UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

þ		Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended September 30, 2006

POPULAR, INC.

Puerto Rico		66-0667416
(State or other jurisdiction of incorporation or organization)		(IRS Employer Identification Number)
Popular Center Building 209 Muñoz Rivera Avenue, Hato Rey San Juan, Puerto Rico		00918
(Address of principal executive offices)		(Zip code)

(787) 765-9800

NOT APPLICABLE

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.

þ Yes       o No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer þ      Accelerated filer o      Non-accelerated filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

o Yes       þ No

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: Common Stock $6.00 par value 278,827,612 shares outstanding as of October 31, 2006.

 

 

POPULAR, INC.
INDEX

		Page
Part I — Financial Information
Item 1. Financial Statements
Unaudited Consolidated Statements of Condition as of September 30, 2006, December 31, 2005 and September 30, 2005			4
Unaudited Consolidated Statements of Income for the quarters and nine months ended September 30, 2006 and 2005			5
Unaudited Consolidated Statements of Changes in Stockholders’ Equity for the nine months ended September 30, 2006 and 2005			6
Unaudited Consolidated Statements of Comprehensive Income for the quarters and nine months ended September 30, 2006 and 2005			7
Unaudited Consolidated Statements of Cash Flows for the nine months ended September 30, 2006 and 2005			8
Notes to Unaudited Consolidated Financial Statements			9
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			63
Item 3. Quantitative and Qualitative Disclosures about Market Risk			93
Item 4. Controls and Procedures			97
Part II – Other Information
Item 1. Legal Proceedings			97
Item 1A. Risk Factors			97
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			99
Item 6. Exhibits			100
Signatures			101
EX-12.1 COMPUTATION OF RATIOS OF EARNINGS TO FIXED CHARGES AND PREFERRED STOCK DIVIDENDS
EX-31.1 SECTION 302 CERTIFICATION OF CEO
EX-31.2 SECTION 302 CERTIFICATION OF CFO
EX-32.1 SECTION 906 CERTIFICATION OF CEO
EX-32.2 SECTION 906 CERTIFICATION OF CFO

Forward-Looking Information

The information included in this Form 10-Q contains certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements may relate to the Corporation’s financial condition, results of operations, plans, objectives, future performance and business, including, but not limited to, statements with respect to the adequacy of the allowance for loan losses, market risk and the impact of interest rate changes, capital adequacy and liquidity, and the effect of legal proceedings and new accounting standards on the Corporation’s financial condition and results of operations. All statements contained herein that are not clearly historical in nature are forward-looking, and the words “anticipate,” “believe,” “continues,” “expect,” “estimate,” “intend,” “project” and similar expressions and future or conditional verbs such as “will,” “would,” “should,” “could,” “might,” “can,” “may,” or similar expressions are generally intended to identify forward-looking statements.

These statements are not guarantees of future performance and involve certain risks, uncertainties, estimates and assumptions by management that are difficult to predict. Various factors, some of which are beyond the Corporation’s control, could cause actual results to differ materially from those expressed in, or implied by, such forward-looking statements. Factors that might cause such a difference include, but are not limited to: the rate of growth in the economy, as well as general business and economic conditions; changes in interest rates, as well as the magnitude of such changes; the fiscal and monetary policies of the federal government and its agencies; the relative strength or weakness of the consumer and commercial credit sectors and of the real estate markets; the performance of the stock and bond markets; competition in the financial services industry; possible legislative, tax or regulatory changes; and difficulties in combining the operations of acquired entities.

Moreover, the outcome of legal proceedings, as discussed in “Part II, Item I. Legal Proceedings,” is inherently uncertain and depends on judicial interpretations of law and the findings of regulators, judges and juries.

All forward-looking statements included in this document are based upon information available to the Corporation as of the date of this document, and we assume no obligation to update or revise any such forward-looking statements to reflect occurrences or unanticipated events or circumstances after the date of such statements.

ITEM 1. FINANCIAL STATEMENTS

POPULAR, INC.

		September 30,				December 31,				September 30,
(In thousands, except share information)		2006				2005				2005
ASSETS
Cash and due from banks		$	736,669			$	906,397			$	889,145
Money market investments:
Federal funds sold			323,980				186,000				69,005
Securities purchased under agreements to resell			211,439				554,770				562,636
Time deposits with other banks			9,830				8,653				6,580
			545,249				749,423				638,221
Investment securities available-for-sale, at fair value:
Pledged securities with creditors’ right to repledge			4,463,023				6,110,179				5,607,849
Other investment securities available-for-sale			5,695,302				5,606,407				5,885,359
Investment securities held-to-maturity, at amortized cost			357,430				153,104				359,228
Other investment securities, at lower of cost or realizable value			297,472				319,103				331,141
Trading account securities, at fair value:
Pledged securities with creditors’ right to repledge			211,942				343,659				361,411
Other trading securities			239,720				175,679				180,578
Loans held-for-sale, at lower of cost or market value			447,314				699,181				867,059
Loans held-in-portfolio:
Loans held-in-portfolio pledged with creditors’ right to repledge			—				208,774				259,779
Other loans held-in-portfolio			31,614,759				31,099,865				29,717,001
Less – Unearned income			305,114				297,613				293,756
Allowance for loan losses			487,339				461,707				459,425
			30,822,306				30,549,319				29,223,599
Premises and equipment, net			588,282				596,571				592,250
Other real estate			83,636				79,008				77,993
Accrued income receivable			288,342				245,646				261,097
Other assets			1,374,900				1,325,800				1,276,576
Goodwill			678,666				653,984				525,036
Other intangible assets			104,497				110,208				43,566
		$	46,934,750			$	48,623,668			$	47,120,108
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities:
Deposits:
Non-interest bearing		$	3,822,584			$	3,958,392			$	3,733,226
Interest bearing			19,314,861				18,679,613				18,845,483
			23,137,445				22,638,005				22,578,709
Federal funds purchased and assets sold under agreements to repurchase			7,045,466				8,702,461				8,017,783
Other short-term borrowings			2,709,511				2,700,261				2,908,523
Notes payable			9,681,897				9,893,577				9,564,425
Subordinated notes			—				—				125,000
Other liabilities			724,296				1,240,002				704,171
			43,298,615				45,174,306				43,898,611
Commitments and contingencies (See Note 11)
Minority interest in consolidated subsidiaries			111				115				101
Stockholders’ equity:
Preferred stock, $25 liquidation value; 30,000,000 shares authorized; 7,475,000 shares issued and outstanding in all periods presented			186,875				186,875				186,875
Common stock, $6 par value; 470,000,000 shares authorized in all periods presented; 291,977,949 shares issued (December 31, 2005 – 289,407,190; September 30, 2005 – 280,604,768) and 278,553,152 outstanding (December 31, 2005 – 275,955,391; September 30, 2005 – 267,152,969)			1,751,868				1,736,443				1,683,629
Surplus			494,398				452,398				292,418
Retained earnings			1,611,103				1,456,612				1,403,133
Accumulated other comprehensive loss, net of tax of ($61,834) (December 31, 2005 – ($58,292); September 30, 2005 – ($40,310))			(201,687	)			(176,000	)			(137,578	)
Treasury stock – at cost, 13,424,797 shares (December 31, 2005 – 13,451,799; September 30, 2005 – 13,451,799)			(206,533	)			(207,081	)			(207,081	)
			3,636,024				3,449,247				3,221,396
		$	46,934,750			$	48,623,668			$	47,120,108

The accompanying notes are an integral part of these unaudited consolidated financial statements.

POPULAR, INC.

		Quarter ended								Nine months ended
		September 30,								September 30,
(In thousands, except per share information)		2006				2005				2006				2005
INTEREST INCOME:
Loans		$	637,246			$	527,134			$	1,842,873			$	1,542,639
Money market investments			7,038				7,502				22,926				22,942
Investment securities			129,323				123,701				396,130				358,757
Trading account securities			7,724				7,751				23,649				22,126
			781,331				666,088				2,285,578				1,946,464
INTEREST EXPENSE:
Deposits			151,008				113,799				411,380				310,543
Short-term borrowings			141,727				89,213				393,604				232,392
Long-term debt			146,558				114,966				413,013				340,703
			439,293				317,978				1,217,997				883,638
Net interest income			342,038				348,110				1,067,581				1,062,826
Provision for loan losses			63,445				49,960				179,488				144,232
Net interest income after provision for loan losses			278,593				298,150				888,093				918,594
Service charges on deposit accounts			47,484				46,836				142,277				135,660
Other service fees (See Note 12)			79,637				85,004				240,000				247,860
Net gain (loss) on sale and valuation adjustment of investment securities			7,123				(920	)			5,039				50,891
Trading account profit			10,019				4,707				23,324				28,138
Gain on sale of loans			20,113				17,585				96,428				42,675
Other operating income			26,973				21,836				97,100				65,871
			469,942				473,198				1,492,261				1,489,689
OPERATING EXPENSES:
Personnel costs:
Salaries			130,613				120,012				392,845				351,361
Pension, profit sharing and other benefits			34,083				34,670				116,386				113,489
			164,696				154,682				509,231				464,850
Net occupancy expenses			31,573				27,719				88,840				78,414
Equipment expenses			34,346				31,185				101,516				90,029
Other taxes			11,770				10,368				32,940				29,088
Professional fees			29,618				27,888				105,184				82,787
Communications			17,343				15,640				51,936				46,579
Business promotion			33,855				23,940				98,669				69,860
Printing and supplies			4,408				4,845				13,331				13,971
Other operating expenses			28,706				30,759				85,609				88,098
Impact of change in fiscal period of certain subsidiaries			—				—				9,741				—
Amortization of intangibles			3,608				2,387				9,160				6,770
			359,923				329,413				1,106,157				970,446
Income before income tax and cumulative effect of accounting change			110,019				143,785				386,104				519,243
Income tax			27,859				28,569				88,060				112,395
Income before cumulative effect of accounting change			82,160				115,216				298,044				406,848
Cumulative effect of accounting change, net of tax			—				—				—				3,607
NET INCOME		$	82,160			$	115,216			$	298,044			$	410,455
NET INCOME APPLICABLE TO COMMON STOCK		$	79,181			$	112,237			$	289,109			$	401,520
BASIC EARNINGS PER COMMON SHARE (EPS) BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE		$	0.28			$	0.42			$	1.04			$	1.49
DILUTED EPS BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE		$	0.28			$	0.42			$	1.04			$	1.49
BASIC EPS AFTER CUMULATIVE EFFECT OF ACCOUNTING CHANGE		$	0.28			$	0.42			$	1.04			$	1.50
DILUTED EPS AFTER CUMULATIVE EFFECT OF ACCOUNTING CHANGE		$	0.28			$	0.42			$	1.04			$	1.50
DIVIDENDS DECLARED PER COMMON SHARE		$	0.16			$	0.16			$	0.48			$	0.48

The accompanying notes are an integral part of these unaudited consolidated financial statements.

POPULAR, INC.

		Nine months ended
		September 30,
(In thousands)		2006				2005
Preferred stock:
Balance at beginning and end of year		$	186,875			$	186,875
Common stock:
Balance at beginning of year			1,736,443				1,680,096
Common stock issued under the Dividend Reinvestment Plan			3,919				3,307
Issuance of common stock			11,312				—
Stock options exercised			194				226
Balance at end of period			1,751,868				1,683,629
Surplus:
Balance at beginning of year			452,398				278,840
Common stock issued under the Dividend Reinvestment Plan			8,634				10,211
Issuance of common stock			28,281				—
Issuance cost of common stock			1,462				—
Stock options expense on unexercised options			2,160				2,791
Stock options exercised			463				576
Transfer from retained earnings			1,000				—
Balance at end of period			494,398				292,418
Retained earnings:
Balance at beginning of year			1,456,612				1,129,793
Net income			298,044				410,455
Cash dividends declared on common stock			(133,618	)			(128,180	)
Cash dividends declared on preferred stock			(8,935	)			(8,935	)
Transfer to surplus			(1,000	)			—
Balance at end of period			1,611,103				1,403,133
Accumulated other comprehensive loss:
Balance at beginning of year			(176,000	)			35,454
Other comprehensive loss, net of tax			(25,687	)			(173,032	)
Balance at end of period			(201,687	)			(137,578	)
Treasury stock – at cost:
Balance at beginning of year			(207,081	)			(206,437	)
Purchase of common stock			—				(1,467	)
Reissuance of common stock			548				823
Balance at end of period			(206,533	)			(207,081	)
Total stockholders’ equity		$	3,636,024			$	3,221,396

Disclosure of changes in number of shares:

		September 30,				December 31,				September 30,
		2006				2005				2005
Preferred Stock:
Balance at beginning and end of period			7,475,000				7,475,000				7,475,000
Common Stock – Issued:
Balance at beginning of year			289,407,190				280,016,007				280,016,007
Issued under the Dividend Reinvestment Plan			653,142				728,705				551,175
Issuance of common stock			1,885,380				8,614,620				—
Stock options exercised			32,237				47,858				37,586
Balance at end of period			291,977,949				289,407,190				280,604,768
Treasury stock			(13,424,797	)			(13,451,799	)			(13,451,799	)
Common Stock – Outstanding			278,553,152				275,955,391				267,152,969

The accompanying notes are an integral part of these unaudited consolidated financial statements.

POPULAR, INC.

		Quarter ended								Nine months ended
		September 30,								September 30,
(In thousands)		2006				2005				2006				2005
Net income		$	82,160			$	115,216			$	298,044			$	410,455
Other comprehensive income (loss), before tax:
Foreign currency translation adjustment			(150	)			(183	)			(467	)			(611	)
Unrealized holding gains (losses) on securities available-for-sale arising during the period			192,674				(166,553	)			(23,150	)			(170,856	)
Reclassification adjustment for (gains) losses included in net income			(7,123	)			920				(5,039	)			(50,368	)
Net loss on cash flow hedges			(4,992	)			(1,717	)			(1,082	)			(3,496	)
Reclassification adjustment for losses included in net income			1,126				2,210				509				5,209
			181,535				(165,323	)			(29,229	)			(220,122	)
Income tax (expense) benefit			(48,433	)			40,646				3,542				47,090
Total other comprehensive income (loss), net of tax			133,102				(124,677	)			(25,687	)			(173,032	)
Comprehensive income (loss)		$	215,262			($	9,461	)		$	272,357			$	237,423

Disclosure of accumulated other comprehensive loss:

		September 30,				December 31,				September 30,
(In thousands)		2006				2005				2005
Foreign currency translation adjustment		($	36,782	)		($	36,315	)		($	36,141	)
Minimum pension liability adjustment			(2,354	)			(2,354	)			—
Tax effect			918				918				—
Net of tax amount			(1,436	)			(1,436	)			—
Unrealized losses on securities available-for-sale			(223,879	)			(195,690	)			(142,719	)
Tax effect			60,642				57,297				40,512
Net of tax amount			(163,237	)			(138,393	)			(102,207	)
Unrealized (losses) gains on cash flows hedges			(749	)			(176	)			606
Tax effect			274				77				(202	)
Net of tax amount			(475	)			(99	)			404
Cumulative effect of accounting change, net of tax			243				243				366
Accumulated other comprehensive loss, net of tax			($201,687	)			($176,000	)			($137,578	)

The accompanying notes are an integral part of these unaudited consolidated financial statements.

POPULAR, INC.

		Nine months ended
		September 30,
(In thousands)		2006				2005
Cash flows from operating activities:
Net income		$	298,044			$	410,455
Less: Cumulative effect of accounting change, net of tax							3,607
Less: Impact of change in fiscal period of certain subsidiaries, net of tax			(6,129	)
Net income before cumulative effect of accounting change and change in fiscal period			304,173				406,848
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization of premises and equipment			63,805				60,767
Provision for loan losses			179,488				144,232
Amortization of intangibles			9,160				6,770
Amortization of servicing assets			43,309				15,085
Net gain on sale and valuation adjustment of investment securities			(5,039	)			(50,891	)
Net gain on disposition of premises and equipment			(7,177	)			(11,165	)
Net gain on sale of loans			(96,428	)			(42,675	)
Net amortization of premiums and accretion of discounts on investments			19,060				30,709
Net amortization of premiums and deferred loan origination fees and costs			99,065				92,586
Earnings from investments under the equity method			(9,081	)			(8,917	)
Stock options expense			2,308				2,970
Net disbursements on loans held-for-sale			(4,940,234	)			(3,036,706	)
Acquisitions of loans held-for-sale			(1,188,844	)			(672,186	)
Proceeds from sale of loans held-for-sale			5,559,968				2,607,051
Net decrease in trading securities			1,195,639				982,919
Net increase in accrued income receivable			(44,311	)			(46,259	)
Net increase in other assets			(14,308	)			(179,575	)
Net increase in interest payable			41,257				35,737
Net decrease (increase) in deferred income tax			20,423				(13,174	)
Net increase in postretirement benefit obligation			3,028				3,631
Net decrease in other liabilities			(88,160	)			(37,950	)
Total adjustments			842,928				(117,041	)
Net cash provided by operating activities			1,147,101				289,807
Cash flows from investing activities:
Net decrease in money market investments			204,322				271,264
Purchases of investment securities:
Available-for-sale			(243,481	)			(3,321,802	)
Held-to-maturity			(20,847,771	)			(25,548,426	)
Other			(50,980	)			(63,394	)
Proceeds from calls, paydowns, maturities and redemptions of investment securities:
Available-for-sale			1,560,612				2,716,663
Held-to-maturity			20,644,100				25,549,005
Other			72,611				34,693
Proceeds from sale of investment securities available-for-sale			198,191				272,609
Net (disbursements) repayments on loans			(877,628	)			656,262
Proceeds from sale of loans			759,518				109,244
Acquisition of loan portfolios			(291,330	)			(2,301,771	)
Assets acquired, net of cash			(2,752	)			(180,744	)
Acquisition of premises and equipment			(85,415	)			(118,382	)
Proceeds from sale of premises and equipment			39,031				30,631
Proceeds from sale of foreclosed assets			99,928				84,008
Net cash provided by (used in) investing activities			1,178,956				(1,810,140	)
Cash flows from financing activities:
Net increase in deposits			494,091				1,313,013
Net (decrease) increase in federal funds purchased and assets sold under agreements to repurchase			(1,770,146	)			1,543,210
Net decrease in other short-term borrowings			(97,642	)			(234,365	)
Payments of notes payable			(1,822,303	)			(2,076,130	)
Proceeds from issuance of notes payable			777,171				1,273,203
Dividends paid			(140,765	)			(137,014	)
Proceeds from issuance of common stock			51,895				14,141
Treasury stock acquired			—				(1,467	)
Net cash (used in) provided by financing activities			(2,507,699	)			1,694,591
Cash effect of change in fiscal period of certain subsidiaries and change in accounting principle			11,914				(1,572	)
Net (decrease) increase in cash and due from banks			(169,728	)			172,686
Cash and due from banks at beginning of period			906,397				716,459
Cash and due from banks at end of period		$	736,669			$	889,145

The accompanying notes are an integral part of these unaudited consolidated financial statements.

Notes to Unaudited Consolidated Financial Statements

Note 1 – Nature of operations and basis of presentation

Popular, Inc. (the “Corporation” or “Popular”) is a diversified, publicly owned financial holding company subject to the supervision and regulation of the Board of Governors of the Federal Reserve System. The Corporation is a full service financial services provider with operations in Puerto Rico, the United States, the Caribbean and Latin America. As the leading financial institution based in Puerto Rico, the Corporation offers retail and commercial banking services through its banking subsidiary, Banco Popular de Puerto Rico (“BPPR”), as well as investment banking, auto and equipment leasing and financing, mortgage loans, consumer lending and insurance services through specialized subsidiaries. In the United States, the Corporation provides complete financial solutions to all the communities it serves through branches of Banco Popular North America (“BPNA”) in California, Texas, Illinois, New York, New Jersey and Florida. The Corporation’s consumer finance subsidiary in the United States, Popular Financial Holdings, Inc. (“PFH”), offers mortgage and personal loans, and maintains a substantial wholesale loan brokerage network, a warehouse lending division and a loan servicing unit. PFH, through its subsidiary E-LOAN, Inc. (“E-LOAN”), provides online consumer direct lending to obtain mortgage, auto and home equity loans. The Corporation strives to use its expertise in technology and electronic banking as a competitive advantage in its Caribbean and Latin America expansion, as well as internally servicing many of its subsidiaries’ system infrastructures and transactional processing businesses. EVERTEC, Inc. (“EVERTEC”), the Corporation’s main subsidiary in this business segment, is the leading provider of financial transaction processing and information technology solutions in Puerto Rico and the Caribbean. EVERTEC serves customers in 11 Latin American countries. Also, the Corporation recently incorporated EVERTEC USA, Inc. with plans to expand its service offerings in the U.S. mainland. Note 19 to the consolidated financial statements presents further information about the Corporation’s business segments.

The unaudited consolidated financial statements include the accounts of Popular, Inc. and its majority-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. These unaudited statements are, in the opinion of management, a fair statement of the results for the periods reported and include all necessary adjustments, all of a normal recurring nature, for a fair statement of such results. Certain reclassifications have been made to the prior period unaudited consolidated financial statements to conform to the 2006 presentation.

In the normal course of business, except for the Corporation’s banks and the parent holding company, the Corporation utilized a one-month lag in the consolidation of the financial results of its other subsidiaries (the “non-banking subsidiaries”). As previously described in the Corporation’s 2005 Annual Report on Form 10-K (the “2005 Annual Report”) for the year ended December 31, 2005, in that year, the Corporation commenced a two-year plan to change the reporting period of its non-banking subsidiaries to a December 31^st calendar period, primarily as part of a strategic plan to put in place a corporate-wide integrated financial system and to facilitate the consolidation process. In 2005, the impact of this change in net income was included as a cumulative effect of accounting change in the Corporation’s consolidated financial results for the first quarter, and corresponded to the financial results for the month of December 2004 of the non-banking subsidiaries which implemented the change in the first reporting period of 2005. In the first quarter of 2006, the Corporation completed the second phase of the two-year plan, as such the financial results for the month of December 2005 of PFH (excluding E-LOAN which already had a December 31^st year-end closing), Popular FS, Popular Securities and Popular North America (holding company only) were included in a separate line within operating expenses (before tax) in the consolidated statement of operations for the nine months ended September 30, 2006. The financial impact amounted to a loss of $9.7 million (before tax). After tax, this change resulted in a net loss of $6.1 million, which was included in the quarterly results for the period ended March 31, 2006 and thus, as part of the results of the nine-month period ended September 30, 2006. As of the end of the first quarter of 2006, all subsidiaries of the Corporation had aligned their year-end closings to December 31^st, similar to the parent holding company. There were no unadjusted significant intervening events resulting from the difference in fiscal periods, which management believed could have materially affected the financial position or results of operations of the Corporation for the periods presented.

The statement of condition data as of December 31, 2005 was derived from audited financial statements. Certain information and note disclosures normally included in financial statements prepared in accordance with generally

accepted accounting principles in the United States of America have been condensed or omitted from the statements presented as of September 30, 2006, December 31, 2005 and September 30, 2005 pursuant to the rules and regulations of the Securities and Exchange Commission. Accordingly, these financial statements should be read in conjunction with the audited consolidated financial statements of the Corporation for the year ended December 31, 2005, included in the Corporation’s 2005 Annual Report.

Foreign Currency Translation

Assets and liabilities denominated in foreign currencies are translated to U.S. dollars using prevailing rates of exchange at the end of the period. Revenues, expenses, gains and losses are translated using weighted average rates for the period. The resulting foreign currency translation adjustment from operations for which the functional currency is other than the U.S. dollar is reported in accumulated other comprehensive (loss) income, except for highly inflationary environments in which the effects are included in other operating income, as described below.

The Corporation conducts business in certain Latin American markets through several of its processing and information technology services and products subsidiaries. Also, it holds interests in Consorcio de Tarjetas Dominicanas, S.A. (“CONTADO”) and Centro Financiero BHD, S.A. in the Dominican Republic. Although not significant, some of these businesses are conducted in the country’s foreign currency. At September 30, 2006, the Corporation had approximately $37 million in an unfavorable foreign currency translation adjustment as part of accumulated other comprehensive loss (December 31, 2005 — $36 million; September 30, 2005 — $36 million).

The Corporation has been monitoring the inflation levels in the Dominican Republic to evaluate whether it still meets the “highly inflationary economy” test prescribed by SFAS No. 52, “Foreign Currency Translation.” Such statement defines highly inflationary as a “cumulative inflation of approximately 100 percent or more over a 3-year period.” In accordance with the provisions of SFAS No. 52, the financial statements of a foreign entity in a highly inflationary economy are remeasured as if the functional currency were the reporting currency. Accordingly, since June 2004, the Corporation’s interests in the Dominican Republic have been remeasured into the U.S. dollar. Although as of September 30, 2006, the cumulative inflation rate in the Dominican Republic over a 3-year period was below 100 percent, approximating 66% at quarter-end, the Corporation continued to apply the remeasurement accounting as of September 30, 2006 based on the accounting guidance obtained. The International Practices Task Force (“IPTF”) of the SEC Regulations Committee of the American Institute of Certified Public Accountants had concluded that the Dominican Republic was considered highly inflationary as of December 31, 2005, and concluded that such country would not cease being regarded as highly inflationary for the first nine months of 2006. The Dominican peso’s exchange rate to the U.S. dollar was $45.50 at June 30, 2004, when the economy reached the “highly inflationary” threshold, compared with $33.14 at December 31, 2005 and $32.85 at September 30, 2006. During the quarter and nine months ended September 30, 2006, approximately $0.5 million and $1.1 million, respectively, in net remeasurement gains on the investments held by the Corporation in the Dominican Republic were reflected in other operating income instead of accumulated other comprehensive loss. The net remeasurement gains totaled $1.0 million and $1.3 million for quarter and nine months ended September 30, 2005, respectively. These remeasurement gains will continue to be reflected in earnings until the economy is no longer considered highly inflationary. The unfavorable cumulative translation adjustment associated with these interests at the reporting date in which the economy became highly inflationary approximated $32 million.

Other event

The Corporation exercised certain Tag Along Rights granted under the Shareholders Agreement dated as of March 2, 1999 by and among Telecomunicaciones de Puerto Rico, Inc. (“TelPRI”), GTE International Telecommunications Incorporated, GTE Holdings (Puerto Rico) LLC, Popular and Puerto Rico Telephone Authority and entered into a Joinder Agreement dated as of May 4, 2006 (the “Joinder Agreement”) by and among Popular, GTE Holdings and Sercotel S.A. de C.V. (“Sercotel”). Pursuant to the Joinder Agreement, Popular has agreed to sell to Sercotel all the shares of common stock of TelPRI owned by Popular under similar terms and conditions set forth in the Stock Purchase Agreement dated as of April 2, 2006, by and between Sercotel and GTE Holdings. The estimated gain net of taxes for Popular is approximately $86.0 million; however, such gain is subject to purchase price adjustments at the date of the closing. The transaction is expected to close in 2006 or early in 2007 subject to obtaining the necessary governmental and regulatory approvals.

Note 2 – Recent Accounting Developments

SFAS No. 123-R “Share-Based Payment”

In December 2004, the Financial Accounting Standard Board (“FASB”) issued a revision to SFAS No. 123, “Accounting for Stock-Based Compensation,” SFAS No. 123-R, “Share-Based Payment.” SFAS No. 123-R focuses primarily on transactions in which an entity exchanges its equity instruments for employee services and generally establishes standards for the accounting of transactions in which an entity obtains goods or services in share-based payment transactions. SFAS No. 123-R requires companies to (1) use fair value to measure stock-based compensation awards and (2) cease using the “intrinsic value” method of accounting, which APB 25 allowed and resulted in no expense for many awards of stock options for which the exercise price of the option did not exceed the price of the underlying stock at the grant date. In addition, SFAS No. 123-R retains the modified grant date model from SFAS No. 123. Under that model, compensation cost is measured at the grant date fair value of the award and is adjusted to reflect anticipated forfeitures and the expected outcome of certain conditions. The fair value of an award is not remeasured after its initial estimation on the grant date, except in the case of a liability award or if the award is modified, based on specific criteria included in SFAS No. 123-R. Also, SFAS 123-R clarifies the financial impact of vesting and/or acceleration clauses due at retirement. Under the revised SFAS, the expense should be fully accrued for any employee that is eligible to retire regardless of the actual retirement experience of the employer. The Corporation prospectively applied SFAS No. 123-R to its financial statements as of January 1, 2006. The impact of this adoption was not significant for the results of the quarter. Refer to Note 12 to these consolidated financial statements for required disclosures and further information on the impact of the adoption of this accounting pronouncement.

SFAS No. 153 “Exchanges of Nonmonetary Assets”

In December 2004, the FASB issued SFAS No. 153, “Exchanges of Nonmonetary Assets, an amendment of APB Opinion No. 29, Accounting for Nonmonetary Transactions.” This Statement amends the principle that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged and more broadly provides for exceptions regarding exchanges of nonmonetary assets that do not have commercial substance. A nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. The entity’s future cash flows are expected to significantly change if either of the following criteria is met: a) the configuration (risk, timing, and amount) of the future cash flows of the asset(s) received differs significantly from the configuration of the future cash flows of the asset(s) transferred; or b) the entity-specific value of the asset(s) received differs from the entity-specific value of the asset(s) transferred, and the difference is significant in relation to the fair values of the assets exchanged. A qualitative assessment will, in some cases, be conclusive in determining that the estimated cash flows of the entity are expected to significantly change as a result of the exchange. SFAS No. 153 is effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. This Statement did not have a material impact on the Corporation’s financial condition, results of operations, or cash flows upon adoption in 2006.

SFAS No. 154 “Accounting Changes and Error Corrections”

In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections”, a replacement of APB Opinion No. 20 and FASB Statement No. 3. The Statement applies to all voluntary changes in accounting principle, and changes the requirements for accounting and reporting of a change in accounting principle. SFAS No. 154 requires retrospective application to prior periods’ financial statements of a voluntary change in accounting principle unless it is impracticable. Statement 154 is the result of a broader effort by the FASB to improve the comparability of cross-border financial reporting by working with the International Accounting Standards Board toward development of a single set of high-quality accounting standards. SFAS No. 154 requires that a change in method of depreciation, amortization, or depletion for long-lived, non-financial assets be accounted for as a change in accounting estimate that is effected by a change in accounting principle. APB Opinion No. 20 previously required that such a change be reported as a change in accounting principle. The Statement does not change the transition provisions of any existing accounting pronouncements, including those that are in a transition phase as of the effective date of this Statement. SFAS No. 154 did not have a significant impact on the statement of condition or results of operations upon adoption in 2006.

SFAS No. 155 “Accounting for Certain Hybrid Financial Instruments — an amendment of FASB Statements No. 133 and 140”

In February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments — an Amendment of FASB Statements No. 133 and 140.” This Statement amends SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”, and No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.” SFAS No. 155 resolves issues addressed in SFAS No. 133 Implementation Issue No. D1, “Application of Statement 133 to Beneficial Interests in Securitized Financial Assets.” SFAS No. 155:

	•		Permits fair value remeasurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation;
	•		Clarifies which interest-only strips and principal-only strips are not subject to the requirements of SFAS No. 133;
	•		Establishes a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation;
	•		Clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives;
	•		Amends SFAS No. 140 to eliminate the prohibition on a qualifying special-purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument.

SFAS No. 155 is effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 15, 2006. The fair value election provided for in paragraph 4(c) of this SFAS 155 may also be applied upon adoption of this Statement for hybrid financial instruments that had been bifurcated under paragraph 12 of SFAS No. 133 prior to the adoption of SFAS No. 155. Earlier adoption is permitted as of the beginning of an entity’s fiscal year, provided the entity has not yet issued financial statements, including financial statements for any interim period for that fiscal year. Provisions of this Statement may be applied to instruments that an entity holds at the date of adoption on an instrument-by-instrument basis. At adoption, any difference between the total carrying amount of the individual components of the existing bifurcated hybrid financial instrument and the fair value of the combined hybrid financial instrument should be recognized as a cumulative-effect adjustment to beginning retained earnings. An entity should separately disclose the gross gains and losses that make up the cumulative-effect adjustment, determined on an instrument-by-instrument basis. Prior periods should not be restated. The Corporation elected to adopt SFAS No. 155 commencing in January 2007. The Corporation is currently evaluating the impact that this accounting pronouncement may have in its financial condition and results of operations.

SFAS No. 156 “Accounting for Servicing of Financial Assets — an amendment of FASB No. 140”

This Statement amends SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities”, with respect to the accounting for separately recognized servicing assets and servicing liabilities. This Statement:

1. Requires an entity to recognize a servicing asset or servicing liability each time it undertakes an obligation to service a financial asset by entering into a servicing contract in any of the following situations:

a. A transfer of the servicer’s financial assets that meets the requirements for sale accounting

b. A transfer of the servicer’s financial assets to a qualifying special-purpose entity in a guaranteed mortgage securitization in which the transferor retains all of the resulting securities and classifies them as either available-for-sale securities or trading securities in accordance with SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities”

c. An acquisition or assumption of an obligation to service a financial asset that does not relate to financial assets of the servicer or its consolidated affiliates.

2. Requires all separately recognized servicing assets and servicing liabilities to be initially measured at fair value, if practicable.

3. Permits an entity to choose either of the following subsequent measurement methods for each class of separately recognized servicing assets and servicing liabilities:

a. Amortization method—Amortize servicing assets or servicing liabilities in proportion to and over the period of estimated net servicing income or net servicing loss and assess servicing assets or servicing liabilities for impairment or increased obligation based on fair value at each reporting date.

b. Fair value measurement method—Measure servicing assets or servicing liabilities at fair value at each reporting date and report changes in fair value in earnings in the period in which the changes occur.

4. At its initial adoption, permits a one-time reclassification of available-for-sale securities to trading securities by entities with recognized servicing rights, without calling into question the treatment of other available-for-sale securities under SFAS No. 115, provided that the available-for-sale securities are identified in some manner as offsetting the entity’s exposure to changes in fair value of servicing assets or servicing liabilities that a servicer elects to subsequently measure at fair value.

5. Requires separate presentation of servicing assets and servicing liabilities subsequently measured at fair value in the statement of financial position and additional disclosures for all separately recognized servicing assets and servicing liabilities.

The Corporation elected to adopt SFAS No. 156 commencing in January 2007. The Corporation is currently evaluating the impact that this accounting pronouncement may have in its financial condition and results of operations, subject to the measurement methods, class definitions and other determinations that need to be made upon adoption.

SFAS No. 157 “Fair Value Measurements”

SFAS No. 157, issued in September 2006, defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles (GAAP), and expands disclosures about fair value measurements. SFAS No. 157 does not require any new fair value measurements. This Statement, among other matters:

	•		Clarifies that the exchange price is the price in an orderly transaction between market participants to sell the asset or transfer the liability in the market in which the reporting entity would transact for the asset or liability, that is, the principal or most advantageous market for the asset or liability. The definition focuses on the price that would be received to sell the asset or paid to transfer the liability (an exit price), not the price that would be paid to acquire the asset or received to assume the liability (an entry price).
	•		Emphasizes that fair value is a market-based measurement, not an entity-specific measurement. Therefore, a fair value measurement should be determined based on the assumptions that market participants would use in pricing the asset or liability. As a basis for considering market participant assumptions in fair value measurements, this Statement establishes a fair value hierarchy that distinguishes between (1) market participant assumptions developed based on market data obtained from sources independent of the reporting entity (observable inputs) and (2) the reporting entity’s own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs).
	•		Clarifies that market participant assumptions include assumptions about risk, for example, the risk inherent in a particular valuation technique used to measure fair value (such as a pricing model) and/or the risk inherent in the inputs to the valuation technique. A fair value measurement should include an adjustment for risk if market participants would include one in pricing the related asset or liability, even if the adjustment is difficult to determine.
	•		Clarifies that market participant assumptions also include assumptions about the effect of a restriction on the sale or use of an asset.
	•		Clarifies that a fair value measurement for a liability reflects its nonperformance risk (the risk that the obligation will not be fulfilled).

SFAS No. 157 expands disclosures about the use of fair value to measure assets and liabilities in interim and annual periods subsequent to initial recognition. The disclosures focus on the inputs used to measure fair value and for recurring fair value measurements using significant unobservable inputs, and the effect of the measurements on earnings (or changes in net assets) for the period.

The guidance in this Statement applies for derivatives and other financial instruments measured at fair value under Statement 133 at initial recognition and in all subsequent periods. Therefore, this Statement nullifies the guidance in footnote 3 of EITF Issue No. 02-3, “Issues Involved in Accounting for Derivative Contracts Held for Trading Purposes and Contracts Involved in Energy Trading and Risk Management Activities.” This Statement also amends

Statement 133 to remove the similar guidance to that in Issue 02-3, which was added by FASB Statement No. 155, Accounting for Certain Hybrid Financial Instruments.

SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. Earlier application is encouraged, provided that the reporting entity has not yet issued financial statements for that fiscal year, including financial statements for an interim period within that fiscal year. The provisions of SFAS No. 157 should be applied prospectively as of the beginning of the fiscal year in which this Statement is initially applied, except for particular financial instruments indicated in the Statement in which the provisions should be applied retrospectively as of the beginning of the fiscal year in which this Statement is initially applied (a limited form of retrospective application).

The Corporation plans to adopt the provisions of SFAS No. 157 commencing with the first quarter of 2008. The Corporation is evaluating the impact that this accounting pronouncement may have in its financial condition, results of operations and financial statement disclosures.

SFAS No. 158 “Employers’Accounting for Defined Benefit Pension and Other Postretirement Plans”

In September 2006, the FASB issued SFAS No. 158 (an amendment of FASB Statements No. 87, 88, 106, and 132R), which requires an employer that is a business entity and sponsors one or more single-employer defined benefit plans to:

	a.		Recognize the funded status of a benefit plan—measured as the difference between plan assets at fair value (with limited exceptions) and the benefit obligation—in its statement of financial position. For a pension plan, the benefit obligation is the projected benefit obligation; for any other postretirement benefit plan, such as a retiree health care plan, the benefit obligation is the accumulated postretirement benefit obligation.
	b.		Recognize as a component of other comprehensive income, net of tax, the gains or losses and prior service costs or credits that arise during the period but are not recognized as components of net periodic benefit cost pursuant to FASB Statement No. 87, Employers’ Accounting for Pensions, or No. 106, Employers’ Accounting for Postretirement Benefits Other Than Pensions. Amounts recognized in accumulated other comprehensive income, including the gains or losses, prior service costs or credits, and the transition asset or obligation remaining from the initial application of Statements 87 and 106, are adjusted as they are subsequently recognized as components of net periodic benefit cost pursuant to the recognition and amortization provisions of those Statements.
	c.		Measure defined benefit plan assets and obligations as of the date of the employer’s fiscal year-end statement of financial position (with limited exceptions).
	d.		Disclose in the notes to financial statements additional information about certain effects on net periodic benefit cost for the next fiscal year that arise from delayed recognition of the gains or losses, prior service costs or credits, and transition asset or obligation.

Upon initial application of SFAS No. 158 and subsequently, an employer should continue to apply the provisions in Statements 87, 88, and 106 in measuring plan assets and benefit obligations as of the date of its statement of financial position and in determining the amount of net periodic benefit cost.

An employer with publicly traded equity securities is required to initially recognize the funded status of a defined benefit postretirement plan and to provide the required disclosures as of the end of the fiscal year ending after December 15, 2006.

The Corporation provides pension, benefit restoration and postretirement benefit plans for certain employees. Upon adoption of SFAS No. 158 in December 31, 2006, the Corporation will be required to recognize the underfunded status of the plans as a liability on its statement of financial condition. The Corporation has always used December 31^st as the measurement date of the plans.

The impact of the adoption of SFAS No. 158 as of December 31, 2006 is estimated to be a reduction in equity of approximately $77 million (after tax), with a corresponding increase in total liabilities of $126 million and in the deferred tax asset of $49 million. The estimated impact is based on the Corporation’s expected funded status of its pension and postretirement benefit plans. The actual impact of the implementation of SFAS No. 158 on the financial

statements may differ due to changes in economic assumptions such as discount rates, fair values of assets, and other changes in actuarial assumptions that will occur in connection with the upcoming December 31, 2006 measurement date. The Corporation expects that the effect of the implementation of SFAS No. 158 on its financial covenants will be immaterial. Additionally, based on the estimated impact in regulatory capital ratios, the Corporation will continue to be well-capitalized.

FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes-an Interpretation of FASB Statement 109” (FIN 48)

In June 2006, the FASB issued FIN 48, which prescribes a comprehensive model for how a company should recognize, measure, present, and disclose in its financial statements uncertain tax positions that the company has taken or expects to take on a tax return (including a decision whether to file or not to file a return in a particular jurisdiction). Under the Interpretation, the financial statements will reflect expected future tax consequences of such positions presuming the taxing authorities’ full knowledge of the position and all relevant facts, but without considering time values.

FIN 48 is applicable to all uncertain positions for taxes accounted for under SFAS 109, “Accounting for Income Taxes,” and is not intended to be applied by analogy to other taxes, such as sales taxes, value-added taxes, or property taxes. Significant elements of the new guidance include the following:

	•		Recognition: A tax benefit from an uncertain position may be recognized only if it is “more likely than not” that the position is sustainable, based on its technical merits.
	•		Measurement: The tax benefit of a qualifying position is the largest amount of tax benefit that is greater than 50 percent likely of being realized upon ultimate settlement with a taxing authority having full knowledge of all relevant information.
	•		Change in judgment: The assessment of the recognition threshold and the measurement of the associated tax benefit might change as new information becomes available. Unrecognized tax benefits should be recognized in the period that the position reaches the recognition threshold, which might occur prior to absolute finality of the matter. Similarly, recognized tax benefits should be derecognized in the period in which the position falls below the threshold.
	•		Interest/Penalties: A taxpayer is required to accrue interest and penalties that, under relevant tax law, the taxpayer would be regarded as having incurred. Accordingly, under FIN 48, interest would start to accrue in the period that it would begin accruing under the relevant tax law, and penalties should be accrued in the first period for which a position is taken (or is expected to be taken) on a tax return that would give rise to the penalty. How a company classifies interest and penalties in the income statement is an accounting policy decision. The company should disclose that policy and the amounts recognized.
	•		Balance sheet classification: Liabilities resulting from FIN 48 are classified as long-term, unless payment is expected within the next 12 months.
	•		Disclosures: FIN 48 requires qualitative and quantitative disclosures, including discussion of reasonably possible changes that might occur in the recognized tax benefits over the next 12 months; a description of open tax years by major jurisdictions; and a roll-forward of all unrecognized tax benefits, presented as a reconciliation of the beginning and ending balances of the unrecognized tax benefits on a worldwide aggregated basis.

After considering other applicable guidance (such as the guidance that the Emerging Issues Task Force specifies in Issue 93-7, “Uncertainties Related to Income Taxes in a Purchase Business Combination)”, a company should record the change in net assets that results from the application of the Interpretation as an adjustment to retained earnings.

The accounting provisions of FIN 48 will be effective for the Corporation beginning January 1, 2007. Based on a preliminary analysis performed at this time, management does not expect that the adoption of this accounting interpretation will have a material impact to its financial condition or results of operations.

EITF Issue No. 06-03 “How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross versus Net Presentation” (“EITF 06-03”)

In June 2006, the EITF reached a consensus on EITF Issue No. 06-03, How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross versus Net Presentation). EITF 06-03 provides that the presentation of taxes assessed by a governmental authority that is directly imposed on a revenue-producing transaction between a seller and a customer on either a gross basis (included in revenues and costs) or on a net basis (excluded from revenues) is an accounting policy decision that should be disclosed. The provisions of EITF 06-03 will be effective for the Corporation as of January 1, 2007. The adoption of EITF 06-03 is not expected to have a material impact on the Corporation’s consolidated financial statements.

EITF Issue No. 06-5 “Accounting for Purchases of Life Insurance – Determining the Amount That Could Be Realized in Accordance with FASB Technical Bulletin No. 85-4, Accounting for Purchases of Life Insurance” (“EITF 06-5”)

EITF Issue 06-5 focuses on how an entity should determine the “amount that could be realized under the insurance contract” at the balance sheet date in applying FTB 85-4, and whether the determination should be on an individual or group policy basis.

At the September 2006 meeting, the Task Force affirmed as a final consensus agreeing that the cash surrender value and any additional amounts provided by the contractual terms of the insurance policy that are realizable at the balance sheet date should be considered in determining the amount that could be realized under FTB 85-4, and any amounts that are not immediately payable to the policyholder in cash should be discounted to their present value. Additionally, the Task Force affirmed as a final consensus the tentative conclusion that in determining “the amount that could be realized,” companies should assume that policies will be surrendered on an individual-by-individual basis, rather than surrendering the entire group policy. Also, the Task Force reached a consensus that contractual limitations on the ability to surrender a policy do not affect the amount to be reflected under FTB 85-4, but, if significant, the nature of those restrictions should be disclosed.

The consensus would be effective for fiscal years beginning after December 15, 2006. Early application of this guidance would be permitted as of the beginning of a fiscal year in financial statements for any period for which interim or annual financial statements have not yet been issued. The guidance should be adopted with a cumulative effect adjustment to beginning retained earnings for all existing arrangements or retrospectively in accordance with SFAS No. 154.

The Corporation is currently evaluating any impact that the adoption of Issue 06-5 may have on its statement of financial condition or results of operations as it relates to the bank-owned life insurance policy for which the Corporation is beneficiary. Management does not expect such impact to be material.

Staff Accounting Bulletin No. 108 — Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements (“SAB 108”)

In September 2006, the Securities and Exchange Commission (“SEC”) issued SAB No. 108 expressing the SEC staff’s views regarding the process of quantifying financial statement misstatements and the build up of improper amounts on the balance sheet. SAB 108 requires that registrants quantify errors using both a balance sheet and income statement approach and evaluate whether either approach results in a misstated amount that, when all relevant quantitative and qualitative factors are considered, is material. The built up misstatements, while not considered material in the individual years in which the misstatements were built up, may be considered material in a subsequent year if a company were to correct those misstatements through current period earnings. Initial application of SAB No. 108 allows registrants to elect not to restate prior periods but to reflect the initial application in their annual financial statements covering the first fiscal year ending after November 15, 2006. The cumulative effect of the initial application should be reported in the carrying amounts of assets and liabilities as of the beginning of that fiscal year and the offsetting adjustment, net of tax, should be made to the opening balance of retained earnings for that year. Registrants will need to disclose the nature and amount of each item, when and how each error being

corrected arose, and the fact that the errors were previously considered immaterial. SAB 108 is effective for the Corporation’s annual financial statements for the year ended December 31, 2006. The adoption of SAB 108 is not expected to have a material impact on the Corporation’s consolidated financial statements.

Note 3 — Restrictions on cash and due from banks and highly liquid securities

The Corporation’s subsidiary banks are required by federal and state regulatory agencies to maintain average reserve balances with the Federal Reserve Bank or with a correspondent bank. Those required average reserve balances were approximately $591 million at September 30, 2006 (December 31, 2005 — $584 million; September 30, 2005 — $540 million). Cash and due from banks as well as other short-term, highly liquid securities are used to cover the required average reserve balances.

In compliance with rules and regulations of the Securities and Exchange Commission, at September 30, 2006, the Corporation had securities with a market value of $445 thousand (December 31, 2005 - $549 thousand; September 30, 2005 — $699 thousand) segregated in a special reserve bank account for the benefit of brokerage customers of its broker-dealer subsidiary. These securities are classified in the consolidated statement of condition within the other trading securities category.

As required by the Puerto Rico International Banking Center Law, at September 30, 2006, the Corporation maintained separately for its two international banking entities (“IBEs”), $600 thousand in time deposits, equally split for the two IBEs, which were considered restricted assets (December 31, 2005 — $600 thousand; September 30, 2005 — $600 thousand).

The Corporation had restricted securities available-for-sale with a market value of $1.2 million at September 30, 2006 (December 31, 2005 — $1.2 million; September 30, 2005 — $1.2 million) to comply with certain requirements of the Insurance Code of Puerto Rico.

As part of a line of credit facility with a financial institution, at September 30, 2006, the Corporation maintained restricted cash of $1.9 million as collateral for the line of credit (December 31, 2005 — $2.4 million). The cash is being held in certificates of deposits which mature in less than 90 days. The line of credit is used to support letters of credit.

Note 4 — Pledged Assets

Certain securities and loans were pledged to secure public and trust deposits, assets sold under agreements to repurchase, other borrowings and credit facilities available. The classification and carrying amount of the Corporation’s pledged assets, in which the secured parties are not permitted to sell or repledge the collateral, were as follows:

		September 30,				December 31,				September 30,
(In thousands)		2006				2005				2005
Investment securities available-for-sale		$	2,882,589			$	2,566,668			$	2,928,729
Investment securities held-to-maturity			659				953				1,255
Loans held-for-sale			20,838				30,584				—
Loans held-in-portfolio			10,694,144				12,049,850				11,289,750
		$	13,598,230			$	14,648,055			$	14,219,734

Pledged securities and loans in which the creditor has the right by custom or contract to repledge are presented separately in the consolidated statements of condition.

Note 5 — Investment Securities Available-For-Sale

The amortized cost, gross unrealized gains and losses and approximate market value (or fair value for certain investment securities where no market quotations are available) of investment securities available-for-sale as of September 30, 2006, December 31, 2005 and September 30, 2005 were as follows:

		AS OF SEPTEMBER 30, 2006
						Gross				Gross
		Amortized				Unrealized				Unrealized				Market
(In thousands)		Cost				Gains				Losses				Value
U.S. Treasury securities		$	521,885				—			$	28,418			$	493,467
Obligations of U.S. Government sponsored entities			6,776,956			$	178				154,923				6,622,211
Obligations of Puerto Rico, States and political subdivisions			119,999				308				3,927				116,380
Collateralized mortgage obligations			1,725,068				5,031				17,198				1,712,901
Mortgage-backed securities			1,099,321				1,412				29,535				1,071,198
Equity securities			70,987				4,938				3,109				72,816
Others			67,745				2,289				682				69,352
		$	10,381,961			$	14,156			$	237,792			$	10,158,325

		AS OF DECEMBER 31, 2005
						Gross				Gross
		Amortized				Unrealized				Unrealized				Market
(In thousands)		Cost				Gains				Losses				Value
U.S. Treasury securities		$	528,378			$	14			$	24,067			$	504,325
Obligations of U.S. Government sponsored entities			7,867,613				540				157,477				7,710,676
Obligations of Puerto Rico, States and political subdivisions			107,864				631				1,841				106,654
Collateralized mortgage obligations			1,854,843				8,209				14,289				1,848,763
Mortgage-backed securities			1,396,246				6,251				28,755				1,373,742
Equity securities			68,521				15,120				1,107				82,534
Others			88,568				1,324				—				89,892
		$	11,912,033			$	32,089			$	227,536			$	11,716,586

		AS OF SEPTEMBER 30, 2005
						Gross				Gross
		Amortized				Unrealized				Unrealized				Market
(In thousands)		Cost				Gains				Losses				Value
U.S. Treasury securities		$	551,152				—			$	22,803			$	528,349
Obligations of U.S. Government sponsored entities			7,640,659			$	1,158				121,114				7,520,703
Obligations of Puerto Rico, States and political subdivisions			165,872				4,402				931				169,343
Collateralized mortgage obligations			1,694,299				5,639				12,914				1,687,024
Mortgage-backed securities			1,441,383				10,161				18,540				1,433,004
Equity securities			61,453				12,102				304				73,251
Others			80,743				1,048				257				81,534
		$	11,635,561			$	34,510			$	176,863			$	11,493,208

The following table shows the Corporation’s gross unrealized losses and market value of investment securities available-for-sale, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at September 30, 2006, December 31, 2005 and September 30, 2005:

		AS OF SEPTEMBER 30, 2006
		Less than 12 Months
		Amortized				Unrealized				Market
(In thousands)		Cost				Losses				Value
U.S. Treasury securities		$	19,410			$	91			$	19,319
Obligations of U.S. Government sponsored entities			443,593				4,348				439,245
Obligations of Puerto Rico, States and political subdivisions			26,398				375				26,023
Collateralized mortgage obligations			507,121				4,037				503,084
Mortgage-backed securities			165,200				2,363				162,837
Equity securities			46,811				2,811				44,000
Others			10,360				682				9,678
		$	1,218,893			$	14,707			$	1,204,186

		12 months or more
		Amortized				Unrealized				Market
(In thousands)		Cost				Losses				Value
U.S. Treasury securities		$	502,475			$	28,327			$	474,148
Obligations of U.S. Government sponsored entities			6,254,447				150,575				6,103,872
Obligations of Puerto Rico, States and political subdivisions			53,305				3,552				49,753
Collateralized mortgage obligations			576,660				13,161				563,499
Mortgage-backed securities			858,717				27,172				831,545
Equity securities			300				298				2
		$	8,245,904			$	223,085			$	8,022,819

		Total
		Amortized				Unrealized				Market
(In thousands)		Cost				Losses				Value
U.S. Treasury securities		$	521,885			$	28,418			$	493,467
Obligations of U.S. Government sponsored entities			6,698,040				154,923				6,543,117
Obligations of Puerto Rico, States and political subdivisions			79,703				3,927				75,776
Collateralized mortgage obligations			1,083,781				17,198				1,066,583
Mortgage-backed securities			1,023,917				29,535				994,382
Equity securities			47,111				3,109				44,002
Others			10,360				682				9,678
		$	9,464,797			$	237,792			$	9,227,005

		AS OF DECEMBER 31, 2005
		Less than 12 Months
		Amortized				Unrealized				Market
(In thousands)		Cost				Losses				Value
U.S. Treasury securities		$	9,854			$	136			$	9,718
Obligations of U.S. Government sponsored entities			4,401,412				69,250				4,332,162
Obligations of Puerto Rico, States and political subdivisions			18,070				33				18,037
Collateralized mortgage obligations			672,546				6,394				666,152
Mortgage-backed securities			486,266				9,406				476,860
Equity securities			22,168				915				21,253
		$	5,610,316			$	86,134			$	5,524,182

		12 months or more
		Amortized				Unrealized				Market
(In thousands)		Cost				Losses				Value
U.S. Treasury securities		$	499,148			$	23,931			$	475,217
Obligations of U.S. Government sponsored entities			3,379,970				88,227				3,291,743
Obligations of Puerto Rico, States and political subdivisions			54,680				1,808				52,872
Collateralized mortgage obligations			238,254				7,895				230,359
Mortgage-backed securities			672,428				19,349				653,079
Equity securities			3,837				192				3,645
		$	4,848,317			$	141,402			$	4,706,915

		Total
		Amortized				Unrealized				Market
(In thousands)		Cost				Losses				Value
U.S. Treasury securities		$	509,002			$	24,067			$	484,935
Obligations of U.S. Government sponsored entities			7,781,382				157,477				7,623,905
Obligations of Puerto Rico, States and political subdivisions			72,750				1,841				70,909
Collateralized mortgage obligations			910,800				14,289				896,511
Mortgage-backed securities			1,158,694				28,755				1,129,939
Equity securities			26,005				1,107				24,898
		$	10,458,633			$	227,536			$	10,231,097

		AS OF SEPTEMBER 30, 2005
		Less than 12 Months
		Amortized				Unrealized				Market
(In thousands)		Cost				Losses				Value
U.S. Treasury securities		$	24,814			$	271			$	24,543
Obligations of U.S. Government sponsored entities			6,276,514				89,341				6,187,173
Obligations of Puerto Rico, States and political subdivisions			13,240				41				13,199
Collateralized mortgage obligations			673,542				6,256				667,286
Mortgage-backed securities			520,241				7,628				512,613
Equity securities			29				5				24
Others			11,180				257				10,923
		$	7,519,560			$	103,799			$	7,415,761

		12 months or more
		Amortized				Unrealized				Market
(In thousands)		Cost				Losses				Value
U.S. Treasury securities		$	526,238			$	22,532			$	503,706
Obligations of U.S. Government sponsored entities			1,163,926				31,773				1,132,153
Obligations of Puerto Rico, States and political subdivisions			52,370				890				51,480
Collateralized mortgage obligations			225,321				6,658				218,663
Mortgage-backed securities			482,962				10,912				472,050
Equity securities			300				299				1
		$	2,451,117			$	73,064			$	2,378,053

		Total
		Amortized				Unrealized				Market
(In thousands)		Cost				Losses				Value
U.S. Treasury securities		$	551,052			$	22,803			$	528,249
Obligations of U.S. Government sponsored entities			7,440,440				121,114				7,319,326
Obligations of Puerto Rico, States and political subdivisions			65,610				931				64,679
Collateralized mortgage obligations			898,863				12,914				885,949
Mortgage-backed securities			1,003,203				18,540				984,663
Equity securities			329				304				25
Others			11,180				257				10,923
		$	9,970,677			$	176,863			$	9,793,814

At September 30, 2006, “Obligations of Puerto Rico, States and political subdivisions” include approximately $57 million in Commonwealth of Puerto Rico Appropriation Bonds (“Appropriation Bonds”) the rating on which was downgraded in May 2006 by Moody’s Investors Service (“Moody’s”) to Ba1, one notch below investment grade. At that time, Moody’s commented that this action reflected the Government’s strained financial condition, the ongoing political conflict and the lack of agreement regarding the measures necessary to end the government’s multi-year trend of financial deterioration. In July 2006, this credit rating agency maintained the credit rating, but removed the Puerto Rico Government obligations from its watch list for further downgrades as the Government of Puerto Rico approved the 2007 fiscal year budget and established a new sales tax. A percentage of this sales tax is designated to be used as a revenue source to repay Puerto Rico Government Obligations. Future rating stability will be subject to the Government’s actions to reduce operating expenditures, improve managerial and budgetary controls, and eliminate its reliance on loans from the Government Development Bank for Puerto Rico, the Commonwealth’s fiscal

agent, to cover operating deficits. Standard & Poor’s (S&P), another nationally recognized credit rating agency, rated the Appropriation Bonds BBB-, which is still considered investment grade. As of September 30, 2006, the appropriation bonds indicated above represented approximately $3.2 million in unrealized losses in the Corporation’s available-for-sale investment securities portfolio. The Corporation is closely monitoring the political and economic situation of the Island and evaluates its available-for-sale portfolio for any declines in value that management may consider being other-than-temporary. Management has the intent and ability to hold these investments for a reasonable period of time for a forecasted recovery of fair value up to (or beyond) the cost of these investments.

The unrealized loss positions of available-for-sale securities at September 30, 2006, except for the obligations of the Puerto Rico government described above, are primarily associated with U.S. government sponsored entities and Treasury obligations, and to a lesser extent, U.S. Agency and government sponsored-issued mortgage-backed securities and collateralized mortgage obligations. The vast majority of these securities are rated the equivalent of AAA by the major rating agencies. The investment portfolio is structured primarily with highly liquid securities which possess a large and efficient secondary market. Valuations are performed at least on a quarterly basis using third party providers and dealer quotes. Management believes that the unrealized losses in these available-for-sale securities at September 30, 2006 are substantially related to market interest rate fluctuations and not to the deterioration in the creditworthiness of the issuers. Also, management has the intent and ability to hold these investments for a reasonable period of time for a forecasted recovery of fair value up to (or beyond) the cost of these investments.

During the quarter and nine months ended September 30, 2006, the Corporation recognized through earnings approximately $0.4 million and $17.4 million, respectively, in losses in interest-only securities classified as available-for-sale that management considered to be other than temporarily impaired. For the nine months ended September 30, 2005, the impairment adjustment amounted to $12.6 million and was associated with interest-only strips and equity securities.

The following table states the name of issuers, and the aggregate amortized cost and market value of the securities of such issuer (includes available-for-sale and held-to-maturity securities), when the aggregate amortized cost of such securities exceeds 10% of stockholders’ equity. This information excludes securities of the U.S. Government agencies and corporations. Investments in obligations issued by a state of the U.S. and its political subdivisions and agencies which are payable and secured by the same source of revenue or taxing authority, other than the U.S. Government, are considered securities of a single issuer.

		September 30, 2006								December 31, 2005								September 30, 2005
(In thousands)		Amortized Cost				Market Value				Amortized Cost				Market Value				Amortized Cost				Market Value
FNMA		$	1,594,165			$	1,570,842			$	1,790,840			$	1,776,604			$	1,694,826			$	1,688,626
FHLB			6,621,836				6,470,786				7,480,188				7,327,736				7,422,223				7,304,602
Freddie Mac			1,195,093				1,178,715				1,244,044				1,228,566				1,189,090				1,177,706

Note 6 — Investment Securities Held-to-Maturity

The amortized cost, gross unrealized gains and losses and approximate market value (or fair value for certain investment securities where no market quotations are available) of investment securities held-to-maturity as of September 30, 2006, December 31, 2005 and September 30, 2005 were as follows:

		AS OF SEPTEMBER 30, 2006
						Gross				Gross
		Amortized				Unrealized				Unrealized				Market
(In thousands)		Cost				Gains				Losses				Value
Obligations of U.S. Government sponsored entities		$	269,683				—			$	34			$	269,649
Obligations of Puerto Rico, States and political subdivisions			72,154			$	1,605				158				73,601
Collateralized mortgage obligations			409				—				22				387
Others			15,184				43				15				15,212
		$	357,430			$	1,648			$	229			$	358,849

		AS OF DECEMBER 31, 2005
						Gross				Gross
		Amortized				Unrealized				Unrealized				Market
(In thousands)		Cost				Gains				Losses				Value
Obligations of U.S. Government sponsored entities		$	42,011				—			$	25			$	41,986
Obligations of Puerto Rico, States and political subdivisions			78,248			$	2,845				134				80,959
Collateralized mortgage obligations			497				—				27				470
Others			32,348				315				10				32,653
		$	153,104			$	3,160			$	196			$	156,068

		AS OF SEPTEMBER 30, 2005
						Gross
		Amortized				Unrealized				Gross				Market
(In thousands)		Cost				Gains				Unrealized Losses				Value
Obligations of U.S. Government sponsored entities		$	246,861				—			$	96			$	246,765
Obligations of Puerto Rico, States and political subdivisions			79,550			$	2,879				129				82,300
Collateralized mortgage obligations			527				—				26				501
Others			32,290				357				10				32,637
		$	359,228			$	3,236			$	261			$	362,203

The following table shows the Corporation’s gross unrealized losses and fair value of investment securities held-to-maturity, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at September 30, 2006, December 31, 2005 and September 30, 2005:

		AS OF SEPTEMBER 30, 2006
		Less than 12 months
		Amortized				Unrealized				Market
(In thousands)		Cost				Losses				Value
| | |
Obligations of U.S. Government sponsored entities		$	269,683			$	34				269,649
Obligations of Puerto Rico, States and political subdivisions			2,110				3				2,107
		$	271,793			$	37			$	271,756

		12 months or more
		Amortized				Unrealized				Market
(In thousands)		Cost				Losses				Value
Obligations of Puerto Rico, States and political subdivisions		$	2,534			$	155			$	2,379
Collateralized mortgage obligations			409				22				387
Others			1,250				15				1,235
		$	4,193			$	192			$	4,001

		Total
		Amortized				Unrealized				Market
(In thousands)		Cost				Losses				Value
Obligations of U.S. Government sponsored entities		$	269,683			$	34			$	269,649
Obligations of Puerto Rico, States and political subdivisions			4,644				158				4,486
Collateralized mortgage obligations			409				22				387
Others			1,250				15				1,235
		$	275,986			$	229			$	275,757