FIRST BANCORP.
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (D) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 2005
Commission
File No. 001-14793
First BanCorp.
(Exact name of registrant as specified in its charter)
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| Puerto Rico
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66-0561882 |
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(State or other jurisdiction of
incorporation or organization)
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(I.R.S. Employer
Identification No.) |
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1519 Ponce de León Avenue, Stop 23
Santurce, Puerto Rico
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00908 |
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(Zip Code) |
Registrant’s telephone number, including area code:
(787) 729-8200
Securities registered under Section 12(b) of the Act:
Common Stock ($1.00 par value)
7.125% Noncumulative Perpetual Monthly Income
Preferred Stock, Series A (Liquidation Preference $25 per share)
8.35% Noncumulative Perpetual Monthly Income
Preferred Stock, Series B (Liquidation Preference $25 per share)
7.40% Noncumulative Perpetual Monthly Income
Preferred Stock, Series C (Liquidation Preference $25 per share)
7.25% Noncumulative Perpetual Monthly Income
Preferred Stock, Series D (Liquidation Preference $25 per share)
7.00% Noncumulative Perpetual Monthly Income
Preferred Stock, Series E (Liquidation Preference $25 per share)
Securities registered under Section 12(g) of the Act:
NONE
Indicate by check mark if the registrant is a well known seasoned issuer, as defined in Rule
405 of the Securities Act. Yes þ No o
Indicate by check mark if the registrant is not required to file reports pursuant to Section
13 or 15 (d) of the Act. Yes o No þ
Indicate by check mark whether the registrant (1) has filed all reports required to be filed
by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes o No þ
Indicate by check mark if disclosure of delinquent filer pursuant to Item 405 of Regulation
S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge,
in definite proxy or information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated
filer, or a non-accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
Large Accelerated Filer þ Accelerated Filer o Non-Accelerated Filer o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of
the Exchange Act). Yes o No þ
The aggregate market value of the voting common stock held by nonaffiliates of the registrant
as of June 30, 2006 (the last day of the registrant’s most recently completed second quarter) was
$763,121,000 based on the closing price of $9.30 per share of common stock on the New York Stock
Exchange on June 30, 2006 (see Note 1 below).
The number of shares outstanding of the registrant’s common stock, as of December 31, 2006
was:
Common stock, par value $1.00 – 83,254,056
Note 1-The registrant had no nonvoting common equity outstanding as of June 30, 2006. In
calculating the aggregate market value of the common stock held by non affiliates of the
registrant, registrant has treated as common stock held by affiliates only common stock of the
registrant held by its principal
executive officer and voting stock held by the registrant’s employee benefit plans. The
registrant’s response to this item is not intended to be an admission that any person is an
affiliate of the registrant for any purposes other than this response.
FIRST BANCORP
2005 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
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EXPLANATORY NOTE
As a result of the delay in completing First Bancorp’s amended Annual Report on Form 10-K for
the year ended December 31, 2004, which included the restatement of the Corporation’s audited
financial statements for the years ended December 31, 2004, 2003 and 2002, and the unaudited
selected quarterly financial data for each of the four quarters of 2004 and 2003, First Bancorp was
unable to timely file with the Securities and Exchange Commission (“SEC”) this Annual Report on
Form 10-K and the Quarterly Reports on Form 10-Q for the fiscal quarters ended September 30, 2006,
June 30, 2006, March 31, 2006, September 30, 2005 and June 30, 2005. For information regarding the
restatement of First Bancorp’s previously issued financial statements, see the Corporation’s
Amendment No. 1 to Annual Report on Form 10-K/A (“Amended 2004 Form 10-K”) for the year ended
December 31, 2004, which was filed with the SEC on September 26, 2006.
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Forward Looking Statements
This Form 10-K contains “forward-looking statements” within the meaning of the Private
Securities Litigation Reform Act of 1995. When used in this Form 10-K or future filings by First
BanCorp with the Securities and Exchange Commission, in the Corporation’s press releases or in
other public or shareholder communications, or in oral statements made with the approval of an
authorized executive officer, the word or phrases “would be,” “will allow,” “intends to,” “will
likely result,” “are expected to,” “should,” “anticipate” and similar expressions are meant to
identify “forward-looking statements.”
First BanCorp wishes to caution readers not to place undue reliance on any such
“forward-looking statements,” which speak only as of the date made, and represent First BanCorp’s
expectations of future conditions or results and are not guarantees of future performance. First
BanCorp advises readers that various factors could cause actual results to differ materially from
those contained in any “forward-looking statement.” Such factors include, but are not limited to,
the following:
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risks arising from material weaknesses in the Corporation’s internal control over
financial reporting; |
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risks associated with the Corporation’s inability to prepare and timely submit
regulatory filings; |
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the Corporation’s ability to attract new clients and retain existing ones; |
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general economic conditions, including prevailing interest rates and the performance of
the financial markets, which may affect demand for the Corporation’s products and services
and the value of the Corporation’s assets, including the value of all of the interest rate
swaps that hedge the interest rate risk mainly relating to brokered certificates of
deposit, medium-term notes, and commercial loans and the ineffectiveness of such hedges or
the undesignated portion of such interest rate swaps; |
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credit and other risks of lending and investment activities; |
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changes in the Corporation’s expenses associated with acquisitions and dispositions; |
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developments in technology; |
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risks associated with changing the Corporation’s business strategy to no longer acquire
mortgage loans in bulk; |
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risks associated with the ongoing shareholder litigation against the Corporation; |
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risks associated with the ongoing SEC investigation; |
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risks associated with being subject to the cease and desist order; |
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potential further downgrades in the credit ratings of the Corporation’s securities; |
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general competitive factors and industry consolidation; and |
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risks associated with regulatory and legislative changes for financial services
companies in Puerto Rico, the United States, and the U.S. and British Virgin Islands. |
The Corporation does not undertake, and specifically disclaims any obligation, to update any
“forward-looking statements” to reflect occurrences or unanticipated events or circumstances after
the date of such statements except as required by the federal securities laws.
4
PART I
Item 1. Business
GENERAL
First BanCorp (the “Corporation”) is a publicly-owned financial holding corporation that is
subject to regulation, supervision and examination by the Federal Reserve Board. The Corporation
was incorporated under the laws of the Commonwealth of Puerto Rico to serve as the bank holding
company for FirstBank Puerto Rico (“FirstBank”). The Corporation is a full service provider of
Financial services and products with operations in Puerto Rico, the United States and the US and
British Virgin Islands.
The Corporation provides a wide range of financial services for retail, commercial and
institutional clients. At December 31, 2005, the Corporation controlled four wholly-owned
subsidiaries: FirstBank Puerto Rico (“FirstBank” or the “Bank”), FirstBank Insurance Agency, Inc.,
Grupo Empresas de Servicios Financieros (d/b/a “PR Finance Group”) and Ponce General Corporation,
Inc. (“Ponce General”). FirstBank is a Puerto Rico-chartered commercial bank, FirstBank Insurance
Agency is a Puerto Rico-chartered insurance agency, PR Finance Group is a domestic corporation and
Ponce General is the holding company of a federally chartered stock savings association, FirstBank
Florida. FirstBank is subject to the supervision, examination and regulation of both the Office
of the Commissioner of Financial Institutions of the Commonwealth of Puerto Rico and the Federal
Deposit Insurance Corporation (the “FDIC”). Deposits are insured through the FDIC Deposit Insurance
Fund. Within FirstBank, there are two separately regulated businesses:
(1) the Virgin Islands operations; (2) the Miami loan agency. The U.S. Virgin Islands operations of FirstBank are subject to regulation and examination by the
United States Virgin Islands Banking Board and the British Virgin Islands operations are subject to regulation by the British Virgin Islands Financial Services
Commission. FirstBank’s loan agency in the state of Florida is regulated by the Office of Financial
Regulation of the State of Florida, the Federal Reserve Bank of Atlanta and Federal Reserve Bank of
New York. As of December 31, 2005, the Corporation had total assets of $19.9 billion, total
deposits of $12.4 billion and total stockholders’ equity of $1.2 billion.
FirstBank Insurance Agency is subject to the supervision, examination and regulation of the
Office of the Insurance Commissioner of the Commonwealth of Puerto Rico. PR Finance Group is
subject to the supervision, examination and regulation of the Office of the Commissioner of
Financial Institutions of the Commonwealth of Puerto Rico. FirstBank Florida is subject to the
supervision, examination and regulation of the Office of Thrift Supervision (the “OTS”).
At December 31, 2005, FirstBank conducted its business through its main offices located in San
Juan, Puerto Rico, forty-six full service banking branches in Puerto Rico, fourteen branches in the
United States Virgin Islands (USVI) and British Virgin Islands (BVI) and a loan agency in Coral
Gables, Florida (USA). FirstBank had four wholly-owned subsidiaries with operations in Puerto
Rico; First Leasing and Rental Corporation, a vehicle leasing and daily rental company with nine
offices in Puerto Rico; First Federal Finance Corp. (d/b/a Money Express La Financiera), a finance
company with thirty-seven offices in Puerto Rico; First Mortgage, Inc., a residential mortgage loan
origination company with thirty offices in FirstBank branches and at stand alone sites; and
FirstBank Overseas Corporation, an international banking entity under the International Banking
Entity Act of Puerto Rico. FirstBank had three subsidiaries with operations outside of Puerto
Rico; First Insurance Agency VI, Inc., an insurance agency with three offices that sell insurance
products in the USVI; First Trade, Inc., which provides foreign sales corporation management
services with an office in the USVI and an office in Barbados; and First Express, a small loans
company with three offices in the USVI.
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Business combinations
On March 31, 2005, the Corporation completed the acquisition of 100% of the outstanding common
shares of Ponce General Corporation, the holding company of Unibank and Ponce Realty. The purpose
of the acquisition was to build a platform in Florida from which to initiate further expansion into
the United States. As of the acquisition date, excluding the effect of purchase accounting entries,
Ponce General had approximately $546.2 million in assets, $476.0 million in loans composed mainly
of residential and commercial mortgage loans amounting to approximately $425.8 million, commercial
and construction loans amounting to approximately $28.2 million and consumer loans amounting to
approximately $22.1 million and $439.1 million in deposits. The consideration consisted mainly of
payments made to principal and minority shareholders of Ponce General’s outstanding common stock at
acquisition date. This consideration along with other direct acquisition costs and liabilities
incurred led to a total acquisition cost of approximately $101.9 million. The purchase price
resulted in a premium of approximately $36 million that was mainly allocated to core deposit
intangibles and goodwill. The Corporation subsequently changed the name of Unibank to FirstBank
Florida.
FirstBank Florida is a federally chartered stock savings association which is headquartered in
Miami, Florida (USA) and currently is the only operating subsidiary of Ponce General. FirstBank
Florida provides a wide range of banking services to individual and corporate customers through its
eight branches in Florida (USA).
BUSINESS SEGMENTS
Based upon the Corporation’s organizational structure and the information provided to the Chief
Operating Decision Maker and to a lesser extent the Board of Directors, the operating segments
are driven primarily by the legal entities.
The Corporation has four reportable segments: Consumer (Retail), Commercial and Corporate
Banking, Mortgage Banking and Treasury and Investments. These segments are described below:
Consumer
The Consumer (Retail) segment consists of the Corporation’s consumer lending and
deposit-taking activities conducted mainly through its branch network and loan centers. Loans to
consumers include auto, credit card and personal loans. Deposit products include checking and
savings accounts, Individual Retirement Accounts (IRA) and retail certificates of deposit. Retail
deposits gathered through each branch of the FirstBank’s retail network serve as one of the funding
sources for the lending and investment activities.
Consumer lending growth has been mainly driven by auto loan originations. The growth of these
portfolios has been achieved through a strategy of providing outstanding service to selected auto
dealers who provide the channel for the bulk of the Corporation’s auto loan originations. This
strategy is directly linked to our commercial lending activities as the Corporation maintains
strong and stable auto floor plan relationships, which is the foundation of a successful auto loan
generation operation. The Corporation continues to strengthen the commercial relations with floor
plan dealers, which directly benefit the Corporation’s consumer lending operation and which are
managed as part of the consumer banking activities.
Personal loans, and to a lesser extent marine financing and a small credit card portfolio also
contribute to interest income generated on consumer lending. Management plans to continue to be
active in the consumer loans market, applying the Corporation’s strict underwriting standards.
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Commercial and Corporate Banking
The Commercial and Corporate Banking segment consists of the Corporation’s lending and other
services for the public sector and specialized industries such as healthcare, tourism, financial
institutions, food and beverage, shopping centers and middle-market clients. The Commercial and
Corporate Banking segment offers commercial loans, including commercial real estate and
construction loans, and other products such as cash management and business management services. A
substantial portion of this portfolio is secured by commercial real estate. Although commercial
loans involve greater credit risk because they are larger in size and more risk is concentrated in
a single borrower, the Corporation has and maintains an effective credit risk management
infrastructure designed to mitigate potential losses associated with commercial lending, including
strong underwriting and loan review functions, sales of loan participations and continuous
monitoring of concentrations within portfolios.
Mortgage Banking
The Mortgage Banking segment conducts its operations mainly through FirstBank and its mortgage
origination subsidiary, FirstMortgage. These operations consist of the origination, sale and
servicing of a variety of residential mortgage loans products. Originations are sourced through
different channels such as branches, mortgage brokers, real estate brokers, and in association with
new project developers. FirstMortgage focuses on originating residential real estate loans, some of
which conform to Federal Housing Administration (“FHA”), Veterans Administration (“VA”) and Rural
Development (“RD”) standards. Loans originated that meet FHA standards qualify for the federal
agency’s insurance program whereas loans that meet VA and RD standards are guaranteed by their
respective federal agencies. Mortgage loans that do not qualify under these programs are commonly
referred to as conventional loans. Conventional real estate loans could be conforming and
non-conforming. Conforming loans are residential real estate loans that meet the standards for sale
under the Fannie Mae and Freddie Mac programs whereas loans that do not meet the standards are
referred to as non-conforming residential real estate loans. The Corporation’s strategy is to
penetrate markets by providing customers with a variety of high quality mortgage products to serve
their financial needs faster, simpler and at competitive prices.
The Mortgage Banking segment also acquires and sells mortgages in the secondary markets. From
time to time, residential real estate conforming loans are typically sold to secondary buyers like
Fannie Mae and Freddie Mac.
Treasury and Investments
The Treasury and Investments segment is responsible for the Corporation’s investment portfolio
and treasury functions designed to manage and enhance liquidity. This segment sells funds to
Commercial and Corporate Banking, Mortgage Banking, and Consumer Lending segments to finance their
lending activities and purchases funds gathered by those segments. The interest rates charged or
credited by Treasury and Investments are based on market rates.
For information regarding First BanCorp’s reportable segments, please refer to note 32
“Segment Information” to the Corporation’s financial statements for the year ended December 31,
2005 included in Item 8 of this Form 10-K.
Employees
At December 31, 2005, the Corporation and its subsidiaries employed 2,725 persons. None of its
employees are represented by a collective bargaining group. The Corporation considers its employee
relations to be good.
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RECENT SIGNIFICANT EVENTS
Audit Committee Review
As previously announced on August 1, 2005, the Audit Committee (the “Committee”) of the
Corporation determined that it should review the background and accounting for certain
mortgage-related transactions that FirstBank had entered into between 1999 and 2005. The Committee
retained the law firms of Clifford Chance U.S. LLP and Martínez Odell & Calabria and forensic
accountants FTI Consulting Inc. to assist the Committee in its review. Subsequent to the
announcement of the review, a number of significant events occurred, including the announcement of
the restatement and other events described below. In August 2006, the Committee completed its
review and the Amended 2004 Form 10-K for the fiscal year ended December 31, 2004 was filed with
the SEC on September 26, 2006.
Governmental Action
SEC
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On August 23, 2005, the Corporation received a letter
from the SEC in which the SEC indicated that it was
conducting an informal inquiry into the Corporation.
The inquiry pertains to, among other things, the
accounting for mortgage-related transactions with
Doral and R&G during the calendar years 1999 through
2005. |
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On October 21, 2005, the Corporation announced that
the SEC issued a formal order of investigation in its
ongoing inquiry of the Corporation. The Corporation
has cooperated with the SEC in connection with this
investigation. |
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On September 26, 2006, the Corporation filed with the
SEC the Amended 2004 Form 10-K which included restated
financial information for the fiscal years 2000
through 2004. |
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First BanCorp has been engaged in discussions with the
staff of the SEC regarding a possible resolution to
its investigation of the Corporation’s restatement,
and has accrued $8.5 million in its consolidated
financial statements for the year ended December 31,
2005 in connection with a potential settlement of the
SEC’s investigation of the Corporation. Any
settlement is subject to the approval of the
Commissioners of the SEC. There can be no assurance
that the Corporation’s efforts to resolve the SEC’s
investigation with respect to the Corporation will be
successful, or that the amount accrued will be
sufficient, and the Corporation cannot predict at this
time the timing or final terms of any settlement. |
Banking Regulators
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Beginning in the Fall of 2005, the Corporation received inquiries from
federal banking regulators regarding the status and impact of the
restatement and related safety and soundness concerns. |
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On December 6, 2005, the Commonwealth of Puerto Rico Commissioner of
Financial Institutions (“Commissioner”) determined that the
Corporation had exceeded the lending limit requirements of Section
17(a) of the Puerto Rico Banking Law which governs the amount a bank
may lend to a single person, group or related entity. The Puerto Rico
Banking Law also authorizes OCIF to determine other components which
may be considered as part of a bank’s capital for purposes of
establishing its lending limit. After consideration of other
components, OCIF authorized the Corporation to retain the secured
loans of Doral and R&G as it believed that these loans are secured by
sufficient collateral to diversify, disperse and significantly diffuse
the risks connected to such loans thereby satisfying the safety and
soundness considerations mandated by Section 28 of the Puerto Rico
Banking Law. |
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On December 7, 2005, the Corporation was advised by the FDIC that the
revised classification of the mortgage-related transactions for
accounting purposes resulted in such transactions being viewed for
regulatory capital purposes as commercial loans to mortgage companies
rather than mortgage loans secured by one-to-four family residential
properties. FirstBank then advised the FDIC that pursuant to
regulatory requirements, the revised classification of the mortgage
transactions and the correction of the accounting for the interest
rate swaps would cause FirstBank to be slightly below the
well-capitalized level, within the meaning established by the FDIC. On
March 17, 2006, the Corporation announced that FirstBank had returned
to the well-capitalized level. The partial payment made by R&G
(described below under Business Developments) contributed to return to
the well-capitalized level. |
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In reaction to these earlier events, in February 2006, the OTS imposed
restrictions on FirstBank Florida. Under these restrictions, FirstBank
Florida cannot make any payments to the Corporation or its affiliates
pursuant to a tax-sharing agreement nor can FirstBank Florida employ
or receive consultative services from an executive officer of the
Corporation or its affiliates without the prior written approval of
the OTS’ Regional Director. Additionally, FirstBank Florida cannot
enter into any agreement to sell loans or any portions of any loans to
the Corporation or its affiliates nor can FirstBank Florida make any
payment to the Corporation or its affiliates via an intercompany
account or arrangement unless pursuant to a pre-existing contractual
agreement for services rendered in the normal course of business.
Also, FirstBank Florida can not pay dividends to its parent, First
BanCorp, without prior approval from the OTS. |
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On March 17, 2006, the Corporation announced that it had agreed with
the Board of Governors of the Federal Reserve System to a cease and
desist order issued with the consent of the Corporation (the “Consent
Order”). The Consent Order addresses certain concerns of banking
regulators relating to the incorrect accounting for and documentation
of mortgage-related transactions with Doral and R&G. The Corporation
had initially reported those transactions as purchases of mortgage
loans when they should have been accounted for as secured loans to the
financial institutions because as a legal matter, they did not
constitute “true sales” but rather financing arrangements. The
Corporation also announced that FirstBank had entered into a similar
agreement with the FDIC and the Commissioner (referred to together
with the Consent Orders as the “Consent Orders”). The agreements,
signed by all parties involved, did not impose any restrictions on the
Corporation’s or FirstBank’s day-to-day banking and lending
activities. |
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The Consent Orders with banking regulators imposed certain
restrictions and reporting requirements on the Corporation and
FirstBank. Under the Consent Order, FirstBank may not directly or
indirectly enter into, participate in, or in any other manner engage
certain transactions with any affiliate without the prior written
approval of the FDIC. The Consent Orders require the Corporation and
FirstBank to take various affirmative actions, including engaging an
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consultant to review the mortgage portfolios and prepare a
report including findings and recommendations, submitting capital and
liquidity contingency plans, providing notice prior to the incurring
of additional debt or the restructuring or repurchasing of debt,
obtaining approval prior to purchasing or redeeming stock, filing
amended regulatory reports upon completion of the restatement of
financial statements, and obtaining regulatory approval prior to
paying dividends after those payable in March 2006. The Cease and
Desist Order requirements have been substantially completed and
submitted to the Regulators as required by the Consent Orders. |
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FirstBank received a letter dated May 24, 2006 from the FDIC regarding
FirstBank’s failure to file with the FDIC its Part 363 annual report
for the fiscal year ended December 31, 2005. On June 12, 2006,
FirstBank notified the FDIC that it intended to file an amended 2004
Part 363 annual report and its 2005 Part 363 annual report after the
Corporation filed this 2005 Form 10-K with the SEC. |
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Subsequent to the effectiveness of the Consent Orders, the Corporation
and FirstBank have requested and obtained written approval from the
Federal Reserve Board and the FDIC for the payment of dividends by
FirstBank to its holding company, and for the payment of dividends by
the Corporation to the holders of its preferred stock, common stock
and trust preferred stock. The written approvals have been obtained in
accordance with the Consent Order requirements. |
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On August 29, 2006, the Corporation announced that its subsidiary,
FirstBank, consented and agreed to the issuance of a Cease and Desist
Order by the FDIC (the “Order”) relating to the Bank’s compliance with
certain provisions of the Bank Secrecy Act (the “BSA Consent Order”).
The BSA Consent Order requires FirstBank to take various affirmative
actions, including that FirstBank operate with adequate management
supervision and Board of Directors’ oversight to prevent any future
unsafe or unsound banking practices or violations of law or
regulation, on BSA related matters; implementing systems of internal
controls, independent testing and training programs to ensure full
compliance with BSA and laws and regulations enforced by the Office of
Foreign Assets Control (“OFAC”); designating a BSA and OFAC Officer,
and amending existing policies, procedures and processes relating to
internal and external audits to review compliance with BSA and OFAC
provisions as part of routine auditing; engaging independent
consultants to review account and transaction activity from June 1,
2005 to the effective date of the Order and to conduct a comprehensive
review of FirstBank’s actions to implement the consent Order in order
to assess the effectiveness of the policies, procedures and processes
adopted by FirstBank; and appointing a compliance committee of the
Board of Directors. |
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Since the beginning of 2006, FirstBank has been refining core areas of
its risk management and compliance systems, and prior to this BSA
Order has instituted a significant number of measures required by the
BSA consent Order. The BSA consent Order did not impose any civil or
monetary penalties, and does not restrict FirstBank’s current
day-to-day banking operations. |
New
York Stock Exchange Listing
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On April 13, 2006, the Corporation notified the NYSE
that, given the delay in the filing of the
Corporation’s 2005 Form 10-K, which required the
postponement of the 2006 Annual Meeting of
Stockholders, the Corporation was not going to
distribute its annual report to shareholders by April
30, 2006. As a result, the Corporation is not in
compliance with Section Rule 203.01, Annual Report
Requirement, of the NYSE Listed Company Manual, which
requires a listed company to distribute its annual
report within 120 days after its fiscal year end. |
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The NYSE’s Section 802.01E procedures apply to the
Corporation given its failure to file the Form 10-K
for the fiscal year ended December 31, 2005, which the
NYSE explained in a letter dated April 3, 2006. These
procedures contemplate that the NYSE will monitor a
company that has not timely filed a Form 10-K. If the
company does not file its annual report within six
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of the filing due date, the NYSE may, in its
sole discretion, allow the company’s securities to be
traded for up to an additional six months depending on
the company’s specific circumstances. If the NYSE
determines that an additional trading period of up to
six months is not appropriate, suspension and
delisting procedures will be commenced. If the NYSE
determines that an additional trading period of up to
six months is appropriate and the company fails to
file its annual report by the end of that additional
period, suspension and delisting procedures will
generally commence. The procedures provide that the
NYSE may commence delisting proceedings at any time.
On October 3, 2006, the Corporation announced that the
New York Stock Exchange (NYSE) granted an extension
for continued listing and trading on the NYSE through
April 3, 2007, subject to the NYSE’s ongoing
monitoring of the Corporation’s 2005 10-K filing
efforts. With the filing of this 2005 Annual Report
on Form 10-K on or prior to April 3, 2007, the
Corporation will have complied with the extension
granted by the NYSE. |
Recent Legislation
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Act 41 of August 1, 2005 imposed a
transitory additional tax of 2.5% on taxable income for all
corporations. This transitory tax effectively increased the statutory
tax rate from 39% to 41.5%. Act 41 is effective for taxable years
commencing after December 31, 2004 and ending on or before December
31, 2006, and therefore is effective for the 2005 and 2006 taxable
years with a retroactive effect to January 1, 2005. |
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Act 89 of May 13, 2006 imposed a 2%
additional income tax on income subject to regular taxes of all
corporations operating pursuant to Act 55 of 1933. Act 89 will be
effective for the taxable year commencing after December 31, 2005 and
on or before December 31, 2006 and therefore, increased the statutory
tax for the 2006 taxable year to 43.5%. The statutory tax will revert
to 39% for taxable years commencing after December 31, 2006. |
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Act 98 of May 16, 2006 imposed an
extraordinary 5% tax on the taxable income reported in the corporate
tax return of corporations whose gross income exceeded $10 million for
the taxable year ended on or before December 31, 2005. Covered
taxpayers were required to file a special return and pay the tax no
later than July 31, 2006. The extraordinary tax paid will be taken as
a credit against the income tax of the entity determined for taxable
years commencing after July 31, 2006, subject to certain limitations.
Any unused credit may be carried forward to subsequent taxable years,
subject to certain limitations. |
Private Litigation
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Following the announcement of the Audit Committee’s review, the
Corporation and certain of its officers and directors and former
officers and directors were named as defendants in five (5) separate
securities class actions filed between October 31, 2005 and December
5, 2005, alleging violations of Sections 10(b) and 20(a) of the
Securities Exchange Act of 1934. At present, all securities class
actions have been consolidated into one case named “In Re: First
BanCorp Securities Litigations” currently pending before the U.S.
District Court for the District of Puerto Rico. The Corporation has
been engaged in discussions with lead plaintiffs through private
mediation proceedings. In connection with a potential settlement, the
Corporation accrued $74.2 million in its consolidated financial
statements for the year ended December 31, 2005. There can be no
assurance that the amount accrued will be sufficient and the
Corporation cannot predict at this time the timing or final terms of
any settlement. |
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Between November 8, 2005 and March 7, 2006 several shareholders of the
Corporation |
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commenced five separate derivative actions against certain
current and former executive officers and directors of the
Corporation. In these actions, the Corporation was included as a
nominal defendant. These actions were filed pursuant to Section 304
of the Sarbanes-Oxley Act of 2002 and alleged, among other things, a
breach of fiduciary duty on behalf of the defendants. All shareholder
derivative actions were consolidated into one case named “In Re: First
BanCorp Derivative Litigation” which was dismissed on November 30,
2006 before the U.S. District Court for the District of Puerto Rico. |
Restatement
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On October 21, 2005, December 13, 2005, and March 17, 2006, the
Corporation announced that it had concluded that the mortgage-related
transactions that FirstBank entered into with Doral and R&G since 1999
did not qualify as “true sales” for accounting purposes. As a
consequence, the Corporation announced on December 13, 2005 that
management, with the concurrence of the Board of Directors, determined
to restate its previously reported financial statements to correct its
accounting for the mortgage-related transactions. In addition, the
Corporation announced that it would also restate its financial
statements to correct the accounting treatment used for certain
interest rate swaps it accounted for as hedges using the short-cut
method. |
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On September 26, 2006, the Corporation filed with the SEC the Amended
2004 Form 10-K for the fiscal year ended December 31, 2004, which
includes restated financial information for the fiscal years 2000
through 2004. |
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The Corporation has taken a number of significant actions
to remedy the material weaknesses in its internal controls
during 2005 and has remedied some of the
most pervasive weaknesses existing as of December 31, 2004.
These steps have primarily taken place since December 31, 2005.
Accordingly, First
BanCorp’s management concluded that its internal control over
financial reporting remained ineffective as of December 31, 2005 based
on the criteria set forth in Internal Control — Integrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway
Commission (“COSO”). A description of the material weaknesses existing
as of December 31, 2005 is included in Part II, Item 9A. Controls and
Procedures of this Annual Report on Form 10-K. |
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The Corporation developed and is implementing a plan for remedying all
of the identified material weaknesses, and the work continues in 2007. As part of this remediation program, the Corporation has added
skilled resources to improve controls and increase the reliability of
the financial closing process. |
Corporate Governance Changes
Changes in Senior Management
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In September 2005, following the announcement of the Audit Committee’s
review, the Corporation implemented changes to its senior management.
Specifically, the Board of Directors asked that Angel Alvarez-Pérez,
then President, Chief Executive Officer and Chairman of the Board (the
“Former CEO”), Annie Astor-Carbonell, then Chief Financial Officer and
Director of the Board (the “Former CFO”), and Carmen Szendrey-Ramos,
then General Counsel and Secretary of the Board (the “Former GC”),
resign. On September 30, 2005, the Corporation announced that the
Former CEO had resigned from his management positions and that the
Former CFO had resigned |
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from her position as CFO. In October 2005, the
Corporation terminated the Former GC. |
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On September 30, 2005, the Board of Directors made the following
appointments: Luis M. Beauchamp to serve as President and CEO of the
Corporation; Aurelio Alemán to serve as Chief Operating Officer
(“COO”) and Senior Executive Vice President; and Luis Cabrera-Marín to
serve, on an interim basis, as CFO of the Corporation. |
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On February 22, 2006, the Corporation announced the retention of
Lawrence Odell as Executive Vice President and General Counsel of the
Corporation and its subsidiary, FirstBank. |
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On July 18, 2006, the Company’s Board of Directors appointed Fernando
Scherrer as Executive Vice President and Chief Financial Officer of
the Company, effective July 24, 2006. Mr. Scherrer had been working
with the Corporation since October 2005 as a consultant in its
reassessment of accounting issues and preparation of restated
financial statements and other consulting matters. |
Changes in Board Structure
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On September 30, 2005, the Corporation announced that the Former CEO
retired from his positions as Chairman of the Board of Directors and
as Director of the Corporation, effective December 31, 2005.
Additionally, effective September 30, 2005, the Former CFO resigned
from her position as Director of the Corporation. |
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On September 30, 2005, the Board of Directors of the Corporation
elected Luis Beauchamp and Aurelio Alemán as Directors. |
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On November 28, 2005, the Corporation announced that the Board of
Directors elected Fernando Rodríguez-Amaro as a Director and as an
additional financial expert to serve in the Audit Committee.
Thereafter, he was appointed Chairman of the Audit Committee effective
January 1, 2006. In addition, the Board of Directors appointed José
Menéndez-Cortada as Independent Lead Director effective February 15,
2006. |
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On March 28, 2006, José Julián Alvarez, 72, informed the Corporation
that he would resign from his position as director of the Corporation,
effective March 31, 2006. Mr. Alvarez’s term as a director would have
expired at the 2006 Annual Meeting of Stockholders and, given the
Company’s retirement policy for the Board of Directors, Mr. Alvarez
would not have been eligible for reelection. |
Change in By-Laws
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On March 14, 2006, the Board of Directors of the Corporation approved
an amendment to the Corporation’s By-Laws. As amended, Section 2 of
Article I of the By-Laws provides that the Board of Directors will set
a date and time for the annual meeting of stockholders in
circumstances that do not permit the meeting to occur within 120 days
after the Corporation’s fiscal year end due to the Corporation’s
inability to issue its annual report with audited financial
statements. In such event, the Board will set such date and time
within a reasonable period after the Corporation submits an annual
report with audited financial statements to stockholders. Prior to
adoption of this amendment, Section 2 of Article I did not provide
that the Board of Directors could set the date and time of the annual
meeting. The amendment was effective upon approval by the Board. |
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Business Developments
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On March 13, 2005, the Corporation announced the closing of its
acquisition of Ponce General Corporation, a Delaware corporation, and
its subsidiaries, Unibank, a federal savings and loan association, and
Ponce Realty Corporation, a Delaware corporation with real estate
holdings in Florida. Unibank, headquartered in Miami, Florida, had 11
financial service facilities located in the Miami/Dade, Broward,
Orange and Osceola counties of Florida. The Corporation subsequently
changed the name of Unibank to FirstBank Florida. |
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Following the Corporation’s October 21, 2005 announcement that the SEC
had issued a formal order of investigation, the major rating agencies
downgraded the Corporation’s and FirstBank’s ratings in a series of
actions. Fitch Ratings, Ltd., a subsidiary of Fimalac, S.A. lowered
the Corporation’s long-term senior debt rating from BBB- to BB and
placed the rating on Rating Watch Negative. Standard & Poors, a
division of the McGraw Hill Companies, Inc. lowered the long-term
senior debt and counterparty rating of FirstBank, from BBB- to BB+ and
placed the rating on Credit Watch Negative. Moody’s Investor Service
lowered FirstBank’s long-term senior debt rating from Baa3 to Ba1 and
placed the rating on negative outlook. |
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On March 17, 2006, the Corporation announced that in the fourth
quarter of 2005, R&G made a partial payment of $137 million, which
released capital allocated to the loans secured by the mortgage loans
to R&G and that First BanCorp made a capital contribution to FirstBank
of $110 million at the end of 2005. |
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On May 31, 2006, the Corporation announced that its subsidiary,
FirstBank, received a cash payment from Doral of approximately $2.4
billion, substantially reducing the balance in secured commercial
loans resulting from the Corporation’s previously-announced revised
classification of several mortgage-related transactions with Doral. In
addition, FirstBank and Doral entered into a sharing agreement with
respect to certain profits or losses that Doral incurs as part of the
sales of the mortgages that previously collateralized the commercial
loans, subject to a maximum reimbursement of $9.5 million, which will
be reduced proportionately to the extent that Doral does not sell the
mortgages. |
Disclosure Controls and Procedures and Internal Control over Financial Reporting
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See Item 9A in this Form 10-K for information concerning management’s
conclusion that, as of December 31, 2005, our disclosure controls and
procedures were not effective as a result of the material weaknesses
discussed in Management’s Report on Internal Control Over Financial
Reporting, see also therein the Remediation Plan initiated to correct
identified material weaknesses and to further enhance the
Corporation’s overall governance standards. |
Certain of these and other subsequent events were addressed in the Corporation’s Current
Reports on Form 8-K filed with the SEC on August 25, 2005; October 5, 2005; October 26, 2005;
November 29, 2005; December 13, 2005; February 22, 2006; March 20, 2006; June 1, 2006; July 24,
2006; August 29,
2006; September 26, 2006; October 4, 2006; October 6, 2006; October 24, 2006; November 3, 2006;
December 5, 2006; December 28, 2006 and December 29, 2006.
WEBSITE ACCESS TO REPORT
We make available our annual report on Form 10-K, quarterly reports on Form 10-Q, current
reports on Form 8-K, and amendments to those reports, filed or furnished pursuant to section 13(a)
or 15(d) of the Securities Exchange Act of 1934 available free of charge on or through our internet
website www.firstbankpr.com, (“Sobre nosotros” section, SEC Filings link), as soon as
reasonably practicable after we electronically file such material with, or furnish it to, the SEC.
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We also make available the Corporation’s corporate governance standards, the charters of the
audit, compensation and benefits, corporate governance and nominating committees; and the codes
mentioned below, free of charge on or through our internet website www.firstbankpr.com
(“Sobre nosotros,” Governance Documents link):
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Code of Ethics for Senior Financial Officers |
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Code of Ethics applicable to all employees |
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Independence Principles for Directors |
The corporate governance standards, and the aforementioned
charters and codes may also be obtained free of charge by
request to Mr. Lawrence Odell, Executive Vice President and
General Counsel, PO Box 9146, San Juan, Puerto Rico 00908.
As previously announced on December 13, 2005, First BanCorp determined that previously filed
interim unaudited and annual audited financial statements should no longer be relied upon and that
it needed to restate previously issued financial statements. The Corporation restated financial
information for the periods from January 1, 2000 through December 31, 2004. Other than the Annual
Report on Amended 2004 Form 10-K, the Corporation has not amended any of its previously filed
reports. The consolidated financial statements and other financial information in First BanCorp’s
previously filed reports for the dates and periods referred to above, other than the Amended 2004
Form 10-K should no longer be relied upon.
The public may read and copy any materials First BanCorp files with the SEC at the SEC’s
Public Reference Room at 100 F Street, NE, Washington, DC 20549. In addition, the public may obtain
information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The
SEC maintains an Internet site that contains reports, proxy, and information statements, and other
information regarding issuers that file electronically with the SEC at its website
(www.sec.gov).
MARKET AREA AND COMPETITION
Puerto Rico, where the banking market is highly competitive, is the main geographic service
area of the Corporation. At December 31, 2005, the Corporation also had a presence through its
subsidiaries in the United States and British Virgin Islands and through its loan agency in Coral
Gables, Florida. Through the acquisition of Ponce General Corporation, FirstBank has established a
presence in Florida with the plan of future expansion into the United States market. Puerto Rico
banks are subject to the same federal laws, regulations and supervision that apply to similar
institutions in the United States mainland.
Competitors include other banks, insurance companies, mortgage banking companies, small loan
companies, automobile financing companies, leasing companies, vehicle rental companies, brokerage
firms with retail operations, and credit unions, in Puerto Rico, the Virgin Islands and in the
state of Florida. The Corporation’s businesses compete with these other firms with respect to the
range of products and services offered and the types of clients, customers, and industries served.
The Corporation’s ability to compete effectively depends on the relative performance of its
products, the degree to which the features of its products appeal to customers, and the extent to
which the Corporation meets client’s needs and expectations. The Corporation’s ability to compete
also depends on its ability to attract and retain professional and other personnel, and on its
reputation.
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The Corporation encounters intense competition in attracting and retaining deposits and in its
consumer and commercial lending activities. The Corporation competes for loans with other financial
institutions, some of which are larger and have greater resources available than those of the
Corporation. Management believes that the Corporation has been able to compete effectively for
deposits and loans by offering a variety of transaction account products and loans with competitive
features, by pricing its products at competitive interest rates, by offering convenient branch
locations, and by emphasizing the quality of its service. The Corporation’s ability to originate
loans depends primarily on the rates and fees charged and the service it provides to its borrowers
in making prompt credit decisions. There can be no assurance that in the future the Corporation
will be able to continue to increase its deposit base or originate loans in the manner or on the
terms on which it has done so in the past.
SUPERVISION AND REGULATION
On March 17, 2006, the Corporation announced that the Corporation and FirstBank consented to
cease and desist orders with the Federal Reserve Board and the FDIC. For more information regarding
these orders, see “Recent Significant Events – Governmental Action, Banking Regulatory Matters.”
Bank Holding Company Activities and Other Limitations
The Corporation is subject to ongoing regulation, supervision, and examination by the Federal
Reserve Board, and is required to file with the Federal Reserve Board periodic and annual reports
and other information concerning its own business operations and those of its subsidiaries. In
addition, under the provisions of the Bank Holding Company Act, a bank holding company must obtain
Federal Reserve Board approval before it acquires directly or indirectly ownership or control of
more than 5% of the voting shares of another bank, or merges or consolidates with another bank
holding company. The Federal Reserve Board also has authority under certain circumstances to issue
cease and desist orders against bank holding companies and their non-bank subsidiaries.
A bank holding company is prohibited under the Bank Holding Company Act, with limited
exceptions, from engaging, directly or indirectly, in any business unrelated to the business of
banking or of managing or controlling banks. One of the exceptions to these prohibitions permits
ownership by a bank holding company of the shares of any corporation if the Federal Reserve Board,
after due notice and opportunity for hearing, by regulation or order has determined that the
activities of the corporation in question are so closely related to the business of banking or of
managing or controlling banks as to be a proper incident thereto.
Under the Federal Reserve Board policy, a bank holding company such as the Corporation is
expected to act as a source of financial strength to its banking subsidiaries and to commit support
to them. This support may be required at times when, absent such policy, the bank holding company
might not
otherwise provide such support. In the event of a bank holding company’s bankruptcy, any commitment
by the bank holding company to a federal bank regulatory agency to maintain capital of a subsidiary
bank will be assumed by the bankruptcy trustee and be entitled to a priority of payment. In
addition, any capital loans by a bank holding company to any of its subsidiary banks must be
subordinated in right of payment to deposits and to certain other indebtedness of such subsidiary
bank. At December 31, 2005, FirstBank and FirstBank Florida were the only depository institution
subsidiaries of the Corporation. On March 31, 2005, the Corporation announced the acquisition, in
an all-cash consideration merger transaction, of Ponce General Corporation, a Delaware corporation,
and its subsidiaries, Unibank, a federal savings and loan association, and Ponce Realty
Corporation, a Delaware corporation with real estate holdings in Florida. The Corporation
subsequently changed the name of the acquired bank to FirstBank Florida. For additional
information, see “Recent Significant Events – Business Developments.”
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The Gramm-Leach-Bliley Act revised and expanded the provisions of the Bank Holding Company Act
by including a section that permits a bank holding company to elect to become a financial holding
company to engage in a full range of financial activities. The Gramm-Leach-Bliley Act requires that
in the event that the bank holding company elects to become a financial holding company, the
election must be made by filing a written declaration with the appropriate Federal Reserve Bank and
complying with the following (and such compliance must continue while the entity is treated as a
financial holding company): (i) state that the bank holding company elects to become a financial
holding company; (ii) provide the name and head office address of the bank holding company and each
depository institution controlled by the bank holding company; (iii) certify that all depository
institutions controlled by the bank holding company are well capitalized as of the date the bank
holding company files for the election; (iv) provide the capital ratios for all relevant capital
measures as of the close of the previous quarter for each depository institution controlled by the
bank holding company; and (v) certify that all depository institutions controlled by the bank
holding company are well managed as of the date the bank holding company files the election. All
insured depository institutions controlled by the bank holding company must have also achieved at
least a rating of “satisfactory record of meeting community credit needs” under the Community
Reinvestment Act during the depository institution’s most recent examination. In April 2000, the
Corporation filed an election with the Federal Reserve Board and became a financial holding
company.
Financial holding companies may engage, directly or indirectly, in any activity that is
determined to be (i) financial in nature, (ii) incidental to such financial activity, or (iii)
complementary to a financial activity and does not pose a substantial risk to the safety and
soundness of depository institutions or the financial system generally. The Gramm-Leach-Bliley Act
specifically provides that the following activities have been determined to be “financial in
nature”: (a) Lending, trust and other banking activities; (b) Insurance activities; (c) Financial
or economic advice or services; (d) Pooled investments; (e) Securities underwriting and dealing;
(f) Existing bank holding company domestic activities; (g) Existing bank holding company foreign
activities; and (h) Merchant banking activities. The Corporation offers insurance agency services
through its wholly-owned subsidiary, FirstBank Insurance Agency, Inc. and through First Insurance
Agency V. I., Inc., a subsidiary of FirstBank.
In addition, the Gramm-Leach-Bliley Act specifically gives the Federal Reserve Board the
authority, by regulation or order, to expand the list of “financial” or “incidental” activities,
but requires consultation with the U.S. Treasury, and gives the Federal Reserve Board authority to
allow a financial holding company to engage in any activity that is “complementary” to a financial
activity and does not “pose a substantial risk to the safety and soundness of depository
institutions or the financial system generally.”
Under the Gramm-Leach-Bliley Act, if the Corporation fails to meet any of the requirements for
being a financial holding company and is unable to resolve such deficiencies within certain
prescribed periods of time, the Federal Reserve Board could require the Corporation to divest
control of one or more of its
depository institution subsidiaries or alternatively cease conducting financial activities that are
not permissible for bank holding companies that are not financial holding companies.
Sarbanes-Oxley Act
On July 20, 2002, President Bush signed into law the Sarbanes-Oxley Act of 2002 (“SOA”), which
implemented legislative reforms intended to address corporate and accounting fraud. SOA contains
reforms of various business practices and numerous aspects of corporate governance. Most of these
requirements have been implemented by regulations issued by the SEC. The following is a summary of
certain key provisions of SOA.
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In addition to the establishment of an accounting oversight board that enforces auditing,
quality control and independence standards and is funded by fees from all publicly traded
companies, SOA places restrictions on the scope of services that may be provided by accounting
firms to their public corporation audit clients. Any non-audit services being provided to a public
corporation audit client requires pre-approval by the corporation’s audit committee. In addition,
SOA makes certain changes to the requirements for rotation of certain persons involved in the audit
after a period of time. SOA requires chief executive officers and chief financial officers, or
their equivalent, to certify to the accuracy of periodic reports filed with the SEC, subject to
civil and criminal penalties if they knowingly or willingly violate this certification requirement.
In addition, counsel is required to report evidence of a material violation of the securities laws
or a breach of fiduciary duties to the corporation’s chief executive officer or its chief legal
officer, and, if such officer does not appropriately respond, to report such evidence to the audit
committee or other similar committee of the board of directors or the board itself.
Under SOA, longer prison terms may apply to corporate executives who violate federal
securities laws; the period during which certain types of suits can be brought against a
corporation or its officers is extended; and bonuses issued to top executives prior to restatement
of a corporation’s financial statements are now subject to disgorgement if such restatement was due
to corporate misconduct. Executives are also prohibited from insider trading during retirement plan
“blackout” periods, and loans to corporations’ executives (other than loans by financial
institutions permitted by federal rules or regulations) are prohibited. In addition, the
legislation accelerates the time frame for disclosures by public companies, as they must
immediately disclose any certain material changes in their financial condition or operations.
Directors and executive officers required to report changes in ownership in a corporation’s
securities must report within two business days of the change.
SOA increases responsibilities and codifies certain requirements related to audit committees
of public companies and how they interact with the corporation’s “registered public accounting
firm.” Audit committee members must be independent and are barred from accepting consulting,
advisory or other compensatory fees from the issuer. In addition, companies are required to
disclose whether at least one member of the committee is a “financial expert” (as such term is
defined by the SEC) and if not, the reasons why. A corporation’s registered public accounting firm
is prohibited from performing statutorily mandated audit services for a corporation if the
corporation’s chief executive officer, chief financial officer, controller, chief accounting
officer or any person serving in equivalent positions had been employed by such firm and
participated in the audit of such corporation during the one-year period preceding the audit
initiation date. SOA also prohibits any officer or director of a corporation or any other person
acting under their direction from taking any action to fraudulently influence, coerce, manipulate,
or mislead any independent public or certified accountant engaged in the audit of the corporation’s
financial statements for the purpose of rendering the financial statements materially misleading.
SOA also has provisions relating to inclusion of certain internal control reports and
assessments by management in the annual report on Form 10-K. The law also requires the
corporation’s independent
registered public accounting firm that issues the audit report to attest to and report on
management’s assessment of the corporation’s internal controls and on the effectiveness of internal
controls over financial reporting. Commencing with the 2004 Form 10-K (the “Original Filing”), the
Corporation has been required to include an internal control report containing management’s
assessment regarding the effectiveness of the Corporation’s internal control structure and
procedures over financial reporting. The internal controls report includes a statement of
management’s responsibility for establishing and maintaining adequate internal controls over
financial reporting for the Corporation; management’s assessment as to the effectiveness of the
Corporation’s internals controls over financial reporting based on management’s evaluation of them,
as of year-end; and the framework used by management as criteria for evaluating the effectiveness
of the Corporation’s internal controls over financial reporting. Both reports,
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by Management and
the Independent Registered Public Accounting Firm, are being filed as part of the Annual Report on
this Form 10-K.
USA Patriot Act
Under Title III of the USA Patriot Act, also known as the International Money Laundering
Abatement and Anti-Terrorism Financing Act of 2001, all financial institutions are required to,
among other things, identify their customers, adopt formal and comprehensive anti-money laundering
programs, scrutinize or prohibit altogether certain transactions of special concern, and be
prepared to respond to inquiries from U.S. law enforcement agencies concerning their customers and
their transactions. Presently, only certain types of financial institutions (including banks,
savings associations and money services businesses) are subject to final rules implementing the
anti-money laundering program requirements of the USA Patriot Act.
Failure of a financial institution to comply with the USA Patriot Act’s requirements could
have serious legal and reputational consequences for the institutions. The Corporation has adopted
appropriate policies, procedures and controls to address compliance with the USA Patriot Act and
U.S. Treasury Department regulations. See “Recent Significant Events – Governmental Action and
Banking Regulators” for information regarding recent issues relating to compliance with the Bank
Secrecy Act.
Privacy Policies
Under the Gramm-Leach-Bliley Act, all financial institutions are required to adopt privacy
policies, restrict the sharing of nonpublic customer data with nonaffiliated parties at the
customer’s request and establish policies and procedures to protect customer data from unauthorized
access. The Corporation and its subsidiaries have adopted policies and procedures in order to
comply with the privacy provisions of the Gramm-Leach-Bliley Act and the regulations issued there
under.
State Chartered Non-Member Bank; Federal Savings Bank; Banking Laws and Regulations in General
FirstBank is subject to extensive regulation and examination by the Commissioner and the FDIC,
and is subject to certain requirements established by the Federal Reserve Board. FirstBank Florida
is a federally regulated savings bank subject to extensive regulation and examination by the OTS
and FDIC, and subject to certain Federal Reserve regulations. The federal and state laws and
regulations which are applicable to banks and savings banks regulate, among other things, the scope
of their business, their investments, their reserves against deposits, the timing and availability
of deposited funds, and the nature and amount of and collateral for certain loans. In addition to
the impact of regulations, commercial banks are affected significantly by the actions of the
Federal Reserve Board as it attempts to control the money supply and credit availability in order
to influence the economy. References herein to applicable statutes or regulations are brief
summaries of portions thereof which do not purport to be complete and which are
qualified in their entirety by reference to those statutes and regulations. Any change in
applicable laws or regulations may have a material adverse effect on the business of commercial
banks, thrifts and bank holding companies, including FirstBank, FirstBank Florida and the Corporation.
However, management is not aware of any current proposals by any federal or state regulatory
authority that, if implemented, would have or would be reasonably likely to have a material effect
on the liquidity, capital resources or operations of FirstBank, FirstBank Florida or the
Corporation.
As a creditor and financial institution, FirstBank is subject to certain regulations
promulgated by the Federal Reserve Board, including, without limitation, Regulation B (Equal Credit
Opportunity Act), Regulation DD (Truth in Savings Act), Regulation E (Electronic Funds Transfer
Act), Regulation F
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(Limits on Exposure to Other Banks), Regulation Z (Truth in Lending Act),
Regulation CC (Expedited Funds Availability Act), Regulation X (Real Estate Settlement Procedures
Act), Regulation BB (Community Reinvestment Act) and Regulation C (Home Mortgage Disclosure Act).
There are periodic examinations by the Commissioner and the FDIC, or the OTS and the FDIC to
test each bank’s compliance with various statutory and regulatory requirements. This regulation and
supervision establishes a comprehensive framework of activities in which an institution can engage
and is intended primarily for the protection of the FDIC’s insurance fund and depositors. The
regulatory structure also gives the regulatory authorities extensive discretion in connection with
their supervisory and enforcement activities and examination policies, including policies with
respect to the classification of assets and the establishment of adequate loan loss reserves for
regulatory purposes. This enforcement authority includes, among other things, the ability to assess
civil money penalties, to issue cease-and-desist or removal orders and to initiate injunctive
actions against banking organizations and institution-affiliated parties. In general, these
enforcement actions may be initiated for violations of laws and regulations and for engaging in
unsafe or unsound practices. In addition, certain bank actions are required by statute and
implementing regulations. Other actions or failure to act may provide the basis for enforcement
action, including the filing of misleading or untimely reports with regulatory authorities.
For a discussion of bank regulatory actions relating to FirstBank and FirstBank Florida, see
the discussion under “Recent Significant Events – Governmental Action-Banking Regulators.”
Dividend Restrictions
The Corporation is subject to certain restrictions generally imposed on Puerto Rico
corporations with respect to the declaration and payment of dividends (i.e., that dividends may be
paid out only from the Corporation’s net assets in excess of capital or in the absence of such
excess, from the Corporation’s net earnings for such fiscal year and/or the preceding fiscal year).
The Federal Reserve Board has also issued a policy statement that provides that bank holding
companies should generally pay dividends only out of current operating earnings.
At December 31, 2005, the principal source of funds for the Corporation is dividends declared
and paid by its subsidiary, FirstBank. The ability of FirstBank to declare and pay dividends on its
capital stock is regulated by the Puerto Rico Banking Law, the Federal Deposit Insurance Act (the
“FDIA”), and FDIC regulations. In general terms, the Puerto Rico Banking Law provides that when the
expenditures of a bank are greater than receipts, the excess of expenditures over receipts shall be
charged against undistributed profits of the bank and the balance, if any, shall be charged against
the required reserve fund of the bank. If the reserve fund is not sufficient to cover such balance
in whole or in part, the outstanding amount must be charged against the bank’s capital account. The
Puerto Rico Banking Law provides that, until said capital has been restored to its original amount
and the reserve fund to 20% of the original capital, the bank may not declare any dividends.
In general terms, the FDIA and the FDIC regulations restrict the payment of dividends when a
bank is undercapitalized, when a bank has failed to pay insurance assessments, or when there are
safety and soundness concerns regarding such bank.
In
addition, the Consent Orders impose certain restrictions on dividend payments. FirstBank, the insured
institution, may not declare or pay dividends or any other form of payment representing a reduction
in capital without the prior written approval of the FDIC. The FDIC will approve a dividend or any
other form of payment representing a reduction in capital provided that the FDIC determines that
such dividend or payment will not have an unacceptable impact on FirstBank’s capital position, cash
flow, concentrations of credit, asset quality and allowance for loan
and lease loss needs. Also, the
20
Corporation may not pay dividends or other payments without the permission of the
Federal Reserve Bank.
Limitations on Transactions with Affiliates and Insiders
Certain transactions between financial institutions such as FirstBank and FirstBank Florida
and affiliates are governed by Sections 23A and 23B of the Federal Reserve Act and by Regulation
W. An affiliate of a financial institution is any corporation or entity, which controls, is
controlled by, or is under common control with the financial institution. In a holding company
context, the parent bank holding company and any companies which are controlled by such parent bank
holding company are affiliates of the financial institution. Generally, Sections 23A and 23B of the
Federal Reserve Act (i) limit the extent to which the financial institution or its subsidiaries may
engage in “covered transactions” (defined below) with any one affiliate to an amount equal to 10%
of such financial institution’s capital stock and surplus, and contain an aggregate limit on all
such transactions with all affiliates to an amount equal to 20% of such financial institution’s
capital stock and surplus and (ii) require that all “covered transactions” be on terms
substantially the same, or at least as favorable, to the financial institution or affiliate, as
those provided to a non-affiliate. The term “covered transaction” includes the making of loans,
purchase of assets, issuance of a guarantee and other similar transactions. In addition, loans or
other extensions of credit by the financial institution to the affiliate are required to be
collateralized in accordance with the requirements set forth in Section 23A of the Federal Reserve
Act.
The Gramm-Leach-Bliley Act provides that financial subsidiaries of banks be treated as
affiliates for purposes of Sections 23A and 23B of the Federal Reserve Act, but provides that (i)
the 10% capital limitation on transactions between the bank and such financial subsidiary as an
affiliate not be applicable, and (ii) the investment by the bank in the financial subsidiary does
not include retained earnings of the financial subsidiary. The Gramm-Leach-Bliley Act provides
that: (1) any purchase of, or investment in, the securities of a financial subsidiary by any
affiliate of the parent bank is considered a purchase or investment by the bank; and (2) if the
Federal Reserve Board determines that such treatment is necessary, any loan made by an affiliate of
the parent bank to the financial subsidiary is to be considered a loan made by the parent bank.
The Federal
Reserve Board has adopted Regulation W which interprets the provisions of Sections 23A and 23B. The regulation unifies and updates staff
interpretations issued over the years, incorporates several new interpretations and provisions
(such as to clarify when transactions with an unrelated third party will be attributed to an
affiliate), and addresses new issues arising as a result of the expanded scope of nonbanking
activities engaged in by banks and bank holding companies in recent years and authorized for
financial holding companies under the Gramm-Leach-Bliley Act.
In addition, Sections 22(h) and (g) of the Federal Reserve Act, implemented through Regulation
O, place restrictions on loans to executive officers, directors, and principal stockholders.
Under Section 22(h)
of the Federal Reserve Act, loans to a director, an executive officer, a greater than 10%
stockholder of a financial institution, and certain related interests of these, may not exceed,
together with all other outstanding loans to such person and affiliated interests, the financial
institution’s loans to one borrower limit, generally equal to 15% of the institution’s unimpaired
capital and surplus. Section 22(h) of the Federal Reserve Act also requires that loans to
directors, executive officers, and principal stockholders be made on terms substantially the same
as offered in comparable transactions to other persons and also requires prior board approval for
certain loans. In addition, the aggregate amount of extensions of credit by a financial institution
to insiders cannot exceed the institution’s unimpaired capital and surplus. Furthermore, Section
22(g) of the Federal Reserve Act places additional restrictions on loans to executive officers. On
December 6, 2006, the Federal Reserve Board announced the approval of, and invited public
21
consent
on, an interim rule amending Regulation O that will eliminate several statutory reporting and
disclosure requirements relating to insider lending. The interim rule does not alter the
substantial restrictions on loans by insured depository institutions to their insiders.
The Consent Orders with banking regulators imposed some additional restrictions and reporting
requirements on the Corporation and FirstBank. Under its Consent Order with the FDIC, FirstBank
must not, directly or indirectly, enter into, participate, or in any other manner engage in any of
the following transactions with any affiliate without the prior written approval of the FDIC: (i) a
loan or extension of credit to the affiliate; (ii) a purchase of or an investment in securities
issued by the affiliate; (iii) a purchase of assets, including assets subject to an agreement to
repurchase, from the affiliate; (iv) the acceptance of securities issued by the affiliate as
collateral security for a loan or extension of credit to any person or company; (v) the issuance of
a guarantee, acceptance, or letter of credit, including an endorsement or standby letter of credit,
on behalf of an affiliate; (vi) the sale of securities or other assets to an affiliate, including
assets subject to an agreement to repurchase; (vii) the payment of money or furnishing of services
to an affiliate under contract, lease or otherwise; (viii) any transaction in which an affiliate
acts as agent or broker or receives a fee for its services to FirstBank; and (ix) any transaction
or series of transactions with a third party if an affiliate has a financial interest in the third
party, or an affiliate is a participant in such transaction or series of transactions. Under its
Consent Order with the Federal Reserve Bank, the Corporation must report all covered transactions
and not engage in insider transactions without the prior written approval of the Federal Reserve
Bank.
In February 2006, the Office of Thrift Supervision (“OTS”) imposed restrictions on FirstBank
Florida, formerly Unibank, a subsidiary acquired by First BanCorp in March 2005. Under these
restrictions, FirstBank Florida cannot make any payments to the Corporation or its affiliates
pursuant to a tax-sharing agreement nor can the bank employ or receive consultative services from
an executive officer of the Corporation or its affiliates without the prior written approval of the
OTS Regional Director. Additionally, FirstBank Florida cannot enter into any agreement to sell
loans or any portions of any loans to the Corporation or its affiliates nor can the bank make any
payment to the Corporation or its affiliates via an intercompany account or arrangement unless
pursuant to a pre-existing contractual agreement for services rendered in the normal course of
business.
Federal Reserve Board Capital Requirements
The Federal Reserve Board has adopted capital adequacy guidelines pursuant to which it
assesses the adequacy of capital in examining and supervising a bank holding company and in
analyzing applications to it under the Bank Holding Company Act. The Federal Reserve Board capital
adequacy guidelines generally require bank holding companies to maintain total capital equal to 8%
of total risk-adjusted assets, with at least one-half of that amount consisting of Tier I or core
capital and up to one-half of that amount consisting of Tier II or supplementary capital. Tier I
capital for bank holding companies generally consists of the sum of common stockholders’ equity and
perpetual preferred stock, subject in the case of the latter to limitations on the kind and amount
of such perpetual preferred stock that may be included as
Tier I capital, less goodwill and, with certain exceptions, other intangibles. Tier II capital
generally consists of hybrid capital instruments, perpetual preferred stock that is not eligible to
be included as Tier I capital; term subordinated debt and intermediate-term preferred stock; and,
subject to limitations, allowances for loan losses. Assets are adjusted under the risk-based
guidelines to take into account different risk characteristics, with the categories ranging from 0%
(requiring no additional capital) for assets such as cash to 100% for the bulk of assets, which are
typically held by a bank holding company, including multi-family residential and commercial real
estate loans, commercial business loans and commercial loans. Off-balance sheet items also are
adjusted to take into account certain risk characteristics.
22
In addition to the risk-based capital requirements, the Federal Reserve Board requires bank
holding companies to maintain a minimum leverage capital ratio of Tier I capital to total assets of
3.0%. Total assets for purposes of this calculation do not include goodwill and any other
intangible assets and investments that the Federal Reserve Board determines should be deducted. The
Federal Reserve Board has announced that the 3.0% Tier I leverage capital ratio requirement is the
minimum for the top-rated bank holding companies without supervisory, financial or operational
weaknesses or deficiencies or those which are not experiencing or anticipating significant growth.
Other bank holding companies will be expected to maintain Tier I leverage capital ratios of at
least 4.0% or more, depending on their overall condition. As of December 31, 2005, the Corporation
exceeded each of its capital requirements and was a well-capitalized institution as defined in the
Federal Reserve Board regulations.
The federal banking agencies are currently analyzing regulatory capital requirements as part
of an effort to implement the Basel Committee on Banking Supervision new capital adequacy framework
for large, internationally active banking organizations (Basel II), as well as to update their
risk-based capital standards to enhance the risk-sensitivity of the capital charges, to reflect
changes in accounting standards and financial markets, and to address competitive equity questions
that may be raised by U.S. implementation of the Basel II framework. Accordingly, the federal
agencies, including the Federal Reserve and the FDIC, are considering several revisions to
regulations issued in response to an earlier set of standards published by the Basel Committee in
1988 (Basel I). On September 25, 2006, the banking agencies proposed in a notice of proposal a new
risk-based capital adequacy framework under Basel II. The framework is intended to produce
risk-based capital requirements that are more risk-sensitive than the existing risk-based capital
rules.
FDIC Risk-Based Assessment System
Under a new rule adopted by the FDIC in November 2006, beginning in 2007, the FDIC will place
each institution that it insures in one of four risk categories using a two-step process based
first on capital ratios and then on other relevant information (the supervisory group assignment).
Beginning in 2007, FDIC insurance premium rates will range between 5 and 43 cents per $100 in
accessible deposits.
FDIC Capital Requirements
The FDIC has promulgated regulations and adopted a statement of policy regarding the capital
adequacy of state-chartered non-member banks like FirstBank. These requirements are substantially
similar to those adopted by the Federal Reserve Board regarding bank holding companies, as
described above. In addition, FirstBank Florida must comply with similar capital requirements
adopted by OTS.
The regulators require that banks meet a risk-based capital standard. The risk-based capital
standard for banks requires the maintenance of total capital (which is defined as Tier I capital
and supplementary (Tier 2) capital) to risk weighted assets of 8%. In determining the amount of
risk-weighted assets, weights used (range from 0% to 100%) are based on the risks inherent in the
type of asset or item. The
components of Tier I capital are equivalent to those discussed below under the 3.0% leverage
capital standard. The components of supplementary capital include certain perpetual preferred
stock, certain mandatory convertible securities, certain subordinated debt and intermediate
preferred stock and generally allowances for loan and lease losses. Allowance for loan and lease
losses includable in supplementary capital is limited to a maximum of 1.25% of risk-weighted
assets. Overall, the amount of capital counted toward supplementary capital cannot exceed 100% of
core capital.
The FDIC’s and OTS’ capital regulations establish a minimum 3.0% Tier I capital to total
assets requirement for the most highly-rated state-chartered, non-member banks, with an additional
cushion of at least 100 to 200 basis points for all other state-chartered, non-member banks, which
effectively will
23
increase the minimum Tier I leverage ratio for such other banks from 4.0% to 5.0%
or more. Under these regulations, the highest-rated banks are those that are not anticipating or
experiencing significant growth and have well diversified risk, including no undue interest rate
risk exposure, excellent asset quality, high liquidity and good earnings and, in general, are
considered a strong banking organization and are rated composite I under the Uniform Financial
Institutions Rating System. Leverage or core capital is defined as the sum of common stockholders’
equity including retained earnings, noncumulative perpetual preferred stock and related surplus,
and minority interests in consolidated subsidiaries, minus all intangible assets other than certain
qualifying supervisory goodwill and certain purchased mortgage servicing rights.
In August 1995, the FDIC and OTS published a final rule modifying their existing risk-based
capital standards to provide for consideration of interest rate risk when assessing the capital
adequacy of a bank. Under the final rule, the FDIC must explicitly include a bank’s exposure to
declines in the economic value of its capital due to changes in interest rates as a factor in
evaluating a bank’s capital adequacy. In June 1996, the FDIC and OTS adopted a joint policy
statement on interest rate risk. Because market conditions, bank structure, and bank activities
vary, the agencies concluded that each bank needs to develop its own interest rate risk management
program tailored to its needs and circumstances. The policy statement describes prudent principles
and practices that are fundamental to sound interest rate risk management, including appropriate
board and senior management oversight and a comprehensive risk management process that effectively
identifies, measures, monitors and controls such interest rate risk.
Failure to meet capital guidelines could subject an insured bank like to a variety of prompt
corrective actions and enforcement remedies under the FDIA (as amended by FDICIA), including, with
respect to an insured bank, the termination of deposit insurance by the FDIC, and certain
restrictions on its business. In general terms, undercapitalized depository institutions are
prohibited from making any capital distributions (including dividends), are subject to restrictions
on borrowing from the Federal Reserve System, are subject to growth limitations and are required to
submit capital restoration plans.
At December 31, 2005, FirstBank and FirstBank Florida were well capitalized. A bank’s capital
category, as determined by applying the prompt corrective action provisions of law, may not
constitute an accurate representation of the overall financial condition or prospects of the Bank,
and should be considered in conjunction with other available information regarding financial
condition and results of operations.
Set forth below are the Corporation’s, FirstBank’s and FirstBank Florida’s capital ratios at
December 31, 2005, based on then existing Federal Reserve and FDIC guidelines.
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First BanCorp Banking Subsidiary |
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Well- |
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FirstBank |
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Capitalized |
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First BanCorp |
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FirstBank |
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Florida |
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Minimum |
Total capital (Total capital to risk-weighted assets) |
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10.72 |
% |
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10.89 |
% |
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10.97 |
% |
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10.00 |
% |
Tier 1 capital ratio (Tier 1 capital to risk-weighted assets) |
|
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9.71 |
% |
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9.85 |
% |
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10.65 |
% |
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6.00 |
% |
Leverage ratio |
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|
6.72 |
% |
|
|
6.78 |
% |
|
|
7.99 |
% |
|
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5.00 |
% |
The
Consent Orders entered into with banking regulators require the Corporation and
FirstBank Puerto Rico to submit a capital plan to ensure that an adequate capital position is
maintained by both FirstBank and the Corporation in light of the reclassification of the
mortgage-related transactions as secured loans. The capital plan was submitted to regulators and is
being periodically reviewed against actual results.
24
Activities and Investments
The activities as “principal” and equity investments of FDIC-insured, state-chartered banks
such as FirstBank are generally limited to those that are permissible for national banks. Under
regulations dealing with equity investments, an insured state-chartered bank generally may not
directly or indirectly acquire or retain any equity investments of a type, or in an amount, that is
not permissible for a national bank.
Federal Home Loan Bank System
FirstBank is a member of the Federal Home Loan Bank (FHLB) system. The FHLB system consists of
twelve regional Federal Home Loan Banks governed and regulated by the Federal Housing Finance Board
(FHFB). The Federal Home Loan Banks serve as reserve or credit facilities for member institutions
within their assigned regions. They are funded primarily from proceeds derived from the sale of
consolidated obligations of the FHLB system, and they make loans (advances) to members in
accordance with policies and procedures established by the FHLB system and the Board of directors
of each regional FHLB.
FirstBank is a member of the FHLB of New York (FHLB-NY) and as such is required to acquire and
hold shares of capital stock in that FHLB for a certain amount, which is calculated in accordance
with the requirements set forth in applicable laws and regulations. FirstBank is in compliance with
the stock ownership requirements of the FHLB-NY. All loans, advances and other extensions of credit
made by the FHLB-NY to FirstBank are secured by a portion of FirstBank’s mortgage loan portfolio,
certain other investments and the capital stock of the FHLB-NY held by FirstBank.
FirstBank Florida is a member of the FHLB of Atlanta and is subject to similar requirements as
those of FirstBank.
Ownership and Control
Because of FirstBank’s status as an FDIC-insured bank, as defined in the Bank Holding Company
Act, First Bancorp as the owner of FirstBank’s common stock is subject to certain restrictions and
disclosure obligations under various federal laws, including the Bank Holding Company Act and the
Change in Bank Control Act (the “CBCA”). Regulations pursuant to the Bank Holding Company Act
generally require prior Federal Reserve Board approval for an acquisition of control of an insured
institution (as defined in the Act) or holding company thereof by any person (or persons acting in
concert). Control is deemed to exist if, among other things, a person (or persons acting in
concert) acquires more than 25% of any class of voting stock of an insured institution or holding
company thereof. Under the CBCA, control is presumed to exist subject to rebuttal, if a person (or
persons acting in concert) acquires more than 10% of any class of voting stock and either (i) the
corporation has registered securities under Section 12 of the Securities Exchange Act of 1934, or
(ii) no person will own, control or hold the power to vote a greater percentage of that class of
voting securities immediately after the transaction. The concept of acting in concert is very broad
and also is subject to certain rebuttable presumptions, including among others, that relatives,
business partners, management officials, affiliates and others are presumed to be acting in
concert with each other and their businesses. The FDIC’s and OTS’ regulations implementing the CBCA
are generally similar to those described above.
The Puerto Rico Banking Law requires the approval of the Commissioner for changes in control
of a Puerto Rico bank. See “Puerto Rico Banking Law.”
25
Cross-Guarantees
Under the FDIA, a depository institution (which term includes both banks and savings
associations), the deposits of which are insured by the FDIC, can be held liable for any loss
incurred by, or reasonably expected to be incurred by, the FDIC in connection with (i) the default
of a commonly controlled FDIC-insured depository institution or (ii) any assistance provided by the
FDIC to any commonly controlled FDIC-insured depository institution “in danger of default.”
“Default” is defined generally as the appointment of a conservator or a receiver and “in danger of
default” is defined generally as the existence of certain conditions indicating that a default is
likely to occur in the absence of regulatory assistance. In some circumstances (depending upon the
amount of the loss or anticipated loss suffered by the FDIC), cross-guarantee liability may result
in the ultimate failure or insolvency of one or more insured depository institutions liable to the
FDIC, and any obligations of that bank to its parent corporation are subordinated to the subsidiary
bank’s cross-guarantee liability with respect to commonly controlled insured depository
institutions. FirstBank and FirstBank Florida are currently the only FDIC insured depository
institutions controlled by the Corporation and therefore subject to this guaranty provision.
Standards for Safety and Soundness
The FDIA, as amended by FDICIA and the Riegle Community Development and Regulatory Improvement
Act of 1994, requires the FDIC and the other federal bank regulatory agencies to prescribe
standards of safety and soundness, by regulations or guidelines, relating generally to operations
and management, asset growth, asset quality, earnings, stock valuation, and compensation. The FDIC
and the other federal bank regulatory agencies adopted, effective August 9, 1995, a set of
guidelines prescribing safety and soundness standards pursuant to FDIA, as amended. The guidelines
establish general standards relating to internal controls and information systems, internal audit
systems, loan documentation, credit underwriting, interest rate exposure, asset growth and
compensation, fees and benefits. In general, the guidelines require, among other things,
appropriate systems and practices to identify and manage the risks and exposures specified in the
guidelines. The guidelines prohibit excessive compensation as an unsafe and unsound practice and
describe compensation as excessive when the amounts paid are unreasonable or disproportionate to
the services performed by an executive officer, employee, director or principal shareholder. For
additional information, see the discussion under “Recent Significant Events – Governmental Action,
Banking Regulators.”
Brokered Deposits
FDIC regulations adopted under the FDIA govern the receipt of brokered deposits by banks. Well
capitalized institutions are not subject to limitations on brokered deposits, while adequately
capitalized institutions are able to accept, renew or rollover brokered deposits only with a waiver
from the FDIC and subject to certain restrictions on the interest paid on such deposits.
Undercapitalized institutions are not permitted to accept brokered deposits. As of December 31,
2005, FirstBank was a well-capitalized institution and was therefore not subject to any limitations
on brokered deposits.
Puerto Rico Banking Law
As a commercial bank organized under the laws of the Commonwealth, FirstBank is subject to
supervision, examination and regulation by the Commonwealth of Puerto Rico Commissioner of
Financial Institutions (“Commissioner”) pursuant to the Puerto Rico Banking Law of 1933, as amended
(the “Banking Law”). The Banking Law contains provisions governing the incorporation and
organization, rights and responsibilities of directors, officers and stockholders as well as the
corporate powers, lending limitations, capital requirements, investment requirements and other
aspects of FirstBank and its affairs. In addition, the Commissioner is given extensive rule making
power and administrative discretion under the Banking Law.
26
The Banking Law authorizes Puerto Rico commercial banks to conduct certain financial and
related activities directly or through subsidiaries, including the leasing of personal property and
operating a small loan corporation.
The Banking Law requires every bank to maintain a legal reserve which shall not be less than
twenty percent (20%) of its demand liabilities, except government deposits (federal, state and
municipal), which are secured by actual collateral. The reserve is required to be composed of any
of the following securities or combination thereof: (1) legal tender of the United States; (2)
checks on banks or trust companies located in any part of Puerto Rico, to be presented for
collection during the day following that on which they are received, (3) money deposited in other
banks provided said deposits are authorized by the Commissioner, subject to immediate collection;
(4) federal funds sold to any Federal Reserve Bank and securities purchased under agreement to
resell executed by the bank with such funds that are subject to be repaid to the bank on or before
the close of the next business day; and (5) any other asset that the Commissioner identifies from
time to time.
The Banking Law permits Puerto Rico commercial banks to make loans to any one person, firm,
partnership or corporation, up to an aggregate amount of fifteen percent (15%) of the sum of: (i)
the bank’s paid-in capital; (ii) the bank’s reserve fund; (iii) 50% of the bank’s retained
earnings; and (iv) any other components that the Commissioner may determine from time to time. If
such loans are secured by collateral worth at least twenty five percent (25%) more than the amount
of the loan, the aggregate maximum amount may reach one third of the sum of the bank’s paid-in
capital, reserve fund, 50% of retained earnings and such other components that the Commissioner may
determine from time to time. There are no restrictions under the Banking Law on the amount of loans
which are wholly secured by bonds, securities and other evidence of indebtedness of the Government
of the United States, of the Commonwealth of Puerto Rico, or by bonds, not in default, of
municipalities or instrumentalities of the Commonwealth of Puerto Rico. The Corporation’s
restatement of previously issued financial statements (Form 10-K/A 2004) due to, among other
corrections, the revised classification of mortgage-related transactions as secured commercial
loans to Doral and R&G Financial, caused the transactions to be treated as two secured commercial
loans, which were in excess of lending limits imposed by the Banking Law. FirstBank received a
ruling from the Commissioner that results in FirstBank being considered in continued compliance
with the loan to one borrower limitation.
The Banking Law prohibits Puerto Rico commercial banks from making loans secured by their own
stock, and from purchasing their own stock, unless such purchase is made pursuant to a stock
repurchase program approved by the Commissioner or is necessary to prevent losses because of a debt
previously contracted in good faith. The stock purchased by the Puerto Rico commercial bank must be
sold by the bank in a public or private sale within one year from the date of purchase.
The Banking Law provides that no officers, directors, agents or employees of a Puerto Rico
commercial bank may serve or discharge a position of officer, director, agent or employee of
another Puerto Rico commercial bank, financial corporation, savings and loan association, trust
corporation, corporation engaged in granting mortgage loans or any other institution engaged in the
money lending
business in Puerto Rico. This prohibition is not applicable to the affiliates of a Puerto Rico
commercial bank.
The Banking Law requires that Puerto Rico commercial banks prepare each year a balance summary
of their operations, and submit such summary balance for approval at a regular meeting of
stockholders, together with an explanatory report thereon. The Banking Law also requires that at
least ten percent (10%) of the yearly net income of a Puerto Rico commercial bank be credited
annually to a reserve fund.
27
This apportionment is required to be done every year until such reserve
fund shall be equal to the total paid in capital of the bank.
The Banking Law also provides that when the expenditures of a Puerto Rico commercial bank are
greater than receipts, the excess of the expenditures over receipts shall be charged against the
undistributed profits of the bank, and the balance, if any, shall be charged against the reserve
fund, as a reduction thereof. If there is no reserve fund sufficient to cover such balance in whole
or in part, the outstanding amount shall be charged against the capital account and no dividend
shall be declared until said capital has been restored to its original amount and the reserve fund
to twenty percent (20%) of the original capital.
The Banking Law requires the prior approval of the Commissioner with respect to a transfer of
capital stock of a bank that results in a change of control of the bank. Under the Banking Law, a
change of control is presumed to occur if a person or a group of persons acting in concert,
directly or indirectly, acquire more than 5% of the outstanding voting capital stock of the bank.
The Commissioner has interpreted the restrictions of the Banking Law as applying to acquisitions of
voting securities of entities controlling a bank, such as a bank holding company. Under the Banking
Law, the determination of the Commissioner whether to approve a change of control filing is final
and non-appealable.
The Finance Board, which is composed of the Commissioner, the Secretary of the Treasury, the
Secretary of Commerce, the Secretary of Consumer Affairs, the President of the Economic Development
Bank, the President of the Government Development Bank, and the President of the Planning Board,
has the authority to regulate the maximum interest rates and finance charges that may be charged on
loans to individuals and unincorporated businesses in Puerto Rico. The current regulations of the
Finance Board provide that the applicable interest rate on loans to individuals and unincorporated
businesses, including real estate development loans but excluding certain other personal and
commercial loans secured by mortgages on real estate properties, is to be determined by free
competition. Accordingly, the regulations do not set a maximum rate for charges on retail
installment sales contracts and for credit card purchases and set aside previous regulations which
regulated these maximum finance charges. Furthermore, there is no maximum rate set for installment
sales contracts involving motor vehicles, commercial, agricultural and industrial equipment,
commercial electric appliances and insurance premiums.
International Banking Act of Puerto Rico (“IBE Act”)
The business and operations of the First BanCorp IBE, FirstBank IBE and FirstBank Overseas
Corporation are subject to supervision and regulation by the Commissioner. Under the IBE Act,
certain sales, encumbrances, assignments, mergers, exchanges or transfers of shares, interests
or participation(s) in the capital of an international banking entity (an “IBE”) may
not be initiated without the prior approval of the Commissioner. The IBE Act and the regulations
issued thereunder by the Commissioner (the “IBE Regulations”) limit the business activities that
may be carried out by an IBE. Such activities are limited in part to persons and assets located
outside of Puerto Rico.
Pursuant to the IBE Act and the IBE Regulations, each of First BanCorp and FirstBank IBEs and
FirstBank Overseas Corporation must maintain books and records of all its transactions in the
ordinary
course of business. The First BanCorp and FirstBank IBEs and FirstBank Overseas Corporation are
also required thereunder to submit to the Commissioner quarterly and annual reports of their
financial condition and results of operations, including annual audited financial statements.
The IBE Act empowers the Commissioner to revoke or suspend, after notice and hearing, a
license issued thereunder if, among other things, the IBE fails to comply with the IBE Act, the IBE
Regulations
28
or the terms of its license, or if the Commissioner finds that the business or affairs
of the IBE are conducted in a manner that is not consistent with the public interest.
Puerto Rico Income Taxes
Under the Puerto Rico Internal Revenue Code of 1994 (the “Code”), all companies are treated as
separate taxable entities and are not entitled to file consolidated tax returns. The Corporation,
and each of its subsidiaries are subject to a maximum statutory corporate income tax rate of 39% or
an alternative minimum tax (“AMT”) on income earned from all sources, whichever is higher. 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. The Code provides for a dividend received
deduction of 100% on dividends received from wholly owned subsidiaries subject to income taxation
in Puerto Rico and 85% on dividends received from other taxable domestic corporations.
In computing the interest expense deduction, the Corporation’s interest deduction will be
reduced in the same proportion that the average exempt assets bear to the average total assets.
Therefore, to the extent that the Corporation holds certain investments and loans which are exempt
from Puerto Rico income taxation, part of its interest expense will be disallowed for tax purposes.
The Corporation has maintained an effective tax rate lower than the maximum statutory tax rate
of 41.5% (39% plus a 2.5% transitory tax) as of December 31, 2005,
mainly by investing in government obligations and mortgage-backed
securities exempt from U.S. and Puerto Rico income tax combined with income from the international
banking divisions (IBE) of the Corporation and the Bank and by the Bank’s subsidiary, FirstBank
Overseas Corporation. The IBE, and FirstBank Overseas Corporation were created under the IBE Act,
which provides for Puerto Rico tax exemption on net income derived by IBEs operating in Puerto
Rico. Pursuant to the provisions of Act No. 13 of January 8, 2004, the IBE Act was amended to
impose income tax at regular rates on IBEs that operate as units of a bank, to the extent that the
IBEs net income exceeds 40% of the bank’s total net taxable income (including net income generated
by the IBE unit) for the taxable year that commenced on July 1, 2003, 30% for the taxable year that
commenced on July 1, 2004 and 20% for taxable years commencing in July 1, 2005, and thereafter.
These amendments apply only to IBEs that operate as units of a bank; they do not impose income tax
on an IBE that operates as a subsidiary of a bank.
Puerto Rico Banking Law Act 41 of August 1, 2005 amended the Puerto Rico Internal Revenue Code
by imposing a transitory additional tax of 2.5% on net taxable income for all corporations. This
transitory tax effectively increased the statutory tax rate from 39% to 41.5%. The Act became
effective for taxable years commencing after December 31, 2004 and ending on or before December 31,
2006 and therefore is effective for the 2005 and 2006 taxable years with a retroactive effect to
January 1, 2005.
Puerto Rico Internal Revenue Code Act 89 of May 13, 2006 imposed a 2% additional income tax on
income subject to regular taxes of all corporations operating
pursuant to Act 55 of 1933 (The Puerto Rico Banking Act). Act 89
will be effective for the taxable year commencing after December 31, 2005 and on or before December
31, 2006 and therefore, increased the statutory tax for the 2006 taxable year to 43.5%. The
statutory tax will revert to 39% for taxable years commencing after December 31, 2006.
United States Income Taxes
The Corporation is also subject to federal income tax on its income from sources within the
United States and on any item of income that is, or is considered to be, effectively connected with
the active conduct of a trade or business within the United States. The U.S. Internal Revenue code
provides for tax exemption of portfolio interest received by a foreign corporation from sources
within the United States,
29
therefore, the Corporation is not subject to federal income tax on
certain U.S. investments which qualify under the term “portfolio interest”.
Insurance Operations Regulation
FirstBank Insurance Agency, Inc. is registered as an insurance agency with the Insurance
Commissioner of Puerto Rico and is subject to regulations issued by the Insurance Commissioner
relating to, among other things, licensing of employees, sales, solicitation and advertising
practices, and to the FDIC as to certain consumer protection provisions mandated by the
Gramm-Leach-Bliley Act and its implementing regulations.
Community Reinvestment
Under the Community Reinvestment Act (“CRA”), federally insured banks have a continuing and
affirmative obligation to meet the credit needs of their entire community, including low and
moderate-income residents, consistent with their safe and sound operation. The CRA does not
establish specific lending requirements or programs for financial institutions nor does it limit an
institution’s discretion to develop the type of products and services that it believes are best
suited to its particular community, consistent with the CRA. The CRA requires the federal
supervisory agencies, as part of the general examination of supervised banks, to assess the bank’s
record of meeting the credit needs of its community, assign a performance rating, and take such
record and rating into account on their evaluation of certain applications by such bank. The CRA
also requires all institutions to make public disclosure of their CRA ratings. FirstBank and
FirstBank Florida received a “satisfactory” CRA rating in its most recent examination by the FDIC.
Mortgage Banking Operations
FirstBank is subject to the rules and regulations of the Federal Housing Administration
(“FHA”), U.S. Department of Veteran Affairs (“VA”), Federal National Mortgage Association (“FNMA”),
Federal Home Loan Mortgage Corporation (“FHLMC”), Housing and Urban Development (“HUD”) and
Government National Mortgage Association (“GNMA”) with respect to originating, processing, selling
and servicing mortgage loans and the issuance and sale of mortgage-backed securities. Those rules
and regulations, among other things, prohibit discrimination and establish underwriting guidelines
that include provisions for inspections and appraisals, require credit reports on prospective
borrowers and fix maximum loan amounts, and with respect to VA loans, fix maximum interest rates.
Moreover, lenders such as FirstBank are required annually to submit to FHA, VA, FNMA, FHLMC, GNMA
and HUD audited financial statements, and each regulatory entity has its own financial
requirements. FirstBank’s affairs are also subject to supervision and examination by FHA, VA, FNMA,
FHLMC, GNMA and HUD at all times to assure compliance with the applicable regulations, policies and
procedures. Mortgage origination activities are subject to, among others, the Equal Credit
Opportunity Act, Federal Truth-in-Lending Act, and the Real Estate Settlement Procedures Act and
the regulations promulgated thereunder which, among other things, prohibit discrimination and
require the disclosure of certain basic information to mortgagors concerning credit terms and
settlement costs. FirstBank is licensed by the Commissioner under the Puerto Rico Mortgage Banking
Law, and as such is subject to regulation by the Commissioner,
with respect to, among other things, licensing requirements and establishment of maximum
origination fees on certain types of mortgage loan products.
Section 5 of the Puerto Rico Mortgage Banking Law requires the prior approval of the
Commissioner for the acquisition of control of any mortgage banking institution licensed under such
law. For purposes of the Puerto Rico Mortgage Banking Law, the term “control” means the power to
direct or influence decisively, directly or indirectly, the management or policies of a mortgage
banking institution. The
30
Puerto Rico Mortgage Banking Law provides that a transaction that results
in the holding of less than 10% of the outstanding voting securities of a mortgage banking
institution shall not be considered a change in control.
Recent Legislation
Act 89 of May 13, 2006 imposed a 2% additional income tax on
the net income subject to regular taxes of all corporations operating pursuant to Act 55 of 1933
(The Puerto Rico Banking Act). The Act became effective for the taxable year commencing after
December 31, 2005 and on or before December 31, 2006, and therefore, increased the statutory tax
for the 2006 taxable year to 43.5%. The statutory tax will revert to 39% for taxable years
commencing after December 31, 2006.
Act 98 of May 16, 2006 imposed an extraordinary 5% tax on
the net taxable income reported in the corporate tax return of corporations whose gross income
exceeded $10 million for the taxable year ended on or before December 31, 2005. Covered taxpayers
were required to file a special return and pay the tax no later than July 31, 2006. The
extraordinary tax paid will be taken as a credit against the income tax of the entity determined
for taxable years commencing after July 31, 2006, subject to certain limitations. Any unused credit
may be carried forward to subsequent taxable years.
On December 22, 2006, Law No. 283 was approved, amending the Section 27 of Law No. 55 of
May 12, 1933, as amended. This law clarifies the process for the determination of loan losses by
financial institutions in the Commonwealth of Puerto Rico, stipulating that accrued interest on
loans past due 90 days or more should be excluded from income, except on loans collateralized
by mortgages, where interest past due not exceeding one year, could be included as part of
income given proper disclosure of the fact that they have not been collected. It also requires that
loans past due 365 days for which no interest was collected during the periods be charged to
losses, except on collateralized and under legal collection efforts, which will be charged to losses
up to their net realizable value.
Item 1A. Risk Factors
Certain risk factors that may affect the Corporation’s future results of operations are
discussed below.
Risks Relating to the 2004 Restatement Process
First BanCorp is subject to the ongoing regulatory investigation by the SEC
On August 25, 2005, the Corporation announced the receipt of a letter from the SEC in which
the SEC indicated that it was conducting an informal inquiry into the Corporation. The inquiry
relates to, among other things, the accounting for mortgage loans purchased by the Corporation from
two other financial institutions during the calendar years 1999 through 2004. On October 21, 2005,
the Corporation announced that the SEC had issued a formal order of investigation into the
accounting for the mortgage–related transactions with Doral and R&G.
First BanCorp has been engaged in discussions with the staff of the SEC regarding a possible
resolution to its investigation of the Corporation’s restatement, and has accrued $8.5 million in
its consolidated financial statements for the year ended December 31, 2005 in connection with a
potential settlement of the SEC’s investigation of the Corporation. Any settlement is subject to
the approval of the Commissioner of the SEC. There can be no assurance that the Corporation’s
efforts to resolve the SEC’s investigation with respect to the Corporation will be successful, or
that the amount accrued will be sufficient, and the Corporation cannot predict at this time the
timing or final terms of any settlement.
Pending litigation could adversely affect First BanCorp’s results of operations
As a consequence of the accounting review and restatement, the Corporation is subject to
pending class-action proceedings (refer to “Recent Significant Events” above).
Following the announcement of the Audit Committee’s review, the Corporation and certain of its
officers and directors and former officers and directors were named as defendants in five separate
securities class actions filed between October 31, 2005 and December 5, 2005, alleging violations
of Sections 10(b) and 20(a) of the
31
Securities Exchange Act of 1934. At present, all securities
class actions have been consolidated into one case named “In Re: First BanCorp Securities
Litigations” currently pending before the U.S. District Court for the District of Puerto Rico. The
Corporation has been engaged in discussions with lead plaintiffs through private mediation
proceedings. The Corporation has accrued $74.2 million in its consolidated financial statements for
the year ended December 31, 2005 in connection with a potential settlement. There can be no
assurance that the amount accrued will be sufficient and the Corporation cannot predict at this
time the timing or final terms of any settlement.
Between November 8, 2005 and March 7, 2006 several shareholders of the Corporation
commenced five separate derivative actions against certain current and former executive
officers and directors of the Corporation. In these actions, the Corporation was included
as a nominal defendant. These actions were filed pursuant to Section 304 of the
Sarbanes-Oxley Act of 2002 and alleged, among other things, a breach of fiduciary duty
on behalf of the defendants. All shareholder derivative actions were consolidated into
one case named “In Re: First BanCorp Derivative Litigation” which was dismissed on
November 30, 2006 before the U.S. District Court for the District of Puerto Rico.
Banking regulators could take adverse action against the Corporation or its banking
subsidiaries as a result of the Consent Orders
The Corporation is subject to supervision and regulation by the Board of Governors of the
Federal Reserve System. The Corporation is a bank holding company that qualifies as a financial
holding corporation. As such, the Corporation is permitted to engage in a broader spectrum of
activities than those permitted to bank holding companies that are not financial holding companies.
To continue to qualify as a financial holding corporation, each of the Corporation’s banking
subsidiaries must continue to qualify as “well capitalized” and “well managed.” As of December 31,
2005, the Corporation and its banking subsidiaries continue to satisfy all applicable capital
guidelines. This, however, does not prevent banking regulators from taking adverse actions against
the Corporation or its banking subsidiaries as a result of the Consent Orders or related internal
control matters. If the Corporation were not to continue to qualify as a financial holding
corporation, it might be required to discontinue certain activities and may be prohibited from
engaging in new activities without prior regulatory approval.
Federal banking regulators, in the performance of their supervisory and enforcement duties,
have significant discretion and power to initiate enforcement actions for violations of laws and
regulations and unsafe or unsound practices. Failure of the Corporation or FirstBank to remain in
compliance with the terms of the Consent Orders could result in the imposition of additional cease
and desist orders and/or in monetary penalties.
Downgrades in the Corporation’s credit ratings could potentially increase the cost of
borrowing funds
Following the Corporation’s announcement on October 21, 2005 that the SEC had issued a formal
order of investigation, the major rating agencies downgraded the Corporation’s and FirstBank’s
ratings in a series of actions. Fitch Ratings, Ltd. lowered the Corporation’s long-term senior debt
rating from BBB- to BB and placed the rating on Rating Watch Negative. Standard & Poors lowered the
long-term senior debt and counterparty rating of FirstBank, from BBB- to BB+ and placed the rating
on Credit Watch Negative. Moody’s Investor Service lowered FirstBank’s long-term senior debt rating
from Baa3 to Ba1 and placed the rating on negative outlook. These or further downgrades may
adversely affect the Corporation’s and FirstBank’s ability to access capital and will likely result
in more stringent covenants and higher interest rates under the terms of any future indebtedness.
The Corporation’s liquidity is contingent upon its ability to obtain external sources of
funding to finance its operations. Downgrades in credit ratings can hinder the Corporation’s access
to external
funding and/or cause external funding to be more expensive, which could in turn adversely affect
the results of operations.
These debt and financial strength ratings are current opinions of the rating agencies. As
such, they may be changed, suspended or withdrawn at any time by the rating agencies as a result of
changes in, or unavailability of, information or based on other circumstances.
32
Management has identified several material weaknesses in the Corporation’s internal controls
over financial reporting
The Corporation’s management has concluded that the Corporation’s internal controls over
financial reporting were not effective at December 31, 2005 as a result of several material
weaknesses described in this Form 10-K. A discussion of the material weaknesses that have been
identified by management can be found in Item 9A of Part II of this Form 10-K along with the
Corporation’s remediaton plan.
There is a lack of public disclosure concerning the Corporation
The Corporation has not yet filed with the SEC its quarterly reports on Form 10-Q for the
fiscal quarters ended June 30, 2005, September 30, 2005, March 31, 2006,
June 30, 2006 and September 30, 2006. In addition, it needs
to file an Amended quarterly report in Form 10Q for fiscal quarter
ended March 31, 2005. The Corporation expects to file these reports or the
financial information required by these reports as soon as practicable after the filing of this
Form 10-K. Until the Corporation files these quarterly reports, there will be limited public
information available concerning the Corporation’s most recent results of operations and financial
condition.
Failure to comply with reporting covenants under debt arrangements may result in the
acceleration of payment obligations
Under certain debt instruments and notes, the Corporation is required to timely file its
periodic reports with the appropriate counterparty holders. The Corporation has not yet filed its
quarterly reports on Form 10-Q for the fiscal quarters ended March 31, 2005 (Amended), June 30,
2005, September 30, 2005, March 31, 2006, June 30, 2006 and September 30, 2006 (the “Delayed
Reports”).
The Corporation is not currently in default as the counterparty holders have extended the
timing required for the filing of the Delayed Reports until December 31, 2006 or later. However, if
the Corporation were to default on the filing of the delayed reports, the counterparty holders will
have the right to accelerate the maturity of the debt arrangements which amount to approximately $165 million.
The Corporation’s
delay in filing all required reports may adversely affect its ability
to attract customers, investors and employees
The Corporation’s ability to attract customers and investors may be adversely affected by its
delay in filing all the required reports and the risks and uncertainties that delay may suggest.
This delay may also have an adverse effect on the Corporation’s ability to attract and retain key
employees and management personnel.
Risks Relating to the Corporation’s Business
Fluctuations in interest rates may impact the Corporation’s results of operations
Increases in interest rates are the primary market risk affecting the Corporation. Interest
rates are highly sensitive to many factors, such as governmental monetary policies and domestic and
international economic and political conditions that are beyond the control of the Corporation.
Since the year 2004, interest rates have been increasing and this may negatively affect the
following areas of the Corporation’s business:
33
| |
• |
|
The net interest income; |
| |
| |
• |
|
The value of owned securities, including interest rate swaps; and |
| |
| |
• |
|
the volume of loans originated, particularly mortgage loans. |
Increases in interest rates may reduce net interest income
Increases in short-term interest rates may reduce net interest income, which is the principal
component of the Corporation’s earnings. Net interest income is the difference between the amount
received by the Corporation on its interest-earning assets and the interest paid by the Corporation
on its interest-bearing liabilities. When interest rates rise, the Corporation must pay more in
interest on its liabilities while the interest earned on its assets does not rise as quickly. This
may cause the Corporation’s profits to decrease.
Increases in interest rates may reduce the value of holdings of securities, including interest
rate swaps
Fixed-rate securities and the interest rate swaps entered into by the Corporation are
generally subject to decreases in market value when interest rates rise, which would require
recognition of a loss, thereby potentially affecting adversely the results of operations.
Increases in interest rates may reduce demand for mortgage and other loans
Higher interest rates increase the cost of mortgage and other loans to consumers and
businesses and may reduce demand for such loans, which may negatively impact the Corporation’s
profits by reducing the amount of loan origination income.
In addition, the Corporation’s net interest margin may be negatively impacted prospectively by
the excess liquidity from cash receipts from Doral and R&G for the repayment of secured loans to
these institutions. The negative impact could be the result of reinvestment of proceeds in lower
yielding assets until a planned deleverage of the Corporation’s
financial statement of condition is completed.
The Corporation is subject to default risk on loans, which may adversely affect its results
The Corporation is subject to the risk of loss from loan defaults and foreclosures with
respect to the loans it originates. The Corporation establishes provisions for loan losses, which
lead to reductions in its income from operations, in order to maintain its allowance for inherent
loan losses at a level which its management deems to be appropriate based upon an assessment of the
quality of its loan portfolio. Although the Corporation’s management utilizes its best judgment in
providing for loan losses, there can be no assurance that management has accurately estimated the
level of inherent loan losses or that the Corporation will not have to increase its provisions for
loan losses in the future as a result of future increases in non performing loans or for other
reasons beyond its control. Any such increases in the Corporation’s provisions for loan losses or
any loan losses in excess of its provisions for loan losses would have an adverse effect on the
Corporation’s future financial condition and results of operations.
The Corporation’s business concentration in Puerto Rico imposes risks
The Corporation conducts its operations in a geographically concentrated area, as its main
market is Puerto Rico. This imposes risks from lack of diversification in the geographical
portfolio. The Corporation’s financial condition and results of operations are highly dependent on
the economic conditions of Puerto Rico, where adverse political or economic developments, natural
disasters, etc. could affect the volume of loan originations, increase the level of nonperforming
assets, increase the rate of foreclosure losses on loans, and reduce the value of the Corporation’s
loans and loan servicing portfolio.
34
These factors could materially and adversely affect the
Corporation’s financial condition and results of operations. As a result of the reclassification of
purchases of mortgage loans, the Corporation had substantial secured loans to local financial
institutions in the amount of $3.7 billion and $3.8 billion
in 2005 and 2004, respectively. On May 31, 2006, the Corporation announced that its subsidiary, FirstBank, received a
cash payment from Doral of approximately $2.4 billion, substantially reducing the
balance in secured commercial loans resulting from the Corporation’s previously-announced revised classification of several mortgage-related transactions with Doral.
First BanCorp is subject to risks associated with the Commonwealth of Puerto Rico’s temporary
budget crisis
Due to a budget impasse, the Commonwealth of Puerto Rico (the “Commonwealth”) closed all
public agencies on May 1, 2006, except those related to safety, health and other essential
services. All agencies were subsequently opened two weeks later and a budget approval by the
Legislature was signed into law by the Governor, Aníbal Acevedo Vilá. Subsequently, Moody’s
Investors Service downgraded the Commonwealth’s general obligation bond rating to Baa3 from Baa2,
and kept the rating on Watchlist for possible further downgrade.
According to Moody’s, this action reflects the Commonwealth’s strained financial condition,
and ongoing political conflict and lack of agreement regarding the measures necessary to end the
government’s multi-year trend of financial deterioration. A fiscal reform has been recently
approved, where the House and Senate approved a tax reform authorizing a 7% sales tax, with the
option, if expected revenues do not materialize, to raise it to 8% after December 2006.
Notwithstanding, significant budget deficits and fiscal imbalance could continue in the coming
years. Any significant adverse political or economic developments in Puerto Rico resulting from the
budget impasse could have a negative impact on the Corporation’s future financial condition and
results of operations.
Rating downgrades on the Government of Puerto Rico’s debt obligations may affect the
Corporation’s credit exposure
Even though Puerto Rico’s economy is closely integrated to that of the U.S. mainland and its
government and many of its instrumentalities are investment-grade rated borrowers in the U.S.
capital markets, the current fiscal situation of the Government of Puerto Rico has led nationally
recognized rating agencies to downgrade its debt obligations.
In May 2006, Moody’s Investors Service downgraded the Government’s general obligation bond
rating to Baa3 from Baa2, and put the credit on “watchlist” for possible further downgrades. The
Commonwealth’s appropriation bonds and some of the subordinated revenue bonds were also downgraded
by one notch and are now rated just below investment grade at Ba1. Moody’s commented that this
action reflects the Government’s strained financial condition, the ongoing political conflict and
lack of agreement regarding the measures necessary to end the government’s multi-year trend of
financial deterioration. Standard & Poor’s Rating Services (“S&P”) still rates the Government’s
general obligations two notches above junk at BBB, and the Commonwealth’s appropriation bonds and
some of the subordinated revenue bonds BBB-, a category that continues to be investment-grade
rated.
In July 2006, S&P and Moody’s affirmed their credit ratings on the Commonwealth debt, and
removed the debt from their respective watch lists, thus reducing the possibility of an immediate
additional downgrade. These actions resulted after the Government approved the budget for the 2007
fiscal year, which runs from July 2006 through June 2007 and included the adoption of a new sales
tax. Revenues from the sales tax are to be dedicated primarily to fund the government’s operating
expenses, and to a lesser extent, to repay government debt and fund local municipal governments.
35
Both rating agencies maintained the negative outlook for the Puerto Rico obligation bonds.
Factors such as the government’s ability to implement meaningful steps to curb operating
expenditures, improve managerial and budgetary controls, and eliminate the government’s reliance on
operating budget loans from the Government Development Bank of Puerto Rico will be key determinants
of future rating stability and restoration of a stable long-term outlook. Also, the inability to
agree on future fiscal year Commonwealth budgets could result in ratings pressure from the rating
agencies.
It is uncertain how the financial markets may react to any potential future ratings downgrade
in Puerto Rico’s debt obligations. However, the fallout from the recent budgetary crisis and a
possible ratings downgrade could adversely affect the value of Puerto Rico’s Government
obligations.
First Bancorp’s credit quality may be adversely affected by Puerto Rico’s current economic
condition
The slowdown on the island’s growth rate, which appears to have started in 2005 according to
the Puerto Rico Planning Board statistics, has continued in 2006. Manufacturing has declined in
overall activity for 2006 as compared to the same period in 2005, for the first time since 2002.
Construction remained relatively weak during 2006, as the combination of rising interest
rates, the Commonwealth’s fiscal situation and decreasing public investment in construction
projects affected the sector. However, it did manage to expand very modestly versus the prior-year
period. The value of construction permits during the fiscal year ending June 2006 declined 4.3%,
with most of the drop coming from the public sector. Retail sales during the six months ending June
2006 also reflected the uncertainty prevalent at the time related to the Commonwealth’s fiscal
situation, as well as increased oil and utility prices. Sales registered a decline of 1.9% as
compared to the same period in 2005, as the months surrounding the temporary government shutdown
were particularly affected. The unemployment rate was 9.6% as of October 2006.
Tourism is the one sector that has been resilient. Activity in the sector has expanded
consistently since 2004, and in the 2006 fiscal year ending June 2006 it registered the strongest
increase in four years. Factors that may be boosting the tourism sector are geo-political tensions
throughout the world, a relative benign hurricane season for the past two years, and a relatively
firm U.S. economy.
In general, it is apparent that in 2006 the Puerto Rican economy continued its trend of
decreasing growth and ended the first half of the year with minimal momentum, primarily due to
weaker manufacturing, softer consumption and decreased government investment in construction.
The above economic concerns and uncertainty in the private and public sectors may also have an
adverse effect in the credit quality of the Corporation’s loan portfolios, as delinquency rates are
expected to increase in the short-term, until the economy stabilizes. Also, a potential reduction
in consumer spending may also impact growth in other interest and non-interest revenue sources of
the Corporation.
A prolonged economic slowdown or a decline in the real estate market in the U.S mainland could
harm the results of operations of FirstMortgage
The residential mortgage loan origination business has historically been cyclical, enjoying
periods of strong growth and profitability followed by periods of shrinking volumes and
industry-wide losses. Any decline in residential mortgage loan originations in the market could
also reduce the level of mortgage loans the Corporation may produce in the future and adversely
impact our business. During periods of rising interest rates, refinancing originations for many
mortgage products tend to decrease as
36
the economic incentives for borrowers to refinance their
existing mortgage loans are reduced. In addition, the residential mortgage loan origination
business is impacted by home values. Over the past several years, residential real estate values in
some areas of the U.S. mainland have increased greatly, which has contributed to the recent rapid
growth in the residential mortgage industry, particularly with respect to refinancings. If
residential real estate values decline, this could lead to lower volumes and higher losses across
the industry, adversely impacting our mortgage business.
The actual rates of delinquencies, foreclosures and losses on loans could be higher during
economic slowdowns. Rising unemployment, higher interest rates or declines in housing prices tend
to have a greater negative effect on the ability of borrowers to repay their mortgage loans. Any
sustained period of increased delinquencies, foreclosures or losses could harm the Corporation’s
ability to sell loans, the prices the Corporation’s receives for loans, the values of mortgage
loans held-for-sale or residual interests in securitizations, which could harm the Corporation’s
financial condition and results of operations. In addition, any material decline in real estate
values would weaken the collateral loan-to-value ratios and increase the possibility of loss if a
borrower defaults. In such event, the Corporation will be subject to the risk of loss on such
mortgage asset arising from borrower defaults to the extent not covered by third-party credit
enhancement.
Changes in regulations and legislation could have a financial impact on First BanCorp
As a financial institution, the Corporation is subject to the scrutiny of various regulatory
and legislative bodies. Any change in regulations and/or legislation, whether in the United States
or Puerto Rico, could have a financial impact on the results of operations of the Corporation.
Item 1B. Unresolved Staff Comments
None.
Item 2. Properties
At December 31, 2005, First BanCorp owned the following three main offices located in Puerto
Rico:
Main offices:
| 1. |
|
Headquarter Offices – Located at First Federal Building, 1519 Ponce
de León Avenue, Santurce, Puerto Rico, a 16 story office building.
Approximately 60% of the building, an underground three level
parking lot and an adjacent parking lot are owned by the Corporation. |
| |
| 2. |
|
EDP & Operations Center – A five story structure located at 1506 Ponce
de León Avenue, Santurce, Puerto Rico. These facilities are fully
occupied by the Corporation. |
| |
| 3. |
|
Consumer Lending Center – A three story building with a three-level
parking lot located at 876 Muñoz Rivera Avenue, corner Jesús T. Piñero
Avenue, Hato Rey, Puerto Rico. These facilities are fully occupied by
the Corporation. |
| |
| |
|
In addition, during 2006, First BanCorp purchased the following office located in Puerto Rico: |
| |
| |
|
1130 |
|
Muñoz Rivera – a building located on 1130 Muñoz Rivera Avenue,
Hato Rey, Puerto Rico. These facilities will be remodeled and
expanded to accommodate branch operations, data processing, |
37
| |
|
administrative and headquarter offices. FirstBank expects to commence
occupancy in the fourth quarter of 2007. |
In addition, the Corporation owned 28 branch and office premises and an auto lot and leased
107 branch premises, loan and office centers and other facilities. All of these premises are
located in Puerto Rico and in the U.S. and British Virgin Islands and Florida. Management believes
that the Corporation’s properties are well maintained and are suitable for the Corporation’s
business as presently conducted.
Item 3. Legal Proceedings
During 2005 and 2006, the Corporation became subject to various legal proceedings, including
regulatory investigations and civil litigation, as a result of the restatement of 2004 financial
information. For information on these proceedings, see “Recent Significant Events — Governmental
Action” and “Recent Significant Events – Private Litigation”, above.
Additionally, the Corporation and its subsidiaries are defendants in various lawsuits arising
in the ordinary course of business. In the opinion of the Corporation’s management, except as
described in the Recent Significant Events section above, the pending and threatened legal
proceedings for which management is aware will not have a material adverse effect on the financial
condition or results of operations of the Corporation.
Item 4. Submission of Matters to a Vote of Security Holders
On April 28, 2005 First BanCorp held its annual meeting of stockholders. The number of shares
present in person and/or by proxy at such meeting was 37,644,661 representing 93% of the 40,393,155
shares of common stock issued and outstanding on March 14, 2005, which was the record date for the
determination of the stockholders entitled to vote at the meeting.
The following was voted upon at the Annual Meeting of Stockholders:
(a) The election of the following directors:
| |
|
|
|
|
|
|
|
|
| |
|
For |
|
Withheld |
Annie Astor-Carbonell |
|
|
37,005,125 |
|
|
|
639,536 |
|
Jorge L. Díaz-Irizarry |
|
|
36,129,639 |
|
|
|
1,515,022 |
|
José Menéndez Cortada |
|
|
36,129,539 |
|
|
|
1,515,122 |
|
The following were the directors whose terms of office continued:
| |
Angel Alvarez-Pérez |
José Julián Alvarez Bracero |
José L. Ferrer-Canals |
Richard Reiss Huyke |
José Teixidor-Méndez |
Sharee Ann Umpierre-Catinchi |
| |
(b) |
|
Ratification of the appointment of
PricewaterhouseCoopers as the Corporation’s
Independent Registered Public Accounting Firm
for fiscal year 2005. |
The appointment of PricewaterhouseCoopers was ratified as follows:
38
| |
|
|
|
|
For |
|
|
36,160,779 |
|
Against |
|
|
1,407,676 |
|
Abstain |
|
|
76,206 |
|
In September 2005, following the announcement of the Audit Committee’s review, the Corporation
implemented changes to its senior management. Specifically, the Board of Directors asked for the
resignation of Angel Alvarez-Pérez, then President, Chief Executive Officer and Chairman of the
Board and Annie Astor-Carbonell, then Chief Financial Officer and Director of the Board. On
September 30, 2005, the Corporation announced that the Former CEO had resigned from his management
positions effective September 30, 2005 and would retire as a
director effective December 31, 2005 and that the Former CFO had resigned from her position as
CFO and as a director effective September 30, 2005.
PART II
Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters and Issuer Purchases
of Equity Securities
Market and Holders Information
The Corporation’s common stock is traded on the New York Stock Exchange (the “NYSE”) under the
symbol FBP. On December 31, 2006 and 2005, there were 566 and 589, respectively, holders of
record of the Corporation’s common stock.
The following table sets forth the high and low prices of the Corporation’s common stock for
the periods indicated as reported by the NYSE. This table reflects the effect of the June 2005
stock split.
| |
|
|
|
|
|
|
|
|
|
|
|
|
| Quarter ended |
|
High |
|
Low |
|
Last |
2006: |
|
|
|
|
|
|
|
|
|
|
|
|
December |
|
$ |
10.79 |
|
|
$ |
9.39 |
|
|
$ |
9.53 |
|
September |
|
|
11.15 |
|
|
|
8.66 |
|
|
|
11.06 |
|
June |
|
|
12.22 |
|
|
|
8.90 |
|
|
|
9.30 |
|
March |
|
|
13.15 |
|
|
|
12.20 |
|
|
|
12.36 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2005: |
|
|
|
|
|
|
|
|
|
|
|
|
December |
|
$ |
15.56 |
|
|
$ |
10.61 |
|
|
$ |
12.41 |
|
September |
|
|
26.07 |
|
|
|
16.50 |
|
|
|
16.92 |
|
June |
|
|
21.31 |
|
|
|
17.31 |
|
|
|
20.08 |
|
March |
|
|
32.26 |
|
|
|
20.78 |
|
|
|
21.13 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2004: |
|
|
|
|
|
|
|
|
|
|
|
|
December |
|
$ |
32.43 |
|
|
$ |
23.65 |
|
|
$ |
31.76 |
|
September |
|
|
24.93 |
|
|
|
19.81 |
|
|
|
24.15 |
|
June |
|
|
21.34 |
|
|
|
17.57 |
|
|
|
20.38 |
|
March |
|
|
21.66 |
|
|
|
19.50 |
|
|
|
20.80 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2003: |
|
|
|
|
|
|
|
|
|
|
|
|
December |
|
$ |
20.16 |
|
|
$ |
15.62 |
|
|
$ |
19.78 |
|
September |
|
|
15.99 |
|
|
|
14.18 |
|
|
|
15.38 |
|
June |
|
|
15.84 |
|
|
|
13.73 |
|
|
|
13.73 |
|
March |
|
|
14.00 |
|
|
|
11.36 |
|
|
|
13.49 |
|
First BanCorp has five outstanding series of non convertible preferred stock: 7.125%
noncumulative perpetual monthly income preferred stock, Series A (liquidation preference $25 per
share),
39
8.35% noncumulative perpetual monthly income preferred stock, Series B (liquidation
preference $25 per share), 7.40% noncumulative perpetual monthly income preferred stock, Series C
(liquidation preference $25 per share), 7.25 % noncumulative perpetual monthly income preferred
stock, Series D (liquidation preference $25 per share) and 7.00% noncumulative perpetual monthly
income preferred stock, Series E (liquidation preference $25 per share) (collectively “Preferred
Stock”), which trade on the NYSE.
On April 13, 2006, the Corporation notified the NYSE that, given the delay in the filing of
the Corporation’s 2005 Form 10-K, which required the postponement of the 2006 Annual Meeting of
Stockholders, the Corporation was not going to distribute its annual report to shareholders by
April 30, 2006. As a result, the Corporation is not in compliance with Section Rule 203.01, Annual
Report Requirement, of the NYSE Listed Company Manual, which requires a listed company to
distribute its annual report within 120 days after its fiscal year end.
The NYSE’s Section 802.01E procedures apply to the Corporation given its failure to file the
Form 10-K for the fiscal year ended December 31, 2005, which the NYSE explained in a letter dated
April 3, 2006. These procedures contemplate that the NYSE will monitor a company that has not
timely filed a Form 10-K. If the company does not file its annual report within six months of the
filing due date, the NYSE may, in its sole discretion, allow the company’s securities to be traded
for up to an additional six months depending on the company’s specific circumstances. If the NYSE
determines that an additional trading period of up to six months is not appropriate, suspension and
delisting procedures will be commenced. If the NYSE determines that an additional trading period of
up to six months is appropriate and the company fails to file its annual report by the end of that
additional period, suspension and delisting procedures will generally commence. The procedures
provide that the NYSE may commence delisting proceedings at any time. On October 3, 2006, the
Corporation announced that the New York Stock Exchange (NYSE) granted an extension for continued
listing and trading on the NYSE through April 3, 2007, subject to the NYSE’s ongoing monitoring of
the Corporation’s 2005 10-K filing efforts. With the filing of this 2005 Form 10-K on or prior to
April 3, 2007, the Corporation will have complied with the extension granted.
Dividends
The Corporation has a policy of paying quarterly cash dividends on its outstanding shares of
common stock. Accordingly, the Corporation declared a cash dividend of $0.07 per share for each
quarter of 2005, $0.06 per share for each quarter of 2004 and $0.06 per share for each quarter of
2003. See the discussion under “Dividend Restrictions” under Item 1 for additional information
concerning restrictions on the payment of dividends that apply to the Corporation and FirstBank.
The Puerto Rico Internal Revenue Code requires the withholding of income tax from dividend
income derived by resident U.S. citizens, special partnerships, trusts and estates and non-resident
U.S. citizens, custodians, partnerships, and corporations from sources within Puerto Rico.
Resident U.S. Citizens
A special tax of 10% is imposed on eligible dividends paid to individuals, special
partnerships, trusts, and estates to be applied to all distributions unless the taxpayer
specifically elects otherwise. Once this election is made it is irrevocable. However, the
taxpayer can elect to include in gross income the eligible distributions received and take a credit
for the amount of tax withheld. If the taxpayer does not make this election on the tax return,
then he can exclude from gross income the distributions received and reported without claiming the
credit for the tax withheld.
40
Nonresident U.S. Citizens
Nonresident U.S. citizens have the right to certain exemptions when a Withholding Tax
Exemption Certificate (Form 2732) is properly completed and filed with the Corporation. The
Corporation as withholding agent is authorized to withhold a tax of 10% only from the excess of the
income paid over the applicable tax-exempt amount.
U.S. Corporations and Partnerships
Corporations and partnerships not organized under Puerto Rico laws that have not engaged in
trade or business in Puerto Rico during the taxable year in which the dividend is paid are subject
to the 10% dividend tax withholding. Corporations or partnerships not organized under the laws of
Puerto Rico that have engaged in trade or business in Puerto Rico are not subject to the 10%
withholding, but they must declare the dividend as gross income on their Puerto Rico income tax
return.
Equity Compensation Plan Disclosure
The following summarizes equity compensation plans approved by security holders and equity
compensation plans that were not approved by security holders as of December 31, 2005:
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
(A) |
|
|
(B) |
|
|
(C) |
|
| |
|
|
|
|
|
|
|
|
|
Number of Securities |
|
| |
|
|
|
|
|
|
|
|
|
Remaining Available for |
|
| |
|
Number of Securities |
|
|
|
|
|
|
Future Issuance Under |
|
| |
|
to be Issued Upon |
|
|
Weighted-Average |
|
|
Equity Compensation |
|
| |
|
Exercise of Outstanding |
|
|
Exercise Price of |
|
|
Plans (Excluding Securities |
|
| Plan category |
|
Options |
|
|
Outstanding Options |
|
|
Reflected in Column (A)) |
|
Equity compensation
plans approved by
stockholders: |
|
|
|
|
|
|
|
|
|
|
|
|
Stock Option Plans |
|
|
5,316,410 |
|
|
$ |
13.28 |
|
|
|
2,031,013 |
|
|
|
|
|
|
|
|
|
|
|
Sub-total |
|
|
5,316,410 |
|
|
$ |
13.28 |
|
|
|
2,031,013 |
|
|
|
|
|
|
|
|
|
|
|
Equity compensation
plans not approved
by stockholders |
|
|
N/A |
|
|
|
N/A |
|
|
|
N/A |
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
5,316,410 |
|
|
$ |
13.28 |
|
|
|
2,031,013 |
|
|
|
|
|
|
|
|
|
|
|
Item 6. Selected Financial Data
The following table presents consolidated financial and operating information for the
Corporation as of the dates indicated. This information should be read in conjunction with the
audited financial statements and the notes thereto.
41
SELECTED FINANCIAL DATA
(Dollars in thousands except for per share and financial ratios results)
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
2005 |
|
|
2004 |
|
|
2003 |
|
|
2002 |
|
|
2001 |
|
Condensed Income Statements: Year ended |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total interest income |
|
$ |
1,067,590 |
|
|
$ |
690,334 |
|
|
$ |
549,466 |
|
|
$ |
550,107 |
|
|
$ |
526,841 |
|
Total
interest expense (1) |
|
|
635,271 |
|
|
|
292,853 |
|
|
|
297,528 |
|
|
|
235,575 |
|
|
|
292,067 |
|
Net interest income |
|
|
432,319 |
|
|
|
397,481 |
|
|
|
251,938 |
|
|
|
314,532 |
|
|
|
234,774 |
|
Provision for loan losses |
|
|
50,644 |
|
|
|
52,800 |
|
|
|
55,915 |
|
|
|
62,302 |
|
|
|
61,030 |
|
Other income |
|
|
63,077 |
|
|
|
59,624 |
|
|
|
106,798 |
|
|
|
48,785 |
|
|
|
40,773 |
|
Other operating expenses |
|
|
315,132 |
|
|
|
180,480 |
|
|
|
164,630 |
|
|
|
132,811 |
|
|
|
120,522 |
|
Income before income tax provision
and cumulative effect of accounting change |
|
|
129,620 |
|
|
|
223,825 |
|
|
|
138,191 |
|
|
|
168,204 |
|
|
|
93,995 |
|
Provision for income tax |
|
|
15,016 |
|
|
|
46,500 |
|
|
|
18,297 |
|
|
|
35,342 |
|
|
|
15,002 |
|
Income before cumulative effect of accounting
change |
|
|
114,604 |
|
|
|
177,325 |
|
|
|
119,894 |
|
|
|
132,862 |
|
|
|
78,993 |
|
Cumulative effect of accounting change |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(1,015 |
) |
Net income |
|
|
114,604 |
|
|
|
177,325 |
|
|
|
119,894 |
|
|
|
132,862 |
|
|
|
77,978 |
|
Per Common
Share Results (2): Year ended |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before cumulative effect of accounting
change diluted |
|
$ |
0.90 |
|
|
$ |
1.65 |
|
|
$ |
1.09 |
|
|
$ |
1.32 |
|
|
$ |
0.78 |
|
Cumulative effect of accounting change |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(0.01 |
) |
Net income per common share diluted |
|
$ |
0.90 |
|
|
$ |
1.65 |
|
|
$ |
1.09 |
|
|
$ |
1.32 |
|
|
$ |
0.77 |
|
Net income per common share basic |
|
$ |
0.92 |
|
|
$ |
1.70 |
|
|
$ |
1.12 |
|
|
$ |
1.34 |
|
|
$ |
0.77 |
|
Cash dividends declared |
|
$ |
0.28 |
|
|
$ |
0.24 |
|
|
$ |
0.22 |
|
|
$ |
0.20 |
|
|
$ |
0.18 |
|
Average shares outstanding |
|
|
80,847 |
|
|
|
80,418 |
|
|
|
79,988 |
|
|
|
79,802 |
|
|
|
79,702 |
|
Average shares outstanding diluted |
|
|
82,771 |
|
|
|
83,010 |
|
|
|
81,966 |
|
|
|
81,106 |
|
|
|
80,288 |
|
Balance Sheet Data: End of year |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans and loans held for sale |
|
$ |
12,685,929 |
|
|
$ |
9,697,994 |
|
|
$ |
7,041,056 |
|
|
$ |
5,635,023 |
|
|
$ |
4,306,963 |
|
Allowance for possible loan losses |
|
|
147,999 |
|
|
|
141,036 |
|
|
|
126,378 |
|
|
|
111,911 |
|
|
|
91,060 |
|
Investments |
|
|
6,702,892 |
|
|
|
5,699,201 |
|
|
|
5,368,123 |
|
|
|
3,728,669 |
|
|
|
3,827,481 |
|
Total assets |
|
|
19,917,651 |
|
|
|
15,637,045 |
|
|
|
12,679,042 |
|
|
|
9,625,110 |
|
|
|
8,331,382 |
|
Deposits |
|
|
12,463,752 |
|
|
|
7,912,322 |
|
|
|
6,771,869 |
|
|
|
5,445,714 |
|
|
|
4,100,233 |
|
Borrowings |
|
|
5,750,197 |
|
|
|
6,300,573 |
|
|
|
4,634,237 |
|
|
|
3,238,369 |
|
|
|
3,414,236 |
|
Total common equity |
|
|
647,741 |
|
|
|
654,233 |
|
|
|
523,722 |
|
|
|
455,522 |
|
|
|
326,379 |
|
Total equity |
|
|
1,197,841 |
|
|
|
1,204,333 |
|
|
|
1,073,822 |
|
|
|
816,022 |
|
|
|
594,879 |
|
Book value per common share |
|
|
8.01 |
|
|
|
8.10 |
|
|
|
6.54 |
|
|
|
5.70 |
|
|
|
6.14 |
|
Selected Financial Ratios (In Percent): Year ended |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income to average total assets |
|
|
0.64 |
|
|
|
1.30 |
|
|
|
1.15 |
|
|
|
1.51 |
|
|
|
1.16 |
|
Net income to average total equity |
|
|
8.98 |
|
|
|
15.73 |
|
|
|
13.31 |
|
|
|
18.63 |
|
|
|
14.80 |
|
Net income to average common equity |
|
|
10.23 |
|
|
|
23.75 |
|
|
|
18.21 |
|
|
|
29.49 |
|
|
|
19.83 |
|
Average total equity to average total assets |
|
|
7.09 |
|
|
|
8.28 |
|
|
|
8.64 |
|
|
|
8.11 |
|
|
|
7.84 |
|
Dividend payout ratio |
|
|
30.46 |
|
|
|
14.10 |
|
|
|
19.66 |
|
|
|
15.00 |
|
|
|
22.51 |
|
Efficiency
ratio (3) |
|
|
63.61 |
|
|
|
39.48 |
|
|
|
45.89 |
|
|
|
36.56 |
|
|
|
43.74 |
|
Common Stock Price: End of year |
|
$ |
12.41 |
|
|
$ |
31.76 |
|
|
$ |
19.78 |
|
|
$ |
11.30 |
|
|
$ |
9.50 |
|
Offices: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of full service branches |
|
|
68 |
|
|
|
57 |
|
|
|
54 |
|
|
|
54 |
|
|
|
48 |
|
|
|
|
| 1- |
|
Includes the changes in fair value of interest rate swaps
that hedge brokered certificates of deposit. |
| |
| 2- |
|
Amounts presented were recalculated, when applicable, to retroactively consider the effect of the June 30, 2005 common stock split. |
| |
| 3- |
|
Other operating expenses to the sum of net interest income and other income. |
42
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following Management’s Discussion and Analysis of Financial Condition and Results of
Operations relates to the accompanying consolidated audited financial statements of First BanCorp.
(“the Corporation” or “First BanCorp”) and should
be read in conjunction with the audited financial
statements and the notes thereto.
Description of Business
First BanCorp and subsidiaries (“the Corporation”) is a diversified financial holding company
headquartered in San Juan, Puerto Rico offering a full range of financial products to consumers and
commercial customers. First BanCorp is the holding company of FirstBank Puerto Rico (“FirstBank” or
the “Bank”), Ponce General Corporation (the holding company of FirstBank Florida) and FirstBank Insurance Agency. Through its wholly-owned
subsidiaries, the Corporation operates offices in Puerto Rico, United States and British Virgin
Islands and in the state of Florida (USA) specializing in commercial banking, residential mortgage
loan originations, finance leases, personal loans, small loans, vehicle rental, insurance agency services
and international banking.
On March 31, 2005, the Corporation completed the acquisition of 100% of the outstanding common
shares of Ponce General Corporation, the holding company of Unibank a
thrift subsidiary, and Ponce Realty, with a total of eleven financial service
facilities in the state of Florida. The purpose of the acquisition
was for First BanCorp to build a platform in Florida to consider further expansion into the United States. The Corporation subsequently changed
the name of Unibank to FirstBank Florida.
The Corporation’s results of operations are sensitive to fluctuations in interest rates.
Changes in interest rates can materially affect key earnings drivers such as the volume of loan
originations, net interest income earned, and gains/losses on investment security holdings. The
Corporation manages interest rate risk on an ongoing basis through asset/liability management
strategies which have included the use of various derivative instruments. The Corporation also manages
credit risk inherent in its loan portfolios through its underwriting, loan review and collection
functions. The Corporation’s business activities and credit exposures are mainly concentrated in
Puerto Rico. Consequently, its financial condition and results of operations are dependent on the
economic conditions as well as changes in legislation on the Island.
Forward Looking Statements
This Form 10-K contains “forward-looking statements” within the meaning of the Private
Securities Litigation Reform Act of 1995. When used in this Form 10-K or future filings by First
BanCorp with the Securities and Exchange Commission, in the Corporation’s press releases or in
other public or shareholder communications, or in oral statements made with the approval of an
authorized executive officer, the word or phrases “would be,” “will allow,” “intends to,” “will
likely result,” “are expected to,” “should,” “anticipate” and similar expressions are meant to
identify “forward-looking statements.”
First BanCorp wishes to caution readers not to place undue reliance on any such
“forward-looking statements,” which speak only as of the date made, and represent First BanCorp’s
expectations of
43
future conditions or results and are not guarantees of future performance. First BanCorp advises
readers that various factors could cause actual results to differ materially from those contained
in any “forward-looking statement.” Such factors include, but are not limited to, the following:
| |
• |
|
risks arising from material weaknesses in the Corporation’s internal control over
financial reporting; |
| |
| |
• |
|
risks associated with the Corporation’s inability to prepare and timely submit
regulatory filings; |
| |
| |
• |
|
the Corporation’s ability to attract new clients and retain existing ones; |
| |
| |
• |
|
general economic conditions, including prevailing interest rates and the performance of
the financial markets, which may affect demand for the Corporation’s products and services
and the value of the Corporation’s assets, including the value of all of the interest rate
swaps that hedge the interest rate risk mainly relating to brokered certificates of
deposit, medium-term notes, and commercial loans and the ineffectiveness of such hedges or
the undesignated portion of such interest rate swaps; |
| |
| |
• |
|
credit and other risks of lending and investment activities; |
| |
| |
• |
|
changes in the Corporation’s expenses associated with acquisitions and dispositions; |
| |
| |
• |
|
developments in technology; |
| |
| |
• |
|
risks associated with changing the Corporation’s business strategy to no longer acquire
mortgage loans in bulk; |
| |
| |
• |
|
risks associated with the ongoing shareholder litigation against the Corporation; |
| |
| |
• |
|
risks associated with the ongoing SEC investigation; |
| |
| |
• |
|
risks associated with being subject to the cease and desist order; |
| |
| |
• |
|
potential further downgrades in the credit ratings of the Corporation’s securities; |
| |
| |
• |
|
general competitive factors and industry consolidation; and |
| |
| |
• |
|
risks associated with regulatory and legislative changes for financial services
companies in Puerto Rico, the United States, and the U.S. and British Virgin Islands. |
The Corporation does not undertake, and specifically disclaims any obligation, to update any
“forward-looking statements” to reflect occurrences or unanticipated events or circumstances after
the date of such statements except as required by the federal securities laws.
Internal Control over Financial Reporting
The Corporation has taken a number of significant actions to remedy the material
weaknesses in its internal controls during 2005, First BanCorp’s
management concluded that its internal control over financial reporting remained ineffective as of
December 31, 2005 based on the criteria set forth in Internal Control — Integrated Framework issued
by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). A description of
the material weaknesses existing as of December 31, 2005 is included in Part II, Item 9A. Controls
and Procedures of this Annual Report on Form 10-K.
The Corporation developed and is implementing a plan for remedying all of the identified
material weaknesses, and the work continues in 2007. As part of this remediation program, the
Corporation has added skilled resources to improve controls and increase the reliability of the
financial closing process.
44
Overview of Management’s Discussion and Analysis of Financial Condition and Results of
Operations
Total assets at December 31, 2005 and 2004 were $19.9 billion and $15.6 billion, respectively.
The growth was mainly driven by increases in the Corporation’s loan and investment portfolios. Net
loans increased 31% to $12.5 billion, when compared to the previous year, resulting from strong
commercial loan originations in Puerto Rico, increases in construction loans disbursed by the
Corporation’s Florida loan agency, residential mortgages and consumer loans originations and the
acquisition of FirstBank Florida, which loan portfolio is mainly composed of residential and
commercial mortgages. The increases were partially offset by decreases in secured loans to local
financial institutions. Total investments increased $1 billion from
2004, mainly attributable to purchases of money-market investments
government agency securities and mortgage-backed securities during
2005. Deposits at December 31, 2005 and 2004 were $12.5 billion and $7.9
billion, respectively, the increase is mainly attributed to issuances of brokered certificates of
deposit which were used mainly to fund loan originations.
Net income was $114.6 million or $0.92 per common share (basic) and $0.90 per common share
(diluted) for 2005, compared to $177.3 million or $1.70 per common share (basic) and $1.65 per
common share (diluted) for 2004 and $119.9 million or $1.12 per common share (basic) and $1.09 per
common share (diluted) for 2003. Even though the Corporation’s interest income increased
significantly as compared to 2004, net income was significantly impacted by negative changes in the
fair value of derivative instruments, the flat to inverted interest
rate yield curve, the increase in
operating expenses, including those legal, accounting and consulting fees associated with the
internal review conducted by the Corporation’s Audit Committee, the restatement process and other
related legal liabilities, such as those related to the class action litigation and the SEC
investigation, and a significantly higher current provision for income taxes
mainly due to both an increase in taxable assets and an unfavorable impact resulting from a change in the Puerto Rico statutory tax rate. For 2005 as compared
to 2004, net income decreased by $62.7 million or $0.75 per common share (diluted), and for 2004 as
compared to 2003, net income increased by $57.4 million or $0.56 per common share (diluted). The
earnings volatility for the reported years is mainly attributable to
the non-cash valuation through earnings
of interest rate swaps that economically hedge brokered certificates of deposit that were not
designated under hedge accounting in 2005, 2004 and 2003, and to the class action and SEC related
accruals recorded in 2005. The Corporation obtained a return on average assets of 0.64%
compared to 1.30% for 2004 and 1.15% for 2003 and a return on common equity of 10.23% for 2005
compared to 23.75% for 2004 and 18.21% for 2003.
While the yield on earning assets increased as compared to 2004, the cost of interest bearing
liabilities increased as well, thereby decreasing the net interest margin as
compared to 2004. Total yield on earning assets on a taxable equivalent basis, excluding the impact
of changes in the fair value of derivatives, was 6.45% for 2005 as compared to 5.68% for 2004. The
increase is mainly attributed to the re-pricing and origination of commercial loans at higher rates. The
average cost of funds rate, excluding the impact of the change in the fair value of derivatives,
for 2005 was 3.58% compared to 2.62% for 2004. The increase in cost of funds as compared to 2005 is
the result of increases in rates, given the re-pricing of variable rate liabilities and the
origination of new debt at higher rates, as well as a reduction in the benefit realized from
interest exchanged on interest rate swaps that economically hedge brokered certificates of deposit.
The interest earned on earning assets is computed on a tax equivalent basis; both the yield on
earning assets and cost of funds rate exclude the impact of the change in the fair value of
derivatives. When adjusted on a taxable equivalent basis and excluding valuation changes, yields
on taxable and exempt assets are comparable. The excluded changes in the fair value of derivative
instruments, mainly interest rate swaps, are non-cash temporary adjustments that do not affect
economically the Corporation’s yield on earnings assets and funding cost, but that affected
materially the reported net interest income.
45
The changes in the fair value of derivatives are mainly composed of changes in the fair value
of interest rate swaps economically hedging brokered certificates of deposit. Refer to the “Net
Interest Income” section of this Management’s Discussion and Analysis for further information.
The provision for loan losses decreased by $2.2 million to $50.6 million in 2005, when
compared to the prior year. The net charge offs as a percentage of average loans decreased to 0.39%
from 0.48%.
Other income for 2005 increased by $3.5 million as compared to 2004. The increase is mainly
attributable to net gains realized in the year 2005 from investment activities. The net gains
amounted $12.3 million and $9.5 million in 2005 and 2004, respectively. The increase is also in
part attributable to increases in commission income from the Corporation’s insurance businesses and
increases in other service charges on loans as a result of a larger volume of insurance
and loans transactions during 2005, partially offset by decreases in other commissions and fees and
no gain on the sale of credit card portfolio in 2005 as compared to 2004.
On August 1, 2005, the Audit Committee of the Corporation determined that the Committee should
review the background and accounting for certain mortgage-related transactions that FirstBank had
entered into between 1999 and 2005. Following the announcement of the Committee’s review, the
Corporation and certain of its officers and directors were named as defendants in separate class
actions filed late in 2005. The class actions were subsequently consolidated. The Corporation has
been engaged in discussions with lead plaintiffs through private mediation proceedings. The
Corporation accrued $74.25 million in its consolidated financial statements for the year ended
December 31, 2005 in connection with a potential settlement on the class action suit. In addition,
the Corporation has accrued $8.5 million in connection with a potential settlement of the SEC’s
investigation of the Corporation related to matters identified on the
Amended 2004 Form 10-K.
There can be no assurance that the amounts
accrued for the SEC investigation and the class action suit will be
sufficient and the Corporation cannot predict at this time the timing
or final terms of any settlement. In addition, the Corporation and
certain of its former officers and directors were named as defendants
in separate shareholder derivative actions which were subsequently
consolidated into one case. These derivative actions were dismissed
on November 30, 2006.
Operating expenses increased by $134.6 million from $180.5 million in 2004 to $315.1 million
in 2005. The increase as compared to 2004 is mainly attributable to
$82.75 million of accruals recorded related to the class action
litigation and the SEC investigation. In addition, operating expenses increased due to personnel and
occupancy costs to support the Corporation’s growth, increases related to the acquisition of
FirstBank Florida, increases in professional fees and strong advertising and business promotion
costs to support new products and services.
Critical Accounting Policies and Practices
The accounting principles of the Corporation and the methods of applying these principles
conform with generally accepted accounting principles in the United States and to general practices
within the banking industry. The Corporation’s critical accounting policies relate to the 1)
allowance for loan losses; 2) other-than-temporary impairments; 3) income taxes; 4) investment
securities classification and related values; 5) valuation of
financial instruments and 6) derivative financial instruments. These
critical accounting policies involve judgments, estimates and assumptions made by management that
affect the recorded assets and liabilities and contingent assets and liabilities disclosed at the
date of the financial statements and the reported amounts of revenues and expenses during the
reporting periods. Actual results could differ from estimates, if different assumptions or
conditions prevail. Certain determinations inherently have greater reliance on the use of
estimates, assumptions, and judgments and, as such, have a greater possibility of producing results
that could be materially different than originally reported.
Allowance for Loan Losses
The Corporation maintains the allowance for loan losses at a level that management considers
adequate to absorb losses inherent in the loan portfolio. The allowance for loan losses is an
accounting
46
policy that requires the most significant judgments and estimates used in the preparation of
the consolidated financial statements. The adequacy of the allowance for loan losses is reviewed on
a quarterly basis as part of the continuing evaluation of the quality of the assets. Groups of
small balance and homogeneous loans are collectively evaluated for impairment. The portfolios of
residential mortgage loans, consumer loans, auto loans and finance
leases are individually considered
homogeneous and each portfolio is evaluated collectively for impairment. In estimating the
allowance for loan losses, management uses historical information about loan losses as well as
other factors including the effects on the loan portfolio of current economic indicators and their
probable impact on the borrowers, information and trends on charge-offs, non-accrual loans, changes
in underwriting policies, risk characteristics relevant to the particular loan category and
delinquencies. The Corporation measures impairment individually for those commercial and real
estate loans with a principal balance exceeding $1 million. An allowance for impaired loans is
established based on the present value of expected future cash flows or the fair value of the
collateral, if the loan is collateral dependent. Accordingly, the measurement of impairment for
loans evaluated individually involves assumptions by management as to the amount and timing of cash
flows to be recovered and of appropriate discount rates. When the loans are collateral dependent,
the fair value of the collateral is based on an independent appraisal that may also involve
estimates of future cash flows and appropriate discount rates or adjustments to comparable
properties.
Other-than-temporary impairments
The Corporation evaluates its investment securities for impairment on a quarterly basis or
earlier if other factors indicative of potential impairment exist. An impairment charge in the
consolidated statements of income is recognized when the decline in the fair value of investments
below their cost basis is judged to be other-than-temporary. The Corporation considers various
factors in determining whether it should recognize an impairment charge, including but not limited
to, the length of time and extent to which the fair value has been less than its cost basis and the
Corporation’s intent and ability to hold the investment for a period of time sufficient to allow
for any anticipated recovery in market value. For debt securities, the Corporation also considers,
among other factors, the obligor’s repayment ability on its bond obligations and its cash and
capital generation ability. Any change in the factors evaluated to determine the need for an
impairment charge could have an impact on that decision.
Income Taxes
The Corporation is required to estimate income taxes in preparing its consolidated financial
statements. This involves the estimation of current income tax expense together with an assessment
of temporary differences resulting between the carrying amounts of assets and liabilities for
financial reporting purposes and the amounts used for income tax purposes. The determination of
current income tax expense involves estimates and assumptions that require the Corporation to
assume certain positions based on its interpretation of current tax regulations. Management
assesses the relative benefits and risks of the appropriate tax treatment of transactions, taking
into account statutory, judicial and regulatory guidance and recognizes tax benefits only when
deemed probable. Changes in assumptions affecting estimates may be required in the future and
estimated tax liabilities may need to be increased or decreased accordingly. The accrual of tax
contingencies is adjusted in light of changing facts and circumstances, such as the progress of tax
audits, case law and emerging legislation. The Corporation’s effective tax rate includes the impact
of tax contingencies and changes to such accruals, as considered appropriate by management. When
particular matters arise, a number of years may elapse before such matters are audited by the
taxing authorities and finally resolved. Favorable resolution of such matters or the expiration of
the statute of limitations may result in the release of tax contingencies which are recognized as a
reduction to the Corporation’s effective rate in the year of resolution. Unfavorable settlement of
any particular issue could increase the effective rate and may require the use of cash in the year
of resolution. As of
47
December 31, 2005, there were no open income tax investigations. Information regarding income taxes
is included in Note 26 to the Corporation’s audited financial statements.
The determination of deferred tax expense or benefit is based on changes in the carrying
amounts of assets and liabilities that generate temporary differences. The carrying value of the
Corporation’s net deferred tax assets assumes that the Corporation will be able to generate
sufficient future taxable income based on estimates and assumptions. If these estimates and related
assumptions change, the Corporation may be required to record valuation allowances against its
deferred tax assets resulting in additional income tax expense in the consolidated statements of
income. Management evaluates its deferred tax assets on a quarterly basis and assesses the need for
a valuation allowance, if any. A valuation allowance is established when management believes that
it is more likely than not that some portion of its deferred tax assets will not be realized.
Changes in valuation allowance from period to period are included in the Corporation’s tax
provision in the period of change (see Note 26 to the consolidated audited financial statements).
SFAS No. 109, “Accounting for Income Taxes” (SFAS 109), requires companies to make adjustments
to their financial statements in the quarter that new tax legislation is enacted. In the 2005
third quarter, the P.R. legislature passed and the governor signed into law a temporary two-year
surtax of 2.5% applicable to corporations. The surtax is applicable to taxable years after December
31, 2004 and increases the maximum marginal corporate income tax rate from 39% to 41.5%.
Investment Securities Classification and Related Values
Management determines the appropriate classification of debt and equity securities at the time
of purchase. Debt securities are classified as held-to-maturity when the Corporation has the
intent and ability to hold the securities to maturity. Held-to-maturity (HTM) securities are
stated at amortized cost. Debt and equity securities classified as trading securities are reported
at fair value, with unrealized gains and losses included in earnings. Debt and equity securities
not classified as HTM or trading, except for equity securities which do not have readily available
fair values, are classified as available-for-sale (AFS). Securities AFS are reported at fair
value, with unrealized gains and losses excluded from earnings and reported net of taxes in
accumulated other comprehensive income (a component of stockholders’ equity). Investments in
equity securities that do not have publicly and readily determinable fair values are classified as
other equity securities in the statement of financial condition and carried at the lower of cost or
realizable value.
The assessment of fair value applies to certain of the Corporation’s assets and liabilities,
including the investment portfolio. Fair values are volatile and are affected by factors such as
market interest rates, prepayment speeds and discount rates.
Valuation of Financial Instruments
The Corporation holds fixed income and equity securities, derivatives, investments and other
financial instruments. The Corporation holds its investments and liabilities on the statement of
financial condition mainly to manage liquidity needs and interest rate risks.
A substantial part of these assets and liabilities are reflected at fair value on the
Corporation’s financial statement of condition. Fair values are determined in the following ways:
| |
• |
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externally verified via comparison to quoted market prices or third-party broker
quotations; |
48
| |
• |
|
by using models that are verified by comparison to third-party broker quotations
or other third-party sources; or |
| |
| |
• |
|
by using alternative procedures such as comparison to comparable securities
and/or subsequent liquidation prices. |
Changes in the valuation of the derivatives instruments flow through the income statement.
Changes in the valuation of available-for-sale assets generally flow through other comprehensive
income, which is a component of equity on the balance sheet. A full description of the
Corporation’s related policies and procedures can be found in Notes 4, 5 and 31 to the Consolidated
Audited Financial Statements.
Derivative Financial Instruments
The Corporation enters into derivatives instruments as fair value hedges or cash flow hedges of its
assets or liabilities and into standalone derivatives economically hedging its assets or
liabilities. Before entering into a derivative transaction, the Corporation analyzes the costs,
risks, returns, accounting treatment and the impact on the Corporation’s financial statements.
To qualify for hedge accounting, the Corporation makes sure all hedges meet all of the following
criteria:
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• |
|
The derivatives used as hedges must be linked to a specific asset or liability that
affects earnings and the hedging relationship must be documented at inception as required
by SFAS 133. The hedging relationship documentation must include which instrument is the
hedging instrument and which specific asset or liability it is hedging, the nature of the
risk being hedged, the Corporation’s risk management objective or strategy, the method the
Corporation will use to assess and measure effectiveness (prospectively and
retrospectively), and the method the Corporation will use to measure hedge
ineffectiveness. |
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• |
|
|
Throughout the term of the hedge, the Corporation expects the hedging instrument to be
highly effective in offsetting changes in the fair value or cash flow of the hedged item. |
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• |
|
The Corporation recognizes the ineffectiveness from mismatches in terms and other
factors on the Consolidated Statement of Income. |
For all hedging relationships, the changes in the fair value of the derivative instrument and the
changes in fair value of the asset or liability being hedged are recognized on the Consolidated
Statement of Income, only remaining in the then-current-period earnings the gains and losses
related to the ineffectiveness of the hedge. Similarly, the changes in the fair value of
standalone derivative instruments or derivatives not qualifying for hedge accounting under SFAS 133
are reported in the then-current-period earnings. At
December 31, 2005, the Corporation has no derivative instruments
designated
under hedge accounting.
Recent Accounting Pronouncements
The Financial Accounting Standards Board (FASB), its Emerging Issues Task Force (EITF) and the
SEC have issued the following accounting pronouncements and Issue discussions relevant to the
Corporation’s operations:
In September 2006, the SEC issued Staff Accounting Bulletin No. 108 “Considering the Effects
of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements”
(SAB 108). This interpretation expresses the SEC staff’s views regarding the process of
quantifying financial statement misstatements that could result in improper amounts of assets or
liabilities. While a misstatement may not be considered material for the period in which it
occurred, it may be considered material in a subsequent year if the corporation where to correct
the misstatement through current period earnings. SAB 108 requires a materiality evaluation based
on all relevant quantitative and qualitative factors and the quantification of the misstatement
using a balance sheet and income statement approach to determine materiality. SAB 108 is effective
for periods ending after November 15, 2006. The Corporation does not expect a material effect on
its financial condition and results of operations upon adoption of SAB 108.
In
September 2006, the FASB issued Statement of Financial Accounting Standards
(SFAS) No. 157 “Fair Value Measurements” (SFAS 157). This
Statement defines fair value, establishes a framework for measuring fair value in GAAP and expands
disclosures about fair value measurements. This Statement is effective for periods beginning after
November 15, 2007. The Corporation is currently evaluating the effects, if any, that the proposed
statement may have on its future financial condition and results of operations.
In June 2006, the FASB issued Financial Interpretation No. 48 – “Accounting for Uncertainty in
Income Taxes – an interpretation of FASB Statement No. 109” (FIN 48). This interpretation clarifies
the accounting for uncertainty in income taxes recognized in accordance with SFAS 109. This
interpretation provided a recognition threshold and measurement attribute for the financial
statement recognition and measurement of a tax position taken or expected to be taken in a tax
return. This interpretation also provides guidance on derecognition, classification, interest and
penalties, accounting in interim periods, disclosure and transition. This interpretation is
effective for periods beginning after December 15, 2006. The Corporation is currently evaluating
the effects that the proposed statement may have on its future financial condition and results of
operations.
In March 2006, the FASB issued SFAS 156 “Accounting for Servicing of Financial Assets,” an
amendment of SFAS No. 140. This Statement requires that servicing assets and servicing
liabilities be initially measured at fair value along with any derivative instruments used to
mitigate inherent risks. This Statement is effective for periods beginning after September 15,
2006. The
49
Corporation does not expect to have a material effect on its future financial condition and results
of operations upon adoption of this Statement.
In February 2006, the FASB issued SFAS 155 “Accounting for Certain Hybrid Financial
Instruments, an amendment of FASB Statements No. 133 and 140”. This Statement allows fair value
measurement for any hybrid financial instrument that contains an embedded derivative requiring
bifurcation. It also establishes a requirement to evaluate interests in securitized financial
assets to establish whether the interests are freestanding derivatives or hybrid financial
instruments that contain an embedded derivative requiring bifurcation. This Statement is effective
for all financial instruments acquired or issued after September 15, 2006. The Corporation does not
expect to have a material effect on its future financial condition and results of operations upon
adoption of this Statement.
In May 2005, the FASB issued SFAS 154 “Accounting Changes and Error Corrections – a
replacement of APB Opinion No. 20 and FASB Statement No. 3”. This Statement changes the
requirements for the accounting for and reporting of a voluntary change in accounting principle.
This Statement requires retrospective application to prior periods’ financial statements of a
change in accounting principle unless it is impracticable to do so; in which case the earliest
period for which retrospective application is practicable should be applied. If it is impracticable
to calculate the cumulative effect of a change in accounting principle, the Statement requires
prospective application as of the earliest date practicable. This Statement does not change the
guidance in APB Opinion No. 20 with regard to the reporting of the correction of an error, or a
change in accounting estimate. The Statement’s purpose is to improve the comparability of financial
information among periods. FAS No. 154 is effective for fiscal years beginning after December 15,
2005.
SFAS 123 (Revised) (SFAS 123R) -This Statement is a revision of SFAS 123, “Accounting for
Stock-Based Compensation”. This Statement, issued in December 2004, supersedes APB 25, and its
related implementation guidance.
This Statement requires a public entity to measure the cost of employee services received in
exchange for an award of equity instruments based on the grant-date fair value of the award (with
limited exceptions). That cost will be recognized over the period during which an employee is
required to provide service in exchange for the award-the requisite service period (usually the
vesting period). No compensation cost is recognized for equity instruments for which employees do
not render the requisite service.
SFAS 123R eliminates the alternative to use APB 25’s intrinsic value method of accounting that
was provided in SFAS 123 as originally issued. Under APB 25, issuing stock options to employees
generally resulted in recognition of no compensation cost. SFAS 123R requires entities to recognize
the cost of employee services received in exchange for awards of equity instruments based on the
grant-date fair value of those awards (with limited exceptions).
The effective date of this standard is the first annual period that begins after June 15,
2005. The Corporation implemented SFAS 123R for stock option grants subsequent to December 31,
2005. The adoption of the statement had similar effects to those presented in the proforma
information for years 2003 through 2005 presented in Note 1 to the
corporation’s audited financial statements.
EITF Issue No. 03-01 -“The Meaning of Other-Than-Temporary Impairment and Its Application to
Certain Investments” — In this Issue the Task Force reached a consensus on guidance that should be
used to determine when an investment is considered impaired, whether that impairment is other than
temporary, and the measurement of an impairment loss. The guidance also includes accounting
50
considerations subsequent to the recognition of an other-than-temporary impairment and requires
certain disclosures about unrealized losses that have not been recognized as other-than-temporary
impairments. In September 2004, the FASB issued proposed FSP EITF Issue 03-1-a, “Implementation
Guidance for the Application of Paragraph 16 of EITF Issue No. 03-1”, which provides guidance for
the application of paragraph 16 of EITF Issue 03-1 to debt securities that are impaired because of
interest rate and/or sector spread increases. Also, in September 2004, the FASB issued FSP EITF
Issue 03-1-1, “Effective Date of Paragraphs 10-20 of EITF Issue 03-1”, which delayed the effective
date of paragraph 10-20 of Issue 03-1. Paragraphs 10-20 of Issue 03-1 provide guidance on the
impairment model to be used to determine when an investment is considered impaired, whether that
impairment is other than temporary, and the measurement of an impairment loss. EITF Issue 03-1-1
expands the scope of the deferral to include all securities covered by EITF 03-1 rather than
limiting the deferral to only certain debt securities that are impaired solely because of interest
rate and/or sector spread increases.
In June 2005, the FASB decided not to provide additional guidance on the meaning of
other-than-temporary impairment, but directed the staff to issue proposed FSP EITF 03-1-a, as
final. The final FSP superseded EITF Issue No. 03-1 and EITF Topic No. D-44, “Recognition of
Other-Than-Temporary Impairment upon the Planned Sale of a Security Whose Cost Exceeds Fair Value.”
The final FSP, retitled FSP FAS 115-1, “The Meaning of Other-Than-Temporary Impairment and Its
Application to Certain Investments,” replaced the guidance set forth in paragraphs 10-18 of EITF
Issue 03-1 with references to existing other than temporary impairment guidance, such as SFAS 115,
“Accounting for Certain Investments in Debt and Equity Securities,” SEC Staff Accounting Bulletin
No. 59, “Accounting for Noncurrent Marketable Equity Securities,” and Accounting Principles Board
(“APB”) Opinion No. 18, “The Equity Method of Accounting for Investments in Common Stock.” FSP FAS
115-1 codifies the guidance set forth in EITF Topic D-44 and clarifies that an investor should
recognize an impairment loss no later than when the impairment is deemed other-than-temporary, even
if a decision to sell has not been made, and is effective for other-than-temporary impairment
analyses conducted in periods beginning after September 15, 2005. The adoption of this statement
did not have a material effect to the Corporation’s financial condition and results of operations.
Results of Operations
The Corporation’s results of operations depend primarily on net interest income, which is the
difference between the interest income earned on interest earning assets, including investment
securities and loans, and the interest expense on interest bearing liabilities, including deposits
and borrowings. Net interest income is affected by various factors including the interest rate
scenario, the volumes, mix and composition of interest earning assets and interest bearing
liabilities; and the re-pricing characteristics of these assets and liabilities. The Corporation’s
results of operations are also affected by the provision for loan losses, operating expenses (such
as personnel, occupancy and other costs), other income (mainly service charges and fees on loans),
the result of derivatives activities, gains on sale of investments and loans, and income taxes.
Net Interest Income
Net interest income increased to $432.3 million for 2005 from $397.5 million in 2004 and
$251.9 million in 2003. The increase in net interest income for the year 2005 was mainly driven by
the increase in the average volume of interest earnings assets of $4.3 billion attributable primarily to the
growth in the Corporation’s loan and investment portfolios, especially commercial loan and
residential real estate loan portfolios and government agency securities. In addition to volume
increases, higher yield on loans favorably impacted net interest income. These positive factors
were partially offset by higher cost of funds and negative changes in
51
the valuation of derivative instruments, mainly interest rate swaps that economically hedge
brokered certificates of deposit.
The following table includes a detailed analysis of net interest income. Part I presents
average volumes and rates on a tax equivalent basis, excluding the impact of changes in the fair
value of derivatives, (please refer to explanation below regarding changes in the fair value of
derivative instruments). Part II presents the extent to which changes in interest rates and changes in
volume of interest-related assets and liabilities have affected the Corporation’s net interest
income. The analysis is also on a tax equivalent basis and excluding changes in the fair value of
derivatives. For each category of earning assets and interest bearing liabilities, information is
provided on changes attributable to changes in volume (changes in volume multiplied by old rates),
and changes in rate (changes in rate multiplied by old volumes). Rate-volume variances (changes in
rate multiplied by changes in volume) have been allocated to the changes in volume and changes in
rate based upon their respective percentage of the combined totals. Changes in the fair value of
derivative instruments recorded as part of interest income and interest expenses are excluded from the
analysis (refer to explanation below regarding changes in the fair value of derivative instruments, mainly interest rate swaps).
Part I
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| Year ended December 31, |
|
Average volume |
|
|
Interest Income (1) / expense |
|
|
Average rate (1) |
|
| |
|
2005 |
|
|
2004 |
|
|
2003 |
|
|
2005 |
|
|
2004 |
|
|
2003 |
|
|
2005 |
|
|
2004 |
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2003 |
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(Dollars in thousands) |
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Earning assets: |
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Money market investments |
|
$ |
636,114 |
|
|
$ |
308,962 |
|
|
|
455,242 |
|
|
$ |
22,191 |
|
|
$ |
3,736 |
|
|
$ |
4,707 |
|
|
|
3.49 |
% |
|
|
1.21 |
% |
|
|
1.03 |
% |
Government obligations (2) |
|
|
2,493,725 |
|
|
|
2,061,280 |
|
|
|
851,140 |
|
|
|
166,724 |
|
|
|
132,324 |
|
|
|
47,873 |
|
|
|
6.69 |
% |
|
|
6.42 |
% |
|
|
5.62 |
% |
Mortgage-backed securities |
|
|
2,738,388 |
|
|
|
2,729,125 |
|
|
|
2,256,790 |
|
|
|
152,813 |
|
|
|
154,233 |
|
|
|
114,750 |
|
|
|
5.58 |
% |
|
|
5.65 |
% |
|
|
5.08 |
% |
Corporate bonds |
|
|
48,311 |
|
|
|
57,462 |
|
|
|
181,063 |
|
|
|
2,487 |
|
|
|
(425 |
) |
|
|
6,795 |
|
|
|
5.15 |
% |
|
|
-0.74 |
% |
|
|
3.75 |
% |
FHLB stock |
|
|
71,588 |
|
|
|
56,698 |
|
|
|
40,447 |
|
|
|
3,286 |
|
|
|
974 |
|
|
|
1,206 |
|
|
|
4.59 |
% |
|
|
1.72 |
% |
|
|
2.98 |
% |
Equity securities |
|
|
50,784 |
|
|
|
43,876 |
|
|
|
34,158 |
|
|
|
1,686 |
|
|
|
511 |
|
|
|
703 |
|
|
|
3.32 |
% |
|
|
1.16 |
% |
|
|
2.06 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total investments (3) |
|
|
6,038,910 |
|
|
|
5,257,403 |
|
|
|
3,818,840 |
|
|
|
349,187 |
|
|
|
291,353 |
|
|
|
176,034 |
|
|
|
5.78 |
% |
|
|
5.54 |
% |
|
|
4.61 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Residential real estate loans |
|
|
1,813,506 |
|
|
|
1,127,525 |
|
|
|
947,450 |
|
|
|
121,066 |
|
|
|
78,889 |
|
|
|
71,065 |
|
|
|
6.68 |
% |
|
|
7.00 |
% |
|
|
7.50 |
% |
Construction loans |
|
|
710,753 |
|
|
|
379,356 |
|
|
|
314,588 |
|
|
|
52,300 |
|
|
|
19,396 |
|
|
|
14,824 |
|
|
|
7.36 |
% |
|
|
5.11 |
% |
|
|
4.71 |
% |
Commercial loans |
|
|
7,171,366 |
|
|
|
5,079,832 |
|
|
|
3,688,419 |
|
|
|
395,280 |
|
|
|
188,330 |
|
|
|
140,626 |
|
|
|
5.51 |
% |
|
|
3.71 |
% |
|
|
3.81 |
% |
Finance leases |
|
|
243,384 |
|
|
|
183,924 |
|
|
|
149,539 |
|
|
|
22,263 |
|
|
|
17,822 |
|
|
|
15,387 |
|
|
|
9.15 |
% |
|
|
9.69 |
% |
|
|
10.29 |
% |
Consumer loans |
|
|
1,570,468 |
|
|
|
1,244,386 |
|
|
|
1,188,730 |
|
|
|
191,071 |
|
|
|
157,465 |
|
|
|
161,145 |
|
|
|
12.17 |
% |
|
|
12.65 |
% |
|
|
13.56 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total loans (4) |
|
|
11,509,477 |
|
|
|
8,015,023 |
|
|
|
6,288,726 |
|
|
|
781,980 |
|
|
|
461,902 |
|
|
|
403,047 |
|
|
|
6.79 |
% |
|
|
5.76 |
% |
|
|
6.41 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total earning assets |
|
$ |
17,548,387 |
|
|
$ |
13,272,426 |
|
|
$ |
10,107,566 |
|
|
$ |
1,131,167 |
|
|
$ |
753,255 |
|
|
$ |
579,081 |
|
|
|
6.45 |
% |
|
|
5.68 |
% |
|
|
5.73 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest-bearing liabilities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest bearing checking
accounts |
|
$ |
376,360 |
|
|
$ |
317,634 |
|
|
$ |
259,438 |
|
|
$ |
4,730 |
|
|
$ |
3,688 |
|
|
$ |
3,426 |
|
|
|
1.26 |
% |
|
|
1.16 |
% |
|
|
1.32 |
% |
Savings accounts |
|
|
1,092,938 |
|
|
|
1,020,228 |
|
|
|
922,875 |
|
|
|
12,572 |
|
|
|
10,938 |
|
|
|
11,849 |
|
|
|
1.15 |
% |
|
|
1.07 |
% |
|
|
1.28 |
% |
Certificates
of deposit |
|
|
8,386,463 |
|
|
|
5,065,390 |
|
|
|
4,133,919 |
|
|
|
306,687 |
|
|
|
118,626 |
|
|
|
107,336 |
|
|
|
3.66 |
% |
|
|
2.34 |
% |
|
|
2.60 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest bearing deposits |
|
|
9,855,761 |
|
|
|
6,403,252 |
|
|
|
5,316,232 |
|
|
|
323,989 |
|
|
|
133,252 |
|
|
|
122,611 |
|
|
|
3.29 |
% |
|
|
2.08 |
% |
|
|
2.31 |
% |
Other borrowed funds |
|
|
5,001,384 |
|
|
|
4,235,215 |
|
|
|
2,964,417 |
|
|
|
207,503 |
|
|
|
144,924 |
|
|
|
112,984 |
|
|
|
4.15 |
% |
|
|
3.42 |
% |
|
|
3.81 |
% |
FHLB advances |
|
|
890,680 |
|
|
|
1,056,325 |
|
|
|
633,693 |
|
|
|
32,756 |
|
|
|
27,668 |
|
|
|
19,418 |
|
|
|
3.68 |
% |
|
|
2.62 |
% |
|
|
3.06 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total interest bearing
liabilities |
|
$ |
15,747,825 |
|
|
$ |
11,694,792 |
|
|
$ |
8,914,342 |
|
|
$ |
564,248 |
|
|
$ |
305,844 |
|
|
$ |
255,013 |
|
|
|
3.58 |
% |
|
|
2.62 |
% |
|
|
2.86 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net interest income |
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
566,919 |
|
|
$ |
447,411 |
|
|
$ |
324,068 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest rate spread |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2.87 |
% |
|
|
3.06 |
% |
|
|
2.87 |
% |
Net interest margin |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3.23 |
% |
|
|
3.37 |
% |
|
|
3.21 |
% |
|
|
|
| (1) |
|
On a tax equivalent basis. The tax equivalent yield was computed by dividing the
interest rate spread on exempt assets by (1- Puerto Rico statutory tax rate of 41.5%) and
adding to it the cost of interest bearing liabilities. When adjusted to a tax equivalent
basis, yields on taxable and exempt assets are comparative. Changes in the fair value of
derivative instruments are excluded from interest income and interest expense for average rate
calculation purposes because the changes in valuation do not affect
interest paid or received. |
| |
| (2) |
|
Government obligations include debt issued by government sponsored agencies. |
| |
| (3) |
|
Valuation in investments available-for-sale is excluded from the average volumes. |
| |
| (4) |
|
Non-accruing loans are included in the average balances, however, uncollected interest
on these loans is excluded from this analysis. |
52
Part II
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
2005 compared to 2004 |
|
|
2004 compared to 2003 |
|
| |
|
Increase (decrease) |
|
|
Increase (decrease) |
|
| |
|
Due to: |
|
|
Due to: |
|
| |
|
Volume |
|
|
Rate |
|
|
Total |
|
|
Volume |
|
|
Rate |
|
|
Total |
|
| |
|
|
|
|
|
|
|
|
|
(Dollars in thousands) |
|
|
|
|
|
|
|
|
|
Interest income on earning assets: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Money market investments |
|
$ |
6,638 |
|
|
$ |
11,817 |
|
|
$ |
18,455 |
|
|
$ |
(1,641 |
) |
|
$ |
670 |
|
|
$ |
(971 |
) |
Government obligations |
|
|
28,722 |
|
|
|
5,678 |
|
|
|
34,400 |
|
|
|
76,815 |
|
|
|
7,636 |
|
|
|
84,451 |
|
Mortgage-backed securities |
|
|
521 |
|
|
|
(1,941 |
) |
|
|
(1,420 |
) |
|
|
25,764 |
|
|
|
13,719 |
|
|
|
39,483 |
|
Corporate bonds |
|
|
(400 |
) |
|
|
3,312 |
|
|
|
2,912 |
|
|
|
(2,622 |
) |
|
|
(4,598 |
) |
|
|
(7,220 |
) |
FHLB stock |
|
|
314 |
|
|
|
1,998 |
|
|
|
2,312 |
|
|
|
382 |
|
|
|
(614 |
) |
|
|
(232 |
) |
Equity Securities |
|
|
93 |
|
|
|
1,082 |
|
|
|
1,175 |
|
|
|
157 |
|
|
|
(349 |
) |
|
|
(192 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total investments |
|
|
35,888 |
|
|
|
21,946 |
|
|
|
57,834 |
|
|
|
98,855 |
|
|
|
16,464 |
|
|
|
115,319 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Residential real estate loans |
|
|
46,896 |
|
|
|
(4,719 |
) |
|
|
42,177 |
|
|
|
13,053 |
|
|
|
(5,229 |
) |
|
|
7,824 |
|
Construction loans |
|
|
21,896 |
|
|
|
11,008 |
|
|
|
32,904 |
|
|
|
3,235 |
|
|
|
1,337 |
|
|
|
4,572 |
|
Commercial loans |
|
|
94,838 |
|
|
|
112,112 |
|
|
|
206,950 |
|
|
|
52,318 |
|
|
|
(4,614 |
) |
|
|
47,704 |
|
Finance leases |
|
|
5,601 |
|
|
|
(1,160 |
) |
|
|
4,441 |
|
|
|
3,434 |
|
|
|
(999 |
) |
|
|
2,435 |
|
Consumer loans |
|
|
40,468 |
|
|
|
(6,862 |
) |
|
|
33,606 |
|
|
|
7,294 |
|
|
|
(10,974 |
) |
|
|
(3,680 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total loans |
|
|
209,699 |
|
|
|
110,379 |
|
|
|
320,078 |
|
|
|
79,334 |
|
|
|
(20,479 |
) |
|
|
58,855 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total interest income |
|
|
245,587 |
|
|
|
132,325 |
|
|
|
377,912 |
|
|
|
178,189 |
|
|
|
(4,015 |
) |
|
|
174,174 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense on interest bearing liabilities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deposits |
|
|
91,917 |
|
|
|
98,820 |
|
|
|
190,737 |
|
|
|
23,846 |
|
|
|
(13,205 |
) |
|
|
10,641 |
|
Other borrowed funds |
|
|
28,779 |
|
|
|
33,800 |
|
|
|
62,579 |
|
|
|
45,960 |
|
|
|
(14,020 |
) |
|
|
31,940 |
|
FHLB advances |
|
|
(5,215 |
) |
|
|
10,303 |
|
|
|
5,088 |
|
|
|
12,011 |
|
|
|
(3,761 |
) |
|
|
8,250 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total interest expense |
|
|
115,481 |
|
|
|
142,923 |
|
|
|
258,404 |
|
|
|
81,817 |
|
|
|
(30,986 |
) |
|
|
50,831 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change in net interest income |
|
$ |
130,106 |
|
|
$ |
(10,598 |
) |
|
$ |
119,508 |
|
|
$ |
96,372 |
|
|
$ |
26,971 |
|
|
$ |
123,343 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
A portion of the Corporation’s interest earning assets, mostly investments in
obligations of some U.S. Government agencies and sponsored entities, generate interest which is
exempt from income tax, principally in Puerto Rico. Also interest and gains on sale of investments
held by the Corporation’s international banking entities are tax-exempt, under Puerto Rico tax law.
To facilitate the comparison of all interest data related to these assets, the interest income has
been converted to a taxable equivalent basis, using the Puerto Rico statutory income tax rate. The
computation considers the interest expense disallowance required by Puerto Rico tax law. Total
interest income, excluding changes in the fair value of derivatives includes tax equivalent
adjustments of $61.2 million, $64.3 million and $31.0 million for 2005, 2004 and 2003,
respectively. Refer to explanation below on derivative instruments valuations.
On a tax equivalent basis, net interest income, excluding changes in the fair value of
derivative instruments, increased to $566.9 million for 2005 from $447.4 million for 2004, and
$324.1 million for 2003. The interest rate spread and net interest margin amounted to 2.87% and
3.23%, respectively, for 2005, as compared to 3.06% and 3.37%, respectively, for 2004 and to 2.87%
and 3.21%, respectively, for 2003.
The exclusion of unrealized changes in the fair value of derivative instruments (mainly changes
in the fair value of interest rate swaps) from the detailed analysis of net interest income
provides additional information about the Corporation’s net interest income and facilitates
comparability and analysis. The changes in the fair value of the financial instrument have no
effect on interest due or interest earned on interest bearing assets or interest bearing
liabilities, respectively, or on interest payments exchanged with swap counterparties. In addition,
since the Corporation intends to hold the interest rate swaps until they mature because,
economically, the interest rate swaps are satisfying their intended results, the unrealized changes
in fair value will reverse over the remaining lives of the swaps.
The following table reconciles the interest income on a tax equivalent basis set forth in
Table I above to interest income set forth in the Consolidated Statements of Income:
53
The following table summarizes the components of interest income:
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Year ended December 31, |
|
| |
|
2005 |
|
|
2004 |
|
|
2003 |
|
| |
|
(Dollars in thousands) |
|
Interest income on a tax equivalent basis |
|
$ |
1,131,167 |
|
|
$ |
753,255 |
|
|
$ |
579,081 |
|
Less: tax equivalent adjustments |
|
|
(61,166 |
) |
|
|
(64,258 |
) |
|
|
(30,994 |
) |
Plus: net unrealized (loss) gain on derivatives (economic hedges) |
|
|
(2,411 |
) |
|
|
1,337 |
|
|
|
1,379 |
|
|
|
|
|
|
|
|
|
|
|
Total interest income |
|
$ |
1,067,590 |
|
|
$ |
690,334 |
|
|
$ |
549,466 |
|
|
|
|
|
|
|
|
|
|
|
The following table summarizes the components of the changes in fair values of interest rate swaps and interest rate caps,
which are included in interest income.
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
2005 |
|
|
2004 |
|
|
2003 |
|
| |
|
(Dollars in thousands) |
|
Unrealized gain (loss) on derivatives (economic hedges): |
|
|
|
|
|
|
|
|
|
|
|
|
Interest rate caps |
|
$ |
(4,039 |
) |
|
$ |
16 |
|
|
$ |
— |
|
Interest rate swaps on corporate bonds |
|
|
823 |
|
|
|
2,858 |
|
|
|
1,591 |
|
Interest rate swaps on loans |
|
|
805 |
|
|
|
(1,537 |
) |
|
|
(212 |
) |
|
|
|
|
|
|
|
|
|
|
Net unrealized (loss) gain on valuations (economic hedges) |
|
$ |
(2,411 |
) |
|
$ |
1,337 |
|
|
$ |
1,379 |
|
|
|
|
|
|
|
|
|
|
|
The following table summarizes the components of interest expense for the years ended
December 31, 2005, 2004 and 2003. As mentioned before, the net interest margin analysis excludes
the changes in the fair value of interest rate swaps.
The following table summarizes the components of interest expense:
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Year ended December 31, |
|
| |
|
2005 |
|
|
2004 |
|
|
2003 |
|
| |
|
(Dollars in thousands) |
|
Interest expense on interest bearing liabilities |
|
$ |
620,774 |
|
|
$ |
416,852 |
|
|
$ |
324,489 |
|
Net interest realized on interest rate swaps |
|
|
(71,650 |
) |
|
|
(124,883 |
) |
|
|
(82,343 |
) |
Amortization of broker placement fees |
|
|
15,096 |
|
|
|
12,942 |
|
|
|
12,867 |
|
Amortization of medium-term notes placement fees |
|
|
28 |
|
|
|
933 |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
Interest expense excluding unrealized loss (gain) on derivatives (economic hedges) |
|
|
564,248 |
|
|
|
305,844 |
|
|
|
255,013 |
|
Net unrealized loss (gain) on derivatives (economic hedges) |
|
|
71,023 |
|
|
|
(12,991 |
) |
|
|
42,515 |
|
|
|
|
|
|
|
|
|
|
|
Total interest expense |
|
$ |
635,271 |
|
|
$ |
292,853 |
|
|
$ |
297,528 |
|
|
|
|
|
|
|
|
|
|
|
The following table summarizes the components of the unrealized loss (gain) on derivatives (economic hedges) which are included in
interest expense:
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Year ended December 31, |
|
| |
|
2005 |
|
|
2004 |
|
|
2003 |
|
| |
|
(Dollars in thousands) |
|
Unrealized loss (gain) on derivatives (economic hedges): |
|
|
|
|
|
|
|
|
|
|
|
|
Interest rate swaps on brokered certificates of deposit |
|
$ |
69,163 |
|
|
$ |
(13,408 |
) |
|
$ |
42,515 |
|
Interest rate swaps on medium-term notes |
|
|
1,860 |
|
|
|
417 |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
Net unrealized loss (gain) on derivatives (economic hedges) |
|
$ |
71,023 |
|
|
$ |
(12,991 |
) |
|
$ |
42,515 |
|
|
|
|
|
|
|
|
|
|
|
Interest
income on interest earning assets primarily represents interest earned on
loan receivables and investment securities.
Interest expense on interest bearing liabilities primarily represents interest due on brokered
CDs, branch-based deposits, repurchase agreements and notes payable.
54
Net interest realized on interest rate swaps primarily represents net interest exchanged on
pay-float swaps that economically hedge brokered CDs and medium-term notes.
The amortization of broker placement fees represents the amortization of fees paid upon
issuance to brokers selling the related financial instruments (i.e., brokered CDs).
Unrealized gains or losses on derivatives (economic hedges) mainly represent changes in the
fair value of interest rate swaps that economically hedge assets (i.e., loans and corporate bonds)
or liabilities (i.e., brokered CDs and medium-term notes).
As shown on the tables above, the results of operations for the year 2005 were significantly
impacted mainly by negative changes in the valuation of interest rate swaps that economically hedge
brokered certificates of deposit and medium-term notes; the change in the valuation of interest
rate swaps recorded as part of interest expense was negative $71.0 million (2004- positive $12.9
million, 2003- negative $42.5 million). These are non-cash changes in the value of these
derivatives that the Corporation intends to hold to their maturity, therefore, the unrealized
changes will reverse as the instruments approach maturity.
Derivative instruments, such as interest rate swaps, are subject to market risk. While the
Corporation does have certain trading derivatives to facilitate customer transactions, the
Corporation does not utilize derivative instruments for speculative purposes. The Corporation’s
derivatives are mainly composed of interest rate swaps that are used to economically hedge brokered
certificates of deposit and medium-term notes. Refer to the “Derivative Activities” section of
this discussion for a detail of the notional amounts of derivative instruments and other
information. As is the case with cash securities, the market value of derivative instruments is
largely a function of the financial market’s expectations regarding the future direction of
interest rates. Accordingly, current market values are not necessarily indicative of the future
impact of derivative instruments on net interest income. This will depend, for the most part, on
the shape of the yield curve as well as the level of interest rates.
2005 compared to 2004
On a tax equivalent basis, interest income, excluding the changes in the fair values of
derivative instruments, increased by $377.9 million for 2005 as compared to 2004. The tax equivalent
yield on interest earning assets increased by 77 basis points, 6.45% for 2005 as compared to 5.68%
for 2004. The tax equivalent yield on the loan portfolio increased 103 basis points to 6.79% for
2005 as compared to 5.76% for 2004, mainly due to the re-pricing of variable rate commercial loans
and the origination of new commercial loans at higher rates, and the tax equivalent yield on the
investment portfolio increased 24 basis points to 5.78% as compared to 5.54% for 2004, due to the
re-investment of proceeds from prepayments on mortgage-backed securities and larger volume of new
investments in higher yielding long-term securities.
Significant volume increases in the Corporation’s loan portfolio, mainly in the
commercial and residential real estate portfolios, and significant rate increases in the commercial loans portfolio contributed significantly to interest income for
2005. As shown in Part I, the Corporation experienced continuous growth in the loan portfolios.
Average loans increased by $3.5 billion compared to 2004.
Commercial loans and construction loans accounted for the largest
growth in the portfolio with average volumes rising $2.1 billion
and $331.4 million, respectively, and residential real estate loans
followed with $686.0 million. For the loan portfolio, the growth in average volume, mainly driven
by loan originations, represented a positive increase of
$209.7 million in interest income on loans.
The increases due to rate of $110.4 million are primarily
attributable to
the origination of new loans at higher rates and to the re-pricing
of variable rate loans. The majority of total commercial loans and
construction loans yield variable rates to
the Bank. The rising trend in interest rates by the Federal Reserve Bank has contributed to higher
interest
55
income; the federal funds rate increased 200 basis points during the year, the Prime and LIBOR
rates also increased during the year, both of which are indexes used by the Corporation to re-price
majority of its floating rate loans including the secured loans to local financial institutions
(refer to the Financial Condition-
Loans Receivable section of this discussion). At December 31, 2005, 93% of the commercial and 96%
of the construction loan portfolios had floating rates.
Average volume increases in the Corporation’s investment portfolio and positive rate
variances, mainly in the money market investments and government obligations portfolio, also contributed to interest income for
2005. Average investment securities increased by $781.5 million. With the increase in long-term
rates during 2004 and the continuing trend in 2005, the Corporation re-entered the long-term
investment market which contributed to the increase in interest income. These purchases accounted
for most of the positive variances in interest income from investments due to volume and due to
rate. The growth in the average balance of investments represented a positive increase in interest
income on investments due to volume of $35.9 million and due to
rate of $21.9 million, mainly
attributable to a higher volume of higher yielding government agency securities.
On the liabilities side, the Corporation’s suffered from the re-pricing of short-term (i.e.,
deposits and repurchase agreements) and long-term (i.e., long-term repurchase agreements and other
advances) liabilities at higher rates, after considering net interest realized on economic hedges.
Interest expense, excluding changes in the fair value of interest rate swaps, increased by 84%,
$258.4 million for 2005 as compared to 2004, due in part to volume increases in interest bearing
deposits at higher yields to support the Corporation’s loans and
investment portfolio growth, and other borrowed
funds. The average volume of deposits increased by $3.5 billion
and the average rate increased by 121 basis
points. The average volume of other borrowed funds increased by $766.2 million and the average rate
increased by 73 basis points. The increase in the average volume of interest bearing liabilities to fund the
loans and investment portfolios growth along with the increase in rates, given the re-pricing and
origination of interest bearing liabilities at higher rates and decreases in net interest realized
on interest rate swap instruments, resulted in an increase in interest expense due to volume of
$115.5 million and due to rate of $143.0 million. While the LIBOR rate has increased since December
2004 approximately 197 basis points, the Corporation’s cost of interest bearing liabilities,
excluding the changes in the fair value of interest rate swaps, have increased 96 basis points from
2.62% for 2004 to 3.58% for 2005. The increases in the three-month LIBOR rates resulted in a
compression of interest exchanged on received fixed pay-floating interest rate swaps. The net
interest realized on these economic hedges of brokered certificates
of deposit decreased from $125 million in 2004 to $72 million in 2005 negatively impacting interest expense
and cost of funds
when comparing both
periods.
In summary, positive volume variances resulting from an increase in average earning assets
were offset by negative rate variances derived from higher cost of funds, despite higher yields on
the loans and investment portfolio. The net impact on net interest income and earnings was
positive on a rate/volume basis. The Corporation’s net interest income (on a tax equivalent basis
and excluding changes in the fair value of derivative instruments) increased by $119.5 million, the
net result of a positive volume variance of $130.1 million and a
negative rate variance of $10.6
million. The net interest margin decreased from 3.37% for the year 2004 to 3.23% for 2005. The
contraction is primarily due to the flat to inverted yield curve.
2004 compared to 2003
On a tax equivalent basis, interest income, excluding the changes in the fair values of
derivative instruments, increased by $174.2 million for 2004 as compared to 2003. The tax equivalent
yield on interest earning assets was 5.68% for 2004 as compared to 5.73% for 2003. While the tax
equivalent yield on the investment portfolio increased to 5.54% as compared to 4.61% for 2003, due
to the re-investment of proceeds from prepayments on mortgage-backed securities and to new
investments in higher yielding long-term securities, the tax equivalent yield on the loan portfolio
decreased to 5.76% for 2004 as
56
compared to 6.41% for 2003, due to the re-pricing of variable rate
loans and to the purchase and origination of loans at lower rates.
Significant volume increases in the Corporation’s total loan portfolio partially offset by negative
variances due to rate, mainly in the residential real estate and consumer portfolios, contributed
significantly to interest income for 2004. As shown in Part I, the Corporation experienced
continuous growth of its loan portfolios. Average loans increased by $1.7 billion compared to 2003.
Commercial loans, which include the secured loans to local financial institutions, accounted for
the largest growth in the portfolio with average volumes rising $1.4 billion. For the loan
portfolio, the growth in average volume mainly driven by loan originations represented a positive
increase of $79.3 million in interest income on loans due to volume. The $20.5 million decrease in
interest income on loans due to rate, mentioned earlier, is mainly attributable to the floating
rate characteristics of a substantial portion of the Corporation’s portfolio and to the origination
of new loans at lower rates. At December 31, 2004, 91% of the commercial and 95% of the
construction loan portfolios had floating rates.
Significant volume increases in the Corporation’s investment portfolio and positive rate
variances, mainly in the mortgage-backed securities and government obligations portfolio,
contributed significantly to interest income for 2004. Average investment securities increased by
$1.4 billion. During the first quarter of 2004, the Corporation maintained a portion of its
investment portfolio, mostly the proceeds of prepayments on mortgage-backed securities, in
short-term instruments, awaiting an opportunity to re-enter the longer-term investment market. With
the increase in long-term rates during the latter part of the first quarter of 2004, the
Corporation re-entered the long-term investment market by purchasing $1.6 billion in higher
yielding 15 to 25 year callable agency securities, of which $306.8 million were called during the
fourth quarter of 2004. Most of the purchases were made during the second quarter of 2004. As a
result of the purchases of these higher yielding securities, interest income increased
significantly. These purchases accounted for most of the positive variances in interest income from
investments due to volume and due to rate. The growth in the average balance of investments
represented a positive increase in interest income on investments due to volume of $98.9 million.
The positive variance in interest income on investments due to rate, mainly due to higher yielding
mortgage-backed securities and government agency securities, amounted to $16.5 million.
On the liabilities side, the Corporation benefited from the re-pricing of short-term
liabilities and by the origination of new short-term (i.e., deposits and repurchase agreements) and
long-term (i.e., long-term repurchase agreements and other advances) liabilities at lower rates,
after considering net interest realized on economic hedges. Interest expense, excluding changes in
the fair value of interest rate swaps, increased by $50.8 million for 2004 as compared to 2003,
mainly due to volume increases in interest bearing liabilities to support the Corporation’s
investment and loan portfolio growth. The increase in the average volume of interest bearing
liabilities to fund the investment and loan portfolios growth resulted in an increase in interest
expense due to volume of $81.8 million. The increase in interest expense due to volume variance was
partially offset by decreases resulting from rate decreases given the re-pricing and origination of
interest bearing liabilities at lower rates, as explained above, which resulted in a decrease in
interest expense due to rate of $31.0 million. The cost of interest bearing liabilities, excluding
changes in the fair value of interest rate swaps, decreased from 2.86% for 2003 to 2.62% for 2004.
In summary, positive variances resulting from an increase in average earning assets, higher
yields on the investment’s portfolio and lower cost of funds were partially offset by a decrease in
the loan portfolio interest yields. The net impact on net interest income and earnings was
positive, on a rate/volume basis. The Corporation’s net interest income (on a tax equivalent basis
and excluding changes in the fair value of derivative instruments increased by $123.3 million, as a
result of positive volume and rate variances of $96.4 million and $27.0 million, respectively. The
net interest margin increased from 3.21% for the year 2003 to 3.37% for 2004.
57
Provision for Loan Losses
During 2005, the Corporation provided $50.6 million for loan losses, as compared to $52.8
million in 2004 and $55.9 million in 2003.
The decrease in the provision since 2003 is primarily attributed to
the seasoning of the corporate commercial loans portfolio and in 2005
to a decrease in the specific reserve allocated to a commercial loan
based on new facts that satisfied the Corporation as to the ultimate recoverability of the loan. The Corporation has not incurred significant losses as a percentage of its commercial
loans receivable since it started emphasizing the corporate
commercial lending activities in the late 1990s, therefore, the
provision for inherent losses in this portfolio has decreased. The
provision for 2005 is mainly attributable to the consumer loans portfolio and to a lesser extent to the construction loans portfolio which increased significantly in 2005 from loans disbursed by the Corporation’s
loan agency in Coral Gables, Florida.
Net charge-offs to average loans outstanding
during the period were 0.39% as compared to 0.48% in 2004 and 0.66% in 2003. Net charge-offs amounted to $45.0 million for 2005,
$38.1 million for 2004, and $41.4 million for 2003.
The provision for loan losses totaled 112% of net charge-offs for 2005, compared with 138% of net
charge-offs, for 2004 and 135% for
2003. The increase of $6.9 million in net charge-offs in the
2005 year, compared with the previous year, was mainly composed of
$5 million of higher charge-offs in consumer
loans primarily auto loans, given higher delinquencies during 2005. Auto loans are
collateralized by the underlying automobile units. Commercial loans,
including construction loans, that were charged-off amounted to $8.6 million
for 2005, an increase of $2.4 million when compared to
$6.2 million in 2004;
total charged-off for 2003 amounted to $6.5 million. The commercial loans portfolio includes the secured loans to local financial institutions; these institutions have always paid the loans in accordance with the terms and conditions. Further, these commercial loans are mainly secured by residential real estate collateral.
Due to the trend of increasing home values,
losses in the residential mortgage portfolio have
been minimal; therefore, reserves allocated to the loans to local
financial institutions secured by residential mortgages and to the Corporation’s residential real estate portfolios are not significant.
Recoveries
made from previously written-off accounts were $6.9 million in 2005 compared to $5.9 million in
2004 and $6.7 million in 2003.
The allowance for loan losses at December 31, 2005 totaled $148.0 million as compared to
$141.0 million at December 31, 2004. Non-accruing loans increased $42.7 million during 2005 (refer
to the Financial Condition — Non Performing Assets section of this discussion); however, $23.2 million of
such increase represented residential real estate loans
for which historical losses have been
minimal and, as such, reserves allocated to this portfolio are not significant.
The allowance activity for 2005, and previous four years was as follows:
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Year ended December 31, |
|
2005 |
|
|
2004 |
|
|
2003 |
|
|
2002 |
|
|
2001 |
|
| |
|
(Dollars in thousands) |
|
Allowance for loan losses, beginning of
year |
|
$ |
141,036 |
|
|
$ |
126,378 |
|
|
$ |
111,911 |
|
|
$ |
91,060 |
|
|
$ |
76,919 |
|
Provision for loan losses |
|
|
50,644 |
|
|
|
52,799 |
|
|
|
55,916 |
|
|
|
62,302 |
|
|
|
61,030 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans charged off: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Residential real estate |
|
|
(945 |
) |
|
|
(254 |
) |
|
|
(475 |
) |
|
|
(555 |
) |
|
|
(192 |
) |
Commercial and construction |
|
|
(8,558 |
) |
|
|
(6,190 |
) |
|
|
(6,488 |
) |
|
|
(4,643 |
) |
|
|
(9,523 |
) |
Finance leases |
|
|
(2,748 |
) |
|
|
(2,894 |
) |
|
|
(2,424 |
) |
|
|
(2,532 |
) |
|
|
(2,316 |
) |
Consumer |
|
|
(39,669 |
) |
|
|
(34,704 |
) |
|
|
(38,745 |
) |
|
|
(41,261 |
) |
|
|
(42,349 |
) |
Recoveries |
|
|
6,876 |
|
|
|
5,901 |
|
|
|
6,683 |
|
|
|
7,540 |
|
|
|
7,391 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net charge-offs |
|
|
(45,044 |
) |
|
|
(38,141 |
) |
|
|
(41,449 |
) |
|
|
(41,451 |
) |
|
|
(46,989 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other adjustments (1) |
|
|
1,363 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
100 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Allowance for loan losses, end of year |
|
$ |
147,999 |
|
|
$ |
141,036 |
|
|
$ |
126,378 |
|
|
$ |
111,911 |
|
|
$ |
91,060 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Allowance for loan losses to year end total
loans |
|
|
1.17 |
% |
|
|
1.49 |
% |
|
|
1.80 |
% |
|
|
1.99 |
% |
|
|
2.12 |
% |
Net charge offs to average loans
outstanding during the period |
|
|
0.39 |
% |
|
|
0.48 |
% |
|
|
0.66 |
% |
|
|
0.87 |
% |
|
|
1.22 |
% |
|
|
|
| (1) |
|
Represents allowance for loan losses from the acquisition of FirstBank Florida in 2005. |
The Corporation maintains the allowance for loan losses that is based upon estimates of
inherent losses in the loan portfolio. The amount of actual losses can vary significantly from
estimated amounts. The adequacy of the allowance for loan losses is reviewed on a quarterly basis
as part of the continuing evaluation of the quality of the assets. The methodology used includes
several features intended to diminish differences between estimated losses and actual losses.
Historical loss factors may be adjusted for significant factors that
58
based on management’s
judgment, reflect the impact of any current condition on loss recognition. The Corporation’s
evaluation is based upon a number of factors, including the following: historical loan loss
experience, projected loan losses, loan portfolio composition, current economic conditions, changes
in
underwriting process, fair value of the underlying collateral, financial condition of the
borrowers, and, as such, includes amounts based on judgments and estimates made by management.
The allowance for loan losses on commercial and real estate loans over $1 million is
determined based on the present value of expected future cash flows or the fair value of the
collateral, if the loan is collateral dependent.
Other Income
The following table presents the composition of other income.
| |
|
|
|
|
|
|
|
|
|
|
|
|
| Year ended December 31, |
|
2005 |
|
|
2004 |
|
|
2003 |
|
| |
| |
|
(Dollars in thousands) |
|
Other service charges on loans |
|
$ |
5,431 |
|
|
$ |
3,910 |
|
|
$ |
6,522 |
|
Service charges on deposit accounts |
|
|
11,796 |
|
|
|
10,938 |
|
|
|
9,527 |
|
Mortgage banking activities |
|
|
3,798 |
|
|
|
3,921 |
|
|
|
3,014 |
|
Rental income |
|
|
3,463 |
|
|
|
3,071 |
|
|
|
2,224 |
|
Insurance income |
|
|
9,443 |
|
|
|
6,439 |
|
|
|
4,258 |
|
Other commissions and fees |
|
|
911 |
|
|
|
1,983 |
|
|
|
1,386 |
|
Other operating income |
|
|
15,896 |
|
|
|
14,372 |
|
|
|
11,892 |
|
|
|
|
|
|
|
|
|
|
|
Other income before net gain on
sale of investments and gain on sale of
credit card portfolio |
|
|
50,738 |
|
|
|
44,634 |
|
|
|
38,823 |
|
|
|
|
|
|
|
|
|
|
|
Net gain on sale of investments |
|
|
20,713 |
|
|
|
12,156 |
|
|
|
41,351 |
|
Impairment on investments |
|
|
(8,374 |
) |
|
|
(2,699 |
) |
|
|
(5,761 |
) |
|
|
|
|
|
|
|
|
|
|
Gain on investments, net |
|
|
12,339 |
|
|
|
9,457 |
|
|
|
35,590 |
|
|
|
|
|
|
|
|
|
|
|
Gain on sale of credit card portfolio |
|
|
— |
|
|
|
5,533 |
|
|
|
32,385 |
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
63,077 |
|
|
$ |
59,624 |
|
|
$ |
106,798 |
|
|
|
|
|
|
|
|
|
|
|
Other income primarily consists of other service charges on loans, service charges on
deposit accounts, commissions derived from various banking activities, securities and insurance
activities and net gain on investments. Other income, excluding the net gains on investments and a
gain on sale of credit card loans portfolio, increased
$6.1 million for 2005 as compared to 2004 and increased $5.8
million for 2004 as compared to 2003.
The increase is mainly attributable to increases in commission income from the
Corporation’s insurance businesses, other service charges on loans and service charges on deposit
accounts, partially offset by decreases in other commissions and fees when comparing 2005 to 2004.
The gain on the sale of credit card portfolio in 2004 and 2003 results from portfolios sold pursuant to a
strategic alliance agreement reached with MBNA Corporation in 2003.
Other service charges on loans consist mainly of service charges on credit card related
activities which increased for 2005 when compared to 2004. Furthermore, the increase was driven by
the acquisition of FirstBank Florida.
59
Service charges on deposit accounts include monthly and other fees on deposit accounts. This
source of income has continuously increased due to a larger volume of accounts and transactions during 2005 and 2004.
Mortgage banking activities income includes gains on the sale of residential mortgage loans
and the fees earned for administering residential mortgage loans originated by the Corporation and
subsequently sold
with servicing retained. Gains on sale of loans amounted to $3.6 million in 2005 (2004-$3.6
million, 2003-$2.9 million). During the first quarter of 2005, the Corporation entered into an
arrangement with another unrelated financial institution (the “Counterparty”) in which, in
substance, the parties agreed to sell and purchase similar mortgage loan portfolios. Pursuant to
this arrangement, the Corporation purchased mortgage loans with an aggregate unpaid principal
balance of $87.2 million for $88.9 million in March 2005. In April and May of 2005, the
Corporation sold to the Counterparty mortgage loans with aggregate unpaid principal balances of
$60.0 million and $29.7 million, for $61.1 million and
$30.3 million, respectively, resulting in
gains on the sales of $1.3 million and $0.6 million, respectively. Since the Corporation retained
the servicing on the mortgage loans sold to the Counterparty, it also recognized a servicing asset
of $1.2 million. The Corporation entered into these transactions because, among other reasons, they
were consistent with its business objectives of developing a mortgage-banking business that would
provide its liquidity as well as new sources for its acquisition of mortgage loans.
Notwithstanding that the transactions were in substance the purchase and sale of similar mortgage
loan portfolios, generally accepted accounting principles require that the transactions be treated
as a separate purchase and a separate sale.
The Corporation’s subsidiary, First Leasing and Rental Corporation, generates income on the
rental of various types of motor vehicles. Rental income amounted to $3.5 million for 2005 as
compared to $3.1 million for 2004 and $2.2 million for
2003, respectively. The increase when comparing 2005 to 2004 and 2004 to 2003, is attributed to a higher number of rental units and
a higher number of rental locations.
Insurance income consists of commissions earned by the Corporation’s subsidiary FirstBank
Insurance Agency, Inc., and the Bank’s subsidiary in the U.S.V.I., First Insurance Agency, Inc.
These subsidiaries offer a wide variety of insurance related products and have increased business
through cross selling strategies, marketing efforts and the strategic locations of sales offices.
The Corporation maintains an allowance to cover the commissions which management estimates will be
returned upon cancellation of a policy.
Other commissions and fees income is the result of an agreement with a major investment
banking firm to participate in bond issues by the Government Development Bank for Puerto Rico, and
an agreement with an international brokerage firm doing business in Puerto Rico to offer brokerage
services in selected branches.
The other operating income category is composed of miscellaneous fees such as check fees and
rental of safe deposit boxes.
The net gain on investment securities reflects gains or losses as a result of sales that are
consistent with the Corporation’s investment policies and strategy as well as other-than-temporary
impairment charges on portfolio securities. Net gains on investments, excluding
other-than-temporary impairments, resulted mainly from the sale of a substantial portion of the
Corporation’s equity portfolio held at one of the international banking entities at gains of
approximately $21 million. The proceeds from the sale of equity
securities and other funds available at the Corporation’s
holding company were used to make a $110 million capital contribution to FirstBank Puerto Rico at the end of 2005. During 2005, the Corporation recorded other-than-temporary impairments
on three equity securities held in portfolio amounting to $8.4 million. Management concluded that
the declines in value of the securities were other-than-temporary, as such the cost basis of these
securities was written down to the market value at the date of the analyses. Management evaluates
investment securities for impairment on a quarterly basis or earlier if other factors indicative of
potential impairment exist. The decrease in net gains on investments for 2004 compared to 2003 results
mainly from significant sales of mortgage-backed securities during
2003 that were sold at substantial gains when the 10-year Treasury
note reached low levels at 3.56% during the first quarter of such year.
60
Other Operating Expenses
Other operating expenses amounted to $315.1 million for 2005 as compared to $180.5 million for
2004 and $164.6 million for 2003. The following table presents the components of other operating
expenses.
| |
|
|
|
|
|
|
|
|
|
|
|
|
| Year ended December 31, |
|
2005 |
|
|
2004 |
|
|
2003 |
|
| |
|
(Dollars in thousands) |
|
Salaries and benefits |
|
$ |
102,078 |
|
|
$ |
82,440 |
|
|
$ |
74,488 |
|
Occupancy and equipment |
|
|
47,582 |
|
|
|
39,430 |
|
|
|
36,363 |
|
Deposit insurance premium |
|
|
1,248 |
|
|
|
979 |
|
|
|
806 |
|
Other taxes, insurance and supervisory fees |
|
|
14,071 |
|
|
|
11,615 |
|
|
|
10,329 |
|
Professional fees |
|
|
13,387 |
|
|
|
4,165 |
|
|
|
2,992 |
|
Servicing and processing fees |
|
|
6,573 |
|
|
|
2,727 |
|
|
|
6,410 |
|
Business promotion |
|
|
18,718 |
|
|
|
16,349 |
|
|
|
12,415 |
|
Communications |
|
|
8,642 |
|
|
|
7,274 |
|
|
|
6,959 |
|
Provision for contingencies |
|
|
82,750 |
|
|
|
— |
|
|
|
— |
|
Other |
|
|
20,083 |
|
|
|
15,501 |
|
|
|
13,868 |
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
315,132 |
|
|
$ |
180,480 |
|
|
$ |
164,630 |
|
|
|
|
|
|
|
|
|
|
|
Salaries and benefits increased in 2005 as compared to 2004 and 2003. The increase is mainly
attributable to increases in average salary and employee benefits
and headcount
from approximately 2,100 persons at December 31, 2003, to approximately 2,300 persons at December 31, 2004 and to approximately 2,700 persons at December 31, 2005
mainly to support the growth in operations and from the acquisition of FirstBank Florida in 2005.
The increase in occupancy and equipment expenses in 2005 as compared to 2004 and in 2004 as compared to 2003 is mainly
attributed to increases in costs associated with the Corporation’s branch network and loan
origination offices. The increase in 2005 also includes higher electricity costs and the acquisition of FirstBank Florida.
Professional fees for 2005 increased by approximately $9.2 million when compared to 2004. The
increase for 2005 was primarily due to legal, accounting and consulting fees associated with the
internal review conducted by the Corporation’s Audit Committee, the restatement process and other
related legal proceedings which amounted to approximately $6.0
million. The increase in 2004 as compared to 2003 is attributed to the Corporation’s general growth.
Following the announcement of the Corporation’s Audit Committee review, the Corporation and
certain of its officers and directors and former officers and directors were named as defendants in
separate class action suits filed late in 2005. The securities class actions were consolidated.
First BanCorp has been engaged in discussions with the lead plaintiff for a possible settlement of
the class action and has accrued $74.25 million in its consolidated financial statements for the
year ended December 31, 2005 in connection with a potential settlement. There can be no assurance
that the amount accrued will be sufficient and the Corporation cannot predict at this time the
timing or final terms of any settlement. In addition, the Corporation has been engaged in
discussions with the staff of the SEC regarding a possible resolution to its investigation of the
Corporation’s restatement, and has accrued $8.5 million in its consolidated financial statements
for the year ended December 31, 2005 in connection with a potential settlement of the SEC’s
investigation of the Corporation. Any settlement is subject to the approval of
the SEC. There can be no assurance that the Corporation’s efforts to resolve the SEC’s
investigation with respect to the Corporation will be successful, or that the amount accrued will
be sufficient, and the Corporation cannot predict at this time the timing or final terms of any
settlement. Both the SEC and class action contingencies are presented in the Statement
of Income as Provision for contingencies.
61
Income Tax Expense
The Corporation has maintained an effective tax rate lower than the maximum statutory rate of
41.5% (39% plus a 2.5% transitory tax) mainly by investing in government obligations and mortgage-backed securities exempt from U.S.
and Puerto Rico income tax combined with gains on sale of investments held by the international
banking divisions (IBEs) of the Corporation and the Bank and by the Bank’s subsidiary FirstBank
Overseas Corporation. The IBEs and FirstBank Overseas Corporation were created under the
International Banking Entity Act of Puerto Rico, which provides for total Puerto Rico tax exemption
on net income derived by the IBEs operating in Puerto Rico. Since 2004, IBEs that operate as a unit
of a bank are imposed income tax at normal rates to the extent that the IBEs’ net income exceeds
predetermined percentages of the bank’s total net taxable income; such limitations were 30% of
total net taxable income for a taxable year commencing between July 1, 2004 and July 1, 2005, and
20% of such total net taxable income for taxable years commencing thereafter. On August 2005, the
Governor of Puerto Rico signed into law a transitory additional surtax of 2.5% over net taxable
income, effectively increasing the maximum statutory regular rate to 41.5%. This transitory
additional tax is in effect for taxable years 2005 and 2006 and had a retroactive effect to January
1, 2005.
The provision for income tax amounted to $15.0 million (or 12% of pre-tax earnings) for 2005
as compared to $46.5 million (or 21% of pre-tax earnings) in 2004, and $18.3 million (or 13% of
pre-tax earnings) in 2003.
The decrease in 2005 as compared to 2004
is mainly due to total deferred tax benefits of $60.2 million recognized during
the year mainly composed of $30.1 million
as a result of unrealized losses on
derivative instruments, $29.0 million
as a result of accrued amount for class action settlement and
$3.7 million as a result of increases in the allowance for loan
losses, net of increases in the current tax provision. The increase
in 2004 as compared to 2003 is mainly due to a higher current tax
provision and lower positive changes in temporary differences.
The current provision for income taxes
amounted to $75.2 million,
compared to $53.0 million in 2004, and $45.0 million in 2003. The increase in the current
provision for 2005, when compared to 2004, is attributed to significant increases in the
Corporation’s taxable income generated from the loan portfolios. The change in the proportion of
exempt and taxable income resulted in a higher current tax. In addition, the current
provision was impacted by the transitory surtax of 2.5% over net taxable income, explained above,
which resulted in an additional income tax provision of $3.6 million.
Deferred income taxes reflect primarily the effect of “temporary” differences between amounts
of assets and liabilities for financial reporting purposes and their respective tax bases. The
provision for income taxes include total deferred income tax benefits of
$60.2 million, $6.5 million and
$26.7 million for 2005, 2004 and 2003 respectively, which are mainly attributed to temporary
differences related to the above referred allowance for loan losses, unrealized losses on derivative instruments
and to the class action related liability recorded at December 31, 2005.
For additional information relating to income taxes, see Note 26 to the Corporation’s
financial statements.
62
Financial Condition
The following table presents an average balance sheet of the Corporation for the following
years:
| |
|
|
|
|
|
|
|
|
|
|
|
|
| December 31, |
|
2005 |
|
|
2004 |
|
|
2003 |
|
| (Dollars in thousands) |
|
|
|
|
|
|
|
|
|
|
|
|
| |
Assets |
|
|
|
|
|
|
|
|
|
|
|
|
Interest earning assets: |
|
|
|
|
|
|
|
|
|
|
|
|
Money market investments |
|
$ |
636,114 |
|
|
$ |
308,962 |
|
|
$ |
455,242 |
|
Government obligations |
|
|
2,493,725 |
|
|
|
2,061,280 |
|
|
|
851,140 |
|
Mortgage-backed securities |
|
|
2,738,388 |
|
|
|
2,729,125 |
|
|
|
2,256,790 |
|
Corporate bonds |
|
|
48,311 |
|
|
|
57,462 |
|
|
|
181,063 |
|
FHLB stock |
|
|
71,588 |
|
|
|
56,698 |
|
|
|
40,447 |
|
Equity securities |
|
|
50,784 |
|
|
|
43,876 |
|
|
|
34,158 |
|
|
|
|
|
|
|
|
|
|
|
Total investments |
|
|
6,038,910 |
|
|
|
5,257,403 |
|
|
|
3,818,840 |
|
|
|
|
|
|
|
|
|
|
|
Residential real estate loans |
|
|
1,813,506 |
|
|
|
1,127,525 |
|
|
|
947,450 |
|
Construction loans |
|
|
710,753 |
|
|
|
379,356 |
|
|
|
314,588 |
|
Commercial loans |
|
|
7,171,366 |
|
|
|
5,079,832 |
|
|
|
3,688,419 |
|
Finance leases |
|
|
243,384 |
|
|
|
183,924 |
|
|
|
149,539 |
|
Consumer loans |
|
|
1,570,468 |
|
|
|
1,244,386 |
|
|
|
1,188,730 |
|
|
|
|
|
|
|
|
|
|
|
Total loans |
|
|
11,509,477 |
|
|
|
8,015,023 |
|
|
|
6,288,726 |
|
|
|
|
|
|
|
|
|
|
|
Total interest earning assets |
|
|
17,548,387 |
|
|
|
13,272,426 |
|
|
|
10,107,566 |
|
Total non-earning assets (1) |
|
|
452,652 |
|
|
|
348,712 |
|
|
|
314,857 |
|
|
|
|
|
|
|
|
|
|
|
Total assets |
|
$ |
18,001,039 |
|
|
$ |
13,621,138 |
|
|
$ |
10,422,423 |
|
|
|
|
|
|
|
|
|
|
|
Liabilities and
stockholders’ equity |
|
|
|
|
|
|
|
|
|
|
|
|
Interest bearing liabilities: |
|
|
|
|
|
|
|
|
|
|
|
|
Interest bearing checking
accounts |
|
$ |
376,360 |
|
|
$ |
317,634 |
|
|
$ |
259,438 |
|
Savings accounts |
|
|
1,092,938 |
|
|
|
1,020,228 |
|
|
|
922,875 |
|
Certificates of deposit |
|
|
8,386,463 |
|
|
|
5,065,390 |
|
|
|
4,133,919 |
|
|
|
|
|
|
|
|
|
|
|
Interest bearing deposits |
|
|
9,855,761 |
|
|
|
6,403,252 |
|
|
|
5,316,232 |
|
Other borrowed funds |
|
|
5,001,384 |
|
|
|
4,235,215 |
|
|
|
2,964,417 |
|
FHLB advances |
|
|
890,680 |
|
|
|
1,056,325 |
|
|
|
633,693 |
|
|
|
|
|
|
|
|
|
|
|
Total interest bearing
liabilities |
|
|
15,747,825 |
|
|
|
11,694,792 |
|
|
|
8,914,342 |
|
Total non-interest bearing
liabilities |
|
|
976,705 |
|
|
|
799,114 |
|
|
|
607,557 |
|
|
|
|
|
|
|
|
|
|
|
Total liabilities |
|
|
16,724,530 |
|
|
|
12,493,906 |
|
|
|
9,521,899 |
|
Stockholders’ equity: |
|
|
|
|
|
|
|
|
|
|
|
|
Preferred stock |
|
|
550,100 |
|
|
|
550,100 |
|
|
|
408,809 |
|
Common stockholders’ equity |
|
|
726,409 |
|
|
|
577,132 |
|
|
|
491,715 |
|
|
|
|
|
|
|
|
|
|
|
Stockholders’ equity |
|
|
1,276,509 |
|
|
|
1,127,232 |
|
|
|
900,524 |
|
|
|
|
|
|
|
|
|
|
|
Total liabilities and
stockholders’ equity |
|
$ |
18,001,039 |
|
|
$ |
13,621,138 |
|
|
$ |
10,422,423 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| (1) |
|
Includes the allowance for loan losses and the valuation on investment securities available-for-sale. |
Assets
The Corporation’s total assets at December 31, 2005 amounted to $19.9 billion, $4.3 billion
over the $15.6 billion at December 31, 2004; the increase is mainly attributable to significant
increases in the Corporation’s loan portfolios and to the leveraged growth of the Corporation’s
investment portfolio.
As previously discussed on March 31, 2005 the Corporation completed
the acquisition of Ponce General, the holding company of First Bank
Florida. Total assets acquired amounted to approximately $546.2
million. Loans amounted to approximately $476.0 million and deposits
$439.1 million. The purchase price resulted in a premium of
approximately $36 million. The Corporation recognized goodwill of
$19 million and core deposit intangibles of
$17 million as part of the purchase price
allocation.
63
Loans Receivable
The following table presents the composition of the loan portfolio including loans held for
sale at year-end for each of the last five years.
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
% of |
|
|
|
|
|
|
% of |
|
|
|
|
|
|
% of |
|
|
|
|
|
|
% of |
|
|
|
|
|
|
% of |
|
| December 31, |
|
2005 |
|
|
Total |
|
|
2004 |
|
|
Total |
|
|
2003 |
|
|
Total |
|
|
2002 |
|
|
Total |
|
|
2001 |
|
|
Total |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Dollars in thousands) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Residential real
estate loans |
|
$ |
2,346,945 |
|
|
|
18 |
% |
|
$ |
1,322,650 |
|
|
|
14 |
% |
|
$ |
1,023,188 |
|
|
|
15 |
% |
|
$ |
896,252 |
|
|
|
16 |
% |
|
$ |
542,679 |
|
|
|
13 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial real
estate loans |
|
|
1,090,193 |
|
|
|
9 |
% |
|
|
690,900 |
|
|
|
7 |
% |
|
|
683,766 |
|
|
|
10 |
% |
|
|
651,798 |
|
|
|
11 |
% |
|
|
602,922 |
|
|
|
14 |
% |
Construction loans |
|
|
1,137,118 |
|
|
|
9 |
% |
|
|
398,453 |
|
|
|
4 |
% |
|
|
328,175 |
|
|
|
5 |
% |
|
|
259,052 |
|
|
|
5 |
% |
|
|
219,396 |
|
|
|
5 |
% |
Commercial loans |
|
|
2,421,219 |
|
|
|
19 |
% |
|
|
1,871,851 |
|
|
|
19 |
% |
|
|
1,623,964 |
|
|
|
23 |
% |
|
|
1,427,086 |
|
|
|
25 |
% |
|
|
1,245,443 |
|
|
|
29 |
% |
Commercial loans to local financial institutions
collateralized by real estate mortgages
and pass-through trust certificates |
|
|
3,676,314 |
|
|
|
29 |
% |
|
|
3,841,908 |
|
|
|
40 |
% |
|
|
2,061,437 |
|
|
|
29 |
% |
|
|
1,119,532 |
|
|
|
20 |
% |
|
|
555,228 |
|
|
|
13 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total commercial |
|
|
8,324,844 |
|
|
|
66 |
% |
|
|
6,803,112 |
|
|
|
70 |
% |
|
|
4,697,342 |
|
|
|
67 |
% |
|
|
3,457,468 |
|
|
|
61 |
% |
|
|
2,622,989 |
|
|
|
61 |
% |
Finance leases |
|
|
280,571 |
|
|
|
2 |
% |
|
|
212,234 |
|
|
|
2 |
% |
|
|
159,696 |
|
|
|
2 |
% |
|
|
142,421 |
|
|
|
3 |
% |
|
|
127,494 |
|
|
|
3 |
% |
Consumer loans |
|
|
1,733,569 |
|
|
|
14 |
% |
|
|
1,359,998 |
|
|
|
14 |
% |
|
|
1,160,829 |
|
|
|
16 |
% |
|
|
1,138,882 |
|
|
|
20 |
% |
|
|
1,013,801 |
|
|
|
23 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
12,685,929 |
|
|
|
100 |
% |
|
$ |
9,697,994 |
|
|
|
100 |
% |
|
$ |
7,041,055 |
|
|
|
100 |
% |
|
$ |
5,635,023 |
|
|
|
100 |
% |
|
$ |
4,306,963 |
|
|
|
100 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Lending Activities
Total
loans receivable increased by $3.0 billion in 2005 when compared
to 2004. As shown in
the table above, the 2005 loan portfolio was comprised of commercial (66%), residential real estate
(18%), and consumer and finance leases (16%). Of the total loans of $12.7 billion for 2005,
approximately 84% have credit risk concentration in Puerto Rico, 10% in Florida (USA) and 6% in the
Virgin Islands.
Residential Real Estate Loans
During
2005, the Corporation’s residential mortgage loans originations continued to be driven
by FirstMortgage, the mortgage loan origination subsidiary. The Corporation continued to commit
substantial resources to this operation with the goal of becoming a leading institution in the
highly competitive residential mortgage loans market. As a result, residential real estate loans
represent 21% of total loans originated and purchased for 2005, with the residential mortgage loans
balance increasing $1.0 billion, from $1.3 billion
in 2004 to $2.3 billion in 2005. At December 31, 2005,
residential real estate loans include $256 million from
FirstBank Florida. The Corporation’s strategy is to penetrate markets by providing customers with a
variety of high quality mortgage products.
Commercial Loans
In recent years, the Corporation has emphasized commercial lending activities and continues to
penetrate this market. A substantial
portion of this portfolio is collateralized by real estate. As a result, total commercial loans
originated amounted to $4.0 billion for 2005, for total commercial loans of $8.3 billion at December 31, 2005.
The Corporation’s subsidiary bank loan agency in Coral Gables accounted for a substantial portion
of the construction loans increase during 2005. The total loans receivable by the agency increased
from $13.4 million at December 31, 2004 to $671.6 million at December 31, 2005. The majority of
the loans held by the agency are
construction loans collateralized by real estate collateral.
Commercial loans at December 31, 2005 include $320 million
from FirstBank Florida, composed primarily of $288 million of
commercial mortgage loans.
Although commercial loans involve greater credit risk because they are larger in size and more
risk is concentrated in a single borrower, the Corporation has and continues to develop an
effective credit risk management infrastructure that mitigates potential losses associated with
commercial lending,
64
including strong underwriting and loan review functions, sales of loan
participations, and continuous monitoring of concentrations within portfolios.
The Corporation’s commercial loans are primarily variable and adjustable rate loans.
Commercial loan originations come from existing customers as well as through referrals and direct
solicitations. The Corporation follows a strategy aimed to cater customer needs in the
commercial loans middle market segment.
The Corporation has a significant lending concentration of $3.1 billion in one mortgage
originator in Puerto Rico, Doral Financial Corporation, at December 31, 2005. The Corporation has outstanding
$596.7 million with another mortgage originator in Puerto Rico,
R&G Financial Corporation, for total loans
to mortgage originators amounting to $3.7 billion at December 31, 2005. These commercial
loans are secured by 41,038 individual mortgage loans on residential and commercial real estate
with an average principal balance of $89,776 each. The mortgage originators have always paid the
loans in accordance with their terms and conditions. In December 2005, the Corporation obtained a
waiver from the Office of the Commissioner of Financial Institutions of the Commonwealth of Puerto
Rico with respect to the statutory limit for individual borrowers (loan to one borrower limit). In
May 2006, FirstBank Puerto Rico received a cash payment from Doral Financial Corporation of
approximately $2.4 billion, substantially reducing the balance of the secured commercial loan to
that institution. In addition, during the fourth quarter of 2005, FirstBank
Puerto Rico received a partial payment from R&G Financial
Corporation of $137 million for its secured
commercial loans. As part
of the Cease and Desist Order imposed on the Corporation by its regulators the Corporation has
continued working on the reduction of these exposures with both financial institutions.
Consumer Loans
Consumer lending has increased by $373.6 million in 2005 when compared to 2004, mainly
driven by auto loan originations. Management finds the auto market attractive; the growth of this
portfolio has been achieved through a strategy of providing outstanding service to selected auto
dealers who provide the channel for the bulk of the Corporation’s auto loan originations.
The above mentioned strategy is directly linked to our commercial lending activities as the
Corporation maintains strong and stable auto floor plan relationships, which is the foundation of a
successful auto loan generation operation. The Corporation will continue to strengthen the
commercial relations with floor plan dealers, which directly benefit the Corporation’s consumer
lending operation.
Personal loans, and to a lesser extent marine financing and a small credit card portfolio also
contribute to interest income generated from consumer lending. Management plans to continue to be
active in the consumer loan market applying the Corporation’s strict underwriting standards.
Finance Leases
Finance leases, which are mostly composed of loans to individuals to finance the acquisition
of an auto, increased by $68.3 million in 2005.
65
The following table sets forth certain additional data related to the Corporation’s loan
portfolio net of the allowance for loan losses for the dates indicated:
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
For the year ended December 31, |
|
| |
|
2005 |
|
|
2004 |
|
|
2003 |
|
|
2002 |
|
|
2001 |
|
| |
|
(Dollars in thousands) |
|
Beginning balance |
|
$ |
9,556,958 |
|
|
$ |
6,914,677 |
|
|
$ |
5,523,111 |
|
|
$ |
4,215,903 |
|
|
$ |
3,419,520 |
|
Residential real estate loans originated
and purchased |
|
|
1,372,490 |
|
|
|
765,486 |
|
|
|
546,703 |
|
|
|
265,599 |
|
|
|
271,062 |
|
Construction loans originated and purchased |
|
|
1,061,773 |
|
|
|
309,053 |
|
|
|
259,684 |
|
|
|
161,933 |
|
|
|
110,929 |
|
Commercial loans originated and
purchased |
|
|
2,289,148 |
|
|
|
1,020,753 |
|
|
|
924,712 |
|
|
|
581,302 |
|
|
|
747,300 |
|
Commercial
loans disbursed to local financial institutions
|
|
|
681,407 |
|
|
|
2,228,056 |
|
|
|
1,258,782 |
|
|
|
726,250 |
|
|
|
376,042 |
|
Finance leases originated |
|
|
145,808 |
|
|
|
116,200 |
|
|
|
67,332 |
|
|
|
54,750 |
|
|
|
45,094 |
|
Consumer loans originated and purchased |
|
|
992,942 |
|
|
|
746,113 |
|
|
|
583,083 |
|
|
|
443,154 |
|
|
|
363,170 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total loans originated and purchased(1) |
|
|
6,543,568 |
|
|
|
5,185,661 |
|
|
|
3,640,296 |
|
|
|
2,232,988 |
|
|
|
1,913,597 |
|
Sales and securitizations of loans |
|
|
(118,527 |
) |
|
|
(180,818 |
) |
|
|
(228,824 |
) |
|
|
(80,446 |
) |
|
|
(41,060 |
) |
Repayments and prepayments |
|
|
(3,810,346 |
) |
|
|
(2,258,180 |
) |
|
|
(1,928,726 |
) |
|
|
(747,986 |
) |
|
|
(985,500 |
) |
Other increases (decreases)(2)(3) |
|
|
366,277 |
|
|
|
(104,382 |
) |
|
|
(91,180 |
) |
|
|
(97,348 |
) |
|
|
(90,654 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net increase |
|
|
2,980,972 |
|
|
|
2,642,281 |
|
|
|
1,391,566 |
|
|
|
1,307,208 |
|
|
|
796,383 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ending balance |
|
$ |
12,537,930 |
|
|
$ |
9,556,958 |
|
|
$ |
6,914,677 |
|
|
$ |
5,523,111 |
|
|
$ |
4,215,903 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Percentage increase |
|
|
31.19 |
% |
|
|
38.21 |
% |
|
|
25.20 |
% |
|
|
31.01 |
% |
|
|
23.29 |
% |
|
|
|
| (1) |
|
Loan origination for 2002 includes $435 million acquired from JPMorgan Chase VI. |
| |
| (2) |
|
Includes the change in the allowance for loan losses and cancellation of loans due to
the repossession of the collateral. |
| |
| (3) |
|
Includes $470 million of loans acquired from Ponce General. |
Investment Activities
The Corporation’s investment portfolio at December 31, 2005 amounted to $6.7 billion, an
increase of $1.1 billion when compared with the investment portfolio of $5.6 billion at December
31, 2004. The increase in investment securities resulted mainly from the purchase of government
agency, U.S. Treasury securities and mortgage-backed securities at higher yields. These purchases
contributed to increases in the Corporation’s interest income both because of higher average
balances in 2005 as compared to 2004 and higher coupon rates.
Total purchases of investments securities, excluding those invested short-term (money market
investments), during 2005 amounted to approximately $3.0 billion and were composed mainly of
mortgage-backed securities in the amount of $793.4 million with a weighted average coupon of 5.13%
and government agency securities and U.S. Treasury securities in the amount of $2.2 billion and a
weighted average coupon of 5.53%. Total investment securities called during 2005 amounted to $1.5
billion, these were mainly agency securities.
66
The following table presents the carrying value of investments at December 31, 2005 and 2004:
| |
|
|
|
|
|
|
|
|
| |
|
2005 |
|
|
2004 |
|
| |
|
(Dollars in thousands) |
|
Money market investments |
|
$ |
1,273,759 |
|
|
$ |
920,764 |
|
|
|
|
|
|
|
|
|
|
Investment securities held-to-maturity: |
|
|
|
|
|
|
|
|
U.S. Government and agencies obligations |
|
|
2,190,714 |
|
|
|
1,822,262 |
|
Puerto Rico Government obligations |
|
|
14,163 |
|
|
|
13,643 |
|
Mortgage-backed securities |
|
|
1,233,711 |
|
|
|
1,541,662 |
|
|
|
|
|
|
|
|
|
|
|
3,438,588 |
|
|
|
3,377,567 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment securities available-for-sale: |
|
|
|
|
|
|
|
|
U.S. Government and agencies obligations |
|
|
389,650 |
|
|
|
197,219 |
|
Puerto Rico Government obligations |
|
|
25,006 |
|
|
|
24,961 |
|
Mortgage-backed securities |
|
|
1,478,720 |
|
|
|
995,035 |
|
Corporate bonds |
|
|
25,381 |
|
|
|
44,288 |
|
Equity securities |
|
|
29,421 |
|
|
|
58,092 |
|
|
|
|
|
|
|
|
|
|
|
1,948,178 |
|
|
|
1,319,595 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other equity securities |
|
|
42,368 |
|
|
|
81,275 |
|
|
|
|
|
|
|
|
Total investments |
|
$ |
6,702,893 |
|
|
$ |
5,699,201 |
|
|
|
|
|
|
|
|
Mortgage-backed securities at December 31, 2005 and 2004, consist of:
| |
|
|
|
|
|
|
|
|
| |
|
2005 |
|
|
2004 |
|
| |
|
(Dollars in thousands) |
|
Held-to-maturity: |
|
|
|
|
|
|
|
|
FHLMC certificates |
|
$ |
20,211 |
|
|
$ |
26,579 |
|
FNMA certificates |
|
|
1,213,500 |
|
|
|
1,515,083 |
|
|
|
|
|
|
|
|
|
|
|
1,233,711 |
|
|
|
1,541,662 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Available-for-sale: |
|
|
|
|
|
|
|
|
FHLMC certificates |
|
|
9,962 |
|
|
|
7,917 |
|
GNMA certificates |
|
|
438,881 |
|
|
|
103,576 |
|
FNMA certificates |
|
|
1,029,474 |
|
|
|
883,020 |
|
Mortgage pass-through certificates |
|
|
403 |
|
|
|
522 |
|
|
|
|
|
|
|
|
|
|
|
1,478,720 |
|
|
|
995,035 |
|
|
|
|
|
|
|
|
Total mortgage-backed securities |
|
$ |
2,712,431 |
|
|
$ |
2,536,697 |
|
|
|
|
|
|
|
|
The carrying amount of investment securities classified as available-for-sale and held-to-maturity at December 31, 2005, by contractual maturity (excluding
mortgage-backed securities and money market investments) are shown below:
| |
|
|
|
|
|
|
|
|
| |
|
Carrying amount |
|
|
Weighted average yield % |
|
| |
|
(Dollars in thousands) |
|
U.S. Government and agencies obligations |
|
|
|
|
|
|
|
|
Due within one year |
|
$ |
150,156 |
|
|
|
3.98 |
|
Due after five years through ten years |
|
|
388,650 |
|
|
|
4.27 |
|
Due after ten years |
|
|
2,041,558 |
|
|
|
5.83 |
|
|
|
|
|
|
|
|
|
|
|
2,580,364 |
|
|
|
5.49 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Puerto Rico Government obligations |
|
|
|
|
|
|
|
|
Due after one year through five years |
|
|
9,817 |
|
|
|
5.57 |
|
Due after five years through ten years |
|
|
14,789 |
|
|
|
4.84 |
|
Due after ten years |
|
|
14,563 |
|
|
|
5.92 |
|
|
|
|
|
|
|
|
|
|
|
39,169 |
|
|
|
5.42 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporate bonds |
|
|
|
|
|
|
|
|
Due after one year through five years |
|
|
2,566 |
|
|
|
7.75 |
|
Due after five years through ten years |
|
|
1,882 |
|
|
|
8.09 |
|
Due after ten years |
|
|
20,933 |
|
|
|
7.44 |
|
|
|
|
|
|
|
|
|
|
|
25,381 |
|
|
|
7.52 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
2,644,914 |
|
|
|
5.51 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mortgage-backed securities |
|
|
2,712,431 |
|
|
|
4.77 |
|
Equity securities |
|
|
29,421 |
|
|
|
3.70 |
|
|
|
|
|
|
|
|
Total investment securities |
|
$ |
5,386,766 |
|
|
|
5.13 |
|
|
|
|
|
|
|
|
67
Total proceeds from the sale of securities during the year ended December 31, 2005 amounted to $252.7 million (2004-$131.6 million).
In 2005, the Corporation realized gross gains of $21.4 million (2004 — $12.2 million, 2003 -
$44.5 million), and gross losses of $711 thousand (2004 — $15 thousand, 2003 — $3.1 million).
During the year ended December 31, 2005, the Corporation recognized through earnings
approximately $8.4 million (2004 — $2.7 million, 2003 — $5.8 million) of losses in the investment
securities available-for-sale portfolio that management considered to be other-than-temporarily
impaired. The impairment losses were related to equity securities.
Net interest income of future periods may be affected by the acceleration in prepayments of
mortgage-backed securities. Acceleration in the prepayments of mortgage-backed securities would
lower yields on these securities, as the amortization of premiums paid upon acquisition of these
securities would accelerate. Also, net interest income in future periods might be affected given
substantial investments in callable securities. The book value of the callable securities, mainly agency
securities, amounted to $2.0 billion at December 31, 2005. Lower reinvestment rates and a time
lag between calls, prepayments and/or the maturity of investments and actual reinvestment of
proceeds into new investments, might also affect net interest income. Increases in short-term interest rates may reduce net interest income, when rates rise the Corporation must pay more in interest on its liabilities while the interest earned on its assets, including investments does not rise as quickly. These risks are directly
linked to future period’s market interest rate fluctuations. Refer to the “Quantitative and
Qualitative Disclosures about Market Risk” section of this Management’s Discussion and Analysis for
further analysis of the effects of changing interest rates on the Corporation’s net interest income
and for the interest rate risk management strategies followed by the Corporation.
Investment Securities and Loans Receivable Maturities
The following table presents the maturities of the loan and investment portfolio at December
31, 2005:
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
As of December 31, 2005 |
|
| |
|
Maturities |
|
| |
|
|
|
|
|
After one year through five years |
|
|
After five years |
|
|
|
|
| |
|
One year |
|
|
Fixed interest |
|
|
Variable |
|
|
Fixed interest |
|
|
Variable |
|
|
|
|
| |
|
or less |
|
|
rates |
|
|
interest rates |
|
|
rates |
|
|
interest rates |
|
|
Total |
|
| |
|
|
|
|
|
|
|
|
|
(Dollars in thousands) |
|
|
|
|
|
|
|
|
|
Money market investments |
|
$ |
1,273,759 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
1,273,759 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment securities (1) |
|
|
347,552 |
|
|
$ |
626,284 |
|
|
$ |
783 |
|
|
$ |
4,451,313 |
|
|
$ |
3,202 |
|
|
|
5,429,134 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans (2): |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Residential real estate |
|
|
98,317 |
|
|
|
205,797 |
|
|
|
15,849 |
|
|
|
1,872,688 |
|
|
|
154,294 |
|
|
|
2,346,945 |
|
Construction |
|
|
16,194 |
|
|
|
18,546 |
|
|
|
1,014,850 |
|
|
|
28,061 |
|
|
|
59,467 |
|
|
|
1,137,118 |
|
Commercial and
commercial real estate |
|
|
584,453 |
|
|
|
101,339 |
|
|
|
607,158 |
|
|
|
330,411 |
|
|
|
5,564,365 |
|
|
|
7,187,726 |
|
Lease financing |
|
|
63,634 |
|
|
|
216,937 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
280,571 |
|
Consumer |
|
|
397,954 |
|
|
|
1,231,200 |
|
|
|
8,270 |
|
|
|
50,851 |
|
|
|
45,294 |
|
|
|
1,733,569 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Loans |
|
|
1,160,552 |
|
|
|
1,773,819 |
|
|
|
1,646,127 |
|
|
|
2,282,011 |
|
|
|
5,823,420 |
|
|
|
12,685,929 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
2,781,863 |
|
|
$ |
2,400,103 |
|
|
$ |
1,646,910 |
|
|
$ |
6,733,324 |
|
|
$ |
5,826,622 |
|
|
$ |
19,388,822 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| (1) |
|
Equity securities available-for-sale and other equity securities were included under the “one year or less category”.
|
| |
| (2) |
|
Non-accruing loans were included under the “one year or less category”. |
68
Non-performing Assets
Total non-performing assets are the sum of non-accruing loans and investments, other real
estate owned and other repossessed properties. Non-accruing loans and investments are loans and
investments as to which interest is no longer being recognized. When loans and investments fall
into non-accruing status, all previously accrued and uncollected interest is charged against
interest income.
At December 31, 2005, total non-performing assets amounted to approximately $149.0 million
(0.75% of total assets) as compared to $108.2 million (0.69% of total assets) at December 31, 2004
and $100.8 million (0.79% of total assets) at December 31, 2003. The Corporation’s allowance for
loan losses to non-performing loans was 110.18 % at December 31, 2005 as compared to 153.86% and
147.77% at December 31, 2004 and 2003, respectively.
The following table presents non-performing assets at the dates indicated.
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| December 31, |
|
2005 |
|
|
2004 |
|
|
2003 |
|
|
2002 |
|
|
2001 |
|
| |
|
(Dollars in thousands) |
|
Non-accruing loans: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Residential real estate |
|
$ |
54,777 |
|
|
$ |
31,577 |
|
|
$ |
26,327 |
|
|
$ |
23,018 |
|
|
$ |
18,540 |
|
Commercial, commercial real estate
and construction |
|
|
35,814 |
|
|
|
32,454 |
|
|
|
38,304 |
|
|
|
47,705 |
|
|
|
29,378 |
|
Finance leases |
|
|
3,272 |
|
|
|
2,212 |
|
|
|
3,181 |
|
|
|
2,049 |
|
|
|
2,469 |
|
Consumer |
|
|
40,459 |
|
|
|
25,422 |
|
|
|
17,713 |
|
|
|
18,993 |
|
|
|
22,611 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
134,322 |
|
|
|
91,665 |
|
|
|
85,525 |
|
|
|
91,765 |
|
|
|
72,998 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other real estate owned |
|
|
5,019 |
|
|
|
9,256 |
|
|
|
4,617 |
|
|
|
2,938 |
|
|
|
1,456 |
|
Other repossessed property |
|
|
9,631 |
|
|
|
7,291 |
|
|
|
6,879 |
|
|
|
6,222 |
|
|
|
4,596 |
|
Investment securities |
|
|
— |
|
|
|
— |
|
|
|
3,750 |
|
|
|
3,750 |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total non-performing assets |
|
$ |
148,972 |
|
|
$ |
108,212 |
|
|
$ |
100,771 |
|
|
$ |
104,675 |
|
|
$ |
79,050 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Past due loans |
|
$ |
27,501 |
|
|
$ |
18,359 |
|
|
$ |
23,493 |
|
|
$ |
24,435 |
|
|
$ |
27,497 |
|
Non-performing assets to total assets |
|
|
0.75 |
% |
|
|
0.69 |
% |
|
|
0.79 |
% |
|
|
1.09 |
% |
|
|
0.95 |
% |
Non-performing loans to total loans |
|
|
1.06 |
% |
|
|
0.95 |
% |
|
|
1.21 |
% |
|
|
1.63 |
% |
|
|
1.69 |
% |
Allowance for loan losses |
|
$ |
147,999 |
|
|
$ |
141,036 |
|
|
$ |
126,378 |
|
|
$ |
111,911 |
|
|
$ |
91,060 |
|
Allowance to total non-performing loans |
|
|
110.18 |
% |
|
|
153.86 |
% |
|
|
147.77 |
% |
|
|
121.95 |
% |
|
|
124.74 |
% |
Allowance to total non-performing loans
excluding residential real estate loans |
|
|
186.06 |
% |
|
|
234.72 |
% |
|
|
213.48 |
% |
|
|
162.79 |
% |
|
|
167.21 |
% |
Non-accruing Loans
At December 31, 2005, loans in which the accrual of interest income had been discontinued
amounted to $134.3 million (2004 — $91.7 million; 2003 — $85.5 million). If these loans had been
accruing interest, the additional interest income realized would have been $7.0 million (2004 -
$5.9 million; 2003 — $6.6 million). There are no material commitments to lend additional funds to
borrowers whose loans were in non-accruing status at these dates.
Residential Real Estate Loans – The Corporation classifies real estate loans in non-accruing
status when interest and principal have not been received for a period of 90 days or more. Even
though these loans are in non-accruing status, management considers, based on the value of the
underlying collateral, the loan to value ratios and historical experience, that no material losses
will be incurred in this portfolio, therefore, provisions for this
portfolio are minimal as no material losses have been incurred
historically. Non-accruing residential real estate loans amounted to $54.8 million
(2.33% of total residential real estate loans) at December 31, 2005, as compared to $31.6 million
(2.39% of total residential real estate loans) and $26.3 million (2.57% of total residential real
estate loans) at December 31, 2004 and 2003, respectively. The increase as compared to
69
2004 is
mainly attributable to the general growth of this portfolio. At December 31, 2005 there was one
non-accruing residential mortgage loans in an amount over $1 million.
Commercial Loans – The Corporation places commercial loans (including commercial real estate
and construction loans) in non-accruing status when interest and principal have not been received
for a period of 90 days or more. The risk exposure of this portfolio is diversified as to
individual borrowers and industries among other factors. In addition, a large portion is secured
with real estate collateral. Non-accruing commercial loans amounted to $35.8 million (0.43% of
total commercial loans) at December 31, 2004 as compared to $32.5 million (0.48% of total
commercial loans) and $38.3 million (0.82% of total commercial loans) at December 31, 2004 and
2003, respectively. At December 31, 2005 there were 10 non-accruing commercial loans in amounts
over $1 million, for a total of $21.2 million.
Finance Leases – Finance leases are classified in non-accruing status when interest and
principal have not been received for a period of 90 days or more. Non-accruing finance leases
amounted to $3.3 million (1.17% of total finance leases) at December 31, 2005 as compared to $2.2
million (1.04% of total finance leases) and $3.2 million (1.99% of total finance leases) at
December 31, 2004 and 2003, respectively.
Consumer Loans – Consumer loans are classified in non-accruing status when interest and
principal have not been received for a period of 90 days or more.
Non-accruing consumer loans amounted to $40.5 million (2.33% of the total consumer loan
portfolio) at December 31, 2005, $25.4 million (1.87% of the total consumer loan portfolio) at
December 31, 2004 and $17.7 million (1.53% of the total consumer loan portfolio) at December 31,
2003. The increase as compared to 2004 and 2003 is mainly attributable to the general growth of this
portfolio.
Other Real Estate Owned (OREO)
OREO acquired in settlement of loans is carried at the lower of cost (carrying value of the
loan) or fair value less estimated costs to sell off the real estate (estimated realizable value).
Other Repossessed Property
The other repossessed property category includes repossessed boats and autos acquired in
settlement of loans. Repossessed boats and autos are recorded at the lower of cost or estimated
fair value.
Investment Securities
This category presents investment securities reclassified to non-accruing status, at their
carrying amount.
Past Due Loans
Past due loans are mainly accruing commercial loans, which are contractually delinquent
for 90 days or more. Past due commercial loans are current as to interest but delinquent in the
payment of principal.
Sources of Funds
The Corporation’s principal funding sources are branch-based deposits, brokered CDs,
institutional deposits, federal funds purchased, securities sold under agreements to repurchase,
notes payable and FHLB advances.
70
As of December 31, 2005, total liabilities amounted to $18.7 billion, an increase of $4.3
billion as compared to $14.4 billion as of December 31, 2004. The net increase in total
liabilities was mainly due to a $4.6 billion increase in total deposits, including a $4.2 billion
increase in brokered CDs offset by a decrease of $550.4 million in total borrowings.
The Corporation maintains unsecured standby lines of credit with other banks. At December 31,
2005, the Corporation’s total unused lines of credit with these banks amounted to $370.0 million.
At December 31, 2005, the Corporation had an available line of credit with the FHLB, guaranteed
with excess collateral pledged to the FHLB in the amount of $597.9 million.
Deposits
Total deposits amounted to $12.5 billion at December 31, 2005, as compared to $7.9 billion and
$6.8 billion at December 31, 2004 and 2003, respectively.
The following table presents the composition of total deposits.
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Weighted |
|
|
|
|
|
|
|
|
|
|
|
| |
|
average rates |
|
|
|
|
|
|
December 31, |
|
|
|
|
| |
|
at December 31, 2005 |
|
|
2005 |
|
|
2004 |
|
|
2003 |
|
| |
|
|
|
|
|
|
|
|
|
(Dollars in thousands) |
|
|
|
|
|
Savings accounts |
|
|
1.29 |
% |
|
$ |
1,034,047 |
|
|
$ |
1,077,002 |
|
|
$ |
985,062 |
|
Interest bearing checking accounts |
|
|
1.36 |
% |
|
|
375,305 |
|
|
|
385,078 |
|
|
|
286,584 |
|
Certificates of deposit |
|
|
4.35 |
% |
|
|
10,243,394 |
|
|
|
5,750,660 |
|
|
|
4,953,132 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest bearing deposits |
|
|
3.89 |
% |
|
|
11,652,746 |
|
|
|
7,212,740 |
|
|
|
6,224,778 |
|
Non-interest bearing deposits |
|
|
|
|
|
|
811,006 |
|
|
|
699,582 |
|
|
|
547,091 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
|
|
|
$ |
12,463,752 |
|
|
$ |
7,912,322 |
|
|
$ |
6,771,869 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest bearing deposits: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average balance outstanding |
|
|
|
|
|
$ |
9,855,761 |
|
|
$ |
6,403,252 |
|
|
$ |
5,316,232 |
|
Non-interest bearing deposits: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average balance outstanding |
|
|
|
|
|
$ |
791,815 |
|
|
$ |
645,512 |
|
|
$ |
520,902 |
|
Weighted average rate during the
period on interest bearing deposits(1) |
|
|
|
|
|
|
3.29 |
% |
|
|
2.08 |
% |
|
|
2.31 |
% |
|
|
|
| (1) |
|
Excludes changes in the fair value of interest rate swaps. |
Total deposits are composed of branch-based deposits, brokered CDs and, to a lesser
extent of institutional deposits. Institutional deposits include, among others, certificates
issued to agencies of the Government of Puerto Rico and to Government agencies in the Virgin
Islands.
Total deposits increased by $4.6 billion at December 31, 2005 when compared to December 31,
2004 mainly due to an increase in brokered CDs. Brokered CDs, which are certificates sold through
brokers, amounted to $8.6 billion at December 31, 2005. The total U.S. market for this source of funding approximates $480
billion. The use of brokered CDs has been particularly important to the growth of the Corporation.
The Corporation encounters intense competition in attracting and retaining deposits, as financial
institutions are at a competitive disadvantage since the income generated on other investment
products available to investors in Puerto Rico is taxed at lower rates than tax rates for income
generated on deposit products. The brokered CDs market is a very competitive and liquid market in
which the Corporation has been able to obtain substantial amounts of funding in short periods of
time. This strategy enhanced the Corporation’s liquidity
position, since the brokered CDs
are unsecured and can be obtained at substantially longer maturities than other regular retail
deposits. Also the Corporation has the ability to convert the fixed
rate brokered CDs to
short-term adjustable rate liabilities using interest rate swap agreements. Refer to the
71
“Derivative Activities” section of this Management’s
Discussion and Analysis for further discussion on interest rate risk management strategies followed
by the Corporation.
At December 31, 2005, 54% of the value of retail brokered CDs held by the Corporation were
long-term fixed callable certificates, but only at the Corporation’s option. At December 31, 2005,
the average remaining maturity of long-term callable brokered certificates of deposit approximated
11.60 years (2004 – 13.44 years) and of short-term fixed brokered certificates of deposits
approximated 0.39 years (2004 – 1.27 years). When
using interest rate swaps, the Corporation mainly hedges those
brokered CDs with long-term maturities.
During
2005, the Corporation’s brokered CDs increased significantly.
Significant amounts of short-term brokered CDs were issued to fund the
Corporation’s growth and to replace advances from the Federal Home Loan Bank as these matured since
the collateral for these funds was under evaluation by the FHLB.
During 2005, the FHLB evaluated the eligibility of collateral that
secured the commercial loans to local financial institutions and
concluded that such collateral was not eligible to secure advances
from the FHLB. The rate of the short-term brokered CDs approximated long-term rates given the flat to inverted yield curve. During 2006, the
funds received from the paydown of approximately $2.4 billion
from Doral Financial in May 2006 were used
to paydown substantial amounts of short-term brokered CDs entered in 2005 as these matured in 2006.
The following table presents a maturity summary of certificates of deposit with balances of
$100,000 or more at December 31, 2005:
| |
|
|
|
|
| |
|
(Dollars in thousands) |
|
Three months or less |
|
$ |
1,985,583 |
|
Over three months to six months |
|
|
1,306,047 |
|
Over six months to one year |
|
|
1,387,890 |
|
Over one year |
|
|
4,869,384 |
|
|
|
|
|
Total |
|
$ |
9,548,904 |
|
|
|
|
|
Borrowings
At December 31, 2005 total borrowings amounted to $5.8 billion as compared to $6.3 billion and
$4.6 billion at December 31, 2004 and 2003, respectively.
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Weighted average rates |
|
|
December 31, |
|
| |
|
at December 31, 2005 |
|
|
2005 |
|
|
2004 |
|
|
2003 |
|
| |
|
|
|
|
|
|
|
|
(Dollars in thousands) |
|
|
|
|
|
Federal funds purchased and securities
sold under agreements to repurchase |
|
|
4.31 |
% |
|
$ |
4,833,882 |
|
|
$ |
4,165,361 |
|
|
$ |
3,639,472 |
|
Advances from FHLB |
|
|
4.45 |
% |
|
|
506,000 |
|
|
|
1,598,000 |
|
|
|
913,000 |
|
Notes payable |
|
|
4.43 |
% |
|
|
178,693 |
|
|
|
178,240 |
|
|
|
— |
|
Other borrowings |
|
|
7.11 |
% |
|
|
231,622 |
|
|
|
276,692 |
|
|
|
— |
|
Subordinated notes |
|
|
|
|
|
|
— |
|
|
|
82,280 |
|
|
|
81,765 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
4.44 |
% |
|
$ |
5,750,197 |
|
|
$ |
6,300,573 |
|
|
$ |
4,634,237 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average rate during the period |
|
|
|
|
|
|
4.08 |
% |
|
|
3.26 |
% |
|
|
3.68 |
% |
The
Corporation uses federal funds purchased, repurchase agreements,
advances from the Federal Home Loan Bank (FHLB),
notes payable and other borrowings, such as trust preferred securities, as additional funding
sources.
72
The leveraged growth of the Corporation’s investment portfolio is substantially funded with
repurchase agreements. One of the Corporation’s most important interest rate risk protection
strategies is the use of structured repurchase agreements, which are generally used to fund
purchases of mortgage-backed and governmental agency securities. Under these agreements, the
Corporation attempts to reduce exposure to interest rate risk by lengthening the final maturities
of its liabilities while keeping funding cost low. As of December 31, 2005, the outstanding
balance of structured repurchase agreements was $3.2 billion.
FirstBank is a member of the FHLB system and obtains advances to fund
its operations under a collateral agreement with the FHLB that requires the Bank to maintain
minimum qualifying mortgages as collateral for advances taken.
During 2004, the Corporation undertook several financing transactions to diversify its funding
sources. FirstBank, the Corporation’s bank subsidiary, issued notes payable that as of December
31, 2005 had an outstanding balance of $178.7 million.
In the second quarter of 2004, FBP Statutory Trust I, a statutory trust that is wholly owned
by the Corporation and not consolidated in the Corporation’s financial statements, sold to
institutional investors
$100 million of its variable rate trust preferred securities. The proceeds of the issuance,
together with the proceeds of the purchase by the Corporation of $3.1 million of FBP Statutory
Trust I variable rate common securities, were used to purchase $103.1 million aggregate principal
amount of the Corporation’s Junior Subordinated Deferrable Debentures.
In the third quarter of 2004, FBP Statutory Trust II, a statutory trust that is wholly-owned
by the Corporation and not consolidated in the Corporation’s financial statements, sold to
institutional investors $125 million of its variable rate trust preferred securities. The proceeds
of the issuance, together with the proceeds of the purchase by the Corporation of $3.9 million of
FBP Statutory Trust II variable rate common securities, were used to purchase $128.9 million
aggregate principal amount of the Corporation’s Junior Subordinated Deferrable Debentures.
The Trust Preferred debentures are presented in the Corporation’s Consolidated Statement of
Financial Condition as Other Borrowings, net of related issuance costs. The variable rate trust
preferred securities are fully and unconditionally guaranteed by the Corporation. The $100 million
Junior Subordinated Deferrable Debentures issued by the Corporation in April 2004 and the $125
million issued in September 2004, mature on September 17, 2034 and September 20, 2034,
respectively; however, under certain circumstances, the maturity of Junior Subordinated Debentures
may be shortened (which shortening would result in a mandatory redemption of the variable rate
trust preferred securities). The trust preferred securities, subject to certain limitations,
qualify as Tier I regulatory capital under current Federal Reserve rules and regulations.
The composition and estimated weighted average interest rates of interest bearing liabilities
at December 31, 2005, were as follows:
| |
|
|
|
|
|
|
|
|
| |
|
Amount |
|
|
Weighted |
|
| |
|
(Dollars in thousands) |
|
|
Average Rate |
|
Interest bearing deposits |
|
$ |
11,652,746 |
|
|
|
3.89 |
% |
Borrowed funds |
|
|
5,750,197 |
|
|
|
4.44 |
% |
|
|
|
|
|
|
|
|
|
|
$ |
17,402,943 |
|
|
|
4.07 |
% |
|
|
|
|
|
|
|
|
The
weighted average interest rate on interest bearing deposits excludes the changes in the fair value
of interest rate swaps.
73
Derivative Activities
First BanCorp uses derivative instruments and other strategies to manage its exposure to
interest rate risk caused by changes in interest rates beyond management’s control. The
Corporation’s asset liability management program includes the use of derivatives instruments, which
have worked effectively to date, and that management believes will continue to be effective in the
future.
The following summarizes major strategies, including derivatives activities, used by the
Corporation in managing interest rate risk:
Interest rate swaps — Under interest rate swap agreements, the Corporation agrees with other
parties to exchange, at specified intervals, the difference between fixed-rate and floating-rate
interest rate amounts calculated by reference to an agreed notional principal amount. Since a
substantial portion of the Corporation’s loans, mainly commercial loans, yield variable rates, the
interest rate swaps are utilized to
convert fixed-rate brokered certificates of deposit (liabilities), mainly those with long-term maturities, to a variable rate to better
match the variable rate nature of these loans.
Interest rate cap agreements — In order to hedge risk inherent on certain commercial loans to
other financial institutions, as the yield is a variable rate limited to the weighted-average
coupon of the referenced residential mortgage collateral, less a contractual servicing fee, the
Corporation enters into referenced interest rate cap agreements that provide protection against
rising interest rates. In managing this risk, the Corporation determines the need of derivatives,
including cap agreements, based on different rising interest rate scenario projections and the
weighted-average coupon of the referenced residential mortgage loan pools.
Structured repurchase agreements — The Corporation uses structured repurchase agreements, with
embedded call options, with the intention of reducing the Corporation’s exposure to interest rate
risk by lengthening the contractual maturities of its liabilities, while keeping funding costs low.
Another type of structured repurchase agreement includes repurchased agreements with embedded cap
corridors; these instruments also provide protection for a rising rate scenario.
The following table summarizes the notional amount of all derivative instruments as of
December 31, 2005 and 2004:
| |
|
|
|
|
|
|
|
|
| |
|
Notional Amount |
|
| |
|
December 31, |
|
| |
|
2005 |
|
|
2004 |
|
| |
|
(Dollars in thousands) |
|
Interest rate swap agreements: |
|
|
|
|
|
|
|
|
Pay fixed versus receive floating |
|
$ |
109,320 |
|
|
$ |
113,165 |
|
Receive fixed versus pay floating |
|
|
5,751,128 |
|
|
|
4,118,615 |
|
Embedded written options |
|
|
13,515 |
|
|
|
13,515 |
|
Purchased options |
|
|
13,515 |
|
|
|
13,515 |
|
Written interest rate cap agreements |
|
|
150,200 |
|
|
|
25,000 |
|
Purchased interest rate cap agreements |
|
|
386,750 |
|
|
|
250,043 |
|
|
|
|
|
|
|
|
|
|
$ |
6,424,428 |
|
|
$ |
4,533,853 |
|
|
|
|
|
|
|
|
The majority of the Corporation’s derivatives represent interest rate swaps used mainly to
convert long-term fixed-rate brokered CDs to a variable rate. A summary of the types at
December 31, 2005 and 2004 follows:
74
| |
|
|
|
|
|
|
|
|
| |
|
December 31, |
| |
|
2005 |
|
2004 |
| |
|
(Dollars in thousands) |
Pay fixed/receive floating: |
|
|
|
|
|
|
|
|
Notional amount |
|
$ |
109,320 |
|
|
$ |
113,165 |
|
Weighted average receive rate at year end |
|
|
6.41 |
% |
|
|
4.39 |
% |
Weighted average pay rate at year end |
|
|
6.60 |
% |
|
|
6.97 |
% |
Floating rates range from 175 to 252 basis points over LIBOR rate |
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
| |
|
December 31, |
| |
|
2005 |
|
2004 |
| |
|
(Dollars in thousands) |
Receive fixed/pay floating: |
|
|
|
|
|
|
|
|
Notional amount |
|
$ |
5,751,128 |
|
|
$ |
4,118,615 |
|
Weighted average receive rate at year end |
|
|
4.90 |
% |
|
|
5.17 |
% |
Weighted average pay rate at year end |
|
|
4.37 |
% |
|
|
2.33 |
% |
Floating rates range from minus 5 basis points to 20 basis points over LIBOR rate |
|
|
|
|
|
|
|
|
The changes in notional amount of interest rate swaps outstanding during the years ended
December 31, 2005 and 2004 follows:
| |
|
|
|
|
| |
|
Notional amount |
|
| |
|
(Dollars in thousands) |
|
Pay-fixed and receive-floating swaps: |
|
|
|
|
Balance at December 31, 2003 |
|
$ |
118,165 |
|
Canceled and matured contracts |
|
|
(5,000 |
) |
|
|
|
|
Balance
at December 31, 2004 |
|
|
113,165 |
|
Canceled and matured contracts |
|
|
(44,565 |
) |
New contracts |
|
|
40,720 |
|
|
|
|
|
Balance at December 31, 2005 |
|
$ |
109,320 |
|
|
|
|
|
|
|
|
|
|
Receive-fixed and pay floating swaps: |
|
|
|
|
Balance at December 31, 2003 |
|
$ |
2,872,372 |
|
Canceled and matured contracts |
|
|
(849,473 |
) |
New contracts |
|
|
2,095,716 |
|
|
|
|
|
Balance at December 31, 2004 |
|
|
4,118,615 |
|
Canceled and matured contracts |
|
|
(549,302 |
) |
New contracts |
|
|
2,181,815 |
|
|
|
|
|
Balance at December 31, 2005 |
|
$ |
5,751,128 |
|
|
|
|
|
The cumulative valuation of interest rate swaps at December 31, 2005 and 2004 was $(153.1)
million and $(68.3) million, respectively. None of these instruments were qualified for hedge
accounting in 2005 and 2004. Effective April 2006, the Corporation designated the majority of
interest rate swap instruments (98% of the interest rate swaps outstanding) under the long-haul
method of hedge accounting. Going forward, the Corporation will be able to offset changes in the
fair value of the interest rate swaps with changes in the fair value of hedged brokered
CDs, therefore, earnings volatility will be reduced.
75
Contractual Obligations and Commitments
The following table presents a detail of the maturities of the Corporation’s contractual
obligations and commitments, which consists of certificates of deposits, long-term contractual debt
obligations, operating leases, other contractual obligations, commitments to purchase loans and
commitments to extend credit:
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Contractual Obligations and Commitments |
|
| |
|
(Dollars in thousands) |
|
| |
|
Total |
|
|
Less than 1 year |
|
|
1-3 years |
|
|
4-5 years |
|
|
After 5 years |
|
Contractual obligations: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Certificates of deposit |
|
$ |
10,243,394 |
|
|
$ |
5,173,408 |
|
|
$ |
852,718 |
|
|
$ |
276,860 |
|
|
$ |
3,940,408 |
|
Federal funds purchased and
securities sold under agreements
to repurchase |
|
|
4,833,882 |
|
|
|
1,677,922 |
|
|
|
900,000 |
|
|
|
387,500 |
|
|
|
1,868,460 |
|
Advances from FHLB |
|
|
506,000 |
|
|
|
223,000 |
|
|
|
39,000 |
|
|
|
— |
|
|
|
244,000 |
|
Notes payable |
|
|
178,693 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
178,693 |
|
Other borrowings |
|
|
231,622 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
231,622 |
|
Operating leases |
|
|
51,378 |
|
|
|
8,077 |
|
|
|
19,051 |
|
|
|
3,857 |
|
|
|
20,393 |
|
Other contractual obligations |
|
|
9,201 |
|
|
|
3,423 |
|
|
|
4,375 |
|
|
|
744 |
|
|
|
659 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total contractual obligations |
|
$ |
16,054,170 |
|
|
$ |
7,085,830 |
|
|
$ |
1,815,144 |
|
|
$ |
668,961 |
|
|
$ |
6,484,235 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commitments to purchase mortgage loans |
|
$ |
1,650,000 |
|
|
$ |
1,650,000 |
(1) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commitments to sell mortgage loans |
|
$ |
50,000 |
|
|
$ |
50,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Standby letters of credit |
|
$ |
136,502 |
|
|
$ |
136,502 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other commitments |
|
$ |
5,000 |
|
|
$ |
5,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commitments to extend credit: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Lines of credit |
|
$ |
1,192,855 |
|
|
$ |
1,192,855 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Letters of credit |
|
|
77,122 |
|
|
|
77,122 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Commitments to originate loans |
|
|
619,943 |
|
|
|
619,943 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total commercial commitments |
|
$ |
1,889,920 |
|
|
$ |
1,889,920 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| (1) |
|
Represents Commitments to Purchase Mortgage Loans from Doral which were subsequently
cancelled in 2006. |
The Corporation has obligations and commitments to make future payments under contracts,
such as debt and lease agreements, and under other commitments to purchase and sell loans and to
extend credit. 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. Other contractual obligations result
mainly from contracts for rental and maintenance of equipment. Since certain commitments are
expected to expire without being drawn upon, the total commitment amount does not necessarily
represent future cash requirements. For credit cards and personal lines of credit, the Corporation
can at any time and without cause, cancel the unused credit facility.
On March 31, 2005, the Corporation completed the acquisition of 100% of the outstanding common
shares of Ponce General Corporation, the holding company of Unibank
(later renamed FirstBank Florida) and Ponce Realty, both of which
were based in Miami, Florida. At December 31, 2005, obligations transferred upon the closing of the
acquisition are presented on the contractual obligations.
Capital
The Corporation’s capital amounted to $1.2 billion at December 31, 2005 and 2004. Total
capital decreased by $6.5 million. The change in capital for
2005 is composed of increases due to earnings of $114.6 million
and the issuance of 76,373
shares of common stock through the exercise of stock options with
proceeds of $2.1 million, which were offset by
cash dividends of $62.9 million and by a negative non-cash valuation of securities
available-for-sale of $59.3 million.
As of December 31, 2005,
First BanCorp, FirstBank and FirstBank Florida were in compliance
with regulatory capital requirements that were applicable to them as a financial holding company,
a state non-member bank and a thrift, respectively (i.e., total capital and Tier 1 capital to risk-weighted
assets of at least 8% and 4%, respectively, and Tier 1 capital to average assets of at least 4%).
Set forth below are First BanCorp,
76
FirstBank
and FirstBank Florida’s regulatory capital ratios as
of December 31, 2005, based on existing Federal Reserve and FDIC guidelines
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
First BanCorp Banking Subsidiary |
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
Well- |
| |
|
|
|
|
|
|
|
|
|
FirstBank |
|
Capitalized |
| |
|
First BanCorp |
|
FirstBank |
|
Florida |
|
Minimum |
Total capital (Total capital to risk-weighted assets) |
|
|
10.72 |
% |
|
|
10.89 |
% |
|
|
10.97 |
% |
|
|
10.00 |
% |
Tier 1 capital ratio (Tier 1 capital to
risk-weighted assets) |
|
|
9.71 |
% |
|
|
9.85 |
% |
|
|
10.65 |
% |
|
|
6.00 |
% |
Leverage ratio |
|
|
6.72 |
% |
|
|
6.78 |
% |
|
|
7.99 |
% |
|
|
5.00 |
% |
As of December 31, 2005, FirstBank was considered a well-capitalized bank for purposes of
the prompt corrective action regulations adopted by the FDIC.
The regulatory capital ratios for 2005 were significantly impacted by decreases in net income
from legal contingencies accrued and from the negative impact of changes in the fair value of
interest rate swaps for the period. The capital ratios improved significantly subsequent to
December 31, 2005 as a result of the $2.4 billion paydown received from Doral Financial during 2006
on the loans receivable which as commercial loans carry a 100%
regulatory capital risk weight when calculating capital
ratios.
Dividends
In 2005, 2004 and 2003 the Corporation declared four quarterly cash dividends of $0.07, $0.06
and $0.06 per common share outstanding, respectively, for an annual dividend of $0.28, $0.24 and
$0.22, respectively. Total cash dividends paid on common shares amounted to $22.6 million for 2005
(or a 30.46% dividend payout ratio), $19.3 million for 2004 (or a 14.10% dividend payout ratio) and
$17.6 million for 2003 (or a 19.66% dividend payout ratio). Dividends declared on preferred stock
amounted to $40.3 million in 2005 and 2004, and $30.4 million in 2003. The increase in preferred
stock dividends in 2004 is attributable to the issuance of 7,584,000 shares of the Corporation’s
Preferred Stock Series E at the end of the third quarter of 2003.
77
Quantitative and Qualitative Disclosures about Market Risk
First BanCorp manages its asset/liability position in order to limit the effects of changes in
interest rates on net interest income, subject to other goals of management and within guidelines
set forth by the ALCO Committee and approved by the Board of Directors.
The Asset Liability Management and Investment Committee of FirstBank (ALCO) oversees interest
rate risk, liquidity management and other related matters. The ALCO
is composed of senior management officers, including the Chief
Executive Officer, the Chief Financial Officer, the Chief Operating
Officer and the Treasurer. An Investment Committee for
First BanCorp also monitors the investment portfolio of the Holding Company. During 2005, this
Committee generally met weekly and had the same members as the ALCO Committee described previously.
Committee meetings focused on, among other things, current and expected conditions in world
financial markets, competition and prevailing rates in the local deposit market, reviews of
liquidity, unrealized gains and losses in securities, recent or proposed changes to the investment
portfolio, alternative funding sources and their costs, hedging and the possible purchase of
derivatives such as swaps and caps, and any tax or regulatory issues which may be pertinent to
these areas. The ALCO approves funding decisions in light of the Corporation’s overall growth
strategies and objectives. On a quarterly basis, the ALCO performs a comprehensive asset/liability
review, examining interest rate risk as described below together with other issues such as
liquidity and capital.
The Corporation uses scenario analysis to measure the effects of changes in interest rates on
net interest income. These simulations are carried out over a one-year time horizon, assuming
gradual upward and downward interest rate movements of 200 basis points. Simulations are carried
out in two ways:
| |
(1) |
|
using the same balance sheet as the Corporation had on the simulation
date, and |
| |
| |
(2) |
|
using a growing balance sheet based on recent growth patterns and
strategies. |
The balance sheet is divided into groups of assets and liabilities in order to simplify the
projections. As interest rates rise or fall, these simulations incorporate expected future lending
rates, current and expected future funding sources and cost, the possible exercise of options,
changes in prepayment rates, and other factors which may be important in determining the future
growth of net interest income. These projections are carried out for First BanCorp on a fully
consolidated basis.
The
Corporation uses an asset-liability software to project future movements in the
Corporation’s balance sheet. The starting point of the
projections generally corresponds to the
actual values of the balance sheet on the date of the simulations. Interest rates used for the
simulations also correspond to actual rates at the start of the projection period.
These simulations are highly complex, and they use many simplifying assumptions that are
intended to reflect the general behavior of the Corporation over the period in question. However,
there can be no assurance that actual events will match these assumptions in all cases. For this
reason, the results of these simulations are only approximations of the true sensitivity of net
interest income to changes in market interest rates.
78
Assuming a no growth balance sheet as of December 31, 2005, net interest income projected for
2006 would fall by $25.9 million (4.70%) under a rising rate scenario and would rise by $7.2
million (1.31%) under falling rates.
As
of December 31, 2005, the same simulations were also carried out assuming a growing balance
sheet, as described above. The growing balance sheet simulations indicate that net interest income
projected for 2006 would fall by $21.4 million (3.84%) under a rising rate scenario and would rise
by $0.4 million (0.08%) with falling rates.
To evaluate these simulations it is helpful to compare current exposures with those for the
previous year. The simulation for the year 2005 assuming a no growth balance sheet, as of December
31, 2004, concluded that under a gradual 200 basis point rising rate scenario, net interest income
would have fallen by $4.85 million (1.01%) and that under a gradual 200 basis point falling rate
scenario would have increased by $10.1 million (2.11%).
As
of December 31, 2004, the same simulations were also carried assuming a growing balance
sheet. This scenario showed that net interest income for 2005 would have fallen by $16.0 million
(3.14%) under a gradual 200 basis point rising interest rate scenario. Net interest income would
have increased by $12.5 million (2.46%) with rates gradually falling by 200 basis points.
The Corporation compared actual 2005 results with projections made one year before, at the end
of 2004. In the growth scenario, which is more realistic, the Bank
projected taxable equivalent net interest income
of $493.6 million under rising rates (+200bp) for 2005.
Short-term rates actually increased by 225bp during that year, and
First Bancorp actually earned taxable equivalent net interest income
of $566.9 million. The most important reason for this difference was that the projections did not
include purchases of tax-exempt Treasury and Agency securities which
occurred during 2005.
The Corporation’s financial instruments that are sensitive to interest rate risk are mainly
the fixed rate loans, fixed investment securities and derivative instruments, to the extent to
which those assets were funded by variable rate liabilities. The following table shows the
Corporation’s Investments and Loans Receivable portfolios by repricing date as of December 31,
2005.
79
LOAN & INVESTMENT MATURITIES OR REPRICINGS AS OF DECEMBER 31, 2005
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
2-5 Years |
|
|
Over 5 Years |
|
|
|
|
| |
|
|
|
|
|
Fixed |
|
|
Variable |
|
|
Fixed |
|
|
Variable |
|
|
|
|
| |
|
One Year |
|
|
Interest |
|
|
Interest |
|
|
Interest |
|
|
Interest |
|
|
|
|
| |
|
or Less |
|
|
Rates |
|
|
Rates |
|
|
Rates |
|
|
Rates |
|
|
Total |
|
Money Market
Investments |
|
$ |
1,273,759 |
|
|
$ |
— |
|
|
$ |
— |
|
|
$ |
— |
|
|
$ |
— |
|
|
$ |
1,273,759 |
|
Mortgage-Backed Securities |
|
|
132,722 |
|
|
|
616,567 |
|
|
|
— |
|
|
|
1,963,142 |
|
|
|
— |
|
|
|
2,712,431 |
|
Other Securities |
|
|
218,813 |
|
|
|
9,717 |
|
|
|
— |
|
|
|
2,488,173 |
|
|
|
— |
|
|
|
2,716,703 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
Investments |
|
|
1,625,294 |
|
|
|
626,284 |
|
|
|
— |
|
|
|
4,451,315 |
|
|
|
— |
|
|
|
6,702,893 |
|
| |
Loans : |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial
and Commercial Real Estate |
|
|
6,478,808 |
|
|
|
101,339 |
|
|
|
234,456 |
|
|
|
314,111 |
|
|
|
59,012 |
|
|
|
7,187,726 |
|
Construction |
|
|
1,090,511 |
|
|
|
18,546 |
|
|
|
— |
|
|
|
28,061 |
|
|
|
— |
|
|
|
1,137,118 |
|
Finance
Leases |
|
|
63,634 |
|
|
|
216,937 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
280,571 |
|
Consumer |
|
|
462,327 |
|
|
|
1,231,200 |
|
|
|
— |
|
|
|
40,042 |
|
|
|
— |
|
|
|
1,733,569 |
|
Residential
Real Estate |
|
|
161,629 |
|
|
|
205,797 |
|
|
|
106,831 |
|
|
|
1,872,688 |
|
|
|
— |
|
|
|
2,346,945 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Loans |
|
|
8,256,909 |
|
|
|
1,773,819 |
|
|
|
341,287 |
|
|
|
2,254,902 |
|
|
|
59,012 |
|
|
|
12,685,929 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Earning Assets |
|
$ |
9,882,203 |
|
|
$ |
2,400,103 |
|
|
$ |
341,287 |
|
|
$ |
6,706,217 |
|
|
$ |
59,012 |
|
|
$ |
19,388,822 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
This
table shows that $6.7 billion of the Corporation’s $19.4 billion of earning assets
had fixed rates with maturities of five years or more. Of these
assets, investments including
mortgage-backed securities and government and agency bonds account for $4.5 billion and
residential mortgages make up an additional $1.9 billion. Since the Corporation also has a
substantial amount of variable rate liabilities, this pattern of asset holdings helps to explain
the Corporation’s exposure to rising interest rates.
The derivative instruments held at December 31, 2005 were not qualified for hedge accounting
in 2005, therefore, changes in the market value of these instruments for the year ended December
31, 2005 were charged to current earnings. The Corporation designated the majority of its
derivatives, which are mainly interest rate swaps, under hedge accounting effective in April 2006.
The majority of interest rate swaps were designated under the long-haul method to hedge the
changes in fair value of brokered certificates of deposit. Prospectively, the effective portion of
the changes in value of the brokered certificates of deposit (the “hedge” item) are recorded as an
adjustment to income that offsets or partially offsets the fair value adjustment of the related
interest rate swaps.
The
following tables summarize the fair value changes of the
Corporation’s derivatives as well as the source
of the fair values:
Fair Value Changes
| |
|
|
|
|
| (Dollars in thousands) |
|
December 31, 2005 |
|
Fair value of contracts outstanding at the beginning of the year |
|
$ |
(59,920 |
) |
Contracts realized or otherwise settled during the year |
|
|
1,854 |
|
Fair value of new contracts entered into during the year |
|
|
(36,423 |
) |
Changes in fair value during the year |
|
|
(47,858 |
) |
Fair value of contracts outstanding at the end of the year |
|
$ |
(142,347 |
) |
80
Source of Fair Value
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| (Dollars
in thousands) |
|
Payments Due by Period |
| |
|
Maturity |
|
|
|
|
|
|
|
|
|
Maturity |
|
|
| |
|
Less Than |
|
Maturity |
|
Maturity |
|
In Excess |
|
Total |
| As of December 31, 2005 |
|
One Year |
|
1-3 Years |
|
3-5 Years |
|
of 5 Years |
|
Fair Value |
| |
Prices provided by external sources |
|
|
(3,905 |
) |
|
|
(4,690 |
) |
|
|
(5,203 |
) |
|
|
(128,549 |
) |
|
|
(142,347 |
) |
The use of derivatives involves market and credit risk. The market risk of derivatives
stems principally from the potential for changes in the value of derivatives contracts based on
changes in interest rates.
The credit risk of derivatives arises from the potential of a counterparty’s default on its
contractual obligations. To manage this credit risk, the Corporation deals with counterparties of
good credit standing, enters into master netting agreements whenever possible and, when
appropriate, obtains collateral. Master netting agreements incorporate rights of set-off that
provide for the net settlement of contracts with the same counterparty in the event of default.
Derivative Counterparty Credit Exposure
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| (Dollars in thousands) |
|
December 31, 2005 |
|
| |
|
|
|
|
|
|
|
|
|
Total |
|
|
|
|
|
|
|
| |
|
Number of |
|
|
|
|
|
|
Exposure at |
|
|
Negative |
|
|
Total |
|
| Rating (1) |
|
Counterparties (2) |
|
|
Notional |
|
|
Fair Value (3) |
|
|
Fair Values |
|
|
Fair Value |
|
AA+ |
|
|
1 |
|
|
$ |
241,505 |
|
|
$ |
— |
|
|
$ |
(5,646 |
) |
|
$ |
(5,646 |
) |
AA- |
|
|
4 |
|
|
|
2,356,778 |
|
|
|
— |
|
|
|
(72,440 |
) |
|
|
(72,440 |
) |
A+ |
|
|
6 |
|
|
|
3,342,410 |
|
|
|
3,406 |
|
|
|
(74,003 |
) |
|
|
(70,597 |
) |
A |
|
|
1 |
|
|
|
80,750 |
|
|
|
1,580 |
|
|
|
(2,069 |
) |
|
|
(489 |
) |
BBB- |
|
|
1 |
|
|
|
236,550 |
|
|
|
9,560 |
|
|
|
— |
|
|
|
9,560 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Subtotal |
|
|
13 |
|
|
$ |
6,257,993 |
|
|
$ |
14,546 |
|
|
$ |
(154,158 |
) |
|
$ |
(139,612 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other derivatives: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Caps (4) |
|
|
|
|
|
|
150,200 |
|
|
|
— |
|
|
|
(866 |
) |
|
|
(866 |
) |
Equity
indexed options (4) |
|
|
|
|
|
|
13,515 |
|
|
|
— |
|
|
|
(3,098 |
) |
|
|
(3,098 |
) |
Loans (4) |
|
|
|
|
|
|
2,720 |
|
|
|
29 |
|
|
|
— |
|
|
|
29 |
|
Warrants |
|
|
|
|
|
|
N/A |
|
|
|
1,200 |
|
|
|
— |
|
|
|
1,200 |
|
|
|
|
|
|
|
|
$ |
6,424,428 |
|
|
$ |
15,775 |
|
|
$ |
(158,122 |
) |
|
$ |
(142,347 |
) |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| (Dollars in thousands) |
|
December 31, 2004 |
|
| |
|
|
|
|
|
|
|
|
|
Total |
|
|
|
|
|
|
|
| |
|
Number of |
|
|
|
|
|
|
Exposure at |
|
|
Negative |
|
|
Total |
|
| Rating (1) |
|
Counterparties (2) |
|
|
Notional |
|
|
Fair Value (3) |
|
|
Fair Values |
|
|
Fair Value |
|
AA+ |
|
|
1 |
|
|
$ |
251,873 |
|
|
$ |
79 |
|
|
$ |
(2,881 |
) |
|
$ |
(2,802 |
) |
AA- |
|
|
2 |
|
|
|
853,446 |
|
|
|
166 |
|
|
|
(10,774 |
) |
|
|
(10,608 |
) |
A+ |
|
|
7 |
|
|
|
3,083,822 |
|
|
|
2,148 |
|
|
|
(54,443 |
) |
|
|
(52,295 |
) |
A |
|
|
2 |
|
|
|
81,154 |
|
|
|
1,500 |
|
|
|
(918 |
) |
|
|
582 |
|
BBB |
|
|
1 |
|
|
|
225,043 |
|
|
|
7,155 |
|
|
|
— |
|
|
|
7,155 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Subtotal |
|
|
13 |
|
|
$ |
4,495,338 |
|
|
$ |
11,048 |
|
|
$ |
(69,016 |
) |
|
$ |
(57,968 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other derivatives : |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Caps (4) |
|
|
|
|
|
|
25,000 |
|
|
|
— |
|
|
|
(79 |
) |
|
|
(79 |
) |
Equity
indexed options (4) |
|
|
|
|
|
|
13,515 |
|
|
|
— |
|
|
|
(3,073 |
) |
|
|
(3,073 |
) |
Warrants |
|
|
|
|
|
|
N/A |
|
|
|
1,200 |
|
|
|
— |
|
|
|
1,200 |
|
|
|
|
|
|
|
|
$ |
4,533,853 |
|
|
$ |
12,248 |
|
|
$ |
(72,168 |
) |
|
$ |
(59,920 |
) |
|
|
|
| (1) |
|
Based on the S&P and Fitch Long Term Issuer Credit Ratings |
| |
| (2) |
|
Based on legal entities. Affiliated legal entities are reported separately. |
| |
| (3) |
|
For each counterparty, this amount includes derivatives with a positive fair value excluding
the related accrued interest receivable/payable. |
| |
| (4) |
|
These derivatives represent transactions sold to local companies or institutions for which a
credit rating is not readily available. The credit
exposure is mitigated because a transaction with the same terms and conditions was bought with a
rated counterparty. |
81
Liquidity
Liquidity refers to the level of cash and eligible investments to meet loan and investment
commitments, potential deposit outflows and debt repayments. ALCO, using measures of liquidity
developed by management, which involves the use of several assumptions, reviews the Corporation’s
liquidity position on a weekly basis.
The Corporation utilizes different sources of funding to help ensure that adequate levels of
liquidity are available when needed. Diversification of funding sources is of great importance as
it protects the Corporation’s liquidity from market disruptions. The principal sources of
short-term funds are deposits, securities sold under agreements to repurchase, and lines of credit
with the FHLB and other unsecured lines established with financial institutions. ALCO reviews
credit availability on a regular basis. In the past, the Corporation has securitized and sold auto
and mortgage loans as supplementary sources of funding. Commercial paper has also provided
additional funding as well as long-term funding through the issuance of notes and long-term
brokered certificates of deposit. The cost of these different alternatives, among other things, is
taken into consideration. The Corporation’s principal uses of funds are the origination of loans
and the repayment of maturing deposit accounts and borrowings.
A large portion of the Corporation’s funding is retail brokered CDs issued by the Bank
subsidiary. In the event that the Corporation’s Bank subsidiary falls under the ratios of a
well-capitalized institution, it faces the risk of not being able to replace this source of
funding. The Bank currently complies with the minimum requirements of ratios for a “well-capitalized” institution and does not foresee falling below required levels to issue brokered
deposits. In addition, the average life of the retail brokered CDs was approximately 6 years at
December 31, 2005. Approximately 54% of the value of these certificates are callable, but only at
the Bank’s option.
Certificates of deposit with denominations of $100,000 or higher amounted to $9.5 billion at
December 31, 2005 of which $8.6 billion were brokered CDs.
The following table presents a maturity summary of brokered CDs at December 31, 2005:
| |
|
|
|
|
| |
|
Total |
|
| |
|
(Dollars in thousands) |
|
Less than one year |
|
$ |
3,854,890 |
|
Over one year to five years |
|
|
793,963 |
|
Over five years to ten years |
|
|
1,153,269 |
|
Over ten years |
|
|
2,776,829 |
|
|
|
|
|
Total |
|
$ |
8,578,951 |
|
|
|
|
|
The Corporation’s liquidity plan contemplates alternative sources of funding that could
provide significant amounts of funding at a reasonable cost. The alternative sources of funding
include, among others, sales of commercial loan participations, and the securitization of auto
loans and commercial paper.
Impact of Inflation and Changing Prices
The financial statements and related data presented herein have been prepared in conformity
with accounting principles generally accepted in the United States of America, which require the
measurement of financial position and operating results in terms of historical dollars without
considering changes in the relative purchasing power of money over time due to inflation.
82
Unlike most industrial companies, substantially all of the assets and liabilities of a
financial institution are monetary in nature. As a result, interest rates have a greater impact on
a financial institution’s performance than the effects of general levels of inflation. Interest
rate movements are not necessarily correlated with changes in the prices of goods and services.
Concentration Risk
The Corporation conducts its operations in a geographically concentrated area, as its main
market is Puerto Rico. However, the Corporation continues diversifying its geographical risk as
evidenced by its operations in the Virgin Islands and entrance into new markets. For example, on
March 31, 2005, the Corporation completed the acquisition of 100% of the outstanding common shares
of Ponce General Corporation, the holding company of FirstBank
Florida based in Miami, Florida. The purpose of the acquisition was to build a platform in Florida from
which to initiate further expansion into the United States.
The Corporation has a significant lending concentration of $3.1 billion in one mortgage
originator in Puerto Rico at December 31, 2005, but received in
May 2006 a cash payment of approximately $2.4 billion, substantially
reducing the balance in secured commercial loans. The Corporation has outstanding $596.7 million with
another mortgage originator in Puerto Rico for total loans granted to mortgage originators
amounting to $3.7 billion at December 31, 2005. These commercial loans are secured by 41,038 individual mortgage loans on residential and commercial real estate with an average principal
balance of $89,776 each. The mortgage originators have always paid the loans in accordance with
their terms and conditions. On December 6, 2005, the Corporation obtained a waiver from the Office
of the Commissioner of Financial Institutions of the Commonwealth of Puerto Rico with respect to
the statutory limit for individual borrowers (loan to one borrower limit). Of the total loans of
$12.7 billion for 2005, approximately 84% have credit risk concentration in Puerto Rico, 10% in
Florida (USA) and 6% in the Virgin Islands.
Selected Quarterly Financial Data
Financial
data showing results of the 2005 and 2004 quarters is presented below.
In the opinion of management, all adjustments necessary for a fair
presentation have been included. This financial data has not been
reviewed by the Corporation’s independent registered public
accounting firm.
83
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
2005 |
| |
|
(As Restated) |
|
|
|
|
|
|
| |
|
March 31 |
|
June 30 |
|
September 30 |
|
December 31 |
| |
|
(Dollars in thousands, except for per share results) |
Interest income |
|
$ |
212,377 |
|
|
$ |
249,157 |
|
|
$ |
292,263 |
|
|
$ |
313,793 |
|
Net interest income |
|
|
65,276 |
|
|
|
193,071 |
|
|
|
66,743 |
|
|
|
107,229 |
|
Provision for loan losses |
|
|
10,954 |
|
|
|
11,075 |
|
|
|
12,861 |
|
|
|
15,754 |
|
Net income (loss) |
|
|
25,215 |
|
|
|
97,406 |
|
|
|
17,305 |
|
|
|
(25,322 |
) |
Earnings per common share-basic |
|
$ |
0.19 |
|
|
$ |
1.08 |
|
|
$ |
0.09 |
|
|
$ |
(0.44 |
) |
Earnings per common share-diluted |
|
$ |
0.18 |
|
|
$ |
1.05 |
|
|
$ |
0.09 |
|
|
$ |
(0.42 |
) |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
2004 |
| |
|
March 31 |
|
June 30 |
|
September 30 |
|
December 31 |
| |
|
(Dollars in thousands, except for per share results) |
Interest income |
|
$ |
150,550 |
|
|
$ |
160,869 |
|
|
$ |
186,664 |
|
|
$ |
192,251 |
|
Net interest income |
|
|
128,519 |
|
|
|
5,251 |
|
|
|
170,606 |
|
|
|
93,105 |
|
Provision for loan losses |
|
|
13,200 |
|
|
|
13,200 |
|
|
|
13,200 |
|
|
|
13,200 |
|
Net income (loss) |
|
|
65,430 |
|
|
|
(18,192 |
) |
|
|
88,393 |
|
|
|
41,694 |
|
Earnings per common share-basic |
|
$ |
0.69 |
|
|
$ |
(0.35 |
) |
|
$ |
0.97 |
|
|
$ |
0.39 |
|
Earnings per common share-diluted |
|
$ |
0.67 |
|
|
$ |
(0.34 |
) |
|
$ |
0.94 |
|
|
$ |
0.38 |
|
Market Prices and Stock Data
The Corporation’s common stock is traded in the New York Stock Exchange (NYSE) under the
symbol FBP. At December 31, 2006 and 2005, there were
566 and 589, respectively, holders of
record of the Corporation’s common stock.
The following table sets forth the high and low prices of the Corporation’s common stock for
the periods indicated as reported by the NYSE. This table reflects the effect of the June 2005
two-for-one stock split on the Corporation’s outstanding shares of common stock at June 15, 2005.
84
| |
|
|
|
|
|
|
|
|
|
|
|
|
| Quarter ended |
|
High |
|
Low |
|
Last |
2006: |
|
|
|
|
|
|
|
|
|
|
|
|
December |
|
$ |
10.79 |
|
|
$ |
9.39 |
|
|
$ |
9.53 |
|
September |
|
|
11.15 |
|
|
|
8.66 |
|
|
|
11.06 |
|
June |
|
|
12.22 |
|
|
|
8.90 |
|
|
|
9.30 |
|
March |
|
|
13.15 |
|
|
|
12.20 |
|
|
|
12.36 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2005: |
|
|
|
|
|
|
|
|
|
|
|
|
December |
|
$ |
15.56 |
|
|
$ |
10.61 |
|
|
$ |
12.41 |
|
September |
|
|
26.07 |
|
|
|
16.50 |
|
|
|
16.92 |
|
June |
|
|
21.31 |
|
|
|
17.31 |
|
|
|
20.08 |
|
March |
|
|
32.26 |
|
|
|
20.78 |
|
|
|
21.13 |
|
| |
2004: |
|
|
|
|
|
|
|
|
|
|
|
|
December |
|
$ |
32.43 |
|
|
$ |
23.65 |
|
|
$ |
31.76 |
|
September |
|
|
24.93 |
|
|
|
19.81 |
|
|
|
24.15 |
|
June |
|
|
21.34 |
|
|
|
17.57 |
|
|
|
20.38 |
|
March |
|
|
21.66 |
|
|
|
19.50 |
|
|
|
20.80 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2003: |
|
|
|
|
|
|
|
|
|
|
|
|
December |
|
$ |
20.16 |
|
|
$ |
15.62 |
|
|
$ |
19.78 |
|
September |
|
|
15.99 |
|
|
|
14.18 |
|
|
|
15.38 |
|
June |
|
|
15.84 |
|
|
|
13.73 |
|
|
|
13.73 |
|
March |
|
|
14.00 |
|
|
|
11.36 |
|
|
|
13.49 |
|
Changes in Internal Controls over Financial Reporting
Refer to Item 9A
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
The information required herein is incorporated by reference to the information included under
the sub caption “Quantitative and Qualitative Disclosures about Market Risk” in the Management’s
Discussion and Analysis of Financial Condition and Results of Operations section in this Form 10K.
Item 8. Financial Statements and Supplementary Data
The
information required herein is incorporated by reference from pages
93 through 161 of the annual report to security holders for the year
ended December 31, 2005.
Item 9.
Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
85
Item 9A. Controls and Procedures
Disclosure Controls and Procedures
First BanCorp’s management, with the participation of its Chief Executive Officer and Chief
Financial Officer, has evaluated the effectiveness of the design and operation of First BanCorp’s
disclosure controls and procedures as of December 31, 2005. Disclosure controls and procedures are
defined under SEC rules as controls and other procedures that are designed to ensure that
information required to be disclosed by a company in the reports that it files or submits under the
Securities Exchange Act of 1934 is recorded, processed, summarized and reported within required
time periods. Disclosure controls and procedures include controls and procedures designed to ensure
that information required to be disclosed by an issuer in the reports that it files or submits
under the Securities Exchange Act of 1934 is accumulated and communicated to the issuer’s
management, including its principal executive and principal financial officers, or persons
performing similar functions, as appropriate, to allow timely decisions regarding required
disclosure. There are inherent limitations to the effectiveness of any system of disclosure
controls and procedures, including the possibility of human error and the circumvention or
overriding of the controls and procedures. Accordingly, even effective disclosure controls and
procedures can only provide reasonable assurance of achieving their control objectives.
Based on the Corporation’s identification of the material weaknesses in the Corporation’s internal
control over financial reporting described within Management’s Report on Internal Control Over
Financial Reporting, the Chief Executive Officer and the Chief Financial Officer have concluded
that the Corporation’s disclosure controls and procedures were
not effective as of December 31, 2005.
Management’s Report on Internal Control Over Financial Reporting
The Corporation’s management is responsible for establishing and maintaining adequate internal
control over financial reporting, as defined in Rules 13a-15(f) and 15d-15(f) under the Securities
Exchange Act of 1934, and for the assessment of the effectiveness of internal control over
financial reporting. The Corporation’s internal control over financial reporting is a process
designed to provide reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with generally accepted
accounting principles (“GAAP”) and includes controls over the preparation of financial statements
in accordance with the instructions for the Consolidated Financial Statements for Bank Holding
Companies (Form FR Y-9C) to comply with the reporting requirements of Section 112 of FDICIA.
A company’s internal control over financial reporting includes those policies and procedures that
(i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect
the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance
that transactions are recorded as necessary to permit the preparation of financial statements in
accordance with GAAP, and that receipts and expenditures of the company are being made only in
accordance with authorizations of management and directors of the company; and (iii) provide
reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or
disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or
detect misstatements. Also, projections of any evaluation of effectiveness to future periods are
subject to the risk that controls may become inadequate because of changes in conditions, or that
the degree of compliance with the policies or procedures may deteriorate.
86
In making its assessment, management, including the Chief Executive Officer and Chief Financial
Officer, used the criteria set forth in Internal Control — Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission (“COSO”).
Management has excluded FirstBank Florida (formerly Ponce General Corporation) from its assessment
of internal control over financial reporting as of December 31, 2005 because it was acquired by the
Company in a purchase business combination during 2005. FirstBank Florida, a wholly-owned
subsidiary, represents approximately 4% of the Corporation’s total assets as of December 31,
2005 and approximately 3% of the Corporation’s total revenues for the year ended December 31,
2005.
A material weakness is a control deficiency, or combination of control deficiencies, that results
in more than a remote likelihood that a material misstatement of the annual or interim financial
statements will not be prevented or detected. As of December 31, 2005, First BanCorp’s management
has identified the following material weaknesses in the Corporation’s internal control over
financial reporting.
| 1. |
|
Ineffective Control Environment. The Corporation did not maintain an effective control
environment. Specifically the
Corporation did not maintain effective controls with respect to the review, supervision and
monitoring of its accounting operations, including with respect to the accounting of purchases
in bulk of mortgage loans and pass-through trust certificates (the “mortgage-related
transactions”). This ineffective control environment enabled certain former members of
management to override the Corporation’s internal control over financial reporting thereby
precluding other members of management, the Board of Directors, the Audit Committee and the
Corporation’s independent registered public accounting firm from having access to certain
information relevant to the Corporation’s accounting for the variable interest rate features
associated with certain of its mortgage-related transactions. |
| |
| 2. |
|
Ineffective controls over the documentation and communication of relevant terms of certain
mortgage loans bulk purchase transactions. The Corporation did not maintain effective
controls over the documentation and communication of all of the relevant terms and conditions
of certain mortgage loans bulk purchase transactions, including the existence of oral and
emails agreements and extended recourse. |
| |
| 3. |
|
Ineffective controls over communications to the Audit Committee. The Corporation did not
maintain effective controls to ensure that management provided the Audit Committee complete
information regarding certain mortgage-related transactions in an organized manner so as to
enable the Audit Committee to properly oversee those transactions and their associated
external financial reporting. |
| |
| 4. |
|
Ineffective controls over communications to the Corporation’s independent registered public
accounting firm. The Corporation did not maintain effective controls to ensure complete and
adequate communication to the Corporation’s registered public accounting firm. |
| |
| 5. |
|
Ineffective anti-fraud controls and procedures. The Corporation did not maintain effective
anti-fraud controls and procedures to ensure the effective assignment of authority and
monitoring of its external financial reporting process. |
| |
| 6. |
|
Insufficient accounting resources and expertise. The Corporation did not maintain a
sufficient complement of accounting and financial personnel with sufficient knowledge,
experience, and training to meet the Corporation’s external financial reporting
responsibilities. |
| |
| |
|
The material weaknesses described above in numbered paragraphs 1 through 6 contributed to the
existence of the material weaknesses discussed below in numbered paragraphs 7 through 9. |
87
| |
|
Additionally, these material weaknesses resulted in the restatement of the consolidated financial statements
for the first quarter of 2005 and could result in misstatements of any of the Corporation’s
financial statement accounts and disclosures that would result in a material misstatement to
the annual or interim consolidated financial statements that would not be prevented or
detected. |
| |
| 7. |
|
Ineffective controls over the accounting for mortgage-related transactions. The Corporation
did not maintain effective controls over the accounting for its mortgage-related transactions
with certain counterparties. Specifically, the Corporation did not have effective controls in
place to ensure the identification of recourse provisions that precluded the recognition of
such transactions as purchases of loans or collaterized mortgage securities in written
agreements relating to the mortgage-related transactions. This
control deficiency resulted in the restatement of the
consolidated financial statements for the first quarter of 2005 and could result in a
misstatement in the classification of investment securities, loans receivable and interest
income accounts that would result in a material misstatement to the annual or interim
consolidated financial statements that would not be prevented or detected. Accordingly,
management has concluded that this control deficiency constitutes a material weakness. |
| |
| 8. |
|
Ineffective controls over the accounting for derivative financial instruments. The
Corporation did not maintain effective controls over the accounting for its derivative
financial instruments. Specifically, the Corporation’s internal controls were not properly
designed to identify derivatives embedded within its mortgage purchases and other loan
contracts. Additionally, the Corporation did not maintain effective controls over the
identification and valuation of hedge ineffectiveness as required by generally accepted
accounting principles. This control deficiency resulted in the restatement of the consolidated financial
statements for the first quarter of 2005 and could result in a misstatement of the
Corporation’s derivative financial instruments and related accounts that would result in a
material misstatement to the annual or interim consolidated financial statements that would
not be prevented or detected. Accordingly, management has concluded that this control
deficiency constitutes a material weakness. |
| |
| 9. |
|
Ineffective controls over the valuation of premiums and discounts on mortgage-backed
securities. The Corporation did not maintain effective controls over the valuation of
premiums and discounts on mortgage-backed securities. Specifically, the Corporation amortized
premium and discounts on mortgage-backed securities using a straight-line pro rata method
rather than the effective interest method, as required by generally accepted accounting
principles. This control deficiency resulted in the restatement of the consolidated financial statements for
the first quarter of 2005 and could result in a misstatement in the deferred premiums and
discounts amortization accounts that would result in a material misstatement to annual or
interim consolidated financial statements that would not be prevented or detected.
Accordingly, management has concluded that this control deficiency constitutes a material
weakness. |
As a result of the existence of the material weaknesses discussed above, the Corporation did not
maintain effective control over financial reporting as of December 31, 2005, based on criteria
established in Internal Control — Integrated Framework issued by the COSO.
First BanCorp’s assessment of the effectiveness of its internal control over financial reporting as
of December 31, 2005 has been audited by PricewaterhouseCoopers LLP, an independent registered
public accounting firm, as stated in their report which appears under Item 8 of this Annual Report
on Form 10-K along with the Corporation’s consolidated financial statements.
88
Plan for Remediation of Material Weaknesses that Existed as of December 31, 2005
First BanCorp has implemented a number of remedial measures designed to address the material
weaknesses identified in the Corporation’s internal control over financial reporting as of December
31, 2005 and to enhance the Corporation’s overall corporate governance.
Although
the material weaknesses disclosed in the 2004
Annual Report on Form 10K/A have not been remediated as of December 31, 2005, the Company
continues its remedial activities as described in its remediation plan included in the 2004 10K/A
and further described below.
1.
First BanCorp has significantly improved its control environment,
including the following:
| |
* |
|
Changes in Management and Clarification of the Role, Responsibilities
and Authority of Management. The former CEO and former CFO resigned from the
Corporation, after the Audit Committee recommended this action to the Board and the
Board requested their resignation. Also the Board appointed a new CEO and a new CFO
and created the new position of COO, to which it appointed an executive. In
addition, the Board appointed a new General Counsel, who reports to the CEO. The
roles, responsibilities and authority of the persons in each of these positions have
been clarified to better inhibit any override of the Corporation’s internal control
over financial reporting. In addition, in 2006 the Corporation has implemented
detection controls to improve the identification and response to any instances of
undue control by an unauthorized person of the financial reporting process. |
| |
| |
* |
|
Risk Management Program and Enhancement of the Communication of
Information to the Audit Committee. During the first quarter of 2006, the Board
reviewed the Corporation’s risk management program with the assistance of outside
consultants and legal counsel. This effort has resulted in a realignment of risk
management functions and the adoption of an enterprise-wide risk management process.
The Board appointed a senior management officer as Chief Risk Officer and appointed
this officer to the Risk Management Council with reporting responsibilities to the
CEO and the Audit Committee. In addition, the Board has formed an Asset/Liability
Risk Committee of the Board which will be responsible for the oversight of risk
management, including asset quality, portfolio performance, interest rate and market
sensitivity, and portfolio diversification. In addition, the Asset/Liability Risk
Committee will have the authority to examine the Corporation’s investment activities
and liabilities, such as its brokered CDs, to facilitate appropriate oversight by
the Board. Finally, management will be required to bring to the attention of the
Asset/Liability Risk Committee new forms of transactions or variants of forms of
transactions that the Asset/Liability Risk Committee has not yet reviewed to enable
the Asset/Liability Risk Committee to fully evaluate the consequences of such
transactions to the Corporation. In addition, management will be required to bring
to the attention of the Audit Committee new forms of transactions or variants of
forms of transactions for which the Corporation has not determined the appropriate
accounting treatment to enable the Audit Committee to fully evaluate the accounting
treatment of such transactions. The enhancements of the risk management program are
expected to result in a control environment that ensures the discussion and analysis
of the legal and accounting implications of new forms of transactions or variants of
transactions that may have a significant impact on the Corporation’s financial
condition or on the accuracy and completeness of the financial reporting process. |
89
| |
* |
|
Transaction Documentation. In August 2006, the Corporation
adopted a specific policy that requires that all transactions be completely and
fully documented, thereby prohibiting any oral or undisclosed side agreements, and
that such documentation be contemporaneously prepared and executed and centrally
maintained and organized. |
| |
| |
* |
|
Board Membership Changes. The Board appointed the new CEO and
new COO to the Board. In addition, in November 2005, the Board elected Fernando
Rodríguez-Amaro as a new independent director to serve as an additional audit
committee financial expert, and thereafter appointed him Chairman of the Audit
Committee as of January 1, 2006. Also, in the first quarter of 2006, the Board
appointed Jose Menéndez Cortada as the Lead Independent Director of the Board. |
| |
| |
* |
|
Corporate Governance Review. During the first quarter of 2006,
with the assistance of outside consultants and outside counsel, the Corporate
Governance Committee of the Board re-evaluated the Corporation’s corporate
governance and made recommendations to the full Board for changes. This effort is
expected to result in a clearer understanding of the responsibilities and duties of
the Board and its committees and in an alignment of those responsibilities with the
industry’s best practices. |
| |
| |
* |
|
Ethical Training of Employees and Directors. In 2006, the
Corporation has designed and offered enhanced corporate compliance seminars to every
employee and director. Through the corporate compliance training program, the
Corporation is emphasizing the importance of compliance with the Corporation’s
policies and procedures and control systems, including the new policy regarding full
and complete documentation of agreements and prohibiting oral and side agreements,
the Corporation’s Code of Ethics and Code of Conduct, the Corporation’s various
legal compliance programs, and the availability of mechanisms to report possible
unethical behavior, such as the Audit Committee’s whistleblower hotline. |
| |
| |
* |
|
Procedures Relating to Concerns About Senior Management’s
Conduct. During 2006, the Board and the Audit Committee revised their
respective procedures to emphasize more clearly the requirement that the Board or
the Audit Committee be notified whenever any concerns arise regarding the conduct of
senior management, including allegations of possible fraud, self-dealing or any
other inappropriate conduct. In addition, when the Corporation appointed a new
General Counsel, it specified that the General Counsel will report to the CEO in
contrast to the former General Counsel who reported to the former CFO. |
2. Accounting for Mortgage-Related Transactions. The Corporation’s management believes
that, as of June 30, 2006, the Corporation has fully remediated the material weakness in its
internal control over financial reporting with respect to purchases of mortgages in bulk and
the purchases of mortgages where the seller of the mortgages retains the servicing
responsibilities. The Corporation has controls that specify that the terms of any recourse
provisions or retained servicing arrangements must be reviewed by the General Counsel before
they are included in purchase agreements. In addition, the Board has reviewed the
Corporation’s risk management program, enhanced the communication to the Audit Committee and
adopted a specific policy for transactions documentation as further described in item 1
above.
3.
Accounting for Derivative Financial Instruments. The Corporation’s management believes
that, as of June 30, 2006, the Corporation has fully remediated the material weakness in its
internal control over financial reporting with respect to the identification of derivatives
and the measurement of hedge effectiveness. With respect to the identification of
derivatives, the Corporation has implemented the following changes:
| |
• |
|
the legal and accounting departments must review any new forms of
transactions or any variants of forms of transactions for which the Corporation has
not determined the
|
90
| |
|
|
accounting in order to identify any derivatives resulting from the structure of such
transactions; and |
| |
| |
• |
|
periodic testing of this review process is required to make sure that it
is operating effectively to ensure compliance with SFAS 133. |
| |
| |
• |
|
education of personnel on derivative financial instruments and
involvement of outside experts, as necessary. |
With respect to the measurement of hedge effectiveness, the Corporation has revised its
controls accounting procedures to state that the receipt of an upfront payment from an
interest rate swap counterparty precludes the use of the short-cut method of accounting
under SFAS 133.
4. Accounting for the Amortization of Premiums and Discounts on Mortgage-Backed Securities.
The Corporation’s management believes that, as of January 1, 2006, the Corporation has fully
remediated the material weakness in its internal control over financial reporting with
respect to the accounting for the amortization of premiums and
discounts on mortgage-backed
securities. Management adjusted the balances to reflect the use of the effective interest
method. In addition, the Corporation has reviewed the accounting policy to require the use
of the interest method for the amortization of premiums and discounts on mortgage-backed
securities. As a result of such review, effective January 1, 2006 the Corporation
implemented the interest method for the amortization of premiums and discounts on
mortgage-backed securities.
5. Overall Accounting Resources and Expertise. The Corporation has recruited additional
staff to strengthen its accounting, internal control, financial reporting, legal, regulatory
compliance, and internal audit functions. Further, the Corporation has appointed a senior
management executive as the Chief Accounting Officer with primary responsibility for the
development and implementation of the Corporation’s accounting policies and practices and to
review and monitor critical accounts and transactions to ensure that they are managed in
accordance with such policies and practices, generally accepted accounting principles in the
United States and applicable regulatory requirements.
First
BanCorp’s remediation efforts have continued into 2007. During 2006, First BanCorp
concentrated its remediation efforts on those areas that had the most pervasive effects on
First BanCorp’s internal control over financial reporting. Specifically, with respect to the
material weaknesses described within Management’s Report on Internal Control Over Financial
Reporting , First BanCorp took significant actions to (i)improve its control environment,
including its “tone at the top”, (ii) remediate the material weakness related to purchases
of mortgages in bulk and purchases of mortgages where the seller of the mortgages retains
the servicing responsibilities, (iii) remediate the material weakness with respect to the
identification of derivatives and measurement of hedge effectiveness, and (iv) remediate the
material weakness related to the accounting for the amortization of premiums and discounts
on mortgage backed securities. First BanCorp’s Audit Committee has provided and will
continue to provide oversight and review of the Company’s initiatives to remediate material
weaknesses in First BanCorp’s internal control over financial reporting.
Other Enhancements to Internal Control Over Financial Reporting
The following describes other enhancements that are being undertaken by First BanCorp, in addition
to the measures described above, to address the material weaknesses in the Corporation’s internal
control over financial reporting:
91
| |
1. |
|
The Corporation has created the position of Corporate Controller that reports directly
to the CFO. The Corporate Controller oversees the corporate financial records of the
Corporation. The controllers of the Corporation’s subsidiaries now report directly to the
Corporate Controller. |
| |
| |
2. |
|
The Corporation has segregated the investment accounting department from the treasury
department. The investment accounting department reports now directly to the Corporate
Controller. |
| |
| |
3. |
|
The Corporation has created the corporate reporting department reporting directly to
the Chief Accounting Officer. The corporate reporting department has the responsibility of
SEC filings and financial reporting to the Corporation’s Board of Directors. |
First BanCorp believes that the remediation and other efforts described above have significantly
improved and will continue to improve First BanCorp’s internal control over financial reporting and
its disclosure controls and procedures. First BanCorp’s management, with the oversight of the
Audit Committee, will continue to take steps to remedy the identified material weaknesses in the
Corporation’s internal control over financial reporting as expeditiously as possible.
Changes in Internal Control Over Financial Reporting
There were
the following changes to the Corporation’s internal control over financial reporting during the last
quarter of year 2005: the appointment of a new CEO, new COO and hiring of a new
independent director to serve as an additional audit committee financial expert on the Audit
Committee.
Item 9B. Other Information
On April 28, 2005, FirstBank and Fernando Batlle entered into a Separation Agreement, pursuant
to which Mr. Batlle’s employment as an Executive Vice President was terminated. Pursuant to the
terms of the Separation Agreement as consideration for entering into the Agreement, providing a
release and settling all claims Mr. Batlle or his wife had or may have had in the future against
FirstBank, the Corporation and its affiliates,
Mr. Batlle and his wife received an aggregate lump sum payment of $1,800,000, 12 months
of COBRA coverage, the company car he utilized, and the computer and printer he utilized.
On April 28, 2005, FirstBank also entered into Contract for Consulting Service with Mr. Batlle.
Pursuant to the Contract for Consulting Service, Mr. Batlle was
entitled to receive a monthly fee of $4,166 during
the one-year term of the contract for providing to FirstBank, for up to 22 hours per month,
consulting services with respect to financial and banking matters as well as providing it with
assistance and cooperation with respect to any lawsuit, claim, dispute or investigation regarding
issues to which Mr. Batlle had knowledge or which were his responsibility while he was employed by
FirstBank. Pursuant to the termination clause of the Contract, on
June 10, 2005, Mr. Batlle notified FirstBank of his decision
to terminate the Contract. Upon such termination, Mr. Batlle was
entitled to receive in Full the fees allocable to the remaining
portion of the Contract. In this regard, FirstBank delivered a
payment to Mr. Batlle in the amount of $50,000 less a 7%
withholding tax applicable to such payment.
92
PricewaterhouseCoopers LLP
254 Muñoz Rivera Avenue
BBVA Tower, 9th Floor
Hato Rey, PR 00918
Telephone (787) 754-9090
Facsimile (787) 766-1094
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders
of First BanCorp
We have completed integrated audits of First BanCorp’s 2005 and 2004 consolidated financial
statements and of its internal control over financial reporting as of December 31, 2005 and an
audit of its 2003 consolidated financial statements in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Our opinions, based on our audits, are
presented below.
Consolidated financial statements
In our opinion, the accompanying consolidated statements of financial condition and the related
consolidated statements of income, comprehensive income, changes in stockholders’ equity and cash
flows present fairly, in all material respects, the financial position of First BanCorp and its
subsidiaries (the “Corporation”) at December 31, 2005 and 2004, and the results of their operations
and their cash flows for each of the three years in the period ended December 31, 2005 in
conformity with accounting principles generally accepted in the United States of America. These
financial statements are the responsibility of the Corporation’s management. Our responsibility is
to express an opinion on these financial statements based on our audits. We conducted our audits
of these statements in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material misstatement. An
audit of financial statements includes examining, on a test basis, evidence supporting the amounts
and disclosures in the financial statements, assessing the accounting principles used and
significant estimates made by management, and evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our opinion.
Internal control over financial reporting
Also, we have audited management’s assessment, included in Management’s Report on Internal Control
Over Financial Reporting appearing under Item 9A, that the Corporation did not maintain effective
internal control over financial reporting as of December 31, 2005, because the Corporation did not
maintain (1) an effective control environment, (2) effective controls over the documentation and
communication of relevant terms of certain mortgage loans bulk purchase transactions, (3) effective
controls over communications to the Audit Committee, (4) effective controls over communications to
the Corporation’s independent registered public accounting firm, (5) effective anti-fraud controls
and procedures, (6) sufficient accounting resources and expertise, (7) effective controls over the
accounting for its mortgage-related transactions with certain counterparties, (8) effective
controls over the accounting for its derivative financial instruments,
and (9) effective controls over the valuation of premiums and discounts on mortgage- backed
securities, based on criteria established in Internal Control — Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Corporation’s
management is responsible for maintaining
93
effective internal control over financial reporting and
for its assessment of the effectiveness of internal control over financial reporting. Our
responsibility is to express opinions on management’s assessment and on the effectiveness of the
Corporation’s internal control over financial reporting based on our audit.
We conducted our audit of internal control over financial reporting in accordance with the
standards of the Public Company Accounting Oversight Board (United States). Those standards
require that we plan and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material respects. An audit of
internal control over financial reporting includes obtaining an understanding of internal control
over financial reporting, evaluating management’s assessment, testing and evaluating the design and
operating effectiveness of internal control, and performing such other procedures as we consider
necessary in the circumstances. We believe that our audit provides a reasonable basis for our
opinions.
A company’s internal control over financial reporting is a process designed to provide reasonable
assurance regarding the reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally accepted accounting principles. A
company’s internal control over financial reporting includes those policies and procedures that (i)
pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the
transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that
transactions are recorded as necessary to permit preparation of financial statements in accordance
with generally accepted accounting principles, and that receipts and expenditures of the company
are being made only in accordance with authorizations of management and directors of the company;
and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized
acquisition, use, or disposition of the company’s assets that could have a material effect on the
financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or
detect misstatements. Also, projections of any evaluation of effectiveness to future periods are
subject to the risk that controls may become inadequate because of changes in conditions, or that
the degree of compliance with the policies or procedures may deteriorate.
A material weakness is a control deficiency, or combination of control deficiencies, that results
in more than a remote likelihood that a material misstatement of the annual or interim financial
statements will not be prevented or detected. The following material weaknesses as of December 31,
2005 have been identified and included in management’s assessment:
| 1. |
|
Ineffective Control Environment. The Corporation did not maintain an effective control
environment. Specifically, the Corporation did not maintain effective controls with respect
to the review, supervision and monitoring of its accounting operations, including with respect
to the accounting of purchases in bulk of mortgage loans and pass-through trust certificates
(the “mortgage-related transactions”). This ineffective control environment enabled certain
former members of management to override the Corporation’s internal control over financial
reporting thereby precluding other members of management, the Board of Directors, the Audit
Committee and the Corporation’s independent registered public accounting firm from having
access to certain information relevant to the Corporation’s accounting for the variable
interest rate features associated with certain of its mortgage-related transactions. |
| 2. |
|
Ineffective controls over the documentation and communication of relevant terms of certain
mortgage loans bulk purchase transactions. The Corporation did not maintain effective
controls over the documentation and communication of all of the relevant terms and conditions
of certain mortgage loans bulk purchase transactions, including the existence of oral and
emails agreements and extended recourse. |
| |
| 3. |
|
Ineffective controls over communications to the Audit Committee. The Corporation did not
maintain effective controls to ensure that management provided the Audit Committee complete |
94
| |
|
information regarding certain mortgage-related transactions in an organized manner so as to
enable the Audit Committee to properly oversee those transactions and their associated
external financial reporting. |
| |
| 4. |
|
Ineffective controls over communications to the Corporation’s independent registered public
accounting firm. The Corporation did not maintain effective controls to ensure complete and
adequate communication to the Corporation’s registered public accounting firm. |
| |
| 5. |
|
Ineffective anti-fraud controls and procedures. The Corporation did not maintain effective
anti-fraud controls and procedures to ensure the effective assignment of authority and
monitoring of its external financial reporting process. |
| |
| 6. |
|
Insufficient accounting resources and expertise. The Corporation did not maintain a
sufficient complement of accounting and financial personnel with sufficient knowledge,
experience, and training to meet the Corporation’s external financial reporting
responsibilities. |
The material weaknesses described above in numbered paragraphs 1 through 6 contributed to the
existence of the material weaknesses discussed below in numbered paragraphs 7 through 9.
Additionally, these material weaknesses resulted in the restatement of the consolidated financial
statements for the first quarter of 2005 and could result in misstatements of any of the
Corporation’s financial statement accounts and disclosures that would result in a material
misstatement to the annual or interim consolidated financial statements that would not be prevented
or detected.
| 7. |
|
Ineffective controls over the accounting for mortgage-related transactions. The Corporation
did not maintain effective controls over the accounting for its mortgage-related transactions
with certain counterparties. Specifically, the Corporation did not have effective controls in
place to ensure the identification of recourse provisions that precluded the recognition of
such transactions as purchases of loans or collateralized mortgage securities in written
agreements relating to the mortgage-related transactions. This control deficiency resulted in
the restatement of the consolidated financial statements for the first quarter of 2005 and
could result in a misstatement in the classification of investment securities, loans
receivable and interest income accounts that would result in a material misstatement to the
annual or interim consolidated financial statements that would not be prevented or detected.
Accordingly, management has concluded that this control deficiency constitutes a material
weakness. |
| |
| 8. |
|
Ineffective controls over the accounting for derivative financial instruments. The
Corporation did not maintain effective controls over the accounting for its derivative
financial instruments. Specifically, the Corporation’s internal controls were not properly
designed to identify derivatives embedded within its mortgage purchases and other loan
contracts. Additionally, the Corporation did not maintain effective controls over the
identification and valuation of hedge ineffectiveness as required by generally accepted
accounting principles. This control deficiency resulted in the restatement of the
consolidated
financial statements for the first quarter of 2005 and could result in a misstatement of the
Corporation’s derivative financial instruments and related accounts that would result in a
material misstatement to the annual or interim consolidated financial statements that would
not be prevented or detected. Accordingly, management has concluded that this control
deficiency constitutes a material weakness. |
| |
| 9. |
|
Ineffective controls over the valuation of premiums and discounts on mortgage-backed
securities. The Corporation did not maintain effective controls over the valuation of
premiums and discounts on mortgage-backed securities. Specifically, the Corporation amortized
premium and discounts on mortgage-backed securities using a straight-line pro rata method
rather than the effective interest method, as required by generally accepted accounting
principles. This control deficiency resulted in the restatement of the consolidated financial
statements for the first quarter of 2005 and could result in a misstatement in the deferred
premiums and discounts amortization |
95
| |
|
accounts that would result in a material misstatement to
annual or interim consolidated financial statements that would not be prevented or detected.
Accordingly, management has concluded that this control deficiency constitutes a material
weakness. |
The material weaknesses referred to above were considered in determining the nature, timing, and
extent of audit tests applied in our audit of the 2005 consolidated financial statements, and our
opinion regarding the effectiveness of the Corporation’s internal control over financial reporting
does not affect our opinion on those consolidated financial statements.
As described in Management’s Report on Internal Control Over Financial Reporting, management has
excluded FirstBank Florida (formerly Ponce General Corporation) from its assessment of internal
control over financial reporting as of December 31, 2005 because it was acquired by the Company in
a purchase business combination during 2005. We have also excluded FirstBank Florida from our
audit of internal control over financial reporting. FirstBank Florida, a wholly-owned subsidiary,
represents approximately 4% of the Corporation’s total assets as of December 31, 2005 and
approximately 3% of the Corporation’s total revenues for the year ended December 31, 2005.
In our opinion, management’s assessment that the Corporation did not maintain effective internal
control over financial reporting as of December 31, 2005, is fairly stated, in all material
respects, based on criteria established in Internal Control — Integrated Framework issued by the
COSO. Also, in our opinion, because of the effects of the material weaknesses described above on
the achievement of the objectives of the control criteria, the Corporation has not maintained
effective internal control over financial reporting as of December 31, 2005, based on criteria
established in Internal Control — Integrated Framework issued by the COSO.
/s/ PricewaterhouseCoopers LLP
PricewaterhouseCoopers LLP
San Juan, Puerto Rico
February 6, 2007
CERTIFIED PUBLIC ACCOUNTANTS
(OF PUERTO RICO)
License No. 216 Expires Dec. 1, 2007
Stamp 2128103 of the P.R. Society of
Certified Public Accountants has been
affixed to the file copy of this report
96
FIRST BANCORP
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
| |
|
|
|
|
|
|
|
|
| |
|
December 31, 2005 |
|
|
December 31, 2004 |
|
Assets |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and due from banks |
|
$ |
106,881,335 |
|
|
$ |
6,211,372 |
|
Money market
instruments, including $381,848,364 pledged that can be repledged for 2005 (2004 - $404,748,972) |
|
|
715,823,907 |
|
|
|
702,163,791 |
|
Federal
funds sold and securities purchased under agreements to resell |
|
|
508,967,369 |
|
|
|
118,000,000 |
|
Time deposits with other financial institutions |
|
|
48,967,475 |
|
|
|
100,600,000 |
|
|
|
|
|
|
|
|
Total money market investments |
|
|
1,273,758,751 |
|
|
|
920,763,791 |
|
|
|
|
|
|
|
|
Investment securities available-for-sale, at fair value: |
|
|
|
|
|
|
|
|
Securities pledged that can be repledged |
|
|
1,744,846,054 |
|
|
|
1,072,058,479 |
|
Other investment securities |
|
|
203,331,449 |
|
|
|
247,536,295 |
|
|
|
|
|
|
|
|
Total investment securities available-for-sale |
|
|
1,948,177,503 |
|
|
|
1,319,594,774 |
|
|
|
|
|
|
|
|
Investment securities held-to-maturity, at amortized cost: |
|
|
|
|
|
|
|
|
Securities pledged that can be repledged |
|
|
3,115,260,660 |
|
|
|
2,996,930,801 |
|
Other investment securities |
|
|
323,327,297 |
|
|
|
380,636,249 |
|
|
|
|
|
|
|
|
Total investment securities held-to-maturity |
|
|
3,438,587,957 |
|
|
|
3,377,567,050 |
|
|
|
|
|
|
|
|
Other equity securities |
|
|
42,367,500 |
|
|
|
81,275,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans, net
of allowance for loan losses of $147,998,733 (2004 - $141,035,841) |
|
|
12,436,257,993 |
|
|
|
9,547,054,561 |
|
Loans held for sale, at lower of cost or market |
|
|
101,672,531 |
|
|
|
9,903,189 |
|
|
|
|
|
|
|
|
Total loans, net |
|
|
12,537,930,524 |
|
|
|
9,556,957,750 |
|
|
|
|
|
|
|
|
Premises and equipment, net |
|
|
116,947,772 |
|
|
|
95,813,545 |
|
Other real estate owned |
|
|
5,019,106 |
|
|
|
9,255,973 |
|
Accrued interest receivable |
|
|
103,692,478 |
|
|
|
56,936,934 |
|
Due from customers on acceptances |
|
|
353,864 |
|
|
|
407,625 |
|
Other assets |
|
|
343,933,937 |
|
|
|
212,261,455 |
|
|
|
|
|
|
|
|
Total assets |
|
$ |
19,917,650,727 |
|
|
$ |
15,637,045,269 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities & Stockholders’ Equity |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities: |
|
|
|
|
|
|
|
|
Non-interest bearing deposits |
|
$ |
811,006,126 |
|
|
$ |
699,581,764 |
|
Interest bearing deposits |
|
|
11,652,746,080 |
|
|
|
7,212,740,444 |
|
Federal funds purchased and securities sold
under agreements to repurchase |
|
|
4,833,882,000 |
|
|
|
4,165,360,913 |
|
Advances from the Federal Home Loan Bank (FHLB) |
|
|
506,000,000 |
|
|
|
1,598,000,000 |
|
Notes payable |
|
|
178,693,249 |
|
|
|
178,239,975 |
|
Other borrowings |
|
|
231,622,020 |
|
|
|
276,692,251 |
|
Subordinated notes |
|
|
— |
|
|
|
82,280,418 |
|
Bank acceptances outstanding |
|
|
353,864 |
|
|
|
407,625 |
|
Accounts payable and other liabilities |
|
|
505,506,453 |
|
|
|
219,408,593 |
|
|
|
|
|
|
|
|
|
|
|
18,719,809,792 |
|
|
|
14,432,711,983 |
|
|
|
|
|
|
|
|
Commitments and contingencies (Note 30 and 33) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stockholders’ equity: |
|
|
|
|
|
|
|
|
Preferred stock, authorized 50,000,000 shares; issued and
outstanding 22,004,000 shares at $25 liquidation value
per share |
|
|
550,100,000 |
|
|
|
550,100,000 |
|
Common stock, $1 par value, authorized
250,000,000 shares; issued 90,772,856 shares
(2004 - 45,310,055 shares) |
|
|
90,772,856 |
|
|
|
45,310,055 |
|
Less: Treasury Stock (at par value) |
|
|
(9,897,800 |
) |
|
|
(4,920,900 |
) |
|
|
|
|
|
|
|
Common stock outstanding |
|
|
80,875,056 |
|
|
|
40,389,155 |
|
|
|
|
|
|
|
|
Additional paid-in capital |
|
|
— |
|
|
|
4,863,299 |
|
Capital reserve |
|
|
— |
|
|
|
82,825,000 |
|
Legal surplus |
|
|
265,844,192 |
|
|
|
183,019,192 |
|
Retained earnings |
|
|
316,696,971 |
|
|
|
299,501,016 |
|
Accumulated other comprehensive (loss) income, net of tax
of $16,259 (2004 - ($894,396)) |
|
|
(15,675,284 |
) |
|
|
43,635,624 |
|
|
|
|
|
|
|
|
|
|
|
1,197,840,935 |
|
|
|
1,204,333,286 |
|
|
|
|
|
|
|
|
Total liabilities and stockholders’ equity |
|
$ |
19,917,650,727 |
|
|
$ |
15,637,045,269 |
|
|
|
|
|
|
|
|
The accompanying notes are an integral part of these statements.
97
FIRST BANCORP
CONSOLIDATED STATEMENTS OF INCOME
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Year ended December 31, |
|
| |
|
2005 |
|
|
2004 |
|
|
2003 |
|
Interest income: |
|
|
|
|
|
|
|
|
|
|
|
|
Loans |
|
$ |
772,099,930 |
|
|
$ |
458,180,082 |
|
|
$ |
400,908,876 |
|
Investment securities |
|
|
273,603,902 |
|
|
|
228,417,189 |
|
|
|
143,850,531 |
|
Money market investments |
|
|
21,886,150 |
|
|
|
3,736,452 |
|
|
|
4,707,054 |
|
|
|
|
|
|
|
|
|
|
|
Total interest income |
|
|
1,067,589,982 |
|
|
|
690,333,723 |
|
|
|
549,466,461 |
|
|
|
|
|
|
|
|
|
|
|
Interest expense: |
|
|
|
|
|
|
|
|
|
|
|
|
Deposits |
|
|
393,151,942 |
|
|
|
119,843,691 |
|
|
|
165,126,334 |
|
Federal funds purchased and repurchase agreements |
|
|
179,124,075 |
|
|
|
129,572,722 |
|
|
|
105,705,205 |
|
Advances from FHLB |
|
|
32,756,084 |
|
|
|
27,668,471 |
|
|
|
19,418,432 |
|
Notes payable and other borrowings |
|
|
30,238,672 |
|
|
|
15,767,897 |
|
|
|
7,278,384 |
|
|
|
|
|
|
|
|
|
|
|
Total interest expense |
|
|
635,270,773 |
|
|
|
292,852,781 |
|
|
|
297,528,355 |
|
|
|
|
|
|
|
|
|
|
|
Net interest income |
|
|
432,319,209 |
|
|
|
397,480,942 |
|
|
|
251,938,106 |
|
|
|
|
|
|
|
|
|
|
|
Provision for loan losses |
|
|
50,644,344 |
|
|
|
52,799,550 |
|
|
|
55,915,598 |
|
|
|
|
|
|
|
|
|
|
|
Net interest income after provision
for loan losses |
|
|
381,674,865 |
|
|
|
344,681,392 |
|
|
|
196,022,508 |
|
|
|
|
|
|
|
|
|
|
|
Other income: |
|
|
|
|
|
|
|
|
|
|
|
|
Other service charges on loans |
|
|
5,430,713 |
|
|
|
3,910,483 |
|
|
|
6,522,276 |
|
Service charges on deposit accounts |
|
|
11,796,185 |
|
|
|
10,937,998 |
|
|
|
9,526,946 |
|
Mortgage banking activities |
|
|
3,798,145 |
|
|
|
3,921,135 |
|
|
|
3,013,840 |
|
Net gain on investments |
|
|
12,338,969 |
|
|
|
9,457,190 |
|
|
|
35,590,260 |
|
Rental income |
|
|
3,462,504 |
|
|
|
3,070,697 |
|
|
|
2,223,734 |
|
Gain on sale of credit card portfolio |
|
|
— |
|
|
|
5,532,684 |
|
|
|
32,385,353 |
|
Other operating income |
|
|
26,250,063 |
|
|
|
22,793,769 |
|
|
|
17,535,927 |
|
|
|
|
|
|
|
|
|
|
|
Total other income |
|
|
63,076,579 |
|
|
|
59,623,956 |
|
|
|
106,798,336 |
|
|
|
|
|
|
|
|
|
|
|
Other operating expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
Employees’ compensation and benefits |
|
|
102,077,927 |
|
|
|
82,439,613 |
|
|
|
74,488,194 |
|
Occupancy and equipment |
|
|
47,582,007 |
|
|
|
39,430,288 |
|
|
|
36,363,434 |
|
Business promotion |
|
|
18,717,468 |
|
|
|
16,348,849 |
|
|
|
12,414,820 |
|
Professional fees |
|
|
13,387,333 |
|
|
|
4,165,093 |
|
|
|
2,991,839 |
|
Taxes, other than income taxes |
|
|
9,809,320 |
|
|
|
8,467,962 |
|
|
|
7,404,729 |
|
Insurance and supervisory fees |
|
|
5,509,429 |
|
|
|
4,125,835 |
|
|
|
3,729,860 |
|
Provision for contingencies |
|
|
82,750,000 |
|
|
|
— |
|
|
|
— |
|
Other operating expenses |
|
|
35,298,372 |
|
|
|
25,502,068 |
|
|
|
27,236,805 |
|
|
|
|
|
|
|
|
|
|
|
Total other operating expenses |
|
|
315,131,856 |
|
|
|
180,479,708 |
|
|
|
164,629,681 |
|
|
|
|
|
|
|
|
|
|
|
Income before income tax provision |
|
|
129,619,588 |
|
|
|
223,825,640 |
|
|
|
138,191,163 |
|
Income tax provision |
|
|
15,015,504 |
|
|
|
46,500,247 |
|
|
|
18,297,490 |
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
114,604,084 |
|
|
$ |
177,325,393 |
|
|
$ |
119,893,673 |
|
|
|
|
|
|
|
|
|
|
|
Dividends to preferred stockholders |
|
|
40,275,996 |
|
|
|
40,275,996 |
|
|
|
30,358,863 |
|
|
|
|
|
|
|
|
|
|
|
Net income available to common stockholders |
|
$ |
74,328,088 |
|
|
$ |
137,049,397 |
|
|
$ |
89,534,810 |
|
|
|
|
|
|
|
|
|
|
|
Net income per common share basic: |
|
|
|
|
|
|
|
|
|
|
|
|
Earnings per common share basic |
|
$ |
0.92 |
|
|
$ |
1.70 |
|
|
$ |
1.12 |
|
|
|
|
|
|
|
|
|
|
|
Net income per common share diluted: |
|
|
|
|
|
|
|
|
|
|
|
|
Earnings per common share diluted |
|
$ |
0.90 |
|
|
$ |
1.65 |
|
|
$ |
1.09 |
|
|
|
|
|
|
|
|
|
|
|
Dividends declared per common share |
|
$ |
0.28 |
|
|
$ |
0.24 |
|
|
$ |
0.22 |
|
|
|
|
|
|
|
|
|
|
|
The accompanying notes are an integral part of these statements.
98
FIRST BANCORP
CONSOLIDATED STATEMENTS OF CASH FLOWS
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Year ended December 31, |
|
| |
|
2005 |
|
|
2004 |
|
|
2003 |
|
Cash flows from operating activities: |
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
114,604,084 |
|
|
$ |
177,325,393 |
|
|
$ |
119,893,673 |
|
|
|
|
|
|
|
|
|
|
|
Adjustments to reconcile net income to net cash provided
by operating activities: |
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation |
|
|
15,412,284 |
|
|
|
13,939,369 |
|
|
|
13,761,331 |
|
Amortization of core deposit intangibles |
|
|
3,709,074 |
|
|
|
2,396,620 |
|
|
|
2,396,620 |
|
Provision for loan losses |
|
|
50,644,344 |
|
|
|
52,799,550 |
|
|
|
55,915,598 |
|
Deferred income tax benefit |
|
|
(60,222,881 |
) |
|
|
(6,508,814 |
) |
|
|
(26,744,079 |
) |
Gain on sale of investments, net |
|
|
(20,712,604 |
) |
|
|
(12,156,182 |
) |
|
|
(41,350,820 |
) |
Other-than-temporary impairments on available-for-sale securities |
|
|
8,373,635 |
|
|
|
2,698,992 |
|
|
|
5,760,560 |
|
Unrealized derivative loss (gain) |
|
|
73,442,943 |
|
|
|
(15,528,996 |
) |
|
|
41,136,523 |
|
Net gain on sale of loans |
|
|
(3,635,744 |
) |
|
|
(3,594,875 |
) |
|
|
(2,917,364 |
) |
Amortization of deferred net loan (fees) cost |
|
|
389,049 |
|
|
|
(1,511,254 |
) |
|
|
(2,639,188 |
) |
Amortization of broker placement fees |
|
|
15,123,382 |
|
|
|
13,874,998 |
|
|
|
12,866,952 |
|
Amortization of premium and (discount) on investment securities |
|
|
14,520,096 |
|
|
|
15,090,031 |
|
|
|
17,305,088 |
|
Amortization
of discount on subordinated notes |
|
|
544,582 |
|
|
|
515,029 |
|
|
|
474,618 |
|
Gain on sale of credit card portfolio |
|
|
— |
|
|
|
(5,532,684 |
) |
|
|
(32,385,353 |
) |
Increase (decrease) in accrued income tax payable |
|
|
28,362,574 |
|
|
|
(4,766,394 |
) |
|
|
8,353,011 |
|
Increase in accrued interest receivable |
|
|
(43,996,026 |
) |
|
|
(15,400,487 |
) |
|
|
(982,130 |
) |
Increase in accrued interest payable |
|
|
77,493,499 |
|
|
|
14,587,835 |
|
|
|
12,518,654 |
|
Decrease in other assets |
|
|
5,661,362 |
|
|
|
7,375,482 |
|
|
|
1,657,323 |
|
Increase (decrease) in other liabilities |
|
|
87,254,869 |
|
|
|
4,869,117 |
|
|
|
(2,765,265 |
) |
|
|
|
|
|
|
|
|
|
|
Total adjustments |
|
|
252,364,438 |
|
|
|
63,147,337 |
|
|
|
62,362,079 |
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by operating activities |
|
|
366,968,522 |
|
|
|
240,472,730 |
|
|
|
182,255,752 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from investing activities: |
|
|
|
|
|
|
|
|
|
|
|
|
Principal collected on loans |
|
|
3,823,228,343 |
|
|
|
2,266,859,637 |
|
|
|
1,938,300,698 |
|
Loans originated |
|
|
(6,088,694,602 |
) |
|
|
(4,985,689,733 |
) |
|
|
(3,507,655,892 |
) |
Purchases of loans |
|
|
(454,873,010 |
) |
|
|
(199,970,917 |
) |
|
|
(132,639,610 |
) |
Proceeds from sale of loans |
|
|
122,163,134 |
|
|
|
138,838,749 |
|
|
|
264,126,724 |
|
Proceeds from sale of available-for-sale investment securities |
|
|
252,745,618 |
|
|
|
131,571,934 |
|
|
|
1,439,718,183 |
|
Purchases of securities held-to-maturity |
|
|
(4,757,903,632 |
) |
|
|
(5,996,237,666 |
) |
|
|
(11,580,703,043 |
) |
Purchases of securities available-for-sale |
|
|
(1,227,796,001 |
) |
|
|
(508,236,946 |
) |
|
|
(1,480,586,968 |
) |
Principal repayments and maturities of securities held-to-maturity |
|
|
4,690,680,465 |
|
|
|
5,744,069,157 |
|
|
|
9,144,728,663 |
|
Principal repayments of securities available-for-sale |
|
|
325,987,310 |
|
|
|
341,102,094 |
|
|
|
1,550,033,956 |
|
Additions to premises and equipment |
|
|
(28,920,984 |
) |
|
|
(24,483,512 |
) |
|
|
(11,435,164 |
) |
Increases (decreases) in other equity securities |
|
|
41,690,600 |
|
|
|
(35,250,000 |
) |
|
|
(8,997,500 |
) |
Cash paid
for net assets acquired on acquisition of businesses |
|
|
(78,404,803 |
) |
|
|
— |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
Net cash used in investing activities |
|
|
(3,380,097,562 |
) |
|
|
(3,127,427,203 |
) |
|
|
(2,385,109,953 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from financing activities: |
|
|
|
|
|
|
|
|
|
|
|
|
Net increase in deposits |
|
|
4,120,051,019 |
|
|
|
1,149,976,606 |
|
|
|
1,341,442,350 |
|
Net increase in federal funds purchased and securities
sold under repurchase agreements |
|
|
668,521,087 |
|
|
|
525,888,563 |
|
|
|
855,394,414 |
|
FHLB advances taken (payments) |
|
|
(1,132,000,000 |
) |
|
|
685,000,000 |
|
|
|
540,000,000 |
|
Net proceeds from the issuance of notes payable and other borrowings |
|
|
— |
|
|
|
595,778,616 |
|
|
|
— |
|
Repayments of notes payable and other borrowings |
|
|
(127,992,616 |
) |
|
|
(140,185,000 |
) |
|
|
— |
|
Dividends |
|
|
(62,914,802 |
) |
|
|
(59,593,300 |
) |
|
|
(47,958,718 |
) |
Exercise of stock options |
|
|
2,094,354 |
|
|
|
4,956,314 |
|
|
|
1,119,957 |
|
Issuance of preferred stock, net of cost |
|
|
— |
|
|
|
— |
|
|
|
182,998,539 |
|
Treasury stock acquired |
|
|
(965,079 |
) |
|
|
— |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by financing activities |
|
|
3,466,793,963 |
|
|
|
2,761,821,799 |
|
|
|
2,872,996,542 |
|
|
|
|
|
|
|
|
|
|
|
Net increase (decrease) in cash and cash equivalents |
|
|
453,664,923 |
|
|
|
(125,132,674 |
) |
|
|
670,142,341 |
|
Cash and cash equivalents at beginning of period |
|
|
926,975,163 |
|
|
|
1,052,107,837 |
|
|
|
381,965,496 |
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents at end of period |
|
$ |
1,380,640,086 |
|
|
$ |
926,975,163 |
|
|
$ |
1,052,107,837 |
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents include: |
|
|
|
|
|
|
|
|
|
|
|
|
Cash and due from banks |
|
$ |
106,881,335 |
|
|
$ |
6,211,372 |
|
|
$ |
86,161,347 |
|
Money market investments |
|
|
1,273,758,751 |
|
|
|
920,763,791 |
|
|
|
965,946,490 |
|
|
|
|
|
|
|
|
|
|
|
Total Cash and cash equivalents |
|
$ |
1,380,640,086 |
|
|
$ |
926,975,163 |
|
|
$ |
1,052,107,837 |
|
|
|
|
|
|
|
|
|
|
|
The accompanying notes are an integral part of these statements.
99
FIRST BANCORP
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Year ended December 31, |
|
| |
|
2005 |
|
|
2004 |
|
|
2003 |
|
Preferred Stock: |
|
|
|
|
|
|
|
|
|
|
|
|
Balance at beginning of year |
|
$ |
550,100,000 |
|
|
$ |
550,100,000 |
|
|
$ |
360,500,000 |
|
Shares issued (7.00% Non-cumulative non convertible, Series E) |
|
|
— |
|
|
|
— |
|
|
|
189,600,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at end of year |
|
$ |
550,100,000 |
|
|
$ |
550,100,000 |
|
|
$ |
550,100,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common stock: |
|
|
|
|
|
|
|
|
|
|
|
|
Balance at beginning of year |
|
|
40,389,155 |
|
|
|
40,027,285 |
|
|
|
39,954,535 |
|
Common stock issued under stock option plan before stock split |
|
|
76,373 |
|
|
|
361,870 |
|
|
|
72,750 |
|
Treasury stock acquired before June 30, 2005 stock split |
|
|
(28,000 |
) |
|
|
— |
|
|
|
— |
|
Shares issued as a result of stock split on June 30, 2005 |
|
|
40,437,528 |
|
|
|
— |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at end of year |
|
$ |
80,875,056 |
|
|
$ |
40,389,155 |
|
|
$ |
40,027,285 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Additional paid-in capital: |
|
|
|
|
|
|
|
|
|
|
|
|
Balance at beginning of year |
|
|
4,863,299 |
|
|
|
268,855 |
|
|
|
— |
|
Treasury stock acquired |
|
|
(937,079 |
) |
|
|
— |
|
|
|
— |
|
Issuance cost of preferred stock |
|
|
— |
|
|
|
— |
|
|
|
(778,352 |
) |
Shares issued under stock option plan |
|
|
2,017,981 |
|
|
|
4,594,444 |
|
|
|
1,047,207 |
|
Adjustment for stock split on June 30, 2005 |
|
|
(5,944,201 |
) |
|
|
— |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at end of year |
|
$ |
— |
|
|
$ |
4,863,299 |
|
|
$ |
268,855 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Capital Reserve: |
|
|
|
|
|
|
|
|
|
|
|
|
Balance at beginning of year |
|
|
82,825,000 |
|
|
|
80,000,000 |
|
|
|
70,000,000 |
|
Transfer from retained earnings |
|
|
— |
|
|
|
2,825,000 |
|
|
|
10,000,000 |
|
Transfer to legal surplus |
|
|
(82,825,000 |
) |
|
|
— |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at end of year |
|
$ |
— |
|
|
$ |
82,825,000 |
|
|
$ |
80,000,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Legal surplus: |
|
|
|
|
|
|
|
|
|
|
|
|
Balance at beginning of year |
|
|
183,019,192 |
|
|
|
165,709,122 |
|
|
|
155,192,258 |
|
Transfer from retained earnings |
|
|
— |
|
|
|
17,310,070 |
|
|
|
10,516,864 |
|
Transfer from capital reserve |
|
|
82,825,000 |
|
|
|
— |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at end of year |
|
$ |
265,844,192 |
|
|
$ |
183,019,192 |
|
|
$ |
165,709,122 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Retained earnings: |
|
|
|
|
|
|
|
|
|
|
|
|
Balance at beginning of year |
|
|
299,501,016 |
|
|
|
201,903,993 |
|
|
|
156,309,011 |
|
Net income |
|
|
114,604,084 |
|
|
|
177,325,393 |
|
|
|
119,893,673 |
|
Cash dividend declared on common stock |
|
|
(22,638,806 |
) |
|
|
(19,317,304 |
) |
|
|
(17,599,855 |
) |
Cash dividend declared on preferred stock |
|
|
(40,275,996 |
) |
|
|
(40,275,996 |
) |
|
|
(30,358,863 |
) |
Issuance cost of preferred stock |
|
|
— |
|
|
|
— |
|
|
|
(5,823,109 |
) |
Adjustment for stock split on June 30, 2005 |
|
|
(34,493,327 |
) |
|
|
— |
|
|
|
— |
|
Transfer to capital reserve |
|
|
— |
|
|
|
(2,825,000 |
) |
|
|
(10,000,000 |
) |
Transfer to legal surplus |
|
|
— |
|
|
|
(17,310,070 |
) |
|
|
(10,516,864 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at end of year |
|
$ |
316,696,971 |
|
|
$ |
299,501,016 |
|
|
$ |
201,903,993 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated other comprehensive (loss) income, net of tax: |
|
|
|
|
|
|
|
|
|
|
|
|
Balance at beginning of year |
|
|
43,635,624 |
|
|
|
35,812,500 |
|
|
|
34,066,622 |
|
Other comprehensive (loss) income, net of deferred tax |
|
|
(59,310,908 |
) |
|
|
7,823,124 |
|
|
|
1,745,878 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at end of year |
|
$ |
(15,675,284 |
) |
|
$ |
43,635,624 |
|
|
$ |
35,812,500 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total stockholders’ equity |
|
$ |
1,197,840,935 |
|
|
$ |
1,204,333,286 |
|
|
$ |
1,073,821,755 |
|
|
|
|
|
|
|
|
|
|
|
The accompanying notes are an integral part of these statements.
100
FIRST BANCORP
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Year ended December 31, |
|
| |
|
2005 |
|
|
2004 |
|
|
2003 |
|
Net income |
|
$ |
114,604,084 |
|
|
$ |
177,325,393 |
|
|
$ |
119,893,673 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other comprehensive income: |
|
|
|
|
|
|
|
|
|
|
|
|
| |
Unrealized (losses) gains on securities: |
|
|
|
|
|
|
|
|
|
|
|
|
Unrealized holding (losses) gains arising during the period |
|
|
(47,839,301 |
) |
|
|
17,561,629 |
|
|
|
26,822,165 |
|
Less: Reclassification adjustment
for net gains and other-than-temporary impairments
included in net income |
|
|
(12,382,262 |
) |
|
|
(9,457,190 |
) |
|
|
(35,590,260 |
) |
Income tax benefit (expense) related to items
of other comprehensive income |
|
|
910,655 |
|
|
|
(281,315 |
) |
|
|
10,513,973 |
|
|
|
|
|
|
|
|
|
|
|
Other comprehensive (loss) income for the period, net of tax |
|
|
(59,310,908 |
) |
|
|
7,823,124 |
|
|
|
1,745,878 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total comprehensive income |
|
$ |
55,293,176 |
|
|
$ |
185,148,517 |
|
|
$ |
121,639,551 |
|
|
|
|
|
|
|
|
|
|
|
The accompanying notes are an integral part of these statements.
101
FIRST BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 — Nature of Business and Summary of Significant Accounting Policies
The accompanying financial statements have been prepared in conformity with accounting
principles generally accepted in the United States of America (“GAAP”) and with prevailing
practices within the financial services industry. The following is a description of First BanCorp’s
(“First BanCorp” or “the Corporation”) most significant policies:
Nature of business
First BanCorp is a publicly-owned, Puerto Rico-chartered bank holding company that is subject
to regulation, supervision and examination by the Board of Governors of the Federal Reserve System.
The Corporation is a full service provider of financial services and products with operations in
Puerto Rico, the United States and the US and British Virgin Islands.
The Corporation provides a wide range of financial services for retail, commercial and institutional clients.
At December 31, 2005, the Corporation controlled four wholly-owned subsidiaries: FirstBank
Puerto Rico (“FirstBank” or the “Bank”), FirstBank Insurance Agency, Inc., Grupo Empresas de
Servicios Financieros (d/b/a “PR Finance Group”) and Ponce General Corporation, Inc. (“Ponce
General”). FirstBank is a Puerto Rico-chartered commercial bank, FirstBank Insurance Agency is a
Puerto Rico-chartered insurance agency, PR Finance Group is a domestic corporation and Ponce
General is the holding company of a federally chartered stock savings association, FirstBank
Florida. FirstBank is subject to the supervision, examination and regulation of both the Office of
the Commissioner of Financial Institutions of the Commonwealth of Puerto Rico and the Federal
Deposit Insurance Corporation (the “FDIC”). Deposits are insured through the FDIC Deposit Insurance
Fund.
Within FirstBank, there are two separately regulated businesses: (1) the Virgin
Islands operations; (2) the Miami loan agency.
The U.S. Virgin Islands operations of FirstBank are subject to regulation and examination by the
United States Virgin Islands Banking Board and the British Virgin Islands
operations are subject to regulation by the British Virgin Islands
Financial Services
Commission. FirstBank’s loan agency in the state of Florida is regulated by the Office of Financial
Regulation of the state of Florida, the Federal Reserve Bank of Atlanta and Federal Reserve Bank of
New York.
As of December 31, 2005, the Corporation had total assets of $19.9 billion, total
deposits of $12.4 billion and total stockholders’ equity of $1.2 billion.
FirstBank Insurance Agency is subject to the supervision, examination and regulation by the
Office of the Insurance Commissioner of the Commonwealth of Puerto Rico. PR Finance Group is
subject to the supervision, examination and regulation of the Office of the Commissioner of
Financial Institutions of the Commonwealth of Puerto Rico. FirstBank Florida is subject to the
supervision, examination and regulation of the Office of Thrift Supervision (the “OTS”).
At December 31, 2005, FirstBank conducted its business through its main offices located in San
Juan, Puerto Rico, forty-six full service banking branches in Puerto Rico, fourteen branches in the
United States Virgin Islands (USVI) and British Virgin Islands (BVI) and a loan agency in Coral
Gables, Florida (USA). FirstBank had four wholly-owned subsidiaries with operations in Puerto
Rico; First Leasing and Rental Corporation, a vehicle leasing and daily rental company with nine
offices in Puerto Rico; First Federal Finance Corp. (d/b/a Money Express La Financiera), a finance
company with thirty-seven offices in Puerto Rico; First Mortgage, Inc., a residential mortgage loan
origination company with thirty offices in FirstBank branches and at stand alone sites; and
FirstBank Overseas Corporation, an international banking entity under the International Banking
Entity Act of Puerto Rico. FirstBank had three subsidiaries with operations outside of Puerto
Rico; First Insurance Agency VI, Inc., an insurance agency with three offices that sell insurance
products in the USVI; First Trade, Inc., which provides foreign sales corporation management
services with an office in the USVI and an office in Barbados; and First Express, a small loans
company with three offices in the USVI.
102
Business combinations
On March 31, 2005, the Corporation completed the acquisition of 100% of the outstanding common
shares of Ponce General Corporation, the holding company of Unibank, a thrift subsidiary,
and Ponce Realty,
with a total of eleven financial service facilities in the state of Florida. The purpose of the acquisition was to build a platform in Florida from which to
initiate further expansion into the United States. As of the acquisition date, excluding the effect
of purchase accounting entries, Ponce General had approximately
$546.2 million in assets, $476.0
million in loans composed mainly of residential and commercial mortgage loans amounting to
approximately $425.8 million, commercial and construction loans amounting to approximately $28.2
million and consumer loans amounting to approximately $22.1 million and $439.1 million in deposits.
The consideration consisted mainly of payments made to principal and minority shareholders of Ponce
General’s outstanding common stock at acquisition date. This consideration along with other direct
acquisition costs and liabilities incurred led to a total acquisition cost of approximately $101.9
million. The purchase price resulted in a premium of approximately $36 million that was mainly
allocated to core deposit intangibles and goodwill. The Corporation subsequently changed the name
of Unibank to FirstBank Florida.
FirstBank Florida is a federally chartered stock savings association which is headquartered in
Miami, Florida (USA) and currently is the only operating subsidiary of Ponce General. FirstBank
Florida provides a wide range of banking services to individual and corporate customers through its
eight branches in Florida (USA).
Principles of consolidation
The consolidated financial statements include the accounts of the Corporation and its
subsidiaries. All significant intercompany balances and transactions have been eliminated in
consolidation.
Statutory business trusts that are wholly-owned by the Corporation and are issuers of trust
preferred securities are not consolidated in the Corporation’s consolidated financial statements in
accordance with the provisions of Financial Interpretation No. 46R (“FIN 46R”). “Consolidation of
Variable Interest Entities – an Interpretation of ARB No. 51”.
Reclassifications
For purposes of comparability, certain prior period amounts have been reclassified to conform
to the 2005 presentation.
Use of estimates in the preparation of financial statements
The preparation of financial statements in conformity with accounting principles generally
accepted in the United States of America requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and contingent assets and liabilities at the
date of the financial statements, and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Stock split
All references to the numbers of common shares and per share amounts in the financial
statements and notes to the financial statements, except for the number of shares issued,
outstanding and held in
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treasury at December 31, 2004 and 2003 presented in the consolidated statements of changes in
stockholders’ equity, have been restated to reflect the June 30, 2005 two-for-one common stock
split.
Cash and cash equivalents
For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts
due from banks and short-term money market instruments with original maturities of three months or
less.
Securities purchased under agreements to resell
The Corporation purchases securities under agreements to resell the same securities. The
counterparty retains control over the securities acquired. Accordingly, amounts advanced under
these agreements represent short-term loans and are reflected as assets in the statements of
financial condition. The Corporation monitors the market value of the underlying securities as
compared to the related receivable, including accrued interest, and requests additional collateral
when deemed appropriate.
Investment securities
The Corporation classifies its investments in debt and equity securities into one of four
categories:
Held-to-maturity - Securities which the entity has the intent and ability to hold-to-maturity.
These securities are carried at amortized cost. The Corporation may not sell or transfer
held-to-maturity securities without calling into question its intent to hold other debt securities
to maturity, unless a nonrecurring or unusual event that could not have been reasonably anticipated
has occurred.
Trading - Securities that are bought and held principally for the purpose of selling them in
the near term. These securities are carried at fair value, with unrealized gains and losses
reported in earnings. At December 31, 2005 and 2004 the Corporation did not hold investment
securities for trading purposes.
Available-for-sale - Securities not classified as held-to-maturity or trading. These
securities are carried at fair value, with unrealized holding gains and losses, net of deferred
tax, reported in other comprehensive income as a separate component of stockholders’ equity.
Other equity securities - Equity securities that do not have readily available fair values are
classified as other equity securities in the consolidated statements of financial condition. These securities
are stated at the lower of cost or realizable value. This category is principally composed of stock
that is owned by the Corporation to comply with Federal Home Loan Bank (FHLB) regulatory
requirements. Their realizable value equals their cost.
Premiums and discounts are amortized as an adjustment to interest income on investments over
the life of the related securities under the interest method. Net realized gains and losses and
valuation adjustments considered other-than-temporary, if any, related to investment securities are
determined using the specific identification method and are reported in Other Income as net gain on
sale of investments. Purchases and sales of securities are recognized on a trade-date basis.
Evaluation of other-than-temporary impairment on held-to-maturity and available-for-sale
securities
The Corporation evaluates for impairment its debt and equity securities when their fair market
value has remained below cost for six months or more, or earlier if other factors indicative of
potential impairment exist. Investments are considered to be impaired when their cost exceeds fair
market value.
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The Corporation evaluates if the impairment is other-than-temporary depending upon whether the
portfolio is of fixed income securities or equity securities as further described below. The
Corporation employs a systematic methodology that considers all available evidence in evaluating a
potential impairment of its investments.
The impairment analysis of the fixed income investments places special emphasis on the
analysis of the cash position of the issuer, its cash and capital generation capacity, which could
increase or diminish the issuer’s ability to repay its bond obligations. The Corporation also
considers its intent and ability to hold the fixed income securities until recovery. If management
believes, based on the analysis, that the issuer will not be able to service its debt and pay its
obligations in a timely manner, the security is written down to management’s estimate of net
realizable value. For securities written down to its estimated net realizable value, any accrued
and uncollected interest is also reversed. Interest income is then recognized when collected.
The impairment analysis of equity securities is performed and reviewed on an ongoing basis
based on the latest financial information and any supporting research report made by a major
brokerage firm. This analysis is very subjective and based, among other things, on relevant
financial data such as capitalization, cash flow, liquidity, systematic risk, and debt outstanding
of the issuer. Management also considers the issuer’s industry trends, the historical performance
of the stock, as well as the Corporation’s intent to hold the security for an extended period. If
management believes there is a low probability of recovering book value in a reasonable time frame,
then an impairment will be recorded by writing the security down to market value. As previously
mentioned, equity securities are monitored on an ongoing basis but special attention is given to
those securities that have experienced a decline in fair value for six months or more. An
impairment charge is generally recognized when the fair value of an equity security has remained
significantly below cost for a period of twelve months or more.
Loans
Loans are stated at the principal outstanding balance, net of unearned interest, unamortized
deferred origination fees and costs and unamortized premiums and discounts. Fees collected and
costs incurred in the origination of new loans are deferred and amortized using the interest method
or a method which approximates the interest method over the term of the loan as an adjustment to
interest yield. Unearned interest on certain personal, auto loans and finance leases is recognized as income under
a method which approximates the interest method. When a loan is paid off or sold, any unamortized
net deferred fee (cost) is credited (charged) to income.
Loans on which the recognition of interest income has been discontinued are designated as
non-accruing. When loans are placed on non-accruing status, any accrued but uncollected interest
income is reversed and charged against interest income. Consumer, commercial and mortgage loans are
classified as non-accruing when interest and principal have not been received for a period of 90
days or more. This policy is also applied to all impaired loans based upon an evaluation of the
risk characteristics of said loans, loss experience, economic conditions and other pertinent
factors. Loan losses are charged and recoveries are credited to the allowance for loan losses.
Closed-end consumer loans and leases are charged-off when payments are 120 days in arrears.
Open-end (revolving credit) consumer loans are charged-off when payments are 180 days in arrears.
Loans held for sale
Loans held for sale are stated at the lower of cost or market. The amount by which cost
exceeds market value in the aggregate portfolio of loans held for sale, if any, is accounted for as
a valuation allowance with changes therein included in the determination of net income. At December
31, 2005, the aggregate
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cost exceeds the fair value of loans held for sale and therefore loans held for sale were adjusted
down to reflect their fair value. At December 31, 2004, the aggregate fair value of loans held for
sale exceeded their cost.
Allowance for loan losses
The Corporation follows a systematic methodology to establish and evaluate the adequacy of the
allowance for loan losses to provide for inherent losses in the loan portfolio. This methodology
includes the consideration of factors such as current economic conditions, portfolio risk
characteristics, prior loss experience and results of periodic credit reviews of individual loans.
The provision for loan losses charged to current operations is based on such methodology. Loan
losses are charged and recoveries are credited to the allowance for loan losses.
The methodology used to establish the allowance for loan losses is based on SFAS No. 114
“Accounting by Creditors for Impairment of a Loan” (as amended by SFAS No. 118) and SFAS No. 5
“Accounting for Contingencies.” Under SFAS No. 114, commercial loans over a predefined amount are
identified for impairment evaluation on an individual basis.
The Corporation has defined impaired loans as loans with interest and/or principal past due 90
days or more and other specific loans for which, based on current information and events, it is
probable that the debtor will be unable to pay all amounts due according to the contractual terms
of the loan agreement. The Corporation measures impairment individually for those commercial, real
estate and construction loans with a principal balance exceeding $1 million. An allowance for
impaired loans is established based on the present value of expected future cash flows or the fair
value of the collateral, if the loan is collateral dependent. Groups of small balance, homogeneous
loans are collectively evaluated for impairment considering among other factors, historical
charge-off experience, existing economic conditions and risk characteristics relevant to the
particular loan category.