OFG Bancorp - 10-Q quarterly report FY

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 September 30, 2005

or


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

For the transition period from to

Commission File Number 001-12647

Oriental Financial Group Inc.


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

Principal Executive Offices:
998 San Roberto Street
Professional Offices Park, S.E.
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 is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes þ No 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 o

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

24,582,197 common shares ($1.00 par value per share)
outstanding as of October 31, 2005

TABLE OF CONTENTS


	PAGE
PART — I FINANCIAL INFORMATION:

Item 1 Financial Statements

Unaudited consolidated statements of financial condition at September 30, 2005 and June 30, 2005

Unaudited consolidated statements of income for the three-month periods ended September 30, 2005 and 2004

Unaudited consolidated statements of changes in stockholders’ equity for the three-month periods ended September 30, 2005 and 2004

Unaudited consolidated statements of comprehensive income for the three-month periods ended September 30, 2005 and 2004

Unaudited consolidated statements of cash flows for the three-month periods ended September 30, 2005 and 2004

Notes to unaudited consolidated financial statements

Item 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations

Item 3 Quantitative and Qualitative Disclosures about Market Risk

Item 4 Controls and Procedures

PART — II OTHER INFORMATION:

Item 1 Legal Proceedings

Item 2 Unregistered Sales of Equity Securities and Use of Proceeds

Item 3 Defaults upon Senior Securities

Item 4 Submissions of Matters to a Vote of Security Holders

Item 5 Other Information

Item 6 Exhibits

Signatures

Certifications

- 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 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.

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PART 1 — FINANCIAL INFORMATION

Item 1 — Financial Statements

UNAUDITED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
SEPTEMBER 30, 2005 AND JUNE 30, 2005
(In thousands, except share data)


	September 30,			June 30,
	2005			2005
ASSETS

Cash and due from banks	$	15,930		$	14,892


Investments:
Time deposits with other banks		60,000			30,000
Money market investments		10,387			9,791

Short term investments		70,387			39,791

Trading securities, at fair value with amortized cost of $185 (June 30, 2005 — $259)		188			265

Investment securities available-for-sale, at fair value with amortized cost of $1,034,663 (June 30, 2005 — $1,036,153):
Securities pledged that can be repledged		414,557			409,556
Other investment securities		602,798			620,164

Total investment securities available-for-sale		1,017,355			1,029,720

Investment securities held-to-maturity, at amortized cost with fair value of $2,239,607 (June 30, 2005 — $2,142,708):
Securities pledged that can be repledged		1,770,326			1,802,596
Other investment securities		490,829			332,150

Total investment securities held-to-maturity		2,261,155			2,134,746

Federal Home Loan Bank (FHLB) stock, at cost		27,058			27,058

Total investments		3,376,143			3,231,580


Securities sold but not yet delivered		707			1,034


Loans:
Mortgage loans held-for-sale, at lower of cost or market		19,572			17,963
Loans receivable, net of allowance for loan losses of $6,837 (June 30, 2005 - $6,495)		882,152			889,428

Total loans, net		901,724			907,391


Accrued interest receivable		26,178			23,735
Premises and equipment, net		15,471			15,269
Deferred tax asset, net		6,980			6,191
Foreclosed real estate		4,521			4,186
Other assets		47,392			46,374


Total assets	$	4,395,046		$	4,250,652


LIABILITIES AND STOCKHOLDERS’ EQUITY

Deposits:
Demand deposits	$	145,950		$	152,165
Savings accounts		86,258			93,925
Certificates of deposit		1,072,564			1,006,807

Total deposits		1,304,772			1,252,897


Borrowings:
Federal Funds purchased		11,641			12,310
Securities sold under agreements to repurchase		2,208,847			2,191,756
Advances from FHLB		300,000			300,000
Term notes		15,000			15,000
Subordinated capital notes		72,166			72,166

Total borrowings		2,607,654			2,591,232


Securities and loans purchased but not yet received		100,000			22,772
Accrued expenses and other liabilities		38,443			42,584


Total liabilities		4,050,869			3,909,485


Commitments and contingencies		—			—

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; 25,321,372 shares issued (June 30, 2005 — 25,103,636 shares)		25,321			25,104
Additional paid-in capital		188,525			187,301
Legal surplus		34,916			33,893
Retained earnings		71,348			68,620
Treasury stock, at cost 545,000 (June 30, 2005 — 228,000 shares)		(8,031	)		(3,368	)
Accumulated other comprehensive loss, net of tax benefit of $1,055 (June 30, 2004 — $311)		(35,902	)		(38,383	)

Total stockholders’ equity		344,177			341,167


Total liabilities and stockholders’ equity	$	4,395,046		$	4,250,652

See notes to consolidated financial statements.

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UNAUDITED CONSOLIDATED STATEMENTS OF INCOME
FOR THE THREE-MONTH PERIODS ENDED SEPTEMBER 30, 2005 AND 2004
(In thousands, except per share data)


	2005			2004
Interest income:
Loans	$	15,218		$	13,289
Mortgage-backed securities		21,655			28,469
Investment securities		13,265			3,123
Short term investments		675			66

Total interest income		50,813			44,947


Interest expense:
Deposits		9,589			6,518
Securities sold under agreements to repurchase		20,132			11,808
Advances from FHLB, term notes and other borrowings		2,551			2,051
Subordinated capital notes		1,213			917

Total interest expense		33,485			21,294


Net interest income		17,328			23,653
Provision for loan losses		951			700

Net interest income after provision for loan losses		16,377			22,953


Non-interest income (expense):
Commissions and fees from brokerage, investment banking, insurance and fiduciary activities		3,924			3,697
Banking service revenues		2,219			1,951
Net gain (loss) on sale and valuation of:
Mortgage banking activities		1,068			2,057
Securities available-for-sale		341			3,245
Derivatives		(50	)		(570	)
Trading securities		4			(2	)
Other		319			26

Total non-interest income, net		7,825			10,404


Non-interest expenses:
Compensation and employees’ benefits		6,260			6,768
Occupancy and equipment		2,976			2,501
Advertising and business promotion		1,350			1,341
Professional and service fees		1,693			1,674
Communication		413			451
Loan servicing expenses		446			449
Taxes, other than payroll and income taxes		597			450
Electronic banking charges		388			490
Printing, postage, stationery and supplies		259			248
Insurance, including deposit insurance		185			198
Other		823			613

Total non-interest expenses		15,390			15,183


Income before income taxes		8,812			18,174
Income tax expense		(391	)		(768	)

Net income		8,421			17,406
Less: Dividends on preferred stock		(1,200	)		(1,200	)

Net income available to common shareholders	$	7,221		$	16,206


Income per common share:
Basic	$	0.29		$	0.67

Diluted	$	0.29		$	0.64


Average common shares outstanding		24,926			24,262
Average potential common share-options		214			1,195

		25,140			25,457


Cash dividends per share of common stock	$	0.14		$	0.13

See notes to consolidated financial statements.

-5-

UNAUDITED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
FOR THE THREE-MONTH PERIODS ENDED SEPTEMBER 30, 2005 AND 2004
(In thousands)


CHANGES IN STOCKHOLDERS’ EQUITY:	2005			2004
Preferred stock:
Balance at beginning of period	$	68,000		$	68,000

Balance at end of period		68,000			68,000


Common stock:
Balance at beginning of period		25,104			22,253
Stock options exercised		217			250

Balance at end of period		25,321			22,503


Additional paid-in capital:
Balance at beginning of period		187,301			125,206
Stock options exercised		1,224			1,915

Balance at end of period		188,525			127,121


Legal surplus:
Balance at beginning of period		33,893			27,425
Transfer from retained earnings		1,023			1,881

Balance at end of period		34,916			29,306


Retained earnings:
Balance at beginning of period		68,620			101,723
Net income		8,421			17,406
Cash dividends declared on common stock		(3,470	)		(3,118	)
Cash dividends declared on preferred stock		(1,200	)		(1,200	)
Transfer to legal surplus		(1,023	)		(1,881	)

Balance at end of period		71,348			112,930


Treasury stock:
Balance at beginning of period		(3,368	)		(4,578	)
Stock purchased		(4,679	)		—
Stock used to match defined contribution plan 1165(e)		16			96

Balance at end of period		(8,031	)		(4,482	)


Accumulated other comprehensive loss, net of deferred tax:
Balance at beginning of period		(38,383	)		(45,362	)
Other comprehensive income, net of tax		2,481			4,848

Balance at end of period		(35,902	)		(40,514	)


Total stockholders’ equity	$	344,177		$	314,864

UNAUDITED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
THREE-MONTH PERIODS ENDED SEPTEMBER 30, 2005 AND 2004
(In thousands)


COMPREHENSIVE INCOME	2005			2004
Net income	$	8,421		$	17,406


Other comprehensive income, net of tax:
Unrealized gain (loss) on securities available-for-sale arising during the period	$	(8,978	)	$	20,772
Realized gains on investment securities available-for-sale included in net income		(341	)		(3,245	)
Unrealized gain (loss) on derivatives designated as cash flows hedges arising during the period		11,225			(16,886	)
Realized (gain) loss on derivatives designated as cash flow hedges included in net income		(169	)		4,403
Income tax effect related to unrealized (gain) loss on securities available-for-sale		744			(196	)

Other comprehensive income for the period		2,481			4,848


Comprehensive income	$	10,902		$	22,254

See notes to consolidated financial statements.

-6-

UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE-MONTH PERIODS ENDED SEPTEMBER 30, 2005 AND 2004
(In thousands)


	2005			2004
Cash flows from operating activities:
Net income	$	8,421		$	17,406

Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Amortization of deferred loan origination fees, net of costs		(438	)		(915	)
Amortization of premiums, net of accretion of discounts on investment securities, net		2,692			2,542
Depreciation and amortization of premises and equipment		1,595			1,347
Deferred income tax benefit		(46	)		(24	)
Equity in earnings of investment in limited liability partnership		(219	)		—
Stock options expense		6			—
Provision for loan losses		951			700
Loss (gain) on:
Sale of securities available-for-sale		(341	)		(3,245	)
Mortgage banking activities		(1,068	)		(2,057	)
Derivatives		50			570
Originations of loans held-for-sale		(48,094	)		(26,346	)
Proceeds from sale of loans held-for-sale		8,125			11,143
Net decrease (increase) in:
Trading securities		77			520
Accrued interest receivable		(2,443	)		56
Other assets		1,882			(58	)
Net increase in:
Accrued interest on deposits and borrowings		7,941			3,934
Other liabilities		1,480			1,844

Total adjustments		(27,850	)		(9,989	)


Net cash provided by (used in) operating activities		(19,429	)		7,417


Cash flows from investing activities:
Net increase in time deposits with other banks		(30,000	)		—
Purchases of:
Investment securities available-for-sale		(112,238	)		(679,028	)
Investment securities held-to-maturity		(100,000	)		(25,395	)
Purchases of equity options		(163	)		(475	)
Maturities and redemptions of:
Investment securities available-for-sale		23,228			57,525
Investment securities held-to-maturity		117,248			49,559
Proceeds from sales of:
Investment securities available-for-sale		65,215			522,394
Foreclosed real estate		816			390
Loan production:
Origination and purchase of loans, excluding loans held-for-sale		(62,930	)		(125,944	)
Principal repayment of loans		67,994			44,622
Additions to premises and equipment		(1,798	)		(669	)

Net cash used in investing activities		(32,628	)		(157,021	)


Cash flows from financing activities:
Net increase (decrease) in:
Deposits		45,179			15,139
Securities sold under agreements to repurchase		17,091			205,475
Federal funds purchased		(669	)		—
Proceeds from:
Advances from FHLB		590,501			28,500
Exercise of stock options, net		1,441			2,165
Repayments of advances from FHLB		(590,501	)		(28,500	)
Common stock purchased		(4,662	)		—
Dividends paid		(4,689	)		(4,283	)

Net cash provided by financing activities		53,691			218,496


Net change in cash and cash equivalents		1,634			68,892
Cash and cash equivalents at beginning of period		24,683			17,031

Cash and cash equivalents at end of period	$	26,317		$	85,923


Cash and cash equivalents include:
Cash and due from banks	$	15,930		$	11,321
Money market investments		10,387			74,602

	$	26,317		$	85,923

Supplemental Cash Flow Disclosure and Schedule of Noncash Activities:
Interest paid	$	25,544		$	17,360

Income taxes paid	$	554		$	—

Mortgage loans securitized into mortgage-backed securities	$	37,564		$	15,238

Investment securities available-for-sale transferred to held-to-maturity	$	—		$	60,460

Accrued dividend payable	$	3,469		$	3,116

Other comprehensive income for the period	$	2,481		$	4,848

Securities sold but not yet delivered	$	707		$	23,369

Securities and loans purchased but not yet received	$	100,000		$	53,300

Transfer from loans to foreclosed real estate	$	1,035		$	481

See notes to consolidated financial statements.

-7-

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 accounting principles generally accepted in the United States of America (“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 financial statements include all adjustments necessary, to present fairly the consolidated financial condition as of September 30, 2005 and June 30, 2005, and the results of operations for the three-month periods ended September 30, 2005 and 2004, and the cash flows for the three-month periods ended September 30, 2005 and 2004. 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. Financial information as of June 30, 2005 has been derived from the Group’s audited consolidated financial statements. The results of operations and cash flows for the three-month periods ended September 30, 2005 and 2004 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 June 30, 2005, included in the Group’s Annual Report on Form 10-K.

Nature of Operations

Oriental is a financial holding company incorporated under the laws of the Commonwealth of Puerto Rico. The Group provides a wide range of financial services such as mortgage, commercial and consumer lending, financial planning, insurance sales, money management and investment brokerage services, as well as corporate and individual trust and retirement services through the following subsidiaries: Oriental Bank and Trust (the “Bank”), Oriental Financial Services Corp. (“Oriental Financial Services”), Oriental Insurance, Inc. (“Oriental Insurance”) and Caribbean Pension Consultants, Inc. (“CPC”).

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

The Bank operates twenty-four branches 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 and the Federal Deposit Insurance Corporation (“FDIC”), which insures its deposits through the Savings Association Insurance Fund (SAIF), up to $100,000 per depositor. The Bank has two international banking entities (each an “IBE”): O.B.T. International Bank, which is a unit of the Bank, and Oriental International Bank Inc., which is a subsidiary of the Bank. Both IBE’s were organized pursuant to the International Banking Center Regulatory Act of Puerto Rico, as amended (the “IBE Act”). The Group transferred as of January 1, 2004 substantially all of the assets and liabilities of O.B.T. International Bank to Oriental International Bank Inc. The IBE’s offer the Bank certain Puerto Rico tax advantages and their services are limited under Puerto Rico law to persons and assets located outside of Puerto Rico.

Oriental Financial Services is subject to the supervision, examination and regulation of the National Association of Securities Dealers, Inc., the SEC, and the Office of the Commissioner of Financial Institutions of Puerto Rico. Oriental Insurance is subject to the supervision, examination and regulation of the Office of the Commissioner of Insurance of Puerto Rico.

Significant Accounting Policies

•		Use of Estimates in the Preparation of Financial Statements

		The preparation of financial statements in conformity with GAAP requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the consolidated financial statements and the reported amount of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate mainly to the determination of the allowance for loan losses, income tax, and the valuation of derivatives.

- 8 -

•		Principles of Consolidation

		The accompanying consolidated financial statements include the accounts of the Group and it wholly owned Subsidiaries. All significant intercompany transactions and balances have been eliminated in consolidation.

•		Significant Group Concentrations of Credit Risk

		Most of the Group’s business activities are with customers located in Puerto Rico. Note 2 discusses the types of securities in which the Group invests. Note 3 discusses the types of lending activities in which the Group is engaged. The Group does not have any significant concentrations with any one industry or customer.

•		Cash Equivalents

		For purposes of presentation in the consolidated statements of cash flows, the Group considers as cash equivalents all money market instruments that are not pledged with maturities of three months or less at the date of acquisition.

•		Earnings per Common Share

		Basic earnings per share excludes potential dilutive common shares and is calculated by dividing net income available to common shareholders (net income reduced by dividends on preferred stock) by the weighted average of outstanding common shares. Diluted earnings per share is similar to the computation of basic earnings per share except that the weighted average of common shares is increased to include the number of additional common shares that would have been outstanding if the dilutive potential common shares (options) had been issued, assuming that proceeds from exercise are used to repurchase shares in the market (treasury stock method). Any stock splits and dividends are retroactively recognized in all periods presented in the financial statements.

•		Securities Purchased / Sold Under Agreements to Resell / Repurchase

		The Group purchases securities under agreements to resell the same or similar securities. Amounts advanced under these agreements represent short-term loans and are reflected as assets in the statements of financial condition. It is the Group’s policy to take possession of securities purchased under resale agreements while the counterparty retains effective control over the securities. The Group monitors the market value of the underlying securities as compared to the related receivable, including accrued interest, and requests additional collateral when deemed appropriate. The Group also sells securities under agreements to repurchase the same or similar securities. The Group retains effective control over the securities sold under these agreements; accordingly, such agreements are treated as financing agreements, and the obligations to repurchase the securities sold are reflected as liabilities. The securities underlying the financing agreements remain included in the asset accounts. The counterparty to repurchase agreements generally has the right to repledge the securities received as collateral.

•		Investment Securities

		Securities are classified as held-to-maturity, available-for-sale or trading. Securities for which the Group has the positive intent and ability to hold to maturity are classified as held-to-maturity and are carried at amortized cost. Securities that might be sold prior to maturity because of interest rate changes, to meet liquidity needs, or to better match the repricing characteristics of funding sources are classified as available-for-sale. These securities are reported at fair value, with unrealized gains and losses excluded from earnings and reported net of tax in other comprehensive income.

		The Group classifies as trading those securities that are acquired and held principally for the purpose of selling them in the near future. These securities are carried at fair value with realized and unrealized changes in fair value included in earnings in the period in which the changes occur. Interest revenue arising from trading instruments is included in the statements of income as part of interest income.

		The Group’s investment in the Federal Home Loan Bank (FHLB) of New York stock has no readily determinable fair value and can only be sold back to the FHLB at cost. Therefore, the carrying value represents its fair value.

		Premiums and discounts are amortized to interest income over the life of the related securities using the interest method. Net realized gains or losses on sales of investment securities available for sale, and unrealized loss valuation adjustments considered other than temporary, if any, on securities classified as either available-for-sale or held-to-maturity are reported separately in the statements of income. The cost of securities sold is determined on the specific identification method.

- 9 -

•		Impairment of Investment Securities

		The Group evaluates its securities available-for-sale and held-to-maturity for impairment. An impairment charge in the consolidated statements of income is recognized when the decline in the fair value of investments below their cost basis is judged to be other-than-temporary. The Group considers various factors in determining whether it should recognize an impairment charge, including, but not limited to the length of time and extent to which the fair value has been less than its cost basis, and the Group’s intent and ability to hold the investment for a period of time sufficient to allow for any anticipated recovery in market value. For debt securities, the Group also considers, among other factors, the debtors repayment ability on its bond obligations and its cash and capital generation ability.

•		Derivative Financial Instruments

		As part of the Group’s asset and liability management, the Group uses interest-rate contracts, which include interest-rate swaps to hedge various exposures or to modify interest rate characteristics of various statement of financial condition accounts.

		The Group follows Statement of Financial Accounting Standards (“SFAS”) No. 133, “Accounting for Derivative Instruments and Hedging Activities”, as amended (refer to Note 8), which establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. The statement requires that all derivative instruments be recognized as assets and liabilities at fair value. If certain conditions are met, the derivative may qualify for hedge accounting treatment and be designated as one of the following types of hedges: (a) hedge of the exposure to changes in the fair value of a recognized asset or liability or an unrecognized firm commitment (“fair value hedge”); (b) a hedge of the exposure to variability of cash flows of a recognized asset, liability or forecasted transaction (“cash flow hedge”) or (c) a hedge of foreign currency exposure (“foreign currency hedge”).

		In the case of a qualifying fair value hedge, changes in the value of the derivative instruments that have been highly effective are recognized in current period earnings along with the change in value of the designated hedged item. In the case of a qualifying cash flow hedge, changes in the value of the derivative instruments that have been highly effective are recognized in other comprehensive income, until such time as those earnings are affected by the variability of the cash flows of the underlying hedged item. In either a fair value hedge or a cash flow hedge, net earnings may be impacted to the extent the changes in the fair value of the derivative instruments do not perfectly offset changes in the fair value or cash flows of the hedged items. If the derivative is not designated as a hedging instrument, the changes in fair value of the derivative are recorded in earnings.

		Certain contracts contain embedded derivatives. When the embedded derivative possesses economic characteristics that are not clearly and closely related to the economic characteristics of the host contract, it should be bifurcated and carried at fair value.

		The Group uses several 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 to derive the fair value of certain derivatives contracts.

•		Off-Balance Sheet Instruments

		In the ordinary course of business, the Group enters into off-balance sheet instruments consisting of commitments to extend credit and commitments under credit card arrangements. Such financial instruments are recorded in the financial statements when they are funded or related fees are incurred or received. The Group periodically evaluates the credit risks inherent in these commitments, and establishes loss allowances for such risks if and when these are deemed necessary.

•		Mortgage Banking Activities and Loans Held-For-Sale

		The mortgages reported as loans held-for-sale are stated at the lower of cost or market in the aggregate. Net unrealized losses are recognized through a valuation allowance by charges to income. Realized gains or losses on these loans are determined using the specific identification method. From time to time, the Group sells loans to other financial institutions or securitizes conforming mortgage loans into Government National Mortgage Association (GNMA), Federal National Mortgage Association (FNMA) and Federal Home Loan Mortgage Corporation (FHLMC) certificates using another institution as issuer. This other institution services the mortgages included in the resulting GNMA, FNMA and FHLMC pools.

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		Servicing rights on mortgage loans originated and held by the Group are sold to another financial institution. The gain on the sale of these rights is amortized over the expected life of the loans are sold, at which time the unamortized deferred gain is taken into income.

•		Loans and Allowance for Loan Losses

		Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off are reported at their outstanding unpaid principal balances adjusted for charge-offs, the allowance for loan losses, and any deferred fees or costs on originated loans. Interest income is accrued on the unpaid principal balance. Loan origination fees and costs and premiums and discounts on loans purchased are deferred and amortized over the estimated life of the loans as an adjustment of their yield through interest income using a method that approximates the interest method. Interest recognition is discontinued when loans are 90 days or more in arrears on principal and/or interest, except for well-collateralized residential real estate loans for which recognition is discontinued when they become 365 days or more past due and are written down, if necessary, based on the specific evaluation of the collateral underlying the loan. Loans for which the recognition of interest income has been discontinued are designated as non-accruing. Such loans are not reinstated to accrual status until interest is received on a current basis and other factors indicative of doubtful collection cease to exist. The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.

		The Group follows a systematic methodology to establish and evaluate the adequacy of the allowance for loan losses. This methodology consists of several key elements. The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectibility of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as more information becomes available.

		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 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 and for loans that are recorded at fair value or at the lower of cost or market. The Group measures for impairment all commercial loans over $250,000. The portfolios of mortgages, and consumer loans, are considered homogeneous and are evaluated collectively for impairment.

		For loans that are not individually graded, the Group uses a methodology that follows a loan credit risk rating process that involves dividing loans into risk categories. The following are the credit risk categories: pass, special mention, substandard, doubtful and loss.

		The Group, using an aged-based 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, economic trends and unusual events such as hurricanes.

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

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•		Premises and Equipment

		Premises and equipment are carried at cost less accumulated depreciation. Depreciation is provided using the straight-line method over the estimated useful life of each type of asset. Amortization of leasehold improvements is computed using the straight-line method over the terms of the leases or estimated useful lives of the improvements, whichever is shorter.

		Long-lived assets and identifiable intangibles, except for financial instruments, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. In performing the review for recoverability, an estimate is made of the future cash flows expected to result from the use of the asset and its eventual disposition. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount of the asset, an impairment loss is recognized if the fair value is less than the carrying amount of the related asset. Otherwise, an impairment loss is not recognized. There were no such impairment losses for the three-month periods ended September 30, 2005 and 2004.

•		Foreclosed Real Estate

		Foreclosed real estate is initially recorded at the lower of the related loan balance or the fair value of the real estate at the date of foreclosure. At the time properties are acquired in full or partial satisfaction of loans, any excess of the loan balance over the estimated fair market value of the property is charged against the allowance for loan losses. After foreclosure, these properties are carried at the lower of cost or fair value less estimated costs to sell. Any excess of the carrying value over the estimated fair market value, less estimated costs to sale is charged to operations. The costs and expenses associated to holding these properties in portfolio are expensed as incurred.

•		Investment in limited partnerships

		Investment in limited partnership is accounted for in accordance to the provisions of EITF D-46, “Accounting for Limited Partnership Investment,” which requires the application of the equity method to investments in limited partnerships, pursuant to paragraph 8 of AICPA Statement of Position 78-9, “Accounting for Investments in Real Estate Ventures,”. The statement requires the use of the equity method unless the investor’s interest is “so minor that the limited partner may have virtually no influence over partnership operating and financial policies.”

•		Transfers and Servicing of Financial Assets and Extinguishments of Liabilities

		A transfer of financial assets is accounted for as a sale when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the transferor, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the transferor does not maintain effective control over the transferred assets through an agreement to repurchase them before maturity. As such, the Group recognizes the financial assets and servicing assets it controls and the liabilities it has incurred. At the same time, it ceases to recognize financial assets when control has been surrendered and liabilities when they are extinguished.

•		Income Taxes

		In preparing the consolidated financial statements, the Group is required to estimate income taxes. This involves an estimate of current income tax expense together with an assessment of temporary differences resulting from differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The determination of current income tax expense involves estimates and assumptions that require the Group to assume certain positions based on its interpretation of current tax 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. The Group’s effective tax rate includes the impact of tax contingency accruals and changes to such accruals, including related interest and penalties, as considered appropriate by management. 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.

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		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 income.

		Management evaluates the realizability of the deferred tax assets on a quarterly 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. As of September 30, 2005 and June 30, 2005, the Group had no recorded valuation allowances related to its net deferred tax assets.

		In addition to valuation allowances, the Group establishes accruals for certain tax contingencies 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 tax contingency 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 tax contingency accruals are reflected as a component of accrued liabilities.

		On August 1, 2005 the Puerto Rico Legislature approved Act No. 41 “Act for the Educational Future of the Puerto Rican Children.” This law imposes an additional tax of 2.5% on taxable net income. This law is applicable to all corporations and partnerships with a taxable net income over $20,000, according to part (a) of Section 1015 of the Puerto Rico Internal Revenue Code of 1994. The law will be effective for tax years beginning after December 31, 2004 and ending on or before December 31, 2006. Although the effectiveness of this law is subject to the final approval of the Legislature’s Joint Resolution Number 445, concerning the General Budget of the 2005-2006 fiscal year, which Joint Resolution was vetoed by the Governor, the Puerto Rico Treasury Department has taken the position that the law is in effect.

		On October 20, 2005, the Puerto Rico Legislature approved a new tax bill. This bill imposes an additional tax of 1% on the net taxable income of banks. This bill will be applicable to all corporations mentioned or covered under the Act No. 55 of May 12, 1933, known as “The Banking Law of Puerto Rico,” as amended. The additional funds expected to be obtained from this tax will be assigned to the Department of Education of Puerto Rico. The additional tax, if it is finally approved by the Governor of Puerto Rico, will be effective for the tax years commencing after June 30, 2005 and ending on or before December 31, 2006.

•		Stock Option Plans

		At September 30, 2005, the Group had three stock-based employee compensation plans: the 1996, 1998, and 2000 Incentive Stock Option Plans. These plans offer key officers, directors and employees an opportunity to purchase shares of the Group’s common stock. The Compensation Committee of the Board of Directors has sole authority and absolute discretion as to the number of stock options to be granted to any officer, director or employee, their vesting rights, and the options’ exercise prices. The plans provide for a proportionate adjustment in the exercise price and the number of shares that can be purchased in case of merger, consolidation, combination, exchange of shares, other reorganization, recapitalization, reclassification, stock dividend, stock split or reverse stock split in which the number of shares of common stock of the Group as a whole are increased, decreased, changed into or exchanged for a different number or kind of shares or securities. Stock options vest upon completion of specified years of service.

		On December 16, 2004, the Financial Accounting Standard Board (“FASB”) issued Statement 123(R) — Accounting for Stock-Based Compensation, requiring that the compensation cost relating to share-based payment transactions be recognized in financial statements. The statement became effective in the first interim or annual reporting period of the registrant’s fiscal year beginning on or after June 15, 2005. On June 30, 2005, the Compensation Committee of the Group’s Board of Directors approved the acceleration of the vesting of all outstanding options to purchase shares of common stock of the Group that were held by employees, officers and directors as of June 30, 2005. As a result, options to purchase approximately 1,219,333 shares became exercisable. The purpose of the accelerated vesting is to enable the Group to avoid recognizing in its income statement compensation expense associated with these options in future periods, upon adoption of FASB Statement No. 123(R). Effective July 1, 2005, the Group adopted FASB Statement No. 123 (R) — Accounting for Stock-Based Compensation.

		During the quarter ended September 30, 2005, the Group granted options for the purchase of 50,000 of its common stock to two executive officers. The Group recognized $5,986 in stock option compensation expense for the quarter ended September 30, 2005, under the provisions of Statement 123(R) which requires that the compensation cost relating to share-based payment transactions be recognized in financial statements. That cost is measured based on the fair value of the equity or liability instruments issued. Statement 123(R) covers a wide range of share-based compensation arrangements including share options, restricted share plans, performance-based awards, share appreciation rights, and

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		employee share purchase plans. Statement 123(R) replaces FASB Statement No. 123, Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees. Statement 123, as originally issued in 1995, established as preferable a fair-value-based method of accounting for share-based payment transactions with employees. However, that Statement permitted entities the option of continuing to apply the guidance in Opinion 25, as long as the footnotes to the financial statements disclosed what net income would have been had the preferable fair-value-based method been used.

		The weighted average assumptions used for the valuation of the grants issued during the three-month period ended September 30, 2005 were:


• Expected dividend yield		2.33	%
• Expected volatility		42.35	%
• Risk-free interest rate		3.98	%
• Expected employee turnover		2.85	%
• Expected life of options		5.35
• Weighted average fair value of options granted (per option)	$	5.51

		The fair value of the options was estimated on the date of the grants using the Black-Scholes Option Pricing Model. The Black-Scholes option-pricing model was developed for use in estimating the fair value of traded options that have no restrictions and are fully transferable and negotiable in a free trading market. Black-Scholes does not consider the employment, transfer or vesting restrictions that are inherent in the Group’s employee options. Use of an option valuation model, as required by GAAP, includes highly subjective assumptions based on long-term predictions, including the expected stock price volatility and average life of each option grant. Because the Group’s employee options have characteristics significantly different from those of freely traded options, and because changes in the subjective input assumptions can materially affect the Group’s estimate of the fair value of those options, in the Group’s opinion, the existing valuation models, including Black-Scholes, are not reliable single measures and the use of other option pricing models may result in different fair values of the Group’s employee options.

		Prior to the adoption of FASB No. 123 (R), the Group accounted for these plans under the recognition and measurement principles of APB Opinion No. 25, “Accounting for Stock Issued to Employees”, and related interpretations as described in the preceding paragraphs. Compensation expense was generally recognized for any excess of the quoted market price of the Group’s stock at measurement date over the amount an employee must pay to acquire the stock. No stock-based employee compensation cost was reflected in net income for the fiscal periods ended before July 1, 2005, as all options granted under these plans had an exercise price equal to the market value of the underlying common stock on the date of grant. These plans are described more fully in Note 9.

New Accounting Pronouncements

•		SFAS No. 153 “Exchanges of Nonmonetary Assets”

		In December 2004, the FASB issued SFAS No. 153, “Exchanges of Nonmonetary Assets, an amendment of APB Opinion No. 29, Accounting for Nonmonetary Transactions.” This statement amends the principle that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged and more broadly provides for exceptions regarding exchanges of nonmonetary assets that do not have commercial substance. A nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. The entity’s future cash flows are expected to significantly change if either of the following criteria is met: a) the configuration (risk, timing, and amount) of the future cash flows of the asset(s) received differs significantly from the configuration of the future cash flows of the asset(s) transferred or b) the entity-specific value of the asset(s) received differs from the entity-specific value of the asset(s) transferred, and the difference is significant in relation to the fair values of the assets exchanged. A qualitative assessment will, in some cases, be conclusive in determining that the estimated cash flows of the entity are expected to significantly change as a result of the exchange. SFAS No. 153 is effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. Management believes that the adoption of this statement will not have a significant effect on the Group’s consolidated financial statements.

•		SFAS No. 154, Accounting Changes and Error Corrections — a replacement of APB Opinion No. 20 and FASB Statement No. 3

		In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections.” This Statement replaces APB Opinion No. 20, “Accounting Changes”, and FASB Statement No. 3, “Reporting Accounting Changes in Interim Financial Statements”, and changes the requirements for the accounting for and reporting of a change in accounting principle. This Statement applies to all voluntary changes in accounting principle. It also applies to changes required by an accounting pronouncement in the unusual instance that the pronouncement does not include specific transition provisions. When a

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pronouncement includes specific transition provisions, those provisions should be followed. Opinion 20 previously required that most voluntary changes in accounting principle be recognized by including in net income of the period of the change the cumulative effect of changing to the new accounting principle. This Statement requires retrospective application to prior periods’ financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. This Statement also redefines restatement as the revising of previously issued financial statements to reflect the correction of an error. This Statement requires that retrospective application of a change in accounting principle be limited to the direct effects of the change. Indirect effects of a change in accounting principle should be recognized in the period of the accounting change. This Statement also requires that a change in depreciation, amortization, or depletion method for long-lived, nonfinancial assets be accounted for as a change in accounting estimate effected by a change in accounting principle. This Statement carries forward without change the guidance contained in Opinion 20 for reporting the correction of an error in previously issued financial statements and a change in accounting estimate. This Statement also carries forward the guidance in Opinion 20 requiring justification of a change in accounting principle on the basis of preferability. This Statement will be effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. Early adoption is permitted for accounting changes and corrections of errors made in fiscal years beginning after the date this Statement is issued. This Statement does not change the transition provisions of any existing accounting pronouncements, including those that are in a transition phase as of the effective date of this Statement. Management believes that the adoption of this statement will not have a significant effect on the Group’s consolidated financial statements.

Change of Fiscal Year-End

On August 30, 2005, the Group’s Board of Directors (the “Board) approved and amendment to Section 1 of Article IX of the Group’s By-Laws to change its fiscal year to a calendar year. The Group’s fiscal year was from July 1 of each year to June 30 of the following year. The Group’s transition period will be from July 1, 2005 to December 31, 2005.

NOTE 2 — INVESTMENT SECURITIES:

Short Term Investments

At September 30, 2005 and June 30, 2005, the Group’s short term investments were comprised of money market instruments in the aggregate amount of $10,387,000 and $9,791,000, respectively.

Trading Securities

A summary of trading securities owned by the Group at September 30, 2005 and June 30, 2005 is as follows:


	(In thousands)
	September 30,		June 30,
	2005		2005
P.R. Government and agency obligations	$	97	$	144
Mortgage-backed securities		58		32
Other equity securities		14		89
U.S. Treasury securities		19		—

Total trading securities	$	188	$	265

As of September 30, 2005, the Group’s trading portfolio weighted average yield was 4.56% (June 30, 2005 — 4.14%).

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Investment securities

The amortized cost, gross unrealized gains and losses, fair value, and weighted average yield of the investment securities as of September 30, 2005 and June 30, 2005, were as follows:


	September 30, 2005 (In thousands)
			Gross		Gross				Weighted
	Amortized		Unrealized		Unrealized		Fair		Average
	Cost		Gains		Losses		Value		Yield

Available-for-sale
US Treasury securities	$	174,831	$	—	$	4,954	$	169,877		3.63	%
Puerto Rico Government and agency obligations		45,763		1,270		138		46,895		5.89	%
Corporate bonds and other		94,080		4		2,653		91,431		4.80	%

Total investment securities		314,674		1,274		7,745		308,203

FNMA and FHLMC certificates		514,914		—		7,891		507,023		4.47	%
GNMA certificates		36,174		482		257		36,399		5.69	%
Collateralized mortgage obligations (CMO’s)		168,901		154		3,325		165,730		4.40	%

Total mortgage-backed-securities and CMO’s		719,989		636		11,473		709,152

Total securities available-for-sale	$	1,034,663	$	1,910	$	19,218	$	1,017,355		4.41	%


Held-to-maturity
US Treasury securities		1,056,801		—		17,316		1,039,485		3.98	%
Puerto Rico Government and agency obligations		62,094		23		1,975		60,142		5.44	%

Total investment securities		1,118,895		23		19,291		1,099,627

FNMA and FHLMC certificates		861,937		4,721		7,203		859,455		5.31	%
GNMA certificates		230,076		1,954		969		231,061		5.58	%
Collateralized mortgage obligations		50,247		—		783		49,464		4.84	%

Total mortgage-backed-securities and CMO’s		1,142,260		6,675		8,955		1,139,980

Total securities held-to-maturity		2,261,155		6,698		28,246		2,239,607		4.07	%

Total	$	3,295,818	$	8,608	$	47,464	$	3,256,962		4.76	%


	June 30, 2005 (In thousands)
			Gross		Gross				Weighted
	Amortized		Unrealized		Unrealized		Fair		Average
	Cost		Gains		Losses		Value		Yield

Available-for-sale
US Treasury securities	$	174,823	$	—	$	1,807	$	173,016		3.47	%
Puerto Rico Government and agency obligations		45,744		1,138		152		46,730		5.78	%
Corporate bonds and other		69,028		4		3,098		65,934		4.45	%

Total investment securities		289,595		1,142		5,057		285,680

FNMA and FHLMC certificates		549,936		477		1,880		548,533		4.48	%
GNMA certificates		13,959		306		36		14,229		5.65	%
Collateralized mortgage obligations (CMO’s)		182,663		410		1,795		181,278		4.61	%

Total mortgage-backed-securities and CMO’s		746,558		1,193		3,711		744,040

Total securities available-for-sale	$	1,036,153	$	2,335	$	8,768	$	1,029,720		4.40	%


Held-to-maturity
US Treasury securities		856,964		968		7,250		850,682		3.76	%
Puerto Rico Government and agency obligations		62,094		10		1,664		60,440		5.33	%

Total investment securities		919,058		978		8,914		911,122

FNMA and FHLMC certificates		914,174		14,226		2,184		926,216		5.11	%
GNMA certificates		250,189		4,520		473		254,236		5.33	%
Collateralized mortgage obligations		51,325		181		372		51,134		4.49	%

Total mortgage-backed-securities and CMO’s		1,215,688		18,927		3,029		1,231,586

Total securities held-to-maturity		2,134,746		19,905		11,943		2,142,708		4.59	%

Total	$	3,170,899	$	22,240	$	20,711	$	3,172,428		4.53	%

The amortized cost and fair value of the Group’s investment securities available-for-sale and held-to-maturity at September 30, 2005, by contractual maturity, are shown in the next table. 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.

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	(In thousands)
	Available-for-sale				Held-to-maturity
	Amortized Cost		Fair Value		Amortized Cost		Fair Value

Investment securities
Due within one year	$	5,000	$	5,038	$	70,125	$	69,202
Due after 1 to 5 years		275,284		268,041		637,112		625,818
Due after 5 to 10 years		1,891		1,952		249,720		245,490
Due after 10 years		32,499		33,172		161,938		159,117

		314,674		308,203		1,118,895		1,099,627

Mortgage-backed securities
Due after 1 to 5 years		634		670		—		—
Due after 5 to 10 years		11,994		11,685		—		—
Due after 10 years		707,361		696,797		1,142,260		1,139,980

		719,989		709,152		1,142,260		1,139,980

	$	1,034,663	$	1,017,355	$	2,261,155	$	2,239,607

Proceeds from the sale of investment securities available-for-sale during the three-month period ended September 30, 2005 totaled $65,215,000 (2004 — $522,394,000). Gross realized gains on those sales during the three-month period ended September 30, 2005 were $341,000. Gross realized gains and losses on those sales during the three-month period ended September 30, 2004 were $5,175,000 and $1,930,000, respectively.

During the fiscal year ended June 30, 2005 the Group’s management reclassified, at fair value, $565,191,000 of its available-for-sale investment portfolio to the held-to-maturity investment category as management intends to hold these securities to maturity. No reclassifications were made during the three-month period ended September 30, 2005. The unrealized loss on those securities transferred to held-to-maturity category during fiscal 2005 amounted to $22.7 million at September 30, 2005, and is included as part of the accumulated other comprehensive loss in the consolidated statements of financial condition. This unrealized loss is amortized over the remaining life of the securities as a yield adjustment.

The following table shows the Group’s gross unrealized losses and fair value of investment securities available-for-sale and held-to-maturity, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at September 30, 2005.

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September 30, 2005
Available-for-sale
(In thousands)


	Less than 12 months
	Amortized		Unrealized		Market
	Cost		Loss		Value
US Treasury securities	$	174,831	$	4,954	$	169,877
Puerto Rico Government and agency obligations		4,117		138		3,979
Mortgage-backed-securities		542,047		7,509		534,538
Other debt securities		92,044		2,653		89,391

		813,039		15,254		797,785


	12 months or more
Mortgage-backed-securities		138,604	3,964	134,640

		138,604	3,964	134,640


	Total
	Amortized		Unrealized		Market
	Cost		Loss		Value
US Treasury securities		174,831		4,954		169,877
Puerto Rico Government and agency obligations		4,117		138		3,979
Mortgage-backed-securities		680,651		11,473		669,178
Other debt securities		92,044		2,653		89,391

	$	951,643	$	19,218	$	932,425

Held-to-maturity
(In thousands)


			Less than 12 months
	Book		Unrealized		Market
	Value		Loss		Value
US Treasury securities	$	1,011,676	$	16,735	$	994,941
Mortgage-backed-securities		448,994		5,758		443,236

		1,460,670		22,493		1,438,177


			12 months or more
	Amortized		Unrealized		Market
	Cost		Loss		Value
US Treasury securities		45,125		581		44,544
Puerto Rico Government and agency obligations		52,129		1,975		50,154
Mortgage-backed-securities		114,000		3,197		110,803

		211,254		5,753		205,501


			Total
	Amortized		Unrealized		Market
	Cost		Loss		Value
US Treasury securities		1,056,801		17,316		1,039,485
Puerto Rico Government and agency obligations		52,129		1,975		54,104
Mortgage-backed-securities		562,994		8,955		571,949

	$	1,671,924	$	28,246	$	1,665,538

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June 30, 2005
Available-for-sale
(In thousands)


	Less than 12 months
	Amortized		Unrealized		Market
	Cost		Loss		Value
US Treasury securities	$	174,823	$	1,807	$	173,016
Puerto Rico Government and agency obligations		14,381		152		14,229
Mortgage-backed-securities and CMO’s		426,657		1,626		425,031
Other debt securities		66,993		3,098		63,895

		682,854		6,683		676,171


	12 months or more
	Amortized		Unrealized		Market
	Cost		Loss		Value
Mortgage-backed-securities and CMO’s		139,387		2,085		137,302

		139,387		2,085		137,302


	Total
	Amortized		Unrealized		Market
	Cost		Loss		Value
US Treasury securities		174,823		1,807		173,016
Puerto Rico Government and agency obligations		14,381		152		14,229
Mortgage-backed-securities and CMO’s		566,044		3,711		562,333
Other debt securities		66,993		3,098		63,895

	$	822,241	$	8,768	$	813,473

Held-to-maturity
(In thousands)


	Less than 12 months
	Amortized		Unrealized		Market
	Cost		Loss		Value
US Treasury securities	$	702,535	$	7,250	$	695,285
Mortgage-backed-securities and CMO’s		183,997		1,209		182,788

		886,532		8,459		878,073


	12 months or more
	Amortized		Unrealized		Market
	Cost		Loss		Value
Puerto Rico Government and agency obligations		52,130		1,664		50,465
Mortgage-backed-securities and CMO’s		121,351		1,820		119,532

		173,481		3,484		169,997


	Total
	Amortized		Unrealized			Market
	Cost		Loss			Value
US Treasury securities		702,535		(7,250	)		695,285
Puerto Rico Government and agency obligations		52,130		(1,664	)		50,465
Mortgage-backed-securities and CMO’s		305,348		(3,029	)		302,320

	$	1,060,013	$	(11,943	)	$	1,048,070

Securities in an unrealized loss position at September 30, 2005 are mainly composed of securities issued or backed by U.S. government agencies. The vast majority of them are rated the equivalent of AAA by nationally recognized statistical rating organizations. The investment portfolio is structured primarily with highly liquid securities which posses a large and efficient secondary market. Valuations are performed on a monthly basis using a third party provider and dealer quotes. Management believes that the unrealized losses in the investment portfolio at September 30, 2005 are mainly related to market interest rate fluctuations and not to deterioration in the creditworthiness of the issuer. The Group is a well capitalized financial institution which has the ability and intent to hold the investment securities with unrealized losses until maturity or until the unrealized losses are recovered, and expects to continue its pattern of holding the securities until the forecasted recovery of fair value.

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NOTE 3 — LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES:

Loans Receivable

The Group’s credit activities are mainly with customers located in Puerto Rico. The Group’s loan transactions are encompassed within three main categories: mortgage, commercial and consumer. The composition of the Group’s loan portfolio at September 30, 2005 and June 30, 2005 was as follows:


	(In thousands)
	September 30, 2005			June 30, 2005

Residential mortgage loans	$	686,582		$	692,259
Home equity loans and secured personal loans		48,593			52,076
Commercial loans, mainly secured by real estate		131,165			129,965
Consumer loans		31,246			30,027

Loans receivable, gross		897,586			904,327
Less: deferred loan fees, net		(8,597	)		(8,404	)

Loans receivable		888,989			895,923
Allowance for loan losses		(6,837	)		(6,495	)

Loans receivable, net		882,152			889,428
Mortgage loans held-for-sale		19,572			17,963

Total loans, net	$	901,724		$	907,391

On August 31, 2004, September 30, 2004, and March 30, 2005, the Group entered into three agreements to purchase a total $114.9 million of fixed rate mortgage loans from a financial institution in Puerto Rico. As part of the agreements, the seller guarantees the scheduled timely payments of principal as well as interest payable on the aggregate outstanding principal balance of the mortgage loans based on variable interest rate equal to 150 basis points plus 90 day LIBOR (4.07% at September 30, 2005). Swaps have been accounted for in the Group’s consolidated financial statements to give effect to the conversion of fixed rate loans into variable rates. These swaps are considered by management as balance guaranteed swaps because their notional amounts, fixed interest rates and other terms match to those of the outstanding purchased mortgage loans. Since the contracts meet the sale accounting provisions of SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,” SFAS No. 133 and related interpretations provide that the interest rate swaps be accounted for separately. Since the hedged item and the hedging instrument have identical critical terms, no ineffectiveness is assumed and the fair value changes in the interest rate swaps are recorded as changes in the value of both the interest rate swaps and the mortgage loans. At September 30, 2005, the notional amount of these interest rate swaps and the principal balance of the mortgage loans amounted to $102,320,000 ($106,702,000 at June 30, 2005); the weighted average floating rate received at September 30, 2005 was 5.57% (3.47% — June 30, 2005); the weighted average pay fixed rate was 6.50% (6.20% — June 30, 2005); and the floating rate spread was 150 basis points.

Also on February 11, 2005 and June 30, 2005, the Group entered into separate agreements with a public instrumentality of the Commonwealth of Puerto Rico and a commercial bank to purchase a total of $15.6 million and $22.2 million, respectively, of residential mortgage loans. The Group purchased all rights, title and interest in such residential loans purchased during fiscal 2005.

At September 30, 2005 and June 30, 2005, residential mortgage loans held-for-sale amounted to $19,572,000 and $17,963,000, respectively. All residential mortgage loans originated and sold during the three-month periods ended September 30, 2005 and 2004 were sold based on pre-established commitments or at market values. In the three-months periods ended September 2005 and 2004, the Group recognized gains of $1,068,000 and $2,057,000, respectively, in these sales which are presented in the statements of income as part of the mortgage banking activities.

Allowance for Loan Losses

The Group maintains an allowance for loan losses at a level that management considers adequate to provide for probable losses based upon an evaluation of known and inherent risks. The Group’s allowance for loan losses policy provides for a detailed quarterly analysis of probable losses. The analysis includes a review of historical loan loss experience, value of underlying collateral, current economic conditions, financial condition of borrowers and other pertinent factors.

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While management uses available information in estimating probable loan losses, future additions to the allowance may be necessary based on factors beyond the Group’s control. Refer to Table 4 of the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for the changes in the allowance for loan losses for the three-month periods ended September 30, 2005 and 2004.

The Group evaluates all loans, some individually and other as homogeneous groups, for purposes of determining impairment. At September 30, 2005 and June 30, 2005, the total investment in impaired commercial loans was $3,524,000 and $3,199,000 respectively. The impaired loans were measured based on the fair value of collateral. The Group determined that no specific impairment allowance was required for such loans. The average investment in impaired loans for the three-month period ended September 30, 2005 amounted to $3.5 million. Management determined that impaired loans did not require a valuation allowance in accordance with FASB Statement 114 “Accounting by Creditor’s for Impairment of a Loan”

The provision for loan losses for the three-month period ended September 30, 2005 and 2004 totaled $951,000 and $700,000, respectively. Based on an analysis of the credit quality and the composition of the Group’s loan portfolio, Management determined that the provision for the three-month periods ended September 30, 2005 and 2004 was adequate in order to maintain the allowance for loan losses at an appropriate level. The increase in the loan portfolio is mainly related to new high quality and well collateralized loans which do not require large amounts of allowance for loan losses.

NOTE 4 — PLEDGED ASSETS

At September 30, 2005, residential mortgage loans amounting to $381,046,000 and investment securities amounting to $35,701,000 were pledged to secure advances and borrowings from the FHLB. Investment securities with carrying values totaling $2,169,163,000, $163,404,000, $16,678,000 and $20,638,000 at September 30, 2005, were pledged to secure securities sold under agreements to repurchase, public fund deposits, term notes and interest rate swap agreements, respectively. Also, at September 30, 2005, investment securities with carrying values totaling $1,554,000 were pledged to the Federal Reserve Bank of New York, and investments securities with carrying values of $398,000 and $125,000 were pledged to the Puerto Rico Treasury Department for the Bank’s IBE unit and subsidiary and for the Bank’s trust operations, respectively.

As of September 30, 2005, investment securities available-for-sale and held-to-maturity not pledged amounted to $514,041,000 and $304,574,000 respectively. As of September 30, 2005, mortgage loans not pledged (excluding deferred fees) amounted to $372,701,000.

NOTE 5 — OTHER ASSETS

Other assets at September 30, 2005 and June 30, 2005 include the following:


	(In thousands)
	September 30,		June 30,
	2005		2005
Investment in equity indexed options	$	21,139	$	18,999
Investment in limited liability partnership		10,466		10,247
Deferred charges		3,648		3,536
Prepaid expenses		3,619		3,764
Accounts receivable		2,685		3,590
Investment in Statutory Trusts		2,168		2,171
Goodwill		2,006		2,006
Prepaid income tax		1,661		2,061

	$	47,392	$	46,374

On January 31, 2005, Oriental International Bank Inc. subscribed an agreement with Quiddity Earnings Diversification Fund, L.P. (the “Partnership”) to purchase units of a partnership interest for $10,000,000. The Partnership was organized under the laws of the State of Illinois and is engaged in the speculative trading of futures and futures options contracts on a wide range of financial instruments. The general partner is Quiddity LLC (the “General Partner”). The General Partner is an Illinois limited liability company and is the commodity pool operator of the Partnership, pursuant to Regulation D of The Securities Act of 1933.

The Partnership is an active manager of option based relative value strategies. Three distinct but complimentary relative value strategies are employed: (1) Non-directional (market neutral) options positions that capture unique relative value characteristics of these instruments. Proprietary quantitative software and market making techniques are combined in a systematic non-discretionary approach that accepts market determined probabilities as correct; (2) Discretionary

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macroeconomic positions based on probability biases developed from our fundamental research, require options to capture the probability differences versus the market neutral distribution; and (3) Discretionary situation specific opportunities exploit exceptionally favorable reward to risk situations, which typically result from either market price or implied volatility overreaction to current events, and utilize options to maximize risk-adjusted returns. All three individual strategies are managed with an explicit probability-based evaluation of return and risk, insuring that individual positions and the total portfolio meet minimum expected return and maximum exposure constrains. Relative allocation among the three strategies is a dynamic process that maintains an optimally efficient, risk-adjusted return in changing market conditions. Risk management is the foundation of the Partnership strategies. The Group uses the Partnership service as a hedge strategy to neutralize the risk in our fixed income portfolio.

NOTE 6 — BORROWINGS

Securities Sold under Agreements to Repurchase

At September 30, 2005, securities underlying agreements to repurchase were delivered to, and are being held by, the counterparties with whom the repurchase agreements were transacted. The counterparties have agreed to resell to the Group the same or similar securities at the maturity of the agreements. Securities sold under agreements to repurchase at September 30, 2005 mature as follows: within 30 days — $1,129,862,000; between 31 to 90 days — $970,310,000 and within 132 days — $108,675,000.

At September 30, 2005 and June 30, 2005, the weighted average interest rate of the Group’s repurchase agreements was 3.73% and 3.07%, respectively, and included agreements with interest ranging from 3.40% to 3.98% (June 30, 2005 — 1.90% to 3.47%). The following summarizes significant data on securities sold under agreements to repurchase as of September 30, 2005 and June 30, 2005:


	(In thousands)
	September 30,			June 30,
	2005			2005
Average daily aggregate balance outstanding	$	2,266,148		$	2,174,312

Maximum amount outstanding at any month-end	$	2,328,939		$	2,398,861

Weighted average interest rate at end of period		3.73	%		3.07	%

Advances from the Federal Home Loan Bank

At September 30, 2005, advances from the Federal Home Loan Bank of New York (FHLB) consisted of the following:


				Amount
Maturity Date	Fixed Interest Rate			(In thousands)

January-2006		3.82	%	$	50,000
April-2006		2.48	%		25,000
July-2006		2.01	%		50,000
July-2006		2.13	%		50,000
August-2006		2.96	%		50,000
April-2007		3.09	%		25,000
August-2008		4.07	%		50,000

				$	300,000

Weighted average interest rate					2.94	%

Advances are received from the FHLB under an agreement whereby the Group is required to maintain a minimum amount of qualifying collateral with a market value of at least 110% of the outstanding advances. At September 30, 2005, these advances were secured by mortgage loans amounting to $381,046,000 and investment securities with carrying value of $35,701,000. Also, at September 30, 2005, the Group has an additional borrowing capacity with the FHLB of $32.6 million. At September 30, 2005, average maturity of FHLB’s advances was 12.4 months (June 30, 2005 — 15.4 months).

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Term Notes

At September 30, 2005 and June 30, 2005, there was one term note outstanding in the amount of $15,000,000, with a floating interest rate due quarterly (September 30, 2005 — 3.21%; June 30, 2005 — 2.83%), a maturity date of March 27, 2007, and secured by investment securities with fair value amounting to $16,678,000 (June 30, 2005 — $16,810,000).

Subordinated Capital Notes

Subordinated capital notes amounted to $72,166,000 at September 30, 2005 and June 30, 2005.

In October 2001 and August 2003, the Statutory Trust I and the Statutory Trust II, respectively, special purpose entities of the Group, were formed for the purpose of issuing trust redeemable preferred securities. In December 2001 and September 2003, $35 million of trust redeemable preferred securities were issued by the Statutory Trust I and by the Statutory Trust II, respectively, as part of pooled underwriting transactions. Pooled underwriting involves participating with other bank holding companies in issuing the securities through a special purpose pooling vehicle created by the underwriters.

The proceeds from these issuances were used by the Statutory Trust I and the Statutory Trust II to purchase a like amount of floating rate junior subordinated deferrable interest debentures (“subordinated capital notes”) issued by the Group. The first of these subordinated capital notes has a par value of $36.1 million, bear interest based on 3 months LIBOR plus 360 basis points (7.67% at September 30, 2005; 7.12% at June 30, 2005) provided, however, that prior to December 18, 2006, this interest rate shall not exceed 12.5%, payable quarterly, and matures on December 23, 2031. The second one, has a par value of $36.1 million, bears interest based on 3 months LIBOR plus 295 basis points (7.02% at September 30, 2005; 6.47% at June 30, 2005), payable quarterly, and matures on September 17, 2033. Both subordinated capital notes may be called at par after five years. The trust redeemable preferred securities have the same maturity and call provisions as the subordinated capital notes. The subordinated deferrable interest debentures issued by the Group are accounted for as a liability denominated as subordinated capital notes on the consolidated statements of financial condition.

In August 2004, the Group entered into a $35 million notional amount interest rate swap to fix the cost of the subordinate capital notes of the Statutory Trust I. This swap was fixed at a rate of 6.57% and matures on December 18, 2006. At the time the transaction was done, the cost of fixing the rate on the additional $35 million in subordinated capital notes for the Statutory Trust II, was deemed too expensive for the Group to absorb full coverage. The cost for the additional swap would be for a longer dated swap given the longer call date on the subordinated capital notes, which would have effectively raise the cost on the trade.

The subordinated capital notes are treated as Tier 1 capital for regulatory purposes. On March 4, 2005, the Federal Reserve Board issued a final rule that continues to allow trust preferred securities to be included in Tier I regulatory capital, subject to stricter quantitative and qualitative limits. Under this rule, restricted core capital elements, which are defined to include qualifying trust preferred securities, qualifying cumulative perpetual preferred stock (and related surplus), and certain minority interests in consolidated subsidiaries, are limited in the aggregate to no more than 25% of a bank holding company’s core capital elements (including restricted core capital elements), net of goodwill less any associated deferred tax liability. In addition, the amount of restricted core capital elements (other than qualifying mandatory convertible preferred securities) that an internationally active bank holding company may include in Tier 1 capital must not exceed 15% of the sum of core capital elements (including restricted core capital elements), net of goodwill less any associated deferred tax liability. An internationally active bank holding company is a bank holding company that (i) as of its most recent year-end FR Y-9C reports has total consolidated assets equal to $250 billion or more, or (ii) on a consolidated basis, reports total on-balance sheet foreign exposure of $10 billion or more on its filings of the most recent year-end FFIEC 009 Country Exposure Report.

Unused Lines of Credit

The Group maintains lines of credit with three financial institutions from which funds are drawn as needed. At September 30, 2005, the Group’s total available funds under these lines of credit totaled $28,000,000 (June 30, 2005 — $55,000,000). At September 30, 2005 and June 30, 2005, there was no balance outstanding under these lines of credit.

NOTE 7 — DERIVATIVES ACTIVITIES

The Group utilizes various derivative instruments for hedging purposes, as part of its asset and liability management. These transactions involve both credit and market risks. The notional amounts are amounts on which calculations, payments, and the value of the derivatives are based. Notional amounts do not represent direct credit exposures. Direct credit exposure is limited to the net difference between the calculated amounts to be received and paid, if any. The actual risk of loss is the cost of replacing, at market, these contracts in the event of default by the counterparties. The Group controls the credit risk of its derivative financial instrument agreements through credit approvals, limits, monitoring procedures and collateral, when considered necessary.

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The Group generally uses interest rate swaps and options in managing its interest rate risk exposure. Certain swaps were entered into to convert the forecasted rollover of short-term borrowings into fixed rate liabilities for longer periods and provide protection against increases in short-term interest rates. Under these swaps, the Group pays a fixed monthly or quarterly cost and receives a floating thirty or ninety-day payment based on LIBOR. Floating rate payments received from the swap counterparties offset to the interest payments to be made on the forecasted rollover of short-term borrowings thus resulting in a net fixed rate cost to the Group.

The Group’s swaps (excluding those used to manage exposure to the stock market and those described below used to hedge the mortgage loans purchased) and their terms at September 30, 2005 and June 30, 2005 are set forth in the table below:


	(Dollars in thousands)
	September 30,			June 30,
	2005			2005
Swaps:
Pay fixed swaps notional amount	$	1,210,000		$	885,000
Weighted average pay rate — fixed		3.66	%		3.44	%
Weighted average receive rate — floating		3.80	%		3.27	%
Maturity in months		2 to 61			4 to 64
Floating rate as a percent of LIBOR		100	%		100	%

Derivative instruments are recognized as assets and liabilities at fair value. If certain conditions are met, the derivative may qualify for hedge accounting treatment and be designated as one of the following types of hedges: (a) hedge of the exposure to changes in the fair value of a recognized asset or liability or an unrecognized firm commitment (“fair value hedge”); (b) a hedge of the exposure to variability of cash flows of a recognized asset, liability or forecasted transaction (“cash flow hedge”) or (c) a hedge of foreign currency exposure (“foreign currency hedge”).

In the case of a qualifying fair value hedge, changes in the value of the derivative instruments that have been highly effective are recognized in current period earnings along with the change in value of the designated hedged item. In the case of a qualifying cash flow hedge, changes in the value of the derivative instruments that have been highly effective are recognized in other comprehensive income (loss), until such time as those earnings are affected by the variability of the cash flows of the underlying hedged item. In either a fair value hedge or a cash flow hedge, net earnings may be impacted to the extent the changes in the fair value of the derivative instruments do not perfectly offset changes in the face value or cash flows of the hedged items. If the derivative is not designated as a hedging instrument, the changes in fair value of the derivative are recorded in earnings.

Certain contracts contain embedded derivatives. When the embedded derivative possesses economic characteristics that are not clearly and closely related to the economic characteristics of the host contract, it should be bifurcated and carried at fair value.

In August 2004, the group entered into a $35 million notional amount interest swap to fix the cost of the subordinate capital notes of the Statutory Trust 1. This swap was fixed at a rate of 6.57% and matures on December 18, 2006.

Also, on August 31, 2004, September 30, 2004, and March 30, 2005, the Group entered into three agreements to purchase a total $114.9 million of fixed rate mortgage loans from a financial institution in Puerto Rico. As part of the agreements, the seller guarantees the scheduled timely payments of principal as well as interest payable on the aggregate outstanding principal balance of the mortgage loans based on variable interest rate equal to 150 basis points plus 90-day LIBOR (4.07% at September 30, 2005). Swaps have been accounted for in the Group’s consolidated financial statements to give effect to the conversion of fixed rate loans into variable rates. These swaps are considered by management as balance guaranteed swaps because their notional amounts, fixed interest rates and other terms match to those of the outstanding purchased mortgage loans. Since the contracts meet the sale accounting provisions of SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,” SFAS No. 133 and related interpretations provide that the interest rate swaps be accounted for separately. Since the hedged item and the hedging instrument have identical critical terms, no ineffectiveness is assumed and the fair value changes in the interest rate swaps are recorded as changes in the value of both the interest rate swaps and the mortgage loans. At September 30, 2005, the notional amount of these interest rate swaps and the principal balance of the mortgage loans amounted to $102,320,000 ($106,702,000 at June 30, 2005); the weighted average floating rate received at September 30, 2005 was 5.57% (3.47% — June 30, 2005); the weighted average pay fixed rate was 6.50% (6.20% — June 30, 2005); and the floating rate spread was 150 basis points.

In September 1, 2005, the Bank entered into a $325 million notional amount interest rate swap to hedge the repurchase agreement (“repo”) program of the Bank’s wholly owned IBE subsidiary, Oriental International Bank Inc. (the “IBE subsidiary”). The swap maturity date is September 6, 2010. The IBE subsidiary will pay interest at a fixed rate of 4.26% on a semiannual basis and will receive quarterly payments of interest based on the 90-days LIBOR rate, as revised at the

- 24 -

beginning of each quarterly period. The purpose of the transaction is to fix the rate of a portion of the IBE’s repurchase agreement portfolio. The notional amount of the hedge entered in, will cover a similar repo amount with same repricing schedule in order to match it with the underlying liability. As of September 30, 2005, four repos totaling $139 million were matched against the swap. Since they were not perfectly match with the liability (similar amount and reset dates), a correlation analysis measuring the 90-day LIBOR rate (variable) with the fixed repo rate was performed and a 99.11% correlation was achieved. Also, a regression test was performed, achieving a 99.8% correlation. As the repos mature during the month, extensions will be negotiated with an interest reset date of December 6, 2005 (same reset date of the swap).

The Group offers its customers certificates of deposit with an option tied to the performance of the Standard & Poor’s 500 stock market index. At the end of five years, the depositor receives a specified percentage of the average increase of the month-end value of the index. If the index decreases, the depositor receives the principal without any interest. The Group uses swap and option agreements with major money center banks and major broker-dealer companies to manage its exposure to changes in this index. Under the terms of the option agreements, the Group receives the average increase in the month-end value of the index in exchange for a fixed premium. Under the term of the swap agreements, the Group receives the average increase in the month-end value of the index in exchange for a quarterly fixed interest cost. The changes in fair value of the swap agreements used to economically hedge the certificates of deposit are recorded in earnings in accordance with SFAS No. 133, as amended.

Derivative instruments are generally negotiated over-the-counter (“OTC”) contracts. Negotiated OTC derivatives are generally entered into between two counterparties that negotiate specific agreement terms, including the underlying instrument, amount, exercise price and maturity.

Information pertaining to the notional amounts of the Group’s derivative financial instruments as of September 30, 2005 and June 30, 2005 is as follows:


	Notional Amount
	(In thousands)
	September 30, 2005		June 30, 2005

Type of Contract:

Cash Flow Hedging Activities:
Interest rate swaps used to hedge:
Securities sold under agreement to repurchase	$	1,175,000	$	850,000
Subordinated capital notes		35,000		35,000
Fair Value Hedging Activities:
Balance guaranteed swaps		102,320		106,703

	$	1,312,320	$	991,703


Derivatives Not Designated as Hedge:

Purchased options used to manage exposure to the stock market on stock indexed deposits	$	177,330	$	186,010
Embedded options on stock indexed deposits		169,616		178,478

	$	346,946	$	364,488

During the three-month periods ended September 30, 2005 and 2004, losses of $50,000 and $570,000, respectively, were charged to earnings and reflected as “Derivatives” in the unaudited consolidated statements of income. During the three-month periods ended September 30, 2005 and 2004, unrealized gains of $11.2 million and unrealized losses of $16.9 million, respectively, on derivatives designated as cash flow hedges were included in other comprehensive income (loss). Ineffectiveness of $199,000 and $509,000 were charged to earnings during the three-month periods ended September 30, 2005 and 2004, respectively.

At September 30, 2005 and June 30, 2005, the fair value of derivatives was recognized as either assets or liabilities in the consolidated statements of financial condition as follows: the fair value of the interest rate swaps used to manage the exposure to the stock market on stock indexed deposits, to fix the cost of short-term borrowings and hedge the mortgage loan purchased represented a liability of $2.3 million and $14.9 million, respectively, presented in accrued expenses and other liabilities; the purchased options used to manage the exposure to the stock market on stock indexed deposits represented an other asset of $21.3 million and $19.0 million, respectively; and the options sold to customers embedded in the certificates of deposit represented a liability of $20.2 million and $18.2 million, respectively, recorded in deposits.

NOTE 8 — STOCKHOLDERS’ EQUITY TRANSACTIONS:

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Common Stock

On February 12, 2004, the Group filed a registration statement with the SEC for an offering of 2,565,000 shares of common stock. The registration statement was amended by the Group on February 27, 2004. The offering consisted of 1,700,000 shares offered by the Group, and an aggregate of 865,000 shares offered by three stockholders of the Group. The offering also included an additional 384,750 shares subject to over-allotment options granted by the Group and the selling stockholders to the underwriters. The registration statement was declared effective by the SEC on March 3, 2004.

On March 20, 2004, the underwriters exercised their options to purchase from the Group and the selling stockholders an aggregate of 384,750 shares of the Group’s common stock to cover over-allotments (255,000 of these shares were purchased from the Group and 129,750 from the three selling stockholders of the Group). Following such exercise, the total offering was for 2,949,750 shares at a public offering price of $28.00 per share, consisting of 1,955,000 shares offered by the Group and an aggregate of 994,750 shares by the three selling stockholders of the Group. Proceeds to the Group from the issuance of common stock were approximately $51,560,000, net of $3,180,000 of issuance costs.

Stock Dividend

On November 30, 2004, the Group declared a ten percent (10%) stock dividend on common stock held by shareholders of record as of December 31, 2004. As a result, a total of 2,236,152 shares of common stock were distributed on January 17, 2005 (1,993,711 shares of common stock were issued and 242,441 were distributed from the Group’s treasury stock account.) For purposes of the computation of income per common share, cash dividends and stock price, the stock dividend was retroactively recognized for all periods presented in the accompanying consolidated financial statements.

Treasury Stock

On August 30, 2005, the Board approved a new stock repurchase program for the repurchase of up to $12.1 million of the Group’s outstanding shares of common stock, which has replaced the previous program approved on March 27, 2004. The authority granted by the Board of Directors does not require the Group to repurchase any shares. The Group makes such repurchases from time to time in the open market at such times and prices as market conditions shall warrant and in compliance with the terms of applicable federal and Puerto Rico laws and regulations. The Group repurchased 345,000 shares of its common stock for $4,679,000 during the three-month period ended September 30, 2005. No repurchases were made during the three-month period ended September 30, 2004.

Earnings per Common Share

The diluted per share calculations for the three-month period ended September 30, 2004 have been adjusted from previous reported figures to take into account additional incentive stock options required to be issued by the anti-dilution provisions of employment agreements with certain executives. The contractual provisions required the Group to adjust stock options granted to the executives pursuant to their employment agreements to avoid any form of dilution, including dilution resulting from stock dividends and additional offerings of common stock by the Group. Although all stock options granted to the executives had been adjusted pursuant to the anti-dilution provisions of the Group’s incentive stock option plans to account for stock dividends, the stock options granted to the executives pursuant to their employment agreements had not been adjusted as contractually mandated for additional events of dilution such as the Group’s issuance of common stock in 2004 and the granting of stock options from time to time to other participants under the Group’s incentive stock option plans.

After an evaluation on the merits, the Compensation Committee of the Group’s Board of Directors determined during the fourth quarter of the year ended June 30, 2005 that the executives were entitled to additional options for the implied value of their exercised options by crediting them the amount of such implied value upon future exercises of stock options granted under the Group’s incentive stock option plans and by issuing to each executive the number of additional stock options required to account for the events of dilution with respect to unexercised options granted to them under their employment agreements.

As a result, the Group has increased the number of options used in the calculation of fully diluted shares by 363,325 for the first three quarterly periods of fiscal 2005, which represent the Group’s calculation of the additional options affecting these periods. The additional options reduced diluted per share results by approximately one cent per share for the quarter ended September 30, 2004.

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NOTE 9 — STOCK OPTIONS AND OTHER INCENTIVE PLANS:

Stock-based employee compensation plans

At September 30, 2005, the Group had three stock-based employee compensation plans: the 1996, 1998, and 2000 Incentive Stock Option Plans. These plans offer key officers, directors and employees an opportunity to purchase shares of the Group’s common stock. The Compensation Committee of the Board of Directors has sole authority and absolute discretion as to the number of stock options to be granted to any officer, director or employee, their vesting rights, and the options’ exercise prices. The plans provide for a proportionate adjustment in the exercise price and the number of shares that can be purchased in case of merger, consolidation, combination, exchange of shares, other reorganization, recapitalization, reclassification, stock dividend, stock split or reverse stock split in which the number of shares of common stock of the Group as a whole are increased, decreased, changed into or exchanged for a different number or kind of shares or securities. Stock options vest upon completion of specified years of service.

The following table summarizes the stock options activity and related information for the three-month period ended September 30, 2005:


							Weighted
					Weighted		Average of
					Average		Remaining
					Exercise		Contractual Life
	Options		Exercise Price		price		(in years)
Outstanding as of 06/30/2005		1,222,661	$	0.00 - $28.17	$	13.21
Vested		1,222,661	$	0.00 - $28.17	$	13.21
Unvested		—		—		—

Exercisable as of 06/30/2005		1,222,661	$	0.00 - $28.17	$	13.21
Granted		50,000	$	15.11 - $15.80	$	15.25
Exercised		217,736	$	0.00 - $13.33	$	2.86
Canceled		—		—		—

Outstanding as of 09/30/2005		1,054,925	$	6.28 - $28.17	$	15.44		6.84

Vested		1,004,925	$	6.28 - $28.17	$	15.45		6.69

Unvested		50,000	$	15.11 - $15.80	$	15.25		9.77


Exercisable as of 09/30/2005		1,004,925	$	6.28 - $28.17	$	15.45		6.69

The following table summarizes the range of exercise prices and the weighted average remaining contractual life of the options outstanding at September 30, 2005:


	Outstanding								Exercisable
							Weighted				Weighted
					Weighted		Average				Average
	Number of Options				Average		Contract Life		Number of		Exercise
Range of Exercise Prices	Vested		Unvested		Exercise Price		(Years)		Options		Price
$5.63 to $8.45		249,482		—	$	7.25		4.8		249,482	$	7.25
$8.45 to $11.27		82,050		—	$	10.74		4.5		82,050	$	10.74
$11.27 to $14.09		246,636		—	$	12.84		6.4		246,636	$	12.84
$14.09 to $16.90		41,622		—	$	15.55		8.5		41,622	$	15.90
$16.90 to $19.72		24,200		50,000	$	19.28		7.9		24,200	$	19.28
$19.72 to $22.54		88,935		—	$	19.90		7.9		88,935	$	19.90
$22.54 to $25.35		199,400		—	$	23.95		8.7		199,400	$	23.95
$25.35 to $28.17		72,600		—	$	27.53		9.1		72,600	$	27.53

		1,004,925		50,000	$	15.44		6.8		1,004,925	$	15.44

On June 30, 2005, the Compensation Committee of the Group’s Board of Directors approved the acceleration of the vesting of all outstanding options to purchase shares of common stock of the Group that were held by employees, officers and directors as of June 30, 2005. As a result, options to purchase approximately 1,219,333 shares became exercisable. The purpose of the accelerated vesting is to enable the Group to avoid recognizing in its income statement compensation expense associated with these options in future periods, upon adoption of FASB Statement No. 123(R).

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During the quarter ended September 30, 2005, the Group granted options for the purchase of 50,000 of its common stock to two executive officers. Effective July 1, 2005, the Group adopted FASB Statement No. 123 (R) — Accounting for Stock-Based Compensation. As a result, the Group recognized $5,986 in stock option compensation expense for the quarter ended September 30, 2005. Statement 123(R) requires that the compensation cost relating to share-based payment transactions be recognized in financial statements. That cost will be measured based on the fair value of the equity or liability instruments issued. Statement 123(R) covers a wide range of share-based compensation arrangements including share options, restricted share plans, performance-based awards, share appreciation rights, and employee share purchase plans. Statement 123(R) replaces FASB Statement No. 123, Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees. Statement 123, as originally issued in 1995, established as preferable a fair-value-based method of accounting for share-based payment transactions with employees. However, that Statement permitted entities the option of continuing to apply the guidance in Opinion 25, as long as the footnotes to the financial statements disclosed what net income would have been had the preferable fair-value-based method been used.

Prior to the adoption of FASB No. 123 (R), the Group accounted for these plans under the recognition and measurement principles of APB Opinion No. 25, “Accounting for Stock Issued to Employees”, and related interpretations. Compensation expense was generally recognized for any excess of the quoted market price of the Group’s stock at measurement date over the amount an employee must pay to acquire the stock. No stock-based employee compensation cost was reflected in net income for the three-month period ended September 30, 2004, as all options granted under these plans had an exercise price equal to the market value of the underlying common stock on the date of grant.

The weighted average assumptions used for the valuation of the grants issued during the three-month period ended September 30, 2005 were:


Expected dividend yield		2.33	%
Expected volatility		42.35	%
Risk-free interest rate		3.98	%
Expected employee turnover		2.85	%
Expected life of options		5.35
Weighted average fair value of options granted (per option)	$	5.51

The fair value of the options was estimated on the date of the grants using the Black-Scholes Option Pricing Model. The Black-Scholes option-pricing model was developed for use in estimating the fair value of traded options that have no restrictions and are fully transferable and negotiable in a free trading market. Black-Scholes does not consider the employment, transfer or vesting restrictions that are inherent in the Group’s employee options. Use of an option valuation model, as required by GAAP, includes highly subjective assumptions based on long-term predictions, including the expected stock price volatility and average life of each option grant. Because the Group’s employee options have characteristics significantly different from those of freely traded options, and because changes in the subjective input assumptions can materially affect the Group’s estimate of the fair value of those options, in the Group’s opinion, the existing valuation models, including Black-Scholes, are not reliable single measures and the use of other option pricing models may result in different fair values of the Group’s employee options.

Other Employee Benefit Plans

The Group has a cash or deferred arrangement profit sharing plan qualified under Section 1165(e) of the Puerto Rico Internal Revenue Code of 1994, as amended, covering all full-time employees of the Group who have six months of service and are age twenty-one or older. Under this plan, participants may contribute each year from 2% to 10% of their compensation, as defined, up to a specified amount. The Group contributes 80 cents for each dollar contributed by an employee, up to $832 per employee. The Group’s matching contribution is invested in shares of its common stock. The plan is entitled to acquire and hold qualified employer securities as part of its investment of the trust assets pursuant to ERISA Section 407.

During the three-month period ended September 30, 2005 the Group contributed a total of 1,956 shares of its common stock with a market value of approximately $27,700, of which 1,117 (with market value of $16,000) were contributed from the Group’s treasury stock account. During the three-month period ended September 30, 2004, the Group contributed a total of 1,220 shares of its common stock with a market value of approximately $32,270 at the time of contribution. The Group’s contribution becomes 100% vested once the employee completes three years of service.

Also, the Group offers to its executive management a non-qualified deferred compensation plan, where executives can defer taxable income. Both the employer and employee have flexibility because non-qualified plans are not subject to ERISA contribution limits nor are they subject to discrimination tests in terms of who must be included in the plan. Under this plan, the employee’s current taxable income is reduced by the amount being deferred. Funds deposited in a deferred compensation

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plan can accumulate without current income tax to the individual. Taxes are due when the funds are withdrawn, at the current income tax rate which may be lower than the individual’s current tax bracket.

NOTE 10 — SEGMENT REPORTING:

The Group segregates its businesses into the following major reportable segments: Banking, Treasury and Financial Services. Management established the reportable segments based on the internal reporting used to evaluate performance and to assess where to allocate resources. Other factors such as the Group’s organization, nature of products, distribution channels and economic characteristics of the products were also considered in the determination of the reportable segments. The Group measures the performance of these reportable segments based on pre-established goals of different financial parameters such as net income, net interest income, loan production and fees generated.

Banking includes the Bank’s branches and mortgage banking, with traditional banking products such as deposits and mortgage, commercial and consumer loans. Mortgage banking activities are carried out by the Bank’s mortgage banking division, whose principal activity is to originate mortgage loans for the Group’s own portfolio. From time to time, if conditions so warrant, the Group may sell loans to other financial institutions or securitize conforming loans into GNMA, FNMA and FHLMC certificates using another institution as issuer. The other institution services mortgages included in the resulting GNMA, FNMA, and FHLMC pools. The Group also sells the rights to service mortgage loans for others.

The Treasury segment encompasses all of the Group’s assets and liability management activities such as: purchases and sales of investment securities, interest rate risk management and funding derivatives and borrowings.

Financial services is comprised of the Bank’s trust division (Oriental Trust), the brokerage subsidiary (Oriental Financial Services Corp.), the insurance agency subsidiary (Oriental Insurance, Inc.), and the pension plan administration subsidiary (Caribbean Pension Consultants, Inc.). The core operations of this segment are financial planning, money management and investment brokerage services, insurance sales, corporate and individual trust and retirement services, as well as pension plan administration services.

Intersegment sales and transfers, if any, are accounted for as if the sales or transfers were to third parties, that is, at current market prices. The accounting policies of the segments are the same as those described in the “Summary of Significant Accounting Policies” included in the Group’s Annual Report on Form 10-K. Following are the results of operations and the selected financial information by operating segment for the three-month periods ended September 30, 2005 and 2004:

Unaudited — quarters ended September 30, (Dollars in thousands)


							Financial			Total						Consolidated
	Banking			Treasury			Services			Segments			Eliminations			Total

September 30, 2005
Interest income	$	15,218		$	35,562		$	33		$	50,813			—		$	50,813
Interest expense		(4,174	)		(29,311	)		—			(33,485	)		—			(33,485	)

Net interest income		11,044			6,251			33			17,328			—			17,328
Non-interest income		3,117			483			4,225			7,825			—			7,825
Non-interest expenses		(10,441	)		(625	)		(4,324	)		(15,390	)		—			(15,390	)
Intersegment revenue		894			—			—			894			(894	)		—
Intersegment expense		—			—			(894	)		(894	)		894			—
Provision for loan losses		(951	)		—			—			(951	)					(951	)

Income before income taxes	$	3,663		$	6,109		$	(960	)	$	8,812		$	—		$	8,812


Total assets as of September 30, 2005	$	478,349		$	4,300,925		$	9,254		$	4,788,528		$	(393,482	)	$	4,395,046


September 30, 2004
Interest income	$	13,290		$	31,650		$	7		$	44,947			—		$	44,947
Interest expense		(3,561	)		(17,733	)		—			(21,294	)		—			(21,294	)

Net interest income		9,729			13,917			7			23,653			—			23,653
Non-interest income		4,213			2,676			3,515			10,404			—			10,404
Non-interest expenses		(10,416	)		(1,055	)		(3,712	)		(15,183	)		—			(15,183	)
Intersegment revenue		718			—			—			718			(718	)		—
Intersegment expense		—			(103	)		(615	)		(718	)		718			—
Provision for loan losses		(700	)		—			—			(700	)					(700	)

Income before income taxes	$	3,544		$	15,435		$	(805	)	$	18,174		$	—		$	18,174


Total assets as of September 30, 2004	$	368,578		$	3,739,825		$	15,054		$	4,123,457		$	(185,066	)	$	3,938,391

NOTE 11 — SUBSEQUENT EVENTS:

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Change of custodian and broker-dealer of the Group’s CODA Profit Sharing Plan

On October 10, 2005, the Group was notified by the administrator of the Oriental Group CODA Profit Sharing Plan (the “Plan”), pursuant to ERISA section 101(i)(2)(E), that the Plan would change the custodian of its assets and the broker-dealer for its mutual investments. As a result of these changes, Plan participants will be temporarily unable to direct or diversify investments in their Plan accounts to obtain a loan or distribution from the Plan. The blackout period for the Plan began October 13, 2005 and is expected to end during the week of November 14, 2005. This blackout period, during which Plan participants will be unable to exercise these rights otherwise available under the Plan, will trigger certain SEC trading prohibitions applicable to equity securities of the Group acquired by any director or executive officer in connection with his or her service or employment as a director or executive officer.

Changes in Puerto Rico’s Income Tax Law

On October 20, 2005, the Puerto Rico Legislature approved a new tax bill. This bill imposes an additional tax of 1% on the net taxable income of banks. This bill will be applicable to all corporations mentioned or covered under the Act No. 55 of May 12, 1933, known as “The Banking Law of Puerto Rico,” as amended. The additional funds expected to be obtained from this tax will be assigned to the Department of Education of Puerto Rico. The additional tax, if it is finally approved by the Governor of Puerto Rico, will be effective for the tax years commencing after June 30, 2005 and ending on or before December 31, 2006.

Appointment of KPMG LLP as the Group’s independent accountants

On October 25, 2005 the Group’s Audit Committee appointed KPMG LLP (“KPMG”), as the Group’s independent registered public accountant for such periods. The engagement of the Group’s current independent registered public accountant, Deloitte & Touche LLP, San Juan, Puerto Rico (“Deloitte & Touche”), will terminate with the filing of the Group’s Form 10-Q for the quarter ended September 30, 2005.

Deloitte & Touche’s report on the Group’s financial statements for each of the past two fiscal years did not contain an adverse opinion or a disclaimer of opinion, or was qualified or modified as to uncertainty, audit scope, or accounting principles. During such two-year period and the interim period through the date of KPMG’s appointment, there were no disagreements between the Group and Deloitte & Touche on any matter of accounting principles or practices, financial statement disclosure, or audit scope or procedure, which disagreements if not resolved to Deloitte & Touche’s satisfaction, would have caused it to make reference to the subject matter thereof in connection with its report. Furthermore, during such two-year and interim periods, there were no “reportable events” advised by Deloitte & Touche to the Group.

During the past two fiscal years and the current interim period prior to the engagement of KPMG, the Group did not consult KPMG on the application of accounting principles to a specified transaction, either completed or proposed, or the type of audit opinion that might be rendered on the Company’s financial statements, or any matter that was either the subject of a disagreement with Deloitte & Touche (as described above) or a “reportable event,” as such term is defined in Item 304(a)(1)(v) of SEC Regulation S-K, advised by Deloitte & Touche to the Group.

AFICA Loan Program Development

On October 25, 2005, the Group’s Board of Directors authorized the Bank to enter into a loan agreement with the Puerto Rico Industrial, Tourist, Educational, Medical and Environmental Control Facilities Financing Authority (kwon by its Spanish acronym as “AFICA”). AFICA is a public corporation and instrumentality of the Commonwealth of Puerto Rico created by Act Number 121 of the Legislature of Puerto Rico approved June 27, 1977, as amended, for the purpose of promoting the economic development, health, welfare and safety of the citizens of Puerto Rico. AFICA is authorized to borrow money through the issuance of revenue bonds and to loan the proceeds to finance the acquisition, construction and equipping of industrial, tourist, educational, medical, pollution control and solid waste disposal facilities. The proposed aggregate program size is expected to be $100 million, issued in two stages of $50 million each. The second $50 million stage will be issued after the capacity of the first issue is filled. The main purpose of the Bank for this transaction is to obtain long-term financing through the issuance of bonds at a historically low interest rate and the benefit of fixing the interest cost of these bonds for a long term. The Bank will extend these benefits to its small and medium-size eligible business customers through the extension of loans at preferential rates. The Bank will use its BBB credit rating to obtain the lowest possible interest cost.

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Item 2 — Management’s Discussion and Analysis of
Financial Condition and Results of Operations

SELECTED FINANCIAL DATA
FOR THE THREE-MONTH PERIODS ENDED SEPTEMBER 30, 2005 AND 2004
(In thousands, except for per shares information)


	Three-Month Period
	2005			2004			Variance %

EARNINGS, PER SHARE AND DIVIDENDS DATA:

Interest income	$	50,813		$	44,947			13.1	%
Interest expense		(33,485	)		(21,294	)		57.3	%

Net interest income		17,328			23,653			-26.7	%
Provision for loan losses		(951	)		(700	)		35.9	%

Net interest income after provision for loan losses		16,377			22,953			-28.7	%
Non-interest income		7,825			10,404			-24.8	%
Non-interest expenses		(15,390	)		(15,183	)		1.4	%

Income before income taxes		8,812			18,174			-51.5	%
Income tax benefit (expense )		(391	)		(768	)		-49.1	%

Net income		8,421			17,406			-51.6	%
Less: dividends on preferred stock		(1,200	)		(1,200	)		0.0	%

Net income available to common shareholders	$	7,221		$	16,206			-55.4	%


Income per common share (1) :
Basic	$	0.29		$	0.67			-56.7	%

Diluted	$	0.29		$	0.64			-54.7	%


Average shares and potential shares (1)		25,140			25,457			-1.2	%


Book value per common share (1)	$	11.15		$	10.08			10.6	%

Market price at end of period (1)	$	12.24		$	24.60			-50.2	%

Cash dividends declared per common share (1)	$	0.14		$	0.13			7.7	%

Cash dividends declared on common shares	$	3,470		$	3,118			11.3	%


SELECTED FINANCIAL RATIOS AND OTHER INFORMATION:

Return on average assets (ROA)		0.78	%		1.84	%

Return on average common equity (ROE)		12.68	%		27.60	%

Efficiency ratio		62.72	%		48.42	%

Expense ratio		0.78	%		0.83	%

Interest rate spread		1.42	%		2.46	%

Interest rate margin		1.64	%		2.64	%

Number of financial centers		24			23

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SELECTED FINANCIAL DATA
PERIOD END BALANCES AND CAPITAL RATIOS:
AS OF SEPTEMBER 30, 2005 and JUNE 30, 2005


	September 30,			June 30,
	2005			2005			Variance %
Total financial assets
Trust assets managed	$	1,850,957		$	1,823,292			1.5	%
Broker-dealer assets gathered		1,143,873			1,135,115			0.8	%

Assets managed		2,994,830			2,958,407			1.2	%
Assets owned		4,395,046			4,250,652			3.4	%

Total financial assets managed and owned	$	7,389,876		$	7,209,059			2.5	%


Assets:
Investments and loans
Investments securities	$	3,376,143		$	3,231,580			4.5	%
Loans (including loans held-for-sale), net		901,724			907,391			-0.6	%

		4,277,867			4,138,971			3.4	%


Other Assets
Cash and due from banks		15,930			14,892			7.0	%
Securities sold but not yet delivered		707			1,034			-31.6	%
Accrued interest receivable		26,178			23,735			10.3	%
Premises and equipment, net		15,471			15,269			1.3	%
Deferred tax asset, net		6,980			6,191			12.7	%
Foreclosed real estate, net		4,521			4,186			8.0	%
Other assets		47,392			46,374			2.2	%

		117,179			111,681			4.9	%

Total assets	$	4,395,046		$	4,250,652			3.4	%


Liabilities and stockholders’ equity:
Deposits and borrowings
Deposits	$	1,304,772		$	1,252,897			4.1	%
Securities sold under agreements to repurchase		2,208,847			2,191,756			0.8	%
Other borrowings		398,807			399,476			-0.2	%

		3,912,426			3,844,129			1.8	%


Other liabilities
Securities purchased but not yet delivered		100,000			22,772			339.1	%
Accrued expenses and other liabilities		38,443			42,584			-9.7	%

		138,443			65,356			111.8	%

Total liabilities		4,050,869			3,909,485			3.6	%


Stockholders’ equity
Preferred equity		68,000			68,000			0.0	%
Common equity		276,177			273,167			1.1	%

		344,177			341,167			0.9	%

Total liabilities and stockholders’ equity:	$	4,395,046		$	4,250,652			3.4	%


Capital Ratios:
Leverage capital		10.33	%		10.65	%		-3.0	%

Tier 1 risk-based capital		38.80	%		38.83	%		-0.1	%

Total risk-based capital		39.39	%		39.39	%		0.0	%

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OVERVIEW OF FINANCIAL PERFORMANCE

Introduction

The Group, now in its 41st year, provides a complete range of banking and financial services in Puerto Rico, including consumer, commercial and mortgage lending; checking and savings accounts; financial planning, insurance, money management, and investment brokerage; and corporate and individual trust and retirement products and programs. The Group has three business segments: Banking, Treasury and Financial Services, and distinguishes itself based on quality, individualized service, with marketing focused on professionals and owners of small and mid-sized businesses, and aspiring individuals and families, segments that have been largely underserved. Although all of these businesses, to varying degrees, are affected by interest rate and financial markets fluctuations and other external factors, the Group’s commitment is to produce a balanced and growing revenue stream.

On April 27, 2005, Oriental announced a strategy intended to expedite the Group’s transition to becoming a more asset-sensitive bank. This strategy is based on (1) continuing to increase loan volume, with an emphasis on variable rate loans, versus investment securities; (2) continuing to expand the Group’s commercial and consumer lending business and to revitalize its mortgage lending business; (3) retaining more mortgage loans and investment securities for their recurring interest income; (4) increasing the use of longer-term, fixed rate deposits versus short-term repurchase agreements, which re-price more frequently, to fund interest earning assets; (5) expanding the Group’s branch network to 33 financial centers from 24 to support the growth of loans, deposits and non-interest income; and (6) further limiting the growth of non-interest expenses.

Change of Fiscal Year

On August 30, 2005, the Group’s Board of Directors (the “Board”) approved an amendment to Section 1 of Article IX of the Group’s By-Laws to change its fiscal year to a calendar year. The Group’s fiscal year was from July 1 of each year to June 30 of the following year. The Group’s transition period will be from July 1, 2005 to December 31, 2005.

Net Income

For the quarter ended September 30, 2005, the Group’s net income available to common shareholders was $7.2 million, a decrease of 55.4%, from the $16.2 million reported in the quarter ended September 30, 2004. Earnings per diluted share were $0.29 for the quarter ended September 30, 2005, down 54.7% from $0.64 for the corresponding period last year. Earnings per share for the quarter ended September 30, 2005 reflected 1.2% less average shares outstanding.

Return on Assets & Common Equity

Return on common equity (ROE) and return on assets (ROA) for the quarter ended September 30, 2005 were 12.68% and 0.78%, respectively, which represent a decrease of 54.1% in ROE, from 27.6% for the quarter ended September 30, 2004, and a decrease of 57.6% in ROA, from 1.84% for the quarter ended September 30, 2004, mainly due to reduced net income available to common shareholders. Compared to its peer group, the Group’s has a highly favorable return on equity and return on assets.

Net Interest Income after Provision for Loan Losses

Net interest income after provision for loan losses decreased 28.7% for the quarter ended September 30, 2005, totaling $16.4 million, compared with $23.0 million for the same periods last fiscal year. The increase of 12.4% on investment interest income was due to the increment in investment securities volume, which was offset by lower average yields and higher interest rates and increased volume on borrowings. Net interest margin for the September 30, 2005 quarter was 1.64% compared to 2.64% in the prior year’s quarter. Investment yields declined as the Group continued to reposition the portfolio, shifting into short-term government securities and away from long-term, mortgage-backed securities. Interest income from commercial and consumer loans increased 51.2% on increased volume, reflecting the success of the Group’s expanded lending program. Also, interest income from mortgage loans increased 8.2% compared to the same quarter a year ago.

Non-Interest Income

Non-interest income totaled $7.8 million for the quarter ended September 30, 2005, compared with $10.4 million in the same fiscal 2004 quarter, a decrease of 24.8%. As compared to the year ago, performance primarily reflected the absence of gains on the sale of securities and mortgage loans and a lower level of public finance investment banking activity and related commissions.

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During the quarter, the Group announced an agreement with American Express Company (NYSE: AXP) that made the Group the only bank in Puerto Rico to offer American Express Green, Gold and Corporate Cards; convert American Express Corporate Card balances to line of credit loans; and accept branch payments from American Express Card customers. American Express Cards will become the Group’s exclusive credit card offering. The Group expects this agreement to contribute to the growth of bank service fees and commercial lending on a long-term basis, consistent with its focus to serve professionals and owners of small and mid-sized businesses, and aspiring individuals and families.

Non-Interest Expenses

For the quarter ended September 30, 2005, non-interest expenses increased 1.4% to $15.4 million as compared to $15.2 million in the quarter ended September 30, 2004, but decreased of 8.7% from $16.9 million in the June 2005 quarter. The sequential decline reflects early results of the Group’s plan to reduce annualized overhead by 5% from the $63 million spent during the year ended June 30, 2005, notwithstanding the debut of the Miramar branch in July, cost in connection with plans to expand and relocate its Arecibo branch in December, the opening of a branch in Canóvanas planned for calendar 2006, and the relocation of the Group centralized operations to a new facility in May 2006. For the quarter ended September 30, 2005, the efficiency ratio was 62.72% compared to 48.42% in the year ago quarter.

Income Tax Expense

The income tax expense was $391,000 for the quarter ended September 30, 2005, compared to $768,000 for the quarter ended September 30, 2004. The current income tax provision is lower than the provision based on the statutory tax rate for the Group, which is 39%, due to the high level of tax-advantaged interest income earned on certain investments and loans, net of the disallowance of related expenses attributable to the exempt income. In addition, the Puerto Rico Internal Revenue Code of 1994, as amended, provides a dividend received deduction of 100% on dividends received from wholly-owned subsidiaries organized in Puerto Rico and subject to income taxation in Puerto Rico. Exempt interest relates principally to interest earned on obligations of the United States and Puerto Rico governments and certain mortgage-backed securities, including securities held by the Group’s international banking entities.

Group’s Financial Assets

The Group’s total financial assets include owned assets and the assets managed by the trust division, the securities broker-dealer subsidiary and the private pension plan administration subsidiary. At September 30, 2005, total financial assets reached $7.390 billion, an increase of 2.5% compared to $7.209 billion at June 30, 2005. The increase reflected a 3.4% growth in owned assets, when compared to June 30, 2005, and 1.2% growth in assets managed by the trust and broker-dealer, when compared to June 30, 2005. Owned assets, the Group’s largest financial assets component, are approximately 99% owned by the Group’s banking subsidiary.

The Group’s second largest financial assets component is assets managed by the trust division and the retirement plan administration subsidiary. The Group’s trust division offers various types of individual retirement accounts (“IRA”) and manages 401(K) and Keogh retirement plans, custodian and corporate trust accounts, while Caribbean Pension Consultants, Inc. (“CPC”) manages the administration of private pension plans. At September 30, 2005, total assets managed by the Group’s trust division and CPC amounted to $1.851 billion, 1.5% more than the $1.823 billion reported at June 30, 2005. The other financial asset component is assets gathered by the securities broker-dealer. The Group’s securities broker-dealer subsidiary offers a wide array of investment alternatives to its client base such as tax-advantaged fixed income securities, mutual funds, stocks, bonds and money management wrap-fee programs. At September 30, 2005, total assets gathered by the securities broker-dealer from its customer investment accounts, increased to $1.144 billion compared to $1.135 billion as of June 30, 2005. Both financial asset components reflect the Group’s success attracting financial assets as well as improved equity market conditions.

Interest Earning Assets

The investment portfolio amounted to $3.376 billion as of September 30, 2005, a 4.5% increase, compared to $3.232 billion as of June 30, 2005, while the loan portfolio decreased 0.6% to $901.7 million as of September 30, 2005, compared to $907.4 million as of June 30, 2005. The increase in the size of the investment portfolio reflects purchases of short-term triple-A government agency paper and general obligation bonds, as opposed to long-term mortgage-backed securities, for both available-for-sale and held-to-maturity accounts, intended to offset pre-payments of mortgage-backed securities totaling approximately $120 million in the quarter ended September 30, 2005 and a similar amount that is expected to be prepaid in the December 2005 quarter.

The slight decrease in the loan portfolio reflects mortgage prepayments and securitization of $22.0 million of purchased loans in the quarter ended September 30, 2005, partially offset by a higher mortgage, commercial and consumer loan production. Gross real estate loans totaled $726.6 million, 1.3% decrease from the balance of $736.0 million at June 30, 2005, and 2.7% increase from the balance of $707.7 million a year ago, reflecting higher sales and reduced purchases from third-party originators for the first quarter of fiscal 2005. Real Estate loan production totaled $73.3 million, an $18.9 million or 34.7% increase compared to the same quarter of prior fiscal year. Consumer loan production totaled $6.1 million, a $1 million or 19.8% increase compared to the same quarter of prior fiscal year. Commercial loan production totaled $23.0 million for the first quarter of fiscal 2005, 2.6% lower than the three-month period ended September 30, 2004, but 117.6% higher than the production for the quarter ended June 30, 2005, which totaled $10.6 million.

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Interest Bearing Liabilities

Deposits increased 4.1% from $1.253 billion as of June 30, 2005, to $1.305 billion as of September 30, 2005. This performance reflects the Group’s strategy of attracting longer-term checking and savings balances from consumer, professional and commercial customers, based on the Group’s total capabilities to service their needs, and the issuance of $103.6 million in brokered certificates of deposit. Total borrowings as of September 30, 2005 reached $2.608 billion, a 0.6% increase, when compared to $2.591 billion as of June 30, 2005. This increase reflects the Group’s use of repurchase agreements, coupled with interest rate swaps, to finance asset growth and fix funding costs over multi-year periods.

Stockholders’ Equity

Stockholders’ equity as of September 30, 2005, was $344.2 million, a 0.9% increase from $341.2 million as of June 30, 2005. This increase reflects the impact of earnings retention and the improvement in derivatives valuation from June 30, 2005, partially offset by the new stock repurchase program. On August 30, 2005, the Group’s Board of Directors approved a new stock repurchase program pursuant to which the Group is authorized to purchase in the open market up to $12.1 million of its outstanding shares of common stock. The shares of common stock so repurchased are to be held by the Company as treasury shares.

Dividends

During the quarter ended September 30, 2005, the Group declared $3.5 million in cash dividends, an 11.3% increase when compared to $3.1 million declared for the same period a year ago.

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Net interest income is a function of the difference between rates earned on the Group’s interest-earning assets and rates paid on its interest-bearing liabilities (interest rate spread) and the relative amounts of its interest-earning assets and interest-bearing liabilities (interest rate margin). Typically, bank liabilities re-price in line with changes in short-term rates, while many asset positions are affected by longer-term rates. The Group constantly monitors the composition and re-pricing of its assets and liabilities to maintain its net interest income at adequate levels.

For the quarter ended September 30, 2005, net interest income amounted to $17.3 million, a 26.7% decrease from $23.7 million in the same period of the previous year. The decrease reflects a 13.1% or $5.9 million increase in interest from loans, due to a $7.5 million positive volume variance and a $1.7 million negative rate variance in interest income, and 57.3% or $12.2 million increase in interest expense, due to an increase of $4.2 million from volume and $8.0 million from rate. Interest rate spread dropped 104 basis points, to 1.42% from 2.46% in the September 2004 quarter. This was due to a decrease of 19 basis points in the combined average yield of investments and loans and an 85 basis point increase in the average cost of funds.

For the quarter ended September 30, 2005, the average balance of total interest-earnings assets grew 17.5% to $4.217 billion versus $3.588 billion for the same period of the previous year, reflecting a 17.8% increase in the investment portfolio to $3,298.8 million, and a 16.4% increase in loans, to $917.8. Most of the dollar increase in loans comes from the real estate loans portfolio average balance, which increased by 12.2% to $761.5 million for the quarter ended September 30, 2005 from $678.5 million for the quarter ended September 30, 2004.

For the quarter ended September 30, 2005, the average yield on interest-earning assets was 4.82%, 19 basis points lower than the 5.01% reported in the same period a year ago. The decline in the average yield was primarily due to a decrease of 20 basis points on the yield of the investment portfolio, which decreased to 4.32% in the quarter ended September 30, 2005, versus 4.52% in the corresponding period of the previous fiscal year. The decrease is mostly concentrated in the yield from mortgage-backed securities, which declined 25 basis points on a quarter-to-quarter comparison. Investment yields also declined by a slight 2 basis points, as the Group continued to reposition the portfolio, shifting away from long-term into short-term government and mortgage-backed securities. The decrease of 11 basis points in the yield of the loan portfolio is mainly due to lower mortgage rates on new production as a result of market conditions and strong competition on such products. Real estate loans and consumer loans decreased 25 and 18 basis points, respectively, from September 2004 to September 2005, partially offset by an increase of 53 basis points in commercial loans reflecting higher rates on variable rate loans due to the higher interest rate environment for lending.

For the quarter ended September 30, 2005, interest expense increased 57.3% to $33.5 million from $21.3 million for the year ago quarter. Rate variance of $8.0 million is the main cause for the increase as average rates increased 85 basis points to 3.40% when compared to 2.53% for the same period of the previous year. Also, there was a $4.2 million volume increase, from a 14.6% increase year over year, or $341.0 million, in the average balance of borrowings, to $2.674 billion.

For the quarter ended September 30, 2005, the cost of deposits increased 46 basis points to 3.04% as compared to 2.58% in the year ago quarter. The increase reflects higher average rates paid on higher balances, specifically in certificates of deposit. For the quarter ended September 30, 2005, the cost of borrowings increased 104 basis points to 3.57% as compared to 2.53% in the year ago quarter. The increase is mainly the result of higher average rates paid on repurchase agreements. Repurchase agreements increased 205 basis points (to 3.55% from 1.50% for the quarter ended September 30, 2004), reflecting the effect of rate increases by the Board of Governors of the Federal Reserve System of 200 basis points within the periods. The cost of repurchase agreements was offset by a 94 basis point reduction in the Group’s hedging costs for the quarter ended September 30, 2005, as the Group’s use of interest rate swaps in a rising interest rate environment partially offset rising borrowing financing fees. As approved and executed in the September’s meeting of the Assets and Liabilities Management Committee (“ALCO”), the Group entered into a new interest rate Swap with a notional amount of $325 million and a 5-year maturity, to fix the rate on a portion of the Group’s repurchase agreements portfolio, based on the current and expected interest rate scenario. Cost of FHLB advances increased 44 basis points to 3.01% versus 2.57% for the quarter ended September 30, 2004, term notes and subordinated capital notes increased 184 and 164 basis points, to 3.28% and 6.72%, respectively, versus 1.44% and 5.08% for the quarter ended September 30, 2004.

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TABLE 2 — NON-INTEREST INCOME SUMMARY
FOR THE THREE-MONTH PERIODS ENDED SEPTEMBER 30, 2005 AND 2004
(Dollars in thousands)


	Three-Month Period
	2005			2004			Variance %

Mortgage banking activities	$	1,068		$	2,057			-48.1	%
Commissions and fees from fiduciary activities		2,038			2,028			0.5	%
Commissions and fees from brokerage investment banking, and insurance activities		1,886			1,669			13.0	%

Non-banking service revenues		4,992			5,754			-13.2	%


Fees on deposit accounts		1,538			1,245			23.5	%
Bank service charges and commissions		652			567			15.0	%
Other operating revenues		29			139			-79.1	%

Banking service revenues		2,219			1,951			13.7	%


Securities net activity		341			3,245			-89.5	%
Derivatives net gain (loss)		(50	)		(570	)		91.2	%
Trading net gain (loss)		4			(2	)		300.0	%

Securities, derivatives and trading activities		295			2,673			-89.0	%


Other non-interest income		319			26			1126.9	%


Total non-interest income	$	7,825		$	10,404			-24.8	%

Non-interest income, the second largest source of earnings, is affected by the amount of securities and trading transactions, the level of trust assets under management, transactions generated by the gathering of financial assets by the securities broker-dealer subsidiary, the level of investment and mortgage banking activities, and the fees generated from loans, deposit accounts and insurance.

Non-interest income totaled $7.8 million in the quarter ended September 30, 2005, a 24.8% decrease when compared to $10.4 million in the same quarter of the previous fiscal year. Performance in the quarter reflects decreases in investment banking activities and mortgage banking activities, primarily reflecting the Group’s strategy, initiated during the quarter ended March 30, 2005, to retain more securities and mortgages for their recurring interest income rather than sell them. Performance also reflects a higher level of public finance investment banking activity in the year ago quarter.

Non-banking service revenues, generated from trust, mortgage banking, brokerage and insurance activities, is one of the principal components of non-interest income. For the quarter ended September 30, 2005, these revenues decreased 13.2% to $5.0 million, from $5.8 million for the year ago quarter. Mortgage banking activities decreased 48.1%, when comparing the $1.1 million current quarter activity to $2.1 million in the year ago quarter. The decline reflects the Group’s current strategy of retaining most mortgage loans for their recurring interest income. Commissions and fees from brokerage and insurance activities, increased 13.0%, to $1.9 million, from $1.7 in the year-ago quarter. Growth for the year reflected the general improvement in the equity markets and increased underwriting activities. Commissions and fees from fiduciary activities remain in line as compared to the year ago quarter.

Banking service revenues, another major component of non-interest income, consist primarily of fees generated by deposit accounts, electronic banking services and bank service commissions. For the quarter ended September 30, 2005, these revenues increased 13.7% to $2.2 million compared to the year ago quarter primarily due to higher fees on deposit accounts, mainly overdraft fees, and the ongoing success of the Group’s product and service marketing programs. Fees on deposit accounts increased 23.5% to $1.538 million from $1.245 million in the year ago quarter. Bank service charges and commissions increased 15.0% to $652,000 from $567,000 in the year ago quarter reflecting higher transactional volume in the Bank’s debit and credit cards.

For the quarter ended September 30, 2005, revenues from securities, derivatives and trading activities was $295,000 compared to $2.7 million for the year ago quarter. For the quarter, derivatives net loss was $50,000 compared to a loss of $570,000 for the same quarter of last year, and securities net activity decreased 89.5%, to $341,000 compared to $3.2 million for the same quarter of last year.

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TABLE 3 — NON-INTEREST EXPENSES SUMMARY
FOR THE THREE-MONTH PERIODS ENDED SEPTEMBER 30, 2005 AND 2004
(Dollars in thousands)


	2005			2004			Variance %

Compensation and employees’ benefits	$	6,260		$	6,768			-7.5	%
Occupancy and equipment		2,976			2,501			19.0	%
Advertising and business promotion		1,350			1,341			0.7	%
Professional and service fees		1,693			1,674			1.1	%
Communications		413			451			-8.4	%
Loan servicing expenses		446			449			-0.7	%
Taxes, other than payroll and income taxes		597			450			32.7	%
Electronic banking charges		388			490			-20.8	%
Printing, postage, stationery and supplies		259			248			4.4	%
Insurance, including deposits insurance		185			198			-6.6	%
Other operating expenses		823			613			34.3	%

Total non-interest expenses	$	15,390		$	15,183			1.4	%


Relevant ratios and data:
Compensation and benefits to non-interest expenses		40.7	%		44.6	%

Compensation to total assets		0.57	%		0.64	%

Average compensation per employee (annualized)	$	47.5		$	52.3

Average number of employees		527			518

Bank assets per employee	$	8,340		$	7,603


Total work force:
Banking operations		416			436
Trust operations		51			52
Brokerage and Insurance operations		47			25

Total work force		514			513

Non-interest expenses for the quarter ended September 30, 2005, were $15.4 million compared to $15.2 million in the year ago quarter, with the efficiency ratio totaling 62.72% compared to 48.42% in the quarter ended September 30, 2004. The efficiency ratio measures how much of a company’s revenue is used to pay operating expenses. The Group computes its efficiency ratio by dividing operating expenses by the sum of its net interest income and recurring non-interest income, but excluding gains on sale of investments securities.

To date, the Group has been successful limiting expense growth to those areas that directly contribute to increased the efficiency, service quality and profitability. As result, non-interest expenses increased 1.4% year over year, they decreased 8.7% and 0.5% from the June 30, 2005 and March 30, 2005 quarters, respectively. Further reductions are anticipated.

Compensation and benefits, the largest non-interest expense category accounts for 41% of the total non-interest expense. For the quarter ended September 30, 2005, total compensation and benefits amounted to $6.3 million, a 7.5% decrease compared to $6.8 million for the same period a year ago even though the Group has been continued to invest in highly qualified employees and the opening of a new branch in Miramar. Total workforce increased by only one full-time equivalent employee to 514 from same period last year and declined by six full-time equivalent employees from 520 on June 30, 2005.

Occupancy and equipment expenses amounts to $3.0 million, an increase of 19.0% from $2.5 million at September 30, 2004. The increase is mainly due to the acceleration of leasehold improvements depreciation expense due to the planned relocation of the Group’s main offices to a new financial center building in May 2006. Also included is rent for the Oriental Mortgage building which was sold and leased back in June 2005 and for the opening of the Group’s 24^th branch in Miramar.

Taxes, other than payroll and income taxes, increased 32.7% to $597,000 from a year ago, mainly due to the increase in revenues and income subject patent to municipal license tax.

The aggregated decrease in electronic banking, communications, loan servicing and insurance expenses is principally due to effective cost controls.

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TABLE 4 — ALLOWANCE FOR LOAN LOSSES SUMMARY
FOR THE THREE-MONTH PERIODS ENDED SEPTEMBER 30, 2005 AND 2004
(Dollars in thousands)


	Three-Month Period						Change in
	2005			2004			%
Beginning balance	$	6,495		$	7,553			-14.0	%
Provision for loan losses		951			700			35.9	%
Net credit losses — see Table 5 below		(609	)		(393	)		55.0	%

Ending balance	$	6,837		$	7,860			-13.0	%


Selected Data and Ratios:
Outstanding gross loans at September 30,	$	908,561		$	834,125			8.9	%

Recoveries to net charge-off’s		12.8	%		60.6	%		-78.9	%

Allowance coverage ratio
Total loans		0.75	%		0.94	%		-20.4	%

Non-performing loans		24.03	%		27.08	%		-11.3	%

Non-real estate non-performing loans		134.85	%		243.87	%		-44.7	%

TABLE 5 — NET CREDIT LOSSES STATISTICS
FOR THE THREE-MONTH PERIODS ENDED SEPTEMBER 30, 2005 AND 2004
(Dollars in thousands)


	Three-Month Period						Change in
	2005			2004			%
Mortgage
Charge-offs	$	(70	)	$	(145	)		51.7	%
Recoveries		—			—			0.0	%

		(70	)		(145	)		51.7	%

Commercial
Charge-offs		(98	)		(24	)		-308.3	%
Recoveries		4			80			-95.0	%

		(94	)		56			267.9	%

Consumer
Charge-offs		(519	)		(462	)		12.3	%
Recoveries		74			158			-53.2	%

		(445	)		(304	)		46.4	%

Net credit losses
Total charge-offs		(687	)		(631	)		8.9	%
Total recoveries		78			238			-67.2	%

	$	(609	)	$	(393	)		55.0	%

Net credit losses to average loans outstanding (1):
Mortgage		0.04	%		0.09	%

Commercial		0.30	%		(0.25	%)

Consumer		5.80	%		6.19	%

Total		0.27	%		0.20	%


Average loans:
Mortgage	$	761,547		$	678,459			12.2	%
Commercial		125,562			90,596			38.6	%
Consumer		30,702			19,635			56.4	%

Total	$	917,811		$	788,690			16.4	%


(1)		Annualized rates

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TABLE 6 — ALLOWANCE FOR LOSSES BREAKDOWN
AS OF SEPTEMBER 30, 2005, 2004 and JUNE 30, 2005
(Dollars in thousands)


	September 30,			June 30,			Change in			September 30,
	2005			2005			%			2004
Allowance for loan losses breakdown:
Mortgage	$	3,428		$	3,167			8.2	%	$	4,009
Commercial		1,768			1,714			3.2	%		1,566
Consumer		1,331			1,335			-0.3	%		1,837
Unallocated allowance		310			279			11.1	%		448

	$	6,837		$	6,495			5.3	%	$	7,860


Allowance composition:
Mortgage		50.1	%		48.8	%					51.0	%
Commercial		25.9	%		26.4	%					19.9	%
Consumer		19.5	%		20.6	%					23.4	%
Unallocated allowance		4.5	%		4.3	%					5.7	%

		100.0	%		100.0	%					100.0	%

The provision for loan losses for the quarter ended September 30, 2005, totaled $951,000, a 35.9% increase from the $700,000 reported for the same period of the previous fiscal year. Based on an analysis of the credit quality and composition of its loan portfolio, the Group determined that the provision for the first three months of the current fiscal year was adequate in order to maintain the allowance for loan losses at an appropriate level. During the quarter ended September 30, 2005, the Group continued its effort to accelerate foreclosure on certain, older non-performing real estate loans. This resulted in a year-over-year increase in in foreclosed real estate properties.

Net credit losses for the quarter increased 55.0%, from $393,000 in the quarter ended September 30, 2004, to $609,000 in the quarter ended September 30, 2005. The increase was primarily due to a $141,000 increment in net credit losses for consumer loans when compared to the same period in the previous fiscal year. During the quarter ended September 30, 2005, $164,000 was recorded as charged-off related to the consumer loan portfolio sold to another financial institution during fiscal year 2000, since part of the sale agreement the Group was required to assume certain losses related to these loans. For the first three months of the current fiscal year, the net credit losses average ratio was 0.27%, compared to 0.20% reported for the same period of the prior fiscal year. Non-performing loans of $28.5 million as of September 30, 2005 were 2.0% lower than the $29.0 million as of September 30, 2004, and 7.8% lower than the $30.9 million reported as of June 30, 2005 (Table 9).

At September 30, 2005, the Group’s allowance for loan losses amounted to $6.8 million (0.75% of total average loans) compared to $6.5 million (0.71% of total loans) reported at June 30, 2005. Commercial and Mortgage loan allowances increased by 3.2% and 8.2%, or $54,000 and $261,000, respectively, when compared with balances recorded at June 30, 2005. Consumer loans allowance decreased 0.3% or $4,000, when compared to June 30, 2005. Unallocated reserve increased 11.1%, or $31,000, when compared to $279,000 recorded at June 30, 2005.

The Group maintains an allowance for loan losses at a level that management considers adequate to provide for potential losses based upon an evaluation of known and inherent risks. The Group’s allowance for loan losses policy provides for a detailed quarterly analysis of possible losses.

The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectibility of the loans in light of historical loss experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as more information becomes available.

The Group uses a methodology that follows a loan credit risk rating process that involves dividing loans into risk categories. The following are the credit risk categories used:

1.		Pass — loans considered highly collectible due to their repayment history or current status.

2.		Special Mention — loans with potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects of the loan.

- 41 -

3.		Substandard — loans inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.

4.		Doubtful — loans that have all the weaknesses inherent in substandard, with the added characteristic that collection or liquidation in full is highly questionable and improbable.

4.		Loss — loans considered uncollectible and of such little value that their continuance as bankable assets is not warranted.

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.

The Group evaluates all loans, some individually and others as homogeneous groups, for purposes of determining impairment. The portfolios of mortgages and consumer loans are considered homogeneous and are evaluated collectively for impairment. For the commercial loans portfolio, all loans over $250,000 are evaluated for impairment. At September 30, 2005, the total investment in impaired loans was $3.5 million which is comprised of six loans. Impaired loans are measured based on the fair value of collateral. The Group determined that no specific impairment allowance was required for such loans. Impaired loans at June 30, 2005 were $3.2 million.

The Group, using an aged-based 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:

	1.		Overall historical loss trends; and

	2.		Other information including underwriting standards, economic trends and unusual events.

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

An unallocated allowance is established recognizing the estimation risk associated with the aged-based rating system and with the specific allowances. It is based upon management’s evaluation of various conditions, the effects of which are not directly measured in determining the aged-based rating system and the specific allowances. These conditions include then-existing general economic and business conditions affecting our key lending areas; credit quality trends, including trends in non-performing loans expected to result from existing conditions, collateral values, loan volumes and concentrations, seasoning of the loan portfolio, recent loss experience in particular segments of the portfolio, regulatory examination results, and findings by the Group’s management. The evaluation of the inherent loss regarding these conditions involves a higher degree of uncertainty because they are not identified with specific problem credits or portfolio segments.

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FINANCIAL CONDITION

TABLE 7 — BANK ASSETS SUMMARY AND COMPOSITION
AS OF SEPTEMBER 30, 2005, 2004 and JUNE 30, 2004
(Dollars in thousands)


	September 30,			June 30,			Variance			September 30,
	2005			2005			%			2004
Investments:
Mortgage-backed securities	$	1,851,470		$	1,959,760			-5.5	%	$	2,380,507
U.S. Government and agency obligations		1,226,697			1,029,980			19.1	%		389,427
P.R. Government and agency obligations		109,086			108,968			0.1	%		113,517
Other investment securities		91,445			66,023			38.5	%		15,800
Short-term investments		70,387			39,791			76.9	%		74,602
FHLB stock		27,058			27,058			—			28,160

		3,376,143			3,231,580			4.5	%		3,002,013

Loans:
Mortgage		726,636			735,971			-1.3	%		707,697
Commercial, mainly secured by real estate		130,819			129,670			0.9	%		98,748
Consumer		31,534			30,282			4.1	%		21,712

Loans receivable		888,989			895,923			-0.8	%		828,157
Allowance for loan losses		(6,837	)		(6,495	)		5.3	%		(7,860	)

Loans receivable, net		882,152			889,428			-0.8	%		820,297
Mortgage loans held for sale		19,572			17,963			9.0	%		5,968

Total loans receivable, net		901,724			907,391			-0.6	%		826,265


Securities sold but not yet delivered		707			1,034			-31.60	%		23,369


Total securities and loans		4,278,574			4,140,005			3.3	%		3,851,647


Other assets:
Cash and due from banks		15,930			14,892			7.0	%		11,321
Accrued interest receivable		26,178			23,735			10.3	%		19,071
Premises and equipment, net		15,471			15,269			1.3	%		17,874
Deferred tax asset, net		6,980			6,191			12.7	%		6,649
Foreclosed real estate, net		4,521			4,186			8.0	%		978
Other assets		47,392			46,374			2.2	%		30,851

Total other assets		116,472			110,647			5.3	%		86,744


Total assets	$	4,395,046		$	4,250,652			3.4	%	$	3,938,391


Investments portfolio composition:
Mortgage-backed securities		54.8	%		60.6	%					79.3	%
U.S. Government and agency obligations		36.3	%		31.9	%					13.0	%
P.R. Government and agency obligations		3.2	%		3.4	%					3.8	%
FHLB stock, short term investments and debt securities		5.7	%		4.1	%					3.9	%

		100.0	%		100.0	%					100.0	%

Loan portfolio composition:
Mortgage (1)		82.1	%		82.5	%					85.6	%
Commercial, mainly secured by real estate		14.4	%		14.2	%					11.8	%
Consumer		3.5	%		3.3	%					2.6	%

		100.0	%		100.0	%					100.0	%


(1)		Includes loans held for sale.

At September 30, 2005, the Group’s total assets amounted to $4.395 billion, an increase of 3.4%, when compared to $4.251 billion at June 30, 2005. At September 30, 2005, interest-earning assets were $4.279 billion, a 3.3% increase compared to $4.140 billion at June 30, 2005.

Investments are the Group’s largest interest-earning assets component. Investments principally consist of money market instruments, U.S. government bonds, mortgage-backed securities, collateralized mortgage obligations and Puerto Rico government municipal bonds. At September 30, 2005, the investment portfolio increased 4.5% to $3.376 billion, from $3.231 billion as of June 30, 2005. The increase reflects purchases of US and Puerto Rico government securities and sales of 30-year maturity mortgage-backed securities and collateralized mortgage obligations. These activities are in line with the Group’s strategy in a rising interest rate environment of investing in fixed and variable rate, short-term and medium-term government securities, and the sale of long-term mortgage-backed securities.

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At September 30, 2005, the Group’s loan portfolio, the second largest category of the Group’s interest-earning assets, slightly decreased by 0.6% to $901.7 million when compared to $907.4 million at June 30, 2005. This was principally due to a conversion of $25 million whole mortgages into GNMA and normal portfolio run-offs. Commercial and consumer loans grew by 0.9% and 4.1%, respectively, to $130.8 million and $31.5 million, when compared to $129.7 million and $30.3 million at June 30, 2005. Such increases reflect the Group’s strategy to expand the commercial and consumer loan portfolios. During the quarter ended September 30, 2005, commercial loan production amounted to $23.0 million, a slight decrease of 2.6% over the year ago quarter but an increase of 117.6% from June 30, 2005 quarter-end. Consumer loan production expanded 19.8% over the prior year quarter, to $6.1 million. Mortgage production increased 19.8% to $73.3 million when compared to the prior year quarter.

TABLE 8 — NON-PERFORMING ASSETS
AS OF SEPTEMBER 30, 2005, 2004 and JUNE 30, 2005
(Dollars in thousands)


	September 30,			June 30,			Change in			September 30,
	2005			2005			%			2004
Non-performing assets:
Non- Accruing Loans	$	20,586		$	21,859			-5.8	%	$	21,247
Accruing Loans		7,869			8,997			-12.5	%		7,777

Total Non-performing loans		28,455			30,856			-7.8	%		29,024
Foreclosed real estate		4,521			4,186			8.0	%		978

	$	32,976		$	35,042			-5.9	%	$	30,002


Non-performing assets to total assets		0.75	%		0.82	%		-9.0	%		0.76	%

TABLE 9 — NON-PERFORMING LOANS
AS OF SEPTEMBER 30, 2005, 2004 and JUNE 30, 2005
(Dollars in thousands)


	September 30,			June 30,			Change in			September 30,
	2005			2005			%			2004
Non-performing loans:
Mortgage	$	23,385		$	26,184			-10.7	%	$	25,801
Commercial, mainly secured by real estate		4,802			4,549			5.6	%		2,898
Consumer		268			123			117.9	%		325

Total	$	28,455		$	30,856			-7.8	%	$	29,024


Non-performing loans composition:
Mortgage		82.2	%		84.9	%					88.9	%
Commercial, mainly secured by real estate		16.9	%		14.7	%					10.0	%
Consumer		0.9	%		0.4	%					1.1	%

Total		100.0	%		100.0	%					100.0	%


Non-performing loans to:
Total loans		3.13	%		3.38	%		-7.4	%		3.48	%

Total assets		0.65	%		0.73	%		-11.0	%		0.74	%

Total capital		8.27	%		9.04	%		-8.5	%		9.21	%

At September 30, 2005, the Group’s non-performing assets totaled $33.0 million (0.75% of total assets) versus $35.0 million (0.82% of total assets) at June 30, 2005. Foreclosed real estate properties increased 8.0% to $4.5 million, when compared to $4.2 million reported as of June 30, 2005.

Non-performing consumer loans increased to $268,000 as of September 30, 2005, from $123,000 as of June 30, 2005, mainly due to the higher loan portfolio held by the Group. Non-performing mortgage loans decreased 10.7% to $23.4 million as of September 30, 2005, when compared to the June 30, 2005 non-performing level of $26.2 million. Such decrease is mainly due to a more aggressive effort made by management to foreclose the properties held as collateral. The commercial and residential real estate loan portfolios are well collateralized.

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At September 30, 2005, the allowance for loan losses to non-performing loans coverage ratio was 24.03%. Detailed information concerning each of the items that comprise non-performing assets follows:

•

Mortgage loans are placed on a non-accrual basis when they become 365 days or more past due and are written-down, if necessary, based on the specific evaluation of the collateral underlying the loan. At September 30, 2005, the Group’s non-performing mortgage loans totaled $23.4 million (82% of the Group’s non-performing loans) a 10.7% decrease from the $26.2 million (85% of the Group’s non-performing loans) reported at June 30, 2005. Non-performing loans in this category are primarily residential mortgage loans. Based on the value of the underlying collateral, the loan-to-value ratios and credit loss experience, management considers that no significant losses will be incurred on this portfolio.

•

Commercial loans are placed on non-accrual status when they become 90 days or more past due and are written-down, if necessary, based on the specific evaluation of the underlying collateral, if any. At September 30, 2005, the Group’s non-performing commercial loans amounted to $4.8 million (17% of the Group’s non-performing loans), a 5.6% increase from $4.6 million reported at June 30, 2005 (15% of the Group’s non-performing loans). Most of this portfolio is collateralized by real estate and no significant losses are expected.

•

Consumer loans are placed on non-accrual status when they become 90 days past due and written-off when payments are delinquent 120 days in personal loans and 180 days in credit cards and personal lines of credit. At September 30, 2005, the Group’s non-performing consumer loans amounted to $268,000 (1% of the Group’s total non-performing loans), which increase from the $123,000 reported at June 30, 2005 (less than 1% of total non-performing loans).

•

Foreclosed real estate is initially recorded at the lower of the related loan balance or fair value at the date of foreclosure. Any excess of the loan balance over the fair market value of the property is charged against the allowance for loan losses. Subsequently, any excess of the carrying value over the estimated fair market value less disposition cost is charged to operations.

At September 30, 2005, the Group’s total liabilities reached $4.051 billion, 3.6% higher than the $3.909 billion reported at June 30, 2005. Deposits and borrowings, the Group’s funding sources, amounted to $4.012 billion at September 30, 2005, an increase of 3.8% when compared to $3.867 billion reported at June 30, 2005. At September 30, 2005, borrowings represented 65% of interest-bearing liabilities and deposits 31%, versus 67% and 32%, respectively, at June 30, 2005. The Group’s medium term objective is a 55%-45% ratio of borrowings to deposits, as it grows up the loan portfolio to 45% of total earning assets.

Borrowings are the Group’s largest interest-bearing liability component. They consist mainly of diversified funding sources through the use of repurchase agreements, FHLB advances, subordinated capital notes, term notes and lines of credit. At September 30, 2005, borrowings amounted to $2.607 billion, 0.6% greater than the $2.591 billion at June 30, 2005. The increase is due to an increase of 0.8% in repurchase agreements, reflecting the funding needed to finance the Group’s investment and loan portfolio as well as the Group’s strategy from the past two years to use lower cost repurchase agreements, coupled with interest rate swaps, to fix these costs over multi-year periods.

The FHLB system functions as a source of credit to financial institutions that are members of a regional Federal Home Loan Bank. As a member of the FHLB, the Group can obtain advances from the FHLB, secured by the FHLB stock owned by the Group, as well as by certain of the Group’s mortgages and investment securities. FHLB advances totaled $300 million as of September 30, 2005, and June 30, 2005. The Group has the capacity to expand FHLB funding up to maximum of $532 million based on our current $27.1 million FHLB capital contribution.

At September 30, 2005, deposits, the second largest category of the Group’s interest-bearing liabilities, reached $1.305 billion, up 4.1%, compared to the $1.253 billion reported as of June 30, 2005. Deposits reflected 6.5% sequential quarterly growth in certificates of deposits, to $1,067.8 million primarily due to an increase in one year CDs. Such increases are due in part to the Group’s success in opening accounts as part of its expanded commercial and consumer lending businesses and the Oriental Preferred program of bank services and accounts, as well as an increase in brokered deposits.

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TABLE 10 — LIABILITIES SUMMARY AND COMPOSITION
AS OF SEPTEMBER 30, 2005, 2004 and JUNE 30, 2004
(Dollars in thousands)


	September 30,			June 30,			Variance			September 30,
	2005			2005			%			2004
Deposits:
Non-interest bearing deposits	$	61,307		$	62,205			-1.4	%	$	42,703
Now accounts		84,615			89,930			-5.9	%		83,500
Savings accounts		86,252			93,920			-8.2	%		91,712
Certificates of deposit		1,067,781			1,002,908			6.5	%		812,972

		1,299,955			1,248,963			4.1	%		1,030,887
Accrued interest payable		4,817			3,934			22.4	%		1,544

		1,304,772			1,252,897			4.1	%		1,032,431


Borrowings:
Repurchase agreements		2,208,847			2,191,756			0.8	%		2,101,340
Advances from FHLB		300,000			300,000			0.0	%		300,000
Subordinated capital notes		72,166			72,166			0.0	%		72,166
Term notes		15,000			15,000			0.0	%		15,000
Federal Funds Purchased		11,641			12,310			-5.4	%		—

		2,607,654			2,591,232			0.6	%		2,488,506


Securities purchased but not yet received		100,000			22,772			339.1	%		53,300


Total deposits and borrowings		4,012,426			3,866,901			3.8	%		3,574,237
Other liabilities		38,443			42,584			-9.7	%		49,290

Total liabilities	$	4,050,869		$	3,909,485			3.6	%	$	3,623,527


Deposits portfolio composition percentages:
Non-interest bearing deposits		4.7	%		5.0	%					4.1	%
Now accounts		6.5	%		7.2	%					8.1	%
Savings accounts		6.6	%		7.5	%					8.9	%
Certificates of deposit		82.2	%		80.3	%					78.9	%

		100.0	%		100.0	%					100.0	%


Borrowings portfolio composition percentages:
Repurchase agreements		84.7	%		84.6	%					84.4	%
Advances from FHLB		11.5	%		11.6	%					12.1	%
Subordinated capital notes		2.8	%		2.8	%					2.9	%
Term notes		0.6	%		0.6	%					0.6	%
Federal Funds Purchased		0.4	%		0.4	%					0.0	%

		100.0	%		100.0	%					100.0	%


Repurchase agreements
Amount outstanding at quarter-end	$	2,208,847		$	2,191,756					$	2,101,340

Daily average outstanding balance	$	2,266,148		$	2,174,312					$	1,935,574

Maximum outstanding balance at any month-end	$	2,328,939		$	2,398,861					$	2,101,340

Stockholders’ Equity

Stockholders’ equity as of September 30, 2005, was $344.2 million, a 0.9% increase from $341.2 million as of June 30, 2005. This increase reflects the impact of earnings retention and the improvement in Other Comprehensive Income resulted from the derivatives valuation for the three-month period ended September 30, 2005, partially offset by the new stock repurchase program. On August 30, 2005, the Group’s Board of Directors approved a new stock repurchase program pursuant to which the Group is authorized to purchase in the open market up to $12.1 million of its outstanding shares of common stock. The shares of common stock so repurchased are to be held by the Group as treasury shares.

On August 30, 2005 the Group declared a 0.14 cent cash dividend per share, totaling $3.5 million, an 11.3% increase compared to $3.1 million declared for the same period a year ago.

The Group’s common stock is traded on the New York Stock Exchange (NYSE) under the symbol OFG. At September 30, 2005, the Group’s market capitalization for its outstanding common stock was $303.3 million ($12.24 per share).

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Under the regulatory framework for prompt corrective action, banks that meet or exceed a Tier I capital risk-based ratio of 6%, a total capital risk-based ratio of 10% and a leverage ratio of 5% are considered well capitalized. The Bank exceeds those regulatory capital requirements.

TABLE 11 — CAPITAL, DIVIDENDS AND STOCK DATA
AS OF SEPTEMBER 30, 2005, 2004 and JUNE 30, 2005
(In thousands, except for per share data)


	September 30,			June 30,			Variance			September 30,
	2005			2005			%			2004
Capital data:
Stockholders’ equity	$	344,177		$	341,167			0.9	%	$	314,864


Regulatory Capital Ratios data:
Leverage Capital Ratio		10.33	%		10.65	%		-3.0	%		11.18	%

Minimum Leverage Capital Ratio Required		4.00	%		4.00	%					3.00	%

Actual Tier 1 Capital	$	448,073		$	447,543			0.1	%	$	423,358

Minimum Tier 1 Capital Required	$	173,430		$	168,080			3.2	%	$	113,357


Tier 1 Risk-Based Capital Ratio		38.80	%		38.83	%		-0.1	%		37.87	%

Minimum Tier 1 Risk-Based Capital Ratio Required		4.00	%		4.00	%					4.00	%

Actual Tier 1 Risk-Based Capital	$	448,073		$	447,543			0.1	%	$	423,358

Minimum Tier 1 Risk-Based Capital Required	$	46,192		$	46,105			0.2	%	$	44,712


Total Risk-Based Capital Ratio		39.39	%		39.39	%		0.0	%		38.58	%

Minimum Total Risk-Based Capital Ratio Required		8.00	%		8.00	%					8.00	%

Actual Total Risk-Based Capital	$	454,910		$	454,038			0.2	%	$	431,218

Minimum Total Risk-Based Capital Required	$	92,384		$	92,210			0.2	%	$	89,425


Stock data:
Outstanding common shares, net of treasury (1)		24,776			24,904			-0.5	%		24,486

Book value (1)	$	11.15		$	10.97			1.6	%	$	10.08

Market Price at end of period	$	12.24		$	15.26			-19.8	%	$	24.60

Market capitalization	$	303,258		$	380,035			-20.2	%	$	602,356


	September 30,			September 30,			Variance
	2005			2004			%
Common dividend data:
Cash dividends declared	$	3,470		$	3,118			11.3	%

Cash dividends declared per share (1)	$	0.14		$	0.13			10.0	%

Payout ratio		48.04	%		19.24	%		149.7	%

Dividend yield		3.94	%		2.11	%		86.7	%

The following provides the high and low prices and dividend per share of the Group’s stock for each quarter of the last three fiscal periods. Common stock prices and cash dividend per share were adjusted to give retroactive effect to the stock dividend declared on the Group’s common stock.


					Cash
	Price				Dividend
	High		Low		Per share
Fiscal 2005 (Transition period)
September 30, 2005	$	16.51	$	12.16	$	0.14


Fiscal 2005
June 30, 2005	$	23.47	$	13.66	$	0.14

March 31, 2005	$	28.94	$	22.97	$	0.14

December 31, 2004	$	28.41	$	24.37	$	0.14

September 30, 2004 (1)	$	26.64	$	22.76	$	0.13


Fiscal 2004 (1)
June 30, 2004	$	29.77	$	23.26	$	0.13

March 31, 2004	$	29.55	$	22.45	$	0.13

December 31, 2003	$	23.77	$	19.88	$	0.13

September 30, 2003	$	22.30	$	19.28	$	0.12


Fiscal 2003 (1)
June 30, 2003	$	21.77	$	17.90	$	0.12

March 31, 2003	$	17.96	$	16.58	$	0.12

December 31, 2002	$	17.03	$	13.12	$	0.12

September 30, 2002	$	16.69	$	13.72	$	0.10


(1)		Adjusted to give retroactive effect to the 10% stock dividends declared on the Group’s common stock on November 30, 2004.

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Interest Rate Risk and Asset/Liability Management

The Group’s interest rate risk and asset/liability management is the responsibility of the Asset and Liability Management Committee (“ALCO”), which reports to the Board of Directors and is composed of members of the Group’s senior management. The principal objective of ALCO is to enhance profitability while maintaining an appropriate level of interest rate and liquidity risks. ALCO is also involved in formulating economic projections and strategies used by the Group in its planning and budgeting process and, also, oversees the Group’s sources, uses and pricing of funds.

Interest rate risk can be defined as the exposure of the Group’s operating results or financial position to adverse movements in market interest rates, which mainly occur when assets and liabilities reprice at different times and at different rates. This difference is commonly referred to as a “maturity mismatch” or “gap”. The Group employs various techniques to assess its degree of interest rate risk.

The Group is liability sensitive due to its fixed rate and medium to long-term asset composition being funded with shorter-term repricing liabilities. As a result, the Group utilizes various derivative instruments for hedging credit and market risk. The notional amounts are amounts from which calculations and payments are based. Notional amounts do not represent direct credit exposures. Direct credit exposure is limited to the net difference between the calculated amount to be received and paid, if any. The actual risk of loss is the cost of replacing, at market, these contracts in the event of default by the counterparties. The Group controls the credit risk of its derivative financial instrument agreements through credit approvals, limits, monitoring procedures and collateral, when considered necessary.

The Group generally uses interest rate swaps and interest rate options in managing its interest rate risk exposure. The swaps were entered into to convert short-term borrowings into fixed rate liabilities for longer periods and provide protection against increases in short-term interest rates. Under these swaps, the Group pays a fixed monthly or quarterly cost and receives a floating monthly or quarterly payment based on LIBOR. Floating rate payments received from the swap counterparties correspond to the floating rate payments made on the short-term borrowings thus resulting in a net fixed rate cost to the Group. Please refer to Note 8-Derivatives Activities of the accompanying financial statements for more information related to the Group’s swaps, including those used to manage exposure to the stock market on the certificates of deposit with an option tied to the performance of the Standard & Poor’s 500 stock market index, and other derivatives instruments used by the Group for hedging credit and market risk.

During the quarters ended September 30, 2005 and 2004, losses of $50,000 and of $570,000, respectively, were charged to earnings and reflected as “Derivatives Activities” in the consolidated statements of income. For the quarters ended September 30, 2005 and 2004 unrealized gains of $11.2 million and unrealized losses of $16.9 million, respectively, on derivatives designated as cash flow hedges were included in other comprehensive income. Ineffectiveness of $199,000 and $509,000 were charged to earnings during the three-month periods ended September 30, 2005 and 2004, respectively.

At September 30, 2005 and June 30, 2005, the fair value of derivatives was recognized as either assets or liabilities in the consolidated statements of financial condition as follows: the fair value of the interest rate swaps used to manage the exposure to the stock market on stock indexed deposits, and to fix the cost of short-term borrowings and hedge mortgage loan purchased represented a liability of $22.3 million and $14.9 million, respectively, presented in accrued expenses and other liabilities; the purchased options used to manage the exposure to the stock market on stock indexed deposits represented an other asset of $14.3 million and $19.0 million, respectively; and the options sold to customers embedded in the certificates of deposit represented a liability of $13.2 million and $18.2 million, respectively, recorded in deposits.

Rate changes expose the Group to changes in net interest income. The result of the sensitivity analysis on net interest income on a hypothetical 200 basis points rate increase as of September 30, 2005 for the next twelve months would be a decrease of $24.9 million or 34.37% of net interest income. The change for the same period, utilizing a hypothetical declining rate scenario of 100 basis points, is an increase of $11.6 million or 16.05%. Both hypothetical rate scenarios consider a gradual change of +200 and -100 basis points during the twelve-month period. The decreasing rate scenario has a floor of 25 basis points. These estimated changes are slightly above the policy guidelines established by the Board of Directors, which established a target of 15%.

Liquidity Risk Management

The objective of the Group’s asset/liability management function is to maintain consistent growth in net interest income within the Group’s policy limits. This objective is accomplished through management of the Group’s Statement of Financial Condition composition, liquidity, and interest rate risk exposure arising from changing economic conditions, interest rates and customer preferences.

- 48 -

The goal of liquidity management is to provide adequate funds to meet changes in loan demand or unexpected deposit withdrawals. This is accomplished by maintaining liquid assets in the form of investment securities, maintaining sufficient unused borrowing capacity in the national money markets and delivering consistent growth in core deposits. As of September 30, 2005, the Group had approximately $1.1 billion in securities and other investments available to cover liquidity needs. Securitizable loans provide additional asset-driven liquidity. These sources, in addition to the Group’s 10.33% leverage capital ratio, provide a stable funding base.

In addition to core deposit funding, the Group also accesses a variety of other short-term and long-term funding sources. Short-term funding sources mainly include securities sold under agreements to repurchase. Borrowing funding source limits are determined annually by each counterparty and depend on the Group’s financial condition and delivery of acceptable collateral securities. The Group may be required to provide additional collateral based on the fair value of the underlying securities. The Group also uses the FHLB as a funding source, issuing notes payable, such as advances, through its FHLB member subsidiary, the Bank. The FHLB requires the Group to maintain a minimum amount of qualifying collateral with a fair value of at least 110% of the outstanding advances. At September 30, 2005, the Group has an additional borrowing capacity with the FHLB of $32.6 million based on the collateral already pledge to FHLB. However, the Group’s total borrowing capacity of FHLB based on its capital contribution is up to $532 million.

The Bank also utilizes the National Certificate of Deposit (“CD”) Market as a source of cost effective brokered deposit funding in addition to local market deposit inflows. Depositors in this market consist of credit unions, banking institutions, CD brokers and some private corporations and non-profit organizations. The Bank’s ability to acquire brokered deposits can be restricted if it becomes in the future less than well-capitalized. An adequately-capitalized bank, by regulation, may not accept deposits from brokers unless it applies for and receives a waiver from the FDIC.

As of September 30, 2005, the Bank had line of credit agreements with other financial institutions permitting the Bank to borrow a maximum aggregate amount of $28.0 million. No borrowings were made during the quarter ended September 30, 2005 under such lines of credit. The agreements provide for unsecured advances to be used by the Bank on an overnight basis. Interest rates are negotiated at the time of the transactions. The credit agreements are renewable annually.

The Group’s liquidity targets are reviewed monthly by the ALCO Committee and are based on the Group’s commitments to make loans and purchase investments and its ability to generate funds.

The principal source of funding for the Group is dividends from the Bank. The ability of the Bank to pay dividends is restricted by regulatory authorities. The Group meets its cash obligations and pays dividends to its common and preferred stockholders primarily through such dividends. Management believes that the Group will continue to meet its cash obligations as they become due and pay dividends as they are declared.

Changes in statutes and regulations, including tax laws and rules

The Group, as a Puerto Rico-chartered financial holding company, and its subsidiaries, are each subject to extensive federal and local governmental supervision and regulation relating to its banking, securities and insurance business. The Group also benefits from favorable tax treatment under regulations relating to the activities of its international banking entities. In addition, there are laws and other regulations that restrict transactions between the Group and its subsidiaries. Any change in such tax or other regulations, whether by applicable regulators or as a result of legislation subsequently enacted by the Congress of the United States or the Legislature of Puerto Rico, could have an affect on the Group’s results of operations and financial condition.

Puerto Rico international banking entities, or IBE’s, are currently exempt from taxation under Puerto Rico law. The IBE Act, as amended, imposes income taxes at normal statutory rates on each IBE that operates as a unit of a bank, if the IBE’s net income exceeds 20 percent of the bank’s net income in taxable years commencing on July 1, 2005, and thereafter. It does not impose income taxation on an IBE that operates as a subsidiary of a bank.

The Group has an IBE that operates as a unit of the Bank. In November 2003, the Group organized a new IBE that operates as a subsidiary of the Bank. The Bank transferred as of January 1, 2004, substantially all of the Bank’s IBE assets to the new IBE subsidiary. Although this transfer of IBE assets allows the Group to continue enjoying tax benefits, there cannot be any assurance that the IBE Act will not be modified in the future in a manner to reduce the tax benefits available to the new IBE subsidiary.

On August 1, 2005 the Puerto Rico Legislature approved Act No. 41 “Act for the Educational Future of the Puerto Rican Children.” This law imposes an additional tax of 2.5% on taxable net income. This law is applicable to all corporations and partnerships with a taxable net income over $20,000, according to part (a) of Section 1015 of the Puerto Rico Internal Revenue Code of 1994. The law will be effective for tax years beginning after December 31, 2004 and ending on or before December 31, 2006. Although the effectiveness of this law is subject to the final approval of the Legislature’s Joint Resolution Number 445, concerning the General Budget of the 2005-2006 fiscal year, which Joint Resolution was vetoed by the Governor, the Puerto Rico Treasury Department has taken the position that the law is in effect.

- 49 -

On October 20, 2005, the Puerto Rico Legislature approved a new tax bill. This bill imposes an additional tax of 1% on the net taxable income of banks. This bill will be applicable to all corporations mentioned or covered under the Act No. 55 of May 12, 1933, known as “The Banking Law of Puerto Rico,” as amended. The additional funds expected to be obtained from this tax will be assigned to the Department of Education of Puerto Rico. The additional tax, if it is finally approved by the Governor of Puerto Rico, will be effective for the tax years commencing after June 30, 2005 and ending on or before December 31, 2006.

Item 4. CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

As of the end of the period covered by this quarterly report on Form 10-Q, an evaluation was carried out under the supervision and with the participation of the Group’s management, including the Chief Executive Officer (“CEO”) and the Chief Financial Officer (“CFO”), of the effectiveness of the design and operation of the Group’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act). Based upon such evaluation, the CEO and the CFO have concluded that, as of the end of such period, the Group’s disclosure controls and procedures are effective in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by the Group in the reports that it files or submits under the Exchange Act.

Internal Control over Financial Reporting

There have not been any changes in the Group’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the quarter ended September 30, 2005 that has materially affected, or is reasonably likely to materially affect, the Group’s internal control over financial reporting.

PART — II OTHER INFORMATION

Item 1. LEGAL PROCEEDINGS

On August 14, 1998, as a result of a review of its accounts in connection with the admission by a former Group officer of having embezzled funds, and manipulated bank accounts and records, the Group became aware of certain irregularities. The Group notified the appropriate regulatory authorities and commenced an intensive investigation with the assistance of forensic accountants, fraud experts and legal counsel. The investigation determined losses of $9.6 million ($5.8 net of tax) resulting from dishonest and fraudulent acts and omissions involving several former Group employees, which were submitted to the Group’s fidelity insurance policy (the “Policy”) issued by Federal Insurance Company, Inc. (“FIC”). In the opinion of the Group’s management, its legal counsel and experts, the losses determined by the investigation were covered by the Policy. However, FIC denied all claims for such losses. On August 11, 2000, the Group filed a lawsuit in the United States District Court for the District of Puerto Rico against FIC, a stock insurance corporation organized under the laws of the State of Indiana, for breach of insurance contract, breach of covenant of good faith and fair dealing and damages, seeking payment of the Group’s $9.6 million insurance claim loss and the payment of consequential damages of no less than $13.0 million resulting from FIC capricious, arbitrary, fraudulent and without cause denial of the Group’s claim. The losses resulting from such dishonest and fraudulent acts and omissions were expensed in prior years. On October 3, 2005, a jury rendered a verdict of $7,531,859 in favor of the Group and against FIC, the defendant. The jury granted the Group $453,219 for fraud and loss documentation in connection with its Accounts Receivable Returned Checks Account; it could not reach a decision on the Group’s claim for $3,442,450 in connection with fraud in its Cash Accounts, thus forcing a new trial on this issue. The jury denied the Group’s claim for $5,600,000 in connection with fraud in the Mortgage Loans Account, but the jury determined that FIC had acted in bad faith and with “dolo”. It, therefore, awarded the Group $7,078,640 in consequential damages. The court decided not to enter a final judgment for the aforementioned awards until after a new trial on the fraud in the Cash Accounts claim. After a final judgment is entered the parties would be allowed to exhaust their post-judgment and appellate rights. The Group expects to be able to request prejudgment interest, costs, fees and expenses related to its prosecution of this case.

In addition, the Group and its subsidiaries are defendants in a number of legal proceedings incidental to their business. The Group is vigorously contesting such claims. Based upon a review by legal counsel and the development of these matters to date, management is of the opinion that the ultimate aggregate liability, if any, resulting from these claims will not have a material adverse effect on the Group’s financial condition or results of operations.”

- 50 -

Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

	a)		None

	b)		Not applicable

	c)		Purchases of equity securities by the issuer and affiliated purchasers The following table sets forth issuer purchases of equity securities made by the Group during the three-month period ended September 30, 2005:


	(a)		(b)		(c)		(d)
							Maximum Number
							(or Approximate
					Total Number of		Dollar Value) of
					Shares (or Units)		Shares (or Units)
	Total Number of				Purchased as Part of		that May Yet Be
	Shares (or units)		Average Price Paid		Publicly Announced		Purchased Under the
Period	Purchased		per Share (or Unit)		Plans or Programs		Plans or Programs
From July 1, 2005 to July 31, 2005		—		—		—		—
From August 1, 2005 to August 31, 2005		200,000	$	14.01		200,000		11,900,000
From September 1, 2005 to September 30, 2005		145,000	$	13.75		145,000		11,755,000
Total		345,000	$	13.92		345,000		11,755,000

Item 3. DEFAULTS UPON SENIOR SECURITIES

None

Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS

None

Item 5. OTHER INFORMATION

a) None

b) None

Item 6. EXHIBITS


31.1		Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2		Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1		Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2		Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

- 51 -

Signatures

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

ORIENTAL FINANCIAL GROUP INC.
(Registrant)


By:	/s/ José Rafael Fernández	Dated: November 9, 2005
José Rafael Fernández
President and Chief Executive Officer

By:	/s/ Héctor Méndez	Dated: November 9, 2005
Hector Mendez
Senior Executive Vice President,
Treasurer and Chief Financial Officer

- 52 -


	Volume		Rate			Total


C. Changes in net interest income due to (3):
Interest Income:
Investments	$	5,439	$	(1,502	)	$	3,937
Loans (1)		2,143		(214	)		1,929

		7,582		(1,716	)		5,866


Interest Expense:
Deposits	$	2,639		432			3,071
Repurchase agreements		1,465		6,859			8,324
Other borrowings		75		721			796

		4,179		8,012			12,191


Net Interest Income	$	3,403	$	(9,728	)	$	(6,325	)


*		Certain adjustments were made to conform figures to current period presentation.

(1)		- Loans fees amounted to $494, and $950 in fiscal 2005 and 2004, respectively.

(2)		- Real estate loans averages include loans held-for-sale.

(3)		- The changes that are not due solely to volume or rate are allocated on the proportion of the change in each category.

OFG Bancorp - 10-Q quarterly report FY

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	Interest									Average rate									Average balance
							Variance									Variance									Variance
	2005			2004			in %			2005			2004			in BP			2005			2004			in %

A — TAX EQUIVALENT SPREAD

Interest-earning assets	$	50,813		$	44,947			13.1	%		4.82	%		5.01	%		(19	)	$	4,216,584		$	3,588,468			17.5	%
Tax equivalent adjustment		10,779			10,071			7.0	%		1.02	%		1.12	%		(10	)		—			—			0.0	%

Interest-earning assets — tax equivalent		61,592			55,018			12.0	%		5.84	%		6.13	%		(29	)		4,216,584			3,588,468			17.5	%
Interest-bearing liabilities		33,485			21,294			57.3	%		3.40	%		2.55	%		85			3,934,446			3,342,608			17.7	%

Tax equivalent net interest income / spread	$	28,107		$	33,724			-16.7	%		2.44	%		3.58	%		(114	)	$	282,138		$	245,860			14.8	%

Tax equivalent interest rate margin											2.66	%		3.76	%		(110	)


B — NORMAL SPREAD

Interest-earning assets:
Investments:
Investment securities	$	35,299		$	32,055			10.1	%		4.37	%		4.62	%		(25	)	$	3,233,196		$	2,777,381			16.4	%
Investment management fees		(382	)		(465	)		-17.9	%		-0.05	%		-0.07	%		(2	)		—			—			0.0	%

Total investment securities		34,917			31,590			10.5	%		4.32	%		4.55	%		(23	)		3,233,196			2,777,381			16.4	%
Trading securities		3			2			50.0	%		4.30	%		2.86	%		144			279			280			-0.4	%
Money market investments		675			66			922.7	%		4.13	%		1.19	%		294			65,298			22,116			195.3	%

		35,595			31,658			12.4	%		4.32	%		4.52	%		(20	)		3,298,773			2,799,777			17.8	%


Loans:
Mortgage (1) (2)		12,247			11,322			8.2	%		6.43	%		6.68	%		(25	)		761,547			678,460			12.2	%
Commercial		2,189			1,458			50.1	%		6.97	%		6.44	%		53			125,562			90,596			38.6	%
Consumer		782			509			53.6	%		10.19	%		10.37	%		(18	)		30,702			19,635			56.4	%

		15,218			13,289			14.5	%		6.63	%		6.74	%		(11	)		917,811			788,691			16.4	%


		50,813			44,947			13.1	%		4.82	%		5.01	%		(19	)		4,216,584			3,588,468			17.5	%

Interest-bearing liabilities:
Deposits:
Non-interest bearing deposits		—			—			—			—			—			—			59,654			49,702			20.0	%
Now Accounts		227			211			7.6	%		1.06	%		1.05	%		1			86,001			80,404			7.0	%
Savings		226			231			-2.2	%		1.02	%		1.03	%		(1	)		88,659			89,956			-1.4	%
Certificates of Deposit		9,136			6,076			50.4	%		3.56	%		3.08	%		48			1,025,914			789,280			30.0	%

		9,589			6,518			47.1	%		3.04	%		2.58	%		46			1,260,228			1,009,342			24.9	%

Borrowings:
Repurchase agreements		20,128			7,264			177.1	%		3.55	%		1.50	%		205			2,266,148			1,935,574			17.1	%
Interest rate risk management		(169	)		4,402			-103.8	%		-0.03	%		0.91	%		(94	)		—			—			0.0	%
Financing fees		173			142			21.8	%		0.03	%		0.03	%		0			—			—			0.0	%

Total repurchase agreements		20,132			11,808			70.5	%		3.55	%		2.44	%		111			2,266,148			1,935,574			17.1	%
FHLB advances		2,322			1,997			16.3	%		3.01	%		2.57	%		44			308,640			310,526			-0.6	%
Subordinated capital notes		1,213			917			32.3	%		6.72	%		5.08	%		164			72,166			72,166			0.0	%
Term Notes		123			54			127.8	%		3.28	%		1.44	%		184			15,000			15,000			0.0	%
Other borrowings		106			—						3.46	%		—			346			12,264			—			100.0	%

		23,896			14,776			61.7	%		3.57	%		2.53	%		104			2,674,218			2,333,266			14.6	%


		33,485			21,294			57.3	%		3.40	%		2.55	%		85			3,934,446			3,342,608			17.7	%


Net interest income / spread	$	17,328		$	23,653			-26.7	%		1.42	%		2.46	%		(104	)


Interest rate margin											1.64	%		2.64	%		(100	)


Excess of average interest-earning assets over average interest-bearing liabilities																			$	282,138		$	245,860			14.8	%


Average interest-earning assets over average interest-bearing liabilities ratio																				107.17	%		107.36	%