UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-K

For the fiscal year ended: December 31, 2004

OR

Commission File No.: 0-21137

R&G FINANCIAL CORPORATION

Registrant’s telephone number, including area code: (787) 758-2424

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act:

Series A-D Noncumulative Perpetual Monthly Income Preferred Stock
(liquidation value $25 per share and par value $.01 per share)

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

Indicate by check mark whether Registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes þ No o

The aggregate value of the 27,780,426 shares of Class B Common Stock of the Registrant issued and outstanding on June 30, 2004, which excludes 1,762,410 shares held by all directors and officers of the Registrant as a group, was approximately $918.4 million. This figure is based on the last known trade price of $33.06 per share of the Registrant’s Class B Common Stock on June 30, 2004.

Number of shares of Class B Common Stock outstanding as of February 28, 2005: 29,572,120. (Does not include 21,559,584 shares of Class A Common Stock that are exchangeable into shares of Class B Common Stock at the option of the holder.)

DOCUMENTS INCORPORATED BY REFERENCE

      List hereunder the following documents incorporated by reference and the Part of the Form 10-K into which the document is incorporated:

(1)	Portions of the Annual Report to Stockholders for the fiscal year ended December 31, 2004 are incorporated into Parts II and IV.

(2)	Portions of the definitive proxy statement for the Annual Meeting of Stockholders are incorporated into Part III.

Table of Contents

PART I

Cautionary Statement Regarding Forward-Looking Statements

      A number of the presentations and disclosures in this Form 10-K, including any statements preceded by, followed by or which include the words “may,” “could,” “should,” “will,” “would,” “hope,” “might,” “believe,” “expect,” “anticipate,” “estimate,” “intend,” “plan,” “assume” or similar expressions constitute forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995.

      These forward-looking statements, implicitly and explicitly, include the assumptions underlying the statements and other information with respect to our beliefs, plans, objectives, goals, expectations, anticipations, estimates, intentions, financial condition, results of operations, future performance and business, including our expectations and estimates with respect to our revenues, expenses, earnings, return on equity, return on assets, efficiency ratio, asset quality and other financial data and capital and performance ratios.

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

	•	the strength of the United States economy in general and the strength of the regional and local economies within Puerto Rico and Florida;
	•	the effects of, and changes in, trade, monetary and fiscal policies and laws, including interest rate policies of the Board of Governors of the Federal Reserve System;
	•	inflation, interest rate, market and monetary fluctuations;
	•	our timely development of new products and services in a changing environment, including the features, pricing and quality of our products and services compared to the products and services of our competitors;
	•	the willingness of users to substitute competitors’ products and services for our products and services;
	•	the impact of changes in financial services policies, laws and regulations, including laws, regulations and policies concerning taxes, banking, securities and insurance, and the application thereof by regulatory bodies;
	•	technological changes;
	•	changes in consumer spending and savings habits; and
	•	regulatory or judicial proceedings.

      If one or more of the factors affecting our forward-looking information and statements proves incorrect, then our actual results, performance or achievements could differ materially from those expressed in, or implied by, forward-looking information and statements contained in this Form 10-K.

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Therefore, we caution you not to place undue reliance on our forward-looking information and statements.

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

ITEM 1: BUSINESS

General

The Company

     R&G Financial Corporation, or the Company, is a Puerto Rico chartered, financial holding company that operates R-G Premier Bank of Puerto Rico, or Premier Bank, a Puerto Rico commercial bank, and R-G Crown Bank, or Crown Bank, a Florida domiciled federal savings bank. The Company also operates R&G Mortgage Corp, or R&G Mortgage, the second largest mortgage company in Puerto Rico, The Mortgage Store of Puerto Rico, Inc., or the Mortgage Store, a subsidiary of R&G Mortgage, and Continental Capital Corp., or Continental, a mortgage banking subsidiary of Crown Bank which does business in the continental United States. The Company also conducts an insurance agency business and offers broker dealer services in Puerto Rico through Home & Property Insurance Corp. and R-G Investments Corporation, respectively.

     The Company is currently in its 33^rd year of operations and operates its business through its subsidiaries. The Company provides a full range of banking services through its banking subsidiaries, Premier Bank with 33 branches in Puerto Rico and Crown Bank with 15 branches in Florida. Banking services include commercial banking services, corporate real estate and business lending, residential construction lending, consumer lending and credit cards, offers a diversified range of deposit products and, to a lesser extent, trust and investment services through its private banking department and our broker-dealer. The Company also provides a range of real estate secured lending activities, including the origination, servicing, purchase and sale of mortgages on single-family residences, the securitization and sale of various mortgage-backed and related securities, the holding and financing of mortgage loans and mortgage-backed and related securities for sale or investment and the purchase and sale of servicing rights associated with such mortgage loans.

     The Company, through its mortgage banking subsidiary R-G Mortgage, is the second largest mortgage loan originator and servicer of mortgages on single-family residences in Puerto Rico.

     In June 2002, the Company acquired Crown Bank, which operates in the Tampa — St. Petersburg — Clearwater and Orlando metropolitan areas. At the time of acquisition, the Company operated 15 full-service offices. According to the Metro Orlando Economic Development Commission, the Orlando market is one of the fastest growing markets in Florida, both generally and for Hispanics in particular (mainly Puerto Rican). Management believes that owning and operating Crown Bank is a cost effective way to access the Hispanic markets in the United States, while providing a strong platform for further expansion in Florida. On October 11, 2004, the Company and Crown Bank entered into a purchase and assumption agreement with SouthTrust Bank to acquire 18 SouthTrust branches located in three banking markets in Florida and one banking market in Georgia. The acquisition was completed on February 18, 2005. In the transaction, Crown Bank assumed deposits and other liabilities of approximately $628.0 million and acquired approximately $502.6 million of primarily commercial real estate, commercial business and consumer loans, as well as cash and other assets. Crown Bank will now operate through 33 full service branches. The transaction permits Crown Bank to expand its Central Florida footprint into nearby Lakeland, Florida and obtain a foothold in the Jacksonville, Florida and Augusta, Georgia markets.

     The Company has generally sought to achieve long-term financial strength and profitability by increasing the amount and stability of its net interest income and non-interest income. The Company has sought to implement this strategy by (i) expanding its retail banking franchise in order to achieve increased market presence and to increase core deposits; (ii) enhancing its net interest income by increasing its loans held for investment, particularly real estate secured loans, and investment securities; (iii) emphasizing the growth of its mortgage banking activities, including the origination and sale of mortgage loans, and growing its loan servicing operation; (iv) developing new business relationships through an increased emphasis on commercial real estate and commercial business lending; (v) diversifying its retail products and services, including an increase in consumer loan originations; (vi) meeting the financial needs of its customers through, among other things, the offering of trust and investment services and insurance products; (vii) expanding its operations in the continental United States; and, (viii) emphasizing controlled growth, while pursuing a variety of acquisition opportunities when appropriate.

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expects a decrease in demand for its mortgage loans as interest rates increase. Reduced demand for mortgage loans results in reduced loan originations and lower gain on sale of loans. Demand for refinancings is particularly sensitive to increases in interest rates.

      Increases in interest rates reduce net interest income. Increases in short-term interest rates reduce net interest income, which is an important part of the Company’s earnings. Net interest income is the difference between the interest the Company receives on its earning assets and the interest the Company pays on its borrowings. Most of the Company’s assets, like its mortgage loans and mortgage-backed securities, are long-term assets. In contrast, a large portion of the Company’s borrowings are short-term. When interest rates rise, the Company must pay more in interest on its borrowings while interest earned on its assets does not rise as quickly, which causes profits to decrease.

      Increases in interest rates may reduce or eliminate gain on sale of mortgage loans. If long-term interest rates increase between the time the Company commits to or establishes an interest rate on a mortgage loan and the time it sells the loan, the Company may realize a reduced gain or a loss on such sale.

      Increases in interest rates may reduce the value of mortgage loans and securities holdings. Increases in interest rates may reduce the value of the Company’s financial assets and have an adverse impact on the Company’s earnings and financial condition. The Company owns a substantial portfolio of mortgage loans, mortgage-backed securities and other debt securities, including interest only strips (IO’s), and trading derivatives, including residual interests in financial asset transfers accounted for as sales considered implied interest rate swaps, which have both fixed and adjustable interest rates. The market value may have an adverse effect on the Company’s earnings and financial condition. In addition, the market value of an obligation with an adjustable interest rate can be adversely affected when interest rates increase due to a lag in the implementation of repricing terms as well as due to caps, which may limit the amount of increase in the obligation’s interest rate.

      Decreases in interest rates may adversely affect the value of the Company’s servicing asset. Decreases in interest rates lead to increases in the prepayment of mortgages by borrowers, which may reduce the value of the Company’s servicing asset. The servicing asset is the estimated present value of the fees the Company expects to receive on the mortgages it services over their expected term. If prepayments increase above expected levels, the value of the servicing asset decreases because the amount of future fees expected to be received by the Company decreases. The Company may be required to recognize this decrease in value by taking a charge against its earnings, which would cause its profits to decrease.

      The Company experienced an increase in prepayments of mortgages as interest rates decreased dramatically during the past two years, which impacted the value of the Company’s servicing asset. As a consequence, the Company recognized impairment charges on its servicing portfolio of $14.1 million for the year ended December 31, 2004. During the last half of 2004, the Board of Governors of the Federal Reserve began tightening monetary policy and the increasing interest rates it charges to banks, which has resulted in an increase in interest rates generally. The Company believes, based on historical experience, that the amount of prepayments and related impairment charges should decrease as interest rates increase.

      The Company is subject to default and recourse risk in connection with its loan originations. From the time that the Company funds the mortgage loans it originates for third parties to the time it sells them, the Company is generally at risk or any mortgage loan defaults. Once the Company sells the mortgage loan, the risk of loss from mortgage loan defaults and foreclosures passes to the purchaser or insurer of the mortgage loans. However, in the ordinary course of business, the Company makes representations and warranties to the purchasers and insurers of mortgage loans. If a borrower defaults on a mortgage loan and there has been a breach of any of these representations or warranties, the Company

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may become liable for the unpaid principal and interest on the defaulted mortgage loan and may be required to repurchase the mortgage loan and bear any subsequent loss on the mortgage loan. In addition, with respect to the non-conventional mortgage loans originated by the Company, which are subsequently securitized and/or sold from time to time, the Company provides recourse in the event of mortgage loan defaults and/or foreclosures or certain documentation deficiencies. At December 31, 2004, there were $2.1 billion of loans subject to such recourse provisions.

      The Company is subject to default risk in connection with loan originations of its banking subsidiaries. Both Premier Bank and Crown Bank are subject to the risk of loss from mortgage loan defaults and foreclosures with respect to the loans originated for their respective portfolios. Notwithstanding the care with which loans are originated, industry experience indicates that a portion of a bank’s loans will become delinquent and a portion of the loans will require partial or entire charge-off. Regardless of the underwriting criteria utilized by Premier Bank and Crown Bank, losses may be experienced as a result of various factors beyond each bank’s control, including, among others, changes in market conditions affecting the value of collateral and problems affecting the credit of the borrower. Due to the concentration of Premier Bank and Crown Bank’s loans in Puerto Rico or Florida, respectively, adverse economic conditions in Puerto Rico and Florida could result in a decrease in the value of either bank’s loan portfolio and underlying collateral. Although loan delinquencies have historically been higher in Puerto Rico than in the continental United States, loan charge-offs have historically been lower than in the continental United States.

      Each of Premier Bank and Crown Bank has established provisions for loan losses, which are charged to operations, in order to maintain the allowance or loan losses at a level which is deemed to be appropriate by management based upon an assessment of prior loss experience, the volume and type of lending being conducted, industry standards, past due loans, general economic conditions in their market area and other factors related to the collectibility of the loan portfolios. Although each bank’s management utilizes its best judgment in providing for loan losses, there can be no assurance that management has accurately estimated the level of future loan losses or that either bank will not have to increase its provisions for loan losses in the future as a result of future increases in non-performing loans or for other reasons beyond the control of either bank. Any such increases in either bank’s provisions for loan losses with respect thereto could have a negative impact on the Company’s future financial condition and/or results of operations.

      The Company’s exposure to larger credit risk will increase as a consequence of the increase in construction and commercial lending activities. Each of the banking subsidiaries of R&G Financial has increased its emphasis on residential construction, commercial real estate and commercial business lending, which is likely to increase overall credit risk. Banks generally charge higher interest rates on commercial and residential construction loans than on residential mortgage loans, because larger loan losses are expected in this business line. Generally, commercial and construction loans are considered to be riskier than residential mortgage loans because they have larger balances to a single borrower or group of related borrowers. In addition, the borrower’s ability to repay a commercial and 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. The properties securing these loans are also more difficult to dispose of in foreclosure. If Premier Bank or Crown Bank experienced loan losses that are higher than its allowance for loan losses, the Company’s profits and financial condition would be adversely affected.

      The Company is subject to risks in servicing loans for others. The Company is also affected by mortgage loan delinquencies and defaults on mortgage loans that the Company services for third parties. Under certain types of servicing contracts, the servicer must forward all or part of the scheduled payments to the owner of the mortgage loan, even when mortgage loan payments are delinquent. Also, to protect

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their liens on mortgaged properties, owners of mortgage loans usually require the servicer to advance mortgage and hazard insurance and tax payments on schedule even though sufficient escrow funds may not be available. The servicer will generally recover its advances from the mortgage owner or from liquidation proceeds when the mortgage loan is foreclosed. However, in the interim, the servicer must absorb the cost of funds advanced during the time the advance is outstanding. Further, the servicer must bear the increased costs of attempting to collect on delinquent and defaulted mortgage loans. In addition, if a default is not cured, the mortgage loan will be cancelled as a result of foreclosure proceedings. As a consequence, the Company is required to forego servicing income from the time such loan becomes delinquent forward.

      The economic hedging transactions which the Company enters into may not be effective in managing its exposure to interest rate risk. The Company uses derivatives to manage its exposure to interest rate risk caused by changes in interest rates. Derivatives include interest rate swaps, interest rate collars, futures, forwards and options. Derivatives are generally either privately-negotiated over-the-counter, or OTC, or standard contracts transacted through regulated exchanges. OTC contracts generally consist of swaps, collars, forwards and options. Exchange-traded derivatives include futures and options. The derivative instruments that the Company may utilize also have their own risks, which include (1) basis risk, which consists of the risk of loss associated with variations in the spread between the asset yield and the funding and/or hedge cost; (2) credit or default risk, which consists of the risk of insolvency or other inability of the counterparty to a particular transaction to perform its obligations thereunder; and (3) legal risk, which consists of the risk that the Company is unable to enforce certain terms of such instruments. All or any of such risks could expose the Company to losses. Consequently, the Company’s profitability may be adversely affected during any period as a result of the use of derivatives in a hedging transaction.

      For financial reporting purposes, the Company’s general policy is to account for derivative instruments on a marked-to-market basis with gains or losses charged to current operations as they occur. Contracts with positive fair value are reported as assets and contracts with negative fair values are reported as liabilities, after the application of netting arrangements, with unrealized gains and losses recorded either in other comprehensive income in the Company’s consolidated statements of financial condition or in the Company’s consolidated statements of income, depending on the purpose for which the derivative is held. Under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, as subsequently amended, the Company may designate a derivative as a hedge of the fair value of a recognized fixed rate asset or liability (“fair value” hedge) only if certain conditions are met. Certain hedging activities related to the fair value of certain beneficial interests retained on financial asset transfers accounted for as sales are reported as trading derivatives. Both the changes in fair value of the hedged item (in this case beneficial interests retained on financial asset transfers accounted for as sales) and changes in fair value of the derivative are included in trading activities in the Company’s consolidated statements of income. The Company recognized pre-tax losses of $2.6 million on such trading derivatives that serve as economic fair value hedges for its beneficial interests retained during the year ended December 31, 2004.

      The Company’s business has historically been concentrated in Puerto Rico, and adverse conditions in Puerto Rico could negatively impact the Company’s operations. The Company’s business activities and credit exposure have historically been concentrated with customers in Puerto Rico. Accordingly, the Company’s financial condition and results of operations have been dependent to a significant extent upon the economic conditions prevailing in Puerto Rico, including the effect of such economic conditions on real estate values. Any significant adverse political or economic developments or

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nature-related occurrences, such as hurricanes, in Puerto Rico, and, in particular, any decline in real estate values, could result in a downturn in loan originations, an increase in the level of nonperforming assets and a reduction in the value of the Company’s loans, real estate owned and mortgage servicing portfolio, all of which would negatively affect the Company’s profitability. While the acquisition and subsequent growth of Crown Bank has facilitated a diversification of overall lending concentration, Crown Bank is subject to similar concentration risks in the Florida markets in which it operates.

      The Company’s origination business could be adversely affected if the Company cannot maintain access to stable funding sources. The Company’s business requires continuous access to various funding sources. While Premier Bank and Crown Bank are able to fund their operations through deposits as well as through longer-term borrowings from the Federal Home Loan Bank, or FHLB, and other alternative sources, the business of R&G Mortgage has been significantly dependent upon short-term borrowings under warehousing lines. Some of these warehousing lines of credit require the maintenance of minimum levels of net worth and debt service and limit the amount of indebtedness and dividends that may be declared.

      While the Company expects to have continued access to credit from the foregoing sources of funds, there can be no assurance that such financing sources will continue to be available or will be available on favorable terms. In the event that the warehousing lines of credit of the Company’s subsidiaries were reduced or eliminated and the Company was not able to replace such lines on a cost-effective basis, the Company would be forced to curtail or cease its mortgage origination business, which would have a material adverse effect on its operations and financial condition. Although the Company’s subsidiaries could also potentially access borrowings from the Company’s banking subsidiaries, any such borrowings would be subject to and limited by certain regulatory restrictions which apply to transactions between banks and their affiliates, including certain of the Company’s subsidiaries.

      For the quarters ended September 30, and December 31, 2004, R&G Mortgage breached a covenant not to pay in excess of 50% of its net income for the fiscal year. The breach was occasioned primarily due to the previously disclosed trading losses during the last two quarters of 2004. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7 hereof. R&G Mortgage’s lender has agreed to waive the breach of covenant for each of the quarters in question. Except as disclosed herein, management of R&G Financial believes that as of December 31, 2004, it was in compliance with all such covenants and restrictions and does not anticipate that such covenants and restrictions will limit its operations.

      The Company’s loan portfolio has significantly increased in recent years and many of the Company’s commercial real estate and commercial construction loans are relatively unseasoned, and defaults on such loans could adversely affect the Company’s financial condition and results of operations. The Company’s total loan portfolio has grown significantly in recent years, from $1.6 billion at December 31, 2000 to $5.1 billion at December 31, 2004. While 52.4% of the Company’s loan portfolio continues to be secured by residential properties, an increasing amount of the Company’s loan portfolio is comprised of commercial real estate loans and commercial construction and land acquisition loans.

      At December 31, 2004, the Company’s commercial real estate, land acquisition and construction portfolios amounted to an aggregate of $2.2 billion or 38.5% of the Company’s loan portfolio. Because such loans are relatively unseasoned, many of the loans may be too new to demonstrate problems. While the Company attempts to mitigate these risks in commercial real estate lending through stringent underwriting criteria and in the case of construction loans, by limiting originations to primarily residential properties, no assurance can be made that an increase in delinquencies and defaults will not occur. Defaults on these loans could negatively effect the Company’s financial condition and results of operations.

      Taxation of the Company’s international banking entity may impact the Company’s future earnings. In January 2004, the Puerto Rico Legislature passed legislation to modify the taxation of international banking entities, or IBEs, organized under the Puerto Rico International Banking Center Law. Under the new legislation, which affects only those entities organized as divisions of banks (as opposed to those organized as separate subsidiaries of banks), the income generated by international bank divisions will be subject to the regular Puerto Rico statutory tax rate to the extent it exceeds 40% of the combined taxable income of the bank and its IBE divisions for the period January 1, 2004 to December

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31, 2004, 30% for the period January 1, 2005 to December 31, 2005, and 20% thereafter. The new law does not impose taxes on IBEs that operate as a subsidiary of a bank.

      The Company presently operates an IBE as a division of Premier Bank. The Company intends to transfer some of the assets of Premier Bank’s IBE to a new IBE that will operate as a subsidiary of Premier Bank, which will allow the Company to continue to enjoy such tax benefits. The Company cannot give any assurance that the legislation may not be further modified in the future in a manner which would reduce the tax benefits available to the Company’s IBE. A reduction of such tax benefits may reduce the Company’s earnings.

      The Company is subject to numerous laws and significant regulation and the failure to comply with these laws and regulations could adversely affect the Company. The Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act, and the related rules and regulations promulgated by the Securities Exchange Commission, or SEC, and the New York Stock Exchange, have increased the scope, complexity and cost of the Company’s corporate governance reporting and disclosure practices. The Sarbanes-Oxley Act imposes a variety of civil and criminal penalties with respect to any violations of such act and the related rules and regulations.

       The USA Patriot Act of 2001, or Patriot Act, and the Bank Secrecy Act, or BSA, contain anti-money laundering and financial transparency laws. The regulations under such acts include standards for verifying client identification at account opening and rules designed to prevent money laundering and to identify parties that may be involved in terrorism. In connection with BSA, as a result of an examination of Premier Bank as of June 2004, in December 2004 the Federal Deposit Insurance Corporation, or FDIC, the Office of Puerto Rico Commissioner of Financial Institutions, or OCFI, and Premier Bank entered into a Memorandum of Understanding, or MOU, to correct and strengthen perceived deficiencies in Premier Bank’s BSA and anti-money laundering programs. Premier Bank is required, among other things, to enhance monitoring, reporting, and documentation, strengthen controls, revise policies, increase its audits and enhance the training of its personnel. Premier Bank has taken certain measures in accordance with a corrective action plan submitted to the FDIC and OCFI, and believes that it is in substantial compliance with the MOU.

      Changes in statutes, regulations and the regulatory environment in which the Company operates could adversely affect the Company. R&G Financial, as a Puerto Rico chartered financial holding company, and its various subsidiaries, are each subject to federal and local governmental supervision and regulation. There are laws and regulations which restrict transactions between the Company and its various subsidiaries. Any change in such regulations, whether by applicable regulators or as a result of legislation subsequently enacted by the Congress of the United States or the applicable local legislatures, could have a substantial impact on the Company’s operations and profitability.

      Competition with other financial institutions could adversely affect the Company’s profitability. The Company faces substantial competition in originating loans and in attracting deposits. The competition in originating loans comes principally from other United States, Puerto Rico and foreign banks, mortgage banking companies, consumer finance companies, insurance companies and other institutional lenders and purchasers of loans. The Company will encounter greater competition as it continues to expand its operations in the continental United States. A number of institutions with which the Company competes have significantly greater assets, capital, name recognition and other resources. In addition, many of the Company’s competitors are not subject to the same federal regulation that governs the Company’s business. As a result, many of the Company’s competitors have advantages in conducting certain businesses and providing certain services. Increased competition could require the Company to increase the rates it offers on deposits or lower the rates it charges on loans, which could adversely affect the Company’s profitability.

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      If the Company was to lose the services of its key individuals, its business would suffer. The Company’s success has been largely dependent on Víctor J. Galán, Chairman of the Board and Chief Executive Officer, and Ramón Prats, Vice Chairman of the Board and President. The Company’s future success will also depend, to a great extent, upon the services of Mr. Galán and Mr. Prats. The Company believes that the prolonged unavailability or the unexpected loss of the services of Mr. Galán and/or Mr. Prats could have a material adverse effect upon the Company, as attracting suitable replacements may involve significant time and/or expense.

      The concentration of ownership in the Company’s stock and disparate voting rights may leave minority stockholders with little control over R&G Financial. Shares of the Company’s Class A common stock are entitled to two votes per share and shares of the Company’s Class B common stock are entitled to one vote per share. At December 31, 2004, Víctor J. Galán, Chairman of the Board and Chief Executive Officer, owned 42.2% of the Company’s outstanding common stock and was entitled to exercise 59.3% of the outstanding voting rights. As a result, Mr. Galán has the power to elect and remove all of R&G Financial’s board of directors and management and to determine the outcome of substantially all other matters to be decided by a vote of stockholders. Mr. Galán’s interest may not necessarily always be consistent with the interests of all other stockholders. Any future offerings of Class A common stock will dilute the voting power of the Class B common stock.

      Certain provisions in the Company’s certificate of incorporation and bylaws could discourage an acquisition of R&G Financial. In addition to the amount of common stock controlled by the Company’s Chairman of the Board and Chief Executive Officer described above under “— The concentration of ownership in the Company’s stock and disparate voting right may leave minority stockholders with little control over R&G Financial,” certain provisions of the Company’s certificate or incorporation and bylaws could have the effect of discouraging non-negotiated takeover attempts, which certain stockholders might deem to be in their interest, and make it more difficult for the Company’s stockholders to remove members of the Company’s board of directors and management. In addition, various federal laws and regulations could affect the ability of a person, firm or entity to acquire the Company or shares of the Company’s common stock.

Banking Operations

      General. The Company provides a full range of banking services through its banking subsidiaries, including residential, commercial and personal loans and a diversified range of deposit products. Premier Bank also provides private banking, trust and other financial services to its customers.

      R&G Financial’s banking business consists principally of holding deposits from the general public and using them, together with funds obtained from other sources, to originate and purchase loans secured primarily by residential real estate, and to purchase mortgage-backed and other securities. To a lesser extent, but with increasing emphasis over the past few years, R&G Financial also originates construction loans and loans secured by commercial real estate, as well as consumer and personal loans and commercial business loans. Such loans offer higher yields, are generally for shorter terms and offer the Company an opportunity to provide a greater range of financial services to its customers. Premier Bank also offers trust services through its trust department. To date, Premier Bank has engaged in business solely in Puerto Rico. Crown Bank conducts business from its Florida locations, and Continental originates retail construction and commercial loans in New York, New Jersey, Connecticut, North Carolina and Florida.

      Residential Loans. At December 31, 2004, R&G Financial’s loans receivable, net, totaled $5.1 billion, that represented 50.3% of R&G Financial’s $10.2 billion of total assets. At such date, all of R&G Financial’s loans receivable were held by its banking subsidiaries. R&G Financial’s loan portfolio

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historically has had a substantial amount of loans secured by first mortgage liens on existing single-family residences. At December 31, 2004, $2.9 billion, or 51.7% of R&G Financial’s total loans held for investment, consisted of such loans, of which all but $1.2 million consisted of conventional loans.

      Construction Loans. At December 31, 2004, retail construction loans amounted to $428.2 million, or 7.6% of R&G Financial’s total loans held for investment, while commercial construction and land acquisition loans amounted to $836.0 million in the aggregate, or 14.9% of total loans held for investment. R&G Financial intends to continue to increase its involvement in single-family residential construction lending. Such loans afford the Company the opportunity to increase the interest rate sensitivity of its loan portfolio.

      Commercial and Consumer Loans. R&G Financial also originates mortgage loans secured by commercial real estate, primarily office buildings, retail stores, warehouses and general purpose industrial space. At December 31, 2004, $896.0 million, or 16.0% of R&G Financial’s total loans held for investment, consisted of such loans. Finally, R&G Financial also offers commercial business loans, including working capital lines of credit, inventory and accounts receivable loans, equipment financing (including equipment and auto leases), term loans, insurance premium loans and loans guaranteed by the Small Business Administration and various consumer loans. At December 31, 2004, consumer loans, some of which are secured by real estate and deposits, amounted to $206.5 million, or 3.7% of total loans held for investment, and commercial business loans (including leases) amounted to $307.5 million, or 5.5% of total loans held for investment.

Mortgage Banking

      Originations. The Company is the second largest mortgage loans originator and servicer of mortgage loans on single-family residences in Puerto Rico. R&G Mortgage is primarily engaged in the business of originating first and second mortgage loans on single-family residential properties secured by real estate. R&G Mortgage also originates residential mortgage loans through The Mortgage Store, its wholly-owned subsidiary. Pursuant to agreements entered into between R&G Mortgage and Premier Bank, non-conforming conventional single-family residential loans and consumer loans secured by real estate are also originated by R&G Mortgage for portfolio retention by Premier Bank. Premier Bank retains most of the nonconforming conventional single-family residential loans because these loans generally do not satisfy resale guidelines of purchasers in the secondary mortgage market, primarily because of size (in the case of “jumbo” loans) or other underwriting technicalities (mostly related to documentation requirements) at the time of origination. However, from time to time, the Company may sell or securitize some of these loans should the need arise for asset/liability management or other considerations. Jumbo loans may be packaged and sold in the secondary market, while loans with underwriting technicalities may be cured through payment experience and subsequently sold. Management believes that these loans are essentially of the same credit quality as conforming loans. During the years ended December 31, 2004, 2003 and 2002, R&G Financial originated a total of $2.3 billion, $2.8 billion and $2.0 billion of residential mortgage loans, respectively. These aggregate originations include loans originated by R&G Mortgage directly for Premier Bank of $1.3 billion, $1.3 billion and $811.8 million during the years ended December 31, 2004, 2003 and 2002, respectively, or 55%, 45% and 41%, respectively, of total originations. The loans originated by R&G Mortgage for Premier Bank are comprised primarily of conventional residential loans and, to a lesser extent, residential construction loans and consumer loans secured by real estate.

      Servicing. R&G Financial’s servicing portfolio has grown significantly over the past several years. At December 31, 2004, R&G Financial’s servicing portfolio totaled $11.4 billion and consisted of a total of 145,324 loans. These amounts include R&G Mortgage’s servicing portfolio, totaling $8.5 billion, and Crown Bank’s servicing portfolio, totaling $2.9 billion, at December 31, 2004. At December

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31, 2004, R&G Financial’s servicing portfolio included $2.1 billion of loans serviced for Premier Bank and $647.7 million of loans serviced for Crown Bank, or 18.3% and 5.7%, respectively, of the total servicing portfolio. Substantially all of the mortgage loans in R&G Financial’s servicing portfolio are secured by single-family residences. R&G Financial generally retains the servicing function with respect to the loans that have been securitized and sold.

      Securitizations. R&G Financial pools Federal Housing Administration, or FHA, and Veterans Administration, or VA, loans into mortgage-backed securities that are guaranteed by the Government National Mortgage Association, the GNMA. These securities are sold to securities broker-dealers and other investors in Puerto Rico. Conventional loans may either be sold directly to agencies such as the Federal National Mortgage Association, or FNMA, and the Federal Home Loan Mortgage Corporation, or FHLMC, or to private investors, or may be pooled into FNMA or FHLMC mortgage-backed securities, that are generally sold to investors. During the years ended December 31, 2004, 2003 and 2002, R&G Financial sold $1.2 billion, $1.6 billion and $1.2 billion of loans respectively, as part of its mortgage banking activities, that includes loans securitized and sold, but does not include loans originated for Premier Bank.

Regulation

      The Company operates its businesses under a variety of federal, state and Puerto Rico laws and rules. As a financial holding company, it is subject to the rules of the Board of Governors of the Federal Reserve System and the OCFI. Among other things, the Company is required to meet minimum capital requirements, and its activities are limited to those that are determined to be financial in nature or incidental or complimentary to a financial activity.

      Premier Bank is subject to extensive regulation and examination by the FDIC and by the OCFI, and Crown Bank is subject to extensive regulation and supervision by the Office of Thrift Supervision, or OTS. This regulation and supervision establishes a comprehensive framework of activities in which the Company’s banking subsidiaries can engage. In addition, the FDIC and the OTS are required to take “prompt corrective action” if a given bank does not meet its minimum capital requirements. The FDIC and the OTS have established five capital tiers to implement this requirement, from “well-capitalized” to “critically undercapitalized.” A bank’s capital tier will depend on various capital measures and other qualitative factors and will subject it to specific requirements. As of December 31, 2004, Premier Bank and Crown Bank met the capital measures for being “well-capitalized” under the regulations.

      The Company’s mortgage banking business is subject to the rules of the FHA, VA, GNMA, FNMA, FHLMC and the Department of Housing and Urban Development with respect to originating, processing, selling and servicing mortgage loans. In addition to these rules, the Company’s Puerto Rico mortgage banks are subject to the rules of the OCFI and Continental is subject to the rules of the OTS. Among other things, all of these rules prohibit discrimination, establish underwriting guidelines, require credit reports, fix maximum loan amounts and, in some cases, fix maximum interest rates.

Lending Activities from Banking Operations

      General. At December 31, 2004, R&G Financial’s loans receivable, net totaled $5.1 billion, which represented 50.3% of R&G Financial’s $10.2 billion of total assets. At December 31, 2004, all of R&G Financial’s loans receivable, net were held by its banking subsidiaries. The principal category of loans in R&G Financial’s portfolio is conventional loans that are secured by first liens on single-family residences. Conventional residential real estate loans are loans that are neither insured by the FHA nor

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partially guaranteed by the VA. At December 31, 2004, all but $1.2 million of R&G Financial’s first mortgage single-family residential loans consisted of conventional loans. The other principal categories of loans in R&G Financial’s loans receivable, net portfolio are second mortgage residential real estate loans, construction loans, commercial real estate loans, commercial business loans and consumer loans.

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      Loan Portfolio Composition. The following table sets forth the composition of R&G Financial’s loan portfolio by type of loan at the dates indicated. Except as noted in the footnotes to the table, all of the loans are held by banking subsidiaries of R&G Financial.

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      Contractual Principal Repayments and Interest Rates. The following table sets forth certain information at December 31, 2004 regarding the dollar amount of loans maturing in R&G Financial’s total loan portfolio based on the contractual terms to maturity. Loans having no stated schedule of repayments and no stated maturity are reported as due in one year or less.

      The following table sets forth the dollar amount of total loans at December 31, 2004 that have fixed interest rates or that have floating or adjustable interest rates.

      Scheduled contractual amortization of loans does not reflect the expected term of R&G Financial’s loan portfolio. The average life of loans is substantially less than their contractual terms

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because of prepayments and due-on-sale clauses that give R&G Financial the right to declare a conventional loan immediately due and payable in the event, among other things, that the borrower sells the real property subject to the mortgage and the loan is not repaid. The average life of mortgage loans tends to increase when current mortgage loan rates are higher than rates on existing mortgage loans and, conversely, decrease when rates on existing mortgage loans are lower than current mortgage loan rates (due to refinancing of adjustable-rate and fixed-rate loans at lower rates). Under the latter circumstance, the weighted average yield on loans decreases as higher-yielding loans are repaid or refinanced at lower rates.

      Origination, Purchases and Sales of Loans. The following table sets forth loan originations, purchases and sales from banking operations for the periods indicated.

      R&G Financial, through its banking subsidiaries, originates for both investment and sale mortgage loans secured by residential real estate (secured by both first and second mortgage liens) as well as construction loans (for residential real estate), commercial real estate loans, commercial business loans and consumer loans.

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      R&G Mortgage assists Premier Bank in meeting its loan production targets and goals by, among other things, (i) advertising, promoting and marketing to the general public; (ii) interviewing prospective borrowers and conducting the initial processing of the requisite loan applications, consistent with Premier Bank’s underwriting guidelines; and (iii) providing personnel and facilities with respect to the execution of loan agreements approved by Premier Bank. R&G Mortgage performs the foregoing loan origination services on behalf of Premier Bank with respect to residential mortgage loans, some commercial real estate loans and construction loans. R&G Mortgage receives from Premier Bank 75% of the applicable loan origination fee with respect to loans originated by R&G Mortgage on behalf of Premier Bank. During the years ended December 31, 2004, 2003 and 2002, R&G Mortgage received $14.7 million, $15.6 million and $11.6 million, respectively, of loan origination fees with respect to loans originated by R&G Mortgage on behalf of Premier Bank. These fees are eliminated in consolidation in R&G Financial’s Consolidated Financial Statements. See “— Regulation — R&G Financial — Limitations on Transactions with Affiliates.”

      R&G Financial originates commercial real estate, commercial business and consumer loans. Applications for commercial real estate, commercial business and unsecured consumer loans are taken at all branch offices of the Company’s banking subsidiaries, and may be approved by lending officers of each banking subsidiary within designated limits that are established and modified from time to time to reflect an individual’s expertise and experience. All loans in excess of an individual’s designated limits are referred to an officer with the requisite authority. In addition, Premier Bank’s Management Credit Committee is authorized to approve all loans not exceeding $5.0 million, and the Executive Committee of the Board of Directors is authorized to approve all loans exceeding $5.0 million. In the case of Crown Bank, all loans over $1.0 million require approval by Crown Bank’s Credit Committee and Board of Directors. Management of R&G Financial believes that its relatively centralized approach to approving loan applications ensures strict adherence to its underwriting guidelines, while still allowing the Company to approve loan applications on a timely basis.

      R&G Financial also purchases conventional loans secured by first liens on single-family residential real estate from unrelated financial institutions. Such loan purchases are underwritten pursuant to the same guidelines as direct loan originations. During the years ended December 31, 2004, 2003 and 2002, Premier Bank purchased $207.2 million, $7.1 million and $236.2 million of loans, respectively, and Crown Bank purchased $399.9 million and $423.7 million during the years ended December 31, 2004 and 2003. Crown Bank did not purchase any such loans during the year ended December 31, 2002.

      During the years ended December 31, 2004, 2003 and 2002, loans sold from banking operations were $981.4 million, $254.0 million and $35.3 million, respectively. These loans, which were primarily nonconforming loans at the time of origination, were generally sold in packages in privately negotiated transactions with FNMA and FHLMC or other private parties.

      Loans sold from banking institutions may include loans sold in which the Company promises to pay a variable yield to the investor. As part of its risk management activities, the Company may purchase variable yielding loans from the same counterparty to achieve an economic hedge against loans sold to other counterparties at variable yields. During late 2004, the Company sold $200.0 million conventional loans to another financial institution; on the same date, the Company acquired other loans totaling approximately $201.0 million from the same financial institution.

      R&G Mortgage services all loans held in Premier Bank’s portfolio (including single-family residential loans retained by Premier Bank, commercial real estate, commercial business and consumer loans (although R&G Mortgage does not actually acquire such servicing rights)). In addition, Premier Bank processes payments on all loans serviced by R&G Mortgage on behalf of Premier Bank. Finally, R&G Mortgage renders securitization services with respect to the pooling of some of Premier Bank’s mortgage loans into mortgage-backed securities. See “— Mortgage Banking Activities.”

      Single-Family Residential Real Estate Loans. R&G Financial historically has had a substantial portion of its lending activities in the origination of loans secured by first mortgage liens on existing single-family residences. At December 31, 2004, $2.9 billion or 51.7% of R&G Financial’s total loans held for investment consisted of such loans, of which all but $1.2 million consisted of conventional loans. Premier Bank’s first mortgage single-family residential loans consist exclusively of fixed-rate loans with

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terms of between 15 and 30 years. As evidenced by this statistic, the Puerto Rico residential mortgage market has not been receptive to long-term adjustable rate mortgage loans.

      R&G Financial’s first mortgage single-family residential loans typically do not exceed 80% of the appraised value of the security property. Pursuant to underwriting guidelines adopted by its Board of Directors, R&G Financial may lend up to 95% of the appraised value of the property securing a first mortgage single-family residential loan provided it is with private mortgage insurance with respect to the top 25% of the loan.

      The Company also originates loans secured by second mortgages on single-family residential properties. At December 31, 2004, $40.5 million or 0.7% of R&G Financial’s total loans held for investment consisted of second mortgage loans on single-family residential properties. R&G Financial offers such second mortgage loans in amounts up to $125,000 for a term not to exceed 15 years. The loan-to-value ratio of second mortgage loans generally is limited to 75% of the property’s appraised value (including the first mortgage).

      Construction Loans. At December 31, 2004, retail construction (“spot”) loans amounted to $428.2 million or 7.6% of R&G Financial’s total loans held for investment, while commercial construction and land acquisition loans amounted to $836.0 million or 14.9% of total loans held for investment.

      Premier Bank and Crown Bank offer “spot” loans to individual borrowers for the purpose of constructing single-family residences. Substantially all of the Company’s construction lending to individuals is originated on a construction/permanent mortgage loan basis. Construction/permanent loans are made to individuals who hold a contract with a general contractor acceptable to the Company to construct their personal residence. The construction phase of the loan provides for monthly payments on an interest only basis at a designated fixed rate for the term of the construction period, that generally does not exceed nine months. Thereafter, the permanent loan is made at then market rates, provided that such rate shall not be more than 2% greater than the interim construction rate. In the case of Premier Bank, R&G Mortgage’s construction loan department approves the proposed contractors and administers the loan during the construction phase. The Company’s construction/permanent loan program has been successful due to its ability to offer borrowers a single closing and, consequently, reduced costs.

      R&G Financial also originates construction loans to developers to develop single-family residential properties. At December 31, 2004, R&G Financial had residential construction loans to develop single-family residences with an aggregate principal balance of $366.3 million. Commitments for future funding included in such amount approximate $181.9 million. In addition, R&G Financial had loans to develop commercial properties with an aggregate principal balance of $95.6 million. All loans were performing in accordance with their terms at December 31, 2004.

      In addition to the foregoing, at December 31, 2004, R&G Financial had land acquisition loans with an aggregate balance of $373.2 million, that were made in connection with projects to construct single-family residences. R&G Financial and the financial institution that made the interim construction loan have entered into an agreement pursuant to which R&G Financial is to be paid a percentage of the proceeds from each home as it is released upon construction and sale. R&G Financial expects to make the permanent construction loan on some of these projects. Premier Bank also had made a working capital/pre-development loan with an outstanding principal balance of $1.0 million at December 31, 2004 that is secured by land.

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      R&G Financial intends to continue to increase its involvement in single-family residential construction lending. Such loans afford the Company the opportunity to increase the interest rate sensitivity of its loan portfolio. Construction lending is generally considered to involve a higher level of risk as compared to permanent single-family residential lending, due to the concentration of principal in a limited number of loans and borrowers and the effects of general economic conditions on real estate developers and managers. Moreover, a construction loan can involve additional risks because of the inherent difficulty in estimating both a property’s value at completion of the project and the estimated costs (including interest) of the project. The nature of these loans is such that they are generally more difficult to evaluate and monitor. The Company has taken steps to minimize the foregoing risks by, among other things, limiting its construction lending primarily to residential properties. In addition, the Company has adopted underwriting guidelines that impose stringent loan-to-value, debt service and other requirements for loans that are believed to involve higher elements of credit risk and by working with builders with whom it has established relationships or knowledge thereof. At December 31, 2004, $1.4 million of R&G Financial’s retail construction loans were classified as non-performing. As of such date, $711,000 of commercial construction or land acquisition loans were non-performing.

      Commercial Real Estate Loans. The Company also originates mortgage loans secured by commercial real estate. At December 31, 2004, $896.0 million or 16.0% of R&G Financial’s total loans held for investment consisted of such loans. At December 31, 2004, $19.1 million of R&G Financial’s commercial real estate loans were classified as non-performing.

      Commercial real estate loans of the Company are primarily secured by office buildings, retail stores, warehouses and general purpose industrial space. Although terms vary, commercial real estate loans generally are amortized over a period of 7 to 15 years in Premier Bank and 10 to 20 years in Crown Bank, and have maturity dates of 5 to 7 years in Premier Bank and 3 to 10 years in Crown Bank. R&G Financial generally originates these loans with interest rates that adjust monthly in accordance with a designated prime rate plus a margin, which generally is negotiated at the time of origination. Such loans will have a floor but no ceiling on the amount by which the rate of interest may adjust over the loan term. Loan-to-value ratios on the Company’s commercial real estate loans are currently limited to 80% or lower. As part of the criteria for underwriting commercial real estate loans, R&G Financial generally requires a debt coverage ratio (the ratio of net cash from operations before payment of debt service to debt service) of 1.20 or more. It is also the Company’s policy to seek additional protection to mitigate any weaknesses identified in the underwriting process. Additional coverage may be provided through mortgage insurance, secondary collateral and/or personal guarantees from the principals of the borrower.

      Commercial real estate lending entails different and significant risks when compared to single-family residential lending because such loans typically involve large loan balances to single borrowers and because the payment experience on such loans is typically dependent on the successful operation of the project or the borrower’s business. These risks can also be significantly affected by supply and demand conditions in the local market for apartments, offices, warehouses or other commercial space. R&G Financial attempts to minimize its risk exposure by limiting the extent of its commercial lending generally. In addition, the Company imposes stringent loan-to-value ratios, requires conservative debt coverage ratios, and continually monitors the operation and physical condition of the collateral. Although the Company has begun to increase its emphasis on commercial real estate lending, management does not currently anticipate that the commercial real estate loans portfolio will grow significantly as a percentage of the total loan portfolio. As of December 31, 2004, no significant industry concentration exists among the Company’s commercial real estate loan portfolio.

      Commercial Business Loans. The Company offers commercial business loans, including working capital lines of credit, inventory and accounts receivable loans, equipment financing (including equipment leases), term loans, insurance premiums loans and loans guaranteed by the Small Business Administration. Depending on the collateral pledged to secure the extension of credit, maximum loan to

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value ratios are 75% or less, with exceptions permitted to a maximum of 80%. Loan terms may vary from one to 15 years. The interest rates on such loans are generally variable and are indexed to a designated prime rate, plus a margin. The Company also generally obtains personal guarantees from the principals of the borrowers. At December 31, 2004, commercial business loans (including leases) amounted to $307.5 million or 5.5% of total loans held for investment. Although the Company has begun to increase its emphasis on commercial business lending, management does not currently anticipate that its portfolio of commercial business loans will grow significantly as a percentage of the total loan portfolio.

      Consumer Loans. R&G Financial also originates consumer loans. At December 31, 2004, $206.5 million or 3.7% of R&G Financial’s total loans held for investment consisted of consumer loans. This amount is comprised mostly of credit cards and other unsecured loans, but the Company also offers real estate secured consumer loans (which in the case of Premier Bank are originated by R&G Mortgage) and deposit accounts. Although R&G Financial has begun to increase the emphasis on consumer lending, management does not currently anticipate that its portfolio of consumer loans will grow significantly as a percentage of the total loan portfolio.

      R&G Financial’s unsecured consumer loans consisted principally of credit card receivables and personal loans. At December 31, 2004, credit card receivables, all held by Premier Bank, totaled $67.3 million, and personal loans amounted to $70.4 million. Most credit card receivables are offered to targeted customers, which include referrals (cross selling) from other segments/divisions of the Company. The Company has established minimum FICO scores for these loans. R&G Financial also offers loans secured by deposit accounts, that amounted to $24.3 million at December 31, 2004. Such loans are originated generally for up to 90% of the account balance, with a hold placed on the account restricting the withdrawal of the account balance. In addition, R&G Financial offers real estate secured loans in amounts up to 75% of the appraised value of the property, including the amount of any existing prior liens. Such loans generally have shorter terms and higher interest rates than other mortgage loans. Real estate secured consumer loans generally have a maximum term of 10 years, which may be extended at management’s sole discretion in certain circumstances, and an interest rate that is set at a fixed rate based on market conditions. The loans are secured with a first or second mortgage on the property, including loans where another institution holds the first mortgage. At December 31, 2004, real estate secured consumer loans totaled $44.5 million. Most of the Company’s secured consumer loans have been primarily obtained through newspaper advertising, although such loans are also obtained from existing and walk-in customers.

      Consumer loans generally have shorter terms and higher interest rates than mortgage loans but generally involve more credit risk than mortgage loans because of the type and nature of the collateral and, in certain cases, the absence of collateral. In addition, consumer lending collections are dependent on the borrower’s continuing financial stability, and thus are more likely to be adversely effected by job loss, divorce, illness and personal bankruptcy. In many cases, any repossessed collateral for a defaulted consumer loan will not provide an adequate source of repayment of the outstanding loan balance because of improper repair and maintenance of the underlying security. The remaining deficiency may not warrant further substantial collection efforts against the borrower. As a matter of policy, R&G Financial charges-off any unsecured consumer loans delinquent over 120 days. At December 31, 2004, $3.7 million of consumer loans were classified as non-performing, of which $2.5 million were secured by real estate.

      Asset Quality. When a borrower fails to make a required payment on a loan, R&G Financial attempts to cure the deficiency by contacting the borrower and seeking payment. Contacts are generally made between the 10th and 15th day after a payment is due. In most cases, deficiencies are cured promptly. If a delinquency extends beyond 15 days, the loan and payment history is reviewed and efforts are made to collect the loan. While R&G Financial generally prefers to work with borrowers to resolve such problems, when the account becomes 90 days delinquent in the case of mortgage loans, R&G

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Financial does institute foreclosure or other proceedings, as necessary, to minimize any potential loss. In the case of consumer loans, the Company refers the file for collection action after 60 days.

      Loans secured by real estate are placed on non-accrual status when, in the judgment of management, the probability of collection of interest is deemed to be insufficient to warrant further accrual. When such a loan is placed on non-accrual status, previously accrued but unpaid interest is deducted from interest income. As a matter of policy, R&G Financial does not accrue interest on loans past due 90 days or more that are secured by real estate, except for certain residential mortgage loans in which the probability of collection of interest is deemed sufficient to warrant accrual. The Company generally does not accrue interest on consumer loans past due over 90 days.

      Real estate acquired by the Company as a result of foreclosure or by deed-in-lieu of foreclosure is classified as real estate owned until sold. Pursuant to a statement of position (“SOP 92-3”) that provides guidance on determining the balance sheet treatment of foreclosed assets in annual financial statements, there is a rebuttable presumption that foreclosed assets are held for sale and such assets are recommended to be carried at the lower of fair value minus estimated costs to sell the property, or cost (generally the balance of the loan on the property at the date of acquisition). After the date of acquisition, all costs incurred in maintaining the property are expensed and costs incurred for the improvement or development of such property are capitalized up to the extent of their net realizable value. The Company’s accounting for its real estate owned complies with the guidance set forth in SOP 92-3.

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      The following table sets forth the amounts and categories of R&G Financial’s non-performing assets at the dates indicated. R&G Financial did not have any troubled debt restructurings at any of the periods presented. Except as otherwise indicated in the footnotes to the table, the non-performing assets are assets of banking subsidiaries of the Company.

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      Non-performing loans amounted to $108.3 million at December 31, 2004, as compared to $85.4 million at December 31, 2003. The increase in the aggregate amount of non-performing loans during 2004 is due primarily to an increase in residential real estate non-performing loans in the process of being foreclosed of $25.8 million, partially offset by a decrease of $3.4 million in non-performing commercial real estate loans. An aggregate of $82.9 million or 76.5% of non-performing loans held at December 31, 2004 consisted of residential mortgage loans. Because of the nature of the collateral, R&G Financial has historically recognized a low level of loan charge-offs. R&G Financial’s aggregate charge-offs amounted to 0.27% during 2004, as compared to 0.32% during 2003. Although loan delinquencies have historically been higher in Puerto Rico than in the United States, loan charge-offs have historically been lower than in the United States.

      Non-performing residential loans increased by $26.4 million or 46.2% from December 31, 2003 to December 31, 2004. The average loan balance on non-performing mortgage loans amounted to $74,000 at December 31, 2004. As of such date, 628 loans with an aggregate balance of $52.6 million (including 85 consumer loans secured by real estate with an aggregate balance of $1.4 million) were in the process of foreclosure. The total delinquency ratio (including loans past due less than 90 days) on residential mortgages of banking subsidiaries, excluding consumer loans secured by real estate, increased from 3.09% in 2003 to 3.48% in 2004. The Company’s loss experience on such portfolio has been minimal over the last several years.

      Non-performing commercial real estate loans decreased by $3.4 million or 15.2% from $22.6 million at December 31, 2003 to $19.1 million at December 31, 2004. The decrease in non-performing commercial real estate loans is attributable to a decrease of $5.4 million of such loans in Premier Bank, partially offset by an increase of $674,000 in Crown Bank, as certain borrowers brought their loans current during the year ended December 31, 2004. The number of loans delinquent over 90 days amounted to 90 loans at December 31, 2004, with an average balance of $213,000. The largest non-performing commercial real estate loan as of December 31, 2004 had a balance of $2.4 million.

      Non-performing commercial business loans consist of 27 loans. Such loans include three loans with an aggregate balance of $1.1 million which are 90% guaranteed by the Small Business Administration, 14 commercial leases amounting to $199,000 and six other commercial business loans with an aggregate balance of $215,000. These loans have a combined average loan size of $69,000. The largest non-performing commercial business loan as of December 31, 2004 had a $786,000 balance.

      At December 31, 2004, R&G Financial’s five largest loans-to-one borrower and their related entities amounted to $51.9 million, $50.7 million, $38.5 million, $30.5 million and $29.0 million. All of such loan concentrations were performing at December 31, 2004.

      At December 31, 2004, R&G Financial’s allowance for loan losses totaled $51.9 million, which represented a $12.3 million or 31.0% increase from the level maintained at December 31, 2003. At December 31, 2004, R&G Financial’s allowance represented approximately 0.92% of the total loan portfolio and 47.90% of total non-performing loans, as compared to 0.92% and 46.38% at December 31, 2003. The increase in the allowance for loan losses reflects the increase in R&G Financial’s commercial real estate and construction loan portfolios, which have higher inherent credit risk compared to residential loans.

      Allowance for Loan Losses. It is the policy of the Company to maintain an allowance for estimated losses on loans based on a number of quantitative and qualitative factors, including levels and trends of past due and nonaccrual loans, levels and trends in asset classifications, change in volume and

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mix of loans and collateral values. Quantitative factors used to assess the adequacy of the allowance for loan losses are established based upon management’s assessment of the credit risk in the portfolio, historical loan loss experience and the Company’s loan underwriting policies as well as management’s judgment and experience. Provisions for loan losses are provided on both a specific and general basis. Specific and general valuation allowances are increased by provisions charged to expense and decreased by charge-offs of loans, net of recoveries. Specific allowances are provided for impaired loans for which the expected loss is measurable. General valuation allowances are provided based on a formula that incorporates the factors discussed above. R&G Financial periodically reviews the assumptions and formula by which additions are made to the specific and general valuation allowances for losses in an effort to refine such allowances in light of the current status of the factors described above.

      Although management believes that it uses the best information available to make such determinations, future adjustments to the allowance may be necessary, and net earnings could be significantly affected, if circumstances differ substantially from the assumptions used in making the initial determinations. The Company’s amount of future losses is susceptible to changes in economic, operating and other conditions, including changes in interest rates, that may be beyond the Company’s control and future losses may exceed current estimates. Premier Bank’s and Crown Bank’s Internal Asset Review Committee undertakes a monthly evaluation of the adequacy of the allowance for loan losses, which is reviewed and approved at least quarterly by the Board of Directors. The Company provides an allowance to absorb losses that are both probable and reasonably quantifiable as well as for those that are not specifically identified but can be reasonably estimated.

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      The following table sets forth an analysis of R&G Financial’s allowance for loan losses during the periods indicated, of which $49.4 million is maintained against the loan portfolios of the banking subsidiaries at December 31, 2004:

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      The following table sets forth information concerning the allocation of R&G Financial’s allowance for loan losses by loan category at the dates indicated.

      The allowance for loan losses reflects management’s judgment of the level of allowance adequate to absorb estimated credit losses inherent in R&G Financial’s loan portfolio. The Board of Directors of R&G Financial approved a policy formulated by management for a systematic analysis of the adequacy of the allowance. The major elements of the policy consist of: (1) a monthly analysis of reserve amounts at Premier Bank (quarterly at Crown Bank); (2) approval by the Board of Directors of each banking subsidiary of the periodic analysis; and (3) division of the reserve into specific allocation and general reserve portions. The analysis is based on management’s assessment of the historic rate of losses in addition to concentration, segmentation, regional economic conditions, non-performing loan and asset levels, past due status, composition of the portfolio, and other factors.

      Specific Allocations. All classified loans are evaluated for loss portions or potential loss exposure. The evaluation occurs at the time the loan is classified and on a regular basis (at least every 360 days) thereafter. This evaluation is documented in the Internal Asset Review Report relating to a specific loan. Specific allocation of reserves considers the value of collateral, the financial condition of the borrower, and industry and current economic trends.

      General Allowances. Management realizes that an institution’s past loss history should be considered in evaluating the inherent loss potential of the loan portfolio. Consequently, management has deemed it prudent to develop and implement a migration analysis for the determination of inherent loss

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potential for both its homogeneous and non-homogeneous loan portfolios. Homogeneous loan categories consist of one-to-four family residential mortgages and consumer loans. Commercial business and commercial real estate loans less than $500,000 are also treated as homogeneous loans for asset review purposes. Homogeneous loans are analyzed on a group or pool basis for evaluating credit quality and impairment under FASB’s SFAS No 5. Non-homogeneous loan categories consist of all other commercial business and commercial real estate loans. These assets are reviewed individually for the purpose of evaluating credit quality and impairment under FASB’s SFAS No. 114. The migration loss percentage factors used for each risk class or grade for both homogeneous and non-homogeneous loan categories are based on the results of a 3 year write-off experience migration analysis.

      General allowances are derived for consumer lending utilizing historical loss factors derived through migration analysis and adjusting for current trends, economic conditions and portfolio behavioral characteristics. Consumer lending poses more inherent risks than one-to-four family residential lending and, consequently, the loss factors are higher. Because of the Company’s limited loss history for one-to-four family residential loans in Crown Bank, general allowances for Crown Bank are derived utilizing historical industry loss factors, also adjusted for management’s assessment of the qualitative factors presented above. Loss factors are applied based upon delinquency status with higher loss factors applied as the number of days past due increases.

Mortgage Banking Activities

      Loan Originations, Purchases and Sales. During the years ended December 31, 2004, 2003 and 2002, R&G Financial originated a total of $2.3 billion, $2.8 billion and $2.0 billion of residential mortgage loans, respectively. These aggregate originations include loans originated by R&G Mortgage directly for Premier Bank of $1.3 billion, $1.3 billion and $811.8 million during the years ended December 31, 2004, 2003 and 2002, respectively, of such originations, or 55%, 45% and 41% respectively, of total originations. The loans originated by R&G Mortgage for Premier Bank are comprised primarily of conventional residential loans and, to a lesser extent, consumer loans secured by real estate.

      R&G Financial is engaged to a significant extent in the origination of FHA-insured and VA-guaranteed single-family residential loans that are primarily securitized into GNMA mortgage-backed securities and sold to institutional and/or private investors in the secondary market. During the years ended December 31, 2004, 2003 and 2002, R&G Financial originated $175.7 million, $358.9 million and $365.2 million, respectively, of FHA/VA loans, which represented 7.5%, 12.7% and 18.6%, respectively, of total loans originated during such respective periods.

      R&G Financial also originates conventional single-family residential loans which are either insured by private mortgage insurers or do not exceed 80% of the appraised value of the mortgaged property. During the years ended December 31, 2004, 2003 and 2002, R&G Financial originated $2.2 billion, $2.5 billion and $1.6 billion, respectively, of conventional single-family residential mortgage loans. Substantially all conforming conventional single-family residential loans are securitized and sold in the secondary market, while a substantial portion of non-conforming conventional single-family residential loans are originated by R&G Mortgage (either directly or through The Mortgage Store) on behalf of Premier Bank and either held by Premier Bank in its portfolio or subsequently securitized by R&G Mortgage and/or sold in the secondary market from time to time.

      Non-conforming loans generally consist of loans which, primarily because of size or other underwriting technicalities (mostly related to documentation requirements) which may be cured through seasoning, do not satisfy the guidelines for resale of FNMA, FHLMC, GNMA and other private secondary market investors at the time of origination. Management believes that these loans are

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essentially of the same credit quality as conforming loans. In connection with mortgage operations, during the years ended December 31, 2004, 2003 and 2002, non-conforming conventional loans represented approximately 63%, 52% and 54%, respectively, of R&G Financial’s total volume of mortgage loans originated, most of which were originated by R&G Mortgage on behalf of Premier Bank. During the years ended December 31, 2004, 2003 and 2002, 95.2%, 96.3% and 94.1% of loans originated by R&G Mortgage on behalf of Premier Bank consisted of single-family residential loans during such respective periods. R&G Mortgage originates single-family residential, construction and commercial real estate loans on behalf of Premier Bank pursuant to the terms of a Master Production Agreement between R&G Mortgage and Premier Bank. See “— Lending Activities from Banking Operations — Origination, Purchase and Sale of Loans.”

      While R&G Financial makes available a wide variety of mortgage products designed to respond to consumer needs and competitive conditions, it currently emphasizes 15-year and 30-year conventional first mortgages and 15-year and 30-year FHA loans and VA loans. Substantially all of such loans consist of fixed-rate mortgages. R&G Financial also offers second mortgage loans up to $125,000 with a maximum term of 15 years. The maximum loan-to-appraised value ratio on second mortgage loans permitted by R&G Financial is generally 75% (including the amount of any first mortgage). In addition, R&G Financial also offers real estate secured consumer loans up to $60,000 with a maximum term of 15 years. The maximum loan-to-appraised value ratio on real estate secured consumer loans permitted by R&G Financial is generally 80%. R&G Financial will secure such loans with either a first or second mortgage on the property.

      The Company’s loan origination activities in Puerto Rico are conducted out of R&G Mortgage offices and mortgage banking centers, and in the continental United States, mainly through loan officers and solicitors, out of Crown Bank’s branches and Continental’s mortgage offices. Residential mortgage loan applications are attributable to walk-in customers, existing customers and advertising and promotion, referrals from real estate brokers and builders, loan solicitors and mortgage brokers.

      Loan origination activities performed by the Company include soliciting, completing and processing mortgage loan applications and preparing and organizing the necessary loan documentation. Loan applications are examined for compliance with underwriting criteria and, if all requirements are met, the Company issues a commitment to the prospective borrower specifying the amount of the loan and the loan origination fees, points and closing costs to be paid by the borrower or seller and the date on which the commitment expires.

      R&G Mortgage also purchases FHA loans and VA loans from other mortgage bankers for resale to institutional investors and other investors in the form of GNMA mortgage-backed securities. R&G Mortgage’s strategy is to increase its servicing portfolio primarily though internal originations through its branch network and, to a lesser extent, purchases from third parties. Purchases of loans from other mortgage bankers in the wholesale loan market are generally limited to FHA loans and VA loans and such purchases provide R&G Mortgage with a source of low cost production that allows R&G Mortgage to continue to increase the size of its servicing portfolio. R&G Mortgage purchased $22.7 million, $23.7 million and $21.9 million of loans from third parties during the years ended December 31, 2004, 2003 and 2002, respectively.

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      The following table sets forth loan originations, purchases and sales by R&G Financial from its mortgage banking business for the periods indicated.

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      All loan originations, regardless of whether originated by the Company or purchased from third parties, must be underwritten in accordance with R&G Financial’s underwriting criteria, including loan-to-appraised value ratios, borrower income qualifications, debt ratios and credit history, investor requirements, necessary insurance and property appraisal requirements. R&G Financial’s underwriting standards also comply with the relevant guidelines set forth by HUD, VA, FNMA, FHLMC, bank regulatory authorities, private mortgage investment conduits and private mortgage insurers, as applicable. The Company’s underwriting personnel, while operating out of its loan offices, make underwriting decisions independent of the Company’s mortgage loan origination personnel.

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      Typically, when a mortgage loan is originated, the borrower pays an origination fee. These fees are generally in the range of 0% to 7% of the principal amount of the mortgage loan, and are payable at the closing of such loan. The Company receives these fees on mortgage loans originated through its retail branches. The Company may charge additional fees depending upon market conditions and regulatory considerations as well as the Company’s objectives concerning mortgage loan origination volume and pricing. The Company incurs certain costs in originating mortgage loans, including overhead, out-of-pocket costs and, in some cases, where the mortgage loans are subject to a purchase commitment from private investors, related commitment fees. The volume and type of mortgage loans and of commitments made by investors vary with competitive and economic conditions (such as the level of interest rates and the status of the economy in general), resulting in fluctuations in revenues from mortgage loan originations. Generally accepted accounting principles, or GAAP, require that general operating expenses incurred in originating mortgage loans be charged to current expense. Direct origination costs and origination fee income must be deferred until the repayment or sale of the related mortgage loans. Historically, the value of servicing rights which result from R&G Financial’s origination activities has exceeded the net costs attributable to such activities.

      R&G Financial customarily sells most of the loans that it originates, except for those originated on behalf of Premier Bank pursuant to a Master Production Agreement with R&G Mortgage. See “—Lending Activities from Banking Operations — Origination, Purchases and Sales of Loans.” During the years ended December 31, 2004, 2003 and 2002, R&G Financial sold $1.2 billion, $1.6 billion and $1.2 billion of loans, respectively, which includes loans securitized and sold but does not include loans originated by R&G Mortgage on behalf of Premier Bank. With respect to such loan sales, $136.5 million or 11.2%, $211.8 million or 13.2% and $253.1 million or 21.7%, respectively, consisted of GNMA-guaranteed mortgage-backed securities of FHA loans or VA loans packaged into pools of $1 million or more ($2.5 million to $5 million for GNMA serial notes) by R&G Mortgage. These securities were sold directly either through R-G Investments Corporation, R&G Financial’s broker-dealer, Premier Bank’s Trust Department, or indirectly through securities broker-dealers.

      Conforming conventional loans originated or purchased by the Company are generally sold directly to FNMA, FHLMC or private investors for cash or are grouped into pools of $1 million or more in aggregate principal balance and exchanged for FNMA or FHLMC-issued mortgage-backed securities, which the Company sells to securities broker-dealers. In connection with any such exchanges, the Company pays guarantee fees to FNMA and FHLMC. The issuance of mortgage-backed securities provides R&G Financial with flexibility in selling the mortgages that it originates or purchases and also provides income by increasing the value and marketability of the loans. Mortgage loans that do not conform to GNMA, FNMA or FHLMC requirements (so-called “non-conforming loans”) are generally originated on behalf of Premier Bank by R&G Mortgage and either retained in Premier Bank’s portfolio, sold to financial institutions or other private investors.

      While R&G Financial’s exchanges of mortgage loans into agency securities and sales of mortgage loans are generally made on a non-recourse basis, the Company also engages in the sale or exchange of mortgage loans on a recourse basis. In the past, recourse sales often involved the sale of non-conforming loans to FNMA, FHLMC and local financial institutions. R&G Financial estimates the fair value of the retained recourse obligation at the time mortgage loans are sold. At December 31, 2004, R&G Financial had loans in its servicing portfolio with provisions for recourse in the principal amount of approximately $2.1 billion, as compared to $1.1 billion and $762.3 million as of December 31, 2003 and 2002, respectively. Of the recourse loans existing at December 31, 2004, approximately $222.9 million in principal amount consisted of loans sold to FNMA and FHLMC and converted into mortgage-backed securities of such agencies, and approximately $1.9 billion in principal amount consisted of non-conforming loans sold to other financial institutions and/or private investors. As of December 31, 2004,

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R&G Financial had reserves for possible losses related to its recourse obligations of $6.8 million. Historical losses on recourse obligations have not been significant.

      Loan Servicing. R&G Financial acquires servicing rights through its mortgage loan originations (including originations on behalf of Premier Bank) and purchases from third parties. The Company generally retains the rights to service mortgage loans sold, which it has originated or purchased, and receives the related servicing fees. Loan servicing includes collecting principal and interest and remitting the same to the holders of the mortgage loans or mortgage-backed securities to which such mortgage loan relates, holding escrow funds for the payment of real estate taxes and insurance premiums, contacting delinquent borrowers, supervising foreclosures in the event of unremedied defaults and generally administering the loans. The Company receives annual loan servicing fees ranging from 0.25% to 0.50% of the declining outstanding principal balance of the loans serviced plus any late charges. In general, the Company’s servicing agreements are terminable by the investor for cause without penalty or after payment of a termination fee ranging from 0.5% to 1.0% of the outstanding principal balance of the loans being serviced.

      R&G Financial’s servicing portfolio has grown significantly over the past several years. At December 31, 2004, R&G Financial’s servicing portfolio totaled $11.4 billion and consisted of a total of 145,324 loans. These amounts include R&G Mortgage’s servicing portfolio totaling $8.5 billion and Crown Bank’s servicing portfolio totaling $2.9 billion at December 31, 2004. At December 31, 2004, R&G Financial’s servicing portfolio included $2.1 billion of loans serviced for Premier Bank and $647.7 million of loans serviced for Crown Bank, or 18.3% and 5.7%, respectively, of the total servicing portfolio. Most of the mortgage loans in R&G Financial’s servicing portfolio are secured by single (one-to-four) family residences. At December 31, 2004, approximately 75% of R&G Financial’s mortgage servicing portfolio is comprised of mortgages secured by real estate located in Puerto Rico.

      R&G Mortgage services all loans held in Premier Bank’s loan portfolio (including single-family residential loans retained by Premier Bank and certain commercial real estate loans), although R&G Mortgage does not actually acquire such servicing rights. Once loans are sold, Premier Bank retains the servicing rights to such loans; R&G Mortgage continues to service the loans on behalf of Premier Bank. Premier Bank pays R&G Mortgage servicing fees with respect to the loans serviced by R&G Mortgage on behalf of Premier Bank. In addition, Premier Bank processes payments of all loans originated by R&G Mortgage on behalf of Premier Bank. In connection therewith, R&G Mortgage pays Premier Bank a fee equal to between $0.50 and $1.00 per loan. See “— Regulation — R&G Financial — Limitations on Transactions with Affiliates.”

      R&G Financial’s mortgage loan servicing portfolio is subject to reduction by reason of normal amortization, prepayments and foreclosure of outstanding mortgage loans. Additionally, R&G Financial may sell mortgage loan servicing rights from time to time.

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

      The following table sets forth certain information at December 31, 2004 regarding the number and aggregate principal balance of the mortgage loans serviced by R&G Financial for its loan portfolio and for third parties at various mortgage interest rates.

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      The amount of principal prepayments on mortgage loans serviced by R&G Financial was $373.9 million, $356.9 million and $288.2 million for the years ended December 31, 2004, 2003, and 2002, respectively. This represented approximately 3.3%, 3.3% and 3.1% of the aggregate principal amount of mortgage loans serviced during such periods. The primary means used by R&G Mortgage to reduce the sensitivity of its servicing fee income to changes in interest and prepayment rates is the development of a strong internal origination capability that has allowed R&G Financial to continue to increase the size of its servicing portfolio even in times of high prepayments.

      Servicing agreements relating to the mortgage-backed securities programs of FNMA, FHLMC and GNMA, and certain other investors, require R&G Financial to advance funds to make scheduled payments of principal, interest, taxes and insurance, if such payments have not been received from the borrowers. During the years ended December 31, 2004, 2003 and 2002, the monthly average amount of funds advanced by R&G Financial under such servicing agreements was $28.9 million, $26.7 million and $24.4 million, respectively. Funds advanced by R&G Financial pursuant to these arrangements are generally recovered by R&G Financial within 30 days.

      In connection with its loan servicing activities, R&G Financial holds escrow funds for the payment of real estate taxes and insurance premiums with respect to the mortgage loans it services. At December 31, 2004, R&G Financial held $150.3 million of such escrow funds, $94.6 million of which were deposited in Premier Bank, $55.6 million of which were deposited in Crown Bank and $101,000 of which were deposited with other financial institutions. The escrow funds lower the overall cost of funds, while the escrow funds deposited with other financial institutions serve as part of R&G Financial’s compensating balances which permit the Company to borrow funds from such institutions (pursuant to certain warehouse lines of credit) at rates that are lower than would otherwise apply. See “— Sources of Funds — Borrowings.”

      The degree of risk associated with a mortgage loan servicing portfolio is largely dependent on the extent to which the servicing portfolio is non-recourse or recourse. In non-recourse servicing, the principal credit risk to the servicer is the cost of temporary advances of funds. In recourse servicing, the servicer agrees to share credit risk with the owner of the mortgage loans such as FNMA or FHLMC or with an insurer or guarantor. Losses on recourse servicing occur primarily when foreclosure sale proceeds of the property underlying a defaulted mortgage are less than the then outstanding principal balance and accrued interest of such mortgage loan and the cost of holding and disposing of such underlying property. At December 31, 2004, R&G Financial was servicing mortgage loans with an aggregate principal amount of $2.1 billion on a recourse basis. During the last three years, losses incurred due to recourse servicing have not been significant.

      R&G Financial’s general strategy is to retain the servicing rights related to the mortgage loans it originates and purchases. Nevertheless, there is a market for servicing rights, which are generally valued in relation to the present value of the expected income stream generated by the servicing rights. Among the factors which influence the value of a servicing portfolio are servicing fee rates, loan balances, loan types, loan interest rates, the expected average life of the underlying loans (which may be reduced through foreclosure or prepayment), the value of escrow balances, delinquency and foreclosure experience, servicing costs, servicing termination rights of permanent investors and any recourse provisions. Although the Company may on occasion consider future sales of a portion of its servicing portfolio, management does not anticipate sales of servicing rights to become a significant part of its operations.

      The market value of, and earnings from, R&G Financial’s mortgage loan servicing portfolio may be adversely affected if mortgage interest rates decline and mortgage loan prepayments increase. In a period of declining interest rates and accelerated prepayments, income generated from the Company’s

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mortgage loan servicing portfolio may also decline. Conversely, as mortgage interest rates increase, the market value of the Company’s mortgage loan servicing portfolio may be positively affected. See Note 1 to R&G Financial’s Notes to Consolidated Financial Statements for a discussion of SFAS No. 140 and the treatment of servicing rights, incorporated by reference into Item 8 hereof.

      Mortgage Loan Delinquencies and Foreclosures. The following table shows the delinquency statistics for R&G Financial’s servicing portfolio at the dates indicated.

      While delinquency rates in Puerto Rico are generally higher than in the mainland United States, these rates are not necessarily indicative of future foreclosure rates or losses on foreclosures. Real estate owned as a result of foreclosures, or REO, related to R&G Financial’s mortgage banking business arises primarily through foreclosure on mortgage loans repurchased from investors either because of breach of representations or warranties or pursuant to recourse arrangements. As of December 31, 2004, 2003 and 2002, R&G Financial held REO related to servicing activities with a book value of approximately $13.4 million, $13.0 million and $9.6 million, respectively. Sales of REO resulted in losses to R&G Financial of $4.1 million, $3.5 million and $1.5 million during the years ended December 31, 2004, 2003 and 2002, respectively. There is no liquid secondary market for the sale of R&G Financial’s REO. The increase in the amount of losses resulting from the sale of REO is related to an increase in the volume of foreclosed loans and the eventual disposition of the resulting REOs.

      With respect to mortgage loans securitized through GNMA programs, the Company is fully insured as to principal by the FHA and VA against foreclosure loans. As a result of these programs, foreclosure on these loans had generated no loss of principal as of December 31, 2004. Currently, Crown Bank only services conventional loans, as opposed to FHA/VA loans. R&G Mortgage, however, incurs about $3,000 per loan foreclosed in interest and legal charges during the time between payment by R&G Mortgage and FHA or VA reimbursement. For the years ended December 31, 2004, 2003 and 2002, total expenses related to FHA or VA loans foreclosed amounted to $3,002,000, $983,000 and $797,000,

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respectively. Although FNMA and FHLMC are obligated to reimburse the Company for principal and interest payments advanced by the Company as a servicer (except for recourse servicing), the funding of delinquent payments or the exercise of foreclosure rights involves costs to the Company which may not be recovered. Such unrecovered expenses have to date been immaterial.

      Any significant adverse economic developments could result in an increase in defaults or delinquencies on mortgage loans that are serviced by the Company or held by the Company pending sale in the secondary mortgage market, thereby reducing the resale value of such mortgage loans.

Investment Activities

      General. R&G Financial’s securities portfolio is managed by investment officers in accordance with a comprehensive written investment policy which addresses strategies, types and levels of allowable investments and which is reviewed and approved annually by the respective Boards of Directors of the Company’s banking subsidiaries. The management of the securities portfolio is set in accordance with strategies developed by Interest Rate Risk, Budget and Investments Committee, or IRRBICO, of each banking subsidiary.

      As discussed under “— Mortgage Banking Activities,” R&G Mortgage is primarily engaged in the origination of mortgage loans and the securitization of such loans into mortgage-backed and related securities and the subsequent sale of such securities to securities broker-dealers and other investors in the secondary market. As a result of R&G Mortgage’s securitization activities, R&G Mortgage maintains a substantial portfolio of GNMA mortgage-backed securities. As of December 31, 2004, R&G Mortgage held tax-exempt GNMA mortgage-backed securities with a fair value of $251.0 million, which are classified as available for sale. At December 31, 2004, R&G Mortgage’s CMO interest-only residuals and interest only strips, which are classified as available for sale, had an amortized cost of $38.7 million and a fair value of $38.7 million.

      Under Premier Bank’s and Crown Bank’s Investment Policies, the Company’s banking subsidiaries generally invest in U.S. Treasury obligations (with a maturity up to five years), U.S. Agency obligations, FNMA, GNMA and FHLMC mortgage-backed certificates, investment grade municipal obligations (with a maturity of up to five years), bankers’ acceptances and FHLB notes (with a maturity of up to five years), investment grade commercial paper (with a maturity of up to 9 months), federal funds (with a maturity of six months or less), certificates of deposit in other financial institutions (including Eurodollar deposits), repurchase agreements (with a maturity of six months or less), investment grade corporate bonds (with a maturity of five years or less) and certain mortgage-backed derivative securities (with a weighted average life of less than ten years).

      At December 31, 2004, the securities portfolios of the Company’s banking subsidiaries included $58.7 million of securities held for investment, consisting principally of $3.5 million of GNMA mortgage-backed securities, $4.0 million of FHLMC and FNMA mortgage backed securities, and $51.2 million of certain Puerto Rico Government obligations and other Puerto Rico securities, all held by Premier Bank. In addition, at December 31, 2004, the securities portfolios of the Company’s banking subsidiaries classified as available for sale had a fair value of $3.4 billion, consisting principally of $46.3 million of GNMA mortgage-backed securities, $894.5 million of FHLMC and FNMA mortgage-backed securities, $1.5 billion of CMOs, $24.8 million of CMO interest-only residuals and interest only strips, $50.4 million corporate debt obligations and $834.1 million of U.S. Government and Agency securities. A substantial amount of securities held by Premier Bank are tax-exempt.

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      Premier Bank’s Treasury Department from time to time conducts certain trading. At December 31, 2004, securities for trading held by Premier Bank totaled $60.0 million, consisting of interest only strips and FHLMC mortgage-backed securities.

      At December 31, 2004, $408.3 million or 10.7% of R&G Financial’s mortgage-backed and investment securities were pledged to secure various obligations of R&G Financial (excluding repurchase agreements).

      The following table presents certain information regarding the composition and period to maturity of R&G Financial’s securities portfolio held to maturity as of the dates indicated below. The weighted average yield in the following table is calculated on an actual basis and not on a tax-equivalent basis. All of the securities in the following table are assets of the Company’s banking subsidiaries, except as otherwise indicated in the footnote below.