e10vq
 
 
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 June 30, 2010
Commission File Number: 001-34084
POPULAR, INC.
(Exact name of registrant as specified in its charter)
     
Puerto Rico   66-0667416
     
(State or other jurisdiction of   (IRS Employer Identification Number)
incorporation or organization)    
     
Popular Center Building    
209 Muñoz Rivera Avenue, Hato Rey    
San Juan, Puerto Rico   00918
     
(Address of principal executive offices)   (Zip code)
(787) 765-9800
(Registrant’s telephone number, including area code)
NOT APPLICABLE
(Former name, former address and former fiscal year, if changed since last report)
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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
     þ Yes           o No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
             
Large accelerated filer þ   Accelerated filer o   Non-accelerated filer o   Smaller reporting company o
        (Do not check if a smaller reporting company)    
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 $0.01 par value, 1,022,695,797 shares outstanding as of August 5, 2010.
 
 

 


 

POPULAR, INC.
INDEX
         
    Page  
Part I — Financial Information
       
 
       
 
       
    4  
 
       
    5  
 
       
    6  
 
       
    7  
 
       
    8  
 
       
    9  
 
       
    95  
 
       
    146  
 
       
    154  
 
       
       
 
       
    155  
 
       
    156  
 
       
    159  
 
       
    159  
 
       
       

2


 

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 Popular, Inc.’s (the “Corporation”) 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 markets conditions, 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 Popular’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 and employment levels, as well as general business and economic conditions;
 
    difficulties in combining the operations of acquired entities, including in connection with our acquisition of certain assets and assumption of certain liabilities of Westernbank Puerto Rico from the Federal Deposit Insurance Corporation (“FDIC”);
 
    lower than expected gains related to any sale or potential sale of businesses;
 
    changes in interest rates, as well as the magnitude of such changes;
 
    the fiscal and monetary policies of the federal government and its agencies;
 
    changes in federal bank regulatory and supervisory policies, including required levels of capital;
 
    regulatory approvals that may be necessary to undertake certain actions or consummate strategic transactions such as acquisitions and dispositions;
 
    the impact of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Financial Reform Act) on the Corporation’s businesses, business practices and costs of operations;
 
    the relative strength or weakness of the consumer and commercial credit sectors and of the real estate markets in Puerto Rico and the other markets in which borrowers are located;
 
    the performance of the stock and bond markets;
 
    competition in the financial services industry;
 
    additional FDIC assessments; and
 
    possible legislative, tax or regulatory changes.
Investors should refer to the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2009 as well as “Part II, Item 1A” of this Form 10-Q for a discussion of such factors and certain risks and uncertainties to which the Corporation is subject.
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 other than as required by law, including the requirements of applicable securities laws, 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.

3


 

ITEM 1. FINANCIAL STATEMENTS
POPULAR, INC.
CONSOLIDATED STATEMENTS OF CONDITION (UNAUDITED)
                         
(In thousands, except share information)   June 30, 2010   December 31, 2009   June 30, 2009
 
ASSETS
                       
Cash and due from banks
  $ 744,769     $ 677,330     $ 661,852  
 
Money market investments:
                       
Federal funds sold
    11,540       159,807       106,092  
Securities purchased under agreements to resell
    299,921       293,125       306,974  
Time deposits with other banks
    2,132,748       549,865       538,581  
 
Total money market investments
    2,444,209       1,002,797       951,647  
 
Trading account securities, at fair value:
                       
Pledged securities with creditors’ right to repledge
    371,619       415,653       400,128  
Other trading securities
    29,924       46,783       87,054  
Investment securities available-for-sale, at fair value:
                       
Pledged securities with creditors’ right to repledge
    1,981,931       2,330,441       2,599,558  
Other investment securities available-for-sale
    4,499,256       4,364,273       4,646,901  
Investment securities held-to-maturity, at amortized cost (fair value as of June 30, 2010 - $209,207; December 31, 2009 - $213,146; June 30, 2009 - $313,462)
    209,416       212,962       320,061  
Other investment securities, at lower of cost or realizable value (realizable value as of June 30, 2010 - $153,845; December 31, 2009 - $165,497; June 30, 2009 - $216,551)
    152,562       164,149       214,923  
Loans held-for-sale measured at lower of cost or fair value
    101,251       90,796       242,847  
 
Loans held-in-portfolio:
                       
Loans not covered under loss sharing agreements with the FDIC
    22,576,299       23,827,263       24,717,321  
Loans covered under loss sharing agreements with the FDIC
    4,079,017              
Less — Unearned income
    109,911       114,150       111,259  
Allowance for loan losses
    1,277,016       1,261,204       1,146,239  
 
Total loans held-in-portfolio, net
    25,268,389       22,451,909       23,459,823  
 
FDIC loss share indemnification asset
    3,345,896              
Premises and equipment, net
    573,941       584,853       614,366  
Other real estate not covered under loss sharing agreements with the FDIC
    142,372       125,483       105,553  
Other real estate covered under loss sharing agreements with the FDIC
    76,331              
Accrued income receivable
    151,245       126,080       135,978  
Servicing assets (at fair value on June 30, 2010 - $171,994; December 31, 2009 - $169,747; June 30, 2009 - $180,808)
    174,170       172,505       184,189  
Other assets (See Note 12)
    1,402,072       1,322,159       1,214,849  
Goodwill
    710,579       604,349       607,164  
Other intangible assets
    63,720       43,803       48,447  
Assets from discontinued operations
                3,452  
 
Total assets
  $ 42,443,652     $ 34,736,325     $ 36,498,792  
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
                       
Liabilities:
                       
Deposits:
                       
Non-interest bearing
  $ 4,793,338     $ 4,495,301     $ 4,408,865  
Interest bearing
    22,320,235       21,429,593       22,504,620  
 
Total deposits
    27,113,573       25,924,894       26,913,485  
Federal funds purchased and assets sold under agreements to repurchase
    2,307,194       2,632,790       2,941,678  
Other short-term borrowings
    1,263       7,326       1,825  
Notes payable
    8,237,401       2,648,632       2,643,722  
Other liabilities
    1,180,773       983,866       1,084,455  
Liabilities from discontinued operations
                13,926  
 
Total liabilities
    38,840,204       32,197,508       33,599,091  
 
Commitments and contingencies (See Note 19)
                       
 
Stockholders’ equity:
                       
Preferred stock, 30,000,000 shares authorized; 2,006,391 shares issued and outstanding at June 30, 2010 and December 31, 2009 (June 30, 2009 - 24,410,000) (aggregate liquidation preference value as of June 30, 2010 and December 31, 2009 - $50,160 (June 30, 2009 - $1,521,875))
    50,160       50,160       1,487,000  
Common stock, $0.01 par value; 1,700,000,000 shares authorized as of June 30, 2010 (December 31, 2009 and June 30, 2009 - 700,000,000); 1,022,878,228 shares issued as of June 30, 2010 (December 31,2009 - 639,544,895; June 30, 2009 - 282,034,819) and 1,022,695,797 outstanding as of June 30, 2010 (December 31, 2009 - 639,540,105; June 30, 2009 - 282,031,548)
    10,229       6,395       2,820  
Surplus
    4,094,429       2,804,238       2,185,757  
Accumulated deficit
    (625,302 )     (292,752 )     (659,165 )
Treasury stock — at cost, 182,431 shares as of June 30, 2010 (December 31, 2009 - 4,790 shares; June 30, 2009 - 3,271)
    (518 )     (15 )     (11 )
Accumulated other comprehensive income (loss), net of tax expense of $17,744 (December 31, 2009 - $33,964; June 30, 2009 - $67,257)
    74,450       (29,209 )     (116,700 )
 
Total stockholders’ equity
    3,603,448       2,538,817       2,899,701  
 
Total liabilities and stockholders’ equity
  $ 42,443,652     $ 34,736,325     $ 36,498,792  
 
The accompanying notes are an integral part of these unaudited consolidated financial statements.

4


 

POPULAR, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
                                 
    Quarter ended   Six months ended
    June 30,   June 30,
(In thousands, except per share information)   2010   2009   2010   2009
 
INTEREST INCOME:
                               
Loans
  $ 385,314     $ 382,244     $ 739,963     $ 784,012  
Money market investments
    1,893       2,381       2,935       5,514  
Investment securities
    62,915       75,818       127,841       149,301  
Trading account securities
    6,599       10,603       13,177       21,411  
 
Total interest income
    456,721       471,046       883,916       960,238  
 
INTEREST EXPENSE:
                               
Deposits
    90,615       128,452       183,589       276,491  
Short-term borrowings
    15,552       16,631       30,811       37,334  
Long-term debt
    71,578       42,903       121,623       90,867  
 
Total interest expense
    177,745       187,986       336,023       404,692  
 
Net interest income
    278,976       283,060       547,893       555,546  
Provision for loan losses
    202,258       349,444       442,458       721,973  
 
Net interest income after provision for loan losses
    76,718       (66,384 )     105,435       (166,427 )
 
Service charges on deposit accounts
    50,679       53,463       101,257       107,204  
Other service fees (See Note 24)
    103,725       102,437       205,045       200,970  
Net gain on sale and valuation adjustments of investment securities
    397       53,705       478       229,851  
Trading account profit
    2,464       16,839       2,241       23,662  
Loss on sale of loans, including adjustments to indemnity reserves, and valuation adjustments on loans held-for-sale
    (9,311 )     (13,453 )     (21,533 )     (27,266 )
FDIC loss share income
    23,334             23,334        
Fair value change in equity appreciation instrument
    24,394             24,394        
Other operating income
    20,176       12,848       38,508       26,149  
 
Total non-interest income
    215,858       225,839       373,724       560,570  
 
OPERATING EXPENSES:
                               
Personnel costs:
                               
Salaries
    109,124       107,079       204,997       212,402  
Pension and other benefits
    28,908       29,127       53,967       69,095  
 
Total personnel costs
    138,032       136,206       258,964       281,497  
Net occupancy expenses
    29,058       26,024       57,934       52,465  
Equipment expenses
    25,346       25,202       48,799       51,306  
Other taxes
    12,459       13,084       24,763       26,260  
Professional fees
    34,225       27,048       61,274       51,949  
Communications
    11,342       12,386       22,114       24,213  
Business promotion
    10,204       9,946       18,499       17,856  
Printing and supplies
    2,653       3,017       5,022       5,807  
FDIC deposit insurance
    17,393       36,331       32,711       45,448  
Other operating expenses
    45,249       38,968       74,745       73,202  
Amortization of intangibles
    2,455       2,433       4,504       4,839  
 
Total operating expenses
    328,416       330,645       609,329       634,842  
 
Loss from continuing operations before income tax
    (35,840 )     (171,190 )     (130,170 )     (240,699 )
Income tax expense (benefit )
    19,988       5,393       10,713       (21,540 )
 
Loss from continuing operations
    (55,828 )     (176,583 )     (140,883 )     (219,159 )
Loss from discontinued operations, net of income tax
          (6,599 )           (16,545 )
 
NET LOSS
  $ (55,828 )   $ (183,182 )   $ (140,883 )   $ (235,704 )
 
NET LOSS APPLICABLE TO COMMON STOCK
  $ (247,495 )   $ (207,810 )   $ (332,550 )   $ (285,010 )
 
NET LOSS PER COMMON SHARE — BASIC
                               
Net loss from continuing operations
  $ (0.29 )   $ (0.71 )   $ (0.45 )   $ (0.95 )
Net loss from discontinued operations
          (0.03 )           (0.06 )
 
Net loss per common share — basic
  $ (0.29 )   $ (0.74 )   $ (0.45 )   $ (1.01 )
 
NET LOSS PER COMMON SHARE — DILUTED
                               
Net loss from continuing operations
  $ (0.29 )   $ (0.71 )   $ (0.45 )   $ (0.95 )
Net loss from discontinued operations
          (0.03 )           (0.06 )
 
Net loss per common share — diluted
  $ (0.29 )   $ (0.74 )   $ (0.45 )   $ (1.01 )
 
DIVIDENDS DECLARED PER COMMON SHARE
                    $ 0.02  
 
The accompanying notes are an integral part of these unaudited consolidated financial statements.

5


 

POPULAR, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (UNAUDITED)
                                                 
                                    Accumulated    
                                    other    
    Common   Preferred           Accumulated   comprehensive    
(In thousands)   stock   stock   Surplus   deficit   (loss) income   Total
 
Balance as of December 31, 2008
  $ 1,566,277     $ 1,483,525     $ 621,879     $ (374,488 )   $ (28,829 )   $ 3,268,364  
Net loss
                            (235,704 )             (235,704 )
Accretion of discount
            3,475  [1]             (3,475 ) [1]                
Stock options expense on unexercised options, net of forfeitures
                    45                       45  
Change in par value
    (1,689,389 ) [2]             1,689,389  [2]                        
Dividends declared:
                                               
Common stock
                            (5,641 )             (5,641 )
Preferred stock
                            (39,857 )             (39,857 )
Common stock reissuance
    378                                       378  
Common stock purchases
    (13 )                                     (13 )
Treasury stock retired
    125,556               (125,556 )                        
Other comprehensive loss, net of tax
                                    (87,871 )     (87,871 )
 
Balance as of June 30, 2009
  $ 2,809     $ 1,487,000     $ 2,185,757     $ (659,165 )   $ (116,700 )   $ 2,899,701  
 
Balance as of December 31, 2009
  $ 6,380     $ 50,160     $ 2,804,238     $ (292,752 )   $ (29,209 )   $ 2,538,817  
Net loss
                            (140,883 )             (140,883 )
Issuance of stocks
            1,150,000  [3]                             1,150,000  
Issuance of common stock upon conversion of preferred stock
    3,834  [3]     (1,150,000 ) [3]     1,337,833  [3]                     191,667  
Issuance costs
                    (47,642 ) [4]                     (47,642 )
Deemed dividend on preferred stock
                            (191,667 )             (191,667 )
Common stock purchases
    (503 )                                     (503 )
Other comprehensive income, net of tax
                                    103,659       103,659  
 
Balance as of June 30, 2010
  $ 9,711     $ 50,160     $ 4,094,429     $ (625,302 )   $ 74,450     $ 3,603,448  
 
 
[1]   Accretion of preferred stock discount 2008 Series C preferred stock
 
[2]   Change in par value from $6.00 to $0.01 (not in thousands)
 
[3]   Issuance and subsequent conversion of depositary shares representing interests in shares of contingent convertible non-cumulative preferred stock Series D into common stock
 
[4]   Issuance costs related to issuance and conversion of depositary shares (Preferred stock — Series D)
 
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
Disclosure of changes in number of shares:
                         
    June 30,   December 31,   June 30,
    2010   2009   2009
 
Preferred Stock:
                       
Balance at beginning of period
    2,006,391       24,410,000       24,410,000  
Issuance of stocks
    1,150,000  [1]     (22,403,609 ) [2]      
 
Conversion of stocks
    (1,150,000 ) [1]            
 
Balance at end of period
    2,006,391       2,006,391       24,410,000  
 
Common Stock — Issued:
                       
Balance at beginning of period
    639,544,895       295,632,080       295,632,080  
Issuance of stocks
    383,333,333  [1]     357,510,076  [3]      
Treasury stock retired
          (13,597,261 )     (13,597,261 )
 
Balance at end of period
    1,022,878,228       639,544,895       282,034,819  
 
Treasury stock
    (182,431 )     (4,790 )     (3,271 )
 
Common Stock — outstanding
    1,022,695,797       639,540,105       282,031,548  
 
 
[1]   Issuance of 46,000,000 in depositary shares; converted into 383,333,333 common shares (full conversion of depositary shares, each representing a 1/40th interest in shares of contingent convertible perpetual non-cumulative preferred stock, into common stock).
 
[2]   Exchange of 21,468,609 preferred stock Series A and B for common shares, and exchange of 935,000 preferred stock Series C for trust preferred securities.
 
[3]   Shares issued in exchange of Series A and B preferred stock and early extinguishment of debt (exchange of trust preferred securities for common stock).
The accompanying notes are an integral part of these unaudited consolidated financial statements.

6


 

POPULAR, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME
(UNAUDITED)
                                 
    Quarter ended   Six months ended
    June 30,   June 30,
(In thousands)   2010   2009   2010   2009
 
Net loss
  $ (55,828 )   $ (183,182 )   $ (140,883 )   $ (235,704 )
 
Other comprehensive income (loss) before tax:
                               
Foreign currency translation adjustment
    (1,531 )     (877 )     (577 )     (757 )
Adjustment of pension and postretirement benefit plans
    4,486       1,855       6,236       63,095  
Unrealized holding gains (losses) on securities available-for-sale arising during the period
    80,801       (34,712 )     116,912       (19,399 )
Reclassification adjustment for losses (gains) included in net loss
    6       (1,410 )     16       (177,556 )
Unrealized net losses on cash flow hedges
    (1,509 )     (37 )     (1,540 )     (1,623 )
Reclassification adjustment for losses (gains) included in net loss
    31       3,469       (1,168 )     5,883  
 
Other comprehensive income (loss) before tax:
    82,284       (31,712 )     119,879       (130,357 )
Income tax (expense) benefit
    (12,065 )     5,694       (16,220 )     42,486  
 
Total other comprehensive income (loss), net of tax
    70,219       (26,018 )     103,659       (87,871 )
 
Comprehensive income (loss), net of tax
  $ 14,391     $ (209,200 )   $ (37,224 )   $ (323,575 )
 
CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME
Tax Effects Allocated to Each Component of Other Comprehensive Income (Loss):
                                 
    Quarter ended   Six months ended
    June 30,   June 30,
(In thousands)   2010   2009   2010   2009
 
Underfunding of pension and postretirement benefit plans
  $ (882 )         $ (1,765 )   $ (22,783 )
Unrealized holding gains (losses) on securities available-for-sale arising during the period
    (11,759 )   $ 6,050       (15,507 )     3,293  
Reclassification adjustment for losses (gains) included in net loss
          247       (4 )     62,709  
Unrealized net losses on cash flows hedges
    588       15       600       633  
Reclassification adjustment for losses (gains) included in net loss
    (12 )     (618 )     456       (1,366 )
 
Income tax (expense) benefit
  $ (12,065 )   $ 5,694     $ (16,220 )   $ 42,486  
 
CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME
Disclosure of accumulated other comprehensive income (loss):
                                 
    June 30,   December 31,   June 30,        
(In thousands)   2010   2009   2009        
 
Foreign currency translation adjustment
  $ (41,253 )   $ (40,676 )   $ (39,825 )        
 
Underfunding of pension and postretirement benefit plans
    (121,550 )     (127,786 )     (197,114 )        
Tax effect
    46,801       48,566       76,858          
 
Underfunding of pension and postretirement benefit plans, net of tax
    (74,749 )     (79,220 )     (120,256 )        
 
Unrealized holding gains on securities available-for-sale
    221,018       104,090       53,019          
Tax effect
    (29,645 )     (14,134 )     (9,616 )        
 
Unrealized holding gains on securities available-for-sale, net of tax
    191,373       89,956       43,403          
 
Unrealized (losses) gains on cash flows hedges
    (1,509 )     1,199       (37 )        
Tax effect
    588       (468 )     15          
 
Unrealized (losses) gains on cash flows hedges, net of tax
    (921 )     731       (22 )        
 
 
                               
Accumulated other comprehensive income (loss)
  $ 74,450     $ (29,209 )   $ (116,700 )        
 
The accompanying notes are an integral part of these unaudited consolidated financial statements.

7


 

POPULAR, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
                 
    Six months ended
    June 30,
(In thousands)   2010   2009
 
Cash flows from operating activities:
               
Net loss
  $ (140,883 )   $ (235,704 )
 
Adjustments to reconcile net loss to net cash provided by operating activities:
               
Depreciation and amortization of premises and equipment
    30,759       33,603  
Provision for loan losses
    442,458       721,973  
Amortization of intangibles
    4,504       4,839  
Fair value adjustments of mortgage servicing rights
    9,577       10,505  
Net (accretion of discounts) amortization of premiums
    (18,639 )     8,126  
Net gain on sale and valuation adjustments of investment securities
    (478 )     (229,851 )
Fair value change in equity appreciation instrument
    (24,394 )      
FDIC loss share income
    (23,334 )      
Gains from changes in fair value related to instruments measured at fair value pursuant to the fair value option
          (1,141 )
Net (gain) loss on disposition of premises and equipment
    (2,071 )     1,771  
Net loss on sale of loan, including adjustments to indemnity reserves and valuation adjustments on loans held-for-sale
    21,533       32,472  
Net amortization of deferred loan origination fees and costs
    2,140       4,374  
Earnings from investments under the equity method
    (14,513 )     (6,380 )
Net loss on sale and subsequent write-downs of foreclosed assets
    8,429       8,585  
Stock options expense
          45  
Deferred income taxes, net of valuation
    (15,752 )     (73,983 )
Net disbursements on loans held-for-sale
    (312,489 )     (685,500 )
Acquisitions of loans held-for-sale
    (133,798 )     (209,814 )
Proceeds from sale of loans held-for-sale
    35,867       43,875  
Net decrease in trading securities
    396,940       911,066  
Net decrease in accrued income receivable
    10,729       19,553  
Net decrease in other assets
    22,935       46,218  
Net decrease in interest payable
    (17,566 )     (30,133 )
Net increase in postretirement benefit obligation
    1,627       2,404  
Net increase in other liabilities
    9,312       61,055  
 
Total adjustments
    433,776       673,662  
 
Net cash provided by operating activities
    292,893       437,958  
 
Cash flows from investing activities:
               
Net increase in money market investments
    (1,344,614 )     (156,993 )
Purchases of investment securities:
               
Available-for-sale
    (542,506 )     (3,962,978 )
Held-to-maturity
    (37,131 )     (28,328 )
Other
    (13,076 )     (22,243 )
Proceeds from calls, paydowns, maturities and redemptions of investment securities:
               
Available-for-sale
    818,380       846,944  
Held-to-maturity
    40,716       3,133  
Other
    83,272       24,988  
Proceeds from sale of investment securities available-for-sale
    19,484       3,747,567  
Proceeds from sale of other investment securities
          44,425  
Net repayments on loans
    1,024,846       670,771  
Proceeds from sale of loans
    10,878       304,468  
Acquisition of loan portfolios
    (87,471 )     (18,260 )
Cash received from acquisitions
    261,311        
Mortgage servicing rights purchased
    (364 )     (727 )
Acquisition of premises and equipment
    (27,161 )     (37,741 )
Proceeds from sale of premises and equipment
    9,626       8,800  
Proceeds from sale of foreclosed assets
    69,058       76,334  
 
Net cash provided by investing activities
    285,248       1,500,160  
 
Cash flows from financing activities:
               
Net decrease in deposits
    (1,202,219 )     (633,722 )
Net decrease in assets sold under agreements to repurchase
    (325,596 )     (609,930 )
Net decrease in other short-term borrowings
    (6,063 )     (3,109 )
Payments of notes payable
    (189,780 )     (804,072 )
Proceeds from issuance of notes payable
    111,101       61,031  
Net proceeds from issuance of depositary shares
    1,102,358        
Dividends paid
          (71,438 )
Treasury stock acquired
    (503 )     (13 )
 
Net cash used in financing activities
    (510,702 )     (2,061,253 )
 
Net increase (decrease) in cash and due from banks
    67,439       (123,135 )
Cash and due from banks at beginning of period
    677,330       784,987  
 
Cash and due from banks at end of period
  $ 744,769     $ 661,852  
 
The accompanying notes are an integral part of these unaudited consolidated financial statements.
Note: The Consolidated Statement of Cash Flows for the six months ended June 30, 2009 includes the cash flows from operating, investing and financing activities associated with discontinued operations.

8


 

Notes to Unaudited Consolidated Financial Statements
 
Note 1 - Nature of Operations
Note 2 - Business Combination
Note 3 - Basis of Presentation and Summary of Significant Accounting Policies
Note 4 - Adoption of New Accounting Standards and Issued But Not Yet Effective Accounting Standards
Note 5 - Discontinued Operations
Note 6 - Restrictions on Cash and Due from Banks and Certain Securities
Note 7 - Pledged Assets
Note 8 - Investment Securities Available-For-Sale
Note 9 - Investment Securities Held-to-Maturity
Note 10 - Loans Held-in-Portfolio and Allowance for Loan Losses
Note 11 - Transfers of Financial Assets and Mortgage Servicing Rights
Note 12 - Other Assets
Note 13 - Goodwill and Other Intangible Assets
Note 14 - Derivative Instruments and Hedging Activities
Note 15 - Deposits
Note 16 - Borrowings
Note 17 - Trust Preferred Securities
Note 18 - Stockholders’ Equity
Note 19 - Commitments, Contingencies and Guarantees
Note 20 - Non-consolidated Variable Interest Entities
Note 21 - Fair Value Measurement
Note 22 - Fair Value of Financial Instruments
Note 23 - Net Loss per Common Share
Note 24 - Other Service Fees
Note 25 - Pension and Postretirement Benefits
Note 26 - Stock-Based Compensation
Note 27 - Income Taxes
Note 28 - Supplemental Disclosure on the Consolidated Statements of Cash Flows
Note 29 - Segment Reporting
Note 30 - Subsequent Events
Note 31 - Condensed Consolidating Financial Information of Guarantor and Issuers of Registered Guaranteed Securities

9


 

Notes to Unaudited Consolidated Financial Statements
Note 1 — Nature of Operations
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 has operations in Puerto Rico, the United States, the Caribbean and Latin America. In Puerto Rico, the Corporation provides retail and commercial banking services through its principal banking subsidiary, Banco Popular de Puerto Rico (“BPPR”), as well as auto and equipment leasing and financing, mortgage loans, investment banking, broker-dealer and insurance services through specialized subsidiaries. In the United States, the Corporation operates Banco Popular North America (“BPNA”), including its wholly-owned subsidiary E-LOAN. BPNA is a community bank providing a broad range of financial services and products to the communities it serves. BPNA operates branches in New York, California, Illinois, New Jersey and Florida. E-LOAN markets deposit accounts under its name for the benefit of BPNA. The Corporation, through its subsidiary EVERTEC, provides transaction processing services throughout the Caribbean and Latin America, as well as internally services many of Popular’s subsidiaries’ system infrastructures and transactional processing businesses. The sections that follow provide a description of two significant transactions that impacted or will impact the Corporation’s current and future operations.
Westernbank FDIC-Assisted Transaction
On April 30, 2010, BPPR entered into a purchase and assumption agreement with the Federal Deposit Insurance Corporation (the “FDIC”) to acquire certain assets and assume certain deposits and liabilities of Westernbank Puerto Rico, a Puerto Rico state-chartered bank headquartered in Mayaguez, Puerto Rico (“Westernbank”)(herein the “Westernbank FDIC-assisted transaction”). Westernbank was a wholly-owned commercial bank subsidiary of W Holding Company, Inc. and operated through a network of 45 branches located throughout Puerto Rico. On May 1, 2010, Westernbank’s branches reopened as branches of BPPR; however, the physical branch locations and leases were not immediately acquired by BPPR. BPPR has an option, which was extended until August 30, 2010, to acquire, at fair market value, any bank premises that were owned by, or any leases relating to bank premises held by, Westernbank (including ATM locations). BPPR is currently reviewing the bank premises and related leases of Westernbank, and expects to reduce the number of branches due to bank synergies. Currently, all former Westernbank banking facilities and equipment used by the Corporation are leased from the FDIC on a month-to-month basis. The integration of Westernbank’s operations into BPPR is expected to be substantially completed by the end of the third quarter of 2010. Refer to Note 2 to the consolidated financial statements for detailed information on the Westernbank FDIC-assisted transaction. Refer to the Corporation’s Form 8-K/A filed on July 16, 2010 for additional information with respect to this FDIC-assisted transaction.
EVERTEC
Popular, EVERTEC, and two newly formed subsidiaries of a fund managed by an affiliate of Apollo Management VII, L.P. (“Apollo”), AP Carib Holdings, Ltd. (“AP Carib”) and Carib Acquisition, Inc. (“Merger Sub”), have entered into an Agreement and Plan of Merger (the “Merger Agreement”) dated as of June 30, 2010, as amended as of August 5, 2010 and August 8, 2010, pursuant to which Merger Sub will be merged with and into EVERTEC (the “Merger”). EVERTEC currently operates Popular’s merchant acquiring and processing and technology business and owns the ATH Network connecting the ATMs of various financial institutions throughout Puerto Rico, the U.S. Virgin Islands and the British Virgin Islands. Following the effective time of the Merger, AP Carib and Popular will contribute their respective shares of EVERTEC capital stock to Carib Holdings, Inc. (“Carib Holdings”) in exchange for shares of Carib Holdings capital stock. Following that contribution, EVERTEC will be a wholly-owned subsidiary of Carib Holdings, and Carib Holdings will be operated as a joint venture between Apollo and Popular, with AP Carib and Popular initially owning 51% and 49%, respectively, of Carib Holdings’s outstanding capital stock, subject to pro rata dilution to the extent that non-voting stock or other securities convertible into non-voting stock and/or derivative securities whose value is derived from such capital stock or non-voting stock are issued to EVERTEC management. The transaction is expected to contribute significantly to the Corporation’s capital levels and capital ratios, and results of operations. The closing of the transaction is currently expected to be completed in the third quarter of 2010 and is subject to various conditions and regulatory approvals. Refer to the Corporation’s Form 8-K filed with the Securities and Exchange Commission (“SEC”) on July 8, 2010 for additional information regarding transaction terms and structure.
Under the Merger Agreement, Apollo has the option to require the Corporation to sell or retain EVERTEC’s operations in Venezuela. Apollo has informed management of the Corporation of their plan to exercise this option. Therefore, as a condition to closing, EVERTEC must transfer its operations in Venezuela to another one of the Corporation’s subsidiaries for an amount equal to the net book value of those operations and the transaction consideration will be reduced.

10


 

Prior to entering into the merger agreement, Popular and its subsidiaries BPPR, Popular International Bank, Inc. (“PIBI”) and EVERTEC completed an internal reorganization transferring certain intellectual property assets and interests in certain foreign subsidiaries to EVERTEC on June 30, 2010. Commencing on June 30, 2010, PIBI’s wholly-owned subsidiaries ATH Costa Rica S.A. and T.I.I. Smart Solutions Inc. became wholly-owned subsidiaries of EVERTEC. These foreign subsidiaries were reported as part of the EVERTEC reportable segment prior to the internal reorganization. Also, in connection with the reorganization, BPPR’s Merchant Business and TicketPop divisions were transferred to EVERTEC. As of June 30, 2010, the Corporation continued to evaluate and report the merchant acquiring business and TicketPop divisions as part of the BPPR reportable segment.
Note 2 — Business Combination
As indicated in Note 1 to the consolidated financial statements, on April 30, 2010, the Corporation’s banking subsidiary, BPPR, acquired certain assets and assumed certain deposits of Westernbank Puerto Rico from the FDIC, as receiver for Westernbank, in an assisted transaction. BPPR acquired approximately $9.1 billion in assets and assumed approximately $2.4 billion in deposits, excluding the effects of purchase accounting adjustments. As part of the transaction, BPPR issued a five-year $5.8 billion note payable to the FDIC bearing an annual interest rate of 2.50%. The note is secured by a substantial amount of the assets, including loans and foreclosed other real estate properties acquired by BPPR from the FDIC in the Westernbank assisted transaction, and which are subject to the loss sharing agreements. In addition, as part of the consideration for the transaction, the FDIC received a cash-settled equity appreciation instrument, which is described in detail below.
Loss Sharing Agreements
In connection with the acquisition, BPPR entered into loss sharing agreements with the FDIC with respect to approximately $8.6 billion of loans and other real estate (the “covered assets”) acquired in the Westernbank FDIC-assisted transaction. Pursuant to the terms of the loss sharing agreements, the FDIC’s obligation to reimburse BPPR for losses with respect to covered assets begins with the first dollar of loss incurred. The FDIC will reimburse BPPR for 80% of losses with respect to covered assets, and BPPR will reimburse the FDIC for 80% of recoveries with respect to losses for which the FDIC paid BPPR 80% reimbursement under the loss sharing agreements. The loss sharing agreement applicable to single-family residential mortgage loans provides for FDIC loss and recoveries sharing for ten years. The loss sharing agreement applicable to commercial and consumer loans provides for FDIC loss sharing for five years and BPPR reimbursement to the FDIC for eight years, in each case, on the same terms and conditions as described above.
In addition, BPPR has agreed to make a true-up payment to the FDIC on the date that is 45 days following the last day (the “True-Up Measurement Date”) of the final shared loss month, or upon the final disposition of all covered assets under the loss sharing agreements in the event losses on the loss sharing agreements fail to reach expected levels. The estimated fair value of such true-up payment is recorded as a reduction in the fair value of the FDIC loss share indemnification asset. Under the loss sharing agreements, BPPR shall pay to the FDIC, 50% of the excess, if any, of: (i) 20% of the Intrinsic Loss Estimate of $4.6 billion (or $925 million)(as determined by the FDIC) less (ii) the sum of: (A) 25% of the asset discount (per bid) (or ($1.1 billion)); plus (B) 25% of the cumulative shared-loss payments (defined as the aggregate of all of the payments made or payable to BPPR minus the aggregate of all of the payments made or payable to the FDIC); plus (C) the sum of the period servicing amounts for every consecutive twelve-month period prior to and ending on the True-Up Measurement Date in respect of each of the loss sharing agreements during which the loss sharing provisions of the applicable loss sharing agreement is in effect (defined as the product of the simple average of the principal amount of shared loss loans and shared loss assets at the beginning and end of such period times 1%).
Covered loans under loss sharing agreements with the FDIC (the “covered loans”) are reported in loans exclusive of the estimated FDIC loss share indemnification asset. The covered loans acquired in the Westernbank transaction are, and will continue to be, reviewed for collectability, based on the expectations of cash flows on these loans. As a result, if there is a decrease in the expected cash flows due to an increase in estimated credit losses compared to the estimate made at the April 30, 2010 acquisition date, the Corporation will record a charge to the provision for loan losses and an allowance for loan losses will be established. A related credit to income and an increase in the FDIC loss share indemnification asset will be recognized at the same time, measured based on the loss share percentages described above.
The operating results of the Corporation for the quarter and six-months ended June 30, 2010 include the operating results produced by the acquired assets and liabilities assumed for the period of May 1, 2010 to June 30, 2010. Note 29 to the consolidated financial statements provides limited information on the results of the BPPR Westernbank operations, which is presented as additional information within the BPPR reportable segment. The Corporation believes that given the nature of assets and liabilities assumed, the significant amount of fair value adjustments, the nature of additional consideration provided to the FDIC (note payable and equity appreciation instrument) and the FDIC loss sharing agreements now in place, historical results of Westernbank are not meaningful to Popular’s results, and thus no pro forma information is presented.

11


 

The following table presents balances recorded by the Corporation at the time of the Westernbank FDIC-assisted transaction on April 30, 2010.
                                 
    Book value                    
    prior to                    
    purchase                   As recorded by
    accounting   Fair value   Additional   Popular, Inc. on
(In thousands)   adjustments   adjustments   consideration   April 30, 2010
 
Assets:
                               
Cash and money market investments
  $ 358,132                 $ 358,132  
Investment in Federal Home Loan Bank stock
    58,610                   58,610  
Covered loans
    8,510,748     $ (4,293,756 )           4,216,992  
Non-covered loans
    43,996                     43,996  
FDIC loss share indemnification asset
          3,322,561             3,322,561  
Covered other real estate owned
    125,947       (52,712 )           73,235  
Core deposit intangible
          24,415             24,415  
Receivable from FDIC (associated to the Note payable issued to the FDIC)
              $ 111,101       111,101  
Other assets
    44,926                   44,926  
 
Total assets
  $ 9,142,359     $ (999,492 )   $ 111,101     $ 8,253,968  
 
 
                               
Liabilities:
                               
Deposits
  $ 2,380,170     $ 11,465           $ 2,391,635  
Note payable issued to the FDIC (including a premium of $11,612 resulting from the fair value adjustment)
              $ 5,769,696       5,769,696  
Equity appreciation instrument
                52,500       52,500  
Contingent liability on unfunded loan commitments
          132,442             132,442  
Accrued expenses and other liabilities
    13,925                   13,925  
 
Total liabilities
  $ 2,394,095     $ 143,907     $ 5,822,196     $ 8,360,198  
 
Excess of assets acquired over liabilities assumed
  $ 6,748,264                          
 
Aggregate fair value adjustments
          $ (1,143,399 )                
 
Aggregate additional consideration, net
                  $ 5,711,095          
 
Goodwill on acquisition
                          $ 106,230  
 
 
As previously disclosed, the fair values initially assigned to the assets acquired and liabilities assumed were preliminary and subject to refinement for up to one year after the closing date of the acquisition as new information relative to closing date fair values becomes available. Because of the short time period between the April 30, 2010 closing of the transaction and the June 30, 2010 reporting date, as well as delays in the receipt of certain information, the Corporation continues to analyze its estimates of fair value on loans acquired, FDIC loss share indemnification asset recorded and the note payable issued to the FDIC. As the Corporation finalizes its analyses of these assets and liabilities, there may be adjustments to the recorded carrying values, and thus the recognized goodwill may increase or decrease.

12


 

The following is a description of the methods used to determine the fair values of significant assets and liabilities:
Loans
Fair values for loans were based on a discounted cash flow methodology. Certain loans were valued individually, while other loans were valued as pools. Aggregation into pools considered characteristics such as loan type, payment term, rate type and accruing status, among others. Principal and interest projections considered prepayment rates and credit loss expectations. The discount rates were developed based on the relative risk of the cash flows, taking into account principally the loan type, market rates as of the valuation date, liquidity expectations, and the expected life of the loans.
FDIC loss share indemnification asset
Fair value was estimated using projected cash flows related to the loss sharing agreements based on the expected reimbursements for losses, including consideration of the true up payment and the applicable loss sharing percentages. These expected reimbursements do not include reimbursable amounts related to future covered expenditures. The estimates of expected losses used in valuation of this asset are consistent with the loss estimates used in the valuation of the covered assets. These cash flows were discounted to reflect the estimated timing of the receipt of the loss share reimbursement from the FDIC and the value of any true-up payment due to the FDIC at the end of the loss sharing agreements, to the extent applicable. The discount rate used in this calculation was determined using a yield of an A-rated corporate security with a term based on the weighted average life of the recovery of cash flows plus a risk premium reflecting the uncertainty related to the timing of cash flows and the potential rejection of claims by the FDIC. Due to the increased uncertainty of the true-up payment, an additional risk premium was added to the discount rate.
As of June 30, 2010, the Corporation has not made any claims to the FDIC associated with losses incurred on covered loans or covered other real estate owned. Non-interest income for the quarter ended June 30, 2010 was positively impacted by $23.3 million derived from the two-month accretion of the FDIC loss share indemnification asset.
Receivable from the FDIC
The note payable issued to the FDIC as of the April 30, 2010 transaction date was determined based on a pro-forma statement of assets acquired and liabilities assumed as of February 24, 2010, the bid transaction date. The receivable from the FDIC represents an adjustment to reconcile the consideration paid based on the assets acquired and liabilities assumed as of April 30, 2010 compared with the pro-forma statement as of February 24, 2010. The carrying amount of this receivable was a reasonable estimate of fair value based on its short-term nature. The receivable from the FDIC was collected by BPPR in June 2010 and is reflected as a cash inflow from financing activities in the consolidated statement of cash flows for the six months ended June 30, 2010. The proceeds were remitted to the FDIC in July 2010 as a payment on the note.
Other real estate covered under loss sharing agreements with the FDIC (“OREO”)
OREO includes real estate acquired in settlement of loans. OREO properties were recorded at estimated fair values less costs to sell at the date acquired based on management’s assessments of existing appraisals or broker price opinions. The estimated costs to sell are based on past experience with similar property types and terms customary for real estate transactions.
Goodwill
The amount of goodwill is the residual difference in the fair value of liabilities assumed and net consideration paid to the FDIC over the fair value of the assets acquired. The goodwill is deductible for income tax purposes. The goodwill from the Westernbank FDIC-assisted transaction was assigned to the BPPR reportable segment.
Core deposit intangible
This intangible asset represents the value of the relationships that Westernbank had with its deposit customers. The fair value of this intangible asset was estimated based on a discounted cash flow methodology that gave appropriate consideration to expected customer attrition rates, cost of the core deposit base, interest costs, and the net maintenance cost attributable to customer deposits, and the cost of alternative funds.
Deposits
The fair values used for the demand and savings deposits that comprise the transaction accounts acquired, by definition equal the amount payable on demand at the reporting date. The fair values for time deposits were estimated using a discounted cash flow calculation that applies interest rates currently offered to comparable time deposits with similar maturities.

13


 

Contingent liability on unfunded loan commitments
Unfunded loan commitments are contractual obligations to provide future funding. The fair value of a liability associated to unfunded loan commitments is principally based on the expected utilization rate or likelihood that the commitment will be exercised. The estimated value of the unfunded commitments was equal to the expected loss associated with the balance expected to be funded. The expected loss is comprised of both credit and non-credit components; therefore, the discounts derived from the loan valuation were applied to the expected funded balance to derive to fair value. The unfunded loan commitments outstanding as of the April 30, 2010 transaction date, which approximated $227 million, relate principally to commercial and construction loans and commercial revolving lines of credit. Losses incurred on loan disbursements made under these unfunded loan commitments are covered by the FDIC loss sharing agreements provided that the Corporation complies with specific requirements under such agreements. The fair value of the unfunded loan commitments amounting to $132 million is included as part of “other liabilities” in the consolidated statement of condition as of June 30, 2010.
Deferred taxes
Deferred taxes relate to a difference between the financial statement and tax basis of the assets acquired and liabilities assumed in the transaction. Deferred taxes are reported based upon the principles in ASC Topic 740 “Income Taxes”, and are measured using the enacted statutory income tax rate to be in effect for BPPR at the time the deferred tax is expected to reverse, which is 39%.
For income tax purposes, the Westernbank transaction was accounted for as an asset purchase and the tax bases of assets acquired were allocated based on fair values using a modified residual method. Under this method, the purchase price was allocated among the assets in order of liquidity (the most liquid first) up to its fair market value.
Note payable issued to the FDIC
The fair value of the note payable issued to the FDIC was determined using discounted cash flows based on market rates currently available for debt with similar terms, including consideration that the debt is collateralized by the assets covered under the loss sharing agreements. The principal source of cash flows to pay down the note payable derives from the cash flows collected from the covered assets, as well as payments from the FDIC on claimed credit losses associated to the covered assets. The Corporation is required under the agreements with the FDIC to use those proceeds to repay the note payable and remit payments on a monthly basis.
Equity appreciation instrument
As part of the consideration, BPPR also issued an equity appreciation instrument to the FDIC. Under the terms of the equity appreciation instrument, the FDIC has the opportunity to obtain a cash payment with a value equal to the product of (a) 50 million units and (b) the difference between (i) Popular, Inc.’s “average volume weighted price” over the two NASDAQ trading days immediately prior to the exercise date and (ii) the exercise price of $3.43. The equity appreciation instrument is exercisable by the holder thereof, in whole or in part, up to May 7, 2011. The fair value of the equity appreciation instrument was estimated by determining a call option value using the Black-Scholes Option Pricing Model. The equity appreciation instrument is recorded as a liability and any subsequent changes in its estimated fair value will be recognized in earnings. The Corporation recognized non-interest income of $24.4 million during the quarter ended June 30, 2010 as a result of a decrease in the fair value of the equity appreciation instrument.
Note 3 — Basis of Presentation and Summary of Significant Accounting Policies
The 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. The consolidated interim financial statements have been prepared without audit. The statement of condition data as of December 31, 2009 was derived from audited financial statements. The unaudited interim financial 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 information and note disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted from the unaudited financial statements 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, 2009, included in the Corporation’s Annual Report on Form 10-K filed on March 1, 2010 (the “2009 Annual Report”). Additionally, where applicable, the policies conform to the accounting and reporting guidelines prescribed by bank regulatory authorities. Operating results for the interim periods disclosed herein are not necessarily indicative of the results that may be expected for a full year or any future period.

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Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the consolidated statement of condition.
Management exercised significant judgment regarding assumptions about discount rates, future expected cash flows including prepayments, default rates, market conditions and other future events that are highly subjective in nature, and subject to change, and all of which affected the estimation of the fair values of the net assets acquired in the Westernbank FDIC-assisted transaction. Actual results could differ from those estimates; others provided with the same information could draw different reasonable conclusions and calculate different fair values. Changes that may vary significantly from our assumptions include loan prepayments, credit losses, the estimated market values of collateral at disposition, the timing of such disposition, and deposit attrition.
Business Acquisition
The Corporation determined that the acquisition of certain assets and assumption of certain liabilities of Westernbank in the Westernbank FDIC-assisted transaction constitutes a business acquisition as defined by the Financial Accounting Standards Board (“FASB”) Codification (“ASC”) Topic 805 “Business Combinations”. The assets and liabilities, both tangible and intangible, were initially recorded at their estimated fair values. Fair values were determined based on the requirements of FASB Codification Topic 820 “Fair Value Measurements”. These fair value estimates are preliminary and subject to refinement for up to one year after the closing date of the acquisition as additional information regarding the closing date fair value becomes available. Acquisition-related costs are expensed as incurred.
Loans acquired in an FDIC-assisted transaction
Loans acquired in a business acquisition are recorded at their fair value at the acquisition date. Credit discounts are included in the determination of fair value; therefore, an allowance for loan losses is not recorded at the acquisition date.
Since the loans from the Westernbank FDIC-assisted transaction were acquired with a significant discount for credit, the Corporation applied the discount accretion guidance of ASC Subtopic 310-30 “Loans and Debt Securities Acquired with Deteriorated Credit Quality” (“ASC Subtopic 310-30”) to all acquired loans, except for credit cards and revolving lines of credit that were expressly scoped out from the application of this guidance. As documented in a letter from the AICPA Depository Institutions Expert Panel (“DIEP”) to the Office of Chief Accountant of the SEC, on December 5, 2009, the SEC addressed the recognition of discount accretion for loans acquired under these circumstances. As referred to in the AICPA’s letter, when loans are acquired with a significant discount for credit and such loans are not within the scope of ASC 310-30, they believed that the SEC “would not object to an accounting policy based on contractual cash flows or an accounting policy based on expected cash flows”, meaning that an entity could either apply the accretion guidance of ASC 310-20 or that of ASC 310-30 to such loans. Consistent with the AICPA’s views, the Corporation applied the guidance of ASC 310-30 to all loans acquired in Westernbank FDIC-assisted transaction, except for credit cards and revolving lines of credit as indicated above.
Under ASC Subtopic 310-30, the covered loans acquired from the FDIC were aggregated into pools based on similar characteristics, including factors such as loan type, interest rate type, accruing status, and amortization type. Each loan pool is accounted for as a single asset with a single composite interest rate and an aggregate expectation of cash flows. Under ASC Subtopic 310-30, the difference between the undiscounted cash flows expected at acquisition and the fair value in the loans, or the “accretable yield,” is recognized as interest income using the effective yield method over the estimated life of the loan if the timing and amount of the future cash flows of the pool is reasonably estimable. The non-accretable difference represents the difference between contractually required principal and interest and the cash flows expected to be collected. Subsequent to the acquisition date, increases in cash flows over those expected at the acquisition date are recognized as interest income prospectively. Decreases in expected cash flows after the acquisition date are recognized by recording an allowance for loan losses.

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The fair value discount of lines of credit with revolving privileges that are accounted for pursuant to the guidance of ASC Subtopic 310-20, represents the difference between the contractually required loan payment receivable in excess of the initial investment in the loan. This discount is accreted into interest income over the life of the loan if the loan is in accruing status. Any cash flows collected in excess of the carrying amount of the loan are recognized in earnings at the time of collection. The carrying amount of lines of credit with revolving privileges, which are accounted pursuant to the guidance of ASC Subtopic 310-20, are subject to periodic review to determine the need for recognizing an allowance for loan losses.
Covered Assets
Assets subject to loss sharing agreements with the FDIC are labeled “covered” on the consolidated statement of condition and include certain loans and other real estate properties. Loans acquired in the Westernbank FDIC-assisted transaction, except for credit cards, are considered “covered loans” because the Corporation will be reimbursed for 80% of any future losses on these loans subject to the terms of the FDIC loss sharing agreements.
FDIC Loss Share Indemnification Asset
The acquisition date fair value of the reimbursement that the Corporation expects to receive from the FDIC under the loss sharing agreements was recorded as an FDIC loss share indemnification asset on the consolidated statement of condition. Fair value was estimated using projected cash flows related to the loss sharing agreements. Refer to Note 2 for additional information on the valuation methodology. The impact of the FDIC loss share indemnification on the Corporation’s results of operations is included in non-interest income, particularly in the category of “FDIC loss share income”, and considers the accretion due to discounting and the changes in expected loss sharing reimbursements. Decreases in expected reimbursements will be recognized in income prospectively consistent with the approach taken to recognize increases in cash flows on covered loans. Increases in expected reimbursements will be recognized in income in the same period that the allowance for credit losses for the related loans is recognized.
The FDIC loss share indemnification asset for loss share agreements is measured separately from the related covered assets as it is not contractually embedded in the assets and is not transferable with the assets should the assets be sold.
Equity Appreciation Instrument
The equity appreciation instrument is recorded as an “other liability” in the consolidated statement of condition and any subsequent change in its estimated fair value is recognized in earnings on each quarterly reporting date. Refer to Note 2 to the consolidated financial statements for additional information on the equity appreciation instrument issued to the FDIC.
Note 4 — Adoption of New Accounting Standards and Issued But Not Yet Effective Accounting Standards
FASB Accounting Standards Update 2009-16, Transfers and Servicing (Accounting Standards Codification (“ASC”)

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Topic 860) — Accounting for Transfers of Financial Assets (“ASU 2009-16”)
ASU 2009-16 amends previous guidance relating to transfers of financial assets and eliminates the concept of a qualifying special-purpose entity, removes the exception for guaranteed mortgage securitizations when a transferor has not surrendered control over the transferred financial assets, changes the requirements for derecognizing financial assets, and includes additional disclosures requiring more information about transfers of financial assets in which entities have continuing exposure to the risks related to the transferred financial assets. Among the most significant amendments and additions to this guidance are changes to the conditions for sales of financial assets which objective is to determine whether a transferor and its consolidated affiliates included in the financial statements have surrendered control over transferred financial assets or third-party beneficial interests; and the addition of the meaning of the term participating interest which represents a proportionate (pro rata) ownership interest in an entire financial asset. The requirements for sale accounting must be applied only to a financial asset in its entirety, a pool of financial assets in its entirety, or participating interests as defined in ASC Subparagraph 860-10-40-6A. This guidance has been applied as of the beginning of the first annual reporting period that began after November 15, 2009, for interim periods within that first annual reporting period and will be applied for interim and annual reporting periods thereafter. Earlier application was prohibited. The recognition and measurement provisions have been applied to transfers that have occurred on or after the effective date. On and after the effective date, existing qualifying special-purpose entities have been evaluated for consolidation in accordance with the applicable consolidation guidance in the Codification. The Corporation adopted this new authoritative accounting guidance effective January 1, 2010. The Corporation evaluated transfers of financial assets executed during the six months ended June 30, 2010 pursuant to the new accounting guidance, principally consisting of guaranteed mortgage securitizations (Government National Mortgage Association (“GNMA”) and Federal National Mortgage Association (“FNMA”) mortgage-backed securities, and determined that the adoption of ASU 2009-16 did not have a significant impact on the Corporation’s accounting for such transactions or results of operations or financial condition for such period.
A securitization of a financial asset, a participating interest in a financial asset, or a pool of financial assets in which the Corporation (and its consolidated affiliates) (a) surrenders control over the transferred assets and (b) receives cash or other proceeds is accounted for as a sale. Control is considered to be surrendered only if all three of the following conditions are met: (1) the assets have been legally isolated; (2) the transferee has the ability to pledge or exchange the assets; and (3) the transferor no longer maintains effective control over the assets. When the Corporation transfers financial assets and the transfer fails any one of the above criteria, the Corporation is prevented from derecognizing the transferred financial assets and the transaction is accounted for as a secured borrowing.
The Corporation recognizes and initially measures at fair value a servicing asset or servicing liability each time it undertakes an obligation to service a financial asset by entering into a servicing contract in either of the following situations: (1) a transfer of an entire financial asset, a group of entire financial assets, or a participating interest in an entire financial asset that meets the requirements for sale accounting; or (2) an acquisition or assumption of a servicing obligation of financial assets that do not pertain to the Corporation or its consolidated subsidiaries. Upon adoption of ASU 2009-16, the Corporation does not recognize either a servicing asset or a servicing liability if it transfers or securitizes financial assets in a transaction that does not meet the requirements for sale accounting and is accounted for as a secured borrowing.
Refer to Note 11 to the consolidated financial statements for disclosures on transfers of financial assets and servicing assets retained as part of guaranteed mortgage securitizations.
FASB Accounting Standards Update 2009-17, Consolidations (ASC Topic 810) — Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities (“ASU 2009-17”) and FASB Accounting Standards Update 2010-10, Consolidation (ASC Topic 810): Amendments for Certain Investment Funds (“ASU 2010-10”)
ASU 2009-17 amends the guidance applicable to variable interest entities (“VIE”) and changes how a reporting entity determines when an entity that is insufficiently capitalized or is not controlled through voting (or similar rights) should be consolidated. This guidance replaces a quantitative-based risks and rewards calculation for determining which entity, if any, has both (a) a controlling financial interest in a variable interest entity with an approach focused on identifying which entity has the power to direct the activities of a variable interest entity that

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most significantly impact the entity’s economic performance and (b) the obligation to absorb losses of the entity or the right to receive benefits from the entity that could potentially be significant to the variable interest entity. This guidance requires reconsideration of whether an entity is a variable interest entity when any changes in facts or circumstances occur such that the holders of the equity investment at risk, as a group, lose the power to direct the activities of the entity that most significantly impact the entity’s economic performance. It also requires ongoing assessments of whether a variable interest holder is the primary beneficiary of a variable interest entity. The amendments to the consolidated guidance affect all entities that were within the scope of the original guidance, as well as qualifying special-purpose entities (“QSPEs”) that were previously excluded from the guidance. ASU 2009-17 requires a reporting entity to provide additional disclosures about its involvement with variable interest entities and any significant changes in risk exposure due to that involvement. The Corporation adopted this new authoritative accounting guidance effective January 1, 2010. The new accounting guidance on variable interest entities did not have an effect on the Corporation’s consolidated statement of condition or results of operations upon adoption.
The principal variable interest entities evaluated by the Corporation during the six months ended June 30, 2010 included: (1) GNMA and FNMA guaranteed mortgage securitizations and for which management has concluded that the Corporation is not the primary beneficiary (refer to Note 20 to the consolidated financial statements) and (2) the trust preferred securities for which management believes that the Corporation does not possess a significant variable interest on the trusts (refer to Note 17 to the consolidated financial statements).
Additionally, the Corporation has variable interests in certain investments that have the attributes of investment companies, as well as limited partnership investments in venture capital companies. However, in January 2010, the FASB issued ASU 2010-10, Consolidation (ASC Topic 810), Amendments for Certain Investment Funds, which deferred the effective date of the provisions of ASU 2009-17 for a reporting entity’s interest in an entity that has all the attributes of an investment company; or for which it is industry practice to apply measurement principles for financial reporting purposes that are consistent with those followed by investment companies. The deferral allows asset managers that have no obligation to fund potentially significant losses of an investment entity to continue to apply the previous accounting guidance to investment entities that have the attributes of entities subject to ASC Topic 946 (the “Investment Company Guide”). The FASB also decided to defer the application of ASU 2009-17 for money market funds subject to Rule 2a-7 of the Investment Company Act of 1940. Asset managers would continue to apply the applicable existing guidance to those entities that qualify for the deferral. ASU 2010-10 did not defer the disclosure requirements in ASU 2009-17.
The Corporation was not required to consolidate existing variable interest entities for which it has a variable interest as of June 30, 2010. Refer to Note 20 to the consolidated financial statements for required disclosures associated with the guaranteed mortgage securitizations in which the Corporation holds a variable interest.
FASB Accounting Standards Update 2010-06, Fair Value Measurements and Disclosures (ASC Topic 820) - Improving Disclosures about Fair Value Measurements (“ASU 2010-06”)
ASU 2010-06, issued in January 2010, revises two disclosure requirements concerning fair value measurements and clarifies two others. It requires separate presentation of significant transfers into and out of Levels 1 and 2 of the fair value hierarchy and disclosure of the reasons for such transfers. It will also require the presentation of purchases, sales, issuances and settlements within Level 3 on a gross basis rather than a net basis. The amendments also clarify that disclosures should be disaggregated by class of asset or liability and that disclosures about inputs and valuation techniques should be provided for both recurring and non-recurring fair value measurements. ASU 2010-06 has been effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements in the rollforward of activity in Level 3 fair value measurements, which are effective for interim and annual reporting periods beginning after December 15, 2010. This guidance impacts disclosures only and will not have an effect on the Corporation’s consolidated statements of condition or results of operations. The Corporation’s disclosures about fair value measurements are presented in Note 21 to the consolidated financial statements.
FASB Accounting Standards Update 2010-11, Derivatives and Hedging (ASC Topic 815): Scope Exception Related to Embedded Credit Derivatives (“ASU 2010-11”)

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ASU 2010-11 clarifies the type of embedded credit derivative that is exempt from embedded derivative bifurcation requirements. The type of credit derivative that qualifies for the exemption is related only to the subordination of one financial instrument to another. As a result, entities that have contracts containing an embedded credit derivative feature in a form other than such subordination may need to separately account for the embedded credit derivative feature. The amendments in ASU 2010-11 are effective for each reporting entity at the beginning of its first fiscal quarter beginning after June 15, 2010. Early adoption is permitted at the beginning of each entity’s first fiscal quarter beginning after March 5, 2010. The Corporation does not expect that the adoption of this standard will have a significant effect, if any, on its consolidated financial statements.
FASB Accounting Standards Update 2010-18, Receivables (ASC Topic 310): Effect of a Loan Modification When the Loan is Part of a Pool That is Accounted for as a Single Asset (“ASU 2010-18”)
The amendments in ASU 2010-18, issued in April 2010, affect any entity that acquires loans subject to ASC Subtopic 310-30, that accounts for some or all of those loans within pools, and that subsequently modifies one or more of those loans after acquisition. ASC Subtopic 310-30 provides guidance on accounting for acquired loans that have evidence of credit deterioration upon acquisition. As a result of the amendments in ASU 2010-18, modifications of loans that are accounted for within a pool under ASC Subtopic 310-30 do not result in the removal of those loans from the pool even if the modification of those loans would otherwise be considered a troubled debt restructuring. An entity will continue to be required to consider whether the pool of assets in which the loan is included is impaired if expected cash flows for the pool change. The amendments in ASU 2010-18 do not affect the accounting for loans under the scope of Subtopic 310-30 that are not accounted for within pools. Loans accounted for individually under Subtopic 310-30 continue to be subject to the troubled debt restructuring accounting provisions within ASC Subtopic 310-40, Receivables—Troubled Debt Restructurings by Creditors. The amendments in ASU 2010-18 are effective for modifications of loans accounted for within pools under Subtopic 310-30 occurring in the first interim or annual period ending on or after July 15, 2010. The amendments are to be applied prospectively. Early application is permitted. Upon initial adoption of the guidance in ASU 2010-18, an entity may make a one-time election to terminate accounting for loans as a pool under Subtopic 310-30. This election may be applied on a pool-by-pool basis and does not preclude an entity from applying pool accounting to subsequent acquisitions of loans with credit deterioration. The Corporation elected to early adopt the provisions of this statement, effective with the closing of the Westernbank FDIC-assisted transaction on April 30, 2010. As a result, the accounting for modified loans follows the guidelines of ASU 2010-18; however, the adoption of these provisions did not have a significant impact on the Corporation’s result of operations or financial position as of June 30, 2010.
FASB Accounting Standards Update 2010-20, Receivables (ASC Topic 310): Disclosure about the Credit Quality of Financing Receivables and the Allowance for Credit Losses (“ASU 2010-20”)
ASU 2010-20, issued in July 2010, expands disclosure requirements about the credit quality of financing receivables and allowance for credit losses. The objective of this ASU is for an entity to provide disclosures that facilitate financial statement users’ evaluation of the following: (1) the nature of credit risk inherent in the entity’s portfolio of financing receivables; (2) how that risk is analyzed and assessed in arriving at the allowance for credit losses; and (3) the changes and reasons for those changes in the allowance for credit losses. Disclosures should be provided on a disaggregated basis on two defined levels: (1) portfolio segment; and (2) class of financing receivable. The ASU 2010-20 makes changes to existing disclosure requirements and includes additional disclosure requirements about financing receivables, including: the credit quality indicators of financing receivables at the end of the reporting period by class of financing receivables; the aging of past due financing receivables at the end of the reporting period by class of financing receivables; and the nature and extent of troubled debt restructurings that occurred during the period by class of financing receivables and their effect on the allowance for credit losses. The disclosure requirements as of the end of a reporting period are effective for interim and annual reporting periods ending on or after December 15, 2010. The disclosures about activity that occurs during a reporting period are effective for interim and annual reporting periods beginning on or after December 15, 2010. This guidance impacts disclosures only and will not have an effect on the Corporation’s consolidated statements of condition or results of operations.
Note 5 — Discontinued Operations
In 2008, the Corporation discontinued the operations of Popular Financial Holdings (“PFH”) by selling assets and closing service branches and other units. The loss from discontinued operations for the quarter and six months

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ended June 30, 2009 was $6.6 million and $16.5 million, respectively, net of taxes. This loss was primarily related to salary and other expenses incurred in providing loan portfolio servicing to affiliated companies and other costs for full-time equivalent employees (“FTEs”) that were retained for a transition period, as well as adjustments to indemnity reserves on loans previously sold.
Note 6 — Restrictions on Cash and Due from Banks and Certain 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 other banks. Those required average reserve balances were $788 million as of June 30, 2010 (December 31, 2009 — $721 million; June 30, 2009 — $718 million). Cash and due from banks as well as other short-term, highly-liquid securities are used to cover the required average reserve balances.
As required by the Puerto Rico International Banking Center Regulatory Act, as of June 30, 2010, December 31, 2009, and June 30, 2009, the Corporation maintained separately for its two international banking entities (“IBEs”), $0.6 million in time deposits, equally divided for the two IBEs, which were considered restricted assets.
As part of a line of credit facility with a financial institution, as of June 30, 2010, the Corporation maintained restricted cash of $1 million (December 31, 2009 and June 30, 2009 — $2 million) as collateral for the line of credit. 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.
As of June 30, the Corporation maintained restricted cash of $6 million to support letters of credit (December 31, 2009 — $4 million; June 30, 2009 — $5 million).
As of June 30, 2010, the Corporation maintained restricted cash of $2 million that represents funds deposited in an escrow account which are guaranteeing possible liens or encumbrances over the title of insured properties.
As of June 30, 2010, the Corporation maintained restricted cash of $5 million as collateral for repurchase liabilities.
As of June 30, 2010, the Corporation had restricted cash of $4 million which represents cash received on deposit from participant institutions of the ATH network that has been segregated for the development of the ATH brand.
As of June 30, 2010, the Corporation maintained restricted cash of $12 million to comply with the requirements of the credit card networks.
Note 7 — Pledged Assets
Certain securities and loans were pledged principally to secure public and trust deposits, assets sold under agreements to repurchase, other borrowings and credit facilities available, derivative positions and loan servicing agreements.
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:
                         
    June 30,   December 31,   June 30,
(In thousands)   2010   2009   2009
 
Investment securities available-for-sale, at fair value
  $ 2,384,829     $ 1,923,338     $ 2,252,017  
Investment securities held-to-maturity, at amortized cost
    125,770       125,769       125,770  
Loans held-for-sale measured at lower of cost or fair value
    3,069       2,254       34,014  
Loans held-in-portfolio covered under loss sharing agreements with the FDIC
    3,932,700              
Loans held-in-portfolio not covered under loss sharing agreements with the FDIC
    9,392,857       8,993,967       7,629,613  
Other real estate covered under loss sharing agreements with the FDIC
    76,331              
 
Total pledged assets
  $ 15,915,556     $ 11,045,328     $ 10,041,414  
 
Pledged investment 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.

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Investment securities available-for-sale and held-to-maturity totaling $2.0 billion as of June 30, 2010 served as collateral to secure public funds.
The Corporation’s banking subsidiaries have the ability to borrow funds from the Federal Home Loan Bank of New York (“FHLB) and from the Federal Reserve Bank of New York (“Fed”). As of June 30, 2010, the banking subsidiaries had short-term and long-term credit facilities authorized with the FHLB aggregating $1.7 billion. Refer to Note 16 to the consolidated financial statements for borrowings outstanding under these credit facilities. As of June 30, 2010, the credit facilities authorized with the FHLB were collateralized by $3.0 billion in loans held-in-portfolio and investment securities available-for-sale. Also, the Corporation’s banking subsidiaries had a borrowing capacity at the Fed discount window of $3.2 billion, which remained unused as of such date. The amount available under this credit facility is dependent upon the balance of loans and securities pledged as collateral. As of June 30, 2010, the credit facilities with the Fed were collateralized by $6.4 billion in loans held-in-portfolio. These pledged assets are included in the above table and were not reclassified and separately reported in the consolidated statement of condition as of June 30, 2010.
Loans held-in-portfolio and other real estate owned that are covered by loss sharing agreements with the FDIC amounting to $4.0 billion as of June 30, 2010, serve as collateral to secure the Note payable issued to the FDIC. Refer to Note 2 to the consolidated financial statements for descriptive information on the note payable issued to the FDIC.

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Note 8 — Investment Securities Available-For-Sale
The amortized cost, gross unrealized gains and losses, fair value and weighted average yield of investment securities available-for-sale as of June 30, 2010, December 31, 2009 and June 30, 2009 were as follows:
                                         
    AS OF JUNE 30, 2010
            Gross   Gross           Weighted
    Amortized   Unrealized   Unrealized   Fair   Average
(In thousands)   Cost   Gains   Losses   Value   Yield
 
U.S. Treasury securities
                                       
After 1 to 5 years
  $ 107,776     $ 1,311           $ 109,087       1.47 %
After 5 to 10 years
    29,023       2,577             31,600       3.80  
 
Total U.S. Treasury securities
    136,799       3,888             140,687       1.97  
 
Obligations of U.S. Government sponsored entities
                                       
Within 1 year
    384,536       5,504             390,040       3.52  
After 1 to 5 years
    1,254,234       65,786             1,320,020       3.41  
After 5 to 10 years
    11,928       83             12,011       5.30  
After 10 years
    26,887       517             27,404       5.68  
 
Total obligations of U.S. Government sponsored entities
    1,677,585       71,890             1,749,475       3.49  
 
Obligations of Puerto Rico, States and political subdivisions
                                       
After 1 to 5 years
    22,406       171             22,577       4.09  
After 5 to 10 years
    27,049       321     $ 4       27,366       5.12  
After 10 years
    5,560       129             5,689       5.28  
 
Total obligations of Puerto Rico, States and political subdivisions
    55,015       621       4       55,632       4.72  
 
Collateralized mortgage obligations — federal agencies
                                       
Within 1 year
    159       3             162       4.06  
After 1 to 5 years
    4,714       136             4,850       4.61  
After 5 to 10 years
    98,717       1,507       88       100,136       2.65  
After 10 years
    1,310,206       32,005       2,341       1,339,870       2.93  
 
Total collateralized mortgage obligations — federal agencies
    1,413,796       33,651       2,429       1,445,018       2.92  
 
Collateralized mortgage obligations — private label
                                       
After 5 to 10 years
    16,737       21       522       16,236       2.08  
After 10 years
    92,212       116       6,577       85,751       2.37  
 
Total collateralized mortgage obligations — private label
    108,949       137       7,099       101,987       2.32  
 
Mortgage-backed securities — agencies
                                       
Within 1 year
    20,661       177             20,838       2.96  
After 1 to 5 years
    20,438       544             20,982       3.96  
After 5 to 10 years
    188,865       12,762             201,627       4.72  
After 10 years
    2,629,056       107,342       161       2,736,237       4.31  
 
Total mortgage-backed securities — agencies
    2,859,020       120,825       161       2,979,684       4.33  
 
Equity securities
    9,005       202       503       8,704       3.46  
 
Total investment securities available-for-sale
  $ 6,260,169     $ 231,214     $ 10,196     $ 6,481,187       3.70 %
 

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    AS OF DECEMBER 31, 2009
            Gross   Gross           Weighted
    Amortized   Unrealized   Unrealized   Fair   Average
(In thousands)   Cost   Gains   Losses   Value   Yield
 
U.S. Treasury securities
                                       
After 5 to 10 years
  $ 29,359     $ 1,093           $ 30,452       3.80 %
 
Obligations of U.S. Government sponsored entities
                                       
Within 1 year
    349,424       7,491             356,915       3.67  
After 1 to 5 years
    1,177,318       58,151             1,235,469       3.79  
After 5 to 10 years
    27,812       680             28,492       4.96  
After 10 years
    26,884       176             27,060       5.68  
 
Total obligations of U.S. Government sponsored entities
    1,581,438       66,498             1,647,936       3.82  
 
Obligations of Puerto Rico, States and political subdivisions
                                       
After 1 to 5 years
    22,311       7     $ 15       22,303       6.92  
After 5 to 10 years
    50,910       249       632       50,527       5.08  
After 10 years
    7,840             61       7,779       5.26  
 
Total obligations of Puerto Rico, States and political subdivisions
    81,061       256       708       80,609       5.60  
 
Collateralized mortgage obligations — federal agencies
                                       
Within 1 year
    41                   41       3.78  
After 1 to 5 years
    4,875       120             4,995       4.44  
After 5 to 10 years
    125,397       2,105       404       127,098       2.85  
After 10 years
    1,454,833       19,060       5,837       1,468,056       3.03  
 
Total collateralized mortgage obligations — federal agencies
    1,585,146       21,285       6,241       1,600,190       3.02  
 
Collateralized mortgage obligations — private label
                                       
After 5 to 10 years
    20,885             653       20,232       2.00  
After 10 years
    105,669       109       8,452       97,326       2.59  
 
Total collateralized mortgage obligations — private label
    126,554       109       9,105       117,558       2.50  
 
Mortgage-backed securities — agencies
                                       
Within 1 year
    26,878       512             27,390       3.61  
After 1 to 5 years
    30,117       823             30,940       3.94  
After 5 to 10 years
    205,480       8,781             214,261       4.80  
After 10 years
    2,915,689       32,102       10,203       2,937,588       4.40  
 
Total mortgage-backed securities — agencies
    3,178,164       42,218       10,203       3,210,179       4.42  
 
Equity securities
    8,902       233       1,345       7,790       3.65  
 
Total investment securities available-for-sale
  $ 6,590,624     $ 131,692     $ 27,602     $ 6,694,714       3.91 %
 

23


 

                                         
    AS OF JUNE 30, 2009
            Gross   Gross           Weighted
    Amortized   Unrealized   Unrealized   Market   Average
(In thousands)   Cost   Gains   Losses   Value   Yield
 
U.S. Treasury securities
                                       
After 5 to 10 years
  $ 29,695     $ 1,138           $ 30,833       3.80 %
 
Obligations of U.S. Government sponsored entities
                                       
Within 1 year
    154,896       2,990             157,886       4.33  
After 1 to 5 years
    1,476,345       65,241     $ 174       1,541,412       3.77  
After 5 to 10 years
    27,811       1,060             28,871       4.96  
After 10 years
    26,880       579             27,459       5.68  
 
Total obligations of U.S. Government sponsored entities
    1,685,932       69,870       174       1,755,628       3.87  
 
Obligations of Puerto Rico, States and political subdivisions
                                       
Within 1 year
    4,500       10             4,510       6.10  
After 1 to 5 years
    2,150       5       8       2,147       4.95  
After 5 to 10 years
    68,476       264       4,906       63,834       4.79  
After 10 years
    28,690       4       277       28,417       5.23  
 
Total obligations of Puerto Rico, States and political subdivisions
    103,816       283       5,191       98,908       4.97  
 
Collateralized mortgage obligations — federal agencies
                                       
Within 1 year
    266       1             267       4.12  
After 1 to 5 years
    8,566       181       16       8,731       5.16  
After 5 to 10 years
    148,888       2,202       473       150,617       3.04  
After 10 years
    1,508,619       17,049       11,638       1,514,030       3.19  
 
Total collateralized mortgage obligations — federal agencies
    1,666,339       19,433       12,127       1,673,645       3.18  
 
Collateralized mortgage obligations — private label
                                       
Within 1 year
    221             1       220       3.87  
After 5 to 10 years
    27,224             746       26,478       2.35  
After 10 years
    128,354       3       18,567       109,790       3.60  
 
Total collateralized mortgage obligations — private label
    155,799       3       19,314       136,488       3.38  
 
Mortgage-backed securities
                                       
Within 1 year
    5,143       52             5,195       3.04  
After 1 to 5 years
    78,841       1,502       1       80,342       3.80  
After 5 to 10 years
    149,901       4,812       4       154,709       4.82  
After 10 years
    3,304,858       17,212       19,559       3,302,511       4.50  
 
Total mortgage-backed securities
    3,538,743       23,578       19,564       3,542,757       4.50  
 
Equity securities
    13,116       81       4,997       8,200       2.48  
 
Total investment securities available-for-sale
  $ 7,193,440     $ 114,386     $ 61,367     $ 7,246,459       4.02 %
 

24


 

The following table shows the Corporation’s fair value and gross unrealized losses 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 as of June 30, 2010, December 31, 2009 and June 30, 2009.
                                                 
    AS OF JUNE 30, 2010
    Less than 12 months   12 months or more   Total
            Gross           Gross           Gross
            Unrealized   Fair   Unrealized           Unrealized
(In thousands)   Fair Value   Losses   Value   Losses   Fair Value   Losses
 
Obligations of Puerto Rico, States and political subdivisions
              $ 305     $ 4     $ 305     $ 4  
Collateralized mortgage obligations — federal agencies
  $ 138,856     $ 1,915       114,113       514       252,969       2,429  
Collateralized mortgage obligations — private label
    200       8       84,564       7,091       84,764       7,099  
Mortgage-backed securities — agencies
    8,174       109       1,465       52       9,639       161  
Equity securities
    22       18       7,191       485       7,213       503  
 
Total investment securities available-for-sale in an unrealized loss position
  $ 147,252     $ 2,050     $ 207,638     $ 8,146     $ 354,890     $ 10,196  
 
                                                 
    AS OF DECEMBER 31, 2009
    Less than 12 months   12 months or more   Total
            Gross           Gross           Gross
            Unrealized   Fair   Unrealized           Unrealized
(In thousands)   Fair Value   Losses   Value   Losses   Fair Value   Losses
 
Obligations of Puerto Rico, States and political subdivisions
  $ 2,387     $ 8     $ 63,429     $ 700     $ 65,816     $ 708  
Collateralized mortgage obligations — federal agencies
    298,917       3,667       359,214       2,574       658,131       6,241  
Collateralized mortgage obligations — private label
    6,716       18       97,904       9,087       104,620       9,105  
Mortgage-backed securities — agencies
    905,028       10,130       3,566       73       908,594       10,203  
Equity securities
    2,347       981       3,898       364       6,245       1,345  
 
Total investment securities available-for-sale in an unrealized loss position
  $ 1,215,395     $ 14,804     $ 528,011     $ 12,798     $ 1,743,406     $ 27,602  
 
                                                 
    AS OF JUNE 30, 2009
    Less than 12 months   12 months or more   Total
            Gross           Gross           Gross
            Unrealized   Fair   Unrealized           Unrealized
(In thousands)   Fair Value   Losses   Value   Losses   Fair Value   Losses
 
Obligations of U.S. government sponsored entities
  $ 60,287     $ 174                 $ 60,287     $ 174  
Obligations of Puerto Rico, States and political subdivisions
    28,498       253     $ 52,609     $ 4,938       81,107       5,191  
Collateralized mortgage obligations — federal agencies
    284,948       4,493       483,759       7,634       768,707       12,127  
Collateralized mortgage obligations — private label
    19,433       869       116,674       18,445       136,107       19,314  
Mortgage-backed securities — agencies
    1,613,487       19,151       45,984       413       1,659,471       19,564  
Equity securities
    5,969       4,770       2,096       227       8,065       4,997  
 
Total investment securities available-for-sale in an unrealized loss position
  $ 2,012,622     $ 29,710     $ 701,122     $ 31,657     $ 2,713,744     $ 61,367  
 

25


 

Management evaluates investment securities for other-than-temporary (“OTTI”) declines in fair value on a quarterly basis. Once a decline in value is determined to be other-than-temporary, the value of a debt security is reduced and a corresponding charge to earnings is recognized for anticipated credit losses. Also, for equity securities that are considered other-than-temporarily impaired, the excess of the security’s carrying value over its fair value at the evaluation date is accounted for as a loss in the results of operations. The OTTI analysis requires management to consider various factors, which include, but are not limited to: (1) the length of time and the extent to which fair value has been less than the amortized cost basis, (2) the financial condition of the issuer or issuers, (3) actual collateral attributes, (4) the payment structure of the debt security and the likelihood of the issuer being able to make payments, (5) any rating changes by a rating agency, (6) adverse conditions specifically related to the security, industry, or a geographic area, and (7) management’s intent to sell the debt security or whether it is more likely than not that the Corporation would be required to sell the debt security before a forecasted recovery occurs.
As of June 30, 2010, management performed its quarterly analysis of all debt securities in an unrealized loss position. Based on the analyses performed, management concluded that no individual debt security was other-than-temporarily impaired as of such date. As of June 30, 2010, the Corporation does not have the intent to sell debt securities in an unrealized loss position and it is not more likely than not that the Corporation will have to sell the investment securities prior to recovery of their amortized cost basis. Also, management evaluated the Corporation’s portfolio of equity securities as of June 30, 2010. During the quarter ended June 30, 2010, the Corporation did not record any other-than-temporary impairment losses on equity securities. Management has the intent and ability to hold the investments in equity securities that are at a loss position as of June 30, 2010 for a reasonable period of time for a forecasted recovery of fair value up to (or beyond) the cost of these investments.
The unrealized losses reported for “Collateralized mortgage obligations — federal agencies” are principally associated to CMOs that were issued by U.S. Government-sponsored entities and agencies, primarily Federal National Mortgage Association (“FNMA”) and Federal Home Loan Mortgage Corporation (“FHLMC”), institutions which the government has affirmed its commitment to support, and Government National Mortgage Association (“GNMA”), which has the full faith and credit of the U.S. Government. These collateralized mortgage obligations are rated AAA by the major rating agencies and are backed by residential mortgages. The unrealized losses in this portfolio were primarily attributable to changes in interest rates and levels of market liquidity relative to when the investment securities were purchased and not due to credit quality of the securities.
The unrealized losses associated with “Collateralized mortgage obligations — private label” are primarily related to securities backed by residential mortgages. In addition to verifying the credit ratings for the private-label CMOs, management analyzed the underlying mortgage loan collateral for these bonds. Various statistics or metrics were reviewed for each private-label CMO, including among others, the weighted average loan-to-value, FICO score, and delinquency and foreclosure rates of the underlying assets in the securities. As of June 30, 2010, there were no “sub-prime” or “Alt-A” securities in the Corporation’s private-label CMOs portfolios. For private-label CMOs with unrealized losses as of June 30, 2010, credit impairment was assessed using a cash flow model that estimates the cash flows on the underlying mortgages, using the security-specific collateral and transaction structure. The model estimates cash flows from the underlying mortgage loans and distributes those cash flows to various tranches of securities, considering the transaction structure and any subordination and credit enhancements that exist in that structure. The cash flow model incorporates actual cash flows through the current period and then projects the expected cash flows using a number of assumptions, including default rates, loss severity and prepayment rates. Management’s assessment also considered tests using more stressful parameters. Based on the assessments, management concluded that the tranches of the private-label CMOs held by the Corporation were not other-than-temporarily impaired as of June 30, 2010, thus management expects to recover the amortized cost basis of the securities.
All of the Corporation’s securities classified as mortgage-backed securities were issued by U.S. Government-sponsored entities and agencies, primarily GNMA and FNMA, thus as previously expressed, have the guarantee or support of the U.S. Government. These mortgage-backed securities are rated AAA by the major rating agencies and are backed by residential mortgages. Most of the mortgage-backed securities held as of June 30, 2010 with unrealized

26


 

losses had been purchased at a premium during 2009, and although their fair values have declined, they continue to exceed the par value of the securities. The unrealized losses in this portfolio were generally attributable to changes in interest rates relative to when the investment securities were purchased and not due to credit quality of the securities.
Proceeds from the sale of investment securities available-for-sale during the six months ended June 30, 2010 amounted to $19.5 million with no realized gains as the securities were sold at par value, and mostly related to the sale of Commonwealth of Puerto Rico Appropriation Bonds. This compares with proceeds of $3.7 billion for the six months ended June 30, 2009, mostly related to the sale of “FHLB” notes during the first quarter of 2009, and realized net gains of $184.1 million.
During the six months ended June 30, 2009, the Corporation recognized approximately $6.6 million in losses in equity securities classified as available-for-sale that management considered to be other-than-temporarily impaired.
The following table states the names of issuers and the aggregate amortized cost and fair value of the securities of such issuer (includes available-for-sale and held-to-maturity securities), in which 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.
                                                 
    June 30, 2010   December 31, 2009   June 30, 2009
(In thousands)   Amortized Cost   Fair Value   Amortized Cost   Fair Value   Amortized Cost   Fair Value
 
FNMA
  $ 963,714     $ 996,966     $ 970,744     $ 991,825     $ 1,230,691     $ 1,246,060  
FHLB
    1,418,562       1,486,376       1,385,535       1,449,454       1,465,847       1,532,656  
Freddie Mac
    624,844       638,388       959,316       971,556       999,435       1,006,425  
 

27


 

Note 9 — Investment Securities Held-to-Maturity
The amortized cost, gross unrealized gains and losses, fair value and weighted average yield of investment securities held-to-maturity as of June 30, 2010, December 31, 2009 and June 30, 2009 were as follows:
                                         
    AS OF JUNE 30, 2010
            Gross   Gross           Weighted
    Amortized   Unrealized   Unrealized   Fair   Average
(In thousands)   Cost   Gains   Losses   Value   Yield
 
U.S. Treasury securities
                                       
Within 1 year
  $ 25,797     $ 4           $ 25,801       0.22 %
 
Obligations of Puerto Rico, States and political subdivisions
                                       
Within 1 year
    7,110       13             7,123       2.12  
After 1 to 5 years
    109,820       509             110,329       5.52  
After 5 to 10 years
    17,808       289     $ 75       18,022       5.94  
After 10 years
    46,050       63       1,000       45,113       3.88  
 
Total obligations of Puerto Rico, States and political subdivisions
    180,788       874       1,075       180,587       5.01  
 
Collateralized mortgage obligations — private label
                                       
After 10 years
    209             12       197       5.45  
 
Others
                                       
Within 1 year
    1,372                   1,372       1.91  
After 1 to 5 years
    1,250                   1,250       0.84  
 
Total others
    2,622                   2,622       1.40  
 
Total investment securities held-to-maturity
  $ 209,416     $ 878     $ 1,087     $ 209,207       4.38 %
 
                                         
    AS OF DECEMBER 31, 2009
            Gross   Gross           Weighted
    Amortized   Unrealized   Unrealized   Fair   Average
(In thousands)   Cost   Gains   Losses   Value   Yield
 
U.S. Treasury securities
                                       
Within 1 year
  $ 25,777     $ 4           $ 25,781       0.11 %
 
Obligations of Puerto Rico, States and political subdivisions
                                       
Within 1 year
    7,015       6             7,021       2.04  
After 1 to 5 years
    109,415       3,157     $ 6       112,566       5.51  
After 5 to 10 years
    17,112       39       452       16,699       5.79  
After 10 years
    48,600             2,552       46,048       4.00  
 
Total obligations of Puerto Rico, States and political subdivisions
    182,142       3,202       3,010       182,334       5.00  
 
Collateralized mortgage obligations — private label
                                       
After 10 years
    220             12       208       5.45  
 
Others
                                       
Within 1 year
    3,573                   3,573       3.77  
After 1 to 5 years
    1,250                   1,250       1.66  
 
Total others
    4,823                   4,823       3.22  
 
Total investment securities held-to-maturity
  $ 212,962     $ 3,206     $ 3,022     $ 213,146       4.37 %
 

28


 

                                         
    AS OF JUNE 30, 2009
            Gross   Gross           Weighted
    Amortized   Unrealized   Unrealized   Fair   Average
(In thousands)   Cost   Gains   Losses   Value   Yield
 
Obligations of U.S. Government sponsored entities
                                       
Within 1 year
  $ 25,795     $ 14           $ 25,809       0.37 %
 
Obligations of Puerto Rico, States and political subdivisions
                                       
Within 1 year
    106,985       7             106,992       2.67  
After 1 to 5 years
    109,245       79     $ 44       109,280       5.51  
After 5 to 10 years
    16,818       51       1,381       15,488       5.77  
After 10 years
    50,340             5,312       45,028       4.36  
 
Total obligations of Puerto Rico, States and political subdivisions
    283,388       137       6,737       276,788       4.25  
 
Collateralized mortgage obligations — private label
                                       
After 10 years
    231             13       218       5.45  
 
Others
                                       
Within 1 year
    9,147                   9,147       3.92  
After 1 to 5 years
    1,500                   1,500       2.51  
 
Total others
    10,647                   10,647       3.72  
 
Total investment securities held-to-maturity
  $ 320,061     $ 151     $ 6,750     $ 313,462       3.92 %
 
The following table shows the Corporation’s fair value and gross unrealized losses 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 as of June 30, 2010, December 31, 2009 and June 30, 2009:
                                                 
    AS OF JUNE 30, 2010    
    Less than 12 months   12 months or more Total  
            Gross           Gross           Gross
            Unrealized   Fair   Unrealized           Unrealized
(In thousands)   Fair Value   Losses   Value   Losses   Fair Value   Losses
 
Obligations of Puerto Rico, States and political subdivisions
              $ 45,460     $ 1,075     $ 45,460     $ 1,075  
Collateralized mortgage obligations — private label
                197       12       197       12  
 
Total investment securities held-to-maturity in an unrealized loss position
              $ 45,657     $ 1,087     $ 45,657     $ 1,087  
 
                                                 
    AS OF DECEMBER 31, 2009
    Less than 12 months   12 months or more   Total
            Gross           Gross           Gross
            Unrealized   Fair   Unrealized           Unrealized
(In thousands)   Fair Value   Losses   Value   Losses   Fair Value   Losses
 
Obligations of Puerto Rico, States and political subdivisions
  $ 21,187     $ 1,908     $ 37,718     $ 1,102     $ 58,905     $ 3,010  
Collateralized mortgage obligations — private label
                208       12       208       12  
 
Total investment securities held-to-maturity in an unrealized loss position
  $ 21,187     $ 1,908     $ 37,926     $ 1,114     $ 59,113     $ 3,022  
 
                                                 
    AS OF JUNE 30, 2009
    Less than 12 months   12 months or more   Total
            Gross           Gross           Gross
            Unrealized   Fair   Unrealized           Unrealized
(In thousands)   Fair Value   Losses   Value   Losses   Fair Value   Losses
 
Obligations of Puerto Rico, States and political subdivisions
  $ 61,746     $ 6,654     $ 562     $ 83     $ 62,308     $ 6,737  
Collateralized mortgage obligations — private label
                218       13       218       13  
Others
    3,000             250             3,250        
 
Total investment securities held-to-maturity in an unrealized loss position
  $ 64,746     $ 6,654     $ 1,030     $ 96     $ 65,776     $ 6,750  
 
As indicated in Note 8 to these consolidated financial statements, management evaluates investment securities for other-than-temporary (“OTTI”) declines in fair value on a quarterly basis.

29


 

The “Obligations of Puerto Rico, States and political subdivisions” classified as held-to-maturity as of June 30, 2010 are primarily associated with securities issued by municipalities of Puerto Rico and are generally not rated by a credit rating agency. The Corporation performs periodic credit quality reviews on these issuers. The decline in fair value as of June 30, 2010 was attributable to changes in interest rates and not credit quality; thus no other-than-temporary decline in value was recorded in these held-to-maturity securities. As of June 30, 2010, the Corporation does not have the intent to sell securities held-to-maturity and it is not more likely than not that the Corporation will have to sell these investment securities prior to recovery of their amortized cost basis.
Note 10 — Loans Held-in-Portfolio and Allowance for Loan Losses
Because of the loss protection provided by the FDIC, the risks of the Westernbank FDIC-assisted transaction acquired loans are significantly different from those loans not covered under the FDIC loss sharing agreements. Accordingly, the Corporation presents loans subject to the loss sharing agreements as “covered loans” in the information below and loans that are not subject to the FDIC loss sharing agreements as “non-covered loans”.
The composition of loans held-in-portfolio (“HIP”) as of June 30, 2010, December 31, 2009, and June 30, 2009 was as follows:
                                         
    Non-covered   Covered   Total loans HIP        
    loans as of   loans as of   as of June 30,   December 31,   June 30,
(In thousands)   June 30, 2010   June 30, 2010   2010   2009   2009
 
Commercial
  $ 11,786,235     $ 2,421,708     $ 14,207,943     $ 12,664,059     $ 13,078,506  
Construction
    1,495,615       281,178       1,776,793       1,724,373       2,033,448  
Lease financing
    636,913             636,913       675,629       730,396  
Mortgage [1]
    4,688,656       1,192,786       5,881,442       4,603,245       4,444,498  
Consumer
    3,858,969       183,345       4,042,314       4,045,807       4,319,214  
 
Total loans held-in-portfolio
  $ 22,466,388     $ 4,079,017     $ 26,545,405     $ 23,713,113     $ 24,606,062  
 
 
[1]   Includes residential construction loans.
 
 
The following table presents acquired loans accounted for pursuant to ASC Subtopic 310-30 as of the April 30, 2010 acquisition date:
         
(In thousands)        
 
Contractually-required principal and interest
  $ 10,995,387  
Non-accretable difference
    5,789,480  
 
Cash flows expected to be collected
    5,205,907  
Accretable yield
    1,303,908  
 
Fair value of loans accounted for under ASC Subtopic 310-30
  $ 3,901,999  [1]
 
 
[1]   Reflects a difference of $11.4 million compared with the amounts disclosed in the Form 8-K/A filed on July 16, 2010, which included the financial statements and exhibits pertaining to the Westernbank FDIC-assisted transaction at the acquisition date. The Corporation reassessed the classification of certain acquired loans and, due to their revolving characteristics, reclassified the loans for accounting purposes from ASC Subtopic 310-30 to ASC Subtopic 310-20. The reclassification did not impact the fair value of the loans.
 
 
The cash flows expected to be collected consider the estimated remaining life of the underlying loans and include the effects of estimated prepayments. The unpaid principal balance of the acquired loans from the Westernbank FDIC-assisted transaction that are accounted under ASC Subtopic 310-30 amounted to $7.8 billion as of the April 30, 2010 transaction date.
Changes in the carrying amount and the accretable yield for the acquired loans in the Westernbank FDIC-assisted transaction as of and for the quarter ended June 30, 2010, and which are accounted pursuant to the ASC Subtopic 310-30, were as follows:

30


 

                 
            Carrying amount
(In thousands)   Accretable yield   of loans
 
Balance at beginning of period
           
Additions [1]
  $ 1,303,908     $ 3,901,999  
Accretion
    (38,998 )     38,998  
Payments received, net
          (130,169 )
 
Balance at end of period
  $ 1,264,910     $ 3,810,828  
 
 
[1]   Represents the estimated fair value of the loans at the date of acquisition. There were no reclassifications from non-accretable difference to accretable yield from April 30, 2010 to June 30, 2010.
 
 
As of June 30, 2010, none of the acquired loans accounted under ASC Subtopic 310-30 were considered non-performing loans. Therefore, interest income, through accretion of the difference between the carrying amount of the loans and the expected cash flows, was recognized on all acquired loans. There was no allowance for loan losses related to the covered loans as of June 30, 2010, since the loan pools are performing as anticipated in the projections used in the purchase accounting fair value calculations.
As indicated in Note 3 to the consolidated financial statements, the Corporation accounts for lines of credit with revolving privileges under the accounting guidance of ASC Subtopic 310-20, which requires that any differences between the contractually required loan payment receivable in excess of the initial investment in the loans be accreted into interest income using the effective yield method over the life of the loan, if the loan is accruing interest. The following table presents acquired loans accounted for under ASC Subtopic 310-20 as of the April 30, 2010 acquisition date:
         
(In thousands)        
 
 
Fair value of loans accounted under ASC Subtopic 310-20
  $ 358,989  [1]
 
Gross contractual amounts receivable (principal and interest)
  $ 1,007,880  
 
Estimate of contractual cash flows not expected to be collected
  $ 614,653  
 
 
[1]   Reflects a difference of $11.4 million compared with the amounts disclosed in the Form 8-K/A filed on July 16, 2010, which included the financial statements and exhibits pertaining to the Westernbank FDIC-assisted transaction at the acquisition date. The Corporation reassessed the classification of certain acquired loans and, due to their revolving characteristics, reclassified the loans for accounting purposes from ASC Subtopic 310-30 to ASC Subtopic 310-20. The reclassification did not impact the fair value of the loans.
 
 
The cash flows expected to be collected consider the estimated remaining life of the underlying loans and include the effects of estimated prepayments. The unpaid principal balance of the acquired loans from the Westernbank FDIC-assisted transaction that are accounted pursuant to ASC Subtopic 310-20 amounted to $739 million as of the April 30, 2010 transaction date.
The activity in the allowance for loan losses for the six months ended June 30, 2010 and 2009 is summarized as follows:
                 
(In thousands)   June 30, 2010   June 30, 2009
 
Balances at beginning of period
  $ 1,261,204     $ 882,807  
Provision for loan losses
    442,458       721,973  
Loan charge-offs
    (477,958 )     (489,134 )
Loan recoveries
    51,312       30,593  
 
Balance at end of period
  $ 1,277,016     $ 1,146,239  
 
Note 11 — Transfers of Financial Assets and Mortgage Servicing Rights
The Corporation typically transfers conforming residential mortgage loans in conjunction with GNMA and FNMA securitization transactions whereby the loans are exchanged for cash or securities and servicing rights. The securities issued through these transactions are guaranteed by the corresponding agency and, as such, under seller/servicer

31


 

agreements the Corporation is required to service the loans in accordance with the agencies’ servicing guidelines and standards. Substantially all mortgage loans securitized by the Corporation in GNMA and FNMA securities have fixed rates and represent conforming loans. As seller, the Corporation has made certain representations and warranties with respect to the originally transferred loans and, in some instances, has sold loans with credit recourse to a government-sponsored entity, namely FNMA. Refer to Note 19 to the consolidated financial statements for a description of such arrangements.
During the six months ended June 30, 2010, the Corporation retained servicing rights on guaranteed mortgage securitizations (FNMA and GNMA) and whole loan sales involving approximately $452 million in principal balance outstanding (June 30, 2009 — $805 million). During the quarter and six months ended June 30, 2010, the Corporation recognized gains of approximately $2.8 million and $8.8 million, respectively, on these transactions (June 30, 2009 — $27.0 million for the quarter and $26.4 million for the six-month period). All loan sales or securitizations performed during the six months ended June 30, 2010 were without credit recourse arrangements.
During the quarter ended June 30, 2010, the Corporation obtained as proceeds $210 million of assets as a result of securitization transactions with FNMA and GNMA, consisting of $206 million in mortgage-backed securities and $4 million in servicing rights. During the six months ended June 30, 2010, the Corporation obtained as proceeds $419 million of assets as a result of securitization transactions with FNMA and GNMA, consisting of $411 million in mortgage-backed securities and $8 million in servicing rights. No liabilities were incurred as a result of these transfers during the quarter and six month-period ended June 30, 2010 because they did not contain any credit recourse arrangements. The Corporation recorded a gain of $5.0 million and $10.3 million, respectively, during the quarter and six months ended June 30, 2010 related to these residential mortgage loans securitized.
The following tables present the initial fair value of the assets obtained as proceeds from residential mortgage loans securitized during the quarter and six months ended June 30, 2010.
                                 
    Proceeds Obtained During Quarter Ended June 30, 2010
                            Initial Fair
(In thousands)   Level 1   Level 2   Level 3   Value
 
Assets
                               
 
Investment securities available-for-sale:
                               
Mortgage-backed securities — GNMA
                       
Mortgage-backed securities — FNMA
                       
 
Total investment securities available-for-sale
                       
 
Trading account securities:
                               
Mortgage-backed securities — GNMA
        $ 165,675     $ 2,518     $ 168,193  
Mortgage-backed securities — FNMA
          37,814             37,814  
 
Total trading account securities
        $ 203,489     $ 2,518     $ 206,007  
 
Mortgage servicing rights
              $ 3,794     $ 3,794  
 
Total
        $ 203,489     $ 6,312     $ 209,801  
 
                                 
    Proceeds Obtained During Six Months Ended June 30, 2010
                            Initial Fair
(In thousands)   Level 1   Level 2   Level 3   Value
 
Assets
                               
 
Investment securities available-for-sale:
                               
Mortgage-backed securities — GNMA
              $ 2,810     $ 2,810  
Mortgage-backed securities — FNMA
                       
 
Total investment securities available-for-sale
              $ 2,810     $ 2,810  
 
Trading account securities:
                               
Mortgage-backed securities — GNMA
        $ 327,600     $ 4,147     $ 331,747  
Mortgage-backed securities — FNMA
            76,506             76,506  
 
Total trading account securities
        $ 404,106     $ 4,147     $ 408,253  
 
Mortgage servicing rights
              $ 7,535     $ 7,535  
 
Total
        $ 404,106     $ 14,492     $ 418,598  
 

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Refer to Note 21 to the consolidated financial statements for key inputs, assumptions, and valuation techniques used to measure the fair value of these mortgage-backed securities and mortgage servicing rights.
Mortgage servicing rights
The Corporation recognizes as assets the rights to service loans for others, whether these rights are purchased or result from asset transfers such as sales and securitizations.
Classes of mortgage servicing rights were determined based on the different markets or types of assets being serviced. The Corporation recognizes the servicing rights of its banking subsidiaries that are related to residential mortgage loans as a class of servicing rights. These mortgage servicing rights (“MSRs”) are measured at fair value. Fair value determination is performed on a subsidiary basis, with assumptions varying in accordance with the types of assets or markets served.
The Corporation uses a discounted cash flow model to estimate the fair value of MSRs. The discounted cash flow model incorporates assumptions that market participants would use in estimating future net servicing income, including estimates of prepayment speeds, discount rate, cost to service, escrow account earnings, contractual servicing fee income, prepayment and late fees, among other considerations. Prepayment speeds are adjusted for the Corporation’s loan characteristics and portfolio behavior.
The following table presents the changes in residential MSRs measured using the fair value method for the six months ended June 30, 2010 and June 30, 2009.
                 
(In thousands)   2010   2009
 
Fair value as of January 1
  $ 169,747     $ 176,034  
Purchases
    4,015       727  
Servicing from securitizations or asset transfers
    7,809       13,661  
Changes due to payments on loans [1]
    (7,932 )     (7,921 )
Changes in fair value due to changes in valuation model
               
inputs or assumptions
    (1,645 )     (1,693 )
 
Fair value as of June 30
  $ 171,994     $ 180,808  
 
[1]   Represents changes due to collection / realization of expected cash flows over time.
Residential mortgage loans serviced for others were $17.9 billion as of June 30, 2010 (December 31, 2009 — $17.7 billion; June 30, 2009 — $17.7 billion).
Net mortgage servicing fees, a component of other service fees in the consolidated statements of operations, include the changes from period to period in the fair value of the MSRs, which may result from changes in the valuation model inputs or assumptions (principally reflecting changes in discount rates and prepayment speed assumptions) and other changes, including changes due to collection / realization of expected cash flows. Mortgage servicing fees, excluding fair value adjustments, for the quarter and six months ended June 30, 2010 amounted to $11.9 million and $23.8 million, respectively (June 30, 2009 — $11.3 million and $23.0 million). The banking subsidiaries receive servicing fees based on a percentage of the outstanding loan balance. As of June 30, 2010, those weighted average mortgage servicing fees were 0.27% (June 30, 2009 — 0.26%). Under these servicing agreements, the banking subsidiaries do not generally earn significant prepayment penalty fees on the underlying loans serviced.
The discussion that follows includes information on assumptions used in the valuation model of the MSRs, originated and purchased.
Key economic assumptions used in measuring the servicing rights retained at the date of the residential mortgage loan securitizations and whole loan sales by the banking subsidiaries during the quarter ended June 30, 2010 and year ended December 31, 2009 were as follows:
                 
    June 30, 2010   December 31, 2009
 
Prepayment speed
    4.6 %     7.8 %
Weighted average life
  21.8 years   12.8 years
Discount rate (annual rate)
    11.5 %     11.0 %
 

33


 

Key economic assumptions used to estimate the fair value of MSRs derived from sales and securitizations of mortgage loans performed by the banking subsidiaries and the sensitivity to immediate changes in those assumptions as of June 30, 2010 and December 31, 2009 were as follows:
                 
    Originated MSRs
(In thousands)   June 30, 2010   December 31, 2009
 
Fair value of retained interests
  $ 100,956     $ 97,870  
Weighted average life
    11.8 years       8.8 years
Weighted average prepayment speed (annual rate)
    8.5 %     11.4 %
Impact on fair value of 10% adverse change
  $ (3,296 )   $ (3,182 )
Impact on fair value of 20% adverse change
  $ (6,521 )   $ (7,173 )
Weighted average discount rate (annual rate)
    12.86 %     12.41 %
Impact on fair value of 10% adverse change
  $ (4,212 )   $ (2,715 )
Impact on fair value of 20% adverse change
  $ (8,201 )   $ (6,240 )
 
The banking subsidiaries also own servicing rights purchased from other financial institutions. The fair value of purchased MSRs, their related valuation assumptions and the sensitivity to immediate changes in those assumptions as of period end were as follows:
                 
    Purchased MSRs
(In thousands)   June 30, 2010   December 31, 2009
 
Fair value of retained interests
  $ 71,038     $ 71,877  
Weighted average life
    12.7 years       9.9 years
Weighted average prepayment speed (annual rate)
    7.9 %     10.1 %
Impact on fair value of 10% adverse change
  $ (2,715 )   $ (2,697 )
Impact on fair value of 20% adverse change
  $ (4,801 )   $ (5,406 )
Weighted average discount rate (annual rate)
    11.6 %     11.1 %
Impact on fair value of 10% adverse change
  $ (3,150 )   $ (2,331 )
Impact on fair value of 20% adverse change
  $ (5,604 )   $ (4,681 )
 
The sensitivity analyses presented in the tables above for servicing rights are hypothetical and should be used with caution. As the figures indicate, changes in fair value based on a 10 and 20 percent variation in assumptions generally cannot be extrapolated because the relationship of the change in assumption to the change in fair value may not be linear. Also, in the sensitivity tables included herein, the effect of a variation in a particular assumption on the fair value of the retained interest is calculated without changing any other assumption. In reality, changes in one factor may result in changes in another (for example, increases in market interest rates may result in lower prepayments and increased credit losses), which might magnify or counteract the sensitivities.
As of June 30, 2010, the Corporation serviced $4.2 billion (December 31, 2009 — $4.5 billion; June 30, 2009 — $4.7 billion) in residential mortgage loans with credit recourse to the Corporation.
Under the GNMA securitizations, the Corporation has the right to repurchase, at its option and without GNMA’s prior authorization, any loan that is collateral for a GNMA guaranteed mortgage-backed security when certain delinquency criteria are met. At the time that individual loans meet GNMA’s specified delinquency criteria and are eligible for repurchase, the Corporation is deemed to have regained effective control over these loans. As of June 30, 2010, the Corporation had recorded $141 million in mortgage loans on its financial statements related to this buy-back option program (December 31, 2009 — $124 million; June 30, 2009 — $88 million).

34


 

Note 12 — Other Assets
The caption of other assets in the consolidated statements of condition consists of the following major categories:
                         
    June 30,   December 31,   June 30,
(In thousands)   2010   2009   2009
 
Net deferred tax assets (net of valuation allowance)
  $ 347,396     $ 363,967     $ 390,467  
Bank-owned life insurance program
    235,499       232,387       228,675  
Prepaid FDIC insurance assessment
    179,130       206,308        
Other prepaid expenses
    161,963       130,762       136,634  
Investments under the equity method
    98,234       99,772       91,558  
Derivative assets
    79,571       71,822       76,019  
Trade receivables from brokers and counterparties
    73,110       1,104       66,943  
Others
    227,169       216,037       224,553  
 
Total other assets
  $ 1,402,072     $ 1,322,159     $ 1,214,849  
 
Note 13 — Goodwill and Other Intangible Assets
The changes in the carrying amount of goodwill for the six months ended June 30, 2010 and 2009, allocated by reportable segments, were as follows (refer to Note 29 for the definition of the Corporation’s reportable segments):
                                         
2010
                    Purchase            
    Balance as of   Goodwill   accounting           Balance as of
(In thousands)   January 1, 2010   on acquisition   adjustments   Other   June 30, 2010
 
Banco Popular de Puerto Rico:
                                       
Commercial Banking
  $ 31,729                       $ 31,729  
Consumer and Retail Banking
    117,000                         117,000  
Other Financial Services
    8,296                         8,296  
Westernbank
        $ 106,230                   106,230  
Banco Popular North America:
                                       
Banco Popular North America
    402,078                         402,078  
EVERTEC
    45,246                         45,246  
 
Total Popular, Inc.
  $ 604,349     $ 106,230                 $ 710,579  
 
                                         
2009
            Goodwill   Purchase            
    Balance as of   on   accounting           Balance as of
(In thousands)   January 1, 2009   acquisition   adjustments   Other   June 30, 2009
 
Banco Popular de Puerto Rico:
                                       
Commercial Banking
  $ 31,729                 $ 111     $ 31,840  
Consumer and Retail Banking
    117,000           $ 1       544       117,545  
Other Financial Services
    8,330             (34 )           8,296  
Banco Popular North America:
                                       
Banco Popular North America
    404,237                         404,237  
EVERTEC
    44,496             750             45,246  
 
Total Popular, Inc.
  $ 605,792           $ 717     $ 655     $ 607,164  
 

35


 

The gross amount of goodwill and accumulated impairment losses at the beginning and the end of the quarter by reportable segment were as follows:
                                                 
2010
    Balance at   Accumulated   Balance at   Balance at   Accumulated   Balance at
    January 1, 2010   Impairment   January 1, 2010   June 30, 2010   Impairment   June 30, 2010
(In thousands)   (Gross amounts)   Losses   (Net amounts)   (Gross amounts)   Losses   (Net amounts)
 
Banco Popular de Puerto Rico:
                                               
Commercial Banking
  $ 31,729           $ 31,729     $ 31,729           $ 31,729  
Consumer and Retail Banking
    117,000             117,000       117,000             117,000  
Other Financial Services
    8,296             8,296       8,296             8,296  
Westernbank
                      106,230             106,230  
Banco Popular North America:
                                               
Banco Popular North America
    402,078             402,078       402,078             402,078  
E-LOAN
    164,411     $ 164,411             164,411     $ 164,411        
EVERTEC
    45,429       183       45,246       45,429       183       45,246  
 
Total Popular, Inc.
  $ 768,943     $ 164,594     $ 604,349     $ 875,173     $ 164,594     $ 710,579  
 
                                                 
2009
    Balance at   Accumulated   Balance at   Balance at   Accumulated   Balance at
    January 1, 2009   Impairment   January 1, 2009   June 30, 2009   Impairment   June 30, 2009
(In thousands)   (Gross amounts)   Losses   (Net amounts)   (Gross amounts)   Losses   (Net amounts)
 
Banco Popular de Puerto Rico:
                                               
Commercial Banking
  $ 31,729           $ 31,729     $ 31,840           $ 31,840  
Consumer and Retail Banking
    117,000             117,000       117,545             117,545  
Other Financial Services
    8,330             8,330       8,296             8,296  
Banco Popular North America:
                                               
Banco Popular North America
    404,237             404,237       404,237             404,237  
E-LOAN
    164,411     $ 164,411             164,411     $ 164,411        
EVERTEC
    44,679       183       44,496       45,429       183       45,246  
 
Total Popular, Inc.
  $ 770,386     $ 164,594     $ 605,792     $ 771,758     $ 164,594     $ 607,164  
 
The goodwill recognized in the BPPR reportable segment during the quarter ended June 30, 2010 relates to the Westernbank FDIC-assisted transaction. Refer to Note 2 to the consolidated financial statements for further information on the accounting for the transaction and the resulting goodwill recognition. The fair values initially assigned to the assets acquired and liabilities assumed in the Westernbank FDIC-assisted transaction are subject to refinement for up to one year after the closing date of the acquisition as new information relative to closing date fair values becomes available. Any changes in such fair value estimates may impact the goodwill initially recorded.
The purchase accounting adjustments in the EVERTEC reportable segment for the six months ended June 30, 2009 are related to contingency payments on acquisitions made prior to January 1, 2009.
As of June 30, 2010, December 31, 2009 and June 30, 2009, the Corporation had $6 million of identifiable intangible assets, other than goodwill, with indefinite useful lives.

36


 

The following table reflects the components of other intangible assets subject to amortization:
                                                 
    June 30, 2010   December 31, 2009   June 30, 2009
    Gross   Accumulated   Gross   Accumulated   Gross   Accumulated
(In thousands)   Amount   Amortization   Amount   Amortization   Amount   Amortization
 
Core deposits
  $ 80,591     $ 25,625     $ 65,379     $ 30,991     $ 65,379     $ 27,560  
 
                                               
Other customer relationships
    8,743       6,372       8,816       5,804       8,816       5,152  
 
                                               
Other intangibles
    125       90       125       71       2,981       2,366  
 
 
                                               
Total
  $ 89,459     $ 32,087     $ 74,320     $ 36,866     $ 77,176     $ 35,078  
 
During the quarter ended June 30, 2010, the Corporation recognized $24 million in a core deposit intangible asset associated with the Westernbank FDIC-assisted transaction. This core deposit intangible asset is to be amortized to operating expenses ratably on a monthly basis over a 10-year period.
Certain core deposit intangible with a gross amount of $9 million became fully amortized during the six months ended June 30, 2010, and, as such, their gross amount and accumulated amortization were eliminated from the tabular disclosure presented above.
During the quarter ended June 30, 2010, the Corporation recognized $2.5 million in amortization related to other intangible assets with definite useful lives (June 30, 2009 — $2.4 million). During the six months ended June 30, 2010, the Corporation recognized $4.5 million in amortization related to other intangible assets with definite useful lives (June 30, 2009 — $4.8 million).
The following table presents the estimated amortization of the intangible assets with definite useful lives for each of the following periods:
         
(In thousands)        
 
Remaining 2010
  $ 4,802  
Year 2011
    9,424  
Year 2012
    8,409  
Year 2013
    8,225  
Year 2014
    7,587  
Year 2015
    5,478  
 
Note 14 — Derivative Instruments and Hedging Activities
Refer to Note 31 to the consolidated financial statements included in the 2009 Annual Report for a complete description of the Corporation’s derivative activities.
The following discussion and tables provide a description of the derivative instruments used as part of the Corporation’s interest rate risk management strategies. The use of derivatives is incorporated as part of the Corporation’s overall interest rate risk management strategy to minimize significant unplanned fluctuations in earnings and cash flows that are caused by interest rate volatility. The Corporation’s goal is to manage interest rate sensitivity by modifying the repricing or maturity characteristics of certain balance sheet assets and liabilities so that the net interest income is not, on a material basis, adversely affected by movements in interest rates. The Corporation uses derivatives in its trading activities to facilitate customer transactions, to take proprietary positions and as a means of risk management. As a result of interest rate fluctuations, hedged fixed and variable interest rate assets and liabilities will appreciate or depreciate in fair value. The effect of this unrealized appreciation or depreciation is expected to be substantially offset by the Corporation’s gains or losses on the derivative instruments that are linked to these hedged assets and liabilities. As a matter of policy, the Corporation does not use highly leveraged derivative instruments for interest rate risk management.

37


 

By using derivative instruments, the Corporation exposes itself to credit and market risk. If a counterparty fails to fulfill its performance obligations under a derivative contract, the Corporation’s credit risk will equal the fair value of the derivative asset. Generally, when the fair value of a derivative contract is positive, this indicates that the counterparty owes the Corporation, thus creating a repayment risk for the Corporation. To manage the level of credit risk, the Corporation deals with counterparties of good credit standing, enters into master netting agreements whenever possible and, when appropriate, obtains collateral. The derivative assets include a $5.7 million negative adjustment as a result of the credit risk of the counterparties as of June 30, 2010 (December 31, 2009 — $5.1 million negative adjustment; June 30, 2009 — $4.2 million negative adjustment). On the other hand, when the fair value of a derivative contract is negative, the Corporation owes the counterparty and, therefore, the fair value of derivative liabilities incorporates nonperformance risk or the risk that the obligation will not be fulfilled. The derivative liabilities include a $1.2 million positive adjustment related to the incorporation of the Corporation’s own credit risk as of June 30, 2010 (December 31, 2009 — $2.1 million positive adjustment; June 30, 2009 — $1.2 million positive adjustment).
Market risk is the adverse effect that a change in interest rates, currency exchange rates, or implied volatility rates might have on the value of a financial instrument. The Corporation manages the market risk associated with interest rates and, to a limited extent, with fluctuations in foreign currency exchange rates by establishing and monitoring limits for the types and degree of risk that may be undertaken. The Corporation regularly measures this risk by using static gap analysis, simulations and duration analysis.
Pursuant to the Corporation’s accounting policy, the fair value of derivatives is not offset with the amounts for the right to reclaim cash collateral or the obligation to return cash collateral. As of June 30, 2010, the amount recognized for the right to reclaim cash collateral under master netting arrangements was $93 million and the amount recognized for the obligation to return cash collateral was $5 million (December 31, 2009 — $88 million and $4 million, respectively).
Certain of the Corporation’s derivative instruments include financial covenants tied to the corresponding banking subsidiary’s well-capitalized status and credit rating. These agreements could require exposure collateralization, early termination, or both. The aggregate fair value of all derivative instruments with contingent features that were in a liability position as of June 30, 2010 was $79 million (December 31, 2009 — $66 million; June 30, 2009 — $72 million). Based on the contractual obligations established on these derivative instruments, the Corporation has fully collateralized these positions by pledging collateral of $93 million as of June 30, 2010 (December 31, 2009 — $88 million; June 30, 2009 — $79 million).

38


 

Financial instruments designated as cash flow hedges or non-hedging derivatives outstanding as of June 30, 2010 and December 31, 2009 were as follows:
                                         
As of June 30, 2010
            Derivative Assets   Derivative Liabilities
            Statement of           Statement of    
    Notional   Condition   Fair   Condition    
(In thousands)   Amount   Classification   Value   Classification   Fair Value
Derivatives designated as hedging instruments:
                                       
Forward commitments
  $ 130,225     Other assets   $ 17     Other liabilities   $ 1,527  
 
Total derivatives designated as hedging instruments
  $ 130,225             $ 17             $ 1,527  
 
Derivatives not designated as hedging instruments:
                                       
Forward contracts
  $ 157,085     Trading account securities   $ 40     Other liabilities   $ 1,480  
Interest rate swaps associated with:
                                       
- swaps with corporate clients
    936,782     Other assets     73,858          
- swaps offsetting position of corporate clients’ swaps
    936,782               Other liabilities     79,317  
Foreign currency and exchange rate commitments with clients
    200     Other assets     13            
Foreign currency and exchange rate commitments with counterparty
    199               Other liabilities     12  
Interest rate caps and floors
    89,748     Other assets     231            
Interest rate caps and floors for the benefit of corporate clients
    89,748               Other liabilities     231  
Indexed options on deposits
    76,089     Other assets     5,452            
Bifurcated embedded options
    72,583               Interest bearing deposits     4,279  
 
Total derivatives not designated as hedging instruments
  $ 2,359,216             $ 79,594             $ 85,319  
 
Total derivative assets and liabilities
  $ 2,489,441             $ 79,611             $ 86,846  
 

39


 

                                         
As of December 31, 2009
            Derivative Assets   Derivative Liabilities
            Statement of           Statement of    
    Notional   Condition           Condition    
(In thousands)   Amount   Classification   Fair Value   Classification   Fair Value
 
Derivatives designated as hedging instruments:
                                       
Forward commitments
  $ 120,800     Other assets   $ 1,346     Other liabilities   $ 22  
 
Total derivatives designated as hedging instruments
  $ 120,800             $ 1,346             $ 22  
 
Derivatives not designated as hedging instruments:
                                       
Forward contracts
  $ 165,300     Trading account securities   $ 1,253     Other liabilities   $ 79  
Interest rate swaps associated with:
                                       
- swaps with corporate clients
    1,006,154     Other assets     63,120     Other liabilities     131  
- swaps offsetting position of corporate clients’ swaps
    1,006,154     Other assets     131     Other liabilities     67,358  
Interest rate caps and floors
    139,859     Other assets     249            
Interest rate caps and floors for the benefit of corporate clients
    139,859               Other liabilities     249  
Indexed options on deposits
    110,900     Other assets     6,976              
Bifurcated embedded options
    84,316               Interest bearing deposits     5,402  
 
Total derivatives not designated as hedging instruments
  $ 2,652,542             $ 71,729             $ 73,219  
 
Total derivative assets and liabilities
  $ 2,773,342             $ 73,075             $ 73,241  
 
Cash Flow Hedges
The Corporation utilizes forward contracts to hedge the sale of mortgage-backed securities with duration terms over one month. Interest rate forwards are contracts for the delayed delivery of securities, which the seller agrees to deliver on a specified future date at a specified price or yield. These forward contracts are hedging a forecasted transaction and thus qualify for cash flow hedge accounting. Changes in the fair value of the derivatives are recorded in other comprehensive income (loss). The amount included in accumulated other comprehensive income (loss) corresponding to these forward contracts is expected to be reclassified to earnings in the next twelve months. These contracts have a maximum remaining maturity of 83 days as of June 30, 2010.
For cash flow hedges, gains and losses on derivative contracts that are reclassified from accumulated other comprehensive income (loss) to current period earnings are included in the line in which the hedged item is recorded and during the period in which the forecasted transaction impacts earnings, as presented in the tables below:
                                         
Quarter ended June 30, 2010
                            Classification of    
                            Gain (Loss)   Amount of Gain
            Classification in           Recognized in   (Loss) Recognized
    Amount of   the           Income on   in Income on
    Gain (Loss)   Statement of   Amount of Gain   Derivatives   Derivatives
    Recognized in   Operations of the   (Loss)   (Ineffective Portion   (Ineffective Portion
    OCI on   Gain (Loss)   Reclassified from   and Amount   and Amount
    Derivatives   Reclassified from   AOCI into   Excluded from   Excluded from
    (Effective   AOCI into Income   Income (Effective   Effectiveness   Effectiveness
(In thousands)   Portion)   (Effective Portion)   Portion)   Testing)   Testing)
 
Forward commitments
  $ (1,509 )   Trading account profit   $ (31 )            
 
Total cash flow hedges
  $ (1,509 )           $ (31 )              
 
 
OCI —   “Other Comprehensive Income”
 
AOCI —   “Accumulated Other Comprehensive Income”

40


 

                                         
Six months ended June 30, 2010
                            Classification of    
                            Gain (Loss)   Amount of Gain
            Classification in           Recognized in   (Loss) Recognized
    Amount of   the           Income on   in Income on
    Gain (Loss)   Statement of   Amount of Gain   Derivatives   Derivatives
    Recognized in   Operations of the   (Loss)   (Ineffective Portion   (Ineffective Portion
    OCI on   Gain (Loss)   Reclassified from   and Amount   and Amount
    Derivatives   Reclassified from   AOCI into   Excluded from   Excluded from
    (Effective   AOCI into Income   Income (Effective   Effectiveness   Effectiveness
(In thousands)   Portion)   (Effective Portion)   Portion)   Testing)   Testing)
 
Forward commitments
  $ (1,540 )   Trading account profit   $ 1,168              
 
Total cash flow hedges
  $ (1,540 )           $ 1,168                
 
                                         
Quarter ended June 30, 2009
                            Classification of    
                            Gain (Loss)   Amount of Gain
            Classification in           Recognized in   (Loss) Recognized
    Amount of   the           Income on   in Income on
    Gain (Loss)   Statement of   Amount of Gain   Derivatives   Derivatives
    Recognized in   Operations of the   (Loss)   (Ineffective Portion   (Ineffective Portion
    OCI on   Gain (Loss)   Reclassified from   and Amount   and Amount
    Derivatives   Reclassified from   AOCI into   Excluded from   Excluded from
    (Effective   AOCI into Income   Income (Effective   Effectiveness   Effectiveness
(In thousands)   Portion)   (Effective Portion)   Portion)   Testing)   Testing)
 
Forward commitments
  $ (37 )   Trading account profit   $ (1,586 )            
Interest rate swaps
        Interest expense     (1,883 )            
 
Total cash flow hedges
  $ (37 )           $ (3,469 )              
 
                                         
Six months ended June 30, 2009
                            Classification of    
                            Gain (Loss)   Amount of Gain
            Classification in           Recognized in   (Loss) Recognized
    Amount of   the           Income on   in Income on
    Gain (Loss)   Statement of   Amount of Gain   Derivatives   Derivatives
    Recognized in   Operations of the   (Loss)   (Ineffective Portion   (Ineffective Portion
    OCI on   Gain (Loss)   Reclassified from   and Amount   and Amount
    Derivatives   Reclassified from   AOCI into   Excluded from   Excluded from
    (Effective   AOCI into Income   Income (Effective   Effectiveness   Effectiveness
(In thousands)   Portion)   (Effective Portion)   Portion)   Testing)   Testing)
 
Forward commitments
  $ (1,623 )   Trading account profit   $ (3,503 )            
Interest rate swaps
        Interest expense     (2,380 )            
 
Total cash flow hedges
  $ (1,623 )           $ (5,883 )              
 

41


 

Non-Hedging Activities
For the quarters and six months ended June 30, 2010, the Corporation recognized a loss of $7.9 million and $12.1 million, respectively (June 30, 2009 — loss of $1.8 million and $14.1 million, respectively) related to its non-hedging derivatives, as detailed in the tables below.
                         
            Amount of Gain (Loss) Recognized in
    Classification of Gain   Income on Derivatives
    (Loss) Recognized in   Quarter ended   Six months ended
(In thousands)   Income on Derivatives   June 30, 2010   June 30, 2010
 
Forward contracts
  Trading account profit   $ (8,639 )   $ (11,710 )
Interest rate swap contracts
  Other operating income     513       (1,221 )
Foreign currency and exchange rate commitments
  Interest expense     (1 )     1  
Foreign currency and exchange rate commitments
  Other operating income     5       5  
Indexed options
  Interest expense     (1,609 )     (1,346 )
Bifurcated embedded options
  Interest expense     1,872       2,158  
 
Total
          $ (7,859 )   $ (12,113 )
 
                         
            Amount of Gain (Loss) Recognized in
    Classification of Gain   Income on Derivatives
    (Loss) Recognized in   Quarter ended   Six months ended
(In thousands)   Income on Derivatives   June 30, 2009   June 30, 2009
 
Forward contracts
  Trading account profit   $ 1,204     $ (6,848 )
Interest rate swap contracts
  Other operating income     (1,554 )     (5,524 )
Credit derivatives
  Other operating income     (2,599 )     (2,599 )
Foreign currency and exchange rate commitments
  Interest expense     (3 )     (2 )
Foreign currency and exchange rate commitments
  Other operating income     10       19  
Indexed options
  Interest expense     470       (746 )
Bifurcated embedded options
  Interest expense     698       1,575  
 
Total
          $ (1,774 )   $ (14,125 )
 
Forward Contracts
The Corporation has forward contracts to sell mortgage-backed securities with terms lasting less than a month, which are accounted for as trading derivatives. Changes in their fair value are recognized in trading account profit (loss).
Interest Rates Swaps and Foreign Currency and Exchange Rate Commitments
In addition to using derivative instruments as part of its interest rate risk management strategy, the Corporation also utilizes derivatives, such as interest rate swaps and foreign exchange contracts, in its capacity as an intermediary on behalf of its customers. The Corporation minimizes its market risk and credit risk by taking offsetting positions under the same terms and conditions with credit limit approvals and monitoring procedures. Market value changes on these swaps and other derivatives are recognized in earnings in the period of change.
Interest Rate Caps and Floors
The Corporation enters into interest rate caps and floors as an intermediary on behalf of its customers and simultaneously takes offsetting positions under the same terms and conditions, thus minimizing its market and credit risks.

42


 

Note 15 — Deposits
Total interest bearing deposits as of June 30, 2010 and December 31, 2009, consisted of the following:
                 
    June 30,   December 31,
(In thousands)   2010   2009
 
Savings deposits
  $ 6,093,088     $ 5,480,124  
NOW, money market and other interest bearing demand deposits
    5,133,317       4,726,204  
 
Total savings, NOW, money market and other Interest bearing demand deposits
    11,226,405       10,206,328  
 
 
               
Certificates of deposits:
               
Under $100,000
    6,476,312  [1]     6,553,022  [1]
$100,000 and over
    4,617,518       4,670,243  
 
Total certificates of deposits
    11,093,830       11,223,265  
 
Total interest bearing deposits
  $ 22,320,235     $ 21,429,593  
 
 
[1]   Includes brokered certificates of deposit amounting to $2.0 billion as of June 30, 2010 and $2.7 billion as of December 31, 2009.
 
 
A summary of certificates of deposit by maturity as of June 30, 2010 follows:
         
(In thousands)        
 
Remaining 2010
  $ 4,777,350  
2011
    3,283,244  
2012
    1,166,393  
2013
    618,196  
2014
    408,342  
2015 and thereafter
    840,305  
 
Total
  $ 11,093,830  
 
Note 16 — Borrowings
The composition of federal funds purchased and assets sold under agreements to repurchase was as follows:
                         
    June 30,   December 31,   June 30,
(In thousands)   2010   2009   2009
 
Federal funds purchased
  $ 9,900              
Assets sold under agreements to repurchase
    2,297,294     $ 2,632,790     $ 2,941,678  
 
Total federal funds purchased and assets sold under agreements to repurchase
  $ 2,307,194     $ 2,632,790     $ 2,941,678  
 
The repurchase agreements outstanding as of June 30, 2010 were collateralized by $2.0 billion in investment securities available-for-sale and $372 million in trading securities. It is the Corporation’s policy to maintain effective control over assets sold under agreements to repurchase; accordingly, such securities continue to be carried on the consolidated statements of condition.
In addition, there were repurchase agreements outstanding collateralized by $177 million in securities purchased underlying agreements to resell to which the Corporation has the right to repledge. It is the Corporation’s policy to take possession of securities purchased under agreements to resell. However, the counterparties to such agreements maintain effective control over such securities, and accordingly are not reflected in the Corporation’s consolidated statements of condition.

43


 

Other short-term borrowings consisted of:
                         
    June 30,   December 31,   June 30,
(In thousands)   2010   2009   2009
 
Secured borrowing with clearing broker with an interest rate of 1.50%
        $ 6,000        
Unsecured borrowings with private investors paying interest at a fixed rate of 0.40%
              $ 500  
Others
  $ 1,263       1,326       1,325  
 
Total other short-term borrowings
  $ 1,263     $ 7,326     $ 1,825  
 
Notes payable consisted of:
                         
    June 30,   December 31,   June 30,
(In thousands)   2010   2009   2009
 
Advances with the FHLB:
                       
-with maturities ranging from 2010 through 2015 paying interest at monthly fixed rates ranging from 1.48% to 5.10% (June 30, 2009 — 1.48% to 5.06%)
  $ 1,032,873     $ 1,103,627     $ 1,107,216  
-maturing in 2010 paying interest quarterly at a fixed rate of 5.10%
    20,000       20,000       20,000  
 
                       
Note payable issued to the FDIC, including unamortized premium of $10,091; paying interest monthly at an annual fixed rate of 2.50%; maturing on April 30, 2015 or such earlier date as such amount may become due and payable pursuant to the terms of the note
    5,728,078              
 
                       
Term notes paying interest monthly at fixed rates ranging from 3.00% to 6.00%
                3,100  
 
                       
Term notes with maturities ranging from 2011 to 2013 paying interest semiannually at fixed rates ranging from 5.25% to 13.00% (June 30, 2009 — 5.20% to 9.75%)
    380,995       382,858       383,720  
 
                       
Term notes with maturities ranging from 2010 to 2013 paying interest monthly at a floating rate of 3.00% over the 10-year U.S. Treasury note rate
    1,217       1,528       2,678  
 
                       
Term notes maturing in 2011 paying interest quarterly at a floating rate of 9.75% (June 30, 2009 — 6.00%) over the 3-month LIBOR rate
    175,000       250,000       250,000  
 
                       
Junior subordinated deferrable interest debentures (related to trust preferred securities) with maturities ranging from 2027 to 2034 with fixed interest rates ranging from 6.125% to 8.327% (Refer to Note 17)
    439,800       439,800       849,672  
 
                       
Junior subordinated deferrable interest debentures (related to trust preferred securities) ($936,000 less discount of $502,113 as of June 30, 2010) with no stated maturity and a fixed interest rate of 5.00% until, but excluding December 5, 2013 and 9.00% thereafter (Refer to Note 17)
    433,887       423,650        
 
                       
Others
    25,551       27,169       27,336  
 
Total notes payable
  $ 8,237,401     $ 2,648,632     $ 2,643,722  
 
 
Note:   Refer to the Corporation’s Form 10-K for the year ended December 31, 2009, for rates and maturity information corresponding to the borrowings outstanding as of such date. Key index rates as of June 30, 2010 and June 30, 2009, respectively, were as follows: 3-month LIBOR rate = 0.53% and 0.60%; 10-year U.S. Treasury note = 2.93% and 3.54%.
 
 
Included in the table above are $175 million in term notes with interest that adjusted in the event of senior debt rating downgrades. These floating rate term notes had an interest rate of 9.75% over the 3-month LIBOR as of June 30, 2010. These term notes, which had contractual maturities in September 2011, were repurchased by the Corporation from holders of record in July 2010.

44


 

In consideration for the excess assets acquired over liabilities assumed as part of the Westernbank FDIC-assisted transaction, BPPR issued to the FDIC a secured note (the “note payable issued to the FDIC”) in the amount of $5.8 billion as of April 30, 2010 bearing an annual interest rate of 2.50%, which has full recourse to BPPR. As indicated in Note 2 to the consolidated financial statements, the note payable issued to the FDIC is collateralized by the loans (other than certain consumer loans) and other real estate acquired in the agreement with the FDIC and all proceeds derived from such assets, including cash inflows from claims to the FDIC under the loss sharing agreements. Proceeds received from such sources are used to pay the note under the conditions stipulated in the agreement. As of June 30, 2010, the carrying amount of loans and other real estate property that serves as collateral on the note amounted to approximately $4.0 billion. The entire outstanding principal balance of the note payable issued to the FDIC is due five years from issuance (April 30, 2015), or such date as such amount may become due and payable pursuant to the terms of the note payable issued to the FDIC. Borrowings under the note bear interest at a fixed annual rate of 2.50% and is paid monthly. If the Corporation fails to pay any interest as and when due, such interest shall accrue interest at the note interest rate plus 2.00% per annum. The Corporation may repay the note in whole or in part without any penalty subject to certain notification requirements indicated in the agreement. In July 2010, the Corporation prepaid $2.0 billion of the note payable to the FDIC from funds unrelated to the assets securing the note.
A breakdown of borrowings by contractual maturities as of June 30, 2010 is included in the table below. Given its nature, the maturity of the Note payable to the FDIC was based on expected repayment dates and not in its April 30, 2015 contractual maturity date. The expected repayments consider the timing of expected cash inflows on the loans, OREO and claims on the loss sharing agreements that will be applied to repay the note during the period that the note payable to the FDIC is outstanding. The table also reflects the $2.0 billion partial prepayment on the Note payable to the FDIC described in the preceding paragraph in 2010.
                                 
    Federal funds            
    sold and            
    repurchase   Short-term        
(In thousands)   agreements   borrowings   Notes payable   Total
 
Year
                               
2010
  $ 1,145,004     $ 1,263     $ 3,334,119     $ 4,480,386  
2011
    50,000             3,232,390       3,282,390  
2012
    75,000             631,529       706,529  
2013
    49,000             128,059       177,059  
2014
    350,000             10,824       360,824  
Later years
    638,190             466,593       1,104,783  
No stated maturity
                936,000       936,000  
 
Subtotal
  $ 2,307,194     $ 1,263     $ 8,739,514     $ 11,047,971  
Less: Discount
                502,113       502,113  
 
Total borrowings
  $ 2,307,194     $ 1,263     $ 8,237,401     $ 10,545,858  
 
Note 17 — Trust Preferred Securities
As of June 30, 2010 and 2009, the Corporation had established four trusts (BanPonce Trust I, Popular Capital Trust I, Popular North America Capital Trust I and Popular Capital Trust II) for the purpose of issuing trust preferred securities (also referred to as “capital securities”) to the public. The proceeds from such issuances, together with the proceeds of the related issuances of common securities of the trusts (the “common securities”), were used by the trusts to purchase junior subordinated deferrable interest debentures (the “junior subordinated debentures”) issued by the Corporation. In August 2009, the Corporation established the Popular Capital Trust III for the purpose of exchanging the shares of Series C preferred stock held by the U.S. Treasury at the time for trust preferred securities issued by this trust. In connection with this exchange, the trust used the Series C preferred stock, together with the proceeds of issuance and sale of common securities of the trust, to purchase junior subordinated debentures issued by the Corporation.
The sole assets of the five trusts consisted of the junior subordinated debentures of the Corporation and the related accrued interest receivable. These trusts are not consolidated by the Corporation.

45


 

The junior subordinated debentures are included by the Corporation as notes payable in the consolidated statements of condition, while the common securities issued by the issuer trusts are included as other investment securities. The common securities of each trust are wholly-owned, or indirectly wholly-owned, by the Corporation.
Financial data pertaining to the trusts as of June 30, 2010 and December 31, 2009 were as follows:
                                         
(In thousands)
                    Popular North        
    BanPonce   Popular Capital   America Capital   Popular Capital   Popular Capital
Issuer   Trust I   Trust I   Trust I   Trust II   Trust III
 
Capital securities
  $ 52,865     $ 181,063     $ 91,651     $ 101,023     $ 935,000  
Distribution rate
    8.327 %     6.700 %     6.564 %     6.125 %   5.000% until, but excluding December 5, 2013 and 9.000% thereafter
 
                                       
Common securities
  $ 1,637     $ 5,601     $ 2,835     $ 3,125     $ 1,000  
Junior subordinated debentures aggregate liquidation amount
  $ 54,502     $ 186,664     $ 94,486     $ 104,148     $ 936,000  
 
                                       
Stated maturity date
  February 2027     November 2033     September 2034     December 2034     Perpetual  
 
                                       
Reference notes
    [a],[c],[f],[g]       [b],[d],[f]       [a],[c],[f]       [b],[d],[f]       [b], [d], [h], [i]  
 
Financial data pertaining to the trusts as of June 30, 2009 were as follows:
                                         
(In thousands)
                    Popular North        
    BanPonce   Popular Capital   America Capital   Popular Capital   Popular Capital
Issuer   Trust I   Trust I   Trust I   Trust II   Trust III
 
Capital securities
  $ 144,000     $ 300,000     $ 250,000     $ 130,000        
Distribution rate
    8.327 %     6.700 %     6.564 %     6.125 %      
Common securities
  $ 4,640     $ 9,279     $ 7,732     $ 4,021        
Junior subordinated debentures aggregate liquidation amount
  $ 148,640     $ 309,279     $ 257,732     $ 134,021        
Stated maturity date
  February 2027     November 2033     September 2034     December 2034        
Reference notes
    [a],[c],[e],[f],[g]       [b],[d],[f]       [a],[c],[f]       [b],[d],[f]        
 
 
[a]   Statutory business trust that is wholly-owned by Popular North America (“PNA”) and indirectly wholly-owned by the Corporation.
 
[b]   Statutory business trust that is wholly-owned by the Corporation.
 
[c]   The obligations of PNA under the junior subordinated debentures and its guarantees of the capital securities under the trust are fully and unconditionally guaranteed on a subordinated basis by the Corporation to the extent set forth in the applicable guarantee agreement.
 
[d]   These capital securities are fully and unconditionally guaranteed on a subordinated basis by the Corporation to the extent set forth in the applicable guarantee agreement.
 
[e]   The original issuance was for $150 million. The Corporation had reacquired $6 million of the 8.327% capital securities as of December 31, 2008.
 
[f]   The Corporation has the right, subject to any required prior approval from the Federal Reserve, to redeem after certain dates or upon the occurrence of certain events mentioned below, the junior subordinated debentures at a redemption price equal to 100% of the principal amount, plus accrued and unpaid interest to the date of redemption. The maturity of the junior subordinated debentures may be shortened at the option of the Corporation prior to their stated maturity dates (i) on or after the stated optional redemption dates stipulated in the agreements, in whole at any time or in part from time to time, or (ii) in whole, but not in part, at any time within 90 days following the occurrence and during the continuation of a tax event, an investment company event or a capital treatment event as set forth in the indentures relating to the capital securities, in each case subject to regulatory approval.
 
[g]   Same as [f] above, except that the investment company event does not apply for early redemption.

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[h]   The debentures are perpetual and may be redeemed by Popular at any time, subject to the consent of the Board of Governors of the Federal Reserve System.
 
[i]   Carrying value of junior subordinates debentures of $434 million as of June 30, 2010 ($936 million aggregate liquidation amount, net of $502 million discount) and $424 million as of December 31, 2009 ($936 million aggregate liquidation amount, net of $512 million discount).
In accordance with the Federal Reserve Board guidance, the trust preferred securities represent restricted core capital elements and qualify as Tier 1 Capital, subject to quantitative limits. The aggregate amount of restricted core capital elements that may be included in the Tier 1 Capital of a banking organization must not exceed 25% of the sum of all core capital elements (including cumulative perpetual preferred stock and trust preferred securities). As of June 30, 2010, the Corporation’s restricted core capital elements did not exceed the 25% limitation. Thus, all trust preferred securities were allowed as Tier 1 capital. As of December 31, 2009, there were $7 million of the outstanding trust preferred securities which were disallowed as Tier 1 capital. Amounts of restricted core capital elements in excess of this limit generally may be included in Tier 2 capital, subject to further limitations. The Federal Reserve Board revised the quantitative limit which would limit restricted core capital elements included in the Tier 1 capital of a bank holding company to 25% of the sum of core capital elements (including restricted core capital elements), net of goodwill less any associated deferred tax liability. The new limit would be effective on March 31, 2011. Furthermore, the Dodd-Frank Wall Street Reform and Consumer Protection Act, recently passed in July 2010, has a provision to effectively phase out the use of trust preferred securities as Tier 1 capital throughout a five-year period. As of June 30, 2010, the Corporation had $427 million in trust preferred securities (capital securities) that are subject to the phase-out. As of June 30, 2010, the remaining $935 million in trust preferred securities corresponded to capital securities issued to the U.S. Treasury pursuant to the Emergency Economic Stabilization Act of 2008 that are exempt from the phase-out provisions of the Act.
Note 18 — Stockholders’ Equity
Increase in authorized shares of common stock
On May 4, 2010, following stockholder approval, the Corporation amended its certificate of incorporation to provide for an increase in the number of shares of the Corporation’s common stock authorized for issuance from 700 million shares to 1.7 billion shares.
Issuance of depositary shares representing preferred stock and conversion to shares of common stock
In April 2010, the Corporation raised $1.15 billion through the sale of 46,000,000 depositary shares, each representing a 1/40th interest in a share of Contingent Convertible Perpetual Non-Cumulative Preferred Stock, Series D, no par value, $1,000 liquidation preference per share. The preferred stock represented by depositary shares automatically converted into shares of Popular, Inc.’s common stock at a conversion rate of 8.3333 shares of common stock for each depositary share on May 11, 2010, which was the 5th business day after the Corporation’s common shareholders approved the amendment to the Corporation’s restated certificate of incorporation to increase the number of authorized shares of common stock. The conversion of the depositary shares of preferred stock resulted in the issuance of 383,333,333 additional shares of common stock. The net proceeds from the public offering amounted to approximately $1.1 billion, after deducting the underwriting discount and estimated offering expenses. Note 23 to the consolidated financial statements provides information on the impact of the conversion on net loss per common share.
BPPR statutory reserve
The Banking Act of the Commonwealth of Puerto Rico requires that a minimum of 10% of BPPR’s net income for the year be transferred to a statutory reserve account until such statutory reserve equals the total of paid-in capital on common and preferred stock. Any losses incurred by a bank must first be charged to retained earnings and then to the reserve fund. Amounts credited to the reserve fund may not be used to pay dividends without the prior consent of the Puerto Rico Commissioner of Financial Institutions. The failure to maintain sufficient statutory reserves would preclude BPPR from paying dividends. BPPR’s statutory reserve fund totaled $402 million as of June 30, 2010 (December 31, 2009 — $402 million; June 30, 2009 — $392 million). There were no transfers between the statutory reserve account and the retained earnings account during the quarters ended June 30, 2010 and 2009.

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Note 19 — Commitments, Contingencies and Guarantees
Commercial letters of credit and standby letters of credit amounted to $16 million and $142 million, respectively, as of June 30, 2010 (December 31, 2009 — $13 million and $134 million, respectively; and June 30, 2009 — $18 million and $168 million, respectively). In addition, the Corporation has commitments to originate mortgage loans amounting to $46 million as of June 30, 2010 (December 31, 2009 — $48 million; June 30, 2009 — $59 million).
As of June 30, 2010, the Corporation recorded a liability of $0.5 million (December 31, 2009 — $0.7 million and June 30, 2009 — $0.6 million), which represents the unamortized balance of the obligations undertaken in issuing the guarantees under the standby letters of credit. The Corporation recognizes at fair value the obligation at inception of the standby letters of credit. The fair value approximates the fee received from the customer for issuing such commitments. These fees are deferred and recognized over the commitment period. This liability is included as part of other liabilities in the consolidated statements of condition. The contract amounts in standby letters of credit outstanding represent the maximum potential amount of future payments the Corporation could be required to make under the guarantees in the event of nonperformance by the customers. These standby letters of credit are used by the customer as a credit enhancement and typically expire without being drawn upon. In the event of nonperformance by the customers, the Corporation has rights to the underlying collateral provided, if any, which normally includes cash and marketable securities, real estate, receivables, among others. Management does not anticipate any material losses related to these instruments.
Commitments to extend credit, which include credit card lines, commercial lines of credit, and other unused credit commitments, amounted to $6.3 billion as of June 30, 2010 (December 31, 2009 - $7.0 billion; June 30, 2009 — $7.2 billion), excluding the commitments to extend credit that pertain to the lending relationships of the Westernbank operations.
As of June 30, 2010, the Corporation maintained a reserve of approximately $10 million for potential losses associated with unfunded loan commitments related to commercial and consumer lines of credit unrelated to the acquired lending relationships from the Westernbank FDIC-assisted transaction (December 31, 2009 — $15 million; June 30, 2009 — $17 million). The estimated reserve is principally based on the expected draws on these facilities using historical trends and the application of the corresponding reserve factors determined under the Corporation’s allowance for loan losses methodology. This reserve for unfunded exposures remains separate and distinct from the allowance for loan losses and is reported as part of other liabilities in the consolidated statement of condition.
As of June 30, 2010, the commitments to extend credit related to the Westernbank operations approximated $0.2 billion. The acquired commitments to extend credit are covered under the loss sharing agreements with the FDIC, subject to FDIC approvals, limitations on the timing for such disbursements, and servicing guidelines, among various considerations. As indicated in Note 2 to the consolidated financial statements, on the April 30, 2010 acquisition date, the Corporation recorded a contingent liability for such commitments at fair value, which was estimated at $132 million. As of June 30, 2010, that contingent liability remained at that level and is recorded as part of other liabilities in the consolidated statement of condition.
The Corporation securitized mortgage loans into guaranteed mortgage-backed securities subject to limited, and in certain instances, lifetime credit recourse on the loans that serve as collateral for the mortgage-backed securities. Also, from time to time, the Corporation may have sold, in bulk sale transactions, residential mortgage loans subject to credit recourse or to certain representations and warranties from the Corporation to the purchaser. These representations and warranties may relate, for example, to borrower creditworthiness, loan documentation, collateral, prepayment and early payment defaults. The Corporation may be required to repurchase the loans under the credit recourse agreements or for breach of representations and warranties.
As of June 30, 2010, the Corporation serviced $4.2 billion (December 31, 2009 — $4.5 billion; June 30, 2009 — $4.7 billion) in residential mortgage loans subject to credit recourse provisions, principally loans associated with FNMA and Freddie Mac programs. In the event of any customer default, pursuant to the credit recourse provided, the Corporation may be required to repurchase the loan or reimburse for the incurred loss. The maximum potential amount of future payments that the Corporation would be required to make under the recourse arrangements in the event of nonperformance by the borrowers is equivalent to the total outstanding balance of the residential mortgage loans serviced with recourse and interest, if applicable. During the six months ended June 30, 2010, the Corporation repurchased approximately $60 million in mortgage loans subject to the credit recourse provisions. In the event of

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nonperformance by the borrower, the Corporation has rights to the underlying collateral securing the mortgage loan. The Corporation suffers losses on these loans when the proceeds from a foreclosure sale of the property underlying a defaulted mortgage loan are less than the outstanding principal balance of the loan plus any uncollected interest advanced and the costs of holding and disposing of the related property. The losses associated to these credit recourse arrangements, which pertain to residential mortgage loans in Puerto Rico, have not been significant. As of June 30, 2010, the Corporation’s liability established to cover the estimated credit loss exposure related to loans sold or serviced with credit recourse amounted to $37 million (December 31, 2009 — $16 million; June 30, 2009 — $13 million).
When the Corporation sells or securitizes mortgage loans, it generally makes customary representations and warranties regarding the characteristics of the loans sold. The Corporation’s mortgage operations in Puerto Rico group conforming mortgage loans into pools which are exchanged for FNMA and GNMA mortgage-backed securities, which are generally sold to private investors, or may sell the loans directly to FNMA or other private investors for cash. To the extent the loans do not meet specified characteristics, the Corporation may be required to repurchase such loans or indemnify for losses. As required under the government agency programs, quality review procedures are performed by the Corporation to ensure that asset guideline qualifications are met. The Corporation has not recorded any specific contingent liability in the consolidated financial statements for these customary representation and warranties related to loans sold by the Corporation’s mortgage operations in Puerto Rico, and management believes that, based on historical data, the probability of payments and expected losses under these representations and warranty arrangements is not significant.
Servicing agreements relating to the mortgage-backed securities programs of FNMA and GNMA, and to mortgage loans sold or serviced to certain other investors, including FHLMC, require the Corporation to advance funds to make scheduled payments of principal, interest, taxes and insurance, if such payments have not been received from the borrowers. As of June 30, 2010, the Corporation serviced $17.9 billion in mortgage loans, including the loans serviced with credit recourse (December 31, 2009 — $17.7 billion; June 30, 2009 — $13.0 billion). The Corporation generally recovers funds advanced pursuant to these arrangements from the mortgage owner, from liquidation proceeds from mortgage loans foreclosed or, in the case of FHA/VA loans, under the applicable FHA and VA insurance and guarantee programs. However, in the meantime, the Corporation must absorb the cost of the funds it advances during the time the advance is outstanding. The Corporation must also bear the costs of attempting to collect on delinquent and defaulted mortgage loans. In addition, if a defaulted loan is not cured, the mortgage loan would be canceled as part of the foreclosure proceedings and the Corporation would not receive any future servicing income with respect to that loan. As of June 30, 2010, the outstanding balance of funds advanced by the Corporation under such mortgage loan servicing agreements was approximately $26 million (December 31, 2009 — $14 million; June 30, 2009 — $12 million). To the extent the mortgage loans underlying the Corporation’s servicing portfolio experience increased delinquencies, the Corporation would be required to dedicate additional cash resources to comply with its obligation to advance funds as well as incur additional administrative costs related to increases in collection efforts.
As of June 30, 2010, the Corporation established reserves for customary representations and warranties related to loans sold by its U.S. subsidiary E-LOAN. Loans had been sold to investors on a servicing released basis subject to certain representations and warranties. Although the risk of loss or default was generally assumed by the investors, the Corporation is required to make certain representations relating to borrower creditworthiness, loan documentation and collateral, which if not complied, may result in requiring the Corporation to repurchase the loans or indemnify investors for any related losses associated to these loans. The loans had been sold prior to 2009. As of June 30, 2010, the Corporation’s reserve for estimated losses from such representation and warranty arrangements amounted to $33 million, which was included as part of other liabilities in the consolidated statement of condition (December 31, 2009 — $33 million; June 30, 2009 — $15 million). E-LOAN is no longer originating and selling loans, since the subsidiary ceased these activities during 2008. On a quarterly basis, the Corporation reassesses its estimate for expected losses associated to E-LOAN’s customary representation and warranty arrangements. The analysis incorporates expectations on future disbursements based on quarterly repurchases and make-whole events. The analysis also considers factors such as the average length-time between the loan’s funding date and the loan repurchase date as observed in the historical loan data. During the six months ended June 30, 2010, E-LOAN charged-off approximately $6.2 million against this representation and warranty reserve associated with loan repurchases and indemnification or make-whole events (six months ended June 30, 2009 — $9 million). Make-whole events are typically defaulted loans in which the investor attempts to recover through the collateral or guarantees, and the seller is obligated to cover any impaired or unrecovered portion of the loan.

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During 2008, the Corporation provided indemnifications for the breach of certain representations or warranties in connection with various sales of assets by the discontinued operations of PFH. These sales were on a non-credit recourse basis. The agreements primarily include indemnification for breaches of certain key representations and warranties, some of which expire within a definite time period; others survive until the expiration of the applicable statute of limitations, and others do not expire. Certain of the indemnifications are subject to a cap or maximum aggregate liability defined as a percentage of the purchase price. The indemnifications agreements outstanding as of June 30, 2010 are related principally to make-whole arrangements. As of June 30, 2010, the Corporation’s reserve related to PFH’s indemnity arrangements amounted to $7 million (December 31, 2009 — $9 million; June 30, 2009 — $19 million). During the six months ended June 30, 2010, the Corporation recorded charge-offs with respect to the PFH’s representation and warranty arrangements amounting to approximately $1.6 million (six months ended June 30, 2009 — $0.6 million). The reserve balance as of June 30, 2010 contemplates historical indemnity payments. Certain indemnification provisions, which included, for example, reimbursement of premiums on early loan payoffs and repurchase obligations for defaulted loans within a short-term period, expired during 2009. Popular, Inc. Holding Company and Popular North America have agreed to guarantee certain obligations of PFH with respect to the indemnification obligations.
During the six months ended June 30, 2009, the Corporation sold a lease financing portfolio of approximately $0.3 billion. As of June 30, 2010, the reserve established to provide for any losses on the breach of certain representations and warranties included in the associated sale agreements amounted to $3 million (December 31, 2009 — $6 million; June 30, 2009 — $12 million). This reserve is included as part of other liabilities in the consolidated statement of condition.
Popular, Inc. Holding Company (“PIHC”) fully and unconditionally guarantees certain borrowing obligations issued by certain of its wholly-owned consolidated subsidiaries totaling $0.6 billion as of June 30, 2010 (December 31, 2009 — $0.6 billion; June 30, 2009 — $1.0 billion). In addition, as of June 30, 2010, PIHC fully and unconditionally guaranteed on a subordinated basis $1.4 billion of capital securities (trust preferred securities) (December 31, 2009 — $1.4 billion; June 30, 2009 — $0.8 billion) issued by wholly-owned issuing trust entities to the extent set forth in the applicable guarantee agreement. Refer to Note 17 to the consolidated financial statements for further information on the trust preferred securities.
As described in Note 2 to the consolidated financial statements, as part of the Westernbank FDIC-assisted transaction, BPPR has agreed to make a true-up payment to the FDIC on the true up measurement date of the final shared loss month, or upon the final disposition of all covered assets under the loss sharing agreements in the event losses on the loss sharing agreements fail to reach expected levels. The estimated fair value of such true up payment is recorded as a reduction in the fair value of the FDIC loss share indemnification asset.
Legal Proceedings
The Corporation and its subsidiaries are defendants in a number of legal proceedings arising in the ordinary course of business. Based on the opinion of legal counsel, management believes that the final disposition of these matters, except for the matters described below which are each in early stages and management cannot currently predict their outcome, will not have a material adverse effect on the Corporation’s business, results of operations, financial condition and liquidity.
Between May 14, 2009 and September 9, 2009, five putative class actions and two derivative claims were filed in the United States District Court for the District of Puerto Rico and the Puerto Rico Court of First Instance, San Juan Part, against Popular, Inc., certain of its directors and officers, among others. The five class actions have now been consolidated into two separate actions: a securities class action captioned Hoff v. Popular, Inc., et al. (consolidated with Otero v. Popular, Inc., et al.) and an Employee Retirement Income Security Act (ERISA) class action entitled In re Popular, Inc. ERISA Litigation (comprised of the consolidated cases of Walsh v. Popular, Inc. et al.; Montañez v. Popular, Inc., et al.; and Dougan v. Popular, Inc., et al.).
On October 19, 2009, plaintiffs in the Hoff case filed a consolidated class action complaint which includes as defendants the underwriters in the May 2008 offering of Series B Preferred Stock, among others. The consolidated action purports to be on behalf of purchasers of Popular’s securities between January 24, 2008 and February 19,

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2009 and alleges that the defendants violated Section 10(b) of the Exchange Act, and Rule 10b-5 promulgated thereunder, and Section 20(a) of the Exchange Act by issuing a series of allegedly false and/or misleading statements and/or omitting to disclose material facts necessary to make statements made by the Corporation not false and misleading. The consolidated action also alleges that the defendants violated Section 11, Section 12(a)(2) and Section 15 of the Securities Act by making allegedly untrue statements and/or omitting to disclose material facts necessary to make statements made by the Corporation not false and misleading in connection with the May 2008 offering of Series B Preferred Stock. The consolidated securities class action complaint seeks class certification, an award of compensatory damages and reasonable costs and expenses, including counsel fees. On January 11, 2010, Popular, the underwriter defendants and the individual defendants moved to dismiss the consolidated securities class action complaint. On August 2, 2010, the U.S. District Court for the District of Puerto Rico granted the motion to dismiss filed by the underwriter defendants on statute of limitations grounds. The Court also dismissed the Section 11 claim brought against Popular’s directors on statute of limitations grounds and the Section 12(a)(2) claim brought against Popular because plaintiffs lacked standing. The Court declined to dismiss the claims brought against Popular and certain of its officers under Section 10(b) of the Exchange Act (and Rule 10b-5 promulgated thereunder), Section 20(a) of the Exchange Act, and Sections 11 and 15 of the Securities Act, holding that plaintiffs had adequately alleged that defendants made materially false and misleading statements with the requisite state of mind.
On November 30, 2009, plaintiffs in the ERISA case filed a consolidated class action complaint. The consolidated complaint purports to be on behalf of employees participating in the Popular, Inc. U.S.A. 401(k) Savings and Investment Plan and the Popular, Inc. Puerto Rico Savings and Investment Plan from January 24, 2008 to the date of the Complaint to recover losses pursuant to Sections 409 and 502(a)(2) of the ERISA against Popular, certain directors, officers and members of plan committees, each of whom is alleged to be a plan fiduciary. The consolidated complaint alleges that the defendants breached their alleged fiduciary obligations by, among other things, failing to eliminate Popular stock as an investment alternative in the plans. The complaint seeks to recover alleged losses to the plans and equitable relief, including injunctive relief and a constructive trust, along with costs and attorneys’ fees. On December 21, 2009, and in compliance with a scheduling order issued by the Court, Popular and the individual defendants submitted an answer to the amended complaint. Shortly thereafter, on December 31, 2009, Popular and the individual defendants filed a motion to dismiss the consolidated class action complaint or, in the alternative, for judgment on the pleadings. On May 5, 2010, a magistrate judge issued a report and recommendation in which he recommended that the motion to dismiss be denied except with respect to Banco Popular de Puerto Rico, as to which he recommended that the motion be granted. On May 19, 2010, Popular filed objections to the magistrate judge’s report and recommendation. On June 21, 2010, plaintiffs filed a response to these objections. On July 9, 2010, with leave of the Court, Popular filed a reply to plaintiffs’ response.
The derivative actions (García v. Carrión, et al. and Díaz v. Carrión, et al.) have been brought purportedly for the benefit of nominal defendant Popular, Inc. against certain executive officers and directors and allege breaches of fiduciary duty, waste of assets and abuse of control in connection with our issuance of allegedly false and misleading financial statements and financial reports and the offering of the Series B Preferred Stock. The derivative complaints seek a judgment that the action is a proper derivative action, an award of damages and restitution, and costs and disbursements, including reasonable attorneys’ fees, costs and expenses. On October 9, 2009, the Court coordinated for purposes of discovery the García action and the consolidated securities class action. On October 15, 2009, Popular and the individual defendants moved to dismiss the García complaint for failure to make a demand on the Board of Directors prior to initiating litigation. On November 20, 2009, and pursuant to a stipulation among the parties, plaintiffs filed an amended complaint, and on December 21, 2009, Popular and the individual defendants moved to dismiss the García amended complaint. The Díaz case, filed in the Puerto Rico Court of First Instance, San Juan, has been removed to the U.S. District Court for the District of Puerto Rico. On October 13, 2009, Popular and the individual defendants moved to consolidate the García and Díaz actions. On October 26, 2009, plaintiff moved to remand the Díaz case to the Puerto Rico Court of First Instance and to stay defendants’ consolidation motion pending the outcome of the remand proceedings. At a scheduling conference held on January 14, 2010, the Court stayed discovery in both the Hoff and García matters pending resolution of their respective motions to dismiss.
On April 13, 2010, the Puerto Rico Court of First Instance in San Juan granted summary judgment dismissing a separate complaint brought by plaintiff in the García action that sought to enforce an alleged right to inspect the books and records of the Corporation in support of the pending derivative action. The Court held that the plaintiff had not propounded a “proper purpose” under Puerto Rico law for such inspection. On April 28, 2010, the plaintiff in that action moved for reconsideration of the Court’s dismissal. On May 4, 2010, the Court denied plaintiff’s

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request for reconsideration. On June 7, 2010, plaintiff filed an appeal before the Puerto Rico Court of Appeals. On June 11, 2010, Popular and the individual defendants moved to dismiss the appeal. On June 22, 2010, the Court of Appeals dismissed the appeal. On July 6, 2010, plaintiff moved for reconsideration of the Court’s dismissal. On July 16, 2010, the Court of Appeals denied plaintiff’s request for reconsideration.
At this early stage, it is not possible for management to assess the probability of an adverse outcome, or reasonably estimate the amount of any potential loss. It is possible that the ultimate resolution of these matters, if unfavorable, may be material to the Corporation’s results of operations.
Note 20 —Non-Consolidated Variable Interest Entities
The Corporation transfers residential mortgage loans in guaranteed loan securitizations. The Corporation’s continuing involvement in these transfers includes owning certain beneficial interests in the form of securities as well as the servicing rights retained. The Corporation is not required to provide additional financial support to any of the variable interest entities to which it has transferred the financial assets. The mortgage-backed securities, to the extent retained, are classified in the Corporation’s consolidated statement of condition as available-for-sale or trading securities.
The Corporation is involved with various special purpose entities mainly in guaranteed mortgage securitization transactions. These special purpose entities are deemed to be variable interest entities (“VIEs”) since they lack equity investments at risk. As part of the adoption of ASU 2009-17, during the first quarter of 2010, the Corporation evaluated these guaranteed mortgage securitization structures in which it participates, including GNMA and FNMA, and concluded that the Corporation is not the primary beneficiary of these VIEs, and therefore, are not required to be consolidated in the Corporation’s financial statements. The Corporation qualitatively assessed whether it held a controlling financial interest in these VIEs, which included analyzing if it had both the power to direct the activities of the VIE that most significantly impact the entity’s economic performance and the obligation to absorb losses of the entity that could potentially be significant to the VIE. The Corporation concluded that, essentially, these entities (FNMA and GNMA) control the design of the VIE, dictate the quality and nature of the collateral, require the underlying insurance, set the servicing standards via the servicing guides and can change them at will, and remove a primary servicer with cause, and without cause in the case of FNMA. Moreover, through their guarantee obligations, agencies (FNMA and GNMA) have the obligation to absorb losses that could be potentially significant to the VIE. The conclusion on the assessment of these guaranteed mortgage securitization transactions did not change during the second quarter of 2010.
The Corporation holds variable interests in these VIEs in the form of agency mortgage-backed securities and collateralized mortgage obligations, including those securities originated by the Corporation and those acquired from third parties. Additionally, the Corporation holds agency mortgage-backed securities, agency collateralized mortgage obligations and private label collateralized mortgage obligations issued by third party VIEs in which it has no other form of continuing involvement. Refer to Note 21 to the consolidated financial statements for additional information on the debt securities outstanding as of June 30, 2010, December 31, 2009 and June 30, 2009, which are classified as available-for-sale and trading securities in the Corporation’s consolidated statement of condition. In addition, the Corporation may retain the right to service the transferred loans in those government-sponsored special purpose entities (“SPEs”) and may also purchase the right to service loans in other government-sponsored SPEs that were transferred to those SPEs by a third-party. Pursuant to ASC Subtopic 810-10, the servicing fees that the Corporation receives for its servicing role are considered variable interests in the VIEs because the servicing fees are subordinated to the principal and interest that first needs to be paid to the mortgage-backed securities’ investors and to the guaranty fees that need to be paid to the federal agencies.

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The following table presents the carrying amount and classification of the assets related to the Corporation’s variable interests in non-consolidated VIEs and the maximum exposure to loss as a result of the Corporation’s involvement as servicer with non-consolidated VIEs as of June 30, 2010 and December 31, 2009.
                   
(In thousands)   June 30, 2010     December 31, 2009  
 
Assets
               
 
Servicing assets:
               
Mortgage servicing rights
  $ 106,428     $ 104,984  
 
Total servicing assets
  $ 106,428     $ 104,984  
 
Other assets:
               
Servicing advances
  $ 2,894     $ 2,029  
 
Total other assets
  $ 2,894     $ 2,029  
 
Total
  $ 109,322     $ 107,013  
 
Maximum exposure to loss
  $ 109,322     $ 107,013  
 
The size of the non-consolidated VIEs, in which the Corporation has a variable interest in the form of servicing fees, measured as the total unpaid principal balance of the loans, amounted to $9.3 billion as of June 30, 2010 and December 31, 2009.
Maximum exposure to loss represents the maximum loss, under a worst case scenario, that would be incurred by the Corporation, as servicer for the VIEs, assuming all loans serviced are delinquent and that the value of the Corporation’s interests and any associated collateral declines to zero, without any consideration of recovery. The Corporation determined that the maximum exposure to loss includes the fair value of the MSRs and the assumption that the servicing advances as of June 30, 2010 and December 31, 2009 will not be recovered. The agency debt securities are not included as part of the maximum exposure to loss since they are guaranteed by the related agencies.
Note 21 — Fair Value Measurement
ASC Subtopic 820-10 “Fair Value Measurements and Disclosures” establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three levels in order to increase consistency and comparability in fair value measurements and disclosures. The hierarchy is broken down into three levels based on the reliability of inputs as follows:
    Level 1- Unadjusted quoted prices in active markets for identical assets or liabilities that the Corporation has the ability to access at the measurement date. Valuation on these instruments does not necessitate a significant degree of judgment since valuations are based on quoted prices that are readily available in an active market.
 
    Level 2- Quoted prices other than those included in Level 1 that are observable either directly or indirectly. Level 2 inputs include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, or other inputs that are observable or that can be corroborated by observable market data for substantially the full term of the financial instrument.
 
    Level 3- Inputs are unobservable and significant to the fair value measurement. Unobservable inputs reflect the Corporation’s own assumptions about assumptions that market participants would use in pricing the asset or liability.
The Corporation maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the observable inputs be used when available. Fair value is based upon quoted market prices when available. If listed prices or quotes are not available, the Corporation employs internally-developed models that primarily use market-based inputs including yield curves, interest rates, volatilities, and credit curves, among others. Valuation adjustments are limited to those necessary to ensure that the financial instrument’s fair value is adequately representative of the price that would be received or paid in the marketplace. These adjustments include amounts that reflect counterparty credit quality, the Corporation’s credit standing, constraints on liquidity and unobservable parameters that are applied consistently.
The estimated fair value may be subjective in nature and may involve uncertainties and matters of significant judgment for certain financial instruments. Changes in the underlying assumptions used in calculating the fair value could significantly affect the results.

53


 

Fair Value on a Recurring Basis
The following fair value hierarchy tables present information about the Corporation’s assets and liabilities measured at fair value on a recurring basis as of June 30, 2010, December 31, 2009 and June 30, 2009:
                                 
    As of June 30, 2010
                            Balance as of
(In millions)   Level 1   Level 2   Level 3   June 30, 2010
 
Assets
                               
 
Continuing Operations
                               
Investment securities available-for-sale:
                               
U.S. Treasury securities
        $ 141           $ 141  
Obligations of U.S. Government sponsored entities
          1,749             1,749  
Obligations of Puerto Rico, States and political subdivisions
          55             55  
Collateralized mortgage obligations — federal agencies
          1,445             1,445  
Collateralized mortgage obligations — private label
          102             102  
Residential mortgage-backed securities — agencies
          2,948     $ 32       2,980  
Equity securities
  $ 4       5             9  
 
Total investment securities available-for-sale
  $ 4     $ 6,445     $ 32     $ 6,481  
 
Trading account securities, excluding derivatives:
                               
Obligations of Puerto Rico, States and political subdivisions
        $ 10           $ 10  
Collateralized mortgage obligations
          1     $ 3       4  
Residential mortgage-backed securities — agencies
          261       114       375  
Other
          9       3       12  
 
Total trading account securities
        $ 281     $ 120     $ 401  
 
Mortgage servicing rights
              $ 172     $ 172  
Derivatives (Refer to Note 14)
        $ 80           $ 80  
 
Total
  $ 4     $ 6,806     $ 324     $ 7,134  
 
 
                               
 
Liabilities
                               
 
Continuing Operations
                               
Derivatives (Refer to Note 14)
        $ (87 )         $ (87 )
Equity appreciation instrument
        $ (28 )         $ (28 )
 
Total
        $ (115 )         $ (115 )
 

54


 

                                 
    As of December 31, 2009
                            Balance as of
                            December 31,
(In millions)   Level 1   Level 2   Level 3   2009
 
Assets
                               
 
Continuing Operations
                               
Investment securities available-for-sale:
                               
U.S. Treasury securities
        $ 30           $ 30  
Obligations of U.S. Government sponsored entities
          1,648             1,648  
Obligations of Puerto Rico, States and political subdivisions
          81             81  
Collateralized mortgage obligations — federal agencies
          1,600             1,600  
Collateralized mortgage obligations — private label
          118             118  
Residential mortgage-backed securities — agencies
          3,176     $ 34       3,210  
Equity securities
  $ 3       5             8  
 
Total investment securities available-for-sale
  $ 3     $ 6,658     $ 34     $ 6,695  
 
Trading account securities, excluding derivatives:
                               
Obligations of Puerto Rico, States and political subdivisions
        $ 13           $ 13  
Collateralized mortgage obligations
          1     $ 3       4  
Residential mortgage-backed securities — agencies
          208       224       432  
Other
          9       3       12  
 
Total trading account securities
        $ 231     $ 230     $ 461  
 
Mortgage servicing rights
              $ 170     $ 170  
Derivatives (Refer to Note 14)
        $ 73           $ 73  
 
Total
  $ 3     $ 6,962     $ 434     $ 7,399  
 
 
                               
 
Liabilities
                               
 
Continuing Operations
                               
Derivatives (Refer to Note 14)
        $ (73 )         $ (73 )
 
Total
        $ (73 )         $ (73 )
 

55


 

                                 
    As of June 30, 2009
                            Balance as of
(In millions)   Level 1   Level 2   Level 3   June 30, 2009
 
Assets
                               
 
Continuing Operations
                               
Investment securities available-for-sale:
                               
U.S. Treasury securities
        $ 31           $ 31  
Obligations of U.S. Government sponsored entities
          1,756             1,756  
Obligations of Puerto Rico, States and political subdivisions
          99             99  
Corporate bonds
                               
Collateralized mortgage obligations — federal agencies
          1,673             1,673  
Collateralized mortgage obligations — private label
          136             136  
Residential mortgage-backed securities — agencies
          3,508     $ 35       3,543  
Equity securities
  $ 3       5             8  
 
Total investment securities available-for-sale
  $ 3     $ 7,208     $ 35     $ 7,246  
 
Trading account securities, excluding derivatives:
                               
Obligations of Puerto Rico, States and political subdivisions
        $ 14           $ 14  
Collateralized mortgage obligations
          2     $ 5       7  
Residential mortgage-backed securities — agencies
            163       284       447  
Other
          13       5       18  
 
Total trading account securities
        $ 192     $ 294     $ 486  
 
Mortgage servicing rights
              $ 181     $ 181  
Derivatives (Refer to Note 14)
        $ 77           $ 77  
 
Discontinued Operations
                               
Loans measured at fair value pursuant to fair value option
              $ 1     $ 1  
 
Total
  $ 3     $ 7,477     $ 511     $ 7,991  
 
 
                               
 
Liabilities
                               
 
Continuing Operations
                               
Derivatives (Refer to Note 14)
        $ (80 )         $ (80 )
 
Total
        $ (80 )         $ (80 )
 

56


 

The following tables present the changes in Level 3 assets and liabilities measured at fair value on a recurring basis for the quarters and six months ended June 30, 2010 and 2009:
                                                 
Quarter ended June 30, 2010
                                            Changes in
                                            unrealized
                                            gains (losses)
                                            included in
                    Purchases,                   earnings
                    sales,                   related to
                    issuances,                   assets and
    Balance   Gains   settlements,                   liabilities still
    as of   (losses)   and   Transfers   Balance as   held as of
    March 31,   included in   paydowns   in (out) of   of June 30,   June 30,
(In millions)   2010   earnings   (net)   Level 3   2010   2010
 
Assets
                                               
 
Continuing Operations
                                               
Investment securities available-for-sale:
                                               
Residential mortgage-backed securities — agencies
  $ 36           $ (1 )   $ (3 )   $ 32        
 
Total investment securities available-for-sale
  $ 36           $ (1 )   $ (3 )   $ 32        
 
Trading account securities:
                                               
Collateralized mortgage obligations
  $ 3                       $ 3        
Residential mortgage-backed securities-agencies
    197     $ (5 )   $ (2 )   $ (76 )     114     $ 1  [a]
Other
    3                         3        
 
Total trading account securities
  $ 203     $ (5 )   $ (2 )   $ (76 )   $ 120     $ 1  
 
Mortgage servicing rights
  $ 173     $ (9 )   $ 8           $ 172     $ (5 ) [b]
 
Total
  $ 412     $ (14 )   $ 5     $ (79 )   $ 324     $ (4 )
 
[a]   Gains (losses) are included in “Trading account profit” in the statement of operations
 
[b]   Gains (losses) are included in “Other service fees” in the statement of operations

57


 

                                                 
Six months ended June 30, 2010
                                            Changes in
                                            unrealized
                                            gains (losses)
                                            included in
                    Purchases,                   earnings
                    sales,                   related to
                    issuances,                   assets and
    Balance   Gains   settlements,                   liabilities still
    as of   (losses)   and   Transfers   Balance as   held as of
    January 1,   included in   paydowns   in (out) of   of June 30,   June 30,
(In millions)   2010   earnings   (net)   Level 3   2010   2010
 
Assets
                                               
 
Continuing Operations
                                               
Investment securities available-for-sale:
                                               
Residential mortgage-backed securities — agencies
  $ 34           $ 1     $ (3 )   $ 32        
 
Total investment securities available-for-sale
  $ 34           $ 1     $ (3 )   $ 32        
 
Trading account securities:
                                               
Collateralized mortgage obligations
  $ 3                       $ 3        
Residential mortgage-backed securities-agencies
    224     $ (5 )   $ (29 )   $ (76 )     114     $ 1  [a]
Other
    3                         3        
 
Total trading account securities
  $ 230     $ (5 )   $ (29 )   $ (76 )   $ 120     $ 1  
 
Mortgage servicing rights
  $ 170     $ (10 )   $ 12           $ 172     $ (2 ) [b]
 
Total
  $ 434     $ (15 )   $ (16 )   $ (79 )   $ 324     $ (1 )
 
[a]   Gains (losses) are included in “Trading account profit” in the statement of operations
 
[b]   Gains (losses) are included in “Other service fees” in the statement of operations

58


 

                                                         
  Quarter ended June 30, 2009
                                                    Changes in
                                                    unrealized
                                                    gains (losses)
                                    Purchases,           included in
                                    sales,           earnings
                    Gains (losses)   Increase   issuances,           related to
    Balance   Gains   included in   (decrease)   settlements,           assets and
    as of   (losses)   other   in accrued   and   Balance as   liabilities still
    January 1,   included in   comprehensive   interest   paydowns   of June 30,   held as of June
(In millions)   2009   earnings   income   receivable   (net)   2009   30, 2009
 
Assets
                                                       
 
Continuing Operations
                                                       
Investment securities available-for-sale:
                                                       
Residential mortgage- backed securities — agencies
  $ 36                       $ (1 )   $ 35        
 
Total investment securities available-for-sale
  $ 36                       $ (1 )   $ 35        
 
Trading account securities:
                                                       
Collateralized mortgage obligations
  $ 3                       $ 2     $ 5        
Residential mortgage- backed securities- agencies
    276     $ (1 )                 9       284     $ 1  [a]
Other
    5                               5        
 
Total trading account securities
  $ 284     $ (1 )               $ 11     $ 294     $ 1  
 
Mortgage servicing rights
  $ 177     $ (4 )               $ 8     $ 181     $ (1 ) [c]
 
Discontinued Operations
                                                       
Loans measured at fair value pursuant to fair value option
  $ 5                       $ (4 )   $ 1        [b]
 
Total
  $ 502     $ (5 )               $ 14     $ 511        
 
[a]   Gains (losses) are included in “Trading account profit” in the statement of operations
 
[b]   Gains (losses) are included in “Loss from discontinued operations, net of tax” in the statement of operations
 
[c]   Gains (losses) are included in “Other service fees” in the statement of operations

59


 

                                                         
  Six months ended June 30, 2009
                                                    Changes in
                                                    unrealized
                                                    gains (losses)
                                    Purchases,           included in
                                    sales,           earnings
                    Gains (losses)   Increase   issuances,           related to
    Balance   Gains   included in   (decrease)   settlements,           assets and
    as of   (losses)   other   in accrued   and   Balance as   liabilities still
    January 1,   included in   comprehensive   interest   paydowns   of June 30,   held as of June
(In millions)   2009   earnings   income   receivable   (net)   2009   30, 2009
 
Assets
                                                       
 
Continuing Operations
                                                       
Investment securities available-for-sale:
                                                       
Mortgage-backed securities — agencies
  $ 37                       $ (2 )   $ 35        
 
Total investment securities available-for-sale
  $ 37                       $ (2 )   $ 35        
 
Trading account securities:
                                                       
Collateralized mortgage obligations
  $ 3                       $ 2     $ 5        
Residential mortgage- backed securities- agencies
    292     $ 1                   (9 )     284     $ 4  [a]
Other
    5                               5        
 
Total trading account securities
  $ 300     $ 1                 $ (7 )   $ 294     $ 4  
 
Mortgage servicing rights
  $ 176     $ (9 )               $ 14     $ 181     $ (2 ) [c]
 
Discontinued Operations
                                                       
Loans measured at fair value pursuant to fair value option
  $ 5     $ 1                 $ (5 )   $ 1        [b]
 
Total
  $ 518     $ (7 )                     $ 511     $ 2  
 
[a]   Gains (losses) are included in “Trading account profit” in the statement of operations
 
[b]   Gains (losses) are included in “Loss from discontinued operations, net of tax” in the statement of operations
 
[c]   Gains (losses) are included in “Other service fees” in the statement of operations
 
 
There were $79 million in transfers out of Level 3 for financial instruments measured at fair value on a recurring basis during the quarter and six months ended June 30, 2010. These transfers resulted from exempt FNMA mortgage-backed securities, which were transferred out of Level 3 and into Level 2, as a result of a change in valuation methodology from an internally-developed matrix pricing to pricing them based on a bond’s theoretical value from similar bonds defined by credit quality and market sector. Their fair value incorporates an option adjusted spread. Pursuant to the Corporation’s policy, these transfers were recognized as of the end of the reporting period. There were no transfers in and / or out of Level 1 during the quarter and six months ended June 30, 2010.
There were no transfers in and / or out of Level 3 for financial instruments measured at fair value on a recurring basis during the quarter and six months ended June 30, 2009. There were no transfers in and / or out of Level 1 and Level 2 during the quarter and six months ended June 30, 2009.

60


 

Gains and losses (realized and unrealized) included in earnings for the quarters and six months ended June 30, 2010 and 2009 for Level 3 assets and liabilities included in the previous tables are reported in the consolidated statement of operations as follows:
                                 
    Quarter ended June 30, 2010   Six months ended June 30, 2010
            Changes in           Changes in
            unrealized gains           unrealized gains
            (losses) relating to           (losses) relating to
    Total gains (losses)   assets / liabilities   Total gains (losses)   assets / liabilities
    included in   still held at   included in   still held at
(In millions)   earnings   reporting date   earnings   reporting date
 
Continuing Operations
                               
Other service fees
  $ (9 )   $ (5 )   $ (10 )   $ (2 )
Trading account profit
    (5 )     1       (5 )     1  
 
Total
  $ (14 )   $ (4 )   $ (15 )   $ (1 )
 
                                 
    Quarter ended June 30, 2009   Six months ended June 30, 2009
            Changes in           Changes in
            unrealized gains           unrealized gains
            (losses) relating to           (losses) relating to
    Total gains (losses)   assets / liabilities   Total gains (losses)   assets / liabilities
    included in   still held at   included in   still held at
(In millions)   earnings   reporting date   earnings   reporting date
 
Continuing Operations
                               
Other service fees
  $ (4 )   $ (1 )   $ (9 )   $ (2 )
Trading account profit
    (1 )     1       1       4  
Discontinued Operations
                               
Loss from discontinued operations, net of tax
                1        
 
Total
  $ (5 )         $ (7 )   $ 2  
 
Additionally, in accordance with generally accepted accounting principles, the Corporation may be required to measure certain assets at fair value on a nonrecurring basis in periods subsequent to their initial recognition. The adjustments to fair value usually result from the application of lower of cost or fair value accounting, identification of impaired loans requiring specific reserves under ASC Subsection 310-10-35 “Accounting by Creditors for Impairment of a Loan”, or write-downs of individual assets. The following tables present financial and non-financial assets that were subject to a fair value measurement on a nonrecurring basis during the six months ended June 30, 2010 and 2009, and which were still included in the consolidated statement of condition as of such dates. The amounts disclosed represent the aggregate fair value measurements of those assets as of the end of the reporting period.
                                 
Carrying value as of June 30, 2010
(In millions)   Level 1   Level 2   Level 3   Total
 
Assets
                               
 
Continuing Operations
                               
Loans [1]
              $ 610     $ 610  
Loans held-for-sale [2]
                2       2  
Other real estate owned [3]
                42       42  
 
Total
              $ 654     $ 654  
 
[1]   Relates mostly to certain impaired collateral dependent loans. The impairment was measured based on the fair value of the collateral, which is derived from appraisals that take into consideration prices in observed transactions involving similar assets in similar locations, in accordance with the provisions of ASC Subsection 310-10-35.
 
[2]   Relates to lower of cost or fair value adjustments of loans held-for-sale and loans transferred from loans held-in- portfolio to loans held-for-sale. These adjustments were principally determined based on negotiated price terms for the loans.
 
[3]   Represents the fair value of foreclosed real estate and other collateral owned that were measured at fair value.

61


 

                                 
Carrying value as of June 30, 2009
(In millions)   Level 1   Level 2   Level 3   Total
 
Assets
                               
 
Continuing Operations
                               
Loans [1]
              $ 612     $ 612  
Loans held-for-sale [2]
                16       16  
Other real estate owned [3]
                51       51  
Other foreclosed assets [3]
                7       7  
Discontinued Operations
                               
Loans held-for-sale [2]
                1       1  
 
Total
                  $ 687     $ 687  
 
[1]   Relates mostly to certain impaired collateral dependent loans. The impairment was measured based on the fair value of the collateral, which is derived from appraisals that take into consideration prices in observed transactions involving similar assets in similar locations, in accordance with the provisions of ASC Subsection 310-10-35.
 
[2]   Relates to lower of cost or fair value adjustments of loans held-for-sale and loans transferred from loans held-in- portfolio to loans held-for-sale. These adjustments were principally determined based on negotiated price terms for the loans.
 
[3]   Represents the fair value of foreclosed real estate and other collateral owned that were measured at fair value.
 
 
Following is a description of the Corporation’s valuation methodologies used for assets and liabilities measured at fair value. The disclosure requirements exclude certain financial instruments and non-financial instruments. Accordingly, the aggregate fair value of the financial instruments disclosed do not represent management’s estimate of the underlying value of the Corporation.
Trading Account Securities and Investment Securities Available-for-Sale
    U.S. Treasury securities: The fair value of U.S. Treasury securities is based on yields that are interpolated from the constant maturity treasury curve. These securities are classified as Level 2.
 
    Obligations of U.S. Government sponsored entities: The Obligations of U.S. Government sponsored entities include U.S. agency securities, which fair value is based on an active exchange market and on quoted market prices for similar securities. The U.S. agency securities are classified as Level 2.
 
    Obligations of Puerto Rico, States and political subdivisions: Obligations of Puerto Rico, States and political subdivisions include municipal bonds. The bonds are segregated and the like characteristics divided into specific sectors. Market inputs used in the evaluation process include all or some of the following: trades, bid price or spread, two sided markets, quotes, benchmark curves including but not limited to Treasury benchmarks, LIBOR and swap curves, market data feeds such as MSRB, discount and capital rates, and trustee reports. The municipal bonds are classified as Level 2.
 
    Mortgage-backed securities — agencies: Certain agency mortgage-backed securities (“MBS”) are priced based on a bond’s theoretical value from similar bonds defined by credit quality and market sector. Their fair value incorporates an option adjusted spread. The agency MBS are classified as Level 2. Other agency MBS such as GNMA Puerto Rico Serials are priced using an internally-developed pricing matrix with quoted prices from local broker dealers. These particular MBS are classified as Level 3.
 
    Collateralized mortgage obligations: Agency and private collateralized mortgage obligations (“CMOs”) are priced based on a bond’s theoretical value from similar bonds defined by credit quality and market sector and for which fair value incorporates an option adjusted spread. The option adjusted spread model includes prepayment and volatility assumptions, ratings (whole loans collateral) and spread adjustments. These investment securities are classified as Level 2.
 
    Equity securities: Equity securities with quoted market prices obtained from an active exchange market are classified as Level 1. Other equity securities that do not trade in highly liquid markets are classified as Level 2.

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    Corporate securities and mutual funds (included as “other” in the “trading account securities” category): Quoted prices for these security types are obtained from broker dealers. Given that the quoted prices are for similar instruments or do not trade in highly liquid markets, the corporate securities and mutual funds are classified as Level 2. The important variables in determining the prices of Puerto Rico tax-exempt mutual fund shares are net asset value, dividend yield and type of assets in the fund. All funds trade based on a relevant dividend yield taking into consideration the aforementioned variables. In addition, demand and supply also affect the price. Corporate securities that trade less frequently or are in distress are classified as Level 3.
Mortgage servicing rights
Mortgage servicing rights (“MSRs”) do not trade in an active market with readily observable prices. MSRs are priced internally using a discounted cash flow model. The valuation model considers servicing fees, portfolio characteristics, prepayment assumptions, delinquency rates, late charges, other ancillary revenues, cost to service and other economic factors. Due to the unobservable nature of certain valuation inputs, the MSRs are classified as Level 3.
Derivatives
Interest rate swaps, interest rate caps and indexed options are traded in over-the-counter active markets. These derivatives are indexed to an observable interest rate benchmark, such as LIBOR or equity indexes, and are priced using an income approach based on present value and option pricing models using observable inputs. Other derivatives are liquid and have quoted prices, such as forward contracts or “to be announced securities” (“TBAs”). All of these derivatives are classified as Level 2. The non-performance risk is determined using internally-developed models that consider the collateral held, the remaining term, and the creditworthiness of the entity that bears the risk, and uses available public data or internally-developed data related to current spreads that denote their probability of default.
Equity appreciation instrument
Refer to Note 2 to the consolidated financial statements for a description of the terms of the equity appreciation instrument. The fair value of the equity appreciation instrument was estimated by determining a call option value using the Black-Scholes Option Pricing Model. The principal variables in determining the fair value of the equity appreciation instrument include the implied volatility determined based on the one-year historical daily volatility of the Corporation’s common stock, the exercise price of the instrument, the price of the call option, and the risk-free rate. The equity appreciation instrument is classified as Level 2.
Loans held-in-portfolio considered impaired under ASC Subsection 310-10-35 that are collateral dependent
The impairment is measured based on the fair value of the collateral, which is derived from appraisals that take into consideration prices in observed transactions involving similar assets in similar locations, in accordance with the provisions of ASC Subsection 310-10-35. Currently, the associated loans considered impaired are classified as Level 3.
Loans measured at fair value pursuant to lower of cost or fair value adjustments
Loans measured at fair value on a nonrecurring basis pursuant to lower of cost or fair value were priced based on bids received from potential buyers, secondary market prices, and discounted cash flow models which incorporate internally-developed assumptions for prepayments and credit loss estimates. These loans are classified as Level 3.
Other real estate owned and other foreclosed assets
Other real estate owned includes real estate properties securing mortgage, consumer, and commercial loans. Other foreclosed assets include automobiles securing auto loans. The fair value of foreclosed assets may be determined using an external appraisal, broker price opinion or an internal valuation. These foreclosed assets are classified as Level 3 given certain internal adjustments that may be made to external appraisals.

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Note 22 — Fair Value of Financial Instruments
The fair value of financial instruments is the amount at which an asset or obligation could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. Fair value estimates are made at a specific point in time based on the type of financial instrument and relevant market information. Many of these estimates involve various assumptions and may vary significantly from amounts that could be realized in actual transactions.
The information about the estimated fair values of financial instruments presented hereunder excludes all nonfinancial instruments and certain other specific items.
Derivatives are considered financial instruments and their carrying value equals fair value. For disclosures about the fair value of derivative instruments refer to Note 14 to the consolidated financial statements.
For those financial instruments with no quoted market prices available, fair values have been estimated using present value calculations or other valuation techniques, as well as management’s best judgment with respect to current economic conditions, including discount rates, estimates of future cash flows, and prepayment assumptions.
The fair values reflected herein have been determined based on the prevailing interest rate environment as of June 30, 2010 and December 31, 2009, respectively. In different interest rate environments, fair value estimates can differ significantly, especially for certain fixed rate financial instruments. In addition, the fair values presented do not attempt to estimate the value of the Corporation’s fee generating businesses and anticipated future business activities, that is, they do not represent the Corporation’s value as a going concern. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Corporation. The methods and assumptions used to estimate the fair values of significant financial instruments as of June 30, 2010 and December 31, 2009 are described in the paragraphs below.
Short-term financial assets and liabilities have relatively short maturities, or no defined maturities, and little or no credit risk. The carrying amounts of other liabilities reported in the consolidated statements of condition approximate fair value because of the short-term maturity of those instruments or because they carry interest rates which approximate market. Included in this category are: cash and due from banks, federal funds sold and securities purchased under agreements to resell, time deposits with other banks, bankers acceptances and assets sold under agreements to repurchase and short-term borrowings. The equity appreciation instrument is included in other liabilities and is accounted at fair value. Note 21 to the consolidated financial statements provides a description of the valuation methodology for the equity appreciation instrument. Resell and repurchase agreements with long-term maturities are valued using discounted cash flows based on market rates currently available for agreements with similar terms and remaining maturities.
Trading and investment securities, except for investments classified as other investment securities in the consolidated statement of condition, are financial instruments that regularly trade on secondary markets. The estimated fair value of these securities was determined using either market prices or dealer quotes, where available, or quoted market prices of financial instruments with similar characteristics. Trading account securities and securities available-for-sale are reported at their respective fair values in the consolidated statements of condition since they are marked-to-market for accounting purposes. These instruments are detailed in the consolidated statements of condition and in Notes 8 and 9.
The estimated fair value for loans held-for-sale was based on secondary market prices, bids received from potential buyers and discounted cash flow models. The fair values of the loans held-in-portfolio have been determined for groups of loans with similar characteristics. Loans were segregated by type such as commercial, construction, residential mortgage, consumer, and credit cards. Each loan category was further segmented based on loan characteristics, including interest rate terms, credit quality and vintage. Generally, fair values were estimated based on an exit price by discounting scheduled cash flows for the segmented groups of loans using a discount rate that considers interest, credit and expected return by market participant under current market conditions. Additionally, prepayment, default and recovery assumptions have been applied in the mortgage loan portfolio valuations. Generally accepted accounting principles do not require a fair valuation of the lease financing portfolio, therefore it is included in the loans total at its carrying amount.

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The fair value of deposits with no stated maturity, such as non-interest bearing demand deposits, savings, NOW, and money market accounts was, for purposes of this disclosure, equal to the amount payable on demand as of the respective dates. The fair value of certificates of deposit was based on the discounted value of contractual cash flows using interest rates being offered on certificates with similar maturities. The value of these deposits in a transaction between willing parties is in part dependent of the buyer’s ability to reduce the servicing cost and the attrition that sometimes occurs. Therefore, the amount a buyer would be willing to pay for these deposits could vary significantly from the presented fair value.
Long-term borrowings were valued using discounted cash flows, based on market rates currently available for debt with similar terms and remaining maturities and in certain instances using quoted market rates for similar instruments as of June 30, 2010 and December 31, 2009.
As part of the fair value estimation procedures of certain liabilities, including repurchase agreements (regular and structured) and FHLB advances, the Corporation considered, where applicable, the collateralization levels as part of its evaluation of non-performance risk. Also, for certificates of deposit, the non-performance risk was determined using internally-developed models that consider, where applicable, the collateral held, amounts insured, the remaining term, and the credit premium of the institution.
Refer to Note 2 to the consolidated financial statements for a description of the FDIC loss share indemnification asset, equity appreciation instrument issued to the FDIC and the contingent liability on unfunded loan commitments, which are separately disclosed in the table below and all relate to the Westernbank FDIC-assisted transaction. The latter two items are included as other liabilities in the consolidated statement of condition.
Commitments to extend credit were valued using the fees currently charged to enter into similar agreements. For those commitments where a future stream of fees is charged, the fair value was estimated by discounting the projected cash flows of fees on commitments. The fair value of letters of credit was based on fees currently charged on similar agreements.

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Carrying or notional amounts, as applicable, and estimated fair values for financial instruments were:
                                 
    June 30, 2010   December 31, 2009
    Carrying   Fair   Carrying   Fair
(In thousands)   amount   value   amount   value
 
Financial Assets:
                               
Cash and money market investments
  $ 3,188,978     $ 3,188,978     $ 1,680,127     $ 1,680,127  
Trading securities
    401,543       401,543       462,436       462,436  
Investment securities available-for-sale
    6,481,187       6,481,187       6,694,714       6,694,714  
Investment securities held-to-maturity
    209,416       209,207       212,962       213,146  
Other investment securities
    152,562       153,845       164,149       165,497  
Loans held-for-sale
    101,251       105,448       90,796       91,542  
Loans held-in-portfolio, net
    25,268,389       22,720,737       22,451,909       20,021,224  
FDIC loss share indemnification asset
    3,345,896       3,345,896              
 
                               
Financial Liabilities:
                               
Deposits
  $ 27,113,573     $ 27,245,650     $ 25,924,894     $ 26,076,515  
Federal funds purchased
    9,900       9,900              
Assets sold under agreements to repurchase
    2,297,294       2,443,281       2,632,790       2,759,438  
Short-term borrowings
    1,263       1,263       7,326       7,326  
Notes payable
    8,237,401       8,141,882       2,648,632       2,453,037  
Contingent liability on unfunded loan commitments
    132,441       132,441              
Equity appreciation instrument
    28,106       28,106              
 
 
                                 
    Notional   Fair   Notional   Fair
(In thousands)   amount   Value   Amount   Value
 
Commitments to extend credit
  $ 6,547,201     $ 1,730     $ 7,013,148     $ 882  
Letters of credit
    158,344       1,265       147,647       1,565  
 
Note 23 — Net Loss per Common Share
The computation of net loss per common share (“EPS”) follows:
                                 
    Quarter ended     Six months ended  
    June 30,     June 30,  
(In thousands, except share information)   2010     2009     2010     2009  
 
Net loss from continuing operations
  $ (55,828 )   $ (176,583 )   $ (140,883 )   $ (219,159 )
Net loss from discontinued operations
          (6,599 )           (16,545 )
Preferred stock dividends
          (22,915 )           (45,831 )
Preferred stock discount accretion
          (1,713 )           (3,475 )
Deemed dividend on preferred stock
    (191,667 )           (191,667 )      
 
 
                               
Net loss applicable to common stock
  $ (247,495 )   $ (207,810 )   $ (332,550 )   $ (285,010 )
 
 
                               
Average common shares outstanding
    853,010,208       281,888,394       746,598,082       281,861,563  
Average potential common shares
                       
 
Average common shares outstanding — assuming dilution
    853,010,208       281,888,394       746,598,082       281,861,563  
 
 
                               
Basic and diluted EPS from continuing operations
  $ (0.29 )   $ (0.71 )   $ (0.45 )   $ (0.95 )
Basic and diluted EPS from discontinued operations
          (0.03 )           (0.06 )
 
Basic and diluted EPS
  $ (0.29 )   $ (0.74 )   $ (0.45 )   $ (1.01 )
 
The conversion of contingently convertible perpetual non-cumulative preferred stock into shares of the Corporation’s common stock, as discussed in Note 18 to the financial statements, resulted in a non-cash beneficial conversion of $191.7 million, representing the intrinsic value between the conversion rate of $3.00 and the common stock closing price of $3.50 on April 13, 2010, the date the preferred shares were offered. The beneficial

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conversion was recorded as a deemed dividend to the preferred stockholders reducing retained earnings, with a corresponding offset to surplus (paid in capital), and thus did not affect total stockholders’ equity or the book value of the common stock. However, the deemed dividend increased the net loss applicable to common stock and affected the calculation of basic and diluted EPS for the quarter and six months ended June 30, 2010. Moreover, in computing diluted EPS, dilutive convertible securities that remained outstanding for the period prior to actual conversion were not included as average potential common shares because the effect would have been antidilutive. In computing both basic and diluted EPS, the common shares issued upon actual conversion were included in the weighted average calculation of common shares, after the date of conversion, that they remained outstanding.
Potential common shares consist of common stock issuable under the assumed exercise of stock options and restricted stock awards using the treasury stock method. This method assumes that the potential common shares are issued and the proceeds from exercise, in addition to the amount of compensation cost attributed to future services, are used to purchase common stock at the exercise date. The difference between the number of potential shares issued and the shares purchased is added as incremental shares to the actual number of shares outstanding to compute diluted earnings per share. Warrants, stock options and restricted stock awards that result in lower potential shares issued than shares purchased under the treasury stock method are not included in the computation of dilutive earnings per share since their inclusion would have an antidilutive effect in earnings per common share.
For the quarter and six-month period ended June 30, 2010, there were 1,272,058 and 2,541,337 weighted average antidilutive stock options outstanding, respectively (June 30, 2009 — 2,702,428 and 2,819,169). Additionally, the Corporation has outstanding a warrant to purchase 20,932,836 shares of common stock, which has an antidilutive effect as of June 30, 2010. The Corporation also has 1,323,445 restricted shares, which have an antidilutive effect as of June 30, 2010.
Note 24 — Other Service Fees
The caption of other service fees in the consolidated statements of operations consists of the following major categories:
                                 
    Quarter ended   Six months ended
    June 30,   June 30,
(In thousands)   2010   2009   2010   2009
 
Debit card fees
  $ 29,176     $ 27,508     $ 55,769     $ 53,881  
Credit card fees and discounts
    26,013       23,449       49,310       47,454  
Processing fees
    14,170       13,727       28,132       27,135  
Insurance fees
    12,084       12,547       23,074       24,551  
Sale and administration of investment products
    10,245       9,694       17,412       17,023  
Other fees
    12,037       15,512       31,348       30,926  
 
Total other service fees
  $ 103,725     $ 102,437     $ 205,045     $ 200,970  
 

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Note 25 — Pension and Postretirement Benefits
The Corporation has noncontributory defined benefit pension plans (the “retirement plans”) and supplementary benefit pension plans for regular employees of certain of its subsidiaries. Effective May 1, 2009, the accrual of the benefits under the BPPR retirement plan was frozen to all participants. Pursuant to the amendment, the retirement plan participants will not receive any additional credit for compensation earned and service performed after April 30, 2009 for purposes of calculating benefits under the retirement plans.
During the second quarter of 2010, the Corporation settled its U.S. retirement plan, which had been frozen in 2007. The U.S. retirement plan assets are expected to be distributed to plan participants during the last two quarters of 2010.
The components of net periodic pension cost for the quarters and six months ended June 30, 2010 and 2009 were as follows:
                                                                 
                    Benefit Restoration                   Benefit Restoration
    Pension Plans   Plans   Pension Plans   Plans
    Quarters ended   Quarters ended   Six months ended   Six months ended
    June 30,   June 30,   June 30,   June 30,
(In thousands)   2010   2009   2010   2009   2010   2009   2010   2009
 
Service cost
        $ 887           $ 116           $ 3,330           $ 341  
Interest cost
  $ 7,953       8,042     $ 385       390     $ 15,906       16,589     $ 769       834  
Expected return on plan assets
    (7,777 )     (6,222 )     (404 )     (307 )     (15,553 )     (13,099 )     (807 )     (625 )
Amortization of prior service cost (credit)
                                  44             (8 )
Amortization of net loss
    2,206       3,204       99       185       4,412       7,387       198       498  
 
Net periodic cost
    2,382       5,911       80       384       4,765       14,251       160       1,040  
Curtailment loss (gain)
                                  820             (341 )
Settlement loss
    3,380                         3,380                    
 
Total cost
  $ 5,762     $ 5,911     $ 80     $ 384     $ 8,145     $ 15,071     $ 160     $ 699  
 
During the quarter and six months ended June 30, 2010, the Corporation made contributions to the pension and benefit restoration plans amounting to $0.4 million. The total contributions expected to be paid during the year 2010 for the pension and benefit restoration plans amount to approximately $3.2 million.
The Corporation also provides certain health care benefits for retired employees of certain subsidiaries. The components of net periodic postretirement benefit cost for the quarters and six months ended June 30, 2010 and 2009 were as follows:
                                 
    Quarters ended   Six months ended
    June 30,   June 30,
(In thousands)   2010   2009   2010   2009
 
Service cost
  $ 432     $ 549     $ 864     $ 1,098  
Interest cost
    1,608       2,026       3,217       4,052  
Amortization of prior service cost
    (261 )     (262 )     (523 )     (523 )
Amortization of net gain
    (294 )           (588 )      
 
Total net periodic cost
  $ 1,485     $ 2,313     $ 2,970     $ 4,627  
 
Contributions made to the postretirement benefit plan for the quarter and six months ended June 30, 2010 amounted to approximately $1.3 million and $2.4 million, respectively. The total contributions expected to be paid during the year 2010 for the postretirement benefit plan amount to approximately $5.2 million.
Note 26 — Stock-Based Compensation
The Corporation maintained a Stock Option Plan (the “Stock Option Plan”), which permitted the granting of incentive awards in the form of qualified stock options, incentive stock options, or non-statutory stock options of the Corporation. In April 2004, the Corporation’s shareholders adopted the Popular, Inc. 2004 Omnibus Incentive Plan (the “Incentive Plan”), which replaced and superseded the Stock Option Plan. The adoption of the Incentive Plan did not alter the original terms of the grants made under the Stock Option Plan prior to the adoption of the Incentive Plan.

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Stock Option Plan
Employees and directors of the Corporation or any of its subsidiaries were eligible to participate in the Stock Option Plan. The Board of Directors or the Compensation Committee of the Board had the absolute discretion to determine the individuals that were eligible to participate in the Stock Option Plan. This plan provided for the issuance of Popular, Inc.’s common stock at a price equal to its fair market value at the grant date, subject to certain plan provisions. The shares are to be made available from authorized but unissued shares of common stock or treasury stock. The Corporation’s policy has been to use authorized but unissued shares of common stock to cover each grant. The maximum option term is ten years from the date of grant. Unless an option agreement provides otherwise, all options granted are 20% exercisable after the first year and an additional 20% is exercisable after each subsequent year, subject to an acceleration clause at termination of employment due to retirement.
The following table presents information on stock options outstanding as of June 30, 2010:
                                         
(Not in thousands)
                    Weighted-Average        
            Weighted-Average   Remaining Life of   Options   Weighted-Average
Exercise Price   Options   Exercise Price of   Options Outstanding   Exercisable   Exercise Price of
Range per Share   Outstanding   Options Outstanding   In Years   (fully vested)   Options Exercisable
 
$14.39 - $18.50
    1,231,412     $ 15.84       2.24       1,231,412     $ 15.84  
$19.25 - $27.20
    1,298,725     $ 25.21       3.99       1,298,725     $ 25.21  
 
$14.39 - $27.20
    2,530,137     $ 20.65       3.14       2,530,137     $ 20.65  
 
There was no intrinsic value of options outstanding as of June 30, 2010 (June 30, 2009 — $0.2 million). There was no intrinsic value of options exercisable as of June 30, 2010 and 2009.
The following table summarizes the stock option activity and related information:
                 
    Options   Weighted-Average
(Not in thousands)   Outstanding   Exercise Price
 
Outstanding as of January 1, 2009
    2,965,843     $ 20.59  
Granted
           
Exercised
           
Forfeited
    (59,631 )     26.42  
Expired
    (353,549 )     19.25  
 
Outstanding as of December 31, 2009
    2,552,663     $ 20.64  
Granted
           
Exercised
           
Forfeited
               
Expired
    (22,526 )     19.56  
 
Outstanding as of June 30, 2010
    2,530,137     $ 20.65  
 
The stock options exercisable as of June 30, 2010 totaled 2,530,137 (June 30, 2009 — 2,613,446). There were no stock options exercised during the quarters and six-month periods ended June 30, 2010 and 2009. Thus, there was no intrinsic value of options exercised during the quarters and six month-periods ended June 30, 2010 and 2009.
There were no new stock option grants issued by the Corporation under the Stock Option Plan during 2009 and 2010.
For the quarter ended June 30, 2010, there was no stock option expense recognized (June 30, 2009 — credit of $0.1 million, with an income tax expense of $51 thousand). For the six months ended June 30, 2010, there was no stock option expense recognized (June 30, 2009 — $27 thousand, with a tax benefit of $4 thousand).

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Incentive Plan
The Incentive Plan permits the granting of incentive awards in the form of Annual Incentive Awards, Long-term Performance Unit Awards, Stock Options, Stock Appreciation Rights, Restricted Stock, Restricted Units or Performance Shares. Participants in the Incentive Plan are designated by the Compensation Committee of the Board of Directors (or its delegate as determined by the Board). Employees and directors of the Corporation and / or any of its subsidiaries are eligible to participate in the Incentive Plan. The shares may be made available from common stock purchased by the Corporation for such purpose, authorized but unissued shares of common stock or treasury stock. The Corporation’s policy with respect to the shares of restricted stock has been to purchase such shares in the open market to cover each grant.
Under the Incentive Plan, the Corporation has issued restricted shares, which become vested based on the employees’ continued service with Popular. Unless otherwise stated in an agreement, the compensation cost associated with the shares of restricted stock is determined based on a two-prong vesting schedule. The first part is vested ratably over five years commencing at the date of grant and the second part is vested at termination of employment after attainment of 55 years of age and 10 years of service. The five-year vesting part is accelerated at termination of employment after attaining 55 years of age and 10 years of service.
The following table summarizes the restricted stock activity under the Incentive Plan for members of management:
                 
    Restricted   Weighted-Average
(Not in thousands)   Stock   Grant Date Fair Value
 
Non-vested as of January 1, 2009
    248,339     $ 22.83  
Granted
           
Vested
    (104,791 )     21.93  
Forfeited
    (5,036 )     19.95  
 
Non-vested as of December 31, 2009
    138,512     $ 23.62  
Granted
    1,525,416       2.70  
Vested
    (163,993 )     11.67  
Forfeited
    (176,490 )     2.04  
 
Non-vested as of June 30, 2010
    1,323,445     $ 3.86  
 
During the quarter ended June 30, 2010, 563,043 shares of restricted stock were awarded to management under the Incentive Plan, from which 360,527 shares of restricted stock were awarded to management consistent with the requirements of the TARP Interim Final Rule. During the six-month period ended June 30, 2010, 1,525,416 shares of restricted stock were awarded to management under the Incentive Plan, from which 1,246,755 shares of restricted stock were awarded to management consistent with the requirements of the TARP Interim Final Rule. The shares of restricted stock, which were awarded to management consistent with the requirements of the TARP Interim Final Rule, were determined upon consideration of management’s execution of critical 2009 initiatives to manage the Corporation’s liquidity and capitalization, strategically reposition its United States operations, and improve management effectiveness and cost control. The shares will vest on the secondary anniversary of the grant date, and they may become payable in 25% increments as the Corporation repays each 25% portion of the aggregate financial assistance received under the United States Treasury Department’s Capital Purchase Program under the Emergency Economic Stabilization Act of 2008. In addition, the grants are also subject to further performance criteria as the Corporation must achieve profitability for at least one fiscal year for awards to be payable. During the quarter and six-month period ended June 30, 2009, no shares of restricted stock were awarded to management under the Incentive Plan.
Beginning in 2007, the Corporation authorized the issuance of performance shares, in addition to restricted shares, under the Incentive Plan. The performance share awards consist of the opportunity to receive shares of Popular, Inc.’s common stock provided that the Corporation achieves certain performance goals during a three-year performance cycle. The compensation cost associated with the performance shares is recorded ratably over a three-

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year performance period. The performance shares are granted at the end of the three-year period and vest at grant date, except when the participant’s employment is terminated by the Corporation without cause. In such case, the participant would receive a pro-rata amount of shares calculated as if the Corporation would have met the performance goal for the performance period. As of June 30, 2010, 12,426 shares have been granted under this plan (June 30, 2009 — 33,700).
During the quarter ended June 30, 2010, the Corporation recognized a credit of $0.2 million of restricted stock related to management incentive awards, with an income tax expense of $56 thousand (June 30, 2009 — $0.6 million, with a tax benefit of $0.2 million). For the six-month period ended June 30, 2010, the Corporation recognized $0.1 million of restricted stock expense related to management incentive awards, with a tax benefit of $71 thousand (June 30, 2009 — $0.8 million, with a tax benefit of $0.3 million). The fair market value of the restricted stock vested was $2.5 million at grant date and $0.4 million at vesting date. This triggers a shortfall, net of windfalls, of $2.1 million that was recorded as an additional income tax expense at the applicable income tax rate, net of the deferred tax asset valuation allowance. During the quarter ended June 30, 2010, there was no performance share expense recognized (June 30, 2009 —$0.4 million, with a tax benefit of $99 thousand). During the six-month period ended June 30, 2010, the Corporation recognized $0.1 million of performance share expense, with a tax benefit of $60 thousand (June 30, 2009 — $0.2 million, with a tax benefit of $21 thousand). The total unrecognized compensation cost related to non-vested restricted stock awards and performance shares to members of management as of June 30, 2010 was $3.3 million and is expected to be recognized over a weighted-average period of 2 years.
The following table summarizes the restricted stock activity under the Incentive Plan for members of the Board of Directors:
                 
    Restricted   Weighted-Average
(Not in thousands)   Stock   Grant Date Fair Value
 
Non-vested as of January 1, 2009
           
Granted
    270,515     $ 2.62  
Vested
    (270,515 )     2.62  
Forfeited
           
 
Non-vested as of December 31, 2009
           
Granted
    242,394     $ 3.00  
Vested
    (242,394 )     3.00  
Forfeited
           
 
Non-vested as of June 30, 2010
           
 
During the quarter ended June 30, 2010, the Corporation granted 207,261 shares of restricted stock to members of the Board of Directors of Popular, Inc. and BPPR, which became vested at grant date (June 30, 2009 — 151,612). During this period, the Corporation recognized $0.1 million of restricted stock expense related to these restricted stock grants, with a tax benefit of $60 thousand (June 30, 2009 — $0.1 million, with a tax benefit of $47 thousand). For the six-month period ended June 30, 2010, the Corporation granted 242,394 shares of restricted stock to members of the Board of Directors of Popular, Inc. and BPPR, which became vested at grant date (June 30, 2009 — 173,923). During this period, the Corporation recognized $0.3 million of restricted stock expense related to these restricted stock grants, with a tax benefit of $0.1 million (June 30, 2009 - $0.2 million, with a tax benefit of $94 thousand). The fair value at vesting date of the restricted stock vested during 2010 for directors was $0.7 million.

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Note 27 — Income Taxes
The reconciliation of unrecognized tax benefits was as follows:
                 
(In millions)   2010   2009
 
Balance as of January 1
  $ 41.8     $ 40.5  
Additions for tax positions — January through March
    0.4       1.0  
Reduction as a result of settlements — January through March
    (14.3 )     (0.6 )
 
Balance as of March 31
  $ 27.9     $ 40.9  
Additions for tax positions — April through June
    0.2       1.3  
Reduction for tax positions — April through June
    (1.6 )      
 
Balance as of June 30
  $ 26.5     $ 42.2  
 
As of June 30, 2010, the related accrued interest approximated $7.1 million (June 30, 2009 - $6.3 million). Management determined that as of June 30, 2010 and 2009 there was no need to accrue for the payment of penalties.
After consideration of the effect on U.S. federal tax of unrecognized U.S. state tax benefits, the total amount of unrecognized tax benefits, including U.S. and Puerto Rico, that if recognized, would affect the Corporation’s effective tax rate, was approximately $32.1 million as of June 30, 2010 (June 30, 2009 — $46.8 million).
The amount of unrecognized tax benefits may increase or decrease in the future for various reasons including adding amounts for current tax year positions, expiration of open income tax returns due to the statutes of limitation, changes in management’s judgment about the level of uncertainty, status of examinations, litigation and legislative activity and the addition or elimination of uncertain tax positions.
The Corporation and its subsidiaries file income tax returns in Puerto Rico, the U.S. federal jurisdiction, various U.S. states and political subdivisions, and foreign jurisdictions. As of June 30, 2010, the following years remain subject to examination in the U.S. Federal jurisdiction: 2008 and thereafter; and in the Puerto Rico jurisdiction, 2005 and thereafter. During 2010, the U.S. Internal Revenue Service (“IRS”) completed an examination of the Corporation’s U.S. operations tax return for 2007, and as a result, the Corporation recognized a tax benefit of $14.3 million during the first quarter of 2010.
The Corporation does not anticipate a significant change to the total amount of unrecognized tax benefits within the next 12 months.

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The following table presents the components of the Corporation’s deferred tax assets and liabilities.
                 
    June 30,   December 31,
(In thousands)   2010   2009
 
Deferred tax assets:
               
Tax credits available for carryforward
  $ 8,687     $ 11,026  
Net operating loss and donation carryforward available
    924,410       843,968  
Postretirement and pension benefits
    104,890       103,979  
Deferred loan origination fees
    7,817       7,880  
Allowance for loan losses
    549,580       536,277  
Deferred gains
    13,462       14,040  
Accelerated depreciation
    2,372       2,418  
Intercompany deferred gains
    8,048       7,015  
Other temporary differences
    20,710       39,096  
 
Total gross deferred tax assets
    1,639,976       1,565,699  
 
 
               
Deferred tax liabilities:
               
Differences between assigned values and the tax basis of the assets and liabilities recognized in purchase business combinations
    43,870       25,896  
Deferred loan origination costs
    8,795       9,708  
Unrealized net gain on trading and available-for-sale securities
    54,368       30,323  
Other temporary differences
    3,453       5,923  
 
Total gross deferred tax liabilities
    110,486       71,850  
 
Gross deferred tax assets less liabilities
    1,529,490       1,493,849  
Less: Valuation allowance
    1,182,114       1,129,882  
 
Net deferred tax assets
  $ 347,376     $ 363,967  
 
A deferred tax asset should be reduced by a valuation allowance if based on the weight of all available evidence; it is more likely than not (a likelihood of more than 50%) that some portion or the entire deferred tax asset will not be realized. The valuation allowance should be sufficient to reduce the deferred tax asset to the amount that is more likely than not to be realized. The determination of whether a deferred tax asset is realizable is based on weighting all available evidence, including both positive and negative evidence. The realization of deferred tax assets, including carryforwards and deductible temporary differences, depends upon the existence of sufficient taxable income of the same character during the carryback or carryforward period. The analysis considers all sources of taxable income available to realize the deferred tax asset, including the future reversal of existing taxable temporary differences, future taxable income exclusive of reversing temporary differences and carryforwards, taxable income in prior carryback years and tax-planning strategies.
The Corporation’s U.S. mainland operations are in a cumulative loss position for the three-year period ended June 30, 2010. For purposes of assessing the realization of the deferred tax assets in the U.S. mainland, this cumulative taxable loss position is considered significant negative evidence and has caused management to conclude that the Corporation will not be able to realize the associated deferred tax assets in the future. As of June 30, 2010, the Corporation recorded a valuation allowance of $1.2 billion on the deferred tax asset of its U.S. operations. As of June 30, 2010, the Corporation’s deferred tax assets related to its Puerto Rico operations amounted to $366.8 million and the deferred tax liability, net of the valuation allowance, of its U.S. operations amounted to $19.4 million. The Corporation assessed the realization of the Puerto Rico portion of the net deferred tax asset and based on the weighting of all available evidence has concluded that it is more likely than not that such net deferred tax assets will be realized.
During the second quarter of 2010, a deferred tax asset of $1.33 billion and a deferred tax liability of $1.34 billion was recognized as a result of Westernbank FDIC-assisted transaction. The net amount is included as part of the deferred tax liability due to the differences between assigned values and the tax basis of the assets and liabilities recognized in the purchase business combination.

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Note 28 — Supplemental Disclosure on the Consolidated Statements of Cash Flows
Additional disclosures on non-cash activities for the six-month period are listed in the following table:
                 
(In thousands)   June 30, 2010   June 30, 2009
 
Non-cash activities:
               
Loans transferred to other real estate
  $ 77,919     $ 71,766  
Loans transferred to other property
    19,968       19,757  
 
Total loans transferred to foreclosed assets
    97,887       91,523  
Transfers from loans held-in-portfolio to loans held-for-sale
    23,159       29,332  
Transfers from loans held-for-sale to loans held-in-portfolio
    6,292       91,985  
Loans securitized into investment securities [a]
    411,063       759,532  
Recognition of mortgage servicing rights on securitizations or asset transfers
    7,809       13,661  
Treasury stock retired
          207,139  
Conversion of preferred stock to common stock:
               
Preferred stock converted
    (1,150,000 )      
Commons stock issued
    1,341,667        
 
[a]   Includes loans securitized into investment securities and subsequently sold before quarter end.
 
 
For the six months ended June 30, 2010 the changes in operating assets and liabilities included in the reconciliation of net income to net cash provided by operating activities, as well as the changes in assets and liabilities presented in the investing and financing sections are net of the effect of the assets acquired and liabilities assumed from the Westernbank FDIC-assisted transaction. Refer to Note 2 to the consolidated financial statements for the composition and balances of the assets and liabilities recorded at fair value by the Corporation on April 30, 2010.
The cash received in the transaction, which amounted to $261 million, is presented in the investing activities section of the Consolidated Statement of Cash Flows as “Cash received from acquisition”.
Note 29 — Segment Reporting
The Corporation’s corporate structure consists of three reportable segments — Banco Popular de Puerto Rico, Banco Popular North America and EVERTEC.
Management determined the reportable segments based on the internal reporting used to evaluate performance and to assess where to allocate resources. The segments were determined based on the organizational structure, which focuses primarily on the markets the segments serve, as well as on the products and services offered by the segments.
Banco Popular de Puerto Rico:
Given that Banco Popular de Puerto Rico constitutes a significant portion of the Corporation’s results of operations and total assets as of June 30, 2010, additional disclosures are provided for the business areas included in this reportable segment, as described below:
  Commercial banking represents the Corporation’s banking operations conducted at BPPR, which are targeted mainly to corporate, small and middle size businesses. It includes aspects of the lending and depository businesses, as well as other finance and advisory services. BPPR allocates funds across business areas based on duration matched transfer pricing at market rates. This area also incorporates income related with the investment of excess funds, as well as a proportionate share of the investment function of BPPR.
  Consumer and retail banking represents the branch banking operations of BPPR which focus on retail clients. It includes the consumer lending business operations of BPPR, as well as the lending operations of Popular Auto and Popular Mortgage. Popular Auto focuses on auto and lease financing, while Popular Mortgage focuses principally in residential mortgage loan originations. The consumer and retail banking area also incorporates income related with the investment of excess funds from the branch network, as well as a proportionate share of the investment function of BPPR.

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  Other financial services include the trust and asset management service units of BPPR, the brokerage and investment banking operations of Popular Securities, and the insurance agency and reinsurance businesses of Popular Insurance, Popular Insurance V.I., Popular Risk Services, and Popular Life Re. Most of the services that are provided by these subsidiaries generate profits based on fee income.
  Westernbank includes revenues and expenses related to the assets acquired, liabilities assumed and additional consideration paid to the FDIC as it relates to the FDIC-assisted transaction described in Note 2 to the consolidated financial statements. It also includes operating costs to run the branches and certain back-office operations during the two-month period ended June 30, 2010, as well as acquisition and integration costs.
Banco Popular North America:
Banco Popular North America’s reportable segment consists of the banking operations of BPNA, E-LOAN, Popular Equipment Finance, Inc. and Popular Insurance Agency, U.S.A. BPNA operates through a retail branch network in the U.S. mainland, while E-LOAN supports BPNA’s deposit gathering through its online platform. All direct lending activities at E-LOAN were ceased during the fourth quarter of 2008. Popular Equipment Finance, Inc. also holds a running-off loan portfolio as this subsidiary ceased originating loans during 2009. Popular Insurance Agency, U.S.A. offers investment and insurance services across the BPNA branch network.
EVERTEC:
This reportable segment includes the financial transaction processing and technology functions of the Corporation, including EVERTEC, with offices in Puerto Rico, Florida, the Dominican Republic and Venezuela; and ATH Costa Rica, S.A., EVERTEC LATINOAMERICA, SOCIEDAD ANONIMA and T.I.I. Smart Solutions Inc. located in Costa Rica. In addition, this reportable segment includes the equity investments in Consorcio de Tarjetas Dominicanas, S.A. (“CONTADO”) and Servicios Financieros, S.A. de C.V. (“Serfinsa”), which operate in the Dominican Republic and El Salvador, respectively. This segment provides processing and technology services to other units of the Corporation as well as to third parties, principally other financial institutions in Puerto Rico, the Caribbean and Central America.
As indicated in Note 1 to the consolidated financial statements, BPPR’s merchant acquiring business and TicketPop divisions were transferred to EVERTEC in connection with an internal corporate reorganization effected on June 30, 2010. For the quarter and six months ended June 30, 2010, the merchant acquiring business and TicketPop divisions continued to be evaluated and reported as part of the BPPR reportable segment.
The Corporate group consists primarily of the holding companies: Popular, Inc., Popular North America and Popular International Bank, excluding the equity investments in CONTADO and Serfinsa, which due to the nature of their operations are included as part of the EVERTEC segment. The Corporate group also includes the expenses of certain corporate areas that are identified as critical to the organization: Finance, Risk Management and Legal.
The accounting policies of the individual operating segments are the same as those of the Corporation. Transactions between reportable segments are primarily conducted at market rates, resulting in profits that are eliminated for reporting consolidated results of operations.

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The results of operations included in the tables below for the quarter ended June 30, 2009 exclude the results of operations of the discontinued business of PFH. Segment assets as of June 30, 2009 also exclude the assets of the discontinued operations.
2010
For the quarter ended June 30, 2010
</
                                     
    Banco Popular de   Banco Popular           Intersegment
(In thousands)   Puerto Rico   North America   EVERTEC   Eliminations
 
Net interest income (expense)
  $ 232,140     $ 75,323     $ (275 )        
Provision for loan losses
    122,267       79,991                  
Non-interest income
    169,880       15,926       65,402     $ (37,427 )
Amortization of intangibles
    1,358       910       187