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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

     
x   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2004

OR

     
o   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: 000-21137

R&G FINANCIAL CORPORATION


(Exact name of registrant as specified in its charter)
     
Puerto Rico
  66-0532217

(State of incorporation
or organization)
  (I.R.S. Employer
Identification No. )
     
280 Jesús T. Piñero Avenue
Hato Rey, San Juan, Puerto Rico
  00918

(Address of principal executive offices)   (Zip Code)

(787) 758-2424

(Registrant’s telephone number, including area code)

Indicate by checkmark whether Registrant (a) 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 report (s) and (b) has been subject to such filing requirements for at least 90 days.

YES x            NO o

Indicate by checkmark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934). xYes oNo

Number of shares of Class B Common Stock outstanding as of June 30, 2004: 29,542,836 (Does not include 21,559,584 Class A Shares of Common Stock which are exchangeable into Class B Shares of Common Stock at the option of the holder.)

 


R&G FINANCIAL CORPORATION

INDEX

         
    Page
       
    3  
    3  
    4  
    5  
    6  
    7  
    19  
    31  
    31  
       
    32  
    32  
    32  
    32  
    33  
    33  
    37  
 EX-31.1 SECTION 302 CERTIFICATION OF THE CEO
 EX-31.2 SECTION 302 CERTIFICATION OF THE CFO
 EX-32 SECTION 906 cERTIFICATION OF THE CEO AND THE CFO

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PART 1-FINANCIAL INFORMATION

ITEM 1: CONSOLIDATED FINANCIAL STATEMENTS

R&G FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
                 
    June 30, 2004
  December 31, 2003
    (Unaudited)        
    (Dollars in thousands)
ASSETS
               
Cash and due from banks
  $ 120,776     $ 114,916  
Money market investments:
               
Securities purchased under agreements to resell
    144,221       85,053  
Time deposits with other banks
    79,437       34,349  
Mortgage loans held for sale, at lower of cost or market
    277,025       315,691  
Mortgage-backed and investment securities held for trading, at fair value
    25,232       31,797  
Trading securities pledged on repurchase agreements, at fair value
    5,405       6,558  
Mortgage-backed and investment securities available for sale, at fair value
    1,827,789       1,805,360  
Available for sale securities pledged on repurchase agreements, at fair value
    1,367,387       1,215,287  
Mortgage-backed and investment securities held to maturity, at amortized cost (estimated market value: 2004 - $15,145; 2003 - $14,940)
    15,073       14,883  
Held to maturity securities pledged on repurchase agreements, at amortized cost (estimated market value: 2004 - $59,931; 2003 - $65,248)
    58,013       63,317  
Federal Home Loan Bank stock, at cost
    111,092       100,461  
Loans receivable, net
    4,506,621       4,048,507  
Accounts receivable, including advances to investors, net
    48,897       38,195  
Accrued interest receivable
    46,619       42,527  
Servicing asset, net
    117,740       119,610  
Premises and equipment, net
    47,461       42,782  
Other assets
    145,787       119,587  
 
   
 
     
 
 
 
  $ 8,944,575     $ 8,198,880  
 
   
 
     
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
Liabilities:
               
Deposits
  $ 3,822,998     $ 3,555,764  
Federal funds purchased
    40,000       21,000  
Securities sold under agreements to repurchase
    2,488,536       2,220,795  
Notes payable
    136,813       192,259  
Advances from FHLB
    1,238,600       1,129,600  
Other borrowings
    265,281       157,670  
Accounts payable and accrued liabilities
    152,485       158,006  
Other liabilities
    20,035       13,433  
 
   
 
     
 
 
 
    8,164,748       7,448,527  
 
   
 
     
 
 
Commitments and contingencies (see Note 7)
               
Stockholders’equity:
               
Preferred stock, $.01 par value, 20,000,000 shares authorized:
               
Non-cumulative perpetual Monthly Income Preferred Stock, $25 liquidation value:
               
7.40% Series A, 2,000,000 shares authorized, issued and outstanding
    50,000       50,000  
7.75% Series B, 1,000,000 shares authorized, issued and outstanding
    25,000       25,000  
7.60% Series C, 2,760,000 shares authorized, issued and outstanding
    69,000       69,000  
7.25% Series D, 2,760,000 shares authorized, issued and outstanding
    69,000       69,000  
Common stock:
               
Class A - - $.01 par value, 80,000,000 shares authorized in 2004 (2003 - 40,000,000), 21,559,584 issued and outstanding
    216       216  
Class B - - $.01 par value, 120,000,000 shares authorized in 2004 (2003 - 60,000,000), 29,542,836 issued and outstanding (2003 - 29,506,715)
    295       295  
Additional paid-in capital
    115,412       115,017  
Retained earnings
    449,077       387,036  
Capital reserves
    25,103       25,103  
Accumulated other comprehensive (loss) income, net of tax
    (23,276 )     9,686  
 
   
 
     
 
 
 
    779,827       750,353  
 
   
 
     
 
 
 
  $ 8,944,575     $ 8,198,880  
 
   
 
     
 
 

The accompanying notes are an integral part of these statements.

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R&G FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF INCOME
                                 
    Three month   Six month
    period ended   period ended
    June 30,
  June 30,
    2004
  2003
  2004
  2003
    (Unaudited)           (Unaudited)
    (Dollars in thousands except for per share data)
Interest income:
                               
Loans
  $ 70,091     $ 55,007     $ 138,260     $ 106,962  
Money market and other investments
    8,112       7,972       15,206       16,590  
Mortgage-backed securities
    31,493       29,579       63,861       57,262  
 
   
 
     
 
     
 
     
 
 
Total interest income
    109,696       92,558       217,327       180,814  
 
   
 
     
 
     
 
     
 
 
Interest expense:
                               
Deposits
    23,742       22,968       47,445       44,661  
Securities sold under agreements to repurchase
    14,119       12,814       27,632       25,585  
Notes payable
    550       2,139       2,019       4,009  
Other
    15,279       10,068       28,511       19,769  
 
   
 
     
 
     
 
     
 
 
Total interest expense
    53,690       47,989       105,607       94,024  
 
   
 
     
 
     
 
     
 
 
Net interest income
    56,006       44,569       111,720       86,790  
Provision for loan losses
    (6,265 )     (4,444 )     (12,735 )     (8,664 )
 
   
 
     
 
     
 
     
 
 
Net interest income after provision for loan losses
    49,741       40,125       98,985       78,126  
 
   
 
     
 
     
 
     
 
 
Non-interest income:
                               
Net gain on origination and sale of loans
    41,439       44,883       81,332       77,900  
Loan administration, fee income and other
    17,885       20,330       36,114       39,252  
 
   
 
     
 
     
 
     
 
 
 
    59,324       65,213       117,446       117,152  
 
   
 
     
 
     
 
     
 
 
Total revenues
    109,065       105,338       216,431       195,278  
 
   
 
     
 
     
 
     
 
 
Non-interest expenses:
                               
Employee compensation and benefits
    18,839       14,506       35,539       29,653  
Office occupancy and equipment
    6,906       6,074       13,286       11,776  
Other administrative and general
    29,394       42,706       60,637       73,249  
 
   
 
     
 
     
 
     
 
 
 
    55,139       63,286       109,462       114,678  
 
   
 
     
 
     
 
     
 
 
Income before income taxes
    53,926       42,052       106,969       80,600  
 
   
 
     
 
     
 
     
 
 
Income tax expense:
                               
Current
    9,353       6,866       22,858       12,806  
Deferred
    3,826       3,736       4,824       7,203  
 
   
 
     
 
     
 
     
 
 
 
    13,179       10,602       27,682       20,009  
 
   
 
     
 
     
 
     
 
 
Net income
  $ 40,747     $ 31,450     $ 79,287     $ 60,591  
 
   
 
     
 
     
 
     
 
 
Earnings per common share — Basic
  $ 0.72     $ 0.54     $ 1.40     $ 1.03  
 
   
 
     
 
     
 
     
 
 
- Diluted
  $ 0.72     $ 0.54     $ 1.39     $ 1.03  
 
   
 
     
 
     
 
     
 
 
Weighted average number of shares outstanding — Basic
    51,101,380       51,064,650       51,095,431       51,049,449  
- Diluted
    51,377,157       51,271,706       51,351,763       51,271,424  

The accompanying notes are an integral part of these statements.

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R&G FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
                                 
    Three month   Six month
    period ended   period ended
    June 30,
  June 30,
    2004
  2003
  2004
  2003
    (Unaudited)   (Unaudited)
            (Dollars in thousands)        
Net income
  $ 40,747     $ 31,450     $ 79,287     $ 60,591  
 
   
 
     
 
     
 
     
 
 
Other comprehensive income, before tax:
                               
Unrealized gains (losses):
                               
Cash flow hedges
    7,086       (1,979 )     4,390       (1,639 )
 
   
 
     
 
     
 
     
 
 
Investment securities:
                               
Arising during period
    (63,767 )     (4,933 )     (58,281 )     (9,661 )
Less: Reclassification adjustments for gains included in net income
    (83 )     (714 )     (70 )     (820 )
 
   
 
     
 
     
 
     
 
 
 
    (63,850 )     (5,647 )     (58,351 )     (10,481 )
 
   
 
     
 
     
 
     
 
 
Other comprehensive loss before income taxes
    (56,764 )     (7,626 )     (53,961 )     (12,120 )
Income tax benefit related to items of other comprehensive income
    22,061       2,971       20,999       4,728  
 
   
 
     
 
     
 
     
 
 
Other comprehensive loss, net of tax
    (34,703 )     (4,655 )     (32,962 )     (7,392 )
 
   
 
     
 
     
 
     
 
 
Comprehensive income, net of tax
  $ 6,044     $ 26,795     $ 46,325     $ 53,199  
 
   
 
     
 
     
 
     
 
 

The accompanying notes are an integral part of these statements.

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R&G FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS
                 
    Six month period ended June 30,
    2004
  2003
    (Unaudited)
    (Dollars in thousands)
Cash flows from operating activities:
               
Net income
  $ 79,287     $ 60,591  
 
   
 
     
 
 
Adjustments to reconcile net income to net cash provided by operating activities:
               
Depreciation and amortization
    4,691       4,455  
Amortization of premium on investments and mortgage-backed securities, net
    4,709       5,766  
Scheduled amortization of servicing asset
    11,009       11,245  
Impairment charges on servicing asset, net
    5,943       27,536  
Provision for loan losses
    12,735       8,664  
Gain on sales of mortgage-backed and investment securities available for sale
    (70 )     (820 )
Unrealized loss on trading securities and derivative instruments, net
    1,287       1,284  
Decrease (increase) in mortgage loans held for sale
    38,262       (7,212 )
Net decrease in securities held for trading
    7,470       32,425  
Increase in receivables
    (14,794 )     (4,205 )
Increase in other assets
    (19,033 )     (23,340 )
(Decrease) increase in notes payable and other borrowings
    (55,567 )     9,149  
Increase in accounts payable and accrued liabilities
    18,829       53,764  
Increase in other liabilities
    6,602       5,721  
 
   
 
     
 
 
   Total adjustments
    22,073       124,432  
 
   
 
     
 
 
   Net cash provided by operating activities
    101,360       185,023  
 
   
 
     
 
 
Cash flows from investing activities:
               
Purchases of investment securities available for sale and held to maturity
    (915,432 )     (1,431,196 )
Proceeds from sales and redemption of securities available for sale
    281,580       109,908  
Principal repayments on mortgage-backed securities
    422,628       877,984  
Proceeds from sales of loans
    346,490       52,312  
Net originations of loans
    (838,108 )     (588,032 )
Purchases of FHLB stock, net
    (10,631 )     (18,604 )
Acquisition of premises and equipment
    (8,813 )     (5,890 )
Acquisition of servicing rights
    (15,082 )     (23,593 )
 
   
 
     
 
 
   Net cash used in investing activities
    (737,368 )     (1,027,111 )
 
   
 
     
 
 
Cash flows from financing activities:
               
Increase in deposits — net
    267,234       438,283  
Increase in federal funds purchased
    19,000       5,000  
Increase in securities sold under agreements to repurchase — net
    267,741       355,730  
Advances from FHLB, net
    109,000       76,000  
Proceeds from issuance of long-term debt
    100,000        
Proceeds from issuance of common stock
    395       218  
Cash dividends:
               
Common stock
    (9,304 )     (6,961 )
Preferred stock
    (7,942 )     (7,942 )
 
   
 
     
 
 
   Net cash provided by financing activities
    746,124       860,328  
 
   
 
     
 
 
Net increase in cash and cash equivalents
    110,116       18,240  
Cash and cash equivalents at beginning of period
    234,318       197,643  
 
   
 
     
 
 
Cash and cash equivalents at end of period
  $ 344,434     $ 215,883  
 
   
 
     
 
 
Cash and cash equivalents include:
               
Cash and due from banks
  $ 120,776     $ 144,380  
Short-term investments
          15,000  
Securities purchased under agreements to resell
    144,221       34,726  
Time deposits with other banks
    79,437       21,777  
 
   
 
     
 
 
 
  $ 344,434     $ 215,883  
 
   
 
     
 
 

The accompanying notes are an integral part of these statements.

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R&G FINANCIAL CORPORATION

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 — REPORTING ENTITY AND BASIS OF PRESENTATION

Reporting entity

     The accompanying unaudited consolidated financial statements include the accounts of R&G Financial Corporation (the “Company”), a diversified financial services company, and its wholly-owned subsidiaries, R-G Premier Bank of Puerto Rico (“Premier Bank”), a Puerto Rico commercial bank, R-G Crown Bank (“Crown Bank”), a Florida-based federal savings bank, R&G Mortgage Corp. (“R&G Mortgage”), Puerto Rico’s second largest mortgage banker, R&G International Corp., a Puerto Rico international banking entity, R-G Investments Corporation, a Puerto Rico licensed securities broker-dealer, and Home & Property Insurance Corp., a Puerto Rico insurance agency. The Company, currently in its 32nd year of operations, operates as a financial holding company pursuant to the provisions of the Gramm-Leach-Bliley Act of 1999, and is engaged in banking, mortgage banking, and securities and insurance brokerage through its subsidiaries.

     Premier Bank and Crown Bank provide a full range of banking services, including residential, commercial and personal loans and a variety of deposit products. Premier Bank operates through thirty-two branches located mainly in the northeastern part of the Commonwealth of Puerto Rico. Crown Bank operates in the Orlando and Tampa/St. Petersburg metropolitan areas through fifteen full service branches and six commercial lending offices. Premier Bank also provides private banking and trust and other financial services to its customers. Premier Bank and Crown Bank are subject to the regulations of certain federal and Puerto Rico agencies, and undergo periodic examinations by those regulatory agencies.

     Crown Bank is also engaged in the origination of FHA-insured, VA-guaranteed and privately insured first and second mortgage loans on residential real estate (1 to 4 families) in the States of New York, New Jersey, Connecticut and North Carolina, through its wholly-owned subsidiary, Continental Capital Corporation (“Continental Capital”).

     R&G Mortgage is engaged primarily in the business of originating FHA-insured, VA- guaranteed, and privately insured first and second mortgage loans on residential real estate (1 to 4 families), directly and through its wholly-owned subsidiary, Mortgage Store of Puerto Rico, Inc. R&G Mortgage pools FHA and VA loans into GNMA mortgage-backed securities and collateralized mortgage obligation certificates for sale to investors. After selling the loans, it retains the servicing on the loans. R&G Mortgage is also a FNMA and FHLMC seller-servicer of conventional loans.

Basis of presentation

     The accompanying unaudited consolidated financial statements have been prepared in accordance with the instructions for Form 10-Q. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles. However, in the opinion of management, the accompanying unaudited consolidated financial statements include all adjustments (principally consisting of normal recurring accruals) necessary for a fair presentation of the Company’s financial condition as of June 30, 2004 and the results of operations and changes in its cash flows for the three and six months ended June 30, 2004 and 2003.

     The results of operations for the three and six month periods ended June 30, 2004 are not necessarily indicative of the results to be expected for the year ending December 31, 2004. The unaudited consolidated financial statements and notes thereto should be read in conjunction with the audited financial statements and notes thereto for the year ended December 31, 2003.

Basis of consolidation

     All significant intercompany balances and transactions have been eliminated in the accompanying unaudited financial statements.

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Recent accounting pronouncements

Accounting for Derivative Instruments and Hedging Activities

     On July 1, 2003, the Company adopted SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities,” which amends and clarifies financial accounting and reporting for derivative instruments, including certain derivatives instruments embedded in other contracts, and for hedging activities under FASB Statement No. 133, “Accounting for Derivative Instruments and Hedging Activities.” The adoption of this Statement on July 1, 2003 had no significant effect on the consolidated financial condition or results of operations of the Company.

Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity

     On July 1, 2003 the Company adopted SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity.” SFAS No. 150 covers a limited number of instruments that are to be classified as liabilities and specifies that such instruments embody obligations of the issuer and that, therefore, the issuer must classify them as liabilities.

     Among the instruments specified by SFAS No. 150, mandatorily redeemable financial instruments had to be classified as liabilities. The Company had $35 million of guaranteed preferred beneficial interest in company junior subordinated deferrable interest debentures (“trust preferred securities”) that had already been classified as other borrowings in its consolidated statements of financial condition as of June 30, 2003 and accordingly, the adoption of this Statement on July 1, 2003 did not have any effect on the Company’s consolidated financial statements.

Accounting for Consolidation of Variable Interest Entities

     In January 2003, the FASB issued FIN 46, “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51” (“FIN 46”). Under FIN 46, entities that would be assessed for consolidation are typically referred to as Special-Purposed Entities (“SPEs”), although non-SPE-type entities may also be subject to the guidance. FIN 46 requires a variable interest entity to be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity’s activities or entitled to receive a majority of the entities residual returns, or both. FIN 46 was effective immediately for variable interest entities created after January 31, 2003. For variable interest entities created prior to February 1, 2003, the provisions of FIN 46 became effective October 1, 2003.

     Under the provisions of FIN 46, effective July 1, 2003, the Company deconsolidated R&G Capital Trust I and II, which had issued trust preferred securities prior to February 1, 2003. As discussed above, the Company had classified its $35 million trust preferred securities as borrowings in its consolidated statements of financial condition prior to such deconsolidation. The primary effect of deconsolidating these trusts was to change the balance sheet classification of the liabilities from guaranteed preferred beneficial interest in company junior subordinated deferrable interest debentures to long-term debt.

     The Company did not consolidate R&G Capital Trust IV, which in August 2003, issued $15 million in trust preferred securities in a private placement, R&G Capital Trust III, which in October 2003 issued $100 million of trust preferred securities in a public offering, and R&G Capital Trust V, which in March 2004 issued $100 million of trust preferred securities in a public offering.

     On May 6, 2004, the Federal Reserve issued a proposed rule that would continue to allow trust preferred securities issued by variable interest entities to constitute Tier I capital for bank holding companies. The proposed rules would impose stricter quantitative and qualitative limits on the Tier I measurement of trust preferred securities. Currently, trust preferred securities and qualifying perpetual preferred stock are limited in the aggregate to no more than 25% of a holding company’s core capital elements. The proposed rule would amend the existing limit by providing that restricted core capital elements (including trust preferred securities and qualifying perpetual preferred stock) can be no more than 25% of core capital, net of goodwill. It is possible that the Federal Reserve rules will not be adopted as proposed and that the Federal Reserve will conclude that trust preferred securities should no longer be treated as Tier I regulatory capital.

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Accounting for Certain Loans and/or Debt Securities Acquired in a Transfer

     In December 2003, the Accounting Standards Executive Committee issued Statement of Position (SOP) No. 03-3, “Accounting for Certain Loans and/or Debt Securities Acquired in a Transfer.” This SOP addresses accounting for differences between contractual cash flows and cash flows expected to be collected from an investor’s initial investment in loans or debt securities acquired in a transfer if those differences are attributable to credit quality. This SOP does not apply to loans originated by the entity, and it prohibits both the creating and carry over of valuation allowances in the initial accounting of all loans acquired in a transfer within the scope of this SOP. The prohibition of the carry over applies to purchase of an individual loan, a pool of loans, a group of loans, and loans acquired in a purchase business combination. This SOP is effective for loans acquired in fiscal years beginning after December 15, 2004. Based on presently available information, management believes the adoption of this SOP will not have a significant effect on its consolidated financial statements.

Application of Accounting Principles to Loan Commitments

     On March 9, 2004, the SEC issued Staff Accounting Bulletin 105, “Application of Accounting Principles to Loan Commitments,” (“SAB 105”) to inform registrants of the Staff’s view that the fair value of the recorded loan commitments should not consider the expected future cash flows related to the associated servicing of the future loan. The provisions of SAB 105 must be applied to loan commitments accounted for as derivatives that are entered into after March 31, 2004. The Staff will not object to the application of existing accounting practices to loan commitments accounted for as derivatives that are entered into on or before March 31, 2004, with appropriate disclosures. On April 1, 2004, R&G Financial adopted the provisions of SAB 105. R&G Financial records the value of its mortgage loan commitments at fair market value for mortgages it intends to sell. R&G Financial does not currently include, and was not including, the value of mortgage servicing or any other internally-developed intangible assets in the valuation of its mortgage loan commitments. Therefore, the adoption of SAB 105 did not have an impact on the Company’s financial condition or results of operations.

The Meaning of Other-than-Temporary Impairment and its Application to Certain Investments

     At its March 2004 meetings, the Emerging Issues Task Force (“EITF”) revisited EITF Issue No. 03-1, “The Meaning of Other-than-Temporary Impairment and its Application to Certain Investments” (EITF No. 03-1). Effective with reporting periods beginning after June 15, 2004, companies carrying certain types of debt and equity securities whose amortized cost is higher than the securities’ fair values will have to use more detailed criteria to evaluate whether to record a loss and will have to disclose additional information about unrealized losses. The Company has reviewed the revised EITF No. 03-1 and plans to implement these additional procedures effective with the quarter beginning on July 1, 2004. Even though as of June 30, 2004 most of the unrealized losses on the Company’s investments and mortgage-backed securities were deemed temporary, at this time the Company can not determine whether the adoption of this new issuance will have an impact on the Company’s financial position and results of operations, as the extent of any impact will vary due to the fact that the model calls for many judgments and additional evidence gathering at each securities valuation date.

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NOTE 2 — EARNINGS PER SHARE

     Basic earnings per common share are computed by dividing net income (less preferred stock dividends) by the weighted average number of shares of common stock outstanding. The weighted average number of outstanding stock options granted in connection with the Company’s Stock Option Plan (275,777 and 207,056 during the three months ended June 30, 2004 and 2003, respectively, and 256,332 and 221,975 during the six month periods ended June 30, 2004 and 2003, respectively, after giving effect to stock split paid in January 2004), is included in the weighted average number of shares for purposes of the diluted earnings per share computation. No other adjustments are made to the computation of basic earnings per share to arrive at diluted earnings per share.

Dividends per share on common stock declared and paid by the Company were as follows:

                                 
    Three month   Six month
    period ended   period ended
    June 30,
  June 30,
    2004
  2003
  2004
  2003
 
  $ 0.0943     $ 0.0707     $ 0.1821     $ 0.1364  

NOTE 3 — INVESTMENT AND MORTGAGE-BACKED SECURITIES

     The carrying value and estimated fair value of investment and mortgage-backed securities by category are shown below. The fair value of investment securities is based on quoted market prices and dealer quotes.

                 
    June 30,   December 31,
    2004
  2003
    (Unaudited)        
    (Dollars in thousands)
Mortgage-backed securities held for trading:
               
FHLMC certificates
  $ 28,566     $ 33,245  
 
   
 
     
 
 
 
    28,566       33,245  
 
   
 
     
 
 
Investment securities held for trading:
               
Corporate debt obligations
    2,016        
Municipal securities
          446  
Bank issued trust preferred securities
    25       4,650  
Other
    30       14  
 
   
 
     
 
 
 
    2,071       5,110  
 
   
 
     
 
 
 
  $ 30,637     $ 38,355  
 
   
 
     
 
 

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    June 30, 2004
  December 31, 2003
    Amortized   Fair   Amortized   Fair
    cost
  value
  cost
  value
    (Unaudited)                
    (Dollars in thousands)
Mortgage-backed securities available for sale:
                               
Collaterized mortgage obligations (CMO):
                               
Due from one to five years
  $ 3,922     $ 3,975     $ 5,939     $ 6,019  
Due from five to ten years
    57,884       56,847       20,889       20,873  
Due over ten years
    957,773       940,899       941,970       939,757  
 
   
 
     
 
     
 
     
 
 
 
    1,019,579       1,001,721       968,798       966,649  
 
   
 
     
 
     
 
     
 
 
CMO residuals (interest only), and interest only strips (IO’s)
    143,829       141,114       107,058       107,957  
 
   
 
     
 
     
 
     
 
 
FNMA certificates:
                               
Due from one to five years
    195       207       71       72  
Due from five to ten years
    221,871       217,713       87,989       87,101  
Due over ten years
    366,479       367,429       388,687       405,193  
 
   
 
     
 
     
 
     
 
 
 
    588,545       585,349       476,747       492,366  
 
   
 
     
 
     
 
     
 
 
FHLMC certificates:
                               
Due from one to five years
    285       302       3       3  
Due from five to ten years
    63,371       62,222       20,308       19,955  
Due over ten years
    371,904       376,442       439,876       448,161  
 
   
 
     
 
     
 
     
 
 
 
    435,560       438,966       460,187       468,119  
 
   
 
     
 
     
 
     
 
 
GNMA certificates:
                               
Due from one to five years
    3,125       3,228       50       52  
Due from five to ten years
    15,050       15,327       12,563       12,918  
Due over ten years
    311,159       311,990       346,568       350,217  
 
   
 
     
 
     
 
     
 
 
 
    329,334       330,545       359,181       363,187  
 
   
 
     
 
     
 
     
 
 
 
    2,516,847       2,497,695       2,371,971       2,398,278  
 
   
 
     
 
     
 
     
 
 
Investment securities available for sale:
                               
U.S. Government and Agencies securities:
                               
Due within one year
    12,473       12,590       62,519       63,113  
Due from one to five years
    566,592       555,815       399,275       398,028  
Due from five to ten years
    62,583       63,069       79,388       81,042  
 
   
 
     
 
     
 
     
 
 
 
    641,648       631,474       541,182       542,183  
 
   
 
     
 
     
 
     
 
 
Corporate debt obligations:
                               
Due within one year
    2,500       2,503       14,247       14,362  
Due from one to five years
    48,558       50,201       48,578       51,376  
Due from five to ten years
    1,324       1,302       2,123       2,109  
 
   
 
     
 
     
 
     
 
 
 
    52,382       54,006       64,948       67,847  
 
   
 
     
 
     
 
     
 
 
US Municipal debt obligations-
                               
Due over ten years
    12,313       12,001       12,209       12,339  
 
   
 
     
 
     
 
     
 
 
 
    706,343       697,481       618,339       622,369  
 
   
 
     
 
     
 
     
 
 
 
  $ 3,223,190     $ 3,195,176     $ 2,990,310     $ 3,020,647  
 
   
 
     
 
     
 
     
 
 

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    June 30, 2004
  December 31, 2003
    Amortized   Fair   Amortized   Fair
    cost
  value
  cost
  value
    (Unaudited)                
    (Dollars in thousands)
Mortgage-backed securities held to maturity:
                               
GNMA certificates:
                               
Due from one to five years
  $ 2,973     $ 3,082     $ 3,497     $ 3,581  
Due from five to ten years
    370       379       463       469  
Due over ten years
    21,208       21,688       25,475       26,079  
 
   
 
     
 
     
 
     
 
 
 
    24,551       25,149       29,435       30,129  
 
   
 
     
 
     
 
     
 
 
FNMA certificates-
                               
Due over ten years
    4,307       4,493       4,785       4,999  
 
   
 
     
 
     
 
     
 
 
FHLMC certificates-
                               
Due over ten years
    73       71       81       79  
 
   
 
     
 
     
 
     
 
 
 
    28,931       29,713       34,301       35,207  
 
   
 
     
 
     
 
     
 
 
Investment securities held to maturity:
                               
United States Government and Agencies obligations-
                               
Due from one to five years
    2,500       2,500       1,997       1,997  
 
   
 
     
 
     
 
     
 
 
 
    2,500       2,500       1,997       1,997  
 
   
 
     
 
     
 
     
 
 
Puerto Rico Government and Agencies obligations:
                               
Due within one year
    549       559       558       567  
Due from one to five years
    31,607       32,932       31,846       33,088  
Due from five to ten years
    9,399       9,272       9,398       9,230  
 
   
 
     
 
     
 
     
 
 
 
    41,555       42,763       41,802       42,885  
 
   
 
     
 
     
 
     
 
 
Other — Due from one to five years
    100       100       100       100  
 
   
 
     
 
     
 
     
 
 
 
    44,155       45,363       43,899       44,982  
 
   
 
     
 
     
 
     
 
 
 
  $ 73,086     $ 75,076     $ 78,200     $ 80,189  
 
   
 
     
 
     
 
     
 
 

In addition to the investment and mortgage-backed securities pledged on repurchase agreements and reported as pledged assets in the statement of financial condition, at June 30, 2004 the Company had investment and mortgage-backed securities pledged as collateral on repurchase agreements where the counterparties do not have the right to sell or repledge the assets as follows:

         
    Carrying Amount
    (Unaudited)
    (Dollars in thousands)
Mortgage-backed and investment securities available for sale, at fair value
  $ 1,022,839  
Mortgage-backed and investment securities held to maturity, at amortized cost
    243  
 
   
 
 
 
  $ 1,023,082  
 
   
 
 

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NOTE 4 — LOANS AND ALLOWANCE FOR LOAN LOSSES

      Loans consist of the following:

                 
    June 30,   December 31,
    2004
  2003
    (Unaudited)        
    (Dollars in thousands)
Real estate loans:
               
Residential — first mortgage
  $ 2,613,638     $ 2,384,279  
Residential — second mortgage
    37,700       34,999  
Land
    196,384       96,796  
Construction
    665,100       603,867  
Commercial
    844,054       792,950  
 
   
 
     
 
 
 
    4,356,876       3,912,891  
Undisbursed portion of loans in process
    (262,562 )     (224,960 )
Net deferred loan costs
    2,355       1,369  
 
   
 
     
 
 
 
    4,096,669       3,689,300  
 
   
 
     
 
 
Other loans:
               
Commercial
    250,377       188,690  
Consumer:
               
Secured by deposits
    24,343       24,713  
Secured by real estate
    49,545       53,709  
Other
    132,487       131,711  
Unearned interest
    (1 )     (1 )
 
   
 
     
 
 
 
    456,751       398,822  
 
   
 
     
 
 
Total loans
    4,553,420       4,088,122  
Allowance for loan losses
    (46,799 )     (39,615 )
 
   
 
     
 
 
 
  $ 4,506,621     $ 4,048,507  
 
   
 
     
 
 

      The changes in the allowance for loan losses follow:

                 
    Six months ended
    June 30,
    2004
  2003
    (Unaudited)
    (Dollars in thousands)
Balance, beginning of period
  $ 39,615     $ 32,675  
Provision for loan losses
    12,735       8,664  
Loans charged-off
    (7,171 )     (7,787 )
Recoveries
    1,559       763  
Transfers
    61        
 
   
 
     
 
 
Balance, end of period
  $ 46,799     $ 34,315  
 
   
 
     
 
 

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The following table sets forth the amounts and categories of R&G Financial’s non-performing assets at the dates indicated.

                 
    June 30,   December 31,
    2004
  2003
    (Unaudited)
    (Dollars in thousands)
Non-accruing loans:
               
Residential real estate (1)
  $ 58,671     $ 57,031  
Residential construction
    2,170       2,424  
Commercial real estate
    23,913       22,589  
Commercial business
    2,092       1,733  
Consumer unsecured
    737       833  
 
   
 
     
 
 
Total
    87,583       84,610  
 
   
 
     
 
 
Accruing loans greater than 90 days delinquent:
               
Residential real estate (1)
           
Residential construction
           
Commercial real estate
           
Commercial business
    357       382  
Consumer
    247       422  
 
   
 
     
 
 
Total accruing loans greater than 90 days delinquent
    604       804  
 
   
 
     
 
 
Total non-performing loans
    88,187       85,414  
 
   
 
     
 
 
Real estate owned (2)
    21,273       19,954  
Other repossessed assets
    134       220  
 
   
 
     
 
 
 
    21,407       20,174  
 
   
 
     
 
 
Total non-performing assets
  $ 109,594     $ 105,588  
 
   
 
     
 
 
Total non-performing loans as a percentage of total loans
    1.83 %     1.98 %
 
   
 
     
 
 
Total non-performing assets as a percentage of total assets
    1.23 %     1.29 %
 
   
 
     
 
 
Allowance for loan losses as a percentage of total non-performing loans
    53.07 %     46.38 %
 
   
 
     
 
 
Allowance for loan losses as a percentage of total loans outstanding
    0.97 %     0.92 %
 
   
 
     
 
 
Net charge-offs to average loans outstanding
    0.25 %     0.32 %
 
   
 
     
 
 

  (1)   R&G Financial’s historical charge-offs with respect to residential real estate loans have been low. As a result, R&G Financial’s aggregate charge-offs as a percentage of total average loans outstanding amounted to 0.25% during the six months ended June 30, 2004 and 0.32% during the year ended December 31, 2003.
 
  (2)   Consist primarily of residential real estate foreclosed by the Company.

During the quarter ended June 30, 2004, the Company sold approximately $28.2 million of non-performing residential mortgage loans on a recourse basis.

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NOTE 5 — SERVICING ASSET

The changes in the servicing asset of the Company follows:

                                 
    Three months   Six months
    period ended   period ended
    June 30,
  June 30,
    2004
  2003
  2004
  2003
    (Unaudited)   (Unaudited)
    (Dollars in thousands)
Balance at beginning of period
  $ 112,467     $ 133,830     $ 119,610     $ 142,334  
Rights originated
    7,228       7,591       14,642       14,083  
Rights purchased
    218       8,081       440       9,510  
Scheduled amortization
    (5,530 )     (5,648 )     (11,009 )     (11,245 )
Impairment charges:
                               
Unscheduled amortization
    (885 )     (6,116 )     (6,650 )     (12,824 )
Reversal (provision) of valuation reserves
    4,242       (10,592 )     707       (14,712 )
 
   
 
     
 
     
 
     
 
 
Balance at end of period
  $ 117,740     $ 127,146     $ 117,740     $ 127,146  
 
   
 
     
 
     
 
     
 
 

NOTE 6 — DEPOSITS

Deposits are summarized as follows:

                 
    June 30,   December 31,
    2004
  2003
    (Unaudited)        
    (Dollars in thousands)
Passbook savings
  $ 366,063     $ 337,463  
 
   
 
     
 
 
NOW accounts
    153,158       133,201  
Super NOW accounts
    434,185       426,144  
Regular checking accounts (non-interest bearing)
    158,527       134,659  
Commercial checking accounts (non-interest bearing)
    297,784       259,614  
 
   
 
     
 
 
 
    1,043,654       953,618  
 
   
 
     
 
 
Certificates of deposit:
               
Under $100,000
    718,908       731,655  
$100,000 and over
    1,687,141       1,527,581  
 
   
 
     
 
 
 
    2,406,049       2,259,236  
 
   
 
     
 
 
Accrued interest payable
    7,232       5,447  
 
   
 
     
 
 
 
  $ 3,822,998     $ 3,555,764  
 
   
 
     
 
 

Certificates of deposit include $705.1 million and $623.8 million of brokered deposits at June 30, 2004 and December 31, 2003, respectively.

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NOTE 7 — COMMITMENTS AND CONTINGENCIES

As of June 30, 2004, the Company had open commitments to issue GNMA certificates of approximately $57.7 million. In addition, the Company had commitments to sell mortgage loans to third party investors amounting to approximately $846.6 million.

Unrealized gains and losses are recorded in trading activities in the accompanying consolidated statements of income related to these forward sales commitments, for the difference between committed prices and market prices at the balance sheet date. Unrealized trading gains or losses were not significant during the six months ended June 30, 2004.

Litigation

The Company is a defendant in legal proceedings arising from normal business activities. Even though a number of claims are in their early stages, management believes, based on presently available information and the opinion of legal counsel, that the final disposition of these matters will not have a material adverse effect on the Company’s financial position or results of operations.

Lease commitments

The Company is obligated under several noncancelable leases for office space and equipment rentals, all of which are accounted for as operating leases. The leases expire at various dates with options for renewals.

Other

At June 30, 2004, the Company is liable under limited recourse provisions resulting from the sale of loans to several investors, principally FHLMC. The principal balance of these loans, which are serviced by the Company, amounts to approximately $1.4 billion at June 30, 2004. At June 30, 2004, the Company has an allowance for recourse provisions of $5.1 million. Historical losses on recourse obligations have not been significant.

In April 2002, R&G Acquisition Holdings Corporation (a wholly-owned subsidiary of R&G Financial) (“RAC”), a Florida corporation and the holding company of Crown Bank, formed R&G Capital Trust I. R&G Capital Trust I issued $25 million of trust preferred securities in a private placement. In addition, in August 2003, RAC also formed R&G Capital Trust IV, which issued $15 million of trust preferred securities in a private placement. In October 2003 and March 2004, the Company formed R&G Capital Trust III and R&G Capital Trust V, respectively, each of which issued $100 million of trust preferred securities in public offerings (see Note 1). The Company has guaranteed certain obligations of RAC to R&G Capital Trust I and IV, and has guaranteed certain obligations of R&G Capital Trust III and V.

During the second quarter of 2003, the US Internal Revenue Service (“IRS”) began an income tax examination of the income tax returns for the year 2001 for the predecessor thrift holding company of Crown Bank prior to its acquisition by the Company in June 2002. Management believes that this examination should not result in any significant adverse effect on the Company’s financial condition or results of operations.

During the first quarter of 2004, the Puerto Rico Treasury Department (“PRTD”) began an income tax examination of the income tax returns for the year 2001 of R&G Financial (parent only) and R-G Mortgage. Management believes that this examination should not result in any significant adverse effect on the Company’s financial condition or results of operations.

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Table of Contents

NOTE 8 — SUPPLEMENTAL INCOME STATEMENT INFORMATION

Employee costs and other administrative and general expenses are shown in the Consolidated Statements of Income net of direct loan origination costs. Direct loan origination costs are capitalized as part of the carrying cost of mortgage loans and are offset against mortgage loan sales and fees when the loans are sold, or amortized as a yield adjustment to interest income on loans held for investment. Total employee costs and other expenses before capitalization follows:

                                 
    Three month period ended   Six month period ended
    June 30,
  June 30,
    2004
  2003
  2004
  2003
    (Unaudited)   (Unaudited)
    (Dollars in thousands)
Employee costs
  $ 27,729     $ 23,202     $ 53,576     $ 46,304  
 
   
 
     
 
     
 
     
 
 
Other administrative and general expenses
  $ 29,966     $ 44,128     $ 62,904     $ 76,220  
 
   
 
     
 
     
 
     
 
 

NOTE 9 — INDUSTRY SEGMENTS

The following summarized information presents the results of the Company’s operations for its traditional banking and mortgage banking activities:

                                                                 
    (Dollars in thousands)
    Three month period ended June 30,
    2004
  2003
    (Unaudited)
            Mortgage           Segments           Mortgage           Segments
    Banking
  Banking
  Other (1)
  Totals
  Banking
  Banking
  Other (1)
  Totals
Revenues
  $ 65,131     $ 40,618     $ 4,593     $ 110,342     $ 46,364     $ 55,696     $ 3,929     $ 105,989  
Non-interest expenses
    29,735       24,761       1,564       56,060       25,170       37,745       1,156       64,071  
Income before income taxes
  $ 35,396     $ 15,857     $ 3,029     $ 54,282     $ 21,194     $ 17,951     $ 2,773     $ 41,918  
                                                                 
    Six month period ended June 30,
    2004
  2003
    (Unaudited)
            Mortgage           Segments           Mortgage           Segments
    Banking
  Banking
  Other (1)
  Totals
  Banking
  Banking
  Other (1)
  Totals
Revenues
  $ 134,319     $ 74,926     $ 9,871     $ 219,116     $ 87,789     $ 101,359     $ 7,198     $ 196,346  
Non-interest expenses
    55,670       52,490       3,459       111,619       48,545       65,352       2,354       116,251  
Income before income taxes
  $ 78,649     $ 22,436     $ 6,412     $ 107,497     $ 39,244     $ 36,007     $ 4,844     $ 80,095  

(1)   Comprised of broker-dealer and insurance agency operations.

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The following is a reconciliation of reportable segment revenues and income before income taxes to the Company’s consolidated amounts (unaudited):

                                 
    Three month period ended   Six month period ended
    June 30,
  June 30,
    2004
  2003
  2004
  2003
    (Dollars in thousands)
Revenues:
                               
Total revenues for reportable segments
  $ 110,342     $ 105,989     $ 219,116     $ 196,346  
Elimination of intersegment revenues
    (1,676 )     (1,079 )     (3,405 )     (1,983 )
Corporate revenues
    399       428       720       915  
 
   
 
     
 
     
 
     
 
 
Total consolidated revenues
  $ 109,065     $ 105,338     $ 216,431     $ 195,278  
 
   
 
     
 
     
 
     
 
 
Income before income taxes:
                               
Total income before income taxes for reportable segments
  $ 54,282     $ 41,918     $ 107,497     $ 80,095  
Elimination of intersegment profits
    (97 )     21       (127 )     123  
Unallocated corporate (expenses) income
    (259 )     113       (401 )     382  
 
   
 
     
 
     
 
     
 
 
Income before income taxes, consolidated
  $ 53,926     $ 42,052     $ 106,969     $ 80,600  
 
   
 
     
 
     
 
     
 
 

Total assets of the Company among its industry segments and a reconciliation of reportable segment assets to the Company’s consolidated total assets as of June 30, 2004 and December 31, 2003 follows:

                 
    June 30,   December 31,
    2004
  2003
    (Unaudited)        
    (Dollars in thousands)
Assets:
               
Banking
  $ 8,232,795     $ 7,387,475  
Mortgage Banking
    880,486       890,023  
Other
    167,360       168,294  
 
   
 
     
 
 
Total assets for reportable segments
    9,280,641       8,445,792  
Parent company assets
    168,409       66,920  
Elimination of intersegment balances
    (504,475 )     (313,832 )
 
   
 
     
 
 
Consolidated total assets
  $ 8,944,575     $ 8,198,880  
 
   
 
     
 
 

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Item 2: Management’s Discussion and Analysis

Cautionary Statement Regarding Forward-Looking Statements

     A number of the presentations and disclosures in this Form 10-Q, including, without limitation, statements regarding the level of allowance for loan losses, the rate of delinquencies and amounts of charge-offs, and the rates of loan growth, and any statements preceded by, followed by or which include the words “may,” “could,” “should,” “will,” “would,” “hope,” “might,” “believe,” “expect,” “anticipate,” “estimate,” “intend,” “plan,” “assume” or similar expressions constitute forward-looking statements. These forward-looking statements, implicitly and explicitly, include the assumptions underlying the statements and other information with respect to our beliefs, plans, objectives, goals, expectations, anticipations, estimates, intentions, financial condition, results of operations, future performance and business, including our expectations and estimates with respect to our revenues, expenses, earnings, return on equity, return on assets, efficiency ratio, asset quality and other financial data and capital and performance ratios.

     Although we believe that the expectations reflected in our forward-looking statements are reasonable, these statements involve risks and uncertainties that are subject to change based on various important factors (some of which are beyond our control). The following factors, among others, could cause our financial performance to differ materially from our goals, plans, objectives, intentions, expectations and other forward-looking statements:

    the strength of the United States economy in general and the strength of the regional and local economies within our markets;
 
    geopolitical conditions, including acts or threats of terrorism, actions taken by the United States or other governments in response to acts or threats of terrorism and/or military conflicts, which could impact business and economic conditions in the United States and abroad;
 
    adverse changes in the local real estate market, as most of the Company’s loans are concentrated in Puerto Rico and Florida and a substantial portion of these loans have real estate as collateral;
 
    the effects of, and changes in, trade, monetary and fiscal policies and laws, including interest rate policies of the Board of Governors of the Federal Reserve System;
 
    inflation, interest rate, market and monetary fluctuations;
 
    adverse changes in asset quality and the resulting credit risk-related losses and expenses;
 
    our timely development of new products and services in a changing environment, including the features, pricing and quality of our products and services compared to the products and services of our competitors;
 
    the willingness of users to substitute competitors’ products and services for our products and services;
 
    the impact of changes in financial services policies, laws and regulations, including laws, regulations and policies concerning taxes, banking, securities and insurance, and the application thereof by regulatory bodies;
 
    technological changes;
 
    changes in consumer spending and savings habits; and
 
    regulatory or judicial proceedings.

     If one or more of the factors affecting our forward-looking information and statements proves incorrect, then our actual results, performance or achievements could differ materially from those expressed in, or implied by, forward-looking information and statements contained in this Form 10-Q. Therefore, we caution you not to place undue reliance on our forward-looking information and statements.

     We do not intend to update our forward-looking information and statements, whether written or oral, to reflect change. All forward-looking statements attributable to us are expressly qualified by these cautionary statements.

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General

     R&G Financial Corporation (the “Company”) is a Puerto Rico chartered diversified financial holding company that, through its wholly-owned subsidiaries, is engaged in banking, mortgage banking, securities and insurance brokerage activities. The Company, currently in its 32nd year of operations, operates 32 bank branches mainly located in the northeastern section of Puerto Rico, 15 bank branches in the Orlando and Tampa/St. Petersburg Florida markets, 5 mortgage and 6 commercial lending offices in the continental United States, and 53 mortgage offices in Puerto Rico, including 26 facilities located within Premier Bank’s branches.

     The Company is engaged in providing a full range of banking services through R-G Premier Bank of Puerto Rico (“Premier Bank”), its Puerto Rico commercial bank, and R-G Crown Bank (“Crown Bank”), its Florida-based federal savings bank acquired in June 2002. Banking activities include commercial banking services, corporate and construction lending, consumer lending and credit cards, offering a variety of deposit products and, to a lesser extent, trust and investment services through private banking.

     The Company is also engaged in mortgage banking activities. Mortgage banking activities are conducted through R&G Mortgage Corp., Puerto Rico’s second largest mortgage banker, The Mortgage Store of Puerto Rico, Inc., also a Puerto Rico mortgage company, and Continental Capital Corporation (“Continental Capital”), a New York mortgage banking subsidiary of Crown Bank with offices in New York and North Carolina. Mortgage banking activities include the origination, purchase, sale and servicing of mortgage loans on single-family residences, the issuance and sale of various types of mortgage-backed securities, the holding of mortgage loans, mortgage-backed securities and other investment securities for sale or investment, and the purchase and sale of servicing rights associated with such mortgage loans and, to a lesser extent, the origination of construction loans and mortgage loans secured by income producing real estate and land (the “mortgage banking business”).

     The Company is also engaged in insurance brokerage through Home & Property Insurance Corp., a Puerto Rico insurance agency, and securities brokerage through R-G Investments Corporation, a Puerto Rico licensed broker-dealer.

     The Company is the second largest mortgage loan originator and servicer of mortgage loans on single family residences in Puerto Rico. R&G Financial’s mortgage servicing portfolio amounted to approximately $10.9 billion as of June 30, 2004, or essentially the same amount as of the same date a year ago. While R&G Financial’s servicing portfolio continues to be affected by a high level of prepayments due to lower interest rates, R&G Financial continues to emphasize increasing the size of its mortgage servicing portfolio by relying principally on internal loan originations.

     As part of its strategy to maximize net interest income, R&G Financial maintains a substantial portfolio of mortgage-backed and investment securities. At June 30, 2004, the Company held securities available for sale with a fair market value of $3.2 billion, which included $2.5 billion of mortgage-backed securities, of which $320.4 million consisted of Puerto Rico GNMA securities, the interest on which is tax-exempt to the Company. These securities are generally held by the Company for longer periods prior to sale in order to maximize the tax-exempt interest received thereon. R&G Financial’s lower effective tax rate compared to the maximum statutory rate reflects the exemption under Puerto Rico law of the net interest income derived from such securities. In addition, the Company invests in certain U.S. agency securities that are exempt from Puerto Rico taxation and are not subject to federal income taxation. Finally, through its international banking subsidiaries, the Company may invest in various U.S. securities, the income on which is exempt from Puerto Rico income taxation and is also not subject to federal income taxation.

     A substantial portion of R&G Financial’s total mortgage loan originations has been comprised of refinance loans. R&G Financial’s future results could be adversely affected by a significant increase in mortgage interest rates that reduces refinancing activity. However, the Company believes that refinancing

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activity is less sensitive to interest rate changes in Puerto Rico than in the mainland United States because a significant amount of refinance loans are made for debt consolidation purposes.

     R&G Financial customarily sells or securitizes into mortgage-backed securities substantially all the loans it originates, except for certain non-conforming conventional mortgage loans and certain consumer, construction, land, and commercial loans which are held for investment and classified as loans receivable.

Financial Condition

     At June 30, 2004, total assets amounted to $8.9 billion, as compared to $8.2 billion at December 31, 2003. The $745.7 million or 9.1% increase in total assets since the beginning of the year was primarily the result of a $174.5 million or 5.8% increase in mortgage-backed and investment securities available for sale, and a $458.1 million or 11.3% increase in loans receivable, net, due to continued strong loan production during the first half of 2004. Total loan production for the six months ended June 30, 2004 was $2.1 billion, a 2.2% decrease when compared to the corresponding period in 2003. Although the Company’s loan production during the six months ended June 30, 2004 was affected by decreased refinancings in its U.S. mortgage subsidiary Continental Capital, the Company’s loan production continues to be driven principally by the Company’s ongoing expansion in commercial and residential lending in Central Florida and Puerto Rico, as well as refinancings in Puerto Rico, which continue to be consistent with R&G Financial’s historical experience.

     At June 30, 2004, R&G Financial had $4.2 billion of borrowings (consisting of securities sold under agreements to repurchase, notes payable, FHLB advances and other borrowings), compared to $3.7 billion at December 31, 2003. R&G Financial utilized repurchase agreements and deposits to fund its growth during the period; total deposits grew 7.5% from $3.6 billion at December 31, 2003 to $3.8 billion at June 30, 2004, whereas repurchase agreements increased by $267.7 million or 12.1%.

     At June 30, 2004, R&G Financial’s allowance for loan losses totaled $46.8 million, which represented a $7.2 million or 18.1% increase from the level maintained at December 31, 2003. At June 30, 2004, R&G Financial’s allowance represented approximately 0.97% of the total loan portfolio and 53.07% of total non-performing loans. However, excluding R&G Financial’s residential loan portfolio, which has minimal charge-off experience, the allowance for loan losses to total loans and to total non-performing loans would have been 2.16% and 158.55%, respectively, at June 30, 2004, compared to 2.09% and 139.57% at December 31, 2003.

      The reconciliation of non-performing loans to non-performing loans excluding residential real estate follows:

                   
June 30, 2004 December 31, 2003


(Unaudited)
(Dollars in thousands)
Allowance for loan losses
  $ 46,799     $ 39,615  
     
     
 
 
Total non-performing loans
  $ 88,187     $ 85,414  
Less: Residential real estate
    (58,671 )     (57,031 )
     
     
 
    $ 29,516     $ 28,383  
     
     
 
 
Total loans
  $ 4,813,627     $ 4,311,714  
Less: Residential real estate
    (2,651,338 )     (2,419,278 )
     
     
 
    $ 2,162,289     $ 1,892,436  
     
     
 
Allowance for loan losses as a percentage of total non-performing loans (excluding residential real estate)
    158.55 %     139.57 %
     
     
 
Allowance for loan losses as a percentage of total loans (excluding residential real estate)
    2.16 %     2.09 %
     
     
 

     Non-performing loans amounted to $88.2 million at June 30, 2004, an increase of $2.8 million or 3.24% when compared to $85.4 million at December 31, 2003. The increase is primarily related to a $1.6 million increase in delinquent residential real estate loans over 90 days past due. During the first quarter of 2004, the Company repurchased certain residential mortgage loans pursuant to recourse provisions in existing sale contracts. On certain contracts made prior to 2001, the Company is required to repurchase any loans sold that become delinquent over 120 days. During the quarter ended June 30, 2004, the Company sold approximately $28.2 million of non-performing residential mortgage loans on a recourse basis, including most of the loans repurchased during the first quarter. Under the recourse provisions made for the loans sold during the second quarter, the Company guarantees the timely payment of principal and interest on the mortgage loans. A reserve was made for the Company’s estimated liability under the recourse provisions at the time of sale.

At June 30, 2004, $58.7 million or 66.5% of non-performing loans consisted of residential mortgage loans in which R&G Financial has historically experienced a low level of loan charge-offs. R&G Financial’s aggregate net charge-offs as a percentage of total average loans outstanding amounted to 0.25% during the six months ended June 30, 2004 and 0.32% during the year ended December 31, 2003. Although loan delinquencies have historically been higher in Puerto Rico than in the United States, actual foreclosures and the resulting loan charge-offs have historically been lower than in the United States.

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     Stockholders’ equity increased from $750.4 million at December 31, 2003 to $779.8 million at June 30, 2004. The $29.5 million or 3.9% increase was due primarily to the net income recognized during the period, net of dividends paid and a $33.0 million loss in other comprehensive income.

Results of Operations

     During the three and six months ended June 30, 2004, R&G Financial reported net income of $40.7 million and $79.3 million or $0.72 and $1.39 of earnings per diluted share, respectively, compared to net income of $31.5 million and $60.6 million or $0.54 and $1.03 of earnings per diluted share for the comparative periods in 2003. These results reflect an increase in earnings per diluted share of 33.3% and 35.0% for the three and six month periods ending June 30, 2004 over the comparable periods in 2003.

     Net interest income increased by $24.9 million or 28.7% during the six month period ended June 30, 2004 to $111.7 million, due to a $1.7 billion increase in the average balance of interest-earning assets, together with a 3 basis point increase in the Company’s net interest margin from 2.76% to 2.79%. The increase in the average balance of interest earning assets is mostly related with a $1.3 billion or 39.5% increase in the average balance of loans receivable as a result of strong loan production. Total loan production during the six months ended June 30, 2004 amounted to $2.07 billion compared to $2.11 billion during the prior comparable period.

     The provision for loan losses amounted to $12.7 million during the six months ended June 30, 2004, a 47.0% increase over the prior comparable period, reflecting the continuing increase in the Company’s commercial real estate and construction loan portfolios, which have higher credit risk compared to residential loans.

     R&G Financial also experienced an increase in non-interest income during the six months ended June 30, 2004 over the comparable period. Net gain on sale of loans increased by $3.4 million or 4.4% over the prior comparable period, as a result of strong loan production within the Company’s Puerto Rico mortgage operations, and an increase in the volume of loans sold during the period. Loan administration, fee income and other income decreased by $3.1 million or 8.0% over the comparable period, due principally to a decrease in the Company’s weighted average servicing fee during the period, net of a $4.1 million increase in fee and other income.

     Net interest income increased by $11.4 million or 25.7% to $56.0 million during the quarter ended June 30, 2004 over the prior comparable period, due to a $1.7 billion increase in the average balance of interest-earning assets while the Company’s net interest margin remained constant at 2.71%. Net gain on sale of loans decreased 7.7% to $41.4 million during the three month ended June 30, 2004, together with a $2.4 million or 12.0% decrease in loan administration, fee income and other income.

     Total expenses decreased by $5.2 million or 4.5% during the six months ended June 30, 2004 over the comparable 2003 period, due to a $12.6 million or 17.2% decrease in other administrative and general expenses, partially offset by a $5.9 million or 19.8% increase in employee compensation and benefits associated with general growth in Company operations in Puerto Rico and Florida. Office occupancy and equipment expenses also increased by $1.5 million or 12.8%. The decrease in other administrative and general expenses is mainly due to a $21.6 million reduction in expenses associated with impairment charges of the Company’s servicing asset.

     Total expenses decreased by $8.1 million or 12.8% during the three month period ended June 30, 2004 over the prior comparable period, due to a $13.3 million or 31.2% decrease in other general and administrative expenses, which includes a $20.1 million decrease in expenses associated with impairment charges of the Company’s servicing asset, partially offset by a $4.3 million or 29.9% increase in employee compensation and benefits, and a $832,000 or 13.7% increase in occupancy expenses.

     During the six months ended June 30, 2004, the Company reported $6.7 million of impairment charges on its servicing asset related to unscheduled amortization amounts, compared to $12.8 million during the

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prior comparable period. The decrease in unscheduled amortization amounts during the six months period June 30, 2004 compared to prior comparable period is due to lower prepayment speeds in the Company’s servicing portfolio. The decrease in prepayments reflect the increase in interest rates for mortgage loans during the period. Based on the level of interest rates during the second quarter of 2004, the Company recorded during the three months ended June 30, 2004 a $4.2 million reversal of impairment charges on its servicing asset related to previously recorded valuation reserves for temporary declines in the fair value of its servicing portfolio. The value of the Company’s servicing portfolio is expected to increase given the more recent levels of higher interest rates, which is expected to result in lower prepayment speeds. Unscheduled amortization amounts are expected to decline also in future periods due to the lower prepayment speeds.

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Interest Rate Risk Management

     The following table summarizes the anticipated maturities or repricing of R&G Financial’s interest-earning assets and interest-bearing liabilities as of June 30, 2004, based on the information and assumptions set forth in the notes below. For purposes of this presentation, the interest earning components of loans held for sale and mortgage-backed securities held in connection with the Company’s mortgage banking business, as well as all securities held for trading, are assumed to mature within one year. In addition, investments held by the Company which have call features are presented according to their contractual maturity date.

                                                 
    Within   Four to   More Than   More Than        
    Three   Twelve   One Year to   Three Years   Over Five    
(Dollars in Thousands)
  Months
  Months
  Three Years
  to Five Years
  Years
  Total
Interest-earning assets(1):
                                               
Loans receivable
  $ 1,446,339     $ 885,207     $ 961,193     $ 517,532     $ 740,797     $ 4,551,068  
Mortgage loans held for sale
    70,028       189,582       5,274       3,784       8,357       277,025  
Mortgage-backed securities(2)(3)
    205,085       526,111       564,385       360,255       899,358       2,555,194  
Investment Securities(3)
    136,089       63,564       297,988       328,957       28,202       854,800  
Other interest-earning assets(4)
    209,749       13,910                         223,659  
 
   
 
     
 
     
 
     
 
     
 
     
 
 
Total
  $ 2,067,290     $ 1,678,374     $ 1,828,840     $ 1,210,528     $ 1,676,714     $ 8,461,746  
 
   
 
     
 
     
 
     
 
     
 
     
 
 
Interest bearing liabilities:
                                               
Deposits (5)
                                               
NOW and Super NOW accounts
  $ 29,118     $ 82,263     $ 90,432     $ 73,250     $ 312,280     $ 587,343  
Passbook savings accounts
    9,153       26,541       66,074       52,860       211,436       366,064  
Regular and commercial checking
    22,815       63,885       70,226       56,884       242,502       456,312  
Certificates of deposit
    352,157       926,553       792,230       333,480       1,628       2,406,048  
FHLB advances
    278,000       104,600       431,000       285,000       140,000       1,238,600  
Securities sold under agreements to repurchase (6)
    1,241,315       194,976       816,545       97,500       138,200       2,488,536  
Other borrowings(7)
    122,470       113,438                   206,186       442,094  
 
   
 
     
 
     
 
     
 
     
 
     
 
 
Total
    2,055,028       1,512,256       2,266,507       898,974       1,252,232       7,984,997  
 
   
 
     
 
     
 
     
 
     
 
     
 
 
Effect of hedging instruments
    170,000             330,100       (420,100 )     (80,000 )      
 
   
 
     
 
     
 
     
 
     
 
     
 
 
Excess (deficiency) of interest-earning assets over interest-bearing liabilities
  $ 182,262     $ 166,118       ($107,567 )     ($108,546 )   344,482     $ 476,749  
 
   
 
     
 
     
 
     
 
     
 
     
 
 
Cumulative excess (deficiency) of interest-earning assets over interest-bearing liabilities
  $ 182,262     $ 348,380     $ 240,813     $ 132,267     $ 476,749          
 
   
 
     
 
     
 
     
 
     
 
     
 
 
Cumulative excess (deficiency) of interest-earning assets over interest-bearing liabilities as a percent of total assets
    2.04 %     3.89 %     2.69 %     1.48 %     5.33 %        
 
   
 
     
 
     
 
     
 
     
 
     
 
 

(footnotes on following page)

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(1)   Adjustable-rate loans are included in the period in which interest rates are next scheduled to adjust rather that in the period in which they are due, and fixed-rate loans are included in the periods in which they are scheduled to be repaid, based on scheduled amortization, in each case as adjusted to take into account estimated prepayments.
 
(2)   Reflects estimated prepayments in the current interest rate environment.
 
(3)   Includes securities held for trading, available for sale and held to maturity.
 
(4)   Includes securities purchased under agreement to resell, time deposits with other banks and federal funds sold.
 
(5)   Does not include non-interest-bearing deposit accounts.
 
(6)   Includes federal funds purchased, if any.
 
(7)   Comprised of warehousing lines, notes payable and other borrowings.
 
     

     As of June 30, 2004, the Company had a one year positive gap of approximately $348.4 million, which constituted 3.9% of total assets at such date, compared to a negative gap of approximately $116.2 million or 1.4% of total assets at December 31, 2003. R&G Financial had a positive gap within one year as of June 30, 2004 compared to a negative gap as of December 31, 2003, due primarily to the Company’s emphasis on commercial and construction lending, which results in a greater amount of adjustable rate loans in the Company’s loan portfolio, as well as to the continued extension during the first half of 2004 of the maturity dates of certain borrowings of the Company into longer-term maturities, taking advantage of the continued low interest rate environment. The Company estimates that as of June 30, 2004, close to 50.2% of all borrowings of the Company had maturity dates longer than one year.

     While the Company presents its fixed-rate residential mortgage loans receivable portfolio held for investment purposes according to its maturity date, from time to time the Company may negotiate special transactions with FHLMC and/or FNMA or other third party investors for the sale of such loans. There can be no assurance, however, that the Company will be successful in consummating any such transactions.

Average Balances, Net Interest Margin, Yields Earned, and Rates Paid

     The following table presents for the periods indicated R&G Financial’s total dollar amount of interest from average interest-earning assets and the resultant yields, as well as the interest expense on average interest-bearing liabilities expressed both in dollars and rates, and the net interest margin. The table does not reflect any effect of income taxes. All average balances are based on the average of month-end balances for non-banking subsidiaries and average daily balances for banking subsidiaries in each case during the periods presented.

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    For the three months period ended June 30,
    2004
  2003
    Average           Yield /   Average           Yield /
(Dollars in thousands)
  Balance
  Interest
  Rate
  Balance
  Interest
  Rate
Interest-Earning Assets:
                                               
Cash and cash equivalents(1)
  $ 217,495     $ 822       1.51 %   $ 81,550     $ 318       1.56 %
Investment securities held for trading
    1,846       9       1.95                    
Investment securities available for sale
    675,209       6,196       3.67       603,477       6,782       4.50  
Investment securities held to maturity
    44,351       603       5.44       30,374       369       4.86  
Mortgage-backed securities held for trading
    37,843       629       6.65       50,666       957       7.56  
Mortgage-backed securities available for sale
    2,449,535       30,443       4.97       2,198,671       27,262       4.96  
Mortgage-backed securities held to maturity
    29,651       421       5.68       41,608       595       5.72  
Loans receivable, net (2)
    4,713,895       70,091       5.95       3,458,562       55,007       6.36  
FHLB Stock
    107,752       482       1.79       101,050       1,268       5.02  
 
   
 
     
 
             
 
     
 
         
Total interest-earning assets
    8,277,577     $ 109,696       5.30 %     6,565,958     $ 92,558       5.64 %
 
   
 
     
 
     
 
     
 
     
 
     
 
 
Non-interest-earning assets
    486,800                       507,176                  
 
   
 
                     
 
                 
Total assets
  $ 8,764,377                     $ 7,073,134                  
 
   
 
                     
 
                 
Interest-Bearing Liabilities:
                                               
Deposits
  $ 3,724,802     $ 23,742       2.55 %   $ 3,123,204     $ 22,968       2.94 %
Securities sold under agreements to repurchase (3)
    2,442,591       14,119       2.31       1,725,061       12,814       2.97  
Notes payable
    175,388       550       1.25       227,648       2,139       3.76  
Other borrowings(4)
    1,446,783       15,279       4.22       1,006,511       10,068       4.00  
 
   
 
     
 
             
 
     
 
         
Total interest-bearing liabilities
    7,789,564     $ 53,690       2.76 %     6,082,424     $ 47,989       3.16 %
 
   
 
     
 
     
 
     
 
     
 
     
 
 
Non-interest-bearing liabilities
    193,634                       299,598                  
 
   
 
                     
 
                 
Total liabilities
    7,983,198                       6,382,022                  
 
   
 
                     
 
                 
Stockholders’ equity
    781,179                       691,112                  
 
   
 
                     
 
                 
Total liabilities and stockholders’ equity
  $ 8,764,377                     $ 7,073,134                  
 
   
 
                     
 
                 
Net interest income; interest rate spread (5)
          $ 56,006       2.54 %           $ 44,569       2.48 %
 
           
 
     
 
             
 
     
 
 
Net interest margin
                    2.71 %                     2.71 %
 
                   
 
                     
 
 
Average interest-earning assets to average interest-bearing liabilities
                    106.26 %                     107.95 %
 
                   
 
                     
 
 

(footnotes on the following page)

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    For the three months period ended June 30,
    2004
  2003
    Average           Yield /   Average           Yield /
(Dollars in thousands)
  Balance
  Interest
  Rate
  Balance
  Interest
  Rate
Interest-Earning Assets:
                                               
Cash and cash equivalents(1)
  $ 198,592     $ 1,437       1.45 %   $ 79,750     $ 583       1.46 %
Investment securities held for trading
    1,564       18       2.30                    
Investment securities available for sale
    624,594       11,739       3.76       596,003       12,910       4.33  
Investment securities held to maturity
    44,304       1,098       4.96       30,419       768       5.05  
Mortgage-backed securities held for trading
    40,335       1,291       6.40       81,494       1,931       4.74  
Mortgage-backed securities available for sale
    2,392,055       61,688       5.16       2,080,655       54,081       5.20  
Mortgage-backed securities held to maturity
    31,006       882       5.69       43,359       1,249       5.76  
Loans receivable, net (2)
    4,581,052       138,260       6.04       3,284,068       106,962       6.51  
FHLB Stock
    104,149       914       1.76       96,608       2,330       4.82  
 
   
 
     
 
             
 
     
 
         
Total interest-earning assets
    8,017,651     $ 217,327       5.42 %   $ 6,292,356     $ 180,814       5.75 %
 
   
 
     
 
     
 
     
 
     
 
     
 
 
Non-interest-earning assets
    558,227                       515,482                  
 
   
 
                     
 
                 
Total assets
  $ 8,575,878                     $ 6,807,838                  
 
   
 
                     
 
                 
Interest-Bearing Liabilities:
                                               
Deposits
  $ 3,660,685     $ 47,445       2.59 %   $ 2,984,816     $ 44,661       2.99 %
Securities sold under agreements to repurchase (3)
    2,330,893       27,632       2.37       1,723,074       25,585       2.97  
Notes payable
    177,199       2,019       2.28       229,167       4,009       3.50  
Other borrowings(4)
    1,356,141       28,511       4.20       996,032       19,769       3.97  
 
   
 
     
 
             
 
     
 
         
Total interest-bearing liabilities
    7,524,918     $ 105,607       2.81 %   $ 5,933,089     $ 94,024       3.17 %
 
   
 
     
 
     
 
     
 
     
 
     
 
 
Non-interest-bearing liabilities
    280,056                       193,268                  
 
   
 
                     
 
                 
Total liabilities
    7,804,974                       6,126,357                  
 
   
 
                     
 
                 
Stockholders’ equity
    770,904                       681,481                  
 
   
 
                     
 
                 
Total liabilities and stockholders’ equity
  $ 8,575,878                     $ 6,807,838                  
 
   
 
                     
 
                 
Net interest income; interest rate spread (5)
          $ 111,720       2.61 %           $ 86,790       2.58 %
 
           
 
     
 
             
 
     
 
 
Net interest margin
                    2.79 %                     2.76 %
 
                   
 
                     
 
 
Average interest-earning assets to average interest-bearing liabilities
                    106.55 %                     106.06 %
 
                   
 
                     
 
 

(footnotes on the following page)

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(1)   Comprised of cash and due from banks, securities purchased under agreements to resell, time deposits with other banks and other short term investments.
 
(2)   Includes mortgage loans held for sale and non-accrual loans.
 
(3)   Includes federal funds purchased, if any.
 
(4)   Comprised of long-term debt, advances from FHLB and other borrowings.
 
(5)   Interest rate spread represents the difference between R&G Financial’s weighted average yield on interest-earning assets and the weighted average rate on interest-bearing liabilities. Net interest margin represents net interest income as a percent of average interest-earning assets.

Mortgage Loan Servicing

     The following table sets forth certain information regarding the mortgage loan servicing portfolio of R&G Financial for the periods indicated.

                 
    At or for the six months period ended
    June 30,
    2004
  2003
    (Dollars in thousands)
Composition of Servicing Portfolio at period end:
               
GNMA
  $ 2,079,520     $ 2,474,267  
FNMA/FHLMC
    4,487,059       5,711,663  
Other mortgage loans (3)
    4,380,879       3,132,576  
 
   
 
     
 
 
Total servicing portfolio (3)
  $ 10,947,458     $ 11,318,506  
 
   
 
     
 
 
Activity in the Servicing Portfolio:
               
Beginning servicing portfolio
  $ 10,942,821     $ 10,991,945  
Add: Loan originations and purchases
    1,714,071       1,424,138  
Servicing of portfolio loans acquired
    2,016       1,006,036  
Less: Sale of servicing rights(1)
    (149,337 )     (129,184 )
Run-offs(2)
    (1,562,113 )     (1,974,429 )
 
   
 
     
 
 
Ending servicing portfolio(3)
  $ 10,947,458     $ 11,318,506  
 
   
 
     
 
 
Number of loans serviced
    144,914       155,946  
Average loan size
  $ 76     $ 73  
Average servicing fee rate
    0.40 %     0.48 %

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(1)   Corresponds to loans sold, servicing released, by Continental Capital.
 
(2)   Run-off refers to regular amortization of loans, prepayments and foreclosures.
 
(3)   At the dates shown, included $2.1 billion and $1.5 billion, respectively, serviced for Premier Bank, which constituted 19.6% and 13.5% of the total servicing portfolio, and $387.2 million and $82.5 million, respectively, serviced for Crown Bank, which constituted 3.5% and 0.7%, respectively, of the total servicing portfolio at such dates.

     Most of the mortgage loans in R&G Financial’s servicing portfolio are secured by single (one-to-four) family residences secured by real estate located in Puerto Rico. At June 30, 2004, approximately 25.3% of the Company’s mortgage servicing portfolio was related to mortgages secured by real property located outside Puerto Rico.

     The Company reduces the sensitivity of its servicing income to increases in prepayment rates through a strong retail origination network that has increased or maintained the size of R&G Financial’s servicing portfolio even during periods of high prepayments. In addition, a substantial portion of the Company’s servicing portfolio consists of tax-exempt FHA/VA mortgage loans which carry lower interest rates than those on conventional loans, which tends to reduce risks related to R&G Financial’s servicing portfolio. During the six month periods ended June 30, 2004 and 2003, the Company recognized $6.7 million and $12.8 million, respectively, of unscheduled amortization on mortgage servicing rights.

Liquidity and Capital Resources

     Liquidity - Liquidity refers to the Company’s ability to generate sufficient cash to meet the funding needs of current loan demand, savings deposit withdrawals, principal and interest payments with respect to outstanding borrowings and to pay operating expenses. It is management’s policy to maintain greater liquidity than required in order to be in a position to fund loan purchases and originations, to meet withdrawals from deposit accounts, to make principal and interest payments with respect to outstanding borrowings and to make investments that take advantage of interest rate spreads. The Company monitors its liquidity in accordance with guidelines established by the Company and applicable regulatory requirements. The Company’s need for liquidity is affected by loan demand, net changes in deposit levels and the scheduled maturities of its borrowings. The Company can minimize the cash required during the times of heavy loan demand by modifying its credit policies or reducing its marketing efforts. Liquidity demand caused by net reductions in deposits are usually caused by factors over which the Company has limited control. The Company derives its liquidity from both its assets and liabilities. Liquidity is derived from assets by receipt of interest and principal payments and prepayments, by the ability to sell assets at market prices and by utilizing unpledged assets as collateral for borrowings. Liquidity is derived from liabilities by maintaining a variety of funding sources, including deposits, advances from the FHLB of New York and Atlanta (the “FHLB”) and other short and long-term borrowings.

     The Company’s liquidity management is both a daily and long-term function of funds management. Liquid assets are generally invested in short-term investments such as securities purchased under agreements to resell, federal funds sold and certificates of deposit in other financial institutions. If the Company requires funds beyond its ability to generate them internally, various forms of both short and long-term borrowings provide an additional source of funds. At June 30, 2004, the Company had $150.0 million in borrowing capacity under unused warehousing and other lines of credit, $1.2 billion in borrowing capacity under unused lines of credit with the FHLB and $55.0 million available unused fed funds lines of credit.

     At June 30, 2004, the Company had outstanding commitments to originate and/or purchase mortgage and non-mortgage loans of $641.7 million (including unused lines of credit). Certificates of deposit which are scheduled to mature within one year totaled $1.3 billion at June 30, 2004, and borrowings that are scheduled to mature within the same period amounted to $1.9 billion. The Company anticipates that it will have sufficient funds available to meet its current loan commitments and other liquidity needs.

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     Capital Resources - The FDIC’s capital regulations establish a minimum 3.0 % Tier I leverage capital requirement for the most highly-rated state-chartered, non-member banks, with an additional cushion of at least 100 to 200 basis points for all other state-chartered, non-member banks, which effectively will increase the minimum Tier 1 leverage ratio for such other banks from 4.0% to 5.0% or more. Under the FDIC’s regulations, the highest-rated banks are those that the FDIC determines are not anticipating or experiencing significant growth and have well diversified risk, including no undue interest rate risk exposure, excellent asset quality, high liquidity, good earnings and, in general, which are considered a strong banking organization and are rated composite 1 under the Uniform Financial Institutions Rating System. Leverage or core capital is defined as the sum of common stockholders’ equity (including retained earnings), noncumulative perpetual preferred stock and related surplus, and minority interests in consolidated subsidiaries, minus all intangible assets other than certain qualifying supervisory goodwill and certain purchased mortgage servicing rights.

     The FDIC also requires that banks meet a risk-based capital standard. The risk-based capital standard for banks requires the maintenance of total capital (which is defined as Tier I capital and supplementary (Tier 2) capital) to risk weighted assets of 8%. In determining the amount of risk-weighted assets, all assets, plus certain off-balance sheet items, are multiplied by a risk-weight of 0% to 100%, based on the risks the FDIC believes are inherent in the type of asset or item. The components of Tier 1 capital are equivalent to those discussed above under the 3% leverage capital standard. The components of supplementary capital include certain perpetual preferred stock, certain mandatory convertible securities, certain subordinated debt and intermediate preferred stock and general allowances for loan and lease losses. Allowance for loan and lease losses includable in supplementary capital is limited to a maximum of 1.25% of risk-weighted assets. Overall, the amount of capital counted toward supplementary capital cannot exceed 100% of core capital. At June 30, 2004, Premier Bank met each of its capital requirements, with Tier 1 leverage capital, Tier 1 risk-based capital and total risk-based capital ratios of 7.07%, 12.28% and 13.29%, respectively. At June 30, 2004, Crown Bank also met each of its capital requirements, with Tier 1 leverage capital, Tier 1 risk-based capital and total risk-based capital ratios of 7.35%, 11.20% and 12.06%, respectively. Thus, at June 30, 2004 both Premier Bank and Crown Bank were “well capitalized” institutions under the capital adequacy regulatory guidelines.

     In addition, the Federal Reserve Board has promulgated capital adequacy guidelines for bank holding companies which are substantially similar to those adopted by FDIC regarding state-chartered banks, as described above. R&G Financial is currently in compliance with such regulatory capital requirements.

On May 6, 2004, the Federal Reserve issued a proposed rule that would continue to allow trust preferred securities issued by variable interest entities to constitute Tier 1 capital for bank holding companies. The proposed rules would impose stricter quantitative and qualitative limits on the Tier 1 treatment of trust preferred securities. Currently, trust preferred securities and qualifying perpetual preferred stock are limited in the aggregate to no more than 25% of a holding company’s core capital elements. The proposed rule would amend the existing limit by providing that restricted core capital elements (including trust preferred securities and qualifying perpetual preferred stock) can be no more than 25% of core capital, net of goodwill. It is possible that the Federal Reserve rules will not be adopted as proposed and that the Federal Reserve will conclude that trust preferred securities should no longer be treated as Tier 1 regulatory capital.

Inflation and Changing Prices

     The unaudited consolidated financial statements and related data presented herein have been prepared in accordance with generally accepted accounting principles, which require the measurement of financial position and operating results in terms of historical dollars (except with respect to securities which are carried at market value), without considering changes in the relative purchasing power of money over time due to inflation. Unlike most industrial companies, substantially all of the assets and liabilities of the Company are monetary in nature. As a result, interest rates have a more significant impact on the Company’s performance than the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or in the same magnitude as the prices of goods and services.

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Item 3: Quantitative and Qualitative Disclosures about Market Risk

     Quantitative and qualitative disclosures about market risks at December 31, 2003 are presented in Item 7A of the Company’s Annual report on Form 10-K. Information at June 30, 2004 is presented on page 24 of this Report. Management believes there have been no material changes in the Company’s market risk since December 31, 2003.

Item 4: Controls and Procedures

     As of the end of the period covered by this report, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer along with the Company’s Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to the Securities Exchange Act of 1934 (“Exchange Act”) Rule 13a-15(b). Based upon that evaluation, the Company’s Chief Executive Officer along with the Company’s Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company’s periodic Securities and Exchange Commission (“SEC”) filings. There has not been any change in the Company’s internal control over financial reporting that occurred during the Company’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

     Disclosure controls and procedures are Company controls and other procedures that are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

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PART II — OTHER INFORMATION

Item 1: Legal Proceedings

    The Registrant is involved in routine legal proceedings occurring in the ordinary course of business which, in the aggregate, are believed by management to be immaterial to the financial condition and results of operations of the Registrant.

Item 2: Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities

     Not applicable.

Item 3: Defaults Upon Senior Securities

     Not applicable.

Item 4: Submission of Matters to a Vote of Security Holders

    The Company’s Annual Meeting of Stockholders was held on April 23, 2004. The following matters were submitted for a vote:

1.   With respect to the election of three directors to serve three-year terms expiring at the Annual Meeting of Stockholders to be held in the year 2007 or until their respective successors are elected and qualified, the following were the number of shares voted for each nominee:

                                 
Victor L. Galan-Fundora
  Class A - For     21,559,584     Against      
 
  Class B - For     16,312,497     Against     9,032,562  
Rafael Nin
  Class A - For     21,559,584     Against      
 
  Class B - For     24,037,414     Against     1,307,645  
Benigno Fernandez
  Class A - For     21,559,584     Against      
 
  Class B - For     24,037,417     Against     1,307,642  

    The following directors’ terms of office continued after the meeting: Gilberto Rivera - Arreaga, Laureano Carus, Ileana M. Colon-Carlo, Roberto Gorbea, Victor J. Galan, Ramon Prats, Enrique Umpierre Suárez and Eduardo McCormack.

2.   With respect to the ratification of the appointment of PricewaterhouseCoopers, LLP as the Company’s independent auditors for the fiscal year ending December 31, 2004, the following were the number of shares voted:

                                                                 
Class A -
  For     21,559,584     Against         Abstain         Broker Non-votes      
Class B -
  For     25,232,436     Against     100,722     Abstain     11,901     Broker Non-votes      

3.   With respect to the approval of an amendment to the Amended and Restated Certificate of Incorporation of the Company to increase the authorized common stock of the Company from One Hundred Million (100,000,000) to Two Hundred Million (200,000,000), the following were the number of shares voted:

                                                                 
Class A -
  For     21,559,584     Against         Abstain         Broker Non-votes      
Class B -
  For     22,398,615     Against     2,929,881     Abstain     16,563     Broker Non-votes      

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4.   With respect to the approval of the R&G Financial Corporation 2004 Stock Option Plan, the following were the number of shares voted:

                                                                 
Class A -
  For     21,559,584     Against         Abstain         Broker Non-votes      
Class B -
  For     13,066,873     Against     2,887,645     Abstain     9,390,541     Broker Non-votes      

Item 5: Other Information.

     Not applicable.

Item 6: Exhibits and Reports on Form 8-K.

(a) Item 601 Exhibits.

     
No.
  Description
2.1
  Amended and Restated Agreement and Plan of Merger by and between R&G Financial Corporation, R-G Premier Bank of Puerto Rico and R-G Interim Premier Bank, dated as of September 27, 1996 (1)
 
   
2.2.0
  Agreement and Plan of Reorganization among R&G Financial Corporation, R&G Acquisition Holdings Corporation, The Crown Group, Inc. and Crown Bank, a Federal Savings Bank dated as of December 19, 2001 (2)
 
   
2.2.1
  Amendment No. 2 to Agreement and Plan of Reorganization among R&G Financial Corporation, R&G Acquisition Holdings Corporation, The Crown Group, Inc. and Crown Bank, a Federal Savings Bank dated as of February 27, 2002 (3)
 
   
3.1.0
  Certificate of Incorporation of R&G Financial Corporation (4)
 
   
3.1.1
  Certificate of Amendment to Certificate of Incorporation of R&G Financial Corporation (4)
 
   
3.1.2
  Amended and Restated Certificate of Incorporation of R&G Financial Corporation (5)
 
   
3.1.3
  Certificate of Amendment to Amended and Restated Certificate of Incorporation of R&G Financial Corporation (6)
 
   
3.1.4
  Second Certificate of Amendment to Amended and Restated Certificate of Incorporation of R&G Financial Corporation (15)
 
   
3.1.5
  Certificate of Resolution designating the terms of the Series A Preferred Stock (7)
 
   
3.1.6
  Certificate of Resolution designating the terms of the Series B Preferred Stock (8)
 
   
3.1.7
  Certificate of Designation for Series C Preferred Stock (12)
 
   
3.1.8
  Certificate of Designation for Series D Preferred Stock (13)
 
   
3.2
  Bylaws of R&G Financial Corporation (4)
 
   
4.0
  Form of Stock Certificate of R&G Financial Corporation (4)
 
   
4.1
  Form of Series A Preferred Stock Certificate of R&G Financial Corporation (9)
 
   
4.2
  Form of Series B Preferred Stock Certificate of R&G Financial Corporation (10)
 
   
4.3
  Form of Series C Preferred Stock Certificate of R&G Financial Corporation (11)
 
   
4.4
  Form of Series D Preferred Stock Certificate of R&G Financial Corporation (14)
 
   
4.5
  Form of Indenture dated as of October 6, 2003, between R&G Financial Corporation and Wilmington Trust Company (18)
 
   
4.6
  Form of Indenture dated as of March 31, 2004, between R&G Financial Corporation and Wilmington Trust Company (20)
 
   
10.1
  Master Purchase, Servicing and Collection Agreement between R&G

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No.
  Description
  Mortgage Corporation and R-G Premier Bank of Puerto Rico dated February 16, 1990, as amended on April 1, 1991, December 1, 1991, February 1, 1994 and July 1, 1994 (4)
 
   
10.2
  Master Custodian Agreement between R&G Mortgage Corporation and R-G Premier Bank of Puerto Rico dated February 16, 1990, as amended on June 27, 1996 (4)
 
   
10.3
  Master Production Agreement between R&G Mortgage and R-G Premier Bank of Puerto Rico dated February 16, 1990, as amended on August 30, 1991 and March 31, 1995 (4)
 
   
10.3.1
  Amendment No. 3 to the Master Production Agreement, dated as of January 1, 2004
 
   
10.4
  Data Processing Computer Service Agreement between R&G Mortgage and R-G Premier Bank of Puerto Rico dated December 1, 1994 (4)
 
   
10.5
  Securitization Agreement by and between R&G Mortgage and R-G Premier Bank of Puerto Rico, dated as of July 1, 1995 (4)
 
   
10.6
  R&G Financial Corporation Stock Option Plan (4)(*)
 
   
10.6.1
  R&G Financial Corporation 2004 Stock Option Plan (19)(*)
 
   
10.7
  Guarantee Agreement between R&G Financial Corporation, R&G Acquisition Holdings Corporation and Wilmington Trust as Guarantee Trustee with respect to the Capital Securities issued by R&G Capital Trust I, dated as of April 10, 2002 (16)
 
   
10.8
  Guarantee Agreement between R&G Financial Corporation and U.S. Bank National Association as Guarantee Trustee with respect to the Capital Securities issued by R&G Capital Trust IV, LLT, dated as of August 8, 2003 (17)
 
   
10.9
  Form of Preferred Securities Agreement, dated as of October 6, 2003, by and between R&G Financial Corporation and Wilmington Trust Company(18)
 
   
10.10
  Form of Amended and Restated Declaration of Trust, dated as of October 6, 2003, among R&G Financial Corporation, Wilmington Trust Company and the Administrative Trustees named therein (18)
 
   
10.11
  Form of Guarantee Agreement between R&G Financial Corporation and Wilmington Trust as Guarantee Trustee with respect to the Capital Securities issued by R&G Capital Trust dated as of March 31, 2004 (20)
 
   
10.12
  Form of Amended and Restated Declaration of Trust dated as of March 31, 2004, among R&G Financial Corporation, Wilmington Trust Company and the Administrative Trustees named therein (20)
 
   
31.1
  Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act
 
   
31.2
  Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act
 
   
32
  Certification pursuant to Section 906 of the Sarbanes-Oxley Act


(1)   Incorporated by reference from the Registration Statement on Form S-4 (Registration No. 333-13199) filed by the Registrant with the Securities and Exchange Commission (“SEC”) on October 1, 1996.
 
(2)   Incorporated by reference from the Registrant’s Current Report on Form 8-K filed with the SEC on December 20, 2001.
 
(3)   Incorporated by reference from the Registrant’s Current Report on Form 8-K filed with the SEC on February 28, 2002.
 
(4)   Incorporated by reference from the Registration Statement on Form S-1 (Registration No. 333-06245) filed by the Registrant with the SEC on September 18, 1996, as amended.

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(5)   Incorporated by reference from the Registrant’s Current Report on Form 8-K filed with the SEC on November 19, 1999.
 
(6)   Incorporated by reference from the Registrant’s Current Report on Form 8-K filed with the SEC on June 12, 2001.
 
(7)   Incorporated by reference from the Registrant’s Current Report on Form 8-K filed with the SEC on August 31, 1998.
 
(8)   Incorporated by reference from the Registrant’s Form 10-K filed with the SEC on April 13, 2000.
 
(9)   Incorporated by reference from the Registrant’s Registration Statement on Form S-3 (Registration No. 333-60923) filed with the SEC on August 7, 1998.
 
(10)   Incorporated by reference from the Registrant’s Registration Statement on Form S-3 (Registration No. 333-90463) filed with the SEC on November 5, 1999.
 
(11)   Incorporated by reference from the Registrant’s Registration Statement on Form S-3 (File No. 333-55834) filed with the SEC on February 16, 2001.
 
(12)   Incorporated by reference from the Registrant’s Form 10-K filed with the SEC on April 2, 2001.
 
(13)   Incorporated by reference from the Registrant’s Current Report on Form 8-K filed with the SEC on March 7, 2002.
 
(14)   Incorporated by reference from the Registrant’s Registration Statement on Form S-3 (File No. 333-81214) filed with the SEC on January 22, 2002.
 
(15)   Incorporated by reference from the Registrant’s Current Report on Form 8-K filed with the SEC on June 18, 2002.
 
(16)   Incorporated by reference from the Registrant’s Form 10-Q filed with the SEC on November 14, 2002.
 
(17)   Incorporated by reference from the Registrant’s Form 10-Q filed with the SEC on November 14, 2003.
 
(18)   Incorporated by reference from the Registrant’s Registration Statement on Form S-3 (Registration No. 333-107365) filed with the SEC on July 25, 2003.
 
(19)   Incorporated by reference from the Registrant’s Definitive Proxy Statement for its 2004 Annual Meeting filed with the SEC on April 5, 2004.
 
(20)   Incorporated by reference from the Registrant’s Registration Statement on Form S-3 (Registration No. 333-113321) filed with the SEC on March 15, 2004.
 
(21)   Incorporated by reference from the Registrant’s Form 10-Q filed with the SEC on May 10, 2004.
 
(*)   Management contract or compensatory plan or arrangement.
 
(b)   Reports on Form 8-K

     The Registrant filed the following Reports on Form 8-K during the quarter ended June 30, 2004.

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(1)   Form 8-K filed on April 20, 2004 with an attached press release announcing the Registrant’s earnings for the quarter ended March 30, 2004.
 
(2)   Form 8-K filed on April 23, 2004 with an attached investor presentation of Registrant’s results for the quarter ended March 30, 2004.
 
(3)   Form 8-K filed on April 1, 2004 reporting the successful completion of its $100 million trust preferred securities offering to the Puerto Rico Conservation Trust Fund, a Puerto Rico charitable trust.

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SIGNATURES

     Pursuant to the requirements 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.
         
  R&G FINANCIAL CORPORATION

 
 
 
August 9, 2004  By:   Date:/S/ VICTOR J. GALAN    
    Víctor J. Galán, Chairman  
    and Chief Executive Officer
(Principal Executive Officer) 
 
 
         
     
  By:   /S/ JOSEPH R. SANDOVAL    
    Joseph R. Sandoval  
    Executive Vice President
and Chief Financial Officer
(Principal Financial and
Accounting Officer) 
 

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