategies
and mortgage loan sales, as well as derivative financial instruments. Eurobank
may enter into interest rate swap agreements, in which it exchanges the periodic
payments, based on a notional amount and agreed-upon fixed and variable interest
rates. At December 31, 2004, the Bank had interest rate swap agreements which
converted $50.2 million of fixed rate time deposits to variable rate time
deposits of which $19.4 million will mature in 2005 and 2006 and $30.8 million
with maturity between 2010 and 2023 but with semi-annual call options which
match call options on the swaps. In addition, at December 31, 2004, the Bank had
interest rate swap agreements which converted $52.5 million of variable rate
loans to fixed rate loans maturing $10.0 million in 2005, $12.0 million in 2006
and $30.5 million in 2007. The use of the above-mentioned derivative financial
instruments, which were acquired as part of the merger with The Bank & Trust
Puerto Rico, has not had a material impact on the Bank’s financial position at
December 31, 2004. For more detail on derivative financial instruments please
refer to *“Note
17 - Derivative Financial Instruments”* of our
2004 consolidated financial statements included herein.
  Our
primary measurement of interest rate risk is earnings at risk, which is
determined through computerized simulation modeling. The primary simulation
model assumes a static balance sheet, using the balances, rates, maturities and
repricing characteristics of all of the Bank’s existing assets and liabilities,
including off-balance sheet financial instruments. Net interest income is
computed by the model assuming market rates remaining unchanged and compares
those results to other interest rate scenarios with changes in the magnitude,
timing and relationship between various interest rates. At December 31, 2004, we
modeled rising ramp and declining interest rate simulations in 100 basis point
increments over a 12-month period. The impact of imbedded options in such
products as callable and mortgage-backed securities, real estate mortgage loans
and callable borrowings were considered. Changes in net interest income in the
rising and declining rate scenarios are then measured against the net interest
income in the rates unchanged scenario. The Asset/Liability Management Committee
utilizes the results of the model to quantify the estimated exposure of net
interest income to sustained interest rate changes.
  In the
December 31, 2004 simulation, our model indicated an exposure in the level of
net interest income to rising rates for a 12-month period. The hypothetical rate
scenarios consider a change of 100 and 200 basis points during a 12-month
period. The decreasing rate scenarios have a floor of 200 basis points. This
floor causes liabilities to have little cost reduction, while assets do have a
decrease in yields, causing a small loss in declining rate simulations of 200
basis points. At December 31, 2004, the net interest income at risk for year one
in the 100 basis point falling rate scenario was calculated at $213,000, or
0.33% lower than the net interest income in the rates unchanged scenario, and
$598,000, or 0.93%, lower than the net interest income in the rates unchanged
scenario at the December 31, 2004 simulation with a 200 basis point decrease.
These exposures are well within our policy guidelines of 15.0%. At December 31,
2004, the net interest income for year one in the 100 basis point rising rate
scenario was calculated to be $901,000, or 1.40%, higher than the net interest
income in the rates unchanged scenario, and $1.8 million, or 2.71%, higher than
the net interest income in the rate unchanged scenario at the December 31, 2004
simulation with a 200 basis point increase. Computation of prospective effects
of hypothetical interest rate changes are based on numerous assumptions,
including relative levels of market interest rates, loan and security
prepayments, deposit run-offs and pricing and reinvestment strategies and should
not be relied upon as indicative of actual results. Further, the computations do
not contemplate any actions we may take in response to changes in interest
rates. We cannot assure you that our actual net interest income would increase
or decrease by the amounts computed by the simulations. The following table
indicates the estimated impact on net interest income under various interest
rate scenarios as of December 31, 2004:
  62
  **Change
      in Future**
      **Net
      Interest Income******
    
    **At
      December 31, 2004****Change
      in Interest Rates**
    
    **Dollar
      Change**
    
    **Percentage
      Change****(Dollars
      in thousands)**+
      200 basis points over one year
    
    $
    1,752
    
    
    2.71
    %+
      100 basis points over one year
    
    
    901
    
    
    1.40-
      100 basis points over one year
    
    
    (213
    )
    
    (0.33
    )-
      200 basis points over one year
    
    
    (598
    )
    
    (0.93
    )
 We also
monitor the repricing terms of our assets and liabilities through gap matrix
reports for the rates in unchanged, rising and falling interest rate scenarios.
The reports illustrate, at designated time frames, the dollar amount of assets
and liabilities maturing or repricing.
  The
following table sets forth, on a stand-alone basis, Eurobank’s amounts of
interest-earning assets, interest-bearing liabilities and the nominal amount of
interest rate swaps outstanding at December 31, 2004, which we anticipate, based
upon certain assumptions, to reprice or mature in each of the future time
periods shown. The projected repricing of assets and liabilities anticipates
prepayments and scheduled rate adjustments, as well as contractual maturities
under an interest rate unchanged scenario within the selected time intervals.
While we believe such assumptions are reasonable, we cannot assure you that
assumed repricing rates will approximate our actual future deposit
activity.
  **As
      of December 31, 2004**
      **Volumes
      Subject to Repricing Within******
      ****
    
    **0-1**
      **Days**
    
    **2-180**
      **Days**
    
    **181-365**
      **Days**
    
    **1-3**
      **Years**
    
    **Over**
      **3
      Years**
    
    **Non-Interest**
      **Sensitive**
    
    ****
      **Total****(Dollars
      in thousands)****Assets:**Short-term
      investments and federal funds sold
    
    $
    42,810
    
    $
    —
    
    $
    —
    
    $
    —
    
    $
    —
    
    $
    —
    
    $
    42,810Investment
      securities and FHLB/ Federal Reserve Bank stock
    
    
    —
    
    
    94,517
    
    
    195,416
    
    
    194,060
    
    
    131,588
    
    
    —
    
    
    615,581Loans
    
    
    —
    
    
    717,175
    
    
    66,244
    
    
    277,231
    
    
    307,924
    
    
    —
    
    
    1,368,574Fixed
      and other assets
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    92,931
    
    
    92,931Total
      swaps
    
    
    —
    
    
    10,000
    
    
    9,442
    
    
    63,285
    
    
    —
    
    
    —
    
    
    82,727Total
      assets
    
    $
    42,810
    
    $
    821,692
    
    $
    271,102
    
    $
    534,576
    
    $
    439,512
    
    $
    92,931
    
    $
    2,202,623**Liabilities
      and Stockholders’ Equity:**Interest-bearing
      checking, savings and money market accounts
    
    
    —
    
    
    71,279
    
    
    231
    
    
    —
    
    
    —
    
    
    463,496
    
    
    535,006Certificates
      of deposit
    
    
    —
    
    
    275,540
    
    
    150,626
    
    
    273,853
    
    
    172,949
    
    
    —
    
    
    872,968Borrowed
      funds
    
    
    —
    
    
    435,585
    
    
    16,802
    
    
    40,314
    
    
    26,112
    
    
    —
    
    
    518,813Other
      liabilities
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    14,194
    
    
    14,194Total
      swaps
    
    
    —
    
    
    102,727
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    102,727Stockholders’
      equity
    
    
    —
    
    
    10,763
    
    
    —
    
    
    —
    
    
    —
    
    
    158,915
    
    
    169,678Total
      liabilities and stockholders’ equity
    
    $
    —
    
    $
    895,894
    
    $
    167,659
    
    $
    314,167
    
    $
    199,061
    
    $
    636,605
    
    $
    2,213,386Period
      gap
    
    $
    42,810
    
    $
    (74,202
    )
    $
    103,443
    
    $
    220,409
    
    $
    240,451Cumulative
      gap
    
    $
    42,810
    
    $
    (31,392
    )
    $
    72,051
    
    $
    292,460
    
    $
    532,911Period
      gap to total assets
    
    
    1.94
    %
    
    -3.37
    %
    
    4.70
    %
    
    10.01
    %
    
    10.92
    %Cumulative
      gap to total assets
    
    
    1.94
    %
    
    -1.43
    %
    
    3.27
    %
    
    13.28
    %
    
    20.89
    %Cumulative
      interest-earning assets to cumulative interest-bearing
      liabilities
    
    
    N/A
    
    
    96.50
    %
    
    106.77
    %
    
    121.23
    %
    
    129.19
    %
 Certain
shortcomings are inherent in the method of analysis presented in the gap table.
For example, although certain assets and liabilities may have similar maturities
or periods of repricing, they may react in different degrees to changes in
market interest rates. Additionally, certain assets, such as adjustable-rate
loans, have features that restrict changes in interest rates, both on a
short-term basis and over the life of the asset. More importantly, changes in
interest rates, prepayments and early withdrawal levels may deviate
significantly from those assumed in the calculations in the table. As a result
of these shortcomings, we focus more on earnings at risk simulation modeling
than on gap analysis. Even though the gap analysis reflects a ratio of
cumulative gap to total assets within acceptable limits, the earnings at risk
simulation modeling is considered by management to be more informative in
forecasting future income at risk.
  63
 Finally,
we also monitor core funding utilization in each interest rate scenario as well
as market value of equity. These measures are used to evaluate long-term
interest rate risk beyond the two-year planning horizon.
  ***Aggregate
Contractual Obligations***
  The
following table represents our on and off-balance sheet aggregate contractual
obligations, other than deposit liabilities, to make future payments to third
parties as of the date specified:
  **As
      of December 31, 2004******
      ****
    
    **Less
      than**
      **One
      Year**
    
    **One
      Year to**
      **Three
      Years**
    
    **Over
      Three Years**
      **to
      Five Years**
    
    ****
      **Over
      Five Years****(In
      thousands)**FHLB
      advances
    
    $
    —
    
    $
    9,800
    
    $
    —
    
    $
    604Notes
      payable to statutory trusts
    
    
    —
    
    
    —
    
    
    —
    
    
    46,393Operating
      leases
    
    
    2,199
    
    
    3,638
    
    
    1,988
    
    
    8,277Total
    
    $
    2,199
    
    $
    13,438
    
    $
    1,988
    
    $
    55,274
 ***Off-Balance
Sheet Arrangements***
  During
the ordinary course of business, we provide various forms of credit lines to
meet the financing needs of our customers. These commitments, which have a term
of less than one year, represent a credit risk and are not represented in any
form on our balance sheets.
  As of
December 31, 2004, 2003 and 2002, we had commitments to extend credit of $269.4
million, $156.4 million and $139.0, respectively. These commitments included
standby letters of credit of $10.5 million, $2.7 million and $2.7 for December
31, 2004, 2003 and 2002, respectively, and commercial letters of credit of $1.8
million, $977,000 and $1.3 million for those same periods, respectively.
Starting in the fiscal year 2003, in accordance with FIN 45, it is our policy to
recognize the estimated fair value of our obligations under standby letters of
credit issued, which are then reduced by credits to earnings as we are released
from the stand-ready risk. However, at December 31, 2004, no obligation was
recorded since the amounts were inconsequential.
  The
effect on our revenues, expenses, cash flows and liquidity of the unused
portions of these commitments cannot reasonably be predicted because there is no
guarantee that the lines of credit will be used. For more information regarding
our off-balance sheet arrangements, see *“Note
27 — Financial Instruments with Off-Balance-Sheet Risk”* to our
2004 consolidated financial statements.
  ***Recent
Accounting Pronouncements***
  SFAS
No. 150, Accounting for Certain Financial Instruments with Characteristics
of both Liabilities and Equity, was issued in May 2003. This statement
establishes standards for the classification and measurement of certain
financial instruments with characteristics of both liabilities and equity. The
statement also includes required disclosures for financial instruments within
its scope. For the Company, the statement was effective for instruments entered
into or modified after May 31, 2003 and otherwise will be effective as of
January 1, 2004, except for mandatorily redeemable financial instruments.
For certain mandatorily redeemable financial instruments, the statement will be
effective for the Company on January 1, 2005. The effective date has been
deferred indefinitely for certain other types of mandatorily redeemable
financial instruments. This statement did not have a material impact on the
Company’s financial statements.
  In
December 2003, the Accounting Standards Executive Committee issued Statement of
Position 03-3 (SOP 03-3), *Accounting
for Certain Loans or Debt Securities Acquired in a Transfer* . This
statement addresses accounting for differences between contractual cash flows
and cash flows expected to be collected from an investor’s initial investment in
loans or debt securities acquired in a transfer if those differences are
attributable, at least in part, to credit quality. SOP 03-3 does not apply to
loans originated by the entity. SOP 03-3 limits the yield that may be accreted
(accretable yield) to the excess of the investor’s estimate of undiscounted
expected principal, interest, and other cash flows (cash flows expected at
acquisition to be collected) over the investor’s initial investment in the loan.
SOP 03-3 requires that the excess of contractual cash flows over cash flows
expected to be collected (nonaccretable difference) not be recognized as an
adjustment of yield, loss accrual, or valuation allowance. SOP 03-3 prohibits
investors from displaying accretable yield and nonaccretable difference in the
balance sheet. Subsequent increases in cash flows expected to be collected
generally should be recognized prospectively through adjustment of the loan’s
yield over its remaining life. Decreases in cash flows expected to be collected
should be recognized as impairment. SOP 03-3 prohibits “carrying over” or
creation of valuation allowances in the initial accounting of all loans acquired
in a transfer that are within the scope of this statement. The prohibition of
the valuation allowance carryover applies to the purchase of an individual loan,
a pool of loans, a group of loans, and loans acquired in a purchase business
combination. SOP 03-3 is effective for loans acquired in fiscal years beginning
after December 15, 2004. Early adoption is encouraged. The Company elected to
adopt SOP 03-3 for the year ending December 31, 2005. The impact of the new
accounting pronouncement cannot be reasonably estimated as it is related to
future loan acquisitions.
  64
 In March
2004, the U.S. Securities and Exchange Commission released the Staff Accounting
Bulletin (“SAB”) No. 105, “Loan Commitments Accounted for as Derivative
Instruments.” This bulletin informs registrants of the staff’s view that the
fair value of the recorded loan commitments should not consider the expected
future cash flows related to the associated servicing of the future loan. The
provisions of SAB 105 must be applied to loan commitments accounted for as
derivatives that are entered into after March 31, 2004. The staff will not
object to the application of existing accounting practices to loan commitments
accounted for as derivatives that are entered into on or before March 31,
2004, with appropriate disclosures. On April 1, 2004, the Company adopted
the provisions of SAB 105, which did not have an impact on the Company’s
financial condition or results of operations.
  In March
2004, the Emerging Issues Task Force (“EITF”) reached a consensus on the
application on Issue 03-1, “The Meaning of Other-Than-Temporary Impairment
and Its Application to Certain Investments.” The EITF reached a consensus on the
impairment model to be used to determine when an investment is considered
impaired, whether that impairment is other than temporary, and the measurement
of an impairment loss. The impairment model also includes accounting
considerations subsequent to the recognition of an other-than-temporary
impairment and requires certain disclosures about unrealized losses that have
not been recognized as other-than-temporary impairments. This impairment model
is applicable for investments in debt and equity securities that are within the
scope of SFAS No. 115, “Accounting for Certain Investments in Debt and
Equity Securities” and equity securities that are not subject to the scope of
SFAS 115 and not accounted for under the equity method under APB Opinion
No. 18, “The Equity Method of Accounting for Investments in Common Stock”
referred in Issue 03-1 as the cost method investments. The impairment model
developed by the EITF to determine whether an investment is within the scope of
Issue 03-1 involves a sequence of steps including the following:
Step 1 - determine whether an investment is impaired. If an impairment
indicator is present, as determined in Step 1, the investor should estimate
the fair value of the investment. If the fair value of the investment is less
than its cost, proceed with Step 2 - evaluate whether an impairment is
other than temporary. Step 3 - if the impairment is other than temporary,
recognize an impairment loss equal to the difference between the investment’s
cost and its fair value. The impairment model described above-used to determine
other-than-temporary impairment was effective for reporting periods beginning
after June 15, 2004. In September 2004, the FASB delayed the requirements
to record impairment losses under EITF 03-1 until such time as new guidance is
issued and comes into effect. Currently, the disclosure requirements originally
prescribed by EITF 03-1 will remain in effect.
  In
December 2004, the Financial Accounting Standards Board (“FASB”) issued its
final standard on accounting for share-based payments (“SBP”), FASB Statement
No. 123R, revised 2004, “Share-Based Payment” ** (“FAS
123R”), that requires companies to expense the value of employee stock options
and similar awards. Under FAS 123R, SBP awards result in a cost that will be
measured at fair value on the awards grant date, based on the estimated number
of awards that are expected to vest. Compensation cost for awards that vest
would not be reversed if the awards expire without being exercised. When
measuring fair value, companies can choose an option-pricing model that
appropriately reflects their specific circumstances and the economics of their
transactions. FAS 123R states that companies will recognize compensation cost
for SBP awards as they vest including the related tax effects. Upon settlement
of SBP awards, the tax effects will be recognized in the income statement or
additional paid-in capital. Public companies are allowed to select from three
alternative transition methods each having different reporting implications:
modified prospective method, modified prospective method variation and modified
retrospective method. Public companies with calendar year-ends will be required
to adopt FAS 123R in the third quarter of 2005. The Company elected to adopt the
requirements of FASB 123R for the third quarter of 2005. Management believes it
will not have a material impact on the Company’s financial condition or results
of operations.
  65
 **ITEM
7A. Quantitative and Qualitative Disclosures About Market
Risk.**
  The
information contained in the section captioned “Management’s Discussion and
Analysis of Financial Condition and Results of Operations” as set forth in Part
II, Item 7 of this Annual Report on Form 10-K is incorporated herein by
reference.
  **ITEM
8.** **Financial
Statements and Supplementary Data.**
  The
consolidated financial statements, the reports thereon, the notes thereto and
supplementary data commence at page F-1 of this Annual Report on Form
10-K.
  **ITEM
9.** **Changes
in and Disagreements With Accountants on Accounting and Financial
Disclosure.**
  Not
applicable.
  **ITEM
9A. Controls and Procedures.**
 *Introductory
Note* . As of
the date of this Annual Report on Form 10-K, we are not an accelerated filer
within the meaning of Rule 12b-2 of the Securities Exchange Act of 1934, as
amended. As such, we are not currently subject to the internal control over
financial reporting requirements of Section 404 of the Sarbanes-Oxley Act that
require us to include in our Annual Report on Form 10-K a report by management
of our internal control over financial reporting and an accompanying auditor’s
report. However, our subsidiary bank, Eurobank, is subject to the reporting
obligations under Section 36 of the Federal Deposit Insurance Act which contains
certain reporting requirements of the Bank that are similar to those contained
in Section 404, including the delivery of a report of management of the Bank as
to the effectiveness of the Bank’s internal control structure and procedures for
financial reporting. The information set forth below with respect to the
identification of an internal control deficiency in Eurobank’s internal control
over financial reporting has been disclosed only for purposes of Eurobank’s
compliance with its reporting obligations under Section 36 of the Federal
Deposit Insurance Act and should not be read in the context of any similar
reporting requirement under Section 404 of the Sarbanes-Oxley Act.
  *Disclosure
Controls and Procedures* . We
maintain disclosure controls and procedures that are designed to ensure that
information required to be disclosed in our reports under the Securities
Exchange Act of 1934, as amended, is recorded, processed, summarized and
reported within the time periods specified in the SEC’s rules and forms, and
that such information is accumulated and communicated to management, including
the Company’s Chief Executive Officer and Chief Financial Officer, as
appropriate, to allow timely decisions regarding required disclosure. In
designing and evaluating the disclosure controls and procedures, management
recognized that any controls and procedures, no matter how well designed and
operated, can provide only reasonable assurance of achieving the desired control
objectives.
  In
connection with the preparation of this Annual Report on Form 10-K, as of the
end of the period, an evaluation was performed with the participation of the CEO
and CFO, of the effectiveness of our disclosure controls and procedures as
required by Rule 13a-14 of the Exchange Act. Based upon that evaluation and
because of the internal control deficiency described below, the CEO and CFO
concluded that our disclosure controls and procedures may not be effective as of
the end of the period covered by this report so as to alert them in a timely
fashion to material information required to be disclosed in reports we file
under the Exchange Act.
  In
designing and evaluating the disclosure controls and procedures, our management
recognized that any controls and procedures, no matter how well designed and
operated, can provide only reasonable assurance of achieving the desired control
objectives and in reaching a reasonable level of assurance our management
necessarily was required to apply its judgment in evaluating the cost-benefit
relationship of possible controls and procedures.
  There
were no changes in our internal controls over financial reporting during the
year ended December 31, 2004 that materially affected, or were reasonably likely
to materially affect, our internal controls over financial reporting; however,
we are in the process of reviewing our internal controls in light of the
weakness identified below.
  *Management’s
Annual Report on Internal Control over Financial Reporting for Eurobank Under
Section 36 of the Federal Deposit Insurance Act* . Under
regulations adopted by the FDIC implementing Section 36 of the Federal Deposit
Insurance Act, a federally insured depository institution with total assets of
$500 million or more, such as Eurobank, is required, among other things, to
prepare an annual management report that contains:
  ·
    A
      statement of management’s responsibility for preparing the institution’s
      annual financial statements, for establishing and maintaining an adequate
      internal control structure and procedures for financial reporting, and for
      complying with designated laws and regulations relating to safety and
      soundness; and
  ·
    Management’s
      assessment of the effectiveness of the institution’s internal control
      structure and procedures for financial reporting as of the end of the
      fiscal year and the institution’s compliance with the designated safety
      and soundness laws and regulations during the fiscal
  year.
  The
FDIC’s regulations additionally require the institution’s independent accountant
to examine, and attest to, management’s assertions concerning the effectiveness
of the institution’s internal control structure and procedures for financial
reporting. The institution’s management report and the accountant’s attestation
report must be filed with the FDIC, the institution’s primary federal regulator
(if other than the FDIC), and any appropriate state depository institution
supervisor and must be available for public inspection.
  Although
bank and thrift holding companies are not required under the FDIC’s regulations
to prepare these internal control reports, many of these holding companies do so
under a provision of Part 363 of the FDIC’s regulations that permits an insured
depository institution that is the subsidiary of a holding company to satisfy
its internal control report requirements with an internal control report of the
consolidated holding company’s management if:
  ·
    Services
      and functions comparable to those required of the subsidiary by Part 363
      are provided at the holding company level;
and
  ·
    The
      subsidiary has, as of the beginning of its fiscal year, (i) total assets
      of less than $5 billion or (ii) total assets of $5 billion or more and a
      composite rating of 1 or 2 under the Uniform Financial Institutions Rating
      System.
  Currently,
we satisfy these internal control report requirements with an internal control
report of Eurobank.
  Management
of Eurobank is responsible for establishing and maintaining an adequate internal
control structure and procedures for financial reporting under FDIC rules and
regulations. Eurobank’s internal control over financial reporting is designed to
provide reasonable assurance to the Bank’s management and Board of Directors
regarding the preparation and fair presentation of published financial
statements. Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Also, projections of any
evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions, or that the
degree of compliance with the policies or procedures may
deteriorate.
  Management
of Eurobank has assessed the effectiveness of the Bank’s internal control over
financial reporting as of the end of the period covered by this report. In
making its assessment of internal control over financial reporting, management
used the criteria set forth by the Committee of Sponsoring Organizations of the
Treadway Commission (“COSO”) in *Internal
Control—Integrated Framework* . In
performing this assessment, management identified a deficiency related to
accounting for certain derivative financial instruments that were acquired in
connection with our acquisition of BankTrust in May 2004 under Statement of
Financial Accounting Standards No. 133, “Accounting for Derivative
Instruments and Hedging Activities,” (“SFAS 133”). Specifically, the deficiency
resulted from the lack of adequate controls designed to ensure that the
documentation, monitoring and evaluation required by generally accepted
accounting principles is properly maintained for the term of the respective
derivative financial instrument and that such documentation provides reasonable
assurance to support the ongoing monitoring of the Bank’s hedging activities.
Management has concluded that the amounts involved with respect to these
derivative financial instruments are not material for the periods reported and
that prior 2004 interim financial statements need not be revised.
  Management
evaluated the impact of this deficiency on Eurobank assessment of internal
control over financial reporting and has concluded that the control deficiency
described above represents a material weakness (as defined in Auditing Standard
No. 2 by the Public Company Accounting Oversight Board). Accordingly,
management has concluded that, as of the end of the period covered by this
report, Eurobank’s internal control over financial reporting may not be
effective based on the criteria set forth by the COSO in *Internal
Control—Integrated Framework* .
  *Remediation
of Material Weakness of Eurobank* . We and
Eurobank are in the process of evaluating, analyzing and designing our
internal control systems with respect to the Bank’s accounting of derivative
financial instruments to determine if the Bank’s current documentation,
monitoring and evaluation process is effective. While the Bank has maintained
some documentation to support the effectiveness of the Bank’s existing hedging
activities, we are in the process of compiling additional documentation as may
be required to comply with SFAS 133. We will discontinue accounting for
derivative financial instruments under SFAS 133 unless we believe that adequate
controls, documentation, monitoring and evaluations are in
place.
 
 **ITEM
9B. Other Information.**
  Not
applicable.
  **PART
III**
  **ITEM
10.** **Directors
and Executive Officers of the Registrant.**
  The
information under the captions “Proposal Regarding Election of Directors” and
“Section 16(a) Beneficial Ownership Reporting Compliance” in our definitive
proxy statement for our 2005 annual meeting of stockholders to be filed with the
SEC pursuant to Regulation 14A under the Securities and Exchange Act of 1934, as
amended, is incorporated herein by reference.
  We have
adopted a Code of Business Conduct and Ethics that applies to our directors,
officers and employees. Our Code of Business Conduct and Ethics is publicly
available on our website at http://investor.eurobankpr.com . If we
make any substantive amendments to our Code of Business Conduct and Ethics or
grant any waiver, including any implicit waiver, from a provision of the code to
our principal executive officer, principal financial officer, principal
accounting officer or controller, we will disclose the nature of such amendment
or waiver on that website or in a report on Form 8-K.
  66
 **ITEM
11.** **Executive
Compensation.**
  The
information under the caption “Executive Compensation” in our definitive proxy
statement for our 2005 annual meeting of stockholders to be filed with the SEC
pursuant to Regulation 14A under the Securities and Exchange Act of 1934, as
amended, is incorporated herein by reference.
  **ITEM
12.** **Security
Ownership of Certain Beneficial Owners and Management.**
  The
information under the caption “Security Ownership of Certain Beneficial Owners
and Management” in our definitive proxy statement for our 2005 annual meeting of
stockholders to be filed with the SEC pursuant to Regulation 14A under the
Securities and Exchange Act of 1934, as amended, is incorporated herein by
reference.
  **ITEM
13.** **Certain
Relationships and Related Transactions.**
  The
information under the caption “Certain Relationships and Related Transactions”
in our definitive proxy statement for our 2005 annual meeting of stockholders to
be filed with the SEC pursuant to Regulation 14A under the Securities and
Exchange Act of 1934, as amended, is incorporated herein by
reference.
  **ITEM
14.** **Principal
Accounting Fees and Services.**
  The
information under the caption “Principal Auditor Fees and Services” in our
definitive proxy statement for our 2005 annual meeting of stockholders to be
filed with the SEC pursuant to Regulation 14A under the Securities and Exchange
Act of 1934, as amended, is incorporated herein by reference.
  **PART
IV**
  **ITEM
15.** **Exhibits,
Financial Statement Schedules**
  **Financial
Statements**
  Reference
is made to the consolidated financial statements, the reports thereon, the notes
thereto and supplementary data commencing at page F-1 of this Annual Report on
Form 10-K. Set forth below is a list of such financial statements:
  Report of
Independent Registered Public Accounting Firm
 Consolidated
Balance Sheets as of December 31, 2004 and 2003
 Consolidated
Statements of Income for each of the years in the three-year period ended
December 31, 2004
 Consolidated
Statements of Changes in Stockholders’ Equity and Comprehensive Income for each
of the years in the three-year period ended December 31, 2004
 Consolidated
Statements of Cash Flows for each of the years in the three-year period ended
December 31, 2004
 Notes to
Consolidated Financial Statements
  **Financial
Statement Schedules**
  All
supplemental schedules are omitted as inapplicable or because the required
information is included in the consolidated financial statements or related
notes.
  **Exhibits**
  **Exhibit
      Number**
    
    **Description
      of Exhibit**3.1
    
    Amended
      and Restated Certificate of Incorporation of EuroBancshares, Inc.
      (incorporated herein by reference to Exhibit 3.1 to the Registration
      Statement on Form S-1 (File No. 333-115510) previously filed by
      EuroBancshares, Inc. on May 5, 2004)3.2
    
    Amended
      and Restated Bylaws of EuroBancshares, Inc. (incorporated herein by
      reference to Exhibit 3.2 to the Registration Statement on Form S-1 (File
      No. 333-115510) previously filed by EuroBancshares, Inc. on May 5,
      2004)
  67
  **Exhibit
      Number**
    
    **Description
      of Exhibit**
 3.3
    
    Certificate
      of Designation of EuroBancshares, Inc. Noncumulative Preferred Stock,
      Series A (incorporated herein by reference to Exhibit 3.3 to the
      Registration Statement on Form S-1 (File No. 333-115510) previously filed
      by EuroBancshares, Inc. on May 5, 2004)4.1
    
    Specimen
      stock certificate representing EuroBancshares, Inc. Common Stock
      (incorporated herein by reference to Exhibit 4.1 to the Registration
      Statement on Form S-1 (File No. 333-115510) previously filed by
      EuroBancshares, Inc. on August 2, 2004)4.2*
    
    Specimen
      stock certificate representing EuroBancshares, Inc. Preferred
      Stock4.3
    
    Indenture,
      dated as of December 18, 2001, between EuroBancshares, Inc. and U.S. Bank
      National Association (f/k/a State Street Bank & Trust Company of
      Connecticut, National Association) (incorporated herein by reference to
      Exhibit 4.2 to the Registration Statement on Form S-1 (File No.
      333-115510) previously filed by EuroBancshares, Inc. on May 5,
      2004)4.4
    
    Amended
      and Restated Declaration of Trust, dated as of December 18, 2001, by and
      among EuroBancshares, Inc. and U.S. Bank National Association (f/k/a State
      Street Bank & Trust Company of Connecticut, National Association), and
      Rafael Arrillaga-Torréns, Jr., Jorge Calderón Drowett, and William
      Torres-Torres, as Administrators (incorporated herein by reference to
      Exhibit 4.3 to the Registration Statement on Form S-1 (File No.
      333-115510) previously filed by EuroBancshares, Inc. on May 5,
      2004)4.5
    
    Guarantee
      Agreement, dated as of December 18, 2001, between EuroBancshares, Inc. and
      U.S. Bank National Association (f/k/a State Street Bank & Trust
      Company of Connecticut, National Association) (incorporated herein by
      reference to Exhibit 4.4 to the Registration Statement on Form S-1 (File
      No. 333-115510) previously filed by EuroBancshares, Inc. on May 5,
      2004)4.6
    
    Indenture,
      dated as of December 19, 2002, between EuroBancshares, Inc. and U.S. Bank
      National Association (f/k/a State Street Bank & Trust Company of
      Connecticut, National Association) (incorporated herein by reference to
      Exhibit 4.5 to the Registration Statement on Form S-1 (File No.
      333-115510) previously filed by EuroBancshares, Inc. on May 5,
      2004)4.7
    
    Amended
      and Restated Declaration of Trust, dated as of December 19, 2002, by and
      among EuroBancshares, Inc. and U.S. Bank National Association (f/k/a State
      Street Bank & Trust Company of Connecticut, National Association), and
      Jose Martinez Recondo, Isabella Arrillaga, as Administrators (incorporated
      herein by reference to Exhibit 4.6 to the Registration Statement on Form
      S-1 (File No. 333-115510) previously filed by EuroBancshares, Inc. on May
      5, 2004)4.8
    
    Guarantee
      Agreement, dated as of December 19, 2002, between EuroBancshares, Inc. and
      U.S. Bank National Association (f/k/a State Street Bank & Trust
      Company of Connecticut, National Association) (incorporated herein by
      reference to Exhibit 4.7 to the Registration Statement on Form S-1 (File
      No. 333-115510) previously filed by EuroBancshares, Inc. on May 5,
      2004)10.1†
    
    EuroBancshares,
      Inc. 2002 Stock Option Plan (incorporated herein by reference to Exhibit
      10.1 to the Registration Statement on Form S-1 (File No. 333-115510)
      previously filed by EuroBancshares, Inc. on May 5, 2004)10.2†
    
    Form
      of EuroBancshares, Inc. Incentive Stock Option Award Agreement
      (incorporated herein by reference to Exhibit 10.2 to the Registration
      Statement on Form S-1 (File No. 333-115510) previously filed by
      EuroBancshares, Inc. on May 5, 2004)10.3†
    
    Form
      of EuroBancshares, Inc. Non-Qualified Stock Option Award Agreement
      (incorporated herein by reference to Exhibit 10.3 to the Registration
      Statement on Form S-1 (File No. 333-115510) previously filed by
      EuroBancshares, Inc. on May 5, 2004)
  68
  **Exhibit
      Number**
    
    **Description
      of Exhibit**
 10.4†
    
    Executive
      Severance Compensation Agreement, dated as of April 12, 1999, between
      Eurobank and Ms. Yadira R. Mercado (incorporated herein by reference to
      Exhibit 10.4 to the Registration Statement on Form S-1 (File No.
      333-115510) previously filed by EuroBancshares, Inc. on May 5,
      2004)10.5†
    
    Eurobank
      Master Trust Retirement Plan Program (incorporated herein by reference to
      Exhibit 10.5 to the Registration Statement on Form S-1 (File No.
      333-115510) previously filed by EuroBancshares, Inc. on May 5,
      2004)10.6†
    
    Form
      of EuroBancshares, Inc. Restricted Stock Purchase Agreement (incorporated
      herein by reference to Exhibit 10.6 to the Registration Statement on Form
      S-1 (File No. 333-115510) previously filed by EuroBancshares, Inc. on May
      5, 2004)10.7
    
    Agreement
      and Plan of Merger, dated as of September 6, 2002, by and among
      EuroBancshares, Inc. and Banco Financiero de Puerto Rico (incorporated
      herein by reference to Exhibit 10.7 to the Registration Statement on Form
      S-1 (File No. 333-115510) previously filed by EuroBancshares, Inc. on May
      5, 2004)10.8
    
    Agreement
      and Plan of Merger, dated as of February 24, 2004, by and among
      EuroBancshares, Inc., Eurobank, and The Bank & Trust of Puerto Rico
      (incorporated herein by reference to Exhibit 2 to the Registration
      Statement on Form S-1 (File No. 333-115510) previously filed by
      EuroBancshares, Inc. on May 5, 2004)21
    
    List
      of Subsidiaries of EuroBancshares, Inc. (incorporated herein by reference
      to Exhibit 21 to the Registration Statement on Form S-1 (File No.
      333-115510) previously filed by EuroBancshares, Inc. on May 5,
      2004)23.1*
    
    Consent
      of KPMG LLP, independent registered public accounting firm31.1*
    
    Rule
      13a-14(a) Certification of Chief Executive Officer.31.2*
    
    Rule
      13a-14(a) Certification of Chief Financial Officer.32.1*
    
    Certification
      of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted
      pursuant to Section 906 of the Sarbanes-Oxley Act of
  2002.32.2*
    
    Certification
      of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted
      pursuant to Section 906 of the Sarbanes-Oxley Act of
  2002.
 ___________________
 * Filed
with this Annual Report on Form 10-K.
 †
Constitutes a management contract or compensatory plan or
arrangement.
 
 69
 
 **SIGNATURES**
  Pursuant
to the requirements of Section 13 or 15(d) of the Securities Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
  EUROBANCSHARES,
INC.
  Date:
March 31, 2005     By: /s/
Rafael Arrillaga-Torréns, Jr.
 Rafael
Arrillaga Torréns, Jr.
 Chairman
of the Board, President and Chief
 Executive
Officer
  Pursuant
to the requirements of the Securities Act of 1934, this report has been signed
below by the following persons on behalf of the registrant and in the capacities
and on the dates indicated.
  Date:
March 31, 2005     By: /s/
Rafael Arrillaga-Torréns, Jr.
 Rafael
Arrillaga Torréns, Jr.
 Chairman
of the Board, President and Chief
 Executive
Officer (principal executive officer)
 
 Date:
March 31, 2005     By: /s/
Yadira R. Mercado
 Yadira R.
Mercado
 Executive
Vice President and Chief Financial Officer
 (principal
financial officer and principal accounting
 officer)
 
 Date:
March 31, 2005     By: /s/
Pedro Feliciano Benítez
 Pedro
Feliciano Benítez
 Director
 
 Date:
March 31, 2005     By: /s/
Juan Ramón Gómez-Cuétara Aguilar
 Juan
Ramón Gómez-Cuétara Aguilar
 Director
 
 Date:
March 31, 2005     By: /s/
Antonio R. Pavía Bibiloni
 Antonio
R. Pavía Bibiloni
 Director
 
 Date:
March 31, 2005     By: /s/
Plácido González Córdova
 Plácido
González Córdova
 Director
 
 Date:
March 31, 2005     By: /s/
Jorge Calderón Drowett
 Jorge
Calderón Drowett
 Director
 
 Date:
March 31, 2005     By: /s/
Ricardo Levy Echeandía
 Ricardo
Levy Echeandía
 Director
 
 Date:
March 31, 2005     By: /s/
Diana López-Feliciano
 Diana
López-Feliciano
 Director
 
 Date:
March 31, 2005     By: /s/
William Torres Torres
 William
Torres Torres
 Director
 
    70


**EUROBANCSHARES,
INC. AND SUBSIDIARIES**
  Consolidated
Financial Statements
  December 31,
2004 and 2003
  (With
Report of Independent Registered Public Accounting Firm Thereon)
  
 **Report
of Independent Registered Public Accounting Firm**
  The Board
of Directors and Shareholders of
 Eurobancshares,
Inc.:
  We have
audited the accompanying consolidated balance sheets of EuroBancshares, Inc. and
subsidiaries (the Company) as of December 31, 2004 and 2003, and the
related consolidated statements of income, changes in stockholders’ equity and
comprehensive income, and cash flows for each of the years in the three-year
period ended December 31, 2004. These consolidated financial statements are the
responsibility of the Company’s management. Our responsibility is to express an
opinion on these consolidated financial statements based on our
audits.
  We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
  In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of EuroBancshares, Inc. and
subsidiaries as of December 31, 2004 and 2003, and the results of their
operations and their cash flows for each of the years in the three-year period
ended December 31, 2004, in conformity with U.S. generally accepted accounting
principles.
  As
discussed in note 1, the Company adopted the provision of Financial
Accounting Standards Board’s Interpretation No. 46R, *Consolidation
of Variable Interest Entities* , as of
December 31, 2003.
  /s/ KPMG
LLP
 San
Juan , Puerto
RicoMarch 30, 2005
  Stamp
No. 1988734 of the Puerto Rico
 Society
of Certified Public Accountants
 was
affixed to the record copy of this report.
 
 F-1
 ******EUROBANCSHARES,
INC. AND SUBSIDIARIES**
**CONSOLIDATED
BALANCE SHEETS**
**December
31, 2004 and
2003******
 **2004**
    
    **2003****ASSETS**Cash
      and due from banks
    
    $
    18,597,116
    
    $
    22,522,342Interest-bearing
      deposits
    
    
    3,271,377
    
    
    19,324,216Securities
      purchased under agreements to resell
    
    
    42,810,479
    
    
    20,483,736Investment
      securities available for sale, at fair value:Pledged
      securities with creditors’ right to repledge
    
    
    457,247,716
    
    
    213,355,417Other
      investment securities
    
    
    98,234,027
    
    
    111,582,625Investment
      securities held to maturity, at amortized cost:Pledged
      securities with creditors’ right to repledge
    
    
    34,390,675
    
    
    —Other
      investment securities
    
    
    15,113,768
    
    
    —Other
      investment securities, at cost
    
    
    8,715,600
    
    
    3,342,100Loans
      held for sale
    
    
    2,684,063
    
    
    6,846,330Loans,
      net of allowance for loan and lease losses of $19,038,836 in
      2004and
      $9,393,943 in 2003
    
    
    1,365,890,375
    
    
    883,151,891Accrued
      interest receivable
    
    
    11,167,973
    
    
    6,792,687Customers’
      liability on acceptances
    
    
    395,161
    
    
    558,085Premises
      and equipment, net
    
    
    11,261,213
    
    
    10,531,353Other
      assets
    
    
    33,009,509
    
    
    22,443,283Total
      assets
    
    $
    2,102,789,052
    
    $
    1,320,934,065**LIABILITIES
      AND STOCKHOLDERS' EQUITY**Deposits:Noninterest
      bearing
    
    $
    137,895,861
    
    $
    104,757,697Interest
      bearing
    
    
    1,271,140,575
    
    
    879,791,433Total
      deposits
    
    
    1,409,036,436
    
    
    984,549,130Securities
      sold under agreements to repurchase
    
    
    463,409,056
    
    
    207,523,000Acceptances
      outstanding
    
    
    395,161
    
    
    558,085Advances
      from Federal Home Loan Bank
    
    
    10,403,638
    
    
    10,700,000Notes
      payable to statutory trusts
    
    
    46,393,000
    
    
    46,393,000Accrued
      interest payable
    
    
    6,719,851
    
    
    2,868,130Accrued
      expenses and other liabilities
    
    
    8,130,222
    
    
    3,267,4641,944,487,364
    
    
    1,255,858,809Stockholders’
      equity:Preferred
      stock:Preferred
      stock Series A, $0.01 par value. Authorized 20,000,000shares;
      issued and outstanding 430,537 in 2004
    
    
    4,305
    
    
    —Capital
      paid in excess of par value
    
    
    10,759,120
    
    
    —Common
      stock:Common
      stock, $0.01 par value. Authorized 150,000,000shares;
      issued and outstanding 19,564,086 and13,947,396
      shares in 2004 and 2003, respectively
    
    
    195,641
    
    
    69,737Capital
      paid in excess of par value
    
    
    105,408,402
    
    
    42,943,014Retained
      earnings:Reserve
      fund
    
    
    4,721,756
    
    
    2,348,598Undivided
      profits
    
    
    40,369,955
    
    
    20,521,151Accumulated
      other comprehensive loss, net of tax
    
    
    (3,157,491
    )
    
    (807,244
    )Total
      stockholders’ equity
    
    
    158,301,688
    
    
    65,075,256Commitments
      and contingenciesTotal
      liabilities and stockholders’ equity
    
    $
    2,102,789,052
    
    $
    1,320,934,065
 See
accompanying notes to consolidated financial
statements.
 F-2
 ****EUROBANCSHARES,
INC. AND SUBSIDIARIES**
**CONSOLIDATED
STATEMENTS OF INCOME**
**Years
Ended December 31, 2004, 2003, and
2002****
  **2004**
    
    **2003**
    
    **2002**Interest
      income:Loans,
      including fees
    
    $
    90,873,069
    
    $
    64,952,274
    
    $
    48,958,689Investment
      securities:Available
      for sale
    
    
    11,887,768
    
    
    6,009,233
    
    
    5,341,882Held
      to maturity
    
    
    201,017
    
    
    —
    
    
    —Interest-bearing
      deposits, securities purchasedunder
      agreements to resell, and other
    
    
    514,602
    
    
    554,344
    
    
    667,158Total
      interest income
    
    
    103,476,456
    
    
    71,515,851
    
    
    54,967,729Interest
      expense:Deposits
    
    
    33,309,033
    
    
    27,384,400
    
    
    21,467,060Securities
      sold under agreements to repurchase,notes
      payable, and other
    
    
    8,172,239
    
    
    4,537,848
    
    
    3,656,508Total
      interest expense
    
    
    41,481,272
    
    
    31,922,248
    
    
    25,123,568Net
      interest income
    
    
    61,995,184
    
    
    39,593,603
    
    
    29,844,161Provision
      for loan and lease losses
    
    
    7,100,000
    
    
    6,451,000
    
    
    3,353,686Net
      interest income after provision for loanand
      lease losses
    
    
    54,895,184
    
    
    33,142,603
    
    
    26,490,475Noninterest
      income:Service
      charges – fees and other
    
    
    8,056,482
    
    
    5,456,397
    
    
    4,331,341Net
      gain on sale of securities
    
    
    —
    
    
    707,155
    
    
    —Net
      loss on sale of other real estate owned, repossessedassets,
      and on disposition of other assets
    
    
    (358,890
    )
    
    (662,556
    )
    
    (310,567
    )Net
      gain on sale of loans
    
    
    1,395,105
    
    
    3,546,634
    
    
    —Total
      noninterest income
    
    
    9,092,697
    
    
    9,047,630
    
    
    4,020,774Noninterest
      expense:Salaries
      and employee benefits
    
    
    19,193,637
    
    
    15,434,082
    
    
    11,943,084Net
      occupancy
    
    
    6,942,603
    
    
    5,909,923
    
    
    4,592,442Professional
      services
    
    
    2,196,101
    
    
    1,402,283
    
    
    1,055,126Municipal
      and other taxes
    
    
    1,253,950
    
    
    725,474
    
    
    507,065Commissions
      and service fees
    
    
    1,206,119
    
    
    1,050,733
    
    
    764,348Office
      supplies
    
    
    1,032,576
    
    
    984,290
    
    
    746,458Insurance
    
    
    803,727
    
    
    627,540
    
    
    384,635Promotional
    
    
    545,128
    
    
    510,782
    
    
    356,823Other
    
    
    3,850,665
    
    
    2,229,940
    
    
    1,584,545Total
      noninterest expense
    
    
    37,024,506
    
    
    28,875,047
    
    
    21,934,526Income
      before income taxes and extraordinary item
    
    
    26,963,375
    
    
    13,315,186
    
    
    8,576,723Provision
      for income taxes
    
    
    8,662,633
    
    
    3,432,465
    
    
    2,723,852Income
      before extraordinary item
    
    
    18,300,742
    
    
    9,882,721
    
    
    5,852,871Extraordinary
      gain on acquisition of BankTrust in 2004 andBanco
      Financiero in 2002 (note 3)
    
    
    4,419,118
    
    
    —
    
    
    1,080,983Net
      income
    
    $
    22,719,860
    
    $
    9,882,721
    
    $
    6,933,854Earnings
      per share:Basic:Income
      before extraordinary item
    
    $
    1.08
    
    $
    0.71
    
    $
    0.43Extraordinary
      item
    
    
    0.27
    
    
    —
    
    
    0.08Net
      income
    
    $
    1.35
    
    $
    0.71
    
    $
    0.51Diluted:Income
      before extraordinary item
    
    $
    1.04
    
    $
    0.69
    
    $
    0.42Extraordinary
      item
    
    
    0.26
    
    
    —
    
    
    0.08Net
      income
    
    $
    1.30
    
    $
    0.69
    
    $
    0.50
 See
accompanying notes to consolidated financial
statements.
 F-3
 **EUROBANCSHARES,
INC. AND SUBSIDIARIES**
**CONSOLIDATED
STATEMENTS OF CHANGES INSTOCKHOLDERS’ EQUITY AND COMPREHENSIVE
INCOME**
**Years
Ended December 31, 2004, 2003 and
2002**
 **2004**
    
    **2003**
    
    **2002**Preferred
      stock:Balance
      at beginning of year
    
    $
    —
    
    $
    —
    
    $
    —Issuance
      of preferred stock
    
    
    4,305
    
    
    —
    
    
    —Balance
      at end of year
    
    
    4,305
    
    
    —
    
    
    —Capital
      paid in excess of par value - preferred stock:Balance
      at beginning of year
    
    
    —
    
    
    —
    
    
    —Issuance
      of preferred stock
    
    
    10,759,120
    
    
    —
    
    
    —Balance
      at end of year
    
    
    10,759,120
    
    
    —
    
    
    —Common
      stock:Balance
      at beginning of year
    
    
    69,737
    
    
    69,397
    
    
    6,778,497Issuance
      of Eurobank common stock
    
    
    —
    
    
    —
    
    
    9,924Exchange
      as a result of the creation of the holding company
    
    
    —
    
    
    —
    
    
    (6,720,537
    )Purchase
      and retirement of common stock
    
    
    (10
    )
    
    —
    
    
    (97
    )Issuance
      of common stock before stock split
    
    
    7,928
    
    
    340
    
    
    1,610Stock
      split
    
    
    77,655
    
    
    —
    
    
    —Issuance
      of common stock after stock split
    
    
    40,331
    
    
    —
    
    
    —Balance
      at end of year
    
    
    195,641
    
    
    69,737
    
    
    69,397Capital
      paid in excess of par value – common stock:Balance
      at beginning of year
    
    
    42,943,014
    
    
    42,675,749
    
    
    34,610,787Issuance
      of Eurobank common stock
    
    
    —
    
    
    —
    
    
    56,073Exchange
      as a result of the creation of the holding company
    
    
    —
    
    
    —
    
    
    6,720,537Purchase
      and retirement of common stock
    
    
    (8,684
    )
    
    —
    
    
    (87,319
    )Issuance
      of common stock before stock split
    
    
    12,290,548
    
    
    267,265
    
    
    1,375,671Stock
      split
    
    
    (77,655
    )
    
    —
    
    
    —Issuance
      of common stock after stock split
    
    
    50,261,179
    
    
    —
    
    
    —Balance
      at end of year
    
    
    105,408,402
    
    
    42,943,014
    
    
    42,675,749Reserve
      fund:Balance
      at beginning of year
    
    
    2,348,598
    
    
    1,299,469
    
    
    602,857Transfer
      from undivided profits
    
    
    2,373,158
    
    
    1,049,129
    
    
    696,612Balance
      at end of year
    
    
    4,721,756
    
    
    2,348,598
    
    
    1,299,469Undivided
      profits:Balance
      at beginning of year
    
    
    20,521,151
    
    
    11,687,559
    
    
    5,450,317Net
      income
    
    
    22,719,860
    
    
    9,882,721
    
    
    6,933,854Preferred
      stock dividends
    
    
    (497,898
    )
    
    —
    
    
    —Transfer
      to reserve fund
    
    
    (2,373,158
    )
    
    (1,049,129
    )
    
    (696,612
    )Balance
      at end of year
    
    
    40,369,955
    
    
    20,521,151
    
    
    11,687,559Accumulated
      other comprehensive income (loss), net of taxes:Balance
      at beginning of year
    
    
    (807,244
    )
    
    1,603,307
    
    
    363,467Unrealized
      net gain (loss) on investment securities available for sale andcash-flow-hedges
    
    
    (2,350,247
    )
    
    (2,410,551
    )
    
    1,239,840Balance
      at end of year
    
    
    (3,157,491
    )
    
    (807,244
    )
    
    1,603,307Total
      stockholders’ equity
    
    $
    158,301,688
    
    $
    65,075,256
    
    $
    57,335,481Comprehensive
      income:
    
    
    ****Net
      income
    
    $
    22,719,860
    
    $
    9,882,721
    
    $
    6,933,854Other
      comprehensive income (loss), net of tax:Unrealized
      net gain (loss) on investment securities available for sale and
      cashflow
      hedges
    
    
    (2,350,247
    )
    
    (1,880,185
    )
    
    1,239,840Reclassification
      adjustment for realized gains included in net income
    
    
    —
    
    
    (530,366
    )
    
    —Unrealized
      net gains (losses) on investment securities available for
    saleand
      cash-flow-hedges
    
    
    (2,350,247
    )
    
    (2,410,551
    )
    
    1,239,840Comprehensive
      income
    
    $
    20,369,613
    
    $
    7,472,170
    
    $
    8,173,694
 See
accompanying notes to consolidated financial
statements.
 F-4
 ****EUROBANCSHARES,
INC. AND SUBSIDIARIES**
**CONSOLIDATED
STATEMENTS OF CASH FLOWS**
**Years
Ended December 31, 2004, 2003 and
2002****
 **2004**
    
    **2003**
    
    **2002**Cash
      flows from operating activities:Net
      income
    
    $
    22,719,860
    
    $
    9,882,721
    
    $
    6,933,854Adjustments
      to reconcile net income to net cash provided by operating
      activities:Depreciation
      and amortization
    
    
    3,706,507
    
    
    1,442,973
    
    
    1,243,089Provision
      for loan and lease losses
    
    
    7,100,000
    
    
    6,451,000
    
    
    3,353,686Deferred
      tax provision
    
    
    4,715,347
    
    
    473,178
    
    
    303,568Extraordinary
      gain on acquisitions (note 3)
    
    
    (4,419,118
    )
    
    —
    
    
    (1,080,983
    )Net
      gain on sale of securities
    
    
    —
    
    
    (707,155
    )
    
    —Net
      gain on sale of loans
    
    
    (1,395,105
    )
    
    (3,546,634
    )
    
    —Net
      loss on sale of other real estate owned, repossessed assets,and
      on disposition of other assets
    
    
    358,890
    
    
    662,556
    
    
    310,567Net
      amortization of premiums and accretion of discounts on investment
      securities
    
    
    6,784,807
    
    
    2,916,668
    
    
    337,728Increase
      in deferred loan costs
    
    
    (1,773,009
    )
    
    (1,688,506
    )
    
    (1,241,706
    )Origination
      of loans held for sale
    
    
    (28,941,128
    )
    
    (49,165,365
    )
    
    (32,634,629
    )Proceeds
      from sale of loans held for sale
    
    
    29,250,216
    
    
    48,284,312
    
    
    32,447,691Increase
      in accrued interest receivable
    
    
    (2,262,588
    )
    
    (1,309,044
    )
    
    (1,602,118
    )Net
      (increase) decrease in other assets
    
    
    (5,035,216
    )
    
    (5,930,458
    )
    
    9,258,004Increase
      (decrease) in accrued interest payable, accrued expenses, and other
      liabilities
    
    
    7,423,628
    
    
    (545,698
    )
    
    (404,516
    )Net
      cash provided by operating activities
    
    
    38,233,091
    
    
    7,220,548
    
    
    17,224,235Cash
      flows from investing actitivies:Net
      decrease (increase) in securities purchased under agreements to resell andfederal
      funds sold
    
    
    785,044
    
    
    24,530,684
    
    
    (35,450,327
    )Net
      decrease (increase) in interest-bearing deposits
    
    
    19,324,216
    
    
    10,557,759
    
    
    (13,122,683
    )Proceeds
      from sale of investment securities available for sale
    
    
    —
    
    
    83,219,690
    
    
    —Purchases
      of investment securities available for sale
    
    
    (316,639,752
    )
    
    (400,874,835
    )
    
    (105,347,471
    )Proceeds
      from principal payments and maturities of investment securities availablefor
      sale
    
    
    134,869,775
    
    
    133,088,387
    
    
    52,692,672Purchases
      of investment securities held to maturity
    
    
    (59,086,330
    )
    
    (1,673,100
    )
    
    (1,188,900
    )Proceeds
      from principal payments, maturities, and calls of investment securitiesheld
      to maturity
    
    
    4,172,230
    
    
    2,124,700
    
    
    260,100Net
      increase in loans
    
    
    (200,340,918
    )
    
    (194,890,697
    )
    
    (255,641,865
    )Proceeds
      from sale of loans
    
    
    35,555,732
    
    
    50,000,046
    
    
    —Proceeds
      from sale of other real estate owned, repossessed assets,and
      on disposition of other assets
    
    
    17,987,709
    
    
    17,160,959
    
    
    6,693,814Capital
      expenditures
    
    
    (2,465,055
    )
    
    (2,594,393
    )
    
    (1,947,741
    )Cash
      and due from banks received from the acquisitions of banks,
      net
    
    
    71,134,806
    
    
    —
    
    
    4,273,349Acquisition
      of Banco Financiero including direct costs
    
    
    —
    
    
    —
    
    
    (541,272
    )Net
      cash used in investing activities
    
    
    (294,702,543
    )
    
    (279,350,800
    )
    
    (349,320,324
    )Cash
      flows from financing activities:Net
      increase in deposits
    
    
    25,931,840
    
    
    141,504,053
    
    
    273,148,701Increase
      in securities sold under agreements to repurchase
    
    
    235,886,056
    
    
    143,410,313
    
    
    36,749,187Advances
      from Federal Home Loan Bank
    
    
    —
    
    
    —
    
    
    5,550,000Repayment
      to Federal Home Loan Bank
    
    
    (66,034,362
    )
    
    (8,150,000
    )
    
    (1,950,000
    )Proceeds
      from issuance of trust preferred capital securities
    
    
    —
    
    
    —
    
    
    20,000,000Dividends
      paid to preferred stockholders
    
    
    (480,879
    )
    
    —
    
    
    —Net
      proceeds from issuance of common stocks
    
    
    57,241,571
    
    
    267,605
    
    
    220,998Purchase
      and retirement of common stocks
    
    
    —
    
    
    —
    
    
    (87,416
    )Net
      cash provided by financing activities
    
    
    252,544,226
    
    
    277,031,971
    
    
    333,631,470Net
      (decrease) increase in cash and cash equivalents
    
    
    (3,925,226
    )
    
    4,901,719
    
    
    1,535,381Cash
      and cash equivalents beginning balance
    
    
    22,522,342
    
    
    17,620,623
    
    
    16,085,242Cash
      and cash equivalents ending balance
    
    $
    18,597,116
    
    $
    22,522,342
    
    $
    17,620,623
 F-5
 **EUROBANCSHARES,
INC. AND SUBSIDIARIES**
Notes to
Consolidated Financial Statements
December 31,
2004 and
2003


**(1)**
    **Organization******EuroBancshares,
      Inc. (the Company or EuroBancshares) was incorporated on
      November 21, 2001, under the laws of the Commonwealth of Puerto Rico
      to engage, for profit, in any lawful acts or businesses and serve as the
      holding company for Eurobank (the Bank). The Bank is a full service
      commercial bank with a delivery system of 21 branches in Puerto Rico.
      During 2002, the Bank became a wholly owned subsidiary of EuroBancshares,
      Inc. The reorganization into a holding company was effected on
      March 18, 2002 pursuant to an agreement and plan of merger by and
      among the Bank, Euro Interim Bank (a non-operating bank organized
      under the laws of the Commonwealth of Puerto Rico for purposes of the
      merger), and the Company whereby the common stock of the Bank was
      converted into common stock of the Company.In
      connection with the merger of the Bank and Euro Interim Bank, which was
      carried out as part of the reorganization, each stockholder of the Bank
      who owned at least 100 shares of the Bank stock was entitled to
      receive from the Company, in exchange for each share of the Bank stock
      owned as of the effective date of the merger, one share of the voting
      common stock of the Company, par value $0.01 per share. All remaining
      stockholders of the Bank received cash for their shares of the Bank stock
      equal to $9.00 per share. On September 20, 2002, the Company became a
      financial holding company. As part of the reorganization, each holder of
      options to acquire shares of the Bank stock outstanding received one
      option to purchase a share of the Company’s stock. The formation of the
      Company and the reorganization has been accounted for at historical cost.As
      a financial holding company, the Company is subject to the provisions of
      the Bank Holding Company Act, and to the supervision and regulation by the
      board of governors of the Federal Reserve System.The
      consolidated financial statements of the Company include the accounts of
      its wholly owned subsidiaries: the Bank (including two international
      banking entities) and Euroseguros, Inc. (Euroseguros or the Agency),
      a company acting as an agent to sell life, property, and casualty
      insurance products in Puerto Rico, principally to customers of the Bank.
      Effective December 31, 2003, the Company adopted Financial Accounting
      Standards Board’s Interpretation No. 46R (FIN 46R),*Consolidation
      of Variable Interest Entities*.
      FIN 46R required the Company to deconsolidate the Eurobank Statutory
      Trust I (the Trust) and Eurobank Statutory Trust II (the Trust II) as
      of December 31, 2003. Deconsolidation resulted in the
      recharacterization of the liability previously presented as trust
      preferred capital securities as notes payable to the statutory trusts that
      issued the capital securities. The Company’s equity interest in the Trust
      and Trust II has been included in other investments in the 2004 and
      2003 consolidated balance sheets. The Trust and the Trust II are
      special purpose vehicles that entered into financing transactions
      involving the issuance of trust preferred capital securities
      (note 18).
  (Continued)
 F-6
 **EUROBANCSHARES,
INC. AND SUBSIDIARIES**
Notes to
Consolidated Financial Statements
December 31,
2004 and 2003
 **(2)**
    **Summary
      of Significant Accounting Policies**The
      preparation of the consolidated financial statements in conformity with
      accounting principles generally accepted in the United States of America
      requires management to make estimates and assumptions that affect the
      reported amount of assets and liabilities and disclosure of contingent
      assets and liabilities at the date of the consolidated financial
      statements and the reported amount of revenue and expenses during the
      reporting periods. These estimates are based on information available as
      of the date of the consolidated financial statements. Therefore, actual
      results could differ from those estimates. Following is a description of
      significant accounting policies followed by the Company in the preparation
      of the accompanying consolidated financial statements:*********(a)***
    ***Principles
      of Consolidation***The
      consolidated financial statements include the accounts of the Company and
      its subsidiaries. All significant intercompany balances and transactions
      have been eliminated in consolidation.*********(b)***
    ***Cash
      Equivalents***For
      purposes of the presentation in the statements of cash flows, cash and
      cash equivalents are defined as those amounts included in the balance
      sheets caption cash and due from banks.*********(c)***
    ***Securities
      Purchased under Agreements to Resell***The
      Company enters into purchases of securities under agreements to resell.
      The amounts advanced under these agreements represent short-term
      investment transactions.*********(d)***
    ***Investment
      Securities Available for Sale***Investment
      securities available for sale consist of bonds, notes, other debt
      securities, and certain equity securities not classified as trading or
      held-to-maturity securities. Investment securities available for sale are
      recorded at fair value and unrealized gains and losses, net of tax, on
      these investments are reflected as a separate component of stockholders’
      equity in accumulated other comprehensive income until realized. Realized
      gains or losses on sales of investment securities available for sale are
      recognized when realized and are computed on the specific-identification
      basis.Declines
      in fair value of securities below their cost that are deemed to be other
      than temporary result in an impairment that is charged to earnings and a
      new cost basis for the security is established. To determine whether an
      impairment is other than temporary, the Company considers whether it has
      the ability and intent to hold the investment until a market price
      recovery and considers whether evidence indicating the cost of the
      investment is recoverable outweighs evidence to the contrary. Evidence
      considered in this assessment includes the reasons for the impairment, the
      severity and duration of the impairment, changes in value subsequent to
      year-end, and forecasted performance of the investee.Premiums
      and discounts are amortized over the estimated average life of the related
      investment security available for sale as an adjustment to yield using a
      method that approximates the effective-interest method. Additionally, the
      Company anticipates estimated prepayments on mortgage-backed securities in
      the amortization of premiums and accretion of discounts on such
      securities. Dividend and interest income are recognized when earned.
  (Continued)
 F-7
 **EUROBANCSHARES,
INC. AND SUBSIDIARIES**
Notes to
Consolidated Financial Statements
December 31,
2004 and 2003
  ***(e)***
    ***Investment
      Securities Held to Maturity***Investment
      securities held to maturity are carried at cost, adjusted for premium
      amortization and discount accretion. Purchases of investment securities
      are recorded at trade date. The amortization of premiums is deducted and
      the accretion of discounts is added to interest income based on a method
      that approximates the interest method over the outstanding period of the
      related investment securities. The Bank classifies investments as held to
      maturity when it has the intent and the ability to hold the investment
      until maturity.A
      decline in the fair value of the securities below their cost that are
      deemed to be other than temporary result in an impairment that is charged
      to earnings and a new cost basis for the security is established. To
      determine whether an impairment is other than temporary, the Company
      considers whether evidence indicating that the cost of the investment is
      recoverable outweights evidence to the contrary. Evidence considered in
      this assessment includes the reasons for the impairment, the severity and
      duration of the impairment, changes in value subsequent to year-end, and
      forecasted performance of the investee.*********(f)***
    ***Other
      Investments***Other
      investments include Federal Home Loan Bank (FHLB) stock and the equity
      investment in the Trust and Trust II (unconsolidated statutory
      trusts). The FHLB stock is carried at cost, representing the amount for
      which the FHLB would redeem the stock. Investment in statutory trusts is
      carried on the equity method of accounting.***(g)***
    ***Loans
      Held for Sale***Mortgage
      loans originated and intended for sale in the secondary market are carried
      at the lower of cost or estimated fair value in the aggregate. Net
      unrealized losses, if any, are recognized through a valuation allowance by
      charges to income.*********(h)***
    ***Loans
      and Allowance for Loan and Lease Losses***Loans
      that management has the intent and ability to hold for the foreseeable
      future or until maturity or payoff are reported at their outstanding
      unpaid principal balances adjusted by any charge-offs, unearned finance
      charges, allowance for loan and lease losses, and net deferred
      nonrefundable fees or costs on origination. The allowance for loan and
      lease losses is an estimate to provide for probable collection losses in
      the loan portfolio. Losses are charged and recoveries are credited to the
      allowance account at the time a loss is incurred or a recovery is
      received.The
      Company follows a consistent procedural discipline and accounts for loan
      loss contingencies in accordance with Statement of Financial Accounting
      Standards (SFAS) No. 5,*Accounting
      for Contingencies*,
      and SFAS No. 114,*Accounting
      by Creditors for Impairment of a Loan*,
      as amended by SFAS No. 118,*Accounting
      by Creditors for Impairment of a Loan - Income Recognition and
      Disclosures*.
      The following is a description of how each portion of the allowance for
      loan and lease losses is determined.When
      analyzing the adequacy of the allowance for loan and lease losses, the
      portfolio is segmented into as many components as practical. Although the
      evaluation of the adequacy of the allowance for loan and lease losses
      focuses on loans and pools of similar loans and leases, no part of the
      allowance is segregated for, or allocated to, any particular asset or
      group of assets. The allowance is available to absorb all credit losses
      inherent in the portfolio.
  (Continued)
 F-8
 **EUROBANCSHARES,
INC. AND SUBSIDIARIES**
Notes to
Consolidated Financial Statements
December 31,
2004 and 2003
 Each
      component would normally have similar characteristics, such as
      classification, type of loan or lease, industry or collateral. As needed,
      the Company separately analyzes the following components of the portfolio
      and provides for them in the allowance for loan and lease losses: credit
      quality; sufficiency of credit and collateral documentation; proper lien
      perfection; appropriate approval by the loan officer and the credit
      committees; adherence to any loan agreement covenants; and compliance with
      internal policies and procedures and laws and regulations.The
      general portion of the allowance for loan and lease losses is determined
      by applying loss factors to all categories of loans and leases outstanding
      in the portfolio. The Company uses historic loss rates, determined over a
      period of years. The resulting loss factors are then multiplied against
      the current period’s balance of loans outstanding to derive an estimated
      loss. The historical loss percentage is adjusted for each pool of loans to
      reflect any current conditions that are expected to result in loss
      recognition. Factors considered include, but are not limited to: effects
      of any changes in lending policies and procedures, including those for
      underwriting, collection, charge-offs, and recoveries; changes in the
      experience, ability, and depth of our lending management and staff;
      concentrations of credit that might affect loss experience across one or
      more components of the portfolio; levels of, and trends in, delinquencies
      and nonaccruals; and national and local economic business trends and
      conditions.Historical
      loss rates are reviewed and adjusted for the above factors on a
      pool-by-pool basis. Rates for each pool are based on those factors
      management believes are applicable to that pool. When applied to a pool of
      loans or leases, the adjusted historical loss rate is a measure of the
      total inherent losses in the portfolio that would have been estimated if
      each individual loan or lease had been reviewed. For such pools of loans
      or leases, management believes that coverage of one year’s losses in the
      current portfolio is an appropriate measure.Specific
      allowances are provided in the event that the specific analysis on each
      classified loan indicates that it is probable that the Company will be
      unable to collect all amounts due, both principal and interest, according
      to the contractual terms of the loan agreement. When a loan is impaired,
      the Company measures impairment based on either (a) the present value
      of the expected future cash flows of the impaired loan discounted at the
      loan’s original effective rate, (b) the observable market price of
      the impaired loans, or (c) the fair value of the collateral of a
      collateral-dependent loan. The Company selects the measurement method on a
      loan-by-loan basis, except for collateral-dependent loans for which
      foreclosure is probable must be measured at the fair value of the
      collateral. When the measure of the impaired loan is less than the
      recorded amount, the impairment is recorded through a valuation allowance.
      In a troubled debt restructuring involving a restructured loan, the
      Company measures impairment by discounting the total expected future cash
      flows at the loan’s original effective rate of interest. The provision for
      loan and lease loss is adjusted in order to state the allowance for loan
      and lease losses to the required level as determined above.Management
      believes that the allowance for loan and lease losses is adequate;
      however, regulatory agencies, including the Federal Reserve System and the
      Federal Deposit Insurance Corporation (the FDIC), as an integral part
      of their examination process, periodically review the Company’s allowance
      for loan and lease losses.The
      Company classifies loans as nonperforming when they become 90 days
      past due.*********(i)***
    ***Lease
      Financing***The
      Company leases vehicles and equipment to individual and corporate
      customers. The finance method of accounting is used to recognize revenue
      on lease contracts that meet the criteria specified by SFAS No. 13,*Accounting
      for Leases*,
      as amended. Aggregate rentals due over the term of the leases, less
      unearned income, are included in net loans. Unearned income is amortized
      using a method that results in approximate level rates of return on the
      principal amounts outstanding. Finance lease origination fees and costs
      are deferred and amortized over the average life of the portfolio as an
      adjustment to yield.******
  (Continued)
 F-9
 **EUROBANCSHARES,
INC. AND SUBSIDIARIES**
Notes to
Consolidated Financial Statements
December 31,
2004 and 2003
 ***(j)***
    ***Transfer
      of Financial Assets and Servicing Rights Retained***Transfers
      of financial assets are accounted for as sales when control over the
      assets has been surrendered. Control over transferred assets is deemed to
      be surrendered when (a) the assets have been isolated from the
      Company, (b) the transferee obtains the right (free of conditions
      that constrain it from taking advantage of that right) to pledge or
      exchange the transferred assets, and (c) the Company does not
      maintain effective control over the transferred assets through an
      agreement to repurchase them before their maturity.Upon
      completion of a transfer of assets that satisfies the conditions described
      above to be accounted for as a sale, the Company:·
    Derecognizes
      all assets sold;·
    Recognizes
      all assets obtained and liabilities incurred in consideration as proceeds
      of the sale;·
    Initially
      measures, at fair value, assets obtained and liabilities incurred in a
      sale; and·
    Recognizes
      in earnings any gain or loss on the sale.The
      Company receives fees for servicing activities on loans it has sold. These
      activities include, but are not limited to, collecting principal, interest
      and escrow payments from borrowers; paying taxes and insurance from
      escrowed funds; monitoring delinquencies; and accounting for and remitting
      principal and interest payments. To the extent that the servicing fees
      exceed or do not provide adequate compensation for the services provided,
      the Company records a servicing asset or liability for the fair value of
      the servicing retained.*********(k)***
    ***Servicing
      Assets***The
      Company has no contracts to service loans for others, except for servicing
      retained on loan sales. The total cost of loans to be sold with servicing
      assets retained is allocated to the servicing assets and the loans
      (without the servicing assets), based on their relative fair values.
      Servicing assets are amortized in proportion to and over the period of
      estimated net servicing income. In addition, the Company assesses
      capitalized servicing assets for impairment based on the fair value of
      those assets.To
      estimate the fair value of servicing assets the Company considers prices
      for similar assets and the present value of expected future cash flows
      associated with the servicing assets calculated using assumptions that
      market participants would use in estimating future servicing income and
      expense, including discount rates, anticipated prepayment, and credit loss
      rates. For purposes of evaluating and measuring impairment of capitalized
      servicing assets, the Company evaluates separately servicing retained for
      each loan portfolio sold. The amount of impairment recognized, if any, is
      the amount by which the capitalized servicing assets exceed its estimated
      fair value. Impairment is recognized through a valuation allowance with
      changes included in net income for the period in which the change occurs.
      Servicing assets are included as part of other assets in the consolidated
      balance sheets.******
 (Continued)
 F-10
 **EUROBANCSHARES,
INC. AND SUBSIDIARIES**
Notes to
Consolidated Financial Statements
December 31,
2004 and 2003
 ***(l)***
    ***Premises
      and Equipment***Premises
      and equipment are stated at cost, less accumulated depreciation and
      amortization, which are computed utilizing the straight-line method over
      the estimated useful lives of the depreciable assets. Leasehold
      improvements are stated at cost and are amortized using the straight-line
      method over the estimated useful lives of the assets or the term of the
      lease, whichever is shorter. Expenditures for major improvements and
      remodeling are capitalized while maintenance and repairs are charged to
      expense. Gains or losses on disposition of premises and equipment and
      related operating income and maintenance expenses are included in current
      operations.***(m)***
    ***Other
      Real Estate and Repossessed Assets***Other
      real estate and repossessed assets, normally obtained through foreclosure
      or other workout situations, are initially recorded at the lower of fair
      value or book value at the date of foreclosure, establishing a new cost
      basis. Any resulting loss is charged to the allowance for loan and lease
      losses. An appraisal of other real estate properties and repossessed
      assets is made periodically after its acquisition and comparison between
      the appraised value and the carrying value is performed. Additional
      declines in value after acquisition, if any, are charged to current
      operations. Gains or losses on disposition of other real estate and
      repossessed assets and related operating income and maintenance expenses
      are included in current operations.*********(n)***
    ***Trust
      Services***In
      connection with its trust activities, the Company administers and is
      custodian of assets, which amounted to approximately $283,224,000
      (including $269,134,000 at year-end related to the acquisition of
      BankTrust) and $10,227,000 at December 31, 2004 and 2003,
      respectively.*********(o)***
    ***Securities
      Sold under Agreements to Repurchase***The
      Company sells securities under agreements to repurchase the same or
      similar securities. Amounts received under these agreements represent
      short-term financing transactions.*********(p)***
    ***Income
      Taxes***The
      Company uses the asset and liability method for the recognition of
      deferred tax assets and liabilities for the expected future tax
      consequences of events that have been recognized in the Company’s
      financial statements or tax returns. Deferred income tax assets and
      liabilities are determined for differences between financial statement and
      tax bases of assets and liabilities that will result in taxable or
      deductible amounts in the future as well as net operating losses
      carryforwards. The computation is based on enacted tax laws and rates
      applicable to periods in which the temporary differences are expected to
      be recovered or settled.*********(q)***
    ***Reserve
      Fund***The
      Banking Law of Puerto Rico requires that a reserve fund be created and
      that annual transfers of at least 10% of annual net income of the Bank be
      made, until such fund equals total paid-in capital. Such transfers
      restrict the retained earnings, which would otherwise be available for
      dividends. On the other hand, if net losses are experienced, such losses
      will be initially charged to retained earnings before reducing the reserve
      fund.******
 (Continued)
 F-11
 **EUROBANCSHARES,
INC. AND SUBSIDIARIES**
Notes to
Consolidated Financial Statements
December 31,
2004 and 2003
 ***(r)***
    ***Interest
      Income***Interest
      income on loans and investment securities is recognized on a basis which
      produces a constant yield over the term of the loan or security. Accrual
      of interest income is discontinued when collectibility of the related loan
      appears doubtful or after 90 days of delinquency, unless the credit
      is well secured and in process of collection. All interest accrued but not
      collected for loans that are placed on nonaccrual or charged off is
      reversed against interest income. The interest on these loans is accounted
      on the cash basis or cost recovery method, until qualifying for return to
      accrual. Loans are returned to accrual status when all the principal and
      interest amounts contractually due are brought current and future payments
      are reasonably assured.***(s)***
    ***Loan
      Origination and Commitment Fees***Loan
      fees and certain direct loan origination costs are deferred, and the net
      amount is recognized in interest income using the interest method over the
      contractual life of the loans. Commitment fees and costs relating to
      commitments whose likelihood of exercise is remote are recognized over the
      commitment period on a straight-line basis. If the commitment is
      subsequently exercised during the commitment period, the remaining
      unamortized commitment fee at the time of exercise is recognized over the
      life of the loan as an adjustment of yield.*********(t)***
    ***Earnings
      Per Share***Basic
      earnings per share represents income available to common stockholders
      divided by the weighted average number of common shares outstanding during
      the period. Diluted earnings per share reflects additional common shares
      that would have been outstanding if dilutive potential common shares had
      been issued, as well as any adjustment to income that would result from
      the assumed issuance. Potential common shares that may be issued by the
      Company relate solely to outstanding stock options are determined using
      the treasury stock method. Any stock splits or stock dividends are
      retroactively recognized in all periods presented in the consolidated
      financial statements. Any stock splits are retroactively recognized in all
      periods presented in the consolidated financial statements.
 (Continued)
 F-12
 **EUROBANCSHARES,
INC. AND SUBSIDIARIES**
Notes to
Consolidated Financial Statements
December 31,
2004 and 2003
 *********(u)***
    ***Supplementary
      Cash Flow Information***Supplemental
      disclosures of cash flow information are as follows:
  **2004**
    
    **2003**
    
    **2002**Cash
      paid during the years for:Interest
    
    $
    37,630,000
    
    $
    32,494,000
    
    $
    23,939,000Income
      taxes
    
    
    2,533,000
    
    
    3,116,000
    
    
    2,037,000Noncash
      transactions:Repossessed
      assets acquiredthrough
      foreclosure of loans
    
    $
    20,282,000
    
    $
    15,431,000
    
    $
    7,463,000Change
      in fair value ofavailable-for-sale
      securitiesand
      cash-flow-hedges
    
    
    (2,434,211
    )
    
    (3,214,069
    )
    
    1,653,120Tax
      effect of change in fair valueof
      available-for-sale securitiesand
      cash-flow hedges
    
    
    (83,964
    )
    
    (803,518
    )
    
    413,280Capital
      contribution throughissuance
      of EuroBancshares'stocks
      on acquisition ofBankTrust
      (note 3):Common
      stocks
    
    
    5,551,845
    
    
    —
    
    
    —Preferred
      stocks
    
    
    10,763,425
    
    
    —
    
    
    —Capital
      contribution throughissuance
      of EuroBancsharescommon
      stock on acquisitionof
      Banco Financiero (note 3)
    
    
    —
    
    
    —
    
    
    1,222,280
  ***(v)***
    ***Stock
      Option Plan***As
      allowed by SFAS No. 123,*Accounting
      for Stock-Based Compensation*,
      and as amended by SFAS No. 148,*Accounting
      for Stock-Based Compensation - Transition and Disclosure, an Amendment of
      FASB Statement No. 123*,
      the Company has elected to continue to measure cost for its stock
      compensation plan using the intrinsic value method prescribed by
      Accounting Principles Board (APB) Opinion No. 25,*Accounting
      for Stock Issued to Employees*.
      Under the intrinsic value method, compensation cost is the excess, if any,
      of the quoted market price of the stock at the grant date or other
      measurement over the amount an employee must pay to acquire the stock.
      Entities choosing to continue applying APB Opinion No. 25 on employee
      stock options granted in or after January 1996 must provide pro forma
      disclosures of the consolidated net income, as if the fair value method of
      accounting had been applied. Under this method, compensation cost is
      measured at the grant date based on the fair value of the employee stock
      option and is recognized ratably over the service period of the option,
      which is usually the vesting period.SFAS
      No. 123 established accounting and disclosure requirements using the
      fair value based method of accounting for stock-based employee
      compensation plans. The per share fair value of stock options granted
      during 2004, 2003, and 2002 was $1.85, $1.27, and $1.60 on the date of the
      grant using the Black-Scholes option pricing model with the following
      weighted average assumptions used for grants in 2004, 2003, and 2002,
      respectively: no dividend yield for 2004, 2003, and 2002; risk-free
      interest rates of 3.03% for 2004, 2.75% for 2003, and 4% for 2002;
      volatility assumption of 18% for 2004 and none for 2003 and 2002; and
      expected lives of five years.
 (Continued)
 F-13
 **EUROBANCSHARES,
INC. AND SUBSIDIARIES**
Notes to
Consolidated Financial Statements
December 31,
2004 and 2003
 The
      following table illustrates the effect on net income if the fair value
      based method had been applied to all outstanding stock-based compensation
      in each period.
  **2004**
    
    **2003**
    
    **2002**Net
      income, as reported
    
    $
    22,719,860
    
    $
    9,882,721
    
    $
    6,933,854Deduct
      total stock-based employeecompensation
      expensedetermined
      under fair valuebased
      method for all awards
    
    
    (370,143
    )
    
    (364,421
    )
    
    (270,832
    )Pro
      forma net income
    
    $
    22,349,717
    
    $
    9,518,300
    
    $
    6,663,022Earnings
      per share:Basic
      – as reported
    
    $
    1.35
    
    $
    1.42
    
    $
    1.02Basic
      – pro forma
    
    
    1.32
    
    
    1.37
    
    
    0.98Diluted
      – as reported
    
    
    1.30
    
    
    1.39
    
    
    1.01Diluted
      – pro forma
    
    
    1.27
    
    
    1.34
    
    
    0.97
  As
      part of the reorganization described in note 1, each holder of
      options to acquire shares of the Bank stock outstanding at the merger
      effective date received one option to purchase a share of the Company
      stock in exchange for each option to purchase a share of the Bank stock
      that such person held as of the merger effective date.*********(w)***
    ***Comprehensive
      Income***Comprehensive
      income is defined, as the change in equity of a business enterprise during
      a period from transactions and other events and circumstances require to
      be recognized by the accounting standard. In addition to net income, the
      Company recognizes unrealized holding gains and losses, net of taxes, from
      available-for-sale securities and the change in fair value of the
      cash-flow hedges as components of comprehensive income.*********(x)***
    ***Impairment
      of Long-Lived Assets***Long-lived
      assets, such as property, plant, and equipment and purchased intangibles
      subject to amortization, are reviewed for impairment whenever events or
      changes in circumstances indicate that the carrying amount of an asset may
      not be recoverable. Recoverability of assets to be held and used is
      measured by a comparison of the carrying amount of an asset to estimate
      undiscounted future cash flows expected to be generated by the asset. If
      the carrying amount of an asset exceeds its estimated future cash flows,
      an impairment charge is recognized by the amount by which the carrying
      amount of the asset exceeds the fair value of the asset. Assets to be
      disposed of would be separately presented in the balance sheet and
      reported at the lower of the carrying amount or fair value less costs to
      sell, and are no longer depreciated. The assets and liabilities of a
      disposed group classified as held for sale would be presented separately
      in the appropriate asset and liability sections of the consolidated
      balance sheet.There
      were no impairment losses in 2004, 2003, and 2002.******
 (Continued)
 F-14
 **EUROBANCSHARES,
INC. AND SUBSIDIARIES**
Notes to
Consolidated Financial Statements
December 31,
2004 and 2003
 ***(y)***
    ***Derivative
      Instruments***As
      a result of the acquisition of The Bank & Trust of Puerto Rico
      (BankTrust), the Company assumed several derivative instruments (swaps),
      which were recorded at their estimated fair value at acquisition. The
      Company follows the provisions of SFAS No. 133,*Accounting
      for Derivative Instruments and Certain Hedging Activities*,
      as amended, which requires that all derivative instruments be recorded on
      the balance sheet at their respective fair values. The Company has treated
      all derivatives acquired as new contracts.On
      the date a derivative contract is entered into, the Company designates the
      derivative as either a hedge of the fair value of a recognized asset or
      liability or of an unrecognized firm commitment (fair-value hedge), or a
      hedge of a forecasted transaction or the variability of cash flows to be
      received or paid related to a recognized asset or liability (cash-flow
      hedge). For all hedging relationships the Company formally documents the
      hedging relationship and its risk-management objective and strategy for
      undertaking the hedge, the hedging instrument, the item, the nature of the
      risk being hedged, how the hedging instrument’s effectiveness in
      offsetting the hedged risk will be assessed, and a description of the
      method of measuring ineffectiveness. This process includes linking all
      derivatives that are designated as fair-value and cash-flow hedges to
      specific assets and liabilities on the balance sheet or to specific firm
      commitments or forecasted transactions. The Company also formally
      assesses, both at the hedge’s inception and on an ongoing basis, whether
      the derivatives that are used in hedging transactions are highly effective
      in offsetting changes in fair values or cash flows of hedged items. When
      it is determined that a derivative is not highly effective as a hedge or
      that it has ceased to be a highly effective hedge, the Company
      discontinues hedge accounting prospectively.Changes
      in the fair value of a derivative that is highly effective and that is
      designated and qualifies as a fair-value hedge, along with the loss or
      gain on the hedged asset or liability or unrecognized firm commitment of
      the hedged item that is attributable to the hedged risk, are recorded in
      earnings. Changes in the fair value of a derivative that is highly
      effective and that is designated and qualifies as a cash-flow hedge are
      recorded in other comprehensive income (loss) to the extent that the
      derivative is effective as a hedge, until earnings are affected by the
      variability in cash flows of the designated hedged item. The ineffective
      portion of the change in fair value of a derivative instrument, if any,
      that qualifies as either a fair-value or a cash-flow hedge is reported in
      earnings. Changes in the fair value of derivative trading instruments are
      reported in current period earnings.The
      Company discontinues hedge accounting prospectively when it is determined
      that the derivative is no longer effective in offsetting changes in the
      fair value or cash flows of the hedged item, the derivative expires or is
      sold, terminated, or exercised, the derivative is de-designated as a
      hedging instrument, because it is unlikely that a forecasted transaction
      will occur, a hedged firm commitment no longer meets the definition of a
      firm commitment, or management determines that designation of the
      derivative as a hedging instrument is no longer appropriate.
 (Continued)
 F-15
 **EUROBANCSHARES,
INC. AND SUBSIDIARIES**
Notes to
Consolidated Financial Statements
December 31,
2004 and 2003
 When
      hedge accounting is discontinued because it is determined that the
      derivative no longer qualifies as an effective fair-value hedge, the
      Company continues to carry the derivative on the balance sheet at its fair
      value and no longer adjusts the hedged asset or liability for changes in
      fair value. The adjustment of the carrying amount of the hedged asset or
      liability is accounted for in the same manner as other components of the
      carrying amount of that asset or liability. When hedge accounting is
      discontinued because the hedged item no longer meets the definition of a
      firm commitment, the Company continues to carry the derivative on the
      balance sheet at its fair value, removes any asset or liability that was
      recorded pursuant to recognition of the firm commitment from the balance
      sheet, and recognizes any gain or loss in earnings. When hedge accounting
      is discontinued because it is probable that a forecasted transaction will
      not occur, the Company continues to carry the derivative on the balance
      sheet at its fair value with subsequent changes in fair value included in
      earnings, and gains and losses that were accumulated in other
      comprehensive income are recognized immediately in earnings. In all other
      situations in which hedge accounting is discontinued, the Company
      continues to carry the derivative at its fair value on the balance sheet
      and recognizes any subsequent changes in its fair value in earnings.*********(z)***
    ***Reclassifications***Certain
      prior period amounts have been reclassified to conform with 2004
      presentation.***(aa)***
    ***Business
      Segments***An
      operating segment is a component of a business for which separate
      financial information is available that is evaluated regularly by the
      chief operating decision-maker in deciding how to allocate resources and
      evaluate performance. Presently, the Company’s decisions are generally
      based on specific market areas and/or product offerings. Accordingly,
      based on the financial information now regularly evaluated by the
      Company’s chief operating decision-maker, the Company operates in a single
      business segment.***(ab)***
    ***Recently
      Issued Accounting Standards***SFAS
      No. 150,*Accounting
      for Certain Financial Instruments with Characteristics of both Liabilities
      and Equity*,
      was issued in May 2003. This statement establishes standards for the
      classification and measurement of certain financial instruments with
      characteristics of both liabilities and equity. The statement also
      includes required disclosures for financial instruments within its scope.
      For the Company, the statement was effective for instruments entered into
      or modified after May 31, 2003 and otherwise will be effective as of
      January 1, 2004, except for mandatorily redeemable financial
      instruments. For certain mandatorily redeemable financial instruments, the
      statement will be effective for the Company on January 1, 2005. The
      effective date has been deferred indefinitely for certain other types of
      mandatorily redeemable financial instruments. This statement did not have
      a material impact on the Company’s financial statements.
 (Continued)
 F-16
 **EUROBANCSHARES,
INC. AND SUBSIDIARIES**
Notes to
Consolidated Financial Statements
December 31,
2004 and 2003
 In
      December 2003, the Accounting Standards Executive Committee issued
      Statement of Position 03-3 (SOP 03-3),*Accounting
      for Certain Loans or Debt Securities Acquired in a
      Transfer*.
      This statement addresses accounting for differences between contractual
      cash flows and cash flows expected to be collected from an investor’s
      initial investment in loans or debt securities acquired in a transfer if
      those differences are attributable, at least in part, to credit quality.
      SOP 03-3 does not apply to loans originated by the entity. SOP 03-3 limits
      the yield that may be accreted (accretable yield) to the excess of the
      investor’s estimate of undiscounted expected principal, interest, and
      other cash flows (cash flows expected at acquisition to be collected) over
      the investor’s initial investment in the loan. SOP 03-3 requires that the
      excess of contractual cash flows over cash flows expected to be collected
      (nonaccretable difference) not be recognized as an adjustment of yield,
      loss accrual, or valuation allowance. SOP 03-3 prohibits investors from
      displaying accretable yield and nonaccretable difference in the balance
      sheet. Subsequent increases in cash flows expected to be collected
      generally should be recognized prospectively through adjustment of the
      loan’s yield over its remaining life. Decreases in cash flows expected to
      be collected should be recognized as impairment. SOP 03-3 prohibits
      “carrying over” or creation of valuation allowances in the initial
      accounting of all loans acquired in a transfer that are within the scope
      of this statement. The prohibition of the valuation allowance carryover
      applies to the purchase of an individual loan, a pool of loans, a group of
      loans, and loans acquired in a purchase business combination. SOP 03-3 is
      effective for loans acquired in fiscal years beginning after December 15,
      2004. Early adoption is encouraged. The Company elected to adopt SOP 03-3
      for the year ending December 31, 2005. The impact of the new accounting
      pronouncement cannot be reasonably estimated, as it is related to future
      loan acquisitions.In
      March 2004, the U.S. Securities and Exchange Commission released the
      Staff Accounting Bulletin (SAB) No. 105,*Loan
      Commitments Accounted for as Derivative Instruments*.
      This bulletin informs registrants of the staff’s view that the fair value
      of the recorded loan commitments should not consider the expected future
      cash flows related to the associated servicing of the future loan. The
      provisions of SAB No. 105 must be applied to loan commitments accounted
      for as derivatives that are entered into after March 31, 2004. The
      staff will not object to the application of existing accounting practices
      to loan commitments accounted for as derivatives that are entered into on
      or before March 31, 2004, with appropriate disclosures. On
      April 1, 2004, the Company adopted the provisions of SAB No. 105,
      which did not have an impact on the Company’s financial condition or
      results of operations.In
      March 2004, the Emerging Issues Task Force (EITF) reached a consensus
      on the application on Issue 03-1,*The
      Meaning of Other-Than-Temporary Impairment and Its Application to Certain
      Investments*.
      The EITF reached a consensus on the impairment model to be used to
      determine when an investment is considered impaired, whether that
      impairment is other than temporary, and the measurement of an impairment
      loss. The impairment model also includes accounting considerations
      subsequent to the recognition of an other-than-temporary impairment and
      requires certain disclosures about unrealized losses that have not been
      recognized as other-than-temporary impairments. This impairment model is
      applicable for investments in debt and equity securities that are within
      the scope of SFAS No. 115,*Accounting
      for Certain Investments in Debt and Equity Securities,*and
      equity securities that are not subject to the scope of SFAS No. 115 and
      not accounted for under the equity method under APB Opinion No. 18,*The
      Equity Method of Accounting for Investments in Common
      Stock*,
      referred to in Issue 03-1 as the cost method investments. The impairment
      model developed by the EITF to determine whether an investment is within
      the scope of Issue 03-1 involves a sequence of steps including the
      following: Step 1-determine whether an investment is impaired. If an
      impairment indicator is present, as determined in Step 1, the investor
      should estimate the fair value of the investment. If the fair value of the
      investment is less than its cost, proceed with Step 2 -evaluate whether an
      impairment is other than temporary. Step 3 - if the impairment is other
      than temporary, recognize an impairment loss equal to the difference
      between the investment’s cost and its fair value. The impairment model
      described above used to determine other-than-temporary impairment was
      effective for reporting periods beginning after June 15, 2004. In
      September 2004, the FASB delayed the requirements to record impairment
      losses under EITF 03-1 until such time as new guidance is issued and comes
      into effect. Currently, the disclosure requirements originally prescribed
      by EITF 03-1 will remain in effect.
 (Continued)
 F-17
 **EUROBANCSHARES,
INC. AND SUBSIDIARIES**
Notes to
Consolidated Financial Statements
December 31,
2004 and 2003
 In
      December 2004, the SFAS No. 123 was revised. This statement establishes
      standards for the accounting for transactions in which an entity exchanges
      its equity instruments for goods or services. It also addresses
      transactions in which an entity incurs liabilities in exchange for goods
      or services that are based on the fair value of the entity’s equity
      instruments or that may be settled by the issuance of those equity
      instruments. This statement focuses primarily on accounting for
      transactions in which an entity obtains employee services in share-based
      payment transactions. This statement requires a public entity to measure
      the cost of employee services received in exchange for an award of equity
      instruments based on the grant-date fair value of the award (with limited
      exceptions). That cost will be recognized over the period during which an
      employee is required to provide service in exchange for the award—the
      requisite service period (usually the vesting period). No compensation
      cost is recognized for equity instruments for which employees do not
      render the requisite service. Employee share purchase plans will not
      result in recognition of compensation cost if certain conditions are met;
      those conditions are much the same as the related conditions in SFAS No.
      123. A public entity will initially measure the cost of employee services
      received in exchange for an award of liability instruments based on its
      current fair value; the fair value of that award will be remeasured
      subsequently at each reporting date through the settlement date. Changes
      in fair value during the requisite service period will be recognized as
      compensation cost over that period. For public entities that do not file
      as small business issuers—as of the beginning of the first interim or
      annual reporting period that begins after June 15, 2005. The Company
      expects to adopt this new implementation for the third quarter of 2005. We
      believe that the impact would not be material to our year-end
      operations.**(3)**
    **Acquisitions**On
      May 3, 2004, the Company acquired all of the capital stock of BankTrust
      for approximately $23.4 million for which the Company issued 683,304
      common shares (valued at $8.13 per share) and 430,537 shares of perpetual
      noncumulative preferred stock, Series A (valued at $25 per share) and made
      cash payments of approximately $6.5 million. The Series A Preferred Stock
      are neither convertible nor exchangeable. The monthly noncumulative cash
      dividend has a rate per annum equal to 6.85%. BankTrust was a commercial
      bank operating in Puerto Rico through an existing network of five branches
      and whose total assets at December 31, 2003 amounted to approximately
      $567 million. The BankTrust acquisition was consistent with the Company’s
      growth strategy.
 (Continued)
 F-18
 **EUROBANCSHARES,
INC. AND SUBSIDIARIES**
Notes to
Consolidated Financial Statements
December 31,
2004 and 2003
 The
      following table summarizes the estimated fair value of the assets acquired
      and liabilities assumed as of May 3, 2004 (in thousands):
  Cash
      and due from banks
    
    $
    78,476Interest-bearing
      deposits with banks
    
    
    3,271Investments
      securities
    
    
    80,140Loans,
      net
    
    
    336,275Other
      assets
    
    
    23,828Total
      assets acquired
    
    
    521,990Deposits
    
    
    (398,555
    )Borrowings
    
    
    (85,738
    )Other
      liabilities
    
    
    (8,632
    )Total
      liabilities assumed
    
    
    (492,925
    )Net
      assets acquired
    
    $
    29,065
  The
      estimated fair value of assets acquired less liabilities assumed exceeded
      the purchase price by approximately $5,700,000. This was allocated to
      eliminate the fair value of intangible assets acquired (core deposit
      intangible of $365,000 and value of trust business of $305,000, net of
      their tax effect), and the value of furniture, fixtures, and equipment
      acquired in the amount of $627,000. Since all other remaining assets were
      either financial assets, assets to be disposed of in the near term or
      prepaid assets, the remaining negative goodwill amounting to $4.4 million
      resulted in an extraordinary gain on the acquisition.In
      connection with the acquisition of BankTrust, on May 12, 2004, the Company
      issued 733,316 shares of common stock to its common stockholders and to
      holders of options to purchase its common stock who were not otherwise
      stockholders, through a private placement offering. The net proceeds
      received by the Company from the private placement of its common stock
      were $5,958,193.The
      pro forma information below is theoretical in nature and not necessarily
      indicative of future or past consolidated results of operations of the
      Company. The Company’s unaudited pro forma condensed consolidated
      statements of operations for the years ended December 31, 2004 and 2003,
      assuming BankTrust had been acquired as of January 1, 2003, are as
      follows:
  **Years
      Ended December 31****2004**
    
    **2003**Interest
      income
    
    $
    115,526
    
    $
    110,065Income
      before extraordinary item/unusual
      recovery
    
    
    2,137
    
    
    2,479Net
      income
    
    
    6,556
    
    
    4,783Earnings
      per share:Basic
    
    
    0.35
    
    
    0.28Diluted
    
    
    0.34
    
    
    0.33
  (Continued)
 F-19
 **EUROBANCSHARES,
INC. AND SUBSIDIARIES**
Notes to
Consolidated Financial Statements
December 31,
2004 and 2003
 Effective
      December 15, 2002, the Company, through the Bank, acquired all of the then
      issued and outstanding shares of common stock of Banco Financiero de
      Puerto Rico (Banco Financiero) for a purchase price of $1,548,671,
      consisting of the issuance of common stock of the Company valued at
      $1,222,280 and $326,391 paid in cash. Banco Financiero was a commercial
      bank, which operated through three branches in Ponce, Puerto Rico. Also,
      as a result of this transaction, Banco Financiero merged with and into the
      Bank in a business combination. The estimated fair value of the assets
      acquired less liabilities assumed of $2,844,535 exceeded the acquisition
      price of $1,763,552, including costs associated to the acquisition of
      $214,881. This excess resulted in an extraordinary gain on business
      acquisition of $1,080,983 after reducing the value of certain assets
      acquired by $456,351.******(4)**
    **Securities
      Purchased Under Agreements to Resell**Securities
      purchased under agreements to resell at December 31, 2004 and 2003
      consist of short-term investments, usually overnight transactions. The
      following table summarizes certain information on securities purchased
      under agreements to resell:
 **2004**
    
    **2003**Amount
      outstanding at year-end
    
    $
    42,810,479
    
    $
    20,483,736Maximum
      aggregate balance outstandingat
      any month-end
    
    
    63,763,679
    
    
    49,314,518Average
      monthly aggregate balanceoutstanding
      during the year
    
    
    26,607,444
    
    
    21,017,618Weighted
      average interest rate for the yearended
      December 31
    
    
    1.30
    %
    
    1.19
    %Weighted
      average interest rate at year-end
    
    
    2.36
    %
    
    1.00
    %
 The
      amounts advanced under those agreements are reflected as assets in the
      balance sheets. It is the Company’s policy to take possession of
      securities purchased under agreements to resell. Agreements with third
      parties specify the Company’s rights to request additional collateral,
      based on its monitoring of the fair value of the underlying securities on
      a daily basis. The securities are segregated by the broker or dealer
      custodian bank account designated under a written custodial agreement that
      explicitly recognizes the Company’s interest in the securities.The
      fair value of the collateral securities held by the Bank on these
      transactions as of December 31, 2004 and 2003 was approximately
      $43,664,000 and $20,504,000, respectively. It is the Company’s policy to
      request collateral securities with fair value of 102% of the transaction
      amount.
 (Continued)
 F-20
 **EUROBANCSHARES,
INC. AND SUBSIDIARIES**
Notes to
Consolidated Financial Statements
December 31,
2004 and 2003
 ******(5)**
    **Investment
      Securities Available for Sale******Investment
      securities available for sale and related contractual maturities as of
      December 31 2004 and 2003 are as follows:
 **2004****Amortized**
    
    
    **Gross
      unrealized**
    
    
    **Gross
      unrealized**
    
    
    **Fair****cost**
    
    
    **gains**
    
    
    **losses**
    
    
    **value**Commonwealth
      of PuertoRico
      obligations:Less
      than one year
    
    $
    1,506,276
    
    $
    8,960
    
    $
    (905
    )
    $
    1,514,331One
      through five years
    
    
    6,264,714
    
    
    39,714
    
    
    (13,920
    )
    
    6,290,508More
      than ten years
    
    
    1,706,383
    
    
    15,429
    
    
    (12,819
    )
    
    1,708,993U.S.
      treasury obligations:Less
      than one year
    
    
    84,882,054
    
    
    —
    
    
    (489,884
    )
    
    84,392,170Federal
      Home Loan Bank notes:Less
      than one year
    
    
    37,517,099
    
    
    —
    
    
    (237,465
    )
    
    37,279,634One
      through five years
    
    
    41,391,666
    
    
    —
    
    
    (257,723
    )
    
    41,133,943Federal
      National MortgageAssociation
      notes:One
      through five years
    
    
    7,461,983
    
    
    —
    
    
    (49,295
    )
    
    7,412,688Federal
      Home Loan MortgageCorporation
      notes:One
      through five years
    
    
    3,005,088
    
    
    —
    
    
    (32,433
    )
    
    2,972,655Mortgage-backed
      securities
    
    
    374,320,227
    
    
    1,385,436
    
    
    (2,928,842
    )
    
    372,776,821Total
    
    $
    558,055,490
    
    $
    1,449,539
    
    $
    (4,023,286
    )
    $
    555,481,743
  (Continued)
 F-21
 **EUROBANCSHARES,
INC. AND SUBSIDIARIES**
Notes to
Consolidated Financial Statements
December 31,
2004 and 2003
  2003Amortized
    
    
    Gross
      unrealized
    
    
    Gross
      unrealized
    
    
    Faircost
    
    
    gains
    
    
    losses
    
    
    valueCommonwealth
      of PuertoRico
      obligations:One
      through five years
    
    $
    4,317,444
    
    $
    48,556
    
    $
    —
    
    $
    4,366,000More
      than five years
    
    
    201,685
    
    
    7,815
    
    
    —
    
    
    209,500U.S.
      corporate notes:Less
      than one year
    
    
    2,967,893
    
    
    26,442
    
    
    —
    
    
    2,994,335U.S.
      treasury obligations:One
      through five years
    
    
    84,748,443
    
    
    367,808
    
    
    —
    
    
    85,116,251Federal
      Home Loan Bank notes:Less
      than one year
    
    
    1,000,000
    
    
    6,347
    
    
    —
    
    
    1,006,347One
      through five years
    
    
    23,052,150
    
    
    24,598
    
    
    —
    
    
    23,076,748Five
      through ten years
    
    
    5,356,640
    
    
    12,474
    
    
    —
    
    
    5,369,114Federal
      National MortgageAssociation
      notes:One
      through five years
    
    
    7,449,036
    
    
    21,951
    
    
    —
    
    
    7,470,987Federal
      Home Loan MortgageCorporation
      notes:One
      through five years
    
    
    3,009,060
    
    
    —
    
    
    (2,324
    )
    
    3,006,736Mortgage-backed
      securities
    
    
    193,912,017
    
    
    400,923
    
    
    (1,990,916
    )
    
    192,322,024Total
    
    $
    326,014,368
    
    $
    916,914
    
    $
    (1,993,240
    )
    $
    324,938,042
 Contractual
      maturities on certain investment securities available for sale could
      differ from actual maturities since certain issuers have the right to call
      or prepay these securities.At
      December 31, 2004 and 2003, no investments that are payable from and
      secured by the same source of revenue or taxing authority, other than the
      U.S. government and U.S. agencies exceed 10% of stockholders’
      equity.During
      the years ended December 31, 2004 and 2002, there were no sales of
      investment securities. During the year ended December 31, 2003,
      proceeds from sales of investment securities were approximately
      $83,220,000 and gross gains of approximately $707,000 were realized.
 (Continued)
 F-22
 **EUROBANCSHARES,
INC. AND SUBSIDIARIES**
Notes to
Consolidated Financial Statements
December 31,
2004 and 2003
 Gross
      unrealized losses on investment securities available for sale and the fair
      value of the related securities, aggregated by investment category and
      length of time that individual securities have been in a continuous
      unrealized loss position, at December 31, 2004, were as
      follows:
  **Less
      than 12 months**
    
    **12
      months or more**
    
    **Total****Unrealized**
    
    **Fair**
    
    **Unrealized**
    
    **Fair**
    
    **Unrealized**
    
    **Fair****losses**
    
    **value**
    
    **losses**
    
    **value**
    
    **losses**
    
    **value**U.S.
      agency debt securities
    
    $
    (544,483
    )
    $
    38,161,288
    
    $
    (32,433
    )
    $
    2,972,655
    
    $
    (576,916
    )
    $
    41,133,943State
      and municipal obligations
    
    
    (27,644
    )
    
    2,679,081
    
    
    —
    
    
    —
    
    
    (27,644
    )
    
    2,679,081U.S.
      treasury obligations
    
    
    (489,884
    )
    
    84,882,054
    
    
    —
    
    
    —
    
    
    (489,884
    )
    
    84,882,054Mortgage-backed
      securities
    
    
    (2,141,723
    )
    
    183,629,377
    
    
    (787,119
    )
    
    53,218,529
    
    
    (2,928,842
    )
    
    236,847,906$
    (3,203,734
    )
    $
    309,351,800
    
    $
    (819,552
    )
    $
    56,191,184
    
    $
    (4,023,286
    )
    $
    365,542,984
 ·
    ***U.S.
      Agency Debt Securities***-
      The unrealized losses on investments in U.S. agency debt securities
      were caused by interest rate increases. The contractual terms of these
      investments do not permit the issuer to settle the securities at a price
      less than the amortized cost of the investment. Because the Company has
      the ability and intent to hold these investments until a market price
      recovery or maturity, these investments are not considered
      other-than-temporarily impaired.·
    ***U.S.
      Treasury Obligations***-
      The unrealized losses on investment in U.S. Treasury obligations were
      caused by interest rate increases. The contractual terms of these
      investments do not permit the issuer to settle the securities at a price
      less than the amortized cost of the investment. Because the Company has
      the ability and intent to hold these investments until a market price
      recovery or maturity, these investments are not considered
      other-than-temporarily impaired.·
    ***Mortgage-Backed
      Securities***-
      The unrealized losses on investments in mortgage-backed securities were
      caused by interest rate increases. The contractual cash flows of these
      securities are guaranteed by Federal National Mortgage Association (FNMA)
      and Federal Home Loan Mortgage Corporation (FHLMC). It is expected that
      the securities would not be settled at a price less than the amortized
      cost of the investment. Because the decline in fair value is attributable
      to changes in interest rates and not credit quality, and because the
      Company has the ability and intent to hold these investments until a
      market price recovery or maturity, these investments are not considered
      other-than-temporarily impaired.
 (Continued)
 F-23
 **EUROBANCSHARES,
INC. AND SUBSIDIARIES**
Notes to
Consolidated Financial Statements
December 31,
2004 and 2003
 **(6)**
    **Investment
      Securities Held to Maturity**Investment
      securities held to maturity as of December 31, 2004 are as
      follows:****
  **Amortized**
    
    **Gross
      unrealized**
    
    **Gross
      unrealized**
    
    **Fair****cost**
    
    **gains**
    
    **losses**
    
    **value**Federal
      Home Loan Bank Notes:Five
      through ten years
    
    $
    4,813,645
    
    $
    —
    
    $
    (38,338
    )
    $
    4,775,307Mortgage-backed
      securities
    
    
    44,690,798
    
    
    183,194
    
    
    (342,738
    )
    
    44,531,254Total
    
    $
    49,504,443
    
    $
    183,194
    
    $
    (381,076
    )
    $
    49,306,561
  During
      the years ended December 31, 2004 and 2003, there were no sales of
      investment securities held to maturity. There were no investment
      securities held to maturity as of December 31, 2003.******(7)**
    **Other
      Investments**Other
      investments at December 31, 2004 and 2003 consist of the
      following:
  **2004**
    
    **2003**FHLB
      stock, at cost
    
    $
    7,330,100
    
    $
    1,953,600Investment
      in statutory trusts (notes 1 and 18)
    
    
    1,385,500
    
    
    1,388,500Other
      investments
    
    $
    8,715,600
    
    $
    3,342,100
 (Continued)
 F-24
 **EUROBANCSHARES,
INC. AND SUBSIDIARIES**
Notes to
Consolidated Financial Statements
December 31,
2004 and 2003
  **(8)**
    **Pledged
      Assets**At
      December 31, 2004, various securities and loans were pledged to
      secure the following:
 **Carrying**
    
    ******Asset
      pledged**
    
    **value**
    
    ****Items
      secured/**collateralized**Securities
    
    $11,186,051
    
    Deposits
      of public fundsCommercial
      loans guaranteed by the Small Business Administration
    
    2,869,473
    
    Deposits
      of public fundsSecuritiesResidential
      mortgage loans
    
    10,183,548
    
    Advances
      from Federal Home Loan Bank965,097
    
    Advances
      from Federal Home Loan BankSecurities
    
    125,923
    
    Assets
      pledged with Commissioner of Financial Institutions of the Commonwealth of
      Puerto Rico for IRA TrustSecurities
    
    52,565
    
    Assets
      for Eurobank IRA TrustSecurities
    
    438,384
    
    Assets
      pledged with Commissioner of Financial Institutions of the Commonwealth of
      Puerto Rico for the Trust and the International Banking Entity
      operationsSecurities
    
    295,725
    
    Assets
      pledged with the Federal Reserve Bank for Treasury, tax, and loan
      accountSecurities
    
    2,168,652
    
    Assets
      pledged with the Federal Reserve Bank for Discount
  WindowSecurities
    
    491,638,391
    
    Securities
      sold under agreements to repurchaseSecurities
    
    2,918,463
    
    Assets
      pledged with brokers for interest rateswaps
 **(9)**
    **Interest
      and Dividends on Investment Securities**A
      detail of interest and FHLB dividend income on investment securities
      follows:
  **Year
      ended December 31****2004**
    
    **2003**
    
    **2002**Mortgage-backed
      securities:Taxable
    
    $
    381,436
    
    $
    —
    
    $
    —Exempt
    
    
    6,527,806
    
    
    2,506,807
    
    
    2,855,460$
    6,909,242
    
    $
    2,506,807
    
    $
    2,855,460Other
      investment securities:Taxable
    
    $
    358,917
    
    $
    89,044
    
    $
    361,328Exempt
    
    
    4,820,626
    
    
    3,413,382
    
    
    2,125,094$
    5,179,543
    
    $
    3,502,426
    
    $
    2,486,422
 (Continued)
 F-25
 **EUROBANCSHARES,
INC. AND SUBSIDIARIES**
Notes to
Consolidated Financial Statements
December 31,
2004 and 2003
 **(10)**
    **Loans,
      Net**A
      summary of the Company’s loan portfolio at December 31, 2004 and 2003
      is as follows:
 **2004**
    
    **2003**Commercial
      and industrial secured by real estate
    
    $
    463,500,209
    
    $
    299,891,670Other
      commercial and industrial
    
    
    242,479,758
    
    
    176,854,219Construction
      secured by real estate
    
    
    79,334,108
    
    
    47,370,068Other
      construction
    
    
    1,123,435
    
    
    1,135,092Mortgage
    
    
    51,730,399
    
    
    15,941,467Consumer
      secured by real estate
    
    
    1,311,343
    
    
    1,657,682Other
      consumer
    
    
    74,755,008
    
    
    26,592,124Lease
      financing contracts
    
    
    459,250,841
    
    
    315,935,299Overdrafts
    
    
    6,133,558
    
    
    4,235,4861,379,618,659
    
    
    889,613,107Deferred
      loan costs, net
    
    
    6,479,782
    
    
    4,706,774Unearned
      finance charges
    
    
    (1,169,230
    )
    
    (1,774,047
    )Allowance
      for loan and lease losses
    
    
    (19,038,836
    )
    
    (9,393,943
    )Loans,
      net
    
    $
    1,365,890,375
    
    $
    883,151,891
 The
      components of the net financing leases receivable at December 31,
      were as follows:
  **2004**
    
    **2003**Minimum
      lease payments
    
    $
    395,318,044
    
    $
    285,444,407Guaranteed
      residual payments
    
    
    63,932,797
    
    
    30,490,892Deferred
      origination costs, net
    
    
    6,795,587
    
    
    4,932,656Less
      unearned income (equipment leases)
    
    
    (1,163,859
    )
    
    (1,734,141
    )Less
      allowance for lease losses
    
    
    (3,815,222
    )
    
    (1,950,090
    )$
    461,067,347
    
    $
    317,183,724
 Guaranteed
      residual payments apply to leases where there is a more than nominal final
      payment for transfer of the unit to lessee. Such amounts are obligations
      of the lessee, which are generally established at amounts not to exceed
      the unit’s estimated value at the end of the lease term.
  (Continued)
 F-26
 **EUROBANCSHARES,
INC. AND SUBSIDIARIES**
Notes to
Consolidated Financial Statements
December 31,
2004 and 2003
 At
      December 31, 2004, future minimum lease payments are expected to be
      received as follows:
  Years
      ending December 31:2005
    
    $
    90,217,7852006
    
    
    91,353,3882007
    
    
    87,278,7382008
    
    
    72,265,5832009
    
    
    42,552,984Thereafter
    
    
    11,649,566$
    395,318,044
 The
      following is a summary of information pertaining to impaired loans:
  **2004**
    
    **2003**Impaired
      loans with related allowance
    
    $
    14,230,000
    
    $
    7,187,000Impaired
      loans that did not require allowance
    
    
    9,429,000
    
    
    6,242,000Total
      impaired loans
    
    $
    23,659,000
    
    $
    13,429,000Allowance
      for impaired loans
    
    $
    924,000
    
    $
    451,000
  **2004**
    
    **2003**
    
    **2002**Average
      investment in impaired loans
    
    $
    21,317,000
    
    $
    13,246,000
    
    $
    10,210,000Interest
      income recognized onimpaired
      loans
    
    
    560,000
    
    
    547,000
    
    
    574,000Interest
      income recognized on a cashbasis
      on impaired loans
    
    
    560,000
    
    
    547,000
    
    
    574,000
 No
      additional funds are committed to be advanced in connection with impaired
      loans.As
      of December 31, 2004, 2003, and 2002, loans on which the accrual of
      interest has been discontinued amounted to $32,168,494, $17,058,295, and
      $15,889,045, respectively. If these loans had been accruing interest, the
      additional interest income realized would have been $1,640,797, $822,355,
      and $833,228, for 2004, 2003, and 2002, respectively.Commercial
      and industrial loans with principal outstanding balances amounting to
      approximately $3,474,000 and $3,650,000 in 2004 and 2003, respectively,
      are guaranteed by the U.S. government through the Small Business
      Administration at percentages varying from 75% to 90%. As of
      December 31, 2004 and 2003, industrial loans with a principal
      outstanding balance of approximately $1,555,000 and $1,556,000,
      respectively, were guaranteed by the U.S. government through the
      U.S. Department of Agriculture.
 (Continued)
 F-27
 **EUROBANCSHARES,
INC. AND SUBSIDIARIES**
Notes to
Consolidated Financial Statements
December 31,
2004 and 2003
 **(11)**
    **Allowance
      for Loan and Lease Losses**The
      following analysis summarizes the changes in the allowance for loan and
      lease losses for the years ended December 31:
 **2004**
    
    **2003**
    
    **2002**Balance
      at beginning of year
    
    $
    9,393,943
    
    $
    6,918,141
    
    $
    4,512,932Provision
      for loan and lease losses
    
    
    7,100,000
    
    
    6,451,000
    
    
    3,353,686Loans
      charged-off
    
    
    (10,499,850
    )
    
    (5,065,207
    )
    
    (3,387,240
    )Recoveries
    
    
    2,143,197
    
    
    1,090,009
    
    
    420,764Allowance
      from the acquisition ofBanco
      Financiero
    
    
    —
    
    
    —
    
    
    2,017,999Allowance
      from the acquisition ofBankTrust
    
    
    10,901,546
    
    
    —
    
    
    —Balance
      at end of year
    
    $
    19,038,836
    
    $
    9,393,943
    
    $
    6,918,141
 **(12)**
    **Premises
      and Equipment, Net**Premises
      and equipment at December 31 are as follows:
 **Estimated****useful
      lives****(years)**
    
    **2004**
    
    **2003**Building
    
    
    40
    
    $
    5,749,435
    
    $
    5,748,836Leasehold
      improvements
    
    
    5
      to 20
    
    
    6,389,119
    
    
    5,315,561Furniture,
      fixtures, and equipment
    
    
    2
      to 5
    
    
    10,008,632
    
    
    8,734,216Construction
      in progress
    
    
    
    
    
    —
    
    
    122,36222,147,186
    
    
    19,920,975Accumulated
      depreciation and amortization
    
    
    
    
    
    (10,885,973
    )
    
    (9,389,622
    )$
    11,261,213
    
    $
    10,531,353
 Depreciation
      and amortization expense for the years ended December 31, 2004, 2003, and
      2002 amounted to $1,674,309, $1,442,973, and $1,243,089,
      respectively.
 (Continued)
 F-28
 **EUROBANCSHARES,
INC. AND SUBSIDIARIES**
Notes to
Consolidated Financial Statements
December 31,
2004 and 2003
 **(13)**
    **Other
      Assets**Other
      assets at December 31 consist of the following:
 **2004**
    
    **2003**Deferred
      tax assets, net (note 21)
    
    $
    12,523,726
    
    $
    4,010,050Merchant
      credit card items in process of collection
    
    
    1,845,113
    
    
    1,918,965Auto
      insurance claims receivable on repossessed vehicles
    
    
    1,228,858
    
    
    1,214,016Accounts
      receivable
    
    
    1,337,594
    
    
    806,545Other
      real estate, net of valuation allowance of $22,779 and $27,525 in 2004 and 2003, respectively
    
    
    2,875,002
    
    
    2,774,124Other
      repossessed assets, net of valuation allowance of $1,493,305 and $885,135
      in 2004 and 2003, respectively
    
    
    3,566,446
    
    
    3,642,886Servicing
      assets, net of valuation allowance of $1,003,618 in 2004 (note
      20)
    
    
    3,554,276
    
    
    3,031,297Prepaid
      expenses and deposits
    
    
    5,615,626
    
    
    3,982,463Other
    
    
    462,868
    
    
    1,062,937$
    33,009,509
    
    $
    22,443,283
 Other
      repossessed assets are presented net of an allowance for losses. The
      following analysis summarizes the changes in the allowance for losses for
      the years ended December 31:
 **2004**
    
    **2003**
    
    **2002**Balance,
      beginning of year
    
    $
    885,135
    
    $
    824,473
    
    $
    402,114Provision
      for losses
    
    
    884,593
    
    
    522,660
    
    
    428,530Allowance
      from acquisition of BankTrust
    
    
    601,078
    
    
    —
    
    
    —Net
      charge-offs
    
    
    (877,501
    )
    
    (461,998
    )
    
    (6,171
    )Balance,
      end of year
    
    $
    1,493,305
    
    $
    885,135
    
    $
    824,473
 (Continued)
 F-29
 **EUROBANCSHARES,
INC. AND SUBSIDIARIES**
Notes to
Consolidated Financial Statements
December 31,
2004 and 2003
 **(14)**
    **Deposits**
    
    ****Total
      interest-bearing deposits as of December 31 consisted of:
 **2004**
    
    **2003**Savings
      deposits:Savings
      accounts
    
    $
    278,802,480
    
    $
    230,326,464Now
      and money market accounts
    
    
    118,076,729
    
    
    77,019,283396,879,209
    
    
    307,345,747Time
      deposits:Under
      $100,000
    
    
    185,897,292
    
    
    166,232,067$100,000
      and over
    
    
    688,364,074
    
    
    406,213,619874,261,366
    
    
    572,445,686$
    1,271,140,575
    
    $
    879,791,433
 Interest
      expense on time deposits over $100,000 or more amounted to approximately
      $20,155,000, $14,396,000, and $12,383,000 for the years ended
      December 31, 2004, 2003, and 2002, respectively.
 At
      December 31, 2004, the scheduled maturities of time deposits are as
      follows:
 2005
    
    $
    424,257,2852006
    
    
    168,203,3532007
    
    
    106,913,2392008
    
    
    60,458,9622009
    
    
    58,964,326Thereafter
    
    
    53,564,573872,361,738Net
      premiums on time deposits
    
    
    1,899,628$
    874,261,366
 At
      December 31, 2004 and 2003, the Company had brokered certificates of
      deposit amounting to approximately $511,158,000 and $228,212,000,
      respectively.
 (Continued)
 F-30
 **EUROBANCSHARES,
INC. AND SUBSIDIARIES**
Notes to
Consolidated Financial Statements
December 31,
2004 and 2003
 **(15)**
    **Securities
      Sold Under Agreements to Repurchase**Securities
      sold under agreements to repurchase represent short-term financing
      transactions with securities dealers and the FHLB. The following table
      summarizes certain information on securities sold under agreements to
      repurchase:
 **2004**
    
    **2003**
    
    **2002**Amount
      outstanding at year-end
    
    $
    463,409,056
    
    $
    207,523,000
    
    $
    64,112,687Maximum
      aggregate balance outstandingat
      any month-end
    
    
    465,302,056
    
    
    207,523,000
    
    
    64,112,687Average
      aggregate balance outstandingduring
      the year
    
    
    312,169,363
    
    
    92,068,813
    
    
    44,472,450Weighted
      average interest rate for the year
    
    
    1.70
    %
    
    1.71
    %
    
    2.60
    %Weighted
      average interest rate at year-end
    
    
    2.47
    %
    
    1.25
    %
    
    2.04
    %
 The
      investment securities underlying such agreements were delivered to the
      dealers with whom the agreements were transacted. The dealers may have
      sold, loaned, or otherwise disposed of such securities in the normal
      course of business operations, but have agreed to resell to the Company
      substantially the same securities on the maturity dates of the
      agreements.
 (Continued)
 F-31
 **EUROBANCSHARES,
INC. AND SUBSIDIARIES**
Notes to
Consolidated Financial Statements
December 31,
2004 and
2003
  The
      following table presents the borrowing associated with the repurchased
      transactions (including accrued interest), their maturities and weighted
      average interest rates. Also, it includes the amortized cost and
      approximate fair value of the underlying collateral (including accrued
      interest) as of December 31, 2004 and 2003:
  **2004****Amortized**
    
    
    
    **Weighted****Borrowing**
    
    **cost
      of**
    
    **Fair
      value**
    
    **average****balance**
    
    **collateral**
    
    **of
      collateral**
    
    **interest
      rate**U.S.
      Treasury securities:Within
      30 days
    
    $
    84,650,000
    
    $
    84,882,054
    
    $
    84,392,170
    
    
    2.10
    %Obligation
      of U.S. governmentagencies
      and corporations:Within
      30 days
    
    
    10,572,056
    
    
    10,885,000
    
    
    10,885,000
    
    
    1.99
    %After
      30 to 90 days
    
    
    24,264,000
    
    
    25,138,586
    
    
    24,836,342
    
    
    2.38
    %After
      90 days
    
    
    13,981,000
    
    
    15,058,084
    
    
    14,968,750
    
    
    1.79
    %48,817,056
    
    
    51,081,670
    
    
    50,690,092Mortgage-backed
      securities:After
      30 to 90 days
    
    
    6,896,000
    
    
    7,412,815
    
    
    7,366,726
    
    
    2.40
    %After
      90 days
    
    
    27,192,000
    
    
    29,146,635
    
    
    29,413,054
    
    
    2.91
    %34,088,000
    
    
    36,559,450
    
    
    36,779,780Collateralized
      mortgage obligations:Within
      30 days
    
    
    3,421,000
    
    
    3,549,359
    
    
    3,575,061
    
    
    2.36
    %After
      30 to 90 days
    
    
    115,830,000
    
    
    124,127,363
    
    
    123,662,535
    
    
    2.30
    %After
      90 days
    
    
    176,603,000
    
    
    193,520,194
    
    
    192,538,753
    
    
    2.54
    %295,854,000
    
    
    321,196,916
    
    
    319,776,349$
    463,409,056
    
    $
    493,720,090
    
    $
    491,638,391
    
    
    2.37
    %
 (Continued)
 F-32
 **EUROBANCSHARES,
INC. AND SUBSIDIARIES**
Notes to
Consolidated Financial Statements
December 31,
2004 and
2003
 **2003****Amortized**
    
    
    
    **Weighted****Borrowing**
    
    **cost
      of**
    
    **Fair
      value**
    
    **average****balance**
    
    **collateral**
    
    **of
      collateral**
    
    **interest
      rate**U.S.
      Treasury securities:Within
      30 days
    
    $
    84,975,000
    
    $
    84,748,443
    
    $
    85,116,251
    
    
    0.89
    %Obligation
      of U.S. governmentagencies
      and corporations:Within
      30 days
    
    
    4,450,000
    
    
    4,550,000
    
    
    4,551,283
    
    
    1.18
    %Mortgage-backed
      securities:After
      90 days
    
    
    19,979,554
    
    
    21,436,974
    
    
    21,440,930
    
    
    1.41
    %Collateralized
      mortgage obligations:Within
      30 days
    
    
    35,445,000
    
    
    36,860,804
    
    
    36,620,424
    
    
    1.47
    %After
      30 to 90 days
    
    
    7,034,000
    
    
    7,115,127
    
    
    7,052,649
    
    
    1.16
    %After
      90 days
    
    
    55,639,446
    
    
    59,239,196
    
    
    58,573,880
    
    
    1.65
    %98,118,446
    
    
    103,215,127
    
    
    102,246,953$
    207,523,000
    
    $
    213,950,544
    
    $
    213,355,417
    
    
    1.26
    %
 **(16)**
    **Advances
      from FHLB**
 At
      December 31 the Company owes several advances to the FHLB as
      follows:
 **Maturity**
    
    **Interest
      rate range**
    
    **2004**
    
    **2003**2004
    
    
    6.50%
      to 6.81%
    
    $
    —
    
    $
    2,500,0002005
    
    
    2.63%
    
    
    1,600,000
    
    
    —2006
    
    
    4.81%
      to 5.72%
    
    
    7,000,000
    
    
    7,000,0002007
    
    
    5.20%
    
    
    1,200,000
    
    
    1,200,0002014
    
    
    4.38%
    
    
    603,638
    
    
    —$
    10,403,638
    
    $
    10,700,000
 Interest
      rates are fixed for the term of each advance and payable on the first
      business day of the following month when the original maturity of the note
      exceeds six months. In notes with original terms of six months or
      less, interest is paid at maturity. Interest payments during 2004, 2003,
      and 2002, amounted to approximately $584,523, $831,000, and $998,000,
      respectively. These notes are guaranteed by approximately $10,184,000 in
      securities and $965,000 in mortgage loans as of December 31, 2004
      (note 8).
 (Continued)
 F-33
 **EUROBANCSHARES,
INC. AND SUBSIDIARIES**
Notes to
Consolidated Financial Statements
December 31,
2004 and
2003
 **(17)**
    **Derivative
      Financial Instruments**As
      of December 31, 2004, the Company had the following derivative financial
      instruments outstanding (none at December 31, 2003):
 **Notional****amount**
    
    **Fair
      value**
    
    **Tax
      effect**
    
    **Net
      effect**Cash-flow
      hedges:Interest
      rate swaps
    
    $
    52,500,000
    
    $
    (236,690
    )
    $
    92,309
    
    $
    (144,381
    )
    (1)Fair-value
      hedges:Interest
      rate swaps
    
    
    50,227,000
    
    
    (1,061,846
    )
    
    (414,120
    )
    
    (1,475,966
    )
    (2)$
    102,727,000
    
    $
    (1,298,536
    )
    $
    (321,811
    )
    $
    (1,620,347
    )
 (1)
    Included
      in other comprehensive income (loss).(2)
    Recorded
      in results of operations for the year together with the offsetting effect
      of the revaluation of hedged deposits of
1,475,966.
 Interest-rate
      swaps involve the exchange of fixed and floating interest-rate payments
      without an exchange of the underlying principal. Net interest settlements
      of interest-rate swaps are recorded as an adjustment to interest income or
      interest expense of the hedged item. The Company’s principal objective in
      holding interest-rate swap agreements is the management of interest-rate
      risk and related changes in the fair value of assets and liabilities. The
      Company’s policy is that each swap contract be specifically tied to assets
      or liabilities with the objective of transforming the interest-rate
      characteristics of the instrument.As
      of December 31, 2004, the Company has interest-rate swaps agreements
      primarily to hedge commercial loans and offset the risk of decrease in
      floating interest rates. The swaps have an aggregate notional amount of
      $52,500,000 maturing through the year 2007. The weighted average rates
      payable and receivable as of December 31, 2004 on these contracts were
      4.59% and 6.26%, respectively. The floating rates on the swaps outstanding
      at December 31, 2004 are based on USD-Prime and London Interbank Offered
      Rate (LIBOR). These swaps were designated as cash-flow-hedges.As
      of December 31, 2004, the Company has interest-rate swaps primarily to
      convert fixed-rate time deposits into variable rate liabilities for longer
      periods of time and provide protection against increases in interest
      rates. These swaps have an aggregate notional amount of $50,227,000 and
      maturities through the year 2018. These swaps were designated as
      fair-value-hedges. The weighted average rates payable and receivable as of
      December 31, 2004 on these contracts were 2.73% and 4.86%,
      respectively.During
      the year ended December 31, 2004 no gain or loss on ineffectiveness of any
      of the hedging relationships was recorded since ineffectiveness was deemed
      inconsequential.******(18)**
    **Notes
      Payable to Statutory Trusts**On
      December 18, 2001, the Trust issued $25,000,000 of floating rate
      Trust Preferred Capital Securities Series 1 due in 2031 with a
      liquidation amount of $1,000 per security. Distributions payable on each
      capital security will be payable at an annual rate equal to 5.60%
      beginning on (and including) the date of original issuance and ending on
      (but excluding) March 18, 2002, and at an annual rate for each
      successive period equal to the three-month LIBOR, plus 3.60% with a
      ceiling rate of 12.50%. The capital securities of the Trust are fully and
      unconditionally guaranteed by EuroBancshares (a wholly owned
      subsidiary of the Bank in 2001), now the Company (note 1).
      EuroBancshares then issued $25,774,000 of floating rate junior
      subordinated deferrable interest debentures to the Trust due in 2031. The
      terms of the debentures, which comprise substantially all of the assets of
      the Trust, are equal to the terms of the capital securities issued by the
      Trust. These debentures are fully and unconditionally guaranteed by the
      Bank. The Bank subsequently issued an unsecured promissory note to
      EuroBancshares for the issued amount and at an annual rate equal to that
      being paid on the Trust Preferred Capital Securities Series 1 due in
      2031.
 (Continued)
 F-34
 **EUROBANCSHARES,
INC. AND SUBSIDIARIES**
Notes to
Consolidated Financial Statements
December 31,
2004 and
2003
 On
      December 19, 2002, the Trust II issued $20,000,000 of floating
      rate Trust Preferred Capital Securities due in 2032 with a liquidation
      amount of $1,000 per security. Distributions payable on each capital
      security will be payable at an annual rate equal to 4.66% beginning on
      (and including) the date of original issuance and ending on (but
      excluding) March 26, 2003, and at an annual rate for each successive
      period equal to the three-month LIBOR plus 3.25% with a ceiling rate of
      11.75%. The capital securities of the Trust II are fully and
      unconditionally guaranteed by EuroBancshares. EuroBancshares then issued
      $20,619,000 of floating rate junior subordinated deferrable interest
      debentures to the Trust II due in 2032. The terms of the debentures,
      which comprise substantially all of the assets of the Trust II, are
      equal to the terms of the capital securities issued by the Trust II.
      These debentures are fully and unconditionally guaranteed by the Bank. The
      Bank subsequently issued an unsecured promissory note to the
      EuroBancshares for the issued amount and at an annual rate equal to that
      being paid on the Trust Preferred Capital Securities due in 2032.Prior
      to FIN No. 46R, the statutory trusts described above, were considered
      subsidiaries of the Company. As a result of the adoption of FIN No. 46R,
      the Company deconsolidated these statutory trusts effective December 31,
      2003. The junior subordinated debentures issued by the Company to the
      statutory trusts, totaling $46,393,000 are reflected in the Company’s
      consolidated balance sheets under the caption of “notes payable to
      statutory trusts”. The Company records interest expense on the notes
      payable to statutory trusts in the consolidated statements of income and
      included in the caption of other investments in the consolidated balance
      sheets, the common securities issued by the statutory trusts.Interest
      expense on notes payable to statutory trusts amounted to approximately
      $2,319,000, $2,189,000, and $1,472,000 for the years ended
      December 31, 2004, 2003, and 2002, respectively.The
      Federal Reserve Board indicated in supervisory letter SR 03-13 (the
      Supervisory Letter), dated July 2, 2003, that trust preferred
      securities will be treated as Tier 1 capital until notice is given of the
      contrary. The Supervisory Letter also indicates that the Federal Reserve
      will review the regulatory implications of any accounting treatment
      changes and will provide further guidance if necessary or warranted.On
      March 1, 2005 the Federal Reserve Board adopted the final rule that allows
      the continued limited inclusion of trust preferred securities in the tier
      1 capital of bank holding companies (BHCs). Under the final rule, trust
      preferred securities and other restricted core capital elements would be
      subject to stricter quantitative limits. The Federal Reserve Board’s final
      rule limits restricted core capital elements to 25% of all core capital
      elements, net of goodwill less any associated deferred tax liability.
      Internationally active BHCs, defined as those with consolidated assets
      greater than $250 billion or on-balance-sheet foreign exposure greater
      than $10 billion, will be subject to a 15% limit. But they may include
      qualifying mandatory convertible preferred securities up to the generally
      applicable 25% limit. Amounts of restricted core capital elements in
      excess of these limits generally may be included in Tier 2 capital. The
      final rule provides a five-year transition period, ending March 31, 2009,
      for application of the quantitative limits.
 (Continued)
 F-35
 **EUROBANCSHARES,
INC. AND SUBSIDIARIES**
Notes to
Consolidated Financial Statements
December 31,
2004 and
2003
 **(19)**
    **Commitments
      and Contingencies**The
      Company leases certain premises used in its operations under operating
      lease agreements expiring at various dates through 2033. The total
      approximated minimum rental payments and the related approximated minimum
      future rental income, respectively, under the agreements, including
      rentals based upon increases in taxes and other costs, are approximately
      as follows:
 **Minimum**
    
    **Estimated****rental**
    
    **rental****payments**
    
    **income**
    
    **Net**Year
      ending December 31:2005
    
    $
    2,199,000
    
    $
    248,000
    
    $
    1,951,0002006
    
    
    1,984,000
    
    
    265,000
    
    
    1,719,0002007
    
    
    1,654,000
    
    
    265,000
    
    
    1,389,0002008
    
    
    1,107,000
    
    
    285,000
    
    
    822,0002009
    
    
    881,000
    
    
    285,000
    
    
    596,000Thereafter
    
    
    8,277,000
    
    
    591,000
    
    
    7,686,000$
    16,102,000
    
    $
    1,939,000
    
    $
    14,163,000
 Rent
      expense for the years ended December 31, 2004, 2003, and 2002 was
      approximately $1,994,000, $1,780,000, and $1,322,000, respectively.The
      Company is involved as plaintiff or defendant in a variety of routine
      litigation incidental to the normal course of business. Management
      believes, based on the opinion of legal counsels, that it has adequate
      defense or insurance protection with respect to such litigations and that
      any losses therefrom, whether or not insured, would not have a material
      adverse effect on the results of operations or financial position of the
      Company.The
      Bank was defendant in a suit filed in 1994 alleging that money was
      permitted to be withdrawn from a corporate account at the Bank without
      full written authorization. On March 30, 2004, the court ruled against the
      Bank ordering restoration of approximately $890,000 in funds, interest
      thereon, and attorney’s fees. While the trial court found in favor of
      plaintiff, the Bank has appealed the decision. Management, based on the
      opinion of its legal counsel, expects to prevail.******(20)**
    **Sale
      of Receivables and Servicing Assets**During
      November 2004 and June 2003, the Company sold to a third party lease
      financing contracts with carrying values of approximately $30 million for
      each sale and $20 million in December 2003. In these sales the Company
      retained servicing responsibilities and servicing assets of $1,522,453,
      $2,316,450, and $1,344,330 were recognized, respectively. The Company
      surrendered control of the lease financing receivables, as defined by
      SFAS No. 140,*Accounting
      for Transfers and Servicing of Financial Assets and Extinguishment of
      Liabilities*,
      and accounted for these transactions as sales and recognized net gains of
      approximately $977,000, $1,797,000, and $1,023,000, respectively. Under
      the terms of the transactions, the Company has limited recourse
      obligations to repurchase defaulted leases up to 5% of the outstanding
      aggregate principal balance of all leases sold at repossession date. As of
      December 31, 2004, total amount accrued on books related to such recourse
      liability amounted to approximately $440,000.
 (Continued)
 F-36
 **EUROBANCSHARES,
INC. AND SUBSIDIARIES**
Notes to
Consolidated Financial Statements
December 31,
2004 and
2003
 In
      May 2004, the Company also assumed servicing responsibilities and
      servicing assets related to previous auto and marine lease financing
      contracts sales of BankTrust (note 3).During
      the years 2004 and 2003, the Company sold approximately $28.9 million and
      $42.8 million of mortgage loans, respectively. The Company
      surrendered control of the mortgage loans receivables, including servicing
      rights, as defined by SFAS No. 140, and accounted for these
      transactions as a sale. The net proceeds from the sale of such loans
      amounted to approximately $29.3 million and $43.5 million during 2004
      and 2003, respectively, resulting in a gain of approximately $309,000 and
      $700,000, respectively.In
      addition, in August 2004, the Company sold approximately $5.4 million of a
      loan portfolio (related to the BankTrust acquisition), including consumer
      and mortgage loans, which were served by another entity. The Company
      surrendered control of the loan receivables, including servicing rights,
      as defined by SFAS No. 140, and accounted for these transactions as a
      sale with net proceeds of approximately $5.5 million and a gain of
      approximately $108,000.Total
      loans serviced for other were $67,176,460 (including $8,618,478 formerly
      serviced by BankTrust) and $45,300,506 at December 31, 2004 and 2003,
      respectively.
 (Continued)
 F-37
 **EUROBANCSHARES,
INC. AND SUBSIDIARIES**
Notes to
Consolidated Financial Statements
December 31,
2004 and
2003
 A
      summary of servicing assets for the years ended December 31, 2004 and
      2003 follows:
 **2004**
    
    **2003**Balance,
      beginning of year
    
    $
    3,031,297
    
    $
    —Servicing
      assets from the acquisition ofBankTrust
      (note 3)
    
    
    1,933,412
    
    
    —Servicing
      retained on loans sold
    
    
    1,522,453
    
    
    3,660,780Amortization
    
    
    (1,929,268
    )
    
    (629,483
    )Balance,
      end of year
    
    
    4,557,894
    
    
    3,031,297Less
      valuation allowance from acquisitionof
      BankTrust (note 3)
    
    
    (789,561
    )
    
    —Less
      valuation allowance recorded forimpairment
      loss
    
    
    (214,057
    )
    
    —Total
      valuation allowance
    
    
    (1,003,618
    )
    
    —Balance,
      end of year, net
    
    $
    3,554,276
    
    $
    3,031,297
 Key
      assumptions used in measuring the servicing assets at the dates of the
      sales of loans completed during the years ended December 31, 2004 and
      2003, were as follows:
  **2004**
    
    **2003**Prepayment
      rate
    15.12%
    
    5.50%Weighted
      average life (in years)
    3.70
    
    3.90
      to 4.03Discount
      rate
    8.68%
    
    9.35
      to 9.95%
 The
      estimated fair value of servicing assets at December 31, 2004 was
      $3,846,481. Such fair value was estimated by an independent financial
      advisor using the present value of expected cash flows associated with the
      servicing assets using a prepayment assumption of 15.1% for the auto pools
      and 24% for the marine pools. For purposes of impairment, the Company
      considers each of its sold lease portfolios individually. An impairment
      loss of approximately $214,000 was recognized during year ended December
      31, 2004. No impairment loss was recognized during 2003.The
      estimated aggregate amortization expense related to servicing assets for
      the next years is as follows:
 2005
    
    $
    2,031,8912006
    
    
    1,052,5702007
    
    
    362,0402008
    
    
    60,4042009
    
    
    19,112Thereafter
    
    
    28,259$
    3,554,276
  (Continued)
 F-38
 **EUROBANCSHARES,
INC. AND SUBSIDIARIES**
Notes to
Consolidated Financial Statements
December 31,
2004 and
2003
 **(21)**
    **Income
      Taxes**Puerto
      Rico income tax law does not provide for filing a consolidated income tax
      return; therefore, the income tax expense reflected in the accompanying
      consolidated statements of income represents the sum of the income tax
      expense of the individual companies. At December 31, 2004, the
      Company’s tax provision and related accounts are substantially those of
      its subsidiary Bank.The
      Bank is subject to Puerto Rico income tax at statutory rates. Under the
      provisions of the Puerto Rico Internal Revenue Code of 1994, as amended,
      the Bank is subject to regular tax or the alternative minimum tax,
      whichever is higher. The excess of the alternative minimum tax over the
      regular income tax paid in any year is available to offset the regular
      income tax determined in future years, subject to certain limitations.
      Customarily, the effective tax rate is lower than the statutory rate
      primarily because interest income on certain U.S. and Puerto Rico
      securities is exempt from Puerto Rico income taxes.The
      Bank is also subject to federal income tax on its U.S. source income.
      However, the Bank had no taxable U.S. income for the years ended
      December 31, 2004, 2003, and 2002. The Bank is not subject to federal
      income tax on U.S. treasury securities that qualify as portfolio interest,
      nor to the branch profit tax and the branch-level interest tax on such
      income.During
      2000, the Bank established an international banking entity (IBE) engaged
      in investment securities, deposits, and other funding transactions outside
      Puerto Rico. During 2004 the Bank transferred the assets and liabilities
      of the IBE to a recent organized IBE subsidiary of the Bank, EBS Overseas,
      Inc. The Company also has an IBE that operates as a division of the Bank
      under the name of BT International, which the Company acquired as a result
      of the BankTrust acquisition. The revenue generated by these entities, net
      of related interest costs and operating expenses, are exempt from Puerto
      Rico taxes.In
      February 2005, the Puerto Rico Treasury Department (PRTD) completed an
      examination of Eurobank’s income tax return for the year ended December
      31, 2000. The PRTD assessed an income tax deficiency of $688,938, which
      includes $193,933 of accrued interest. The deficiency relates to a
      portion of the net operating losses acquired as a result of Banco del
      Comercio acquisition, which was not adjusted in the year 2000 by the
      Bank’s exempt income net of related expenses. Such deficiency was formally
      assessed by the PRTD on March 10, 2005, and recorded as of December 31,
      2004.Total
      income taxes for the years ended December 31 are as follows:
 **2004**
    
    **2003**
    
    **2002**Income
      tax from operations
    
    $
    8,662,633
    
    $
    3,432,465
    
    $
    2,723,852Stockholders'
      equity for unrealized (losses)and
      gain on investment securities andcash-flow
      hedges
    
    
    (83,964
    )
    
    (803,518
    )
    
    413,280$
    8,578,669
    
    $
    2,628,947
    
    $
    3,137,132
 (Continued)
 F-39
 **EUROBANCSHARES,
INC. AND SUBSIDIARIES**
Notes to
Consolidated Financial Statements
December 31,
2004 and
2003
 The
      components of the income tax provision for the years ended
      December 31, are as follows:
  **2004**
    
    **2003**
    
    **2002**Current
      tax provision
    
    $
    3,947,286
    
    $
    2,959,287
    
    $
    2,420,284Deferred
      tax provision
    
    
    4,715,347
    
    
    473,178
    
    
    303,568Total
      income tax provision
    
    $
    8,662,633
    
    $
    3,432,465
    
    $
    2,723,852
 The
      difference between the income tax provision and the amount computed using
      the statutory rate at December 31, is due to the
      following:
  **2004**
    
    **2003**
    
    **2002****Amount**
    
    **Rate**
    
    **Amount**
    
    **Rate**
    
    **Amount**
    
    **Rate**Income
      tax at statutory rate
    
    $
    10,515,716
    
    
    39.00
    %
    $
    5,192,923
    
    
    39.00
    %
    $
    3,344,922
    
    
    39.00
    %Change
      in the beginning-of-the-yearbalance of valuation
      allowance
    
    
    —
    
    
    —
    
    
    (584,712
    )
    
    (4.40
    )
    
    —
    
    
    —Benefits
      of tax-exempt interestincome, net
    
    
    (191,492
    )
    
    (0.71
    )
    
    (175,070
    )
    
    (1.31
    )
    
    (146,381
    )
    
    (1.71
    )International
      banking entities
    
    
    (1,410,672
    )
    
    (5.25
    )
    
    (1,054,468
    )
    
    (7.92
    )
    
    (524,366
    )
    
    (6.11
    )Puerto
      Rico Treasury Departmentexamination
    
    
    495,005
    
    
    1.84
    
    
    —
    
    
    —
    
    
    —
    
    
    —(Allowance)
      disallowance ofcertain expenses for tax purposes and other
      items
    
    
    (745,924
    )
    
    (2.78
    )
    
    53,792
    
    
    0.41
    
    
    49,677
    
    
    0.58$
    8,662,633
    
    
    32.10
    %
    $
    3,432,465
    
    
    25.78
    %
    $
    2,723,852
    
    
    31.76
    %
 (Continued)
 F-40
 **EUROBANCSHARES,
INC. AND SUBSIDIARIES**
Notes to
Consolidated Financial Statements
December 31,
2004 and
2003
 Deferred
      income taxes reflect the net tax effects of temporary differences between
      the carrying amounts of assets and liabilities for financial reporting
      purposes and the amounts used for income tax purposes. Significant
      components of the Bank’s deferred tax assets and liabilities at
      December 31, were as follows:
  **2004**
    
    **2003**Deferred
      tax assets:Allowance
      for loan and lease losses
    
    $
    7,425,146
    
    $
    3,663,638Net
      operating loss carryforward
    
    
    7,762,236
    
    
    2,297,665Unrealized
      loss on securities available-for-sale
    
    
    —
    
    
    269,082Unrealized
      loss on swaps designated as fair-value-hedges
    
    
    414,120
    
    
    —Other
      temporary differences
    
    
    2,144,161
    
    
    662,269Gross
      deferred tax assets
    
    
    17,745,663
    
    
    6,892,654Less
      valuation allowance
    
    
    —
    
    
    —Deferred
      tax assets
    
    
    17,745,663
    
    
    6,892,654Deferred
      tax liabilities:Deferred
      loan costs, net
    
    
    (2,527,115
    )
    
    (1,835,642
    )Servicing
      assets
    
    
    (1,214,567
    )
    
    (854,261
    )Fair
      value adjustments on loans
    
    
    (1,057,790
    )
    
    (192,701
    )Unrealized
      gain on securities available-for-sale
    
    
    (8,345
    )
    
    —Discount
      on interest-bearing time deposits
    
    
    (414,120
    )
    
    —Deferred
      tax liabilities
    
    
    (5,221,937
    )
    
    (2,882,604
    )Net
      deferred tax assets
    
    $
    12,523,726
    
    $
    4,010,050
 In
      assessing the realizability of deferred tax assets, management considers
      whether it is more likely than not that some portion or all of the
      deferred tax assets will be realized. The ultimate realization of deferred
      tax assets is dependent upon the generation of future taxable income
      during the periods in which those temporary differences become deductible.
      Management considers the scheduled reversal of deferred tax liabilities,
      projected future taxable income, and tax planning strategies in making
      this assessment. Considering economies of scale to be achieved from the
      merger and projected future taxable income over the periods in which the
      deferred tax assets are deductible, management believes it is more likely
      than not that the Bank will realize the benefits of these deductible
      differences at December 31, 2004. The amount of the deferred tax
      asset considered realizable, however, could be reduced in the near term if
      estimates of future taxable income during the carryforward period are
      reduced.
 (Continued)
 F-41
 **EUROBANCSHARES,
INC. AND SUBSIDIARIES**
Notes to
Consolidated Financial Statements
December 31,
2004 and
2003
 At
      December 31, 2004, the Bank has net operating loss carryforwards for
      income tax purposes of approximately $19.9 million, which are available to
      offset future taxable income of the former BankTrust and Banco Financiero
      (note 3). Such operations yielded approximately $10.0 million of taxable
      income during 2004. The expiration dates of the net operating loss
      carryforwards are detailed as follows:
 ****
    
    **Net
      operating loss carryforwards****Expiration Date**
    
    **BankTrust**
    
    **Banco
      Financiero**
    
    **Total**2006
    
    $
    —
    
    $
    334,132
    
    $
    334,1322007
    
    
    —
    
    
    452,822
    
    
    452,8222008
    
    
    —
    
    
    1,570,684
    
    
    1,570,6842009
    
    
    3,097,157
    
    
    2,853,184
    
    
    5,950,3412011
    
    
    11,595,189
    
    
    —
    
    
    11,595,189$
    14,692,346
    
    $
    5,210,822
    
    $
    19,903,168
  **(22)**
    **Stock
      Transactions******
  During
      2004, EuroBancshares issued 230,802 of the common stock shares, through
      stock options exercised as follows:
 **Number
      of****Date**
    
    **shares**
    
    **Price**
    
    **Total**January-04
    
    
    50,000
    
    $
    5.000
    
    $
    250,000March-04
    
    
    30,000
    
    
    3.325
    
    
    99,750March-04
    
    
    35,250
    
    
    4.500
    
    
    158,625March-04
    
    
    50,000
    
    
    5.000
    
    
    250,000November-04
    
    
    32,776
    
    
    3.325
    
    
    108,980December-04
    
    
    32,776
    
    
    3.325
    
    
    108,980230,802
    
    
    
    
    $
    976,335
 The
      Company also issued 3,700 common shares valued at $8.13 per share through
      restricted stock grants to some employees in 2004.In
      addition, during 2004 the Company also issued 683,304 common shares valued
      at $8.13 per share and 430,537 shares of perpetual noncumulative preferred
      stock Series A as a result of the acquisition of BankTrust.
 (Continued)
 F-42
 **EUROBANCSHARES,
INC. AND SUBSIDIARIES**
Notes to
Consolidated Financial Statements
December 31,
2004 and
2003
 The
      Series A preferred stockholders are entitled to receive, when and if
      declared by the board of directors, monthly noncumulative cash dividends
      at an annual rate of 6.825%. The board of directors has no obligation to
      declare dividends on the Series A preferred stock in any dividend period.
      However, so long as any Series A preferred stock remains outstanding,
      there are certain limitations on the payment of dividends or distributions
      on common stock. The Series A preferred stock is not convertible or
      exchangeable for any other class of stock. The stock is redeemable at the
      option of the Company at redemption price of $25.00 per share, plus
      accrued but unpaid dividends (noncumulative), which is equal to its
      liquidation value. The stock has no voting preferences and has no
      preemptive rights.Also,
      in connection with the acquisition of BankTrust on May 12, 2004, the
      Company issued 733,316 shares of common stock at a price of $8.13 to its
      common stockholders and to holders of options to purchase its common stock
      who were not otherwise stockholders through a private placement
      offering.On
      June 21, 2004, the board of directors authorized a two-for-one common
      stock split in the form of a stock dividend. The stock dividend was
      distributed on July 15, 2004 to stockholders of record on
      July 1, 2004. All share data and earnings per share data in these
      financial statements give effect to the stock split, applied
      retroactively, to all periods.On
      July 15, 2004, the Company purchased and retired approximately 1,932
      shares of its outstanding common stock, $0.01 par value, at a price of
      $4.50 per share.On
      August 11, 2004, the Company completed an initial public offering in
      which the Company sold 3,450,000 shares of common stock, plus an
      additional 517,500 shares in connection with the exercise of the
      underwriters’ over allotment option, at the initial offering price of
      $14.00 per share. Total proceeds received from the offering, after
      deducting offering expenses, including underwriting discounts and
      commissions, were approximately $50.1 million.During
      2003, EuroBancshares issued 34,013 of the common stock shares at $7.87 per
      share through stock options exercised.As
      a result of the reorganization into a holding company (note 1), on
      July 1, 2002, EuroBancshares became the sole owner of the Bank’s
      common stock. As part of such reorganization, the outstanding
      6,788,421 shares of the Bank’s common stock, $1 par value, were
      exchanged to 6,788,421 shares of EuroBancshares common stock, $0.01
      par value per share. Also as part of the reorganization, during 2002
      EuroBancshares purchased and retired approximately 9,707 shares of
      its outstanding common stock, $0.01 par value, held by the remaining
      minority stockholders at a price of $9.00 per share.During
      2002, EuroBancshares issued 38,750 of its common stock shares at $4.00 per
      share through stock options exercised. In addition, as a result of the
      acquisition of Banco Financiero (note 3), EuroBancshares also issued
      122,228 shares of its common stock, $0.01 par value, at a price of
      $10 per share, amounting to $1,222,280.During
      2002, the Bank issued 9,924 of the common stock shares at $3.33 per share
      through stock options exercised.
 (Continued)
 F-43
 **EUROBANCSHARES,
INC. AND SUBSIDIARIES**
Notes to
Consolidated Financial Statements
December 31,
2004 and
2003
 **(23)**
    **Stock
      Option Plan******During
      2002, the board of directors approved the stock option plan
      (the Plan), which was ratified at a special meeting of stockholders.
      Under the Plan, 1,982,864 shares of authorized common stock of the
      Company, representing 10% of the shares of common stock outstanding of
      February 25, 2002, were reserved for issuance under the Plan. The
      outstanding options as of December 31, 2004 include options granted under
      a stock option plan held by the Bank until the reorganization.All
      officers and directors of EuroBancshares are eligible under the Plan,
      provided, however, that stock options shall not be exercisable by an
      optionee who is the owner of 5% or more of the issued and outstanding
      shares of the Company or in exercising the stock options would become the
      owner of 5% or more of the issued and outstanding shares of the Company,
      unless the optionee obtains the approvals required from the appropriate
      regulatory agencies to hold shares in excess of such percent. Any eligible
      person may hold more than one option at a time.The
      compensation committee, appointed by the board of directors, has absolute
      discretion to select which of the eligible persons will be granted stock
      options, the number of shares of the Company’s common stock subject to
      such options, whether stock appreciation rights will be granted for such
      options, and generally, to determine the terms and conditions of such
      options in accordance to the provisions of the Plan. Options are
      exercisable within five years after the grant date at the discretion of
      the optionee. The options are granted at the approximate fair value of the
      Company’s common stock at the date of issuance, accordingly no
      compensation expense has been recorded during the years ended December 31,
      2004, 2003, and 2002.A
      summary of the status of stock options under the Plan at December 31,
      2004, 2003, and 2002 and changes during the years then ended is presented
      in the table below:
  **2004**
    
    **2003**
    
    **2002****Weighted**
    
    
    
    **Weighted**
    
    
    
    **Weighted****average**
    
    
    
    **average**
    
    
    
    **average****exercise**
    
    
    
    **exercise**
    
    
    
    **exercise****Shares**
    
    **price**
    
    **Shares**
    
    **price**
    
    **Shares**
    
    **price**Options
      outstanding January 1
    
    
    1,122,114
    
    $
    4.50
    
    
    616,140
    
    $
    3.97
    
    
    375,676
    
    $
    3.05Granted
    
    
    200,000
    
    
    8.13
    
    
    574,000
    
    
    5.00
    
    
    337,812
    
    
    4.50Exercised
    
    
    (230,802
    )
    
    4.23
    
    
    (68,026
    )
    
    3.94
    
    
    (97,348
    )
    
    2.27Options
      outstanding andexercisable
      December 31
    
    
    1,091,312
    
    $
    5.22
    
    
    1,122,114
    
    $
    4.50
    
    
    616,140
    
    $
    3.97
  At
      the end of February 2005, the Company granted, under the established stock
      option plan, a total of 125,000 options, which are vested immediately, to
      its Directors and Executive Officers. These options will have a strike
      price, which in no event will be less than the price the shares trade on
      the close of the last day of 2004, which amounted to
  $21.
 (Continued)
 F-44
 **EUROBANCSHARES,
INC. AND SUBSIDIARIES**
Notes to
Consolidated Financial Statements
December 31,
2004 and
2003
 The
      following is a summary of outstanding and exercisable options under the
      Plan at December 31, 2004:
 **Options****outstanding**
    
    **Exercise****Date
      granted**
    
    **and
      exercisable**
    
    **price**
    
    **Exercisable
      date**
    
    **Expiration
      date**2001
    
    
    150,000
    
    $
    3.33
    
    
    February
      28, 2001
    
    
    February
      28, 20062002
    
    
    267,312
    
    
    4.50
    
    
    February
      26, 2002
    
    
    February
      26, 20072003
    
    
    474,000
    
    
    5.00
    
    
    March
      24, 2003
    
    
    March
      24, 20082004
    
    
    200,000
    
    
    8.13
    
    
    February
      23, 2004
    
    
    February
      23, 20091,091,312
 (Continued)
 F-45
 **EUROBANCSHARES,
INC. AND SUBSIDIARIES**
Notes to
Consolidated Financial Statements
December 31,
2004 and
2003
 **(24)**
    **Earnings
      Per Share******The
      computation of earnings per share is presented below:
 **2004**
    
    **2003**
    
    **2002**Net
      income before extraordinary itemand
      preferred stock dividends
    
    $
    18,300,742
    
    $
    9,882,721
    
    $
    5,852,871Dividend
      paid to preferred shareholders
    
    
    (497,898
    )
    
    —
    
    
    —Extraordinary
      gain on the acquisitionof
      Banco Financiero
    
    
    —
    
    
    —
    
    
    1,080,983Extraordinary
      gain on the acquisitionof
      BankTrust
    
    
    4,419,118
    
    
    —
    
    
    —Net
      income available tocommon
      shareholders
    
    $
    22,221,962
    
    $
    9,882,721
    
    $
    6,933,854Weighted
      average number of commonshares
      outstanding applicable tobasic
      earnings per share
    
    
    16,523,373
    
    
    13,881,272
    
    
    13,622,970Effect
      of dilutive securities
    
    
    628,888
    
    
    352,896
    
    
    101,278Adjusted
      weighted averagenumber
      of common sharesoutstanding
      applicable todiluted
      earnings per share
    
    
    17,152,261
    
    
    14,234,168
    
    
    13,724,248Basic
      earnings per share:Income
      before extraordinary item
    
    $
    1.08
    
    $
    0.71
    
    $
    0.43Extraordinary
      item
    
    
    0.27
    
    
    —
    
    
    0.08Net
      income
    
    $
    1.35
    
    $
    0.71
    
    $
    0.51Diluted
      earnings per share:Income
      before extraordinary item
    
    $
    1.04
    
    $
    0.69
    
    $
    0.42Extraordinary
      item
    
    
    0.26
    
    
    —
    
    
    0.08Net
      income
    
    $
    1.30
    
    $
    0.69
    
    $
    0.50
 For
      periods prior to the formation of the holding company (note 1), the
      share information above is that of the Bank, since the exchange of shares
      of that transaction was one to one (note 22).******(25)**
    **Employees’
      Benefit Plan******The
      Company maintains a defined contribution plan covering substantially all
      its employees after three months of service. Under the provisions of
      the plan, employees elect to contribute to the plan from up to 10% of
      their compensation and the Company matches 100% of the amount contributed
      by the employees up to a maximum of 3% of the employees’ annual
      compensation. The amount of contribution expense recognized by the Company
      for the years ended December 31, 2004, 2003, and 2002 amounted to
      approximately $246,000, $185,000, and $140,000, respectively.
 (Continued)
 F-46
 **EUROBANCSHARES,
INC. AND SUBSIDIARIES**
Notes to
Consolidated Financial Statements
December 31,
2004 and
2003
 **(26)**
    **Related-Party
      Transactions**The
      Company makes loans to its directors, principal stockholders, officers,
      employees, organizations, and individuals associated with them in the
      normal course of business. At December 31, 2004 and 2003, loans
      outstanding with these parties amounted to $3,807,224 and $4,108,944,
      respectively, all of which are substantially on the same terms and credit
      risks as loans to third parties.The
      summary of change in the related-party loans follows:
  **Executive**
    
    
    
    
    
    **Principal****officers**
    
    
    
    
    
    **shareholders****and
      related**
    
    **Directors
      and**
    
    
    
    **and
      related****parties**
    
    **related
      parties**
    
    **Employees**
    
    **parties**
    
    **Total**Balance
      at December 31, 2002
    
    $
    719,647
    
    $
    3,032,282
    
    $
    406,799
    
    $
    1,050
    
    $
    4,159,778Additions
    
    
    99,124
    
    
    678,485
    
    
    208,574
    
    
    573
    
    
    986,756Reductions
    
    
    (408,942
    )
    
    (408,360
    )
    
    (220,288
    )
    
    —
    
    
    (1,037,590
    )Balance
      at December 31, 2003
    
    
    409,829
    
    
    3,302,407
    
    
    395,085
    
    
    1,623
    
    
    4,108,944Additions
    
    
    134,418
    
    
    2,814,899
    
    
    43,364
    
    
    —
    
    
    2,992,681Reductions
    
    
    (126,100
    )
    
    (3,061,724
    )
    
    (104,954
    )
    
    (1,623
    )
    
    (3,294,401
    )Balance
      at December 31, 2004
    
    $
    418,147
    
    $
    3,055,582
    
    $
    333,495
    
    $
    —
    
    $
    3,807,224
  Deposits
      of $7,010,191 and $7,836,751 from these parties were outstanding as of
      December 31, 2004 and 2003, respectively.******(27)**
    **Financial
      Instruments with Off-Balance-Sheet Risk******The
      Company is a party to financial instruments with off-balance-sheet risk in
      the normal course of business to meet the financial needs of its
      customers, such as commitments to extend credit, approved loans not yet
      disbursed, unused lines of credit, and standby letters of credit. Such
      instruments involve, to varying degrees, elements of credit and interest
      rate risk in excess of the amount recognized in the consolidated balance
      sheets. The contract or notional amount reflects the extent of involvement
      the Company has in this particular class of financial instrument.The
      Company’s exposure to credit loss in the event of nonperformance by the
      other party to these financial instruments is represented by the
      contractual notional amount of those instruments. The Company uses some
      credit policies in making commitments and conditional obligations as it
      does for on-balance-sheet instruments.Unless
      noted otherwise, the Company requires collateral or other security to
      support financial instruments with credit risk. The Company performs its
      normal credit granting due diligence procedures, to the extent necessary,
      in evaluating its involvement in financial instruments with credit
      risk.
 (Continued)
 F-47
 **EUROBANCSHARES,
INC. AND SUBSIDIARIES**
Notes to
Consolidated Financial Statements
December 31,
2004 and
2003
 At
      December 31, the approximate contract or notional amount of the
      Company’s financial instruments with off-balance-sheet risk follows:
 **2004**
    
    **2003**Financial
      instruments whose contract amounts representcredit risk – stand-by
      and commercial letters of credit
    
    $
    12,331,000
    
    $
    3,674,000Commitments
      to extend credit, approved loans not yetdisbursed, and unused
      lines of credit:Variable
      rate
    
    
    213,623,000
    
    
    131,815,000Fixed
      rate
    
    
    43,406,000
    
    
    20,910,000
 Commitments
      to extend credit are agreements to lend to a customer as long as there is
      no violation of any condition established in the contract. Commitments
      generally have fixed expiration dates or other termination clauses and may
      require payment of a fee. The commitments may expire without being drawn
      upon. Therefore, the total commitment amounts do not necessarily represent
      future cash requirements. The amount of collateral obtained, if it is
      deemed necessary by the Company, is based on management’s credit
      evaluation of the customer.Unused
      lines of credit are commitments for possible future extensions of credit
      to existing customers. These lines of credit are uncollateralized and
      usually do not contain a specified maturity date and may not be drawn upon
      to the total extent to which the Company is committed.Commercial
      and stand-by letters of credit are conditional commitments issued by the
      Company to guarantee the performance of a customer to a third party. Those
      guarantees are primarily issued to support public and private borrowing
      arrangements, including commercial paper, bond financing, and similar
      transactions. All guarantees expire within a year. The credit risk
      involved in issuing letters of credit is essentially the same as that
      involved in extending loan facilities to customers. The Company holds
      certificates of deposit as collateral supporting those commitments for
      which collateral is deemed necessary.******(28)**
    **Fair
      Value of Financial Instruments******The
      following methods and assumptions were used to estimate the fair value of
      each class of financial instruments in accordance with SFAS No. 107,
      as amended by SFAS No. 119,*Disclosure
      about Derivative Financial Instruments and Fair Value of Financial
      Instruments*.*********(a)***
    ***Cash
      and Due from Banks, Interest-Bearing Deposits, and Securities Purchased
      under Agreements to Resell***The
      carrying amount of cash and cash equivalents, interest-bearing deposits,
      and securities purchased under agreements to resell is a reasonable
      estimate of fair value, due to the short maturity of these
      instruments.*********(b)***
    ***Investment
      Securities***The
      fair value of investment securities available for sale and held to
      maturity are estimated based on bid prices published in financial
      newspapers or bid quotations received from securities dealers. If a quoted
      market price is not available, fair value is estimated using quoted market
      prices for similar securities.
  (Continued)
 F-48
 **EUROBANCSHARES,
INC. AND SUBSIDIARIES**
Notes to
Consolidated Financial Statements
December 31,
2004 and
2003
 ***(c)***
    ***Other
      Investment Securities***The
      carrying value of FHLB stock approximates fair value based on the
      redemption provisions of the FHLB. The carrying value of equity interest
      in unconsolidated statutory trusts approximates the fair value of the
      residual equity in the trusts.*********(d)***
    ***Loans
      and Loans Held for Sale***Fair
      values are estimated for portfolios of loans with similar financial
      characteristics. Loans are segregated by type such as commercial,
      consumer, mortgage, and other loans. Each loan category is further
      segmented into fixed and adjustable interest rate terms.The
      fair value of loans is calculated by discounting scheduled cash flows
      through the estimated maturity using estimated market discount rates that
      reflect the credit and interest rate risk inherent in the loan.The
      estimate of fair value of loans considers the credit risk inherent in the
      portfolio through the allowance for loan and lease losses. Assumptions
      regarding credit risk, cash flows, and discount rates are judgmentally
      determined using available market information and specific-borrower
      information.*********(e)***
    ***Accrued
      Interest Receivable***The
      carrying amount of accrued interest receivable is a reasonable estimate of
      its fair value, due to the short-term nature of the instruments.*********(f)***
    ***Deposits***
    ******The
      fair value of deposits with no stated maturity, such as demand deposits,
      savings accounts, money market, and checking accounts is equal to the
      amount payable on demand as of December 31, 2004 and 2003. The fair
      value of time deposits is based on the discounted value of contractual
      cash flows. The discount rate is estimated using the rate currently
      offered for deposits of similar remaining maturities.*********(g)***
    ***Security
      Sold under Agreements to Repurchase***The
      fair value of securities sold under agreements to repurchase are estimated
      using discounted cash flow analysis using rates for similar types of
      borrowing arrangements.*********(h)***
    ***Advances
      from Federal Home Loan Bank***The
      fair value of notes payable is calculated by discounted scheduled cash
      flows through the estimated maturity using market discount rates.*********(i)***
    ***Accrued
      Interest Payable, Accrued Expenses, and Other Liabilities***The
      carrying amount of accrued interest payable, accrued expenses, and other
      liabilities is a reasonable estimate of fair value, due to the short-term
      nature of the instruments.
  (Continued)
 F-49
 **EUROBANCSHARES,
INC. AND SUBSIDIARIES**
Notes to
Consolidated Financial Statements
December 31,
2004 and
2003
 ***(j)***
    ***Notes
      Payable to Statutory Trusts***The
      fair value of notes payable to statutory trust outstanding is calculated
      by discounting scheduled cash flows through the estimated maturity using
      the annual rate for each successive period equal to the three-month LIBOR,
      plus 3.60%, and the three-month LIBOR, plus 3.25%.*********(k)***
    ***Commitments
      to Extend Credit and Letters of Credit***The
      fair value of commitments to extend credit and letters of credit was not
      readily available and not deemed significant.*********(l)***
    ***Limitations***The
      fair value estimates are made at a discrete point in time based on
      relevant market information and information about the financial
      instruments. Because no market exists for a significant portion of the
      Company’s financial instruments, fair value estimates are based on
      judgments regarding future expected loss experience, current economic
      conditions, risk characteristics of various financial instruments, and
      other factors. These estimates are subjective in nature and involve
      uncertainties and matters of significant judgment and therefore cannot be
      determined with precision. Changes in assumptions could significantly
      affect the estimates.The
      fair value estimates are based on existing on- and off-balance-sheet
      financial instruments without attempting to estimate the value of
      anticipated future business and the value of assets and liabilities that
      are not considered financial instruments. As described for investments and
      mortgage-backed securities, the tax ramifications related to the
      realization of the unrealized gains and losses may have a significant
      effect on fair value estimates and have not been considered in many of the
      estimates.
  (Continued)
 F-50
 **EUROBANCSHARES,
INC. AND SUBSIDIARIES**
Notes to
Consolidated Financial Statements
December 31,
2004 and
2003
 Following
      are the carrying amount and fair value of financial instruments as of
      December 31:
  **2004**
    
    **2003****Carrying**
    
    
    
    **Carrying****amount**
    
    **Fair
      value**
    
    **amount**
    
    **Fair
      value**Financial
      assets:Cash
      and due from banks
    
    $
    18,597,116
    
    $
    18,597,116
    
    $
    22,522,342
    
    $
    22,522,342Interest-bearing
      deposits
    
    
    3,271,377
    
    
    3,271,377
    
    
    19,324,216
    
    
    19,324,216Securities
      purchased underagreements
      to resell
    
    
    42,810,479
    
    
    42,810,479
    
    
    20,483,736
    
    
    20,483,736Investment
      securitiesavailable
      for sale
    
    
    555,481,743
    
    
    555,481,743
    
    
    324,938,042
    
    
    324,938,042Investment
      securitiesheld
      to maturity
    
    
    49,504,443
    
    
    49,306,561
    
    
    —
    
    
    —Other
      investment securities
    
    
    8,715,600
    
    
    8,715,600
    
    
    3,342,100
    
    
    3,342,100Loans
      held for sale
    
    
    2,684,063
    
    
    2,684,063
    
    
    6,846,330
    
    
    6,846,330Loans,
      net
    
    
    1,365,890,375
    
    
    1,396,092,624
    
    
    883,151,891
    
    
    886,156,371Accrued
      interest receivable
    
    
    11,167,973
    
    
    11,167,973
    
    
    6,792,687
    
    
    6,792,687Financial
      liabilities:Deposits
    
    
    1,409,036,436
    
    
    1,442,098,693
    
    
    984,549,130
    
    
    1,008,458,089Securities
      sold underagreements
      to repurchase
    
    
    463,409,056
    
    
    460,677,355
    
    
    207,523,000
    
    
    207,649,425Advances
      from FHLB
    
    
    10,403,638
    
    
    10,604,869
    
    
    10,700,000
    
    
    11,543,272Notes
      payable to statutory trusts
    
    
    46,393,000
    
    
    46,388,754
    
    
    46,393,000
    
    
    46,395,250Accrued
      interest payable
    
    
    6,719,851
    
    
    6,719,851
    
    
    2,868,130
    
    
    2,868,130Accrued
      expenses andother
      liabilities
    
    
    8,130,222
    
    
    8,130,222
    
    
    3,267,464
    
    
    3,267,464
 **(29)**
    **Significant
      Group Concentrations of Credit Risk**Most
      of the Company’s business activities are with customers located within
      Puerto Rico. The Company has a commercial, industrial, and leasing loan
      portfolio with no significant concentration in any economic sector.**(30)**
    **Regulatory
      Matters**The
      Company (on a consolidated basis) and the Bank are subject to various
      regulatory capital requirements administered by the federal banking
      agencies. Failure to meet minimum capital requirements can initiate
      certain mandatory and possibly additional discretionary actions by
      regulators that, if undertaken, could have a direct material effect on the
      Bank’s financial statements. Under capital adequacy guidelines and the
      regulatory framework for prompt corrective action, the Company and the
      Bank must meet specific capital guidelines that involve quantitative
      measures of their assets, liabilities, and certain off-balance-sheet items
      as calculated under regulatory accounting practices. The capital amounts
      and classifications are also subject to qualitative judgments by the
      regulators about components, risk weightings, and other factors. Prompt
      corrective action provisions are not applicable to bank holding
      companies.
  (Continued)
 F-51
 **EUROBANCSHARES,
INC. AND SUBSIDIARIES**
Notes to
Consolidated Financial Statements
December 31,
2004 and
2003
 Quantitative
      measures established by regulations to ensure capital adequacy require the
      Company and the Bank to maintain minimum amounts and ratios (set forth in
      the following table) of total and Tier I Capital (as defined in the
      regulations) to risk-weighted assets (as defined), and of Tier I
      Capital (as defined) to average assets (Leverage) (as defined). Management
      believes, as of December 31, 2004 and 2003, that the Company and the
      Bank met all capital adequacy requirements to which they are
      subject.The
      most recent notification from the FDIC categorized the Bank as well
      capitalized under the regulatory framework for prompt corrective action.
      To be categorized as well capitalized, an institution must maintain
      minimum total risk-based, Tier I risk-based, and Tier I Leverage
      ratios as set forth in the following tables. There are no conditions or
      events since the notification that management believes have changed the
      institution’s capital category. The Company’s and the Bank’s actual
      capital amounts and ratios as of December 31, 2004 and 2003 are also
      presented in the table.At
      December 31, required and actual regulatory capital amounts and
      ratios are as follow (dollars in thousands):
  **2004****Well****Required**
    
    
    
    **Actual**
    
    
    
    **capitalized****amount**
    
    **Ratio**
    
    **amount**
    
    **Ratio**
    
    **ratio**Total
      Capital (to risk-weighted assets):Consolidated
    
    $
    126,564
    
    
    8.00
    %
    $
    220,585
    
    
    13.94
    %
    
    N/AEurobank
    
    
    127,286
    
    
    8.00
    %
    
    169,705
    
    
    10.67
    %
    
    310.00
    %Tier
      I Capital (to risk-weightedassets):Consolidated
    
    
    63,282
    
    
    4.00
    %
    
    201,342
    
    
    12.73
    %
    
    N/AEurobank
    
    
    63,643
    
    
    4.00
    %
    
    130,461
    
    
    8.20
    %
    
    36.00
    %Tier
      I Capital (to average assets):Consolidated
    
    
    81,303
    
    
    4.00
    %
    
    201,342
    
    
    9.91
    %
    
    N/AEurobank
    
    
    81,244
    
    
    4.00
    %
    
    130,461
    
    
    6.42
    %
    
    35.00
    %
  (Continued)
 F-52
 **EUROBANCSHARES,
INC. AND SUBSIDIARIES**
Notes to
Consolidated Financial Statements
December 31,
2004 and
2003
 **2003****Well****Required**
    
    
    
    **Actual**
    
    
    
    **capitalized****amount**
    
    **Ratio**
    
    **amount**
    
    **Ratio**
    
    **ratio**Total
      Capital (to risk-weighted assets):Consolidated
    
    $
    81,308
    
    
    8.00
    %
    $
    117,934
    
    
    11.60
    %
    
    N/AEurobank
    
    
    81,315
    
    
    8.00
    %
    
    117,614
    
    
    11.57
    %
    
    310.00
    %Tier
      I Capital (to risk-weighted assets):Consolidated
    
    
    40,654
    
    
    4.00
    %
    
    84,400
    
    
    8.30
    %
    
    N/AEurobank
    
    
    40,657
    
    
    4.00
    %
    
    75,638
    
    
    7.44
    %
    
    36.00
    %Tier
      I Capital (to average assets):Consolidated
    
    
    49,958
    
    
    4.00
    %
    
    84,400
    
    
    6.76
    %
    
    N/AEurobank
    
    
    49,958
    
    
    4.00
    %
    
    75,638
    
    
    6.06
    %
    
    35.00
    %
  (Continued)
 F-53
 **EUROBANCSHARES,
INC. AND SUBSIDIARIES**
Notes to
Consolidated Financial Statements
December 31,
2004 and
2003
 **(31)**
    **Parent
      Company Financial Information**As
      discussed in note 1, Eurobancshares became the holding company of Eurobank
      effective March 18, 2002. The following condensed financial information
      presents the financial position of Eurobancshares as of December 31, 2004
      and 2003 and the results of its operations and its cash flows for the
      years ended December 31, 2004, 2003, and 2002.


**Condensed
      Balance Sheets:****2004**
    
    **2003**(In
      thousands)**Assets**Notes
      receivable from Eurobank
    
    $
    20,000
    
    $
    32,500Interest
      receivable from Eurobank
    
    
    16
    
    
    38Interest
      receivable from other subsidiaries
    
    
    2
    
    
    2Due
      from Eurobank
    
    
    50,857
    
    
    331Investment
      in Eurobank
    
    
    132,421
    
    
    77,255Investment
      in other subsidiaries
    
    
    1,504
    
    
    1,412Prepaid
      expenses
    
    
    5
    
    
    3Total
      assets
    
    $
    204,805
    
    $
    111,541**Liabilities
      and Stockholders' Equity**Due
      to Eurobank
    
    $
    5
    
    $
    -Due
      to other subsidiary
    
    
    10
    
    
    10Dividends
      payable
    
    
    17Notes
      payable to subsidiaries
    
    
    46,393
    
    
    46,393Accrued
      interest payable to other subsidiaries
    
    
    78
    
    
    63Total
      liabilities
    
    
    46,503
    
    
    46,466Stockholders'
      equity
    
    
    158,302
    
    
    65,075Total
      liabilities and stockholders' equity
    
    $
    204,805
    
    $
    111,541


(Continued)
 F-54
 **EUROBANCSHARES,
INC. AND SUBSIDIARIES**
Notes to
Consolidated Financial Statements
December 31,
2004 and
2003
 **Condensed
      Statements of Income:****Year
      ended December 31****2004**
    
    **2003**
    
    **2002**(In
      thousands)Income:Interest
      on note receivable from Eurobank
    
    $
    1,160
    
    $
    1,513
    
    $
    1,412Dividend
      income from preferred stocks of Eurobank
    
    
    1,089
    
    
    610
    
    
    16Dividend
      income from other subsidiaries
    
    
    70
    
    
    66
    
    
    44Total
      interest income
    
    
    2,319
    
    
    2,189
    
    
    1,472Interest
      expense on notes payable to subsidiaries
    
    
    2,319
    
    
    2,189
    
    
    1,472Net
      interest income
    
    
    —
    
    
    —
    
    
    —Equity
      in undistributed earnings of subsidiaries
    
    
    22,734
    
    
    9,891
    
    
    6,951Noninterest
      expense
    
    
    14
    
    
    8
    
    
    17Earnings
      before income taxes
    
    
    22,720
    
    
    9,883
    
    
    6,934Provision
      for income taxes
    
    
    —
    
    
    —
    
    
    —Net
      income
    
    $
    22,720
    
    $
    9,883
    
    $
    6,934
  (Continued)
 F-55
 **EUROBANCSHARES,
INC. AND SUBSIDIARIES**
Notes to
Consolidated Financial Statements
December 31,
2004 and
2003
 **Condensed
      Statements of Cash Flows:****Year
      ended December 31****2004**
    
    **2003**
    
    **2002**(In
      thousands)Cash
      flows from operating activities:Net
      income
    
    $
    22,720
    
    $
    9,883
    
    $
    6,934Adjustments
      to reconcile net income to netcash
      used in operating activities:Equity
      in undistributed earnings ofsubsidiaries
    
    
    (22,734
    )
    
    (9,891
    )
    
    (6,951
    )Decrease
      (increase) in accrued interestreceivable
      from subsidiaries
    
    
    (21
    )
    
    29
    
    
    (15
    )Increase
      in prepaid expenses
    
    
    (2
    )
    
    (1
    )
    
    (2
    )Increase
      in due from Eurobank
    
    
    (57,242
    )
    
    (160
    )
    
    (171
    )Increase
      (decrease) in accrued interestpayable
      to subsidiaries
    
    
    15
    
    
    (128
    )
    
    30Increase
      in due to Eurobank
    
    
    5
    
    
    —
    
    
    —Increase
      in due to other subsidiary
    
    
    -
    
    
    —
    
    
    107Increase
      in dividends payable
    
    
    17
    
    
    —
    
    
    —Other
    
    
    —
    
    
    —
    
    
    (66
    )Net
      cash used in operating activities
    
    
    (57,242
    )
    
    (268
    )
    
    (134
    )Cash
      flows from financing activities:Proceeds
      from issuance of common stock
    
    
    57,242
    
    
    268
    
    
    221Purchase
      and retirement of common stock
    
    
    -
    
    
    -
    
    
    (87
    )Net
      cash provided in investing activities
    
    
    57,242
    
    
    268
    
    
    134Net
      increase (decrease) in cash andcash
      equivalents
    
    
    —
    
    
    —
    
    
    —Cash
      and cash equivalents, beginning of year
    
    
    —
    
    
    —
    
    
    —Cash
      and cash equivalents, end of year
    
    $
    —
    
    $
    —
    
    $
    —Supplemental
      disclosure:Issuance
      of Eurobancshares common stocks onacquisition
      of BankTrust
    
    $
    5,552
    
    $
    —
    
    $
    —Issuance
      of Eurobancshares preferred stocks onacquisition
      of BankTrust
    
    
    10,763
    
    
    —
    
    
    —Capital
      contributions through issuance ofEurobancshares'
      common stocks on acquisitionof
      Banco Financiero
    
    
    —
    
    
    —
    
    
    1,222
 (Continued)
 F-56
 **EUROBANCSHARES,
INC. AND SUBSIDIARIES**
Notes to
Consolidated Financial Statements
December 31,
2004 and
2003
 **Condensed
      Statement of Cash Flows (continued):****Year
      ended December 31****2004**
    
    **2003**
    
    **2002**(In
      thousands)Issuance
      of Eurobancshares common stocks on acquisition of Banco
      Financiero
    
    
    —
    
    
    —
    
    
    1,222Conversion
      of note receivable from Eurobank in Eurobank's preferred
      stocks
    
    
    —
    
    
    —
    
    
    12,500Note
      receivable resulting from Trust Preferred Capital Securities
      issuance
    
    
    —
    
    
    —
    
    
    20,000Note
      payable to the Trust II in connection with its creation
    
    
    —
    
    
    —
    
    
    619Equity
      in other comprehensive income of subsidiaries
    
    
    (2,350
    )
    
    (2,411
    )
    
    1,240
 **(32)**
    **Selected
      Quarterly Financial Data (Unaudited)**The
      following is a summary of the unaudited quarterly results of operations
      for the years ended December 31, 2004, 2003, and 2002 are as
      follows:
 (Continued)
 F-57
 **EUROBANCSHARES,
INC. AND SUBSIDIARIES**
Notes to
Consolidated Financial Statements
December 31,
2004 and
2003
 **Year
      ended December 31, 2004****Fourth**
    
    **Third**
    
    **Second**
    
    **First****quarter**
    
    **quarter**
    
    **quarter**
    
    **quarter**Interest
      income
    
    $
    30,484,569
    
    $
    28,565,698
    
    $
    25,419,848
    
    $
    19,006,342Interest
      expense
    
    
    12,171,282
    
    
    11,064,900
    
    
    9,897,769
    
    
    8,347,321Net
      interest income
    
    
    18,313,287
    
    
    17,500,798
    
    
    15,522,079
    
    
    10,659,021Provision
      for loan and lease losses
    
    
    1,250,000
    
    
    1,875,000
    
    
    2,475,000
    
    
    1,500,000Net
      interest incomeafter
      provisionfor
      loan and lease losses
    
    
    17,063,287
    
    
    15,625,798
    
    
    13,047,079
    
    
    9,159,021Total
      other income
    
    
    3,365,466
    
    
    2,341,494
    
    
    1,779,771
    
    
    1,593,122Total
      other expenses
    
    
    10,986,310
    
    
    9,786,176
    
    
    8,875,639
    
    
    7,363,537Income
      beforeincome
      taxes
    
    
    9,442,443
    
    
    8,181,116
    
    
    5,951,211
    
    
    3,388,606Income
      tax
    
    
    3,319,085
    
    
    2,804,423
    
    
    1,475,145
    
    
    1,063,981Extraordinary
      gain
    
    
    4,898
    
    
    -
    
    
    4,414,220
    
    
    -Net
      income
    
    $
    6,128,256
    
    $
    5,376,693
    
    $
    8,890,286
    
    $
    2,324,625Earnings
      per share:Basic
      earnings per share:Income
      before extraor-dinary
      item
    
    $
    0.30
    
    $
    0.30
    
    $
    0.29
    
    $
    0.17Extraordinary
      item
    
    
    -
    
    
    -
    
    
    0.29
    
    
    -Net
      income
    
    $
    0.30
    
    $
    0.30
    
    $
    0.58
    
    $
    0.17Diluted
      earnings per share:Income
      before extraor-dinary
      item
    
    $
    0.29
    
    $
    0.28
    
    $
    0.28
    
    $
    0.16Extraordinary
      item
    
    
    -
    
    
    -
    
    
    0.29
    
    
    -Net
      income
    
    $
    0.29
    
    $
    0.28
    
    $
    0.57
    
    $
    0.16
 (Continued)
 F-58
 **EUROBANCSHARES,
INC. AND SUBSIDIARIES**
Notes to
Consolidated Financial Statements
December 31,
2004 and
2003
 **Year
      ended December 31, 2003****Fourth**
    
    **Third**
    
    **Second**
    
    **First****quarter**
    
    **quarter**
    
    **quarter**
    
    **quarter**Interest
      income
    
    $
    18,735,453
    
    $
    18,113,546
    
    $
    17,398,785
    
    $
    17,268,067Interest
      expense
    
    
    8,050,132
    
    
    7,972,925
    
    
    7,944,189
    
    
    7,955,002Net
      interest income
    
    
    10,685,321
    
    
    10,140,621
    
    
    9,454,596
    
    
    9,313,065Provision
      for loan and lease losses
    
    
    1,330,000
    
    
    1,450,000
    
    
    1,577,000
    
    
    2,094,000Net
      interest incomeafter
      provisionfor
      loan and lease losses
    
    
    9,355,321
    
    
    8,690,621
    
    
    7,877,596
    
    
    7,219,065Total
      other income
    
    
    2,811,942
    
    
    1,843,708
    
    
    3,283,312
    
    
    1,108,668Total
      other expenses
    
    
    8,115,283
    
    
    7,082,156
    
    
    7,220,886
    
    
    6,456,722Income
      beforeincome
      taxes
    
    
    4,051,980
    
    
    3,452,173
    
    
    3,940,022
    
    
    1,871,011Income
      tax
    
    
    467,835
    
    
    1,001,042
    
    
    1,380,348
    
    
    583,240Net
      income
    
    $
    3,584,145
    
    $
    2,451,131
    
    $
    2,559,674
    
    $
    1,287,771Net
      income per share:Basic
    
    $
    0.26
    
    $
    0.17
    
    $
    0.19
    
    $
    0.09Diluted
    
    
    0.25
    
    
    0.17
    
    
    0.18
    
    
    0.09
 (Continued)
 F-59
 **EUROBANCSHARES,
INC. AND SUBSIDIARIES**
Notes to
Consolidated Financial Statements
December 31,
2004 and
2003
 **Year
      ended December 31, 2002****Fourth**
    
    **Third**
    
    **Second**
    
    **First****quarter**
    
    **quarter**
    
    **quarter**
    
    **quarter**Interest
      income
    
    $
    15,675,155
    
    $
    14,347,000
    
    $
    13,289,878
    
    $
    11,655,696Interest
      expense
    
    
    7,189,114
    
    
    6,514,357
    
    
    6,023,986
    
    
    5,396,111Net
      interest income
    
    
    8,486,041
    
    
    7,832,643
    
    
    7,265,892
    
    
    6,259,585Provision
      for loan and lease losses
    
    
    1,034,462
    
    
    1,006,000
    
    
    540,224
    
    
    773,000Net
      interest incomeafter
      provisionfor
      loan and leaselosses
    
    
    7,451,579
    
    
    6,826,643
    
    
    6,725,668
    
    
    5,486,585Total
      other income
    
    
    1,005,186
    
    
    956,305
    
    
    1,088,666
    
    
    970,617Total
      other expenses
    
    
    6,358,082
    
    
    5,092,489
    
    
    5,572,576
    
    
    4,911,379Income
      beforeincome
      taxes
    
    
    2,098,683
    
    
    2,690,459
    
    
    2,241,758
    
    
    1,545,823Income
      tax
    
    
    706,625
    
    
    841,416
    
    
    718,061
    
    
    457,749Extraordinary
      gain
    
    
    1,080,983
    
    
    -
    
    
    -
    
    
    -Net
      income
    
    $
    2,473,041
    
    $
    1,849,043
    
    $
    1,523,697
    
    $
    1,088,074Earnings
      per share:Basic
      earnings per share:Income
      before extraor-dinary
      item
    
    $
    0.10
    
    $
    0.13
    
    $
    0.12
    
    $
    0.08Extraordinary
      item
    
    
    0.08
    
    
    —
    
    
    —
    
    
    —Net
      income
    
    $
    0.18
    
    $
    0.13
    
    $
    0.12
    
    $
    0.08Diluted
      earnings per share:Income
      before extraordinary item
    
    $
    0.10
    
    $
    0.13
    
    $
    0.11
    
    $
    0.08Extraordinary
      item
    
    
    0.08
    
    
    —
    
    
    —
    
    
    —Net
      income
    
    $
    0.18
    
    $
    0.13
    
    $
    0.11
    
    $
    0.08
  F-60