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Article by DailyStocks_admin    (01-05-10 12:13 AM)

Oriental Financial Group Inc.. CEO Josen Rossi bought 25000 shares on 8-27-2009 at $13.1

BUSINESS OVERVIEW


General

The Group is a publicly-owned financial holding company incorporated on June 14, 1996 under the laws of the Commonwealth of Puerto Rico, providing a full range of financial services through its subsidiaries. The Group is subject to the provisions of the U.S. Bank Holding Company Act of 1956, as amended, (the “BHC Act”) and, accordingly, subject to the supervision and regulation of the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”).

The Group provides comprehensive financial services to its clients through a complete range of banking and financial solutions, including mortgage, commercial and consumer lending; checking and savings accounts; financial planning, insurance, asset management, and investment brokerage; and corporate and individual trust and retirement services. The Group operates through three major business segments: Banking, Financial Services, and Treasury, and distinguishes itself based on quality service and marketing efforts focused on mid and high net worth individuals and families, including professionals and owners of small and mid-sized businesses, primarily in Puerto Rico. The Group has 23 financial centers in Puerto Rico and a subsidiary, Caribbean Pension Consultants Inc. (“CPC”), based in Boca Raton, Florida. The Group’s long-term goal is to strengthen its banking and financial services franchise by expanding its lending businesses, increasing the level of integration in the marketing and delivery of banking and financial services, continuing to maintain effective asset-liability management, growing non-interest revenues from banking and financial services, and improving operating efficiencies.

The Group’s strategy involves:

(1) Strengthening its banking and financial services franchise by expanding its ability to attract deposits and build relationships with mid net worth individual customers and professional and mid-market commercial businesses through aggressive marketing and expansion of its sales force;

(2) Focusing on greater growth in mortgage, commercial and consumer lending; insurance products, trust and wealth management services; and increasing the level of integration in the marketing and delivery of banking and financial services;

(3) Matching its portfolio of investment securities with the related funding to better lock-in favorable spreads, and primarily investing in U.S. government agency obligations.

(4) Opening, expanding or relocating financial centers; improving operating efficiencies; and continuing to maintain effective asset-liability management; and

(5) Implementing a broad ranging effort to instill in employees and make customers aware of the Group’s determination to effectively serve and advise its customer base in a responsive and professional manner.

Together with a highly experienced group of senior and mid level executives, this strategy has generally resulted in sustained growth in the Group’s mortgage, commercial, consumer lending and wealth-management activities, allowing the Group to distinguish itself in a highly competitive industry. The unstable interest rate environment of recent years has validated the strategy’s basic premise for greater revenue diversity, which remains an integral part of the Group’s long-term goal.

While progress is expected to continue, the Group is not immune from general and local financial and economic conditions. Past experience is not necessarily indicative of future performance, especially given market uncertainties, but based on a reasonable time horizon of three to five years, the strategy is expected to maintain its steady progress towards the Group’s long-term goal.

Segment Disclosure

The Group has three reportable segments: Banking, Financial Services, and Treasury. Management established the reportable segments based on the internal reporting used to evaluate performance and to assess where to allocate resources. Other factors such as the Group’s organizational structure, nature of products, distribution channels and economic characteristics of the products were also considered in the determination of the reportable segments. The Group measures the performance of these reportable segments based on pre-established goals involving different financial parameters such as net income, interest spread, loan production, and fees generated.

For detailed information regarding performance of the Group’s operating segments, please refer to Note 17 to the Group’s accompanying consolidated financial statements.

Banking Activities

Oriental Bank and Trust (the “Bank”), the Group’s main subsidiary, is a full-service Puerto Rico commercial bank with its main office located in San Juan, Puerto Rico. The Bank has 23 branches throughout Puerto Rico and was incorporated in 1964 as a federal mutual savings and loan association. It became a federal mutual savings bank in July 1983 and converted to a federal stock savings bank in April 1987. Its conversion from a federally-chartered savings bank to a commercial bank chartered under the banking law of the Commonwealth of Puerto Rico, on June 30, 1994, allowed the Bank to more effectively pursue opportunities in its market and obtain more flexibility in its businesses, placing the Bank in the mainstream of financial services in Puerto Rico. As a Puerto Rico-chartered commercial bank, it is subject to examination by the Federal Deposit Insurance Corporation (the “FDIC”) and the Office of the Commissioner of Financial Institutions of Puerto Rico (the “OCFI”). The Bank offers banking services such as commercial and consumer lending, saving and time deposit products, financial planning, and corporate and individual trust services, and, through its residential mortgage lending division and its mortgage lending subsidiary, Oriental Mortgage Corporation (“Oriental Mortgage”), capitalizes on its banking network. The Bank operates an international banking entity (“IBE”) pursuant to the International Banking Center Regulatory Act of Puerto Rico, as amended (the “IBE Act”) which is a wholly-owned subsidiary of the Bank, named Oriental International Bank Inc. (the “IBE subsidiary”) organized in November 2003. The IBE subsidiary offers the Bank certain Puerto Rico tax advantages and its services are limited under Puerto Rico law to persons and assets/liabilities located outside of Puerto Rico.

Banking activities include the Bank’s branches and mortgage banking activities with traditional retail banking products such as deposits and mortgage, commercial, and consumer loans. The Bank’s lending activities are primarily with consumers located in Puerto Rico. The Bank’s loan transactions include a diversified number of industries and activities, all of which are encompassed within three main categories: mortgage, commercial, and consumer.

The Group’s mortgage banking activities are conducted through a division of the Bank, and also through Oriental Mortgage. The mortgage banking activities primarily consist of the origination and purchase of residential mortgage loans for the Group’s own portfolio and from time to time, if conditions so warrant, the Group may engage in the sale of such loans to other financial institutions in the secondary market. The Group originates Federal Housing Administration (“FHA”)-insured, Veterans Administration (“VA”)-guaranteed mortgages, and Rural Housing Service (“RHS”)-guaranteed loans that are primarily securitized for issuance of Government National Mortgage Association (“GNMA”) mortgage-backed securities which can be resold to individual or institutional investors in the secondary market. Conventional loans that meet the underwriting requirements for sale or exchange under standard Federal National Mortgage Association (the “FNMA”) or the Federal Home Loan Mortgage Corporation (the “FHLMC”) programs are referred to as conforming mortgage loans and are also securitized for issuance of FNMA or FHLMC mortgage-backed securities. The Group is an approved seller of FNMA, as well as FHLMC, mortgage loans for issuance of FNMA and FHLMC mortgage-backed securities. The Group is also an approved issuer of GNMA mortgage-backed securities. The Group continues to outsource the servicing of the GNMA, FNMA and FHLMC pools that it issues and its mortgage loan portfolio.

Servicing assets represent the contractual right to service loans for others. Servicing assets are included as part of other assets in the consolidated statements of financial condition. Loan servicing fees, which are based on a percentage of the principal balances of the loans serviced, are credited to income as loan payments are collected.

Servicing assets are initially recognized at fair value. The Group elected the amortization method with periodic testing for impairment.

Loan Underwriting

All loan originations, regardless of whether originated through the Group’s retail banking network or purchased from third parties, must be underwritten in accordance with the Group’s underwriting criteria including loan-to-value ratios, borrower income qualifications, debt ratios and credit history, investor requirements, and title insurance and property appraisal requirements. The Group’s underwriting standards comply with the relevant guidelines set forth by the Department of Housing and Urban Development (“HUD”), VA, FNMA, FHLMC, federal and Puerto Rico banking regulatory authorities, as applicable. The Group’s underwriting personnel, while operating within the Group’s loan offices, make underwriting decisions independent of the Group’s mortgage loan origination personnel.

Sale of Loans and Securitization Activities

The Group may engage in the sale or securitization of a portion of the residential mortgage loans that it originates and purchases and utilizes various channels to sell its mortgage products. The Group is an approved issuer of GNMA-guaranteed mortgage-backed securities which involves the packaging of FHA loans, RHS loans or VA loans into pools of mortgage-backed securities for sale primarily to securities broker-dealers and other institutional investors. The Group can also act as issuer in the case of conforming conventional loans in order to group them into pools of FNMA or FHLMC-issued mortgage-backed securities which the Group then sells to securities broker-dealers. The issuance of mortgage-backed securities provides the Group with flexibility in selling the mortgage loans that it originates or purchases and also provides income by increasing the value and marketability of such loans. In the case of conforming conventional loans, the Group also has the option to sell such loans through the FNMA and FHLMC cash window program.

Financial Services Activities

Financial services activities are generated by such businesses as securities brokerage, fiduciary services, insurance, and pension administration.

Oriental Financial Services Corp. (“OFSC”) is a Puerto Rico corporation and the Group’s subsidiary engaged in securities brokerage and investment banking activities in accordance with the Group’s strategy of providing fully integrated financial solutions to the Group’s clients. OFSC, a member of the Financial Industry Regulatory Authority (“FINRA”) and the Securities Investor Protection Corporation, is a registered securities broker-dealer pursuant to Section 15(b) of the Securities Exchange Act of 1934. OFSC does not carry customer accounts and is, accordingly, exempt from the Customer Protection Rule (SEC Rule 15c3-3) pursuant to subsection (k)(2)(ii) of such rule. It clears securities transactions through National Financial Services, LLC, a clearing agent which carries the accounts of OFSC’s customers on a “fully disclosed” basis.

OFSC offers securities brokerage services covering various investment alternatives such as tax-advantaged fixed income securities, mutual funds, stocks, and bonds to retail and institutional clients. It also offers separately managed accounts and mutual fund asset allocation programs sponsored by unaffiliated professional asset managers. These services are designed to meet each client’s specific needs and preferences, including transaction-based pricing and asset-based fee pricing.

OFSC also manages and participates in public offerings and private placements of debt and equity securities in Puerto Rico and engages in municipal securities business with the Commonwealth of Puerto Rico and its instrumentalities, municipalities, and public corporations. Investment banking revenue from such activities include gains, losses, and fees, net of syndicate expenses, arising from securities offerings in which OFSC acts as an underwriter or agent. Investment banking revenue also includes fees earned from providing merger-and-acquisition and financial restructuring advisory services. Investment banking management fees are recorded on the offering date, sales concessions on settlement date, and underwriting fees at the time the underwriting is completed and the income is reasonably determinable.

Oriental Insurance Inc. (“Oriental Insurance”) is a Puerto Rico corporation and the Group’s subsidiary engaged in insurance agency services. It was established by the Group to take advantage of the cross-marketing opportunities provided by financial modernization legislation. Oriental Insurance currently earns commissions by acting as a licensed insurance agent in connection with the issuance of insurance policies by unaffiliated insurance companies and anticipates continued growth as it expands the products and services it provides and continues to cross market its services to the Group’s existing customer base.

Caribbean Pension Consultants, Inc., a Florida corporation, is the Group’s subsidiary engaged in the administration of retirement plans in the U.S., Puerto Rico, and the Caribbean.

Treasury Activities

Treasury activities encompass all of the Group’s treasury-related functions. The Group’s investment portfolio consists of mortgage-backed securities, obligations of U.S. Government sponsored agencies, PuertoRico Government and agency obligations, structured credit investments, and money market instruments. Agency mortgage-backed securities, the largest component, consist principally of pools of residential mortgage loans that are made to consumers and then resold in the form of pass-through certificates in the secondary market, the payment of interest and principal of which is guaranteed by GNMA, FNMA or FHLMC. For more information see Notes 2 and 3 to the accompanying consolidated financial statements.

The Group’s principal funding sources are securities sold under agreements to repurchase, branch deposits, Federal Home Loan Bank (“FHLB”) advances, wholesale deposits, and subordinated capital notes. Through its branch system, the Bank offers personal non-interest and interest-bearing checking accounts, savings accounts, certificates of deposit, individual retirement accounts (“IRAs”) and commercial non-interest bearing checking accounts. The FDIC insures the Bank’s deposit accounts up to applicable limits. Management makes retail deposit pricing decisions periodically through the Asset and Liability Management Committee (“ALCO”), which adjusts the rates paid on retail deposits in response to general market conditions and local competition. Pricing decisions take into account the rates being offered by other local banks, LIBOR, and mainland U.S. market interest rates.

Market Area and Competition

The main geographic business and service area of the Group is in Puerto Rico, where the banking market is highly competitive. Puerto Rico banks are subject to the same federal laws, regulations and supervision that apply to similar institutions in the United States of America. The Group also competes with brokerage firms with retail operations, credit unions, savings and loan cooperatives, small loan companies, insurance agencies, and mortgage banks in Puerto Rico. The Group encounters intense competition in attracting and retaining deposits and in its consumer and commercial lending activities. Management believes that the Group has been able to compete effectively for deposits and loans by offering a variety of transaction account products and loans with competitive terms, by emphasizing the quality of its service, by pricing its products at competitive interest rates, by offering convenient branch locations, and by offering financial planning services at each of its branch locations. The Group’s ability to originate loans depends primarily on the service it provides to its borrowers in making prompt credit decisions and on the rates and fees that it charges.

Regulation and Supervision

General

The Group is a financial holding company subject to supervision and regulation by the Federal Reserve Board under the BHC Act and the Gramm-Leach-Bliley Act of 1999. The qualification requirements and the process for a bank holding company that elects to be treated as a financial holding company requires that all of the subsidiary banks controlled by the bank holding company at the time of election must be and remain at all times “well capitalized” and “well managed.”

The Group elected to be treated as a financial holding company as permitted by the Gramm-Leach-Bliley Act. Under the Gramm-Leach-Bliley Act, if the Group fails to meet the requirements for being a financial holding company and is unable to correct such deficiencies within certain prescribed time periods, the Federal Reserve Board could require the Group to divest control of its depository institution subsidiary or alternatively cease conducting activities that are not permissible for bank holding companies that are not financial holding companies.

Financial holding companies may engage, directly or indirectly, in any activity that is determined to be (i) financial in nature, (ii) incidental to such financial activity, or (iii) complementary to a financial activity provided it does not pose a substantial risk to the safety and soundness of depository institutions or the financial system generally. The Gramm-Leach-Bliley Act specifically provides that the following activities have been determined to be “financial in nature”: (a) lending, trust and other banking activities; (b) insurance activities; (c) financial, investment or economic advisory services; (d) securitization of assets; (e) securities underwriting and dealing; (f) existing bank holding company domestic activities; (g) existing bank holding company foreign activities; and (h) merchant banking activities.

In addition, the Gramm-Leach-Bliley Act specifically gives the Federal Reserve Board the authority, by regulation or order, to expand the list of financial or incidental activities but requires consultation with the U.S. Treasury Department and gives the Federal Reserve Board authority to allow a financial holding company to engage in any activity that is complementary to a financial activity and does not pose a substantial risk to the safety and soundness of depository institutions or the financial system.

The Group is required to file with the Federal Reserve Board and the SEC periodic reports and other information concerning its own business operations and those of its subsidiaries. In addition, Federal Reserve Board approval must also be obtained before a bank holding company acquires all or substantially all of the assets of another bank or merges or consolidates with another bank holding company. The Federal Reserve Board also has the authority to issue cease and desist orders against bank holding companies and their non-bank subsidiaries.

The Bank is regulated by various agencies in the United States and the Commonwealth of Puerto Rico. Its main regulators are the OCFI and the FDIC. The Bank is subject to extensive regulation and examination by the OCFI and the FDIC, and is subject to certain Federal Reserve Board regulations of transactions with Bank affiliates. The federal and Puerto Rico laws and regulations which are applicable to the Bank regulate, among other things, the scope of its business, its investments, its reserves against deposits, the timing of the availability of deposited funds, and the nature and amount of and collateral for certain loans. In addition to the impact of such regulations, commercial banks are affected significantly by the actions of the Federal Reserve Board as it attempts to control the money supply and credit availability in order to control inflation in the economy.

The Group’s mortgage banking business is subject to the rules and regulations of FHA, VA, RHS, FNMA, FHLMC, HUD and GNMA with respect to the origination, processing and selling of mortgage loans and the sale of mortgage-backed securities. Those rules and regulations, among other things, prohibit discrimination and establish underwriting guidelines which include provisions for inspections and appraisal reports, require credit reports on prospective borrowers and fix maximum loan amounts, and, with respect to VA loans, fix maximum interest rates. Mortgage origination activities are subject to, among others, the Equal Credit Opportunity Act, Federal Truth-in-Lending Act, the Real Estate Settlement Procedures Act and the regulations promulgated thereunder which, among other things, prohibit discrimination and require the disclosure of certain basic information to mortgagors concerning credit terms and settlement costs. The Group is also subject to regulation by the OCFI with respect to, among other things, licensing requirements and maximum origination fees on certain types of mortgage loan products.

The Group and its subsidiaries are subject to the rules and regulations of certain other regulatory agencies. OFSC, as a registered broker-dealer, is subject to the supervision, examination and regulation of the FINRA, the SEC, and the OCFI in matters relating to the conduct of its securities business, including record keeping and reporting requirements, supervision and licensing of employees and obligations to customers.

Oriental Insurance is subject to the supervision, examination and regulation of the Office of the Commissioner of Insurance of Puerto Rico in matters relating to insurance sales, including but not limited to, licensing of employees, sales practices, charging of commissions and reporting requirements.

Holding Company Structure

The Bank is subject to restrictions under federal laws that limit the transfer of funds to its affiliates (including the Group), whether in the form of loans, other extensions of credit, investments or asset purchases, among others. Such transfers are limited to 10% of the transferring institution’s capital stock and surplus with respect to any affiliate (including the Group), and, with respect to all affiliates, to an aggregate of 20% of the transferring institution’s capital stock and surplus. Furthermore, such loans and extensions of credit are required to be secured in specified amounts, carried out on an arm’s length basis, and consistent with safe and sound banking practices.

Under Federal Reserve Board policy, a bank holding company, such as the Group, is expected to act as a source of financial and managerial strength to its banking subsidiaries and to also commit resources to support them. This support may be required at times when, absent such policy, the bank holding company might not otherwise provide such support. In the event of a bank holding company’s bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain capital of a subsidiary bank will be assumed by the bankruptcy trustee and be entitled to a priority of payment. In addition, any capital loans by a bank holding company to any of its subsidiary banks are subordinate in right of payment to deposits and to certain other indebtedness of such subsidiary bank. The Bank is currently the only depository institution subsidiary of the Group.

Since the Group is a financial holding company, its right to participate in the assets of any subsidiary upon the latter’s liquidation or reorganization will be subject to the prior claims of the subsidiary’s creditors (including depositors in the case of depository institution subsidiaries) except to the extent that the Group is a creditor with recognized claims against the subsidiary.

Dividend Restrictions

The principal source of funds for the Group is the dividends from the Bank. The ability of the Bank to pay dividends on its common stock is restricted by the Puerto Rico Banking Act of 1933, as amended (the Banking Act”), the FDIA and FDIC regulations. In general terms, the Banking Act provides that when the expenditures of a bank are greater than receipts, the excess of expenditures over receipts shall be charged against the undistributed profits of the bank and the balance, if any, shall be charged against the required reserve fund of the bank. If there is no sufficient reserve fund to cover such balance in whole or in part, the outstanding amount shall be charged against the bank’s capital account. The Banking Act provides that until said capital has been restored to its original amount and the reserve fund to 20% of the original capital, the bank may not declare any dividends from the reserve account. In general terms, the FDIA and the FDIC regulations restrict the payment of dividends when a bank is undercapitalized, when a bank has failed to pay insurance assessments, or when there are safety and soundness concerns regarding a bank. For more information see Note 13 to the accompanying consolidated financial statements.

The payment of dividends by the Bank may also be affected by other regulatory requirements and policies, such as maintenance of adequate capital. If, in the opinion of the regulatory authority, a depository institution under its jurisdiction is engaged in, or is about to engage in, an unsafe or unsound practice (that, depending on the financial condition of the depository institution, could include the payment of dividends), such authority may require, after notice and hearing, that such depository institution cease and desist from such practice. The Federal Reserve Board has issued a policy statement that provides that insured banks and bank holding companies should generally pay dividends only out of operating earnings for the current and preceding two years. In addition, all insured depository institutions are subject to the capital-based limitations required by the Federal Deposit Insurance Corporation Improvement Act of 1991(“FDICIA”).

Federal Home Loan Bank System

The FHLB system, of which the Bank is a member, consists of 12 regional FHLBs governed and regulated by the Federal Housing Finance Board. The FHLB serves as a credit facility for member institutions within their assigned regions. They are funded primarily from proceeds derived from the sale of consolidated obligations of the FHLB system. They make loans (i.e., advances) to members in accordance with policies and procedures established by the FHLB and the boards of directors of each regional FHLB.

As a system member, the Bank is entitled to borrow from the FHLB of New York (the “FHLB-NY”) and is required to own capital stock in the FHLB-NY in an amount equal to the greater of $500; 1% of the Bank’s aggregate unpaid principal of its home mortgage loans, home purchase contracts, and similar obligations; or 5% of the Bank’s aggregate amount of outstanding advances by the FHLB-NY. The Bank is in compliance with the stock ownership rules described above with respect to such advances, commitments, home mortgage loans and similar obligations. All loans, advances and other extensions of credit made by the FHLB-NY to the Bank are secured by a portion of the Bank’s mortgage loan portfolio, certain other investments, and the capital stock of the FHLB-NY held by the Bank. At no time may the aggregate amount of outstanding advances made by the FHLB-NY to the Bank exceed 20 times the amount paid in by the Bank for capital stock in the FHLB-NY.

Federal Deposit Insurance Corporation Improvement Act

Under FDICIA the federal banking regulators must take prompt corrective action in respect to depository institutions that do not meet minimum capital requirements. FDICIA, and the regulations issued thereunder, established five capital tiers: (i) “well capitalized,” if it has a total risk-based capital ratio of 10.0% or more, has a Tier I risk-based capital ratio of 6.0% or more, has a Tier I leverage capital ratio of 5.0% or more, and is not subject to any written capital order or directive; (ii) “adequately capitalized,” if it has a total risk-based capital ratio of 8.0% or more, a Tier I risk-based capital ratio of 4.0% or more and a Tier I leverage capital ratio of 4.0% or more (3.0% under certain circumstances) and does not meet the definition of “well capitalized,” (iii) “undercapitalized,” if it has a total risk-based capital ratio that is less than 8.0%, a Tier I risk-based ratio that is less than 4.0% or a Tier I leverage capital ratio that is less than 4.0% (3.0% under certain circumstances), (iv) “significantly undercapitalized,” if it has a total risk-based capital ratio that is less than 6.0%, a Tier I risk-based capital ratio that is less than 3.0% or a Tier I leverage capital ratio that is less than 3.0%, and (v) “critically undercapitalized,” if it has a ratio of tangible equity to total assets that is equal to or less than 2.0%. A depository institution may be deemed to be in a capitalization category that is lower than is indicated by its actual capital position if it receives a less than satisfactory examination rating in any of the first four categories. The Bank is a “well-capitalized” institution.

FDICIA generally prohibits a depository institution from making any capital distribution (including payment of a dividend) or paying any management fees to its holding company if the depository institution would thereafter be undercapitalized. Undercapitalized depository institutions are subject to restrictions on borrowing from the Federal Reserve System. In addition, undercapitalized depository institutions are subject to growth limitations and are required to submit capital restoration plans. A depository institution’s holding company must guarantee the capital plan, up to an amount equal to the lesser of 5% of the depository institution’s assets at the time it becomes undercapitalized or the amount of the capital deficiency when the institution fails to comply with the plan. The federal banking agencies may not accept a capital plan without determining, among other things, that the plan is based on realistic assumptions and is likely to succeed in restoring the depository institution’s capital. Significantly undercapitalized depository institutions may be subject to a number of requirements and restrictions, including orders to sell sufficient voting stock to become adequately capitalized, requirements to reduce total assets, and cessation of receipt of deposits from corresponding banks. Critically undercapitalized depository institutions are subject to the appointment of a receiver or conservator.

CEO BACKGROUND

Josen Rossi (Age 50) – Director of the Group since August 2008 (including term as a director of Oriental Bank and Trust). Mr. Rossi is the Chairman of the Board of Directors and majority owner of Aireko, a multi-enterprise construction group in business in Puerto Rico and the Caribbean since 1963. Mr. Rossi has managed civil, institutional and industrial jobs for Aireko since 1980. He has also directed the development of Aireko’s computerized estimating, cost control, and management systems. Today, he chairs the board of three construction services companies in Puerto Rico and one in Florida. Mr. Rossi is also an official of a metal products manufacturer in the industry and has been actively involved as an official or director in many community and industry associations locally and abroad such as the Puerto Rico Manufacturer’s Association, the Aireko Foundation, the Associated General Contractors (Puerto Rico chapter), the Construction Cluster of Puerto Rico, and the Young Presidents Organization (Puerto Rico chapter). He currently chairs the Puerto Rico Manufacturer’s Association, where he has previously served as vice president and director as well.
Nelson García, Julian S. Inclán, Rafael Machargo Chardón and Pedro Morazzani have been nominated as directors for a three-year term expiring in 2012. Set forth below is certain information with respect to such nominees.
Nelson García, C.P.A. (Age 68) – Director of the Group since 2006 (including term as a director of Oriental Bank and Trust) and Chairman of the Audit Committee. Mr. García has been the Chairman of the Audit Committee of our Board of Directors since November 2006. He is a retired Certified Public Accountant and a former partner of an international public accounting firm, where he gained extensive experience in the banking industry. Mr. García has also occupied top level managerial positions in private industry through 1991. Since then, he founded, and is currently the sole owner and president of, Impress Quality Business Forms, Inc. d/b/a Impress Quality Printing, a commercial printer dedicated to high quality commercial printing.
Julian S. Inclán (Age 61) – Director of the Group since August 2008 (including term as a director of Oriental Bank and Trust) and Vice Chairman of the Corporate Governance and Nominating Committee. Mr Inclán previously served as a director of the Group from 1995 to 2006. He is the President of American Paper Corporation, San Juan, Puerto Rico, a distributor of fine papers, office supplies and graphic art supplies, since September 1994. Mr. Inclán has served as Managing General Partner of Calibre, S. E., a real estate investment company, since 1991, and as President of Inclán Realty, San Juan, Puerto Rico, a real estate development company, since 1995. He is also the President of Inmac Corporation, San Juan, Puerto Rico, a leasing and investment company that is currently inactive, since 1989.
Rafael Machargo Chardón, Esq. (Age 65) – Director of the Group since August 2008 (including term as a director of Oriental Bank and Trust) and member of the Compensation Committee. From 1997 to present Mr. Machargo has been the Managing Partner of Machargo Chardon & Assoc., a law firm concentrating in civil litigation, construction, banking, insurance, real estate and corporate law. From 1992 to 1997, he served as the Managing Partner of Machargo, Del Valle & De la Rosa, a medium size law firm engaged in civil litigation and in banking, real estate, insurance, commercial, and construction law. From 1977 to 1992, Mr. Machargo established his own law firm concentrating in commercial law, construction law, contracts, banking, real estate, insurance law and litigation. From 1975 to 1977, he was a Partner of the law firm Dubón & Dubón, where from 1974 to 1977, he was a litigating attorney concentrating in civil cases, contracts, banking, real estate, corporate, and insurance law. Mr. Machargo is the Chairman of the Board of Directors and CEO of Bosque Llano Development, Corp. and Marfran Development, Corp., each a real estate development company.
Pedro Morazzani, C.P.A., C.V.A., C.F.E. (Age 56) - Director of the Group since 2006 (including term as a director of Oriental Bank and Trust), Chairman of the Compensation Committee and Vice Chairman of the Audit Committee. Mr. Morazzani is a Certified Public Accountant, Certified Valuation Analyst and Certified Fraud Examiner. He is a partner of the accounting firm Zayas, Morazzani & Co. Mr. Morazzani is also the President of the Puerto Rico Chapter of the National Association of Certified Valuation Analysts. Previously, he was a Senior Manager at Peat, Marwick, Mitchell & Co. (presently know as KPMG, LLC). He also served as the President of the Peer Review Committee of the Puerto Rico Society of Certified Public Accountants. He is very active in providing litigation support, consulting, forensic, and business valuation services. Mr. Morazzani has been an instructor at various seminars on technical matters including business valuations of private businesses, fraud, litigation support, and audit and accounting matters.


MANAGEMENT DISCUSSION FOR LATEST QUARTER

Introduction
The Group’s diversified mix of businesses and products generates both the interest income traditionally associated with a banking institution and non-interest income traditionally associated with a financial services institution (generated by such businesses as securities brokerage, fiduciary services, investment banking, insurance and pension administration). Although all of these businesses, to varying degrees, are affected by interest rate and financial markets fluctuations and other external factors, the Group’s commitment is to continue producing a balanced and growing revenue stream.
During the quarter ended September 30, 2009, the strategies in place enabled the Group to continue to perform well despite the turbulent credit market and the recession in Puerto Rico. Highlights of the third quarter included:
• Pre-tax operating income (net interest income after provision for loan losses, core non-interest income from banking and financial service revenues, less non-interest expenses) of approximately $15.4 million compared to $14.2 million in the year-ago quarter.

• Net interest income increased 17.3% compared to the year-ago quarter, due to an improvement in the net interest margin to 2.17% from 1.88% in the year-ago quarter, primarily reflecting lower cost of funds.

• Benefitting from the strategic positioning of its investment securities portfolio, the Group took advantage of market conditions during the quarter to realize gains on sales of securities of $35.5 million. These gains more than offset a $17.6 million charge for early termination of $200 million in high-cost repurchase agreements and credit-related other than temporary impairment charges of $8.3 million on non-agency mortgage-backed securities.

• Proceeds from these sales of securities have been used in a combination of strategies to position Oriental for a potential increase in interest rates, while maintaining the flexibility to take advantage of local market opportunities. These strategies include keeping higher levels of short-term money market instruments, and investing in seasoned U.S. agency mortgage-backed securities and short-to-intermediate maturing U.S. agency debentures.

• Stockholders’ equity increased $22.9 million during the quarter and $121.3 million since December 31, 2008, representing an increase of 46.4% on a year-to-date basis. Book value per common share increased to $12.98, from $12.04 at June 30, 2009 and $7.96 at December 31, 2008.

• Non-interest expenses fell 7.8% from the second quarter which included an industry-wide FDIC special assessment on insured depository institutions.
Income Available to Common Shareholders
For the quarter and nine-month period ended September 30, 2009, the Group’s income available to common shareholders totaled $20.1 million and $93.4 million, respectively, compared to a loss to common shareholders of $46.1 million and $17.2 million, respectively, in the comparable year-ago quarter and nine-month period. Earnings per basic and fully diluted common share were $0.83, for the quarter ended September 30, 2009, compared to losses per basic and fully diluted common share of $1.90 and $1.89, respectively, in the same year-ago period; and earnings per basic and fully diluted common share of $3.85 and $3.84 for the nine-month period ended September 30, 2009, compared to losses of $0.71 per basic and fully diluted common share in the year ago period.
Return on Average Assets and Common Equity
Return on average common equity (ROE) for the quarter and nine-month period ended September 30, 2009, was 28.12% and 51.61%, respectively, up from (88.58%) and (8.97)% for the quarter and nine-month period ended September 30,2008, respectively. Return on average assets (ROA) for the quarter and nine-month period ended September 30, 2009, was 1.32% and 1.98%, respectively, up from (2.99%) and (0.30%), for the quarter and nine-month period ended September 30, 2008, respectively.
Net Interest Income after Provision for Loan Losses
Net interest income after provision for loan losses increased 9.2% for the quarter and 15.6% for the nine-month period ended September 30, 2009, totaling $28.5 million and $87.8 million, respectively, compared with $26.1 million and $76.0 million for the same periods last year. Growth reflects the significant reduction in cost of funds, which has declined more rapidly than the yield on interest-earning assets.
Non-Interest Income
Non-interest income was $16.3 million and $79.6 million, respectively, for the quarter and nine-month period ended September 30, 2009, representing an increase of 128.6% and 291.1% when compared to losses of $57.0 million and $41.7 million in the year-ago periods. Core banking and financial service revenues increased 18.3% and 7.4% when compared to the corresponding quarter and nine-month period ended September 30, 2008. During the September 2009 quarter the Group took advantage of market conditions during the quarter to realize gains on sales of securities of $35.5 million, partially offset by $17.6 million loss on the early termination of certain repurchase agreements and credit-related other than temporary impairment charges of $8.3 million on non-agency mortgage-backed securities.
Non-Interest Expenses
Non-interest expenses of $20.5 million and $62.0 million, respectively, for the quarter and nine-month period ended September 30, 2009, compared to $18.2 million and $54.0 million, respectively, in the year ago periods, resulting in an efficiency ratio of 50.82% and 51.31%, respectively, for the quarter and nine-month period ended September 30, 2009 (compared to 53.03% and 53.07% in the year-ago periods).

Income Tax Expense
The income tax expense was $3.0 million and $8.5 million, respectively, for the quarter and nine-month period ended September 30, 2009, which includes Puerto Rico’s additional taxes on international banking entities and financial institutions, compared to a benefit of $4.2 million and $6.1 million for the respective periods ended September 30, 2008.
Group’s Financial Assets
The Group’s total financial assets include owned assets and the assets managed by the trust division, the securities broker-dealer subsidiary, and the private pension plan administration subsidiary. At September 30, 2009, total financial assets reached $9.376 billion, compared to $9.108 billion at December 31, 2008, a 2.94% increase. When compared to December 31, 2008, there was 2.83% increase in assets owned as of September 30, 2009, while assets managed by the trust division and the broker-dealer subsidiary increased from $2.902 billion as of December 31, 2008 to $2.995 billion as of September 30, 2009.
The Group’s trust division offers various types of individual retirement accounts (“IRA”) and manages 401(K) and Keogh retirement plans and custodian and corporate trust accounts, while Caribbean Pension Consultants, Inc. (“CPC”) manages the administration of private pension plans. At September 30, 2009, total assets managed by the Group’s trust division and CPC amounted to $1.759 billion, compared to $1.706 billion at December 31, 2008. The Group’s broker-dealer subsidiary offers a wide array of investment alternatives to its client base, such as tax-advantaged fixed income securities, mutual funds, stocks, bonds and money management wrap-fee programs. At September 30, 2009, total assets gathered by the broker-dealer from its customer investment accounts increased to $1.235 billion, compared to $1.196 billion at December 31, 2008.
Interest Earning Assets
The investment portfolio amounted to $4.513 billion at September 30, 2009, a 14.4% increase compared to $3.946 billion at December 31, 2008, while the loan portfolio decreased 5.5% to $1.152 billion at September 30, 2009, compared to $1.219 billion at December 31, 2008.
The mortgage loan portfolio totaled $955.6 million at September 30, 2009, a 7.3% decrease from $1.031 billion at September 30, 2008, and a decrease of 6.6%, from $1.023 billion at December 31, 2008. Mortgage loan production for the quarter and nine-month period ended September 30, 2009, totaled $56.2 million and $188.1 million, respectively, which represents an increase of 0.2% for the quarter and a 3.7% increase for the nine-month period from the preceding year.
Interest Bearing Liabilities
Total deposits amounted to $1.918 billion at September 30, 2009, an increase of 7.5% compared to $1.785 billion at December 31, 2008, primarily due to increased retail deposits, particularly in demand deposit accounts.
Stockholders’ Equity
Stockholders’ equity at September 30, 2009, was $382.6 million, compared to $261.3 million at December 31, 2008, mainly reflecting increased earnings in the nine-month period.
The Group maintains capital ratios in excess of regulatory requirements. At September 30, 2009, Tier 1 Leverage Capital Ratio was 7.69% (1.92 times the requirement of 4.00%), Tier 1 Risk-Based Capital Ratio was 15.81% (3.95 times the requirement of 4.00%), and Total Risk-Based Capital Ratio was 16.45% (2.06 times the requirement of 8.00%).
Due to the initial adoption of FASB ASC 320-10-65-1, in the second quarter of 2009 the Group reclassified the noncredit-related portion of an other-than-temporary impairment loss previously recognized in earnings in the third quarter of 2008 for an amount of $14.4 million that increased retained earnings and accumulated other comprehensive loss. This reclassification had a positive impact on regulatory capital, but no impact on stockholders’ equity.

Financial Service-Banking Franchise
The Group’s niche market approach to the integrated delivery of services to mid and high net worth clients performed well as Oriental expanded market share based on its service proposition and capital strength, as opposed to using rates to attract loans or deposits.
Lending
Total loan production and purchases of $69.2 million for the quarter remained strong, as the Group’s capital levels and low credit losses enabled it to continue prudent lending. The average FICO score was 724 and the average loan to value ratio was 84% on residential mortgage loans originated in the quarter.
The Group sells most of its conforming mortgages, which represented 94% of third quarter production, into the secondary market, and retains servicing rights. As a result, mortgage banking activities now reflect originations as well as a growing servicing portfolio, a source of recurring revenue.
Deposits
Growth in retail deposits primarily reflects increases in demand and savings deposits of $97.5 million in the quarter and $338.7 million year to date. The Group also reduced brokered deposits by $55.4 million in the quarter and $164.4 million year to date.
Assets Under Management
Assets under management increased 5.19% from June 30, 2009, to $2.99 billion, which contributed to a 14.6% sequential growth in financial service revenues.
Credit Quality
Net credit losses declined by 54.69%, to $0.9 million (0.32% of average loans outstanding), from $2.1 million (0.70%), in the previous quarter. The Group increased its provision for loan losses to $4.4 million, mainly due to an increase in non-performing commercial loans, resulting in a $20.2 million allowance at September 30, 2009, up 20.68% from the preceding quarter.
Non-performing loans (NPLs) increased $3.2 million in the quarter. The Group’s NPLs generally reflect the economic environment in Puerto Rico. The Group does not expect non-performing loans to result in significantly higher losses as most are well-collateralized with adequate loan-to-value ratios. In residential mortgage lending, more than 90% of the Group’s portfolio consists of fixed-rate, fully amortizing, fully documented loans that do not have the level of risk generally associated with subprime loans. In commercial lending, more than 90% of its loans are collateralized by real estate.

Net interest income is a function of the difference between rates earned on the Group’s interest-earning assets and rates paid on its interest-bearing liabilities (interest rate spread) and the relative amounts of its interest-earning assets and interest-bearing liabilities (interest rate margin). The Group constantly monitors the composition and re-pricing of its assets and liabilities to maintain its net interest income at adequate levels.
For the quarter and nine-month period ended September 30, 2009, net interest income amounted to $32.9 million and $99.0 million, respectively, an increase of 17.3% and 21.5% from $28.0 million and $81.5 million, in the same periods of the previous year. The increase for the quarter and nine-month period reflects a 19.5% and 14.7% decrease in interest expense, due to a negative rate variance of interest-bearing liabilities of $12.8 million and $32.9 million, respectively, partially offset by a positive volume variance of interest-bearing liabilities $1.8 million and $7.9 million, respectively. The decrease of 7.3% and 3.0% in interest income for the quarter and nine-month period ended September 30, 2009, was primarily the result of a decrease of $7.1 million and $14.1 million, respectively in rate variance, partially offset by an increase of $1.0 million and $6.6 million, respectively, in volume variance. Interest rate spread increased 44 basis points to 2.07% for the quarter ended September 30, 2009 from 1.63% in the September 30, 2008 quarter, and 45 basis points to 2.01% for the nine-month period ended September 30, 2009 from 1.56% for the year ago period. These increases reflect a 113 basis point decrease in the average cost of funds to 3.13% in the quarter ended September 30, 2009 from 4.26% in September 30, 2008 quarter, partially offset by a 48 basis point decrease in the average yield of interest earning assets to 5.19% in the quarter ended September 30, 2009 from 5.67% in September 30, 2008 quarter; and a 91 point decrease in the average cost of funds to 3.33% in the nine-month period ended September 30, 2009 from 4.24% for the year ago period, partially offset by a 33 basis point decrease in the average yield of interest earning assets to 5.31% in the nine-month period ended September 30, 2009 from 5.64% for the year ago period.
For the quarter and nine-month period ended September 30, 2009, the average balances of total interest-earnings assets were $6.056 billion and $6.136 billion, respectively, a 1.3% and 3.0% increase from the same periods last year. The increase in the quarterly average balance of the 2009 third quarter reflects increases of 2.7% to $4.886 billion in the investment portfolio, partially offset by a decrease of 4.5% to $1.170 billion in the loans portfolio from the same period in previous year. The increase in the nine-month period average balance reflects increases of 4.2% to $4.950 billion in the investment portfolio, partially offset by a decrease of 1.8% to $1.186 billion in the loans portfolio for the 2009 nine-month period.
For the quarter and nine-month period ended September 30, 2009, the average yield on interest-earning assets was 5.19% and 5.31%, respectively, compared to 5.67% and 5.64% in the same periods last year, due to lower average yields in the loan portfolio and the investment portfolio. The loan portfolio yield decreased to 6.24% and 6.21% in the quarter and nine-month period ended September 30, 2009, respectively, versus 6.52% and 6.57% in the same periods last year, respectively. The investment portfolio yield decreased to 4.94% and 5.10% in the quarter and nine-month period ended September 30, 2009, respectively, versus 5.45% and 5.40% in the same periods last year, respectively.
For the quarter and nine-month period ended September 30, 2009, interest expense amounted to $45.7 million and $145.5 million, respectively, a decrease of 19.5% and 14.7%, respectively, from $56.7 million and $170.5 million, in the same periods last year, mainly resulting from a significant reduction in cost of funds, which has declined more rapidly than the yield on interest-earning assets. Reduction in cost of funds is mostly due to structured repurchase agreements amounting $1.25 billion, which reset at the put date at a formula which is based on the three-month LIBOR rate less fifteen times the difference between the ten-year SWAP rate and the two-year SWAP rate, with a minimum of 0.00% on $1.0 billion and 0.25% on $250 million, and a maximum of 10.6%. These repurchase agreements bear the respective minimum rates of 0.0% (from March 6, 2009) and 0.25% (from March 2, 2009) to at least their next put dates scheduled for December 2009.
For the quarter ended September 30, 2009, the cost of deposits decreased 31 basis points to 3.10%, as compared to the same period a year ago. For the nine-month period ended September 30, 2009, the cost of deposits decreased 40 basis points to 3.21%, as compared to the same period a year ago. The decrease reflects lower average rates paid on higher balances, most significantly in savings and certificates of deposit accounts. For the quarter and nine-month period ended September 30, 2009, the cost of borrowings decreased 113 basis points and 91 basis points, respectively, to 3.13% and 3.33%, respectively, from the same periods last year.

Non-interest income is affected by the amount of securities, derivatives and trading transactions, the level of trust assets under management, transactions generated by the gathering of financial assets by the securities broker-dealer subsidiary, the level of investment and mortgage banking activities, and the fees generated from loans, deposit accounts, and insurance activities.
Non-interest income totaled $16.3 million and $79.6 million in the quarter and nine-month period ended September 30, 2009, an increase of 128.6% and 291.1% when compared to non-interest losses of $57.0 million and $41.7 million in the same periods last year. Increase in revenues from sale of securities was partially offset by decrease in financial service revenues.
Financial service revenues, which consist of commissions and fees from fiduciary activities, and commissions and fees from securities brokerage, and insurance activities, increased 18.3% and 7.4% to $7.4 million and $21.7 million in the quarter and nine-month period ended September 30, 2009, respectively, from $6.3 million and $20.2 million in the same periods of 2008, mainly the result of higher mortgage banking activities. Banking service revenue, which consists primarily of fees generated by deposit accounts, electronic banking services, and customer services, increased 1.1% and 1.2% to $1.4 million and $4.4 million in the quarter and nine-month period ended September 30, 2009, respectively, from $1.4 million and $4.3 million in the same periods last year, mainly driven by increase in consumer banking activity. Income generated from mortgage banking activities increased 145.3% and 192.2% in the quarter and nine-month period ended September 30, 2009, respectively, from $910 thousand and $2.5 million in the quarter and nine-month period ended September 30, 2008, to $2.2 million and $7.2 million in the same periods of 2009 mainly the result of increased mortgage banking revenues due to the securitization and sale of mortgage loans held-for-sale into the secondary market and increase in residential mortgage loan production.

For the quarter and nine-month period ended September 30, 2009, gains from securities, derivatives, trading activities and other investment activities were $8.9 million and $57.9 million, compared to a loss of $63.3 million and $61.9 million for the same periods last year. During the quarter ended September 30, 2009, a loss of $64 thousands and during the nine-month period ended September 30, 2009, gain of $19.8 million, respectively, was recognized in derivatives, compared to a loss of $5.5 million and $13.2 million, respectively. During the third quarter of 2008, the Group charged $4.9 million as a loss in connection with equity indexed option agreements, and recorded an other-than-temporary non-cash loss of $58.8 million. Results for the nine months of 2008 include an interest-rate swap contract that the Group entered into on January 2008 to manage the Group’s interest rate risk exposure with a notional amount of $500.0 million, which was subsequently terminated resulting in a loss to the Group of approximately $7.9 million. Keeping with the Group’s investment strategy, during the nine-month periods ended September 30, 2009 and 2008, there were certain sales of available-for-sale securities because the Group felt at the time of such sales that gains could be realized while at the same time having good opportunities to invest the proceeds in other investment securities with attractive yields and terms that would allow the Group to continue to protect its net interest margin. Sale of securities available-for-sale, which generated gains of $35.5 million and $56.4 million, for the quarter and nine-month period ended September 30, 2009, respectively, increased when compared to $386 thousand and $9.9 million in the same periods a year ago. During the quarter and nine-month period ended September 30, 2009, a loss of $505 thousand and a gain of $12.4 million, respectively, was recognized in trading securities, compared to a loss of $31 thousand and a loss of $32 thousand, respectively.
The Group adopted the provisions of FASB ASC 320-10-65-1 as of April 1, 2009. For those debt securities for which the fair value of the security is less than its amortized cost, the Group does not intend to sell such security and it is more likely than not that it will not be required to sell such security prior to the recovery of its amortized cost basis less any current period credit losses. These provisions require that the credit-related portion of other-than-temporary impairment losses be recognized in earnings while the noncredit-related portion is recognized in other comprehensive income, net of related taxes. As a result of the adoption of FASB ASC 320-10-65-1 and as more fully described below, in the second and third quarter of 2009 a $4.4 million and $8.3 million, respectively, net credit-related impairment loss was recognized in earnings and a $94.7 million noncredit-related impairment loss was recognized in other comprehensive income for several non-agency collateralized mortgage obligation pools not expected to be sold. Also in accordance with FASB ASC 320-10-65-1, in the second quarter of 2009 the Group reclassified the noncredit-related portion of an other-than-temporary impairment loss previously recognized in earnings in the third quarter of 2008. This reclassification was reflected as a cumulative effect adjustment of $14.4 million that increased retained earnings and increased accumulated other comprehensive loss. The amortized cost basis of this non-agency collateralized mortgage obligation pool for which an other-than-temporary impairment loss was recognized in the third quarter of 2008 was adjusted by the amount of the cumulative effect adjustment. These other-than-temporary impairment losses do not have income tax effect because the impaired securities are held in the Group’s IBE, and potential recoveries of these losses, if any, are expected to occur in a period in which the income earned by IBE, would be 100% exempt from income taxes.

Non-interest expenses for the quarter and nine-month period ended September 30, 2009 were $20.5 million and $62.0 million, representing an increase of 12.6% and 14.7%, respectively, when compared to $18.2 million and $54.0 million in the same periods a year ago, primarily as a result of higher insurance expense, occupancy and equipment, professional and service fees, advertising and business promotion. Insurance expense increased 106.0% and 209.1% for quarter and nine-month period ended September 30, 2009, respectively, from $618 thousand and $1.8 million in the quarter and nine-month period ended September 30, 2008 to $1.3 million and $5.6 million in the same periods for 2009, mostly as a result of the industry-wide FDIC special assessment on insured depository institutions recognized during the second quarter of 2009, which was paid on September 2009. Occupancy and equipment charges increased 5.2% and 7.6% to $3.7 million and $11.0 million for the quarter and nine-month period ended September 30, 2009, respectively, from $3.6 million and $10.2 million in the same periods a year ago. Professional and service fee increased to $2.5 million and $7.5 million, representing an increase of 0.1% and 13.0% for the quarter and nine-month period ended September 30, 2009, respectively, when compared to $2.5 million and $6.6 million in the same periods a year ago. Advertising and business promotion increased 29.5% and 20.7% for the quarter and nine-month period ended September 30, 2009, respectively, from $847 thousands and $2.8 million in the quarter and nine-month period ended September 30, 2008 to $1.1 million and $3.3 million in the same periods for 2009. The non-interest expense results reflect an efficiency ratio of 50.82% for the quarter ended September 30, 2009, compared to 53.03% in the same quarter last year. For the nine-month period ended September 30, 2009, the efficiency ratio was 51.31% compared to 53.07% for the same periods last year. The efficiency ratio measures how much of a company’s revenue is used to pay operating expenses. The Group computes its efficiency ratio by dividing non-interest expenses by the sum of its net interest income and non-interest income, but excluding gains on sale of investments securities, derivatives gains or losses and other income that may be considered volatile in nature. Management believes that the exclusion of those items permit greater comparability. Amounts presented as part of non-interest income that are excluded from the efficiency ratio computation amounted to $8.9 million and $57.9 million for the nine-month periods ended September 30, 2009 and 2008, respectively.

The provision for loan losses for the quarter and nine-month period ended September 30, 2009, totaled $4.4 million and $11.3 million, representing an increase of 125.6% and 101.6% from the $2.0 million and $5.6 million reported for the same periods last year. Based on an analysis of the credit quality and composition of the Group’s loan portfolio, management determined that the provision for the quarter and nine-month period ended September 30, 2009 was adequate in order to maintain the allowance for loan losses at an adequate level.
Net credit losses for the quarter ended September 30, 2009 decreased 31.2% to $942 thousand from $1.4 million and for the nine-month period ended September 30, 2009, increased 63.9% to $5.4 million from $3.3 million in the same periods of 2008. The increase was primarily due to higher net credit losses from mortgage loans and commercial loans. Non-performing loans of $93.1 million at September 30, 2009, were 35.6% higher than the $68.6 million at September 30, 2008, and 20.1% higher than the $77.5 million at December 31, 2008.
The Group maintains an allowance for loan losses at a level that management considers adequate to provide for probable losses based upon an evaluation of known and inherent risks. The Group’s allowance for loan losses policy provides for a detailed quarterly analysis of probable losses.
The Group follows a systematic methodology to establish and evaluate the adequacy of the allowance for loan losses to provide for inherent losses in the loan portfolio. This methodology includes the consideration of factors such as economic conditions, portfolio risk characteristics, prior loss experience, and results of periodic credit reviews of individual loans. The provision for loan losses charged to current operations is based on such methodology. Loan losses are charged and recoveries are credited to the allowance for loan losses.
Larger commercial loans that exhibit potential or observed credit weaknesses are subject to individual review and grading. Where appropriate, allowances are allocated to individual loans based on management’s estimate of the borrower’s ability to repay the loan given the availability of collateral, other sources of cash flow and legal options available to the Group.
Included in the review of individual loans are those that are impaired. A loan is considered impaired when, based on current information and events, it is probable that the Group will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Impaired loans are measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate, or as a practical expedient, at the observable market price of the loan or the fair value of the collateral, if the loan is collateral dependent. Loans are individually evaluated for impairment, except large groups of small balance homogeneous loans that are collectively evaluated for impairment, and loans that are recorded at fair value or at the lower of cost or market. The portfolios of mortgage and consumer loans are considered homogeneous, and are evaluated collectively for impairment. For the commercial loans portfolio, all loans over $250 thousand and over 90-days past due are evaluated for impairment. At September 30, 2009, the total investment in impaired loans was $6.8 million, compared to $4.6 million at December 31, 2008. Impaired loans are measured based on the fair value of collateral method, since all impaired loans during the period were collateral dependant. The valuation allowance for impaired loans amounted to approximately $265 thousand and $1.1 million at September 30, 2009 and December 31, 2008, respectively. Net credit losses on impaired loans for the nine-month period ended September 30, 2009 were $776 thousand. There were no credit losses on impaired loans for the nine-month period ended September 30, 2008 .
The Group, using a rating system, applies an overall allowance percentage to each loan portfolio category based on historical credit losses adjusted for current conditions and trends. This delinquency-based calculation is the starting point for management’s determination of the required level of the allowance for loan losses. Other data considered in this determination includes overall historical loss trends and other information, including underwriting standards, economic trends and unusual events.
Loan loss ratios and credit risk categories are updated quarterly and are applied in the context of GAAP and the Joint Interagency Guidance on the importance of depository institutions having prudent, conservative, but not excessive loan loss allowances that fall within an acceptable range of estimated losses. While management uses available information in estimating probable loan losses, future changes to the allowance may be necessary, based on factors beyond the Group’s control, such as factors affecting general economic conditions.
In the current year, the Group has not substantively changed in any material respect of its overall approach in the determination of the allowance for loan losses. There have been no material changes in criteria or estimation techniques as compared to prior periods that impacted the determination of the current period allowance for loan losses.


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