OFG Bancorp - 10-Q quarterly report FY

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

Quarterly Report Pursuant to Section 13 or 15(d) of the

Securities Exchange Act of 1934

For the Quarter Ended March 31, 2002

Commission File No. 001-12647

Oriental Financial Group Inc.

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

15,244,576 common shares ($1.00 par value per share)

outstanding as of March 31, 2002

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     ý        No    o.

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TABLE OF CONTENTS

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PART 1 - FINANCIAL INFORMATION

Item 1 - Financial Statements

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

MARCH 31, 2002 AND JUNE 30, 2001

(In thousands, except shares information)

The accompanying notes are an integral part of these consolidated financial statements.

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CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

FOR THE QUARTER AND NINE-MONTH PERIODS ENDED MARCH 31, 2002 AND 2001

(In thousands, except shares information)

The accompanying notes are an integral part of these consolidated financial statements.

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CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (UNAUDITED)

FOR THE NINE-MONTH PERIODS ENDED MARCH 31, 2002 AND 2001

(In thousands)

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME  (UNAUDITED)

FOR THE QUARTER AND NINE-MONTH PERIODS ENDED MARCH 31, 2002 AND 2001

(In thousands)

The accompanying notes are an integral part of these consolidated financial statements.

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CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

FOR THE NINE-MONTH PERIODS ENDED MARCH 31, 2002 AND 2001

(In thousands)

The accompanying notes are an integral part of these consolidated financial statements.

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NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

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 (which consist of normal recurring accruals) necessary, to present fairly the consolidated financial condition as of March 31, 2002 and June 30, 2001, and the results of operations and cash flows for the quarter and nine-month periods ended March 31, 2002 and 2001. All significant intercompany balances and transactions have been eliminated in the accompanying unaudited condensed 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, 2001 has been derived from the Group’s audited Consolidated Financial Statements. The results of operations and cash flows for the nine-month periods ended March 31, 2002 and 2001 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, 2001, included in the Group’s Annual Report on Form 10-K.

Certain reclassifications have been made to prior periods financial statements to conform to the current period presentation.

The following is a description of the Group’s most significant accounting policies:

Nature of Operations

Oriental is a bank holding company incorporated under the laws of the Commonwealth of Puerto Rico. It has four subsidiaries, Oriental Bank and Trust (the “Bank”), Oriental Financial Services Corp. (“Oriental Financial Services”), FISA Insurance Agency, Inc., and Oriental Financial Group, Inc. Statutory Trust I (the “Trust”, see Note 5). Through these subsidiaries, 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 services. Note 8 to the consolidated financial statements presents further information about the operations of the Group’s business segments.

Main offices for the Group and its subsidiaries are located in San Juan, Puerto Rico. The Bank operates through twenty branches located throughout the island and is subject to the supervision, examination and regulation of the Federal Reserve Bank, 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). Oriental Financial Services is subject to the supervision, examination and regulation of the National Association of Securities Dealers, the Securities and Exchange Commission, and the Office of the Commissioner of Financial Institutions of Puerto Rico.

NOTE 2 - INVESTMENTS AND SECURITIES:

The Group’s 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. There were no held-to-maturity securities as of March 31, 2002 and June 30, 2001. Securities that might be sold prior to maturity because of interest rate changes, to meet liquidity needs, or to better match the reprising 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 deferred taxes, 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 term.  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 net interest income rather than in the trading profit or loss account. The Group’s investment in the Federal Home Loan Bank (FHLB) of New York has no readily determinable fair value and can only be sold to the FHLB at par value. Therefore, this investment is carried at cost and its redemption value represents its fair value.

Premiums and discounts are amortized to interest income over the life of the related securities using the interest method.  Net realized gains or losses on sales of investment securities and unrealized 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 statement of income.  The cost of securities is determined using the specific identification method.

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Trading Securities

A summary of trading securities owned by the Group at March 31, 2002 and June 30, 2001 is as follows:

At March 31, 2002, the Group’s trading portfolio weighted average yield was 6.46% (June 30, 2001 — 7.92%).

Investment securities available-for-sale

The amortized cost, gross unrealized gains and losses, fair value, and weighted average yield of the investment securities available-for-sale owned by the Group at March 31, 2002 and June 30, 2001, were as follows:

The amortized cost and fair value of the Group’s investment securities available-for-sale at March 31, 2002, 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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Proceeds from the sale of investment securities available-for-sale during the first nine months of fiscal 2002 totaled $282,860,864 (Fiscal 2001 - $329,815,000). Gross realized gains and losses on those sales during the first nine months of fiscal 2002 were $6,014,029 and $2,723,059, respectively, (Fiscal 2001 – $3,772,000 and $5,597,000 respectively).

NOTE 3 - LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES:

Loans Receivable

The Group’s business activity is with consumers located in Puerto Rico.  Oriental’s loan transactions are encompassed within three main categories: mortgage, commercial, and consumer. Oriental’s loan portfolio has a higher concentration of loans to consumers such as residential mortgage loans and personal loans.  The composition of the Group’s loan portfolio at March 31, 2002 and June 30, 2001 was as follows:

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.  Oriental’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.

While management uses available information in estimating probable loan losses, future additions to the allowance may be necessary based on factors beyond Oriental’s control, such as factors affecting Puerto Rico economic conditions. 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 quarter and nine-month periods ended March 31, 2002 and 2001.

The Group evaluates all loans, some individually and other as homogeneous groups, for purposes of determining impairment. At March   31, 2002 and June 30, 2001, the Group determined that no impairment allowance was necessary.

NOTE 4 - PLEDGED ASSETS:

At March 31, 2002, residential mortgage loans and investment securities available for sale amounting to $308,764,320 and  $1,571,123,917, respectively, were pledged to secure public fund deposits, investment securities sold under agreements to repurchase, letters of credit, advances and borrowings from the Federal Home Loan Bank of New York, term notes and interest rate swap agreements.

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NOTE 5 - SUBORDINATED CAPITAL NOTES

In October 2001, Oriental Financial Group, Inc. Statutory Trust I, a wholly owned special purpose subsidiary of Oriental, was formed for the purpose of issuing company-obligated securities. On December 18, 2001, $35 million of trust redeemable preferred securities were issued by the Trust as part of a pooled underwriting transaction. Pooled underwriting involves participating with other bank-holding companies in issuing the securities through a special purpose pooling vehicle created by the underwriters. The securities have a par value of $35 million, bear interest based on 3 months LIBOR plus 360 basis points (5.74% at March 31, 2002) (provided, however, that prior to December 18, 2006, this interest rate shall not exceed 12.5%), payable quarterly, and mature on December 23, 2031. The securities may be called at par after five years. The proceeds from this issuance were used to purchase a like amount of floating rate junior subordinated deferrable interest debentures issued by Oriental, which have the same maturity and call provisions as the redeemable capital securities.

These company-obligated securities of the subsidiary grantor trust (trust preferred securities) are accounted for as a liability on the consolidated statements of financial condition. Dividends on the trust preferred securities are accounted for as an interest expense on an accrual basis. These debts are treated as Tier-1 capital for regulatory purposes.

NOTE 6 - DERIVATIVES AND HEDGING ACTIVITIES

The Group uses interest rate swaps and caps as an interest rate risk hedging mechanism.  Under the swaps, the Group pays a fixed annual cost and receives a floating ninety-day payment based on LIBOR.  Floating rate payments received from the swap counterparty correspond to the floating rate payments made on the borrowings thus resulting in a net fixed rate cost to the Group (Cash flows hedging instruments).  Under the caps, Oriental pays an up front premium or fee for the right to receive cash flow payments in excess of the predetermined cap rate; thus, effectively capping its interest rate cost for the duration of the agreement.  The Group’s swaps and caps outstanding and their terms at March 31, 2002 and June 30, 2001 are set forth in the table below:

The agreements were signed to convert short-term borrowings into fixed rate liabilities for longer periods of time and provide protection against increases in interest rates.  The amounts potentially subject to credit loss are the net streams of payments under the agreements and not the notional principal amounts used to express the volume of the swaps.  The Group controls the credit risk of its interest rate swap agreements through approvals, limits, monitoring procedures and collateral, where considered necessary.  The Group does not anticipate nonperformance by the counterparties.

The Bank offers its customers certificates of deposit tied to the performance of one of the following stock market indexes, Standard & Poor’s 500 Composite Stock Index, Dow Jones Industrial Average and Russell 2000 Small Stock Index. At the end of five years, the depositor will receive a specified percent of the average increase of the month-end value of the corresponding stock index.  If such index decreases, the depositor receives the principal without any interest. The Group uses option agreements with major money center banks to manage its exposure to the stock market.  Under the terms of the agreements, the Group will receive the average increase in the month-end value of the corresponding index in exchange for a fixed premium.  At March 31, 2002, the notional amount of these agreements totaled $213,790,000 (June 30, 2001 — $180,950,000). Changes in fair value of options purchased and options embedded in certificates of deposit are recorded in earnings.

At March 31, 2002 and June 30, 2001, 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 equity indexed options represented an asset of $20.6 million ($27.0 million, June 2001) and the options sold to customers embedded in the certificates of deposits represented a liability of $25.2 million ($34.2 million, June 2001) recorded in deposits. The interest rate swaps represented a liability of $11.6 million ($10.3 million, June 2001) presented in “Accrued Expenses and Other Liabilities”. The Caps did not have a carrying value as of March 31, 2002 and June 30, 2001.

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NOTE 7 - STOCK DIVIDEND:

On January 29, 2002, the Group declared a ten percent (10%) stock dividend on common stock held by registered shareholders as of April 1, 2002. As a result, 1,249,125 shares of common stock were distributed on April 15, 2002. For purpose of the computation of income per common share, the dividend was retroactively recognized for all periods presented in the accompanying consolidated financial statements.

NOTE 8 - SEGMENT REPORTING:

The Group operates three major reportable segments: Financial Services, Mortgage Banking, and Retail Banking. Management determined 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 organizational chart, 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.

The Group’s largest business segment is retail banking.  The Bank’s branches and treasury functions are its main components, with traditional banking products such as deposit and electronic banking.

Oriental’s second largest business segment is the financial services, which is comprised of the Bank’s trust division (Oriental Trust), the brokerage subsidiary (Oriental Financial Services) and the insurance subsidiary (FISA Insurance Agency, Inc.). The core operations of this segment are financial planning, money management and investment brokerage services, investment banking, insurance sales activity, as well as corporate and individual trust services.

The Group’s other business segment is mortgage banking.  It consists of Oriental Mortgage, whose principal activity is to originate and purchase mortgage loans for the Group’s own portfolio, as well as sale of loans in the secondary market.

The accounting policies of the segments are the same as those described in the “Summary of Significant Accounting Policies” included in the Group Annual Report on Form 10-K. Following are the results of operations and the selected financial information by operating segment for each of the third quarter and nine-month periods ended March 31:

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NOTE 9 - RECENT ACCOUNTING DEVELOPMENTS

In August 2001, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS 144). SFAS 144 addresses financial accounting and reporting for the impairment or disposal of long-lived assets. This statement supersedes SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets to Be Disposed Of”, and the accounting and reporting provisions of APB Opinion No. 30, “Reporting the Results of Operations-Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions”. SFAS 144 will become effective on July 1, 2002, and is not expected to have a material effect on the Oriental’s consolidated financial statements.

On April 30, 2002, the FASB issued SFAS No. 145, “Rescission of FASB Statements No. 4, 44 and 64, Amendment of SFAS No. 13, and Technical Corrections”(“SFAS 145”). SFAS 145 rescinds SFAS 4, “Reporting Gains and Losses from  extinguishment of Debt–an amendment of APB Opinion No. 30”, which required all gains and losses from extinguishment of debt to be aggregated and, if material, classified as extraordinary item, net of related income tax effect. As a result, the criteria in Opinion No. 30 will now be used to classify those gains and losses.

SFAS 145 also amends SFAS 13, “Accounting for Leases”, to require that certain lease modifications that have economics effects similar to sale–leaseback transactions be accounted for in the same manner as sale-leaseback transactions. SFAS 145 is not expected to have significant effect on the Group’s consolidated financial condition or result of operations.

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Item 2 - Management’s Discussion and Analysis of Financial Condition

and Results of Operations

Table of Contents