W HOLDING CO INC - 10-Q Quarterly Report

UNITED STATES 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 SEPTEMBER 30, 2004


o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED)

For the transition period from to

Commission File Number 000-27377

W HOLDING COMPANY, INC.

(Exact name of Registrant as Specified in its Charter)


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

19 West McKinley Street
Mayagüez, Puerto Rico 00681
(Address of Principal Executive Offices) (Zip Code)

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of l934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES x NO o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12-b-2 of the Exchange Act). x NO o

As of October 31, 2004, there were 107,071,886 shares outstanding of the Registrant’s Common Stock, $1.00 par value.

Part I. Financial Information

Item I. Financial Statements

W HOLDING COMPANY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)


	September 30,			December 31,
	2004			2003
ASSETS
Cash and due from banks	$	89,495		$	92,811
Money market instruments:
Federal funds sold and resell agreements		680,078			649,852
Interest-bearing deposits in banks		51,799			37,767
Investment securities available for sale, at fair value		12,226			55,080
Investment securities held to maturity, at amortized cost with a fair value of $6,532,863 in 2004 and $5,638,816 in 2003		6,613,078			5,723,710
Federal Home Loan Bank stock, at cost		57,105			39,750
Mortgage loans held for sale, at lower of cost or fair value		1,714			2,555
Loans, net of allowance for loan losses of $76,588 in 2004 and $61,608 in 2003		5,716,931			4,683,118
Accrued interest receivable		78,442			75,567
Foreclosed real estate held for sale, net of allowance of $307 in 2004 and $28 in 2003		4,444			4,082
Premises and equipment, net		108,340			103,370
Deferred income taxes, net		29,787			24,910
Other assets		35,419			26,868

TOTAL	$	13,478,858		$	11,519,440

LIABILITIES AND STOCKHOLDERS’ EQUITY
LIABILITIES:
Deposits:
Noninterest-bearing	$	240,841		$	192,760
Interest-bearing		5,991,784			5,192,716

Total deposits		6,232,625			5,385,476
Federal funds purchased and repurchase agreements		6,011,735			5,046,045
Advances from Federal Home Loan Bank		211,000			146,000
Mortgage note payable		36,960			37,234
Securities purchased but not yet received		5,020			—
Advances from borrowers for taxes and insurance		4,643			4,307
Accrued expenses and other liabilities		58,086			71,869

Total liabilities		12,560,069			10,690,931

COMMITMENTS AND CONTINGENCIES STOCKHOLDERS’ EQUITY:
Preferred stock — $1.00 par value per share (liquidation preference $25 per share — $381,136,325 in 2004 and $384,893,625 in 2003); authorized 20,000,000 shares; issued and outstanding 15,245,453 shares in 2004 and 15,395,745 shares in 2003		15,245			15,396
Common stock — $1.00 par value per share; authorized 300,000,000 shares; issued and outstanding 106,847,565 shares in 2004 and 106,290,294 shares in 2003		106,848			106,290
Paid-in capital		516,113			514,800
Retained earnings:
Reserve fund		56,027			43,375
Undivided profits		224,827			149,581
Accumulated other comprehensive loss, net of income tax		(271	)		(933	)

Total stockholders’ equity		918,789			828,509

TOTAL	$	13,478,858		$	11,519,440

See notes to consolidated financial statements.

W HOLDING COMPANY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)


	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2004			2003			2004			2003
INTEREST INCOME:
Loans, including loan fees	$	82,645		$	71,568		$	232,710		$	203,222
Investment securities		55,159			31,607			153,542			89,327
Mortgage and asset-backed securities		9,162			11,489			28,660			29,137
Money market instruments		4,579			1,771			12,056			8,605

Total interest income		151,545			116,435			426,968			330,291

INTEREST EXPENSE:
Deposits		36,858			27,941			102,282			85,985
Federal funds purchased and repurchase agreements		35,874			24,866			97,250			71,612
Advances from Federal Home Loan Bank		1,767			1,515			4,621			4,525
Other borrowings		—			—			—			142

Total interest expense		74,499			54,322			204,153			162,264

NET INTEREST INCOME		77,046			62,113			222,815			168,027
PROVISION FOR LOAN LOSSES		10,379			7,893			30,141			20,718

NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES		66,667			54,220			192,674			147,309

NONINTEREST INCOME (LOSS):
Service charges on deposit accounts		2,054			1,792			5,974			5,284
Other fees and commissions		5,476			5,714			15,433			15,313
Gain (loss) on derivative instruments		249			(54	)		12			(155	)
Net gain (loss) on sales and valuation of loans, securities and other assets		594			21			867			(20,983	)

Total noninterest income (loss)		8,373			7,473			22,286			(541	)

TOTAL NET INTEREST INCOME AND NONINTEREST INCOME (LOSS)		75,040			61,693			214,960			146,768

NONINTEREST EXPENSES:
Salaries and employees’ benefits		9,701			8,267			27,846			24,808
Equipment		2,179			2,318			6,981			6,714
Deposits insurance premium and supervisory examination		753			661			2,112			1,727
Occupancy		1,536			1,656			4,882			4,923
Advertising		3,031			1,976			8,895			4,983
Printing, postage, stationery and supplies		817			822			2,490			2,526
Telephone		577			569			1,764			1,707
Municipal taxes		1,078			900			2,875			2,700
Other		5,636			4,703			16,350			10,749

Total noninterest expenses		25,308			21,872			74,195			60,837

INCOME BEFORE PROVISION FOR INCOME TAXES		49,732			39,821			140,765			85,931

PROVISION FOR INCOME TAXES:
Current		6,308			6,657			19,861			20,351
Deferred credit		(819	)		(1,474	)		(4,856	)		(9,591	)

Total provision for income taxes		5,489			5,183			15,005			10,760

NET INCOME	$	44,243		$	34,638		$	125,760		$	75,171

NET INCOME ATTRIBUTABLE TO COMMON STOCKHOLDERS	$	37,510		$	28,469		$	105,509		$	60,402

BASIC EARNINGS PER COMMON SHARE	$	0.35		$	0.27	(1)	$	0.99		$	0.58	(1)

DILUTED EARNINGS PER COMMON SHARE	$	0.34		$	0.26	(1)	$	0.95		$	0.56	(1)

(1)

Adjusted to reflect the three-for-two stock split in the form of a stock dividend and a 2% stock dividend on our common stock declared on November 4, 2003 and November 11, 2003, respectively, and distributed both on December 10, 2003.

W HOLDING COMPANY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
AND OF COMPREHENSIVE INCOME (UNAUDITED)
(IN THOUSANDS)


	Nine Months Ended
	September 30,
	2004			2003
Changes in Stockholders’ Equity:
Preferred stock:
Balance at beginning of period	$	15,396		$	8,943
Issuance of preferred stock		—			6,872
Conversion of preferred stock		(151	)		(205	)

Balance at end of period		15,245			15,610

Common stock:
Balance at beginning of period		106,290			68,346
Issuance of common stock upon conversion of preferred stock		343			305
Issuance of common stock upon exercise of stock options		215			—

Balance at end of period		106,848			68,651

Paid-in capital:
Balance at beginning of period		514,800			319,106
Stock options exercised		754			—
Effect of stock options granted to employees		752			795
Issuance of common stock upon conversion of preferred stock		(193	)		(100	)
Issuance of preferred stock		—			158,992

Balance at end of period		516,113			478,793

Reserve fund:
Balance at beginning of period		43,375			32,011
Transfer from undivided profits		12,652			7,527

Balance at end of period		56,027			39,538

Undivided profits:
Balance at beginning of period		149,581			157,442
Net income		125,760			75,171
Cash dividends on common stock		(17,611	)		(13,595	)
Cash dividends on preferred stock		(20,251	)		(14,769	)
Transfer to reserve fund		(12,652	)		(7,527	)

Balance at end of period		224,827			196,722

Accumulated other comprehensive loss, net of income tax:
Balance at beginning of period		(933	)		(1,100	)
Other comprehensive income (loss), net of income tax for the period		662			(465	)

Balance at end of period		(271	)		(1,565	)

Total Stockholders’ Equity	$	918,789		$	797,749

Comprehensive Income:
Net income	$	125,760		$	75,171

Other comprehensive income (loss), net of income tax:
Unrealized net gains (losses) on securities available for sale:
Unrealized gains (losses) arising during the period		769			(7,579	)
Reclassification adjustments for (gains) losses included in net income		(128	)		7,094

		641			(485	)

Income tax effect		21			20

Net change in other comprehensive income (loss), net of income tax		662			(465	)

Total Comprehensive Income	$	126,422		$	74,706

See notes to consolidated financial statements.

W HOLDING COMPANY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(IN THOUSANDS)


	Nine Months Ended
	September 30,
	2004			2003
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	125,760		$	75,171
Adjustments to reconcile net income to net cash provided by operating activities:
Provision (credit) for:
Loan losses		30,141			20,718
Losses on foreclosed real estate held for sale		554			—
Deferred income tax credit		(4,856	)		(9,591	)
Depreciation and amortization on:
Premises and equipment		5,225			5,377
Foreclosed real estate held for sale		—			244
Mortgage servicing rights		311			546
Stock options granted to employees		754			795
Amortization of premium (discount), net on:
Investment securities available for sale		354			295
Investment securities held to maturity		(1,038	)		(1,558	)
Mortgage-backed securities held to maturity		1,059			4,325
Loans		993			1,130
Amortization of discount on deposits		2,632			1,998
Amortization of net deferred loan origination fees		(7,653	)		(6,253	)
Net loss (gain) on sale and in valuation of:
Investment securities available for sale		(128	)		7,094
Impairment on investment securities held to maturity		—			15,701
Called investment securities held to maturity		(525	)		—
Mortgage loans held for sale		(311	)		(46	)
Derivative instruments		(1,360	)		155
Foreclosed real estate held for sale		(140	)		(48	)
Capitalization of servicing rights		(92	)		—
Originations of mortgage loans held for sale		(20,982	)		(39,647	)
Sales of mortgage loans held for sale		14,734			—
Decrease (increase) in:
Trading securities		7,307			19,771
Accrued interest receivable		(2,875	)		(12,595	)
Other assets		(2,670	)		179
Increase (decrease) in:
Accrued interest on deposits and borrowings		9,517			6,198
Other liabilities		(15,536	)		671

Net cash provided by operating activities		141,175			90,630

CASH FLOWS FROM INVESTING ACTIVITIES:
Net increase in interest-bearing deposits in banks		(14,032	)		(43,943	)
Net decrease (increase) in federal funds sold and resell agreements		19,774			(4,131	)
Resell agreements with original maturities over three months:
Purchases		(250,000	)		—
Collections		200,000			—
Increase in due from brokers		—			(16,583	)
Investment securities available for sale:
Sales		130,066			67,623
Maturities, prepayments and calls		38,203			116,435
Purchases		(125,000	)		(128,585	)
Investment securities held to maturity:
Maturities, prepayments and calls		11,907,321			16,585,184
Purchases		(12,933,209	)		(17,978,326	)
Mortgage-backed securities held to maturity:
Maturities, prepayments and calls		193,884			990,269
Purchases		(50,061	)		(1,399,767	)
Loans:
Purchases		(225,079	)		(258,657	)
Sales		—			69,915
Loans originations and principal collections, net		(836,422	)		(588,960	)
Purchases of derivative options		(4,807	)		(3,332	)
Proceeds from sales of foreclosed real estate held for sale		1,124			518
Additions to premises and equipment		(9,448	)		(11,487	)
Redemptions of Federal Home Loan Bank stock		3,500			3,572
Purchases of Federal Home Loan Bank stock		(20,855	)		—

Net cash used in investing activities		(1,975,041	)		(2,600,255	)

Forward	$	(1,833,866	)	$	(2,509,625	)

				(Continued)

W HOLDING COMPANY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(IN THOUSANDS)


	Nine Months Ended
	September 30,
	2004			2003
Forward	$	(1,833,866	)	$	(2,509,625	)

CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits		836,348			700,221
Net increase (decrease) in federal funds purchased and repurchase agreements		995,411			(156,533	)
Repurchase agreements with original maturities over three months:
Proceeds		2,770,207			2,045,765
Payments		(2,799,928	)		(231,035	)
Payments of mortgage note payable		(274	)		(486	)
Advances from Federal Home Loan Bank:
Proceeds		268,000			199,000
Payments		(203,000	)		(173,000	)
Net increase (decrease) in advances from borrowers for taxes and insurance		336			(70	)
Dividends paid		(37,519	)		(27,387	)
Issuance of preferred stock		—			165,864
Proceeds from stock options exercised		969			—

Net cash provided by financing activities		1,830,550			2,522,339

NET CHANGE IN CASH AND DUE FROM BANKS		(3,316	)		12,714
CASH AND DUE FROM BANKS, BEGINNING OF PERIOD		92,811			76,080

CASH AND DUE FROM BANKS, END OF PERIOD	$	89,495		$	88,794

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest on deposits and borrowings	$	196,923		$	157,413
Income taxes		37,988			10,835
Noncash activities:
Accrued dividends payable		3,080			2,908
Securities purchased but not yet received		5,020			—
Net change in other comprehensive income (loss)		662			(465	)
Mortgage loans securitized and transferred to:
Trading securities		7,399			22,403
Mortgage-backed securities held to maturity		2,305			—
Transfer from held to maturity to available for sale		—			51,671
Transfer from loans to foreclosed real estate held for sale		2,158			2,130
Mortgage loans originated to finance the sale of foreclosed real estate held for sale		258			588
Unpaid additions to premises and equipment		763			11
Transfer from undivided profits to reserve fund		12,652			7,527
Effect in valuation of derivatives and their hedged items:
Increase in other assets		(674	)		(3,178	)
Increase (decrease) in deposits		3,318			(1,673	)
Increase (decrease) in other liabilities		(1,372	)		3,616
Conversion of preferred stock into common stock:
Common stock		343			305
Paid in capital		(193	)		(100	)
Preferred stock		(151	)		(205	)

See notes to consolidated financial statements.
				(Concluded)

W HOLDING COMPANY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

W Holding Company, Inc. (the “Company”) is a financial holding company offering a full range of financial services. The business of the Company is conducted primarily through its wholly owned commercial bank subsidiary, Westernbank Puerto Rico (“Westernbank”). The Company’s other operating subsidiary is Westernbank Insurance Corp. The Company was organized under the laws of the Commonwealth of Puerto Rico in February 1999 to become the bank holding company of Westernbank. Westernbank was founded as a savings institution in 1958 operating in the western and southwestern regions of Puerto Rico, focusing on retail banking and emphasizing long-term fixed-rate residential mortgage loans on one-to-four family residential properties. In 1994, Westernbank changed its charter to become a full-service commercial bank. Westernbank offers a full range of business and consumer financial services, including banking, trust and brokerage services. Westernbank Insurance Corp. is a general insurance agent placing property, casualty, life and disability insurance. The assets, liabilities, revenues and expenses of Westernbank Insurance Corp. at September 30, 2004 and December 31, 2003, and for the three and nine month periods ended September 30, 2004 and 2003 were not significant.

In July 2000, the Company became a financial holding company under the Bank Holding Company Act. As a financial holding company, the Company is permitted to engage in financial related activities, including insurance and securities activities, provided that the Company and its banking subsidiary meet certain regulatory standards.

Westernbank is the second largest commercial bank in Puerto Rico, based on total assets at September 30, 2004. Westernbank operates through 52 full service branch offices located throughout Puerto Rico, primarily in the western and southwestern regions of the island, and a fully functional banking site on the Internet. Westernbank Puerto Rico traditional banking operations include retail operations, such as its branches, including the branches of the Expresso division, together with consumer loans, mortgage loans, commercial loans (excluding the asset-based lending operations), investments (treasury) and deposit products. In addition, Westernbank operates through four divisions: Westernbank International Division, which is an International Banking Entity (IBE) under the Puerto Rico Act No. 52 of August 11, 1989, as amended, known as the International Banking Regulatory Act, which activities consist of commercial and related services, and treasury and investment activities outside of Puerto Rico; Westernbank Business Credit, which specializes in commercial business loans secured principally by accounts receivable, inventory and equipment; Westernbank Trust Division, which offers a full array of trust services; and Expresso of Westernbank, a division which specializes in small, unsecured consumer loans up to $15,000 and real estate collateralized consumer loans up to $150,000 through 19 full-service branches.

Westernbank World Plaza, Inc. (“WWPI”), a wholly owned subsidiary of Westernbank, owns and operates Westernbank World Plaza, a 23-story office building, including its related parking facility, located in Hato Rey, Puerto Rico, the main Puerto Rican business district. WWPI serves as the Company’s San Juan metropolitan area headquarters for Westernbank’s regional commercial lending office and the headquarters for the Westernbank Business Credit and Expresso of Westernbank divisions. Westernbank also owns 100% of the voting shares of SRG Net, Inc., a Puerto Rico corporation that operates an electronic funds transfer network. The assets, liabilities, revenues and expenses of SRG Net, Inc. at September 30, 2004 and December 31, 2003, and for the three and nine month periods ended September 30, 2004 and 2003 were not significant.

The accounting and reporting policies of the Company conform to accounting principles generally accepted in the United States of America (“GAAP”) and banking industry practices (See Note 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – on the Company’s Consolidated Financial Statements as of December 31, 2003 and 2002, and for each of the three years in the period ended December 31, 2003, included in the Company’s Annual Report on Form 10-K). The unaudited Consolidated Financial Statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). In the opinion of management, the unaudited Consolidated Financial Statements include all adjustments (which consist of normal recurring accruals) necessary to present fairly the consolidated financial condition as of September 30, 2004 and December 31, 2003, and the results of operations and cash flows for the three and nine months ended September 30, 2004 and 2003. All significant intercompany balances and transactions have been eliminated in the accompanying unaudited consolidated financial statements. Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to SEC rules and regulations. Management believes that the disclosures made are adequate to make the information presented not misleading. Financial information as of December 31, 2003, has been derived from the audited Consolidated Financial Statements of the Company. The result of operations and cash flows for the three and nine months ended September 30, 2004 and 2003, are not necessarily indicative of the results to be expected for the full year. For further information, refer to the Consolidated Financial Statements and footnotes thereto for the year ended December 31, 2003, included in the Company’s Annual Report on Form 10-K.

Following is a summary of the most recent accounting policies adopted by the Company:

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

occur, or both. Qualifying Special Purpose Entities are exempt from the consolidation requirements. In addition to numerous FASB Staff Positions written to clarify and improve the application of FIN 46, the FASB recently announced a deferral for certain entities, and an amendment to FIN 46 entitled FASB Interpretation No. 46 (revised December 2003), Consolidation of Variable Interest Entities (FIN 46R). FIN 46R must be applied to interests in all entities subject to the interpretation as of the first interim or annual period ending after March 15, 2004. FIN 46R did not have any effect on the Company’s financial position or results of operations.

In March 2004, the Emerging Issues Task Force (“EITF”) reached a consensus on Issue 03-1, Meaning of Other Than Temporary Impairment (Issue 03-1). The Task Force reached a consensus on an other-than-temporary impairment model for debt and equity securities accounted for under SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities and cost method investments. The basic model developed by the Task Force in evaluating whether an investment within the scope of Issue 03-1 is other-than-temporarily impaired is as follows: Step 1: Determine whether an investment is impaired. An investment is considered impaired if its fair value is less than its cost. Step 2: Evaluate whether an impairment is other-than-temporary. For equity securities and debt securities that can contractually be prepaid or otherwise settled in such a way that the investor would not recover substantially all of its cost, an impairment is presumed to be other-than-temporary unless: the investor has the ability and intent to hold the investment for a reasonable period of time sufficient for a forecasted market price recovery of the investment, and evidence indicating that the cost of the investment is recoverable within a reasonable period of time outweighs evidence to the contrary. For other debt securities, an impairment is deemed other-than-temporary if: the investor does not have the ability and intent to hold the investment until a forecasted market price recovery (may mean until maturity), or it is probable that the investor will be unable to collect all amounts due according to the contractual terms of the debt security. Step 3: If the impairment is other-than-temporary, recognize in earnings an impairment loss equal to the difference between the investment cost and its fair value. The fair value of the investment then becomes the new cost basis of the investment and cannot be adjusted for subsequent recoveries in fair value, unless required by other authoritative literature.

On September 30, 2004, the FASB issued FSP EITF Issue 03-01-1, which delayed the effective date for the measurement and recognition guidance of an impairment loss that is other-than-temporary (i.e. steps 2 and 3 of the impairment model) contained in paragraphs 10-20 of EITF 03-1. Application of these paragraphs is deferred pending issuance of proposed FSP EITF Issue 03-1a. This delay does not suspend the requirement to recognize other-than-temporary impairments as required by existing authoritative literature. The guidance in paragraphs 6 to 9 of EITF 03-1 (i.e. step 1 of the impairment model), as well as the disclosure requirements in paragraphs 21 and 22 have not been deferred and should be applied based on the transition provisions in EITF 03-1. Based on the composition of the investment portfolio held at September 30, 2004, EITF 03-1 is not expected to have a material effect on the Company’s financial position or results of operations.

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. The adoption of SAB 105 did not have a material impact on the Company’s financial condition or results of operations.

Reclassifications – Certain reclassifications have been made to prior periods financial statements to conform with current periods presentation.

2. EARNINGS PER SHARE AND CAPITAL TRANSACTIONS

Basic and diluted earnings per common share for the three and nine months ended September 30, 2004 and 2003, were computed by dividing the net income attributable to common stockholders for such periods by the weighted average number of shares of common stock outstanding during the same periods, as follows:


	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2004		2003				2004		2003
	(Dollars in thousands, except share data)
Basic and diluted earnings per common share:
Net income	$	44,243	$	34,638			$	125,760	$	75,171
Less preferred stock dividends		6,733		6,169				20,251		14,769

Income attributable to common stockholders		37,510		28,469				105,509		60,402
Plus convertible preferred stock dividends		297		467				942		—

Income attributable to common stockholders - - diluted	$	37,807	$	28,936			$	106,451	$	60,402

Weighted average number of common shares outstanding during the period		106,795,432		105,035,438	(1	)		106,676,510		104,816,499	(1	)
Dilutive potential common shares — stock options		3,370,329		3,301,440	(1	)		3,393,477		3,266,136	(1	)
Assumed conversion of preferred stock		1,478,477		2,311,854	(1	)		1,478,477		—

Total		111,644,238		110,648,732				111,548,464		108,082,635

Basic earnings per common share	$	0.35	$	0.27	(1	)	$	0.99	$	0.58	(1	)

Diluted earnings per common share	$	0.34	$	0.26	(1	)	$	0.95	$	0.56	(1	)

(1)

Adjusted to reflect the three-for-two stock split in the form of a stock dividend and a 2% stock split on our common stock declared on November 4, 2003 and November 11, 2003, respectively, both distributed on December 10, 2003.

On November 4, 2003, the Company declared a three-for-two split in the form of a stock dividend on its common stock, for stockholders of record as of November 28, 2003, distributed on December 10, 2003. The effect of the stock split was a decrease in retained earnings and an increase in common stock of approximately $34.7 million.

On November 11, 2003, the Company declared a two percent (2%) stock dividend, for stockholders of record as of November 28, 2003, distributed on December 10, 2003. The effect of the stock dividend was a decrease in retained earnings, an increase in paid-in-capital and an increase in common stock of approximately $35.2 million, $33.1 million and $2.1 million, respectively.

On May 30 and June 16, 2003, the Company issued 3,680,000 and 552,000 shares, respectively, of the Company’s Series F Preferred Stock. The Series F Preferred Stock was issued at a price of $25.00 per share. Proceeds from the issuance of the Series F Preferred Stock amounted to $102.2 million, net of $3.6 million of issuance costs.

During the nine month period ended September 30, 2004, 150,292 shares of the Company’s convertible preferred stock series A were converted into 342,521 shares of the Company’s common stock. In addition, the Company issued 214,750 common shares from the exercise of stock options during the nine month period ended September 30, 2004.

3. DIVIDENDS DECLARED PER COMMON SHARE

The Company’s Board of Directors has adopted an ongoing policy that provides for the distribution of dividends to common shareholders on the basis of a percentage of the average earnings for the last two preceding years. The same are paid monthly on the 15th day of each month for stockholders of record as of the last day of the preceding month.

On January 15, 2004, the Company’s Board of Directors approved an increase in its annual dividend payments to stockholders for 2004 to $0.22 per share. This represents an increase of 26.31% over the dividends paid in 2003.

The Company’s cash dividends per share declared for the nine months ended September 30, 2004 and 2003, were as follows:


RECORD DATE	PAYABLE DATE	AMOUNT PER SHARE ⁽¹⁾
2004
January 31, 2004	February 17, 2004	$	0.01833
February 29, 2004	March 15, 2004		0.01833
March 31, 2004	April 15, 2004		0.01833
April 30, 2004	May 17, 2004		0.01833
May 31, 2004	June 15, 2004		0.01833
June 30, 2004	July 15, 2004		0.01833
July 31, 2004	August 16, 2004		0.01833
August 31, 2004	September 15, 2004		0.01833
September 30, 2004	October 15, 2004		0.01833

Total		$	0.16497

2003 ⁽²⁾
January 31, 2003	February 15, 2003	$	0.01198
February 28, 2003	March 15, 2003		0.01471
March 31, 2003	April 15, 2003		0.01471
April 30, 2003	May 15, 2003		0.01471
May 30, 2003	June 13, 2003		0.01471
June 30, 2003	July 15, 2003		0.01471
July 31, 2003	August 15, 2003		0.01471
August 29, 2003	September 15, 2003		0.01471
September 30, 2003	October 15, 2003		0.01471

Total		$	0.12966

⁽¹⁾	Dividend amounts in the table are rounded.

⁽²⁾	Adjusted to reflect the three-for-two stock split in the form of a stock dividend and a 2% stock dividend on our common stock declared on November 4, 2003 and November 11, 2003, respectively, both distributed on December 10, 2003.

4. INVESTMENT SECURITIES

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


			Gross		Gross
	Amortized		Unrealized		Unrealized		Fair
September 30, 2004	Cost		Gains		Losses		Value
			(In thousands)
Available for sale:
Collateralized mortgage obligations (CMO’s) issued or guaranteed by Federal National Mortgage
Association (FNMA)	$	8,557	$	—	$	202	$	8,355
CMO’s issued or guaranteed by Federal Home Loan Mortgage Corporation (FHLMC)		3,940		—		69		3,871

Total	$	12,497	$	—	$	271	$	12,226

Held to maturity:
U.S. Government and agencies obligations	$	5,504,928	$	14,404	$	22,574	$	5,496,758
Puerto Rico Government and agencies obligations		34,822		320		303		34,839
Commercial paper — matures within six days		160,140		—		—		160,140
Corporate notes		51,415		3,035		—		54,450

Subtotal		5,751,305		17,759		22,877		5,746,187

Mortgage-backed securities:
FHLMC certificates		5,869		349		—		6,218
Government National Mortgage Association
(GNMA) certificates		10,505		482		—		10,987
FNMA certificates		3,817		265		—		4,082
CMO’s issued or guaranteed by FHLMC		792,594		14		73,789		718,819
CMO’s issued or guaranteed by FNMA		48,858		1		2,419		46,440
CMO’s other		130		—		—		130

Subtotal		861,773		1,111		76,208		786,676

Total	$	6,613,078	$	18,870	$	99,085	$	6,532,863

The Company’s investment portfolio as of September 30, 2004, consisted principally of U.S. Government and agencies obligations, Puerto Rico Government and agencies obligations, and mortgage-backed securities issued or guaranteed by FHLMC, FNMA or GNMA. There were no investment securities other than those referred to above in unrealized loss position as of September 30, 2004. These unrealized losses relate to interest rate changes. Investment securities with prepayment provisions did not have a significant unamortized premium at September 30, 2004. As management has the ability to hold debt securities until maturity, or for the foreseeable future if classified as available for sale, no declines are deemed to be other-than-temporary.


			Gross		Gross
	Amortized		Unrealized		Unrealized		Fair
December 31, 2003	Cost		Gains		Losses		Value
			(In thousands)
Available for sale:
CMO’s issued or guaranteed by FNMA	$	30,647	$	—	$	699	$	29,948
CMO’s issued or guaranteed by FHLMC		20,345		—		383		19,962
Equity securities — preferred stock		5,000		170		—		5,170

Total	$	55,992	$	170	$	1,082	$	55,080

Held to maturity:
U.S. Government and agencies obligations	$	4,463,493	$	15,632	$	35,811	$	4,443,314
Puerto Rico Government and agencies obligations		34,500		287		292		34,495
Commercial paper		174,976		—		—		174,976
Corporate notes		51,409		3,196		—		54,605

Subtotal		4,724,378		19,115		36,103		4,707,390

Mortgage and asset-backed securities:
FHLMC certificates		7,297		445		—		7,742
GNMA certificates		9,753		475		—		10,228
FNMA certificates		4,542		303		—		4,845
CMO’s issued or guaranteed by FHLMC		885,408		442		67,390		818,460
CMO’s issued or guaranteed by FNMA		84,322		2		2,183		82,141
CMO’s other		168		—		—		168
Asset-backed securities		7,842		—		—		7,842

Subtotal		999,332		1,667		69,573		931,426

Total	$	5,723,710	$	20,782	$	105,676	$	5,638,816

The amortized cost and fair value of investment securities held to maturity at September 30, 2004, by contractual maturity (excluding mortgage and asset-backed securities) are shown below:


	Amortized		Fair
	Cost		Value
	(In thousands)
Due within one year	$	188,140	$	188,242
Due after one year through five years		3,498,882		3,502,486
Due after five years through ten years		2,041,508		2,029,935
Due after ten years		22,775		25,524

Subtotal		5,751,305		5,746,187
Mortgage and asset-backed securities		861,773		786,676

Total	$	6,613,078	$	6,532,863

Proceeds from sales of investment securities available for sale and their respective gross realized gains and losses for the nine months ended September 30, 2004 and 2003, were as follows:


	2004		2003
	(In thousands)
Proceeds from sales	$	130,066	$	67,623
Gross realized gains		128		1,890
Gross realized losses		—		8,984

Gross realized gains and losses for the nine months ended September 30, 2003, are mainly related to the Company’s liquidation of its CBO’s and CLO’s investment portfolio, as explained below.

The Company uses certain methods and assumptions in estimating fair values of financial instruments. (See Note 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – Fair value of Financial Instruments of the Company’s Consolidated Financial Statements as of December 31, 2003 and 2002, and for each of the three years in the period ended December 31, 2003, included in the Company’s Annual Report on Form 10-K).

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

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

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

In applying the foregoing analysis, management concluded that at March 31, 2003, its investments in corporate bond and loan obligations (“CBO’s and CLO’s”) were other-than-temporarily impaired. First, two tranches of a CBO with an amortized cost of $13.0 million were downgraded by two different rating agencies on April 3 and April 15, 2003. Second, the available secondary market prices for those two securities and the remaining portfolio of CBO’s and CLO’s with a carrying value of $56.0 million continued to deteriorate. In line with such decline, management concluded, based on these facts and the secondary market prices, that a $15.7 million other-than-temporary impairment write-down adjustment was warranted. The same was recorded effective for the quarterly period ended March 31, 2003. As of March 31, 2003, there were no defaults within the securities portfolio underlying the CBO’s and CLO’s. In connection with the write-down, and in accordance with applicable accounting pronouncements, management also reassessed its intent to hold to maturity and reclassified the securities related to the CBO that was downgraded as available for sale as of March 31, 2003.

During the quarter ended June 30, 2003, the Company, based upon additional information available from trustees, further ratings downgradings, a default on the scheduled interest payment in one of the CBO tranches and further declines in quoted market prices for such investments, reclassified the remaining portfolio of CBO’s and CLO’s to available for sale and subsequently on June 6, 2003 sold its entire portfolio of CBO’s and CLO’s. The sale of the portfolio, with an original total investment of $62.9 million and adjusted to a fair value of $45.4 million as of March 31, 2003, was completed at an additional net loss of $7.0 million which was recorded during the quarter ended June 30, 2003.

See Note 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES for recent developments on the measurement and recognition guidance on other-than-temporary impairments.

5. LOANS

The loan portfolio consisted of the following:


	September 30,			December 31,
	2004			2003
	(In thousands)
REAL ESTATE LOANS SECURED BY FIRST MORTGAGES:
Commercial real estate	$	2,961,341		$	2,269,380
Conventional:
One-to-four family residences		926,139			873,345
Other properties		1,954			2,233
Construction and land acquisition		298,665			207,593
Insured or guaranteed — Federal Housing
Administration, Veterans Administration, and others		11,509			19,117

Total		4,199,608			3,371,668

Plus (less):
Undisbursed portion of loans in process		(3,749	)		(4,993	)
Premium on loans purchased		768			1,016
Deferred loan fees — net		(11,628	)		(9,615	)

Total		(14,609	)		(13,592	)

Real estate loans — net		4,184,999			3,358,076

OTHER LOANS:
Commercial loans		741,679			526,105
Consumer loans:
Loans on deposits		29,523			30,805
Credit cards		53,326			54,832
Other		788,300			777,573
Plus (less):
Premium on loans purchased		1,573			2,281
Deferred loan fees — net		(5,881	)		(4,946	)

Other loans — net		1,608,520			1,386,650

TOTAL LOANS		5,793,519			4,744,726
ALLOWANCE FOR LOAN LOSSES		(76,588	)		(61,608	)

LOANS — NET	$	5,716,931		$	4,683,118

The total investment in impaired commercial and construction loans at September 30, 2004 and December 31, 2003, was $51,447,000 and $50,305,000, respectively. All impaired commercial and construction loans were measured based on the fair value of collateral at September 30, 2004 and December 31, 2003. Impaired commercial and construction loans amounting to $31,241,000 and $28,217,000 at September 30, 2004 and December 31, 2003, respectively, were covered by a valuation allowance of $8,495,000 and $4,646,000, respectively. Impaired commercial and construction loans amounting to $20,206,000 at September 30, 2004, and $22,088,000 at December 31, 2003, did not require a valuation allowance in accordance with SFAS No. 114, Accounting by Creditors for Impairment of a Loan. The average investment in impaired commercial and construction loans for the nine-month periods ended September 30, 2004 and 2003, amounted to $49,177,000 and $45,888,000, respectively. The Company’s policy is to recognize interest income related to impaired loans on a cash basis, when these are over 90 days in arrears on payments of principal or interest. Interest on impaired commercial and construction loans collected and recognized as income for the nine-month periods ended September 30, 2004 and 2003, amounted to $1,936,000 and $2,044,000, respectively.

6. PLEDGED ASSETS

At September 30, 2004, residential mortgage loans, investment securities (held to maturity and available for sale) and money market instruments amounting to $668,184,000; $6,070,644,000; and $5,149,000, respectively, were pledged to secure public funds, individual retirement accounts, repurchase agreements, commercial letters of credit, advances and borrowings from the Federal Home Loan Bank and the Federal Reserve Bank of New York, interest rate swap agreements, and the Puerto Rico Treasury Department (for Westernbank International Division). Pledged investment securities amounting to $5,988,087,000 at September 30, 2004, can be repledged.

7. DEPOSITS

Deposits consisted of the following:


	September 30,		December 31,
	2004		2003
	(In thousands)
Noninterest bearing accounts	$	240,841	$	192,760
Passbook accounts		827,872		692,190
NOW accounts		238,594		218,616
Super NOW accounts		32,053		27,723
Money market accounts		100		198
Certificates of deposit		4,862,160		4,230,477

Total		6,201,620		5,361,964
Accrued interest payable		31,005		23,512

Total	$	6,232,625	$	5,385,476

8. INCOME TAXES

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

Westernbank World Plaza, Inc., a wholly owned subsidiary of Westernbank, elected to be treated as a special partnership under the Code; accordingly, its taxable income is taxed by Westernbank.

The Code provides a dividend received deduction of 100%, on dividends received from wholly owned subsidiaries subject to income taxation in Puerto Rico. The income on certain investments is exempt for income tax purposes. Also, Westernbank International division operates as an International Banking Entity (IBE) under the International Banking Regulatory Act. Under Puerto Rico tax law, an IBE can hold non-Puerto Rico assets, and earn interest on these assets, as well as generate fee income outside of Puerto Rico on a tax-exempt basis under certain circumstances. As a result of the above, the Company’s effective tax rate is substantially below the statutory rate.

Pursuant to the provisions of Act No. 13 of January 8, 2004, for taxable years commencing after June 30, 2003, the net income earned by an IBE that operates as a unit of a bank under the Puerto Rico Banking Law, will be considered taxable and subject to income taxes at the current tax rates in the amount by which the IBE taxable income exceeds 40% in the first applicable taxable year (2004), 30% in the second year (2005) and 20% thereafter, of the taxable income of Westernbank, including its IBE taxable income. Westernbank’s IBE carries on its books a significant amount of securities which are tax exempt by law. Moreover, the Act provides that IBE’s operating as subsidiaries will continue to be exempt from the payment of income taxes. At September 30, 2004, management estimated that the provisions of the Act did not have a significant effect on the Company’s result of operations.

A reconciliation of the provision for income taxes computed by applying the Puerto Rico income tax statutory rate to the tax provision as reported for the three and nine month periods ended September 30, 2004 and 2003, is as follows:


	Three Months						Nine Months
	2004			2003			2004			2003
	(Dollars in thousands)
Computed at Puerto Rico statutory rate	$	19,395		$	15,530		$	54,898		$	33,513
Effect on provision of:
Exempt interest income, net		(15,808	)		(9,958	)		(39,613	)		(24,505	)
Net nondeductible expenses		86			56			124			158
Other		1,816			(445	)		(404	)		1,594

Provision for income taxes as reported	$	5,489		$	5,183		$	15,005		$	10,760

Statutory tax rate		39	%		39	%		39	%		39	%

Effective tax rate		11	%		13	%		11	%		13	%

Deferred income tax assets (liabilities) consisted of the following:


	September 30,			December 31,
	2004			2003
	(In thousands)
Allowance for loan losses	$	28,741		$	22,899
Unrealized gain in valuation of derivative instruments		(1,200	)		(746	)
Mortgage servicing rights		(1,015	)		(1,100	)
Allowance for foreclosed real estate held for sale		38			4
Capital losses on sales of investment securities		4,963			5,699
Other temporary differences		12			(128	)

Total		31,539			26,628
Less valuation allowance		1,752			1,718

Deferred income tax assets, net	$	29,787		$	24,910

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

9. FINANCIAL INSTRUMENTS

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

Commitments to Extend Credit and Commercial Letters of Credit

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

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary upon extension of credit, is based on management’s credit evaluation of the counterparty. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, and income producing commercial properties.

Commercial letters of credit are conditional commitments issued by the Company on behalf of a customer authorizing a third party to draw drafts on the Company up to a stipulated amount and with specified terms and conditions.

The contract amount of financial instruments, whose amounts represent credit risk at September 30, 2004 and December 31, 2003, was as follows:


	2004		2003
	(In thousands)
Commitments to extend credit:
Fixed rates	$	12,465	$	11,541
Variable rates		532,402		243,825
Unused lines of credit:
Commercial		114,606		80,008
Credit cards and other		137,751		94,259
Commercial letters of credit		36,854		12,287
Commitments to purchase mortgage loans		25,000		200,000

Total	$	859,078	$	641,920

Such commitments will be funded in the normal course of business from the Company’s principal sources of funds. At September 30, 2004, the Company had $2.75 billion in deposits that mature during the following twelve months. The Company anticipates retaining such deposits. The Company also has on-going commitments to repay borrowings, fund maturing certificates of deposit and meet obligations under long-term operating leases for certain branches. No material changes are anticipated in regards to such commitments.

Derivative financial instruments - The Company maintains an overall interest rate risk management strategy that may incorporate the use of derivative instruments to reduce unplanned fluctuations in earnings and cash flows caused by interest rate volatility. The Company’s interest rate risk management strategy may also involve modifying the re-pricing characteristics of certain liabilities so that changes in interest rates do not adversely affect the net interest margin and cash flows. Derivative instruments that the Company may use as part of its interest rate risk management strategy include interest rate swaps and options. These transactions involve both credit and market risk. The notional amounts are amounts on which calculations, payments and the value of the derivative are based. Notional amounts do not represent direct credit exposures. Direct credit exposure is limited to the net difference between the calculated amounts to be received and paid, if any. Such difference, which represents the fair value of the derivative, is reflected on the Company’s statements of financial condition as derivative assets and derivative liabilities.

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

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

The Company enters into interest-rate swap contracts in managing its interest rate exposure. Interest-rate swap contracts generally involve the exchange of fixed and floating-rate interest payment obligations without the exchange of the underlying principal amounts. Entering into interest-rate swap contracts involves not only the risk of dealing with counterparties and their ability to meet the terms of the contracts, but also the interest rate risk associated with unmatched positions. Interest rate swaps are the most common type of derivative contracts that the Company utilizes. The Company currently utilizes interest rate swaps to convert its fixed-rate certificates of deposit (liabilities) to a variable rate, and to convert certain equity linked deposits to a fixed rate. By entering into the swap, the principal amount of the hedged item would remain unchanged but the interest payment streams would change.

Interest-rate swap contracts used to convert the Company’s fixed-rate certificates of deposit (liabilities) to a variable rate mature between one to twenty years with a right by the counterparty to call them after the first anniversary. The Company has an identical right to call the certificates of deposit.

In addition, the Company offers its customers certificates of deposit which contain an embedded derivative tied to the performance of the Standard & Poor’s 500 Composite Stock Index that is bifurcated from the host deposit and recognized in the consolidated statements of financial condition in accordance with SFAS No. 133. At the end of five years, the depositor will receive a specified percent of the average increase of the month-end value of the stock index. If such index decreases, the depositor receives the principal without any interest. The Company uses option and interest rate swap agreements with major broker dealer companies to manage its exposure to the stock market. Under the option agreements, the Company will receive the average increase in the month-end value of the index in exchange for the payment of a premium when the contract is initiated. Under the terms of the swap agreements, the Company also will receive the average increase in the month-end value of the index in exchange for a quarterly fixed interest cost. Since the embedded derivative instrument on the certificates of deposit and the option and interest rate swap agreements do not qualify for hedge accounting, these derivative instruments are marked to market through earnings.

Interest rate options are contracts that transfer, modify, or reduce interest rate risk in exchange for the payment of a premium when the contract is initiated. The Company pays a premium for the right to receive the average increase of the month end value of the stock index. The credit risk inherent in options is the risk that the exchange party may default.

Information pertaining to the notional amounts of the Company’s derivative financial instruments as of September 30, 2004 and December 31, 2003, was as follows:


	Notional Amount
Type of Contract	2004		2003
	(In thousands)
Hedging activities:
Fair value hedge:
Interest rate swaps used to hedge fixed rate certificates of deposit	$	832,793	$	636,818

Derivatives not designated as hedge:
Interest rate swaps (unmatched portion)	$	9,207	$	3,182
Interest rate swaps used to manage exposure to the stock market		36,329		36,329
Embedded options on stock indexed deposits		112,195		85,811
Purchased options used to manage exposure to the stock market on stock indexed deposits		77,750		50,343

Total	$	235,481	$	175,665

At September 30, 2004, the fair value of derivatives qualifying for fair value hedge represented an unrealized net loss of $10.5 million, which was recorded as “Other Liabilities”, before right to offset effect, and as a decrease to the hedged “Deposits” of $10.3 million and as an increase in “Other Assets” of $194,000 in the accompanying consolidated statements of financial condition. At December 31, 2003, the fair value of derivatives qualifying for fair value hedge represented an unrealized net loss of $12.2 million, which was recorded as “Other Liabilities”, before right to offset effect, and as a decrease to the hedged “Deposits” in the accompanying consolidated statements of financial condition. An offsetting effect of $2.6 million and $2.8 million was recorded at September 30, 2004 and at December 31, 2003, respectively, as a decrease in “Other Assets” and “Other Liabilities” in the accompanying consolidated statements of financial condition.

At September 30, 2004, the fair value of derivatives not qualifying as a hedge represented an unrealized net loss of $3.1 million and was recorded as part of “Other Assets” of $7.8 million, as part of “Deposits” of $10.8 million and as part of “Other Liabilities” of $183,000, in the accompanying September 30, 2004, consolidated statement of financial condition.

At December 31, 2003, the fair value of derivatives not qualifying as a hedge represented an unrealized net loss of $4.5 million and was recorded as part of “Other Assets” $2.8 million, as part of “Deposits” $7.2 million and as part of “Other Liabilities” $99,000, in the accompanying December 31, 2003, consolidated statement of financial condition.

A summary of the types of swaps used, excluding those used to manage exposure to the stock market, and their terms at September 30, 2004 and December 31, 2003, follows:


	2004			2003
	(In thousands)
Pay floating/receive fixed:
Notional amount	$	842,000		$	640,000
Weighted average receive rate at period end		4.21	%		4.85	%
Weighted average pay rate at period end		1.81	%		1.28	%
Floating rate as a percentage of three month LIBOR, plus a spread ranging from minus .45% to plus .36%		100	%		100	%

The changes in notional amount of swaps during the nine months ended September 30, 2004, follows:


	(In thousands)
Balance at December 31, 2003	$	676,329
New swaps		320,500
Called and matured swaps		(118,500	)

Balance at September 30, 2004	$	878,329

During the nine months ended September 30, 2004, various counterparties of swap agreements exercised their option to cancel their swaps, and consequently, the Company immediately exercised its option to call the hedged certificates of deposit. No gains or losses resulted from the above cancellations.

At September 30, 2004, the maturities of interest rate swaps, embedded options and purchased options by year were as follows:


Year Ending			Embedded		Purchased
December 31,	Swaps		Options		Options
	(In thousands)
2004	$	—	$	—	$	—
2005		165,000		—		—
2006		61,329		37,060		1,623
2007		7,500		26,664		27,150
2008		—		21,184		21,571
Thereafter		644,500		27,287		27,406

Total	$	878,329	$	112,195	$	77,750

10. STOCK OPTION PLANS

The Company has two stock option plans, the 1999 Qualified Stock Option Plan (the “1999 Qualified Option Plan”) and the 1999 Nonqualified Stock Option Plan (the “1999 Nonqualified Option Plan”), for the benefit of employees of the Company and its subsidiaries. These plans offer to key officers, directors and employees an opportunity to purchase shares of the Company’s common stock. Under the 1999 Qualified Option Plan, options for up to 9,639,000 shares (as adjusted for stock splits and stock dividend) of common stock can be granted. Also, options for up to 9,639,000 shares (as adjusted) of common stock, reduced by any share issued under the 1999 Qualified Option Plan, can be granted under the 1999 Nonqualified Option Plan. The option price for both plans is determined at the grant date. Both plans will remain in effect for a term of 10 years. The Board of Directors has sole authority and absolute discretion as to the number of stock options to be granted, their vesting rights, and the options’ exercise price. The Plans provide for a proportionate adjustment in the exercise price and the number of shares that can be purchased in the event of a stock split, reclassification of stock and a merger or reorganization. At September 30, 2004, the Company only had outstanding 4,648,000 options (as adjusted) under the 1999 Qualified Option Plan. These options were granted to various executive officers and employees, which become fully exercisable after five years following the grant date. No options were granted during the nine month periods ended September 30, 2004 and 2003. During the nine month period ended September 30, 2004, three of the Company’s executive officers exercised 215,000 options under the Company’s 1999 Qualified Option Plan at an exercise price of $4.36 (169,000 options) and $5.12 (46,000 options), respectively. During the nine month period ended September 30, 2003, no options were exercised. No options were forfeited during the nine month periods ended September 30, 2004 and 2003.

The Company has only three exercise prices for options granted, all of them granted at three different dates. The following table summarizes the exercise prices and the weighted average remaining contractual life of the options outstanding at September 30, 2004:


	Outstanding				Exercisable
			Weighted
			Average
			Remaining
	Number of		Contract Life		Number of
Exercise Price (1)	Options (1)		(Years)		Options (1)
$ 4.36		4,334,000		5.37		3,004,000
5.12		126,000		6.63		76,000
10.36		188,000		7.81		75,000

Total		4,648,000				3,155,000

(1)

As adjusted for stock splits and stock dividend.

Effective January 1, 2003, the Company changed the method of accounting for employee stock options from the intrinsic value method to the fair value method. Under the modified prospective method selected by the Company under the provisions of SFAS No. 148, compensation cost to be recognized in future years is the same that would have been recognized if the recognition provisions of FASB No. 123 had been applied from its original effective date. Results prior to 2003 were not restated. Compensation expense of stock options granted to employees for the three month periods ended September 30, 2004 and 2003, was a charge of $225,000 and $265,000, respectively, and for the nine month periods ended September 30, 2004 and 2003, was a charge of $752,000 and $795,000, respectively.

11. SEGMENT INFORMATION

The Company’s management monitors and manages the financial performance of two reportable business segments, the traditional banking operations of Westernbank Puerto Rico and the activities of the division known as Westernbank International. Other operations of the Company not reportable in either segment include Westernbank Business Credit Division, which specializes in asset-based commercial business lending; Westernbank Trust Division, which offers trust services; SRG Net, Inc., which operates an electronic funds transfer network; Westernbank Insurance Corp., which operates a general insurance agency; Westernbank World Plaza, Inc., which operates the Westernbank World Plaza, a 23-story office building located in Hato Rey, Puerto Rico; and the transactions of the parent company only, which mainly consist of other income related to the equity in the net income of its two wholly owned subsidiaries.

Management determined the reportable segments based on the internal reporting used to evaluate performance and to assess where to allocate resources. Other factors such as the Company’s organizational structure by divisions, nature of the products, distribution channels, and the economic characteristics of the products were also considered in the determination of the reportable segments. The Company evaluates performance based on net interest income and other income. Operating expenses and the provision for income taxes are analyzed on a combined basis.

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

Westernbank International operates as an IBE under the International Banking Regulatory Act. Westernbank International’s business activities consist of commercial banking and related services, and treasury and investment activities outside of Puerto Rico. As of September 30, 2004 and December 31, 2003, and for the periods then ended, substantially all of Westernbank International’s business activities consisted of investment in securities and loans. Loans outstanding at September 30, 2004 and December 31, 2003, amounted to $111,813,000 and $73,581,000, respectively.


	As of and for the nine months ended
	September 30, 2004
						Total major			Other
	Puerto Rico			International		segments			segments			Eliminations			Total
	(In thousands)
Interest income:
Consumer loans	$	56,245		$	—	$	56,245		$	—		$	—		$	56,245
Commercial loans		107,082			3,567		110,649			—			—			110,649
Asset-based loans		—			—		—			30,348			—			30,348
Mortgage loans		35,467			—		35,467			—			—			35,467
Treasury and investment activities		119,036			75,046		194,082			1,700			(1,523	)		194,259

Total interest income		317,830			78,613		396,443			32,048			(1,523	)		426,968
Interest expense		158,464			35,556		194,020			11,656			(1,523	)		204,153

Net interest income		159,366			43,057		202,423			20,392			—			222,815

Provision for loan losses		(23,993	)		—		(23,993	)		(6,148	)		—			(30,141	)

Other income, net:
Service charges on deposit accounts		5,974			—		5,974			—			—			5,974
Other fees and commissions		11,072			78		11,150			170			(170	)		11,150
Trust account fees		—			—		—			711			—			711
Insurance commission fees		—			—		—			1,483			(7	)		1,476
Asset-based lending related fees		—			—		—			2,096			—			2,096
Other		879			—		879			—			—			879

Total other income		17,925			78		18,003			4,460			(177	)		22,286

Equity in income (loss) of subsidiaries		(426	)		—		(426	)		127,297			(126,871	)		—

Total net interest income and other income	$	152,872		$	43,135	$	196,007		$	146,001		$	(127,048	)	$	214,960

Total assets as of September 30, 2004	$	11,355,825		$	2,664,336	$	14,020,161		$	1,385,535		$	(1,926,838	)	$	13,478,858


	Three months ended
	September 30, 2004
						Total major			Other
	Puerto Rico			International		segments			segments			Eliminations			Total
	(In thousands)
Interest income:
Consumer loans	$	18,497		$	—	$	18,497		$	—		$	—		$	18,497
Commercial loans		39,854			1,287		41,141			—			—			41,141
Asset-based loans		—			—		—			10,992			—			10,992
Mortgage loans		12,014			—		12,014			—			—			12,014
Treasury and investment activities		43,897			24,945		68,842			601			(542	)		68,901

Total interest income		114,262			26,232		140,494			11,593			(542	)		151,545
Interest expense		58,223			12,646		70,869			4,172			(542	)		74,499

Net interest income		56,039			13,586		69,625			7,421			—			77,046

Provision for loan losses		(8,009	)		—		(8,009	)		(2,370	)		—			(10,379	)

Other income (loss), net:
Service charges on deposit accounts		2,054			—		2,054			—			—			2,054
Other fees and commissions		3,785			33		3,818			57			(57	)		3,818
Trust account fees		—			—		—			240			—			240
Insurance commission fees		—			—		—			692			(3	)		689
Asset-based lending related fees		—			—		—			730			—			730
Other		842			—		842			—			—			842

Total other income		6,681			33		6,714			1,719			(60	)		8,373

Equity in income (loss) of subsidiaries		(76	)		—		(76	)		44,723			(44,647	)		—

Total net interest income and other income	$	54,635		$	13,619	$	68,254		$	51,493		$	(44,707	)	$	75,040


	As of and for the nine months ended
	September 30, 2003
						Total major			Other
	Puerto Rico			International		segments			segments			Eliminations			Total
	(In thousands)
Interest income:
Consumer loans	$	55,381		$	—	$	55,381		$	—		$	—		$	55,381
Commercial loans		86,057			3,245		89,302			—			—			89,302
Asset-based loans		—			—					23,725			—			23,725
Mortgage loans		34,815			—		34,815			—			—			34,815
Treasury and investment activities		62,154			64,286		126,440			1,865			(1,237	)		127,068

Total interest income		238,407			67,531		305,938			25,590			(1,237	)		330,291
Interest expense		124,288			31,892		156,180			7,321			(1,237	)		162,264

Net interest income		114,119			35,639		149,758			18,269			—			168,027

Provision for loan losses		(17,979	)		—		(17,979	)		(2,739	)		—			(20,718	)

Other income (loss), net:
Service charges on deposit accounts		5,284			—		5,284			—			—			5,284
Other fees and commissions		10,477			402		10,879			165			(165	)		10,879
Trust account fees		—			—		—			590			—			590
Insurance commission fees		—			—		—			1,609			—			1,609
Asset-based lending related fees		—			—		—			2,235			—			2,235
Other		(21,138	)		—		(21,138	)		—			—			(21,138	)

Total other income (loss), net		(5,377	)		402		(4,975	)		4,599			(165	)		(541	)

Equity in income of subsidiaries		610			—		610			76,167			(76,777	)		—

Total net interest income and other income (loss), net	$	91,373		$	36,041	$	127,414		$	96,296		$	(76,942	)	$	146,768

Total assets as of September 30, 2003	$	8,501,963		$	2,797,569	$	11,299,532		$	1,185,161		$	(1,671,630	)	$	10,813,063


	Three months ended
	September 30, 2003
						Total major			Other
	Puerto Rico			International		segments			segments			Eliminations			Total
	(In thousands)
Interest income:
Consumer loans	$	18,858		$	—	$	18,858		$	—		$	—		$	18,858
Commercial loans		30,877			1,359		32,236			—			—			32,236
Asset-based loans		—			—		—			9,311			—			9,311
Mortgage loans		11,164			—		11,164			—			—			11,164
Treasury and investment activities		21,270			23,417		44,687			627			(448	)		44,866

Total interest income		82,169			24,776		106,945			9,938			(448	)		116,435
Interest expense		40,713			11,289		52,002			2,768			(448	)		54,322

Net interest income		41,456			13,487		54,943			7,170			—			62,113

Provision for loan losses		(7,264	)		—		(7,264	)		(629	)		—			(7,893	)

Other income (loss), net:
Service charges on deposit accounts		1,792			—		1,792			—			—			1,792
Other fees and commissions		3,801			307		4,108			55			(55	)		4,108
Trust account fees		—			—		—			252			—			252
Insurance commission fees		—			—		—			722			—			722
Asset-based lending related fees		—			—		—			632			—			632
Other		(33	)		—		(33	)		—			—			(33	)

Total other income, net		5,560			307		5,867			1,661			(55	)		7,473

Equity in income of subsidiaries		(110	)		—		(110	)		35,040			(34,930	)		—

Total net interest income and other income (loss), net	$	39,642		$	13,794	$	53,436		$	43,242		$	(34,985	)	$	61,693

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Part I — Item 2

FORWARD LOOKING STATEMENTS

Certain statements in this filing and future filings by the Company, especially within Management’s Discussion and Analysis of Financial Condition and Results of Operations, will include forward-looking statements within the meaning of the Securities Exchange Act of 1934, as amended. In general, the word or phrases “will likely result”, “are expected to”, “will continue”, “is anticipated”, “estimate”, “project”, “believe” or similar expressions are intended to identify “forward-looking statements”. In addition, certain disclosures and information customarily provided by financial institutions, such as analysis of the adequacy of the allowance for loan losses or an analysis of the interest rate sensitivity of the Company’s assets and liabilities, are inherently based upon predictions of future events and circumstances. Although the Company makes such statements based on assumptions which it believes to be reasonable, there can be no assurance that actual results will not differ materially from the Company’s expectations. Some of the important factors which could cause its results to differ from any results which might be projected, forecasted or estimated, based on such forward-looking statements include:

• general economic and competitive conditions in the markets in which the Company operates, and the risks inherent in its operations;

• the Company’s ability to manage its credit risk and control its operating expense, increase earning assets and non-interest income, and maintain its net interest margin; and

• the level of demand for new and existing products. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those described in the forward-looking statements. Except as required by applicable law, the Company does not intend, and specifically disclaims any obligation, to update forward-looking statements.

Various factors, including those described above, could affect the Company’s financial performance and could cause the Company’s actual results or circumstances for future periods to differ materially from those anticipated or projected.

Unless required by law, the Company does not undertake, and specifically disclaims any obligations to publicly release the result of any revisions that may be made to any forward-looking statements to reflect statements to the occurrence of anticipated or unanticipated events or circumstances after the date of such statements.

GENERAL

Westernbank offers a full range of business and consumer financial services, including banking, trust and brokerage services. Westernbank Insurance Corp. is a general insurance agent placing property, casualty, life and disability insurance. The assets, liabilities, revenues and expenses of Westernbank Insurance Corp. at September 30, 2004 and December 31, 2003, and for the three and nine month periods ended September 30, 2004 and 2003, were not significant.

At September 30, 2004, the Company had total assets of $13.48 billion, a loan portfolio-net of $5.72 billion, an investment portfolio, excluding short-term money market instruments, of $6.63 billion, deposits of $6.23 billion, borrowings of $6.26 billion and stockholders’ equity of $918.8 million.

Westernbank is the second largest commercial bank in Puerto Rico, based on total assets at September 30, 2004. Westernbank operates through 52 bank branches, including 19 Expresso of Westernbank branches, located throughout Puerto Rico, primarily in the western and southwestern regions of the island, and a website on the Internet. Westernbank operates through four divisions: Westernbank International Division, which is an International Banking Entity (IBE) under the Puerto Rico Act No. 52 of August 11, 1989, as amended, known as the International Banking Regulatory Act, which activities consist of commercial and related services, and treasury and investment activities outside of Puerto Rico; Westernbank Business Credit, which specializes in commercial business loans secured principally by accounts receivable, inventory and equipment; Westernbank Trust Division, which offers a full array of trust services; and Expresso of Westernbank, a division which specializes in small, unsecured consumer loans up to $15,000 and real estate collateralized consumer loans up to $150,000. Westernbank owns 100% of the voting shares of Westernbank World Plaza, Inc. (“WWPI”), which owns and operates Westernbank World Plaza; a 23-story office building, including its related parking facility, located in Hato Rey, Puerto Rico, the main Puerto Rican business district. Westernbank also owns 100% of the voting shares of SRG Net, Inc., a Puerto Rico corporation that operates an electronic funds transfer network. The assets, liabilities, revenues and expenses of SRG Net, Inc. at September 30, 2004 and December 31, 2003, and for the three and nine month periods ended September 30, 2004 and 2003, were not significant.

Westernbank seeks to differentiate itself from other banks by focusing on customer relationships and personalized service, offering customers direct access to senior management. As part of this strategy, Westernbank strives to make fast and effective decisions locally. Westernbank’s branches offer modern facilities with advanced technology and remain open to customers for longer hours compared to many other local banks, with a number of branches offering both Saturday and Sunday hours. In addition, Westernbank trains its employees to promote an effective and customer-focused sales culture.

The Company continues to emphasize on growing Westernbank’s commercial loan portfolio through commercial real estate, asset-based, unsecured business and construction lending, as well as its consumer loan and investment securities portfolios. As a result, the Company has shifted its asset composition from primarily traditional long-term fixed-rate residential mortgage loans to assets with shorter maturities and greater repricing flexibility. As of September 30, 2004, commercial loans were $3.69 billion or 64.60% (79.92% collateralized by real estate) and consumer loans were $867.0 million or 15.17% (62.51% collateralized by real estate) of the $5.72 billion loan portfolio-net. Investment securities, excluding short-term money market instruments, totaled $6.63 billion at September 30, 2004. These loans and securities tend to have shorter maturities and reprice faster than traditional residential mortgage loans. The Company also continues to diversify and grow Westernbank’s sources of revenue, while maintaining its status as a secured lender, with approximately 82% of its loans collateralized by real estate as of September 30, 2004.

The Company is focused on the expansion of Westernbank in the San Juan metropolitan area. We have opened 12 branches in the San Juan metropolitan area since 1998, including seven Expresso of Westernbank branches in July 2002. In the first quarter of 2002, Westernbank acquired Westernbank World Plaza; a 23-story office building that is the tallest in Puerto Rico’s main business district and now serves as the Company’s San Juan metropolitan area headquarters, our regional commercial lending office and the headquarters for the Westernbank Business Credit and Expresso of Westernbank divisions. In addition, the Company continues to build upon its existing platform and further expand its fee-based businesses, including insurance brokerage, trust services and securities brokerage. On October 22, 2004, Westernbank opened its most advanced banking branch in the historic city of Old San Juan, Puerto Rico.

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

The Company’s financial performance is reported in two primary business segments, the traditional banking operations of Westernbank Puerto Rico and the activities of Westernbank’s division known as Westernbank International. Other operations of the Company, not reportable in either segment, include Westernbank Business Credit Division; Westernbank Trust Division; SRG Net, Inc.; Westernbank Insurance Corp.; Westernbank World Plaza, Inc.; and the transactions of the parent company only, which mainly consist of other income related to the equity in the net income of its two wholly owned subsidiaries.

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

Established in 2001, Westernbank Insurance Corp. is a general insurance agent placing property, casualty, life and disability insurance on which it earns commission income. Currently, most of the agency’s volume is derived from two areas — mortgage insurance on residential mortgage loans and credit life insurance for borrowers of personal loans.

The Company and its wholly owned subsidiaries’ executive offices are located at 19 West McKinley Street, Mayagüez, Puerto Rico 00681, and the telephone number is (787) 834-8000. The Company also maintains a website, which can be accessed at http://www.wholding.com.

OVERVIEW

This financial discussion contains an analysis of the consolidated financial position and financial performance of W Holding Company, Inc. and its wholly owned subsidiaries, Westernbank Puerto Rico and Westernbank Insurance Corp.

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

The main objective of the Company’s Asset and Liability Management program is to invest funds judiciously and reduce interest rate risks while optimizing net income and maintaining adequate liquidity levels. As further discussed in Item 3: “Quantitative and Qualitative Disclosures About Market Risk”, the Company uses several tools to manage the risks associated with the composition and repricing of assets and liabilities. Therefore, management has followed a conservative practice geared towards the preservation of capital with adequate returns. The Company’s Investment Committee, which includes members of the Board of Directors and senior management, is responsible for the asset-liability oversight. The Investment Department is responsible for implementing the policies established by the Investment Committee.

The policies established and practices followed are intended to retain depositors’ confidence, obtain a favorable match between the maturity of its interest-earning assets and its interest-bearing liabilities, and enhance the stockholders’ investment in the Company.

The Company’s asset growth during the three and nine month periods ended September 30, 2004, was mainly driven by increases in the loan and investment portfolios, primarily in the commercial real estate and other commercial loan portfolios, and in the investment securities held to maturity portfolio, primarily in tax-exempt securities guaranteed by the United States Government. Also, the Company has continued effective management of interest rate risk and a tight control of operating expenses. The efficiency ratio for the three and nine month periods ended September 30, 2004, was 29.92% and 30.38%, respectively. Net income for the three and nine months ended September 30, 2004, increased to $44.2 million or $0.35 earnings per basic common share $0.34 on a diluted basis) and to $125.8 million or $0.99 earnings per basic

common share ($0.95 on a diluted basis), respectively, up 27.73% and 67.30% when compared to $34.6 million or $0.27 earnings per basic common share ($0.26 on a diluted basis) (as adjusted) and $75.2 million or $0.58 earnings per basic common share ($0.56 on a diluted basis) (as adjusted), for the three and nine months ended September 30, 2003, respectively. The increase of $9.6 million in net income for the three month period ended September 30, 2004, when compared to the respective period in 2003, was mainly due to an increase of $14.9 million or 24.04% in the net interest income. The increase of $50.6 million in net income for the nine month period ended September 30, 2004, was mainly due to an increase of $54.8 million or 32.61% in the net interest income and the net loss of $22.7 million ($17.0 million net of tax) resulting from the valuation and disposition of the Company’s investment in CBO’s and CLO’s during the nine month period ended September 30, 2003 (See Note 4 – Investment Securities – Notes to consolidated financial statements (unaudited)). Excluding this $22.7 million net loss ($17.0 million net of tax) for a more meaningful comparison against the nine months ended September 30, 2004, net income for the same period in 2003 would have been $92.2 million, which when compared to the net income of $125.8 million for the nine months ended September 30, 2004, represents an increase of $33.6 million or 36.44% over the adjusted comparable period of 2003.

The increase in net interest income was the result of higher average balances in interest-earning assets, partially offset by higher average balances in interest-bearing liabilities and a reduction in our net interest margin. The increase in net interest income was partially offset by increases in the provision for loan losses and in operating expenses. Net income attributable to common stockholders for the three and nine month periods ended September 30, 2004, increased to $37.5 million and $105.5 million, respectively, up 31.76% and 74.68% when compared to $28.5 million and $60.4 million for the same periods in 2003. The Company’s profitability ratios for the three and nine month periods ended September 30, 2004, represented returns on assets (ROA) of 1.33% and 1.34%, respectively, and returns on common stockholders’ equity (ROCE) of 28.81% and 28.67%, respectively, compared with a ROA of 1.36% and 1.05% and a ROCE of 28.69% and 20.95% for the same periods in 2003. The ratios for the comparable nine month period ended September 30, 2003, were affected by the Company’s net loss on its CBO’s and CLO’s investment portfolio, as previously discussed.

Different components that impacted the Company’s performance are discussed in more detail in the following pages.

RESULTS OF OPERATIONS

Net Interest Income

Net interest income represents the main source of earnings of the Company. As further discussed in the Item 3: “Quantitative and Qualitative Disclosures of Market Risk”, the Company uses several tools to manage the risks associated with the composition and repricing of assets and liabilities.

Net interest income increased $14.9 million or 24.04% for the three months ended September 30, 2004, and $54.8 million or 32.61% for the nine months ended September 30, 2004, when compared to the corresponding 2003 periods. The increase for the three and nine months ended September 30, 2004, was the result of increases in the average balance of interest-earning assets although at lower yields than the comparable prior year periods, partially offset by increases in the average balance of interest-bearing liabilities.

Average interest-earning assets increased from $9.48 billion for the three months ended September 30, 2003, to $12.75 billion for the three months ended September 30, 2004, an increase of $3.26 billion or 34.42%. For the nine-month period, average interest-earning assets increased from $8.86 billion in 2003, to $12.09 billion in 2004, an increase of $3.22 billion or 36.33%. The increase in average interest-earning assets is mainly related to a rise in the average loan portfolio, the higher yielding category of interest-earning assets of $1.18 billion and $1.09 billion for the three and nine month periods ended September 30, 2004, respectively, due primarily to an increase in the commercial real estate loan and other commercial loan portfolios, and the increases of $2.08 billion and $2.13 billion, respectively, in the average investment portfolio, mainly in tax-exempt securities, such as U.S. Government and agencies obligations. Average yields on interest-earning assets decreased from 4.87% and 4.98% for the three and nine months ended September 30, 2003, respectively, to 4.73% and 4.72% for the same periods in 2004. The decrease in the average yield was mainly due to a lower average yield earned on the loans portfolio, primarily due to a higher volume of commercial real estate loans and other commercial loans with floating rates. The decrease in the average yield earned on the loans portfolio was partially offset by higher reinvestment rates on matured and called securities. Reinvestment rates for new securities were higher, when compared to the prior year periods, as the U.S. Treasury yield curve initially steepened ahead of the reaction by the Federal Reserve who started to increase interest rates in the second week of August 2004. As a result of this lagging factor, yields earned on floating rate loans were not adjusted as fast as on investment securities since the Prime Rate (an index used by the Bank to re-price most of its loans) was raised at a slower pace following the Federal Reserve action. For the quarter ended September 30, 2004, the overall cost of rates paid increased 4 basis points, from 2.43% to 2.47%, while for the nine month period ended September 30, 2004; the overall cost of rates paid decreased 21 basis points, from 2.61% to 2.40%. The increase on the overall cost of rates paid for the quarter ended September 30, 2004, was primarily due to an increase of 15 basis points on the average interest rate paid on deposits, from 2.27% at September 30, 2003, to 2.42% at September 30, 2004, partially offset by lower cost of rates in borrowings. The cost of rates for deposits adjusted immediately as the LIBOR rate (an index used by the Bank to re-price its deposits) increased by market conditions following the change in the U.S. Treasury yield curve. The decrease in the nine month period ended September 30, 2004, to the comparable 2003 period is attributable to a lower cost of deposits and borrowing during most of the period, compared to the 2003 period.

The increase in the average interest-earning assets was in part offset by an increase in the average interest-bearing liabilities. Average interest-bearing liabilities increased from $8.87 billion for the three months ended September 30, 2003, to $11.98 billion for the three months ended September 30, 2004, an increase of $3.11 billion or 35.11%. For the nine-month period, average interest-bearing liabilities increased from $8.32 billion in 2003, to $11.37 billion in 2004, an increase of $3.05 billion or 36.68%. The increase in average interest-bearing liabilities for the three and nine months ended September 30, 2004, was mainly related to an increase in the average balance of federal funds purchased and repurchase agreements which grew from $3.84 billion and $3.53 billion for the three and nine month periods ended September 30, 2003, respectively, to $5.74 billion and $5.43 billion for the three and nine month periods ended September 30, 2004, respectively, an increase of $1.91 billion for both periods or 49.73% and 54.12%, respectively. The average balance of deposits also grew from $4.89 billion for the three month period ended September 30, 2003, to $6.05 billion for the same period in 2004, an increase of $1.16 billion or 23.68%. For the nine month period ended September 30, 2004, the average balance of deposits grew from $4.66 billion in 2003, to $5.79 billion in 2004, an increase of $1.14 billion or 24.39%.

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


	Three months ended September 30,
	2004								2003
	Interest		Average Balance (1)			Average Yield/Rate			Interest		Average Balance (1)			Average Yield/Rate
	(Dollars in thousands)
Normal spread:
Interest-earning assets:
Loans, including loan fees (2)	$	82,645	$	5,565,089			5.91	%	$	71,568	$	4,383,246			6.48	%
Investment securities (3)		55,159		5,618,796			3.91	%		31,607		3,328,556			3.77	%
Mortgage and asset- backed securities (4)		9,162		910,848			4.00	%		11,489		1,196,542			3.81	%
Money market instruments		4,579		651,355			2.80	%		1,771		573,853			1.22	%

Total		151,545		12,746,088			4.73	%		116,435		9,482,197			4.87	%

Interest-bearing liabilities:
Deposits		36,858		6,046,809			2.42	%		27,941		4,889,213			2.27	%
Federal funds purchased and repurchase agreements		35,874		5,743,827			2.48	%		24,866		3,836,165			2.57	%
Advances from FHLB		1,767		187,747			3.74	%		1,515		140,524			4.28	%

Total		74,499		11,978,383			2.47	%		54,322		8,865,902			2.43	%

Net interest income	$	77,046							$	62,113

Interest rate spread							2.26	%							2.44	%

Net interest-earning assets			$	767,705							$	616,295

Net yield on interest-earning assets (5)							2.40	%							2.60	%

Interest-earning assets to interest-bearing liabilities ratio				106.41	%							106.95	%

Tax equivalent spread:
Interest-earning assets	$	151,545	$	12,746,088			4.73	%	$	116,435	$	9,482,197			4.87	%
Tax equivalent adjustment		13,907		—			0.43	%		10,347		—			0.43	%

Interest-earning assets - tax equivalent		165,452		12,746,088			5.16	%		126,782		9,482,197			5.30	%
Interest-bearing liabilities		74,499		11,978,383			2.47	%		54,322		8,865,902			2.43	%

Net interest income	$	90,953							$	72,460

Interest rate spread							2.69	%							2.87	%

Net yield on interest-earning assets (5)							2.84	%							3.03	%

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

(2)		Average loans exclude non-performing loans. Loan fees amounted to $3.1 million and $2.5 million for the three-month periods ended September 30, 2004 and 2003, respectively.

(3)		Includes trading securities and investments available for sale.

(4)		Includes mortgage-backed securities available for sale and for trading.

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


	Nine months ended September 30,
	2004								2003
	Interest		Average Balance (1)			Average Yield/Rate			Interest		Average Balance (1)			Average Yield/Rate
	(Dollars in thousands)
Normal spread:
Interest-earning assets:
Loans, including loan fees (2)	$	232,710	$	5,237,517			5.93	%	$	203,222	$	4,150,723			6.55	%
Investment securities (3)		153,542		5,206,047			3.94	%		89,327		3,221,270			3.71	%
Mortgage and asset- backed securities (4)		28,660		961,326			3.98	%		29,137		966,352			4.03	%
Money market instruments		12,056		680,406			2.37	%		8,605		526,511			2.19	%

Total		426,968		12,085,296			4.72	%		330,291		8,864,856			4.98	%

Interest-bearing liabilities:
Deposits		102,282		5,791,741			2.36	%		85,985		4,656,115			2.47	%
Federal funds purchased and repurchase agreements		97,250		5,433,281			2.39	%		71,612		3,525,405			2.72	%
Advances from FHLB		4,621		148,547			4.16	%		4,525		135,087			4.48	%
Other borrowings		—		—			—			142		4,945			3.84	%

Total		204,153		11,373,569			2.40	%		162,264		8,321,552			2.61	%

Net interest income	$	222,815							$	168,027

Interest rate spread							2.32	%							2.37	%

Net interest-earning assets			$	711,727							$	543,304

Net yield on interest-earning assets (5)							2.46	%							2.53	%

Interest-earning assets to interest-bearing liabilities ratio				106.26	%							106.53	%

Tax equivalent spread:
Interest-earning assets	$	426,968	$	12,085,296			4.72	%	$	330,291	$	8,864,856			4.98	%
Tax equivalent adjustment		39,893		—			0.44	%		22,753		—			0.34	%

Interest-earning assets - tax equivalent		466,861		12,085,296			5.16	%		353,044		8,864,856			5.32	%
Interest-bearing liabilities		204,153		11,373,569			2.40	%		162,264		8,321,552			2.61	%

Net interest income	$	262,708							$	190,780

Interest rate spread							2.76	%							2.71	%

Net yield on interest-earning assets (5)							2.90	%							2.88	%

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

(2)		Average loans exclude non-performing loans. Loan fees amounted to $8.3 million and $6.2 million for the nine-month periods ended September 30, 2004 and 2003, respectively.

(3)		Includes trading securities and investments available for sale.

(4)		Includes mortgage-backed securities available for sale and for trading.

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

The following table presents the dollar amount of changes in interest income and interest expense for the major components of interest-earning assets and interest-bearing liabilities and distinguishes between the increase (decrease) related to higher outstanding balances and the changes in interest rates.


	Three months ended September 30,									Nine months ended September 30,
	2004 vs. 2003									2004 vs. 2003
	Volume			Rate			Total			Volume			Rate			Total
	(In thousands)
Interest income:
Loans	$	16,441		$	(5,364	)	$	11,077		$	45,824		$	(16,336	)	$	29,488
Investment securities (1)		22,361			1,191			23,552			58,294			5,921			64,215
Mortgage and asset-backed securities (2)		(2,951	)		624			(2,327	)		(143	)		(334	)		(477	)
Money market instruments		202			2,606			2,808			2,817			634			3,451

Total increase (decrease) in interest income		36,053			(943	)		35,110			106,792			(10,115	)		96,677

Interest expense:
Deposits		6,893			2,024			8,917			19,943			(3,646	)		16,297
Federal funds purchased and repurchase agreements		11,811			(803	)		11,008			32,916			(7,278	)		25,638
Advances from FHLB		401			(149	)		252			348			(252	)		96
Other borrowings		—			—			—			(142	)		—			(142	)

Total increase (decrease) in interest expense		19,105			1,072			20,177			53,065			(11,176	)		41,889

Increase (decrease) in net interest income	$	16,948		$	(2,015	)	$	14,933		$	53,727		$	1,061		$	54,788

(1)		Includes trading securities and investments available for sale.

(2)		Includes mortgage-backed securities available for sale and for trading.

Provision For Loan Losses

The provision for loan losses amounted to $10.4 million for the quarter ended September 30, 2004, up from $7.9 million for the same period in the previous year, an increase of $2.5 million or 31.50%. Net charge-offs during the quarter ended September 30, 2004, amounted to $6.2 million, which when subtracted from the provision for loan losses of $10.4 million, resulted in a net increase in the allowance for loan losses of $4.2 million. For the quarter ended September 30, 2003, net charge-offs amounted to $3.8 million, which when subtracted from the provision for loan losses of $7.9 million, resulted in a net increase in the allowance for loan losses of $4.1 million. For the nine month periods ended September 30, 2004 and 2003, net charge-offs amounted to $15.2 million and $8.7 million, respectively, which when subtracted from the provision for loan losses of $30.1 million in 2004 and $20.7 million in 2003, resulted in a net increase in the allowance for loan losses of $15.0 million and $12.0 million for the nine months ended September 30, 2004 and 2003, respectively.

The allowance for loan losses is maintained at a level which, in management’s judgment, is adequate to absorb credit losses inherent in the loans portfolio. The amount of the allowance is based on management’s evaluation of the collectibility of the loans portfolio, including the nature and volume of the portfolio, credit concentrations, trends in historical loss experience, specific impaired loans, and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. Allowances for impaired loans are generally determined based on collateral values or the present value of estimated cash flows. Although no assurance can be given, management believes that the present allowance for loan losses is adequate considering loss experience, delinquency trends and current economic conditions. Management regularly reviews the Company’s loan loss allowance as its loan portfolio grows and diversifies. See “— Financial Condition — Allowance for Loan Losses”.

The allowance for possible loan losses amounted to $76.6 million as of September 30, 2004, and $61.6 million as of December 31, 2003. The increase in the allowance for loan losses is attributable to the overall growth in the Company’s loans portfolio, particularly those of its commercial real estate loans portfolio and the loans portfolio of its asset-based lending division, Westernbank Business Credit, and to cover the write-off experience of the loan portfolio of the Expresso of Westernbank. The commercial real estate loans portfolio grew to $3.0 billion at September 30, 2004, an increase of $690.0 million or 30.51%, when compared to December 31, 2003. On a year to year basis, the commercial real estate loans portfolio grew $807.1 million or 37.64%, from $2.15 billion at September 30, 2003. Westernbank Business Credit loans portfolio grew to $795.5 million at September 30, 2004, an increase of $156.9 million or 24.58%, when compared to December 31, 2003, or an increase of $146.9 million or 22.64%, when compared to September 30, 2003. The Expresso of Westernbank loans portfolio decreased from $150.4 million at December 31, 2003, to $144.6 million at September 30, 2004, a decrease of $5.7 million or 3.81%. On a year to year basis, the Expresso of Westernbank loans portfolio also decreased by $5.7 million or 3.80%, from $150.3 million at September 30, 2003. The decrease in the Expresso of Westernbank loans portfolio was mainly due to management’s strategy of stabilizing charge-offs as the division’s loans portfolio matures and the average yield continues to increase. The provision for loan losses for Westernbank Business Credit and Expresso of Westernbank divisions amounted to $2.4 million and $2.9 million, for the quarter ended September 30, 2004, respectively, and $6.1 million and $11.7 million, for the nine months ended September 30, 2004, respectively, contributing to the increase in the allowance for loan losses when compared to the same periods in 2003.

Non-performing loans stand at $38.7 million or 0.67% (less than 1%) of Westernbank’s loans portfolio at September 30, 2004, relatively stable when compared to 0.66% reported at December 31, 2003. In absolute amounts, non-performing loans increased by $7.5 million, from $31.2 million at December 31, 2003. The increase in non-performing loans primarily comes from the Company’s commercial and regular consumer loan portfolios. Non-performing loans on the commercial loan portfolio increased by $4.0 million, when compared to December 31, 2003. This increase is mostly attributed to two commercial loans with principal balances of $1.5 million and $1.1 million, and two other loans with outstanding principal balances below $1.0 million, all of which are collateralized by real estate properties. At September 30, 2004, only two of these loans with principal balances of $1.1 million and $979,000, had a specific valuation allowance of $277,000 and $235,000, respectively. At September 30, 2004, the allowance for possible loan losses was 197.84% of total non-performing loans (reserve coverage), compared to the 197.17% reported at December 31, 2003. Moreover, of the total allowance of $76.6 million, $9.3 million is for our specific allowance and the remaining $67.3 million is for our general allowance.

Net loans charge-off in the third quarter of 2004 were $6.2 million or 0.44% (annualized) of average loans, compared to $3.8 million or 0.35% of average loans for the same period in 2003, an increase of $2.4 million. For the nine month period ended September 30, 2004, net charge-offs amounted to $15.2 million or 0.38% (annualized) of average loans, an increase of $6.5 million, when compared to $8.7 million or 0.28% (annualized) of average loans in 2003. Both increases were primarily due to loans charged-off in the ordinary course of business, mainly in our consumer loan portfolio. The increase in consumer loans charged-off for the quarter and nine month periods ended September 30, 2004, was principally due to loans charged-off by the Expresso of Westernbank division, which amounted to $3.2 million and $9.9 million, respectively, for the three and nine month periods ended September 30, 2004. The delinquency ratio of the Expresso of Westernbank division portfolio at September 30, 2004, was 2.60% for the categories of 60 days and over. This ratio is slightly above management’s estimate and accordingly, management is emphasizing an increase in the overall yield charged on such loans, continuously revising its underwriting policies, as well as increasing the level of collateralized loans, to compensate for such higher delinquency. The loan portfolio of Expresso of Westernbank collateralized by real estate at September 30, 2004, accounts for 12.07% of the outstanding balance.

Noninterest Income (Loss)

Noninterest income (loss) increased $900,000 for the three month period ended September 30, 2004, when compared to the same period in 2003. This increase was the result of an increase of $573,000 on the net gain (loss) on sales and valuation of loans, securities and other assets and an increase of $303,000 in the gain (loss) on derivative instruments. The increase on the net gain (loss) on sales and valuation of loans, securities and other assets was primarily due to a realized gain of $525,000 on an investment security, while the increase in the unrealized gain (loss) on derivative instruments relate to changes in the valuation of these instruments. Service charges on deposit accounts and other fees and commissions increased slightly by $24,000, when compared to same quarter in year 2003.

For the nine months ended September 30, 2004, noninterest income (loss) increased $22.8 million, when compared to the same period in 2003. The increase was mainly due to the net loss of $22.7 million recorded during the same period in 2003, relating to our investment in CBO’s and CLO’s, and included in loss on sales and valuation of loans, securities and other assets, as previously reported. Service charges on deposit accounts and other fees and commissions increased by $810,000, when compared to the nine months ended September 30, 2003.

Noninterest Expenses

Total noninterest expenses increased $3.4 million or 15.71% for the three-month period ended September 30, 2004, and $13.4 million or 21.96% for the nine months ended September 30, 2004, when compared to the corresponding periods in 2003. Salaries and employees’ benefits, which is the largest component of total noninterest expenses, increased $1.4 million or 17.35% for the third quarter of year 2004, and $3.0 million or 12.25% for the nine months ended September 30, 2004, as compared to the corresponding periods in 2003. Such increases are attributed to the continued expansion of the Company, including increases in personnel, normal salary increases and related employees’ benefits, principally attributed to our continued expansion in the San Juan Metropolitan area. At September 30, 2004, the Company had 1,141 full-time employees, including its executive officers, an increase of 70 employees or 6.54%, since September 30, 2003.

Advertising expense increased by $1.1 million or 53.39% for the three months ended September 30, 2004, and $3.9 million or 78.51% for the nine months ended September 30, 2004, when compared to the same periods in 2003. These increases are principally due to various radio, newspaper and television campaigns promoting Westernbank’s institutional image and positioning the Company for its strategy in the San Juan Metropolitan area, as well as 2004 promotional campaigns for several Westernbank’s products.

Noninterest expenses, other than salaries and employees’ benefits, and advertising discussed above, increased $947,000 or 8.14% for the third quarter of 2004, and $6.4 million or 20.64% for the nine months ended September 30, 2004, resulting primarily from costs associated with the Company’s growth and expansion.

Even though such increases in noninterest expenses, the Company maintained noninterest expenses at adequate levels, and achieved an efficiency ratio of 29.92% for the third quarter of year 2004, and 30.38% for the nine months ended September 30, 2004, well below management’s long term target of 40% to 42%.

Provision for Income Taxes

Under Puerto Rico income tax laws, the Company is required to pay the higher of an alternative minimum tax of 22% or regular statutory rates ranging from 20% to 39%. The current provision for Puerto Rico income taxes for the three and nine month periods ended September 30, 2004, amounted to $6.3 million and $19.9 million, respectively, compared to $6.7 million and $20.4 million in the same periods of 2003. The increases in the income before the provision for income taxes mainly resulted from an increase in the Company’s exempt interest income derived from a significant investment in tax exempt securities, primarily in U.S. Government and Agencies Obligations (See Note 8- Income Taxes- Notes to consolidated financial statements (unaudited). Also, activities relating to the Westernbank International division are exempt for income tax purposes. The deferred income tax credit decreased in 2004, as compared to 2003, since the Company recorded a capital loss carryforward on the liquidation of the Company’s CBO’s and CLO’s portfolio in 2003 which is available to offset capital gains in future years. Deferred income taxes reflect the impact of credit and capital losses carryforwards and “temporary differences” between amounts of assets and liabilities for financial reporting purposes and their respective tax bases. Therefore, the Company’s effective tax rate is substantially below the statutory rate.

Net Income

Net income increased $9.6 million or 27.73%, and $50.6 million or 67.30% for the three and nine month periods ended September 30, 2004, when compared to the same periods in 2003. The increase for the three and nine month periods ended September 30, 2004, primarily resulted from an increase in net interest income, which was partially offset by increases in total operating expenses and in the provision for loan losses. The net income of $75.2 million for the nine months ended September 30, 2003, was affected by a net loss of $22.7 million ($17.0 million net of tax) on valuation and disposition of the Company’s investment in CBO’s and CLO’s. Excluding this $22.7 million net loss ($17.0 million net of tax), for a more meaningful comparison against the nine months ended September 30, 2004 results, net income for the same period in 2003 would have been $92.2 million, which when compared to the net income of $125.8 million for the nine months ended September 30, 2004, represents an increase of $33.6 million or 36.44% over the adjusted comparable period of 2003.

FINANCIAL CONDITION

The Company had total assets of $13.48 billion as of September 30, 2004, compared to $11.52 billion as of December 31, 2003, an increase of $1.96 billion or 17.01%. Loans receivable-net, grew by $1.03 billion or 22.08%, resulting from the Company’s continued strategy of growing its loans portfolio through commercial real estate, asset-based and other commercial lending, as well as its consumer loans portfolio. The investment portfolio, excluding short-term money market instruments, increased $846.5 million or 14.65%, from $5.78 billion as of December 31, 2003, to $6.63 billion as of September 30, 2004. As of September 30, 2004, total liabilities amounted to $12.56 billion, an increase of $1.87 billion or 17.48%, when compared to $10.69 billion as of December 31, 2003. Deposits increased $847.1 million or 15.73%, from $5.39 billion as of December 31, 2003, to $6.23 billion as of September 30, 2004. Federal funds purchased and repurchase agreements grew by $965.7 million or 19.14%, from $5.05 billion as of December 31, 2003, to $6.01 billion as of September 30, 2004.

Loans

Loans receivable-net were $5.72 billion or 42.41% of total assets at September 30, 2004, an increase of $1.03 billion or 22.08%, when compared to $4.83 billion at December 31, 2003.

The Company continues to focus on growing its commercial loans portfolio through commercial real estate, asset-based lending and other commercial loans. As a result, the portfolio of real estate loans secured by first mortgages increased from $3.36 billion as of December 31, 2003, to $4.18 billion as of September 30, 2004, an increase of $826.9 million or 24.62%. Commercial real estate loans secured by first mortgages were $2.95 billion as of September 30, 2004, an increase of $690.0 million or 30.51%, from $2.26 billion at December 31, 2003. Consumer loans (including credit cards, loans on deposits and other loans) and commercial loans (principally collateralized by other than real estate) increased from $1.39 billion as of December 31, 2003, to $1.61 billion as of September 30, 2004, an increase of $221.9 million or 16.00%.

Westernbank’s commercial real estate and other loans are primarily variable and adjustable rate products. Commercial loans origination come from existing customers as well as through direct solicitation and referrals. Westernbank offers different types of consumer loans, including secured and unsecured products, in order to provide a full range of financial services to its retail customers. In addition, Westernbank offers VISA ™ and Master Card ™ accounts to its customers.

As of September 30, 2004, commercial loans were 64.60% (79.92% collateralized by real estate) and consumer loans were 15.17% (62.51% collateralized by real estate) of the $5.72 billion loan portfolio-net. This has enabled Westernbank to shift its asset composition to assets with shorter maturities and greater repricing flexibility. The Company has also continued to diversify Westernbank’s sources of revenue, while maintaining its status as a secured lender, with approximately 82% of its loans collateralized by real estate as of September 30, 2004. At September 30, 2004, Westernbank Business Credit (asset-based lending) and the Expresso of Westernbank (generally unsecured consumer lending) divisions loan portfolios amounted to $795.5 million and $144.6 million, respectively. At September 30, 2004, the average yield on Westernbank Business Credit division asset-based loans portfolio was 6.26%, while for the Expresso of Westernbank division loans portfolio, the average yield was 19.17%.

The following table sets forth the composition of Westernbank’s loans portfolio, by type of loan at the dates indicated.


	September 30, 2004						December 31, 2003
	Amount			Percent			Amount			Percent
				(Dollars in thousands)
Residential real estate:
Mortgage	$	938,637			16.4	%	$	894,007			19.1	%
Construction		294,916			5.2			202,600			4.3
Commercial, industrial and agricultural (1):
Real estate		2,951,446			51.6			2,261,469			48.3
Business and others		741,518			13.0			524,747			11.2
Consumer and others (2)		867,002			15.2			861,903			18.4

Total loans		5,793,519			101.4			4,744,726			101.3
Allowance for loan losses		(76,588	)		(1.4	)		(61,608	)		(1.3	)

Loans — net	$	5,716,931			100.0	%	$	4,683,118			100.0	%

(1)		Includes $795.5 million and $638.6 million at September 30, 2004 and December 31, 2003, respectively, of Westernbank Business Credit division outstanding loans.

(2)		Includes $144.6 million and $150.4 million at September 30, 2004 and December 31, 2003, respectively, of the Expresso of Westernbank division outstanding loans.

Residential real estate mortgage loans at September 30, 2004, are mainly comprised of loans secured by first mortgages on one-to-four family residential properties. At September 30, 2004, residential mortgage loans included $11.5 million of mortgages insured or guaranteed by government agencies of the United States or Puerto Rico.

Westernbank originated $1.34 billion of commercial real estate loans, including asset-based and construction loans, during the nine month period ended September 30, 2004. At September 30, 2004, commercial real estate loans totaled $2.95 billion. In general, commercial real estate loans are considered by management to be of somewhat greater risk of uncollectibility than residential lending because such loans are typically larger in size and more risk is concentrated in a single borrower. In addition, the borrower’s ability to repay a commercial loan or a construction loan depends, in the case of a commercial loan, on the successful operation of the business or the property securing the loan and, in the case of a construction loan, on the successful completion and sale or operation of the project. Substantially all of the Company’s borrowers and properties and other collateral securing the commercial, real estate mortgage and consumer loans are located in Puerto Rico. These loans may be subject to a greater risk of default if the Puerto Rico economy suffers adverse economic, political or business developments, or if natural disasters affect Puerto Rico. At September 30, 2004, the Company maintained its status as a secured lender, with approximately 82% of its loans collateralized by real estate.

The portfolio of Consumer and Other loans at September 30, 2004, consisted of consumer loans of $867.0 million, of which $542.0 million are secured by real estate, $295.5 million are unsecured consumer loans (consisting of $128.9 million of the Expresso of Westernbank division loans portfolio, credit card loans of $53.3 million and other consumer loans of $113.3 million) and loans secured by deposits in Westernbank totaling $29.5 million.

The following table summarizes the contractual maturities of Westernbank’s total loans for the periods indicated at September 30, 2004. Contractual maturities do not necessarily reflect the actual term of a loan, including prepayments.


	MATURITIES
					After one year to five years				After five years
							(In thousands)
	Balance outstanding at		One year or		Fixed interest		Variable interest		Fixed interest rates
	September 30, 2004		less		rates		rates		rates		Variable interest
Residential real estate:
Mortgage	$	938,637	$	8,251	$	16,005	$	82	$	236,058	$	678,241
Construction		294,916		152,489		—		142,427		—		—
Commercial, industrial and agricultural:
Real Estate		2,951,446		944,608		315,157		210,818		75,791		1,405,072
Business and other		741,518		532,250		26,187		23,331		28,045		131,705
Consumer and other		867,002		111,234		205,327		—		550,441		—

Total	$	5,793,519	$	1,748,832	$	562,676	$	376,658	$	890,335	$	2,215,018

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

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

Westernbank’s Senior Credit Committee approval is required for all loans in excess of $5.0 million ($15.0 million in the case of Westernbank Business Credit Division). The Senior Credit Committee also reviews and ratifies all loans between $1.0 million, to $5.0 million approved by Westernbank’s regional credit committees. The Senior Credit Committee is composed by a majority of the members of the Company’s Board of Directors and senior lending officers. All loans in excess of $5.0 million ($15.0 million for Westernbank Business Credit Division) approved by the Senior Credit Committee are also reviewed and ratified by the Board of Directors. All loans in excess of $50.0 million, up to Westernbank’s maximum regulatory amounts, require the approval of the Board of Directors.

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

Westernbank originates most of its residential real estate loans as conforming loans, eligible for sale in the secondary market. The loan-to-value ratio at the time of origination on residential mortgages is generally 75%, except that Westernbank may lend up to 90% of the lower of the purchase price or appraised value of residential properties if private mortgage insurance is obtained by the borrower for amounts in excess of 80%.

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

In addition to its residential loan originations, Westernbank also purchases residential first mortgage loans from other mortgage originators in Puerto Rico. During the nine month period ended September 30, 2004, Westernbank purchased $225.1 million of such loans.

Westernbank originates primarily variable and adjustable rate commercial business and real estate loans. Westernbank also makes real estate construction loans subject to firm permanent financing commitments. As of September 30, 2004, Westernbank’s commercial loans portfolio had a total delinquency ratio, including the categories of 60 days and over, of 0.75% (less than 1%), compared to 0.84% (less than 1%) at December 31, 2003.

Westernbank offers different types of consumer loans in order to provide a full range of financial services to its customers. Within the different types of consumer loans offered by Westernbank, there are various types of secured and unsecured consumer loans with varying amortization schedules. In addition, Westernbank makes fixed-rate residential second mortgage loans. In July 2002, Westernbank launched a new division focused on offering consumer loans through 19 full-service branches, called “Expresso of Westernbank”, denoting the branches’ emphasis on small, unsecured consumer loans up to $15,000 and real estate collateralized consumer loans up to $150,000.

Westernbank offers the service of VISA ™ and Master Card ™ credit cards. At September 30, 2004, there were approximately 24,764 outstanding accounts, with an aggregate outstanding balance of $53.3 million and unused credit card lines available of $97.3 million.

In connection with all consumer loans originated, Westernbank’s underwriting standards include a determination of the applicants’ payment history on other debts and an assessment of the ability to meet existing obligations and payments on the proposed loan. As of September 30, 2004, Westernbank’s consumer loans portfolio, including the Expresso of Westernbank loans portfolio, had a total delinquency ratio, including the categories of 60 days and over, of 1.62%, compared to 0.89% at December 31, 2003. The increase in the delinquency ratio from 2003 to 2004 reflects the delinquencies of the Company’s consumer loans portfolio, primarily collateralized by real estate.

W Holding’s asset quality continues to be strong, as measured by our reserves to total loans, non-performing loans as a percentage of total loans and net charge-offs to average loans. W Holding is essentially a secured lender having 82% of its loan portfolio as of September 30, 2004 secured by real estate. Our combined delinquency on all portfolios for the categories of 60 days and over continues to be below our benchmark of 1% for both periods, being 0.82% at September 30, 2004, and 0.84% at September 30, 2003.

Non-performing loans and foreclosed real estate held for sale

When a borrower fails to make a required payment on a loan, Westernbank attempts to cure the deficiency by contacting the borrower. In most cases, deficiencies are cured promptly. If the delinquency exceeds 90 days and is not cured through normal collection procedures, Westernbank will generally institute measures to remedy the default. If a foreclosure action is instituted and the loan is not cured, paid in full or refinanced, the property is sold at a judicial sale at which Westernbank may acquire the property. In the event that the property is sold at a price insufficient to cover the balance of the loan, the debtor remains liable for the deficiency. Thereafter, if Westernbank acquires the property, such acquired property is appraised and included in the foreclosed real estate held for sale account at the fair value at the date of acquisition. Then, this asset is carried at the lower of fair value less estimated costs to sell or cost until the property is sold.

The accrual of interest on loans is discontinued when, in management’s opinion, the borrower may be unable to meet payments as they become due, but in no event is it recognized after 90 days in arrears on payments of principal or interest. When interest accrual is discontinued, all unpaid interest is reversed. Interest income is subsequently recognized only to the extent cash payments are received.

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


	September 30, 2004			December 31, 2003
	(Dollars in thousands)
Commercial, industrial and agricultural loans	$	28,187		$	24,142
Consumer loans		8,309			4,845
Residential real estate mortgage and construction loans		2,217			2,259

Total non-performing loans		38,713			31,246
Foreclosed real estate held for sale		4,444			4,082

Total non-performing loans and foreclosed real estate held for sale	$	43,157		$	35,328

Interest that would have been recorded if the loans had not been classified as non-performing	$	3,062		$	2,500

Interest recorded on non-performing loans	$	206		$	583

Total non-performing loans as a percentage of loans receivable (1)		0.67	%		0.66	%

Total non-performing loans and foreclosed real estate held for sale as a percentage of total assets (2)		0.32	%		0.31	%

(1)		Computed using end of period loans.

(2)		Computed using end of period assets.

Non-performing loans stand at $38.7 million or 0.67% (less than 1%) of Westernbank’s loan portfolio at September 30, 2004, relatively stable when compared to 0.66% reported at December 31, 2003. In absolute amounts, non-performing loans increased by $7.5 million, from $31.2 million as of December 31, 2003. The increase in non-performing loans primarily comes from the Company’s commercial and consumer loan portfolios. Non-performing loans on the commercial loan portfolio increased by $4.0 million, when compared to December 31, 2003. This increase is mostly attributed to two commercial loans with principal balances of $1.5 million and $1.1 million, and two other loans with outstanding principal balances below $1.0 million, all of which are collateralized by real estate properties. At September 30, 2004, only two of these loans with principal balances of $1.1 million and $979,000, had a specific valuation allowance of $277,000 and $235,000, respectively. Total non-performing loans in the consumer loans portfolio grew by $3.5 million, when compared to December 31, 2003. Such increase was mainly due to consumer loans past due over 90 days which are collateralized by real estate properties. At September 30, 2004, the allowance for possible loan losses was 197.84% of total non-performing loans (reserve coverage), compared to the 197.17% reported at December 31, 2003. Moreover, of the total allowance of $76.6 million, $9.3 million is for our specific allowance and the remaining $67.3 million is for our general allowance.

Allowance for loan losses

Westernbank maintains an allowance for loan losses to absorb losses inherent in the loan portfolio. The allowance is based on ongoing, quarterly assessments of the probable estimated losses inherent in the loan portfolio. The Company follows a systematic methodology to establish and evaluate the adequacy of the allowance for loan losses. This methodology consists of several key elements, which include:

The Formula Allowance. The formula allowance is calculated by applying loss factors to outstanding loans not otherwise covered by specific allowances. Loss factors are based on our historical loss experience and may be adjusted for significant factors that, in management’s judgment, affect the collectibility of the portfolio as of the evaluation date. Loss factors are described as follows:

• Loan loss factors for commercial loans, including construction and land acquisition loans, are based on historical loss trends for three years, as adjusted for management’s expected loss factors given the increase in such loan portfolios over the last few years.

• Pooled loan loss factors are also based on historical loss trends for one to three years. Pooled loans are loans that are homogeneous in nature, such as consumer installment and residential mortgage loans.

The Specific Allowances for Identified Problem Loans and Portfolio Segments. Specific allowances are established and maintained where management has identified significant conditions or circumstances related to a credit or portfolio segment that management believes indicate the probability that a loss has been incurred in excess of the amount determined by the application of the formula allowance. Larger commercial and construction loans that exhibit potential or observed credit weaknesses are subject to individual review. Where appropriate, allowances are allocated to individual loans based on management’s estimate of the borrower’s ability to repay the loan given the availability of collateral, other sources of cash flow and legal options available to Westernbank.

In addition, the specific allowance incorporates the results of measuring impaired loans as provided in SFAS No. 114, Accounting by Creditors for Impairment of a Loan, as amended. This accounting standard prescribes the measurement methods, income recognition and disclosures concerning impaired loans.

The Unallocated Allowance. An unallocated allowance is established recognizing the estimation risk associated with the formula and specific allowances. It is based upon management’s evaluation of various conditions, the effects of which are not directly measured in determining the formula and specific allowances. These conditions include then-existing general economic and business conditions affecting our key lending areas, credit quality trends, including trends in nonperforming loans expected to result from existing conditions,

collateral values, loan volumes and concentrations, seasoning of the loan portfolio, recent loss experience in particular segments of the portfolio, regulatory examination results, and findings of our internal credit examiners. The evaluation of the inherent loss regarding these conditions involves a higher degree of uncertainty because they are not identified with specific problem credits or portfolio segments.

Management assesses these conditions quarterly. If any of these conditions is evidenced by a specifically identifiable problem credit or portfolio segment as of the evaluation date, management’s estimate of the effect of this condition may be reflected as a specific allowance applicable to this credit or portfolio segment. Where any of these conditions is not evidenced by a specifically identifiable problem credit or portfolio segment as of the evaluation date, management’s evaluation of the probable loss concerning this condition is reflected in the unallocated allowance.

The allowance for loan losses is based upon estimates of probable losses inherent in the loans portfolio. The amount actually observed for these losses can vary significantly from the estimated amounts. Our methodology includes several features that are intended to reduce the differences between estimated and actual losses. Historical loss factors for commercial and consumer loans may be adjusted for significant factors that, in management’s judgment, reflect the impact of any current condition on loss recognition. Factors which management considers in the analysis include the effect of the national and local economies, trends in the nature and volume of loans (delinquencies, charge-offs, non-accrual and problem loans), changes in the internal lending policies and credit standards, collection practices, and examination results from bank regulatory agencies and Westernbank’s internal credit examiners. Loan loss factors are adjusted quarterly based upon the level of net charge offs expected by management in the next twelve months, after taking into account historical loss ratios adjusted for current trends. By assessing the probable estimated losses inherent in the loans portfolio on a quarterly basis, we are able to adjust specific and inherent loss estimates based upon any more recent information that has become available.

At September 30, 2004, Westernbank’s allowance for loan losses was $76.6 million, consisting of $67.3 million formula allowance and $9.3 million of specific allowances. As of September 30, 2004, the allowance for loan losses equals 1.32% of total loans, and 197.84% of total non-performing loans, compared with an allowance for loan losses at December 31, 2003 of $61.6 million, or 1.30% of total loans, and 197.17% of total non-performing loans.

As of September 30, 2004, there have been no significant changes in estimation methods or assumptions that affected our methodology for assessing the appropriateness of the allowance for loan losses.

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


	September 30, 2004			December 31, 2003
	(Dollars in thousands)
Balance, beginning of year	$	61,608		$	47,114

Loans charged-off:
Consumer loans (1)		(12,889	)		(12,203	)
Commercial, industrial and agricultural loans		(4,658	)		(2,479	)
Real estate-mortgage and construction loans		(197	)		(184	)

Total loans charged-off		(17,744	)		(14,866	)

Recoveries of loans previously charged-off:
Consumer loans		1,409			799
Commercial, industrial and agricultural loans		1,102			1,141
Real estate-mortgage and construction loans		72			372

Total recoveries of loans previously charged-off		2,583			2,312

Net loans charged-off		(15,161	)		(12,554	)
Provision for loan losses		30,141			27,048

Balance, end of period	$	76,588		$	61,608

Ratios:
Allowance for loan losses to total end of period loans		1.32	%		1.30	%
Provision for loan losses to net loans charged-off		198.81	%		215.45	%
Recoveries of loans to loans charged-off in previous period		23.18	%(2)		29.03	%
Net loans charged-off to average loans (3)		0.38	%(2)		0.29	%
Allowance for loan losses to non-performing loans		197.84	%		197.17	%

(1)		Includes $9.9 million and $7.9 million of Expresso of Westernbank loans charged-off for the nine months ended September 30, 2004, and year ended December 31, 2003, respectively.

(2)		Recoveries and net loans charge-off ratios for 2004 are annualized for comparison purposes.

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

The following table presents the allocation of the allowance for credit losses and the percentage of loans in each category to total loans, as set forth in the “Loans” table on page 44.


	September 30, 2004					December 31, 2003
	Amount		Percent			Amount		Percent
	(Dollars in thousands)
Commercial, industrial and agricultural loans (1)	$	55,272		63.7	%	$	41,400		58.7	%
Consumer loans (2)		19,320		15.0			17,472		18.2
Residential real estate mortgage and construction loans		443		21.3			415		23.1
Unallocated allowance		1,553		—			2,321		—

Total allowance for loan losses	$	76,588		100.0	%	$	61,608		100.0	%

(1)		Includes $12.7 million and $6.6 million of Westernbank Business Credit loans at September 30, 2004 and December 31, 2003, respectively.

(2)		Includes $12.4 million and $10.0 million of Expresso of Westernbank loans at September 30, 2004 and December 31, 2003, respectively.

Loans are classified as impaired or not impaired in accordance with SFAS No. 114. A loan is impaired when, based on current information and events, it is probable that Westernbank will be unable to collect the scheduled payments of principal or interest when due, according to the contractual terms of the agreement.

Westernbank measures the impairment of a loan based on the present value of expected future cash flows discounted at the loan’s effective interest rate, or as a practical expedient, at the observable market price of the loan or the fair value of the collateral, if the loan is collateral dependent. Significant loans (those exceeding $500,000) are individually evaluated for impairment. Large groups of small balance, homogeneous loans are collectively evaluated for impairment; loans that are recorded at fair value or at the lower of cost or market are not evaluated for impairment. The portfolios of mortgage and consumer loans are considered homogeneous and are evaluated collectively for impairment.

Impaired loans for which the discounted cash flows, collateral value or market price exceeds its carrying value do not require an allowance. The allowance for impaired loans is part of the Company’s overall allowance for loan losses.

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


	September 30, 2004		December 31, 2003
	(In thousands)
Investment in impaired loans:
Covered by a valuation allowance	$	31,241	$	28,217
Do not require a valuation allowance		20,206		22,088

Total	$	51,447	$	50,305

Valuation allowance for impaired loans	$	8,495	$	4,646


	September 30, 2004		September 30, 2003
	(In thousands)
Average investment in impaired loans	$	49,177	$	45,888

Interest collected and recognized as income on impaired loans	$	1,936	$	2,044

Although the Company investment on impaired loans remained relatively stable when compared to December 31, 2003, the loans comprising total impaired loans between periods may have changed. The valuation allowance for impaired loans increased from $4.6 million at December 31, 2003, to $8.5 million at September 30, 2004, an increase of $3.8 million or 82.85%. The increase in the valuation allowance was mainly due to two commercial loans with principal balances of $12.5 million and $10.4 million at September 30, 2004. The loan with a principal balance of $12.5 million required a valuation allowance of $6.3 million as of September 30, 2004, when compared to $1.8 million as of December 31, 2003, an increase of $4.5 million; and the loan with a principal balance of $10.4 million, a newly classified loan, required a valuation allowance of $500,000 at September 30, 2004.

Investments

The Company’s investments are managed by the Investment Department. Purchases and sales are required to be reported monthly to the Investment Committee (composed of members of the Board of Directors, as well as the President and Chief Executive Officer and the Chief Financial Officer).

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

At the date of purchase, the Company classifies debt and equity securities into one of three categories: held to maturity; trading; or available for sale. At each reporting date, the appropriateness of the classification is reassessed. Investments in debt securities for which management has the positive intent and ability to hold to maturity are classified as held to maturity and stated at cost increased by accretion of discounts and reduced by amortization of premiums, both computed by the interest method. Securities that are bought and held principally for the purpose of selling them in the near term are classified as trading and measured at fair value in the financial statements with unrealized gains and losses included in earnings. Securities not classified as either held to maturity or trading are classified as available for sale and measured at fair value in the financial statements with unrealized gains and losses reported, net of income tax, as a component of accumulated other comprehensive income (loss) until realized. Gains and losses on sales of securities are determined using the specific-identification method.

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

Federal funds sold and resell agreements amounted to $290.0 million and $390.1 million, respectively, at September 30, 2004. Federal funds sold mature the next business day, while resell agreements mature as follows: $140.1 million the next business day, $50.0 million in 2009, and $200.0 million in 2010. The Company monitors the fair value of the underlying securities as compared to the related receivable, including accrued interest, and requests additional collateral when the fair value of the underlying collateral falls to less than the collateral requirement. At September 30, 2004, the fair value of the underlying collateral amounted to $395.1 million.

The following table presents the carrying value of investments at September 30, 2004 and December 31, 2003:


	September 30,		December 31,
	2004		2003
	(In thousands)
Held to maturity :
US Government and agencies obligations	$	5,504,928	$	4,463,493
Puerto Rico Government and agencies obligations		34,822		34,500
Commercial paper		160,140		174,976
Corporate notes		51,415		51,409
Mortgage and asset-backed securities		861,773		999,332

Total		6,613,078		5,723,710

Available for sale:
Collateralized mortgage obligations		12,226		49,910
Equity securities — preferred stock		—		5,170

Total		12,226		55,080

Total investments	$	6,625,304	$	5,778,790

The carrying amount of investment securities at September 30, 2004, by contractual maturity (excluding mortgage and asset- backed securities and equity securities), are shown below:


			Weighted
	Carrying		average
	amount		yield
	(Dollars in thousands)
US Government and agencies obligations:
Due within one year	$	—		—	%
Due after one year through five years		3,483,424		3.89
Due after five years through ten years		2,021,504		4.05
Due after ten years		—		—

		5,504,928		3.95

Puerto Rico Government and agencies obligations:
Due within one year		3,000		4.75
Due after one year through five years		10,468		5.25
Due after five years through ten years		20,004		4.15
Due after ten years		1,350		6.15

		34,822		4.61

Commercial paper and corporate notes:
Due within one year (1)		185,140		1.95
Due after one year through five years		4,990		6.13
Due after five years through ten years		—		—
Due after ten years		21,425		8.33

		211,555		2.70

Total		5,751,305		3.91
Mortgage and asset-backed securities		873,999		4.21

Total	$	6,625,304		3.95	%

(1)

Includes $160.1 million in commercial paper maturing within six days.

Mortgage and asset-backed securities at September 30, 2004, consist of:


	(In thousands)
Available for sale — CMO certificates issued or guaranteed by FHLMC or FNMA	$	12,226

Held to maturity:
FHLMC certificates		5,869
GNMA certificates		10,505
FNMA certificates		3,817
CMO certificates issued or guaranteed by FHLMC or FNMA		841,452
CMO’s other		130

Total held to maturity		861,773

Total mortgage and asset-backed securities	$	873,999

The Company’s investment portfolio at September 30, 2004, had an average contractual maturity of 55 months, when compared to an average maturity of 63 months at December 31, 2003. The Company’s interest rate risk model takes into consideration the callable feature of certain investment securities. Taking into consideration the callable features of these securities, the Company’s investment portfolio as of September 30, 2004, had a remaining average maturity of 7 months. However, no assurance can be given that such levels will be maintained in future periods.

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

In applying the foregoing analysis, management concluded that at March 31, 2003, its investments in corporate bond and loan obligations (“CBO’s and CLO’s”) were other-than-temporarily impaired. First, two tranches of a CBO with an amortized cost of $13.0 million were downgraded by two different rating agencies on April 3 and 15, 2003. Second, the available secondary market prices for those two securities and the remaining portfolio of CBO’s and CLO’s with a carrying value of $56.0 million continued to deteriorate. In line with such decline management concluded, based on these facts and the secondary market prices, that a $15.7 million other than temporary impairment write-down was warranted. The same was recorded effective for the quarterly period ended March 31, 2003. In connection with the write-down, and in accordance with applicable accounting pronouncements, management also reassessed its intent to hold to maturity and reclassified the securities related to the CBO that was downgraded as available for sale as of March 31, 2003. As of March 31, 2003, there were no defaults within the securities portfolio underlying the CBO’s and CLO’s.

During the quarter ended June 30, 2003, the Company, based upon additional information available from trustees, further rating downgradings, a default on the scheduled interest payment in one of the CBO tranches and further declines in quoted market prices for such investments, reclassified the remaining portfolio of CBO’s and CLO’s to available for sale and subsequently, on June 6, 2003, sold its entire portfolio of CBO’s and CLO’s. The sale of the portfolio, with an original total investment of $62.9 million and adjusted to a fair value of $45.4 million as of March 31, 2003, was completed at an additional net loss of $7.0 million which was recorded during the quarter ended June 30, 2003.

At September 30, 2004, management concluded that there was no other-than-temporary impairment on its investment securities portfolio.

See Note 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES for recent developments on the measurement and recognition guidance on other-than-temporary impairments.

Deposits

Westernbank offers a diversified choice of deposit accounts. Savings deposits increased from $692.2 million as of December 31, 2003, to $827.9 million as of September 30, 2004, an increase of $135.7 million or 19.60%. Also, other deposits represented mainly by time deposits, brokered deposits and Individual Retirement Account deposits (IRA’s), increased from $4.69 billion as of December 31, 2003, to $5.40 billion as of September 30, 2004, an increase of $711.5 million or 15.16%. Brokered deposits amounted to $4.17 billion and $3.51 billion as of September 30, 2004 and December 31, 2003, respectively. These accounts have historically been a stable source of funds.

At September 30, 2004, Westernbank had total deposits of $6.23 billion, of which $827.9 million or 13.28% consisted of savings deposits, $270.6 million or 4.34% consisted of interest bearing demand deposits, $240.8 million or 3.86% consisted of noninterest bearing deposits, and $4.89 billion or 78.52% consisted of time deposits. Westernbank also offers negotiable order of withdrawal (“NOW”) accounts, Super Now accounts, special checking accounts and commercial demand accounts.

At September 30, 2004, the scheduled maturities of time deposits in amounts of $100,000 or more are as follows:


	(In thousands)
3 months or less	$	1,022,923
over 3 months through 6 months		770,785
over 6 months through 12 months		720,395
over 12 months		1,290,714

Total	$	3,804,817

The following table sets forth the average amount and the average rate paid on the following deposit categories for the nine months ended September 30, 2004, and for the year ended December 31, 2003:


	September 30, 2004					December 31, 2003
	Average		Average			Average		Average
	amount		rate			amount		rate
			(Dollars in thousands)
Time deposits	$	4,526,358		2.54	%	$	3,775,263		2.59	%
Savings deposits		771,833		2.15	%		605,854		2.15	%
Interest bearing demand deposits		199,484		2.61	%		160,015		2.55	%
Noninterest bearing demand deposits		294,066		—			227,358		—

	$	5,791,741		2.36	%	$	4,768,490		2.41	%

Borrowings

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


	September 30, 2004		December 31, 2003
	(In thousands)
Federal funds purchased and repurchase agreements (1)	$	6,011,735	$	5,046,045
Advances from FHLB		211,000		146,000
Mortgage note payable		36,960		37,234

	$	6,259,695	$	5,229,279

(1)

Federal funds purchased amounted to $95.0 million at September 30, 2004, at a weighted average interest rate of 2.04%, and matures within one day. No such borrowings were outstanding at December 31, 2003.

Westernbank has made use of institutional federal funds purchased and repurchase agreements in order to obtain funding, primarily through investment banks and brokerage firms. Repurchase agreements are collateralized with investment securities while federal funds purchased do not require collateral. Westernbank had $6.01 billion in federal funds purchased and repurchase agreements outstanding at September 30, 2004, at a weighted average rate of 2.59%. Federal funds purchased and repurchase agreements outstanding as of September 30, 2004, mature as follows: $3.35 billion within 30 days; $115.0 million within 60 days; $703.9 million in 2005; $47.5 million in 2006; $782.6 million in 2007; and $1.02 billion thereafter.

Westernbank also obtains advances from FHLB of New York. As of September 30, 2004, Westernbank had $211.0 million in outstanding FHLB advances at a weighted average rate of 3.47%. Advances from FHLB mature as follows: $25.0 million within 30 days; $14.0 million within 60 days; $70.0 million in 2006; $60.0 million in 2007; and $42.0 million thereafter.

At September 30, 2004, Westernbank World Plaza, Inc., a wholly-owned subsidiary of Westernbank Puerto Rico, had outstanding $37.0 million of a mortgage note, at a fixed interest rate of 8.05% per year up to September 11, 2009. Subsequent to September 11, 2009, the mortgage note will bear interest on the then outstanding principal balance at a rate per year equal to (1) the greater of 13.05% or the Treasury Rate plus five percentage points, or (2) 10.05%, depending on the fulfillment of certain conditions on the repricing date. Westernbank World Plaza has a prepayment option on the repricing date, without penalty. The mortgage note is collateralized by a 23-story office building, including its related parking facility, located in Hato Rey, Puerto Rico.

The following table presents certain information regarding the Westernbank’s short-term borrowings for the periods indicated.


	September 30, 2004			December 31, 2003
	(Dollars in thousands)
Amount outstanding at period end	$	3,769,651		$	1,964,641
Monthly average outstanding balance		2,664,125			1,267,234
Maximum outstanding balance at any month end		3,769,651			2,147,934
Weighted average interest rate:
For the nine months and period ended		1.55	%		1.24	%
At the end of nine months and at period end		1.97	%		1.31	%

Stockholders’ Equity

As of September 30, 2004, total stockholders’ equity amounted to $918.8 million, an increase of $90.3 million or 10.90%, when compared to $828.5 million as of December 31, 2003. The increase resulted primarily from the net income of $125.8 million generated during the nine month period ended September 30, 2004, partially offset by dividends declared during the period of $17.6 million and $20.3 million on the Company’s common and preferred shares, respectively, and a decrease of $662,000 in other comprehensive loss, net of tax, on the mark to market of the Company’s portfolio of investment securities available for sale at September 30, 2004, when compared to December 31, 2003. The period-end number of common shares outstanding increased from 106,290,294 as of December 31, 2003, to 106,847,565 as of September 30, 2004, as a result of the conversion of 150,292 shares of the Company’s convertible preferred stock series A, into 342,521 shares of the Company’s common stock, and the issuance of 214,750 common shares from the exercise of stock options.

SELECTED FINANCIAL RATIOS AND OTHER DATA

The following table sets forth, for the indicated periods, certain ratios reflecting the productivity, profitability and other selected data of the Company:


	Three months ended						Nine months ended						Year ended
	September 30,						September 30,						December 31,
	2004			2003			2004			2003			2003
			(Dollars in thousands, except share data)
Per share data:
Dividend payout ratio		15.66	%		16.28	%		16.69	%		22.51	%		19.97	%
Book value per common share	$	5.03		$	3.88	(2)	$	5.03		$	3.88	(2)	$	4.17
Preferred stock outstanding at end of period		15,245,453			15,610,405			15,245,453			15,610,405			15,395,745
Preferred stock equity at end of period	$	381,136		$	390,260		$	381,136		$	390,260		$	384,894
Performance ratios:
Return on average assets (1)		1.33	%		1.36	%		1.34	%		1.05	%		1.15	%
Return on average common stockholders’ equity (1)		28.81	%		28.69	%		28.67	%		20.95	%		22.79	%
Efficiency ratio		29.92	%		31.62	%		30.38	%		32.49	%		31.75	%
Operating expenses to end-of-period assets		0.75	%		0.81	%		0.73	%		0.75	%		0.74	%
Capital ratios:
Total capital to risk-weighted assets		14.09	%		14.83	%		14.09	%		14.83	%		14.87	%
Tier I capital to risk-weighted assets		13.15	%		13.95	%		13.15	%		13.95	%		13.98	%
Tier I capital to average assets		7.00	%		8.06	%		7.00	%		8.06	%		7.22	%
Equity-to-assets ratio		6.82	%		7.38	%		6.82	%		7.38	%		7.19	%
Other selected data:
Total trust assets managed	$	388,932		$	317,606		$	388,932		$	317,606		$	326,527
Branch offices		51			51			51			51			51
Number of employees		1,141			1,071			1,141			1,071			1,092

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

(2)		Adjusted to reflect the three-for-two stock split in the form of a stock dividend and a 2% stock dividend on our common stock declared on November 4, 2003 and November 11, 2003, respectively, both distributed on December 10, 2003.

CRITICAL ACCOUNTING POLICIES AND PRACTICES

The information required herein is incorporated by reference from page 53 of the Company’s Consolidated Financial Statements as of December 31, 2003 and 2002, and for each of the three years in the period ended December 31, 2003, included in the Company’s Annual Report on Form 10-K.

LIQUIDITY

Liquidity refers to the Company’s ability to generate sufficient cash to meet the funding needs of current loans demand; deposit withdrawals, principal and interest payments with respect to outstanding borrowings and to pay operating expenses. The Company monitors its liquidity in accordance with guidelines established by the Investment Committee 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. Liquidity demand caused by net reductions in deposits is 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 other short and long-term borrowings. At September 30, 2004, the Company had approximately $1.1 billion in securities and other short-term securities maturing or repricing within one year or available for sale. Additional asset-driven liquidity is provided by the remainder of the investment securities portfolio and securitizable loans.

Liquidity is derived from liabilities by maintaining a variety of funding sources, including deposits, and other short and long-term borrowing, such as repurchase agreements. Other borrowings funding source limits are determined annually by each counterparty and depend on the Company’s financial condition and delivery of acceptable collateral securities. The Company may be required to provide additional collateral based on the fair value of the underlying securities. In addition, the Company utilizes the National Certificate of Deposit (“CD”) Market as a source of cost effective deposit funding in addition to local market deposit inflows. Depositors in this market consist of credit unions, banking institutions, CD brokers and some private corporations or non-profit organizations. Westernbank’s ability to acquire brokered deposits can be restricted if it becomes in the future less than well-capitalized. An adequately-capitalized bank, by regulation, may not accept deposits from brokers unless it applies for and receives a waiver from the FDIC. The Company also uses the Federal Home Loan Bank (FHLB) as a funding source, issuing notes payable, such as advances, and other borrowings, such as repurchase agreements, through its FHLB member subsidiary, Westernbank. This funding source requires Westernbank to maintain a minimum amount of qualifying collateral with a fair value of at least 110% and 105% of the outstanding advances and repurchase agreements, respectively.

The Company’s liquidity targets are reviewed monthly by the Investment Committee and are based on the Company’s commitment to make loans and investments and its ability to generate funds. The Committee’s targets are also affected by yields on available investments and upon the Committee’s judgment as to the attractiveness of such yields and its expectations as to future yields.

The Company’s investment portfolio at September 30, 2004, had an average contractual maturity of 55 months. However, no assurance can be given that such levels will be maintained in future periods.

As of September 30, 2004, Westernbank had line of credit agreements with six commercial banks permitting Westernbank to borrow a maximum aggregate amount of $175.0 million. The agreements provide for unsecured advances to be used by the Company on an overnight basis. Interest rate is negotiated at the time of the transaction usually at Fed Fund rate. The credit agreements are renewable annually.

Payments due by period for the Company’s contractual obligations (other than deposit liabilities) at September 30, 2004, are presented below:


			Due after		Due after
			one year		three years
	Due within		through		through		Due after
	one year		three years		five years		five years		Total
	(In thousands)
Short-term borrowings	$	3,769,651	$	—	$	—	$	—	$	3,769,651
Long-term borrowings		—		1,393,886		—		1,096,158		2,490,044
Operating lease obligations		2,232		4,212		2,641		16,618		25,703

Total contractual obligations	$	3,771,883	$	1,398,098	$	2,641	$	1,112,776	$	6,285,398

Such commitments will be funded in the normal course of business from the Company’s principal source of funds. At September 30, 2004, the Company had $2.75 billion in certificates of deposit that mature during the following twelve months. The Company does not anticipate any difficulty in retaining or replacing such deposits.

The contractual amount of the Company’s financial instruments with off-balance sheet risk expiring by period at September 30, 2004, is presented below:


	Total		Less than one year		2-5 years
			(In thousands)
Lines of credit	$	252,357	$	241,749	$	10,608
Commercial letters of credit		36,854		36,854		—
Commitments to extend credit		544,867		285,554		259,313
Commitments to purchase mortgage loans		25,000		25,000		—

Total	$	859,078	$	589,157	$	269,921

Due to the nature of the Company’s unfunded loan commitments, including unfunded lines of credit, the amounts presented above do not necessarily represent the amounts the Company anticipates funding in the periods presented above.

Minimum Regulatory Capital Requirements

The Federal Reserve Board has established guidelines regarding the capital adequacy of bank holding companies, such as the Company. These requirements are substantially similar to those adopted by the FDIC for depository institutions, such as Westernbank, as set forth below.

The Company (on a consolidated basis) and Westernbank (the “Companies”) are subject to risk-based capital guidelines issued by the federal banking agencies. These guidelines are used to evaluate capital adequacy based primarily on the perceived credit risk associated with balance sheet assets as well as certain off-balance sheet exposures such as unused loan commitments, letters of credit and derivatives.

Under the risk-based capital guidelines, qualifying total capital consists of two types of capital components. Tier 1 capital includes common shareholders’ equity, qualifying perpetual preferred stock (subject to limitations) and minority interest in consolidated subsidiaries less goodwill and certain other deductions. Tier 2 capital includes Tier 1 capital plus perpetual preferred stock not included in Tier 1 capital (subject to limitations), the general allowance for credit losses, qualifying senior and subordinated debt, and limited-life preferred stock less certain deductions.

The risk-based capital guidelines require a minimum ratio of Tier 1 capital to risk-weighted assets of 4.0% and a minimum ratio of combined Tier 1 and Tier 2 capital (“total risk-based capital”) to risk weighted assets of 8.0%. The risk-based capital guidelines are supplemented by a leverage ratio requirement. This requirement establishes a minimum leverage ratio of 3.0% for the highest rated banking organizations. Other banking organizations are expected to have ratios of at least 4.0% to 5.0% depending on their particular growth plans and condition (including diversification of risk, asset quality, earnings, and liquidity). The ratio is defined as Tier 1 capital divided by total average assets, less certain deductions, including goodwill.

As of March 31, 2004 (latest examination date), Westernbank qualified as a well capitalized institution under the regulatory framework for prompt corrective action. To be categorized as well capitalized, an institution must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the following table. At September 30, 2004, there are no conditions or events that management believes have changed Westernbank’s category.

The following table reflects the Companies’ actual capital amounts and ratios, and applicable regulatory requirements at September 30, 2004:


											Minimum To Be
						Minimum					Well Capitalized Under
						Capital					Prompt Corrective
	Actual					Requirement					Action Provisions
	Amount		Ratio			Amount		Ratio			Amount		Ratio
						(Dollars in Thousands)
Total Capital to Risk Weighted Assets:
Consolidated	$	992,796		14.09	%	$	563,535		8.00	%		N/A		N/A
Westernbank		983,864		13.97	%		563,378		8.00	%	$	704,223		10.00	%
Tier I Capital to Risk Weighted Assets:
Consolidated		916,209		13.15	%		278,704		4.00	%		N/A		N/A
Westernbank		907,276		13.03	%		278,626		4.00	%		417,939		6.00	%
Tier I Capital to Average Assets:
Consolidated		916,209		7.00	%		392,508		3.00	%		N/A		N/A
Westernbank		907,276		6.94	%		392,068		3.00	%		653,446		5.00	%

The Company’s ability to pay dividends to its stockholders and other activities can be restricted if its capital falls below levels established by the Federal Reserve guidelines. In addition, any bank financial holding company whose capital falls below levels specified in the guidelines can be required to implement a plan to increase capital. Management believes that the Company will continue to meet its cash obligations as these become due and pay dividends as these are declared.

Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Interest rate risk and asset/liability management

The Company’s financial performance is impacted by among other factors, interest rate risk and credit risk. Management considers interest rate risk the Company’s most significant market risk. Interest rate risk is the exposure to adverse changes in net interest income due to changes in interest rates. Consistency of the Company’s net interest income is largely dependent upon the effective management of interest rate risk. The Company does not utilize derivatives to mitigate its credit risk, relying instead on an extensive counterparty review process. See “Management’s Discussion and Analysis of Results of Operations and Financial Condition — Allowance for Loan Losses” herein.

Interest rate risk is addressed by the Company’s Asset & Liability Committee (“ALCO”), which includes the full Board of Directors and certain senior management representatives. The ALCO monitors interest rate risk by analyzing the potential impact to the net portfolio of equity value and net interest income from potential changes to interest rates and considers the impact of alternative strategies or changes in balance sheet structure. The ALCO manages the Company’s balance sheet in part to minimize the potential impact on net portfolio value and

net interest income despite changes in interest rates. The Company’s exposure to interest rate risk is reviewed on a quarterly basis by the ALCO. Interest rate risk exposure is measured using interest rate sensitivity analysis to determine the change in net portfolio value in the event of hypothetical changes in interest rates. If potential changes to net portfolio value and net interest income resulting from hypothetical interest rate changes are not within the limits established by the Board, this may direct management to adjust its asset and liability mix to bring interest rate risk within Board-approved limits. In order to reduce the exposure to interest rate fluctuations, the Company has implemented strategies to more closely match its balance sheet composition. Interest rate sensitivity is computed by estimating the changes in net portfolio of equity value, or market value over a range of potential changes in interest rates. The market value of equity is the market value of the Company’s assets minus the market value of its liabilities plus the market value of any off-balance sheet items. The market value of each asset, liability, and off-balance sheet item is its net present value of expected cash flows discounted at market rates after adjustment for rate changes. The Company measures the impact on market value for an immediate and sustained 200 basis point increase or decrease (shock) in interest rates. Given the fed fund rate of 1.75% at September 30, 2004 and 1.00% at December 31, 2003, a linear 100 and 50 basis points decrease for September 30, 2004 and December 31, 2003, respectively, was modeled in the estimated change in interest rate in place of the linear 200 basis points decrease.

The Company’s profitability is dependent to a large extent upon its net interest income, which is the difference between its interest income on interest-earning assets, such as loans and investments, and its interest expense on interest-bearing liabilities, such as deposits and borrowings. The Company is subject to interest rate risk to the degree that its interest-earning assets reprice differently than its interest-bearing liabilities.

The Company manages its mix of assets and liabilities with the goals of limiting its exposure to interest rate risk, ensuring adequate liquidity, and coordinating its sources and uses of funds. Specific strategies have included securitization and sale of long-term, fixed-rate residential mortgage loans, shortening the average maturity of fixed-rate loans and increasing the volume of variable and adjustable rate loans to reduce the average maturity of the Company’s interest-earning assets. All long-term, fixed-rate single family residential mortgage loans underwritten according to Federal Home Loan Mortgage Corporation, Federal National Mortgage Association and Government National Mortgage Association guidelines, are sold for cash upon origination. In addition, the Company enters into certain derivative financial instruments. (See “Note 9 – Financial Instruments, Derivative Financial Instruments – Notes to Consolidated Financial Statements (unaudited)”).

The Company is exposed to changes in the level of Net Interest Income (“NII”) in a changing interest rate environment. NII will fluctuate pursuant to changes in the levels of interest rates and of interest-sensitive assets and liabilities. If (1) the weighted average rates in effect at period end remain constant, or increase or decrease on an instantaneous and sustained change of plus 200 or minus 100 basis points (50 basis points at December 31, 2003), and (2) all scheduled repricing, reinvestments and estimated prepayments, and reissuances are at such constant, or increase or decrease accordingly; NII will fluctuate as shown on the table below:

September 30, 2004:


Change in Interest Rate	*Expected NII ()**		Amount Change			% Change
			(Dollars in thousands)
+200 Basis Points	$	281,148	$	(34,040	)		(10.80	)%
Base Scenario		315,188		—			—
-100 Basis Points		312,753		(2,435	)		(0.77	)%

December 31, 2003:


Change in Interest Rate	*Expected NII ()**		Amount Change			% Change
			(Dollars in thousands)
+200 Basis Points	$	280,197	$	(14,573	)		(4.94	)%
Base Scenario		294,770		—			—
-50 Basis Points		291,543		(3,227	)		(1.09	)%

(*) The NII figures exclude the effect of the amortization of loan fees. Given the fed fund rate of 1.75% at September 30, 2004, and 1.00% at December 31, 2003, a linear 100 and 50 basis points decrease for September 30, 2004 and December 31, 2003, respectively, was modeled in the estimated change in interest rate in place of the linear 200 basis points decrease.

The model utilized to create the information presented above makes various estimates at each level of interest rate change regarding cash flows from principal repayments on loans and mortgage-backed securities and/or call activity on investment securities. Actual results could differ significantly from these estimates which would result in significant differences in the calculated projected change. In addition, the limits stated above do not necessarily represent the level of change under which management would undertake specific measures to realign its portfolio in order to reduce the projected level of change.

The interest rate sensitivity (“GAP”) is defined as the difference between interest-earning assets and interest-bearing liabilities maturing or repricing within a given time period. A GAP is considered positive when the amount of interest rate sensitive assets exceeds the amount of interest rate sensitive liabilities. A GAP is considered negative when the amount of interest rate sensitive liabilities exceeds interest rate sensitive assets. During a period of rising interest rates, a negative GAP would tend to adversely affect net interest income, while a positive GAP would tend to result in an increase in net interest income. During a period of falling interest rates, a negative GAP would tend to result in an increase in net interest income, while a positive GAP would tend to affect net interest income adversely. While the GAP is a useful measurement and contributes toward effective asset and liability management, it is difficult to predict the effect of changing interest rates solely on that measure. Because different types of assets and liabilities with the same or similar maturities may react differently to changes in overall market rates or conditions, changes in interest rates may affect net interest income positively or negatively, even if an institution were perfectly matched in each maturity category.

Competition and economic conditions

The financial services and banking business are highly competitive, and the profitability of the Company will depend principally upon the Company’s ability to compete in its market area as well as to a significant extent upon general economic conditions in the island of Puerto Rico. The Company competes with other commercial and non-commercial banks, finance companies, mutual funds, insurance companies, brokerage and investment banking firms, asset-based non-bank lenders and certain other non-financial institutions, including certain governmental organizations which may offer subsidized financing at lower rates than those offered by the Company. The Company has been able to compete effectively with other financial institutions by emphasizing technology and customer service, including local office decision-making on loans, establishing long-term customer relationships and building customer loyalty, and by providing products and services designed to address the specific needs of its customers. The success of the Company is also highly dependent on the economic strength of the Company’s general market area. Significant deterioration in the local economy or external economic conditions, such as inflation, recession, unemployment, real estate values and other factors beyond the Company’s control, could also substantially impact the Company’s performance. There can be no assurance that future adverse changes in the local economy would not have a material adverse effect on the Company’s consolidated financial condition, results of operations or cash flows. For further information, refer to the Economic Conditions, Market Area and Competition section included in the Company’s Annual Report on Form 10-K.

Changes in statutes and regulations, including tax laws and rules

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

ITEM 4. CONTROLS AND PROCEDURES

The Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) (the “Exchange Act”) as of the end of the period covered by this report. Based upon that evaluation, the Company’s management, including the Chief Executive Officer and Chief Financial Officer, concluded that the Company’s disclosure controls and procedures are effective in timely alerting them to any material information relating to the Company and its subsidiaries required to be included in the Company’s Exchange Act filings.

There were no significant changes made in the Company’s internal controls 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.

Sarbanes-Oxley Section 404 Compliance

Section 404 of the Sarbanes-Oxley Act of 2002 (the “Act”) will require us to include an internal control report from management in our Annual Report on Form 10-K for the year ended December 31, 2004 and in subsequent Annual Reports thereafter. The internal control report must include the following: (1) a statement of management’s responsibility for establishing and maintaining adequate internal control over financial reporting, (2) a statement identifying the framework used by management to conduct the required evaluation of the effectiveness of our internal control over financial reporting, (3) management’s assessment of the effectiveness of our internal control over financial reporting as of December 31, 2004, including a statement as to whether or not internal control over financial reporting is effective, and (4) a statement that our independent auditors have issued an attestation report on management’s assessment of internal control over financial reporting.

Management acknowledges its responsibility for establishing and maintaining internal controls over financial reporting and seeks to continually improve those controls. In addition, in order to achieve compliance with Section 404 of the Act within the required timeframe, we have been conducting a process to document and evaluate our internal controls over financial reporting. In this regard, we have dedicated internal resources, engaged outside consultants and adopted a detailed work plan to: (i) assess and document the adequacy of internal control over financial reporting; (ii) take steps to improve control processes where required; (iii) validate through testing that controls are functioning as documented; and (iv) implement a continuous reporting and improvement process for internal control over financial reporting. We believe our process for documenting, evaluating and monitoring our internal control over financial reporting is consistent with the objectives of Section 404 of the Act.

Although as stated above we have not made any significant changes in our internal controls over financial reporting in the most recent fiscal quarter, based on our documentation and testing to date, we have made improvements in the documentation, design or effectiveness of internal controls over financial reporting. However, given the risks inherent in the design and operation of internal controls over financial reporting, we can provide no assurance as to our or our independent auditors’ conclusions at December 31, 2004 with respect to the effectiveness of our internal controls over financial reporting.

It should be noted that any system of controls, however well designed and operated, can provide only reasonable, and not absolute, assurance that the objectives of the control system are met. In addition, the design of any control system is based in part upon certain assumptions about the likelihood of future events. Because of these and other inherent limitations of control systems, there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote.

PART II – OTHER INFORMATION

Item 1. Legal Proceedings

The Company has had discussions with the Securities and Exchange Commission (SEC) related to an informal, non-public inquiry, which appears to be primarily related to the other-than-temporary impairment charges announced by the Company in April 2003 in connection with its investments in corporate bond and loan obligations. The SEC has stated that the inquiry should not be regarded as an indication by the SEC or its staff that any violations of law have occurred.

Item 6. Exhibits and Reports on Form 8-K

A – Exhibits

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

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

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

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

B – Reports on Form 8-K

None.


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PART I FINANCIAL INFORMATION:

	Item 1.	Financial Statements (Unaudited)

		Consolidated Statements of Financial Condition as of September 30, 2004 and December 31, 2003		1

		Consolidated Statements of Income for the Three and Nine Months Ended September 30, 2004 and 2003		2

		Consolidated Statements of Changes in Stockholders’ Equity and of Comprehensive Income for the Nine Months Ended September 30, 2004 and 2003		3

		Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2004 and 2003		4-5

		Notes to Consolidated Financial Statements		6-29

	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		30-64

	Item 3.	Quantitative and Qualitative Disclosures About Market Risk		64-67

	Item 4.	Controls and Procedures		68

PART II OTHER INFORMATION:

	Item 1.	Legal Proceedings		69

	Item 6.	Exhibits and Reports on Form 8-K		69

SIGNATURES				70
EX-31.1 SECTION 302 CERTIFICATION OF CEO
EX-31.2 SECTION 302 CERTIFICATION OF CFO
EX-32.1 SECTION 906 CERTIFICATION OF CEO
EX-32.2 SECTION 906 CERTIFICATION OF CFO



Date: November 8, 2004	By /s/ Frank. C. Stipes
	Frank C. Stipes, Esq.
	Chairman of the Board, Chief Executive Officer and President



Date: November 8, 2004	By /s/ Freddy Maldonado
	Freddy Maldonado
	Chief Financial Officer and Vice President of Finance and Investment