OFG BANCORP - Quarter Report: 2009 September (Form 10-Q)

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANG ACT OF 1934

Commission File Number 001-12647

Oriental Financial Group Inc.

Incorporated in the Commonwealth of Puerto Rico,		IRS Employer Identification No. 66-0538893

Principal Executive Offices:
997 San Roberto Street
Oriental Center 10th Floor
Professional Offices Park
San Juan, Puerto Rico 00926
Telephone Number: (787) 771-6800

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes þ No o

      Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes o No o

      Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o		Accelerated filer þ		Non-accelerated filer o (Do not check if a smaller reporting company)		Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o No þ

Number of shares outstanding of the registrant’s common stock, as of the latest practicable date:

24,233,762 common shares ($1.00 par value per share)
outstanding as of October 31, 2009

 

 

TABLE OF CONTENTS

		Page
Part I FINANCIAL INFORMATION:
Item 1 Financial Statements
Unaudited consolidated statements of financial condition at September 30, 2009 and December 31, 2008			1
Unaudited consolidated statements of operations for the quarters and nine-month periods ended September 30, 2009 and 2008			2
Unaudited consolidated statements of changes in stockholders’ equity for the nine-month periods ended September 30, 2009 and 2008			3
Unaudited consolidated statements of comprehensive income for the quarters and nine-month periods ended September 30, 2009 and 2008			3
Unaudited consolidated statements of cash flows for the nine-month periods ended September 30, 2009 and 2008			4
Notes to unaudited consolidated financial statements			5
Item 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations			33
Item 3 Quantitative and Qualitative Disclosures About Market Risk			53
Item 4 Controls and Procedures			56
PART II OTHER INFORMATION:
Item 1 Legal Proceedings			57
Item 1A Risk Factors			57
Item 2 Unregistered Sales of Equity Securities and Use of Proceeds			57
Item 3 Defaults Upon Senior Securities			57
Item 4 Submissions of Matters to a Vote of Security Holders			57
Item 5 Other Information			57
Item 6 Exhibits			57
Signatures			58
Certifications
EX-10.28
EX-31.1
EX-31.2
EX-32.1
EX-32.2

FORWARD-LOOKING STATEMENTS

When used in this Form 10-Q or future filings by Oriental Financial Group Inc. (the “Group”) with the Securities and Exchange Commission (the “SEC”), in the Group’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,” “estimated,” “project,” “believe,” “should” or similar expressions are intended to identify “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995.

The future results of the Group could be affected by subsequent events and could differ materially from those expressed in forward-looking statements. If future events and actual performance differ from the Group’s assumptions, the actual results could vary significantly from the performance projected in the forward-looking statements.

The Group wishes to caution readers not to place undue reliance on any such forward-looking statements, which speak only as of the date made and are based on management’s current expectations, and to advise readers that various factors, including local, regional and national economic conditions, substantial changes in levels of market interest rates, credit and other risks of lending and investment activities, competitive, and regulatory factors, legislative changes and accounting pronouncements, could affect the Group’s financial performance and could cause the Group’s actual results for future periods to differ materially from those anticipated or projected. The Group 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.

PART – I FINANCIAL INFORMATION

ITEM

UNAUDITED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
SEPTEMBER 30, 2009 AND DECEMBER 31, 2008

(In thousands, except share data)

		September 30,				December 31,
		2009				2008
ASSETS
Cash and due from banks		$	170,443			$	66,372
Investments:
Trading securities, at fair value with amortized cost of $37 (December 31, 2008 - $255)			39				256
Investment securities available-for-sale, at fair value with amortized cost of $4,604,048 (December 31, 2008 - $4,052,574)
Securities pledged that can be repledged			3,919,168				3,790,733
Other investment securities			573,458				133,474
Total investment securities available-for-sale			4,492,626				3,924,207
Other Investments			150				150
Federal Home Loan Bank (FHLB) stock, at cost			19,937				21,013
Total investments			4,512,752				3,945,626
Securities sold but not yet delivered			417,280				834,976
Loans:
Mortgage loans held-for-sale, at lower of cost or fair value			26,213				26,562
Loans receivable, net of allowance for loan losses of $20,176 (December 31, 2008 - $14,293)			1,125,379				1,192,550
Total loans, net			1,151,592				1,219,112
Accrued interest receivable			39,970				43,914
Deferred tax asset, net			26,590				28,463
Premises and equipment, net			20,202				21,184
Foreclosed real estate			8,319				9,162
Investment in equity indexed options			5,983				12,801
Other assets			27,915				23,926
Total assets		$	6,381,046			$	6,205,536
LIABILITIES AND STOCKHOLDERS’ EQUITY
Deposits:
Demand deposits		$	775,503			$	453,690
Savings accounts			66,713				50,152
Certificates of deposit			1,075,689				1,281,458
Total deposits			1,917,905				1,785,300
Borrowings:
Federal funds purchased and other short term borrowings			35,328				29,193
Securities sold under agreements to repurchase			3,557,086				3,761,121
Advances from FHLB			281,741				308,442
FDIC-guaranteed term notes			105,112				—
Subordinated capital notes			36,083				36,083
Total borrowings			4,015,350				4,134,839
Securities purchased but not yet received			30,945				398
Accrued expenses and other liabilities			34,277				23,682
Total liabilities			5,998,477				5,944,219
Stockholders’ equity:
Preferred stock, $1 par value; 5,000,000 shares authorized; $25 liquidation value; 1,340,000 shares of Series A and 1,380,000 shares of Series B issued and outstanding			68,000				68,000
Common stock, $1 par value; 40,000,000 shares authorized; 25,739,397 shares issued; 24,232,301 shares outstanding (December 31, 2008 - 25,739,397; 24,297,132)			25,739				25,739
Additional paid-in capital			213,264				212,625
Legal surplus			52,659				43,016
Retained earnings			146,421				51,233
Treasury stock, at cost 1,507,096 shares (December 31, 2008 - 1,442,265 shares)			(17,147	)			(17,109	)
Accumulated other comprehensive loss, net of tax of $4,881 (December 31, 2008 - $6,004)			(106,367	)			(122,187	)
Total stockholders’ equity			382,569				261,317
Total liabilities and stockholders’ equity		$	6,381,046			$	6,205,536

See notes to unaudited consolidated financial statements.

UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE QUARTERS AND NINE-MONTH PERIODS ENDED SEPTEMBER 30, 2009 AND 2008

(In thousands, except per share data)

		Quarter Ended September 30,								Nine-Month Period Ended September 30,
		2009				2008				2009				2008
Interest income:
Loans		$	18,251			$	19,971			$	55,278			$	59,481
Mortgage-backed securities			48,750				47,040				151,179				134,306
Investment securities and other			11,552				17,733				38,078				58,216
Total interest income			78,553				84,744				244,535				252,003
Interest expense:
Deposits			13,990				12,202				41,962				36,746
Securities sold under agreements to repurchase			27,209				40,456				90,937				120,904
Advances from FHLB and other borrowings			3,106				3,505				9,277				11,042
FDIC-guaranteed term notes			1,021				—				2,154				—
Subordinated capital notes			333				540				1,158				1,776
Total interest expense			45,659				56,703				145,488				170,468
Net interest income			32,894				28,041				99,047				81,535
Provision for loan losses			4,400				1,950				11,250				5,580
Net interest income after provision for loan losses			28,494				26,091				87,797				75,955
Non-interest income:
Financial service revenues			3,764				3,756				10,163				12,496
Banking service revenues			1,422				1,406				4,381				4,328
Investment banking revenues (losses)			—				200				(4	)			950
Mortgage banking activities			2,232				910				7,191				2,461
Total banking and financial service revenues			7,418				6,272				21,731				20,235
Excess of amortized costs over fair value on other-than-temporarily impaired securities			(44,737	)			(58,804	)			(107,331	)			(58,804	)
Non-credit related unrealized loss on securities recognized in other comprehensive income			36,478				—				94,656				—
Other-than-temporary impairments on securities			(8,259	)			(58,804	)			(12,675	)			(58,804	)
Net gain(loss) on:
Sale of securities			35,528				386				56,388				9,908
Derivatives			(64	)			(5,522	)			19,778				(13,247	)
Early extinguishment of repurchase agreements			(17,551	)			—				(17,551	)			—
Trading securities			(505	)			(31	)			12,427				(32	)
Foreclosed real estate			(278	)			58				(576	)			(452	)
Other investments			10				16				34				132
Other			21				609				60				608
Total non-interest income (loss), net			16,320				(57,016	)			79,616				(41,652	)
Non-interest expenses:
Compensation and employees’ benefits			7,882				7,742				23,626				23,281
Occupancy and equipment			3,747				3,561				10,994				10,213
Professional and service fees			2,459				2,457				7,461				6,604
Insurance			1,273				618				5,560				1,799
Advertising and business promotion			1,097				847				3,329				2,757
Taxes, other than payroll and income taxes			834				644				2,129				1,862
Electronic banking charges			471				428				1,607				1,242
Loan servicing expenses			397				352				1,167				1,022
Communication			382				314				1,163				964
Directors and investor relations			348				273				1,029				854
Clearing and wrap fees expenses			293				294				860				901
Printing, postage, stationery and supplies			194				214				665				736
Other			1,109				453				2,381				1,772
Total non-interest expenses			20,486				18,197				61,971				54,007
Income (loss) before income taxes			24,328				(49,122	)			105,442				(19,704	)
Income tax expense (benefit)			3,001				(4,226	)			8,452				(6,083	)
Net income (loss)			21,327				(44,896	)			96,990				(13,621	)
Less: Dividends on preferred stock			(1,201	)			(1,200	)			(3,602	)			(3,601	)
Income available (loss) to common shareholders		$	20,126			$	(46,096	)		$	93,388			$	(17,222	)
Income (loss) per common share:
Basic		$	0.83			$	(1.90	)		$	3.85			$	(0.71	)
Diluted		$	0.83			$	(1.89	)		$	3.84			$	(0.71	)
Average common shares outstanding			24,303				24,292				24,284				24,249
Average potential common shares-options			65				82				17				100
Average diluted common shares outstanding			24,368				24,374				24,301				24,349
Cash dividends per share of common stock		$	0.04			$	0.14			$	0.12			$	0.42

See notes to unaudited consolidated financial statements.

UNAUDITED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
FOR THE NINE-MONTH PERIODS ENDED SEPTEMBER 30, 2009 AND 2008

(In thousands)

		Nine-Month Period Ended September 30,
		2009				2008
CHANGES IN STOCKHOLDERS’ EQUITY:
Preferred stock:
Balance at beginning and end of period		$	68,000			$	68,000
Common stock:
Balance at beginning of period			25,739				25,557
Stock options exercised			—				181
Balance at end of period			25,739				25,738
Additional paid-in capital:
Balance at beginning of period			212,625				210,073
Stock-based compensation expense			550				444
Capital contribution			89				—
Stock options exercised			—				1,994
Balance at end of period			213,264				212,511
Legal surplus:
Balance at beginning of period			43,016				40,573
Transfer from retained earnings			9,643				—
Balance at end of period			52,659				40,573
Retained earnings:
Balance at beginning of period			51,233				45,296
Cummulative effect on initial adoption of FASB ASC 320-10-65-1			14,359				—
Net income (loss)			96,990				(13,621	)
Cash dividends declared on common stock			(2,916	)			(10,206	)
Cash dividends declared on preferred stock			(3,602	)			(3,601	)
Transfer to legal surplus			(9,643	)			—
Balance at end of period			146,421				17,868
Treasury stock:
Balance at beginning of period			(17,109	)			(17,023	)
Stock used to match defined contribution plan 1165(e)			144				116
Stock purchased			(182	)			(235	)
Balance at end of period			(17,147	)			(17,142	)
Accumulated other comprehensive loss, net of tax:
Balance at beginning of period			(122,187	)			(13,015	)
Cummulative effect on initial adoption of FASB ASC 320-10-65-1			(14,359	)			—
Other comprehensive income (loss), net of tax			30,179				(92,515	)
Balance at end of period			(106,367	)			(105,530	)
Total stockholders’ equity		$	382,569			$	242,018

UNAUDITED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
FOR THE QUARTERS AND NINE-MONTH PERIODS ENDED SEPTEMBER 30, 2009 AND 2008

(In thousands)

		Quarter Ended September 30,								Nine-Month Period Ended September 30,
		2009				2008				2009				2008
COMPREHENSIVE INCOME
Net income (loss)		$	21,327			$	(44,896	)		$	96,990			$	(13,621	)
Other comprehensive income (loss):
Unrealized gain (loss) on securities available-for-sale arising during the period			30,026				(49,336	)			75,015				(129,021	)
Realized gain on investment securities available-for-sale included in net income			(35,528	)			(386	)			(56,388	)			(9,908	)
Excess of amortized cost over fair value on other-than-temporarily impaired securities			44,737				38,932				107,331				38,932
Non-credit related unrealized loss on securities			(36,478	)			—				(94,656	)			—
Income tax effect related to unrealized loss (gain) on securities available-for-sale			716				915				(1,123	)			7,482
Other comprehensive income (loss) for the period			3,473				(9,875	)			30,179				(92,515	)
Comprehensive income (loss)		$	24,800			$	(54,771	)		$	127,169			$	(106,136	)

UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE-MONTH PERIODS ENDED SEPTEMBER 30, 2009 AND 2008

(In thousands)

		Nine-Month Period Ended September 30,
		2009				2008
Cash flows from operating activities:
Net income (loss)		$	96,990			$	(13,621	)
Adjustments to reconcile net income (loss) to net cash used in operating activities:
Amortization of deferred loan origination fees, net of costs			151				(315	)
Amortization of premiums, net of accretion of discounts			9,070				971
Other-than-temporary impairments on securities			12,675				58,804
Depreciation and amortization of premises and equipment			4,505				4,021
Deferred income tax expense (benefit)			750				(4,732	)
Provision for loan losses			11,250				5,580
Common stock used to match defined contribution plan 1165(e)			144				116
Stock-based compensation			550				444
Servicing asset capitalized, net			(4,430	)			(1,165	)
(Gain) loss on:
Sale of securities available-for-sale			(56,388	)			(9,908	)
Sale of mortgage loans held-for-sale			(2,761	)			(1,296	)
Derivatives			(19,778	)			13,247
Early extinguishment of repurchase agreements			17,551				—
Sale of foreclosed real estate			576				452
Sale of premises and equipment			(60	)			1
Originations and purchases of loans held-for-sale			(169,598	)			(99,372	)
Proceeds from sale of loans held-for-sale			88,838				36,920
Net decrease (increase) in:
Trading securities			217				61
Accrued interest receivable			3,944				14,211
Other assets			(4,679	)			(9,391	)
Net increase (decrease) in:
Accrued interest on deposits and borrowings			(3,525	)			1,572
Accrued expenses and other liabilities			10,810				(960	)
Net cash used in operating activities			(3,198	)			(4,360	)
Cash flows from investing activities:
Purchases of:
Investment securities available-for-sale			(9,290,454	)			(2,912,220	)
Equity options			(3,738	)			(11,796	)
FHLB stock			(13,355	)			(4,112	)
Maturities and redemptions of:
Investment securities available-for-sale			3,251,327				1,441,945
Investment securities held-to-maturity			—				281,337
Other investments			—				1,511
FHLB stock			14,431				12,642
Proceeds from sales of:
Investment securities available-for-sale			6,090,572				1,035,000
Foreclosed real estate			6,594				2,501
Premises and equipment			114				55
Origination and purchase of loans, excluding loans held-for-sale			(60,370	)			(127,440	)
Principal repayments of loans			92,437				90,313
Additions to premises and equipment			(3,577	)			(3,209	)
Net cash provided by (used in) investing activities			83,981				(193,473	)
Cash flows from financing activities:
Net increase (decrease) in:
Deposits			142,761				295,431
Securities sold under agreements to repurchase			(217,551	)			(90,023	)
Federal funds purchased and other short term borrowings			6,135				13,566
Proceeds from:
Issuance of FDIC-guaranteed term notes			105,000				—
Advances from FHLB			761,380				1,103,650
Exercise of stock options			—				2,175
Capital contribution			89				—
Repayments of advances from FHLB			(788,080	)			(1,153,650	)
Purchase of treasury stock			(182	)			(235	)
Termination of derivative instruments			20,254				(7,875	)
Dividends paid on common and preferred stock			(6,518	)			(13,807	)
Net cash provided by financing activities			23,288				149,232
Net change in cash and due from banks			104,071				(48,601	)
Cash and due from banks at beginning of period			66,372				88,983
Cash and due from banks at end of period		$	170,443			$	40,382
Supplemental Cash Flow Disclosure and Schedule of Noncash Activities:
Interest paid		$	149,012			$	168,895
Income tax paid		$	74			$	54
Mortgage loans securitized into mortgage-backed securities		$	105,676			$	49,537
Securities sold but not yet delivered		$	417,280			$	4,857
Securities purchased but not yet received		$	30,945			$	—
Transfer from loans to foreclosed real estate		$	6,327			$	6,966

ORIENTAL FINANCIAL GROUP INC.

Notes to Unaudited Consolidated Financial Statements

The accounting and reporting policies of Oriental Financial Group Inc. (the “Group” or “Oriental”) conform with U.S. generally accepted accounting principles (“GAAP”) and to financial services industry practices.

The unaudited consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). All significant intercompany balances and transactions have been eliminated in consolidation. These unaudited statements are, in the opinion of management, a fair statement of the results for the periods reported and include all necessary adjustments, all of a normal recurring nature, for a fair statement of such results. Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such SEC rules and regulations. Management believes that the disclosures made are adequate to make the information presented not misleading. The results of operations and cash flows for the periods ended September 30, 2009 and 2008 are not necessarily indicative of the results to be expected for the full year. For further information, refer to the consolidated financial statements and footnotes thereto for the year ended December 31, 2008, included in the Group’s 2008 annual report on Form 10-K.

Nature of Operations

The Group is a publicly-owned financial holding company incorporated under the laws of the Commonwealth of Puerto Rico. It has four direct subsidiaries, Oriental Bank and Trust (the “Bank”), Oriental Financial Services Corp. (“Oriental Financial Services”), Oriental Insurance, Inc. (“Oriental Insurance”) and Caribbean Pension Consultants, Inc., which is located in Boca Raton, Florida. The Group also has a special purpose entity, Oriental Financial (PR) Statutory Trust II (the “Statutory Trust II”). Through these subsidiaries and its divisions, the Group provides a wide range of financial services such as mortgage, commercial and consumer lending, financial planning, insurance sales, money management and investment banking and brokerage services, as well as corporate and individual trust services. Note 11 to the unaudited consolidated financial statements presents further information about the operations of the Group’s business segments.

The main offices of the Group and its subsidiaries are located in San Juan, Puerto Rico. The Group is subject to examination, regulation and periodic reporting under the U.S. Bank Holding Company Act of 1956, as amended, which is administered by the Board of Governors of the Federal Reserve System.

The Bank operates through 21 financial centers located throughout Puerto Rico and is subject to the supervision, examination and regulation of the Office of the Commissioner of Financial Institutions of Puerto Rico (“OCIF”) and the Federal Deposit Insurance Corporation (“FDIC”). The Bank offers banking services such as commercial and consumer lending, saving and time deposit products, financial planning, and corporate and individual trust services, and capitalizes on its commercial banking network to provide mortgage lending products to its clients. Oriental International Bank Inc. (“OIB”), a wholly-owned subsidiary of the Bank, operates as an international banking entity (“IBE”) pursuant to the International Banking Center Regulatory Act of Puerto Rico, as amended. OIB offers the Bank certain Puerto Rico tax advantages. OIB activities are limited under Puerto Rico law to persons and assets/liabilities located outside of Puerto Rico.

Oriental Financial Services is subject to the supervision, examination and regulation of the Financial Industry Regulatory Authority (“FINRA”), the SEC, and the OCIF. Oriental Insurance is subject to the supervision, examination and regulation of the Office of the Commissioner of Insurance of Puerto Rico.

The Group’s mortgage banking activities are conducted through a division of the Bank. The mortgage banking activities primarily consist of the origination and purchase of residential mortgage loans for the Group’s own portfolio and from time to time, if the conditions so warrant, the Group may engage in the sale of such loans to other financial institutions in the secondary market. The Group originates Federal Housing Administration (“FHA”)-insured and Veterans Administration (“VA”)-guaranteed mortgages that are primarily securitized for issuance of Government National Mortgage Association (“GNMA”) mortgage-backed securities which can be resold to individual or institutional investors in the secondary market. Conventional loans that meet the underwriting requirements for sale or exchange under standard Federal National Mortgage Association (the “FNMA”) or the Federal Home Loan Mortgage Corporation (the “FHLMC”) programs are referred to as conforming mortgage loans and are also securitized for issuance of FNMA or FHLMC mortgage-backed securities. The Group is an approved seller of FNMA, as well as FHLMC, mortgage loans for issuance of FNMA and FHLMC mortgage-backed securities. The Group is also an approved issuer of GNMA mortgage-backed securities. The Group outsources the servicing of the GNMA, FNMA and FHLMC pools that it issues and of its mortgage loan portfolio.

Significant Accounting Policies

The unaudited consolidated financial statements of the Group are prepared in accordance with GAAP and with the general practices within the financial services industry. In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The Group believes that of its significant accounting policies, the following may involve a higher degree of judgment and complexity.

Allowance for Loan Losses

The Group follows a systematic methodology to establish and evaluate the adequacy of the allowance for loan losses to provide for inherent losses in the loan portfolio. This methodology includes the consideration of factors such as economic conditions, portfolio risk characteristics, prior loss experience, and results of periodic credit reviews of individual loans. The provision for loan losses charged to current operations is based on such methodology. Loan losses are charged and recoveries are credited to the allowance for loan losses.

Larger commercial loans that exhibit potential or observed credit weaknesses are subject to individual review and grading. Where appropriate, allowances are allocated to individual loans based on management’s estimate of the borrower’s ability to repay the loan given the availability of collateral, other sources of cash flow and legal options available to the Group.

Included in the review of individual loans are those that are impaired. A loan is considered impaired when, based on current information and events, it is probable that the Group will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Impaired loans are measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate, or as a practical expedient, at the observable market price of the loan or the fair value of the collateral, if the loan is collateral dependent. Loans are individually evaluated for impairment, except large groups of small balance homogeneous loans that are collectively evaluated for impairment, and loans that are recorded at fair value or at the lower of cost or fair value. The Group measures for impairment all commercial loans over $250 thousand and over 90-days past-due. The portfolios of mortgage and consumer loans are considered homogeneous, and are evaluated collectively for impairment.

The Group, using a rating system, applies an overall allowance percentage to each loan portfolio category based on historical credit losses adjusted for current conditions and trends. This delinquency-based calculation is the starting point for management’s determination of the required level of the allowance for loan losses. Other data considered in this determination includes: the overall historical loss trends and other information including underwriting standards and economic trends.

Loan loss ratios and credit risk categories are updated quarterly and are applied in the context of GAAP and the importance of depository institutions having prudent, conservative, but not excessive loan allowances that fall within an acceptable range of estimated losses. While management uses current available information in estimating possible loan losses, factors beyond the Group’s control such as those affecting general economic conditions may require future changes to the allowance.

Financial Instruments

Certain financial instruments including derivatives, trading securities and investment securities available-for-sale are recorded at fair value and unrealized gains and losses are recorded in other comprehensive income or as part of non-interest income, as appropriate. Fair values are based on listed market prices, if available. If listed market prices are not available, fair value is determined based on other relevant factors, including price quotations for similar instruments. The fair values of certain derivative contracts are derived from pricing models that consider current market and contractual prices for the underlying financial instruments as well as time value and yield curve or volatility factors underlying the positions.

Effective January 1, 2008, the Group determines the fair value of its financial instruments based on the Fair Value Measurement framework, which establishes a fair value hierarchy that prioritizes the inputs of valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (level 1 measurements) and the lowest priority to unobservable inputs (level 3 measurements). The three levels of the fair value hierarchy are described below:

Level 1 —

Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities;

Level 2 —

Quoted prices in markets that are not considered to be active or financial instruments for which all significant inputs are observable, either directly or indirectly;

Level 3 —

Prices or valuations that require inputs that are both significant to the fair value measurement and unobservable.

A financial instrument’s level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement.

Impairment of Investment Securities

The Group conducts periodic reviews to identify and evaluate each investment in an unrealized loss position for other-than-temporary impairments. On April 1, 2009, the Group adopted Financial Accounting Standard Board (“FASB”) Accounting Standard Codification (“ASC”) 320-10-65-1, which changed the accounting requirements for other than temporary impairments for debt securities, and in certain circumstances, separates the amount of total impairment into credit and noncredit-related amounts. The review takes into consideration current market conditions, issuer rating changes and trends, the credit worthiness of the obligor of the security, current analysts’ evaluations, failure of the issuer to make scheduled interest or principal payments, the Group’s intent to not sell the security or whether it is more-likely-than-not that the Group will be required to sell the debt security before its anticipated recovery, as well as other qualitative factors. The term other than temporary impairments is not intended to indicate that the decline is permanent, but indicates that the prospects for a near-term recovery of value is not necessarily favorable, or that there is a lack of evidence to support a realizable value equal to or greater than the carrying value of the investment. Any portion of a decline in value associated with credit loss is recognized in income with the remaining noncredit-related component being recognized in other comprehensive income. A credit loss is determined by assessing whether the amortized cost basis of the security will be recovered, by comparing the present value of cash flows expected to be collected from the security, computed using original yield as the discount rate, to the amortized cost basis of the security. The shortfall of the present value of the cash flows expected to be collected in relation to the amortized cost basis is considered to be the “credit loss.”

The Group’s review for impairment generally entails:

	•		intent to sell the debt security;
	•		if it is more likely than not that the Group will be required to sell the debt securities before the anticipated recovery;
	•		identification and evaluation of investments that have indications of possible other-than-temporary impairment;
	•		analysis of individual investments that have fair values less than amortized cost, including consideration of the length of time the investment has been in an unrealized loss position and the expected recovery period;
	•		discussion of evidential matter, including an evaluation of factors or triggers that could cause individual investments to qualify as having other-than-temporary impairment and those that would not support other-than-temporary impairment; and
	•		documentation of the results of these analyses.

The extent of the Group’s analysis regarding credit quality and the stress on assumptions used in the analysis for identifying securities for which all principal and interest contractually due might not be recovered have been refined for non-agency collateralized mortgage obligations and structured credit investments given the declines in fair values and length of time in which these securities have been in an unrealized loss position, general concerns regarding housing prices and the delinquency and default rates on the mortgage loans and credit spreads underlying these securities.

Income Taxes

In preparing the unaudited consolidated financial statements, the Group is required to estimate income taxes. This involves an estimate of current income tax expense together with an assessment of temporary differences resulting from differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The determination of current income tax expense involves estimates and assumptions that require the Group to assume certain positions based on its interpretation of current tax laws and regulations. Changes in assumptions affecting estimates may be required in the future and estimated tax assets or liabilities may need to be increased or decreased accordingly. The accrual for tax contingencies is adjusted in light of changing facts and circumstances, such as the progress of tax audits, case law and emerging legislation. When particular matters arise, a number of years may elapse before such matters are audited and finally resolved. Favorable resolution of such matters could be recognized as a reduction to the Group’s effective rate in the year of resolution. Unfavorable settlement of any particular issue could increase the effective rate and may require the use of cash in the year of resolution.

The determination of deferred tax expense or benefit is based on changes in the carrying amounts of assets and liabilities that generate temporary differences. The carrying value of the Group’s net deferred tax assets assumes that the Group will be able to generate sufficient future taxable income based on estimates and assumptions. If these estimates and related assumptions change in the future, the Group may be required to record valuation allowances against its deferred tax assets resulting in additional income tax expense in the consolidated statements of operations.

Management evaluates the realizability of the deferred tax assets on a regular basis and assesses the need for a valuation allowance. A valuation allowance is established when management believes that it is more likely than not that some portion of its deferred tax assets will not be realized. Changes in valuation allowance from period to period are included in the Group’s tax provision in the period of change.

In addition to valuation allowances, the Group establishes accruals for uncertain tax positions when, despite the belief that Group’s tax return positions are fully supported, the Group believes that certain positions are likely to be challenged. The uncertain tax positions accruals are adjusted in light of changing facts and circumstances, such as the progress of tax audits, case law and emerging legislation. The Group’s uncertain tax positions accruals are reflected as income tax payable as a component of accrued expenses and other liabilities.

The Group follows a two-step approach for recognizing and measuring uncertain tax positions. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation process, if any. The second step is to measure the tax benefit as the largest amount that is more than 50% likely of being realized upon ultimate settlement.

The Group’s policy is to include interest and penalties related to unrecognized tax benefits within the provision for taxes on the consolidated statements of operations.

Equity-Based Compensation Plans

On April 25, 2007, the Board of Directors (the “Board”) adopted the Oriental Financial Group Inc. 2007 Omnibus Performance Incentive Plan (the “Omnibus Plan”), which was subsequently approved by the Group’s stockholders at their annual meeting held on June 27, 2007. The Omnibus Plan provides for equity-based compensation incentives through the grant of stock options, stock appreciation rights, restricted stock, restricted stock units and dividend equivalents, as well as equity-based performance awards.

The purpose of the Omnibus Plan is to provide flexibility to the Group to attract, retain and motivate directors, officers, and key employees through the grant of awards based on performance and to adjust its compensation practices to the best compensation practice and corporate governance trends as they develop from time to time. The Omnibus Plan is further intended to motivate high levels of individual performance coupled with increased shareholder returns. Therefore, awards under the Omnibus Plan (each, an “Award”) are intended to be based upon the recipient’s individual performance, level of responsibility and potential to make significant contributions to the Group. Generally, the Omnibus Plan will terminate as of (a) the date when no more of the Group’s shares of common stock are available for issuance under the Omnibus Plan, or, if earlier, (b) the date the Omnibus Plan is terminated by the Group’s Board.

The Board’s Compensation Committee (the “Committee”), or such other committee as the Board may designate, has full authority to interpret and administer the Omnibus Plan in order to carry out its provisions and purposes. The Committee has the authority to determine those persons eligible to receive an Award and to establish the terms and conditions of any Award. The Committee may delegate, subject to such terms or conditions or guidelines as it shall determine, to any employee or group of employees any portion of its authority and powers under the Omnibus Plan with respect to participants who are not directors or executive officers subject to the reporting requirements under Section 16(a) of the Securities Exchange Act of 1934. Only the Committee may exercise authority in respect of Awards granted to such participants.

The Omnibus Plan replaced and superseded the Oriental Financial Group Inc. 1996, 1998 and 2000 Incentive Stock Option Plans (the “Stock Option Plans”). All outstanding stock options under the Stock Option Plans continue in full force and effect, subject to their original terms and conditions.

The Group follows the fair value method of recording stock-based compensation. The following assumptions were used in estimating the fair value of the options granted:

		Nine-Month Period Ended
		September 30,
		2009				2008
Weighted Average Assumptions:
Dividend yield			4.74	%			4.64	%
Expected volatility			36.14	%			33.61	%
Risk-free interest rate			4.40	%			4.48	%
Expected life (in years)			8.5				8.5

The expected term of share options granted represents the period of time that share options granted are expected to be outstanding. Expected volatilities are based on historical volatility of the Group’s shares over the most recent period equal to the expected term of the share option.

Accumulated Other Comprehensive Loss

Accumulated other comprehensive income (loss), net of income tax, as of September 30, 2009 and December 31, 2008 consisted of:

		September, 30				December 31,
		2009				2008
		(In thousands)
Unrealized loss on securities available-for-sale which are not other-than-temporarily impaired		$	(16,592	)		$	(128,191	)
Unrealized loss on securities available-for-sale which a portion of other-than-temporary impairment has been recorded in earnings			(94,656	)			—
Tax effect of accumulated other comprehensive income			4,881				6,004
		$	(106,367	)		$	(122,187	)

Subsequent Events

We have evaluated events subsequent to the balance sheet date and prior to filing of this Quarterly Report on Form 10-Q for the quarter ended September 30, 2009 through November 6, 2009 and determined there have not been any events that have occurred that would require adjustment or disclosure in our unaudited consolidated financial statements.

Recent Accounting Developments

In June 2009, the FASB issued FAS No. 168, “The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles – a replacement of FASB Statement No. 162,” (“FAS 168”). FAS 168 establishes the FASB Accounting Standards Codification (“Codification”) as the source of authoritative GAAP for nongovernmental entities. The Codification does not change GAAP. Instead, it takes the thousands of individual pronouncements that currently comprise GAAP and reorganizes them into approximately 90 accounting Topics, and displays all Topics using a consistent structure. Contents in each Topic are further organized first by Subtopic, then Section and finally Paragraph. The Paragraph level is the only level that contains substantive content. Citing particular content in the Codification involves specifying the unique numeric path to the content through the Topic, Subtopic, Section and Paragraph structure. FASB suggests that all citations begin with “FASB ASC,” where ASC stands for Accounting Standards Codification. Changes to the ASC subsequent to June 30, 2009 are referred to as Accounting Standards Updates (“ASU”).

In conjunction with the issuance of FAS 168, the FASB also issued its first Accounting Standards Update No. 2009-1, “Topic 105 –Generally Accepted Accounting Principles” (“ASU 2009-1”) which includes FAS 168 in its entirety as a transition to the ASC. ASU 2009-1 is effective for interim and annual periods ending after September 15, 2009 and will not have an impact on the Group’s financial position or results of operations but will change the referencing system for accounting standards. Certain of the following pronouncements were issued prior to the issuance of the ASC and adoption of the ASUs. For such pronouncements, citations to the applicable Codification by Topic, Subtopic and Section are provided where applicable in addition to the original standard type and number.

FAS 166 “Accounting for Transfers of Financial Assets” and FAS 167, “Amendments to FASB Interpretation No. 46(R)” (not yet reflected in FASB ASC) were issued in June 2009, and change the way entities account for securitizations and special-purpose entities, and will have a material effect on how banking organizations account for off-balance sheet vehicles. The new standards amend FAS 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities”, and FASB Interpretation No. 46(R), “Consolidation of Variable Interest Entities”. Both Statements 166 and 167 will be effective January 1, 2010 for companies reporting earnings on a calendar-year basis. The Group is evaluating the impact, if any, that the adoption of FAS 166 and 167 could have on the Group’s consolidated financial statements.

The FASB issued ASU 2009–05, “Fair Value Measurements and Disclosures (Topic 820) – Measuring Liabilities at Fair Value” in August 2009 to provide guidance when estimating the fair value of a liability. When a quoted price in an active market for the identical liability is not available, fair value should be measured using (a) the quoted price of an identical liability when traded as an asset; (b) quoted prices for similar liabilities or similar liabilities when traded as assets; or (c) another valuation technique consistent with the principles of Topic 820 such as an income approach or a market approach. If a restriction exists that prevents the transfer of the liability, a separate adjustment related to the restriction is not required when estimating fair value. The ASU was effective October 1, 2009 for the Group and will have no impact on financial position or operations.

ASU 2009-12, “Fair Value Measurements and Disclosures (Topic 820) — Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent)” issued in September 2009, allows a company to measure the fair value of an investment that has no readily determinable fair market value on the basis of the investee’s net asset value per share as provided by the investee. This allowance assumes that the investee has calculated net asset value in accordance with the GAAP measurement principles of Topic 946 as of the reporting entity’s measurement date. Examples of such investments include investments in hedge funds, private equity funds, real estate funds and venture capital funds. The update also provides guidance on how the investment should be classified within the fair value hierarchy based on the value for which the investment can be redeemed. The amendment is effective for interim and annual periods ending after December 15, 2009 with early adoption permitted. The Group does not have investments in such entities and, therefore, there will be no impact to its financial statements.

Issued October, 2009, ASU 2009-15, “Accounting for Own-Share Lending Arrangements in Contemplation of Convertible Debt Issuance or Other Financing” amends ASC Topic 470 and provides guidance for accounting and reporting for own-share lending arrangements issued in contemplation of a convertible debt issuance. At the date of issuance, a share-lending arrangement entered into on an entity’s own shares should be measured at fair value in accordance with Topic 820 and recognized as an issuance cost, with an offset to additional paid-in capital. Loaned shares are excluded from basic and diluted earnings per share unless default of the share-lending arrangement occurs. The amendments also require several disclosures including a description and the terms of the arrangement and the reason for entering into the arrangement. The effective dates of the amendments are dependent upon the date the share-lending arrangement was entered into and include retrospective application for arrangements outstanding as of the beginning of fiscal years beginning on or after December 15, 2009. The Group has no plans to issue convertible debt and, therefore, does not expect the update to have an impact on its financial statements.

Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies are not expected to have a material impact on the Group’s financial position, results of operations or cash flows.

NOTE 2 — INVESTMENTS

Money Market Investments

The Group considers as cash equivalents all money market instruments that are not pledged and that have maturities of three months or less at the date of acquisition. At September 30, 2009, and December 31, 2008, cash equivalents included as part of cash and due from banks amounted to $29.2 million and $52.0 million, respectively.

Investment Securities

The amortized cost, gross unrealized gains and losses, fair value, and weighted average yield of the investment securities as of September 30, 2009, and December 31, 2008, were as follows:

		September 30, 2009
						Gross				Gross								Weighted
		Amortized				Unrealized				Unrealized				Fair				Average
		Cost				Gains				Losses				Value				Yield
						(In thousands)
Available-for-sale
Obligations of US Government sponsored agencies		$	706,573			$	1,736			$	12,397			$	695,912				5.09	%
Puerto Rico Government and agency obligations			71,583				10				7,131				64,462				5.37	%
Structured credit investments			177,440				1,860				38,041				141,259				2.79	%
Total investment securities			955,596				3,606				57,569				901,633
FNMA and FHLMC certificates			2,572,910				28,640				35				2,601,515				4.26	%
GNMA certificates			220,888				8,906				34				229,760				5.06	%
CMOs issued by US Government sponsored agencies			296,271				6,231				—				302,502				5.22	%
Non-agency collateralized mortgage obligations			558,383				—				101,167				457,216				5.87	%
Total mortgage-backed-securities and CMOs			3,648,452				43,777				101,236				3,590,993
Total securities available-for-sale		$	4,604,048			$	47,383			$	158,805			$	4,492,626				4.64	%

		December 31, 2008
						Gross				Gross								Weighted
		Amortized				Unrealized				Unrealized				Fair				Average
		Cost				Gains				Losses				Value				Yield
		(In thousands)
Available-for-sale
Obligations of US Government sponsored agencies		$	941,144			$	7,172			$	6,400			$	941,916				5.37	%
Puerto Rico Government and agency obligations			91,599				597				9,307				82,889				5.40	%
Structured credit investments			176,127				3,469				43,415				136,181				4.25	%
Total investment securities			1,208,870				11,238				59,122				1,160,986
FNMA and FHLMC certificates			1,521,428				25,527				205				1,546,750				5.51	%
GNMA certificates			332,071				4,206				496				335,781				5.76	%
CMOs issued by US Government sponsored agencies			352,579				202				1,755				351,026				5.34	%
Non-agency collateralized mortgage obligations			637,626				—				107,962				529,664				8.49	%
Total mortgage-backed-securities and CMOs			2,843,704				29,935				110,418				2,763,221
Total securities available-for-sale		$	4,052,574			$	41,173			$	169,540			$	3,924,207				5.90	%

The amortized cost and fair value of the Group’s investment securities available-for-sale at September 30, 2009, by contractual maturity, are shown in the next table. Securities not due on a single contractual maturity date, such as collateralized mortgage obligations, are classified in the period of final contractual maturity. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.

		Amortized Cost				Fair Value
		(In thousands)
Investment securities
Due less than 1 year		$	15,500			$	15,500
Due after 5 to 10 years			241,658				222,416
Due after 10 years			698,438				663,717
			955,596				901,633
Mortgage-backed securities
Due after 5 to 10 years			18,938				19,703
Due after 10 years			3,629,514				3,571,290
			3,648,452				3,590,993
		$	4,604,048			$	4,492,626

Keeping with the Group’s investment strategy, during the nine-month period ended September 30, 2009 and 2008, there were certain sales of available-for-sale securities because the Group felt at the time of such sales that gains could be realized while at the same time having good opportunities to invest the proceeds in other investment securities with attractive yields and terms that would allow the Group to continue to protect its net interest margin. Specifically during the third quarter of 2009, the Group engaged in a series of transactions involving the sale of certain FNMA and FHLMC mortgage-backed securities with similar characteristics, in which the aggregate gains amounted to $36.6 million, while the aggregate losses amounted to $1.2 million. The sale of these securities was the result of the Group’s decision to restructure this homogenous component of the investment securities portfolio and to take advantage of market opportunities in light of anticipated economic conditions that could have a negative impact on the value of these securities going forward. Also, the Group, as part of its asset and liability management, purchases agency discount notes close to their maturities as a short term vehicle to reinvest the proceeds of sales of transactions until similar investment securities with attractive yields can be purchased. The discount notes are pledged as collateral for repurchase agreements. During the nine-month period ended September 30, 2009, the Group sold $534.0 million of discount notes, included in obligations of U.S. Government sponsored agencies, with minimal aggregate gross gains of approximately $5 thousand and sold $1.139 billion of discount notes with minimal aggregate gross losses of approximately $17 thousand.

The table below presents an analysis the gross realized gains and losses by category for the nine-month periods ended September 30, 2009 and 2008:

Nine-Month Period Ended September 30, 2009

																		Gross				Gross
Description		Original Face				Original Cost				Sale Price				Sale Book Value				Gains				Losses
		(In thousands)
Sale of Securities Available-for-Sale
Investment securities
Obligations of U.S. Government sponsored agencies		$	2,237,785			$	2,238,556			$	2,237,600			$	2,237,414			$	203			$	17
Puerto Rico Government and agency obligations			90,000				90,612				90,000				90,000				—				—
Total investment securities			2,327,785				2,329,168				2,327,600				2,327,414				203				17
Mortgage-backed securities and CMOs
FNMA and FHLMC certificates			3,910,151				3,808,523				3,500,406				3,450,661				50,894				1,150
CMOs issued by U.S. Government sponsored agencies			330,000				330,938				336,993				330,584				6,410				—
GNMA certificates			112,406				113,157				113,155				113,107				48				—
Total mortgage-backed securities and CMOs			4,352,557				4,252,618				3,950,554				3,894,352				57,352				1,150
Total		$	6,680,342			$	6,581,786			$	6,278,154			$	6,221,766			$	57,555			$	1,167

Nine-month period ended September 30, 2008

																						Gross
Description		Original Face				Original Cost				Sale Price				Sale Book Value				Gross Gains				Losses
		(In thousands)
Sale of Securities Available-for-Sale
Investment securities
Obligations of U.S. Government sponsored agencies		$	709,300			$	708,957			$	718,291			$	709,070			$	9,221			$	—
Puerto Rico Government and agency obligations			1,830				1,843				1,862				1,804				58				—
Total investment securities			711,130				710,800				720,153				710,874				9,279				—
Mortgage-backed securities and CMOs
FNMA and FHLMC certificates			311,170				311,356				259,549				259,074				475				—
GNMA certificates			45,920				47,319				45,494				45,340				154				—
Total mortgage-backed securities and CMOs			357,090				358,675				305,043				304,414				629				—
Total		$	1,068,220			$	1,069,475			$	1,025,196			$	1,015,288			$	9,908			$	—