SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2001 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO ------------- -------------. Commission file number: 000-21137 R&G FINANCIAL CORPORATION ----------------------------------------------------- (Exact name of registrant as specified in its charter) Puerto Rico 66-0532217 ------------------------------------------------------------------------------- (State of incorporation (I.R.S. Employer or organization) Identification No.) 280 Jesus T. Pinero Avenue Hato Rey, San Juan, Puerto Rico 00918 ------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) (787) 758-2424 (Registrant's telephone number, including area code) Indicate by checkmark whether Registrant (a) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such report (s) and (b) has been subject to such filing requirements for at least 90 days. YES [X] NO [ ] Number of shares of Class B Common Stock outstanding as of September 30, 2001: 14,693,700 (Does not include 16,233,056 Class A Shares of Common Stock which are exchangeable into Class B Shares of Common Stock at the option of the holder.) 1 R&G FINANCIAL CORPORATION INDEX PART I - FINANCIAL INFORMATION Page ITEM 1. Consolidated Financial Statements .......................................................................3 Consolidated Statements of Financial Condition as of September 30, 2001 (Unaudited) and December 31, 2000............................................3 Consolidated Statements of Income for the Three and Nine Months Ended September 30, 2001 and 2000 (Unaudited)............................................4 Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended September 30, 2001 and 2000 (Unaudited)............................................5 Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2001 and 2000 (Unaudited) ..................................................6 Notes to Unaudited Consolidated Financial Statements .................................................7 ITEM 2. Management's Discussion and Analysis....................................................................17 ITEM 3. Quantitative and Qualitative Disclosures about Market Risk..............................................27 PART II - OTHER INFORMATION ITEM 1. Legal Proceedings ......................................................................................27 ITEM 2. Changes in Securities ..................................................................................27 ITEM 3. Defaults upon Senior Securities ........................................................................27 ITEM 4. Submission of Matters ..................................................................................27 ITEM 5. Other Information ......................................................................................27 ITEM 6. Exhibits and Reports on Form 8-K .......................................................................28 Signatures .............................................................................................28 2 PART 1-FINANCIAL INFORMATION ITEM 1: CONSOLIDATED FINANCIAL STATEMENTS R&G FINANCIAL CORPORATION CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION September 30, December 31, 2001 2000 --------------- --------------- (Unaudited) ASSETS Cash and due from banks $ 5,382,343 $ 43,466,268 Money market investments: Securities purchased under agreements to resell 81,627,002 -- Time deposits with other banks -- 25,623,696 Federal funds sold -- -- Mortgage loans held for sale, at lower of cost or market 238,605,309 95,668,320 Mortgage-backed securities held for trading, at fair value 68,322,228 -- Trading securities pledged on repurchase agreements, at fair value 31,358,317 12,038,040 Mortgage-backed and investment securities available for sale, at fair value 1,325,450,128 1,044,164,433 Available for sale securities pledged on repurchase agreements 545,359,308 474,206,504 Mortgage-backed and investment securities held to maturity, at amortized cost (estimated market value: 2001 - $56,198,856; 2000 - $5,111,404) 55,994,364 5,121,108 Held to maturity securities pledged on repurchase agreements, at amortized cost (estimated market value: 2001 - $10,624,347; 2000 - $18,265,000) 10,670,100 18,400,485 Loans receivable, net 1,722,636,490 1,631,276,069 Accounts receivable, including advances to investors, net 21,733,763 16,107,136 Accrued interest receivable 34,035,627 28,919,237 Servicing asset 103,288,924 95,078,530 Premises and equipment 21,773,282 20,144,726 Other assets 31,807,209 29,229,655 --------------- --------------- $ 4,298,044,394 $ 3,539,444,207 =============== =============== LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities: Deposits $ 1,874,685,401 $ 1,676,062,163 Federal funds purchased 10,000,000 25,000,000 Securities sold under agreements to repurchase 1,184,651,536 827,749,494 Notes payable 200,638,507 138,857,562 Advances from FHLB 478,625,000 505,000,000 Other borrowings 8,208,535 8,839,770 Accounts payable and accrued liabilities 78,644,198 43,614,238 Other liabilities 9,126,105 5,485,330 --------------- --------------- 3,844,579,282 3,230,608,557 --------------- --------------- Stockholders' equity: Preferred stock, $.01 par value, 10,000,000 shares authorized: Non-cumulative perpetual: 7.40% Monthly Income Preferred Stock, Series A, $25 liquidation value, 2,000,000 shares authorized, issued and outstanding 50,000,000 50,000,000 7.75% Monthly Income Preferred Stock, Series B, $25 liquidation value, 1,000,000 shares authorized, issued and outstanding 25,000,000 25,000,000 7.60% Monthly Income Preferred Stock, Series C, $25 liquidation value, 2,760,000 shares authorized, issued and outstanding 69,000,000 -- Common stock: Class A - $.01 par value, 40,000,000 shares authorized, 16,233,056 issued and outstanding in 2001 (2000-18,440,556) 162,331 184,406 Class B - $.01 par value, 40,000,000 shares authorized, 14,693,700 issued and outstanding in 2001 (2000-10,230,029) 146,937 102,300 Additional paid-in capital 69,771,033 40,800,652 Retained earnings 219,034,454 186,028,611 Capital reserves of the Bank 7,444,108 7,444,108 Accumulated other comprehensive income (loss) 12,906,249 (724,427) --------------- --------------- 453,465,112 308,835,650 --------------- --------------- $ 4,298,044,394 $ 3,539,444,207 =============== =============== The accompanying notes are an integral part of these statements. 3 R&G FINANCIAL CORPORATION CONSOLIDATED STATEMENTS OF INCOME Three month Nine month period ended period ended September 30, September 30, ------------------------------ ------------------------------ 2001 2000 2001 2000 ------------ ------------ ------------ ------------ (Unaudited) (Unaudited) (Dollars in thousands except for per share data) Interest income: Loans $ 40,509 42,337 114,292 $ 119,115 Money market and other investments 8,075 6,676 23,683 17,946 Mortgage-backed securities 22,792 11,888 60,761 34,834 ------------ ------------ ------------ ------------ Total interest income 71,376 60,901 198,736 171,895 ------------ ------------ ------------ ------------ Interest expense: Deposits 22,242 21,439 67,937 57,496 Securities sold under agreements to repurchase 12,112 13,348 36,628 35,597 Notes payable 3,523 2,708 8,545 8,972 Other 5,603 7,528 18,142 20,459 ------------ ------------ ------------ ------------ Total interest expense 43,480 45,023 131,252 122,524 ------------ ------------ ------------ ------------ Net interest income 27,896 15,878 67,484 49,371 Provision for loan losses (3,225) (1,500) (7,325) (4,350) ------------ ------------ ------------ ------------ Net interest income after provision for loan losses 24,671 14,378 60,159 45,021 ------------ ------------ ------------ ------------ Other income: Net gain on origination and sale of loans and sales of securities available for sale 17,314 11,407 44,301 28,220 Loan administration and servicing fees 8,339 7,730 25,031 22,720 Service charges, fees and other 3,089 1,784 8,994 5,209 ------------ ------------ ------------ ------------ 28,742 20,921 78,326 56,149 ------------ ------------ ------------ ------------ Total revenues 53,413 35,299 138,485 101,170 ------------ ------------ ------------ ------------ Operating expenses: Employee compensation and benefits 8,991 6,748 23,840 19,952 Office occupancy and equipment 4,270 3,375 12,291 9,952 Other administrative and general 16,716 10,260 41,040 30,381 ------------ ------------ ------------ ------------ 29,977 20,383 77,171 60,285 ------------ ------------ ------------ ------------ Income before income taxes and cumulative effect from change in accounting principle 23,436 14,916 61,314 40,885 ------------ ------------ ------------ ------------ Income tax expense: Current 4,795 2,712 12,006 10,057 Deferred 1,236 842 3,136 (729) ------------ ------------ ------------ ------------ 6,031 3,554 15,142 9,328 ------------ ------------ ------------ ------------ Income before cumulative effect from change in accounting principle 17,405 11,362 46,172 31,557 Cumulative effect from change in accounting principle, net of income tax benefit of $206 -- -- (323) -- ------------ ------------ ------------ ------------ Net income $ 17,405 11,362 $ 45,849 $ 31,557 ============ ============ ============ ============ Earnings per common share before cumulative effect from change in accounting principle - Basic $ 0.48 $ 0.35 $ 1.32 $ 0.95 ------------ ------------ ------------ ------------ Earnings per common share before cumulative effect from change in accounting principle - Diluted $ 0.46 $ 0.34 $ 1.29 $ 0.93 ------------ ------------ ------------ ------------ Earnings per common share - Basic $ 0.48 $ 0.35 $ 1.31 $ 0.95 ------------ ------------ ------------ ------------ - Diluted $ 0.46 $ 0.34 $ 1.28 $ 0.93 ------------ ------------ ------------ ------------ Weighted average number of shares outstanding - Basic 30,895,298 28,663,526 29,453,062 28,660,813 - Diluted 31,639,707 29,314,874 30,181,107 29,314,830 The accompanying notes are an integral part of these statements. 4 R&G FINANCIAL CORPORATION CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME Three month Nine month period ended period ended September 30, September 30, ------------------------ ------------------------ 2001 2000 2001 2000 --------- --------- --------- --------- (Unaudited) (Unaudited) (Dollars in thousands) Net income $ 17,405 $ 11,362 $ 45,849 $ 31,557 --------- --------- --------- --------- Other comprehensive income, before tax: Unrealized gains (losses): Cash flow hedges (5,216) -- (10,958) -- --------- --------- --------- --------- Investment securities: Arising during period 27,277 3,784 32,324 1,400 Less: Reclassification adjustments for (gains) losses included in net income 312 176 (932) 329 --------- --------- --------- --------- 27,589 3,960 31,392 1,729 --------- --------- --------- --------- 22,373 3,960 20,434 1,729 Income tax expense related to items of other comprehensive income (8,725) (1,544) (7,969) (674) --------- --------- --------- --------- 13,648 2,416 12,465 1,055 Cumulative effect from change in accounting principle, net of income taxes of $745 -- -- 1,166 -- --------- --------- --------- --------- Other comprehensive income, net of tax 13,648 2,416 13,631 1,055 --------- --------- --------- --------- Comprehensive income, net of tax $ 31,053 $ 13,778 $ 59,480 $ 32,612 ========= ========= ========= ========= The accompanying notes are an integral part of these statements. 5 R&G FINANCIAL CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS Nine month period ended September 30, --------------------------------- 2001 2000 ----------- ----------- (Unaudited) Cash flows from operating activities: (Dollars in thousands) Net income $ 45,849 $ 31,557 ----------- ----------- Adjustments to reconcile net income to net cash used in operating activities: Depreciation and amortization 4,897 3,792 Amortization of premium on investment securities, net 349 203 Amortization and provision for impairment of servicing rights 11,904 7,196 Provision for loan losses 7,325 4,350 Provision for bad debts in accounts receivable 450 370 Gain on sales of loans (793) (125) (Gain) loss on sales of securities available for sale (932) 328 Unrealized profit on trading securities and derivative instruments, net (554) (6) Increase in mortgage loans held for sale (200,990) (131,897) Net (increase) decrease in mortgage-backed securities held for trading (8,968) 31,669 Increase in receivables (10,387) (6,264) Increase in other assets (4,039) (6,051) Increase in notes payable and other borrowings 96,650 33,117 Increase in accounts payable and accrued liabilities 15,698 18,806 Increase in other liabilities 3,641 1,237 ----------- ----------- Total adjustments (85,749) (43,275) ----------- ----------- Net cash used in operating activities (39,900) (11,718) ----------- ----------- Cash flows from investing activities: Purchases of investment securities (567,260) (107,865) Proceeds from sales of securities available for sale 205,905 41,057 Principal repayments and redemptions of investment securities 336,375 26,977 Proceeds from sales of loans 91,631 26,469 Net originations of loans (532,983) (382,147) Purchases of FHLB stock, net (13,847) (7,235) Acquisition of premises and equipment (5,688) (2,290) Acquisition of servicing rights (20,114) (13,332) ----------- ----------- Net cash used by investing activities (505,981) (418,366) ----------- ----------- Cash flows from financing activities: Increase in deposits - net 198,623 251,852 Decrease in federal funds purchased (15,000) (5,000) Increase in securities sold under agreements to repurchase - net 356,903 106,860 (Repayments) advances from FHLB, net (26,375) 70,250 Payments on term notes (35,500) (5,000) Proceeds from issuance of preferred stock 66,602 -- Proceeds from issuance of common stock 31,391 40 Cash dividends: Common stock (5,644) (4,192) Preferred stock (7,200) (4,228) ----------- ----------- Net cash provided by financing activities 563,800 410,582 ----------- ----------- Net increase (decrease) in cash and cash equivalents 17,919 (19,502) Cash and cash equivalents at beginning of period 69,090 65,996 ----------- ----------- Cash and cash equivalents at end of period $ 87,009 $ 46,494 =========== =========== Cash and cash equivalents include: Cash and due from banks $ 5,382 $ 27,410 Securities purchased under agreements to resell 81,627 6,163 Time deposits with other banks -- 12,921 Federal funds sold -- -- ----------- ----------- $ 87,009 $ 46,494 =========== =========== The accompanying notes are an integral part of these statements. 6 R&G FINANCIAL CORPORATION NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 - REPORTING ENTITY AND BASIS OF PRESENTATION REPORTING ENTITY The accompanying unaudited consolidated financial statements include the accounts of R&G Financial Corporation (the Company), a diversified financial services company, and its wholly-owned subsidiaries, R&G Mortgage Corp. ("R&G Mortgage"), a Puerto Rico corporation, R-G Premier Bank of Puerto Rico (the "Bank"), a commercial bank chartered under the laws of the Commonwealth of Puerto Rico, Home & Property Insurance Corp., a Puerto Rico corporation and insurance agency, and R-G Investments Corporation, a Puerto Rico corporation and broker-dealer. The Company, currently in its 29th year of operations, operates R&G Mortgage, which is engaged primarily in the business of originating FHA-insured, VA-guaranteed, and privately insured first and second mortgage loans on residential real estate. R&G Mortgage pools loans into mortgage-backed securities and collateralized mortgage obligation certificates for sale to investors. After selling the loans, it retains the servicing function. R&G Mortgage is also a seller-servicer of conventional loans. R&G Mortgage is licensed by the Secretary of the Treasury of Puerto Rico as a mortgage company and is duly authorized to do business in the Commonwealth of Puerto Rico. R&G Mortgage also originates FHA insured, VA guaranteed and privately insured first and second mortgage loans on residential real estate (1 to 4 families) through its wholly-owned subsidiary, Mortgage Store of Puerto Rico. The Company also operates the Bank, which provides a full range of banking services, including residential, commercial and personal loans and a diversified range of deposit products through twenty-five branches located mainly in the northeastern part of the Commonwealth of Puerto Rico. The Bank also provides private banking and trust and other financial services to its customers. The Bank is subject to the regulations of certain federal and local agencies, and undergoes periodic examinations by those regulatory agencies. The Bank also is engaged in the business of originating FHA insured, VA guaranteed and privately insured first and second mortgage loans on residential real estate (1 to 4 families) in the States of New York, New Jersey, Connecticut, North Carolina and Florida, through its wholly-owned subsidiary, Continental Capital Corporation ("Continental Capital"). BASIS OF PRESENTATION The accompanying unaudited consolidated financial statements have been prepared in accordance with the instructions for Form 10-Q. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles. However, in the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments (principally consisting of normal recurring accruals) necessary for a fair presentation of the Company's financial condition as of September 30, 2001 and the results of operations and changes in its cash flows for the three and nine months ended September 30, 2001 and 2000. The results of operations for the three and nine months periods ended September 30, 2001 are not necessarily indicative of the results to be expected for the year ending December 31, 2001. The unaudited consolidated financial statements and notes thereto should be read in conjunction with the audited financial statements and notes thereto for the year ended December 31, 2000. BASIS OF CONSOLIDATION All significant intercompany balances and transactions have been eliminated in the accompanying unaudited financial statements. 7 ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES Effective January 1, 2001, the Company adopted Statement of Financial accounting standards (SFAS) No. 133, Accounting for Derivative Instruments and Hedging Activities. Upon the adoption of this Statement, the Company recognized a gain of approximately $1.9 million as other comprehensive income in stockholders' equity related to derivative instruments that were designated as cash flow hedges, and a loss of approximately $529,000 in the income statement related to derivative instruments that did not qualify for hedge accounting. NEW ACCOUNTING PRONOUNCEMENTS In October 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lives Assets, which addresses financial accounting and reporting for the impairment or disposal of long-lived assets. While SFAS No. 144 supersedes SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, it retains many of the fundamental provisions of that statement. SFAS No. 144 also supersedes the accounting and reporting provisions of APB Opinion No. 30, Reporting the Results of Operations-Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions, for the disposal of a segment of a business. However, it retains the requirement in Opinion No. 30 to report separately discontinued operations and extends that reporting to a component of an entity that either has been disposed of by sale, abandonment, or in a distribution to owners or is classified as held for sale. This Statements is effective for fiscal years beginning after December 15, 2001. Management has determined the impact of this Statement will not have a material effect on the consolidated financial position or the future results of operations of the Company. In July 2001, the FASB issued SFAS No. 141, Business Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001 as well as all purchase method business combinations completed after June 30, 2001. SFAS No. 141 also specifies criteria intangible assets acquired in a purchase method business combination must meet to be recognized and reported apart from goodwill. SFAS No. 142 will require that goodwill and intangible assets with indefinite useful lives no longer be amortized but instead tested for impairment at least annually in accordance with the provisions of SFAS No. 142. SFAS No. 142 will also require that intangible assets with definite useful lives be amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment in accordance with SFAS No. 121, Accounting for the Impairment of Long-Lived Asset and for Long-Lived Assets to Be Disposed Of or SFAS No. 144 upon adoption. The Company is required to adopt the provisions of SFAS No. 141 immediately and SFAS No. 142 effective January 1, 2002. Furthermore, any goodwill and any intangible asset determined to have an indefinite useful life that are acquired in a purchase business combination completed after June 30, 2001 will not be amortized, but will continue to be evaluated for impairment. Goodwill and intangible assets acquired in business combinations completed before July 1, 2001 will continue to be amortized prior to the adoption of SFAS No. 142. Upon adoption on January 1, 2002, the Company expects to recognize a gain as the cumulative effect of a change in accounting principle related to negative goodwill currently existing from an acquisition in prior years of one of the Company's subsidiaries accounted for under the purchase method of accounting, however, the amounts involved are not material. The Company expects to have unamortized goodwill in the amount of $4.6 million, which will be subject to the transition provisions of SFAS Nos. 141 and 142. Amortization expense related to goodwill (including that related to negative goodwill) was $352,000 and $447,000 for the nine months ended September 30, 2001 and for the year ended December 31, 2000, respectively. Because of the extensive effort needed to comply with adopting Statement Nos. 141 and 142, it is not practicable to reasonably estimate the impact, after initial adoption, of these pronouncements on the Company's financial statements at the date of this report, including whether any transitional impairment losses will be required to be recognized as the cumulative effect of a change in accounting principle subsequent to January 1, 2002. 8 NOTE 2 - EARNINGS AND DIVIDENDS PER SHARE Basic earnings per common share for the three and nine month periods ended September 30, 2001 and 2000 are computed by dividing net income for such periods by the weighted average number of shares of common stock outstanding during such periods. The weighted average of outstanding stock options granted in connection with the Company's Stock Option Plan are included in the weighted average number of shares for purposes of the diluted earnings per share computation (744,409 and 651,348 during the three month periods ended September 30, 2001 and 2000, respectively, and 728,045 and 654,017 during the nine month periods ended September 30, 2001 and 2000, respectively). No other adjustments were made to the computation of basic earnings per share to arrive at diluted earnings per share. Dividends per share on common stock declared and paid by the Company were as follows: Three month Nine month period ended period ended September 30, September 30, ---------------------- ---------------------------- 2001 2000 2001 2000 ---- ---- ---- ----- $0.06775 $0.0565 $0.1915 $0.15025 NOTE 3 - INVESTMENT AND MORTGAGE-BACKED SECURITIES The carrying value and estimated fair value of investment and mortgage-backed securities by category are shown below. The fair value of investment securities is based on quoted market prices and dealer quotes, except for the investment in Federal Home Loan Bank (FHLB) stock which is valued at its redemption value. September 30, December 31, 2001 2000 ------------ ------------ (Unaudited) MORTGAGE-BACKED SECURITIES HELD FOR TRADING: GNMA certificates $ 20,286,695 $ 12,038,040 FHLMC certificates 79,393,850 -- ------------ ------------ $ 99,680,545 $ 12,038,040 ============ ============ 9 September 30, 2001 December 31, 2000 Amortized Fair Amortized Fair cost value cost value -------------- -------------- -------------- -------------- (Unaudited) MORTGAGE-BACKED SECURITIES AVAILABLE FOR SALE: CMO's, CMO residuals (interest only), interest only strips (IO's) and other mortgage-backed securities $ 162,776,898 $ 168,857,299 $ 21,398,077 $ 23,227,026 -------------- -------------- -------------- -------------- FNMA certificates: Due from five to ten years 554,178 570,457 633,552 633,552 Due over ten years 301,223,686 307,805,478 98,779,069 99,968,168 -------------- -------------- -------------- -------------- 301,777,864 308,375,935 99,412,621 100,601,720 -------------- -------------- -------------- -------------- FHLMC certificates: Due within one year 3,463 3,651 13,395 13,395 Due from one to five years 88,258 89,409 131,526 129,956 Due from five to ten years 1,417,265 1,459,435 1,587,103 1,587,034 Due over ten years 389,291,864 397,200,008 434,864,554 437,226,389 -------------- -------------- -------------- -------------- 390,800,850 398,752,503 436,596,578 438,956,774 -------------- -------------- -------------- -------------- GNMA certificates: Due from one to five years 50,071 50,321 25,582 25,502 Due from five to ten years 8,345,285 8,306,638 10,491,790 10,419,318 Due over ten years 527,931,498 526,412,587 584,419,215 576,869,337 -------------- -------------- -------------- -------------- 536,326,854 534,769,546 594,936,587 587,314,157 -------------- -------------- -------------- -------------- 1,391,682,466 1,410,755,283 1,152,343,863 1,150,099,677 -------------- -------------- -------------- -------------- INVESTMENT SECURITIES AVAILABLE FOR SALE: U.S. Government and Agencies securities: Due within one year 9,600,000 9,863,140 8,500,000 8,446,450 Due from one to five years 54,959,086 56,217,540 192,762,585 193,298,396 Due from five to ten years 280,854,312 289,244,770 114,881,388 115,351,548 -------------- -------------- -------------- -------------- 345,413,398 355,325,450 316,143,973 317,096,394 -------------- -------------- -------------- -------------- Corporate debt obligations - Due from one to five years 43,688,842 44,908,636 5,097,519 5,201,699 -------------- -------------- -------------- -------------- FHLB stock 59,820,067 59,820,067 45,973,167 45,973,167 -------------- -------------- -------------- -------------- 448,922,307 460,054,153 367,214,659 368,271,260 -------------- -------------- -------------- -------------- $1,840,604,773 $1,870,809,436 $1,519,558,522 $1,518,370,937 ============== ============== ============== ============== 10 September 30, 2001 December 31, 2000 --------------------------------- --------------------------------- Amortized Fair Amortized Fair cost value cost value -------------- -------------- -------------- -------------- (Unaudited) MORTGAGE-BACKED SECURITIES HELD TO MATURITY: GNMA certificates: Due within one year $ -- $ -- $ 2,435 $ 2,611 Due from five to ten years 7,146,854 7,031,160 8,864,274 8,605,749 Due over ten years 37,781,717 37,638,933 1,844,978 1,765,812 -------------- -------------- -------------- -------------- 44,928,571 44,670,093 10,711,687 10,374,172 -------------- -------------- -------------- -------------- FNMA certificates: Due over ten years 7,912,342 8,197,219 8,946,973 9,145,168 -------------- -------------- -------------- -------------- FHLMC certificates: Due over ten years 131,948 128,378 159,544 153,675 -------------- -------------- -------------- -------------- 52,972,861 52,995,690 19,818,204 19,673,015 -------------- -------------- -------------- -------------- INVESTMENT SECURITIES HELD TO MATURITY: Puerto Rico Government and Agencies obligations: Due from one to five years 2,280,000 2,302,800 1,948,000 1,948,000 Due from five to ten years 11,311,603 11,424,713 1,755,389 1,755,389 -------------- -------------- -------------- -------------- 13,591,603 13,727,513 3,703,389 3,703,389 Other 100,000 100,000 -- -- -------------- -------------- -------------- -------------- 13,691,603 13,827,513 3,703,389 3,703,389 -------------- -------------- -------------- -------------- $ 66,664,464 $ 66,823,203 $ 23,521,593 $ 23,376,404 ============== ============== ============== ============== In addition to the investment and mortgage-backed securities pledged on repurchase agreements and reported as pledged assets in the statement of financial condition, at September 30, 2001 the Company had investment securities pledged as collateral on repurchase agreements where the counterparties do not have the right to sell or repledge the assets as follows: Carrying Amount --------------- Mortgage-backed and investment securities available for sale, at fair value $ 620,353,862 Mortgage-backed securities held to maturity, at amortized cost 36,809,267 ------------- $ 657,163,129 ============= 11 NOTE 4 - LOANS AND ALLOWANCE FOR LOAN LOSSES Loans consist of the following: September 30, December 31, 2001 2000 --------------- --------------- (Unaudited) Real estate loans: Residential - first mortgage $ 994,169,425 $ 998,983,595 Residential - second mortgage 33,825,716 27,419,145 Land 7,832,554 6,049,179 Construction 190,400,160 151,692,483 Commercial 348,861,972 304,104,485 --------------- --------------- 1,575,089,827 1,488,248,887 Undisbursed portion of loans in process (91,394,557) (78,163,117) Net deferred loan costs 394,096 908,553 --------------- --------------- 1,484,089,366 1,410,994,323 --------------- --------------- Other loans: Commercial 78,446,047 59,120,394 Consumer: Secured by deposits 29,091,247 26,925,836 Secured by real estate 89,428,442 100,357,019 Other 56,888,680 45,563,186 Unamortized interest (138,167) (85,055) --------------- --------------- 253,716,249 231,881,380 --------------- --------------- Total loans 1,737,805,615 1,642,875,703 Allowance for loan losses (15,169,125) (11,599,634) --------------- --------------- $ 1,722,636,490 $ 1,631,276,069 =============== =============== The changes in the allowance for loan losses follow: Nine months ended September 30, ----------------------------- 2001 2000 --------- --------- (Unaudited) (Dollars in thousands) Balance, beginning of period $ 11,600 $ 8,971 Provision for loan losses 7,325 4,350 Transferred reserves 806 -- Loans charged-off (4,961) (2,924) Recoveries 399 660 --------- --------- Balance, end of period $ 15,169 $ 11,057 ========= ========= 12 The following table sets forth the amounts and categories of R&G Financial's non-performing assets at the dates indicated. September 30, December 31, 2001 2000 (Unaudited) ------------- ------------ (Dollars in thousands) Non-accruing loans: Residential real estate $ 100,891 $ 79,234 Residential construction 832 487 Commercial real estate 15,647 11,881 Commercial business 3,534 1,414 Consumer unsecured 403 1,186 ---------- ---------- Total 121,307 94,202 ---------- ---------- Accruing loans greater than 90 days delinquent: Residential real estate -- -- Residential construction -- -- Commercial real estate -- -- Commercial business 391 420 Consumer 546 360 ---------- ---------- Total accruing loans greater than 90 days delinquent 937 780 ---------- ---------- Total non-performing loans 122,244 94,982 ---------- ---------- Real estate owned, net of reserves 9,160 9,056 Other repossessed assets 883 583 ---------- ---------- 10,043 9,639 ---------- ---------- Total non-performing assets $ 132,287 $ 104,621 ---------- ---------- Total non-performing loans as a percentage of total loans (1) 6.68% 5.52% ---------- ---------- Total non-performing assets as a percentage of total assets 3.08% 2.96% ---------- ---------- Allowance for loan losses as a percentage of total non-performing loans (2) 12.41% 12.21% ---------- ---------- Allowance for loan losses as a percentage of total loans outstanding (2) 0.83% 0.67% ---------- ---------- Net charge-offs to average loans outstanding 0.33% 0.17% ---------- ---------- --------------- (1) The increase in the ratio was mainly caused by loan securitizations during the last two quarters of 2000 and the first three quarters of 2001, which reduced the amount of loans held in portfolio which are considered in the calculation of the ratio. Without giving effect to loan securitizations, as of September 30, 2001 and December 31, 2000, the ratio of non-performing loans to total loans would have been 4.87% and 4.46%, respectively. (2) Because of the nature of the collateral, R&G Financial's historical charge-offs with respect to residential real estate loans have been low. Excluding R&G Financial's residential loan portfolio, the allowance for loan losses to total loans and to total non-performing loans at September 30, 2001 and December 31, 2000 would have been 1.89% and 71.0%, respectively, and 1.61% and 73.7%, respectively. 13 NOTE 5 - MORTGAGE LOAN SERVICING The changes in the servicing asset of the Company follows: For the nine month period ended September 30, 2001 2000 -------------- ------------- (Unaudited) Balance at beginning of period $ 95,078,530 $ 84,252,506 Rights originated 19,002,167 8,312,646 Rights purchased 1,112,264 5,019,821 Scheduled amortization (8,210,037) (7,195,586) Unscheduled amortization (2,500,000) -- Reserves for impairment (1,194,000) -- -------------- ------------- Balance at end of period $ 103,288,924 $ 90,389,387 ============== ============= The portion of the Company's mortgage loans servicing portfolio consisting of the servicing asset that was originated by the Company prior to the adoption of SFAS No. 122 is not reflected as an asset on the Company's Consolidated Financial Statements, and is not subject to amortization or impairment. NOTE 6 - DEPOSITS Deposits are summarized as follows: September 30, December 31, 2001 2000 ------------- ------------ (Unaudited) (Dollars in Thousands) Passbook savings $ 133,052 $ 116,776 ------------ ------------ NOW accounts 55,014 43,271 Super NOW accounts 150,858 97,172 Regular checking accounts (non-interest bearing) 78,644 70,760 Commercial checking accounts (non-interest bearing) 109,640 101,178 ------------ ------------ 394,156 312,381 ------------ ------------ Certificates of deposit: Under $100,000 510,203 489,221 $100,000 and over 831,621 749,081 ------------ ------------ 1,341,824 1,238,302 ------------ ------------ Accrued interest payable 5,653 8,603 ------------ ------------ $ 1,874,685 $ 1,676,062 ============ ============ 14 NOTE 7 - COMMITMENTS AND CONTINGENCIES COMMITMENTS TO BUY AND SELL GNMA CERTIFICATES As of September 30, 2001, the Company had open commitments to issue GNMA certificates of approximately $21.0 million. COMMITMENTS TO SELL MORTGAGE LOANS As of September 30, 2001 the Company had commitments to sell mortgage loans to third party investors amounting to approximately $181.2 million. LEASE COMMITMENTS The Company is obligated under several noncancellable leases for office space and equipment rentals, all of which are accounted for as operating leases. The leases expire at various dates with options for renewals. OTHER At September 30, 2001, the Company is liable under limited recourse provisions resulting from the sale of loans to several investors, principally FHLMC. The principal balance of these loans, which are serviced by the Company, amounts to approximately $581.0 million at September 30, 2001. Liability, if any, under the recourse provisions at September 30, 2001 is estimated by management to be insignificant. NOTE 8 - SUPPLEMENTAL INCOME STATEMENT INFORMATION Employee costs and other administrative and general expenses are shown in the Consolidated Statements of Income net of direct loan origination costs. Direct loan origination costs are capitalized as part of the carrying cost of mortgage loans and are offset against mortgage loan sales and fees when the loans are sold, or amortized as a yield adjustment to interest income on loans held for investment. Total employee costs and other expenses before capitalization follows: (Unaudited) Three month period ended Nine month period ended September 30, September 30, 2001 2000 2001 2000 ------------- ------------- ------------- ------------- Employee costs $ 14,811,263 $ 10,335,570 $ 40,857,976 $ 31,496,056 ------------- ------------- ------------- ------------- Other administrative and general expenses $ 18,197,774 $ 11,337,002 $ 44,828,206 $ 33,289,473 ------------- ------------- ------------- ------------- 15 NOTE 9 - INDUSTRY SEGMENTS The following summarized information presents the results of the Company's operations for its traditional banking and mortgage banking activities: --------------------------------------------------------------------------------------------- Three month period ended September 30, --------------------------------------------------------------------------------------------- 2001 2000 --------------------------------------------------------------------------------------------- (Dollars in thousands) Mortgage Segment Mortgage Segment Banking Banking Other Totals Banking Banking Other Totals ----------------------------------------------------------------------------------------------------------------------------------- Revenues $ 30,343 $ 21,923 $ 1,419 $ 53,685 $ 21,558 $ 14,607 $ -- $ 36,165 Non-interest expenses 12,947 17,396 320 30,663 9,543 12,004 -- 21,547 --------------------------------------------------------------------------------------------- Income before income taxes and cumulative effect from change in accounting principle $ 17,396 $ 4,527 $ 1,099 $ 23,022 $ 12,015 $ 2,603 $ -- $ 14,618 ============================================================================================= Nine month period ended September 30, --------------------------------------------------------------------------------------------- 2001 2000 --------------------------------------------------------------------------------------------- Mortgage Segment Mortgage Segment Banking Banking Other Totals Banking Banking Other Totals ----------------------------------------------------------------------------------------------------------------------------------- Revenues $ 77,793 $ 60,049 $ 3,561 $141,403 $ 55,562 $ 48,207 $ -- $103,769 Non-interest expenses 34,180 44,374 809 79,363 27,359 35,412 -- 62,771 --------------------------------------------------------------------------------------------- Income before income taxes and cumulative effect from change in accounting principle $ 43,613 $ 15,675 $ 2,752 $ 62,040 $ 28,203 $12,795 $ -- $ 40,998 ============================================================================================= 16 ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS GENERAL R&G Financial Corporation (the "Company") is a diversified financial holding company that, through its wholly-owned subsidiaries, is engaged in mortgage banking, banking, broker-dealer and insurance activities. Its mortgage banking activities include the origination, purchase, sale and servicing of mortgage loans on single-family residences, the issuance and sale of various types of mortgage-backed securities, the holding of mortgage loans, mortgage-backed securities and other investment securities for sale or investment, and the purchase and sale of servicing rights associated with such mortgage loans and, to a lesser extent, the origination of construction loans and mortgage loans secured by income producing real estate and land (the "mortgage banking business"). The Company is also engaged in providing a full range of banking services, including commercial banking services, corporate and construction lending, consumer lending and credit cards, offering a diversified range of deposit products and, to a lesser extent, trust and investment services through its private banking department. R&G Financial is currently in its 29th year of operations. The Company is the second largest mortgage loans originator and servicer of mortgage loans on single family residences in Puerto Rico. R&G Financial's mortgage servicing portfolio increased to approximately $7.1 billion as of September 30, 2001, from $6.5 billion as of the same date a year ago, an increase of 8.8%. R&G Financial's strategy is to increase the size of its mortgage servicing portfolio by relying principally on internal loan originations. R&G Financial is experiencing strong growth in originations due to a strong housing market in Puerto Rico and continued branch expansion, together with low interest rates and state-of-the art technology. As part of its strategy to maximize net interest income, R&G Financial maintains a loans portfolio of $1.7 billion, which consisted principally of residential real estate loans backed by a very strong housing market, and a substantial portfolio of mortgage-backed and investment securities. At September 30, 2001, the Company held securities available for sale with a fair market value of $1.9 billion, which included $1.4 billion of mortgage-backed securities of which $534.8 million consisted primarily of Puerto Rico GNMA securities, the interest on which is tax-exempt to the Company. These securities are generally held by the Company for longer periods prior to sale in order to maximize the tax-exempt interest received thereon. A substantial portion of R&G Financial's total mortgage loan originations has consistently been comprised of refinance loans. R&G Financial's future results could be adversely affected by a significant increase in mortgage interest rates that reduces refinancing activity. However, the Company believes that refinancing activity is less sensitive to interest rate changes in Puerto Rico than in the mainland United States because a significant amount of refinance loans are made for debt consolidation purposes. R&G Financial customarily sells or securitizes into mortgage-backed securities substantially all the loans it originates, except for certain non-conforming conventional mortgage loans and certain consumer, construction, land, and commercial loans which are held for investment and classified as loans receivable. At September 30, 2001 R&G Financial maintained a very low credit risk profile, as its loans receivable portfolio consisted principally of $1.1 billion in residential real estate. At September 30, 2001 R&G Financial operated 25 banking and 34 mortgage banking branches in Puerto Rico and four mortgage offices in the US, with about 1,500 professionals. FINANCIAL CONDITION At September 30, 2001, total assets amounted to $4.3 billion, as compared to $3.5 billion at December 31, 2000. The $758.6 million or 21.4% increase in total assets was primarily the result of a $352.4 million or 23.2% increase in mortgage-backed and investment securities available for sale, a $101.3 million or 841.8% increase in mortgage-backed securities held for trading, a $43.1 million or 183.4% increase in mortgage-backed and investment 17 securities held to maturity, a $143.1 million or 149.6% increase in mortgage loans held for sale and a $91.4 million or 5.6% increase in loans receivable, net. At September 30, 2001, deposits totaled $1.9 billion, an increase of $198.6 million or 11.9% when compared to December 31, 2000. In addition, at September 30, 2001, R&G Financial had $1.9 billion of borrowings (consisting of securities sold under agreements to repurchase, notes payable, FHLB advances and other borrowings), as compared to $1.5 billion at December 31, 2000. R&G Financial mainly utilized deposits (primarily retail certificates of deposits) and repurchase agreements to fund its growth in assets during the period. At September 30, 2001, R&G Financial's allowance for loan losses totaled $15.2 million, which represented a $3.6 million or 30.8% increase from the level maintained at December 31, 2000. At September 30, 2001, R&G Financial's allowance represented approximately 0.83% of the total loan portfolio and 12.41% of total non-performing loans. However, excluding R&G Financial's residential loan portfolio, which has minimal charge-off experience, the allowance for loan losses to total loans and to total non-performing loans would have been 1.89% and 71.0%, respectively, at September 30, 2001. The increase in the allowance for loan losses reflects the increase in R&G Financial's commercial real estate and construction loan portfolio as well as the increase in R&G Financial non-performing loans during the year. Non-performing loans amounted to $122.2 million at September 30, 2001, an increase of $62.9 million when compared to $59.4 million at December 31, 1999. However, $60.2 million or 96% of such increase consisted of residential mortgage loans, which resulted to a large extent from increased delays over the period in the foreclosure process in Puerto Rico. As noted above, because of the nature of the real estate collateral, R&G Financial has historically recognized a low level of loan charge-offs. R&G Financial's aggregate charge-offs amounted to 0.33% during the first three quarters of 2001, 0.17% during 2000 and 0.25% during 1999. Although loan delinquencies have historically been higher in Puerto Rico than in the United States, actual foreclosures and any resulting loan charge-offs have historically been lower than in the United States. While the ratio of non-performing loans to total loans increased from 5.52% at December 31, 2000 to 6.68% at September 30, 2001, the increase in the ratio was made larger than it would otherwise have been due to significant loan securitizations during the last two quarters of 2000 and the first three quarters of 2001, which reduced the amount of loans considered in the calculation of the ratio. Without giving effect to loan securitizations, as of September 30, 2001 and December 31, 2000, the ratio of non-performing loans would have been 4.87% and 4.46%, respectively. Stockholders' equity increased from $308.8 million at December 31, 2000 to $453.5 million at September 30, 2001. The $144.7 million or 46.8% increase was due primarily to the issuance of 2,207,500 shares of Class B common stock in late June and early July 2001 for aggregate net proceeds of $31.1 million, the issuance of 2,760,000 shares of the Company's 7.60% Monthly Income Preferred Stock, Series C, in March 2001 for aggregate net proceeds of $66.6 million and the net income recognized, together with a $13.6 million increase in other comprehensive income during the period. RESULTS OF OPERATIONS During the three and nine months ended September 30, 2001, R&G Financial reported net income before the cumulative effect of a change in accounting principle of $17.4 million and $46.2 million, or $0.46 and $1.29 of earnings per diluted share, respectively, compared to $11.4 million and $31.6 million or $0.34 and $0.93 of earnings per diluted share for the respective comparative periods in 2000. Net interest income increased by $18.1 million or 36.7% during the nine month period ended September 30, 2001 to $67.5 million, primarily due to an increase in the average balance of interest-earning assets, together with a 25 basis point increase in the net interest margin from 2.24% to 2.49%. With interest rates currently declining, R&G Financial expects a gradual improvement in its net interest margin, as evidenced by the improvement in its margin during the three month period ended September 30, 2001 as discussed below. The provision for loan losses amounted to $7.3 million during the nine months ended September 30, 2001, a 68.4% increase over the prior comparable period, as R&G Financial increased it general reserves reflecting the continued growth in commercial lending, which involves greater credit risk than residential lending. 18 R&G Financial also experienced an increase in non-interest income during the nine months ended September 30, 2001 over the prior comparable period. Net gain on sale of loans increased significantly, by $16.1 million or 57.0% over the prior comparable period, which was due both to the volume of loans originated and sold as well as increased profits made on loans sold. Loan administration and servicing fees also increased by $2.3 million or 10.2% over the comparable periods, due to the growth in the loan servicing portfolio, while other miscellaneous revenue sources increased $3.8 million or 72.7%, primarily as a result of the Company's fee-based insurance operations which began in late 2000. Net interest income increased by $12.0 million or 75.7% to $27.9 million during the quarter ended September 30, 2001, due to an increase in the average balance of interest-earning assets, together with a 82 basis points increase in the net interest margin from 2.04% to 2.86%. Net gain on sale of loans increased 51.8% to $17.3 million during the three month ended September 30, 2001. Total expenses increased by $16.9 million or 28.0% during the nine months ended September 30, 2001 over the prior comparable period, primarily due to a $10.7 million or 35.1% increase in other administrative and general expenses, primarily due to increased amortization of the Company's servicing asset and increased advertising expenses, to increase loan production. Employee compensation and benefits increased by $3.9 million or 19.5% associated with employees hired to accommodate increased loan production. These increases were accompanied by a $2.3 million or 23.5% increase in occupancy expenses. Total expenses increased by $9.6 million or 47.1% during the three month period ended September 30, 2001 over the prior comparable period, due to a $6.5 million or 62.9% increase in other general and administrative expenses of which $3.2 million or 50% of such increase is related to increased amortization and reserves for impairment of the Company's servicing asset, a $2.2 million or 33.2% increase in employee compensation and benefits, and a $895,000 or 26.5% increase in occupancy expenses. INTEREST RATE RISK MANAGEMENT The following table summarizes the anticipated maturities or repricing or R&G Financial's interest-earning assets and interest-bearing liabilities as of September 30, 2001, based on the information and assumptions set forth in the notes below. For purposes of this presentation, the interest earning components of loans held for sale and mortgage-backed securities held in connection with the Company's mortgage banking business, as well as all securities held for trading, are assumed to mature within one year. In addition, investments held by the Company which have call features are presented according to their contractual maturity date. 19 Within Four to More Than More Than Three Twelve One Year to Three Years Over Five Months Months Three Years to Five Years Years Total ---------------------------------------------------------------------------------- (Dollars in thousands) Interest-earning assets(1): Loans receivable: Residential real estate loans $ 35,020 $ 98,695 $ 222,065 $172,724 $ 507,324 $1,035,828 Construction loans 76,250 22,756 -- -- -- 99,006 Commercial real estate loans 348,862 -- -- -- -- 348,862 Consumer loans 50,428 36,891 51,476 23,359 13,254 175,408 Commercial business loans 60,397 7,982 8,684 1,366 17 78,446 Mortgage loans held for sale 31,361 32,088 72,159 55,818 47,363 238,789 Mortgage-backed securities(2)(3) 157,946 419,535 217,389 169,068 599,471 1,563,409 Investment Securities(3) 101,916 191,793 135,424 40,562 4,051 473,746 Other interest-earning assets(4) 81,627 -- -- -- -- 81,627 ---------------------------------------------------------------------------------- Total $ 943,807 $ 809,740 $ 707,197 $462,897 $1,171,480 $4,095,121 ================================================================================== Interest bearing liabilities: Deposits (5) NOW and Super NOW accounts $ 10,380 $ 28,810 $ 31,670 $ 25,652 $ 109,360 $ 205,872 Passbook savings accounts 3,327 9,647 24,016 19,213 76,849 133,052 Regular and commercial checking 9,414 26,360 28,977 23,471 100,062 188,284 Certificates of deposit 372,626 657,982 96,477 209,624 5,115 1,341,824 FHLB advances 120,000 10,000 78,125 192,500 78,000 478,625 Securities sold under agreements to repurchase (6) 555,028 201,001 235,813 115,000 87,810 1,194,652 Other borrowings(7) 31,425 154,661 22,761 -- -- 208,847 ---------------------------------------------------------------------------------- Total 1,102,200 1,088,461 517,839 585,460 457,196 3,751,156 ---------------------------------------------------------------------------------- Effect of hedging instruments (355,000) -- 210,000 65,000 80,000 -- ---------------------------------------------------------------------------------- $ 747,200 $1,088,461 $ 727,839 $650,460 $ 537,196 $3,751,156 ================================================================================== Excess (deficiency) of interest-earning assets over interest-bearing liabilities $ 196,607 $(278,721) $ (20,642) $(187,563) $ 634,284 $ 343,965 ---------------------------------------------------------------------------------- Cumulative excess (deficiency) of interest-earning assets over interest-bearing liabilities $ 196,607 $ (82,114) $ (102,756) $(290,319) $ 343,965 ---------------------------------------------------------------------------------- Cumulative excess (deficiency) of interest-earning assets over interest-bearing liabilities as a percent of total assets -4.57% -1.91% -2.39% -6.75% 8.00% ---------------------------------------------------------------------------------- (footnotes on following page) 20 --------------- (1) Adjustable-rate loans are included in the period in which interest rates are next scheduled to adjust rather that in the period in which they are due, and fixed-rate loans are included in the periods in which they are scheduled to be repaid, based on scheduled amortization, in each case as adjusted to take into account estimated prepayments. (2) Reflects estimated prepayments in the current interest rate environment. (3) Includes securities held for trading, available for sale and held to maturity. (4) Includes securities purchased under agreement to resell, time deposits with other banks and federal funds sold. (5) Does not include non-interest-bearing deposit accounts. (6) Includes federal funds purchased. (7) Comprised of warehousing lines, notes payable and other borrowings. --------------- As of September 30, 2001, the Company had a one year negative gap of approximately $82.1 million which constituted 1.91% of total assets as such date, compared to a negative gap of approximately $477.8 million or 13.5% of total assets at December 31, 2000. R&G Financial's negative gap within one year at December 31, 2000 was due primarily to its large fixed-rate mortgage loans receivable portfolio held for investment and a portion of its portfolio of FHLB notes and other US agency securities which have call features but were not likely to be exercised by such agencies due to the actual interest rate environment. During the nine months ended September 30, 2001, the Company extended the maturity dates of certain borrowings into longer-term maturities at lower rates to take advantage of reductions in interest rates during the period. In addition, the Company entered into certain derivative instruments and increased its portfolio of investment securities held for trading, reducing its gap exposure. While the above table presents the Company's loans receivable portfolio held for investment purposes according to its maturity date, from time to time the Company may negotiate special transactions with FHLMC and/or FNMA or other third party investors for the sale of such loans. There can be no assurance, however, that the Company will be successful in consummating any such transactions. The following table presents for the periods indicated R&G Financial's total dollar amount of interest from average interest-earning assets and the resultant yields, as well as the interest expense on average interest-bearing liabilities expressed both in dollars and rates, and the net interest margin. The table does not reflect any effect of income taxes. All average balances are based on the average of month-end balances for R&G Mortgage and average daily balances for the Bank in each case during the periods presented. 21 For the three month period ended September 30, 2001 2000 -------------------------------------------------------------------------- Average Yield / Average Yield / Balance Interest Rate Balance Interest Rate -------------------------------------------------------------------------- (Dollars in thousands) Interest-Earning Assets: Cash and cash equivalents(1) $ 30,431 $ 324 4.26% $ 17,094 $ 291 6.81% Investment securities available for sale 420,479 6,851 6.52 324,333 5,640 6.96 Investment securities held to maturity 13,706 200 5.84 5,493 79 5.75 Mortgage-backed securities held for trading 113,846 1,802 6.33 17,956 228 5.08 Mortgage-backed securities available for sale 1,208,431 20,255 6.70 715,493 11,288 6.31 Mortgage-backed securities held to maturity 48,868 735 6.02 21,222 372 7.01 Loans receivable, net (2) 2,011,547 40,509 8.06 1,972,807 42,337 8.58 FHLB of New York Stock 55,380 700 5.06 40,085 666 6.65 ------------------------------------------------------------------ Total interest-earning assets 3,902,688 $ 71,376 7.32% 3,114,483 $60,901 7.82% ------------------------------------------------------------------ Non-interest-earning assets 310,280 225,467 ------------------------------------------------------------------ Total assets $4,212,968 $3,339,950 ------------------------------------------------------------------ Interest-Bearing Liabilities: Deposits $1,872,192 $ 22,242 4.75% $1,568,110 $21,439 5.47% Securities sold under agreements to repurchase (3) 1,098,472 12,135 4.42 800,996 13,348 6.67 Notes payable 280,165 3,523 5.03 187,950 2,708 5.76 Other borrowings(4) 433,739 5,580 5.15 459,902 7,528 6.55 ------------------------------------------------------------------ Total interest-bearing liabilities 3,684,568 $ 43,480 4.72% 3,016,958 $45,023 5.97% ------------------------------------------------------------------ Non-interest-bearing liabilities 103,108 34,670 ------------------------------------------------------------------ Total liabilities 3,787,676 3,051,628 ------------------------------------------------------------------ Stockholders' equity 425,292 288,322 -------------------------------------------------------------------- Total liabilities and stockholders' equity $ 4,212,968 $3,339,950 ==================================================================== Net interest income; interest rate spread (5) $ 27,896 2.60% $15,878 1.85% ------------------- --------------- Net interest margin 2.86% 2.04% ------- ----- Average interest-earning assets to average interest-bearing liabilities 105.92% 103.23% ------- ------ (footnotes on page 24) 22 For the nine month period ended September 30, 2001 2000 -------------------------------------------------------------------------------- Average Yield/ Average Yield/ Balance Interest Rate Balance Interest Rate -------------------------------------------------------------------------------- (Dollars in thousands) Interest-Earning Assets: Cash and cash equivalents(1) $ 37,109 $ 1,345 4.83% $ 15,001 $ 732 6.51% Investment securities available for sale 394,164 19,770 6.69 289,265 15,174 6.99 Investment securities held to maturity 7,506 325 5.77 5,435 237 5.81 Mortgage-backed securities held for trading 108,557 5,117 6.28 20,706 891 5.74 Mortgage-backed securities available for sale 1,114,439 54,343 6.50 702,921 32,903 6.24 Mortgage-backed securities held to maturity 29,049 1,301 5.97 21,847 1,040 6.35 Loans receivable, net (2) 1,866,557 114,292 8.16 1,849,630 119,115 8.59 FHLB of New York Stock 49,933 2,243 5.99 37,287 1,803 6.45 -------------------------------------------------------------------------------- Total interest-earning assets 3,607,314 $ 198,736 7.35% 2,942,092 $171,895 7.79% -------------------------------------------------------------------------------- Non-interest-earning assets 301,899 236,340 -------------------------------------------------------------------------------- Total assets $3,909,213 $3,178,432 ================================================================================ Interest-Bearing Liabilities: Deposits $1,773,775 $ 67,937 5.11% $1,465,850 $ 57,496 5.23% Securities sold under agreements to repurchase (3) 973,255 36,717 5.03 747,268 35,597 6.35 Notes payable 235,968 8,545 4.83 193,342 8,972 6.19 Other borrowings(4) 446,538 18,053 5.39 432,248 20,459 6.31 -------------------------------------------------------------------------------- Total interest-bearing liabilities 3,429,536 $ 131,252 5.10% 2,838,708 $122,524 5.75% -------------------------------------------------------------------------------- Non-interest-bearing liabilities 92,456 59,372 -------------------------------------------------------------------------------- Total liabilities 3,521,992 2,898,080 -------------------------------------------------------------------------------- Stockholders' equity 387,221 280,352 -------------------------------------------------------------------------------- Total liabilities and stockholders' equity $3,909,213 $3,178,432 ================================================================================ Net interest income; interest rate spread (5) $ 67,484 2.25% $ 49,371 2.04% ---------------------- -------------------- Net interest margin 2.49% 2.24% --------- ------ Average interest-earning assets to average interest-bearing liabilities 105.18% 103.64% --------- ------- (footnotes on page 24) 23 --------------- (1) Comprised of cash and due from banks, securities purchased under agreements to resell, time deposits with other banks and federal funds sold. (2) Includes mortgage loans held for sale and non-accrual loans. (3) Includes federal funds purchased. (4) Comprised of long-term debt, advances from the FHLB of New York and other borrowings. (5) Interest rate spread represents the difference between R&G Financial's weighted average yield on interest-earning assets and the weighted average rate on interest-bearing liabilities. Net interest margin represents net interest income as a percent of average interest-earning assets. --------------- MORTGAGE LOAN SERVICING The following table sets forth certain information regarding the mortgage loan servicing portfolio of R&G Financial for the periods indicated. At or for the three months ended September 30, ------------------------------------ 2001 2000 ------------ ------------ (Dollars in Thousands) Composition of Servicing Portfolio at period end: GNMA $ 2,958,985 $ 3,004,759 FNMA/FHLMC 2,337,570 1,715,331 Other mortgage loans (3) 1,808,222 1,810,896 ------------ ------------ Total servicing portfolio (3) $ 7,104,777 $ 6,530,986 ============ ============ Activity in the Servicing Portfolio: Beginning servicing portfolio $ 6,634,059 $ 6,177,511 Add: Loan originations and purchases 1,415,853 937,852 Servicing of portfolio loans acquired 1,361 31,404 Less: Sale of servicing rights(1) (164,875) (171,578) Run-offs(2) (781,621) (444,203) ------------ ------------ Ending servicing portfolio(3) $ 7,104,777 $ 6,530,986 ============ ============ Number of loans serviced 113,181 110,192 Average loan size $ 63 $ 59 Average servicing fee rate 0.501% 0.507% --------------- (1) Includes loans sold, servicing released, by Continental Capital, totaling $164.9 million and $130.5 million in 2001 and 2000, respectively. 24 (2) Run-offs refers to regular amortization of loans, prepayments and foreclosures. (3) At the dates shown, included $1.0 billion and $1.1 billion of loans serviced for the Bank, respectively, which constituted 14.1% and 17.4% of the total servicing portfolio, respectively. --------------- Substantially all of the mortgage loans in R&G Financial's servicing portfolio are secured by single (one-to-four) family residences secured by real estate located in Puerto Rico. At September 30, 2001 less than 7% of the Company's mortgage servicing portfolio was related to mortgages secured by real property located outside Puerto Rico. The Company reduces the sensitivity of its servicing income to increases in prepayment rates through a strong retail origination network that has increased or maintained the size of R&G Financial's servicing portfolio even during periods of high prepayments. In addition, a substantial portion of the Company's servicing portfolio consists of tax-exempt FHA/VA mortgage loans which carry lower interest rates than those on conventional loans, which tends to reduce risks related to R&G Financial's servicing portfolio. During the nine months ended September 30, 2001 the Company recognized $2.5 million of unscheduled amortization of mortgage servicing rights and made provisions for impairment of mortgage servicing rights of approximately $1.2 million. These amounts include $475,000 and $594,000 of unscheduled amortization and provisions for impairment, respectively, attributable to Continental Capital, the Company's wholly-owned mortgage banking subsidiary in the State of New York. LIQUIDITY AND CAPITAL RESOURCES LIQUIDITY - Liquidity refers to the Company's ability to generate sufficient cash to meet the funding needs of current loan demand, savings deposit withdrawals, principal and interest payments with respect to outstanding borrowings and to pay operating expenses. It is management's policy to maintain greater liquidity than required in order to be in a position to fund loan purchases and originations, to meet withdrawals from deposit accounts, to make principal and interest payments with respect to outstanding borrowings and to make investments that take advantage of interest rate spreads. The Company monitors its liquidity in accordance with guidelines established by the Company and applicable regulatory requirements. The Company's need for liquidity is affected by loan demand, net changes in deposit levels and the scheduled maturities of its borrowings. The Company can minimize the cash required during the times of heavy loan demand by modifying its credit policies or reducing its marketing efforts. Liquidity demand caused by net reductions in deposits are usually caused by factors over which the Company has limited control. The Company derives its liquidity from both its assets and liabilities. Liquidity is derived from assets by receipt of interest and principal payments and prepayments, by the ability to sell assets at market prices and by utilizing unpledged assets as collateral for borrowings. Liquidity is derived from liabilities by maintaining a variety of funding sources, including deposits, advances from the FHLB of New York and other short and long-term borrowings. The Company's liquidity management is both a daily and long-term function of funds management. Liquid assets are generally invested in short-term investments such as securities purchased under agreements to resell, federal funds sold and certificates of deposit in other financial institutions. If the Company requires funds beyond its ability to generate them internally, various forms of both short and long-term borrowings provide an additional source of funds. At September 30, 2001, the Company had $104.5 million in borrowings capacity under unused warehousing and other lines of credit, $560.5 million in borrowings capacity under unused lines of credit with the FHLB of New York and $15 million under unused federal funds lines of credit. The Company has generally not relied upon brokered deposits as a source of liquidity. At September 30, 2001, the Company had outstanding commitments to originate and/or purchase mortgage and non-mortgage loans of $154.0 million (including unused lines of credit). Certificates of deposit which are scheduled to mature within one year totaled $1.0 billion at September 30, 2001, and borrowings that are scheduled to mature within the same period amounted to $1.0 billion. The Company anticipates that it will have sufficient funds available to meet its current loan commitments. 25 CAPITAL RESOURCES - The FDIC's capital regulations establish a minimum 3.0 % Tier I leverage capital requirement for the most highly-rated state-chartered, non-member banks, with an additional cushion of at least 100 to 200 basis points for all other state-chartered, non-member banks, which effectively will increase the minimum Tier 1 leverage ratio for such other banks from 4.0% to 5.0% or more. Under the FDIC's regulations, the highest-rated banks are those that the FDIC determines are not anticipating or experiencing significant growth and have well diversified risk, including no undue interest rate risk exposure, excellent asset quality, high liquidity, good earnings and, in general, which are considered a strong banking organization and are rated composite 1 under the Uniform Financial Institutions Rating System. Leverage or core capital is defined as the sum of common stockholders' equity (including retained earnings), noncumulative perpetual preferred stock and related surplus, and minority interests in consolidated subsidiaries, minus all intangible assets other than certain qualifying supervisory goodwill and certain purchased mortgage servicing rights. The FDIC also requires that banks meet a risk-based capital standard. The risk-based capital standard for banks requires the maintenance of total capital (which is defined as Tier I capital and supplementary (Tier 2) capital) to risk weighted assets of 8%. In determining the amount of risk-weighted assets, all assets, plus certain off-balance sheet assets, are multiplied by a risk-weight of 0% to 100%, based on the risks the FDIC believes are inherent in the type of asset or item. The components of Tier 1 capital are equivalent to those discussed above under the 3% leverage capital standard. The components of supplementary capital include certain perpetual preferred stock, certain mandatory convertible securities, certain subordinated debt and intermediate preferred stock and general allowances for loan and lease losses. Allowance for loan and lease losses includable in supplementary capital is limited to a maximum of 1.25% of risk-weighted assets. Overall, the amount of capital counted toward supplementary capital cannot exceed 100% of core capital. At September 30, 2001, the Bank met each of its capital requirements, with Tier 1 leverage capital, Tier 1 risk-based capital and total risk-based capital ratios of 6.67%, 12.00% and 12.73%, respectively. In addition, the Federal Reserve Board has promulgated capital adequacy guidelines for bank holding companies which are substantially similar to those adopted by FDIC regarding state-chartered banks, as described above. The Company is currently in compliance with such regulatory capital requirements. INFLATION AND CHANGING PRICES The unaudited consolidated financial statements and related data presented herein have been prepared in accordance with generally accepted accounting principles, which require the measurement of financial position and operating results in terms of historical dollars (except with respect to securities which are carried at market value), without considering changes in the relative purchasing power of money over time due to inflation. Unlike most industrial companies, substantially all of the assets and liabilities of the Company are monetary in nature. As a result, interest rates have a more significant impact on the Company's performance than the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or in the same magnitude as the prices of goods and services. "SAFE HARBOR" STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 Statements made in this Form 10-Q that relate to future events are made pursuant to the Private Securities Litigation Reform Act of 1995. These forward-looking statements are based upon current expectations and R&G Financial assumes no obligation to update this information. Because actual results may differ materially from expectations, R&G Financial cautions readers not to place undue reliance on these statements. A number of factors, including changes in economic conditions in the Company's market area, changes in policies by regulatory agencies, fluctuations in interest rates, demand for loans in the Company's market area, and competition, could cause actual results to differ materially from historical results and those presently anticipated or projected. For a detailed discussion of the important factors affecting R&G Financial, please see the Company's Form 10-K for the year ended December 31, 2000 and Form 10-Q for the quarters ended March 31 and June 30, 2001 filed with the Securities and Exchange Commission. 26 ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Quantitative and qualitative disclosures about market risks at December 31, 2000 are presented in Item 7A of the Company's Annual report on Form 10-K. Information at September 30, 2001 is presented on page 19 of this Report. Management believes there have been no material changes in the Company's market risk since December 31, 2000. PART II - OTHER INFORMATION ITEM 1: Legal Proceedings The Registrant is involved in routine legal proceedings occurring in the ordinary course of business which, in the aggregate, are believed by management to be immaterial to the financial condition and results of operations of the Registrant. ITEM 2: Changes in Securities Not applicable ITEM 3: Defaults Upon Senior Securities Not applicable ITEM 4: Submission of Matters to a Vote of Security Holders Not applicable ITEM 5: Other Information Not applicable 27 ITEM 6: Exhibits and Reports on Form 8-K a) Exhibits EXHIBIT NO. EXHIBIT ----------- ------- 2.0 Amended and Restated Agreement and Plan of Merger by and between R&G Financial Corporation, the Bank and R-G Interim Premier Bank, dated as of September 27, 1996(1) 3.1 Certificate of Incorporation of R&G Financial Corporation(2) 3.2.1 Amended and Restated Certificate of Incorporation of R&G Financial Corporation(4) 3.2.2 Certificate of Amendment to Amended and Restated Certificate of R&G Financial Corporation(9) 3.3 Bylaws of R&G Financial Corporation(2) 3.4 Certificate of Resolutions designating the terms of the Series A Preferred Stock(6) 3.5 Certificate of Resolutions designating the terms of the Series B Preferred Stock(7) 3.6 Certificate of Resolutions designating the terms of the Series C Preferred Stock(8) 4.0 Specimen of Stock Certificate of R&G Financial Corporation(2) 4.1 Form of Series A Preferred Stock Certificate of R&G Financial Corporation(3) 4.2 Form of Series B Preferred Stock Certificate of R&G Financial Corporation(5) 4.3 Form of Series C Preferred Stock Certificate of R&G Financial Corporation(8) 10.1 Master Purchase, Servicing and Collection Agreement between R&G Mortgage and the Bank dated February 16, 1990, as amended on April 1, 1991, December 1, 1991, February 1, 1994 and July 1, 1994(2) 10.2 Master Custodian Agreement between R&G Mortgage and the Bank dated February 16, 1990, as amended on June 27, 1996(2) 10.3 Master Production Agreement between R&G Mortgage and the Bank dated February 16, 1990, as amended on August 30, 1991 and March 31, 1995(2) 10.4 Data Processing Computer Service Agreement between R&G Mortgage and R-G Premier Bank dated December 1, 1994(2) 10.5 Securitization Agreement by and between R&G Mortgage and the Bank, dated as of July 1, 1995(2) 10.6 R&G Financial Corporation Stock Option Plan(2)(*) ----------------- (1) Incorporated by reference from the Registration Statement on Form S-4 Registration No. 333-13199) filed by the Registrant with the Securities and Exchange Commission ("SEC") on October 1, 1996. (2) Incorporated by reference from the Registration Statement on Form S-1 (Registration No. 333-06245) filed by the Registrant with the SEC on June 18, 1996, as amended. (3) Incorporated by reference from the Registrant's Registration Statement on Form S-3 (Registration No. 333-60923), as amended, filed with the SEC on August 7, 1998. (4) Incorporated by reference from the Registrant's Current Report on Form 8-K filed with the SEC on November 19, 1999. (5) Incorporated by reference from the Registrant's Registration Statement on Form S-3 (Registration No. 333-90463), filed with the SEC on November 5, 1999. (6) Incorporated by reference from the Registrant's Current Report on Form 8-K filed with the SEC on August 31, 1998. (7) Incorporated by reference from the Registrant's Form 10-K filed with the SEC on April 13, 2000. (8) Incorporated by reference from Pre-Effective Amendment No. 1 to the Registrant's Registration Statement on Form S-3 (File No. 333-55834), filed with the SEC on March 7, 2001. (*) Management contract or compensatory plan or arrangement. (9) Incorporated by reference from the Registrant's Current Report on Form 8-K filed with the SEC on June 12, 2001. b) Form 8-K None SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. R&G FINANCIAL CORPORATION Date: November 9, 2001 By: /S/ VICTOR J. GALAN ------------------------------------- Victor J. Galan, Chairman and Chief Executive Officer (Principal Executive Officer) By: /S/ JOSEPH R. SANDOVAL ------------------------------------- Joseph R. Sandoval Senior Vice President and Chief Financial Officer (Principal Financial and Accounting Officer) 28