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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549
   FORM 10-Q (MARK ONE) [X]
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2004[  ]
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OF 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM
            TO
 COMMISSION FILE NUMBER 0-17224 DORAL FINANCIAL CORPORATION (EXACT NAME OF THE REGISTRANT AS SPECIFIED IN ITS CHARTER) Puerto Rico
    
    66-0312162(State or other jurisdiction of
    
    (I.R.S. employerincorporation or organization)
    
    identification number)1451 F.D. Roosevelt Avenue,San Juan, Puerto Rico
    
    00920-2717(Address of principalexecutive offices)
    
    (Zip Code)
 (787) 474-6700   Not applicable
( Former name, former address and former fiscal year, if changed since last report) INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS
REQUIRED TO BE FILED BY SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF
1934 DURING THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE
REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH
FILING REQUIREMENTS FOR THE PAST 90 DAYS. YES  [X]  NO  [  ] INDICATE BY CHECK MARK WHETHER THE REGISTRANT IS AN ACCELERATED FILER (AS
DEFINED IN RULE 12B-2 OF THE EXCHANGE ACT). YES  [X]  NO  [  ] NUMBER OF SHARES OF COMMON STOCK OUTSTANDING AT JULY 26, 2004: 107,908,412




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DORAL FINANCIAL CORPORATION
INDEX PAGE PAGEPART I - FINANCIAL INFORMATIONItem 1 - Financial StatementsConsolidated Statements of Financial Condition (Unaudited) as of June 30, 2004
and December 31, 2003
    
    
    4Consolidated Statements of Income (Unaudited) - Quarters ended June 30, 2004
and June 30, 2003 and six months ended June 30, 2004 and June 30, 2003
    
    
    5Consolidated Statements of Changes in Stockholders Equity (Unaudited)  Six months
ended June 30, 2004 and June 30, 2003
    
    
    6Consolidated Statements of Comprehensive Income (Unaudited) - Quarters ended
June 30, 2004 and June 30, 2003 and six months ended June 30, 2004 and June 30, 2003.
    
    
    7Consolidated Statements of Cash Flows (Unaudited)  Six months ended June 30, 2004
and June 30, 2003
    
    
    8Notes to Consolidated Financial Statements (Unaudited)
    
    
    9Item 2 - Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    25Item 3 - Quantitative and Qualitative Disclosures About Market Risk
    
    
    54Item 4 - Controls and Procedures
    
    
    54PART II - OTHER INFORMATIONItem 1 - Legal Proceedings
    
    
    54Item 2 - Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities
    
    
    54Item 3 - Defaults Upon Senior Securities
    
    
    54Item 4 - Submission of Matters to a Vote of Security Holders
    
    
    54Item 5 - Other Information
    
    
    54Item 6 - Exhibits and Reports on Form 8-K
    
    
    55SIGNATURES
    
    
    56CEO and CFO CertificationsEX-12.1 COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGESEX-12.2 COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES & PREFERRED STOCK DIVIDENDSEX-31.1 SECTION 302 CERTIFICATION OF CEOEX-31.2 SECTION 302 CERTIFIACTION OF CFOEX-32.1 SECTION 906 CERTIFICATION OF CEOEX-32.2 SECTION 906 CERTIFICATION OF CFO
  2




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FORWARD LOOKING STATEMENTS When used in this form 10-Q or future filings by the Company with the
Securities and Exchange Commission, in the Companys press releases or other
public or shareholder communications, or in oral statements made with the
approval of an authorized executive officer, the words or phrases would be,
will allow, intends to, will likely result, are expected to, will
continue, is anticipated, estimate, project or similar expressions are
intended to identify forward-looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995. The Company wishes to caution readers not to place undue reliance on any
such forward-looking statements, which speak only as of the date made, and to
advise readers that various factors, including regional and national economic
conditions, adverse changes in the Puerto Rico real estate market, substantial
changes in levels of interest rates, credit and other risks of lending and
investment activities, competitive and regulatory factors, legislative changes
and regulatory or judicial proceedings, could affect the Companys financial
performance and could cause the Companys actual results for future periods to
differ materially from those anticipated or projected. The Company does not undertake, and specifically disclaims any obligation,
to update any forward-looking statements to reflect occurrences or
unanticipated events or circumstances after the date of such statements. 3




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DORAL FINANCIAL CORPORATION 
 CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
 (IN THOUSANDS OF DOLLARS, EXCEPT FOR SHARE INFORMATION)
(UNAUDITED)
 JUNE 30,
    
    DECEMBER 31,2004
    
    2003ASSETSCash and due from banks
    
    $
    86,953
    
    
    $
    84,713Money market investments
    
    
    1,615,003
    
    
    
    870,009Pledged investment securities that can be re-pledged:Trading securities, at fair value
    
    
    265,807
    
    
    
    272,046Securities available for sale, at fair value
    
    
    3,166,337
    
    
    
    2,205,951Securities held to maturity, at amortized cost (market value of $2,392,511 for 2004;
$1,405,634 for 2003)
    
    
    2,513,081
    
    
    
    1,452,035Total pledged investment securities that can be re-pledged
    
    
    5,945,225
    
    
    
    3,930,032Other investment securities:Trading securities, at fair value
    
    
    837,917
    
    
    
    672,104Securities available for sale, at fair value
    
    
    17,805
    
    
    
    644,647Securities held to maturity, at amortized cost (market value of $110,658 for 2004; $178,468
for 2003)
    
    
    112,005
    
    
    
    188,874Federal Home Loan Bank of NY (FHLB) stock, at cost
    
    
    83,620
    
    
    
    81,720Total other investment securities
    
    
    1,051,347
    
    
    
    1,587,345Total investment securities
    
    
    6,996,572
    
    
    
    5,517,377Loans:Mortgage loans held for sale, at lower of cost or market
    
    
    1,937,387
    
    
    
    1,966,608Loans receivable, net of allowance for loan losses of $18,001 (2003 - $19,709)
    
    
    1,602,619
    
    
    
    1,410,849Total loans
    
    
    3,540,006
    
    
    
    3,377,457Receivables and mortgage servicing advances
    
    
    113,584
    
    
    
    90,835Accounts receivable from investment sales
    
    
    541,944
    
    
    
    19,520Accrued interest receivable
    
    
    66,220
    
    
    
    63,771Servicing assets, net
    
    
    178,645
    
    

    
    167,498Premises and equipment, net
    
    
    143,941
    
    
    
    136,037Real estate held for sale, net
    
    
    17,099
    
    
    
    19,253Other assets
    
    
    40,452
    
    
    
    47,526Total assets
    
    $
    13,340,419
    
    
    $
    10,393,996LIABILITIESDeposits:Non-interest-bearing deposits
    
    $
    414,418
    
    
    $
    364,292Interest-bearing deposits
    
    
    2,824,978
    
    
    
    2,606,980Securities sold under agreements to repurchase
    
    
    5,385,234
    
    
    
    3,602,942Advances from FHLB
    
    
    1,194,500
    
    
    
    1,206,500Loans payable
    
    
    298,872
    
    
    
    178,334Notes payable
    
    
    710,246
    
    
    
    602,581Accounts payable from investment purchases
    
    
    511,378
    
    
    
    2,245Accrued expenses and other liabilities
    
    
    282,523
    
    
    
    237,682Total liabilities
    
    
    11,622,149
    
    
    
    8,801,556Commitments and contingencies (Note p)STOCKHOLDERS EQUITYPreferred stock, $1 par value; 40,000,000 shares authorized; 9,015,000 shares issued and
outstanding in 2004 and 2003, at aggregate liquidation preference value:Perpetual noncumulative nonconvertible preferred stock (Series A, B and C)
    
    
    228,250
    
    
    
    228,250Perpetual cumulative convertible preferred stock
    
    
    345,000
    
    
    
    345,000Common stock, $1 par value; 500,000,000 shares authorized; 107,907,512 and 107,903,912
shares issued and outstanding in 2004 and 2003, respectively
    
    
    107,908
    
    
    
    107,904Additional paid-in capital
    
    
    156,777
    
    
    
    151,902Legal surplus
    
    
    13,806
    
    
    
    13,806Retained earnings
    
    
    977,217
    
    
    
    804,518Accumulated other comprehensive loss, net of income tax (benefit) expense of ($11.5 million)
(2003 - $568)
    
    
    (110,688
    )
    
    
    (58,940
    )Total stockholders equity
    
    
    1,718,270
    
    
    
    1,592,440Total liabilities and stockholders equity
    
    $
    13,340,419
    
    
    $
    10,393,996
 The accompanying notes are an integral part of these financial statements. 4




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DORAL FINANCIAL CORPORATION 
 CONSOLIDATED STATEMENTS OF INCOME
 (IN THOUSANDS OF DOLLARS, EXCEPT FOR PER SHARE DATA)
(UNAUDITED)
 QUARTER ENDED
    
    SIX MONTH PERIODJUNE 30,
    
    ENDED JUNE 30,2004
    
    2003
    
    2004
    
    2003Interest income:Loans
    
    $
    56,743
    
    
    $
    54,291
    
    
    $
    116,879
    
    
    $
    109,331Mortgage-backed securities
    
    
    16,852
    
    
    
    18,532
    
    
    
    34,322
    
    
    
    36,057Interest-only strips (IOs)
    
    
    14,406
    
    
    
    8,944
    
    
    
    26,790
    
    
    
    19,800Investment securities
    
    
    45,225
    
    
    
    23,375
    
    
    
    77,817
    
    
    
    45,435Other interest-earning assets
    
    
    4,711
    
    
    
    4,062
    
    
    
    8,228
    
    
    
    8,191Total interest income
    
    
    137,937
    
    
    
    109,204
    
    
    
    264,036
    
    
    
    218,814Interest expense:Deposits
    
    
    19,499
    
    
    
    18,994
    
    
    
    38,481
    
    
    
    37,060Securities sold under agreements to repurchase
    
    
    25,412
    
    
    
    23,005
    
    
    
    48,084
    
    
    
    46,942Advances from FHLB
    
    
    12,358
    
    
    
    12,321
    
    
    
    24,144
    
    
    
    24,695Loans payable
    
    
    1,723
    
    
    
    1,930
    
    
    
    3,128
    
    
    
    3,381Notes payable
    
    
    12,299
    
    
    
    13,048
    
    
    
    24,500
    
    
    
    25,553Total interest expense
    
    
    71,291
    
    
    
    69,298
    
    
    
    138,337
    
    
    
    137,631Net interest income
    
    
    66,646
    
    
    
    39,906
    
    
    
    125,699
    
    
    
    81,183Provision for loan losses
    
    
    2,612
    
    
    
    3,618
    
    
    
    4,173
    
    
    
    8,396Net interest income after provision for loan losses
    
    
    64,034
    
    
    
    36,288
    
    
    
    121,526
    
    
    
    72,787Non-interest income:Net gain on mortgage loan sales and fees
    
    
    130,586
    
    
    
    98,081
    
    
    
    267,442
    
    
    
    175,406Investment activities:Trading activities
    
    
    6,048
    
    
    
    (4,951
    )
    
    
    (42,566
    )
    
    
    (50
    )Net (loss) gain on sale of investment securities
    
    
    (17,489
    )
    
    
    7,002
    
    
    
    (1,339
    )
    
    
    14,089Total investment activities
    
    
    (11,441
    )
    
    
    2,051
    
    
    
    (43,905
    )
    
    
    14,039Servicing loss , net of amortization and impairment of
$12,572 - 2004 and $17,104 - 2003 for the quarter, and
$20,373 - 2004 and $29,751  2003 for the six months
    
    
    (2,345
    )
    
    
    (8,353
    )
    
    
    (656
    )
    
    
    (12,462
    )Commissions, fees and other income
    
    
    9,780
    
    
    
    7,425
    
    
    
    18,461
    
    
    
    13,640Total non-interest income
    
    
    126,580
    
    
    
    99,204
    
    
    
    241,342
    
    
    
    190,623Non-interest expenses:Compensation and benefits
    
    
    22,276
    
    
    
    21,368
    
    
    
    42,033
    
    
    
    42,567Taxes, other than payroll and income taxes
    
    
    2,258
    
    
    
    1,751
    
    
    
    4,468
    
    
    
    3,508Advertising
    
    
    4,113
    
    
    
    3,597
    
    
    
    7,303
    
    
    
    7,360Professional services
    
    
    2,605
    
    
    
    2,128
    
    
    
    5,027
    
    
    
    4,100Communication and information systems
    
    
    3,308
    
    
    
    3,279
    
    
    
    6,588
    
    
    
    6,297Occupancy and other office expenses
    
    
    6,489
    
    
    
    5,695
    
    
    
    12,178
    
    
    
    11,137Depreciation and amortization
    
    
    4,311
    
    
    
    3,631
    
    
    
    8,583
    
    
    
    7,219Other
    
    
    5,182
    
    
    
    4,518
    
    
    
    10,302
    
    
    
    8,342Total non-interest expenses
    
    
    50,542
    
    
    
    45,967
    
    
    
    96,482
    
    
    
    90,530Income before income taxes
    
    
    140,072
    
    
    
    89,525
    
    
    
    266,386
    
    
    
    172,880Income taxes
    
    
    25,166
    
    
    
    14,548
    
    
    
    47,903
    
    
    
    27,916Net income
    
    $
    114,906
    
    
    $
    74,977
    
    
    $
    218,483
    
    
    $
    144,964Net income attributable to common shareholders
    
    $
    106,581
    
    
    $
    70,749
    
    
    $
    201,833
    
    
    $
    136,508Earnings per common share:Basic
    
    $
    0.99
    
    
    $
    0.66
    
    
    $
    1.87
    
    
    $
    1.27Diluted
    
    $
    0.96
    
    
    $
    0.64
    
    
    $
    1.82
    
    
    $
    1.24Dividends per common share
    
    $
    0.15
    
    
    $
    0.09
    
    
    $
    0.27
    
    
    $
    0.19
 The accompanying notes are an integral part of these financial statements. 5




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DORAL FINANCIAL CORPORATION 
 CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY
 (IN THOUSANDS OF DOLLARS)
(UNAUDITED)
 SIX MONTH PERIOD ENDEDJUNE 30,2004
    
    2003PREFERRED STOCK
    
    $
    573,250
    
    
    $
    228,250COMMON STOCK:Balance at beginning of period
    
    
    107,904
    
    
    
    71,933Shares issued under stock option plan
    
    
    4
    
    
    
    56Treasury stock canceled and retired
    
    
    
    
    
    
    (84
    )Balance at end of period
    
    
    107,908
    
    
    
    71,905PAID-IN CAPITAL:Balance at beginning of period
    
    
    151,902
    
    
    
    191,216Common shares issued under stock option plan
    
    
    21
    
    
    
    410Stock-based compensation recognized
    
    
    4,854
    
    
    
    2,245Balance at end of period
    
    
    156,777
    
    
    
    193,871LEGAL SURPLUS
    
    
    13,806
    
    
    
    10,777RETAINED EARNINGS:Balance at beginning of period
    
    
    804,518
    
    
    
    550,554Net income
    
    
    218,483
    
    
    
    144,964Cash dividends declared on common stock
    
    
    (29,134
    )
    
    
    (20,127
    )Cash dividends declared on preferred stock
    
    
    (16,650
    )
    
    
    (8,456
    )Balance at end of period
    
    
    977,217
    
    
    
    666,935ACCUMULATED OTHER COMPREHENSIVE LOSS,
NET OF TAX:Balance at beginning of period
    
    
    (58,940
    )
    
    
    (7,675
    )Other comprehensive loss, net of deferred tax
    
    
    (51,748
    )
    
    
    (13,954
    )Balance at end of period
    
    
    (110,688
    )
    
    
    (21,629
    )TREASURY STOCK AT PAR:Balance at beginning of period
    
    
    
    
    
    
    (84
    )Shares canceled and retired
    
    
    
    
    
    
    84Balance at end of period
    
    
    
    
    
    
    Total stockholders equity
    
    $
    1,718,270
    
    
    $
    1,150,109
 The accompanying notes are an integral part of these financial statements. 6




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DORAL FINANCIAL CORPORATION 
 CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
 (IN THOUSANDS OF DOLLARS)
(UNAUDITED)
 QUARTER ENDED
    
    SIX MONTH PERIODJUNE 30,
    
    ENDED JUNE 30,2004
    
    2003
    
    2004
    
    2003Net income
    
    $
    114,906
    
    
    $
    74,977
    
    
    $
    218,483
    
    
    $
    144,964Other comprehensive loss, before tax:Unrealized losses on securities arising during the period
    
    
    (122,802
    )
    
    
    (5,841
    )
    
    
    (67,574
    )
    
    
    (17,401
    )Amortization of unrealized loss on securities reclassified to held
to maturity
    
    
    3
    
    
    
    7
    
    
    
    14
    
    
    
    17Reclassification adjustment for losses (gains) included in net
income
    
    
    19,879
    
    
    
    (2,208
    )
    
    
    3,729
    
    
    
    1,960Other comprehensive loss, before tax
    
    
    (102,920
    )
    
    
    (8,042
    )
    
    
    (63,831
    )
    
    
    (15,424
    )Income tax benefit related to items of other comprehensive loss
    
    
    10,335
    
    
    
    400
    
    
    
    12,083
    
    
    
    1,470Other comprehensive loss
    
    
    (92,585
    )
    
    
    (7,642
    )
    
    
    (51,748
    )
    
    
    (13,954
    )Comprehensive income, net of taxes
    
    $
    22,321
    
    
    $
    67,335
    
    
    $
    166,735
    
    
    $
    131,010
 The accompanying notes are an integral part of these financial statements. 7




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DORAL FINANCIAL CORPORATION 
 CONSOLIDATED STATEMENTS OF CASH FLOWS
 (IN THOUSANDS OF DOLLARS)
(UNAUDITED)
 SIX MONTH PERIOD ENDEDENDED JUNE 30,2004
    
    2003Cash flows from operating activities:Net income
    
    $
    218,483
    
    
    $
    144,964Adjustments to reconcile net income to net cash (used in) provided by operating activities:Stock-based compensation recognized
    
    
    4,854
    
    
    
    2,245Depreciation and amortization
    
    
    8,583
    
    
    
    7,219Amortization and impairment of servicing assets
    
    
    20,373
    
    
    
    29,751Deferred income tax provision
    
    
    28,472
    
    
    
    5,684Provision for loan losses
    
    
    4,173
    
    
    
    8,396Provision for losses on real estate held for sale
    
    
    409
    
    
    
    682Amortization of premium and accretion of discount on loans and investment securities
    
    
    1,941
    
    
    
    1,931Origination and purchases of mortgage loans held for sale
    
    
    (3,277,485
    )
    
    
    (2,676,597
    )Principal repayment and sales of mortgage loans held for sale
    
    
    1,800,448
    
    
    
    1,345,486Purchases of securities held for trading
    
    
    (1,902,668
    )
    
    
    (6,293,093
    )Principal repayment and sales of trading securities
    
    
    2,650,155
    
    
    
    8,053,223Increase in interestonly strips, net
    
    
    (179,929
    )
    
    
    (85,296
    )Increase in servicing assets
    
    
    (31,520
    )
    
    
    (25,984
    )Increase in receivables and mortgage servicing advances
    
    
    (23,531
    )
    
    
    (12,890
    )(Increase) decrease in accrued interest receivable
    
    
    (2,449
    )
    
    
    291Decrease (increase) in other assets
    
    
    7,074
    
    
    
    (11,603
    )Increase in accrued expenses and other liabilities
    
    
    29,226
    
    
    
    307,769Total adjustments
    
    
    (861,874
    )
    
    
    657,214Net cash (used in) provided by operating activities
    
    
    (643,391
    )
    
    
    802,178Cash flows from investing activities:Purchases of securities available for sale
    
    
    (5,177,366
    )
    
    
    (4,591,362
    )Proceeds from sales of securities available for sale
    
    
    5,020,791
    
    
    
    3,841,054Principal repayment of securities available for sale
    
    
    94,006
    
    
    
    338,291Purchases of securities held to maturity
    
    
    (709,519
    )
    
    
    (717,722
    )Principal repayment and maturities of securities held to maturity
    
    
    147,607
    
    
    
    240,789(Increase) decrease in FHLB stock
    
    
    (1,900
    )
    
    
    2,750Origination of loans receivable
    
    
    (517,598
    )
    
    
    (399,374
    )Principal repayment of loans receivable
    
    
    319,736
    
    
    
    204,252Purchase of premises and equipment
    
    
    (16,487
    )
    
    
    (14,707
    )Proceeds from sales of real estate held for sale
    
    
    10,495
    
    
    
    2,707Net cash used in investing activities
    
    
    (830,235
    )
    
    
    (1,093,322
    )Cash flows from financing activities:Increase in deposits
    
    
    268,124
    
    
    
    402,285Increase (decrease) in securities sold under agreements to repurchase
    
    
    1,782,292
    
    
    
    (336,730
    )Increase in loans payable
    
    
    120,538
    
    
    
    24,423Increase (decrease) in notes payable
    
    
    107,665
    
    
    
    (8,383
    )Decrease in FHLB advances
    
    
    (12,000
    )
    
    
    (55,000
    )Issuance of common stock, net
    
    
    25
    
    
    
    466Dividends paid
    
    
    (45,784
    )
    
    
    (28,583
    )Net cash provided by (used in) financing activities
    
    
    2,220,860
    
    
    
    (1,522
    )Net increase (decrease) in cash and cash equivalents
    
    
    747,234
    
    
    
    (292,666
    )Cash and cash equivalents at beginning of period
    
    
    954,722
    
    
    
    1,573,291Cash and cash equivalents at the end of period
    
    $
    1,701,956
    
    
    $
    1,280,625Cash and cash equivalents includes:Cash and due from banks
    
    $
    86,953
    
    
    $
    293,699Money market investments
    
    
    1,615,003
    
    
    
    986,926$
    1,701,956
    
    
    $
    1,280,625Supplemental schedule of non-cash activities:Loan securitizations
    
    $
    1,500,457
    
    
    $
    1,494,764Loans foreclosed
    
    $
    8,339
    
    
    $
    9,438Supplemental information for cash flows:Cash used to pay interest
    
    $
    139,172
    
    
    $
    135,644Cash used to pay income taxes
    
    $
    31,076
    
    
    $
    22,260
 The accompanying notes are an integral part of these financial statements. 8




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##### Table of Contents



DORAL FINANCIAL CORPORATION 
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
  a.
    
    The Consolidated Financial Statements (unaudited) include the accounts of
Doral Financial Corporation (Doral Financial or the Company), Doral
Mortgage Corporation (Doral Mortgage), SANA Mortgage Bankers, Inc.
(SANA), Centro Hipotecario de Puerto Rico, Inc., Doral Securities, Inc.
(Doral Securities), Doral Bank (Doral Bank PR), Doral Bank, FSB
(Doral Bank NY), Doral Money, Inc. (Doral Money), Doral International,
Inc. (Doral International), Doral Properties, Inc. (Doral Properties)
and Doral Insurance Agency, Inc. (Doral Agency). References herein to
Doral Financial or the Company shall be deemed to refer to the Company
and its consolidated subsidiaries, unless otherwise provided. All
significant intercompany accounts and transactions have been eliminated in
consolidation. The Consolidated Financial Statements (unaudited) have
been prepared in conformity with the accounting policies stated in the
Companys Annual Audited Financial Statements included in the Companys
Annual Report for the year ended December 31, 2003. Certain information
and note disclosure normally included in the financial statements prepared
in accordance with generally accepted accounting principles in the United
States of America have been condensed or omitted from these statements
pursuant to the rules and regulations of the Securities and Exchange
Commission and, accordingly, these financial statements should be read in
conjunction with the audited Consolidated Financial Statements of the
Company for the year ended December 31, 2003, included in the Companys
Annual Report on Form 10-K. All adjustments (consisting only of normal
recurring accruals) which are, in the opinion of management, necessary for
a fair presentation of financial position, results of operations and cash
flows for the interim periods have been reflected. Certain amounts
reflected in the Companys Consolidated Financial Statements for the 2003
periods, have been reclassified to conform to the presentation of 2004.b.
    
    The results of operations for the quarter and six month period ended June
30, 2004 are not necessarily indicative of the results to be expected for
the full year.c.
    
    At June 30, 2004, escrow funds included approximately $146.2 million
deposited with Doral Bank PR. These funds are included in the Companys
consolidated financial statements. Escrow funds also included
approximately $36.3 million deposited with other banks, which are excluded
from the Companys assets and liabilities. At June 30, 2004, the Company
had fidelity bond coverage of $15.0 million and errors and omissions
coverage of $15.0 million.d.
    
    The reconciliation of the numerator and denominator of the basic and
diluted earnings-per-share follows: 9




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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Dollars in thousands, except per share amounts) Quarter Ended
    
    Six Month Period EndedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Net Income:Net income
    
    $
    114,906
    
    
    $
    74,977
    
    
    $
    218,483
    
    
    $
    144,964Convertible preferred stock dividend
    
    
    (4,097
    )
    
    
    
    
    
    
    (8,194
    )
    
    
    Nonconvertible preferred stock dividend
    
    
    (4,228
    )
    
    
    (4,228
    )
    
    
    (8,456
    )
    
    
    (8,456
    )Net income attributable to common stock
    
    $
    106,581
    
    
    $
    70,749
    
    
    $
    201,833
    
    
    $
    136,508Weighted Average Shares(1):Basic weighted average number of common shares outstanding
    
    
    107,907,512
    
    
    
    107,851,530
    
    
    
    107,906,894
    
    
    
    107,828,195Incremental shares issuable upon exercise of stock options(2)
    
    
    2,844,247
    
    
    
    2,560,020
    
    
    
    2,853,996
    
    
    
    2,374,312Diluted weighted average number of common shares outstanding
    
    
    110,751,759
    
    
    
    110,411,550
    
    
    
    110,760,890
    
    
    
    110,202,507Net Income per Common Share:Basic
    
    $
    0.99
    
    
    $
    0.66
    
    
    $
    1.87
    
    
    $
    1.27Diluted
    
    $
    0.96
    
    
    $
    0.64
    
    
    $
    1.82
    
    
    $
    1.24
   (1)
    
    For the quarter and six months ended June 30, 2004, 1,380,000 shares of the Companys 4.75% Perpetual cumulative
convertible preferred stock that were issued in the second half of 2003 were not included in the computation of diluted
earnings per share because the conditions for conversion as described below had not been met. Each share of
convertible preferred stock is currently convertible into 6.2856 shares of common stock, subject to adjustment under
specific conditions. The option of the purchasers to convert the convertible preferred stock into shares of the
Companys common stock is exercisable only (a) if during any fiscal quarter after September 30, 2003, the closing sale
price of the Companys common stock for at least 20 trading days in a period of 30 consecutive trading days ending on
the last trading day of the preceding fiscal quarter exceeds 120% of the conversion price of the convertible preferred
stock (conversion price of $39.77 as of June 30, 2004); (b) upon the occurrence of certain corporate transactions; or
(c) upon the delisting of the Companys common stock. On or after September 30, 2008, the Company may, at its option,
cause the convertible preferred stock to be converted into the number of shares of common stock that are issuable at
the conversion price. The Company may only exercise its conversion right if the closing sale price of the Companys
common stock exceeds 130% of the conversion price of the convertible preferred stock in effect for 20 trading days
within any period of 30 consecutive trading days ending on a trading day not more than two trading days prior to the
date the Company gives notice of conversion.(2)
    
    For the quarter and six month period ended June 30, 2004, options to purchase an additional 15,000 shares of common
stock were outstanding, but were not included in the computation of diluted earnings per share because their inclusion
would have had an antidilutive effect. For the quarter and six month period ended June 30, 2003, all stock options
outstanding were included in the computation of weighted average outstanding shares. 10




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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)  e.
    
    Employee costs and other expenses are shown in the Consolidated
Statements of Income net of direct loan origination costs which, pursuant
to SFAS No. 91, are capitalized as part of the carrying cost of mortgage
loans and are offset against net gains on mortgage loan sales and fees
when the loans are sold or amortized as yield adjustment in the case of
loans held for investment (loans receivable).Set forth below is a reconciliation of the application of SFAS No. 91 to
employee costs and other expenses: (In thousands) Quarter Ended
    
    Six Month Period EndedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Employee costs, gross
    
    $
    33,380
    
    
    $
    27,060
    
    
    $
    64,432
    
    
    $
    53,366Deferred costs pursuant to SFAS No. 91
    
    
    (11,104
    )
    
    
    (5,692
    )
    
    
    (22,399
    )
    
    
    (10,799
    )Employee cost, net
    
    $
    22,276
    
    
    $
    21,368
    
    
    $
    42,033
    
    
    $
    42,567Other expenses, gross
    
    $
    6,612
    
    
    $
    5,733
    
    
    $
    13,017
    
    
    $
    10,580Deferred costs pursuant to SFAS No. 91
    
    
    (1,430
    )
    
    
    (1,215
    )
    
    
    (2,715
    )
    
    
    (2,238
    )Other expenses, net
    
    $
    5,182
    
    
    $
    4,518
    
    
    $
    10,302
    
    
    $
    8,342
  As of June 30, 2004, the Company had a net deferred origination cost on
mortgage loans held for sale amounting to approximately $1.1 million and
a net deferred origination fee on loans receivable amounting to $9.2
million (December 31, 2003 a net deferred origination cost on mortgage
loans held for sale amounting to $1.4 million and a net deferred
origination fee on loans receivable amounting to $18.0 million).f.
    
    Segment informationThe Company operates in four reportable segments identified by line of
business: mortgage banking, banking (including thrift operations),
institutional securities operations and insurance agency activities.
Management made this determination based on operating decisions
particular to each business line and because each one targets different
customers and requires different strategies. The majority of the
Companys operations are conducted in Puerto Rico. The Company also
operates in the mainland United States, principally in the New York City
metropolitan area.The results of the mortgage banking segment for the six month periods
ended June 30, 2004 and 2003 and for the quarter ended June 30, 2003
include the results of Doral Overseas, an international banking entity
organized as a division at the parent company level. In connection with
local legislation passed on January 8, 2004, designed to encourage
international banking entities to operate as separate legal entities
rather than operating divisions, effective March 31, 2004, Doral
Financial phased out the operations of Doral Overseas. At the same time,
the Company has increased the investment activities of Doral
International, another international banking entity and a wholly-owned
subsidiary of Doral Bank PR. The operations of Doral International are
included within the banking segment.For the quarter ended June 30, 2003, the operations of Doral Overseas
contributed $1.6 million of the total net interest income, $23.1 million
of total non-interest income and $24.4 million of total net income of the
mortgage banking segment. For the six month period ended June 30, 2003,
the operations of Doral Overseas contributed $2.9 million of the total
net interest income, $29.9 million of total non-interest income and $32.2
million of total net income of the mortgage banking segment. For the six
month period ended June 30, 2004, the operations of Doral Overseas
contributed approximately $641,000 of the total net interest income,
$804,000 of total non-interest income and $1.2 million of total net
income of the mortgage banking segment.The Company monitors the performance of its reportable segments based on
pre-established goals for different financial parameters such as net
income, interest rate spread, loan production and market share.The following tables present net interest income, non-interest income,
net income and identifiable assets for each of the Companys reportable
segments for the periods presented as well as for the Companys Puerto
Rico and mainland U.S. operations for the periods presented. 11




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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (In thousands) Mortgage
    
    
    
    
    
    Institutional
    
    Insurance
    
    IntersegmentBanking
    
    Banking
    
    Securities
    
    Agency
    
    Eliminations*
    
    TotalsQUARTER ENDED JUNE 30, 2004Net interest income
    
    $
    17,818
    
    
    
    43,565
    
    
    
    888
    
    
    
    1,553
    
    
    
    2,822
    
    
    $
    66,646Non-interest income
    
    $
    98,304
    
    
    
    29,465
    
    
    
    854
    
    
    
    2,466
    
    
    
    (4,509
    )
    
    $
    126,580Net income
    
    $
    73,595
    
    
    
    38,977
    
    
    
    1,061
    
    
    
    2,780
    
    
    
    (1,507
    )
    
    $
    114,906Identifiable assets
    
    $
    4,326,648
    
    
    
    9,123,909
    
    
    
    330,055
    
    
    
    107,964
    
    
    
    (548,157
    )
    
    $
    13,340,419QUARTER ENDED JUNE 30, 2003Net interest income
    
    $
    11,520
    
    
    
    25,260
    
    
    
    866
    
    
    
    463
    
    
    
    1,797
    
    
    $
    39,906Non-interest income
    
    $
    53,615
    
    
    
    43,601
    
    
    
    3,326
    
    
    
    2,048
    
    
    
    (3,386
    )
    
    $
    99,204Net income
    
    $
    27,317
    
    
    
    45,050
    
    
    
    2,131
    
    
    
    1,469
    
    
    
    (990
    )
    
    $
    74,977Identifiable assets
    
    $
    2,914,952
    
    
    
    6,660,207
    
    
    
    412,431
    
    
    
    35,388
    
    
    
    (626,532
    )
    
    $
    9,396,446
 (In thousands) Mortgage
    
    
    
    
    
    Institutional
    
    Insurance
    
    IntersegmentBanking
    
    Banking
    
    Securities
    
    Agency
    
    Eliminations*
    
    TotalsSIX MONTH PERIOD ENDED JUNE 30, 2004Net interest income
    
    $
    36,806
    
    
    
    76,887
    
    
    
    1,838
    
    
    
    2,534
    
    
    
    7,634
    
    
    $
    125,699Non-interest income
    
    $
    154,112
    
    
    
    85,762
    
    
    
    2,326
    
    
    
    5,343
    
    
    
    (6,201
    )
    
    $
    241,342Net income
    
    $
    111,295
    
    
    
    99,376
    
    
    
    2,437
    
    
    
    5,404
    
    
    
    (29
    )
    
    $
    218,483Identifiable assets
    
    $
    4,326,648
    
    
    
    9,123,909
    
    
    
    330,055
    
    
    
    107,964
    
    
    
    (548,157
    )
    
    $
    13,340,419SIX MONTH PERIOD ENDED JUNE 30, 2003Net interest income
    
    $
    22,851
    
    
    
    52,111
    
    
    
    1,644
    
    
    
    863
    
    
    
    3,714
    
    
    $
    81,183Non-interest income
    
    $
    112,272
    
    
    
    77,266
    
    
    
    4,493
    
    
    
    3,842
    
    
    
    (7,250
    )
    
    $
    190,623Net income
    
    $
    62,938
    
    
    
    78,660
    
    
    
    2,970
    
    
    
    2,780
    
    
    
    (2,384
    )
    
    $
    144,964Identifiable assets
    
    $
    2,914,952
    
    
    
    6,660,207
    
    
    
    412,431
    
    
    
    35,388
    
    
    
    (626,532
    )
    
    $
    9,396,446
  *
    
    The intersegment eliminations in the above
tables, include direct intersegment loan origination costs
amortized as yield adjustment (mainly related with
origination costs paid by the banking segment to the
mortgage banking segment) and other income derived from
intercompany transactions, related principally to fees and
commissions paid to the Companys institutional securities
subsidiary and rental income paid to Doral Properties, the
Companys subsidiary that owns the corporate headquarters
facilities. During the six month period ended June 30,
2004, the intersegment eliminations for net income also
include realized losses recognized by the mortgage banking
segment on sale of investment securities to the banking
segment. Assets include internal funding and investment in
subsidiaries accounted for at cost. 12




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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (In thousands) Puerto Rico
    
    Mainland US
    
    Eliminations
    
    TotalsQUARTER ENDED JUNE 30, 2004Net interest income
    
    $
    63,388
    
    
    
    3,203
    
    
    
    55
    
    
    $
    66,646Non-interest income
    
    $
    125,969
    
    
    
    536
    
    
    
    75
    
    
    $
    126,580Net income
    
    $
    114,218
    
    
    
    493
    
    
    
    195
    
    
    $
    114,906Identifiable assets
    
    $
    12,901,735
    
    
    
    554,440
    
    
    
    (115,756
    )
    
    $
    13,340,419QUARTER ENDED JUNE 30, 2003Net interest income
    
    $
    37,928
    
    
    
    1,965
    
    
    
    13
    
    
    $
    39,906Non-interest income
    
    $
    98,758
    
    
    
    649
    
    
    
    (203
    )
    
    $
    99,204Net income (loss)
    
    $
    75,509
    
    
    
    (413
    )
    
    
    (119
    )
    
    $
    74,977Identifiable assets
    
    $
    8,952,393
    
    
    
    492,683
    
    
    
    (48,630
    )
    
    $
    9,396,446
 (In thousands) Puerto Rico
    
    Mainland US
    
    Eliminations
    
    TotalsSIX MONTH PERIOD ENDED JUNE 30, 2004Net interest income
    
    $
    119,739
    
    
    
    5,891
    
    
    
    69
    
    
    $
    125,699Non-interest income
    
    $
    240,017
    
    
    
    1,412
    
    
    
    (87
    )
    
    $
    241,342Net income
    
    $
    217,667
    
    
    
    702
    
    
    
    114
    
    
    $
    218,483Identifiable assets
    
    $
    12,901,735
    
    
    
    554,440
    
    
    
    (115,756
    )
    
    $
    13,340,419SIX MONTH PERIOD ENDED JUNE 30, 2003Net interest income
    
    $
    75,329
    
    
    
    5,865
    
    
    
    (11
    )
    
    $
    81,183Non-interest income
    
    $
    187,335
    
    
    
    3,542
    
    
    
    (254
    )
    
    $
    190,623Net income
    
    $
    144,039
    
    
    
    1,084
    
    
    
    (159
    )
    
    $
    144,964Identifiable assets
    
    $
    8,952,393
    
    
    
    492,683
    
    
    
    (48,630
    )
    
    $
    9,396,446
  The breakdown of non-interest income from the mortgage banking and
banking segments, for the periods presented, follows: (In thousands) MortgageBanking
    
    BankingQUARTER ENDEDJUNE 30, 2004Net gain on mortgage loan sales and fees
    
    $
    98,740
    
    
    $
    34,254Investment activities
    
    
    (1,588
    )
    
    
    (9,406
    )Servicing loss
    
    
    (1,282
    )
    
    
    (12
    )Commissions, fees and other income
    
    
    2,434
    
    
    
    4,629Total non-interest income
    
    $
    98,304
    
    
    $
    29,465QUARTER ENDEDJUNE 30, 2003Net gain on mortgage loan sales and fees
    
    $
    89,935
    
    
    $
    10,001Investment activities
    
    
    (30,446
    )
    
    
    30,621Servicing loss
    
    
    (6,473
    )
    
    
    (990
    )Commissions, fees and other income
    
    
    599
    
    
    
    3,969Total non-interest income
    
    $
    53,615
    
    
    $
    43,601
 13




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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (In thousands) MortgageBanking
    
    BankingSIX MONTH PERIOD ENDEDJUNE 30, 2004Net gain on mortgage loan sales and fees
    
    $
    205,728
    
    
    $
    66,305Investment activities
    
    
    (57,697
    )
    
    
    11,295Servicing income (loss)
    
    
    1,470
    
    
    
    (11
    )Commissions, fees and other income
    
    
    4,611
    
    
    
    8,173Total non-interest income
    
    $
    154,112
    
    
    $
    85,762SIX MONTH PERIOD ENDEDJUNE 30, 2003Net gain on mortgage loan sales and fees
    
    $
    153,888
    
    
    $
    24,651Investment activities
    
    
    (33,212
    )
    
    
    45,707Servicing loss
    
    
    (9,569
    )
    
    
    (1,234
    )Commissions, fees and other income
    
    
    1,165
    
    
    
    8,142Total non-interest income
    
    $
    112,272
    
    
    $
    77,266
  g.
    
    The fair value of the Companys trading securities and the fair value and
carrying value of its securities classified as available for sale and held
to maturity are shown below by category.  1.
    
    The following table summarizes Doral Financials holdings of
trading securities as of June 30, 2004 and December 31, 2003. TRADING SECURITIES
    
    JUNE 30,
    
    DECEMBER 31,(In thousands)
    
    2004
    
    2003Mortgage-backed securities
    
    $
    325,415
    
    
    $
    346,597Interest-only strips
    
    
    758,053
    
    
    
    578,124Puerto Rico government and agencies
    
    
    7,606
    
    
    
    5,646Other
    
    
    12,650
    
    
    
    13,783Total
    
    $
    1,103,724
    
    
    $
    944,150
  2.
    
    The following tables summarize the amortized cost, unrealized
gains and losses, approximate market values, weighted- average yield
and contractual maturities of securities available for sale as of
June 30, 2004 and December 31, 2003.The weighted average yield is computed based on amortized cost and,
therefore, does not give effect to changes in fair value. Expected
maturities of mortgage-backed securities and certain debt
securities might differ from contractual maturities because
borrowers may have the right to call or prepay obligations with or
without call or prepayment penalties. 14




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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) SECURITIES AVAILABLE FOR
SALE
AS OF JUNE 30, 2004 (Dollars in thousands) WEIGHTEDAMORTIZED
    
    UNREALIZED
    
    UNREALIZED
    
    MARKET
    
    AVERAGECOST
    
    GAINS
    
    LOSSES
    
    VALUE
    
    YIELDMORTGAGE-BACKED
SECURITIES
GNMADue over ten years
    
    $
    421,641
    
    
    $
    124
    
    
    $
    11,747
    
    
    $
    410,018
    
    
    
    5.33
    %FHLMC and FNMADue over ten years
    
    
    442,486
    
    
    
    57
    
    
    
    19,670
    
    
    
    422,873
    
    
    
    5.19
    %DEBT
SECURITIES
FHLB NOTESDue over ten years
    
    
    111,945
    
    
    
    1,339
    
    
    
    
    
    
    
    113,284
    
    
    
    5.51
    %US TREASURYDue from one to five years
    
    
    857,791
    
    
    
    
    
    
    
    11,511
    
    
    
    846,280
    
    
    
    1.91
    %Due from five to ten years
    
    
    1,243,273
    
    
    
    375
    
    
    
    54,336
    
    
    
    1,189,312
    
    
    
    4.01
    %Due over ten years
    
    
    219,954
    
    
    
    
    
    
    
    17,579
    
    
    
    202,375
    
    
    
    4.71
    %$
    3,297,090
    
    
    $
    1,895
    
    
    $
    114,843
    
    
    $
    3,184,142
    
    
    
    3.88
    %
 15




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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) SECURITIES AVAILABLE FOR SALE
AS OF DECEMBER 31, 2003 (Dollars in thousands)
 WEIGHTEDAMORTIZED
    
    UNREALIZED
    
    UNREALIZED
    
    MARKET
    
    AVERAGECOST
    
    GAINS
    
    LOSSES
    
    VALUE
    
    YIELDMORTGAGE-BACKED
SECURITIES
GNMADue over ten years
    
    $
    467,451
    
    
    $
    553
    
    
    $
    5,096
    
    
    $
    462,908
    
    
    
    5.70
    %FHLMC and FNMADue over ten years
    
    
    539,034
    
    
    
    196
    
    
    
    13,360
    
    
    
    525,870
    
    
    
    5.17
    %DEBT SECURITIESFHLB NOTESDue over ten years
    
    
    111,940
    
    
    
    
    
    
    
    1,847
    
    
    
    110,093
    
    
    
    5.25
    %US TREASURYDue from one to five years
    
    
    149,897
    
    
    
    291
    
    
    
    
    
    
    
    150,188
    
    
    
    1.84
    %Due from five to ten years
    
    
    1,375,706
    
    
    
    
    
    
    
    35,144
    
    
    
    1,340,562
    
    
    
    3.87
    %Due over ten years
    
    
    266,962
    
    
    
    
    
    
    
    5,985
    
    
    
    260,977
    
    
    
    4.92
    %$
    2,910,990
    
    
    $
    1,040
    
    
    $
    61,432
    
    
    $
    2,850,598
    
    
    
    4.45
    %
 16




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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)  3.
    
    The following tables summarize the amortized cost, unrealized
gains and losses, approximate market values, weighted average yield
and contractual maturities of securities held to maturity as of June
30, 2004 and December 31, 2003.The weighted average yield is computed based on amortized cost and,
therefore, does not give effect to changes in fair value. Expected
maturities of mortgage-backed securities and certain debt
securities might differ from contractual maturities because
borrowers may have the right to call or prepay obligations with or
without call or prepayment penalties. SECURITIES HELD TO MATURITY
AS OF JUNE 30, 2004 (Dollars in thousands)
 WEIGHTEDAMORTIZED
    
    UNREALIZED
    
    UNREALIZED
    
    MARKET
    
    AVERAGECOST
    
    GAINS
    
    LOSSES
    
    VALUE
    
    YIELDMORTGAGE-BACKED SECURITIESGNMADue from five to ten years
    
    $
    1,414
    
    
    $
    75
    
    
    $
    
    
    
    $
    1,489
    
    
    
    6.76
    %Due over ten years
    
    
    6,463
    
    
    
    386
    
    
    
    
    
    
    
    6,849
    
    
    
    6.99
    %FHLMC and FNMADue over ten years
    
    
    466,797
    
    
    
    
    
    
    
    12,340
    
    
    
    454,457
    
    
    
    5.16
    %CMO CERTIFICATESDue within a year
    
    
    31
    
    
    
    
    
    
    
    
    
    
    
    31
    
    
    
    8.25
    %Due from one to five years
    
    
    1,008
    
    
    
    
    
    
    
    4
    
    
    
    1,004
    
    
    
    6.36
    %Due over ten years
    
    
    32,998
    
    
    
    
    
    
    
    635
    
    
    
    32,363
    
    
    
    6.37
    %DEBT SECURITIESFHLB NOTESDue from one to five years
    
    
    100,000
    
    
    
    
    
    
    
    1,095
    
    
    
    98,905
    
    
    
    2.89
    %Due from five to ten years
    
    
    49,988
    
    
    
    
    
    
    
    13
    
    
    
    49,975
    
    
    
    3.48
    %Due over ten years
    
    
    575,462
    
    
    
    1,565
    
    
    
    9,815
    
    
    
    567,212
    
    
    
    5.57
    %FHLMC and FNMA NOTESDue over ten years
    
    
    149,988
    
    
    
    
    
    
    
    1,803
    
    
    
    148,185
    
    
    
    5.82
    %FHLB ZERO COUPONDue over ten years
    
    
    271,154
    
    
    
    
    
    
    
    21,038
    
    
    
    250,116
    
    
    
    6.59
    %FHLMC ZERO COUPONDue over ten years
    
    
    274,694
    
    
    
    
    
    
    
    17,317
    
    
    
    257,377
    
    
    
    5.90
    %PR HOUSING BANKDue from one to five years
    
    
    5,000
    
    
    
    50
    
    
    
    
    
    
    
    5,050
    
    
    
    6.00
    %Due over ten years
    
    
    2,235
    
    
    
    
    
    
    
    
    
    
    
    2,235
    
    
    
    6.20
    %U.S. TREASURYDue from five to ten years
    
    
    201,573
    
    
    
    
    
    
    
    13,917
    
    
    
    187,656
    
    
    
    3.52
    %Due over ten years
    
    
    474,861
    
    
    
    313
    
    
    
    46,876
    
    
    
    428,298
    
    
    
    4.33
    %OTHERDue from one to five years
    
    
    3,875
    
    
    
    71
    
    
    
    
    
    
    
    3,946
    
    
    
    5.38
    %Due from five to ten years
    
    
    545
    
    
    
    10
    
    
    
    
    
    
    
    555
    
    
    
    6.73
    %Due over ten years
    
    
    7,000
    
    
    
    466
    
    
    
    
    
    
    
    7,466
    
    
    
    5.93
    %$
    2,625,086
    
    
    $
    2,936
    
    
    $
    124,853
    
    
    $
    2,503,169
    
    
    
    5.14
    %
 17




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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) SECURITIES HELD TO MATURITY
AS OF DECEMBER 31, 2003 (Dollars in thousands)
 WEIGHTEDAMORTIZED
    
    UNREALIZED
    
    UNREALIZED
    
    MARKET
    
    AVERAGECOST
    
    GAINS
    
    LOSSES
    
    VALUE
    
    YIELDMORTGAGE-BACKED SECURITIESGNMADue from five to ten years
    
    $
    1,682
    
    
    $
    89
    
    
    $
    
    
    
    $
    1,771
    
    
    
    6.75
    %Due over ten years
    
    
    7,908
    
    
    
    482
    
    
    
    
    
    
    
    8,390
    
    
    
    6.97
    %CMO CERTIFICATESDue within a year
    
    
    40
    
    
    
    
    
    
    
    
    
    
    
    40
    
    
    
    8.25
    %Due from one to five years
    
    
    677
    
    
    
    
    
    
    
    2
    
    
    
    675
    
    
    
    6.78
    %Due from five to ten years
    
    
    462
    
    
    
    
    
    
    
    3
    
    
    
    459
    
    
    
    5.80
    %Due over ten years
    
    
    43,182
    
    
    
    2
    
    
    
    781
    
    
    
    42,403
    
    
    
    6.23
    %DEBT SECURITIESFHLB NOTESDue from one to five years
    
    
    50,000
    
    
    
    
    
    
    
    
    
    
    
    50,000
    
    
    
    3.05
    %Due over ten years
    
    
    517,960
    
    
    
    2,051
    
    
    
    
    
    
    
    520,011
    
    
    
    5.58
    %FHLB ZERO COUPONDue over ten years
    
    
    288,253
    
    
    

    
    
    
    
    1,099
    
    
    
    287,154
    
    
    
    6.63
    %FHLMC ZERO COUPONDue over ten years
    
    
    34,287
    
    
    
    
    
    
    
    5,500
    
    
    
    28,787
    
    
    
    6.01
    %PR HOUSING BANKDue from one to five years
    
    
    5,000
    
    
    
    50
    
    
    
    
    
    
    
    5,050
    
    
    
    6.00
    %Due over ten years
    
    
    2,235
    
    
    
    
    
    
    
    
    
    
    
    2,235
    
    
    
    6.20
    %US TREASURYDue from five to ten years
    
    
    201,661
    
    
    
    
    
    
    
    9,161
    
    
    
    192,500
    
    
    
    3.51
    %Due over ten years
    
    
    476,167
    
    
    
    3,503
    
    
    
    46,498
    
    
    
    433,172
    
    
    
    4.38
    %OTHERDue from one to five years
    
    
    3,680
    
    
    
    11
    
    
    
    4
    
    
    
    3,687
    
    
    
    5.33
    %Due from five to ten years
    
    
    715
    
    
    
    13
    
    
    
    
    
    
    
    728
    
    
    
    6.73
    %Due over ten years
    
    
    7,000
    
    
    
    40
    
    
    
    
    
    
    
    7,040
    
    
    
    5.93
    %$
    1,640,909
    
    
    $
    6,241
    
    
    $
    63,048
    
    
    $
    1,584,102
    
    
    
    5.13
    %
 18




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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)  h.
    
    The following table shows Doral Financials available for sale and held
to maturity investments gross unrealized losses and fair value,
aggregated by investment category and length of time that individual
securities have been in a continuous unrealized loss position, at June 30,
2004. LESS THAN 12 MONTHS
    
    12 MONTHS OR MORE
    
    TOTALFAIR
    
    UNREALIZED
    
    FAIR
    
    UNREALIZED
    
    FAIR
    
    UNREALIZED(Dollars in thousands)
    
    VALUE
    
    LOSSES
    
    VALUE
    
    LOSSES
    
    VALUE
    
    LOSSESMortgage-Backed
SecuritiesGNMA
    
    $
    350,589
    
    
    $
    11,747
    
    
    $
    
    
    
    $
    
    
    
    $
    350,589
    
    
    $
    11,747FHLMC and FNMA
    
    
    858,654
    
    
    
    31,304
    
    
    
    12,419
    
    
    
    706
    
    
    
    871,073
    
    
    
    32,010CMO Certificates
    
    
    11,863
    
    
    
    344
    
    
    
    19,378
    
    
    
    295
    
    
    
    31,241
    
    
    
    639Debt SecuritiesFHLB Notes
    
    
    412,636
    
    
    
    10,923
    
    
    
    
    
    
    
    
    
    
    
    412,636
    
    
    
    10,923FHLMC and FNMA
Notes
    
    
    98,185
    
    
    
    1,803
    
    
    
    
    
    
    
    
    
    
    
    98,185
    
    
    
    1,803FHLB Zero Coupon
    
    
    153,124
    
    
    
    8,118
    
    
    
    96,992
    
    
    
    12,920
    
    
    
    250,116
    
    
    
    21,038FHLMC Zero Coupon
    
    
    257,377
    
    
    
    17,317
    
    
    
    
    
    
    
    
    
    
    
    257,377
    
    
    
    17,317U.S. Treasury
    
    
    1,864,610
    
    
    
    76,638
    
    
    
    604,245
    
    
    
    67,581
    
    
    
    2,468,855
    
    
    
    144,219$
    4,007,038
    
    
    $
    158,194
    
    
    $
    733,034
    
    
    $
    81,502
    
    
    $
    4,740,072
    
    
    $
    239,696
  The securities held by the Company are principally mortgage-backed
securities, U.S. Treasury and agency securities. Thus a substantial
portion of these instruments is guaranteed by either mortgages, a U.S.
government sponsored entity or the full faith and credit of the U.S.
government and, therefore, principal and interest on the securities are
deemed recoverable. The Company has the ability and intent to hold the
securities until maturity or until the unrealized losses are recovered.
Therefore, no other than temporary impairment loss has been recognized.i.
    
    The following table sets forth certain information regarding Doral
Financials mortgage loans held for sale as of the dates indicated: MORTGAGE LOANS HELD FOR SALE (In thousands)
    
    JUNE 30, 2004
    
    DECEMBER 31, 2003Conventional single family residential loans
    
    $
    1,576,885
    
    
    $
    1,532,149FHA/VA loans
    
    
    93,753
    
    
    
    87,810Mortgage loans on residential multifamily
    
    
    60,433
    
    
    
    79,641Construction and commercial real estate loans
    
    
    206,293
    
    
    
    266,982Consumer loans secured by mortgages
    
    
    23
    
    
    
    26$
    1,937,387
    
    
    $
    1,966,608
 19




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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)  j.
    
    The following table sets forth certain information regarding Doral
Financials loans receivable as of the dates indicated: LOANS RECEIVABLE, NET (Dollars in thousands) JUNE 30, 2004
    
    DECEMBER 31, 2003AMOUNT
    
    PERCENT
    
    AMOUNT
    
    PERCENTConstruction loans(1)
    
    $
    581,257
    
    
    
    36
    %
    
    $
    603,909
    
    
    
    42
    %Residential mortgage loans
    
    
    582,353
    
    
    
    36
    %
    
    
    529,147
    
    
    
    36
    %Commercial  secured by real estate
    
    
    300,055
    
    
    
    18
    %
    
    
    152,016
    
    
    
    10
    %Consumer  secured by real estate
    
    
    233
    
    
    
    0
    %
    
    
    375
    
    
    
    0
    %Consumer  other:Personal loans
    
    
    30,089
    
    
    
    2
    %
    
    
    31,083
    
    
    
    2
    %Auto loans
    
    
    1,291
    
    
    
    0
    %
    
    
    1,291
    
    
    
    0
    %Credit cards
    
    
    10,095
    
    
    
    1
    %
    
    
    8,367
    
    
    
    1
    %Overdrawn checking accounts
    
    
    447
    
    
    
    0
    %
    
    
    357
    
    
    
    0
    %Revolving lines of credit
    
    
    26,349
    
    
    
    2
    %
    
    
    25,418
    
    
    
    2
    %Commercial non-real estate
    
    
    31,389
    
    
    
    2
    %
    
    
    22,006
    
    
    
    2
    %Loans on saving deposits
    
    
    9,348
    
    
    
    0
    %
    
    
    8,769
    
    
    
    1
    %Land secured
    
    
    56,908
    
    
    
    3
    %
    
    
    65,818
    
    
    
    4
    %Loans receivable, gross
    
    
    1,629,814
    
    
    
    100
    %
    
    
    1,448,556
    
    
    
    100
    %Less:Unearned interest and deferred
loan fees, net
    
    
    (9,194
    )
    
    
    
    
    
    
    (17,998
    )Allowance for loan losses(2)
    
    
    (18,001
    )
    
    
    
    
    
    
    (19,709
    )(27,195
    )
    
    
    
    
    
    
    (37,707
    )Loans receivable, net
    
    $
    1,602,619
    
    
    
    
    
    
    $
    1,410,849
   (1)
    
    Includes $481.6 million and $402.2 million of construction loans for residential housing
projects as of June 30, 2004 and December 31, 2003, respectively. Also includes $99.7 million
and $201.7 million of construction loans for commercial, condominiums and multifamily projects as
of June 30, 2004 and December 31, 2003, respectively.(2)
    
    Does not include $11.7 million and $8.5 million of allowance for loan losses allocated to
mortgage loans held for sale as of June 30, 2004 and December 31, 2003, respectively. During the
first quarter of 2004, $3.2 million of the allowance for loan losses previously allocated to
loans receivable was transferred to mortgage loans held for sale. 20




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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)  k.
    
    Doral Financial is the guarantor of various serial and term bonds issued
by Doral Properties, a wholly-owned subsidiary, through the Puerto Rico
Industrial, Tourist, Educational, Medical and Environmental Control
Facilities Financing Authority (AFICA). The bonds were issued to
finance the construction and development of the Doral Financial Plaza, the
headquarters facility of Doral Financial. As of June 30, 2004, the
outstanding principal balance of the bonds was $51.4 million with fixed
interest rates, ranging from 6.15% to 6.90%, and maturities ranging from
December 2004 to December 2029. Certain series of the bonds are secured
by a mortgage on the building and underlying real property.l.
    
    The Company routinely originates, securitizes and sells mortgage loans
into the secondary market. As a result of this process, the Company
typically retains the servicing rights and may retain interest-only
strips. The Companys retained interests are subject to prepayment and
interest rate risks. The following tables show the changes in the
Companys mortgage servicing assets and interest-only strips for each of
the periods shown: MORTGAGE SERVICING ASSETS ACTIVITY (In thousands)
 QUARTER ENDED
    
    SIX MONTH PERIODJUNE 30,
    
    ENDED JUNE 30,2004
    
    2003
    
    2004
    
    2003Balance at beginning of period
    
    $
    176,401
    
    
    $
    160,270
    
    
    $
    167,498
    
    
    $
    159,881Capitalization of rights
    
    
    14,816
    
    
    
    12,948
    
    
    
    31,520
    
    
    
    25,984Amortization:Scheduled
    
    
    (6,294
    )
    
    
    (7,263
    )
    
    
    (12,258
    )
    
    
    (15,026
    )Unscheduled and impairment
    
    
    (6,278
    )
    
    
    (9,841
    )
    
    
    (8,115
    )
    
    
    (14,725
    )Balance at end of period
    
    $
    178,645
    
    
    $
    156,114
    
    
    $
    178,645
    
    
    $
    156,114
  An impairment charge is recognized through a valuation allowance for each
individual stratum of mortgage loans subject to servicing rights. The
valuation allowance is adjusted to reflect the amount, if any, by which
the cost basis of the servicing asset for a given stratum of loans being
serviced exceeds its fair value. Any fair value in excess of the cost
basis of the servicing asset for a given stratum is not recognized. A
direct write-down of servicing assets is recognized for any given stratum
on which an impairment allowance has been provided for three consecutive
quarters. 21




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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)  Changes in the impairment allowance for servicing assets were as follows: (In thousands) Quarter ended
    
    Six Month period endedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Balance at beginning of period
    
    $
    7,936
    
    
    $
    14,036
    
    
    $
    11,392
    
    
    $
    9,152Impairment charges
    
    
    6,952
    
    
    
    9,453
    
    
    
    11,759
    
    
    
    16,945Direct write-down
    
    
    (1,483
    )
    
    
    
    
    
    
    (6,289
    )
    
    
    Recoveries
    
    
    (1,214
    )
    
    
    (3,849
    )
    
    
    (4,671
    )
    
    
    (6,457
    )Balance at end of period
    
    $
    12,191
    
    
    $
    19,640
    
    
    $
    12,191
    
    
    $
    19,640
  At June 30, 2004, and based on recent prepayment experience, the expected
weighted average life of the Companys servicing assets was 10 years.
Any projection of the expected weighted average life of servicing assets
is limited by conditions that existed at the time the calculations were
performed, and may not be indicative of actual amortization expense that
will be recorded in future periods. INTEREST-ONLY STRIPS ACTIVITY (In thousands)
 Quarter ended
    
    Six month period endedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Balance at beginning of period
    
    $
    678,129
    
    
    $
    411,054
    
    
    $
    578,124
    
    
    $
    359,185IOs on loan sales
    
    
    111,160
    
    
    
    64,263
    
    
    
    224,714
    
    
    
    116,128Amortization
    
    
    (25,255
    )
    
    
    (19,248
    )
    
    
    (48,260
    )
    
    
    (33,849
    )Valuation adjustment
    
    
    (5,981
    )
    
    
    (11,588
    )
    
    
    (20,341
    )
    
    
    (6,957
    )Purchases of IOs
    
    
    
    
    
    
    
    
    
    
    23,816
    
    
    
    9,974Balance at end of period
    
    $
    758,053
    
    
    $
    444,481
    
    
    $
    758,053
    
    
    $
    444,481
  m.
    
    At June 30, 2004 and December 31, 2003, money market investments included
$732.6 million and $198.8 million, respectively, of pledged money market
investments. Such money market investments secured short-term borrowings
generally due within 90 days. At June 30, 2004 and December 31, 2003, the
carrying value of securities purchased under resell agreements included in
money market investments was $74.8 million and $50.0 million,
respectively. The underlying securities were held on behalf of the
Company by the dealers that arranged the transactions. At June 30, 2004
and December 31, 2003, the Company had repledged all $74.8 million and
$50.0 million, respectively, of the underlying securities to
secure obligations under repurchase agreements.n.
    
    The Company expenses the fair value of stock options granted to employees
using the modified prospective method . Under this method, the Company
expenses the fair value of all employee stock options granted after
January 1, 2003, as well as the unvested portions of previously granted
options. The before-tax expense associated with expensing stock options
for the second quarter and first half of 2004 was approximately $2.4
million and $4.9 million, respectively, compared to $1.1 million and $2.2
million for the comparable 2003 periods. 22




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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)  o.
    
    GuaranteesIn November 2002, the Financial Accounting Standards Boards (FASB)
issued Interpretation No. 45, (FIN 45) Guarantors Accounting and
Disclosure Requirements for Guarantees. This interpretation requires a
guarantor of certain types of guarantees to recognize, at the inception
of the guarantee, a liability for the fair value of the obligation
undertaken in issuing the guarantee. As of June 30, 2004, the Company
had outstanding $3.2 million in commercial and financial standby letters
of credit. The fair value on these commitments is not significant.p.
    
    Commitments and ContingenciesThe Company is a party to financial instruments with off-balance sheet
risk in the normal course of business to meet the financing needs of its
customers. These financial instruments may include commitments to extend
credit and sell mortgage-backed securities and loans. At June 30, 2004,
commitments to extend credit amounted to approximately $478.2 million and
commitments to sell/purchase mortgage-backed securities and loans
amounted to approximately $1.4 billion. Commitments to extend credit are
agreements to lend to a customer as long as the conditions established in
the contract are met. Commitments generally have fixed expiration dates
or other termination clauses.The Company is subject to legal proceedings and claims that have arisen
in the ordinary course of business and have not been adjudicated.
Management believes that these actions, when concluded, will not have a
material adverse effect upon the financial position, results of
operations or cash flows of the Company. For further details, refer to
Part II  Other Information, Item 1  Legal Proceedings.q.
    
    Recent Accounting PronouncementsAccounting for Certain Loans or Debt Securities Acquired in a Transfer.
In November 2003, the Accounting Standards Executive Committee issued the
Statement of Position (SOP) No. 03-3, Accounting for Certain Loans of
Debt Securities Acquired in a Transfer. This statement addresses
accounting for differences between contractual cash flows and cash flows
expected to be collected from an investors initial investment in loans
or debt securities (loans) acquired in a transfer if those differences
are attributable, at least in part, to credit quality. This SOP does not
apply to loans originated by the entity. This SOP prohibits carrying
over or creation of valuation allowances in the initial accounting of
all loans acquired in a transfer that are within the scope of this SOP.
The prohibition of the valuation allowance carryover applies to the
purchase of an individual loan, a group of loans, and loans acquired in a
purchase business combination. This SOP is effective for loans acquired
in fiscal years beginning after December 15, 2004. Management believes
that the adoption of this statement will not have a material effect on
Doral Financials Consolidated Financial Statements.Loan Commitments Accounted for as Derivative Instruments.In March 2004,
the U.S. Securities and Exchange Commission released the Staff Accounting
Bulletin (SAB) No. 105, Loan Commitments Accounted for as Derivative
Instruments. This bulletin informs registrants of the staffs view that
the fair value of the recorded loan commitments should not consider the
expected future cash flows related to the associated servicing of the
future loan. The provisions of SAB 105 must be applied to loan
commitments accounted for as derivatives that are entered into after
March 31, 2004. The staff will not object to the application of existing
accounting practices to loan commitments accounted for as derivatives
that are entered into on or before March 31, 2004, with appropriate
disclosures. On April 1, 2004, the Company adopted the provisions of SAB
105. Doral Financial records the value of its mortgage loan commitments
at fair market value for mortgages it intends to sell. Doral Financial
does not currently include and prior to SAB 105 did not include, the
value of mortgage servicing or any other internally developed intangible
assets in the valuation of its mortgage loan commitments. Therefore, the
adoption of SAB 105 did not have an impact on Doral Financials financial
condition or results of operations.The Meaning of Other-Than-Temporary Impairment and Its Application to
Certain Investments.In March 2004, the Emerging Issues Task Force
(EITF) reached a consensus on the application on Issue 03-1, The
Meaning of Other-Than-Temporary Impairment and Its Application to Certain
Investments. The EITF reached a consensus on the impairment model to be
used to determine when an investment is considered impaired, whether that
impairment is other than temporary, and the measurement of an impairment
loss. The impairment model also includes accounting considerations
subsequent to the recognition of an other-than-temporary impairment and
requires certain disclosures about unrealized losses that have not been
recognized as other-than-temporary impairments. This impairment model is
applicable for investments in debt and equity securities that are within
the scope of Statement of Financial Accounting Standards No. 115 (SFAS
115), Accounting for Certain Investments in Debt and Equity Securities
and equity securities that are not subject to the scope of SFAS 115 and
not accounted for under the equity method under APB Opinion No. 18, The
Equity Method of Accounting for Investments in Common Stock referred in
Issue 03-1 as the cost method investments. The impairment model developed
by the EITF to determine whether an investment is within the scope of
Issue 03-1 involves a sequence of steps including the following:
Step 1-determine whether an investment is impaired. If an impairment indicator
is present, as determined in Step 1, the investor should estimate the
fair value of the 23




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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)  investment. If the fair value of the investment is less than its cost,
proceed with Step 2 -evaluate whether an impairment is other than
temporary. Step 3 - if the impairment is other than temporary, recognize
an impairment loss equal to the difference between the investments cost
and its fair value. The impairment model described above used to
determine other-than-temporary impairment should be applied to
other-than-temporary impairment evaluations in reporting periods
beginning after June 15, 2004. The adoption of Issue 03-1 will not have a
material effect on Doral Financials Consolidated Financial Statements. 24




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ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS OVERVIEW Doral Financial Corporation is a financial holding company that, together
with its wholly-owned subsidiaries, is engaged in mortgage banking, commercial
banking (including thrift operations), institutional securities operations and
insurance agency activities. Doral Financials mortgage banking activities
(its mortgage banking business), include the origination, purchase, sale and
servicing of mortgage loans on single-family residences, the issuance and sale
of various types of mortgage-backed securities, the holding of mortgage loans,
mortgage-backed securities and other investment securities for sale or
investment, the purchase and sale of servicing rights associated with such
mortgage loans and the origination of construction loans and mortgage loans
secured by income producing real estate and land. Doral
Financial is currently in its 32nd year of operations. Doral
Financial once again achieved record earnings for the second quarter of 2004
with net income and net income per diluted share increasing by 53% and 50%,
respectively, compared to the second quarter of 2003. The results for the
quarter and six months ended June 30, 2004 reflect the continued strength of
the Puerto Rico mortgage market, which did not experience the slowdown
experienced by the U.S. mortgage market since the second half of 2003. Doral
Financial continues to be Puerto Ricos largest residential mortgage lender.
The volume of loans originated and purchased by Doral Financial during the
quarters ended June 30, 2004 and 2003 was approximately $1.9 billion and $1.6
billion, respectively. The loan production volume for the second quarter of
2004 was higher than the first quarter of 2004 notwithstanding an average
increase in U.S. mortgage interest rates of approximately 75 basis points
(3/4%) from quarter to quarter and approximately 100 basis points (1%) from a
year ago. Doral Financials loan servicing portfolio increased to approximately
$13.5 billion as of June 30, 2004, from $12.0 billion as of June 30, 2003.
Doral Financials strategy is to increase the size of its mortgage servicing
portfolio by relying principally on internal loan originations and
supplementing such internal loan originations by purchases of mortgage loans on
a servicing released basis. While Doral Financial continues to diversify its sources of revenues, net
gains from mortgage loan sales and fees, recorded at both its mortgage banking
and banking units, continue to be its principal source of revenues. For the
quarter ended June 30, 2004, the Companys net gain on mortgage loan sales and
fees was $130.6 million compared to $98.1 million for the second quarter of
2003, an increase of approximately 33%. For the first half of 2004, net gain
on mortgage loan sales and fees was $267.4 million compared to $175.4 million
for the corresponding period a year ago. Net gain on mortgage loan sales and
fees constituted approximately 53% of Doral Financials total revenues for the
first half of 2004 and was driven by strong demand for mortgages from federal
government-sponsored secondary mortgage entities and local financial
institutions looking to increase their investment in residential mortgage
loans. The increase in mortgage loan sales and fees also reflects the positive
impact of the retained IOs in connection with the sale of non-conforming loan
pools to local financial institutions. During the second quarter and first
half of 2004, the Company retained $111.2 million and $224.7 million,
respectively, of IOs in connection with loan sales compared to $64.3 million
and $116.1 million for the second quarter and first half of 2003, respectively. Net interest income is Doral Financials second most significant source of
revenues. Net interest income is the excess of interest earned by the Company
on its interest-earning assets over the interest incurred on its
interest-bearing liabilities. Net interest income increased by 67% during the
second quarter of 2004 compared to the same period for 2003. For the first
half of 2004, net interest income increased by 55% compared to the first six
months of 2003. The increase was driven by an increase in the amount of the
Companys average interest-earning assets, which increased by 46% and 35%
compared to the second quarter and first half of 2003, respectively. Doral Financial also earns revenues from the sale of securities in which
it invests. For the second quarter of 2004, the net loss on sale of securities
classified as available for sale amounted to $17.5 million compared to a gain
of $7.0 million for the second quarter of 2003. Net loss on sale of
securities classified as available for sale for the first six months of 2004
amounted to $1.3 million compared to a gain of $14.1 million for the first half
of 2003. During the second quarter of 2004, the Company restructured a portion
of its investment portfolio by selling lower yielding securities and replacing
these with higher yielding instruments. Doral Financials trading activities,
which include realized and unrealized gains or losses on its securities held
for trading and options, futures contracts and other derivatives used for
interest rate management purposes, resulted in a gain of $6.0 million for the
second quarter of 2004 and a loss of $42.6 million for the first six months of
2004 (including pre-tax losses of $2.4 million representing the ineffective
portion of fair value hedges of certain available for sale securities),
compared to losses of approximately $5.0 million and $50,000 for the second
quarter and first half of 2003, respectively. The gain on trading activities
experienced during the second quarter of 2004 was principally due to rising
long-term interest rates that resulted in gains on the Companys derivatives
activities undertaken for risk management purposes. Doral Financials interest
rate management was directed principally to protect the Company from large
sudden increases in interest rates. Rising long-term interest rates resulted
in unrealized losses on the securities available for sale portfolio, an
increase of $51.7 million compared to December 31, 2003, reflected in
Accumulated other comprehensive loss, net of income tax, in Doral Financials
consolidated financial statements. The net loss in investment activities
during 2004 was offset by higher gains on mortgage loan sales and fees, net
interest income and other sources of revenues. 25




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Net servicing loss for the second quarter of 2004 was approximately $2.3
million compared to a loss of $8.4 million for the second quarter of 2003. For
the first six months of 2004, net servicing loss amounted to approximately
$656,000 compared to a loss of $12.5 million for the first half of 2003. The
decrease in the net servicing loss for the quarter and six month period ended
June 30, 2004 was due to reduced amortization and impairment charges resulting
from lower prepayments. The Company recorded amortization and impairment
charges of $12.6 million during the quarter ended June 30, 2004, compared to
$17.1 million for the same period a year ago. For the first six months of 2004
net impairment charges amounted to $20.4 million, compared to $29.8 million for
the first half of 2003. Doral Financials strong capital base will also allow it to continue to
increase its interest-earning assets during 2004 and continue to grow its net
interest income. Doral Financial has taken steps to lock in a portion of its
borrowing costs at current low levels to help ensure a profitable interest rate
spread. In fact, as of June 30, 2004, Doral Financials internal rate models
reflect that an increase in rates of up to 200 basis points would have a
positive impact on its net interest income. Doral Financial also has adequate sources of liquidity to fund its
operations. Doral Financials historical results of operations and investment
grade ratings allow it to access capital markets and diversify its sources of
borrowings. During the second quarter of 2004, the Company closed the sale of
$115.0 million of its Floating Rate Senior Notes due 2005. The notes were sold
at par, resulting in proceeds to Doral Financial, after selling commissions but
before expenses of approximately $114.9 million. On July 20, 2004 the Company
sold $350.0 million in Floating Rate Senior Notes due July 20, 2007. The notes
also sold at par, produced net proceeds to Doral Financial, after selling

commissions but before expenses of approximately $349.3 million. Doral Financials banking subsidiaries also have the ability to raise
funds quickly and efficiently through retail deposits, brokered deposits and
advances from the Federal Home Loan Bank of New York. Doral Financials strong
capital position and liquidity also gave it the flexibility to invest
substantial amounts in derivative instruments in order to protect the Companys
revenues and assets from sudden large, unanticipated increases in interest
rates. CRITICAL ACCOUNTING POLICIES The preparation of financial statements in accordance with accounting
principles generally accepted in the United States of America requires
management to make a number of judgements, estimates and assumptions that
affect the reported amount of assets, liabilities, income and expenses in the
Companys Consolidated Financial Statements and accompanying notes. The
Company believes that the judgments, estimates and assumptions used in the
preparation of its Consolidated Financial Statements are appropriate given the
factual circumstances as of June 30, 2004. However, given the sensitivity of
Doral Financials Consolidated Financial Statements to these estimates, the use
of other judgments, estimates and assumptions could result in material
differences in the Companys results of operations or financial condition. Various elements of Doral Financials accounting policies, by their
nature, are inherently subject to estimation techniques, valuation assumptions
and other subjective assessments. For a discussion regarding Doral Financials
critical accounting policies, particularly for those relating to its mortgage
securitization and sales activities and the ongoing valuation of retained
interests, particularly mortgage servicing rights and IOs, that arise from
those activities and are critical to an understanding of the Companys
Consolidated Financial Statements, please refer to the Managements Discussion
and Analysis of Financial Condition and Results of Operations section of Doral
Financials Annual Report on Form 10-K for the year ended December 31, 2003. RESULTS OF OPERATIONS FOR THE QUARTERS AND SIX MONTHS ENDED JUNE 30, 2004 AND
2003 Doral Financials results of operations have historically been influenced
primarily by the level of demand for mortgage loans, which is affected by
external factors such as prevailing mortgage interest rates and the strength of
the Puerto Rico housing market. Changes in interest rates also significantly
influence Doral Financials results of operations by affecting the difference
between the rates it earns on its interest-earning assets and the rates it pays
on its interest-bearing liabilities, as well as impacting the gains and losses
it obtains from its mortgage loan sales and trading activities. The components of Doral Financials revenues are: (1) net interest income;
(2) net gain on mortgage loan sales and fees; (3) servicing income; (4)
investment activities; and (5) commissions, fees and other income. NET INCOME Doral Financials net income for the quarter ended June 30, 2004 was
$114.9 million, an increase of $39.9 million, or 53%, from $75.0 million for
the comparable 2003 period. For the first half of 2004 and 2003, the Companys
net income amounted $218.5 million and $145.0 million, respectively, an
increase of 51%. Consolidated results include the operations of Doral Bank PR
and Doral Bank NY, Doral Financials commercial banking units, which
contributed $99.4 million ($104.9 million after intersegment eliminations) to
Doral Financials consolidated net income for the six months ended June 30,
2004, compared to $78.7 million ($80.8 million after intersegment eliminations)
for the respective 2003 period. Refer to note f of the accompanying
Consolidated Financial Statements for additional 26




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information regarding the composition of intersegment eliminations. The
contribution of the banking sector includes the investment activities of Doral
International, Doral Bank PRs wholly-owned international banking subsidiary.
Interest income and capital gains derived from U.S securities are generally
tax-exempt to Doral International under Puerto Rico law. Doral Securities,
Doral Financials institutional securities unit, contributed $2.4 million to
consolidated net income for the six months ended June 30, 2004, compared to
$3.0 million for the respective 2003 period. Doral Agency, Doral Financials
insurance agency, contributed $5.4 million to consolidated net income for the
six months ended June 30, 2004 compared to $2.8 million for the respective 2003
period. Diluted earnings per common share for the second quarter of 2004 were
$0.96, an increase of 50% over the $0.64 per diluted share recorded for the
same period a year ago. Diluted earnings per common share for the six months
ended June 30, 2004 were $1.82, an increase of 47% over the $1.24 per diluted
share recorded for the same period a year ago. NET INTEREST INCOME Net interest income is the excess of interest earned by Doral Financial on
its interest-earning assets over the interest incurred on its interest-bearing
liabilities. Net interest income for the second quarter of 2004 and 2003 was $66.6
million and $39.9 million, respectively, an increase of 67%. For the first
half of 2004 and 2003 net interest income amounted to $125.7 million and $81.2
million, respectively, an increase of 55%. The increase in net interest income
for the second quarter and first half of 2004, compared to the respective 2003
periods, was due to an increase in Doral Financials average balance of net
interest-earning assets, particularly in its investment securities,
mortgage-backed securities and IOs, as well as an increase in the Companys net
interest spread and margin for the period. Average interest-earning assets
grew by 46% from the second quarter of 2003 to the second quarter of 2004 and
by 35% from the six months ended June 30, 2003 to the six months ended June 30,
2004. Doral Financials net interest spread and margin for the second quarter
of 2004 were 1.91% and 2.26%, compared to 1.70% and 1.98% for the second
quarter of 2003. Net interest spread and margin for the first half of 2004
were 1.94% and 2.33%, compared to 1.74% and 2.04% for the first half of 2003. The increase in net interest rate spread and margin during the second
quarter and first half of 2004 was due primarily to the widening of the yield
curve or the tendency of short-term rates paid by Doral Financial on its
borrowings to decline more in relative terms than the rates earned by Doral
Financial on its loans and securities. The average rate paid by Doral
Financial on its interest-bearing liabilities decreased by 93 basis points and
79 basis points during the second quarter and first half of 2004, respectively,
while the average yield earned on its interest-earning assets decreased by only
72 basis points and 59 basis points during the second quarter and first half of
2004, respectively, compared to the same periods of 2003. The Companys commercial banking subsidiaries contributed $43.6 million
($46.4 million after intersegment eliminations) to the consolidated net
interest income for the second quarter of 2004, compared to $25.3 million
($27.0 million after intersegment eliminations) for the second quarter of 2003.
During the first half of 2004, the Companys commercial banking subsidiaries
contributed approximately $76.9 million ($84.5 million after intersegment
eliminations) to the consolidated net interest income, compared to $52.1
million ($55.8 million after intersegment eliminations) for the first half of
2003. Refer to note f of the accompanying Consolidated Financial Statements
for additional information regarding the composition of intersegment
eliminations. The following tables present, for the periods indicated, Doral Financials
average balance sheet, the total dollar amount of interest income from its
average interest-earning assets and the related yields, as well as the interest
expense on its average interest-bearing liabilities expressed in both dollars
and rates, and the net interest margin and spread. The table does not reflect
any effect of income taxes. Average balances are based on the average daily
balances. 27




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TABLE AAVERAGE BALANCE SHEET AND SUMMARY OF NET INTEREST INCOME(DOLLARS IN THOUSANDS) QUARTER ENDED JUNE 30,2004
    
    2003AVERAGE
    
    
    
    
    
    AVERAGE
    
    AVERAGE
    
    
    
    
    
    AVERAGEBALANCE
    
    INTEREST
    
    YIELD/RATE
    
    BALANCE
    
    INTEREST
    
    YIELD/RATEASSETS:Interest-earning assets:Total loans(1)(2)
    
    $
    3,443,616
    
    
    $
    56,743
    
    
    
    6.61
    %
    
    $
    3,207,288
    
    
    $
    54,291
    
    
    
    6.79
    %Mortgage-backed securities
    
    
    1,452,317
    
    
    
    16,852
    
    
    
    4.65
    %
    
    
    1,158,390
    
    
    
    18,532
    
    
    
    6.42
    %Interest-only strips
    
    
    724,618
    
    
    
    14,406
    
    
    
    7.97
    %
    
    
    426,666
    
    
    
    8,944
    
    
    
    8.41
    %Investment securities
    
    
    4,473,638
    
    
    
    45,225
    
    
    
    4.05
    %
    
    
    1,818,362
    
    
    
    23,375
    
    
    
    5.16
    %Money market investments
    
    
    1,712,457
    
    
    
    4,711
    
    
    
    1.10
    %
    
    
    1,484,391
    
    
    
    4,062
    
    
    
    1.10
    %Total interest-earning assets/interest income
    
    
    11,806,646
    
    
    $
    137,937
    
    
    
    4.69
    %
    
    
    8,095,097
    
    
    $
    109,204
    
    
    
    5.41
    %Total non-interest-earning assets
    
    
    568,993
    
    
    
    
    
    
    
    
    
    
    
    781,058Total assets
    
    $
    12,375,639
    
    
    
    
    
    
    
    
    
    
    $
    8,876,155LIABILITIES AND STOCKHOLDERS EQUITY:Interest-bearing liabilities:Deposits
    
    $
    3,188,682
    
    
    $
    19,499
    
    
    
    2.45
    %
    
    $
    2,570,179
    
    
    $
    18,994
    
    
    
    2.96
    %Repurchase agreements
    
    
    4,906,775
    
    
    
    25,412
    
    
    
    2.08
    %
    
    
    2,705,803
    
    
    
    23,005
    
    
    
    3.41
    %Advances from FHLB
    
    
    1,277,467
    
    
    
    12,358
    
    
    
    3.88
    %
    
    
    1,256,500
    
    
    
    12,321
    
    
    
    3.93
    %Loans payable
    
    
    287,247
    
    
    
    1,723
    
    
    
    2.41
    %
    
    
    300,280
    
    
    
    1,930
    
    
    
    2.58
    %Notes payable
    
    
    628,298
    
    
    
    12,299
    
    
    
    7.85
    %
    
    
    649,553
    
    
    
    13,048
    
    
    
    8.06
    %Total interest-bearing liabilities/interest expense
    
    
    10,288,469
    
    
    $
    71,291
    
    
    
    2.78
    %
    
    
    7,482,315
    
    
    $
    69,298
    
    
    
    3.71
    %Total non-interest-bearing liabilities
    
    
    354,168
    
    
    
    
    
    
    
    
    
    
    
    269,079Total liabilities
    
    
    10,642,637
    
    
    
    
    
    
    
    
    
    
    
    7,751,394Stockholders equity
    
    
    1,733,002
    
    
    
    
    
    
    
    
    
    
    
    1,124,761Total liabilities and stockholders equity
    
    $
    12,375,639
    
    
    
    
    
    
    
    
    
    
    $
    8,876,155Net interest-earning assets
    
    $
    1,518,177
    
    
    
    
    
    
    
    
    
    
    $
    612,782Net interest income on a non-taxable equivalent basis
    
    
    
    
    
    $
    66,646
    
    
    
    
    
    
    
    
    
    
    $
    39,906Interest rate spread(3)
    
    
    
    
    
    
    
    
    
    
    1.91
    %
    
    
    
    
    
    
    
    
    
    
    1.70
    %Interest rate margin(4)
    
    
    
    
    
    
    
    
    
    
    2.26
    %
    
    
    
    
    
    
    
    
    
    
    1.98
    %Net interest-earning assets ratio
    
    
    
    
    
    
    
    
    
    
    114.76
    %
    
    
    
    
    
    
    
    
    
    
    108.19
    %
 (1)
    
    Average loan balances include the average balance of non-accruing loans, on which interest income is recognized when collected.(2)
    
    For the second quarter of 2004 interest income on loans includes a yield adjustment of $1.0 million related to deferred fees on a construction loan repaid prior to maturity.(3)
    
    Interest rate spread represents the difference between Doral Financials weighted
average yield on interest-earning assets and the weighted average rate on interest-bearing liabilities.(4)
    
    Interest rate margin represents net interest income on an annualized basis as a percentage of average interest-earning assets.
   28




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TABLE BAVERAGE BALANCE SHEET AND SUMMARY OF NET INTEREST INCOME(DOLLARS IN THOUSANDS) SIX MONTH PERIOD ENDED JUNE 30,2004
    
    2003AVERAGE
    
    
    
    
    
    AVERAGE
    
    AVERAGE
    
    
    
    
    
    AVERAGEBALANCE
    
    INTEREST
    
    YIELD/RATE
    
    BALANCE
    
    INTEREST
    
    YIELD/RATEASSETS:Interest-earning assets:Total loans(1)(2)
    
    $
    3,408,708
    
    
    $
    116,879
    
    
    
    6.88
    %
    
    $
    3,243,164
    
    
    $
    109,331
    
    
    
    6.80
    %Mortgage-backed securities
    
    
    1,430,085
    
    
    
    34,322
    
    
    
    4.81
    %
    
    
    1,187,121
    
    
    
    36,057
    
    
    
    6.13
    %Interest-only strips
    
    
    668,526
    
    
    
    26,790
    
    
    
    8.04
    %
    
    
    403,680
    
    
    
    19,800
    
    
    
    9.89
    %Investment securities
    
    
    3,707,280
    
    
    
    77,817
    
    
    
    4.21
    %
    
    
    1,725,338
    
    
    
    45,435
    
    
    
    5.31
    %Money market investments
    
    
    1,600,725
    
    
    
    8,228
    
    
    
    1.03
    %
    
    
    1,478,346
    
    
    
    8,191
    
    
    
    1.12
    %Total interest-earning assets/interest income
    
    
    10,815,324
    
    
    $
    264,036
    
    
    
    4.90
    %
    
    
    8,037,649
    
    
    $
    218,814
    
    
    
    5.49
    %Total non-interest-earning assets
    
    
    650,606
    
    
    
    
    
    
    
    
    
    
    
    722,828Total assets
    
    $
    11,465,930
    
    
    
    
    
    
    
    
    
    
    $
    8,760,477LIABILITIES AND STOCKHOLDERS EQUITY:Interest-bearing liabilities:Deposits
    
    $
    3,148,900
    
    
    $
    38,481
    
    
    
    2.45
    %
    
    $
    2,463,906
    
    
    $
    37,060
    
    
    
    3.03
    %Repurchase agreements
    
    
    4,106,041
    
    
    
    48,084
    
    
    
    2.35
    %
    
    
    2,787,769
    
    
    
    46,942
    
    
    
    3.40
    %Advances from FHLB
    
    
    1,239,808
    
    
    
    24,144
    
    
    
    3.91
    %
    
    
    1,262,798
    
    
    
    24,695
    
    
    
    3.94
    %Loans payable
    
    
    259,022
    
    
    
    3,128
    
    
    
    2.42
    %
    
    
    259,812
    
    
    
    3,381
    
    
    
    2.62
    %Notes payable
    
    
    614,938
    
    
    
    24,500
    
    
    
    7.99
    %
    
    
    635,030
    
    
    
    25,553
    
    
    
    8.11
    %Total interest-bearing liabilities/interest expense
    
    
    9,368,709
    
    
    $
    138,337
    
    
    
    2.96
    %
    
    
    7,409,315
    
    
    $
    137,631
    
    
    
    3.75
    %Total non-interest-bearing liabilities
    
    
    408,304
    
    
    
    
    
    
    
    
    
    
    
    255,381Total liabilities
    
    
    9,777,013
    
    
    
    
    
    
    
    
    
    
    
    7,664,696Stockholders equity
    
    
    1,688,917
    
    
    
    
    
    
    
    
    
    
    
    1,095,781Total liabilities and stockholders equity
    
    $
    11,465,930
    
    
    
    
    
    
    
    
    
    
    $
    8,760,477Net interest-earning assets
    
    $
    1,446,615
    
    
    
    
    
    
    
    
    
    
    $
    628,334Net interest income on a non-taxable equivalent basis
    
    
    
    
    
    $
    125,699
    
    
    
    
    
    
    
    
    
    
    $
    81,183Interest rate spread(3)
    
    
    
    
    
    
    
    
    
    
    1.94
    %
    
    
    
    
    
    
    
    
    
    
    1.74
    %Interest rate margin(4)
    
    
    
    
    
    
    
    
    
    
    2.33
    %
    
    
    
    
    
    
    
    
    
    
    2.04
    %Net interest-earning assets ratio
    
    
    
    
    
    
    
    
    
    
    115.44
    %
    
    
    
    
    
    
    
    
    
    
    108.48
    %
 (1)
    
    Average loan balances include the average balance of non-accruing loans, on which interest income is recognized when collected.(2)
    
    For the first half of 2004 interest income on loans includes a yield adjustment of $5.7 million related to deferred fees on construction loans repaid prior to maturity.(3)
    
    Interest rate spread represents the difference between Doral Financials weighted average yield on interest-earning assets and the weighted average rate on interest-bearing liabilities.(4)
    
    Interest rate margin represents net interest income on an annualized basis as a percentage of average interest-earning assets.
   29




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##### Table of Contents



The following tables describe the extent to which changes in interest
rates and changes in volume of interest-earning assets and interest-bearing
liabilities have affected Doral Financials interest income and interest
expense during the periods indicated. For each category of interest-earning
assets and interest-bearing liabilities, information is provided on changes
attributable to: (i) changes in volume (change in volume multiplied by prior
year rate), (ii) changes in rate (change in rate multiplied by current year
volume), and (iii) total change in rate and volume. The combined effect of
changes in both rate and volume has been allocated in proportion to the
absolute dollar amounts of the changes due to rate and volume. TABLE CNET INTEREST INCOME VARIANCE ANALYSIS(IN THOUSANDS) QUARTER ENDEDJUNE 30,2004 COMPARED TO 2003INCREASE (DECREASE) DUE TO:VOLUME
    
    RATE
    
    TOTALINTEREST INCOME VARIANCETotal loans
    
    $
    4,012
    
    
    $
    (1,560
    )
    
    $
    2,452Mortgage-backed securities
    
    
    4,718
    
    
    
    (6,398
    )
    
    
    (1,680
    )Interest-only strips
    
    
    6,264
    
    
    
    (802
    )
    
    
    5,462Investment securities
    
    
    34,253
    
    
    
    (12,403
    )
    
    
    21,850Money market investments
    
    
    627
    
    
    
    22
    
    
    
    649TOTAL INTEREST INCOME VARIANCE
    
    
    49,874
    
    
    
    (21,141
    )
    
    
    28,733INTEREST EXPENSE VARIANCEDeposits
    
    
    4,577
    
    
    
    (4,072
    )
    
    
    505Repurchase agreements
    
    
    18,763
    
    
    
    (16,356
    )
    
    
    2,407Advances From FHLB
    
    
    206
    
    
    
    (169
    )
    
    
    37Loans payable
    
    
    (84
    )
    
    
    (123
    )
    
    
    (207
    )Notes payable
    
    
    (428
    )
    
    
    (321
    )
    
    
    (749
    )TOTAL INTEREST EXPENSE VARIANCE
    
    
    23,034
    
    
    
    (21,041
    )
    
    
    1,993NET INTEREST INCOME VARIANCE
    
    $
    26,840
    
    
    $
    (100
    )
    
    $
    26,740
 30




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##### Table of Contents



TABLE DNET INTEREST INCOME VARIANCE ANALYSIS(IN THOUSANDS) SIX MONTH PERIOD ENDEDJUNE 30,2004 COMPARED TO 2003INCREASE (DECREASE) DUE TO:VOLUME
    
    RATE
    
    TOTALINTEREST INCOME VARIANCETotal loans
    
    $
    5,629
    
    
    $
    1,919
    
    
    $
    7,548Mortgage-backed securities
    
    
    7,447
    
    
    
    (9,182
    )
    
    
    (1,735
    )Interest-only strips
    
    
    13,097
    
    
    
    (6,107
    )
    
    
    6,990Investment securities
    
    
    52,621
    
    
    
    (20,239
    )
    
    
    32,382Money market investments
    
    
    685
    
    
    
    (648
    )
    
    
    37TOTAL INTEREST INCOME VARIANCE
    
    
    79,479
    
    
    
    (34,257
    )
    
    
    45,222INTEREST EXPENSE VARIANCEDeposits
    
    
    10,378
    
    
    
    (8,957
    )
    
    
    1,421Repurchase agreements
    
    
    22,411
    
    
    
    (21,269
    )
    
    
    1,142Advances From FHLB
    
    
    (453
    )
    
    
    (98
    )
    
    
    (551
    )Loans payable
    
    
    (10
    )
    
    
    (243
    )
    
    
    (253
    )Notes payable
    
    
    (815
    )
    
    
    (238
    )
    
    
    (1,053
    )TOTAL INTEREST EXPENSE VARIANCE
    
    
    31,511
    
    
    
    (30,805
    )
    
    
    706NET INTEREST INCOME VARIANCE
    
    $
    47,968
    
    
    $
    (3,452
    )
    
    $
    44,516
 INTEREST INCOME Total interest income increased from $109.2 million during the second
quarter of 2003, to $137.9 million during the second quarter of 2004, an
increase of 26%. For the six months ended June 30, 2004 interest income
increased by approximately $45.2 million to $264.0 million compared to $218.8
million for the first six months of 2003. The increases in interest income
during both periods are primarily related to the increase in Doral Financials
total average balance of interest-earning assets, which increased from $8.0
billion at June 30, 2003 to $10.8 billion at June 30, 2004. Interest income on loans increased by approximately $2.5 million or 5%
during the second quarter of 2004, compared to the respective 2003 period. For
the first half of 2004, interest income on loans increased by $7.5 million or
7% as compared to the respective 2003 period. The increases during 2004
reflect an increase in the level of loans held by Doral Financial compared to
2003, due to the increased volume of loan originations and purchases. Also,
during the first half of 2004, the Company recognized a yield adjustment of
$5.7 million related to deferred fees on construction loans with an aggregate
outstanding balance of $62.9 million that were repaid prior to
their stated maturity. Interest income on mortgage-backed securities for the second quarter of
2004 decreased by approximately $1.7 million compared to the respective 2003
period. During the first half of 2004, interest income on mortgage-backed
securities was $34.3 million versus $36.1 million for the comparable 2003
period. The results for the 2004 periods reflect increased amortization of
premiums on mortgage-backed securities, particularly U.S GNMAs, due to higher
prepayments compared to the same periods of 2003, offset in part, by an
increase in the average balance of mortgage-backed securities, which increased
from $1.2 billion for the second quarter of 2003 to $1.5 billion for the
comparable 2004 period. For the first half of 2004 the average balance of
mortgage-backed securities was $1.4 billion compared to $1.2 billion for the
first six months of 2003. The increases in the average balance of
mortgage-backed securities reflect the Companys strategy to continue to
maximize tax-exempt interest income by holding a significant amount of
tax-exempt Puerto Rico GNMA securities and, in the case of its international
banking subsidiary, U.S. FHLMC/FNMA mortgage-backed securities. The interest
earned on such U.S. mortgage-backed securities is tax-exempt to Doral
Financials international banking entity under Puerto Rico law and is not
subject to U.S. income taxation because such entity is considered a foreign
corporation for U.S. income tax purposes and is entitled to the portfolio
interest deduction with respect to interest earned on those securities. Interest income on IOs increased by approximately $5.5 million to $14.4
million during the second quarter of 2004, from $8.9 million for the respective
2003 period. For the first half of 2004, interest income of IOs increased by 31




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$7.0 million or 35%, as compared to the respective 2003 period. The
increases during 2004 when compared to the respective 2003 periods resulted
from an increase in the average balance of IOs, which increased from $426.7
million during the second quarter of 2003 to $724.6 million during the second
quarter of 2004 and from $403.7 million for the first half of 2003 to $668.5
million for the first six months of 2004. The increase in IOs resulted from a
higher volume of sale and securitization activities. The actual cash flow
received on the Companys portfolio of IOs, particularly its floating rate IOs,
increased to $39.7 million for the second quarter of 2004, compared to $28.2
million for the second quarter of 2003 and from $53.6 million for the first
half of 2003 to $75.1 million for the first six months of 2004. Under floating
rate IOs, the purchaser of a mortgage pool is entitled to a pass-through rate
based on a floating rate tied to short-term LIBOR rates. The Company is
entitled to retain the difference between the floating rate paid to the
investor and the actual amount of interest received from the underlying
fixed-rate mortgage loans. As short-term interest rates increase, the
spread received on the Companys retained interest decreases and
negatively affects the value of the IOs. This is offset, to some extent, by a
reduction of prepayments and the extension of the assets maturity. Conversely, as
short-term interest rates decrease the spread received on the IOs
increases at the same time causing accelerated prepayments that
shorten the life of the asset. See
Amortization and Impairment of Servicing Assets and Valuation of IOs. Interest income on investment securities increased by $21.9 million or
93%, from the second quarter of 2003 to the second quarter of 2004. For the
first half of 2004, interest income on investment securities increased by $32.4
million or 71%, as compared to the respective 2003 period. The increase in
interest income on investment securities during the second quarter and first
half of 2004 reflects Doral Financials strategy to increase its tax-exempt
interest income by investing in U.S. Treasury and agency securities, the
interest on which is tax-exempt to the Company under Puerto Rico law and is not
subject to U.S. income taxation because of Doral Financials status as a
foreign corporation for U.S. income tax purposes. The average balance of
investment securities increased from $1.8 billion for the second quarter of
2003 to $4.5 billion for the second quarter of 2004 and from $1.7 billion for
the first half of 2003 to $3.7 billion for the comparative 2004 period. The
Companys higher balances in investment securities was partially offset by a
reduction in the average yield of 111 basis points for the second quarter of
2004 compared to the corresponding 2003 period and of 110 basis points for the
first half of 2004 compared to the first six months of 2003. This reduction
reflects an investment portfolio mostly composed of lower yielding securities,
although at the end of the second quarter of 2004 the Company restructured its
investment portfolio by selling lower yielding securities that resulted in a
loss on sale of investment securities of $17.5 million which were replaced by
higher yielding instruments. Interest income on money market investments increased by approximately
$649,000 from the second quarter of 2003 to the second quarter of 2004 and by
approximately $37,000 from the first six months of 2003 to the corresponding
2004 period. Money market investments consist of fixed income securities whose
original maturity is less than three months including overnight deposits, term
deposits, and reverse repurchase agreements. The increase for the 2004 periods
reflects a significant amount of money market instruments held by Doral
Financial in anticipation of rising interest rates, partly offset by lower
short-term interest rates. The average balance of money market investments
increased from $1.5 billion for the second quarter of 2003 to $1.7 billion for
the second quarter of 2004 and from $1.5 billion for the first half of 2003 to
$1.6 billion for the comparative 2004 period. The average yield on money
market investments declined by 9 basis points from 1.12% for the first half of
2003 to 1.03% for the first six months of 2004. INTEREST EXPENSE Total interest expense increased to $71.3 million during the second
quarter of 2004, from $69.3 million for the respective 2003 period, an increase
of 3%. Total interest expense for the first half of 2004 was $138.3 million,
compared to $137.6 million for the same period of 2003, an increase of 1%. The
increase in interest expense for the 2004 periods was due to an increased
volume of borrowings to finance Doral Financials loan production and
investment activities that was partly offset by a decrease in the average cost
of borrowings due to the low level interest rate environment. The average
balance of interest-bearing liabilities increased to $9.4 billion at an average
cost of 2.96% for the six month period ended June 30, 2004, compared to $7.4
billion at an average cost of 3.75% for the six month period ended June 30,
2003. Interest expense on deposits amounted to $19.5 million during the second
quarter of 2004, an increase of 3% as compared to the respective 2003 period.
For the first half of 2004, interest expense on deposits increased by $1.4
million or 4%, as compared to the respective 2003 period. The increase in
interest expense on deposits reflects a larger deposit base held at Doral
Financials banking subsidiaries that was partly offset by a decrease in the
average cost of borrowings. The average balance of deposits increased to $3.1
billion for the six month period ended June 30, 2004, from $2.5 billion for the
six month period ended June 30, 2003. The increase in deposits reflects the
expansion of Doral Financials bank branch network, which increased to 44
branches as of June 30, 2004, compared to 39 branches as of June 30, 2003. The
average interest cost on deposits was 2.45% for both the quarter and six month
period ended June 30, 2004, compared to 2.96% and 3.03% for the respective 2003
periods. Interest expense related to securities sold under agreements to repurchase
increased by $2.4 million or 10% during the second quarter of 2004 compared to
the same period of 2003. For the first half of 2004, interest expense on
securities sold under agreements to repurchase was $48.1 million, compared to
$46.9 million for the same period of 2003, an increase of 2%. The increase in
interest expense on securities sold under agreements to repurchase during the
2004 periods reflects increased borrowings to finance mortgage-backed
securities and other investment securities, as compared to the respective 2003
periods that more than offset lower borrowing costs experienced during 2004.
The 32




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average balance of borrowings under repurchase agreements for the second
quarter and first half of 2004 was $4.9 billion and $4.1 billion, respectively,
compared to $2.7 billion and $2.8 billion for the respective 2003 periods. The
average cost on securities sold under agreements to repurchase was 2.08% and
2.35% for the quarter and six month period ended June 30, 2004, compared to
3.41% and 3.40%, for the respective 2003 periods. Interest expense on advances from the FHLB increased by approximately
$37,000 for the second quarter of 2004 as compared to the respective 2003
period. For the first half of 2004, interest expense on advances from FHLB
decreased by 2% to $24.1 million from $24.7 million for the respective 2003
period. The increase in interest expense on advances from the FHLB during the
second quarter of 2004 reflects a slight increase in the average balance of
advances from the FHLB. For the second quarter of 2004, the average balance of
advances from FHLB increased by $21.0 million or 2%, compared to the respective
2003 period. This slight increase was partly offset by a decrease in the
average cost of advances from the FHLB from 3.93% for the quarter ended June
30, 2003, to 3.88% for the quarter ended June 30, 2004. The decrease in
interest expense on advances from the FHLB during the first half of 2004
reflects a slight decrease in the average balance of advances from the FHLB,
particularly during the first quarter of 2004. The average balance of advances
from FHLB decreased to $1.2 billion at an average cost of 3.91% for the six months ended June 30, 2004, compared to $1.3 billion at an average cost of
3.94% for the first half of 2003. Increased deposits replaced the decrease in
advances from the FHLB. Interest expense related to loans payable amounted to $1.7 million for the
second quarter of 2004, compared to $1.9 million for the comparative 2003
period. For the first half of 2004 interest expense related to loans payable
was $3.1 million, a decrease of 7% compared to$3.4 million for the same period
of 2003. The decrease in interest expense on loans payable during 2004 periods
was principally due to a decrease in the average cost of borrowings from 2.58%
for the second quarter of 2003 to 2.41% for the comparable period of 2004 and
from 2.62% for the first half of 2003 to 2.42% for the first six months of
2004. Also the average balances of loans payable outstanding decreased from
$300.3 million to $287.2 million for the quarters ended June 30, 2003 and 2004,
respectively, and from $259.8 million to $259.0 million for the first six
months of 2003 and 2004, respectively. Interest expense on notes payable was $12.3 million for the second quarter
of 2004, compared to $13.0 million for the same period a year ago, a decrease
of 6%. For the first half of 2004 interest expense on notes payable was $24.5
million, a decrease of 4% compared to $25.6 million for the same period of
2003. The decrease in interest expense on notes payable is due to a decrease
of $20.1 million in the average balance of notes payable from June 30, 2003 to
June 30, 2004 principally related with principal payments made to reduce the
balance of a 7.50% note payable to a local bank collateralized by mortgage
loans, partly offset by the effect of the issuance, during the second quarter
of 2004, of $115.0 million of the Companys Floating Rate Senior Notes due
2005. The notes were sold at par, resulting in proceeds to Doral Financial,
after selling commissions but before expenses of approximately $114.9 million. PROVISION FOR LOAN LOSSES The provision for loan losses is charged to earnings to bring the total
allowance for loan losses to a level considered appropriate by management based
on Doral Financials historical loss experience, current delinquency rates,
known and inherent risk in the loan portfolio, an assessment of individual
problem loans, the estimated value of underlying collateral, and an assessment
of current economic conditions. While management believes that the current
provision for loan losses is sufficient, future additions to the allowance for
loan losses could be necessary if economic conditions change or if credit
losses increase substantially from the assumptions used by Doral Financial in
determining the allowance for loan losses. Unanticipated increases in the
allowance for loan losses could result in reductions in Doral Financials net
income. As of June 30, 2004, more than 97% of Doral Financials loan portfolio
was secured, and the amounts due on the loans have historically been
substantially recovered through the sale of the property after foreclosure or
negotiated settlements with borrowers. Doral Financial recognized provisions for loan losses of $2.6 million and
$4.2 million, respectively, for the quarter and six month periods ended June
30, 2004, as compared to $3.6 million and $8.4 million for the respective 2003
periods. During 2003, the Company increased the general provision for certain
construction loans to reach a level management deemed appropriate in the
allowance for loan losses based on the composition of the construction loan
portfolio and existing economic conditions. Also, during 2003, the Company had
increased the allowance for loan losses to provide a reserve for a construction
loan with an outstanding balance of $13.4 million that was not considered as a
non-performing loan as of June 30, 2003, but is reflected as a non-performing
loan during 2004 (refer to Non-Performing Assets and Allowance for Loan Losses
- Tables K and L). The Company was able to maintain an adequate allowance for
loan losses, which equals 0.83% of total loans as of June 30, 2004 compared to
0.78% as of June 30, 2003. NON-INTEREST INCOME Net Gain on Mortgage Loan Sales and Fees.Net gain from mortgage loan
sales and fees increased by 33% during the second quarter of 2004 to $130.6
million, compared to $98.1 million for the same period of 2003. For the six
month periods ended June 30, 2004 and 2003, mortgage loan sales and fees were
$267.4 million and $175.4 million, respectively, an increase of 52%. The
increase for 2004 was mainly the result of a greater volume of loan sales of
non-conforming loans to local financial institutions and the ability of the
Company to obtain higher profitability through 33




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##### Table of Contents



increased margins on such sales through the
retention of IOs in connection with such sales. See Amortization and
Impairment of Servicing Assets and Valuation of IOs. Total loan sales and securitizations
were $1.5 billion ($719.5 million
excluding securitizations) for the second quarter of 2004 and $1.5 billion
($334.9 million excluding securitizations) for the second quarter of 2003. For
the six months ended June 30, 2004 loan sales were $2.9 billion ($1.4 billion
excluding securitizations), compared to $2.4 billion ($969.0 million excluding
securitizations) for the respective 2003 period. During the first half of 2004
loan sales and securitizations that resulted in the recording of IOs and
mortgage servicing rights amounted to $1.4 billion compared to $746.5 million
for the first half of 2003. Doral Financial retained IOs as part of its sales
activities of $111.2 million and $224.7 million for the second quarter and
first half of 2004, respectively, compared to $64.3 million and $116.1 million
for the respective 2003 periods. During the second quarter and first half of
2004, Doral Financial also recorded $13.5 million and $28.8 million,
respectively, in connection with the recognition of mortgage servicing rights
as part of its loan sale and securitization activities, compared to $11.3
million and $18.5 million for the respective 2003 periods. Net Servicing Income.Servicing income represents revenues earned for
administering mortgage loans. The main component of Doral Financials
servicing income is loan servicing fees, which depend on the type of mortgage
loan being serviced. The servicing fees on residential mortgage loans
generally range from 0.25% to 0.44%, net of guarantee fees, of the declining
outstanding principal amount of the serviced loan. As of June 30, 2004, the
weighted average gross servicing fee rate for the entire portfolio was .3157%.
The size of Doral Financials loan servicing portfolio has increased
substantially since its inception as a result of increases in loan production
and bulk purchases of servicing rights. Late fees and other servicing-related
fees such as prepayment fees are also included as a component of servicing
income. Late fees and other servicing-related fees were $3.0 million and $5.8
million for the second quarter and first half of 2004, respectively, compared
to $2.3 million and $4.5 million for the comparative 2003 periods. For the quarter ended June 30, 2004, net servicing loss was approximately
$2.3 million compared to a loss of $8.4 million for the corresponding period of
2003. For the first six months of 2004, net servicing loss was approximately
$656,000 compared to a loss of $12.5 million for the corresponding 2003 period.
The decrease in net servicing loss for 2004 was the result of reduced
amortization and impairment charges of mortgage servicing assets resulting from
lower prepayments. Doral Financial recognized amortization and impairment
charges of $12.6 million and $20.4 million for the quarter and six months
ended June 30, 2004, respectively, compared to $17.1 million and $29.8 million
for the same periods a year ago. Net impairment charges for the first half of
2004 amounted to $7.1 million, compared to $10.5 million for the corresponding
2003 period. Reduced impairment charges during 2004 was the result of a stable
low level of mortgage interest rates compared to the sharp decrease in rates
experienced during the early part of 2003 and a reduction in the impairment
allowance for certain mortgage servicing rights stratas which experienced lower
than anticipated prepayments. See Note l to the unaudited consolidated
financial statements contained herein for additional information. Gross
servicing fees amounted to $10.2 million for the second quarter of 2004,
compared to $8.8 million for the second quarter of 2003. For the first six
months of 2004, gross servicing fees amounted to $19.7 million, compared to
$17.3 million for the corresponding 2003 period. The Companys mortgage
servicing portfolio, including its own portfolio of $2.6 billion at June 30,
2004 and $2.4 billion at June 30, 2003, was approximately $13.5 billion at June
30, 2004, compared to $12.0 billion as of June 30, 2003. The value of the servicing asset retained in the sale of a mortgage loan
reduces the basis of the related mortgage loan and thereby results in increased
Net Gain on Mortgage Loans Sales and Fees at the time of sale. During the
quarters ended June 30, 2004 and 2003, Doral Financial recognized servicing
assets of $13.5 million and $11.3 million, respectively, in connection with the
sale of loans to third parties. For the first half of 2004 and 2003, Doral
Financial recognized servicing assets of $28.8 million and $18.5 million,
respectively, in connection with the sale of loans to third parties. Set forth
below is a summary of the components of the net servicing loss: TABLE ENET SERVICING LOSS QUARTER ENDED
    
    SIX MONTH PERIOD ENDEDJUNE 30,
    
    JUNE 30,(In thousands)
    
    2004
    
    2003
    
    2004
    
    2003Servicing fees (net of guarantee fees)
    
    $
    7,210
    
    
    $
    6,402
    
    
    $
    13,953
    
    
    $
    12,764Late charges
    
    
    1,762
    
    
    
    1,687
    
    
    
    3,594
    
    
    
    3,375Prepayment penalties
    
    
    1,675
    
    
    
    1,471
    
    
    
    3,020
    
    
    
    2,531Interest loss
    
    
    (658
    )
    
    
    (852
    )
    
    
    (1,260
    )
    
    
    (1,496
    )Other servicing fees
    
    
    238
    
    
    
    43
    
    
    
    410
    
    
    
    115Amortization and impairment of servicing assets
    
    
    (12,572
    )
    
    
    (17,104
    )
    
    
    (20,373
    )
    
    
    (29,751
    )Total net servicing loss
    
    $
    (2,345
    )
    
    $
    (8,353
    )
    
    $
    (656
    )
    
    $
    (12,462
    )
 34




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##### Table of Contents



Trading Activities.Trading activities include gains and losses, whether
realized or unrealized, in the market value of Doral Financials trading
securities, including IOs, as well as on options, futures contracts and other
derivative instruments used for interest rate risk management purposes. Trading
activities for the quarter and six month periods ended June 30, 2004 resulted
in a gain of $6.0 million and a loss of $42.6 million, respectively, compared
to a loss of $5.0 million and a loss of approximately $50,000 for the
respective 2003 periods. Gain on trading activities for the second quarter of
2004 was principally due to rising long-term interest rates that resulted in
gains on the Companys derivatives activities undertaken for risk management
purposes, offset in part by unrealized losses on the value of its trading
securities pursuant to SFAS No. 115. During the quarter ended June 30, 2004
trading activities include a pre-tax loss of $2.4 million, which represents the
ineffective portion of the fair value hedges of certain available for sale
securities. Set forth below is a summary of the components of gains and losses
from trading activities: TABLE FCOMPONENTS OF TRADING ACTIVITIES QUARTER
    
    SIX MONTH PERIODENDED JUNE 30,
    
    ENDED JUNE 30,(In thousands)
    
    2004
    
    2003
    
    2004
    
    2003Net realized gains on sales of trading securities
    
    $
    210
    
    
    $
    75,902
    
    
    $
    23,590
    
    
    $
    95,913Net unrealized losses on trading securities
    
    
    (7,930
    )
    
    
    (25,982
    )
    
    
    (21,058
    )
    
    
    (26,434
    )Net realized and unrealized gains and (losses)
on derivative instruments
    
    
    13,768
    
    
    
    (54,871
    )
    
    
    (45,098
    )
    
    
    (69,529
    )Total
    
    $
    6,048
    
    
    $
    (4,951)
    
    
    $
    (42,566
    )
    
    $
    (50
    )
 The value of Doral Financials trading securities and derivatives is
generally very sensitive to interest rate changes, and the reported fair values
of certain of these assets such as IOs are based on assumptions regarding the
direction of interest rates and prepayment rates on mortgage loans. As a
result, changes in interest rates and prepayment rates for mortgage loans can
result in substantial volatility in the components of the trading account.
Doral Financial attempts to mitigate the risk to the value of its trading
securities by entering into transactions involving the purchase of derivatives
such as options and futures contracts. During 2004 and 2003, Doral Financials
risk management strategy has been principally directed to protect the value of
its securities and net interest income from a rising interest rate scenario.
During 2003 and early 2004, Doral Financial experienced losses on its
derivatives because interest rates remained stable at low levels. These losses
were generally offset by increases in gains on sale of mortgage loans, net
interest income and commissions, fees and other income. In the second
quarter of 2004, Doral Financial experienced gains on its derivatives
activities as a result of increases in long-term interest rates. Such
gains were offset by declines in the value of the Doral
Financials trading and available for sale portfolio. Net (Loss) Gain on Sale of Investment Securities.Net (loss) gain on sale
of investment securities represents the impact on income of transactions
involving the sale of securities classified as available for sale. In the
latter part of the second quarter of 2004, the Company restructured its
investment portfolio by selling securities, whose market value was negatively
impacted by the increase in the long-term interest rates experienced during the
quarter, at a loss of $17.5 million for the second quarter of 2004 compared to
a gain of $7.0 million for the corresponding 2003 period and replaced the
securities sold with higher yielding instruments. Increased sales activities
resulted in proceeds from sales of securities available for sale of $5.0
billion for the first six months of 2004 compared to $3.8 billion for the first
six months of 2003. Commissions, Fees and Other Income.Commissions, fees and other income
increased 32% during the second quarter of 2004 from $7.4 million for the
quarter ended June 30, 2003 to $9.8 million for the quarter ended June 30,
2004. For the first six months of 2004, commissions, fees and other income
increased 35%, compared to the respective 2003 period. The increase during
2004 was due primarily to increased commissions and fees earned by Doral
Financials retail banking and insurance agency operations. Set forth below is
a summary of Doral Financials principal sources of commissions, fees and other
income. TABLE GCOMMISSIONS, FEES AND OTHER INCOME QUARTER
    
    SIX MONTH PERIODENDED JUNE 30,
    
    ENDED JUNE 30,(In Thousands)
    
    2004
    
    2003
    
    2004
    
    2003Retail banking fees
    
    $
    3,287
    
    
    $
    2,410
    
    
    $
    6,394
    
    
    $
    5,020Securities brokerage and asset
management fees and
commissions
    
    
    382
    
    
    
    1,492
    
    
    
    1,116
    
    
    
    1,714Insurance agency commissions
    
    
    3,032
    
    
    
    1,936
    
    
    
    5,931
    
    
    
    3,723Other income
    
    
    3,079
    
    
    
    1,587
    
    
    
    5,020
    
    
    
    3,183Total
    
    $
    9,780
    
    
    $
    7,425
    
    
    $
    18,461
    
    
    $
    13,640
 Doral Financials fees and commissions have increased steadily as Doral
Financials banking subsidiaries continue to increase their retail branch
network and as Doral Financial continues to diversify its sources of revenues
by generating additional fees and commissions from insurance agency activities.
Doral Financial intends to further increase 35




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##### Table of Contents



its fee income by continuing to aggressively cross-sell new banking and
insurance products to its large retail consumer base. Currently, Doral
Financial is capturing a substantial portion of the insurance policies issued
to borrowers who obtain residential mortgage loans through Doral Financials
mortgage-banking entities. NON-INTEREST EXPENSES Total non-interest expenses increased by 10% during the second quarter
ended June 30, 2004, compared to the respective 2003 period. This increase
reflects increases in compensation, professional fees, depreciation and
amortization, occupancy and other expenses resulting from the continued
expansion of Doral Financials mortgage banking and banking operations and
expenses related to increased loan originations and servicing. Professional
fees for the second quarter of 2004 were $2.6 million, compared to $2.1 million
for the same period a year ago. The increase for the second quarter of 2004
was primarily due to legal, accounting and consulting fees associated with the
continued expansion of Doral Financials business and compliance with the
requirements of the Sarbanes-Oxley Act of 2002. The expansion of Doral
Financials branch network, which increased to 107 branches as of June 30,
2004, compared to 99 branches as of June 30, 2003, produced an increase of 17% in
headcount from 2,175 employees as of June 30, 2003 to 2,538
employees as of June 30,
2004. Depreciation and amortization expense was $4.3 million in the second
quarter of 2004, compared to $3.6 million for the comparative 2003 period. The
increase in depreciation was principally related to increases in leasehold
improvements and the purchase of office furniture and equipment as well as
software and hardware, and computer systems upgrade related to the Companys
growth. For the second quarter of 2004, compensation expense includes $2.4
million, associated with the expensing of the fair value of stock options,
compared to $1.1 million for the second quarter of 2003. The increase in the
stock based compensation expenses was related to 1,560,000 stock options
granted to certain executive officers during the first quarter of 2004. INCOME TAXES Income taxes include Puerto Rico income taxes as well as applicable
federal and state taxes. As Puerto Rico corporations, Doral Financial and all
its Puerto Rico subsidiaries are generally required to pay federal income tax
only with respect to their income derived from the active conduct of a trade or
business in the United States (excluding Puerto Rico) and certain investment
income derived from U.S. assets. Any such tax is creditable, with certain
limitations, against Puerto Rico income taxes. The maximum statutory corporate
income tax rate in Puerto Rico is 39%. For the second quarter and first half
of 2004, the effective income tax rate of Doral Financial was 18%, compared to
16% for the respective 2003 periods. The increase in the effective tax rate
for 2004 reflected increased pre-tax income from the Companys taxable
activities including loan sales and insurance agency. The lower effective tax rates (compared to the maximum statutory rate)
were primarily the result of the tax-exemption enjoyed by Doral Financial on
interest income derived from certain FHA and VA mortgage loans secured by
properties located in Puerto Rico and on GNMA securities backed by such
mortgage loans. Doral Financial also invests in U.S. Treasury and agency
securities that are exempt from Puerto Rico taxation and are not subject to
federal income taxation because of the portfolio interest deduction to which
Doral Financial is entitled as a foreign corporation. In addition, Doral
Financial uses its international banking subsidiary to invest in various U.S.
securities and U.S. mortgage loans, which interest income and gain on sale, if
any, is exempt from Puerto Rico income taxation and excluded from federal
income taxation on the basis of the portfolio interest deduction in the case of
interest, and in the case of capital gains, because the gains are sourced
outside the United States. Net income tax savings to Doral Financial
attributable to tax-exempt income amounted to approximately $29.4 million and
$41.9 million for the six month periods ended June 30, 2004 and 2003,
respectively. Except for the operations of Doral Bank NY and Doral Money, substantially
all of the Companys operations are conducted through subsidiaries in Puerto
Rico. Doral Bank NY and Doral Money are U.S. corporations and are subject to
U.S. income-tax on their income derived from all sources. For the quarters
ended June 30, 2004 and 2003, the provision for income taxes for the Companys
U.S. subsidiaries amounted to approximately $419,000 and $206,000,
respectively. For the six months ended June 30, 2004 and 2003, the provision
for income taxes for the Companys U.S. subsidiaries amounted to approximately
$589,000 and $2.3 million, respectively. Recently, the Legislature of Puerto Rico approved a law designed to
encourage international banking entities to operate as separate legal entities
rather than operating divisions. This law imposes income taxes at normal
statutory rates on each international banking entity that operates as a unit or
division of a bank, to the extent an international banking entitys net income
exceeds 40% of the banks net taxable income in the taxable year commenced on
July 1, 2003, 30% of the banks net taxable income in the taxable year
commencing in July 1, 2004 and 20% of the banks net taxable income in the
taxable year commencing on July 1, 2005 and thereafter. It does not impose
income taxation on an international banking entity that operates as a
subsidiary of a bank. Prior to March 31, 2004, Doral Financial operated two international
banking entities: (1) Doral Overseas, a division at the parent company level
and (2) Doral International, a wholly-owned subsidiary of Doral Bank PR. As of
June 30, 2004, Doral International is conducting all of operations previously
conducted at Doral Overseas. As a result, Doral Financial will continue
enjoying 100% tax-exempted income from its international banking operations.
Doral Financial cannot give any assurance, however, that the law will not be
modified in the future to reduce the tax benefits currently available to
international banking subsidiaries such as Doral International. 36




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AMORTIZATION AND IMPAIRMENT OF SERVICING ASSETS AND VALUATION OF IOs As part of its mortgage sale activities, Doral Financial generally retains
the right to service the mortgage loans it sells. Also in connection with the
sale of non-conforming mortgage loan pools and, to a lesser extent, the sale of
FNMA and FHLMC securities, Doral Financial retains the right to receive any
interest payments on such loans above the contractual pass-through rate payable
to the investor and also retains its compensation for servicing the loans or
mortgage-backed securities. Doral Financial determines the gain on sale of a
mortgage-backed security or loan pool by allocating the acquisition cost of the
underlying mortgage loans between the mortgage-backed security or mortgage loan
pool sold and its retained interests, based on their relative estimated fair
values. The reported gain or loss is the difference between the cash proceeds
from the sale of the security or mortgage pool and its allocated cost after
allocating a portion of the cost to the retained interests. Doral Financials sale and securitization activities generally result in
the recording of two types of retained interests: mortgage-servicing rights
(MSRs) and IOs. MSRs represent the estimated present value of the normal
servicing fees (net of related servicing costs) expected to be received on the
loan over the expected term of the loan. IOs represent the estimated present
value of the excess of the weighted-average coupon of the loans underlying the
mortgage loan pool sold over the sum of (1) the rate required to be paid to
investors and (2) a normal servicing fee after adjusting such amount for
expected losses and prepayments. The contractual rate payable to investors may
be either a fixed or floating rate. In the case of non-conforming loans pools,
it is generally a floating rate based on a spread over the 90-day LIBOR. MSRs
are classified as servicing assets and IOs are classified as trading securities
in Doral Financials Consolidated Statements of Financial Condition. The determination of the fair values of MSRs and IOs at their initial
recording and on an ongoing basis requires considerable management judgment.
Unlike U.S. Treasury and agency mortgage-backed securities, the fair value of
MSRs and IOs cannot be determined with precision because they are not traded in
active securities markets. For MSRs, Doral Financial determines their initial
fair values on the basis of prices paid for comparable mortgage servicing
rights. Doral Financial also receives on a quarterly basis a third party
valuation of its MSRs related to its FNMA, FHLMC and GNMA servicing portfolio.
During the first six months of 2004 and 2003, the market prices used to
recognize Doral Financials MSRs varied from 1.40% to 2.30% of the principal
amount of the loans subject to the servicing rights, with servicing rights for
GNMA (FHA/VA loans) mortgage-backed securities having higher values than
comparable servicing rights for conventional loans. The unamortized balance of
Doral Financials servicing asset as of June 30, 2004 and December 31, 2003 was
$178.6 million and $167.5 million, respectively. For additional information
regarding the unamortized balance of Doral Financials servicing assets and
amortization for the quarters and six months ended June 30, 2004 and 2003,
please refer to Note l to the unaudited consolidated financial statements
contained herein. To determine the fair value of its IOs, Doral Financial, on a quarterly
basis, obtains dealer quotes for comparable instruments and compares these
quotes with external and internal valuations based on discounted cash flow
models that incorporate assumptions regarding discount rates and mortgage
prepayment rates. Doral Financial generally uses the lowest valuation obtained
from these methods. While Doral Financial has sold some IOs in private sales,
currently there is no liquid market for the purchase and sale of IOs. The
market multiple used by Doral Financial to value IOs ranged from 4.95 to 5.50
during the first half of 2004, compared to a range of 4.75 to 5.50 during the
first six months of 2003. As of June 30, 2004 and December 31, 2003, the
carrying value of IOs was $758.1 million (related to $5.6 billion of mortgage
loan pools sold to investors) and $578.1 million (related to $4.8 billion of
mortgage loan pools sold to investors), respectively. The initial recorded
value of IOs is amortized over the expected life of the asset. The
amortization is based on the amount and timing of estimated future cash flows
to be received with respect to IOs. For additional information regarding the
carrying value of Doral Financials IOs and amortization for the quarters and
six months ended June 30, 2004 and 2003, please refer to Note l to the
unaudited consolidated financial statements contained herein. The value of Doral Financials MSRs and IOs is very sensitive to interest
rate changes. Once recorded, Doral Financial periodically evaluates its MSRs
for impairment. Impairment is defined generally as a reduction in current fair
value below the carrying value. If the MSRs are impaired, the impairment is
recognized in current period earnings. Doral Financial records impairment of
MSRs through a valuation allowance. The valuation allowance is adjusted to
reflect the amount, if any, by which the cost basis of MSRs exceeds their fair
value. If the value of MSRs subsequently increases, the valuation allowance is
decreased through a credit to current period earnings. Other than temporary
impairment is recognized as a direct write-down of the servicing assets. As of
June 30, 2004, the impairment allowance for MSRs was $12.2 million. In the
case of MSRs, Doral Financial stratifies the mortgage loans underlying a
mortgage loan pool or mortgage-backed security on the basis of their
predominant risk characteristics, which Doral Financial has determined to be
type of loan (government-guaranteed, conventional, conforming and
non-conforming) and interest rates. Doral Financial measures MSRs impairment by
estimating the fair value of each stratum. MSRs are also subject to periodic amortization. The amortization of MSRs
is based on the amount and timing of estimated cash flows to be recovered with
respect to the MSRs over their expected lives. To the extent changes in
interest rates or prepayment rates warrant, Doral Financial will increase or
decrease the level of amortization. Amortization of MSRs is recorded as a
reduction of servicing income. For impairment and valuation purposes, Doral
Financial continues 37




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##### Table of Contents



to monitor changes in interest rates to determine whether the assumptions
used to value its MSRs and IOs are still appropriate in light of market
conditions. It also attempts to corroborate the values assigned to these assets
through the use of internal valuation models that incorporate assumptions
regarding the direction of interest rates and mortgage prepayment rates. The
reasonableness of managements assumptions is corroborated through valuations
performed by independent third parties on a quarterly basis. Doral Financial reviews all major valuation assumptions periodically using
recent empirical and market data available, and makes adjustments where
warranted. Increases in prepayment rates or credit loss rates over anticipated levels used
in calculating the value of IOs and MSRs can adversely affect Doral Financials
revenues and liquidity by increasing the amortization rates for servicing
assets and IOs, as well as requiring Doral Financial to recognize an impairment
against income over and above scheduled amortization. 38




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##### Table of Contents



BALANCE SHEET AND OPERATING DATA ANALYSIS LOAN PRODUCTION Loan production includes loans internally originated by Doral Financial as
well as residential mortgage loans purchased from third parties. Purchases of
mortgage loans from third parties were $757.0 million and $1.4 billion for the
quarter and six months ended June 30, 2004, respectively, compared to $473.8
million and $915.8 million for the quarter and six months ended June 30, 2003,
respectively. The following table sets forth the number and dollar amount of
Doral Financials loan production for the periods indicated: TABLE H LOAN PRODUCTION (Dollars in Thousands,
Except for Average Initial Loans)
  QUARTER
    
    SIX MONTH PERIODENDED JUNE 30,
    
    ENDED JUNE 30,2004
    
    2003
    
    2004
    
    2003FHA/VA mortgage loansNumber of loans
    
    
    1,208
    
    
    
    1,049
    
    
    
    2,392
    
    
    
    1,901Volume of loans
    
    $
    109,988
    
    
    $
    97,765
    
    
    $
    215,592
    
    
    $
    175,950Percent of total volume
    
    
    5
    %
    
    
    6
    %
    
    
    6
    %
    
    
    6
    %Average initial loan balance
    
    $
    91,050
    
    
    $
    93,198
    
    
    $
    90,130
    
    
    $
    92,557Conventional conforming mortgage loansNumber of loans
    
    
    4,249
    
    
    
    4,323
    
    
    
    9,448
    
    
    
    8,209Volume of loans
    
    $
    773,576
    
    
    $
    675,115
    
    
    $
    1,598,280
    
    
    $
    1,253,395Percent of total volume
    
    
    40
    %
    
    
    42
    %
    
    
    42
    %
    
    
    41
    %Average initial loan balance
    
    $
    182,061
    
    
    $
    156,168
    
    
    $
    169,166
    
    
    $
    152,685Conventional non - conforming mortgage
loans (1)(2)Number of loans
    
    
    8,959
    
    
    
    6,349
    
    
    
    15,891
    
    
    
    12,117Volume of loans
    
    $
    756,186
    
    
    $
    606,850
    
    
    $
    1,363,039
    
    
    $
    1,169,209Percent of total volume
    
    
    39
    %
    
    
    38
    %
    
    
    36
    %
    
    
    38
    %Average initial loan balance
    
    $
    84,405
    
    
    $
    95,582
    
    
    $
    85,774
    
    
    $
    96,493Other (3)Number of loans
    
    
    1,030
    
    
    
    510
    
    
    
    1,892
    
    
    
    1,075Volume of loans
    
    $
    305,574
    
    
    $
    226,248
    
    
    $
    609,834
    
    
    $
    467,980Percent of total volume
    
    
    16
    %
    
    
    14
    %
    
    
    16
    %
    
    
    15
    %Total loansNumber of loans
    
    
    15,446
    
    
    
    12,231
    
    
    
    29,623
    
    
    
    23,302Volume of loans
    
    $
    1,945,324
    
    
    $
    1,605,978
    
    
    $
    3,786,745
    
    
    $
    3,066,534
   (1)
    
    Includes $41.7 million and $14.0 million in second mortgages for the quarters ended June
30, 2004 and 2003, respectively, and $81.0 million and $27.6 million in second mortgages for
the six month periods ended June 30, 2004 and 2003, respectively.(2)
    
    Includes $16.0 million and $34.0 million in home equity or personal loans secured by real
estate mortgages of up to $40,000 for the quarters ended June 30, 2004 and 2003, respectively,
and $26.1 million and $58.0 million for the six month periods ended June 30, 2004 and 2003,
respectively.(3)
    
    Consists of construction loans on residential projects, mortgage loans secured by
multi-family and commercial properties as well as other commercial, land and
consumer loans. 39




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A substantial portion of Doral Financials total residential mortgage loan
originations has consistently been composed of refinance loans. For the six
month periods ended June 30, 2004 and 2003, refinance loans represented
approximately 59% and 65%, respectively, of the total dollar volume of
internally originated mortgage loans. Doral Financials future results could
be adversely affected by a significant increase in mortgage interest rates that
may reduce refinancing activity. However, the Company believes that
refinancing activity in Puerto Rico is less sensitive to interest rate changes
than in the mainland United States because a significant amount of refinance
loans in the Puerto Rico mortgage market are made for debt consolidation
purposes rather than interest savings and because interest cost on mortgage
loans is tax deductible for borrowers. Also, consumers tend to prefer
long-term mortgage loan rates that are generally well below rates on consumer
debt. The following table sets forth the sources of Doral Financials loan
production as a percentage of total loan originations for the periods
indicated: TABLE I
LOAN ORIGINATION SOURCES SIX MONTH PERIOD ENDED JUNE 30,2004
    
    2003Puerto Rico
    
    US
    
    Total
    
    Puerto Rico
    
    US
    
    TotalRetail
    
    
    49
    %
    
    
    
    
    
    
    49
    %
    
    
    54
    %
    
    
    
    
    
    
    54
    %Wholesale (1)
    
    
    7
    %
    
    
    29
    %
    
    
    36
    %
    
    
    6
    %
    
    
    24
    %
    
    
    30
    %New Housing Developments
    
    
    9
    %
    
    
    1
    %
    
    
    10
    %
    
    
    11
    %
    
    
    
    
    
    
    11
    %Multi-family
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2
    %
    
    
    2
    %Other (2)
    
    
    4
    %
    
    
    1
    %
    
    
    5
    %
    
    
    2
    %
    
    
    1
    %
    
    
    3
    %
   (1)
    
    Refers to purchases of mortgage loans from other financial institutions and mortgage lenders. U.S. wholesale purchases normally do not include the related
servicing right.(2)
    
    Refers to commercial, consumer and land loans originated through the banking subsidiaries and other specialized units. MORTGAGE LOAN SERVICING Doral Financials principal source of servicing rights has traditionally
been its internal mortgage loan production. However, Doral Financial also
purchases mortgage loans on a servicing- released basis as well as servicing
rights in bulk. During the second quarters of 2004 and 2003, Doral Financial
purchased servicing rights to approximately $76.7 million and $94.0 million,
respectively, in principal amount of mortgage loans. For the six month periods
ended June 30, 2004 and 2003, the Company purchased servicing rights to
approximately $156.1 million and $410.9 million, respectively, in principal
amount of mortgage loans. Doral Financial intends to continue growing its
mortgage-servicing portfolio by internal loan originations and wholesale
purchases of loans on a servicing-released basis but will also continue to seek
and consider attractive opportunities for bulk purchases of servicing rights
from third parties. 40




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##### Table of Contents



The following table sets forth certain information regarding the total
mortgage loan-servicing portfolio of Doral Financial for the periods indicated: TABLE J
MORTGAGE LOAN SERVICING
(Dollars in Thousands, Except for Average Size of Loans Prepaid) AS OF JUNE 30,2004
    
    2003COMPOSITION OF SERVICING PORTFOLIO AT PERIOD END:GNMA
    
    $
    2,589,042
    
    
    $
    2,881,215FHLMC/FNMA
    
    
    3,589,209
    
    
    
    3,092,780Doral Financial grantor trusts
    
    
    31,037
    
    
    
    43,023Other conventional mortgage loans (1)(2)
    
    
    7,320,022
    
    
    
    5,983,119Total servicing portfolio
    
    $
    13,529,310
    
    
    $
    12,000,137SELECTED DATA REGARDING MORTGAGE LOANS SERVICED:Number of loans
    
    
    156,727
    
    
    
    146,059Weighted- average interest rate
    
    
    6.88
    %
    
    
    7.21
    %Weighted- average remaining maturity (months)
    
    
    258
    
    
    
    256Weighted- average gross servicing fee rate
    
    
    .3157
    %
    
    
    .3206
    %Average servicing portfolio
    
    $
    13,187,217
    
    
    $
    11,720,176Principal prepayments
    
    $
    1,154,914
    
    
    $
    1,201,914Prepayments to average portfolio (annualized)
    
    
    18
    %
    
    
    21
    %Average size of loans prepaid
    
    $
    87,130
    
    
    $
    92,612Servicing assets, net
    
    $
    178,645
    
    
    $
    156,114DELINQUENT MORTGAGE LOANS AND PENDING
FORECLOSURES AT PERIOD END:60-89 days past due
    
    
    1.11
    %
    
    
    1.20
    %90 days or more past due
    
    
    1.70
    %
    
    
    2.05
    %Total delinquencies excluding foreclosures
    
    
    2.81
    %
    
    
    3.25
    %Foreclosures pending
    
    
    1.71
    %
    
    
    1.71
    %SERVICING PORTFOLIO ACTIVITY:Beginning servicing portfolio
    
    $
    12,690,244
    
    
    $
    11,241,523Add:Loans funded and purchased (3)
    
    
    2,044,751
    
    
    
    1,784,881Bulk servicing acquired
    
    
    156,110
    
    
    
    410,858Less:Servicing sales transferred
    
    
    2,652
    
    
    
    2,450Run-off (4)
    
    
    1,359,143
    
    
    
    1,434,675Ending servicing portfolio
    
    $
    13,529,310
    
    
    $
    12,000,137
   (1)
    
    Includes $2.6 billion and $2.4 billion of loans owned by Doral Financial at June 30, 2004 and 2003,
respectively, which represented 20% of the total servicing portfolio as of such dates for which no servicing
rights has been recognized.(2)
    
    Includes portfolios of $270.4 million and $246.0 million at June 30, 2004 and 2003, respectively, of
insured FHA/VA delinquent loans sold to third parties.(3)
    
    Excludes approximately $1.7 billion and $1.3 billion of conventional, commercial, consumer, construction
and other loans not included in Doral Financials mortgage servicing-portfolio as of June 30, 2004 and 2003,
respectively.(4)
    
    Run-off refers to regular amortization of loans, prepayments and foreclosures. Substantially all of the mortgage loans in Doral Financials servicing
portfolio are secured by single (one-to-four) family residences secured by real
estate located in Puerto Rico. At June 30, 2004 and 2003, approximately 2% and
3%, respectively, of Doral Financials mortgage-servicing portfolio was related
to mortgages secured by real property located on the U.S. mainland. The amount of principal prepayments on mortgage loans serviced by Doral
Financial was $1.2 billion for both six month periods ended June 30, 2004 and
2003. This represents approximately 18% and 21%, respectively, on an
annualized basis of the average principal amount of mortgage loans serviced.
Doral Financial reduces the sensitivity of its servicing 41




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##### Table of Contents



income to increases in prepayment rates through a strong retail
origination network that has permitted Doral Financial to increase the size of
its servicing portfolio even during periods of declining interest rates and
high prepayments. CREDIT RISKS RELATED TO LOAN ACTIVITIES With respect to mortgage loans originated for sale as part of its mortgage
banking business, Doral Financial is generally at risk for any mortgage loan
default from the time it originates the mortgage loan until the time it sells
the loan or packages it into a mortgage-backed security. With respect to FHA
loans, Doral Financial is fully insured as to principal by the FHA against
foreclosure loss. VA loans are guaranteed up to 25% to 50% of the principal
amount of the loan subject to a maximum, ranging from $22,500 to $50,750 in
addition to the mortgage collateral. Loan-to-value ratios for residential
mortgage loans generally do not exceed 80% (85% for certain qualifying home
purchase transactions through Doral Bank PR) unless private mortgage insurance
is obtained. In the ordinary course of business, the Company sells loans on a partial
or full recourse basis. When the Company
sells a loan with recourse, it commits, if the loan defaults, to make payments
to remedy the default or to repurchase the defaulted loan. See Off-Balance
Sheet Activities for more information regarding recourse obligation. Doral Financial is also subject to credit risk with respect to its
portfolio of loans receivable. Loans receivable represent loans that Doral
Financial holds for investment and, therefore, Doral Financial is at risk for
the term of the loan. Loans secured by income-producing residential and
commercial properties involve greater credit risk because they are larger in
size and more risk is concentrated in a single borrower. The properties
securing these loans are also more difficult to dispose of in case of
foreclosure. Doral Financial manages credit risk by maintaining sound underwriting
standards, monitoring the quality of the loan portfolio, assessing reserves and
loan concentrations, recruiting qualified credit officers, implementing and
monitoring lending policies and collateral requirements, maintaining
appropriate collection procedures and procedures to ensure appropriate actions
to comply with laws and regulations. Doral Financials collateral requirements
for loans depend on the financial strength of the borrower and the type of loan
involved. Acceptable collateral principally includes cash, deposit and
investment accounts and real estate, and to a lesser extent, liens on accounts
receivable, leases receivable, inventory and personal property. In the case of
non-conforming loans sold subject to recourse, Doral Financial also generally
requires lower loan-to-value ratios to protect itself from possible losses on
foreclosure. Because most of Doral Financials loans are made to borrowers located in
Puerto Rico and secured by properties located in Puerto Rico, Doral Financial
is subject to greater credit risks tied to adverse economic, political or
business developments and natural hazards, such as hurricanes, that may affect
Puerto Rico. For example, if Puerto Ricos real estate market were to
experience an overall decline in property values, the Companys rates of loss
on foreclosure would probably increase. NON-PERFORMING ASSETS AND ALLOWANCE FOR LOAN LOSSES Non-performing assets (NPAs) consist of loans past due 90 days and still
accruing, loans on a non-accrual basis and other real estate owned.
Conventional mortgage loans held for sale by Doral Financials mortgage banking
units are placed on a non-accrual basis after they have been delinquent for
more than 180 days to the extent concern exists as to ultimate collectibility
based on the loan-to-value ratio. When the loan is placed on non-accrual, all
accrued but unpaid interest to date is fully reserved. Doral Financial
believes that its non-accrual policy for mortgage loans held for sale in its
mortgage banking units is reasonable, because these loans are adequately
secured by real estate, generally have low loan-to-value ratios, and the
amounts due on the loans have historically been recovered through the sale of
the property after foreclosure or negotiated settlements with borrowers. Doral
Financials banking subsidiaries place all loans more than 90 days past due on
a non-accrual basis, at which point a reserve for all unpaid interest
previously accrued is established. Interest income is recognized when the
borrower makes a payment, and the loan will return to an accrual basis when it
is no longer more than 90 days delinquent and collectibility is reasonably
assured. As of June 30, 2004 and 2003, Doral Financial would have recognized
$8.8 million and $7.3 million, respectively, in additional interest income had
all delinquent loans been accounted for on an accrual basis. Doral Financial
evaluates loans for impairment. Impaired loans as of June 30, 2004 and
December 31, 2003 amounted to approximately $27.9 million and $23.7 million,
respectively. At June 30, 2004 and December 31, 2003 an impairment allowance of
$4.8 million and $2.4 million, respectively, was allocated to such impaired
loans. The following table sets forth information with respect to Doral
Financials non-accrual loans, other real estate owned (OREO) and other
non-performing assets as of the dates indicated. Doral Financial did not have
any troubled debt restructurings as of any of the periods presented. 42




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TABLE K
NON-PERFORMING ASSETS
(DOLLARS IN THOUSANDS) AS OF
    
    AS OFJUNE 30, 2004
    
    DECEMBER 31, 2003Mortgage banking business:Non-accrual loans:Construction loans
    
    $
    2,574
    
    
    $
    2,901Residential mortgage loans
    
    
    21,252
    
    
    
    20,818Construction loans past due 90 days and still accruing
    
    
    128
    
    
    
    Loans held-for-sale past due 90 days and still accruing (1)(2)
    
    
    66,194
    
    
    
    62,270OREO
    
    
    16,064
    
    
    
    18,176Total NPAs of mortgage banking business
    
    
    106,212
    
    
    
    104,165Other lending activities through banking subsidiaries:Non-accrual loans:Construction loans
    
    
    15,895
    
    
    
    1,503Residential mortgage loans
    
    
    11,741
    
    
    
    11,664Commercial real estate
    
    
    10,984
    
    
    
    5,166Consumer loans
    
    
    1,410
    
    
    
    1,681Commercial non-real estate loans
    
    
    1,202
    
    
    
    586Total non-accrual loans
    
    
    41,232
    
    
    
    20,600OREO
    
    
    1,035
    
    
    
    1,077Total NPAs of banking subsidiaries
    
    
    42,267
    
    
    
    21,677Total NPAs of Doral Financial (consolidated)
    
    $
    148,479
    
    
    $
    125,842Total NPAs of banking subsidiaries as a percentage
of their loans portfolio, net, and OREO
    
    
    1.40
    %
    
    
    0.76
    %Total NPAs of Doral Financial as a percentage of
consolidated total assets
    
    
    1.11
    %
    
    
    1.21
    %Total non-performing loans to total loans
    
    
    3.68
    %
    
    
    3.13
    %Ratio of allowance for loan losses to total
non-performing loans at end of period (consolidated)
    
    
    22.60
    %
    
    
    26.47
    %
   (1)
    
    Includes loans held-for-sale past due 90-180 days and loans held for sale past due over 180 days with a current loan-to-value ratio over 90%.(2)
    
    Does not include approximately $9.9 million and $10.4 million of 90 days past due FHA/VA loans as of June 30, 2004 and December 31, 2003,
respectively, which are not considered non-performing assets by Doral Financial because the principal balance of these loans is insured or
guaranteed under applicable FHA and VA programs and interest is, in most cases, fully recovered in foreclosure proceedings. 43




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The following table summarizes certain information regarding Doral
Financials allowance for loan losses and losses on OREO, for both Doral
Financials banking and mortgage banking business for the periods indicated. TABLE L
ALLOWANCE FOR LOAN LOSSES AND
OREO
(DOLLARS IN THOUSANDS) QUARTER ENDED
    
    SIX MONTHPERIOD ENDEDJUNE 30,
    
    JUNE 30,2004
    
    2003
    
    2004
    
    2003OREO:Balance at beginning of period
    
    $
    4,104
    
    
    $
    2,426
    
    
    $
    3,375
    
    
    $
    2,772Provision for losses
    
    
    109
    
    
    
    412
    
    
    
    409
    
    
    
    682Net losses, charge-offs and others
    
    
    (553
    )
    
    
    (788
    )
    
    
    (124
    )
    
    
    (1,404
    )Balance at end of period
    
    $
    3,660
    
    
    $
    2,050
    
    
    $
    3,660
    
    
    $
    2,050Allowance for Loan Losses:Balance at beginning of period
    
    $
    28,404
    
    
    $
    22,299
    
    
    $
    28,211
    
    
    $
    18,243Provision for loan losses
    
    
    2,612
    
    
    
    3,618
    
    
    
    4,173
    
    
    
    8,396Charge - offs:Mortgage loans held-for-sale
    
    
    (274
    )
    
    
    
    
    
    
    (276
    )
    
    
    (20
    )Construction loans
    
    
    (282
    )
    
    
    
    
    
    
    (282
    )
    
    
    Residential mortgage loans
    
    
    
    
    
    
    
    
    
    
    (20
    )
    
    
    Commercial real estate loans
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Consumer loans
    
    
    (692
    )
    
    
    (828
    )
    
    
    (1,311
    )
    
    
    (1,527
    )Commercial non-real estate loans
    
    
    (291
    )
    
    
    (41
    )
    
    
    (318
    )
    
    
    (93
    )Other
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total charge-offs
    
    
    (1,539
    )
    
    
    (869
    )
    
    
    (2,207
    )
    
    
    (1,640
    )Recoveries:Mortgage loans held-for-sale
    
    
    4
    
    
    
    
    
    
    
    8
    
    
    
    Construction loans
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Residential mortgage loans
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Commercial real estate loans
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Consumer loans
    
    
    40
    
    
    
    60
    
    
    
    109
    
    
    
    105Commercial non-real estate loans
    
    
    2
    
    
    
    2
    
    
    
    41
    
    
    
    6Other
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total recoveries
    
    
    46
    
    
    
    62
    
    
    
    158
    
    
    
    111Net charge-offs
    
    
    (1,493
    )
    
    
    (807
    )
    
    
    (2,049
    )
    
    
    (1,529
    )Other adjustments
    
    
    165
    
    
    
    146
    
    
    
    (647
    )
    
    
    146Balance at end of period (1)
    
    $
    29,688
    
    
    $
    25,256
    
    
    $
    29,688
    
    
    $
    25,256Allowance for loan losses as a percentage of
total loans outstanding at the end of period
    
    
    0.83
    %
    
    
    0.78
    %
    
    
    0.83
    %
    
    
    0.78
    %Net charge-offs to average loans outstanding
    
    
    0.04
    %
    
    
    0.03
    %
    
    
    0.06
    %
    
    
    0.05
    %
   (1)
    
    Includes the allowance of mortgage loans held-for-sale of $11.7 million for 2004 and $8.7 million for 2003, and the allowance for loans
receivable held for investment of $18.0 million for 2004 and $16.6 million for 2003. 44




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The allowance for loan losses relating to loans held by Doral Financial
was $29.7 million at June 30, 2004, compared to $25.3 million as of June 30,
2003. The increase in the allowance was primarily a result of a larger loan
portfolio as well as an increase in the construction and commercial loan
portfolio that carries greater credit risk. The increase also reflects an
increase in non-performing loans. LIQUIDITY AND CAPITAL RESOURCES Doral Financial has an ongoing need for capital to finance its lending,
servicing and investing activities. This need is expected to increase as the
volume of its loan originations and investing activity increases. Doral
Financials cash requirements arise mainly from loan originations and
purchases, purchases and holding of securities, repayments of debt upon
maturity, payments of operating and interest expenses, servicing advances and
loan repurchases pursuant to recourse or warranty obligations. Servicing agreements relating to the mortgage-backed securities programs
of FNMA, FHLMC and GNMA, and to mortgage loans sold to certain other investors,
require Doral Financial to advance funds to make scheduled payments of
principal, interest, taxes and insurance, if such payments have not been
received from the borrowers. While Doral Financial generally recovers funds
advanced pursuant to these arrangements within 30 days, it must absorb the cost
of the funds it advances during the time the advance is outstanding. During
the six month period ended June 30, 2004, the monthly average amount of funds
advanced by Doral Financial under such servicing agreements was approximately
$29.6 million, compared to $23.0 million for the same period during 2003. To
the extent the mortgage loans underlying Doral Financials servicing portfolio
experience increased delinquencies, Doral Financial would be required to
dedicate additional cash resources to comply with its obligation to advance
funds as well as incur additional administrative costs related to increases in
collection efforts. In recent years, Doral Financial has sold pools of
delinquent FHA and VA mortgage loans. Under these arrangements, as under GNMA
servicing requirements, Doral Financial is required to advance the scheduled
payments whether or not collected from the underlying borrower. While Doral
Financial expects to recover the amounts advanced through foreclosure or under
the applicable FHA and VA insurance and guarantee programs, the amounts
advanced tend to be greater than normal arrangements because of the delinquent
status of the loans. As of June 30, 2004, the outstanding principal balance of
such FHA/VA loans was $270.4 million and the aggregate monthly amounts of funds
advanced by Doral Financial was $24.5 million. During the second quarter and
first half of 2004, the Company sold approximately $23.6 million of residential
FHA insured or VA guaranteed delinquent loans. During the second quarter and
first half of 2003, the Company sold approximately $52.9 million and $107.1
million, respectively, of residential FHA insured or VA guaranteed delinquent
loans. When Doral Financial sells mortgage loans to third parties it generally
makes customary representations and warranties regarding the characteristics of
the loans sold. To the extent Doral Financial breaches any of these
warranties, investors are generally entitled to obligate Doral Financial to
repurchase the loan subject of the breach. In addition to its servicing and warranty obligations, Doral Financials
loan sale activities include the sale of non-conforming mortgage loans subject
to recourse arrangements that generally obligate Doral Financial to repurchase
the loans if the loans are 90 days or more past due or otherwise in default.
To the extent the delinquency ratios of the loans sold subject to recourse are
greater than anticipated and Doral Financial is required to repurchase more
loans than anticipated, Doral Financials liquidity requirements would
increase. See Off-Balance Sheet Activities for additional information on
these arrangements. Doral Financials primary sources of liquidity are revenues from
operations, loan sales in the secondary mortgage market, deposits, advances
from the FHLB-NY, short-term borrowings under warehouse, gestation and
repurchase agreement lines of credit secured by pledges of its loans and
mortgage-backed securities. Other sources of liquidity include proceeds from
privately-placed and publicly offered debt and equity financings in the capital
markets. 45




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The following table shows Doral Financials sources of borrowings and the
related average interest rate as of June 30, 2004 and December 31, 2003: TABLE M
SOURCES OF BORROWINGS
(DOLLARS IN THOUSANDS) AS OF JUNE 30, 2004
    
    AS OF DECEMBER 31, 2003AMOUNT
    
    AVERAGE
    
    AMOUNT
    
    AVERAGEOUTSTANDING
    
    RATE
    
    OUTSTANDING
    
    RATEDeposits
    
    $
    3,239,396
    
    
    
    2.30
    %
    
    $
    2,971,272
    
    
    
    2.38
    %Repurchase Agreements
    
    
    5,385,234
    
    
    
    2.15
    %
    
    
    3,602,942
    
    
    
    2.46
    %Advances from FHLB
    
    
    1,194,500
    
    
    
    4.03
    %
    
    
    1,206,500
    
    
    
    3.89
    %Loans Payable
    
    
    298,872
    
    
    
    2.24
    %
    
    
    178,334
    
    
    
    2.12
    %Notes Payable
    
    
    710,246
    
    
    
    6.83
    %
    
    
    602,581
    
    
    
    7.76
    %
 Doral Financial had warehousing, gestation and repurchase agreements lines
of credit (including advances from the FHLB-NY) totaling $13.1 billion as of
June 30, 2004, of which $6.9 billion was outstanding as of such date. Of the
aggregate amount of funding available under Doral Financials warehousing and
repurchase lines of credit, approximately $3.2 billion represented committed
facilities under which the lender is committed to advance funds subject to
compliance with various conditions. The remaining funding was available under
uncommitted lines pursuant to which advances are made at the discretion of the
lender. Doral Financials committed lines of credit generally require Doral
Financial to comply with various financial covenants and ratios. Failure to
comply with any of these covenants permits the lender to require immediate
repayment of all amounts previously advanced and to stop making any further
advances to Doral Financial. As of June 30, 2004, Doral Financial was in
compliance with all such financial covenants and ratios. Doral Financials investment grade credit ratings on its debt securities
have allowed it to obtain liquidity in the capital markets through public and
private offerings of its debt securities. For example, on June 7, 2004, Doral
Financial sold $115.0 million of its Floating Rate Senior Notes due December 7,
2005, resulting in net proceeds to the Company after selling commissions but
before expenses of $114.9 million. On July 20, 2004, Doral Financial sold an
additional $350.0 million of its Floating Rate Senior Notes due July 20, 2007. To the extent Doral Financials credit ratings on its debt securities were
to fall below investment grade, Doral Financials ability to obtain liquidity
through the capital markets would be materially adversely affected. A decrease
in Doral Financials credit ratings could also make it more difficult for it to
sell non-conforming loans subject to recourse provisions since the purchasers
of loans subject to recourse provisions rely in part on the credit of Doral
Financial when purchasing such loans. A decrease in recourse sales could
adversely affect the liquidity of Doral Financial because the secondary market
for non-conforming loans is not as liquid as the secondary market for loans
that qualify for the sale or guarantee programs of FHA, VA, FNMA and FHLMC. A
decrease in Doral Financials credit ratings could also adversely affect its
liquidity because lending institutions may be less inclined to renew or enter
into new lending arrangements with Doral Financial. A ratings downgrade would
also adversely affect liquidity because counterparties to repurchase agreements
used for funding loan origination activities or to derivative contracts used
for interest rate risk management purposes could increase the applicable margin
requirements under such agreements. Under Doral Financials repurchase lines of credit and derivative
contracts, Doral Financial is required to deposit cash or qualifying securities
to meet margin requirements. To the extent that the market value of securities
previously pledged as collateral decline, Doral Financial will be required to
deposit additional cash or securities to meet its margin requirements, thereby
adversely affecting its liquidity. A considerable amount of Doral Financials liquidity is derived from the
sale of mortgage loans in the secondary mortgage market. The U.S. (including
Puerto Rico) secondary mortgage market is the most liquid in the world in large
part because of the sale or guarantee programs maintained by FHA, VA, HUD, FNMA
and FHLMC. To the extent these programs were curtailed or the standard for
insuring or selling loans under such programs were materially increased or for
any reason Doral Financial failed to qualify for such programs, Doral
Financials ability to sell mortgage loans and consequently its liquidity would
be materially adversely affected. Doral Financial maintains a considerable investment in MSRs and IOs
generated as part of its mortgage sale activities. While the servicing assets
and IOs are recorded at the time of sale of the related mortgage loans, the
cash related to such retained interest is received over the life of the asset
and, therefore, does not generally provide immediate liquidity that is
available to Doral Financial to fund its operations or to pay dividends. Doral Financials banking subsidiaries obtain funding for their lending
activities through the receipt of deposits, FHLB-NY advances and from other
borrowings, such as term notes backed by FHLB-NY letters of credit. As of June
30, 46




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##### Table of Contents



2004, Doral Financials banking subsidiaries held approximately $3.2
billion in deposits at a weighted-average interest rate of 2.30%. The following table presents the average balance and the annualized
average rate paid on each deposit type for the periods indicated: TABLE N
AVERAGE DEPOSIT BALANCE
(DOLLARS IN THOUSANDS) SIX MONTH PERIODENDED
    
    YEAR ENDEDJUNE 30, 2004
    
    DECEMBER 31, 2003AVERAGE
    
    AVERAGE
    
    AVERAGE
    
    AVERAGEBALANCE
    
    RATE
    
    BALANCE
    
    RATECertificates of deposit
    
    $
    1,788,371
    
    
    
    3.13
    %
    
    $
    1,535,835
    
    
    
    3.12
    %Regular passbook savings
    
    
    385,953
    
    
    
    2.24
    %
    
    
    268,990
    
    
    
    2.51
    %NOW accounts
    
    
    591,533
    
    
    
    2.13
    %
    
    
    497,277
    
    
    
    2.19
    %Non-interest bearing
    
    
    383,043
    
    
    
    
    
    
    
    349,531
    
    
    
    Total deposits
    
    $
    3,148,900
    
    
    
    2.45
    %
    
    $
    2,651,633
    
    
    
    2.83
    %
 The following table sets forth the maturities of certificates of deposit
having principal amounts of $100,000 or more at June 30, 2004. TABLE O
CERTIFICATES OF DEPOSIT MATURITIES
(IN THOUSANDS) AMOUNTCertificates of deposit maturitiesThree months or less
    
    $
    194,709Over three through six months.
    
    
    93,108Over six through twelve months
    
    
    258,025Over twelve months
    
    
    952,826Total
    
    $
    1,498,668
 As of June 30, 2004 and December 31, 2003, Doral Financials retail
banking subsidiaries had approximately $1.1 billion and $985.3 million,
respectively, in brokered deposits obtained through broker-dealers. Brokered
deposits are used by Doral Financials banking subsidiaries as a source of
long-term funds. Brokered deposits, however, are generally considered a less
stable source of funding than core deposits obtained through retail bank
branches. Brokered-deposit investors are generally very sensitive to interest
rates and will generally move funds from one depository institution to another
based on minor differences in rates offered on deposits. As of June 30, 2004, Doral Financial, Doral Bank PR and Doral Bank NY were
in compliance with all the regulatory capital requirements that were applicable
to them as a financial holding company, state non-member bank and federal
savings bank, respectively (i.e., total capital and Tier 1 capital to risk
weighted assets of at least 8% and 4%, respectively, and Tier 1 capital to
average assets of at least 4%). Set forth below are Doral Financials, and its
banking subsidiaries regulatory capital ratios as of June 30, 2004, based on
existing Federal Reserve, FDIC and OTS guidelines. 47




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TABLE P
REGULATORY CAPITAL RATIOS DORAL
    
    DORAL
    
    DORALFINANCIAL
    
    BANK PR
    
    BANK NYTotal Capital (Total capital to risk- weighted assets)
    
    
    21.7
    %
    
    
    19.4
    %
    
    
    23.4
    %Tier 1 Capital Ratio (Tier 1 capital to risk- weighted assets)
    
    
    21.3
    %
    
    
    18.7
    %
    
    
    23.2
    %Leverage Ratio (1)
    
    
    13.6
    %
    
    
    6.5
    %
    
    
    9.0
    %
   (1)
    
    Tier 1 capital to average assets in the case of Doral Financial and Doral Bank PR and Tier 1
capital to adjusted total assets in the case of Doral Bank NY. As of June 30, 2004, Doral Bank PR and Doral Bank NY were considered
well-capitalized banks for purposes of the prompt corrective action regulations
adopted by the FDIC pursuant to the Federal Deposit Insurance Corporation
Improvement Act of 1991. To be considered a well capitalized institution under
the FDICs regulations, an institution must maintain a Leverage Ratio of at
least 5%, a Tier 1 Capital Ratio of at least 6% and a Total Capital Ratio of at
least 10% and not be subject to any written agreement or directive to meet a
specific capital ratio. Failure to meet minimum regulatory capital requirements could result in
the initiation of certain mandatory and additional discretionary actions by
banking regulators against Doral Financial and its banking subsidiaries that,
if undertaken, could have a material adverse effect on Doral Financial. The federal banking and thrift regulatory agencies have adopted a rule
that imposes a dollar-for-dollar capital requirement on residual interests
retained in sale or securitization transactions and a 25% limit on the amount
of Tier 1 capital that may consist of credit-enhancing interest-only strips, a
subset of residual interests. Currently, Doral Financial classifies most of the
IOs retained in connection with the sale of its non-conforming loans as
credit-enhancing interest-only strips under the rule and thus Doral Financials
IOs are subject to a dollar-for-dollar capital requirement for risk based
capital purposes and to the 25% concentration limit for Tier 1 capital
purposes. The capital ratios set forth above incorporate the impact of the
capital rule for IOs. Subject to certain exceptions, the entire amount of assets sold with
recourse, not just the contractual amount of the recourse obligation, is
converted into an on-balance sheet credit equivalent amount for risk-based
capital requirements. The credit equivalent amount, less any recourse liability
reflected on the balance sheet, is then risk weighted for purposes of applying
the applicable capital requirement. The risk weighting for residential mortgage
loans is currently 50%. As of June 30, 2004, Doral Financials outstanding
balance of loans sold with full or partial recourse was $2.9 billion. Substantially all of Doral Financials recourse obligations and IOs are
recorded at the holding company level and, accordingly, the rule only impacts
the regulatory requirements applicable to Doral Financial as a financial
holding company and has no impact on the banking subsidiaries. While the impact
of this rule is to reduce Doral Financials regulatory capital ratios at the
holding company level, Doral Financial anticipates that it will continue to
comply with all applicable capital requirements. Doral Financial expects that it will continue to have adequate liquidity,
financing arrangements and capital resources to finance its operations. Doral
Financial will continue to explore alternative and supplementary methods of
financing its operations, including both debt and equity financing. There can
be no assurance, however, that Doral Financial will be successful in
consummating any such transactions. ASSETS AND LIABILITIES At June 30, 2004, Doral Financials total assets were $13.3 billion
compared to $10.4 billion at December 31, 2003. The increase in assets was due
primarily to an increase in the investment securities portfolio of $1.5
billion, resulting from Doral Financials strategy to increase its tax-exempt
interest income by investing in U.S. Treasury and agency securities and the
restructuring of its investment portfolio by selling lower yielding instruments
and replacing them with higher yielding instruments. The increase in assets
also reflects an increase in cash and money market investments of $747.2
million, resulting from a higher volume of liquid assets accumulated by the
Company in anticipation of rising interest rates, and an increase of $522.4
million in accounts receivable from investment sales. Total liabilities were
$11.6 billion at June 30, 2004, compared to $8.8 billion at December 31, 2003.
The increase in liabilities was largely the result of an increase in securities
sold under agreements to repurchase, deposit accounts, loans payable and notes
payable used to fund Doral Financials increase in assets. Also, accounts
payable from investment purchases increased by $509.1 million to $511.4 million
for the first half of 2004 from $2.2 million as of December 31, 2003. At June
30, 2004, deposit accounts totaled $3.2 billion, compared to $3.0 billion at
December 31, 2003. As of June 30, 2004, Doral Financials banking subsidiaries
had $9.1 billion in assets, compared to $7.2 billion at December 31, 2003. 48




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OFF-BALANCE SHEET ACTIVITIES In the ordinary course of business, loans that do not qualify for the
insurance or guarantee programs of FHA and VA, or the sale or exchange programs
of FNMA or FHLMC (non-conforming loans) are often sold to investors on a
partial or full recourse basis pursuant to which Doral Financial retains part
or all of the credit risk associated with such loan after sale. Recourse is
generally limited to a period of time (generally 24 months) or a percentage up
to a 15% of the principal amount of the loans sold. Doral Financials
contingent obligation with respect to such recourse provisions is not reflected
on Doral Financials unaudited consolidated financial statements. As of June
30, 2004, the outstanding principal balance of loans sold subject to full
recourse or partial recourse was $2.9 billion. As of such date the maximum
principal amount in loans that Doral Financial would have been required to
repurchase if all loans subject to recourse defaulted was $2.3 billion. As of
June 30, 2004, Doral Financial maintained a reserve of $4.3 million for
estimated losses from such recourse agreements, which is included in Accrued
expenses and other liabilities in Doral Financials unaudited consolidated
financial statements. During the first half of 2004, Doral Financial
repurchased approximately $56.1 million of loans subject to recourse.
Historically, losses on recourse obligations have not been significant. As of
June 30, 2004, approximately $130.6 million or 4% of the principal amount of
loans sold with recourse were 60 days or more past due. The Company is a party to financial instruments with off-balance sheet
risk in the normal course of business to meet the financing needs of its
customers. These financial instruments may include commitments to extend credit
and sell mortgage-backed securities and loans. These instruments involve, to
varying degrees, elements of credit and interest rate risk in excess of the
amount recognized in the statement of financial position. The contractual amounts of these instruments reflect the extent of
involvement the Company has in particular classes of financial instruments.
The Companys exposure to credit losses in the event of nonperformance by the
other party to the financial instrument for commitments to extend credit or for
forward sales is represented by the contractual amount of these instruments.
The Company uses the same credit policies in making these commitments as it
does for on-balance sheet instruments. At June 30, 2004, commitments to extend
credit and commercial and financial standby letters of credit amounted to
approximately $478.2 million and $3.2 million, respectively, and commitments to
sell/purchase mortgage-backed securities and loans amounted to approximately
$1.4 billion. Management believes that the Company has the ability to meet
these commitments and that no loss will result from the same. Commitments to
extend credit are agreements to lend to a customer as long as the conditions
established in the contract are met. Commitments generally have fixed
expiration dates or other termination clauses. A letter of credit is an arrangement that represents an obligation on the
part of the Company to a designated third party, contingent upon the failure of
the Companys customer to perform under the terms of the underlying contract
with a third party. The amount in letters of credit represents the maximum
amount of credit risk in the event of non-performance by these customers.
Under the terms of a letter of credit, an obligation arises only when the
underlying event fails to occur as intended, and the obligation is generally up
to a stipulated amount and with specified terms and conditions. Letters of
credit are used by the customer as a credit enhancement and typically expire
without having been drawn upon. 49




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CONTRACTUAL OBLIGATIONS AND OTHER COMMERCIAL COMMITMENTS The tables below summarize Doral Financials contractual obligations, on
the basis of contractual maturity or first call date, whichever is earlier, and
other commercial commitments as of June 30, 2004. TABLE Q
CONTRACTUAL OBLIGATIONS
(IN THOUSANDS) PAYMENT DUE BY PERIODLESS THAN
    
    
    
    
    
    
    
    
    
    AFTERCONTRACTUAL OBLIGATIONS
    
    TOTAL
    
    1 YEAR
    
    1-3 YEARS
    
    3-5 YEARS
    
    5 YEARSDeposits
    
    $
    3,239,396
    
    
    $
    2,226,757
    
    
    $
    681,508
    
    
    $
    330,297
    
    
    $
    834Repurchase and warehousing lines of credit (1)
    
    
    5,684,106
    
    
    
    5,119,306
    
    
    
    120,000
    
    
    
    444,800
    
    
    
    Advances from FHLB (1)
    
    
    1,194,500
    
    
    
    542,500
    
    
    
    535,000
    
    
    
    117,000
    
    
    
    Notes Payable
    
    
    710,246
    
    
    
    206,345
    
    
    
    214,728
    
    
    
    10,715
    
    
    
    278,458Other liabilities and obligations
    
    
    794,992
    
    
    
    725,225
    
    
    
    27,000
    
    
    
    27,000
    
    
    
    15,767Non-cancellable Operating Leases
    
    
    56,716
    
    
    
    5,870
    
    
    
    10,656
    
    
    
    9,525
    
    
    
    30,665Total Contractual Cash Obligations
    
    $
    11,679,956
    
    
    $
    8,826,003
    
    
    $
    1,588,892
    
    
    $
    939,337
    
    
    $
    325,724
   (1)
    
    Includes $1.7 billion of repurchase agreements with an average rate of 4.35% and $872.5 million in advances from the FHLB-NY with an average rate of 4.50% for which the lenders have the right to call before their contractual maturities. The
majority of such repurchase agreements and advances from the FHLB-NY are included in the less than one year category in the above table but have actual contractual maturities ranging from March 2005 to March 2013. They are included on the first call
date basis because increases in interest rates over the average rate of the Companys callable borrowings may induce the lenders to exercise their call right. TABLE R
OTHER COMMERCIAL COMMITMENTS(1)
(IN THOUSANDS) AMOUNT OF COMMITMENT EXPIRATION PER PERIODTOTALOTHER COMMERCIAL
    
    AMOUNT
    
    LESS THAN
    
    
    
    
    
    
    
    
    
    AFTERCOMMITMENTS
    
    COMMITTED
    
    1 YEAR
    
    1-3 YEARS
    
    3-5 YEARS
    
    5 YEARSCommitments to extend credit
    
    $
    478,176
    
    
    $
    240,551
    
    
    $
    237,339
    
    
    $
    200
    
    
    $
    86Commitments to sell/purchase mortgage-backed
securities and loans
    
    
    1,400,934
    
    
    
    1,400,934
    
    
    
    
    
    
    
    
    
    
    
    Commercial and financial standby letters of credit
    
    
    3,188
    
    
    
    3,188
    
    
    
    
    
    
    
    
    
    
    
    Standby repurchase (recourse) obligations
    
    
    2,281,707
    
    
    
    303,454
    
    
    
    1,433,903
    
    
    
    
    
    
    
    544,350Total
    
    $
    4,164,005
    
    
    $
    1,948,127
    
    
    $
    1,671,242
    
    
    $
    200
    
    
    $
    544,436
   (1)
    
    Refer to Off-Balance Sheet Activities for additional information regarding other commercial commitments of the Company. INTEREST RATE RISK MANAGEMENT General.Interest rate fluctuation is the primary market risk affecting
Doral Financial. The effect of changes in interest rates on the volume of
mortgage loan originations, the net interest income earned on Doral Financials
portfolio of loans and securities, the amount of gain on sale of loans, and the
value of Doral Financials loan servicing portfolio and securities holdings, as
well as Doral Financials strategies to manage such effects, are discussed in
Doral Financials Annual Report to Shareholders, which information is also
incorporated by reference into the Companys Annual Report on Form 10-K for the
year ended December 31, 2003 under Managements Discussion and Analysis of
Financial Condition and Results of Operations - Interest Rate Risk Management. In the future, Doral Financial may use alternative hedging techniques
including futures, options, interest rate swap agreements or other hedge
instruments to help mitigate interest rate and market risk. However, there can
be no assurance that any of the above hedging techniques will be successful. To
the extent they are not successful, Doral Financials profitability may be
adversely affected. For additional information on the use of derivatives to
manage interest rate risk, see Derivatives below. Interest Rate Sensitivity Analysis.Doral Financial employs a variety of
measurement techniques to identify and manage its interest rate risk, including
the use of an earnings simulation model to analyze net interest income
sensitivity to 50




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changing interest rates. The model is based on actual cash flows and
repricing characteristics for on-balance and certain off-balance sheet
instruments and incorporates market-based assumptions regarding the effect of
changing interest rates on the prepayment rates of certain assets and
liabilities. Assumptions based on the historical behavior of deposit rates and
balances in relation to changes in interest rates are also incorporated into
the model. This sensitivity analysis is limited by the fact that it is
performed at a particular point in time, is subject to the accuracy of various
assumptions, including prepayment forecasts, and does not incorporate other
factors that could impact Doral Financials overall performance in each
scenario. Accordingly, the estimates resulting from the use of the model
should not be viewed as an earnings forecast. Actual results will differ from
simulated results due to timing, magnitude, and frequency of interest rate
changes as well as changes in market conditions and management strategies. The Risk Management Committee, which comprises members of senior
management and reports to Doral Financials Board of Directors, monitors
interest rate risk within Board-approved policy limits. Doral Financials
current interest rate risk policy limits are primarily determined by measuring
the anticipated change in net interest income over a 12-month horizon assuming
a 100- and 200- basis point linear increase or decrease in interest rates. The
current policy limits this exposure to a 30% reduction in net interest income
for a 12-month horizon under a 200-basis point increase or decrease in interest
rates. The following table shows Doral Financials net interest income
sensitivity profile as of June 30, 2004, and December 31, 2003: TABLE S
INTEREST RATE SENSITIVITY
AS OF JUNE 30, 2004 PERCENTAGE CHANGECHANGE IN INTEREST RATES
    
    IN 12-MONTH(BASIS POINTS)
    
    NET INTEREST INCOME+200
    
    3.2%+100
    
    2.1%-100
    
    (6.7%)-200
    
    (10.7%)
 INTEREST RATE SENSITIVITY
AS OF DECEMBER 31, 2003 PERCENTAGE CHANGECHANGE IN INTEREST RATES
    
    IN 12-MONTH(BASIS POINTS)
    
    NET INTEREST INCOME+200
    
    8.5%+100
    
    5.3%-100
    
    (7.2%)-200
    
    (10.6%)
 Given a linear 100 and 200 basis point increase in the yield curve used in
the simulation model, it is estimated net interest income for Doral Financial
would increase by 2.1% and 3.2% over one year. The model assumes that the
portfolio of loans held for sale and trading securities reprice at least twice
a year, as such assets are sold and replaced with new assets at current market
rates. A 200 basis point linear decrease in interest rates would reduce net
interest income by 10.7% over one year. All these estimated changes in net
interest income are within the policy guidelines established by Doral
Financials Board of Directors. In addition to the sales assumptions mentioned
above, the model does not assume a full 100 or 200 basis point decrease in
rates for short-term assets and liabilities, principally due to the historical
low level of short-term interest rates. In such cases, the yield curve was
assigned a minimum (floor) value. Also, in both upward and downward rate
scenarios, the increase or decrease in rates was modeled over a specific time
period (3-6 months) rather than an instantaneous shock in rates, in order to
reflect what has been the historical trend of changes in market rates. While the sensitivity model serves as a useful tool for measuring
short-term risk to future net interest income, it does not measure the
sensitivity of the market value of Doral Financials assets or other sources of
income such as trading activities and mortgage loan sales to changes in
interest rates. Derivatives.Doral Financial uses derivatives to manage its exposure to
interest rate risk caused by changes in interest rates beyond the control of
management. Derivatives include interest rate swaps, interest rate collars,
futures, forwards and options. Derivatives are generally either
privately-negotiated over-the-counter (OTC) or standard contracts transacted
through regulated exchanges. OTC contracts generally consist of swaps,
collars, forwards and options. Exchange-traded derivatives include futures and
options. 51




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The Company has purchased various interest rate collars, intended to
protect the Company against significant increases in interest rates. The
following table summarizes the Companys interest rate collars outstanding at
June 30, 2004. TABLE T
INTEREST RATE COLLARS
(DOLLARS IN THOUSANDS) MATURITY
    
    ENTITLED PAYMENT
    
    PREMIUM
    
    FAIRNOTIONAL AMOUNT
    
    DATE
    
    CONDITIONS
    
    PAID
    
    VALUEExcess 3-month$200,000
    
    June 2006
    
    LIBOR and 5.0%
    
    $4,865
    
    $346Excess 3-monthLIBOR and 5.5%provided that3-month LIBOR is$400,000
    
    March 2007
    
    less than 8.5%
    
    $5,760
    
    $908Excess 3-monthLIBOR and 5.5%provided that3-month LIBOR is$600,000
    
    September 2007
    
    less than 8.5%
    
    $5,570
    
    $2,491Excess 3-monthLIBOR and 5.5%provided that3-month LIBOR is$100,000
    
    February 2008
    
    less than 8.0%
    
    $955
    
    $760Excess 3-monthLIBOR and 5.0%provided that3-month LIBOR is$100,000
    
    April 2008
    
    less than 8.0%
    
    $1,000
    
    $799Excess 3-monthLIBOR and 8.0%provided that3-month LIBOR is$200,000
    
    April 2008
    
    less than 10.0%
    
    $353
    
    $146Excess 3-monthLIBOR and 5.0%provided that3-month LIBOR is$300,000
    
    July 2008
    
    less than 8.0%
    
    $2,715
    
    $2,837
 From time to time, Doral Bank PR enters into interest rate swap agreements
to manage its interest rate exposure. Interest rate swap agreements generally
involve the exchange of fixed and floating rate interest payment obligations
without the exchange of the underlying principal. Non-performance by the
counterparty exposes Doral Bank PR to interest rate risk. At June 30, 2004,
Doral Bank PR had two interest rate swaps agreements outstanding (each with a
notional amount of $100.0 million) that are intended to protect Doral Bank PR
from the repricing of its short-term liabilities during a rising interest rate
environment. These agreements end on September 11, 2007 and September 12,
2007, respectively. The interest rate to be received on these swaps agreements
is 100% of the three-month LIBOR rate. The rate being received by Doral Bank PR
on each of these swap agreements was 1.43% and 1.47%, respectively, as of June
30, 2004. The fixed interest rate payable by Doral Bank PR under these
agreements was 3.6875% and 3.655%, respectively, as of June 30, 2004. At June
30, 2004, the agreements had an aggregate negative fair value of approximately
$201,000 which is recorded as a liability in Doral Financials unaudited
consolidated financial statements. Although Doral Financial uses derivatives to manage market risk, for
financial reporting purposes, its general policy is to account for such
instruments on a marked-to-market basis with gains or losses charged to current
operations as they occur. Contracts with positive fair values are recorded as
assets and contracts with negative fair values as liabilities, after the
application of netting arrangements, with unrealized gains and losses recorded
either in other comprehensive income or in the results of operations, depending
on the purpose for which the derivative is held. Under SFAS No. 133, Accounting
for Derivative Instruments and Hedging Activities, as subsequently amended, the
Company may designate a derivative as a hedge of the fair value of a recognized
fixed rate asset or liability (fair value hedge). Certain hedging activities
related to certain available for sale securities are accounted for as a fair
value hedge. In a qualifying fair value hedge, both the changes in fair value
of the hedged item (in this case available for sale securities) and changes in
fair value of the derivative are included in trading activities in the
statement of income. As a result, any hedge ineffectiveness is reflected
immediately in earnings. At the inception of a hedge transaction, the Company
formally documents the hedge relationship and the risk management objective and
strategy for undertaking the hedge. This process includes identification of
the hedging instrument, hedged item, risk being hedged and the methodology for
measuring effectiveness. During the quarter ended June 30, 2004, the Company
recognized pre-tax losses of $2.4 million that represents the ineffective
portion of the fair value hedges of its available for sale securities. 52




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Fair values of derivatives such as interest rate future contracts or
options are determined by reference to market prices. Fair values of
derivatives purchased in the over-the-counter market are determined by prices
provided by external sources or valuation models. The notional amounts of
assets and liabilities related to these derivatives totaled $4.1 billion and
$2.6 billion, respectively, as of June 30, 2004. Notional amounts indicate the
volume of derivatives activity, but do not represent Doral Financials exposure
to market or credit risk. The table below summarizes the fair values of Doral Financials
derivatives, as well as the source of the fair values. TABLE U
FAIR VALUE RECONCILIATION
(IN THOUSANDS) SIX MONTH PERIODENDED JUNE 30, 2004Fair value of contracts outstanding at the beginning of the period
    
    $
    5,573Contracts realized or otherwise settled during the period
    
    
    (47,779
    )Fair value of new contracts entered into during the period
    
    
    39,017Other changes in fair values
    
    
    (4,597
    )Fair value of contracts outstanding at the end of the period
    
    $
    (7,786
    )
 TABLE V
SOURCE OF FAIR VALUE
(IN THOUSANDS) PAYMENT DUE BY PERIODMATURITY
    
    
    
    
    
    
    
    
    
    MATURITY
    
    TOTALAS OF JUNE 30, 2004
    
    LESS THAN
    
    MATURITY
    
    MATURITY
    
    IN EXCESS
    
    FAIRSOURCE OF FAIR VALUE
    
    1 YEAR
    
    1-3 YEARS
    
    3-5 YEARS
    
    OF 5 YEARS
    
    VALUEPrices actively quoted
    
    $
    (17,085
    )
    
    $
    863
    
    
    $
    350
    
    
    $
    
    
    
    $
    (15,872
    )Prices provided by other external sources
    
    
    
    
    
    
    1,254
    
    
    
    6,832
    
    
    
    
    
    
    
    8,086$
    (17,085
    )
    
    $
    2,117
    
    
    $
    7,182
    
    
    $
    
    
    
    $
    (7,786
    )
 The use of derivatives involves market and credit risk. The market risk
of derivatives arises principally from the potential for changes in the value
of derivative contracts based on changes in interest rates. Doral Financial
generally manages its risks by taking risk-offsetting positions. The credit risk of derivatives arises from the potential of a counterparty
to default on its contractual obligations. To manage this credit risk, Doral
Financial deals with counterparties of good credit standing, enters into master
netting agreements whenever possible and, when appropriate, obtains collateral.
Master netting agreements incorporate rights of set-off that provide for the
net settlement of contracts with the same counterparty in the event of default.
The credit risk associated with futures contracts is also limited due to daily
cash settlement of the net change in the value of open contracts with the
exchange on which the contract is traded. INFLATION General and administrative expenses generally increase with inflation.
However, the increase in real estate values in Puerto Rico in recent years has
been a positive factor for Doral Financials mortgage banking business. The
average size of loans originated tends to increase as home values appreciate,
which serves to increase loan origination fees and servicing income faster than
the cost of providing such services. Additionally, appreciation in real estate
property values reduces the loan-to-value ratios of existing loans thereby
reducing credit exposure. Interest rates normally increase during periods of
high inflation and decrease during periods of low inflation. See Interest Rate
Risk Management in the Managements Discussion and Analysis of Financial
Condition and Results of Operations section of the Companys Annual Report on
Form 10-K for the year ended December 31, 2003 for a discussion of the effects
of changes of interest rates on Doral Financials operations. 53




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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK For information regarding market risk to which the Company is exposed, see
the information contained under the caption Managements Discussion and
Analysis of Financial Condition and Results of Operations - Interest Rate Risk
Management. 
 ITEM 4. CONTROLS AND PROCEDURES Disclosure Control and Procedures Doral Financials management, including its Chief Executive Officer and
Chief Financial Officer, evaluated the effectiveness of the design and
operation of Doral Financials disclosure controls and procedures (as defined
in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) as
of June 30, 2004. Based upon this evaluation, the Chief Executive Officer and
Chief Financial Officer concluded that the design and operation of these
disclosure controls and procedures were effective. There have not been any changes in the Companys internal control over
financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f)
under the Exchange Act) during the fiscal quarter in which this report relates
that have materially affected, or are reasonably likely to materially affect,
the Companys internal control over financial reporting. 
 PART II - OTHER INFORMATION 
 ITEM 1 - LEGAL PROCEEDINGS In the opinion of the Companys management, the pending and threatened
legal proceedings of which management is aware will not have a material adverse
effect on the financial condition of the Company. 
 ITEM 2 - CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY SECURITIES Not applicable. 
 ITEM 3 - DEFAULTS UPON SENIOR SECURITIES Not applicable. 
 ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS The proposals and the results of the voting on each proposal submitted at
Doral Financials annual meeting of shareholders was previously disclosed in the
Companys Quarterly Report on Form 10-Q for the quarter ended March 31, 2004,
and is incorporated herein by reference. 
 ITEM 5 - OTHER INFORMATION Declaration of Cash Dividend.On July 14, 2004, the Board of Directors of
Doral Financial voted to declare a cash dividend of $0.15 per common share
payable on September 10, 2004, to shareholders of record on August 27, 2004. On July 14, 2004, a Committee of the Board of Directors of Doral Financial
also voted to declare a cash dividend of $2.96875 per share on the Companys
4.75% Perpetual convertible cumulative preferred stock (liquidation preference
$250 per share) payable on September 15, 2004, to shareholders of record on
September 1, 2004. On June 7, 2004, Doral Financial closed the sale of $115,000,000 of its
Floating Rate Senior Notes due December 7, 2005. The notes were sold at par,
resulting in proceeds to Doral Financial, after selling commissions but before
expenses of approximately $114,885,000. On July 20, 2004, Doral Financial closed the sale of $350,000,000 of its
Floating Rate Senior Notes due July 20, 2007. The notes were sold at par,
resulting in proceeds to Doral Financial, after selling commissions but before
expenses of approximately $349,300,000. 54




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ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K  (a)
    
    Exhibits 1.1
    
    -
    
    Underwriting Agreement, dated as of June 2,
2004, between Doral Financial
Corporation and UBS Securities, LLC (incorporated by
reference to Exhibit 1.1 to Current Report on Form 8-K
dated June 7, 2004).1.2
    
    -
    
    Underwriting Agreement, dated as of July 15, 2004,
between Doral Financial
Corporation and Deutsche Bank Securities Inc.
(incorporated by reference to Exhibit 1.1 of Current
Report on Form 8-K dated July 20, 2004).4.1
    
    -
    
    Floating Rate Senior Note due December 7, 2005
(incorporated by reference to
Exhibit 4.1 to Current Report on Form 8-K dated June 7, 2004).4.2
    
    -
    
    Floating Rate Senior Note due July 20, 2007 (incorporated by reference to
Exhibit 4.1 to Current Report on Form 8-K dated July 20, 2004).12.a
    
    -
    
    Computation of Ratio of Earnings to Fixed Charges.12.b
    
    -
    
    Computation of Ratio of Earnings to Fixed Charges
and Preferred Stock Dividends.31.1
    
    -
    
    CEO Certification pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.31.2
    
    -
    
    CFO Certification pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.32.1
    
    -
    
    CEO Certifications pursuant to 18 U.S.C. Section
1350, as adopted pursuant to the Sarbanes-Oxley Act of 2002.32.2
    
    -
    
    CFO Certifications pursuant to 18 U.S.C. Section
1350, as adopted pursuant to the Sarbanes-Oxley Act of 2002.
 The Company has not filed as exhibits certain instruments defining the
rights of holders of debt of the Company not exceeding 10% of the total assets
of the Company and its consolidated subsidiaries. The Company will furnish
copies of any such instruments to the Securities and Exchange Commission upon
request.  (b)
    
    Reports on Form 8-K i.
    
    Current Report on Form 8-K, dated June 7, 2004,
(a) reporting under Items 5 and 7 that the Company closed the
issuance and sale of $115,000,000 of its Floating Rate Senior
Notes due December 7, 2005 and (b) filing as an exhibit under
Item 7 thereof the Underwriting Agreement, dated as of June 2,
2004 between Doral Financial Corporation and UBS Securities
LLC, including the form of Floating Rate Senior Notes due
December 7, 2005.ii.
    
    Current Report on Form 8-K, dated June 18, 2004,
(a) reporting under Items 7 and 9 that the Company intends to
use an investor presentation in one or more meetings with
investors and analysts and (b) filing as an exhibit under Item
7 a copy of the related investor presentation.iii
    
    Current Report on Form 8-K, dated June 29, 2004,
(a) reporting under Items 7 and 9 the issuance of a press
release stating that contrary to recent announcements by
US-based mortgage lenders, the Company did not believe that
the recent increase in interest rates, would have an adverse
effect on the Companys operations and anticipates record loan
production in 2004. The Company also announced plans to release
its second quarter 2004 earnings on July 14, 2004 immediately
following the close of regular trading in the New York Stock
Exchange and (b) filing as exhibits under Item 7 a copy of the
related press release dated June 29, 2004.iv
    
    Current Report on Form 8-K, dated July 14, 2004,
reporting under Items 7 and 12 (a) the issuance of a press
release announcing the unaudited earnings results for the
quarter ended June 30, 2004 and (b) filing as an exhibit under
Items 7 a copy of the related press release dated July 14,
2004.v
    
    Current Report on Form 8-K, dated July 20, 2004,
(a) reporting under Items 5 and 7 that the Company closed the
issuance and sale of $350,000,000 of its Floating Rate Senior
Notes due July 20, 2007 and (b) filing as an exhibit under
Item 7 thereof the Underwriting Agreement, dated as of July
15, 2004 between Doral Financial Corporation and Deutsche Bank
Securities Inc., including the form of Floating Rate Senior
Notes due July 20, 2007.
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##### Table of Contents



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 hereunto duly authorized. DORAL FINANCIAL CORPORATION
(Registrant)Date: August 9, 2004
    
    /s/   Salomón LevisSalomón LevisChairman of the Boardand Chief Executive Officer
 Date: August 9, 2004
    
    /s/   Ricardo MeléndezRicardo MeléndezExecutive Vice President andChief Financial Officer
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##### Table of Contents



INDEX TO EXHIBITS ExhibitNumber
    
    
    
    Description1.1
    
    -
    
    Underwriting Agreement, dated as of June 2,
2004, between Doral Financial
Corporation and UBS Securities, LLC (incorporated by
reference to Exhibit 1.1 to Current Report on Form 8-K
dated June 7, 2004).1.2
    
    -
    
    Underwriting Agreement, dated as of July 15, 2004,
between Doral Financial
Corporation and Deutsche Bank Securities Inc.
(incorporated by reference to Exhibit 1.1 of Current
Report on Form 8-K dated July 20, 2004).4.1
    
    -
    
    Floating Rate Senior Note due December 7, 2005
(incorporated by reference to
Exhibit 4.1 to Current Report on Form 8-K dated June 7, 2004).4.2
    
    -
    
    Floating Rate Senior Note due July 20, 2007 (incorporated by reference to
Exhibit 4.1 to Current Report on Form 8-K dated July 20, 2004).12.1
    
    -
    
    Computation of Ratio of Earnings to Fixed Charges.12.2
    
    -
    
    Computation of Ratio of Earnings to Fixed Charges and Preferred Stock Dividends.31.1
    
    -
    
    CEO Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.31.2
    
    -
    
    CFO Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.32.1
    
    -
    
    CEO Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant toSection 906 of the Sarbanes-Oxley Act of 2002.32.2
    
    -
    
    CFO Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant toSection 906 of the Sarbanes-Oxley Act of 2002.