UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549  FORM 10-Q  (Mark One)  xQUARTERLY REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934  For the quarterly period ended September 30, 2012  or   ̈TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE
ACT OF 1934  For the transition period from ______________ to ______________  Commission File Number 001-12647  Oriental Financial Group Inc. Incorporated in the Commonwealth of   Puerto Rico,     IRS Employer Identification No. 66-0538893  Principal
Executive Offices: 997 San Roberto Street Oriental Center
10th Floor Professional Offices Park San Juan, Puerto Rico 00926 Telephone Number: (787) 771-6800  Indicate by check mark whether the
registrant (1) has filed all reports required to be filed by Section 13 or
15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the registrant was required to file such reports),
and (2) has been subject to such filing requirements for the past 90 days. YesxNo ̈  Indicate by check mark whether the
registrant has submitted electronically and posted on its corporate Web site,
if any, every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of Regulation S-T (232.405 of this chapter) during the
preceding 12 months (or for such shorter period that the registrant was
required to submit and post such files). YesxNo ̈  Indicate by check mark whether the
registrant is a large accelerated filer, an accelerated filer, a
non-accelerated filer or a smaller reporting company. See definitions of “large
accelerated filer,” “accelerated filer,” and “smaller reporting company” in
Rule 12b-2 of the Exchange Act.  Large Accelerated Filer ̈Accelerated FilerxNon-Accelerated Filer ̈Smaller Reporting Company ̈(Do not check if a smaller reporting company)  Indicate by check mark whether the
registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YesxNo ̈   Number of shares outstanding of the
registrant’s common stock, as of thelatest practicable date:  45,577,920 common shares ($1.00 par
value per share) outstanding as of October 31, 2012


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TABLE OF CONTENTS  PagePART I FINANCIAL INFORMATION:Item
  1 Financial StatementsUnaudited consolidated statements of financial condition at September 30,
  2012 and December 31,
  2011
 1Unaudited consolidated statements of operations for the quarters and
  nine-month periods ended
  September 30, 2012 and 2011
 2Unaudited consolidated statements of comprehensive income for the quarters and
  nine-month periods
  ended September 30, 2012 and 2011
 3Unaudited consolidated statements of changes in stockholders’ equity for the nine-month
  periods ended
  September 30, 2012 and 2011
 4Unaudited consolidated statements of cash flows for the nine-month periods ended
  September 30, 2012
  and 2011
 5Notes to unaudited consolidated financial statements
 7Item
  2 Management’s Discussion and Analysis of Financial Condition and Results of
  Operations
 75Item
  3 Quantitative and Qualitative Disclosures About Market Risk
 111Item
  4 Controls and Procedures
 115PART II OTHER INFORMATION:Item
  1 Legal Proceedings
 116Item
  1A Risk Factors
 116Item
  2 Unregistered Sales of Equity Securities and Use of Proceeds
 119Item
  3 Defaults Upon Senior Securities
 119Item
  4 Mine Safety Disclosures
 120Item
  5 Other Information
 120Item
  6 Exhibits
 120Signatures
 121Certifications


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FORWARD-LOOKING
STATEMENTS  The information included in
this Quarterly Report on Form 10-Q contains certain forward-looking statements
within the meaning of the Private Securities Litigation Reform Act of 1995.
These forward-looking statements may relate to the financial condition, results
of operations, plans, objectives, future performance and business of Oriental
Financial Group Inc. (“we”, “our” or the “Group”), including, but not limited
to, statements with respect to the adequacy of the allowance for loan losses,
delinquency trends, market risk and the impact of interest rate changes,
capital markets conditions, capital adequacy and liquidity, and the effect of
legal proceedings and new accounting standards on the Group’s financial
condition and results of operations. All statements contained herein that are
not clearly historical in nature are forward-looking, and the words
“anticipate,” “believe,” “continues,” “expect,” “estimate,” “intend,” “project”
and similar expressions and future or conditional verbs such as “will,”
“would,” “should,” “could,” “might,” “can,” “may,” or similar expressions are
generally intended to identify forward-looking statements.  These statements are not
guarantees of future performance and involve certain risks, uncertainties,
estimates and assumptions by management that are difficult to predict. Various
factors, some of which by their nature are beyond the Group’s control, could
cause actual results to differ materially from those expressed in, or implied
by, such forward-looking statements. Factors that might cause such a difference
include, but are not limited to:  •  the rate of growth in the
economy and employment levels, as well as general business and economic conditions; •  changes in interest rates,
as well as the magnitude of such changes; •  the fiscal and monetary
policies of the federal government and its agencies; •  a credit default by the U.S.
or Puerto Rico governments or a downgrade in the credit ratings of the U.S. or
Puerto Rico governments; •  changes in federal bank
regulatory and supervisory policies, including required levels of capital; •  the impact of the Dodd-Frank
Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) on the Group’s businesses,
business practices and cost of operations; •   the relative strength or
weakness of the consumer and commercial credit sectors and of the real estate
market in Puerto Rico; •  the performance of the stock
and bond markets; •  competition in the financial
services industry; •  additional Federal Deposit
Insurance Corporation (“FDIC”) assessments; •  possible legislative, tax or
regulatory changes; •  the receipt and timing of
regulatory approvals required to consummate the acquisition of the Puerto Rico operations of Banco Bilbao
Vizcaya Argentaria, S.A. (“BBVA”); •  the Group’s ability to
successfully deleverage the investment securities and wholesale funding
portfolios of the Group and Banco Bilbao
Vizcaya Argentaria Puerto Rico in connection with the acquisition of BBVA’s
Puerto Rico operations; and •  difficulties in integrating
BBVA’s Puerto Rico operations into the Group’s operations.  Other possible events or
factors that could cause results or performance to differ materially from those
expressed in these forward-looking statements include the following: negative
economic conditions that adversely affect the general economy, housing prices,
the job market, consumer confidence and spending habits which may affect, among
other things, the level of non-performing assets, charge-offs and provision
expense; changes in interest rates and market liquidity which may reduce
interest margins, impact funding sources and affect the ability to originate
and distribute financial products in the primary and secondary markets; adverse
movements and volatility in debt and equity capital markets; changes in market
rates and prices which may adversely impact the value of financial assets and
liabilities; liabilities resulting from litigation and regulatory
investigations; changes in accounting standards, rules and interpretations;
increased competition; the Group’s ability to grow its core businesses;
decisions to downsize, sell or close units or otherwise change the Group’s
business mix; and management’s ability to identify and manage these and other
risks.  All forward-looking statements
included in this Quarterly Report on Form 10-Q are based upon information available
to the Group as of the date of this report, and other than as required by law,
including the requirements of applicable securities laws, the Group assumes no
obligation to update or revise any such forward-looking statements to reflect
occurrences or unanticipated events or circumstances after the date of such
statements.


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ORIENTAL FINANCIAL

GROUP INC. UNAUDITED CONSOLIDATED

STATEMENTS OF FINANCIAL CONDITION SEPTEMBER 30, 2012 AND

DECEMBER 31, 2011
 September 30,
 
 December 31,2012
 
 2011(In thousands, except share data)ASSETSCash and cash
  equivalentsCash and due
  from banks
 
 $
 511,478
 
 $
 587,624Money market
  investments
 
 
 4,017
 
 
 3,863Total
  cash and cash equivalents
 
 
 515,495
 
 
 591,487Securities
  purchased under agreements to resell
 
 
 270,000
 
 
 -Investments:Trading
  securities, at fair value, with amortized cost of $1,503 (December 31, 2011 -
  $176)
 
 
 1,514
 
 
 180Investment
  securities available-for-sale, at fair value, with amortized cost of
  $2,228,629 (December 31, 2011 - $2,873,682)
 
 
 2,293,550
 
 
 2,959,912Investment
  securities held-to-maturity, at amortized cost, with fair value of  $874,921
  (December 31, 2011 - $904,556)
 
 
 835,084
 
 
 884,026Federal Home
  Loan Bank (FHLB) stock, at cost
 
 
 22,865
 
 
 23,779Other
  investments
 
 
 69
 
 
 73Total
  investments
 
 
 3,153,082
 
 
 3,867,970Loans:Mortgage
  loans held-for-sale, at lower of cost or fair value
 
 
 38,211
 
 
 26,939Loans not
  covered under shared-loss agreements with the FDIC, net of allowance for loan
  and lease losses of$39,120
  (December 31, 2011 - $37,010)
 
 
 1,144,519
 
 
 1,142,978Loans
  covered under shared-loss agreements with the FDIC, net of allowance for loan
  and lease losses of$56,865
  (December 31, 2011 - $37,256)
 
 
 413,588
 
 
 496,276Total
  loans, net
 
 
 1,596,318
 
 
 1,666,193FDIC shared-loss
  indemnification asset
 
 
 328,573
 
 
 392,367Foreclosed real
  estate covered under shared-loss agreements with the FDIC
 
 
 21,635
 
 
 13,867Foreclosed real
  estate not covered under shared-loss agreements with the FDIC
 
 
 17,765
 
 
 13,812Accrued interest
  receivable
 
 
 14,935
 
 
 20,182Deferred tax
  asset, net
 
 
 35,912
 
 
 32,023Premises and
  equipment, net
 
 
 19,268
 
 
 21,520Servicing assets
 
 
 10,642
 
 
 10,454Derivative
  assets
 
 
 18,495
 
 
 9,317Other assets
 
 
 49,085
 
 
 54,483Total assets
 
 $
 6,051,205
 
 $
 6,693,675LIABILITIES AND STOCKHOLDERS’ EQUITYDeposits:Demand
  deposits
 
 $
 1,048,410
 
 $
 1,043,031Savings
  accounts
 
 
 250,952
 
 
 230,672Certificates
  of deposit
 
 
 915,005
 
 
 1,161,482Total
  deposits
 
 
 2,214,367
 
 
 2,435,185Borrowings:Securities
  sold under agreements to repurchase
 
 
 2,652,366
 
 
 3,056,238Advances
  from FHLB
 
 
 285,395
 
 
 281,753FDIC-guaranteed term notes
 
 
 -
 
 
 105,834Subordinated
  capital notes
 
 
 36,083
 
 
 36,083Total
  borrowings
 
 
 2,973,844
 
 
 3,479,908Derivative
  liabilities
 
 
 58,269
 
 
 47,425Accrued
  expenses and other liabilities
 
 
 33,038
 
 
 35,602Total liabilities
 
 
 5,279,518
 
 
 5,998,120Stockholders’
  equity:Preferred
  stock; 10,000,000 shares authorized;1,340,000 shares of Series A and 1,380,000 shares of Series B issued and
  outstanding, $25 liquidation value
 
 
 68,000
 
 
 68,00084,000
  shares of Series C issued and outstanding; $1,000 liquidation value
 
 
 84,000
 
 
 -Common
  stock, $1 par value; 100,000,000 shares authorized; 47,841,611 shares issued;40,745,946 shares outstanding (December 31, 2011 - 47,808,657; 41,244,533)
 
 
 47,842
 
 
 47,809Additional
  paid-in capital
 
 
 495,155
 
 
 499,096Legal
  surplus
 
 
 54,407
 
 
 50,178Retained
  earnings
 
 
 94,520
 
 
 68,149Treasury
  stock, at cost, 7,095,665 shares (December 31, 2011 - 6,564,124 shares)
 
 
 (81,300)
 
 
 (74,808)Accumulated
  other comprehensive income, net of tax of -$2,411 (December 31, 2011 -
  $1,848)
 
 
 9,063
 
 
 37,131Total stockholders’ equity
 
 
 771,687
 
 
 695,555Total liabilities and stockholders’ equity
 
 $
 6,051,205
 
 $
 6,693,675See notes to unaudited consolidated
  financial statements
 1


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ORIENTAL FINANCIAL

GROUP INC. UNAUDITED CONSOLIDATED

STATEMENTS OF OPERATIONS FOR THE QUARTERS AND

NINE-MONTH PERIODS ENDED SEPTEMBER 30, 2012 AND 2011
 Quarter Ended September 30,
 
 Nine-Month Period Ended September 30,2012
 
 2011
 
 2012
 
 2011(In thousands, except per share data)Interest
  income:Loans
  not covered under shared-loss agreements with the FDIC
 $
 17,964
 
 $
 17,161
 
 $
 53,308
 
 $
 51,095Loans
  covered under shared-loss agreements with the FDIC
 
 22,283
 
 
 18,222
 
 
 64,167
 
 
 45,507Total interest income from loans
 
 40,247
 
 
 35,383
 
 
 117,475
 
 
 96,602Mortgage-backed securities
 
 24,310
 
 
 33,515
 
 
 74,647
 
 
 128,275Investment securities and other
 
 1,129
 
 
 2,638
 
 
 4,271
 
 
 6,895Total interest income
 
 65,686
 
 
 71,536
 
 
 196,393
 
 
 231,772Interest
  expense:Deposits
 
 7,308
 
 
 11,492
 
 
 24,518
 
 
 35,321Securities sold under agreements to repurchase
 
 15,344
 
 
 23,206
 
 
 49,414
 
 
 70,878Advances
  from FHLB and other borrowings
 
 2,508
 
 
 3,042
 
 
 8,438
 
 
 9,036FDIC-guaranteed term notes
 
 -
 
 
 1,021
 
 
 909
 
 
 3,063Subordinated capital notes
 
 323
 
 
 305
 
 
 972
 
 
 916Total interest expense
 
 25,483
 
 
 39,066
 
 
 84,251
 
 
 119,214Net interest
  income
 
 40,203
 
 
 32,470
 
 
 112,142
 
 
 112,558Provision for
  non-covered loan and lease losses
 
 3,600
 
 
 3,800
 
 
 10,400
 
 
 11,400Provision for
  (recapture of) covered loan and lease losses, net
 
 221
 
 
 (1,936)
 
 
 8,845
 
 
 (1,387)Total provision for loan and lease losses
 
 3,821
 
 
 1,864
 
 
 19,245
 
 
 10,013Net interest
  income after provision for loan and lease losses
 
 36,382
 
 
 30,606
 
 
 92,897
 
 
 102,545Non-interest
  income:Wealth
  management revenues
 
 6,042
 
 
 5,387
 
 
 17,835
 
 
 14,644Banking
  service revenues
 
 3,006
 
 
 2,969
 
 
 9,231
 
 
 9,496Mortgage
  banking activities
 
 2,204
 
 
 2,758
 
 
 7,142
 
 
 7,017Total banking and wealth management revenues
 
 11,252
 
 
 11,114
 
 
 34,208
 
 
 31,157Net
  amortization of FDIC shared-loss indemnification asset
 
 (8,096)
 
 
 (2,422)
 
 
 (18,505)
 
 
 (191)Net gain
  (loss) on:Sale
  of securities
 
 36,365
 
 
 13,971
 
 
 55,703
 
 
 23,102Derivatives
 
 (1,326)
 
 
 (695)
 
 
 (1,441)
 
 
 (8,392)Foreclosed real estate
 
 (1,209)
 
 
 (199)
 
 
 (2,493)
 
 
 (334)Early extinguishment of repurchase agreements
 
 (24,312)
 
 
 (4,790)
 
 
 (24,312)
 
 
 (4,790)Other
 
 978
 
 
 (14)
 
 
 208
 
 
 148Total non-interest income, net
 
 13,652
 
 
 16,965
 
 
 43,368
 
 
 40,700Non-interest
  expense:Compensation and employee benefits
 
 11,323
 
 
 11,593
 
 
 32,873
 
 
 34,511Professional and service fees
 
 5,779
 
 
 5,308
 
 
 16,221
 
 
 16,506Occupancy
  and equipment
 
 4,169
 
 
 4,369
 
 
 12,624
 
 
 12,988Insurance
 
 1,594
 
 
 1,302
 
 
 4,856
 
 
 4,933Electronic banking charges
 
 1,415
 
 
 1,375
 
 
 4,581
 
 
 3,984Taxes,
  other than payroll and income taxes
 
 1,091
 
 
 1,184
 
 
 2,158
 
 
 3,422Loan
  servicing and clearing expenses
 
 607
 
 
 975
 
 
 2,530
 
 
 3,072Foreclosure, repossession and other real estate expenses
 
 1,060
 
 
 606
 
 
 2,745
 
 
 1,659Advertising, business promotion, and strategic initiatives
 
 1,594
 
 
 1,686
 
 
 4,006
 
 
 4,386Communication
 
 419
 
 
 391
 
 
 1,246
 
 
 1,212Director
  and investor relations
 
 158
 
 
 352
 
 
 809
 
 
 977Printing, postage, stationary and supplies
 
 299
 
 
 292
 
 
 929
 
 
 937Other
 
 871
 
 
 770
 
 
 2,428
 
 
 2,661Total non-interest expense
 
 30,379
 
 
 30,203
 
 
 88,006
 
 
 91,248Income before
  income taxes
 
 19,655
 
 
 17,368
 
 
 48,259
 
 
 51,997Income
  tax expense
 
 1,894
 
 
 580
 
 
 4,888
 
 
 5,661Net income
 
 17,761
 
 
 16,788
 
 
 43,371
 
 
 46,336Less:
  dividends on preferred stock
 
 (3,039)
 
 
 (1,201)
 
 
 (5,440)
 
 
 (3,602)Income
  available to common shareholders
 $
 14,722
 
 $
 15,587
 
 $
 37,931
 
 $
 42,734Income per
  common share:Basic
 $
 0.36
 
 $
 0.35
 
 $
 0.93
 
 $
 0.95Diluted
 $
 0.35
 
 $
 0.35
 
 $
 0.92
 
 $
 0.95Average
  common shares outstanding and equivalents
 
 47,978
 
 
 44,105
 
 
 43,316
 
 
 45,141Cash
  dividends per share of common stock
 $
 0.06
 
 $
 0.05
 
 $
 0.18
 
 $
 0.15See notes to unaudited consolidated
  financial statements
 2


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ORIENTAL FINANCIAL

GROUP INC. UNAUDITED CONSOLIDATED

STATEMENTS OF COMPREHENSIVE INCOME FOR THE QUARTERS AND

NINE-MONTH PERIODS ENDED SEPTEMBER 30, 2012 AND 2011
 Quarter Ended September 30,
 
 Nine-Month Period Ended September 30,2012
 
 2011
 
 2012
 
 2011(In thousands)
 
 (In thousands)Net income
 $
 17,761
 
 $
 16,788
 
 $
 43,371
 
 $
 46,336Other
  comprehensive loss before tax:Unrealized
  gain on securities available-for-sale
 
 25,220
 
 
 35,471
 
 
 34,220
 
 
 57,098Realized
  gain on investment securities included in net income
 
 (36,365)
 
 
 (13,971)
 
 
 (55,703)
 
 
 (23,102)Unrealized
  loss on cash flow hedges
 
 (2,052)
 
 
 (34,204)
 
 
 (10,844)
 
 
 (48,122)Other
  comprehensive loss before taxes
 
 (13,197)
 
 
 (12,704)
 
 
 (32,327)
 
 
 (14,126)Income tax
  effect
 
 999
 
 
 2,550
 
 
 4,259
 
 
 1,858Other
  comprehensive loss after taxes
 
 (12,198)
 
 
 (10,154)
 
 
 (28,068)
 
 
 (12,268)Comprehensive
  income
 $
 5,563
 
 $
 6,634
 
 $
 15,303
 
 $
 34,068See notes to unaudited consolidated
  financial statements
 3


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ORIENTAL FINANCIAL

GROUP INC. UNAUDITED CONSOLIDATED

STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY FOR THE NINE-MONTH

PERIODS ENDED SEPTEMBER 30, 2012 AND 2011
 Nine-Month Period Ended September 30,2012
 
 2011(In thousands)Preferred
  stock:Balance at
  beginning of period
 $
 68,000
 
 $
 68,000Issuance of
  preferred stock
 
 84,000
 
 
 -Balance
  at end of period
 
 152,000
 
 
 68,000Common stock:Balance at
  beginning of period
 
 47,809
 
 
 47,808Exercised
  stock options
 
 33
 
 
 -Balance
  at end of period
 
 47,842
 
 
 47,808Additional
  paid-in capital:Balance at
  beginning of period
 
 499,096
 
 
 498,435Stock-based
  compensation expense
 
 1,159
 
 
 1,001Exercised
  stock options
 
 361
 
 
 -Lapsed restricted
  stock units
 
 (483)
 
 
 (561)Preferred
  stock issuance costs
 
 (4,978)
 
 
 -Balance at end of period
 
 495,155
 
 
 498,875Legal
  surplus:Balance at
  beginning of period
 
 50,178
 
 
 46,331Transfer
  from retained earnings
 
 4,229
 
 
 4,943Balance at end of period
 
 54,407
 
 
 51,274Retained
  earnings:Balance at
  beginning of period
 
 68,149
 
 
 51,502Net income
 
 43,371
 
 
 46,336Cash
  dividends declared on common stock
 
 (7,331)
 
 
 (6,677)Cash
  dividends declared on preferred stock
 
 (5,440)
 
 
 (3,602)Transfer to
  legal surplus
 
 (4,229)
 
 
 (4,943)Balance at end of period
 
 94,520
 
 
 82,616Treasury
  stock:Balance at
  beginning of period
 
 (74,808)
 
 
 (16,732)Stock
  purchased
 
 (7,022)
 
 
 (29,242)Lapsed
  restricted stock units
 
 483
 
 
 561Stock used
  to match defined contribution plan
 
 47
 
 
 37Balance at end of period
 
 (81,300)
 
 
 (45,376)Accumulated other
  comprehensive income, net of tax:Balance at
  beginning of period
 
 37,131
 
 
 36,987Other
  comprehensive loss, net of tax
 
 (28,068)
 
 
 (12,268)Balance at end of period
 
 9,063
 
 
 24,719Total
  stockholders’ equity
 $
 771,687
 
 $
 727,916See notes to unaudited consolidated
  financial statements
 4


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ORIENTAL FINANCIAL

GROUP INC. UNAUDITED CONSOLIDATED

STATEMENTS OF CASH FLOWS FOR THE NINE-MONTH

PERIODS ENDED SEPTEMBER 30, 2012 AND 2011
 Nine-Month Period Ended September 30,2012
 
 2011(In thousands)Cash flows
  from operating activities:Net income
 $
 43,371
 
 $
 46,336Adjustments
  to reconcile net income to net cash provided by (used in) operating
  activities:Amortization of deferred loan origination fees, net of costs
 
 462
 
 
 (151)Amortization of investment securities premiums, net of accretion of discounts
 
 33,480
 
 
 18,983Amortization of core deposit intangible
 
 107
 
 
 107Net
  amortization of FDIC shared-loss indemnification asset
 
 18,505
 
 
 191Other
  impairments on securities
 
 -
 
 
 75Depreciation and amortization of premises and equipment
 
 3,424
 
 
 4,109Deferred
  income taxes, net
 
 (785)
 
 
 4,485Provision for covered and non-covered loan and lease losses, net
 
 19,245
 
 
 10,013Stock-based compensation
 
 1,159
 
 
 1,001(Gain)
  loss on:Sale
  of securities
 
 (55,703)
 
 
 (23,102)Sale
  of mortgage loans held for sale
 
 (4,658)
 
 
 (3,971)Derivatives
 
 1,441
 
 
 8,392Early extinguishment of repurchase agreements
 
 24,312
 
 
 4,790Foreclosed real estate
 
 2,493
 
 
 334Sale
  of other repossessed assets
 
 (8)
 
 
 34Sale
  of premises and equipment
 
 (85)
 
 
 31Originations and purchases of loans held-for-sale
 
 (140,925)
 
 
 (149,990)Proceeds
  from sale of loans held-for-sale
 
 74,815
 
 
 55,243Net
  (increase) decrease in:Trading securities
 
 (1,334)
 
 
 984Accrued interest receivable
 
 5,247
 
 
 4,470Servicing assets
 
 (188)
 
 
 (319)Other assets
 
 5,080
 
 
 4,708Net
  decrease in:Accrued interest on deposits and borrowings
 
 (8,227)
 
 
 (1,097)Accrued expenses and other liabilities
 
 (8,578)
 
 
 (31,378)Net cash provided by (used in)operating activities
 
 12,650
 
 
 (45,722)Cash flows
  from investing activities:Purchases
  of:Investment securities  available-for-sale
 
 (1,102,606)
 
 
 (493,757)Investment securities  held-to-maturity
 
 (119,026)
 
 
 (209,112)FHLB
  stock
 
 (454)
 
 
 (1,283)Swap
  options
 
 (6,755)
 
 
 -Equity
  options
 
 -
 
 
 (424)Maturities
  and redemptions of:Investment securities  available-for-sale
 
 691,246
 
 
 606,699Investment securities  held-to-maturity
 
 160,502
 
 
 57,509FHLB
  stock
 
 1,368
 
 
 -Proceeds
  from sales of:Investment securities  available-for-sale
 
 1,145,555
 
 
 506,481Foreclosed real estate
 
 11,093
 
 
 8,875Other
  repossessed assets
 
 2,500
 
 
 4,883Premises and equipment
 
 369
 
 
 287Origination and purchase of loans, excluding loans held-for-sale
 
 (172,376)
 
 
 (138,692)Principal
  repayment of loans, including covered loans
 
 195,336
 
 
 204,537Reimbursements from the FDIC on shared-loss agreements
 
 63,272
 
 
 73,267Additions
  to premises and equipment
 
 (1,457)
 
 
 (2,984)Net change
  in securities purchased under agreements to resell
 
 (270,000)
 
 
 (165,000)Net cash provided by investing activities
 
 598,567
 
 
 451,286See notes to unaudited consolidated
  financial statements
 5


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ORIENTAL FINANCIAL

GROUP INC. UNAUDITED CONSOLIDATED

STATEMENTS OF CASH FLOWS – (Continued) FOR THE NINE-MONTH

PERIODS ENDED SEPTEMBER 30, 2012 AND 2011
 Nine-Month Period Ended September 30,2012
 
 2011(In thousands)Cash flows
  from financing activities:Net
  increase (decrease) in:Deposits
 
 (222,408)
 
 
 (207,107)Short
  term borrowings
 
 -
 
 
 4,159Securities sold under agreements to repurchase
 
 (424,312)
 
 
 (104,790)FHLB
  advances
 
 5,013
 
 
 -FDIC-guaranteed term notes
 
 (105,000)
 
 
 -Exercise of stock options
 
 394
 
 
 -Issuance
  of preferred stock, net
 
 79,022
 
 
 -Purchase
  of treasury stock
 
 (7,022)
 
 
 (29,242)Termination of derivative instruments
 
 (125)
 
 
 10,095Dividends
  paid on preferred stock
 
 (5,440)
 
 
 (3,602)Dividends
  paid on common stock
 
 (7,331)
 
 
 (6,677)Net
  cash used in financing activities
 
 (687,209)
 
 
 (337,164)Net change in
  cash and cash equivalents
 
 (75,992)
 
 
 68,400Cash and
  cash equivalents at beginning of period
 
 591,487
 
 
 448,936Cash and
  cash equivalents at end of period
 $
 515,495
 
 $
 517,336Supplemental
  Cash Flow Disclosure and Schedule of Non-cash Activities:Interest
  paid
 $
 91,823
 
 $
 120,544Income
  taxes paid
 $
 8,031
 
 $
 4,021Mortgage
  loans securitized into mortgage-backed securities
 $
 59,629
 
 $
 104,617Transfer
  from loans to foreclosed real estate
 $
 27,583
 
 $
 17,754See notes to unaudited consolidated
  financial statements
 6


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ORIENTAL FINANCIAL

GROUP INC. NOTES TO UNAUDITED

CONSOLIDATED FINANCIAL STATEMENTS
 NOTE
1-BASIS OF PRESENTATION  The accounting and reporting
policies of Oriental Financial Group Inc. (the “Group” or “Oriental”) conform
with U.S. generally accepted accounting principles (“GAAP”) and to banking
industry practices.  The unaudited consolidated
financial statements have been prepared pursuant to the rules and regulations
of the Securities and Exchange Commission (the
“SEC”). All significant intercompany
balances and transactions have been eliminated in consolidation. These
unaudited statements are, in the opinion of management, a fair statement of the
results for the periods reported and include all necessary adjustments, all of
a normal recurring nature, for a fair statement of such results. Certain
information and footnote disclosures normally included in financial statements
prepared in accordance with GAAP have been condensed or omitted pursuant to SEC rules and regulations. Management believes that the disclosures made are adequate to make the
information presented not misleading. The results of operations and cash flows
for the periods ended September 30, 2012 and 2011 are not necessarily
indicative of the results to be expected for the full year. For further
information, refer to the consolidated financial statements and footnotes
thereto for the year ended December 31, 2011, included in the Group’s 2011
Annual Report on Form 10-K.  Nature of Operations  The
Group is a publicly-owned financial holding company incorporated under the laws
of the Commonwealth of Puerto Rico. It has four direct operating subsidiaries,
Oriental Bank and Trust (the “Bank” or “Oriental Bank”), Oriental Financial
Services Corp. (“Oriental Financial Services”), Oriental Insurance, Inc.
(“Oriental Insurance”) and Caribbean Pension Consultants, Inc. (“CPC”).  The
Group also has a special purpose entity, Oriental Financial (PR) Statutory
Trust II (the “Statutory Trust II”). Through these subsidiaries and their
respective divisions, the Group provides a wide range of banking and wealth
management services such as commercial, consumer and mortgage lending, leasing,
financial planning, insurance sales, money management and investment banking
and brokerage services, as well as corporate and individual trust services.  The
main offices of the Group and its subsidiaries are located in San Juan, Puerto
Rico, except for CPC, which is located in Boca Raton, Florida.  The Group is
subject to supervision and regulation by the Board of Governors of the Federal
Reserve System (the “Federal Reserve Board”) under the U.S. Bank Holding
Company Act of 1956, as amended, and the Dodd-Frank Act.  The
Bank operates through 28 financial centers located throughout Puerto Rico and
is subject to the supervision, examination and regulation of the Office of the
Commissioner of Financial Institutions of Puerto Rico (the “OCFI”) and the
Federal Deposit Insurance Corporation (the “FDIC”).  The Bank offers banking
services such as commercial and consumer lending, leasing, savings and time
deposit products, financial planning, and corporate and individual trust
services, and capitalizes on its commercial banking network to provide mortgage
lending products to its clients. Oriental International Bank Inc. (“OIB”), a
wholly-owned subsidiary of the Bank, is an international banking entity
pursuant to the International Banking Center Regulatory Act of Puerto Rico, as
amended. OIB offers the Bank certain Puerto Rico tax advantages. OIB’s
activities are limited under Puerto Rico law to persons and assets/liabilities
located outside of Puerto Rico.  Oriental
Financial Services is a securities broker-dealer and is subject to the
supervision, examination and regulation of the Financial Industry Regulatory
Authority (the “FINRA”), the SEC, and the OCFI.  Oriental Financial Services is
also a member of the Securities Investor Protection Corporation.  Oriental Insurance
is an insurance agency and is subject to the supervision, examination and
regulation of the Office of the Commissioner of Insurance of Puerto Rico.  The
Group’s mortgage banking activities are conducted through a division of the
Bank. The mortgage banking activities include the origination of mortgage loans
for the Bank’s own portfolio, and the sale of loans directly in the secondary
market or the securitization of conforming loans into mortgage-backed
securities. The Bank originates Federal Housing Administration (“FHA”) insured
and Veterans Administration (“VA”) guaranteed mortgages that are primarily
securitized for issuance of Government National Mortgage Association (“GNMA”)
mortgage-backed securities which can be resold to individual or institutional
investors in the secondary market. Conventional loans that meet the
underwriting requirements for sale or exchange under certain Federal National
Mortgage Association (the “FNMA”) or Federal Home Loan Mortgage Corporation
(the “FHLMC”) programs are referred to as conforming mortgage loans and are
also securitized for issuance of FNMA or FHLMC mortgage-backed securities. The
Bank is an approved seller of FNMA, as well as FHLMC, mortgage loans for
issuance of FNMA and FHLMC mortgage-backed securities. The Bank is also an
approved issuer of GNMA mortgage-backed securities. The Bank is the master
servicer of the GNMA, FNMA and FHLMC pools that it issues and of its mortgage
loan portfolio, and has a subservicing arrangement with a third party. 7


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ORIENTAL FINANCIAL

GROUP INC. NOTES TO UNAUDITED

CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 Business
Combinations  Effective April 30, 2010, the Bank assumed all of
the retail deposits and other liabilities and acquired certain assets and
substantially all of the operations of Eurobank from the FDIC, as receiver for
Eurobank, pursuant to the terms of a purchase and assumption agreement entered
into by the Bank and the FDIC on April 30, 2010. This transaction is
referred to as the “FDIC-assisted acquisition.”  On June 28, 2012, the Group entered into a
definitive Acquisition Agreement (the “Acquisition Agreement”) with Banco
Bilbao Vizcaya Argentaria, S.A. (“BBVA”), pursuant to which BBVA agreed to sell
to the Group, and the Group agreed to purchase from BBVA, all of the outstanding
common stock of each of (i) BBVAPR Holding Corporation (“BBVAPR Holding”), the
sole shareholder of Banco Bilbao Vizcaya Argentaria Puerto Rico (“BBVAPR Bank”),
a Puerto Rico chartered commercial bank, and BBVA Seguros, Inc. (“BBVA
Seguros”), a subsidiary offering insurance services, and (ii) BBVA Securities
of Puerto Rico, Inc. (“BBVA Securities”), a registered broker-dealer. This
transaction is referred to as the “BBVAPR Acquisition” and BBVAPR Holding,
BBVAPR Bank, BBVA Seguros and BBVA Securities are collectively referred to as
the “BBVAPR Companies.”  The Group will acquire all of
the outstanding common stock of each of BBVAPR Holding and BBVA Securities with
total assets at June 30, 2012 amounting to $5.0 billion, including $3.6 billion
in loans (net of allowance for loan and lease losses), and $3.4 billion in
deposits for an aggregate purchase price of $500 million. Immediately following
the closing of the BBVAPR Acquisition, the Group will merge BBVAPR Bank with
and into Oriental Bank, with Oriental Bank continuing as the surviving entity. The
unaudited consolidated financial statements do not contemplate the effect of
the BBVAPR Acquisition as the transaction has not been consummated at September
30, 2012.  Closing of the transaction is
targeted for the fourth quarter of 2012. Consummation of the BBVAPR Acquisition
is subject to certain customary conditions, including the receipt of required
regulatory approvals without the imposition of a materially burdensome
regulatory condition, as described in the Acquisition Agreement. On October 10,
2012, the OCFI approved the Group’s acquisition of BBVAPR Bank and the merger
of BBVAPR Bank with and into Oriental Bank, with Oriental Bank as the surviving
entity.  Under the Acquisition Agreement, the Group may be
subject to a reverse break-up fee of $25 million if the closing of the BBVAPR
Acquisition does not occur before one year after execution of the Acquisition
Agreement (or before fifteen months after execution of the Acquisition
Agreement in certain circumstances), the Acquisition Agreement is terminated,
and the failure to close within one year (or such later date) is due to our
inability to raise the specified additional funds or to obtain certain
regulatory approvals or any other reason other than certain breaches by BBVA,
subject to certain conditions.  In addition, BBVA could seek damages in excess
of $25 million if BBVA terminates the Acquisition Agreement due to our failure
to satisfy the funding requirement or if our willful and knowing breach of the
Acquisition Agreement is the proximate cause of the BBVAPR Acquisition not
having been consummated, and BBVA suffers losses as a result in excess of the
$25 million termination fee. If BBVA decides to terminate the Acquisition
Agreement and collect the termination fee, such additional damages would be
limited to BBVA’s losses in excess of the termination fee, and could not exceed
an additional $25 million. Such limit would not apply if BBVA does not elect to
terminate the Acquisition Agreement and collect the termination fee.  In connection with the BBVAPR Acquisition, the Group has
completed the sale of:  (i)84,000 shares of its 8.750%
Non-Cumulative Convertible Perpetual Preferred Stock, Series C (the “Convertible
Preferred Stock”), on July, 3, 2012 at a purchase price of $1,000 per share in
a private placement; (ii)4,829,267 shares of its common
stock on October 31, 2012 at a public offering price of $11.10 and a purchase
price of $10.66 per share in a registered public offering; and (iii)960,000 shares of its 7.125%
Non-Cumulative Perpetual Preferred Stock, Series D (the “Series D Preferred
Stock”) on November 5, 2012 at a public offering price of $25 and purchase
price of $24 per share in a registered public offering.  The Group intends to use the net proceeds of the
foregoing issuances together with its own excess capital to fund the BBVAPR
Acquisition.  8


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ORIENTAL FINANCIAL

GROUP INC. NOTES TO UNAUDITED

CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
  Significant Accounting Policies  The unaudited consolidated financial statements of the
Group are prepared in accordance with GAAP as prescribed by the Financial
Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”)
and with the general practices within the banking industry.  In preparing the
unaudited consolidated financial statements, management is required to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosures of contingent assets and liabilities at the date of
the unaudited consolidated financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates. The Group believes that, of its significant accounting
policies, the following may involve a higher degree of judgment and complexity.  Investment Securities  Securities are classified as held-to-maturity,
available-for-sale or trading. Securities for which the Group has the intent
and ability to hold until maturity are classified as held-to-maturity and are
carried at amortized cost. Securities that might be sold prior to maturity
because of interest rate changes to meet liquidity needs or to better match the
repricing characteristics of funding sources are classified as
available-for-sale. These securities are reported at fair value, with
unrealized gains and losses excluded from earnings and reported net of tax in
other comprehensive income. The
Group has classified certain agency-issued mortgage-backed securities as
held-to-maturity. The Group has both the intent and ability to hold such
securities until their maturities. Furthermore, the Group believes it will be
able to recover substantially all of its recorded investment mainly because
these are agency-issued mortgage-backed securities, and also because the
securities cannot be contractually prepaid or otherwise settled before their
stated maturity by the issuing agency, except for the principal prepayments
that may occur throughout their terms based on the payment behavior of the
collateral loans. Certain securities of the Group that have been classified as
held-to-maturity were classified as such in response to management’s
asset-liability management strategy. The Group believes that it can accomplish
its asset-liability management goals and still maximize net interest income
without having all its securities classified as available-for-sale. This
designation is consistent with held-to-maturity classification requirements,
specifically those stated in section 25-18 of ASC 320-10-25. The
Group classifies as trading those securities that are acquired and held
principally for the purpose of selling them in the near future. These
securities are carried at fair value with realized and unrealized changes in
fair value included in earnings in the period in which the changes occur. The
Group’s investment in the Federal Home Loan Bank (“FHLB”) of New York stock, a
restricted security, has no readily determinable fair value and can only be
sold back to the FHLB at cost. Therefore, the carrying value represents its
fair value. Premiums
and discounts are amortized to interest income over the life of the related
securities using the interest method. Net realized gains or losses on sales of
investment securities and unrealized gains and losses valuation adjustments
considered other than temporary, if any, on securities classified as either
available-for-sale or held-to-maturity are reported separately in the
statements of operations. The cost of securities sold is determined by the
specific identification method.  During the quarter ended September 30, 2012,
the Group made a change in one of the estimates applied in the calculation of
the amortization of premiums/discounts in the mortgage-backed securities
portfolio. The estimate involves the period used in measuring the repayment
experience of each security and the change consists of using a 12-month
look-back period instead of a 3-month period for these purposes.  The Group
believes that this extended period better reflects the portfolio behavior,
especially considering the seasonality cycle of the U.S. housing market, and
also reduces the volatility that affects interest income recognition when using
a more limited prepayment history experience in periods of greater market
volatility.   The impact of this change during the quarter ended September 30,
2012 was an increase of $3.3 million in interest income from mortgage-backed
securities.  Financial Instruments  Certain financial instruments, including derivatives,
trading securities and investment securities available-for-sale, are recorded
at fair value and unrealized gains and losses are recorded in other
comprehensive income or as part of non-interest income, as appropriate. Fair
values are based on listed market prices, if available. If listed market prices
are not available, fair value is determined based on other relevant factors,
including price quotations for similar instruments. The fair values of certain
derivative contracts are derived from pricing models that consider current
market and contractual prices for the underlying financial instruments as well
as time value and yield curve or volatility factors underlying the positions. 9


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ORIENTAL FINANCIAL

GROUP INC. NOTES TO UNAUDITED

CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
  The Group determines the fair value of
its financial instruments based on the fair value measurement framework, which
establishes a fair value hierarchy that prioritizes the inputs of valuation
techniques used to measure fair value. The hierarchy gives the highest priority
to unadjusted quoted prices in active markets for identical assets or
liabilities (level 1 measurements) and the lowest priority to unobservable
inputs (level 3 measurements). The three levels of the fair value hierarchy are
described below:  Level
1— Level 1 assets and liabilities include
equity securities that are traded in an active exchange market, as well as
certain U.S. Treasury and other U.S. government agency securities that are
traded by dealers or brokers in active markets. Valuations are obtained from
readily available pricing sources for market transactions involving identical
assets or liabilities.  Level
2— Observable inputs other than
Level 1 prices, such as quoted prices for similar assets or liabilities, quoted
prices in markets that are not active, or other inputs that are observable or
can be corroborated by observable market data for substantially the full term
of the assets or liabilities. Level 2 assets and liabilities include
(i) mortgage-backed securities for which the fair value is estimated based
on valuations obtained from third-party pricing services for identical or
comparable assets, (ii) debt securities with quoted prices that are traded
less frequently than exchange-traded instruments and (iii) derivative
contracts and financial liabilities whose value is determined using a pricing
model with inputs that are observable in the market or can be derived
principally from or corroborated by observable market data.  Level
3— Unobservable inputs that are
supported by little or no market activity and that are significant to the fair
value of the assets or liabilities. Level 3 assets and liabilities include
financial instruments whose value is determined using pricing models for which
the determination of fair value requires significant management judgment or estimation.  Impairment
of Investment Securities  The Group conducts periodic reviews to identify and
evaluate each investment in an unrealized loss position for
other-than-temporary impairments. The Group separates the amount of total
impairment into credit and noncredit-related amounts. The term
“other-than-temporary impairment” is not intended to indicate that the decline
is permanent, but indicates that the prospects for a near-term recovery of
value is not favorable, or that there is a lack of evidence to support a
realizable value equal to or greater than the carrying value of the investment.
Any portion of a decline in value associated with a credit loss is recognized
in income, while the remaining noncredit-related component is recognized in
other comprehensive income. A credit loss is determined by assessing whether
the amortized cost basis of the security will be recovered by comparing it to
the present value of cash flows expected to be collected from the security
discounted at the rate equal to the yield used to accrete current and
prospective beneficial interest for the security. The shortfall of the present
value of the cash flows expected to be collected in relation to the amortized
cost basis is considered to be the “credit loss.”  The Group’s review for impairment
generally entails, but is not limited to:  •  the identification and evaluation of investments
that have indications of possible other-than-temporary impairment; •  the analysis of individual investments that have
fair values less than amortized cost, including consideration of the length of
time the investment has been in an unrealized loss position, and the expected
recovery period; •  the financial condition of the issuer or issuers; •  the creditworthiness of the obligor of the
security; •  actual collateral attributes; •  any rating changes by a rating agency; •  current analysts’ evaluations; •  the payment structure of the debt security and the
likelihood of the issuer being able to make payments; •  current market conditions; •  adverse conditions specifically related to the
security, industry, or a geographic area; •  the Group’s intent to sell the debt security; •  whether it is more-likely-than-not that the Group
will be required to sell the debt security before its anticipated recovery; and •  other qualitative factors that could support or not
an other-than-temporary impairment.  10


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ORIENTAL FINANCIAL

GROUP INC. NOTES TO UNAUDITED

CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
  Derivative Instruments and Hedging Activities  The Group’s overall interest rate risk-management
strategy incorporates the use of derivative instruments to minimize significant
unplanned fluctuations in earnings that are caused by interest rate volatility.
The Group’s goal is to manage interest rate sensitivity by modifying the
repricing or maturity characteristics of certain balance sheet assets and
liabilities so that the net interest margin is not, on a material basis,
adversely affected by movements in interest rates. As a result of interest rate
fluctuations, hedged fixed-rate assets and liabilities will appreciate or
depreciate in market value. Also, for some fixed-rate assets or liabilities,
the effect of this variability in earnings is expected to be substantially
offset by the Group’s gains and losses on the derivative instruments that are
linked to the forecasted cash flows of these hedged assets and liabilities. The
Group considers its strategic use of derivatives to be a prudent method of
managing interest-rate sensitivity as it reduces the exposure of earnings and
the market value of its equity to undue risk posed by changes in interest
rates. The effect of this unrealized appreciation or depreciation is expected
to be substantially offset by the Group’s gains or losses on the derivative
instruments that are linked to these hedged assets and liabilities. Another
result of interest rate fluctuations is that the contractual interest income
and interest expense of hedged variable-rate assets and liabilities,
respectively, will increase or decrease.  Derivative instruments that are used as part of the
Group’s interest rate risk-management strategy include interest rate swaps,
forward-settlement swaps, futures contracts, and option contracts that have
indices related to the pricing of specific balance sheet assets and
liabilities. Interest rate swaps generally involve the exchange of fixed and
variable-rate interest payments between two parties, based on a common notional
principal amount and maturity date. Interest rate futures generally involve
exchange-traded contracts to buy or sell U.S. Treasury bonds and notes in the
future at specified prices. Interest rate options represent contracts that
allow the holder of the option to (i) receive cash or (ii) purchase,
sell, or enter into a financial instrument at a specified price within a
specified period. Some purchased option contracts give the Group the right to
enter into interest rate swaps and cap and floor agreements with the writer of
the option. In addition, the Group enters into certain transactions that
contain embedded derivatives. When the embedded derivative possesses economic
characteristics that are not clearly and closely related to the economic
characteristics of the host contract, it is bifurcated and carried at fair
value.  The Group also has offered its customers certificates
of deposit with an option tied to the performance of the Standard &
Poor’s 500 stock market index (“S&P 500 Index”). The Group purchases
options from major financial entities to manage its exposure to changes in this
index. Under the terms of the option agreements, the Group receives a certain percentage
of the increase, if any, in the initial month-end value of the S&P 500
Index over the average of the monthly index observations in a five-year period
in exchange for a fixed premium. The changes in fair value of the option
agreements used to manage the exposure in the stock market in the certificates
of deposit are recorded in earnings. The embedded option in the certificates of
deposit is bifurcated, and the changes in the value of that option are also
recorded in earnings.  When using derivative instruments, the Group exposes
itself to credit and market risk. If a counterparty fails to fulfill its
performance obligations under a derivative contract due to insolvency or any
other event of default, the Group’s credit risk will equal the fair value gain
in a derivative plus any cash or securities that may have been delivered to the
counterparty as part of the transaction terms. Generally, when the fair value
of a derivative contract is positive, this indicates that the counterparty owes
the Group, thus creating a repayment risk for the Group. This risk is generally
mitigated by requesting cash or securities from the counterparty to cover the
positive fair value. When the fair value of a derivative contract is negative,
the Group owes the counterparty and, therefore, assumes no credit risk other
than to the extent that the cash or value of the collateral delivered as part
of the transactions exceeds the fair value of the derivative. The Group
minimizes the credit (or repayment) risk in derivative instruments by entering
into transactions with high-quality counterparties.  The Group uses forward-settlement swaps to hedge the
variability of future interest cash flows of forecasted wholesale borrowings
attributable to changes in LIBOR. Once the forecasted wholesale borrowing
transactions occur, the interest rate swap will effectively lock-in the Group’s
interest rate payments on an amount of forecasted interest expense attributable
to the one-month LIBOR corresponding to the swap notional amount. By employing
this strategy, the Group minimizes its exposure to volatility in LIBOR.  As part of this hedging strategy started in the first
quarter of 2011, the Group formally documents all relationships between hedging
instruments and hedged items, as well as its risk-management objective and
strategy for undertaking various hedge transactions. This process includes
linking all derivatives that are designated as cash flow hedges to
(i) specific assets and liabilities on the balance sheet or
(ii) specific firm commitments or forecasted transactions. The Group also
formally assesses (both at the hedge’s inception and on an ongoing basis)
whether the derivatives that are used in hedging transactions have been highly
effective in offsetting changes in the fair value or cash flows of hedged items
and whether those derivatives may be expected to remain highly effective in
future periods. 11


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ORIENTAL FINANCIAL

GROUP INC. NOTES TO UNAUDITED

CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 The changes in fair value of the
forward-settlement swaps are recorded in accumulated other comprehensive income
to the extent there is no significant ineffectiveness.  The Group discontinues hedge accounting prospectively
when (i) it determines that the derivative is no longer effective in
offsetting changes in the cash flows of a hedged item (including hedged items
such as firm commitments or forecasted transactions); (ii) the derivative
expires or is sold, terminated, or exercised; (iii) it is no longer
probable that the forecasted transaction will occur; (iv) a hedged firm
commitment no longer meets the definition of a firm commitment; or
(v) management determines that designating the derivative as a hedging
instrument is no longer appropriate or desired.  The Group’s derivative activities are monitored by its
Asset/Liability Management Committee which is also responsible for approving
hedging strategies that are developed through its analysis of data derived from
financial simulation models and other internal and industry sources. The
resulting hedging strategies are then incorporated into the Group’s overall
interest rate risk-management.  Loans and Allowance for Loan and Lease Losses  Because of the loss protection provided by the FDIC,
the risks of the loans acquired in the FDIC-assisted transaction that are
covered under the FDIC shared-loss agreements are significantly different from
those loans not covered under the FDIC shared-loss agreements. Accordingly, the
Group presents loans subject to the shared-loss agreements as “covered loans”
and loans that are not subject to the FDIC shared-loss agreements as
“non-covered loans.” Non-covered loans include credit card balances acquired in
the FDIC-assisted acquisition.  Non-Covered Loans  Non-covered loans that management has the intent and
ability to hold for the foreseeable future or until maturity or repayment are
reported at their outstanding unpaid principal balances adjusted for (i)
charge-offs, (ii) the allowance for non-covered loan and lease losses, (iii)
unamortized discount related to mortgage servicing rights sold and (iv) any
deferred fees or costs on originated loans. Interest income is accrued on the
unpaid principal balance. Loan origination fees and costs, and premiums and
discounts on loans purchased, are deferred and amortized over the estimated
life of the loans as an adjustment of their yield through interest income using
the interest method. When a loan is paid off or sold, any unamortized deferred
fee (cost) is credited (charged) to income.  Credit card balances acquired as part of the
FDIC-assisted acquisition are accounted for under the guidance of ASC 310-20, which
requires that any differences between the contractually required loan payments
in excess of the Group’s initial investment in the loans be accreted into
interest income on a level-yield basis over the life of the loan. Loans
accounted for under ASC 310-20 are placed on non-accrual status when past due
in accordance with the Group’s non-accruing policy, and any accretion of
discount is discontinued. These assets were written-down to their estimated
fair value on their acquisition date, incorporating an estimate of future
expected cash flows. To the extent actual or projected cash flows are less than
originally estimated, additional provisions for loan and lease losses are
recognized.  On April 1, 2011, the Bank changed on a
prospective basis its policy to place on non-accrual status residential
mortgage loans well collateralized and in process of collection when reaching
90 days past due. All loans that were between 90 and 365 days past due when the
policy was changed were also placed on non-accrual status, and the interest
receivable on such loans was evaluated on a periodic basis against the
collateral underlying the loans and, if necessary, written-down. On December
31, 2011, the Bank further revised its policy to reverse against income all
interest recorded on residential mortgage loans reaching 90 days past due,
including the remaining interest on loans that were between 90 and 365 days
past due as of April 1, 2011. On December 31, 2011, the Bank also charged-off
this remaining accrued interest on residential mortgage loans over 90 days past
due. This change in estimate was considered necessary to comply with guidance
received from the Group’s regulators.  For all other loans, interest recognition is
discontinued when loans are 90 days or more in arrears on principal and/or
interest based on contractual terms. Loans for which the recognition of
interest income has been discontinued are designated as non-accruing.
Collections are accounted for on the cash method thereafter, until qualifying
to return to accrual status. Such loans are not reinstated to accrual status
until interest is received on a current basis and other factors indicative of
doubtful collection cease to exist.  12


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ORIENTAL FINANCIAL

GROUP INC. NOTES TO UNAUDITED

CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
  The Group follows a systematic methodology to
establish and evaluate the adequacy of the allowance for loan and lease losses
to provide for inherent losses in the non-covered loan portfolio. This
methodology includes the consideration of factors such as economic conditions,
portfolio risk characteristics, prior loss experience, and results of periodic
credit reviews of individual loans. The provision for loan and lease losses
charged to current operations is based on such methodology. Loan and lease
losses are charged and recoveries are credited to the allowance for loan and lease
losses on non-covered loans.  Larger commercial loans that exhibit potential or
observed credit weaknesses are subject to individual review and grading. Where
appropriate, allowances are allocated to individual loans based on management’s
estimate of the borrower’s ability to repay the loan given the availability of
collateral, other sources of cash flow, and legal options available to the
Group.  Included in the review of individual loans are those
that are impaired. A loan is considered impaired when, based on current
information and events, it is probable that the Group will be unable to collect
the scheduled payments of principal or interest when due according to the
contractual terms of the loan agreement. Impaired loans are measured based on
the present value of expected future cash flows discounted at the loan’s
effective interest rate, or as a practical expedient, at the observable market
price of the loan or the fair value of the collateral, if the loan is
collateral dependent. Loans are individually evaluated for impairment, except
large groups of small balance homogeneous loans that are collectively evaluated
for impairment and loans that are recorded at fair value or at the lower of
cost or fair value. The Group measures for impairment all commercial loans over
$250 thousand (i) that are either over 90 days past due or adversely
classified, or (ii) when deemed necessary by management. The portfolios of
mortgage, leases and consumer loans are considered homogeneous, and are
evaluated collectively for impairment.  The Group, using a rating system, applies an overall
allowance percentage to each non-covered loan portfolio segment based on
historical credit losses adjusted for current conditions and trends. The
historical loss experience is determined by portfolio segment and is based on
the actual loss history experienced by the Group over the most recent twelve
months. The actual loss experience is supplemented with other economic factors
based on the risks present for each portfolio segment. These economic factors
include consideration of the following: the credit grading assigned to
commercial loans, levels of and trends in delinquencies and impaired loans;
levels of and trends in charge-offs and recoveries; trends in volume and terms
of loans; effects of any changes in risk selection and underwriting standards;
other changes in lending policies, procedures, and practices; experience,
ability, and depth of lending management and other relevant staff, including
the bank’s loan review system as graded by regulatory agencies in their last
examination; local economic trends and conditions; industry conditions; effects
of external factors such as competition and regulatory requirements on the
level of estimated credit losses in the current portfolio; and effects of
changes in credit concentrations and collateral value. Additional impact from
the historical loss experience is applied based on levels of delinquency and
loan classification. During the quarter ended September 30, 2012, the Group
revised this severity impact applied to historical loss factors based on
delinquency buckets and loan classifications to further segregate these impacts
between loans secured by real estate and unsecured loans. The following
portfolio segments have been identified: mortgage loans; commercial loans;
consumer loans; and leasing.  Mortgage Loans:These loans are further divided into four classes: traditional mortgages,
non-traditional mortgages, loans in loan modification programs and home equity
secured personal loans. Traditional mortgage loans include loans secured by a
dwelling, fixed coupons and regular amortization schedules. Non-traditional
mortgages include loans with interest-first amortization schedules and loans
with balloon considerations as part of their terms. Mortgages in loan
modification programs are loans that are being serviced under such programs.
Home equity loans are mainly equity lines of credit. The allowance factor on
these loans is impacted by the historical loss factors on the sub-segments, vintages,
the environmental risk factors described above and by delinquency buckets. 
During the second quarter of 2012, the traditional mortgage loans were further
segregated by vintages.  Commercial loans:These loans are further divided into two classes: commercial loans
secured by existing commercial real estate properties and other commercial
loans. The allowance factor assigned to these loans is impacted by historical
loss factors, by the environmental risk factors described above and by the
credit risk ratings assigned to the loans. These credit risk ratings are based
on relevant information about the ability of borrowers to service their debt
such as: economic conditions, portfolio risk characteristics, prior loss
experience, and results of periodic credit reviews of individual loans.  Consumer loans:These consist of smaller retail loans such as retail credit cards, overdrafts,
unsecured personal lines of credit, and personal unsecured loans. The allowance
factor on these loans is impacted by the historical loss factors on the
segment, the environmental risk factors described above and by delinquency
buckets.  13


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ORIENTAL FINANCIAL

GROUP INC. NOTES TO UNAUDITED

CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 Leasing:This segment consists of personal loans guaranteed by
vehicles in the form of lease financing. The allowance factor on these loans is
impacted by the historical losses on the segment, the environmental risk
factors described above and by delinquency buckets.  Loan loss ratios and credit risk categories are
updated at least quarterly and are applied in the context of GAAP as prescribed
by ASC and the importance of depository institutions having prudent,
conservative, but not excessive loan allowances that fall within an acceptable
range of estimated losses. While management uses current available information
in estimating possible loan and lease losses, factors beyond the Group’s
control, such as those affecting general economic conditions, may require
future changes to the allowance.  Covered Loans  Covered loans acquired in the FDIC-assisted
acquisition are accounted under the provisions of ASC 310-30, “Loans and Debt
Securities Acquired with Deteriorated Credit Quality,” which is applicable when
(a) the Group acquires loans deemed to be impaired when there is evidence
of credit deterioration and it is probable, at the date of acquisition, that
the Group would be unable to collect all contractually required payments and
(b) as a general policy election for non-impaired loans that the Group
acquired with some discount attributable to credit.  The acquired covered loans were recorded at their
estimated fair value at the time of acquisition. Fair value of acquired loans
is determined using a discounted cash flow model based on assumptions about the
amount and timing of principal and interest payments, estimated prepayments,
estimated default rates, estimated loss severity in the event of defaults, and
current market rates. Estimated credit losses are included in the determination
of fair value; therefore, an allowance for loan and lease losses is not
recorded on the acquisition date.  In accordance with ASC 310-30, in estimating the fair
value of covered loans at the acquisition date, the Group (a) calculated
the contractual amount and timing of undiscounted principal and interest
payments (the “undiscounted contractual cash flows”) and (b) estimated the
amount and timing of undiscounted expected principal and interest payments (the
“undiscounted expected cash flows”). The difference between the undiscounted
contractual cash flows and the undiscounted expected cash flows is the
non-accretable discount. The non-accretable discount represents an estimate of
the loss exposure in the covered loan portfolio, and such amount is subject to
change over time based on the performance of the covered loans. The carrying
value of covered loans is reduced by payments received and increased by the
portion of the accretable yield recognized as interest income.  The excess of undiscounted expected cash flows at
acquisition over the initial fair value of acquired loans is referred to as the
“accretable yield” and is recorded as interest income over the estimated life
of the loans using the effective yield method if the timing and amount of the
future cash flows is reasonably estimable. Subsequent to acquisition, the Group
aggregates loans into pools of loans with common risk characteristics to
account for the acquired loans. Increases in expected cash flows over those
originally estimated increase the accretable yield and are recognized as
interest income prospectively or reverse previously recognized allowance for loan
and lease losses. Decreases in expected cash flows compared to those originally
estimated decrease the accretable yield and are recognized by recording a
provision for covered loan and lease losses and establishing an allowance for
loan and lease losses.  ASC 310-30-40-1 states that, once a pool of loans is
assembled, the integrity of the pool shall be maintained. A loan shall be
removed from a pool of loans only if (a) the investor sells, forecloses,
or otherwise receives assets in satisfaction of the loan or (b) the loan
is written off. A refinancing or restructuring of a loan shall not result in
the removal of a loan from a pool. Events that result in a loan being removed
from a pool are often referred to as “confirming events.” When a confirming event
occurs and a loan is removed from a pool, ASC 310-30 indicates that the loan
should be removed at its carrying amount. ASC 310-30-35-15 states that, if a
loan is removed from a pool of loans, the difference between the loan’s
carrying amount and the fair value of the collateral or other assets received
shall not affect the percentage yield calculation used to recognize accretable
yield on the pool of loans. That is, the pool’s yield should be unaffected by
the removal. The Group removes such loans on an “as expected” basis, which
assumes cash or other assets received are equal to the original expectation of
cash flows.  Under the accounting guidance of ASC 310-30 for
acquired loans, the allowance for loan and lease losses on covered loans is
measured at each financial reporting period, or measurement date, based on
expected cash flows. Accordingly, decreases in expected cash flows on these
loans compared to those expected cash flows previously forecasted are
recognized by recording a provision for credit losses on covered loans. The
portion of the loss on covered loans reimbursable from the FDIC is recorded as
an offset to the provision for credit losses and increases the FDIC shared-loss
indemnification asset.  14


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ORIENTAL FINANCIAL

GROUP INC. NOTES TO UNAUDITED

CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
  Lease
Financing  The Group leases vehicles for personal and commercial
use to individual and corporate customers. The direct finance lease method of
accounting is used to recognize revenue on leasing contracts that meet the
criteria specified in the guidance for leases in ASC Topic 840. Aggregate
rentals due over the term of the leases less unearned income are included in
lease financing contracts receivable. Unearned income is amortized using a
method over the average life of the leases as an adjustment to the interest
yield.  Troubled Debt Restructuring  A troubled debt restructuring (“TDR”) is the
restructuring of a receivable in which the Group, as creditor, grants a
concession for legal or economic reasons due to the debtor’s financial
difficulties. A concession is granted when, as a result of the restructuring,
the Group does not expect to collect all amounts due, including interest
accrued at the original contract rate. These concessions may include a
reduction of the interest rate, principal or accrued interest, extension of the
maturity date or other actions intended to minimize potential losses.  To assess whether the debtor is having financial
difficulties, the Group evaluates whether it is probable that the debtor will
default on any of its debt in the foreseeable future.  Receivables that are restructured in a TDR are
presumed to be impaired and are subject to a specific impairment-measurement
method. If the payment of principal at original maturity is primarily dependent
on the value of collateral, the Group considers the current value of that
collateral in determining whether the principal will be paid. For
non-collateral dependent loans, the specific reserve is calculated based on the
present value of expected cash flows discounted at the loan’s effective
interest rate. Loans modified in TDRs are placed on non-accrual status until
the Group determines that future collection of principal and interest is
reasonably assured, which generally requires that the borrower demonstrate
performance according to the restructured terms for a period of at least nine
months.  Reserve for Unfunded Commitments  The reserve for unfunded commitments is maintained at
a level believed by management to be sufficient to absorb estimated probable
losses related to unfunded credit facilities and is included in other
liabilities in the consolidated statements of condition. The determination of
the adequacy of the reserve is based upon an evaluation of the unfunded credit
facilities. Net adjustments to the reserve for unfunded commitments are
included in other operating expenses in the consolidated statements of
operations.  FDIC Shared-Loss Indemnification Asset  The FDIC shared-loss indemnification asset is
accounted for and measured separately from the covered loans acquired in the
FDIC-assisted acquisition as it is not contractually embedded in any of the
covered loans. The shared-loss indemnification asset related to estimated
future loan and lease losses is not transferable should the Group sell a loan
prior to foreclosure or maturity. The shared-loss indemnification asset was
recorded at fair value at the acquisition date and represents the present value
of the estimated cash payments expected to be received from the FDIC for future
losses on covered assets, based on the credit adjustment estimated for each
covered asset and the shared-loss percentages. This balance also includes
incurred expenses under the shared-loss agreements. This asset is presented net
of any clawback liability due to the FDIC under the Purchase and Assumption
Agreement. These cash flows are then discounted at a market-based rate to
reflect the uncertainty of the timing and receipt of the shared-loss
reimbursements from the FDIC. The amount ultimately collected for this asset is
dependent upon the performance of the underlying covered assets, the passage of
time, the proper submission of claims to the FDIC and compliance with the
obligations set forth in the FDIC shared-loss agreements. The time value of
money incorporated into the present value computation is accreted into earnings
over the shorter of the life of the shared-loss agreements or the holding
period of the covered assets.  The FDIC shared-loss indemnification asset is reduced
as losses are recognized on covered loans and shared-loss payments are received
from the FDIC. Realized credit losses in excess of acquisition-date estimates
result in an increase in the FDIC shared-loss indemnification asset.
Conversely, if realized credit losses are less than acquisition-date estimates,
the FDIC shared-loss indemnification asset is amortized through the term of the
shared-loss agreements.  15


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ORIENTAL FINANCIAL

GROUP INC. NOTES TO UNAUDITED

CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
  Core
Deposit Intangible  Core deposit intangible (“CDI”) is a measure of the
value of checking and savings deposits acquired in a business combination. The
fair value of the CDI stemming from any given business combination is based on
the present value of the expected cost savings attributable to the core deposit
funding, relative to an alternative source of funding. CDI is amortized
straight-line over a 10-year period. The Group evaluates such identifiable
intangible for impairment when an indication of impairment exists. No
impairment charges were required to be recorded in the quarters and nine-month
periods ended September 30, 2012 and 2011.  Foreclosed Real Estate and Other Repossessed Property  Non-Covered Foreclosed Real Estate  Foreclosed real estate is initially recorded at the
lower of the related loan balance or the fair value of the real estate less the
cost of selling it at the date of foreclosure. At the time properties are acquired
in full or partial satisfaction of loans, any excess of the loan balance over
the estimated fair value of the property is charged against the allowance for
loan and lease losses on non-covered loans. After foreclosure, these properties
are carried at the lower of cost or fair value less estimated cost to sell,
based on recent appraised values or options to purchase the foreclosed
property. Any excess of the carrying value over the estimated fair value, less
estimated costs to sell, is charged to non-interest expense. The costs and
expenses associated to holding these properties in portfolio are expensed as
incurred.  Covered Foreclosed Real Estate and Other Repossessed
Property  Covered foreclosed real estate and other repossessed
property is initially recorded at their estimated fair value on the acquisition
date, based on appraisal value less estimated selling costs. Any subsequent
write-downs due to declines in fair value and costs and expenses associated
with holding these properties in portfolio are charged as incurred to
non-interest expense with a partially offsetting non-interest income for the
loss reimbursement under the FDIC shared-loss agreement. Any recoveries of
previous write-downs are credited to non-interest expense with a corresponding charge
to non-interest income for the portion of the recovery that is due to the FDIC.  Income
Taxes  In preparing the consolidated financial statements,
the Group is required to estimate income taxes. This involves an estimate of
current income tax expense together with an assessment of temporary differences
resulting from differences between the carrying amounts of assets and
liabilities for financial reporting purposes and the amounts used for income
tax purposes. The determination of current income tax expense involves
estimates and assumptions that require the Group to assume certain positions
based on its interpretation of current tax laws and regulations. Changes in
assumptions affecting estimates may be required in the future, and estimated
tax assets or liabilities may need to be increased or decreased accordingly.
The accrual for tax contingencies is adjusted in light of changing facts and
circumstances, such as the progress of tax audits, case law and emerging
legislation. When particular matters arise, a number of years may elapse before
such matters are audited and finally resolved. Favorable resolution of such
matters could be recognized as a reduction to the Group’s effective tax rate in
the year of resolution. Unfavorable settlement of any particular issue could
increase the effective tax rate and may require the use of cash in the year of
resolution.  The determination of deferred tax expense or benefit
is based on changes in the carrying amounts of assets and liabilities that
generate temporary differences. The carrying value of the Group’s net deferred
tax assets assumes that the Group will be able to generate sufficient future
taxable income based on estimates and assumptions. If these estimates and
related assumptions change in the future, the Group may be required to record
valuation allowances against its deferred tax assets resulting in additional
income tax expense in the consolidated statements of operations.  Management evaluates on a regular basis whether the
deferred tax assets can be realized and assesses the need for a valuation
allowance. A valuation allowance is established when management believes that
it is more likely than not that some portion of its deferred tax assets will
not be realized. Changes in valuation allowance from period to period are
included in the Group’s tax provision in the period of change.  16


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ORIENTAL FINANCIAL

GROUP INC. NOTES TO UNAUDITED

CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
  In addition to valuation allowances, the Group
establishes accruals for uncertain tax positions when, despite the belief that
the Group’s tax return positions are fully supported, the Group believes that
certain positions are likely to be challenged. The accruals for uncertain tax
positions are adjusted in light of changing facts and circumstances, such as
the progress of tax audits, case law, and emerging legislation. The accruals
for the Group’s uncertain tax positions are reflected as income tax payable as
a component of accrued expenses and other liabilities. These accruals are
reduced upon expiration of the applicable statute of limitations.  The Group follows a two-step approach for recognizing
and measuring uncertain tax positions. The first step is to evaluate the tax
position for recognition by determining if the weight of available evidence
indicates that it is more likely than not that the position will be sustained
on audit, including resolution of related appeals or litigation processes, if
any. The second step is to measure the tax benefit as the largest amount that
is more than 50% likely to be realized upon ultimate settlement.  The Group’s policy is to include interest and
penalties related to unrecognized income tax benefits within the provision for
income taxes on the consolidated statements of operations.  On January 31, 2011, the Governor of Puerto Rico
signed into law the Internal Revenue Code for a New Puerto Rico, which has been
subsequently amended several times (the “2011 Code”). The 2011 Code provides
for the gradual repeal of the Puerto Rico Internal Revenue Code of 1994 (the
“1994 Code”), as its provisions started to take effect, with some exceptions,
as of January 1, 2011. For corporate taxpayers, the 2011 Code retains the 20%
flat rate on “normal-tax net income” but establishes significantly lower rates
applicable to “surtax net income” which is the “normal-tax net income” less the
allowed surtax deduction. The 2011 Code provides a surtax rate from 5% to 10%
for taxable years commencing after December 31, 2010 and before January 1,
2014. For taxable years commencing after December 31, 2013, the surtax rate may
be reduced to 5% if certain economic and budgetary control tests are met by the
Government of Puerto Rico. If such economic tests are not met, the reduction of
the surtax rate will be postponed until the year when such economic tests are
met. In the case of a controlled group of corporations, the determination of
which surtax rate applies will be made by adding the “normal-tax net income” of
each of the entities that are members of the controlled group reduced by the
surtax deduction. The 2011 Code also increased the surtax deduction to
$750,000. In the case of a controlled group of corporations, the surtax
deduction should be distributed among the members of the controlled group. The
2011 Code reduces the alternative minimum tax (“AMT”) from 22% to 20%.  It also
eliminates the 5% additional surtax which was established by Act No. 7 of March
9, 2009, and the 5% recapture of the benefit of the income tax tables, except
for income earned by international banking entities, which is currently fully
exempt, but was subject to a 5% income tax for the 2009, 2010 and 2011 taxable
years.  Under the 2011 Code, a corporate taxpayer had a one-time option of
determining its income tax liability and filing its income tax return pursuant
to the 1994 Code. This election was required with the filing of the 2011 income
tax return and, once made, was irrevocable for such taxable year and for each
of the next four taxable years. The Group elected to implement and file its
income tax returns pursuant to the 2011 Code. Under the 2011 Code, all
companies are treated as separate taxable entities and are not entitled to file
consolidated returns. The Group and its subsidiaries are subject to Puerto Rico
regular income tax or AMT on income earned from all sources. The AMT is payable
if it exceeds regular income tax. The excess of AMT over regular income tax
paid in any one year may be used to offset regular income tax in future years,
subject to certain limitations.  Equity-Based Compensation Plan  The Group’s 2007 Omnibus Performance Incentive Plan,
as amended and restated (the “Omnibus Plan”), provides for equity-based
compensation incentives through the grant of stock options, stock appreciation
rights, restricted stock, restricted units and dividend equivalents, as well as
equity-based performance awards. The Omnibus Plan was adopted in 2007, amended
and restated in 2008, and further amended in 2010.  The purpose of the Omnibus Plan is to provide
flexibility to the Group to attract, retain and motivate directors, officers,
and key employees through the grant of awards based on performance and to
adjust its compensation practices to the best compensation practice and
corporate governance trends as they develop from time to time. The Omnibus Plan
is further intended to motivate high levels of individual performance coupled
with increased shareholder returns. Therefore, awards under the Omnibus Plan
(each, an “Award”) are intended to be based upon the recipient’s individual
performance, level of responsibility and potential to make significant
contributions to the Group. Generally, the Omnibus Plan will terminate as of
(a) the date when no more of the Group’s shares of common stock are
available for issuance under the Omnibus Plan or, (b) if earlier, the date the
Omnibus Plan is terminated by the Group’s Board of Directors.  17


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ORIENTAL FINANCIAL

GROUP INC. NOTES TO UNAUDITED

CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
  The Board’s Compensation Committee (the “Committee”),
or such other committee as the Board may designate, has full authority to
interpret and administer the Omnibus Plan in order to carry out its provisions
and purposes. The Committee has the authority to determine those persons
eligible to receive an Award and to establish the terms and conditions of any
Award. The Committee may delegate, subject to such terms or conditions or
guidelines as it shall determine, to any employee or group of employees any
portion of its authority and powers under the Omnibus Plan with respect to
participants who are not directors or executive officers subject to the
reporting requirements under Section 16(a) of the Securities Exchange Act
of 1934, as amended (the “Exchange Act”). Only the Committee may exercise
authority in respect of Awards granted to such participants.  The Omnibus Plan replaced and superseded the Group’s
1996, 1998 and 2000 Incentive Stock Option Plans (the “Stock Option Plans”).
All outstanding stock options under the Stock Option Plans continue in full
force and effect, subject to their original terms and conditions.  The expected term of stock options granted represents
the period of time that such options are expected to be outstanding. Expected
volatilities are based on historical volatility of the Group’s shares of common
stock over the most recent period equal to the expected term of the stock
options. For stock options issued during 2012, the expected volatilities are
based on both historical and implied volatility of the Group’s shares of common
stock.  The Group follows the fair value method of recording
stock-based compensation. The Group uses the modified prospective transition
method, which requires measurement of the cost of employee services received in
exchange for an award of equity instruments based on the grant date fair value
of the award with the cost to be recognized over the service period. It applies
to all awards unvested and granted after this effective date and awards modified,
repurchased, or cancelled after that date.  Subsequent Events  The Group has evaluated other events subsequent to the
balance sheet date and prior to the filing of this Quarterly Report on Form
10-Q for the quarter ended September 30, 2012, and has adjusted and disclosed
those events that have occurred that would require adjustment or disclosure in
the unaudited consolidated financial statements.  Refer to Note 1Business Combinationssectionfor details of preferred stock and common stock issued after September 30,
2012 in connection to the prospective BBVAPR Acquisition.  Reclassifications  When necessary, certain reclassifications have been
made to prior year amounts to conform to the current year presentation.  Recent
Accounting Developments  Comprehensive Income— FASB Accounting Standards Update (“ASU”) 2011-12, “Deferral of the
Effective Date for Amendments to the Presentation of Reclassifications of Items
Out of Accumulated Other Comprehensive Income in Accounting Standards Update
No. 2011-05” (Topic 220) was issued in December 2011. This update defers the
effective date for the presentation of reclassification adjustments.  The
amendments are being made to allow the FASB time to redeliberate whether to
present on the face of the financial statements the effects of
reclassifications out of accumulated comprehensive income on the components of
net income and other comprehensive income for all periods presented. The
amendments in this update are effective for interim and annual reporting periods
beginning after December 15, 2011. The Group adopted this guidance for the
deferment of the presentation of reclassifications of items out of accumulated
comprehensive income.  18


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ORIENTAL FINANCIAL

GROUP INC. NOTES TO UNAUDITED

CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
  Fair Value Measurement— FASB ASU
2011-04, “Amendments to Achieve Common Fair Value Measurement and Disclosure
Requirements in U.S. GAAP and IFRSs” (Topic 820) was issued in May 2011. This
update establishes common fair value measurement and disclosure requirements in
U.S. GAAP and IFRSs. Consequently, the amendments change the wording used to
describe many of the requirements in U.S. GAAP for measuring fair value and for
disclosing information about fair value measurements. Among the changes,
additional information about the sensitivity of a fair value measurement
categorized within Level 3 of the fair value hierarchy to changes in
unobservable inputs and any interrelationships between those unobservable
inputs will be required. Also, entities now will be required to categorize by
level of the fair value hierarchy items that are not measured at fair value in
the statement of financial position, but for which the fair value of such items
is required to be disclosed. The amendments in this update are effective during
interim and annual periods beginning after December 15, 2011, are to be applied
prospectively. The Group adopted this guidance for fair value measurements.  Repurchase
Agreements— FASB ASU 2011-03,
“Reconsideration of Effective Control for Repurchase Agreements” (Topic 860)
was issued in April 2011. This update removes from the assessment of effective
control the criterion requiring the transferor to have the ability to
repurchase or redeem the financial assets on substantially the agreed terms,
even in the event of default by the transferee, and the collateral maintenance
implementation guidance related to that criterion. Other criteria applicable to
the assessment of effective control are not changed by the amendments in this
update. The amendments in this update are effective for the first interim or
annual period beginning on or after December 15, 2011. The guidance should be
applied prospectively to transactions or modifications of existing transactions
that occur on or after the effective date. Early adoption was not permitted.
The Group adopted this guidance for the repurchase agreements.  Intangibles—Goodwill
and Other– FASB ASU 2012-02,
“Testing Indefinite-Lived Intangible Assets for Impairment(Topic 350)
was issued in July 2012.This update establish that
an entity has the option first to assess qualitative factors to determine
whether the existence of events and circumstances indicates that it is more
likely than not that the indefinite-lived intangible asset is impaired. If,
after assessing the totality of events and circumstances, an entity concludes
that it is not more likely than not that the indefinite-lived intangible asset
is impaired, then the entity is not required to take further action. However,
if an entity concludes otherwise, then it is required to determine the fair
value of the indefinite-lived intangible asset and perform the quantitative
impairment test by comparing the fair value with the carrying. An entity also
has the option to bypass the qualitative assessment for any indefinite-lived
intangible asset in any period and proceed directly to performing the
quantitative impairment test. An entity will be able to resume performing the
qualitative assessment in any subsequent period.The amendments are
effective for annual and interim impairment tests performed for fiscal years
beginning after September 15, 2012. Early adoption is permitted, including for
annual and interim impairment tests performed as of a date before July 27, 2012. 19


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ORIENTAL FINANCIAL

GROUP INC. NOTES TO UNAUDITED

CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 NOTE 2-FDIC-ASSISTED
ACQUISITION AND FDIC SHARED-LOSS INDEMNIFICATION ASSET  On April 30, 2010, the Bank
acquired certain assets and assumed certain deposits and other liabilities in
the FDIC-assisted acquisition of Eurobank.  As part of the Purchase and Assumption
Agreement between the Bank and the FDIC (the “Purchase and Assumption
Agreement”), the Bank and the FDIC entered into shared-loss agreements, whereby
the FDIC covers a substantial portion of any losses on loans (and related
unfunded loan commitments), foreclosed real estate and other repossessed
properties.  The acquired loans, foreclosed
real estate, and other repossessed property subject to the shared-loss
agreements are collectively referred to as “covered assets.” Under the terms of
the shared-loss agreements, the FDIC absorbs 80% of losses and shares in 80% of loss recoveries on
covered assets. The term of the shared-loss agreement covering single family
residential mortgage loans is ten years with respect to losses and loss
recoveries, while the term of the shared-loss agreement covering commercial
loans is five years with respect to losses and eight years with respect to loss
recoveries, from the April 30, 2010 acquisition date. The shared-loss
agreements also provide for certain costs directly related to the collection
and preservation of covered assets to be reimbursed at an 80% level.  The assets acquired and
liabilities assumed as of April 30, 2010 were presented at their fair value. In
many cases, the determination of these fair values required management to make
estimates about discount rates, expected cash flows, market conditions and
other future events that are highly subjective in nature and were subject to change.
The fair values initially assigned to the assets acquired and liabilities
assumed were preliminary and subject to refinement for up to one year after the
closing date of the acquisition as new information relative to closing date
fair values became available. The process was completed on April 29, 2011.  The Bank has agreed to make a
true-up payment, also known as clawback liability, to the FDIC on the date that
is 45 days following the last day (such day, the “True-Up Measurement Date”) of
the final shared-loss month, or upon the final disposition of all covered
assets under the shared-loss agreements in the event losses thereunder fail to
reach expected levels. Under the shared-loss agreements, the Bank will pay to
the FDIC 50% of the excess, if any, of: (i) 20% of the Intrinsic Loss Estimate
of $906.0 million (or $181.2 million) (as determined by the FDIC) less (ii) the
sum of: (A) 25% of the asset discount (per bid) (or $227.5 million); plus (B)
25% of the cumulative shared-loss payments (defined as the aggregate of all of
the payments made or payable to the Bank minus the aggregate of all of the
payments made or payable to the FDIC); plus (C) the sum of the period servicing
amounts for every consecutive twelve-month period prior to and ending on the
True-Up Measurement Date in respect of each of the shared-loss agreements
during which the shared-loss provisions of the applicable shared-loss agreement
is in effect (defined as the product of the simple average of the principal
amount of shared-loss loans and shared-loss assets at the beginning and end of
such period times 1%). The true-up payment represents an estimated liability of
$14.8 million and $13.3
million, net of discount, as of September 30, 2012 and December 31, 2011,
respectively. This estimated liability is accounted for as a reduction of the
indemnification asset. The indemnification asset represents the portion of
estimated losses covered by the shared-loss agreements between the Bank and the
FDIC.  The operating results of the
Group for the quarters and nine-month periods ended September 30, 2012 and 2011
include the operating results produced by the acquired assets and assumed
liabilities from the FDIC-assisted acquisition.  The FDIC shared-loss
indemnification asset activity for the nine-month periods ended September 30,
2012 and 2011 is as follows:  Nine-Month Period Ended September 30,2012
 
 2011(In thousands)Balance at beginning of period
 $
 392,367
 
 $
 473,629Shared-loss agreements reimbursements from the FDIC
 
 (63,272)
 
 
 (73,267)Increase (decrease) in expected credit losses to be
  covered under shared-loss agreements, net
 
 10,764
 
 
 (10,659)Amortization of FDIC shared-loss indemnification asset, net
 
 (18,505)
 
 
 (191)Incurred expenses to be reimbursed under shared-loss
  agreements
 
 7,219
 
 
 2,584Balance at end of period
 $
 328,573
 
 $
 392,096
 20


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ORIENTAL FINANCIAL

GROUP INC. NOTES TO UNAUDITED

CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 NOTE
3-INVESTMENTS  Money
Market Investments  The Group considers as cash
equivalents all money market instruments that are not pledged and that have maturities
of three months or less at the date of acquisition. At September 30, 2012 and December
31, 2011, money market instruments included as part of cash and cash
equivalents amounted to $4.0 million and $3.9 million, respectively.  Securities
Purchased Under Agreements to Resell Securities
purchased under agreements to resell consist of short-term investments and are
carried at the amounts at which the assets will be subsequently resold as
specified in the respective agreements. At September 30, 2012, securities
purchased under agreements to resell amounted to $270.0 million. At
December 31, 2011, there were no securities purchased under agreements to
resell. The
amounts advanced under those agreements are reflected as assets in the
unaudited consolidated statements of financial condition. It is the Group’s
policy to take possession of securities purchased under agreements to resell.
Agreements with third parties specify the Group’s right to request additional
collateral based on its monitoring of the fair value of the underlying
securities on a daily basis. The fair value of the collateral securities held
by the Group on these transactions as of September 30, 2012 was approximately
$275.4 million.  Investment
Securities  The amortized cost, gross
unrealized gains and losses, fair value, and weighted average yield of the
securities owned by the Group at September 30, 2012 and December 31, 2011 were
as follows:  September 30, 2012Gross
 
 Gross
 
 
 WeightedAmortized
 
 Unrealized
 
 Unrealized
 
 Fair
 AverageCost
 
 Gains
 
 Losses
 
 Value
 Yield(In thousands)Available-for-saleMortgage-backed securitiesFNMA and
  FHLMC certificates
 $
 1,530,787
 
 $
 68,843
 
 $
 1
 
 $
 1,599,629
 
 3.10%GNMA
  certificates
 
 17,336
 
 
 1,404
 
 
 8
 
 
 18,732
 
 4.89%CMOs
  issued by US Government sponsored agencies
 
 193,543
 
 
 1,770
 
 
 208
 
 
 195,105
 
 1.78%Total mortgage-backed securities
 
 1,741,666
 
 
 72,017
 
 
 217
 
 
 1,813,466
 
 2.97%Investment securitiesUS
  Treasury securities
 
 387,992
 
 
 2
 
 
 -
 
 
 387,994
 
 0.04%Obligations
  of US Government sponsored agencies
 
 25,017
 
 
 118
 
 
 -
 
 
 25,135
 
 1.40%Obligations of Puerto Rico Government and
  political subdivisions
 
 22,240
 
 
 126
 
 
 12
 
 
 22,354
 
 5.41%Structured credit investments
 
 36,424
 
 
 -
 
 
 7,422
 
 
 29,002
 
 2.10%Other
  debt securities
 
 15,290
 
 
 309
 
 
 -
 
 
 15,599
 
 3.44%Total investment securities
 
 486,963
 
 
 555
 
 
 7,434
 
 
 480,084
 
 0.62%Total securities available-for-sale
 
 2,228,629
 
 
 72,572
 
 
 7,651
 
 
 2,293,550
 
 2.45%Held-to-maturityMortgage-backed securitiesFNMA and
  FHLMC certificates
 
 722,823
 
 
 38,283
 
 
 -
 
 
 761,106
 
 3.30%CMOs
  issued by US Government sponsored agencies
 
 112,261
 
 
 1,554
 
 
 -
 
 
 113,815
 
 1.97%Total securities held-to-maturity
 
 835,084
 
 
 39,837
 
 
 -
 
 
 874,921
 
 3.12%Total
  investments
 $
 3,063,713
 
 $
 112,409
 
 $
 7,651
 
 $
 3,168,471
 
 2.63%
 21


---



ORIENTAL FINANCIAL

GROUP INC. NOTES TO UNAUDITED

CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
  December 31, 2011Gross
 
 Gross
 
 
 WeightedAmortized
 
 Unrealized
 
 Unrealized
 
 Fair
 AverageCost
 
 Gains
 
 Losses
 
 Value
 Yield(In thousands)Available-for-saleMortgage-backed securitiesFNMA and
  FHLMC certificates
 $
 2,583,881
 
 $
 92,899
 
 $
 -
 
 $
 2,676,780
 
 3.61%GNMA
  certificates
 
 26,186
 
 
 2,151
 
 
 -
 
 
 28,337
 
 5.94%CMOs
  issued by US Government sponsored agencies
 
 128,505
 
 
 1,739
 
 
 199
 
 
 130,045
 
 2.33%Total mortgage-backed securities
 
 2,738,572
 
 
 96,789
 
 
 199
 
 
 2,835,162
 
 3.57%Investment securitiesObligations of Puerto Rico Government and
  political subdivisions
 
 72,437
 
 
 225
 
 
 1,204
 
 
 71,458
 
 5.37%Structured credit investments
 
 46,904
 
 
 -
 
 
 9,616
 
 
 37,288
 
 2.92%Other
  debt securities
 
 15,769
 
 
 235
 
 
 -
 
 
 16,004
 
 3.42%Total investment securities
 
 135,110
 
 
 460
 
 
 10,820
 
 
 124,750
 
 4.29%Total securities available-for-sale
 
 2,873,682
 
 
 97,249
 
 
 11,019
 
 
 2,959,912
 
 3.60%Held-to-maturityMortgage-backed securitiesFNMA and
  FHLMC certificates
 
 884,026
 
 
 20,530
 
 
 -
 
 
 904,556
 
 3.34%Total
  investments
 $
 3,757,708
 
 $
 117,779
 
 $
 11,019
 
 $
 3,864,468
 
 3.54%
 22


---



ORIENTAL FINANCIAL

GROUP INC. NOTES TO UNAUDITED

CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
  The amortized cost and fair
value of the Group’s investment securities at September 30, 2012, by contractual
maturity, are shown in the next table. Securities not due on a single
contractual maturity date, such as collateralized mortgage obligations, are
classified in the period of final contractual maturity. Expected maturities may
differ from contractual maturities because issuers may have the right to call
or prepay obligations with or without call or prepayment penalties.  September 30, 2012Available-for-sale
 
 Held-to-maturityAmortized Cost
 
 Fair Value
 
 Amortized Cost
 
 Fair Value(In thousands)Mortgage-backed
  securitiesDue after 5
  to 10 yearsFNMA and
  FHLMC certificates
 $
 44,430
 
 $
 45,805
 
 $
 -
 
 $
 -Total due after 5 to 10 years
 
 44,430
 
 
 45,805
 
 
 -
 
 
 -Due after 10
  yearsFNMA and
  FHLMC certificates
 
 1,486,357
 
 
 1,553,824
 
 
 722,823
 
 
 761,106GNMA
  certificates
 
 17,336
 
 
 18,732
 
 
 -
 
 
 -CMOs
  issued by US Government sponsored agencies
 
 193,543
 
 
 195,105
 
 
 112,261
 
 
 113,815Total due after 10 years
 
 1,697,236
 
 
 1,767,661
 
 
 835,084
 
 
 874,921Total  mortgage-backed securities
 
 1,741,666
 
 
 1,813,466
 
 
 835,084
 
 
 874,921Investment
  securitiesDue in less
  than one yearUS
  Treasury securities
 
 387,992
 
 
 387,994
 
 
 -
 
 
 -Total due in less than one year
 
 387,992
 
 
 387,994
 
 
 -
 
 
 -Due from 1
  to 5 yearsOther debt
  securities
 
 10,000
 
 
 10,017
 
 
 -
 
 
 -Obligations of Puerto Rico Government and political subdivisions
 
 398
 
 
 397
 
 
 -
 
 
 -Total due from 1 to 5 years
 
 10,398
 
 
 10,414
 
 
 -
 
 
 -Due after 5
  to 10 yearsObligations of Puerto Rico Government and political subdivisions
 
 11,380
 
 
 11,426
 
 
 -
 
 
 -Structured credit investments
 
 36,424
 
 
 29,002
 
 
 -
 
 
 -Obligations of US Government and sponsored agencies
 
 25,017
 
 
 25,135
 
 
 -
 
 
 -Total due after 5 to 10 years
 
 72,821
 
 
 65,563
 
 
 -
 
 
 -Due after 10
  yearsObligations of Puerto Rico Government and political subdivisions
 
 10,462
 
 
 10,531
 
 
 -
 
 
 -Other
  debt securities
 
 5,290
 
 
 5,582
 
 
 -
 
 
 -Total due after 10 years
 
 15,752
 
 
 16,113
 
 
 -
 
 
 -Total  investment securities
 
 486,963
 
 
 480,084
 
 
 -
 
 
 -Total
  investments
 $
 2,228,629
 
 $
 2,293,550
 
 $
 835,084
 
 $
 874,921
  Keeping with the Group’s
investment strategy, during the nine-month period ended September 30, 2012 and
2011, there were certain sales of available-for sale securities because the
Group felt at the time of such sales that gains could be realized while at the
same time having good opportunities to invest the proceeds in other investment
securities with attractive yields and terms that would allow the Group to
continue to protect its net interest margin. The Group is also pursuing the
strategy of selling securities subject to higher prepayment speeds. During the
quarter ended September 30, 2012, the Group sold $532.4 million of investment securities and extinguished
$400 million of securities repurchase agreements prior to their contractual
maturities in furtherance of the Group’s plan to deleverage its balance sheet
in connection with the BBVAPR Acquisition.  Premiums and discounts are
amortized to interest income over the life of the related securities using the
interest method. Net realized gains or losses on sales of investment securities
and unrealized gains and losses valuation adjustments considered other than
temporary, if any, on securities classified as either available-for-sale or
held-to-maturity are reported separately in the statements of operations. The
cost of securities sold is determined by the specific identification
method.  During the quarter ended September 30, 2012, the Group made a
change in one of the estimates applied in the calculation of the amortization
of premiums/discounts in the 23


---



ORIENTAL FINANCIAL

GROUP INC. NOTES TO UNAUDITED

CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 mortgage-backed
securities portfolio. The estimate involves the period used in measuring the
repayment experience of each security and the change consists of using a
12-month look-back period instead of a 3-month period for these purposes. 
The Group believes that this extended period better reflects the portfolio
behavior, especially considering the seasonality cycle of the U.S. housing
market, and also reduces the high volatility that affects interest income
recognition when using a more limited prepayment history experience in periods
of greater market volatility.   The impact of this change during the
quarter ended September 30, 2012 was an increase of $3.3 million in interest
income from mortgage-backed securities.  The Group, as part of its
asset/liability management, may purchase U.S. Treasury securities and U.S.
government sponsored agencies discount notes close to their maturities as a
short term vehicle to reinvest the proceeds of sale transactions until
investment securities with attractive yields can be purchased.  The Group recorded a net gain
on sale of securities of $55.7 million and $23.1 million during the nine-month
periods ended September 30, 2012 and 2011, respectively. The tables below
present the gross realized gains and losses by category for the nine-month
periods ended September 30, 2012 and 2011:  Nine-Month Period Ended September 30,
  2012Book Value
 
 Gross
 
 GrossDescription
 Sale Price
 
 at Sale
 
 Gains
 
 Losses(In thousands)Sale of
  Securities Available-for-SaleMortgage-backed securitiesFNMA and
  FHLMC certificates
 $
 936,779
 
 $
 881,834
 
 $
 54,945
 
 $
 -GNMA
  certificates
 
 62,639
 
 
 62,638
 
 
 1
 
 
 -CMOs
  issued by US Government sponsored agencies
 
 19,725
 
 
 18,372
 
 
 1,353
 
 
 -Total mortgage-backed securities and CMOs
 
 1,019,143
 
 
 962,844
 
 
 56,299
 
 
 -Investment securitiesUS
  Treasury securities
 
 80,000
 
 
 80,000
 
 
 -
 
 
 -Obligations of Puerto Rico Government and political subdivisions
 
 35,882
 
 
 36,478
 
 
 32
 
 
 628Structured credit investments
 
 10,530
 
 
 10,530
 
 
 -
 
 
 -Total investment securities
 
 126,412
 
 
 127,008
 
 
 32
 
 
 628Total
 $
 1,145,555
 
 $
 1,089,852
 
 $
 56,331
 
 $
 628
  Nine-Month Period Ended September 30,
  2011Sale BookDescription
 Sale Price
 
 Value
 
 Gross Gains
 
 Gross Losses(In thousands)Sale of
  Securities Available-for-SaleMortgage-backed securitiesFNMA and
  FHLMC certificates
 $
 309,112
 
 $
 293,580
 
 $
 15,532
 
 $
 -GNMA
  certificates
 
 183,269
 
 
 175,699
 
 
 7,571
 
 
 1Total mortgage-backed securities
 
 492,381
 
 
 469,279
 
 
 23,103
 
 
 1Investment securitiesObligations of U.S. Government sponsored agencies
 
 14,100
 
 
 14,100
 
 
 -
 
 
 -Total investment securities
 
 14,100
 
 
 14,100
 
 
 -
 
 
 -Total
 $
 506,481
 
 $
 483,379
 
 $
 23,103
 
 $
 1
 24


---



ORIENTAL FINANCIAL

GROUP INC. NOTES TO UNAUDITED

CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 The following tables show the Group’s gross unrealized
losses and fair value of investment securities available-for-sale, aggregated
by investment category and length of time that individual securities have been
in a continuous unrealized loss position, at September 30, 2012 and December
31, 2011:  September 30, 201212 months or moreAmortized
 
 Unrealized
 
 FairCost
 
 Loss
 
 Value(In thousands)Securities
  Available-for-saleStructured
  credit investments
 $
 36,424
 
 $
 7,422
 
 $
 29,002Obligations
  of Puerto Rico Government and political subdivisions
 
 1,653
 
 
 12
 
 
 1,641CMOs issued
  by US Government sponsored agencies
 
 2,243
 
 
 183
 
 
 2,060$
 40,320
 
 $
 7,617
 
 $
 32,703Less than 12 monthsAmortized
 
 Unrealized
 
 FairCost
 
 Loss
 
 Value(In thousands)Securities
  Available-for-saleCMOs issued
  by US Government sponsored agencies
 $
 13,803
 
 $
 25
 
 $
 13,778Obligations
  of Puerto Rico Government and political subdivisions
 
 125
 
 
 -
 
 
 125GNMA
  certificates
 
 85
 
 
 8
 
 
 77FNMA and FHLMC
  certificates
 
 68
 
 
 1
 
 
 67$
 14,081
 
 $
 34
 
 $
 14,047TOTALAmortized
 
 Unrealized
 
 FairCost
 
 Loss
 
 Value(In thousands)Securities
  Available-for-saleStructured
  credit investments
 $
 36,424
 
 $
 7,422
 
 $
 29,002Obligations
  of Puerto Rico Government and political subdivisions
 
 1,778
 
 
 12
 
 
 1,766CMOs issued
  by US Government sponsored agencies
 
 16,046
 
 
 208
 
 
 15,838FNMA and FHLMC
  certificates
 
 68
 
 
 1
 
 
 67GNMA
  certificates
 
 85
 
 
 8
 
 
 77$
 54,401
 
 $
 7,651
 
 $
 46,750
  December 31, 201112 months or moreAmortized
 
 Unrealized
 
 FairCost
 
 Loss
 
 Value(In thousands)Securities
  Available-for-saleStructured
  credit investments
 $
 36,374
 
 $
 9,616
 
 $
 26,758Obligations
  of Puerto Rico Government and political subdivisions
 
 24,697
 
 
 1,204
 
 
 23,493CMOs issued
  by US Government sponsored agencies
 
 2,384
 
 
 199
 
 
 2,185$
 63,455
 
 $
 11,019
 
 $
 52,436
  At December 31, 2011, there
were no available-for-sale securities in a continuous unrealized loss position
for less than 12 months. In addition, at September 30, 2012 and December 31,
2011, there were no individual held-to-maturity securities in an unrealized
loss position.  25


---



ORIENTAL FINANCIAL

GROUP INC. NOTES TO UNAUDITED

CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 The Group
conducts quarterly reviews to identify and evaluate each investment in an
unrealized loss position for other-than-temporary impairment.  Any portion of a decline in value associated with
credit loss is recognized in income with the remaining noncredit-related
component recognized in other comprehensive income. A credit loss is determined
by assessing whether the amortized cost basis of the security will be recovered
by comparing the present value of cash flows expected to be collected from the
security, discounted at the rate equal to the yield used to accrete current and
prospective beneficial interest for the security. The shortfall of the present
value of the cash flows expected to be collected in relation to the amortized
cost basis is considered to be the “credit loss.”  Other-than-temporary impairment analysis is based on
estimates that depend on market conditions and are subject to further change
over time. In addition, while the Group believes that the methodology used to
value these exposures is reasonable, the methodology is subject to continuing
refinement, including those made as a result of market developments.
Consequently, it is reasonably possible that changes in estimates or conditions
could result in the need to recognize additional other-than-temporary
impairment charges in the future.  At September 30, 2012, the Group’s portfolio of
structured credit investments amounted to $36.4 million (amortized cost) in the
available-for-sale portfolio, with net unrealized losses of approximately $7.4
million. The Group’s structured credit investments portfolio consist of three
collateralized loan obligations (“CLOs”).  The CLOs are collateralized mostly by senior secured
(via first liens) “middle market” commercial and industrial loans, which are
securitized in the form of obligations. These investments are all floating rate
notes, which reset quarterly based on the three-month LIBOR rate.  The determination of the credit loss
assumption in the discounted cash flow analysis related to the Group’s
structured credit investments is based on the underlying data for each type of
security. In the case of the CLOs, the determination of the future cash flows
is based on the following factors:  •Identification of the estimated
fair value of the contractual coupon of the loans underlying the CLO. Such fair
values are calculated based on information that is obtained directly from the
trustee’s reports for each CLO security. •Calculation of the
yield-to-maturity for each loan in the CLO, and determination of the interest
rate spread (yield less the risk-free rate). •Estimated default probabilities
for each loan in the CLO. These are based on the credit ratings for each
company in the structure, and this information also is obtained directly from
the trustee’s reports for each CLO security. The default probabilities are
adjusted based on the credit rating assuming the highest default probabilities
for the loans of those entities with the lowest credit ratings. In addition to
determining the current default probabilities, estimates are developed to
calculate the cumulative default probabilities in successive years. To
establish the reasonability of the default estimates, market-implied default
rates are compared to historical credit ratings-based default rates. •Once the default probabilities are
estimated, the average numbers of defaults is calculated for the loans
underlying each CLO security. In those cases where defaults are deemed to
occur, a recovery rate is applied to the cash flow determination at the time in
which the default is expected to occur. The recovery rate is based on average
historical information for similar securities, as well as the actual recovery
rates for defaults that have occurred within the pool of loans underlying the
securities owned by the Group. •One hundred simulations are
carried out and run through a cash flow engine for the underlying pool of loans
in each CLO security. Each one of the simulations uses different default
estimates and forward yield curve assumptions.  The three CLOs held by the Group have face values of
$12 million, $10 million and $15 million. In light of the other-than-temporary
impairment analyses described below, the Group has determined that it is more
likely than not that it will recover all interest and principal invested in the
CLOs.  The cash flow analysis performed by the Group for the
$12 million CLO did not reflect any scenario where there was a principal
impairment. Moreover, the CLO has maintained its “AA-” S&P rating and its
“A2” Moody’s rating since November 2011. In addition, as of September 30, 2012 and
December 31, 2011, the CLO’s subordination level is 26.18%.  26


---



ORIENTAL FINANCIAL

GROUP INC. NOTES TO UNAUDITED

CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 With respect to the $10
million CLO, the cash flow analysis performed by the Group also did not reflect
any scenario where there was a principal impairment. The CLO has maintained its
“A+” S&P rating and its “A2” Moody’s rating since February 2012. Also, as
of September 30, 2012 and December 31, 2011, the CLO’s subordination level is
20.64%.  The cash flow analysis performed by the Group for the
$15 million CLO as of September 30, 2012, detected that there was a principal
impairment in 10 out of 100 scenarios, with average losses of 3.42%. and no
scenarios where the impairment amount is 100% of the Group’s investment. The
CLO has maintained its “BBB+” S&P rating and its “Baa2” Moody’s rating
since August 2011.  Also, as of September 30, 2012 and December 31, 2011, the
CLO’s subordination level is 7.54%.  The Group estimates that it will recover all interest
and principal for the Group’s specific tranches of these securities. This
assessment is based on the cash flow analysis mentioned above in which the
credit quality of the Group’s positions was evaluated through a determination
of the expected losses on the underlying collateral. The model results show
that the estimated future collateral losses, if any, are lower than the Group’s
subordination levels for each one of these securities. Therefore, these
securities are deemed to have sufficient credit support to absorb the estimated
collateral losses.  On January 12, 2012, the Group made the strategic
decision to sell its $25.5 million investment in a corporate bond that was
partially invested in a synthetic collateralized debt obligation (CDO) at a
loss of $15.0 million. This loss was accounted for as an other-than-temporary
impairment in the fourth quarter of 2011, and no additional gain or loss was
realized on the sale in January 2012, since this asset was sold at the same
value reflected at December 31, 2011. The main considerations underlying
the Group’s decision to sell the security included the continued deteriorating
credit conditions surrounding the underlying reference portfolio of the CDO,
including an event of default that occurred during the fourth quarter of 2011,
and a projected analysis prepared by a third-party specialist that showed
defaults in excess of the deal’s subordination level in more than 50% of the
scenarios modeled. The corporate bond sold was a unique and completely
distinguishable investment from the rest of the Group’s portfolio, including
the remaining structured credit investments. As a result of this transaction,
the Group continued to reduce its exposure to non-agency securities, as well as
to credit risk in the U.S. economy, and also was able to improve its risk-based
capital position.  Other securities in an
unrealized loss position at September 30, 2012 are mainly composed of highly
liquid securities that in most cases have a large and efficient secondary
market. Valuations are performed on a monthly basis. The Group’s management
believes that the unrealized losses of such other securities at September 30,
2012 are temporary and are substantially related to market interest rate
fluctuations and not to deterioration in the creditworthiness of the issuer or
guarantor. At September 30, 2012, the Group does not have the intent to sell
these investments in an unrealized loss position. 27


---



ORIENTAL FINANCIAL

GROUP INC. NOTES TO UNAUDITED

CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 NOTE
4-PLEDGED ASSETS  The following table shows a
summary of pledged and not pledged assets at September 30, 2012 and December
31, 2011. Investment securities are presented at fair value, and residential
mortgage loans, commercial loans and leases are presented at amortized cost:  September 30, 2012
 
 December 31, 2011(In thousands)Pledged
  investment securities to secure:Securities
  sold under agreements to repurchase
 $
 2,885,058
 
 $
 3,399,145Puerto Rico
  public fund deposits
 
 8,522
 
 
 71,863Puerto Rico
  Cash & Money Market Fund
 
 72,312
 
 
 62,739Interest
  rate risk swap contracts
 
 56,444
 
 
 56,189Federal
  Reserve Bank Credit Facility
 
 10,254
 
 
 15,560Bond for
  the Bank's trust operations
 
 125
 
 
 126Total pledged investment securities
 
 3,032,715
 
 
 3,605,622Pledged
  residential mortgage loans to secure:Advances
  from the Federal Home Loan Bank
 
 515,669
 
 
 548,809Pledged
  commercial loans to secure:Advances
  from the Federal Home Loan Bank
 
 54,614
 
 
 40,937Puerto Rico
  public fund deposits
 
 2,271
 
 
 -56,885
 
 
 40,937Pledged
  leases to secure:Federal
  Reserve Bank Credit Facility
 
 8,543
 
 
 7,821Total pledged assets
 $
 3,613,812
 
 $
 4,203,189Financial
  assets not pledged:Investment
  securities
 $
 135,757
 
 $
 258,845Residential
  mortgage loans
 
 428,465
 
 
 435,716Commercial
  loans
 
 590,795
 
 
 603,444Consumer
  loans
 
 54,577
 
 
 49,663Leases
 
 37,369
 
 
 54,069Total assets not pledged
 $
 1,246,963
 
 $
 1,401,737
  At September
30, 2012 and December 31, 2011, OIB held a certificate of deposit free of liens
in the amount of $300 thousand as the legal reserve required for international
banking entities under Puerto Rico law. Such certificate of deposit cannot be
withdrawn by OIB without the OCFI’s prior written approval. 28


---



ORIENTAL FINANCIAL

GROUP INC. NOTES TO UNAUDITED

CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 NOTE
5-LOANS RECEIVABLE AND ALLOWANCE FOR LOAN AND LEASE LOSSES  Loans
Receivable Composition  The composition of the Group’s
loan portfolio at September 30, 2012 and December 31, 2011 was as follows:  September 30,
 
 December 31,2012
 
 2011(In thousands)Loans not
  covered under shared-loss agreements with FDIC:Loans
  secured by real estate:Residential
 $
 770,979
 
 $
 819,651Home
  equity loans and others
 
 768
 
 
 1,411Commercial
 
 239,654
 
 
 218,261Deferred
  loan fees, net
 
 (3,962)
 
 
 (4,300)1,007,439
 
 
 1,035,023Other
  loans:Commercial
 
 98,710
 
 
 83,312Personal
  consumer loans and credit lines
 
 43,631
 
 
 36,130Leasing
 
 33,772
 
 
 25,768Deferred
  loan costs (fees), net
 
 87
 
 
 (245)176,200
 
 
 144,965Loans
  receivable
 
 1,183,639
 
 
 1,179,988Allowance for loan and lease losses on non-covered loans
 
 (39,120)
 
 
 (37,010)Loans
  receivable, net
 
 1,144,519
 
 
 1,142,978Mortgage
  loans held-for-sale
 
 38,211
 
 
 26,939Total
  loans not covered under shared-loss agreements with FDIC, net
 
 1,182,730
 
 
 1,169,917Loans covered
  under shared-loss agreements with FDIC:Loans
  secured by 1-4 family residential properties
 
 138,138
 
 
 140,824Construction
  and development secured by 1-4 family residential properties
 
 7,933
 
 
 16,976Commercial
  and other construction
 
 301,383
 
 
 325,832Leasing
 
 12,140
 
 
 36,122Consumer
 
 10,859
 
 
 13,778Total
  loans covered under shared-loss agreements with FDIC
 
 470,453
 
 
 533,532Allowance for loan and lease losses on covered loans
 
 (56,865)
 
 
 (37,256)Total
  loans covered under shared-loss agreements with FDIC, net
 
 413,588
 
 
 496,276Total loans
  receivable, net
 $
 1,596,318
 
 $
 1,666,193
 29


---



ORIENTAL FINANCIAL

GROUP INC. NOTES TO UNAUDITED

CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
  Non-Covered
Loans  The Group’s credit activities
are mainly with customers located in Puerto Rico. The Group’s loan transactions
are encompassed within four portfolio segments: mortgage, commercial, consumer
and leasing.  The following table presents
the aging of the recorded investment in gross loans not covered under
shared-loss agreements with the FDIC, excluding mortgage loans held for sale,
as of September 30, 2012 and December 31, 2011 by class of loans:  September 30, 201230-59 Days
 
 60-89 Days
 
 90+ Days
 
 Total PastPast Due
 
 Past Due
 
 Past Due
 
 Due
 
 Current
 
 Total Loans(In thousands)MortgageTraditional
  (by
  origination year):Up to
  the year 2002
 $
 3,760
 
 $
 793
 
 $
 10,501
 
 $
 15,054
 
 $
 87,484
 
 $
 102,538Years
  2003 and 2004
 
 7,051
 
 
 2,398
 
 
 16,956
 
 
 26,405
 
 
 127,625
 
 
 154,030Year
  2005
 
 1,538
 
 
 681
 
 
 8,027
 
 
 10,246
 
 
 73,744
 
 
 83,990Year
  2006
 
 4,085
 
 
 1,251
 
 
 14,129
 
 
 19,465
 
 
 98,143
 
 
 117,608Years
  2007, 2008
  and
  2009
 
 1,655
 
 
 738
 
 
 9,414
 
 
 11,807
 
 
 115,050
 
 
 126,857Years
  2010, 2011
  and
  2012
 
 801
 
 
 398
 
 
 670
 
 
 1,869
 
 
 43,162
 
 
 45,03118,890
 
 
 6,259
 
 
 59,697
 
 
 84,846
 
 
 545,208
 
 
 630,054Non-traditional
 
 2,153
 
 
 460
 
 
 11,177
 
 
 13,790
 
 
 48,107
 
 
 61,897Loss
  mitigation program
 
 6,047
 
 
 1,475
 
 
 17,010
 
 
 24,532
 
 
 54,496
 
 
 79,02827,090
 
 
 8,194
 
 
 87,884
 
 
 123,168
 
 
 647,811
 
 
 770,979Home equity
  secured personal loans
 
 -
 
 
 -
 
 
 12
 
 
 12
 
 
 756
 
 
 76827,090
 
 
 8,194
 
 
 87,896
 
 
 123,180
 
 
 648,567
 
 
 771,747CommercialCommercial
  secured by real estate
 
 1,041
 
 
 369
 
 
 15,768
 
 
 17,178
 
 
 222,476
 
 
 239,654Other
  commercial and industrial
 
 240
 
 
 267
 
 
 2,425
 
 
 2,932
 
 
 95,778
 
 
 98,7101,281
 
 
 636
 
 
 18,193
 
 
 20,110
 
 
 318,254
 
 
 338,364Consumer
 
 396
 
 
 229
 
 
 254
 
 
 879
 
 
 42,752
 
 
 43,631Leasing
 
 578
 
 
 109
 
 
 11
 
 
 698
 
 
 33,074
 
 
 33,772Total loans not covered under shared-loss
  agreements with the FDIC
 $
 29,345
 
 $
 9,168
 
 $
 106,354
 
 $
 144,867
 
 $
 1,042,647
 
 $
 1,187,514
 30


---



ORIENTAL FINANCIAL

GROUP INC. NOTES TO UNAUDITED

CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
  December 31, 201130-59 Days
 
 60-89 Days
 
 90+ Days
 
 Total PastPast Due
 
 Past Due
 
 Past Due
 
 Due
 
 Current
 
 Total Loans(In thousands)MortgageTraditional
  (by
  origination year):Up to the
  year 2002
 $
 2,009
 
 $
 1,514
 
 $
 15,638
 
 $
 19,161
 
 $
 95,886
 
 $
 115,047Years
  2003 and 2004
 
 7,835
 
 
 3,140
 
 
 19,692
 
 
 30,667
 
 
 138,490
 
 
 169,157Year
  2005
 
 2,137
 
 
 2,573
 
 
 10,325
 
 
 15,035
 
 
 77,256
 
 
 92,291Year
  2006
 
 4,018
 
 
 1,358
 
 
 17,673
 
 
 23,049
 
 
 107,526
 
 
 130,575Years
  2007, 2008
  and
  2009
 
 2,562
 
 
 655
 
 
 8,996
 
 
 12,213
 
 
 124,594
 
 
 136,807Years
  2010, 2011
  and
  2012
 
 370
 
 
 194
 
 
 513
 
 
 1,077
 
 
 40,848
 
 
 41,92518,931
 
 
 9,434
 
 
 72,837
 
 
 101,202
 
 
 584,600
 
 
 685,802Non-traditional
 
 1,109
 
 
 819
 
 
 10,857
 
 
 12,785
 
 
 57,240
 
 
 70,025Loss
  mitigation program
 
 4,887
 
 
 2,113
 
 
 13,323
 
 
 20,323
 
 
 43,501
 
 
 63,82424,927
 
 
 12,366
 
 
 97,017
 
 
 134,310
 
 
 685,341
 
 
 819,651Home
  equity secured personal loans
 
 142
 
 
 -
 
 
 323
 
 
 465
 
 
 946
 
 
 1,41125,069
 
 
 12,366
 
 
 97,340
 
 
 134,775
 
 
 686,287
 
 
 821,062CommercialCommercial
  secured by real estate
 
 1,205
 
 
 1,697
 
 
 27,741
 
 
 30,643
 
 
 187,618
 
 
 218,261Other
  commercial and industrial
 
 1,536
 
 
 99
 
 
 616
 
 
 2,251
 
 
 81,061
 
 
 83,3122,741
 
 
 1,796
 
 
 28,357
 
 
 32,894
 
 
 268,679
 
 
 301,573Consumer
 
 557
 
 
 226
 
 
 334
 
 
 1,117
 
 
 35,013
 
 
 36,130Leasing
 
 339
 
 
 -
 
 
 102
 
 
 441
 
 
 25,327
 
 
 25,768Total loans not covered under shared-loss
  agreements with the FDIC
 $
 28,706
 
 $
 14,388
 
 $
 126,133
 
 $
 169,227
 
 $
 1,015,306
 
 $
 1,184,533
 31


---



ORIENTAL FINANCIAL

GROUP INC. NOTES TO UNAUDITED

CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
  The following table presents
the recorded investment in non-covered loans on non-accrual status by class of loans
as of September 30, 2012 and December 31, 2011:  September 30,
 
 December 31,2012
 
 2011(In thousands)MortgageTraditional
  (by
  origination year):Up to
  the year 2002
 $
 10,501
 
 $
 15,637Years
  2003 and 2004
 
 16,956
 
 
 19,693Year
  2005
 
 8,027
 
 
 10,325Year
  2006
 
 14,129
 
 
 17,673Years
  2007, 2008
  and
  2009
 
 9,414
 
 
 8,996Years
  2010, 2011
  and
  2012
 
 670
 
 
 51359,697
 
 
 72,837Non-traditional
 
 11,177
 
 
 10,857Loss
  mitigation program
 
 17,010
 
 
 13,32387,884
 
 
 97,017Home equity
  secured personal loans
 
 12
 
 
 32387,896
 
 
 97,340CommercialCommercial
  secured by real estate
 
 26,959
 
 
 34,789Other commercial
  and industrial
 
 2,690
 
 
 2,19929,649
 
 
 36,988Consumer
 
 276
 
 
 334Leasing
 
 11
 
 
 102Total non-accrual loans
 $
 117,832
 
 $
 134,764
  At September 30, 2012 and
December 31, 2011, loans whose terms have been extended and which are
classified as troubled-debt restructuring that are not included in non-accrual
loans amounted to $56.6 million and $41.3 million, respectively. 32


---



ORIENTAL FINANCIAL

GROUP INC. NOTES TO UNAUDITED

CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
  Credit
Quality Indicators  The Group categorizes
non-covered loans into risk categories based on relevant information about the
ability of borrowers to service their debt such as: economic conditions,
portfolio risk characteristics, prior loss experience, and results of periodic
credit reviews of individual loans.  Larger commercial loans that
exhibit potential or observed credit weaknesses are subject to individual
review and grading. Where appropriate, allowances are allocated to individual
loans based on management’s estimate of the borrower’s ability to repay the
loan given the availability of collateral, other sources of cash flow, and
legal options available to the Group.  Included in the review of
individual loans are those that are impaired. A loan is considered impaired
when, based on current information and events, it is probable that the Group
will be unable to collect the scheduled payments of principal or interest when
due according to the contractual terms of the loan agreement. Impaired loans
are measured based on the present value of expected future cash flows
discounted at the loan’s effective interest rate, or as a practical expedient,
at the observable market price of the loan or the fair value of the collateral,
if the loan is collateral dependent. Loans are individually evaluated for
impairment, except large groups of small balance homogeneous loans that are
collectively evaluated for impairment, and loans that are recorded at fair
value or at the lower of cost or fair value. The Group measures for impairment
all commercial loans over $250 thousand that are either over 90 days past due
or adversely classified, or when deemed necessary by management. The portfolios
of loans secured by residential properties, leases and consumer loans are
considered homogeneous, and are evaluated collectively for impairment.  The Group uses the following
definitions for risk ratings:  Special Mention:Loans classified as special mention have a potential weakness that
deserves management’s close attention. If left uncorrected, these potential
weaknesses may result in deterioration of the repayment prospects for the loan
or of the institution’s credit position at some future date.  Substandard:Loans classified as substandard are inadequately protected by the current net
worth and paying capacity of the obligor or of the collateral pledged, if any.
Loans so classified have a well defined weakness or weaknesses that jeopardize
the liquidation of the debt. They are characterized by the distinct possibility
that the institution will sustain some loss if the deficiencies are not
corrected.  Doubtful:Loans classified as doubtful have all the weaknesses inherent in those
classified as substandard, with the added characteristic that the weaknesses
make collection or liquidation in full, on the basis of currently existing
facts, conditions, and values, questionable and improbable.  Loss:Loans
classified loss are considered uncollectible and of such little value that
their continuance as bankable assets is not warranted. This classification does
not mean that the asset has absolutely no recovery or salvage value, but rather
that it is not practical or desirable to defer writing off this worthless loan
even though partial recovery may be affected in the future.  Loans not meeting the criteria
above that are analyzed individually as part of the above described process are
considered to be pass rated loans. 33


---



ORIENTAL FINANCIAL

GROUP INC. NOTES TO UNAUDITED

CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
  As of September
30, 2012 and December 31, 2011, and based on the most recent analysis
performed, the risk category of gross non-covered loans subject to risk rating,
by class of loans, is as follows:  September 30, 2012Risk RatingsIndividuallyBalance
 
 
 
 
 Special
 
 
 
 
 
 
 
 Measured forOutstanding
 
 Pass
 
 Mention
 
 Substandard
 
 Doubtful
 
 Impairment(In thousands)CommercialCommercial
  secured
  by real
  estate
 $
 239,654
 
 $
 182,898
 
 $
 23,390
 
 $
 1,957
 
 $
 99
 
 $
 31,310Other
  commercial
  and
  industrial
 
 98,710
 
 
 86,886
 
 
 6,823
 
 
 394
 
 
 -
 
 
 4,607Total
 $
 338,364
 
 $
 269,784
 
 $
 30,213
 
 $
 2,351
 
 $
 99
 
 $
 35,917
  December 31, 2011Risk RatingsIndividuallyBalance
 
 
 
 
 Special
 
 
 
 
 
 
 
 Measured forOutstanding
 
 Pass
 
 Mention
 
 Substandard
 
 Doubtful
 
 Impairment(In thousands)CommercialCommercial
  secured
  by real
  estate
 $
 218,261
 
 $
 148,894
 
 $
 25,185
 
 $
 1,957
 
 $
 13
 
 $
 42,212Other
  commercial
  and
  industrial
 
 83,312
 
 
 74,714
 
 
 3,517
 
 
 929
 
 
 -
 
 
 4,152Total
 $
 301,573
 
 $
 223,608
 
 $
 28,702
 
 $
 2,886
 
 $
 13
 
 $
 46,364
  34


---



ORIENTAL FINANCIAL

GROUP INC. NOTES TO UNAUDITED

CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 For residential and
consumer loan classes, the Group also evaluates credit quality based on the
delinquency status of the loan. As of September 30, 2012 and December 31, 2011,
and based on the most recent analysis performed, the risk category of gross
non-covered loans not subject to risk rating, by class of loans, is as follows:  September 30, 2012DelinquencyIndividuallyBalance
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 Measured for
 Outstanding
 
 0-29 days
 
 30-59 days
 
 60-89 days
 
 90-119 days
 
 120-364 days
 
 365+ days
 
 Impairment(In thousands)
 MortgageTraditional
  (by
  origination year):Up to
  the year 2002
 $
 102,538
 
 $
 87,483
 
 $
 3,760
 
 $
 793
 
 $
 846
 
 $
 2,580
 
 $
 7,076
 
 $
 -Years
  2003 and 2004
 
 154,030
 
 
 127,625
 
 
 7,051
 
 
 2,398
 
 
 596
 
 
 4,857
 
 
 11,503
 
 
 -Year
  2005
 
 83,990
 
 
 73,745
 
 
 1,538
 
 
 681
 
 
 204
 
 
 2,916
 
 
 4,906
 
 
 -Year
  2006
 
 117,608
 
 
 98,143
 
 
 4,085
 
 
 1,251
 
 
 641
 
 
 4,588
 
 
 8,900
 
 
 -Years
  2007, 2008
  and
  2009
 
 126,857
 
 
 115,050
 
 
 1,655
 
 
 738
 
 
 514
 
 
 3,582
 
 
 5,318
 
 
 -Years
  2010, 2011
  and
  2012
 
 45,031
 
 
 43,162
 
 
 801
 
 
 398
 
 
 -
 
 
 165
 
 
 505
 
 
 -630,054
 
 
 545,208
 
 
 18,890
 
 
 6,259
 
 
 2,801
 
 
 18,688
 
 
 38,208
 
 
 -Non-traditional
 
 61,897
 
 
 48,107
 
 
 2,153
 
 
 460
 
 
 289
 
 
 2,623
 
 
 8,265
 
 
 -Loss
  mitigation program
 
 79,028
 
 
 9,856
 
 
 344
 
 
 177
 
 
 54
 
 
 912
 
 
 2,815
 
 
 64,870770,979
 
 
 603,171
 
 
 21,387
 
 
 6,896
 
 
 3,144
 
 
 22,223
 
 
 49,288
 
 
 64,870Home equity
  secured
  personal
  loans
 
 768
 
 
 756
 
 
 -
 
 
 -
 
 
 -
 
 
 -
 
 
 12
 
 
 -771,747
 
 
 603,927
 
 
 21,387
 
 
 6,896
 
 
 3,144
 
 
 22,223
 
 
 49,300
 
 
 64,870Consumer
 
 43,631
 
 
 42,752
 
 
 396
 
 
 229
 
 
 100
 
 
 151
 
 
 3
 
 
 -Leasing
 
 33,772
 
 
 33,074
 
 
 578
 
 
 109
 
 
 4
 
 
 1
 
 
 6
 
 
 -Total
 $
 849,150
 
 $
 679,753
 
 $
 22,361
 
 $
 7,234
 
 $
 3,248
 
 $
 22,375
 
 $
 49,309
 
 $
 64,870
 35


---



ORIENTAL FINANCIAL

GROUP INC. NOTES TO UNAUDITED

CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
  December 31, 2011DelinquencyIndividuallyBalance
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 Measured for
 Outstanding
 
 0-29 days
 
 30-59 days
 
 60-89 days
 
 90-119 days
 
 120-364 days
 
 365+ days
 
 Impairment(In thousands)
 MortgageTraditional
  (by
  origination year)Up to
  the year 2002
 $
 115,047
 
 $
 95,886
 
 $
 2,009
 
 $
 1,514
 
 $
 406
 
 $
 4,972
 
 $
 10,260
 
 $
 -Years
  2003 and 2004
 
 169,157
 
 
 138,490
 
 
 7,835
 
 
 3,140
 
 
 939
 
 
 7,318
 
 
 11,435
 
 
 -Year
  2005
 
 92,291
 
 
 77,255
 
 
 2,137
 
 
 2,573
 
 
 945
 
 
 3,117
 
 
 6,264
 
 
 -Year
  2006
 
 130,575
 
 
 107,526
 
 
 4,018
 
 
 1,358
 
 
 446
 
 
 7,416
 
 
 9,811
 
 
 -Years
  2007, 2008
  and
  2009
 
 136,807
 
 
 124,595
 
 
 2,562
 
 
 655
 
 
 1,039
 
 
 3,224
 
 
 4,732
 
 
 -Years
  2010 and 2011
 
 41,925
 
 
 40,848
 
 
 370
 
 
 194
 
 
 -
 
 
 410
 
 
 103
 
 
 -685,802
 
 
 584,600
 
 
 18,931
 
 
 9,434
 
 
 3,775
 
 
 26,457
 
 
 42,605
 
 
 -Non-traditional
 
 70,025
 
 
 57,240
 
 
 1,109
 
 
 819
 
 
 849
 
 
 2,725
 
 
 7,283
 
 
 -Loss
  mitigation program
 
 63,824
 
 
 7,928
 
 
 601
 
 
 757
 
 
 -
 
 
 1,002
 
 
 2,054
 
 
 51,482819,651
 
 
 649,768
 
 
 20,641
 
 
 11,010
 
 
 4,624
 
 
 30,184
 
 
 51,942
 
 
 51,482Home equity
  secured
  personal
  loans
 
 1,411
 
 
 946
 
 
 142
 
 
 -
 
 
 -
 
 
 -
 
 
 323
 
 
 -821,062
 
 
 650,714
 
 
 20,783
 
 
 11,010
 
 
 4,624
 
 
 30,184
 
 
 52,265
 
 
 51,482Consumer
 
 36,130
 
 
 35,013
 
 
 557
 
 
 226
 
 
 202
 
 
 132
 
 
 -
 
 
 -Leasing
 
 25,768
 
 
 25,327
 
 
 339
 
 
 -
 
 
 21
 
 
 81
 
 
 -
 
 
 -Total
 $
 882,960
 
 $
 711,054
 
 $
 21,679
 
 $
 11,236
 
 $
 4,847
 
 $
 30,397
 
 $
 52,265
 
 $
 51,482
 36


---



ORIENTAL FINANCIAL

GROUP INC. NOTES TO UNAUDITED

CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
  The following table presents
the troubled-debt restructurings modified during the nine-month periods ended
September 30, 2012 and 2011:  Nine-Month Period Ended September 30,
  2012Number of contracts
 
 Pre Modification Outstanding Recorded
  Investment
 
 Pre-Modification Weighted Average Rate
 
 Pre-Modification Weighted Average Term
  (in Months)
 
 Post-Modification Outstanding Recorded
  Investment
 
 Post-Modification Weighted Average Rate
 
 Post-Modification Weighted Average Term
  (in Months)(Dollars in thousands)Mortgage loans
 155
 
 $
 23,701
 
 6.44%
 
 310
 
 $
 25,385
 
 4.86%
 
 400Commercial loans
 7
 
 
 6,981
 
 6.13%
 
 46
 
 
 6,550
 
 6.17%
 
 46Nine-Month Period Ended September 30,
  2011Number of contracts
 
 Pre Modification Outstanding Recorded
  Investment
 
 Pre-Modification Weighted Average Rate
 
 Pre-Modification Weighted Average Term
  (in Months)
 
 Post-Modification Outstanding Recorded
  Investment
 
 Post-Modification Weighted Average Rate
 
 Post-Modification Weighted Average Term
  (in Months)(Dollars in thousands)Mortgage loans
 101
 
 $
 14,023
 
 6.88%
 
 329
 
 $
 15,112
 
 5.87%
 
 379Commercial loans
 10
 
 
 13,117
 
 3.61%
 
 77
 
 
 13,046
 
 3.36%
 
 75
  The following table presents troubled-debt
restructurings modified and for which there was a payment default during the
twelve-month periods ended September 30, 2012 and 2011:  Twelve-Month Period Ended September 30,2012
 
 2011Number of contracts
 
 Recorded Investment
 
 Number of contracts
 
 Recorded Investment(Dollars in thousands)Mortgage loans
 37
 
 $
 5,029
 
 28
 
 $
 3,738Commercial
 -
 
 $
 -
 
 4
 
 $
 9,254
 37


---



ORIENTAL FINANCIAL

GROUP INC. NOTES TO UNAUDITED

CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
  Allowance
for Loan and Lease Losses  Non-Covered
Loans  The Group maintains an
allowance for loan and lease losses at a level that management considers
adequate to provide for probable losses based upon an evaluation of known and
inherent risks. The Group’s allowance for loan and lease losses policy provides
for a detailed quarterly analysis of probable losses. The analysis includes a
review of historical loan loss experience, value of underlying collateral,
current economic conditions, financial condition of borrowers and other
pertinent factors. While management uses available information in estimating
probable loan losses, future additions to the allowance may be required based
on factors beyond the Group’s control.  The following table presents
the changes and the balance in the allowance for loan and lease losses for the
quarters and nine-month periods ended September 30, 2012 and 2011:  Quarter Ended September 30, 2012Mortgage
 
 Commercial
 
 Consumer
 
 Leasing
 
 Unallocated
 
 Total(In thousands)Allowance for
  loan and lease losses for
  non-covered loans:Balance at
  beginning of period
 $
 19,788
 
 $
 15,978
 
 $
 998
 
 $
 197
 
 $
 441
 
 $
 37,402Charge-offs
 
 (1,752)
 
 
 (65)
 
 
 (198)
 
 
 (75)
 
 
 -
 
 
 (2,090)Recoveries
 
 131
 
 
 28
 
 
 46
 
 
 3
 
 
 -
 
 
 208Provision for (recapture of) non-covered
  loan
  and lease losses
 
 2,886
 
 
 (502)
 
 
 328
 
 
 119
 
 
 769
 
 
 3,600Balance at end of period
 $
 21,053
 
 $
 15,439
 
 $
 1,174
 
 $
 244
 
 $
 1,210
 
 $
 39,120
  Quarter Ended September 30, 2011Mortgage
 
 Commercial
 
 Consumer
 
 Leasing
 
 Unallocated
 
 Total(In thousands)Allowance for
  loan and lease losses for
  non-covered loans:Balance at
  beginning of period
 $
 17,770
 
 $
 13,800
 
 $
 1,520
 
 $
 868
 
 $
 271
 
 $
 34,229Charge-offs
 
 (1,391)
 
 
 (440)
 
 
 (368)
 
 
 (82)
 
 
 -
 
 
 (2,281)Recoveries
 
 -
 
 
 56
 
 
 63
 
 
 2
 
 
 -
 
 
 121Provision for (recapture of) non-covered
  loan
  and lease losses
 
 4,851
 
 
 (2,297)
 
 
 486
 
 
 659
 
 
 101
 
 
 3,800Balance at end of period
 $
 21,230
 
 $
 11,119
 
 $
 1,701
 
 $
 1,447
 
 $
 372
 
 $
 35,869
  Nine-Month Period Ended September 30,
  2012Mortgage
 
 Commercial
 
 Consumer
 
 Leasing
 
 Unallocated
 
 Total(In thousands)Allowance for
  loan and lease losses for
  non-covered loans:Balance at
  beginning of period
 $
 21,652
 
 $
 12,548
 
 $
 1,423
 
 $
 845
 
 $
 542
 
 $
 37,010Charge-offs
 
 (4,621)
 
 
 (3,423)
 
 
 (563)
 
 
 (104)
 
 
 -
 
 
 (8,711)Recoveries
 
 131
 
 
 129
 
 
 153
 
 
 8
 
 
 -
 
 
 421Provision for (recapture of) non-covered
  loan
  and lease losses
 
 3,891
 
 
 6,185
 
 
 161
 
 
 (505)
 
 
 668
 
 
 10,400Balance at end of period
 $
 21,053
 
 $
 15,439
 
 $
 1,174
 
 $
 244
 
 $
 1,210
 
 $
 39,120
 38


---



ORIENTAL FINANCIAL

GROUP INC. NOTES TO UNAUDITED

CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
  Nine-Month Period Ended September 30,
  2011Mortgage
 
 Commercial
 
 Consumer
 
 Leasing
 
 Unallocated
 
 Total(In thousands)Allowance for
  loan and lease losses for
  non-covered loans:Balance at
  beginning of period
 $
 16,179
 
 $
 11,153
 
 $
 2,286
 
 $
 860
 
 $
 952
 
 $
 31,430Charge-offs
 
 (4,480)
 
 
 (1,478)
 
 
 (1,160)
 
 
 (174)
 
 
 -
 
 
 (7,292)Recoveries
 
 45
 
 
 108
 
 
 175
 
 
 3
 
 
 -
 
 
 331Provision for (recapture of) non-covered
  loan
  and lease losses
 
 9,486
 
 
 1,336
 
 
 400
 
 
 758
 
 
 (580)
 
 
 11,400Balance at end of period
 $
 21,230
 
 $
 11,119
 
 $
 1,701
 
 $
 1,447
 
 $
 372
 
 $
 35,869
  The following table presents the
recorded investment in gross loans by portfolio segment and based on the
impairment method as of September 30, 2012 and 2011:  September 30, 2012Mortgage
 
 Commercial
 
 Consumer
 
 Leasing
 
 Unallocated
 
 Total(In thousands)Allowance for
  loan and lease losses for
  non-covered loans:Ending
  allowance balance attributable to loans:Individually evaluated for impairment
 $
 4,833
 
 $
 1,317
 
 $
 -
 
 $
 -
 
 $
 -
 
 $
 6,150Collectively evaluated for impairment
 
 16,220
 
 
 14,122
 
 
 1,174
 
 
 244
 
 
 1,210
 
 
 32,970Total ending allowance balance
 $
 21,053
 
 $
 15,439
 
 $
 1,174
 
 $
 244
 
 $
 1,210
 
 $
 39,120Loans:Individually evaluated for impairment
 $
 64,870
 
 $
 35,917
 
 $
 -
 
 $
 -
 
 $
 -
 
 $
 100,787Collectively evaluated for impairment
 
 706,877
 
 
 302,447
 
 
 43,631
 
 
 33,772
 
 
 -
 
 
 1,086,727Total ending non-covered loans balance
 $
 771,747
 
 $
 338,364
 
 $
 43,631
 
 $
 33,772
 
 $
 -
 
 $
 1,187,514
  September 30, 2011Mortgage
 
 Commercial
 
 Consumer
 
 Leasing
 
 Unallocated
 
 Total(In thousands)Allowance for
  loan and lease losses for
  non-covered loans:Ending
  allowance balance attributable to loans:Individually evaluated for impairment
 $
 2,973
 
 $
 1,829
 
 $
 -
 
 $
 -
 
 $
 -
 
 $
 4,802Collectively evaluated for impairment
 
 18,257
 
 
 9,290
 
 
 1,701
 
 
 1,447
 
 
 372
 
 
 31,067Total ending allowance balance
 $
 21,230
 
 $
 11,119
 
 $
 1,701
 
 $
 1,447
 
 $
 372
 
 $
 35,869Loans:Individually evaluated for impairment
 $
 46,513
 
 $
 35,073
 
 $
 -
 
 $
 -
 
 $
 -
 
 $
 81,586Collectively evaluated for impairment
 
 790,651
 
 
 235,560
 
 
 37,241
 
 
 21,283
 
 
 -
 
 
 1,084,735Total ending non-covered loans balance
 $
 837,164
 
 $
 270,633
 
 $
 37,241
 
 $
 21,283
 
 $
 -
 
 $
 1,166,321
  The Group evaluates all loans,
some individually and others as homogeneous groups, for purposes of determining
impairment. The total investment in impaired commercial loans was $35.9 million
and $46.4 million at September 30, 2012 and December 31, 2011, respectively.  The
impaired commercial loans were measured based on the fair value of collateral
or the present value of cash flows method, including those identified as
troubled-debt restructurings.  The valuation allowance for impaired commercial
loans amounted to approximately $1.3 million and $3.5 million at September 30,
2012 and December 31, 2011, respectively. The total investment in impaired
mortgage loans was $64.9 million and $51.5 million at September 30, 2012 and
December 31, 2011, respectively. Impairment on mortgage loans assessed as
troubled-debt restructurings was measured using the present value of cash
flows.  The valuation allowance for impaired mortgage loans amounted to
approximately $4.8 million and $3.4 million at September 30, 2012 and December
31, 2011, respectively. 39


---



ORIENTAL FINANCIAL

GROUP INC. NOTES TO UNAUDITED

CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
  The Group’s recorded
investment in commercial and mortgage loans that were individually evaluated
for impairment, excluding FDIC covered loans, and the related allowance for
loan and lease losses at September 30, 2012 and December 31, 2011 are as
follows:  September 30, 2012Unpaid
 
 Recorded
 
 SpecificPrincipal
 
 Investment
 
 Allowance
 
 Coverage(In thousands)Impaired loans
  with specific allowanceCommercial
 $
 15,323
 
 $
 12,260
 
 $
 1,317
 
 11%Residential troubled-debt restructuring
 
 66,556
 
 
 64,870
 
 
 4,833
 
 7%Impaired loans
  with no specific allowanceCommercial
 
 26,709
 
 
 23,657
 
 
 N/A
 
 N/ATotal investment in impaired loans
 $
 108,588
 
 $
 100,787
 
 $
 6,150
 
 6%
  December 31, 2011Unpaid
 
 Recorded
 
 SpecificPrincipal
 
 Investment
 
 Allowance
 
 Coverage(In thousands)Impaired loans
  with specific allowanceCommercial
 $
 25,974
 
 $
 23,368
 
 $
 3,518
 
 15%Residential troubled-debt restructuring
 
 52,480
 
 
 51,482
 
 
 3,355
 
 7%Impaired loans
  with no specific allowanceCommercial
 
 23,780
 
 
 22,996
 
 
 N/A
 
 N/ATotal
  investment in impaired loans
 $
 102,234
 
 $
 97,846
 
 $
 6,873
 
 7%
  The following table presents
the interest recognized in commercial and mortgage loans that were individually
evaluated for impairment, excluding FDIC covered loans for the quarters and
nine-month periods ended September 30, 2012 and 2011:  Quarter Ended September 30,2012
 
 2011Interest Income Recognized
 
 Average Recorded Investment
 
 Interest Income Recognized
 
 Average Recorded Investment(In thousands)Impaired loans
  with specific allowanceCommercial
 $
 40
 
 $
 9,027
 
 $
 277
 
 $
 17,494Residential troubled-debt restructuring
 
 510
 
 
 65,932
 
 
 336
 
 
 47,350Impaired loans
  with no specific allowanceCommercial
 
 83
 
 
 28,475
 
 
 196
 
 
 18,241Total interest income from impaired loans
 $
 633
 
 $
 103,434
 
 $
 809
 
 $
 83,085
  Nine-Month Period Ended September 30,2012
 
 2011Interest Income Recognized
 
 Average Recorded Investment
 
 Interest Income Recognized
 
 Average Recorded InvestmentImpaired loans
  with specific allowanceCommercial
 $
 163
 
 $
 16,686
 
 $
 810
 
 $
 16,257Residential troubled-debt restructuring
 
 1,344
 
 
 61,622
 
 
 777
 
 
 39,912Impaired loans
  with no specific allowanceCommercial
 
 261
 
 
 24,068
 
 
 555
 
 
 15,295Total interest income from impaired loans
 $
 1,768
 
 $
 102,376
 
 $
 2,142
 
 $
 71,464
 40


---



ORIENTAL FINANCIAL

GROUP INC. NOTES TO UNAUDITED

CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
  Covered
Loans under ASC 310-30  The Group’s acquired loans
under the FDIC-assisted acquisition of Eurobank were initially recorded at fair
value, and no separate valuation allowance was recorded at the date of
acquisition. The Group reviewed each loan at acquisition to determine if it
should be accounted for under ASC 310-30 and, if so, determine whether each
loan is to be accounted for individually or whether loans will be aggregated
into pools of loans based oncommon risk characteristics.
During the evaluation of whether a loan was considered impaired under ASC 310-30,
the Group considered a number of factors, including the delinquency status of
the loan, payment options and other loan features (i.e., reduced documentation,
interest only, or negative amortization features), the geographic location of
the borrower or collateral and the risk ratings assigned to the loans. In
instances where it was determined that for some of the loans in the acquired
loan pool that it is probable that all the contractual payments would be
received (therefore the loans meet the first criteria of ASC 310-30-15-2 but
not the second), the Group applied the discount accretion guidance as ASC
310-30, instead of the standard loan discount accretion guidance of ASC 310-20
to those loans (the loans under SOP 03-3). As documented in a letter from the
AICPA Depository Institution Expert Panel to the Office of Chief Accountant of
the SEC, on December 5, 2009, the SEC addressed the recognition of discount
accretion for loans acquired under these circumstances. As referred to in the
AICPA’s letter, when loans are acquired with at a discount attributable in part
to credit (e.g., at a fair value lower than the contractual amounts due) and
such loans are not within the scope of ASC 310-30, the AICPA believed that the
SEC would not object to an accounting policy based on contractual cash flows or
an accounting policy based on expected cash flows, meaning that an entity could
either apply the accretion guidance of ASC 310-20 or that of the ASC 310-30 to
such loans. Consistent with the AICPA’s views, the Group applied the guidance
of ASC 310-30 to all loans acquired in the transaction including loans that do
not meet the scope of ASC 310-30. Based on the criteria, the Group considered
the entire portfolio acquired in the FDIC-assisted acquisition, except for
credit cards, to be impaired and accounted for under ASC 310-30. Credit cards
were accounted under ASC 310-20.  To the extent credit
deterioration occurs in covered loans after the date of acquisition, the Group
will record an allowance for loan and lease losses and an increase in the FDIC
shared-loss indemnification asset for the expected reimbursement from the FDIC
under the shared-loss agreements. The covered loans carrying amounts included
in the balance sheet at September 30, 2012 and December 31, 2011 are as
follows:  September 30, 2012
 
 December 31, 2011(In thousands)Contractual
  required payments receivable
 $
 918,289
 
 $
 1,134,524Less:
  Non-accretable discount
 
 264,003
 
 
 412,170Cash expected to
  be collected
 
 654,286
 
 
 722,354Less: Accretable
  yield
 
 183,833
 
 
 188,822Carrying amount,
  gross
 
 470,453
 
 
 533,532Less: Allowance
  for covered loan and lease losses
 
 56,865
 
 
 37,256Carrying amount,
  net
 $
 413,588
 
 $
 496,276
 41


---



ORIENTAL FINANCIAL

GROUP INC. NOTES TO UNAUDITED

CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
  The
following tables describe the accretable yield and non-accretable discount
activity for the quarters and nine-month periods ended September 30, 2012 and
2011:  Quarter Ended September 30,
 
 Nine-Month Period Ended September 30,2012
 
 2011
 
 2012
 
 2011(In thousands)
 
 (In thousands)Accretable
  Yield ActivityBalance at
  beginning of period
 $
 177,248
 
 $
 115,722
 
 $
 188,822
 
 $
 148,556Accretion
 
 (22,283)
 
 
 (18,222)
 
 
 (64,167)
 
 
 (45,507)Transfer
  from non-accretable discount
 
 28,868
 
 
 70,906
 
 
 59,178
 
 
 65,357Balance at
  end of period
 $
 183,833
 
 $
 168,406
 
 $
 183,833
 
 $
 168,406Quarter Ended September 30,
 
 Nine-Month Period Ended  September 30,2012
 
 2011
 
 2012
 
 2011(In thousands)
 
 (In thousands)Non-Accretable
  Discount ActivityBalance at
  beginning of period
 $
 314,404
 
 $
 557,938
 
 $
 412,170
 
 $
 603,296Principal
  losses
 
 (21,533)
 
 
 (24,930)
 
 
 (88,989)
 
 
 (75,837)Transfer to
  accretable yield
 
 (28,868)
 
 
 (70,906)
 
 
 (59,178)
 
 
 (65,357)Balance at
  end of period
 $
 264,003
 
 $
 462,102
 
 $
 264,003
 
 $
 462,102
  For covered loans, as part of
the evaluation of actual versus expected cash flows, the Group assesses on a
quarterly basis the credit quality of these loans based on delinquency,
severity factors and risk ratings, among other assumptions. Migration and
credit quality trends are assessed at the pool level, by comparing information
from the latest evaluation period through the end of the reporting period. During
the first quarter of 2012, the Group reviewed certain pools composed of commercial
real estate, construction and development loans, which have been in non-accrual
status since acquisition, whose cash flows were lower than the expectations
exceeding the established thresholds. The Group reviewed the timing of the
collections expected through workouts and/or the timing assessed for the
particular workout loan to foreclose for the most significant loans comprising
the particular pools selected for review. The credit quality assumptions for
these pools were updated to reflect increases in default rates, severities and
extension of recovery lags resulting in an increase in the provision for
covered loan and lease losses. For other pools composed of performing
commercial real estate loans and leases, the Group noted that the actual cash flows
were better than expected. Thus, for these pools a reversal of previously
recorded allowance and a re-yielding of the leasing pools were recorded. As a
result of such assessment, during the first quarter of 2012, the Group recorded
a net increase in the allowance for covered loans of $19.2 million which was
partially offset by an increase in the FDIC shared-loss indemnification asset
of $12.0 million. Also, as part of our quarterly assessment of the actual
versus expected cash flows for covered loans, during the second quarter of
2012, the Group reviewed particular loan performances and expected workout
developments to derive more assumptions on certain pools secured by real estate
and pools of commercial and industrial loans.  Certain pools of loans secured
by real estate and a pool of loans secured by farmland underperformed in their
actual cash flows, and an impairment of $2.2 million was recorded during that
quarter.  Such amount was partially offset by an increase in the FDIC
shared-loss indemnification asset of $724 thousand.  For the quarter ended September 30, 2012, the assessment
of actual versus expected cash flows resulted in a net provision of $221
thousand as certain pools of real estate backed loans and of commercial and
industrial loans underperformed.  The net provision also included the reversal
of a previously recorded allowance in certain commercial real estate and construction
pools whose loans the Group has managed to workout with better outcomes than forecasted.  The loss share portion of the
reversal of allowance during the quarter ended September 30, 2012 was
proportionally higher than the allowance reversal recorded on the impaired
loans. This resulted from the fact that there were some pools in which
additional allowance was recognized but no adjustment was done to the FDIC
shared-loss indemnification asset as these losses were not covered by a loss
share agreement. This resulted in the reduction of the FDIC shared-loss indemnification
asset of $1.9 million that is part of the aforementioned net provision for
covered loans of $221 thousand. 42


---



ORIENTAL FINANCIAL

GROUP INC. NOTES TO UNAUDITED

CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
  The changes in the allowance
for loan and lease losses on covered loans for the quarters and nine-month
periods ended September 30, 2012 and 2011 were as follows:  Quarter Ended September 30,
 
 Nine-Month Period Ended September 30,2012
 
 2011
 
 2012
 
 2011(In thousands)
 
 (In thousands)Balance at
  beginning of the period
 $
 58,628
 
 $
 53,036
 
 $
 37,256
 
 $
 49,286Provision
  for (recapture of) covered loan and lease losses, net
 
 221
 
 
 (1,936)
 
 
 8,845
 
 
 (1,387)FDIC
  shared-loss portion of provision for (recapture of)covered
  loan and lease losses, net
 
 (1,984)
 
 
 (13,860)
 
 
 10,764
 
 
 (10,659)Balance at
  end of the period
 $
 56,865
 
 $
 37,240
 
 $
 56,865
 
 $
 37,240
  The
Group’s recorded investment in covered loan pools that have recorded impairments
and their related allowance for covered loan and lease losses as of September
30, 2012 and December 31, 2011 are as follows:  September 30, 2012Unpaid
 
 Recorded
 
 SpecificPrincipal
 
 Investment
 
 Allowance
 
 Coverage(In thousands)Impaired covered
  loan pools with specific allowanceLoans
  secured by 1-4 family residential properties
 $
 35,689
 
 $
 24,025
 
 $
 4,700
 
 20%Construction and development secured by 1-4 family
  residential properties
 
 75,641
 
 
 7,668
 
 
 7,668
 
 100%Commercial and other construction
 
 187,108
 
 
 84,906
 
 
 43,819
 
 52%Consumer
 
 16,490
 
 
 10,859
 
 
 678
 
 6%Total investment in impaired covered loan pools
 $
 314,928
 
 $
 127,458
 
 $
 56,865
 
 45%
  December 31, 2011Unpaid
 
 Recorded
 
 SpecificPrincipal
 
 Investment
 
 Allowance
 
 Coverage(In thousands)Impaired covered
  loan pools with specific allowanceLoans
  secured by 1-4 family residential properties
 $
 55,901
 
 $
 32,130
 
 $
 1,657
 
 5%Construction and development secured by 1-4 family
  residential properties
 
 80,821
 
 
 16,976
 
 
 2,042
 
 12%Commercial and other construction
 
 357,596
 
 
 146,924
 
 
 31,665
 
 22%Consumer
 
 19,619
 
 
 13,778
 
 
 1,892
 
 14%Total investment in impaired covered loan pools
 $
 513,937
 
 $
 209,808
 
 $
 37,256
 
 18%
 43


---



ORIENTAL FINANCIAL

GROUP INC. NOTES TO UNAUDITED

CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 NOTE
6-SERVICING ASSETS  The Group periodically sells
or securitizes mortgage loans while retaining the obligation to perform the
servicing of such loans. In addition, the Group may purchase or assume the
right to service mortgage loans originated by others. Whenever the Group
undertakes an obligation to service a loan, management assesses whether a
servicing asset and/or liability should be recognized. A servicing asset is
recognized whenever the compensation for servicing is expected to more than
adequately compensate the Group for servicing the loans and leases. Likewise, a
servicing liability would be recognized in the event that servicing fees to be
received are not expected to adequately compensate the Group for its expected
cost.  All separately recognized
servicing assets are recognized at fair value using the fair value measurement
method. Under the fair value measurement method, the Group measures servicing
rights at fair value at each reporting date, reports changes in fair value of
servicing assets in earnings in the period in which the changes occur, and
includes these changes, if any, with mortgage banking activities in the
consolidated statements of operations. The fair value of servicing rights is
subject to fluctuations as a result of changes in estimated and actual prepayment
speeds and default rates and losses.  The fair value of servicing
rights is estimated by using a cash flow valuation model which calculates the
present value of estimated future net servicing cash flows, taking into
consideration actual and expected loan prepayment rates, discount rates,
servicing costs, and other economic factors, which are determined based on
current market conditions.  At September 30, 2012,
servicing assets are composed of $10.6 million ($10.2 million — December 31, 2011) related
to residential mortgage loans and $80 thousand ($221 thousand — December 31, 2011) of
leasing servicing assets acquired in the FDIC-assisted acquisition of Eurobank.  The following table presents
the changes in servicing rights measured using the fair value method for the quarters
and nine-month periods ended September 30, 2012 and 2011:  Quarter Ended September 30,
 
 Nine-Month Period Ended September 30,2012
 
 2011
 
 2012
 
 2011(In thousands)
 
 (In thousands)Fair value at
  beginning of period
 $
 10,776
 
 $
 9,840
 
 $
 10,454
 
 $
 9,695Servicing
  from mortgage securitizations or asset transfers
 
 487
 
 
 615
 
 
 1,407
 
 
 1,828Changes due
  to payments on loans
 
 (307)
 
 
 (225)
 
 
 (783)
 
 
 (705)Changes in
  fair value due to changes in valuation model
  inputs
  or assumptions
 
 (314)
 
 
 (216)
 
 
 (436)
 
 
 (804)Fair value at
  end of period
 $
 10,642
 
 $
 10,014
 
 $
 10,642
 
 $
 10,014
  The following table presents
key economic assumption ranges used in measuring the mortgage-related servicing
asset fair value for the quarters and nine-month periods ended September 30,
2012 and 2011:  Quarter Ended September 30,
 
 Nine-Month Period Ended September 30,2012
 
 2011
 
 2012
 
 2011Constant
  prepayment rate
 9.43% - 15.80%
 
 10.56% - 39.25%
 
 9.43% - 33.05%
 
 7.87% - 39.25%Discount
  rate
 10.50% - 12.50%
 
 11.00% - 14.00%
 
 10.50% - 13.50%
 
 11.00% - 14.00%
 44


---



ORIENTAL FINANCIAL

GROUP INC. NOTES TO UNAUDITED

CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
  The following table presents
key economic assumption ranges used in measuring the leasing-related servicing asset
fair value for the quarters and nine-month periods ended September 30, 2012 and
2011:  Quarter Ended September 30,
 
 Nine-Month Period Ended September 30,2012
 
 2011
 
 2012
 
 2011Discount
  rate
 13.27% - 15.14%
 
 14.33% - 15.07%
 
 13.19% - 15.52%
 
 13.22% - 17.38%
  The sensitivity of the current
fair value of servicing assets to immediate 10 percent and 20 percent adverse changes
in the above key assumptions were as follows:  September 30, 2012(In thousands)Mortgage
  related servicing assetCarrying
  value of mortgage servicing asset
 $
 10,562Constant
  prepayment rateDecrease in
  fair value due to 10% adverse change
 $
 (452)Decrease in
  fair value due to 20% adverse change
 $
 (874)Discount
  rateDecrease in
  fair value due to 10% adverse change
 $
 (441)Decrease in
  fair value due to 20% adverse change
 $
 (849)Leasing
  servicing assetCarrying
  value of leasing servicing asset
 $
 80Discount
  rateDecrease in
  fair value due to 10% adverse change
 $
 (1)Decrease in
  fair value due to 20% adverse change
 $
 (2)
 45


---



ORIENTAL FINANCIAL

GROUP INC. NOTES TO UNAUDITED

CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
  These sensitivities are
hypothetical and should be used with caution. As the figures indicate, changes
in fair value based on a 10 percent variation in assumptions generally cannot
be extrapolated because the relationship of the change in assumption to the
change in fair value may not be linear. Also, in this table, the effect of a
variation in a particular assumption on the fair value of the retained interest
is calculated without changing any other assumption.  In reality, changes in one
factor may result in changes in another (for example, increases in market
interest rates may result in lower prepayments), which may magnify or offset
the sensitivities. Mortgage banking activities, a component of total banking
and wealth management revenues in the unaudited consolidated statements of
operations, include the changes from period to period in the fair value of the
mortgage loan servicing rights, which may result from changes in the valuation model
inputs or assumptions (principally reflecting changes in discount rates and
prepayment speed assumptions) and other changes, including changes due to
collection/realization of expected cash flows.  Servicing fee income is based
on a contractual percentage of the outstanding principal and is recorded as
income when earned. Servicing fees on mortgage loans totaled $920 thousand and
$806 thousand for the quarters ended September 30, 2012 and 2011, respectively.
These fees totaled $2.7 million and $2.3 million for the nine-month periods
ended September 30, 2012 and 2011, respectively. There were no late fees and
ancillary fees recorded in such periods because these fees belong to the third
party with which the Group is engaged in a subservicing agreement. Servicing
fees on leases amounted to $53 thousand and $150 thousand for the quarters
ended September 30, 2012 and 2011, respectively. These fees totaled $200
thousand and $549 thousand for the nine-month periods ended September 30, 2012
and 2011, respectively.  NOTE
7—PREMISES AND EQUIPMENT  Premises
and equipment at September 30, 2012 and December 31, 2011 are stated at cost
less accumulated depreciation and amortization as follows:  Useful Life
 
 September 30,
 
 December 31,(Years)
 
 2012
 
 2011(In thousands)Land
 —
 
 $
 2,254
 
 $
 2,254Buildings and
  improvements
 40
 
 
 6,282
 
 
 5,890Leasehold
  improvements
 5 — 10
 
 
 18,289
 
 
 18,182Furniture and
  fixtures
 3 — 7
 
 
 9,219
 
 
 9,718Information
  technology and other
 3 — 7
 
 
 19,533
 
 
 20,00855,577
 
 
 56,052Less:
  accumulated depreciation and amortization
 
 
 
 (36,309)
 
 
 (34,532)$
 19,268
 
 $
 21,520
  Depreciation and amortization
of premises and equipment for the quarters ended September 30, 2012 and 2011
totaled $1.1 million and $1.4 million, respectively. For the nine-month periods
ended September 30, 2012 and 2011, these expenses amounted to $3.4 million and
$4.1 million, respectively. These are included in the unaudited consolidated
statements of operations as part of occupancy and equipment expenses. 46


---



ORIENTAL FINANCIAL

GROUP INC. NOTES TO UNAUDITED

CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 NOTE 8—DERIVATIVE ACTIVITIES  During
the nine-month period ended September 30, 2012, losses of $1.4 million were
recognized and reflected as “Derivative Activities” in the unaudited
consolidated statements of operations. These were mainly related to the
amortization of premiums paid on options purchased in July 2012 to enter into
interest rate swaps, not designated as cash flow hedges, with an aggregate
notional amount of $200.0 million. The amortization recorded during the quarter
ended September 30, 2012, amounted to $1.5 million. During the nine-month period ended September
30, 2011, losses of $8.4 million were recognized and reflected as “Derivative
Activities” in the unaudited consolidated statements of operations. These
losses were mainly due to realized losses of $4.3 million from terminations of
forward-settlement swaps with a notional amount of $1.25 billion, and to
realized losses of $2.2 million from terminations of options to enter into
interest rate swaps with a notional amount of $250 million.  The following table details
“Derivative Assets” and “Derivative Liabilities” as reflected in the unaudited consolidated
statements of financial condition at September 30, 2012 and December 31, 2011:  September 30,
 
 December 31,2012
 
 2011(In thousands)Derivative
  assets:Options tied
  to S&P 500 Index
 $
 13,088
 
 $
 9,317Options on
  interest rate swaps
 
 5,407
 
 
 -$
 18,495
 
 $
 9,317Derivative
  liabilities:Forward
  settlement swaps and interest rate swaps
 $
 58,269
 
 $
 47,425
 47


---



ORIENTAL FINANCIAL

GROUP INC. NOTES TO UNAUDITED

CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
  Forward-Settlement
Swaps and Interest Rate Swaps  The
Group enters into forward-settlement swaps to hedge the variability of future
interest cash flows of forecasted wholesale borrowings, attributable to changes
in the one-month LIBOR rate. Once the forecasted wholesale borrowings
transactions occur, the interest rate swap will effectively fix the Group’s
interest payments on an amount of forecasted interest expense attributable to
the one-month LIBOR rate corresponding to the swap notional stated rate. These
forward-settlement swaps are designated as cash flow hedges for the forecasted wholesale
borrowings transactions and are properly documented as such, and therefore,
qualify for cash flow hedge accounting. Changes in the fair value of these
derivatives are recorded in accumulated other comprehensive income to the
extent there is no significant ineffectiveness in the cash flow hedging
relationships. Currently, the Group does not expect to reclassify any amount
included in other comprehensive income related to these forward-settlement
swaps to earnings in the next twelve months.  The
following table shows a summary of these swaps and their terms at September 30,
2012:  Notional
 
 Fixed
 
 Trade
 
 Settlement
 
 MaturityType
 
 Amount
 
 Rate
 
 Date
 
 Date
 
 Date(In thousands)Interest Rate
  Swaps
 
 $
 100,000
 
 1.9275%
 
 03/18/11
 
 12/28/11
 
 01/28/15100,000
 
 2.0000%
 
 03/18/11
 
 12/28/11
 
 03/28/15100,000
 
 2.1100%
 
 03/18/11
 
 12/28/11
 
 06/28/1525,000
 
 2.4365%
 
 05/05/11
 
 05/04/12
 
 05/04/16125,000
 
 1.6550%
 
 03/18/11
 
 05/09/12
 
 02/09/14125,000
 
 1.7700%
 
 03/18/11
 
 05/09/12
 
 05/09/14100,000
 
 1.8975%
 
 03/18/11
 
 05/09/12
 
 08/09/1425,000
 
 2.6200%
 
 05/05/11
 
 07/24/12
 
 07/24/1625,000
 
 2.6350%
 
 05/05/11
 
 07/30/12
 
 07/30/1650,000
 
 2.6590%
 
 05/05/11
 
 08/10/12
 
 08/10/16100,000
 
 2.2225%
 
 05/05/11
 
 08/14/12
 
 05/14/15100,000
 
 2.6750%
 
 05/05/11
 
 08/16/12
 
 08/16/16$
 975,000Forward-Settlement
  Swaps
 
 $
 150,000
 
 2.7795%
 
 05/05/11
 
 12/06/12
 
 06/06/16$
 1,125,000
  An
unrealized loss of $58.3 million was recognized in accumulated other
comprehensive income related to the valuation of these swaps at September 30,
2012, and the related liability is being reflected in the accompanying
unaudited consolidated statements of financial condition. 48


---



ORIENTAL FINANCIAL

GROUP INC. NOTES TO UNAUDITED

CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
  Swap Options  In
July 2012, the Group purchased options to enter into interest rate swaps, not designated
as cash flow hedges, with an aggregate notional amount of $200 million. At
September 30, 2012, the purchased options used to manage the exposure on the
interest rate swaps represented an asset of $5.4 million in the consolidated
statements of financial position. The following table shows a summary of these
swap options and their terms at September 30, 2012:  Notional
 
 Fixed
 
 Trade
 
 Option
 
 Swap
 
 SwapAmount
 
 Rate
 
 Date
 
 Maturity Date
 
 Start Date
 
 Maturity Date(In thousands)$
 100,000
 
 2.2350%
 
 07/06/12
 
 07/07/14
 
 07/09/14
 
 07/09/24100,000
 
 1.8400%
 
 07/06/12
 
 01/07/13
 
 01/09/13
 
 01/09/23$
 200,000
  Options Tied to Standard & Poor’s 500 Stock Market Index  The
Group has offered its customers certificates of deposit with an option tied to
the performance of the S&P 500 Index.  The Group uses option agreements
with major broker-dealer companies to manage its exposure to changes in this
index. Under the terms of the option agreements, the Group receives the average
increase in the month-end value of the index in exchange for a fixed premium.
The changes in fair value of the option agreements used to manage the exposure
in the stock market in the certificates of deposit are recorded in earnings. At
September 30, 2012 and December 31, 2011, the purchased options used to manage
the exposure to the S&P 500 Index on stock indexed deposits represented an
asset of $13.1 million (notional amount of $72.2 million) and $9.3 million
(notional amount of $130.0 million),
respectively; the options sold to customers embedded in the certificates of
deposit and recorded as deposits in the unaudited consolidated statements of
financial condition, represented a liability of $12.6 million (notional amount of
$67.6 million) and $9.4 million (notional amount of $125.8 million), respectively.  NOTE 9—ACCRUED INTEREST RECEIVABLE AND OTHER ASSETS  Accrued
interest receivable at September 30, 2012 and December 31, 2011 consists of the
following:  September 30,
 
 December 31,2012
 
 2011(In thousands)Non-covered
  loans
 $
 5,588
 
 $
 5,519Investments
 
 9,347
 
 
 14,663$
 14,935
 
 $
 20,182
 49


---



ORIENTAL FINANCIAL

GROUP INC. NOTES TO UNAUDITED

CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
  Other assets at September 30,
2012 and December 31, 2011 consist of the following:  September 30,
 
 December 31,2012
 
 2011(In thousands)Prepaid FDIC
  insurance
 $
 7,705
 
 $
 11,599Other prepaid
  expenses
 
 11,047
 
 
 6,498Servicing
  advances
 
 9,041
 
 
 13,990Goodwill
 
 2,701
 
 
 2,701Mortgage tax
  credits
 
 1,303
 
 
 1,303Core deposit
  intangible
 
 1,079
 
 
 1,185Investment in
  Statutory Trust
 
 1,086
 
 
 1,086Debt issuance
  costs
 
 822
 
 
 1,067Other
  repossessed assets (covered by FDIC shared-loss agreements)
 
 396
 
 
 708Accounts
  receivable and other assets
 
 13,905
 
 
 14,346$
 49,085
 
 $
 54,483
  On
November 12, 2009, the FDIC adopted a final rule requiring insured depository
institutions to prepay their estimated quarterly risk-based assessments for the
fourth quarter of 2009, and for all of 2010, 2011, and 2012, on December 31, 2009,
along with each institution’s risk-based deposit insurance assessment for the
third quarter of 2009. The prepayment balance of the assessment covering fiscal
years 2011 and 2012 amounted to $7.7 million and $11.6 million at September 30,
2012 and December 31, 2011, respectively.  Other
prepaid expenses amounting to $11.0 million and $6.5 million at September 30,
2012 and December 31, 2011, respectively, include prepaid municipal, property
and income taxes aggregating to $7.8 million and $3.2 million, respectively.  Servicing
advances amounting to $9.0 million and $14.0 million at September 30, 2012 and
December 31, 2011, respectively, represent the advances made to Bayview Loan
Servicing, LLC in order to service some of the loans acquired in the FDIC-assisted
acquisition of Eurobank.  In
December 2007, the Commonwealth of Puerto Rico established mortgage loan tax
credits for financial institutions that provided financing for the acquisition
of new homes. Under an agreement reached during the quarter ended September 30,
2011 with the Puerto Rico Treasury Department, the Group was allowed to use
half of these credits to reduce taxable income in taxable year 2011, and the
remaining half of the credits in taxable year 2012. At September 30, 2012 and
December 31, 2011, tax credits for the Group amounted $1.3 million for both
periods.  As part of the FDIC-assisted
acquisition of Eurobank, the Group registered a core deposit intangible
representing the value of checking and savings deposits acquired. At September
30, 2012 and December 31, 2011, the core deposit intangible amounted to $1.1
million and $1.2 million, respectively. Also, as part of this transaction, the
Group recorded a goodwill amounting to $695 thousand.  Other
repossessed assets amounting to $396 thousand and $708 thousand at September
30, 2012 and December 31, 2011, respectively, represent covered assets under
the FDIC shared-loss agreements and are related to the leasing portfolio
acquired in the FDIC-assisted acquisition of Eurobank. 50


---



ORIENTAL FINANCIAL

GROUP INC. NOTES TO UNAUDITED

CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 NOTE 10—DEPOSITS AND RELATED INTEREST  Total deposits as of September 30, 2012 and December
31, 2011 consist of the following:  September 30, 2012
 
 December 31, 2011(In thousands)Non-interest
  bearing demand deposits
 $
 197,664
 
 $
 192,256Interest-bearing
  savings and demand deposits
 
 1,101,698
 
 
 1,081,447Individual
  retirement accounts
 
 369,680
 
 
 361,411Retail
  certificates of deposit
 
 330,395
 
 
 375,891Total
  retail deposits
 
 1,999,437
 
 
 2,011,005Institutional
  deposits
 
 73,657
 
 
 168,301Brokered
  deposits
 
 141,273
 
 
 255,879$
 2,214,367
 
 $
 2,435,185
  At
September 30, 2012 and December 31, 2011, the weighted average interest rate of
the Group’s deposits was 1.32%, and 1.87%, respectively, inclusive of non-interest
bearing deposits of $197.7 million and $192.3 million, respectively. Interest expense for the quarters and nine-month periods ended
September 30, 2012 and 2011 is set forth below:  Quarter Ended September 30,
 
 Nine-Month Period Ended September 30,2012
 
 2011
 
 2012
 
 2011(In thousands)
 
 (In thousands)Demand and
  savings deposits
 $
 2,547
 
 $
 4,058
 
 $
 8,571
 
 $
 12,683Certificates of
  deposit
 
 4,761
 
 
 7,434
 
 
 15,947
 
 
 22,638$
 7,308
 
 $
 11,492
 
 $
 24,518
 
 $
 35,321
  At
September 30, 2012 and December 31, 2011, demand and interest-bearing deposits
and certificates of deposit included deposits of the Puerto Rico Cash &
Money Market Fund, which amounted to $87.2 million and $64.9 million, respectively, with a weighted average rate
of 0.77% and 0.82%, and were collateralized with investment securities with a
fair value of $72.3 million and $62.7 million, respectively.  At
September 30, 2012 and December 31, 2011, time deposits in denominations of
$100 thousand or higher, excluding unamortized discounts, amounted to $335.1
million and $456.1 million, including public fund time deposits from various
Puerto Rico government agencies of $195 thousand and $65.2 million,
respectively, at a weighted average rate of 0.5% in both periods.  At
September 30, 2012 and December 31, 2011, public fund deposits from various
Puerto Rico government agencies were collateralized with investment securities
with a fair value of $8.5 million and $71.9 million, respectively, and with
commercial loans amounting to $2.3 million at September 30, 2012. There were no
commercial loans pledged as collateral for public fund deposits at December 31,
2011. 51


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ORIENTAL FINANCIAL

GROUP INC. NOTES TO UNAUDITED

CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
  Excluding
equity indexed options in the amount of $12.6 million, which are used by the Group
to manage its exposure to the S&P 500 Index, and also excluding accrued
interest of $2.3 million and unamortized deposit discounts in the amount of $3.2
million, the scheduled maturities of certificates of deposit at September 30,
2012 are as follows:  September 30, 2012(In thousands)Within one year:Three (3)
  months or less
 $
 167,688Over 3
  months through 1 year
 
 372,340540,028Over 1 through 2
  years
 
 199,339Over 2 through 3
  years
 
 74,822Over 3 through 4
  years
 
 76,814Over 4 through 5
  years
 
 12,062$
 903,065
  The
aggregate amount of overdraft in demand deposit accounts that were reclassified
to loans amounted to $224 thousand
and $456 thousand as of September 30, 2012 and December 31, 2011, respectively.  NOTE
11—BORROWINGS  Securities Sold under Agreements to Repurchase  At
September 30, 2012, securities underlying agreements to repurchase were
delivered to, and are being held by, the counterparties with whom the
repurchase agreements were transacted. The counterparties have agreed to resell
to the Group the same or similar securities at the maturity of the agreements.  At September 30, 2012 and December 31, 2011,
securities sold under agreements to repurchase (classified by counterparty),
excluding accrued interest in the amount of $2.4 million and $6.2 million, respectively, were as
follows:  September 30,
 
 December 31,2012
 
 2011Fair Value of
 
 
 
 
 Fair Value ofBorrowing
 
 Underlying
 
 Borrowing
 
 UnderlyingBalance
 
 Collateral
 
 Balance
 
 Collateral(In thousands)Credit Suisse
  Securities (USA) LLC
 $
 1,250,000
 
 $
 1,299,180
 
 $
 1,250,000
 
 $
 1,337,394UBS Financial
  Services Inc.
 
 500,000
 
 
 621,614
 
 
 500,000
 
 
 620,888Deutsche Bank
 
 225,000
 
 
 243,803
 
 
 100,000
 
 
 109,177JP Morgan Chase
  Bank NA
 
 200,000
 
 
 215,069
 
 
 300,000
 
 
 357,400Citigroup Global
  Markets Inc.
 
 150,000
 
 
 156,833
 
 
 900,000
 
 
 974,286Goldman Sachs
  & Co.
 
 125,000
 
 
 133,555
 
 
 -
 
 
 -Barclays Bank
 
 100,000
 
 
 109,055
 
 
 -
 
 
 -Wells Fargo
 
 100,000
 
 
 105,949
 
 
 -
 
 
 -Total
 $
 2,650,000
 
 $
 2,885,058
 
 $
 3,050,000
 
 $
 3,399,145
 52


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ORIENTAL FINANCIAL

GROUP INC. NOTES TO UNAUDITED

CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
  The original terms of the
Group’s remaining structured repurchase agreements is ten years. For the
repurchase agreements maturing in 2017 and amounting to $1.750 billion as of
September 30, 2012, the counterparties have the right to exercise put options on
such structured repurchase agreements at par on a quarterly basis before their
contractual maturities from one to three years after the agreements’ settlement
dates. The Group’s $500 million repurchase agreement maturing on March 2, 2017
also provides for an optional early termination by either party upon no less
than two business days’ prior written notice to the other party.  In the event
of any such optional early termination, the amounts owed by or to the
terminating party by the other party on the optional early termination date
must take account of the termination value of the transaction, as determined by
the calculation agent in the manner described in the repurchase agreement.
During the quarter ended September 30, 2012, the Group opted to terminate prior
to maturity two repurchase agreements amounting to $400 million. The early
termination fee paid by the Group amounted to $24.2 million and is presented in
the statement of operations as a net loss on the early extinguishment of
repurchase agreements for the quarter and nine-month period ended September 30,
2012.  The
following table shows a summary of the Group’s repurchase agreements and their
terms, excluding accrued interest in the amount of $2.4 million, at September
30, 2012:  Weighted-Borrowing
 
 Average
 
 
 
 Maturity
 
 Next PutYear of Maturity
 
 Balance
 
 Coupon
 
 Settlement Date
 
 Date
 
 Date(In thousands)2012$
 100,000
 
 0.53%
 
 9/10/2012
 
 10/9/2012
 
 N/A125,000
 
 0.39%
 
 9/10/2012
 
 10/9/2012
 
 N/A125,000
 
 0.39%
 
 9/10/2012
 
 10/9/2012
 
 N/A100,000
 
 0.41%
 
 9/14/2012
 
 10/15/2012
 
 N/A150,000
 
 4.31%
 
 3/6/2007
 
 12/6/2012
 
 N/A600,0002015100,000
 
 0.51%
 
 12/28/2011
 
 3/30/2015
 
 N/A100,000
 
 0.62%
 
 12/29/2011
 
 1/28/2015
 
 N/A100,000
 
 0.56%
 
 12/28/2011
 
 6/28/2015
 
 N/A300,0002017500,000
 
 4.67%
 
 3/2/2007
 
 3/2/2017
 
 12/3/2012250,000
 
 0.25%
 
 3/2/2007
 
 3/2/2017
 
 12/3/2012100,000
 
 0.00%
 
 6/6/2007
 
 3/6/2017
 
 12/6/2012900,000
 
 0.00%
 
 3/6/2007
 
 6/6/2017
 
 12/6/20121,750,000$
 2,650,000
 
 1.28%
  All of the structured
repurchase agreements referred to above with maturity dates up to the date of
this report were renewed as one-month short-term repurchase agreements.  Repurchase
agreements include $1.25 billion, which reset at each put date at a formula
which is based on the three-month LIBOR rate less fifteen times the difference
between the ten-year SWAP rate and the two-year SWAP rate, with a minimum of
0.00% on $1.0 billion and 0.25% on $250 million, and a maximum of 10.6%. These
repurchase agreements bear the respective minimum rates of 0.00% and 0.25% to
at least their next put dates scheduled for December 2012. 53


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ORIENTAL FINANCIAL

GROUP INC. NOTES TO UNAUDITED

CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
  Advances from the Federal Home Loan Bank  Advances
are received from the FHLB under an agreement whereby the Group is required to
maintain a minimum amount of qualifying collateral with a fair value of at
least 110% of the outstanding advances. At September 30, 2012, these advances
were secured by mortgage and commercial loans amounting to $515.7 million and $54.6
million, respectively. Also, at September 30, 2012, the Group had an additional
borrowing capacity with the FHLB of $155.6 million. At September 30, 2012 and December 31
2011, the weighted average remaining maturity of FHLB’s advances was 5.0 months
and 11.2 months, respectively. The original terms of these advances range
between five and seven years, and the FHLB has the right to exercise put
options at par on a quarterly basis before the contractual maturity of the
advances from nine months to one year after the advances’ settlement dates. The
following table shows a summary of these advances and their terms, excluding
accrued interest in the amount of $382 thousand, at September 30, 2012:  Weighted-Borrowing
 
 Average
 
 
 
 Maturity
 
 Next PutYear of Maturity
 
 Balance
 
 Coupon
 
 Settlement Date
 
 Date
 
 Date(In thousands)2012$
 25,000
 
 0.43%
 
 8/30/2012
 
 10/1/2012
 
 N/A25,000
 
 0.41%
 
 9/4/2012
 
 10/4/2012
 
 N/A25,000
 
 0.37%
 
 9/24/2012
 
 10/24/2012
 
 N/A50,000
 
 0.41%
 
 9/10/2012
 
 10/10/2012
 
 N/A100,000
 
 0.40%
 
 9/17/2012
 
 10/16/2012
 
 N/A225,000201425,000
 
 4.20%
 
 5/8/2007
 
 5/8/2014
 
 11/8/201230,000
 
 4.22%
 
 5/11/2007
 
 5/11/2014
 
 11/12/201255,00020175,013
 
 1.24%
 
 4/3/2012
 
 4/3/2017
 
 N/A5,013$
 285,013
 
 1.15%
  All of the advances referred
to above with maturity dates up to the date of this report were renewed as one-month
short-term advances.  FDIC-Guaranteed
Term Notes—Temporary
Liquidity Guarantee Program  On
March 16, 2012, the Group’s banking subsidiary repaid at maturity the $105
million in senior unsecured notes that it issued in March 2009 under the FDIC’s
Temporary Liquidity Guarantee Program.  54


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ORIENTAL FINANCIAL

GROUP INC. NOTES TO UNAUDITED

CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 Subordinated Capital
Notes  Subordinated
capital notes amounted to $36.1 million at September 30, 2012 and December 31,
2011.  In
August 2003, the Statutory Trust II, a special purpose entity of the Group, was
formed for the purpose of issuing trust redeemable preferred securities. In
September 2003, $35.0 million of trust redeemable preferred securities were
issued by the Statutory Trust II as part of a pooled underwriting transaction.
Pooled underwriting involves participating with other bank holding companies in
issuing the securities through a special purpose pooling vehicle created by the
underwriters.  The
proceeds from this issuance were used by the Statutory Trust II to purchase a
like amount of floating rate junior subordinated deferrable interest debenture
(“subordinated capital note”) issued by the Group. The subordinated capital
note has a par value of $36.1 million, bears interest based on 3-month LIBOR
plus 295 basis points (3.34% at September 30, 2012; 3.30% at December 31, 2011),
is payable quarterly, and matures on September 17, 2033. The subordinated
capital note purchased by the Statutory Trust II may be called at par after
five years and quarterly thereafter (next call date December 2012). The trust
redeemable preferred securities have the same maturity and call provisions as
the subordinated capital note. The subordinated deferrable interest debenture
issued by the Group are accounted for as a liability denominated as
subordinated capital note on the unaudited consolidated statements of financial
condition.  The
subordinated capital note is treated as Tier 1 capital for regulatory purposes.
Under Federal Reserve Board rules, restricted core capital elements, which are
qualifying trust preferred securities, qualifying cumulative perpetual
preferred stock (and related surplus) and certain minority interests in
consolidated subsidiaries, are limited in the aggregate to no more than 25% of
a bank holding company’s core capital elements (including restricted core
capital elements), net of goodwill less any associated deferred tax liability.
However, under the Dodd-Frank Act, bank holding companies are prohibited from
including in their Tier 1 capital hybrid debt and equity securities, including
trust preferred securities, issued on or after May 19, 2010. Any such
instruments issued before May 19, 2010 by a bank holding company, such as the
Group, with total consolidated assets of less than $15 billion as of December
31, 2009, may continue to be included as Tier 1 capital. Therefore, the Group
is permitted to continue to include its existing trust preferred securities as
Tier 1 capital.  NOTE 12—RELATED PARTY TRANSACTIONS  The Bank grants loans to its directors,
executive officers and to certain related individuals or organizations in the
ordinary course of business. These loans are offered at the same terms as loans
to unrelated third parties. As of September 30, 2012 and December 31, 2011,
these loans balances amounted to $5.0 million and $3.8 million, respectively.
The activity and balance of these loans for the quarters and nine-month periods
ended September 30, 2012 and 2011 were as follows:  Quarter Ended September 30,
 
 Nine-Month Period Ended September 30,2012
 
 2011
 
 2012
 
 2011(In thousands)
 
 (In thousands)Balance at
  the beginning of period
 $
 5,058
 
 $
 3,213
 
 $
 3,772
 
 $
 3,452New loans
 
 -
 
 
 582
 
 
 1,396
 
 
 582Repayments
 
 (17)
 
 
 15
 
 
 (93)
 
 
 (37)Credits of
  persons no longer
  considered
  related parties
 
 (23)
 
 
 -
 
 
 (57)
 
 
 (187)Balance at
  the end of period
 $
 5,018
 
 $
 3,810
 
 $
 5,018
 
 $
 3,810
 55


---



ORIENTAL FINANCIAL

GROUP INC. NOTES TO UNAUDITED

CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 NOTE 13—INCOME TAXES  At September 30, 2012 and
December 31, 2011, the Group’s net deferred tax asset amounted to $35.9 million
and $32.0 million, respectively. Income tax expense for the quarters ended
September 30, 2012 and 2011 totaled of $1.9 million and $580 thousand,
respectively. Income tax expense for the nine-month periods ended September 30,
2012 and 2011 totaled $4.9 million and $5.7 million, respectively.  At December 31, 2011, OIB had $2.9 million in the
income tax effect of unrecognized gain on available-for-sale securities
included in other comprehensive income. Following the change in OIB’s
applicable tax rate from 5% to 0% as a result of new Puerto Rico legislation
adopted in 2011, this remaining tax balance will flow through income as these
securities are repaid or sold in future periods. During the quarter and
nine-month period ended September 30, 2012, the income tax provision included $1.1
million and $1.8 million, respectively, related to this residual tax effect
from OIB.  The Group classifies unrecognized tax benefits in income taxes
payable. These gross unrecognized tax benefits would affect the effective tax
rate if realized. The balance of unrecognized tax benefits at September 30,
2012 was $1.5 million (December 31, 2011 - $1.4 million). The Group had accrued
$768 thousand at September 30, 2012 (December 31, 2011 - $342 thousand) for the payment of interest and
penalties relating to unrecognized tax benefits.  NOTE 14—STOCKHOLDERS’ EQUITY  Regulatory
Capital Requirements  The Group (on a consolidated
basis) and the Bank are subject to various regulatory capital requirements administered
by the federal banking agencies. Failure to meet minimum capital requirements
can initiate certain mandatory and possibly additional discretionary actions by
regulators that, if undertaken, could have a direct material effect on the
Group’s and the Bank’s financial statements. Under capital adequacy guidelines
and the regulatory framework for prompt corrective action, the Group and the
Bank must meet specific capital guidelines that involve quantitative measures
of their assets, liabilities and certain off-balance sheet items as calculated under
regulatory accounting practices. The capital amounts and classification are
also subject to qualitative judgments by the regulators about components, risk
weightings, and other factors. This has changed under the Dodd-Frank Act, which
requires federal banking regulators to establish minimum leverage and
risk-based capital requirements, on a consolidated basis, for insured
institutions, depository institutions, depository institution holding
companies, and non-bank financial companies supervised by the Federal Reserve
Board. The minimum leverage and risk-based capital requirements are to be
determined based on the minimum ratios established for insured depository
institutions under prompt corrective action regulations.  Quantitative measures
established by regulation to ensure capital adequacy require the Group and the
Bank to maintain minimum amounts and ratios (set forth in the following table)
of total and Tier 1 capital (as defined in the regulations) to risk-weighted
assets (as defined in the regulations) and of Tier 1 capital to average assets
(as defined in the regulations). As of September 30, 2012 and December 31,
2011, the Group and the Bank met all capital adequacy requirements to which
they are subject. As of September 30, 2012 and December 31, 2011, the FDIC
categorized the Bank as “well capitalized” under the regulatory framework for
prompt corrective action. To be categorized as “well capitalized,” an
institution must maintain minimum total risk-based, Tier 1 risk-based and Tier
1 leverage ratios as set forth in the following tables. 56


---



ORIENTAL FINANCIAL

GROUP INC. NOTES TO UNAUDITED

CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
  The
Group’s and the Bank’s actual capital amounts and ratios as of September 30,
2012 and December 31, 2011 are as follows:  Minimum CapitalActual
 
 RequirementAmount
 
 Ratio
 
 Amount
 
 Ratio(Dollars in thousands)Group RatiosAs of
  September 30, 2012Total capital to
  risk-weighted assets
 $
 711,987
 
 37.63%
 
 $
 151,362
 
 8.00%Tier 1 capital
  to risk-weighted assets
 $
 687,436
 
 36.33%
 
 $
 75,681
 
 4.00%Tier 1 capital
  to total assets
 $
 687,436
 
 10.91%
 
 $
 252,145
 
 4.00%As of
  December 31, 2011Total capital to
  risk-weighted assets
 $
 688,188
 
 33.12%
 
 $
 167,929
 
 8.00%Tier 1 capital
  to risk-weighted assets
 $
 661,614
 
 31.84%
 
 $
 83,964
 
 4.00%Tier 1 capital
  to total assets
 $
 661,614
 
 9.65%
 
 $
 274,230
 
 4.00%
  Minimum to be WellCapitalized Under PromptMinimum Capital
 
 Corrective ActionActual
 
 Requirement
 
 ProvisionsAmount
 
 Ratio
 
 Amount
 
 Ratio
 
 Amount
 
 Ratio(Dollars in thousands)Bank RatiosAs of
  September 30, 2012Total capital to
  risk-weighted assets
 $
 685,032
 
 36.77%
 
 $
 149,049
 
 8.00%
 
 $
 186,311
 
 10.00%Tier 1 capital
  to risk-weighted assets
 $
 660,838
 
 35.47%
 
 $
 74,525
 
 4.00%
 
 $
 111,787
 
 6.00%Tier 1 capital
  to total assets
 $
 660,838
 
 10.66%
 
 $
 247,862
 
 4.00%
 
 $
 309,827
 
 5.00%As of
  December 31, 2011Total capital to
  risk-weighted assets
 $
 643,065
 
 31.07%
 
 $
 165,573
 
 8.00%
 
 $
 206,967
 
 10.00%Tier 1 capital
  to risk-weighted assets
 $
 616,590
 
 29.79%
 
 $
 82,787
 
 4.00%
 
 $
 124,180
 
 6.00%Tier 1 capital
  to total assets
 $
 616,590
 
 9.06%
 
 $
 272,177
 
 4.00%
 
 $
 340,221
 
 5.00%
  The
Group’s ability to pay dividends to its shareholders and other activities can
be restricted if its capital falls below levels established by the Federal
Reserve Board’s guidelines. In addition, any bank holding company whose capital
falls below levels specified in the guidelines can be required to implement a
plan to increase capital. 57


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ORIENTAL FINANCIAL

GROUP INC. NOTES TO UNAUDITED

CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
  Equity-Based Compensation Plan  The
Omnibus Plan provides for equity-based compensation incentives through the
grant of stock options, stock appreciation rights, restricted stock, restricted
stock units, and dividend equivalents, as well as equity-based performance
awards. The Omnibus Plan replaced and superseded the Stock Option Plans. All
outstanding stock options under the Stock Option Plans continue in full force
and effect, subject to their original terms.  The activity in outstanding
options for the nine-month periods ended September 30, 2012 and 2011 is set
forth below:  Nine-Month Period Ended September 30,2012
 
 2011Weighted
 
 
 
 WeightedNumber
 
 Average
 
 Number
 
 AverageOf
 
 Exercise
 
 Of
 
 ExerciseOptions
 
 Price
 
 Options
 
 PriceBeginning of
  period
 786,704
 
 $
 15.02
 
 765,989
 
 $
 15.25Options
  granted
 204,543
 
 
 11.83
 
 85,000
 
 
 11.90Options
  exercised
 (32,954)
 
 
 11.98
 
 (550)
 
 
 9.19Options
  forfeited
 (23,500)
 
 
 11.93
 
 (33,142)
 
 
 14.82End of period
 934,793
 
 $
 14.51
 
 817,297
 
 $
 14.89
  The following table summarizes
the range of exercise prices and the weighted average remaining contractual
life of the optionsoutstanding at September
30, 2012:  Outstanding
 
 ExercisableWeightedAverageWeighted
 
 Contract Life
 
 
 
 
 WeightedNumber of
 
 Average
 
 Remaining
 
 Number of
 
 AverageRange of
  Exercise Prices
 
 Options
 
 Exercise Price
 
 (Years)
 
 Options
 
 Exercise Price$5.63 to $8.45
 
 
 12,432
 
 $
 8.28
 
 6.6
 
 
 5,885
 
 $
 8.288.46 to 11.27
 
 
 1,000
 
 
 10.29
 
 4.9
 
 
 750
 
 
 10.2911.28 to 14.09
 
 
 691,876
 
 
 12.06
 
 7.3
 
 
 196,933
 
 
 12.3914.10 to 16.90
 
 
 62,035
 
 
 15.60
 
 1.9
 
 
 62,035
 
 
 15.6019.72 to 22.54
 
 
 25,050
 
 
 20.68
 
 2.4
 
 
 22,925
 
 
 20.5722.55 to 25.35
 
 
 83,350
 
 
 23.99
 
 1.5
 
 
 83,350
 
 
 23.9925.36 to 28.17
 
 
 59,050
 
 
 27.46
 
 2.1
 
 
 59,050
 
 
 27.46934,793
 
 $
 14.51
 
 6.0
 
 
 430,928
 
 $
 17.53Aggregate
  Intrinsic Value
 
 $
 28,078
 
 
 
 
 
 
 $
 13,355
  The
average fair value of each option granted during the nine-month period ended September
30, 2012 was $5.41. The average fair value of each option granted was estimated
at the date of the grant using the Black-Scholes option pricing model. The
Black-Scholes option-pricing model was developed for use in estimating the fair
value of traded options that have no restrictions and are fully transferable
and negotiable in a free trading market. Black-Scholes does not consider the
employment, transfer or vesting restrictions that are inherent in the Group’s
stock options. Use of an option valuation model, as required by GAAP, includes
highly subjective assumptions based on long-term predictions, including the
expected stock price volatility and average life of each option grant. 58


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ORIENTAL FINANCIAL

GROUP INC. NOTES TO UNAUDITED

CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
  The
following assumptions were used in estimating the fair value of the options
granted during the nine-month periods ended September 30, 2012 and 2011:  Nine-Month Period Ended September 30,2012
 
 2011Weighted
  average assumptions:Dividend
  yield
 1.80%
 
 1.63%Expected
  volatility
 51.13%
 
 59.04%Risk-free
  interest rate
 1.70%
 
 3.11%Expected
  life (in years)
 8.0
 
 8.0
  The following table summarizes
the restricted units’ activity under the Omnibus Plan for the nine-month
periods ended September 30, 2012 and 2011:  Nine-Month Period Ended September 30,2012
 
 2011Weighted
 
 
 
 WeightedAverage
 
 
 
 AverageRestricted
 
 Grant Date
 
 Restricted
 
 Grant DateUnits
 
 Fair Value
 
 Units
 
 Fair ValueBeginning of
  period
 205,149
 
 $
 11.27
 
 243,525
 
 $
 13.43Restricted
  units granted
 57,350
 
 
 11.85
 
 39,500
 
 
 11.88Restricted
  units lapsed
 (46,210)
 
 
 8.29
 
 (51,116)
 
 
 20.44Restricted
  units forfeited
 (2,789)
 
 
 11.71
 
 (14,620)
 
 
 12.21End of period
 213,500
 
 $
 12.06
 
 217,289
 
 $
 11.67
  Preferred Stock  In connection with the BBVAPR Acquisition,
as discussed in Note 1, on July 3, 2012, the Group completed its sale to
various institutional purchasers of $84 million of its Convertible Preferred Stock,
with a conversion price, subject to certain conditions, of $11.77 per share of
common stock, through a private placement, pursuant to a Subscription Agreement
dated June 28, 2012, between the Group and each of the purchasers.  Additional
paid-in capital  Additional paid-in capital
represents contributed capital in excess of par value of common and preferred
stock net of costs of the issuance.  During the quarter ended September 30,
2012, $4.9 million of preferred stock issue costs were charged against
additional paid-in capital.  As of September 30, 2012, accumulated issuance
costs charged against additional paid in capital amounted to $7.6 million and
$9.2 million for preferred and common stock, respectively.   Legal Surplus  The
Puerto Rico Banking Act requires that a minimum of 10% of the Bank’s net income
for the year be transferred to a reserve fund until such fund (legal surplus)
equals the total paid in capital on common and preferred stock. At September
30, 2012 and December 31, 2011, legal surplus amounted to $54.4 million and $50.2 million, respectively. The
amount transferred to the legal surplus account is not available for the payment
of dividends to shareholders. 59


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ORIENTAL FINANCIAL

GROUP INC. NOTES TO UNAUDITED

CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
  Earnings
per Common Share  The calculation of earnings
per common share for the quarters and nine-month periods ended September 30,
2012 and 2011 is as follows:  Quarter Ended September 30,
 
 Nine-Month Period Ended September 30,2012
 
 2011
 
 2012
 
 2011(In thousands, except per share data)Net income
 $
 17,761
 
 $
 16,788
 
 $
 43,371
 
 $
 46,336Less:
  Dividends on preferred stockNon-convertible preferred stock (Series A and B)
 
 (1,201)
 
 
 (1,201)
 
 
 (3,602)
 
 
 (3,602)Convertible Preferred Stock (Series C)
 
 (1,838)
 
 
 -
 
 
 (1,838)
 
 
 -Income
  available to common shareholders
 $
 14,722
 
 $
 15,587
 
 $
 37,931
 
 $
 42,734Effect of
  assumed conversion of the ConvertiblePreferred
  Stock
 
 1,838
 
 
 -
 
 
 1,838
 
 
 -Income
  available to common shareholdersassuming
  conversion
 $
 16,560
 
 $
 15,587
 
 $
 39,769
 
 $
 42,734Weighted
  average common shares and share equivalents:Average common
  shares outstanding
 
 40,738
 
 
 44,015
 
 
 40,828
 
 
 45,050Effect of dilutive
  securities:Average
  potential common shares-options
 
 102
 
 
 90
 
 
 109
 
 
 91Average
  potential common shares-assumingconversion
  of Convertible Preferred Stock
 
 7,138
 
 
 -
 
 
 2,379
 
 
 -Total
  weighted average common sharesoutstanding
  and equivalents
 
 47,978
 
 
 44,105
 
 
 43,316
 
 
 45,141Earnings per
  common share - basic
 $
 0.36
 
 $
 0.35
 
 $
 0.93
 
 $
 0.95Earnings per
  common share - diluted
 $
 0.35
 
 $
 0.35
 
 $
 0.92
 
 $
 0.95
  In computing diluted earnings
per common share, the 84,000 shares of Convertible Preferred Stock, which
remained outstanding at September 30, 2012, with a conversion rate, subject to
certain conditions, of 84.9798 shares of common stock per share, were included
as average potential common shares from the date they were outstanding.
Moreover, in computing diluted earnings per common share, the dividends
declared during the quarter ended September 30, 2012 on the Convertible
Preferred Stock were added back as income available to common shareholders.  For the quarters ended September
30, 2012 and 2011, weighted-average stock options with an anti-dilutive effect
on earnings per share not included in the calculation amounted to 708,976 and
572,284, respectively. For the nine-month periods ended September 30, 2012 and
2011, weighted-average stock options with an anti-dilutive effect on earnings
per share not included in the calculation amounted to 707,976 and 558,193,
respectively.  Treasury Stock  On
February 3, 2011, the Group announced that its Board of Directors had approved
a stock repurchase program pursuant to which the Group was authorized to
purchase in the open market up to $30 million of its outstanding shares of common
stock. On June 29, 2011, the Group announced the completion of the $30 million
stock repurchase program and the approval by the Board of Directors of a new
program to purchase an additional $70 million of common stock in the open
market.  60


---



ORIENTAL FINANCIAL

GROUP INC. NOTES TO UNAUDITED

CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
  Any shares of common stock repurchased are held by the
Group as treasury shares. The Group records treasury stock purchases under the
cost method whereby the entire cost of the acquired stock is recorded as
treasury stock. Under the $30 million program, initiated in February 2011, the
Group purchased a total of 2,406,303 shares at an average price of $12.10 per
share.  During 2011, the Group purchased approximately 2,783,000 shares under
the $70 million program for a total of $29.4 million, at an average price of
$10.57 per share. During the nine-month period ended September 30, 2012, the
Group purchased approximately 603,000 additional shares under this program for
a total of $7.0 million, at an average price of $11.61 per share.  The activity in connection
with common shares held in treasury by the Group for the nine-month periods ended
September 30, 2012 and 2011 is set forth below:  Nine-Month Period Ended September 30,2012
 
 2011Dollar
 
 
 
 DollarShares
 
 Amount
 
 Shares
 
 Amount(In thousands, except shares data)Beginning of
  period
 6,564,124
 
 $
 74,808
 
 1,459,067
 
 $
 16,732Common shares
  used upon lapsing of restricted stock units
 (46,210)
 
 
 (483)
 
 (51,116)
 
 
 (561)Common shares
  repurchased as part of the stock repurchase program
 603,000
 
 
 7,022
 
 2,406,303
 
 
 29,242Common shares
  used to match defined contribution plan, net
 (25,249)
 
 
 (47)
 
 (20,761)
 
 
 (37)End of period
 7,095,665
 
 $
 81,300
 
 3,793,493
 
 $
 45,376
  Accumulated
Other Comprehensive Income  Accumulated
other comprehensive income, net of income tax, as of September 30, 2012 and December
31, 2011 consisted of:  September 30,
 
 December 31,2012
 
 2011(In thousands)Unrealized gain
  on securities available-for-sale which are not
  other-than-temporarily impaired
 $
 64,921
 
 $
 86,404Income tax
  effect of unrealized gain on securities available-for-sale
 
 (4,823)
 
 
 (7,160)Unrealized loss
  on cash flow hedges
 
 (58,269)
 
 
 (47,425)Income tax
  effect of unrealized loss on cash flow hedges
 
 7,234
 
 
 5,312$
 9,063
 
 $
 37,131
  At December 31, 2011, OIB had $2.9
million in the income tax effect of unrecognized gain on available-for-sale
securities included in other comprehensive income. Following the change in OIB’s
applicable tax rate from 5% to 0% as a result of new Puerto Rico legislation
adopted in 2011, this remaining tax balance will flow through income as these
securities are repaid or sold in future periods. During the nine-month period
ended September 30, 2012, $1.8 million related to this residual tax effect from
OIB were reclassified from accumulated other comprehensive income into income
tax provision. 61


---



ORIENTAL FINANCIAL

GROUP INC. NOTES TO UNAUDITED

CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 NOTE 15—COMMITMENTS  Loan Commitments  At September 30, 2012 and December 31, 2011,
there were $135.4 million and $106.1 million, respectively, in loan commitments,
which represent unused lines of credit and letters of credit provided to
customers. These lines of credit had a reserve of $603 thousand and $518 thousand at September 30, 2012
and December 31, 2011, respectively. Commitments to extend credit are
agreements to lend to customers as long as there is no violation of any
condition established in the contract. Commitments generally have fixed
expiration dates, bear variable interest and may require payment of a fee.
Since the commitments may expire unexercised, the total commitment amounts do
not necessarily represent future cash requirements. The Group evaluates each
customer’s credit-worthiness on a case-by-case basis. The amount of collateral
obtained, if deemed necessary by the Group upon the extension of credit, is
based on management’s credit evaluation of the customer. Commitments for loans
covered under the FDIC shared-loss agreements amounted to $14.1 million and $31.1 million at September 30, 2012
and December 31, 2011, respectively.  At September 30, 2012 and December 31,
2011, commitments to sell or securitize mortgage loans amounted to approximately
$39.3 million and $66.1 million, respectively.  Lease Commitments  The Group has entered into various
operating lease agreements for branch facilities and administrative offices.
Rent expense for the quarters ended September 30, 2012 and 2011 amounted to $1.6
million and 1.5 million, respectively. Rent expense for the nine-month periods
ended September 30, 2012 and 2011 amounted to $4.9 million and $3.0 million, respectively. Both are
included in the “occupancy and equipment” caption in the unaudited consolidated
statements of operations. Future rental commitments under leases in effect at September
30, 2012, exclusive of taxes, insurance, and maintenance expenses payable by
the Group, are summarized as follows:  Year
  Ending December 31,
 Minimum Rent(In thousands)2012
 $
 1,1422013
 
 4,5722014
 
 4,5692015
 
 4,3232016
 
 3,741Thereafter
 
 17,341$
 35,688
 62


---



ORIENTAL FINANCIAL

GROUP INC. NOTES TO UNAUDITED

CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 NOTE 16—CONTINGENCIES  The Group and its subsidiaries are
defendants in a number of legal proceedings incidental to their business. In
the ordinary course of business, the Group and its subsidiaries are also
subject to governmental and regulatory examinations. Certain subsidiaries of
the Group, including the Bank, Oriental Financial Services, and Oriental
Insurance, are subject to regulation by various U.S., Puerto Rico and other
regulators.  The Group seeks to resolve all
litigation and regulatory matters in the manner management believes is in the
best interests of the Group and its shareholders, and contests allegations of liability
or wrongdoing and, where applicable, the amount of damages or scope of any
penalties or other relief sought as appropriate in each pending matter.  Subject to the accounting and disclosure
framework under the provisions of ASC 450, it is the opinion of the Group’s
management, based on current knowledge and after taking into account its
current legal accruals, that the eventual outcome of all matters would not be
likely to have a material adverse effect on the unaudited consolidated
financial condition of the Group. Nonetheless, given the substantial or
indeterminate amounts sought in certain of these matters, and the inherent
unpredictability of such matters, an adverse outcome in certain of these
matters could, from time to time, have a material adverse effect on the Group’s
unaudited consolidated results of operations or cash flows in particular
quarterly or annual periods. The Group has evaluated all litigation and
regulatory matters where the likelihood of a potential loss is deemed
reasonably possible. The Group has determined that the estimate of the
reasonably possible loss is not significant.  NOTE 17-FAIR VALUE  As discussed in Note 1, the
Group follows the fair value measurement framework under GAAP.  Fair
Value Measurement  The fair value measurement
framework defines fair value as the exchange price that would be received for
an asset or paid to transfer a liability (an exit price) in the principal or
most advantageous market for the asset or liability in an orderly transaction
between market participants on the measurement date. This framework also
establishes a fair value hierarchy which requires an entity to maximize the use
of observable inputs and minimize the use of unobservable inputs when measuring
fair value. The standard describes three levels of inputs previously described
that may be used to measure fair value.  Money
market investments  The fair value of money market
investments is based on the carrying amounts reflected in the unaudited
consolidated statements of financial condition as these are reasonable
estimates of fair value given the short-term nature of the instruments.  Investment
securities  The fair value of investment
securities is based on quoted market prices, when available, or market prices
provided by recognized broker-dealers. If listed prices or quotes are not
available, fair value is based upon externally developed models that use both
observable and unobservable inputs depending on the market activity of the
instrument. Structured credit investments are classified as Level 3. The
estimated fair value of the structured credit investments are determined by
using a third-party cash flow valuation model to calculate the present value of
projected future cash flows. The assumptions, which are highly uncertain and
require a high degree of judgment, include primarily market discount rates,
current spreads, duration, leverage, default, home price depreciation, and loss
rates. The assumptions used are drawn from a wide array of data sources,
including the performance of the collateral underlying each deal. The
external-based valuation, which is obtained at least on a quarterly basis, is
analyzed and its assumptions are evaluated and incorporated in either an
internal-based valuation model when deemed necessary or compared to
counterparties’ prices, and agreed by management.  63


---



ORIENTAL FINANCIAL

GROUP INC. NOTES TO UNAUDITED

CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
  Derivative
instruments  The fair value of the
forward-starting interest rate swaps and options on interest rate swaps is
largely a function of the financial market’s expectations regarding the future
direction of interest rates. Accordingly, current market values are not
necessarily indicative of the future impact of derivative instruments on
earnings. This will depend, for the most part, on the shape of the yield curve,
the level of interest rates, as well as the expectations for rates in the
future. The fair value of most of these derivative instruments is based on
observable market parameters, which include discounting the instruments’ cash
flows using the U.S. dollar LIBOR-based discount rates, and also applying yield
curves that account for the industry sector and the credit rating of the
counterparty and/or the Group.  Certain other derivative
instruments with limited market activity are valued using externally developed
models that consider unobservable market parameters. Based on their valuation
methodology, derivative instruments are classified as Level 3. The Group has
offered its customers certificates of deposit with an option tied to the
performance of the S&P Index and uses equity indexed option agreements with
major broker-dealer companies to manage its exposure to changes in this index.
Their fair value is obtained through the use of an external based valuation
that was thoroughly evaluated and adopted by management as its measurement tool
for these options. The payoff of these options is linked to the average value
of the S&P Index on a specific set of dates during the life of the option.
The methodology uses an average rate option or a cash-settled option whose
payoff is based on the difference between the expected average value of the
S&P Index during the remaining life of the option and the strike price at
inception. The assumptions, which are uncertain and require a degree of
judgment, include primarily S&P Index volatility, forward interest rate
projections, estimated index dividend payout, and leverage.  Servicing
assets  Servicing assets do not trade
in an active market with readily observable prices. Servicing assets are priced
using a discounted cash flow model. The valuation model considers servicing
fees, portfolio characteristics, prepayment assumptions, delinquency rates,
late charges, other ancillary revenues, cost to service and other economic
factors. Due to the unobservable nature of certain valuation inputs, the
servicing rights are classified as Level 3.  Loans
receivable considered impaired that are collateral dependent  The impairment is measured
based on the fair value of the collateral, which is derived from appraisals
that take into consideration prices in observed transactions involving similar
assets in similar locations, in accordance with the provisions of ASC
310-10-35. Currently, the associated loans considered impaired are classified
as Level 3.  Foreclosed
real estate  Foreclosed real estate
includes real estate properties securing residential mortgage and commercial
loans. The fair value of foreclosed real estate may be determined using an
external appraisal, broker price option or an internal valuation. These
foreclosed assets are classified as Level 3 given certain internal adjustments
that may be made to external appraisals. 64


---



ORIENTAL FINANCIAL

GROUP INC. NOTES TO UNAUDITED

CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
  Assets and liabilities
measured at fair value on a recurring and non-recurring basis, including
financial liabilities for which the Group has elected the fair value option,
are summarized below:  September 30, 2012Fair Value MeasurementsLevel 1
 
 Level 2
 
 Level 3
 
 Total(In thousands)Recurring fair
  value measurements:Investment
  securities available-for-sale
 $
 -
 
 $
 2,254,531
 
 $
 39,019
 
 $
 2,293,550Securities
  purchased under agreements to resell
 
 -
 
 
 270,000
 
 
 -
 
 
 270,000Money
  market investments
 
 4,017
 
 
 -
 
 
 -
 
 
 4,017Derivative
  assets
 
 -
 
 
 5,407
 
 
 13,088
 
 
 18,495Servicing
  assets
 
 -
 
 
 -
 
 
 10,642
 
 
 10,642Derivative
  liabilities
 
 -
 
 
 (58,269)
 
 
 (12,569)
 
 
 (70,838)$
 4,017
 
 $
 2,471,669
 
 $
 50,180
 
 $
 2,525,866Non-recurring
  fair value measurements:Impaired
  commercial loans
 $
 -
 
 $
 -
 
 $
 35,917
 
 $
 35,917Foreclosed
  real estate
 
 -
 
 
 -
 
 
 39,400
 
 
 39,400$
 -
 
 $
 -
 
 $
 75,317
 
 $
 75,317
  December 31, 2011Fair Value MeasurementsLevel 1
 
 Level 2
 
 Level 3
 
 Total(In thousands)Recurring fair
  value measurements:Investment
  securities available-for-sale
 $
 -
 
 $
 2,912,600
 
 $
 47,312
 
 $
 2,959,912Money
  market investments
 
 3,863
 
 
 -
 
 
 -
 
 
 3,863Derivative
  assets
 
 -
 
 
 -
 
 
 9,317
 
 
 9,317Servicing
  assets
 
 -
 
 
 -
 
 
 10,454
 
 
 10,454Derivative
  liabilities
 
 -
 
 
 (47,425)
 
 
 (9,362)
 
 
 (56,787)$
 3,863
 
 $
 2,865,175
 
 $
 57,721
 
 $
 2,926,759Non-recurring
  fair value measurements:Impaired
  commercial loans
 $
 -
 
 $
 -
 
 $
 46,364
 
 $
 46,364Foreclosed
  real estate
 
 -
 
 
 -
 
 
 27,679
 
 
 27,679$
 -
 
 $
 -
 
 $
 74,043
 
 $
 74,043
 65


---



ORIENTAL FINANCIAL

GROUP INC. NOTES TO UNAUDITED

CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
  The table below presents a
reconciliation of all assets and liabilities measured at fair value on a
recurring basis using significant unobservable inputs (Level 3) for the quarters
and nine-month periods ended September 30, 2012 and 2011:  Quarter Ended September 30, 2012Investment securities available-for-saleDerivative
 
 
 
 
 Derivativeasset
 
 
 
 
 liabilityOther
 
 (S&P
 
 
 
 
 (S&Pdebt
 
 Purchased
 
 Servicing
 
 EmbeddedLevel 3
  Instruments Only
 CDOs
 
 CLOs
 
 securities
 
 Options)
 
 assets
 
 Options)
 
 Total(In thousands)Balance at
  beginning of period
 $
 -
 
 $
 27,280
 
 $
 10,016
 
 $
 11,367
 
 $
 10,776
 
 $
 (10,912)
 
 $
 48,527Gains
  (losses) included in earnings
 
 -
 
 
 -
 
 
 -
 
 
 1,721
 
 
 -
 
 
 (1,707)
 
 
 14Changes in
  fair value of investment
  securities available for sale included
  in other
  comprehensive income
 
 -
 
 
 1,705
 
 
 1
 
 
 -
 
 
 -
 
 
 -
 
 
 1,706New
  instruments acquired
 
 -
 
 
 -
 
 
 -
 
 
 -
 
 
 487
 
 
 -
 
 
 487Principal
  repayments
 
 -
 
 
 -
 
 
 -
 
 
 -
 
 
 (307)
 
 
 -
 
 
 (307)Amortization
 
 -
 
 
 17
 
 
 -
 
 
 -
 
 
 -
 
 
 50
 
 
 67Changes in
  fair value of servicing assets
 
 -
 
 
 -
 
 
 -
 
 
 -
 
 
 (314)
 
 
 -
 
 
 (314)Balance at end
  of period
 $
 -
 
 $
 29,002
 
 $
 10,017
 
 $
 13,088
 
 $
 10,642
 
 $
 (12,569)
 
 $
 50,180
  Quarter Ended September 30, 2011Investment securities available-for-saleDerivative
 
 
 
 
 Derivativeasset
 
 
 
 
 liabilityOther
 
 (S&P
 
 
 
 
 (S&Pdebt
 
 Purchased
 
 Servicing
 
 EmbeddedLevel 3
  Instruments Only
 CDOs
 
 CLOs
 
 securities
 
 Options)
 
 assets
 
 Options)
 
 Total(In thousands)Balance at
  beginning of period
 $
 17,484
 
 $
 28,229
 
 $
 10,068
 
 $
 11,925
 
 $
 9,840
 
 $
 (12,877)
 
 $
 64,669Gains
  (losses) included in earnings
 
 -
 
 
 -
 
 
 -
 
 
 (5,272)
 
 
 -
 
 
 4,459
 
 
 (813)Changes in
  fair value of investment
  securities available for sale included
  in other
  comprehensive income
 
 (1,951)
 
 
 (2,965)
 
 
 10
 
 
 -
 
 
 -
 
 
 -
 
 
 (4,906)New
  instruments acquired
 
 -
 
 
 -
 
 
 -
 
 
 54
 
 
 615
 
 
 1,183
 
 
 1,852Amortization
 
 -
 
 
 179
 
 
 (1)
 
 
 -
 
 
 (225)
 
 
 -
 
 
 (47)Changes in
  fair value of servicing assets
 
 -
 
 
 -
 
 
 -
 
 
 -
 
 
 (216)
 
 
 -
 
 
 (216)Balance at end
  of period
 $
 15,533
 
 $
 25,443
 
 $
 10,077
 
 $
 6,707
 
 $
 10,014
 
 $
 (7,235)
 
 $
 60,539
 66


---



ORIENTAL FINANCIAL

GROUP INC. NOTES TO UNAUDITED

CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
  Nine-Month Period Ended September 30,
  2012Investment securities available-for-saleDerivative
 
 
 
 
 Derivativeasset
 
 
 
 
 liabilityOther
 
 (S&P
 
 
 
 
 (S&Pdebt
 
 Purchased
 
 Servicing
 
 EmbeddedLevel 3
  Instruments Only
 CDOs
 
 CLOs
 
 securities
 
 Options)
 
 assets
 
 Options)
 
 Total(In thousands)Balance at
  beginning of period
 $
 10,530
 
 $
 26,758
 
 $
 10,024
 
 $
 9,317
 
 $
 10,454
 
 $
 (9,362)
 
 $
 57,721Gains
  (losses) included in earnings
 
 -
 
 
 -
 
 
 -
 
 
 3,771
 
 
 -
 
 
 (3,742)
 
 
 29Changes in
  fair value of investment
  securities available for sale included
  in other
  comprehensive income
 
 -
 
 
 2,193
 
 
 (6)
 
 
 -
 
 
 -
 
 
 -
 
 
 2,187New
  instruments acquired
 
 -
 
 
 -
 
 
 -
 
 
 -
 
 
 1,407
 
 
 -
 
 
 1,407Principal
  repayments
 
 -
 
 
 -
 
 
 -
 
 
 -
 
 
 (783)
 
 
 -
 
 
 (783)Amortization
 
 -
 
 
 51
 
 
 (1)
 
 
 -
 
 
 -
 
 
 535
 
 
 585Sales of
  instruments
 
 (10,530)
 
 
 -
 
 
 -
 
 
 -
 
 
 -
 
 
 -
 
 
 (10,530)Changes in
  fair value of servicing assets
 
 -
 
 
 -
 
 
 -
 
 
 -
 
 
 (436)
 
 
 -
 
 
 (436)Balance at end
  of period
 $
 -
 
 $
 29,002
 
 $
 10,017
 
 $
 13,088
 
 $
 10,642
 
 $
 (12,569)
 
 $
 50,180
  Nine-Month Period Ended September 30,
  2011Investment securities available-for-saleDerivative
 
 
 
 
 Derivativeasset
 
 
 
 
 liabilityOther
 
 (S&P
 
 
 
 
 (S&Pdebt
 
 Purchased
 
 Servicing
 
 EmbeddedLevel 3
  Instruments Only
 CDOs
 
 CLOs
 
 securities
 
 Options)
 
 assets
 
 Options)
 
 Total(In thousands)Balance at
  beginning of period
 $
 16,143
 
 $
 25,550
 
 $
 -
 
 $
 9,870
 
 $
 9,695
 
 $
 (12,830)
 
 $
 48,428Gains
  (losses) included in earnings
 
 -
 
 
 -
 
 
 -
 
 
 (3,587)
 
 
 -
 
 
 3,175
 
 
 (412)Changes in
  fair value of investment
  securities
  available for sale included
  in other
  comprehensive income
 
 (610)
 
 
 (287)
 
 
 75
 
 
 -
 
 
 -
 
 
 -
 
 
 (822)New
  instruments acquired
 
 -
 
 
 -
 
 
 10,005
 
 
 424
 
 
 1,828
 
 
 482
 
 
 12,739Principal
  repayments
 
 -
 
 
 -
 
 
 -
 
 
 -
 
 
 (705)
 
 
 -
 
 
 (705)Amortization
 
 -
 
 
 180
 
 
 (3)
 
 
 -
 
 
 -
 
 
 1,938
 
 
 2,115Changes in
  fair value of servicing assets
 
 -
 
 
 -
 
 
 -
 
 
 -
 
 
 (804)
 
 
 -
 
 
 (804)Balance at end
  of period
 $
 15,533
 
 $
 25,443
 
 $
 10,077
 
 $
 6,707
 
 $
 10,014
 
 $
 (7,235)
 
 $
 60,539
  There were purchases and
sales of assets and liabilities measured at fair value on a recurring basis.  There
were no transfers into and out of Level 1 and Level 2 fair value measurements
during the quarters and nine-month periods ended September 30, 2012 and 2011. 67


---



ORIENTAL FINANCIAL

GROUP INC. NOTES TO UNAUDITED

CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
  The table below presents quantitative
information for all assets and liabilities measured at fair value on a
recurring basis using significant unobservable inputs (Level 3) at September 30,
2012:  September 30, 2012Fair Value
 
 Valuation Technique
 
 Unobservable Input
 
 Range(In thousands)Investment
  securities
  available-for-sale:CLOs
 
 $
 29,002
 
 Discounted cash
  flow
 
 Prepayment rate
 
 0% staticProbability of
  default
 
 0% - 25%Loss severity
 
 100%Other debt
  securities
 
 $
 10,017
 
 Market
  comparable bonds
 
 Indicative
  pricing
 
 101.9% - 107.2%Option adjusted
  spread
 
 132.1% - 225.9%Yield to
  maturity
 
 1.6% - 2.6%Spread to
  maturity
 
 131.7% - 225.6%Derivative asset
  (S&P
  Purchased
  Options)
 
 $
 13,088
 
 Option pricing
  model
 
 Implied option
  volatility
 
 11.9% - 35.7%Counterparty
  credit risk
  (based on
  5-year CDS
  spread)
 
 122.1% - 232.7%Servicing assets
 
 $
 10,642
 
 Cash flow
  valuation
 
 Constant
  prepayment rate
 
 9.43% - 33.05%Discount rate
 
 10.50% - 13.50%Derivative
  liability (S&P
  Embedded
  Options)
 
 $
 (12,569)
 
 Option pricing
  model
 
 Implied option
  volatility
 
 11.9% - 35.7%Counterparty
  credit risk (based on 5-year CDS spread)
 
 122.1% - 232.7%
  Information about Sensitivity to Changes in
Significant Unobservable Inputs  CLOs– The significant unobservable inputs used in the
fair value measurement of the Group’s CLOs are prepayment rates, probability of
default, and loss severity in the event of default. Significant increases
(decreases) in any of those inputs in isolation would result in a significantly
lower (higher) fair value measurement. Generally, a change in the assumption
used for the probability of default is accompanied by a directionally similar
change in the assumption used for the loss severity and a directionally,
although not equally proportional, opposite change in the assumption used for
prepayment rates. Other
debt securities– The significant
unobservable inputs used in the fair value measurement of one of the Group’s
other debt securities are indicative comparable pricing, option adjusted spread
(“OAS”), yield to maturity, and spread to maturity. Significant increases
(decreases) in any of those inputs in isolation would result in a significantly
lower (higher) fair value measurement. Generally, a change in the assumption
used for indicative comparable pricing is accompanied by a directionally
opposite change in the assumption used for OAS and a directionally, although
not equally proportional, opposite change in the assumptions used for yield to
maturity and spread to maturity. Derivative
asset (S&P Purchased Options)–
The significant unobservable inputs used in the fair value measurement of
Group’s derivative assets related to S&P purchased options are implied
option volatility and counterparty credit risk. Significant increases
(decreases) in any of those inputs in isolation would result in a significantly
lower (higher) fair value measurement. Generally, a change in the assumption
used for implied option volatility is not necessarily accompanied by
directionally similar or opposite changes in the assumption used for
counterparty credit risk. Servicing
assets– The significant unobservable
inputs used in the fair value measurement of the Group’s servicing assets are
constant prepayment rates and discount rates. Changes in one factor may result
in changes in another (for example, increases in market interest rates may
result in lower prepayments), which may magnify or offset the sensitivities.
Mortgage banking activities, a component of total banking and wealth management
revenues in the unaudited consolidated statements of operations, include the
changes from period to period in the fair value of the mortgage loan servicing
rights, which may result from changes in the valuation model inputs or
assumptions (principally reflecting changes in discount rates and prepayment
speed assumptions) and other changes, including changes due to
collection/realization of expected cash flows. 68


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ORIENTAL FINANCIAL

GROUP INC. NOTES TO UNAUDITED

CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
  Derivative
liability (S&P Embedded Options)– The significant unobservable inputs used in the fair value measurement of the
Group’s derivative liability related to S&P purchased options are implied
option volatility and counterparty credit risk. Significant increases
(decreases) in any of those inputs in isolation would result in a significantly
lower (higher) fair value measurement. Generally, a change in the assumption
used for implied option volatility is not necessarily accompanied by
directionally similar or opposite changes in the assumption used for
counterparty credit risk.  The table below presents a
detail of investment securities available-for-sale classified as Level 3 at September
30, 2012:  September 30, 2012WeightedAmortized
 
 Unrealized
 
 
 
 
 Average
 
 PrincipalType
 
 Cost
 
 Gains (Losses)
 
 Fair Value
 
 Yield
 
 Protection(In thousands)Other debt
  securities
 
 $
 10,000
 
 $
 17
 
 $
 10,017
 
 3.50%
 
 N/AStructured
  credit investmentsCLO
 
 
 15,000
 
 
 (3,174)
 
 
 11,826
 
 2.59%
 
 7.54%CLO
 
 
 11,980
 
 
 (2,418)
 
 
 9,562
 
 2.01%
 
 26.18%CLO
 
 
 9,444
 
 
 (1,830)
 
 
 7,614
 
 1.46%
 
 20.64%36,424
 
 
 (7,422)
 
 
 29,002
 
 2.12%Total
 
 $
 46,424
 
 $
 (7,405)
 
 $
 39,019
 
 2.42%
  Fair Value of Financial Instruments  The information about the
estimated fair value of financial instruments required by GAAP is presented
hereunder. The aggregate fair value amounts presented do not necessarily
represent management’s estimate of the underlying value of the Group.  The estimated fair value is
subjective in nature, involves uncertainties and matters of significant
judgment, and therefore, cannot be determined with precision. Changes in
assumptions could affect these fair value estimates. The fair value estimates
do not take into consideration the value of future business and the value of
assets and liabilities that are not financial instruments. Other significant tangible
and intangible assets that are not considered financial instruments are the
value of long-term customer relationships of the retail deposits, and premises
and equipment. 69


---



ORIENTAL FINANCIAL

GROUP INC. NOTES TO UNAUDITED

CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
  The estimated fair value and
carrying value of the Group’s financial instruments at September 30, 2012 and
December 31, 2011 is as follows:  September 30,
 
 December 31,2012
 
 2011Fair
 
 Carrying
 
 Fair
 
 CarryingValue
 
 Value
 
 Value
 
 Value(In thousands)Level 1Financial
  Assets:Cash and
  cash equivalents
 $
 515,495
 
 $
 515,495
 
 $
 591,487
 
 $
 591,487Level 2Financial
  Assets:Securities
  purchased under agreements to resell
 
 270,000
 
 
 270,000
 
 
 -
 
 
 -Trading securities
 
 1,514
 
 
 1,514
 
 
 180
 
 
 180Investment
  securities available-for-sale
 
 2,254,531
 
 
 2,254,531
 
 
 2,912,600
 
 
 2,912,600Investment
  securities held-to-maturity
 
 874,921
 
 
 835,084
 
 
 904,556
 
 
 884,026Federal
  Home Loan Bank (FHLB) stock
 
 22,865
 
 
 22,865
 
 
 23,779
 
 
 23,779Derivative
  assets
 
 5,407
 
 
 5,407
 
 
 -
 
 
 -Financial
  Liabilities:Derivative
  liabilities
 
 58,269
 
 
 58,269
 
 
 47,425
 
 
 47,425Level 3Financial Assets:Investment
  securities available-for-sale
 
 39,019
 
 
 39,019
 
 
 47,312
 
 
 47,312Total loans
  (including loans held-for-sale)Non-covered loans, net
 
 1,199,806
 
 
 1,182,730
 
 
 1,211,539
 
 
 1,169,917Covered
  loans, net
 
 512,344
 
 
 413,588
 
 
 584,110
 
 
 496,276Derivative
  assets
 
 13,088
 
 
 13,088
 
 
 9,317
 
 
 9,317FDIC
  shared-loss indemnification asset
 
 216,394
 
 
 328,573
 
 
 312,957
 
 
 392,367Accrued
  interest receivable
 
 14,935
 
 
 14,935
 
 
 20,182
 
 
 20,182Servicing
  assets
 
 10,642
 
 
 10,642
 
 
 10,454
 
 
 10,454Financial
  Liabilities:Deposits
 
 2,323,831
 
 
 2,214,367
 
 
 2,567,352
 
 
 2,435,185Securities
  sold under agreements to repurchase
 
 2,702,122
 
 
 2,652,366
 
 
 3,092,122
 
 
 3,056,238Advances
  from FHLB
 
 287,616
 
 
 285,395
 
 
 285,663
 
 
 281,753FDIC-guaranteed term notes
 
 -
 
 
 -
 
 
 105,752
 
 
 105,834Subordinated capital notes
 
 36,464
 
 
 36,083
 
 
 36,235
 
 
 36,083Accrued
  expenses and other liabilities
 
 33,038
 
 
 33,038
 
 
 35,602
 
 
 35,602
 70


---



ORIENTAL FINANCIAL

GROUP INC. NOTES TO UNAUDITED

CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
  The following methods and assumptions were used to estimate
the fair values of significant financial instruments at September 30, 2012 and
December 31, 2011:  •Cash and cash equivalents (including money
market investments and time deposits with other banks), accrued interest
receivable, securities purchased under agreements to resell, accrued expenses
and other liabilities have been valued at the carrying amounts reflected in the
unaudited consolidated statements of financial condition as these are
reasonable estimates of fair value given the short-term nature of the
instruments.  •Investments in FHLB stock are valued
at their redemption value.  •The fair value of investment
securities, including trading securities, is based on quoted market prices,
when available, or market prices provided by recognized broker dealers. If
listed prices or quotes are not available, fair value is based upon externally
developed models that use both observable and unobservable inputs depending on
the market activity of the instrument. The estimated fair value of the
structured credit investments is determined by using a third-party cash flow
valuation model to calculate the present value of projected future cash flows.
The assumptions used, which are highly uncertain and require a high degree of
judgment, include primarily market discount rates, current spreads, duration,
leverage, default, home price depreciation, and loss rates. The assumptions
used are drawn from a wide array of data sources, including the performance of
the collateral underlying each deal. The external-based valuation, which is
obtained at least on a quarterly basis, is analyzed and its assumptions are
evaluated and incorporated in either an internal-based valuation model when
deemed necessary, or compared to counterparties’ prices and agreed by
management.  •The fair value of the FDIC shared-loss
indemnification asset represents the present value of the estimated cash
payments (net of amounts owed to the FDIC) expected to be received from the
FDIC for future losses on covered assets based on the credit assumptions on
estimated cash flows for each covered asset pool and the loss sharing percentages.
The ultimate collectability of the FDIC shared-loss indemnification asset is
dependent upon the performance of the underlying covered loans, the passage of
time and claims paid by the FDIC which are impacted by the Bank’s adherence to
certain guidelines established by the FDIC.  •The
fair value of servicing assets is estimated by using a cash flow valuation
model which calculates the present value of estimated future net servicing cash
flows, taking into consideration actual and expected loan prepayment rates,
discount rates, servicing costs, and other economic factors, which are
determined based on current market conditions.  •The
fair values of the derivative instruments are provided by valuation experts and
counterparties. Certain derivatives with limited market activity are valued
using externally developed models that consider unobservable market parameters.
The Group has offered its customers certificates of deposit with an option tied
to the performance of the S&P Index, and uses equity indexed option
agreements with major broker-dealer companies to manage its exposure to changes
in this index. Their fair value is obtained through the use of an external
based valuation that was thoroughly evaluated and adopted by management as its
measurement tool for these options. The payoff of these options is linked to
the average value of the S&P Index on a specific set of dates during the
life of the option. The methodology uses an average rate option or a
cash-settled option whose payoff is based on the difference between the
expected average value of the S&P Index during the remaining life of the
option and the strike price at inception. The assumptions, which are uncertain
and require a degree of judgment, include primarily S&P Index volatility,
forward interest rate projections, estimated index dividend payout, and
leverage.  •Fair
value of derivative liabilities, which include interest rate swaps and
forward-settlement swaps, are based on the net discounted value of the
contractual projected cash flows of both the pay-fixed receive-variable legs of
the contracts. The projected cash flows are based on the forward yield curve,
and discounted using current estimated market rates.  •The
fair value of the covered and non-covered loan portfolio (including loans
held-for-sale) is estimated by segregating by type, such as mortgage,
commercial, consumer, and leasing. Each loan segment is further segmented into
fixed and adjustable interest rates and by performing and non-performing
categories. The fair value of performing loans is calculated by discounting
contractual cash flows, adjusted for prepayment estimates (voluntary and
involuntary), if any, using estimated current market discount rates that
reflect the credit and interest rate risk inherent in the loan. This fair value
is not currently an indication of an exit price as that type of assumption
could result in a different fair value estimate.  •The
fair value of demand deposits and savings accounts is the amount payable on
demand at the reporting date. The fair value of fixed-maturity certificates of
deposit is based on the discounted value of the contractual cash flows, using
estimated current market discount rates for deposits of similar remaining
maturities.  71


---



ORIENTAL FINANCIAL

GROUP INC. NOTES TO UNAUDITED

CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 •The fair value of long-term borrowings, which include
securities sold under agreements to repurchase, advances from FHLB,
FDIC-guaranteed term notes, and subordinated capital notes is based on the
discounted value of the contractual cash flows using current estimated market
discount rates for borrowings with similar terms, remaining maturities and put
dates.  •The
fair value of commitments to extend credit and unused lines of credit is based
on fees currently charged to enter into similar agreements, taking into account
the remaining terms of the agreements and the counterparties’ credit standings.  NOTE 18-SEGMENT REPORTING  The Group segregates its
businesses into the following major reportable segments of business: Banking,
Wealth Management, and Treasury. Management established the reportable segments
based on the internal reporting used to evaluate performance and to assess
where to allocate resources. Other factors such as the Group’s organization,
nature of its products, distribution channels and economic characteristics of
the products were also considered in the determination of the reportable
segments. The Group measures the performance of these reportable segments based
on pre-established goals of different financial parameters such as net income,
net interest income, loan production, and fees generated. The Group’s
methodology for allocating non-interest expenses among segments is based on
several factors such as revenues, employee headcount, occupied space, dedicated
services or time, among others. These factors are reviewed on a periodical
basis and may change if the conditions warrant.  Banking includes the Bank’s
branches and mortgage banking, with traditional banking products such as
deposits and mortgage, commercial and consumer loans. Mortgage banking
activities are carried out by the Bank’s mortgage banking division, whose
principal activity is to originate mortgage loans for the Group’s own
portfolio. As part of its mortgage banking activities, the Group may sell loans
directly into the secondary market or securitize conforming loans into
mortgage-backed securities.  Wealth Management is
comprised of the Bank’s trust division, Oriental Financial Services, Oriental
Insurance, and CPC. The core operations of this segment are financial planning,
money management and investment banking, brokerage services, insurance sales
activity, corporate and individual trust and retirement services, as well as
pension plan administration services.  The Treasury segment
encompasses all of the Group’s asset/liability management activities such as:
purchases and sales of investment securities, interest rate risk management,
derivatives, and borrowings. Intersegment sales and transfers, if any, are
accounted for as if the sales or transfers were to third parties, that is, at
current market prices. The accounting policies of the segments are the same as
those described in the “Summary of Significant Accounting Policies” included in
the Group’s Annual Report on Form 10-K. 72


---



ORIENTAL FINANCIAL

GROUP INC. NOTES TO UNAUDITED

CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
  Following
are the results of operations and the selected financial information by operating
segment as of and for the quarters and nine-month periods ended September 30,
2012 and 2011:  Quarter Ended September 30, 2012Wealth
 
 
 
 
 Total Major
 
 
 
 
 ConsolidatedBanking
 
 Management
 
 Treasury
 
 Segments
 
 Eliminations
 
 Total(In thousands)Interest income
 $
 40,247
 
 $
 -
 
 $
 25,439
 
 $
 65,686
 
 $
 -
 
 $
 65,686Interest expense
 
 (5,328)
 
 
 -
 
 
 (20,155)
 
 
 (25,483)
 
 
 -
 
 
 (25,483)Net interest
  income
 
 34,919
 
 
 -
 
 
 5,284
 
 
 40,203
 
 
 -
 
 
 40,203Provision for
  non-covered loan and lease losses
 
 (3,600)
 
 
 -
 
 
 -
 
 
 (3,600)
 
 
 -
 
 
 (3,600)Provision for
  covered loan and lease losses, net
 
 (221)
 
 
 -
 
 
 -
 
 
 (221)
 
 
 -
 
 
 (221)Non-interest
  income (loss)
 
 (3,130)
 
 
 6,072
 
 
 10,710
 
 
 13,652
 
 
 -
 
 
 13,652Non-interest
  expenses
 
 (22,980)
 
 
 (2,540)
 
 
 (4,859)
 
 
 (30,379)
 
 
 -
 
 
 (30,379)Intersegment
  revenues
 
 343
 
 
 -
 
 
 -
 
 
 343
 
 
 (343)
 
 
 -Intersegment
  expenses
 
 -
 
 
 (265)
 
 
 (78)
 
 
 (343)
 
 
 343
 
 
 -Income before
  income taxes
 $
 5,331
 
 $
 3,267
 
 $
 11,057
 
 $
 19,655
 
 $
 -
 
 $
 19,655Total assets
 $
 3,157,147
 
 $
 16,370
 
 $
 3,590,836
 
 $
 6,764,353
 
 $
 (713,148)
 
 $
 6,051,205
  Quarter Ended September 30, 2011Wealth
 
 
 
 
 Total Major
 
 
 
 
 ConsolidatedBanking
 
 Management
 
 Treasury
 
 Segments
 
 Eliminations
 
 Total(In thousands)Interest income
 $
 35,383
 
 $
 -
 
 $
 36,153
 
 $
 71,536
 
 $
 -
 
 $
 71,536Interest expense
 
 (8,247)
 
 
 -
 
 
 (30,819)
 
 
 (39,066)
 
 
 -
 
 
 (39,066)Net interest
  income
 
 27,136
 
 
 -
 
 
 5,334
 
 
 32,470
 
 
 -
 
 
 32,470Provision for
  non-covered loan and lease losses
 
 (3,800)
 
 
 -
 
 
 -
 
 
 (3,800)
 
 
 -
 
 
 (3,800)Recapture of covered
  loan and lease losses, net
 
 1,936
 
 
 -
 
 
 -
 
 
 1,936
 
 
 -
 
 
 1,936Non-interest
  income
 
 3,065
 
 
 5,503
 
 
 8,397
 
 
 16,965
 
 
 -
 
 
 16,965Non-interest
  expenses
 
 (22,899)
 
 
 (4,167)
 
 
 (3,137)
 
 
 (30,203)
 
 
 -
 
 
 (30,203)Intersegment
  revenues
 
 319
 
 
 -
 
 
 -
 
 
 319
 
 
 (319)
 
 
 -Intersegment
  expenses
 
 -
 
 
 (202)
 
 
 (117)
 
 
 (319)
 
 
 319
 
 
 -Income (loss)
  before income taxes
 $
 5,757
 
 $
 1,134
 
 $
 10,477
 
 $
 17,368
 
 $
 -
 
 $
 17,368Total assets
 $
 3,236,344
 
 $
 14,361
 
 $
 4,464,861
 
 $
 7,715,566
 
 $
 (692,278)
 
 $
 7,023,288
 73


---



ORIENTAL FINANCIAL

GROUP INC. NOTES TO UNAUDITED

CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
  Nine-Month Period Ended September 30,
  2012Wealth
 
 
 
 
 Total Major
 
 
 
 
 ConsolidatedBanking
 
 Management
 
 Treasury
 
 Segments
 
 Eliminations
 
 Total(In thousands)Interest income
 $
 117,475
 
 $
 -
 
 $
 78,918
 
 $
 196,393
 
 $
 -
 
 $
 196,393Interest expense
 
 (17,625)
 
 
 -
 
 
 (66,626)
 
 
 (84,251)
 
 
 -
 
 
 (84,251)Net interest
  income
 
 99,850
 
 
 -
 
 
 12,292
 
 
 112,142
 
 
 -
 
 
 112,142Provision for
  non-covered loan and lease losses
 
 (10,400)
 
 
 -
 
 
 -
 
 
 (10,400)
 
 
 -
 
 
 (10,400)Provision for
  covered loan and lease losses, net
 
 (8,845)
 
 
 -
 
 
 -
 
 
 (8,845)
 
 
 -
 
 
 (8,845)Non-interest
  income (loss)
 
 (3,707)
 
 
 17,803
 
 
 29,272
 
 
 43,368
 
 
 -
 
 
 43,368Non-interest
  expenses
 
 (69,095)
 
 
 (13,050)
 
 
 (5,861)
 
 
 (88,006)
 
 
 -
 
 
 (88,006)Intersegment
  revenues
 
 1,187
 
 
 -
 
 
 -
 
 
 1,187
 
 
 (1,187)
 
 
 -Intersegment
  expenses
 
 -
 
 
 (870)
 
 
 (317)
 
 
 (1,187)
 
 
 1,187
 
 
 -Income before
  income taxes
 $
 8,990
 
 $
 3,883
 
 $
 35,386
 
 $
 48,259
 
 $
 -
 
 $
 48,259
  Nine-Month Period Ended September 30,
  2011Wealth
 
 
 
 
 Total Major
 
 
 
 
 ConsolidatedBanking
 
 Management
 
 Treasury
 
 Segments
 
 Eliminations
 
 Total(In thousands)Interest income
 $
 96,602
 
 $
 -
 
 $
 135,170
 
 $
 231,772
 
 $
 -
 
 $
 231,772Interest expense
 
 (25,898)
 
 
 -
 
 
 (93,316)
 
 
 (119,214)
 
 
 -
 
 
 (119,214)Net interest income
 
 70,704
 
 
 -
 
 
 41,854
 
 
 112,558
 
 
 -
 
 
 112,558Provision for
  non-covered loan and lease losses
 
 (11,400)
 
 
 -
 
 
 -
 
 
 (11,400)
 
 
 -
 
 
 (11,400)Recapture of
  covered loan and lease losses, net
 
 1,387
 
 
 -
 
 
 -
 
 
 1,387
 
 
 -
 
 
 1,387Non-interest
  income
 
 15,719
 
 
 14,879
 
 
 10,102
 
 
 40,700
 
 
 -
 
 
 40,700Non-interest
  expenses
 
 (70,873)
 
 
 (12,362)
 
 
 (8,013)
 
 
 (91,248)
 
 
 -
 
 
 (91,248)Intersegment
  revenues
 
 1,042
 
 
 -
 
 
 -
 
 
 1,042
 
 
 (1,042)
 
 
 -Intersegment
  expenses
 
 -
 
 
 (708)
 
 
 (334)
 
 
 (1,042)
 
 
 1,042
 
 
 -Income before
  income taxes
 $
 6,579
 
 $
 1,809
 
 $
 43,609
 
 $
 51,997
 
 $
 -
 
 $
 51,997
  NOTE 19–SUBSEQUENT EVENTS  On October 31, 2012 the Group sold 4,829,267 shares of
its common stock at a public offering price of $11.10 and a purchase price of
$10.66 per share in a registered public offering.  On November 5, 2012 the Group sold 960,000 shares of
its 7.125% Non-Cumulative Perpetual Preferred Stock, Series D (the “Series D
Preferred Stock”) at a public offering price of $25 and a purchase price of $24
per share in a registered public offering.    74


---



Item
2 — MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS  SELECTED
  FINANCIAL DATAQuarter Ended September 30,
 
 Nine-Month Period Ended September 30,Variance
 
 
 
 
 
 
 
 Variance2012
 
 2011
 
 %
 
 2012
 
 2011
 
 %EARNINGS
  DATA:
 (In thousands, except per share data)Interest income
 $
 65,686
 
 $
 71,536
 
 -8.2%
 
 $
 196,393
 
 $
 231,772
 
 -15.3%Interest expense
 
 25,483
 
 
 39,066
 
 -34.8%
 
 
 84,251
 
 
 119,214
 
 -29.3%Net
  interest income
 
 40,203
 
 
 32,470
 
 23.8%
 
 
 112,142
 
 
 112,558
 
 -0.4%Provision for
  non-covered loan and lease losses
 
 3,600
 
 
 3,800
 
 -5.3%
 
 
 10,400
 
 
 11,400
 
 -8.8%Provision for
  (recapture of) covered loan and lease losses, net
 
 221
 
 
 (1,936)
 
 111.4%
 
 
 8,845
 
 
 (1,387)
 
 737.7%Total
  provision for loan and lease losses, net
 
 3,821
 
 
 1,864
 
 105.0%
 
 
 19,245
 
 
 10,013
 
 92.2%Net
  interest income after provision for loan
  and lease losses
 
 36,382
 
 
 30,606
 
 18.9%
 
 
 92,897
 
 
 102,545
 
 -9.4%Non-interest
  income
 
 13,652
 
 
 16,965
 
 -19.5%
 
 
 43,368
 
 
 40,700
 
 6.6%Non-interest
  expenses
 
 30,379
 
 
 30,203
 
 0.6%
 
 
 88,006
 
 
 91,248
 
 -3.6%Income
  before taxes
 
 19,655
 
 
 17,368
 
 13.2%
 
 
 48,259
 
 
 51,997
 
 -7.2%Income tax
  expense
 
 1,894
 
 
 580
 
 226.6%
 
 
 4,888
 
 
 5,661
 
 -13.7%Net
  Income
 
 17,761
 
 
 16,788
 
 5.8%
 
 
 43,371
 
 
 46,336
 
 -6.4%Less: dividends
  on preferred stock
 
 (3,039)
 
 
 (1,201)
 
 153.0%
 
 
 (5,440)
 
 
 (3,602)
 
 51.0%Income
  available to common shareholders
 $
 14,722
 
 $
 15,587
 
 -5.5%
 
 $
 37,931
 
 $
 42,734
 
 -11.2%PER SHARE
  DATA:Basic
 $
 0.36
 
 $
 0.35
 
 2.1%
 
 $
 0.93
 
 $
 0.95
 
 -2.1%Diluted
 $
 0.35
 
 $
 0.35
 
 -2.3%
 
 $
 0.92
 
 $
 0.95
 
 -3.0%Average
  common shares outstanding
 
 40,738
 
 
 44,015
 
 -7.4%
 
 
 40,828
 
 
 45,050
 
 -9.4%Average common
  shares outstanding and equivalents
 
 47,978
 
 
 44,105
 
 8.8%
 
 
 43,316
 
 
 45,141
 
 -4.0%Book value
  per common share
 $
 15.40
 
 $
 15.05
 
 2.3%
 
 $
 15.40
 
 $
 15.05
 
 2.3%Tangible book
  value per common share
 $
 15.30
 
 $
 14.96
 
 2.3%
 
 $
 15.30
 
 $
 14.96
 
 2.3%Market price
  at end of period
 $
 10.52
 
 $
 9.67
 
 8.8%
 
 $
 10.52
 
 $
 9.67
 
 8.8%Cash
  dividends declared per common share
 $
 0.06
 
 $
 0.05
 
 20.0%
 
 $
 0.18
 
 $
 0.15
 
 20.0%Cash
  dividends declared on common shares
 $
 2,445
 
 $
 2,202
 
 11.0%
 
 $
 7,331
 
 $
 6,677
 
 9.8%PERFORMANCE
  RATIOS:Return on
  average assets (ROA)
 
 1.11%
 
 
 0.95%
 
 16.7%
 
 
 0.89%
 
 
 0.86%
 
 4.0%Return on
  average common equity (ROE)
 
 9.27%
 
 
 9.41%
 
 -1.5%
 
 
 8.01%
 
 
 8.65%
 
 -7.3%Equity-to-assets
  ratio
 
 12.75%
 
 
 10.36%
 
 23.0%
 
 
 12.75%
 
 
 10.36%
 
 23.0%Efficiency
  ratio
 
 59.04%
 
 
 69.30%
 
 -14.8%
 
 
 60.13%
 
 
 63.49%
 
 -5.3%Expense ratio
 
 1.32%
 
 
 1.19%
 
 10.6%
 
 
 1.22%
 
 
 1.23%
 
 -0.9%Interest rate
  spread
 
 2.69%
 
 
 1.97%
 
 36.7%
 
 
 2.48%
 
 
 2.27%
 
 9.3%Interest rate
  margin
 
 2.77%
 
 
 2.03%
 
 36.4%
 
 
 2.55%
 
 
 2.31%
 
 10.4%
 75


---



SELECTED
  FINANCIAL DATA - (Continued)September 30,
 
 December 31,
 
 Variance2012
 
 2011
 
 %PERIOD END
  BALANCES AND CAPITAL RATIOS:
 (In thousands, except per share data)Investments
  and loansInvestments
  securities
 $
 3,153,082
 
 $
 3,867,970
 
 -18.5%Loans and
  leases not covered under shared-loss
  agreements with the FDIC, net
 
 1,182,730
 
 
 1,169,917
 
 1.1%Loans and
  leases covered under shared-loss
  agreements with the FDIC, net
 
 413,588
 
 
 496,276
 
 -16.7%Total
  investments and loans
 $
 4,749,400
 
 $
 5,534,163
 
 -14.2%Deposits and
  borrowingsDeposits
 $
 2,214,367
 
 $
 2,435,185
 
 -9.1%Securities
  sold under agreements to repurchase
 
 2,652,366
 
 
 3,056,238
 
 -13.2%Other
  borrowings
 
 321,478
 
 
 423,670
 
 -24.1%Total
  deposits and borrowings
 $
 5,188,211
 
 $
 5,915,093
 
 -12.3%Stockholders’
  equityPreferred
  stock
 $
 152,000
 
 $
 68,000
 
 123.5%Common stock
 
 47,842
 
 
 47,809
 
 0.1%Additional
  paid-in capital
 
 495,155
 
 
 499,096
 
 -0.8%Legal
  surplus
 
 54,407
 
 
 50,178
 
 8.4%Retained
  earnings
 
 94,520
 
 
 68,149
 
 38.7%Treasury
  stock, at cost
 
 (81,300)
 
 
 (74,808)
 
 -8.7%Accumulated
  other comprehensive income
 
 9,063
 
 
 37,131
 
 -75.6%Total
  stockholders' equity
 $
 771,687
 
 $
 695,555
 
 10.9%Capital
  ratiosLeverage
  capital
 
 10.91%
 
 
 9.65%
 
 13.0%Tier 1
  risk-based capital
 
 36.33%
 
 
 31.84%
 
 14.1%Total
  risk-based capital
 
 37.63%
 
 
 33.12%
 
 13.6%Tier 1
  common equity to risk-weighted assets
 
 31.03%
 
 
 27.01%
 
 14.9%Financial
  assets managedTrust assets
  managed
 $
 2,449,718
 
 $
 2,216,088
 
 10.5%Broker-dealer assets gathered
 
 2,167,379
 
 
 1,926,147
 
 12.5%Total assets
  managed
 $
 4,617,097
 
 $
 4,142,235
 
 11.5%
 76


---



OVERVIEW OF FINANCIAL
PERFORMANCE  The following discussion of
the Group’s financial condition and results of operations should be read in
conjunction with the foregoing “Selected Financial Data” and the Group’s
unaudited consolidated financial statements and related notes. This discussion
and analysis contains forward-looking statements. Please see “Forward-Looking
Statements” and “Risk Factors” for discussion of the uncertainties, risks and
assumptions associated with these statements.  The Group is a publicly-owned
financial holding company that provides a full range of banking and wealth management
services through its subsidiaries. It provides comprehensive banking and wealth
management services through a complete range of banking and financial
solutions, including mortgage, commercial and consumer lending; financing leases;
checking and savings accounts; financial planning, insurance, wealth
management, and investment brokerage; and corporate and individual trust and
retirement services. The Group operates through three major business segments:
Banking, Wealth Management, and Treasury, and distinguishes itself based on quality
service and marketing efforts focused on mid and high net worth individuals and
families, including professionals and owners of small and mid-sized businesses,
primarily in Puerto Rico. The Group has 28 financial centers in Puerto Rico and
a subsidiary in Boca Raton, Florida. The Group’s long-term goal is to strengthen
its banking and wealth management franchise by expanding its lending
businesses, increasing the level of integration in the marketing and delivery
of banking and wealth management services, maintaining effective
asset-liability management, growing non-interest revenues from banking and
wealth management services, and improving operating efficiencies.  The Group’s diversified mix
of businesses and products generates both the interest income traditionally associated
with a banking institution and non-interest income traditionally associated
with a financial services institution (generated by such businesses as
securities brokerage, fiduciary services, investment banking, insurance and
retirement plan administration). Although all of these businesses, to varying
degrees, are affected by interest rate and financial market fluctuations and
other external factors, the Group’s commitment is to continue producing a
balanced and growing revenue stream.  By
acquiring the BBVAPR Companies, we will accelerate our longstanding goal of
creating a more stable balance sheet, with a larger and more diversified loan
portfolio, a greater retail deposit funding base, and a smaller investment
securities portfolio, improving earnings stability. Furthermore, in connection
with the BBVAPR Acquisition, we plan to complete the sale of approximately $1.6
billion of our and BBVAPR Bank’s investment securities and use the proceeds
from such sales as well as approximately $200 million of cash to repay
approximately $1.8 billion of wholesale funding.  In addition to reducing the
sensitivity of our balance sheet to interest rates, the planned deleveraging
would improve our capital ratios by reducing the size of our balance sheet.  We
expect that the completion of the planned deleveraging will result in a
one-time charge to income before income taxes of approximately $10 million (or
$7.6 million after giving effect to income taxes), in the aggregate, which
includes the expected securities mark-to-market gains or losses and the
expected cost on the termination of the wholesale funding agreements.  There is
no expected one-time charge from the planned deleveraging of BBVAPR Bank’s
securities portfolio and wholesale funding since the purchase accounting fair
value adjustments will reflect the sales price of the securities and the
liquidation value of the liabilities being deleveraged.  The $1.8 billion
planned deleveraging is also expected to result in a reduction to pre-tax income
of approximately $6.2 million in 2013 and approximately $4.0 million in 2014
(or $4.3 million and $2.8 million, respectively, after giving effect to income
taxes).  Actual amounts will depend on market prices for the investment
securities to be sold and the remaining term under the wholesale funding
agreements at the time of the deleveraging transactions.  To finance in part the BBVAPR
Acquisition, we have raised an aggregate amount of approximately $158.5 million
(before expenses) in common and preferred stock through the private placement
of $84 million in Convertible Preferred Stock, which closed on July 3, 2012,
the underwritten public offering of approximately $51.5 million in common
stock, which closed on October 31, 2012, and the underwritten public offering
of approximately $23 million in Series D Preferred Stock, which closed on
November 5, 2012.  We focused on two main
initiatives during the quarter ended September 30, 2012, that is, continuing to
grow our banking operations, and achieving the milestones necessary to
successfully close the BBVAPR Acquisition before the end of the year. 
Operating revenues for the quarter ended September 30, 2012 increased 8.9%, or
$4.4 million, to $53.9 million when compared to the same period in 2011.  Operating
revenues for the nine-month period ended 2012 increased 1.5%, or $2.3 million,
to $155.5 million when compared to the same period in 2011.  77


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The table below presents the
Group’s operating revenues for the quarters and nine-month periods ended September
30, 2012 and 2011:  Quarter Ended September 30,
 
 Nine-Month Period Ended September 30,2012
 
 2011
 
 2012
 
 2011(In thousands)OPERATING
  REVENUENet interest
  income
 $
 40,203
 
 $
 32,470
 
 $
 112,142
 
 $
 112,558Non-interest
  income, net
 
 13,652
 
 
 16,965
 
 
 43,368
 
 
 40,700Total
  operating revenues
 $
 53,855
 
 $
 49,435
 
 $
 155,510
 
 $
 153,258
  Interest Income  Total interest income for the
quarter and nine-month period ended September 30, 2012 decreased 8.2% to $65.7
million and 15.3% to $196.4 million, respectively, as compared to the same
periods in 2011. Such decrease primarily reflects a 29.6% and 41.6% decrease on
interest income from investments for the quarter and nine-month period ended
September 30, 2012, respectively, primarily related to lower yields and a lower
balance in the investment securities portfolio as a result of the sale of $962.8
million in mortgage-backed securities. Also, there was an increase in premium
amortization due to increased prepayment speeds. The yield on investments
decreased from 3.08% and 3.79% for the quarter and nine-month period ended
September 30, 2011, respectively, to 2.44% and 2.50% for the quarter and
nine-month period ended September 30, 2012.  The decrease in interest
income on investments was mitigated by an increase in interest income from
covered loans from $18.2 million and $45.5 million for the quarter and
nine-month period ended September 30, 2011, respectively, to $22.3 million and
$64.2 million for the quarter and nine-month period ended September 30, 2012.  Also,
the yield on covered loans increased from 13.73% and 10.61% for the quarter and
nine-month period ended September 30, 2011, respectively, to 20.38% and 18.50%
for the quarter and nine-month period ended September 30, 2012. This increase
in yield is the result of higher projected cash flows on certain pools of
covered loans, as credit losses have been lower than initially estimated for
these loan pools. The accretable yield amounted to $183.8 million at September
30, 2012 compared to $188.8 million at December 31, 2011. Interest income from
non-covered loans remained level.  Interest Expense  Total interest expense for
the quarter and nine-month period ended September 30, 2012 decreased 34.8% to $25.5
million and 29.3% to $84.3 million, respectively, as compared to the same
periods in 2011. This reflects the lower cost of both, securities sold under
agreements to repurchase (2.03% vs. 2.72%; 2.16% vs. 2.74%) and deposits (1.32%
vs. 1.90%; 1.44% vs. 1.88%) for the quarter and nine-month period ended
September 30, 2012, as compared to the same periods in 2011, which reflects
continuing progress in the repricing of the Group’s core retail deposits and
further reductions in its cost of funds.  In December 2011, $600
million in repurchase agreements, with an average cost of 4.23%, matured. The
Group paid off $300 million of these repurchase agreements. The remaining
balance of $300 million was renewed for an average period of approximately 3.5
years at an effective fixed rate of 2.36%. To further reduce its cost of
borrowings, in May 2012, the Group renewed $350 million in repurchase
agreements, with an average cost of 4.26%, at a new effective rate of
approximately 1.90%.  During the quarter ended September 30, 2012, the Group
initiated a plan to deleverage its balance sheet in connection with the BBVAPR
Acquisition ahead of schedule by terminating repurchase agreements amounting to
$400 million with an average cost of 3.25%.  In accordance with the terms of the
repurchase agreements the Group had to pay cancellation fees amounting to $24.3
million.  As a result of the aforementioned transactions, total interest
expense on securities sold under agreements to repurchase declined 33.9% and 30.3%
during the quarter and nine-month period ended September 30, 2012,
respectively, as compared to the same periods in 2011.  78


---



Net
Interest Income  Net interest income for the
quarter and nine-month period ended September 30, 2012 was $40.2 million and $112.1
million, respectively, an increase of 23.8% and a slight decrease of 0.4% when
compared with the same periods in 2011.  The increase for the quarter ended
September 30, 2012 was mostly due to the net effect of a 22.3% increase in
interest income from covered loans as a result of higher yields and a 34.8%
decrease in interest expense due to lower cost of funds, offset by a decrease
of 29.6% on interest income from investments, related to lower yields and a
lower balance in the investment securities portfolio.  Net interest margin of 2.77% and
2.55% for the quarter and nine-month period ended September 30, 2012 increased
74 and 24 basis points, respectively, when compared to the same periods in 2011.  Provision for Loan and
Lease Losses  Provision for non-covered
loans and lease losses for the quarter and nine-month period ended September
30, 2012 decreased $200 thousand and $1 million, respectively, when compared to
the same periods in the previous year.  Provision for covered loans and lease
losses for the quarter and nine-month period ended September 30, 2012 was $221
thousand and $8.8 million, respectively, reflecting the Group’s revision to the
expected cash flows in the covered loan portfolio considering actual
experiences and changes in the Group’s expectations for the remaining terms of
the loan pools. During the first quarter of 2012, some covered construction and
development and commercial real estate loan pools underperformed, which
required a provision amounting to $7.2 million, net of the estimated
reimbursement from the FDIC.  Additional net provisions of $1.5 million and
$221 thousand were recorded for the quarters ended June 30, 2012 and September
30, 2012, respectively.  Non-Interest Income  During the quarter and
nine-month period ended September 30, 2012, core banking and wealth management revenues
increased 1.2% to $11.3 million and 9.8% to $34.2 million, respectively, as compared
to the same periods in 2011, primarily reflecting a $655 thousand and $3.2
million increase in wealth management revenues to $6.0 million and $17.8
million, respectively, attributed to an increase of 11.5% in assets under
management from December 31, 2011.  Net amortization of the FDIC shared-loss
indemnification asset of $8.1 million and $18.5 million for the quarter and
nine-month period ended September 30, 2012, respectively, compared to a net amortization
of $2.4 million and $191 thousand for the same periods in 2011, resulted from
the ongoing evaluation of expected cash flows of the loan portfolio acquired in
the FDIC-assisted acquisition.  As a result of such evaluation, the Group
expects a decrease in losses to be collected from the FDIC and the improved
re-yielding of the accretable yield on the covered loans.  This reduction in
claimable losses amortizes the shared-loss indemnification asset through the
life of the shared-loss agreements.  This amortization is net of the accretion
of the discount recorded to reflect the expected claimable loss at its net
present value.  The quarter and nine-month
period ended September 30, 2012 include a gain on the sale of investment
securities of $36.4 million and $55.7 million, respectively, as the Group took
advantage of market opportunities and initiated its deleverage in connection
with the BBVAPR Acquisition. The purpose of the deleverage plan is to reduce
the Group’s capital needs for the BBVAPR Acquisition; to enhance its returns
going forward; and to have a more traditional bank balance sheet following the
BBVAPR Acquisition.  As part of this plan, in the quarter ended September 30,
2012, the Group sold $532.4 million of securities with an average book yield of
3.86%.  At the same time, the Group terminated prior to maturity $400 million
of repurchase agreements with an average cost of 3.33%.  Non-Interest Expense  Non-interest expense slightly
increased to $30.4 million for the quarter ended September 30, 2012, and
decreased to $88.0 million for the nine-month period then ended, compared to $30.2
million and $91.2 million in the same periods of the previous year.  The
quarter ended September 30, 2012 included approximately $1.5 million in
expenses related to the proposed BBVAPR Acquisition.  The efficiency ratio for the
quarter and nine-month period ended September 30, 2012 was 59.04% and 60.13%,
respectively, compared to 69.30% and 63.49% for the quarter and nine-month
period ended September 30, 2011.  79


---



Income Tax Expense  Income tax expense was $1.9
million and $4.9 million for the quarter and nine-month period ended September
30, 2012, respectively, compared to an expense of $580 thousand and $5.7
million for the same periods in 2011. At
December 31, 2011, OIB had $2.9 million in income tax effect of unrecognized
gain on available-for-sale securities included in other comprehensive income.
Following the change in OIB’s applicable tax rate from 5% to 0% as a result of
new Puerto Rico legislation adopted in 2011, this remaining tax balance will
flow through income as these securities are repaid or sold in future periods.
During the quarter and nine-month period ended September 30, 2012, income tax
provision included $1.1 million and $1.8 million, respectively, related to this
residual tax effect from OIB.  Income Available to Common
Shareholders  For
the quarter and nine-month period ended September 30, 2012, the Group’s income
available to common shareholders amounted to $14.7 million and $37.9 million,
respectively, compared to $15.6 million and $42.7 million for the same periods
in 2011.  Earnings per basic common share and fully diluted common share were $0.36
and $0.35 for the quarter ended September 30, 2012, respectively, compared to
income per basic and fully diluted common share of $0.35 for the quarter ended
September 30, 2011.  Income per basic common share and fully diluted common
share were $0.93 and $0.92, respectively, for the nine-month period ended
September 30, 2012, compared to income per basic and fully diluted common share
of $0.95 for the nine-month period ended September 30, 2011.  The quarter ended
September 30, 2012 included $1.8 million in dividends declared on the Convertible
Preferred Stock issued early in the quarter in connection with the BBVAPR
Acquisition. Interest Earning Assets  The investment portfolio
amounted to $3.153 billion at September 30, 2012, a 18.5% decrease compared to $3.868
billion at December 31, 2011.  The decrease in the investment portfolio
reflects a reduction of 22.51%, or $666.4 million, in the available-for-sale
portfolio, due to the sale of approximately $1.090 billion in investment
securities as part of the Group’s ongoing strategy of replacing securities with
loans and selling mortgage-backed securities subject to high prepayment speeds,
and a decrease of 5.5%, or $48.9 million, in the held-to-maturity portfolio.  The
decrease is also attributed to the sale of $532.4 million of securities during
the quarter ended September 30, 2012 as part of our balance sheet deleveraging
in connection with the BBVAPR Acquisition.  The loan portfolio decreased 4.2%
to $1.596 billion at September 30, 2012, compared to $1.666 billion at December
31, 2011.  The decrease in the loan portfolio is mostly due to an increase of
$19.6 million, in the allowance for loan and lease losses on covered loans and
a decrease of 11.8% in covered loans as they continue to be repaid.  Interest Bearing Liabilities  Total deposits amounted to $2.214
billion at September 30, 2012, a decrease of 9.1% compared to $2.435 billion at
December 31, 2011. Core retail deposits, which exclude institutional and
brokered deposits, declined $11.6 million, or 0.6%, compared to December 31,
2011, while wholesale deposits decreased  $209.2 million or 49.3% as higher
cost deposits matured during the period. Non-interest bearing demand deposits,
interest-bearing savings and demand deposits and individual retirement accounts
increased 2.8%, 1.9% and 2.3%, respectively, while retail certificates of
deposits decreased 12.1%.  Using available cash, in
March 2012, the Bank repaid at maturity $105.0 million in senior unsecured
notes issued in March 2009 under the FDIC’s Temporary Liquidity Guarantee
Program (“TLGP”) with an all-in cost of 3.75%.  During the nine-month period
ended September 30, 2012, the Group renewed $350 million in repurchase
agreements with an average cost of 4.26%, at a new effective rate of
approximately 1.90%, as one-month short-term repurchase agreements. The
repurchase agreements are being rolled over on a monthly basis on the same
terms as the variable rate leg of the interest rate swaps that are designated
as cash flow hedges of such repurchase agreements.  In addition during the
quarter ended September 30, 2012, the Group elected to terminate repurchase
agreements amounting to $400 million with an average cost of 3.25%, as part of
the previously mentioned deleverage plan in connection with the BBVAPR
Acquisition.  Due to the repayment of the TLGP notes and the termination of the
repurchase agreements, total borrowings decreased 14.5% to $2.974 billion at
September 30, 2012, compared to $3.480 billion at December 31, 2011. 80


---



Stockholders’ Equity  Stockholders’ equity at
September 30, 2012 was $771.7 million, compared to $695.6 million at December
31, 2011, an increase of 10.9%. This increase is mainly due to the $84 million issuance
of the Convertible Preferred Stock on July 3, 2012, partially offset by a
decrease in other comprehensive income for such period.  Book value per share was $15.40
at September 30, 2012 compared to $15.28 at December 31, 2011.  The Group maintains capital
ratios in excess of regulatory requirements. At September 30, 2012, Tier 1
Leverage Capital Ratio was 10.91% (2.73 times the requirement of 4.00%), Tier 1
Risk-Based Capital Ratio was 36.33% (9.08 times the requirement of 4.00%), and
Total Risk-Based Capital Ratio was 37.63% (4.70 times the requirement of
8.00%).  Return on Average Assets
and Common Equity  Return on average common
equity (“ROE”) for the quarter and nine-month period ended September 30, 2012 was
9.27% and 8.01%, respectively, down from 9.41% and 8.65% for the quarter and nine-month
period ended September 30, 2011.  Return on average assets (“ROA”) for the
quarter and nine-month period ended September 30, 2012 was 1.11% and 0.89%,
respectively, up from 0.95% and 0.86% for the same periods in 2011. The
increase in ROA is mainly due to the 9.6% decrease in total assets as of
September 30, 2012, when compared to the balance at December 31, 2011.  Assets under Management  Assets managed by the Group’s
trust division, the pension plan administration subsidiary (CPC), and Oriental
Financial Services increased from $4.142 billion as of December 31, 2011 to $4.617
billion as of September 30, 2012. The trust division offers various types of
individual retirement accounts (“IRA”) and manages 401(k) and Keogh retirement
plans and custodian and corporate trust accounts, while CPC manages the
administration of private retirement plans. At September 30, 2012, total assets
managed by the Group’s trust division and CPC increased to $2.450 billion,
compared to $2.216 billion at December 31, 2011, mainly related to account
contributions and capital market appreciation. At September 30, 2012, total
assets managed by Oriental Financial Services from its customer investment
accounts increased to $2.167 billion, compared to $1.926 billion at December
31, 2011, also mainly because of account contributions and capital market
appreciation.  Lending  Total loan production of
$313.3 million for the nine-month period ended September 30, 2012 increased
8.5% year over year, including $106.4 million in the quarter ended September
30, 2012. Total commercial loan production of $134.8 million for the nine-month
period ended September 30, 2012, increased 46.0% from the year ago period,
including $43.6 million in the quarter ended September 30, 2012.  The Group sells most of its
conforming mortgages in the secondary market, and retains servicing rights. As
a result, mortgage banking activities reflect originations as well as a growing
servicing portfolio, a source of recurring revenue.  Mortgage loan production and
purchases of $47.0 million and $140.9 million for the quarter and nine-month
period ended September 30, 2012, respectively, decreased 10.8% and 14.7% from
the same periods in 2011.  Leasing and consumer loans production for the
quarter and nine-month period ended September 30, 2012 totaled $15.8 million and
$37.6 million, up 39.9% and 20.6% from the same periods in 2011.  Credit Quality on
Non-Covered Loans  Net credit losses increased
$1.3 million to $8.3 million during the nine-month period ended September 30,
2012, representing 0.92% of average non-covered loans outstanding, versus 0.79%
in 2011. The allowance for loan and lease losses on non-covered loans increased
to $39.1 million (3.29% of total non-covered loans) at September 30, 2012,
compared to $37.0 million (3.12% of total non-covered loans) at December 31,
2011.  81


---



Non-performing loans
(“NPLs”), which excludes loans covered under shared-loss agreements with the
FDIC, decreased 12.56%, or $16.9 million, in the nine-month period ended
September 30, 2012. The Group does not expect NPLs to result in significantly
higher losses as most are well-collateralized with adequate loan-to-value
ratios. In residential mortgage lending, more than 90% of the Group’s portfolio
consists of fixed-rate, fully amortizing, fully documented loans that do not
have the level of risk generally associated with subprime loans. In commercial
lending, more than 90% of our loans are collateralized by real estate. Early
delinquency loans (30-89 days past due) dropped 10.6% from December 31, 2011.
Covered loans are considered to be performing due to the application of the
accretion method under ASC 310-30.  Non-GAAP Measures  The Group uses certain
non-GAAP measures of financial performance to supplement the financial
statements presented in accordance with GAAP. The Group presents non-GAAP
measures that management believes are useful and meaningful to investors.
Non-GAAP measures do not have any standardized meaning and are therefore
unlikely to be comparable to similar measures presented by other companies. The
presentation of non-GAAP measures is not intended to be a substitute for, and
should not be considered in isolation from, the financial measures reported in
accordance with GAAP.  The Group’s management has
reported and discussed the results of operations herein both on a GAAP basis
and on a pre-tax pre-provision operating income basis (defined as net interest
income, plus banking and wealth management revenues, less non-interest
expenses, as calculated on the table below). The Group’s management believes
that, given the nature of the items excluded from the definition of pre-tax pre-provision
operating income, it is useful to state what the results of operations would
have been without them so that investors can see the financial trends from the
Group’s continuing business.  During the quarter and nine-month period ended September 30, 2012,
the Group’s pre-tax
pre-provision operating income was approximately $21.1 million and $58.3
million, respectively, an increase of 57.5% and 11.2% from $13.4 million and
$52.5 million in the same periods of last year. Pre-tax pre-provision operating
income is calculated as follows:  Quarter Ended September 30,
 
 Nine-Month Period Ended September 30,2012
 
 2011
 
 2012
 
 2011(In thousands)PRE-TAX
  PRE-PROVISION OPERATING INCOMENet interest
  income
 $
 40,203
 
 $
 32,470
 
 $
 112,142
 
 $
 112,558Core
  non-interest income:Wealth
  management revenues
 
 6,042
 
 
 5,387
 
 
 17,835
 
 
 14,644Banking
  service revenues
 
 3,006
 
 
 2,969
 
 
 9,231
 
 
 9,496Mortgage
  banking activities
 
 2,204
 
 
 2,758
 
 
 7,142
 
 
 7,017Total core non-interest income
 
 11,252
 
 
 11,114
 
 
 34,208
 
 
 31,157Less non
  interest expenses
 
 (30,379)
 
 
 (30,203)
 
 
 (88,006)
 
 
 (91,248)Total pre-tax pre-provision operating income
 $
 21,076
 
 $
 13,381
 
 $
 58,344
 
 $
 52,467
  Tangible common equity
consists of common equity less goodwill and core deposit intangibles. Tier 1
common equity consists of common equity less goodwill, core deposit intangibles,
net unrealized gains on available for sale securities, net unrealized losses on
cash flow hedges, and disallowed deferred tax asset and servicing assets.  Management
believes that the ratios of tangible common equity to total assets, tangible common
equity to risk-weighted assets, total equity to risk-weighted assets and tier 1
common equity to risk-weighted assets, assist investors in analyzing the
Group’s capital position.  At September 30, 2012, tangible common equity to total assets
and tangible common equity to risk-weighted assets increased to 10.30% and
32.96%, respectively, from 9.36% and 30.14% at December 31, 2011.  Total equity
to risk-weighted assets and Tier 1 common equity to risk-weighted assets at September
30, 2012 increased to 40.79% and 31.03%, respectively, from 33.48% and 27.01% at
December 31, 2011. 82


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ANALYSIS
  OF RESULTS OF OPERATIONSTABLE 1 -
  QUARTERLY ANALYSIS OF NET INTEREST INCOME AND CHANGES DUE TO VOLUME/RATEFOR THE
  QUARTERS ENDED SEPTEMBER 30, 2012 AND 2011Interest
 
 Average rate
 
 Average balanceSeptember
 
 September
 
 September
 
 September
 
 September
 
 September2012
 
 2011
 
 2012
 
 2011
 
 2012
 
 2011(Dollars in thousands)A - TAX
  EQUIVALENT SPREADInterest-earning
  assets
 $
 65,686
 
 $
 71,536
 
 4.52%
 
 4.46%
 
 $
 5,806,796
 
 $
 6,409,910Tax
  equivalent adjustment
 
 17,994
 
 
 13,505
 
 1.24%
 
 0.84%
 
 
 -
 
 
 -Interest-earning
  assets - tax equivalent
 
 83,680
 
 
 85,041
 
 5.76%
 
 5.30%
 
 
 5,806,796
 
 
 6,409,910Interest-bearing liabilities
 
 25,483
 
 
 39,066
 
 1.83%
 
 2.49%
 
 
 5,562,082
 
 
 6,263,930Tax
  equivalent net interest income / spread
 
 58,197
 
 
 45,975
 
 3.93%
 
 2.81%
 
 
 244,714
 
 
 145,980Tax
  equivalent interest rate margin
 
 
 
 
 
 
 4.01%
 
 2.87%B - NORMAL
  SPREADInterest-earning
  assets:Investments:Investment
  securities
 
 25,026
 
 
 35,881
 
 3.00%
 
 3.35%
 
 
 3,341,763
 
 
 4,288,321Money market
  investments
 
 413
 
 
 272
 
 0.20%
 
 0.27%
 
 
 827,106
 
 
 410,258Total
  investments
 
 25,439
 
 
 36,153
 
 2.44%
 
 3.08%
 
 
 4,168,869
 
 
 4,698,579Loans not
  covered under shared-loss agreements
  with the
  FDIC:Mortgage
 
 12,165
 
 
 12,105
 
 6.01%
 
 5.59%
 
 
 808,949
 
 
 866,947Commercial
 
 4,313
 
 
 3,612
 
 5.43%
 
 5.54%
 
 
 317,888
 
 
 260,932Consumer
 
 869
 
 
 977
 
 8.20%
 
 11.43%
 
 
 42,382
 
 
 34,188Leasing
 
 617
 
 
 467
 
 7.85%
 
 10.05%
 
 
 31,426
 
 
 18,584Total
  non-covered loans
 
 17,964
 
 
 17,161
 
 5.98%
 
 5.81%
 
 
 1,200,645
 
 
 1,180,651Loans covered
  under shared-loss agreements
  with the
  FDIC:Loans
  secured by residential properties
 
 5,162
 
 
 4,096
 
 13.71%
 
 10.20%
 
 
 150,599
 
 
 159,891Commercial
  and construction
 
 13,664
 
 
 11,727
 
 21.03%
 
 13.20%
 
 
 259,922
 
 
 305,859Leasing
 
 2,546
 
 
 2,047
 
 64.15%
 
 15.85%
 
 
 15,876
 
 
 51,669Consumer
 
 911
 
 
 352
 
 33.48%
 
 8.95%
 
 
 10,886
 
 
 13,261Total
  covered loans
 
 22,283
 
 
 18,222
 
 20.38%
 
 13.73%
 
 
 437,282
 
 
 530,680Total loans
 
 40,247
 
 
 35,383
 
 9.83%
 
 8.27%
 
 
 1,637,927
 
 
 1,711,331Total interest earning assets
 
 65,686
 
 
 71,536
 
 4.52%
 
 4.46%
 
 
 5,806,796
 
 
 6,409,910Interest-bearing
  liabilities:Deposits:Non-interest
  bearing deposits
 
 -
 
 
 -
 
 0.00%
 
 0.00%
 
 
 179,480
 
 
 177,936NOW accounts
 
 1,964
 
 
 3,203
 
 0.90%
 
 1.56%
 
 
 877,129
 
 
 822,420Savings and
  money market
 
 583
 
 
 855
 
 0.98%
 
 1.40%
 
 
 236,989
 
 
 244,341Individual
  retirement accounts
 
 2,104
 
 
 2,443
 
 2.28%
 
 2.74%
 
 
 368,365
 
 
 356,770Retail
  certificates of deposits
 
 1,598
 
 
 2,372
 
 1.92%
 
 2.36%
 
 
 332,727
 
 
 402,158Total
  retail deposits
 
 6,249
 
 
 8,873
 
 1.25%
 
 1.77%
 
 
 1,994,690
 
 
 2,003,625Institutional deposits
 
 228
 
 
 1,024
 
 1.20%
 
 2.12%
 
 
 76,282
 
 
 193,448Brokered
  deposits
 
 831
 
 
 1,595
 
 2.34%
 
 2.81%
 
 
 141,859
 
 
 226,681Total
  wholesale deposits
 
 1,059
 
 
 2,619
 
 1.94%
 
 2.49%
 
 
 218,141
 
 
 420,129Total deposits
 
 7,308
 
 
 11,492
 
 1.32%
 
 1.90%
 
 
 2,212,831
 
 
 2,423,754Borrowings:Securities
  sold under agreements to repurchase
 
 15,344
 
 
 23,206
 
 2.03%
 
 2.72%
 
 
 3,027,100
 
 
 3,411,161Advances
  from FHLB and other borrowings
 
 2,508
 
 
 3,042
 
 3.51%
 
 4.24%
 
 
 286,068
 
 
 286,909FDIC-guaranteed term notes
 
 -
 
 
 1,021
 
 -
 
 3.85%
 
 
 -
 
 
 106,023Subordinated
  capital notes
 
 323
 
 
 305
 
 3.58%
 
 3.38%
 
 
 36,083
 
 
 36,083Total
  borrowings
 
 18,175
 
 
 27,574
 
 2.17%
 
 2.87%
 
 
 3,349,251
 
 
 3,840,176Total interest bearing liabilities
 
 25,483
 
 
 39,066
 
 1.83%
 
 2.49%
 
 
 5,562,082
 
 
 6,263,930Net interest
  income / spread
 $
 40,203
 
 $
 32,470
 
 2.69%
 
 1.97%Interest rate
  margin
 
 
 
 
 
 
 2.77%
 
 2.03%Excess of
  average interest-earning assets
  over
  average interest-bearing liabilities
 
 
 
 
 
 
 
 
 
 
 $
 244,714
 
 $
 145,980Average
  interest-earning assets to average
  interest-bearing liabilities ratio
 
 
 
 
 
 
 
 
 
 
 
 104.40%
 
 
 102.33%
 83


---



C - CHANGES
  IN NET INTEREST INCOME DUE TO:Volume
 
 Rate
 
 Total(In thousands)Interest
  Income:Investments
 $
 (4,076)
 
 $
 (6,638)
 
 $
 (10,714)Loans
 
 (2,916)
 
 
 7,780
 
 
 4,864Total
  interest income
 
 (6,992)
 
 
 1,142
 
 
 (5,850)Interest
  Expense:Deposits
 
 (1,000)
 
 
 (3,184)
 
 
 (4,184)Securities
  sold under agreements to repurchase
 
 (2,613)
 
 
 (5,249)
 
 
 (7,862)Other
  borrowings
 
 (1,088)
 
 
 (449)
 
 
 (1,537)Total
  interest  expense
 
 (4,701)
 
 
 (8,882)
 
 
 (13,583)Net Interest
  Income
 $
 (2,291)
 
 $
 10,024
 
 $
 7,733
 84


---



TABLE 1/A -
  YEAR-TO-DATE ANALYSIS OF NET INTEREST INCOME AND CHANGES DUE TO VOLUME/RATEFOR THE
  NINE-MONTH PERIODS ENDED SEPTEMBER 30, 2012 AND 2011Interest
 
 Average rate
 
 Average balanceSeptember
 
 September
 
 September
 
 September
 
 September
 
 September2012
 
 2011
 
 2012
 
 2011
 
 2012
 
 2011(Dollars in thousands)A - TAX EQUIVALENT
  SPREADInterest-earning
  assets
 $
 196,393
 
 $
 231,772
 
 4.46%
 
 4.76%
 
 $
 5,870,015
 
 $
 6,495,208Tax
  equivalent adjustment
 
 46,890
 
 
 44,461
 
 1.07%
 
 0.91%
 
 
 -
 
 
 -Interest-earning
  assets - tax equivalent
 
 243,283
 
 
 276,233
 
 5.53%
 
 5.67%
 
 
 5,870,015
 
 
 6,495,208Interest-bearing liabilities
 
 84,251
 
 
 119,214
 
 1.98%
 
 2.49%
 
 
 5,670,500
 
 
 6,371,511Tax
  equivalent net interest income / spread
 
 159,032
 
 
 157,019
 
 3.55%
 
 3.18%
 
 
 199,515
 
 
 123,697Tax
  equivalent interest rate margin
 
 
 
 
 
 
 3.61%
 
 3.22%B - NORMAL
  SPREADInterest-earning
  assets:Investments:Investment
  securities
 
 77,718
 
 
 134,378
 
 2.94%
 
 4.09%
 
 
 3,521,595
 
 
 4,379,701Money market
  investments
 
 1,200
 
 
 792
 
 0.23%
 
 0.28%
 
 
 685,380
 
 
 372,247Total
  investments
 
 78,918
 
 
 135,170
 
 2.50%
 
 3.79%
 
 
 4,206,975
 
 
 4,751,948Loans not
  covered under shared-loss agreements
  with the
  FDIC:Mortgage
 
 36,645
 
 
 36,604
 
 5.94%
 
 5.55%
 
 
 822,116
 
 
 879,463Commercial
 
 12,463
 
 
 10,616
 
 5.37%
 
 5.78%
 
 
 309,373
 
 
 245,053Consumer
 
 2,465
 
 
 2,847
 
 8.22%
 
 11.86%
 
 
 39,993
 
 
 32,019Leasing
 
 1,735
 
 
 1,028
 
 7.94%
 
 9.20%
 
 
 29,126
 
 
 14,906Total
  non-covered loans
 
 53,308
 
 
 51,095
 
 5.92%
 
 5.82%
 
 
 1,200,608
 
 
 1,171,441Loans covered
  under shared-loss agreements
  with the
  FDIC:Loans
  secured by residential properties
 
 15,494
 
 
 10,977
 
 13.52%
 
 8.46%
 
 
 152,852
 
 
 172,977Commercial
  and construction
 
 40,383
 
 
 27,001
 
 19.70%
 
 11.23%
 
 
 273,284
 
 
 320,514Leasing
 
 6,801
 
 
 6,325
 
 37.47%
 
 13.25%
 
 
 24,200
 
 
 63,659Consumer
 
 1,489
 
 
 1,204
 
 16.41%
 
 10.94%
 
 
 12,096
 
 
 14,669Total
  covered loans
 
 64,167
 
 
 45,507
 
 18.50%
 
 10.61%
 
 
 462,432
 
 
 571,819Total loans
 
 117,475
 
 
 96,602
 
 9.42%
 
 7.39%
 
 
 1,663,040
 
 
 1,743,260Total interest earning assets
 
 196,393
 
 
 231,772
 
 4.46%
 
 4.76%
 
 
 5,870,015
 
 
 6,495,208Interest-bearing
  liabilities:Deposits:Non-interest
  bearing deposits
 
 -
 
 
 -
 
 -
 
 -
 
 
 176,158
 
 
 179,071NOW accounts
 
 6,781
 
 
 9,969
 
 1.04%
 
 1.63%
 
 
 872,059
 
 
 813,179Savings and
  money market
 
 1,790
 
 
 2,715
 
 1.01%
 
 1.49%
 
 
 235,675
 
 
 243,529Individual
  retirement accounts
 
 6,557
 
 
 7,527
 
 2.38%
 
 2.80%
 
 
 367,461
 
 
 358,516Retail
  certificates of deposits
 
 5,366
 
 
 7,975
 
 2.10%
 
 2.39%
 
 
 341,339
 
 
 445,087Total
  retail deposits
 
 20,494
 
 
 28,186
 
 1.37%
 
 1.84%
 
 
 1,992,692
 
 
 2,039,382Institutional deposits
 
 1,098
 
 
 2,846
 
 1.54%
 
 1.70%
 
 
 95,192
 
 
 222,940Brokered deposits
 
 2,926
 
 
 4,289
 
 2.11%
 
 2.39%
 
 
 184,652
 
 
 239,169Total
  wholesale deposits
 
 4,024
 
 
 7,135
 
 1.92%
 
 2.06%
 
 
 279,844
 
 
 462,109Total deposits
 
 24,518
 
 
 35,321
 
 1.44%
 
 1.88%
 
 
 2,272,536
 
 
 2,501,491Borrowings:Securities
  sold under agreements to repurchase
 
 49,414
 
 
 70,878
 
 2.16%
 
 2.74%
 
 
 3,047,605
 
 
 3,445,167Advances
  from FHLB and other borrowings
 
 8,438
 
 
 9,036
 
 3.95%
 
 4.26%
 
 
 284,822
 
 
 283,028FDIC-guaranteed term notes
 
 909
 
 
 3,063
 
 4.11%
 
 3.86%
 
 
 29,454
 
 
 105,742Subordinated
  capital notes
 
 972
 
 
 916
 
 3.59%
 
 3.38%
 
 
 36,083
 
 
 36,083Total
  borrowings
 
 59,733
 
 
 83,893
 
 2.34%
 
 2.89%
 
 
 3,397,964
 
 
 3,870,020Total interest bearing liabilities
 
 84,251
 
 
 119,214
 
 1.98%
 
 2.49%
 
 
 5,670,499
 
 
 6,371,511Net interest
  income / spread
 $
 112,142
 
 $
 112,558
 
 2.48%
 
 2.27%Interest rate
  margin
 
 
 
 
 
 
 2.55%
 
 2.31%Excess of
  average interest-earning assets
  over
  average interest-bearing liabilities
 
 
 
 
 
 
 
 
 
 
 $
 199,514
 
 $
 123,697Average
  interest-earning assets to average
  interest-bearing liabilities ratio
 
 
 
 
 
 
 
 
 
 
 
 103.52%
 
 
 101.94%
 85


---



C - CHANGES
  IN NET INTEREST INCOME DUE TO:Volume
 
 Rate
 
 Total(In thousands)Interest
  Income:Investments
 $
 (15,502)
 
 $
 (40,750)
 
 $
 (56,252)Loans
 
 (7,433)
 
 
 28,306
 
 
 20,873Total
  interest income
 
 (22,935)
 
 
 (12,444)
 
 
 (35,379)Interest
  Expense:Deposits
 
 (3,233)
 
 
 (7,570)
 
 
 (10,803)Securities
  sold under agreements to repurchase
 
 (8,179)
 
 
 (13,285)
 
 
 (21,464)Other
  borrowings
 
 (2,282)
 
 
 (414)
 
 
 (2,696)Total
  interest  expense
 
 (13,694)
 
 
 (21,269)
 
 
 (34,963)Net Interest
  Income
 $
 (9,241)
 
 $
 8,825
 
 $
 (416)
 86


---



Net Interest Income  Net interest income is a
function of the difference between rates earned on the Group’s interest-earning
assets and rates paid on its interest-bearing liabilities (interest rate
spread) and the relative amounts of its interest earning assets and
interest-bearing liabilities (interest rate margin). The Group constantly
monitors the composition and re-pricing of its assets and liabilities to
maintain its net interest income at adequate levels. Tables 1 and 1A above show
the major categories of interest-earning assets and interest-bearing
liabilities, their respective interest income, expenses, yields and costs, and
their impact on net interest income due to changes in volume and rates for the
quarters and nine-month periods ended September 30, 2012 and 2011,
respectively.  Net interest income amounted
to $40.2 million and $112.1 million for the quarter and nine-month period ended
September 30, 2012, an increase of 23.8% and a slight decrease of 0.4% from
$32.5 million and $112.6 million, respectively, for the same periods in 2011.
These changes reflect a decrease of 29.6% in interest income from investments,
partially offset by a 13.7% increase in interest income from loans and a decrease
of 34.8% in interest expense for the quarter ended September 30, 2012 compared
to the same period in 2011.  They also reflect a decrease of 41.6% in interest
income from investments, partially offset by a 21.6% increase in interest
income from loans and a decrease of 29.3% in interest expense for the
nine-month period ended September 30, 2012 compared to the same period in 2011.  Interest rate spread
increased 72 basis points to 2.69% for the quarter ended 2012 from 1.97% in the
quarter ended September 30, 2011.  This is due to the effect of a 6 basis
points increase in the average yield of interest earning assets from 4.46% to
4.52%, combined with a 66 basis points decrease in the average cost of funds
from 2.49% to 1.83%.  For the nine-month period ended September 30, 2012,
interest rate spread increased 21 basis points from 2.27% to 2.48% in the same period
of 2011. This increase is mainly due to the net effect of a 51 basis points
decrease in the average cost of funds from 2.49% to 1.98%, and a 30 basis
points decrease in the average yield of interest earning assets from 4.76% to
4.46%.  The decrease in interest
income for the quarter was primarily the net effect of a decrease of $7.0
million in interest-earning assets volume variance, and a $1.1 million increase
in interest rate variance.  The nine-month period decrease in interest income
was primarily the result of a decrease of $22.9 million in interest-earning
assets volume variance, and a $12.4 million decrease in interest rate
variance.  Interest income from loans increased 13.7% to $40.2 million and
21.6% to $117.5 million for the quarter and nine-month period ended September
30, 2012, respectively.  During the quarter and nine-month period ended
September 30, 2012, interest income from covered loans increased 22.3% to $22.3
million and 41.0% to $64.2 million, respectively, compared to the same periods
in 2011, mainly due to the re-yielding of various pools of covered loans mainly
during the second half of 2011. Interest income on investments decreased 29.6%
to $25.4 million and 41.6% to $78.9 million for the quarter and nine-month
period ended September 30, 2012, respectively, compared to the same periods in
2011, reflecting lower balance in the investment securities portfolio, lower
yield on investment securities and an increase in premium amortization due to
increased prepayment speeds.  Interest expense decreased
34.8% to $25.5 million and 29.3% to $84.3 million for the quarter and
nine-month period ended September 30, 2012, respectively.  The decrease for the
quarter was primarily the result of a $8.9 million decrease in interest rate
variance, and a $4.7 million decrease in interest-bearing liabilities volume
variance.  The nine-month period decrease was primarily the result of a $21.3
million decrease in interest rate variance, and a $13.7 million decrease in
interest-bearing liabilities volume variance.  These decreases are due to a
reduction in the balance of interest bearing liabilities and the cost of
funds.  Interest bearing liabilities interest rate spread decreased 66 basis
points to 1.83% and 51 basis points to 1.98% for the quarter and nine-month
period ended September 30, 2012, respectively, compared to the same periods in
2011.  The cost of deposits decreased by 58 basis points to 1.32% and 44 basis
points to 1.44% during the quarter and nine-month period ended September 30,
2012, respectively, compared to 1.90% and 1.88% for the same periods in 2011
primarily due to continuing progress in repricing the core retail deposits and
to the maturity of higher cost wholesale deposits during the period.  The cost
of borrowings decreased by 70 basis points to 2.17% and 55 basis points to
2.34% during the quarter and nine-month period ended September 30, 2012,
respectively, compared to 2.87% and 2.89% for the same periods in 2011. The
decrease in the cost of borrowing is attributable to the fact that in December
2011, as previously reported, $600 million in repurchase agreements, with an
average cost of 4.23%, matured. The Group paid off $300 million of these
repurchase agreements, and the remaining balance of $300 million was renewed
for an average period of approximately three and a half years at an effective
fixed rate of 2.36%. To further reduce cost of borrowings, in May 2012, the
Group renewed $350 million in repurchase agreements, with an average cost of 4.26%,
at a new effective rate of approximately 1.90%.  During the quarter ended
September 30, 2012, the Group initiated a plan to deleverage its balance sheet
in connection with the BBVAPR Acquisition ahead of schedule by terminating
repurchase agreements amounting to $400 million with an average cost of 3.25%. 
Also, total borrowings decreased due to the repayment in March 2012, at
maturity, of the TLGP notes.  87


---



For
the quarter and nine-month period ended September 30, 2012, the average balance
of total interest-earning assets was $5.807 billion and $5.870 billion,
respectively, a decrease of 9.4% and 9.6% from the same periods in 2011. The
decrease in average balance of interest-earning assets was mainly attributable
to a 11.3% and 11.5% decrease for the quarter and nine-month period ended
September 30, 2012, respectively, in average investments, in addition to a 4.3%
and 4.6% decrease in average loans compared to the same periods in 2011 resulting
from normal pay downs of covered loans and to the re-yielding of various pools
of covered loans mainly during the second half of 2011.  The decrease in the
investment portfolio reflects a reduction in the available-for-sale portfolio,
due to the sale of approximately $1.090 billion in investment securities during
the nine-month period ended September 30, 2012.  As of September 30, 2012, the
Group had $515.5 million in cash and cash equivalents and $270.0 million in
securities purchased under agreements to resell, compared to $591.5 million in
cash and cash equivalents and no securities purchased under agreements to
resell as of December 31, 2011.  For the quarter ended
September 30, 2012, the average yield on interest-earning assets was 4.52%
compared to 4.46% for the same period in 2011, and for the nine-month period
ended September 30, 2012, it was 4.46% compared to 4.76% for the same period in
2011. This was mainly due to a decrease in the investment portfolio yield from
3.08% to 2.44% and from 3.79% to 2.50% for the quarter and nine-month period
ended September 30, 2012, respectively. However, such decrease was partially
offset by the higher average yields in the loan portfolio, mainly due to the
covered loans that had an average yield of 20.38% and 18.50% for the quarter
and nine-month period ended September 30, 2012, respectively, compared to
13.73% and 10.61% for the same periods in 2011.  TABLE 2 -
  NON-INTEREST INCOME SUMMARYQuarter Ended September 30,
 
 Nine-Month Period Ended September 30,2012
 
 2011
 
 Variance
 
 2012
 
 2011
 
 Variance(Dollars in thousands)Wealth
  management revenues
 $
 6,042
 
 $
 5,387
 
 12.2%
 
 $
 17,835
 
 $
 14,644
 
 21.8%Banking service
  revenues
 
 3,006
 
 
 2,969
 
 1.2%
 
 
 9,231
 
 
 9,496
 
 -2.8%Mortgage banking
  activities
 
 2,204
 
 
 2,758
 
 -20.1%
 
 
 7,142
 
 
 7,017
 
 1.8%Total
  banking and wealth management revenues
 
 11,252
 
 
 11,114
 
 1.2%
 
 
 34,208
 
 
 31,157
 
 9.8%Net amortization
  of FDIC shared-loss
  indemnification asset
 
 (8,096)
 
 
 (2,422)
 
 -234.3%
 
 
 (18,505)
 
 
 (191)
 
 -9588.5%Net gain (loss)
  on:Sale of
  securities
 
 36,365
 
 
 13,971
 
 160.3%
 
 
 55,703
 
 
 23,102
 
 141.1%Derivatives
 
 (1,326)
 
 
 (695)
 
 -90.8%
 
 
 (1,441)
 
 
 (8,392)
 
 82.8%Foreclosed
  real estate
 
 (1,209)
 
 
 (199)
 
 -507.5%
 
 
 (2,493)
 
 
 (334)
 
 -646.4%Early
  extinguishment of repurchase agreement
 
 (24,312)
 
 
 (4,790)
 
 -407.6%
 
 
 (24,312)
 
 
 (4,790)
 
 -407.6%Other
 
 978
 
 
 (14)
 
 7085.7%
 
 
 208
 
 
 148
 
 40.5%2,400
 
 
 5,851
 
 -59.0%
 
 
 9,160
 
 
 9,543
 
 -4.0%Total
  non-interest income, net
 $
 13,652
 
 $
 16,965
 
 -19.5%
 
 $
 43,368
 
 $
 40,700
 
 6.6%
  Non-Interest Income  Non-interest income is affected by the
amount of securities, derivatives and trading transactions, the level of trust
assets under management, transactions generated by clients’ financial assets
serviced by the securities broker-dealer and insurance subsidiaries, the level
of mortgage banking activities, and the fees generated from loans and deposit
accounts. It is also affected by the net amortization of the FDIC shared-loss
indemnification asset, which varies depending on the results of the on-going
evaluation of expected cash flows of the loan portfolio acquired in the FDIC-assisted
acquisition of Eurobank.  As shown in Table 2 above, the Group
recorded non-interest income in the amount of $13.7 million and $43.4 million
for the quarter and nine-month period ended September 30, 2012, respectively,
compared to $17.0 million and $40.7 million for the same periods in 2011, a decrease
of $3.3 million and an increase of $2.7 million, respectively.  The quarter ended September 30, 2012
includes $36.4 million from the gain on sale of $532.4 million securities, partially
offset by an early extinguishment cost of $24.3 million on $400 million
repurchase agreement funding.  These transactions are part of our deleverage
plan related to the BBVAPR Acquisition.  88


---



The net amortization of the FDIC shared-loss
indemnification asset of $8.1 million and $18.5 million for the quarter and
nine-month period ended September 30, 2012, respectively, compared to net
amortization of $2.4 million and $191 thousand for the same periods in 2011, resulted
from the ongoing evaluation of expected cash flows of the covered loan
portfolio, which resulted in reduced losses expected to be collected from the
FDIC and the improved re-yielding of the accretable yield on the covered loans.
The reduction in claimable losses amortizes the loss-share indemnification
asset through the life of the shared loss agreement.  This amortization is net
of the accretion of the discount recorded to reflect the expected claimable
loss at its net present value. The losses related to derivatives increased
approximately $631 thousand and decreased $7.0 million as compared to the
quarter and nine-month period ended September 30, 2011, respectively.  Wealth management revenues, which
consist of commissions and fees from fiduciary activities, and securities
brokerage and insurance activities, increased 12.2% to $6.0 million and 21.8%
to $17.8 million in the quarter and nine-month period ended September 30, 2012,
respectively, from $5.4 million and $14.6 million for the same periods in 2011,
due to increased brokerage, trust and insurance business and transactions.  Banking service revenues, which consist
primarily of fees generated by deposit accounts, electronic banking services,
and customer services, increased 1.2% to $3.0 million in the quarter ended
September 30, 2012 and decreased 2.8% to $9.2 million in the nine-month period
then ended, from $3.0 million and $9.5 million, respectively, for the same
periods in 2011. This decrease for the nine-month period is attributable to a
decrease in loan fees.  Income generated from mortgage banking
activities decreased $554 thousand in the quarter ended September 30, 2012 and
increased 1.8% to $7.1 million in the nine-month period then ended, compared to
the same periods in 2011. Such increase is mainly a result of favorable pricing
of mortgages sold into the secondary market.  TABLE 3 -
  NON-INTEREST EXPENSES SUMMARYQuarter Ended September 30,
 
 Nine-Month Period Ended September 30,2012
 
 2011
 
 Variance %
 
 2012
 
 2011
 
 Variance %(Dollars in thousands)Compensation and
  employee benefits
 $
 11,323
 
 $
 11,593
 
 -2.3%
 
 $
 32,873
 
 $
 34,511
 
 -4.7%Professional and
  service fees
 
 5,779
 
 
 5,308
 
 8.9%
 
 
 16,221
 
 
 16,506
 
 -1.7%Occupancy and
  equipment
 
 4,169
 
 
 4,369
 
 -4.6%
 
 
 12,624
 
 
 12,988
 
 -2.8%Insurance
 
 1,594
 
 
 1,302
 
 22.4%
 
 
 4,856
 
 
 4,933
 
 -1.6%Electronic
  banking charges
 
 1,415
 
 
 1,375
 
 2.9%
 
 
 4,581
 
 
 3,984
 
 15.0%Taxes, other
  than payroll and income taxes
 
 1,091
 
 
 1,184
 
 -7.9%
 
 
 2,158
 
 
 3,422
 
 -36.9%Loan servicing
  and clearing expenses
 
 607
 
 
 975
 
 -37.7%
 
 
 2,530
 
 
 3,072
 
 -17.6%Foreclosure and
  repossession expenses
 
 1,060
 
 
 606
 
 74.9%
 
 
 2,745
 
 
 1,659
 
 65.5%Advertising,
  business promotion,
  and
  strategic initiatives
 
 1,594
 
 
 1,686
 
 -5.5%
 
 
 4,006
 
 
 4,386
 
 -8.7%Communication
 
 419
 
 
 391
 
 7.2%
 
 
 1,246
 
 
 1,212
 
 2.8%Director and
  investors relations
 
 158
 
 
 352
 
 -55.1%
 
 
 809
 
 
 977
 
 -17.2%Printing,
  postage, stationery and supplies
 
 299
 
 
 292
 
 2.4%
 
 
 929
 
 
 937
 
 -0.9%Other operating
  expenses
 
 871
 
 
 770
 
 13.1%
 
 
 2,428
 
 
 2,661
 
 -8.8%Total
  non-interest expenses
 $
 30,379
 
 $
 30,203
 
 0.6%
 
 $
 88,006
 
 $
 91,248
 
 -3.6%Relevant
  ratios and data:Efficiency
  ratio
 
 59.04%
 
 
 69.30%
 
 
 
 
 60.13%
 
 
 63.49%Expense
  ratio
 
 1.32%
 
 
 1.19%
 
 
 
 
 1.22%
 
 
 1.23%Compensation
  and benefits to
  non-interest expense
 
 37.27%
 
 
 38.38%
 
 
 
 
 37.35%
 
 
 37.82%Compensation
  to total assets owned
 
 0.75%
 
 
 0.66%
 
 
 
 
 0.72%
 
 
 0.66%Average
  number of employees
 
 755
 
 
 720
 
 
 
 
 750
 
 
 724Average
  compensation per employee
 $
 60.0
 
 $
 64.4
 
 
 
 $
 58.4
 
 $
 63.6Assets owned
  per average employee
 $
 8,015
 
 $
 9,755
 
 
 
 $
 8,068
 
 $
 9,701
 89


---



Non-Interest Expense  Non-interest expense for the quarter ended September
30, 2012 increased 0.6% to $30.4 million, compared to $30.2 million for the
same period in 2011. For the nine-month period ended September 30, 2012,
non-interest expense reached $88.0 million, representing a decrease of 3.6%
compared to $91.2 million for the same period in 2011 as a result of the
effective implementation of cost controls. Taxes, other than payroll and income taxes, for the
quarter and nine-month period ended September 30, 2012 decreased 7.9% to $1.1
million and 36.9% to $2.2 million, respectively, as compared to the same
periods in 2011, principally due to the effect of the Eurobank integration,
which for 2011 contemplated municipal license and property taxes for all of
Eurobank’s former facilities.  In addition, during the nine-month period ended
September 30, 2012, the Group recorded a municipal license benefit of $1.4
million, attributed to a settlement reached with the municipality of San Juan
during the second quarter of 2012, in which the Group paid $60 thousand in full
and final satisfaction of any and all claims for municipal license taxes for
all fiscal years prior to and including 2011. Compensation and employee benefits decreased
2.3% to $11.3 million and 4.7% to $32.9 million for the quarter and nine-month
period ended September 30, 2012, respectively, from $11.6 million and $34.5
million for the same periods in 2011. The decrease is mostly related to an
excess provision for bonus amounting to $857 thousand compared to the amount
finally paid during the first quarter of 2012, resulting in a benefit in the
nine-month period ended September 30, 2012.  Insurance expense increased 22.4% and
decreased 1.6% for the quarter and nine-month period ended September 30, 2012,
respectively, as compared to the same periods in 2011.  The decrease for the
nine-month period ended September 30, 2012 is principally due to a change in
FDIC assessment rates and a change in the methodology of the assessment applied
to the Bank. The current methodology is based on average consolidated total
assets less average tangible equity, instead of average total domestic
deposits.  Loan servicing and clearing expenses and
director and investment relations expenses decreased by 37.7% and 55.1%,
respectively, in the quarter ended September 30, 2012 and 17.6% and 17.2%,
respectively, in the nine-month period ended September 30, 2012.  Other expenses increased by 13.1% to
$871 thousand and professional and service fees by 8.9% to $5.8 million for the
quarter ended September 30, 2012, as compared to $770 thousand and $5.3 million
for the same period in 2011, mainly due to cost associated with the BBVAPR
Acquisition.  The increase in the Group’s net-interest
income resulted in a decrease in the efficiency ratio to 59.04% for the quarter
ended September 30, 2012 compared to 69.30% for the quarter ended September 30,
2011, while it decreased to 60.13% for the nine-month period ended September
30, 2012 from 63.49% in the prior year. The efficiency ratio measures how much
of a company’s revenue is used to pay operating expenses. The Group computes
its efficiency ratio by dividing non-interest expenses by the sum of its net
interest income and non-interest income, but excluding gains on sale of
investments securities, derivatives gains or losses, credit-related
other-than-temporary impairment losses, net accretion or amortization of FDIC
shared-loss indemnification assets, and other income that may be considered
volatile in nature. Management believes that the exclusion of those items
permits greater comparability. Amounts presented as part of non-interest income
that are excluded from the efficiency ratio computation amounted to gains of
$2.4 million and $9.2 million for the quarter and nine-month period ended
September 30, 2012, respectively, compared to gains of $5.9 million and $9.5
million for the quarter and nine-month period ended September 30, 2011.
Revenues for purposes of the efficiency ratio for the quarter and nine-month
period ended September 30, 2012 amounted to $51.5 million and $146.4 million,
respectively, compared to $43.6 million and $143.7 million for the same periods
in 2011.  Provision for Loan and Lease Losses  The provision for non-covered loan and
lease losses for the quarter ended September 30, 2012 decreased by $200
thousand to $3.6 million, and totaled $10.4 million for the nine-month period
ended September 30, 2012, an 8.8% decrease from the $11.4 million reported for the
same period in 2011.  Based on an analysis of the credit quality and the
composition of the Group’s loan portfolio, management determined that the
provision for the quarter and nine-month period ended September 30, 2012 was
adequate in order to maintain the allowance for loan and lease losses at an
adequate level to provide for probable losses based upon an evaluation of known
and inherent risks. The Group’s allowance for loan and lease losses policy
provides for a detailed quarterly analysis of probable losses. The decrease in
the provision for loan and lease losses for the nine-month period ended
September 30, 2012 is supported by the following observed trends:  • Current loans to total
gross loans increased from 85.7% at December 31, 2011 to 87.8% at September 30,
2012. 90


---



•
Loans that are 90 days past due to total gross loans decreased from 10.6% at
December 31, 2011 to 9.0% at September 30, 2012. • Non-accruing loans
decreased from $134.8 million at December 31, 2011 to $117.8 million at
September 30, 2012.  During the quarter and nine-month period
ended September 30, 2012, net credit losses amounted to $1.9 million and $8.3
million, respectively, a decrease of 12.9% and an increase of 19.1% when
compared to $2.2 million and $7.0 million reported for the same periods in
2011.  The decrease for the quarter ended September 30, 2012 is mainly due to a
reduction in net credit losses for commercial and consumer loans of
approximately $501 thousand when compared to the same quarter in 2011.  The
increase for the nine-month period ended September 30, 2012 was primarily due
to an increase in net credit losses for commercial loans of $1.9 million when
compared to the same period in 2011.  Total charge-offs decreased 8.4% to $2.1
million and increased 19.5% to $8.7 million in the quarter and nine-month period
ended September 30, 2012, respectively, as compared to the same periods in
2011, and total recoveries increased from $121 thousand and $331 thousand in
the quarter and nine-month period ended September 30, 2011, respectively, to
$208 thousand and $421 thousand in the quarter and nine-month period ended
September 30, 2012, respectively. As a result, the recoveries to charge-offs
ratio increased from 5.3% and 4.83% in the quarter and nine-month period ended
September 30, 2011 to 9.95% and 4.83% in the quarter and nine-month period
ended September 30, 2012.  The loans covered by the FDIC
shared-loss agreement were recognized at fair value as of April 30, 2010, which
included the impact of expected credit losses. To the extent credit
deterioration occurs in covered loans after the date of acquisition, the Group
would record an allowance for loan and lease losses. Also, the Group would
record an increase in the FDIC share-loss indemnification asset for the
expected reimbursement from the FDIC under the shared-loss agreements.  As part
of the Group’s assessment of actual versus expected cash flows on covered loans
during the nine-month period ended September 30, 2012, the Group observed that
some pools of construction and development loans and commercial real estate
loans underperformed. These observations required a provision for covered loan
and lease losses of $8.8 million, net of the effect from the FDIC shared-loss
indemnification asset, for the nine-month period ended September 30, 2012, an
increase from the recapture of covered loans and lease losses of ($1.4) million
for the same period in 2011.  Please refer to the “Allowance for Loan
and Lease Losses and Non-Performing Assets” section in this MD&A and Table
8 through Table 13 below for more detailed information concerning the
allowances for loan and lease losses, net credit losses and credit quality
statistics.  Income Taxes  Income
tax expense was $1.9 million and $4.9 million for the quarter and nine-month
period ended September 30, 2012, respectively, compared to an expense of $580
thousand and $5.7 million for the same periods in 2011.  The decrease during
the nine-month period ended September 30, 2012 was mainly due to the
re-measurement of the net deferred tax assets due to a reduction in the marginal
corporate income tax rates from 40.95% to 30%, which was partially offset by
the contingencies settled during the quarter ended June 30, 2011. At
December 31, 2011, OIB had $2.9 million in the income tax effect of
unrecognized gain on available-for-sale securities included in other
comprehensive income. Following the change in OIB’s applicable tax rate from 5%
to 0% as a result of new Puerto Rico legislation adopted in 2011, this
remaining tax balance will flow through income as these securities are repaid
or sold in future periods. During the quarter and nine-month period ended
September 30, 2012, income tax provision included $1.1 million and $1.8
million, respectively, related to this residual tax effect from the OIB. 91


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ANALYSIS OF
FINANCIAL CONDITION  TABLE 4 -
  ASSETS SUMMARY AND COMPOSITIONSeptember 30,
 
 December 31,2012
 
 2011
 
 Variance %(Dollars in thousands)Investments:FNMA and
  FHLMC certificates
 $
 2,322,451
 
 $
 3,560,806
 
 -34.8%Obligations
  of US Government sponsored agencies
 
 25,135
 
 
 -
 
 100.0%US Treasury
  Securities
 
 387,994
 
 
 -
 
 100.0%CMOs issued
  by US Government sponsored agencies
 
 307,367
 
 
 130,045
 
 136.4%GNMA
  certificates
 
 18,732
 
 
 28,337
 
 -33.9%Structured
  credit investments
 
 29,002
 
 
 37,288
 
 -22.2%Puerto Rico
  Government and agency obligations
 
 22,354
 
 
 71,458
 
 -68.7%FHLB stock
 
 22,865
 
 
 23,779
 
 -3.8%Other debt
  securities
 
 15,599
 
 
 16,004
 
 -2.5%Other investments
 
 1,583
 
 
 253
 
 525.7%Total
  investments
 
 3,153,082
 
 
 3,867,970
 
 -18.5%Loans:Loans not
  covered under shared-loss agreements with the FDIC
 
 1,183,639
 
 
 1,179,988
 
 0.3%Allowance
  for loan and lease losses on non covered loans
 
 (39,120)
 
 
 (37,010)
 
 -5.7%Non
  covered loans receivable, net
 
 1,144,519
 
 
 1,142,978
 
 0.1%Mortgage
  loans held for sale
 
 38,211
 
 
 26,939
 
 41.8%Total loans not covered under shared-loss agreements with the FDIC, net
 
 1,182,730
 
 
 1,169,917
 
 1.1%Loans
  covered under shared-loss agreements with the FDIC
 
 470,453
 
 
 533,532
 
 -11.8%Allowance
  for loan and lease losses on covered loans
 
 (56,865)
 
 
 (37,256)
 
 -52.6%Total loans covered under shared-loss agreements with the FDIC, net
 
 413,588
 
 
 496,276
 
 -16.7%Total loans, net
 
 1,596,318
 
 
 1,666,193
 
 -4.2%Securities
  purchased under agreements to resell
 
 270,000
 
 
 -
 
 100.0%Total
  securities and loans
 
 5,019,400
 
 
 5,534,163
 
 -9.3%Other assets:Cash and due
  from banks
 
 511,478
 
 
 587,624
 
 -13.0%Money market
  investments
 
 4,017
 
 
 3,863
 
 4.0%FDIC
  shared-loss indemnification asset
 
 328,573
 
 
 392,367
 
 -16.3%Foreclosed
  real estate
 
 39,400
 
 
 27,679
 
 42.3%Accrued
  interest receivable
 
 14,935
 
 
 20,182
 
 -26.0%Deferred tax
  asset, net
 
 35,912
 
 
 32,023
 
 12.1%Premises and
  equipment, net
 
 19,268
 
 
 21,520
 
 -10.5%Servicing
  assets
 
 10,642
 
 
 10,454
 
 1.8%Derivative
  assets
 
 18,495
 
 
 9,317
 
 98.5%Other assets
 
 49,085
 
 
 54,483
 
 -9.9%Total
  other assets
 
 1,031,805
 
 
 1,159,512
 
 -11.0%Total
  assets
 $
 6,051,205
 
 $
 6,693,675
 
 -9.6%Investments
  portfolio composition:FNMA and
  FHLMC certificates
 
 73.7%
 
 
 92.1%Obligations
  of US Government sponsored agencies
 
 0.8%
 
 
 0.0%US Treasury
  Securities
 
 12.3%
 
 
 0.0%CMOs issued
  by US Government sponsored agencies
 
 9.7%
 
 
 3.4%GNMA
  certificates
 
 0.6%
 
 
 0.7%Structured
  credit investments
 
 0.9%
 
 
 1.0%Puerto Rico
  Government and agency obligations
 
 0.7%
 
 
 1.8%FHLB stock
 
 0.7%
 
 
 0.6%Other debt
  securities and other investments
 
 0.6%
 
 
 0.3%100.0%
 
 
 99.9%
 92


---



Assets Owned  At September 30, 2012, the Group’s total
assets amounted to $6.051 billion, a decrease of 9.60% when compared to $6.694
billion at December 31, 2011, and interest-earning assets decrease 9.3% from
$5.534 billion at December 31, 2011 to $5.019 billion at September 30, 2012.  As set forth in Table 4 above,
investments are the Group’s largest components of interest-earning assets.
Investments principally consist of U.S. treasury securities, U.S. government
and agency bonds, mortgage-backed securities and Puerto Rico government and
agency bonds.  At September 30, 2012, the investment portfolio decreased 18.5%
to $3.153 billion from $3.868 billion at December 31, 2011.  This decrease is
mostly due to the net effect of a decrease of $1.238 billion in FNMA and FHLMC
certificates and an increase in U.S. treasury securities of $388.0 million.  During
the nine-month period ended September 30, 2012, the Group had net realized
gains of $55.7 million, mainly due to sales of mortgage-backed securities and
CMOs of $1.019 billion with a book value at sales of $962.8 million. During the
nine-month period ended September 30, 2011, the Group had gross realized gains
of $23.1 million, mainly due to sales of mortgage-backed securities of $492.4
million with a book value at sales of $469.3 million.  At September 30, 2012, approximately 97%
of the Group’s investment securities portfolio consists of fixed-rate
mortgage-backed securities or notes guaranteed or issued by FNMA, FHLMC or
GNMA, and U.S. agency senior debt obligations backed by a U.S.
government-sponsored entity or the full faith and credit of the U.S.
government, compared to 96% at December 31, 2011.  The Group’s loan portfolio is comprised
of residential loans, home equity loans, commercial loans collateralized by
mortgages on real estate located in Puerto Rico, other commercial and
industrial loans, consumer loans, and leases. At September 30, 2012, the
Group’s loan portfolio, the second largest category of the Group’s
interest-earning assets decreased 4.2% to $1.596 billion compared to the loan
portfolio of $1.666 billion at December 31, 2011. The covered loan portfolio
decreased $82.7 million, or 16.7%, mainly due to an increase of $19.6 million
in the allowance for loan and lease losses on covered loans, and as a net
effect of the repayment of loans and the portion of the accretable yield
recognized as interest income. The non-covered loan portfolio increased $12.8
million, or 1.1%.  At September 30, 2012, the Group’s
non-covered loan portfolio composition and trends were as follows:  ·Mortgage loan portfolio amounted
to $771.7 million (65.0% of the gross non-covered loan portfolio), compared to
$821.1 million (69.3% of the gross non-covered loan portfolio) at December 31,
2011. Mortgage loan production and purchases totaled $47.0 million and $140.9
million for the quarter and nine-month period ended September 30, 2012,
respectively, decreases of 10.8% from $52.7 million and 14.7% from $165.2
million in the quarter and nine-month period of the previous year,
respectively.  ·Commercial loan portfolio amounted
to $338.4 million (28.5% of the gross non-covered loan portfolio), compared to
$301.6 million (25.5% of the gross non-covered loan portfolio) at December 31,
2011. Commercial loan production increased 45.1% to $43.6 million for the
quarter ended September 30, 2012, and increased 46.0% to $134.8 million for the
nine-month period ended September 30, 2012 from $30.0 million and $92.3 million
for the same periods in 2011.  ·Consumer loan portfolio amounted
to $43.6 million (3.7% of the gross non-covered loan portfolio), compared to
$36.1 million (3.1% of the gross non-covered loan portfolio) at December 31,
2011. Consumer loan production increased 66.2% to $9.5 million for the quarter
ended September 30, 2012 and increased 48.8% to $22.4 million for the
nine-month period ended September 30, 2012 from $5.7 million and $15.0 million
for the same periods in 2011.  ·Leasing portfolio amounted to
$33.8 million (2.8% of the gross non-covered loan portfolio), compared to $25.8
million (2.2% of the gross non-covered loan portfolio) at December 31, 2011.
Leasing production increased 12.9% to $6.3 million for the quarter ended September
30, 2012 but decreased 5.6% to $15.2 million for the nine-month period ended
September 30, 2012 from $5.6 million and $16.1 million for the same periods in
2011.  93


---



The FDIC shared-loss indemnification
asset amounted to $328.6 million as of September 30, 2012 and $392.4 million as
of December 31, 2011. The FDIC shared-loss indemnification asset is reduced as
claims over losses recognized on covered loans are collected from the FDIC.
Realized credit losses in excess of previously forecasted estimates result in
an increase in the FDIC shared-loss indemnification asset. Conversely, if
realized credit losses are less than previously forecasted estimates, the FDIC
shared-loss indemnification asset is amortized through the term of the
shared-loss agreements. The decrease in the FDIC shared-loss indemnification
asset is mainly related to reimbursements received from the FDIC during the
nine-month period ended September 30, 2012 of $63.3 million and amortization of
$18.5 million, which was partially offset by an increase of $10.8 million in
expected credit impairment losses to be covered under shared-loss agreements,
net and $7.2 million in incurred expenses to be reimbursed under the
shared-loss agreements.  TABLE 5 —
  LOANS RECEIVABLE COMPOSITIONSeptember 30,
 
 December 31,
 
 Variance2012
 
 2011
 
 %(In thousands)Loans not
  covered under shared-loss agreements with FDIC:Loans
  secured by real estate:Residential
 $
 770,979
 
 $
 819,651
 
 -5.9%Home
  equity loans and others
 
 768
 
 
 1,411
 
 -45.6%Commercial
 
 239,654
 
 
 218,261
 
 9.8%Deferred
  loan fees, net
 
 (3,962)
 
 
 (4,300)
 
 7.9%Total loans secured by real estate
 
 1,007,439
 
 
 1,035,023
 
 -2.7%Other
  loans:Commercial
 
 98,710
 
 
 83,312
 
 18.5%Personal
  consumer loans and credit lines
 
 43,631
 
 
 36,130
 
 20.8%Leasing
 
 33,772
 
 
 25,768
 
 31.1%Deferred
  loan costs (fees), net
 
 87
 
 
 (245)
 
 135.5%Total other loans
 
 176,200
 
 
 144,965
 
 21.5%Loans
  receivable
 
 1,183,639
 
 
 1,179,988
 
 0.3%Allowance for loan and lease losses on non-covered loans
 
 (39,120)
 
 
 (37,010)
 
 -5.7%Loans
  receivable, net
 
 1,144,519
 
 
 1,142,978
 
 0.1%Mortgage
  loans held-for-sale
 
 38,211
 
 
 26,939
 
 41.8%Total
  loans not covered under shared-loss agreements with FDIC, net
 
 1,182,730
 
 
 1,169,917
 
 1.1%Loans covered
  under shared-loss agreements with FDIC:Loans
  secured by 1-4 family residential properties
 
 138,138
 
 
 140,824
 
 -1.9%Construction
  and development secured by 1-4 family residential properties
 
 7,933
 
 
 16,976
 
 -53.3%Commercial
  and other construction
 
 301,383
 
 
 325,832
 
 -7.5%Leasing
 
 12,140
 
 
 36,122
 
 -66.4%Consumer
 
 10,859
 
 
 13,778
 
 -21.2%Total
  loans covered under shared-loss agreements with FDIC
 
 470,453
 
 
 533,532
 
 -11.8%Allowance for loan and lease losses on covered loans
 
 (56,865)
 
 
 (37,256)
 
 -52.6%Total
  loans covered under shared-loss agreements with FDIC, net
 
 413,588
 
 
 496,276
 
 -16.7%Total loans
  receivable, net
 $
 1,596,318
 
 $
 1,666,193
 
 -4.2%
 94


---



TABLE 6 -
  LIABILITIES SUMMARY AND COMPOSITIONSeptember 30,
 
 December 31,
 
 Variance2012
 
 2011
 
 %(Dollars in thousands)Deposits:Non-interest
  bearing deposits
 $
 197,664
 
 $
 192,256
 
 2.8%NOW accounts
 
 850,735
 
 
 850,762
 
 0.0%Savings and
  money market accounts
 
 250,952
 
 
 230,672
 
 8.8%Certificates
  of deposit
 
 912,674
 
 
 1,157,002
 
 -21.1%Total
  deposits
 
 2,212,025
 
 
 2,430,692
 
 -9.0%Accrued
  interest payable
 
 2,342
 
 
 4,493
 
 -47.9%Total
  deposits and accrued interest payable
 
 2,214,367
 
 
 2,435,185
 
 -9.1%Borrowings:Securities
  sold under agreements to repurchase
 
 2,652,366
 
 
 3,056,238
 
 -13.2%Advances
  from FHLB
 
 285,395
 
 
 281,753
 
 1.3%FDIC-guaranteed term notes
 
 -
 
 
 105,834
 
 -100.0%Subordinated
  capital notes
 
 36,083
 
 
 36,083
 
 0.0%Total
  borrowings
 
 2,973,844
 
 
 3,479,908
 
 -14.5%Total deposits and borrowings
 
 5,188,211
 
 
 5,915,093
 
 -12.3%Derivative
  liabilities
 
 58,269
 
 
 47,425
 
 22.9%Other
  liabilities
 
 33,038
 
 
 35,602
 
 -7.2%Total liabilities
 $
 5,279,518
 
 $
 5,998,120
 
 -12.0%Deposits
  portfolio composition percentages:Non-interest
  bearing deposits
 
 8.9%
 
 
 7.9%NOW accounts
 
 38.5%
 
 
 35.0%Savings and
  money market accounts
 
 11.3%
 
 
 9.5%Certificates
  of deposit
 
 41.3%
 
 
 47.6%100.0%
 
 
 100.0%Borrowings
  portfolio composition percentages:Securities
  sold under agreements to repurchase
 
 89.2%
 
 
 87.9%Advances
  from FHLB
 
 9.6%
 
 
 8.1%FDIC-guaranteed term notes
 
 0.0%
 
 
 3.0%Subordinated
  capital notes
 
 1.2%
 
 
 1.0%100.0%
 
 
 100.0%Securities
  sold under agreements to repurchaseAmount
  outstanding at quarter-end
 $
 2,652,366
 
 $
 3,056,238Daily
  average outstanding balance
 $
 3,047,605
 
 $
 3,445,167Maximum outstanding
  balance at any month-end
 $
 3,060,578
 
 $
 3,466,480
 95


---



Liabilities and Funding Sources  As shown in Table 6 above, at September
30, 2012, the Group’s total liabilities were $5.280 billion, 12.0% lower than
the $5.998 billion reported at December 31, 2011. Deposits and borrowings, the
Group’s funding sources, amounted to $5.188 billion at September 30, 2012
versus $5.915 billion at December 31, 2011, a 12.3% decrease.  At September 30, 2012, borrowings
represented 57.3% of interest-bearing liabilities and deposits represented
42.7%. Borrowings consist mainly of funding sources through the use of
repurchase agreements, FHLB advances, and subordinated capital notes. At
September 30, 2012, borrowings amounted to $2.974 billion, 14.5% lower than the
$3.480 billion reported at December 31, 2011. The TLGP notes totaling $105
million were repaid in full at maturity in March 2012.  Repurchase agreements
as of September 30, 2012 decreased approximately $403.9 million to $2.652 billion
from $3.056 billion at December 31, 2012, mainly due to the early termination
of repurchase agreements amounting to $400 million during the quarter ended
September 30, 2012.  As a member of the FHLB, the Bank can
obtain advances from the FHLB, secured by the FHLB stock owned by the Bank, as
well as by certain of the Bank’s mortgage loans and investment securities.
Advances from FHLB amounted to $285.4 million and $281.8 million as of
September 30, 2012 and December 31, 2011, respectively. These advances mature
from October 2012 through April 2017.  At September 30, 2012, deposits and
accrued interest payable, the second largest category of the Group’s
interest-bearing liabilities, were $2.214 billion, down 9.1% from $2.435 billion
at December 31, 2011. This decrease was mainly attributable to a decrease in
higher cost brokered deposits and other wholesale institutional deposits which
decreased 44.8% and 56.2%, respectively, to $141.3 million and $73.7 million as
of September 30, 2012 from $255.9 million and $168.3 million as of December 31,
2011.  Stockholders’ Equity  At September 30, 2012, the Group’s total
stockholders’ equity was $771.7 million, a 10.9% increase when compared to
$695.6 million at December 31, 2011. The increase reflects the issuance of the
Convertible Preferred Stock during the quarter ended September 30, 2012
amounting to $84 million and a decrease of 75.6% or $28.1 million in other
comprehensive income, partially offset by the net income for the nine-month
period ended September 30, 2012.  Tangible common equity to risk-weighted
assets and total equity to risk-weighted assets at September 30, 2012 increased
to 32.96% and 40.79%, respectively, from 30.14% and 33.48% at December 31,
2011.  The Group maintains capital ratios in
excess of regulatory requirements. At September 30, 2012, Tier 1 Leverage
Capital Ratio was 10.91% (2.73 times the requirement of 4.00%), Tier 1
Risk-Based Capital Ratio was 36.33% (9.08 times the requirement of 4.00%), and
Total Risk-Based Capital Ratio was 37.63% (4.70 times the requirement of
8.00%).  Taking into consideration our strong
capital position, we increased the quarterly cash dividend per common share by
20.0% to $0.06 per share on November 30, 2011. On an annualized basis, this
represents an increase from $0.20 to $0.24 per share. 96


---



The following are the consolidated
capital ratios of the Group at September 30, 2012 and December 31, 2011:  TABLE 7 —
  CAPITAL, DIVIDENDS AND STOCK DATASeptember 30,
 
 December 31,
 
 Variance2012
 
 2011
 
 %(Dollars in thousands, except per share
  data)Capital data:Stockholders’ equity
 $
 771,687
 
 $
 695,555
 
 10.9%Regulatory
  Capital Ratios data:Leverage
  capital ratio
 
 10.91%
 
 
 9.65%
 
 13.0%Minimum
  leverage capital ratio required
 
 4.00%
 
 
 4.00%Actual tier
  1 capital
 $
 687,436
 
 $
 661,614
 
 3.9%Minimum tier
  1 capital required
 $
 252,145
 
 $
 274,230
 
 -8.1%Excess over
  regulatory requirement
 $
 435,291
 
 $
 387,384
 
 12.4%Tier 1
  risk-based capital ratio
 
 36.33%
 
 
 31.84%
 
 14.1%Minimum tier
  1 risk-based capital ratio required
 
 4.00%
 
 
 4.00%Actual tier
  1 risk-based capital
 $
 687,436
 
 $
 661,614
 
 3.9%Minimum tier
  1 risk-based capital required
 $
 75,681
 
 $
 83,110
 
 -8.9%Excess over
  regulatory requirement
 $
 611,755
 
 $
 578,504
 
 5.7%Risk-weighted assets
 $
 1,892,021
 
 $
 2,077,742
 
 -8.9%Total
  risk-based capital ratio
 
 37.63%
 
 
 33.12%
 
 13.6%Minimum
  total risk-based capital ratio required
 
 8.00%
 
 
 8.00%Actual total
  risk-based capital
 $
 711,987
 
 $
 688,188
 
 3.5%Minimum
  total risk-based capital required
 $
 151,362
 
 $
 166,219
 
 -8.9%Excess over
  regulatory requirement
 $
 560,625
 
 $
 521,969
 
 7.4%Risk-weighted assets
 $
 1,892,021
 
 $
 2,077,742
 
 -8.9%Tangible
  common equity to total assets
 
 10.30%
 
 
 9.36%
 
 10.0%Tangible
  common equity to risk-weighted assets
 
 32.96%
 
 
 30.14%
 
 9.4%Total equity
  to total assets
 
 12.75%
 
 
 10.39%
 
 22.7%Total equity
  to risk-weighted assets
 
 40.79%
 
 
 33.48%
 
 21.8%Tier 1
  common equity to risk-weighted assets
 
 31.03%
 
 
 27.01%
 
 14.9%Tier 1
  common equity capital
 $
 587,098
 
 $
 561,275
 
 4.6%Stock data:Outstanding
  common shares
 
 40,745,946
 
 
 41,244,533
 
 -1.2%Book value
  per common share
 $
 15.40
 
 $
 15.28
 
 0.8%Market price
  at end of period
 $
 10.52
 
 $
 12.11
 
 -13.1%Market
  capitalization at end of period
 $
 428,647
 
 $
 499,471
 
 -14.2%
  Nine-Month Period Ended September 30,
 
 Variance2012
 
 2011
 
 %(Dollars in thousands, except per share
  data)Common
  dividend data:Cash
  dividends declared
 $
 7,331
 
 $
 6,677
 
 9.8%Cash
  dividends declared per share
 $
 0.18
 
 $
 0.15
 
 20.0%Payout ratio
 
 19.60%
 
 
 16.02%
 
 22.3%Dividend
  yield
 
 2.28%
 
 
 2.07%
 
 10.3%
 97


---



The table that follows presents a
reconciliation of the Group’s total stockholders’ equity to tangible common
equity and total assets to tangible assets at September 30, 2012 and December
31, 2011:  September 30,
 
 December 31,2012
 
 2011(In thousands, except share or per
  share information)Total
  stockholders' equity
 $
 771,687
 
 $
 695,555Preferred stock
 
 (152,000)
 
 
 (68,000)Preferred stock
  issuance costs
 
 7,639
 
 
 2,662Goodwill
 
 (2,701)
 
 
 (2,701)Core deposit
  intangible
 
 (1,079)
 
 
 (1,185)Total
  tangible common equity
 $
 623,546
 
 $
 626,331Total assets
 
 6,051,205
 
 
 6,693,675Goodwill
 
 (2,701)
 
 
 (2,701)Core deposit
  intangible
 
 (1,079)
 
 
 (1,185)Total tangible
  assets
 $
 6,047,425
 
 $
 6,689,789Tangible
  common equity to tangible assets
 
 10.31%
 
 
 9.36%Common shares
  outstanding at end of period
 
 40,745,946
 
 
 41,244,533Tangible book
  value per common share
 $
 15.30
 
 $
 15.19
  The tangible common equity ratio and
tangible book value per common share are non-GAAP measures. Management and many
stock analysts use the tangible common equity ratio and tangible book value per
common share in conjunction with more traditional bank capital ratios to
compare the capital adequacy of banking organizations. Neither tangible common
equity nor tangible assets or related measures should be considered in
isolation or as a substitute for stockholders’ equity, total assets or any
other measure calculated in accordance with GAAP. Moreover, the manner in which
the Group calculates its tangible common equity, tangible assets and any other
related measures may differ from that of other companies reporting measures
with similar names.  The Tier 1 common equity to
risk-weighted assets ratio is another non-GAAP measure. Ratios calculated based
upon Tier 1 common equity have become a focus of regulators and investors, and
management believes ratios based on Tier 1 common equity assist investors in
analyzing the Group’s capital position. In connection with the Supervisory
Capital Assessment Program, the Federal Reserve Board began supplementing its
assessment of the capital adequacy of a bank holding company based on a
variation of Tier 1 capital, known as Tier 1 common equity.  Because Tier 1 common equity is not
formally defined by GAAP or, unlike Tier 1 capital, codified in the federal
banking regulations, this measure is considered to be a non-GAAP financial
measure. Non-GAAP financial measures have inherent limitations, are not required
to be uniformly applied and are not audited. To mitigate these limitations, the
Group has procedures in place to calculate these measures using the appropriate
GAAP or regulatory components. Although these non-GAAP financial measures are
frequently used by stakeholders in the evaluation of a company, they have
limitations as analytical tools and should not be considered in isolation or as
a substitute for analyses of results as reported under GAAP. 98


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The table below presents a
reconciliation of the Group’s total common equity (GAAP) at September 30, 2012
and December 31, 2011 to Tier 1 common equity (non-GAAP):  September 30,
 
 December 31,2012
 
 2011(In thousands)Common
  stockholders' equity
 $
 627,326
 
 $
 630,216Unrealized gains
  on available-for-sale securities, net of income tax
 
 (60,098)
 
 
 (79,244)Unrealized
  losses on cash flow hedges, net of income tax
 
 51,035
 
 
 42,113Disallowed
  deferred tax assets
 
 (26,322)
 
 
 (26,879)Disallowed
  servicing assets
 
 (1,064)
 
 
 (1,045)Intangible
  assets:Goodwill
 
 (2,701)
 
 
 (2,701)Other
  disallowed intangibles
 
 (1,079)
 
 
 (1,185)Total Tier 1
  common equity
 $
 587,097
 
 $
 561,275Tier 1 common
  equity to risk-weighted assets
 
 31.03%
 
 
 27.01%
  The following table presents the Group’s
capital adequacy information at September 30, 2012 and December 31, 2011:  September 30,
 
 December 31,2012
 
 2011(In thousands)Risk-based
  capital:Tier 1
  capital
 $
 687,436
 
 $
 661,614Supplementary (Tier 2) capital
 
 24,551
 
 
 26,574Total
  Capital
 $
 711,987
 
 $
 688,188Risk-weighted
  assets:Balance
  sheet items
 $
 1,835,653
 
 $
 2,032,982Off-balance
  sheet items
 
 56,368
 
 
 44,760Total
  risk-weighted assets
 $
 1,892,021
 
 $
 2,077,742Ratios:Tier 1
  capital (minimum required - 4%)
 
 36.33%
 
 
 31.84%Total
  capital (minimum required - 8%)
 
 37.63%
 
 
 33.12%Leverage
  ratio
 
 10.91%
 
 
 9.65%Equity to
  assets
 
 12.75%
 
 
 10.39%Tangible
  common equity to assets
 
 10.30%
 
 
 9.36%
  The Federal Reserve Board has risk-based
capital guidelines for bank holding companies. Under the guidelines, the
minimum ratio of qualifying total capital to risk-weighted assets is 8%. At
least half of the total capital is to be comprised of qualifying common
stockholders’ equity, qualifying noncumulative perpetual preferred stock (including
related surplus), minority interests related to qualifying common or
noncumulative perpetual preferred stock directly issued by a consolidated U.S.
depository institution or foreign bank subsidiary, and restricted core capital
elements (collectively “Tier 1 Capital”). Banking organizations are expected to
maintain at least 50% of their Tier 1 Capital as common equity. Except as otherwise
discussed below in light of the Dodd-Frank Act in connection with certain debt
or equity instruments issued on or after May 19, 2010, not more than 25% of
qualifying Tier 1 Capital may consist of qualifying cumulative perpetual
preferred stock, trust preferred securities or other so-called restricted core
capital elements. “Tier 2 Capital” may consist, subject to certain limitations,
of allowance for loan and lease losses; perpetual preferred stock and related
surplus; hybrid capital instruments, perpetual debt, and mandatory convertible
debt securities; term subordinated debt and intermediate-term preferred stock,
including related surplus; and unrealized holding gains on equity securities.
“Tier 3 Capital” consists of qualifying unsecured subordinated debt.  The sum of Tier 2 and Tier 3 Capital may
not exceed the amount of Tier 1 Capital. At September 30, 2012 and December 31,
2011, the Group was a “well capitalized” institution for regulatory purposes.  The Federal Reserve Board has
regulations with respect to risk-based and leverage capital ratios that require
most intangibles, including goodwill and core deposit intangibles, to be
deducted from Tier 1 Capital. The only types of identifiable intangible assets 99


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that may be included in, that is, not deducted from, an
organization’s capital are readily marketable mortgage servicing assets,
nonmortgage servicing assets, and purchased credit card relationships.  In addition, the Federal Reserve Board
has established minimum leverage ratio (Tier 1 Capital to total assets) guidelines
for bank holding companies and member banks. These guidelines provide for a
minimum leverage ratio of 3% for bank holding companies and member banks that
meet certain specified criteria, including that they have the highest regulatory
rating.  All other bank holding companies and member banks are required to maintain
a minimum ratio of Tier 1 Capital to total assets of 4%. The guidelines also
provide that banking organizations experiencing internal growth or making
acquisitions are expected to maintain strong capital positions substantially
above the minimum supervisory levels without significant reliance on intangible
assets. Furthermore, the guidelines state that the Federal Reserve Board will
continue to consider a “tangible Tier 1 leverage ratio” and other indicators of
capital strength in evaluating proposals for expansion or new activities.  Under the Dodd-Frank Act, federal
banking regulators are required to establish minimum leverage and risk-based capital
requirements on a consolidated basis for insured institutions, depository
institution holding companies, and non-bank financial companies supervised by
the Federal Reserve Board. The minimum leverage and risk based capital
requirements are to be determined based on the minimum ratios established for
insured depository institutions under prompt corrective action regulations. In
effect, such provision of the Dodd-Frank Act (i.e., Section 171), which is commonly
known as the Collins Amendment, applies to bank holding companies the same
leverage and risk based capital requirements that apply to insured depository
institutions. Because the capital requirements must be the same for insured
depository institutions and their holding companies, the Collins Amendment generally
excludes certain debt or equity instruments, such as cumulative perpetual
preferred stock and trust preferred securities, from Tier 1 Capital, subject to
a three-year phase-out from Tier 1 qualification for such instruments issued
before May 19, 2010, with the phase-out commencing on January 1, 2013. However,
such instruments issued before May 19, 2010 by a bank holding company, such as
the Group, with total consolidated assets of less than $15 billion as of
December 31, 2009, are not affected by the Collins Amendment and may continue
to be included in Tier 1 Capital as a restricted core capital element.  On June 12, 2012, the Office of the
Comptroller of the Currency (the “OCC”), the Federal Reserve Board, and the
FDIC issued three notices of proposed rulemaking (“NPRs”) that would revise and
replace the agencies’ current capital rules.  The agencies also announced the
finalization of the market risk capital rule that was proposed in 2011.  In the first Basel III NPR, “Regulatory
Capital Rules: Regulatory Capital, Implementation of Basel III, Minimum
Regulatory Capital Ratios, Capital Adequacy, and Transition Provisions” (the
“Basel III NPR”), the agencies are proposing to revise their risk-based and
leverage capital requirements consistent with agreements reached by the Basel
Committee on Banking Supervision (“Basel III”).  The Basel III NPR would apply
to all insured banks and savings associations, top-tier bank holding companies
domiciled in the United States with more than $500 million in assets, and
savings and loan holding companies that are domiciled in the United States. 
Provisions of the Basel III NPR that would apply to such banking organizations
include implementation of a new common equity Tier 1 minimum capital
requirement, a higher minimum Tier 1 capital requirement, and, for banking
organizations subject to the advanced approaches capital rules, a supplementary
leverage ratio that incorporates a broader set of exposures.  Additionally,
consistent with Basel III, the agencies propose to apply limits on a banking
organization’s capital distributions and certain discretionary bonus payments
if the banking organization does not hold a specified “buffer” of common equity
Tier 1 capital in addition to the minimum risk-based capital requirements.  The
revisions set forth in the Basel III NPR are consistent with Section 171 of the
Dodd-Frank Act, which requires the agencies to establish minimum risk-based and
leverage capital requirements.  The Basel III NPR also would revise the
agencies’ prompt corrective action framework by incorporating the new
regulatory capital minimums and updating the definition of tangible common
equity.  Prompt corrective action is an enforcement framework that constrains
the activities of insured depository institutions based on their level of
regulatory capital.  The second Basel III NPR, “Regulatory
Capital Rules: Advanced Approaches Risk-based Capital Rules; Market Risk
Capital Rule” (the “Advanced Approaches and Market Risk NPR”), would revise the
advanced approaches risk-based capital rules consistent with Basel III and
other changes to the Basel Committee’s capital standards.  The agencies also
propose revising the advanced approaches risk-based capital rules to be
consistent with Section 939A and Section 171 of the Dodd-Frank Act.  Additionally
in the Advanced Approaches and Market Risk NPR, the OCC and the FDIC propose
that the market risk capital rules apply to federal and state savings
associations, and the Federal Reserve Board proposes that the advanced
approaches and market risk capital rules apply to top-tier savings and loan
holding companies domiciled in the United States, if stated thresholds for
trading activity are met.  Generally, the advanced approaches rules would apply
to such institutions with $250 billion or more in consolidated assets or $10
billion or more in foreign exposure, and the market risk rule would apply to
savings and loan holding companies with significant trading activity.  100


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In the third
capital NPR, “Regulatory Capital Rules: Standardized Approach for Risk-weighted
Assets; Market Discipline and Disclosure Requirements” (the “Standardized
Approach NPR”), the agencies propose to revise and harmonize rules for
calculating risk-weighted assets to enhance risk sensitivity and address
weaknesses identified over recent years, including by incorporating aspects of
the Basel II standardized framework, and alternatives to credit ratings,
consistent with Section 939A of the Dodd-Frank Act.  The revisions include
methods for determining risk-weighted assets for residential mortgages,
securitization exposures, and counterparty credit risk.  The Standardized
Approach NPR also would introduce disclosure requirements that would apply to
U.S. banking organizations with $50 billion or more in total assets.  The
Standardized Approach NPR would apply to the same set of institutions as the
Basel III NPR.  The Group’s common stock is traded on
the New York Stock Exchange (“NYSE”) under the symbol “OFG.”  At September 30,
2012 and December 31, 2011, the Group’s market capitalization for its
outstanding common stock was $428.6 million ($10.52 per share) and $499.5
million ($12.11 per share), respectively.  The following table provides the high
and low prices and dividends per share of the Group’s common stock for each
quarter of the last three calendar years:  CashPrice
 
 DividendHigh
 
 Low
 
 Per share2012September
  30, 2012
 $
 11.49
 
 $
 10.02
 
 $
 0.06June 30,
  2012
 $
 12.37
 
 $
 9.87
 
 $
 0.06March 31,
  2012
 $
 12.69
 
 $
 11.25
 
 $
 0.062011December 31,
  2011
 $
 12.35
 
 $
 9.19
 
 $
 0.06September
  30, 2011
 $
 13.20
 
 $
 9.18
 
 $
 0.05June 30,
  2011
 $
 13.07
 
 $
 11.26
 
 $
 0.05March 31,
  2011
 $
 12.84
 
 $
 11.40
 
 $
 0.052010December 31,
  2010
 $
 13.72
 
 $
 11.50
 
 $
 0.05September
  30, 2010
 $
 14.45
 
 $
 12.13
 
 $
 0.04June 30,
  2010
 $
 16.72
 
 $
 12.49
 
 $
 0.04March 31,
  2010
 $
 14.09
 
 $
 10.00
 
 $
 0.04
 101


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The Bank is considered “well
capitalized” under the regulatory framework for prompt corrective action. The
table below shows the Bank’s regulatory capital ratios at September 30, 2012
and at December 31, 2011:  September 30,
 
 December 31,
 
 Variance2012
 
 2011
 
 %(Dollars in thousands)Oriental Bank
  and Trust Regulatory Capital Ratios:Total
  Tier 1 Capital to Total Assets
 
 10.66%
 
 
 9.06%
 
 17.7%Actual tier
  1 capital
 $
 660,838
 
 $
 616,590
 
 7.2%Minimum
  capital requirement (4%)
 $
 247,862
 
 $
 272,177
 
 -8.9%Minimum to
  be well capitalized (5%)
 $
 309,827
 
 $
 340,221
 
 -8.9%Tier 1
  Capital to Risk-Weighted Assets
 
 35.47%
 
 
 29.79%
 
 19.1%Actual tier
  1 risk-based capital
 $
 660,838
 
 $
 616,590
 
 7.2%Minimum
  capital requirement (4%)
 $
 74,525
 
 $
 82,787
 
 -10.0%Minimum to
  be well capitalized (6%)
 $
 111,787
 
 $
 124,180
 
 -10.0%Total
  Capital to Risk-Weighted Assets
 
 36.77%
 
 
 31.07%
 
 18.3%Actual total
  risk-based capital
 $
 685,032
 
 $
 643,065
 
 6.5%Minimum
  capital requirement (8%)
 $
 149,049
 
 $
 165,573
 
 -10.0%Minimum to
  be well capitalized (10%)
 $
 186,311
 
 $
 206,967
 
 -10.0%
  Group’s Financial Assets Managed  The Group’s financial assets managed
include those managed by the Group’s trust division, retirement plan
administration subsidiary, and Oriental Financial Services. Assets managed by
the trust division and Oriental Financial Services increased from $4.142
billion as of December 31, 2011 to $4.617 billion as of September 30, 2012,
mainly as a result of an increase in account contributions and capital market
appreciation.  The Group’s trust division offers
various types of IRAs and manages 401(k) and Keogh retirement plans and
custodian and corporate trust accounts, while the retirement plan
administration subsidiary, CPC, manages private retirement plans.  At September
30, 2012, total assets managed by the Group’s trust division and CPC amounted
to $2.450 billion, compared to $2.216 billion at December 31, 2011.  Oriental
Financial Services offers a wide array of investment alternatives to its client
base, such as tax-advantaged fixed income securities, mutual funds, stocks,
bonds and money management wrap-fee programs.  At September 30, 2012, total
assets gathered by Oriental Financial Services from its customer investment
accounts increased to $2.167 billion, compared to $1.926 billion at December
31, 2011.  Allowance for Loan and Lease Losses
and Non-Performing Assets  The Group maintains an allowance for
loan and lease losses at a level that management considers adequate to provide
for probable losses based upon an evaluation of known and inherent risks. The
Group’s allowance for loan and lease losses policy provides for a detailed
quarterly analysis of probable losses. Tables 8 through 13 set forth an analysis
of activity in the allowance for loan and lease losses and present selected
loan loss statistics. In addition, refer to Table 5 for the composition of the
loan portfolio.  Non-covered Loans  At September 30, 2012, the Group’s
allowance for non-covered loan and lease losses amounted to $39.1 million or
3.29% of total non-covered loans versus $37.0 million, or 3.12%, of total
non-covered loans at December 31, 2011. The allowance for residential mortgage
loans, consumer loans, and leases decreased by 2.8% (or $599 thousand), 17.5%
(or $249 thousand), and 71.1% (or $601 thousand), respectively, when compared
with balances recorded at December 31, 2011.  The allowance for commercial
loans increased by 23.0%, or $2.9 million, when compared with balances recorded
at December 31, 2011.  The unallocated allowance increased by 123.2%, or $668
thousand, when compared with balances recorded at December 31, 2011.  Please refer to the “Provision for Loan
and Lease Losses” section in this MD&A for a more detailed analysis of
provisions for loan and lease losses.  102


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The Group
follows a systematic methodology to establish and evaluate the adequacy of the
allowance for loan and lease losses to provide for inherent losses in the loan
portfolio. This methodology includes the consideration of factors such as
economic conditions, portfolio risk characteristics, prior loss experience, and
results of periodic credit reviews of individual loans. The provision for loan
losses charged to current operations is based on such methodology. Loan losses
are charged and recoveries are credited to the allowance for loan and lease
losses.  Larger commercial loans that exhibit
potential or observed credit weaknesses are subject to individual review and
grading. Where appropriate, allowances are allocated to individual loans based
on management’s estimate of the borrower’s ability to repay the loan given the
availability of collateral and other sources of cash flow and legal options
available to the Group.  Included in the review of individual loans
are those that are impaired. A loan is considered impaired when, based on
current information and events, it is probable that the Group will be unable to
collect the scheduled payments of principal or interest when due according to
the contractual terms of the loan agreement. Impaired loans are measured based
on the present value of expected future cash flows discounted at the loan’s
effective interest rate, or as a practical expedient, at the observable market
price of the loan or the fair value of the collateral, if the loan is
collateral dependent. Loans are individually evaluated for impairment, except
large groups of small balancehomogeneous loans that are collectively
evaluated for impairment and loans that are recorded at fair value or at the
lower of cost or market value. The portfolios of mortgage loans, leases and
consumer loans are considered homogeneous, and are evaluated collectively for
impairment. For the commercial loans portfolio, all loans over $250 thousand
that are either over 90 days past due or adversely classified, or when deemed
necessary by management, are evaluated for impairment. At September 30, 2012, the
total investment in impaired commercial loans was $35.9 million, compared to
$46.4 million at December 31, 2011.  Most of the impaired commercial loans are
measured based on the fair value of collateral method, since most impaired
loans during the period were collateral dependent, all other loans are measured
using the present value of cash flows method. The valuation allowance for
impaired commercial loans amounted to approximately $1.3 million and $3.5
million at September 30, 2012 and December 31, 2011, respectively. At September
30, 2012, the total investment in impaired mortgage loans was $64.9 million,
compared to $51.5 million at December 31, 2011.  Impairment on mortgage loans
assessed as troubled-debt restructuring was measured using the present value of
cash flows. The valuation allowance for impaired mortgage loans amounted to approximately
$4.8 million and $3.4 million at September 30, 2012 and December 31, 2011.  The Group, using a rating system,
applies an overall allowance percentage to each non-covered loan portfolio
segment based on historical credit losses adjusted for current conditions and
trends. The historical loss experience is determined by portfolio segment and
is based on the actual loss history experienced by the Group over the most
recent twelve months. The actual loss experience is supplemented with other
economic factors based on the risks present for each portfolio segment. These
economic factors include consideration of the following: levels of and trends
in delinquencies and impaired loans; levels of and trends in charge-offs and
recoveries; trends in volume and terms of loans; effects of any changes in risk
selection and underwriting standards, and other changes in lending policies,
procedures and practices; experience, ability, and depth of lending management
and other relevant staff, including the bank’s loan review system as graded by
regulatory agencies in their last examination; local economic trends and
industry conditions; effects of external factors such as competition and
regulatory requirements on the level of estimated credit losses in the current
portfolio; and effects of changes in credit concentrations and collateral
value. The following portfolio segments have been identified: mortgage loans;
commercial loans; consumer loans; and leasing.  Loan loss ratios and credit risk
categories are updated quarterly and are applied in the context of GAAP and the
2006 Interagency Policy Statement on the Allowance for Loan and Lease Losses,
which requires that depository institutions have prudent, conservative, but not
excessive loan loss allowances that fall within an acceptable range of
estimated losses. While management uses available information in estimating
probable loan losses, future changes to the allowance may be necessary, based
on factors beyond the Group’s control, such as factors affecting general
economic conditions.  There have been no material changes in
criteria or estimation techniques as compared to prior periods that impacted
the determination of the current period allowance for loan and lease losses,
except for the further segregation of the traditional residential mortgage
portfolio by origination vintages made since the June 30, 2012 quarter. The new
segregation allows management to perform more efficient assessment of the
traditional mortgage portfolio historical losses and risk.  Also, since the
quarter ended June 30, 2012, the following changes were made to the current
environmental factors consider for the determination of the allowance for loan
and lease losses: •  consolidation of national and local economic trends
and industry conditions as one factor; • the addition of the quality of the Bank’s loan
review system as graded in the last FDIC report of examination to the factor
dealing with management’s experience, ability, and depth of lending management
and other relevant staff; and •  the addition of the changes in the value of
underlying collateral for collateral dependant loans. 103


---



The Group’s non-performing assets
include non-performing loans and foreclosed real estate (see Tables 11 and 12).
At September 30, 2012 and December 31, 2011, the Group had $117.8 million and
$134.8 million, respectively, of non-accrual non-covered loans including credit
cards accounted under ASC 310-20, a decrease of 12.56%.  Covered loans are
considered to be performing due to the application of the accretion method
under ASC 310-30.  At September 30, 2012 and December 31, 2011, loans whose
terms have been extended and which are classified as troubled-debt
restructuring that are not included in non-performing assets amounted to $56.6
million and $41.3 million, respectively.  At September 30, 2012, the Group’s
non-performing assets decreased 8.58% to $136.9 million (2.44% of total assets,
excluding covered loans) from $149.8 million (2.42% of total assets, excluding
covered loans) at December 31, 2011.  The decrease in the Group’s
non-performing loans generally reflects the ongoing stabilization of the economic
environment in Puerto Rico.  The Group does not expect non-performing loans to
result in significantly higher losses as most are well-collateralized with
adequate loan-to-value ratios. At September 30, 2012, the allowance for
non-covered loan and lease losses to non-performing loans coverage ratio was
33.20% (27.46% at December 31, 2011).  The Group follows a conservative
residential mortgage lending policy, with more than 90% of its residential
mortgage portfolio consisting of fixed-rate, fully amortizing, fully documented
loans that do not have the level of risk associated with subprime loans offered
by certain major U.S. mortgage loan originators. Furthermore, the Group has
never been active in negative amortization loans or adjustable rate mortgage
loans, including those with teaser rates, and does not originate construction
and development loans.  The following items comprise
non-performing assets:  ·Mortgage loans— are placed on non-accrual status when they become
90 days or more past due and are written-down, if necessary, based on the
specific evaluation of the collateral underlying the loan.  At September 30,
2012, the Group’s non-performing mortgage loans totaled $87.9 million (74.6% of
the Group’s non-performing loans), a 9.70% decrease from $97.3 million (72.2%
of the Group’s non-performing loans) at December 31, 2011.  Non-performing
loans in this category are primarily residential mortgage loans. On April 1,
2011, the Bank changed on a prospective basis its policy to place on
non-accrual status residential mortgage loans well collateralized and in
process of collection when reaching 90 days past due. All loans that were
between 90 and 365 days past due when the policy was changed were also placed
on non-accrual status. The interest receivable on such loans is evaluated on a
periodic basis against the collateral underlying the loans, and written-down,
if necessary. On December 31, 2011, the Bank further revised its policy to
reverse against income all interest recorded on residential mortgage loans
reaching 90 days past due, including the remaining interest on loans that were
between 90 and 365 days past due as of April 1, 2011.  On December 31, 2011, the
Bank also charged-off this remaining accrued interest on residential mortgage
loans over 90 days past due.  This change in estimate was considered necessary
to comply with guidance received from the Group’s regulators.  ·Commercial loans— are placed on non-accrual status when they become 90
days or more past due and are written-down, if necessary, based on the specific
evaluation of the underlying collateral, if any.  At September 30, 2012, the
Group’s non-performing commercial loans amounted to $29.6 million (25.2% of the
Group’s non-performing loans), a 19.84% decrease when compared to
non-performing commercial loans of $37.0 million at December 31, 2011 (27.4% of
the Group’s non-performing loans).  Approximately 72% of this portfolio is
collateralized by commercial real estate properties.  ·Consumer loans— are placed on non-accrual status when they become
90 days past due and written-off when payments are delinquent 120 days in
personal loans and 180 days in credit cards and personal lines of credit.  At
September 30, 2012, the Group’s non-performing consumer loans amounted to $276 thousand
(0.2% of the Group’s total non-performing loans), a 17.4% decrease from $334 thousand
at December 31, 2011 (0.3% of total non-performing loans).  ·Leases— are placed on non-accrual status when they become
90 days past due and partially written-off to collateral value when payments
are delinquent 120 days, and fully written-off when payments are delinquent 180
days.  At September 30, 2012, the Group’s non-performing leases amounted to $11thousand
(0.01% of the Group’s total non-performing loans), a decrease of 89.22% from
$102 thousand at December 31, 2011 (0.1% of total non-performing loans).  ·Foreclosed real estate— is initially recorded at the lower of the related
loan balance or fair value less cost to sell as of the date of foreclosure. Any
excess of the loan balance over the fair value of the property is charged
against the allowance for loan and lease losses. Subsequently, any excess of
the carrying value over the estimated fair value less disposition cost is
charged to operations. Net losses on the sale of foreclosed real estate for the
quarter and nine-month period ended September
30, 2012, amounted to $1.2 104


---



million and $2.5 million, respectively, compared to $199
thousand and $334 thousand in the quarter and nine-month period ended September 30, 2011.  The Group has two mortgage loan
modification programs. These are the Loss Mitigation Program and the
Non-traditional Mortgage Loan Program. Both programs are intended to help
responsible homeowners toremain in their homes and avoid
foreclosure, while also reducing the Group’s losses on non-performing mortgage
loans.  The Loss Mitigation Program helps
mortgage borrowers who are or will become financially unable to meet the
current or scheduled mortgage payments. Loans that qualify under this program
are those guaranteed by FHA, VA, RHS, “Banco de la Vivienda de Puerto Rico,”
conventional loans guaranteed by Mortgage Guaranty Insurance Corporation
(MGIC), conventional loans sold to the FNMA and FHLMC, and conventional loans
retained by the Group. The program offers diversified alternatives such as
regular or reduced payment plans, payment moratorium, mortgage loan
modification, partial claims (only FHA), short sale, and payment in lieu of
foreclosure.  The Non-traditional Mortgage Loan
Program is for non-traditional mortgages, including balloon payment, interest
only/interest first, variable interest rate, adjustable interest rate and other
qualified loans. Non-traditional mortgage loan portfolios are segregated into
the following categories: performing loans that meet secondary market
requirement and are refinanced by the credit underwriting guidelines of
FHA/VA/FNMA/FMAC, and performing loans not meeting secondary market guidelines,
processed by the Group’s current credit and underwriting guidelines. The Group
achieved an affordable and sustainable monthly payment by taking specific,
sequential, and necessary steps such as reducing the interest rate, extending
the loan term, capitalizing arrearages, deferring the payment of principal or,
if the borrower qualifies, refinancing the loan.  There may not be a foreclosure sale
scheduled within 60 days prior to a loan modification under any such programs.
This requirement does not apply to loans where the foreclosure process has been
stopped by the Group. In order to apply for any of the loan modification
programs, the borrower may not be in active bankruptcy or have been discharged
from Chapter 7 bankruptcy since the loan was originated. Loans in these programs
will be evaluated by management for troubled debt restructuring classification
if the Group grants a concession for legal or economic reasons due to the
debtor’s financial difficulties.  Covered Loans  The allowance for loan and
lease losses on covered loans acquired in the FDIC-assisted acquisition of
Eurobank is accounted under the provisions of ASC 310-30. Under this accounting
guidance, the allowance for loan and lease losses on covered loans is evaluated
at each financial reporting period, based on forecasted cash flows. Credit
related decreases in expected cash flows, compared to those previously
forecasted are recognized by recording a provision for credit losses on covered
loans. The portion of the loss on covered loans reimbursable from the FDIC is recorded
as an offset to the provision for credit losses and increases the FDIC
shared-loss indemnification asset.  As part of the evaluation of actual
versus expected cash flows, the Group assesses on a quarterly basis the credit
quality of these loans based on delinquency, severity factors and risk ratings,
among other assumptions. The credit quality assumptions for certain pools were
updated to reflect an increase in default rates, severities and extension of
recovery lags resulting in an increase in the provision for covered loan and
lease losses of $221 thousand for the quarter ended September 30, 2012.  Such increase in provision was
net of the effect of the increase in the FDIC shared-loss indemnification
asset.  As a result, the allowance for covered loans increased from $37.3million
at December 31, 2011 to $56.9million
at September 30, 2012. 105


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TABLE 8 —
  ALLOWANCE FOR LOAN AND LEASE LOSSES SUMMARYQuarter Ended September 30,
 
 Variance
 
 Nine-Month Period Ended September 30,
 
 Variance2012
 
 2011
 
 %
 
 2012
 
 2011
 
 %(Dollars in thousands)
 
 
 
 (Dollars in thousands)Non-covered
  loansBalance at
  beginning of period
 $
 37,402
 
 $
 34,229
 
 9.3%
 
 $
 37,010
 
 $
 31,430
 
 17.8%Provision
  for non-covered
  loan and
  lease losses
 
 3,600
 
 
 3,800
 
 -5.3%
 
 
 10,400
 
 
 11,400
 
 -8.8%Charge-offs
 
 (2,090)
 
 
 (2,281)
 
 -8.4%
 
 
 (8,711)
 
 
 (7,292)
 
 19.5%Recoveries
 
 208
 
 
 121
 
 71.9%
 
 
 421
 
 
 331
 
 27.2%Balance at
  end of period
 $
 39,120
 
 $
 35,869
 
 9.1%
 
 $
 39,120
 
 $
 35,869
 
 9.1%Allowance for
  loans and lease
  losses
  to:Total loans,
  excluding
  covered
  loans
 
 3.29%
 
 
 3.08%
 
 6.8%Non-performing loans,
  excluding
  covered loans
 
 33.21%
 
 
 27.08%
 
 22.6%Covered
  loansBalance at
  beginning of period
 $
 58,628
 
 $
 53,036
 
 10.5%
 
 $
 37,256
 
 $
 49,286
 
 -24.4%Provision
  for (recapture of) covered
  loan and
  lease losses, net
 
 221
 
 
 (1,936)
 
 -111.4%
 
 
 8,845
 
 
 (1,387)
 
 -737.7%FDIC
  shared-loss portion on
  provision
  for (recapture of) loan
  and lease
  losses
 
 (1,984)
 
 
 (13,860)
 
 -85.7%
 
 
 10,764
 
 
 (10,659)
 
 -201.0%Balance at
  end of period
 $
 56,865
 
 $
 37,240
 
 52.7%
 
 $
 56,865
 
 $
 37,240
 
 52.7%
 106


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TABLE 9 —
  ALLOWANCE FOR NON-COVERED LOAN AND LEASE LOSSES BREAKDOWNSeptember 30,
 
 December 31,
 
 Variance2012
 
 2011
 
 %(Dollars in thousands)Allowance
  balance:Mortgage
 $
 21,053
 
 $
 21,652
 
 -2.8%Commercial
 
 15,439
 
 
 12,548
 
 23.0%Consumer
 
 1,174
 
 
 1,423
 
 -17.5%Leasing
 
 244
 
 
 845
 
 -71.1%Unallocated
  allowance
 
 1,210
 
 
 542
 
 123.2%Total allowance balance
 $
 39,120
 
 $
 37,010
 
 5.7%Allowance
  composition:Mortgage
 
 53.82%
 
 
 58.52%
 
 -8.0%Commercial
 
 39.47%
 
 
 33.90%
 
 16.4%Consumer
 
 3.00%
 
 
 3.84%
 
 -21.9%Leasing
 
 0.62%
 
 
 2.28%
 
 -72.8%Unallocated
  allowance
 
 3.09%
 
 
 1.46%
 
 111.6%100.00%
 
 
 100.00%Allowance
  coverage ratio at end of period applicable to:Mortgage
 
 2.73%
 
 
 2.64%
 
 3.4%Commercial
 
 4.56%
 
 
 4.16%
 
 9.6%Consumer
 
 2.64%
 
 
 3.79%
 
 -30.3%Leasing
 
 0.72%
 
 
 3.28%
 
 -78.0%Unallocated
  allowance to total loans
 
 0.10%
 
 
 0.05%
 
 100.0%Total
  allowance to total loans, excluding covered loans
 
 3.29%
 
 
 3.12%
 
 5.4%Allowance
  coverage ratio to non-performing loans:Mortgage
 
 23.95%
 
 
 22.32%
 
 7.3%Commercial
 
 52.07%
 
 
 33.92%
 
 53.5%Consumer
 
 462.20%
 
 
 216.59%
 
 113.4%Leasing
 
 2218.18%
 
 
 828.43%
 
 167.8%Total
 
 33.21%
 
 
 27.46%
 
 20.9%
 107


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TABLE 10 —
  NET CREDIT LOSSES STATISTICS ON NON-COVERED LOAN AND LEASESQuarter Ended September 30,
 
 Variance
 
 Nine-Month Period Ended September 30,
 
 Variance2012
 
 2011
 
 %
 
 2012
 
 2011
 
 %(In thousands)
 
 
 
 (In thousands)MortgageCharge-offs
 $
 (1,752)
 
 $
 (1,391)
 
 26.0%
 
 $
 (4,621)
 
 $
 (4,480)
 
 3.1%Recoveries
 
 131
 
 
 -
 
 -
 
 
 131
 
 
 45
 
 191.1%Total
 
 (1,621)
 
 
 (1,391)
 
 16.5%
 
 
 (4,490)
 
 
 (4,435)
 
 1.2%CommercialCharge-offs
 
 (65)
 
 
 (440)
 
 -85.2%
 
 
 (3,423)
 
 
 (1,478)
 
 131.6%Recoveries
 
 28
 
 
 56
 
 -50.0%
 
 
 129
 
 
 108
 
 19.4%Total
 
 (37)
 
 
 (384)
 
 -90.4%
 
 
 (3,294)
 
 
 (1,370)
 
 140.4%ConsumerCharge-offs
 
 (198)
 
 
 (368)
 
 -46.2%
 
 
 (563)
 
 
 (1,160)
 
 -51.5%Recoveries
 
 46
 
 
 63
 
 -27.0%
 
 
 153
 
 
 175
 
 -12.6%Total
 
 (152)
 
 
 (305)
 
 -50.2%
 
 
 (410)
 
 
 (985)
 
 -58.4%LeasingCharge-offs
 
 (75)
 
 
 (82)
 
 -8.5%
 
 
 (104)
 
 
 (174)
 
 -40.2%Recoveries
 
 3
 
 
 2
 
 50.0%
 
 
 8
 
 
 3
 
 166.7%Total
 
 (72)
 
 
 (80)
 
 -10.0%
 
 
 (96)
 
 
 (171)
 
 -43.9%Net credit
  lossesTotal
  charge-offs
 
 (2,090)
 
 
 (2,281)
 
 -8.4%
 
 
 (8,711)
 
 
 (7,292)
 
 19.5%Total
  recoveries
 
 208
 
 
 121
 
 71.9%
 
 
 421
 
 
 331
 
 27.2%Total
 $
 (1,882)
 
 $
 (2,160)
 
 -12.9%
 
 $
 (8,290)
 
 $
 (6,961)
 
 19.1%Net credit
  losses to average
  loans
  outstanding:Mortgage
 
 0.80%
 
 
 0.64%
 
 24.9%
 
 
 0.73%
 
 
 0.67%
 
 8.3%Commercial
 
 0.05%
 
 
 0.59%
 
 -92.1%
 
 
 1.42%
 
 
 0.75%
 
 90.4%Consumer
 
 1.43%
 
 
 3.57%
 
 -59.8%
 
 
 1.37%
 
 
 4.10%
 
 -66.7%Leasing
 
 0.92%
 
 
 1.72%
 
 -46.8%
 
 
 0.44%
 
 
 1.53%
 
 -71.3%Total
 
 0.63%
 
 
 0.73%
 
 -14.3%
 
 
 0.92%
 
 
 0.79%
 
 16.2%Recoveries to
  charge-offs
 
 9.95%
 
 
 5.30%
 
 87.6%
 
 
 4.83%
 
 
 4.54%
 
 6.5%Average loans
  not covered under
  shared-loss agreements
  with the
  FDIC:Mortgage
 $
 808,949
 
 $
 866,947
 
 -6.7%
 
 $
 822,116
 
 $
 879,463
 
 -6.5%Commercial
 
 317,888
 
 
 260,932
 
 21.8%
 
 
 309,373
 
 
 245,053
 
 26.2%Consumer
 
 42,382
 
 
 34,188
 
 24.0%
 
 
 39,993
 
 
 32,019
 
 24.9%Leasing
 
 31,426
 
 
 18,584
 
 69.1%
 
 
 29,126
 
 
 14,906
 
 95.4%Total
 $
 1,200,645
 
 $
 1,180,651
 
 1.7%
 
 $
 1,200,608
 
 $
 1,171,441
 
 2.5%
 108


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TABLE 11 —
  NON-PERFORMING ASSETSSeptember 30,
 
 December 31,
 
 Variance2012
 
 2011
 
 (%)(Dollars in thousands)Non-performing
  assets:Non-accruing
  loansTroubled
  Debt Restructuring loans
 $
 27,055
 
 $
 27,533
 
 -1.7%Other loans
 
 90,777
 
 
 107,231
 
 -15.3%Total non-performing loans
 $
 117,832
 
 $
 134,764
 
 -12.6%Foreclosed
  real estate not covered under the
  shared-loss agreements with the FDIC
 
 17,765
 
 
 13,812
 
 28.6%Other
  repossessed assets not covered under
  the
  shared-loss agreement with the FDIC
 
 97
 
 
 -
 
 100.0%Mortgage
  loans held for sale in non-accrual
 
 1,247
 
 
 1,223
 
 2.0%$
 136,941
 
 $
 149,799
 
 -8.6%Non-performing
  assets to total assets, excluding covered assets
 
 2.44%
 
 
 2.42%
 
 0.8%Non-performing
  assets to total capital
 
 17.75%
 
 
 21.54%
 
 -17.6%
  Quarter Ended September 30,
 
 Nine-Month Period Ended September 30,2012
 
 2011
 
 2012
 
 2011(In thousands)Interest that
  would have been recorded in the period if the
  loans had
  not been classified as non-accruing loans
 $
 1,597
 
 $
 1,654
 
 $
 4,147
 
 $
 4,152
  TABLE 12 —
  NON-PERFORMING LOANSSeptember 30,
 
 December 31,
 
 Variance2012
 
 2011
 
 %(Dollars in thousands)Non-performing
  loans:Mortgage
 $
 87,896
 
 $
 97,340
 
 -9.7%Commercial
 
 29,649
 
 
 36,988
 
 -19.8%Consumer
 
 276
 
 
 334
 
 -17.4%Leasing
 
 11
 
 
 102
 
 -89.2%Total
 $
 117,832
 
 $
 134,764
 
 -12.6%Non-performing
  loans composition percentages:Mortgage
 
 74.6%
 
 
 72.2%Commercial
 
 25.2%
 
 
 27.4%Consumer
 
 0.2%
 
 
 0.3%Leasing
 
 0.0%
 
 
 0.1%Total
 
 100.0%
 
 
 100.0%Non-performing
  loans to:Total loans,
  excluding covered loans
 
 9.96%
 
 
 11.42%
 
 -12.8%Total
  assets, excluding covered assets
 
 2.10%
 
 
 2.18%
 
 -3.7%Total
  capital
 
 15.27%
 
 
 19.38%
 
 -21.2%Non-performing
  loans with partial charge-offs to:Total loans,
  excluding covered loans
 
 3.07%
 
 
 2.77%
 
 10.8%Non-performing loans, excluding covered loans
 
 30.89%
 
 
 24.45%
 
 26.3%Other
  non-performing loans ratios:Charge-off
  rate on non-performing loans to non-performing loans
  on which
  charge-offs have been taken, excluding covered loans
 
 29.59%
 
 
 23.73%
 
 24.7%Allowance
  for loan and lease losses to non-performing loans on
  which no
  charge-offs have been taken, excluding covered loans
 
 48.04%
 
 
 36.35%
 
 32.2%
 109


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TABLE 13 — HIGHER
  RISK RESIDENTIAL MORTGAGE LOANS
 September 30, 2012Higher-Risk Residential Mortgage Loans*High Loan-to-Value Ratio MortgagesJunior Lien Mortgages
 
 Interest Only Loans
 
 LTV 90% and overCarrying
 
 
 
 
 
 
 Carrying
 
 
 
 
 
 
 Carrying
 Value
 
 Allowance
 
 Coverage
 
 Value
 
 Allowance
 
 Coverage
 
 Value
 
 Allowance
 
 Coverage(In thousands)
 Delinquency:0 - 89 days
 $
 15,753
 
 $
 262
 
 1.66%
 
 $
 28,891
 
 $
 600
 
 2.08%
 
 $
 74,743
 
 $
 1,804
 
 2.41%90 - 119 days
 
 393
 
 
 6
 
 1.53%
 
 
 164
 
 
 4
 
 2.44%
 
 
 170
 
 
 18
 
 10.59%120 - 179 days
 
 114
 
 
 10
 
 8.77%
 
 
 -
 
 
 -
 
 0.00%
 
 
 1,538
 
 
 111
 
 7.22%180 - 364 days
 
 961
 
 
 72
 
 7.49%
 
 
 1,064
 
 
 144
 
 13.53%
 
 
 3,149
 
 
 261
 
 8.29%365+ days
 
 1,537
 
 
 243
 
 15.81%
 
 
 3,503
 
 
 802
 
 22.89%
 
 
 10,040
 
 
 1,576
 
 15.70%Total
 $
 18,758
 
 $
 593
 
 3.16%
 
 $
 33,622
 
 $
 1,550
 
 4.61%
 
 $
 89,640
 
 $
 3,770
 
 4.21%Percentage of
  total loans not covered
  by FDIC
  shared-loss agreements
 
 1.54%
 
 
 
 
 
 
 
 2.75%
 
 
 
 
 
 
 
 7.34%Refinanced
  or Modified Loans:Amount
 $
 2,525
 
 $
 243
 
 9.62%
 
 $
 -
 
 $
 -
 
 0.00%
 
 $
 17,941
 
 $
 1,558
 
 8.68%Percentage of
  Higher-Risk Loan
  Category
 
 13.46%
 
 
 
 
 
 
 
 0.00%
 
 
 
 
 
 
 
 20.01%Loan-to-Value
  Ratio:Under 70%
 $
 14,133
 
 $
 405
 
 2.87%
 
 $
 5,064
 
 $
 168
 
 3.32%
 
 $
 -
 
 $
 -
 
 -70% - 79%
 
 2,966
 
 
 51
 
 1.72%
 
 
 7,340
 
 
 477
 
 6.50%
 
 
 -
 
 
 -
 
 -80% - 89%
 
 1,060
 
 
 39
 
 3.68%
 
 
 8,673
 
 
 341
 
 3.93%
 
 
 -
 
 
 -
 
 -90% and over
 
 599
 
 
 98
 
 16.36%
 
 
 12,545
 
 
 564
 
 4.50%
 
 
 89,640
 
 
 3,770
 
 4.21%$
 18,758
 
 $
 593
 
 3.16%
 
 $
 33,622
 
 $
 1,550
 
 4.61%
 
 $
 89,640
 
 $
 3,770
 
 4.21%* Loans may be
  included in more than one higher-risk loan category.
 110


---



Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK  Background  The Group’s risk management policies are
established by its Board of Directors (the “Board”) and implemented by
management through the adoption of a risk management program, which is overseen
and monitored by the Chief Risk Officer and the Risk Management and Compliance
Committee. The Group has continued to refine and enhance its risk management
program by strengthening policies, processes and procedures necessary to maintain
effective risk management.  All aspects of the Group’s business
activities are susceptible to risk. Consequently, risk identification and monitoring
are essential to risk management. As more fully discussed below, the Group’s
primary risk exposures include, market, interest rate, credit, liquidity, operational
and concentration risks.  Market Risk  Market risk is the risk to earnings or
capital arising from adverse movements in market rates or prices, such as interest
rates or prices. The Group evaluates market risk together with interest rate
risk. The Group’s financial results and capital levels are constantly exposed
to market risk. The Board and management are primarily responsible for ensuring
that the market risk assumed by the Group complies with the guidelines
established by policies approved by the Board. The Board has delegated the
management of this riskto the Asset/Liability Management
Committee (“ALCO”) which is composed of certain executive officers from the
business, treasury and finance areas. One of ALCO’s primary goals is to ensure
that the market risk assumed by the Group is within the parameters established
in such policies.  Interest Rate Risk  Interest rate risk is the exposure of
the Group’s earnings or capital to adverse movements in interest rates. It is a
predominant market risk in terms of its potential impact on earnings. The Group
manages its asset/liability position in order to limit the effects of changes
in interest rates on net interest income. ALCO oversees interest rate risk,
liquidity management and other related matters.  In discharging its responsibilities,
ALCO examines current and expected conditions in world financial markets, competition
and prevailing rates in the local deposit market, liquidity, unrealized gains
and losses in securities, recent or proposed changes to the investment
portfolio, alternative funding sources and their costs, hedging and the
possible purchase of derivatives such as swaps, and any tax or regulatory
issues which may be pertinent to these areas.  On a monthly basis, the Group performs a
net interest income simulation analysis on a consolidated basis to estimate the
potential change in future earnings from projected changes in interest rates.
These simulations are carried out over a one-year time horizon, assuming certain
gradual upward and downward interest rate movements, achieved during a
twelve-month period. Simulations are carried out in two ways:  (1)using a static balance sheet as
the Group had on the simulation date, and  (2)using a dynamic balance sheet
based on recent growth patterns and business strategies.  The balance sheet is divided into groups
of assets and liabilities detailed by maturity or re-pricing and their corresponding
interest yields and costs. As interest rates rise or fall, these simulations
incorporate expected future lending rates, current and expected future funding
sources and costs, the possible exercise of options, changes in prepayment
rates, deposits decay and other factors which may be important in projecting
the future growth of net interest income.  The Group uses a software application to
project future movements in the Group’s balance sheet and income statement. The
starting point of the projections generally corresponds to the actual values of
the balance sheet on the date of the simulations. 111


---



These simulations are highly complex,
and use many simplifying assumptions that are intended to reflect the general
behavior of the Group over the period in question. There can be no assurance
that actual events will match these assumptions in all cases. For this reason,
the results of these simulations are only approximations of the true
sensitivity of net interest income to changes in market interest rates. The
following table presents the results of the simulations at September 30, 2012 for
the most likely scenario, assuming a one-year time horizon:  Net Interest Income Risk (one year
  projection)Static Balance Sheet
 
 Growing SimulationAmount
 
 Percent
 
 Amount
 
 PercentChange
 
 Change
 
 Change
 
 ChangeChange in interest rate
 (Dollars in thousands)+ 200 Basis
  points
 $
 14,241
 
 9.76%
 
 $
 12,546
 
 8.91%+ 100 Basis
  points
 $
 7,429
 
 5.09%
 
 $
 6,636
 
 4.71%- 50 Basis
  points
 $
 (4,280)
 
 -2.93%
 
 $
 (3,997)
 
 -2.84%
  The impact of -100 and -200 basis point
reductions in interest rates is not presented in view of current level of the
federal funds rate and other short-term interest rates.  Future net interest income could be
affected by the Group’s investments in callable securities, prepayment risk related
to mortgage loans and mortgage-backed securities, and its structured repurchase
agreements and advances from the FHLB. As part of the strategy to limit the
interest rate risk and reduce the re-pricing gaps of the Group’s assets and
liabilities, the maturity and the re-pricing frequency of the liabilities has
been extended to longer terms.  The Group maintains an overall interest
rate risk management strategy that incorporates the use of derivative instruments
to minimize significant unplanned fluctuations in earnings that are caused by
interest rate volatility. The Group’s goal is to manage interest rate
sensitivity by modifying the repricing or maturity characteristics of certain
balance sheet assets and liabilities so that the net interest margin is not, on
a material basis, adversely affected by movements in interest rates. As a
result of interest rate fluctuations, hedged fixed-rate assets and liabilities
will appreciate or depreciate in market value. Also, for some fixed-rate assets
or liabilities, the effect of this variability in earnings is expected
to be substantially offset by the Group’s gains and losses on the derivative instruments
that are linked to the forecasted cash flows of these hedged assets and
liabilities. The Group considers its strategic use of derivatives to be a
prudent method of managing interest-rate sensitivity as it reduces the exposure
of earnings and the market value of its equity to undue risk posed by changes
in interest rates. The effect of this unrealized appreciation or depreciation
is expected to be substantially offset by the Group’s gains or losses on the
derivative instruments that are linked to these hedged assets and liabilities.
Another result of interest rate fluctuations is that the contractual interest
income and interest expense of hedged variable-rate assets and liabilities,
respectively, will increase or decrease.  Derivative instruments that are used as
part of the Group’s interest risk management strategy include interest rate swaps,
forward-settlement swaps, futures contracts, and option contracts that have
indices related to the pricing of specific balance sheet assets and
liabilities. Interest rate swaps generally involve the exchange of fixed and variable-rate
interest payments between two parties based on a common notional principal
amount and maturity date. Interest rate futures generally involve
exchanged-traded contracts to buy or sell U.S. Treasury bonds and notes in the
future at specified prices. Interest rate options represent contracts that
allow the holder of the option to (i) receive cash or (ii) purchase, sell, or
enter into a financial instrument at a specified price within a specified period.
Some purchased option contracts give the Group the right to enter into interest
rate swaps and cap and floor agreements with the writer of the option. In
addition, the Group enters into certain transactions that contain embedded
derivatives. When the embedded derivative possesses economic characteristics
that are not clearly and closely related to the economic characteristics of the
host contract, it is bifurcated and carried at fair value. Please refer to Note
8 to the accompanying unaudited consolidated financial statements for further
information concerning the Group’s derivative activities.  Following is a summary of certain strategies,
including derivative activities, currently used by the Group to manage interest
rate risk:  Interest rate swaps— The Group entered into forward-settlement swaps to
hedge the variability of future interest cash flows of forecasted wholesale
borrowings, attributable to changes in the one-month LIBOR rate. Once the
forecasted wholesaleborrowings transactions occur, the interest rate swap
will effectively fix the Group’s interest payments on an amount of forecasted
interest expense attributable to the one-month LIBOR rate corresponding to the
swap notional stated rate. A derivative liability of $58.3 million was 112


---



recognized at September 30, 2012, related to the
valuation of these swaps. Refer to Note 8 of the unaudited consolidated
financial statements for a description of these swaps.  Swap options— In July 2012, the Group purchased options to enter
into interest rate swaps, not designated as cash flow hedges, with an aggregate
notional amount of $200 million. At September 30, 2012, the purchased options
used to manage the exposure on the interest rate swaps represented an asset of
$5.4 million in the consolidated statements of financial position.  S&P options— The Group has offered its customers certificates of
deposit with an option tied to the performance of the S&P 500 Index. At the
end of five years, the depositor receives a minimum return or a specified
percentage of the average increase of the month-end value of the S&P 500
Index. The Group uses option agreements with major money center banks and major
broker-dealer companies to manage its exposure to changes in that index. Under
the terms of the option agreements, the Group receives the average increase in
the month-end value of S&P 500 Index in exchange for a fixed premium. The
changes in fair value of the options purchased and the options embedded in the
certificates of deposit are recorded in earnings.  At September 30, 2012 and December 31,
2011, the fair value of the purchased options used to manage the exposure to
the S&P 500 Index on stock-indexed certificates of deposits represented an
asset of $13.1 million and $9.3 million, respectively, and the options sold to
customers embedded in the certificates of deposit represented a liability of
$12.6 million and $9.4 million, respectively, recorded in deposits.  Wholesale borrowings— The Group uses interest rate swaps to hedge the
variability of interest cash flows of certain repurchase agreements and
advances from FHLB that are tied to a variable rate index. The interest rate
swaps effectively fix the Group’s interest payments on these borrowings. As of September
30, 2012, the Group had $975 billion in interest rate swaps at an average rate
of 2.22% designated as cash flow hedges for $750 million in repurchase
agreements and $225 million in advances from FHLB that reprice or are being rolled
over on a monthly basis.  As of September 30, 2012, the Group had $150 million
in forward-settle interest rate swaps at an average rate of 2.78% designated as
cash flow hedges.  In addition, the Group has outstanding
structured repurchase agreements and advances from FHLB in which the
counterparty has the right to put back the borrowing to the Group before their
stated maturity under certain conditions.  Credit Risk  Credit risk is the possibility of loss
arising from a borrower or counterparty in a credit-related contract failing to
perform in accordance with its terms. The principal source of credit risk for
the Group is its lending activities. In Puerto Rico, the Group’s principal
market, according to government data, the economic recession moderated in
calendar year 2012 and is expected to improve in calendar year 2013. However,
economic growth remains a challenge due to the lack of significant employment
growth and a housing sector that remains under pressure in spite of progress
made by the Puerto Rico government in reducing its fiscal deficit.  The Group manages its credit risk
through a comprehensive credit policy which establishes sound underwriting standards
by monitoring and evaluating loan portfolio quality, and by the constant
assessment of reserves and loan concentrations. The Group also employs
proactive collection and loss mitigation practices.  The Group may also encounter risk of
default in relation to its securities portfolio. The securities held by the Group
are principally agency mortgage-backed securities. Thus, a substantial portion
of these instruments are guaranteed by mortgages, a U.S. government-sponsored
entity, or the full faith and credit of the U.S. government. At September 30,
2012, the available-for-sale securities portfolio also includes approximately
$29 million in structured credit investments that are considered of a higher
credit risk than agency securities.  Management’s Executive Credit Committee,
composed of the Group’s Chief Executive Officer, Chief Credit Risk Officer and
other senior executives, has primary responsibility for setting strategies to
achieve the Group’s credit risk goals and objectives. Those goals and
objectives are set forth in the Group’s Credit Policy as approved by the Board.  113


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Liquidity Risk  Liquidity risk is the risk of the Group
not being able to generate sufficient cash from either assets or liabilities to
meet obligations as they become due without incurring substantial losses. The
Board has established a policy tomanage this risk. The Group’s cash requirements
principally consist of deposit withdrawals, contractual loan funding, repayment
of borrowings as these mature, and funding of new and existing investments as
required.  The Group’s business requires continuous
access to various funding sources. While the Group is able to fund its operations
through deposits as well as through advances from the FHLB of New York and
other alternative sources, the Group’s business is dependent upon other
wholesale funding sources. Although the Group has selectively reduced its use
of wholesale funding sources, such as repurchase agreements and brokered
deposits, it is still significantly dependent on repurchase agreements. The
Group’s repurchase agreements have been structured with initial terms that
mature in ten years, and for four repurchase agreements totaling $1.75 billion,
the counterparties have the right to exercise at par on a quarterly basis put
options before their contractual maturities. The Group’s $500 million
repurchase agreement that matures on March 2, 2017 also provides for an
optional early termination by either party upon no less than two business days’
prior written notice to the other party. In the event of any such optional
early termination, the amounts owed by or to the terminating party by the other
party on the optional early termination date must take account of the
termination value of the transaction, as determined by the calculation agent in
the manner described in the repurchase agreement.  Brokered deposits are typically offered
through an intermediary to small retail investors. The Group’s ability to continue
to attract brokered deposits is subject to variability based upon a number of
factors, including volume and volatility in the global securities markets, the
Group’s credit rating, and the relative interest rates that it is prepared to
pay for these liabilities. Brokered deposits are generally considered a less
stable source of funding than core deposits obtained through retail bank branches.
Investors in brokered deposits are generally more sensitive to interest rates
and will generally move funds from one depository institution to another based
on small differences in interest rates offered on deposits.  Although the Group expects to have
continued access to credit from the foregoing sources of funds, there can be no
assurance that such financing sources will continue to be available or will be
available on favorable terms. In a period of financial disruption or if
negative developments occur with respect to the Group, the availability and cost
of the Group’s funding sources could be adversely affected. In that event, the
Group’s cost of funds may increase, thereby reducing its net interest income,
or the Group may need to dispose of a portion of its investment portfolio,
which depending upon market conditions, could result in realizing a loss or
experiencing other adverse accounting consequences upon the dispositions. The
Group’s efforts to monitor and manage liquidity risk may not be successful to
deal with dramatic or unanticipated changes in the global securities markets or
other reductions in liquidity driven by the Group or market-related events. In
the event that such sources of funds are reduced or eliminated and the Group is
not able to replace these on a cost-effective basis, the Group may be forced to
curtail or cease its loan origination business and treasury activities, which
would have a material adverse effect on its operations and financial condition.  As of September 30, 2012, the Group had
approximately $515.5million in cash and cash equivalents, $270.0 million
in securities purchased under agreements to resell, $135.8million
in investment securities, $590.8 million in commercial loans, $428.5 million in
mortgage loans, $54.6 million in consumer loans, and $37.4 million in leases
available to cover liquidity needs.  114


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Operational Risk  Operational risk is the risk of loss
from inadequate or failed internal processes, personnel and systems or from external
events. All functions, products and services of the Group are susceptible to
operational risk.  The Group faces ongoing and emerging
risk and regulatory pressure related to the activities that surround the delivery
of banking and financial products. Coupled with external influences such as
market conditions, security risks, and legal risk, the potential for
operational and reputational loss has increased. In order to mitigate and control
operational risk, the Group has developed, and continues to enhance, specific
internal controls, policies and procedures that are designed to identify and
manage operational risk at appropriate levels throughout the organization. The
purpose of these policies and procedures is to provide reasonable assurance
that the Group’s business operations are functioning within established limits.  The Group classifies operational risk
into two major categories: business specific and corporate-wide affecting all
business lines. For business specific risks, a risk assessment group works with
the various business units to ensure consistency in policies, processes and
assessments. With respect to corporate-wide risks, such as information
security, business recovery, legal and compliance, the Group has specialized
groups, such as Information Security, Enterprise Risk Management, Corporate
Compliance, Information Technology and Operations. These groups assist the lines
of business in the development and implementation of risk management practices
specific to the needs of the business groups. All these matters are reviewed
and discussed in the Information Technology Steering Committee, and the Risk
Management and Compliance Committee.  The Group is subject to extensive
federal and Puerto Rico regulation, and this regulatory scrutiny has been significantly
increasing over the last several years. The Group has established and continues
to enhance procedures based on legal and regulatory requirements that are
reasonably designed to ensure compliance with all applicable statutory and
regulatory requirements. The Group has a corporate compliance function headed
by a Compliance Director who reports to the Chief Risk Officer and is
responsible for the oversight of regulatory compliance and implementation of a
company-wide compliance program.  Concentration Risk  Substantially all of the Group’s
business activities and a significant portion of its credit exposure are concentrated
in Puerto Rico. As a consequence, the Group’s profitability and financial
condition may be adversely affected by an extended economic slowdown, adverse
political or economic developments in Puerto Rico or the effects of a natural
disaster, all of which could result in a reduction in loan originations, an
increase in non-performing assets, an increase in foreclosure losses on
mortgage loans, and a reduction in the value of its loans and loan servicing
portfolio.  Item 4. CONTROLS AND PROCEDURES  Disclosure Controls and Procedures  As of the end of the period covered by
this Quarterly Report on Form 10-Q, an evaluation was carried out under the supervision
and with the participation of the Group’s management, including the Chief
Executive Officer (“CEO”) and the Chief Financial Officer (“CFO”), of the
effectiveness of the design and operation of the Group’s disclosure controls
and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under
the Exchange Act). Based upon such evaluation, the CEO and the CFO have
concluded that, as of the end of such period, the Group’s disclosure controls
and procedures provided reasonable assurance of effectiveness in recording,
processing, summarizing and reporting, on a timely basis, information required
to be disclosed by the Group in the reports that it files or submits under the
Exchange Act. Notwithstanding the foregoing, a control system, no matter how
well designed and operated, can provide only reasonable, not absolute assurance
that it will detect or uncover failures within the Group to disclose material
information otherwise required to be set forth in the Group’s periodic reports.  Internal Control over Financial Reporting  There was no change in the Group’s
internal control over financial reporting (as such term is defined on rules
13a-15(f) and 15d-15(f) under the Exchange Act) during the quarter ended September
30, 2012 that has materially affected, or is reasonably likely to materially
affect, the Group’s internal control over financial reporting. 115


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PART -
II OTHER INFORMATION  Item 1. LEGAL PROCEEDINGS  The Group and its subsidiaries are
defendants in a number of legal proceedings incidental to their business. The
Group is vigorously contesting such claims. Based upon a review by legal
counsel and the development of these matters to date, management is of the
opinion that the ultimate aggregate liability, if any, resulting from these
claims will not have a material adverse effect on the Group’s financial
condition or results of operations.  Item 1A. RISK FACTORS  In addition to other information set
forth in this report, you should carefully consider the risk factors included
in the Group’s Annual Report on Form 10-K, as updated by this report and other
filings the Group makes with the SEC under the Exchange Act.  Additional risks
and uncertainties not presently known to us at this time or that the Group
currently deems immaterial may also adversely affect the Group’s business,
financial condition or results of operations. A
decline in the market value of the Group’s investment securities portfolio
could adversely impact its regulatory capital ratios. The Federal
Reserve Board, together with other federal banking regulatory agencies,
recently issued proposed capital rules to implement the so-called “Basel III”
capital framework in the United States. Among other things, the proposed rules
would require banking organizations such as Oriental Bank to include gains and
losses on its securities holdings classified as available-for-sale (“AFS”) in
its common equity tier 1 capital (“CET1”). This aspect of the rules would be
phased in over six years with full gain and loss flow-through to capital starting
in 2018. Currently, unrealized losses on AFS equity securities are counted
against Tier 1 capital, unrealized gains on AFS equity securities are partially
included in Tier 2 capital and unrealized gains and losses on AFS debt
securities are excluded from regulatory capital. However, these unrealized
gains and losses are reflected in stockholders’ equity under accounting
principles generally accepted in the United States (“GAAP”). The agencies’
proposals introduce the concept of CET1—which is comprised of qualifying common
stock instruments, retained earnings, accumulated other comprehensive income
(“AOCI”), certain qualifying minority interests in consolidated subsidiaries
and other adjustments and establish a new minimum ratio of CET1 to total risk-weighted
assets of 4.5% and a capital conservation buffer of 2.5% to be phased in over
several years. Because of the inclusion of AOCI, unlike the current general
risk-based capital rules, unrealized gains and losses on all AFS-classified
securities would flow through to CET1 capital, after the transition period, if
the proposals are adopted in their current form. The Group’s CET1 levels are
likely to be significantly more volatile under the agencies’ proposals than
previously because unrealized gains and losses on AFS classified securities
recognized in stockholders’ equity on the balance sheet for accounting purposes
would also be incorporated for regulatory capital purposes. Accordingly, a
decline in the market value of the Group’s investment securities portfolio
could adversely impact its regulatory capital ratios. The
Group operates in a highly regulated environment and may be adversely affected
by changes in federal and local laws and regulations. The Group’s
operations are subject to extensive regulation by federal, state and local
governmental authorities and are subject to various laws and judicial and
administrative decisions imposing requirements and restrictions on part or all
of its operations. Because its business is highly regulated, the laws, rules
and regulations applicable to the Group are subject to regular modification and
change. For example, the Dodd-Frank Act has a broad impact on the financial
services industry, including significant regulatory and compliance changes,
such as: (i) enhanced resolution authority of troubled and failing banks
and their holding companies; (ii) enhanced lending limits strengthening
the existing limits on a depository institution’s credit exposure to one
borrower and to affiliates; (iii) increased capital and liquidity
requirements; (iv) increased regulatory examination fees; (v) changes
to assessments to be paid to the FDIC for federal deposit insurance;
(vi) prohibiting bank holding companies, such as the Group, from including
in regulatory Tier 1 capital future issuances of trust preferred
securities or other hybrid debt and equity securities; (vii) caps on the
interchange fees that banks are able to charge merchants for debit card
transactions pursuant to the “Durbin Amendment”; and (viii) numerous other
provisions designed to improve supervision and oversight of the financial
services industry. Additionally, the Dodd-Frank Act established a new framework
for systemic risk oversight within the financial system to be distributed among
new and existing federal regulatory agencies, including the Financial Stability
Oversight Council, the Federal Reserve Board, the Office of the Comptroller of
the Currency, and the FDIC. It also creates a new consumer financial protection
regulator, the Consumer Financial Protection Bureau (“CFPB”), which assumed
most of the consumer financial protection regulatory responsibilities that were
exercised by federal banking regulators and other agencies. Further, the
Dodd-Frank Act addresses many corporate governance and executive compensation
matters that affect most U.S. publicly-traded companies, including the
Group. 116


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Certain recent regulatory changes under the Dodd-Frank
Act, and otherwise, apply only to depository institutions with more than $10
billion in total assets, including requirements to undergo regular “stress
testing” of capital under hypothetical adverse economic scenarios, “large bank”
adjustments to assessments paid to the FDIC for deposit insurance, supervision
and examination by the CFPB, and requirements to establish a risk committee on
a company’s board of directors. In addition, financial institutions with more
than $10 billion in assets will not be eligible for the “commercial end user”
exemption to Dodd-Frank Act’s mandatory clearing requirements for swaps and security-based
swaps transactions used to hedge commercial risk. Although the Group expects
that it and Oriental Bank will have total assets of less than $10 billion after
the Closing of the proposed BBVAPR Acquisition and the planned deleveraging of
the Oriental Bank’s and BBVAPR Bank’s investment securities and wholesale
funding portfolios, the Group and Oriental Bank may still be treated for
certain regulatory and supervisory purposes as institutions with more than $10
billion in assets based on the combined total assets of the Oriental Bank and
BBVAPR Bank prior to the merger, until such time as the Bank (or the Group, as
applicable) has closed four consecutive quarters with $10 billion or less in
total assets. If the Group is not able to complete the deleveraging or
otherwise grows to have more than $10 billion of assets through additional
acquisitions or organic growth, the Group’s costs of doing business would be
likely to increase permanently as a result of these requirements. Given that
many of the provisions of the Dodd-Frank Act are being implemented over time
and are subject to implementing regulations, the full extent of the impact that
such requirements, and other legislative and regulatory developments, will have
on the Group’s operations is unclear. The changes resulting from the Dodd-Frank
Act may impact the profitability of the Group’s business activities, require
changes to certain of its business practices, impose upon the Group more
stringent capital, liquidity and leverage ratio requirements or otherwise
adversely affect the Group’s business. In particular, the potential impact of
the Dodd-Frank Act on the Group’s operations and activities, both currently and
prospectively, include, among others: ·a
reduction in the Group’s ability to generate or originate revenue-producing
assets as a result of compliance with heightened capital standards; ·increased
cost of operations due to greater regulatory oversight, supervision and
examination of banks and bank holding companies, and higher deposit insurance
premiums; ·the
limitation on the Group’s ability to raise capital through the use of trust
preferred securities as these securities will no longer be included as
Tier I capital going forward; and ·the
limitation on the Group’s ability to expand consumer product and service
offerings due to anticipated stricter consumer protection laws and regulations. Further, the
Group may be required to invest significant management attention and resources
to evaluate and make necessary changes in order to comply with new statutory
and regulatory requirements. Failure to comply with the new requirements may
negatively impact the Group’s results of operations and financial condition.
While the Group cannot predict what effect any presently contemplated or future
changes in the laws or regulations or their interpretations would have, these
changes could be materially adverse to the Group results of operations. Legislative
and other measures that may be taken by Puerto Rico governmental authorities
could materially increase the Group’s tax burden or otherwise adversely affect
its financial condition, results of operations or cash flows. OIB, the
Group’s international banking entity pursuant to the International Banking
Center Regulatory Act of Puerto Rico (the “IBE Act”), provides the Group with
significant tax advantages. OIB is exempt from Puerto Rico income taxes on
interest earned on, or gain realized from the sale of, non-Puerto Rico assets,
including U.S. government obligations and certain mortgage-backed securities.
This exemption has allowed the Group to have effective tax rates significantly
below the maximum statutory tax rates. In the past, the Legislature of Puerto
Rico has considered proposals to curb the tax benefits afforded to
international banking entities. Recently, a new Puerto Rico law was enacted in
this area. Although it did not repeal the IBE Act, the new law does not allow
new license applications under the IBE Act to organize and operate an
international banking entity. Any newly organized entity (now called an
“international financial entity”) must be licensed under the new law and such
entity (as opposed to existing international banking entities organized under
the IBE Act, including OIB, which are “grandfathered”) will generally be
subject to a 4% Puerto Rico income tax rate. In the event other legislation is
passed in Puerto Rico to eliminate or modify the tax exemption enjoyed by
international banking entities, the consequences could have a materially
adverse impact on the Group, including increasing the tax burden or otherwise
adversely affecting the Group’s financial condition, results of operations or
cash flows. Risks
Related to the Proposed BBVAPR Acquisition The
BBVAPR Companies are subject to similar business risks that the Group faces. The BBVAPR
Companies concentrate their business activities in the geographic area, operate
their businesses and offer financial products that are similar to the Group’s,
and therefore, the BBVAPR Companies are affected by many of the same
macroeconomic conditions in Puerto Rico and similar risks faced by the Group in
its business operations. 117


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The Group may not receive the necessary regulatory
approvals to consummate the BBVAPR Acquisition. The
consummation of the proposed BBVAPR Acquisition is subject to the receipt of
all necessary regulatory approvals, including those of federal and Puerto Rico
bank regulators. In determining whether to approve a proposed acquisition,
federal bank regulators will consider, among other factors, the effect of the
acquisition on competition, the Group’s financial condition and future
prospects, and the financial stability of the United States. The regulators
also review current and projected capital ratios and levels, the competence,
experience, and integrity of management and its record of compliance with laws
and regulations, the convenience and needs of the communities to be served
(including the acquiring institution’s record of compliance under the Community
Reinvestment Act of 1977) and the effectiveness of the acquiring institution in
combating money laundering activities. Such regulatory approvals may not be
granted at all or may be granted only on terms that are so materially
burdensome that they would prevent completion of the proposed transaction
pursuant to the Acquisition Agreement. The Group may also be required to sell
branches as a condition to receiving regulatory approval and be subject to the
Group’s ability to find third-party purchasers for the divestitures of such
branches on satisfactory terms and conditions, which may reduce the benefit of
the BBVAPR Acquisition. There can be no assurance as to when or whether these
regulatory approvals will be received or the conditions associated with any
approval. The
Group may not be able to realize the anticipated benefits of the BBVAPR
Acquisition. The Group’s
future growth and profitability depend, in part, on the ability to successfully
manage the combined operations. The success of the Group’s proposed BBVAPR
Acquisition will depend on, among other things, its ability to assess the
quality of assets acquired, to realize anticipated cost savings and to
integrate the acquired companies in a manner that permits growth opportunities
and does not materially disrupt the Group’s or the BBVAPR Companies’ existing
customer relationships or result in decreased revenues resulting from any loss
of customers. If the Group is not able to successfully achieve these
objectives, the anticipated benefits of the BBVAPR Acquisition may not be
realized fully or at all or may take longer to realize than expected. Loans
that the Group will acquire in the BBVAPR Acquisition may be subject to greater
than anticipated impairment. The Group
will make fair value estimates of certain assets and liabilities in recording
the BBVAPR Acquisition. Actual values of these assets and liabilities could
differ from the Group’s estimates, which could result in the Group not
achieving the anticipated benefits of the BBVAPR Acquisition. In addition,
BBVAPR Bank’s loan scoring system may be different than the Group’s, and as the
Group evaluates BBVAPR Bank’s loan portfolio using the its systems, the Group
may have to make additional adjustments. Given the
economic conditions in Puerto Rico, the Group may continue to experience
increased credit costs or need to take greater than anticipated markdowns and
make greater than anticipated provisions to increase the allowances for loan
losses on the loans acquired that could adversely affect the Group’s financial
condition and results of operations in the future. The Group
may not be able to complete the planned deleveraging of Oriental Bank’s and
BBVAPR Bank’s investment securities and wholesale funding portfolios. In
connection with the BBVAPR Acquisition, the Group intends to complete the sale
of approximately $1.6 billion of its and BBVAPR Bank’s investment securities
and use the proceeds from such sales as well as approximately $200 million of
cash to repay approximately $1.8 billion of its and BBVAPR Bank’s wholesale
funding to further shift the Group’s funding base from investment securities
and wholesale funding to higher yielding assets, reduce interest rate
sensitivity and improve regulatory capital ratios. The completion of the
deleveraging transactions could be delayed or the Group may not be able to
complete the deleveraging on satisfactory terms or at all. If the Group is
unable to complete the deleveraging in a timely manner, it may be permanently
subject to additional regulatory requirements (see “—The Group operates in a
highly regulated environment and may be adversely affected by changes in
federal and local laws and regulations.”) and may be required to raise
additional capital. The Group expects to incur a one-time charge to income
before income taxes of approximately $10 million (or $7.6 million after giving
effect to income taxes) as well as a reduction to pre-tax income of
approximately $6.2 million in 2013 and approximately $4.0 million in 2014 (or
$4.3 million and $2.8 million, respectively, after giving effect to income
taxes) in connection with the deleveraging; however, the Group could incur
larger than expected losses based on market conditions at the time the
deleveraging is completed, and those losses could be material. The
Group may not be able to integrate BBVAPR’s business into its operations. The
successful integration of BBVAPR’s banking operations and the Group’s future
growth and profitability depend in part on the Group’s ability to successfully
manage the combined operations. Integration of an acquired business can be
complex and costly, sometimes including combining relevant accounting and data
processing systems and management controls and policies, as well as managing
relevant relationships with employees, clients, suppliers and other business
partners. Integration efforts could divert management attention and resources,
which could adversely affect its operations or results. The loss of key
employees in connection with this acquisition could adversely affect the
Group’s ability to successfully conduct the combined operations. In connection
with the BBVAPR Acquisition, the BBVAPR Companies have offered bonuses to
certain of their executives if they remain with the BBVAPR Companies through
the Closing. However, there can be no assurance that any of these executives
will choose to continue 118


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working at the combined
business following the completion of the BBVAPR Acquisition, or if they do,
that the Group will be able to successfully integrate any of these executives
as part of its management team in the combined business. The BBVAPR
Acquisition may also result in business disruptions that cause the Group to
lose customers or cause customers to move their accounts or business to
competing financial institutions. It is possible that the integration process
related to the proposed acquisition could disrupt the Group’s ongoing business
or result in inconsistencies in customer service that could adversely affect
the Group’s ability to maintain relationships with clients, customers,
depositors and employees. The Group’s inability to overcome these risks could
have a material adverse effect on its business or financial condition, results
of operations and future prospects. There is no assurance that the Group’s
integration efforts will not result in other unanticipated costs. The
Group may not be able to agree with BBVA on a transition services agreement
that will provide the Group with sufficient services to facilitate the
integration of the BBVAPR Acquisition. At Closing,
BBVA and the Group will enter into a transition services agreement pursuant to
which BBVA will provide the Group with certain services to assist with the
day-to-day operations of the acquired companies and their transition to the
Group’s infrastructure, and to provide data for the integration of information,
for a period of up to 12 months. There can be no assurance that the services
that BBVA agrees to provide to the Group will be sufficient, in scope or
duration, to ensure the successful integration of the BBVAPR Companies. If the
BBVAPR Acquisition is completed, we will incur significant transaction and
acquisition-related costs. If the
BBVAPR Acquisition is completed, the Group expects to incur certain one-time
restructuring charges of approximately $40 million in connection with the
transaction. The substantial majority of non-recurring expenses resulting from
the BBVAPR Acquisition will be comprised of transaction costs related to the
BBVAPR Acquisition and financing arrangements and employment-related costs. The
Group also will incur transaction fees and costs related to formulating and
implementing integration plans. The Group continues to assess the magnitude of
these costs, and additional unanticipated costs may be incurred in the business
integration of the two groups of companies. Although the Group expects that the
elimination of duplicative costs, as well as the realization of other
efficiencies or synergies related to the integration of the businesses should
allow the Group to offset incremental transaction and acquisition-related costs
over time, this net benefit may not be achieved in the near term, or at all. The
Group may fail to consummate the BBVAPR Acquisition, which may subject it to
penalties. While the
Group intends and expects to meet all of the conditions required to consummate
the BBVAPR Acquisition, the Group’s ability to consummate the BBVAPR
Acquisition is subject to certain events that are beyond its control. These
events include the receipt of regulatory approvals from the FDIC, the Federal
Reserve Board, FINRA and the OCFI (the “Approvals”). On October 10, 2012, the
OCFI approved Oriental’s acquisition of BBVAPR Bank and the merger of BBVAPR
Bank with and into Oriental Bank, with Oriental Bank as the surviving entity.
See “—The Group may not receive the necessary regulatory approvals to consummate
the BBVAPR Acquisition.” for factors that the federal bank regulators may
consider in granting the Approvals. Under the Acquisition Agreement, the Group may be
subject to a termination fee of $25 million if the Closing does not occur
before one year after execution of the Acquisition Agreement (or before 15
months after execution of the Acquisition Agreement in certain circumstances),
the Acquisition Agreement is terminated, and the failure to close within one
year (or such later date) is due to the Group’s inability to raise the
specified additional funds or to obtain the Approvals or any other reason other
than certain breaches by BBVA, subject to certain conditions. In addition, BBVA
could seek damages in excess of $25 million if BBVA terminates the Acquisition
Agreement due to the Group’s failure to satisfy the funding requirement or if
the Group’s willful and knowing breach of the Acquisition Agreement is the
proximate cause of the Closing not having been consummated, and BBVA suffers
losses as a result in excess of the $25 million termination fee. If BBVA
decides to terminate the Acquisition Agreement and collect the termination fee,
such additional damages would be limited to BBVA’s losses in excess of the
termination fee, and could not exceed an additional $25 million. Such limit
would not apply if BBVA does not elect to terminate the Acquisition Agreement
and collect the termination fee.  Item 2. Unregistered Sales of Equity
Securities and Use of Proceeds  Information as to the sale of the
Convertible Preferred Stock was furnished in the Group’s Current Report on Form
8-K filed with the SEC on July 3, 2012.  The shares of Convertible Preferred
Stock were purchased by “qualified institutional buyers” as defined in Rule
144A under the Securities Act of 1933, as amended.  Item 3. Defaults
Upon Senior Securities  None. 119


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Item 4. Mine Safety Disclosures  Not applicable.  Item 5. Other
Information  None.  Item 6. Exhibits  Exhibit No.Description
of Document:   2.1      Acquisition Agreement, dated June 28, 2012,
between the Group and Banco Bilbao Vizcaya Argentaria, S.A., relating to the
purchase and sale of 100% of the common stock of each of BBVA PR Holding
Corporation and BBVA Securities of Puerto Rico, Inc. (1)  3.1      Certificate of Designations of 7.125%
Non-Cumulative Perpetual Preferred Stock, Series D. (2)  3.2      Certificate of Designations of 8.750%
Non-Cumulative Convertible Perpetual Preferred Stock, Series C. (3)  4.1      Form of Certificate for the 8.750%
Non-Cumulative Convertible Perpetual Preferred Stock, Series C. (4)  31.1    Certification of Chief Executive Officer
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.  31.2    Certification of Chief Financial Officer
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.  32.1    Certification of Chief Executive Officer
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.  32.2    Certification of Chief Financial Officer
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.  101     The following materials from Oriental
Financial Group Inc.’s Quarterly Report on Form 10-Q for the quarter ended
September 30, 2012, formatted in XBRL (eXtensible Business Reporting Language):
(i) Unaudited Consolidated Statements of Financial Condition, (ii) Unaudited
Consolidated Statements of Operations, (iii) Unaudited Consolidated Statements
of Comprehensive Income, (iv) Unaudited Consolidated Statements of Changes in
Stockholders’ Equity, (v) Unaudited Consolidated Statements of Cash Flows, and
(vi) Notes to Unaudited Consolidated Financial Statements.           
  (1)Incorporated herein by reference to
Exhibit 2.1 of the Group’s Current Report on Form 8-K filed with the SEC on
July 3, 2012.  (2)Incorporated herein by reference to
Exhibit 3.1 of the Group’s Current Report on Form 8-K filed with the SEC on
November 8, 2012.  (3)Incorporated herein by reference to
Exhibit 3.2 of the Group’s Current Report on Form 8-K filed with the SEC on
July 3, 2012.  (4)Incorporated herein by reference to
Exhibit 4.1 of the Group’s Current Report on Form 8-K filed with the SEC on
July 3, 2012. 120


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Signatures Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized. ORIENTAL FINANCIAL
GROUP INC. (Registrant)  By:
 /s/ José Rafael Fernández
 
 Date: November 
  9, 2012José
  Rafael FernándezPresident
  and Chief Executive OfficerBy:
 /s/ Ganesh Kumar
 
 Date: November 
  9, 2012Ganesh
  KumarExecutive
  Vice President and Chief Financial Officer
  121


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