UNITED STATES 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 Quarterly Period Ended September 30, 2009

Commission File Number 001-16799

W HOLDING COMPANY, INC.

(Exact name of Registrant as Specified in its Charter)


Commonwealth of Puerto Rico (State or Other Jurisdiction of Incorporation or Organization)		66-0573197 (I.R.S. Employer Identification Number)

19 West McKinley Street
Mayagüez, Puerto Rico 00680
(Address of Principal Executive Offices) (Zip Code)

(787) 834-8000
(Registrant’s Telephone Number Including Area Code)

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 l934 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 o NO þ

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 229.405 of this chapter) during the preceeding 12 months (or for such shorter period that the registrant was required to submit and post such files). YES o NO o

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


Large Accelerated Filer o		Accelerated Filer o		Non-Accelerated Filer þ (Do not check if a smaller reporting company)		Smaller Reporting Company o

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Common stock: 3,297,815 outstanding as of November 30, 2009.

W HOLDING COMPANY, INC. AND SUBSIDIARIES

CONTENTS


	Page
PART I FINANCIAL INFORMATION:

Item 1. Financial Statements (Unaudited)		1

Condensed Consolidated Statements of Financial Condition as of September 30, 2009 and December 31, 2008		1

Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2009 and 2008		2

Condensed Consolidated Statements of Changes in Stockholders’ Equity and Condensed Consolidated Statements of Comprehensive Income (Loss) for the Nine Months Ended September 30, 2009 and 2008		3

Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2009 and 2008		4

Notes to Condensed Consolidated Financial Statements		6

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		61

Item 3. Quantitative and Qualitative Disclosures About Market Risk		111

Item 4T. Controls and Procedures		111

PART II OTHER INFORMATION:

Item 1. Legal Proceedings		113

Item 1A. Risk Factors		113

Item 6. Exhibits		114

SIGNATURES		115
EX-31.1
EX-31.2
EX-32.1
EX-32.2

Forward-Looking Information

Certain statements in this Quarterly Report on Form 10-Q, especially within Management’s Discussion and Analysis of Financial Condition and Results of Operations, include forward-looking statements within the meaning of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). In general, the word or phrases “may”, “should”, “will”, “expect”, “anticipate”, “estimate”, “project”, “intend”, “continue”, “believe” or similar expressions are intended to identify forward-looking statements. In addition, certain disclosures and information customarily provided by financial institutions, such as analysis of the adequacy of the allowance for loan losses or an analysis of the interest rate sensitivity of the Company’s assets and liabilities, are inherently based upon predictions of future events and circumstances. Although the Company makes such statements based on assumptions which it believes to be reasonable, there can be no assurance that actual results will not differ materially from the Company’s expectations. Important factors which could cause its results to differ from any results which might be projected, forecasted or estimated, based on such forward-looking statements include, but are not limited to: (i) general economic and competitive conditions in the markets in which the Company operates, and the risks inherent in its operations; (ii) the Company’s ability to manage its credit risk and control its operating expenses, increase interest-earning assets and non-interest income, and maintain its net interest margin; (iii) fluctuations in interest rate and inflation; and (iv) the level of demand for new and existing products. Investors should refer to the Company’s Annual Report on Form 10-K for the year ended December 31, 2008 as well as Item 1A of Part II of this Quarterly Report on Form 10-Q for a discussion of such factors and certain risks and uncertainties to which the Company is subject. Should one or more of these risks or uncertainties materialize, other risks or uncertainties arise, or should underlying assumptions prove incorrect, actual results may vary materially from those described in the forward-looking statements. Except as required by applicable law, the Company does not intend, and specifically disclaims any obligation, to update forward-looking statements.

Part I. Financial Information

Item 1. Financial Statements

W HOLDING COMPANY, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (UNAUDITED)

(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)


	September 30,			December 31,
	2009			2008
ASSETS
Cash and due from banks	$	52,484		$	68,368
Money market instruments:
Federal funds sold		49,008			—
Interest-bearing deposits in banks		417,709			1,096,465
Investment securities available for sale, at fair value with an amortized cost of $2,504,839 in 2009 and $3,713,645 in 2008		2,533,849			3,670,241
Investment securities held to maturity, at amortized cost with a fair value of $563,710 in 2009 and $1,020,837 in 2008		575,251			1,037,970
Securities sold but not yet delivered		624,501			—
Federal Home Loan Bank stock, at cost		52,252			64,190
Residential mortgage loans held for sale, at lower of cost or fair value		46,681			18,871
Loans, net of allowance for loan losses of $225,502 in 2009 and $282,089 in 2008		8,482,884			8,667,717
Accrued interest receivable		42,344			56,224
Foreclosed real estate held for sale, net of allowance of $4,045 in 2009 and $3,104 in 2008		119,308			98,570
Other real estate held for sale, net		—			5,462
Premises and equipment, net		128,837			120,796
Deferred income taxes, net		144,724			155,661
Other assets		219,785			222,362

TOTAL	$	13,489,617		$	15,282,897


LIABILITIES AND STOCKHOLDERS’ EQUITY
LIABILITIES:
Deposits:
Noninterest-bearing	$	295,989		$	250,380
Interest-bearing and related accrued interest payable, includes $14,482 in 2009 and $109,944 in 2008 of deposits measured at fair value		9,073,811			10,751,793

Total deposits		9,369,800			11,002,173
Repurchase agreements		2,657,725			3,204,142
Advances from Federal Home Loan Bank		392,000			42,000
Mortgage note payable		—			34,932
Advances from borrowers for taxes and insurance		10,096			11,759
Accrued expenses and other liabilities		77,871			72,524

Total liabilities		12,507,492			14,367,530


COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS’ EQUITY:
Preferred stock — $1.00 par value per share (liquidation preference — $530,838 in 2009 and 2008); authorized 50,000,000 shares; issued and outstanding 18,156,709 shares in 2009 and 2008		18,157			18,157
Common stock — $1.00 par value per share; authorized 500,000,000 shares; issued and outstanding 3,297,815 shares in 2009 and 3,298,138 shares in 2008		3,298			3,298
Paid-in capital		870,679			870,450
Retained earnings:
Reserve fund		79,070			78,389
Accumulated losses		(13,298	)		(13,939	)
Accumulated other comprehensive income (loss), net of income tax		24,219			(40,988	)

Total stockholders’ equity		982,125			915,367

TOTAL	$	13,489,617		$	15,282,897

See notes to condensed consolidated financial statements.

W HOLDING COMPANY, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)


	Three Months Ended					Nine Months Ended
	September 30,					September 30,
	2009		2008			2009		2008
INTEREST INCOME:
Loans, including loan fees	$	111,785	$	141,897		$	347,296	$	440,485
Investment securities		1,680		19,596			6,892		88,624
Mortgage-backed securities		37,317		37,639			106,423		78,609
Money market instruments		1,175		4,513			3,427		17,420

Total interest income		151,957		203,645			464,038		625,138

INTEREST EXPENSE:
Deposits		83,611		112,536			281,238		342,363
Federal funds purchased and repurchase agreements		20,890		52,051			77,968		165,548
Advances from Federal Home Loan Bank		1,074		630			2,317		2,351

Total interest expense		105,575		165,217			361,523		510,262

NET INTEREST INCOME		46,382		38,428			102,515		114,876
PROVISION FOR LOAN LOSSES		12,366		15,382			32,345		44,685

NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES		34,016		23,046			70,170		70,191

NONINTEREST INCOME:
Service and other charges on loans		1,934		2,549			6,467		7,751
Service charges on deposit accounts		2,159		2,851			6,691		8,903
Other fees and commissions		4,506		5,504			14,583		16,993
Net gain on derivative instruments and deposits measured at fair value		664		1,622			1,410		2,844
Net gain (loss) on sales and valuation of loans held for sale, securities, and other assets		30,072		(2,655	)		67,353		11,674

Total noninterest income		39,335		9,871			96,504		48,165

NONINTEREST EXPENSES:
Salaries and employees’ benefits		14,157		17,064			42,801		49,926
Equipment		3,354		3,337			9,486		10,136
Deposits insurance premium and supervisory examination		12,218		3,957			40,785		10,578
Occupancy		2,431		2,601			6,736		7,903
Advertising		1,604		1,650			5,289		5,943
Printing, postage, stationery and supplies		971		976			2,727		3,168
Telephone		663		784			1,976		2,364
Net loss from operations of foreclosed real estate held for sale		974		107			1,508		216
Municipal taxes		2,862		2,726			8,386		7,510
Professional fees		4,443		5,848			11,892		13,943
Provision for claim receivable		—		485			—		485
Other		10,451		6,531			21,707		20,679

Total noninterest expenses		54,128		46,066			153,293		132,851

INCOME (LOSS) BEFORE PROVISION (CREDIT) FOR INCOME TAXES		19,223		(13,149	)		13,381		(14,495	)
PROVISION (CREDIT) FOR INCOME TAXES		7,886		(2,070	)		6,758		(37,126	)

NET INCOME (LOSS)		11,337		(11,079	)		6,623		22,631
LESS DIVIDENDS TO PREFERRED STOCKHOLDERS		—		9,228			4,614		27,684

INCOME (LOSS) ATTRIBUTABLE TO COMMON STOCKHOLDERS	$	11,337	$	(20,307	)	$	2,009	$	(5,053	)

BASIC EARNINGS (LOSS) PER COMMON SHARE	$	3.44	$	(6.16	)	$	0.61	$	(1.53	)

DILUTED EARNINGS (LOSS) PER COMMON SHARE	$	3.40	$	(6.16	)	$	0.61	$	(1.53	)

See notes to condensed consolidated financial statements.

W HOLDING COMPANY, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

AND CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (UNAUDITED)

(IN THOUSANDS)


	Nine Months Ended
	September 30,
	2009			2008
Changes in Stockholders’ Equity:
Preferred stock:
Balance at beginning of year	$	18,157		$	18,157

Balance at end of period		18,157			18,157


Common stock:
Balance at beginning of year		3,298			3,298

Balance at end of period		3,298			3,298


Paid-in capital:
Balance at beginning of year		870,450			870,128
Stock-based compensation expense		229			231

Balance at end of period		870,679			870,359


Reserve fund:
Balance at beginning of year		78,389			78,389
Transfer from undivided profits		681			2,645

Balance at end of period		79,070			81,034


Undivided profits (accumulated losses):
Balance at beginning of year		(13,939	)		31,383
Cumulative impact of change in accounting for financial assets and liabilities at fair value (SFAS No. 159 - See Note 1)		—			5,283


Balance at beginning of year — as adjusted		(13,939	)		36,666
Net income		6,623			22,631
Cash dividends on common stock		(687	)		(6,182	)
Cash dividends on preferred stock		(4,614	)		(27,684	)
Transfer to reserve fund		(681	)		(2,645	)

Balance at end of period		(13,298	)		22,786


Accumulated other comprehensive income (loss), net of income tax:
Balance at beginning of year		(40,988	)		(5,119	)
Other comprehensive income (loss)		65,207			(113,382	)

Balance at end of period		24,219			(118,501	)


Total Stockholders’ Equity	$	982,125		$	877,133


Comprehensive Income (Loss):
Net income	$	6,623		$	22,631

Other comprehensive income (loss):
Unrealized net gains (losses) on securities available for sale:
Unrealized gains (losses) arising during the period		138,251			(124,361	)
Reclassification adjustment for losses (gains) included in net income (loss)		(65,837	)		53

		72,414			(124,308	)

Unrealized net gains on cash flow hedge derivatives — (fixed — price sale contracts):
Unrealized losses arising during the period		(1,760	)		—
Reclassification adjustment for losses (gains) included in net income (loss)		—			—

		(1,760	)		—

Sub-total		70,654			(124,308	)

Income tax effect		(5,447	)		10,926

Other comprehensive income (loss)		65,207			(113,382	)

Total Comprehensive Income (Loss)	$	71,830		$	(90,751	)

See notes to condensed consolidated financial statements.

W HOLDING COMPANY, INC. AND SUBISIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(IN THOUSANDS)


	Nine Months Ended
	September 30,
	2009			2008
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	6,623		$	22,631
Adjustments to reconcile net income to net cash used in operating activities:
Provision (credit) for:
Loan losses		32,345			44,685
Unfunded loan commitments		89			—
Claim receivable		—			485
Deferred income tax		5,490			(4,762	)
Foreclosed real estate held for sale		941			63
Depreciation and amortization of:
Premises and equipment		7,043			7,437
Mortgage servicing rights		276			208
Stock-based compensation expense		229			231
Amortization of premium (discount)-net, on:
Investment securities available for sale		6,559			(1,072	)
Investment securities held to maturity		195			(15,875	)
Mortgage-backed securities held to maturity		528			33
Loans		14			18
Amortization of discount on deposits		1,771			2,039
Amortization of net deferred loan origination fees		(6,684	)		(6,281	)
Net loss (gain) on sale and in valuation of:
Investment securities available for sale		(65,837	)		53
Called investment securities held to maturity		—			2,814
Mortgage loans held for sale		(836	)		(627	)
Derivative instruments		(253	)		(2,801	)
Deposits measured at fair value		(694	)		3,266
Foreclosed real estate held for sale		229			(238	)
Other real estate held for sale		(671	)		(13,746	)
Loans		—			261
Premises and equipment		(8	)		(31	)
Other assets		—			(2,299	)
Capitalization of servicing rights		(443	)		(461	)
Originations of mortgage loans held for sale		(62,130	)		(41,175	)
Proceeds from sales of mortgage loans held for sale		35,156			32,363
Decrease (increase) in:
Trading securities		—			4,184
Accrued interest receivable		13,880			32,476
Other assets		(3,245	)		(11,258	)
Increase (decrease) in:
Accrued interest on deposits and borrowings		(72,685	)		(41,788	)
Other liabilities		10,532			(35,607	)

Net cash used in operating activities		(91,586	)		(24,774	)

CASH FLOWS FROM INVESTING ACTIVITIES:
Net decrease (increase) in interest-bearing deposits in banks		678,756			(111,586	)
Net increase in federal funds sold and resell agreements		(49,008	)		(287,200	)
Cancellation of resell agreements over three months		—			547,800
Investment securities available for sale:
Maturities, prepayments and calls		472,494			1,157,864
Proceeds from sales		2,522,338			98,343
Purchases		(2,351,249	)		(4,670,210	)
Investment securities held to maturity:
Maturities, prepayments and calls		372,595			37,175,008
Purchases		—			(33,282,682	)
Mortgage-backed securities held to maturity:
Maturities, prepayments and calls		89,402			6,786
Loans:
Sales		—			12,783
Loan principal collections, net of originations		133,118			209,958
Purchases of derivative options		(2,204	)		(507	)
Proceeds from derivative instruments		4,822			9,124
Cash received on terminated swaps		404			—
Proceeds from sales of foreclosed real estate held for sale		4,128			906
Proceeds from sales of other real estate held for sale		1,875			19,675
Additions to premises and equipment		(10,142	)		(10,262	)
Proceeds from sales of premises and equipment		8			31
Proceeds from sales of other assets		—			2,299
Purchases of Federal Home Loan Bank stock		(44,146	)		(50,740	)
Redemptions of Federal Home Loan Bank stock		56,084			30,604

Net cash provided by investing activities		1,879,275			857,994

Forward	$	1,787,689		$	833,220

See notes to condensed consolidated financial statements.

(Continued)

W HOLDING COMPANY, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(IN THOUSANDS)


	Nine Months Ended
	September 30,
	2009			2008
Forward	$	1,787,689		$	833,220


CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase (decrease) in deposits		(1,558,506	)		582,383
Net increase in federal funds purchased and repurchase agreements		9,583			413,250
Repurchase agreements with original maturities over three months:
Payments		—			(1,803,575	)
Cancellations		(556,000	)		—
Net increase (decrease) in advances from Federal Home Loan Bank		350,000			(60,000	)
Repayments of mortgage note payable		(34,932	)		(392	)
Cash paid on matured embedded derivatives		(4,529	)		(8,578	)
Net decrease in advances from borrowers for taxes and insurance		(1,663	)		(2,423	)
Dividends paid		(7,526	)		(35,791	)

Net cash used in financing activities		(1,803,573	)		(915,126	)


NET DECREASE IN CASH AND DUE FROM BANKS		(15,884	)		(81,906	)

CASH AND DUE FROM BANKS, BEGINNING OF YEAR		68,368			153,473


CASH AND DUE FROM BANKS, END OF PERIOD	$	52,484		$	71,567


SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest on deposits and other borrowings	$	420,426		$	536,991
Income taxes		864			12,300
Noncash activities (see Note 9):
Accrued dividends payable		—			2,225
Net change in other comprehensive income (loss)		65,207			(113,382	)
Securities sold but not yet delivered		624,501			—
Mortgage loans securitized and transferred to:
Trading securities		—			4,184
Transfer from :
Loans to foreclosed real estate held for sale		27,307			89,632
Premises and equipment to other real estate held for sale		—			12,181
Other real estate held for sale to premises and equipment		4,258			—
Undivided profits to reserve fund		681			2,645
Mortgage loans originated to finance the sale of foreclosed real estate held for sale		1,267			1,245
Unpaid additions to premises and equipment		821			226
Effect of derivative transactions:
Decrease in other assets		2,459			9,894
Decrease in deposits		(161	)		(3,891	)
Decrease in other liabilties		(3,245	)		(5,538	)

See notes to condensed consolidated financial statements.

(Concluded)

W HOLDING COMPANY, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

W Holding Company, Inc. (the “Company”) is a bank holding company offering a full range of financial services. The business of the Company is conducted through its wholly-owned commercial bank subsidiary, Westernbank Puerto Rico (“Westernbank” or the “Bank”). The Company was organized under the laws of the Commonwealth of Puerto Rico in February 1999 to become the bank holding company of Westernbank. Westernbank is a commercial bank chartered under the laws of the Commonwealth of Puerto Rico effective November 30, 1994. Originally, Westernbank was organized as a federally chartered mutual savings and loan association in 1958, and in January 1984 became a federal mutual savings bank. In February 1985, the savings bank was converted to the stock form of ownership. Westernbank offers a full range of business and consumer financial services, including banking, trust and brokerage services and placing insurances. On May 19, 2008, the Company contributed 100% of its ownership in Westernbank Insurance Corp. (“WIC”) to Westernbank. WIC is a general insurance agent placing property, casualty, life and disability insurances.

In July 2000, the Company became a financial holding company under the Bank Holding Company Act (“BHC Act”). As a financial holding company, the Company was permitted to engage in financial related activities, including insurance and securities activities, provided that the Company and its banking subsidiary met certain regulatory standards. On May 20, 2008, the Company withdrew its financial holding company status under the BHC Act. As a result, effective on such date the Company’s activities are limited to those deemed closely related to banking by the Board of Governors of the Federal Reserve System (the “FRB”).

Westernbank operates through a network of 48 bank branches (including 10 Expresso of Westernbank branches) located throughout Puerto Rico, including 25 in the Western and Southwestern regions, 14 in the San Juan metropolitan area, 7 in the Northeastern region, and 2 in the Eastern region, and a website on the Internet. On October 3, 2008, the Congress of the United States of America approved the Emergency Economic Stabilization Act of 2008, pursuant to which among other things, the amount of deposit insurance provided by the Federal Deposit Insurance Corporation (the “FDIC”) was temporarily increased from $100,000 to $250,000 per depositor until December 31, 2009. On May 20, 2009, President Barack Obama signed legislation that extended this temporary increase to $250,000 through December 31, 2013. Westernbank’s deposits, including Individual Retirement Accounts (“IRAs”), are insured by the Deposit Insurance Fund (“DIF”), which is administered by the FDIC, up to $250,000 per depositor.

Westernbank’s traditional banking operations include retail operations, such as its branches, including the branches of the Expresso division, together with consumer loans, mortgage loans, commercial loans (excluding the Asset-Based Lending Unit operations), investments (treasury) and deposit products. Besides the traditional banking operations, at September 30, 2009, Westernbank operates four other divisions:

	•		Westernbank International Division, which is an International Banking Entity (“IBE”) under the Puerto Rico Act No. 52 of August 11, 1989, as amended, known as the International Banking Center Regulatory Act, which offers commercial banking and related services, and treasury and investment activities outside of Puerto Rico;

	•		Westernbank Trust Division, which offers a full array of trust services;

	•		Expresso of Westernbank, a division which specializes in small, unsecured consumer loans up to $15,000 and real estate collateralized consumer loans up to $150,000;

	•		and Westernbank International Trade Services, established during the first quarter of year 2006, a division which specializes in international trade products and services.

In addition, Westernbank operates the Asset-Based Lending Unit, which specializes in commercial business loans secured principally by commercial real estate, accounts receivable, inventories and machinery and equipment.

Westernbank owns 100% of the voting shares of:

	•		Westernbank World Plaza, Inc. (“WWPI”), which owns and operates Westernbank World Plaza, a 23-story office building, including its related parking facility, located in Hato Rey, Puerto Rico, the main Puerto Rican business district.

	•		SRG Net, Inc., a Puerto Rico corporation that operates an electronic funds transfer network. The assets, liabilities, revenues and expenses of SRG Net, Inc. at September 30, 2009 and December 31, 2008, and for each of the three and nine months ended September 30, 2009 and 2008, were not significant.

	•		Westernbank Financial Center Corp (“WFCC”), which was incorporated under the laws of the State of Florida to conduct commercial lending and other related activities in the United States of America. WFCC commenced operations in February 2007, was largely inactive, and was closed during the third quarter of 2008. The assets, liabilities, revenues and expenses of WFCC as of and for the three and nine months ended September 30, 2008, were not significant.

	•		Westernbank Insurance Corp., a general insurance agent placing property, casualty, life and disability insurances. On May 19, 2008, the Company contributed 100% of its ownership in WIC to Westernbank. The assets, liabilities, revenues and expenses of WIC at September 30, 2009 and December 31, 2008, and for the three and nine months ended September 30, 2009 and 2008, were not significant.

The accounting and reporting policies of the Company conform to accounting principles generally accepted in the United States of America (“GAAP”) and banking industry practices. The accompanying unaudited Condensed Consolidated Financial Statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). The (unaudited) Consolidated Financial Statements have been prepared in conformity with the accounting policies stated in the Company’s Audited Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2008. In the opinion of management, the unaudited Condensed Consolidated Financial Statements include all adjustments (which consist of normal recurring accruals) necessary to present fairly the consolidated financial condition as of September 30, 2009 and December 31, 2008, the consolidated results of operations for the three and nine months ended September 30, 2009 and 2008, and the consolidated changes in stockholders’ equity, comprehensive income (loss), and cash flows for the nine months ended September 30, 2009 and 2008. All significant

intercompany balances and transactions have been eliminated in the accompanying unaudited condensed 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 SEC rules and regulations. Management believes that the disclosures made are adequate to make the information presented not misleading. Financial information as of December 31, 2008, has been derived from the audited Consolidated Financial Statements of the Company. The results of operations for the three and nine months ended September 30, 2009 and 2008, and cash flows for the nine months ended September 30, 2009 and 2008, are not necessarily indicative of the results to be expected for the full year. The accompanying unaudited condensed financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2008.

FASB Accounting Standards Codification

In June 2009, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2009-01, “Topic 105 — Generally Accepted Accounting Principles Amendments Based on Statement of Financial Accounting Standards No. 168 — The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles”. This Update amends the FASB Accounting Standards Codification (“ASC”) for the issuance of Statement No. 168, which establishes the Codification as the single source of authoritative U.S. GAAP recognized by the FASB to be applied by nongovernmental entities. Rules and interpretive releases of the SEC under authority of federal securities laws are also sources of authoritative U.S. GAAP for SEC registrants. ASU No. 2009-01 is effective for financial statements issued for interim and annual periods ending after September 15, 2009. The Company has incorporated the disclosure requirements of ASU No. 2009-01 by reference to the ASC in these Notes to the Company’s Condensed Consolidated Financial Statements.

Accounting Pronouncements Recently Adopted

In September 2006, the FASB issued authoritative guidance which defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements (the “Fair Value Guidance”). The Fair Value Guidance emphasizes that fair value is a market-based measurement and should be determined based on assumptions that a market participant would use when pricing an asset or liability. This guidance clarifies that market participant assumptions should include assumptions about risk as well as the effect of a restriction on the sale or use of an asset. Additionally, the Fair Value Guidance establishes a fair value hierarchy that provides the highest priority to quoted prices in active markets and the lowest priority to unobservable data. The adoption of this guidance on January 1, 2008 did not have a material impact on the Company’s consolidated financial position or results of operations. In February 2008, the FASB issued additional authoritative guidance which delayed the effective date of the Fair Value Guidance for non-financial assets and non-financial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually), to fiscal years beginning after November 15, 2008. The adoption of this guidance for non-financial assets and non-financial liabilities at January 1, 2008, did not have a material impact on the Company’s condensed consolidated financial position or results of operations.

In October 2008, the FASB issued authoritative guidance which clarifies the application of the Fair Value Guidance in a market that is not active and illustrates key considerations in determining the fair value. The guidance was effective upon issuance, including prior periods for which financial statements had not been issued. The adoption of this guidance did not have any impact on the Company’s condensed consolidated financial statements.

In February 2007, the FASB issued authoritative guidance which permits an entity to choose to measure certain financial instruments and certain other items at fair value on an instrument-by-instrument basis. Once an entity has elected to record eligible items at fair value, the decision is irrevocable and the entity should report unrealized gains and losses on items for which the fair value option has been elected in earnings. The guidance establishes presentation and disclosure requirements to help financial statement users understand the effect of the entity’s election on its earnings, but does not eliminate disclosure requirements of other accounting standards. Eligible items that are measured at fair value must be displayed on the face of the statements of financial condition. The Company adopted this guidance on January 1, 2008 and recorded a cumulative effect adjustment of $5.3 million that was credited to retained earnings and decreased deposits, other assets and deferred income tax asset by $12.9 million, $4.2 million and $3.4 million, respectively. See Note 17.

In March 2008, the FASB issued authoritative guidance which enhances required disclosures regarding derivatives and hedging activities, including enhanced disclosures regarding how: (a) an entity uses derivative instruments; (b) derivative instruments and related hedged items are accounted for under the existing guidance and its related interpretations, and (c) derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. This guidance is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. The Company early adopted the disclosure framework dictated by this guidance during 2008.

In April 2009, the FASB amended the existing guidance on the disclosure about fair values of financial instruments, which requires entities to disclose the method(s) and significant assumptions used to estimate the fair value of financial instruments, in both interim financial statements, as well as annual financial statements. This FSB guidance reiterates that fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. This guidance provides additional direction and utilizes a two-step process to determine whether there has been a significant decrease in the volume and level of activity for an asset or liability when compared with normal market activity for the asset or liability, and whether a transaction is not orderly. If it is determined that there has been a significant decrease in the volume and level of activity for the asset or liability in relation to normal market activity for the asset or liability, transactions or quoted prices may not be determinative of fair value. Accordingly, further analysis of the transactions or quoted prices is needed, and a significant adjustment to the transactions or quoted prices may be necessary to estimate fair. This guidance is effective for interim and annual reporting periods ending after June 15, 2009 on a prospective basis. Early adoption is permitted for periods ending after March 15, 2009. The adoption of this guidance did not have a material impact on the Company’s condensed consolidated financial statements.

In April 2009, the FASB issued authoritative guidance amending the recognition and measurement guidance related to other-than-temporary impairment (“OTTI”) for debt securities. This guidance requires that an OTTI shall be recognized in earnings if the Company intends to sell the security or more likely than not will be required to sell the security before recovery of its amortized cost basis. If the Company does not intend to sell the security, and it is not likely that the Company will be required to sell the security before recovery of its cost basis, the OTTI related to credit losses shall be recognized in earnings, and the OTTI related to all other factors shall be recorded in other comprehensive income (loss), net of applicable taxes. An entity shall recognize the cumulative effect of initially applying this guidance as an adjustment to the opening balance of retained earnings, net of applicable taxes, with a corresponding adjustment to accumulated other comprehensive income (loss). This guidance is effective for interim and annual reporting periods ending after June 15, 2009 and should be applied to existing and new investments held by an entity as of the beginning of the interim period in which it is adopted. The guidance also requires increased and more timely disclosures regarding expected cash flows, credit losses, and an aging of securities with unrealized losses. This guidance does not amend existing recognition and measurement guidance related to other-than-temporary impairments of equity securities. The guidance is effective for interim and annual reporting periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. The adoption of this guidance did not have a material impact on the Company’s condensed consolidated financial statements.

In April 2009, the FASB issued authoritative guidance which requires disclosures about fair value of financial instruments in interim financial statements as well as in annual financial statements. This guidance is effective for interim and annual reporting periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. This guidance does not require disclosures for earlier periods presented for comparative purposes at initial adoption. In periods after initial adoption, this guidance requires comparative disclosures only for periods ending subsequent to initial adoption. The Company adopted this guidance in the second quarter of 2009. See Note 17.

In May 2009, the FASB issued authoritative guidance which establishes the general standards of accounting for and disclosure of events that occur after the balance sheet date, but before financial statements are issued. This guidance reflects the principles underpinning previous subsequent event guidance in existing accounting literature and US Auditing Standards (AU) Section 560, “Subsequent Events,” therefore the Company’s adoption of this guidance should not result in significant changes in the subsequent events that the Company’s reports either through recognition or disclosure in the consolidated financial statements. This guidance requires the Company’s to disclose the date through which it has evaluated subsequent events, which for public entities, is the date the financial statements are issued. This guidance became effective for interim and annual reporting periods ending after June 15, 2009. The adoption of this guidance did not have any impact on the Company’s condensed consolidated financial statements.

In September 2009, the FASB updated the Codification to reflect SEC staff pronouncements on earnings-per-share calculations. According to the update, the SEC staff believes that when a public company redeems preferred shares, the difference between the fair value of the consideration transferred to the holders of the preferred stock and the carrying amount on the balance sheet after issuance costs of the preferred stock should be added to or subtracted from net income before doing an earnings-per-share calculation. The SEC’s staff also thinks it is not appropriate to aggregate preferred shares with different dividend yields when trying to determine

whether the “if-converted” method is dilutive to the earnings-per-share calculation. The guidance is effective for new share lending arrangements for interim and annual periods beginning on or after June 15, 2009. For existing arrangements, the guidance is effective for fiscal years beginning on or after December 15, 2009 and must be applied retrospectively for arrangements outstanding as of the effective date. The adoption of this guidance did not have a material impact on the Company’s condensed consolidated financial statements.

Accounting Pronouncements To Be Adopted

In June 2009, the FASB amended the existing guidance on the accounting for transfer of financial assets, which improves the relevance, representational faithfulness, and comparability of the information that a reporting entity provides in its financial statements about a transfer of financial assets; the effects of a transfer on its financial position, financial performance, and cash flows; and a transferor’s continuing involvement, if any, in transferred financial assets. This guidance removes the concept of a “qualifying special-purpose entity” (QSPE), changes the requirements for derecognizing financial assets, and requires additional disclosures about transfers of financial assets and a transferor’s continuing involvement in transferred financial assets. This Statement is effective for interim and annual periods beginning after November 15, 2009, with early adoption prohibited. The adoption of this guidance is not expected to have any effect on the Company’s condensed consolidated financial statements.

In June 2009, the FASB amended the methodology for determining the primary beneficiary (and therefore consolidator) of a variable interest entity (“VIE”) and will require such assessment to be performed on an ongoing basis. Under this new guidance, the primary beneficiary of a VIE is defined as the enterprise that has both (1) the power to direct activities of the VIE that most significantly impact the VIE’s economic performance, and (2) the obligation to absorb losses or receive benefits from the VIE that could potentially be significant to the VIE. These amendments affect all entities currently within the scope of ASC Topic 810 Consolidation Variable Interest Entities (previously FIN No. 46(R)), as well as qualifying special-purpose entities (“QSPEs”) that are currently excluded from the scope of previous existing guidance. This guidance will require a reporting entity to provide additional disclosures about its involvement with variable interest entities and any significant changes in risk exposure due to that involvement. A reporting entity will be required to disclose how its involvement with a variable interest entity affects the reporting entity’s financial statements. This guidance will be effective as of the beginning of the first fiscal year that begins after November 15, 2009. The adoption of this guidance is not expected to have any effect on the Company’s condensed consolidated financial statements.

In August 2009, the FASB updated the Codification in connection with the fair value measurement of liabilities to clarify that in circumstances in which a quoted price in an active market for the identical liability is not available, a reporting entity is required to measure fair value using either the quoted price of the identical liability when traded as an asset, quoted prices for similar liabilities or similar liabilities when traded as assets, or another valuation technique that is consistent with the principles of fair value measurement. Two examples would be an income approach, such as a present value technique, or a market approach, such as a technique that is based on the amount at the measurement date that the reporting entity would pay to transfer the identical liability or would receive to enter into the identical liability. The amendments in this update also clarifies that when estimating the fair value of a liability, a reporting entity is not required to include a separate input or adjustment to other inputs relating to the existence of a restriction that prevents the transfer of the liability. The amendments in this

update also clarifies that both a quoted price in an active market for the identical liability at the measurement date and the quoted price for the identical liability when traded as an asset in an active market, when no adjustment to the quoted price of the asset are required, are Level 1 fair value measurements. This update is effective for the first reporting period (including interim periods) beginning after its issuance. The adoption of this guidance in the fourth quarter of 2009 is not expected to have any impact on the Company’s condensed consolidated financial statements.

2. EARNINGS (LOSS) PER SHARE

In accordance with existing guidance, basic earnings per share is computed by dividing income (loss) attributable to common stockholders by the weighted-average number of common shares outstanding during the period. Diluted earnings per share is computed by dividing income (loss) attributable to common stockholders as adjusted to add back dividends on convertible preferred stock, by the weighted-average number of common and potentially dilutive common shares outstanding during the period. Potentially dilutive common shares represent assumed conversion of outstanding convertible preferred stock, which are determined using the if-converted method, and outstanding stock options, which are determined using the treasury stock method. The effect of convertible preferred stock (33,674 shares in the three and nine months ended September 30, 2009 and 2008, as adjusted to reflect the reverse stock split approved on November 7, 2008 and effective on December 1, 2008) was dilutive for the three months ended September 30, 2009 and antidilutive for the nine months ended September 30, 2009. Stock options outstanding at September 30, 2009 and 2008 were 113,335 and 134,369, respectively. In 2009 and 2008, no potentially dilutive common shares resulted from the stock options because the exercise price of the options was greater than the average market price of the common stock.

Basic and diluted earnings (loss) per common share were computed as follows:


	Three Months Ended					Nine Months Ended
	September 30,					September 30,
	2009		2008			2009		2008
	(Amounts in thousands, except per share data)
Basic and diluted earnings (loss) per common share:
Net income (loss)	$	11,337	$	(11,079	)	$	6,623	$	22,631
Less preferred stock dividends		—		9,228			4,614		27,684


Income (loss) attributable to common stockholders - basic		11,337		(20,307	)		2,009		(5,053	)
Plus convertible preferred stock dividends		34		—			—		—

Income (loss) attributable to common stockholders - diluted	$	11,371	$	(20,307	)	$	2,009	$	(5,053	)


Weighted average number of common shares outstanding during the period		3,298		3,298			3,298		3,298

Assumed conversion of preferred shares		34		—			—		—


Total		3,332		3,298			3,298		3,298


Basic earnings (loss) per common share	$	3.44	$	(6.16	)	$	0.61	$	(1.53	)

Diluted earnings (loss) per common share	$	3.40	$	(6.16	)	$	0.61	$	(1.53	)

3. DIVIDENDS DECLARED PER COMMON SHARE

The Company’s cash dividends per share declared for the nine months ended September 30, 2009 and 2008 were as follows:


RECORD DATE	PAYABLE DATE	AMOUNT PER SHARE⁽¹⁾
2009
January 30, 2009	February 16, 2009		$0.2083


2008 ⁽²⁾
January 31, 2008	February 15, 2008		$0.2083
February 28, 2008	March 15, 2008		0.2083
March 30, 2008	April 17, 2008		0.2083
April 30, 2008	May 15, 2008		0.2083
May 31, 2008	June 15, 2008		0.2083
June 29, 2008	July 17, 2008		0.2083
July 31, 2008	August 15, 2008		0.2083
August 31, 2008	September 17, 2008		0.2083
September 30, 2008	October 17, 2008		0.2083


Total			$1.8747


(1)		Dividends amounts in the table are rounded.

(2)		As adjusted to reflect the one-for-fifty reverse stock split approved on November 7, 2008 and effective on December 1, 2008.

On February 17, 2009, the Company’s Board of Directors announced that the Board voted to suspend regular monthly dividends on the Company’s common stock and all outstanding series of its preferred stock, effective with the payment to be made on March 16, 2009 and applicable to stockholders of record as of February 27, 2009, as a measure to strengthen the Company’s and Westernbank’s capital positions.

Refer to Note 19 – “Contingencies – Regulatory Matters” below for a description of certain regulatory agreements entered into with the FDIC, the Office of the Commissioner of Financial Institutions (“OCIF”) and the Board of Governors of the Federal Reserve System (the “FRB”) and the regulatory restrictions on the payment of dividends imposed by the agreements.

4. ACCUMULATED OTHER COMPRENSIVE INCOME (LOSS), NET

Accumulated other comprehensive income (loss), net of income tax, consisted of the following:


	September 30,			December 31,
	2009			2008
	(In thousands)
Unrealized net gains (losses) on investment securities available for sale, net of income tax of $3,295,000 in 2009 and $2,415,000 in 2008	$	25,715		$	(40,988	)

Unrealized net losses on cash flow hedge derivatives (fixed-price sale contracts), net of income tax of $264,000 in 2009		(1,496	)		—


Total	$	24,219		$	(40,988	)

5. MONEY MARKET INSTRUMENTS

At September 30, 2009 and December 31, 2008, money market instruments included $417.7 million and $1.1 billion, respectively, in interest bearing deposits with other banks. At September 30, 2009 and December 31, 2008, the Company maintained $408.5 million and $1.1 billion, respectively, as interest-bearing deposit with the Federal Reserve Bank of New York. Restricted interest bearing deposits with other banks amounted to $3.6 million at September 30, 2009 and December 31, 2008. In addition, interest bearing deposits with other banks amounting to $400,000 were pledged to the Puerto Rico Treasury Department for Westernbank’s International Division at September 30, 2009 and December 31, 2008.

The Company sells federal funds and enters into purchases of securities under agreements to resell the same securities (“resell agreements”). These agreements are classified as secured loans and are reflected as assets in the condensed consolidated statements of financial condition. At September 30, 2009, the Company had $49.0 million of federal funds sold outstanding. There were no such agreements outstanding at December 31, 2008.

The Company monitors the fair value of the underlying securities as compared to the related receivable, including accrued interest, and requests additional collateral when the fair value of the underlying collateral falls to less than the collateral requirement. The collateral requirement was equal to 102 percent of the related receivable, including interest. Securities purchased under resell agreements may be held in safekeeping, in the name of the Company, by Citibank N.A., the Company’s custodian, or held by the counterparty.

6. INVESTMENT SECURITIES

The amortized cost, gross unrealized gains and losses and fair value of investment securities were as follows:


			Gross		Gross
	Amortized		Unrealized		Unrealized		Fair
September 30, 2009	Cost		Gains		Losses		Value
	(In thousands)
Available for sale:
U.S. Government and agencies obligations (USGO’s)	$	48,965	$	197	$	701	$	48,461
Puerto Rico Government and agencies obligations (PRGO’s)		11,258		294		—		11,552


Subtotal		60,223		491		701		60,013


Mortgage-backed securities:
Government National Mortgage Association (GNMA) certificates		1,329,101		18,946		111		1,347,936
Collateralized mortgage obligations (CMO’s) issued and guaranteed by GNMA		757,537		19,520		—		777,057
CMO’s issued and guaranteed by Federal National Mortgage Association (FNMA)		343,291		—		7,734		335,556
CMO’s issued and guaranteed by Federal Home Loan Mortgage Corporation (FHLMC)		12,781		—		292		12,489


Subtotal		2,442,710		38,466		8,137		2,473,038


Equity securities — common stock		1,906		—		1,108		798


Total	$	2,504,839	$	38,957	$	9,946	$	2,533,849


Held to maturity:
PRGO’s	$	12,833	$	9	$	102	$	12,740
Corporate notes		21,436		—		7,461		13,975


Subtotal		34,269		9		7,563		26,715


Mortgage-backed securities:
GNMA certificates		5,010		273		—		5,283
FHLMC certificates		1,647		131		—		1,778
FNMA certificates		2,392		165		—		2,557
CMO’s issued and guaranteed by FHLMC		478,817		2,278		8,063		473,032
CMO’s issued and guaranteed by FNMA		53,116		1,291		62		54,345


Subtotal		540,982		4,138		8,125		536,995


Total	$	575,251	$	4,147	$	15,688	$	563,710


			Gross		Gross
	Amortized		Unrealized		Unrealized		Fair
December 31, 2008	Cost		Gains		Losses		Value
	(In thousands)
Available for sale:
USGO’s	$	306,259	$	1,621	$	—	$	307,880
PRGO’s		11,122		335		—		11,457


Subtotal		317,381		1,956		—		319,337


Mortgage-backed securities:
GNMA certificates		523,339		3,332		295		526,376
CMO’s issued and guaranteed by GNMA		2,461,199		124		33,796		2,427,527
CMO’s issued and guaranteed by FNMA		395,492		—		15,054		380,438
CMO’s issued and guaranteed by FHLMC		14,328		—		677		13,651


Subtotal		3,394,358		3,456		49,822		3,347,992


Equity securities — common stock		1,906		1,006		—		2,912


Total	$	3,713,645	$	6,418	$	49,822	$	3,670,241


Held to maturity:
USGO’s	$	372,311	$	793	$	—	$	373,104
PRGO’s		13,312		3		167		13,148
Corporate notes		21,436		—		1,870		19,566


Subtotal		407,059		796		2,037		405,818


Mortgage-backed securities:
GNMA certificates		5,574		195		2		5,767
FHLMC certificates		1,942		88		—		2,030
FNMA certificates		2,691		118		1		2,808
CMO’s issued and guaranteed by FHLMC		551,802		788		16,987		535,603
CMO’s issued and guaranteed by FNMA		68,902		607		698		68,811


Subtotal		630,911		1,796		17,688		615,019


Total	$	1,037,970	$	2,592	$	19,725	$	1,020,837

The amortized cost and fair value of investment securities available for sale and held to maturity at September 30, 2009, by contractual maturity (excluding mortgage-backed securities), are shown below.


	Available For Sale				Held to Maturity
	Amortized		Fair		Amortized		Fair
	Cost		Value		Cost		Value
	(In thousands)
Due within one year	$	6,505	$	6,656	$	3,820	$	3,820
Due after one year through five years		4,753		4,896		8,528		8,439
Due after five years through ten years		48,965		48,461		485		481
Due after ten years		—		—		21,436		13,975

Subtotal		60,223		60,013		34,269		26,715

Mortgage-backed securities		2,442,710		2,473,038		540,982		536,995
Equity securities		1,906		798		—		—


Total	$	2,504,839	$	2,533,849	$	575,251	$	563,710

The following tables show the Company’s available for sale and held to maturity investments’ fair value and gross unrealized losses, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, as of September 30, 2009 and December 31, 2008:


	Less than 12 Months				12 Months or More				Total
			Gross				Gross				Gross		Number of
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized		Investment
September 30, 2009	Value		Losses		Value		Losses		Value		Losses		Positions
	(In thousands)
Available for sale:

USGO’s	$	23,860	$	701	$	—	$	—	$	23,860	$	701		1


Mortgage-backed securities:
GNMA certificates		97,053		111		—		—		97,053		111		2
CMO’s issued and guaranteed by FNMA		335,556		7,734		—		—		335,556		7,734		11
CMO’s issued and guaranteed by FHLMC		12,488		292		—		—		12,488		292		1


Subtotal		445,097		8,137		—		—		445,097		8,137		14


Equity securities — common stock		798		1,108		—		—		798		1,108		1


Total	$	469,755	$	9,946	$	—	$	—	$	469,755	$	9,946		16


Held to maturity:
PRGO’s	$	6,353	$	75	$	4,993	$	27	$	11,346	$	102		11
Corporate notes		—		—		13,975		7,461		13,975		7,461		3


Subtotal		6,353		75		18,968		7,488		25,321		7,563		14


Mortgage-backed securities:
CMO’s issued and guaranteed by FHLMC		12,847		45		368,355		8,018		381,202		8,063		4
CMO’s issued and guaranteed by FNMA		—		—		10,887		62		10,887		62		1


Subtotal		12,847		45		379,242		8,080		392,089		8,125		5


Total	$	19,200	$	120	$	398,210	$	15,568	$	417,410	$	15,688		19


	Less than 12 months				12 months or more				Total
			Gross				Gross				Gross		Number of
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized		Investment
December 31, 2008	Value		Losses		Value		Losses		Value		Losses		Positions
	(In thousands)
Available for sale:

Mortgage-backed securities:
GNMA certificates	$	235,547	$	295	$	—	$	—	$	235,547	$	295		6
CMO’s issued and guaranteed by GNMA		2,365,960		33,796		—		—		2,365,960		33,796		42
CMO’s issued and guaranteed by FNMA		—		—		380,439		15,054		380,439		15,054		11
CMO’s issued and guaranteed by FHLMC		—		—		13,651		677		13,651		677		1


Total	$	2,601,507	$	34,091	$	394,090	$	15,731	$	2,995,597	$	49,822	$	60


Held to maturity:
PRGO’s	$	3,905	$	45	$	8,770	$	122	$	12,675	$	167		12
Corporate notes		4,096		148		15,470		1,722		19,566		1,870		3


Subtotal		8,001		193		24,240		1,844		32,241		2,037		15


Mortgage-backed securities:
GNMA certificates		139		2		—		—		139		2		2
FNMA certificates		67		1		—		—		67		1		1
CMO’s issued and guaranteed by FHLMC		13,588		204		462,737		16,783		476,325		16,987		9
CMO’s issued and guaranteed by FNMA		—		—		30,128		698		30,128		698		3


Subtotal		13,794		207		492,865		17,481		506,659		17,688		15


Total	$	21,795	$	400	$	517,105	$	19,325	$	538,900	$	19,725		30

Available-for-sale and held-to-maturity securities are reviewed at least quarterly for possible other-than-temporary impairment (“OTTI”). If the fair value of an available-for-sale or held-to-maturity security is less than its amortized cost basis, the Company must determine whether an OTTI has occurred. Under GAAP, the recognition and measurement requirements related to OTTI differ for debt and equity securities.

For debt securities, if the Company intends to sell the debt security or will more likely than not be required to sell the debt security before recovery of the entire amortized cost basis, then an OTTI has occurred, and the Company must recognize through earnings the entire OTTI, which is calculated as the difference between the fair value of the debt security and its amortized cost basis. However, even if the Company does not intend to sell the debt security and will not likely be required to sell the debt security before recovery of its entire amortized cost basis, the Company must evaluate expected cash flows to be received and determine if a credit loss has occurred. In the event of a credit loss, the credit component of the impairment is recognized through earnings and the non-credit component is recognized through accumulated other comprehensive income (loss). During the three and nine months ended September 30, 2009 and 2008, the Company did not recognize OTTI on any of its available-for-sale or held-to-maturity debt securities.

For equity securities, the Company’s management evaluates the securities in an unrealized loss position in the available-for-sale portfolio for OTTI on the basis of the duration of the decline in value of the security and severity of that decline as well as the Company’s intent and ability to hold these securities for a period of time sufficient to allow for any anticipated recovery in the market value. If it is determined that the impairment on an equity security is other than temporary, an impairment loss equal to the difference between the carrying value of the security and its fair value is recognized in earnings. During the three and nine months ended September 30, 2009 and 2008, the Company did not recognize OTTI on any of its available-for-sale equity securities.

The Company’s investment portfolio as of September 30, 2009 and December 31, 2008, consisted principally of U.S. Government and agencies obligations, Puerto Rico Government and agencies obligations, and mortgage-backed securities issued or guaranteed by GNMA, FHLMC or FNMA.

At September 30, 2009 and December 31, 2008, the unrealized loss position relates to interest rate changes and not to credit deterioration of any of the securities issuers. The Company assessed the ratings of the different agencies for the mortgage-backed securities, noting that at September 30, 2009 and December 31, 2008, all of them have maintained the highest rating by all the rating agencies and reflect a stable outlook. The aggregate unrealized gross losses of the investment securities available for sale and held to maturity amounted to $25.6 million and $69.5 million at September 30, 2009 and December 31, 2008, respectively.

Proceeds from sales of investment securities available for sale and the respective gross realized gains and losses for the nine months ended September 30, 2009 and 2008, were as follows:


	2009		2008
	(In thousands)
Proceeds from sales	$	2,522,338	$	98,343
Gross realized gains		65,837		22
Gross realized losses		—		75

Unencumbered investment securities available for sale and held to maturity at September 30, 2009 amounted to $321,115,000 and $324,647,000, respectively, after taking into account the investment securities pledged described in Note 8.

7. LOANS

The loans portfolio consisted of the following:


	September 30,			December 31,
	2009			2008
	(In thousands)
REAL ESTATE LOANS SECURED BY MORTGAGES ON:
Commercial real estate	$	4,965,102		$	5,105,663
Residential real estate, mainly one-to-four family residences		990,081			985,564
Construction and land acquisition		1,358,957			1,446,191


Subtotal		7,314,140			7,537,418


Plus (less):
Undisbursed portion of loans in process		(1,695	)		(3,214	)
Premium on loans purchased		28			42
Deferred loan fees — net		(24,463	)		(29,303	)


Subtotal		(26,130	)		(32,475	)


Real estate loans — net		7,288,010			7,504,943


OTHER LOANS:
Commercial, industrial and agricultural loans		637,602			721,987
Consumer loans:
Loans on deposits		28,742			28,753
Credit cards		50,262			49,301
Installment		707,651			649,961
Less deferred loan fees — net		(3,881	)		(5,139	)


Other loans — net		1,420,376			1,444,863


TOTAL LOANS		8,708,386			8,949,806

ALLOWANCE FOR LOAN LOSSES		(225,502	)		(282,089	)


LOANS — NET	$	8,482,884		$	8,667,717

At September 30, 2009, commercial real estate loans totaled $5.0 billion. In general, commercial real estate loans are considered by management to be of somewhat greater risk of collectibility due principally to the size and risk concentration of such loan and for non-owner occupied commercial real estate due to the dependency on income production or future development of the real estate. The Company’s commercial real estate loan portfolio is mostly comprised of loans to owner-occupied borrowers in which the real estate collateral is taken as a secondary source of repayment. At September 30, 2009, commercial real estate loans to owner-occupied borrowers amounted to 80%. Non-owner occupied commercial real estate loans are principally collateralized by property dedicated to wholesale, rental business activities, and retail.

Commercial lending, including commercial real estate, asset-based, unsecured business and construction, generally carry a greater risk than consumer lending, including residential real estate, because such loans are typically larger in size and more risk is concentrated in a single borrower. In addition, the borrower’s ability to repay a commercial loan or a construction loan depends, in the case of a commercial loan, on the successful operation of the business or the property securing the loan and, in the case of a construction loan, on the successful completion and sale or operation of the project. Substantially all of the Company’s borrowers and properties and other collateral securing the commercial, real estate mortgage and consumer loans are located in Puerto Rico.

At September 30, 2009, Westernbank has a significant lending concentration with an aggregate unpaid principal balance of $386.0 million to a commercial group in Puerto Rico, which exceeds the loan-to-one borrower limit. Westernbank has explored various alternatives to decrease its exposure to this borrower to comply with the loan-to-one borrower limitation. However, due to the credit tightening propelled by the current economic environment, efforts have not materialized. Westernbank continues to pursue other actions in order to reduce such excess. For this violation, Westernbank paid a penalty of $50,000 during 2008. As of September 30, 2009, this loan relationship is not impaired. There can be no assurance that the Commissioner of the OCIF will not take further actions on this issue.

The outstanding principal balance of non-performing loans at September 30, 2009 and December 31, 2008 amounted to $1,462,022,000 and $1,560,031,000, respectively. The interest that would have been recorded if the loans had not been classified as non-performing amounted to $34,373,000 and $27,424,000 for the nine months ended September 30, 2009 and 2008, respectively. Interest collected and recognized as income on non-performing loans amounted to $17,867,000 and $32,575,000 for the nine months ended September 30, 2009 and 2008, respectively.

The following table presents a reconciliation of changes in the allowance for loan losses for the three and nine months ended September 30, 2009 and 2008:


	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2009			2008			2009			2008
	(In thousands)
Balance, beginning of period	$	240,832		$	327,902		$	282,089		$	338,720
Provision for loan losses		12,366			15,382			32,345			44,685
Recoveries of loans previously charged-off		696			967			2,341			3,157
Charge-off of uncollectible accounts		(28,392	)		(14,889	)		(91,273	)		(57,200	)

Balance, end of period	$	225,502		$	329,362		$	225,502		$	329,362

The following table sets forth information regarding the investment in impaired loans:


	September 30,		December 31,
	2009		2008
	(In thousands)
Investment in impaired loans:

Covered by a valuation allowance	$	705,990	$	901,146
Do not require a valuation allowance		785,587		570,030


Total	$	1,491,577	$	1,471,176


Impaired non-performing loans	$	1,263,636	$	1,364,192


Valuation allowance for impaired loans	$	86,132	$	131,018


	Nine Months Ended September 30,
	2009		2008
	(In thousands)
Average investment in impaired loans	$	1,467,456	$	1,629,923


Interest collected and recognized as income on non-performing and impaired loans	$	16,357	$	31,939

The Company engages in the restructuring of the debt of borrowers, who are delinquent due to economic or legal reasons, if the Company determines that it is in the best interest for both the Company and the borrower to do so. In some cases, due to the nature of the borrower’s financial condition, the restructure or loan modification fits the definition of Troubled Debt Restructuring (“TDR”) as defined by existing FASB guidance. Such restructures are identified as TDR and accounted for based on the provisions of FASB ASC Topic 310 Sub-topic 40, Receivables — Troubled Debt Restructurings by Creditors. The following table set forth commercial loans that fit the definition of TDR, and therefore have been accounted for as TDR:


	September 30,		December 31,
	2009		2008
	(In thousands)
Performing loans	$	92,707	$	4,768
Non-performing loans		132,034		118,137


Total	$	224,741	$	122,905

8. PLEDGED ASSETS

At September 30, 2009, residential and commercial mortgage loans amounting to $1,175,482,000 (Note 13) and investment securities available for sale and held to maturity amounting to $2,209,202,000 and $254,136,000, respectively, were pledged to secure public funds (see Note 10), individual retirement accounts (see Note 10), repurchase agreements (see Note 11), advances and borrowings from the Federal Home Loan Bank (“FHLB”) (see note 13), interest rate swap agreements (see Note 16), and pledged to the Federal Reserve Bank of New York ($3,236,000). Pledged investment securities available for sale and held to maturity amounting to $2,135,971,000 and $241,513,000, respectively, at September 30, 2009, can be repledged.

In addition, at September 30, 2009 securities sold but not yet delivered amounting to $624,501,000 were pledged to secure repurchase agreements (see Note 11).

9. CLAIM RECEIVABLE FROM LEHMAN BROTHERS HOLDINGS INC.

Westernbank has counterparty exposure to affiliates of Lehman Brothers Holdings Inc. (“LBHI”), which filed a voluntary petition for relief under Chapter 11 of the Bankruptcy Code on September 15, 2008 in connection with certain securities repurchase agreements and derivative transactions. Lehman Brothers Special Financing Inc. (“LBSF”) was the counterparty to the Company on certain interest rate swap and cap agreements guaranteed by LBHI. The filing of bankruptcy by LBHI was an event of default under the agreements. On September 19, 2008, the Company terminated all agreements with LBSF and replaced them with another counterparty under similar terms and conditions. In connection with such termination, the Company had an unsecured counterparty exposure with LBSF of approximately $484,600. This unsecured exposure was written-off during the third quarter of 2008.

In addition, Lehman Brothers Inc. (“LBI”) was the counterparty to the Company on certain sale of securities under agreements to repurchase. On September 19, 2008, LBI was placed in a Securities Investor Protection Act (“SIPA”) liquidation proceeding after the filing for bankruptcy of its parent LBHI. The filing of the SIPA liquidation proceeding was an event of default under the repurchase agreements resulting in their termination as of September 19, 2008. The termination of the agreements caused the Company to recognize the unrealized loss on the value of the securities subject to the agreements, resulting in a $3.3 million charge during the third quarter of 2008. Westernbank also has an aggregate exposure of $139.2 million representing the amount by which the value of Westernbank securities delivered to LBI exceeds the amount owed to LBI under repurchase agreements. On January 27, 2009, Westernbank filed customer claims with the trustee in LBI’s SIPA liquidation proceeding. On June 1, 2009, Westernbank filed amended customer claims with the trustee. Management evaluated this receivable in accordance with the ASC Topic 450, Contingencies (previously SFAS No. 5, “Accounting for Contingencies”) and related pronouncements. In making this determination, management consulted with legal counsel and technical experts. As a result of its evaluation, the Company recognized a loss of $13.9 million against the $139.2 million owed by LBI as of December 31, 2008. Determining the loss amount required management to use considerable judgment and assumptions, and is based on the facts currently available. As additional information on the LBI’s SIPA liquidation proceeding becomes available, the Company may need to recognize additional losses. A material difference between the amount claimed and the amount ultimately recovered would have a material adverse effect on the Company’s and Westernbank’s financial condition and results of operations, and could cause the Company’s and Westernbank’s regulatory capital ratios to fall below the minimum to be categorized as well capitalized.

The Company expects to receive from the LBI’s SIPA trustee notices of determination (i) denying the Company’s claims for treatment as a customer with respect to the securities held by LBI under the repurchase financing agreements, and (ii) converting the Company’s claim to a general creditor claim. As such time, the Company expects to file objections in court to this determination by the LBI’s SIPA trustee.

The cancellation of the repurchase financing agreements and derivative transactions with LBHI resulted in the following noncash activities recorded in 2008: (1) decrease in investment securities held to maturity by $76,597,000; (2) decrease in accrued interest receivable by $4,688,000; (3) increase in other assets by $139,210,000; (4) decrease in repurchase agreements by $433,198,000; (5) decrease in accrued interest payable by $3,541,000; and (6) decrease in accrued expenses and other liabilities by $1,520,000.

10. DEPOSITS

Deposits consisted of the following:


	September 30,		December 31,
	2009		2008
	(In thousands)
Noninterest bearing accounts	$	295,989	$	250,380
Passbook accounts		704,440		670,224
NOW accounts		280,496		275,530
Super NOW accounts		17,211		18,656
Money market accounts		36		37
Certificates of deposit (1)		8,027,563		9,672,333

Total		9,325,735		10,887,160
Accrued interest payable (2)		44,065		115,013

Total	$	9,369,800	$	11,002,173


(1)		Includes brokered deposits with contractual principal balance of $14.5 million and $109.3 million, measured at fair value of $14.5 million and $109.9 million, excluding accrued interest, at September 30, 2009 and December 31, 2008, respectively.

(2)		Includes $120,000 and $708,000 of accrued interest payable on brokered deposits measured at fair value at September 30, 2009 and December 31, 2008, respectively.

The weighted average interest rate of all deposits at September 30, 2009 and December 31, 2008, was approximately 3.35% and 4.09%, respectively. At September 30, 2009, the aggregate amount of deposits in denominations of $100,000 or more was $943,487,000 ($891,917,000 at December 31, 2008). Certificates of deposit include brokered deposits of $6,858,730,000 and $8,475,504,000 at September 30, 2009 and December 31, 2008, respectively.

At September 30, 2009, the scheduled maturities of certificates of deposit are as follows:


Year Ending
December 31,	(In thousands)
2009	$	1,693,947
2010		4,313,238
2011		1,240,619
2012		608,519
2013		79,843
Thereafter		91,397


Total	$	8,027,563

At September 30, 2009, the Company had pledged investment securities held to maturity with a carrying value of $7,328,000, mortgage-backed securities held to maturity with a carrying value of $5,027,000, and investment securities available for sale with a carrying value of $55,609,000 to secure public funds, and mortgage-backed securities held to maturity with a carrying value of $162,000 as bond requirement for individual retirement accounts.

11. REPURCHASE AGREEMENTS

Repurchase agreements, and the related weighted average interest rates at September 30, 2009 and December 31, 2008, consisted of the following:

September 30, 2009

December 31, 2008

Weighted

Average

Amount

Interest Rate

Amount

Interest Rate

(Dollars in thousands)

Repurchase agreements:

Fixed rate

2,657,725

3.02

3,204,142

3.77

The Company enters into sales of securities under agreements to repurchase the same securities (“repurchase agreements”). Repurchase agreements are classified as secured borrowings and are reflected as a liability in the condensed consolidated statements of financial condition. Repurchase agreements require the Company to deliver securities to counterparties to collateralize the agreements. The dealers may sell, loan or otherwise dispose of such securities to other parties in the normal course of their operations, and have agreed to resell to the Company the same securities at the maturities of the agreements. The Company may be required to provide additional collateral based on the fair value of the underlying securities. At September 30, 2009, the Company had outstanding $1.8 billion in repurchase agreements for which the counterparties have the option to terminate the agreements at the first anniversary date and at each interest payment date thereafter.

Repurchase agreements at September 30, 2009 mature as follows:


Year Ending
December 31,	(In thousands)
2009 (1)		$836,225
2010		942,000
2011		25,000
2012		409,500
2013		—
Thereafter		445,000


Total	$	2,657,725


(1)		Matures within 30 days.

Repurchase agreements (classified by counterparty) were as follows:


	September 30, 2009				December 31, 2008
			Fair Value				Fair Value
	Borrowing		of Underlying		Borrowing		of Underlying
	Balance		Collateral		Balance		Collateral
	(In thousands)
Federal Home Loan Bank of New York	$	338,000	$	355,193	$	1,073,000	$	1,141,125
Salomon Smith Barney Inc. and affiliates		295,000		358,848		593,000		707,210
Credit Suisse First Boston LLC		748,528		842,086		532,142		600,820
J.P. Morgan Securities, Inc.		468,497		540,821		330,000		417,308
Barclays Capital, Inc.		509,700		578,895		330,000		374,508
Morgan Stanley Dean Witter		273,000		287,604		273,000		294,235
Merrill Lynch Government
Securities Inc. and affiliates		25,000		38,412		73,000		78,107


Total	$	2,657,725	$	3,001,859	$	3,204,142	$	3,613,313

Borrowings under repurchase agreements were collateralized as follows:


	September 30,				December 31,
	2009				2008
	Carrying		Fair		Carrying		Fair
Securities Underlying	Value of		Value of		Value of		Value of
Repurchase	Underlying		Underlying		Underlying		Underlying
Agreements	Collateral		Collateral		Collateral		Collateral
	(In thousands)
U.S. Government and agencies obligations (“USGO’s”) — held to maturity	$	—	$	—	$	150,755	$	151,028
USGO’s — available for sale		3,336		3,381		155,341		155,142
Mortgage-backed securities (“MBS”) — held to maturity		241,513		239,888		373,940		370,710
MBS — available for sale		2,101,753		2,132,590		2,981,040		2,936,433


Total		2,346,602		2,375,859		3,661,076		3,613,313

Securities sold but not yet delivered:

MBS — available for sale		624,501		626,000		—		—


Total		2,971,103	$	3,001,859		3,661,076	$	3,613,313


Accrued interest receivable of underlying securities		12,901				19,475


Total	$	2,984,004			$	3,680,551

12. LINES OF CREDIT

At September 30, 2009, the Company has an available line of credit with the FHLB of New York guaranteed with excess collateral already pledged, in the amount of $191.3 million (December 31, 2008 — $467.6 million). See Note 13 for the FHLB lines of credit terms. At September 30, 2009 and December 31, 2008, the Company did not have other outstanding lines of credit agreements.

13. ADVANCES FROM FEDERAL HOME LOAN BANK AND MORTGAGE NOTE PAYABLE

Advances from Federal Home Loan Bank and mortgage note payable, and the related weighted average interest rates consisted of the following:


	September 30, 2009					December 31, 2008
			Weighted					Weighted
			Average					Average
	Amount		Interest Rate			Amount		Interest Rate
	(Dollars in thousands)
ADVANCES FROM FHLB:
Fixed rate convertible advances (0.52% to 5.93%)	$	392,000		1.14	%	$	42,000		5.87	%


MORTGAGE NOTE PAYABLE	$	—		0.00	%	$	34,932		8.05	%

Advances and repurchase agreements are received from the FHLB under an agreement (Note 12) whereby Westernbank is required to maintain a minimum amount of qualifying collateral with a fair value of at least 110% and 105% of the outstanding advances and repurchase agreements, respectively. At September 30, 2009, convertible advances were secured by residential and commercial mortgage loans amounting to $1.2 billion. Also, with respect to repurchase agreements and advances from the FHLB amounting to $380.0 million at September 30, 2009, at the first anniversary date and each quarter thereafter, the FHLB has the option to convert them into replacement funding for the same or a lesser principal amount based on any funding then offered by FHLB at the then current market rates, unless the interest rate has been predetermined between FHLB and the Company. If the Company chooses not to replace the funding, it will repay the convertible advances and reverse repurchase agreements, including any accrued interest, on such optional conversion date.

On July 12, 2009, Westernbank World Plaza, Inc., a wholly-owned subsidiary of Westernbank Puerto Rico, exercised a prepayment option, without penalty, and paid-off a then outstanding mortgage note of $34.6 million. The mortgage note bore an interest rate of 8.05%.

Advances from FHLB by contractual maturities at September 30, 2009, mature as follows:


Year Ending
December 31,
	(In thousands)
2009 (1)	$	350,000
2010		42,000


Total	$	392,000


(1)		Matures in less than 60 days.

14. INCOME TAXES

Under the Puerto Rico Internal Revenue Code (the “Code”), all companies are treated as separate taxable entities and are not entitled to file consolidated tax returns. The Company, Westernbank, Westernbank Insurance Corp. and SRG Net, Inc. are subject to Puerto Rico regular income tax or alternative minimum tax (“AMT”) on income earned from all sources. The AMT is payable if it exceeds regular income tax. The excess of AMT over regular income tax paid in any one year may be used to offset regular income tax in future years, subject to certain limitations. Westernbank World Plaza, Inc., a wholly owned subsidiary of Westernbank, elected to be treated as a special partnership under the Code; accordingly, its taxable income or deductible loss is included in the taxable income of Westernbank.

The Code provides a dividend received deduction of 100%, on dividends received from wholly owned subsidiaries subject to income taxation in Puerto Rico. The income on certain investments is exempt for income tax purposes. Also, Westernbank International division operates as an International Banking Entity (“IBE”) under the International Banking Center Regulatory Act. Under Puerto Rico tax law, an IBE can hold non-Puerto Rico assets, and earn interest on these assets, as well as generate fee income outside of Puerto Rico on a tax-exempt basis under certain circumstances. As a result, the Company’s effective tax rate is generally below the statutory rate. On March 9, 2009, the Governor of Puerto Rico signed into law Act No. 7 (“Act No. 7”), also known as Special Act Declaring a Fiscal Emergency Status to Save the Credit of Puerto Rico, which amended several sections of the Code, including sections related to the IBE Act. Act No. 7, as amended by Act No. 37 approved on July 10, 2009, imposes a series of temporary and permanent measures, including a special 5% tax on IBE net income not otherwise subject to tax under the Code. This special assessment is effective for tax years that commenced after December 31, 2008 and before January 1, 2012. The imposition of this special tax is not expected to have any effect on the Company’s Financial position or results of operations.

Pursuant to the provisions of Act No. 13 of January 8, 2004 (“Act No. 13”), for taxable years commencing after September 30, 2003, the net income earned by an IBE that operates as a unit of a bank under the Puerto Rico Banking Law, will be considered taxable and subject to income taxes at the current tax rates in the amount by which the IBE taxable income exceeds 40% in the first applicable taxable year (2004), 30% in the second year (2005) and 20% thereafter, of the taxable income of Westernbank, including its IBE taxable income. Westernbank’s IBE carries on its books securities which are, irrespective of the IBE status, tax exempt by law. Moreover, Act No. 13 provides that IBE’s operating as subsidiaries will continue to be exempt from the

payment of income taxes. For the three and nine months ended September 30, 2009 and 2008, the provisions of Act No. 13 did not have any effect on the Company’s financial positions or results of operations because the Company sustained a net operating loss.

In addition to the tax imposition on the IBE Act No. 7, as amended by Act No. 37 approved on July 10, 2009, also imposes a series of temporary and permanent measures, including the imposition of a 5% surtax over the total income tax liability determined, which is applicable to companies whose combined income exceeds $100,000, effectively increasing the maximum statutory rate from 39% to 40.95% and double the property tax paid on the Company’s real estate properties. These temporary measures are effective for tax years that commenced after December 31, 2008 and before January 1, 2012.

Prepaid income tax amounted to $33,395,000 and $33,630,000 at September 30, 2009 and December 31, 2008, respectively. Accrued income tax payable amounted to $2,894,000 and $3,188,000 at September 30, 2009 and December 31, 2008, respectively. Prepaid income tax is included as part of “Other assets” and accrued income tax payable is included as part of “Accrued expenses and other liabilities” in the accompanying condensed statements of financial condition. Under the Puerto Rico tax code, the Company could use prepaid income taxes to offset future tax liability or ask the PR taxing authority to refund the excess paid. The usage of prepaid income taxes to offset future tax liability is not subject to time limitation. The accrued income tax payable includes a liability for unrecognized tax benefits of $1.5 million and $2.0 million at September 30, 2009 and December 31, 2008, respectively. The provision (credit) for income taxes for the three and nine months ended September 30, 2009 and 2008, consisted of the following:


	Three Months Ended					Nine Months Ended
	September 30,					September 30,
	2009		2008			2009		2008
	(In thousands)
Current provision (credit):
Puerto Rico	$	225	$	(62	)	$	81	$	(21,063	)
U.S.		143		252			1,187		(11,301	)

		368		190			1,268		(32,364	)

Deferred provision (credit)		7,518		(2,260	)		5,490		(4,762	)


Total provision (credit)	$	7,886	$	(2,070	)	$	6,758	$	(37,126	)

The Company evaluates and assesses the relative risks and appropriate tax treatment of transactions and filing positions after considering statutes, regulations, judicial precedent and other information and maintains tax accruals consistent with its evaluation of these relative risks and merits. Changes to the estimate of accrued taxes occur periodically due to changes in tax rates, interpretations of tax laws, the status of examinations being conducted by taxing authorities and changes to statutory, judicial and regulatory guidance that impact the relative

risks of tax positions. These changes, when they occur, can affect the income tax accruals as well as the current period’s income tax expense and can be significant to the operating results of the Company.

Unrecognized tax benefits at September 30, 2009 and December 31, 2008 mainly relate to certain expense deductions taken in income tax returns. The reconciliation for the three and nine months ended September 30, 2009 and 2008 of the unrecognized tax benefits, including accrued interest and penalties, was as follows:


	Three Months Ended					Six Months Ended
	September 30,					September 30,
	2009		2008			2009			2008
	(In thousands)
Balance — at the beginning of period	$	1,432	$	1,866		$	1,958		$	43,987

Gross amount of increase in unrecognized tax benefits as a result of tax positions taken during a prior period		27		298			88			107
Gross amount of decrease in unrecognized tax benefits as a result of tax positions taken during a prior period		—		—			—			(33,345	)
Gross amount of increase in unrecognized tax benefits as a result of tax positions taken during the current period		11		10			31			30
Amount of decrease in the unrecognized tax benefits relating to settlements with taxing authorities		—		(262	)		—			(8,867	)
Reduction to unrecognized tax benefits as a result of lapse of the applicable statute of limitations		—		—			(607	)		—


Balance — September 30,	$	1,470	$	1,912		$	1,470		$	1,912

During the nine months ended September 30, 2008, the Company settled with tax authorities most of its uncertain income tax positions for $8.9 million. The resulting income tax benefit of $33.6 million was recognized as a reduction to the income tax provision in the nine months ended September 30, 2008.

The total amount of net unrecognized tax benefits that, if recognized, would affect the effective income tax rate was $1.5 million and $2.0 million at September 30, 2009 and December 31, 2008, respectively. The Company classifies interests and penalties related to unrecognized tax benefits as a component of its income tax provision. The accrual for uncertain income tax positions includes an accrual for interests and penalties of $361,000 and $475,000 at September 30, 2009 and December 31, 2008, respectively. For the nine months ended September 30, 2009, the Company decreased the accrual for interest and penalties for uncertain income tax positions by $113,000. For the nine months ended September 30, 2008, the Company decreased the accrual for interest and penalties for uncertain income tax positions by $4.1 million, mainly as a result of the settlement of certain income tax positions with tax authorities, as explained above. Interest paid on such settlement amounted to $985,000.

The Company’s primary tax jurisdiction is Puerto Rico. The Company’s primary subsidiary, Westernbank, is the entity which has recorded a liability for these unrecognized tax benefits. In the Puerto Rico tax jurisdiction, Westernbank’s open tax years are 2003 to present. For uncertain foreign withholdings income tax positions, the statute of limitation (four years) began when Westernbank filed the income tax returns in 2007 and 2008.

A reconciliation of the provision (credit) for income taxes computed by applying the Puerto Rico income tax statutory rate to the tax provision as reported was as follows:


	Three Months Ended September 30,												Nine months Ended September 30,
	2009						2008						2009					2008
				% of						% of					% of Pre-						% of Pre-
				Pre-tax						Pre-tax					tax						tax
	Amount			Income			Amount			Income			Amount		Income			Amount			Income
	(Dollars in thousands)
Tax provsion (credit) computed at Puerto Rico statutory rate	$	7,872			41.0	%	$	(5,128	)		(39	%)	$	5,480		41.0	%	$	(5,653	)		(39.0	%)
Effect on provision of:
Exempt income net of related expenses		132			0.7			4,947			37.6			178		1.3			5,637			38.9
Income taxes related to unrecognized tax benefits or income tax contingencies, include U.S. income tax		181			0.9			37			0.3			699		5.2			(32,412	)		(223.6	)
Nondeductible expenses		23			0.1			(59	)		(0.4	)		56		0.4			56			0.4
Differential in statutory rate on capital gains		—			—			475			3.6			—		—			(3,344	)		(23.1	)
Other		(322	)		(1.7	)		(2,342	)		(17.8	)		345		2.6			(1,410	)		(9.7	)

Provision (credit) for income taxes as reported	$	7,886			41.0	%	$	(2,070	)		(15.7	%)	$	6,758		52.5	%	$	(37,126	)		(256.1	%)

Income (loss) before provision for income taxes	$	19,223					$	(13,149	)				$	13,381				$	(14,495	)

Deferred income tax asset consisted of the following:


	September 30,		December 31,
	2009		2008
	(In thousands)
Deferred tax assets:
Allowance for loan losses	$	86,914	$	108,984
Net operating loss carryforwards, expire through 2016		61,282		44,485
Net unrealized losses on available for sale securities		—		2,616
Net unrealized loss in valuation of cash flow hedge derivative instruments		264		—
Net unrealized loss in valuation of trading derivative instruments		—		262
Other		1,272		718


Total deferred tax assets		149,732		157,065
Less valuation allowance		1,092		896

Subtotal		148,640		156,169


Less deferred tax liabilities:
Deferred loan origination costs		229		209
Net unrealized gains on available for sale securities		3,295		—
Net unrealized gains in valuation of trading derivative instruments		108		—
Other		284		299

Subtotal		3,916		508

Deferred income tax asset, net	$	144,724	$	155,661

Changes in the valuation allowance for deferred income tax assets for the nine months ended September 30, 2009 were as follows:


	(In thousands)
Balance — at January 1, 2009	$	896
Increase in valuation allowance		196


Balance — at September 30, 2009	$	1,092

Realization of deferred tax assets is dependent on generating sufficient future taxable income or capital gains. The amount of the deferred tax assets considered realizable could be reduced in the near term if estimates of future taxable income or capital gains are not met.

15. OFF-BALANCE SHEET ACTIVITIES

In the normal course of business, the Company becomes a party to credit related financial instruments with off-balance sheet risk to meet the financing needs of its customers. These financial instruments include commitments to extend credit and commercial letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated statements of financial condition. The contract or notional amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments.

Commitments to Extend Credit and Letters of Credit

The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit, commitments under credit card arrangements and standby and commercial letters of credit is represented by the contractual notional amount of those instruments, which does not necessarily represent the amount potentially subject to risk. In addition, the measurement of the risks associated with these instruments is meaningful only when all related and offsetting transactions are identified. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary upon extension of credit, is based on management’s credit evaluation of the counterparty. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, and income producing commercial properties. At September 30, 2009, the Company had an allowance for unfunded loan commitments totaling $89,000 included in “Accrued expenses and other liabilities” in the accompanying condensed consolidated statements of financial condition. At December 31, 2008, there was no such allowance for unfunded loan commitments as the exposures were adequately collateralized or were not considered significant. Commercial letters of credit are conditional commitments issued by the Company on behalf of a customer authorizing a third party to draw drafts on the Company up to a stipulated amount and with specified terms and conditions.

The Company issues financial standby letters of credit to guarantee the performance of various customers to third parties. If the customer fails to meet its financial or performance obligation to the third party under the terms of the contract, then, upon their request, the Company would be obligated to make the payment to the guaranteed party. In accordance with the provisions of ASC Topic 640 Guarantees ( previously FIN No. 45), at September 30, 2009 and December 31, 2008, the Company recorded a liability of $133,000 and $348,000, respectively, which represents the fair value of the obligation undertaken to stand ready to perform in issuing the guarantees under the standby letters of credit. The fair value approximates the fee received from the customer for issuing such commitments. These fees are deferred and recognized over the commitment period. The contract amounts in standby letters of credit outstanding at September 30, 2009 and December 31, 2008, shown in the table below, represent the maximum potential amount of future payments the Company could be required to make under the guarantees in the event of nonperformance by the customers. These standby letters of credit are used by the customer as a credit enhancement and typically expire without being drawn upon. The Company’s standby letters of credit are generally secured, and in the event of nonperformance by the customers, the Company has rights to the underlying collateral provided, which normally includes cash and marketable securities, real estate, receivables and others. Management does not anticipate any material losses related to these standby letters of credit.

The contract amount of financial instruments, whose amounts represent credit risk was as follows:


	September 30,		December 31,
	2009		2008
	(In thousands)
Commitments to extend credit:
Fixed rates	$	12,362	$	9,389
Variable rates		143,822		312,212
Unused lines of credit:
Commercial		106,602		152,455
Credit cards and other		84,953		111,978
Standby letters of credit		28,232		31,222
Commercial letters of credit		2,026		4,289

Total	$	377,997	$	621,545

At September 30, 2009 and December 31, 2008, the Company did not record any loss allowances in connection with risks involved in off-balance sheet credit-related financial instruments, other than the $89,000 allowance for losses on unfunded loan commitments recorded at September 30, 2009. At September 30, 2009 and December 31, 2008, there were no additional off-balance sheet credit-related financial instruments other than those mentioned above.

16. DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

One of the main risks facing the Company is interest rate risk, which includes the risk that changes in interest rates will result in changes in the value and in the cash flows of the Company’s assets and liabilities and the risk that net interest income will change in response to changes in interest rates. The Company maintains an overall interest rate risk management strategy that, from time to time, incorporates the use of derivative instruments to minimize significant unplanned fluctuations in earnings and cash flows caused by interest rate volatility. Additionally, the Company holds derivative instruments for the benefit of its commercial customers. The Company does not enter into derivative instruments for speculative purposes.

The Company’s interest rate risk management strategy involves modifying the repricing characteristics of certain financial instruments so that changes in interest rates do not adversely affect the Company’s net interest margin. Derivative instruments that the Company may use as part of its interest rate risk management strategy include interest rate swaps, indexed options and interest rate caps. These transactions involve both credit and market risk. The notional amounts are amounts on which calculations, payments and the value of the derivative 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 fair value of a derivative is based on the estimated amount the Company would receive or pay to terminate the derivative contract, taking into account the current interest rates and the creditworthiness of the counterparty. The fair value of the derivatives is reflected on the Company’s condensed statements of financial condition as derivative assets and derivative liabilities.

The Company is exposed to credit-related losses in the event of nonperformance by the counterparties to these agreements. The Company controls the credit risk of its financial contracts through credit approvals, limits and monitoring procedures, and does not expect any counterparties to fail their obligations. The Company deals only with primary dealers.

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. OTC contracts generally consist of swaps, caps and Standard & Poor’s 500 Composite Stock Index options.

Interest-rate swap contracts generally involve the exchange of fixed and floating-rate interest payment obligations without the exchange of the underlying principal amounts. Entering into interest-rate swap contracts involves not only the risk of dealing with counterparties and their ability to meet the terms of the contracts, but also the interest rate risk associated with unmatched positions. Interest rate swaps are the most common type of derivative contracts that the Company utilizes.

Indexed options are contracts that the Company enters into in order to receive the average appreciation of the month end value of the Standard & Poor’s 500 Composite Stock Index over a specified period in exchange for the payment of a premium when the contract is initiated. The credit risk inherent in the indexed options is the risk that the exchange party may default.

Interest rate caps represent a right to receive cash if a reference interest rate rises above a contractual strike rate; therefore, its value increases as reference interest rates rise. Interest rate caps protect against rising interest rates. The credit risk inherent in the interest rate cap is the risk that the exchange party may default.

The Company utilizes interest rate swaps (“CD Swaps”) to convert a portion of its long-term, callable, fixed-rate brokered certificates of deposit (“CDs”) or firm commitments to originate long-term, callable, fixed-rate brokered CDs to a variable rate. The purpose of entering into these CD Swaps is to hedge the risk of changes in the fair value of certain brokered CDs or firm commitments to originate brokered CDs attributable to changes in the LIBOR rate (interest rate risk). The hedged brokered CDs are typically structured with terms of 3 to 20 years with a call option on the Company’s part, but no surrender option for the CD holder, other than for death or disability. The extended term of the brokered CDs minimizes liquidity risk while the option to call the CDs after the first year provides the Company with funding flexibility.

On January 1, 2008, the Company adopted the fair value option of FASB ASC 825, Financial Instruments, and discontinued the use of fair value hedge accounting of FASB ASC 815, Derivatives and Hedging, on these CD Swaps. This Statement allows entities to choose to measure certain financial assets and liabilities at fair value with any changes in fair value reflected in earnings. The Company elected to measure at fair value the brokered deposits being hedged with the CD Swaps. The fair value option may be applied on an instrument-by-instrument basis. One of the main considerations in the determination for the adoption of this guidance was to eliminate the operational procedures required by the long-haul method of accounting in terms of documentation, effectiveness assessment, and manual procedures followed by the Company to fulfill the requirements specified by FASB ASC 815, Derivatives and Hedging (see Note 17).

The Company offers its customers an equity-linked certificate of deposit that has a return linked to the performance of the Standard & Poor’s 500 Composite Stock Index. Under SFAS No. 133, a certificate of deposit that pays interest based on changes on an equity index is a hybrid instrument that requires separation into a host contract (the certificate of deposit) and an embedded derivative contract (written equity call option). At the end of five years, the depositor will receive a specified percent of the average increase of the month-end value of the stock index. If such index decreases, the depositor receives the principal without any interest. The Company enters into an offsetting derivative contract (indexed option agreement that has a return linked to the performance of the Standard & Poor’s 500 Composite Stock Index) to economically hedge the exposure taken through the issuance of equity-linked certificates of deposit. Under the option agreements, the Company will receive the average increase in the month-end value of the index in exchange for the payment of a premium when the contract is initiated. Since the embedded derivative and the derivative contract entered into by the Company do not qualify for hedging accounting, these derivatives are recorded at fair value with offsetting gains and losses recognized within noninterest income in the condensed consolidated statements of operations.

The Company also enters into derivative contracts (including interest rate swaps and interest rate caps) for the benefit of commercial customers. The Company may economically hedge significant exposures related to these derivatives by entering into offsetting third-party contracts with approved, reputable counterparties with substantially matching terms. Credit risk arises from the possible inability of counterparties to meet the terms of their contracts. The Company’s exposure is limited to the replacement value of the contracts rather than the

notional, principal or contract amounts. The Company minimizes the credit risk through credit approvals, limits, counterparty collateral and monitoring procedures. Since these derivatives do not qualify for hedging accounting, they are recorded at fair value with offsetting gains and losses recognized within noninterest income in the condensed consolidated statements of operations.

During the three and nine months ended September 30, 2009 and 2008, there were no credit downgrades to counterparties of derivative contracts.

In addition, the Company designates as hedging instruments the purchase or sale firm commitments (fixed-price purchase or sale contracts) in a cash flow hedge of the variability of the consideration to be paid or received in the forecasted purchase or sale of investment securities that will occur upon gross settlement of the derivative contract itself.

The following table summarizes the fair value of derivative instruments, excluding accrued interest, and the location in the condensed consolidated statements of financial condition:


	September 30,					December 31,
	2009					2008
	Notional		Fair			Notional		Fair
	Amount		Value			Amount		Value
			(In thousands)
Derivative designated as cash flow hedge:
Included in other liabilities:
Fixed-price sale contracts	$	200,000	$	1,760		$	—	$	—


Derivatives not designated as hedge:
Included in other assets:
CD swaps	$	—	$	—			120,525		658
Interest rate swaps with commercial loan borrowers		146,292		8,132			171,972		11,660
Interest rate cap used to offset exposure of interest rate cap with commercial loan borrowers		42,954		169			43,251		71
Purchased options used to manage exposure to the stock market on equity indexed deposits		56,344		4,969			72,370		6,806
Right to offset effect		—		(307	)		—		(824	)

Total	$	245,590	$	12,963		$	408,118	$	18,371


Included in accrued expenses and other liabilities:
Interest rate swaps used to offset exposure of interest rate swaps with commercial loan borrowers	$	146,292	$	8,195		$	171,972	$	12,051
Interest rate cap with commercial loan borrowers		42,954		121			43,251		27
CD swaps		17,300		72			—		—
Right to offset effect		—		(307	)		—		(824	)

Total	$	206,546	$	8,081		$	215,223	$	11,254


Included in deposits:
Embedded options on equity indexed deposits	$	54,271	$	5,194		$	69,444	$	6,986

Accrued interest receivable and accrued interest payable (included in accrued expenses and other liabilities) on interest rate swaps were as follows:


	September 30, 2009				December 31, 2008
	Accrued Interest				Accrued Interest
	Receivable		Payable		Receivable		Payable
			(In thousands)
CD Swaps	$	109	$	—	$	22	$	117
Interest rate swaps with commercial loan borrowers		446		—		158		—
Interest rate swaps used to offset exposure of interest rate swaps with commercial loan borrowers		—		448		—		154

Total	$	555	$	448	$	180	$	271

The following table summarizes the fair value of derivative instruments and the location in the condensed consolidated statements of operations:


	For the Three Months						For the Nine Months
	Ended September 30,						Ended September 30,
	2009			2008			2009			2008
				(In thousands)
Derivatives designated as cash flow hedge:
Included in other comprehensive income (loss):
Fixed-price sale and purchase contracts	$	(6,093	)	$	—		$	(1,760	)	$	—


Derivatives not designated as hedge:
Included in net gain (loss) on derivative instruments:
Interest rate swaps with commercial loan borrower	$	1,502		$	2,134		$	2,307		$	6,123
Interest rate swaps used to offset exposure of interest rate swaps with commercial loan borrower		554			(935	)		3,424			(3,351	)
Interest rate cap with commercial loan borrower		1			42			(94	)		20
Interest rate cap used to offset exposure of interest rate cap with commercial loan borrower		(28	)		75			97			210
Purchased options used to manage exposure to the stock market on equity indexed deposits		2,319			(2,239	)		782			(8,285	)
Embedded options on equity indexed deposits		(2,126	)		2,136			(533	)		7,157
CD swaps		(1,388	)		1,139			(5,267	)		4,639

	$	834		$	2,352		$	716		$	6,513

A summary of the types of swaps used and their terms follows:


	September, 30			December 31,
	2009			2008
	(Dollars in thousands)
Pay floating/receive fixed:
Notional amount	$	163,592		$	292,497
Weighted average receive rate at period end		5.19	%		5.06	%
Weighted average pay rate at period end (100% floating rate over three month LIBOR, plus a spread ranging from minus .40% to plus .03%)		0.49	%		2.78	%

Pay fixed/receive floating:
Notional amount	$	146,292		$	171,972
Weighted average receive rate at period end (100% floating rate over one or three month LIBOR)		0.48	%		2.70	%
Weighted average pay rate at period end		5.24	%		5.30	%

The changes in notional amount of swaps outstanding during the nine months ended September 30, 2009 were as follows:


	(In thousands)
Balance — at January 1, 2009	$	464,469
New swaps		26,967
Called and matured swaps		(181,552	)


Balance — at September 30, 2009	$	309,884

At September 30, 2009, the maturities of interest rate swaps, embedded options and purchased options by year were as follows:


Period Ending	Fixed-price
December 31,	Sale				Interest Rate		Embedded		Purchased
	Contract (1)		Swaps		Caps		Options		Options
			(In thousands)
2009	$	200,000	$	—	$	—	$	390	$	462
2010		—		206,267		—		15,479		16,469
2011		—		—		—		7,792		8,206
2012		—		73,419		—		7,828		8,234
2013		—		—		85,908		11,394		11,593
Thereafter		—		30,198		—		11,388		11,380


Total	$	200,000	$	309,884	$	85,908	$	54,271	$	56,344


(1)		Mature within 20 days.

Swap agreements amounting to $17.3 million at September 30, 2009, provide the counterparties the option to cancel the swap agreements on any interest payment date after the first anniversary (matching the call option that Westernbank has purchased on the certificates of deposit).

At September 30, 2009, the specific collateral held by the counterparties consisted of investment securities available for sale with a carrying value of $14,548,000.

17. FAIR VALUE MEASUREMENTS

Effective January 1, 2008, the Company adopted issued FASB authoritative guidance, which provides a framework for measuring fair value under accounting principles generally accepted in the United States of America. The FASB issued authoritative guidance defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The FASB issued authoritative guidance also establishes a fair value hierarchy, which prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). A financial instrument’s categorization within the fair value hierarchy is based upon the lowest level of input that is significant to the instrument’s fair value measurement. The three levels within the fair value hierarchy are described as follows:

Level 1 — Quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date. Level 1 assets and liabilities include equity securities that are traded in an active exchange market, as well as certain U.S. Treasury and other U.S. government and agency securities and corporate debt securities that are traded by dealers or brokers in active markets.

Level 2 — Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs include: quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; inputs other than quoted prices that are observable for the asset or liability; and inputs that are derived principally from or corroborated by observable market data by correlation or other means. Level 2 assets and liabilities include (i) mortgage-backed securities for which the fair value is estimated based on the value of identical or comparable assets, (ii) debt securities with quoted prices that are traded less frequently than exchange-traded instruments and (iii) derivative contracts and financial liabilities (e.g., brokered deposits elected for fair value option under FASB ASC 825) whose value is determined using a pricing model with inputs that are observable in the market or can be derived principally from or corroborated by observable market data.

Level 3 — Unobservable inputs for the asset or liability for which there is little, if any, market activity at the measurement date. Unobservable inputs reflect the Company’s own assumptions about what market participants would use to price the asset or liability. The inputs are developed based on the best information available in the circumstances, which might include the Company’s own financial data such as internally developed pricing models, discounted cash flow methodologies, as well as instruments for which the fair value determination requires significant management judgment.

Effective January 1, 2008, the Company adopted issued FASB authoritative guidance, which allows an entity the irrevocable option to elect fair value for the initial and subsequent measurement for certain financial assets and liabilities on an instrument-by-instrument basis (“fair value option”). Upon election of the fair value option in accordance with the issued FASB authoritative guidance, subsequent changes in fair value are recorded as an adjustment to earnings. The adoption of the issued FASB authoritative guidance resulted on cumulative adjustments of: (1) $5.3 million increase to retained earnings; (2) $12.9 million decrease to deposits; (3) $4.2 million decrease to other assets; and (4) $3.4 million decrease to deferred income tax.

The disclosures required for each of the above issued FASB authoritative guidance’s have been included in this Note.

Fair Value Option

The Company elected on January 1, 2008 to measure at fair value certain long-term, callable brokered deposits (financial liabilities) that were hedged with interest rate swaps (“Hedged Brokered CDs”) and were previously designated for fair value hedge accounting in accordance with issued FASB authoritative guidance’s (see Note 16). Electing the fair value option allows the Company to eliminate the burden of complying with the requirements for hedge accounting under previous issued FASB authoritative guidance’s (e.g., documentation and effectiveness assessment) without introducing earnings volatility. Interest rate risk on the Hedged Brokered CDs continues to be economically hedged with callable interest rate swaps with the same terms and conditions. The Company did not elect the fair value option for the vast majority of other brokered deposits because these are not hedged by derivatives.

The fair value of Hedged Brokered CDs is obtained from non-binding third party pricing services. The third party pricing service provider determines the fair value of the brokered deposits through the use of discounted cash flow analyses over the full term of the CDs. The options component, the callable feature, is valued using a “Hull-White Interest Rate Tree” approach, an industry-standard approach for valuing instruments with interest rate call options. The model assumes that the embedded options are exercised economically. The fair value of the CDs is computed using the outstanding principal amount. The discount rates used are based on US dollar LIBOR and swap rates. The fair value does not incorporate a credit risk spread, since the callable brokered deposits are generally for amount less than the FDIC insurance.

Interest paid/accrued on Hedged Brokered CDs is recorded as part of interest expense on deposits and the accrued interest and the fair value (excluding accrued interest) of the Hedged Brokered CDs are reported within deposits in the condensed consolidated statement of financial condition. Fair value changes are included in earnings within noninterest income in the condensed consolidated statement of operations.

As of September 30, 2009 and December 31, 2008, deposits included callable brokered deposits (see Note 10) measured at fair value with an aggregate fair value of $14,482,000 and $109,944,000, and carrying principal balance of $14,513,000 and $109,281,000, respectively.

Changes in fair value and interest expense for callable brokered CD’s measured at fair value pursuant to election of the fair value option for the three and nine months ended September 30, 2009 and 2008, were as follows:


	Three Months Ended September 30,					Nine Months Ended September 30,
	2009			2008		2009		2008
	(In thousands)
Unrealized gains (losses) (1)	$	(170	)	$	6,165	$	694	$	3,266


Interest income expense	$	175		$	9,974	$	1,323	$	11,122


(1)		Reported in non-interest income as net gain (loss) on derivative instruments and deposits measured at fair value in the condensed consolidated statements of operations.

Estimated Fair Value

The information about the estimated fair value of financial instruments required by GAAP is presented hereunder. The aggregate fair value amounts presented do not necessarily represent management’s estimate of the underlying value for the Company.

The estimated fair value of financial instruments is subjective in nature and involves uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. Changes in the underlying assumptions used in calculating fair value could significantly affect the results. In addition, the fair value estimates are based on outstanding balances without attempting to estimate the value of anticipated future business.

The following methods and assumptions were used by the Company in estimating fair values of financial instruments as disclosed in these condensed consolidated financial statements as required by SFAS No. 107, Disclosures about Fair Value of Financial Instruments:

• Short-term Financial Assets and Liabilities — For financial instruments with a short-term or no stated maturity, at prevailing market rates and limited credit risk, carrying amounts approximate fair value. Those financial instruments include cash and due from banks, money market instruments, certain deposits (passbook accounts, money market and checking accounts), federal funds purchased and accrued interest.

• Investment Securities Available for Sale, Held to Maturity and Trading Securities — The fair values of most of the investment securities available for sale, held to maturity and trading securities are estimated based on quotations received from pricing service firms and/or securities dealers. These securities are generally classified within Level 2 of the valuation hierarchy and include U.S. Government and agencies obligations, Puerto Rico Government obligations, and mortgage-backed securities. Equity securities are traded in an active exchange market and are classified within Level 1 of the valuation hierarchy.

• Federal Home Loan Bank (FHLB) Stock — FHLB stock is valued at its redemption value.

• Residential Mortgage Loans Held for Sale — Fair value is based on the contract price at which the mortgage loans are expected to be sold and are classified within Level 2 of the valuation hierarchy.

• Loans — Fair values are estimated for portfolios of loans with similar financial characteristics. Loans are segregated by type such as residential mortgage, commercial, consumer, credit cards and other loans. Each loan category is further segmented into fixed and adjustable interest rate terms and by performing, nonperforming and loans with payments in arrears.

The fair value of performing loans, except residential mortgages and credit card loans is calculated by discounting scheduled cash flows through the estimated maturity dates using estimated market discount rates that reflect the credit and interest rate risk inherent in the loan. For performing residential mortgage loans, fair value is computed using an estimated market rate based on secondary market sources adjusted to reflect differences in servicing and credit costs. For credit card loans, cash flows and maturities are estimated based on contractual interest rates and historical experience and are discounted using estimated market rates.

Fair value for significant nonperforming loans and certain loans with payments in arrears is based on recent external appraisals of collateral. If appraisals are not available, estimated cash flows are discounted using a rate that is commensurate with the risk associated with the estimated cash flows. Assumptions regarding credit risk, cash flows, and discount rates are judgmentally determined using available market information and specific borrower information.

• Mortgage Servicing Rights (MSRs) — The carrying amount of mortgage servicing rights, which is evaluated periodically for impairment, approximates the fair value. MSRs do not trade in an active market with readily observable prices. MSRs are priced internally using prices for similar assets (which are based on discounted cash flow model with unobservable inputs). Due to the unobservable nature of valuation inputs used by valuation model, the MSRs are classified within Level 3 of the valuation hierarchy.

• Deposits — The fair value of deposits with no stated maturity, such as non-interest bearing, demand deposits, savings, NOW, and money market accounts is, for purpose of this disclosure, equal to the amount payable on demand as of the respective dates. The fair value of fixed rate certificates of deposit is based on the discounted value of contractual cash flows using current rates for certificates of deposit with similar terms and remaining maturities. The discount rate is estimated using the rates currently offered for deposits of similar remaining maturities. For fair value of SFAS 159 Brokered CDs refer to “Fair Value Option” section included in this Note. These deposits are classified within Level 2 of the valuation hierarchy.

• Resell Agreements, Repurchase Agreements, Advances from FHLB and Mortgage Note Payable — The fair value of resell agreements, repurchase agreements, advances from FHLB and mortgage note payable is based on the discounted value using rates currently available to the Company for instruments with similar terms and remaining maturities.

• Derivative Assets and Derivative Liabilities —The fair value of the derivative instruments is based on an independent valuation model that uses primarily observable market parameters, such as yield curves, and takes into consideration the credit risk component, when

appropriate. Derivatives are mainly composed of interest rate swaps, indexed option contracts and caps. These derivatives are classified within Level 2 of the valuation hierarchy.

Although most of the derivative instruments are fully collateralized, a credit spread is considered for those that are not secured in full. The cumulative mark-to-market effect of credit risk in the valuation of derivative instruments resulted in an unrealized loss unrealized gain (loss) of $172,000 and $(527,000) as of September 30, 2009 and December 31, 2008.

• Commitments to Extend Credit and Letters of Credit — The fair value of commitments to extend credit and letters of credit are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standings.

The following table presents the estimated carrying value and fair value of the Company’s financial instruments:


	September 30,				December 31,
	2009				2008
	Carrying		Fair		Carrying		Fair
	Amount		Value		Amount		Value
	(In thousands)
Financial Assets:
Cash and due from banks	$	52,484	$	52,484	$	68,368	$	68,368
Federal funds sold and resell agreements		49,008		49,008		—		—
Interest-bearing deposits in banks		417,709		417,709		1,096,465		1,096,465
Investment securities available for sale		2,533,849		2,533,849		3,670,241		3,670,241
Investment securities held to maturity		575,251		563,710		1,037,970		1,020,837
FHLB stock		52,252		52,252		64,190		64,190
Securities sold but not yet delivered		624,501		626,000		—		—
Residential mortgage loans held for sale		46,681		46,681		18,871		18,871
Loans (excluding allowance for loan losses)		8,708,386		8,570,678		8,949,806		8,931,661
Accrued interest receivable		42,344		42,344		56,224		56,224
Mortgage servicing rights		3,436		3,436		3,270		3,270
Derivatives, included in assets		12,963		12,963		18,371		18,371
Other		134		134		644		644

Financial Liabilities:
Deposits:
Non-interest bearing		295,989		295,989		250,380		250,380
Interest bearing		9,024,552		9,138,691		10,629,794		10,765,630
Embedded options on deposits		5,194		5,194		6,986		6,986
Federal funds purchased and repurchase agreements		2,657,725		2,709,331		3,204,142		3,272,079
Advances from FHLB		392,000		394,181		42,000		44,913
Mortgage note payable		—		—		34,932		35,401
Accrued interest payable		54,456		54,456		127,141		127,141
Derivatives, included in liabilities		9,841		9,841		11,254		11,254
Other		10,194		10,194		12,403		12,403

Off-Balance Sheet Credit Related Financial Instruments:

Liabilities:
Commitments to extend credit		—		28		—		2,585
Unused lines of credit:
Commercial		163		163		462		462
Credit cards and other		158		158		137		137
Commercial letters of credit		179		179		348		348

Financial Assets and Liabilities Recorded at Fair Value on a Recurring Basis

The tables below presents the balance of assets and liabilities measured at fair value on a recurring basis, including financial liabilities for which the Company has elected the fair value option as of September 30, 2009 and December 31, 2008:


September 30, 2009	Level 1		Level 2		Level 3		Total
	(In thousands)
Financial Assets:
Investment securities available for sale⁽¹⁾	$	49,259	$	2,484,590	$	—	$	2,533,849
Residential mortgage loans held for sale ⁽¹⁾		—		9,007		—		9,007
Derivatives, included in other assets ⁽¹⁾		—		12,963		—		12,963
Mortgage servicing rights, included in other assets ⁽¹⁾		—		—		3,436		3,436
Financial Liabilities:
Brokered Deposits ⁽²⁾		—		14,482		—		14,482
Derivatives, included in deposits ⁽¹⁾		—		5,194		—		5,194
Derivatives, included in accrued expenses and other liabilities ⁽¹⁾		—		9,841		—		9,841


December 31, 2008	Level 1		Level 2		Level 3		Total
	(In thousands)
Financial Assets:
Investment securities available for sale (1)	$	2,912	$	3,667,329	$	—	$	3,670,241
Residential mortgage loans held for sale (1)		—		1,270		—		1,270
Derivatives, included in other assets (1)		—		18,371		—		18,371
Mortgage servicing rights, included in other assets (1)		—		—		3,270		3,270
Financial Liabilities:
Brokered Deposits (2)		—		109,944		—		109,944
Derivatives, included in deposits (1)		—		6,986		—		6,986
Derivatives, included in accrued expenses and other liabilities (1)		—		11,254		—		11,254


(1)		Carried at fair value prior to the adoption of FASB ASC Topic 825.

(2)		Represents items to which the Company has elected the fair value option under FASB ASC Topic 825

Level 3 assets measured at fair value on a recurring basis correspond to the mortgage servicing rights, which amounted to $3,436,000 and $3,270,000 at September 30, 2009 and December 31, 2008, respectively For the nine months ended September 30, 2009 and 2008 the Company capitalized mortgage servicing rights amounting to $442,000 and $225,000, respectively, and recognized an amortization expense of them of $276,000 and $143,000, respectively. The carrying amount of mortgage servicing rights, which is evaluated periodically for impairment, approximates the fair value (fair value is estimated considering prices for similar assets). In 2009 and 2008, there were no level 3 liabilities measured at fair value.

There were no transfers in and/or out of Level 3 for financial instruments recorded at fair value on a recurring basis during the three and nine moths ended September 30, 2009 and 2008.

Financial Assets and Liabilities Recorded at Fair Value on a Nonrecurring Basis

The Company may be required, from time to time, to measure certain assets at fair value on a nonrecurring basis in accordance with GAAP. These adjustments to fair value usually result from application of lower-of-cost-or-market accounting or write-downs of individual assets. The

valuation methodologies used to measure these fair value adjustments are described above. For assets measured at fair value on a nonrecurring basis in 2009 and 2008, that were still held on the condensed statements of financial condition at period end, the following table provides the level of valuation assumptions used to determine each adjustment and the carrying value of the related individual assets or portfolios at September 30, 2009 and December 31, 2008.


	Carrying Value
	Level 1		Level 2		Level 3		Valuation Allowance
September 30, 2009	(In thousands)
Assets:
Loans receivable ⁽¹⁾	$	—	$	—	$	607,959	$	86,646
Foreclosed real estate held for sale ⁽²⁾		—		—		29,545		4,045


	Carrying Value
	Level 1		Level 2		Level 3		Valuation Allowance
December 31, 2008	(In thousands)
Assets:
Loans receivable ⁽¹⁾	$	—	$	—	$	772,423	$	128,983
Foreclosed real estate held for sale ⁽²⁾		—		—		10,030		1,341


(1)		Mainly impaired commercial and construction loans. The impairment was generally measured based on the fair value of the collateral in accordance with the provisions of FASB ASC Topic 310-40. The fair values are derived from appraisals that take into consideration prices in observed transactions involving similar assets in similar locations but adjusted for specific characteristics and assumptions of the collateral (e.g. age and condition), which are not market observable and have become significant to the fair value determination.

(2)		The fair value is derived from appraisals that take into consideration prices in observed transactions involving similar assets in similar locations but adjusted for specific characteristics and assumptions of the properties (e.g. absorption rates), which are not market observable. Valuation allowance is based on market valuation adjustments after the transfer from the loan portfolio to the foreclosed real estate held for sale portfolio.

18. SEGMENT INFORMATION

The Company’s management monitors and manages the financial performance of three reportable business segments, the traditional banking operations of Westernbank Puerto Rico, the activities of the division known as Westernbank International, which includes the activities of Westernbank Financial Center Corp. (“Westernbank International”) and the activities of the Asset-Based Lending Unit (”ABL”), which specializes in asset-based commercial business lending. Other operations of the Company not reportable in those segments include: Westernbank Trust Division, which offers trust services; Westernbank International Trade Services Division, which specializes in international trade products and services; SRG Net, Inc., which operates an electronic funds transfer network; Westernbank Insurance Corp., which operates a general insurance agency; Westernbank World Plaza, Inc., which operates the Westernbank World Plaza, a 23-story office building located in

Hato Rey, Puerto Rico; and the transactions of the parent company only, which mainly consist of other income related to the equity in the net income (loss) of its wholly-owned subsidiaries.

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 Company’s organizational structure by divisions, nature of the products, distribution channels, and the economic characteristics of the products were also considered in the determination of the reportable segments. The Company evaluates performance based on net interest income and other income. Operating expenses and the provision for income taxes are analyzed on a combined basis.

Westernbank Puerto Rico’s traditional banking operations consist of Westernbank’s retail operations, such as its branches, including the branches of the Expresso division, together with consumer loans, mortgage loans, commercial loans (excluding the asset-based lending operations), investments (treasury) and deposit products. Consumer loans include loans such as personal, collateralized personal loans, credit cards, and small loans. Commercial products consist of commercial loans including commercial real estate, unsecured commercial and construction loans.

Westernbank International operates as an IBE under the International Banking Center Regulatory Act. Westernbank Financial Center Corp. was incorporated to carry out commercial lending and other related activities in the United States of America and commenced operations in February 2007. The operations of Westernbank Financial Center Corp, were largely inactive, and was closed during the third quarter of 2008. Westernbank International’s business activities consist of commercial banking and related services, and treasury and investment activities outside of Puerto Rico. As of September 30, 2009 and December 31, 2008, and for the three and nine months ended September 30, 2009, substantially all of Westernbank International’s business activities consisted of investments in securities by the U.S. Government or U.S. sponsored agencies and money market instruments with entities located in the United States of America. Investment securities held by Westernbank International amounted to $1.4 billion and $1.9 billion at September 30, 2009 and December 31, 2008, respectively. These securities principally consisted of investment in U.S. Government agencies, GNMA, FHLMC and FNMA. There are no investments in residual tranches. At September 30, 2009 and December 31, 2008, management concluded that there was no other-than-temporary impairment on Westernbank International’s investment securities portfolio (see Note 6). Money market instruments amounted to $1.6 million and $1.3 million at September 30, 2009 and December 31, 2008, respectively. Money market instruments include interest bearing deposits with other financial institutions.

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.

Substantially all of the Company’s business activities are with customers located in the United States of America and its territories (mainly in the Commonwealth of Puerto Rico). In addition, all of the Company’s long-lived assets are located in Puerto Rico.

The financial information presented below was derived from the internal management accounting system and does not necessarily represent each segment’s financial condition and results of operations as if these were independent entities.


	As of and for the Nine Months Ended
	September 30, 2009
	Westernbank Puerto			Westernbank		Asset-Based Lending
	Rico			International		Unit			Total Major Segments			Other Segments		Eliminations			Total
	(In thousands)

Interest income:
Consumer loans	$	51,403		$	—	$	—		$	51,403		$	—	$	—		$	51,403
Construction loans		30,250			—		—			30,250			—		—			30,250
Commercial loans		177,086			—		34,799			211,885			—		—			211,885
Mortgage loans		53,758			—		—			53,758			—		—			53,758
Treasury and investment activities		76,644			41,996		—			118,640			1,732		(3,630	)		116,742

Total interest income		389,141			41,996		34,799			465,936			1,732		(3,630	)		464,038
Interest expense		312,807			29,638		25,282			367,727			205		(6,409	)		361,523

Net interest income		76,334			12,358		9,517			98,209			1,527		2,779			102,515

Provision for loan losses		(21,480	)		—		(10,865	)		(32,345	)		—		—			(32,345	)

Noninterest income, net:
Service and other charges on loans		5,234			—		1,233			6,467			—		—			6,467
Service charges on deposit accounts		6,691			—		—			6,691			—		—			6,691
Other fees and commisions		11,133			2		—			11,135			1,218		(198	)		12,155
Trust account fees		—			—		—			—			1,158		(87	)		1,071
Insurance commission fees		—			—		—			—			1,357		—			1,357
Net gain on derivative instruments and deposits measured at fair value		1,410			—		—			1,410			—		—			1,410
Net gain on sales and valuation of loans held for sale, securities and other assets		60,047			7,306		—			67,353			—		—			67,353

Total noninterest income		84,515			7,308		1,233			93,056			3,733		(285	)		96,504

Equity in earnings of subsidiaries		814			—		—			814			6,812		(7,626	)		—

Total net interest income and noninterest income (loss)	$	140,183		$	19,666	$	(115	)	$	159,734		$	12,072	$	(5,132	)	$	166,674

Total assets	$	12,885,089		$	1,492,911	$	669,057		$	15,047,057		$	1,687,141	$	(3,244,580	)	$	13,489,618


	For the Three Months Ended
	September 30, 2009
	Westernbank Puerto			Westernbank		Asset-Based Lending
	Rico			International		Unit			Total major segments			Other Segments			Eliminations			Total
	(In thousands)

Interest income:
Consumer loans	$	17,329		$	—	$	—		$	17,329		$	—		$	—		$	17,329
Construction loans		10,348			—		—			10,348			—			—			10,348
Commercial loans		55,683			—		10,680			66,363			—			—			66,363
Mortgage loans		17,744			—		—			17,744			—			—			17,744
Treasury and investment activities		28,150			12,520		—			40,670			(1,278	)		781			40,173

Total interest income		129,254			12,520		10,680			152,454			(1,278	)		781			151,957
Interest expense		92,956			6,925		7,652			107,533			41			(1,999	)		105,575

Net interest income		36,298			5,595		3,028			44,921			(1,319	)		2,780			46,382

Provision for loan losses		(1,189	)		—		(11,177	)		(12,366	)		—			—			(12,366	)

Noninterest income, net:
Service and other charges on loans		1,533			—		401			1,934			—			—			1,934
Service charges on deposit accounts		2,159			—		—			2,159			—			—			2,159
Other fees and commisions		3,632			2		—			3,634			393			(65	)		3,962
Trust account fees		—			—		—			—			108			(29	)		79
Insurance commission fees		—			—		—			—			465			—			465
Net gain on derivative instruments and deposits measured at fair value		664			—		—			664			—			—			664
Net gain on sales and valuation of loans held for sale, securities and other assets		27,443			2,629		—			30,072			—			—			30,072

Total noninterest income		35,431			2,631		401			38,463			966			(94	)		39,335

Equity in earnings of subsidiaries		546			—		—			546			11,000			(11,546	)		—

Total net interest income and noninterest income (loss)	$	71,086		$	8,226	$	(7,748	)	$	71,564		$	10,647		$	(8,860	)	$	73,351


	As of December 31, 2008 and for the Nine Months Ended
	September 30, 2008
				Westernbank			Asset-Based Lending
	Westernbank Puerto Rico			International			Unit			Total Major Segments			Other Segments		Eliminations			Total
	(In thousands)

Interest income:
Consumer loans	$	53,607		$	—		$	—		$	53,607		$	—	$	—		$	53,607
Construction loans		42,159			—			—			42,159			—		—			42,159
Commercial loans		244,326			1,476			41,174			286,976			—		—			286,976
Mortgage loans		57,743			—			—			57,743			—		—			57,743
Treasury and investment activities		120,309			62,455			—			182,764			4,526		(2,637	)		184,653

Total interest income		518,144			63,931			41,174			623,249			4,526		(2,637	)		625,138
Interest expense		426,939			50,038			34,920			511,897			1,002		(2,637	)		510,262

Net interest income		91,205			13,893			6,254			111,352			3,524		—			114,876

Provision for loan losses		(25,770	)		1,531			(20,446	)		(44,685	)		—		—			(44,685	)

Noninterest income, net:
Service and other charges on loans		6,478			—			1,273			7,751			—		—			7,751
Service charges on deposit accounts		8,903			—			—			8,903			—		—			8,903
Other fees and commisions		12,897			19			—			12,916			1,588		(194	)		14,310
Trust account fees		—			—			—			—			1,577		(95	)		1,482
Insurance commission fees		—			—			—			—			1,210		(9	)		1,201
Net gain on derivative instruments and deposits measured at fair value		2,844			—			—			2,844			—		—			2,844
Net gain (loss) on sales and valuation of loans held for sale, securities and other assets		13,991			(2,317	)		—			11,674			—		—			11,674

Total noninterest income (loss)		45,113			(2,298	)		1,273			44,088			4,375		(298	)		48,165

Equity in earnings of subsidiaries		1,041			—			—			1,041			24,303		(25,344	)		—

Total net interest income and noninterest income (loss)	$	111,589		$	13,126		$	(12,919	)	$	111,796		$	32,202	$	(25,642	)	$	118,356

Total assets	$	14,022,308		$	2,033,476		$	765,690		$	16,821,474		$	1,628,524	$	(3,167,101	)	$	15,282,897


	For the Three Months Ended
	September 30, 2008
	Westernbank Puerto			Westernbank			Asset-Based Lending
	Rico			International			Unit			Total Major Segments			Other Segments			Eliminations			Total
	(In thousands)

Interest income:
Consumer loans	$	17,548		$	—		$	—		$	17,548		$	—		$	—		$	17,548
Construction loans		11,875			—			—			11,875			—			—			11,875
Commercial loans		80,872			317			12,337			93,526			—			—			93,526
Mortgage loans		18,948			—			—			18,948			—			—			18,948
Treasury and investment activities		40,846			20,285			—			61,131			1,511			(894	)		61,748

Total interest income		170,089			20,602			12,337			203,028			1,511			(894	)		203,645
Interest expense		140,307			15,217			10,293			165,817			294			(894	)		165,217

Net interest income		29,782			5,385			2,044			37,211			1,217			—			38,428

Provision for loan losses		(1,779	)		—			(13,603	)		(15,382	)		—			—			(15,382	)

Noninterest income, net:
Service and other charges on loans		2,123			1			425			2,549			—			—			2,549
Service charges on deposit accounts		2,851			—			—			2,851			—			—			2,851
Other fees and commisions		4,067			1			—			4,068			537			(63	)		4,542
Trust account fees		—			—			—			—			609			(32	)		577
Insurance commission fees		—			—			—			—			385			—			385
Net gain on derivative instruments and deposits measured at fair value		1,622			—			—			1,622			—			—			1,622
Net loss on sales and valuation of loans held for sale, securities and other assets		(1,788	)		(867	)		—			(2,655	)		—			—			(2,655	)

Total noninterest income (loss)		8,875			(865	)		425			8,435			1,531			(95	)		9,871

Equity in earnings (loss) of subsidiaries		502			—			—			502			(10,230	)		9,728			—

Total net interest income and noninterest income (loss)	$	37,380		$	4,520		$	(11,134	)	$	30,766		$	(7,482	)	$	9,633		$	32,917

19. CONTINGENCIES

In the ordinary course of business, the Company has various outstanding commitments and contingent liabilities that are not reflected in the accompanying consolidated financial statements. In addition, the Company is a defendant in certain claims and legal actions arising in the ordinary course of business. In the opinion of management, in consultation with internal and external legal counsels, the ultimate disposition of these matters is not expected to have a material adverse effect on the Company’s financial condition or results of operations.

LAWSUITS

The following describes the material legal proceedings that (1) were pending as of March 31, 2009; (2) were terminated during the period covered by this report; or (3) are pending as of the filing of this report. Thus, the description of a matter may include developments that occurred since March 31, 2009, as well as those that occurred during the period covered by this report.

• Shareholder Securities Class Action. In September and October 2007, three separate complaints, entitled Hildenbrand v. W Holding Company, Inc., et al., C.A.No. 07-1886 FAB (D.P.R.), Webb v. W Holding Company, Inc., et al., C.A.No. 07-1915 FAB (D.P.R.), and Saavedra v. W Holding Company, Inc., et al., C.A.No. 07-1931 FAB (D.P.R), were filed in the United States District Court for the District of Puerto Rico as putative class actions against the Company, Westernbank and certain of their current or former officers and directors. Thereafter, all three cases were consolidated into the Hildenbrand action.

Following the filing of motions mandated by statute, the Court appointed Felix Rivera, Jose A. Nicolao, Fundacion Rios Pasarell, Inc. and Efren E. Moreno as lead plaintiffs in Hildenbrand. Pursuant to an agreed scheduling order, the lead plaintiffs’ Consolidated Amended Complaint was filed April 28, 2008. The complaint names as defendants the Company and Westernbank, as well as current and former officers of the Company and Westernbank. The complaint alleges that the individual defendants engaged the Company and Westernbank in a fraudulent lending scheme and issued misleading information to the market, principally in connection with the timing and reporting of impairments to loans to Inyx that are described below. Plaintiffs allege that these actions artificially inflated the trading prices of the Company’s securities. The plaintiffs brought the action on behalf of all those who purchased the Company’s securities during the period between April 24, 2006 and June 26, 2007, claiming violation of Section 10(b) of the Exchange Act (and Rule 10b-5 promulgated thereunder) by the Company, Westernbank and the individual defendants, as well as violation of Section 20(a) of the Exchange Act by the individual defendants. Plaintiffs are seeking unspecified damages for the class arising from alleged economic losses from investing in the Company’s securities.

The Company and individual defendants filed motions to dismiss, arguing that the Consolidated Amended Complaint lacks particularized factual allegations required to state claims for securities fraud under Sections 10(b) and 20(a). Briefing on the motions was completed on September 10, 2008. On March 24, 2009, the Court denied the defendants’ motions to dismiss. On April 7, 2009, the Company and the individual defendants (except for a former officer of the Company and Westernbank) filed a motion for reconsideration or, in the alternative, for certification of an interlocutory appeal, and the former officer of the Company and Westernbank joined in that motion on April 15, 2009. Discovery was stayed while the defendants’ motion was pending.

After briefing by the parties, the defendants’ motion for reconsideration and the request for certification of an interlocutory appeal were denied by the Court on July 28, 2009.

On August 11, 2009, the Company and Westernbank filed their answer to the Consolidated Amended Complaint, denying liability and raising numerous affirmative defenses to the claims asserted against them. On August 25, 2009, all individual defendants, except for a former officer of the Company and Westernbank, filed their answers to the Consolidated Amended Complaint, also denying liability and raising numerous affirmative defenses to the claims asserted against them.

On October 13, 2009, a former officer of the Company and Westernbank filed his answer to the Consolidated Amended Complaint, denying liability and raising numerous affirmative defenses, and also asserting cross-claims against the other defendants, including the Company and Westernbank, and third-party claims against numerous other current or former officers, directors, or shareholders. In his cross-claims, the former officer of the Company and Westernbank claims a right to indemnification for any judgment entered against him and a right to join the class as a purchaser of Company stock during the alleged class period.

The Company, Westernbank, and several individual and third-party defendants have moved to dismiss the claims asserted by the former officer and also moved to strike portions of his answer. The former officer has responded to those motions, including a request for leave to amend.

The initial pre-trial conference is set for December 18, 2009, and preliminary dates for the end of discovery and trial are set for May 10, 2010 and August 2, 2010, respectively, although the parties have agreed to request an extension of these dates at the initial pre-trial conference.

The Company intends to vigorously defend this action.

• Shareholder Derivative Action. On January 11, 2008, Hunter Wylie, who claims to be a Company shareholder, filed a shareholder derivative complaint (the “Complaint”), entitled Wylie v. Stipes, et al., and W Holding Company, Inc., C.A.No. 08-1036 GAG (D.P.R.), in the United States District Court for the District of Puerto Rico, purportedly on behalf of the Company against certain of the Company’s current and former officers and directors, and named the Company as a nominal defendant. Plaintiff contends that since April 2006 the individual named defendants caused the Company to overstate the value of its loan portfolio, principally in connection with the timing and reporting of impairments to loans to Inyx that are described below, and thereby allegedly caused monetary and reputational losses to the Company. After the Company and individual defendants moved to dismiss on April 7, 2008, the plaintiff filed an Amended Complaint on June 9, 2008, alleging breach of fiduciary duty, waste of corporate assets, unjust enrichment, violation of the Title 14, Section 2727 of the laws of Puerto Rico, and a claim for reimbursement under Section 304 of the U.S. Sarbanes-Oxley Act. The Amended Complaint seeks unspecified monetary damages for the Company’s benefit from the individual defendants and a court order directing the Company to alter its governance policies. The Company and the individual defendants moved to dismiss the Amended Complaint, arguing principally that plaintiff failed to make a pre-suit demand on the Company’s Board of Directors, and thus lacks standing to proceed with this derivative action, that plaintiff otherwise failed to allege facts sufficient to state claims for relief, and that there is no private right of action under Section 304 of the Sarbanes-Oxley Act. Briefing on the motions to dismiss was completed on December 16, 2008. On February 2, 2009, the Court entered an Opinion and Order granting the

motions to dismiss in part and denying them in part. The Court dismissed Count I of the Amended Complaint (claiming reimbursement under Section 304 of the Sarbanes-Oxley Act) in its entirety, dismissed Count IV (alleging unjust enrichment) as to certain defendants, and denied the motions to dismiss as to the other counts challenged therein.

Following the Court’s February 2, 2009 Order on the motion to dismiss, the Company’s board of directors formed a Special Litigation Committee (the “SLC”) and charged it with full and exclusive authority to investigate, review and analyze the facts and circumstances that are the subject of the Wylie lawsuit and to determine what action should be taken on behalf of the Company with respect to plaintiff’s claims. The SLC has engaged the law firm of Conception, Sexton & Martinez of Coral Gables, Florida to assist in carrying out its charge. On April 22, 2009, the SLC moved the Court to stay the case to permit the SLC time to conduct its investigation and, if necessary, take action on the Company’s behalf. On June 5, 2009, the Court granted the SLC’s motion, staying the case until August 24, 2009.

Subsequent to August 24, 2009, the Company filed an answer to the Amended Complaint as nominal defendant, and the remaining defendants (except for a former officer of the Company and Westernbank) filed answers to the Amended Complaint, denying liability and raising numerous affirmative defenses to the claims asserted against them, but no other litigation activities, including discovery, have commenced.

On December 15, 2009, the SLC filed its report with the Court under seal and moved to dismiss all remaining counts against all defendants.

The Company intends to vigorously defend this action.

• SEC Informal Inquiry. The SEC has requested information and documentation relating to Westernbank’s loans to Inyx. The Company has provided that information and the documents to the SEC Staff on a voluntary basis.

• Litigation Relating to the Inyx Loan — Westernbank Puerto Rico v. Kachkar, et al., 07-civ.-1606 (ADC-BJM) (D.P.R.) and member cases Inyx, Inc., et al. v. W Holding Company, Inc., et al, Civil No. 08-2428 (ADC-BJM) and Kachkar, et al. v. Westernbank Puerto Rico, Civil No. 08-2427 (ADC-BJM): Westernbank filed an initial complaint against Inyx, Inc., Jack Kachkar, Inyx’s Chief Executive Officer, and certain other officers in the United States District Court for the District of Puerto Rico on July 5, 2007, and amended the complaint on August 23, 2007. In its amended filing, Westernbank alleges violations of the U.S. Racketeer Influenced and Corrupt Organizations Act (“RICO”) and other fraud-based claims, as well as claims related to alleged breaches of certain loan agreements and guarantees. Westernbank, among other things: (a) seeks damages of over $142 million against the defendants under, among other causes of action, RICO; (b) requests payment of over $142 million from the defendants on amounts due and payable under certain loan agreements; and (c) requests that the Court order foreclosure on Westernbank’s collateral. On September 20, 2007, Westernbank moved to freeze certain of defendants’ assets. On July 23, 2008, a Report and Recommendation was issued by the Magistrate Judge recommending that Westernbank’s motion to freeze assets be granted (the “Asset Freeze Report and Recommendation”).

All defendants moved to dismiss and certain defendants moved alternatively to stay or transfer the case to the United States District Court for the Southern District of Florida in which they had, at that time, two other cases pending. The two cases were: (1) Kachkar, et al v. Westernbank Puerto Rico (Florida Circuit Court Case No. 07-22573-CA-40) and (2) Inyx v. Westernbank, et al. (Florida Circuit Court 07-26412-CA-30). The first of these cases was filed on July 23, 2007, when Jack Kachkar and Viktoria Benkovitch filed a complaint against Westernbank in the Circuit Court for the 11th Circuit of Miami-Dade County, Florida. The complaint alleges that Kachkar and Benkovitch should not have to perform their obligations under the guarantees, security agreements, and asset pledges they provided to Westernbank, and asserts causes of action for: (1) fraudulent inducement and damages; (2) rescission of instruments based on fraudulent conduct and/or lack of consideration; (3) slander of title and damages; and (4) violation of Florida’s Deceptive and Unfair Trade Practices Act. This action was subsequently removed to the U.S. District Court for the Southern District of Florida under the caption Kachkar and Benkovitch v. Westernbank Puerto Rico, Civil No. 07-22140-Cooke (the “Kachkar Case”). The second case was filed on August 17, 2007, when Inyx filed a complaint against Westernbank, the Company and certain current and former officers of the Company and Westernbank in the Circuit Court for the 11th Circuit of Miami-Dade County, Florida. Inyx alleged that a promissory note and mortgage that Inyx provided to Westernbank during the course of the business relationship between the parties should be rescinded, and that Inyx should be awarded damages because Westernbank allegedly breached an oral forbearance agreement to refrain from collecting on loans it had made to Inyx and its subsidiaries, and because Westernbank failed to provide additional financing to these companies. This action was subsequently removed to the U.S. District Court for the Southern District of Florida under the caption Inyx, Inc. v. Westernbank Puerto Rico, et. al., Civil No. 07-22409-Cooke (the “Inyx Case”). On September 25, 2008, the Kachkar Case was consolidated into the Inyx Case in the United States District Court for the Southern District of Florida (the “Florida Consolidated Cases”).

On April 17, 2008, all the transfer motions were denied. On September 5, 2008, the Magistrate Judge issued another Report and Recommendation by which he recommended that all of the defendants’ motions to dismiss be denied. On September 22, 2008, the defendants, except for Inyx, filed their respective objections to the Magistrate Judge’s Report and Recommendation concerning the motions to dismiss. On October 9, 2008, Westernbank filed its response to the defendants’ objections to this Report and Recommendation.

On September 8, 2008, Westernbank filed a Motion for Partial Summary Judgment on the breach of contract claims. On March 3, 2009, the Magistrate Judge issued a third Report and Recommendation, this time recommending that Westernbank’s Motion for Partial Summary Judgment on the breach of contract claims be granted (the “Summary Judgment Report and Recommendation”). Among other things, the Magistrate Judge recommended that defendants Kachkar and Benkovitch be personally liable under certain personal guarantees for $100.1 million.

On October 3, 2008, all of the defendants filed their respective answers to Westernbank’s Amended Complaint. Some of the defendants (Kachkar, Benkovitch, Inyx, Inc., and Green) also filed counterclaims. On December 2, 2008, Westernbank filed a motion to dismiss the original counterclaims filed by the defendants Kachkar, Benkovitch, Green and Inyx pursuant to Fed.R.Civ.P. 12(b)(6). On January 14, 2009, defendants Kachkar, Benkovitch, Inyx and Green filed amended answers to Westernbank’s First Amended Complaint and Kachkar,

Benkovitch and Inyx filed amended counterclaims. Defendant Green withdrew his counterclaim against Westernbank for alleged defamation. The Amended Counterclaims can be categorized into five distinct groups. The primary set of counterclaims, raised by Inyx, Kachkar, and Benkovitch, seeks enforcement of an alleged “oral forbearance and workout agreement” between Westernbank, Inyx, Kachkar, and Benkovitch related to approximately $142 million in loans that Westernbank had made to Inyx and its subsidiaries under various written loan agreements. The second subject of the counterclaims is the claim brought by Inyx alleging that Westernbank breached the agreements and otherwise breached an implied covenant of good faith and fair dealing by not giving Inyx ten days to pay the amounts then outstanding (close to $140 million), and by abruptly placing Inyx into administration in the United Kingdom. The third set of counterclaims involves allegations that Westernbank either breached a confidentiality agreement relating to Kachkar’s supposed business relationship with Mr. Saadi Gadhafi, or tortiously interfered with that relationship. A fourth set of counterclaims revolves around the allegation that Westernbank breached an unwritten escrow agreement allegedly entered into on or about the 20th of June, 2007. The fifth and final set of counterclaims is composed of Kachkar’s and Benkovitch’s claims relating to their real estate in Florida, with respect to which they raise claims of conversion, rescission of instruments, slander of title, and violations of Florida’s Deceptive and Unfair Trade Practices Act.

On December 23, 2008, the Florida Consolidated Cases were transferred to the District of Puerto Rico. Subsequently, on June 23, 2009, the Court granted Westernbank’s motion to consolidate Civil Case No. 07-1606 (ADC/BJM) (“Lead Case”) with the two transferred Florida cases under the following captions in the District of Puerto Rico, Civil Case Nos. 08-2427 (JAF) and 08-2428 (ADC/BJM) (“Consolidated Cases”).

On February 18, 2009, Westernbank filed another motion to dismiss the amended counterclaims pursuant to Fed.R.Civ.P. 12(b)(6). At the request of the Court, and notwithstanding that a motion to dismiss was filed, on June 22, 2009, Westernbank filed its answers to the defendants’ Amended Counterclaims in Civil Case No. 07-1606 (ADC/BJM).

On June 25, 2009, Westernbank filed an emergency motion to stay discovery in the pending Consolidated Cases before the Court until a ruling on the three Reports and Recommendations and motions to dismiss that were pending consideration in the Lead and Consolidated Cases. Pursuant to an Order dated July 7, 2009, the Court granted Westernbank’s request.

On July 24, 2009, the Court ordered the Inyx Parties to re-file their objections to the Summary Judgment Report & Recommendation within the applicable 25-page limit. Also on July 24, 2009, the Court granted Westernbank five (5) working days from the filing of the Inyx Parties’ revised objections to the Summary Judgment Report and Recommendation to file its corresponding response to the same. The Inyx Parties filed their Amended Objections on July 29, 2009, to which Westernbank responded on August 5, 2009.

On August 20, 2009, the Court issued the first opinion and order adopting in full the Report & Recommendation issued by the Magistrate Judge on September 5, 2008, thus denying the Motions to Dismiss filed by the Inyx Parties in Civil Case No. 07-1606. Also on August 20, 2009, the Court ordered the Inyx Parties to file, within 5 days of the issuance of the order, a motion setting forth the amount of the bond, if any, that should be imposed upon Westernbank in the event the Court adopted the Asset Freeze Report and Recommendation (the “August 20th Order”).

On August 31, 2009, the Inyx Parties filed a “Motion to Set Bond of $150 Million” (“Motion to Set Bond”). On September 1, 2009, Westernbank moved to strike the Motion to Set Bond based on the Inyx Parties’ failure to comply with the time period established by the Court in its August 20th Order. Pursuant to an order issued on that same date, the Inyx Parties’ Motion to Set Bond was stricken from the record (the “Order Striking the Bond Motion”).

Also on September 1, 2009, the Court issued its second opinion and order, this time adopting in full the Asset Freeze Report and Recommendation and, consequently, granting Westernbank’s Motion to Freeze Assets (the “Asset Freeze Opinion and Order”).

On September 9, 2009, the Inyx Parties filed a Motion for Reconsideration whereby they request the Court to reconsider its Asset Freeze Opinion and Order (the “First Motion for Reconsideration”). On September 10, 2009, the Inyx Parties filed a motion to stay the Asset Freeze Opinion and Order pending the disposition of the First Motion for Reconsideration. On September 11, 2009, the Inyx Parties filed a motion requesting the Court to reconsider its September 1st Order Striking the Bond Motion (the “Second Motion for Reconsideration”). On September 15, 2009, the Inyx Parties’ filed a motion to stay the Asset Freeze Order pending the disposition of the Second Motion for Reconsideration.

On September 22, 2009, the Court issued a third opinion and order, this time adopting in full the Summary Judgment Report and Recommendation, thus granting Westernbank’s breach of contract claims.

On September 23, 2009, Westernbank filed a motion for voluntary dismissal without prejudice against co-defendants Colin Hunter and Steven Handley, as a result of a confidential settlement agreement reached with them. On September 28, 2009, the Court granted this motion and entered Partial Judgment dismissing Westernbank’s claims against co-defendants Colin Hunter and Steven Handley, without prejudice, pursuant to the terms and conditions of the confidential settlement agreement.

On September 28, 2009, Westernbank also filed its oppositions to the defendants’ First and Second Motions for Reconsideration and the motion to stay the Asset Freeze Opinion and Order.

On October 1, 2009, defendants Inyx, Inc., Kachkar, Benkovitch and Rima Goldschmidt filed a motion requesting, among other things, that the Court produce to them the confidential settlement agreement entered into by Westernbank and co-defendants Hunter and Handley, which Westernbank had submitted under seal to the Court on September 23, 2009, as part of the filings related to the voluntary dismissal without prejudice of the claims against said co-defendants. On October 2, 2009, Westernbank filed its response to the arguments raised in the motion requesting disclosure of the settlement agreement, and produced said agreement to Inyx, Inc., Kachkar, Benkovitch and Goldschmidt. Thus, on October 14, 2009, the Court issued an order finding as moot the motion for disclosure of the settlement agreement.

On October 5, 2009, defendants filed a motion to strike from the record Westernbank’s oppositions to the First and Second Motions for Reconsideration, and Westernbank opposed on October 19, 2009. The motion to strike the First and Second Motions for Reconsideration is still pending before the Court’s consideration.

On October 12, 2009, Westernbank filed a Motion for Partial Summary Judgment on the Fraud Guarantees executed by defendants. Defendants have until October 29, 2009, to file their response in opposition to this motion for summary judgment.

On October 22, 2009, Westernbank filed a motion for entry of partial judgment on its breach of contract claims pursuant to which Westernbank seeks entry of a judgment in excess of $150 million.

On October 30, 2009, Defendants requested that the case be stayed for 45 days because their counsel was transitioning to a new law firm and allegedly did not have access to the files during the transition. Defendants also requested leave to file replies to in support of the First and Second Motions for Reconsideration. Westernbank opposed the request for stay on November 3, 2009. The Court granted leave to file the replies but denied the request for stay, as requested by Westernbank. Defendants later requested a thirty day extension of after their counsel could gain access to the case files to submit these replies, as well as other documents, but the Court denied this request.

On November 6, 2009, the Court referred the case to a visiting judge for a settlement conference, which was held on November 9, 2009. No settlement was reached during the conference.

On November 10, 2009, Defendants filed a motion to strike Westernbank’s motion for partial summary judgment on the fraud guarantees, and the Court denied this request on the same date. Defendants filed a motion for reconsideration, which the Court also denied.

On November 23, 2009, Defendants opposed Westernbank’s motion for entry of partial judgment on its breach of contract claims. Westernbank replied on December 11, 2009.

On December 10, 2009, the Magistrate Judge issued a Report and Recommendation pursuant to which the Magistrate Judge recommended that Westernbank’s motion to dismiss the Counterclaims be granted. Defendants have until December 28, 2009, to file any objections to the Report and Recommendation.

The Company intends to vigorously defend this action.

REGULATORY MATTERS

The SEC has requested information and documentation relating to the Company’s loans to Inyx and the Company has provided that information and the documents to the SEC Staff on a voluntary basis.

The Company, as a Puerto Rico chartered bank holding company, and its subsidiaries are each subject to extensive federal and local government supervision and regulation relating to its bank holding company status and the banking and insurance businesses. There are laws and regulations that restrict transactions between the Company and its subsidiaries. In addition, the Company benefits from favorable tax treatment of activities relating to the Westernbank’s International Division. Any change in such regulations, whether by applicable regulators or as a result of legislation subsequently enacted by the Congress of the United States or the applicable local legislature, could have a substantial impact on the companies’ operations.

On February 27, 2008, the Board of Directors of Westernbank, the Office of the Commissioner of Financial Institutions of Puerto Rico (the “OCIF”) and the FDIC reached an agreement (the “Informal Agreement”) which establishes timeframes for the completion of corrective and remedial measures which have been previously identified and are in process of completion. The Informal Agreement provides that the Board of Directors of Westernbank will, among other things, conduct management and loan reviews; review and make any necessary revisions to Westernbank’s asset/liability and investment policies; ensure the Westernbank’s compliance with the Bank Secrecy Act (“BSA”) and Westernbank’s BSA Compliance Program; correct all apparent violations of laws and regulations; formulate a plan to improve asset quality; submit and implement a profit and budget plan; develop and submit a capital plan to remain well-capitalized; and establish a compliance committee to monitor and coordinate compliance with the agreement. As described in Note 7, Westernbank has a significant lending concentration with an aggregate unpaid principal balance of $386.0 million at December 31, 2008 to a commercial group in Puerto Rico, which exceeds the statutory limit for loans to individual borrowers and continues to be a violation of the agreement. On May 20, 2008, a penalty of $50,000 was imposed by the OCIF. As of December 31, 2008, this loan relationship was not impaired. There can be no assurance that the OCIF and the FDIC will not take further action on this issue.

On November 24, 2008, Westernbank received notice from the FDIC. As a result of that notice and the Informal Agreement described above, Westernbank’s operations and activities are now subject to heightened regulatory oversight. For instance, pursuant to Section 914 of the Financial Institution Reform, Recovery, and Enforcement Act of 1989 (“FIRREA”), Westernbank must notify the FDIC prior to certain management changes, and must obtain approval prior to the payment of certain severance payments. Further, Westernbank must obtain the non-objection of the FDIC before engaging in any transactions that would materially change the balance sheet composition of the Bank, including growth in total assets of 5% or more or significant changes in funding sources, such as increasing brokered deposits or volatile funding. Additionally, prior written approval of the FDIC will be required in order for Westernbank to issue any debt guaranteed by the FDIC under the Temporary Liquidity Guarantee Program.

In May 2009, Westernbank entered into a Consent Order (the “Consent Order”) with the FDIC and the OCIF and W Holding Company, Inc. entered into a Written Agreement with the Board of Governors of the Federal Reserve System (the “Written Agreement”, and, together with the Consent Order, the “Orders”). The Orders formalize the Informal Agreement under which Westernbank has operated since February of 2008.

The Orders do not impose penalties or fines on the Company or Westernbank. The Orders require the Company and Westernbank to take various affirmative actions, including, but not limited to, strengthening the Bank’s and the Company’s Boards of Directors by increasing the number of independent directors; strengthening Westernbank’s management team; submitting a capital, budget, profit and liquidity contingency plans; obtaining approvals prior to paying any dividends; submitting a written plan to reduce and monitor Westernbank’s problem and adversely classified loans; eliminating from Westernbank’s books, by collection or charge-offs, all items or portions of items classified “Loss” as a result of the FDIC’s 2008 examination; submitting loan policies and procedures for regulatory approval; restricting credit advances to adversely classified borrowers; establishing an adequate and effective appraisal compliance program; and maintaining an adequate allowance for loan losses.

In addition to the aforementioned actions, the Consent Order requires Westernbank to maintain a Tier 1 leverage ratio of not less than 5.5% as of the date of the Consent Order, 5.75% at September 30, 2009 and 6.0% at March 31, 2010. As of September 30, 2009, Westernbank’s Leverage Ratio was 6.32%. Although Westernbank satisfies the quantitative definition of a well capitalized institution, by virtue of having a capital directive within the Consent Order, the Bank was deemed to be adequately capitalized. Simultaneously with the Consent Order, the FDIC granted Westernbank a renewable waiver for the issuance of brokered deposits, and in December 2009, the FDIC granted Westernbank’s request to roll over a portion of the Bank’s brokered deposits through March 31, 2010, subject to certain limitations. No assurance can be given that the Orders would not have a material adverse effect on the Company or Westernbank.

Section 29 of the Federal Deposit Insurance Act (“FDIA”) limits the use of brokered deposits by institutions that are less than “well-capitalized” and permits the FDIC to place restrictions on interest rates that institutions may pay. On May 29, 2009, the FDIC approved a final rule to implement new interest rate restrictions on institutions that are not “well capitalized.” The rule limits the interest rate paid by such institutions to 75 basis points above a “national rate,” defined as a simple average of rates paid by all institutions for which data are available. If an institution can provide evidence that its local rate is higher than the national rate, the FDIC may permit that institution to offer the higher local rate plus 75 basis points. However, because the local rates in Puerto Rico are significantly higher than the national rate, we intend to apply to the FDIC for permission to offer rates based on our higher local rates but we can make no assurances that such permission will be granted. Although the rule is not effective until January 1, 2010, the FDIC has stated that it will not object to the rule’s immediate application. The failure of the FDIC to recognize the significant disparity between the local and national rates for Puerto Rico institutions is likely to significantly impair our liquidity position.

20. SUBSEQUENT EVENTS

In October 2009, one of the Company’s largest commercial loan customers suffered an explosion and fire at one of its storage facilities. As of December 21, 2009, the impact of this explosion on the commercial loan customer’s operations and the resulting impact on its ability to repay its obligation to the Company could not be determined. This incident had no impact on the Allowance for Loan Losses as of September 30, 2009.

Subsequent events have been evaluated as of December 21, 2009, the date the Company’s consolidated financial statements were issued, and determined that, other than events described in the notes to the consolidated financial statements, no events have occurred that would require adjustments or disclosures to the Company’s unaudited consolidated financial statements.

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

SELECTED FINANCIAL DATA


	Quarter Ended September 30,						Nine Months Ended September 30,
	2009			2008			2009			2008
	(Amounts in thousands, except per share data)
Income Statement Data:

Interest income	$	151,957		$	203,645		$	464,038		$	625,138
Interest expense		105,575			165,217			361,523			510,262

Net interest income		46,382			38,428			102,515			114,876
Provision for loan losses		(12,366	)		(15,382	)		(32,345	)		(44,685	)

Net interest income after provision for loan losses		34,016			23,046			70,170			70,191
Noninterest income		39,335			9,871			96,504			48,165
Noninterest expenses		(54,128	)		(46,066	)		(153,293	)		(132,851	)

Income (loss) before income taxes		19,223			(13,149	)		13,381			(14,495	)
Income taxes		(7,886	)		2,070			(6,758	)		37,126

Net income		11,337			(11,079	)		6,623			22,631
Preferred stock dividends		—			9,228			4,614			27,684

Income (loss) attributable to common stockholders	$	11,337		$	(20,307	)	$	2,009		$	(5,053	)


Share Data:
Basic earnings (loss) per common share (1)	$	3.44		$	(6.16	)	$	0.61		$	(1.53	)
Diluted earnings (loss) per common share (1)	$	3.40		$	(6.16	)	$	0.61		$	(1.53	)
Cash dividends declared per common share (1)(2)	$	—		$	0.62		$	0.21		$	1.88
Cash dividends declared on common shares	$	—		$	2,059		$	687		$	6,182
Period end number of common shares outstanding (1)		3,298			3,298			3,298			3,298
Weighted average number of common shares outstanding on a fully diluted basis (1)		3,332			3,298			3,298			3,298
Dividend payout ratio (3)		—	%		(10.14)	%		34.20	%		(122.34)	%
Book value per share data (1)	$	136.84		$	105.00		$	136.84		$	105.00

Performance ratios:
Return on assets (4)		0.33	%		(0.27)	%		0.06	%		0.18	%
Return on common stockholders’ equity (4)		11.37			(19.11	)		1.55			(2.90	)
Annualized operating expenses to total end-of-period assets		1.61			1.12			1.52			1.08
Net yield on interest-earning assets		1.36			0.91			0.99			0.92

Capital Ratios:
Total capital to risk-weighted assets		11.26	%		10.23	%		11.26	%		10.23	%
Tier I capital to risk-weighted assets		9.99			8.96			9.99			8.96
Tier I capital to average assets		6.33			5.23			6.33			5.23
Equity-to-asset ratio (4)		6.92			5.33			6.59			5.44

Asset Quality Ratios:
Total non-performing loans and foreclosed real estate held for sale as a percentage of total assets at end of period		11.72	%		10.42	%		11.72	%		10.42	%
Total non-performing loans as a percentage of loans at end of period		16.79			17.51			16.79			17.51
Net loans charged-off to average total loans (5)		1.26			0.60			1.34			0.77
Allowance for loan losses to total loans at end of period		2.59			3.58			2.59			3.58
Allowance for loan losses to non-performing loans		15.42			20.47			15.42			20.47
Allowance for loan losses to non-performing loans, excluding loans collateralized by real estate		288.07			155.79			288.07			155.79

Other Information:
Common Stock Price: End of Period (1)	$	13.40		$	27.00		$	13.40		$	27.00


	As of
	September 30, 2009		December 31, 2008
	(Amounts in thousands, except per share data)
Balance Sheet Data:
Total assets	$	13,489,617	$	15,282,897
Money market instruments		466,717		1,096,465
Investments securities held to maturity, securities available for sale and trading securities		3,109,100		4,708,211
Loans-net		8,482,884		8,667,717
Total liabilities		12,507,492		14,367,530
Total deposits		9,369,800		11,002,173
Borrowings		3,049,725		3,281,074
Total preferred equity		530,838		530,838
Stockholders’ equity		982,125		915,367


(1)		Adjusted to reflect all Company stock splits and stock dividends, including, most recently, the one-for-fifty reverse stock split approved on November 7, 2008 and effective on December 1, 2008.

(2)		Cash dividends amounts are rounded.

(3)		Common stockholders’ dividend declared divided by income (loss) attributable to common stockholders.

(4)		The return on assets is computed by dividing net income by average total assets for the period. The return on common stockholders’ equity is computed by dividing net income less preferred stock dividends by average common stockholders’ equity for the period. The equity-to-asset ratio is computed by dividing average equity by average total assets. Average balances have been computed using beginning and period-end balances.

(5)		Average balances were computed using beginning and period-end balances.

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) section analyzes the major elements of the Company’s condensed consolidated financial statements and should be read in conjunction with the Condensed Consolidated Financial Statements of the Company and Notes thereto and other detailed information appearing elsewhere in this Quarterly Report on Form 10-Q. Readers should also review carefully Item 1, “Forward-Looking Statements” for a description of the forward-looking statements in this report and a discussion of the factors that might cause our actual results to differ, perhaps materially, from those forward-looking statements.

The MD&A includes the following sections:

	•		DEFINITIONS: Provides a brief definition of key terms used through the MD&A.

	•		GENERAL: Provides a brief description of the Company’s operations.

	•		OVERVIEW OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS: Provides a brief summary of the most significant events and drivers affecting the Company’s financial condition and results of operations.

	•		CRITICAL ACCOUNTING POLICIES: Provides a discussion of the Company’s accounting policies that require critical judgment, assumptions and estimates.

	•		RESULTS OF OPERATIONS: Provides an analysis of the consolidated results of operations for the quarter and nine-months ended September 30, 2009 compared to same periods in 2009.

	•		FINANCIAL CONDITION: Provides an analysis of the most significant balance sheet items that impact the Company’s financial statements and business.

	•		REGULATORY CAPITAL RATIOS: Provides disclosures of the Company’s and Westernbank regulatory capital requirements.

	•		RISK MANAGEMENT: Provides disclosure and analysis about the Company’s main risks, specifically credit risk, market risk and interest rate risk, liquidity risk, operation risk, legal risk, reputational risk, and concentration risk. This section also includes a discussion of the Company’s off-balance sheet activities and contractual obligations.

DEFINITIONS

	•		Loans receivable — net — represents extensions of credit (commercial or personal) resulting from direct negotiations between Westernbank and a borrower, and which management has the intent and ability to hold for the foreseeable future or until maturity or pay-off, net of any deferred fees or costs the allowance for loan losses.

	•		Commercial real estate loans — extensions of credit secured by commercial real estate properties (excludes construction loans).

	•		Residential real estate loans — extensions of credit secured by 1 to 4 family residential properties.

	•		Construction loans — extensions of credit secured by real estate made to finance (a) land development (i.e., the process of improving land) preparatory to erecting new structures or (b) the on-site construction of industrial, commercial, residential, or farm buildings.

	•		Total commercial real estate loans — includes commercial real estate and construction loans.

	•		Commercial, industrial & agricultural (“C&I”) — extensions of credit to sole proprietorships, partnerships, corporations, and other business enterprises, whether secured (other than those that meet the definition of a “loan secured by real estate”) or unsecured, single-payment or installment.

	•		Total commercial loans — includes commercial real estate, construction and C&I loans.

	•		Consumer loans secured by real estate — extensions of credit secured by commercial real estate properties or residential real estate properties.

	•		Consumer other — unsecured extensions of credit, includes installment loans, lines of credit, overdraft, and credit cards.

	•		Total consumer loans — includes consumer loans secured by real estate and consumer other.

	•		Retail deposits — includes non-interest bearing accounts, passbook accounts, NOW accounts, money market accounts and individual certificate of deposits.

	•		Brokered Deposits — represents funds which Westernbank obtains, directly or indirectly, by or through any deposit broker for deposit into one or more deposit accounts.

GENERAL

The Company’s financial performance is reported in three primary business segments: (1) the traditional banking operations of Westernbank Puerto Rico, (2) the activities of the division known as Westernbank International, which includes the activities of WFCC (“Westernbank International”) and (3) the activities of the Asset-Based Lending Unit, which specialized in asset-based commercial business lending. Other operations of the Company not reportable in those segments include: Westernbank Trust Division, which offers trust services; Westernbank International Trade Services Division, which specializes in international trade products and services; SRG Net, Inc., which operates an electronic funds transfer network; Westernbank Insurance Corp., which operates a general insurance agency; Westernbank World Plaza, Inc., which operates the Westernbank World Plaza, a 23-story office building located in Hato Rey, Puerto Rico; and the transactions of the parent company only, which mainly consist of other income related to the equity in the net income (loss) of its wholly-owned subsidiary. Refer to Note 18 of the accompanying unaudited condensed consolidated financial statements for additional information about the Company’s Segment Information.

The Company and its wholly owned subsidiaries’ executive offices are located at 19 West McKinley Street, Mayagüez, Puerto Rico 00680, and the telephone number is (787) 834-8000. The Company’s Internet address is www.wholding.com.

OVERVIEW OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Total assets at September 30, 2009 decreased to $13.5 billion, from $15.3 billion at December 31, 2008. The decrease in total assets was mainly driven by decreases in the Company’s short-term money market instruments, investments and loan portfolios. Money market instruments decreased by $629.7 million or 57%, from $1.1 billion at December 31, 2008, to $466.7 million at September 30, 2009, due to the Company’s decisions to deleverage its balance sheet to strengthen its regulatory capital ratios and to decrease its on-balance sheet liquidity due to improving financial market conditions. During the second half of 2008, the Company decided to build up its on-balance sheet liquidity in light of the financial crisis that affected the financial markets. As a result, during the second half of 2008, the Company increased its on-balance sheet liquidity by raising brokered deposits. During late 2008 and the first half of 2009, the Company undertook additional actions to increase its off-balance sheet liquidity, including among other things, the posting of additional collateral, thereby increasing its borrowing capacity with

the Federal Home Loan Bank of New York (“FHLB”). During the second quarter of 2009, with the additional borrowing capacity established with the FHLB and after much of the financial crisis had passed, the Company decided to decrease its on-balance sheet liquidity. The investment portfolio, excluding short-term money market instruments, decreased $1.6 billion, from $4.7 billion at December 31, 2008 to $3.1 billion at September 30, 2009, due to the aforementioned deleverage decision to strengthen the Company’s regulatory capital ratios. Loans receivable-net decreased by $184.8 million, from $8.7 billion at December 31, 2008, to $8.5 billion at September 30, 2009, due primarily to the Company’s decision to curtail major commercial lending since the summer of 2007 in light of worsening economic conditions in Puerto Rico and the application of stricter underwriting guidelines.

Total deposits stands at $9.4 billion at September 30, 2009, from $11.0 billion at December 31, 2008. The decrease is mainly attributable to the decrease in brokered deposits due to the Company’s decision to decrease its on-balance sheet liquidity, as described above. Brokered deposits at September 30, 2009 and December 31, 2008 were $6.9 billion (74% of total deposits) and $8.6 billion (78% of total deposits), respectively.

Stockholders’ equity increased to $982.1 million at September 30, 2009, from $915.4 million at December 31, 2008. The 2009 increase was principally due to a positive variance of $65.2 million in the accumulated other comprehensive income (loss), net of tax, mainly on unrealizable gains arising during the period on available for sale securities as a result of a favorable interest rate movements coupled with a net income of $6.6 million realized during the first three quarters of 2009, offset in part by dividends of $5.3 million on the Company’s preferred and common shares declared during the first quarter of 2009.

Net income for the quarter and nine-month periods ended September 30, 2009 was $11.3 million and $6.6 million, respectively, compared to a net loss of $11.1 million and a $22.6 million, respectively, for the comparable periods in 2008. Basic and diluted earnings (loss) per common share for the quarter and nine-month periods ended September 30, 2009 amounted to $3.44 ($3.40 on a diluted basis) and $0.61, respectively, compared to basic and diluted earnings (loss) per common share of $(6.16) and $(1.53) (adjusted to reflect the one-for-fifty reverse stock split approved on November 7, 2008 and effective on December 1, 2008), respectively, for the same periods in 2008. The Company’s financial performance for the quarter ended September 30, 2009, as compared to the same quarter in 2008, was principally impacted by:

	•		an increase of $29.5 million in noninterest income due to gain on sales realized from the Company’s available for sale securities portfolio;

	•		a negative variance of $10.0 million in income tax expenses mainly due to a variance in the deferred tax provision as a result of temporary differences related to the Company’s allowance for loan losses and net operating loss carryforwards;

	•		an increase of $8.1 million in noninterest expenses mainly due to an increase in deposit insurance premium and supervisory examination assessed by the FDIC;

	•		an increase of $8.0 million in net interest income principally due to an increase in the Company’s net yield on interest earning assets due to the refinance of high cost liabilities (repurchase agreements and brokered deposits), offset in part by a significant decrease of $3.2 billion or 19% in the Company’s average net earning assets due mainly to Company’s decision to deleverage its balance sheet; and

	•		a decrease of $3.0 million in the provision for loan losses mainly attributable to the positive result of steps taken by the Company since the middle of 2007 to mitigate the overall credit risk underlying the Company’s total commercial loan portfolio and the effect of the continuing downturn in the economy of Puerto Rico, which has been in recession since 2006.

The Company’s return on average assets (ROA) and the return on average common stockholders’ equity (ROCE) for the quarter ended September 30, 2009 were 0.33% and 11.37%, respectively, compared to (0.27)% and (19.11)%, respectively, for the same quarter in 2008. For the nine months ended September 30, 2009 and 2008, the Company’s ROA and ROCE were 0.06% and 1.55%, respectively, compared to 0.18% and (2.90)%, respectively.

CRITICAL ACCOUNTING POLICIES

The accounting and reporting policies followed by the Company and its subsidiary conform to accounting principles generally accepted in the United States of America and general practices within the financial services industry. Various elements of the Company’s accounting policies, by their nature, are inherently subject to estimation techniques, valuation assumptions and other subjective assessments. These estimates are made under facts and circumstances at a point in time and changes in those facts and circumstances could produce actual results that differ from those estimates. The Company’s most significant estimates are the allowance for loan losses, the other-than temporary impairments, the valuation of financial instruments and the income tax and contingencies accruals.

Management has discussed the development and selection of the critical accounting policies and estimates with the Company’s Audit Committee. There have not been any material changes in the Company’s critical accounting policies since December 31, 2008, except for changes in the Other-than-Temporary Impairment (“OTTI”) model. On April 1, 2009, the Company adopted Financial Accounting Standard Board (“FASB”) Accounting Standard Codification (“ASC”) 320-10-65-1, which changed the accounting requirements for other than temporary impairments for debt securities, and in certain circumstances, separates the amount of total impairment into credit and noncredit-related amounts. Refer to Note 1 of the accompanying unaudited condensed consolidated financial statements for additional information about the adoption of this new issued FASB authoritative guidance’s. The adoption of this guidance did not have a significant impact on the Company’s condensed consolidated financial statements.

RESULTS OF OPERATIONS

Net Interest Income

The Company’s principal source of earnings is its net interest income, which is the difference between interest income on loans and invested assets (“interest-earning assets”) and interest expense on deposits and borrowings, including federal funds purchased and repurchase agreements and advances from the FHLB (“interest-bearing liabilities”). Loan origination and commitments fees, net of related costs, are deferred and amortized over the life of the related loans as a yield adjustment. Gains or losses on the sale of loans and investments, service charges, fees and other income, also affect income. In addition, the Company’s net income is affected by the level of its non-interest expenses, such as the provision for loan losses, compensation, employees’ benefits, occupancy costs, other operating expenses and income taxes.

The Company’s net interest income is subject to interest rate risk due to the re-pricing and maturity mismatch of the Company’s assets and liabilities. The Company manages its exposure to interest rate risk through the Company’s Assets and Liabilities Management Committee (“ALCO”). The main objective of the Company’s Assets and Liabilities Management program is to invest funds judiciously and reduce interest rate risks while optimizing net income and maintaining adequate liquidity levels. As further discussed under the header “- Market Risk and Interest Rate Risk”, the Company uses several tools to manage the risks associated with the composition and repricing of assets and liabilities. Therefore, management has followed a conservative practice inclined towards the preservation of capital with adequate returns. The ALCO, which includes the entire Board of Directors and the Company’s senior management, is responsible for the asset-liability management oversight. The Investment Department is responsible for implementing the policies established by the ALCO.

Net interest income for the third quarter and nine-month periods ended September 30, 2009, was $46.4 million and $102.5 million, respectively, an increase of $8.0 million or 21% and a decrease of $12.4 million or 11%, respectively, when compared to the same periods in 2008. The increase for the third quarter of 2009, when compared to same quarter of 2008, is mainly attributable to an increase in the Company’s net yield on interest earning assets offset in part by a decrease of $228.2 million or 26% in the Company’s average net earning assets, due mainly to Company’s decision to deleverage its balance sheet. For the quarter ended September 30, 2009, the net yield on interest-earning assets increased by 45 basis points, from 0.91% in 2008 to 1.36% in 2009. The increase in net yield on interest-earning assets in 2009 was driven by lower funding costs as a result of the refinancing of high cost liabilities in a lower rate environment, offset in part by lower yield on assets. The Company’s average interest rate paid in total deposits decreased by 68 basis points from 4.11% for third quarter of 2008, to 3.43% for the third quarter of 2009. The Company’s average interest rate paid in federal funds purchased and repurchase agreements decreased 131 basis points from 4.19% for the third quarter of 2008, to 2.88% for the same period in 2009. These decreases were influenced by the reduction in short-term interest rates experienced during 2008 and 2009. For the quarter ended September 30, 2009, the yield on the Company’s interest-earning assets decreased by 39 basis points, when compared to the same period in 2008, mainly due to lower loan yield resulting from the repricing of variable-rate construction and commercial loans tied to short-term indexes, coupled with lower yields on the Company’s money market instruments. For further details on the Company’s interest rate risk profile, refer to “Risk Management — Market Risk & Interest Rate Risk” section of this discussion.

The decrease in net interest income for the nine-month period ended September 30, 2009, when compared to the same period in 2008, was mainly due to a decrease in the Company’s average net interest-earning assets, offset in part by an in decrease in net yield earned on the average interest-earning assets. Average net interest-earning assets for the first nine months of 2009 decreased by $253.6 billion or 26%, compared to the same period in 2008, driven by an overall decrease in the average investment securities and loan portfolios of $2.0 billion and $475.3 million, respectively, offset in part by an overall decrease in the average deposits and federal funds purchased and repurchase agreements of $451.6 million and $2.2 billion, respectively, due to the Company’s decision to de-leverage its balance sheet to improve regulatory capital ratios and the Company’s decision to curtail commercial lending. For the nine-month period ended September 30, 2009, the net yield on interest-earning assets increased by 7 basis points, from 0.92% in 2008, to 0.99% in 2009.

The following table presents, for the periods indicated, the total dollar amount of interest income from average interest-earning assets and the resultant yields, as well as the interest expense on average interest-bearing liabilities, expressed both in dollars and rates, as well as in a normal and tax equivalent basis. Average balances are daily monthly average balances. The yield on the securities portfolio is based on average amortized cost balances and does not give effect to changes in fair value that are reflected as a component of consolidated stockholders’ equity for investment securities available for sale.


	Three Months Ended September 30,
	2009								2008
						Annualized Average								Annualized Average
	Interest		Average Balance (1)			Yield/Rate			Interest		Average Balance (1)			Yield/Rate
						(Dollars in thousands)
Normal spread:
Interest-earning assets:
Loans, including loan fees (2)	$	111,785	$	8,853,040			5.01	%	$	141,897	$	9,315,431			6.06	%
Investment securities (3)		1,680		199,632			3.34			19,596		2,987,827			2.61
Mortgage-backed securities (4)		37,317		4,044,651			3.66			37,639		3,681,959			4.07
Money market instruments		1,175		442,892			1.05			4,513		757,939			2.37

Total		151,957		13,540,215			4.45			203,645		16,743,156			4.84


Interest-bearing liabilities:
Deposits:
Retail		14,360		2,474,415			2.30			15,680		2,528,310			2.47
Brokered		69,251		7,193,020			3.82			96,856		8,356,781			4.61

Total		83,611		9,667,435			3.43			112,536		10,885,091			4.11
Federal funds purchased and repurchase agreements		20,890		2,879,150			2.88			52,051		4,943,035			4.19
Advances from FHLB		1,074		348,793			1.22			630		42,000			5.97

Total		105,575		12,895,378			3.25			165,217		15,870,126			4.14


Net interest income	$	46,382							$	38,428

Interest rate spread							1.20	%							0.70	%

Net interest-earning assets			$	644,837							$	873,030

Net yield on interest-earning assets (5)							1.36	%							0.91	%

Ratio of interest-earning assets to interest-bearing liabilities				105.00	%							105.50	%


(1)		Average balance on interest-earning assets and interest-bearing liabilities is computed using daily monthly average balances during the period.

(2)		Loan fees, net amounted to $2.3 million and $2.0 million for the three-month period ended September 30, 2009 and 2008, respectively.

(3)		Includes available for sale securities.

(4)		Includes trading and available for sale securities.

(5)		Annualized net interest income divided by average interest-earning assets.


	Nine Months Ended September 30,
	2009								2008
						Annualized Average								Annualized Average
	Interest		Average Balance (1)			Yield/Rate			Interest		Average Balance (1)			Yield/Rate
						(Dollars in thousands)
Normal spread:
Interest-earning assets:
Loans, including loan fees (2)	$	347,296	$	8,946,502			5.19	%	$	440,485	$	9,421,781			6.24	%
Investment securities (3)		6,892		336,091			2.74			88,624		3,957,300			2.99
Mortgage-backed securities (4)		106,423		3,832,190			3.71			78,609		2,547,150			4.12
Money market instruments		3,427		754,769			0.61			17,420		805,359			2.89

Total		464,038		13,869,552			4.47			625,138		16,731,590			4.99


Interest-bearing liabilities:
Deposits:
Retail		44,023		2,438,539			2.41			51,013		2,545,656			2.68
Brokered		237,215		7,757,622			4.09			291,350		8,102,119			4.80

Total		281,238		10,196,161			3.69			342,363		10,647,775			4.29
Federal funds purchased and repurchase agreements		77,968		2,822,066			3.69			165,548		5,064,842			4.37
Advances from FHLB		2,317		146,304			2.12			2,351		60,372			5.20

Total		361,523		13,164,531			3.67			510,262		15,772,989			4.32

Net interest income	$	102,515							$	114,876

Interest rate spread							0.80	%							0.67	%

Net interest-earning assets			$	705,021							$	958,601

Net yield on interest-earning assets (5)							0.99	%							0.92	%

Ratio of interest-earning assets to interest-bearing liabilities				105.36	%							106.08	%


(1)		Average balance on interest-earning assets and interest-bearing liabilities is computed using daily monthly average balances during the period.

(2)		Loan fees, net amounted to $6.7 million and $6.3 million for the three-month period ended September 30, 2009 and 2008, respectively.

(3)		Includes available for sale securities.

(4)		Includes trading and available for sale securities.

(5)		Annualized net interest income divided by average interest-earning assets.

The following table presents the dollar amount of changes in interest income and interest expense for the major components of interest-earning assets and interest-bearing liabilities and distinguishes between the increase (decrease) related to changes in outstanding balances and changes in interest rates. The changes are segregated for each major category of interest-earning asset and interest-bearing liability into amounts attributable to (a) changes in volume (change in volume times old rate), (b) changes in rates (change in rate times old volume), and (c) changes in rate/volume (change in rate times the change in volume). The rate/volume variances are allocated to changes in volume and changes in rate on a proportional basis.


	Three Months Ended September 30,									Nine Months Ended September 30,
	2009 vs. 2008									2009 vs. 2008
	Volume			Rate			Total			Volume			Rate			Total
							(In thousands)
Interest income:
Loans	$	(6,787	)	$	(23,325	)	$	(30,112	)	$	(21,341	)	$	(71,848	)	$	(93,189	)
Investment securities (1)		(25,688	)		7,772			(17,916	)		(74,829	)		(6,903	)		(81,732	)
Mortgage-backed securities (2)		(24,183	)		23,861			(322	)		34,711			(6,897	)		27,814
Money market instruments		(1,432	)		(1,906	)		(3,338	)		(1,030	)		(12,963	)		(13,993	)

Total decrease in interest income		(58,090	)		6,402			(51,688	)		(62,489	)		(98,611	)		(161,100	)

Interest expense:
Deposits:
Retail		(330	)		(990	)		(1,320	)		(2,082	)		(4,908	)		(6,990	)
Brokered		(12,476	)		(15,129	)		(27,605	)		(11,969	)		(42,166	)		(54,135	)

Total		(12,806	)		(16,119	)		(28,925	)		(14,051	)		(47,074	)		(61,125	)
Federal funds purchased and repurchase agreements		(17,880	)		(13,281	)		(31,161	)		(64,885	)		(22,695	)		(87,580	)
Advances from FHLB		498			(54	)		444			(58	)		24			(34	)

Total increase in interest expense		(30,188	)		(29,454	)		(59,642	)		(78,994	)		(69,745	)		(148,739	)

Increase (decrease) in net interest income	$	(27,902	)	$	35,856		$	7,954		$	16,505		$	(28,866	)	$	(12,361	)


(1)		Includes available for sale securities.

(2)		Includes trading and available for sale securities.

Provision For Loan Losses

The provision for loan losses is charged to earnings to maintain the allowance for loan losses at a level that the Company considers adequate to absorb probable losses inherent in the loan portfolio. The adequacy of the allowance for loan losses is based on ongoing, quarterly assessments and evaluations of the collectibility and historical loss experience of loans. The Company follows a systematic methodology to establish and evaluate the adequacy of the allowance for loan losses. Although the Company believes that the allowance for loan losses is adequate, factors beyond the Company’s control, including factors affecting the Puerto Rico economy may contribute to delinquencies and defaults, thus necessitating additional reserves.

For the quarter and nine-month periods ended September 30, 2009, the Company provided $12.4 million and $32.3 million, respectively, for loan losses, as compared to $15.4 million and $44.7 million, respectively, for the comparable periods in 2008.

The decrease in provision for loan losses in 2009, compared to 2008, reflects the positive results of actions taken by the Company since the middle of 2007 to mitigate the overall credit risks underlying the Company’s total commercial loan portfolio in light of the continued downturn in the economy of Puerto Rico, which has been in recession since 2006. These steps included setting portfolio limits and applying stricter underwriting guidelines, among others. As a result of these steps, among other things, the Company’s loan portfolio decreased by $481.1 million, from $9.2 billion at September 30, 2008, to $8.7 billion at September 30, 2009 and the Company’s non-performing and impaired loans decreased by $146.6 million or 9% from September 30, 2008 to September 30, 2009.

For discussion regarding Loans Charged-Off, Non-Performing and Impaired Loans, Allowance for Loan Losses, and related ratios refer to “Non-performing loans, Troubled Debt Restructurings and Foreclosed Real Estate Held For Sale” under “Financial Condition.”

Noninterest Income

Total noninterest income for the quarter and nine-month periods ended September 30, 2009 amounted to $39.3 million and $96.5 million, respectively, as compared to $9.9 million and $48.2 million for the same respective periods in 2008.

The following table presents the components of total noninterest income:


	Quarter Ended September 30,					Nine Months Ended September 30,
	2009		2008			2009		2008
			(In thousands)
Service and other charges on loans	$	1,934	$	2,549		$	6,467	$	7,751
Service charges on deposit accounts		2,159		2,851			6,691		8,903
Other fees and commissions		4,506		5,504			14,583		16,993
Net gain on derivative instruments		664		1,622			1,410		2,844
Net gain (loss) on sales of loans, securities and others assets		30,072		(2,655	)		67,353		11,674


Total noninterest income	$	39,335	$	9,871		$	96,504	$	48,165

For the quarter and nine-month periods ended September 30, 2009, noninterest income increased by $29.5 million and $48.3 million, respectively, when compared to the same periods in 2008. The increase in 2009 was mainly driven by positive variances in net gain on sales of loans, securities and other assets, offset in part by decreases in net gain on derivative instruments and charges and fees on loans, deposits and other activities. The positive variance in net gain (loss) on sales of loans, securities and other assets, for 2009 when compared to 2008, was mainly due to an increase in gain on sales realized from the Company’s available for sale securities portfolio as a result of market rate movements, coupled with the termination during the third quarter of 2008 of agreements that the Company had with affiliates of Lehman Brothers Holdings, Inc. (“LBHI”) after LBHI filed for bankruptcy, which resulted in a charge of $3.3 million (refer to “Investments” under “Financial Condition” for further details).

The decrease in service and other charges on loans was mainly due to lower volume of business in commercial loans due to the Company’s decision to curtail major commercial lending, principally related to the operations of the Asset-Based Lending Unit, in light of worsening economic conditions in Puerto Rico. The decrease in service charges on deposit accounts was mainly due to a decrease in the volume of transactions that require service charges. Customers engaged in fewer transactions because of the current economic environment. Other fees and commissions decreased during 2009 due to lower merchant fees and lower automatic teller machine fees as a result of fewer transactions in light of the current economic environment.

This decrease in net gain on derivative instruments in 2009 was mainly the result of variances on the mark-to-market positions on derivative instruments.

Noninterest Expenses

Total noninterest expenses for the quarter and nine-month period ended September 30, 2009 amounted to $54.1 million and $153.3 million, respectively, as compared to $46.1 million and $132.9 million, respectively, for the same periods in 2008. The following table presents the components of total noninterest expenses:


	Quarter Ended September 30,				Nine Months Ended September 30,
	2009		2008		2009		2008
			(Dollars in thousands)
Salaries and employees’ benefits	$	14,157	$	17,064	$	42,801	$	49,926
Equipment expenses		3,354		3,337		9,486		10,136
Deposits insurance premium and supervisory examination		12,218		3,957		40,785		10,578
Occupancy		2,431		2,601		6,736		7,903
Advertising		1,604		1,650		5,289		5,943
Printing, postage, stationery and supplies		971		976		2,727		3,168
Telephone		663		784		1,976		2,364
Net loss from operations of foreclosed real estate held for sale		974		107		1,508		216
Municipal taxes		2,862		2,726		8,386		7,510
Professional fees		4,443		5,848		11,892		13,943
Provision for claims		—		485		—		485
Other		10,451		6,531		21,707		20,679


Total noninterest expenses	$	54,128	$	46,066	$	153,293	$	132,851

Total noninterest expenses for the quarter and nine-month periods ended September 30, 2009 increased by $8.1 million and $20.4 million, respectively, when compared to same periods in 2008. The increase in total noninterest expenses for 2009 was mainly due to increases in deposit insurance premiums and supervisory examination, offset in part by decreases in salaries and employees’ benefits and professional fees and other expenses.

As a result of new assessment systems implemented under the Federal Deposit Insurance Reform Act of 2005 and a one-time special assessment as discussed below, deposit insurance premiums paid to the FDIC for the quarter and nine-month periods ended September 30, 2009 increased by $8.3 million and $30.2 million, respectively, when compared to the same periods in 2008. In addition to a new assessment system implemented in 2009, an emergency special assessment of five basis points on each FDIC-insured depository institution’s assets, minus

its Tier 1 capital, was approved by the FDIC, for collection in the third quarter of 2009, based on applicable assets as of June 30, 2009. This special assessment resulted in an additional charge to Westernbank of $6.8 million that was recorded in the second quarter of 2009. In addition, on November 12, 2009, the FDIC adopted a final rule amending its assessment regulations to require insured depository institutions, including Westernbank, to prepay quarterly regular risk-based assessments for the fourth quarter of 2009 and for all of 2010, 2011. These prepayments are due on December 31, 2009 and are in addition to the regular third quarter 2009 assessment due on that same date. In accordance with the discretion provided to the FDIC under 12 C.F.R. § 327.12(i)(1), the FDIC exempted Westernbank from prepaying its quarterly risk-based assessment for the fourth quarter of 2009, and all of 2010, 2011, and 2012.

Noninterest expenses, as a group, excluding deposit insurance premiums and supervisory examination expenses, decreased by $200,000 for the third quarter of 2009 and $9.8 million for the first nine months of 2009, as compared to 2008. This is the result of continued cost control measures implemented by the Company.

Salaries and employees’ benefits, the largest component of total noninterest expenses, decreased $2.9 million or 17% for the third quarter of 2009 and $7.1 million or 14% for the first nine months of 2009, as compared to the same periods in 2008. The decrease in 2009 was principally attributed to the implementation of a restructuring plan during the fourth quarter of 2008, which included closing seven branches and the elimination of approximately 125 positions. Total full time employees decreased from 1,473 at September 30, 2008, to 1,411 at September 30, 2009.

Professional fees expenses decreased $1.4 million or 24% for the third quarter of 2009 and $2.1 million or 15% for the first nine months of 2009, as compared to the same periods in 2008. The decrease was mainly due to the conclusion of the internal review conducted by the Company’s Audit Committee as a result of the restatement announcement and other legal and regulatory matters.

Provision for Income Taxes

The Company’s primary tax jurisdiction is Puerto Rico. Under Puerto Rico income tax laws, the Company is required to pay the higher of an alternative minimum tax of 22% or regular statutory rates ranging from 20% to 39%. Under the Puerto Rico Internal Revenue Code (“PR-IRC”), all companies are treated as separate taxable entities. The Company, Westernbank, Westernbank Insurance Corp. and SRG Net, Inc. are subject to Puerto Rico regular income tax or alternative minimum tax on income earned from all sources. Westernbank World Plaza, Inc., a wholly owned subsidiary of Westernbank, elected to be treated as a special partnership under the PR-IRC; accordingly, its taxable income or deductible loss is included in the taxable income of Westernbank. On March 9, 2009, the Governor of Puerto Rico signed into law Act No. 7 (“Act No. 7”), also known as Special Act Declaring a Fiscal Emergency Status to Save the Credit of Puerto Rico, which amended several sections of the PR-IRC, including sections related to income, property, excise and sales and use tax provision. Act No. 7, as amended by Act No. 37 approved on July 10, 2009, imposes a series of temporary and permanent measures, including the imposition of a 5% surtax over the total income tax determined, which is applicable to companies whose combined income exceeds $100,000, effectively increasing the maximum statutory rate from 39% to 40.95%. This temporary measure is effective for tax years that commenced after December 31, 2008 and before January 1, 2012.

For the quarter ended September 30, 2009, the Company recognized an income tax expense of $7.9 million, compared to a benefit of $2.1 million recorded for the same quarter in 2008. The negative variance in the third quarter of 2009, as compared to the same quarter in 2008, was mainly attributable to a negative variance in the Company’s provision for deferred taxes due temporary differences related to changes in the allowance for loan losses.

For the first nine months of 2009, the Company recorded an income tax expense of $6.8 million, a negative variance of $43.9 million when compared to the tax benefit of $37.2 million for the same period in 2008. The negative variance in income taxes was mainly attributable to agreements reached by the Company with local and federal authorities during the first quarter of 2008 that yielded a benefit of $33.3 million for 2008, coupled with negative variance in the Company’s provision for deferred taxes due to temporary differences related to changes in the allowance for loan losses.

The Company evaluates and assesses the relative risks and appropriate tax treatment of transactions and filing positions after considering statutes, regulations, judicial precedent and other information and maintains tax accruals consistent with its evaluation of these relative risks and merits. Changes to the estimate of accrued taxes occur periodically due, among other, to changes in tax rates, interpretations of tax laws, the status of examinations being conducted by taxing authorities and changes to statutory, judicial and regulatory guidance that impact the relative risks of tax positions. These changes, when they occur, can affect the income tax accruals as well as the current period’s income tax expense and can be significant to the operating results of the Company.

The portion of the provision for income taxes related to unrecognized tax benefits amounted to a provision of $38,000 and a credit of $488,000 for the quarter and nine-month periods ended September 30, 2009, respectively, compared to a provision of $308,000 and a credit of $33.2 million, respectively, for the comparable periods in 2008. The Company’s condensed consolidated statements of financial condition include liabilities of $1.5 million and $2.0 million at September 30, 2009 and December 31, 2008, respectively, for the exposures resulting from income taxes related to unrecognized tax benefits identified by the Company in connection with this evaluation. Uncertain income tax positions at September 30, 2009 and December 31, 2008, mainly relate to certain expense deductions taken in income tax returns.

FINANCIAL CONDITION

Loans

Loans receivable-net, were $8.5 billion or 63% of total assets at September 30, 2009, a decrease of $184.8 million, when compared to $8.7 billion or 57%, at December 31, 2008.

The following table presents the composition of the loan portfolio at the dates indicated:


	September 30, 2009						December 31, 2008
	Amount			Percent			Amount			Percent
				(Dollars in thousands)
Commercial real estate loans (1)	$	4,961,896			58.5	%	$	5,100,483			58.8	%
Residential real estate loans		971,478			11.4			965,171			11.2
Construction loans		1,354,587			16.0			1,439,224			16.6
Commercial, industrial and agricultural (1)		633,340			7.5			716,514			8.3
Consumer — secured by real estate		541,144			6.4			494,556			5.7
Consumer — other		245,941			2.9			233,858			2.7


Total loans		8,708,386			102.7			8,949,806			103.3

Allowance for loan losses		(225,502	)		(2.7	)		(282,089	)		(3.3	)

Loans — net	$	8,482,884			100.0	%	$	8,667,717			100.0	%


(1)		Includes $681.2 million and $782.6 million at September 30, 2009 and December 31, 2008, respectively, of the outstanding loans of the Asset Based Lending Unit.

Westernbank’s commercial real estate, construction, and commercial, industrial, and agricultural loans are primarily variable and adjustable rate products. Total Commercial loan originations come from existing customers as well as through direct solicitation and referrals. Westernbank offers different types of consumer loans, including secured and unsecured products, in order to provide a full range of financial services to its retail customers. In addition, Westernbank offers VISA (™) and MasterCard (™) accounts to its customers.

Total Commercial Loans

As of September 30, 2009, commercial real estate and construction loans were $6.3 billion or 75% and C&I loans were $633.3 million or 7% of the $8.5 billion loan portfolio-net, compared to commercial real estate and construction loans of $6.5 billion or 75% and C&I loans of $716.5 million or 8% of the $8.7 billion loan portfolio-net as of December 31, 2008. Over the last few years, the Company has emphasized the commercial loan segment in Puerto Rico. This has enabled Westernbank to shift its asset composition to assets with shorter maturities and greater repricing flexibility. The strategy has also enabled Westernbank to diversify its revenue sources, while maintaining its status as a secured lender, with approximately 90% of its loans collateralized by real estate as of September 30, 2009. As of September 30, 2009, the loan portfolios of the Asset Based Lending Unit amounted to $681.2 million (64% collateralized by real estate) compared to $782.6 million (60% collateralized by real estate) as of December 31, 2008, a decrease of $101.4 million. The decrease in 2009 was mainly due to the Company’s decision to curtail lending in this line of business.

this violation, Westernbank paid a penalty of $50,000 during 2008. At September 30, 2009, this loan relationship was not impaired. There can be no assurance that the Commissioner of the OCIF will not take further actions on this issue.

At September 30, 2009, commercial real estate loans totaled $5.0 billion. In general, commercial lending, including commercial real estate, asset-based, unsecured business and construction, are considered by management to be of greater risk of collectibility than consumer lending, including residential real estate, because such loans are typically larger in size and more risk is concentrated in a single borrower. In addition, the borrower’s ability to repay a commercial loan or a construction loan depends, in the case of a commercial loan, on the successful operation of the business or the property securing the loan and, in the case of a construction loan, on the successful completion and sale or operation of the project. Substantially all of the Company’s borrowers and properties and other collateral securing the commercial real estate mortgage and consumer loans are located in Puerto Rico. These loans may be subject to a greater risk of default if the Puerto Rico economy suffers adverse economic, political or business developments, or if natural disasters affect Puerto Rico.

Westernbank has historically provided land acquisition, development, and construction financing to developers for residential housing projects. Construction loans extended to developers are typically adjustable rate loans, indexed to the prime interest rate with terms ranging generally from 12 to 48 months.

The Company’s commercial real estate loan portfolio is mostly comprised of loans to owner-occupied borrowers in which the real estate collateral is taken as a secondary source of repayment or through an abundance of caution. As of September 30, 2009, commercial real estate loans to owner-occupied borrowers amounted to 80% of total commercial real estate loans. These loans are sensitive to the economic condition and cash flow of the borrower’s business, but are less sensitive to factors such as market conditions, capitalization rates, vacancy rates and rental rates.

The composition of the Company’s construction loan portfolio as of September 30, 2009 by category follows:


	(In thousands)
Loans for residential housing projects:
High-rise (1)	$	170,585
Mid-rise (2)		241,565
Single-family detach		217,426
Mix		176,995


Total for residential housing projects		806,571

Construction loans to individuals secured by residential properties		5,757
Land loans		287,893
Loans for commercial projects:
Hospitals and other healthcare services		65,126
Shopping malls		43,350
Hotels		45,859
Piers		28,848
Others		73,859

Total before net deferred fees and allowance for loan losses		1,357,263
Net deferred fees		(2,676	)

Total construction loan portfolio, gross		1,354,587
Allowance for loan losses		(78,749	)

Total construction loan portfolio, net	$	1,275,838


(1)		For purposes of the above table, high-rise portfolio is composed of buildings with more than seven stories.

(2)		Mid-rise relates to buildings up to seven stories.


	(Dollars in
	thousands)
Total undisbursed funds under existing commitments	$	131,860

Construction loans in non-accrual status	$	400,800

Net charge-offs — construction loans for the nine-months period ended September 30, 2009	$	42,556

Allowance for loan losses — Construction loans	$	78,749

Non-performing construction loans to total construction loans		29.59	%

Allowance for loan losses — construction loans to total construction loans		5.81	%

Net charge-offs to total average construction loans for the nine-months period ended September 30, 2009		4.06	%

The following summarizes the construction loans for residential housing projects in Puerto Rico segregated by the estimated selling price of the units at September 30, 2009:


	(In thousands)
Under $300,000	$	245,510
$300,000 - $600,000		248,002
Over $600,000		313,059


Total	$	806,571

Residential Real Estate Loans

Residential real estate loans are mainly comprised of loans secured by first mortgages on one-to-four family residential properties. At September 30, 2009, the Company’s residential real estate loan portfolio amounted to $971.5 million, an increase of $6.3 million, when compared to balances as of December 31, 2008. The increase was mainly due to the Company’s strategic of emphasize residential real estate lending to diversify the Company’s revenue source and to increase liquidity.

Consumer Loans

The Company’s consumer loan category is comprised of consumer loans secured by real estate and other loans. The Company originates consumer loans secured by real estate in amounts up to 75% of the appraised value of the property, including the amount of any existing prior liens. Such loans generally have an interest rate that is variable based on market conditions. The loans are secured with a first or second mortgage on the property, including loans where another institution holds the first mortgage. The Company’s consumer other loan category consists principally of unsecured consumer and credit card loans. At September 30, 2009, the Company’s consumer loan portfolio totaled $787.1 million (of which $541.1 million were secured by real estate) compared to $728.4 million (of which $494.6 million were secured by real estate) at December 31, 2008. Consumer loans generally have shorter terms and higher interest rates than commercial and mortgage loans but generally involve more credit risk because of the type and nature of the collateral and, in certain cases, the absence of collateral. In addition, consumer lending collections are dependent on the borrower’s continuing financial stability, and thus are more likely to be adversely effected by job loss, divorce, illness and personal bankruptcy.

The following table summarizes the contractual maturities of Westernbank’s total loans for the periods indicated at September 30, 2009. Contractual maturities do not necessarily reflect the expected term of a loan, including prepayments.


			MATURITIES
					After One Year to Five Years				After Five Years
	Balance		One Year or		Fixed		Variable		Fixed		Variable
	Outstanding		Less		Interest		Interest		Interest		Interest
	(In thousands)
Commercial real estate loans	$	4,961,896	$	1,533,382	$	438,287	$	642,870	$	92,679	$	2,254,678
Residential real estate loans		971,478		592,916		52,665		26,501		299,259		137
Construction loans		1,354,587		971,011		17,065		297,213		9,400		59,898
Commercial, industrial and agricultural		633,340		409,117		32,093		116,378		251		75,501
Consumer — secured by real estate		541,144		12,934		35,234		12,076		64,173		416,727
Consumer — other		245,941		111,928		104,900		55		27,709		1,349


Total	$	8,708,386	$	3,631,288	$	680,244	$	1,095,093	$	493,471	$	2,808,290

Westernbank’s loan originations come from a number of sources. The primary sources for residential loan originations are depositors and walk-in customers. Commercial loan originations come from existing customers as well as through direct solicitation and referrals.

It is Westernbank’s policy to originate loans in accordance with written, non-discriminatory underwriting standards and loan origination procedures prescribed in the Board of Directors approved loan policies. Detailed loan applications are obtained to determine the borrower’s repayment ability. Applications are verified through the use of credit reports, financial statements and other confirmation procedures. Property valuations by independent appraisers approved by the Board of Directors are required for mortgage and all real estate loans.

It is Westernbank’s policy to require Senior Lending Credit Committee (“SLCC”) approval for all loans in excess of $25.0 million, including the Asset-Based Lending Unit, formerly known as Westernbank Business Credit Division. The SLCC also reviews and ratifies all loans from $2.5 million to $25.0 million approved by Westernbank’s regional credit committees. The SLCC is composed of a majority of the members of the Company’s Board of Directors and senior lending officers. All loans in excess of $25.0 million, including the Asset-Based Lending Unit, formerly known as Westernbank Business Credit Division, approved by the SLCC are also reviewed and ratified by the Board of Directors of the Company. All loans in excess of $100.0 million require the approval of the Board of Directors of the Company.

It is Westernbank’s policy to require borrowers to provide title insurance policies certifying or ensuring that Westernbank has a valid first lien on the mortgaged real estate. Borrowers must also obtain hazard insurance policies prior to closing and, when required by the Department of Housing and Urban Development, flood insurance policies. Borrowers may be required to advance funds on a monthly basis together with each payment of principal and interest to a mortgage escrow account from which Westernbank makes disbursements for items such as real estate taxes, hazard insurance premiums and private mortgage insurance premiums as they fall due.

Westernbank’s practice is that its production and origination of residential real estate loans are mostly conforming loans, eligible for sale in the secondary market. The loan-to-value ratio at the time of origination on residential mortgages is generally 75%, except that Westernbank may lend up to 97% of the lower of the purchase price or appraised value of residential properties if private mortgage insurance is obtained, except for certain qualified new development projects, by the borrower for amounts in excess of 80%.

Westernbank originates fixed and adjustable rate residential mortgage loans secured by a first mortgage on the borrower’s real property, payable in monthly installments for terms ranging from ten to forty years. Adjustable rates are indexed to specified prime or LIBOR rate. All 30-year conforming mortgage loans are originated with the intent to sell. Westernbank has also granted loans, mainly secured by first mortgages on one-to-four residential properties, to mortgage originators in Puerto Rico.

Westernbank originates primarily variable and adjustable rate commercial business and real estate loans. Westernbank also makes real estate construction loans subject to firm permanent financing commitments.

Westernbank offers different types of consumer loans in order to provide a full range of financial services to its customers. Within the different types of consumer loans offered by Westernbank, there are various types of secured and unsecured consumer loans with varying amortization schedules. In addition, Westernbank makes fixed-rate residential second mortgage consumer loans. In July 2002, Westernbank launched a new banking division focused on offering consumer loans that now has 10 full-service branches, called “Expresso of Westernbank”, denoting the branches’ emphasis on small, unsecured consumer loans up to $15,000 and collateralized consumer loans up to $150,000.

Westernbank offers the service of VISA ^TM and MasterCard ^TM credit cards. At September 30, 2009, there were approximately 21,298 outstanding accounts, with an aggregate outstanding balance of $50.3 million and unused credit card lines available of $72.2 million.

In connection with all consumer loans originated, Westernbank’s underwriting standards include a determination of the applicants’ payment history on other debts and an assessment of the ability to meet existing obligations and payments on the proposed loan.

Non-performing loans and foreclosed real estate held for sale

The Company places a loan in non-performing status as soon as management has doubts as to the ultimate collectibility of principal or interest or when contractual payments of principal or interest are 90 days overdue. When a loan is designated as non-performing, interest accrual is suspended and a specific provision is established, if required. When a borrower fails to make a required payment on a loan, Westernbank attempts to cure the deficiency by contacting the borrower. If the delinquency exceeds 90 days and is not cured through normal collection procedures, Westernbank will generally institute measures to remedy the default. For collateral dependant loans, if a foreclosure action is instituted and the loan is not cured, paid in full or refinanced, the property is sold at a judicial sale at which Westernbank may acquire the property. In the event that the property is sold at a price insufficient to cover the balance of the loan, the debtor remains liable for the deficiency. Thereafter, if Westernbank acquires the property, such acquired property is appraised and included in the foreclosed real estate held

for sale account at the fair value less costs to sell at the date of acquisition. Then, this asset is carried at the lower of fair value less estimated costs to sell or cost until the property is sold.

The accrual of interest on loans is discontinued when there is a clear indication that the borrower’s cash flows may not be sufficient to meet payments as they become due, but in no event is it recognized after a borrower is 90 days in arrears on payments of principal or interest. When a loan is placed on nonaccrual status, all previously accrued and unpaid interest is charged against income and interest is accounted for on the cash-basis method or for certain high loan-to-value credits on the cost-recovery method until qualifying for return to accrual status. Generally, a loan is returned to accrual status when all delinquent interest and principal payments become current in accordance with the terms of the loan agreement or when the loan is both well secured and in the process of collection and collectibility is no longer doubtful. Consumer loans that have principal and interest payments that have become past due one hundred and twenty days and credit cards and other consumer revolving lines of credit that have principal and interest payments that have become past due one hundred and eighty days are charged-off against the allowance for loan losses.

Westernbank engages in the restructuring of the debt of borrowers who are delinquent due to economic or legal reasons, if the Company determines that it is in the best interest for both the Company and the borrower to do so. In some cases, due to the nature of the borrower’s financial condition, the restructure or loan modification fits the definition of Troubled Debt Restructuring (“TDR”) as promulgated under existing FASB guidance. Such restructurings are identified as TDRs and accounted for based on the relevant accounting pronouncements.

The following table sets forth information regarding non-performing loans and foreclosed real estate held for sale of the Company at the dates indicated:


	September 30, 2009			December 31, 2008
	(Dollars in thousands)
Commercial real estate loans (1)	$	891,187		$	825,504
Residential real estate loans		64,472			43,106
Construction loans		400,800			523,093
Commercial, industrial and agricultural loans (2)		72,559			148,446
Consumer — secured by real estate		27,282			14,890
Consumer — other		5,722			4,992

Total non-performing loans		1,462,022			1,560,031
Foreclosed real estate held for sale		119,308			98,570

Total non-performing loans and foreclosed real estate held for sale	$	1,581,330		$	1,658,601


Interest that would have been recorded if the loans had not been classified as non-performing	$	125,077		$	90,704

Interest recorded on non-performing loans	$	17,867		$	25,874

Total non-performing loans as a percentage of total loans at end of period		16.79	%		17.43	%

Total non-performing loans and foreclosed real estate held for sale as a percentage of total assets at end of period		11.72	%		10.85	%


(1)		Includes $47.6 million and $118.2 million of loans of the Asset Based Lending Unit, at September 30, 2009 and December 31, 2008, respectively.

(2)		Includes $63.1 million and $141.2 million of loans of the Asset Based Lending Unit, at September 30, 2009 and December 31, 2008, respectively.

Total non-performing loans at September 30, 2009 decreased by $98.0 million or 6% when compared to balances at December 31, 2008. The decrease of non-performing loans is mainly attributable to the Company’s decision to curtail major commercial lending, including construction lending, during the summer of 2007 and the application of stricter underwriting guidelines. Since the summer of 2007, as a result of the slowdown in the economy of Puerto Rico and after determining that one of the Bank’s largest asset-based lending relationships was impaired and that there was a significant collateral deficiency, the Company decided to curtail major commercial lending and to make adjustments to Company’s underwriting standards designed to strengthen the credit quality of its loan portfolio.

Allowance for loan losses

The Company maintains an allowance to absorb probable loan losses inherent in the loan portfolio. The allowance is maintained at a level the Company considers to be adequate and is based on ongoing quarterly assessments and evaluations of the collectibility and historical loss experience of loans. Credit losses are charged and recoveries are credited to the allowance. Provisions for loan losses are based on the Company’s review of the historical credit loss experience and such factors that, in management’s judgment, deserve consideration under existing economic conditions in estimating probable credit losses.

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. While management utilizes its best judgment and information available, the ultimate adequacy of the allowance is dependent upon a variety of factors beyond the Company’s control. Because of uncertainties inherent in the estimation process, management’s estimate of credit losses in the loan portfolio and the related allowance may change.

The allowance consists of two components: the specific allowance and the general allowance. The Company follows a systematic methodology in determining the appropriate level of these two allowance components.

Larger commercial and construction loans that exhibit probable or observed credit weaknesses are subject to individual review and thus subject to specific allowance allocations. 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, as well as evaluation of legal options available to the Company. The review of individual loans includes those loans that are impaired as defined under applicable accounting pronouncements. Any allowances for impaired loans are measured based on the present value of expected future cash flows discounted at the loans’ effective interest rate or the fair value of the underlying collateral. The Company evaluates the collectibility of both principal and interest when assessing the need for loss accrual.

General allowances based on loss rates are applied to commercial and construction loans which are not impaired and thus not subject to specific allowance allocations. The loss rates are generally derived from two or three year average loss trends (historical net charge-off and changes in specific allowances) by loan category adjusted for significant qualitative factors that, in management’s judgment, are necessary to reflect losses inherent in the portfolio. These qualitative factors include: the effect of the national and local economies; trends in loans growth; trends in the impaired and delinquent loans; risk management and loan administration; changes in concentration of loans to one obligor; changes in the internal lending policies and credit standards; and examination results from bank examiners and the Company’s internal credit examiners.

Homogeneous loans, such as consumer installments, residential mortgage loans, and credit cards are not individually risk graded. General allowances are established for each pool of loans based on the expected net charge-offs for one year. Loss rates are generally based on the higher of current year or the average of the last two to three year loss trends (historical net charge-off and changes in specific allowances) from two to three years by loan category, adjusted for significant qualitative factors that, in management’s judgment, are necessary to reflect losses inherent in the portfolio. These qualitative factors include: the effect of the national and local economies; trends in the delinquent loans; risk management; collection practices; and changes in the internal lending policies and credit standards.

At September 30, 2009, the allowance for loan losses was $225.5 million, consisting of $86.8 million of specific allowance and $138.7 million of general allowance. At September 30, 2008, the allowance for loan losses was $329.4 million, consisting of $170.8 million of specific allowance and $155.6 million of general allowance. The decrease in specific allowance in 2009 was mainly attributable to charge-offs taken for previously reserved impaired relationships,

offset in part by specific allowances assessed for new impaired relationships. The decrease in the general allowance in 2009 is mainly attributable to a lower overall loss ratio applied to unimpaired loans due to management’s assessment of the qualitative factor “trends in loans growth” that led to a reduction of this factor coupled with a decrease in the Company’s loan portfolio.

During the nine-month period ended September 30, 2009, the Company has not substantively changed in any material respect of its overall approach in the determination of the allowance for loan losses. There have been no material changes in criteria or estimation techniques as compared to prior periods that impacted the determination of the current period allowance for loan losses.

The table below presents a reconciliation of changes in the allowance for loan losses for the periods indicated:


	Quarter Ended September 30,						Nine Months Ended September 30,
	2009			2008			2009			2008
	(Dollars in thousands)						(Dollars in thousands)
Balance, beginning of period	$	240,832		$	327,902		$	282,089		$	338,720

Loans charged-off:
Commercial real estate loans (1)		(4,633	)		(5,333	)		(17,752	)		(29,565	)
Residential real estate loans		(294	)		(71	)		(832	)		(496	)
Construction loans		(10,470	)		—			(42,556	)		(59	)
Commercial, industrial and agricultural loans (2)		(9,606	)		(5,669	)		(17,330	)		(16,057	)
Consumer — secured by real estate		(196	)		(188	)		(670	)		(360	)
Consumer — other		(3,193	)		(3,628	)		(12,133	)		(10,663	)

Total loans charged-off		(28,392	)		(14,889	)		(91,273	)		(57,200	)

Recoveries of loans previously charged-off:
Commercial real estate loans		24			268			492			448
Residential real estate-mortgage loans		109			65			131			133
Construction loans		—			36			—			36
Commercial, industrial and agricultural loans		141			70			215			1,057
Consumer — secured by real estate		17			69			75			169
Consumer — other		405			459			1,428			1,314

Total recoveries of loans previously charged-off		696			967			2,341			3,157

Net loans charged-off		(27,696	)		(13,922	)		(88,932	)		(54,043	)
Provision for loan losses		12,366			15,382			32,345			44,685

Balance, end of period	$	225,502		$	329,362		$	225,502		$	329,362

Ratios:
Allowance for loan losses to total loans at end of period		2.59	%		3.58	%		2.59	%		3.58	%
Provision for loan losses to net loans charged-off		44.65	%		110.49	%		36.37	%		82.68	%
Recoveries of loans to loans charged-off in previous period		2.18	%		2.68	%		2.44	%		2.19	%
Net loans charged-off to average total loans (3)		1.26	%		0.60	%		1.34	%		0.77	%
Allowance for loans losses to non-performing loans		15.42	%		20.47	%		15.42	%		20.47	%


(1)		Includes $0.2 million and $4.0 million, respectively, of loans charged-off of the Asset-Based Lending Unit during the quarter and nine-month periods ended September 30, 2008. No loans were charged-off during quarter and the nine-month periods ended September 30, 2009.

(2)		Includes $5.1 million and $14.7 million, respectively, of loans charged-off of the Asset-Based Lending Unit during the quarter and nine-month periods ended September 30, 2008 and $8.1 million and $13.7 million, respectively, for the quarter and nine-month periods ended September 30, 2009.

(3)		Average loans were computed using beginning and period-end balances.

The allowance for loan losses at September 30, 2009 amounted to $225.5 million, compared to $329.4 million at September 30, 2008. As a percentage of total loans, the allowance for loan losses amounted to 2.59% and 3.58% at September 30, 2009 and 2008, respectively. The Company maintains an allowance for loan losses to absorb probable credit-related losses inherit in its loans receivable portfolio. The allowance for loan losses is affected by net charge-offs, loan portfolio balance, and the provision for loan losses for each period. Refer to the discussion on the “Provision for Loan Losses” above for further details regarding the Company’s provision for loan losses.

The Company’s net loans charged-off for the third quarter and nine months of 2009 were $27.7 million (1.26% of average loans on an annualized basis) and $88.9 million (1.34% of average loans on an annualized basis), respectively, compared to $13.9 million (0.60% of average loans on an annualized basis) and $54.0 million (0.77% of average loans on an annualized basis), respectively, for the same periods in 2008. The increase in net loans charged-off during 2009 was mainly due to increases in charge-offs from the Company’s construction loan portfolios. For the quarter and nine-month periods ended September 30, 2009, construction loan charge-offs increased by $10.5 million and $42.5 million, respectively, when compared to charge-offs to the same periods in 2008. Construction loans charge-offs recorded during 2009 were mainly related to loans with specific reserves established in previous quarters. The construction loan charge-offs were influenced by the continued deterioration in the economy of Puerto Rico that is impacting the absorption levels of existing construction projects in Puerto Rico.

The following table presents the Company’s historical loss rate by loan category for each of the periods presented:


	Quarter Ended September 30,						Nine Months Ended September 30,
	2009			2008			2009			2008
Net charge-off to average loan:
Commercial real estate loans		0.37	%		0.38	%		0.46	%		0.72	%
Residential real estate loans		0.08	%		—			0.10	%		0.05	%
Construction loans		3.07	%		-0.01	%		4.06	%		—
Commercial, industrial and agricultural loans		5.67	%		2.88	%		3.38	%		2.48	%
Consumer — secured by real estate		0.13	%		0.10	%		0.15	%		0.05	%
Consumer — other		4.56	%		5.09	%		5.95	%		4.96	%

Total net charge-offs to average loan		1.26	%		0.60	%		1.34	%		0.77	%

The accounts charged-off are submitted to the Collections Department recovery unit for continued collection efforts. Recoveries made from accounts previously charged-off amounted to $696,000 and $2.3 million, respectively, for the quarter and nine-month periods ended September 30, 2009 and $1.0 million and $3.2 million, respectively, for the same periods in 2008.

The following table presents the allocation of the allowance for loan losses, the loan portfolio composition percentage and the allowance to total loans ratio in each loan category, as set forth in the “Loans” table above at the end of each period.


	September 30, 2009			December 31, 2008
	(Dollars in thousands)
Allowance for loan losses:

Commercial real estate loans (1)	$	95,333		$	115,108
Residential real estate loans		4,310			3,948
Construction loans		78,749			110,777
Commercial, industrial and agricultural loans (2)		29,641			38,273
Consumer — secured by real estate		3,856			2,787
Consumer — other		13,613			11,196

Total allowance for loan losses	$	225,502		$	282,089


Loan portfolio composition percentages:
Commercial real estate loans		56.98	%		56.99	%
Residential real estate loans		11.16	%		10.78	%
Construction loans		15.56	%		16.08	%
Commercial, industrial and agricultural loans		7.27	%		8.01	%
Consumer — secured by real estate		6.21	%		5.53	%
Consumer — other and others		2.82	%		2.61	%

Total loans		100.00	%		100.00	%


Allowance to total loans ratio at end of year applicable to:
Commercial real estate loans		1.92	%		2.26	%
Residential real estate loans		0.44	%		0.41	%
Construction loans		5.81	%		7.70	%
Commercial, industrial and agricultural loans		4.68	%		5.34	%
Consumer — secured by real estate		0.71	%		0.56	%
Consumer — other and others		5.54	%		4.79	%

Total loans		2.59	%		3.15	%


(1)		Includes an allowance of $15.0 million and $8.2 million for the Asset-Based Lending Unit portfolio at September 30, 2009 and December 31, 2008, respectively.

(2)		Includes an allowance of $20.8 million and $30.3 million for the Asset-Based Lending Unit portfolio at September 30, 2009 and December 31, 2008, respectively.

At September 30, 2009, the allowance for possible loan losses was 15.42% of total non-performing loans (“reserve coverage”) compared to 18.08% at December 31, 2008. The following table summarizes and segregates the Company’s reserve coverage ratio by the allowance methodology employed (specific or general allowance methodology) at September 30, 2009:


	(Dollars in thousands)
Total loans
Total nonperforming loans	$	1,462,022
Total allowance for loan losses		225,502
Reserve Coverage Ratio		15.42	%

Nonperforming loans subject to specific impairment analysis (ASC Topic 310 (previously SFAS 114) loans)
Total nonperforming loans subject to specific impairment analysis	$	1,295,212
Total specific valuation allowance		86,817
Reserve Coverage Ratio for loans subject to specific impairment analysis		6.70	%

Nonperforming loans not subject to specific impairment analysis (ASC Topic 310 (previously SFAS 114) loans)
Total nonperforming loans	$	166,810
General valuation allowance		138,685
Reserve Coverage Ratio for loans not subject to specific impairment analysis (“Homogenous Coverage Ratio”)		83.14	%

The reserve coverage ratio is impacted by the Company’s business model. Most of the Company’s nonperforming loans are subject to specific reviews and to specific allowance allocations. Specifically, at September 30, 2009, 89% of the Company’s total nonperforming loans were subject to specific impairment analysis. The Company’s policies require specific impairment analysis to be based on recent appraisals (every 18 months or on a needed basis, in conformity with market conditions and regulatory requirements). The specific impairment analysis incorporates such appraisals in the calculation of the specific allowances. Due to the Company’s secured lender status and the adequacy of collaterals underlying the Company’s nonperforming loans, the reserve coverage ratio for loans subject to specific impairment analysis at September 30, 2009 was only 7%.

Excluding nonperforming loans subject to specific impairment analysis, the Company’s reserve coverage ratio (“Homogeneous Coverage Ratio”) at September 30, 2009 was 83%. The Homogenous Coverage Ratio is also influenced by the Company’s business model. Most of the loans subject to the Homogenous Coverage Ratio are secured with either commercial or residential real estate, for which the Company’s loss experience has been relatively low. Specifically, at September 30, 2009, 94% of the Company’s loans included in the Homogenous Coverage Ratio were secured with either commercial or residential real estate.

Troubled Debt Restructurings

A troubled debt restructuring is a formal restructure of a loan where the lender, for economic or legal reasons related to the borrower’s financial difficulties, grants a concession to the borrower that it would not otherwise consider. The concessions may be granted in various forms, including reduction in the stated interest rate, reduction in the loan balance or accrued interest, and deferral of cash payments. Note, however, that a debt restructuring is not necessarily a troubled debt restructuring even if the debtor is experiencing some financial difficulties.

As of September 30, 2009 and December 31, 2008, Westernbank had commercial loans totaling $224.7 million and $122.9 million, respectively, which met the definition of TDR’s, and therefore have been accounted for as TDR’s. At September 30, 2009 and December 31, 2008, commercial loans accounted for as TDR’s and amounting to $92.7 million and $4.8 million, respectively, were in accrual status. The increase in TDR’s was primarily due to new restructured loans as a result of the continuing downturn in the economy of Puerto Rico.

Impaired Loans

As defined under FASB’s criteria, a loan is deemed impaired when, based on current information and events, it is probable that Westernbank will be unable to collect the scheduled payments of principal or interest when due, according to the contractual terms of the agreement. The allowance for impaired loans is part of the Company’s overall allowance for loan losses.

Westernbank measures the impairment of a loan 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. Larger commercial and construction loans that exhibit probable or observed credit weaknesses are individually evaluated for impairment. Large groups of small balance, homogeneous loans are collectively evaluated for impairment; loans that are recorded at fair value or at the lower of cost or market are not evaluated for impairment. The portfolios of mortgage and consumer loans are considered homogeneous and are evaluated collectively for impairment.

Historically, the Company’s loss experience with commercial real estate loans, including construction loans, has been relatively low due to the sufficiency of the underlying real estate collateral. As a consequence, at September 30, 2009, 53% of the impaired loans did not require an allowance.

The following table sets forth information regarding the investment in impaired loans:


	September 30, 2009			December 31, 2008
	(Dollars in thousands)
Investment in impaired loans:

Covered by a valuation allowance:
Commercial real estate loans (1)	$	380,560		$	389,550
Construction loans		274,529			440,847
Commercial, industrial and agricultural loans (2)		50,901			70,749

Sub-total		705,990			901,146

Do not require a valuation allowance:
Commercial real estate loans (3)		516,588			413,061
Construction loans		242,934			83,389
Commercial, industrial and agricultural loans (4)		26,065			73,580

Sub-total		785,587			570,030


Total	$	1,491,577		$	1,471,176


Valuation allowance for impaired loans:
Commercial real estate loans (5)	$	39,108		$	49,121
Construction loans		38,776			64,903
Commercial, industrial and agricultural loans (6)		8,248			16,994

	$	86,132		$	131,018


Percentage of valuation allowance to impaired loans		5.77	%		8.91	%


	For the Nine Months Ended
	September 30, 2009		September 30, 2008
	(In thousands)
Average investment in impaired loans:
Commercial real estate loans	$	808,339	$	911,988
Construction loans		518,123		486,544
Commercial, industrial and agricultural loans		140,994		231,391

	$	1,467,456	$	1,629,923

Interest collected and recognized as income on non-performing and impaired loans:
Commercial real estate loans	$	6,995	$	19,228
Construction loans		7,190		6,093
Commercial, industrial and agricultural loans		2,172		6,618

	$	16,357	$	31,939


(1)		Includes $17.3 million and $6.5 million of loans of the Asset-Based Lending Unit at September 30, 2009 and December 31, 2008, respectively.

(2)		Includes $49.0 million and $111.1 million of loans of the Asset-Based Lending Unit at September 30, 2009 and December 31, 2008, respectively.

(3)		Includes $44.6 million and $38.5 million of loans of the Asset-Based Lending Unit at September 30, 2009 and December 31, 2008, respectively.

(4)		Includes $17.3 million and $101.9 million of loans of the Asset-Based Lending Unit at September 30, 2009 and December 31, 2008, respectively.

(5)		Includes $7.1 million and $473,000 of loans of the Asset-Based Lending Unit at September 30, 2009 and December 31, 2008, respectively.

(6)		Includes $6.3 million and $12.5 million of loans of the Asset-Based Lending Unit at September 30, 2009 and December 31, 2008, respectively.

Investments

The Company’s investments are managed by the Investment Department. Purchases and sales are required to be reported monthly to the Assets and Liabilities Committee (composed of the entire Board of Directors of the Company, the Chief Financial Officer, the Chief Operating Officer, the Treasurer and Chief Investment Officer of Westernbank, and the Chief Accounting Officer).

The Investment Department is authorized to purchase and sell federal funds, interest bearing deposits in banks, banker’s acceptances of commercial banks insured by the FDIC, mortgage and asset-backed securities, Puerto Rico and U.S. Government and agencies obligations, municipal securities rated A or better by any of the nationally recognized rating agencies, commercial paper and corporate notes rated P-1 by Moody’s Investors Service, Inc. or A-1 by Standard and Poor’s, a Division of the McGraw-Hill Companies, Inc. In addition, the Investment Department is responsible for the pricing and sale of deposits and repurchase agreements.

At the date of purchase, the Company classifies securities into one of three categories: held to maturity; trading; or available for sale. At each reporting date, the appropriateness of the classification is reassessed. Investments in debt securities for which management has the intent and ability to hold to maturity are classified as held to maturity and stated at cost increased by accretion of discounts and reduced by amortization of premiums, both computed by the interest method. Securities that are bought and held principally for the purpose of selling them in the near term are classified as trading and measured at fair value in the financial statements with unrealized gains and losses included in earnings. Securities not classified as either held to maturity or trading are classified as available for sale and measured at fair value in the financial statements with unrealized gains and losses reported, net of income tax, as a component of accumulated other comprehensive income (loss) until realized. Gains and losses on sales of securities are determined using the specific-identification method. Available-for-sale and held-to-maturity securities are reviewed at least quarterly for possible other-than-temporary impairment (“OTTI”). If the fair value of an available-for-sale or held-to-maturity security is less than its amortized cost basis, the Company must determine whether an OTTI has occurred. Under GAAP, the recognition and measurement requirements related to OTTI differ for debt and equity securities.

For debt securities, if the Company intends to sell the debt security or will more likely than not be required to sell the debt security before recovery of the entire amortized cost basis, then an OTTI has occurred, and the Company must recognize through earnings the entire OTTI, which is calculated as the difference between the fair value of the debt security and its amortized cost basis. However, even if the Company does not intend to sell the debt security and will not likely be required to sell the debt security before recovery of its entire amortized cost basis, the Company must evaluate expected cash flows to be received and determine if a credit loss has occurred. In the event of a credit loss, the credit component of the impairment is recognized through earnings and the non-credit component is recognized through accumulated other comprehensive income (loss). During the three and nine months ended September 30, 2009, the Company did not recognize OTTI on any of its available-for-sale or held-to-maturity debt securities.

The Company’s investment strategy is affected by both the rates and terms available on competing investments and tax and other legal considerations.

The following table presents the carrying value of investments at September 30, 2009 and December 31, 2008:


	September 30,		December 31,
	2009		2008
	(In thousands)
Held to maturity :
US Government and agencies obligations (USGO’s)	$	—	$	372,311
Puerto Rico Government and agencies obligations (PRGO’s)		12,833		13,312
Corporate notes		21,436		21,436
Mortgage-backed securities		540,982		630,911

Total		575,251		1,037,970

Available for sale:
USGO’s		48,461		307,880
PRGO’s		11,552		11,457
Mortgage-backed securities		2,473,038		3,347,992
Equity securities — common stock		798		2,912

Total		2,533,849		3,670,241

Total investments	$	3,109,100	$	4,708,211

Mortgage-backed securities at September 30, 2009 and December 31, 2008, consist of:


	September 30,		December 31,
	2009		2008
	(In thousands)
Available for sale:
Government National Mortgage Association (GNMA) certificates	$	1,347,936	$	526,376
Collateralized Mortgage Obligations (CMO’s) issued and guaranteed by GNMA		777,057		2,427,527
CMO’s issued and guaranteed by the Federal National Mortgage Association (FNMA)		335,556		380,438
CMO’s issued and guaranteed by the Federal Home Loan Mortgage Corporation (FHLMC)		12,489		13,651

Total available for sale		2,473,038		3,347,992


Mortgage-backed securities held to maturity:
GNMA certificates		5,010		5,574
FHLMC certificates		1,647		1,942
FNMA certificates		2,392		2,691
CMO’s certificates issued or guaranteed by FHLMC		478,817		551,802
CMO’s certificates issued or guaranteed by FNMA		53,116		68,902

Total held to maturity		540,982		630,911

Total mortgage-backed securities	$	3,014,020	$	3,978,903

The carrying amount of investment securities at September 30, 2009, by contractual maturity (excluding mortgage-backed securities), are shown below:


			Weighted
	Carrying		Average
	Amount		Yield
	(Dollars in thousands)
US Government and agencies obligations:
Due after five years through ten years	$	48,461		2.94	%


Puerto Rico Government and agencies obligations:
Due within one year		10,476		3.92
Due after one year through five years		13,424		4.24
Due after five years through ten years		485		4.86

		24,385		4.11


Other:
Due after ten years		21,436		8.33


Total		94,282		4.47
Mortgage-backed securities		3,014,020		3.96
Equity securities		798		0.77

Total	$	3,109,100		3.97	%

At September 30, 2009 and December 31, 2008, the unrealized loss position relates to interest rate changes and not to credit deterioration of any of the securities issuers. The Company assessed the ratings of the different agencies for the mortgage-backed securities, noting that at September 30, 2009 and December 31, 2008, all of them have maintained the highest rating by all the rating agencies and reflects a stable outlook. The aggregate unrealized gross losses of the investment securities available for sale and held to maturity amounted to $25.6 million and $69.5 million at September 30, 2009 and December 31, 2008, respectively.

Deposits

Westernbank offers a diversified choice of deposit accounts. At September 30, 2009, total deposits, including brokered deposits, amounted to $9.4 billion, a decrease of $1.6 billion or 15%, when compared to $11.0 billion at December 31, 2008. The decrease was mainly due to a decrease in brokered deposits to the Company’s decision to decrease its on-balance sheet liquidity. During the second half of 2008, the Company decided to build up its on-balance sheet liquidity in light of the financial crisis that affected the financial markets. As a result, during the second half of 2008, the Company increased its on-balance sheet liquidity by raising brokered deposits. During late 2008 and the first half of 2009, the Company undertook additional actions to increase its off-balance sheet liquidity, including among other things, the posting of additional collateral, thereby increasing its borrowing capacity with the FHLB. During the second quarter of 2009, with the additional borrowing capacity established with the FHLB and after much of the financial crisis had passed, the Company decided to decrease its on-balance sheet liquidity by not renewing maturing brokered deposits. The Company’s brokered deposits at September 30, 2009, amounted to $6.9 billion, a decrease of $1.6 billion or 19% as compared to balances of $8.6 billion at December 31, 2008. In connection with its asset/liability management, the Company uses brokered deposits since these deposits provide the flexibility of selecting short, medium and long term maturities to better match the Company’s asset/liability management strategies. Typically, brokered deposits tend to be highly rate-sensitive deposits, and therefore, these are considered under many circumstances to be a less stable source of funding for an institution as compared to deposits generated primarily in a bank’s local markets. Brokered deposits come primarily from brokers that provide intermediary services for banks and investors, therefore providing banks, such as Westernbank, increased access to a broad range of potential depositors who have no relationship with Westernbank and who actively seek the highest returns offered within the financial industry. However, due to the competitive market for deposits in Puerto Rico, coupled with generally low interest rates in the United States, the rates paid by Westernbank on these deposits are often lower than those paid for local market area retail deposits. The Puerto Rico deposit market is more challenging than the deposit market on the U.S. mainland. Puerto Rico has a relatively stable population base, a number of very competitive local banks looking to expand, and a large proportion of citizens that do not have bank accounts. Also, the difference between the tax rate on interest earned from bank deposits, versus the much lower tax rate on returns from investments held in local mutual funds, preferred stock and local GNMAs makes those other investments more attractive than deposits to some investors. These dynamics present significant challenges for gathering and retaining local retail deposits. The result is a high cost local deposits market. Moreover, while the Company believes that the benefits of brokered deposits outweigh the risk of deposit instability given that these accounts have historically been a stable source of funds.

The Company offers deposits accounts through its retail branch network. Retail deposits are principally attracted from retail and commercial customers in Puerto Rico, the Company’s primary market area, through the offering of a broad selection of deposit instruments, including passbook, negotiable order of withdrawal, or NOW, and Super NOW, checking and commercial checking accounts and time deposits. Retail deposits at September 30, 2009 increased by $54.8 million when compared to balances at December 31, 2008.

At September 30, 2009, the scheduled maturities of time deposits in amounts of $100,000 or more are as follows:


	(In thousands)
3 months or less	$	163,925
over 3 months through 6 months		85,643
over 6 months through 12 months		128,620
over 12 months		60,257

Total	$	438,445

The following table sets forth the average amount and the average rate paid on the following deposit categories for the nine months ended September 30, 2009 and 2008:


	2009					2008
	Average		Average			Average		Average
	Amount		Rate			Amount		Rate
			(Dollars in thousands)
Time deposits	$	8,940,897		4.03	%	$	9,132,322		4.79	%
Savings deposits		664,171		1.64	%		708,773		1.78	%
Interest bearing demand deposits		297,001		1.64	%		354,143		2.05	%
Noninterest bearing demand deposits		294,092		—			452,537		—

	$	10,196,161		3.69	%	$	10,647,775		4.29	%

Borrowings

The following table sets forth the borrowings of the Company at the dates indicated:


	September 30, 2009		December 31, 2008
	(In thousands)
Repurchase agreements	$	2,657,725	$	3,204,142
Advances from Federal Home Loan Bank (FHLB)		392,000		42,000
Mortgage note payable		—		34,932

	$	3,049,725	$	3,281,074

================================================================================

Westernbank has made use of institutional federal funds purchased and repurchase agreements in order to obtain funding, primarily through investment banks and brokerage firms. Repurchase agreements are collateralized with investment securities while federal funds purchased do not require collateral. Westernbank had $2.7 billion in repurchase agreements outstanding at September 30, 2009, at a weighted average rate of 3.02%. Repurchase agreements outstanding as of September 30, 2009, mature as follows: $836.2 million within 30 days; $942.0 million in 2010; $25.0 million in 2011; $409.5 million in 2012; and $445.0 million in 2014 and thereafter.

Westernbank also obtains advances from FHLB of New York. As of September 30, 2009, Westernbank had $392.0 million in outstanding FHLB advances at a weighted average rate of 1.14%. Advances from FHLB mature as follows: $350.0 million within 60 days and $42.0 million in 2010.

At September 30, 2009, the Company had outstanding $1.8 billion in repurchase agreements for which the counterparties have the option to terminate the agreements at the first anniversary date and at each interest payment date thereafter. Also, with respect to repurchase agreements and advances from FHLB amounting to $380.0 million at September 30, 2009, at the first anniversary date and each quarter thereafter, the FHLB has the option to convert them into replacement funding for the same or a lesser principal amount based on any funding then offered by FHLB at the then current market rates, unless the interest rate has been predetermined between FHLB and the Company. If the Company chooses not to replace the FHLB’s funding, it will repay the convertible advances and repurchase agreements, including any accrued interest, on such optional conversion date.

consulted with legal counsel and technical experts. As a result of its evaluation, the Company recognized a loss of $13.9 million against the $139.2 million owed by LBI as of December 31, 2008. Determining the loss amount required management to use considerable judgment and assumptions, and is based on the facts currently available. As additional information on the LBI’s SIPA liquidation proceeding becomes available, the Company may need to recognize additional losses. A material difference between the amount claimed and the amount ultimately recovered would have a material adverse effect on the Company’s and Westernbank’s financial condition and results of operations, and could cause the Company’s and Westernbank’s regulatory capital ratios to fall below the minimum to be categorized as well capitalized.

The following table presents certain information regarding Westernbank’s borrowings, excluding the mortgage payable, for the periods indicated.


	September 30, 2009			December 31, 2008
	(Dollars in thousands)
Amount outstanding at period end	$	3,049,725		$	3,246,142
Monthly average outstanding balance		2,959,783			4,937,299
Maximum outstanding balance at any month end		3,394,321			6,000,775
Weighted average interest rate:
For the nine months and year ended		3.69	%		4.26	%
At the end of period		2.78	%		3.80	%

Stockholders’ Equity

Stockholders’ equity increased to $982.1 million at September 30, 2009, from $915.4 million at December 31, 2008. The 2009 increase was principally due to a positive variance of $65.2 million in the accumulated other comprehensive income (loss), net of tax, mainly on unrealized gains arising during the period on available for sale securities as a result of favorable interest rate movements coupled with a net income of $6.6 million realized during the first three quarters of 2009, offset in part by dividends of $5.3 million on the Company’s preferred and common sshares declared during the first quarter of 2009.

REGULATORY CAPITAL RATIOS

The Company (on a consolidated basis) and Westernbank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s and Westernbank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and Westernbank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Prompt corrective action provisions are not applicable to bank holding companies.

At September 30, 2009, the Company and Westernbank were in compliance with all the regulatory capital requirements that were applicable to them as a financial holding company and state non-member bank, respectively, (i.e., total capital to risk-weighted assets (“Total Capital Ratio”) and Tier 1 capital to risk-weighted assets (“Tier 1 Capital Ratio”) of at least 8% and 4%, respectively, and Tier 1 capital to average assets (“Leverage Ratio”) of at least 4%) to be considered an adequately capitalized institution.

At September 30, 2009, Westernbank’s Leverage Ratio, Tier 1 Capital Ratio and Total Capital Ratio were 6.32%, 9.96%, and 11.22%, respectively, meeting the numerical requirements to be considered well-capitalized. To be considered a well-capitalized institution under the FDIC’s regulations, an institution must maintain a Leverage Ratio of at least 5%, a Tier 1 Capital Ratio of at least 6% and a Total Capital Ratio of at least 10%, and not be subject to any written agreement or directive to meet a specific capital ratio.

In May 2009, the Company and Westernbank entered into (i) a Consent Order (the “Consent Order”) with the FDIC and the OCIF and (ii) a Written Agreement with the Board of Governors of the Federal Reserve System (the “Written Agreement”, and, together with the Consent Order, the “Orders”). The Orders build on the informal agreement which Westernbank entered into with the FDIC in February of 2008. The Consent Order includes a capital directive requiring Westernbank to maintain a Tier 1 leverage ratio of not less than 5.5% as of the date of the Consent Order, 5.75% at September 30, 2009 and 6.0% at March 31, 2010. As of September 30, 2009, Westernbank’s Leverage Ratio was 6.32%. Although Westernbank complies with the quantitative definition of a well capitalized institution, by virtue of having a capital directive within the Consent Order, the Bank was deemed to be adequately capitalized. Simultaneously with the Consent Order, the FDIC granted Westernbank a renewable waiver for the issuance of brokered deposits, and in December 2009, the FDIC granted Westernbank’s request to roll over a portion of the Bank’s brokered deposits through March 31, 2010, subject to certain limitations. No assurance can be given that the Orders would not have a material adverse effect on the Company or Westernbank.

The principal source of income and funds for the Company are dividends from its subsidiaries. Federal and Puerto Rico banking regulations place certain restrictions on dividends paid and loans or advances made by Westernbank to the Company. The total amount of dividends which may be paid at any date is generally limited to the retained earnings of Westernbank, and loans or advances are limited to 10 percent of Westernbank’s capital stock and surplus on a secured

basis. On February 17, 2009, the Company and Westernbank’s Boards of Directors adopted a resolution to suspend the payment of dividends on Westernbank’s common stock and on the Company’s common shares and all of the outstanding series of its preferred shares, effective with the payment on March 16, 2009 and applicable to stockholders of record as of February 27, 2009, to strengthen and maintain the Company’s and Westernbank’s capital positions.

RISK MANAGEMENT

General

Effective management of risk is an integral part of the Company’s business and critical to the Company’s safety and soundness. Risks are inherent in virtually all aspects of the Company’s business activities and operations. Consequently, an effective risk management program is fundamental to the success of the Company. Risk management is an ongoing process and a state of mind that is present at all levels throughout the Company. The Company’s risk management process involves all employees, management, senior management and the Company’s Board of Directors in order to be effective and strengthen the Company’s ability to identify, measure, monitor and control risk.

The Company has established a risk management program to monitor, evaluate and manage the principal risks assumed in conducting its activities. The Company’s business is exposed to the following seven categories of risks: (1) credit risk, (2) market & interest rate risk, (3) liquidity risk, (4) operational risk, (5) legal risk, (6) reputational risk and (7) concentration risk.

Risks Definition

Credit Risk — arises from the potential that a borrower or counterparty will fail to perform an obligation.

Market Risk & Interest Rate Risk — is the risk to the Company’s condition resulting from adverse movements in market rates or prices, such as interest rates, foreign-exchange rates, or equity prices.

Liquidity Risk — is the potential that the Company will be unable to meet its obligations as they come due because of an inability to liquidate assets or obtain adequate funding, or the potential that the Company cannot easily unwind or offset specific exposures without significantly lowering market prices because of inadequate market depth or market disruptions.

Operational Risk — arises from the potential that inadequate information systems, operational problems, breaches in internal controls, fraud, or unforeseen catastrophes will result in unexpected losses.

Legal Risk — arises from the potential that unenforceable contracts, lawsuits, or adverse judgments can disrupt or otherwise negatively affect the operations or condition of the Company.

Reputational Risk – is the potential risk that negative publicity regarding the Company’s business practices, whether true or not, will cause a decline in the customer base, costly litigation, or revenue reductions.

Concentration Risk – is the potential risk to the Company of conducting its operations in a geographically concentrated area.

Audit Committee

The Company’s Audit Committee is appointed by the Board of Directors (the “Board”) to assist the Board in its oversight of the risk management processes related to compliance, operations, internal audit function, external financial reporting and internal control over financial reporting process. In performing this function, the Audit Committee is assisted by the Company’s Senior Management.

Risk Management Program

The Company’s risk management program, which is approved by its Board of Directors, is designed to balance a strong Company oversight with well-defined independent risk management functions within each business unit. The main objective of the Company’s risk management program is to ensure that all employees, management and Senior Management and processes are organized in a way that promotes a cross-functional approach to risk management and that controls are in place to better manage the Company’s risks and comply with legal and regulatory requirements. As a result, the Company’s risk management program has always been an ongoing process and a state of mind that is present at all levels within the Company. The risk management program is administered by the Company’s Risk Management Committee.

The Company’s senior managers of each business unit are responsible and accountable for identifying, measuring and managing key risks within their business units consistent with the Company’s policies. The Company’s Risk Management Committee is responsible for supporting the Company’s Chief Risk Officer in measuring and managing the Company’s aggregate risk profile. The Chief Risk Officer is responsible for establishing the Company’s overall risk management structure and providing an independent evaluation and oversight of the Company’s risk management activities. The Company’s Risk Management Committee executes management’s oversight role regarding risk management. This committee has been designed to ensure that the appropriate authorities, resources, responsibilities and reporting are in place to support an effective risk management program. The Company’s Risk Management Committee consists of various senior executive officers of the Company, including its Chief Executive Officer and Chief Financial Officer. The Company’s Risk Management Committee is responsible for ensuring that the Company’s overall risk profile is consistent with the Company’s objectives and risk tolerance levels.

The Company’s Internal Audit group provides an objective and independent assessment of the design and execution of the Company’s internal control system, including management systems, risk management, policies and procedures, among other.

As part of the Company’s risk management program, the Company has various risk management related committees. These committees are jointly responsible, along with the Risk Management Committee, for ensuring adequate risk measurement and management in their respective areas of authority. At the management level, these committees include:

	•		Assets & Liabilities Committee – oversees interest rate and market risk, liquidity management and other related matters.

	•		Steering Committee – is responsible for the oversight of and counsel on matters related to information technology including the development of information management policies and procedures throughout the Company.

	•		Compliance and Risk Management Committee – is responsible for the oversight of federal and local regulatory compliance.

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W HOLDING CO INC 10-Q