ORIENTAL FINANCIAL GROUP INC - 10-Q Quarterly Report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 2003

[ ]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to

Commission File Number 001-12647

Oriental Financial Group Inc.


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

Principal Executive Offices:

998 San Roberto Street
Professional Offices Park, S.E.
San Juan, Puerto Rico 00926
Telephone Number: (787) 771-6800

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes [x] No [ ].

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes [x] No [ ].

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

19,785,942 common shares ($1.00 par value per share)

outstanding as of December 31, 2003

TABLE OF CONTENTS


			PAGE

PART - 1	FINANCIAL INFORMATION:		2
Item - 1		Financial Statements	2
		Unaudited consolidated statements of financial condition at December 31, 2003 and June 30, 2003	2
		Unaudited consolidated statements of income for the quarter and six-month periods ended December 31, 2003 and 2002	3
		Unaudited consolidated statements of changes in stockholders’ equity for the six-month periods ended December 31, 2003 and 2002	4
		Unaudited consolidated statements of comprehensive income (loss) for the quarter and six-month periods ended December 31, 2003 and 2002	4
		Unaudited consolidated statements of cash flows for the six-month periods ended December 31, 2003 and 2002	5
		Notes to unaudited consolidated financial statements	6
Item - 2		Management’s Discussion and Analysis of Financial Condition and Results of Operations	18
Item - 3		Quantitative and Qualitative Disclosures about Market Risk	36
Item - 4		Controls and Procedures	39
PART - 2	OTHER INFORMATION:		40
Item - 1		Legal Proceedings	40
Item - 2		Change in Securities and Use of Proceeds	40
Item - 3		Defaults upon Senior Securities	41
Item - 4		Submissions of Matters to a Vote of Security Holders	41
Item - 5		Other Information	41
Item - 6		Exhibits and Reports on Form 8-K	42
		Signatures	42
		Certifications

PART 1 - FINANCIAL INFORMATION
Item 1 - Financial Statements

UNAUDITED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
DECEMBER 31, 2003 AND JUNE 30, 2003
(In thousands, except shares information)


				December 31,			June 30,
				2003			2003

ASSETS
Cash and due from banks				$	7,746		$	15,945

Investments:
	Short term investments				3,645			1,152

	Trading securities, at fair value with amortized cost of $1,740 (June 30, 2003 - - $998)				1,760			1,037

	Investment securities available-for-sale, at fair value with amortized cost of $1,402,700 (June 30, 2003 - $2,162,480):
			Securities pledged that can be repledged		1,022,332			1,446,385
			Other investment securities		399,591			761,219

			Total investment securities available-for-sale		1,421,923			2,207,604

	Investment securities held-to-maturity, at amortized cost with fair value of $1,106,483 :
			Securities pledged that can be repledged		854,082			—
			Other investment securities		235,686			—

			Total investment securities held-to-maturity		1,089,768			—

	Federal Home Loan Bank (FHLB) stock, at cost				22,537			22,537

		Total investments			2,539,633			2,232,330

Securities sold but not yet delivered					7,304			1,894

Loans:
	Mortgage loans held-for-sale, at lower of cost or market				34,332			9,198
	Loans receivable, net of allowance for loan losses of $6,020 (June 30, 2003 - $5,031)				677,095			719,264

		Total loans, net			711,427			728,462

Accrued interest receivable					19,341			17,716
Foreclosed real estate, net					601			536
Premises and equipment, net					18,503			16,162
Other assets					39,688			27,506

Total assets				$	3,344,243		$	3,040,551

LIABILITIES AND STOCKHOLDERS’ EQUITY
Deposits:
	Demand deposits			$	115,955		$	132,328
	Saving accounts				87,337			92,210
	Individual retirement accounts				361,120			348,346
	Certificates of deposit				513,339			471,381

		Total deposits			1,077,751			1,044,265

Borrowings:
	Securities sold under agreements to repurchase				1,605,647			1,400,598
	Advances from FHLB				301,000			130,000
	Subordinated capital notes				72,166			36,083
	Term notes				15,000			15,000

		Total borrowings			1,993,813			1,581,681

Securities purchased but not yet received					317			152,219

Accrued expenses and other liabilities					48,845			60,706

Total liabilities					3,120,726			2,838,871

Commitments and contingencies
Stockholders’ equity:
	Preferred stock, $1 par value; 5,000,000 shares authorized; $25 liquidation value; 1,340,000 shares of Series A and 1,380,000 shares of Series B issued and outstanding [June 30, 2003 - 1,340,000 shares of Series A]				68,000			33,500
	Common stock, $1 par value; 40,000,000 shares authorized; 20,028,383 shares issued (June 30, 2003 - 19,684,343 shares)				20,028			19,684
	Additional paid-in capital				73,035			57,236
	Legal surplus				23,371			21,099
	Retained earnings				79,926			106,358
	Treasury stock, at cost, 242,441 shares (June 30, 2003 - 2,025,363 shares)				(4,473	)		(35,888	)
	Accumulated other comprehensive loss, net of tax effect of $3,407 (June 30, 2003 - $1,566)				(36,370	)		(309	)

	Total stockholders’ equity				223,517			201,680

Total liabilities and stockholders’ equity				$	3,344,243		$	3,040,551

See notes to consolidated financial statements.

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UNAUDITED CONSOLIDATED STATEMENTS OF INCOME
FOR THE QUARTER AND SIX-MONTH PERIODS ENDED DECEMBER 31, 2003 AND 2002
(In thousands, except per share information)


				Quarter Period						Six-Month Period

				2003			2002			2003			2002

Interest income:
Loans				$	13,403		$	12,812		$	27,033		$	25,447
Mortgage-backed securities					26,563			24,023			48,734			48,423
Investment securities					2,066			852			3,591			1,478
Short term investments					53			164			93			218

		Total interest income			42,085			37,851			79,451			75,566

Interest expense:
Deposits					7,763			8,512			15,303			17,333
Securities sold under agreements to repurchase					8,444			8,311			16,940			16,435
Other borrowed funds					2,107			2,088			4,034			4,179
Subordinated capital notes					825			503			1,329			1,015

		Total interest expense			19,139			19,414			37,606			38,962

Net interest income					22,946			18,437			41,845			36,604
Provision for loan losses					1,014			1,100			2,354			1,940

Net interest income after provision for loan losses					21,932			17,337			39,491			34,664

Non-interest income (losses):
Trust, money management, brokerage and insurance fees:
			Commissions and fees from fiduciary activities		2,145			1,431			4,304			2,871
			Commissions, broker fees and other		1,559			1,821			3,420			2,985
			Insurance commissions and fees		590			722			1,133			957
Banking service revenues					1,709			1,458			3,405			2,978
Net gain (loss) on sale and valuation of:
		Mortgage banking activities			1,708			1,709			4,454			3,651
		Sale of securities available-for-sale			2,247			2,056			6,211			6,388
		Derivatives activities			(608	)		(725	)		(660	)		(3,990	)
		Trading securities			(17	)		120			(9	)		540
		Premises and equipment			—			—			—			(220	)
		Other			24			—			39			—

		Total non-interest income, net			9,357			8,592			22,297			16,160

Non-interest expenses:
Compensation and employees’ benefits					5,719			4,526			11,774			9,168
Occupancy and equipment					2,324			2,193			4,618			4,353
Advertising and business promotion					2,097			1,763			4,167			3,557
Professional and service fees					1,435			1,517			3,075			3,344
Communication					471			397			924			821
Taxes, other than payroll and income taxes					433			388			865			776
Printing, postage, stationery and supplies					295			236			589			510
Insurance, including deposit insurance					198			205			393			347
Other					1,631			1,246			3,578			2,433

		Total non-interest expenses			14,603			12,471			29,983			25,309

Income before income taxes					16,686			13,458			31,805			25,515
	Income tax expense				(998	)		(943	)		(2,558	)		(1,426	)

Net income					15,688			12,515			29,247			24,089
	Less: Dividends on preferred stock				(1,200	)		(597	)		(1,797	)		(1,193	)

Net income available to common shareholders				$	14,488		$	11,918		$	27,450		$	22,896

Income per common share:
Basic				$	0.73		$	0.62		$	1.40		$	1.21

Diluted				$	0.70		$	0.59		$	1.33		$	1.13

Average common shares outstanding					19,714			19,095			19,582			18,984
Average potential common share-options					973			1,178			1,044			1,212

					20,687			20,273			20,626			20,196

Cash dividends per share of common stock				$	0.14		$	0.13		$	0.27		$	0.24

See notes to consolidated financial statements.

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UNAUDITED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
FOR THE SIX-MONTH PERIODS ENDED DECEMBER 31, 2003 AND 2002
(In thousands)


CHANGES IN STOCKHOLDERS’ EQUITY:			2003			2002

Preferred stock:
	Balance at beginning of period		$	33,500		$	33,500
	Issuance of preferred stock			34,500			—

		Balance at end of period		68,000			33,500

Common stock:
	Balance at beginning of period			19,684			15,300
	Stock options exercised			344			158
	Stock split effected in the form of a dividend			—			3,865

		Balance at end of period		20,028			19,323

Additional paid-in capital:
	Balance at beginning of period			57,236			52,670
	Stock options exercised			2,716			1,590
	Preferred stock issuance costs			(1,443	)		—
	Stock dividend			14,526			—

		Balance at end of period		73,035			54,260

Legal surplus:
	Balance at beginning of period			21,099			15,997
	Transfer from retained earnings			2,272			2,459

		Balance at end of period		23,371			18,456

Retained earnings:
	Balance at beginning of period			106,358			75,806
	Net income			29,247			24,089
	Cash dividends declared on common stock			(5,275	)		(4,500	)
	Stock dividend and stock split effected in the form of a dividend			(46,335	)		(3,865	)
	Cash dividends declared on preferred stock			(1,797	)		(1,193	)
	Transfer to legal surplus			(2,272	)		(2,459	)

		Balance at end of period		79,926			87,878

Treasury stock:
	Balance at beginning of period			(35,888	)		(33,674	)
	Stock purchased			(394	)		(944	)
	Stock dividend			31,809			—

		Balance at end of period		(4,473	)		(34,618	)

Accumulated other comprehensive income (loss), net of deferred tax:
	Balance at beginning of period			(309	)		6,830
	Other comprehensive income (loss), net of tax			(36,061	)		7,947

		Balance at end of period		(36,370	)		14,777

Total stockholders’ equity			$	223,517		$	193,576

UNAUDITED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
FOR THE QUARTER AND SIX-MONTH PERIODS ENDED DECEMBER 31, 2003 AND 2002
(In thousands)


		Quarter Period						Six-Month Period

COMPREHENSIVE INCOME (LOSS):		2003			2002			2003			2002

Net income		$	15,688		$	12,515		$	29,247		$	24,089

Other comprehensive income (loss), net of tax:
	Unrealized gain (loss) on securities available-for-sale arising during the period	$	669		$	7,906		$	(47,721	)	$	31,964
	Realized gains on investment securities available-for-sale included in net income		(2,247	)		(2,056	)		(6,211	)		(6,388	)
	Unrealized gain (loss) on derivatives designated as cash flows hedges arising during the period		1,185			(6,506	)		5,376			(23,105	)
	Realized loss on derivatives designated as cash flow hedges included in net income		4,609			3,393			8,828			7,221
	Amount reclassified into earnings during the period related to transition adjustment on derivative activities		93			32			260			125
	Income tax effect related to unrealized (gain) loss on securities available-for-sale		841			(1,364	)		3,407			(1,870	)

Other comprehensive income (loss) for the period			5,150			1,405			(36,061	)		7,947

Comprehensive income (loss)		$	20,838		$	13,920		$	(6,814	)	$	32,036

See notes to consolidated financial statements.

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UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX-MONTH PERIODS ENDED DECEMBER 31, 2003 AND 2002
(In thousands)


					2003			2002

Cash flows from operating activities:
		Net income			$	29,247		$	24,089

		Adjustments to reconcile net income to net cash used in operating activities:
			Amortization of deferred loan origination fees and costs			(5,092	)		(764	)
			Amortization of premiums and accretion of discounts on investment securities, net			6,788			(1,815	)
			Depreciation and amortization of premises and equipment			2,302			2,263
			Deferred income tax benefit			(89	)		(1,512	)
			Provision for loan losses			2,354			1,940
			Loss (gain) on:
				Sale of securities available-for-sale		(6,211	)		(6,388	)
				Mortgage banking activities		(4,454	)		(3,651	)
				Derivatives activities		660			3,990
				Sale of premises and equipment		—			220
			Originations of loans held-for-sale			(170,437	)		(53,579	)
			Proceeds from sale of loans held-for-sale			87,690			2,610
			Net decrease (increase) in:
				Trading securities		(723	)		7,811
				Accrued interest receivable		(1,625	)		(1,558	)
				Other assets		(2,537	)		(675	)
			Net increase in:
				Accrued interest on deposits and borrowings		1,527			395
				Other liabilities		234			4,638

		Total adjustments				(89,613	)		(46,075	)

Net cash used in operating activities						(60,366	)		(21,986	)

Cash flows from investing activities:
		Purchases of:
			Investment securities available-for-sale			(1,417,229	)		(748,747	)
			Investment securities held-to-maturity			(437,167	)		—
			FHLB stock			—			(17,320	)
		Net redemption / (purchases) of equity options				(1,262	)		156
		Maturities and redemptions of:
			Investment securities available-for-sale			513,090			415,941
			Investment securities held-to-maturity			497,275			—
			FHLB stock			—			17,320
		Proceeds from sale of:
			Investment securities available-for-sale			394,045			206,438
		Loan production:
			Origination and purchase of loans, excluding loans held-for-sale, net			(50,202	)		(154,609	)
			Principal repayment of loans			97,235			72,862
		Contribution to Statutory Trust II				(1,083	)		—
		Capital expenditures				(4,643	)		(2,221	)

	Net cash used in investing activities					(409,941	)		(210,180	)

Cash flows from financing activities:
		Net increase (decrease) in:
			Demand, saving and time (including IRA accounts) deposits			24,856			(14,457	)
			Securities sold under agreements to repurchase			205,049			250,419
		Proceeds from:
			Advances from FHLB			620,400			467,460
			Exercise of stock options			3,060			1,748
		Repayments of advances from FHLB				(449,400	)		(464,660	)
		Issuance of subordinated capital notes				35,043			—
		Issuance of preferred stock, net				33,057			—
		Common stock purchased				(394	)		(944	)
		Dividends paid				(7,070	)		(5,326	)

			Net cash provided by financing activities			464,601			234,240

Net change in cash and cash equivalents						(5,706	)		2,074
		Cash and cash equivalents at beginning of period				17,097			10,312

Cash and cash equivalents at end of period					$	11,391		$	12,386

Cash and cash equivalents include:
		Cash and due from banks			$	7,746		$	11,508
		Short term investments				3,645			878

					$	11,391		$	12,386

Supplemental Cash Flow Disclosure and Schedule of Noncash Activities:
		Interest paid			$	21,521		$	19,020

		Income taxes paid			$	1,808		$	—

		Real estate loans securitized into mortgage-backed securities			$	58,077		$	48,522

		Investment securities available-for-sale transferred to held-to-maturtity			$	856,037		$	—

		Accrued dividend payable			$	2,770		$	2,432

		Other comprehensive income (loss) for the period			$	(36,061	)	$	7,947

		Securities and loans sold but not yet delivered			$	7,304		$	16,884

		Securities purchased but not yet received			$	317		$	90,550

		Transfer from loans to foreclosed real estate			$	708		$	410

		Stock dividend and stock split effected in the form of a dividend			$	46,335		$	3,865

See notes to consolidated financial statements.

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ORIENTAL FINANCIAL GROUP INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 – BASIS OF PRESENTATION:

The accounting and reporting policies of Oriental Financial Group Inc. (the “Group” or “Oriental”) conform with accounting principles generally accepted in the United States of America (“GAAP”) and to financial services industry practices.

The unaudited Consolidated Financial Statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). In the opinion of management, these financial statements include all adjustments (which consist of normal recurring accruals) necessary, to present fairly the consolidated financial condition as of December 31, 2003 and June 30, 2003, and the results of operations and cash flows for the six-month periods ended December 31, 2003 and 2002. All significant intercompany balances and transactions have been eliminated in the accompanying unaudited consolidated financial statements. Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such SEC rules and regulations. Management believes that the disclosures made are adequate to make the information presented not misleading. Financial information as of June 30, 2003 has been derived from the Group’s audited Consolidated Financial Statements. The results of operations and cash flows for the six-month periods ended December 31, 2003 and 2002 are not necessarily indicative of the results to be expected for the full year. For further information, refer to the Consolidated Financial Statements and footnotes thereto for the year ended June 30, 2003, included in the Group’s Annual Report on Form 10-K.

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

Nature of Operations

Oriental is a financial holding company that provides a wide range of financial services such as retail and commercial banking, mortgage banking, and commercial and consumer lending, as well as financial planning, insurance sales, money management and investment brokerage services, and corporate and individual trust services. The Group focuses its marketing on attracting professional consumer and commercial customers. It operates through three major business segments, Retail Banking, Treasury, and Financial Services, which are comprised of four subsidiaries, Oriental Bank and Trust (the “Bank”), Oriental Financial Services Corp. (“Oriental Financial Services”), Oriental Insurance, Inc. (“Oriental Insurance”) and Caribbean Pension Consultants, Inc. The main offices of the Group and most of its subsidiaries are located in San Juan, Puerto Rico. Note 9 to the consolidated financial statements presents further information about the operations of the Group’s business segments.

Oriental is incorporated under the laws of the Commonwealth of Puerto Rico and operates under U.S. and Puerto Rico banking laws and regulations. The Group is subject to examination, regulation and periodic reporting under the Bank Holding Company Act of 1956, as amended, which is administered by the Board of Governors of the Federal Reserve System. The Bank operates through twenty-three branches located throughout Puerto Rico and is subject to the supervision, examination and regulation of the Office of the Commissioner of Financial Institutions of Puerto Rico and the Federal Deposit Insurance Corporation (FDIC), which insures its deposits through the Savings Association Insurance Fund (SAIF). The Bank also operates an international banking entity, which is a unit of the bank named O.B.T. International Bank, pursuant to the International Banking Center Regulatory Act of Puerto Rico, as amended (the “IBE Act”). In November 2003, the Group organized a new international banking entity named Oriental International Bank Inc. as a wholly owned subsidiary of Oriental Bank and Trust. The Group transferred as of January 1, 2004 substantially all the assets of O.B.T. International Bank to the new subsidiary. The international banking entity offers the Bank certain Puerto Rico tax advantages and its services are limited under Puerto Rico law to persons and assets located outside of Puerto Rico. Oriental Financial Services is subject to the supervision, examination and regulation of the National Association of Securities Dealers, Inc., the SEC, and the Office of the Commissioner of Financial Institutions of Puerto Rico. Oriental Insurance is subject to the supervision, examination and regulation of the Office of the Commissioner of Insurance of Puerto Rico.

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Significant Accounting Policies

The consolidated financial statements of the Group are prepared in accordance with GAAP and with general practices within the financial industry. In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amount of revenues and expenses during the reporting period. Actual results could differ from those estimates. The Group believes that of its significant accounting policies, the following may involve a higher degree of judgement and complexity.

• Allowance for Loan Losses

The Group assesses the overall risks in its loan portfolio and establishes and maintains an allowance for probable losses thereon. The allowance for loan losses is maintained at a level sufficient to provide for estimated loan losses based on the evaluation of known and inherent risks in the Group’s loan portfolio. The Group’s management evaluates the adequacy of the allowance for loan losses on a quarterly basis. Based on current and expected economic conditions, the expected level of net loan losses and the methodology established to evaluate the adequacy of the allowance for loan losses, management considers that the allowance for loan losses is adequate to absorb probable losses on its loan portfolio. Any significant changes in these considerations would have an impact on the allowance for loan losses. See Item 2 “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Allowance for Loan Losses and Non-Performing Assets” for a detailed description of the Group’s estimation process and methodology related to the allowance for loan losses.

• Financial Instruments

Certain financial instruments including derivatives, hedged items and investment securities available-for-sale are recorded at fair value and unrealized gains and losses are recorded in other comprehensive income (loss) or other gains and losses as appropriate. Fair values are based on listed market prices, if available. If listed market prices are not available, fair value is determined based on other relevant factors including price quotations for similar instruments. Fair value for certain derivative contracts are derived from pricing models that consider current market and contractual prices for the underlying financial instruments as well as time valued and yield curve or volatility factors underlying the positions.

• Impairment of Investment Securities

The Group evaluates for impairment its investment securities on a quarterly basis or earlier if other factors indicative of potential impairment exist. An impairment charge in the consolidated statements of income is recognized when the decline in the fair value of the securities below their cost basis is judged to be other-than-temporary. The Group considers various factors in determining whether it should recognize an impairment charge, including, but not limited to the length of time and extent to which the fair value has been less than its cost basis, expectations of recoverability of its original investment, the employment of a systematic methodology that considers available evidence in evaluating potential impairment, available secondary market prices from broker/dealers, and the Group’s intention and ability to hold the security for a period of time sufficient to allow for any anticipated recovery in fair value.

The impairment analysis on the mortgage backed securities is done placing special emphasis on the analysis of the trustee and collateral manager monthly reports, as well as on sensitivity and expected cash flow analysis made by major brokerage houses. The Group also considers its intent and ability to hold these securities. If management believes, based on the analysis, that the principal, and available secondary market prices from broker/dealer and interest obligations on any mortgage and other asset backed security will not be received in a timely manner, the security is written down to fair value.

The equity securities impairment analyses are performed and reviewed quarterly based on the latest financial information and any supporting research report made by a major brokerage house. These analyses are subjective and based, among other things, on relevant financial data such as capitalization, cash flow, liquidity, systematic risk and debt outstanding. Management also considers the industry trends, the historical performance of the stock, as well as the Group’s intent to hold the security. If management believes there is a low probability of achieving book value in a reasonable time frame, then an impairment is recorded by writing down the security to fair value.

Stock Option Plans

At December 31, 2003, the Group has four stock-based employee compensation plans: the 1988, 1996, 1998, and 2000 Incentive Stock Option Plans. These plans offer key officers, directors and employees an opportunity to purchase shares of the Group’s common stock. The Compensation Committee of the Board of Directors has sole authority and absolute discretion as

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to the number of stock options to be granted, their vesting rights, and the options’ exercise prices. The plans provide for a proportionate adjustment in the exercise price and the number of shares that can be purchased in case of a stock split, reclassification of stock, and a merger or reorganization. Stock options vest upon completion of specified years of service.

The Group follows the intrinsic value-based method of accounting for measuring compensation expense, if any. Compensation expense is generally recognized for any excess of the quoted market price of the Group’s stock at measurement date over the amount an employee must pay to acquire the stock. No stock-based employee compensation cost is reflected in net income, as all options granted during the quarters and six-month periods ended December 31, 2003 and 2002 under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per share if the Group had applied the fair value recognition provisions:


						Six-Month Periods Ended
		Quarters Ended December 31,				December 31,
		2003		2002		2003		2002

(In thousands, except for per share data)
Net income, as reported		$	15,688	$	12,515	$	29,247	$	24,089
	Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards		372		305		744		610

Pro forma net income		$	15,316	$	12,210	$	28,503	$	23,479

Earning per share:
	Basic - as reported	$	0.73	$	0.62	$	1.40	$	1.21

	Basic - pro forma	$	0.72	$	0.61	$	1.36	$	1.17

	Diluted - as reported	$	0.70	$	0.59	$	1.33	$	1.13

	Diluted - pro forma	$	0.68	$	0.57	$	1.29	$	1.10

The fair value of each option granted during the six-month periods ended December 31, 2003 and 2002 was $6.82 and $5.25 per option, respectively, as adjusted for the stock dividend effected on January 16, 2004. The fair value of each option granted during the six-month periods ended December 31, 2003 and 2002 was estimated at the date of the grant using the Black-Scholes option pricing model.

The following assumptions were used in estimating the fair value of the options granted:

(1) The expected option term is 7 years.

(2) The expected weighted average volatility was 33% for options granted in the six-months ended December 31, 2003 (2002 – 32%).

(3) The expected weighted average dividend yield was 2.36% for options granted in the six-months ended December 31 2003 (2002 – 3.19%), after giving retroactive effect to the 10% stock dividend effected on January 15, 2004.

(4) The weighted average risk-free interest rate was 3.93% for options granted in the six-months ended December 31, 2003 (2002 – 4.10%).

NOTE 2 – INVESTMENT SECURITIES:

Short Term Investments

At December 31, 2003 and June 30, 2003 the Group’s short term investments were comprised of:


		( In thousands)
		December 31,		June 30,
		2003		2003
Time deposits with other banks		$	3,545	$	787
Money market accounts and other short-term investments			100		365

	Total short term investments	$	3,645	$	1,152

Trading Securities

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A summary of trading securities owned by the Group at December 31, 2003 and June 30, 2003 is as follows:


	(In thousands)

	December 31, 2003		June 30, 2003

P.R. Government and agency obligations	$	985	$	131
Equity securities		765		855
Mortgage-backed securities		10		51

Total trading securities	$	1,760	$	1,037

As of December 31, 2003, the Group’s trading portfolio weighted average yield was 6.27% (June 30, 2003 – 6.35%).

Investment securities

The amortized cost, gross unrealized gains and losses, fair value, and weighted average yield of the investment securities as of December 31, 2003 and June 30, 2003, were as follows:


			December 31, 2003 (In thousands)

					Gross		Gross				Weighted
			Amortized		Unrealized		Unrealized		Fair		Average
			Cost		Gains		Losses		Value		Yield

Available-for-sale
US Treasury securities			$	23,686	$	93	$	1,224	$	22,555		3.67	%
Puerto Rico Government and agency obligations				55,877		1,392		221		57,048		5.73	%
Other debt securities				9,372		1,378		—		10,750		9.04	%

	Total investment securities			88,935		2,863		1,445		90,353

FNMA and FHLMC certificates				1,073,016		15,828		2,473		1,086,371		4.36	%
GNMA certificates				73,977		1,342		98		75,221		4.57	%
Collateralized mortgage obligations (CMOs)				166,772		3,206		—		169,978		5.40	%

	Total mortgage-backed-securities			1,313,765		20,376		2,571		1,331,570

		Total securities available-for-sale	$	1,402,700	$	23,239	$	4,016	$	1,421,923		4.51	%

Held-to-maturity
Puerto Rico Government and agency obligations			$	62,099	$	—	$	905	$	61,194		5.33	%

	Total investment securities			62,099		—		905		61,194

FNMA and FHLMC certificates				745,936		12,800		—		758,736		5.26	%
GNMA certificates				281,733		4,820		—		286,553		5.41	%

	Total mortgage-backed-securities			1,027,669		17,620		—		1,045,289

		Total securities held-to-maturity	$	1,089,768	$	17,620	$	905	$	1,106,483		5.34	%


			June 30, 2003 (In thousands)

					Gross		Gross				Weighted
			Amortized		Unrealized		Unrealized		Fair		Average
			Cost		Gains		Losses		Value		Yield

Available-for-sale
US Treasury securities			$	54,444	$	172	$	803	$	53,813		3.49	%
Puerto Rico Government and agency obligations				46,914		3,195		32		50,077		5.95	%
Other debt securities				9,368		1,434		—		10,802		9.04	%

	Total investment securities			110,726		4,801		835		114,692

FNMA and FHLMC certificates				1,638,567		29,061		1,673		1,665,955		4.59	%
GNMA certificates				206,013		5,318		110		211,221		4.78	%
CMOs				207,174		8,876		314		215,736		5.68	%

	Total mortgage-backed-securities			2,051,754		43,255		2,097		2,092,912

		Total securities available-for-sale	$	2,162,480	$	48,056	$	2,932	$	2,207,604		4.73	%

At June 30, 2003, there were no held-to-maturity securities.

The amortized cost and fair value of the Group’s investment securities available-for-sale and held-to-maturity at December

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31, 2003, by contractual maturity, are shown in the next table. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.


	(In thousands)

	Available-for-sale				Held-to-maturity

	Amortized Cost		Fair Value		Amortized Cost		Fair Value

Due after 1 to 5 years	$	14,253	$	14,621	$	—	$	—
Due after 5 to 10 years		27,893		26,985		—		—
Due after 10 years		46,789		48,747		62,099		61,194

		88,935		90,353		62,099		61,194
Mortgage-backed securities		1,313,765		1,331,570		1,027,669		1,045,289

	$	1,402,700	$	1,421,923	$	1,089,768	$	1,106,483

Proceeds from the sale of investment securities available-for-sale during the six-month period ended December 31, 2003 totaled $394,045,000 (2002 - $206,438,000). Gross realized gains and losses on those sales during the six-month period ended December 31, 2003 were $7,261,000 and $1,050,000, respectively, (2002 – $11,565,000 and $5,177,000, respectively). During the quarter ended September 30, 2003, the Group’s management reclassified, at fair value, $856,037,000 of its available-for-sale investment portfolio to the held-to-maturity investment category as management now intends to hold these securities to maturity. Unrealized loss on those securities transferred to held-to maturity category amounted to $28.0 million at December 31, 2003, and is included as part of the accumulated other comprehensive loss in the unaudited consolidated statement of financial condition. This unrealized loss is amortized over the remaining life of the securities as a yield adjustment. For the six-month periods ended December 31, 2003 and 2002, management concluded that there was no other-than-temporary impairment on its investment securities portfolio.

NOTE 3 - LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES:

Loans Receivable

The Group’s credit activity is mainly with customers located in Puerto Rico. Oriental’s loan transactions are encompassed within three main categories: mortgage, commercial, and consumer. The composition of the Group’s loan portfolio at December 31, 2003 and June 30, 2003 was as follows:


		(In thousands)

		December 31, 2003			June 30, 2003

	Residential mortgage loans	$	545,531		$	584,009
	Home equity loans and secured personal loans		77,858			90,516
	Commercial loans, mainly secured by real estate		54,204			42,931
	Consumer loans		17,861			20,572
	Less: deferred loan fees, net		(12,339	)		(13,733	)

Loans receivable			683,115			724,295
	Allowance for loan losses		(6,020	)		(5,031	)

Loans receivable, net			677,095			719,264
	Mortgage loans held-for-sale		34,332			9,198

Total loans, net		$	711,427		$	728,462

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Allowance for Loan Losses

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

While management uses available information in estimating probable loan losses, future additions to the allowance may be necessary based on factors beyond Oriental’s control, such as factors affecting Puerto Rico economic conditions. Refer to Table 4 of the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for the changes in the allowance for loan losses for the quarter and six-month periods ended December 31, 2003 and 2002.

The Group evaluates all loans, some individually and other as homogeneous groups, for purposes of determining impairment. At December 31, 2003, the total investment in impaired commercial loans was $520,000. Impaired commercial loan was measured based on the fair value of collateral and the Group determined that no specific impairment allowance was required for such loans. At June 30, 2003 there were no impaired loans.

NOTE 4 - PLEDGED ASSETS:

At December 31, 2003, investment securities and residential mortgage loans with a carrying value of $2,086,328,000 and $466,025,000, respectively, were pledged to secure public fund deposits, investment securities sold under agreements to repurchase, letters of credit, advances and borrowings from the Federal Home Loan Bank of New York, term notes and interest rate swap agreements. As of December 31, 2003, investment securities available-for-sale and held-to-maturity not pledged amounted to $273,224,000 and $152,139,000 respectively.

NOTE 5 – OTHER ASSETS

Other assets at December 31, 2003 and June 30, 2003 include the following:


	(In thousands)

	December 31,		June 30,
	2003		2003

Investment in equity options	$	13,073	$	6,787
Investment in unconsolidated subsidiaries (See Note 6)		2,170		1,083
Prepaid income tax		1,772		2,313
Deferred tax asset, net		7,155		3,731
Other prepaid expenses		7,440		7,478
Accounts receivable and other assets		6,057		4,106
Goodwill		2,021		2,008

	$	39,688	$	27,506

NOTE 6 – SUBORDINATED CAPITAL NOTES

Subordinated capital notes amounted to $72,166,000 and $36,083,000 at December 31, 2003 and June 30, 2003, respectively.

In October 2001 and in August 2003, Oriental Financial (PR) Statutory Trust I (the “Statutory Trust I”) and Oriental Financial (PR) Statutory Trust II (the “Statutory Trust II”), wholly owned special purpose subsidiaries of the Group, were formed for the purpose of issuing company-obligated securities. In September 2003 and in December 2001, $35 million of trust redeemable preferred securities were issued by the Trust II and by the Trust I, respectively, as part of pooled underwriting transactions. Pooled underwriting involves participating with other bank holding companies in issuing the securities through a special purpose pooling vehicle created by the underwriters.

The proceeds from these issuances were used by the Statutory Trust I and the Statutory Trust II to purchase a like amount of floating rate junior subordinated deferrable interest debentures (“subordinated capital notes”) issued by the Group. The first of these subordinated capital notes has a par value of $36.1 million, bears interest based on 3 months LIBOR plus 360 basis points (4.75% at December 31, 2003 and 4.72% at June 30, 2003) provided, however, that prior to December 18, 2006, this interest rate shall not exceed 12.5%, payable quarterly, and matures on December 23, 2031. The second one, has a par value of $36.1 million, bear interest based on 3 months LIBOR plus 295 basis points (4.10% at December 31, 2003), payable quarterly, and matures on September 17, 2033. Both subordinated capital notes may be called at par after

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five years. The trust redeemable preferred securities have the same maturity and call provisions as the subordinated capital notes.

In January 2003, the Financial Accounting Standards Board (“FASB”) Issued FASB Interpretation No. 46, “Consolidation of Variable Interest Entities, an interpretation of ARB No. 51.” FIN No. 46 addresses consolidation by business enterprises of variable interest entities. FIN No. 46 requires an enterprise to consolidate a variable interest entity if that enterprise has a variable interest that will absorb a majority of the entity’s expected losses if they occur, receive a majority of the entity’s expected residual returns if they occur, or both. A variable interest entity is a corporation, partnership, trust, or any other legal structure used for business purposes that either (a) does not issue voting interests (or other interests with similar rights) or (b) the total equity investment at risk is not sufficient to permit the entity to finance its activities. Qualifying Special Purpose Entities are exempt from the consolidation requirements.

The Group adopted FIN No. 46 in the second quarter of fiscal 2004. FIN No. 46 requires the Group to deconsolidate its investments in the Statutory Trust I and the Statutory Trust II, which were presented on a consolidated basis in previous financial statements. As a result of the adoption of FIN No. 46, the subordinated deferrable interest debentures issued by the Group are accounted for as a liability denominated as subordinated capital notes on the consolidated statements of financial condition. Interest on these subordinated capital notes and the amortization of related issuance costs are accounted for as interest expense on an accrual basis. FIN No. 46 was adopted by restating previously issued financial statements which resulted in increasing total assets and total liabilities by $2.2 million and $1.1 million as of December 31, 2003 and June 30, 2003, respectively, and did not have any effect on the Group’s net income for any period.

The trust redeemable preferred securities are treated as Tier-1 capital for regulatory purposes. In July 2003, the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”) issued a supervisory letter instructing bank holding companies to continue to include the trust preferred securities in their Tier 1 capital for regulatory capital purposes until notice is given to the contrary. The Federal Reserve Board intends to review the regulatory implications of any accounting treatment changes and, if necessary or warranted, provide further appropriate guidance.

NOTE 7 – DERIVATIVES ACTIVITIES

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

The Group generally uses interest rate swaps and interest rate options, such as caps and options, in managing its interest rate risk exposure. The swaps were entered into to convert short-term borrowings into fixed rate liabilities for longer periods and provide protection against increases in short-term interest rates. Under these swaps, the Group pays a fixed monthly or quarterly cost and receives a floating thirty or ninety-day payment based on LIBOR. Floating rate payments received from the swap counterparties correspond to the floating rate payments made on the short-term borrowings thus resulting in a net fixed rate cost to the Group. Under the caps, the Group pays an up front premium or fee for the right to receive cash flow payments in excess of the predetermined cap rate; thus, effectively capping its interest rate cost for the duration of the agreement.

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

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

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

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value, and designated as a trading or non-hedging derivative instrument.

The Group’s swaps, excluding those used to manage exposure to the stock market, and caps outstanding and their terms at December 31, 2003 and June 30, 2003 are set forth in the table below:


		(Dollars in thousands)

		December 31, 2003			June 30, 2003

Swaps:
	Pay fixed swaps notional amount	$	675,000		$	650,000
	Weighted average pay rate – fixed		3.71	%		3.97	%
	Weighted average receive rate – floating		1.16	%		1.24	%
	Maturity in months	2 to 82			1 to 88
	Floating rate as a percent of LIBOR		100	%		100	%
Caps:
	Cap agreements notional amount	$	75,000		$	75,000
	Cap rate		4.50	%		4.50	%
	Current 90 day LIBOR		1.15	%		1.31	%
	Maturity in months		3			9

The Group offers its customers certificates of deposit with an option tied to the performance of the Standard & Poor’s 500 stock market index. At the end of five years, the depositor will receive a specified percentage of the average increase of the month-end value of the index. If the index decreases, the depositor receives the principal without any interest. The Group uses swap and option agreements with major money center banks and major broker-dealer companies to manage its exposure to changes in this index. Under the terms of the option agreements, the Group will receive the average increase in the month-end value of the index in exchange for a fixed premium. Under the term of the swap agreements, the Group will receive the average increase in the month-end value of the index in exchange for a quarterly fixed interest cost. The changes in fair value of the options purchased, the swap agreements and the options embedded in the certificates of deposit are recorded in earnings.

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

Information pertaining to the notional amounts of the Group’s derivative financial instruments as of December 31, 2003 and June 30, 2003 is as follows:


		Notional Amount
		(In thousands)

		December 31,		June 30,
Type of Contract:		2003		2003

Cash Flows Hedging Activities:
	Interest rate swaps used to hedge a forecasted transaction - short-term borrowings	$	675,000	$	650,000

Derivatives Not Designated as Hedge:
	Interest rate swaps used to manage exposure to the stock market on stock indexed deposits	$	2,750	$	7,450
	Purchased options used to manage exposure to the stock market on stock indexed deposits		241,450		232,800
	Embedded options on stock indexed deposits		234,067		229,574
	Caps		75,000		75,000

		$	553,267	$	544,824

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During the six-month periods ended December 31, 2003 and 2002, $660,000 and $4.0 million, respectively, of losses were charged to earnings and reflected as “Derivatives Activities” in the consolidated statements of income. During the six-month periods ended December 31, 2003 and 2002, unrealized gains (losses) of $5.4 million and ($23.1) million, respectively, on derivatives designated as cash flow hedges were included in other comprehensive income (loss). Ineffectiveness of $557,000 and $36,000 was charged to earnings during the six-month periods ended December 31, 2003 and 2002, respectively.

At December 31, 2003 and June 30, 2003, the fair value of derivatives was recognized as either assets or liabilities in the consolidated statements of financial condition as follows: the fair value of the interest rate swaps used to manage the exposure to the stock market on stock indexed deposits represented a liability of $93,000 and $316,000, respectively; the purchased options used to manage the exposure to the stock market on stock indexed deposits represented an other asset of $13.2 million and $7.4 million, respectively; and the options sold to customers embedded in the certificates of deposit represented a liability of $13.0 million and $7.2 million, respectively, recorded in deposits. The fair value of the interest rate swaps represented a liability of $29.0 million and $42.8 million, respectively, presented in accrued expenses and other liabilities. The caps did not have carrying value as of December 31, 2003 and June 30, 2003.

NOTE 8 – STOCKHOLDERS’ EQUITY TRANSACTIONS:

Stock Dividend

On October 28, 2002, the Group declared a twenty-five percent (25%) stock split effected in the form of a dividend on common stock held by shareholders of record as of December 30, 2002. As a result, 3,864,800 shares of common stock were issued and distributed on January 15, 2003. Also, on November 20, 2003, the Group declared a ten percent (10%) stock dividend on common stock held by shareholders of record as of December 31, 2003. As a result, 1,798,722 shares of common stock were distributed on January 16, 2004, from the Group’s treasury stock account. For purpose of the computation of income per common share, cash dividend and stock price, the stock dividends were retroactively recognized for the periods presented in the accompanying consolidated financial statements.

Preferred Stock

On September 30, 2003, the Group issued 1,380,000 shares of 7.0% Noncumulative Monthly Income Preferred Stock, Series B, at $25 per share. Proceeds from issuance of the Series B Preferred Stock, were approximately $33,057,000, net of $1,443,000 of issuance costs.

The Series B Preferred Stock has the following characteristics: (1) annual dividends of $1.75 per share, payable monthly, if declared by the Board of Directors; missed dividends are not cumulative, (2) redeemable at the Group’s option beginning on October 31, 2008, (3) no mandatory redemption or stated maturity date and (4) liquidation value of $25 per share.

Treasury Stock

On March 26, 2003, the Group’s Board of Directors announced the authorization of a new program for the repurchase of up to $9.0 million of its outstanding shares of common stock. This program supersedes the ongoing repurchase program established earlier. The Group will make such repurchases from time to time, depending on market conditions and prices. The Group repurchased 15,800 and 42,500 shares of its common stock, for $394,000 and $944,000, during the six-month periods of fiscal ended December 31, 2003 and 2002, respectively.

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NOTE 9 – SEGMENT REPORTING:

In the quarter ended December 31, 2002, the Group operated the following three major reportable segments: Financial Services, Mortgage Banking, and Retail Banking. In the quarter ended March 31, 2003, the Group segregated its businesses into the following new major reportable segments of business: Retail Banking, Treasury and Financial Services. As required by GAAP, consolidated financial statements published by the Group reflected modifications to its reportable segments resulting from this organizational change, including reclassification of all comparable prior period segment information.

Management determined the reportable segments based on the internal reporting used to evaluate performance and to assess where to allocate resources. Other factors such as the Group’s organizational chart, nature of products, distribution channels and economic characteristics of the products were also considered in the determination of the reportable segments. The Group measures the performance of these reportable segments based on pre-established goals of different financial parameters such as net income, net interest income, loan production, and fees generated.

The Group’s two largest business segments are Retail Banking and Treasury. Retail Banking includes the Bank’s branches and mortgage banking, with traditional banking products such as deposits and mortgage, commercial and consumer loans. The mortgage banking activities are carried out by the Bank’s mortgage banking division, which principal activity is to originate and purchase mortgage loans for the Group’s own portfolio. From time to time, if conditions so warrant, it may sell loans to other financial institutions or securitize conforming loans into GNMA, FNMA and FHLMC certificates using another institution as issuer. The other institution services mortgages included in the resulting GNMA, FNMA, and FHLMC pools. The Group also sells the rights to service mortgage loans for others. The Treasury segment encompasses all of the Group’s assets and liabilities management activities such as: purchases and sales of investment securities, interest rate risk management and funding derivatives and borrowings.

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

Intersegment sales and transfers, if any, are accounted for as if the sales or transfers were to third parties, that is, at current market prices. The accounting policies of the segments are the same as those described in the “Summary of Significant Accounting Policies” included in the Group’s Annual Report on Form 10-K. Following are the results of operations and the selected financial information by operating segment for the quarter and six-month periods ended December 31, 2003 and 2002:

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	Unaudited - quarter periods ended December 31 (Dollars in thousands)

										Total
	Retail						Financial			Major			Other						Consolidated
	Banking			Treasury			Services			Segments			Segments			Eliminations			Total

December 31, 2003
Interest income	$	13,403		$	28,657		$	25		$	42,085		$	—			—		$	42,085
Interest expense		(4,416	)		(14,723	)		—			(19,139	)		—			—			(19,139	)

Net interest income (loss)		8,987			13,934			25			22,946			—			—			22,946
Non-interest income (loss)		3,143			1,639			4,575			9,357			—			—			9,357
Non-interest expenses		(9,736	)		(418	)		(4,062	)		(14,216	)		(387	)		—			(14,603	)
Intersegment revenue		593			—			275			868			—			(868	)		—
Intersegment expense		—			—			(768	)		(768	)		(100	)		868			—
Equity income in subsidiaries		—			—			—			—			14,683			(14,683	)		—
Provision for loan losses		(1,014	)		—			—			(1,014	)								(1,014	)

Income before taxes	$	1,973		$	15,155		$	45		$	17,173		$	14,196		$	(14,683	)	$	16,686

December 31, 2002
Interest income	$	12,812		$	25,033		$	6		$	37,851		$	—		$	—		$	37,851
Interest expense		(5,796	)		(13,618	)		—			(19,414	)		—			—			(19,414	)

Net interest income		7,016			11,415			6			18,437			—			—			18,437
Non-interest income		3,153			1,422			4,017			8,592			—						8,592
Non-interest expenses		(10,069	)		(392	)		(1,611	)		(12,072	)		(399	)					(12,471	)
Intersegment revenue		583			—			—			583						(583	)		—
Intersegment expense		—			—			(502	)		(502	)		(81	)		583			—
Equity income in subsidiaries		—			—			—			—			13,095			(13,095	)		—
Provision for loan losses		(1,100	)		—			—			(1,100	)		—			—			(1,100	)

Income (loss) before taxes	$	(417	)	$	12,445		$	1,910		$	13,938		$	12,615		$	(13,095	)	$	13,458


	Unaudited - six-months periods ended December 31, (Dollars in thousands)

										Total
	Retail						Financial			Major			Other						Consolidated
	Banking			Treasury			Services			Segments			Segments			Eliminations			Total

December 31, 2003
Interest income	$	27,034		$	52,375		$	42		$	79,451		$	—		$	—		$	79,451
Interest expense		(8,796	)		(28,810	)		—			(37,606	)		—			—			(37,606	)

Net interest income (loss)		18,238			23,565			42			41,845			—			—			41,845
Non-interest income		7,359			5,551			9,387			22,297			—			—			22,297
Non-interest expenses		(21,213	)		(808	)		(7,224	)		(29,245	)		(738	)		—			(29,983	)
Intersegment revenue		3,510			—			493			4,003			—			(4,003	)		—
Intersegment expense		(1,196	)		—			(2,616	)		(3,812	)		(191	)		4,003			—
Equity income in subsidiaries		—			—			—			—			28,223			(28,223	)		—
Provision for loan losses		(2,354	)		—			—			(2,354	)		—			—			(2,354	)

Income before taxes	$	4,344		$	28,308		$	82		$	32,734		$	27,294		$	(28,223	)	$	31,805

Total assets as of December 31, 2003	$	803,615		$	2,513,017		$	10,932		$	3,327,564		$	250,076		$	(233,397	)	$	3,344,243

December 31, 2002
Interest income	$	25,446		$	50,074		$	46		$	75,566		$	—		$	—		$	75,566
Interest expense		(11,966	)		(26,996	)		—			(38,962	)		—			—			(38,962	)

Net interest income		13,480			23,078			46			36,604			—			—			36,604
Non-interest income		6,333			2,912			6,915			16,160			—			—			16,160
Non-interest expenses		(18,503	)		(759	)		(5,358	)		(24,620	)		(689	)					(25,309	)
Intersegment revenue		2,159			—			—			2,159			—			(2,159	)		—
Intersegment expense		(1,006	)		—			(957	)		(1,963	)		(196	)		2,159			—
Equity income in subsidiaries		—			—			—			—			24,854			(24,854	)		—
Provision for loan losses		(1,940	)		—			—			(1,940	)		—			—			(1,940	)

Income before taxes	$	523		$	25,231		$	646		$	26,400		$	23,969		$	(24,854	)	$	25,515

Total assets as of December 31, 2002	$	747,091		$	1,999,014		$	6,693		$	2,752,798		$	229,571		$	(181,672	)	$	2,800,697

-16-

NOTE 10 – RECENT ACCOUNTING DEVELOPMENTS:

SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities

In April 2003, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities”. This Statement amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities under FASB Statement No. 133, “Accounting for Derivative Instruments and Hedging Activities”. This Statement is effective for contracts entered into or modified after June 30, 2003, and for hedging relationships designated after June 30, 2003. Implementation of SFAS No. 149 did not have a significant effect on the Group’s financial condition or results of operations.

SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity

In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity”. This Statement establishes standards for how an issuer classifies and measures in its statement of financial condition certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances) because that financial instrument embodies an obligation of the issuer. This Statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. Implementation of SFAS No. 150 did not have a significant effect on the Group’s financial condition or results of operations.

-17-

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


Table Description:		Page No.

Selected Financial Data:
	Earnings, Per Share and Dividends Data		-19-
	Period End Balances		-19-
	Selected Financial Ratios and Other Information		-19-
Table 1	Quarterly Analysis of Net Interest Income and Changes due to Volume / Rate		-20-
Table 1A	Fiscal Year-to-Date Analysis of Net Interest Income and Changes due to Volume/Rate		-21-
Table 2	Non-Interest Income Summary		-22-
Table 3	Non-Interest Expenses Summary		-22-
Table 4	Allowance for Loan Losses Summary		-23-
Table 5	Net Credit Losses Statistics		-23-
Table 6	Allowance for Loan Losses Breakdown		-24-
Table 7	Non-Performing Assets		-24-
Table 8	Non-Performing Loans		-24-
Table 9	Bank Assets Summary and Composition		-25-
Table 10	Liabilities Summary and Composition		-26-
Table 11	Capital, Dividends and Stock Data		-27-

- 18 -

SELECTED FINANCIAL DATA
FOR THE QUARTER AND SIX-MONTH PERIODS ENDED DECEMBER 31, 2003 AND 2002
(In thousands, except for shares information)


			Quarter Period									Six-Month Period

			2003			2002			Variance %			2003			2002			Variance %

EARNINGS, PER SHARE AND DIVIDENDS DATA:
Interest income			$	42,085		$	37,851			11.2	%	$	79,451		$	75,566			5.1	%
Interest expense				19,139			19,414			-1.4	%		37,606			38,962			-3.5	%

		Net interest income		22,946			18,437			24.5	%		41,845			36,604			14.3	%
Provision for loan losses				1,014			1,100			-7.8	%		2,354			1,940			21.3	%

		Net interest income after provision for loan losses		21,932			17,337			26.5	%		39,491			34,664			13.9	%
Non-interest income				9,357			8,592			8.9	%		22,297			16,160			38.0	%
Non-interest expenses				(14,603	)		(12,471	)		17.1	%		(29,983	)		(25,309	)		18.5	%

		Income before income taxes		16,686			13,458			24.0	%		31,805			25,515			24.7	%
Income tax expense				(998	)		(943	)		5.8	%		(2,558	)		(1,426	)		79.4	%

		Net income		15,688			12,515			25.4	%		29,247			24,089			21.4	%
Less: dividends on preferred stock				(1,200	)		(597	)		101.0	%		(1,797	)		(1,193	)		50.6	%

		Net income available to common shareholders	$	14,488		$	11,918			21.6	%	$	27,450		$	22,896			19.9	%

Income per common share (1):
		Basic	$	0.73		$	0.62			17.7	%	$	1.40		$	1.21			15.7	%

		Diluted	$	0.70		$	0.59			18.6	%	$	1.33		$	1.13			17.7	%

Average shares and potential shares (1)				20,687			20,273			2.0	%		20,626			20,196			2.1	%

Book value per common share (1)												$	7.86		$	8.39			-6.3	%

Market price at end of period (1)												$	25.70		$	17.88			43.7	%

Cash dividends declared per common share (1)			$	0.14		$	0.13			7.7	%	$	0.27		$	0.24			12.5	%

Cash dividends declared on common shares			$	2,770		$	2,430			14.0	%	$	5,275		$	4,500			17.2	%

SELECTED FINANCIAL RATIOS AND OTHER INFORMATION:
	Return on average assets (ROA)			1.95	%		1.87	%					1.84	%		1.86	%

	Return on average common equity (ROE)			41.28	%		31.25	%					35.27	%		31.19	%

	Efficiency ratio			47.60	%		48.76	%					51.17	%		50.57	%

	Expense ratio			0.89	%		0.82	%					0.88	%		0.97	%

	Interest rate spread			2.85	%		2.97	%					2.71	%		3.02	%

	Number of financial centers												23			23

(1) Data adjusted to give retroactive effect to stock dividends declared on the Group’s common stock.

PERIOD END BALANCES AND CAPITAL RATIOS:
AS OF DECEMBER 31, 2003 and JUNE 30, 2003


					December 31,			June 30,
					2003			2003			Variance %

Total financial assets
		Trust assets managed			$	1,661,598		$	1,670,437			-0.5	%
		Broker-dealer assets gathered				1,101,455			962,919			14.4	%

			Assets managed			2,763,053			2,633,356			4.9	%
		Assets owned				3,344,243			3,040,551			10.0	%

				Total financial assets managed and owned	$	6,107,296		$	5,673,907			7.6	%

Investments and loans
		Investments and securities			$	2,539,633		$	2,232,330			13.8	%
		Loans (including loans held-for-sale), net				711,427			728,462			-2.3	%
		Securities sold but not yet delivered				7,304			1,894			285.6	%

					$	3,258,364		$	2,962,686			10.0	%

Deposits and borrowings
		Deposits			$	1,077,751		$	1,044,265			3.2	%
		Repurchase agreements				1,605,647			1,400,598			14.6	%
		Other borrowings				388,166			181,083			114.4	%
		Securities purchased but not yet delivered				317			152,219			-99.8	%

					$	3,071,881		$	2,778,165			10.6	%

Stockholders’ equity
		Preferred equity			$	68,000		$	33,500			103.0	%
		Common equity				155,517			168,180			-7.5	%

					$	223,517		$	201,680			10.8	%

Capital Ratios:
	Leverage capital					10.50	%		8.19	%

	Total risk-based capital					33.26	%		25.00	%

	Tier 1 risk-based capital					32.66	%		24.48	%

-19-

SELECTED FINANCIAL DATA
FOR THE QUARTERS ENDED DECEMBER 31, 2003 AND 2002
(Dollars in thousands)

TABLE 1 - QUARTERLY ANALYSIS OF NET INTEREST INCOME AND CHANGES DUE TO VOLUME/RATE:


				Interest									Average rate									Average balance

										Variance									Variance									Variance
				2003			2002*			in %			2003			2002*			in BP			2003			2002*			in %

A — TAX EQUIVALENT SPREAD
Interest-earning assets				$	42,085		$	37,851			11.19	%		5.43	%		6.27	%		-84		$	3,100,568		$	2,416,353			28.32	%
		Tax equivalent adjustment			8,969			13,389			-33.01	%		1.16	%		2.22	%		-106			—			—			0.00	%

Interest-earning assets — tax equivalent					51,054			51,240			-0.36	%		6.59	%		8.49	%		(190	)		3,100,568			2,416,353			28.32	%
		Interest-bearing liabilities			19,139			19,414			-1.42	%		2.58	%		3.30	%		-72			2,969,029			2,355,564			26.04	%

Net interest income / spread				$	31,915		$	31,826			0.28	%		4.01	%		5.19	%		(118	)	$	131,539		$	60,789			116.39	%

B — NORMAL SPREAD
Interest-earning assets:
Investments:
	Investment securities			$	29,030		$	24,985			16.2	%		4.91	%		5.85	%		-94		$	2,364,257		$	1,706,968			38.51	%
	Investment management fees				(410	)		(287	)		42.9	%		-0.07	%		-0.07	%		0			—			—			0.00	%

		Total investment securities			28,620			24,698			15.9	%		4.84	%		5.79	%		-95			2,364,257			1,706,968			38.51	%
	Trading securities				9			177			-94.9	%		2.26	%		3.87	%		-161			1,592			18,283			-91.29	%
	Money market investments				53			164			-67.7	%		1.94	%		1.90	%		4			10,903			34,474			-68.37	%

					28,682			25,039			14.5	%		4.83	%		5.69	%		-86			2,376,752			1,759,725			35.06	%

Loans:
	Real estate (1)				11,994			11,303			6.1	%		7.31	%		7.59	%		-28			655,868			595,325			10.17	%
	Consumer				606			702			-13.7	%		13.37	%		14.26	%		-89			18,125			19,689			-7.94	%
	Commercial				803			807			-0.5	%		6.45	%		7.80	%		-135			49,808			41,408			20.29	%
	Financing leases (2)				—			—			0.0	%		0.00	%		0.00	%		0			15			206			-92.72	%

					13,403			12,812			4.6	%		7.41	%		7.80	%		-39			723,816			656,628			10.23	%

					42,085			37,851			11.2	%		5.43	%		6.27	%		-84			3,100,568			2,416,353			28.32	%

Interest-bearing liabilities:
Deposits:
	Non-interest bearing deposits				—			—			—			—			—			—			47,390			53,896			-12.07	%
	Now Accounts				220			292			-24.7	%		1.18	%		1.85	%		-67			74,603			62,979			18.46	%
	Savings				313			352			-11.1	%		1.44	%		1.68	%		-24			86,821			83,590			3.87	%
	Time and IRA accounts				7,230			7,868			-8.1	%		3.42	%		3.99	%		-57			845,188			788,954			7.13	%

					7,763			8,512			-8.8	%		2.95	%		3.44	%		-49			1,054,002			989,419			6.53	%

Borrowings:
	Repurchase agreements				4,263			4,494			-5.1	%		1.12	%		1.62	%		-50			1,520,029			1,108,678			37.10	%
			Interest rate risk management		4,069			3,742			8.7	%		1.07	%		1.35	%		-28			—			—			0.00	%
			Financing fees		112			75			49.3	%		0.03	%		0.03	%		0			—			—			0.00	%

	Total repurchase agreements				8,444			8,311			1.6	%		2.22	%		3.00	%		-78			1,520,029			1,108,678			37.10	%
	FHLB advances and term notes				2,107			2,088			0.9	%		2.61	%		3.77	%		-116			322,832			221,384			45.82	%
	Subordinated capital notes				825			503			64.0	%		4.57	%		5.58	%		-101			72,166			36,083			100.00	%

					11,376			10,902			4.3	%		2.38	%		3.19	%		-81			1,915,027			1,366,145			40.18	%

					19,139			19,414			-1.4	%		2.58	%		3.30	%		-72			2,969,029			2,355,564			26.04	%

Net interest income / spread				$	22,946		$	18,437			24.5	%		2.85	%		2.97	%		-12

Interest rate margin														2.96	%		3.06	%		-10

Excess of average interest-earning assets over average interest-bearing liabilities																						$	131,539		$	60,789			116.39	%

Average interest-earning assets over average interest-bearing liabilities ratio																							104.43	%		102.58	%

C. Changes in net interest income due to:				Volume			Rate			Total

Interest Income:
	Loans (1)			$	1,266		$	(675	)	$	591
	Investments				7,849			(4,206	)		3,643

					9,115			(4,881	)		4,234

Interest Expense:
	Deposits			$	531			(1,280	)		(749	)
	Borrowings				4,694			(4,220	)		474

					5,225			(5,500	)		(275	)

Net Interest Income				$	3,890		$	619		$	4,509

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

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

(2) - Discontinued in June 2000.

-20-

SELECTED FINANCIAL DATA
FOR THE SIX-MONTH PERIODS ENDED DECEMBER 31, 2003 AND 2002
(Dollars in thousands)

TABLE 1A - FISCAL YEAR-TO-DATE ANALYSIS OF NET INTEREST INCOME AND CHANGES DUE TO VOLUME/RATE:


				Interest									Average rate								Average balance

										Variance									Variance								Variance
				2003			2002*			in %			2003			2002*			in BP		2003			2002*			in %

A - TAX EQUIVALENT SPREAD
Interest-earning assets				$	79,451		$	75,566			5.14	%		5.30	%		6.41	%		-111	$	2,997,766		$	2,358,714			27.09	%
		Tax equivalent adjustment			15,870			26,764			-40.70	%		1.06	%		2.27	%		-121		—			—			0.00	%

Interest-earning assets — tax equivalent					95,321			102,330			-6.85	%		6.36	%		8.68	%		-232		2,997,766			2,358,714			27.09	%
		Interest-bearing liabilities			37,606			38,962			-3.48	%		2.59	%		3.39	%		-80		2,904,520			2,300,819			26.24	%

Net interest income / spread				$	57,715		$	63,368			-8.92	%		3.77	%		5.29	%		-152	$	93,246		$	57,895			61.06	%

B - NORMAL SPREAD
Interest-earning assets:
Investments:
	Investment securities			$	53,116		$	50,114			6.0	%		4.71	%		5.95	%		-124	$	2,257,376		$	1,684,390			34.02	%
	Investment management fees				(804	)		(696	)		15.5	%		-0.07	%		-0.04	%		3		—			—			0.00	%

	Total investment securities				52,312			49,418			5.9	%		4.63	%		5.87	%		-124		2,257,376			1,684,390			34.02	%
	Trading securities				14			483			-97.1	%		2.01	%		5.06	%		-305		1,393			19,095			-92.70	%
	Money market investments				92			218			-57.8	%		1.86	%		1.94	%		-8		9,880			22,531			-56.15	%

					52,418			50,119			4.6	%		4.62	%		5.81	%		-119		2,268,649			1,726,016			31.44	%

Loans:
	Real estate (1)				24,312			22,406			8.5	%		7.33	%		7.85	%		-52		663,515			570,673			16.27	%
	Consumer				1,243			1,452			-14.4	%		13.28	%		14.44	%		-116		18,713			20,114			-6.97	%
	Commercial				1,477			1,591			-7.2	%		6.30	%		7.63	%		-133		46,869			41,679			12.45	%
	Financing leases (2)				1			(2	)		-150.0	%		10.00	%		-1.72	%		1172		20			232			-91.38	%

					27,033			25,447			6.2	%		7.42	%		8.04	%		-62		729,117			632,698			15.24	%

					79,451			75,566			5.1	%		5.30	%		6.41	%		-111		2,997,766			2,358,714			27.09	%

Interest-bearing liabilities:
Deposits:
	Non-interest bearing deposits				—			—			—			—			—			—		54,810			52,206			4.99	%
	Now Accounts				381			613			-37.8	%		1.07	%		2.04	%		-97		71,397			60,245			18.51	%
	Savings				537			751			-28.5	%		1.23	%		1.82	%		-59		87,022			82,553			5.41	%
	Time and IRA accounts				14,385			15,969			-9.9	%		3.52	%		4.01	%		-49		817,425			797,019			2.56	%

					15,303			17,333			-11.7	%		2.97	%		3.49	%		-52		1,030,654			992,023			3.89	%

Borrowings:
	Repurchase agreements				8,447			9,099			-7.2	%		1.12	%		1.73	%		-61		1,505,246			1,051,081			43.21	%
			Interest rate risk management		8,273			7,185			15.1	%		1.10	%		1.37	%		-27		—			—			0.00	%
			Financing fees		220			151			45.7	%		0.03	%		0.03	%		0		—			—			0.00	%

	Total repurchase agreements				16,940			16,435			3.1	%		2.25	%		3.13	%		-88		1,505,246			1,051,081			43.21	%
	FHLB advances and term notes				4,034			4,179			-3.5	%		2.59	%		3.77	%		-118		311,750			221,632			40.66	%
	Subordinated capital notes				1,329			1,015			30.9	%		4.67	%		5.63	%		-96		56,870			36,083			57.61	%

					22,303			21,629			3.1	%		2.38	%		3.31	%		-93		1,873,866			1,308,796			43.17	%

					37,606			38,962			-3.5	%		2.59	%		3.39	%		-80		2,904,520			2,300,819			26.24	%

Net interest income / spread				$	41,845		$	36,604			14.3	%		2.71	%		3.02	%		-31

Interest rate margin														2.79	%		3.11	%		-32

Excess of average interest-earning assets over average interest-bearing liabilities																					$	93,246		$	57,895			61.06	%

Average interest-earning assets over average interest-bearing liabilities ratio																						103.21	%		102.52	%

C. Changes in net interest income due to:
Volume Rate Total

Interest Income:

Loans (1)
$ 7,355 $ (5,769 ) $ 1,586

Investments
27,611 (25,312 ) 2,299

34,966 (31,081 ) 3,885

Interest Expense:

Deposits
$ 1,308 (3,338 ) (2,030 )

Borrowings
20,333 (19,659 ) 674

21,641 (22,997 ) (1,356 )

Net Interest Income
$ 13,326 $ (8,085 ) $ 5,241

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

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

(2) - Discontinued in June 2000.

-21-

SELECTED FINANCIAL DATA
FOR THE QUARTER AND SIX-MONTH PERIODS ENDED DECEMBER 31, 2003 AND 2002
(Dollars in thousands)


			Quarter Period									Six-Month Period
			2003			2002			Variance %			2003			2002			Variance %

TABLE 2 - NON-INTEREST INCOME SUMMARY
Commissions and fees from fiduciary activities			$	2,145		$	1,431			49.9	%	$	4,304		$	2,871			49.9	%
Commissions, broker fees and other				1,559			1,821			-14.4	%		3,420			2,985			14.6	%
Insurance commissions and fees				590			722			-18.3	%		1,133			957			18.4	%
Mortgage banking activities				1,708			1,709			-0.1	%		4,454			3,651			22.0	%

		Non-banking service revenues		6,002			5,683			5.6	%		13,311			10,464			27.2	%

Fees on deposit accounts				1,182			1,037			14.0	%		2,375			2,065			15.0	%
Bank service charges and commissions				486			381			27.6	%		944			773			22.1	%
Other operating revenues				41			40			2.5	%		86			140			-38.6	%

		Bank service revenues		1,709			1,458			17.2	%		3,405			2,978			14.3	%

Securities net activity				2,247			2,056			9.3	%		6,211			6,388			-2.8	%
Trading net activity				(17	)		120			-114.2	%		(9	)		540			-101.7	%
Derivatives net activity				(608	)		(725	)		-16.1	%		(660	)		(3,990	)		-83.5	%

		Securities, derivatives and trading activities		1,622			1,451			11.8	%		5,542			2,938			88.6	%

Loss on sale of premises and equipment				—			—			0.0	%		—			(220	)		-100.0	%
Other income				24			—						39			—

		Other non-interest income		24			—			100.0	%		39			(220	)		-117.7	%

Total non-interest income			$	9,357		$	8,592			8.9	%	$	22,297		$	16,160			38.0	%

TABLE 3 - NON-INTEREST EXPENSES SUMMARY
Compensation and employees’ benefits				5,719			4,526			26.4	%		11,774			9,168			28.4	%
Occupancy and equipment				2,324			2,193			6.0	%		4,618			4,353			6.1	%
Advertising and business promotion				2,097			1,763			18.9	%		4,167			3,557			17.1	%
Professional and service fees				1,435			1,517			-5.4	%		3,075			3,344			-8.0	%
Communication				471			397			18.6	%		924			821			12.5	%
Taxes, other than payroll and income taxes				433			388			11.6	%		865			776			11.5	%
Printing, postage, stationery and supplies				295			236			25.0	%		589			510			15.5	%
Insurance, including deposits insurance				198			205			-3.4	%		393			347			13.3	%
Other operating expenses				1,631			1,246			30.9	%		3,578			2,433			47.1	%

Total non-interest expenses			$	14,603		$	12,471			17.1	%	$	29,983		$	25,309			18.5	%

Relevant ratios and data:
	Compensation and benefits to non-interest expenses			39.2	%		36.3	%					39.3	%		36.2	%

	Compensation to total assets			0.68	%		0.60	%					0.70	%		0.65	%

	Average compensation per employee (annualized)		$	41.1		$	40.5					$	42.9		$	83.9

	Average number of employees			556			447						549			437

	Bank assets per employee		$	6,015		$	6,266					$	6,095		$	6,409

Total work force (1):
	Banking operations												451			397
	Trust operations												59			21
	Brokerage and Insurance operations												28			35

		Total work force											538			453

(1) Excludes contracted services.

- 22 -

SELECTED FINANCIAL DATA
FOR THE QUARTER AND SIX-MONTH PERIODS ENDED DECEMBER 31, 2003 AND 2002
(Dollars in thousands)


			Quarter Period						Change in			Six-month period						Change in
			2003			2002			%			2003			2002			%

TABLE 4 - ALLOWANCE FOR LOAN LOSSES SUMMARY
Beginning balance			$	5,889		$	3,300			78.5	%	$	5,031		$	3,039			65.5	%
	Provision for loan losses			1,014			1,100			-7.8	%		2,354			1,940			21.3	%
	Net credit losses — see Table 5			(883	)		(499	)		77.0	%		(1,365	)		(1,078	)		26.6	%

		Ending balance	$	6,020		$	3,901			54.3	%	$	6,020		$	3,901			54.3	%

Selected Data and Ratios:
	Outstanding gross loans at December 31,		$	717,447		$	664,402			8.0	%	$	717,447		$	664,402			8.0	%

	Recoveries to net charge-offs			26.3	%		33.6	%		-21.6	%		29.8	%		30.4	%		-1.9	%

	Allowance coverage ratio
		Total loans											0.84	%		0.59	%		42.9	%

		Non-performing loans											18.64	%		14.35	%		29.9	%

		Non-real estate non-performing loans											162.05	%		233.73	%		-30.7	%

TABLE 5 - NET CREDIT LOSSES STATISTICS
Real Estate
	Charge-offs		$	(249	)	$	—			100.0	%	$	(249	)	$	—			100.0	%
	Recoveries			—			—			0.0	%		—			—			0.0	%

				(249	)		—			100.0	%		(249	)		—			100.0	%

Commercial
	Charge-offs			(248	)		—			100.0	%		(248	)		—			100.0	%
	Recoveries			11			10			10.0	%		21			36			-41.7	%

				(237	)		10			2470.0	%		(227	)		36			730.6	%

Consumer
	Charge-offs			(701	)		(751	)		-6.7	%		(1,447	)		(1,548	)		-6.5	%
	Recoveries			304			242			25.6	%		558			434			28.6	%

				(397	)		(509	)		-22.0	%		(889	)		(1,114	)		-20.2	%

Net credit losses
	Total charge-offs			(1,198	)		(751	)		59.5	%		(1,944	)		(1,548	)		25.6	%
	Total recoveries			315			252			25.0	%		579			470			23.2	%

			$	(883	)	$	(499	)		77.0	%	$	(1,365	)	$	(1,078	)		26.6	%

Net credit losses (recoveries) average ratio:
		Real Estate		0.15	%		0.00	%					0.08	%		—

		Commercial		1.90	%		(0.10	%)					0.97	%		(0.17	%)

		Consumer		8.75	%		10.23	%					9.49	%		10.95	%

		Total		0.49	%		0.30	%					0.37	%		0.34	%

Average loans:
	Real estate		$	655,868		$	595,325			10.2	%	$	663,515		$	570,673			16.3	%
	Commercial			49,808			41,408			20.3	%		46,869			41,679			12.5	%
	Consumer			18,140			19,895			-8.8	%		18,733			20,346			-7.9	%

		Total	$	723,816		$	656,628			10.2	%	$	729,117		$	632,698			15.2	%

-22-

SELECTED FINANCIAL DATA
AS OF DECEMBER 31, 2003, 2002 and JUNE 30, 2003
(Dollars in thousands)


			December 31,			June 30,			Change in			December 31,
			2003			2003			%			2002

TABLE 6 - ALLOWANCE FOR LOSSES BREAKDOWN:
	Residential real estate		$	2,555		$	1,748			46.2	%	$	1,534
	Consumer			1,943			1,300			49.5	%		1,565
	Commercial			545			433			25.9	%		306
	Unallocated allowance			977			1,550			-37.0	%		496

			$	6,020		$	5,031			19.7	%	$	3,901

Allowance composition:
	Residential real estate			42.4	%		34.7	%					39.3	%
	Consumer			32.3	%		25.8	%					40.1	%
	Commercial			9.1	%		8.6	%					7.8	%
	Unallocated allowance			16.2	%		30.9	%					12.8	%

				100.0	%		100.0	%					100.0	%

TABLE 7 - NON-PERFORMING ASSETS:
Non-performing assets:
	Non-accruing loans		$	24,716		$	10,350			138.8	%	$	11,831
	Accruing loans			7,574			18,532			-59.1	%		15,357

		Total non-performing loans		32,290			28,882			11.8	%		27,188
	Foreclosed real estate			601			536			12.1	%		410
	Repossessed autos			—			—			—			12

			$	32,891		$	29,418			11.8	%	$	27,610

Non-performing assets to total assets				0.98	%		0.97	%		1.7	%		0.99	%

TABLE 8 - NON-PERFORMING LOANS:
Non-performing loans:
	Residential real estate		$	28,575		$	26,567			7.6	%	$	25,519
	Commercial			3,145			1,798			74.9	%		1,074
	Consumer			570		$	517			10.3	%		595

		Total	$	32,290		$	28,882			11.8	%	$	27,188

Non-performing loans composition:
	Residential real estate			88.5	%		92.0	%					97.8	%
	Commercial			9.7	%		6.2	%					4.0	%
	Consumer			1.8	%		1.8	%					2.2	%

		Total		100.0	%		100.0	%					100.0	%

Non-performing loans to:
	Total loans			4.50	%		3.94	%		14.2	%		4.09	%

	Total assets			0.97	%		0.95	%		1.6	%		0.97	%

	Total capital			14.45	%		14.32	%		0.9	%		14.05	%

-24-

SELECTED FINANCIAL DATA
AS OF DECEMBER 31, 2003 and JUNE 30, 2003
(Dollars in thousands)


					December 31,			June 30,			Variance
					2003			2003			%

TABLE 9 - BANK ASSETS SUMMARY AND COMPOSITION
Investments:
	Mortgage-backed securities				$	2,359,249		$	2,092,963			12.7	%
	U.S. Government and agency obligations					22,555			53,813			-58.1	%
	P.R. Government and agency obligations					120,132			50,208			139.3	%
	Other Securities					11,515			11,657			-1.2	%
	Short-term investments					3,645			1,152			216.4	%
	FHLB stock					22,537			22,537			—

						2,539,633			2,232,330			13.8	%

Loans:
			Secured by real estate, mainly residential			611,138			660,874			-7.5	%
			Consumer			18,006			19,868			-9.4	%
			Commercial			53,971			43,553			23.9	%

				Loans receivable		683,115			724,295			-5.7	%
			Allowance for loan losses			(6,020	)		(5,031	)		19.7	%

			Loans receivable, net			677,095			719,264			-5.9	%
			Loans held for sale			34,332			9,198			273.3	%

			Total loans receivable, net			711,427			728,462			-2.3	%

	Securities sold but not yet delivered					7,304			1,894			285.60	%

Total securities and loans						3,258,364			2,962,686			10.0	%
		Other assets				85,879			77,865			10.3	%

Total assets					$	3,344,243		$	3,040,551			10.0	%

Investments portfolio composition:
	Mortgage-backed securities					92.9	%		93.8	%
	U.S. and P.R. Government securities					5.6	%		4.7	%
	FHLB stock and other investments					1.5	%		1.5	%

						100.0	%		100.0	%

Loan portfolio composition:
	Real estate, mainly residential (1)					90.0	%		91.4	%
	Consumer					2.5	%		2.7	%
	Commercial					7.5	%		5.9	%

						100.0	%		100.0	%

(1) Includes loans held for sale.

- 25 -

SELECTED FINANCIAL DATA
AS OF DECEMBER 31, 2003 and JUNE 30, 2003
(Dollars in thousands)


				December 31,			June 30,			Variance
				2003			2003			%

TABLE 10 - LIABILITIES SUMMARY AND COMPOSITION
Deposits:
Demand deposits				$	115,918		$	132,308			-12.4	%
Saving accounts					87,335			92,206			-5.3	%
Individual retirement accounts					360,868			348,105			3.7	%
Certificates of deposit					511,648			469,790			8.9	%

					1,075,769			1,042,409			3.2	%
Accrued interest payable					1,982			1,856			6.8	%

					1,077,751			1,044,265			3.2	%

Borrowings:
Repurchase agreements					1,605,647			1,400,598			14.6	%
Advances from FHLB					301,000			130,000			131.5	%
Subordinated capital notes					72,166			36,083			100.0	%
Term notes					15,000			15,000			0.0	%

					1,993,813			1,581,681			26.1	%

	Securities purchased but not yet received				317			152,219			-99.8	%

Total deposits and borrowings					3,071,881			2,778,165			10.6	%
		Other liabilities			48,845			60,706			-19.5	%

Total liabilities				$	3,120,726		$	2,838,871			9.9	%

Deposits portfolio composition percentages:
		Demand deposits			10.8	%		12.3	%
		Saving accounts			8.1	%		8.6	%
		Individual retirement accounts			33.5	%		32.4	%
		Certificates of deposit			47.6	%		46.7	%

					100.0	%		100.0	%

Borrowings portfolio composition percentages:
	Repurchase agreements				80.5	%		88.6	%
	Advances from FHLB				15.1	%		8.2	%
	Subordinated capital notes				3.6	%		2.3	%
	Term notes and other sources of funds				0.8	%		0.9	%

					100.0	%		100.0	%

Short term borrowings
			Amount outstanding at quarter-end	$	1,605,647		$	1,400,598

			Daily average outstanding balance	$	1,505,246		$	1,158,243

			Maximum outstanding balance at any month-end	$	1,626,237		$	1,400,598

- 26 -

SELECTED FINANCIAL DATA
AS OF DECEMBER 31, 2003, 2002 and JUNE 30, 2003
(In thousands, except for per share data)


		December 31,			June 30,			Variance
		2003			2003			%

TABLE 11 - CAPITAL, DIVIDENDS AND STOCK DATA
Capital data:
	Stockholders’ equity	$	223,517		$	201,680			10.8	%

	Leverage Capital Ratio		10.50	%		8.19	%		28.2	%

	Minimum Leverage Capital Ratio Requirement		3.00	%		4.00	%

	Tier 1 Capital (to Average Assets)	$	327,866		$	234,979			39.5	%

	Minimum Tier 1 Capital (to Average Assets) Requirement	$	93,662		$	114,720			-18.4	%

	Tier 1 Risk-Based Capital Ratio		32.66	%		24.48	%		33.4	%

	Minimum Total Risk-Based Capital Ratio Requirement		4.00	%		4.00	%

	Total Tier 1 Risk-Based Capital (to Risk-Weighted Assets)	$	327,866		$	234,979			39.5	%

	Minimum Total Capital (to Risk-Weighted Assets) Requirement	$	40,151		$	38,400			4.6	%

	Total Risk-Based Capital Ratio		33.26	%		25.00	%		33.0	%

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

	Total Adjusted Capital (to Risk-Weighted Assets)	$	333,886		$	240,010			39.1	%

	Minimum Total Capital (to Risk-Weighted Assets) Requirement	$	80,301		$	76,800			4.6	%

Stock data:
	Outstanding common shares, net of treasury (1)		19,786			19,425			1.9	%

	Book value (1)	$	7.86		$	8.66			-9.2	%

	Market Price at end of period	$	25.70		$	23.36			10.0	%

	Market capitalization	$	508,500		$	453,660			12.1	%


		December 31,			December 31,			Variance
		2003			2002			%

Common dividend data:
	Cash dividends declared	$	5,275		$	4,500			17.2	%

	Cash dividends declared per share (1)	$	0.267		$	0.236			13.1	%

	Payout ratio		19.22	%		19.65	%		-2.2	%

	Dividend yield		2.29	%		2.76	%		-17.0	%

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


		Price				Cash
						Dividend
		High		Low		Per share

Fiscal 2004
	December 31, 2003	$	26.15	$	21.86	$	0.1400

	September 30, 2003 (1)	$	24.53	$	21.21	$	0.1273

Fiscal 2003 (1)
	June 30, 2003	$	23.95	$	19.69	$	0.1273

	March 31, 2003	$	19.75	$	18.24	$	0.1273

	December 31, 2002	$	18.73	$	14.44	$	0.1273

	September 30, 2002	$	18.36	$	15.09	$	0.1091

Fiscal 2002 (1):
	June 30, 2002	$	18.44	$	14.58	$	0.1091

	March 31, 2002	$	15.82	$	12.12	$	0.1091

	December 31, 2001	$	13.75	$	11.83	$	0.0992

	September 30, 2001	$	14.45	$	11.11	$	0.0992

(1) Adjusted to give retroactive effect to the 10% stock dividends declared on the Group’s common stock in November 20, 2003

- 27 -

OVERVIEW OF FINANCIAL PERFORMANCE

The Group’s diversified mix of businesses produces both the interest income traditionally associated with a banking institution and the fee income generated by such businesses as brokerage, fiduciary services, investment banking and insurance. Even though all of these businesses, to varying degrees, are affected by financial markets fluctuations and other external factors, the Group’s commitment is to produce a balanced and growing revenue stream over the course of a business cycle.

The Group’s commitment toward its business strategies and goals in a challenging economic environment was evident in the first six months of fiscal 2004 during which the Group increased net income to $29.2 million, a 21.4 percent increase when compared with $24.1 million reported for the first six months of fiscal 2003. On a per diluted share basis, earnings rose 17.7 percent from $1.13 to $1.33. For the quarter ended December 31, 2003, the Group’s net income was $15.7 million, an increase of 25.4 percent, from the $12.5 million reported in the second quarter ended December 31, 2002. Earnings per diluted share increased to $0.70 for the second quarter ended December 31, 2003, up 18.6 percent from $0.59 for the corresponding period last year. The key drivers for such performance were the growth in net interest income and non-interest income, partially offset by an increase in non-interest expenses.

The return on assets (ROA) for the quarter ended December 31, 2003 grew to 1.95 percent from 1.87 percent the prior year comparable quarter. ROA for the six-month period was down slightly to 1.84 percent from 1.86 percent, a decline of 1.1 percent. Return on equity (ROE), which continues to be among the highest within the Group’s peer group, grew to 35.27 percent from 31.19 percent for the six-month periods, and to 41.28 percent from 31.25 percent, for the quarterly periods.

Net interest income after provision for loan losses increased by 26.5 percent for the quarter ended December 21, 2003, reaching $21.9 million, compared with $17.3 million for the same period in the previous fiscal year. This reflected an increase of 20.0 percent in interest earning assets, as well as lower interest expenses, offset somewhat by a 12 basis point decline in the interest rate spread to 2.85 percent. For the six-month period ended December 31, 2003, net interest income after provision for loan losses reached $39.5 million, against $34.7 million for the same six-month period a year earlier, an increase of 13.9 percent.

Non- interest income, such as service fees and the sale of securities, continued to be an important factor in the quarter and the first six months of fiscal 2004. Total non-interest income reached $9.4 million in the quarter ended December 31, 2003, compared with $8.6 million in the same fiscal 2003 quarter, an increase of 8.9 percent. For the six-month period, total non-interest income was $22.3 million in fiscal 2004, against $16.2 million in fiscal 2003, up 38.0 percent.

The Group’s strategy aimed at improving the mix of higher revenue and lower cost deposits and increasing the number of customers caused banking service revenues to increase by 17.2 percent, to $1.7 million, compared to $1.5 million in the year ago quarter. Management is encouraged by the new commercial business as well as the spin-offs that are being developed from the emphasis on building relationships with other products, such as financial planning, investments, mortgages, insurance, credit cards and deposit accounts.

Financial service revenues (trust, mortgage banking activities, brokerage and insurance fees) increased 5.6 percent, to $6.0 million, as compared to $5.7 million, primarily due to the January 2003 acquisition of Caribbean Pension Consultants, Inc., (CPC). As a result, total non-interest income related to banking and financial services revenue amounted to $7.7 million in the quarter ended December 31, 2003, compared with $7.1 million in the year-ago quarter, an increase of 8.0 percent. The net gain on sale of securities totaled $2.2 million, a 2.5 percent increase as compared with the year ago quarter.

For the quarter ended December 31, 2003, non-interest expenses increased 17.1 percent, to $14.6 million as compared to $12.5 million in the year-ago quarter. The increase was the result of investments in human resources, new technology, marketing, improvements to the current network of 23 branches and the acquisition of CPC. On a sequential quarter basis, however, non-interest expenses declined 5.1 percent from $15.4 million, reflecting tighter expense controls. The efficiency ratio improved to 47.60 percent, compared to 55.09 percent in the first quarter and 48.76 percent in the year-ago second quarter.

Total Group financial assets managed and owned (including assets managed by the trust department, the retirement plan administration subsidiary, and the broker-dealer subsidiary) increased 7.6 percent to $6.107 billion as of December 31, 2003, compared to $5.674 billion as of June 30, 2003. Assets managed by the Group’s trust department, the retirement plan administration subsidiary, and broker-dealer subsidiary increased 4.9 percent, to $2.763 billion, from $2.633 billion as of June 30, 2003, mainly due to the effect that the equity market improvement had over the assets gathered by broker-dealer. Assets owned increased 10.0 percent, reaching $3.344 billion as of December 31, 2003, versus $3.040 billion as of June 30, 2003.

-28-

Total investment portfolio amounted to $2.540 billion, a 13.8 percent increase, when compared to $2.232 billion as of June 30, 2003. The loan portfolio decreased by 2.3 percent, to $711.4 million as of December 31, 2003, when compared to $728.5 million as of June 30, 2003.

On the liability side, deposits increased 3.2 percent from $1.044 billion as of June 30, 2003, to $1.078 billion as of December 31, 2003. Total borrowings as of December 31, 2003, reached $1.994 billion, a 26.1 percent increase when compared to $1.582 billion as of June 30, 2003. The increase in borrowings was used primarily to fund the Group’s interest earning assets growth.

Finally, stockholders’ equity as of December 31, 2003, was $223.5 million, increasing 10.8 percent from $201.7 million as of June 30, 2003. This increase mainly reflects the impact of earnings retention, and the issuance of $34.5 million of preferred stock, partially offset by the increase in the accumulated other comprehensive loss of $36.1 million, mostly associated with the decrease in the unrealized gains on the securities available-for-sale portfolio.

In November 2003, Oriental increased its quarterly cash dividend by 10 percent and also declared a 10 percent stock dividend on its common shares.

Net Interest Income

Net interest income is affected by the difference between rates earned on the Group’s interest-earning assets and rates paid on its interest-bearing liabilities (interest rate spread) and the relative amounts of its interest-earning assets and interest-bearing liabilities (interest rate margin). Typically bank liabilities reprice in tandem with changes in short-term rates, while many assets positions are influenced by longer-term rates. Our interest rate risk position generally benefits in a declining rate environment because liabilities reprice more quickly than assets. However, when long-term rates decline faster than short-term rates, this benefit is somewhat offset. The Group constantly monitors the composition and repricing of its assets and liabilities to maintain its net interest income at adequate levels.

For the quarter ended December 31, 2003, the Group’s net interest income amounted to $22.9 million, up 24.5 percent from $18.4 million in the same period of the previous fiscal year. This increase in net interest income was due to a positive volume variance of $3.9 million, along with a positive rate variance of $0.6 million. Interest rate spread dropped 12 basis points during the second quarter ended December 31, 2003, to 2.85%, from 2.97% in the second quarter of the previous fiscal year. This was mainly due to a decrease in the combined average yield of investment and loans of 84 basis points. This was partially offset by a decline in the average cost of funds of 72 basis points.

For the six-month period ended December 31, 2003, net interest income amounted to $41.8 million, up 14.3 percent from $36.6 million for the six-month period ended December 31, 2002, while the interest rate spread declined 31 basis points to 2.71%. Net interest income increase was mainly due to a positive volume variance of $13.3 million, partially offset by a rate negative variance of $8.1 million. Table 1 and 1A provide information on the major categories of interest-earning assets and interest-bearing liabilities, their respective interest income, expenses, yields and costs, and their impact on net interest income due to changes in volume and rates.

The Group’s interest income for the second quarter ended December 31, 2003 totaled $42.1 million, an 11.2 percent increase from $37.9 million reported in the same period of the previous fiscal year. This increase in interest income resulted from a larger volume of average interest earning assets partially offset by a decline in their yield performance. For the second quarter ended December 31, 2003, the average volume of total interest-earning assets grew by 28.3 percent, to $3.101 billion versus $2.416 billion for the same period of the previous fiscal year. Increase in interest earning assets was concentrated on the investment and loan portfolios. The increase in the investment portfolio was concentrated in mortgage-backed securities and Puerto Rico government agencies obligations. The average volume of total loans grew by 10.2 percent, from $656.6 million for the second quarter ended December 31, 2002, versus $723.8 million for the second quarter ended December 31, 2003. The increase in the loan portfolio was concentrated in residential loans as the Group continued to promote and to improve mortgage loans origination. The average volume of real estate mortgage loans grew by 10.2 percent, from $595.3 million for the second quarter ended December 31, 2002, to $655.9 million for the second quarter ended December 31, 2003. Also, average balance of commercial loans grew by 20.29 percent from $41.4 million, to $49.8 million. Most of the commercial loans are secured by real estate.

Likewise, on a year to date basis, interest income increased 5.1 percent to $79.5 million from $75.6 million reported for the six-month period of previous fiscal 2003. Similarly, key drivers for these results are increases in investments and loans average balances. Investments average balances for the six month period ended on December 31, 2003 reached $2.269 billion or 31.44 percent higher than the $1.726 billion reported for the same period of previous fiscal year. Total average loans as of December 31, 2003 were $729.1 million, which represent an increase of 15.24 percent when compared to $632.7 million reported for comparable previous fiscal year period.

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For the quarter ended December 31, 2003, the average yield on interest-earning assets was 5.43%, 84 basis points lower than the 6.27% reported in the same period a year ago. The quarterly yield dilution experienced was mainly related to: (i) the expansion of Group’s investment portfolio, which carries a lower yield than the loan portfolio but provides less risk and generates a significant amount of tax-exempt interest; and (ii) a decrease on the yield of the investment and loan portfolios; reflecting the decrease in market rates (4.83% and 7.41% for the second quarter ended December 31, 2003, versus 5.69% and 7.80%, respectively, for the same period of the previous fiscal year). For the six-month period ended on December 31, 2003, the average yield on interest-earning assets was 5.30%, 111 basis points lower than the 6.41% reported in the same period a year ago. The main reason for this decrease is the yield dilution in the investment portfolio that dropped 119 basis points when compared to previous fiscal year investments yield. As mentioned above, this is the result of the overall decrease on market rates in response to the Federal Reserve Board’s statement of keeping targeted Fed funds rates lower for the near future.

Interest expense for the second quarter ended December 31, 2003 decreased 1.4 percent (to $19.1 million for the second quarter of fiscal year 2004, from $19.4 million of the previous fiscal year). A lower average cost of funds of 2.58% for the quarter ended December 31, 2003, versus 3.30% for the same period of the previous fiscal year, drove the decrease. For the six-month period ended December 31, 2003, interest expense amounted to $37.6 million, 3.5 percent lower than the $39.0 million reported for the same period of previous fiscal year. The average cost of fund for the six-month period was 2.59% or 80 basis points lower than the 3.39% recorded a year earlier. Larger average volumes of repurchase agreements and deposits, which were necessary to fund the growth of the Group’s loan and investment portfolios, drove the increase in average interest-bearing liabilities.

The cost of borrowings, mainly short-term financings, has substantially decreased, reflecting the decline in market rates. For the second quarter ended December 31, 2003, the cost of borrowings decreased 81 basis points (2.38% in the second quarter of fiscal 2004 versus 3.19% in the second quarter of fiscal year 2003). This funding category experienced its larger cost reduction of 116 and 101 basis point in FHLB funds and term notes and in subordinated capital notes, respectively (2.61% and 4.57% cost for the second quarter ended December 2003 versus 3.77% and 5.58% for the same quarter of the previous fiscal year, respectively). Likewise, for the six-month period ended on December 31, 2003 the cost of borrowing was 2.59%, an 80 basis points reduction from 3.39% reported for the previous fiscal year to date. As in the quarter, the interest bearing liabilities components that experienced the higher reduction in cost were the FHLB funds and term notes and the subordinated capital notes. The reduction in FHLB funds and term notes was 118 basis points and in the subordinated capital notes, the reduction was 96 basis points (from 3.77% and 5.63% to 2.59% and 4.67 respectively).

Non-Interest Income

As a diversified financial services provider, the Group’s earnings depend not only on the net interest income generated from its banking and investment activities, but also from fees and other non-interest income generated from the wide array of financial services that it offers. The Group is in a continuing process of balancing its earnings stream with a diversified mix of businesses that provide alternative investment and financing products and services for the more sophisticated needs of its clients. Non-interest income, the second largest source of earnings, is affected by the level of trust assets under management, transactions generated by gathering of financial assets by the broker-dealer subsidiary, investment banking, and the level of mortgage banking activities, fees generated from loans, deposit accounts and insurance.

Non-interest income rose to $9.4 million or 8.9% in the second quarter ended December 31, 2003, compared to $8.6 million in the same quarter of the previous fiscal year. Trust, mortgage banking, brokerage and insurance activities, one of the principal components of non-interest income, increased 5.6 percent during the second quarter ended December 31, 2003, to $6.0 million, from $5.7 million for the same quarter of previous fiscal year. This performance was driven by an increase in revenues from fiduciary activities of 49.9 percent when compared to the same period of the previous fiscal year, mainly due to the fee income generated by CPC, the retirement plan administration subsidiary acquired in January 2003. Revenues from fiduciary activities increased to $2.1 million from $1.4 million recorded in the same quarter of previous year. Partially offsetting this increase are the reductions experienced in insurance commissions and brokerage revenues. Insurance commissions for the second quarter ended December 31, 2003, decreased 18.3 percent from $722,000 to $590,000. Brokerage revenues for the second quarter ended December 31, 2003 declined to $1.6 million from $1.8 million recorded in the same period of fiscal 2003.These decreases resulted from lower than expected sales volumes experienced during the second quarter of fiscal 2004 since for the six-month period ended December 31, 2003 both are up by 18.4 percent and 14.6 percent, respectively, when compared with same period of the prior fiscal year. For the six-month period ended December 31, 2003, non-interest income increased 38.0 percent, to $22.3 million from $16.2 million recorded for the same period of prior fiscal year 2003. The increase is mainly due to the market valuation improvement in assets managed for others and also to the effect of new and revised service fees applied during the current fiscal year in fiduciary activities.

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For the quarter ended December 31, 2003, gains generated by mortgage banking activities remain in line with the second quarter of previous year revenues, these revenues amounted to $1.7 million for both comparable periods. For the six-month period ended December 31, 2003 gains generated by mortgage banking activities amounted to $4.5 million or 22.0 percent more than the $3.7 million recorded for the first six months of fiscal 2003. Such increase reflects the impact of greater volume of mortgage loans securitization and sales during the first quarter of fiscal 2004.

Bank service revenues consist primarily of fees generated by deposit accounts, electronic banking services and bank service commissions. These revenues totaled $1.7 million in the second quarter ended December 31, 2003, a 17.2 percent increase versus $1.5 million reported in the same period of the previous fiscal year. This was mainly due to a 14.0 percent increase on fees on deposit accounts which increased from $1.0 million to $1.2 million in the quarter ended December 31, 2003. Also, bank service charges and commissions contributed to the increase in bank service revenues. Bank service charges and commissions for the second quarter of fiscal 2004 increased to $486,000, from $381,000 reported during the second quarter of previous fiscal year 2003 (a 27.6 percent increase), mainly as a result of electronic banking fees generated during the quarter that correspond to an increase in consumer spending during the holidays. For the six-month period ended December 31, 2003, bank service revenues increased 14.3 percent to $3.4 million, from $3.0 million reported for the same period of fiscal 2003. Likewise, fees on deposits accounts and bank service charges lead these increases. Such increases were mainly driven by the Group’s strategy of expanding its banking franchise in all its aspects. Our ability to attract deposits and build relationship banking with consumer and commercial customers was enhanced by aggressive marketing, good products like the Amiga checking account, substantial investment in technology, the remodeling and the expansion of our financial centers and expansion of our sales force.

Revenues on securities, derivatives and trading activities for the second quarter ended December 31, 2003 increased 11.8 percent. The net revenue on securities, derivatives, and trading activities for the second quarter of fiscal 2004 was $1.6 million, compared to $1.5 million for the same period of the previous fiscal year. On a year-to-date basis, securities, derivatives and trading activities amounted to $5.5 million or 88.6 percent more than previous year’s activity of $2.9 million. Securities net activity remains constant when compared to previous year’s activity as the Group is selectively identifying favorable market opportunities to realize such gains. Derivatives net activity presents an improvement from the prior year’s net derivative loss. The prior year’s loss was related to a decrease in the market value of derivatives, primarily to the cancellation of interest rate caps, due to interest rate market conditions at that time. For more information see “Derivatives Activities” in Note 7 to the unaudited Consolidated Financial Statements and “Item - 3, Quantitative and Qualitative Disclosures about Market Risk”.

Non-Interest Expenses

Non-interest expenses for the quarter ended December 31, 2003 increased 17.1 percent to $14.6 million from $12.5 million in the comparable period of the previous fiscal year. For the six-month period ended December 31, 2003, non-interest expenses amounted to $30.0 million, 18.5 percent more than the $25.3 million recorded for the same period of fiscal 2003. This increase reflects the Group’s growth and increases in spending related to the expansion and improvement of its sales force, the acquisition of CPC, marketing, growth in the retail banking platform and continuing investment in technology and infrastructure supporting risk management processes as well as recent and future growth. On a sequential quarter basis, however, non-interest expenses declined 5.1 percent from $15.4 million, reflecting tighter expense controls. The efficiency ratio improved to 47.60 percent, compared to 55.09 percent in the first quarter and 48.76 percent in the year-ago second quarter.

Employee compensation and benefits is the Group’s largest non-interest expense category. For the second quarter ended December 31, 2003, total compensation and benefits amounted to $5.7 million, an increase of 26.4 percent, when compared to $4.5 million for the same period in the previous fiscal year. This reflects the expansion of the work force to encourage higher volume of business and the restructure of certain departments to improve customer satisfaction in our core business. Refer to Table 3 for more selected data regarding employee compensation and benefits.

Other non-interest expenses, which include occupancy and equipment, advertising and business promotion, professional and service fees, among other costs, for the quarter ended December 31, 2003, amounted to $8.9 million, an 11.8 percent increase when compared to $7.9 million for the same period in the previous year. For the first six months of fiscal 2004, other non-interest expense amounted to $18.2 million, an increase of 12.8 percent when compared to $16.1 million reported for the same period of fiscal 2003.

Occupancy and equipment expenses increased 6.0 percent, from $2.2 million in the second quarter ended December 31, 2002, to $2.3 million in the second quarter of fiscal 2004, as a direct result of the addition of a new branch and the relocation of another branch to improve our retail banking platform in response to bank products demand. For the first six months of fiscal 2004, these expenses increased 6.1 percent from the $4.4 million recorded during the first six months of fiscal 2003. This increase is also due to the relocation of existing financial centers and upgrading financial center technology and infrastructure.

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During the quarter ended December 31, 2003, the Group continued its aggressive promotional campaign to enhance the market recognition of new and existing products in order to increase our fee-based revenues and re-branding activity. As a result, in the quarter ended December 31, 2003, advertising and business promotion increased 18.9 percent to $2.1 million versus $1.8 million reported in the second quarter of fiscal 2003. For the first six months of fiscal 2004, advertising and business promotion increased to $4.2 million or 17.1 percent from the $3.6 million reported for the first six months of fiscal 2003.

Professional and service fees decreased 5.4%, from $1.5 million in the second quarter ended December 31, 2002, to $1.4 million in the second quarter of fiscal 2004. For the first six months of fiscal 2004, professional and service fees decreased 8.0 percent to $3.1 million, from $3.3 million reported for the same period of fiscal 2003. The decrease in professional and service fees are directly related to specific expense control initiatives and operational efficiencies.

The rise in communication, municipal and other general taxes, insurance, printing, postage, stationery and supply, and other operating expenses are mainly due to the general growth in the Group’s business activities, products and services offered. The Group will continue to assess its operations and organizational structures to make sure they are closely aligned with our goal of maximizing performance through increased efficiency and competitiveness in our core businesses.

Provision for Loan Losses

The provision for loan losses for the quarter ended December 31, 2003, totaled $1.0 million, down slightly from the $1.1 million reported for the same period of the previous fiscal year. For the first six months of fiscal 2004, the provision amounted to $2.4 million, a 21.3 percent increase, when compared to $1.9 million reported a year earlier. The increase in the provision for loan losses reflects the required provisions needed to cover the increase of net credit losses. Net credit losses average ratio for the quarter increased 19 basis points, from 0.30% in the quarter ended December 31, 2002, to 0.49% in the quarter ended December 31, 2003. For the first six months of fiscal 2004, net credit losses average ratio was 0.37%, an increase of 3 basis points from the 0.34% reported for the same period of prior fiscal year. Major increases in net credit losses were recorded for residential real estate and commercial loan portfolios partially offset by a decrease in the consumer loans portfolio.

Residential real estate’s net credit losses for the quarter and six-month periods ended December 31, 2003, were $249,000. This amount represents a charge-off on a large real estate loan in which the Group decided to accept the real estate collateral as payment of the loan. The Group did not have any charge-offs on this portfolio last year.

Commercial’s net credit losses increased $247,000 and $264,000 for the quarter and six-month periods ended December 31, 2003, when compared to the same periods of previous fiscal year. The reason for such increases is because management performed a review of the entire commercial loan portfolio and decided to recognize as losses certain loans considered uncollectible or of such little value that the continuance as bankable assets was not warranted. This review was necessary since the Group’s strategy is to expand the commercial loan portfolio in fiscal year 2004. Almost all the commercial lending that the Group is originating is well collateralized.

Net credit losses on consumer loans decreased when compared with the same quarter of last fiscal year. For the quarter ended December 31, 2003, net credit losses on consumer loans were $397,000, which represents a decrease of 22 percent, when compared with the quarter ended December 31, 2002 in which the Group had a net credit loss of $509,000. For the six-month period ended December 31, 2003, net charge-offs on consumer loans were $888,000, which represents a decrease of 20.3 percent, when compared with the six-month period ended December 31, 2002, in which the Group had a net credit loss of $1.1 million.

Non-performing commercial loans increased 74.9 percent, from $1.8 million as of June 30, 2003, to $3.1 million as of December 31, 2003. This increase is due to one large commercial real estate loan of $1.3 million approximately which reached 90 days past-due as of December 31, 2003. The Group is in the process of restructuring such loan. The value of the real estate property held as collateral is enough to cover the principal balance outstanding of this loan. Non-performing residential real estate secured loans increased 7.6 percent, to $28.6 million as of December 31, 2003, when compared to June 30, 2003 non-performing levels of $26.6 million. However, this portfolio is well collateralized and the Group does not expect any major losses on such portfolio.

Provision for Income Taxes

The Group recognized a provision for income tax of $998,000 for the quarter ended December 31, 2003, compared with a provision of $943,000 for the same period of the previous fiscal year. This is in relationship with the increase in income

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before income taxes for the quarter ended December 31, 2003. For the first six months of fiscal 2004, the income tax provision amounted to $2.6 million or 79.4 percent higher than the $1.4 million reported for the same period of fiscal 2003. The current income tax provision is lower than the provision based on the statutory tax rate for the Group, which is 39%, due to the high level of tax-advantage interest income earned on certain investments and loans, net of the disallowance of related expenses attributable to the exempt income. In addition, the Puerto Rico Internal Revenue Code provides a dividend received deduction of 100% on dividends received from wholly-owned subsidiaries subject to income taxation in Puerto Rico. Exempt interest relates mostly to interest earned on obligations of the United States and Puerto Rico Governments and certain mortgage-backed securities, including securities held by the Group’s International Banking Entity.

FINANCIAL CONDITION

Group’s Assets

At December 31, 2003, the Group’s total assets amounted to $3.344 billion, an increase of 10.0%, when compared to $3.040 billion at June 30, 2003. On the same date, interest-earning assets reached $3.258 billion, up 10.0% versus $2.963 billion at June 30, 2003.

Investments are the Group’s largest interest-earning assets component. It mainly consists of money market investments, U.S. Government agencies bonds, mortgage-backed securities, CMO’s and P.R. Government municipal bonds. The Group decided to reposition its investment portfolio during the quarter ended September 30, 2003 and transferred a group of securities ($856 million) from the available-for-sale category to the held-to-maturity category as management now intends to hold these securities to maturity. The investment portfolio increased 13.8%, to $2.540 billion, from $2.232 billion as of June 30, 2003. Most of the increase is mainly due to the acquisition of additional mortgage-backed securities and Puerto Rico government and agency obligations (see Table 9 and Note 2 to the unaudited Consolidated Financial Statements).

At December 31, 2003, the Group’s loan portfolio, the second largest category of the Group’s interest-earning assets, slightly decreased by 2.3 percent, to $711.4 million when compared to $728.5 million at June 30, 2003. This was mainly due to a decrease in the residential and personal mortgage loans (including loans held for sale), the largest component of the Group’s loan portfolio, which decreased by 3.7 percent, to $645.5 million, when compared to $670.1 million at June 30, 2003. Such decrease was due to the residential mortgage loans sold in the secondary market during the first six months of fiscal 2004, which amounted to $145.8 million or $94.7 million more than the $51.1 million sold during the same period of previous fiscal 2003 and the loan repayments. This was partially offset by a 23.9 percent increase in commercial loans. Commercial loans for December 31, 2003 and June 30, 2003 totaled $54.0 million and $43.6 million, respectively (7.5% and 5.9% of total gross loan portfolio, respectively). Such increase reflected the success of the Group’s strategy to expand the commercial loan program in fiscal 2004.Table 9 and Note 3 of the unaudited Consolidated Financial Statements presents the Group’s loan portfolio composition and mix at the end of the periods analyzed.

At December 31, 2003 and June 30, 2003, the consumer loan portfolio totaled $18.0 million and $19.8 million, respectively (2.5% and 2.7% of the Group’s loan total gross portfolio, respectively).

Liabilities and Funding Sources

At December 31, 2003, the Group’s total liabilities reached $3.121 billion, 9.9 percent higher than the $2.839 billion reported at June 30, 2003. Deposits and borrowings, the Group’s funding sources, amounted to $3.072 billion at December 31, 2003, an increase of 10.6 percent, when compared to $2.778 billion recorded at June 30, 2003.

Borrowings are the Group’s largest interest-bearing liability component. They consist mainly of diversified funding sources through the use of Federal Home Loan Bank of New York (FHLB) advances and borrowings, repurchase agreements, term notes, subordinated capital notes, and unused lines of credit. At December 31, 2003, they amounted to $1.994 billion, 26.1% higher than the $1.582 billion at June 30, 2003. The increase, mainly in repurchase agreements and FHLB funds, reflects the funding needed to maintain the Group’s loan and investment portfolios growth.

The FHLB system functions as a source of credit to financial institutions that are members of a regional Federal Home Loan Bank. As a member of the FHLB, the Group can obtain advances from the FHLB, secured by the FHLB stock owned by the Group, as well as by certain of the Group’s mortgages and investment securities. FHLB funds reached $301.0 million as of December 31, 2003, an increase of 131.5 percent when compared to FHLB funds as of June 30, 2003. This increase is mainly due to the strategy of extending the maturity of our liabilities, to take advantage of alternative lower rate funding sources. Table 10 presents the composition of the Group’s borrowings at the end of the periods analyzed.

At December 31, 2003, deposits, the second largest category of the Group’s interest-bearing liabilities, reached $1.078 billion, up 3.2%, compared to the $1.044 billion reported as of June 30, 2003. A $41.9 million increase (or 8.9%) in certificates of deposit other than IRA accounts and $12.8 million increase (or 3.7%) in IRA accounts contributed to this

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raise in total deposits. Table 10 presents the composition of the Group’s deposits at the end of the periods analyzed.

Stockholders’ Equity

At December 31, 2003, the Group’s total stockholders’ equity was $223.5 million, a 10.8% increase, when compared to $201.7 million at June 30, 2003. In addition to earnings from operations, this rise reflects an increase on outstanding preferred stocks of $34.5 million offset by an increase of $36.1 million in the other accumulated comprehensive loss (for the first six months ended December 31, 2003). Accumulated other comprehensive loss, net, consists of the unrealized loss on derivatives designated as cash flow hedges and the unrealized gain or loss on investment securities available-for-sale, net of deferred tax. At December 31, 2003, accumulated unrealized loss, net of tax, on derivatives designated as cash flow hedges was $27.3 million, a $14.5 million decrease, when compared to an accumulated unrealized loss of $41.8 million at June 30, 2003. On the other hand, accumulated unrealized loss, net of tax, on investment securities available-for-sale amounted to $9.1 million at December 31, 2003, a $50.6 million negative change, when compared with an accumulated unrealized gain of $41.5 million at June 30, 2003. Accumulated unrealized loss, net of tax, on investment securities available-for-sale at December 31, 2003 includes an unrealized loss amounted to $28.0 million related to securities transferred to the held-to-maturity category. This unrealized loss is amortized over the remaining life of the securities as a yield adjustment.

On November 20, 2003, the Group declared a 10% common stock dividend payable from the treasury stock account on January 16, 2004 to holders of record as of December 31, 2003. This dividend brings to 242,441 shares the number of shares held by the Group as treasury stock. The Group’s common stock is traded in the New York Stock Exchange (NYSE) under the symbol OFG. At December 31, 2003, the Group’s market capitalization for its outstanding common stock was $508.5 million ($25.70 per share).

Under the regulatory framework for prompt corrective action, banks which meet or exceed a Tier I risk-based ratio of 6%, a total capital risk-based ratio of 10% and a leverage ratio of 5% are considered well capitalized. The Bank exceeds those regulatory capital requirements. See Table 11 for the Group’s regulatory capital ratios.

Group’s Financial Assets

The Group’s total financial assets include the Group’s bank assets owned and the assets managed by the trust division, the broker-dealer subsidiary and the private pension plan administration subsidiary. At December 31, 2003, they reached $6.107 billion — up 7.6%, when compared to $5.674 billion at June 30, 2003. The increase was largely due to a growth of 10.0% in the Group’s bank assets owned, when compared to June 30, 2003, and to the improvement in the equity market conditions as broker- dealer assets gathered increased 14.4% when compared to June 30, 2003. The Group’s financial assets main component is the assets owned by the Group, of which approximately 98 % are owned by the Group’s banking subsidiary. For more on this financial asset component, refer to “Group’s Assets” under “Financial Condition” herein above.

The Group’s second largest financial assets component is assets managed by the trust division and the retirement plan administration subsidiary. The Group’s trust division offers various types of IRA products and manages 401(K) and Keogh retirement plans, custodian and corporate trust accounts, while Caribbean Pension Consultants, Inc. (“CPC”) manages the administration of private pension plans. At December 31, 2003, total assets managed by the Group’s trust division and CPC amounted to $1.662 billion, 0.5% less than the $1.670 billion reported at June 30, 2003.

The other financial asset component is assets gathered by the securities broker-dealer. The Group’s securities broker-dealer subsidiary offers a wide array of investment alternatives to its client base such as tax-advantaged fixed income securities, mutual funds, stocks and bonds. At December 31, 2003, total assets gathered by the securities broker-dealer from its customer investment accounts reached $1.101 billion, up 14.4%, from $963 million at June 30, 2003, as a result of the equity securities market recovery, which led to more trading activities by customers.

ALLOWANCE FOR LOAN LOSSES AND NON-PERFORMING ASSETS:

At December 31, 2003, the Group’s allowance for loan losses amounted to $6.0 million (0.84% of total loans) a 19.7 percent increase from the $5.0 million (0.69% of total loans) reported at June 30, 2003. Residential real estate and consumer loans allowances present the greatest increases of 46.2 percent and 49.5 percent, or $807,000 and $643,000, respectively, when compared with balances recorded at June 30, 2003. Commercial loans allowance increased 25.9 percent or $112,000, when compared to $433,000 recorded at June 30, 2003. These increases were partially offset by a 37.0 percent or $573,000 decrease in the unallocated allowance as management identified specific areas subject to credit risk in the real estate residential and commercial loan portfolios, consequently reducing the unallocated allowance. These increases in allowance were mainly due to a $249,000 charge off in a residential real estate loan during the quarter and

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also to an increase in non-performing loans in this portfolio of 7.6 percent or $2.0 million. Non-performing consumer loans increased only 10.3 percent or $53,000 for the first six months of fiscal 2004, but still comprised 65% of total net credit losses recorded. In addition, actual consumer’s net credit losses higher than those expected increased the consumer loan allowance.

Non-performing commercial loans increased 74.9 percent or $1.3 million, when compared to June 30, 2003 non-performing commercial loans of $1.8 million. Similarly, commercial net credit losses for the first six months of fiscal 2004 were $264,000 more than the $36,000 net recoveries recorded for the first six months of fiscal 2003. The Group maintains an allowance for loan losses at a level that management considers adequate to provide for potential losses based upon an evaluation of known and inherent risks. The Group’s allowance for loan losses policy provides for a detailed quarterly analysis of possible losses.

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

The Group uses a methodology that follows a loan credit risk rating process that involves dividing loans into risk categories. The following are the credit risk categories (established by the FDIC Interagency Policy Statement of 1993) used:

1. Pass - loans considered highly collectible due to their repayment history or current status (to be in this category a loan cannot be more than 90 days past due).

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

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

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

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

Larger commercial loans that exhibit potential or observed credit weaknesses are subject to individual review and grading. Where appropriate, allowances are allocated to individual loans based on management’s estimate of the borrower’s ability to repay the loan given the availability of collateral, other sources of cash flow and legal options available to the Group.

Included in the review of individual loans are those that are impaired. A loan is considered impaired when, based on current information and events, it is probable that the Group will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Impaired loans are measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate, or as a practical expedient, at the observable market price of the loan or the fair value of the collateral, if the loan is collateral dependent. Loans are individually evaluated for impairment, except large groups of small balance, homogeneous loans that are collectively evaluated for impairment and for loans that are recorded at fair value or at the lower of cost or market. The Group measures for impairment all commercial loans over $250,000. The portfolios of mortgages, consumer loans, and leases are considered homogeneous and are evaluated collectively for impairment.

The Group, using an aged-based rating system, applies an overall allowance percentage to each loan portfolio category based on historical credit losses adjusted for current conditions and trends. This delinquency-based calculation is the starting point for management’s determination of the required level of the allowance for loan losses. Other data considered in this determination includes:

1. Overall historical loss trends; and

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

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

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

Net credit losses for the quarter ended December 31, 2003, totaled $883,000 (0.49% of average loans) an increase of 77 percent when compared to $499,000 (0.30% of average loans) for the same period of the previous fiscal year. Major increases in net credit losses were recorded for real estate and commercial loans, which increased $317,000 and $247,000, respectively, when compared to the same period of previous fiscal year 2003. For the first six months of fiscal 2004, net credit losses amounted to $1.4 million, a 26.6 percent increase when compared to $1.1 million reported for the first six months of fiscal 2003. Likewise, net credit losses increases in real estate of $249,000 and in commercial loans of $264,000, shore up these results partially offset by a reduction of $226,000 in net credit losses related to consumer loans. Tables 4 through 6 set forth an analysis of activity in the allowance for loan losses and presents selected loan loss statistics.

At December 31, 2003, the Group’s non-performing assets totaled $32.9 million (0.98% of total assets) versus $29.4 million (0.97% of total assets) at the end of June 30, 2003. The increase was principally due to an 11.8 percent increase on non-performing loans. Foreclosed real estate properties increased 12.1 percent when compared to $536,000 reported on June 30, 2003.

At December 31, 2003, the allowance for loan losses to non-performing loans coverage ratio was 18.64%. Excluding the lesser-risk real estate loans, the ratio is much higher, 162.05%. Detailed information concerning each of the items that comprise non-performing assets follows:

• Real estate loans - are placed on a non-accrual basis when they become 365 days or more past due and are written-down, if necessary, based on the specific evaluation of the collateral underlying the loan. At December 31, 2003, the Group’s non-performing real estate loans totaled $28.6 million (88.5% of the Group’s non-performing loans) a 7.6% increase from the $26.6 million (92.0% of the Group’s non-performing loans) reported as at June 30, 2003. Non-performing loans in this category are primarily residential mortgage loans. Based on the value of the underlying collateral, the loan-to-value ratios and credit loss experienced, management considers that no significant losses will be incurred on this portfolio.

• Commercial loans - are placed on non-accrual basis when they become 90 days or more past due and are written-down, if necessary, based on the specific evaluation of the underlying collateral, if any. At December 31, 2003, the Group’s non-performing commercial loans amounted to $3.1 million (9.7% of the Group’s non-performing loans) a 74.9% increase from $1.8 million reported at June 30, 2003 (6.2% of the Group’s non-performing loans). Most of this portfolio is also collateralized by real estate and no significant losses are expected.

• Consumer loans - are placed on non-accrual status when they become 90 days past due and written-down when payments are delinquent 120 days. At December 31, 2003, the Group’s non-performing consumer loans amounted to $570,000 (1.8% of the Group’s total non-performing loans), a 10.3% increase from the $517,000 reported as at June 30, 2003 (1.8% of total non-performing loans).

• Foreclosed real estate - is initially recorded at the lower of the related loan balance or fair value at the date of foreclosure. Any excess of the loan balance over the fair market value of the property is charged against the allowance for loan losses. Subsequently, any excess of the carrying value over the estimated fair market value less disposition cost is charged to operations. Management is actively seeking prospective buyers for these foreclosed real estate properties. At December 31, 2003, foreclosed real estate balance was $601,000, a 12.1% increase from the $536,000 reported at June 30, 2003.

Item – 3

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Interest Rate Risk and Asset/Liability Management

The Group’s interest rate risk and asset/liability management is the responsibility of the Asset and Liability Management Committee (“ALCO”), which reports to the Board of Directors and is composed of members of the Group’s senior management. The principal objective of ALCO is to enhance profitability while maintaining an appropriate level of interest

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rate and liquidity risks. ALCO is also involved in formulating economic projections and strategies used by the Group in its planning and budgeting process and also, oversee the Group’s sources, uses and pricing of funds.

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

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

The Group generally uses interest rate swaps and interest rate options, such as caps and options, in managing its interest rate risk exposure. The swaps were entered into to convert short-term borrowings into fixed rate liabilities for longer periods and provide protection against increases in short-term interest rates. Under these swaps, the Group pays a fixed monthly or quarterly cost and receives a floating monthly or quarterly payment based on LIBOR. Floating rate payments received from the swap counterparties correspond to the floating rate payments made on the short-term borrowings thus resulting in a net fixed rate cost to the Group. Under the caps, the Group pays an upfront premium or fee for the right to receive cash flow payments in excess of the predetermined cap rate; thus, effectively capping its interest rate cost for the duration of the agreement.

The Group’s swaps, excluding those used to manage exposure to the stock market, and caps outstanding and their terms at December 31, 2003, and June 30, 2003 are set forth in the table below:


		(Dollars in thousands)

		December 31, 2003			June 30, 2003

Swaps:
	Pay fixed swaps notional amount	$	675,000		$	650,000
	Weighted average pay rate - fixed		3.71	%		3.97	%
	Weighted average receive rate - floating		1.16	%		1.24	%
	Maturity in months	2 to 82			1 to 88
	Floating rate as a percent of LIBOR		100	%		100	%
Caps:
	Cap agreements notional amount	$	75,000		$	75,000
	Cap rate		4.50	%		4.50	%
	Current 90 day LIBOR		1.15	%		1.31	%
	Maturity in months		3			9

The Group offers its customers certificates of deposit with an option tied to the performance of the Standard & Poor’s 500 stock market index. At the end of five years, the depositor will receive a specified percentage of the average increase of the month-end value of the corresponding stock index. If such index decreases, the depositor receives the principal without any interest. The Group uses swap and option agreements with major money center banks and major broker dealer companies to manage its exposure to changes in those indexes. Under the terms of the option agreements, the Group will receive the average increase in the month-end value of the corresponding index in exchange for a fixed premium. Under the term of the swap agreements, the Group will receive the average increase in the month-end value of the corresponding index in exchange for a quarterly fixed interest cost. The changes in fair value of the options purchased, the swap agreements and the options embedded in the certificates of deposit are recorded in earnings.

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

Information pertaining to the notional amounts of the Group’s derivative financial instruments as of December 31, 2003

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and June 30, 2003 is as follows:


		Notional Amount
		(In thousands)

Type of Contract:		December 31, 2003		June 30, 2003

Cash Flows Hedging Activities - Interest rate swaps used to hedge a forecasted transaction - short-term borrowings		$	675,000	$	650,000

Derivatives Not Designated as Hedge:
	Interest rate swaps used to manage exposure to the stock market on stock indexed deposits	$	2,750	$	7,450
	Purchased options used to manage exposure to the stock market on stock indexed deposits		241,450		232,800
	Embedded options on stock indexed deposits		234,067		229,574
Caps			75,000		75,000

		$	553,267	$	544,824

During the quarters ended December 31, 2003 and 2002, $608,000 and $725,000, respectively, of losses were charged to earnings and reflected as “Derivatives Activities” in the consolidated statements of income. For the first six months of fiscal 2004 and 2003 these losses amounted to $660,000 and $4.0 million respectively. For the quarter ended on December 31, 2003, unrealized gains of $1.2 million on derivatives designated as cash flow hedges were included in other comprehensive income. For the first six months of fiscal 2004, unrealized gains of $5.4 million on derivatives designated as cash flow hedges were included in other comprehensive income. Ineffectiveness of $540,000 was charged and $349,000 was credited to earnings during the quarters ended December 31, 2003 and 2002, respectively. During the six-month periods ended December 31, 2003 and 2002, ineffectiveness of $557,000 and $36,000 were charged to earnings, respectively.

Rate changes expose the Group to changes in net interest income (NII). The result of the sensitivity analysis on NII of $99.0 million as of December 31, 2003, for the next twelve months is a $10.6 million decrease, or -10.66% change on a hypothetical 200 basis points rate increase. The change for the same period, utilizing a hypothetical declining rate scenario of 50 basis points, is a decrease of $57,000 or -0.06%. Both hypothetical rate scenarios consider a gradual change of +200 and -50 basis points during the twelve-month period. The decreasing rate scenario has a floor of .25%. This floor causes liabilities (already around 1%) to have little cost reduction, while the assets do have a decrease in yields, causing a small loss in declining rate simulations. These estimated changes are within the policy guidelines established by the Board of Directors.

Liquidity Risk Management

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

The goal of liquidity management is to provide adequate funds to meet changes in loan demand or unexpected deposit withdrawals. This is accomplished by maintaining liquid assets in the form of investment securities, maintaining sufficient unused borrowing capacity in the national money markets and delivering consistent growth in core deposits. As of December

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31, 2003, the Group had approximately $425.4 million in securities and other short-term investments available to cover liquidity needs. Additional asset-driven liquidity is provided by securitizable loan assets. These sources, in addition to the Group’s 10.5% average equity capital base, provide a stable funding base.

In addition to core deposit funding, the Group also accesses a variety of other short-term and long-term funding sources. Short-term funding sources mainly include securities sold under agreements to repurchase. Borrowing funding source limits are determined annually by each counter-party and depend on the Group’s financial condition and delivery of acceptable collateral securities. The Bank may be required to provide additional collateral based on the fair value of the underlying securities. The Bank also uses the Federal Home Loan Bank of New York (FHLB) as a funding source, issuing notes payable, such as advances, through its FHLB member subsidiary, the Bank. This funding source requires the Bank to maintain a minimum amount of qualifying collateral with a fair value of at least 110% of the outstanding advances. At December 31, 2003, the Group has an additional borrowing capacity with the FHLB of $42.5 million.

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

As of December 31, 2003, the Bank had line of credit agreements with other financial institutions permitting the Bank to borrow a maximum aggregate amount of $24.4 million. No borrowings were made during the six-month period ended December 31, 2003 under such lines of credit. The agreements provide for unsecured advances to be used by the Bank on an overnight basis. Interest rate is negotiated at the time of the transaction. The credit agreements are renewable annually.

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

The Group’s investment portfolio at December 31, 2003 had an average maturity of 58 months. However, no assurance can be given that such levels will be maintained in future periods.

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

Changes in statutes and regulations, including tax laws and rules

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

Puerto Rico international banking entities, or IBE’s, are currently exempt from taxation under Puerto Rico law. Recently, the Legislature of Puerto Rico and the Governor of Puerto Rico approved a law amending the IBE Act. This law imposes income taxes at normal statutory rates on each IBE that operates as a unit of a bank, if the IBE’s net income generated after December 31, 2003 exceeds 40 percent of the bank’s net income in the taxable year commenced on July 1, 2003, 30 percent of the bank’s net income in the taxable year commencing on July 1, 2004 and 20 percent of the bank’s net income in the taxable year commencing on July 1, 2005 and thereafter. It does not impose income taxation on an IBE that operates as a subsidiary of a bank.

The Group has an IBE that operates as a unit of the Bank. The Group recently organized a new IBE that operates as a subsidiary of the Bank. The Bank transferred as of January 1, 2004, substantially all of the bank’s IBE assets to the new IBE subsidiary. Although this transfer of IBE assets will allow us to continue enjoying tax benefits, we cannot give you any assurance that the IBE Act will not be modified in the future in a manner to reduce the tax benefits available to our new IBE subsidiary.

Item – 4

CONTROLS AND PROCEDURES

The Group’s management, including the Chief Executive Officer and the Acting Chief Financial Officer, evaluated the effectiveness of the design and operation of the Group’s disclosure controls and procedures (as defined in Rules 13a-15(e)

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and 15d-15(e) under the Securities Exchange Act of 1934, as amended) (the “Exchange Act”) as of the end of the period covered by this report. Based upon that evaluation, the Group’s management, including the Chief Executive Officer and the Acting Chief Financial Officer, concluded that the Group’s disclosure controls and procedures are effective in timely alerting them to any material information relating to the Group and its subsidiaries required to be included in the Group’s Exchange Act filings.

There were no significant changes made in the Group’s internal controls over financial reporting that occurred during the Group’s most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Group’s internal control over financial reporting.

PART – 2 OTHER INFORMATION

Item – 1

LEGAL PROCEEDINGS

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

Item – 2

CHANGES IN SECURITIES AND USE OF PROCEEDS

None

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Item – 3

DEFAULTS UPON SENIOR SECURITIES

None

Item – 4

SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS

Only one matter was submitted and approved at the annual meeting of stockholders held on October 28, 2003 in San Juan, Puerto Rico. Such matter consisted of the election of three directors to a three-year term expiring in 2006. Following in tabular form are the voting results per nominee:


Nominees	For		Against

José Enrique Fernández		9,287,295		1,566,331
Efraín Archilla		10,576,515		277,111
Julian S. Inclán		10,345,548		458,078

Continued Item – 4

The terms of the following directors continued after the meeting: Pablo I. Altieri, M.D., Diego Perdomo, C.P.A., Alberto Richa-Angelini, Emilio Rodríguez Jr., Francisco Arriví and Miguel Vázquez-Deynes.

Item – 5

OTHER INFORMATION

None

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Item – 6

EXHIBITS AND REPORTS ON FORM 8-K

A- Exhibits


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

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

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

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

B – Reports on Form 8-K

• Current report on Form 8-K, dated October 27, 2003, reporting under Item 5 the issue of trust redeemable preferred securities and non-cumulative monthly income preferred stock.

• Current report on Form 8-K, dated October 22, 2003, reporting under Items 5 and 12 the release of the Group’s financial results for the quarter ended September 30, 2003.

Signatures

Pursuant to the requirements of Section 13 or 15(d ) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

ORIENTAL FINANCIAL GROUP INC.
(Registrant)


By:	/s/José Enrique Fernández

José Enrique Fernández
Chairman of the Board, President and Chief Executive Officer		Dated: February 12, 2004

By:	/s/Norberto González

Norberto González
Executive Vice President – Acting Chief Financial Officer		Dated: February 12, 2004

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•		*Allowance for Loan Losses*

		The Group assesses the overall risks in its loan portfolio and establishes and maintains an allowance for probable losses thereon. The allowance for loan losses is maintained at a level sufficient to provide for estimated loan losses based on the evaluation of known and inherent risks in the Group’s loan portfolio. The Group’s management evaluates the adequacy of the allowance for loan losses on a quarterly basis. Based on current and expected economic conditions, the expected level of net loan losses and the methodology established to evaluate the adequacy of the allowance for loan losses, management considers that the allowance for loan losses is adequate to absorb probable losses on its loan portfolio. Any significant changes in these considerations would have an impact on the allowance for loan losses. See Item 2 “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Allowance for Loan Losses and Non-Performing Assets” for a detailed description of the Group’s estimation process and methodology related to the allowance for loan losses.

•		*Financial Instruments*

		Certain financial instruments including derivatives, hedged items and investment securities available-for-sale are recorded at fair value and unrealized gains and losses are recorded in other comprehensive income (loss) or other gains and losses as appropriate. Fair values are based on listed market prices, if available. If listed market prices are not available, fair value is determined based on other relevant factors including price quotations for similar instruments. Fair value for certain derivative contracts are derived from pricing models that consider current market and contractual prices for the underlying financial instruments as well as time valued and yield curve or volatility factors underlying the positions.

•		*Impairment of Investment Securities*

		The Group evaluates for impairment its investment securities on a quarterly basis or earlier if other factors indicative of potential impairment exist. An impairment charge in the consolidated statements of income is recognized when the decline in the fair value of the securities below their cost basis is judged to be other-than-temporary. The Group considers various factors in determining whether it should recognize an impairment charge, including, but not limited to the length of time and extent to which the fair value has been less than its cost basis, expectations of recoverability of its original investment, the employment of a systematic methodology that considers available evidence in evaluating potential impairment, available secondary market prices from broker/dealers, and the Group’s intention and ability to hold the security for a period of time sufficient to allow for any anticipated recovery in fair value.

		The impairment analysis on the mortgage backed securities is done placing special emphasis on the analysis of the trustee and collateral manager monthly reports, as well as on sensitivity and expected cash flow analysis made by major brokerage houses. The Group also considers its intent and ability to hold these securities. If management believes, based on the analysis, that the principal, and available secondary market prices from broker/dealer and interest obligations on any mortgage and other asset backed security will not be received in a timely manner, the security is written down to fair value.

		The equity securities impairment analyses are performed and reviewed quarterly based on the latest financial information and any supporting research report made by a major brokerage house. These analyses are subjective and based, among other things, on relevant financial data such as capitalization, cash flow, liquidity, systematic risk and debt outstanding. Management also considers the industry trends, the historical performance of the stock, as well as the Group’s intent to hold the security. If management believes there is a low probability of achieving book value in a reasonable time frame, then an impairment is recorded by writing down the security to fair value.

	(1)		The expected option term is 7 years.

	(2)		The expected weighted average volatility was 33% for options granted in the six-months ended December 31, 2003 (2002 – 32%).

	(3)		The expected weighted average dividend yield was 2.36% for options granted in the six-months ended December 31 2003 (2002 – 3.19%), after giving retroactive effect to the 10% stock dividend effected on January 15, 2004.

	(4)		The weighted average risk-free interest rate was 3.93% for options granted in the six-months ended December 31, 2003 (2002 – 4.10%).

	1.		Pass - loans considered highly collectible due to their repayment history or current status (to be in this category a loan cannot be more than 90 days past due).

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

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

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

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

	1.		Overall historical loss trends; and

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

•		Real estate loans - are placed on a non-accrual basis when they become 365 days or more past due and are written-down, if necessary, based on the specific evaluation of the collateral underlying the loan. At December 31, 2003, the Group’s non-performing real estate loans totaled $28.6 million (88.5% of the Group’s non-performing loans) a 7.6% increase from the $26.6 million (92.0% of the Group’s non-performing loans) reported as at June 30, 2003. Non-performing loans in this category are primarily residential mortgage loans. Based on the value of the underlying collateral, the loan-to-value ratios and credit loss experienced, management considers that no significant losses will be incurred on this portfolio.

•		Commercial loans - are placed on non-accrual basis when they become 90 days or more past due and are written-down, if necessary, based on the specific evaluation of the underlying collateral, if any. At December 31, 2003, the Group’s non-performing commercial loans amounted to $3.1 million (9.7% of the Group’s non-performing loans) a 74.9% increase from $1.8 million reported at June 30, 2003 (6.2% of the Group’s non-performing loans). Most of this portfolio is also collateralized by real estate and no significant losses are expected.

•		Consumer loans - are placed on non-accrual status when they become 90 days past due and written-down when payments are delinquent 120 days. At December 31, 2003, the Group’s non-performing consumer loans amounted to $570,000 (1.8% of the Group’s total non-performing loans), a 10.3% increase from the $517,000 reported as at June 30, 2003 (1.8% of total non-performing loans).

•		Foreclosed real estate - is initially recorded at the lower of the related loan balance or fair value at the date of foreclosure. Any excess of the loan balance over the fair market value of the property is charged against the allowance for loan losses. Subsequently, any excess of the carrying value over the estimated fair market value less disposition cost is charged to operations. Management is actively seeking prospective buyers for these foreclosed real estate properties. At December 31, 2003, foreclosed real estate balance was $601,000, a 12.1% increase from the $536,000 reported at June 30, 2003.

	•		Current report on Form 8-K, dated October 27, 2003, reporting under Item 5 the issue of trust redeemable preferred securities and non-cumulative monthly income preferred stock.

	•		Current report on Form 8-K, dated October 22, 2003, reporting under Items 5 and 12 the release of the Group’s financial results for the quarter ended September 30, 2003.