OFG BANCORP - Quarter Report: 2009 June (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

For the quarterly period ended June 30, 2009

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

For the transition period from                      to                     

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, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

     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:

24,230,843 common shares ($1.00 par value per share)
outstanding as of July 31, 2009

 

 

TABLE OF CONTENTS

		Page
Part I FINANCIAL INFORMATION:
Item 1 Financial Statements
Unaudited consolidated statements of financial condition at June 30, 2009 and December 31, 2008			1
Unaudited consolidated statements of operations for the quarters and six-month periods ended June 30, 2009 and 2008			2
Unaudited consolidated statements of changes in stockholders’ equity for the six-month periods ended June 30, 2009 and 2008			3
Unaudited consolidated statements of comprehensive income for the quarters and six-month periods ended June 30, 2009 and 2008			3
Unaudited consolidated statements of cash flows for the six-month periods ended June 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			31
Item 3 Quantitative and Qualitative Disclosures About Market Risk			50
Item 4 Controls and Procedures			53
PART II OTHER INFORMATION:
Item 1 Legal Proceedings			54
Item 1A Risk Factors			54
Item 2 Unregistered Sales of Equity Securities and Use of Proceeds			54
Item 3 Defaults Upon Senior Securities			54
Item 4 Submissions of Matters to a Vote of Security Holders			54
Item 5 Other Information			54
Item 6 Exhibits			55
Signatures			56
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
JUNE 30, 2009 AND DECEMBER 31, 2008
(In thousands, except share data)

		June 30,				December 31,
		2009				2008
ASSETS
Cash and due from banks		$	307,062			$	66,372
Investments:
Trading securities, at fair value with amortized cost of $888 (December 31, 2008 - $255)			904				256
Investment securities available-for-sale, at fair value with amortized cost of $5,064,700 (December 31, 2008 - $4,052,574)
Securities pledged that can be repledged			4,494,030				3,790,733
Other investment securities			456,490				133,474
Total investment securities available-for-sale			4,950,520				3,924,207
Other Investments			150				150
Federal Home Loan Bank (FHLB) stock, at cost			19,937				21,013
Total investments			4,971,511				3,945,626
Securities sold but not yet delivered			360,764				834,976
Loans:
Mortgage loans held-for-sale, at lower of cost or fair value			40,886				26,562
Loans receivable, net of allowance for loan losses of $16,718 (December 31, 2008 - $14,293)			1,146,188				1,192,550
Total loans, net			1,187,074				1,219,112
Accrued interest receivable			37,785				43,914
Deferred tax asset, net			25,756				28,463
Premises and equipment, net			20,706				21,184
Foreclosed real estate			9,174				9,162
Investment in equity indexed options			2,412				12,801
Other assets			28,060				23,926
Total assets		$	6,950,304			$	6,205,536
LIABILITIES AND STOCKHOLDERS’ EQUITY
Deposits:
Demand deposits		$	682,387			$	453,690
Savings accounts			62,615				50,152
Certificates of deposit			1,107,444				1,281,458
Total deposits			1,852,446				1,785,300
Borrowings:
Federal funds purchased and other short term borrowings			27,748				29,193
Securities sold under agreements to repurchase			3,757,510				3,761,121
Advances from FHLB			281,718				308,442
FDIC-guaranteed term notes			105,834				—
Subordinated capital notes			36,083				36,083
Total borrowings			4,208,893				4,134,839
Securities purchased but not yet received			497,360				398
Accrued expenses and other liabilities			31,971				23,682
Total liabilities			6,590,670				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; 24,229,755 shares outstanding (December 31, 2008 - 25,739,397; 24,297,132)			25,739				25,739
Additional paid-in capital			212,962				212,625
Legal surplus			48,771				43,016
Retained earnings			131,154				51,233
Treasury stock, at cost 1,509,642 shares (December 31, 2008 - 1,442,265 shares)			(17,152	)			(17,109	)
Accumulated other comprehensive loss, net of tax of $4,165 (December 31, 2008 - $6,004)			(109,840	)			(122,187	)
Total stockholders’ equity			359,634				261,317
Total liabilities and stockholders’ equity		$	6,950,304			$	6,205,536

See notes to unaudited consolidated financial statements.

UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE QUARTERS AND SIX-MONTH PERIODS ENDED JUNE 30, 2009 AND 2008
(In thousands, except per share data)

		Quarter Ended June 30,								Six-Month Period Ended June 30,
		2009				2008				2009				2008
Interest income:
Loans		$	18,707			$	19,682			$	37,027			$	39,510
Mortgage-backed securities			51,721				47,765				102,429				87,266
Investment securities and other			11,623				17,711				26,526				40,483
Total interest income			82,051				85,158				165,982				167,259
Interest expense:
Deposits			14,149				12,265				27,972				24,694
Securities sold under agreements to repurchase			27,929				40,208				63,728				80,448
Advances from FHLB and other borrowings			3,075				3,716				6,171				7,537
FDIC-guaranteed term notes			1,021				—				1,133				—
Subordinated capital notes			389				534				825				1,236
Total interest expense			46,563				56,723				99,829				113,915
Net interest income			35,488				28,435				66,153				53,344
Provision for loan losses			3,650				1,980				6,850				3,630
Net interest income after provision for loan losses			31,838				26,455				59,303				49,714
Non-interest income:
Financial service revenues			3,285				4,500				6,399				8,740
Banking service revenues			1,602				1,395				2,995				2,922
Investment banking revenues (losses)			8				12				(4	)			750
Mortgage banking activities			2,806				545				4,959				1,551
Total banking and financial service revenues			7,701				6,452				14,349				13,963
Excess of amortized cost over fair value on other-than-temporarily impaired securities			(62,594	)			—				(62,594	)			—
Non-credit related unrealized loss on securities recognized in other comprehensive income			58,178				—				58,178				—
Credit-related other-than-temporary impairments on securities			(4,416	)			—				(4,416	)			—
Net gain (loss) on:
Sale of securities			10,520				198				20,860				9,522
Derivatives			19,408				228				19,842				(7,575	)
Trading securities			12,959				16				12,932				(1	)
Foreclosed real estate			(136	)			(260	)			(298	)			(510	)
Other investments			11				16				24				116
Other			4				—				4				(1	)
Total non-interest income, net			46,051				6,650				63,297				15,514
Non-interest expenses:
Compensation and employees’ benefits			8,020				7,824				15,744				15,539
Occupancy and equipment			3,758				3,365				7,247				6,652
Insurance			3,472				579				4,287				1,181
Professional and service fees			2,394				2,267				5,002				4,147
Advertising and business promotion			1,028				836				2,232				1,910
Taxes, other than payroll and income taxes			649				607				1,295				1,218
Electronic banking charges			596				396				1,136				814
Communication			402				325				781				650
Loan servicing expenses			388				339				771				670
Directors and investor relations			332				303				681				581
Other			1,175				1,239				2,311				2,448
Total non-interest expenses			22,214				18,080				41,487				35,810
Income before income taxes			55,675				15,025				81,113				29,418
Income tax expense (benefit)			4,761				598				5,451				(1,857	)
Net income			50,914				14,427				75,662				31,275
Less: Dividends on preferred stock			(1,200	)			(1,200	)			(2,401	)			(2,401	)
Income available to common shareholders		$	49,714			$	13,227			$	73,261			$	28,874
Income per common share:
Basic		$	2.05			$	0.54			$	3.02			$	1.19
Diluted		$	2.04			$	0.54			$	3.02			$	1.19
Average common shares outstanding			24,303				24,290				24,274				24,227
Average potential common shares-options			15				94				6				110
Average diluted common shares outstanding			24,318				24,384				24,280				24,337
Cash dividends per share of common stock		$	0.04			$	0.14			$	0.08			$	0.28

See notes to unaudited consolidated financial statements.

UNAUDITED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
FOR THE SIX-MONTH PERIODS ENDED JUNE 30, 2009 AND 2008
(In thousands)

		Six-Month Period Ended June 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			—				179
Balance at end of period			25,739				25,736
Additional paid-in capital:
Balance at beginning of period			212,625				210,073
Stock-based compensation expense			337				252
Stock options exercised			—				1,957
Balance at end of period			212,962				212,282
Legal surplus:
Balance at beginning of period			43,016				40,573
Transfer from retained earnings			5,755				2,960
Balance at end of period			48,771				43,533
Retained earnings:
Balance at beginning of period			51,233				45,296
Cumulative effect on initial adoption of FAS 115-2, net of tax			14,359				—
Net income			75,662				31,275
Cash dividends declared on common stock			(1,944	)			(6,804	)
Cash dividends declared on preferred stock			(2,401	)			(2,401	)
Transfer to legal surplus			(5,755	)			(2,960	)
Balance at end of period			131,154				64,406
Treasury stock:
Balance at beginning of period			(17,109	)			(17,023	)
Stock used to match defined contribution plan 1165(e)			139				121
Stock purchased			(182	)			(234	)
Balance at end of period			(17,152	)			(17,136	)
Accumulated other comprehensive loss, net of tax:
Balance at beginning of period			(122,187	)			(13,015	)
Cumulative effect on initial adoption of FAS 115-2, net of tax			(14,359	)			—
Other comprehensive income (loss), net of tax			26,706				(82,639	)
Balance at end of period			(109,840	)			(95,654	)
Total stockholders’ equity		$	359,634			$	301,167

UNAUDITED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
FOR THE QUARTERS AND SIX-MONTH PERIODS ENDED JUNE 30, 2009 AND 2008
(In thousands)

		Quarter Ended June 30,								Six-Month Period Ended June 30,
		2009				2008				2009				2008
COMPREHENSIVE INCOME
Net income		$	50,914			$	14,427			$	75,662			$	31,275
Other comprehensive income (loss):
Unrealized gain (loss) on securities available-for-sale arising during the period			(4,885	)			(51,649	)			44,989				(79,685	)
Realized gain on investment securities available-for-sale included in net income			(10,520	)			(198	)			(20,860	)			(9,522	)
Excess of amortized cost over fair value on other-than-temporarily impaired securities			62,594				—				62,594				—
Non-credit related unrealized loss on securities			(58,178	)			—				(58,178	)			—
Income tax effect related to unrealized loss (gain) on securities available-for-sale			2,340				4,156				(1,839	)			6,568
Other comprehensive income (loss) for the period			(8,649	)			(47,691	)			26,706				(82,639	)
Comprehensive income (loss)		$	42,265			$	(33,264	)		$	102,368			$	(51,364	)

See notes to unaudited consolidated financial statements.

UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX-MONTH PERIODS ENDED JUNE 30, 2009 AND 2008
(In thousands)

		Six-Month Period Ended June 30,
		2009				2008
Cash flows from operating activities:
Net income		$	75,662			$	31,275
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Amortization of deferred loan origination fees, net of costs			91				(214	)
Amortization of premiums, net of accretion of discounts			5,084				31
Credit-related other-than-temporary impairments on securities			4,416				—
Depreciation and amortization of premises and equipment			3,047				2,613
Deferred income tax expense (benefit)			868				(319	)
Provision for loan losses			6,850				3,630
Common stock used to match defined contribution plan 1165(e)			139				121
Stock-based compensation			337				252
Servicing asset capitalized, net			(3,115	)			(805	)
(Gain) loss on:
Sale of securities available-for-sale			(20,860	)			(9,522	)
Sale of mortgage loans			(1,844	)			(746	)
Derivatives			(19,842	)			7,575
Sale of foreclosed real estate			298				510
Sale of premises and equipment			(4	)			1
Originations and purchases of loans held-for-sale			(116,581	)			(74,265	)
Proceeds from sale of loans held-for-sale			64,993				20,918
Net decrease (increase) in:
Trading securities			(648	)			(189	)
Accrued interest receivable			6,129				9,473
Other assets			(3,712	)			(11,219	)
Net increase (decrease) in:
Accrued interest on deposits and borrowings			(1,451	)			604
Other liabilities			8,370				(3,332	)
Net cash provided by (used in) operating activities			8,227				(23,608	)
Cash flows from investing activities:
Purchases of:
Investment securities available-for-sale			(5,168,019	)			(2,790,964	)
Equity options			(2,965	)			(1,729	)
FHLB stock			(13,355	)			(7,089	)
Maturities and redemptions of:
Investment securities available-for-sale			2,399,362				1,396,359
Investment securities held-to-maturity			—				254,978
Other investments			—				1,511
FHLB stock			14,431				5,685
Proceeds from sales of:
Investment securities available-for-sale			2,815,099				943,134
Foreclosed real estate			4,561				2,466
Premises and equipment			92				14
Origination and purchase of loans, excluding loans held-for-sale			(44,219	)			(84,597	)
Principal repayments of loans			59,316				63,977
Additions to premises and equipment			(2,657	)			(2,227	)
Net cash provided by (used in) investing activities			61,646				(218,482	)
Cash flows from financing activities:
Net increase (decrease) in:
Deposits			79,449				260,671
Securities sold under agreements to repurchase			—				(50,023	)
Federal funds purchased and other short term borrowings			(1,445	)			14,123
Proceeds from:
Issuance of FDIC-guaranted term notes			105,000				—
Advances from FHLB			761,380				294,750
Exercise of stock options			—				2,136
Repayments of advances from FHLB			(788,080	)			(294,750	)
Purchase of treasury stock			(182	)			(234	)
Termination of derivative instruments			19,040				(7,875	)
Dividends paid on common and preferred stock			(4,345	)			(9,205	)
Net cash provided by financing activities			170,817				209,593
Net change in cash and due from banks			240,690				(32,497	)
Cash and due from banks at beginning of period			66,372				88,983
Cash and due from banks at end of period		$	307,062			$	56,486
Supplemental Cash Flow Disclosure and Schedule of Noncash Activities:
Interest paid		$	101,279			$	113,311
Income tax paid		$	—			$	37
Mortgage loans securitized into mortgage-backed securities		$	61,676			$	29,836
Securities sold but not yet delivered		$	360,764			$	—
Securities purchased but not yet received		$	497,360			$	23,103
Transfer from loans to foreclosed real estate		$	4,871			$	3,675

See notes to unaudited consolidated financial statements.

ORIENTAL FINANCIAL GROUP INC.
Notes to Unaudited Consolidated Financial Statements

NOTE 1 — BASIS OF PRESENTATION

The accounting and reporting policies of Oriental Financial Group Inc. (the “Group” or “Oriental”) conform with U.S. generally accepted accounting principles (“GAAP”) and to 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”). In the opinion of management, these consolidated financial statements include all adjustments necessary, all of which are of normal recurring nature, to present fairly the consolidated statement of financial condition as of June 30, 2009, and December 31, 2008, and the consolidated results of operations and cash flows for the quarters and six-month periods ended June 30, 2009 and 2008. All significant intercompany balances and transactions have been eliminated in the accompanying unaudited consolidated financial statements. 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 June 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 10 to the unconsolidated 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 23 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, as provided in the Statement of Financial Accounting Standards (“SFAS”) No. 114, “Accounting by Creditors for Impairment of a Loan.” 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 under the provisions of SFAS No. 5, “Accounting for Contingencies”, as amended, and loans that are recorded at fair value or at the lower of cost or market. 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.

SFAS No. 157, “Fair Value Measurements” (“SFAS 157”), 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 under SFAS 157 are described below:

Basis of Fair Value Measurement

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, in accordance with FASB Staff Position (FSP) No. 115-1, “The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments” (FSP FAS 115-1). In June 2009, the Group adopted FSP FAS 115-2 and 124-2, “Recognition and Presentation of Other-Than-Temporary Impairments,” 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 obligator 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.”

Factors considered in determining whether a loss is temporary include:

	•		the length of time to which fair value has been below cost;
	•		the severity of the impairment;
	•		the cause of the impairment and the financial condition and near-term prospects of the issuer;
	•		activity in the market of the issuer which may indicate adverse credit conditions.

The Group’s review for impairment generally entails:

	•		intent to sell the debt security;
	•		if it is more likely than not that the entity 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 have been refined for securities where the current fair value or other characteristics of the security warrant. Given the declines in fair values and length of time in which non-agency collateralized mortgage obligations and structured credit investments 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, the Group’s analysis for identifying securities for which all principal and interest contractually due might not be recovered have been performed.

Income Taxes

In preparing the unconsolidated 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 the provisions of Financial Accounting Standard Board (“FASB”) Interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109”, which contains a two-step approach to recognizing and measuring uncertain tax positions accounted for in accordance with SFAS 109. 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 to include interest and penalties related to unrecognized tax benefits within the provision for taxes on the consolidated statements of operations did not change as a result of implementing the provisions of FIN 48.

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. Effective July 1, 2005, the Group adopted SFAS No. 123R “Share-Based Payment” (“SFAS 123R”), an amendment of SFAS No. 123 “Accounting for Stock-Based Compensation” using the modified prospective transition method. SFAS 123R requires measurement of the cost of employee services received in exchange for an award of equity instruments based on the grant date fair value of the award with the cost to be recognized over the service period. SFAS No. 123R applies to all awards unvested and granted after this effective date and awards modified, repurchased, or cancelled after that date.

The following assumptions were used in estimating the fair value of the options granted:

		Six-Month Period Ended
		June 30,
		2009				2008
Weighted Average Assumptions:
Dividend yield			4.74	%			4.40	%
Expected volatility			36.14	%			31.86	%
Risk-free interest rate			4.40	%			4.33	%
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 June 30, 2009 and December 31, 2008 consisted of:

		June, 30				December 31,
		2009				2008
		(In thousands)
Unrealized loss on securities available-for-sale which are not other-than-temporarily impaired		$	(11,037	)		$	(128,191	)
Unrealized loss on securities available-for-sale which a portion of other-than-temporary impairment has been recorded in earnings			(102,968	)			—
Tax effect of accumulated other comprehensive income			4,165				6,004
		$	(109,840	)		$	(122,187	)

Subsequent Events

Subsequent to June 30, 2009, as part of its general banking and asset and liability management strategies, the Group executed a $200 million deleverage of its balance sheet at the holding company level by terminating certain repurchase agreements at a cost of approximately $17.5 million (before income taxes). Subsequent events have been evaluated through August 7, 2009, when the Financial Statements were available to be issued.

Recent Accounting Developments

FSP FAS 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly”

FSP FAS 157-4, issued by the FASB in April 2009, provides additional guidance for estimating fair value in accordance with SFAS No. 157 when the volume and level of activity for the asset or liability have decreased significantly. FSP FAS 157-4 also provides guidance on identifying circumstances that indicate a transaction is not orderly. The Group adopted FSP FAS 157-4 effective April 1, 2009 and complied with its guidance in determining the fair value of its securities at June 30, 2009.

FSP FAS 115-2 and FAS 124-2, “Recognition and Presentation of Other-Than-Temporary Impairments”

FSP FAS 115-2 and FAS 124-2, issued by the FASB in April 2009, amend the other-than-temporary impairment guidance in U.S. GAAP for debt securities to make the guidance more operational and to improve the presentation and disclosure of other-than-temporary impairments on debt and equity securities in the financial statements. These FSP do not amend existing recognition and measurement guidance related to other-than-temporary impairments of equity securities. This FSP requires that for securities that are not expected to be sold, the credit-related portion of other-than-temporary impairment losses be recognized in earnings while the non-credit related portion is recognized in other comprehensive loss. The Group adopted the provisions of FSP FAS 115-2 and FAS 124-2 on April 1, 2009. As a result of its adoption, a net other than temporary impairment loss of $4.4 million was recognized in earnings and $58.2 million non-credit related impairment unrealized loss was recognized in other comprehensive loss. Also in accordance with the FSP, the Group reclassified the noncredit-related portion of an other-than-temporary impairment loss previously recognized in earnings in 2008. The reclassification was reflected as a cumulative effect adjustment of $14.4 million that increased retained earnings and accumulated other comprehensive loss.

FSP FAS 107-1 and APB 28-1, “Interim Disclosures about Fair Value of Financial Instruments”

FSP FAS 107-1 and APB 28-1, issued by the FASB in April 2009, amend FASB Statement No. 107, Disclosures about Fair Value of Financial Instruments, to require disclosures about fair value of financial instruments for interim reporting periods of publicly traded companies as well as in annual financial statements. These FSP also amend APB Opinion No. 28, Interim Financial Reporting, requiring to (a) disclose in the body or in the accompanying notes of its financial statements for interim and annual reporting periods the fair value of all financial instruments for which it is practicable to estimate that value, whether recognized or not recognized in the statement of financial position, as required by SFAS No. 107, (b) disclose in the notes, fair value information presented together with the related carrying amount in a form that makes it clear whether the fair value and carrying amount represent assets or liabilities and how the carrying amount relates to what is reported in the statement of financial position and (c) disclose the method(s) and significant assumptions used to estimate the fair value of financial instruments and describe changes in method(s) and significant assumptions, if any, during the period. The provisions and disclosures of FSP FAS 107-1 and APB 28-1 were adopted, as required, effective for the period ended June 30, 2009.

FAS 165 “Subsequent Events”

In May 2009, the FASB issued FAS 165 which establishes general standards of accounting for and disclosures of events that occur after the balance sheet date but before the financial statements are issued or are available to be issued. It requires the disclosure of the date through which an entity has evaluated subsequent events. We adopted the new disclosure requirements in our June 30, 2009 condensed consolidated financial statements.

FAS 166, “Accounting for Transfers of Financial Assets” and FAS 167, “Amendments to FASB Interpretation No. 46(R)”

In June 2009, FASB issued FAS 166 and FAS 167, which 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 anticipates that adoption of FAS 166 and 167 will not have a material impact on the Group’s consolidated financial statements.

FAS 168, “The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles—a replacement of FASB Statement No. 162”

FAS 168, issued by the FASB in June 2009, amends FAS 162, “The Hierarchy of Generally Accepted Accounting Principles, to modify the GAAP hierarchy to include only two levels of GAAP: authoritative and non-authoritative”. The provisions of FAS 168 are effective for financial statements issued for interim and annual periods ending after September 15, 2009. The adoption of FAS 168 is not expected to affect the Group’s statements of financial condition and operations.

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 June 30, 2009, and December 31, 2008, cash equivalents included as part of cash and due from banks amounted to $210.2 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 June 30, 2009, and December 31, 2008, were as follows:

		June 30, 2009 (In thousands)
						Gross				Gross								Weighted
		Amortized				Unrealized				Unrealized				Fair				Average
		Cost				Gains				Losses				Value				Yield
Available-for-sale
Obligations of US Government sponsored agencies		$	929,902			$	3,708			$	12,364			$	921,246				3.48	%
Puerto Rico Government and agency obligations			71,565				5				8,589				62,981				5.37	%
Structured credit investments			176,980				3,355				36,512				143,823				3.11	%
Total investment securities			1,178,447				7,068				57,465				1,128,050
FNMA and FHLMC certificates			2,727,646				44,779				3,960				2,768,465				5.03	%
GNMA certificates			250,929				7,894				102				258,721				4.90	%
CMOs issued by US Government sponsored agencies			312,716				6,413				39				319,090				5.23	%
Non-agency collateralized mortgage obligations			594,962				—				118,768				476,194				5.87	%
Total mortgage-backed-securities and CMOs			3,886,253				59,086				122,869				3,822,470
Total securities available-for-sale		$	5,064,700			$	66,154			$	180,334			$	4,950,520				4.79	%

		December 31, 2008 (In thousands)
						Gross				Gross								Weighted
		Amortized				Unrealized				Unrealized				Fair				Average
		Cost				Gains				Losses				Value				Yield
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				6.18	%
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 June 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.

		(In thousands)
		Available-for-sale
		Amortized Cost				Fair Value
Investment securities
Due less than 1 year		$	338,978			$	338,978
Due after 5 to 10 years			229,206				220,795
Due after 10 years			610,263				568,277
			1,178,447				1,128,050
Mortgage-backed securities
Due after 5 to 10 years			20,164				20,634
Due after 10 years			3,866,089				3,801,836
			3,886,253				3,822,470
		$	5,064,700			$	4,950,520

Keeping with the Group’s investment strategy, during the six-month period ended June 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. 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 six-month period ended June 30, 2009, the Group sold $932.3 million of discount notes with minimal aggregate gross gains of approximately $162 thousand and sold $739.9 million of discounted notes with minimal aggregate gross losses of approximately $13 thousand.

The table below presents an analysis of the gross realized gains and losses by category for the six month periods ended June 30, 2009 and 2008:

Six-Month Period Ended June 30, 2009 (In thousands)
Description		Original Face				Original Cost				Sale Price				Sale Book Value				Gross Gains				Gross Losses
Sale of Securities Available-for-Sale
Investment securities
Puerto Rico Government and agency obligations		$	90,000			$	90,612			$	90,000			$	90,000			$	—			$	—
Obligations of U.S. Government sponsored agencies			1,672,285				1,673,089				1,672,230				1,672,081				162				13
Total investment securities			1,762,285				1,763,701				1,762,230				1,762,081				162				13
Mortgage-backed securities and CMOs
FNMA and FHLMC certificates			783,722				797,092				730,841				716,588				14,253				—
GNMA certificates			68,406				69,092				69,090				69,042				48				—
CMOs issued by U.S. Government sponsored agencies			330,000				330,938				336,994				330,584				6,410				—
Total mortgage-backed securities and CMOs			1,182,128				1,197,122				1,136,925				1,116,214				20,711				—
Total		$	2,944,413			$	2,960,823			$	2,899,155			$	2,878,295			$	20,873			$	13
Six-month period ended June 30, 2008 (In thousands)
Description		Original Face				Original Cost				Sale Price				Sale Book Value				Gross Gains				Gross Losses
Sale of Securities Available-for-Sale
Investment securities
Puerto Rico Government and agency obligations		$	1,830			$	1,843			$	1,862			$	1,804			$	58			$	—
Obligations of U.S. Government sponsored agencies			709,300				708,957				718,291				709,070				9,221				—
Total investment securities			711,130				710,800				720,153				710,874				9,279				—
Mortgage-backed securities and CMOs
FNMA and FHLMC certificates			250,287				250,506				198,348				198,229				119				—
GNMA certificates			24,958				26,440				24,633				24,509				124				—
Total mortgage-backed securities and CMOs			275,245				276,946				222,981				222,738				243				—
Total		$	986,375			$	987,746			$	943,134			$	933,612			$	9,522			$	—

The following table shows the Group’s gross unrealized losses and fair value of investment securities available-for-sale, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at June 30, 2009, and December 31, 2008.

June 30, 2009
Available-for-sale
(In thousands)

		Less than 12 months
		Amortized				Unrealized				Fair
		Cost				Loss				Value
FNMA and FHLMC certificates		$	850,769			$	3,935			$	846,834
Obligations of US Government sponsored agencies			390,924				12,364				378,560
Structured credit investments			29,458				302				29,156
GNMA certificates			10,190				46				10,144
CMOs issued by US Government sponsored agencies			4,536				39				4,497
			1,285,877				16,686				1,269,191

		12 months or more
		Amortized				Unrealized				Fair
		Cost				Loss				Value
FNMA and FHLMC certificates			950				25				925
Non-agency collaterized mortgage obligations			594,963				118,768				476,195
Structured credit investments			122,173				36,210				85,963
Puerto Rico Government and agency obligations			71,183				8,589				62,594
GNMA certificates			4,325				56				4,269
			793,594				163,648				629,946