SBP Santander Bancorp (Holding CO)

 

 

UNITED STATES OF AMERICA SECURITIES AND EXCHANGE COMMISSION

Washington, D.C., 20549

FORM 10-Q

þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OF THE SECURITIES EXCHANGE ACT OF 1934

Registrant’s telephone number, including area code:
(787) 777-4100

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 a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o       Accelerated filer þ      Non-accelerated filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

Indicate the number of shares outstanding of each of the Registrant’s classes of common stock as of the last practicable date.

Securities registered pursuant to Section 12(b) of the Securities Exchange Act of 1934:

Title of each class		Outstanding as of September 30, 2007
Common Stock, $2.50 par value		46,639,104

 

 

SANTANDER BANCORP

CONTENTS

		Page No.
Part I: Financial Information
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets			1
Condensed Consolidated Statements of Operations			2
Condensed Consolidated Statements of Changes in Stockholders’ Equity			3
Condensed Consolidated Statements of Comprehensive (Loss) Income			4
Condensed Consolidated Statements of Cash Flows			5
Notes to Condensed Consolidated Financial Statements			7
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			28
Item 3. Quantitative and Qualitative Disclosures About Market Risk			54
Item 4. Controls and Procedures			59
Part II: Other Information
Item 1. Legal Proceedings			60
Item 1A. Risk Factors			60
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			61
Item 3. Defaults Upon Senior Securities			61
Item 4. Submission of Matters to a Vote of Security Holders			61
Item 5. Other Information			61
Item 6. Exhibits			62
Signatures			64
EX-12 COMPUTATION OF RATIO OF EARNINGS
EX-31.1 SECTION 302 CERTIFICATION OF THE CEO
EX-31.2 SECTION 302 CERTIFICATION OF THE COO
EX-31.3 SECTION 302 CERTIFICATION OF THE CAO
EX-32.1 SECTION 906 CERTIFICATION OF THE CEO, COO AND CAO

Forward-Looking Statements . When used in this Form 10-Q or future filings by Santander BanCorp (the “Corporation”) with the Securities and Exchange Commission, in the Corporation’s press releases or other public or shareholder communications, or in oral statements made with the approval of an authorized executive officer, the word or phrases “would be”, “will allow”, “intends to”, “will likely result”, “are expected to”, “will continue”, “is anticipated”, “estimate”, “project”, “believe”, 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 Corporation 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 Corporation’s assumptions, the actual results could vary significantly from the performance projected in the forward-looking statements.

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

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

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

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

(Concluded)

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

SANTANDER BANCORP AND SUBSIDIARIES

          The Corporation maintains effective control over assets sold under agreements to repurchase; accordingly, such securities continue to be carried on the consolidated balance sheets.

Investment Securitie s

     Investment securities are classified in four categories and accounted for as follows:

	•		Debt securities that the Corporation has the intent and ability to hold to maturity are classified as securities held to maturity and reported at cost adjusted for premium amortization and discount accretion. The Corporation may not sell or transfer held-to-maturity securities without calling into question its intent to hold other securities to maturity, unless a nonrecurring or unusual event that could not have been reasonably anticipated has occurred.
	•		Debt and equity securities that are bought and held principally for the purpose of selling them in the near term are classified as trading securities and reported at fair value, with unrealized gains and losses included results of operations. Financial instruments including, to a limited extent, derivatives, such as option contracts, are used by the Corporation in dealing and other trading activities and are carried at fair value. Interest revenue and expense arising from trading instruments are included in the consolidated statements of operations as part of net interest income.
	•		Debt and equity securities not classified as either securities held to maturity or trading securities, and which have a readily available fair value, are classified as securities available for sale and reported at fair value, with unrealized gains and losses reported, net of taxes, in accumulated other comprehensive income (loss). The specific identification method is used to determine realized gains and losses on sales of securities available for sale, which are included in gain (loss) on sale of investment securities in the consolidated statements of operations.
	•		Investments in debt, equity or other securities, that do not have readily determinable fair values, are classified as other investment securities in the consolidated balance sheets. These securities are stated at cost. Stock that is owned by the Corporation to comply with regulatory requirements, such as Federal Home Loan Bank (FHLB) stock, is included in this category.

          The amortization of premiums is deducted and the accretion of discounts is added to net interest income based on a method which approximates the interest method over the outstanding life of the related securities. The cost of securities sold is determined by specific identification. For securities available for sale, held to maturity and other investment securities, the Corporation reports separately in the consolidated statements of operations, net realized gains or losses on sales of investment securities and unrealized loss valuation adjustments considered other than temporary, if any.

Derivative Financial Instruments

          The Corporation uses derivative financial instruments mostly as hedges of interest rate risk, changes in fair value of assets and liabilities and to secure future cash flows.

          All of the Corporation’s 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 results of operations along with the change in value of the designated hedged item. If the hedge relationship is terminated, hedge accounting is discontinued and any balance related to the derivative is recognized in current operations, and the fair value adjustment to the hedged item continues to be reported as part of the basis of the item and is amortized to earnings as a yield adjustment. 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. If the hedge relationship is terminated, the net derivative gain or loss related to the discontinued cash flow hedge should continue to be reported in accumulated other comprehensive income (loss) and would be reclassified into earnings when the cash flows that were hedged occur, or when the forecasted transaction affects earnings or is no longer expected to occur. In either a fair value hedge or a cash flow hedge, net earnings may be impacted to the extent the changes in the value of the derivative instruments do not perfectly offset changes in the value 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 results of operations.

          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 is bifurcated, carried at fair value, and designated as a trading or non-hedging derivative instrument.

Loans Held for Sale

          Loans held for sale are recorded at the lower of cost or fair value computed on the aggregate portfolio basis. The amount, by which cost exceeds fair value, if any, is accounted for as a valuation allowance with changes included in the determination of results of operations for the period in which the change occurs.

Loans

          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 the allowance for loan losses, unearned finance charges and any deferred fees or costs on originated loans.

          Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and amortized using methods that approximate the interest method over the term of the loans as an adjustment to interest yield. Discounts and premiums on purchased loans are amortized to results of operations over the expected lives of the loans using methods that approximate the interest method.

          The accrual of interest on commercial loans, construction loans, lease financing and closed-end consumer loans is discontinued when, in management’s opinion, the borrower may be unable to meet payments as they become due, but in no event is it recognized after 90 days in arrears on payments of principal or interest. Interest on mortgage loans is not recognized after four months in arrears on payments of principal or interest. Income is generally recognized on open-end (revolving credit) consumer loans until the loans are charged off. When interest accrual is discontinued, unpaid interest is reversed on all closed-end portfolios. Interest income is subsequently recognized only to the extent that it is received. The non accrual status is discontinued when loans are made current by the borrower.

          The Corporation leases vehicles and equipment to individual and corporate customers. The finance method of accounting is used to recognize revenue on lease contracts that meet the criteria specified in Statement of Financial Accounting Standards (“SFAS”) No. 13, “Accounting for Leases,” as amended. Aggregate rentals due over the term of the leases less unearned income are included in lease receivable, which is part of “Loans, net” in the consolidated balance sheets. Unearned income is amortized to results of operations over the lease term so as to yield a constant rate of return on the principal amounts outstanding. Lease origination fees and costs are deferred and amortized over the average life of the portfolio as an adjustment to yield.

Off-Balance Sheet Instruments

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

          Fees received for providing loan commitments and letters of credit that result in loans are typically deferred and amortized to interest income over the life of the related loan, beginning with the initial borrowing. Fees on commitments and letters of credit are amortized to other income as banking fees and commissions over the commitment period when funding is not expected.

Allowance for Loan Losses

          The allowance for loan losses is a current estimate of the losses inherent in the present portfolio based on management’s ongoing quarterly evaluations of the loan portfolio. Estimates of losses inherent in the loan portfolio involve the exercise of judgment and the use of assumptions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. The allowance is increased by a provision for loan losses, which is charged to expense and reduced by charge-offs, net of recoveries. Changes in the allowance relating to impaired loans are charged or credited to the provision for loan losses. Because of uncertainties inherent in the estimation process, management’s estimate of credit losses in the loan portfolio and the related allowance may change in the near term.

          The Corporation follows a systematic methodology to establish and evaluate the adequacy of the allowance for loan losses. This methodology consists of several key elements.

          Larger commercial, construction loans and certain mortgage loans that exhibit potential or observed credit weaknesses are subject to individual review. 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 Corporation.

          Included in the review of individual loans are those that are impaired as defined by GAAP. Any allowances for loans deemed impaired are measured based on the present value of expected future cash flows discounted at the loans’ effective interest rate or on the fair value of the underlying collateral if the loan is collateral dependent. Commercial business, commercial real estate, construction and mortgage loans exceeding a predetermined monetary threshold are individually evaluated for impairment. Other loans are evaluated in homogeneous groups and collectively evaluated for impairment. Loans that are recorded at fair value or at the lower of cost or fair value are not evaluated for impairment. Impaired loans for which the discounted cash flows, collateral value or fair value exceeds its carrying value do not require an allowance. The Corporation evaluates the collectibility of both principal and interest when assessing the need for loss accrual.

          Historical loss rates are applied to other commercial loans not subject to individual review. The loss rates are derived from historical loss trends.

          Homogeneous loans, such as consumer installments, credit cards, residential mortgage loans and consumer finance are not individually risk graded. Allowances are established for each pool of loans based on the expected net charge-offs for one year. Loss rates are based on the average net charge-off history by loan category, market loss trends and other relevant economic factors.

          An unallocated allowance is maintained to recognize the imprecision in estimating and measuring loss when evaluating allowances for individual loans or pools of loans.

          Historical loss rates for commercial and consumer loans may also be adjusted for significant factors that, in management’s judgment, reflect the impact of any current condition on loss recognition. Factors which management considers in the analysis include the effect of the national and local economies, trends in the nature and volume of loans (delinquencies, charge-offs, non-accrual and problem loans), changes in the internal lending policies and credit standards, collection practices, and examination results from bank regulatory agencies and the Corporation’s internal credit examiners.

          Allowances on individual loans and historical loss rates are reviewed quarterly and adjusted as necessary based on changing borrower and/or collateral conditions and actual collection and charge-off experience.

Transfers and Servicing of Financial Assets and Extinguishments of Liabilities

          Transfers of financial assets are accounted for as sales, when control over the transferred assets is deemed to be surrendered: (1) the assets have been isolated from the Corporation, (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 Corporation does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity. The Corporation 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.

          In April 2007, the Bank transferred its merchant business to a subsidiary, MBPR Services, Inc. (“MBPR”). The Bank subsequently sold the stock of MBPR to an unrelated third party. For an interim period that ended October 30, 2007, the Bank provided certain processing and other services to the third party acquirer. The gain on the transaction of $12.3 million was recognized in the fourth quarter of 2007. As part of the transaction, the Bank entered into a long-term marketing alliance agreement with the third party and will serve as its sponsor with the card associations and network organizations. The Bank expects to offer better products and services to its merchant client base and to obtain certain cost efficiencies as a result of this transaction.

Goodwill and Intangible Assets

          The Corporation accounts for goodwill in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets.” The reporting units are tested for impairment annually as of September 30, 2007 to determine whether their carrying value exceeds their fair market value. Should this be the case, the value of goodwill or indefinite-lived intangibles may be impaired

and written down. Goodwill and other indefinite lived intangible assets are also tested for impairment on an interim basis if an event occurs or circumstances change between annual tests that would more likely than not reduce the fair value of the reporting unit below its carrying amount. If there is a determination that the fair value of the goodwill or other identifiable intangible asset is less than the carrying value, an impairment loss is recognized in an amount equal to the difference. Impairment losses, if any, are reflected in operating expenses in the consolidated statement of operations.

          In accordance with SFAS No. 144 “Accounting for the Impairment or Disposal of Long-Lived Assets”, the Corporation reviews finite-lived intangible assets for impairment whenever an event occurs or circumstances change which indicates that the carrying amount of such assets may not be fully recoverable. Determination of recoverability is based on the estimate of undiscounted future cash flows resulting from the use of the asset and its eventual disposition. Measurement of an impairment loss is based on the fair value of the asset compared to its carrying value. If the fair value of the asset is determined to be less that the carrying value, an impairment loss is incurred in the amount equal to the difference. Impairment losses, if any, are reflected in operation expenses in the consolidated statements of operations.

          The Corporation uses judgment in assessing goodwill and intangible assets for impairment. Estimates of fair value are based on projections of revenues, operating costs and cash flows of each reporting unit considering historical and anticipated future results, general economic and market conditions as well as the impact of planned business or operational strategies. The valuations employ a combination of present value techniques to measure fair value and consider market factors. Generally, the Corporation engages third party specialists to assist with its valuations. Additionally, judgment is used in determining the useful lives of finite-lived intangible assets. Changes in judgments and projections could result in a significantly different estimate of the fair value of the reporting units and could result in an impairment of goodwill.

          As a result of the purchase price allocations from prior acquisitions and the Corporation’s decentralized structure, goodwill is included in multiple reporting units. Due to certain factors such as the highly competitive environment, cyclical nature of the business in some of the reporting units, general economic and market conditions as well as planned business or operational strategies, among others, the profitability of the Corporation’s individual reporting units may periodically suffer from downturns in these factors. These factors may have a relatively more pronounced impact on the individual reporting units as compared to the Corporation as a whole and might adversely affect the fair value of the reporting units. If material adverse conditions occur that impact the Corporation’s reporting units, the Corporation’s reporting units, and the related goodwill would need to be written down to an amount considered recoverable.

          As a result of the current unfavorable economic environment in Puerto Rico, SFS’s short-term financial performance and profitability have declined significantly during 2007, caused by reduced lending activity and increases in nonperforming assets and charge-offs. The Corporation decided to perform the impairment test of the goodwill and other intangibles of SFS as of July 1, 2007, a quarter in advance of the scheduled annual impairment test. The Corporation completed the first step of the impairment test and determined that the carrying amount of the goodwill and other intangibles assets of SFS exceeds its fair value, thereby requiring performance of the second step of the impairment test to calculate the amount of the impairment. The Corporation, with the assistance of an independent valuation firm, has begun the second step of the impairment test and expects the resulting valuation report to be completed during the fourth quarter of 2007. However, because an impairment loss is probable and can be reasonably estimated, the Corporation has, in accordance with SFAS No. 142, recorded preliminary estimated non-cash impairment charges of approximately $34.3 million and $5.4 million, which have been recorded as reductions to goodwill and trade name, respectively. The estimated impairment charges were calculated based on market and income approach valuation methodologies. The Corporation may change these estimates during the fourth quarter of 2007, as necessary, upon the completion of the valuation report, which will include additional procedures for determining the fair value of SFS’s assets and liabilities.

          In conjunction with the impairment test mentioned in the previous paragraph, the Corporation also conducted an impairment test of its intangible assets with definite lives associated with its consumer finance business in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”. The Corporation reviews finite-lived intangible assets for impairment whenever an event occurs or circumstances change which indicates that the carrying amount of such assets may not be fully recoverable. The determination of recoverability is based on an estimate of undiscounted future cash flows resulting from the use of the assets and their eventual disposition. The Corporation determined, based on this test, that undiscounted future cash flows from the use of the assets and their eventual disposition exceeded their current carrying amount and, thus, an impairment was not required as of September 30, 2007. Consequently, no impairment losses on intangible assets with definite lives were recorded in operating expenses in the consolidated statement of operations as of September 30, 2007.

          Upon completion of the interim impairment test, the Corporation plans to conduct an update of its annual impairment test as of September 30, 2007 for the consumer finance business intangibles with the assistance of an independent valuation specialist.

          The Corporation will conduct a goodwill valuation for all other segments during the fourth quarter of 2007 and any impairment loss that may result would be recognized as of December 31, 2007.

Mortgage-servicing Rights

          The Corporation’s mortgage-servicing rights (“MSRs”) are stated at the lower of carrying value or fair value at each balance sheet date. On a quarterly basis the Corporation evaluates its MSRs for impairment and charges any such impairment to current period results of operations. In order to evaluate its MSRs the Corporation stratifies the related mortgage loans on the basis of their risk characteristics, which have been determined to be: type of loan (government-guaranteed, conventional, conforming and non-conforming), interest rates and maturities. Impairment of MSRs is recognized through a valuation allowance and is determined by estimating the fair value of each stratum and comparing it to its carrying value. No impairment loss was recognized for the nine months ended September 30, 2007. An impairment loss of $51,000 was recognized for the year ended December 31, 2006.

          MSRs are also subject to periodic amortization. The amortization of MSRs is based on the amount and timing of estimated cash flows to be recovered with respect to the MSRs over their expected lives. Amortization may be accelerated or decelerated to the extent that changes in interest rates or prepayment rates warrant.

Mortgage Banking

          Mortgage loan servicing includes collecting monthly mortgagor payments, forwarding payments and related accounting reports to investors, collecting escrow deposits for the payment of mortgagor property taxes and insurance, and paying taxes and insurance from escrow funds when due. No asset or liability is recorded by the Corporation for mortgages serviced (except for mortgage-servicing rights arising from the sale of mortgages), advances to investors and escrow balances.

          The Corporation recognizes as a separate asset the right to service mortgage loans for others whenever those servicing rights are acquired. The Corporation acquires MSRs by purchasing or originating loans and selling or securitizing those loans (with the servicing rights retained) and allocates the total cost of the mortgage loans sold to the MSRs (included in intangible assets in the accompanying consolidated balance sheets) and the loans based on their relative fair values. Further, mortgage-servicing rights are periodically assessed for impairment based on the fair value of those rights. MSRs are amortized over the estimated life of the related servicing income. Mortgage loan-servicing fees, which are based on a percentage of the principal balances of the mortgages serviced, are credited to income as mortgage payments are collected.

Trust Services

          In connection with its trust activities, the Corporation administers and is custodian of assets amounting to approximately $1,191,000,000 and $3,718,000,000 at September 30, 2007 and December 31, 2006, respectively. Due to the nature of trust activities, these assets are not included in the Corporation’s consolidated balance sheets. In December 2006, the Corporation sold to an unaffiliated third party the servicing rights with respect to the following trust accounts: personal trust, customer employee benefit plans, guardianship accounts, insurance trust, escrow accounts and securities custody accounts. No gain or loss was recognized on this transaction on December 2006. For the third quarter of 2007, a gain of $382,000 was recognized as a result of the transfer of trust accounts. For a period not to exceed ten months after the closing date of the sale, the Corporation will transfer to the purchaser the trust accounts (amounting to approximately $156 million at September 30, 2007), subject to the customer’s consent and related servicing in a timely and orderly manner. Fees collected during the transfer period shall be allocated between both entities on a pro rata basis. Since December 31, 2006, the Corporation’s Trust Division is focusing its efforts on transfer and paying agent and IRA account services.

          While the assets and operations of the Trust Division of the Corporation meet the definition of “discontinued operations,” as defined in SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” the Corporation has not segregated the Division’s assets and results of operation, as the amounts are immaterial. Results of operations (net of

taxes) were approximately $461,000 for the nine months ended September 30, 2007 and $908,000 for the year ended December 31, 2006.

Broker-dealer and Asset Management Commissions

          Commissions of the Corporation’s broker-dealer operations are composed of brokerage commission income and expenses recorded on a trade date basis and proprietary securities transactions recorded on a trade date basis. Investment banking revenues include gains, losses and fees net of syndicate expenses, arising from securities offerings in which the Corporation acts as an underwriter or agent. Investment banking management fees are recorded on offering date, sales concessions on trade date, and underwriting fees at the time the underwriting is completed and the income is reasonably determinable. Revenues from portfolio and other management and advisory fees include fees and advisory charges resulting from the asset management of certain funds and are recognized over the period when services are rendered.

Insurance Commissions

          The Corporation’s insurance agency operation earns commissions on the sale of insurance policies issued by unaffiliated insurance companies to the Corporation’s customers. Commission revenue is reported net of the provision for commission returns on insurance policy cancellations, which is based on management’s estimate of future insurance policy cancellations as a result of historical turnover rates by types of credit facilities subject to insurance.

Income Taxes

          The Corporation uses the asset and liability balance sheet method for the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in the Corporation’s financial statements or tax returns. Deferred income tax assets and liabilities are determined for differences between financial statement and tax bases of assets and liabilities that will result in taxable or deductible amounts in the future. The computation is based on enacted tax laws and rates applicable to periods in which the temporary differences are expected to be recovered or settled. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount that is more likely than not to be realized.

Earnings Per Common Share

          Basic and diluted earnings per common share are computed by dividing net income available to common shareholders, by the weighted average number of common shares outstanding during the period. The Corporation’s average number of common shares outstanding, used in the computation of earnings per common share was 46,639,104 for each of the quarters ended September 30, 2007 and 2006, respectively. Basic and diluted earnings per common share are the same since no stock options or other potentially dilutive common shares were outstanding during the quarters ended September 30, 2007 and 2006.

Recent Accounting Pronouncements that Affect the Corporation

The adoption of the following accounting pronouncements did not have a material impact on the Corporation’s results of operations and financial condition:

•

FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes ” (“FIN 48”).  In July 2006, the FASB issued FIN 48, “Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109” , which clarifies the accounting for uncertainty in tax positions. This Interpretation requires that the Corporation recognize in the financial statements, the impact of a tax position, if that position is more likely than not of being sustained on audit, based on the technical merits of the position. In evaluating the more-likely-than-not recognition threshold, a Corporation should presume the tax position will be subject to examination by a taxing authority with full knowledge of all relevant information. The provisions of FIN 48 were effective on January 1, 2007 and resulted in a reduction of retained earnings of $524,000.

          The Corporation is evaluating the impact that the following recently issued accounting pronouncements may have on its financial condition and results of operations.

•

SFAS No. 157, “Fair Value Measurements.” In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements,” which provides enhanced guidance for using fair value to measure assets and liabilities. SFAS No. 157 establishes a common definition of fair value, provides a framework for measuring fair value under U.S. GAAP

and expands disclosure requirements about fair value measurements. SFAS No. 157 is effective for financial statements issued in fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The Corporation is currently evaluating the impact, if any, the adoption of SFAS No. 157 will have on the Corporation’s financial reporting and disclosures.

•

SFAS No. 159, “Fair Value Option for Financial Assets and Financial Liabilities- an amendment of FASB Statements No. 115.” In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities,” which permits entities to choose to measure many financial instruments and certain other items at fair value. The objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. This statement is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. Early adoption is permitted as of the beginning of a fiscal year that begins on or before November 15, 2007, provided the entity also elects to apply the provisions of FASB Statement No. 157, Fair Value Measurements. The Corporation is currently evaluating the impact, if any, the adoption of SFAS No. 159 will have on the Corporation’s financial reporting and disclosures.

2. Investment Securities Available for Sale:

     The amortized cost, gross unrealized gains and losses, fair value and weighted average yield of investment securities available for sale by contractual maturity are as follows:

     The duration of long-term (over one year) investment securities in the available portfolio is approximately 2.8 years at September 30, 2007, comprised of approximately 1.5 years for treasuries and agencies of the United States Government, 4.7 years for instruments from the Commonwealth of Puerto Rico and its subdivisions, 4.5 years for mortgage backed securities and 1.4 years for all other securities.

     The number of positions, fair value and unrealized losses at September 30, 2007, of investment securities available for sale that have been in a continuous unrealized loss position for less than twelve months and for twelve months or more, are as follows:

     The Corporation evaluates its investment securities for other-than-temporary impairment on a quarterly basis or earlier if other factors indicative of potential impairment exist. An impairment charge in the consolidated statements of income is recognized when the decline in the fair value of the securities below their cost basis is judged to be other-than-temporary. The Corporation 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, expectation of recoverability of its original investment in the securities and the Corporation’s intent and ability to hold the securities for a period of time sufficient to allow for any forecasted recovery of fair value up to (or beyond) the cost of the investment.

     As of September 30, 2007, management concluded that there was no other-than-temporary impairment in its investment securities portfolio. The unrealized losses in the Corporation’s investments in U.S. and P.R. Government agencies and subdivisions were caused by changes in market interest rates. Substantially all of these securities are rated the equivalent of AAA by major rating agencies. The contractual terms of these investments do not permit the issuer to settle the securities at a price less than the amortized cost of the investment. Since the Corporation has the ability and intent to hold these investments until a recovery of fair value, which may be maturity, the Corporation does not consider these investments to be other-than-temporarily impaired at September 30, 2007. The unrealized losses in the Corporation’s investment in mortgage-backed securities were also caused by changes in market interest rates. The Corporation purchased these investments at a discount relative to their face amount, and the contractual cash flows of these investments are guaranteed by an agency of the U.S. government or by other government-sponsored corporations. Accordingly, it is expected that the securities will not be settled at a price less than the amortized cost of the Corporation’s investment. The decline in market value is attributable to changes in interest rates and not credit quality and since the Corporation has the ability and intent to hold these investments until a recovery of fair value, which may be maturity, the Corporation does not consider these investments to be other-than-temporarily impaired at September 30, 2007.

     Contractual maturities on certain securities, including mortgage-backed securities, could differ from actual maturities since certain issuers have the right to call or prepay these securities.

     The weighted average yield on investment securities available for sale is based on amortized cost, therefore it does not give effect to changes in fair value.

3. Loans:

     The Corporation’s loan portfolio consists of the following:

4. Allowance for Loan Losses:

     Changes in the allowance for loan losses are summarized as follows:

5. Goodwill and Other Intangible Assets:

Goodwill

     Goodwill and intangible assets with an indefinite life are tested for impairment at least annually using a two step process at each reporting unit.

     The first step of the goodwill impairment test is used to identify potential impairment by comparing the fair value of the reporting unit with its carrying amount, including goodwill. If the fair value of the reporting unit exceeds its carrying amount, the goodwill of the reporting unit is not considered impaired and the second step of the impairment test is not performed. If the carrying value of the reporting unit exceeds its fair value, the second step in the impairment test consists of comparing the implied fair value of the reporting unit goodwill with the carrying amount of that goodwill. The Corporation uses the market multiple, the discounted cash flows and comparable transaction approaches to determine the fair value of each reporting unit.

     The Corporation has assigned goodwill to reporting units at the time of acquisition. Goodwill is allocated to the Commercial Banking segment, the Wealth Management segment and the Consumer Finance segment as follows:

     Goodwill assigned to the Commercial Banking segment is related to the acquisition of Banco Central Hispano Puerto Rico in 1996, the goodwill assigned to the Wealth Management segment is related to the acquisition of Merrill Lynch’s retail brokerage business in Puerto Rico by Santander Securities Corporation in 2000 and goodwill assigned to the Consumer Finance segment is related to the acquisition of Island Finance in 2006. Based on management’s assessment of the value of the Corporation’s goodwill which includes an independent valuation, among others, management determined that the Corporation’s goodwill and other intangibles assets related to the consumer finance segment was impaired for the nine month period ended September 30, 2007.

     As a result of the current unfavorable economic environment in Puerto Rico, SFS’s short-term financial performance and profitability have declined significantly during 2007, caused by reduced lending activity and increases in nonperforming assets and charge-offs. The Corporation decided to perform the impairment test of the goodwill and other intangibles of SFS as of July 1, 2007, a quarter in advance of the scheduled annual impairment test. The Corporation completed the first step of the impairment test and determined that the carrying amount of the goodwill and other intangibles assets of SFS exceeds its fair value, thereby requiring performance of the second step of the impairment test to calculate the amount of the impairment. The Corporation, with the assistance of an independent valuation firm, has begun the second step of the impairment test and expects the resulting valuation report to be completed during the fourth quarter of 2007. However, because an impairment loss is probable and can be reasonably estimated, the Corporation has, in accordance with SFAS No. 142, recorded preliminary estimated non-cash impairment charges of approximately $34.3 million and $5.4 million, which have been recorded as reductions to goodwill and trade name, respectively. The estimated impairment charges were calculated based on market and income approach valuation methodologies. The Corporation may change these estimates during the fourth quarter of 2007, as necessary, upon the completion of the valuation report, which will include additional procedures for determining the fair value of SFS’s assets and liabilities.

     Upon completion of the interim impairment test, the Corporation plans to conduct an update of its annual impairment test as of September 30, 2007 for its consumer finance business intangibles with the

assistance of an independent valuation specialist.

     The Corporation will conduct a goodwill valuation for all other segments during the fourth quarter of 2007 and any impairment loss that may result would be recognized as of December 31, 2007.

Other Intangible Assets

     Other intangible assets at September 30, 2007 and December 31, 2006 were as follows:

     Mortgage-servicing rights arise from the right to serve mortgages sold and have an estimated useful life of eight years. The advisory-servicing rights are related to the Corporation’s subsidiary acquisition of the right to serve as the investment advisor for the First Puerto Rico Tax-Exempt Fund, Inc. acquired in 2002 and for First Puerto Rico Growth and Income Fund Inc. and First Puerto Rico Daily Liquidity Fund Inc. acquired in December 2006. This intangible asset is being amortized over a 10-year estimated useful life. Trade name is related to the acquisition of Island Finance and has an indefinite useful life and is therefore not being amortized but is tested for impairment at least annually. Customer relationships and non-compete agreements are intangible assets related to the acquisition of Island Finance and are being amortized over their estimated useful lives of 10 years and 3 years, respectively. These intangible assets are also tested for impairment on an interim basis. If the Corporation determines the fair value of the other identifiable intangible asset is less than the carrying value, an impairment loss is recognized in an amount equal to the differences.

     As previously mentioned, the Corporation conducted an impairment test as of July 1, 2007 of SFS’s intangible assets with indefinite lives in accordance with the provisions of SFAS No. 142, “Goodwill and Other Intangible Assets” and recorded and impairment charge on its trade name asset of $5.4 million as of September 30, 2007. In addition, the Corporation reviews finite-lived intangible assets for impairment whenever an event occurs or circumstances change which indicates that the carrying amount of such assets may not be fully recoverable. The determination of recoverability is based on an estimate of undiscounted future cash flows resulting from the use of the assets and their eventual disposition. The Corporation determined, based on this test, that undiscounted future cash flows from the use of the assets and their eventual disposition exceeded their current carrying amount and, thus, an impairment was not required as of September 30, 2007. Consequently, no impairment losses on intangible assets with definite lives were recorded in operating expenses in the consolidated statement of operations as of September 30, 2007.

     Upon completion of the interim impairment test, the Corporation plans to conduct an update of its annual impairment test as of September 30, 2007 for its consumer finance business with the assistance of an independent valuation specialist.

6 . Other Assets:

     Other assets at September 30, 2007 and December 31, 2006 consist of the following:

7. Other Borrowings:

     Following are summaries of borrowings as of and for the periods indicated:

     Federal funds purchased and other borrowings, securities sold under agreements to repurchase and commercial paper issued mature as follows: